**SECURITIESAND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**FORM10-Q**

 

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| **(mark one)** |                                                                                         |
|----------------|----------------------------------------------------------------------------------------------|
| **ý**     | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|                |                                                                                              |  |

 

**For the quarterly period ended June 30, 2002**

 

**OR**

 
| **o** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-------|-----------------------------------------------------------------------------------------------|

 

**For the transition period from         to         **

 

**Commission file number: 333-82713**

 

**CHEROKEEINTERNATIONAL, LLC**

(Exact name of registrant as specified in its charter)

 

| **CALIFORNIA**                                                                      |   | **33-0696451**                       |
|-------------------------------------------------------------------------------------|--------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization)                      |   | (I.R.S. Employer Identification No.) |
|                                                                                |   |                                 |
| **2841 DOW AVENUE  TUSTIN, CALIFORNIA 92780**                                       |
| (Address of principal executive offices)                                            |
|                                                                                |
| **(714) 544-6665**                                                                  |
| (Registrant’s telephone number, including area code)                           |
|                                                                                |   |                                 |
| **N/A**                                                                             |
| (Former name, former address and former fiscal year, if changed since  last report) |

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepast 12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirements forthe past 90 days.  Yes ý  No  o

 

 

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CHEROKEE INTERNATIONAL, LLC

 

TABLE OF CONTENTS

 
| PART I—FINANCIAL  INFORMATION                                                                         |                                                                                                             |
|------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------------|
|                                                                                                       |                                                                                                             |
| Item 1.   Consolidated Financial Statements:                                                          |                                                                                                             |
|                                                                                                       | Condensed  Consolidated Balance Sheets—June 30, 2002 and December 31, 2001                                  |
|                                                                                                       |                                                                                                             |
|                                                                                                       | Condensed  Consolidated Statements of Operations—For the Three and Six Months Ended June  30, 2002 and 2001 |
|                                                                                                       |                                                                                                             |
|                                                                                                       | Condensed  Consolidated Statements of Cash Flows—For the Six Months Ended June 30, 2002  and 2001           |
|                                                                                                       |                                                                                                             |
|                                                                                                       | Notes  to Condensed Consolidated Financial Statements                                                            |
|                                                                                                       |                                                                                                             |
| Item  2.  Management’s Discussion and Analysis of Financial Condition and  Results of Operations |
|                                                                                                       |
| Item  3.  Quantitative and Qualitative Disclosures About Market Risk                                  |
|                                                                                                       |
| PART II—OTHER INFORMATION                                                                             |
|                                                                                                       |
| Item  1.  Legal Proceedings                                                                           |
|                                                                                                       |
| Item 6.   Exhibits and Reports on Form 8-K                                                            |
|                                                                                                       |
| SIGNATURES                                                                                                 |
|                                                                                                            |                                                                                                                  |  |

 

2

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PART I.  FINANCIALINFORMATION

Item 1.  FinancialStatements

 

CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES

CONDENSEDCONSOLIDATED BALANCE SHEETS

(Unaudited)

 
|                                                                                                                                                                    |   | **June  30,  2002** |       | **December 31,  2001** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|-----------------------------|--------|
|                                                                                                                                                                    |   |                |       |                        |   |
| ASSETS                                                                                                                                                                  |   |                |       |                        |   |
| CURRENT ASSETS:                                                                                                                                                         |   |                |       |                        |   |
| Cash and cash equivalents                                                                                                                                               |   | $                   | 2,215,984  |                        | $      | 2,592,489 |   |
| Short-term investments                                                                                                                                                  |   | 1,186,220           |       | 1,155,096                   |   |
| Accounts receivable, net  of allowance for doubtful accounts of $299,566 and $237,307 as of  June  30, 2002 and December 31, 2001, respectively                    |   | 19,345,180          |       | 17,587,062                  |   |
| Inventories, net                                                                                                                                                        |   | 16,278,964          |       | 21,291,787                  |   |
| Prepaid expenses and other  current assets                                                                                                                              |   | 824,370             |       | 1,108,833                   |   |
|                                                                                                                                                                    |   |                |       |                        |   |
| Total current assets                                                                                                                                                    |   | 39,850,718          |       | 43,735,267                  |   |
| PROPERTY AND EQUIPMENT,  net of accumulated depreciation and amortization of $15,070,443 and  $13,146,218 as of  June 30, 2002 and December 31, 2001, respectively |   | 14,147,745          |       | 14,690,370                  |   |
| DEPOSITS                                                                                                                                                                |   | 390,072             |       | 402,990                     |   |
| DEFERRED INCOME TAXES                                                                                                                                                   |   | 306,686             |       | 316,237                     |   |
| DEFERRED FINANCING COSTS,  net of accumulated amortization of $3,069,850 and $2,530,698 as of  June  30, 2002 and December 31, 2001, respectively                  |   | 3,044,328           |       | 3,583,480                   |   |
| GOODWILL                                                                                                                                                                |   | 40,916,922          |       | 40,916,922                  |   |
|                                                                                                                                                                    |   |                |       |                        |   |
|                                                                                                                                                                    |   | $                   | 98,656,471 |                        | $      | 103,645,266 |   |
|                                                                                                                                                                    |   |                |       |                        |   |
| LIABILITIES AND MEMBERS’  EQUITY (DEFICIT)                                                                                                                         |   |                |       |                        |   |
| CURRENT LIABILITIES:                                                                                                                                                    |   |                |       |                        |   |
| Accounts payable                                                                                                                                                        |   | $                   | 7,195,418  |                        | $      | 6,325,785 |   |
| Accrued liabilities                                                                                                                                                     |   | 7,546,756           |       | 6,758,971                   |   |
| Accrued compensation and  benefits                                                                                                                                      |   | 5,867,392           |       | 6,044,568                   |   |
| Accrued interest payable                                                                                                                                                |   | 2,268,715           |       | 2,214,097                   |   |
| Revolving lines of credit                                                                                                                                               |   | 10,716,392          |       | 13,182,146                  |   |
| Current portion of  long-term debt                                                                                                                                      |   | 139,971,064         |       | 7,728,098                   |   |
| Current portion of capital  lease obligations                                                                                                                           |   | 2,612,136           |       | 1,156,795                   |   |
| Deferred income taxes                                                                                                                                                   |   | 361,275             |       | 372,505                     |   |
|                                                                                                                                                                    |   |                |       |                        |   |
| Total current liabilities                                                                                                                                               |   | 176,539,148         |       | 43,782,965                  |   |
| LONG-TERM DEBT, net of  current portion                                                                                                                                 |   | —              |       | 134,073,166                 |   |
| CAPITAL LEASE OBLIGATIONS,  net of current portion                                                                                                                      |   | —              |       | 1,921,018                   |   |
| MEMBERS’ EQUITY (DEFICIT)                                                                                                                                          |   |                |       |                        |   |
| Class A units: 347,671  units issued and outstanding                                                                                                                    |   | 354,371             |       | 354,371                     |   |
| Class B units: 36,035,065  units issued and outstanding                                                                                                                 |   | 37,037,827          |       | 37,037,827                  |   |
| Paid-in capital                                                                                                                                                         |   | 5,330,000           |       | 5,330,000                   |   |
| Retained earnings  (deficit)                                                                                                                                            |   | (121,096,157        | )          | (118,064,169                | )      |
| Accumulated other  comprehensive income (loss)                                                                                                                          |   | 491,282             |       | (789,912                    | )      |
|                                                                                                                                                                    |   |                |       |                        |   |
| Total members’ deficit                                                                                                                                             |   | (77,882,677         | )          | (76,131,883                 | )      |
|                                                                                                                                                                    |   |                |       |                        |   |
|                                                                                                                                                                    |   | $                   | 98,656,471 |                        | $      | 103,645,266 |   |

 

See notes to condensed consolidated financial statements.

