**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

** **

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**FORM 10-Q**

 

| **(Mark One)** |
|----------------|
| **x**          | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|           | **For the quarterly period ended  March 30, 2008** |
| ** **     |
| **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 No. 000-50593**

 

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**Cherokee International Corporation**

(Exact name of Registrant as specified in its charter)

 

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

 

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

** **

Securities registered pursuant to Section 12(b)of the Act:

 

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

 

Securities registered pursuant to Section 12(g)of the Act:

**None**

 

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

 

Yes x  No o

 

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

 
| Large accelerated filer o | Accelerated filer o | Non-accelerated  filer o                   | Smaller reporting  company x |
|--------------------------------|--------------------------|-------------------------------------------------|-----------------------------------|
|                           |                     | (Do not check if a  smaller  reporting company) |                              |

 

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

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 

| **Title**                                 | ** ** | **Shares  Outstanding as of May 4, 2008** |
|-------------------------------------------|------------|------------------------------------------------|
| Common Stock, par value  $0.001 per share |       | 19,453,557 shares                              |

 

 

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TABLEOF CONTENTS

 
| ** **                                                                                           | **Page** |
|------------------------------------------------------------------------------------------------------|----------|
| PART I.  FINANCIAL INFORMATION                                                                  |     |
| Item 1.  Financial Statements:                                                                       | 1        |
| Condensed Consolidated  Balance Sheets (unaudited)                                                   | 1        |
| Condensed Consolidated  Statements of Operations (unaudited)                                         | 2        |
| Condensed Consolidated  Statements of Comprehensive Operations (unaudited)                           | 3        |
| Condensed Consolidated  Statements of Cash Flows (unaudited)                                         | 4        |
| Notes to Condensed  Consolidated Financial Statements (unaudited)                                    | 5        |
| Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of  Operations | 18       |
| Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                  | 26       |
| Item 4T. Controls and  Procedures                                                                    | 26       |
| PART II OTHER  INFORMATION                                                                      | 28       |
| Item 1. Legal Proceedings                                                                            | 28       |
| Item  1A. Risk Factors                                                                               | 28       |
| Item  6. Exhibits                                                                                    | 29       |
| Signatures                                                                                           | 30       |

 

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PART I.   FINANCIAL INFORMATION

 

Item 1.   FINANCIAL STATEMENTS.

 

CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(InThousands, Except Share and Per Share Data)

(Unaudited)

 
| ** **                                                                                                                                                                          | ** ** | **March 30, 2008** | ** ** | **December 30, 2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|---------------------------------|------------|
| ASSETS                                                                                                                                                                              |       |                    |       |                            |       |
| CURRENT ASSETS:                                                                                                                                                                     |       |                    |       |                            |       |
| Cash and cash  equivalents                                                                                                                                                          |       | $                       | 12,014     |                            | $          | 8,484 |   |
| Accounts  receivable, net of allowance for doubtful accounts of $291 and $297  at March 30, 2008 and December 30, 2007, respectively                                           |       | 27,467                  |       | 31,237                          |       |
| Inventories, net                                                                                                                                                                    |       | 30,005                  |       | 28,021                          |       |
| Prepaid expenses  and other current assets                                                                                                                                          |       | 2,042                   |       | 1,583                           |       |
| Deferred income  taxes                                                                                                                                                              |       | 363                     |       | 363                             |       |
| Total current  assets                                                                                                                                                               |       | 71,891                  |       | 69,688                          |       |
| Property and  equipment, net                                                                                                                                                        |       | 19,044                  |       | 19,194                          |       |
| Deposits and  other assets                                                                                                                                                          |       | 1,088                   |       | 1,515                           |       |
| Deferred  financing costs, net of accumulated amortization of $526 and $494  at March 30, 2008 and December 30, 2007, respectively                                             |       | 383                     |       | 86                              |       |
| Deferred income  taxes-long-term portion                                                                                                                                            |       | 1,345                   |       | 1,257                           |       |
| Goodwill                                                                                                                                                                            |       | 1,120                   |       | 1,120                           |       |
| Total Assets                                                                                                                                                                        |       | $                       | 94,871     |                            | $          | 92,860 |   |
|                                                                                                                                                                                |       |                    |       |                            |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                          |       |                    |       |                            |       |
| CURRENT  LIABILITIES:                                                                                                                                                               |       |                    |       |                            |       |
| Accounts payable                                                                                                                                                                    |       | $                       | 15,691     |                            | $          | 15,140 |   |
| Accrued  liabilities                                                                                                                                                                |       | 4,630                   |       | 4,667                           |       |
| Accrued  compensation and benefits                                                                                                                                                  |       | 7,848                   |       | 6,876                           |       |
| Accrued  restructuring costs                                                                                                                                                        |       | 503                     |       | 431                             |       |
| Other short-term  borrowings                                                                                                                                                        |       | 475                     |       | —                          |       |
| Borrowings under  revolving line of credit                                                                                                                                          |       | 2,206                   |       | 3,395                           |       |
| Current debt                                                                                                                                                                        |       | 24,485                  |       | 24,485                          |       |
| Current debt  payable to affiliates                                                                                                                                                 |       | 22,145                  |       | 22,145                          |       |
| Total current  liabilities                                                                                                                                                          |       | 77,983                  |       | 77,139                          |       |
| Other long-term  liabilities                                                                                                                                                        |       | 4,659                   |       | 4,534                           |       |
| Total  Liabilities                                                                                                                                                                  |       | 82,642                  |       | 81,673                          |       |
|                                                                                                                                                                                |       |                    |       |                            |       |
| Commitments and  contingencies (Note 9)                                                                                                                                             |       |                    |       |                            |       |
|                                                                                                                                                                                |       |                    |       |                            |       |
| STOCKHOLDERS’  EQUITY:                                                                                                                                                         |       |                    |       |                            |       |
| Common stock:  $0.001 par value; 60,000,000 shares authorized; 19,453,557 and 19,453,557 shares  issued and outstanding at March 30, 2008 and December 30,  2007, respectively |       | 19                      |       | 19                              |       |
| Paid-in capital                                                                                                                                                                     |       | 186,296                 |       | 186,035                         |       |
| Accumulated  deficit                                                                                                                                                                |       | (178,311                | )          | (178,323                        | )          |
| Accumulated  other comprehensive income                                                                                                                                             |       | 4,225                   |       | 3,456                           |       |
| Total stockholders’  equity                                                                                                                                                    |       | 12,229                  |       | 11,187                          |       |
| Total  Liabilities and Stockholders’ Equity                                                                                                                                    |       | $                       | 94,871     |                            | $          | 92,860 |   |

