Table
of Contents
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM 10-Q
(Mark One)
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x
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Quarterly Report Pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934
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For the quarterly period ended September 28, 2008
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or
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o
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Transition Report Pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934
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For the transition period
from to
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Commission
File No. 000-50593
Cherokee International Corporation
(Exact name of
Registrant as specified in its charter)
Delaware
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95-4745032
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(State or Other Jurisdiction of
Incorporation or Organization)
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(I.R.S. Employer
Identification Number)
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2841 Dow Avenue
Tustin, California
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92780
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(address of the principal executive offices)
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(zip code)
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Registrants
telephone number, including area code
(714) 544-6665
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
x
No
o
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definitions of large accelerated filer, accelerated filer, and
smaller reporting company in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer
o
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Accelerated filer
o
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Non-accelerated filer
o
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Smaller reporting company
x
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(Do not check if a smaller reporting company)
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Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes
o
No
x
Indicate the number of shares outstanding of each of the issuers
classes of common stock, as of the latest practicable date.
Title
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Shares Outstanding as of October 31, 2008
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Common Stock, par value $0.001 per share
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19,475,892 shares
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Table of Contents
PART I.
FINANCIAL INFORMATION
Item 1.
FINANCIAL STATEMENTS.
CHEROKEE
INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONDENSED
CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and
Per Share Data)
(Unaudited)
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September 28, 2008
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December 30, 2007
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ASSETS
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CURRENT ASSETS:
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Cash and cash equivalents
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$
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15,301
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$
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8,484
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Accounts receivable, net of allowance for
doubtful accounts of $280 and $297 at September 28, 2008 and
December 30, 2007, respectively
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29,579
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31,237
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Inventories, net
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29,395
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28,021
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Prepaid expenses and other current assets
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1,509
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1,583
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Deferred income taxes
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363
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Total current assets
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75,784
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69,688
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Property and equipment, net
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17,540
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19,194
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Deposits and other assets
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1,126
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1,515
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Deferred financing costs, net of
accumulated amortization of $580 and $494 at September 28, 2008 and
December 30, 2007, respectively
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86
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Deferred income taxes-long-term portion
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1,257
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Goodwill
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1,120
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Total Assets
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$
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94,450
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$
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92,860
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LIABILITIES AND STOCKHOLDERS EQUITY
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CURRENT LIABILITIES:
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Accounts payable
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$
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15,825
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$
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15,140
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Accrued liabilities
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4,732
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4,667
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Accrued compensation and benefits
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6,983
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6,876
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Accrued restructuring costs
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410
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431
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Other short-term borrowings
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198
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Borrowings under revolving line of credit
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3,796
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3,395
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Current debt
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24,485
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24,485
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Current debt payable to affiliates
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22,145
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22,145
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Total current liabilities
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78,574
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77,139
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Other long-term liabilities
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4,212
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4,534
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Total Liabilities
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82,786
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81,673
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Commitments and contingencies (Note 9)
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STOCKHOLDERS EQUITY:
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Common stock: $0.001 par value; 60,000,000
shares authorized; 19,475,892 and 19,453,557 shares issued and outstanding at
September 28, 2008 and December 30, 2007, respectively
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19
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19
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Paid-in capital
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186,789
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186,035
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Accumulated deficit
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(178,754
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)
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(178,323
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Accumulated other comprehensive income
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3,610
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3,456
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Total stockholders equity
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11,664
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11,187
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Total Liabilities and Stockholders Equity
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$
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94,450
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$
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92,860
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See notes to condensed consolidated financial
statements.
1
Table of Contents
CHEROKEE
INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Share
Amounts)
(Unaudited)
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Three Months Ended
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Nine Months Ended
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September 28, 2008
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September 30, 2007
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September 28, 2008
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September 30, 2007
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Net sales
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$
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36,402
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$
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30,401
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$
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111,689
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$
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89,995
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Cost of sales
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27,170
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24,670
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82,481
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72,996
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Gross profit
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9,232
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5,731
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29,208
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16,999
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Operating expenses:
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Engineering and development
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2,618
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2,561
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8,299
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8,040
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Selling and marketing
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1,682
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1,510
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5,517
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5,247
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General and administrative
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4,152
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2,660
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11,141
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9,177
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Goodwill impairment
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1,120
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Restructuring costs
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155
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Total operating expenses
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8,452
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6,731
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26,077
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22,619
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Operating income (loss)
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780
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(1,000
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)
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3,131
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(5,620
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)
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Interest expense
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(707
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)
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(707
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)
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(2,166
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)
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(2,084
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Gain on sale of Mexico Facility building
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430
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Other income (loss), net
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66
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(23
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)
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305
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291
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Income (loss) before income taxes
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139
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(1,730
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)
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1,270
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(6,983
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)
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Income tax provision (benefit)
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13
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(421
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)
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1,701
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(1,999
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)
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Net income (loss)
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$
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126
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$
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(1,309
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)
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$
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(431
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)
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$
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(4,984
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)
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Net income (loss) per share:
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Basic
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$
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0.01
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$
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(0.07
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)
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$
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(0.02
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)
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$
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(0.26
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)
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Diluted
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$
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0.01
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$
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(0.07
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)
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$
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(0.02
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)
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$
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(0.26
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)
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Weighted average shares outstanding:
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Basic
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19,476
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19,414
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19,465
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19,371
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Diluted
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19,480
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19,414
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19,465
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19,371
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See notes to condensed consolidated financial
statements.
2
Table of Contents
CHEROKEE
INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS
(In
Thousands)
(Unaudited)
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Three Months Ended
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Nine Months Ended
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September 28, 2008
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September 30, 2007
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September 28, 2008
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September 30, 2007
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Net income (loss)
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$
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126
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$
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(1,309
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)
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$
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(431
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)
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$
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(4,984
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)
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Other comprehensive income (loss):
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Foreign currency translation adjustments
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(517
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)
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567
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154
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865
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Comprehensive loss
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$
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(391
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)
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$
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(742
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)
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$
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(277
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)
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$
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(4,119
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)
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See notes to condensed consolidated financial
statements.
3
Table
of Contents
CHEROKEE
INTERNATIONAL CORPORATION AND SUBSIDIARIES
CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In
Thousands)
(Unaudited)
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Nine Months Ended
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September 28, 2008
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September 30, 2007
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CASH FLOWS FROM OPERATING ACTIVITIES:
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Net loss
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$
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(431
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)
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$
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(4,984
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)
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Adjustments to reconcile net loss to net
cash provided by (used in) operating activities:
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Depreciation and amortization
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2,044
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2,397
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Goodwill impairment
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1,120
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Gain on sale of property and equipment
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(430
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)
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Amortization of deferred financing costs
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86
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97
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Stock-based compensation
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707
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589
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Deferred income taxes
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1,650
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Net change in operating assets and
liabilities:
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Accounts receivable, net
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1,562
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2,385
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Inventories, net
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(1,457
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)
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(834
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)
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Prepaid expenses and other current assets
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71
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|
1,180
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Deposits and other assets
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388
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(77
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)
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Accounts payable
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737
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(1,200
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)
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Accrued liabilities and restructuring costs
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(508
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)
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(3,647
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)
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Accrued compensation and benefits
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136
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(95
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)
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Accrued interest payable
|
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555
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|
636
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Other long-term liabilities
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(287
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)
|
(624
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)
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Net cash provided by (used in) operating
activities
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6,373
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(4,607
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)
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CASH FLOWS FROM INVESTING ACTIVITIES:
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|
|
|
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Additions to property and equipment
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(417
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)
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(2,152
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)
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Proceeds from sale of property and
equipment
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1,229
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|
Net cash used in investing activities
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(417
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)
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(923
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)
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CASH FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
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Other short-term borrowings, net
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296
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286
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Borrowings on revolving lines of credit,
net
|
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417
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|
3,308
|
|
Net proceeds from employee stock purchases
and the exercise of stock options
|
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47
|
|
231
|
|
Net cash provided by financing activities
|
|
760
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|
3,825
|
|
Effect of exchange rate changes on cash
|
|
101
|
|
133
|
|
Net increase (decrease) in cash and cash
equivalents
|
|
6,817
|
|
(1,572
|
)
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Cash and cash equivalents, beginning of
period
|
|
8,484
|
|
8,881
|
|
Cash and cash equivalents, end of period
|
|
$
|
15,301
|
|
$
|
7,309
|
|
SUPPLEMENTAL INFORMATION
|
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|
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Cash paid during the period for interest
|
|
$
|
1,541
|
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$
|
1,330
|
|
Cash paid during the period for income
taxes
|
|
$
|
299
|
|
$
|
239
|
|
See notes to condensed consolidated financial
statements.
4
Table
of Contents
CHEROKEE INTERNATIONAL
CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
NATURE OF OPERATIONS
Cherokee
International Corporation (the Company) is a designer and manufacturer of
power supplies for original equipment manufacturers (OEMs). Its advanced
power supply products are typically custom designed into mid- to high-end
commercial applications in the computing and storage, wireless infrastructure,
enterprise networking, telecom, medical and industrial markets.
2.
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The
accompanying condensed consolidated financial statements of Cherokee
International Corporation have been prepared in accordance with accounting
principles generally accepted in the United States of America for interim
financial information and in accordance with the instructions to Form 10-Q
and Article 10 of Regulation S-X. Accordingly, they do not include
certain footnotes and financial presentations normally required under
accounting principles generally accepted in the United States of America for
complete financial reporting. The interim financial information is
unaudited, but reflects all normal adjustments and accruals, which are, in the
opinion of management, considered necessary to provide a fair presentation for
the interim periods presented. The condensed consolidated financial
statements include the financial statements of the Company and its wholly owned
subsidiaries. All intercompany balances and transactions have been
eliminated in the accompanying condensed consolidated financial statements.
Results
of operations for the three and nine months ended September 28, 2008 and September 30,
2007, are not necessarily indicative of the results to be expected for the
entire fiscal year ending December 28, 2008 (fiscal 2008). The
accompanying condensed consolidated financial statements should be read in
conjunction with the audited consolidated financial statements for the fiscal
year ended December 30, 2007, included in the Companys Annual Report on Form 10-K
(File No. 000-50593) filed on March 28, 2008.
Going Concern
The accompanying condensed consolidated
financial statements have been prepared assuming that the Company will continue
as a going concern.
On November 1, 2008, the
$46.6 million aggregate principal amount outstanding under our 5.25%
Senior Notes became due and payable. As
previously disclosed, the Company did not have sufficient cash available to
repay this indebtedness. The Company
made the interest payment due on November 1 but was unable to pay the
principal amount outstanding at maturity and a payment default occurred. As a result of the payment default, in
addition to the aggregate principal amount outstanding under the Senior Notes,
the Company is required to pay interest on overdue principal at the default rate
of 6.25% per annum. It is anticipated that the previously announced merger
(the Merger) pursuant to the Agreement and Plan of Merger, dated as of September 24,
2008 (the Merger Agreement), by and among Lineage Power Holdings, Inc.,
a Delaware corporation (Parent), Birdie Merger Sub, Inc., a Delaware
corporation and a wholly owned subsidiary of Lineage (Merger Sub), and the
Company, as the agreement may be amended from time to time, will close on or
about November 21, 2008, after stockholders vote on the Merger at the
Special Meeting of Stockholders to be held on November 18, 2008.
As
a result of the Merger, pursuant to which Merger Sub will be merged with and
into the Company, with the Company surviving as a wholly owned subsidiary of
Lineage, the Senior Notes will remain an obligation of the Company. The Company anticipates that the outstanding
amounts due and payable under the Senior Notes, together with default interest
on overdue principal, will be paid in full at or after the closing of the Merger. If the Merger fails to be consummated we may be forced to refinance on
terms that are materially less favorable, seek funds through other means such
as a sale of our assets, or otherwise significantly alter our operating plan,
any of which could have a material adverse effect on our business, financial
condition and results of operation and our ability to continue as a going
concern. There can be no assurance that any refinancing or sale of assets would
be available on satisfactory terms, if at all, or that the Company would be
able to continue as a going concern.
Accordingly, if the Merger fails to be consummated, the Company could be
forced to file for bankruptcy protection and thereby reorganize or liquidate
its assets, resulting in material adverse consequences for the Companys stockholders,
creditors and employees.
The accompanying condensed consolidated
financial statements do not include any adjustments relating to the
recoverability and classification of asset carrying amounts or the amount and
classification of liabilities that might result should we be unable to continue
as a going concern.
5
Table
of Contents
Pending Merger with
Lineage Power Holdings, Inc.
As
described above, on September 24, 2008, the Company entered into the
Merger Agreement with Parent andMerger Sub, pursuant to which Merger Sub
will be merged with and into the Company, with the Company continuing after the
Merger as the surviving corporation and a wholly owned subsidiary of
Parent. The Companys board of directors has unanimously approved the
adoption of the Merger Agreement and the Merger and has recommended that the
Companys stockholders approve and adopt the Merger Agreement.
Pursuant
to the Merger Agreement, upon consummation of the Merger: (1) each
issued and outstanding share of common stock of the Company (the Shares), other than Shares owned by
the Company, Parent, Merger Sub or any wholly owned subsidiary of the Company,
Parent or Merger Sub, or by any stockholders who are entitled to and who
properly exercise appraisal rights under Delaware law, will be cancelled and
converted into the right to receive $3.20 in cash, without interest ; (2) each
unexercised stock option that is outstanding at the effective time of the
Merger (whether or not then vested) will be cancelled and converted into the
right to receive an amount in cash (subject to applicable withholding taxes)
equal to (x) the excess, if any, of $3.20 per share over the per share
exercise or purchase price of such outstanding stock option, multiplied by (y) the
number of shares of common stock underlying such stock option; and (3) shares
of common stock purchased under the Companys Employee Stock Purchase Program
will be cancelled and converted into the right to receive $3.20 per share.
The
Company has made customary representations, warranties and covenants in the
Merger Agreement, including, among others, covenants: (1) to, during the
interim period between the execution of the Merger Agreement and consummation
of the Merger, carry on its business in the usual, regular and ordinary course
in the same manner as previously conducted; (2) not to engage in certain
kinds of transactions during such period; and (3) to cause a stockholder
meeting to be held to consider approval of the Merger and the other
transactions contemplated by the Merger Agreement.
Additionally,
the Company has agreed not to (1) solicit, initiate or encourage proposals
relating to alternative business combination transactions or (2) subject
to certain exceptions, enter into discussions concerning alternative business
combination transactions. In addition, the Merger Agreement may be
terminated by the Company and Parent under certain circumstances, including by
the Company if its board of directors determines in good faith that it has
received an unsolicited bona fide superior proposal, as defined in the Merger
Agreement, and otherwise complies with certain terms of the Merger Agreement.
In connection with such
termination, the Company must pay a fee of $2,500,000 to Parent. The
Company may also be required to pay Parent a fee of $2,500,000 under other
specified circumstances in connection with a termination of the Merger Agreement.
Consummation
of the Merger is subject to the satisfaction or waiver (if applicable) of a
number of conditions, including: (1) approval of the Companys
stockholders; (2) subject to certain exceptions, the absence of a material
adverse effect with respect to the Company during the interim period between
the execution of the Merger Agreement and consummation of the Merger; (3) expiration
of the waiting period and approval under any applicable antitrust laws; and (4) no
restraints of any governmental entity prohibiting the consummation of the
Merger. In addition, each partys obligation to consummate the Merger is
subject to the accuracy of the representations and warranties of the other
party, subject to a material adverse effect condition, and material compliance
of the other party with its covenants.
In
connection with the Merger Agreement, certain stockholders of the Company with
controlling voting power of approximately 50.3% of the Shares have entered into
a voting agreement with Parent, Merger Sub and the Company (the Voting
Agreement) pursuant to which those stockholders have agreed to vote in favor
of the transactions contemplated by the Merger Agreement and not to transfer
their shares except under certain circumstances. The Voting Agreement will
terminate upon any termination of the Merger Agreement.
Use of Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent liabilities at the date
of the financial statements and the amounts of revenues and expenses during the
reporting period. Actual results could differ from such estimates.
Stock-Based Compensation
In December 2004, SFAS 123R,
Share-Based Payment
, was issued.
SFAS 123R is a revision of SFAS 123,
Accounting
for Stock Based Compensation
, and supersedes APB 25. Among
other items, SFAS 123R eliminates the use of APB 25 and the intrinsic
value method of accounting, and requires companies to recognize the cost of
employee services received in exchange for awards of equity instruments, based
on the grant-date fair value of those awards, in the financial statements. The Company
was required to adopt SFAS 123R effective on January 2, 2006.
SFAS 123R permits companies to adopt its requirements using either a
modified prospective
method, or a
modified retrospective
method. Under the
modified prospective
method,
compensation cost is recognized in the financial statements beginning with the
effective date, based on the requirements of SFAS 123R for all share-based
payments granted after that date, and based on the requirements of
SFAS 123 for all unvested awards granted prior to the effective date of
SFAS 123R. Under the
modified
retrospective
method, the requirements are the same as under the
modified prospective
method, but also
permit entities to restate financial statements of previous periods based on
proforma disclosures made in accordance with SFAS 123.
6
Table
of Contents
SFAS 123R permits the use of either the
Black-Scholes model or a lattice model.
The Company used the Black-Scholes standard option-pricing model to
measure the fair value of stock options granted to employees and nonemployees
prior to its adoption of SFAS 123R and continued its use thereafter.
SFAS 123R requires that the benefits
associated with the tax deductions in excess of recognized compensation cost be
reported as a financing cash flow, rather than as an operating cash flow as
required under prior literature. This requirement will reduce net operating
cash flows and increase net financing cash flows in periods after the effective
date. These future amounts cannot be estimated, because they depend on, among
other things, when employees exercise stock options.
The Company adopted SFAS 123R on January 2,
2006 using the modified prospective method as permitted by SFAS 123R.