 

3

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CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES

CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 
|                                 |   | **Three  Months Ended** |       | **Six Months  Ended** |   |
|--------------------------------------|--------|-------------------------|------------|-----------------------|--------|
|                                 |   | **June  30,  2002**     |       | **June  30,  2001**   |   | **June  30,  2002** |   | **June  30,  2001** |   |
|                                 |   |                    |       |                  |   |   |   |   |   |
| NET SALES                            |   | $                       | 25,334,433 |                  | $      | 32,863,293 |   | $ | 49,898,771 |   | $ | 72,283,090 |   |
| COST OF SALES                        |   | 18,538,305              |       | 24,823,205            |   | 36,771,836 |   | 53,229,128 |   |
|                                 |   |                    |       |                  |   |   |   |   |   |
| GROSS PROFIT                         |   | 6,796,128               |       | 8,040,088             |   | 13,126,935 |   | 19,053,962 |   |
| OPERATING EXPENSES:                  |   |                    |       |                  |   |   |   |   |   |
| Engineering and  development         |   | 1,748,640               |       | 1,640,947             |   | 3,316,196 |   | 3,611,202 |   |
| Selling and marketing                |   | 1,328,683               |       | 941,274               |   | 2,349,833 |   | 2,097,691 |   |
| General and administrative           |   | 1,533,301               |       | 1,453,730             |   | 2,941,176 |   | 3,178,806 |   |
| Amortization of goodwill             |   | —                  |       | 761,000               |   | — |   | 1,520,000 |   |
|                                 |   |                    |       |                  |   |   |   |   |   |
| Total operating expenses             |   | 4,610,624               |       | 4,796,951             |   | 8,607,205 |   | 10,407,699 |   |
|                                 |   |                    |       |                  |   |   |   |   |   |
| OPERATING INCOME                     |   | 2,185,504               |       | 3,243,137             |   | 4,519,730 |   | 8,646,263 |   |
| OTHER INCOME (EXPENSE):              |   |                    |       |                  |   |   |   |   |   |
| Interest expense                     |   | (3,731,154              | )          | (4,171,064            | )      | (7,454,722 | ) | (8,541,572 | ) |
| Other income                         |   | 6,562                   |       | 55,903                |   | 29,713 |   | 80,486 |   |
|                                 |   |                    |       |                  |   |   |   |   |   |
| Total other expense, net             |   | (3,724,592              | )          | (4,115,161            | )      | (7,425,009 | ) | (8,461,086 | ) |
|                                 |   |                    |       |                  |   |   |   |   |   |
| Income (loss) before  income taxes   |   | (1,539,088              | )          | (872,024              | )      | (2,905,279 | ) | 185,177 |   |
| Provision for income taxes           |   | 65,407                  |       | 59,604                |   | 126,709 |   | 154,604 |   |
| NET INCOME (LOSS)                    |   | $                       | (1,604,495 | )                     | $      | (931,628 | ) | $ | (3,031,988 | ) | $ | 30,573 |   |
|                                 |   |                    |       |                  |   |   |   |   |   |
| NET INCOME (LOSS) PER  UNIT:         |   |                    |       |                  |   |   |   |   |   |
| Basic                                |   | $                       | (.04       | )                     | $      | (.03 | ) | $ | (.08 | ) | $ | .00 |   |
| Diluted                              |   | $                       | (.04       | )                     | $      | (.03 | ) | $ | (.08 | ) | $ | .00 |   |
|                                 |   |                    |       |                  |   |   |   |   |   |
| WEIGHTED AVERAGE UNITS  OUTSTANDING: |   |                    |       |                  |   |   |   |   |   |
| Basic                                |   | 36,382,736              |       | 36,382,736            |   | 36,382,736 |   | 36,382,736 |   |
| Diluted                              |   | 36,382,736              |       | 36,382,736            |   | 36,382,736 |   | 36,552,922 |   |

 

See notes to condensed consolidated financial statements

 

4

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CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES

CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 
|                                                                                            |   | **Six  Months Ended** |       |
|-------------------------------------------------------------------------------------------------|--------|-----------------------|------------|
|                                                                                            |   | **June  30,  2002**   |       | **June  30,  2001** |   |
|                                                                                            |   |                  |       |   |   |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                                          |   |                  |       |   |   |
| Net income (loss)                                                                               |   | $                     | (3,031,988 | ) | $ | 30,573 |   |
| Adjustments to reconcile  net income (loss) to net cash  provided by operating activities: |   |                  |       |   |   |
| Depreciation and  amortization                                                                  |   | 1,702,962             |       | 3,387,064 |   |
| Amortization of deferred  financing costs                                                       |   | 539,152               |       | 485,502 |   |
| Deferred income taxes                                                                           |   | 9,551                 |       | — |   |
| Net change in operating  assets and liabilities:                                                |   |                  |       |   |   |
| Accounts receivable, net                                                                        |   | (641,792              | )          | 9,710,677 |   |
| Inventories, net                                                                                |   | 6,025,088             |       | 6,748,020 |   |
| Prepaid expenses and other  current assets                                                      |   | 332,186               |       | (109,685 | ) |
| Deposits                                                                                        |   | (32,124               | )          | (29,148 | ) |
| Accounts payable                                                                                |   | 283,375               |       | (9,239,744 | ) |
| Accrued liabilities                                                                             |   | 333,240               |       | (388,983 | ) |
| Accrued compensation and  benefits                                                              |   | (717,850              | )          | (1,697,582 | ) |
| Accrued interest payable                                                                        |   | 54,661                |       | (396,988 | ) |
| Net cash provided by  operating activities                                                      |   | 4,856,461             |       | 8,499,706 |   |
|                                                                                            |   |                  |       |   |   |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                                          |   |                  |       |   |   |
| Additions to property and  equipment                                                            |   | (435,615              | )          | (668,586 | ) |
| Net change in short-term  investments                                                           |   | (31,124               | )          | (101,167 | ) |
|                                                                                            |   |                  |       |   |   |
| Net cash used in investing  activities                                                          |   | (466,739              | )          | (769,753 | ) |
|                                                                                            |   |                  |       |   |   |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                                          |   |                  |       |   |   |
| Borrowings on revolving  lines of credit                                                        |   | 4,481,246             |       | 11,770,693 |   |
| Payments on revolving  lines of credit                                                          |   | (7,256,800            | )          | (8,500,000 | ) |
| Payments on obligations  under capital leases                                                   |   | (586,757              | )          | (379,810 | ) |
| Payments on long-term debt                                                                      |   | (1,830,200            | )          | (2,900,302 | ) |
| Equity distribution                                                                             |   | —                |       | (2,118,000 | ) |
|                                                                                            |   |                  |       |   |   |
| Net cash used in financing  activities                                                          |   | (5,192,511            | )          | (2,127,419 | ) |
| Cash effect of exchange  rate changes                                                           |   | 426,284               |       | 141,000 |   |
|                                                                                            |   |                  |       |   |   |
| NET (DECREASE) INCREASE IN  CASH AND CASH EQUIVALENTS                                           |   | (376,505              | )          | 5,743,534 |   |
| CASH AND CASH EQUIVALENTS,  beginning of period                                                 |   | 2,592,489             |       | 852,966 |   |
|                                                                                            |   |                  |       |   |   |
| CASH AND CASH EQUIVALENTS,  end of period                                                       |   | $                     | 2,215,984  |   | $ | 6,596,500 |   |

 

See notes to condensed consolidated financial statements.

