10-Q 1 chke-10q_20180804.htm 10-Q chke-10q_20180804.htm

Table of Content

 

 

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 August 4, 2018.

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 every Interactive Data File required to be submitted 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 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 September 7, 2018

Common Stock, $.02 par value per share

 

14,045,368

 

 

 

 


Table of Content

 

CHEROKEE INC.

 

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION

    

 

 

 

 

ITEM 1. Financial Statements (unaudited):

 

 

 

 

 

Condensed Consolidated Balance Sheets
August 4, 2018 and February 3, 2018

 

3

 

 

 

Condensed Consolidated Statements of Operations
Three and six months ended August 4, 2018 and July 29, 2017

 

4

 

 

 

Condensed Consolidated Statements of Cash Flows
Six months ended August 4, 2018 and July 29, 2017

 

5

 

 

 

Notes to Condensed Consolidated Financial Statements

 

6

 

 

 

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

 

14

 

 

 

ITEM 3. Quantitative and Qualitative Disclosures about Market Risk

 

21

 

 

 

ITEM 4. Controls and Procedures

 

21

 

 

 

PART II. OTHER INFORMATION

 

22

 

 

 

ITEM 1. Legal Proceedings

 

22

 

 

 

ITEM 1A. Risk Factors

 

22

 

 

 

ITEM 6. Exhibits

 

25

 

 

 

SIGNATURES

 

27

 

 

2


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PART 1. FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

CHEROKEE INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except share and per share amounts)

 

 

 

August 4,

 

 

February 3,

 

 

 

2018

 

 

2018

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

6,748

 

 

$

3,174

 

Accounts receivable, net

 

 

5,419

 

 

 

9,805

 

Other receivables

 

 

559

 

 

 

472

 

Prepaid expenses and other current assets

 

 

792

 

 

 

1,258

 

Current assets of discontinued operations

 

 

 

 

 

1,868

 

Total current assets

 

 

13,518

 

 

 

16,577

 

Property and equipment, net

 

 

717

 

 

 

1,090

 

Intangible assets, net

 

 

65,014

 

 

 

69,548

 

Goodwill

 

 

16,252

 

 

 

16,352

 

Accrued revenue and other assets

 

 

1,158

 

 

 

30

 

Total assets

 

$

96,659

 

 

$

103,597

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

7,701

 

 

$

7,205

 

Other current liabilities

 

 

8,668

 

 

 

7,370

 

Current portion of long term debt

 

 

800

 

 

 

46,105

 

Deferred revenue—current

 

 

1,876

 

 

 

2,229

 

Current liabilities of discontinued operations

 

 

155

 

 

 

1,103

 

Total current liabilities

 

 

19,200

 

 

 

64,012

 

Long term liabilities:

 

 

 

 

 

 

 

 

Long term debt

 

 

49,145

 

 

 

 

Deferred income taxes

 

 

11,242

 

 

 

10,466

 

Other liabilities

 

 

3,230

 

 

 

5,004

 

Total liabilities

 

 

82,817

 

 

 

79,482

 

Commitments and Contingencies (Note 9)

 

 

 

 

 

 

 

 

Stockholders’ Equity:

 

 

 

 

 

 

 

 

Preferred stock, $.02 par value, 1,000,000 shares authorized, none issued

 

 

 

 

 

 

Common stock, $.02 par value, 20,000,000 shares authorized, shares issued

  14,045,368 (August 4, 2018) and 13,997,200 (February 3, 2018)

 

 

281

 

 

 

280

 

Additional paid-in capital

 

 

75,622

 

 

 

74,377

 

Accumulated deficit

 

 

(62,061

)

 

 

(50,542

)

Total stockholders’ equity

 

 

13,842

 

 

 

24,115

 

Total liabilities and stockholders’ equity

 

$

96,659

 

 

$

103,597

 

 

See notes to condensed consolidated financial statements.

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CHEROKEE INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except per share amounts)

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

August 4,

 

 

July 29,

 

 

August 4,

 

 

July 29,

 

 

 

2018

 

 

2017

 

 

2018

 

 

2017

 

Revenues

 

$

7,073

 

 

$

7,868

 

 

$

12,475

 

 

$

14,685

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general and administrative expenses

 

 

3,987

 

 

 

6,300

 

 

 

8,343

 

 

 

12,248

 

Stock-based compensation

 

 

125

 

 

 

558

 

 

 

425

 

 

 

1,094

 

Business acquisition and integration costs

 

 

 

 

 

1,776

 

 

 

307

 

 

 

3,822

 

Restructuring charges

 

 

5,615

 

 

 

 

 

 

5,615

 

 

 

128

 

Gain on sale of asset

 

 

(571

)

 

 

 

 

 

(571

)

 

 

 

Depreciation and amortization

 

 

330

 

 

 

346

 

 

 

931

 

 

 

791

 

Total operating expenses

 

 

9,486

 

 

 

