**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K**

**(Mark One)**

**x**        Annual Report Pursuant to Section 13or 15(d) of the Securities Exchange Act of 1934

**Forthe fiscal year ended January 1, 2006**

**o**        Transition Report Pursuantto Section 13 or 15(d) of the Securities Exchange Act of 1934

**Forthe transition period from                    to                   **

**CommissionFile No. 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 registered pursuant toSection 12(b) of the Act:

**None**

Securities registered pursuant toSection 12(g) of the Act:

**CommonStock, $0.001 par value**

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 or Section 15(d) ofthe Act.   Yes o  No x

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. (1) Yes x  No o    (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

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler” and “large accelerated filer” in Rule 12b-2 of the Exchange Act.(Check one):

Large AcceleratedFiler 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 3, 2005) was approximately $36,179,805.

As of February 28,2006, 19,259,612 shares of the registrant’s common stock, $0.001 par value,were outstanding.

**DOCUMENTSINCORPORATED BY REFERENCE**

Portionsof our definitive proxy statement to be filed with the Securities and ExchangeCommission pursuant to Regulation 14A for our 2006 Annual Meeting ofStockholders are incorporated by reference into Part III hereof.

 

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**CHEROKEE INTERNATIONAL CORPORATIONAnnual Report on Form 10-KFor the Fiscal Year Ended January 1, 2006**
|                   |                                                                                                                     | **Page** |
|-------------------|---------------------------------------------------------------------------------------------------------------------|----------|
| **PART I**   |                                                                                                                |     |
| Item 1.           | Business                                                                                                            | 1        |   |
| Item 1B.          | Unresolved Staff Comments                                                                                           | 18       |   |
| Item 2.           | Properties                                                                                                          | 18       |   |
| 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                                                                                             | 22       |   |
| Item 7.           | Management’s Discussion and  Analysis of Financial Condition and Results of  Operations                        | 24       |   |
| Item 7A.          | Quantitative and Qualitative  Disclosures about Market Risk                                                         | 34       |   |
| Item 8.           | Financial Statements and  Supplementary Data                                                                        | 34       |   |
| Item 9.           | Changes in and Disagreements  with Accountants on Accounting and Financial Disclosure                               | 61       |   |
| Item 9A.          | Controls and Procedures                                                                                             | 61       |   |
| Item  9B.         | Other  Information                                                                                                  | 61       |   |
| **PART III** |                                                                                                                |     |   |
| Item 10.          | Directors and Executive  Officers of the Company                                                                    | 62       |   |
| Item 11.          | Executive Compensation                                                                                              | 62       |   |
| Item 12.          | Security Ownership of  Certain Beneficial Owners and Management and Related Stockholder Matters                     | 62       |   |
| Item 13.          | Certain Relationships and  Related Transactions                                                                     | 62       |   |
| Item 14.          | Principal Accounting Fees  and Services                                                                             | 62       |   |
| **PART IV**  |                                                                                                                |     |   |
| Item 15.          | Exhibits and Financial  Statement Schedules                                                                         | 63       |   |
|              | Signatures                                                                                                          | 66       |   |

 

*Certainstatements in this Annual Report on Form 10-K, other than purelyhistorical information, including estimates, projections, statements relatingto our business plans, objectives and expected operating results, and theassumptions 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 13 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 required bylaw, 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 2005, 2004, 2003 and 2002 ended on January 1, 2006, January 2,2005, December 28, 2003 and December 29, 2002, respectively. Forconvenience, our discussion in this Annual Report on Form 10-K showsall fiscal quarters and fiscal years as ending on the last day of the calendarmonth.*

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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 high-end computing, storage equipment, wirelessinfrastructure, enterprise networking, medical and industrial markets. Ourpower supply products are differentiated from those used in lower-endelectronics, such as personal computers and mobile phones, by their complexity,high level of engineering content and reliability. We strive to distinguishourselves from our competitors by offering sophisticated engineering, designflexibility, innovative solutions, rapid prototype development and efficient,low-cost manufacturing 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 reports on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K,and all amendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Securities Exchange Act of 1934, as amended (the “ExchangeAct”) are available free of charge on our website or upon written request to2841 Dow Avenue, Tustin, California 92780, Attention: Investor Relationsas soon as reasonably practicable after the Company electronically files suchmaterials with the SEC. The contents of our website are not incorporated byreference in this Annual Report on Form 10-K and shall not be deemed“filed” under the Exchange Act.

We were founded in 1978 as a small manufacturingcompany serving local California markets. Since then, we have evolved into aworldwide company serving customers through out the world. During our 28-year history, we have established andincreased our presence in multiple international markets by investing in thedevelopment of new facilities and through acquisitions. We opened newfacilities in Bombay, India; Guadalajara, Mexico; and Shanghai, China. In orderto increase our European presence and strengthen our capabilities in thetelecommunications system market, we purchased the Belgium-based ITS Company,(Cherokee Europe) from Panta Electronics on June 15, 2000, which added amanufacturing facility in Wavre, Belgium. In 2005, we further invested in ourbusiness by expanding our operations into the Far East where we opened a newfacility in Shanghai, China (the “China Facility”). Since November 1987,our main office and U.S. manufacturing facility has been located in Tustin,California. On November 26, 2002, we reorganized from a California limitedliability company into a Delaware corporation by merging CherokeeInternational, LLC with and into Cherokee International 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 

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electronicsubsystems and components. Power supplies are also used to regulate and monitorvoltages to protect electronic components from surges or drops in voltage, toperform functions that prevent electronic equipment from being damaged byinternal malfunction and to provide back-up power in the event that a primarypower source fails.

*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 grid intothe precise form and quality of power required by complex electronic equipment,such as mainframe computers, enterprise servers, routers and networkingequipment, wireless base stations, access networks, ultrasound machines, andindustrial process control and automation equipment. This equipment requires aprecise and constant supply of electrical power, significantly more refinedthan the power provided by the electric utility grid.

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 the sophisticationof 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 typically providedby a sole source supplier. Once a custom power supply is designed into an OEM’sproduct, it is difficult, time consuming and costly for the OEM to switchvendors.

·       Modifiedstandard power supplies are standard products or platforms with a minimal amountof modification. These products are characterized by (1) shorter leadtimes; (2) lower up-front engineering costs; (3) potentially quickerdevelopment 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.

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*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;

·       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 standards with high-quality and reliable power supplysolutions. We believe our engineering expertise and our database of productdesigns provides us with a competitive 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 design andmanufacturing facilities, facilitates a faster turn around of changes requestedby our customers to the design of the product during the design and testingprocess, which improves efficiency and lowers the costs, and provides ourcustomers with better service. Therefore, “point of consumption” is importantin our strategy of investing in operations, which exist in close proximity toour customers locally and globally. With our design centers located in theUnited States, Europe, and China we can provide a more efficient alternative totheir design and engineering 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; Guadalajara,Mexico and Bombay, India. These facilities allow us the ability to providelow-cost manufacturing solutions for the more labor-intensive aspects ofour production process. Most of our products can be manufactured in multiplefacilities, which gives us flexibility in meeting our customers’ changingproduction 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;

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

·       Utilizingour lower-cost manufacturing facilities in China, Mexico and India for highervolume and labor-intensive production requirements;

·       Effectively managing ourcosts and our capacity utilizations.

*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 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 applicationsand 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*

We use advanced qualitycontrol methods to monitor our design and manufacturing process. In addition,we test 100% of our finished products using automated equipment andcustomer-approved tests. Our reputation for quality and service has beenrecognized by Frost & Sullivan, a market research consulting firm,which awarded us its 2003 Market Engineering Customer Service Innovative Award.We were the only power supply company to receive this award in 2003.

*Rapid PrototypeLead Times and Time-to-Production*

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 “designwin”. 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.

*ExperiencedManagement Team*

*JeffreyFrank* joined Cherokee in September 2001 as President,Chief Executive Officer and Director. Prior to joining Cherokee, Mr. Frankwas President of Lambda LEI for two years. From May 1996 to March 2000,Mr. Frank was President of Polestar Laboratories. Mr. Frank has over21 years of experience in the electronics industry in which he spent twelveyears with Deltec Electronics, a manufacturer of 

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uninterruptiblepower supplies that are marketed to OEM accounts globally. Mr. Frank is amember of the board of directors of Elgar Holdings, Inc.

*LinsterW. Fox* joined Cherokee in October 2005 as Executive VicePresident of Finance, Chief Financial Officer, and Secretary. Prior to joiningCherokee, Mr. Fox, worked at Anacomp, Inc., an international 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 Senior Vice President, and Corporate Controller, at Anacomp.Mr. Fox previously served in a variety of financial management roles, asVice President in Anacomp’s corporate finance, international, technicalservices, engineering and manufacturing organizations. 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 heheld several financial management positions, including a five-year assignmentin the U.K., as Director of Finance, with their European operations. Prior toDatagraphiX Inc., Mr. Fox worked in public accounting in Washington D.C.with what is now PricewaterhouseCoopers. His clients included public, commercialand international companies. Mr. Fox is a Certified Public Accountant andholds a B.S.B.A. degree from Georgetown University.

*BudPatel*has served as our Executive Vice President since April 1996and was Vice President of Engineering of Cherokee from 1987 to 1993. Mr. Patelserved as 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.

*MukeshPatel*has served as Executive Vice President of GlobalOperations, since June 2005. Prior to June 2005, Mr. Patelserved as Cherokee’s Vice President of Information Technology since August 1996.Prior to Cherokee, Mr. Patel served as Vice President of Operations atBikor Corporation, until Cherokee acquired substantially all of the assets ofBikor.

*AlexPatel*has served as our Vice President of Engineering since August 2002and served as Director of Engineering from 1988 to 1993 and from March 1996to August 2002. Mr. Patel was the Vice President of Engineering atBikor from 1993 through March 1996, when we acquired substantially all ofthe assets of Bikor. Prior to joining the Company in 1988, Mr. Patel was aSenior Development Engineer at GE and Leland Electrosystems for 11 yearscombined.

*DennisPouliot*has served as Vice President of Strategic Accountsfor Cherokee since February 2005. Mr. Pouliot served as a vicepresident in the sales and marketing departments of Cherokee and itspredecessor from March 1991 to February 2005. Prior to joining us, Mr. Pouliotwas a sales manager at Lambda Qualidyne from June 1989 to March 1991and a Director of International Sales and Marketing from September 1978through June 1989.

*HowardRibaudo*has served as Vice President of Sales for Cherokeesince February 2005. Mr. Ribaudo served as Vice President of GlobalAccounts from March 1996 to February 2005, and served in variousother capacities for Cherokee from 1988 through September 1993. Mr. Ribaudoserved as Vice President of Sales and Marketing for Bikor Corporation fromSeptember 1993 through March 1996, when we acquired substantially allof the assets of Bikor.

**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 OurExisting Customers, Development of New Accounts in Growth Markets and aDiversification of Customers in the Four 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 

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programmanagement personnel who provide expanded customer service support, theimplementation of a global account strategy to coordinate the sales efforts ofour North American, European and Asian operations for customers that require aglobal purchasing solution, and systems to improve the efficiency of our orderentry process. We believe these changes have resulted in increased sales andexemplary customer service to many of our existing customers. We intend toleverage our competitive strengths; in-depth knowledge of our customers’needs and expanded product line to continue to increase sales to our existingcustomers. In addition, as OEMs reduce the number of power supply vendorswith whom they work, we continue to focus on increasing our business withexisting customers.

*Expand Our CustomerBase Through Increased Sales and Marketing Efforts*

We continue to invest inour internal sales force and our network of independent sales representatives;their focus and efforts have been on developing new business from our existingcustomer relationships.

*Increase Sales fromComplementary DC/DC Product Offerings*

In 2003, we entered therapidly growing DC/DC market by introducing complementary DC/DC products, whichgenerated 12 design wins, mainly from our existing customers. In 2005, wegenerated 113 design wins for our DC/DC products, our accumulated designwins to date were 161 at December 31, 2005 compared to 48 designs wins at December 31,2004. We continue to focus on selling our DC/DC products to existing AC/DCcustomers, as we believe there is an increased demand for such products.

*Expand andCross-Sell Product 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 that the opportunity exists to market customproducts developed for one customer on a custom, modified standard or standardbasis, to other customers.

*Expand OurInternational Manufacturing Presence*

We expanded our operationsinto the Far East where we opened a new facility in Shanghai, China; we plan tobe fully operational by the second quarter ended 2006. The facility containsover 120,000 square feet of space with the capacity to accommodate sales,marketing, manufacturing, engineering and the requisite support personnel andfunctions that will enable us to fulfill our plans to penetrate this area ofthe world 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.

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*Pursue SelectedAcquisitions*

The worldwide power supplyindustry is highly fragmented. We intend to evaluate opportunities to acquirecompanies that we believe have operations that are complementary to our own andwill improve our geographic reach or strengthen our customer base.

**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 returns could have a greatereffect on us than some of our competitors because of our lower level of netsales.

*Less Dependence onSmall Group of Customers*

Although we believe wehave strong relationships with our customers, we are successfully becoming lessdependent upon sales to a relatively small group of customers. Our top tencustomers accounted for approximately 53% of net sales in 2005 compared toapproximately 58% of net sales in 2004. Net sales for one of our customersaccounted for 10.4% in 2005, and 17% in 2004.

*Fixed OperatingCosts*

Operating costs of our existingmanufacturing facilities and related administrative expenses are relativelyfixed 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 insidecustomers’ end products.

Most of our power supplies are custom made, althoughwe also produce some modified standard and standard products. We focus on designingand manufacturing mid- to high-end custom and modified standard commercialpower supplies because they typically have the highest margins. Our largedatabase of custom and modified standard products allow us to benefit from theopportunity to incorporate our existing engineering and designs into newcustomer products in order to expedite design and time to market. We introduceda complementary line of DC/DC products in the commercial market to takeadvantage of the growing DC/DC market. Our DC/DC converters range from 20 to500 watts. We will continue to focus on selling our DC/DC products to existingAC/DC customers, as we believe there is an 

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increased demand for theseproducts and synergy with a complete distributed power application 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 53% of net sales in 2005, and approximately 58% in2004. One of our customers accounted for 10.4% of net sales during 2005, and17% during 2004. We derived approximately 44% of our net sales during 2005, and41% of our net sales in 2004 from customers in the United States. The remainderof our net sales for such periods was to customers outside of the UnitedStates, with the majority of these sales to customers in Europe. For the dollaramount of net sales attributable to customers located inside and outside theUnited States, please refer to Note 12 in our consolidated financial statementsincluded elsewhere in this report.

**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 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 potentialmarkets for 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 $49.6 million at February 28,2006 and $35.7 million at February 28, 2005. We expect a substantialmajority of our backlog to be shipped within the next 12 months. We have alsoentered into certain warehousing arrangements with some of our customers,whereby we have agreed to bear the risk and cost of carrying inventory. Underthese arrangements, we deliver the power supplies ordered by such customers toa 

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third-partywarehouse location, permit these customers to take delivery of the powersupplies within a specified time period after our delivery of the products, andinvoice these customers for the products only after they have taken ultimatedelivery 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 produce a broad range ofproducts at a low cost. We have ten SMT lines located throughout our facilities.SMT permits reduction in board size by eliminating the need for holes in theprinted circuit boards and by allowing components to be placed on both sides ofa board. Each SMT line is capable of placing as many as 40,000 parts per hour,with each machine hour equating 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, Mexico,China and India are currently ISO 9001: 2000 certified. All facilitiesexcluding our China Facility are also certified to the higher ISO 14000standard. Our China Facility is expected to be certified to ISO 14000 by thesecond half of 2006.

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 

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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.

Two recent EECdirectives that are having an effect on the entire electronics industry are asfollows:

(1)   Restrictionof Hazardous Substances in Electrical and Electronic Equipment, more commonlyknown as RoHS. This directive bans the use of certain elements that arecommonly found in components used to manufacture electrical and electronicassemblies. This directive will become effective on July 1, 2006. Tocomply with the RoHS directive, it will be necessary to purchase more compliantmaterials. Every effort will be made to consume the non-compliant material on-handwithin a reasonable period. However, there is a potential for having to disposeof non-compliant materials in the future, which could adversely affect thefinancial performance of the company. There is also a risk for fines associatedwith non-compliance to the RoHS directive.

(2)   Waste Electrical and Electronic Equipment, also known as WEEE.This directive requires manufacturers and importers to properly recycle ordispose of this 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 interpretation could change in the future. If so, there couldbe significant risk from fines and costs associated with non-compliance to theexisting laws and regulations in the European Union.

**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 ArtesynTechnologies, Astec Power, Delta Electronics, Magnetek, Power One, TycoInternational, 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.

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**Engineering and Product Development**

Our engineering andproduct development activities are principally directed to the improvement ofexisting products and the development of new power supplies to satisfy customerneeds. As part of the collaborative relationships established by us with ourkey customers, we work closely with our customers to develop new products.Product development is performed by a group of design engineers and techniciansprimarily located in Tustin, California and Wavre, Belgium. We plan to open aFar East design center in our China Facility in late 2006.

Our total expenditures forengineering and product development were $9.0 million, $9.1 million and $8.9million for the years ended December 31, 2005, 2004 and 2003,respectively.

