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No. of Recommendations: 9
The company and its history

Cherokee may well be the Seinfeld of stocks--they are all about nothing. They have no facilities, they have no inventory, they have no plants, they have all of 17 employees.

They used to have shoes. The company started in 1973 and was manufacturing women's casual shoes. The footwear grew into apparel and accessories by the 1980's. By the early 1990', the company claims to have had an epiphany concerning marketing and saw that the large retailers were going to cut out the middleman wholesalers and create their own in-house products directly. They saw the death of wholesale and the emergence of private brands.

In 1996 they changed course and closed down all wholesaling, distributing and manufacturing operations and lowered overhead from $23 million to $4 million per year. they became a purveyor of brand names, logos graphics and merchandising campaigns.Cherokee is a brand--the retailers do their own product manufacture and then use the Cherokee family of patented names. In retail direct licensing, they grant retailers a license to use the trademarks on certain categories of merchandise.Cherokee provides design direction, and he licensees can modify or amplify the designs
to suit their seasonal, regional and category needs. In all cases, all products are subject to Cherokee's pre-approved packaging, graphics and quality control standards. The retailer is responsible for manufacturing the merchandise. Wholesale
licensees manufacture and import various categories of apparel, footwear and accessories under the Cherokee trademarks and sell the licensed products to retailers.

Cherokee and its wholly owned subsidiary, SPELL C. own several trademarks, including Cherokee, Sideout, Sideout Sport, Carole Little, CLII, Saint Tropez-West, Chorus Line, All that Jazz, Molly Malloy and others. They feel Cherokee brand, which began as a footwear brand in 1973, has been positioned to connote quality, comfort, fit, and a "Casual American" lifestyle with traditional wholesome values and that the name is a valuable commodity. The Sideout brand and related trademarks were acquired in November 1997. The Carole Little and Chorus Line brands and trademarks were
acquired in December 2002. As of January 31, 2004, Cherokee had twelve continuing license agreements covering both domestic and international markets, of which two are expected to expire in 2004.

Cherokee decided retailers should be able to obtain higher margins on sales and increase store traffic by directly sourcing, stocking and selling licensed products bearing widely recognized(Cherokee) brand names. Cherokee believes that strictly private label goods or branded products from third-party vendors will not be as profitable. Their strategy is to capitalize on these ideas by licensing the Cherokee portfolio of brands to strong and growing retailers, such as Target Stores and TJX Companies in the U.S., Tesco and Carrefour in Europe, and Bolderway in China, who work in conjunction with them to develop merchandise for their stores.

Cherokee is the idea man with the labels. In addition to acquiring brands and licensing their own brands, they assist other companies, wholesalers and retailers in identifying licensees or licensors for their brands or stores.As an exclusive consultant, they perform a range of services, including marketing of brands, solicitation of licensees, and other related services. In return for services they charge a certain percentage of the net royalties generated by the brands they represent and manage. In 2000 they introduced Mossimo to Target Stores, and in 2003 they introduced the House Beautiful brand to May Company department stores.


Various trademarks include:
Sideout Sport
Carole Little
Saint Tropez-West
Chorus Line
All that Jazz
Molly Malloy

Trademark registrations, renewal fees and acquired trademarks are stated at cost and are amortized over their estimated useful life not exceeding fifteen years.

Significant contracts


Cherokee has relied heavily on their relationship with Target since 1997. Royalty revenues from Target Stores were:

** $6.4 million during 1998
** $14.6 million during 1999
** $16.3 million during 2000
** $19.3 million during 2001
** $20.7 million during 2002
** $21.4 million during 2003
** $20.6 million during 2004

which accounted for 75%, 76%, 66%, 68%, 67%, 65% and 57% respectively, of consolidated revenues.Royalty revenues in fiscal 2004 from Target Stores were 196% of the guaranteed minimum royalty under the Amended Target Agreement.

In 1997,they entered into an agreement with Target Stores that grants Target the exclusive right in the United States to use the Cherokee trademarks in certain categories of merchandise. Under the Target Stores agreement, Target Stores will pay a royalty each fiscal year based on percentages of Target Stores' net sales of Cherokee
merchandise. In any event, Target Stores has agreed to pay a minimum guaranteed royalty of $10.5 million for each of the four years 2001 through 2004. The agreement will automatically renew for successive one-year periods, providing Target is current in its minimum guaranteed payments, unless they provides one-year notice to terminate the agreement. In February 2004, Target renewed their agreement with Cherokee under the same terms as of January 31, 2003. The renewal extends through January 2006. The guaranteed minimum royalty for 2006 is $9.0 million.

