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| CHKE > SEC Filings for CHKE > Form 10-Q on 6-Sep-2012 | All Recent SEC Filings |
6-Sep-2012
Quarterly Report
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 (the "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 and our exposure to general economic conditions, the effect of intense competition we face from other apparel lines both within and outside of Target, adverse changes in licensee or consumer acceptance of products bearing the Cherokee brand or our other brands as a result of fashion trends or otherwise, our ability to protect our intellectual property rights, the ability and/or commitment of our licensees to design, manufacture and market Cherokee or our other branded products, our dependence on Target for a substantial portion of our revenues, our dependence on our key management personnel, the success of our strategic and marketing initiatives, the benefits to us of our recently acquired assets related to the Liz Lange and Completely Me by Liz Lange brands, the possibility that we may engage in additional strategic transactions that could impact our liquidity, increase our expenses or present significant distractions to our management, any adverse determination of claims, liabilities or litigation, the requirements under our credit agreement with JPMorgan Chase Bank, our ability to issue preferred stock with rights and privileges that are superior to those of our common stock, our payment or non-payment of dividends in future periods and the volatility in the trading price of our common stock. Several of these risks and uncertainties are discussed in more detail under "Item 1A. Risk Factors" of Part II of 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 28, 2012 ("Fiscal 2012").
Cherokee Inc. (which may be referred to as we, us, our or the Company) is a global marketer and manager of a portfolio of lifestyle brands it owns or represents, licensing the Cherokee, Sideout and Carole Little brands and related trademarks and other brands in multiple consumer product categories and sectors. We are one of the leading licensors of style-focused lifestyle brands for apparel, footwear, home and accessories in the world.
Cherokee was incorporated in Delaware in 1988. Our principal executive offices are located at 5990 Sepulveda Boulevard, Sherman Oaks, California 91411, telephone (818) 908-9868. We maintain a website with the address www.thecherokeegroup.com. We are not including the information contained on our website as part of, or incorporating it by reference into, this Quarterly Report on Form 10-Q.
We own several trademarks, including Cherokee®, Sideout®, Sideout Sport®, Carole Little®, Saint Tropez-West®, Chorus Line®, All That Jazz® and others. As of July 28, 2012, we had twenty-seven continuing license agreements covering both domestic and international markets. As part of our business strategy, we frequently evaluate other brands and trademarks for acquisition into our portfolio.
In addition to licensing our own brands, we also assist other brand-owners, companies, wholesalers and retailers in identifying opportunities as a licensee or licensor for their brands or stores.
We have a 52 or 53 week fiscal year ending on the Saturday nearest to January 31, which aligns us with our retailer 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. In addition, certain of our international licensees report royalties to us for quarterly and annual periods which may differ from ours. We do not believe that the varying quarterly or annual period ending dates applicable to 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.
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 2012, for a discussion of our policies on revenue recognition, deferred taxes, impairment of long-lived assets, contingencies and litigation and accounting for stock-based compensation.
Recent Accounting Pronouncements
We describe recent accounting pronouncements in Item 1 - "Consolidated Financial Statements - Notes to Consolidated Financial Statements."
Results of Operations
Retail Sales
During the quarterly period ended July 28, 2012 (the "Second Quarter"), total U.S. dollar based retail sales of merchandise bearing the Cherokee brand were 5.8% above the total U.S. dollar based retail sales for the second quarter of last year, with U.S. dollar based retail sales totaling approximately $287.7 million in our Second Quarter versus approximately $271.9 million in total U.S. dollar based retail sales for the second quarter of last year. During the six month period ended July 28, 2012 (the "Six Months"), total U.S. dollar based retail sales of merchandise bearing the Cherokee brand were 8.5% above the total U.S. dollar based retail sales for the comparable six month period of last year, with U.S. dollar based retail sales totaling approximately $623.0 million in the Six Months versus approximately $574.2 million in total U.S. dollar based retail sales for the comparable period of last year. Most of this increase is the result of an increase in sales of Cherokee branded products at Target and Zellers, as compared to the comparable periods of last year. The increase in sales at Target and Zellers was partially offset by a decrease in sales for Cherokee branded products at Tesco as compared to the comparable periods of last year.
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. As a result, and except as noted elsewhere in Cherokee's comparisons of its financial results discussed herein, Cherokee does not have sufficient information required to determine the effects on our operations of changes in price, volume or product mix by our licensees. 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 1A of Part II-"Risk Factors").