**Intellectual Property Matters**

Historically, intellectualproperty rights have not been a significant competitive factor in the powersupply industry. Accordingly, we have not expended significant efforts toobtain 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**

At December 31,2005, we employed 1,484 full-time employees at our facilities in the followingcapacities:

| ** **                       | ** ** | **Locations** | ** ** |
|----------------------------------|------------|---------------|------------|
| **Function**                     | ** ** | ** **    | ** ** | **U.S.** | ** ** | **Europe** | ** ** | **Mexico** | ** ** | **India** | ** ** | **China** | ** ** | **Total** | ** ** |
| Manufacturing                    |       | 242           |       |   | 179 |   |   |   | 245 |   |   |   | 528 |   |   |   | 56 |   |   | 1,260 |   |
| Engineering (including  R&D) |       | 41            |       |   | 39 |   |   |   | 3 |   |   |   | 4 |   |   |   | 1 |   |   | 88 |   |
| Quality Control                  |       | 20            |       |   | 11 |   |   |   | 7 |   |   |   | 2 |   |   |   | 6 |   |   | 42 |   |
| Marketing                        |       | 13            |       |   | 19 |   |   |   | 1 |   |   |   | — |   |   |   | 1 |   |   | 33 |   |
| General Administration           |       | 18            |       |   | 23 |   |   |   | 9 |   |   |   | 9 |   |   |   | 7 |   |   | 61 |   |
| Total                            |       | 334           |       |   | 271 |   |   |   | 265 |   |   |   | 543 |   |   |   | 71 |   |   | 1,484 |   |
|                                  |            |               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

None of our domestic andChina employees are represented by a labor organization. Most employees workingin our Guadalajara, Mexico facility do have union representation as requiredunder Mexican law. Additionally, most of the employees in Belgium and India arerepresented by a union that is subject to a collective bargaining agreement. Webelieve that we have good relations with our employees, including our employeesin our Mexico, Belgium and India facilities.

**ITEM 1A.**        RISKFACTORS

*The following riskfactors, among others, could cause our financial performance to differsignificantly from the goals, plans, objectives, intentions and expectationsexpressed in this Annual Report on Form 10-K. If any of the followingrisks and uncertainties or other risks and uncertainties not currently known tous or not currently considered to be material actually occurs, our business,financial condition or operating results could be harmed substantially.*

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**Risks Relating toOur Company and Industry**

**We aresubstantially dependent upon sales to a relatively small group of customers.The loss of one or moremajor customers, or the discontinuation or modification of these customers’products, could materially and adversely affect the results of our operations.**

Our top ten customersaccounted for approximately 53% of our net sales during 2005 and approximately58% of our net sales during 2004. One of our customers accounted for 10.4% ofnet sales during 2005, and 17% during 2004. The loss of any of our majorcustomers could have a material adverse effect on our financial condition orresults of operations. We do not have long-term contracts with our customers,and our customers use alternative power supply providers for some or all oftheir products. We may not be able to maintain our customer relationships, andour customers may reduce the volume or cancel purchase orders, purchase powersupplies elsewhere or develop relationships with additional providers of powersupplies, 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 ourfinancial condition or results of our operations.

**Failure by ourcustomers or us to keep up with rapid technological change in the electronicequipment industriescould result in reduced sales.**

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. 

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Anyfailure or delay in anticipating technological advances or developing andmarketing new products that respond to any significant technological change orsignificant changes in customer demand could have a material adverse effect onour financial condition or results of operations.

**We face significantcompetition, including from some competitors with greater resources andgeographic presence thanus. Our failure to adequately compete could have a material adverse effect onour 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 ArtesynTechnologies, Astec Power, Delta Electronics, Magnetek, Power One, TycoInternational and Vicor. Some of our competitors have substantially greater netsales, resources and geographic presence than we do. Competition from existingcompetitors or new market entrants may increase at any time. We also facecompetition from current and prospective customers that may design andmanufacture their own power supplies. In times of an economic downturn, or whendealing with high-volume orders, price may become a more important competitivefactor, forcing us to reduce prices and thereby adversely affecting ourfinancial results. Some of our major competitors have also consolidated throughmerger and acquisition transactions. Consolidation among our competitors islikely to create companies with increased market share, customer bases,proprietary technology and marketing expertise, and an expanded sales force.These developments may adversely affect our ability to compete.

**Cancellations,reductions or delays in customers’ orders or commitments, or an increase in thenumber of warrantyproduct returns could have a material adverse impact on our financial conditionand results of operations.**

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 $47.3 millionbacklog as of December 31, 2005 was subject to cancellation upon thepayment by our customers of cancellation fees that vary depending on individualpurchase orders. For example, in 2001 we experienced cancellations of approximately$14.0 million as a result of unfavorable economic conditions and reducedcapital spending by communication providers that purchased our customers’ endproducts. We also enter into certain warehousing arrangements with some of ourcustomers, whereby we agree to bear the risk and cost of carrying inventory.Under these arrangements, we deliver the power supplies ordered by suchcustomers to a third-party location, permit these customers to take delivery ofthe power supplies within a specified time period after our delivery of theproducts, and invoice these customers for the products only after they havetaken ultimate delivery and title has passed. We may not be able to replacecancelled, delayed or reduced orders or commitments in a timely manner or atall and in some instances may need to write-off inventory. Significant ornumerous cancellations, as well as reductions or delays in orders orcommitments, including as a result of delays in or the failure to take deliveryof products that are subject to such arrangements, by a customer or group ofcustomers, could materially adversely affect our financial condition or resultsof 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 

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have inthe past. Any significant increase in product failure rates and the resultingwarranty credit returns could have a material adverse effect on our operatingresults for the period or periods in which those warranty returns occur.

**Our internationalmanufacturing operations and our international sales subject us to variousrisks associated with,among other things, foreign laws, policies, economies and exchange ratefluctuations.**

We havemanufacturing operations located in Mexico, Europe, India, and China. We mayexpand our operations 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 56% of our netsales in 2005 and 59% of our net sales in 2004. Our manufacturing operationsand international sales are subject to inherent risks, all of which could havea material adverse effect on our financial condition or results of operations.For example, our European Division (Cherokee Europe) has two restructuringplans in place, the first one (the 1999 Europe restructuring) was inherited byus in 2000 when we purchased this division from Panta Electronics, the second(the 2003 Europe restructuring) was implemented in 2003 by us. Both of theseplans were significantly impacted by local labor laws and union labornegotiations, and required termination benefits.  When we acquired Cherokee Europe in 2000 weinherited approximately $2.2 million liability obligation to be paid through2010. When we implemented the 2003 Europe restructuring we recorded a $4.5million expense to be paid through 2016. See ‘‘Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Results ofOperations.’’ 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 Euro and other European currencies. For 2005 and 2004, net sales in Europeaccounted for 41% and 42% of our net sales, respectively. Fluctuations in thevalue of the U.S. dollar relative to the Euro impacted our revenue, cost ofgoods sold and operating margins for these periods and resulted in foreigncurrency translation gains and losses. Foreign currency translation gains orlosses recorded in other comprehensive income, a component of equity, in 2005and 2004 were a loss of $2.6 million and a gain of $1.6 million, respectively.Historically, we have not actively engaged in substantial exchange rate hedgingactivities and do not intend to do so in the future.

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**An interruption indelivery of component supplies could lead to supply shortages or a significantincrease 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, and politicaland economic stability in the country in which the components used in ourproducts 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 shortages could cause a substantial loss of business due to shipmentdelays. Any significant shortages or price increases of components could have amaterial adverse effect on our financial condition or results of operations.

**Our quarterly salesmay fluctuate while our expenditures remain relatively fixed, potentiallyresulting 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. For example, sales to one of our largest customers in the firstquarter of 2005 were $5.1 million, and decreased 67% to $1.7 million in thesecond quarter of 2005 driven by fluctuations in demand from that customer.Fluctuations in customer needs, cancellations, reductions and delays in ordersand commitments may cause our quarterly results to fluctuate. See ‘‘—Cancellations,reductions or delays in customers’ orders or commitments or an increase in thenumber of warranty product returns could have a material adverse impact on ourfinancial condition and results of operations.’’ Variations in volumeproduction orders and in the mix of products sold by us have also significantlyaffected sales and gross profit. Sales are generally impacted by a combinationof these items and may also be affected by other factors. These factorsinclude:

·       thereceipt and shipment of large orders or reductions in these orders (includingthe impact of any customer warehousing arrangements); raw material availabilityand 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 are difficultto predict and our financial condition or results of operations in a givenquarter may be below our expectations and our gross margins may decrease. Ourexpense levels are relatively fixed and are based, in part, on expectations offuture revenues. If revenue levels are below expectations, the market price ofour common stock could fall substantially, and our financial condition orresults of operations could be materially adversely affected.

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**Our ability tosuccessfully implement our business strategy is dependent on our ability toretain and attract keypersonnel.**

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 of Finance, Chief FinancialOfficer and Secretary, and Mukesh Patel, Executive Vice President, GlobalOperations, along with other members of our senior management team. We have noemployment retention agreements with our key management executives and do notmaintain key person life insurance for any of our executive officers. Webelieve that the loss of service of any of these executives could have amaterial adverse effect on our business. In addition, we depend on highly skilledengineers and other personnel with technical skills that are in high demand andare difficult to replace. As a result, our ability to maintain and enhanceproduct and manufacturing technologies and to manage any future growth alsodepends on our success in attracting and retaining personnel with highlytechnical skills. The competition for these qualified technical personnel maybe intense if the relatively limited number of qualified and available powerengineers continues. We may not be able to attract and retain qualifiedtechnical personnel.

**Changes ingovernment regulations or product certification could result in delays inshipment 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, Germanyand 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.

**Environmentalcompliance could require significant expenditures and failure to so complycould result in fines orrevocation of licenses or permits, any of which could materially and adverselyaffect our financial 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 the contaminationof the environment. Should there be an environmental accident or violationrelated to our operations, our financial condition or results of operations maybe adversely affected. We could be held liable for significant penalties anddamages under environmental laws and could also be subject to a revocation oflicenses or permits, which could materially and adversely affect our financialcondition or results of operations.

Two recent EECdirectives that are having an effect on the entire electronics industry are asfollows:

(1)         Restriction of HazardousSubstances in Electrical and Electronic Equipment, more commonly known as RoHS.This directive bans the use of certain elements that are commonly found incomponents used to manufacture electrical and electronic assemblies. Thisdirective will become effective on July 1, 2006. To comply with the RoHSdirective, it will be necessary to purchase more compliant materials. There isa potential for having to dispose of non-compliant materials in the future,which could adversely affect the financial performance of the company. There isalso a risk for fines associated with non-compliance to the RoHS directive.

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(2)         WasteElectrical and Electronic Equipment, also known as WEEE. This directiverequires manufacturers and importers to properly recycle or dispose of thisequipment at the end of its useful life. This directive became effective August 13,2005. We believe we have limited exposure to the WEEE directive because ourproducts are usually installed into another user’s system, but thisinterpretation could change in the future. If so, there could be significantrisk from fines and costs associated with non-compliance to the existing lawsand regulations in the European Union.

**Our operations arevulnerable to interruption by fire, earthquake, power loss, telecommunicationsfailure and other eventsbeyond our control.**

Our operations arevulnerable to interruption by earthquakes, fires, electrical blackouts, powerlosses, telecommunications failures and other events beyond our control. Ourexecutive offices and key manufacturing and engineering facilities are locatedin Southern California. Because the Southern California area is located in anearthquake-sensitive area, we are particularly susceptible to the risk of damageto, or total destruction of, our facilities in Southern California and thesurrounding transportation infrastructure, which could affect our ability tomake and transport our products. Furthermore, the State of Californiaexperienced deficiencies in its power supply in 2002, which resulted inoccasional rolling blackouts and caused us two-to-four hour power supplyinterruptions over the course of a few days. In addition, California continuesto face periodic shortages in its power supply. If rolling blackouts or otherdisruptions in power occur, our business and operations would be disrupted, andour business would be adversely affected. In January 2004, we experienceda fire in part of our facility in Belgium, Europe, which destroyed certaininventory, property and equipment. Our business interruption insurance may notbe sufficient to compensate us for losses that may occur and would notcompensate us for the loss of consumer goodwill due to disruption 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, 2005, we had $46.6 million of 5.25%senior notes outstanding, and we had in place a $20.0 million senior revolvingcredit facility (with no amounts outstanding) that is subject to a borrowingbase comprised of eligible accounts receivable and inventory. Our outstandingindebtedness, including our 5.25% senior notes and any debt incurred pursuantto the senior revolving credit facility, is secured by substantially all of ourassets.

Cherokee Europe maintains a working capital line ofcredit of approximately $4.1 million with a Belgian bank, BBL, which isdenominated in Euros, is collateralized by a pledge in first and second rankover a specific amount of business assets, which requires Cherokee Europe tomaintain a certain specific minimum solvency ratio and is cancelable at any time.As of December 31, 2005, Cherokee Europe had no outstanding borrowingsunder the line of credit.

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Cherokee may need to incuradditional debt to continue to grow our business in the future. The agreementsgoverning our debt contain a number of covenants that restrict our businessoperations, including covenants limiting our ability to make investments, enterinto mergers or acquisitions, dispose of assets, incur additional debt, grantliens, enter into transactions with affiliates, redeem or repurchase our capitalstock, repay other debt and pay dividends. As of December 31, 2005, wewere in compliance with our covenants set forth in the agreements. Our abilityto comply with covenants under agreements governing our debt may be affected byevents that are beyond our control, including prevailing economic, financialand industry conditions. Our failure to comply with the covenants orrestrictions contained in agreements governing our debt could result in anevent of default under these agreements, which could result in our debt,together with accrued and unpaid interest, being declared immediately due andpayable.

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

Negative or decliningeconomic conditions can increase our exposure to our customers’ credit riskobligations to us. In particular, sales to larger customers are sometimes madethrough contract manufacturers that do not have the same resources as thosecustomers. Additionally, if one of our major customers experienced financialdifficulties, losses could be in excess of our current allowance. At December 31,2005 and 2004, one of our customers accounted for approximately 10.3% of ourtotal net receivables and another one of our customers accounted for 13.1% ,respectively. For the periods ended December 31, 2005 and 2004, ouraccounts 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.

**ITEM 1B.**       UNRESOLVED STAFF COMMENTS

None.

**ITEM 2.**                PROPERTIES

Our headquarters are located in Tustin, California. Weown two manufacturing facilities, both of which are outside of the UnitedStates, and lease five other manufacturing facilities and one warehousefacility. These facilities manufacture labor-intensive magnetic sub-assembliesthat are distributed to our other facilities for incorporation into our finalproducts. In addition, we lease satellite offices located in England, France,Germany and Sweden, which serve as sales offices.

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All ofour leases have renewal options as indicated in the following table. We believethat our leased locations are adequate for our immediate needs and thatadditional or substitute space is available, if needed, to accommodate futuregrowth and expansion, or relocation. Please refer to Note 12 to ourconsolidated financial statements included elsewhere in this report for theamount 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             |       | April 30,  2009       |       | One three-year  renewal       |
| Irvine, California  |       | Manufacturing  Engineering                |       |                  | 31,000     |                            |       | Leased             |       | April 30,  2009       |       | One one-year renewal          |
| Wavre, Belgium      |       | Manufacturing  Engineering Administrative |       |                  | 178,000    |                            |       | Owned              |       | Not applicable             |       | Not applicable                |
| Guadalajara, Mexico |       | Manufacturing                             |       |                  | 35,000     |                            |       | Owned              |       | 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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*       The land is an Industrial Park owned by the Government of thePeople’s Republic of China (the “PRC”). Under PRC law, the government owns the land and no private parties areallowed to purchase land.  However, theCompany owns the building and has invested $5.5 million into the development ofthis new facility and operation.

**ITEM 3.**                LEGAL PROCEEDINGS

On March 15, 2006, we concluded an arbitrationproceeding with our former Chairman of the Board, over the disputed amount dueto him under his 2003 Stock Option Plan Agreement, at the time of hisresignation as Chairman of the Board in July 2004. The arbitrator issuedan award in favor of him. Pursuant to an agreement with an unrelatedthird-party, we will be reimbursed for the amounts awarded against us,including fees and legal expenses, in the proceeding.

In late March 2006, theCompany was made aware that employees of its Indian subsidiary manufacturingoperations had made certain unauthorized payments that may have been inviolation of the Foreign Corrupt Practices Act. The facility in India is used for the sole purpose of manufacturingproducts for other Company locations and, as such, does not generate revenue orissue invoices to external customers.  Itmanufactures approximately 6% (by volume) of the products offered by theCompany. 

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The subject payments, in the aggregate, amount toapproximately $40,000 during 2004 and 2005 and less than $10,000 in 2006.  The Company has retained outside counsel toconduct an internal investigation into these payments and has notified theDepartment of Justice and the Securities and Exchange Commission of thismatter. The investigation is in its final stages and no payments other thandescribed above have been identified.  Wewill share the results of the internal investigation, when finalized, with theappropriate regulatory agencies, and will fully cooperate with anyinvestigations that may be conducted by such regulatory agencies.  The Company believes that this matter willnot have a material impact on its consolidated financial statements.

During the year ended December 31,2005, we were not a party to any other material legal proceedings. We areoccasionally a party to lawsuits relating to routine matters incidental to ourbusiness. As with all litigation, we can provide no assurance as to the outcomeof any particular lawsuit, and we note that litigation inherently involvessignificant 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 ISSUERPURCHASES OF EQUITY 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.

| ** **     | ** ** | **Year ended  December 31,  2005** | ** ** | **Year ended  December 31,  2004** | ** ** |
|----------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **     | ** ** | **High**                                     | ** ** | **Low**                                      | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | 9.25                                         |       | 6.85                                         |       | 16.84 |   | 14.10 |   |
| Second Quarter |       | 6.95                                         |       | 3.67                                         |       | 15.22 |   | 11.09 |   |
| Third Quarter  |       | 5.08                                         |       | 3.38                                         |       | 12.71 |   | 6.99 |   |
| Fourth Quarter |       | 4.70                                         |       | 2.84                                         |       | 9.61 |   | 6.42 |   |

 

As of March 1, 2006, there were approximately 860holders of our common stock.