Target Stores may terminate the agreement effective February 2006 if it gives us written notice of its intent to do so by February 28, 2005, and may terminate at the end of any fiscal year thereafter, if it gives written notice of its intent to do so during February of the calendar year prior to termination.

During 2001, they assisted Mossimo Inc. in locating Target Stores as a licensee of the Mossimo brand and entered into a finder's agreement with Mossimo which provides that Cherokee receive 15% of all royalties paid to Mossimo by Target. Mossimo and Cherokee have been locked in litigation regarding the $5.2 million finders fee.


In 2001, Mervyn's agreed to renew its licensing agreement for certain merchandise categories of the Sideout brand for an additional three years. The renewal term commenced on February 1, 2002 and continues through January 31, 2005. Under the Mervyn's agreement, Mervyn's will pay a royalty each fiscal year based on a percentage of Mervyn's net sales of Sideout branded merchandise during each fiscal year, subject to a guaranteed minimum royalty.

The Sideout brand includes men's, women's and children's sportswear, accessories, luggage, sports bags and backpacks, skin care products and hats. During fiscal 2004, royalty revenues from retail direct licensees for the Sideout brand totaled $2.9 million as compared to $3.1 million during fiscal 2003. During fiscal 2004, the non-exclusive licensees for the Sideout brand included Mervyn's and Bob's Stores( bought by TJ Max). The term of the agreement with Mervyn's continues until January 31, 2005.

During fiscal 2004, $2.9 million, or approximately 8%, of licensing revenues was from Mervyn's(a division of Target Corporation). Current licensing with Mervyn's is for Sideout brand and extends until January 31, 2005. On March 10, 2004 Target
announced that it was reviewing strategic alternatives for its Mervyn's and Marshall Field's divisions, and that it had engaged an investment banker to advise Target
Corporation in this review. If Target Corporation elects to sell Mervyn's to an existing retailer or other qualified buyer, or chooses to spin-off Mervyn's or some other strategic alternative, such a transaction could adversely impact the likelihood that the existing licensing contract would be extended beyond the current term ending January 31, 2005.


In 1997, they began a retail direct licensing agreement with Zellers, a Canadian corporation, which is a division of Hudson's Bay Company. Zellers was granted the exclusive right in Canada to use the Cherokee brand and related trademarks. The term of the agreement is for five years, with automatic renewal options, provided that specified minimums are met each contract year. Under the agreement, Zellers agreed to pay a minimum royalty of $10.0 million over the five-year initial term of the agreement. During Fiscal 2002, Zellers renewed their agreement as of February 1,2003 for an additional five year period, through January 31, 2008. Under the terms of the renewal, Zellers agreed to pay a minimum guaranteed royalty of $15.6 million over the five-year term.

TJ Max

In December, 2002, Cherokee acquired out of bankruptcy the trademarks of CL Fashion Inc. which included Carole Little, CLII, Saint Tropez-West, Chorus Line, All that Jazz, and Molly Malloy. Concurrent, and just after this acquisition, Cherokee entered into a five-year licensing agreement with TJX Companies for the Carole Little, CLII and Saint Tropez-West brands and a master licensing agreement with Gilrichco, Inc. for the remaining brands. The licensing agreement with TJX provides minimum guaranteed annual royalties during the five-year term of the agreement and provides TJX with the option at the expiration of the initial term of the agreement to either renew the agreement for an additional five years or buy the trademarks covered by the agreement.


In early September 2000, they entered into an exclusive international retail with France based Carrefour, the second largest retailer in the world. The Carrefour Group was granted the exclusive right to manufacture, promote, sell and distribute a wide range of products bearing the Cherokee brand in Spain, Mexico and Brazil and subsequently Italy, France, China, Taiwan, Greece and Portugal have been added.

The Carrefour Group pays a royalty based upon a percentage of its net sales in those countries, which includes a minimum annual guaranteed royalty. Royalty revenues from the Carrefour Group totaled $691,000 in fiscal 2004.