 

See notes tocondensed consolidated financial statements.

 

1

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CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIES

CONDENSEDCONSOLIDATED STATEMENTS OF OPERATIONS

(InThousands, Except Per Share Amounts)(Unaudited)

 
| ** **                            | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| ** **                            | ** ** | **March 30, 2008**     | ** ** | **April 1, 2007** | ** ** |
| Net sales                             |       | $                                | 34,738     |   | $ | 30,020 |   |
| Cost of sales                         |       | 26,097                           |       | 24,303 |   |
| Gross profit                          |       | 8,641                            |       | 5,717 |   |
| Operating  expenses:                  |       |                             |       |   |   |
| Engineering and  development          |       | 2,781                            |       | 2,642 |   |
| Selling and  marketing                |       | 1,735                            |       | 1,864 |   |
| General and  administrative           |       | 3,593                            |       | 3,137 |   |
| Restructuring  costs                  |       | —                           |       | 193 |   |
| Total operating  expenses             |       | 8,109                            |       | 7,836 |   |
| Operating income  (loss)              |       | 532                              |       | (2,119 | ) |
| Interest expense                      |       | (742                             | )          | (685 | ) |
| Other income,  net                    |       | 213                              |       | 162 |   |
| Income (loss)  before income taxes    |       | 3                                |       | (2,642 | ) |
| Benefit for  income taxes             |       | (9                               | )          | (620 | ) |
| Net income  (loss)                    |       | $                                | 12         |   | $ | (2,022 | ) |
| Net income  (loss) per share:         |       |                             |       |   |   |
| Basic                                 |       | $                                | —     |   | $ | (0.10 | ) |
| Diluted                               |       | $                                | —     |   | $ | (0.10 | ) |
| Weighted average  shares outstanding: |       |                             |       |   |   |
| Basic                                 |       | 19,454                           |       | 19,341 |   |
| Diluted                               |       | 19,462                           |       | 19,341 |   |

 

See notes tocondensed consolidated financial statements.

 

2

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CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE OPERATIONS

(In Thousands)

(Unaudited)

 
| ** **                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|
| ** **                                | ** ** | **March 30, 2008**     | ** ** | **April 1, 2007** | ** ** |
| Net income (loss)                         |       | $                                | 12         |   | $ | (2,022 | ) |
| Other comprehensive income (loss):        |       |                             |       |   |   |
| Foreign currency  translation adjustments |       | 769                              |       | 163 |   |
| Comprehensive income (loss)               |       | $                                | 781        |   | $ | (1,859 | ) |

 

See notes tocondensed consolidated financial statements.

 

3

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CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