We have not paid any cashdividends on our common stock and do not anticipate paying dividends in theforeseeable future.

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**ITEM 6.**                SELECTED FINANCIALDATA

Theselected consolidated financial data as of December 31, 2005 and 2004 andfor the years ended December 31, 2005, 2004 and 2003 are derived from ouraudited consolidated financial statements that appear elsewhere in this report.The selected consolidated financial data as of December 31, 2003, 2002,2001and for the years ended December 31, 2002, and 2001 have been derivedfrom our audited consolidated financial statements that are not included inthis report. No per share information is available prior to November 2002,when we 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.

| ** **                                                                                        | ** ** | **2005**                                                                                 | ** ** | **2004**   | ** ** | **2003**   | ** ** | **2002**   | ** ** | **2001**   | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|------------|------------|------------|------------|
| ** **                                                                                        | ** ** | **(in thousands except share and per share amounts)** | ** ** |
| **Consolidated Statement of  Operations Data:**                                                   |       |                                                                                     |       |       |       |       |       |       |       |       |       |
| Net sales                                                                                         |       | $                                                                                        | 122,079    |       | $          | 148,511    |       | $          | 111,943    |       | $          | 96,293 |   | $ | 121,994 |   |
| Cost of sales                                                                                     |       | 97,181                                                                                   |       | 104,140    |       | 79,397     |       | 70,598     |       | 91,243     |       |
| Gross profit                                                                                      |       | 24,898                                                                                   |       | 44,371     |       | 32,546     |       | 25,695     |       | 30,751     |       |
| Operating  expenses                                                                               |       | 27,557                                                                                   |       | 25,704     |       | 22,522     |       | 18,150     |       | 20,236     |       |
| Restructuring  costs                                                                              |       | —                                                                                   |       | —     |       | 4,474      |       | —     |       | —     |       |
| Stock  compensation expense                                                                       |       | —                                                                                   |       | 243        |       | 990        |       | —     |       | —     |       |
| Gain from  insurance proceeds                                                                     |       | (2,898                                                                                   | )          | —     |       | —     |       | —     |       | —     |       |
| Operating income                                                                                  |       | 239                                                                                      |       | 18,424     |       | 4,560      |       | 7,545      |       | 10,515     |       |
| Interest expense                                                                                  |       | (2,852                                                                                   | )          | (5,234     | )          | (17,028    | )          | (14,801    | )          | (16,470    | )          |
| Debt  restructuring costs                                                                         |       | —                                                                                   |       | —     |       | —     |       | (3,204     | )          | —     |       |
| Other income  (expense), net                                                                      |       | 258                                                                                      |       | 47         |       | 1,187      |       | (431       | )          | (270       | )          |
| Income (loss) before income taxes and cumulative  effect of a change in accounting principle |       | (2,355                                                                                   | )          | 13,237     |       | (11,281    | )          | (10,891    | )          | (6,225     | )          |
| Provision for  income taxes                                                                       |       | 877                                                                                      |       | 2,796      |       | 1,151      |       | 120        |       | 268        |       |
| Income (loss) before cumulative effect of  a change in accounting principle                  |       | (3,232                                                                                   | )          | 10,441     |       | (12,432    | )          | (11,011    | )          | (6,493     | )          |
| Cumulative effect  of a change in accounting principle: goodwill impairment                       |       | —                                                                                   |       | —     |       | —     |       | (34,600    | )          | —     |       |
| Net income (loss)                                                                                 |       | $                                                                                        | (3,232     | )          | $          | 10,441     |       | $          | (12,432    | )          | $          | (45,611 | ) | $ | (6,493 | ) |
| Net income (loss)  per share:                                                                     |       |                                                                                     |       |       |       |       |       |       |       |       |       |
| Basic                                                                                             |       | $                                                                                        | (0.17      | )          | $          | 0.62       |       | $          | (5.83      | )          | —     |   | — |   |
| Diluted                                                                                           |       | (0.17                                                                                    | )          | 0.62       |       | (5.83      | )          | —     |       | —     |       |
| Weighted average  shares outstanding:                                                             |       |                                                                                     |       |       |       |       |       |       |       |       |       |
| Basic                                                                                             |       | 19,230                                                                                   |       | 16,761     |       | 2,132      |       | —     |       | —     |       |
| Diluted                                                                                           |       | 19,230                                                                                   |       | 18,639     |       | 2,132      |       | —     |       | —     |       |
| **Other  Financial Data:**                                                                        | ** ** | ** **                                                                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash flow  provided by (used in) operating activities                                             |       | $                                                                                        | 1,314      |       | $          | 3,979      |       | $          | (4,805     | )          | $          | 5,161 |   | $ | 17,009 |   |
| Capital  expenditures                                                                             |       | $                                                                                        | 8,144      |       | 4,925      |       | 1,962      |       | 1,027      |       | 1,745      |   |
| Depreciation and  amortization                                                                    |       | 3,141                                                                                    |       | 3,207      |       | 3,594      |       | 3,445      |       | 6,694      |       |

 

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| ** **                            | ** ** | **2005**                | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** |
|---------------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|
| ** **                            | ** ** | **(in thousands)** | ** ** |
| **Consolidated Balance Sheet  Data:** |       |                    |       |     |       |     |       |     |       |     |       |
| Cash and cash  equivalents            |       | $                       | 10,543     |     | $          | 14,585   |       | $        | 4,887      |     | $          | 8,504 |   | $ | 2,592 |   |
| Working capital                       |       | 40,655                  |       | 51,109   |       | 18,626   |       | 15,585   |       | 1,169    |       |
| Total assets                          |       | 91,318                  |       | 99,812   |       | 77,215   |       | 63,944   |       | 103,645  |       |
| Total debt                            |       | 46,630                  |       | 46,630   |       | 172,435  |       | 157,972  |       | 158,061  |       |
| Stockholders’ equity  (deficit)  |       | 16,462                  |       | 22,134   |       | (129,968 | )          | (119,611 | )          | (76,132  | )          |
|                                       |            |                         |            |          |            |          |            |          |            |          |            |  |  |  |  |  |

 

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Overview**

The following Management’sDiscussion and Analysis (the “MD&A”) is intended to help the readerunderstand the results of operations and financial condition of CherokeeInternational Corporation. MD&A is provided as a supplement to, and shouldbe read in conjunction with our financial statements and the accompanying notesto the financial statements (the “Notes”).

**Forward-lookingstatements**

*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. Such factors include, among others, (1) changesin general economic and business conditions, domestically and internationally, (2) reductionsin sales to, or the loss of, any of our significant customers or in customercapacity generally, (3) changes in our sales mix to lower margin products,(4) increased competition in our industry, (5) disruptions of ourestablished supply channels, (6) our level of debt and restrictionsimposed by our debt agreements, and (7) the additional risk factorsidentified in Part I, Item 1 of this document. Except as required by law,we undertake no obligation to update any forward-looking statements even thoughour situation may change in the future.*

**Business**

We are a designer and manufacturer of power suppliesfor OEMs. Our advanced power supply products are typically custom designedinto mid- to high-end commercial applications in the computing and storage,wireless infrastructure, enterprise networking, medical and industrial markets.

We operate worldwide and have facilities in OrangeCounty, California; Bombay, India; Guadalajara, Mexico; Wavre, Belgium (Europe)and Shanghai, China. We were founded in 1978 in Orange County, California. Aswe expanded our business and customer base, we opened facilities in Bombay,India, in Guadalajara, Mexico, and Shanghai, China. In June 2000, weacquired Cherokee Europe, which added a manufacturing facility in Wavre,Belgium to our manufacturing capacity and enabled us to better serve theEuropean market.

We generate a significantportion of our sales from OEMs in the communications and computing marketsegment. Our operating results and financial condition continue to be adverselyaffected by unfavorable economic conditions and reduced capital spending by thecommunication service providers that purchase our customers’ products. Theseconditions have caused our revenues to soften in 2005. In addition, grossmargins in 2005 reflect, among other things, a shift in our sales mix duringthat period, to programs with products with relatively higher material cost.

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**Basis of Reporting**

***Net Sales***

Net sales consist of salesduring the period presented, net of returns. Revenue is recognized from productsales at the time of shipment and passage of title.

***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 ofhourly employees. Manufacturing overhead includes salaries, and the directexpense and allocation of costs attributable to manufacturing for lease costs,depreciation on property, plant and equipment, utilities, property taxes andrepairs and maintenance.

***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 subcontract costs for third-party contractingservices. Selling and marketing expenses primarily include salaries andbenefits to account managers and commissions to independent salesrepresentatives. Administrative expenses primarily include salaries andbenefits for certain management and administrative personnel, professional feesand information system costs. Operating expenses also include the directexpense and allocation of costs attributable to these departments for leasecosts, depreciation on property, plant and equipment, utilities, property taxesand repairs and maintenance.

**Critical AccountingPolicies**

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 financialstatements and the reported amounts of revenues and expenses during the periodspresented. Any future changes to these estimates and assumptions could have amaterial effect on our reported amounts of revenue, expenses, assets andliabilities. The significant accounting policies that we believe are the mostcritical to aid in fully understanding and evaluating our reported financialresults 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 

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andmaintain a provision for estimated credit losses based upon our historicalexperience and any specific customer collection issues that we have identified.While credit losses have historically been within our expectations and theprovisions established, we might not continue to experience the same creditloss rates that we have in the past. A significant portion of our accountsreceivable are concentrated in a small number of customers. A significantchange in the liquidity or financial position of any one of these customerscould have a material adverse effect on the collectibility of our accountsreceivable, our liquidity and our future operating results. During 2005 and2004, our top ten customers accounted for approximately 45% and 50% of ouraccounts receivables, respectively, and 53% and 58% of our net sales,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. Our industry is characterized byrapid technological change, frequent new product development, and rapid productobsolescence that could result in an increase in the amount of obsoleteinventory quantities on hand. As demonstrated during the past five years,demand for our products can fluctuate significantly. A significant increase inthe demand for our products could result in a short-term increase in the costof inventory purchases while a significant decrease in demand could result inan increase in the amount of excess inventory quantities on hand. In addition,our estimates of future product demand may prove to be inaccurate, in whichcase we may have understated or overstated the provision required for excessand obsolete inventory. In the future, if our inventory were determined to beovervalued, we would be required to recognize additional expense in our cost ofgoods sold at the time of such determination. Likewise, if our inventory isdetermined to be undervalued, we may have over reported our costs of goods soldin previous periods and would be required to recognize additional operatingincome at the time such inventory is sold. Therefore, although we make everyreasonable effort to ensure the accuracy of our estimates of future productdemand, any significant unanticipated changes in demand or technologicaldevelopments could have a material effect on the value of our inventory and ourreported 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.

**Goodwill and LongLived Assets**

We review the recoverability of the carrying value ofgoodwill on an annual basis or more frequently when an event occurs orcircumstances change to indicate that an impairment of goodwill has possiblyoccurred. The determination of whether any potential impairment of goodwillexists is based upon a comparison of the fair value of the reporting unit tothe accounting value of its net assets.

We also review therecoverability of the carrying value of long-lived assets whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. Recoverability of 

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theseassets is determined based upon the forecasted undiscounted future net cashflows from the operations to which the assets relate, utilizing our bestestimates, appropriate assumptions and projections at the time. These projectedfuture cash flows may vary significantly over time as a result of increasedcompetition, changes in technology, fluctuations in demand, consolidation ofour customers and reductions in average selling prices. If the carrying valueis determined not to be recoverable from future operating cash flows, the assetwould be deemed impaired and an impairment loss would be recognized to theextent the carrying value exceeded the estimated fair market value of theasset.

**Results ofOperations**

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

| ** **                        | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** |
|-----------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Net sales                         |       | 100.0    | %          | 100.0    | %          | 100.0    | %          |
| Cost of sales                     |       | 79.6     |       | 70.1     |       | 70.9     |       |
| Gross profit                      |       | 20.4     |       | 29.9     |       | 29.1     |       |
| Operating  expenses               |       | 20.2     |       | 17.5     |       | 25.0     |       |
| Operating income                  |       | 0.2      |       | 12.4     |       | 4.1      |       |
| Interest expense                  |       | (2.3     | )          | (3.5     | )          | (15.2    | )          |
| Other income, net                 |       | 0.2      |       | —   |       | 1.0      |       |
| Income (loss) before income taxes |       | (1.9     | )          | 8.9      |       | (10.1    | )          |
| Provision for  income taxes       |       | 0.7      |       | 1.9      |       | 1.0      |       |
| Net income (loss)                 |       | (2.6     | )%         | 7.0      | %          | (11.1    | )%         |

 

***Year Ended December 31, 2005 Compared to YearEnded December 31, 2004***

*Net Sales*

Net sales decreased by approximately 17.8% or$26.4 million, to $122.1 million for the year ended December 31,2005 from $148.5 million for the year ended December 31, 2004.

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 in 2005. Revenues generated from shipments to our top tencustomers declined by $13.8 million, including a $12.6 million decrease insales to one of our largest customers, from 2004. These decreases have occurredas revenues from older programs decline and are replaced by growing revenuesfrom new programs over time. Also contributing to the decrease from 2004 werethe effects of material shortages and the transition of certain customerprograms to consignment hub arrangements. Revenue recognition on shipments tothe consignment hubs is delayed until the customer pulls the product from thehub for their production requirements. A slightly stronger Euro in 2005 offsetthe revenue decrease by approximately $0.3 million.

*Gross Profit*

Gross profit decreased by approximately 43.9% or$19.5 million, to $24.9 million for the year ended December 31, 2005from $44.4 million for the year ended December 31, 2004. Gross marginfor the year ended December 31, 2005 decreased to 20.4% from 29.9% in theprior 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 

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programswith higher material contents than the prior year. The decrease in gross marginwas due primarily to higher labor and overhead costs as a percentage of netsales resulting from the lower revenue level, combined with the change inproduct mix.

*Operating Expenses*

Operating expenses for the year 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 wasdue to the $2.9 million insurance proceeds received in 2005, to compensateus for the replacement value of the Belgium, Europe assets destroyed in the2004 fire. The total recoveries of $6.7 million resulted in a $2.9 million gainreported in the year ending December 31, 2005. As of December 31,2005 the Company has been reimbursed for the values of the damaged property.

Operating expenses relatedto General and Administrative salaries, benefits, professional fees andexpenses were higher in 2005 compared to 2004 due to costs associated withbeing a public company and the readiness efforts for compliance with Section 404of the Sarbanes-Oxley Act, even though the Company was not required to complywith Section 404 of the Sarbanes-Oxley Act in 2005 because of market cap. TheCompany anticipates being compliant with all sections of the legislation whenit is required. In addition, we recognized $0.4 million operating expenses in2005 related to our new Shanghai, China Facility.

*Stock CompensationExpense*

There was no stockcompensation expense for the year ended December 31, 2005 compared to$0.2 million for the year ended December 31, 2004. In 2004, werecorded stock compensation expense of $0.2 million primarily in connectionwith the retirement of our former Chairman of the Board, and the accelerationof the vesting of his unvested options. As described previously in Item 3,Legal Proceedings, he was awarded additional stock compensation as a result ofan arbitration proceeding; however, the cost of the award, including legalexpenses, was paid by an unrelated third party and not by Cherokee. As a resultno additional stock charge 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 December 31, 2005 from$18.4 million for the year ended December 31, 2004. Operating margindecreased to 0.2% from 12.4% in the prior year.

*Interest Expense*

Interest expense for theyear ended December 31, 2005 was $2.9 million compared to$5.2 million for the year ended December 31, 2004. 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 December 31, 2005 was income of $0.3 million compared to incomeof $0.5 million for the year ended December 31, 2004.

*Income Taxes*

The Provision for income taxes for the year ended December 31,2005 decreased by $1.9 million to $.9 million, compared to$2.8 million for the year ended December 31, 2004.

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The decrease in the provision for income taxes from2004 was due largely to the decrease in income (loss) before income taxes; weincurred a loss before income taxes this year compared to income at December 31,2004. The valuation allowance on our deferred tax assets for the year ended December 31,2005 increased by $2.5 million to $56.6 million, compared to $54.1 million forthe year ended December 31, 2004.

Provision for income taxes for the twelve months endedDecember 31, 2005 and 2004 was calculated separately by each taxjurisdictions within the related country of business. In spite of the Company’soverall loss for the year, some of our divisions generated income for the year.For 2005, 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 theirincome for the year, therefore, taxes were applied.

The Company’s new operation in Shanghai, China is notsubject to taxes for two years from the first profit making year due to anapplicable tax holiday.

See further discussion ofthe income tax provision and net operating loss carry-forwards in Note 13 tothe accompanying consolidated financial statements.

*Net Income (Loss)*

As a result of the factorsdiscussed above, we recorded net loss of $3.2 million for the year ended December 31,2005, compared to net income of $10.4 million for the year ended December 31,2004.

***Year Ended December 31, 2004 Compared to YearEnded December 31, 2003***

*Net Sales*

Net sales increased by approximately 32.7% or$36.6 million, to $148.5 million for the year ended December 31,2004 from $111.9 million for the year ended December 31, 2003.

This increase wasprimarily attributable to an increase in sales volume to a broad base ofcustomers in the datacom, telecom and industrial end markets, due to economicimprovements in the end markets in which they operate. Our 2004 sales increaseincluded sales from several new customers. Sales to three new customersaccounted for $12.2 million of the increase in sales during 2004. Afavorable foreign currency exchange rate effect of $5.1 million due to astronger Euro also contributed to the net increase in sales.

