Summary of CHEROKEE INC - Yahoo! Finance

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

Cautionary note regarding forward looking statements

This quarterly report on Form 10-Q and other filings which we make with the Securities and Exchange Commission, as well as press releases and other written or oral statements we may make may contain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. When used, the words "anticipates", "believes", "estimates", "objectives", "goals", "aims", "hopes", "may", "likely", "should" and similar expressions are intended to identify such forward-looking statements. In particular, the forward-looking statements in this Form 10-Q include, among others, statements regarding our goals or expectations regarding our future revenues and earnings, the likelihood of increased retail sales by our current and future licensees, such as Target and Tesco, the likelihood that our licensees will achieve royalty rate reductions, our prospects for obtaining new licensees and our prospects for obtaining new brands to acquire or represent. Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results, performance, achievements or share price to be materially different from any future results, performance, achievements or share price expressed or implied by any forward-looking statements. Such risks and uncertainties include, but are not limited to, the financial condition of the apparel industry and the retail industry, the overall level of consumer spending, the effect of intense competition from other apparel lines both within and outside of Target and Tesco, adverse changes in licensee or consumer acceptance of products bearing the Cherokee or our other brands as a result of fashion trends or otherwise, the ability and/or commitment of our licensees to design, manufacture and market Cherokee or our other branded products, our dependence on a single licensee for a substantial portion of our revenues, our dependence on our key management personnel, any adverse determination of claims, liabilities or litigation, and the effect of a breach or termination by us of the Management Agreement with our Chief Executive Officer. Several of these risks and uncertainties are discussed in more detail under "Item 1A. Risk Factors" in this Report on Form 10-Q or in the discussion and analysis below. You should, however, understand that it is not possible to predict or identify all risks and uncertainties and you should not consider the risks and uncertainties identified by us to be a complete set of all potential risks or uncertainties that could materially affect us. You should not place undue reliance on the forward-looking statements we make herein because some or all of them may turn out to be wrong. We undertake no obligation to update any of the forward-looking statements contained herein to reflect future events and developments.

Introduction

The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Report on Form 10-Q. See "Item 1. Consolidated Financial Statements" and our Form 10-K for our fiscal year ended January 31, 2009 ("Fiscal 2009").

Cherokee Inc. (which may be referred to as we, us, our or the Company) is in the business of marketing and licensing the Cherokee, Sideout and Carole Little brands and related trademarks and other brands we own or represent. We are one of the leading licensors of brand names and trademarks for apparel, footwear and accessories in the world.

We own several trademarks, including Cherokee®, Sideout®, Sideout Sport®, Carole Little®, CLII®, Saint Tropez-West®, Chorus Line®, All That Jazz®, Molly Malloy® and others. As of May 2, 2009, we had sixteen continuing license agreements covering both domestic and international markets. During our fiscal year ended February 3, 2007, we terminated one material licensing agreement (our Finder's Agreement with Mossimo Inc.) in exchange for a one-time payment of $33.0 million during our fourth quarter of that fiscal year. As part of our business strategy, we frequently evaluate other brands and trademarks for acquisition into our portfolio.

In addition to licensing our own brands, we also assist other brand-owners, companies, wholesalers and retailers in identifying licensees or licensors for their brands or stores. For example, during Fiscal 2008 we assisted Norma Kamali in her arrangement with Wal-Mart as a global licensee of the Norma Kamali brand.

We operate on a 52 or 53 week fiscal year ending on the Saturday nearest to January 31 in order to better align us with our licensees who generally also operate and plan using such a fiscal year. This results in a 53 week fiscal year approximately every four or five years. We do not believe that the extra week in the occasionally reported 53 week fiscal year results in any material impact on our financial results.