8,980

 

 

 

15,050

 

 

 

18,083

 

Operating loss

 

 

(2,413

)

 

 

(1,112

)

 

 

(2,575

)

 

 

(3,398

)

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(2,360

)

 

 

(1,601

)

 

 

(4,097

)

 

 

(3,123

)

Other income (expense), net

 

 

(3,229

)

 

 

(51

)

 

 

(3,233

)

 

 

(232

)

Total other expense, net

 

 

(5,589

)

 

 

(1,652

)

 

 

(7,330

)

 

 

(3,355

)

Loss from continuing operations before income taxes

 

 

(8,002

)

 

 

(2,764

)

 

 

(9,905

)

 

 

(6,753

)

Provision for income taxes

 

 

1,051

 

 

 

2,002

 

 

 

1,889

 

 

 

1,555

 

Net loss from continuing operations

 

 

(9,053

)

 

 

(4,766

)

 

 

(11,794

)

 

 

(8,308

)

Income from discontinued operations, net of income taxes

 

 

 

 

 

143

 

 

 

 

 

 

426

 

Net loss

 

$

(9,053

)

 

$

(4,623

)

 

$

(11,794

)

 

$

(7,882

)

Net loss per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic loss per share from continuing operations

 

$

(0.65

)

 

$

(0.37

)

 

$

(0.84

)

 

$

(0.64

)

Diluted loss per share from continuing operations

 

$

(0.65

)

 

$

(0.37

)

 

$

(0.84

)

 

$

(0.64

)

Basic (loss) earnings from discontinued operations per

  share

 

$

 

 

$

0.01

 

 

$

 

 

$

0.03

 

Diluted (loss) earnings from discontinued operations

  per share

 

$

 

 

$

0.01

 

 

$

 

 

$

0.03

 

Basic loss per share

 

$

(0.65

)

 

$

(0.36

)

 

$

(0.84

)

 

$

(0.61

)

Diluted loss per share

 

$

(0.65

)

 

$

(0.36

)

 

$

(0.84

)

 

$

(0.61

)

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

14,030

 

 

 

12,986

 

 

 

14,014

 

 

 

12,970

 

Diluted

 

 

14,030

 

 

 

12,986

 

 

 

14,014

 

 

 

12,970

 

 

See notes to condensed consolidated financial statements.

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CHEROKEE INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

 

 

Six Months Ended

 

 

 

August 4,

 

 

July 29,

 

 

 

2018

 

 

2017

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net loss from continuing operations

 

$

(11,794

)

 

$

(8,308

)

Adjustments to reconcile net loss to net cash used in operating

  activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

931

 

 

 

791

 

Bad debt expense

 

 

 

 

 

193

 

Restructuring charges

 

 

5,615

 

 

 

128

 

Amortization of deferred financing costs

 

 

3,396

 

 

 

527

 

Deferred income taxes and noncurrent provisions

 

 

1,442

 

 

 

1,332

 

Stock-based compensation and stock warrant charges

 

 

469

 

 

 

1,120

 

Gain on sale of assets

 

 

(571

)

 

 

 

Changes in operating assets and liabilities, net of effects from business

  combinations:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

4,577

 

 

 

809

 

Other receivables

 

 

(87

)

 

 

(2,510

)

Prepaid expenses and other current assets

 

 

462

 

 

 

1,991

 

Other assets

 

 

(778

)

 

 

 

Accounts payable

 

 

775

 

 

 

(5,509

)

Other current liabilities

 

 

(4,637

)

 

 

619

 

Deferred revenue

 

 

(1,823

)

 

 

(2,335

)

Net cash used in operating activities

 

 

(2,023

)

 

 

(11,152

)

Net cash (used in) provided by operating activities from

  discontinued operations

 

 

(1,225

)

 

 

5,115

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Capital investments

 

 

(67

)

 

 

(420

)

Proceeds from business disposition and sale of assets

 

 

5,668

 

 

 

 

Net cash provided by (used in) investing activities

 

 

5,601

 

 

 

(420

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Proceeds from term loan, subordinated promissory notes and line of credit

 

 

42,000

 

 

 

5,000

 

Payments on term loan and line of credit

 

 

(38,000

)

 

 

(800

)

Debt issuance costs

 

 

(2,780

)

 

 

 

 

Payments on related party loan

 

 

 

 

 

(2,500

)

Issuance of common stock

 

 

1

 

 

 

47

 

Net cash provided by financing activities

 

 

1,221

 

 

 

1,747

 

Increase (decrease)  in cash and cash equivalents

 

 

3,574

 

 

 

(4,710

)

Cash and cash equivalents, beginning of period

 

 

3,174

 

 

 

8,378

 

Cash and cash equivalents, end of period

 

$

6,748

 

 

$

3,668

 

Cash paid for:

 

 

 

 

 

 

 

 

Income taxes

 

$

536

 

 

$

817

 

Interest

 

$

3,753

 

 

$

2,271

 

Noncash investing and financing activities:

 

 

 

 

 

 

 

 

Conversion of junior participation interests to subordinated promissory notes

 

$

11,500

 

 

$

 

 

 

See notes to condensed consolidated financial statements.