 
| ** **                                                                                | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                | ** ** | **March 30, 2008**          | ** ** | **April 1, 2007** | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                    |       |                             |       |   |   |
| Net income  (loss)                                                                        |       | $                                | 12         |   | $ | (2,022 | ) |
| Adjustments to  reconcile net income (loss) to net cash provided by operating activities: |       |                             |       |   |   |
| Depreciation and  amortization                                                            |       | 697                              |       | 852 |   |
| Amortization of  deferred financing costs                                                 |       | 32                               |       | 32 |   |
| Stock-based  compensation                                                                 |       | 261                              |       | 212 |   |
| Net change in  operating assets and liabilities:                                          |       |                             |       |   |   |
| Accounts  receivable, net                                                                 |       | 4,589                            |       | 4,685 |   |
| Inventories, net                                                                          |       | (1,286                           | )          | (2,342 | ) |
| Prepaid expenses  and other current assets                                                |       | (394                             | )          | 77 |   |
| Deposits and  other assets                                                                |       | 427                              |       | (34 | ) |
| Accounts payable                                                                          |       | 105                              |       | (1,046 | ) |
| Accrued  liabilities and restructuring costs                                              |       | (754                             | )          | (1,066 | ) |
| Accrued compensation  and benefits                                                        |       | 728                              |       | 1,068 |   |
| Accrued interest  payable                                                                 |       | 596                              |       | 622 |   |
| Other long-term  obligations                                                              |       | (179                             | )          | 261 |   |
| Net cash  provided by operating activities                                                |       | 4,834                            |       | 1,299 |   |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                    |       |                             |       |   |   |
| Additions to  property and equipment                                                      |       | (47                              | )          | (723 | ) |
| Net cash used in  investing activities                                                    |       | (47                              | )          | (723 | ) |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                    |       |                             |       |   |   |
| Other short-term  borrowings                                                              |       | 475                              |       | — |   |
| Borrowings  (repayments) on revolving lines of credit, net                                |       | (1,335                           | )          | 1,297 |   |
| Deferred  financing costs                                                                 |       | (329                             | )          | — |   |
| Net proceeds  from exercises of stock options                                             |       | —                           |       | 29 |   |
| Net cash (used  in) provided by financing activities                                      |       | (1,189                           | )          | 1,326 |   |
| Effect of  exchange rate changes on cash                                                  |       | (68                              | )          | 53 |   |
| Net increase in  cash and cash equivalents                                                |       | 3,530                            |       | 1,955 |   |
| Cash and cash  equivalents, beginning of period                                           |       | 8,484                            |       | 8,881 |   |
| Cash and cash  equivalents, end of period                                                 |       | $                                | 12,014     |   | $ | 10,836 |   |
| SUPPLEMENTAL  INFORMATION                                                                 |       |                             |       |   |   |
| Cash paid during  the period for interest                                                 |       | $                                | 75         |   | $ | 8 |   |
| Cash paid during  the period for income taxes                                             |       | $                                | 275        |   | $ | 142 |   |

 

See notes to condensedconsolidated financial statements.

 

4

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CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIES

NOTESTO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.                  NATURE OFOPERATIONS

 

Cherokee International Corporation (the “Company”) isa designer and manufacturer of power supplies for original equipmentmanufacturers (“OEMs”). Its advanced power supply products are typically customdesigned into mid- to high-end commercial applications in the computing andstorage, wireless infrastructure, enterprise networking, telecom, medical andindustrial markets.

 

2.                    BASIS OFPRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Basisof Presentation

 

The accompanyingcondensed consolidated financial statements of Cherokee InternationalCorporation have been prepared in accordance with accounting principlesgenerally accepted in the United States of America for interim financialinformation and in accordance with the instructions to Form 10-Q and Article 10of Regulation S-X.  Accordingly, they do not include certain footnotes andfinancial presentations normally required under accounting principles generallyaccepted in the United States of America for complete financialreporting.  The interim financial information is unaudited, but reflectsall normal adjustments and accruals, which are, in the opinion of management,considered necessary to provide a fair presentation for the interim periodspresented.  The condensed consolidated financial statements include thefinancial statements of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in theaccompanying condensed consolidated financial statements.

 

Results of operations forthe quarters ended March 30, 2008 and April 1, 2007, are not necessarilyindicative of the results to be expected for the entire fiscal year endingDecember 28, 2008 (“fiscal 2008”). The accompanying condensed consolidatedfinancial statements should be read in conjunction with the auditedconsolidated financial statements for the fiscal year ended December 30,2007, included in the Company’s Annual Report on Form 10-K (File No. 000-50593)filed on March 28, 2008.

 

Going Concern

 

Theaccompanying condensed consolidated financial statements have been preparedassuming that the Company will continue as a going concern.

 

OnNovember 1, 2008, the $46.6 million aggregate principal amountoutstanding under our 5.25% Senior Notes will become due and payable. We do notexpect to have sufficient cash available at the time of maturity to repay thisindebtedness and are currently working on a variety of possible alternatives insatisfying this obligation. We also cannot be certain that we will havesufficient assets or cash flow available to support refinancing these notes atcurrent market rates or on terms that are satisfactory to us. If we are unableto refinance on terms satisfactory to us, we may be forced to refinance onterms that are materially less favorable, seek funds through other means suchas a sale of some of our assets, or otherwise significantly alter our operatingplan, any of which could have a material adverse effect on our business,financial condition and results of operation. These circumstances create substantialdoubt about our ability to continue as a going concern.

 

Theaccompanying condensed consolidated financial statements do not include anyadjustments relating to the recoverability and classification of asset carryingamounts or the amount and classification of liabilities that might resultshould we be unable to continue as a going concern.

 

Use of Estimates

 

The preparation of financial statements in accordancewith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent liabilities atthe date of the financial statements and the amounts of revenues and expensesduring the reporting period. Actual results could differ from such estimates.

