**SECURITIES AND EXCHANGECOMMISSION**

**Washington, D.C. 20549**

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**FORM 10-K**

**(Mark One)**

**x**                              AnnualReport Pursuant to Section 13 or 15(d) of the Securities Exchange Actof 1934

**For the fiscal year ended December 31, 2006**

**o**                                 TransitionReport Pursuant to Section 13 or 15(d) of the Securities ExchangeAct of 1934

**For the transition period from                   to**

**Commission FileNo. 000-50593**

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**Cherokee InternationalCorporation**

(Exact name of Registrantas specified in its charter)

| **Delaware**                                                     |   | **95-4745032**                           |
|------------------------------------------------------------------|--------|------------------------------------------|
| (State or Other  Jurisdiction of  Incorporation of Organization) |   | (I.R.S. Employer  Identification Number) |
| **2841 Dow Avenue  Tustin, California**                          |   | **92780**                                |
| (address of the  principal executive offices)                    |   | (zip code)                               |

 

Registrant’s telephonenumber, including area code**(714) 544-6665**

Securities registeredpursuant to Section 12(b) of the Act:

|        |   | **Title of  class**             |   | **Name of  exchange on which registered** |   | ** ** |
|--------|--------|---------------------------------|--------|-------------------------------------------|--------|------------|
|   |   | Common Stock,  $0.001 par value |   | The NASDAQ Stock  Market LLC              |   |       |

 

Securities registeredpursuant to Section 12(g) of the Act:

**None**

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act.   Yes o  No x

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Act.   Yes o  No x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

(1) Yes o  No x    (2) Yes x  No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of the registrant’s knowledge, in definitive proxy or informationstatements incorporated by reference in Part III of this Form 10-K orany amendment to this Form 10-K.   o

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, or anon-accelerated filer. See definition of “accelerated filer” and “largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer o       AcceleratedFiler o       Non-AcceleratedFiler x

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).   Yes o  No x

The aggregate market valueof the voting stock held by non-affiliates of the registrant as of the lastbusiness day of the registrant’s most recently completed second fiscal quarter(July 2, 2006) was approximately $35,972,459.

As of May 15, 2007,19,346,959 shares of the registrant’s common stock, $0.001 par value, wereoutstanding.

**DOCUMENTS INCORPORATED BYREFERENCE**

**None.**

 

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**CHEROKEE INTERNATIONAL CORPORATION**

**Annual Report on Form 10-K**

**For the Fiscal Year Ended December 31,2006**

|                   | ** ** | ** **                                                                                                         | ** ** | **Page** | ** ** |
|-------------------|------------|--------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| **PART I**   |       |                                                                                                               |       |     |       |   |   |
| Item 1.           |       | Business                                                                                                           |       |     | 1          |   |   |
| Item 1B.          |       | Unresolved Staff Comments                                                                                          |       |     | 18         |   |   |
| Item 2.           |       | Properties                                                                                                         |       |     | 19         |   |   |
| Item  3.          |       | Legal  Proceedings                                                                                                 |       |     | 19         |   |   |
| Item 4.           |       | Submission of Matters to a Vote of Security Holders                                                                |       |     | 20         |   |   |
| **PART II**  |       |                                                                                                               |       |     |       |   |   |
| Item 5.           |       | Market for Registrant’s Common Equity, Related  Stockholder Matters and Issuer Purchases of Equity Securities |       |     | 21         |   |   |
| Item  6.          |       | Selected  Financial Data                                                                                           |       |     | 23         |   |   |
| Item 7.           |       | Management’s Discussion and Analysis of Financial  Condition and Results of Operations                        |       |     | 25         |   |   |
| Item 7A.          |       | Quantitative and Qualitative Disclosures about Market  Risk                                                        |       |     | 36         |   |   |
| Item 8.           |       | Financial Statements and Supplementary Data                                                                        |       |     | 37         |   |   |
| Item 9.           |       | Changes in and Disagreements with Accountants on  Accounting and Financial Disclosure                              |       |     | 72         |   |   |
| Item 9A.          |       | Controls and Procedures                                                                                            |       |     | 72         |   |   |
| Item  9B.         |       | Other  Information                                                                                                 |       |     | 75         |   |   |
| **PART III** |       |                                                                                                               |       |     |       |   |   |
| Item 10.          |       | Directors and Executive Officers of the Company                                                                    |       |     | 76         |   |   |
| Item 11.          |       | Executive Compensation                                                                                             |       |     | 78         |   |   |
| Item 12.          |       | Security Ownership of Certain Beneficial Owners and  Management and Related Stockholder Matters                    |       |     | 90         |   |   |
| Item 13.          |       | Certain Relationships and Related Transactions                                                                     |       |     | 93         |   |   |
| Item 14.          |       | Principal Accounting Fees and Services                                                                             |       |     | 94         |   |   |
| **PART IV**  |       |                                                                                                               |       |     |       |   |   |
| Item 15.          |       | Exhibits and Financial Statement Schedules                                                                         |       |     | 95         |   |   |
|              |       | Signatures                                                                                                         |       |     | 98         |   |   |

 

*Certain statements in this Annual Report on Form 10-K,other than purely historical information, including estimates, projections,statements relating to our business plans, objectives and expected operatingresults, and the assumptions upon which those statements are based, are “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995, Section 27A of the Securities Act of 1933 and Section 21E ofthe Securities Exchange Act of 1934. These forward-looking statements generallyare identified by the words “believes,” “projects,” “expects,” “anticipates,” “estimates,”“intends,” “strategy,” “plan,” “may,” “will,” “would,” “will be,” “willcontinue,” “will likely result,” and similar expressions. Forward-lookingstatements are based on current expectations and assumptions that are subjectto risks and uncertainties, which may cause actual results to differ materiallyfrom the forward-looking statements. A detailed discussion of these and otherrisks and uncertainties that could cause actual results and events to differmaterially from such forward-looking statements is included in the sectionentitled “Risk Factors” beginning on page 12 of this report. Theinformation contained in this report should be read together with other reportsand documents that we file with the Securities and Exchange Commission (the “SEC”)from time to time, including Forms 10-Q and 8-K, which maysupplement, modify, supersede or update those risk factors. Except as requiredby law, we undertake no obligation to update or revise publicly anyforward-looking statements, whether as a result of new information, futureevents or otherwise. Unless the context indicates otherwise, all referencesherein to “Cherokee International Corporation,” “the Company,” “we,” “us,” and “our”refer collectively to Cherokee International Corporation and its subsidiaries.*

*Ourfiscal years 2006, 2005, and 2004, ended on December 31, 2006,January 1, 2006, and January 2, 2005, respectively. In our filingswith the Securities and Exchange Commission prior to our Quarterly Report onForm 10-Q for the quarterly period ended July 2, 2006, wereferred to fiscal periods as ending on the last day of the nearest calendarmonth on our financial statements and in our Management’s Discussion andAnalysis of Financial Condition and Results of Operations in order to providethe reader with a more convenient presentation of our disclosure. The datesshown on the cover of our prior reports on Forms 10-K and 10-Q havealways represented the actual period end dates, and will continue to do so. Inorder to comply with a request from the Securities and Exchange Commission, wehave reflected the actual period end dates throughout this filing.*

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**PART I**

**ITEM 1.**                BUSINESS

**Overview**

We are a designer and manufacturer of power suppliesfor original equipment manufacturers (“OEMs”). Our advanced power supplyproducts are typically custom designed into mid- to high-end commercialapplications in the computing and storage, wireless infrastructure, enterprisenetworking, telecom, medical and industrial markets. Our power supply productsare differentiated from those used in lower-end electronics, such as personalcomputers and mobile phones, by their complexity, high level of engineeringcontent and reliability. We strive to distinguish ourselves from ourcompetitors by offering sophisticated engineering, design flexibility,innovative solutions, rapid prototype development and efficient, low-costmanufacturing to our customers.

Our principal executive offices are located at 2841Dow Avenue, Tustin, California  92780,and our telephone number is (714) 544-6665. We maintain a website at*www.cherokeepwr.com.* Our annual reportson Form 10-K, quarterly reports on Form 10-Q, currentreports on Form 8-K, and all amendments to those reports filed orfurnished pursuant to Section 13(a) or 15(d) of the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”), are available free ofcharge on our website or upon written request to 2841 Dow Avenue, Tustin,California 92780, Attention: Investor Relations as soon as reasonablypracticable after the Company electronically files such materials with the SEC.The contents of our website are not incorporated by reference in to this AnnualReport on Form 10-K and shall not be deemed “filed” under theExchange Act.

We operate worldwide and have facilities in OrangeCounty, California; Bombay, India; Wavre, Belgium and Shanghai, China. InAugust 2006, we announced our intention to close our facility in Guadalajara,Mexico by March 2007.  On February 22, 2007, we entered into an agreementto sell our manufacturing facility in Mexico. Since November 1987, our main office and U.S. manufacturingfacility has been located in Tustin, California. On November 26, 2002, wereorganized from a California limited liability company into a Delawarecorporation by merging Cherokee International, LLC with and into CherokeeInternational Corporation.

We completed our initialpublic offering of 6,600,000 shares of our common stock on February 25,2004. The net proceeds from the offering were $86.5 million. We usedapproximately $73.2 million of the net proceeds to repay certain outstandingindebtedness and accrued interest. In connection with the offering, we issued6,283,796 shares of our common stock upon conversion of the original principalamount of our outstanding senior convertible notes, and issued 4,071,114 sharesof common stock upon exercise of our outstanding warrants.

**Our Industry**

*Background*

Power supplies are anessential element in the supply, regulation and distribution of electricalpower in electronic equipment. Generally, power supplies convert alternatingcurrent, or AC, from a primary power source, such as a utility company, into aprecisely controlled direct current, or DC. Virtually every electronic devicethat plugs into an AC wall socket requires some type of AC/DC power supply.DC/DC converters modify one DC voltage level to other DC levels to meet thedistinct power needs of various electronic subsystems and components. Powersupplies are also used to regulate and monitor voltages to protect electroniccomponents from surges or drops in voltage, to perform functions that preventelectronic equipment from being damaged by internal malfunction and to provideback-up power in the event that a primary power source fails.

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*Need for HighlyReliable Power in Critical Commercial Applications*

Power supplies are normally embedded in OEMs’ productsand deliver power critical to the function of those products. Although thepower supply typically constitutes less than 5% of the cost of the end product,it must efficiently and reliably convert power from the electric utility gridinto the precise form and quality of power required by complex electronicequipment, such as mainframe computers, enterprise servers, routers andnetworking equipment, wireless base stations, access networks, ultrasoundmachines, and industrial process control and automation equipment. Thisequipment requires a precise and constant supply of electrical power,significantly more refined than the power provided by the electric utilitygrid.

On average, the electricutility grid supplies quality power, free from surges, spikes or sags, 99.9% ofthe time. However, this still results in the equivalent of nine hours per yearof unavailable power. These nine hours of downtime often occur in many isolatedinterruptions of very short duration. In lower-end consumer electronicsapplications, a brief interruption of power only interrupts operation for thetime that the power is actually unavailable. In commercial applications,however, interruption in the power supply or an inability to regulate anddistribute the precise amount of power within the commercial application couldcause the entire end product to fail, resulting in extensive downtime. Thisdowntime could cause the OEM to lose revenue as a result of customerdissatisfaction and may cause financial and operational damage to the end userof the OEM’s product. As a result, OEMs are very selective in their choiceof a power supply vendor and place a high degree of importance on the vendor’sreliability, emphasizing the quality of the products as well as thesophistication of the vendor’s engineering capabilities.

*Power Supply Market—Custom,Modified Standard and Standard*

Power supplies aredesigned for an OEM based on the needs of specific customer applications. Eachof these applications may require a standard, modified standard or customdesigned power supply.

·       Custompower supplies are typically sold directly to a manufacturer and necessitate astrong working relationship between the OEM and the power supply vendor.OEMs purchase custom power supplies to provide maximum design flexibilityto meet the exact requirements for their specific application. These customproducts usually have low- to mid-production volumes and higher margins thanstandard or modified standard models. Custom power supplies are typicallyprovided by a sole source supplier. Once a custom power supply is designed intoan OEM’s product, it is difficult, time consuming and costly for the OEM toswitch vendors.

·       Modifiedstandard power supplies are standard products or platforms with a minimalamount of modification. These products are characterized by (1) shorterlead times; (2) lower up-front engineering costs; (3) potentiallyquicker development times; and (4) higher production volume.

·       Standard power supplies aredesigned to appeal to a wide range of customers for use in a variety ofdifferent applications. These products are sold directly to manufacturers andthrough third-party distributors. Standard power supplies offer benefits to theOEM because they have limited up-front engineering requirements, are readilyavailable from multiple sources and facilitate a faster time-to-market for newproduct development. This type of product is significantly more pricecompetitive.

*Reduction ofApproved Vendors Benefits Quality Power Supply Companies*

To improveoperating efficiencies and shorten the cycle time required to introduce newproducts, OEMs are relying on a smaller number of approved vendors,including power supply vendors. We believe OEMs are choosing these selectpower supply vendors based on:

·       Customdesign capabilities and engineering expertise;

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·       Completeend to end solutions including a broad product offering built from high powerdensity platforms;

·       Abilityto meet rapid time-to-market requirements;

·       Productquality, reliability and competitive pricing; and

·       Superior supply chainmanagement to resolve global supplies, sourcing and delivery issues.

**CompetitiveStrengths**

We believe that we benefitfrom our competitive strengths in the industry due to the following reasons:

*Focused Provider ofCustom Solutions*

We specialize in providingAC/DC customized and modified standard power supplies. We have a highlytalented team of engineers who have extensive experience in designingcustomized and modified standard power supplies.  We believe our engineering expertise and ourdatabase of product designs provides us with an advantage over our competition.

*DistinctiveCombination of Local Engineering with Low-Cost Manufacturing*

We provide our customers with competitive pricing andbetter service compared to our competition because of our strategically locateddesign and engineering facilities, which are located closer to our customers’design and manufacturing facilities. This proximity to our customers’ designand manufacturing facilitates a faster turn around of changes to the design ofthe product requested by our customers during the design and testing process,which improves efficiency, lowers cost, and provides our customers with betterservice. Therefore, the “point of consumption” is an important part of ourstrategy of investing in operations, which we aim to locate in close proximityto our customers. With our design centers located in the United States, Europe,and China we can provide a more efficient alternative to their design andengineering product demands.

We are able to offercompetitively priced manufactured products to our customers at lower costs tothem due to our manufacturing facilities located in Shanghai, China and Bombay,India. These facilities allow us the ability to provide low-cost manufacturingsolutions for the more labor-intensive aspects of our production process.Most of our products can be manufactured in multiple facilities, which gives usflexibility in meeting our customers’ changing production requirements.

*EfficientOperations Generate Stronger Margins*

We believe ourefficient operations will enable us in the future to generate strongeroperating margins once our shipment volumes and capacity utilization increases.We will achieve stronger margins by:

·       Focusingon designing and manufacturing mid- to high-end custom and modified standardpower supplies;

·       Usingcommon componentry in our products to achieve lower cost of materials;

·       Purchasingsubstantially all of our raw materials directly from manufacturers, rather thandistributors;

·       Utilizingour lower-cost manufacturing facilities in China and India for higher volumeand labor-intensive production requirements; and

·       Effectively managing ourcosts and our capacity utilizations.

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*Strong Partnershipswith Blue Chip OEM Customers*

We provide products to anumber of leading OEMs. We believe our customers continue to seek long-termpower-solution partners to act as an extension of their own engineering teamsand support their global manufacturing product needs over long productlifecycles. We have assembled a team of engineers focused on custom/modifiedstandard design with close relationships to our customers’ engineering staffs.We believe these engineering relationships have allowed us to strengthen ouroverall relationships with our customers.

*Sole Provider forPrograms Comprising a Significant Portion of Sales*

Because of the customnature of our products, a significant portion of our sales are from sole sourcerelationships with our customers. Our products are generally used for theentire life cycle of a customer’s end product, providing a base of recurringsales from year to year during that cycle. This life cycle can range anywherefrom two to five years in computing, storage and communications applications,and up to seven to fifteen years in industrial and medical applications. Wehave found that OEMs generally do not change vendors once a power supplyhas been designed into a product.

*Reputation forQuality and Service in an Increasingly Demanding Environment*

During this past year, the Company has been recognizedby a number of our customers for providing superior quality and value.  For the first time Cherokee was awarded thePrestigious Sun Meritorious Performance supplier award for 2006 from SunMicrosystems.  Suppliers are judged ontheir performance in the area of cost, quality and lead-time, along withstrategic and technical development.

Prototype lead-timeis a critical factor in a customer’s selection of a power supply manufacturer.On average, we deliver custom product prototypes within 10 to 12 weeks of a“design win”. This rapid prototyping capability along with our effort to reduceproduction time helps our customers meet their product development commitmentdates and beat their competitors to market. We provide our customers with shortprototype lead times and fast time-to-production by:

·       Employingexperienced engineers who are dedicated to design and development, andcommunicate directly with a customer’s engineers throughout the design process;

·       Settingup our manufacturing lines to run custom products efficiently; and

·       Leveraging our commoncomponentry and extensive database of product designs.

**Executive Officersof Cherokee**

*Jeffrey Frank*, 52,joined Cherokee in September 2001 as President,Chief Executive Officer and a member of our board of directors. Prior tojoining Cherokee, Mr. Frank was President of Lambda LEI from July 2000through September 2001. From May 1996 to March 2000, Mr. Frankwas President of Polestar Laboratories. Mr. Frank has over 23 years ofexperience in the electronics industry in which he spent twelve years withDeltec Electronics, a manufacturer of uninterruptible power supplies that aremarketed to OEM accounts globally.

*Bud Patel*, 71,hasserved as our Executive Vice President since April 1996 and was a VicePresident of Engineering of Cherokee from 1987 to 1993. Mr. Patel servedas President of Bikor Corporation from June 1993 through March 1996,when we acquired substantially all of the assets of Bikor. Prior to joiningCherokee in 1987, Mr. Patel was a Director of Engineering at LelandElectro Systems for over 25 years. Bud Patel is the uncle of Alex Patel.

*Linster W. Fox*, 58,joined Cherokee in October 2005 as Executive VicePresident, Chief Financial Officer and Secretary.  Prior to joining Cherokee, Mr. Fox worked atAnacomp, Inc., an international 

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*documentmanagement and multi-vendor services company, where he served as Executive VicePresident, and Chief Financial Officer, since November 2000.  Prior to November 2000, Mr. Fox was SeniorVice President and Corporate Controller at Anacomp.  Mr. Fox previously served in a variety offinancial management roles, as Vice President in Anacomp's corporate finance,international, technical services, engineering and manufacturingorganizations.  Prior to Anacomp, Mr. Foxworked for DatagraphiX Inc., a designer and manufacturer of high-end computeroutput devices with sales and service organizations around the world.  There he held several financial management positions,including a five-year assignment in the U.K., as Director of Finance, withtheir European operations.  Prior toDatagraphiX Inc., Mr. Fox worked in public accounting in Washington D.C. withwhat is now PricewaterhouseCoopers.  Hisclients included public, commercial and international companies.  Mr. Fox is a Certified Public Accountant anda graduate of Georgetown University.*

*Alex Patel*, 57,hasserved as our Vice President of Engineering since August 2002 and servedas Director of Engineering from 1988 to 1993 and from March 1996 toAugust 2002. Mr. Patel was the Vice President of Engineering at Bikorfrom 1993 through March 1996, when we acquired substantially all of theassets of Bikor. Prior to joining the Company in 1988, Mr. Patel was aSenior Development Engineer at GE and Leland Electrosystems for 11 yearscombined. Alex Patel is the nephew of Bud Patel.

*Mukesh Patel*, 42,has served as ourExecutive Vice President of Global Operations since June 2005.  Prior to June 2005, Mr. Patel served asCherokee’s Vice President of Information Technology since August 1996. Prior toCherokee, Mr. Patel served as Vice President of Operations at BikorCorporation, until Cherokee acquired substantially all of the assets of Bikor.

*Dennis Pouliot*, 59,hasserved as Vice President of Strategic Accounts for Cherokee sinceFebruary 2005. Mr. Pouliot served as a vice president in the salesand marketing departments of Cherokee and its predecessor from March 1991to February 2005. Prior to joining us, Mr. Pouliot was a salesmanager at Lambda Qualidyne from June 1989 to March 1991 and aDirector of International Sales and Marketing from September 1978 throughJune 1989.

*Howard Ribaudo*, 48,hasserved as Vice President of Sales for Cherokee since February 2005.Mr. Ribaudo served as Vice President of Global Accounts fromMarch 1996 to February 2005, and served in various other capacitiesfor Cherokee from 1988 through September 1993. Mr. Ribaudo served asVice President of Sales and Marketing for Bikor Corporation fromSeptember 1993 through March 1996, when we acquired substantially allof the assets of Bikor.

*Michael Wagner*, 41,hasserved as Vice President of Marketing for Cherokee since November 2001. Mr. Wagnerserved as Director of Marketing for Lambda Electronics from July 1988 toOctober 2001.

**Business Strategy**

Our objective is to growour business profitably by being the power supply partner of choice for selectindustry-leading OEMs who require sophisticated power solutions. Keyelements of our strategy include:

*Increase Sales to Our Existing Customers, Developmentof New Accounts in Growth Markets and a Diversification of Customers in theFour Vertical Markets Served.*

Over the past few years,we have made a significant effort to enhance the processes and systems used inour interaction with customers. These enhancements include the addition ofsales administration and program management personnel who provide expandedcustomer service support, the implementation of a global account strategy tocoordinate the sales efforts of our North American, European and Asianoperations for customers that require a global purchasing solution, and systemsto improve the efficiency of our order entry process. We believe these changeshave resulted in increased sales and exemplary customer service to many of ourexisting customers. We intend to leverage our competitive strengths, 

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in-depthknowledge of our customers’ needs and expanded product line to continue toincrease sales to our existing customers. In addition, as OEMs reduce thenumber of power supply vendors with whom they work, we continue to focus onincreasing our business with existing customers.

*Expand Our CustomerBase Through Increased Sales and Marketing Efforts*

We continue to invest in our internal sales force and ournetwork of independent sales representatives, their focus and efforts have beenon developing new business from our existing customer relationships.

In 2006, we generated 92design wins for all products within all regions, which 53 were considered majordesign wins.  In 2005 we generated 113design wins, of which 48 were considered major design wins.  The quality of our design wins were better in2006 compared to 2005 due to a better selection of customers, and the increasein new products.

*Expand and Cross-SellProduct Offerings*

We plan to continue tobroaden our existing product line and cross-sell products on a global basis toattract new customers in order to capture a larger market share of our existingcustomers’ business. We intend to leverage our portfolio of standard andmodified standard products in order to market these products both directly andon a private label and branded basis through available sales channels. Webelieve we have the ability and the opportunity to market custom products developedfor one customer on a custom, modified standard or standard basis, to othercustomers.

*Expand OurInternational Manufacturing Presence*

We expanded our operationsinto the Far East where we opened a new facility in Shanghai, China; we wereoperational by the second quarter ended 2006. The facility contains over120,000 square feet of space with the capacity to accommodate sales, marketing,manufacturing, engineering and the requisite support personnel and functionsthat will enable us to expand into Asia as well as address the manufacturing needs of our North American andEuropean customers. By locating our manufacturing facilities closer to ourcustomers’ own facilities, we are able to offer solutions with a lower costbase, increase production flexibility and decrease the lead times of ourproducts.

*LeverageInfrastructure to Improve Margins*

Operating costs of ourexisting manufacturing facilities and related administrative expenses arerelatively fixed, and should increase at a slower rate as sales improve. Inaddition, we have the opportunity to leverage our engineering and sales stafffor higher revenue programs without significant increases in staffing andrelated costs. The relatively fixed cost structure of our business model shouldallow us to realize higher margins on incremental revenue. We believe that ouravailable manufacturing capacity, combined with our manufacturing facility inChina, will be sufficient to accommodate significant future growth.Additionally, we intend to further drive efficiencies in manufacturing, andminimize labor, supply and manufacturing costs, through the utilization of ourfacilities located outside of the United States.

**Competitive andBusiness Challenges**

*Relatively LowerNet Sales*

The design, manufactureand sale of power supplies are highly competitive. Some of our competitors havesubstantially greater net sales, resources and geographic presence than we do.In addition, cancellations, reductions or delays in customers’ orders orcommitments or an increase in warranty product 

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returnscould have a greater effect on us than some of our competitors because of ourlower level of net sales.

*Fixed OperatingCosts*

Operating costs of ourexisting manufacturing facilities and related administrative expenses arerelatively fixed and therefore cannot be easily reduced if sales decline.

*Unpredictable EndMarkets*

As a provider of powersupplies to OEMs in the electronic equipment industries, our sales aredependent upon the success of these end markets and the underlying products inwhich our power supplies are components. We have no control over, and cannotalways accurately predict the demand in our customers’ end markets.

*InternationalOperations*

A significant portion ofour business is conducted internationally. Operating internationally subjectsus to risks that we would not otherwise face, such as political and economicinstability, terrorism and civil unrest, difficulties in staffing and managingthese operations, and fluctuations in foreign exchange rates.

**Product Line**

Our products cover a broad range of applications inthe commercial end-market, from low to high power, ranging from 10 to 27,000watts. Our power supplies are self-contained units, range in weight fromone-half of a pound to thirty pounds and are normally incorporated inside OEM’send products.

Most of our power suppliesare custom made, although we also produce some modified standard and standardproducts. We focus on designing and manufacturing mid- to high-end customand modified standard commercial power supplies because they typically have thehighest margins. Our large database of custom and modified standard productsallow us to benefit from the opportunity to incorporate our existingengineering and designs into new customer products in order to expedite designand time-to-market. We introduced a complementary line of DC/DC products in thecommercial market to take advantage of the growing DC/DC market. Our DC/DCconverters range from 20 to 500 watts. We will continue to focus on selling ourDC/DC products to existing AC/DC customers, as we believe there is an increaseddemand for these products and synergy with a complete distributed powerapplication or “DPA” solution.

**Customers**

Our OEM customers are indiverse markets such as servers and storage, networking, wirelessinfrastructure, medical, high-end mainframes, industrial process controls, andother electronic equipment industries. Most of these OEMs are Fortune 500companies and leaders in their respective industries. Our top ten customersaccounted for approximately 51% of net sales for the year ended December 31,2006, and approximately 53% for the year ended January 1, 2006. No customeraccounted for more than 10% of net sales for the year ended December 31, 2006,and one of our customers accounted for 10.4% of net sales for the year endedJanuary 1, 2006.  We derivedapproximately 52% of our net sales during the year ended December 31, 2006, and52% of our net sales during the year ended January 1, 2006 from customers inNorth America. The remainder of our net sales for such periods was to customersoutside of North America, with the majority of these sales to customers inEurope and Asia. For the dollar amount of net sales attributable to customerslocated by geographical region, please refer to Note 13 in our consolidatedfinancial statements included elsewhere in this report.

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**Sales and Marketing**

We market our products and services in North Americathrough an integrated sales approach involving account managers and independentsales representatives with active support from design, engineering andproduction personnel. Our in-house account managers supervise customerrelationships and oversee a nation-wide network of commission-based independentsales representatives whose main purpose is to identify new opportunities. Wemarket our products in Europe using a combination of a local direct sales team,independent sales representatives, in-house account managers and a newdeveloping Value Added Reseller (VAR) channel. We market our products in China using a combination of a local directsales team and independent sales representatives.

We focus our efforts in expanding relationships withexisting customers and aggressively targeting emerging OEM industry leaderswith whom the opportunity exists to provide products and services across anumber of product families and through successive product generations. We focusour resources on markets that are growing relatively quickly and have thepotential for significant profit margins. One example of an emerging market isthe deployment of *Triple Play*voice, video and data to the home. We see this as an opportunity to providepower to a decentralized *Access Network*that will support the infrastructure for the smart home. We have already hadsuccess in powering systems for *AccessNetwork* in Europe and are looking to the Far East as potential marketsfor this technology.

Potential customers areassigned to our in-house account managers who evaluate the customer against ourcustomer selection criteria. On an ongoing basis, our engineering personnelprovide technical support to customers in the areas of product design changes,field performance and testing. Our collaborative relationships allow us to gainvaluable knowledge about an existing customer and its processes, which webelieve gives us an advantage in obtaining future business from that customer.

**Backlog**

We generally sell ourproducts pursuant to purchase orders rather than long-term contracts, andcustomers may generally cancel, reduce or postpone orders or commitments.Backlog consists of purchase orders received for which we have not shippedproduct. A variety of conditions, both specific to the individual customer andgenerally affecting the customer’s 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 tocancellation or postponement. Our backlog was approximately $46.8 million atFebruary 28, 2007 and $49.6 million at February 28, 2006. We expect asubstantial majority of our backlog to be shipped within the next 12 months. Wehave also entered into certain warehousing arrangements with some of ourcustomers, whereby we have agreed to bear the risk and cost of carryinginventory. Under these arrangements, we deliver the power supplies ordered bysuch customers to a third-party warehouse location, permit thesecustomers to take delivery of the power supplies within a specified time periodafter our delivery of the products, and invoice these customers for theproducts only after they have taken ultimate delivery and title has passed.

**ManufacturingProcess and Quality Control**

A typical power supply consists primarily of one ormore printed circuit boards, electronic and electromagnetic components and asheet metal chassis. The production of our power supplies entails the assemblyof structural hardware combined with a sophisticated assembly of circuit boardsencompassing highly automated surface mount technology, or SMT.

In response to market demands for increased qualityand reliability, design complexity, and sophisticated technology, we haveautomated many electronic assembly and testing processes which weretraditionally performed manually and we have standardized our manufacturingprocesses to efficiently utilize our resources and optimize our capacities. Ourmanufacturing facilities are designed to quickly 

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produce a broad range ofproducts at a low cost. At December 31, 2006 we had eight SMT lines locatedthroughout our facilities. We had ten SMT lines by the end of first quarter2007.  SMT permits reduction in boardsize by eliminating the need for holes in the printed circuit boards and byallowing components to be placed on both sides of a board. Each SMT line iscapable of placing as many as 40,000 parts per hour, with each machine hourequating to approximately 50 labor hours.

In addition to increasing automation of ourfacilities, we have standardized our operations to include self-containedcontinuous flow manufacturing lines, which incorporate flow solder machines, incircuit test machines, highly advanced computer controlled burn-in equipment,automated final test machines, ongoing reliability test equipment, andstandardized processes and measurements on all lines. Furthermore,manufacturing processes, quality systems, data collection and documentation arestandardized across all facilities for smooth transition among locations toaccommodate optimal capacity utilization.

Most of our customers require that their powersupplies meet or exceed established international safety and quality standards.In response to this need, we design and manufacture power supplies inaccordance with the certification requirements of many international agencies,including Underwriters Laboratories Incorporated (UL) and Telcordia/Belcore inthe United States; the Canadian Standards Association (CSA) in Canada;Technischer Uberwachungs-Verein (TUV) and Verband Deutscher Electrotechniker(VDE), both in Germany; the British Approval Board for Telecommunications(BABT) in the United Kingdom; the European Telecommunications StandardInstitute (ETSI) and International Electrotechnical Committee (IEC), bothEuropean standards organizations. We have most recently received certificationfrom the China Compulsory Product Certification (CCC), Belgian Safety (CEBEC)and Taiwan’s Bureau of Standards, Metrology and Inspection (BSMI)organizations.

Quality and reliability are emphasized in both thedesign and manufacture of our products. In addition to testing throughout thedesign and manufacturing process, we test 100% of our finished products usingautomated equipment and customer-approved tests. Prototypes are reviewed toensure that they can be efficiently manufactured and an additional out-of-boxtest or pre-ship audit is performed on randomly selected finished units tofurther ensuring manufacturing quality and integrity.

All of our facilities in California, Belgium, Chinaand India are currently ISO 9001: 2000 certified. All facilities excluding ourChina Facility are also certified to the higher ISO 14000 standard. Our ChinaFacility is expected to be certified to ISO 14001 by the second half of 2007.

We are subject to federal, state and localenvironmental laws and regulations (in both the United States and abroad) thatgovern the handling, transportation and discharge of materials into theenvironment, including into the air, water and soil. Environmental laws couldbecome even more stringent in the future, imposing greater compliance costs andincreasing risks and penalties associated with their violation or thecontamination of the environment. Should there be an environmental accident orviolation related to our operations, our financial condition or results ofoperations may be adversely affected. We could be held liable for significantpenalties and damages under environmental laws and could also be subject to arevocation of licenses or permits, which could materially and adversely affectour financial condition or results of operations.

The following aretwo European Economic Community (“EEC”) directives that are having an effect onthe entire electronics industry, including the Company:

(1)   Restrictionof Hazardous Substances in Electrical and Electronic Equipment, more commonlyknown as RoHS. This European directive bans the use of certain elements thatare commonly found in components used to manufacture electrical and electronicassemblies. This directive became effective on July 1, 2006. The Companyis actively working with its customers to ensure compliance, and has begunmanufacturing compliant products.  TheCompany is focused on consuming all non-compliant material on-

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hand within a reasonableperiod.  However, the Company may have todispose of non-compliant materials in the future, which could adversely affectthe financial performance of the Company. There is also a risk of finesassociated with non-compliance with the RoHS directive; however, the Company isnot aware of any specific potential fines, and the Company anticipatescomplying with all provisions of this legislation.

(2)   Waste Electrical and Electronic Equipment, also known as WEEE.This directive requires manufacturers and importers to properly recycle ordispose of such equipment at the end of its useful life. This directive becameeffective August 13, 2005. The Company believes it has limited exposure tothe WEEE directive because its products are usually installed into anotheruser’s system, but this directive may be interpreted and enforced differentlyin the future. If so, the Company may face significant risk of fines and costsassociated with non-compliance with the existing laws and regulations in theEuropean Union. The Company is actively working with its customers to ensurecompliance, and has begun manufacturing compliant products.

**Suppliers**

Our high-quality products and ability to provide suchproducts in a relatively short time-to-market are in part the result of awell-managed supply chain network. We typically design products using commoncomponents, thereby increasing our purchasing power and reducing inventoryrisk. Most of our raw materials, including electronic and other components,sheet metal, transistors, mechanical parts and electrical wires, are readilyavailable from several sources. Although some of our raw materials are sourcedfrom only one manufacturer, they are generally available in large quantitiesfrom a number of different suppliers.

Through centralizedpurchasing, we have negotiated a number of volume discount purchase agreementsto realize economies of scale at each facility. We generally purchase rawmaterials and components directly from manufacturers and not from distributorsto get the most current materials at a lower available cost, thereby furtherreducing our overall cost of production. We view our suppliers as long-termpartners with whom we strive to develop strong relationships. In ourexperience, the repeat business and confidence that these relationships offerour suppliers often lead to a lower cost of materials.

**Competition**

The power supply manufacturing industry is highlyfragmented and characterized by intense competition. According to Micro-TechConsultants, in 2005 there were more than 1,000 third-party AC/DC and DC/DCpower supply manufacturers worldwide. No single company dominates the overallpower supplies market and our competitors vary depending upon the particularpower conversion product category. Our competitors include Emerson NetworkPower, Delta Electronics, Power One, Tyco International, C&D, Eltek, Vicor,and many other companies.

We believe that theprincipal competitive factors in our targeted markets are length oftime-to-market, manufacturing flexibility, technical knowledge, quality andcost. We believe that, compared to our competition, we sell products withcomparable or better quality characteristics at comparable prices.

**Engineering andProduct Development**

Our engineering and product development activities areprincipally directed to the improvement of existing products and thedevelopment of new power supplies to satisfy customer needs. As part of thecollaborative relationships established by us with our key customers, we workclosely with our customers to develop new products. Product development isperformed by a group of design engineers and technicians primarily located inTustin, California and Wavre, Belgium. We opened a Far East design center inour China Facility during the second quarter of 2006.

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Our total expenditures forengineering and product development were $9.5 million, $9.0 million and $9.1million for the years ended December 31, 2006, January 1, 2006 and January2, 2005, respectively.

**IntellectualProperty Matters**

Historically, intellectualproperty rights have not been a significant competitive factor in the powersupply industry. Accordingly, we have not expended significant efforts toobtain patents, trademark registrations or other forms of intellectual propertyprotection covering our brands and technologies. However, there is no guaranteethat intellectual property rights will not become more significant in thefuture, or that our competitors will not try to assert intellectual propertyrights to obtain a competitive advantage. Indeed, from time-to-time we havereceived notices of alleged infringement and/or invitations to take licensesfrom third parties.

**Employees**

AtDecember 31, 2006, we employed 1,630 full-time employees at our facilitiesin the following capacities:
|                                  | ** ** | **Locations** | ** ** |
|----------------------------------|------------|---------------|------------|
| **Function**                     | ** ** | ** **    | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Mexico** | ** ** | **India** | ** ** | **China** | ** ** | **Total** | ** ** |
| Manufacturing                    |       | 307           |       |   | 168 |   |   |   | 64 |   |   |   | 530 |   |   |   | 325 |   |   | 1,394 |   |
| Engineering  (including R&D) |       | 43            |       |   | 36 |   |   |   | 2 |   |   |   | 4 |   |   |   | 7 |   |   | 92 |   |
| Quality Control                  |       | 21            |       |   | 10 |   |   |   | 4 |   |   |   | 2 |   |   |   | 6 |   |   | 43 |   |
| Marketing                        |       | 15            |       |   | 17 |   |   |   | 1 |   |   |   | — |   |   |   | 3 |   |   | 36 |   |
| General  Administration          |       | 21            |       |   | 16 |   |   |   | 7 |   |   |   | 11 |   |   |   | 10 |   |   | 65 |   |
| Total                            |       | 407           |       |   | 247 |   |   |   | 78 |   |   |   | 547 |   |   |   | 351 |   |   | 1,630 |   |
|                                  |            |               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

None of our North Americaand China employees are represented by a labor organization. Most of theemployees in Belgium and India are represented by local unions that are subjectto collective bargaining agreements. We believe that we have good relationswith our employees, including our employees in our Belgium and Indiafacilities.