Under this transition method, stock compensation cost recognized beginning in
the first quarter of fiscal year 2006 includes: (a) compensation cost for
all share-based payments granted subsequent to February 25, 2004 and prior
to January 1, 2006 but not yet vested as of January 1, 2006, based on
the grant-date fair value estimated in accordance with the provisions of
SFAS 123R, and (b) compensation cost for all share-based payments
granted subsequent to January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123R. In accordance
with the modified prospective method of adoption, the Companys results of
operations and financial position for prior periods have not been restated. At
the date of the adoption, the unamortized expense for options issued prior to January 2,
2006 was $2.3 million, which will be amortized as stock compensation costs
through December 2010. Stock-based compensation costs expensed during the
quarters ended September 28, 2008 and September 30, 2007, were $0.2
million and $0.2 million, respectively. During the nine months ended September 28,
2008 and September 30, 2007, the costs recorded were $0.7 million and $0.6
million, respectively.
All grants are made at prices based on the
fair market value of the stock on the date of grant. Outstanding options
generally vest over periods ranging from two to four years from the grant date
and generally expire up to ten years after the grant date.
The Company records
compensation expense for employee stock options based on the estimated fair
value of the options on the date of grant using the Black-Scholes option
pricing formula with the assumptions included in the table below. The Company
uses historical data, among other factors, to estimate the expected price
volatility and the expected forfeiture rate. For options granted prior to January 2,
2006, the Company used the expected option life of 5 years. For options
granted following the Companys adoption of SFAS 123R, the expected life
was increased to 6.25 years using the simplified method under
SAB 107 (an expected term based on the mid-point between the vesting date
and the end of the contractual term). The use of the simplified method requires
our option plan to be consistent with a plain vanilla plan and was originally
permitted through December 31, 2007 under SAB 107. In December 2007,
the SEC issued SAB 110,
Share-Based
Payment
, to amend the SECs views discussed in SAB 107
regarding the use of the simplified method in developing an estimate of
expected life of share options in accordance with SFAS 123R. SAB 110
was effective for the Company beginning December 31, 2007. The Company
will continue to use the simplified method until it has the historical data
necessary to provide a reasonable estimate of expected life, in accordance with
SAB 107, as amended by SAB 110. The options have a maximum
contractual term of 10 years and generally vest pro-rata over two to four
years. The risk-free rate is based on the U.S. Treasury yield curve in effect
at the time of grant for the estimated life of the option.
The following
weighted-average assumptions were used to estimate the fair value of options
granted during the three- and nine-month periods ended September 28, 2008
and September 30, 2007, using the Black-Scholes option pricing formula.
7
Table
of Contents
|
|
Quarter Ended
|
|
Nine Months Ended
|
|
|
|
September 28, 2008
|
|
September 30, 2007
|
|
September 28, 2008
|
|
September 30, 2007
|
|
Dividend yield
|
|
0.0
|
%
|
0.0
|
%
|
0.0
|
%
|
0.0
|
%
|
Expected volatility
|
|
67.1
|
%
|
54.7
|
%
|
61.5
|
%
|
54.8
|
%
|
Risk-free interest rate
|
|
3.85
|
%
|
4.59
|
%
|
3.99
|
%
|
4.97
|
%
|
Expected lives
|
|
6.25 years
|
|
6.25 years
|
|
6.25 years
|
|
6.25 years
|
|
Forfeiture rates
|
|
10.65% - 24.78
|
%
|
11.74% - 21.88
|
%
|
10.65% - 24.78
|
%
|
11.74% - 21.88
|
%
|
The
following table summarizes the Companys activities with respect to its stock
option plans for the nine months ended September 28, 2008 as follows:
Options
|
|
Number
of
Shares
|
|
Weighted-
Average
Exercise Price
Per Share
|
|
Weighted-
Average
Remaining
Contractual
Term
(in years)
|
|
Aggregate
Intrinsic
Value
|
|
Outstanding at December 30, 2007
|
|
2,791,579
|
|
$
|
5.97
|
|
7.49
|
|
$
|
|
|
Granted
|
|
70,000
|
|
$
|
2.33
|
|
9.69
|
|
$
|
45,700
|
|
Exercised
|
|
|
|
$
|
|
|
|
|
$
|
|
|
Forfeited
|
|
(246,653
|
)
|
$
|
6.97
|
|
6.05
|
|
$
|
|
|
Outstanding at September 28, 2008
|
|
2,614,926
|
|
$
|
5.78
|
|
6.87
|
|
$
|
46,625
|
|
Vested and expected to vest in the future
at September 28, 2008
|
|
2,401,996
|
|
$
|
5.90
|
|
6.72
|
|
$
|
26,720
|
|
Exercisable at September 28, 2008
|
|
1,591,601
|
|
$
|
6.70
|
|
6.04
|
|
$
|
387
|
|
Since its inception on February 16,
2004, a total of 400,000 shares of common stock have been reserved for issuance
under the 2004 Employee Stock Purchase Plan (ESPP), subject to annual
increases as described under Note 11 below. Under the terms of the ESPP, the
Companys U.S. employees, nearly all of whom are eligible to participate, can
choose to have up to a maximum of 15% of their eligible annual base earnings
withheld, subject to an annual maximum of $25,000 or 2,100 shares per offering
period, to purchase our common stock. The purchase price of the stock is 85% of
the lower of the closing price at the beginning of each six-month offering
period or at the end of each six-month offering period. The Company recognizes
compensation cost for its ESPP under SFAS 123R.
8
Table
of Contents
In accordance with SFAS 148, and as required by SFAS 123R, the required
pro forma disclosure for options granted in periods prior to adoption of SFAS
123R is shown below (in thousands except per share amounts):
|
|
Quarter Ended
|
|
Nine Months Ended
|
|
|
|
September 28, 2008
|
|
September 30, 2007
|
|
September 28, 2008
|
|
September 30, 2007
|
|
Net income (loss), as reported
|
|
$
|
126
|
|
$
|
(1,309
|
)
|
$
|
(431
|
)
|
$
|
(4,984
|
)
|
Stock-based employee compensation related
to stock options included in net income (loss), as reported, net of tax
|
|
|
|
|
|
|
|
|
|
Total stock-based employee compensation
expense determined under the fair value based method for all awards
(under provisions of APB 25), net of tax (a)
|
|
|
|
(96
|
)
|
(40
|
)
|
(286
|
)
|
Net income (loss)pro forma
|
|
$
|
126
|
|
$
|
(1,405
|
)
|
$
|
(471
|
)
|
$
|
(5,270
|
)
|
Net income (loss) per share, as reported:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.01
|
|
$
|
(0.07
|
)
|
$
|
(0.02
|
)
|
$
|
(0.26
|
)
|
Diluted
|
|
$
|
0.01
|
|
$
|
(0.07
|
)
|
$
|
(0.02
|
)
|
$
|
(0.26
|
)
|
Pro forma net income (loss) per share:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.01
|
|
$
|
(0.07
|
)
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
Diluted
|
|
$
|
0.01
|
|
$
|
(0.07
|
)
|
$
|
(0.02
|
)
|
$
|
(0.27
|
)
|
(a)
During 2008 and
2007, the Company accounted for stock-based compensation for options granted
prior to February 25, 2004, the date of our initial public offering, to
employees and directors using the intrinsic value method prescribed in APB 25
and adopted the disclosure-only alternative of SFAS 123, as amended by SFAS 148
for these options.
Translation of Foreign Currency
Foreign subsidiary assets and liabilities
denominated in foreign currencies are translated at the exchange rate in effect
on the balance sheet date. Revenues, costs and expenses are translated at the
average exchange rate during the period. Transaction gains and losses are
included in results of operations and have not been significant for the periods
presented. The functional currency of Cherokee Europe is the Euro. The
functional currency of Cherokee India, Powertel and Cherokee China is the U.S.
dollar, as the majority of transactions are denominated in U.S. dollars.
Translation adjustments related to Cherokee Europe are reflected as a component
of stockholders equity in other comprehensive income (loss).
Recent Accounting Pronouncements
In September 2006, the FASB issued
SFAS 157,
Fair Value Measurements
.
This Statement defines fair value, establishes a framework for measuring fair
value in generally accepted accounting principles (GAAP), and expands
disclosures about fair value measurements. This Statement applies to accounting
pronouncements that require or permit fair value measurements, except for
share-based payments transactions under FASB Statement No. 123 (Revised),
Share-Based Payment
. This Statement is
effective for financial statements issued for fiscal years beginning after November 15,
2007, except for non-financial assets and liabilities, for which this Statement
will be effective for years beginning after November 15, 2008. The Company
adopted SFAS 157 on December 31, 2007, and the impact of this adoption on
our financial position and results of operations was immaterial.
In October 2008, FASB issued Staff Position No. FAS
157-3 (FSP 157-3)
,
Determining the Fair Value of a Financial
Asset When the Market for that Asset is not Active
, which clarifies
the application of SFAS 157 in a market that is not active and provides an
example to illustrate key considerations in determining the fair value of a
financial asset when the market for that financial asset is not active. FSP 157-3 was effective October 10, 2008 and for prior periods
for which financial statements have not been issued. The adoption of
FSP 157-3 did not have a material impact on our results of operations
or our financial position.
9
Table
of Contents
In February 2007, the FASB issued
SFAS 159,
The Fair Value Option for
Financial Assets and Financial Liabilities
. This Statement permits
entities to choose to measure many financial instruments and certain other
items at fair value that are not currently required to be measured at fair
value. The Statement also establishes presentation and disclosure requirements
designed to facilitate comparisons between entities that choose different
measurement attributes for similar types of assets and liabilities.
SFAS 159 is effective for financial statements issued for fiscal years
beginning after November 15, 2007, although early application is allowed.
The Company did not elect the fair value option for financial assets or
liabilities existing on our adoption date of December 31, 2007. The
Company will consider the applicability of the fair value option for assets
acquired or liabilities incurred in future transactions.
In December 2007, the FASB issued
SFAS 141(R),
Business Combinations
,
and SFAS 160,
Noncontrolling Interests
in Consolidated Financial Statements, an amendment of ARB No. 51
.
These pronouncements are required to be adopted concurrently and are effective
for business combination transactions for which the acquisition date is on or
after the beginning of the first annual reporting period beginning on or after December 15,
2008. Early adoption is prohibited; thus the provisions of these pronouncements
will be effective for us in fiscal year 2009. We do not have any minority
interests. We do not expect the adoption of SFAS 141(R) and SFAS 160
to have a material effect on our financial position or results of operations.
In December 2007, the SEC published
SAB 110,
Share-Based Payment
.
The interpretations in SAB 110 express the SEC staffs views regarding the
acceptability of the use of a simplified method, as discussed in
SAB 107, in developing an estimate of expected term of share options in
accordance with FASB Statement No. 123 (Revised),
Share-Based Payment
. The use of the
simplified method requires our option plan to be consistent with a plain
vanilla plan and was originally permitted through December 31, 2007 under
SAB 107. SAB 110 was effective for the Company beginning December 31,
2007. The Company will continue to use the simplified method until it has the
historical data necessary to provide a reasonable estimate of expected life, in
accordance with SAB 107, as amended by SAB 110.
In March 2008, the FASB issued
SFAS 161,
Disclosures about Derivative
Instruments and Hedging Activities,
an amendment of SFAS 133.
This Statement requires enhanced disclosures about derivative instruments and
hedging activities within an entity by requiring the disclosure of the fair
values of derivative instruments and their gains and losses in a tabular
format. It provides more information about an entitys liquidity by requiring
disclosure of derivative features that are credit risk-related, and it requires
cross-referencing within footnotes to enable financial statement users to
locate important information about derivative instruments. It is effective for
financial statements issued for fiscal years and interim periods beginning after
November 15, 2008, with early adoption permitted. The Company is
evaluating the impact of the adoption of SFAS 161 and believes there will
be no material impact on our consolidated financial statements or financial
operations.
In May 2008, the FASB issued SFAS 162,
The Hierarchy of Generally Accepted Accounting
Principles
. SFAS 162 identifies the sources of accounting principles
and the framework for selecting the principles to be used in the preparation of
financial statements of nongovernmental entities that are presented in
conformity with generally accepted accounting principles in the United
States. It is effective 60 days following the SECs approval of the
Public Company Accounting Oversight Board amendments to AU Section 411,
The Meaning of Present Fairly in Conformity With
Generally Accepted Accounting Principles
. The adoption of this
Statement is not expected to have a material effect on the Companys
consolidated financial statements.
In May 2008, the FASB issued SFAS 163,
Accounting for Financial Guarantee Insurance
Contracts An interpretation of FASB Statement No. 60
. SFAS 163 requires that an insurance enterprise recognize a claim
liability prior to an event of default when there is evidence that credit
deterioration has occurred in an insured financial obligation. It also
clarifies how Statement 60 applies to financial guarantee insurance contracts,
including the recognition and measurement to be used to account for premium
revenue and claim liabilities, and requires expanded disclosures about
financial guarantee insurance contracts. It is effective for financial
statements issued for fiscal years beginning after December 15, 2008,
except for some disclosures about the insurance enterprises risk-management
activities.
SFAS 163 requires
that disclosures about the risk-management activities of the insurance
enterprise be effective for the first period beginning after issuance. Except
for those disclosures, earlier application is not permitted. The
adoption of this Statement is not expected to have a material effect on the
Companys consolidated financial statements.
Inventories
Inventories
are valued at the lower of weighted average cost or market. Inventory costs
include the costs of material, labor and manufacturing overhead and consist of
the following, net of reserve for surplus and obsolescence (in thousands):
10
Table
of Contents
|
|
September 28, 2008
|
|
December 30, 2007
|
|
Raw material
|
|
$
|
16,933
|
|
$
|
16,547
|
|
Work-in-process
|
|
4,578
|
|
4,696
|
|
Finished goods
|
|
7,884
|
|
6,778
|
|
Inventories, net
|
|
$
|
29,395
|
|
$
|
28,021
|
|
As of September 28,
2008 and December 30, 2007, the reserve for excess inventory and
obsolescence was $2.9 million and $3.1 million, respectively, including
managements assessment of reserves for surplus and obsolescence for
non-compliant material related to the Restriction of Hazardous Substances in
Electrical and Electronic Equipment directive.
The following are two European Economic
Community (EEC) directives that are having an effect on the entire
electronics industry, including the Company:
(1) Restriction of Hazardous Substances
in Electrical and Electronic Equipment, more commonly known as RoHS. This
European directive bans the use of certain elements that are commonly found in
components used to manufacture electrical and electronic assemblies. This
directive became effective on July 1, 2006. The Company began manufacturing
compliant products in 2006 and continues to work actively with its customers to
ensure compliance. The Company is focused on consuming all non-compliant
materials on-hand within a reasonable period. However, the Company may have to
dispose of non-compliant materials in the future, which could adversely affect
the financial performance of the Company. There is also a risk of fines
associated with non-compliance with the RoHS directive; however, the Company is
not aware of any specific potential fines, and the Company anticipates
complying with all provisions of this legislation.
(2) Waste Electrical and Electronic
Equipment, also known as WEEE. This directive became effective August 13,
2005 and requires manufacturers and importers to properly recycle or dispose of
such equipment at the end of its useful life. The Company believes it has
limited exposure to the WEEE directive because its products are usually
installed into another users system, but this directive may be interpreted and
enforced differently in the future. If so, the Company may face significant
risk of fines and costs associated with non-compliance with the existing laws
and regulations in the European Union. The Company began manufacturing
compliant products in 2005, and continues to work actively with its customers
to ensure compliance.
As of September 28,
2008, the Company does not foresee any material estimated capital expenditures
for environmental remediation or related costs to its manufacturing facilities
in the future.
3. INCOME TAXES
The Company accounts for
income taxes in accordance with SFAS 109,
Accounting
for Income Taxes
. In accordance with SFAS 109, deferred tax
assets and liabilities are recorded for the estimated future tax effects of
temporary differences between the carrying value of assets and liabilities for
financial reporting and their tax basis, and carry-forwards to the extent they
are realizable. A deferred tax provision or benefit results from the net
change in deferred tax assets and liabilities during the period. A
valuation allowance is recorded if it is more likely than not that all or a
portion of the recorded deferred tax assets will not be realized. As of December 30,
2007 and September 28, 2008, deferred tax assets included $27.8 million
relating to a tax basis step up from a re-capitalization transaction in 1999
and $22.8 million of net operating loss carry-forwards. The Company has
recorded a valuation allowance against all of its deferred tax assets.
Provision (benefit) for
income taxes for the three months ended September 28, 2008 and the
comparable period of September 30, 2007, was less than $0.1 million in
provision, and $0.4 million in benefit, respectively. Income taxes
for the nine months ended September 28, 2008 and the comparable period of September 30,
2007, was $1.7 million in provision and $2.0 million in benefit for income
taxes, respectively. The provision for the nine months ended September 28,
2008 is higher by $3.7 million than the comparable period of September 30,
2007 due to the recording of a valuation allowance against the Companys
European deferred tax assets as a discrete event in the quarter ended June 29,
2008 equal to $1.6 million. Based on available evidence, management can
not conclude it is more likely than not that the deferred tax assets will be
realizable.
Provision (benefit) for
income taxes for the three and nine months ended September 28, 2008 was
calculated using an effective tax rate of less than one percent for the full
fiscal year in addition to the valuation allowance recorded as a discrete event
in the quarter ended June 29, 2008.
The Company adopted FIN 48,
Accounting for Uncertainty in Income Taxes,
on January 1, 2007. As a result of adoption, the Company recognized
a cumulative effect adjustment of less than $0.1 million to the January 1,
2007 accumulated deficit balance.
11
Table
of Contents
As of September 28,
2008, we have approximately $0.3 million of gross unrecognized tax benefits, of
which $0.3 million would reduce our effective tax rate if recognized. The
Companys continuing practice is to recognize interest and/or penalties related
to income tax matters in income tax expense.