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CHEROKEE INC.

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statement presentation.  These financial statements include the accounts of Cherokee Inc. and its consolidated subsidiaries (the “Company”) and include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the Company’s financial condition and the results of operations for the periods presented.  The condensed consolidated financial statements and notes thereto should be read in conjunction with the audited financial statements and notes thereto for the year ended February 3, 2018 included in the Company’s Annual Report on Form 10-K.  Interim results are not necessarily indicative of results to be expected for the full year.

 

Liquidity and Going Concern

 

The accompanying condensed consolidated financial statements have been prepared on the going concern basis of accounting, which assumes the Company will continue to operate as a going concern and which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business.  The report of the Company’s independent registered public accounting firm included in the Company’s Annual Report on Form 10-K for the fiscal year ended February 3, 2018 included an explanatory paragraph describing the uncertainty about the Company’s ability to continue as a going concern at that time.  The uncertainty about the Company’s ability to continue as a going concern previously arose due to forecasted noncompliance with the Company’s previous credit facility that was repaid on August 3, 2018 and replaced with a new term loan and subordinated promissory notes. (See Note 8.)  Under the new term loan agreement, the Company is required to raise $2.0 million of additional liquidity before May 4, 2019; however, this will not be required if the Company’s average working capital exceeds an agreed upon level at the close of the Company’s fiscal year ending February 2, 2019.  

 

The Company’s current forecast indicates that it will need to raise this additional $2.0 million of capital, and because raising additional capital is not certain, there is substantial doubt about the Company’s ability to continue as a going concern.  The new term loan agreement provides various ways in which the Company can raise additional capital, including the issuance of additional subordinated debt, the issuance of convertible subordinated debt instruments or the issuance of additional equity, from which 100% of the net proceeds would be retained by the Company.  The new term loan agreement also provides that the Company can increase its working capital by the disposition of non-core intangible assets, from which 50% of the net proceeds would be retained by the Company and 50% would be used to repay a portion of the term loan.  The Company’s management is planning to increase its working capital through the disposition of non-core assets, or through improved operations to achieve the required working capital threshold at the close of the Company’s fiscal year ending February 2, 2019, which would eliminate the requirement to raise the additional $2.0 million of capital.

 

2.

New Accounting Pronouncements  

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued a comprehensive new revenue recognition standard (“ASC 606”) that superseded previous existing revenue recognition guidance and was adopted by the Company using the modified retrospective method as of February 4, 2018, the beginning of the first quarter of its fiscal year ending February 2, 2019.  The adoption of the new guidance primarily affected the recognition of minimum guaranteed royalties under the Company’s agreements with its licensees that have historically been recognized as earned in accordance with the underlying license agreements.  Under this new standard, such royalties will generally be recognized on a straight-line basis over the term of the license agreement.  Accordingly, for license agreements with escalating minimum guaranteed royalties, revenues will generally be higher during the early years of the license

6


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agreement than they would have been under the previous guidance.  Royalties are typically earned based on the licensees’ retail or wholesale sales of licensed products, or based on the cost of producing the licensed goods.  Revenues from license fees, up-front payments and milestone payments, which are received in connection with other rights and services that represent continuing obligations of the Company, are deferred and recognized in accordance with the license agreements.  The cumulative effect on adoption of ASC 606 totaled $0.3 million, resulting in a charge to accrued revenue and an adjustment to deferred revenue with a corresponding credit to accumulated deficit for all contracts not completed as of the adoption date.  In the three and six months ended August 4, 2018 the Company recognized additional revenue of $0.3 million and $0.6 million, respectively, as a result of applying ASC 606.  The comparative information for the prior period has not been restated.   

 

The Company recognizes contract liabilities as deferred revenue when licensees prepay royalties, or from license fees, up-front payments and milestone payments that have not yet been earned.  Deferred revenue is classified as current or noncurrent depending on when it is anticipated to be recognized.  Deferred revenue totaled $2.6 million and $5.1 million at August 4, 2018 and February 3, 2018, respectively.  Revenue recognized in the three and six months ended August 4, 2018 that was previously included in deferred revenue was $0.9 million and $1.8 million, respectively.  The Company recognizes contract assets as accrued revenue when minimum guaranteed royalties are recognized that have not yet been earned under the license agreements.  The Company typically bills and receives payments from customers on a quarterly basis for royalties earned or for minimum guaranteed royalties that have historically been recognized as earned in accordance with the underlying license agreements.  Accrued revenue is classified as current or noncurrent depending on when the asset is anticipated to be charged to revenue.  Accrued revenue totaled $0.9 million and $0.4 million at August 4, 2018 and February 4, 2018, respectively.  Revenue recognized in the three and six months ended August 4, 2018 for minimum guaranteed royalties that had not yet been earned was $0.3 million and $0.6 million, respectively.   