 

5

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CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES

NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.                                       Basis of Presentation

 

The information set forth inthe accompanying condensed consolidated financial statements is unaudited and,in the opinion of management, reflects all adjustments, consisting only ofnormal recurring adjustments, necessary to present fairly the financialposition, results of operations and cash flows of Cherokee International, LLC(the “Company”) for the periods indicated.

 

Results of operations forthe interim six months ended June 30, 2002 and 2001 are not necessarilyindicative of the results of operations for the full fiscal year. The Company’ssecond quarter represented the 13-week periods ended on June 30 in 2002 andJuly 1 in 2001. For presentation purposes, these fiscal quarters have beenreferred to as ending on June 30.

 

The condensed consolidatedfinancial statements include the financial statements of the Company and itswholly-owned subsidiaries. One such subsidiary, Cherokee International Finance,Inc., was formed in April 1999 as a wholly-owned finance subsidiary to act as aco-obligor of the 101⁄2% senior subordinated notes and has no independent assetsor operations. All significant intercompany accounts and transactions have beeneliminated.

 

Certain information normallyincluded in footnote disclosure to the financial statements has been condensedor omitted in accordance with the rules and regulations of the Securities andExchange Commission. Accordingly, the financial statements do not include allthe information and note disclosures normally included in annual consolidatedfinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America. These unaudited condensedconsolidated financial statements should be read in conjunction with the otherdisclosures contained herein and with the Company’s audited consolidatedfinancial statements and notes thereto contained in the Company’s Form 10-K forthe year ended December 31, 2001.

 

The preparation of financialstatements in conformity with generally accepted accounting principlesnecessarily requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements and the reportedamounts of revenues and expenses during the reporting periods. Actual resultscould differ from these estimates.

 

Certain reclassificationshave been made to the 2001 presentation to conform with the 2002 presentation.In addition, during the second quarter of 2002 the Company changed theclassification of certain expenses incurred by Cherokee Europe to be moreconsistent with the classification of similar expenses incurred by the NorthAmerican operations. Such expenses were reclassified for the three and six monthperiods ended June 30, 2001 and for the three months ended March 31, 2002 toconform with the presentation for the three months ended June 30, 2002.  A summary of the effect of suchreclassification for the three and six months ended June 30, 2001 is asfollows:

 
|                         |   | **As  Previously Reported**             |       | **As  Reclassified**                 |   |
|------------------------------|--------|-----------------------------------------|------------|--------------------------------------|--------|
|                         |   | **Three  Months  Ended  June 30, 2001** |       | **Six Months  Ended  June 30, 2001** |   | **Three  Months  Ended  June 30, 2001** |   | **Six Months  Ended  June 30, 2001** |   |
|                         |   |                                    |       |                                 |   |   |   |   |   |
| Cost of sales                |   | $                                       | 23,849,205 |                                 | $      | 51,190,128 |   | $ | 24,823,205 |   | $ | 53,229,128 |   |
| Engineering and  development |   | 1,604,947                               |       | 3,491,202                            |   | 1,640,947 |   | 3,611,202 |   |
| Selling and marketing        |   | 828,274                                 |       | 1,888,691                            |   | 941,274 |   | 2,097,691 |   |
| General and administrative   |   | 2,576,730                               |       | 5,546,806                            |   | 1,453,730 |   | 3,178,806 |   |
|                              |        |                                         |            |                                      |        |  |  |  |  |  |  |  |  |

 

As shown inthe accompanying condensed consolidated financial statements, the Companyincurred a net loss of $3,031,988 for the six months ended June 30, 2002 andhad negative working capital of $136,688,430 at June 30, 2002, which reflectsthe effect of reclassifying $131,380,253 of debt from long-term to short-termat June 30, 2002 (see Note 8).  Inaddition, the Company was not in compliance with certain debt covenants at June30, 2002; however, such noncompliance was waived upon execution of a Waiver andFourth Amendment to Credit Agreement in August 2002.  These negative trends have resulted from unfavorable economicconditions and reduced capital spending by industries in which the Companyoperates.  If the unfavorable economicconditions continue, the Company’s financial condition and operating resultscould be adversely affected.  Based uponthe Company's present expectations, it anticipates that it will not be incompliance with certain financial covenants under its credit agreement atSeptember 30, 2002 without a restructuring of its senior subordinated notesand/or an amendment, restructuring or refinancing of its credit agreement.  The Company also does not expect to be ableto meet the required financial tests necessary for it to be permitted to makethe November 2002 interest payments on the senior subordinated notes in theabsence of those events.  In addition,the Company believes that cash flow from operations and available borrowingcapacity may not be adequate to meet its anticipated cash requirements for thenext twelve months, including operating requirements, planned capitalexpenditures and debt service without a restructuring of the seniorsubordinated notes and/or an amendment, restructuring or refinancing of itscredit agreement.

 

The Company iscurrently considering alternatives to address these issues, which include (1)an amendment or restructuring of its credit agreement to provide additionalliquidity and room under certain financial covenants, (2) a refinancing of allor some portion of its credit agreement, (3) a restructuring of the seniorsubordinated notes, or (4) some combination of the above. Based upon theCompany's current business plans and prospects, management expects that itsrestructuring alternatives should enable the Company to meet its obligationsand comply with its debt covenants for the next twelve months.  However, if the Company is not successful inimplementing one or more of its restructuring alternatives, it may be unable tofund its cash requirements and continue operating.

 

2.                                       Inventories

 

Inventories are valued atthe lower of cost (first-in, first-out) or market. Inventory costs include thecost of material, labor and manufacturing overhead and consist of thefollowing:

 
|            |   | **June  30, 2002** |       | **December  31, 2001** |   |
|-----------------|--------|--------------------|------------|------------------------|--------|
|            |   |               |       |                   |   |
| Raw material    |   | $                  | 12,180,604 |                   | $      | 14,061,789 |   |
| Work-in-process |   | 1,939,984          |       | 3,526,256              |   |
| Finished goods  |   | 2,158,376          |       | 3,703,742              |   |
|            |   |               |       |                   |   |
|            |   | $                  | 16,278,964 |                   | $      | 21,291,787 |   |

 

6

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3.                                       Income Taxes

 

The Company is a limitedliability company under the provisions of the federal and state tax codes.Under federal laws, taxes based on income of a limited liability companyare payable by the Company’s individual members. Accordingly, no provisionfor U.S. federal income taxes has been provided in the accompanyingfinancial statements. Provisions for California franchise tax and fees are notsignificant for any period presented. The Company’s provision for income taxesprimarily relates to operations in Mexico, Belgium and India which are subjectto income taxes on earnings generated in those countries.