**ITEM 1A.**        RISKFACTORS

*The following risk factors, among others, could causeour financial performance to differ significantly from the goals, plans,objectives, intentions and expectations expressed in this Annual Report onForm 10-K. If any of the following risks and uncertainties or otherrisks and uncertainties not currently known to us or not currently consideredto be material actually occurs, our business, financial condition or operatingresults could be harmed substantially.*

**Risks Relating toOur Company and Industry**

**We are substantially dependent upon sales to arelatively small group of customers. The loss of one or more major customers,or the discontinuation or modification of these customers’ products, couldmaterially and adversely affect the results of our operations.**

Our top ten customersaccounted for approximately 51% of our net sales for the year ended December31, 2006 and approximately 53% of our net sales for the year ended January 1,2006. No customer accounted for more than 10% of net sales in 2006, however,one of our customers accounted for 10.4% in 2005.  The loss of any of our major customers couldhave 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 usealternative power supply providers for some or all of their products. We maynot be able to maintain our customer relationships, and our customers mayreduce or cancel their purchase orders, 

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purchasepower supplies elsewhere or develop relationships with additional providers ofpower supplies, any of which could adversely affect our financial condition orresults of operations. A significant change in the liquidity or financialposition of any of these customers could also have a material adverse effect onthe collectibility of our accounts receivables, our liquidity and our futureoperating results. Prior to, or at the end of, a product’s life cycle, any ofour customers may decide to discontinue or modify any of its products. In thatevent, the customer may no longer have a need for our products or may choose tointegrate a competitor’s power supply into the customer’s new or modifiedproduct. The resulting loss of revenues could also adversely affect our financialcondition or results of our operations.

**Failure by our customers or us to keep up with rapidtechnological change in the electronic equipment industries could result inreduced sales for us.**

Many of our existingcustomers are in the electronic equipment industries, especially wirelessinfrastructure and networking, and produce products that are subject to rapidtechnological change, obsolescence and large fluctuations in world-wide productdemand. These industries are characterized by intense competition and end-userdemand for increased product performance at lower prices. We may not be able toproperly assess developments in the electronic equipment industries or identifyproduct groups or customers with the potential for continued and future growth.Factors affecting the electronic equipment industries, in general, or any ofour major customers or their products, in particular, could have a materialadverse effect on our financial condition or results of operations. Forinstance, as a provider of power supplies to OEMs in the electronic equipmentindustries, our sales are dependent upon the success of the underlying productsof which our power supplies are a component. We have no control over the demandfor or success of these products. If our customers’ products are not wellreceived by, or if demand for their products fail to develop among end-users,our customers may discontinue or modify the product or reduce the production ofthe product. Any of these events could lead to the cancellation or reduction oforders for our power supplies that were previously made or anticipated, whichcould materially adversely affect our financial condition or results ofoperation. See ‘‘Cancellations, reductions or delays in customers’ orders orcommitments, or an increase in the number of warranty product returns couldhave a material adverse impact on our financial condition and results ofoperations’’ for more information. The markets for our products arecharacterized by rapidly changing technologies, increasing customer demands,evolving industry standards, frequent new product introductions and shorteningproduct life cycles. Generally, our customers purchase our power supplies forthe life cycle of a product, which can range anywhere from two to fifteenyears. The development of new, technologically advanced products is a complexand uncertain process requiring high levels of innovation and cost, as well asthe accurate anticipation of technological and market trends. As the life cycleof our customers’ products shorten, we will be required to bid on contracts forreplacement or next generation products to replace revenues generated fromdiscontinued products more frequently. These bids may not be successful. Evenif we are successful, we may not be able to successfully develop, introduce ormanage the transition of new products. Any failure or delay in anticipatingtechnological advances or developing and marketing new products that respond toany significant technological change or significant changes in customer demandcould have a material adverse effect on our financial condition or results ofoperations.

**We face significant competition, including from somecompetitors with greater resources and geographic presence than us. Our failureto adequately compete could have a material adverse effect on our business.**

The design, manufactureand sale of power supplies are highly competitive and characterized byincreasing customer demands for product performance, shorter manufacturingcycles and lower prices. Our competition includes numerous companies throughoutthe world, some of which have advantages over us in terms of labor andcomponent costs and technology. Our principal competitors are Emerson NetworkPower, Delta Electronics,  Power One,Tyco International, C&D, Eltek, and Vicor. Some of our competitors havesubstantially greater net sales, resources and geographic presence than we do. 

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Competitionfrom existing competitors or new market entrants may increase at any time. Wealso face competition from current and prospective customers that may designand manufacture their own power supplies. In times of an economic downturn, orwhen dealing with high-volume orders, price may become a more importantcompetitive factor, forcing us to reduce prices and thereby adversely affectingour financial results. Some of our major competitors have also consolidatedthrough merger and acquisition transactions. Consolidation among ourcompetitors is likely to create companies with increased market share, customerbases, proprietary technology and marketing expertise, and an expanded salesforce. 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 returnscould have a material adverse impact on our financial condition and results ofoperations.**

We do not obtain long-term purchase orders orcommitments from our customers, and customers may generally cancel, reduce orpostpone orders or commitments. A variety of conditions, both specific to theindividual customer and generally affecting the customer’s industry, may causecustomers to cancel, reduce or delay orders or commitments that were previouslymade or anticipated. At any time, a significant portion of our backlog may besubject to cancellation or postponement. Substantially our entire$47.2 million backlog as of December 1, 2006 was subject tocancellation upon the payment by our customers of cancellation fees that varydepending on individual purchase orders. We also enter into certain warehousingarrangements with some of our customers, whereby we agree to bear the risk andcost of carrying inventory. Under these arrangements, we deliver the powersupplies ordered by such customers to a third-party location, permit thesecustomers to take delivery of the power supplies within a specified time periodafter our delivery of the products, and invoice these customers for theproducts only after they have taken ultimate delivery and title has passed. We maynot be able to replace cancelled, delayed or reduced orders or commitments in atimely manner or at all and in some instances may need to write-off inventory.Significant or numerous cancellations, as well as reductions or delays inorders or commitments, including as a result of delays in or the failure totake delivery of products that are subject to such arrangements, by a customeror group of customers, could materially adversely affect our financialcondition or results of operations.

We also offer ourcustomers a warranty for products that do not function properly within alimited time after delivery. We regularly monitor and track warranty productreturns and record a provision for the estimated amount of future warrantyreturns based on historical experience and any notification we receive ofpending warranty returns. We may not continue to experience the same warrantyreturn rates that we have in the past. Any significant increase in productfailure rates and the resulting warranty credit returns could have a materialadverse effect on our operating results for the period or periods in whichthose warranty returns occur.

**Our international manufacturing operations and ourinternational sales subject us to risks associated with foreign laws, policies,economies and exchange rate fluctuations.**

We havemanufacturing operations located in Europe, India, and China. We may expand ouroperations into other foreign countries in the future. In addition,international sales have been, and are expected to continue to be, an importantcomponent of our total sales. International sales represented 48% of our netsales for the year ended December 31, 2006 and 48% of our net sales for theyear ended January 1, 2006. Our manufacturing operations and international salesare subject to inherent risks, all of which could have a material adverseeffect on our financial condition or results of operations. For example, ourEuropean Division (Cherokee Europe) has two restructuring plans in place. Thefirst one (the 1999 Europe restructuring) was inherited by us in 2000 when wepurchased this division from Panta Electronics, and the second (the 2003 Europerestructuring) was implemented in 2003 by us. Both of these plans were 

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significantlyimpacted by local labor laws and union labor negotiations, and requiredtermination benefits.  When we acquiredCherokee Europe in 2000, we inherited approximately $2.2 million liability tobe paid through 2010. When we implemented the 2003 Europe restructuring, werecorded a $4.5 million expense to be paid through 2016. See ‘‘Management’sDiscussion and Analysis of Financial Condition and Results of Operations—Resultsof Operations.’’ Other risks affecting our international operations include:

·       differences or unexpectedchanges in regulatory requirements;

·       political and economicinstability;

·       terrorism and civil unrest;

·       work stoppages orstrikes;

·       interruptions intransportation;

·       restrictions on the exportor import of technology;

·       difficulties in staffingand managing international operations;

·       variations in tariffs,quotas, taxes and other market barriers;

·       longer payment cycles;

·       problems in collectingaccounts receivables;

·       changes in economicconditions in the international markets in which our products are sold; and

·       greater fluctuations insales to customers in developing countries.

Although we transactbusiness primarily in U.S. dollars, a portion of our sales and expenses,including labor costs, are denominated in the Mexican peso, the Indian rupee,the Chinese renminbi (“RMB”), the Euro and other European currencies. For theyear ended December 31, 2006 and January 1, 2006, net sales in Europe accountedfor 37% and 41% of our net sales, respectively. Fluctuations in the value ofthe U.S. dollar relative to the Euro impacted our revenue, cost of goods soldand operating margins for these periods and resulted in foreign currencytranslation gains and losses. Foreign currency translation gains or lossesrecorded in other comprehensive income, a component of equity, for the year endedDecember 31, 2006 and January 1, 2006 were a gain of $1.6 million and a loss of$2.6 million, respectively. Historically, we have not actively engaged insubstantial exchange rate hedging activities and do not intend to do so in thefuture.

**An interruption in delivery of component suppliescould lead to supply shortages or a significant increase in our cost ofmaterials.**

We are dependent on oursuppliers for timely shipments of components, including components manufacturedby us in our India facilities. We typically use a primary source of supply foreach component used in our products. Changing suppliers or establishingalternate primary sources of supply, if needed, could take a significant periodof time, which in turn could result in supply shortages and increased prices.In some cases, we source components from only one manufacturer. Substantiallyall of our revenues are derived from the sale of products that includecomponents that we source from only one manufacturer. In addition, many of oursuppliers are located outside of the United States, and timely delivery fromthese suppliers may not occur due to interruptions in transportation,import-export controls, tariffs, quotas, taxes and other market barriers, andpolitical and economic stability in the country in which the components used inour products are produced or the surrounding region. An interruption in supplycould have a material adverse affect on our operations. Any shortages ofparticular components could increase product delivery times and costsassociated with manufacturing, thereby reducing gross margins. Additionally,these 

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shortagescould cause a substantial loss of business due to shipment delays. Anysignificant shortages or price increases of components could have a materialadverse effect on our financial condition or results of operations.

**Our quarterly sales may fluctuate while ourexpenditures remain relatively fixed, potentially resulting in lower grossmargins and volatility in our stock price.**

Our quarterlyresults of operations have fluctuated in the past and may continue to fluctuatein the future. Fluctuations in customer needs, cancellations, reductions anddelays in orders and commitments may cause our quarterly results to fluctuate.See ‘‘Cancellations, reductions or delays in customers’ orders or commitmentsor an increase in the number of warranty product returns could have a materialadverse impact on our financial condition and results of operations.’’Variations in volume production orders and in the mix of products sold by ushave also significantly affected sales and gross profit. Sales are generallyimpacted by a combination of these items and may also be affected by otherfactors. These factors include:

·       thereceipt and shipment of large orders or reductions in these orders (includingthe impact of any customer warehousing arrangements);

·       rawmaterial availability and pricing;

·       productand price competition; and

·       thelength of sales cycles.

Many of these factors areoutside of our control. In addition, a substantial portion of our sales in agiven quarter may depend on obtaining orders for products to be manufacturedand shipped in the same quarter in which those orders are received. As a resultof this and other factors described above, sales for future quarters aredifficult to predict and our financial condition or results of operations in agiven quarter may be below our expectations and our gross margins may decrease.Our expense levels are relatively fixed and are based, in part, on expectationsof future revenues. If revenue levels are below expectations, the market priceof our common stock could fall substantially, and our financial condition orresults of operations could be materially adversely affected.

**Our ability to successfully implement our businessstrategy is dependent on our ability to retain and attract key personnel.**

Our ability tosuccessfully implement our business strategy depends to a significant degree onthe efforts of Jeffrey M. Frank, President, Chief Executive Officer, andDirector, Linster W. Fox, Executive Vice President, Chief Financial Officer andSecretary, and Mukesh Patel, Executive Vice President, Global Operations, alongwith other members of our senior management team. We have no employmentretention agreements with our key management executives and do not maintain keyperson life insurance for any of our executive officers. We believe that theloss of service of any of these executives could have a material adverse effecton our business. In addition, we depend on highly skilled engineers and otherpersonnel with technical skills that are in high demand and are difficult toreplace. As a result, our ability to maintain and enhance product andmanufacturing technologies and to manage any future growth also depends on oursuccess in attracting and retaining personnel with highly technical skills. Thecompetition for these qualified technical personnel may be intense if therelatively limited number of qualified and available power engineers continues.We may not be able to attract and retain qualified technical personnel.

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**Changes in government regulations or productcertification could result in delays in shipment or loss of sales.**

Our operations are subjectto general laws, regulations and government policies in the United States andabroad. Additionally, our product standards are certified by agencies invarious countries, including, among others, the United States, Canada, Asia,Germany and the United Kingdom. Changes in these laws, regulations, policies orcertification standards could negatively affect the demand for our products,result in the need to modify our existing products, increase time-to-productionor affect the development of new products, each of which may involvesubstantial costs, or loss of or delayed sales and could have a materialadverse effect on our financial condition or results of operations.

**Environmental compliance could require significantexpenditures and failure to so comply could result in fines or revocation oflicenses or permits, any of which could materially and adversely affect ourfinancial condition or results of operations.**

We are subject to federal, state and localenvironmental laws and regulations (in both the United States and abroad) thatgovern the handling, transportation and discharge of materials into theenvironment, including into the air, water and soil. Environmental laws couldbecome even more stringent in the future, imposing greater compliance costs andincreasing risks and penalties associated with their violation or thecontamination of the environment. Should there be an environmental accident orviolation related to our operations, our financial condition or results ofoperations may be adversely affected. We could be held liable for significantpenalties and damages under environmental laws and could also be subject to arevocation of licenses or permits, which could materially and adversely affectour financial condition or results of operations.

The following aretwo European Economic Community (“EEC”) directives that are having an effect onthe entire electronics industry, including the Company:

(1)   Restrictionof Hazardous Substances in Electrical and Electronic Equipment, more commonlyknown as RoHS. This European directive bans the use of certain elements thatare commonly found in components used to manufacture electrical and electronicassemblies. This directive became effective on July 1, 2006. We areactively working with our customers to ensure compliance.  We are focused on consuming all non-compliantmaterial on-hand within a reasonable period. However, we may have to dispose of non-compliant materials in thefuture, which could adversely affect our financial performance. There is also arisk of fines associated with non-compliance with the RoHS directive; however,we are not aware of any specific potential fines, and we anticipate complyingwith all provisions of this legislation.

(2)   Waste Electrical and Electronic Equipment, also known as WEEE.This directive requires manufacturers and importers to properly recycle ordispose of such equipment at the end of its useful life. This directive becameeffective August 13, 2005. We believe we have limited exposure to the WEEEdirective because our products are usually installed into another user’ssystem, but this directive may be interpreted and enforced differently in thefuture. If so, we may face significant risk of fines and costs associated withnon-compliance with the existing laws and regulations in the European Union.

**Our operations are vulnerable to interruption by fire,earthquake, power loss, telecommunications failure and other events beyond ourcontrol.**

Our operations are vulnerable to interruption byearthquakes, fires, electrical blackouts, power losses, telecommunicationsfailures and other events beyond our control. Our executive offices and key manufacturingand engineering facilities are located in Southern California. Because SouthernCalifornia is an earthquake-sensitive area, we are particularly susceptible tothe risk of damage to, or total destruction of, our facilities in SouthernCalifornia and the surrounding transportation infrastructure, which couldaffect our ability to make and transport our products. Furthermore, the Stateof California experienced 

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deficiencies in its powersupply in 2002, which resulted in occasional rolling blackouts and caused ustwo-to-four hour power supply interruptions over the course of a few days. Inaddition, California continues to face periodic shortages in its power supply.If rolling blackouts or other disruptions in power occur, our business andoperations would be disrupted, and our business would be adversely affected. InJanuary 2004, we experienced a fire in part of our facility in Belgium,Europe, which destroyed certain inventory, property and equipment. Our businessinterruption insurance may not be sufficient to compensate us for losses thatmay occur and would not compensate us for the loss of consumer goodwill due todisruption of service.

**Third parties maysue us for alleged infringement of their proprietary rights.**

We have received, fromtime to time, notices of alleged infringement and/or invitations to takelicenses from third parties asserting that they have patents (or otherintellectual property rights) that are relevant to our present or contemplatedbusiness operations. There is no guarantee that we will be able to avoidincurring litigation costs related to such assertions. Intellectual propertyclaims could be successfully asserted against us, preventing us from usingcertain of our technologies, or forcing us to modify our technology or to paylicense fees for use of that technology. Such additional engineering expensesor licensing costs could have an adverse effect on the results of ouroperations. In addition, we could incur substantial expenses in defendingagainst these claims, whether or not we ultimately prevail against theseclaims.

**Provisions of theagreements governing our debt will restrict our business operations.**

At December 31, 2006, we had $46.6 million of 5.25% senior notes outstanding, and wehad in place a $20.0 million senior revolving credit facility (with no amountsoutstanding) that is subject to a borrowing base comprised of eligible accountsreceivable and inventory. Our outstanding indebtedness, including our 5.25%senior notes and any debt incurred pursuant to the senior revolving creditfacility, is secured by substantially all of our assets.

Cherokee Europe maintains a working capital line ofcredit of approximately $4.0 million with Bank Brussels Lambert, a subsidiaryof ING Belgie NV, a bank in Brussels, which is denominated in Euros,collateralized by a pledge in first and second rank over a specific amount ofbusiness assets, requires Cherokee Europe to maintain a certain specificminimum solvency ratio, and is cancelable at any time. As of December 31, 2006,Cherokee Europe had no outstanding borrowings under the line of credit.

We may need to incur additional debt to continue togrow our business in the future. The agreements governing our debt contain anumber of covenants that restrict our business operations, including covenantslimiting our ability to make investments, enter into mergers or acquisitions,dispose of assets, incur additional debt, grant liens, enter into transactionswith affiliates, redeem or repurchase our capital stock, repay other debt andpay dividends. As of December 31, 2006, we were in compliance with ourcovenants set forth in the agreements. However, as of April 2, 2007, we were out of compliance with therequirement that we submit our annual audited financial statements to GE CapitalCorporation, the agent under our revolving credit facility, within 120 days ofour fiscal year end.  We have obtained awaiver of this default from GE Capital Corporation effective May 10, 2007.  This waiver extends the deadline forsubmitting our audited financial statements until August 31, 2007.  The Company will submit the audited financialstatements the day we file this Form 10-K.

Our ability to comply withcovenants under agreements governing our debt may be affected by events thatare beyond our control, including prevailing economic, financial and industryconditions. Our failure to comply with the covenants or restrictions containedin agreements governing our debt could result in an event of default underthese agreements, which could result in our debt, together with accrued andunpaid interest, being declared immediately due and payable.

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**Our 5.25% SeniorNotes mature on November 1, 2008, and we may be unable to repay or refinancethis indebtedness upon maturity.**

On November 1, 2008, the$46.6 million aggregate principal amount outstanding under our 5.25% SeniorNotes will become due and payable.  We donot expect to have sufficient cash available at the time of maturity to repaythis indebtedness.  We also cannot becertain that we will have sufficient assets or cash flow available to supportrefinancing these notes at current market rates or on terms that aresatisfactory to us.  If we are unable torefinance on terms satisfactory to us, we may be forced to refinance on termsthat are materially less favorable, seek funds through other means such as asale of some of our assets, or otherwise significantly alter our operatingplan, any of which could have a material adverse effect on our business,financial condition and results of operation.

**Credit risks couldmaterially and adversely affect our operations and financial condition.**

Negative or decliningeconomic conditions can increase our exposure to our customers’ credit risk. Inparticular, sales to larger customers are sometimes made through contractmanufacturers 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 December 31, 2006and January 1, 2006, one of our customers accounted for approximately 6.9% ofour total net receivables and another one of our customers accounted for 10.3%,respectively. For the periods ended December 31, 2006 and January 1, 2006,our accounts receivable write-offs amounted to less than 1% of our net accountsreceivable balance. In the event our customers or those contract manufacturersexperience financial difficulties and fail to meet their financial obligationsto us, or if our recorded bad debt provisions with respect to receivablesobligations do not accurately reflect future customer payment levels, we couldincur additional write-offs of receivables that are in excess of ourprovisions, which could have a material adverse effect on our operations andfinancial condition. In addition, we depend on the continuing willingness ofour suppliers to extend credit to us to finance our inventory purchases. Ifsuppliers become concerned about our ability to generate cash and service ourdebt, they may delay shipments to us or require payment in advance.

**If we fail to meetthe listing requirements of the Nasdaq Global Market and the Nasdaq determinesto delist our common stock, the delisting would adversely affect the liquidityof our common stock and the market price of our common stock could decline.**

Our common stock is listed on the Nasdaq GlobalMarket.  In order to maintain thatlisting, we must satisfy certain period reporting requirements.  On April 5, 2007, we received a notice fromthe Nasdaq that the Nasdaq had determined to delist our common stock from theNasdaq Global Market as a result of non-compliance with Marketplace Rule4310(c)(14) due to our failure to timely file our Annual Report on Form 10-Kfor the fiscal year ended December 31, 2006 with the SEC.  We [expect to receive] an additional letterof similar substance from the Nasdaq related to our Quarterly Report on Form10-Q for the quarter ended March 31, 2007. We have appealed the Nasdaq’s determination to delist our common stock,and a hearing with the staff of the Nasdaq has been scheduled for May 31,2007.  There is no guarantee that we willbe able to delay or prevent the delisting of our common stock from the NasdaqGlobal Market.

If our common stock isdelisted from the Nasdaq Global Market, the price of our common stock and theability of our stockholders to trade in our common stock would be adverselyaffected.  In addition, such delistingcould adversely affect our ability to obtain financing and could result in theloss of confidence by our investors, suppliers and employees.

**ITEM 1B.**       UNRESOLVED STAFF COMMENTS

None.

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**ITEM 2.**                PROPERTIES

Ourheadquarters are located in Tustin, California. We own three manufacturingfacilities, both of which are outside of the United States, and lease fiveother manufacturing facilities and one warehouse facility. These facilitiesmanufacture labor-intensive magnetic sub-assemblies that are distributed to ourother facilities for incorporation into our final products. In addition, welease satellite offices located in England, France, Germany and Sweden, whichserve as sales offices.All of our leases have renewal options as indicated inthe following table. We believe that our leased locations are adequate for ourimmediate needs and that additional or substitute space is available, ifneeded, to accommodate future growth and expansion, or relocation. Please referto Note 13 to our consolidated financial statements included elsewhere inthis report for the amount of our long-lived assets outside the United States.

| **Facilities**      | ** ** | ** **                               | ** ** | **Primary  Activity** | ** ** | **Approximate  Square  Footage** | ** ** | **Owned/  Leased**     | ** ** | **Lease  Expiration  Date**  | ** ** | **Renewal Option** |
|---------------------|------------|------------------------------------------|------------|-----------------------|------------|----------------------------------|------------|------------------------|------------|------------------------------|------------|--------------------|
| Tustin, California  |       | Manufacturing Engineering Administrative |       |   86,000    |       | Leased                           |       | April 30, 2009    |       | One five-year renewal        |
| Tustin, California  |       | Warehousing                              |       |   10,000    |       | Leased                           |       | June 01, 2008     |       | One three-year renewal       |
| Tustin, California  |       | Warehousing                              |       |   10,000    |       | Leased                           |       | June 01, 2008     |       | One three-year renewal       |
| Irvine, California  |       | Manufacturing Engineering                |       |   31,000    |       | Leased                           |       | April 30, 2009    |       | One five-year renewal        |
| Wavre, Belgium      |       | Manufacturing Engineering Administrative |       | 178,000               |       | Owned                            |       | Not applicable         |       | Not applicable               |
| Guadalajara, Mexico |       | Manufacturing                            |       |   35,000    |       | *Owned/Sale Pending              |       | Not applicable         |       | Not applicable               |
| Bombay, India       |       | Manufacturing                            |       |   14,000    |       | Leased                           |       | March 31, 2008    |       | Unlimited five-year renewals |
| Bombay, India       |       | Manufacturing                            |       |   17,000    |       | Leased                           |       | March 31, 2009    |       | Unlimited five-year renewals |
| Shanghai, China     |       | Manufacturing                            |       | 120,000               |       | **Owned                          |       | October 27,  2055 |       | Not  applicable              |

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*                    On February22, 2007, Cherokee Electronica, S.A. de C.V. (“Cherokee Mexico”), a subsidiaryof Cherokee International Corporation, a Delaware corporation (the “Company”),entered into a Purchase and Sale Agreement (the “Agreement”) with InmobiliariaHondarribia, S.A. de C.V. (the “Buyer”) for the sale of Cherokee Mexico’s35,000-foot manufacturing facility in Guadalajara, Mexico.

The Agreementprovides that the Buyer will pay Cherokee Mexico an aggregate purchase price ofapproximately US $1.2 million, of which approximately US $182,000 was paid onFebruary 22, 2007 and approximately US $1.02 million will be paid when thetransaction closes on or about May 31, 2007. Cherokee Mexico expects to incuran immaterial amount of expenses in connection with the sale of the building,principally related to broker’s fees. Any amounts payable in connection withthe sale of the building will be subtracted from proceeds of the sale.

**             Theland is an Industrial Park owned by the Government of the People’s Republic ofChina (the “PRC”).  Under PRC law, the governmentowns the land and no private parties are allowed to purchase land.  However, the China subsidiary owns thebuilding and has invested $8.6 million into the development of this newfacility and operation.

**ITEM 3.**                LEGALPROCEEDINGS

In late March 2006, the Company learned thatemployees of its Indian subsidiary manufacturing operations had made certainunauthorized payments that may have been in violation of the Foreign CorruptPractices Act and local laws. The facility in India is used for the sole purposeof manufacturing 

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products for other Companylocations and, as such, does not generate revenue or issue invoices to externalcustomers. It manufactures approximately 6% (by volume) of the products offeredby the Company.

The subject payments, in the aggregate, amount toapproximately $40,000 in 2004 and 2005, and less than $10,000 in 2006. TheCompany retained outside counsel who conducted an internal investigation intothese payments.  In January 2007, the Company’soutside counsel met with the SEC to discuss the results of the internalinvestigation.

During the year endedDecember 31, 2006, we were not a party to any other material legalproceedings. We are occasionally a party to lawsuits relating to routinematters incidental to our business. As with all litigation, we can provide noassurance as to the outcome of any particular lawsuit, and we note thatlitigation inherently involves significant costs.

**ITEM 4.**                SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

None.

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**PART II**

**ITEM 5.**                MARKET FORREGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIES

(a)  Our common stock is listed on the NASDAQ andis traded under the symbol “CHRK”. The following table sets forth, for thequarterly periods indicated, the range of high and low closing sale prices forour common stock.

| ** **     | ** ** | **Years Ended**        | ** ** |
|----------------|------------|-----------------------------|------------|
| ** **     | ** ** | **December 31,  2006** | ** ** | **January 1,  2006** | ** ** |
| ** **     | ** ** | **High**                    | ** ** | **Low** | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $                           | 5.27       |   | $ | 3.95 |   | $ | 9.25 |   | $ | 6.85 |   |
| Second Quarter |       | $                           | 6.80       |   | $ | 3.49 |   | $ | 6.95 |   | $ | 3.67 |   |
| Third Quarter  |       | $                           | 4.21       |   | $ | 3.30 |   | $ | 5.08 |   | $ | 3.38 |   |
| Fourth Quarter |       | $                           | 4.03       |   | $ | 2.90 |   | $ | 4.70 |   | $ | 2.84 |   |

 

As of May 15, 2007, there were approximately21,897 holders of our common stock.

We have not paid any cash dividends on our commonstock and do not anticipate paying dividends in the foreseeable future.

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The graph below shows acomparison of cumulative total return for Cherokee International Corporation ofthe NASDAQ Composite index, and a peer group of four companies consisting of: C &D Technologies Inc., Magnetek Inc., Power-One Inc. and Vicor Corp. The graphtracks the performance of a $100 investment in our common stock, in the peergroup, and the index (the reinvestment of all dividends) from 2/25/2004 (thedate of our initial public offering) to 12/31/2006.

**COMPARISON OF 3YEAR CUMULATIVE TOTAL RETURN**AmongCherokee International Corporation, The NASDAQ Composite IndexAnd A Peer Group

****

**The stockprice performance included in this graph is not necessarily indicative offuture stock price performance.**

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**ITEM 6.**                SELECTED FINANCIALDATA

The selected consolidatedfinancial data as of December 31, 2006, and January 1, 2006 and forthe years ended December 31, 2006, January 1, 2006 and January 2,2005 are derived from our audited consolidated financial statements that appearelsewhere in this report. The selected consolidated financial data as of January 2,2005, December 28, 2003, and December 29, 2002 and for the yearsended December 28, 2003 and December 29, 2002 have been derived fromour audited consolidated financial statements that are not included in thisreport. No per share information is available prior to November 2002, whenwe converted from a California limited liability company to a Delawarecorporation. You should read the following financial information together withthe information under “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and our consolidated financial statementsand the related notes appearing elsewhere in this report.

| ** **                                                                                         | ** ** | **December 31,  2006**                                                              | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** | **December 28,  2003** | ** ** | **December 29,  2002** | ** ** |
|----------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|---------------------------|------------|---------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                                                         | ** ** | **(in thousands except share and per share amounts)** | ** ** |
| **Consolidated Statement of Operations  Data:**                                                    |       |                                                                                     |       |                      |       |                      |       |                        |       |                        |       |   |   |   |   |   |   |
| Net sales                                                                                          |       |                                                                                     | $          | 145,028                   |       |                      | $          | 122,079                     |       | $                           | 148,511    |   |   | $ | 111,943 |   |   |   | $ | 96,293 |   |   |
| Cost of sales                                                                                      |       |                                                                                     | 114,439    |                      |       | 97,181                    |       | 104,140                     |       |                        | 79,397     |   |   |   | 70,598 |   |   |
| Gross profit                                                                                       |       |                                                                                     | 30,589     |                      |       | 24,898                    |       | 44,371                      |       |                        | 32,546     |   |   |   | 25,695 |   |   |
| Operating  expenses                                                                                |       |                                                                                     | 28,874     |                      |       | 27,557                    |       | 25,704                      |       |                        | 22,522     |   |   |   | 18,150 |   |   |
| Restructuring  costs                                                                               |       |                                                                                     | 697        |                      |       | —                    |       | —                      |       |                        | 4,474      |   |   |   | — |   |   |
| Asset impairment                                                                                   |       |                                                                                     | 285        |                      |       | —                    |       | —                      |       |                        | —     |   |   |   | — |   |   |
| Long service  award liability reduction                                                            |       |                                                                                     | (1,718     | )                         |       | —                    |       | —                      |       |                        | —     |   |   |   | — |   |   |
| Stock  compensation expense                                                                        |       |                                                                                     | —     |                      |       | —                    |       | 243                         |       |                        | 990        |   |   |   | — |   |   |
| Gain from  insurance proceeds                                                                      |       |                                                                                     | —     |                      |       | (2,898                    | )          | —                      |       |                        | —     |   |   |   | — |   |   |
| Operating income                                                                                   |       |                                                                                     | 2,451      |                      |       | 239                       |       | 18,424                      |       |                        | 4,560      |   |   |   | 7,545 |   |   |
| Interest expense                                                                                   |       |                                                                                     | (2,786     | )                         |       | (2,852                    | )          | (5,234                      | )          |                        | (17,028    | ) |   |   | (14,801 | ) |   |
| Debt  restructuring costs                                                                          |       |                                                                                     | —     |                      |       | —                    |       | —                      |       |                        | —     |   |   |   | (3,204 | ) |   |
| Other income  (expense), net                                                                       |       |                                                                                     | 335        |                      |       | 258                       |       | 47                          |       |                        | 1,187      |   |   |   | (431 | ) |   |
| Income (loss)  before income taxes and cumulative effect of a change in  accounting principle |       |                                                                                     | —     |                      |       | (2,355                    | )          | 13,237                      |       |                        | (11,281    | ) |   |   | (10,891 | ) |   |
| Provision (benefit)  for income taxes                                                              |       |                                                                                     | (83        | )                         |       | 877                       |       | 2,796                       |       |                        | 1,151      |   |   |   | 120 |   |   |
| Income (loss)  before cumulative effect of a change in accounting principle                   |       |                                                                                     | 83         |                      |       | (3,232                    | )          | 10,441                      |       |                        | (12,432    | ) |   |   | (11,011 | ) |   |
| Cumulative effect  of a change in accounting principle: goodwill impairment                        |       |                                                                                     | —     |                      |       | —                    |       | —                      |       |                        | —     |   |   |   | (34,600 | ) |   |
| Net income (loss)                                                                                  |       |                                                                                     | $          | 83                        |       |                      | $          | (3,232                      | )          | $                           | 10,441     |   |   | $ | (12.432 | ) |   |   | $ | (45,611 | ) |   |
| Net income (loss) per  share:                                                                      |       |                                                                                     |       |                      |       |                      |       |                        |       |                        |       |   |   |   |   |   |   |
| Basic                                                                                              |       |                                                                                     | $          | —                    |       |                      | $          | (0.17                       | )          | $                           | 0.62       |   |   | $ | (5.83 | ) |   |   | $ | — |   |   |
| Diluted                                                                                            |       |                                                                                     | $          | —                    |       |                      | $          | (0.17                       | )          | $                           | 0.62       |   |   | $ | (5.83 | ) |   |   | $ | — |   |   |
| Weighted average shares  outstanding:                                                              |       |                                                                                     |       |                      |       |                      |       |                        |       |                        |       |   |   |   |   |   |   |
| Basic                                                                                              |       |                                                                                     | 19,286     |                      |       | 19,230                    |       | 16,761                      |       |                        | 2,132      |   |   |   | — |   |   |
| Diluted                                                                                            |       |                                                                                     | 19,298     |                      |       | 19,230                    |       | 18,639                      |       |                        | 2,132      |   |   |   | — |   |   |

 

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| ** **                                            | ** ** | **December 31,  2006** | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** | **December 28,  2003** | ** ** | **December 29,  2002** | ** ** |
|-------------------------------------------------------|------------|-----------------------------|------------|---------------------------|------------|---------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                            | ** ** | **(in thousands)**     | ** ** |
| **Other Financial Data:**                             | ** ** |                        | ** ** | ** **                |       |                      | ** ** | ** **                  |       |                        | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Cash flow  provided by (used in) operating activities |       |                        | $          | 1,290                     | ** ** |                      |       | $                           | 1,314      | ** **                  |       |   | $ | 3,979 | ** ** |   |   | $ | (4,805 | ) |   |   | $ | 5,161 |   |   |
| Capital  expenditures                                 |       |                        | $          | 3,596                     | ** ** |                      |       | $                           | 8,144      | ** **                  |       |   | $ | 4,925 | ** ** |   |   | $ | 1,962 |   |   |   | $ | 1,027 |   |   |
| Depreciation and  amortization                        |       |                        | $          | 3,362                     | ** ** |                      |       | $                           | 3,141      | ** **                  |       |   | $ | 3,207 | ** ** |   |   | $ | 3,594 |   |   |   | $ | 3,445 |   |   |
| **Consolidated Balance Sheet  Data:**                 |       |                        |       | ** **                |       |                      |       | ** **                  |       |                        |       | ** ** |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                            |       |                        | $          | 8,881                     | ** ** |                      |       | $                           | 10,543     | ** **                  |       |   | $ | 14,585 | ** ** |   |   | $ | 4,887 |   |   |   | $ | 8,504 |   |   |
| Working capital                                       |       |                        | $          | 41,105                    | ** ** |                      |       | $                           | 40,655     | ** **                  |       |   | $ | 51,109 | ** ** |   |   | $ | 18,626 |   |   |   | $ | 15,585 |   |   |
| Total assets                                          |       |                        | $          | 96,893                    | ** ** |                      |       | $                           | 91,318     | ** **                  |       |   | $ | 99,812 | ** ** |   |   | $ | 77,215 |   |   |   | $ | 63,944 |   |   |
| Total debt                                            |       |                        | $          | 46,630                    | ** ** |                      |       | $                           | 46,630     | ** **                  |       |   | $ | 46,630 | ** ** |   |   | $ | 172,435 |   |   |   | $ | 157,972 |   |   |
| Stockholders’ equity  (deficit)                  |       |                        | $          | 15,875                    | ** ** |                      |       | $                           | 16,462     | ** **                  |       |   | $ | 22,134 | ** ** |   |   | $ | (129,968 | ) |   |   | $ | (119,611 | ) |   |

 

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**ITEM7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Overview**

This MD&A is providedas a supplement to, and should be read in conjunction with our consolidatedfinancial statements and the accompanying notes to the consolidated financialstatements (the “Notes”).

The Company adopted SAB108 at January 2, 2006. The result of the adoption is shown in Note 3. Thefollowing Management’s Discussion and Analysis (the “MD&A”) is intended tohelp the reader understand the consolidated results of operations and financialcondition of Cherokee International Corporation.

**Forward-looking statements**

Certain statements in thisAnnual Report on Form 10-K, other than purely historicalinformation, including estimates, projections, statements relating to ourbusiness plans, objectives and expected operating results, and the assumptionsupon which those statements are based, are “forward-looking statements” withinthe meaning of the Private Securities Litigation Reform Act of 1995, Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934. These forward-looking statements are based upon our currentexpectations about future events. When used in this Annual Report, the words “believes,”“projects,” “expects,” “anticipates,” “estimates,” “intends,” “strategy,” “plan,”“may,” “will,” “would,” “will be,” “will continue,” “will likely result,” andsimilar expressions, or the negative of such words and expressions, areintended to identify forward-looking statements, although not allforward-looking statements contain such words or expressions. Theseforward-looking statements generally relate to our plans, objectives andexpectations for future operations. However, these statements are subject to anumber of risks and uncertainties affecting our business. You should read thisAnnual Report completely and with the understanding that actual future resultsmay be materially different from what we expect as a result of these risks anduncertainties and other factors, which include, but are not limited to:  (1) the potential delisting of theCompany’s common stock from the Nasdaq Global Market, (2) changes ingeneral economic and business conditions, domestically and internationally, (3) reductionsin sales to, or the loss of, any of the Company’s significant customers or incustomer capacity generally, (4) the Company’s inability to realizeexpected cost savings by shifting production to its Shanghai facility, (5) changesin the Company’s sales mix to lower margin products, (6) increasedcompetition in the Company’s industry, (7) disruptions of the Company’sestablished supply channels, (8) the Company’s level of debt andrestrictions imposed by its debt agreements, and (9) the additional riskfactors identified in Part I, Item 1 of this document. Except as requiredby law, the Company undertakes no obligation to update any forward-lookingstatements, even though the Company’s situation may change in the future.