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On July 22, 1999, our Board of Directors authorized the repurchase of up to one million shares of our then outstanding common stock. Pursuant to this directive, and including certain repurchases of our common stock that were effected during Fiscal 2009 and are described below, we have used cash of $7.5 million to repurchase and retire a total of 717,516 shares of our common stock since the stock repurchases were authorized. Our Board of Directors has authorized and approved the extension of the expiration date of our stock repurchase program to January 31, 2010 and increased the number of remaining shares which could currently be repurchased from time to time in the open market at prevailing market prices or in privately negotiated transactions to a total of 800,000 shares of our common stock. During Fiscal 2008 and Fiscal 2007, we did not repurchase any shares of our common stock. During Fiscal 2009, we purchased and retired a total of 109,716 shares of our common stock at an average price of $17.99. We did not repurchase any shares of our common stock during the First Quarter. Continued repurchases of our stock, if any, will be made from time to time in the open market at prevailing market prices or in privately negotiated transactions.

Critical Accounting Policies and Estimates

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

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

† Revenue recognition;

† Provision for income taxes and deferred taxes;

† Impairment of long-lived assets;

† Contingencies and litigation; and

† Accounting for stock-based compensation.

You should refer to our Annual Report on Form 10-K for Fiscal 2009, for a discussion of our policies on revenue recognition, deferred taxes, impairment of long-lived assets, contingencies and litigation and accounting for stock-based compensation.

Effective February 4, 2007, we adopted the provision of FASB interpretation (FIN) No. 48, "Accounting for Uncertainty in Income Taxes" which clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes." FIN 48 prescribes a comprehensive model for how companies should recognize, measure, present, and disclose in their financial statements uncertain tax positions taken or expected to be taken on a tax return. Under FIN 48, tax positions shall initially be recognized in the financial statements when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions shall initially and subsequently be measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the tax authority assuming full knowledge of the position and all relevant facts. The cumulative effect of applying FIN 48 has resulted in a decrease to our retained earnings of approximately $0.4 million as of February 4, 2007.

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We recognize interest and penalties, if any, related to unrecognized tax benefits within the provision for income taxes in our consolidated statement of income. As of January 31, 2009 and May 2, 2009, respectively, accrued interest on a gross basis was $96,000 and $51,000. The total amount of gross unrecognized tax benefits as of January 31, 2009 and May 2, 2009, respectively, was approximately $0.5 and $0.4 million, of which approximately $0.5 million and $0.4 million represents the amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate. It is reasonably possible that $0.3 million of unrecognized tax benefits may decrease within the next 12 months as a result of settling certain positions. The expected net impact of the changes would not have a significant impact on our results of operations or financial position.

The Company files U.S. federal and state tax returns. For the federal tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to 2007. With limited exception, our significant state tax jurisdictions are no longer subject to examinations by the various tax authorities for fiscal years prior to 2003.

On January 29, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors for employee stock options based on estimated fair values. SFAS 123(R) supersedes the Company's previous accounting under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") for periods beginning on or after January 1, 2006.

The Company accounts for stock based compensation in accordance with Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which requires companies to estimate the fair value of share-based payment awards on the date of grant using an option-pricing model. The fair value of stock options are estimated using a Black-Scholes option valuation model. This model requires the input of subjective assumptions, including expected stock price volatility, estimated life and estimated forfeitures of each award. The fair value of equity-based awards is amortized over the vesting period of the award, and we have elected to use the straight-line method. We make quarterly assessments of the adequacy of the tax credit pool to determine if there are any deficiencies which require recognition in the consolidated statement of operations. Stock-based compensation expense recognized under SFAS 123(R) for the three months ended May 2, 2009 (the "First Quarter") was $180,000, and for the three months ended May 3, 2008 was $239,000.

Recent Accounting Pronouncements

We describe recent accounting pronouncements in Item 1 - "Consolidated Financial Statements - Notes to Consolidated Financial Statements."

Results of Operations

Retail Sales

During the First Quarter, total U.S. dollar based retail sales of merchandise bearing the Cherokee brand were 23.7% below the total U.S. dollar based retail sales for the first quarter of last year, with U.S. dollar based retail sales totaling approximately $382.5 million in our First Quarter versus approximately $501.7 million in total U.S. dollar based retail sales for the first quarter of last year. Most of this decline was due to the following two factors: (i) a difficult retailing environment worldwide as a result of the global recession; and (ii) the stronger U.S. dollar during the First Quarter as compared to the first quarter of last year, which resulted in lower comparative U.S. dollar-based retail sales from many of our international licensees, and ultimately lower U.S. dollar based royalties.