 

4.                                       Comprehensive Income (Loss)

 

Comprehensive income (loss)is defined as all changes in a company’s net assets except changes resultingfrom transactions with shareholders. It differs from net income (loss) in thatcertain items currently recorded through equity are included in comprehensiveincome (loss). Comprehensive loss for the six months ended June 30, 2002 was$1,750,794, which included a net loss of $3,031,988 and a gain from foreigncurrency translation adjustments of $1,281,194. Comprehensive loss for the sixmonths ended June 30, 2001 was $853,004, which included net income of $30,573and a loss from foreign currency translation adjustments of  $883,577.

 

5.                                       Net Income (Loss) Per Unit

 

The following table setsforth the computation of basic and diluted income (loss) per unit:

 
|                                             |   | **Three  Months Ended** |       | **Six  Months Ended** |   |
|--------------------------------------------------|--------|-------------------------|------------|-----------------------|--------|
|                                             |   | **June  30, 2002**      |       | **June  30, 2001**    |   | **June  30, 2002** |   | **June  30, 2001** |   |
|                                             |   |                    |       |                  |   |   |   |   |   |
| Net income (loss)                                |   | $                       | (1,604,495 | )                     | $      | (931,628 | ) | $ | (3,031,988 | ) | $ | 30,573 |   |
|                                             |   |                    |       |                  |   |   |   |   |   |
| Units:                                           |   |                    |       |                  |   |   |   |   |   |
| Weighted-average units  outstanding—basic   |   | 36,382,736              |       | 36,382,736            |   | 36,382,736 |   | 36,382,736 |   |
| Effect of dilutive options                       |   | —                  |       | —                |   | — |   | 170,186 |   |
|                                             |   |                    |       |                  |   |   |   |   |   |
| Weighted-average units  outstanding—diluted |   | 36,382,736              |       | 36,382,736            |   | 36,382,736 |   | 36,552,922 |   |
|                                             |   |                    |       |                  |   |   |   |   |   |
| Net income (loss) per  unit:                     |   |                    |       |                  |   |   |   |   |   |
| Basic                                            |   | $                       | (.04       | )                     | $      | (.03 | ) | $ | (.08 | ) | $ | .00 |   |
|                                             |   |                    |       |                  |   |   |   |   |   |
| Diluted                                          |   | $                       | (.04       | )                     | $      | (.03 | ) | $ | (.08 | ) | $ | .00 |   |

 

In calculating net loss perunit for the three months ended June 30, 2002 and 2001, and for the six monthsended June 30, 2002, the effect of dilutive options, which was notsignificant,  is excluded because it isantidilutive.

 

6.                                       New Accounting Pronouncements

 

In August 2001, theFinancial Accounting Standards Board ("FASB") issued SFAS No. 144,“Accounting for Impairment or Disposal of Long-Lived Assets.” This statementaddresses financial accounting and reporting for the impairment of long-livedassets and for long-lived assets to be disposed of. SFAS No. 144 supersedesSFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and forLong-Lived Assets to be Disposed of,” and is effective for fiscal yearsbeginning after December 15, 2001.  The adoption of this standard atJanuary 1, 2002 did not have a material impact on the Company’s financialposition and results of operations.

 

In July 2002, the FASBissued SFAS No. 146, "Accounting for Costs Associated with Exit orDisposal Activities," which addresses financial accounting and reportingfor costs associated with exit or disposal activities and supersedes EmergingIssues Task Force ("EITF") Issue 94-3, "Liability Recognitionfor Certain Employee Termination Benefits and Other Costs to Exit an Activity(including Certain Costs Incurred in a Restructuring)."  SFAS No. 146 requires that a liability for acost associated with an exit or disposal activity be recognized when theliability is incurred.  Under Issue94-3, a liability for an exit cost as defined in EITF 94-3 was recognized atthe date of an entity's commitment to an exit plan.  SFAS No. 146 also establishes that the liability should initiallybe measured and recorded at fair value. The Company will adopt the provisions of SFAS No. 146 for exit ordisposal activities that are initiated after December 31, 2002.

 

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7.                                       Goodwill

 

In June 2001, the FASBissued two new pronouncements: SFAS No. 141, “Business Combinations”, and SFASNo. 142, “Goodwill and Other Intangible Assets”.  SFAS No. 141 prohibitsthe use of the pooling-of-interest method for business combinations initiatedafter June 30, 2001 and also applies to all business combinations accounted forby the purchase method that are completed after June 30, 2001.  There arealso transition provisions that apply to business combinationscompleted before July 1, 2001, that were accounted for by the purchasemethod.  The Company has adopted SFAS No. 141 and there was no materialimpact on the consolidated financial statements as a result of theadoption.  The Company adopted SFAS No.142 effective January 1, 2002.   SFASNo. 142 requires that goodwill and other intangible assets with indefiniteuseful lives no longer be amortized, but instead be tested for impairment atleast annually.  The Company no longeramortizes goodwill but will evaluate its carrying value on an annual basis orwhen events or circumstances indicate that their carrying value may be impaired.The adoption of SFAS No. 142 resulted in reduced amortization expense ofapproximately $1,520,000 for the six months ended June 30, 2002 compared to thesix months ended June 30, 2001.

 

In compliancewith the requirements of SFAS No. 142, the Company completed its transitionalimpairment test as of January 1, 2002. Based on an independent valuation, the carrying value of the CherokeeEurope reporting unit exceeded its fair value by approximately $30 million. TheCompany plans to complete the measurement of the goodwill impairment loss duringthe third quarter of 2002. Any such impairment required to be recognized willbe reflected as the cumulative effect of a change in accounting principle as ofJanuary 1, 2002, and the first quarter results will be restated as required bySFAS No. 142.

 

Summarized below is theeffect on net income (loss) per share data, if the Company had followed theamortization provisions of SFAS No. 142 for all periods presented (inthousands, except per share amounts):

 
|                                         |   | **Three  Months Ended** |   | **Six  Months Ended** |   |
|----------------------------------------------|--------|-------------------------|--------|-----------------------|--------|
|                                         |   | **June  30, 2002**      |   | **June  30, 2001**    |   | **June  30, 2002** |   | **June  30, 2001** |   |
| Net income (loss):                           |   |                    |   |                  |   |   |   |   |   |
| As reported                                  |   | $                       | (1,604 | )                     | $      | (932 | ) | $ | (3,032 | ) | $ | 31 |   |
| Add: goodwill amortization                   |   | —                  |   | 761                   |   | — |   | 1,520 |   |
| Adjusted net income (loss)                   |   | $                       | (1,604 | )                     | $      | (171 | ) | $ | (3,032 | ) | $ | 1,551 |   |
| Basic net income (loss)  per unit:           |   |                    |   |                  |   |   |   |   |   |
| As reported                                  |   | $                       | (.04   | )                     | $      | (.03 | ) | $ | (.08 | ) | $ | .00 |   |
| Add: goodwill amortization                   |   | —                  |   | .02                   |   | — |   | .04 |   |
| Adjusted basic net income  (loss) per unit:  |   | $                       | (.04   | )                     | $      | (.01 | ) | $ | (.08 | ) | $ | .04 |   |
| Diluted net income (loss)  per unit:         |   |                    |   |                  |   |   |   |   |   |
| As reported                                  |   | $                       | (.04   | )                     | $      | (.03 | ) | $ | (.08 | ) | $ | .00 |   |
| Add: goodwill amortization                   |   | —                  |   | .02                   |   | — |   | .04 |   |
| Adjusted diluted net  income (loss) per unit |   | $                       | (.04   | )                     | $      | (.01 | ) | $ | (.08 | ) | $ | .04 |   |

 

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8.                                       Long-Term Debt

 

In September2001, the Company's credit agreement was amended to waive the Company's failureto comply with certain financial covenants and to, among other things: (1)require that some of the Company's unitholders, or their equity members,guarantee up to $10.5 million of the Company's obligations under the creditagreement, in exchange for the Company being permitted to make the November2001 and May 2002 scheduled interest payments totaling $10.5 million on its$100 million of senior subordinated notes, (2) modify certain financialcovenants from and after September 2001 and (3) restrict the Company's abilityto make its interest payment due in November 2002 relating to its seniorsubordinated notes until certain financial tests are satisfied.