**Business**

We are a designer andmanufacturer of power supplies for OEMs. Our advanced power supplyproducts are typically custom designed into mid- to high-end commercialapplications in the computing and storage, wireless infrastructure, enterprisenetworking, telecom, medical and industrial markets.

We operate worldwide andhave facilities in Orange County, California; Bombay, India; Wavre, Belgium(Europe) and Shanghai, China. In August 2006, we announced our intentionto close our facility in Guadalajara, Mexico, and we ceased operations there inMarch 2007. We were founded in 1978 in Orange County, California. As weexpanded our business and customer base, we opened facilities in Bombay, India,Guadalajara, Mexico, and Shanghai, China. In June 2000, we acquiredCherokee Europe, which added a manufacturing facility in Wavre, Belgium to ourmanufacturing capacity and enabled us to better serve the European market.

We generate all of oursales in four market sectors, datacom, telecom, industrial and medical. For theyear ended December 31, 2006, our revenues by market sector consisted of43% datacom, 34% telecom, and 20% industrial and medical. Our 18.8% top linegrowth in revenues for the year were the result of 

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favorableeconomic conditions and increased customer demand for capital purchases ofhigh-end servers, storage, networking triple play and other end applications. Theseconditions have caused our revenues and operating income to improve over prioryears.

**Basis of Reporting**

***Net Sales***

We recognize revenue whenpersuasive evidence of an arrangement exists, title transfer has occurred, theprice is fixed or readily determinable, and collectibility is probable. Werecognize revenue in accordance with Staff Accounting Bulletin No. 104, *Revenue Recognition.*Salesare recorded net of discounts, which are estimated at the time of shipmentbased upon historical data. Changes in assumptions regarding the rate of salesdiscounts earned by our customers could impact our results.

We generally recognizerevenue at the time of shipment because this is the point at which revenue isearned and realizable and the earnings process is complete. For most shipments,title to shipped goods transfers at the shipping point, so the risks andrewards of ownership transfer once the product leaves our facility orthird-party hub. Revenue is only recognized when collectibility is reasonablyassured. Shipping and handling fees are included in revenue, with related costsrecorded to cost of sales.

***Cost of Sales***

The principal elementscomprising cost of sales are raw materials, labor and manufacturing overhead.Raw materials account for a large majority of our costs of sales. Raw materialsinclude magnetic sub-assemblies, sheet metal, electronic and other components,mechanical parts and electrical wires. Direct labor costs include costs of hourlyemployees. Manufacturing overhead includes salaries, and the direct expense andallocation of costs attributable to manufacturing for lease costs, depreciationon property, plant and equipment, utilities, property taxes and repairs andmaintenance.

***Operating Expenses***

Operating expenses includeengineering costs, selling and marketing costs and general and administrativeexpenses. Engineering costs primarily include salaries and benefits ofengineering personnel, safety approval and quality certification fees, anddepreciation on equipment and consulting and professional services. Selling andmarketing expenses primarily include salaries and benefits to account managersand commissions to independent sales representatives. Administrative expensesprimarily include salaries and benefits for certain management andadministrative personnel, professional fees and information system costs.Operating expenses also include the direct expense and allocation of costsattributable to these departments for lease costs, depreciation on property,plant and equipment, utilities, property taxes and repairs and maintenance.

***Restructuring Costs***

We record restructuringcharges in accordance with SFAS No. 146, *Accountingfor Costs Associated with Disposal Activities*, which requires that aliability for a cost associated with an exit or disposal activity be recognizedwhen the liability is incurred, in contrast to the date of an entity’scommitment to an exit plan. These charges included costs related to personnelseverance. Calculation of the restructuring reserves includes management’sjudgment regarding closed facilities, which include assumptions about thelength of time it will take to close the operation. Changes in these estimatesmay impact our operating results.

**Critical Accounting Policies**

We prepare ourconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States. As such, we are required to makecertain estimates, judgments and assumptions that we believe are reasonablebased upon the information currently available. These estimates and assumptionsaffect the reported amounts of assets and liabilities at the date of the 

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consolidatedfinancial statements and the reported amounts of revenues and expenses duringthe periods presented. Any future changes to these estimates and assumptionscould have a material effect on our reported amounts of revenue, expenses,assets and liabilities. The significant accounting policies that we believe arethe most critical to aid in fully understanding and evaluating our reportedfinancial results include the following:

***Revenue Recognition***

We recognize revenue fromproduct sales at the time of shipment and passage of title. We also offer ourcustomers the right to return products that do not function properly within alimited time after delivery. We monitor and track product returns and record aprovision for warranty based on historical experience, which has beeninsignificant to our financial condition and results of operations. Anysignificant increase in product failure rates could have a material adverseeffect on our operating results for the period or periods in which thosereturns materialize.

***Accounts Receivable***

We perform ongoing creditevaluations of our customers and adjust credit limits based upon paymenthistory, the customer’s current credit worthiness and various other factors, asdetermined by our review of their current credit information. We continuouslymonitor collections and payments from our customers and maintain a provisionfor estimated credit losses based upon our historical experience and anyspecific customer collection issues that we have identified. While creditlosses have historically been within our expectations and the provisionsestablished, we might not continue to experience the same credit loss ratesthat we have in the past. A significant portion of our accounts receivable areconcentrated in a small number of customers. A significant change in theliquidity or financial position of any one of these customers could have amaterial adverse effect on the collectibility of our accounts receivable, ourliquidity and our future operating results. As of December 31, 2006 and January 1,2006, our top ten customers accounted for approximately 41% and 45% of ouraccounts receivables, respectively.

***Inventories***

We value our inventory atthe lower of the actual cost to purchase and/or manufacture the inventory andthe current estimated market value of the inventory using the weighted averagecost method. We regularly review inventory quantities on hand and record aprovision for excess and obsolete inventory based primarily on our historicalusage data and estimates of future demand. Since substantially all of ourproducts are manufactured according to firm purchase orders and customerforecasts, we evaluate the potential of recovery from our customers whencustomized products approach end-of-life. Our customers are generally liablefor inventory costs we incur for order cancellations that occur after we havecommitted resources to procure or manufacture product. We also regularlyevaluate inventory that is non-compliant with the RoHS directive to determineif additional reserves are needed to cover for potential obsolescence. We havenot established a separate reserve for non-RoHS compliant inventory above whatour normal calculations would require.

Our industry ischaracterized by rapid technological change, frequent new product development,and rapid product obsolescence that could result in an increase in the amountof obsolete inventory quantities on hand. As demonstrated during the past fiveyears, demand for our products can fluctuate significantly. A significantincrease in the demand for our products could result in a short-term increasein the cost of inventory purchases while a significant decrease in demand couldresult in an increase in the amount of excess inventory quantities on hand. Inaddition, our estimates of future product demand may prove to be inaccurate, inwhich case we may have understated or overstated the provision required forexcess and obsolete inventory. In the future, if our inventory were determinedto be overvalued, we would be required to recognize additional expense in ourcost of sales at the time of such determination. Likewise, if our inventory isdetermined to be undervalued, we may have over reported our costs of sales inprevious periods and would be required to recognize additional operating incomeat the time such inventory is sold. 

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Therefore,although we make every reasonable effort to ensure the accuracy of ourestimates of future product demand, any significant unanticipated changes indemand or technological developments could have a material effect on the valueof our inventory and our reported operating results.

***Deferred Taxes***

We recognize deferred taxassets and liabilities based on the differences between the financial statementcarrying values and the tax bases of assets and liabilities. We regularlyreview our deferred tax assets for recoverability and establish a valuationallowance based on historical taxable income, projected future taxable income,and the expected timing of the reversals of existing temporary differences. Ifour future taxable income is significantly higher than expected and/or we areable to utilize our tax credits, we may be required to reverse all or asignificant part of our valuation allowance against such deferred tax assetswhich could substantially reduce our effective tax rate for such period.Therefore, any significant changes in statutory tax rates or the amount of ourvaluation allowance could have a material effect on the value of our deferredtax assets and liabilities and our reported financial results.

The preparation ofconsolidated financial statements in conformity with generally acceptedaccounting principles in the United States requires us to make estimates andassumptions that affect the reported amount of tax-related assets andliabilities and income tax provisions. The Company’s effective tax rate may besubject to fluctuations during the fiscal year as new information is obtainedwhich may affect the assumptions management uses to estimate the annualeffective tax rate including mix of pre-tax earnings in the various taxjurisdictions in which it operates.

We believe it we haveadequately provided for income tax issues not yet resolved with federal, stateand foreign tax authorities. We currently have an income tax contingencyrelated to our India operations. During the year ended December 28, 2003,we paid and expensed an income tax assessment of $0.4 million for three taxyears for which an unfavorable ruling was rendered by the Indian tax authority.In addition, we accrued a tax contingency reserve of $0.9 million in 2003 forpotential additional exposure on the same issue related to subsequent years forwhich an assessment had not been received. During the year ended January 1,2006, we received a favorable ruling on one of the three tax years upon ourappeal of this decision to the Indian Tribunal. Since the timing and the certaintyof the $0.4 million favorable ruling are not probable, we have determined torecognize any gain contingency as and when monies are received. For the yearended December 31, 2006, it was determined that $0.5 million of thecontingency reserve recorded was to be released given litigation settlementsduring 2006. The remaining balance of $0.4 million relates to open tax years.  We are currently undergoing an audit in theNetherlands. Based upon a consideration of all relevant facts andcircumstances, we do not believe the ultimate resolution will have a materiallyadverse effect upon our results of operations or financial condition.

United States income taxesare not provided on undistributed earnings from certain foreign subsidiaries. Thoseearnings are considered to be permanently re-invested in accordance with theAccounting Principles Board (APB) Opinion 23.

**Other Comprehensive Income**

Belgium taxes forunrealized foreign exchange gains on an intercompany loan consideredpermanently re-invested are provided for as a component of other comprehensiveincome. Foreign exchange gains were recognized as Belgium taxable income in2005 and 2006 from repayments of the loan. See further discussion in Note 3 tothe accompanying consolidated financial statements included in Item 8, “FinancialStatements and Supplementary Data.”

**Goodwill and Long Lived Assets**

We review therecoverability of the carrying value of goodwill on an annual basis or morefrequently when an event occurs or circumstances change to indicate that animpairment of goodwill has possibly 

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occurred.The determination of whether any potential impairment of goodwill exists isbased upon a comparison of the fair value of the reporting unit to theaccounting value of its net assets.

We also review the recoverabilityof the carrying value of long-lived assets whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Recoverability of these assets is determined based upon theforecasted undiscounted future net cash flows from the operations to which theassets relate, utilizing our best estimates, appropriate assumptions andprojections at the time. These projected future cash flows may varysignificantly over time as a result of increased competition, changes intechnology, fluctuations in demand, consolidation of our customers andreductions in average selling prices. If the carrying value is determined notto be recoverable from future operating cash flows, the asset would be deemedimpaired and an impairment loss would be recognized to the extent the carryingvalue exceeded the estimated fair market value of the asset.

**Results of Operations**

Thefollowing table sets forth selected items from our statements of operations asa percentage of our net sales for the periods indicated:

| ** **                         | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** | **January 2, 2005** | ** ** |
|------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|-------------------------------|------------|
| Net sales                          |       |                            | 100.0      | %                             |       |                          | 100.0      | % |   |   | 100.0 | % |   |
| Cost of sales                      |       |                            | 78.9       |                          |       |                          | 79.6       |   |   |   | 70.1 |   |   |
| Gross profit                       |       |                            | 21.1       |                          |       |                          | 20.4       |   |   |   | 29.9 |   |   |
| Operating  expenses                |       |                            | 19.4       |                          |       |                          | 20.2       |   |   |   | 17.5 |   |   |
| Operating income                   |       |                            | 1.7        |                          |       |                          | 0.2        |   |   |   | 12.4 |   |   |
| Interest expense                   |       |                            | (1.9       | )                             |       |                          | (2.3       | ) |   |   | (3.5 | ) |   |
| Other income, net                  |       |                            | 0.2        |                          |       |                          | 0.2        |   |   |   | — |   |   |
| Income (loss)  before income taxes |       |                            | —     |                          |       |                          | (1.9       | ) |   |   | 8.9 |   |   |
| Provision for  income taxes        |       |                            | (0.1       | )                             |       |                          | 0.7        |   |   |   | 1.9 |   |   |
| Net income (loss)                  |       |                            | 0.1        | %                             |       |                          | (2.6       | )% |   |   | 7.0 | % |   |

 

***Year Ended December 31,2006 Compared to Year Ended January 1, 2006***

*Net Sales*

Net sales increased byapproximately 18.8%, or $22.9 million, to $145.0 million for the yearended December 31, 2006 from $122.1 million for the year ended January 1,2006.

The increase in net saleswas primarily due to the increase in demand for products from a few of ourlarger customer programs in the telecom and datacom market segments. The growthin these two market sectors accounted for approximately 77.7%, or $17.8million, of the net sales increase in 2006 from 2005, with the remaining 22.3%increase is from the industrial and medical sectors. Revenues generated fromshipments to our top ten customers increased by $9.0 million over 2005, includinga $3.1 million increase in sales to one of our largest customers.

*Gross Profit*

Gross profit increased byapproximately 22.9%, or $5.7 million, to $30.6 million for the yearended December 31, 2006 from $24.9 million for the year ended January 1,2006. Gross margin for the year ended December 31, 2006 increased to 21.1%from 20.4% in the prior year.

The increase in grossprofit was due primarily to the increase in revenues and the resulting gain ofcontribution margin on those revenues, combined with a different product mixduring 2006. The increase in gross margin was due to lower labor cost from thetransitioning of production to our new China facilities, combined with afavorable change in product mix. This was offset by $0.7 million of increased

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transitioncost in factory labor and overhead related to the transitioning of productionfrom Mexico to our new China facilities and $0.3 million of additionalsurplus and obsolescence related to the Mexico move.

*Operating Expenses*

Operating expenses for theyear ended December 31, 2006 increased by $3.5 million, or 14.1%, to$28.1 million from $24.7 million for the year ended January 1,2006, $2.9 million of the increase in expenses was due to the impact ofinsurance proceeds received in 2005. Cherokee Europe was compensated for thereplacement value of assets destroyed in the 2004 fire.

In 2006 the Company incurred$1.0 million of operating costs related to severance and facility closurecosts related to the planned closure of our Mexico facility. The Companyincurred $0.7 million of stock compensation costs related to the adoption ofSFAS 123R during 2006. In addition, operating expenses in 2006 for ourShanghai, China facility increased by $0.3 million compared to 2005 due to theplant becoming fully operational in 2006. There were also $0.4 million oflegal and professional fees incurred to resolve the India unauthorized paymentissue discussed in Note 9—India Matter. Bonuses and commissions were$1.6 million higher in 2006 compared to 2005 because we achieved ourrevenue and financial performance targets for 2006, but not for 2005. In 2005we incurred $1.1 million of consulting and professional fees related toreadiness efforts for compliance with Section 404 of the Sarbanes-OxleyAct, compared to no costs during 2006. There was also a reduction of$1.0 million of sales and general administrative costs in Europe during2006. In addition, we incurred $0.5 million of redundant selling andgeneral administrative costs from the closure of our Mexico facility. Thecumulative increase in operating expense was partially offset by a decrease of$1.7 million to our Cherokee Europe employee long service award plan liabilitydue to a Belgium regulatory law change in the carrying amount of the reserve onthe statutory balance sheet.

*Operating Income*

As a result of the factorsdiscussed above, operating income increased by 925%, or $2.2 million, to$2.4 million for the year ended December 31, 2006 from$0.2 million for the year ended January 1, 2006. Operating marginincreased to 1.7% from 0.2% in the prior year.

*Income Taxes*

The provision for incometaxes for the year ended December 31, 2006 decreased by $1.0 million to a$(0.1) million benefit, compared to a $0.9 million in expense for the yearended January 1, 2006.

The decrease in theprovision for income taxes from 2005 was due largely to the decrease in incomebefore income taxes for entities with out net operating loss carry-forwards andthe release of a tax contingency reserve related to India. Entities with netoperating loss carry-forwards in 2005 continued to generate net operating lossesin 2006. The valuation allowance on our deferred tax assets for the year ended December 31,2006 decreased by $2.0 million to $54.6 million, compared to $56.6 million forthe year ended January 1, 2006.

Provision for income taxesfor the year ended December 31, 2006 and January 1, 2006 wascalculated separately by each of the tax jurisdictions within the relevantcountry of operation. In spite of our overall loss for the year, some of ourdivisions generated taxable income for the year. For the years ended January 1,2006 and December 31, 2006, one of the division’s taxable income wasoffset with net operating losses (NOL’s) that carried forward, while otherdivisions had no NOL’s to offset their income for the year, and therefore,taxes were owed.

Our China operation is notsubject to taxes for five years beginning in 2008 due to a tax holiday.

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See the further discussionof the income tax provision and net operating loss carry-forwards in Note 14to the accompanying consolidated financial statements included in Item 8, “FinancialStatements and Supplementary Data.”.

*Net Income (Loss)*

As a result of the factorsdiscussed above, we recorded net income of $0.1 million for the year ended December 31,2006, compared to net loss of $3.2 million for the year ended January 1,2006.

***Year Ended January 1,2006 Compared to Year Ended January 2, 2005***

*Net Sales*

Net sales decreased byapproximately 17.8% or $26.4 million, to $122.1 million for the yearended January 1, 2006 from $148.5 million for the year ended January 2,2005.

The decrease in net saleswas primarily due to the reduction in demand for products from a few of ourlarger programs in the telecom and datacom market segments. The majority of thedecline in sales was related to the net decrease in sales to some of ourlargest customers for the year ended January 1, 2006. Revenues generatedfrom shipments to our top ten customers declined by $13.8 million, including a$12.6 million decrease in sales to one of our largest customers, from theyear ended January 2, 2005. These decreases have occurred as revenues fromolder programs decline and are replaced by growing revenues from new programsover time. Also contributing to the decrease from the year ended January 2,2005 were the effects of material shortages and the transition of certaincustomer programs to consignment hub arrangements. Revenue recognition onshipments to the consignment hubs is delayed until the customer pulls theproduct from the hub for their production requirements. A slightly stronger Eurofor the year ended January 1, 2006 offset the revenue decrease byapproximately $0.3 million.

*Gross Profit*

Gross profit decreased byapproximately 43.9% or $19.5 million, to $24.9 million for the yearended January 1, 2006 from $44.4 million for the year ended January 2,2005. Gross margin for the year ended January 1, 2006 decreased to 20.4%from 29.9% in the prior year.

The decrease in grossprofit was due primarily to the decrease in revenues and the resulting loss ofcontribution margin on those revenues, combined with a different product mixduring 2005 that included programs with higher material contents than the prioryear. The decrease in gross margin was due primarily to higher labor andoverhead costs as a percentage of net sales resulting from the lower revenuelevel, combined with the change in product mix.

*Operating Expenses*

Operating expenses for theyear ended December 31, 2005 decreased by $1.2 million, or 4.6%, to$24.7 million from $25.9 million for the year ended December 31,2004. The decrease was due to the $2.9 million insurance proceeds werereceived during the year ended January 1, 2006, to compensate us for thereplacement value of the Belgium, Europe assets destroyed in the 2004 fire. Thetotal recoveries of $6.7 million resulted in a $2.9 million gain reportedduring the year ended January 1, 2006. As of January 1, 2006 theCompany has been reimbursed for the values of the damaged property.

Operating expenses relatedto general and administrative salaries, benefits, professional fees andexpenses were higher during the year ended January 1, 2006 compared to theyear ended January 2, 2004 due to costs associated with being a publiccompany and the readiness efforts for compliance with Section 404 of theSarbanes-Oxley Act, even though the Company was not required to comply with Section 404of the Sarbanes-Oxley Act during the year ended January 1, 2006 because ofmarket cap. The Company anticipates being compliant with all sections of thelegislation when it is required. In addition, we recognized $0.4 millionoperating expenses during the year ended January 1, 2006 related to ournew Shanghai, China Facility.

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*Stock CompensationExpense*

There was no stock compensation expense for the yearended January 1, 2006 compared to $0.2 million for the year endedJanuary 2, 2005. In 2004, we recorded stock compensation expense of $0.2 millionprimarily in connection with the retirement of our former Chairman of theBoard, and the acceleration of the vesting of his unvested options. He wasawarded additional stock compensation as a result of an arbitration proceeding;however, the cost of the award, including legal expenses, was paid by anunrelated third party and not by Cherokee. As a result no additional stockcharge was recognized on our books.

*Operating Income*

As a result of the factorsdiscussed above, operating income decreased by 98.7%, or $18.2 million, to$0.2 million for the year ended January 1, 2006 from$18.4 million for the year ended January 2, 2005. Operating margindecreased to 0.2% from 12.4% in the prior year.

*Interest Expense*

Interest expense for theyear ended January 1, 2006 was $2.9 million compared to$5.2 million for the year ended January 2, 2005. The $2.3 milliondecrease in interest expense was due to the repayment of debt and conversion toequity of our senior convertible notes in connection with our initial publicoffering.

*Other Income, Net*

Other income, net, for theyear ended January 1, 2006 was income of $0.3 million compared to incomeof $0.5 million for the year ended January 2, 2005.

*Income Taxes*

The provision for income taxes for the year ended January 1,2006 decreased by $1.9 million to $0.9 million, compared to$2.8 million for the year ended January 1, 2005.

The decrease in the provision for income taxes fromthe year ended January 2, 2005 was due largely to the decrease in income(loss) before income taxes; we incurred a loss before income taxes for the yearended January 1, 2006 compared to income at January 2, 2005. Thevaluation allowance on our deferred tax assets for the year ended January 1,2006 increased by $2.5 million to $56.6 million, compared to $54.1 millionfor the year ended January 2, 2005.

Provision for income taxes for the twelve months endedJanuary 1, 2006 and January 2, 2005 was calculated separately by eachtax jurisdictions within the related country of business. In spite of theCompany’s overall loss for the year ended January 1, 2006, some of ourdivisions generated income for the year. For the year ended January 1,2006, one of the division’s income was offset with net operating losses (NOL’s)that carried forward. The other divisions had no NOL’s to offset their incomefor the year, therefore, taxes were applied.

See further discussion ofthe income tax provision and net operating loss carry-forwards in Note 14 tothe accompanying consolidated financial statements included in Item 8, “FinancialStatements and Supplementary Data.”

*Net Income (Loss)*

As a result of the factorsdiscussed above, we recorded net loss of $3.2 million for the year ended January 1,2006, compared to net income of $10.4 million for the year ended January 2,2005.

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**Liquidity andCapital Resources**

***Cash Flows***

***Year Ended December 31, 2006 Compared to YearEnded January 1, 2006***

Net cash provided by operating activities was $1.3million for the year ended December 31, 2006, and January 1, 2006,respectively. In fiscal year 2006, net income was $3.3 million higher as aresult of our 18.8% sales growth. Consequently, compared to fiscal year 2005,accounts receivable was up $2.6 million, inventories up $1.4 million and othercurrent assets up $0.9 million to support this sales growth. However, accruedcompensation related liabilities were also $3.2 million higher, of which $0.7million was from stock-based compensation accounting related to SFAS 123R,first adopted in fiscal year 2006., and $2.4 million mainly from anincrease in commission and bonus plan liabilities as of December 31, 2006.Finally, the change in Belgium law related to long term employment liabilitiescaused long-term liabilities to decrease by $1.7 million in 2006.

Net cash used in investing activities for the yearended December 31, 2006 was $3.6 million compared to net cash used ininvesting activities of $3.9 million for the year ended January 1, 2006.While the net amounts are basically flat year to year, the investing activitiesfor each period relate to our China facility. In 2005, we incurred $8.1 millionin capital expenditures. In 2006, our capital expenditures dropped to $3.6 million.Most of the $4.5 million decrease was a result of reduced capital expendituresfor China. The year ended January 1, 2006, also included net sales ofshort-term investments of $4.2 million to help finance the purchase ofmanufacturing equipment, construction-in-progress in China, and leaseholdimprovements. In 2006, we did not sell any short-term investments.

Net cash used in financingactivities was $0.2 million for the year ended December 31, 2006, and January 1,2006, respectively. The $0.2 million during both years was related to the netproceeds from the sale of common stock through our Employee Stock PurchasePlan.

***Liquidity***

We expect our liquidity requirements will be primarilyfor working capital and capital expenditures. As of December 31, 2006, wehad cash and cash equivalents of $8.9 million, working capital of$41.1 million, no outstanding borrowings under our main revolving creditfacility and borrowing base availability of $15.8 million under the samefacility. Historically, we have financed our operations with cash fromoperations supplemented by borrowings from credit facilities and debt andequity issuances. Besides our credit line in the United States, Cherokee Europealso maintains a working capital line of credit of approximately $4.0 millionwith Bank Brussels Lambert, a subsidiary of INGBelgie NV, a bank in Brussels,which is denominated in Euros, and is collateralized by a pledge in first andsecond rank over a specific amount of business assets. The facility requiresCherokee Europe to maintain a certain solvency ratio and is cancelable at anytime. As of December 31, 2006, we had no outstanding borrowings under thefacility.

In January 2007, we opened a loan contract thatwould serve as a credit facility with the Industrial and Commercial Bank ofChina Ltd., or ICBC. Pursuant to the contract, ICBC will advance up to theequivalent of approximately $3.0 million, expressed as RMB 25.0 million. Theline is collateralized by the Company’s building in Shanghai, China. Interestis payable monthly at a variable rate as announced by the People’s Bank ofChina, which was 6.55% at January 29, 2007. This facility is intended forworking capital requirements in China, especially as our China operations buildinventory for export to the United States and Europe and incur value-added taxon local purchases that can only be recovered through in-country sales of ourproduct.

We believe these amounts, together with cash flow fromoperations and our credit lines in the United States, Europe and China, aresufficient to meet our cash requirements for at least the next twelve months.

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The years ended December 31, 2006 and January 1,2006, were unusual in that we financed the building, capital expenditures andstart-up working capital requirements of our new Shanghai facility entirelyfrom internally generated cash. Our ongoing current and future liquidity needsprimarily arise from working capital requirements and capital expenditures thathave now returned to comparable historical levels with the completion of ourplant in China. Our historical capital expenditures have primarily resultedfrom investments in equipment to increase or replace manufacturing capacity andto improve manufacturing efficiencies.

For 2007, we expect global capital expenditures to beapproximately $2.9 million, which will relate primarily to our investments inmanufacturing equipment at our facilities of which $1.7 million will be for ourShanghai, China facility. Our required capital investment in China isdecreasing rapidly. In 2006 our China facility required $3.0 million, or almosttwice what we expect to spend in 2007. In 2005, starting our China facilityrequired $5.5 million, or over three times the anticipated spending for 2007.

As of December 31,2006, we had approximately $46.6 million of senior notes bearing an annualinterest rate of 5.25%, payable semi-annually. These notes become due on November 1,2008. Our plan for 2007 through 2009 projects that we will have adequate cash flowto support refinancing these notes at current market rates. Based onpreliminary discussions with third parties, management is optimistic thatseveral viable solutions will be available to the Company for satisfying thisobligation on or before its stated maturity date.

***Contractual Obligations***

As of December 31, 2006, our borrowingsconsisted of approximately $46.6 million of senior notes bearing interest at5.25% annually, and no outstanding borrowings under our revolving creditfacility. We are required to make semi-annual interest payments to holders ofthe senior notes.

We have operating lease obligations relating to ourfacilities in Tustin and Irvine, California, and Bombay, India.

We have purchase commitments primarily with vendorsand suppliers for the purchase of inventory and for other goods, services, andequipment as part of the normal course of business. These commitments aregenerally evidenced by purchase orders that may or may not include cancellationprovisions. Based on current expectations, we do not believe that anycancellation penalties we incur under these obligations would have a materialadverse effect on our financial condition or results of operations.

Thematurities of our long-term debt, including capital leases, and future paymentsrelating to our operating leases and other obligations as of December 31,2006 are as follows (in thousands):

| **Contractual Obligations**                           | ** ** | ** ** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|------------------------------------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Long-term debt                                             |       | $          | —     |     | $          | 46,630   |       | $        | —     |     | $          | —   |       | $              | —     |      |       | $ | — |   |   | $ | 46,630 |   |
| Operating leases                                           |       | 1,623      |       | 1,634    |       | 592      |       | 30       |       | 20       |       |     | 112        |           |       | 4,011     |       |
| Purchase order commitments                                 |       | 18,801     |       | —   |       | —   |       | —   |       | —   |       |     | —     |           |       | 18,801    |       |
| 1999 Europe restructuring                                  |       | 190        |       | 146      |       | 292      |       | 48       |       | —   |       |     | —     |           |       | 676       |       |
| 2003 Europe restructuring                                  |       | 260        |       | 232      |       | 226      |       | 208      |       | 170      |       |     | 325        |           |       | 1,421     |       |
| Long service award                                         |       | 23         |       | 48       |       | 94       |       | 182      |       | 20       |       |     | 451        |           |       | 818       |       |
| Deferred compensation                                      |       | —     |       | —   |       | —   |       | —   |       | —   |       |     | 1,105      |           |       | 1,105     |       |
| Advances for research and development                      |       | 100        |       | 58       |       | 54       |       | 55       |       | 55       |       |     | 275        |           |       | 597       |       |
| Severances and bonuses related to Mexico facility  closure |       | 429        |       | —   |       | —   |       | —   |       | —   |       |     | —     |           |       | 429       |       |
| Total                                                      |       | $          | 21,426     |     | $          | 48,748   |       | $        | 1,258      |     | $          | 523      |       | $              | 265        |      |       | $ | 2,268 |   |   | $ | 74,488 |   |

 

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The long-term liability for accrued pension costsincluded on the consolidated balance sheet is excluded from the table above.Cherokee is unable to estimate the timing of payments for these costs. Cherokeeanticipates making non-U.S. pension contributions of $250,000 in 2007.

Long-term debt includes our senior notes, which matureon November 1, 2008. Interest on the senior notes is payable in cash on May 1and November 1 of each year. The senior notes are secured by asecond-priority lien on substantially all of our domestic assets and by apledge of 65% of the equity of certain of our foreign subsidiaries.

In connection with our initial public offering, weamended our existing senior revolving credit facility with General ElectricCapital Corporation (as amended, the “Credit Facility”). The Credit Facilityprovides for borrowings of up to $20.0 million, subject to a borrowing basecomprised of eligible accounts receivables and inventory, which was $15.8million at December 31, 2006. We plan to use funds available under the CreditFacility to finance working capital and other cash requirements as needed. TheCredit Facility matures in August 2008 and bears interest, at our option,at a rate per annum equal to LIBOR plus 2.5% or the agent bank’s base rate plus1.0%. In addition to paying interest on outstanding principal, we are requiredto pay a commitment fee to the lenders under the Credit Facility in respect ofthe average daily balance of the unused loan commitment at a rate of 0.5% perannum. The Credit Facility is our senior obligation and ranks equal in right ofpayment with our existing and future permitted senior debt (including oursenior notes), and senior in right of payment to our future permittedsubordinated debt. The Credit Facility is secured by a first-priority lien,subject to permitted encumbrances, on substantially all of our domestic assetsand by a pledge of 65% of the equity of certain of our foreign subsidiaries.

The agreements governing the Credit Facility and oursenior notes contain covenants that restrict our business operations, includingcovenants limiting our ability to make investments, enter into mergers oracquisitions, dispose of assets, incur additional debt, grant liens, enter intotransactions with affiliates, redeem or repurchase our capital stock, repayother debt and pay dividends, and contains a financial ratio test based onsenior leverage. They also contain customary events of default, includingdefaults in the payment of principal or interest, defaults in the compliancewith the covenants contained in the agreements governing our debt, crossdefaults to other material debt and bankruptcy or other insolvency events.

Cherokee Europe maintains a working capital line ofcredit of approximately $4.0 million with Bank Brussels Lambert, a subsidiaryof INGBelgie NV, a bank in Brussels, which is denominated in Euros,collateralized by a pledge in first and second rank over a specific amount ofbusiness assets, requires Cherokee Europe to maintain a certain specificminimum solvency ratio and is cancelable at any time. As of December 31,2006, Cherokee Europe had no outstanding borrowings under the line of credit.

As of December 31, 2006, we were in compliancewith all of the covenants set forth in the principal agreements governing ourdebt, except for the submittal of our annual audited financial statements tothe Credit Facility within 120 days of our fiscal year end. We have been incommunications with GE Capital Corporation and consummated a waiver agreementwith them effective May 10, 2007. This agreement extends our submittaldeadline of our audited financial statements until August 31, 2007. TheCompany will submit the audited financial statements the day we file this Form 10-K.

Based on our presentexpectations, we believe that our existing cash and cash equivalents, workingcapital and available borrowing capacity at December 31, 2006 will besufficient to meet our anticipated cash requirements for the next twelvemonths, including operating requirements, contractual obligations, plannedcapital expenditures and debt service.

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**Inflation**

We do not believe thatinflation has had a material impact on our financial position or results ofoperations.

**New AccountingPronouncements**

Information regardingnewly issued accounting pronouncements is contained in Note 3 to ourconsolidated financial statements included elsewhere in this report (see Item8, “Financial Statements and Supplementary Data.”)

**Quarterly FinancialData**

**QuarterlyFinancial Data For TheYears ended December 31, 2006 and January 1, 2006 By Quarters(unaudited)(in thousands, except per share amounts)**

| ** **                                | ** ** | **December 31, 2006,  Quarter Ended,** | ** ** | **January 1, 2006,  Quarter Ended,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                | ** ** | **Apr. 2**                                       | ** ** | **Jul. 2**                                     | ** ** | **Oct. 1** | ** ** | **Dec. 31** | ** ** | **Apr. 3** | ** ** | **Jul. 3** | ** ** | **Oct. 2** | ** ** | **Jan. 1** | ** ** |
| Net sales                                 |       | $                                                     | 36,097     |                                                | $          | 38,314 |   | $ | 33,051 |   | $ | 37,566 |   | $ | 32,010 |   | $ | 30,992 |   | $ | 26,418 |   | $ | 32,659 |   |
| Gross profit                              |       | 8,516                                                 |       | 8,135                                               |       | 6,375 |   | 7,563 |   | 7,642 |   | 6,312 |   | 4,665 |   | 6,279 |   |
| Operating income  (loss)                  |       | 1,879                                                 |       | 1,044                                               |       | (959 | ) | 487 |   | 2,594 |   | (1,034 | ) | (1,642 | ) | 321 |   |
| Net income (loss)                         |       | 827                                                   |       | 352                                                 |       | (1,374 | ) | 278 |   | 625 |   | (1,773 | ) | (2,162 | ) | 78 |   |
| Basic net income  (loss) per share        |       | $                                                     | 0.04       |                                                | $          | 0.02 |   | $ | (0.07 | ) | $ | 0.01 |   | $ | 0.03 |   | $ | (0.09 | ) | $ | (0.11 | ) | $ | 0.00 |   |
| Diluted net  income (loss) per share |       | $                                                     | 0.04       |                                                | $          | 0.02 |   | $ | (0.07 | ) | $ | 0.01 |   | $ | 0.03 |   | $ | (0.09 | ) | $ | (0.11 | ) | $ | 0.00 |   |

 

| ** **               | ** ** | **December 31, 2006,  Quarter Ended,** | ** ** | **January 1, 2006,  Quarter Ended,** | ** ** |
|--------------------------|------------|-------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **Apr. 2**                                       | ** ** | **Jul. 2**                                     | ** ** | **Oct. 1** | ** ** | **Dec. 31** | ** ** | **Apr. 3** | ** ** | **Jul. 3** | ** ** | **Oct. 2** | ** ** | **Jan. 1** | ** ** |
| Net sales                |       | 100.0                                                 | %          | 100.0                                               | %          | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % |
| Gross profit             |       | 23.6                                                  |       | 21.2                                                |       | 19.3 |   | 20.1 |   | 23.9 |   | 20.4 |   | 17.7 |   | 19.2 |   |
| Operating income  (loss) |       | 5.2                                                   |       | 2.7                                                 |       | (2.9 | ) | 1.3 |   | 8.1 |   | (3.3 | ) | (6.2 | ) | 1.0 |   |
| Net income (loss)        |       | 2.3                                                   |       | 0.9                                                 |       | (4.2 | ) | 0.7 |   | 2.0 |   | (5.7 | ) | (8.2 | ) | 0.2 |   |

 

**ITEM 7A.**        QUANTITATIVE ANDQUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk relating to our operations results primarilyfrom changes in foreign currency exchange rates and short-term interest rates.We did not have any derivative financial instruments at December 31, 2006.

We had no variable rate debt outstanding at December 31,2006. However, any debt we incur under the Credit Facility and the CherokeeEurope line of credit will bear interest at a variable rate. We cannot predictmarket fluctuations in interest rates and their impact on any variable ratedebt we may incur in the future, nor can there be any assurance that fixed ratelong-term debt will be available to us at favorable rates, if at all.

The functional currencyfor our European operations is the Euro. We are, therefore, subject to acertain degree of market risk associated with changes in foreign currencyexchange rates. This risk is mitigated by the fact that our revenues andexpenses are generally both transacted in Euros, thereby reducing the risk offoreign currency fluctuation on our European operations. The effect of foreign 

36

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currencyexchange rate fluctuations on our operating results as of and for the yearended December 31, 2006, was not material. Historically, we have notactively engaged in exchange rate-hedging activities.