Tesco Stores

On August 1, 2001, they entered into an exclusive international licensing agreement for the Cherokee brand with Great Britain's Tesco Stores Limited. Tesco was granted the exclusive rights to distribute a wide range of products bearing the Cherokee brand in the United Kingdom and Ireland and is obligated to pay a royalty based upon a
percentage of its net sales of Cherokee branded products in those countries.

Royalty revenues from Tesco totaled $5.2 million during fiscal 2004. Tesco also has a right to add a number of other countries to the territories covered by the agreement, subject to the existing rights given to the Carrefour Group. The initial term of the
agreement expires on January 31, 2005. If Tesco meets certain retail sales thresholds with respect to Cherokee branded products, then Tesco may extend the agreement indefinitely for successive three-year terms.

Including the Carrefour Group and Tesco agreements, as of January 31, 2004, they had four international license agreements for the Cherokee brand. During fiscal 2004, they received $9.4 million in aggregate royalties from international license agreements, which accounted for 26% of consolidated revenues.


During fiscal 2003 and 2004, revenue from a finder's fee for Mossimo of $2.7 million and $2.5 million was recognized on the books. Mossimo refused to pay. The reasons aren't given. That is $5.2 million that had not been paid that was due. In order to collect, Cherokee sued Mossimo. In along series of decisions, they finally won and Mossimo has paid and posted most of the money due minus certain legal fees. As of January 31, 2004 past amounts due from Mossimo totaled approximately $6.2 million, which included approximately $5.2 million in finder's fees owed, and over $1.0 million of interest and reimbursement of legal fees previously awarded, but does not include legal expenses and costs of over $410,000 incurred since January 17, 2003. Based upon the $1.7 million check received on March 24, 2004 and the release by Mossimo of the court deposit of over $4.5 million previously posted by Mossimo (but not yet received), they believe that they will receive at least $6.2 million.


2004 2003 2002

------------------ ------------------ -----------------
Options Weighted Options Weighted Options Weighted

Average Average Average
Exercise Exercise Exercise

Price Price Price

--------- -------- --------- -------- -------- --------
Outstanding at 558,641 $ 10.43 559,536 $ 9.03 599,536 $ 8.98
beginning of year
Granted -- -- 125,464 14.40 10,000 8.90
Exercised (363,652) 9.50 (126,359) 8.14 -- --
Forfeited (20,311) 18.79 -- -- (50,000) 8.50

--------- -------- --------- -------- -------- --------
Outstanding at end 174,678 $ 11.41 558,641 $ 10.43 559,536 $ 9.03
of year

--------- -------- --------- -------- -------- --------
Exercisable at end 102,427 $ 10.43 426,510 $ 9.29 516,203 $ 9.01
of year
Weighted average -- $ 4.20 $ 2.26
grant date fair
value of options
granted during the

Total dilution is 2% which is very reasonable

Financial Statements

ratios for the income statement

2004 2003 2002 2001 2000
operating margins 67% 70% 71% 71% 63%
net margins 39% 39% 39% 38% 33%
growth revenue 10% 8% 8% 15% ---
growth gross 10% 8% 8% 15% ---
growth operating 4% 7% 8% 30% ---
growth net 9% 7% 12% 33% ---
growth SGA 21% 10% 9% 10% ---
growth EPS diluted 9% 5% 13% 37% ---
growth EPS cont operations 8% 7% 14% 37% ---
growth depreciation 49% 25% 35% 52%
growth taxes 8% 14% 11% 47% ---
tax rate 41% 41% 40% 40% 38%

**They have good operating and net margins

**Growth has slowed significantly since 2001. Are they reaching saturation on royalties from Target and have not actively invested in other labels and other retailers? Target has decreased spending with Cherokee in 2004 and since Target is a large proportion of their business, this limits their growth

**Costs growths are exceeding growths in revenue and net income. This is not acceptable. Their efforts are not paying off and bonuses were awarded that seem not to have been deserved.Expenses in fiscal 2004 increased primarily due to increases in bonus expense, which increased to $3.9 million, approximately $200,000 more than the 2003 total of $3.7 million; severance expenses for the separation of a former executive of approximately $575,000 (there were no severance expenses for 2003); amortization of trademarks for 2004, which increased to $991,000 as compared to $667,000 in 2003--primarily due to increased amortization from the Carole Little trademarks acquired near the end of fiscal 2003; and total marketing expenses, which increased by about $100,000 in fiscal 2004. Legal expenses of over $590,000, during fiscal 2004, which includes over $400,000 of legal expenses related to the Mossimo lawsuit, as compared to total legal expenses in fiscal 2003 of about $160,000.