The tax years 2000 to 2007
remain open to examination by the major taxing jurisdictions to which we are
subject. The Company is currently under examination in India for certain years
between 2000 and 2005 and Belgium for years 2005 and 2006. The Company
does not believe the amount of unrecognized tax benefits as of September 28,
2008 will significantly increase or decrease within the next twelve months.
United States income taxes
are not provided on undistributed earnings from certain foreign subsidiaries.
Those earnings are considered to be permanently re-invested in accordance with
the Accounting Principles Board (APB) Opinion 23.
4.
NET INCOME
(LOSS) PER SHARE
In accordance
with SFAS 128,
Earnings Per Share
,
basic income (loss) per share is based upon the weighted average number of
common shares outstanding. For the quarter ended September 28, 2008,
2,610,877 shares subject to outstanding stock options were excluded from the
calculation of diluted income (loss) per share as their exercise prices would
render them anti-dilutive. For the nine months ended September 28, 2008,
stock options to purchase 2,614,926 shares of our common stock were excluded
from the calculation of diluted income (loss) per share as their effect would have
been anti-dilutive due to the net loss for the period. For the quarter and nine
months ended September 30, 2007, stock options to purchase 2,811,579
shares of our common stock were excluded from the calculation of diluted income
(loss) per share as their effect would have been anti-dilutive due to the net
loss for the periods. The following table sets forth the computation of basic
and diluted net income (loss) per share (in thousands, except per share
amounts):
|
|
Quarter Ended
|
|
Nine Months Ended
|
|
|
|
September 28, 2008
|
|
September 30, 2007
|
|
September 28, 2008
|
|
September 30, 2007
|
|
Net income (loss)
|
|
$
|
126
|
|
$
|
(1,309
|
)
|
$
|
(431
|
)
|
$
|
(4,984
|
)
|
Shares:
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares
outstandingbasic
|
|
19,476
|
|
19,414
|
|
19,465
|
|
19,371
|
|
Effect of dilutive securities:
|
|
|
|
|
|
|
|
|
|
Stock options
|
|
4
|
|
|
|
|
|
|
|
Weighted-average common shares
outstandingdiluted
|
|
19,480
|
|
19,414
|
|
19,465
|
|
19,371
|
|
Net income (loss) per share:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.01
|
|
$
|
(0.07
|
)
|
$
|
(0.02
|
)
|
$
|
(0.26
|
)
|
Diluted
|
|
$
|
0.01
|
|
$
|
(0.07
|
)
|
$
|
(0.02
|
)
|
$
|
(0.26
|
)
|
5.
DEFERRED FINANCING COSTS
The Company
capitalizes costs directly related to financing agreements and certain
qualified debt restructuring costs, and amortizes these costs as additional
interest expense over the terms of the related debt.
Net deferred
financing costs are comprised of the following as of September 28, 2008
and December 30, 2007 (in thousands):
|
|
September 28, 2008
|
|
December 30, 2007
|
|
Deferred financing costs
|
|
$
|
580
|
|
$
|
580
|
|
Accumulated amortization
|
|
(580
|
)
|
(494
|
)
|
Deferred financing costs, net
|
|
$
|
|
|
$
|
86
|
|
For the
quarter ended September 28, 2008, the Company wrote off $0.4 million of
financing costs related to the refinancing of the Senior Notes due to mature on
November 1, 2008 since the refinancing efforts were discontinued as a
result of the Agreement and Plan Merger (the Merger Agreement) entered into
with Lineage Power Holdings, Inc., a portfolio company of The Gores Group,
LLC, on September 24, 2008.
12
Table
of Contents
6.
DEBT
Debt consists
of the following at September 28, 2008 and December 30, 2007 (in
thousands):
|
|
September 28, 2008
|
|
December 30, 2007
|
|
5.25% Senior Notes, current portion
|
|
$
|
24,485
|
|
$
|
24,485
|
|
5.25% Senior Notes, current portion due to
affiliates
|
|
22,145
|
|
22,145
|
|
Total debt
|
|
$
|
46,630
|
|
$
|
46,630
|
|
The debt includes the Companys Senior Notes,
which matured on November 1, 2008. Interest on the Senior Notes was
payable in cash on May 1 and November 1 of each year. The Senior
Notes are secured by a second-priority lien on substantially all of the Companys
domestic assets and by a pledge of 65% of the equity of certain of the Companys
foreign subsidiaries. The Company paid the November 1
st
interest payment of $1.2 million to the bondholders on October 30, 2008.
However, the Company did not pay the principal balance due on the Senior Notes
on November 1, 2008 and a payment default occurred. As a result of the payment default, in
addition to the aggregate principal amount outstanding under the Senior Notes,
the Company is required to pay interest on overdue principal at the default
rate of 6.25% per annum. As described under Note 2 under the heading Going
Concern, the Company entered into the Merger Agreement
with
Lineage Power Holdings, Inc. on September 24, 2008. It is anticipated that the Merger will close
on or about November 21, 2008, after stockholders vote on the Merger at
the Special Meeting of Stockholders to be held on November 18, 2008. As a result of the Merger, pursuant to which
Merger Sub will be merged with and into the Company, with the Company surviving
as a wholly owned subsidiary of Lineage, the Senior Notes will remain an
obligation of the Company. The Company
anticipates that the outstanding amounts due and payable under the Senior
Notes, together with default interest on overdue principal, will be paid in
full at or after the closing of the Merger. If the Merger fails to be
consummated, the Company may be forced to refinance on terms that are
materially less favorable, seek funds through other means such as a sale of the
Companys assets, or otherwise significantly alter the Companys operating
plan, any of which could have a material adverse effect on the Companys
business, financial condition and results of operation and the ability of the
Company to continue as a going concern.
There can be no assurance that any refinancing or sale of assets would
be available on satisfactory terms, if at all, or that the Company would be
able to continue as a going concern.
Accordingly, if the Merger fails to be consummated, the Company could be
forced to file for bankruptcy protection and thereby reorganize or liquidate
its assets, resulting in material adverse consequences for the Companys
stockholders, creditors and employees.
The Companys primary line of credit was its
senior revolving credit facility with General Electric Capital Corporation (the
Credit Facility). The Credit Facility expired on August 25, 2008.
Prior to the new factoring arrangement made
on October 8, 2008, Cherokee Europe maintained a working capital line of
credit of approximately $4.4 million, expressed as Euros 3.0 million,
with Bank Brussels Lambert, a subsidiary of ING Belgie NV, a bank in
Brussels, which was denominated in Euros, collateralized by a pledge in first
and second rank over a specific amount of business assets, requiring Cherokee
Europe to maintain a certain specific minimum solvency ratio and was cancelable
at any time. Our access to the line was limited to $3.9 million because
$0.5 million was committed to minimum guarantees on specific collections
and payments. In November 2007, ING Belgie NV restricted the Company
from transferring funds from Europe to the U.S. in the form of management and
dividend fees. During the quarter ended September 30, 2007, Cherokee
Europe borrowed $2.0 million from the line of credit with an interest rate
of 6.02%, subject to changes upon quarterly renewals, which remained
outstanding as of September 28, 2008. The interest rate for the second
quarter of 2008 was renewed at 6.08%. On
April 28, 2008, Cherokee Europe borrowed $0.8 million, with an interest
rate of 5.65%, subject to changes upon quarterly renewals, from its line of
credit with ING Belgie NV. The outstanding balance on the line of credit as of September 28,
2008 was $2.8 million. As of September 28, 2008, Cherokee Europe was in
compliance with all covenants.
On October 8, 2008, Cherokee Europes line
of credit arrangement was converted into a new factoring arrangement with ING
Belgie NV. The arrangement is based on
the factoring of 80% of Cherokee Europes current outstanding accounts
receivable balances with an aging of 90 days or less at each borrowing date up
to a maximum of 25% of the total assigned accounts receivables at any given
time or up to a maximum of $7.3 million expressed as Euros 5.0 million. The
effective interest rate of the new factoring arrangement will be Euribor plus
1% on current balances and arrears interest of 3% per month to be calculated on
overdue balances, whereby any new month started shall be calculated as one
complete month. There will also be a 0.08% loan fee on the outstanding accounts
receivable balance at each borrowing.
In January 2008, Cherokee Europe
borrowed short-term funds of $0.6 million from ING Belgie NV. The
loan arrangement is over twelve months, with monthly payments of $50,000 to be
repaid by December 26, 2008. The loan bears a 6.3% interest rate. The
outstanding balance as of September 28, 2008 was $0.2 million.
As described under Note 14 to the
accompanying Notes to the Condensed Consolidated Financial Statements included
in Item 1, Financial Statements Cherokee Europe was sold to a
third-party on October 18, 2008.
In January 2007, Cherokee China entered
into a loan contract with Industrial and Commercial Bank of China Ltd. (ICBC)
for a working capital line of credit. Pursuant to the contract, ICBC agreed to
make advances up to the equivalent of approximately $3.6 million,
expressed as RMB 25.0 million. The line of credit is collateralized by the
Companys building in Shanghai, China.
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In April 2008, Cherokee China renegotiated the borrowing capacity
on its line of credit with ICBC, from RMB 25 million to RMB 28 million to
reflect the increased market value of the building, with the interest rate of
LIBOR plus 12%, which is effective from April 21, 2008 through April 20,
2011. As of September 28, 2008, RMB
28.0 million was equivalent to $4.1 million in US dollars. Interest is payable
monthly at a fixed rate based on the transaction date of our borrowings; the
rates vary according to the specific dates and are announced by the Peoples
Bank of China. Beginning with its initial borrowing under the contract,
Cherokee China agreed to deposit in the ICBC Shanghai Branch at least 90% of
the operating revenue it collects. Our usage of the cash from these deposits
made into our bank account is not restricted. During May 2008, Cherokee
China borrowed $0.5 million on its line of credit with an interest rate of
6.8985% for the subsequent six-month period.
During August 2008, we borrowed an additional $0.5 million on the
line of credit with an interest rate of 7.8435% for the subsequent twelve-month
period. As of September 28, 2008, the outstanding balance on the line of
credit was $1.0 million, and Cherokee China was in compliance with all of the
covenants.
7.
OTHER LONG-TERM OBLIGATIONS
Other long-term liabilities consist of the following at September 28,
2008 and December 30, 2007 (in thousands):
|
|
September 28, 2008
|
|
December 30, 2007
|
|
1999 Europe restructuring liabilities
|
|
$
|
229
|
|
$
|
397
|
|
2003 Europe restructuring liabilities
|
|
948
|
|
1,064
|
|
Long service award liabilities
|
|
936
|
|
910
|
|
Pension liability-SFAS 158
|
|
1,326
|
|
1,337
|
|
Deferred compensation
|
|
179
|
|
237
|
|
Advances for research & development
|
|
594
|
|
589
|
|
Total other long-term liabilities
|
|
$
|
4,212
|
|
$
|
4,534
|
|
Prior to the
sale of Cherokee Europe, the Company had agreements with a local government
agency in Belgium for funding in advances to Cherokee Europe for research and
development expenses. These advances were interest free and expected to be
repaid to the agency either as a percentage of the revenues generated by the
products developed or through a minimum fixed amount on an annual basis. As described under Note 14 to the accompanying
Notes to the Condensed Consolidated Financial Statements included in
Item 1, Financial Statements Cherokee Europe was sold to a third-party
on October 18, 2008.
As of September 28,
2008, the Company has a recorded liability of $0.3 million, for employee and
non-employee contributions and investment activity to date under the deferred
compensation plan; the current portion of $0.1 million is recorded under
accrued compensation and benefits and the long-term portion of $0.2 million is
recorded in other long-term liabilities.
8.
CUSTOMER CONCENTRATION
For the
quarter ended September 28, 2008, one customer accounted for 15.4% of net
sales, and no other customer accounted for more than 10% of net sales. For the
quarter ended September 30, 2007, one customer accounted for 13.1% of net
sales, and no other customer accounted for more than 10% of net sales. For the
nine months ended September 28, 2008, one customer accounted for 12.5% of
net sales, and no other customer accounted for more than 10% of net sales. For the nine months ended September 30,
2007, one customer accounted for 11.6% of net sales, and no other customer
accounted for more than 10% of net sales. All net sales above were from US
customers; none of the sales were generated by customers under Cherokee Europe.
A decision by a major customer to decrease the amount purchased from the
Company or to cease purchasing the Companys products could have a material
adverse effect on the Companys financial position and results of operations.
As of September 28,
2008, one Cherokee US customer accounted for 14.9% of net accounts receivable
and no other customer accounted for more than 10% of net accounts
receivable. As of December 30,
2007, one Cherokee Europe customer accounted for 10.9% of net accounts
receivable, and one Cherokee US customer accounted for 10.6% of net accounts
receivable.
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9.
COMMITMENTS AND CONTINGENCIES
Guarantees and Indemnities
The Company indemnifies
its directors and officers, to the maximum extent permitted under the laws of
the State of Delaware, and various lessors in connection with facility leases
for certain claims arising from such facility or lease. The maximum amount of
potential future payments under such indemnifications is not determinable.
The Company has not
incurred significant amounts related to these guarantees and indemnifications,
and no liability has been recorded in the consolidated financial statements for
guarantees and indemnifications as of September 28, 2008 and December 30,
2007.
Cash Incentive Compensation Program
and Severance Agreements
The Company adopted a
cash incentive program for certain executives, which provides for cash
incentive payments of up to 123% of base salary subject to attainment of
corporate goals and objectives approved by the Companys board of directors. In
addition, the Company has entered into severance agreements with certain
executives and managers, which provide payments to the executives or managers
if they are terminated (i) other than for cause or (ii) because of a
change in control, as defined in the applicable severance agreement. Certain of
the severance agreements provide additional benefits, including acceleration of
stock options, in the event of termination in connection with a change of
control, as defined in the applicable severance agreement.
On February 29, 2008, the Company
entered into an amendment to the Companys existing severance agreement with
each of Jeffrey M. Frank, the Companys President and Chief Executive Officer,
Linster W. Fox, the Companys Executive Vice President, Chief Financial Officer
and Secretary, and Mukesh Patel, the Companys Executive Vice President of
Global Operations. These executives severance agreements provide for certain
severance payments to be made in the event that the Company terminates the
executives employment without cause. The amendments provide that, if severance
is triggered under the executives severance agreement, the executives
severance benefit will consist of a cash payment equal to two times the
executives current base salary at the time of termination and continued
medical benefits for up to two years. In the case of Mr. Patel, the
amendment further amends his severance agreement to provide that if he
terminates his employment with the Company for good reason within one year
following a change in control event, he will be entitled to the severance
benefits described above. The amendments further amend Mr. Franks and Mr. Foxs
severance agreements to provide that in the event the executives employment is
terminated by the Company without cause or by the executive for any reason
within two years following a change in control of the Company, or by the
Company within six months prior to a change in control and such termination was
in connection with the change in control, the executive will be entitled to: a
cash payment equal to two times the executives current base salary at the time
of termination; a pro rata cash payment equal to the executives annual bonus
at the time of termination (calculated as if the Company achieved financial
performance equal to that set forth in the then-most current budget approved by
the Companys board of directors); immediate vesting of all outstanding stock
options; continued medical benefits for up to two years; a cash payment equal
to the amount forfeited by the executive under the Companys 401(k) or
similar plan; use of an executive outplacement service in an amount not to
exceed $50,000 or a lump-sum cash payment in lieu thereof; and any additional
benefits then due or earned under applicable plans or programs of the Company.
The severance agreements also include certain confidentiality, non-solicitation
and inventions covenants in favor of the Company.
On February 29, 2008, the Company also
entered into a severance agreement with Alex Patel, the Companys Vice
President of Engineering. The severance agreement provides that, in the event Mr. Patels
employment is terminated either by the Company without cause or by Mr. Patel
for good reason within one year following a change in control event, Mr. Patel
will be entitled to receive a cash payment equal to one times his then current
annual base salary and continued medical benefits for up to one year. Mr. Patels
right to receive severance benefits under the severance agreement is subject to
his execution of a release of claims in favor of the Company upon the termination
of his employment. The severance agreement also includes certain
confidentiality, non-solicitation and inventions covenants in favor of the
Company.
Transaction Bonus Agreements
On April 14, 2008, the Company entered into transaction bonus
agreements with each of Jeffrey M. Frank, the Companys President and Chief
Executive Officer, Linster W. Fox, the Companys Executive Vice President,
Chief Financial Officer and Secretary, and Mukesh Patel, the Companys
Executive Vice President of Global Operations (each, an executive). The
transaction bonus agreements provide that, in the event of a company sale
(defined in the agreements as a sale in one or a series of related transactions
of all or substantially all of the Companys assets, or of more than 50% of the
issued and outstanding voting equity securities of the Company other than to
the Company or certain major shareholders), the executive will be entitled to
receive a transaction bonus, provided that the executive is either employed by
the Company at the time of the company sale, the Company terminates the
executives employment without cause (as defined in the agreements) within six
months prior to the company sale, or the executive terminates his employment
for good reason (as defined in the agreements) within six months prior to the
company sale.
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If the executive terminates his employment with the Company voluntarily
or is terminated by the Company for cause prior to the company sale, the
executive is not eligible for a bonus under the transaction bonus
agreement. Further, the executive must execute a general release of
claims in favor of the Company following the company sale in order to receive
his transaction bonus.
The
amount of the transaction bonus for which each executive is eligible pursuant
to his agreement varies and is tied to the net proceeds received by the selling
stockholders in the company sale. Based upon information available as of the
date of the recent proxy statement, the following executive officers would be
entitled to the following cash payments under their respective transaction
bonus agreements assuming the eligibility conditions described in the agreement
are satisfied in connection with the Merger:
Messrs. Frank, Fox and
Patel is $1.3 million, $0.8 million and $117,000, respectively, based on a net
sales price of $3.20 per share. The agreements also contain a
non-solicitation covenant in favor of the Company. These amounts have not been accrued as of September 28,
2008 because they have not been earned, since the merger has not been
consummated
SynQor
On November 16, 2007, SynQor announced
that it had filed a lawsuit against several of its competitors, including the
Company who was named in the complaint, for infringement of two patents
relating to bus converters and/or non-isolated point of load converters used in
intermediate bus architectures. The patents at issue are U.S. patents 7,072,190
and 7,272,021. The suit was filed in Federal Court in the Eastern District of
Texas. The Company intends to and continues to vigorously defend this lawsuit.