**ITEM8.**                FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA

|                                                                                                                                                                                                   | ** ** | **Page** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm                                                                                                                                          |       |     | 38         |   |   |
| Report of Independent Registered Public Accounting  Firm                                                                                                                                          |       |     | 39         |   |   |
| Consolidated  Balance Sheets as of December 31, 2006 and January 1, 2006                                                                                                                |       |     | 40         |   |   |
| Consolidated Statements of Operations for the years  ended December 31, 2006, January 1, 2006 and January 2,  2005                                                            |       |     | 41         |   |   |
| Consolidated Statements of Stockholders’ Equity  (Deficit) and Comprehensive Operations for the years ended  December 31, 2006, January 1, 2006 and January 2, 2005 |       |     | 42         |   |   |
| Consolidated Statements of Cash Flows for the years  ended December 31, 2006, January 1, 2006 and January 2,  2005                                                            |       |     | 43         |   |   |
| Notes to Consolidated Financial Statements                                                                                                                                                        |       |     | 44         |   |   |
| Schedule II: Valuation and Qualifying Accounts                                                                                                                                                    |       |     | 71         |   |   |

 

37

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders

**CherokeeInternational Corporation**

We have audited the accompanying consolidated balancesheet of Cherokee International Corporation and subsidiaries (the Company) asof December 31, 2006 and the related consolidated statements ofoperations, stockholders’ equity (deficit) and comprehensive operations, andcash flows for the year then ended. These consolidated financial statements arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these consolidated financial statements based on ouraudit.

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (UnitedStates).  Those standards require that weplan and perform the audit to obtain reasonable assurance about whether theconsolidated financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts and disclosuresin the consolidated financial statements. An audit also includes assessing the accounting principles used andsignificant estimates made by management, as well as evaluating the overallfinancial statement presentation.  Webelieve that our audit provides a reasonable basis for our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects, the financialposition of Cherokee International Corporation and subsidiaries as ofDecember 31, 2006, and the results of their operations and their cashflows for the year then ended in conformity with U.S. generally acceptedaccounting principles.

As discussed in Note 3 tothe consolidated financial statements, the Company changed its method of accountingfor stock-based compensation and its method of quantifying errors effectiveJanuary 2, 2006.

/s/ MAYER HOFFMAN MCCANN P.C.

MAYER HOFFMAN MCCANN P.C.

Orange County, CaliforniaMay 21,  2007

38

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors ofCherokee International CorporationTustin, California

We have audited the accompanying consolidated balancesheet of Cherokee International Corporation and subsidiaries (the Company) asof January 1, 2006, and the related consolidated statements of operations,stockholders’ equity (deficit) and comprehensive operations, and cash flows foreach of the years ended January 1, 2006 and January 2, 2005. Our audits alsoincluded the financial statement schedule as of and for the years ended January1, 2006 and January 2, 2005 listed in the Index at Item 15(a)(2). Thesefinancial statements and the financial statement schedule are theresponsibility of the Company’s management. Our responsibility is to express anopinion on these financial statements and the financial statement schedulebased on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The Company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances butnot for the purpose of expressing an opinion on the effectiveness of theCompany’s internal control over financial reporting. Accordingly, we express nosuch opinion. An audit also includes examining, on a test basis, evidencesupporting the amounts and disclosures in the financial statements, assessingthe accounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In our opinion, suchconsolidated financial statements present fairly, in all material respects, thefinancial position of Cherokee International Corporation and subsidiaries as ofJanuary 1, 2006, and the results of their operations and their cash flows foreach of the years ended January 1, 2006 and January 2, 2005, in conformity withaccounting principles generally accepted in the United States of America. Also,in our opinion, such financial statement schedule, when considered in relationto the basic consolidated financial statements taken as a whole, presentsfairly, in all material respects, the information set forth therein.

/s/ DELOITTE & TOUCHE LLP

Costa Mesa, California

April 17, 2006

39

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**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(In Thousands, Except Share and Per Share Amounts)**
|                                                                                                                                                                                                     | ** ** | **December 31,  2006** | ** ** | **January 1,  2006** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------|------------|
| **ASSETS**                                                                                                                                                                                          | ** ** |                        | ** ** | ** **                |       | ** ** | ** ** |
| **CURRENT ASSETS:**                                                                                                                                                                                 | ** ** |                        | ** ** | ** **                |       | ** ** | ** ** |
| Cash and cash  equivalents                                                                                                                                                                          |       |                        | $          | 8,881                     | ** ** |   | $ | 10,543 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $292 and $360  at December 31, 2006 and January 1, 2006, respectively                                                     |       |                        | 27,403     | ** **                |       | 24,999 |   |
| Inventories, net                                                                                                                                                                                    |       |                        | 29,991     | ** **                |       | 26,851 |   |
| Prepaid expenses  and other current assets                                                                                                                                                          |       |                        | 2,503      | ** **                |       | 1,679 |   |
| Deferred income  taxes                                                                                                                                                                              |       |                        | —     | ** **                |       | 19 |   |
| Total current assets                                                                                                                                                                                |       |                        | 68,778     | ** **                |       | 64,091 |   |
| Property and equipment, net                                                                                                                                                                         |       |                        | 19,888     | ** **                |       | 19,268 |   |
| Deposits and  other assets                                                                                                                                                                          |       |                        | 1,376      | ** **                |       | 1,296 |   |
| Deferred  financing costs, net of accumulated amortization of $364 and $234  at December 31, 2006 and January 1, 2006, respectively                                                       |       |                        | 216        | ** **                |       | 346 |   |
| Deferred income  taxes-long-term portion                                                                                                                                                            |       |                        | 318        | ** **                |       | — |   |
| Goodwill                                                                                                                                                                                            |       |                        | 6,317      | ** **                |       | 6,317 |   |
| Total Assets                                                                                                                                                                                        |       |                        | $          | 96,893                    | ** ** |   | $ | 91,318 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                                                                                            | ** ** |                        | ** ** | ** **                |       | ** ** | ** ** |
| **CURRENT LIABILITIES:**                                                                                                                                                                            | ** ** |                        | ** ** | ** **                |       | ** ** | ** ** |
| Accounts payable                                                                                                                                                                                    |       |                        | $          | 13,944                    | ** ** |   | $ | 11,658 |   |
| Accrued  liabilities                                                                                                                                                                                |       |                        | 4,968      | ** **                |       | 6,028 |   |
| Accrued  compensation and benefits                                                                                                                                                                  |       |                        | 7,882      | ** **                |       | 5,326 |   |
| Accrued  restructuring costs                                                                                                                                                                        |       |                        | 879        | ** **                |       | 424 |   |
| Total current liabilities                                                                                                                                                                           |       |                        | 27,673     | ** **                |       | 23,436 |   |
| Long-term debt                                                                                                                                                                                      |       |                        | 24,485     | ** **                |       | 24,485 |   |
| Long-term debt  payable to affiliates                                                                                                                                                               |       |                        | 22,145     | ** **                |       | 22,145 |   |
| Total long-term debt                                                                                                                                                                                |       |                        | 46,630     | ** **                |       | 46,630 |   |
| Other long-term liabilities                                                                                                                                                                         |       |                        | 6,715      | ** **                |       | 4,790 |   |
| Total Liabilities                                                                                                                                                                                   |       |                        | 81,018     | ** **                |       | 74,856 |   |
| Commitments and  contingencies (Note 9)                                                                                                                                                             |       |                        |       | ** **                |       |   |   |
| **STOCKHOLDERS’  EQUITY (DEFICIT):**                                                                                                                                                           | ** ** |                        | ** ** | ** **                |       | ** ** | ** ** |
| Common stock:  $0.001 par value; 60,000,000 shares authorized; 19,337,709  and 19,259,612 shares issued and outstanding at December 31,  2006 and January 1, 2006, respectively |       |                        | 19         | ** **                |       | 19 |   |
| Paid-in capital                                                                                                                                                                                     |       |                        | 184,813    | ** **                |       | 183,871 |   |
| Accumulated  deficit                                                                                                                                                                                |       |                        | (169,373)  | ** **                |       | (168,898) |   |
| Accumulated other  comprehensive income (loss)                                                                                                                                                      |       |                        | 416        | ** **                |       | 1,470 |   |
| Total stockholders’ equity (deficit)                                                                                                                                                           |       |                        | 15,875     | ** **                |       | 16,462 |   |
| Total Liabilities and  Stockholders’ Equity (Deficit)                                                                                                                                          |       |                        | $          | 96,893                    | ** ** |   | $ | 91,318 |   |

 

See notes to consolidated financial statements.

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**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF OPERATIONS(In Thousands, Except Per Share Amounts)**
|                                                                                                       | ** ** | **Years Ended**        | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                            | ** ** | **December 31,  2006** | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** |
| Net sales                                                                                             |       |                        | $          | 145,028 |   |   | $ | 122,079 |   | $ | 148,511 |   |
| Cost of sales  (including stock compensation expense of $79, $0 and $0, respectively)                 |       |                        | 114,439    |   |   | 97,181 |   | 104,140 |   |
| Gross profit                                                                                          |       |                        | 30,589     |   |   | 24,898 |   | 44,371 |   |
| Operating Expenses:                                                                                   |       |                        |       |   |   |   |   |   |   |
| Engineering and development (including stock compensation  expense of $205, $0 and $0, respectively)  |       |                        | 9,504      |   |   | 8,981 |   | 9,082 |   |
| Selling and marketing (including stock compensation  expense of $117, $0 and $0, respectively)        |       |                        | 6,887      |   |   | 7,280 |   | 7,896 |   |
| General and administrative (including stock  compensation expense of $329, $0 and $243, respectively) |       |                        | 12,483     |   |   | 11,296 |   | 8,969 |   |
| Restructuring costs                                                                                   |       |                        | 697        |   |   | — |   | — |   |
| Asset impairment                                                                                      |       |                        | 285        |   |   | — |   | — |   |
| Long term employment liabilities reduction                                                            |       |                        | (1,718     | ) |   | — |   | — |   |
| Gain from insurance proceeds                                                                          |       |                        | —     |   |   | (2,898 | ) | — |   |
| Total operating expenses                                                                              |       |                        | 28,138     |   |   | 24,659 |   | 25,947 |   |
| Operating income                                                                                      |       |                        | 2,451      |   |   | 239 |   | 18,424 |   |
| Interest expense                                                                                      |       |                        | (2,786     | ) |   | (2,852 | ) | (5,234 | ) |
| Other income, net                                                                                     |       |                        | 335        |   |   | 258 |   | 47 |   |
| Income (loss)  before income taxes                                                                    |       |                        | —     |   |   | (2,355 | ) | 13,237 |   |
| Provision (benefit) for income taxes                                                                  |       |                        | (83        | ) |   | 877 |   | 2,796 |   |
| Net income (loss)                                                                                     |       |                        | $          | 83 |   |   | $ | (3,232 | ) | $ | 10,441 |   |
| Net income (loss) per  share:                                                                         |       |                        |       |   |   |   |   |   |   |
| Basic                                                                                                 |       |                        | $          | — |   |   | $ | (0.17 | ) | $ | 0.62 |   |
| Diluted                                                                                               |       |                        | $          | — |   |   | $ | (0.17 | ) | $ | 0.62 |   |
| Weighted average shares  outstanding:                                                                 |       |                        |       |   |   |   |   |   |   |
| Basic                                                                                                 |       |                        | 19,286     |   |   | 19,230 |   | 16,761 |   |
| Diluted                                                                                               |       |                        | 19,298     |   |   | 19,230 |   | 18,639 |   |

 

See notes to consolidated financial statements.

41

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**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) AND COMPREHENSIVEOPERATIONS(In Thousands, Except Shares)**
|                                                                                      | ** ** | **Common Stock** | ** ** | **Additional  Paid-In** | ** ** | **Accumulated** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | ** **             | ** ** |
|--------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|-----------------|------------|---------------------------------------|------------|------------------------|------------|
| ** **                                                                           | ** ** | **Shares**            | ** ** | **Amount**              | ** ** | **Capital**     | ** ** | **Deficit**                           | ** ** | **Income (Loss)** | ** ** | **Totals** | ** ** |
| **BALANCE,  December 28, 2003**                                            |       | 2,213,754             |       |                    | $          | 2               |       |                                  |       | $                      | 43,710     |   |   |   | $ | (176,107 | ) |   |   | $ | 2,427 |   |   | $ | (129,968 | ) |
| Comprehensive income  (loss):                                                        |       |                  |       |                    |       |            |       |                                  |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                           |       |                  |       |                    |       |            |       |                                  |       |                   |       |   | 10,441 |   |   |   |   |   |   | 10,441 |   |
| Foreign currency translation                                                         |       |                  |       |                    |       |            |       |                                  |       |                   |       |   |   |   |   |   | 1,641 |   |   | 1,641 |   |
| Total  comprehensive income (loss):                                                  |       |                  |       |                    |       |            |       |                                  |       |                   |       |   |   |   |   |   |   |   |   | 12,082 |   |
| Issuance of common stock                                                             |       | 12,821                |       |                    |       |            |       |                                  |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Issuance of common stock in connection with initial  public offering                 |       | 6,600,000             |       |                    | 7          |            |       |                                  | 86,463     |                   |       |   |   |   |   |   |   |   |   | 86,470 |   |
| Conversion of senior convertible debt into  common stock                   |       | 6,283,796             |       |                    | 6          |            |       |                                  | 53,364     |                   |       |   |   |   |   |   |   |   |   | 53,370 |   |
| Exercise of warrants                                                                 |       | 4,071,114             |       |                    | 4          |            |       |                                  | 4          |                   |       |   |   |   |   |   |   |   |   | 8 |   |
| Issuance of common stock under employee stock  plans                            |       | 24,722                |       |                    |       |            |       |                                  | 172        |                   |       |   |   |   |   |   |   |   |   | 172 |   |
| **BALANCE,  January 2, 2005**                                              |       | 19,206,207            |       |                    | $          | 19              |       |                                  |       | $                      | 183,713    |   |   |   | $ | (165,666 | ) |   |   | $ | 4,068 |   |   | $ | 22,134 |   |
| Comprehensive income  (loss):                                                        |       |                  |       |                    |       |            |       |                                  |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                                             |       |                  |       |                    |       |            |       |                                  |       |                   |       |   | (3,232 | ) |   |   |   |   |   | (3,232 | ) |
| Foreign currency translation                                                         |       |                  |       |                    |       |            |       |                                  |       |                   |       |   |   |   |   |   | (2,598 | ) |   | (2,598 | ) |
| Total  comprehensive income (loss):                                                  |       |                  |       |                    |       |            |       |                                  |       |                   |       |   |   |   |   |   |   |   |   | (5,830 | ) |
| Issuance of common stock under employee stock  plans                            |       | 53,405                |       |                    |       |            |       |                                  | 158        |                   |       |   |   |   |   |   |   |   |   | 158 |   |
| **BALANCE,  January 1, 2006**                                              |       | 19,259,612            |       |                    | $          | 19              |       |                                  |       | $                      | 183,871    |   |   |   | $ | (168,898 | ) |   |   | $ | 1,470 |   |   | $ | 16,462 |   |
| Cumulative effect of adjustments from the adoption of  SAB 108,net of taxes (Note 3) |       |                  |       |                    |       |            |       |                                  |       |                   |       |   | (558 | ) |   |   | (694 | ) |   | (1,252 | ) |
| Comprehensive income  (loss):                                                        |       |                  |       |                    |       |            |       |                                  |       |                   |       |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                           |       |                  |       |                    |       |            |       |                                  |       |                   |       |   | 83 |   |   |   |   |   |   | 83 |   |
| Foreign currency translation adjustments                                             |       |                  |       |                    |       |            |       |                                  |       |                   |       |   |   |   |   |   | 1,599 |   |   | 1,599 |   |
| Tax effect of foreign currency translation  adjustments                              |       |                  |       |                    |       |            |       |                                  |       |                   |       |   |   |   |   |   | (197 | ) |   | (197 | ) |
| Pension benefit adjustment to initially apply SFAS  158, net of tax benefit of $908  |       |                  |       |                    |       |            |       |                                  |       |                   |       |   |   |   |   |   | (1,762 | ) |   | (1,762 | ) |
| Total  comprehensive income (loss):                                                  |       |                  |       |                    |       |            |       |                                  |       |                   |       |   |   |   |   |   |   |   |   | (277 | ) |
| Issuance of common stock under employee stock  plans                            |       | 78,097                |       |                    |       |            |       |                                  | 212        |                   |       |   |   |   |   |   |   |   |   | 212 |   |
| Stock compensation                                                                   |       |                  |       |                    |       |            |       |                                  | 730        |                   |       |   |   |   |   |   |   |   |   | 730 |   |
| **BALANCE,  December 31, 2006**                                            |       | 19,337,709            |       |                    | $          | 19              |       |                                  |       | $                      | 184,813    |   |   |   | $ | (169,373 | ) |   |   | $ | 416 |   |   | $ | 15,875 |   |

 

See notes to consolidated financial statements.

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**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(In Thousands)**
|                                                                                                          | ** ** | **Years Ended**        | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                                                               | ** ** | **December 31,  2006** | ** ** | **January 1,  2006** | ** ** | **January 2,  2005** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                                | ** ** |                        | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** |
| Net income (loss)                                                                                        |       |                        | $          | 83 |   |   |   | $ | (3,232 | ) |   | $ | 10,441 |   |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |       |                        |       |   |   |   |   |   |   |   |   |
| Depreciation and  amortization                                                                           |       |                        | 3,362      |   |   |   | 3,141 |   |   | 3,207 |   |
| Asset impairment                                                                                         |       |                        | 285        |   |   |   | — |   |   | — |   |
| (Gain) loss on  sale / disposition of fixed assets                                                       |       |                        | —     |   |   |   | (30 | ) |   | 2 |   |
| Amortization of  deferred financing costs                                                                |       |                        | 130        |   |   |   | 130 |   |   | 150 |   |
| Stock-based  compensation                                                                                |       |                        | 730        |   |   |   | — |   |   | 243 |   |
| Write-off of  deferred financing costs                                                                   |       |                        | —     |   |   |   | — |   |   | 224 |   |
| Deferred income  taxes                                                                                   |       |                        | 590        |   |   |   | — |   |   | 37 |   |
| Net change in operating assets and liabilities:                                                          |       |                        |       |   |   |   |   |   |   |   |   |
| Accounts  receivable, net                                                                                |       |                        | (1,363     | ) |   |   | 1,230 |   |   | (1,150 | ) |
| Inventories, net                                                                                         |       |                        | (982       | ) |   |   | 404 |   |   | (2,693 | ) |
| Prepaid expenses  and other current assets                                                               |       |                        | (681       | ) |   |   | 210 |   |   | (142 | ) |
| Deposits                                                                                                 |       |                        | (80        | ) |   |   | (331 | ) |   | (715 | ) |
| Accounts payable                                                                                         |       |                        | (176       | ) |   |   | (429 | ) |   | (674 | ) |
| Accrued  liabilities and restructuring                                                                   |       |                        | (1,153     | ) |   |   | 931 |   |   | (2,067 | ) |
| Accrued  compensation and benefits                                                                       |       |                        | 2,131      |   |   |   | (1,036 | ) |   | (988 | ) |
| Accrued interest  payable                                                                                |       |                        | (45        | ) |   |   | 67 |   |   | (296 | ) |
| Other long-term  liabilities                                                                             |       |                        | (1,541     | ) |   |   | 259 |   |   | (1,600 | ) |
| Net cash provided  by operating activities                                                               |       |                        | 1,290      |   |   |   | 1,314 |   |   | 3,979 |   |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                                | ** ** |                        | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** |
| Additions to  property and equipment                                                                     |       |                        | (3,596     | ) |   |   | (8,144 | ) |   | (4,925 | ) |
| Net sales (purchases)  of short-term investments                                                         |       |                        | —     |   |   |   | 4,177 |   |   | (4,087 | ) |
| Proceeds from sale  of property and equipment                                                            |       |                        | —     |   |   |   | 34 |   |   | — |   |
| Net cash used in  investing activities                                                                   |       |                        | (3,596     | ) |   |   | (3,933 | ) |   | (9,012 | ) |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                                | ** ** |                        | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** |
| Borrowings on  revolving lines of credit                                                                 |       |                        | —     |   |   |   | — |   |   | 11,301 |   |
| Payments on  revolving lines of credit                                                                   |       |                        | —     |   |   |   | — |   |   | (17,433 | ) |
| Payments on  obligations under capital leases                                                            |       |                        | —     |   |   |   | — |   |   | (893 | ) |
| Payments on  long-term debt                                                                              |       |                        | —     |   |   |   | — |   |   | (65,519 | ) |
| Deferred financing  costs                                                                                |       |                        | —     |   |   |   | — |   |   | (249 | ) |
| Net proceeds from  sale of common stock                                                                  |       |                        | 213        |   |   |   | 158 |   |   | 86,470 |   |
| Proceeds from exercise of warrants, options  and employee stock purchases                                |       |                        | —     |   |   |   | — |   |   | 180 |   |
| Net cash provided  by financing activities                                                               |       |                        | 213        |   |   |   | 158 |   |   | 13,857 |   |
| Effect of exchange  rate changes on cash                                                                 |       |                        | 431        |   |   |   | (1,581 | ) |   | 874 |   |
| Net increase  (decrease) in cash and cash equivalents                                                    |       |                        | (1,662     | ) |   |   | (4,042 | ) |   | 9,698 |   |
| Cash and cash  equivalents, beginning of period                                                          |       |                        | 10,543     |   |   |   | 14,585 |   |   | 4,887 |   |
| Cash and cash  equivalents, end of period                                                                |       |                        | $          | 8,881 |   |   |   | $ | 10,543 |   |   | $ | 14,586 |   |
| **SUPPLEMENTAL INFORMATION**                                                                             | ** ** |                        | ** ** | ** ** |   |   | ** ** | ** ** |   | ** ** | ** ** |
| Cash paid during  the year for interest                                                                  |       |                        | $          | 2,532 |   |   |   | $ | 2,523 |   |   | $ | 5,156 |   |
| Cash paid during  the year for income taxes                                                              |       |                        | $          | 255 |   |   |   | $ | 439 |   |   | $ | 2,782 |   |
| Conversion of  senior convertible notes into common stock                                                |       |                        | $          | — |   |   |   | $ | — |   |   | $ | 53,370 |   |
| **NON-CASH ITEMS**                                                                                       |       |                        |       |   |   |   |   |   |   |   |   |
| Adjustment to  initially apply SFAS 158, net of tax                                                      |       |                        | $          | (1,762 | ) |   |   | $ | — |   |   | $ | — |   |
| Adoption of SAB  108 to expense VAT related to fixed asset                                               |       |                        | $          | 117 |   |   |   | $ | — |   |   | $ | — |   |

 

See notes to consolidated financial statements.

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**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTSYEARS ENDED DECEMBER 31, 2006, JANUARY 1, 2006 AND JANUARY 2, 2005**

**1.**                 ORGANIZATION

Cherokee InternationalCorporation reorganized from a California limited liability company andconsummated a debt restructuring (the “Restructuring”) through a series oftransactions collectively referred to as the “Transactions” in November 2002.On November 26, 2002, Cherokee International, LLC, a California limitedliability company (the “LLC”), merged with and into Cherokee InternationalCorporation, a Delaware Corporation (the “Company”), with the Company as thesurviving entity pursuant to the Agreement and Plan of Merger (“MergerAgreement”). References herein to “Cherokee” and the “Company” refer toCherokee International, LLC and its consolidated subsidiaries prior to thereorganization and Cherokee International Corporation and its consolidatedsubsidiaries after the reorganization, and all references to common stock forperiods before the reorganization mean our then-issued and outstandingmembership interests. As a result of the Transactions, the former unit holdersof the LLC became stockholders of the Company, with each of them receiving anumber of shares based on their percentage ownership in the LLC. Prior to thisexchange, the Company had no operating assets or liabilities and had not yetconducted any operations. On November 27, 2002, as part of theTransactions, the Company amended its previous credit facility, issued$41.0 million of Second Lien Notes, and completed an exchange offer withrespect to $100.0 million of its 101⁄2% Senior Subordinated Notes for $53.4million of 12% Pay-In-Kind Senior Convertible Notes, $46.6 million of 5.25%Senior Notes and warrants to purchase shares of the Company’s common stock.

**Initial PublicOffering**

The Company completed itsinitial public offering of 6,600,000 shares of its common stock, par value$0.001 per share (“Common Stock”), on February 25, 2004, at a price of$14.50 per share. The net proceeds to the Company from this offering after paidand accrued offering costs of $9.2 million were $86.5 million. The Company usedapproximately $73.2 million of the net proceeds to repay certain outstandingindebtedness and accrued interest. Immediately prior to the consummation of theoffering, the Company completed a 1-for-3.9 reverse stock split ofits outstanding Common Stock. All shares, per share and conversion amountsrelating to common stock, warrants and stock options included in theaccompanying consolidated financial statements and footnotes have been restatedto reflect the reverse stock split for all periods presented. Also inconnection with the offering, the Company issued 6,283,796 shares ofCommon Stock upon conversion of the original principal amount of itsoutstanding senior convertible notes of $53.4 million, and issued 4,071,114shares of Common Stock upon the exercise of outstanding warrants.

**2.**                 LINE OF BUSINESS

The Company is a designerand manufacturer of power supplies for original equipment manufacturers (“OEMs”).Its advanced power supply products are typically custom designed into mid- tohigh-end commercial applications in the computing and storage, wirelessinfrastructure, enterprise networking, medical and industrial markets.

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**3.**                 BASIS OFPRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

**Basis ofPresentation**

The accompanyingconsolidated financial statements have been prepared in accordance withaccounting principles generally accepted in the United States of America.

**Principles ofConsolidation**

The consolidated financialstatements include the financial statements of the Company and its wholly ownedsubsidiaries, Cherokee Europe SCA and related entities (“Cherokee Europe”),Cherokee Electronica, S.A. DE C.V. (“Cherokee Mexico”), Cherokee IndiaPvt. Ltd. (“India”), Powertel India Pvt. Ltd. (“Powertel”), andCherokee International (China) Power Supply LLC (“Cherokee China”).Inter-company accounts and transactions have been eliminated.

**Use of Estimates**

The preparation offinancial statements in accordance with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent liabilities at the date of the financial statementsand the amounts of revenues and expenses during the reporting period. Actualresults could differ from such estimates.

**Fiscal Year**

The Company’s fiscal years2006, 2005, and 2004 ended on December 31, 2006, January 1, 2006, andJanuary 2, 2005, respectively. The fiscal year ending December 31,2006 included 52 weeks, the fiscal year ended January 1, 2006 included 52weeks, and the fiscal year ended January 2, 2005 included 53 weeks.

**Translation ofForeign Currencies**

Foreign subsidiary assetsand liabilities denominated in foreign currencies are translated at theexchange rate in effect on the balance sheet date. Revenues, costs and expensesare translated at the average exchange rate during the period. Transactiongains and losses are included in results of operations and have not beensignificant for the periods presented. The functional currency of CherokeeEurope is the Euro. The functional currency of Cherokee Mexico, India, Powerteland Cherokee China is the U.S. dollar, as the majority of transactions aredenominated in U.S. dollars. Translation adjustments related to Cherokee Europeare reflected as a component of stockholders’ equity in other comprehensiveincome (loss).

**Cash and Cash Equivalents**

All highly liquid debtinstruments purchased with an original maturity date of three months or lessare considered to be cash equivalents.

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**Inventories**

Inventoriesare valued at the lower of weighted average cost or market. Inventory costsinclude the cost of material, labor and manufacturing overhead and consist ofthe following amounts, net of reserves for surplus and obsolescence (inthousands):

| ** **      | ** ** | **December 31,2006** | ** ** | **January 1,2006** | ** ** |
|-----------------|------------|---------------------------|------------|-------------------------|------------|
| Raw material    |       |                      | $          | 20,991                  |       |   |   | $ | 18,855 |   |   |
| Work-in-process |       |                      | 4,034      |                    |       |   | 3,599 |   |   |
| Finished goods  |       |                      | 4,966      |                    |       |   | 4,397 |   |   |
|            |       |                      | $          | 29,991                  |       |   |   | $ | 26,851 |   |   |

 

As of December 31, 2006 and January 1, 2006,the reserve for excess inventory and obsolescence was $4.4 million and$3.8 million, respectively, including management’s assessment of reserves forsurplus and obsolescence for non-compliant material related to the Restrictionof Hazardous Substances in Electrical and Electronic Equipment directive.

During the year ended December 31,2006, the Company recorded $0.4 million of additional provision to the reservefor excess and obsolete inventory, $0.3 million of which was due to ourassessment of potential decrease in future customer demand of product as aresult of the restructuring and closure of the Company’s Guadalajara, Mexicofacility and its effect on the net realizable value of inventory on hand.

**Property andEquipment**

Depreciationand amortization of property and equipment are provided using the straight-linemethod over the following estimated useful lives:

| Buildings and  improvements                          |   | 5-50 years                       |   |
|------------------------------------------------------|--------|----------------------------------|--------|
| Machinery and  equipment                             |   | 5-10 years                       |   |
| Dies, jigs and  fixtures                             |   | 3 years                          |   |
| Computers,  software, office equipment and furniture |   | 3-5 years                        |   |
| Automobiles and  trucks                              |   | 5 years                          |   |
| Leasehold improvements                               |   | Lesser of 5 years  or lease term |   |

 

**Deferred FinancingCosts**

The Company capitalizes costs directly related tofinancing agreements and certain qualified debt restructuring costs, andamortizes these costs as additional interest expense over the terms of therelated debt.

Netdeferred financing costs are comprised of the following as of December 31,2006 and January 1, 2006 (in thousands):

| ** **                     | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** |
|--------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| Deferred  financing costs      |       |                            | $          | 580                           |       |   |   | $ | 580 |   |   |
| Accumulated  amortization      |       |                            | (364       | )                             |       |   | (234 | ) |   |
| Deferred financing  costs, net |       |                            | $          | 216                           |       |   |   | $ | 346 |   |   |

 

During the years ended December 31,2006 and January 1, 2006, the Company amortized deferred financing costsof $0.1 million and $0.2 million, respectively.

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**Goodwill**

The Company adopted Statement of Financial AccountingStandard (“SFAS”) 142, *Goodwill And OtherIntangible Assets*, effective January 1, 2002. SFAS 142requires that goodwill and other intangible assets with indefinite useful livesno longer be amortized, but instead be tested for impairment annually, or morefrequently, when events or circumstances indicate that their carrying value maybe impaired. The Company performs its impairment test annually at the end ofthe third quarter.

In compliance with therequirements of SFAS 142, the Company has determined that its reportingunits consist of two operating segments: Cherokee North America which consistsof the United States, Mexico, India and China operations, and Cherokee Europe,which consists of the European operations. All goodwill has been assigned to the Cherokee Europereporting unit. Based on management’s assessment of improving conditions in theEuropean marketplace and independent valuations utilizing discounted cash flowand industry market multiple valuation methodologies, there were no events orcircumstances for the years ended December 31, 2006, January 1, 2006,and January 2, 2005 that indicated impairment.

**Long-Lived Assets**

The Company accounts forthe impairment and disposition of long-lived assets in accordance with SFAS144, *Accounting for Impairment or Disposalof Long-Lived Assets*. In accordance with SFAS 144, long-livedassets to be held and used are reviewed for events or changes in circumstances,which indicate that their carrying value may not be recoverable. For the yearended December 31, 2006, the Company recorded $0.3 million of impairmentcharges of the value of such assets compared to no charges for the years ended January 1,2006, and January 2, 2005. In 2006 the Company identified certainlong-lived assets associated with the restructuring and closure of the MexicoFacility whose carrying value would not be recoverable from future cash flowsand recorded an impairment charge. These assets consisted of machinery andequipment, computer technology and equipment, and office furniture and equipment.The majority of these assets were written off because the Company consideredthem to have no market value. None of the impairment charges include cashcomponents.

**Fair Value ofFinancial Instruments**

The amounts recorded forcash and cash equivalents, short-term investments, accounts receivable,accounts payable and accrued liabilities approximate their fair values based ontheir short-term nature. The amounts recorded for long-term debt, borrowingsunder our revolving lines of credit and capital lease obligations approximatefair value, as interest is tied to, or approximates, current market rates.

**Income Taxes**

The Company accounts for income taxes in accordancewith SFAS 109, *Accounting for IncomeTaxes*. In accordance with SFAS 109, deferred tax assets andliabilities are recorded for the estimated future tax effects of temporarydifferences between the carrying value of assets and liabilities for financialreporting and their tax basis and carry-forwards to the extent they arerealizable. A deferred tax provision or benefit results from the net change indeferred tax assets and liabilities during the period. A deferred tax assetvaluation allowance is recorded if it is more likely than not that all or aportion of the recorded deferred tax assets will not be realized.

As of December 31, 2006, deferred tax assetsinclude $32.7 million relating to a tax basis step up from a re-capitalizationtransaction in 1999 and $24.2 million of net operating loss (NOL)carry-forwards. The Company has recorded a valuation allowance against asignificant portion of its deferred tax assets.

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The income tax benefit of$0.1 million for the year ended December 31, 2006, reflects the release ofa reserve for tax contingencies related to tax audits in India and a provisionfor withholding tax paid to Mexico. No benefit has been recognized for netoperating losses generated in the current year.

**Other ComprehensiveIncome (Loss)**

Belgium taxes forunrealized foreign exchange gains on an intercompany loan consideredpermanently re-invested are provided for as a component of other comprehensiveincome (loss). Foreign exchange gains were recognized as Belgium taxable incomein 2005 and 2006 from repayments of the loan.

**Revenue Recognition**

We recognize revenue when persuasive evidence of anarrangement exists, title transfer has occurred, the price is fixed or readilydeterminable, and collectibility is probable. We recognize revenue inaccordance with Staff Accounting Bulletin No. 104, *Revenue Recognition.*Sales are recordednet of discounts, which are estimated at the time of shipment based uponhistorical data. Changes in assumptions regarding the rate of sales discountsearned by our customers could impact our results.

We generally recognize revenue at the time of shipmentbecause this is the point at which revenue is earned and realizable and theearnings process is complete. For most shipments, title to shipped goodstransfers at the shipping point, so the risks and rewards of ownership transferonce the product leaves our facility or third-party hub. Revenue is onlyrecognized when collectibility is reasonably assured. Shipping and handlingfees are included in revenue with related costs recorded to cost of sales.

The Company has enteredinto arrangements with certain customers whereby products are delivered to athird-party warehouse location for interim storage until subsequently shippedand accepted by our customers. Revenues from these sales are recognized uponshipment from the third-party warehouse location to the customers, when titlehas passed. The Company offers a one-year warranty for defective products.Warranty charges have been insignificant during the periods presented.

**Credit Risk**

The Company performsongoing credit evaluations of its customers and generally does not requirecollateral. The Company maintains reserves for estimated credit losses. TheCompany generally does not charge interest on customer balances.

**Stock-BasedCompensation**

In December 2004, SFAS 123R, *Share-Based Payment*, was issued. SFAS 123Ris a revision of SFAS 123, *Accountingfor Stock Based Compensation*, and supersedes APB 25. Among otheritems, SFAS 123R eliminates the use of APB 25 and the intrinsic valuemethod of accounting, and requires companies to recognize the cost of employeeservices received in exchange for awards of equity instruments, based on thegrant date fair value of those awards, in the financial statements. The Companywas required to adopt SFAS 123R effective on January 2, 2006. SFAS 123Rpermits companies to adopt its requirements using either a “*modified prospective*” method, or a “*modified retrospective*” method. Under the “*modified prospective*” method, compensationcost is recognized in the financial statements beginning with the effectivedate, based on the requirements of SFAS 123R for all share-based paymentsgranted after that date, and based on the requirements of SFAS 123 for allunvested awards granted prior to the effective date of SFAS 123R. Under the “*modified retrospective*” method, therequirements are the same as under the “*modifiedprospective*’’ method, but also permits entities to restate financialstatements of previous periods based on proforma disclosures made in accordancewith SFAS 123.

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The Company currently uses the Black-Scholes standardoption-pricing model to measure the fair value of stock options granted toemployees and nonemployees. While SFAS 123R permits the Company to continue touse such a model, the standard also permits the use of a “*lattice*” model. The Company is continuingto use the Black-Scholes model to measure the fair value of employee stockoptions upon the adoption of SFAS 123R.

SFAS 123R also requires that the benefits associatedwith the tax deductions in excess of recognized compensation cost be reportedas a financing cash flow, rather than as an operating cash flow as requiredunder prior literature. This requirement will reduce net operating cash flowsand increase net financing cash flows in periods after the effective date.These future amounts cannot be estimated, because they depend on, among otherthings, when employees exercise stock options.

The Company adopted SFAS 123R on January 2, 2006using the “modified prospective” method as permitted by SFAS 123R. Under thistransition method, stock compensation cost recognized beginning in the firstquarter of fiscal year 2006 includes:  (a) compensation cost for allshare-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-datefair value estimated in accordance with the provisions of SFAS 123R, and (b) compensationcost for all share-based payments granted subsequent to January 1, 2006,based on the grant-date fair value estimated in accordance with the provisionsof SFAS 123R. In accordance with the modified prospective method of adoption,the Company’s results of operations and financial position for prior periodshave not been restated. At the date of the adoption, the unamortized expensefor options issued prior to January 2, 2006 was $2.3 million, which willbe amortized as stock compensation costs through December 2010.  Stock based compensation costs expensed duringthe year ended December 31, 2006 were $0.7 million. No stock compensationexpense was recorded during the year ended January 1, 2006, and $0.2million was recorded during the year ended January 2, 2005.

All grants are made at prices based on the fair marketvalue of the stock on the date of grant. Outstanding options generally vestover periods ranging from two to four years from the grant date and generallyexpire up to ten years after the grant date.

The Company records compensation expense for employeestock options based on the estimated fair value of the options on the date ofgrant using the Black-Scholes option pricing formula with the assumptionsincluded in the table below. The Company uses historical data, among otherfactors, to estimate the expected price volatility and the expected forfeiturerate. For options granted prior to January 2, 2006, the Company used theexpected option life of 5 years. For options granted following the Company’sadoption of SFAS 123R, the expected life was increased to 6.25 years using the “simplifiedmethod” under SAB 107 (an expected term based on the mid-point between thevesting date and the end of the contractual term). The use of the simplifiedmethod is permitted through December 31, 2007. We will convert tocompany-specific experience on or before January 1, 2008. The options havea maximum contractual term of 10 years and vest pro-rata over 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 ofthe option.