 

5

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Stock-Based Compensation

 

InDecember 2004, SFAS 123R, *Share-BasedPayment*, was issued. SFAS 123R is a revision of SFAS 123, *Accounting for Stock Based Compensation*,and supersedes APB 25. Among other items, SFAS 123R eliminates theuse of APB 25 and the intrinsic value method of accounting, and requirescompanies to recognize the cost of employee services received in exchange forawards of equity instruments, based on the grant date fair value of thoseawards, in the financial statements. The Company was required to adoptSFAS 123R effective on January 2, 2006. SFAS 123R permitscompanies to adopt its requirements using either a “*modified prospective*” method, or a “*modified retrospective*” method. Under the“*modified prospective*” method,compensation cost is recognized in the financial statements beginning with theeffective date, based on the requirements of SFAS 123R for all share-basedpayments granted after that date, and based on the requirements ofSFAS 123 for all unvested awards granted prior to the effective date ofSFAS 123R. Under the “*modifiedretrospective*” method, the requirements are the same as under the “*modified prospective*” method, but also permitsentities to restate financial statements of previous periods based on proformadisclosures made in accordance with SFAS 123.

 

SFAS123R permits the use of either the Black-Scholes model or a “lattice”model.  The Company used theBlack-Scholes standard option-pricing model to measure the fair value of stockoptions granted to employees and nonemployees prior to its adoption of SFAS123Rand continued its use thereafter.

 

SFAS 123Rrequires that the benefits associated with the tax deductions in excess ofrecognized compensation cost be reported as a financing cash flow, rather thanas an operating cash flow as required under prior literature. This requirementwill reduce net operating cash flows and increase net financing cash flows inperiods after the effective date. These future amounts cannot be estimated,because they depend on, among other things, when employees exercise stockoptions.

 

TheCompany adopted SFAS 123R on January 2, 2006 using the “modifiedprospective” method as permitted by SFAS 123R. Under this transitionmethod, stock compensation cost recognized beginning in the first quarter offiscal year 2006 includes: (a) compensation cost for all share-basedpayments granted subsequent to February 25, 2004 and prior to January 1,2006 but not yet vested as of January 1, 2006, based on the grant-datefair value estimated in accordance with the provisions of SFAS 123R, and(b) compensation cost for all share-based payments granted subsequent toJanuary 1, 2006, based on the grant-date fair value estimated inaccordance with the provisions of SFAS 123R. In accordance with themodified prospective method of adoption, the Company’s results of operationsand financial position for prior periods have not been restated. At the date ofthe adoption, the unamortized expense for options issued prior toJanuary 2, 2006 was $2.3 million, which will be amortized as stockcompensation costs through December 2010. Stock based compensation costsexpensed during the quarters ended March 30, 2008 and April 1, 2007, were$0.3 million and $0.2 million, respectively.

 

Allgrants are made at prices based on the fair market value of the stock on thedate of grant. Outstanding options generally vest over periods ranging from twoto four years from the grant date and generally expire up to ten years afterthe grant date.

 

The Company recordscompensation expense for employee stock options based on the estimated fairvalue of the options on the date of grant using the Black-Scholes optionpricing formula with the assumptions included in the table below. The Companyuses historical data, among other factors, to estimate the expected pricevolatility and the expected forfeiture rate. For options granted prior toJanuary 2, 2006, the Company used the expected option life of 5 years.For options granted following the Company’s adoption of SFAS 123R, theexpected life was increased to 6.25 years using the “simplified method”under SAB 107 (an expected term based on the mid-point between the vestingdate and the end of the contractual term). The use of the simplified methodrequires our option plan to be consistent with a “plain vanilla” plan and wasoriginally permitted through December 31, 2007 under SAB 107. InDecember 2007, the SEC issued SAB 110, *Share-BasedPayment*, to amend the SEC’s views discussed in SAB 107regarding the use of the simplified method in developing an estimate ofexpected life of share options in accordance with SFAS 123R. SAB 110is effective for the Company beginning December 31, 2007. The Company willcontinue to use the simplified method until it has the historical datanecessary to provide a reasonable estimate of expected life, in accordance withSAB 107, as amended by SAB 110. The options have a maximumcontractual term of 10 years and generally vest pro-rata over two to fouryears. The risk-free rate is based on the U.S. Treasury yield curve in effectat the time of grant for the estimated life of the option.

 

6

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The followingweighted-average assumptions were used to estimate the fair value of optionsgranted during the quarters ended March 30, 2008 and April 1, 2007,using the Black-Scholes option pricing formula.

 
| ** **              | ** ** | **Quarter Ended** | ** ** |
|-------------------------|------------|------------------------|------------|
| ** **              | ** ** | **March 30, 3008**     | ** ** | **April 1, 2007** | ** ** |
| Dividend yield          |       | 0.0                    | %          | 0.0 | % |
| Expected volatility     |       | 58.6                   | %          | 56.3 | % |
| Risk free interest rate |       | 3.47                   | %          | 4.65 | % |
| Expected lives          |       | 6.25 years             |       | 6.25 years |   |
| Forfeiture rates        |       | 11.90% - 22.73         | %          | 13.55% - 17.10 | % |

 