During the Second Quarter and Six Months, retail sales of Cherokee branded products by Target Stores totaled approximately $200.4 million and $462.0 million, respectively, compared to approximately $148.0 million and $337.6 million for the second quarter and six months of last year, or an increase of 35.4% and 36.9%, respectively. As a result, our royalty revenues for the Second Quarter and Six Months from Target Stores increased compared to the comparable periods last year.
Tesco's U.S. dollar based retail sales of merchandise bearing the Cherokee brand, which for the Second Quarter and last year's comparable period included the U.K., Ireland, Poland, the Czech Republic, Hungary and Slovakia, were $5.4 million in our Second Quarter, compared to $60.0 million in the second quarter of last year, representing a total decline of 91.0%. Tesco's U.S. dollar based retail sales of merchandise bearing the Cherokee brand for the Six Months was $13.5 million compared to $119.9 million for the comparable period last year, representing a decline of 88.7%. These declines were due to continuing reductions of Cherokee branded product categories in the UK and Central European countries during the Second Quarter and Six Months as compared to the comparable periods of the prior year. Retail sales in the United Kingdom, as measured in British Pounds Sterling, were down 90.1% and 88.1% in the Second Quarter and Six Months, respectively, as compared to the comparable periods in the prior year. Hence, retail sales in U.S. dollars for the United Kingdom totaled $4.2 million and $10.7 million in the Second Quarter and the Six Months, respectively, as compared to $42.3 million and $89.7 million in the comparable periods of last year. The Tesco Central European countries of the Czech Republic, Slovakia, Poland and Hungary, as measured in their respective local currencies, reflected decreases in retail sales ranging from 92% to 94% during the Second Quarter and the Six Months. As a consequence, the collective U.S. dollar based retail sales from Tesco Central Europe for the Second Quarter and Nine Months were $1.0 million and $2.2 million, respectively, as compared to $13.9 million and $25.2 million in the comparable periods of last year. While we continue to work with Tesco in an effort to reverse the trend of its sales of Cherokee branded products in recent periods, we cannot provide assurances that we will be successful or that additional declines will not be forthcoming.
Zeller's retail sales of merchandise bearing the Cherokee brand, in U.S. dollars, were approximately $33.4 million and $59.4 million during the Second Quarter and Six Months, respectively, compared to $23.3 million and $45.1 million for the comparable periods of last year, representing increases of 43.3% and 31.5%, respectively. We attribute this increase primarily due to the reintroduction of the adult apparel category at Zellers and the generally positive acceptance of the Cherokee brand in the Canadian marketplace.
In addition, on a U.S. dollar basis we experienced retail sales increases during the Second Quarter and the Six Months with several other of our foreign licensees, including the countries of China, Japan, Russia, Peru and Colombia. We expect that several of our foreign territories may continue to show growth throughout the remainder of Fiscal 2013.
Royalty Revenues
Total royalty revenues received by Cherokee for all brands were $6.3 million and $13.8 million during the Second Quarter and Six Months, respectively, as compared to $6.7 million and $13.6 million for the comparable periods of last year. We attribute the decrease in total royalty revenues during the Second Quarter primarily to the reduced amount of revenues we received during such periods as a result of our brand representation business (discussed below), together with the decrease in royalty revenues we received from Tesco during such period. We attribute the overall increase in royalty revenues we received during the Six Months primarily to the significant increase in sales at Target that occurred throughout the Six Months. Revenues from the Cherokee brand were $5.8 million and $12.9 million during the Second Quarter and Six Months, respectively, as compared to $5.7 million and $11.8 million for the comparable periods of last year. We attribute the increases royalties that we received for Cherokee branded products primarily due to an increase in royalty revenues from Target and Zellers in both the Second Quarter and the Six Months. Such increased sales at Target and Zellers partially offset the declines in royalties we received from Tesco for the Cherokee brand during the Second Quarter and entirely offset such declines during the Six Months.
During the Second Quarter and Six Months, revenues of $3.1 million and $8.3 million, respectively were recognized from Target stores compared to $2.8 million and $6.6 million for the comparable periods last year. This accounted for 49% and 60% of our total revenues for the Second Quarter and Six Months, respectively, versus 42% and 48% for the comparable periods last year.
Revenues from all of the Tesco countries were $0.2 million and $0.4 million during the Second Quarter and Six Months, respectively, compared to $1.2 million and $2.1 million for the comparable periods last year. Royalty revenues from Tesco U.K. totaled $0.1 million and $0.2 million during the Second Quarter and Six Months, respectively, as compared to $0.8 million and $1.4 million for the comparable periods last year. The decline in royalties from Cherokee branded products in all other Tesco countries (Ireland, Central Europe and Turkey) during the Second Quarter and Six Months was about 93% and 80%, respectively, resulting in royalties of $0.1 million and $0.2 million for the Second Quarter and Six Months, respectively, as compared to $0.4 million and $0.8 million for the comparable periods of last year. We attribute the decrease in royalties from all Tesco territories primarily to the decrease in several Cherokee branded product categories for apparel during the Second Quarter and Six Months as compared to the comparable periods of last year.