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Thefollowing weighted-average assumptions were used to estimate the fair value ofoptions granted during the years ended December 31, 2006, January 1,2006, and January 2, 2005 using the Black-Scholes option pricing formula.

| ** **               | ** ** | **Years Ended**            | ** **       |
|--------------------------|------------|---------------------------------|------------------|
| ** **               | ** ** | **December 31, 2006** | ** **       | **January 1, 2006** | ** ** | **January 2, 2005** | ** ** |
| Dividend yield           |       |                            | 0.0              | % |   |   | 0.0 | % |   |   | 0.0 | % |   |
| Expected  volatility     |       |                            | 58.3             | % |   |   | 52.6 | % |   |   | 53.0 | % |   |
| Risk free  interest rate |       |                            | 4.78             | % |   |   | 3.97 | % |   |   | 3.49 | % |   |
| Expected lives           |       |                            | 5.0 - 6.25 years |   |   |   | 5.0 years |   |   |   | 5.0 years |   |   |
| Forfeiture rates         |       |                            | 15.79% - 16.3    | 5% |   |   | — |   |   |   | — |   |   |

 

Since its inception on February 16, 2004, a totalof 400,000 shares of common stock had been reserved for issuance under the 2004Employee Stock Purchase Plan (“ESPP”). Under the terms of the ESPP, the Company’sU.S. employees, nearly all of whom are eligible to participate, can choose tohave 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, topurchase our common stock. The purchase price of the stock is 85% of the lowerof the closing price at the beginning of each six-month offering period or atthe end of each six-month offering period. The Company recognizes compensationcost for its ESPP under SFAS 123R.

In accordancewith SFAS 148, and as required by SFAS 123R, the required pro forma disclosure,for periods prior to adoption of SFAS 123R, is shown below (in thousands exceptper share amounts):

| ** **                                                                                                                                                  | ** ** | **Year Ended**             | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                                                  | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** | **January 2, 2005** | ** ** |
| Net income  (loss), as reported                                                                                                                             |       |                            | $          | 83 |   |   |   | $ | (3,232 | ) |   |   | $ | 10,441 |   |   |
| Stock-based  employee compensation related to stock options included in net  income (loss), as reported, net of tax                                    |       |                            | —     |   |   |   | — |   |   |   | 243 |   |   |
| 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)        |                            | (610       | ) |   |   | (1,147 | ) |   |   | (853 | ) |   |
| Net income  (loss)—pro forma                                                                                                                           |       |                            | $          | (527 | ) |   |   | $ | (4,379 | ) |   |   | $ | 9,831 |   |   |
| Net income (loss) per  share, as reported:                                                                                                                  |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                                                                                       |       |                            | $          | — |   |   |   | $ | (0.17 | ) |   |   | $ | 0.62 |   |   |
| Diluted                                                                                                                                                     |       |                            | $          | — |   |   |   | $ | (0.17 | ) |   |   | $ | 0.62 |   |   |
| Pro forma net income  (loss) per share:                                                                                                                     |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                                                                                       |       |                            | $          | (0.03 | ) |   |   | $ | (0.23 | ) |   |   | $ | 0.59 |   |   |
| Diluted                                                                                                                                                     |       |                            | $          | (0.03 | ) |   |   | $ | (0.23 | ) |   |   | $ | 0.58 |   |   |

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(a)           During2006 the Company accounted for stock-based compensation for options grantedprior to February 25, 2004, the date of our initial public offering, toemployees and directors using the intrinsic value method prescribed in APB 25and adopted the disclosure-only alternative of SFAS 123, as amended by SFAS 148for these options.

**Segment Information**

The Company is a designerand manufacturer of power supplies for OEMs in the computing and storage,wireless infrastructure, enterprise networking, medical and industrial markets.Operating segments are defined as components of the Company’s business forwhich separate financial information is available that is evaluated by theCompany’s chief operating decision maker (its Chief Executive Officer) 

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indeciding how to allocate resources and in assessing performance. The Company’soperating segments consist of its United States, Mexico, India, and Chinaoperations, which constitute Cherokee North America, and Cherokee Europe. Theseoperating segments have been aggregated into a single reporting segment basedon their similar economic characteristics and common operating characteristics,including comparable gross profit margins and common products, productionprocesses, customers, distribution channels and regulatory requirements.

**Earnings Per Share**

*TheCompany presents both basic and diluted earnings (loss) per share (“EPS”)amounts. Basic EPS is calculated by dividing net income (loss) by the weightedaverage number of common shares outstanding during the period. Diluted EPSamounts are based upon the weighted average number of common and commonequivalent shares outstanding during the period. The Company uses the treasurystock method to calculate the impact of stock compensation. Common equivalentshares are excluded from the computation in periods in which they have ananti-dilutive effect. Stock options for which the exercise price exceeds theaverage market price over the period have an anti-dilutive effect on EPS and,accordingly, are excluded from the calculation of diluted EPS. Dilutive stockoptions have an anti-dilutive effect on EPS in a period with a net loss,therefore, are excluded from the EPS computation.*

**Adjustment toAccumulated Deficit**

In September 2006, the SEC staff issued StaffAccounting Bulletin No. 108, *Considering**the Effects of Prior Year Misstatements whenQuantifying Misstatements in Current Year Financial Statements* (“SAB 108”).SAB 108 was issued in order to eliminate the diversity of practice surroundinghow public companies quantify financial statement misstatements.

Historically Cherokee evaluated uncorrecteddifferences using the “roll-over” method, which focused primarily on the impactof uncorrected differences, including the reversal of prior-year uncorrecteddifferences, on the current-year consolidated statement of operations. Asrequired by SAB 108, Cherokee must now evaluate misstatements under a “dualapproach” method, which requires quantification under both the “roll-over” andthe “iron curtain” methods. The “iron curtain” method quantifies misstatementsbased on the effects of correcting the period-end consolidated balance sheet.

Inaccordance with the transition provisions of SAB 108, Cherokee recordedadjustments totaling $0.6 million to the beginning accumulated deficit forthe year ended December 31, 2006 and $0.7 million to accumulated othercomprehensive income. These adjustments were considered to be immaterial to ourconsolidated statements of operations and our other comprehensive income (loss)in prior years, under the “roll-over”method. The components of the adjustment are detailed in the tables below:

| ** **                      | ** ** | **Year Ended  (in thousands)** | ** ** |
|---------------------------------|------------|------------------------------------------|------------|
| ** **                      | ** ** | **January 1, 2006**            | ** ** | **January 2, 2005** | ** ** | **December 28,  2003 and prior  years** | ** ** | **January 2, 2006  Cumulative  Effect** | ** ** |
| **Debit  (Credit)**             |       |                                     |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Mexico  cost of sales**       | (a)        |                                     | $          | (284 | ) |   |   | $ | 286 |   |   |   | $ | 789 |   |   |   | $ | 791 |   |   |
| **U.S.  cost of sales**         | (b)        |                                     | (211       | ) |   |   | 957 |   |   |   | (1,034 | ) |   |   | (288 | ) |   |
| **China  cost of sales**        | (c)        |                                     | 117        |   |   |   | — |   |   |   | — |   |   |   | 117 |   |   |
| **India  cost of sales**        | (d)        |                                     | 98         |   |   |   | — |   |   |   | — |   |   |   | 98 |   |   |
| **Cost of  sales**              |       |                                     | $          | (280 | ) |   |   | $ | 1,243 |   |   |   | $ | (245 | ) |   |   | $ | 718 |   |   |
| **Provision  for income taxes** | (g)        |                                     | $          | (17 | ) |   |   | $ | (434 | ) |   |   | $ | 291 |   |   |   | $ | (160 | ) |   |
| **Total**                       |       |                                     | $          | (297 | ) |   |   | $ | 809 |   |   |   | $ | 46 |   |   |   | $ | 558 |   |   |

 

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| ** **                                 | ** ** | **Balance at  January 1, 2006** | ** ** | **SAB 108 Adjustment** | ** ** | **Balance at  January 2, 2006** | ** ** |
|--------------------------------------------|------------|------------------------------------------------|------------|----------------------------------|------------|------------------------------------------------|------------|
| ** **                                 | ** ** | **(in thousands)**                        | ** ** |
| **Debit (Credit)**                         |       |                                           |       |                             |       |                                           |       |   |   |   |   |   |   |
| ** **                                 | (a)        |                                           | $          | —                           |       |                                           |       | $ | (7 | ) |   |   | $ | — |   |   |
| ** **                                 | (e)        |                                           | —     |                             |       |                                           | 1,051      |   |   |   | — |   |   |
| ** **                                 | (b)        |                                           | —     |                             |       |                                           | 290        |   |   |   | — |   |   |
| **Inventories,  net**                      |       |                                           | $          | 26,851                           |       |                                           |       | $ | 1,334 |   |   |   | $ | 28,185 |   |   |
| **Property and equipment, net**            | (c)        |                                           | $          | 19,268                           |       |                                           |       | $ | (117 | ) |   |   | $ | 19,151 |   |   |
| ** **                                 | (a)        |                                           | $          | —                           |       |                                           |       | $ | (784 | ) |   |   | $ | — |   |   |
| ** **                                 | (d)        |                                           | —     |                             |       |                                           | (98        | ) |   |   | — |   |   |
| ** **                                 | (e)        |                                           | —     |                             |       |                                           | (1,051     | ) |   |   | — |   |   |
| **Accounts  payable**                      |       |                                           | $          | (11,658                          | )          |                                           |       | $ | (1,933 | ) |   |   | $ | (13,591 | ) |   |
| **Accrued liabilities**                    | (g)        |                                           | $          | (6,028                           | )          |                                           |       | $ | (220 | ) |   |   | $ | (6,248 | ) |   |
| ** **                                 | (f)        |                                           | $          | —                           |       |                                           |       | $ | (476 | ) |   |   | $ | — |   |   |
| ** **                                 | (h)        |                                           | —     |                             |       |                                           | 160        |   |   |   | — |   |   |
| **Other  long-term obligations**           |       |                                           | $          | (4,790                           | )          |                                           |       | $ | (316 | ) |   |   | $ | (5,106 | ) |   |
| **Accumulated other comprehensive income** | (f)        |                                           | $          | (1,470                           | )          |                                           |       | $ | 694 |   |   |   | $ | (776 | ) |   |
| **Accumulated  deficit**                   |       |                                           | $          | 168,898                          |       |                                           |       | $ | 558 |   |   |   | $ | 169,456 |   |   |

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Notes (a) through(h) refer to one or both of the two tables above.

(a)           TheCompany determined that accounts payable for inventory at our Mexico Facilityhad been inaccurately reported for fiscal years 2005 and 2004 and certainperiods prior to 2004. 

(b)          Internationallyproduced finished goods were incorrectly included in U.S. inventorycapitalization calculations. As a result, cost of sales in the U.S. withrespect to fiscal years 2005 and 2004 and certain periods before 2004 wereinaccurate. 

(c)           In2005, previously used equipment was internally transferred to our newlycompleted China Facility. The value added tax charged by the Chinese governmentassociated with the transfer of this equipment was capitalized in 2005 as partof the asset, whereas the tax should have been expensed to moving costs. 

(d)          Thisis an accrual misstatement related to raw materials received in 2005 from ourIndia Facility.

(e)           In-transitmaterials were not accrued in 2005, 2004, and prior to 2004 for all third-partysuppliers of our Mexico Facility.

(f)             Deferredtaxes and other comprehensive income (loss) were not recorded for the tax impactof unrealized foreign exchange gains taxable in Europe and deferred under U.S.generally accepted accounting principles (“GAAP”) for the loans made to ourEuropean subsidiary. This error occurred in 2000 through 2005.

(g)           IncomeTaxes Payable were not recorded for the tax impact of realized exchange gainstaxable in Europe and deferred under U.S. GAAP for the repayment of a portionof loans made to our European subsidiary. This error occurred in 2005. 

(h)          Deferredtaxes were not recorded in the purchase accounting relating to the acquisitionof our European business in 2000. The errors included the deferred tax impactof basis differences in assets acquired and timing differences of acquiredpension obligations.

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**Recent AccountingPronouncements**

In November 2004, the FASB issued SFAS 151,*Inventory Costs*, which amends theguidance in ARB 43, Chapter 4,*Inventory Pricing*. This amendment clarifies the accounting forabnormal amounts of idle facility expense, freight, handling costs and wastedmaterial (spoilage). SFAS 151 requires that those items be recognized ascurrent-period charges, regardless of whether they meet the criteria specifiedin ARB 43 of *so abnormal*. Inaddition, SFAS 151 requires that allocation of fixed production overheads tothe costs of conversion be based on normal capacity of the productionfacilities. SFAS 151 is effective for financial statements for fiscal yearsbeginning after June 15, 2005 with early application permitted. The Companyadopted SFAS 151 during the three-month period ended January 1, 2006;as the result of the adoption, $326,000 of freight-related costs werereclassified from inventory to expense.

In December 2004, the FASB issued SFAS 153, *Exchanges of Non-monetary Assets*—*an amendment of APB Opinion 29*. Theamendment eliminates the exception to fair value accounting for non-monetaryexchanges of similar productive assets and replaces it with a broader exceptionfor exchanges of non-monetary assets that do not have commercial substance.Under APB 29, accounting for an exchange of a productive asset for a similarproductive asset or an equivalent interest in the same or similar productiveasset is to be based upon the recorded amount of the asset relinquished(carry-over basis with no gain or loss recognition). Such transactions will nowbe accounted for based upon the fair value of the assets exchanged. SFAS 153 iseffective for exchanges occurring in fiscal years beginning after June 15,2005 and is to be applied prospectively. This statement did not have a materialimpact on the Company’s consolidated results of operations or financialposition.

In May 2005, the FASB issued SFAS 154, *Accounting Changes and Error Corrections*,which replaced APB Opinion No. 20, *AccountingChanges*, and SFAS  3, *ReportingChanges in Interim Financial Statements*. SFAS 154 requiresretrospective application to prior periods’ financial statements of voluntarychanges in accounting principles and changes required by a new accountingstandard when the standard does not include specific transition provisions.Previous guidance required most voluntary changes in accounting principle to berecognized by including in net income of the period in which the change wasmade the cumulative effect of changing to the new accounting principle. SFAS154 carries forward existing guidance regarding the reporting of the correctionof an error and a change in accounting estimate. SFAS 154 is effective foraccounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005. The Company adopted SFAS 154 as ofJanuary 2, 2006. During the fiscal year ended December 31, 2006, theCompany identified misstatements related to prior periods, the Company appliedSFAS 154 in order to identify which method, the “iron curtain” method or the“roll-over” method, to use in correcting these misstatements. The Companyapplied the “roll-over” method.

In June 2006, the FASB issued FASB InterpretationNo. 48 (FIN 48), *Accounting forUncertainty in**Income Taxes*,*an Interpretation of SFAS No. 109*.FIN 48 clarifies the accounting for uncertainty in income taxes recognized inan enterprise’s financial statements in accordance with SFAS No. 109, *Accounting for Income Taxe*s, byprescribing a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. Under FIN 48, the financial statement effects of a taxposition should initially be recognized when it is more likely than not, basedon the technical merits, that the position will be sustained upon examination.A tax position that meets the more-likely-than-not recognition threshold shouldinitially and subsequently be measured as the largest amount of tax benefit thathas a greater than fifty percent likelihood of being realized upon ultimatesettlement with a taxing authority. FIN 48 is effective for fiscal yearsbeginning after December 15, 2006. The cumulative effect, if any, ofapplying the provisions of FIN 48 will be reported as an adjustment to theopening balance of retained earnings in the period adopted. We are currentlyevaluating the impact that the adoption of FIN 48 will have on the Company’sconsolidated financial position, results of operations, and liquidity.

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In September 2006, the U.S. Securities andExchange Commission (SEC) issued Staff Accounting Bulletin No. 108, *Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements* (“SAB 108”). SAB108 addresses the diversity in practice of quantifying financial statementmisstatements resulting in the potential build up of improper amounts on thebalance sheet. SAB 108 provides interpretive guidance on how the effects of thecarryover or reversal of prior year misstatements should be considered inquantifying a current year misstatement. The SEC staff believes thatregistrants should quantify errors using both a balance sheet and an incomestatement approach and evaluate whether either approach results in quantifyinga misstatement that, when all relevant quantitative and qualitative factors areconsidered, is material. SAB 108 is effective for companies with fiscal yearsending after November 15, 2006. SAB 108 allows a one-time transitionalcumulative effect adjustment to beginning retained earnings, in the first yearof adoption, for errors that were not previously deemed material, but arematerial under the guidance in SAB 108. The Company adopted SAB 108 at January 2,2006 (see “Adjustment to Accumulated Deficit” section above).

In September 2006, the FASB issued SFAS 157 (“SFAS157”), *Fair Value Measurements*, which definesfair value, establishes a framework for measuring fair value in generallyaccepted accounting principles (GAAP), and expands disclosures about fair valuemeasurements. This Statement applies in conjunction with other accountingpronouncements that require or permit fair value measurements. This Statementshall be effective for financial statements issued for fiscal years beginning afterNovember 15, 2007. We are currently evaluating the impact that theadoption of SFAS 157 will have on the Company’s consolidated financial positionand result of operations.

In September 2006, the FASB issued SFAS No. 158(“SFAS 158”), *Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans—an amendment of FASB Statements No. 87,88, 106, and 132(R)*. SFAS 158, Employers’ Accounting for DefinedBenefit Pension and Other Postretirement Plans, became effective for us as of December 31,2006, and requires recognition of an asset or liability in the consolidatedbalance sheet reflecting the funded status of pension and other postretirementbenefit plans such as retiree health and life, with current year changes in thefunded status recognized in the stockholders’ equity. SFAS 158 does not changethe existing criteria for measurement of periodic benefit costs, plan assets orbenefit obligations. SFAS 158 does eliminate the Company’s requirement torecord unfunded accumulated benefit obligation to the consolidated statement ofoperations in the current period. For the year ended December 31, 2006,this amount would have been $0.6 million.

Thefollowing table summarizes the incremental effects of the initial adoption ofSFAS 158 on our consolidated balance sheet at December 31, 2006.

| ** **                                     | ** ** | **Before Application  of SFAS 158** | ** ** | **SFAS 158  Adjustments** | ** ** | **After Application of  SFAS 158** | ** ** |
|------------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------|------------|---------------------------------------------------|------------|
| ** **                                     | ** ** | **(in thousands)**                            | ** ** |
| Deferred income  taxes                         |       |                                               | $          | (590                           | )          |                                              |       | $ | 908 |   |   |   | $ | 318 |   |   |
| Total assets                                   |       |                                               | $          | 95,985                         |       |                                              |       | $ | 908 |   |   |   | $ | 96,893 |   |   |
| Other long-term  liabilities                   |       |                                               | $          | 4,044                          |       |                                              |       | $ | 2,671 |   |   |   | $ | 6,715 |   |   |
| Total liabilities                              |       |                                               | $          | 78,596                         |       |                                              |       | $ | 2,671 |   |   |   | $ | 81,267 |   |   |
| Accumulated other  comprehensive income (loss) |       |                                               | $          | 2,178                          |       |                                              |       | $ | (1,762 | ) |   |   | $ | 416 |   |   |
| Total stockholders’  equity (deficit)     |       |                                               | $          | 17,388                         |       |                                              |       | $ | (1,762 | ) |   |   | $ | 15,626 |   |   |

 

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**4.**                 PROPERTY ANDEQUIPMENT

Propertyand equipment consists of the following (in thousands):

| ** **                                           | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** |
|------------------------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| Land                                                 |       |                            | $          | 1,891                         |       |   |   | $ | 1,738 |   |   |
| Buildings and  improvements                          |       |                            | 7,294      |                          |       |   | 6,626 |   |   |
| Machinery and  equipment                             |       |                            | 26,834     |                          |       |   | 23,397 |   |   |
| Dies, jigs and  fixtures                             |       |                            | 1,198      |                          |       |   | 560 |   |   |
| Computers,  software, office equipment and furniture |       |                            | 3,784      |                          |       |   | 3,328 |   |   |
| Automobiles and  trucks                              |       |                            | 181        |                          |       |   | 111 |   |   |
| Leasehold  improvements                              |       |                            | 8,682      |                          |       |   | 4,287 |   |   |
| Construction in  progress                            |       |                            | 602        |                          |       |   | 5,358 |   |   |
|                                                 |       |                            | $          | 50,466                        |       |   |   | $ | 45,405 |   |   |
| Less accumulated  depreciation and amortization      |       |                            | (30,578    | )                             |       |   | (26,137 | ) |   |
|                                                 |       |                            | $          | 19,888                        |       |   |   | $ | 19,268 |   |   |

 

As of December 31,2006 and January 1, 2006, none of the Company’s assets were under capitallease agreements. As of January 1, 2006, there was $0.5 million ofcapitalized interest included in construction in progress. Depreciation andamortization expense for the years ended December 31, 2006, January 1,2006, and January 2, 2005 was $3.4 million, $3.1 million, and$3.2 million, respectively.

**5.**                 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 sharesoutstanding. For the year ended December 31, 2006, 2,297,054 ofoutstanding stock options were excluded from the calculation of diluted income(loss) per share as their exercise prices would render them anti-dilutive. Forthe year ended January 1, 2006, all 2,270,115 of our outstanding stockoptions were excluded from the calculation of diluted income (loss) per shareas their effect would have been anti-dilutive due to the net loss for the year.For the year ended January 2, 2005, the senior convertible notes areassumed to have been converted at the beginning of the period, and as a result,net income has been increased by $1.0 million for the reduction in interestexpense related to the senior convertible notes.

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Thefollowing table sets forth the computation of basic and diluted net income(loss) per share (in thousands, except per share amounts):

| ** **                                                   | ** ** | **Years Ended**            | ** ** |
|--------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                   | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** | **January 2, 2005** | ** ** |
| Net income (loss)                                            |       |                            | $          | 83 |   |   |   | $ | (3,232 | ) |   |   | $ | 10,441 |   |   |
| Adjustment for  interest expense on senior convertible notes |       |                            | —     |   |   |   | — |   |   |   | 1,036 |   |   |
| Net income (loss),  adjusted                                 |       |                            | $          | 83 |   |   |   | $ | (3,232 | ) |   |   | $ | 11,477 |   |   |
| Shares:                                                      |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Weighted-average common shares outstanding—basic        |       |                            | 19,286     |   |   |   | 19,230 |   |   |   | 16,761 |   |   |
| Effect of  dilutive securities:                              |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Senior convertible notes and warrants                        |       |                            | —     |   |   |   | — |   |   |   | 1,479 |   |   |
| Outstanding stock options                                    |       |                            | 12         |   |   |   | — |   |   |   | 399 |   |   |
| Weighted-average common shares outstanding—diluted      |       |                            | 19,298     |   |   |   | 19,230 |   |   |   | 18,639 |   |   |
| Net income (loss)  per share:                                |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Basic                                                        |       |                            | $          | — |   |   |   | $ | (0.17 | ) |   |   | $ | 0.62 |   |   |
| Diluted                                                      |       |                            | $          | — |   |   |   | $ | (0.17 | ) |   |   | $ | 0.62 |   |   |

 

**6.**                 DEBT

Long-termdebt consists of the following at December 31, 2006 and January 1,2006 (in thousands):

| ** **            | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** |
|-----------------------|------------|---------------------------------|------------|-------------------------------|------------|
| 5.25% senior  notes   |       |                            | $          | 46,630                        |       |   |   | $ | 46,630 |   |   |
| Less current  portion |       |                            | —     |                          |       |   | — |   |   |
| Total long-term debt  |       |                            | $          | 46,630                        |       |   |   | $ | 46,630 |   |   |

 

Presentedbelow is the Company’s long-term debt and long-term debt payable to affiliatesat December 31, 2006 and January 1, 2006 (in thousands):

| ** **                             | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|-------------------------------|------------|
| Long-term debt:                        |       |                            |       |                          |       |   |   |   |   |
| Current                                |       |                            | $          | —                        |       |   |   | $ | — |   |   |
| Non-current                            |       |                            | 24,485     |                          |       |   | 24,485 |   |   |
| Long-term debt  payable to affiliates: |       |                            |       |                          |       |   |   |   |   |
| Current                                |       |                            | —     |                          |       |   | — |   |   |
| Non-current                            |       |                            | 22,145     |                          |       |   | 22,145 |   |   |
| Total long-term debt                   |       |                            | $          | 46,630                        |       |   |   | $ | 46,630 |   |   |

 

As of December 31, 2006, all of the Company’slong-term debt is scheduled to be repaid in 2008.

In connection with theCompany’s initial public offering, the Company amended and restated itsexisting senior revolving credit facility with General Electric CapitalCorporation. The amended facility (the “Credit Facility”) provides forborrowings of up to $20.0 million that are subject to a borrowing basecomprised of eligible accounts receivable and inventory, which was $15.8million at December 31, 2006. The Credit Facility matures in August 2008and borrowings bear interest, at the Company’s option, at a rate per annumequal to LIBOR plus 2.5% or the agent bank’s base rate plus 1.0%. In additionto paying interest on outstanding principal, the Company is required to pay acommitment fee to the lenders under 

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thecredit facility in respect of the average daily balance of unused loancommitments at a rate of 0.5% per annum. The Credit Facility is secured by afirst-priority lien, subject to permitted encumbrances, on substantially all ofthe Company’s domestic assets and by a pledge of 65% of the equity of certainof the Company’s foreign subsidiaries. The Credit Facility contains restrictivecovenants requiring the Company to, among other things, maintain certain seniorleverage ratios. As of December 31, 2006, we were in compliance with ourcovenants set forth in the agreements. As of December 31, 2006, we were incompliance with our covenants set forth in the agreements. However, as of April 2,2007, we were out of compliance with the requirement that we submit our annualaudited financial statements to GE Capital Corporation, the agent under ourrevolving credit facility, within 120 days of our fiscal year end. We haveobtained a waiver of this default from GE Capital Corporation effective May 10,2007. This waiver extends the deadline for submitting our audited financialstatements until August 31, 2007.

Cherokee Europe maintainsa working capital line of credit of approximately $4.0 million with BankBrussels Lambert, a subsidiary of ING Belgie NV, a bank in Brussels, which isdenominated in Euros, collateralized by a pledge in first and second rank overa specific amount of business assets, requires Cherokee Europe to maintain acertain specific minimum solvency ratio and is cancelable at any time. As of December 31,2006, Cherokee Europe had no outstanding borrowings under the line of creditand was in compliance with all covenants.

**7.**                 OTHER LONG-TERMLIABILITIES

Otherlong-term liabilities consist of the following (in thousands):

| ** **                             | ** ** | **Years Ended**            | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** |
| 1999 Europe  restructuring liabilities |       |                            | $          | 676 |   |   |   | $ | 770 |   |   |
| 2003 Europe  restructuring liabilities |       |                            | 1,421      |   |   |   | 1,452 |   |   |
| Long service  award liabilities        |       |                            | 818        |   |   |   | 2,104 |   |   |
| Pension  liability-SFAS 158            |       |                            | 2,671      |   |   |   | — |   |   |
| Deferred  compensation                 |       |                            | 1,105      |   |   |   | 917 |   |   |
| Advances for  research and development |       |                            | 597        |   |   |   | — |   |   |
| Subtotal                               |       |                            | $          | 7,288 |   |   |   | $ | 5,243 |   |   |
| Less current  portion                  |       |                            | (573       | ) |   |   | (453 | ) |   |
|                                   |       |                            | $          | 6,715 |   |   |   | $ | 4,790 |   |   |

 

Estimatedpayments required under other long-term obligations as of December 31,2006 are as follows (in thousands):

| ** **            | ** ** | **1999 Europe  Restructuring** | ** ** | **2003 Europe  Restructuring** | ** ** | **Long Service  Award** | ** ** |
|-----------------------|------------|-------------------------------------|------------|-------------------------------------|------------|------------------------------|------------|
| 2007                  |       |                                | $          | 190                                 |       |                         |       | $ | 260 |   |   |   | $ | 23 |   |   |
| 2008                  |       |                                | 146        |                                |       |                         | 232        |   |   |   | 48 |   |   |
| 2009                  |       |                                | 292        |                                |       |                         | 226        |   |   |   | 94 |   |   |
| 2010                  |       |                                | 48         |                                |       |                         | 208        |   |   |   | 182 |   |   |
| 2011                  |       |                                | —     |                                |       |                         | 170        |   |   |   | 20 |   |   |
| Thereafter            |       |                                | —     |                                |       |                         | 325        |   |   |   | 451 |   |   |
| Subtotal              |       |                                | $          | 676                                 |       |                         |       | $ | 1,421 |   |   |   | $ | 818 |   |   |
| Less current  portion |       |                                | (190       | )                                   |       |                         | (260       | ) |   |   | (23 | ) |   |
|                  |       |                                | $          | 486                                 |       |                         |       | $ | 1,161 |   |   |   | $ | 795 |   |   |

 

The timing of paymentsrequired of the deferred compensation liability of $1,105,000 is notdeterminable.

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**8.**                 CHEROKEE EUROPERESTRUCTURING

Prior to the Company’s acquisition of Cherokee Europe,the facility implemented a restructuring plan (the “1999 Europe Restructuring”).The 1999 Europe Restructuring liability of $2.2 million assumed by the Companywas comprised entirely of termination benefits to be paid through 2010. TheCompany paid $0.2 million, $0.2 million, and $0.2 million in benefitsduring the years ended December 31, 2006, January 1, 2006, and January 2,2005, respectively, under the 1999 Europe Restructuring.

In June 2003, the Company received approval for arestructuring plan (the “2003 Europe Restructuring*”*) of its operations in Europe from the Workers Union andthe appropriate governmental authorities in Belgium. The 2003 EuropeRestructuring involved the elimination of 61 operational and administrativepositions at the Cherokee Europe facility in Belgium due to unfavorableeconomic conditions in that market. All of the terminations were completed in2003. Pursuant to the 2003 Europe Restructuring, the Company recorded atermination benefits charge of $4.5 million for the year ended December 28,2003, to be paid through 2016. The Company paid $0.3 million, $0.4million, and $1.1 million in benefits during the years ended December 31,2006, January 1, 2006, and January 2, 2005, respectively, under the2003 Europe Restructuring.

Areconciliation of the 1999 Europe Restructuring and 2003 Europe Restructuringliabilities for the three years ended December 31, 2006 is as follows (inthousands):

| ** **                                | ** ** | **1999 Europe  Restructuring** | ** ** | **2003 Europe  Restructuring** | ** ** |
|-------------------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Balance as of  December 29, 2002     |       |                                | $          | 1,052                               |       |   |   | $ | — |   |   |
| Provision                                 |       |                                | —     |                                |       |   | 4,474 |   |   |
| Payments                                  |       |                                | (206       | )                                   |       |   | (1,942 | ) |   |
| Foreign exchange rate effect              |       |                                | 182        |                                |       |   | 282 |   |   |
| Balance as of  December 28, 2003     |       |                                | 1,028      |                                |       |   | 2,814 |   |   |
| Provision                                 |       |                                | 165        |                                |       |   | (54 | ) |   |
| Payments                                  |       |                                | (231       | )                                   |       |   | (1,122 | ) |   |
| Foreign exchange rate effect              |       |                                | 66         |                                |       |   | 129 |   |   |
| Balance as of  January 2, 2005       |       |                                | 1,028      |                                |       |   | 1,767 |   |   |
| Provision                                 |       |                                | 27         |                                |       |   | 259 |   |   |
| Payments                                  |       |                                | (163       | )                                   |       |   | (368 | ) |   |
| Foreign exchange rate effect              |       |                                | (122       | )                                   |       |   | (206 | ) |   |
| Balance as of  January  1, 2006 |       |                                | 770        |                                |       |   | 1,452 |   |   |
| Provision                                 |       |                                | 50         |                                |       |   | 99 |   |   |
| Payments                                  |       |                                | (224       | )                                   |       |   | (285 | ) |   |
| Foreign exchange rate effect              |       |                                | 80         |                                |       |   | 155 |   |   |
| Balance as of December 31,  2006     |       |                                | $          | 676                                 |       |   |   | $ | 1,421 |   |   |
| Less current  portion                     |       |                                | (190       | )                                   |       |   | (260 | ) |   |
| Due after one year                        |       |                                | $          | 486                                 |       |   |   | $ | 1,161 |   |   |

 

**9.**                 COMMITMENTS ANDCONTINGENCIES

The Company leases certain of its manufacturingfacilities under non-cancelable operating leases through 2055. One of themanufacturing facilities is leased from an entity controlled by a formerdirector of the Company. Rental expense for the years ended December 31,2006, January 1, 2006 and January 2, 2005 totaled approximately $1.7million, $1.6 million and $1.4 million (including $1.2 million, $1.1 millionand $1.1 million to an entity controlled by a former director), respectively.

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As of December 31,2006, the Company no longer has any capital lease contracts. A summary of theCompany’s operating lease commitments as of December 31, 2006 is asfollows (in thousands):

| **Year ending December 31:** |   |   |   |
|---------------------------------------------|--------|--------|--------|
| 2007                                        |   | $      | 1,623  |   |
| 2008                                        |   | 1,634  |   |
| 2009                                        |   | 592    |   |
| 2010                                        |   | 30     |   |
| 2011                                        |   | 20     |   |
| Thereafter                                  |   | 112    |   |
| Total minimum lease  payments               |   | $      | 4,011  |   |

 

As of December 31,2006, total future minimum payments for operating leases aggregated to $4.0 million,of which $2.7 million is payable to an entity controlled by a former directorof the Company.

**Guarantees andIndemnities**

The Company has agreed to indemnify the former ownersof Cherokee Europe for product liability, environmental hazard and employmentpractice claims relating solely to post-acquisition business. The Company alsoindemnifies its directors and officers to the maximum extent permitted underthe laws of the State of Delaware, and various lessors in connection withfacility leases for certain claims arising from such facility or lease. Themaximum amount of potential future payments under such indemnifications is notdeterminable.

The Company has notincurred significant amounts related to these guarantees and indemnifications,and no liability has been recorded in the consolidated financial statements forguarantees and indemnifications as of December 31, 2006, and January 1,2006.

**Cash IncentiveCompensation Program and Severance Agreements**

The Company adopted a cashincentive program for certain executives, which provides for cash incentivepayments of up to 120% of base salary subject to attainment of corporate goalsand objectives approved by the Company’s board of directors. In addition, theCompany has entered into severance agreements with certain executives, whichprovide payments to the executive if the executive is terminated other than forcause, as defined in the applicable severance agreement. Certain of the severanceagreements provide additional benefits, including acceleration of stockoptions, in the event of termination in connection with a change of control, asdefined in the applicable severance agreement.

**Other Matters**

In the first quarter of2006, we executed a mutual release agreement with a former business partner.The agreement released both parties from obligations arising from pasttransactions. As a result of this agreement, we made a one-time adjustment toreduce our selling and marketing expense by $0.4 million during the threemonths ended April 2, 2006.

**India Matter**

In late March 2006, the Company learned thatemployees of its Indian subsidiary manufacturing operations had made certainunauthorized payments that may have been in violation of the Foreign CorruptPractices Act and local laws. The facility in India is used for the solepurpose of manufacturing products for other Company locations and, as such,does not generate revenue or issue invoices to external customers. Itmanufactures approximately 6% (by volume) of the products offered by theCompany.

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The subject payments, inthe aggregate, amounted to approximately $40,000 in each of the years ended January 2,2005 and January 1, 2006, and less than $10,000 in the year ended December 31,2006. The Company retained outside counsel who conducted an internalinvestigation into these payments. In January 2007, the Company’s outsidecounsel met with the SEC to discuss the results of the internal investigation.

**10.**          Restructuring Costs andAsset Impairment Charges for Closure of Guadalajara, Mexico Facility

During the third quarter of 2006, the Companyannounced the planned closure of its Mexican facilities and a relatedrestructuring plan, which was accounted for in accordance with SFAS 146, *Accounting for Costs Associated with Exit or Disposal Activities*.The Mexico Facility encompasses 35,000 square feet in one building and had beenin operation since 1988, employing approximately 250 full-time and temporaryemployees in the production of power supplies.

The impact of the planned closure for the six monthsended December 31, 2006 was $1.3 million cumulative. This was made up of$0.7 million restructuring, $0.3 million asset impairment and$0.3 million additional excess and obsolescence reserve. The Companyrecorded pre-tax charges of $0.7 million of restructuring costs for severancesand stay bonuses that are included in accrued restructuring costs on the accompanyingconsolidated balance sheet as of December 31, 2006, $0.3 million ofimpairment charges to the carrying value of those assets determined to beimpaired under the guidance of SFAS 144, *Accounting for theImpairment or Disposal of Long-Lived Assets*, and a $0.3 millioncharge to cost of sales to reserve for excess and obsolete inventory due to thepotential decrease in future customer demand of product as a result of therestructuring and closure of the Mexico Facility.

On February 22, 2007,Cherokee Electronica, S.A. de C.V. (“Cherokee Mexico”), a subsidiary ofCherokee International Corporation, a Delaware corporation (the “Company”),entered into a Purchase and Sale Agreement (the “Agreement”) with InmobiliariaHondarribia, S.A. de C.V. (the “Buyer”) for the sale of Cherokee Mexico’s 35,000-footmanufacturing facility in Guadalajara, Mexico. The Agreement provides that theBuyer will pay Cherokee Mexico an aggregate purchase price of approximately US$1.2 million, of which approximately US $182,000 was paid on February 22,2007 and approximately US $1.02 million expected to be paid when thetransaction closes on or about May 31, 2007. Cherokee Mexico expects toincur an immaterial amount of expenses in connection with the sale of thebuilding, principally related to broker’s fees. Any amounts payable inconnection with the sale of the building will be subtracted from proceeds ofthe sale.