**Amortization expenses are expected to increase as a result of the acquisition of the CL Fashion trademarks, Sideout contingent payments, and the purchase of other trademarks and registrations. Management and staff bonus expenses will continue to rise if EBITDA continues to rise.

**Depreciation is mostly in the amortization of expense from acquisitions of trademarks. They own no buildings, property plant or equipment

Balance sheet and ratios

Since this is a company without inventory or physical property it is interesting to see where there assets are:


January 31, February 1,
2004 2003

------------ ------------
Current assets:
Cash and cash equivalents $ 5,850,000 $ 2,852,000
Restricted cash 2,627,000 2,637,000
Receivables, net 12,992,000 9,896,000
Prepaid expenses and other current assets 747,000 425,000
Deferred tax asset 954,000 964,000

------------ ------------
Total current assets 23,170,000 16,774,000
Securitization fees, net of accumulated amortization -- 195,000
of $1,241,000 and $1,046,000, respectively
Deferred tax asset 1,589,000 1,832,000
Property and equipment, net of accumulated 108,000 120,000
depreciation of $342,000 and $311,000, respectively
Trademarks, net 9,726,000 10,127,000
Other assets 34,000 15,000

------------ ------------
Total assets $ 34,627,000 $ 29,063,000

**Assets are concentrated in cash, trademarks and receivables. nearly 335 of total assets is in receivables.The next largest amount is in the amount the trademarks have cost less amortization.These assets strike me as less worthwhile than hard assets of property. The receivables are not guaranteed to be collected and the value of the trademarks is more of an intangible--worth only what customers are willing to pay.

**There are no amounts outstanding under any credit facilities or lines of credit and no Secured Notes or any other material third-party obligations.

**In March 2004 they entered into a new $5.0 million Secured Loan Agreement with U.S. Bank National Association , which expires on July 15, 2005. This New Bank Facility was entered into to provide greater working capital flexibility and liquidity for general corporate purposes, including the potential acquisition of brands or related properties which may be for sale.

Balance sheet ratios

2004 2003 2002 2001 2000
current ratio 3.09 1.11 0.98 0.86 0.85
quick ratio 0.79 0.19 0.3 0.19 0.18
AR growth 31% 60% 5% 23%
DSO 130.7 109.1 73.7 76.1 70.9
growth in payables 150% -50% 33% -50%

ROE 52% 110% -672% -72% -34%
ROA 41% 45% 50% 56% 46%
ROIC 48% 56% 64% 77% 67%

debt/equity 9.6% 106.8% -1222.2% -204.0% -159.8%
debt/capital 9% 52% 109% 196% 267%
book value 3.16 1.44 -0.22 -1.84 -2.84
cash/share $0.69 $0.35 $0.54 $0.32 $0.27
NC WC 12.4 9.2 5.8 5.9 5.8
change in NC WC 3.2 3.4 -0.1 0.1 5.8
increase in LT debt -2.1 -9.4 -8.8 -8.1 28.4
total shares 0.4 0 0 -0.3 8.5

**It is interesting that liabilities exceeded assets in 2002,2001 and 2000. Initially CHKE came up in a screen for high ROE,ROIC and ROA. The high liabilities have decreased as debt and notes were paid. On the other hand, assets have increased markedly with a doubling of accounts receivables since 2002.

**AR growth is higher than growth in revenue and net and days sales outstanding are also increasing. Since they have no inventory to stuff channels., it seems this would be due to sluggish payment of royalties. They recognize revenue in the month prior to payment, but it would seem maybe payment may not be as they describe(the month after revenue is recognized)

**Low debt and assets do no exceed liabilities. Unfortunately a good portion of this is receivables and the next biggest portion is the cost of capitalized trademarks. Granted, capitalizing the trademarks is acceptable, given the nature of the business, but it is not an asset that can be readily liquidated.

**Number of shares is not increasing greatly and there is little dilution.

**They do have some cash on hand and the restricted cash(for payment of notes) has been eliminated this year.

Debt repayment

Royalties paid by Target appear in the financial statements,but since the issuance of the Secured Notes, most of the royalties have been distributed to the holders of the Secured Notes.