 

In August2002, the Company's credit agreement was further modified to, among otherthings, waive compliance with certain covenants (including financial covenantsfor June 30, 2002).  In connection withthat waiver, certain of the Company's unitholders, or their equity members,paid to the lenders the remaining $8.7 million of the $10.5 million guaranty($1.8 million of the guaranty was previously paid on July 1, 2002 to enable theCompany to meet the scheduled amortization payment under the credit agreement)and the Company agreed to (a) restructure its senior subordinated notes in amanner satisfactory to the required lenders by October 15, 2002 (which shallinclude a reduction in the cash interest required to be paid and/or conversioninto preferred equity or the redemption of a portion of the senior subordinatednotes), (b) deliver periodic term sheets as to the terms of such restructuring,(c) shorten the maturity date of the credit agreement from April 30, 2005 toJanuary 8, 2004, (d) reduce the size of the revolving loan commitment from $25million to $20 million and (e) provide that approximately $8.1 million ofpayments under the $10.5 million guaranty referred to above will be applied toreduce term loans with the remainder applied to reduce revolving loans andoveradvance borrowings.  Failure tocomply with the requirements in clauses (a) and (b) will constitute an event ofdefault under the credit agreement.  The$8.7 million guaranty payment would have otherwise been payable in August 2002as a result of the breach of financial covenants under the credit agreementdescribed above.  The guarantors aresubrogated to the rights of the lenders under the senior credit agreement, on abasis senior to the senior subordinated notes.

 

Based upon ourpresent expectations, the Company anticipates that it will not be in compliancewith certain financial covenants under the credit agreement at September 30,2002 without a restructuring of its senior subordinated notes and/or anamendment, restructuring or refinancing of its credit agreement.  The Company also does not expect to be ableto meet the required financial tests necessary for it to be permitted to makethe November 2002 interest payments on the senior subordinated notes in theabsence of those events.  In addition,the Company believes that cash flow from operations and available borrowingcapacity may not be adequate to meet its anticipated cash requirements for thenext twelve months, including operating requirements, planned capital expendituresand debt service without a restructuring of the senior subordinated notesand/or an amendment, restructuring or refinancing of its credit agreement.

 

The Company iscurrently considering alternatives to address these issues, which may include(1) an amendment or restructuring of its credit agreement to provide additionalliquidity and room under certain financial covenants, (2) a refinancing of allor some portion of its credit agreement, (3) a restructuring of the seniorsubordinated notes, or (4) some combination of the above.  The restructuring of the Company’soutstanding senior subordinated notes may include making an offer to exchangesuch notes for equity securities of the Company and/or debt securities of theCompany, which may have a reduced principal amount, reduced interest rates andmay defer the Company’s obligations to make cash interest payments thereon andmaking an offer to purchase such notes for cash at a price below parvalue.  The Company intends to engage afinancial advisor to advise it with respect to its restructuringalternatives.  The Company or itsrepresentatives have had, and may from time to time continue to have,discussions with holders of senior subordinated notes regarding a possiblerestructuring of those securities, which may be effected with the consent ofthe holders of a majority of the outstanding principal amount.  Based upon the Company’s current businessplans and prospects, management expects that its restructuring would occur inthe fourth quarter of 2002 and should enable the Company to meet itsobligations and comply with its debt covenants for the next twelve months.

 

Managementcannot, however, provide any assurances that the Company will be successful inobtaining any desired results on satisfactory terms or as to what effect any ofthe foregoing, if obtained, may have on future business operations.  Management also cannot provide anyassurances that the Company will be able to pay interest on the seniorsubordinated notes in November 2002 or thereafter.  In the event of an event of default under the credit agreement oran event of default under the indenture governing the senior subordinatednotes, the lenders under the credit agreement would become entitled to certainrights, including the right to accelerate the debt.  In the event of failure to pay interest due under the indenturewhich continues for 30 days or in the event of an acceleration of amounts dueunder the credit agreement, the holders of senior subordinated notes could alsoaccelerate the maturity of the senior subordinated notes.

 

Because of the subjectiveacceleration clauses included in the August 2002 amendment to the creditagreement described above, combined with the uncertainties about the Company'sability to meet its financial covenants for the next twelve months, the Companyhas reclassified the long-term portion of its senior bank debt, as well assubordinated debt and capital lease obligations (which contain crossdefault/acceleration terms), from noncurrent to current liabilities at June 30,2002 in accordance with FASB Technical Bulletin 79-3, *Subjective Acceleration Clauses in Long-Term DebtAgreements*. The total amounts of long-term debt and capital leaseobligations reclassified to current at June 30, 2002 were $130,005,470 and $1,374,783,respectively.

 

9.                                       Unit Option Plan

 

Effective March 15, 2002,the Company has made an offer to all option holders to cancel all outstandingoptions to purchase Class B Units with an exercise price equal to or greaterthan $4.00 per unit in reliance on the Company’s intent to grant new options ofan equal number at the fair market value after six months and a day followingcancellation.  As a result of thisoffer, 2,126,500 of such options were cancelled.

 

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MANAGEMENT’S DISCUSSION ANDANALYSIS OF

FINANCIAL CONDITION ANDRESULTS OF OPERATIONS

 

ITEM 2.        Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.

 

OVERVIEW

 

Cherokeeis a leading designer and manufacturer of a broad range of switch mode powersupplies for original equipment manufacturers (OEM’s) primarily in thetelecommunications, networking and high-end workstation industries. The Companyproduces its products and related components in sophisticated manufacturingfacilities located in Tustin and Irvine, California; Wavre, Belgium;Guadalajara, Mexico; and Bombay, India.

 

Theprincipal elements comprising cost of sales are raw materials, labor andmanufacturing overhead. Raw materials account for a majority of cost of sales.Raw materials include magnetic subassemblies, sheet metal, electronic and othercomponents, mechanical parts and electrical wires. Labor costs include employeecosts of salaried and hourly employees. Manufacturing overhead includes lease costs,depreciation on property, plant and equipment, utilities, property taxes andrepairs and maintenance.

 

Operatingexpenses include engineering costs, selling and marketing costs andadministrative expenses. Engineering costs primarily include salaries andbenefits of engineering personnel, safety approval and quality certificationfees, depreciation on equipment and subcontract costs for third partycontracting services. Selling and marketing expenses primarily include salariesand benefits to account managers, commissions to independent salesrepresentatives, and advertising costs. Administrative expenses primarilyinclude salaries and benefits for certain management and administrativepersonnel, professional fees and information system costs.

 

Duringthe second quarter of 2002 the Company changed the classification of certainexpenses incurred by Cherokee Europe to be more consistent with theclassification of similar expenses incurred by the North American operations.Such expenses were reclassified for the three and six month periods ended June30, 2001 and for the three months ended March 31, 2002 to conform with thepresentation for the three months ended June 30, 2002.  See Note 1 of Notes to Condensed ConsolidatedFinancial Statements.