Although the ultimate aggregate amount of monetary liability or financial
impact with respect to this lawsuit is subject to many uncertainties and is
therefore not predictable with assurance, the final outcome of this lawsuit, if
adverse, could have a material adverse effect on our financial position,
results of operations or cash flows.
10.
RESTRUCTURING COSTS AND ASSET
IMPAIRMENT CHARGES FOR CLOSURE OF GUADALAJARA, MEXICO FACILITY
During the quarter ended October 1,
2006, the Company announced the planned closure of its Mexican facilities and a
related restructuring plan, which was accounted for in accordance with
SFAS 146,
Accounting for Costs
Associated with Exit or Disposal Activities
. The Mexico Facility
encompassed 35,000 square feet in one building and had been in operation since
1988, employing approximately 250 full-time and temporary employees in the
production of power supplies.
The restructuring and closure of our Mexico
Facility was completed by the end of the second quarter of 2007. The cumulative
costs for the closure of the Mexico Facility were $1.5 million
($1.3 million of which were recorded in 2006). This was made up of
$0.9 million restructuring, $0.3 million asset impairment and
$0.3 million additional excess and obsolescence reserve. During the second
quarter ended July 1, 2007, there was a reversal of $38,000 to severance
costs due to the transfer and relocation of an employee from the Mexico
Facility to our Tustin Facility. The remaining accrued balance for severance
and stay bonuses was paid on July 1, 2007 to the remaining employees.
Assets held for saleMexico Facility building sold
The Company began actively searching for a
buyer for the Mexico Facility building during the quarter ended October 1,
2006; however, in accordance with SFAS 144,
Accounting for the Impairment or Disposal of Long-Lived Assets
,
the related assets were not classified as assets held for sale in the condensed
consolidated balance sheets prior to April 1, 2007, because the Company
did not meet the criterion that the asset (disposal group) is available for
immediate sale in its present condition subject only to terms that are usual
and customary for sales of such assets, due to our continued utilization of
assets in our ongoing operations at our Mexico Facility.
The Company ceased operations in Mexico in March 2007,
and reclassified the net book value of $0.7 million for the building and
the related assets to
assets held for sale
on the condensed consolidated balance sheet as of April 1, 2007, in
accordance with SFAS 144. In addition, depreciation of the assets related
to this sale was suspended as of April 1, 2007. There was no impairment
charge to the related assets because management determined that the measurement
value, the net book value, was lower than the estimated fair value less cost to
sell.
On February 22, 2007, Cherokee
Electronica, S.A. de C.V. (Cherokee Mexico), a subsidiary of the
Company, entered into a Purchase and Sale Agreement (the Agreement) with
Inmobiliaria Hondarribia, S.A. de C.V. (the Buyer) for the sale of
Cherokee Mexicos 35,000-foot manufacturing facility in Guadalajara, Mexico.
The Agreement provided that the Buyer pay Cherokee Mexico an aggregate purchase
price of approximately US $1.2 million of which a 15% deposit,
approximately US $182,000, was paid on February 22, 2007. On May 24,
2007, the sale of the building was completed, and the remaining 85% of the
sales price was transferred into the Companys bank account. The Company also
collected the value added tax on the building in addition to the sales price
and paid the taxes collected to the Mexican government in June 2007. The
net gain of the sale recorded during the quarter ended July 1, 2007, was
$0.4 million, net of $0.1 million related to the cost to sell the
assets which was deducted from the gain.
16
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Sale of Mexico
Corporation
On December 12,
2007, the Company sold its ownership in the capital stock of Cherokee Mexico.
The Company received the proceeds from the sale on December 13, 2007. The
net gain of the sale was $0.4 million.
Asset Impairment Charges related to Other
Assets
During the quarter ended October 1,
2006, the Company performed an impairment review in accordance with
SFAS 144,
Accounting for the Impairment
and Disposal of Long-Lived Assets,
to determine whether any of its
long-lived assets located at the Mexico Facility were impaired. The Company
identified certain long-lived assets associated with the restructuring and
closure of the Mexico Facility whose carrying value would not be recoverable
from future cash flows and recorded an impairment charge of $0.3 million
for these assets. These assets consisted of machinery and equipment, computer
technology and equipment, and office furniture and equipment. The majority of
these assets were written off because the Company considered them to have no
market value. None of the impairment charges included cash components.
Restructuring Costs
In accordance with SFAS 146, employee
severance, contract termination and other exit costs are recorded at their
estimated fair value when they are incurred. During the quarter ended July 1,
2007, there was a reversal of $38,000 to severance costs due to the transfer
and relocation of an employee from the Mexico Facility to our Tustin Facility.
There were $0.2 million of employee
severance and stay bonus costs during the first six months of 2007, which
included a pro-rata portion from the commencement date of August 10, 2006
through July 1, 2007, of an estimated amount of statutorily required
severance payments and management performance stay-on bonuses incurred for
employees at the Mexico Facility. The Company paid $0.6 million of
severance and related expenses to the remainder of employees terminated during
the quarter ended July 1, 2007. All severance charges were settled with
cash as of July 1, 2007.
11.
STOCK AND DEFERRED COMPENSATION PLANS
2002 Stock Option Plan
In July 2003, the Company adopted the
Cherokee International Corporation 2002 Stock Option Plan (the 2002 Stock
Option Plan) under which up to 1,410,256 shares of the Companys common stock
may be issued pursuant to the grant of non-qualified stock options to the
directors, officers, employees, consultants and advisors of the Company and its
subsidiaries. In connection with the adoption of the 2002 Stock Option Plan,
the Company granted 1,087,327 stock options. The options typically vest over a
four-year period, have a ten-year contractual life, range in exercise price
from $5.85 to $10.34 per share and were granted with exercise prices at or
above fair value as determined by the Companys board of directors based on
income and market valuation methodologies. In February 2004, the Company
granted options to purchase 328,320 shares of common stock at an exercise price
of $14.50 and terminated the 2002 Stock Option Plan. As of September 28,
2008, the Company had granted a total of 1,415,647 options to purchase shares
of common stock under the 2002 Stock Option Plan, which includes options to
purchase shares that were cancelled and subsequently re-granted.
2004 Omnibus Stock Incentive Plan
On February 16,
2004, the Company adopted the 2004 Omnibus Stock Incentive Plan (the 2004 Plan),
which provided for the issuance of 800,000 shares of common stock. The 2004
Plan also provides for an annual increase to be added on the first day of the
Companys fiscal year equal to the lesser of (i) 450,000 shares or (ii) 2%
of the number of outstanding shares on the last day of the immediately
preceding fiscal year. As of September 28, 2008, a total of 3,315,141
shares of the Companys common stock were reserved for issuance under the 2004
Plan. Any officer, director, employee, consultant or advisor of the Company is
eligible to participate in the 2004 Plan. The 2004 Plan provides for the
issuance of stock-based incentive awards, including stock options, stock
appreciation rights, restricted stock, deferred stock, and performance shares.
As of September 28, 2008, the Company had granted options to purchase
2,399,489 shares of common stock under the 2004 Plan, which included 375,589
options issued as partial compensation to non-employee directors. During the
quarter ended September 28, 2008 the Company did not grant any options to
purchase stock. During the nine months
ended September 28, 2008, the Company granted options to purchase 70,000
shares to non-employee directors.
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2004 Employee Stock Purchase Plan
On February 16, 2004, the Company
adopted the ESPP. The ESPP provides for an annual increase to be added on the
first day of the Companys fiscal year equal to the lesser of (i) 250,000
shares or (ii) 1% of the number of outstanding shares on the last day of
the immediately preceding fiscal year. As of September 28, 2008, a total
of 914,220 shares of common stock was reserved for issuance under the plan. The
ESPP, which is intended to qualify as an employee stock purchase plan under Section 423
of the Internal Revenue Code of 1986, is implemented utilizing six-month
offerings with purchases occurring at six-month intervals, with a new offering
period commencing on the first trading day on or after May 15 and November 15
and ending on the last trading day on or before November 14 or May 14,
respectively. The Compensation Committee of the Companys Board of Directors
oversees administration of the ESPP. Employees are eligible to participate if
they are employed for at least 20 hours per week and more than
5 months in a calendar year by the Company, subject to certain
restrictions.
The ESPP permits eligible employees to
purchase common stock through payroll deductions, which may not exceed 15% of
an employees compensation. The price of common stock purchased under the ESPP
is 85% of the lower of the fair market value of the common stock at the
beginning of each six-month offering period or at the end of each six-month offering
period. Employees may end their participation in an offering at any time during
the offering period, and participation ends automatically upon termination of
employment. The Compensation Committee may at any time amend or terminate the
ESPP, except that no such amendment or termination may adversely affect shares
previously issued under the ESPP. As of September 28, 2008, 258,351 shares
of common stock had been issued under the ESPP.
Deferred Compensation Plan
On February 16, 2004, the Company adopted
two executive deferred compensation plans for the benefit of certain designated
employees and non-employee directors of the Company. The plans were amended on January 1,
2008 to comply with the regulations for nonqualified deferred compensation
arrangements under Internal Revenue Code Section 409A. The plans allow
participating employees and non-employee directors to make pre-tax deferrals of
up to 100% of their annual base salary and bonuses, and retainer fees and
meeting fees, respectively. The plans allow the Company to make matching
contributions and employer profit sharing credits at the sole discretion of the
Company. A participants interest in each matching contribution and employer
profit sharing credit, if any, vests in full no later than after three years.
As of September 28, 2008, the Company
has a recorded liability of $0.3 million for employee and non-employee
director contributions and investment activity to date; the current portion of
$0.1 million is recorded under accrued compensation and benefits and the
long-term portion of $0.2 million is recorded in other long-term
liabilities. As of December 30, 2007, the Company had a recorded liability
of $1.4 million, of which $1.1 million was recorded under accrued
compensation and benefits and the long-term portion of $0.2 million was
recorded in other long-term liabilities. The Company has not provided any
matching contributions under the plans.
During the nine months ended September 28,
2008, the Company paid $0.9 million of scheduled distributions to participants
from the deferred compensation plan. The
Company made two partial surrenders on the insurance policies during 2008. The first partial surrenders made were on two
policies during the first quarter of 2008 in the amount of $0.4 million. The second partial surrenders made were on
all five policies for $0.3 million in October 2008. The partial surrenders did not change the
face amount of the policies.
12.
RETIREMENT PLANS
Cherokee
Europe maintains a pension plan for certain levels of staff and management that
include a defined benefit feature. The following represents the amounts related
to this defined benefit plan for the quarter and nine months ended September 28,
2008 and September 30, 2007(in thousands):
|
|
Quarter Ended
|
|
Nine Months Ended
|
|
Components of Net Periodic Benefit Cost
|
|
September 28, 2008
|
|
September 30, 2007
|
|
September 28, 2008
|
|
September 30, 2007
|
|
Service cost
|
|
$
|
57
|
|
$
|
103
|
|
$
|
203
|
|
$
|
280
|
|
Interest cost
|
|
86
|
|
175
|
|
305
|
|
382
|
|
Expected return on plan assets
|
|
(53
|
)
|
(97
|
)
|
(190
|
)
|
(213
|
)
|
Net periodic benefit cost
|
|
$
|
90
|
|
$
|
181
|
|
$
|
318
|
|
$
|
449
|
|
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As described under Note 14 to the accompanying Notes to the
Condensed Consolidated Financial Statements included in Item 1, Financial
Statements Cherokee Europe was sold to a third-party on October 18, 2008.
13.
GOODWILL
IMPAIRMENT CHARGE
Based on our annual assessment of the fair
value of our Cherokee Europe subsidiary in accordance with SFAS 142, we
recorded a goodwill impairment charge of $5.2 million during the year
ended December 30, 2007, to properly report goodwill at its fair value at
that period in time.
Due to the decline in our European operations
revenue volumes during the six months ended June 29, 2008, the Company
performed a revised forecast for the remaining year of 2008 and the next three
years. Since our actual and future
revenues were trending lower than anticipated revenues of our original business
plan, the Company engaged a professional consulting firm to perform a SFAS 142
valuation and analysis study of our goodwill.
As a result of this study, an impairment charge of $1.1 million was recorded
during the quarter ended June 29, 2008 due to the decrease in fair value
of our Cherokee Europe subsidiary. As of
September 28, 2008 the Company no longer has any goodwill recorded. As
described under Note 14 to the accompanying Notes to the Condensed
Consolidated Financial Statements included in Item 1, Financial
Statements Cherokee Europe was sold to a third-party on October 18, 2008.
14.
SUBSEQUENT
EVENT
On October 18, 2008, pursuant to an Agreement
for the Sale and Purchase of All of the Issued and Outstanding Shares of
Cherokee SPRL dated October 18, 2008 (the Purchase Agreement), Cherokee
Netherlands II BV (the Seller), a subsidiary of the Company, sold all of the
issued and outstanding shares of Cherokee Europe SPRL, a private limited liability
company incorporated under Belgian law, and all of the issued and outstanding
shares of Cherokee Europe SCA, a partnership limited by shares incorporated
under Belgian law (together with Cherokee Europe SPRL, the Europe Companies),
to Mr. Eric Brouwers, acting in his own name or in the name of a company
in the process of incorporation under Belgian law. Mr. Brouwers was
the general manager of Cherokees European operations prior to the sale. Mr. Brouwers
paid 1Euro for the shares of the Europe Companies, in exchange for his
agreement to purchase such shares without representations or warranties from,
and without recourse to, the Seller. The terms of the transaction were
determined in arms-length negotiations by the parties.
Item 2.
MANAGEMENTS DISCUSSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Certain statements in this Quarterly Report
on Form 10-Q, other than purely historical information, including
estimates, projections, statements relating to our business plans, objectives
and expected operating results, and the assumptions upon which those statements
are based, are forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995, Section 27A of the Securities
Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These
forward-looking statements are based upon our current expectations about future
events. When used in this Quarterly Report, the words believes, projects, expects,
anticipates, estimates, intends, strategy, plan, may, will, would,
will be, will continue, will likely result, and similar expressions, or
the negative of such words and expressions, are intended to identify
forward-looking statements, although not all forward-looking statements contain
such words or expressions. These forward-looking statements generally relate to
our plans, objectives and expectations for future operations and include
statements in this Quarterly Report regarding the following: our expectations
that cash flows will be sufficient to meeting our operating requirements for at
least the next twelve months; our expectations regarding our working capital
and capital expenditure requirements; and our expectations regarding the
payment of our Senior Note obligations. However, these statements are subject
to a number of risks and uncertainties affecting our business. You should read
this Quarterly Report completely and with the understanding that actual future
results may be materially different from what we expect as a result of these
risks and uncertainties and other factors, which include, but are not limited
to: (1) the potential delisting of the Companys common stock from the
NASDAQ Global Market, (2) changes in general economic and business
conditions, domestically and internationally, (3) reductions in sales to,
or the loss of, any of the Companys significant customers or in customer
capacity generally, (4) changes in the Companys sales mix to lower margin
products, (5) increased competition in the Companys industry, (6) disruptions
of the Companys established supply channels, (7) the Companys level of
debt and restrictions imposed by its debt agreements, and (8) matters
related to the proposed Merger, and (9) the additional risk factors
included in Part II, Item 1A of this Quarterly Report. Except as required
by law, the Company undertakes no obligation to update any forward-looking
statements, even though the Companys situation may change in the future.
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INTRODUCTION
The following discussion should be read in
conjunction with the unaudited condensed consolidated financial statement and
notes of the Company included above in this Quarterly Report on Form 10-Q
and with the audited financial statements, footnotes and Management Discussion
and Analysis of Financial Condition and Results of Operations included in the
Companys Annual Report on Form 10-K.
OVERVIEW
Business
We are a designer and manufacturer of power
supplies for OEMs. Our advanced power supply products are typically custom
designed into mid- to high-end commercial applications in the computing and
storage, wireless infrastructure, enterprise networking, telecom, medical and
industrial markets.
We operate worldwide and as of September 28,
2008, we have facilities in Orange County, California; Bombay, India; and
Shanghai, China. In March 2007, we closed our facility in Guadalajara,
Mexico (the Mexico Facility). In May 2007, we sold our manufacturing
facility in Guadalajara, Mexico and on December 12, 2007, we sold our
subsidiary, Cherokee Electronica, S.A. de C.V. (Cherokee Mexico).
We were founded in 1978 in Orange County,
California. As we expanded our business and customer base, we opened facilities
in Bombay, India, Guadalajara, Mexico, and Shanghai, China and Wavre, Belgium
(Europe).
On September 24, 2008, the Company and Lineage
Power Holdings, Inc. (Parent),
a portfolio company of The Gores Group, LLC, entered into an Agreement and Plan
of Merger (the Merger Agreement)
by and among Parent, Birdie Merger Sub, Inc., a Delaware corporation and
wholly-owned subsidiary of Parent (Merger
Sub), and the Company, pursuant to which Merger Sub will be merged with
and into the Company, with the Company continuing after the merger as the
surviving corporation and a wholly owned subsidiary of Parent (the Merger). The Company
anticipates that the majority of its stockholders will adopt and approve the
Merger Agreement proposal on November 18, 2008 at a Special Meeting of
Stockholders.