 

The Company’s remaining performance obligation is to maintain the licensed intellectual property. As of August 4, 2018, the Company had a contractual right to receive approximately $64.1 million of aggregate minimum licensing revenue through the remaining terms of the current licenses, excluding any renewals, which is primarily expected to be recognized approximately over the next 10 years.

 

3.

Earnings (Loss) Per Share

Basic earnings (loss) per share (“EPS”) is computed by dividing the net (loss) income attributable to common stockholders by the weighted-average number of common shares outstanding during the period, while diluted EPS additionally includes the dilutive effect of outstanding stock options and warrants as if such securities had been exercised at the beginning of the period.  The computation of diluted common shares outstanding excludes outstanding stock options and warrants that are anti‑dilutive.  

4.

Discontinued Operations

The Company’s sales and distribution business for its Hi-Tec portfolio of brands, which operates in Latin America, the Middle East, Russia and Asia Pacific was sold to International Brands Group (“IBG”) during the fourth quarter of Fiscal 2018 for $3.1 million.  Cash proceeds of $1.3 million were received during the fourth quarter of Fiscal 2018, and $1.8 million of cash proceeds were received by the Company in the three months ended May 5, 2018.  The operating assets and liabilities of this business were sold to IBG in conjunction with the execution of a separate license agreement that grants IBG certain sales and distribution rights for Hi-Tec products in those territories.  The discontinued sales and distribution business was previously included in the Company’s Hi-Tec reporting segment.

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The net income from discontinued operations in the condensed consolidated statement of operations includes the following:

 

(In thousands)

 

Three Months

Ended

July 29, 2017

 

 

Six Months

Ended

July 29, 2017

 

Product sales and royalty revenues

 

$

6,096

 

 

$

10,366

 

Cost of goods sold

 

 

4,830

 

 

 

7,820

 

Selling, general and administrative expenses

 

 

1,081

 

 

 

2,036

 

Depreciation and amortization

 

 

42

 

 

 

84

 

Pretax income from discontinued operations

 

 

143

 

 

 

426

 

Income tax (benefit) provision

 

 

 

 

 

 

Net income from discontinued operations

 

$

143

 

 

$

426

 

 

The carrying amounts of assets and liabilities included in discontinued operations comprise the following:

 

 

 

August 4,

 

 

February 3,

 

(In thousands)

 

2018

 

 

2018

 

Accounts receivable and amounts due from sale of business

 

$

 

 

$

1,868

 

Current liabilities of discontinued operations

 

 

155

 

 

 

1,103

 

Net assets of discontinued operations

 

$

(155

)

 

$

765

 

 

5.

Intangible Assets

Intangible assets consist of the following:

 

 

 

August 4, 2018

 

 

February 3, 2018

 

(In thousands)

 

Gross

Amount

 

 

Accumulated

Amortization

 

 

Net Book

Value

 

 

Gross

Amount

 

 

Accumulated

Amortization

 

 

Net Book

Value

 

Amortizable trademarks

 

$

27,823

 

 

 

(19,496

)

 

$

8,327

 

 

$

30,861

 

 

 

(19,029

)

 

$

11,832

 

Amortizable franchise agreements

 

 

 

 

 

 

 

 

 

 

 

1,300

 

 

 

(271

)

 

 

1,029

 

Indefinite lived trademarks

 

 

56,687

 

 

 

 

 

 

56,687

 

 

 

56,687

 

 

 

 

 

 

56,687

 

 

 

$

84,510

 

 

$

(19,496

)

 

$

65,014

 

 

$

88,848

 

 

$

(19,300

)

 

$

69,548

 

 

During the three months ended August 4, 2018, the Company sold its amortizable trademarks, amortizable franchise agreements and other assets related to its Flip Flop Shops franchise business to a third party.  A gain of $0.6 million was recognized on the sale.  The Hi-Tec Acquisition during Fiscal 2017 resulted in trademarks valued at $52.4 million that are classified as indefinite lived and not subjected to amortization.  Other indefinite lived trademarks include certain Cherokee brand trademarks in the school uniforms category that were acquired in historical transactions.  The Company has acquired other trademarks that are being amortized over their estimated useful lives, which average 10.0 years with no residual values.  Amortization of intangible assets was $0.2 million and $0.2 million for the three months ended August 4, 2018 and July 29, 2017, respectively, and $0.6 million and $0.4 million for the six months ended August 4, 2018 and July 29, 2017, respectively.   Goodwill arose from the Hi-Tec Acquisition that occurred during Fiscal 2017.

 

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6.