The following tablesummarizes the Company’s activities with respect to its stock option plans forthe quarter ended March 30, 2008 as follows:

 
| **Options**                                                       | ** ** | **Number  of  Shares** | ** ** | **Weighted-  Average  Exercise Price  Per Share** | ** ** | **Weighted-  Average  Remaining  Contractual  Term  (in years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|-------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at December 30, 2007                             |       | 2,791,579              |       | $                                                           | 5.97       |                                                                  | 7.49       |                            | $          | — |   |
| Granted                                                           |       | —                 |       | $                                                           | —     |                                                                  | —     |                            | $          | — |   |
| Exercised                                                         |       | —                 |       | $                                                           | —     |                                                                  | —     |                            | $          | — |   |
| Forfeited                                                         |       | (221,667               | )          | $                                                           | 7.21       |                                                                  | 6.55       |                            | $          | — |   |
| Outstanding at March 30, 2008                                |       | 2,569,912              |       | $                                                           | 5.86       |                                                                  | 7.30       |                            | $          | — |   |
| Vested and  expected to vest in the future at March 30, 2008 |       | 2,463,011              |       | $                                                           | 5.98       |                                                                  | 6.74       |                            | $          | — |   |
| Exercisable at March 30, 2008                                |       | 1,399,587              |       | $                                                           | 6.97       |                                                                  | 6.18       |                            | $          | — |   |

 

Since its inception on February 16, 2004, a totalof 400,000 shares of common stock have been reserved for issuance under the2004 Employee Stock Purchase Plan (“ESPP”), subject to annual increases asdescribed under Note 11 below. Under the terms of the ESPP, the Company’s U.S.employees, nearly all of whom are eligible to participate, can choose to haveup to a maximum of 15% of their eligible annual base earnings withheld, subjectto an annual maximum of $25,000 or 2,100 shares per offering period, topurchase our common stock. The purchase price of the stock is 85% of the lowerof the closing price at the beginning of each six-month offering period or atthe end of each six-month offering period. The Company recognizes compensationcost for its ESPP under SFAS 123R.

 

7

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In accordance with SFAS 148, and as required by SFAS123R, the required pro forma disclosure for options granted in periods prior toadoption of SFAS 123R is shown below (in thousands except per share amounts):

 
| ** **                                                                                                                                                           | ** ** | **Quarter Ended**       | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                           | ** ** | **March 30, 2008** | ** ** | **April 1, 2007** | ** ** |
| Net income (loss), as reported                                                                                                                                       |       | $                            | 12         |   | $ | (2,022 | ) |
| Stock-based  employee compensation related to stock options included in net  income (loss), as reported, net of tax                                             |       | —                       |       | — |   |
| Total  stock-based employee compensation expense determined under the fair  value based method for all awards (under provisions of APB 25), net of tax (a) |       | (40                          | )          | (95 | ) |
| Net loss—pro forma                                                                                                                                              |       | $                            | (28        | ) | $ | (2,117 | ) |
| Net loss per share, as reported:                                                                                                                                     |       |                         |       |   |   |
| Basic                                                                                                                                                                |       | $                            | —     |   | $ | (0.10 | ) |
| Diluted                                                                                                                                                              |       | $                            | —     |   | $ | (0.10 | ) |
| Pro forma net loss per share:                                                                                                                                        |       |                         |       |   |   |
| Basic                                                                                                                                                                |       | $                            | —     |   | $ | (0.11 | ) |
| Diluted                                                                                                                                                              |       | $                            | —     |   | $ | (0.11 | ) |

 

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(a)             During 2008 and 2007,the Company accounted for stock-based compensation for options granted prior toFebruary 25, 2004, the date of our initial public offering, to employeesand directors using the intrinsic value method prescribed in APB 25 and adoptedthe disclosure-only alternative of SFAS 123, as amended by SFAS 148 for theseoptions.

 

Translation of ForeignCurrency

 

Foreignsubsidiary assets and liabilities denominated in foreign currencies aretranslated at the exchange rate in effect on the balance sheet date. Revenues,costs and expenses are translated at the average exchange rate during theperiod. Transaction gains and losses are included in results of operations andhave not been significant for the periods presented. The functional currency ofCherokee Europe is the Euro. The functional currency of Cherokee India,Powertel and Cherokee China is the U.S. dollar, as the majority of transactionsare denominated in U.S. dollars. Translation adjustments related to CherokeeEurope are reflected as a component of stockholders’ equity in othercomprehensive income (loss).

 

Recent AccountingPronouncements

 

InSeptember 2006, the FASB issued SFAS 157, *FairValue Measurements*. This Statement defines fair value, establishes aframework for measuring fair value in generally accepted accounting principles(GAAP), and expands disclosures about fair value measurements. This Statementapplies to accounting pronouncements that require or permit fair valuemeasurements, except for share-based payments transactions under FASB StatementNo. 123 (Revised) *Share-Based Payment*.This Statement is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007, except for non-financial assets andliabilities, for which this Statement will be effective for years beginningafter November 15, 2008. The Company adopted SFAS 157 on December 31,2007, and the impact of this adoption on our financial position and results ofoperations was immaterial.