 

During2001 and the first six months of 2002, the Company continued to generate asignificant portion of its sales from the communications market segment,particularly the networking and telecommunications sectors.   As aresult of unfavorable economic conditions and reduced capital spending bycommunication service providers that purchase our customers’ products, theCompany’s sales decreased in each quarter of 2001, compared to the immediatelypreceding quarter.  Sales in the first and second quarters of 2002 increasedslightly from their respective immediately preceding quarters. The Companybelieves unstable and unpredictable economic and industry conditions maycontinue.  If these conditions persist, the Company’s operating resultsand financial condition could be adversely affected, which could result infailure by the Company to satisfy its debt obligations and acceleration ofmaturity of the Company's indebtedness.

 

RESULTS OF OPERATIONS

 

THREE MONTHS ENDED JUNE 30,2002 COMPARED TO THREE MONTHS ENDED JUNE 30, 2001

 

NET SALES

 

Netsales decreased by approximately 22.9% or $7.5 million to $25.3 million for thethree months ended June 30, 2002 from last year’s $32.9 million for the threemonths ended June 30, 2001.  Sales of our North American operationsdecreased by approximately 27.6% or $5.0 million compared to the prior year,while sales of Cherokee Europe decreased by approximately 17.0% or $2.5million. These decreases were primarily due to lower customer demand as aresult of unfavorable economic conditions and reduced capital spending bycommunication service providers.

 

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GROSS PROFIT

 

Grossprofit decreased by approximately 15.5% or $1.2 million to $6.8 million for thethree months ended June 30, 2002 from $8.0 million for the three months endedJune 30, 2001. Gross margin for the quarter increased to 26.8% from 24.5% inthe prior year’s quarter.

 

Thedecrease in gross profit was primarily due to significantly lower gross profitcontributed by the North American operations which was attributable to thelower sales, partially offset by increased gross profit contributed by CherokeeEurope due mainly to a more favorable product mix.  The increase in gross margin compared to the prior year wasprimarily a result of higher gross margins for Cherokee Europe due to thefavorable change in product mix, partially offset by a lower gross margin forthe North American operations due mainly to an increase in factory overheadexpenses as a percentage of net sales.

 

OPERATING EXPENSES

 

Operatingexpenses for the three months ended June 30, 2002 decreased by approximately3.9% or $.2 million to $4.6 million from $4.8 million for the three monthsended June 30, 2001. As a percentage of sales, operating expenses increased to18.2% from 14.6% in the prior year’s quarter.

 

Thedecrease in operating expenses was primarily attributable to the absence ofgoodwill amortization in the current year’s quarter as a result of adoptingSFAS No. 142 as of January 1, 2002. Amortization of goodwill in the prior year’s quarter was approximately$0.8 million.  This was partially offsetby an increase in selling and marketing expenses due primarily to variousinitiatives in 2002 relating to new product introductions and expansion of theCompany’s customer base.

 

OPERATING INCOME

 

Operatingincome decreased by approximately 32.6% or $1.1 million to $2.2 million for thethree months ended June 30, 2002 from $3.2 million for the three months endedJune 30, 2001. Operating margin decreased to 8.6% for the quarter from 9.9% inthe prior year’s quarter.

 

Thedecrease in operating income was primarily attributable to a decline inoperating income of the North American operations due to the lower sales anddecreased gross margin.  Operating income contributed by Cherokee Europein the second quarter increased from the prior year due to the favorable changein product mix and the absence of goodwill amortization discussed above.  The decrease in operating margin was primarilyattributable to higher operating expenses as a percentage of sales.

 

INTEREST EXPENSE

 

Interestexpense for the three months ended June 30, 2002 was $3.7 million compared to$4.2 million for the three months ended June 30, 2001. The effect of decreaseddebt during the three months ended June 30, 2002 compared to the prior year’squarter combined with lower interest rates on the Company’s revolver borrowingsand term loans in the current year compared to the prior year contributed tothe decrease in interest expense.

 

NET INCOME (LOSS)

 

Asa result of the items discussed above, the Company recorded a net loss of $1.6million for the three months ended June 30, 2002 compared to net loss of $.9million for the three months ended June 30, 2001.

 

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SIX MONTHS ENDED JUNE 30,2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001

 

NET SALES

 

Netsales decreased by approximately 31.0% or $22.4 million to $49.9 million forthe six months ended June 30, 2002 from $72.3 million for the six months endedJune 30, 2001.  Sales of our North American operations decreased byapproximately 38.3% or $16.8 million compared to the prior year, while sales ofCherokee Europe decreased by approximately 19.8% or $5.6 million. Thesedecreases were primarily due to lower customer demand as a result ofunfavorable economic conditions and reduced capital spending by communicationservice providers.

 

GROSS PROFIT

 

Grossprofit decreased by approximately 31.1% or $5.9 million to $13.1 million forthe six months ended June 30, 2002 from $19.1 million for the six months endedJune 30, 2001. Gross margin for the six months ended June 30, 2002 decreasedslightly to 26.3% from 26.4% in the prior year.

 

Thedecrease in gross profit was primarily due to significantly lower gross profit contributedby the North American operations which was attributable to the lower sales,partially offset by increased gross profit contributed by Cherokee Europe duemainly to a more favorable product mix.  The decrease in gross margincompared to the prior year was primarily a result of a lower gross margin forour North American operations due mainly to an increase in factory overheadexpenses as percentage of net sales. This was partially offset by higher grossmargins for Cherokee Europe due to the favorable change in product mix.

 

OPERATING EXPENSES

 

Operatingexpenses for the six months ended June 30, 2002 decreased by approximately17.3% or $1.8 million to $8.6 million from $10.4 million for the six monthsended June 30, 2001. As a percentage of sales, operating expenses increased to17.2% from 14.4% in the prior year.

 

Thedecrease in operating expenses was primarily attributable to reductions in ourworkforce and other cost control measures implemented mainly during 2001 inresponse to unfavorable economic conditions, partially offset by an increase inselling and marketing expenses due primarily to various initiatives in 2002relating to new product introductions and expansion of the Company’s customerbase.  In addition, as a result ofadopting SFAS No. 142 as of January 1, 2002, the company ceased amortizinggoodwill in the first quarter of 2002. Amortization of goodwill for the sixmonths ended June 30, 2001 was approximately $1.5 million.

 

OPERATING INCOME

 

Operatingincome decreased by approximately 47.7% or $4.1 million to $4.5 million for thesix months ended June 30, 2002 from $8.6 million for the six months ended June30, 2001. Operating margin decreased to 9.1% for the six months ended June 30,2002 from 12.0% in the prior year.

 

Thedecrease in operating income was primarily attributable to a decline inoperating income of the North American operations due to the lower salesand decreased gross margin.  Operating income contributed by CherokeeEurope increased from the prior year due to the favorable change in product mixand the absence of goodwill amortization discussed above.  The decrease in operating margin wasprimarily attributable to higher operating expenses as a percentage of sales.

 

INTEREST EXPENSE

 

Interestexpense for the six months ended June 30, 2002 was $7.5 million compared to$8.5 million for the six months ended June 30, 2001. The effect of decreaseddebt during the six months ended June 30, 2002 compared to the prior yearcombined with lower interest rates on the Company’s revolver borrowings andterm loans in the current year compared to the prior year contributed to thedecrease in interest expense.