Pursuant to our typical arrangements with our licensees, we receive quarterly royalty statements and periodic retail sales information for Cherokee branded products and other product brands that we own or represent. However, our licensees are generally not required to provide, and typically do not provide, information that would enable us to determine the specific reasons for period-to-period fluctuations in retail sales of our branded products by our licensees in the specific territories in which they operate. Fluctuations in retail sales of Cherokee branded products or other product brands that we own or represent may be the result of a variety of factors, including, without limitation: (i) changes in the number of product categories for which a licensee chooses to use our brands from period-to-period, which generally results in changes in the amount of inventory (utilizing our brands) available for sale from period-to-period; (ii) the number of geographical markets/territories or number of stores in which our licensees are currently selling Cherokee or our other branded products from period-to-period; or
(iii) our licensees experiencing changes in retail sales levels as a result of a variety of factors, including fashion-related and general retail sales trends (See Item IA "Risk Factors").

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During the First Quarter, retail sales of Cherokee branded products by Target Stores totaled approximately $210.0 million compared to approximately $259.5 million for the three months ended May 3, 2008, or a decline of 19.1%. This decline was due to both a difficult retailing environment, and also a reduction in the number of men's and women's apparel categories currently being utilized for the Cherokee brand by Target in the First Quarter, as compared to the prior year. This decline was offset somewhat by the growth in Cherokee branded kid's apparel categories at Target during the First Quarter. As a consequence, our royalty revenues for the First Quarter from Target Stores decreased by 22% compared to the comparable period last year.

Tesco's U.S. dollar based retail sales of merchandise bearing the Cherokee brand, which for the First Quarter and last year's comparable period included the U.K., Ireland, Poland, the Czech Republic, Hungary and Slovakia, were $145.1 million in our First Quarter, compared to $207.7 million in the first quarter of last year, representing a total decline of 30.1%. Much of this decline was due to the strengthening of the U.S. dollar, as the change in the exchange rates from last year's first quarter as compared to the First Quarter was -27.5% for the United Kingdom, and ranged from -20% to -33% in the Central European countries. Retail sales in the United Kingdom, as measured in British Pounds Sterling, were down 12.7% in the First Quarter as compared to the comparable period in the prior year. Hence, retail sales in U.S. dollars for the United Kingdom totaled $93.5 million in the First Quarter, as compared to $147.9 million in the first quarter of last year. Retail sales in the Tesco Central European countries of the Czech Republic, Slovakia, Poland and Hungary, as measured in their respective local currencies, reflected increases ranging from 11% to 28%. However, currency rate fluctuations in the Central European countries, reflecting the stronger U.S. dollar in the First Quarter, exhibited unfavorable changes ranging from -20% to -33%, and as a consequence the collective U.S. dollar based retail sales from Tesco Central Europe for the First Quarter were $48.2 million, as compared to $54.3 million in the first quarter of last year.

Zeller's retail sales of merchandise bearing the Cherokee brand, in U.S. dollars, were approximately $12.8 million during the First Quarter compared to $18.8 million for the first quarter of last year, representing a 32% decline. Retail sales as measured in Canadian dollars were down 20.8% in the First Quarter as compared to the comparable period in the prior year. However, the change in the exchange rates from last year's first quarter as compared to the First Quarter was -14.3% for Zellers, due to the stronger U.S. dollar in the First Quarter.

Despite the global recession and a stronger U.S. dollar in the First Quarter, on a U.S. dollar basis we experienced retail sales increases with several other of our foreign licensees, including the countries of Chile and Peru. We expect that several of our newer foreign territories, such as Brazil and Israel, may continue to show growth throughout Fiscal 2010, and we expect our licensee in Spain to begin selling Cherokee branded products later this year.

During the First Quarter, sales of Carole Little and St. Tropez-West branded products by TJX were approximately $36.8 million, as compared to $17.5 million for the first quarter of last year, representing an increase of 109.8% over last year.