In addition, on October 18, 2008,
pursuant to an Agreement for the Sale and Purchase of All of the Issued and Outstanding
Shares of Cherokee SPRL dated October 18, 2008 (the Purchase Agreement),
we sold all of the issued and outstanding shares of Cherokee Europe SPRL, a
private limited liability company incorporated under Belgian law, and all of
the issued and outstanding shares of Cherokee Europe SCA, a partnership limited
by shares incorporated under Belgian law (together, Cherokee Europe). See Note 14, Subsequent Event, in the
accompanying Notes to Condensed Consolidated Financial Statements included in
Item 1, Financial Statements, for additional information regarding the sale
of the Cherokee Europe. Because the sale
of Cherokee Europe occurred following the Companys third quarter ended September 28,
2008, the results of operations of Cherokee Europe are included in the
discussion of the Companys consolidated results of operations below.
We generate the majority of our sales in four
market sectors, datacom, telecom, industrial and medical. For the quarter ended
September 28, 2008, our revenues by market sector consisted of 58%
datacom, 15% telecom, and 27% for the industrial and medical sectors.
Basis of Reporting
Principles of Consolidation
The condensed consolidated financial
statements include the financial statements of the Company and its wholly owned
subsidiaries, Cherokee Europe, Cherokee India Pvt. Ltd. (Cherokee India),
Powertel India Pvt. Ltd. (Powertel), and Cherokee International (China)
Power Supply LLC (Cherokee China), and the financial statements of its
formerly owned subsidiary Cherokee Mexico were included in the year ended December 30,
2007. Inter-company accounts and transactions have been eliminated.
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Net Sales
See
Revenue Recognition of Critical
Accounting Policies section below for Company description.
Cost of Sales
The principal elements comprising
cost of sales are raw materials, labor and manufacturing overhead. Raw
materials account for a large majority of our costs of sales. Raw materials
include magnetic sub-assemblies, sheet metal, electronic and other components,
mechanical parts and electrical wires. Direct labor costs primarily include
costs of hourly employees. Manufacturing overhead includes salaries, and the
direct expense and allocation of costs attributable to manufacturing for lease
costs, depreciation on property, plant and equipment, utilities, property taxes
and repairs and maintenance.
Operating Expenses
Operating expenses include engineering costs,
selling and marketing costs and general and administrative expenses.
Engineering costs primarily include salaries and benefits of engineering
personnel, safety approval and quality certification fees, and depreciation on
equipment and consulting and professional services. Selling and marketing
expenses primarily include salaries and benefits to account managers and
commissions to independent sales representatives. Administrative expenses
primarily include salaries and benefits for certain management and
administrative personnel, professional fees and information system costs.
Operating expenses also include the direct expense and allocation of costs
attributable to these departments for lease costs, depreciation on property,
plant and equipment, utilities, property taxes and repairs and maintenance.
Critical Accounting Policies
We prepare our condensed consolidated
financial statements in conformity with accounting principles generally
accepted in the United States. As such, we are required to make certain
estimates, judgments and assumptions that we believe are reasonable based upon
the information currently available. These estimates and assumptions affect the
reported amounts of assets and liabilities at the date of the condensed
consolidated financial statements and the reported amounts of revenues and
expenses during the periods presented. Any future changes to these estimates
and assumptions could have a material effect on our reported amounts of
revenue, expenses, assets and liabilities. The significant accounting policies
that we believe are the most critical to aid in fully understanding and
evaluating our reported financial results include the following:
Revenue Recognition
We recognize revenue when persuasive evidence
of an arrangement exists, title transfer has occurred, the price is fixed or
readily determinable, and collectability is probable. We recognize revenue in
accordance with Staff Accounting Bulletin No. 104,
Revenue Recognition
. Sales are recorded net of discounts, which are estimated at
the time of shipment based upon historical data. Changes in assumptions
regarding the rate of sales discounts earned by our customers could impact our
results.
We generally recognize revenue at the time of
shipment because this is the point at which revenue is earned and realizable
and the earnings process is complete. For most shipments, title to shipped
goods transfers at the shipping point, so the risks and rewards of ownership
transfer once the product leaves our facility or third-party hub. Revenue is
only recognized when collectability is reasonably assured. Shipping and
handling fees are included in revenue with related costs recorded to cost of
sales.
The Company has entered into arrangements
with certain customers whereby products are delivered to a third-party
warehouse location for interim storage until subsequently shipped and accepted
by our customers. Revenues from these sales are recognized upon shipment from
the third-party warehouse location to the customers, when title has passed. The
Company generally offers a one-year warranty for defective products. Warranty
charges have been insignificant during the periods presented.
Accounts Receivable
In our North American and
European operations we perform ongoing credit evaluations of our customers, the
customers current credit worthiness and various other factors, as determined
by our review of their current credit information. We continuously monitor
collections and payments from our customers and maintain a provision for
estimated credit losses based upon our historical experience and any specific
customer collection issues that we have identified. While credit losses have
historically been within our expectations and the provisions established, we
might not continue to experience the same credit loss rates that we have in the
past.
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A significant portion of our accounts receivable are
concentrated in a small number of customers. A significant change in the
liquidity or financial position of any one of these customers could have a
material adverse effect on the collectability of our accounts receivable, our
liquidity and our future operating results.
As of September 28, 2008 and December 30, 2007, our top ten
customers accounted for 38% and 50% of our accounts receivables, respectively.
Credit
Risk
The Company performs ongoing credit
evaluations of its customers and generally does not require collateral. The
Company maintains reserves for estimated credit losses. The Company generally
does not charge interest on customer balances.
Translation of Foreign Currencies
Foreign subsidiary assets and liabilities
denominated in foreign currencies are translated at the exchange rate in effect
on the balance sheet date. Revenues, costs and expenses are translated at the
average exchange rate during the period. Transaction gains and losses are
included in results of operations and have not been significant for the periods
presented. The functional currency of Cherokee Europe is the Euro. The
functional currency of Cherokee India, Powertel and Cherokee China is the U.S.
dollar, as the majority of transactions are denominated in U.S. dollars.
Translation adjustments related to Cherokee Europe are reflected as a component
of stockholders equity in other comprehensive income (loss).
Inventories
We value our inventory at the lower of the
actual cost to purchase and/or manufacture the inventory and the current
estimated market value of the inventory using the weighted average cost method.
We regularly review inventory quantities on hand and record a provision for
excess and obsolete inventory based primarily on our historical usage data and
estimates of future demand. Since substantially all of our products are
manufactured according to firm purchase orders and customer forecasts, we
evaluate the potential of recovery from our customers when customized products
approach end-of-life. Our customers are generally liable for inventory costs we
incur for order cancellations that occur after we have committed resources to procure
or manufacture product. We also regularly evaluate inventory that is
non-compliant with the European Commissions RoHS directive regarding hazardous
substances in electric and electronic equipment, to determine if additional
reserves are needed to cover for potential obsolescence. We have not
established a separate reserve for non-RoHS compliant inventory above what our
normal calculations would require.
Our industry
is characterized by rapid technological change, frequent new product
development, and rapid product obsolescence that could result in an increase in
the amount of obsolete inventory quantities on hand. As demonstrated during the
past five years, demand for our products can fluctuate significantly. A
significant increase in the demand for our products could result in a
short-term increase in the cost of inventory purchases while a significant
decrease in demand could result in an increase in the amount of excess
inventory quantities on hand. In addition, our estimates of future product demand
may prove to be inaccurate, in which case we may have understated or overstated
the provision required for excess and obsolete inventory. In the future, if our
inventory were determined to be overvalued, we would be required to recognize
additional expense in our cost of sales at the time of such determination.
Likewise, if our inventory is determined to be undervalued, we may have over
reported our costs of sales in previous periods and would be required to
recognize additional operating income at the time such inventory is sold.
Therefore, although we make every reasonable effort to ensure the accuracy of
our estimates of future product demand, any significant unanticipated changes
in demand or technological developments could have a material effect on the
value of our inventory and our reported operating results.
Deferred Taxes
We recognize deferred tax
assets and liabilities based on the differences between the financial statement
carrying values and the tax bases of assets and liabilities. We regularly
review our deferred tax assets for recoverability and establish a valuation
allowance based on historical taxable income, projected future taxable income,
and the expected timing of the reversals of existing temporary differences. If
our future taxable income is significantly higher than expected and/or we are
able to utilize our tax credits, we may be required to reverse all or a
significant part of our valuation allowance against such deferred tax assets
which could substantially reduce our effective tax rate for such period.
Therefore, any significant changes in statutory tax rates or the amount of our
valuation allowance could have a material effect on the value of our deferred
tax assets and liabilities and our reported financial results. The preparation
of condensed consolidated financial statements in conformity with generally
accepted accounting principles in the United States requires us to make
estimates and assumptions that affect the reported amount of tax-related assets
and liabilities and income tax provisions. The Companys effective tax rate may be
subject to fluctuations during the fiscal year as new information is obtained
which may affect the assumptions management uses to estimate the annual
effective tax rate including mix of pre-tax earnings in the various tax
jurisdictions in which it operates.
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The Company adopted the provisions
of FASB Interpretation (FIN) 48,
Accounting
for Uncertainty in Income Taxes
(FIN 48) on January 1, 2007.
FIN 48 clarifies the accounting for uncertainty in income taxes recognized in
an enterprises financial statements in accordance with SFAS 109,
Accounting for Income Taxes
, by
prescribing a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. Under FIN 48, the financial statement effects of a tax
position should initially be recognized when it is more likely than not, based
on the technical merits, that the position will be sustained upon examination.
A tax position that meets the more-likely-than-not recognition threshold should
initially and subsequently be measured as the largest amount of tax benefit
that has a greater than fifty percent likelihood of being realized upon
ultimate settlement with a taxing authority. FIN 48 is effective for fiscal
years beginning after December 15, 2006. See Note 3, Income Taxes, in
the accompanying Notes to Condensed Consolidated Financial Statements included
in Item 1, Financial Statements, for additional information regarding the
impact of adoption.
United States income taxes
are not provided on undistributed earnings from certain foreign subsidiaries.
Those earnings are considered to be permanently re-invested in accordance with
the Accounting Principles Board (APB) Opinion 23.
Other
Comprehensive Income
Belgium
taxes for unrealized foreign exchange gains on an intercompany loan considered
permanently re-invested are provided for as a component of other comprehensive
income or loss.
Goodwill
and Long Lived Assets
We review the recoverability of the carrying
value of goodwill on an annual basis or more frequently when an event occurs or
circumstances change to indicate that an impairment of goodwill has possibly
occurred. The determination of whether any potential impairment of goodwill
exists is based upon a comparison of the estimated fair value of the reporting
unit to the accounting value of its net assets.
We also review the recoverability of the
carrying value of long-lived assets whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable.
Recoverability of these assets is determined based upon the forecasted
undiscounted future net cash flows from the operations to which the assets
relate, utilizing managements best estimates, based on appropriate assumptions
and current projections.
These projected future cash flows may vary
significantly over time as a result of increased competition, changes in
technology, fluctuations in demand, consolidation of our customers and
reductions in average selling prices. If the carrying value is determined not
to be recoverable from future operating cash flows, the asset would be deemed
impaired and an impairment loss would be recognized on the date of
determination to the extent the carrying value exceeded the estimated fair
market value of the asset.
Based on our annual assessment of the fair
value of our Cherokee Europe subsidiary in accordance with SFAS 142, we
recorded a goodwill impairment charge of $5.2 million during the year
ended December 30, 2007, to properly report goodwill at its fair value at
that period in time.
During the quarter ended June 29, 2008,
the remaining balance of $1.1 million of goodwill was deemed impaired. An
impairment charge was recorded due to the decrease in fair value of our
Cherokee Europe subsidiary due to lower revenues than anticipated. As of September 28, 2008, the Company no
longer has any goodwill recorded.
Details are included under Note 13, Goodwill Impairment Charge, to the
accompanying Notes to Condensed Consolidated Financial Statements included in
Item 1, Financial Statements. See also Note 14, Subsequent Event to the
accompanying Notes to Condensed Consolidated Financial Statements included in
Item 1, Financial Statements.
Stock-Based Compensation
The Company adopted SFAS 123R on January 2,
2006 using the modified prospective method as permitted by SFAS 123R.
Under this transition method, stock compensation cost recognized beginning in
the first quarter of fiscal year 2006 includes: (a) compensation cost for
all share-based payments granted subsequent to February 25, 2004 and prior
to January 2, 2006 but not yet vested as of January 2, 2006, based on
the grant-date fair value estimated in accordance with the provisions of
SFAS 123R, and (b) compensation cost for all share-based payments granted
subsequent to January 1, 2006, based on the grant-date fair value
estimated in accordance with the provisions of SFAS 123R. In accordance
with the modified prospective method of adoption, the Companys results of
operations and financial position for prior periods have not been restated. At
the date of the adoption, the unamortized expense for options issued prior to January 2,
2006 was $2.3 million, which will be amortized as stock compensation costs
through December 2010. All grants are made at prices based on the fair
market value of the stock on the date of grant. Outstanding options generally
vest four years from the grant date, with certain limited exceptions, and
expire up to ten years after the grant date.
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The Company
records compensation expense for employee stock options based on the estimated
fair value of the options on the date of grant using the Black-Scholes option
pricing formula with the assumptions included in the table under Stock-Based
Compensation in Note 2 to the accompanying Notes to Condensed
Consolidated Financial Statements. The
Company uses historical data, among other factors, to estimate the expected
price volatility and the expected forfeiture rate. For options granted prior to
January 2, 2006, the Company used the expected option life of
5 years. For options granted following the Companys adoption of
SFAS 123R, the expected life was increased to 6.25 years using the simplified
method under SAB 107 (an expected term based on the mid-point between the
vesting date and the end of the contractual term). The options have a maximum
contractual term of 10 years and generally vest as to 25% of the
underlying stock on each anniversary of the date of grant, subject to
accelerated vesting in the event of a change in control of the Company. The
risk-free rate is based on the U.S. Treasury yield curve in effect at the time of
grant for the estimated life of the option.
RESULTS
OF OPERATIONS FOR THE QUARTER ENDED SEPTEMBER 28, 2008 COMPARED TO THE QUARTER
ENDED SEPTEMBER 30, 2007
NET SALES
Net sales increased by
approximately 19.7%, or $6.0 million, to $36.4 million for the quarter ended September 28,
2008 from $30.4 million for the quarter ended September 30, 2007. During
the quarter ended September 28, 2008, net datacom sales were higher by
$7.3 million, primarily driven by new programs from previous design wins. Telecom net sales were less by $3.9 million,
primarily driven by one large triple play customer. Industrial, medical and
other net sales were higher by $2.6 million from the prior period due to new
customers and new programs. Overall, revenues from all of our markets were
higher for the quarter ended September 28, 2008 compared to the quarter
ended September 30, 2007. Included in the above increases is a $0.7
million benefit related to the foreign currency exchange rate fluctuations from
our Cherokee Europe operations.
GROSS PROFIT
Gross profit increased by
approximately 61.1%, or $3.5 million, to $9.2 million for the quarter ended September 28,
2008 from $5.7 million for the quarter ended September 30, 2007. Gross
margin for the quarter ended September 28, 2008 increased to 25.4% from
18.9% in the prior year period. Gross
profit was higher during the quarter ended September 28, 2008 due
primarily to higher net sales from new programs with better gross margins which
provided better absorption of fixed costs. Gross margins were better due to
increased production volumes in China, the introduction of new models which
represented a positive mix and better overall volumes of products.
OPERATING EXPENSES
Operating
expenses for the quarter ended September 28, 2008 increased approximately
25.6%, or $1.8 million, to $8.5 million from $6.7 million for the quarter ended
September 30, 2007. As a percentage of net sales, operating expenses
increased to 23.2% from 22.1% in the prior year period. The increase in
operating expenses in 2008 from 2007 is as follows:
Engineering and
development costs increased by $0.1 million in foreign currency exchange rate
fluctuations from our Cherokee Europe operations.
Selling and marketing
expense increased by $0.2 million due to an increase of $0.1 million in bonuses
and commissions and $0.1 million in foreign currency exchange rate fluctuations
from our Cherokee Europe operation.
General and
administrative expense increased by $1.5 million due to $0.8 million of
professional and legal fees related to the Merger Agreement, $0.4 million of
professional and legal fees related to efforts to refinance the Senior Notes
prior to entering into the Merger Agreement, $0.2 million in legal expenses
related to our defense of the SynQor litigation, and $0.1 million in foreign
currency exchange rate fluctuations from our Cherokee Europe operation.
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OPERATING INCOME (LOSS)
As a result of
the factors discussed above, operating income increased by $1.8 million to $0.8
million for the quarter ended September 28, 2008, compared to a loss of
$1.0 million for the quarter ended September 30, 2007. Operating margin
increased to 2.1% income from a 3.3% loss in the prior year period.
INTEREST EXPENSE
Interest expense for both
quarters ended September 28, 2008 and September 30, 2007 was $0.7
million. The interest expense is
primarily related to interest payments on our $46.6 million of Senior Notes,
which bear interest at 5.25% annually. As described under Notes 2 and 6 to the
accompanying Notes to the Condensed Consolidated Financial Statements included
in Item 1, we made the interest payment of 5.25% due on November 1
but we were unable to pay the principal amount outstanding at maturity and a
payment default occurred. The default interest rate as of November 1, 2008
until the Senior Notes are paid is 6.25% (5.25% interest rate plus a premium of
1%). As described under Note 2 under the heading Going Concern, the Company
entered into the Merger Agreement with Lineage on September 24, 2008. It is anticipated that the Merger will close
on or about November 21, 2008, after stockholders vote on the Merger at the
Special Meeting of Stockholders to be held on November 18, 2008. As a result of the Merger, pursuant to which
Merger Sub will be merged with and into the Company, with the Company surviving
as a wholly owned subsidiary of Lineage, the Senior Notes will remain an
obligation of the Company. The Company
anticipates that the outstanding amounts due and payable under the Senior
Notes, together with default interest on overdue principal, will be paid in
full at or after the closing of the Merger. If the Merger fails to be
consummated, we may be forced to refinance on terms that are materially less
favorable, seek funds through other means such as a sale of assets, or
otherwise significantly alter our operating plan, any of which could have a
material adverse effect on our business, financial condition and results of
operation and our ability to continue as a going concern. There can be no
assurance that any refinancing or sale of assets would be available on
satisfactory terms, if at all, or that the Company would be able to continue as
a going concern. Accordingly, if the
Merger fails to be consummated, the Company could be forced to file for
bankruptcy protection and thereby reorganize or liquidate its assets, resulting
in material adverse consequences for the Companys stockholders, creditors and
employees.