**Restructuring Costs**

In accordance with SFAS 146, employee severance,contract termination and other exit costs are recorded at their estimated fairvalue when they are incurred. Employee severance and stay bonus costs for theyear ended December 31, 2006 were $0.7 million, which included a pro-rataportion from August 10, 2006, the communication date, through December 31,2006, of an estimated amount of statutory required severance payments andmanagement performance stay-on bonuses incurred for approximately 128 employeesat the Mexico Facility. The Company anticipates approximately $1.0 millionof employee severance and related costs to be incurred in connection with thisplan of which $0.7 million has been earned and expensed as of December 31,2006, with the remaining $0.3 million to be recognized over the first threemonths of 2007, as it is earned. The Company paid $0.3 million of severance andrelated expenses to those employees terminated during the quarter ended December 31,2006, and expects to pay the remainder of severance and related costs to thoseemployees to be terminated during the first six months of 2007. All severancecharges will be settled with cash.

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Asummary of the restructuring costs and reserve activity during the year ended December 31,2006 is as follows (in thousands):

| ** **                 | ** ** | **Restructuring  Liabilities at  January 1, 2006** | ** ** | **Restructuring  Charges** | ** ** | **Cash Paid** | ** ** | **Restructuring  Liabilities at  December 31, 2006** | ** ** |
|----------------------------|------------|-------------------------------------------------------------------|------------|----------------------------|------------|--------------------|------------|---------------------------------------------------------------------|------------|
| Severance and  bonuses     |       |                                                              | $          | —                     |       |               |       | $                                                                   | 697        |   |   |   | $ | (268 | ) |   |   | $ | 429 |   |   |
| Total Restructuring  Costs |       |                                                              | $          | —                     |       |               |       | $                                                                   | 697        |   |   |   | $ | (268 | ) |   |   | $ | 429 |   |   |

 

Asummary of the restructuring costs recorded during the year ended December 31,2006 is as follows (in thousands):

| ** **                 | ** ** | **Year Ended  December 31, 2006** | ** ** |
|----------------------------|------------|--------------------------------------------------|------------|
| Severance and  bonuses     |       |                                             | $          | 697 |   |   |
| Total Restructuring  Costs |       |                                             | $          | 697 |   |   |

 

**Asset ImpairmentCharges**

During the year ended December 31,2006, the Company performed impairment reviews in accordance with SFAS 144, *Accounting for the Impairment and Disposal of Long-Lived Assets,*to determine whether any of its long-lived assets were impaired. The Companyidentified certain long-lived assets associated with the restructuring andclosure of the Mexico Facility whose carrying value would not be recoverablefrom future cash flows and recorded an impairment charge of $0.3 million forthese assets. These assets consisted of machinery and equipment, computertechnology and equipment, and office furniture and equipment. The majority ofthese assets were written off because the Company considered them to have nomarket value. None of the impairment charges include cash components. At December 31,2006, none of our assets were classified as held for sale in accordance withSFAS 144 because the Company did not meet the criterion that “the asset(disposal group) is available for immediate sale in its present conditionsubject 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 ourMexico Facility during the year ended December 31, 2006, and during thefirst quarter of 2007.

**11.**          STOCKHOLDERS’EQUITY

**2002 Stock OptionPlan**

In July 2003, theCompany adopted the Cherokee International Corporation 2002 Stock Option Plan(the “2002 Stock Option Plan”) under which up to 1,410,256 shares of theCompany’s common stock may be issued pursuant to the grant of non-qualifiedstock options to the directors, officers, employees, consultants and advisorsof the Company and its subsidiaries. In connection with the adoption of the2002 Stock Option Plan, the Company granted 1,087,327 stock options. Theoptions 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 withexercise prices at or above fair value as determined by Cherokee’s Board ofDirectors based on income and market valuation methodologies. In February 2004,the Company granted options to purchase 328,320 shares of common stock at anexercise price of $14.50 and terminated the 2002 Stock Option Plan. As of December 31,2006, the Company had granted a total of 1,415,647 options to purchase sharesof common stock under the 2002 Stock Option Plan, which includes options topurchase shares that were cancelled and subsequently re-granted.

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**2004 Omnibus StockIncentive Plan**

On February 16, 2004, the Company adopted the2004 Omnibus Stock Incentive Plan (the “2004 Plan”), which provided for theissuance of 800,000 shares of common stock. The 2004 Plan also provides for anannual increase to be added on the first day of the Company’s fiscal year equalto the lesser of (i) 450,000 shares or (ii) 2% of the number ofoutstanding shares on the last day of the immediately preceding fiscal year. Asof December 31, 2006, a total of 1,569,316 shares of the Company’s commonstock were reserved for issuance under the 2004 Plan. Any officer, director,employee, consultant or advisor of the Company is eligible to participate inthe 2004 Plan. The 2004 Plan provides for the issuance of stock-based incentiveawards, including stock options, stock appreciation rights, restricted stock,deferred stock, and performance shares. As of December 31, 2006, the Companyhad granted options to purchase 1,583,989 shares of common stock under the 2004Plan, which included 235,589 options issued as partial compensation tonon-employee directors. During the year ended December 31, 2006, theCompany granted a total of 157,500 options to purchase shares of common stockunder the 2004 Plan, which includes options to purchase shares that werecancelled and subsequently re-granted. The aggregate fair value for optionsgranted during 2006 was $350,000, which will be amortized as stock compensationcosts over 6.25 years.

Informationwith respect to stock option activity and stock options outstanding under bothstock option plans is as follows:

| ** **                                                                   | ** ** | **Number of  Shares** | ** ** | **Option  Exercise  Price  Per Share** | ** ** | **Weighted  Average  Exercise  Price  Per Share** | ** **   | **Weighted-  Average  Remaining  Contractual  Term (in years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------|------------|--------------------------------------------------------|--------------|---------------------------------------------------------------------------|------------|---------------------------------|------------|
| Options outstanding, January 1, 2003                                    |       |                       | —     |                                        |       | $                                                      | —       |                                                                      |       | $                               | —     |   |   |   |   |   |   |   |   |   |   |
| Options granted (weighted average fair value of  $0.59 per share)  |       |                       | 1,087,327  |                                        |       | $                                                      | 5.85 - 10.34 |                                                                      |       | $                               | 6.74       |   |   |   |   |   |   |   |   |   |   |
| Options exercised                                                            |       |                       | —     |                                        |       | —                                                 |         |                                                                      | —     |                            |       |   |   |   |   |   |   |   |   |
| Options forfeited                                                            |       |                       | (6,410     | )                                           |       | $                                                      | 5.85 - 10.34 |                                                                      |       | $                               | 6.75       |   |   |   |   |   |   |   |   |   |   |
| Options outstanding, December 28, 2003                                  |       |                       | 1,080,917  |                                        |       | $                                                      | 5.85 - 10.34 |                                                                      |       | $                               | 6.78       |   |   |   |   |   |   |   |   |   |   |
| Options granted (weighted average fair value of  $6.57 per share)  |       |                       | 527,320    |                                        |       | $                                                      | 6.96 - 14.50 |                                                                      |       | $                               | 13.32      |   |   |   |   |   |   |   |   |   |   |
| Options exercised                                                            |       |                       | (6,056     | )                                           |       | $                                                      | 5.85 - 10.34 |                                                                      |       | $                               | 6.42       |   |   |   |   |   |   |   |   |   |   |
| Options forfeited                                                            |       |                       | (167,417   | )                                           |       | $                                                      | 5.85 - 14.50 |                                                                      |       | $                               | 7.72       |   |   |   |   |   |   |   |   |   |   |
| Options outstanding, January 2, 2005                                    |       |                       | 1,434,764  |                                        |       | $                                                      | 5.85 - 14.50 |                                                                      |       | $                               | 9.05       |   |   |   |   |   |   |   |   |   |   |
| Options granted (weighted average fair value of  $2.12 per share)  |       |                       | 1,227,489  |                                        |       | $                                                      | 2.97 - 7.26  |                                                                      |       | $                               | 4.56       |   |   |   |   |   |   |   |   |   |   |
| Options exercised                                                            |       |                       | —     |                                        |       | —                                                 |         |                                                                      | —     |                            |       |   |   |   |   |   |   |   |   |
| Options forfeited                                                            |       |                       | (392,138   | )                                           |       | $                                                      | 3.89 - 14.50 |                                                                      |       | $                               | 9.91       |   |   |   |   |   |   |   |   |   |   |
| Options outstanding, January 1, 2006                                    |       |                       | 2,270,115  |                                        |       | $                                                      | 2.97 - 14.50 |                                                                      |       | $                               | 6.47       |   |   |   |   |   |   |   |   |   |   |
| Options granted (weighted average fair value of  $2.22 per share)  |       |                       | 157,500    |                                        |       | $                                                      | 3.18 - 6.76  |                                                                      |       | $                               | 3.69       |   |   |   |   |   |   |   |   |   |   |
| Options exercised                                                            |       |                       | —     |                                        |       | —                                                 |         |                                                                      | —     |                            |       |   |   |   |   |   |   |   |   |
| Options forfeited                                                            |       |                       | (130,561   | )                                           |       | $                                                      | 3.19 - 14.50 |                                                                      |       | $                               | 7.27       |   |   |   |   |   |   |   |   |   |   |
| Options outstanding at December 31, 2006                                |       |                       | 2,297,054  |                                        |       | $                                                      | 2.97 - 14.50 |                                                                      |       | $                               | 6.23       |   |   |   | 7.84 |   |   |   | $ | 671,221 |   |   |
| Options vested and expected to vest in the future at  December 31, 2006 |       |                       | 2,044,893  |                                        |       |                                                   |         |                                                                      | $          | 6.43                            |       |   |   | 7.73 |   |   |   | $ | 530,497 |   |   |
| Options  exercisable at December 31, 2006                               |       |                       | 1,051,929  |                                        |       |                                                   |         |                                                                      | $          | 7.04                            |       |   |   | 7.25 |   |   |   | $ | 161,906 |   |   |

 

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| ** **                          | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|-------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of  Exercise  Prices** | ** ** | ** **                   | ** ** | **Number of  Shares**   | ** ** | **Weighted Average  Remaining  Contractual Life  in Years** | ** ** | **Weighted Average  Exercise Price** | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Exercise Price** | ** ** |
| $2.97 - 3.18                        |       | 127,500                      |       |                         | 9.04       |   |   |   | $ | 3.00 |   |   | 26,875 |   |   | $ | 2.97 |   |   |
| $3.19                               |       | 558,775                      |       |                         | 8.94       |   |   |   | $ | 3.19 |   |   | 152,850 |   |   | $ | 3.19 |   |   |
| $3.49 - 4.16                        |       | 225,000                      |       |                         | 9.04       |   |   |   | $ | 3.73 |   |   | 31,250 |   |   | $ | 3.90 |   |   |
| $5.85                               |       | 649,261                      |       |                         | 6.58       |   |   |   | $ | 5.85 |   |   | 487,436 |   |   | $ | 5.85 |   |   |
| $6.76 - 6.96                        |       | 20,000                       |       |                         | 8.58       |   |   |   | $ | 6.86 |   |   | 5,000 |   |   | $ | 6.96 |   |   |
| $7.26                               |       | 307,500                      |       |                         | 8.20       |   |   |   | $ | 7.26 |   |   | 77,250 |   |   | $ | 7.26 |   |   |
| $8.07                               |       | 30,000                       |       |                         | 7.93       |   |   |   | $ | 8.07 |   |   | 15,000 |   |   | $ | 8.07 |   |   |
| $10.34                              |       | 141,018                      |       |                         | 6.58       |   |   |   | $ | 10.34 |   |   | 134,768 |   |   | $ | 10.34 |   |   |
| $12.37                              |       | 5,000                        |       |                         | 7.56       |   |   |   | $ | 12.37 |   |   | 2,500 |   |   | $ | 12.37 |   |   |
| $14.50                              |       | 233,000                      |       |                         | 7.13       |   |   |   | $ | 14.50 |   |   | 119,000 |   |   | $ | 14.50 |   |   |
|                                |       | 2,297,054                    |       |                         | 7.84       |   |   |   | $ | 6.23 |   |   | 1,051,929 |   |   | $ | 7.04 |   |   |
|                                     |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**2004 Employee StockPurchase Plan**

On February 16, 2004,the Company adopted the 2004 Employee Stock Purchase Plan (the “ESPP”). TheESPP provides for an annual increase to be added on the first day of theCompany’s 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 immediatelypreceding fiscal year. As of December 31, 2006, a total of 784,658 sharesof common stock were reserved for issuance under the plan. The ESPP, which isintended to qualify as an “employee stock purchase plan” under Section 423of the Internal Revenue Code of 1986, is implemented utilizing six-monthofferings with purchases occurring at six-month intervals, with a new offeringperiod commencing on the first trading day on or after May 15 and November 15and ending on the last trading day on or before November 14 or May 14,respectively. The Compensation Committee of the Company’s Board of Directorsoversees administration of the ESPP. Employees are eligible to participate ifthey are employed for at least 20 hours per week and more than 5 months in acalendar year by the Company, subject to certain restrictions. The ESPP permitseligible employees to purchase common stock through payroll deductions, whichmay not exceed 15% of an employee’s compensation. The price of common stockpurchased under the ESPP is 85% of the lower of the fair market value of thecommon stock at the beginning of each six-month offering period or on theapplicable purchase date. Employees may end their participation in an offeringat any time during the offering period, and participation ends automaticallyupon termination of employment. The Compensation Committee may at any timeamend or terminate the ESPP, except that no such amendment or termination mayadversely affect shares previously issued under the ESPP. As of December 31,2006, 150,168 shares of common stock had been issued under the ESPP.

**DeferredCompensation Plan**

On February 16, 2004,the Company adopted two executive deferred compensation plans for the benefitof certain designated employees and non-employee directors of the Company. Theplans allow participating employees and non-employee directors to make pre-taxdeferrals of up to 100% of their annual base salary and bonuses, and retainerfees and meeting fees, respectively. The plans allow the Company to makematching contributions and employer profit sharing credits at the solediscretion of the Company. A participant’s interest in each matchingcontribution and employer profit sharing credits, if any, vests in full nolater than after 3 years. As of December 31, 2006, and January 1,2006, the Company has recorded a liability of $1.1 million and $0.9 million,respectively, for employee and non-employee director contributions andinvestment activity to date, which is recorded in other long-term liabilities,and 

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theCompany has provided no matching contributions for the years ended December 31,2006, January 1, 2006 and January 2, 2005.

**12.**          RETIREMENTPLANS

CherokeeEurope maintains a pension plan for certain levels of staff and management thatincludes a defined benefit feature. The following represents the amountsrelated to this defined benefit plan (in thousands):

| ** **                                                                                        | ** ** | **Years Ended**            | ** ** |
|---------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                        | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** | **January 2, 2005** | ** ** |
| **Change in Benefit Obligation:**                                                                 | ** ** |                            | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Benefit obligation, beginning of period                                                           |       |                            | $          | 5,112 |   |   |   | $ | 5,986 |   |   |   | $ | 4,596 |   |   |
| Benefits paid                                                                                     |       |                            | (546       | ) |   |   | (934 | ) |   |   | (13 | ) |   |
| Effect of exchange rate changes                                                                   |       |                            | 744        |   |   |   | (744 | ) |   |   | 539 |   |   |
| Service cost                                                                                      |       |                            | 238        |   |   |   | 152 |   |   |   | 138 |   |   |
| Plan participant’s contributions                                                             |       |                            | 124        |   |   |   | 125 |   |   |   | 114 |   |   |
| Interest cost                                                                                     |       |                            | 200        |   |   |   | 247 |   |   |   | 244 |   |   |
| Actuarial loss                                                                                    |       |                            | 3,130      |   |   |   | 280 |   |   |   | 368 |   |   |
| Benefit obligation, end of period                                                                 |       |                            | $          | 9,002 |   |   |   | $ | 5,112 |   |   |   | $ | 5,986 |   |   |
| **Change in Plan Assets:**                                                                        | ** ** |                            | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Fair value of plan assets, beginning of period                                                    |       |                            | $          | 2,722 |   |   |   | $ | 3,698 |   |   |   | $ | 2,997 |   |   |
| Benefits paid                                                                                     |       |                            | (546       | ) |   |   | (934 | ) |   |   | (13 | ) |   |
| Effect of exchange rate changes                                                                   |       |                            | 407        |   |   |   | (437 | ) |   |   | 335 |   |   |
| Actual return on plan assets                                                                      |       |                            | 1,864      |   |   |   | 13 |   |   |   | 60 |   |   |
| Employer contribution                                                                             |       |                            | 459        |   |   |   | 257 |   |   |   | 205 |   |   |
| Plan participants’ contributions                                                             |       |                            | 124        |   |   |   | 125 |   |   |   | 114 |   |   |
| Fair value of plan assets, end of period                                                          |       |                            | $          | 5,030 |   |   |   | $ | 2,722 |   |   |   | $ | 3,698 |   |   |
| Unfunded status                                                                                   |       |                            | $          | (3,972 | ) |   |   | $ | (2,390 | ) |   |   | $ | (2,288 | ) |   |
| Unrecognized net actuarial gain                                                                   |       |                            | —     |   |   |   | 1,141 |   |   |   | 886 |   |   |
| Accrued pension liability                                                                         |       |                            | $          | (3,972 | ) |   |   | $ | (1,249 | ) |   |   | $ | (1,402 | ) |   |
| **Information for pension plans  with accumulated benefit obligations in excess of plan assets:** | ** ** |                            | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Projected benefit obligation                                                                      |       |                            | $          | 9,002 |   |   |   | $ | 5,112 |   |   |   | $ | 5,986 |   |   |
| Accumulated benefit obligation                                                                    |       |                            | $          | 6,921 |   |   |   | $ | 3,919 |   |   |   | $ | 4,589 |   |   |
| Fair value of assets                                                                              |       |                            | $          | 5,030 |   |   |   | $ | 2,722 |   |   |   | $ | 3,698 |   |   |
| **Components of Net Periodic  Benefit Cost:**                                                     | ** ** |                            | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Service cost                                                                                      |       |                            | $          | 238 |   |   |   | $ | 152 |   |   |   | $ | 138 |   |   |
| Interest cost                                                                                     |       |                            | 200        |   |   |   | 247 |   |   |   | 244 |   |   |
| Expected return on plan assets                                                                    |       |                            | (127       | ) |   |   | (141 | ) |   |   | (143 | ) |   |
| Amortization of net (gain)/loss                                                                   |       |                            | 61         |   |   |   | — |   |   |   | — |   |   |
| Net periodic  benefit cost                                                                        |       |                            | $          | 372 |   |   |   | $ | 258 |   |   |   | $ | 239 |   |   |

 

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| ** **                                               | ** ** | **Years Ended**            | ** ** |
|----------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                               | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** | **January 2, 2005** | ** ** |
| **Weighted average assumptions  used:**                  | ** ** |                            | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| For determining benefit  obligations at the years ended: |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Discount rate                                            |       |                            | 4.50       | % |   |   | 4.00 | % |   |   | 4.50 | % |   |
| Salary increase                                          |       |                            | 3.75       | % |   |   | 3.50 | % |   |   | 3.50 | % |   |
| For determining net  periodic cost for years ended:      |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Discount rate                                            |       |                            | 4.00       | % |   |   | 4.00 | % |   |   | 5.25 | % |   |
| Salary increase                                          |       |                            | 3.50       | % |   |   | 3.50 | % |   |   | 3.45 | % |   |
| Expected return  on assets                               |       |                            | 4.50       | % |   |   | 4.50 | % |   |   | 4.50 | % |   |
| **Pension plan assets:**                                 | ** ** |                            | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Guaranteed insurance  contracts                          |       |                            | 100        | % |   |   | 100 | % |   |   | 100 | % |   |

 

All plan funds are invested with Fortis AG, aninsurance company in Europe, which guarantees the plan a fixed rate of returnbased on rates in effect at the time of deposit. Returns may be higher than thefixed rates due to a profit sharing provision and are dependent on the overallinvestment results of Fortis AG. In general, the assets of the insurancecontracts are primarily invested in Euro bonds with only a small portion inequities.

TheCompany expects to contribute approximately $250,000 to the pension plan infiscal 2007.

| **Estimated future pension  benefit payments (in thousands):** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|
| 2007                                                           |       | $          | 373        |   |
| 2008                                                           |       | 850        |       |
| 2009                                                           |       | 758        |       |
| 2010                                                           |       | 1,545      |       |
| 2011                                                           |       | 1,107      |       |
| Years 2012 - 2016                                              |       | $          | 2,542      |   |

 

The Company maintains aretirement plan (the “401(k) Plan”) in which substantially all domesticemployees are eligible to participate after completing six months ofemployment. The 401(k) Plan allows participating employees to contributeup to 15% of the employee’s pretax compensation, with the Company makingdiscretionary matching contributions. Company contributions fully vest and arenon-forfeitable after the participant has completed five years of service. Forthe years ended December 31, 2006, January 1, 2006, andJanuary 2, 2005, the Company elected to contribute approximately $312,000,$280,000, and $296,000 respectively, to the 401(k) Plan. Beginning withthe year ended December 31, 2006, the Company made quarterly employercontributions to the 401(k) Plan. Prior to January 2, 2006, employercontributions were generally made after the calendar year end. Participants payadministrative costs associated with the 401(k) Plan.

 

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**13.**          CONCENTRATIONS

TheCompany recorded net sales of greater than 10% of total net sales from thefollowing customers:

| ** **   | ** ** | **Years Ended** | ** ** |
|--------------|------------|----------------------|------------|
| **Customer** | ** ** | ** **           | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** | **January 2, 2005** | ** ** |
| A            |       |                 | *          |   |   |   | 10.4 | % |   |   | 17 | % |   |
| B            |       |                 | *          |   |   |   | * |   |   |   | * |   |   |
|              |            |                      |            |  |  |  |  |  |  |  |  |  |  |  |  |

----

*                    Customer netsales were less than 10% of total net sales.

TheCompany has outstanding accounts receivable balances of greater than 10% oftotal net receivables from the following customers:

| ** **   | ** ** | **As of** | ** ** |
|--------------|------------|----------------|------------|
| **Customer** | ** ** | ** **     | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** |
| A            |       |           | *          |   |   |   | * |   |   |
| B            |       |           | *          |   |   |   | 10.3 | % |   |
|              |            |                |            |  |  |  |  |  |  |  |  |

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*                    Customeraccounts receivable balance was less than 10% of total accounts receivable,net.

Although not anticipated, a decision by a majorcustomer to decrease the amount purchased from the Company or to ceasepurchasing the Company’s products could have an adverse effect on the Company’sfuture financial position and results of operations.

TheCompany sells its power supply products to OEMs in the computing and storage,wireless infrastructure, enterprise networking, medical and industrial markets.These activities are managed as a single business and have been aggregated intoa single reportable operating segment. For the years ended December 31,2006, January 1, 2006, and January 2, 2005, net sales by region wereas follows (in thousands):

| ** **                               | ** ** | **Years Ended**            | ** ** |
|------------------------------------------|------------|---------------------------------|------------|
| ** **                               | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** | **January 2, 2005** | ** ** |
| North America  (primarily United States) |       |                            | $          | 75,264 |   |   |   | $ | 63,157 |   |   |   | $ | 83,148 |   |   |
| Europe                                   |       |                            | 53,201     |   |   |   | 50,399 |   |   |   | 59,859 |   |   |
| Asia                                     |       |                            | 16,182     |   |   |   | 8,051 |   |   |   | 5,360 |   |   |
| Other                                    |       |                            | 381        |   |   |   | 472 |   |   |   | 144 |   |   |
|                                     |       |                            | $          | 145,028 |   |   |   | $ | 122,079 |   |   |   | $ | 148,511 |   |   |

 

The Company’s long-livedassets located outside of the United States were $18.2 million and $16.5 millionas of December 31, 2006 and January 1, 2006, respectively.

**14.**          INCOMETAXES

Income(loss) before income taxes consists of the following components (in thousands):

| ** **    | ** ** | **Years Ended**            | ** ** |
|---------------|------------|---------------------------------|------------|
| ** **    | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** | **January 2, 2005** | ** ** |
| United States |       |                            | $          | 7,218 |   |   |   | $ | 4,604 |   |   |   | $ | 10,171 |   |   |
| Foreign       |       |                            | (7,218     | ) |   |   | (6,959 | ) |   |   | 3,066 |   |   |
|          |       |                            | $          | — |   |   |   | $ | (2,355 | ) |   |   | $ | 13,237 |   |   |

 

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Theprovision for current and deferred income taxes consists of the following (inthousands):

| ** **                            | ** ** | **Years Ended**            | ** ** |
|---------------------------------------|------------|---------------------------------|------------|
| ** **                            | ** ** | **December 31, 2006** | ** ** | **January 1, 2005** | ** ** | **January 2, 2005** | ** ** |
| Current:                              |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Federal                               |       |                            | $          | — |   |   |   | $ | (51 | ) |   |   | $ | — |   |   |
| State                                 |       |                            | —     |   |   |   | — |   |   |   | 1 |   |   |
| Foreign                               |       |                            | 653        |   |   |   | 403 |   |   |   | 2,758 |   |   |
| Total current                         |       |                            | $          | 653 |   |   |   | $ | 352 |   |   |   | $ | 2,759 |   |   |
| Deferred:                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |
| Federal                               |       |                            | $          | — |   |   |   | $ | — |   |   |   | $ | — |   |   |
| State                                 |       |                            | —     |   |   |   | — |   |   |   | — |   |   |
| Foreign                               |       |                            | (736       | ) |   |   | 525 |   |   |   | 37 |   |   |
| Total deferred                        |       |                            | $          | — |   |   |   | $ | 525 |   |   |   | $ | 37 |   |   |
| Provision (benefit) for  income taxes |       |                            | $          | (83 | ) |   |   | $ | 877 |   |   |   | $ | 2,796 |   |   |

 

TheCompany’s effective tax rate differs from the federal statutory rate of 34% asfollows (in thousands):

| ** **                                                                        | ** ** | **Years Ended**            | ** ** |
|-----------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                        | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** | **January 2, 2005** | ** ** |
| Worldwide pre-tax  income (loss) at 34% (35% for year ended January 2, 2005) |       |                            | $          | — |   |   |   | $ | (801 | ) |   |   | $ | 4,633 |   |   |
| State tax, net of  federal benefit                                                |       |                            | 168        |   |   |   | — |   |   |   | — |   |   |
| Foreign income  not subject to U.S. tax (benefit)                                 |       |                            | 935        |   |   |   | 847 |   |   |   | (4,082 | ) |   |
| Foreign taxes                                                                     |       |                            | (305       | ) |   |   | 769 |   |   |   | 2,795 |   |   |
| Change in  valuation allowance                                                    |       |                            | (782       | ) |   |   | 248 |   |   |   | (633 | ) |   |
| Other                                                                             |       |                            | (99        | ) |   |   | (186 | ) |   |   | 83 |   |   |
| Provision (benefit) for  income taxes                                             |       |                            | $          | (83 | ) |   |   | $ | 877 |   |   |   | $ | 2,796 |   |   |

 

TheCompany’s deferred income taxes are comprised of the following (in thousands):

| ** **                                     | ** ** | **Years Ended**            | ** ** |
|------------------------------------------------|------------|---------------------------------|------------|
| ** **                                     | ** ** | **December 31, 2006** | ** ** | **January 1, 2006** | ** ** |
| **Net deferred income taxes**                  | ** ** |                            | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Inventory  reserves                            |       |                            | $          | 1,487 |   |   |   | $ | 1,396 |   |   |
| Nondeductible  reserves                        |       |                            | 607        |   |   |   | 50 |   |   |
| Net operating  loss carry-forwards             |       |                            | 24,223     |   |   |   | 20,097 |   |   |
| Fixed assets                                   |       |                            | 418        |   |   |   | 351 |   |   |
| Tax basis step up  from 1999 re-capitalization |       |                            | 32,653     |   |   |   | 36,949 |   |   |
| Other                                          |       |                            | 326        |   |   |   | 29 |   |   |
| Compensation and  pension                      |       |                            | 2,997      |   |   |   | 681 |   |   |
| Credits                                        |       |                            | 954        |   |   |   | 824 |   |   |
| Foreign exchange  gain                         |       |                            | (4,597     | ) |   |   | — |   |   |
| Deferred fire  gain                            |       |                            | (661       | ) |   |   | (708 | ) |   |
| Deferred state  taxes                          |       |                            | (3,537     | ) |   |   | (3,624 | ) |   |
|                                           |       |                            | 54,870     |   |   |   | 56,045 |   |   |
| Valuation  allowance                           |       |                            | (54,587    | ) |   |   | (56,627 | ) |   |
| Net deferred tax asset  (liability)            |       |                            | $          | 283 |   |   |   | $ | (582 | ) |   |

 

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In the opinion of management, it is more likely thannot that deferred tax assets will not be realized in the foreseeable future. Accordingly,management has determined that a full valuation allowance was required as of January 1,2006 and December 31, 2006 for U.S. and certain foreign deferred taxassets.

Cherokee Europe operations have a history of profitsand in the opinion of management, it is more likely than not that the Companyexpects to realize the deferred tax assets. Cherokee Europe has a long termdeferred tax liability related to a prior year gain which is recognized overseveral years for Belgium tax purposes.

Federal and state NOL carry-forwards at December 31,2006 were $42.2 million and $32.2 million, respectively. Federal NOLcarry-forwards begin expiring in 2022 and state NOL carry-forwards beginexpiring in 2014. Foreign NOL carry-forwards were $26.7 million at December 31,2006 and begin expiring in 2010.

Our China operation is not subject to taxes for fiveyears beginning in 2008 due to a tax holiday.

U.S. deferred income taxes were not provided for onundistributed earnings from non-U.S. subsidiaries at December 31, 2006. Thoseearnings are considered to be permanently reinvested in accordance withAccounting Principles Board (APB) Opinion 23 and will not be remitted to theU.S.

The Company believes ithas adequately provided for income tax issues not yet resolved with federal,state and foreign tax authorities. The Company currently has an income taxcontingency related to India operations. During the year ended December 28,2003, the Company paid and expensed an income tax assessment of $0.4 millionfor the three tax years for which an unfavorable ruling was rendered by theIndian tax authority. In addition, the Company accrued a tax contingencyreserve of $0.9 million in the year ended December 28, 2003 for potentialadditional exposure on the same issue related to subsequent years for which anassessment had not been received. During the year ended January 1, 2006,the Company received a favorable ruling on one of the three tax years uponappeal of this decision to the Indian Tribunal. Since the timing and thecertainty of the $0.4 million favorable ruling are not probable, the Companyhas determined to recognize any gain contingency as and when monies arereceived. For the year ended December 31, 2006, it was determined that$0.5 million of the contingency reserve recorded was to be released givenlitigation settlements during 2006. The remaining balance of $0.4 millionrelates to open tax years.  The Companyis currently undergoing an audit in the Netherlands. Based upon a considerationof all relevant facts and circumstances, the Company does not believe theultimate resolution will have a materially adverse effect upon its consolidatedresults of operations or financial condition.

**15.**          GAINFROM INSURANCE PROCEEDS (CHEROKEE EUROPE FIRE)

On January 19, 2004, the Company experienced afire in part of its facility in Belgium, which destroyed certain inventory,property and equipment. The Company was fully insured for the replacement valueof the destroyed items, subject to a $5,000 deductible. As of January 2,2005, the Company had received $3.4 million in insurance proceeds. Withinoperating expenses for the year ended January 2, 2005, the Companyrecorded a loss related to the destroyed inventory, property and equipment.

During the year ended January 1, 2006 we receivedadditional insurance proceeds to compensate us for the replacement value of theassets destroyed. The total recoveries of $6.7 million resulted in a $2.9 milliongain reported in the year ending January 1, 2006. As of December 31,2006, the Company has been reimbursed for the values of the damage property.

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Thefollowing amounts were recorded in our consolidated financial statements forthe years ending January 1, 2006 and January 2, 2005 (in thousands):

| **Write-off of destroyed assets:**                      | ** ** | ** ** | ** ** |
|---------------------------------------------------------|------------|------------|------------|
| Inventory                                               |       | $          | 2,437      |   |
| Warehouse and  equipment, net book value                |       | 158        |       |
| Supplies and  other expenses                            |       | 1,203      |       |
| Total destroyed  assets                                 |       | $          | 3,798      |   |
| **Insurance proceeds:**                                 | ** ** | ** ** | ** ** |
| Proceeds received  in year ended December 31, 2004 |       | $          | 3,385      |   |
| Proceeds received  in year ended December 31, 2005 |       | 3,311      |       |
| **Total recoveries**                                    |       | $          | 6,696      |   |

 

**16.**          SUBSEQUENTEVENTS

**China Facility—New Line of Credit**

In January 2007, Cherokee China entered into aloan contract with Industrial and Commercial Bank of China Ltd. (“ICBC”) for aworking capital line of credit. Pursuant to the contract, ICBC agreed to makeadvances up to the equivalent of approximately $3.0 million, expressed as RMB25.0 million. The line of credit is collateralized by the Company’s building inShanghai, China. The term ends January 29, 2008 but is cancelable at anytime. Interest is payable monthly at a variable rate as announced by the People’sBank of China, which was 6.55% at January 29, 2007 and 6.04% at March 20,2007, based on dates amounts were borrowed. Beginning with its initialborrowing under the contract, Cherokee China has agreed to deposit in the ICBCShanghai Branch at least 90% of the operating revenue it collects. As of March 31,2007, Cherokee China had $1.3 million under the line of credit and was incompliance with all covenants.

The Company closed itsmanufacturing operation in Guadalajara, Mexico in March 2007, and movedits operations to its newly developed facility in Shanghai, China (the “ChinaFacility”) that began operations in 2006. In February 2006, the Companyopened a new, 120,000 square foot, state-of-the-art manufacturing facility inShanghai, China and has begun consolidating high volume, low mix manufacturingfrom plants that are more costly to operate to this new facility. The designand location of the new China Facility improves the Company’s and its customers’supply chains as an increasing number of Cherokee’s customers and suppliershave their own manufacturing operations in China. It also positions the Companyto take advantage of the overall business growth in Asia.

**GE Capital Credit Facility—Waiver**

As of December 31, 2006, we were in compliancewith our covenants set forth in the agreements. However, as of April 2,2007, we were out of compliance with the requirement that we submit our annualaudited financial statements to GE Capital Corporation, the agent under ourrevolving credit facility, within 120 days of our fiscal year end. We haveobtained a waiver of this default from GE Capital Corporation effective May 10,2007. This waiver extends the deadline for submitting our audited financialstatements until August 31, 2007.

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON SCHEDULE**

To the Board of Directors and Stockholders

**CHEROKEE INTERNATIONAL CORPORATION:**

We have audited theconsolidated financial statements of Cherokee International Corporation andSubsidiaries as of December 31, 2006 and for the year then ended and haveissued our report thereon dated May 21, 2007. Our audit was conducted for thepurpose of forming an opinion on the basic consolidated financial statementstaken as a whole. The information included in the accompanying Schedule II—Valuationand Qualifying Accounts is presented for purposes of complying with theSecurities and Exchange Commission’s rules and is not a required part of thebasic consolidated financial statements. Such information for the year endedDecember 31, 2006 has been subjected to the auditing procedures applied in theaudit of the basic consolidated financial statements and, in our opinion, isfairly stated in all material respects in relation to the basic consolidatedfinancial statements taken as a whole.

/s/    MAYER HOFFMAN MCCANN P.C.

MAYER HOFFMAN MCCANN P.C.

OrangeCounty, California

May 21, 2007

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**CHEROKEEINTERNATIONAL CORPORATIONSCHEDULE II VALUATION AND QUALIFYING ACCOUNTS(in thousands)**

| ** **                             | ** ** | **Balance At  Beginning  of Period** | ** ** | **Charged  to  Cost And  Expenses** | ** ** | **Deductions** | ** ** | **Balance At  End  of Period** | ** ** |
|----------------------------------------|------------|------------------------------------------------|------------|------------------------------------------|------------|----------------|------------|------------------------------------------|------------|
| ALLOWANCE  FOR DOUBTFUL ACCOUNTS: |       |                                           |       |                                     |       |           |       |                                     |       |   |   |   |   |   |   |   |   |
| Year ended  January 2, 2005       |       |                                           | $          | 134                                      |       |           |       | $                                        | 60         |   |   |   | $ | (70 | ) |   |   | $ | 124 |   |   |
| Year ended  January 1, 2006       |       |                                           | $          | 124                                      |       |           |       | $                                        | 272        |   |   |   | $ | (36 | ) |   |   | $ | 360 |   |   |
| Year ended  December 31, 2006     |       |                                           | $          | 360                                      |       |           |       | $                                        | 51         |   |   |   | $ | (119 | ) |   |   | $ | 292 |   |   |

 

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**ITEM 9.**   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ONACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**   CONTROLS AND PROCEDURES

*Disclosure Controlsand Procedures*

Our management, with the participation of ourPresident, Chief Executive Officer and Director, and our Executive VicePresident, Chief Financial Officer and Secretary, has evaluated theeffectiveness of our disclosure controls and procedures (as such term isdefined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the endof the period covered by this report. The evaluation included certain controlareas in which we have made, and are continuing to make, changes to improve andenhance controls.  Based on suchevaluation, our President, Chief Executive Officer and Director, and ourExecutive Vice President, Chief Financial Officer and Secretary have concludedthat, as of the end of such period, our disclosure controls and procedures werenot effective.

A material weakness is acontrol deficiency or a combination of control deficiencies that results inmore than a remote likelihood that a material misstatement of the annual orinterim consolidated financial statements will occur and not be prevented ordetected. In conducting its assessmentof the effectiveness of our internal control over financial reporting, ourmanagement concluded the following material weaknesses existed as of December 31,2006:

*Architecture ofCompany’s IT systems does not presently support the financial reportingrequirements of the Company’s International operations.*

Our subsidiaries in Mexico, India and China (and ourformer subsidiary in Mexico) all maintain disparate financial accountingsystems that do not interface with the Company’s primary ERP system, resultingin duplicate accounting entries on multiple sysrems. This causes a protractedreporting cycle with insufficeient or untimely oversight from corporateheadquarters of transactional details at our international sites. Site levelfinancial statements are delivered on spreadsheets to the corporate office forconsolidation.

Our European operation has its own separate ERP systemthat is integrated into the local accounting system, however this system doesnot automatically interface financially with our corporate headquarters. Therefore,financial results are also delivered to our corporate office by means ofspreadsheets, and the corporate office also has insufficient visibility totransactional details.