Royalty Revenues and Expenses

Royalty revenues were $8.9 million during the First Quarter, which is $2.6 million less than the $11.5 million reported during the three month period ended May 3, 2008. Revenues from the Cherokee brand were $7.9 million during the First Quarter compared to $11.0 million for the first quarter of last year. During the First Quarter and the first quarter of last year, revenues of $4.2 million and $5.4 million were recognized from Target Stores, respectively, which accounted for 47% of our total revenues in each such period. The decrease in revenues from Target Stores was attributable to a difficult retailing environment, and also a significant reduction by Target of the Cherokee brand in the men's and women's apparel product categories in the First Quarter, as compared to the comparable period last year. Despite a difficult retailing environment in the U.S., the Cherokee brand in kids apparel categories at Target experienced growth in the First Quarter as compared to the same period in the prior year. Revenues from all of the Tesco countries were $3.0 million during the First Quarter compared to $4.6 million for the first quarter of last year. Royalties from Tesco U.K. totaled $1.9 million in the First Quarter, as compared to $3.5 million in the prior year (which included about $0.5 million of past years audit royalties). The decline in the U.K. of the retail sales of Cherokee products in local currency was -12.8%, which we attribute primarily to a difficult consumer environment in the U.K., but combined with an unfavorable -27.5% change in the exchange rate due to the strengthening dollar, the resulting change in royalties was a decline of 45%. The decline in royalties from Cherokee branded products in all other Tesco countries (Ireland, Central Europe) was about 12%, significantly less than the decline in the U.K. The decrease in royalties from the Central European Tesco territories is due to the unfavorable change in exchange rates due to the strengthening of the U.S. dollar, as the retail sales in the local currencies were higher in the First Quarter as compared to the first quarter of last year. Revenues from Zellers were $254,000 during the First Quarter compared to $375,000 for the first quarter of last year, due primarily to reductions in men's and women's product categories, including footwear. Royalty revenues from our retail direct licensee in Mexico, Comercial Mexicana, totaled $149,000 during the First Quarter, as compared to $271,000 in royalty revenues for the first quarter of last year. This decline was due to a difficult retail environment in Mexico during the First Quarter, and also the stronger U.S. dollar as compared to the first quarter of last year.

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Revenues from the Sideout brand were $49,000 during the First Quarter compared to $192,000 for the first quarter last year. Revenues from Mervyn's (which is a Sideout brand licensee) during the First Quarter were $0 compared to $155,000 for the first quarter of last year, as Mervyn's is in the process of liquidating its retail operations. First Quarter revenues also included $470,000 from TJX (per our licensing contract for the Carole Little brands), as compared to $244,000 for the first quarter of last year, due to higher retail sales of Carole Little branded products during the First Quarter. Revenues from our brand representation licensing arrangements totaled $429,000 in our First Quarter, as compared to $133,000 in the comparable period last year.

Revenues from international licensees of both Cherokee and Sideout brands, such as Zellers and Tesco, were collectively $3.8 million during the First Quarter compared to $5.5 million for the first quarter of last year. This decrease is primarily due to the strengthening of the U.S. dollar in the First Quarter as compared to the comparable period last year. A 12.7% decline in retail sales in local currency in the U.K. (our largest international territory in terms of retail sales) also contributed to this decrease, but local currency retail sales in the Central European countries were higher.

Royalty revenues during the First Quarter benefitted from higher royalty rates applied under our contracts with Tesco and Target during the period because the cumulative retail sales during the First Quarter had not exceeded the applicable thresholds for reduced royalty rates during Fiscal 2010. In the event that cumulative retail sales in future quarters in Fiscal 2010 do exceed the applicable thresholds for reduced royalty rates, we will then be entitled to a smaller royalty rate on incremental retail sales by Target and Tesco that are in excess of such thresholds.