*Gross Profit*

Gross profit increased by 36.6% or $11.9 million,to $44.4 million for the year ended December 31, 2004 from$32.5 million for the year ended December 31, 2003. Gross margin forthe year ended December 31, 2004 increased to 29.9% from 29.1% in theprior year. Of the $11.9 million increase in gross profit,$10.6 million was attributable to higher sales volume and the remainingportion was attributable to increased gross margin. The increase in grossmargin was due primarily to a reduction in direct labor and factory overheadcosts as a percentage of sales of 0.6% and 1.8%, respectively, and waspartially offset by a 1.6% increase in material cost as a percentage of sales.For the year ended December 31, 2004, direct labor and factory overheadcosts as a percentage of sales at Cherokee Europe improved significantly,reflecting increased efficiencies due to higher production volumes, as well asa lower manufacturing cost structure resulting from the restructuring planimplemented in June 2003, as described below. These decreases in directlabor and overhead costs as a percentage of sales were partially offset by anincrease in material costs as a percentage of sales in both Europe and NorthAmerica, resulting from a change in product mix primarily during the secondhalf of 2004. This mix included programs with higher material contents than theprior year, as well as increased revenues from new programs, which typicallyhave higher material and labor costs in the early stages of production.

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*Operating Expenses*

Operating expenses for the year ended December 31,2004 decreased by $2.1 million or 7.5%, to $25.9 million from$28.0 million for the year ended December 31, 2003. As a percentageof sales, operating expenses decreased significantly to 17.5% from 25.0% in theprior year.

The net decrease inoperating expenses of $2.1 million was primarily due to one-time CherokeeEurope restructuring costs of $4.5 million recorded in June 2003(described below) and a decrease in stock compensation expense of $0.7 million.These decreases were partially offset by increases in engineering anddevelopment, selling and marketing, and general and administrative expenses of$0.2 million, $1.6 million and $1.4 million, respectively. These increasedexpenses were incurred primarily to support the significantly higher salesvolume and related business activities compared to a year ago, as well as theadditional expenses associated with being a public company. Of these increases,approximately $1.0 million was attributable to a stronger Euro versus the yearended December 31, 2003, $0.5 million was attributable to higher salescommissions, $0.5 million was attributable to increased insurance costsprimarily for directors and officers liability, and $0.4 million wasattributable to professional fees and public company expenses. Increases inpayroll and related costs were substantially offset by decreases in incentivecompensation in 2004.

*Restructuring Costs*

During 2003, weimplemented a restructuring plan involving the elimination of a number ofoperational and administrative positions at the Cherokee Europe facility inBelgium due to unfavorable economic conditions in that market. Pursuant to therestructuring plan, we recorded a one-time termination benefit charge of $4.5million for the year ended December 31, 2003.

*Stock CompensationExpense*

Stock compensation expensefor the year ended December 31, 2004 decreased $0.8 million or 75.4%,to $0.2 million from $1.0 million for the year ended December 31,2003.

In 2004, we recorded stockcompensation expense of $0.2 million primarily in connection with theretirement of our former Chairman of the Board, and the acceleration of thevesting of his unvested options. In 2003, we issued 140,677 shares ofcommon stock to management for services rendered. In addition, we issued 12,824shares of common stock to the management of Cherokee Europe for achievingspecified financial performance targets during the second half of 2003, andshares related to the achievement of these performance targets were issued in2004. As a result, we recorded stock compensation in the year ended December 31,2003 of $1.0 million, which represented the estimated fair value of theseshares as of the historical or proposed issuance date.

*Operating Income*

As a result of the factorsdiscussed above, operating income increased by approximately 30.0% or$13.8 million, to $18.4 million for the year ended December 31,2004 from $4.6 million for the year ended December 31, 2003.Operating margin increased to 12.4% from 4.1% in the prior year. Operatingincome for the year ended December 31, 2003 included the effect of theCherokee Europe restructuring costs of $4.5 million and stock compensationexpense of $1.0 million.

*Interest Expense*

Interestexpense for the year ended December 31, 2004 was $5.2 millioncompared to $17.0 million for the year ended December 31, 2003. The$11.8 million decrease in interest expense was due to the repayment of $73.2million of certain outstanding indebtedness and accrued interest, and theconversion to equity of our senior convertible notes, in connection with ourinitial public offering in February 2004.

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*Other Income, Net*

Other income, net for theyear ended December 31, 2004 was $0.05 million compared to $1.2 millionfor the year ended December 31, 2003. Other income, net for the year endedDecember 31, 2003 included a gain on the sale of land of $0.4 million andforeign currency exchange gains of $0.6 million.

*Income Taxes*

Provision for income taxes for the year endedDecember 31, 2004 increased by $1.6 million to $2.8 million, comparedto $1.2 million for the year ended December 31, 2003.

The increase in theprovision for income taxes from 2003 was due largely to shifts in thegeographical mix of income for 2004 and reflects taxable income in Belgium, aswe no longer had net operating losses available in Belgium in 2004. Incomegenerated in the United States during 2004 was fully offset by the utilizationof deferred tax assets. See further discussion of the income tax provision andNOL’s carry-forwards in Note 13 to the accompanying consolidated financialstatements. Provision for income taxes for the year ended December 31,2003 of $1.2 million was primarily due to an accrual for an estimated taxliability relating to an audit assessment by the India tax authorities forprevious years.

*Net Income (Loss)*

As a result of the factorsdiscussed above, we recorded net income of $10.4 million for the yearended December 31, 2004, compared to a net loss of $12.4 million forthe year ended December 31, 2003.

**Liquidity andCapital Resources**

We expect our liquidity requirements will be primarilyfor working capital and capital expenditures. We have historically financed ourcapital needs with cash from operations supplemented by borrowings from creditfacilities and debt issuances. As of December 31, 2005, we had cash andcash equivalents of $10.5 million, and borrowing base availability of $13.6million under our existing revolving credit facility. In addition, CherokeeEurope maintains a working capital line of credit of approximately $4.1 millionwith a Belgian bank, BBL, which is denominated in Euros, is collateralized by apledge in first and second rank over a specific amount of business assets,which requires Cherokee Europe to maintain a certain specific minimum solvencyratio and is cancelable at any time. As of December 31, 2005, we had nooutstanding borrowings. We believe these amounts, together with cash flow fromoperations, are sufficient to meet our cash requirements for at least the nexttwelve months.

We completed our initial public offering of 6,600,000shares of our common stock on February 25, 2004. The net proceeds from theoffering were $86.5 million. We used approximately $73.2 million of the netproceeds to repay outstanding indebtedness, including certain term loans, ourold revolving credit facility, our second lien notes, related interest on theseobligations, as well as accrued interest and interest added to the principalamount of our senior convertible notes. For the twelve months ended December 31,2004 we had a remaining balance of $9.7 million. During the twelve months endedDecember 31, 2005 we invested $5.5 million into the development of our newChina Facility, and $3.2 million was used in operating expenses and loss forthe year. 

Net cash provided by operating activities for the yearended December 31, 2005 was $1.3 million, and for the year ended December 31,2004, net cash provided by operating activities was $4.0 million. This decreasein net cash provided by operating activities for the twelve months ended December 31,2005 was primarily due to a lower operating income compared to the twelvemonths ended December 31, 2004, due to lower revenues for the year. 

Net cash used in investing activities for the yearsended December 31, 2005, and 2004 was $3.9 million, and$9.0 million, respectively. In 2004, the Company used more cash in investingin higher purchases of 

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short-term investments,and the construction at Cherokee Europe related to the portion of the buildingdestroyed by fire in 2004. The Company was fully insured at the replacementvalue for the destroyed items, subject to a $5,000 deductible. See additionaldisclosure in Note 14 to our accompanying consolidated financial statements.

Net cash provided byfinancing activities was $0.2 million in 2005, and $13.9 million in 2004.In February 2004, we completed our initial public offering, whichgenerated net proceeds, after debt repayment and expenses, of approximately$13.3 million. Capital expenditures for the year ended December 31, 2005,were $8.1 million, compared to $4.9 million for the year ended December 31,2004. The primary increase in capital expenditures for the year ended December 31,2005 was largely due to our capital investment related to the development ofour new China Facility. 

*ContractualObligations*

As of December 31, 2005, our borrowingsconsisted of approximately $46.6 million of senior notes bearing interest at5.25% annually, and no borrowings under the Credit Facility. We are required tomake semi-annual interest payments to holders of the senior notes.

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

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 material adverseeffect 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 31,2005 are as follows (in thousands):

| **Contractual Obligations** | ** ** | ** ** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|----------------------------------|------------|------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Long-term debt                   |       | $          | —     |     | $          | —   |       | $        | 46,630     |     | $          | —   |       | $              | —     |      |       | $ | — |   |   | $ | 46,630 |   |
| Operating leases                 |       | 1,570      |       | 1,583    |       | 1,579    |       | 526      |       | 2        |       |     | 114        |           |       | 5,374     |       |
| Purchase order  commitments      |       | 20,166     |       | —   |       | —   |       | —   |       | —   |       |     | —     |           |       | 20,166    |       |
| 1999 Europe  restructuring       |       | 185        |       | 154      |       | 117      |       | 85       |       | 229      |       |     |       |           |       | 770       |       |
| 2003 Europe  restructuring       |       | 239        |       | 216      |       | 194      |       | 188      |       | 173      |       |     | 442        |           |       | 1,452     |       |
| Long service  award              |       | 29         |       | 57       |       | 121      |       | 239      |       | 471      |       |     | 1,187      |           |       | 2,104     |       |
| Deferred  compensation           |       | —     |       | —   |       | —   |       | —   |       | —   |       |     | 917        |           |       | 917       |       |
| Total                            |       | $          | 22,189     |     | $          | 2,010    |       | $        | 48,641     |     | $          | 1,038    |       | $              | 875        |      |       | $ | 2,660 |   |   | $ | 77,413 |   |

 

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 (the Credit Facility). The Credit Facility provides forborrowings of up to $20.0 million, subject to a borrowing base comprised ofeligible accounts receivables and inventory, which was $13.6 million at December 31,2005. We plan to use funds available under the Credit Facility to financeworking capital and other cash requirements as needed. The Credit Facility 

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matures in August 2008and bears interest, at our option, at a rate per annum equal to LIBOR plus 2.5%or the agent bank’s base rate plus 1.0%. In addition to paying interest onoutstanding principal, we are required to pay a commitment fee to the lendersunder the credit facility in respect of the average daily balance of the unusedloan commitment at a rate of 0.5% per annum. The Credit Facility is our seniorobligation and ranks equal in right of payment with our existing and futurepermitted senior debt (including our senior notes), and senior in right ofpayment to our future permitted subordinated debt. The Credit Facility issecured by a first-priority lien, subject to permitted encumbrances, onsubstantially all of our domestic assets and by a pledge of 65% of the equityof 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 $4.1 million with a Belgian bank, BBL, which isdenominated in Euros, is collateralized by a pledge in first and second rankover a specific amount of business assets, which requires Cherokee Europe tomaintain a certain specific minimum solvency ratio and is cancelable at anytime. As of December 31, 2005, Cherokee Europe had no outstandingborrowings under the line of credit. 

As of December 31,2005, we were in compliance with all of the covenants set forth in theprincipal agreements governing our debt. Based on our present expectations, webelieve that our existing cash and cash equivalents, working capital andavailable borrowing capacity at December 31, 2005 will be sufficient tomeet our anticipated cash requirements for the next twelve months, includingoperating requirements, contractual obligations, planned capital expendituresand debt service.

**Inflation**

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

**New Accounting Pronouncements**

Information regardingnewly issued accounting pronouncements is contained in Note 3 of ourconsolidated financial statements included elsewhere in this report. 

**Quarterly FinancialData**

**QUARTERLYFINANCIAL DATA FOR THE2005 AND 2004 QUARTERS (unaudited)(in thousands, except per share amounts)**

| ** **                                | ** ** | **2005 Quarter Ended,** | ** ** | **2004 Quarter Ended,** | ** ** |
|-------------------------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **                                | ** ** | **Mar. 31**                  | ** ** | **Jun. 30**                  | ** ** | **Sept. 30** | ** ** | **Dec. 31** | ** ** | **Mar. 31** | ** ** | **Jun. 30** | ** ** | **Sept. 30** | ** ** | **Dec. 31** | ** ** |
| Net sales                                 |       |                              | $          | 32,010                            |       |   | $ | 30,992 |   |   | $ | 26,418 |   |   | $ | 32,659 |   |   | $ | 36,832 |   |   | $ | 38,622 |   |   | $ | 36,375 |   |   | $ | 36,682 |   |
| Gross profit                              |       |                              | 7,642      |                              |       | 6,312 |   |   | 4,665 |   |   | 6,279 |   |   | 11,923 |   |   | 12,352 |   |   | 9,941 |   |   | 10,155 |   |
| Operating income (loss)                   |       |                              | 2,594      |                              |       | (1,034 | ) |   | (1,642 | ) |   | 321 |   |   | 5,675 |   |   | 6,003 |   |   | 3,127 |   |   | 3,619 |   |
| Net income (loss)                         |       |                              | 625        |                              |       | (1,773 | ) |   | (2,162 | ) |   | 78 |   |   | 2,160 |   |   | 4,369 |   |   | 1,689 |   |   | 2,223 |   |
| Basic net income (loss) per share         |       |                              | $          | 0.03                              |       |   | $ | (0.09 | ) |   | $ | (0.11 | ) |   | $ | 0.00 |   |   | $ | 0.23 |   |   | $ | 0.23 |   |   | $ | 0.09 |   |   | $ | 0.12 |   |
| Diluted net income  (loss) per share |       |                              | $          | 0.03                              |       |   | $ | (0.09 | ) |   | $ | (0.11 | ) |   | $ | 0.00 |   |   | $ | 0.20 |   |   | $ | 0.22 |   |   | $ | 0.09 |   |   | $ | 0.11 |   |

 

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| ** **              | ** ** | **2005 Quarter Ended,** | ** ** | **2004 Quarter Ended,** | ** ** |
|-------------------------|------------|-----------------------------------|------------|-----------------------------------|------------|
| ** **              | ** ** | **Mar. 31**                  | ** ** | **Jun. 30**                  | ** ** | **Sept.30** | ** ** | **Dec. 31** | ** ** | **Mar. 31** | ** ** | **Jun. 30** | ** ** | **Sept. 30** | ** ** | **Dec. 31** | ** ** |
| Net sales               |       |                              | 100.0      | %                                 |       |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |   | 100.0 | % |   |
| Gross profit            |       |                              | 23.9       |                              |       |   | 20.4 |   |   |   | 17.7 |   |   |   | 19.2 |   |   |   | 32.4 |   |   |   | 32.0 |   |   |   | 27.3 |   |   |   | 27.7 |   |   |
| Operating income (loss) |       |                              | 8.1        |                              |       |   | (3.3 | ) |   |   | (6.2 | ) |   |   | 1.0 |   |   |   | 15.4 |   |   |   | 15.5 |   |   |   | 8.6 |   |   |   | 9.9 |   |   |
| Net income (loss)       |       |                              | 2.0        |                              |       |   | (5.7 | ) |   |   | (8.2 | ) |   |   | 0.2 |   |   |   | 5.9 |   |   |   | 11.3 |   |   |   | 4.6 |   |   |   | 6.1 |   |   |

 

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

Market risk relating to our operations resultsprimarily from changes in foreign currency exchange rates and short-terminterest rates. We did not have any derivative financial instruments at December 31, 2005.