INCOME TAXES
Provision (benefit) for
income taxes for the quarter ended September 28, 2008 and the comparable
period of September 30, 2007, was less than $0.1 in million provision, and
$0.4 million in benefit, respectively. The provision for the quarter ended September 28,
2008 is higher by $0.5 million than the comparable period of September 30,
2007. The benefit from the comparable period of September 30, 2007 was
primarily a result of the European operating loss. Based on available
evidence, management can no longer conclude that it is more likely than not
that the Company will realize its deferred tax assets. No benefit was recognized for the European
operating loss for the quarter ended September 28, 2008.
NET INCOME (LOSS)
As a result of
the factors discussed above, we recorded net income of $0.1 million for the
quarter ended September 28, 2008, compared to a net loss of $1.3 million
for the quarter ended September 30, 2007.
RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED
SEPTEMBER 28, 2008 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2007
NET
SALES
Net
sales increased by approximately 24.1%, or $21.7 million, to $111.7 million for
the nine months ended September 28, 2008 from $90.0 million for the nine
months ended September 30, 2007.
During the nine months ended September 28, 2008, datacom sales were
higher by $12.3 million, primarily driven by new programs from previous design
wins, net telecom sales were higher by $1.6 million, primarily driven by one
large triple play customer and industrial, medical and other net sales were
higher by $7.8 million due to new customers and new programs. Overall, revenues
from all of our markets were higher for the nine months ended September 28,
2008 compared to the nine months ended September 30, 2007. Included in the
above increases is a $4.0 million benefit related to foreign currency exchange
rate fluctuations from our Cherokee Europe operations.
GROSS PROFIT
Gross
profit increased by approximately 71.8%, or $12.2 million, to $29.2 million for
the nine months ended September 28, 2008 from $17.0 million for the nine
months ended September 30, 2007. Gross margin for the nine months ended September 28,
2008 increased to 26.2% from 18.9% in the prior year period.
The increase in gross
profit for the nine months ended September 28, 2008 compared to the nine
months ended September 30, 2007 was primarily related to overall higher
revenues this year which provided better absorption of fixed costs. Gross margins
were better due to increased production volumes in China, the introduction of
new models and better overall volumes of products.
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Included in the increase
in gross profit for the nine months ended September 28, 2008 is $0.5
million of foreign currency exchange rate fluctuations related to our Cherokee
Europe operations.
OPERATING
EXPENSES
Operating
expenses for the nine months ended September 28, 2008 increased by
approximately 15.3%, or $3.5 million, to $26.1 million from $22.6 million for
the nine months ended September 30, 2007. As a percentage of net
sales, operating expenses decreased to 23.3% from 25.1% in the prior year
period.
For the nine months ended
September 28, 2008, engineering and development expense increased by $0.3
million compared to the nine months ended September 30, 2007, due to an
increase in foreign currency exchange rate fluctuations related to our Cherokee
Europe operations.
Selling and marketing
expense consists primarily of sales salaries and commissions, travel,
advertising and marketing expenses. For the nine months ended September 28,
2008, selling and marketing expense increased by $0.3 million compared to the
nine months ended September 30, 2007.
Bonuses and commissions were higher by $0.2 million for the nine months
ended September 28, 2008 compared to the nine months ended September 30,
2007 due to higher sales. For the nine
months ended September 28, 2008, the increase in selling and marketing
expense included $0.3 million of foreign currency exchange rate fluctuations
related to our Cherokee Europe operations.
Offsetting these increases were a decrease of $0.2 million in customer
promotional and marketing expenses.
General and
administrative expense consists primarily of salaries and other expense for
management, finance, human resources and information systems. For the nine
months ended September 28, 2008, general and administrative expense
increased by $2.0 million compared to the nine months ended September 30,
2007, due to an increase of $0.9 million of professional and legal fees related
to the Merger Agreement, $0.4 million of professional and legal fees related to
efforts to refinance the Senior Notes prior to entering the Merger Agreement,
$0.4 million in foreign currency exchange rate fluctuations from our Cherokee
Europe operations and $0.3 million in legal expenses in our defense in the SynQor
litigation.
During the quarter ended June 29,
2008, the remaining balance of $1.1 million of goodwill was deemed impaired. An
impairment charge was recorded due to the decrease in fair value of our
Cherokee Europe subsidiary due to lower revenues than anticipated. Details are included under Note 13 to the
accompanying Notes to the Condensed Consolidated Financial Statements included
in Item 1, Financial Statements.
For the six months ended July 1,
2007, there was $0.2 million of operating costs related to severance and
facility closure costs for the Mexico Facility, compared to no expense in 2008.
OPERATING
INCOME (LOSS)
As a
result of the factors discussed above, operating income was $3.1 million for
the nine months ended September 28, 2008 compared to an operating loss of
$5.6 million for the nine months ended September 30, 2007. Operating
margin increased to income of 2.8% from a loss of 6.2% in the prior year
period.
INTEREST
EXPENSE
Interest
expense for the nine months ended September 28, 2008 was $2.2 million
compared to $2.1 million for the nine months ended September 30,
2007. The interest expense is mainly related to our 5.25% senior notes
and commitment fees on our senior revolving credit line.
OTHER
INCOME
For
the nine months ended September 30, 2007, the Company recorded a net gain
of $0.4 million to other income related to the sale of the Mexico Facility
building. See Note 10 to the
accompanying Notes to Condensed Consolidated Financial Statements included in
Item 1, Financial Statements, for additional information.
INCOME
TAXES
Provision (benefit) for
income taxes for the nine months ended September 28, 2008 and the
comparable period of September 30, 2007 was a $1.7 million provision and a
$2.0 million benefit, respectively. The provision for the nine months ended September 28,
2008 is higher by $3.7 million than the comparable period of September 30,
2007 due to the recording of a valuation allowance against the Companys
European deferred tax assets as a discrete event in the quarter ended June 29,
2008 equal to $1.6 million.
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Based on available evidence,
management cannot conclude it is more likely than not that the deferred tax
assets will be realizable.
Provision for income taxes
for the nine months ended September 28, 2008 was calculated using an
effective tax rate of less than one percent for the full fiscal year in
addition to the valuation allowance of $1.6 million recorded as a discrete
event in the quarter ended June 29, 2008.
NET
INCOME (LOSS)
As
a result of the factors discussed above, we recorded a net loss of $0.4 million
for the nine months ended September 28, 2008, compared to the net loss of
$5.0 million for the nine months ended September 30, 2007.
LIQUIDITY
AND CAPITAL RESOURCES
CASH FLOWS
FOR THE NINE MONTHS ENDED
SEPTEMBER 28, 2008 COMPARED TO THE NINE MONTHS ENDED SEPTEMBER 30, 2007
Net
cash provided by operating activities for the nine months ended September 28,
2008 was $6.4 million compared to net cash used in operating activities of $4.6
million for the nine months ended September 30, 2007.
Net
cash provided by operating activities for the nine months ended September 28,
2008 reflected a net loss of $0.4 million, $2.0 million in depreciation and
amortization, $1.1 million in goodwill impairment, $0.1 million in amortization
of deferred financing costs, $0.7 million of stock-based compensation, a
$1.7 million increase in the valuation allowance for deferred income taxes, a
$1.6 million decrease in accounts receivable, a $0.1 million decrease in
prepaid expenses and other current assets, a $0.4 million decrease in deposits
and other assets, a $0.7 million increase in accounts payable, a $0.1 million
increase in accrued compensation and benefits and a $0.6 million increase in
accrued interest payable. This was
offset by a $1.5 million increase in inventories, a $0.5 million decrease in
accrued liabilities and restructuring costs, and a $0.3 million decrease in
other long-term obligations.
Net
cash used in operating activities for the nine months ended September 30,
2007 reflected a net loss of $5.0 million which was primarily a result of $17.5
million lower revenues in 2007 compared to the comparable period in 2006,
offset by a $0.4 million gain in the sale of assets held for sale related to
the sale of the Mexico Facility building, a $0.8 million increase in inventory,
$0.1 million increase in deposits and other assets, a $1.2 million decrease in
accounts payable, a $3.6 million decrease in accrued liabilities and
restructuring costs, a $0.1 million decrease in accrued compensation, and a
decrease of $0.6 million in other long-term obligations. This was offset by $2.4 million in
depreciation and amortization, $0.1 million in amortization of deferred
financing costs, $0.6 million of stock-based compensation related to SFAS 123R,
a $2.4 million decrease in accounts receivable, a $1.2 million decrease in
prepaid expenses and other current assets, and a $0.6 million increase in
interest payable.
Net
cash used in investing activities for the nine months ended September 28,
2008 was $0.4 million, which was related to capital expenditures.
Net
cash used in investing activities for the nine months ended September 30,
2007 was $0.9 million, in which $2.2 million was related to capital
expenditures. We invested $2.1 million
in our China facility. We received $1.2 million of proceeds from the sale of
the Mexico Facility building in 2007.
Net
cash provided by financing activities for the nine months ended September 28,
2008 was $0.8 million, which included a $1.3 million payment with respect to
Cherokees Chinas line of credit with Industrial and Commercial Bank of China
Ltd., or ICBC, during the first quarter of 2008, or ICBC, and payments of $0.3
million by Cherokee Europe on its short-term loan. This was offset by Cherokee Europes
borrowing of $0.6 million in a short-term loan and $0.8 million borrowings from
its line of credit with ING Belgie NV, and $1.0 million borrowings by Cherokee
China from its line of credit with Industrial and Commercial Bank of China Ltd.
Net cash provided by
financing activities for the nine months ended September 30, 2007 was $3.8
million. In July 2007, Cherokee
Europe borrowed short-term funds of $0.6 million from ING Belgie NV. The loan arrangement was for six months and
ended December 25, 2007. The loan bore a 5.3% interest rate. As of September 30,
2007, the outstanding balance owed was $0.3 million. During the three months
ended September 30, 2007, Cherokee Europe borrowed $2.0 million from the
line of credit with Bank Brussels Lambert, a subsidiary of ING Belgie NV. In January 2007, we opened a credit
facility with ICBC, which advanced up to the equivalent of approximately $3.3
million, expressed as RMB 25.0 million. The line is collateralized by the
Companys building in Shanghai, China. During the first three months of 2007,
Cherokee China borrowed $1.3 million under this credit facility to support
working capital requirements as our China subsidiary builds inventory and
incurs value-added tax on local purchases. As of September 30, 2007, the
outstanding balance of $1.3 million due to ICBC remained due. During the nine
months ended September 30, 2007, $0.2 million of employee stock purchase
plan proceeds were received.
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LIQUIDITY
We expect our liquidity requirements will be
primarily for working capital and capital expenditures, including repayment of principal
and default interest on overdue principal of our Senior Notes that were due on November 1,
2008. As of September 28, 2008, we had cash and cash equivalents of
$15.3 million and negative working capital of $2.8 million due to the
$46.6 million of senior notes in payment default as of November 1,
2008, as described under Notes 2 and 6 to the accompanying Notes to the
Condensed Consolidated Financial Statements included in Item 1, being
classified to current liabilities. Our
revolving line of credit with General Electric Capital Corporation matured on August 25,
2008. We currently do not have an existing line of credit for our US domestic
company. Historically, we have financed
our operations with cash from operations supplemented by borrowings from credit
facilities and debt and equity issuances.
In January 2007, we opened a credit
facility with ICBC, as described under Note 6 to the accompanying Notes to
the Condensed Consolidated Financial Statements included in Item 1, Financial
Statements. This facility is intended
for working capital requirements in China, especially as our China subsidiary
builds inventory for export to the United States and Europe and incurs
value-added tax on local purchases that can only be recovered through
in-country sales of our product. During the quarter ended September 28,
2008, Cherokee China borrowed $0.5 million from its line of credit. As of September 28, 2008, Cherokee China
had outstanding borrowings of $1.0 million under this line of credit.
Subject to the refinancing risk described
above, we believe our cash flow from operations and our credit line in China
are sufficient to meet our operating cash requirements for at least the next
twelve months. However, this assumes that the Merger Agreement will be approved
by our stockholders and the Merger will be consummated, in which case the
Company anticipates that the outstanding amounts due and payable under our Senior
Notes, together with default interest on overdue principal, will be paid in
full at or after the closing of the Merger. If the Merger fails to be consummated, the
Company may be forced to refinance on terms that are materially less favorable,
seek funds through other means such as a sale of the Companys assets, or
otherwise significantly alter the operating plan of the Company, any of which
could have a material adverse effect on the Companys business, financial
condition and results of operations and the ability of the Company to continue
as a going concern.
There can be no assurance that any refinancing or
sale of assets would be available on satisfactory terms, if at all, or that the
Company would be able to continue as a going concern. Accordingly, if the Merger fails to be
consummated, the Company could be forced to file for bankruptcy protection and
thereby reorganize or liquidate its assets, resulting in material adverse
consequences for the Companys stockholders, creditors and employees.
Having completed the China plant
construction, ongoing current and future liquidity needs are expected to arise
primarily from working capital requirements and historical level capital
expenditures, assuming we successfully repay or renegotiate our Senior Notes
obligation. Our capital expenditures in 2007 were $2.3 million. In 2008, we
expect our capital expenditures to range between $1.7 million and
$2.1 million.
CONTRACTUAL OBLIGATIONS
As of September 28, 2008, our borrowings consisted of
approximately $46.6 million of senior notes, $2.8 million of outstanding
borrowings on our Cherokee Europe line of credit, $0.2 million of outstanding
borrowings of short-term funds, and $1.0 million of outstanding borrowings
under Cherokee Chinas credit facility and line of credit. For a more detailed discussion related to the
financial instruments and obligations, see Note 6, Debt to the
accompanying Notes to the Condensed Consolidated Financial Statements included
in Item 1, Financial Statements.
We have operating lease obligations relating
to our facilities in Tustin and Irvine, California and Bombay, India.
We have purchase commitments primarily with
vendors and suppliers for the purchase of inventory and for other goods,
services, and equipment as part of the normal course of business. These
commitments are generally evidenced by purchase orders that may or may not
include cancellation provisions. Based on current expectations, we do not
believe that any cancellation penalties we incur under these obligations would
have a material adverse effect on our consolidated financial condition or
results of operations.
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The remaining balance of $0.3 million in the
deferred compensation plan has been reserved and deposited into an investment
account with funds that closely mirror investment funds similar to the
participants investment selections.
The maturities of our long-term debt, including capital leases, and
future payments relating to our operating leases and other obligations as of September 28,
2008 are as follows (in thousands):
Contractual Obligations
|
|
September 28, 2008 to
December 28, 2008
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
Thereafter
|
|
Total
|
|
Debt-senior notes
|
|
$
|
46,630
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
|
|
$
|
46,630
|
|
Operating leases
|
|
403
|
|
568
|
|
43
|
|
18
|
|
|
|
109
|
|
1,141
|
|
Purchase order commitments
|
|
18,556
|
|
|
|
|
|
|
|
|
|
|
|
18,556
|
|
1999 Europe restructuring
|
|
52
|
|
344
|
|
57
|
|
|
|
|
|
|
|
453
|
|
2003 Europe restructuring
|
|
55
|
|
261
|
|
241
|
|
198
|
|
154
|
|
224
|
|
1,133
|
|
Long service award
|
|
17
|
|
117
|
|
219
|
|
25
|
|
21
|
|
585
|
|
984
|
|
Deferred compensation
|
|
45
|
|
53
|
|
19
|
|
19
|
|
19
|
|
122
|
|
277
|
|
Advances for research and development
|
|
22
|
|
60
|
|
60
|
|
62
|
|
64
|
|
348
|
|
616
|
|
Unrecognized tax benefits
|
|
|
|
307
|
|
|
|
|
|
|
|
|
|
307
|
|
Total
|
|
$
|
65,780
|
|
$
|
1,710
|
|
$
|
639
|
|
$
|
322
|
|
$
|
258
|
|
$
|
1,388
|
|
$
|
70,097
|
|
The long-term liability for accrued pension
costs included on the condensed consolidated balance sheet is excluded from the
table above. The Company is unable to estimate the timing of payments for these
costs. During the nine months ended September 28, 2008, the Company
contributed approximately $0.3 million.
In 2008, the Company expects to contribute $0.4 million.
RECENT ACCOUNTING PRONOUNCEMENTS
For a
discussion of the impact of recently issued accounting pronouncements, see the
subsection entitled Recent Accounting Pronouncements contained in Note 2 of
the Notes to Condensed Consolidated Financial Statements under Item 1. Financial
Statements.
Item
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk relating to our operations
results primarily from changes in foreign currency exchange rates and
short-term interest rates. We did not have any derivative financial instruments
at September 28, 2008.
We had no variable rate debt outstanding at September 28,
2008. We cannot predict market fluctuations in interest rates and their impact
on any variable rate debt we may incur in the future, nor can there be any
assurance that fixed rate long-term debt will be available to us at favorable
rates, if at all.
Item
4T. CONTROLS AND PROCEDURES
Disclosure Controls
and Procedures
Our management, with the participation of our
President and Chief Executive Officer, and our Executive Vice President and
Chief Financial Officer, has evaluated the effectiveness of our disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange
Act)), as of the end of the period covered by this report. The evaluation
included certain control areas in which we have made changes to improve and
enhance controls. As described below, we have identified material weaknesses
and significant deficiencies in our internal control over financial reporting
as of December 30, 2007, and as of September 28, 2008, these material
weaknesses and significant deficiencies have not been fully remediated.