The consolidation of all these local results deliveredon spreadsheets is in turn prepared on spreadsheets at our corporate office.Consolidations performed on spreadsheets are prone to human error and aredifficult to review. In addition, because spreadsheet maintenance of theconsolidation process by necessity is a one person task and the personperforming that task also makes journal entries, this process results in aninadequate  segregation of duties. Assuch, the existing consolidation process requires additional monitoring andoversight that was not performed because of staffing constraints in theaccounting area. Segregation of duties, oversight and monitoring are discussedin more detail below.

We have identified and areworking on the following remediations to resolve the weakness over global financialreporting: The Company will perform a comprehensive assessment of its currentIT architecture and projected IT requirements to develop a new IT strategy.Presently the Company believes the existing corporate ERP system can betailored for use as the mechanism to automate, report and consolidate ourforeign subsidiary trial balance results. We have already started writing webbased interfaces for the existing ERP and local accounting systems in China. Weneed to examine and decide what IT solutions will 

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berequired for our other locations The Company will have to evaluate and decidehow to supplement these technical IT solutions with additional staffing andimproved internal procedures.

*The methodology andsupport for valuing inventory*

Historically, the Company has never required trackingdirect labor on an individual product basis. The Company’s historical methodfor capitalizing labor and overhead did not reflect fundamental changes in thebusiness resulting from the diversion of manufacturing to Mexico and India totake advantage of reduced labor cost.

Also, the methodology, assumptions and support fordetermining inventory reserves, specifically surplus and obsolescence, need tobe enhanced. This weakness also appeared in our 2004 report and has now resurfaced.Finally, during the Company’s year-end physical inventory in India the Companydetermined that cost of sales was being improperly valued.

We have since corrected the improper valuation of costof sales in India.

We have also corrected thecalculation for capitalizing inventory. This calculation is now subject todirect oversight. In addition, we are now establishing standardized labor bymodel to support capitalization of labor to finished goods. The methodology andsupport for maintaining our inventory reserves, specifically surplus andobsolescence, has been under review and needs to be implemented. The corporateoffice has also taken the additional step of using the ERP system informationto verify monthly cost of sales in both India and China.

*Segregation ofduties*

The lack of an integratedfinancial reporting system creates the need for significant manual interventionand staffing to prepare spreadsheets, create eliminating entries, make taxadjustments and US GAAP adjustments and for other matters. In order toaccomplish all these and other manual tasks with existing corporate personnel,segregation of duties is not always considered. In certain instances,  the person performing the consolidation alsoprepared and recorded journal entries, an inadequate segregation of duties. TheCompany will evaluate the financial reporting and consolidation process toidentify areas where segregation of duties needs improvement. We intend toresolve these issues through procedural changes, staffing and/or additionaloversight.

*Oversight andmonitoring controls*

Our remote locations, other than Europe, have onelocal controller with little more than clerical support to maintain the localaccounting system, transport information from our ERP system to their localbooks, report financial statements to our headquarters in the US and performroutine functions like account reconciliations. Our controllers in Mexico andIndia have not been performing normal accounts payable reconciliations,recording in-transit inventory or correctly calculating cost of sales.

We have identifiedand have performed or are working on the following remediations to resolve theweakness in oversight and monitoring controls over international financialreporting:

·       Fiscalyear 2006 was the first full year in the Company’s history in which thesubsidiary controllers in our international sites did not report directly totheir local country managers. All subsidiary controllers now report to our newcorporate controller in the U.S. This change was made in the fourth quarter of2005.

·       In2006, the Company began the process of adding structure and uniformity ofaccounting standards and process among our site controllers by holding ourfirst controllers’ conference at our corporate office. We started the criticalself review of how accounting is performed worldwide.

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·       Morefocused internal audits of past problem areas need to be planned and executed.

·       TheCompany also has a new director of internal audit, a new corporate controllerand a new IT manager.

·       Enhancedoversight of the normal closing process needs to be planned and any additionalstaffing changes, training or additions made.

·       OurMexico facility is now closed and employees have been dismissed or are in theprocess of being severed.

·       Aninternal audit plan for monitoring and training our subsidiary controllers willbe developed with the audit committee.

·       The intercompany pricingissues in India that caused the cost of sales error have been resolved and theU.S. corporate office is performing monthly verification of ERP generated costof sales and inventory information in India and China.

*Internal ControlOver Financial Reporting*

In late March 2006, the Company learned thatemployees of its Indian subsidiary manufacturing operations had made certainunauthorized payments that may have been in violation of the Foreign CorruptPractices Act and local laws. The facility in India is used for the solepurpose of manufacturing products for other Company locations and, as such,does not generate revenue or issue invoices to external customers. Itmanufactures approximately 6% (by volume) of the products offered by theCompany.

The subjectpayments, in the aggregate, amount to approximately $40,000 in 2004 and 2005,and less than $10,000 in 2006. The Company retained outside counsel whoconducted an internal investigation into these payments. In January 2007,the Company’s outside counsel met with the SEC to discuss the results of theinternal investigation. During 2006, the Company and members of its internalaudit function spent considerable time remediating this weakness to preventsuch disbursements in the future. The Company completed the following actions:

·       Interviewedtop management at each Cherokee location and conducted Foreign Corrupt PracticesAct testing as a part of internal audit work during 2006. In China local legalcounsel was engaged to perform interviews and provided an attestation. Noissues were found. In Europe no issues were found. In India during a follow upaudit no issues were found. The Mexico facility has been closed and was nottested.

·       Formallyreprimand the General Manager of the Company’s India subsidiary. The GeneralManager and Controller of India were reprimanded in writing and a copy of thereprimand was placed in their personnel files.

·       Cherokeehired a local lawyer in India to handle negotiations with the local union. Hesuccessfully resolved many of the union’s issues and now sits on the uniongrievance committee.

·       Correctedthe Company’s 2005 and 2006 internal accounting records to properly record theunauthorized payments. The Company through internal audit reviewed andcorrected its records in the second quarter of 2006.

·       Replacedthe local India statutory auditor. His term expired September 2006 and wasnot renewed.

·       Assessedall facility deficiencies at the India plants. Local and US managementperformed a comprehensive review of all safety and materials handling issues. CherokeeIndia adjusted procedures and petitioned the local business zone for waivers tobecome compliant with local laws and guidelines.

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·       Improvedthe controls over cash handling and record retention. Copies of checks and cashwithdrawals are now retained, check listings are prepared and physical cashonsite has been reduced. These improvements were verified by internal audit in December 2006with no issues found.

·       Wenow require all executive management to provide quarterly representationletters in addition to general managers, controllers and financial staff, whohad been providing them previously. We have also expanded the scope ofrepresentations effective with the second quarter of 2006 to specifically coverFCPA issues.

The Company believes, asof December 31, 2006 it has fully remediated this material weakness.

*Insufficient Controlsover the Preparation of the Income Tax Provision*

As previously disclosed in the Company’s QuarterlyReport on Form 10-Q, management identified a weakness in internalcontrols over the determination and reporting of the provision for income taxesfor the quarterly period ended July 2, 2006. Specifically, the Company didnot maintain effective controls to review and monitor the accuracy ofsignificant estimates that impacted the components of the income tax provisioncalculations. This control deficiency resulted in a material adjustment duringthe preparation of the unaudited consolidated financial statements as of andfor the three months ended July 2, 2006. Additionally, this controldeficiency could result in a misstatement of the income tax provision orrelated deferred income tax balances that would result in a materialmisstatement to the annual or interim consolidated financial statements thatwould not be prevented or detected. Accordingly, management determined thatthis control deficiency constituted a material weakness.

The Company has remediatedthis material weakness by retaining third-party consultants with significanttax and financial reporting experience to provide assistance in complying withUS GAAP and SEC reporting requirements. The Company has revised its quarterlyclosing procedures to ensure an improved flow of information obtained fromforeign jurisdictions. In addition, the Company has refined its methodology forcalculating the quarterly provision to more accurately reflect and reduce itsreliance on future estimated taxable income by jurisdiction. The Company beganimprovement efforts subsequent to the quarter ended July 2, 2006 and priorto the filing of its Quarterly Report on Form 10-Q for that quarter.The Company believes, as of December 31, 2006 it has fully remediated thismaterial weakness.

*Effectiveness ofRemediation Efforts*

The remediation of the weaknesses identified above andtheir associated risks is dependent on the Company’s ability to address theseissues effectively. The issues of  ITsystems, people and process are interrelated and difficult to separate. Striking the optimum balance betweenimproved process, better trained and supervised staff and mission critical ITimprovements is essential for success.

Except as noted above,there have not been any changes in our internal control over financialreporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) underthe Exchange Act) during our fourth fiscal quarter that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

**ITEM 9B.**   OTHERINFORMATION

None.

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**PART III**

**ITEM 10.**         DIRECTORSAND EXECUTIVE OFFICERS OF THE COMPANY

Thefollowing table sets forth certain information regarding our directors as of May 15,2007:

| **Name of Director** | ** ** | ** ** | ** ** | **Age** | ** ** | **Position**                                     | ** ** |
|--------------------------------|------------|------------|------------|---------|------------|--------------------------------------------------|------------|
| Raymond Meyer                  |       |       | 66         |    |       | Chairman  of the Board                           |       |
| Jeffrey Frank                  |       |       | 52         |    |       | President,  Chief Executive Officer and Director |       |
| Vincent Cebula                 |       |       | 43         |    |       | Director                                         |       |
| Clark Michael  Crawford        |       |       | 61         |    |       | Director                                         |       |
| Daniel Lukas                   |       |       | 36         |    |       | Director                                         |       |
| Larry Schwerin                 |       |       | 50         |    |       | Director                                         |       |
| Edward Philip Smoot            |       |       | 69         |    |       | Director                                         |       |

 

*Raymond Meyer*became a member of our board of directors in December 2004,and he was appointed Chairman of the Board in December 2006. Mr. Meyerhas more than 30 years of electronics industry experience and has been anindependent consultant since 1997. Mr. Meyer was president of DeltecElectronics from 1984 to 1997. Prior to that time, he held executive positionsin the ACDC Division of Emerson Electric Company.

*Jeffrey Frank*joined Cherokee in September 2001 asPresident, Chief Executive Officer and a member of our board of directors.Prior to joining Cherokee, Mr. Frank was President of Lambda LEI from July 2000through September 2001. From May 1996 to March 2000, Mr. Frankwas President of Polestar Laboratories. Mr. Frank has over 23 years ofexperience in the electronics industry, of which he spent twelve years withDeltec Electronics, a manufacturer of uninterruptible power supplies that aremarketed to original equipment manufacturers globally.

*Vincent Cebula*became a member of our board of directors in April 2006.Since June 1995, Mr. Cebula has been a Managing Director of OaktreeCapital Management, LLC, a private equity investment management firm thatinvests in a wide range of public and private securities.

*Clark Michael Crawford*became a member of our board of directors in January 2003.Mr. Crawford has held several key management positions for both VerizonCommunications Inc. and GTE Corporation. At GTE, from June 1993 to June 2000,Mr. Crawford served as Vice President of West Area Operations, Presidentof GTE California, Vice President of Information Technology, President of GTEData Services and Chairman of GTE Commercial Services. Subsequent to his workat GTE, Mr. Crawford served as Senior Vice President, Service Assurancefor Verizon from June 2000 until his retirement from Verizon in July 2001.

*Daniel Lukas*became a member of our board of directors in September 2006.Mr. Lukas has been Managing Director with the New York office of GSCPartners since 2006. From March 2003 until 2005, Mr. Lukas was aManaging Director with GSC Partners. GSC Partners, with offices in New York,New Jersey, Los Angeles and London, is a registered investment advisor with$10.7 billion of assets under management. From December 2000 until March 2003,Mr. Lukas was with Thomas Weisel Partners, where he served as a VicePresident in the private equity and debt funds groups. He began his career inthe Investment Banking Division of Goldman, Sachs & Co.

*Larry Schwerin*became a member of our board of directors in February 2007.Since January 2005, Mr. Schwerin has been the president and CEO ofCapella Photonics, Inc., a privately held company headquartered in SanJose, California, that specializes in wavelength switching subsystems forcommunication networks. He has more than 20 years of firsthand experience intelecommunications, technology, and venture capital. Previously, from April 2001to December 2004, Mr. Schwerin served as general partner withVanguard Ventures focusing on investment in early stage advanced technology 

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*companies.Mr. Schwerin started his professional career at AT&T BellLaboratories, and later became general manager of AT&T’s Global FiberAccess Systems, and led the world-wide deployment of Fiber to the Homeactivities. He also served as a founder and general manager of LucentTechnologies’ Wireless Broadband Networks Division. Mr. Schwerin graduatedwith highest honors from Drexel University with a Bachelor of Science degree inElectrical Engineering. He achieved highest honors with a Master in Sciencedegree in Electrical Engineering from Cornell University.*

*Edward Philip Smoot*became a member of our board of directors in December 2006.Mr. Smoot has been president, chief executive officer and chairman of SanDiego-based Anacomp, Inc. since January 2005. His responsibilitiesinclude overall corporate strategy and management of the day-to-day operationsof Anacomp’s global business units. Prior to joining Anacomp, from April 2001to December 2004, Mr. Smoot was the General Partner of VanguardVentures, a firm that invested in communications and technology companies. Mr. Smoothas spent the majority of his 40-year career in global manufacturing andservice-related businesses.

**Code of Ethics**

The Company has adopted aCode of Ethics for the Chief Executive Officer, President and Senior FinancialOfficers. A copy of the Code of Ethics is available at the Company’s website at*http://www.cherokeepwr.com*. We intend to satisfy the disclosurerequirement under Item 5.05 of Form 8-K regarding an amendmentto, or a waiver from, a provision of the Code of Ethics, by posting suchinformation on the Investor Relations section of our website:http://www.cherokeepwr.com/.

**Board Committees**

*Audit Committee*

The audit committeeselects, on behalf of Cherokee and our board of directors, an independentpublic accounting firm to be engaged to audit our financial statements,assesses the independence of our auditors, reviews and discusses the auditedfinancial statements with the independent auditors and management andrecommends to our board of directors whether the audited financials should beincluded in our Annual Reports on Form 10-K to be filed with theSecurities and Exchange Commission, or the SEC. The audit committee iscomprised of Mr. Smoot (chair), Mr. Meyer and Mr. Schwerin, eachof whom is an independent director. Mr. Smoot has been identified by ourboard of directors as an Audit committee financial expert. During fiscal year2006, the audit committee met 11 times.

*Nominating andCorporate Governance Committee*

The nominating andcorporate governance committee identifies individuals qualified to serve asmembers of our board of directors, recommends director nominees for our annualmeetings of stockholders, evaluates the performance of our board of directorsand recommends corporate governance guidelines to our board of directors. Themembers of our nominating and corporate governance committee are Mr. Meyer(chair) and Mr. Smoot. During fiscal year 2006, the nominating andcorporate governance committee met two times.

*CompensationCommittee*

The compensation committeereviews and recommends to the board of directors the annual salaries and othercompensation of our executive officers and stock and stock option grants issuedas compensation to directors for their service on the board. The materialprinciples underlying the Company’s executive compensation policies anddecisions and the factors relevant to analysis of these policies and decisionsare set forth under the heading “Compensation Discussion and Analysis” below. Thecompensation committee directly administers our equity compensation plans andhas the authority to grant stock options and other 

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forms ofequity compensation to our executive officers and other employees. Thecompensation committee also provides assistance and recommendations withrespect to our compensation policies and practices. The compensation committeeconsists of Mr. Crawford (chair), Mr. Meyer and Mr. Smoot, eachof whom is an independent director. During fiscal year 2006, the compensationcommittee met two times.

**StockholderCommunications with Board of Directors**

Stockholders who wish tocommunicate with a particular board member, or with the board as a whole, maysend a written communication to Cherokee International Corporation, 2841 DowAvenue, Tustin, California 92780, Attention: Secretary. The Secretary willforward such communication to the full board or to any individual director ordirectors to whom the communication is addressed.

**Section 16(a) Beneficial OwnershipReporting Compliance**

Section 16(a) of the Exchange Act requiresour officers and directors and persons who own more than 10% of a registeredclass of our equity securities to file reports of ownership on Form 3 andchanges in ownership on Form 4 or 5 with the SEC. Such officers,directors, and 10% stockholders are also required by SEC rules andregulations to furnish us with copies of all Section 16(a) reportsthey file.

Based solely on our reviewof the copies of such forms received by us, we believe that, during the fiscalyear ended December 31, 2006, all Section 16(a) filingrequirements applicable to our officers, directors, and 10% stockholders werecomplied with, except that certain transactions by Raymond Meyer occurringbetween December 2, 2005 and December 12, 2005 and between November 17,2006 and December 1, 2006 were reported on a Form 4 filed on December 7,2006.

**ITEM 11.**         EXECUTIVECOMPENSATION

**COMPENSATIONDISCUSSION AND ANALYSIS**

**Overview**

The Compensation Committee of the board of directorsoversees aggregate executive compensation, including salary, bonus, long-termequity incentives and perquisites. The Compensation Committee’s goal is tomaintain our executive compensation at a level competitive with peer companiesin the electronics industry that are approximately the same size as Cherokee interms of number of employees, revenue and market capitalization.

While the Compensation Committee has ultimate decisionmaking responsibility with respect to executive compensation, the CompensationCommittee encourages management participation and input. Other members of theboard of directors also provide valuable input to the executive compensationprocess.

In developing ourcompensation programs and policies, the Compensation Committee relies oninformation obtained from surveys, proxy statements and information fromcertain of the companies that comprise our peer group. During 2005, theCompensation Committee retained Towers Perrin, a human resources compensationconsulting firm, to recommend executive salaries and benefits. Theserecommendations were used in 2006 to insure that our compensation policies andlevels were competitive within our industry. We also conducted a benchmarkingstudy in 2006 to further ensure that our salaries and benefits are competitivewithin our industry.

**ExecutiveCompensation Philosophy and Objectives**

The primaryobjectives of our executive compensation policies are to:

·       Attract,motivate and retain highly qualified executives;

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·       Alignmanagement and stockholder interests by tying cash compensation and long-termequity incentive programs to financial performance, including increased returnsto our stockholders; and

·       Reward executives basedupon our financial performance at levels competitive with peer companies.

**Key Elements ofCompensation**

*1.  Salary*

We intend that the basesalary of our executive officers will be consistent with the overallresponsibilities of the position and with the salaries of comparable managementpositions in competitive companies.

*2.  Bonus*

In addition to the base salaries of our executiveofficers, we provide an annual bonus, which is based on our financialperformance and, in the case of certain of our executive officers, theindividual executive’s performance against strategic goals established by managementand the board of directors at the beginning of the fiscal year. In order toimplement our philosophy that executives be rewarded for achieving positivefinancial results and other strategic goals, the Compensation Committee hasdesigned our cash incentive bonus plan to significantly affect the totalcompensation of our executives depending on our success in meeting annualfinancial and strategic goals.

During 2006, Cherokee did not pay a bonus to any ofour executive officers because our 2005 financial performance did not meet thestandards set by the Compensation Committee. The Compensation Committeecontinues to ensure that the goals it sets in connection with our cashincentive bonus plan are aggressive, relative to industry conditions and other factors,emphasizing revenue growth and overall financial performance. During 2007, wewill pay management bonuses with respect to our 2006 financial performancebecause the sales and operating margin targets set under our 2006 cashincentive bonus plan were met.

Our 2007 management bonus plan is designed to rewardselected managers when we meet specific revenue and financial goals. The planbecame effective January 1, 2007 and superseded all other bonus plans thatwere in effect prior to that date. The plan will remain in effect until December 31,2007. Cherokee reserves the right to alter or amend bonus rates, quotas or anypart of the plan as it deems necessary or desirable. The available bonus isbetween 17.2% and 120% of base salary for executive officers. Performancetargets are based on revenues and EBITDA, which the Compensation Committeebelieves are a reflection of Cherokee’s operating performance and whichdirectly influence return to our stockholders. The Compensation Committee hasconcluded that the achievement of the performance targets is substantiallyuncertain.

In the event theemployment of a participant is terminated for any reason (other than asprovided in the severance agreements between Cherokee and each of Messrs. Frank,Fox and M. Patel), any bonus otherwise payable under the plan shall bepermanently forfeited. Any bonuses will be paid in the year following the planyear and after our independent auditors have issued their audit opinion withrespect to the financial results for the applicable year. Payments normallyoccur during March or April. A total of eight officers participate in the2007 bonus plan, including our executive officers and certain other members ofsenior management.

*3.  Long-Term Equity Compensation*

Long-term equity incentives, including stock optionsand stock purchase rights granted pursuant to our stock option and employeestock purchase plans, directly align the economic interests of our executive 

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officers and otheremployees with those of our stockholders. Stock options are a particularlystrong incentive because they are valuable to employees only if the fair marketvalue of our common stock increases above the exercise price, which is set atthe fair market value of our common stock on the date the option is granted. Inaddition, employees must remain employed with the company for a fixed period oftime, generally four years, in order for their options to vest fully. Optionsare granted to employees and executives following a yearly review of individualperformance and consideration of the individual’s long-term value to us. Indetermining the number of options to award to any individual, the CompensationCommittee works with our Chief Executive Officer and considers hisrecommendations as to the position and recommended option grant. Board membersoutside of the Compensation Committee are also consulted in the case of optiongrants to senior management.

During 2006, we made stock option grants to sixemployees, none of whom were executive officers. Our last broad-based employeestock option grants were made in December 2005. The Compensation Committeecontinues to believe that our stock option plan is a valuable tool forcompensating employees and will consider offering stock options in 2007, as ithas in prior years.

Historically, we have granted stock options with anexercise price equal to the closing price of our common stock on the NasdaqNational Market on the date of the grant. Stock options are typically grantedat a meeting of the Compensation Committee. General annual option grants to keyemployees, including our executive officers, are made once annually eitherduring the last quarter of the year or during the first quarter of the nextyear, while individual grants are made on a selective basis in connection withthe hiring of key employees. In addition, each non-employee director is grantedan option to purchase 10,000 shares of our common stock on the date immediatelyfollowing each annual meeting of stockholders. We have no practice of timingoption grants in coordination with the release of non-public information, nordo we time the release of non-public information to affect the value ofexecutive compensation.

We also maintain a taxqualified employee stock purchase plan (the “ESPP”) that allows employees topurchase our common stock at a discount. The ESPP has six-month offeringperiods that allow participants to purchase our common stock at 85% of thelesser of (i) the fair market value of our common stock on the participant’sentry date into the offering period or (ii) the fair market value of ourcommon stock on the purchase date. Participants may contribute up to 15% oftheir compensation through payroll deductions to purchase shares under theESPP, subject to an annual individual limitation of $25,000 as set by law.

*4.  Perquisites*

We offer a deferredcompensation plan to all of our employees. We do not have a defined benefitpension plan, except for the employees of our European operations. We providean executive medical plan, and Mr. Frank receives a car allowance. Weconsider providing tax gross-ups in the case of executive relocations.

**Compensation ofChief Executive Officer**

The base salary for Mr. Frank, our ChiefExecutive Officer, is evaluated based on the achievement of Cherokee’sobjectives and performance. In addition, we conduct a salary review againstprevailing levels of pay among chief executives of companies identified as ourpeers. Based on such a review, the Compensation Committee increased Mr. Frank’sbase salary to $307,000 effective November 2006. Mr. Frank did notreceive any payment under our cash incentive bonus plan during 2006, because wedid not achieve our revenue and financial performance targets for the 2005fiscal year. However, Mr. Frank earned a cash bonus of $320,000 for fiscalyear 2006, because our revenue and profit targets were met for that year.

The Compensation Committeegrants stock options to our Chief Executive Officer based primarily on itsevaluation of his ability to influence our long-term growth and profitability.During 2006, we did not 

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grantany stock options to our Chief Executive Officer. The Compensation Committeewill consider granting stock options during 2007 as it has in many prior years.

**Compensation ofOther Executive Officers**

The Compensation Committee follows the executivecompensation philosophy and objectives described above in determining compensationfor our other executive officers. The Chief Executive Officer recommends to theCompensation Committee base salaries for executive officers that are comparableto the salaries of persons holding similar positions at peer companies. Insetting executive officer salaries, the Chief Executive Officer and theCompensation Committee also consider factors such as our performance relativeto peer companies and the individual officer’s past performance and futurepotential.

As noted above, cashbonuses were not awarded to executive officers during 2006 in accordance withour cash incentive bonus plan because we did not achieve our revenue andfinancial performance targets for 2005. The Compensation Committee made anexception for three officers who were awarded bonuses based on theirachievement of individual management objectives. Performance metrics for 2005were based on sales and operating margin targets set at the beginning of thefiscal year. As with option grants to our Chief Executive Officer, the size ofthe stock option grant to each executive officer is determined by theCompensation Committee’s evaluation of that officer’s ability to influence ourlong-term growth and profitability. In addition, the Compensation Committeeconsiders the incentive effect of additional option grants in connection withthe number of stock options then held by such executive officers and theportion of those options that have not yet vested. During 2006, we did not makea general grant of stock options to our executive management team.

**Amended andRestated Severance Agreements**

In November 2006, weentered into Amended and Restated Severance Agreements with Messrs. Frank,Fox and M. Patel. The agreements with Mr. Frank and Mr. Fox include achange in control provision whereby we must pay certain benefits to Mr. Frankand Mr. Fox if either is terminated other than for “cause,” or if Mr. Frankor Mr. Fox resigns for “good reason,” within two years following a “changein control” of Cherokee (as such terms are defined in the applicable agreement).We negotiated these agreements in order to ensure that Messrs. Frank andFox can be relied on in the event of a potential change in control transactionto support our efforts with respect to the pending transaction. The board ofdirectors believes these agreements equitably balance the interests of ourstockholders and the covered executives.

**Tax Considerations**

Under Section 162(m) ofthe Internal Revenue Code, we may not receive a federal income tax deductionfor compensation paid to any of the four most highly compensated executiveofficers to the extent that any of these persons receives more than $1,000,000in compensation in any one year. However, if we pay compensation that is “performance-based,”under Section 162(m) we can receive a federal income tax deductionfor the compensation paid even if such compensation exceeds $1,000,000 in asingle year. In 2006, all compensation paid to executives will be deductiblefor tax purposes. To maintain flexibility in compensating executive officers ina manner designed to promote varying corporate goals, the compensationcommittee has not adopted a policy that all compensation must be deductible onour federal income tax returns.

**CompensationCommittee Interlocks and Insider Participation**

No member of ourcompensation committee is a current or former officer of Cherokee or any of itssubsidiaries. None of our executive officers serves as a member of the board ofdirectors or compensation 

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committeeof any company that has one or more of its executive officers serving as amember of our board of directors or compensation committee.

**REPORT OF THECOMPENSATION COMMITTEE**

We have reviewed and discussed the CompensationDiscussion and Analysis with the Company’s management. Based on such review anddiscussion, we have recommended to the board of directors that the CompensationDiscussion and Analysis be included in this Proxy Statement.

*CompensationCommittee*

Clark Michael Crawford,ChairmanRaymond MeyerEdward Philip Smoot

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**2006 SUMMARYCOMPENSATION TABLE**

The table below summarizes the total compensation awardedto, earned by or paid to each of our named executive officers for the fiscalyear ended December 31, 2006. 

| **Name and Principal Position**                               | ** ** | ** ** | ** ** | **Year** | ** ** | **Salary  ($)** | ** ** | **Non-Equity   Incentive Plan  Compensation  ($)** | ** ** | **Stock Awards  ($)** | ** ** | **All Other  Compensation  ($)** | ** ** | **Total  ($)** | ** ** |
|------------------------------------------------------------------------------|------------|------------|------------|----------|------------|-----------------|------------|--------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------|------------|----------------|------------|
| Jeffrey Frank  President, Chief Executive Officer and Director               |       | 2006       |       | $        | 294,678    |            |       | $                                                            | 320,000    |                       |       |                                  | $          | 77,531         |       |   |   | $ | 23,781 | (1) |   | $ | 715,990 |   |
| Linster Fox  Executive Vice President, Chief Financial Officer and Secretary |       | 2006       |       | $        | 203,846    |            |       | $                                                            | 160,000    |                       |       |                                  | $          | 40,708         |       |   |   | $ | 8,671 | (2) |   | $ | 413,225 |   |
| Bud Patel  Executive Vice President                                          |       | 2006       |       | $        | 242,058    |            |       | $                                                            | 227,424    |                       |       |                                  | $          | 72,092         |       |   |   | $ | 16,227 | (3) |   | $ | 557,801 |   |
| Mukesh Patel  Executive Vice President of Global Operations                  |       | 2006       |       | $        | 190,228    |            |       | $                                                            | 148,400    |                       |       |                                  | $          | 67,560         |       |   |   | $ | 36,805 | (4) |   | $ | 442,993 |   |
| Alex Patel  Vice President of Engineering                                    |       | 2006       |       | $        | 182,813    |            |       | $                                                            | 138,240    |                       |       |                                  | $          | 43,578         |       |   |   | $ | 14,082 | (2) |   | $ | 378,713 |   |

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(1)          The following amountsare included in “All Other Compensation” for Mr. Frank: car allowance of$10,592, group health and life insurance premiums of $6,889 and 401(k) employermatching contributions of $6,300.

(2)          The following amountsare included in “All Other Compensation” for Mr. Fox: group health andlife insurance premiums of $7,197 and 401(k) employer matchingcontributions of $1,474.

(3)          The following amountsare included in “All Other Compensation” for Mr. B. Patel: group healthand life insurance premiums of $6,862, 401(k) employer matchingcontributions of $6,300 and cash in lieu of vacation time of $3,065.

(4)          The following amountsare included in “All Other Compensation” for Mr. M. Patel: cash in lieu ofvacation time of $27,894, 401(k) employer matching contributions of $6,300and group health and life insurance premiums of $2,611.

(5)          The following amountsare included in “All Other Compensation” for Mr. A. Patel: group healthand life insurance premiums of $8,598 and 401(k) employer matchingcontributions of $5,484.

Amounts listed under “Non-Equity Incentive PlanCompensation” reflect management cash incentive bonuses paid based on thecriteria described below under “Discussion of Plan-Based Awards Table.”

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**2006GRANTS OF PLAN-BASED AWARDS TABLE**

| ** **                                                                   | ** ** | **Estimated Future Payouts Under   Non-Equity Incentive Plan Awards** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|------------|
| **Name**                                                                     | ** ** | ** **                                                                                               | ** ** | **Threshold  ($)** | ** ** | **Target  ($)** | ** ** | **Maximum  ($)** | ** ** |
| Jeffrey Frank  President, Chief Executive Officer and Director               |       |                                                                                                     | $          | 0 |   |   | $ | 100,000 |   | $ | 350,000 |   |
| Linster Fox  Executive Vice President, Chief Financial Officer and Secretary |       |                                                                                                     | $          | 0 |   |   | $ | 50,000 |   | $ | 175,000 |   |
| Bud Patel  Executive Vice President                                          |       |                                                                                                     | $          | 0 |   |   | $ | 71,070 |   | $ | 248,745 |   |
| Mukesh Patel  Executive Vice President of Global Operations                  |       |                                                                                                     | $          | 0 |   |   | $ | 46,375 |   | $ | 162,312 |   |
| Alex Patel  Vice President of Engineering                                    |       |                                                                                                     | $          | 0 |   |   | $ | 43,200 |   | $ | 151,200 |   |
|                                                                              |            |                                                                                                          |            |  |  |  |  |  |  |  |  |  |  |  |

 

**Discussion ofPlan-Based Awards Table**

On January 6, 2006, the Compensation Committeeapproved the 2006 cash incentive compensation program for our executiveofficers and certain other employees. The program ties bonus compensationpayable for 2006 to the achievement of certain revenue and operating incometargets. Performance is calculated at the end of fiscal year 2006, and anybonus payments are made early in 2007.

Based upon achievement of specified revenue andoperating income targets, Mr. Frank was entitled to earn a bonus of up to120% of his base salary; Mr. B. Patel was entitled to earn a bonus of upto 102% of his base salary; Mr. Fox was entitled to earn a bonus of up to88% of his base salary; Mr. M. Patel was entitled to earn a bonus of up to86% of his base salary; and Mr. A. Patel was entitled to earn a bonus ofup to 91% of his base salary. Certain of our other managers and key employeeswere selected by the Compensation Committee to participate in the incentiveprogram and were entitled to earn bonuses of up to between 24% and 73% of theirbase salaries, based upon achievement of the specified revenue and operatingincome targets. The amounts shown on the table above reflect achievement of the2006 revenue and operating income targets and the payment of maximum bonusesunder the cash incentive plan to all named executive officers.

We did not grant any stock options to the namedexecutive officers during 2006, nor did any of the named executive officersexercise any stock options during 2006.

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**2006OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END**

| Name(a)                                                          | ** ** | ** ** | ** ** | **Option  Grant   Date** | ** ** | **Number of  Securities  Underlying  Unexercised  Options (#)  Exercisable** | ** ** | **Number of  Securities  Underlying  Unexercised  Options (#)  Unexercisable(1)** | ** ** | **Option  Exercise  Price ($)** | ** ** | **Option  Expiration  Date** | ** ** |
|------------------------------------------------------------------|------------|------------|------------|-------------------------------|------------|----------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------|------------|
| Jeffrey Frank                                                    |       | 7/30/2003  |       |                          | 190,384    |                                                                                   |       |                                                                                        | 63,462     |                                 |       |                         | $          | 5.85 |   |   | 7/30/2013 |   |
| President, Chief Executive                                       |       | 2/16/2004  |       |                          | 34,500     |                                                                                   |       |                                                                                        | 34,500     |                                 |       |                         | $          | 14.50 |   |   | 2/16/2014 |   |
| Officer and Director                                             |       | 3/14/2005  |       |                          | 15,000     |                                                                                   |       |                                                                                        | 45,000     |                                 |       |                         | $          | 7.26 |   |   | 3/14/2015 |   |
|                                                                  |       | 12/9/2005  |       |                          | 20,000     |                                                                                   |       |                                                                                        | 60,000     |                                 |       |                         | $          | 3.19 |   |   | 12/9/2015 |   |
| Linster Fox                                                      |       | 11/17/2005 |       |                          | 25,000     |                                                                                   |       |                                                                                        | 75,000     |                                 |       |                         | $          | 2.97 |   |   | 11/17/2015 |   |
| Executive Vice  President, Chief Financial Officer and Secretary |       |       |       |                          |       |                                                                                   |       |                                                                                        |       |                                 |       |                         |       |   |   |   |   |
| Bud Patel                                                        |       | 7/30/2003  |       |                          | 48,077     |                                                                                   |       |                                                                                        | 16,026     |                                 |       |                         | $          | 5.85 |   |   | 7/30/2013 |   |
| Executive Vice President                                         |       | 2/16/2004  |       |                          | 22,500     |                                                                                   |       |                                                                                        | 22,500     |                                 |       |                         | $          | 14.50 |   |   | 2/16/2014 |   |
|                                                                  |       | 3/14/2005  |       |                          | 10,000     |                                                                                   |       |                                                                                        | 30,000     |                                 |       |                         | $          | 7.26 |   |   | 3/14/2015 |   |
|                                                                  |       | 12/9/2005  | (a)        |                          | 25,000     |                                                                                   |       |                                                                                        | 25,000     |                                 |       |                         | $          | 3.19 |   |   | 12/9/2015 |   |
| Mukesh Patel                                                     |       | 7/30/2003  |       |                          | 32,211     |                                                                                   |       |                                                                                        | 10,738     |                                 |       |                         | $          | 5.85 |   |   | 7/30/2013 |   |
| Executive Vice  President of                                     |       | 2/16/2004  |       |                          | 3,500      |                                                                                   |       |                                                                                        | 3,500      |                                 |       |                         | $          | 14.50 |   |   | 2/16/2014 |   |
| Global Operations                                                |       | 3/14/2005  |       |                          | 7,500      |                                                                                   |       |                                                                                        | 22,500     |                                 |       |                         | $          | 7.26 |   |   | 3/14/2015 |   |
|                                                             |       | 6/14/2005  |       |                          | 10,000     |                                                                                   |       |                                                                                        | 30,000     |                                 |       |                         | $          | 3.89 |   |   | 6/14/2015 |   |
|                                                             |       | 12/9/2005  |       |                          | 12,500     |                                                                                   |       |                                                                                        | 37,500     |                                 |       |                         | $          | 3.19 |   |   | 12/9/2015 |   |
| Alex Patel                                                       |       | 7/30/2003  |       |                          | 28,365     |                                                                                   |       |                                                                                        | 9,456      |                                 |       |                         | $          | 5.85 |   |   | 7/30/2013 |   |
| Vice President of  Engineering                                   |       | 2/16/2004  |       |                          | 7,500      |                                                                                   |       |                                                                                        | 7,500      |                                 |       |                         | $          | 14.50 |   |   | 2/16/2014 |   |
|                                                                  |       | 3/14/2005  |       |                          | 7,500      |                                                                                   |       |                                                                                        | 22,500     |                                 |       |                         | $          | 7.26 |   |   | 3/14/2015 |   |
|                                                                  |       | 12/9/2005  |       |                          | 12,500     |                                                                                   |       |                                                                                        | 37,500     |                                 |       |                         | $          | 3.19 |   |   | 12/9/2015 |   |

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(1)          Optiongrants vest in accordance with the following schedules:

| **Grant Date** | ** ** | ** ** | ** ** | **Expiration  Date**                                                      | ** ** | **Vesting Schedule** | ** ** |
|---------------------|------------|------------|------------|---------------------------------------------------------------------------|------------|---------------------------|------------|
| 7/30/2003           |       | 7/30/2013  |       | 25% vests each year for  4 years on each anniversary of the date of grant |       |
| 2/16/2004           |       | 2/16/2014  |       | 25% vests each year for  4 years on each anniversary of the date of grant |       |
| 3/14/2005           |       | 3/14/2015  |       | 25% vests each year for  4 years on each anniversary of the date of grant |       |
| 6/14/2005           |       | 6/14/2015  |       | 25% vests each year for  4 years on each anniversary of the date of grant |       |
| 11/17/2005          |       | 11/17/2015 |       | 25% vests each year for  4 years on each anniversary of the date of grant |       |
| 12/9/2005           |       | 12/9/2015  |       | 25% vests each year for  4 years on each anniversary of the date of grant |       |
| 12/9/2005(a)        |       | 12/9/2015  |       | 50% vests each year for 2 years on each anniversary  of the date of grant |       |

 

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**2006NONQUALIFIED DEFERRED COMPENSATION TABLE**

| **Name**                                                                     | ** ** | ** ** | ** ** | **Executive  Contributions  in Last FY  ($)** | ** ** | **Registrant  Contributions  in Last FY  ($)** | ** ** | **Aggregate  Earnings  in Last FY  ($)** | ** ** | **Aggregate  Withdrawals/  Distributions  ($)** | ** ** | **Aggregate  Balance at  Last FYE  ($)** | ** ** |
|------------------------------------------------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------|------------|-------------------------------------------------|------------|----------------------------------------------------|------------|
| Jeffrey Frank  President, Chief Executive Officer and Director               |       |       | —     |                                                    |       |                                                     | —     |                                               |       |                                            | $          | 12,823                                             |       |   |   | — |   |   | $ | 126,412 |   |
| Linster Fox  Executive Vice President, Chief Financial Officer and Secretary |       |       | —     |                                                    |       |                                                     | —     |                                               |       |                                            | —     |                                               |       |   | — |   |   | — |   |
| Bud Patel  Executive Vice President                                          |       |       | $          | 61,281                                                  |       |                                                     |       | —                                             |       |                                            |       | $                                                  | 84,832     |   |   |   | — |   |   | $ | 510,286 |   |
| Mukesh Patel  Executive Vice President of Global Operations                  |       |       | —     |                                                    |       |                                                     | —     |                                               |       |                                            | $          | 1,914                                              |       |   |   | — |   |   | $ | 43,294 |   |
| Alex Patel  Vice President of Engineering                                    |       |       | —     |                                                    |       |                                                     | —     |                                               |       |                                            | —     |                                               |       |   | — |   |   | — |   |
|                                                                              |            |            |            |                                                         |            |                                                          |            |                                                    |            |                                                 |            |                                                    |            |  |  |  |  |  |  |  |  |  |  |  |

 

Under Cherokee’snonqualified deferred compensation plan, between 2% and 100% of the executive’sbase salary and up to 100% of the executive’s cash incentive bonus may bedeferred. Interest and earnings on deferred amounts are calculated based on theperformance of a portfolio of funds selected by the Compensation Committee. Participantsselect the funds into which their deferrals are deemed invested. Participantsare eligible for employer matching and profit sharing credits, which vest infull after three years of employment. To date, Cherokee has not made anymatching or profit sharing credits. Withdrawals may be made while the executiveis still employed with Cherokee two years after the contributions havecommenced. Participants are also eligible to make withdrawals in the case ofeconomic hardship and for education expenses. Upon reaching the plan retirementage of 65, participants may elect to receive distributions in the form of alump sum or equal annual installments over a term of 10 years of less.