We had no variable rate debt outstanding at December 31,2005. However, any debt we incur under the Credit Facility and Cherokee Europeline of credit with BBL will bear interest at a variable rate. We cannotpredict market fluctuations in interest rates and their impact on any variablerate debt we may incur in the future, nor can there be any assurance that fixedrate long-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 a certaindegree of market risk associated with changes in foreign currency exchangerates. This risk is mitigated by the fact that our revenues and expenses aregenerally both transacted in Euros, thereby reducing the risk of foreigncurrency fluctuation on our European operations. The effect of foreign currencyexchange rate fluctuations on our operating results as of and for the yearended December 31, 2005, 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                                                                                                          | 35       |
| Consolidated Balance Sheets as of  December 31, 2005 and 2004                                                                                                | 36       |
| Consolidated Statements of  Operations for the years ended December 31, 2005, 2004 and 2003                                                        | 37       |
| Consolidated Statements of  Stockholders’ Equity (Deficit) and Comprehensive Operations for  the years ended December 31, 2005, 2004 and 2003 | 38       |
| Consolidated Statements of  Cash Flows for the years ended December 31, 2005, 2004 and 2003                                                        | 39       |
| Notes to Consolidated  Financial Statements                                                                                                                       | 40       |
| Schedule  II: Valuation and Qualifying Accounts                                                                                                                   | 60       |

 

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**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors ofCherokee International CorporationTustin, California

We have audited the accompanying consolidated balancesheets of Cherokee International Corporation and subsidiaries (the Company) asof December 31, 2005 and 2004, and the related consolidated statements ofoperations, stockholders’ equity (deficit) and comprehensive operations, andcash flows for each of the three years in the period ended December 31,2005. Our audits also included the financial statement schedule listed in theIndex at Item 15(a)(2). These financial statements and the financial statementschedule are the responsibility of the Company’s management. Our responsibilityis to express an opinion on these financial statements and the financialstatement schedule based 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 ouropinion, such consolidated financial statements present fairly, in all materialrespects, the financial position of Cherokee International Corporation andsubsidiaries as of December 31, 2005 and 2004, and the results of theiroperations and their cash flows for each of the three years in the period endedDecember 31, 2005, in conformity with accounting principles generallyaccepted in the United States of America. Also, in our opinion, such financialstatement schedule, when considered in relation to the basic consolidatedfinancial statements taken as a whole, presents fairly, in all material respects,the information set forth therein.
| /s/ DELOITTE &  TOUCHE LLP |
|-------------------------------------|
| Costa Mesa, California              |
| April 17, 2006                 |

 

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**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(In Thousands, Except per Share Amounts)**

| ** **                                                                                                                                                                              | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                              | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **ASSETS**                                                                                                                                                                              | ** ** | ** **            | ** ** | ** ** | ** ** |
| **CURRENT ASSETS:**                                                                                                                                                                     | ** ** | ** **            | ** ** | ** ** | ** ** |
| Cash and cash  equivalents                                                                                                                                                              |       | $                     | 10,543     |   | $ | 14,585 |   |
| Short-term  investments                                                                                                                                                                 |       |                  |       | 4,178 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $360 and $124  at December 31, 2005 and 2004, respectively                                                    |       | 24,999                |       | 27,929 |   |
| Inventories, net                                                                                                                                                                        |       | 26,851                |       | 28,278 |   |
| Prepaid expenses  and other current assets                                                                                                                                              |       | 1,679                 |       | 2,056 |   |
| Deferred income  taxes                                                                                                                                                                  |       | 19                    |       | — |   |
| Total current assets                                                                                                                                                                    |       | 64,091                |       | 77,026 |   |
| Property and equipment, net                                                                                                                                                             |       | 19,268                |       | 15,028 |   |
| Deposits and  other assets                                                                                                                                                              |       | 1,296                 |       | 965 |   |
| Deferred  financing costs, net of accumulated amortization of $234 and $104  at December 31, 2005 and 2004, respectively                                                      |       | 346                   |       | 476 |   |
| Goodwill                                                                                                                                                                                |       | 6,317                 |       | 6,317 |   |
|                                                                                                                                                                                    |       | $                     | 91,318     |   | $ | 99,812 |   |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY (DEFICIT)**                                                                                                                                | ** ** | ** **            | ** ** | ** ** | ** ** |
| **CURRENT LIABILITIES:**                                                                                                                                                                | ** ** | ** **            | ** ** | ** ** | ** ** |
| Accounts payable                                                                                                                                                                        |       | $                     | 11,658     |   | $ | 12,803 |   |
| Accrued  liabilities                                                                                                                                                                    |       | 6,028                 |       | 5,705 |   |
| Accrued  compensation and benefits                                                                                                                                                      |       | 5,326                 |       | 6,987 |   |
| Accrued  restructuring costs                                                                                                                                                            |       | 424                   |       | 422 |   |
| Total current liabilities                                                                                                                                                               |       | 23,436                |       | 25,917 |   |
| 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                                                                                                                                                             |       | 4,790                 |       | 5,131 |   |
| Commitments and  contingencies (Note 9)                                                                                                                                                 |       |                  |       |   |   |
| **STOCKHOLDERS’ EQUITY:**                                                                                                                                                          | ** ** | ** **            | ** ** | ** ** | ** ** |
| Common stock: $0.001 par value; 60,000,000 shares  authorized; 19,259,612 and 19,206,207 shares issued and outstanding  at December 31, 2005 and 2004, respectively |       | 19                    |       | 19 |   |
| Paid-in capital                                                                                                                                                                         |       | 183,871               |       | 183,713 |   |
| Accumulated  deficit                                                                                                                                                                    |       | (168,898              | )          | (165,666 | ) |
| Accumulated other  comprehensive income                                                                                                                                                 |       | 1,470                 |       | 4,068 |   |
| Net stockholders’ equity                                                                                                                                                           |       | 16,462                |       | 22,134 |   |
|                                                                                                                                                                                    |       | $                     | 91,318     |   | $ | 99,812 |   |

 

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,** | ** ** |
|---------------------------------------|------------|---------------------------------------------|------------|
| ** **                            | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net sales                             |       | $                                           | 122,079    |   | $ | 148,511 |   | $ | 111,943 |   |
| Cost of sales                         |       | 97,181                                      |       | 104,140 |   | 79,397 |   |
| Gross profit                          |       | 24,898                                      |       | 44,371 |   | 32,546 |   |
| Operating Expenses:                   |       |                                        |       |   |   |   |   |
| Engineering and development           |       | 8,981                                       |       | 9,082 |   | 8,905 |   |
| Selling and marketing                 |       | 7,280                                       |       | 7,896 |   | 6,253 |   |
| General and administrative            |       | 11,296                                      |       | 8,726 |   | 7,364 |   |
| Restructuring costs                   |       | —                                      |       | — |   | 4,474 |   |
| Stock compensation expense            |       | —                                      |       | 243 |   | 990 |   |
| Gain from insurance proceeds          |       | (2,898                                      | )          | — |   | — |   |
| Total operating expenses              |       | 24,659                                      |       | 25,947 |   | 27,986 |   |
| Operating income                      |       | 239                                         |       | 18,424 |   | 4,560 |   |
| Interest expense                      |       | (2,852                                      | )          | (5,234 | ) | (17,028 | ) |
| Other income, net                     |       | 258                                         |       | 47 |   | 1,187 |   |
| Income (loss) before income taxes     |       | (2,355                                      | )          | 13,237 |   | (11,281 | ) |
| Provision for income taxes            |       | 877                                         |       | 2,796 |   | 1,151 |   |
| Net income (loss)                     |       | $                                           | (3,232     | ) | $ | 10,441 |   | $ | (12,432 | ) |
| Net income (loss) per  share:         |       |                                        |       |   |   |   |   |
| Basic                                 |       | $                                           | (0.17      | ) | $ | 0.62 |   | $ | (5.83 | ) |
| Diluted                               |       | $                                           | (0.17      | ) | $ | 0.62 |   | $ | (5.83 | ) |
| Weighted average  shares outstanding: |       |                                        |       |   |   |   |   |
| Basic                                 |       | 19,230                                      |       | 16,761 |   | 2,132 |   |
| Diluted                               |       | 19,230                                      |       | 18,639 |   | 2,132 |   |

 

See notes to consolidated financial statements.

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**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) AND COMPREHENSIVEOPERATIONS(In Thousands, Except Shares)**

| ** **                                                           | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Accumulated** | ** ** | **Accumulated  Other  Comprehensive** | ** ** | **Net  Stockholders’  Equity** | ** ** | **Comprehensive** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|---------------------------------------|------------|-------------------------------------|------------|-------------------|------------|
| ** **                                                           | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**                           | ** ** | **Income (Loss)**              | ** ** | **(Deficit)**     | ** ** | **Operations** | ** ** |
| **BALANCE,  December 31, 2002**                            |       | 2,073,077             |       |        | $          | 2               |       |                                  | $          | 42,720                              |       |              | $          | (163,675 | ) |   |   | $ | 1,342 |   |   |   | $ | (119,611 | ) |   |   |   |   |   |
| Issuance of common stock                                             |       | 140,677               |       |        |       |            |       | 990                                   |       |                                |       |              |       |   |   |   |   |   | 990 |   |   |   |   |   |   |
| Components of  comprehensive income (loss):                          |       |                  |       |        |       |            |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                             |       |                  |       |        |       |            |       |                                  |       |                                | (12,432    | )                 |       |   |   |   |   |   | (12,432 | ) |   |   | $ | (12,432 | ) |   |
| Foreign currency translation                                         |       |                  |       |        |       |            |       |                                  |       |                                |       |              |       |   | 1,085 |   |   |   | 1,085 |   |   |   | 1,085 |   |   |
| **BALANCE,  December 31, 2003**                            |       | 2,213,754             |       |        | 2          |            |       | 43,710                                |       |                                | (176,107   | )                 |       |   | 2,427 |   |   |   | (129,968 | ) |   |   | $ | (11,347 | ) |   |
| 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 |   |   |   |   |   |   |
| Components of comprehensive  income (loss):                          |       |                  |       |        |       |            |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                           |       |                  |       |        |       |            |       |                                  |       |                                | 10,441     |              |       |   |   |   |   |   | 10,441 |   |   |   | $ | 10,441 |   |   |
| Foreign currency translation                                         |       |                  |       |        |       |            |       |                                  |       |                                |       |              |       |   | 1,641 |   |   |   | 1,641 |   |   |   | 1,641 |   |   |
| **BALANCE,  December 31, 2004**                            |       | 19,206,207            |       |        | 19         |            |       | 183,713                               |       |                                | (165,666   | )                 |       |   | 4,068 |   |   |   | 22,134 |   |   |   | $ | 12,082 |   |   |
| Issuance of common stock under employee stock  plans            |       | 53,405                |       |        |       |            |       | 158                                   |       |                                |       |              |       |   |   |   |   |   | 158 |   |   |   |   |   |   |
| Components of  comprehensive income (loss):                          |       |                  |       |        |       |            |       |                                  |       |                                |       |              |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net loss                                                             |       |                  |       |        |       |            |       |                                  |       |                                | (3,232     | )                 |       |   |   |   |   |   | $ | (3,232 | ) |   |   | (3,232 | ) |   |
| Foreign currency translation                                         |       |                  |       |        |       |            |       |                                  |       |                                |       |              |       |   | (2,598 | ) |   |   | (2,598 | ) |   |   | (2,598 | ) |   |
| **BALANCE,  December 31, 2005**                            |       | 19,259,612            |       |        | $          | 19              |       |                                  | $          | 183,871                             |       |              | $          | (168,898 | ) |   |   | $ | 1,470 |   |   |   | $ | 16,462 |   |   |   | $ | (5,830 | ) |   |

 

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,** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                               | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| **CASH FLOWS FROM OPERATING ACTIVITIES:**                                                                | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net income (loss)                                                                                        |       | $                                           | (3,232     | ) | $ | 10,441 |   | $ | (12,432 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |       |                                        |       |   |   |   |   |
| Depreciation and  amortization                                                                           |       | 3,141                                       |       | 3,207 |   | 3,594 |   |
| Amortization of  deferred financing costs                                                                |       | 130                                         |       | 150 |   | 311 |   |
| Stock-based  compensation                                                                                |       | —                                      |       | 243 |   | 990 |   |
| Pay-in-kind  interest converted to debt                                                                  |       | —                                      |       | — |   | 12,099 |   |
| (Gain) loss on  sale / disposition of fixed assets                                                       |       | (30                                         | )          | 2 |   | (367 | ) |
| Write-off of  deferred financing costs                                                                   |       | —                                      |       | 224 |   | — |   |
| Deferred income  taxes                                                                                   |       | —                                      |       | 37 |   | (18 | ) |
| Other, net                                                                                               |       | —                                      |       | — |   | (19 | ) |
| Net change in operating assets and liabilities:                                                          |       |                                        |       |   |   |   |   |
| Accounts  receivable, net                                                                                |       | 1,230                                       |       | (1,150 | ) | (7,249 | ) |
| Inventories, net                                                                                         |       | 404                                         |       | (2,693 | ) | (7,936 | ) |
| Prepaid expenses  and other current assets                                                               |       | 210                                         |       | (142 | ) | (681 | ) |
| Deposits                                                                                                 |       | (331                                        | )          | (715 | ) | 291 |   |
| Accounts payable                                                                                         |       | (429                                        | )          | (674 | ) | 4,624 |   |
| Accrued  liabilities and restructuring                                                                   |       | 931                                         |       | (2,067 | ) | (1,700 | ) |
| Accrued  compensation and benefits                                                                       |       | (1,036                                      | )          | (988 | ) | 1,592 |   |
| Accrued interest  payable                                                                                |       | 67                                          |       | (296 | ) | (1,527 | ) |
| Other long-term  liabilities                                                                             |       | 259                                         |       | (1,600 | ) | 3,623 |   |
| Net cash provided  by (used in) operating activities                                                     |       | 1,314                                       |       | 3,979 |   | (4,805 | ) |
| **CASH FLOWS FROM INVESTING ACTIVITIES:**                                                                | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Additions to  property and equipment                                                                     |       | (8,144                                      | )          | (4,925 | ) | (1,962 | ) |
| Net sales  (purchases) of short-term investments                                                         |       | 4,177                                       |       | (4,087 | ) | 672 |   |
| Proceeds from sale  of property and equipment                                                            |       | 34                                          |       | — |   | 516 |   |
| Net cash used in  investing activities                                                                   |       | (3,933                                      | )          | (9,012 | ) | (774 | ) |
| **CASH FLOWS FROM FINANCING ACTIVITIES:**                                                                | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Borrowings on  revolving lines of credit                                                                 |       | —                                      |       | 11,301 |   | 70,638 |   |
| Payments on  revolving lines of credit                                                                   |       | —                                      |       | (17,433 | ) | (64,572 | ) |
| Payments on  obligations under capital leases                                                            |       | —                                      |       | (893 | ) | (1,363 | ) |
| Payments on  long-term debt                                                                              |       | —                                      |       | (65,519 | ) | (2,537 | ) |
| Deferred financing  costs                                                                                |       | —                                      |       | (249 | ) | — |   |
| Net proceeds from  sale of common stock                                                                  |       | 158                                         |       | 86,470 |   | — |   |
| Proceeds from  exercise of warrants, options and employee stock purchases                                |       | —                                      |       | 180 |   | — |   |
| Net cash provided  by financing activities                                                               |       | 158                                         |       | 13,857 |   | 2,166 |   |
| Cash effect of  exchange rate changes                                                                    |       | (1,581                                      | )          | 874 |   | (204 | ) |
| Net increase  (decrease) in cash and cash equivalents                                                    |       | (4,042                                      | )          | 9,698 |   | (3,617 | ) |
| Cash and cash  equivalents, beginning of period                                                          |       | 14,585                                      |       | 4,887 |   | 8,504 |   |
| Cash and cash  equivalents, end of period                                                                |       | $                                           | 10,543     |   | $ | 14,585 |   | $ | 4,887 |   |
| **SUPPLEMENTAL INFORMATION**                                                                             | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash paid during  the year for interest                                                                  |       | $                                           | 2,523      |   | $ | 5,156 |   | $ | 3,433 |   |
| Cash paid during  the year for income taxes                                                              |       | $                                           | 439        |   | $ | 2,782 |   | $ | 254 |   |
| Conversion of  senior convertible notes into common stock                                                |       | $                                           | —     |   | $ | 53,370 |   | $ | — |   |
| Noncash:                                                                                                 |       |                                        |       |   |   |   |   |
| Additions to  property and equipment                                                                     |       | $                                           | 885        |   | $ | — |   | $ | — |   |

 

See notes to consolidated financial statements.

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**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTSYEARS ENDED DECEMBER 31, 2005, 2004 AND 2003**

**1.**                 ORGANIZATION

Cherokee InternationalCorporation reorganized from a California limited liability company and consummateda debt restructuring (the “Restructuring”) through a series of transactionscollectively referred to as the “Transactions” in November 2002. On November 26,2002, Cherokee International, LLC, a California limited liability company (the “LLC”),merged with and into Cherokee International Corporation, a Delaware Corporation(the “Company”), with the Company as the surviving entity pursuant to theAgreement and Plan of Merger (“Merger Agreement”). References herein to “Cherokee”and “the Company” refer to Cherokee International, LLC and its consolidatedsubsidiaries prior to the reorganization and Cherokee International Corporationand its consolidated subsidiaries after the reorganization, and all referencesto common stock for periods before the reorganization mean our then-issued andoutstanding membership interests. As a result of the Transactions, the formerunit holders of the LLC became stockholders of the Company, with each of themreceiving a number of shares based on their percentage ownership in the LLC.Prior to this exchange, the Company had no operating assets or liabilities andhad not yet conducted 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 $0.001per share (“Common Stock”), on February 25, 2004, at a price of $14.50 pershare. The net proceeds to the Company from this offering after paid andaccrued 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.**                 LINEOF 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.**                 SUMMARYOF 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. (“Electronica”), 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 years2005, 2004, and 2003 ended on January 1, 2006, January 2, 2005, and December 28,2003, respectively. For convenience, the accompanying consolidated financialstatements have been shown as ending on December 31st. The fiscal yearending January 1, 2006 included 52 weeks, the fiscal year ended January 2,2005 included 53 weeks, and the fiscal year ended December 28, 2003included 52 weeks.

**Translation ofForeign Currencies**

Foreign subsidiary assetsand liabilities denominated in foreign currencies are translated at theexchange rate on the balance sheet date. Revenues, costs and expenses are translatedat the average exchange rate during the period. Transaction gains and lossesare included in results of operations and have not been significant for theperiods presented. The functional currency of Cherokee Europe is the Euro. Thefunctional currency of Electronica, India, Powertel and Cherokee China is theU.S. dollar, as the majority of transactions are denominated in U.S. dollars.Translation adjustments related to Cherokee Europe are reflected as a componentof stockholders’ equity in other comprehensive operations.

**Cash and CashEquivalents**

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

**Short-TermInvestments**

Short-term investmentsconsist principally of bank certificates of deposit and auction rate securitieswith original maturity dates of approximately three to twelve months.These investments are available-for-sale and all unrealized gains and lossesare insignificant for all periods presented.

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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 obsolescence (in thousands):

| ** **      | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------|------------|-----------------------------|------------|-----------------------------|------------|
| Raw material    |       |                        | $          | 18,855                      |       |   |   | $ | 20,788 |   |   |
| Work-in-process |       |                        | 3,599      |                        |       |   | 4,741 |   |   |
| Finished goods  |       |                        | 4,397      |                        |       |   | 2,749 |   |   |
|            |       |                        | $          | 26,851                      |       |   |   | $ | 28,278 |   |   |

 

As of December 31,2005 and December 31, 2004, the reserve for inventory obsolescence was$3.8 million and $4.5 million, respectively.