Other Current Liabilities

Other current liabilities consists of the following:

 

 

 

August 4,

 

 

February 3,

 

(In thousands)

 

2018

 

 

2018

 

Accrued employee compensation and benefits

 

$

307

 

 

$

239

 

Amounts payable for business acquisitions

 

 

993

 

 

 

1,901

 

Restructuring plan liabilities

 

 

6,227

 

 

 

3,532

 

Income taxes payable

 

 

1,060

 

 

 

792

 

Other liabilities

 

 

81

 

 

 

906

 

 

 

$

8,668

 

 

$

7,370

 

 

7.

Restructuring Plans

The Company incurred restructuring charges in Fiscal 2018 and Fiscal 2017 related to the Hi-Tec Acquisition and its integration into the Company’s ongoing operations (the “Hi-Tec Plan”), including $0.1 million of severance costs in the three months ended April 29, 2017.  Restructuring charges were also incurred in the fourth quarter of Fiscal 2018 as the Company’s staff was realigned to appropriately support its then current business (the “Cherokee Plan”).  Furthermore, during the three months ended August 4, 2018, the Company took additional steps designed to improve its organizational efficiencies by eliminating redundant positions and unneeded facilities, and by terminating various consulting and marketing contracts (the “FY 2019 Plan”).  The FY 2019 Plan resulted in a $5.6 million charge to earnings in the three months ended August 4, 2018, comprising $3.8 million for terminated contracts and leases, $1.2 million for severance and $0.6 million of professional fees.

Charges and payments against the restructuring plan obligations were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

Cherokee Plan

 

 

Hi-Tec Plan

 

 

FY 2019 Plan

 

Balance, February 3, 2018

 

$

1,031

 

 

$

2,501

 

 

$

 

Restructuring charges

 

 

 

 

 

 

 

 

5,615

 

Payments during the period

 

 

(834

)

 

 

(1,400

)

 

 

(686

)

Balance, August 4, 2018

 

$

197

 

 

$

1,101

 

 

$

4,929

 

 

8.

Debt

On August 3, 2018, the Company replaced its Cerberus Credit Facility with a combination of a new senior secured credit facility, which provided a $40.0 term loan (the “Term Loan”), and $13.5 million of subordinated promissory notes (the “Junior Notes”).  The Term Loan matures in August 2021 and requires quarterly principal payments and monthly interest payments based on LIBOR plus a margin.  The Term Loan is secured by substantially all the assets of the Company and is guaranteed by the Company’s subsidiaries.  The Junior Notes mature in November 2021, and they are secured by a second priority lien on substantially all of the assets of Company and guaranteed by the Company’s subsidiaries.  Interest is payable monthly on the Junior Notes, but no periodic amortization payments are required.  The Junior Notes are subordinated in rights of payment and priority to the Term Loan but otherwise have economic terms substantially similar to the Term Loan.  The weighted-average interest rate on both the Term Loan and Junior Notes at August 4, 2018 was 11.1%.

The Term Loan is subject to a borrowing base and includes financial covenants and obligations regarding the operation of the Company’s business that are customary in facilities of this type, including limitations on the payment of dividends.  Financial covenants include the requirement to maintain specified levels of EBITDA, as defined in the agreement, and maintain a specified level of cash on hand.  The Company is required to maintain a borrowing base comprising the value of the Company’s trademarks that exceeds the outstanding balance of the Term Loan.  If the borrowing base is less than the outstanding Term Loan at any measurement period, then the Company would be required to repay a portion of the Term Loan to eliminate such shortfall.  The Company is also required to raise $2.0 million of

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additional subordinated debt or equity before May 4, 2019; however, this will not be required if the Company’s average working capital exceeds an agreed upon level at the close of the Company’s fiscal year ending February 2, 2019.  Events of default include, among other things, the occurrence of a change of control of the Company, and a default under the Term Loan agreement would also trigger a default under the Junior Notes agreements.

The former credit facility included $11.5 million of junior participation interests that were held by a large stockholder, one of the board members and major stockholder, and the chief executive officer who is also one of the board members.  These junior participation interests, along with $2.0 million of cash from a major stockholder, were exchanged into $13.5 million of the new Junior Notes referred to above.

In connection with the refinancing on August 3, 2018, the Company issued warrants to purchase 1,192,997 shares of the Company’s common stock to its Term Loan lenders at an exercise price of $0.45 per share and issued warrants to purchase 1,600,000 shares of the Company’s common stock to certain of its Junior Notes lenders at an exercise price of $0.50 per share.  Each warrant is exercisable on issuance and has a seven-year life.  The fair value of the warrants was $0.8 million on their grant date as determined using a Black Scholes option pricing model and was included as a component of debt issuance costs with an offset to equity.  The following table shows the lenders, their relationship to the Company, the loan amounts provided, and the stock warrants issued to such investors, if any:

 

 

 

Term Loan and

 

 

 

 

 

 

 

Junior Note

 

 

Stock Warrant

 

(Dollars in thousands)

 

Amounts

 

 

Shares

 

Term Loan lenders, unrelated parties

 

$

40,000

 

 