As a result,
our President and Chief Executive Officer and our Executive Vice President and
Chief Financial Officer have concluded that, as of September 28, 2008, our
disclosure controls and procedures were not effective.
A material weakness is a deficiency or a
combination of deficiencies in internal control over financial reporting such
that there is a reasonable possibility that a material misstatement of the annual
or interim consolidated financial statements will not be prevented or detected
on a timely basis. Since the Company
conducted its assessment of the effectiveness of our internal control over
financial reporting as of December 30, 2007, our management has
implemented some changes to its internal control over financial reporting in
response to the following material weaknesses that were identified as of December 30,
2007, as described below:
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Architecture of
Companys IT systems does not presently support the financial reporting
requirements of the Companys international operations
Our subsidiaries in India and China still
maintain disparate financial accounting systems that do not completely
interface with the Companys primary ERP system, resulting in duplicate
accounting entries on multiple systems. This causes a protracted reporting
cycle which limits the oversight from corporate headquarters of transactional
details at our international sites. Site level financial statements are
delivered on spreadsheets to the corporate office for consolidation.
Our European operation has its own separate
ERP system that is integrated into the local accounting system; however this
system does not automatically interface financially with our corporate
headquarters. Therefore, financial results are also delivered to our corporate
office by means of spreadsheets, and the corporate office also has insufficient
visibility to transactional details.
The consolidation of all these local results
delivered on spreadsheets is in turn prepared on spreadsheets at our corporate
office. Consolidations performed on spreadsheets are prone to human error and
are difficult to review. As such, the existing consolidation process requires
additional monitoring and oversight. Oversight and monitoring are discussed in
more detail below.
The Company has completed its development and
implementation of IT interface solutions for key activities in China. The
Company will now begin to focus on determining what IT solutions will be
required for our other locations. Until
this is completed, the Company will continue to supplement these technical IT solutions
with additional staffing and internal monitoring procedures.
The methodology and
support for valuing and capitalizing inventory costs, and determining inventory
reserves
As remediated in the second quarter of 2007,
the Company now evaluates historical and projected labor and overhead costs to
determine their reasonableness. This process is subject to finance management
oversight and review. The Company still does not track labor by product model
at most locations.
Oversight and monitoring controls
The lack of an integrated financial reporting system creates the need
for significant manual intervention and staffing to prepare spreadsheets,
create eliminating entries, make tax adjustments, and U.S. GAAP
adjustments. Additionally, our remote locations, other than Europe, have one
local controller with little more than clerical support to maintain the local
accounting system, transport information from the ERP system to their local
books, report financial statements to our headquarters in the U.S. and perform
routine functions such as account reconciliations. As part of our Sarbanes
Oxley Act of 2002 (SOX) 404 compliance efforts, the Company is performing a
detailed review of procedures and personnel at each site location. The Company
is committed to resolving all deficiencies identified.
We have identified and have performed or are
working on the following remediation to resolve the weakness in oversight and
monitoring controls over international financial reporting:
·
The
process of adding structure and uniformity of accounting standards and process
among our site controllers continues through distribution of corporate policies
and procedures, planned continued development and distribution of policies,
reinforcement of management representations and corporate code of conduct, and
regular visits by the corporate controller to various Company sites. We
continue critical self-review of how accounting is performed worldwide.
·
Due
to personnel changes, the Company expects to rely on outside professionals for
a significant portion of its SOX compliance review. During the second quarter, we engaged Grant
Thornton to assist the Company in its SOX compliance. Initial planning has begun.
·
An
improved consolidated reporting package is now provided to corporate management
and significant items are being reviewed with local management.
30
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SOX Compliance
As a non-accelerated filer, 2007 marked the
first year of SOX compliance for the Company. The Company completed an internal
assessment of controls. While the vast majority of the Companys controls were
operating properly, the Company did identify control deficiencies for
remediation. The corporate office worked closely with the site accounting
personnel to remediate these deficiencies. The vast majority of the
deficiencies were remediated during 2007, but some did remain at year end. While
efforts to remediate these deficiencies have continued into 2008, management
assessed the remaining deficiencies to determine if any additional material
weakness existed. The Company concluded that none of the open deficiencies at
2007 fiscal year end could result in a material weakness but did believe that
one could be classified as a significant deficiency. A significant deficiency
is a deficiency, or combination of deficiencies, in internal control over
financial reporting that is less severe than a material weakness; yet important
enough to merit the attention of those responsible for oversight over the
Companys financial reporting. Since the Company conducted its assessment of
the effectiveness of our internal control over financial reporting as of December 30,
2007, our management has implemented the following changes to its internal
control over financial reporting in response to the significant deficiencies
that were identified as of December 30, 2007, as described below:
1) Inadequate
fixed asset management systems and procedures
During the second quarter, the Company
implemented new IT system controls that we believe will remediate the
inadequate controls over shipping cutoffs which were identified as a
significant deficiency during 2007 SOX compliance. Remediation efforts on the fixed asset
systems are expected to continue over several periods. The issues of IT systems, people and process
are interrelated and difficult to separate. Striking the optimum balance
between improved process, better trained and supervised staff and mission
critical IT improvements is essential for success.
The Company is committed to remediating all
material weaknesses and significant deficiencies presently identified and any
additional deficiencies that may be identified in the future.
In connection with the Companys filing of
its consolidated financial statements for its fiscal year ending December 28,
2008, the Companys internal control over financial reporting will not be
subject to attestation by the Companys registered public accounting firm due
to the deferral of the effective date of these requirements. This date has been
delayed for non-accelerated filers; the provision will now apply to fiscal
years ending on or after December 15, 2009.
Changes in Internal Control Over Financial
Reporting
Except as described above, there have not
been any changes in our internal control over financial reporting (as such term
is defined in Rules 13a-15(f) and 15(d)-15(f) under the Exchange
Act) during our third fiscal quarter of 2008 that have materially affected, or
are reasonably likely to materially affect, our internal control over financial
reporting.
PART II. OTHER
INFORMATION
Item 1. Legal Proceedings
On November 16, 2007, SynQor announced
that it had filed a lawsuit against several of its competitors, including the
Company who was named in the complaint, for infringement of two patents
relating to bus converters and/or non-isolated point of load converters used in
intermediate bus architectures. The patents at issue are U.S. patents 7,072,190
and 7,272,021. The suit was filed in Federal Court in the Eastern District of
Texas. The Company intends to and continues to vigorously defend this lawsuit.
Although the ultimate aggregate amount of monetary liability or financial
impact with respect to this lawsuit is subject to many uncertainties and is
therefore not predictable with assurance, the final outcome of this lawsuit, if
adverse, could have a material adverse effect on our financial position,
results of operations or cash flows.
During the nine months ended September 28,
2008, we were not a party to any other material legal proceedings. We are
occasionally a party to lawsuits relating to routine matters incidental to our
business. As with all litigation, we can provide no assurance as to the outcome
of any particular lawsuit, and we note that litigation inherently involves
significant costs.
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Item 1A. Risk
Factors
We have updated the risk
factors discussed in Item 1A of our Annual Report on Form 10-K for
the year ended December 30, 2007, as set forth below. Except for the risk
factor concerning the 5.25% Senior Notes and the pending Merger, we do not
believe any of the updates constitute material changes from the risk factors
previously disclosed in our Annual Report on Form 10-K for the year ended December 30,
2007.
The following risk
factors, among others, could cause our financial performance to differ
significantly from the goals, plans, objectives, intentions and expectations
expressed in this Quarterly Report on Form 10-Q. If any of the following
risks and uncertainties or other risks and uncertainties not currently known to
us or not currently considered to be material actually occurs, our business,
financial condition or operating results could be harmed substantially.
Risks Relating to Our Company and Industry
We are substantially dependent upon sales to
a relatively small group of customers. The loss of one or more major customers,
or the discontinuation or modification of these customers products, could
materially and adversely affect the results of our operations.
Our top ten customers accounted for approximately
49% of our net sales for the nine months ended September 28, 2008 and
approximately 50% of our net sales for the year ended December 30, 2007.
In addition, one customer accounted for more than 10% of net sales in the nine
months ended September 28, 2008 and for the year ended December 30,
2007. The loss of any of our major customers could have a material adverse
effect on our financial condition or results of operations. We do not have
long-term contracts with our customers, and our customers use alternative power
supply providers for some or all of their products. We may not be able to
maintain our customer relationships, and our customers may reduce or cancel
their purchase orders, purchase power supplies elsewhere or develop
relationships with additional providers of power supplies, any of which could
adversely affect our financial condition or results of operations. A
significant change in the liquidity or financial position of any of these
customers could also have a material adverse effect on the collectibility of
our accounts receivables, our liquidity and our future operating results. Prior
to, or at the end of, a products life cycle, any of our customers may decide
to discontinue or modify any of its products. In that event, the customer may
no longer have a need for our products or may choose to integrate a competitors
power supply into the customers new or modified product. The resulting loss of
revenues could also adversely affect our financial condition or results of our
operations.
Failure by our customers or us to keep up
with rapid technological change in the electronic equipment industries could
result in reduced sales for us.
Many of our existing customers are in the
electronic equipment industries, especially wireless infrastructure and
networking, and produce products that are subject to rapid technological
change, obsolescence and large fluctuations in world-wide product demand. These
industries are characterized by intense competition and end-user demand for
increased product performance at lower prices. We may not be able to properly
assess developments in the electronic equipment industries or identify product
groups or customers with the potential for continued and future growth. Factors
affecting the electronic equipment industries, in general, or any of our major
customers or their products, in particular, could have a material adverse
effect on our financial condition or results of operations. For instance, as a
provider of power supplies to OEMs in the electronic equipment industries,
our sales are dependent upon the success of the underlying products of which
our power supplies are a component. We have no control over the demand for or
success of these products. If our customers products are not well received by,
or if demand for their products fails to develop among end-users, our customers
may discontinue or modify the product or reduce the production of the product.
Any of these events could lead to the cancellation or reduction of orders for
our power supplies that were previously made or anticipated, which could
materially adversely affect our financial condition or results of operation.
See Cancellations, reductions or delays in customers orders or commitments,
or an increase in the number of warranty product returns could have a material
adverse impact on our financial condition and results of operations for more
information. The markets for our products are characterized by rapidly changing
technologies, increasing customer demands, evolving industry standards, frequent
new product introductions and shortening product life cycles. Generally, our
customers purchase our power supplies for the life cycle of a product, which
can range anywhere from two to fifteen years. The development of new,
technologically advanced products is a complex and uncertain process requiring
high levels of innovation and cost, as well as the accurate anticipation of
technological and market trends. As the lifecycle of our customers products
shorten, we will be required to bid on contracts for replacement or next
generation products to replace revenues generated from discontinued products
more frequently. These bids may not be successful. Even if we are successful,
we may not be able to successfully develop, introduce or manage the transition
of new products. Any failure or delay in anticipating technological advances or
developing and marketing new products that respond to any significant
technological change or significant changes in customer demand could have a
material adverse effect on our financial condition or results of operations.
32
Table of Contents
We face significant competition, including
from some competitors with greater resources and geographic presence than us.
Our failure to adequately compete could have a material adverse effect on our
business.
The design, manufacture and sale of power
supplies are highly competitive and characterized by increasing customer
demands for product performance, shorter manufacturing cycles and lower prices.
Our competition includes numerous companies throughout the world, some of which
have advantages over us in terms of labor and component costs and technology.
Our principal competitors are Emerson Network Power, Delta Electronics, TDK
(Lambda), Power One, Lineage Power, Murata, Eltek-Valere, and Vicor. Some of
our competitors have substantially greater net sales, resources and geographic
presence than we do. Competition from existing competitors or new market
entrants may increase at any time. We also face competition from current and
prospective customers that may design and manufacture their own power supplies.
In times of an economic downturn, or when dealing with high-volume orders,
price may become a more important competitive factor, forcing us to reduce
prices and thereby adversely affecting our financial results. Some of our major
competitors have also consolidated through merger and acquisition transactions.
Consolidation among our competitors is likely to create companies with
increased market share, customer bases, proprietary technology and marketing
expertise, and an expanded sales force. These developments may adversely affect
our ability to compete.
Cancellations, reductions or delays in
customers orders or commitments, or an increase in the number of warranty
product returns could have a material adverse impact on our financial condition
and results of operations.
We do not obtain long-term purchase orders or
commitments from our customers and customers may generally cancel, reduce or
postpone orders or commitments. A variety of conditions, both specific to the
individual customer and generally affecting the customers industry, may cause
customers to cancel, reduce or delay orders or commitments that were previously
made or anticipated. At any time, a significant portion of our backlog may be
subject to cancellation or postponement. For example, our entire
$50.6 million backlog as of September 28, 2008 was subject to
cancellation upon the payment by our customers of cancellation fees that vary
depending on individual purchase orders. We also enter into certain warehousing
arrangements with some of our customers, whereby we agree to bear the risk and
cost of carrying inventory. Under these arrangements, we deliver the power
supplies ordered by such customers to a third-party location, permit these
customers to take delivery of the power supplies within a specified time period
after our delivery of the products, and invoice these customers for the
products only after they have taken ultimate delivery and title has passed. We
may not be able to replace cancelled, delayed or reduced orders or commitments
in a timely manner or at all and in some instances may need to write off
inventory. Significant or numerous cancellations, as well as reductions or
delays in orders or commitments, including as a result of delays in or the
failure to take delivery of products that are subject to such arrangements, by
a customer or group of customers, could materially adversely affect our
financial condition or results of operations.
We also offer our customers a warranty for
products that do not function properly within a limited time after delivery. We
regularly monitor and track warranty product returns and record a provision for
the estimated amount of future warranty returns based on historical experience
and any notification we receive of pending warranty returns. We may experience
greater warranty return rates than we have in the past. Any significant
increase in product failure rates and the resulting warranty credit returns
could have a material adverse effect on our operating results for the period or
periods in which those warranty returns occur.
Our international manufacturing operations
and our international sales subject us to risks associated with foreign laws,
policies, economies and exchange rate fluctuations.
We have manufacturing operations located in
India, and China and had manufacturing operations in Europe until we sold
Cherokee Europe in October 2008. We may expand our operations into other
foreign countries in the future. In addition, international sales have been,
and are expected to continue to be, an important component of our total sales.
International sales represented 54% of our net sales for the year ended September 28,
2008 and 50% of our net sales for the year ended December 30, 2007. Our
manufacturing operations and international sales are subject to inherent risks,
all of which could have a material adverse effect on our financial condition or
results of operations. Other risks affecting our international operations
include:
·
differences or unexpected changes in
regulatory requirements;
·
political and economic instability;
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·
terrorism and civil unrest;
·
work stoppages or strikes;
·
interruptions in transportation;
·
restrictions on the export or import of
technology;
·
difficulties in staffing and managing
international operations;
·
variations in tariffs, quotas, taxes and
other market barriers;
·
longer payment cycles;
·
problems in collecting accounts receivables;
·
changes in economic conditions in the
international markets in which our products are sold; and
·
greater fluctuations in sales to customers in
developing countries.
Although we transact business primarily in
U.S. dollars, a portion of our sales and expenses, including labor costs, are
denominated in the Indian rupee, the Chinese renminbi (RMB). For the nine
months ended and the year ended September 28, 2008 and December 30,
2007, net sales in Europe accounted for 31% and 35% of our net sales,
respectively. Declines in the value of the U.S. dollar relative to the Euro
impacted our revenue, cost of goods sold and operating margins for these
periods and resulted in foreign currency transaction gains and losses. Foreign
currency translation gains or losses recorded in other comprehensive income, a
component of equity, for the nine months ended September 28, 2008 and for
the year ended December 30, 2007 were a gain of $0.2 million and a
gain of $1.2 million, respectively. Historically, we have not actively
engaged in substantial exchange rate hedging activities and do not intend to do
so in the future.
An interruption in delivery of component
supplies could lead to supply shortages or a significant increase in our cost
of materials.
We are dependent on our suppliers for timely
shipments of components, including components manufactured by us in our India
facilities. We typically use a primary source of supply for each component used
in our products. Changing suppliers or establishing alternate primary sources
of supply, if needed, could take a significant period of time, which in turn
could result in supply shortages and increased prices. In some cases, we source
components from only one manufacturer. Substantially all of our revenues are
derived from the sale of products that include components that we source from
only one manufacturer. In addition, many of our suppliers are located outside
of the United States, and timely delivery from these suppliers may not occur
due to interruptions in transportation, import-export controls, tariffs, quotas,
taxes and other market barriers, and political and economic stability in the
country in which the components used in our products are produced or the
surrounding region. An interruption in supply could have a material adverse
effect on our operations. Any shortages of particular components could increase
product delivery times and costs associated with manufacturing, thereby
reducing gross margins. Additionally, these shortages could cause a substantial
loss of business due to shipment delays. Any significant shortages or price
increases of components could have a material adverse effect on our financial
condition or results of operations.
Our quarterly sales may fluctuate while our
expenditures remain relatively fixed, potentially resulting in lower gross
margins and volatility in our stock price.
Our quarterly results of operations have
fluctuated in the past and may continue to fluctuate in the future.
Fluctuations in customer needs, cancellations, reductions and delays in orders
and commitments may cause our quarterly results to fluctuate. See the risk
factor above entitled Cancellations, reductions or delays in customers orders
or commitments or an increase in the number of warranty product returns could
have a material adverse impact on our financial condition and results of
operations. Variations in volume production orders and in the mix of products
sold by us have also significantly affected sales and gross profit. Sales are
generally impacted by a combination of these items and may also be affected by
other factors. These factors include:
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·
the receipt and shipment of large orders or
reductions in these orders (including the impact of any customer warehousing
arrangements);
·
raw material availability and pricing;
·
product and price competition; and
·
the length of sales cycles.