**Property andEquipment**

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

| Buildings and  improvements                          |   | 5-20 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 31,2005 and December 31, 2004 (in thousands):

| ** **                     | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Deferred  financing costs      |       |                        | $          | 580                         |       |   |   | $ | 580 |   |   |
| Accumulated  amortization      |       |                        | (234       | )                           |       |   | (104 | ) |   |
| Deferred  financing costs, net |       |                        | $          | 346                         |       |   |   | $ | 476 |   |   |

 

During the year ended December 31,2005, the Company amortized deferred financing costs of $0.2 million, andduring the year ended December 31, 2004, the Company wrote off unamortizeddeferred financing costs of $0.2 million and fully amortized deferred financingcosts of $0.3 million, as a result of the repayment of outstanding indebtednessin connection with the initial public offering.

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**Goodwill**

The Company adopted Statement of Financial AccountingStandard (“SFAS”) 142, *Goodwill And Other IntangibleAssets*, effective January 1, 2002. SFAS 142 requires thatgoodwill and other intangible assets with indefinite useful lives no longer beamortized, but instead be tested for impairment annually, or more frequently,when events or circumstances indicate that their carrying value may beimpaired. The Company performs its impairment test annually at the end of thethird quarter.

In compliance with therequirements of SFAS 142, the Company has determined that its reportingunits consist of two operating segments, which are Cherokee North Americaconsisting of the United States, Mexico, and India operations and CherokeeEurope consisting of the European and Chinese operations. All goodwill has beenassigned to the Cherokee Europe reporting unit. Based on management’sassessment of improving conditions in the European marketplace and independentvaluations utilizing discounted cash flow and industry market multiplevaluation methodologies, there were no events or circumstances for the yearsended December 31, 2005 and 2004 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 are reviewed for events or changes in circumstances, whichindicate that their carrying value may not be recoverable. There was noimpairment of the value of such assets for the years ended December 31,2005, and 2004.

**Fair Value ofFinancial Instruments**

The amounts recorded forcash and cash equivalents, short-term investments, accounts receivable,accounts payable and accrued expenses approximate their fair values based ontheir short-term nature. The amounts recorded for long-term debt, borrowingsunder revolving line of credit and capital lease obligations approximate fairvalue, as interest is tied to or approximates 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, 2005, deferred tax assetsinclude $36.9 million relating to a tax basis step up from a re-capitalizationtransaction in 1999 and $19.9 million of NOL’s carry-forwards. The Company hasrecorded a valuation allowance against a significant portion of its deferredtax assets.

The provision for incometaxes of $0.9 million for the year ended December 31, 2005 primarilyreflects the estimated taxable income in Belgium since there is no longer anyavailable NOL’s carry-forward related to Belgium in 2005 as the remaining NOL’scarry-forward related to Belgium was completely utilized in 2004 by off settingit against the 2004 taxable income.

**Revenue Recognition**

The Company follows the provisions of Staff AccountingBulletin 104, *Revenue Recognition inFinancial Statements* (“SAB 104”), for revenue recognition.Under SAB 104, four conditions must be met 

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before revenue can berecognized: (i) there is persuasive evidence that an arrangement exists, (ii) deliveryhas occurred or service has been rendered, (iii) the price is fixed ordeterminable and (iv) collection is reasonably assured.

The Company generally recognizes revenue at the timeof shipment because this is the point at which revenue is earned and realizableand the earnings process is complete. Title to shipped goods transfers at theshipping point, so the risks and rewards of ownership transfer once the productleaves our warehouse. Revenue is only recognized when collectibility isreasonably assured. We may charge shipping and handling fees to customers,which are included in revenue. The related costs are recorded in cost of goodssold.

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. Warrantycharges have been insignificant during the periods presented.

**Credit Risk**

The Company performsongoing credit evaluations of its customers and generally does not require collateral.The Company maintains reserves for estimated credit losses.

**Stock-BasedCompensation**

As permitted by SFAS 123, *Accounting for Stock-Based Compensation,*the Company accounts for its employee stock-based compensation plan using theintrinsic value method under APB Opinion 25, *Accounting for Stock Issued to Employees*, and provides theexpanded disclosures specified in SFAS 123, as amended by SFAS 148, *Accounting for Stock-Based Compensation—Transitionand Disclosure*.

Thetable below reconciles net income (loss) as reported and pro forma net income(loss) had compensation expense been determined using the provisions of SFAS123 (in thousands except per share amounts):

| ** **                                                                                                                     | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                     | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income  (loss), as reported                                                                                                |       | $                                           | (3,232     | ) | $ | 10,441 |   | $ | (12,432 | ) |
| Stock-based  employee compensation related to stock options included in net  income (loss), net of tax                    |       | —                                      |       | 243 |   | — |   |
| Total stock-based  employee compensation expense determined under the fair value based  method for all awards, net of tax |       | (1,147                                      | )          | (853 | ) | (161 | ) |
| Net income  (loss)—pro forma                                                                                              |       | $                                           | (4,379     | ) | $ | 9,831 |   | $ | (12,593 | ) |
| Net income (loss)  per share, as reported:                                                                                     |       |                                        |       |   |   |   |   |
| Basic                                                                                                                          |       | $                                           | (0.17      | ) | $ | 0.62 |   | $ | (5.83 | ) |
| Diluted                                                                                                                        |       | $                                           | (0.17      | ) | $ | 0.62 |   | $ | (5.83 | ) |
| Pro forma net income  (loss) per share:                                                                                        |       |                                        |       |   |   |   |   |
| Basic                                                                                                                          |       | $                                           | (0.23      | ) | $ | 0.59 |   | $ | (5.91 | ) |
| Diluted                                                                                                                        |       | $                                           | (0.23      | ) | $ | 0.58 |   | $ | (5.91 | ) |

 

For purposes of computing pro forma net income (loss),the Company estimates the fair value of each option grant on the date of grantusing the Black-Scholes option-pricing model. The Black-Scholes option-pricingmodel was developed for use in estimating the value of traded options that haveno vesting restrictions and are fully transferable, while the options issued bythe Company are subject to both vesting 

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and restrictions ontransfer. In addition, option-pricing models require the input of highlysubjective assumptions including expected stock price volatility. The Companycalculates volatility and estimates the expected life of its stock optionsbased upon historical data.

The weighted average assumptions used to value optiongrants during year ended December 31, 2005 were: expected stock pricevolatility of 52.6%; risk-free interest rate of 3.97%; no dividends; andexpected lives of five years. The assumptions used for the year ended December 31,2004 were: expected stock price volatility of 53%; risk-free interest rate of3.49%; no dividends; and expected lives of five years.

Since its inception on February 16,2004, 400,000 shares of common stock had been reserved for issuance under the2004 Employee Stock Purchase Plan (“ESPP”). Under the terms of the ESPP, theCompany’s U.S. employees, nearly all of whom are eligible to participate, canchoose to have up to a maximum of 15% of their eligible annual base earningswithheld, subject to an annual maximum of $25,000 or 2,100 shares per offeringperiod, to purchase our common stock. The purchase price of the stock is 85% ofthe lower of the closing price at the beginning of each six-month offeringperiod or at the end of each six-month offering period. The Company accountsfor its ESPP under APB Opinion 25 and does not recognize compensation costrelated to employee purchase rights under this plan.

**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) indeciding how to allocate resources and assessing performance. The Company’soperating segments consist of the United States, Mexico, and India operations ofCherokee North America and Cherokee Europe and China. These operating segmentshave been aggregated into a single reporting segment based on their similareconomic characteristics and common operating characteristics, includingcomparable gross profit margins and common products, production processes,customers, distribution channels and regulatory requirements.

**Reclassifications**

Certain amounts in thebalance sheet as of December 31, 2004 have been reclassified as follows(amounts in thousands): the current and long term portions of the 1999 EuropeRestructuring of $163 and $865, respectively, have been reclassified fromaccrued liabilities to accrued restructuring costs for the current portion andto other long term liabilities for the long term portion.

**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. The Company adopted SFAS 151 duringthe three-month period ended December 31, 2005; as the result of theadoption, $326,000 of freight related costs were reclassified from inventory toexpense.

In December 2004, SFAS 123R, *Share-Based Payment*, was issued. SFAS 123Ris a revision of SFAS 123, *Accounting forStock Based Compensation*, and supersedes APB 25. Among other items,SFAS 123R eliminates the use of APB 25 and the intrinsic value method ofaccounting, and requires 

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companies to recognize thecost of employee services received in exchange for awards of equityinstruments, based on the grant date fair value of those awards, in thefinancial statements. The Company is required to adopt SFAS 123R effectivefiscal 2006. SFAS 123R permits companies to adopt its requirements using eithera “*modified prospective*” method,or a “*modified retrospective*”method. Under the “*modified prospective*”method, compensation cost is recognized in the financial statements beginningwith the effective date, based on the requirements of SFAS 123R for allshare-based payments granted after that date, and based on the requirements ofSFAS 123 for all unvested awards granted prior to the effective date of SFAS123R. Under the “*modified retrospective*”method, the requirements are the same as under the “*modified prospective* method, but also permits entities torestate financial statements of previous periods based on proforma disclosuresmade in accordance with SFAS 123.

The Company currently uses the Black-Scholes standardoption-pricing model to measure the fair value of stock options granted toemployees. While SFAS 123R permits the Company to continue to use such a model,the standard also permits the use of a “*lattice*”model. The Company will continue to use the Black-Scholes model to measure thefair value of employee stock options 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 current 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 will adopt SFAS 123R effective January 1,2006 using the “modified prospective approach”. The adoption of SFAS 123R’sfair value method will have a significant impact on our results of operations,although it will have no impact on our overall financial position and cashflows. Based on the information at December 31, 2005 we approximate theimpact of adoption of SFAS 123R to be $1.3 million annually, excluding anytax benefits, however, this amount may change due to its dependence on levelsof share-based payments granted in the future.

In December 2004, the FASB issued SFAS 153, *Exchanges of Non-monetary Assets*—“anamendment of APB Opinion 29”. The amendment eliminates the exception to fairvalue accounting for non-monetary exchanges of similar productive assets andreplaces it with a broader exception for exchanges of non-monetary assets thatdo not have commercial substance. Under APB 29, accounting for an exchange of aproductive asset for a similar productive asset or an equivalent interest inthe same or similar productive asset is to be based upon the recorded amount ofthe asset relinquished (carry-over basis with no gain or loss recognition).Such transaction will now be accounted for based upon the fair value of theassets exchanged. SFAS 153 is effective for exchanges occurring in fiscal yearsbeginning after June 15, 2005 and is to be applied prospectively. Thisstatement is not expected to have a material impact on the Company’s financialstatements.

In May 2005, theFASB issued SFAS 154, *AccountingChanges and Error Corrections*, which replaced APB Opinion No. 20,*Accounting Changes*, and SFAS No. 3,*Reporting Changes in Interim FinancialStatements*. SFAS 154 requires retrospective application to priorperiods’ financial statements of voluntary changes in accounting principles andchanges required by a new accounting standard when the standard does notinclude specific transition provisions. Previous guidance required mostvoluntary changes in accounting principle to be recognized by including in netincome of the period in which the change was made the cumulative effect ofchanging to the new accounting principle. SFAS 154 carries forward existingguidance regarding the reporting of the correction of an error and a change inaccounting estimate. SFAS 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning after December 15,2005. Adoption of SFAS 154 as of January 1, 2006 is not expected to have amaterial effect on our consolidated financial position or results ofoperations.

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**4.**                 PROPERTYAND EQUIPMENT

Propertyand equipment consists of the following (in thousands):

| ** **                                           | ** ** | **December 31,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Land                                                 |       | $                     | 1,738      |   | $ | 1,930 |   |
| Buildings and  improvements                          |       | 6,626                 |       | 5,791 |   |
| Machinery and  equipment                             |       | 23,397                |       | 22,096 |   |
| Dies, jigs and  fixtures                             |       | 560                   |       | 534 |   |
| Computers,  software, office equipment and furniture |       | 3,328                 |       | 2,672 |   |
| Automobiles and  trucks                              |       | 111                   |       | 207 |   |
| Leasehold  improvements                              |       | 4,287                 |       | 4,626 |   |
| Construction in  progress                            |       | 5,358                 |       | 1,158 |   |
|                                                 |       | 45,405                |       | 39,014 |   |
| Less accumulated  depreciation and amortization      |       | (26,137               | )          | (23,986 | ) |
|                                                 |       | $                     | 19,268     |   | $ | 15,028 |   |

 

As of December 31,2005 and 2004, there were no assets under capital lease agreements. As of December 31,2005 and 2004, there were capitalized interest on construction in progress of$0.05 million, and $0.00 million respectively. Depreciation expense, for theyears ended December 31, 2005, 2004, and 2003 was $3.1 million,$3.2 million, and $3.6 million, respectively.

**5.**                 NETINCOME (LOSS) PER SHARE

In accordance withSFAS 128, *Earnings Per Share*,basic earnings income (loss) per share is based upon the weighted averagenumber of common shares outstanding. Diluted income (loss) per share is basedupon the weighted average number of common and potential shares of common stockfor each period presented. Potential common shares include the dilutive effectof stock options and warrants under the treasury stock method and seniorconvertible notes under the if-converted method. For purposes of the dilutedearnings per share calculation for the year ended December 31, 2004, thesenior convertible notes are assumed to have been converted at the beginning ofthe period, and as a result, net income has been increased by $1.0 million forthe reduction in interest expense related to the senior convertible notes.

The following table setsforth the computation of basic and diluted net income (loss) per share (inthousands, except share and per share amounts):

| ** **                                                   | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                   | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net income (loss)                                            |       | $                                           | (3,232     | ) | $ | 10,441 |   | $ | (12,432 | ) |
| Adjustment for interest expense on senior  convertible notes |       | —                                      |       | 1,036 |   | — |   |
| Net income (loss), adjusted                                  |       | $                                           | (3,232     | ) | $ | 11,477 |   | $ | (12,432 | ) |
| Shares:                                                      |       |                                        |       |   |   |   |   |
| Weighted-average common shares outstanding—basic        |       | 19,230                                      |       | 16,761 |   | 2,132 |   |
| Effect of  dilutive securities:                              |       |                                        |       |   |   |   |   |
| Senior convertible notes and warrants                        |       | —                                      |       | 1,479 |   | — |   |
| Outstanding stock options                                    |       | —                                      |       | 399 |   | — |   |
| Weighted-average common shares outstanding—diluted      |       | 19,230                                      |       | 18,639 |   | 2,132 |   |
| Net  income (loss) per share:                                |       |                                        |       |   |   |   |   |
| Basic                                                        |       | $                                           | (0.17      | ) | $ | 0.62 |   | $ | (5.83 | ) |
| Diluted                                                      |       | $                                           | (0.17      | ) | $ | 0.62 |   | $ | (5.83 | ) |

 

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**6.**                 DEBT

Long-termdebt consists of the following at December 31, 2005 and 2004 (inthousands):

| ** **            | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------|------------|-----------------------------|------------|-----------------------------|------------|
| 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, 2005 and 2004 (in thousands):

| ** **                             | ** ** | **December 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|----------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| 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, 2005, all of the Company’slong-term debt is scheduled to be repaid in 2008.

In connection with the Company’s initial publicoffering, the Company amended and restated its existing senior revolving creditfacility with General Electric Capital Corporation. The amended facility (the “CreditFacility”) provides for borrowings of up to $20.0 million that are subject to aborrowing base comprised of eligible accounts receivable and inventory, whichwas $13.6 million at December 31, 2005. 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 the credit facility in respect of the averagedaily balance of unused loan commitments at a rate of 0.5% per annum. TheCredit Facility is secured by a first-priority lien, subject to permittedencumbrances, on substantially all of the Company’s domestic assets and by apledge of 65% of the equity of certain of the Company’s foreign subsidiaries.The Credit Facility contains restrictive covenants requiring the Company to,among other things, maintain certain senior leverage ratios. As of December 31,2005, there were no borrowings outstanding under the Credit Facility, and theCompany was in compliance with all of the covenants under the Credit Facility.

As of December 31, 2005, the Company was incompliance with all of the covenants set forth in the principal agreementsgoverning the 5.25% senior notes.

Cherokee Europe maintainsa working capital line of credit of approximately $4.1 million with a Belgianbank, BBL, which is denominated in Euros, is collateralized by a pledge infirst and second rank over a specific amount of business assets, which requiresCherokee Europe to maintain a certain specific minimum solvency ratio and iscancelable at any time. As of December 31, 2005, Cherokee Europe had nooutstanding borrowings under the line of credit and was in compliance with allcovenants.

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**7.**                 OTHERLONG-TERM LIABILITIES

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

| ** **                             | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2005**              | ** ** | **2004** | ** ** |
| 1999 Europe  restructuring liabilities |       | $                     | 770        |   | $ | 1,028 |   |
| 2003 Europe  restructuring liabilities |       | 1,452                 |       | 1,767 |   |
| Long service award  liabilities        |       | 2,104                 |       | 2,077 |   |
| Deferred  compensation                 |       | 917                   |       | 701 |   |
| Subtotal                               |       | $                     | 5,243      |   | $ | 5,573 |   |
| Less current  portion                  |       | (453                  | )          | (442 | ) |
|                                   |       | $                     | 4,790      |   | $ | 5,131 |   |

 

Estimatedpayments required under other long-term obligations as of December 31,2005 are as follows (in thousands):

| ** **           | ** ** | **1999 Europe  Restructuring** | ** ** | **2003 Europe  Restructuring** | ** ** | **Long Service  Award** | ** ** |
|----------------------|------------|-------------------------------------|------------|-------------------------------------|------------|------------------------------|------------|
| 2006                 |       |                                | $          | 185                                 |       |                         |       | $ | 239 |   |   |   | $ | 29 |   |   |
| 2007                 |       |                                | 154        |                                |       |                         | 216        |   |   |   | 57 |   |   |
| 2008                 |       |                                | 117        |                                |       |                         | 194        |   |   |   | 121 |   |   |
| 2009                 |       |                                | 85         |                                |       |                         | 188        |   |   |   | 239 |   |   |
| 2010                 |       |                                | 229        |                                |       |                         | 173        |   |   |   | 471 |   |   |
| Thereafter           |       |                                | —     |                                |       |                         | 442        |   |   |   | 1,187 |   |   |
| Subtotal             |       |                                | 770        |                                |       |                         | 1,452      |   |   |   | 2,104 |   |   |
| Less current portion |       |                                | (185       | )                                   |       |                         | (239       | ) |   |   | (29 | ) |   |
|                 |       |                                | $          | 585                                 |       |                         |       | $ | 1,213 |   |   |   | $ | 2,075 |   |   |

 

The timing of paymentsrequired of the deferred compensation liability of $917,000 is notdeterminable.