$

1,192,997

 

Cove Street Capital, LLC, large stockholder

 

 

9,000

 

 

 

1,245,000

 

Jess Ravich, board member and large stockholder

 

 

4,400

 

 

 

355,000

 

Henry Stupp, Chief Executive Officer and board member

 

 

100

 

 

 

 

 

 

$

53,500

 

 

$

2,792,997

 

 

Outstanding borrowings under the Term Loan were $40.0 million at August 4, 2018 with associated unamortized debt issuance costs of $2.9 million.  Outstanding Junior Notes were $13.5 million at August 4, 2018 with associated unamortized debt issuance costs of $0.7 million.  Outstanding borrowing under the Company’s previous Cerberus Credit Facility were $49.5 million at February 3, 2018 with related unamortized debt issuance costs of $3.4 million.  The remaining unamortized debt issuance costs of $3.2 million related to the Cerberus Credit Facility were charged to other expense when the debt was retired on August 3, 2018.

 

9.

Commitments and Contingencies

The Company 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.  The Company is unable to determine a range of estimated losses that it could incur related to such indemnities since the amount of any potential liabilities cannot be determined until an infringement claim has been made.

The Company is involved from time to time in various claims and other 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 position, results of operations or liquidity.  Estimated reserves for contingent liabilities, including threatened or pending litigation, are recorded as liabilities in the financial statements when the outcome of these matters is deemed probable and the liability is reasonably estimable.

 

10.

Taxes on Income

Each reporting period, the Company evaluates the realizability of its deferred tax assets.  As of August 4, 2018, the Company continued to maintain a full valuation allowance against its deferred tax assets in the United States and the foreign subsidiaries acquired in the Hi-Tec Acquisition.  These valuation allowances will be maintained until there is sufficient positive evidence to conclude that it is more likely than not that these deferred tax assets will be realized.

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The Tax Cuts and Jobs Act was enacted on December 22, 2017 and reduced U.S. corporate income tax rates to 21.0% as of January 1, 2018.  The rate change became effective during the Company’s fiscal year ended February 3, 2018, resulting in a blended statutory tax rate of 32.8% for that year.  The income tax effects of the Tax Cuts and Jobs Act are considered provisional, and the Company is continuing to gather additional information to complete its accounting for these items.  The Company is accumulating data to finalize the underlying calculations and evaluate other aspects of this tax legislation, including its impact on the Company’s foreign subsidiaries, or in certain cases, the U.S. Treasury is expected to issue further guidance on the application of certain provisions of the tax legislation.

As of August 4, 2018, the reserve for uncertain tax positions resulting from unrecognized tax benefits related to the Company’s Hi-Tec subsidiaries was $3.9 million.  During the three months ended August 4, 2018, the Company increased its liability for uncertain tax positions by $0.3 million. For the six months ended August 4, 2018, there was no material net change in the liability for uncertain tax positions. 

 

 


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11.

Segment Reporting and Geographic Information

 

The Company identifies its reportable segments based on how management internally evaluates financial information, business activities and management responsibility.  Financial information for the Company’s reportable segments is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

Cherokee

 

 

Hi-Tec

 

 

Consolidated

 

For the three months ended August 4, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

4,076

 

 

$

2,997

 

 

$

7,073

 

Selling, general and administrative expenses

 

 

3,196

 

 

 

791

 

 

 

3,987

 

Revenues less selling, general and administrative expenses

 

 

880

 

 

 

2,206

 

 

 

3,086

 

Loss (income) from continuing operations before income taxes

 

 

(3,165

)

 

 

(4,837

)

 

 

(8,002

)

Goodwill

 

 

 

 

 

16,252

 

 

 

16,252

 

Total assets

 

$

23,013

 

 

$

73,646

 

 

$

96,659

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the three months ended July 29, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

5,629

 

 

$

2,239

 

 

$

7,868

 

Selling, general and administrative expenses

 

 

3,948

 

 

 

2,352

 

 

 

6,300

 

Revenues less selling, general and administrative expenses

 

 

1,681

 

 

 

(113

)

 

 

1,568

 

Loss from continuing operations before income taxes

 

 

(1,047

)

 

 

(1,717

)

 

 

(2,764

)

Goodwill

 

 

100

 

 

 

15,545

 

 

 

15,645

 

Total assets

 

$

64,097

 

 

$

87,656

 

 

$

151,753

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(In thousands)

 

Cherokee

 

 

Hi-Tec

 

 

Consolidated

 

For the six months ended August 4, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

6,893

 

 

$

5,582

 

 

$

12,475

 

Selling, general and administrative expenses

 

 

6,148

 

 

 

2,195

 

 

 

8,343

 

Revenues less selling, general and administrative expenses

 

 

745

 

 

 

3,387

 

 

 

4,132

 

Loss (income) from continuing operations before income taxes

 

 

(5,465

)

 

 

(4,440

)

 

 

(9,905

)

Goodwill

 