Revenues from Zellers increased 39% and 31% during the Second Quarter and Six Months, respectively, resulting in royalties of $669,000 and $1,198,000 compared to $480,000 and $916,000 for the comparable periods of last year.
Revenues from our brand representation licensing arrangements totaled $4,000 and $39,000 in our Second Quarter and Six Months, respectively, as compared to $542,000 and $1,089,000 for the comparable periods last year.
Most of our international licensees are required to pay the royalty revenues owed to us in U.S. dollars. As a consequence, any weakening of the U.S. dollar benefits us in that the total royalty revenues reported from our international licensees increases when the dollar weakens against such foreign currencies. Conversely, any strengthening of the U.S. dollar against such licensee's foreign currency results in lower royalty revenues from such licensee. We do not anticipate that the exchange rate fluctuation will have a material impact, positive or negative, on our business as a whole.
Our disclosure related to the sales of our international licensees throughout this Quarterly Report on Form 10-Q is denominated in U.S. dollars unless otherwise noted. In arriving at such denominations, Cherokee receives a schedule of retail sales on a monthly and/or quarterly basis from each of our licensees which are denominated in the applicable foreign currency. These amounts are then converted by us to U.S. dollars using an average monthly and/or quarterly exchange rate for the purpose of the disclosure of the retail sales denominated in U.S. dollars. In all periods presented in this report, Cherokee does not consider the period fluctuations in foreign currency exchange rates to have had a significant effect on accuracy of the U.S. dollar-denominated figures presented in this Form 10-Q.
Our license agreement with Target for the Cherokee brand in the U.S. provides for reduced royalty rates based on volume thresholds once specified cumulative levels of retail sales are achieved during each fiscal year. The royalty rate reductions do not apply retroactively to Target's retail sales since the beginning of the year. As a result, for such license agreement our royalty revenues as a percentage of Target's retail sales in the U.S. are highest at the beginning of each fiscal year and decrease during the fiscal year as licensees exceed sales thresholds as outlined in their respective license agreements. The amount of royalty revenue earned by us in any quarter is dependent not only on retail sales in each quarter, but also on the royalty rate then in effect after considering the cumulative level of retail sales for the fiscal year. Royalty revenues during the First Quarter benefitted from higher royalty rates applied under our contract with Target for the Cherokee brand in the U.S. during the period because the cumulative retail sales during the First Quarter had not exceeded the applicable thresholds for reduced royalty rates during Fiscal 2013. By contrast, royalty revenues were lower during the Second Quarter in comparison to the First Quarter in part as a result of Target paying us a lower royalty rate on its sales of Cherokee branded products in the U.S. during such period. In the event that Target's cumulative retail sales of Cherokee branded products in the U.S. in future quarters in Fiscal 2013 exceed the applicable thresholds for reduced royalty rates, we will then be entitled to a reduced royalty rate on incremental retail sales by Target that are in excess of such thresholds. Historically, this has caused our first quarter to be our highest revenue and profitability quarter; our second quarter to be our next highest quarter; and our third and fourth quarters to be our lowest quarters. However, such historical patterns may vary in the future, depending upon the product mix and retail sales volumes achieved in each quarter by Target for Cherokee branded merchandise in the U.S. and also on the revenues we receive from other licensees that do not pay us reduced royalty rates based upon cumulative sales.
We believe that our future revenues from Target, for the remaining six months of Fiscal 2013, will likely be higher when compared to our revenues from Target in Fiscal 2012 during such period, as we expect our presence in certain apparel categories and existing categories at Target may continue to grow. Based on Tesco's sales of Cherokee branded products in Fiscal 2012 and the Six Months, it is likely that our revenues in Fiscal 2013 from Tesco will decline from those of Fiscal 2012.
Our revenue recognition policy provides for recognition of royalties in the quarter royalties are earned, although a large portion of such royalty payments are actually received during the month following the end of a quarter. Our trade receivables balance of $6.0 million and $6.1 million as of the end of the Second Quarter and the end of the second quarter of last year, respectively, included an accrual for royalty revenues earned and these receivables were subsequently received in the following quarter.