**POTENTIAL PAYMENTSUPON TERMINATION OR CHANGE-IN-CONTROL**

Cherokee has entered into severance agreements (the “Agreements”)with each of Mr. Frank, Mr. Fox and Mr. M. Patel. The Agreementsprovide that, in the event that we terminate one of the executive’s employmentother than for “cause” (as such term is defined in the applicable Agreement),the executive will be entitled to: i) the annual base salary then in effect;ii) the bonus that would have been due to the executive, calculated as if theCompany achieved its financial targets for the year the termination occurred andprorated for the number of months worked in that fiscal year; iii) continuedmedical, hospitalization, life and other insurance benefits for the executiveand the executive’s family for up to a period of 12 months; and iv) to theextent permitted under the Internal Revenue Code, a settlement of all deferredcompensation arrangements. The Agreements also prohibit the executives for aperiod of twelve months after termination from soliciting our employees to workin a business that competes with us.

In addition, the Agreements for Mr. Frank and Mr. Foxprovide that in the event that Mr. Frank’s or Mr. Fox’s employment isterminated i) by the Company other than for “cause” or by Mr. Frank or Mr. Foxfor “good reason” (as such term is defined in the applicable Agreement) within2 years following a “change in control” (as such term is defined in theapplicable Agreement) or ii) by the Company without “cause” within six monthsprior to a “change in control” and such termination was in connection with the “changein control,” each of Mr. Frank and Mr. Fox, as the case may be, willbe entitled to: i) two times his annual 

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base salary then ineffect; ii) the bonus that would have been due to him, calculated as if theCompany achieved its financial target for the year the termination occurred andprorated for the number of months worked in that fiscal year; iii) immediatevesting of all outstanding stock options; iv) to the extent permitted under theInternal Revenue Code, a settlement of all deferred compensation arrangements;v) continued medical, hospitalization, life and other insurance benefits forthe him and his family for up to a period of 24 months; vi) payment equal tothe amount forfeited by him under the Company’s 401(k) plan or equivalentplans; vii) the right to utilize services of a nationally recognized executiveplacement service at the Company’s expense in an amount not to exceed $50,000;and viii) other additional benefits then due or earned in accordance withapplicable plans and programs of Cherokee. In addition, Mr. Frank or Mr. Fox,as the case may be, may be entitled to receive an additional payment fromCherokee if the aforementioned payments are subject to excise tax.

The table below reflects the amount of compensationthat would become payable to each of Messrs. Frank, Fox and M. Patel underthe Agreements if the executive’s employment had terminated on December 31,2006, given the executive’s compensation as of such date and, if applicable,based on Cherokee’s closing stock price on that date. These benefits are inaddition to benefits available prior to the occurrence of any termination ofemployment, including under then-exercisable stock options and benefitsgenerally to salaried employees, such as distributions under our 401(k) plan.In addition, in connection with any actual termination of employment, theCompensation Committee may determine to enter into an agreement or to establishan arrangement providing additional benefits or amounts, or altering the termsof benefits described below, as the Compensation Committee determinesappropriate.

The actual amounts thatwould be paid upon an executive’s termination of employment can only bedetermined at the time of such executive’s separation from Cherokee. Due to thenumber of factors that affect the nature and amount of any benefits providedupon the events discussed below, any actual amounts paid or distributed may behigher or lower than reported below. Factors that could affect these amountsinclude the timing during the year of any such event and the company’s stockprice.

*Jeffrey Frank*

| ** **                 | ** ** | **Termination without Cause at  Employer’s Election** | ** ** | **Termination without Cause at  Employer’s Election or for  Good Reason at Employee’s  Election After Change in Control** | ** ** |
|----------------------------|------------|--------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Salary**                 |       |                                                                           | $          | 307,000                                                                                                                                                                                              |       |   |   | $ | 614,000 |   |   |
| **Bonus(1)**               |       |                                                                           | $          | 320,000                                                                                                                                                                                              |       |   |   | $ | 320,000 |   |   |
| **Stock  Options**         |       |                                                                           | $          | 0                                                                                                                                                                                                    |       |   |   | $ | 67,200 |   |   |
| **Deferred  Compensation** |       |                                                                           | $          | 126,412                                                                                                                                                                                              |       |   |   | $ | 126,412 |   |   |
| **Tax  Gross-Up**          |       |                                                                           | $          | 0                                                                                                                                                                                                    |       |   |   | $ | 0 |   |   |
| **Other Benefits**         |       |                                                                           | $          | 10,744                                                                                                                                                                                               | (2)        |   |   | $ | 71,448 | (3) |   |

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(1)          Bonus amounts includebonus for 2006 performance year paid in 2007.

(2)          Includes an estimatedcost for providing continued medical, hospitalization, life and other insurancebenefits to the executive and the executive’s family for a period of 12 monthsafter the date of termination.

(3)          Includesan estimated cost for providing continued medical, hospitalization, life andother insurance benefits to the executive and the executive’s family for aperiod of 24 months after the date of termination plus a $50,000 allowance forexecutive placement services.

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*Linster Fox*

| ** **                 | ** ** | **Termination without Cause at  Employer’s Election** | ** ** | **Termination without Cause at  Employer’s Election or for  Good Reason at Employee’s  Election After Change in Control** | ** ** |
|----------------------------|------------|--------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Salary**                 |       |                                                                           | $          | 225,000                                                                                                                                                                                              |       |   |   | $ | 450,000 |   |   |
| **Bonus(1)**               |       |                                                                           | $          | 160,000                                                                                                                                                                                              |       |   |   | $ | 160,000 |   |   |
| **Stock  Options**         |       |                                                                           | $          | 0                                                                                                                                                                                                    |       |   |   | $ | 106,000 |   |   |
| **Deferred  Compensation** |       |                                                                           | $          | 0                                                                                                                                                                                                    |       |   |   | $ | 0 |   |   |
| **Tax  Gross-Up**          |       |                                                                           | $          | 0                                                                                                                                                                                                    |       |   |   | $ | 0 |   |   |
| **Other Benefits**         |       |                                                                           | $          | 10,240                                                                                                                                                                                               | (2)        |   |   | $ | 75,306 | (3) |   |

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(1)          Bonus amounts includebonus for 2006 performance year paid in 2007.

(2)          Includes an estimatedcost for providing continued medical, hospitalization, life and other insurancebenefits to the executive and the executive’s family for a period of 12 monthsafter the date of termination.

(3)          Includesan estimated cost for providing continued medical, hospitalization, life andother insurance benefits to the executive, and the 401K employer match for theunvested portion to be paid to the executive, and the executive’s family for aperiod of 24 months after the date of termination plus a $50,000 allowance forexecutive placement services.

*Mukesh Patel*

| ** **                 | ** ** | **Termination without Cause at  Employer’s Election** | ** ** | **Termination without Cause at  Employer’s Election or for  Good Reason at Employee’s  Election After Change in Control** | ** ** |
|----------------------------|------------|--------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Salary**                 |       |                                                                           | $          | 195,830                                                                                                                                                                                              |       |   |   | N/A |   |   |
| **Bonus(1)**               |       |                                                                           | $          | 148,400                                                                                                                                                                                              |       |   |   | N/A |   |   |
| **Deferred  Compensation** |       |                                                                           | $          | 43,294                                                                                                                                                                                               |       |   |   | N/A |   |   |
| **Tax  Gross-Up**          |       |                                                                           | $          | 0                                                                                                                                                                                                    |       |   |   | N/A |   |   |
| **Other Benefits**         |       |                                                                           | $          | 3,038                                                                                                                                                                                                | (2)        |   |   | N/A |   |   |

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(1)          Bonus amounts includebonus for 2006 performance year paid in 2007.

(2)          Includesan estimated cost for providing continued medical, hospitalization, life andother insurance benefits to the executive and the executive’s family for aperiod of 12 months after the date of termination.

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**2006 DIRECTORCOMPENSATION**

The table below summarizes the total compensation awardedto, earned by or paid to each of our non-employee directors for the fiscal yearended December 31, 2006.

| **Name**                 | ** ** | ** ** | ** ** | **Fees Earned or  Paid in Cash  ($)** | ** ** | **Option Awards   ($)  (5)(6)** | ** ** | **Total  ($)** | ** ** |
|--------------------------|------------|------------|------------|-----------------------------------------------------------|------------|-------------------------------------------|------------|----------------|------------|
| Raymond Meyer            |       |       | $          | 31,522                                                    |       |                                      |       | $              | 18,639     |   |   | $ | 50,161 |   |
| Anthony Bloom(1)         |       |       | $          | 27,799                                                    |       |                                      |       | $              | 7,753      |   |   | $ | 35,552 |   |
| Christopher  Brothers(2) |       |       | $          | 6,301                                                     |       |                                      |       | $              | 2,469      |   |   | $ | 8,770 |   |
| Vincent Cebula           |       |       | $          | 13,699                                                    |       |                                      |       | $              | 6,969      |   |   | $ | 20,668 |   |
| Clark Michael  Crawford  |       |       | $          | 25,000                                                    |       |                                      |       | $              | 7,753      |   |   | $ | 32,753 |   |
| Kenneth  Kilpatrick(3)   |       |       | $          | 48,533                                                    |       |                                      |       | $              | 15,505     |   |   | $ | 64,038 |   |
| Daniel Lukas             |       |       | $          | 5,707                                                     |       |                                      |       | $              | 1,522      |   |   | $ | 7,229 |   |
| Ian Schapiro(4)          |       |       | $          | 15,000                                                    |       |                                      |       | $              | 10,705     |   |   | $ | 25,705 |   |
| Phil Smoot               |       |       | $          | 2,663                                                     |       |                                      |       | $              | 348        |   |   | $ | 3,011 |   |

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(1)          Mr. Bloom resignedfrom the board of directors effective December 4, 2006.

(2)          Mr. Brothersresigned from the board of directors effective April 26, 2006.

(3)          Mr. Kilpatrickresigned from the board of directors effective February 1, 2007.

(4)          Mr. Schapiroresigned from the board of directors effective September 15, 2006.

(5)          Based on thecompensation cost as determined under Statement of Financial AccountingStandards No. 123R, “Share-Based Payment,” for the year ended December 31,2006, before reflecting estimated forfeitures. See Note 3 to our ConsolidatedFinancial Statements included elsewhere in this Annual Report on Form 10-Kfor assumptions used in computing fair value.

(6)          The aggregate number ofoutstanding stock option awards for each director at December 31, 2006was: Mr. Meyer, 40,000 shares; Mr. Bloom, 7,500 shares; Mr. Brothers,0 shares; Mr. Cebula, 10,000 shares; Mr. Crawford, 32,564 shares; Mr. Kilpatrick,50,000 shares; Mr. Lukas, 10,000 shares; Mr. Schapiro, 0 shares; and Mr. Smoot,10,000 shares. The grant date fair value of awards made during 2006, asdetermined under Statement of Financial Accounting Standard No. 123R, “Share-BasedPayment,” was $40,039 for Mr. Meyer, $21,216 for Mr. Bloom, $0 for Mr. Brothers,$40,861 for Mr. Cebula, $21,216 for Mr. Crawford, $42,432 for Mr. Kilpatrick,$21,365 for Mr. Lukas, $21,216 for Mr. Schapiro, and $18,823 Mr. Smoot.

Effective with our initial public offering in February 2004,all non-employee directors were paid an annual retainer of $20,000 related totheir service on our board of directors and an annual per committee retainer of$5,000. Effective in February 2005, the chairman of the board, currently Mr. Meyer,is paid an annual retainer of $50,000 in lieu of the foregoing amounts and doesnot receive any additional compensation for committee service.

We also reimburse all non-employee directors for reasonableexpenses incurred to attend meetings of our board of directors or committees.In addition, non-employee directors are eligible to receive option grants underour 2004 Omnibus Stock Incentive Plan. Under this plan, each of ournon-employee directors is automatically granted an initial option to purchase10,000 shares of our common stock upon the date the non-employee director firstjoins our board of directors. In addition, subject to certain conditions underthe plan, each non-employee director is also automatically granted an annualoption to purchase 10,000 shares of our common stock on the date immediatelyfollowing our annual meeting of stockholders. In lieu of this automatic grant,our board of directors has granted our chairman an annual option to purchase20,000 shares of our common stock.

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In connection with theirnomination of Mr. Crawford to our board of directors prior to our initialpublic offering, GSC Recovery II, L.P. and GSC Recovery IIA, L.P.(collectively, the “GSC Recovery Funds”) entered into a compensation agreementwith Mr. Crawford. According to the terms of the agreement, the GSCRecovery Funds agreed to pay Mr. Crawford a fee of up to $25,000 per year,to be reduced by the amount of fees Mr. Crawford received from us for hisservice on the board of directors.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERS

The following tablesets forth information known to Cherokee as of April 30, 2007, regardingthe beneficial ownership of Cherokee common stock by:

·       personsknown by us to beneficially own greater than 5% of our outstanding stock,

·       eachdirector and nominee,

·       ourChief Executive Officer and the other named executive officers, and

·       allof our directors and executive officers as a group.

Beneficial ownership is determined in accordance withthe rules and regulations of the SEC, which generally attribute beneficialownership of securities to persons who possess sole or shared voting power orinvestment power with respect to those securities, and includes shares ofcommon stock issuable pursuant to the exercise of stock options that areimmediately exercisable or exercisable within 60 days after April 30, 2007.Unless otherwise indicated, to Cherokee’s knowledge the persons or entitiesidentified in this table have sole voting and investment power with respect toall shares of common stock shown as beneficially owned by them, subject toapplicable community property laws.

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Unlessotherwise indicated, the address of each of the individuals named below is c/oCherokee International Corporation, 2841 Dow Avenue, Tustin, California 92780.

| Name and Address of Beneficial Owner                                                | ** ** | ** ** | ** ** | **Number of   Shares  Owned** | ** ** | **Number of  Shares with  Right to  Acquire** | ** ** | **Total Shares  Beneficially  Owned** | ** ** | **Percent of  Outstanding  Shares(1)** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|------------|------------|-----------------------------------------|------------|--------------------------------------------------------------|------------|--------------------------------------------|------------|---------------------------------------------|------------|
| **5% Stockholders:**                                                                                         |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| GSCP (NJ), Inc.                                                                                         |       | 5,000,148  |       |                                    | —     |                                                         |       | 5,000,148                                  |       |                                        | 25.8       | % |   |
| GSC Recovery II, L.P.                                                                                        |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| GSC  Recovery IIA, L.P.                                                                                      |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| GSC Partners CDO Fund, Limited                                                                               |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| GSC  Partners CDO Fund II, Limited(2)  500 Campus Drive  Suite 220  Florham Park, New Jersey 07932      |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| Oaktree Capital Management, LLC                                                                              |       | 4,777,976  |       |                                    | —     |                                                         |       | 4,777,976                                  |       |                                        | 24.7       | % |   |
| OCM  Principal Opportunities Fund, L.P.                                                                      |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| OCM/GFI Power Opportunities Fund, L.P.(3)  333 South Grand Avenue, 28th Floor  Los Angeles, California 90071 |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| F&C Asset Management plc(4)                                                                              |       | 1,112,851  |       |                                    | —     |                                                         |       | 1,112,851                                  |       |                                        | 5.8        | % |   |
| 80 George Street                                                                                             |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| Edinburgh EH2 3BU, United Kingdom                                                                            |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| Green River Management I, L.L.C.                                                                             |       | 1,070,126  |       |                                    | —     |                                                         |       | 1,070,126                                  |       |                                        | 5.5        | % |   |
| Green  River Offshore Fund Management Company, L.L.C.                                                        |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| Mark McGrath(5)  610 Fifth Avenue, Suite 305  New York, NY 10020                                        |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| BC Advisors, LLC                                                                                             |       | 1,052,500  |       |                                    | —     |                                                         |       | 1,052,500                                  |       |                                        | 5.4        | % |   |
| SRB Management, L.P.                                                                                         |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| Steven  R. Becker(6)  300 Crescent Court, Suite 1111  Dallas, Texas 75201                               |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| **Directors and Named Executive  Officers:**                                                                 |       |       |       |                                    |       |                                                         |       |                                       |       |                                        |       |   |   |
| Raymond Meyer                                                                                                |       | 174,282    |       |                                    | 12,500     |                                                         |       | 186,782                                    |       |                                        | 0.1        | % |   |
| Jeffrey Frank                                                                                                |       | 21,985     |       |                                    | 355,596    |                                                         |       | 377,581                                    |       |                                        | 2.0        | % |   |
| Vincent Cebula(7)                                                                                            |       | 4,777,976  |       |                                    | 2,500      |                                                         |       | 4,780,476                                  |       |                                        | 24.7       | % |   |
| Clark Michael Crawford                                                                                       |       | 31,538     |       |                                    | 16,923     |                                                         |       | 48,461                                     |       |                                        | *          |   |   |
| Daniel Lukas(8)                                                                                              |       | 5,000,148  |       |                                    | —     |                                                         |       | 5,000,148                                  |       |                                        | 25.8       | % |   |
| Larry Schwerin                                                                                               |       | —     |       |                                    | —     |                                                         |       | —                                     |       |                                        | *          |   |   |
| Phil Smoot                                                                                                   |       | —     |       |                                    | —     |                                                         |       | —                                     |       |                                        | *          |   |   |
| Linster W. Fox                                                                                               |       | —     |       |                                    | 25,000     |                                                         |       | 25,000                                     |       |                                        | *          |   |   |
| Bud Patel                                                                                                    |       | 7,170      |       |                                    | 142,853    |                                                         |       | 150,023                                    |       |                                        | *          |   |   |
| Alex Patel                                                                                                   |       | 2,100      |       |                                    | 76,571     |                                                         |       | 78,671                                     |       |                                        | *          |   |   |
| Mukesh Patel                                                                                                 |       | 10,321     |       |                                    | 95,699     |                                                         |       | 106,020                                    |       |                                        | *          |   |   |
| All directors and executive officers as a group:                                                             |       | 10,073,814 |       |                                    | 924,014    |                                                         |       | 10,997,828                                 |       |                                        | 56.8       | % |   |

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*                    Representsless than 1%.

(1)          Based on 19,346,959shares of Cherokee common stock outstanding as of April 30, 2007.

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(2)          In Amendment No. 1to Schedule 13D, jointly filed on September 15, 2004 by GSC Recovery II,L.P., GSC Recovery II GP, L.P., GSC RII, LLC, GSC Recovery IIA, L.P., GSCRecovery IIA GP, L.P., GSC RIIA, LLC, GSC Partners CDO Fund, Limited, GSCPartners CDO Fund II, Limited, GSCP (NJ), Inc., GSCP (NJ), L.P., GSCP (NJ)Holdings, L.P. (collectively, “GSC”), Keith W. Abell, Alfred C. Eckert III,Robert A. Hamwee, Richard M. Hayden, Thomas V. Inglesby, Matthew C. Kaufman,Christine K. Vanden Beukel and Andrew J. Wagner, such persons report that as ofsuch date, they possessed shared power to vote and dispose of these shares.

(3)          In Amendment No. 1to Schedule 13D, jointly filed on September 7, 2004 by Oaktree CapitalManagement, LLC (“Oaktree”), OCM Principal Opportunities Fund, L.P. and OCM/GFIPower Opportunities Fund, L.P., such persons report that as of such date, OCMPrincipal Opportunities Fund, L.P. possessed sole power to vote and dispose of4,465,769 shares of our common stock, and OCM/GFI Power Opportunities Fund,L.P. possessed sole power to vote and dispose of 312,897 of our shares ofcommon stock. OCM Principal Opportunities Fund, L.P. reported on Form 4,filed on January 21, 2005, that it transferred 690 shares of our commonstock to certain third parties in consideration for past services.

(4)          The information providedis based upon Schedule 13G, filed on January 24, 2007 by F&C AssetManagement plc.

(5)          In Amendment No. 1to Schedule 13G, jointly filed on February 15, 2006 by Green RiverManagement I, L.L.C., Green River Offshore Fund Management Company, L.L.C. andMark McGrath, such persons report that as of such date, (i) GreenRiver Management I, L.L.C., as the general partner of Green River Fund I, L.P.and Green River Fund II, L.P., possessed sole power to vote and dispose of437,571 of these shares, (ii) Green River Offshore Fund ManagementCompany, L.L.C., as the investment manager of Green River Offshore Fund,Ltd., possessed sole power to vote and dispose of 632,555 of these shares, and (iii) Mr. McGrath,as the principal of Green River Management I, L.L.C. and Green River OffshoreFund Management Company, L.L.C. (together, Green River, may direct the vote anddisposition of the 1,070,126 shares beneficially owned by Green River.

(6)          The information providedis based upon Schedule 13G/A, filed on February 9, 2007 by BC Advisors,LLC, SRB Management, L.P. and Steven R. Becker.

(7)          Mr. Cebula is aManaging Director of Oaktree. By virtue of his relationship to Oaktree, Mr. Cebulamay be deemed to have or share beneficial ownership of shares of our commonstock owned by Oaktree. Mr. Cebula expressly disclaims beneficialownership of such common stock, except to the extent of his direct pecuniaryinterest therein.

(8)          Mr. Lukasis a Managing Director of GSC Partners. By virtue of his relationship to GSCPartners, Mr. Lukas may be deemed to have or share beneficial ownership ofshares of our common stock owned by GSC. Mr. Lukas expressly disclaimsbeneficial ownership of such common stock, except to the extent of his directpecuniary interest therein.

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**Equity Compensation Plans**

The following tableset forths information regarding outstanding options and shares reserved forfuture issuance under the plans listed below, which are Cherokee’s onlyequity-based compensation plans, as of December 31, 2006. 

| **Plan Category**                                      | ** ** | ** ** | ** ** | **(a)  Number of securities  to be issued upon  exercise of  outstanding options,  warrants and rights** | ** ** | **(b)  Weighted-average  exercise price of  outstanding options,  warrants and rights** | ** ** | **(c)  Number of securities  remaining available for  future issuance under  equity compensation  plans (excluding  securities reflected in  column (a)(1)** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by security holders     |       |       | 2,297,054  |                                                                                                                                                  |       |                                                                                                             | $          | 6.23                                                                                                                                                                                                                |       |   |   | 905,031 |   |   |
| Equity compensation  plans not approved by security holders |       |       | —     |                                                                                                                                                  |       |                                                                                                             | —     |                                                                                                                                                                                                                |       |   | — |   |   |

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(1)          Includes634,490 of shares issuable pursuant to our 2004 Employee Stock Purchase Plan. Thenumber of shares available for future issuance under our 2004 Omnibus StockIncentive Plan is subject to an automatic annual increase equal to the lesserof 450,000 shares or 2% of the number of outstanding shares of our common stockon the last day of the immediately preceding fiscal year. The number of sharesavailable for issuance under our 2004 Employee Stock Purchase Plan is subjectto an automatic annual increase equal to the lesser of 250,000 or 1% of thenumber of outstanding shares on the last day of the immediately precedingfiscal year.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

**Senior Notes**

During 2006, we paid toaffiliates of GSCP (N.J.), Inc. (“GSC”) an aggregate of $2,448,075 in cashinterest payments on our outstanding 5.25% senior notes due 2008. GSC is anaffiliate of GSC Recovery II, L.P., GSC Recovery IIA, L.P., GSC Partners CDOFund, Limited and GSC Partners CDO Fund II, Limited, which themselves arecollectively beneficial owners of 25.8% of our common stock.

**Facility Lease**

We lease our facilitylocated at 2841 Dow Avenue in Tustin, California from Patel/King Investment, orPKI. One of the principals of PKI is Pat Patel, a former member of our board ofdirectors. Pat Patel is the father-in-law of Mukesh Patel, our Executive VicePresident, Global Operations. We currently pay approximately $97,600 in rentper month to PKI, subject to annual Consumer Price Index adjustments. Pursuantto the lease, we made payments to PKI of approximately $1.2 million in 2006.Our lease with PKI will run through April 30, 2009, with an extension foran additional 60 months at our option.

**Review, Approval orRatification of Transactions with Related Persons**

All transactions withrelated persons are reviewed, approved and ratified by the Audit Committee ofour board of directors. The Audit Committee is in the process of adopting awritten policy with respect to the review, approval and ratification oftransactions with related persons.

**DirectorIndependence**

It is the policy of theboard of directors, as well as a requirement of the Nasdaq National Market,that a majority of the board of directors be independent. Currently, four ofour seven directors meet the standards for independence as defined by thelisting standards of the Nasdaq National Market. In making 

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adetermination of independence, our board of directors considers all materialrelationships between us and the director in question. Our independentdirectors are Raymond Meyer, Clark Michael Crawford, Larry Schwerin and PhilSmoot. Mr. Meyer is also chairman of the board. The board of directors hasstanding audit, compensation, and nominating and corporate governancecommittees, the members of which are all independent.

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

The audit committee pre-approves and reviews audit andpermissible non-audit services to be performed by Cherokee’s independentauditors including fees charged by Mayer Hoffman McCann P.C. for such services.The audit committee has determined that the provision of the services describedbelow is compatible with maintaining the independence of Mayer Hoffman McCannP.C.

Thefollowing table sets forth the aggregate fees since June 2006 billed byMayer Hoffman McCann P.C. for the following services for fiscal year 2006:

| **Description of Services** | ** ** | ** ** | ** ** | **2006** |
|---------------------------------------|------------|------------|------------|----------|
| Audit Fees(1)                         |       | $          | 783,871    |
| Audit-Related  Fees(2)                |       | —     |
| Tax Fees(3)                           |       | —     |
| All Other Fees                        |       | —     |
| Total                                 |       | $          | 783,871    |

 

Thefollowing table sets forth the aggregate fees prior to June billed byDeloitte & Touche LLP for the following services for fiscal years 2005and part of 2006:

| **Description of Services** | ** ** | ** ** | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Audit Fees(1)                         |       | $          | 56,635     |     | $          | 758,597  |       |
| Audit-Related  Fees(2)                |       | —     |       | 56,680   |       |
| Tax Fees(3)                           |       | —     |       | 54,563   |       |
| All Other Fees                        |       | —     |       | —   |       |
| Total                                 |       | $          | 56,635     |     | $          | 869,840  |       |

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(1)          Represents the aggregatefees billed for professional services rendered for the audit of our annualfinancial statements, the review of the financial statements included in ourquarterly reports and statutory audits of foreign subsidiaries.

(2)          Represents the aggregatefees billed for professional services rendered for employee benefit planaudits, advisory services relating to the Sarbanes-Oxley Act and otheraccounting consultation and assistance.

(3)          Represents the aggregatefees billed for professional services rendered for tax consultation, planningand compliance.

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**PART IV**

**ITEM 15.**         EXHIBITS AND FINANCIALSTATEMENT SCHEDULES

(a)(1)            ConsolidatedFinancial Statements

Thefollowing documents are contained in Part II, Item 8 of this Annual Reporton Form 10-K:

|                                                                                                                                                                                              | ** ** | **Page** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm                                                                                                                                     |       |     | 38         |   |   |
| Report of Independent Registered Public Accounting  Firm                                                                                                                                     |       |     | 39         |   |   |
| Consolidated  Balance Sheets as of December 31, 2006, and January 1, 2006                                                                                                          |       |     | 40         |   |   |
| Consolidated Statements of Operations for the years  ended December 31, 2006, January 1, 2006 and January 2, 2005                                                             |       |     | 41         |   |   |
| Consolidated Statements of Stockholders’ Equity  (Deficit) and Comprehensive Operations for the years ended  December 31, 2006, January 1, 2006 and January 2, 2005 |       |     | 42         |   |   |
| Consolidated Statements of Cash Flows for the years  ended December 31, 2006, January 1, 2006 and January 2, 2005                                                             |       |     | 43         |   |   |
| Notes to Consolidated Financial Statements                                                                                                                                                   |       |     | 44         |   |   |

 

(a)(2)            FinancialStatement Schedules

Thefollowing financial statement schedule is filed as a part of this Annual Reporton Form 10-K and is incorporated herein by reference:

|                                                                      | ** ** | **Page** | ** ** |
|----------------------------------------------------------------------|------------|----------|------------|
| Report of Independent Registered Public Accounting  Firm on Schedule |       |     | 70         |   |   |
| Schedule II: Valuation and Qualifying Accounts                       |       |     | 71         |   |   |

 

(a)(3)            Exhibits

Exhibitsnot incorporated by reference are filed herewith. The remainder of the exhibitshas heretofore been filed with the SEC and is incorporated herein by reference.Management contracts or compensatory plans or arrangements are marked with anasterisk.

| 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.(4)                                                                                                                                                                                       |   |
| 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 |   | Cherokee  International Corporation 2004 Omnibus Stock Incentive Plan.(3)                                                                                                                                                                                              |   |
| *10.2 |   | Form of 2004  Stock Option Agreement.(3)                                                                                                                                                                                                                          |   |
| *10.3 |   | Form of  Officer and Director Indemnification Agreement.(4)                                                                                                                                                                                                       |   |
| *10.4 |   | Executive  Deferred Compensation Plan (and related schedule).(3)                                                                                                                                                                                                       |   |
| 10.5  |   | Amended and  Restated Credit Agreement, dated as of February 25, 2004, by and between  Cherokee International Corporation and General Electric Capital Corporation,  in its individual capacity and as agent (the Agent) for all of the lenders named therein.(5) |   |
| 10.6  |   | Amended and  Restated Revolving Note, dated as of February 25, 2004, issued by  Cherokee International Corporation.(5)                                                                                                                                            |   |

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| 10.7   |   | Amended and  Restated Security Agreement, dated as of February 25, 2004, by and  between Cherokee International Corporation and the Agent.(5)                                                                                                                                                                                                                                             |   |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
| 10.8   |   | Registration  Rights Agreement, dated as of February 25, 2004, by and among Cherokee  International Corporation and the Securityholders party thereto.(6)                                                                                                                                                                                                                                 |   |
| 10.9   |   | Security  Agreement, dated as of November 27, 2002, between Cherokee International  Corporation and U.S. Bank, N.A., as agent (relating to the 5.25% Senior Note  Indenture).(2)                                                                                                                                                                                                          |   |
| 10.10  |   | Trademark  Security Agreement, dated as of November 27, 2002, between Cherokee  International Corporation and U.S. Bank, N.A., as agent (relating to the  5.25% Senior Note Indenture).(2)                                                                                                                                                                                                |   |
| 10.11  |   | Pledge Agreement,  dated as of November 27, 2002, between Cherokee International  Corporation and U.S. Bank, N.A., as agent (relating to the 5.25% Senior Note  Indenture).(2)                                                                                                                                                                                                            |   |
| 10.12  |   | Pledge Agreement,  dated as of November 27, 2002, between Cherokee Netherlands I B.V. and  U.S. Bank, N.A., as agent (relating to the 5.25% Senior Note Indenture).(2)                                                                                                                                                                                                                    |   |
| *10.13 |   | Cherokee  International Corporation 2002 Stock Option Plan.(2)                                                                                                                                                                                                                                                                                                                                 |   |
| *10.14 |   | Form of 2002  Stock Option Agreement.(2)                                                                                                                                                                                                                                                                                                                                                  |   |
| *10.15 |   | Amended and  Restated Severance Agreement, dated as of December 5, 2006, between  Cherokee International Corporation and Jeffrey M. Frank.(7)                                                                                                                                                                                                                                             |   |
| 10.16  |   | Lease Agreement,  dated as of April 30, 1999, by and between Ganpat I. Patel and Manju G.  Patel, Trustees of the Patel Family Trust dated July 17, 1987, as to an  undivided two-thirds interest, and Kenneth O. King and Arlene King, husband  and wife as joint tenants, as to an undivided one-third interest, as tenants  in common, and Cherokee International Corporation.(2) |   |
| *10.18 |   | Amended and  Restated Severance Agreement, dated as of June 16, 2005, between  Cherokee International Corporation and Mukesh Patel.(9)                                                                                                                                                                                                                                                    |   |
| *10.19 |   | Letter Agreement,  dated as of December 5, 2006, between Cherokee International Corporation  and Linster W. Fox.(7)                                                                                                                                                                                                                                                                       |   |
| *10.20 |   | Amended and  Restated Severance Agreement, dated as of October 14, 2005, between  Cherokee International Corporation and Linster W. Fox.(7)                                                                                                                                                                                                                                               |   |
| 21.1   |   | Subsidiaries of  the Registrant.                                                                                                                                                                                                                                                                                                                                                               |   |
| 23.1   |   | Consent of  Independent Registered Public Accounting Firm.                                                                                                                                                                                                                                                                                                                                     |   |
| 23.2   |   | Consent of  Independent Registered Public Accounting Firm.                                                                                                                                                                                                                                                                                                                                     |   |
| 31.1   |   | Certification of  President, Chief Executive Officer, and Director pursuant to Section 302  of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                                            |   |
| 31.2   |   | Certification of  Executive Vice President, 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.                                                                                                                                                                                                                                             |   |

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       (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.

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       (3) Incorporated by reference from Amendment No. 2 to theRegistration Statement on Form S-1 (File No. 333-110723),filed by the Registrant on February 4, 2004.

       (4) Incorporated by reference from Amendment No. 4 to theRegistration Statement on Form S-1 (File No. 333-110723),filed by the Registrant on February 17, 2004.

       (5) Incorporated by reference from the Quarterly Report on Form 10-Q,filed by the Registrant on May 12, 2004.

       (6) Incorporated by reference from the Quarterly Report on Form 10-Q,filed by the Registrant on August 9, 2004.

       (7) Previously filed as an exhibit to our Form 8-K on December 12,2006.

       (8) Previously filed as an exhibit to our Form 8-K on March 21,2005.

       (9) Previously filed as an exhibit to our Form 8-K on June 16,2005.

(11) Previously filed as an exhibit to our Form 8-K on February 08,2006.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized, on this 23rd day of May 2007.
|        |     |     | CHEROKEE INTERNATIONAL  CORPORATION |
|--------|----------|----------|-------------------------------------|
|   |     |     | By:                                 | /s/ JEFFREY M. FRANK |
|   |     |     |                                | Jeffrey M. Frank |
|   | * * | * * | * *                            | *President, Chief Executive Officer and Director* |

 

Pursuantto the requirements of the Securities Exchange Act of 1934, this report hasbeen signed below by the following persons on behalf of the registrant, and inthe capacities indicated, on this 23rd day of May 2007.
| /s/ JEFFREY M. FRANK        |   | President, Chief Executive Officer and Director |
|-----------------------------|--------|-------------------------------------------------|
| Jeffrey M. Frank            |   | (Principal Executive Officer)                   |
| /s/  LINSTER W. FOX         |   | Executive Vice  President, Chief Financial      |
| Linster W. Fox              |   | Officer and Secretary (Principal Financial and  |
|                        |   | Accounting Officer)                             |
| /s/  RAYMOND MEYER          |   | Chairman of the Board                           |
| Raymond Meyer               |   |                                            |
| /s/  CLARK MICHAEL CRAWFORD |   | Director                                        |
| Clark Michael  Crawford     |   |                                            |
| /s/  VINCENT CEBULA         |   | Director                                        |
| Vincent Cebula              |   |                                            |
| /s/  DANIEL LUKAS           |   | Director                                        |
| Daniel Lukas                |   |                                            |
|                        |   | Director                                        |
| Edward Philip  Smoot        |   |                                            |
| /s/  LARRY SCHWERIN         |   | Director                                        |
| Larry Schwerin              |   |                                            |

 

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