 

 

 

 

16,252

 

 

 

16,252

 

Total assets

 

$

23,013

 

 

$

73,646

 

 

$

96,659

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the six months ended July 29, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

10,806

 

 

$

3,879

 

 

$

14,685

 

Selling, general and administrative expenses

 

 

8,136

 

 

 

4,112

 

 

 

12,248

 

Revenues less selling, general and administrative expenses

 

 

2,670

 

 

 

(233

)

 

 

2,437

 

Loss from continuing operations before income taxes

 

 

(3,342

)

 

 

(3,411

)

 

 

(6,753

)

Goodwill

 

 

100

 

 

 

15,545

 

 

 

15,645

 

Total assets

 

$

64,097

 

 

$

87,656

 

 

$

151,753

 

 

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

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

August 4,

 

 

July 29

 

 

August 4,

 

 

July 29

 

(In thousands)

 

2018

 

 

2017

 

 

2018

 

 

2017

 

U.S. and Canada

 

$

1,580

 

 

$

3,896

 

 

$

3,403

 

 

$

7,284

 

EMEIA(1)

 

 

3,531

 

 

 

2,070

 

 

 

5,426

 

 

 

3,800

 

Asia

 

 

814

 

 

 

1,149

 

 

 

1,479

 

 

 

2,253

 

Latin America

 

 

1,037

 

 

 

753

 

 

 

1,834

 

 

 

1,348

 

All Others

 

 

111

 

 

 

 

 

 

333

 

 

 

 

Total

 

$

7,073

 

 

$

7,868

 

 

$

12,475

 

 

$

14,685

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1)EMEIA represents Europe, Middle East, India and Africa

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Long‑lived assets located in the United States and outside the United States amount to $0.4 million and $0.3 million, respectively, at August 4, 2018 and $0.6 million and $0.5 million, respectively, at February 3, 2018.

 

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

 

As used in this discussion and analysis, “Cherokee”, the “Company”, “we”, “us” and “our” refer to Cherokee Inc. and its consolidated subsidiaries, unless the context indicates or requires otherwise.  Additionally, “Fiscal 2019” refers to our fiscal year ending February 2, 2019 and “Fiscal 2018” refers to our fiscal year ended February 3, 2018.  The following discussion and analysis should be read together with the unaudited condensed consolidated financial statements and the related notes included in this report.  The information contained in this quarterly report on Form 10‑Q is not a complete description of our business or the risks associated with an investment in our securities.  For additional context with which to understand our financial condition and results of operations, refer to management’s discussion and analysis of financial condition and results of operations (“MD&A”) contained in our Annual Report on Form 10‑K, for the fiscal year ended February 3, 2018, which was filed with the Securities and Exchange Commission (“SEC”) on April 19, 2018, 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.  The section entitled “Risk Factors” set forth in Item 1A of our Annual Report and similar disclosures in our other SEC filings discuss some of the important risk factors that may affect our business, results of operations and financial condition.  

In addition to historical information, this discussion and analysis contains “forward‑looking statements” within the meaning of the Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.  Forward-looking statements are statements other than historical facts that relate to future events or circumstances or our future performance.  The words “anticipates”, “believes”, “estimates”, “plans”, “expects”, “objectives”, “goals”, “aims”, “hopes”, “may”, “might”, “will”, “likely”, “should” and similar words or expressions are intended to identify forward‑looking statements, but the absence of these words does not mean that a statement is not forward-looking.  Forward‑looking statements in this discussion and analysis include statements about, among other things, our future financial and operating performance, our future liquidity and capital resources, our business and growth strategies and anticipated trends in our business and our industry.  Forward-looking statements are based on our current views, expectations and assumptions and involve known and unknown risks, uncertainties and other factors 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, uncertainties and other factors include, among others, those described in Item 1A, “Risk Factors” in this report and in our Annual Report.  In addition, we operate in a competitive and rapidly evolving industry in which new risks emerge from time to time, and it is not possible for us to predict all of the risks we may face, nor can we assess the impact of all factors on our business or the extent to which any factor or combination of factors could cause actual results to differ from our expectations.  As a result of these and other potential risks and uncertainties, forward-looking statements should not be relied on or viewed as predictions of future events because some or all of them may turn out to be wrong.  Forward-looking statements speak only as of the date they are made and, except as required by law, we undertake no obligation to update any of the forward‑looking statements we make in this discussion and analysis to reflect future events or developments or changes in our expectations or for any other reason.

Overview

Cherokee is a global marketer and manager of a portfolio of fashion and lifestyle brands it owns, including Cherokee, Hi-Tec, Magnum, 50 Peaks, Interceptor, Hawk Signature, Tony Hawk, Liz Lange, Completely Me by Liz Lange, Everyday California, Carole Little, Sideout and others, which are licensed 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.