During fiscal 2004, of the $20.6 million in royalty revenues received from Target Stores, $10.5 million was paid to the holders of the Secured Notes. The final payment of $2.6 million was made to the holders of the Secured Notes on February 20, 2004.

Cash flow statement ratios

2004 2003 2002 2001 2000
growth in operating cash flow 9% 7% 12% 33% ---
operating cash/revenue 38% 37% 48% 51% 57%
operating cash/net income 98% 94% 121% 134% 175%
operating cash/debt+interest 4.21 1.05 1.19 1.12 1.1
capex/operating cash 5% 28% 12% -1% 0%
free cash flow 14.6 15.64 16.4 14.4 14.2
common shares 8.6 8.2 8.2 8.2 8.5
free cash flow/share $1.70 $1.91 $2.00 $1.76 $1.67

**Cash requirements through the end of fiscal 2005 are primarily to fund operations, repay the last installment of $2.6 million of Secured Notes (which were retired in February 2004), and repurchase shares of common stock or pay dividends and, to a lesser extent, for capital expenditures. They are not a capital intensive business

**During fiscal 2004, cash provided by operations was $13.9 million, compared to $12.2 million in fiscal 2003. However the ratio of operating cash to net income and revenue has been on the decline. It should remain stable. Most of the decline is due to increasing receivables.

**During fiscal 2004, cash used in investing activities was $0.6 million and was primarily related to trademark purchases and registration fees incurred in connection with continued payments under the Sideout Agreement and registration of the Sideout trademarks and for other trademark expenditures. In comparison, during fiscal 2003, cash used in investing activities was $3.4 million, of which $2.7 million was attributable to the acquisition of the CL Fashion Trademarks

**During fiscal 2004, the Board of Directors declared and paid a $0.375 per common share dividend, using $3.2 million.

**During fiscal 2003, they used $861,000 of cash to repurchase 57,500 shares of common stock.

**free cash flow is positive

**Operating cash is sufficient to pay debt

**Common shares not increasing significantly


Sales at Target Stores declined in fiscal 2004 by 5.5% to $1.9 billion, attributed to changes in the mix and placement of Cherokee brands in Target Stores. Target Stores pays royalty revenues based on a percentage of its sales. The Amended Target Agreement, however, is structured to provide royalty rate reductions for Target Stores after it has achieved certain levels of retail sales of Cherokee branded products during each fiscal year. In fiscal 2004 Target Stores reached the maximum royalty rate reduction in the third quarter. This trend is expected to continue and have a positive impact on licensing revenues in the first quarter ended May 1, 2004 , but may have a negative impact on licensing revenues in second and third quarters ending July 31, and October 29, 2004.

Future revenues from Target and Zeller's may remain relatively flat due to changes in how Target and Zellers are placing products in their stores and competition from other branded products. Cherokee is unsure how future revenues from Mervyn's will trend, as Target has announced that it is exploring strategic alternatives with Mervyn's. If Target elects to sell Mervyn's to an existing retailer or other buyer, or chooses to spin-off Mervyn's or some other strategic alternative,they cannot determine whether such transaction would result in the extension or renewal of existing licensing contract beyond the current term ending January 31, 2005. Based on Tesco's sales of Cherokee branded products in the last year and Tesco's expressed interest in continuing to promote the Cherokee brand,revenues from Tesco may continue to grow.


This is not the company I thought it would be. I thought they were a successful wholesale manufacturer of clothes that had a lucrative contract with Target. I have bought some of their labels in the past. As it turns out they hold brand names but no real input into the design or manufacture of the clothes they brand. They do have some say in the quality, advertising and graphics. They only employ 17 people and the returns are high. Those high returns are what brought them to my attention in the first place. However, in looking at the reasons for the improved ROE, I don't like what I see--increasing accounts receivables. The increasing days sales outstanding is also concerning. Do they really have much leverage with their brand names?

Target is another concern and Target also controls their fate with Mervyns. These accounts are more than half of their business and can be canceled with a years notice. This lends an air of uncertainty to their future. Suppose Target finds a more attractive lower cost line? Starts marketing their own brands more aggressively? Decreases shelf space(as they already have) for Cherokee brands? It could take a very real bite out of revenue for Cherokee. The reliance on one retailer, free to let them go, is concerning.

All in all, I don't find them an attractive investment at this point as much as I would have liked to.
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