Expenses
Selling, general and administrative expenses for the Second Quarter and Six Months were $3.6 million and $7.8 million, or 57.7% and 56.4% of revenues, respectively, in comparison to selling, general and administrative expenses of $3.9 million and $7.3 million, or 59.4% and 53.4%, respectively, of revenues during the comparable periods last year. The decrease in our selling, general and administrative expenses during the Second Quarter of approximately $0.3 million in comparison to the second quarter of last year was primarily attributable to lower personnel expenditures and lower marketing expenses. The increase in our selling, general and administrative expenses during the Six Months of approximately $0.5 million in comparison to the comparable period of last year was primarily attributable to higher Director stock option expense.
During the Second Quarter and Six Months, our investment and interest income was $0 and $12,000 compared to $2,000 and $22,000 for the comparable periods last year.
During the Second Quarter and Six Months, we recorded a tax provision of $1,301,000 and $2,282,000, respectively, which equates to an effective tax rate of 39.1% and 38.3%, compared to a tax provision of $966,000 and $1,309,000, respectively, and an effective tax rate of 36.6% and 21%, respectively, recorded for the comparable periods last year. The increase in the tax rate was because in the first quarter of Fiscal 2012 the tax provision was offset by a tax benefit of $1.2 million that resulted from the payment to us of a refund from the California Franchise Tax Board of $2.0 million, plus interest. The refund related to our fiscal 2004 through fiscal 2008 tax years. During the Second Quarter and Six Months, our net income was $1,608,000 and $3,679,000 or $0.19 and $0.44 per diluted share, respectively, compared to $1.7 million and $4.9 million, or $0.20 and $0.58 per diluted share, respectively, for the comparable periods last year.
Acquisition of Assets Related to the Liz Lange and Completely Me by Liz Lange Brands
On September 4, 2012, Cherokee and LLM Management Co., LLC (the "Seller") entered into an Asset Purchase Agreement (the "Asset Purchase Agreement"), pursuant to which Cherokee acquired various assets related to the "Liz Lange" and "Completely Me by Liz Lange" brands (the "Assets" and such transaction, the "Acquisition"). The Acquisition closed on September 4, 2012. As consideration for the Acquisition, Cherokee agreed to pay a cash purchase price equal to $13.1 million, with $12.6 million paid by Cherokee concurrently with the closing and with $500,000 of which we agreed to place in an escrow fund that is to be released no later than March 31, 2013, subject to any funds which we recover or that are to be retained pursuant to indemnification claims. In addition, Cherokee agreed to pay to the Seller additional earn-out payments of $400,000 and $500,000 (for a total of up to $900,000 in contingent consideration), which consideration is payable upon our achievement of specified revenue targets attributable to the Assets during the remainder of 2012 and during 2013. In addition, as part of the Acquisition, Cherokee agreed to assume the Seller's obligations under various agreements, which include a consulting agreement with Ms. Lange as well as certain existing license agreements relating to the Assets, including a license agreement with Target. The Asset Purchase Agreement contains various covenants, indemnities and representations and warranties that are customary for transactions of this type. For additional information regarding the Acquisition and the Asset Purchase Agreement, please see Cherokee's Current Report on Form 8-K dated September 4, 2012 and filed with the Commission on September 6, 2012.
Cherokee's Board of Directors approved the Acquisition following its determination that the Acquisition is in the best interests of Cherokee and its stockholders. We believe the Assets have the potential to be complimentary to Cherokee's other brands and expect to begin to market the assets and consider additional potential licensing opportunities with retailers during the remainder of Fiscal 2013.
Liquidity and Capital Resources
Cash Flows. On July 28, 2012, we had cash and cash equivalents of $2.1 million. On January 28, 2012, we had cash and cash equivalents of $7.4 million. The decrease of $5.3 million was primarily due to our prepayment of all outstanding principal and interest then outstanding under our former loan agreement with U.S. Bank (the "Prior Loan").
During the Six Months, cash provided by our operations was $5.5 million, compared to cash provided by our operations of $3.4 million for the comparable period of last year. The cash provided by operations of $5.5 million during the Six Months was primarily due to the changes in: (i) accrued compensation, which was reduced by $0.1 million in the Six Months, as compared to a decrease of $4.2 million in the six months of last year; (ii) accounts receivable, which increased by $0.6 million in the Six Months, as compared to a decrease of $0.5 million in the six months of last year; and (iii) an increase in accounts payable of $0.7 million in the Six Months, as compared to a decrease of $0.03 million in the six months of last year. In addition, our cash from operations includes non-cash stock-based compensation expense of $455,000 in our Six Months . . .
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