Many of these factors are outside of our
control. In addition, a substantial portion of our sales in a given quarter may
depend on obtaining orders for products to be manufactured and shipped in the
same quarter in which those orders are received. As a result of this and other
factors described above, sales for future quarters are difficult to predict and
our financial condition or results of operations in a given quarter may be
below our expectations and our gross margins may decrease. Our expense levels
are relatively fixed and are based, in part, on expectations of future
revenues. If revenue levels are below expectations, the market price of our common
stock could fall substantially, and our financial condition or results of
operations could be materially adversely affected.
Our ability to successfully implement our
business strategy is dependent on our ability to retain and attract key
personnel.
Our ability to successfully implement our
business strategy depends to a significant degree on the efforts of Jeffrey M.
Frank, President, Chief Executive Officer, and Director, Linster W. Fox,
Executive Vice President, Chief Financial Officer and Secretary, and Mukesh
Patel, Executive Vice President, Global Operations, along with other members of
our senior management team. We believe that the loss of service of any of these
executives could have a material adverse effect on our business. In addition,
we depend on highly skilled engineers and other personnel with technical skills
that are in high demand and are difficult to replace. As a result, our ability
to maintain and enhance product and manufacturing technologies and to manage
any future growth also depends on our success in attracting and retaining
personnel with highly technical skills. The competition for these qualified
technical personnel may be intense if the relatively limited number of
qualified and available power engineers continues. We may not be able to
attract and retain qualified technical personnel.
Changes in government regulations or product
certification could result in delays in shipment or loss of sales.
Our operations are subject to general laws,
regulations and government policies in the United States and abroad.
Additionally, our product standards are certified by agencies in various
countries, including, among others, the United States, Canada, Asia, Germany
and the United Kingdom. Changes in these laws, regulations, policies or certification
standards could negatively affect the demand for our products, result in the
need to modify our existing products, increase time-to-production or affect the
development of new products, each of which may involve substantial costs, or
loss of or delayed sales, and could have a material adverse effect on our
financial condition or results of operations.
Environmental compliance could require
significant expenditures and failure to so comply could result in fines or
revocation of licenses or permits, any of which could materially and adversely
affect our financial condition or results of operations.
We are subject to federal, state and local
environmental laws and regulations (in both the United States and abroad) that
govern the handling, transportation and discharge of materials into the
environment, including into the air, water and soil. Environmental laws could
become even more stringent in the future, imposing greater compliance costs and
increasing risks and penalties associated with their violation or the
contamination of the environment. Should there be an environmental accident or
violation related to our operations, our financial condition or results of
operations may be adversely affected. We could be held liable for significant
penalties and damages under environmental laws and could also be subject to a
revocation of licenses or permits, which could materially and adversely affect
our financial condition or results of operations.
The following are two European Economic
Community (EEC) directives that are having an effect on the entire
electronics industry, including the Company:
(1) Restriction of Hazardous
Substances in Electrical and Electronic Equipment, more commonly known as RoHS.
This European directive bans the use of certain elements that are commonly
found in components used to manufacture electrical and electronic assemblies.
This directive became effective on July 1, 2006. The Company began
manufacturing compliant products in 2006 and continues to work actively with
its customers to ensure compliance. The Company is focused on consuming all
non-compliant material on-hand within a reasonable period. However, the Company
may have to dispose of non-compliant materials in the future, which could
adversely affect the financial performance of the Company. There is also a risk
of fines associated with non-compliance with the RoHS directive; however, the
Company is not aware of any specific potential fines, and the Company
anticipates complying with all provisions of this legislation.
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(2) Waste Electrical and
Electronic Equipment, also known as WEEE. This directive became effective August 13,
2005 and requires manufacturers and importers to properly recycle or dispose of
such equipment at the end of its useful life. The Company believes it has
limited exposure to the WEEE directive because its products are usually installed
into another users system, but this directive may be interpreted and enforced
differently in the future. If so, the Company may face significant risk of
fines and costs associated with non-compliance with the existing laws and
regulations in the European Union. The Company began manufacturing compliant
products in 2005, and continues to work actively with its customers to ensure
compliance.
Our operations are vulnerable to interruption
by fire, earthquake, power loss, telecommunications failure and other events
beyond our control.
Our operations are vulnerable to interruption
by earthquakes, fires, electrical blackouts, power losses, telecommunications
failures and other events beyond our control. Our executive offices and key
manufacturing and engineering facilities are located in Southern California.
Because Southern California is an earthquake-prone area, we are particularly
susceptible to the risk of damage to, or total destruction of, our facilities
in Southern California and the surrounding transportation infrastructure, which
could affect our ability to make and transport our products. In addition,
California continues to face periodic shortages in its power supply. If rolling
blackouts or other disruptions in power were to occur, our business and
operations would be disrupted and our business would be adversely affected. Our
business interruption insurance may not be sufficient to compensate us for
losses that may occur and would not compensate us for the loss of consumer
goodwill due to disruption of service.
Third parties may sue us for alleged
infringement of their proprietary rights.
We have received, from time to time, notices
of alleged infringement and/or invitations to take licenses from third parties
asserting that they have patents (or other intellectual property rights) that
are relevant to our present or contemplated business operations. There is no
guarantee that we will be able to avoid incurring litigation costs related to
such assertions. Intellectual property claims could be successfully asserted
against us, preventing us from using certain of our technologies, or forcing us
to modify our technology or to pay license fees for use of that technology.
Such additional engineering expenses or licensing costs could have an adverse effect
on the results of our operations. In addition, we could incur substantial
expenses in defending against these claims, whether or not we ultimately
prevail against these claims.
On November 16, 2007, SynQor announced
that it had filed a lawsuit against several of its competitors, including the
Company who was named in the complaint, for infringement of two patents
relating to bus converters and/or non-isolated point of load converters used in
intermediate bus architectures. The patents at issue are U.S. patents 7,072,190
and 7,272,021. The suit was filed in Federal Court in the Eastern District of
Texas. The Company intends to and continues to vigorously defend this lawsuit.
Although the ultimate aggregate amount of monetary liability or financial impact
with respect to this lawsuit is subject to many uncertainties and is therefore
not predictable with assurance, the final outcome of this lawsuit, if adverse,
could have a material adverse effect on our financial position, results of
operations or cash flows.
Provisions of the agreements governing our
debt will restrict our business operations.
Cherokee China entered into a loan contract
in January 2007 with ICBC for a working capital line of credit. Pursuant
to the contract, ICBC agreed to make advances up to the equivalent of
approximately $4.1 million, expressed as RMB 28.0 million. The line
of credit is collateralized by the Companys building in Shanghai, China.
Beginning with its initial borrowing under the contract, Cherokee China has
agreed to deposit in the ICBC Shanghai Branch at least 90% of the operating
revenue it collects. Our usage of the cash from these deposits made into our
bank account is not restricted. As of September 28, 2008, Cherokee China
had $1.0 million of outstanding borrowings under the line of credit and
was in compliance with all covenants.
We may need to incur additional debt to
continue to grow our business in the future. The agreements governing our debt
contain a number of covenants that restrict our business operations, including
covenants limiting our ability to make investments, enter into mergers or
acquisitions, dispose of assets, incur additional debt, grant liens, enter into
transactions with affiliates, redeem or repurchase our capital stock, repay
other debt and pay dividends. As of September 28, 2008, we were in
compliance with our covenants set forth in the agreements.
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Our ability to comply with covenants under
agreements governing our debt may be affected by events that are beyond our
control, including prevailing economic, financial and industry conditions. Our
failure to comply with the covenants or restrictions contained in agreements
governing our debt could result in an event of default under these agreements,
which could result in our debt, together with accrued and unpaid interest,
being declared immediately due and payable.
Our 5.25% Senior Notes matured on November 1,
2008, and we were unable to repay or refinance this indebtedness upon maturity.
On
November 1, 2008, the $46.6 million aggregate principal amount outstanding
under our 5.25% Senior Notes became due and payable. As previously disclosed, we did not have
sufficient cash available to repay this indebtedness.. We made the interest
payment due on November 1, but we were unable to pay the principal amount
outstanding at maturity and a payment default occurred. As a result of the payment default, in
addition to the aggregate principal amount outstanding under the Senior Notes,
we are required to pay interest on overdue principal at the default rate of
6.25% per annum. It is anticipated that
the Merger will close on or about November 21, 2008, after stockholders
vote on the Merger at the Special Meeting of Stockholders to be held on November 18,
2008. As a result of the Merger,
pursuant to which Merger Sub will be merged with and into the Company, with the
Company surviving as a wholly owned subsidiary of Lineage, the Senior Notes
will remain an obligation of the Company.
We anticipate that the outstanding amounts due and payable under the
Senior Notes, together with default interest on overdue principal, will be paid
in full at or after the closing of the Merger.
If the Merger fails to be consummated, we may be forced to refinance on
terms that are materially less favorable, seek funds through other means such
as a sale of assets, or otherwise significantly alter our operating plan, any of
which could have a material adverse effect on our business, financial condition
and results of operations and our ability to continue as a going concern.
There
can be no assurance that any refinancing or sale of assets would be available
on satisfactory terms, if at all, or that the Company would be able to continue
as a going concern. Accordingly, if the
Merger fails to be consummated, the Company could be forced to file for
bankruptcy protection and thereby reorganize or liquidate its assets, resulting
in material adverse consequences for the Companys stockholders, creditors and
employees.
Credit risks could materially and adversely
affect our operations and financial condition.
Negative or declining economic conditions can
increase our exposure to our customers credit risk. In particular, sales to
larger customers are sometimes made through contract manufacturers that do not
have the same resources as those customers. Additionally, if one of our major
customers experienced financial difficulties, losses could be in excess of our
current allowance. At September 28, 2008, one of our Cherokee US customers
accounted for approximately 14.9% of our total net receivables and one of our
Cherokee Europe customer accounted for 10.9% of our total net receivables at December 30,
2007. For the periods ended September 28, 2008 and December 30, 2007,
our accounts receivable write-offs amounted to less than 1% of our net accounts
receivable balance. In the event our customers or those contract manufacturers
experience financial difficulties and fail to meet their financial obligations
to us, or if our recorded bad debt provisions with respect to receivables
obligations do not accurately reflect future customer payment levels, we could
incur additional write-offs of receivables that are in excess of our
provisions, which could have a material adverse effect on our operations and
financial condition. In addition, we depend on the continuing willingness of
our suppliers to extend credit to us to finance our inventory purchases. If
suppliers become concerned about our ability to generate cash and service our
debt, they may delay shipments to us or require payment in advance.
If we fail to meet the listing requirements
of the NASDAQ Global Market and the NASDAQ determines to delist our common
stock, the delisting would adversely affect the liquidity of our common stock
and the market price of our common stock could decline.
Our common stock is listed on the NASDAQ
Global Market. In order to maintain that listing we must satisfy certain
periodic reporting requirements under Marketplace Rule 4310(c)(14). If we
fail to file our Quarterly Reports on Form 10-Q or Annual Reports on Form 10-K
timely, NASDAQ could delist our common stock from the NASDAQ Global Market. If
our common stock is delisted from the NASDAQ Global Market, the price of our
common stock and the ability of our stockholders to trade in our common stock
would be adversely affected. In addition, such delisting could adversely affect
our ability to obtain financing and could result in the loss of confidence by
our investors, suppliers and employees.
Failure to complete the proposed Merger could negatively impact our
stock price and future business and financial results because of, among other
things, the disruption that would occur as a result of uncertainties relating
to a failure to complete the merger.
If the proposed Merger is not completed, the price of our common stock
may decline to the extent that the current market price reflects a market
assumption that the merger will be completed and that the benefits of the
merger will be realized, or as a result of the markets perceptions that the
proposed Merger is not consummated due to an adverse change in our business. In
addition, our business may be harmed, and the price of our common stock may
decline, to the extent that customers, suppliers and others believe that we
cannot compete in the marketplace as effectively without the Merger or otherwise
remain uncertain about our future prospects in the absence of the Merger.
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While the
proposed merger is pending, we will be subject to business uncertainties and
contractual restrictions that could adversely affect our business.
Uncertainty about the effect of the proposed Merger on customers and
suppliers may have an adverse effect on us. These uncertainties could cause
customers, suppliers and others who deal with us to seek to change existing
business relationships. In addition, the Merger Agreement restricts our
ability, without Lineages consent and subject to certain exceptions, from
taking specified actions until the Merger is completed or the Merger Agreement
terminates. These restrictions may prevent us from pursuing otherwise
attractive business opportunities and making other changes to our business that
may arise prior to completion of the Merger or termination of the Merger
Agreement.
Item
3. Defaults Upon Senior Securities
On
November 1, 2008, the $46.6 million aggregate principal amount outstanding
under our 5.25% Senior Notes became due and payable. As previously disclosed, we did not have
sufficient cash available to repay this indebtedness. We made the interest payment due on November 1,
but we were unable to pay the principal amount outstanding at maturity and a
payment default occurred. As a result of
the payment default, in addition to the aggregate principal amount outstanding
under the Senior Notes, we are required to pay interest on overdue principal at
the default rate of 6.25% per annum. As of the date of filing of this report,
the aggregate outstanding principal and accrued interest of the 5.25% Senior
Notes was approximately $46,639,715. It
is anticipated that the Merger, described in Note 2 in the accompanying Notes
to Condensed Consolidated Financial Statements included in Part I, Item 1,
Financial Statements, will close on or about November 21, 2008, after
stockholders vote on the Merger at the Special Meeting of Stockholders to be
held on November 18, 2008. As a result of the Merger, pursuant to which
Merger Sub will be merged with and into the Company, with the Company surviving
as a wholly owned subsidiary of Parent, the Senior Notes will remain an
obligation of the Company. We
anticipate that the outstanding amounts due and payable under the Senior Notes,
together with default interest on overdue principal, will be paid in full at or
after the closing of the Merger. If the
merger fails to be consummated, we may be forced to refinance on terms that are
materially less favorable, seek funds through other means such as a sale of
assets, or otherwise significantly alter our operating plan, any of which could
have a material adverse effect on our business, financial condition and results
of operations and our ability to continue as a going concern.
There can
be no assurance that any refinancing or sale of assets would be available on
satisfactory terms, if at all, or that the Company would be able to continue as
a going concern. Accordingly, if the
Merger fails to be consummated, the Company could be forced to file for
bankruptcy protection and thereby reorganize or liquidate its assets, resulting
in material adverse consequences for the Companys stockholders, creditors and
employees.
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Item 6. EXHIBITS
EXHIBIT INDEX
Exhibits have
heretofore been filed with the SEC and are incorporated herein by reference.
Management contracts or compensatory plans or arrangements are marked with an
asterisk.
Exhibit No.
|
|
Description
|
2.1
|
|
Agreement and Plan of
Merger dated as of September 24, 2008, among Lineage Power
Holdings, Inc., Birdie Merger Sub, Inc. and Cherokee International
Corporation.(4)
|
2.2
|
|
Agreement for the Sale and
Purchase of All of the Issued and Outstanding Shares of Cherokee SPRL dated
October 18, 2008, between Cherokee Netherlands II BV and Mr. Eric
Brouwers.(5)
|
3.1
|
|
Restated
Certificate of Incorporation of Cherokee International Corporation.(1)
|
3.2
|
|
Amended and
Restated By-Laws of Cherokee International Corporation.(1)
|
4.1
|
|
Specimen
certificate for shares of common stock, par value $0.001 per share.(3)
|
4.2
|
|
Indenture,
dated as of November 27, 2002, between Cherokee International
Corporation, as issuer, and U.S. Bank, N.A., as trustee, relating to the
5.25% Senior Notes due 2008.(2)
|
4.3
|
|
Form of
5.25% Senior Notes due 2008.(2)
|
*10.1
|
|
Voting Agreement, dated as
of September 24, 2008, by and among GSCP (NJ), Inc., GSC Recovery
II, L.P., GSC Recovery IIA, L.P., GSC Partners CDO Fund, Limited, GSC
Partners CDO Fund II, Limited, OCM Principal Opportunities Fund, L.P. and
OCM/GFI Power Opportunities Fund, L.P., Cherokee International Corporation,
Lineage Power Holdings, Inc. and Birdie Merger Sub, Inc.(4)
|
31.1
|
|
Certification of President and Chief Executive Officer pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
|
31.2
|
|
Certification of Executive Vice President of Finance, Chief Financial
Officer and Secretary pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
|
32.1
|
|
Certification of CEO and CFO Pursuant to 18 U.S.C. Section 1350,
as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
(1)
Incorporated by
reference from the Registration Statement on Form S-8, filed by the
Registrant on March 16, 2004.
(2)
Incorporated
by reference from the Registration Statement on Form S-1 (File No. 333-110723),
filed by the Registrant on November 25, 2003.
(3)
Incorporated
by reference from Amendment No. 4 to the Registration Statement on Form S-1
(File No. 333-110723), filed by the Registrant on February 17, 2004.
(4)
Incorporated
by reference from the Current Report on Form 8-K filed by the Registrant
on September 30, 2008.
(5)
Incorporated
by reference from the Current Report on Form 8-K filed by the Registrant
on October 23, 2008.
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SIGNATURES
Pursuant to
the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
|
CHEROKEE
INTERNATIONAL CORPORATION
|
|
|
Date:
November 12, 2008
|
By:
|
/s/ JEFFREY
M. FRANK
|
|
|
Jeffrey M.
Frank
|
|
|
President
and Chief Executive Officer
|
|
|
(Principal
Executive Officer)
|
|
|
|
|
|
|
Date:
November 12, 2008
|
By:
|
/s/ LINSTER
W. FOX
|
|
|
Linster W.
Fox
|
|
|
Executive
Vice President, Chief Financial Officer,
and Secretary
(Principal Financial and Accounting Officer)
|
40
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