 

InFebruary 2007, the FASB issued SFAS 159 *TheFair Value Option for Financial Assets and Financial Liabilities*.This Statement permits entities to choose to measure many financial instrumentsand certain other items at fair value that are not currently required to bemeasured at fair value. The Statement also establishes presentation anddisclosure requirements designed to facilitate comparisons between entitiesthat choose different measurement attributes for similar types of assets andliabilities. SFAS 159 is effective for financial statements issued forfiscal years beginning after November 15, 2007, although early applicationis allowed. The Company did not elect the fair value option for financialassets or liabilities existing on our adoption date of December 31, 2007.The Company will consider the applicability of the fair value option for assetsacquired or liabilities incurred in future transactions.

 

InDecember 2007, the FASB issued SFAS 141(R), *Business Combinations*, and SFAS 160, *Noncontrolling Interests in Consolidated FinancialStatements, an amendment of ARB No. 51*. These pronouncementsare required to be adopted concurrently and are effective for businesscombination transactions for which the acquisition date is on or after thebeginning of the first annual reporting period beginning on or afterDecember 15, 2008. Early adoption is prohibited, thus the

 

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provisions of thesepronouncements will be effective for us in fiscal year 2009. We do not have anyminority interests and do not expect the adoption of SFAS 160 to have amaterial effect on our financial position or results of operations.

 

InDecember 2007, the SEC published SAB 110, *Share-BasedPayment*. The interpretations in SAB 110 express the SEC staff’sviews regarding the acceptability of the use of a “simplified” method, asdiscussed in SAB 107, in developing an estimate of expected term of shareoptions in accordance with FASB Statement No. 123 (Revised) *Share-Based Payment*. The use of thesimplified method requires our option plan to be consistent with a “plainvanilla” plan and was originally permitted through December 31, 2007 underSAB 107. In December 2007, the SEC issued SAB 110, *Share-Based Payment*, to amend the SEC’sviews discussed in SAB 107 regarding the use of the simplified method indeveloping an estimate of expected life of share options in accordance with FASNo. 123(R). SAB 110 was effective for the Company beginningDecember 31, 2007. The Company will continue to use the simplified methoduntil it has the historical data necessary to provide a reasonable estimate ofexpected life, in accordance with SAB 107, as amended by SAB 110.

 

InMarch 2008, the FASB issued SFAS 161, *Disclosuresabout Derivative Instruments and Hedging Activities,* an amendment ofSFAS 133. This Statement requires enhanced disclosures about derivativeinstruments and hedging activities within an entity by requiring the disclosureof the fair values of derivative instruments and their gains and losses in atabular format. It provides more information about an entity’s liquidity byrequiring disclosure of derivative features that are credit risk-related, andit requires cross-referencing within footnotes to enable financial statementusers to locate important information about derivative instruments. It iseffective for financial statements issued for fiscal years and interim periodsbeginning after November 15, 2008, with early adoption permitted. TheCompany is evaluating the impact of the adoption of SFAS 161 and believesthere will be no material impact on our consolidated financial statements orfinancial operations.

 

Inventories

 

Inventories are valued at the lower of weightedaverage cost or market. Inventory costs include the cost of material, labor andmanufacturing overhead and consist of the following, net of reserve for surplusand obsolescence (in thousands):

 
| ** **       | ** ** | **March 30, 2008** | ** ** | **December 30, 2007** | ** ** |
|------------------|------------|------------------------------|------------|---------------------------------|------------|
| Raw material     |       | $                            | 17,321     |                            | $          | 16,547 |   |
| Work-in-process  |       | 4,930                        |       | 4,696                           |       |
| Finished goods   |       | 7,754                        |       | 6,778                           |       |
| Inventories, net |       | $                            | 30,005     |                            | $          | 28,021 |   |

 

As of March 30, 2008 and December 30, 2007, thereserve for excess inventory and obsolescence was $3.4 million and $3.1million, respectively, including management’s assessment of reserves forsurplus and obsolescence for non-compliant material related to the Restrictionof Hazardous Substances in Electrical and Electronic Equipment directive.

 

Thefollowing are two European Economic Community (“EEC”) directives that arehaving an effect on the entire electronics industry, including the Company:

 

(1) Restriction of Hazardous Substances inElectrical and Electronic Equipment, more commonly known as RoHS. This Europeandirective bans the use of certain elements that are commonly found incomponents used to manufacture electrical and electronic assemblies. Thisdirective became effective on July 1, 2006. The Company began manufacturingcompliant products in 2006 and continues to work actively with its customers toensure compliance. The Company is focused on consuming all non-compliantmaterial on-hand within a reasonable period. However, the Company may have todispose of non-compliant materials in the future, which could adversely affectthe financial performance of the Company. There is also a risk of finesassociated with non-compliance with the RoHS directive; however, the Company isnot aware of any specific potential fines, and the Company anticipatescomplying with all provisions of this legislation.

 

(2) Waste Electrical and Electronic Equipment, alsoknown as WEEE. This directive became effective August 13, 2005 andrequires manufacturers and importers to properly recycle or dispose of suchequipment at the end of its useful life. The Company believes it has limitedexposure to the WEEE directive because its products are usually installed intoanother user’s system, but this directive may be interpreted and enforceddifferently in the future. If so, the Company may face significant risk offines and costs associated with non-compliance with the existing laws andregulations in the European Union. The Company began manufacturing compliantproducts in 2005, and continues to work actively with its customers to ensurecompliance.