**8.**                 CHEROKEEEUROPE RESTRUCTURING

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 Company,was comprised entirely of termination benefits to be paid through 2010. TheCompany paid $0.2 million and $0.2 million in benefits during the yearsended December 31, 2005 and December 31, 2004 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 31,2003, to be paid through 2016. The Company paid $0.4 million and $1.1million in benefits during the years ended December 31, 2005 and December 31,2004 respectively, under the 2003 Europe Restructuring.

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Areconciliation of the 1999 Europe Restructuring and 2003 Europe Restructuringliabilities for the three years ended December 31, 2005 is as follows (inthousands):

| ** **                           | ** ** | **1999 Europe  Restructuring** | ** ** | **2003 Europe  Restructuring** | ** ** |
|--------------------------------------|------------|-------------------------------------|------------|-------------------------------------|------------|
| Balance as of  January 1, 2003  |       |                                | $          | 1,052                               |       |   |   | $ | — |   |   |
| Provision                            |       |                                | —     |                                |       |   | 4,474 |   |   |
| Payments                             |       |                                | (206       | )                                   |       |   | (1,942 | ) |   |
| Foreign exchange rate effect         |       |                                | 182        |                                |       |   | 282 |   |   |
| Balance as of December 31, 2003 |       |                                | 1,028      |                                |       |   | 2,814 |   |   |
| Provision                            |       |                                | 165        |                                |       |   | (54 | ) |   |
| Payments                             |       |                                | (231       | )                                   |       |   | (1,122 | ) |   |
| Foreign exchange rate effect         |       |                                | 66         |                                |       |   | 129 |   |   |
| Balance as of December 31, 2004 |       |                                | 1,028      |                                |       |   | 1,767 |   |   |
| Provision                            |       |                                | 27         |                                |       |   | 259 |   |   |
| Payments                             |       |                                | (163       | )                                   |       |   | (368 | ) |   |
| Foreign exchange rate effect         |       |                                | (122       | )                                   |       |   | (206 | ) |   |
| Balance as of December 31, 2005 |       |                                | 770        |                                |       |   | 1,452 |   |   |
| Less current  portion                |       |                                | (185       | )                                   |       |   | (239 | ) |   |
| Due after one year                   |       |                                | $          | 585                                 |       |   |   | $ | 1,213 |   |   |

 

**9.**                 COMMITMENTSAND CONTINGENCIES

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 31,2005, 2004 and 2003 totaled approximately $1.6 million, $1.4 million and $1.4million (including $1.1 million, $1.1 million and $1.0 million to an entitycontrolled by a former director), respectively.

As of December 31,2005, the Company no longer has any capital lease contracts. A summary of theCompany’s operating lease commitments as of December 31, 2005 is asfollows (in thousands):

| **Year  ending December 31:** | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|
| 2006                               |       | $          | 1,570      |   |
| 2007                               |       | 1,583      |       |
| 2008                               |       | 1,579      |       |
| 2009                               |       | 526        |       |
| 2010                               |       | 2          |       |
| Thereafter                         |       | 114        |       |
| Total minimum  lease payments      |       | $          | 5,374      |   |

 

As of December 31,2005, total future minimum payments for operating leases aggregated $5.4 million,of which $3.8 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 

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facility or lease. Themaximum amount of potential future payments under such indemnifications is notdeterminable.

**TheCompany has not incurred significant amounts related to these guarantees andindemnifications, and no liability has been recorded in the consolidatedfinancial statements for guarantees and indemnifications as of December 31,2005.**

**Employment andSeverance Agreements**

The Company has enteredinto employment agreements with certain executives, which provide for annualbase salaries and cash incentive payments of up to 120% of base salary subjectto attainment of corporate goals and objectives pursuant to incentivecompensation programs approved by the Company’s board of directors, and stockoptions. The agreements provide for severance payments if the executive isterminated other than for cause or terminates for good reason as defined. Theoptions vest over specified time periods.

**Other Matters**

In the first quarter offiscal year 2006 the Company reached an agreement with a former businesspartner to mutually release each other from any obligations arising from pastbusiness transactions.

**India Matter**

In late March 2006, theCompany was made aware that employees of its Indian subsidiary manufacturingoperations had made certain unauthorized payments that may have been inviolation of the Foreign Corrupt Practices Act. The facility in India is used for the sole purpose of manufacturingproducts for other Company locations and, as such, does not generate revenue orissue invoices to external customers.  Itmanufactures approximately 6% (by volume) of the products offered by theCompany. 

The subject payments, in the aggregate, amount toapproximately $40,000 during 2004 and 2005 and less than $10,000 in 2006.  The Company has retained outside counsel toconduct an internal investigation into these payments and has notified theDepartment of Justice and the Securities and Exchange Commission of thismatter. The investigation is in its final stages and no payments other thandescribed above have been identified.  Wewill share the results of the internal investigation, when finalized, with theappropriate regulatory agencies, and will fully cooperate with anyinvestigations that may be conducted by such regulatory agencies.  The Company believes that this matter willnot have a material impact on its consolidated financial statements.

**10.   STOCKHOLDERS’ EQUITY**

In July 2003, the Company issued 140,677 sharesof common stock to management, with an estimated fair value of $5.85 per shareas of the date of issuance, for services rendered. In addition, the Companyissued 12,824 shares of common stock, with an estimated fair value of $13.00per share as of the issuance date, to the management of Cherokee Europe forachieving specified financial performance targets during the second half of2003. As a result, the Company recorded stock compensation expense of $1.0million in 2003, representing the estimated fair value of these shares.

On February 25, 2004,the Company closed the sale of 6,600,000 shares of common stock at a price of$14.50 per share in a firm commitment underwritten initial public offering. Theoffering was affected pursuant to a Registration Statement on Form S-1(File No. 333-110723), which the Securities and Exchange Commissiondeclared effective on February 19, 2004. Also in connection with ourinitial public offering, the Company issued 10,354,910 shares in connectionwith the conversion of senior convertible notes into common stock.

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**2002 Stock OptionPlan**

In July 2003, theCompany adopted the Cherokee International Corporation 2002 Stock Option Plan (“the2002 Stock Option Plan”) under which up to 1,410,256 shares of the Company’scommon stock may be issued pursuant to the grant of non-qualified stock optionsto the directors, officers, employees, consultants and advisors of the Companyand its subsidiaries. In connection with the adoption of the 2002 Stock OptionPlan, the company granted 1,087,327 stock options, the options typically vestover a four-year period, have a 10 year contractual life and range inexercise price from $5.85 to $10.34 per share and were granted with exerciseprices at or above fair value as determined by Cherokee’s Board of Directorsbased on income and market valuation methodologies. In February 2004, theCompany granted options to purchase 328,320 shares of common stock at anexercise price of $14.50 and is no longer granting options pursuant to the 2002Stock Option Plan.  No additional shareshave been issued under the 2002 Stock Option Plan since February 2004. Asof December 31, 2005 the Company has granted a total of 1,415,647 optionsto purchase shares of common stock under the 2002 Stock Option Plan.

**2004 Omnibus StockIncentive Plan**

On February 16, 2004, the Company adopted the 2004Omnibus Stock Incentive Plan (the ‘‘2004 Plan’’). The 2004 Plan provides that atotal of 800,000 shares of the Company’s Common Stock are reserved for issuanceunder the 2004 Plan, plus an annual increase to be added on the first day ofthe Company’s fiscal year (beginning 2005) equal to the lesser of (i) 450,000shares or (ii) 2% of the number of outstanding shares on the last day ofthe immediately preceding fiscal year. Any officer, director, employee,consultant or advisor of the Company is eligible to participate in the 2004Plan. The 2004 Plan provides for the issuance of stock-based incentive awards,including stock options, stock appreciation rights, restricted stock, deferredstock, and performance shares. During 2005 the Company granted options topurchase 1,227,489 shares of common stock under the 2004 Plan, which included75,589 options issued as partial compensation to non-employee directors. As of December 31,2005 the Company has granted a total of 1,426,489 options to purchase shares ofcommon stock under the 2004 Plan, which included 138,153 options granted tonon-employee directors.

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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** | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------|------------|---------------------------------------------|-------------------|--------------------------------------------------------|------------|
| 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 31, 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, December 31, 2004                                |       | 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, December 31, 2005                                 |       | 2,270,115                  |       | $                                           | 2.97 – 14.50 |                                                   |       | $ | 6.47 |   |   |
| Options  exercisable at December 31, 2005                              |       | 701,483                    |       | $                                           | 5.85 – 14.50 |                                                   |       | $ | 7.52 |   |   |

 

| ** **                          | ** ** | **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 – 4.84                   |       | 826,989                      |       |                         | 9.86       |   |   |   | $ | 3.30 |   |   |   | — |   |   |   | — |   |   |
| $5.85 – 8.07                   |       | 1,027,813                    |       |                         | 8.13       |   |   |   | $ | 6.36 |   |   |   | 508,069 |   |   |   | $ | 5.89 |   |   |
| $10.34                              |       | 142,813                      |       |                         | 7.58       |   |   |   | $ | 10.34 |   |   |   | 125,289 |   |   |   | $ | 10.34 |   |   |
| $12.37                              |       | 5,000                        |       |                         | 8.56       |   |   |   | $ | 12.37 |   |   |   | 1,250 |   |   |   | $ | 12.37 |   |   |
| $14.50                              |       | 267,500                      |       |                         | 8.13       |   |   |   | $ | 14.50 |   |   |   | 66,875 |   |   |   | $ | 14.50 |   |   |
|                                |       | 2,270,115                    |       |                         | 8.73       |   |   |   | $ | 6.47 |   |   |   | 701,483 |   |   |   | $ | 7.52 |   |   |
|                                     |            |                              |            |                              |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**2004 Employee StockPurchase Plan**

On February 16, 2004,the Company adopted the 2004 Employee Stock Purchase Plan (the ‘‘ESPP’’). TheESPP provides that a total of 400,000 shares of common stock are reserved forissuance under the plan, plus an annual increase to be added on the first dayof the Company’s fiscal year (beginning 2005) equal to the lesser of (i) 250,000shares or (ii) 1% of the number of outstanding shares on the last day ofthe immediately preceding fiscal year. The ESPP, which is intended to qualifyas an ‘‘employee stock purchase plan’’ under Section 423 of the InternalRevenue Code of 1986, is implemented utilizing six-month offerings withpurchases occurring at six-month intervals, with a new offering periodcommencing on the first trading day on or after May 15 (beginning in theyear 2005) and November 15 (beginning in the year 2004) and ending on thelast trading day on or before November 14 or May 14, respectively.The Company’s Compensation Committee of the Board of Directors oversees theESPP administration. Employees are eligible to participate if they are employedfor at least 20 hours per week and more than five months in a calendar year bythe Company, subject to certain restrictions as defined. 

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The ESPPpermits eligible employees to purchase common stock through payroll deductions,which may not exceed 15% of an employee’s compensation. The price of commonstock purchased under the ESPP will be 85% of the lower of the fair marketvalue of the common stock at the beginning of each six-month offering period oron the applicable purchase date. Employees may end their participation in anoffering at any time during the offering period, and participation endsautomatically upon termination of employment. The Company’s CompensationCommittee may at any time amend or terminate the ESPP, except that no suchamendment or termination may adversely affect shares previously granted underthe ESPP. As of December 31, 2005, 72,071 shares have been issued underthe ESPP.

**DeferredCompensation Plan**

On February 16, 2004, the Company adopted twoexecutive deferred compensation plans for the benefit of certain designatedemployees and non-employee directors of the Company. The plans allowparticipating employees and non-employee directors to make pre-tax deferrals ofup to 100% of their annual base salary and bonuses and retainer fees andmeeting fees, respectively. The plans allow the Company to make matchingcontributions and employer profit sharing credits at the sole discretion of theCompany. A participant’s interest in each matching contribution and employerprofit sharing credits, if any, vests in full no later than after 3 years. Asof December 31, 2005, the Company has recorded a liability of $0.9 millionfor employee and non-employee director contributions and investment activity todate, which is recorded in other long-term liabilities, and the Company hasprovided no matching contributions for the years ended December 31, 2005,2004 and 2003.

54

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**11.   RETIREMENT PLANS**

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,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                        | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Change in Benefit Obligation:**                                                                 | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Benefit obligation,  beginning of period                                                          |       | $                                           | 5,986      |   | $ | 4,596 |   | $ | 3,556 |   |
| Benefits paid                                                                                     |       | (934                                        | )          | (13 | ) | (654 | ) |
| Effect of exchange rate  changes                                                                  |       | (744                                        | )          | 539 |   | 676 |   |
| Service cost                                                                                      |       | 152                                         |       | 138 |   | 123 |   |
| Plan participant’s  contributions                                                            |       | 125                                         |       | 114 |   | 93 |   |
| Interest cost                                                                                     |       | 247                                         |       | 244 |   | 213 |   |
| Actuarial loss                                                                                    |       | 280                                         |       | 368 |   | 589 |   |
| Benefit obligation, end  of period                                                                |       | $                                           | 5,112      |   | $ | 5,986 |   | $ | 4,596 |   |
| **Change in Plan Assets:**                                                                        | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Fair value of plan  assets, beginning of period                                                   |       | $                                           | 3,698      |   | $ | 2,997 |   | $ | 2,659 |   |
| Benefits paid                                                                                     |       | (934                                        | )          | (13 | ) | (654 | ) |
| Effect of exchange rate  changes                                                                  |       | (437                                        | )          | 335 |   | 470 |   |
| Actual return on plan  assets                                                                     |       | 13                                          |       | 60 |   | 285 |   |
| Employer contribution                                                                             |       | 257                                         |       | 205 |   | 143 |   |
| Plan participants’  contributions                                                            |       | 125                                         |       | 114 |   | 94 |   |
| Fair value of plan  assets, end of period                                                         |       | $                                           | 2,722      |   | $ | 3,698 |   | $ | 2,997 |   |
| Unfunded status                                                                                   |       | $                                           | (2,390     | ) | $ | (2,288 | ) | $ | (1,599 | ) |
| Unrecognized net  actuarial gain                                                                  |       | 1,141                                       |       | 886 |   | 359 |   |
| Accrued pension  liability                                                                        |       | $                                           | (1,249     | ) | $ | (1,402 | ) | $ | (1,240 | ) |
| **Information for pension plans with accumulated  benefit obligations in excess of plan assets:** | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Projected benefit  obligation                                                                     |       | $                                           | 5,112      |   | $ | 5,986 |   | $ | 4,596 |   |
| Accumulated benefit  obligation                                                                   |       | $                                           | 3,919      |   | $ | 4,589 |   | $ | 3,463 |   |
| Fair value of assets                                                                              |       | $                                           | 2,722      |   | $ | 3,698 |   | $ | 2,997 |   |
| **Components of Net Periodic Benefit Cost:**                                                      | ** ** | ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Service cost                                                                                      |       | $                                           | 152        |   | $ | 138 |   | $ | 123 |   |
| Interest cost                                                                                     |       | 247                                         |       | 244 |   | 213 |   |
| Expected return on plan  assets                                                                   |       | (141                                        | )          | (143 | ) | (154 | ) |
| Net periodic benefit cost                                                                         |       | $                                           | 258        |   | $ | 239 |   | $ | 182 |   |

 

| ** **                                                          | ** ** | **Years Ended December 31,** | ** ** |
|---------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                          | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| **Weighted average assumptions used:**                              | ** ** | ** **                                  |       | ** ** |   | ** ** |   |
| For determining benefit obligations at  December 31:           |       |                                        |       |   |   |   |   |
| Discount rate                                                       |       | 4.00                                        | %          | 4.50 | % | 5.25 | % |
| Salary increase                                                     |       | 3.50                                        | %          | 3.50 | % | 3.45 | % |
| For determining net periodic cost for year ended  December 31: |       |                                        |       |   |   |   |   |
| Discount rate                                                       |       | 4.00                                        | %          | 5.25 | % | 5.25 | % |
| Salary increase                                                     |       | 3.50                                        | %          | 3.45 | % | 3.45 | % |
| Expected return on assets                                           |       | 4.50                                        | %          | 4.50 | % | 4.50 | % |
| **Pension plan assets:**                                            | ** ** | ** **                                  |       | ** ** |   | ** ** |   |

55

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| 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 time of deposit. Returns may be higher than thefixed rates due to a profit sharing provision and dependent on the overallinvestment results of Fortis AG. In general, the assets of the insurancecontract are primarily invested in Euro bonds with only a small portion inequities.