 

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NET INCOME (LOSS)

 

Asa result of the items discussed above, the Company recorded a net loss of $3.0million for the six months ended June 30, 2002 compared to approximatelybreakeven results for the six months ended June 30, 2001.

 

 

LIQUIDITY AND CAPITALRESOURCES

 

CASH FLOWS

 

SIX MONTHS ENDED JUNE 30,2002 COMPARED TO SIX MONTHS ENDED JUNE 30, 2001

 

Netcash provided by operating activities was $4.9 million for the six months endedJune 30, 2002 compared to $8.5 million for the six months ended June 30, 2001.Cash provided by operating activities for 2002 reflects a net loss ofapproximately $3.0 million, depreciation and amortization of $1.7 million, anda decrease in inventories of  $6.0 million, partially offset by a decreaseof $0.7 million in accrued compensation and benefits. Cash provided byoperating activities for 2001 reflects depreciation and amortization of $3.4 million and decreases of $9.7 million in accounts receivable and $6.7million in inventory, partially offset by decreases of $9.2 million in accountspayable and $1.7 million in accrued compensation and benefits.

 

Netcash used in financing activities of $5.2 million for the six months ended June30, 2002 primarily reflects a net reduction of $2.8 million in revolving creditborrowings and $1.8 million of payments on long-term debt.  Net cash used in financing activities of$2.1 million for the six months ended June 30, 2001 primarily reflects $2.9million of payments on long-term debt and an equity distribution of $2.1million, partially offset by a $3.3 million net increase in revolving creditborrowings.

 

LIQUIDITY

 

Historically,the Company has financed its operations with cash from operations supplementedby borrowings from credit facilities. The Company’s current and futureliquidity needs primarily arise from debt service on indebtedness, workingcapital requirements, capital expenditures and distributions to pay taxes.

 

TheCompany’s historical capital expenditures have substantially resulted frominvestments in equipment to increase manufacturing capacity and improvemanufacturing efficiencies. For fiscal 2002, the Company expects capitalexpenditures to be approximately $1 million.

 

Asof June 30, 2002, the Company’s borrowings consisted of $100 million ofsenior subordinated notes and $50.7 million of borrowings under its variouscredit facilities, including $10.7 million drawn under its domestic revolvingcredit facility. The Company is not subject to any amortization requirementsunder the senior subordinated notes prior to maturity in 2009, but it isrequired to make scheduled principal payments under certain term loans.

 

In September 2001, the Company's credit agreement was amended to waivethe Company's failure to comply with certain financial covenants and to, amongother things: (1) require that some of the Company's unitholders, or theirequity members, guarantee up to $10.5 million of the Company's obligationsunder the credit agreement, in exchange for the Company being permitted to makethe November 2001 and May 2002 scheduled interest payments totaling $10.5million on its $100 million of senior subordinated notes, (2) modify certainfinancial covenants from and after September 2001 and (3) restrict theCompany's ability to make its interest payment due in November 2002 relating toits senior subordinated notes until certain financial tests are satisfied.

 

In August 2002, the Company's credit agreement was further modified to,among other things, waive compliance with certain covenants (includingfinancial covenants for June 30, 2002). In connection with that waiver, certain of the Company's unitholders, ortheir equity members, paid to the lenders the remaining $8.7 million of the$10.5 million guaranty ($1.8 million of the guaranty was previously paid onJuly 1, 2002 to enable the Company to meet the scheduled amortization paymentunder the credit agreement) and the Company agreed to (a) restructure itssenior subordinated notes in a manner satisfactory to the required lenders byOctober 15, 2002 (which shall include a reduction in the cash interest requiredto be paid and/or conversion into preferred equity or the redemption of aportion of the senior subordinated notes), (b) deliver periodic term sheets asto the terms of such restructuring, (c) shorten the maturity date of the creditagreement from April 30, 2005 to January 8, 2004, (d) reduce the size of therevolving loan commitment from $25 million to $20 million and (e) provide thatapproximately $8.1 million of payments under the $10.5 million guarantyreferred to above will be applied to reduce term loans with the remainderapplied to reduce revolving loans and overadvance borrowings.  Failure to comply with the requirements inclauses (a) and (b) will constitute an event of default under the creditagreement.  The $8.7 million guarantypayment would have otherwise been payable in August 2002 as a result of thebreach of financial covenants under the credit agreement described above.  The guarantors are subrogated to the rightsof the lenders under the senior credit agreement, on a basis senior to thesenior subordinated notes.

 

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Based upon our present expectations, the Company anticipates that itwill not be in compliance with certain financial covenants under the creditagreement at September 30, 2002 without a restructuring of its seniorsubordinated notes and/or an amendment, restructuring or refinancing of itscredit agreement.  The Company also doesnot expect to be able to meet the required financial tests necessary for it tobe permitted to make the November 2002 interest payments on the seniorsubordinated notes in the absence of those events.  In addition, the Company believes that cash flow from operationsand available borrowing capacity may not be adequate to meet its anticipatedcash requirements for the next twelve months, including operating requirements,planned capital expenditures and debt service without a restructuring of thesenior subordinated notes and/or an amendment, restructuring or refinancing ofits credit agreement.

 

The Company is currently considering alternatives to address theseissues, which may include (1) an amendment or restructuring of its creditagreement to provide additional liquidity and room under certain financialcovenants, (2) a refinancing of all or some portion of its credit agreement,(3) a restructuring of the senior subordinated notes, or (4) some combinationof the above.  The restructuring of theCompany’s outstanding senior subordinated notes may include making an offer toexchange such notes for equity securities of the Company and/or debt securitiesof the Company, which may have a reduced principal amount, reduced interestrates and may defer the Company’s obligations to make cash interest paymentsthereon and making an offer to purchase such notes for cash at a price belowpar value.  The Company intends toengage a financial advisor to advise it with respect to its restructuringalternatives.  The Company or itsrepresentatives have had, and may from time to time continue to have,discussions with holders of senior subordinated notes regarding a possiblerestructuring of those securities, which may be effected with the consent ofthe holders of a majority of the outstanding principal amount.  Based upon the Company’s current businessplans and prospects, management expects that its restructuring would occur inthe fourth quarter of 2002 and should enable the Company to meet itsobligations and comply with its debt covenants for the next twelve months.

 

Management cannot, however, provide any assurances that the Companywill be successful in obtaining any desired results on satisfactory terms or asto what effect any of the foregoing, if obtained, may have on future businessoperations.  Management also cannotprovide any assurances that the Company will be able to pay interest on thesenior subordinated notes in November 2002 or thereafter.  In the event of an event of default underthe credit agreement or an event of default under the indenture governing thesenior subordinated notes, the lenders under the credit agreement would becomeentitled to certain rights, including the right to accelerate the debt.  In the event of failure to pay interest dueunder the indenture which continues for 30 days or in the event of anacceleration of amounts due under the credit agreement, the holders of seniorsubordinated notes could also accelerate the maturity of the seniorsubordinated notes.

 

                Because of the subjective acceleration clausesincluded in the August 2002 amendment to the credit agreement described above,combined with the uncertainties about the Company's ability to meet itsfinancial covenants for the next twelve months, the Company has reclassifiedthe long-term portion of its senior bank debt, as well as subordinated debt andcapital lease obligations (which contain cross default/acceleration terms),from noncurrent to current liabilities at June 30, 2002 in accordance with FASBTechnical Bulletin 79-3, *SubjectiveAcceleration Clauses in Long-Term Debt Agreements*. The total amountsof long-term debt and capital lease obligations reclassified to current at June30, 2002 were $130,005,470 and $1,374,783, respectively.