 

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As of March 30, 2008, the Company does notforesee any material estimated capital expenditures for environmentalremediation or related costs to its manufacturing facilities in the future.

 

3.                  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 netchange in deferred tax assets and liabilities during the period.  Avaluation 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 ofDecember 30, 2007, deferred tax assets included $27.8 million relating toa tax basis step up from a re-capitalization transaction in 1999 and $22.8 millionof net operating loss (“NOL”) carry-forwards.  The Company has recorded avaluation allowance against a significant portion of its deferred taxassets.  As of December 30, 2007,deferred taxes included $1.6 million of tax benefits on the balance sheet generatedby our European operations.   CherokeeEurope has a history of profits and, in the opinion of management, it is morelikely than not that the Company will realize the deferred tax assets.

 

The benefit for income taxes for the quarter endedMarch 30, 2008 and the comparable period of April 1, 2007, was $9,000 and $0.6million, respectively.   The benefit for the quarter ended March 30,2008 is lower by $0.6 million than the comparable period of April 1, 2007 dueto a reduction in operating losses that generated the tax benefit. Based onavailable evidence, management expects the benefit to be recognized as adeferred tax asset.

 

The benefit for income taxes for the quarter endedMarch 30, 2008 was calculated using an effective tax rate of negative 1.4% forthe full fiscal year.

 

The Company adopted FIN 48, *Accounting for Uncertainty in Income Taxes*, on January 1, 2007.  As aresult of adoption, the Company recognized a cumulative effect adjustment ofless than $0.1 million to the January 1, 2007 accumulated deficitbalance.  At March 30, 2008, the Company had $0.3 million of grossunrecognized tax benefits, of which $0.3 million would reduce itseffective tax rate if recognized.  The Company’s continuing practice is torecognize interest and/or penalties related to income tax matters in income taxexpense.  As of March 30, 2008, the Company has less than $0.1 million ofaccrued interest and penalties related to uncertain tax positions.

 

The tax years 1997 to 2007 remain open to examinationby the major taxing jurisdictions to which the Company is subject. The Companyis currently under examination in India for certain years between 2000 and 2005and in the United States for the year 2005. The Company is scheduled to begin an audit of 2005 and 2006 in Belgiumduring the quarter ending June 29, 2008. Subsequent to the close of the quarter ended March 30, 2008, the IRScompleted its audit examination and the Company expects the United States taxaudit to be closed in the quarter ending June 29, 2008.  The Company does not believe the amount ofunrecognized tax benefits as of March 30, 2008 will significantly increase ordecrease within the next twelve months.

 

United States income taxes are not provided onundistributed earnings from certain foreign subsidiaries. The Company hasneither plans nor intentions intent to repatriate such undistributed earnings.Those earnings are considered to be permanently re-invested in accordance withthe Accounting Principles Board (APB) Opinion 23.

 

4.                  NET INCOME (LOSS) PER SHARE

 

Inaccordance with SFAS 128, *Earnings PerShare*, basic income (loss) per share is based upon the weightedaverage number of common shares outstanding. For the quarter endedMarch 30, 2008, 2,562,208 shares subject to outstanding stock options wereexcluded from the calculation of diluted income (loss) per share as theirexercise prices would render them anti-dilutive. For the quarter ended April 1,2007, 2,240,154 shares subject to outstanding stock options were excluded fromthe calculation of diluted income (loss) per share as their effect would havebeen anti-dilutive due to the net loss for the quarter.

 

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

 
| ** **                                              | ** ** | **Quarter Ended**       | ** ** |
|---------------------------------------------------------|------------|------------------------------|------------|
| ** **                                              | ** ** | **March 30, 2008** | ** ** | **April 1, 2007** | ** ** |
| Net income (loss)                                       |       | $                            | 12         |   | $ | (2,022 | ) |
| Shares:                                                 |       |                         |       |   |   |
| Weighted-average  common shares outstanding—basic  |       | 19,454                       |       | 19,341 |   |
| Effect of dilutive securities:                          |       |                         |       |   |   |
| Stock options                                           |       | 8                            |       | — |   |
| Weighted-average common shares outstanding—diluted |       | 19,462                       |       | 19,341 |   |
| Net income (loss) per share:                            |       |                         |       |   |   |
| Basic                                                   |       | $                            | —     |   | $ | (0.10 | ) |
| Diluted                                                 |       | $                            | —     |   | $ | (0.10 | ) |

 

5.                  DEFERREDFINANCING COSTS

 

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.

 

Net deferred financing costs are comprised of thefollowing as of March 30, 2008 and December 30, 2007 (in thousands):

 
| ** **                    | ** ** | **March 30, 2008** | ** ** | **December 30, 2007** | ** ** |
|-------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Deferred financing costs      |       | $                            | 909        |                            | $          | 580 |   |
| Accumulated amortization      |       | (526                         | )          | (494                            | )          |
| Deferred financing costs, net |       | $                            | 383        |                            | $          | 86 |   |

 

For the quarter ended March 30, 2008 the Companycapitalized $0.3 million of financing costs related to the refinancing of thesenior notes due to mature on November 1, 2008.