TheCompany does not expect to contribute to the pension plan in fiscal 2006.

| **Estimated  future pension benefit payments (in thousands):** | ** ** | ** ** | ** ** |
|----------------------------------------------------------------|------------|------------|------------|
| 2006                                                           |       | $          | 69         |   |
| 2007                                                           |       | 74         |       |
| 2008                                                           |       | 79         |       |
| 2009                                                           |       | 305        |       |
| 2010                                                           |       | 531        |       |
| Years 2011 – 2015                                         |       | 2,664      |       |
|                                                                |            |            |            |  |

 

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, 2005, 2004, and 2003, the Company elected tocontribute approximately $280,000, $296,000, and $253,000 respectively, to the401(k) Plan. Contributions are generally made after the calendar year end.Participants pay administrative costs associated with the 401(k) Plan.

**12.**          CONCENTRATIONS

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

| ** **   | ** ** | **Years Ended December 31,** | ** ** |
|--------------|------------|---------------------------------------------|------------|
| **Customer** | ** ** | ** **                                  | ** ** | **  2005  ** | ** ** | **  2004  ** | ** ** | **  2003  ** | ** ** |
| A            |       |                                        | 10.4       | % |   |   | 17 | % |   |   | 22 | % |   |
| B            |       |                                        | *          |   |   |   | * |   |   |   | 10 | % |   |
|              |            |                                             |            |  |  |  |  |  |  |  |  |  |  |  |  |

----

*                    Customer netsales were less than 10% of total net sales for 2005 and 2004

The Company recordedaccounts receivable balances of greater than 10% of total net receivables fromthe following customers:

| ** **   | ** ** | **As of December 31,** | ** ** |
|--------------|------------|---------------------------------------|------------|
| **Customer** | ** ** | ** **                            | ** ** | **   2005   ** | ** ** | **   2004   ** | ** ** |
| A            |       |                                  | *          |   |   |   | 13.1 | % |   |
| B            |       |                                  | 10.3       | % |   |   | * |   |   |
|              |            |                                       |            |  |  |  |  |  |  |  |  |

----

*                    Customerreceivable balance was less than 10% of total net accounts receivable

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’sfinancial position and results of operations.

56

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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 31,2005, 2004 and 2003, net sales by region were as follows (in thousands):

| ** **    | ** ** | **Years Ended December 31,** | ** ** |
|---------------|------------|---------------------------------------------|------------|
| ** **    | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| United States |       | $                                           | 54,238     |   | $ | 61,211 |   | $ | 53,628 |   |
| Europe        |       | 49,967                                      |       | 62,042 |   | 47,947 |   |
| Asia          |       | 11,680                                      |       | 12,695 |   | 1,301 |   |
| Other         |       | 6,194                                       |       | 12,563 |   | 9,067 |   |
|          |       | $                                           | 122,079    |   | $ | 148,511 |   | $ | 111,943 |   |

 

The Company’s long-livedassets located outside of the United States were $16.5 million and $11.9million as of December 31, 2005 and 2004, respectively.

**13.**          INCOMETAXES

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

| ** **    | ** ** | **Years Ended December 31,** | ** ** |
|---------------|------------|---------------------------------------------|------------|
| ** **    | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| United States |       | $                                           | 4,604      |   | $ | 10,171 |   | $ | (6,675 | ) |
| Foreign       |       | (6,959                                      | )          | 3,066 |   | (4,606 | ) |
|          |       | $                                           | (2,355     | ) | $ | 13,237 |   | $ | (11,281 | ) |

 

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

| ** **              | ** ** | **Years Ended December 31,** | ** ** |
|-------------------------|------------|---------------------------------------------|------------|
| ** **              | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Current:                |       |                                        |       |   |   |   |   |
| Federal                 |       | $                                           | (51        | ) | $ | — |   | $ | — |   |
| State                   |       | —                                      |       | 1 |   | 1 |   |
| Foreign                 |       | 403                                         |       | 2,758 |   | 1,168 |   |
| Total current           |       | 352                                         |       | 2,759 |   | 1,169 |   |
| Deferred:               |       |                                        |       |   |   |   |   |
| Federal                 |       | —                                      |       | — |   | — |   |
| State                   |       | —                                      |       | — |   | — |   |
| Foreign                 |       | 525                                         |       | 37 |   | (18 | ) |
| Total deferred          |       | 525                                         |       | 37 |   | (18 | ) |
| Total for income  taxes |       | $                                           | 877        |   | $ | 2,796 |   | $ | 1,151 |   |

 

As described in Note 1, prior to the Restructuring,the Company was a limited liability company under the provisions of the federaland state tax codes. Under federal laws, taxes based on income of a limitedliability company are payable by the Company’s individual members. Accordingly,no provision for federal income taxes is included in the accompanyingconsolidated financial statements relating to the periods prior to thereorganization. Provisions for California franchise tax and fees are notsignificant for any period presented. The Company’s operations in Mexico, Indiaand Belgium are subject to income taxes on earnings generated in thosecountries. The Company’s new operation in Shanghai, China is not subject totaxes for two years from the first profit making year  due to an applicable tax holiday.

57

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

| ** **                                                                  | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                  | ** ** | **2005**                                    | ** ** | **2004** | ** ** | **2003** | ** ** |
| Worldwide pre-tax  income (loss) at 34% (35% for years ended 2004 and 2003) |       | $                                           | (801       | ) | $ | 4,633 |   | $ | (3,948 | ) |
| Foreign income  not subject to U.S. tax (benefit)                           |       | 847                                         |       | (4,082 | ) | (1,584 | ) |
| Foreign taxes                                                               |       | 769                                         |       | 2,795 |   | 1,150 |   |
| Reduction in  foreign net operating loss carry-forwards                     |       | —                                      |       | — |   | 4,095 |   |
| Change in  valuation allowance                                              |       | 248                                         |       | (633 | ) | 1,224 |   |
| Other                                                                       |       | (186                                        | )          | 83 |   | 214 |   |
| Total                                                                       |       | $                                           | 877        |   | $ | 2,796 |   | $ | 1,151 |   |

 

Accordingly management determined that a fullvaluation allowance was required as of December 31, 2005 and  December 31, 2004 for all the deferredtax assets. The valuation allowance changed by $2,509 in 2005, from $54,118 at December 31,2004 to $56,627 at December 31, 2005. The change is net of a beginningbalance decrease in the valuation allowance of $482; the total change invaluation allowance in 2005 is $2,991.

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

| ** **                                     | ** ** | **December 31,** | ** ** |
|------------------------------------------------|------------|-----------------------|------------|
| ** **                                     | ** ** | **2005**              | ** ** | **2004** | ** ** |
| **Net current deferred income  taxes**         | ** ** | ** **            | ** ** | ** ** | ** ** |
| Inventories                                    |       | $                     | 1,396      |   | $ | (842 | ) |
| Other reserves  and credits                    |       | 338                   |       | 923 |   |
| Deferred state  taxes                          |       | (104                  | )          |   |   |
|                                           |       | 1,630                 |       | 81 |   |
| **Net non-current deferred income  taxes**     | ** ** | ** **            | ** ** | ** ** | ** ** |
| Net operating loss  carry-forwards             |       | 20,097                |       | 15,009 |   |
| Fixed assets                                   |       | (357                  | )          | 181 |   |
| Tax basis step up  from 1999 re-capitalization |       | 36,949                |       | 38,545 |   |
| Other                                          |       | 1,246                 |       | 247 |   |
| Deferred state  taxes                          |       | (3,520                | )          |   |   |
|                                           |       | 54,415                |       | 53,982 |   |
| Valuation  allowance                           |       | (56,627               | )          | (54,118 | ) |
| Net deferred tax  liability                    |       | $                     | (582       | ) | $ | (55 | ) |

 

The deferred tax liability is included in accruedliabilities in the accompanying consolidated financial statements. Federal andstate NOL’s carry-forwards at December 31, 2005 were $38.5 million and$28.8 million, respectively. Federal NOL’s begin expiring in 2022 and state NOL’sbegin expiring in 2014. Foreign NOL’s carry-forwards were $13.8 million at December 31,2005.

The Company believes ithas adequately provided for income tax issues not yet resolved with federal,state and foreign tax authorities. At December 31, 2005, $1.0 million wasaccrued for such federal, state and foreign matters and is included in accruedliabilities. Although not probable, the most adverse resolution of thesefederal, state and foreign issues could result in additional charges toearnings in future periods in addition to the $1.0 million currently provided.Based upon a consideration of all relevant facts and circumstances, the Companydoes not believe the ultimate resolution of tax issues for all open tax periodswill have a materially adverse effect upon its results of operations orfinancial condition.

58

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**14.**          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 December 31,2004, the Company had received $3.4 million in insurance proceeds. Withinoperating expenses for the year ended December 31, 2004, the Companyrecorded a loss related to the destroyed inventory, property and equipment.

During 2005 we received additional insurance proceedsto compensate us for the replacement value of the assets destroyed. The totalrecoveries of $6.7 million  resulted in a$2.9 million gain reported in the year ending December 31, 2005. As of December 31,2005 the Company has been reimbursed for the values of the damage property.

Thefollowing amounts were recorded in our consolidated financial statements forthe years ending December 31, 2005 and 2004 (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      |   |

 

59

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**CHEROKEE INTERNATIONAL 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  December 31, 2003     |       |                                           | $          | 174                                      |       |           |       | $                                        | 50         |   |   |   | $ | (90 | ) |   |   | $ | 134 |   |   |
| Year ended  December 31, 2004     |       |                                           | 134        |                                     |       |           | 60         |                                     |       |   | (70 | ) |   |   | 124 |   |   |
| Year ended  December 31, 2005     |       |                                           | 124        |                                     |       |           | 272        |                                     |       |   | (36 | ) |   |   | 360 |   |   |
| RESERVE FOR  INVENTORY OBSOLESCENCE:   |       |                                           |       |                                     |       |           |       |                                     |       |   |   |   |   |   |   |   |   |
| Year ended  December 31, 2003     |       |                                           | $          | 4,352                                    |       |           |       | $                                        | 660        |   |   |   | $ | (794 | ) |   |   | $ | 4,218 |   |   |
| Year ended  December 31, 2004     |       |                                           | 4,218      |                                     |       |           | 1,026      |                                     |       |   | (787 | ) |   |   | 4,457 |   |   |
| Year ended  December 31, 2005     |       |                                           | 4,457      |                                     |       |           | 1,841      |                                     |       |   | (2,492 | ) |   |   | 3,806 |   |   |

 

60

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**ITEM 9.  **CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING ANDFINANCIAL DISCLOSURE

None.

**ITEM 9A.  **CONTROLSAND PROCEDURES

***DisclosureControls and Procedures***

Our management, with theparticipation of our President, Chief Executive Officer, and Director, andExecutive Vice President of Finance, Chief Financial Officer and Secretary, hasevaluated the effectiveness of our disclosure controls and procedures (as suchterm is defined in Rules 13a-15(e) and 15d-15(e) under the Securities ExchangeAct of 1934, as amended (the “Exchange Act”)) as of the end of the periodcovered by this report.  Based on suchevaluation, our President, Chief Executive Officer, and Director, and ExecutiveVice President of Finance, Chief Financial Officer and Secretary have concludedthat, as of the end of such period, our disclosure controls and procedures wereeffective.

*Internal ControlOver Financial Reporting*

In late March 2006, the Company learned that employeesof its Indian subsidiary manufacturing operations had made certain unauthorizedpayments that may have been in violation of the Foreign Corrupt Practices Actand local laws.  The subject payments, inthe aggregate, amount to approximately $40,000 during 2004 and 2005 and lessthan $10,000 in 2006.  The AuditCommittee of the Company's Board of Directors retained outside counsel toconduct an internal investigation to determine the nature and propriety of thepayments.  In the interim, the Companyhas directed that no such payments be made without prior approval of U.S.management and is enhancing its existing policies and procedures to ensurecompliance with applicable laws.

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) under theExchange Act) during our fourth fiscal quarter that have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

**ITEM 9B.**   OTHERINFORMATION

None.

61

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**PART III**

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

The information under the headings “InformationConcerning the Nominees and Members of the Board of Directors,” “ExecutiveOfficers of the Company” and “Compliance with Section 16(a) of theSecurities and Exchange Act” is incorporated by reference to the DefinitiveProxy Statement relating to our 2006 Annual Meeting of Stockholders, which weexpect to file within 120 days after the end of our fiscal year ended December 31,2005.

The information regarding Cherokee’s Audit Committee andAudit Committee financial expert set forth under the headings “Board Committees”and “Report of the Audit Committee” is incorporated by reference to theDefinitive Proxy Statement relating to our 2006 Annual Meeting of Stockholders,which we expect to file within 120 days after the end of our fiscal year ended December 31,2005.

On May 4, 2004,Cherokee’s Board of Directors adopted a Code of Business Conduct and Ethics(the “Code of Ethics”). The Code of Ethics is applicable to all of Cherokee’semployees, including our principal executive officer, principal financialofficer and principal accounting officer. A copy of the Code of Ethics isavailable on the Investor Relations section of Cherokee’s web site at*www.cherokeepwr.com.*

**ITEM 11.**         EXECUTIVECOMPENSATION

The information under theheading “Executive Compensation” is incorporated by reference to the DefinitiveProxy Statement relating to our 2006 Annual Meeting of Stockholders, which weexpect to file within 120 days after the end of our fiscal year ended December 31,2005.

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

The information under theheading “Security Ownership of Certain Beneficial Owners and Management” isincorporated by reference to the Definitive Proxy Statement relating to our2006 Annual Meeting of Stockholders, which we expect to file within 120 daysafter the end of our fiscal year ended December 31, 2005.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS

The information under theheading “Certain Relationships and Related Transactions” is incorporated byreference to the Definitive Proxy Statement relating to our 2006 Annual Meetingof Stockholders, which we expect to file within 120 days after the end of ourfiscal year ended December 31, 2005.

**ITEM 14.**         PRINCIPALACCOUNTING FEES AND SERVICES

The information under the heading “PrincipalAccounting Fees and Services” is incorporated by reference to the DefinitiveProxy Statement relating to our 2006 Annual Meeting of Stockholders, which weexpect to file within 120 days after the end of our fiscal year ended December 31,2005.

62

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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                                                                                                     |       | 35       |
| Consolidated Balance Sheets as of  December 31, 2005 and 2004                                                                                           |       | 36       |
| Consolidated Statements of  Operations for the years ended December 31, 2005, 2004 and 2003                                                        |       | 37       |
| Consolidated Statements of  Stockholders’ Equity (Deficit) and Comprehensive Operations for  the years ended December 31, 2005, 2004 and 2003 |       | 38       |
| Consolidated Statements of  Cash Flows for the years ended December 31, 2005, 2004 and 2003                                                        |       | 39       |
| Notes  to Consolidated Financial Statements                                                                                                                  |       | 40       |

 

(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** |
|-------------------------------------------------|------------|----------|
| Schedule  II: Valuation and Qualifying Accounts |       | 60       |

 

(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)                                                                                                                                             |
| 10.7  |     | Amended and Restated  Security Agreement, dated as of February 25, 2004, by and between  Cherokee International Corporation and the Agent.(5)                                                                                                                      |

63

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| 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 |   | Severance Agreement,  dated as of March 31, 2005, 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) |
| *10.17 |   | 2005 Cash Incentive  Compensation program for executive officers and other employees dated as of  March 14, 2005.(8)                                                                                                                                                                                                                                                                      |
| *10.18 |   | Severance Agreement,  dated as of June 16, 2005, between Cherokee International Corporation  and Mukesh Patel.(9)                                                                                                                                                                                                                                                                         |
| *10.19 |   | Letter Agreement, dated  as of October 14, 2005, between Cherokee International Corporation and  Linster W. Fox.(10)                                                                                                                                                                                                                                                                      |
| *10.20 |   | Severance Agreement,  dated as of October 14, 2005, between Cherokee International Corporation  and Linster W. Fox.(10)                                                                                                                                                                                                                                                                   |
| *10.21 |   | 2006 Cash Incentive  Compensation program for executive officers and other employees dated as of  January 06, 2006.(11)                                                                                                                                                                                                                                                                   |
| 21.1   |   | Subsidiaries of the  Registrant.                                                                                                                                                                                                                                                                                                                                                               |
| 23.1   |   | 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 of Finance, Chief Financial Officer and Secretary  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                  |
| 32.1   |   | Certification of CEO and  CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                                                                                                             |

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(1)          Incorporated byreference from the Registration Statement on Form S-8, filed by theRegistrant on March 16, 2004.

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

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

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

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

(7)   Previouslyfiled as an exhibit to our Form 10-K on April 1, 2005.

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

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

(10) Previouslyfiled as an exhibit to our Form 8-K on October 31, 2005.

(11) Previouslyfiled 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 17th day of April 2006.
|        |     | 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 17th day of April 2006.
| /s/ JEFFREY M. FRANK        |   | President, Chief Executive Officer and Director       |
|-----------------------------|--------|-------------------------------------------------------|
| Jeffrey M. Frank            |   | (Principal Executive Officer)                         |
| /s/  LINSTER W. FOX         |   | Executive Vice President  of Finance, Chief Financial |
| Linster W. Fox              |   | Officer and Secretary (Principal Financial and        |
|                        |   | Accounting Officer)                                   |
| /s/  KENNETH KILPATRICK     |   | Chairman of the Board                                 |
| Kenneth  Kilpatrick         |   |                                                  |
| /s/  ANTHONY BLOOM          |   | Director                                              |
| Anthony Bloom               |   |                                                  |
| /s/  CHRISTOPHER BROTHERS   |   | Director                                              |
| Christopher  Brothers       |   |                                                  |
| /s/  CLARK MICHAEL CRAWFORD |   | Director                                              |
| Clark Michael  Crawford     |   |                                                  |
| /s/  RAYMOND MEYER          |   | Director                                              |
| Raymond Meyer               |   |                                                  |
| /s/  IAN SCHAPIRO           |   | Director                                              |
| Ian Schapiro                |   |                                                  |

 

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