We believe that our future revenues from Target, for the remaining nine months of Fiscal 2010, will likely be down or flat when compared to the revenues from Fiscal 2009, primarily due to the reduced presence of the Cherokee brand in men's and women's apparel categories, but we expect our presence in kids apparel categories at Target may continue to grow. We believe that our future revenues from Zellers will continue to be down due to reduced economic activity and consumer spending as compared to Fiscal 2009. Based on Tesco's sales of Cherokee branded products in Fiscal 2009 and the First Quarter, and the retail decline occurring in the United Kingdom, we believe that our future revenues from Tesco will likely be down when compared to the revenues from Fiscal 2009. Based upon the royalties received for our First Quarter from TJX, we estimate that our future royalty revenues from TJX may be up or flat when compared to the revenues from Fiscal 2009, but will depend upon the future condition of the U.S. retail market, which is currently difficult and uncertain. Furthermore, although the U.S. dollar has weakened a bit since the end of the First Quarter, should it strengthen in the future against such foreign currencies, our future royalties from our international licensees will be negatively affected throughout the rest of Fiscal 2010.

We recognize royalty revenues in the quarter earned. A large portion of such royalty revenues recognized as earned are collected from licensees during the month following the end of a quarter. Our trade receivables balance of $8.5 million as of the end of the First Quarter included accrual for revenues earned from Target Stores, Zeller's, Tesco, TJX and other licensees that are expected to be received in the month or 45 days following the end of the First Quarter.

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Selling, general and administrative expenses for the First Quarter were $3.1 million, or 35.1% of revenues, in comparison to selling, general and administrative expenses of $3.7 million, or 32.5% of revenues during the first quarter of last year. The changes in our selling, general and administrative expenses, including the decrease of about $0.6 million during the First Quarter as compared to the first quarter of last year, resulted from the following factors, among others: (i) lower marketing salaries and payroll tax and bonus accrual expenses in the First Quarter as compared to the first quarter of last year; (ii) lower marketing and advertising related expenses in the First Quarter as compared to the first quarter of last year; (iii) lower travel and entertainment related expenses; (iv) lower stock compensation expenses of $180,000 in our First Quarter, as compared to $239,000 in the first quarter of last year; and (v) lower tax and audit related expenses.

During the First Quarter, our investment and interest income was $7,000 compared to $70,000 for the first quarter of last year. The decrease in interest income is primarily due to lower cash balances and lower interest rates during the First Quarter as compared to the first quarter of last year.

During the First Quarter, we recorded a tax provision of $1.9 million which equates to an effective tax rate of 33.8%, compared to $3.2 million and an effective tax rate of 40.5% recorded for the first quarter of last year. During the First Quarter, our net income was $3.8 million, or $0.43 per diluted share, compared to $4.7 million, or $0.52 per diluted share, for the first quarter of last year.

Liquidity and Capital Resources

Cash Flows. On May 2, 2009, we had cash and cash equivalents of $9.6 million. On January 31, 2009, we had cash and cash equivalents of $13.7 million. The $4.1 million decrease in cash and cash equivalents during the First Quarter is primarily attributable to the payment of $4.4 million in dividends during the First Quarter, and the payment of our previously accrued management and employee bonuses of $2.9 million during the First Quarter. These were offset by various other items detailed below.

During the First Quarter, cash provided by our operations was $0.4 million, compared to cash provided by our operations of $1.6 million for the first quarter of last year. The cash provided from operations of $0.4 million during our First Quarter was primarily due to the changes in: (i) accrued compensation, which was reduced by $2.4 million in the First Quarter, as compared to a decrease of $3.3 million in the first quarter of last year;
(ii) accounts receivables, which increased by $3.1 million in the First Quarter, as compared to an increase of $3.5 million in the first quarter of last year;
(iii) an increase in income taxes payable of $1.1 million in the First Quarter, as compared to an increase of $2.6 million in the first quarter of last year; and (iv) a decrease in taxes receivable of $0.4 million in the First Quarter, as compared to a minor increase in the first quarter of last year. In addition, our cash from operations includes non-cash stock-based compensation expense of $180,000 in our First Quarter pursuant to SFAS 123 (R) as compared to $239,000 in the first quarter of last year, and our deferred tax assets decreased by . . .