 

NEW ACCOUNTINGPRONOUNCEMENTS

 

InJune 2001, the FASB issued SFAS No. 141, “Business Combinations”, and SFAS No.142, “Goodwill and Other Intangible Assets”.  The Company has adopted SFASNo. 141 and SFAS No. 142 effective January 1, 2002.  See Note 7 of Notes to Condensed Consolidated FinancialStatements.

 

InAugust 2001, the FASB issued SFAS No. 144, “Accounting for Impairment orDisposal of Long-Lived Assets.” This statement addresses financial accountingand reporting for the impairment of long-lived assets and for long-lived assetsto be disposed of. SFAS No. 144 supersedes SFAS No. 121, “Accounting for theImpairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,”and

 

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is effective for fiscalyears beginning after December 15, 2001. The adoption of this standard atJanuary 1, 2002 did not have a material impact on the Company’s financialposition and results of operations.

 

In July 2002, the FASB issued SFAS No. 146, “Accounting for CostsAssociated with Exit or Disposal Activities,” which addresses financialaccounting and reporting for costs associated with exit or disposal activitiesand supersedes EITF Issue 94-3, “Liability Recognition for Certain EmployeeTermination Benefits and Other Costs to Exit an Activity (including CertainCosts Incurred in a Restructuring).”  SFAS No. 146 requires that a liability for a cost associatedwith an exit or disposal activity be recognized when the liability isincurred.  Under Issue 94-3, a liabilityfor an exit cost as defined in EITF 94-3 was recognized at the date of anentity’s commitment to an exit plan. SFAS No. 146 also establishes that the liability should initiallybe measured and recorded at fair value. The Company will adopt the provisions of SFAS No. 146 for exit ordisposal activities that are initiated after December 31, 2002.

 

FORWARD-LOOKING STATEMENTS

 

Statementsin this report containing the words “believes,” “anticipates,”, “expects,” andwords of similar meaning, and any other statements which may be construed as aprediction of future performance or events, constitute “forward-lookingstatements” within the meaning of the Private Securities Litigation Reform Actof 1995. Such forward-looking statements involve known and unknown risks,uncertainties, and other factors that may cause the actual results,performance, or achievements of the Company, or industry results, to bematerially different from any future results, performance, or achievementsexpressed or implied by such forward-looking statements. Such factors include,among others, (1) restrictions imposed by the Company’s substantial leverageand restrictive covenants in its debt agreements, (2) reductions in sales toany of the Company’s significant customers or in customer capacity generally,(3) changes in the Company’s sales mix to lower margin products, (4) increasedcompetition, (5) disruptions of the Company’s established supply channels, and(6) the additional risk factors identified in the Company’s Annual Report onForm 10-K dated December 31, 2001 and those described from time to time in theCompany’s other filings with the SEC, press releases and other communications.The Company disclaims any obligations to update any such factors or to announcepublicly the result of any revisions to any of the forward-looking statementscontained or incorporated by reference herein to reflect future events ordevelopments.

 

 

ITEM 3.       QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK

 

Marketrisks relating to our operations result primarily from changes in short-terminterest rates. The Company did not have any derivative financial instrumentsat June 30, 2002.

 

TheCompany’s exposure to market risk for changes in interest rates relatesprimarily to its current domestic credit facility. In accordance with thecredit facility, the Company enters into variable rate debt obligations tosupport general corporate purposes, including capital expenditures and workingcapital needs. The Company continuously evaluates its level of variable ratedebt with respect to total debt and other factors, including assessment of thecurrent and future economic environment.

 

TheCompany had approximately $51 million in variable rate debt outstanding at June30, 2002. Based upon these variable rate debt levels, a hypothetical 10%adverse change in interest rates would increase interest expense byapproximately $0.4 million on an annual basis, and likewise decrease ourearnings and cash flows. The Company cannot predict market fluctuations ininterest rates and their impact on its variable rate debt, nor can there be anyassurance that fixed rate long-term debt will be available to the Company atfavorable rates, if at all. Consequently, future results may differ materiallyfrom the estimated adverse changes discussed above.

 

Asa result of the Cherokee Europe acquisition in June 2000, the Company hasEuropean operations and is, therefore, subject to a certain degree of marketrisk associated with changes in foreign currency exchange rates. The Companyhas not actively engaged in exchange rate hedging activities.

 

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PART II.          OTHER INFORMATION

 

ITEM 1.           LEGAL PROCEEDINGS

 

TheCompany is subject to disputes and potential claims by third parties that areincidental to the conduct of its business. The Company does not believe thatthe outcome of any such matters, pending at June 30, 2002 will have a materialadverse effect on its financial condition or results of operations.

 

ITEM 6.           EXHIBITS AND REPORTS ON FORM 8-K
| (a)    |   | EXHIBITS:                                                                                                                                                                            |
|--------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                 |
| 3.1*   |   | Second  Amended and Restated Operating Agreement of Cherokee International, LLC,  dated as of April 30, 1999.                                                                        |
|   |   |                                                                                                                                                                                 |
| 3.2*   |   | Amendment  No. 1 to the Second Amended and Restated Operating Agreement of Cherokee  International, LLC, dated as of June 28, 1999.                                                  |
|   |   |                                                                                                                                                                                 |
| 3.3*   |   | Amendment  No. 2 to the Second Amended and Restated Operating Agreement of Cherokee  International, LLC, dated as of June 28, 1999.                                                  |
|   |   |                                                                                                                                                                                 |
| 3.4**  |   | Amendment  No. 3 to the Second Amended and Restated Operating Agreement of Cherokee  International, LLC, dated as of June 12, 2000.                                                  |
|   |   |                                                                                                                                                                                 |
| 3.5**  |   | Amendment  No. 4 to the Second Amended and Restated Operating Agreement of Cherokee  International, LLC, dated as of June 14, 2000.                                                  |
|   |   |                                                                                                                                                                                 |
| 10.1   |   | Waiver  and Fourth Amendment to Credit Agreement dated as of August 13, 2002 by andbetween Cherokee  International, LLC, Heller Financial, Inc., and the Lenders signatory  thereto. |
|   |   |                                                                                                                                                                                 |
| 99.1   |   | Certification  of Chief Executive Officer and Chief Financial Officer.                                                                                                               |
|   |   |                                                                                                                                                                                 |
| (b)    |   | REPORTS  ON FORM 8-K

None                                                                                                                                                           |

 

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*                                 Incorporated by reference to designatedexhibit to the Company’s Registration  Statement on Form S-4 (File No.333-82713).

 

**                          Incorporated by reference to designated exhibitto the Company’s Quarterly  Report on Form 10-Q, dated July 2, 2000.

 

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SIGNATURES

 

Pursuantto the requirements of the Securities Exchange Act of 1934, as amended, theregistrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 
|                   | Cherokee  International, LLC  |
|------------------------|-------------------------------|
|                   |                          |
| Date:  August 14, 2002 | /s/  R. Van Ness Holland, Jr. |   |
|                   |                          |
|                   | R.  Van Ness Holland, Jr.     |
|                   | Chief  Financial Officer      |

 

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