We have licensing relationships with recognizable retail partners in their global locations to provide them with the rights to design, manufacture and sell products bearing our brands.  We refer to this strategy as our “Direct to Retail” or “DTR” licensing model.  We also have license agreements with manufacturers and distributors for the manufacture and sale of products bearing our brands, which we refer to as “wholesale” licensing.  As a brand marketer and manager, we do not directly sell product ourselves.  Rather, we earn royalties when our licensees sell licensed products bearing the trademarks that we own.

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For certain of our key legacy brands, including Cherokee, Hawk Signature and Tony Hawk and Liz Lange, we are shifting our strategy for U.S. sales from DTR licensing to wholesale licensing.  In addition, we are primarily pursuing a wholesale licensing strategy for global sales of our Hi-Tec, Magnum, Interceptor and 50 Peaks brands.  We believe these arrangements signal a significant shift in our business strategy, from our historical focus on DTR licensing for all of our brands to a substantially greater focus on wholesale licensing for many of our key brands.  Although we believe these new wholesale licensing arrangements may help to diversify our sources of revenue and licensee or other partner relationships and may provide additional avenues to obtain brand recognition and grow our Company, this shift in our strategy also exposes us to a number of risks, and it has had a negative effect on our results of operations in Fiscal 2018 and Fiscal 2019 to date as we transition to our new licensees.  This effect could continue or worsen, particularly in the near-term.

We derive revenues primarily from licensing our trademarks to retailers and wholesalers all over the world, and we are continually pursuing relationships with new retailers, wholesalers and others in order to expand the reach of our existing brands into new geographic and customer markets and new types of stores and other selling mediums.  As of August 4, 2018, we had 43 continuing license agreements in approximately 80 countries, 33 of which pertained to brands in our Cherokee reportable segment and 10 of which pertained to our Hi-Tec portfolio of brands, which are included in our Hi-Tec reportable segment.  These arrangements include relationships with Walmart, Soriana, Comercial Mexicana, TJ Maxx, Tottus, Pick N Pay, Nishimatsuya, Big 5, Academy, JD Sports, Black’s and Lidl.  

The terms of our royalty arrangements vary for each of our licensees.  We receive quarterly royalty statements and periodic sales and purchasing information from our licensees.  However, our licensees are generally not required to provide, and typically do not provide, information that would enable us to determine the specific reasons for period‑to‑period fluctuations in sales or purchases.  As a result, we do not typically have sufficient information to determine the effects on our operations of changes in price, volume or mix of products sold.

Business Developments

During the three months ended August 4, 2018, we initiated a restructuring plan designed to improve our organizational efficiencies by eliminating redundant positions and unneeded facilities, and by terminating various consulting and marketing contracts.  The plan resulted in a $5.6 million charge in the three months ended August 4, 2018.  We believe that these changes eliminate unnecessary costs and enable us to operate effectively going forward as we leverage one executive structure to manage our business globally.

On June 1, 2018, we completed the sale of Flip Flop Shops, our franchise retail chain, to Bearpaw Holdings, LLC. We used the sale proceeds to reduce our long-term debt and recognized a $0.6 million gain on the sale of Flip Flop Shops assets during the three months ended August 4, 2018.

On August 3, 2018, we replaced our existing credit facility with a combination of a new $40.0 million term loan under a senior secured credit facility and $13.5 million of subordinated promissory notes.  We also issued warrants to the lenders to purchase 2.8 million shares of our common stock in connection with this refinancing.  The term loan is subject to a borrowing base and requires us to maintain specified levels of EBITDA, as defined in the credit facility, and cash on hand.  If the borrowing base is less than the outstanding term loan at any measurement period, then we would be required to repay a portion of the loan to eliminate such shortfall.  We are also required to raise $2.0 million of additional subordinated debt or equity before May 4, 2019; however, this will not be required if our average working capital exceeds an agreed upon level at the close of the company’s fiscal year ending February 2, 2019.  If we do not comply with these requirements or we are unable to raise the additional capital if required, or if there is a change of control of the Company, it would be an event of default, and, subject to certain cure periods, the lender would have the right to demand immediate repayment of the loans, and/or exercise any other rights or remedies it may have, including foreclosing on our assets that serve as collateral.  Furthermore, a default under our term loan agreement would also trigger a default under our subordinated promissory note agreements.  While we anticipate compliance with the requirements of our loan agreements, if there were to be an event of default, it would jeopardize our ability to continue as a going concern.

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Revenue Overview

We typically enter into license agreements with retailers, manufacturers and distributors for a certain brand in specific product categories over explicit territories, which can include one country or groups of countries and territories.  Our revenues by geographic territory are as follows:

 

 

 

Three Months Ended

 

 

Six Months Ended

 

 

 

August 4, 2018

 

 

July 29, 2017

 

 

August 4, 2018

 

 

July 29, 2017

 

(In thousands,

 

 

 

 

 

% of

 

 

 

 

 

 

% of

 

 

 

 

 

 

% of

 

 

 

 

 

 

% of