 

6.                  DEBT

 

Debt consists of the following at March 30, 2008 andDecember 30, 2007 (in thousands):

 
| ** **                                             | ** ** | **March 30, 2008** | ** ** | **December 30, 2007** | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| 5.25% senior notes, current portion                    |       | $                            | 24,485     |                            | $          | 24,485 |   |
| 5.25% senior  notes, current portion due to affiliates |       | 22,145                       |       | 22,145                          |       |
| Total debt                                             |       | $                            | 46,630     |                            | $          | 46,630 |   |

 

Thedebt includes the Company’s senior notes, which mature on November 1,2008. Interest on the senior notes is payable in cash on May 1 andNovember 1 of each year. On May 1, 2008, we paid $1.2 million of interestto the bondholders as required. The senior notes are secured by asecond-priority lien on substantially all of the Company’s domestic assets andby a pledge of 65% of the equity of certain of the Company’s foreignsubsidiaries. As of March 30, 2008, the Company was in compliance with allof the covenants set forth in the principal agreements governing the 5.25%senior secured notes due in 2008. The Company does not currently havesufficient funds to repay these notes and is actively working to eitherrefinance this obligation or to satisfy it through a number of strategicalternatives currently being explored. The Company acknowledges that if it doesrefinance the obligation, the interest rate will probably be substantiallyhigher than the current interest rate of 5.25% and any refinancing may be onterms that are materially less favorable. In addition, if the Company is notable to obtain satisfactory financing, the Company may be forced to sell someof its assets or to otherwise significantly alter its operating plan.

 

TheCompany’s primary line of credit is its senior revolving credit facility withGeneral Electric Capital Corporation (the “Credit Facility”). In order toincrease borrowing capacity that has been lowered by the Company’s historicalearnings before interest, taxes, depreciation and amortization expense(“EBITDA”) covenant, the Company approached General Electric 

 

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Capital Corporation aboutre-negotiating the Credit Facility. On November 1, 2007, the Company andGeneral Electric Capital Corporation amended the credit agreement for therevolving line of credit dated February 24, 2004. The amended CreditFacility provides for borrowings of up to the lesser of $7.5 million or85% of eligible domestic accounts receivable. As of March 30, 2008, ourborrowing base was $7.5 million, and our eligible accounts receivable was$7.7 million. The Credit Facility expires in August 2008. Prior toNovember 1, 2007, the borrowings bore interest, at the Company’s option,at a rate per annum equal to LIBOR plus 2.5% or the agent bank’s base rate plus1.0%. Effective November 1, 2007, the borrowings bear interest, at theCompany’s option, at a rate per annum equal to LIBOR plus 3.5% or the agentbank’s base rate plus 2.0%. In addition to paying interest on outstandingprincipal, the Company is required to pay a commitment fee to the lender underthe Credit Facility in respect of the average daily balance of unused loancommitments at a rate of 1.0% per annum effective November 1, 2007. Priorto November 1, 2007 the rate was 0.5% per annum. In lieu of a maximumsenior leverage multiple covenant, the new amended Credit Facility effectiveNovember 1, 2007 includes a minimum EBITDA target for the trailingquarters starting with the fourth quarter of 2007, which the Company was incompliance with at March 30, 2008. Prior to November 1, 2007, theEBITDA covenant limited our borrowing to the lower of the borrowing base or twotimes our EBITDA as defined by the prior credit agreement. The Credit Facilityis secured by a first-priority lien, subject to permitted encumbrances, onsubstantially all of the Company’s domestic assets and by a pledge of 65% ofthe equity of certain of the Company’s foreign subsidiaries. The CreditFacility contains certain restrictive covenants including the minimum EBITDAtarget. In March 2008, General Electric Capital Corporation modified theamended credit agreement effective as of December 30, 2007 for a balancesheet covenant issue resulting from the capitalization of intercompany debtwith our Dutch holding company during 2007. As of March 30, 2008, therewere no borrowings outstanding under the Credit Facility, and the Company wasin compliance with all of the covenants under the Credit Facility.

 

CherokeeEurope maintains a working capital line of credit of approximately$4.8 million, expressed as Euros 3.0 million, with Bank BrusselsLambert, a subsidiary of ING Belgie NV, a bank in Brussels, which isdenominated in Euros, collateralized by a pledge in first and second rank overa specific amount of business assets, requires Cherokee Europe to maintain acertain specific minimum solvency ratio and is cancelable at any time. Ouraccess to the line is limited to $4.2 million because $0.6 million iscommitted to minimum guarantees on specific collections and payments. InNovember 2007, ING Belgie NV restricted the Company from transferringfunds from Europe to the U.S. in the form of management and dividend fees.During the quarter ended September 30, 2007, Cherokee Europe borrowed $2.2 millionfrom the line of credit with an interest rate of 6.02%, subject to change uponquarterly renewals, which remained outstanding as of March 30, 2008.  The interest rate for the second quarter of2008 was renewed at 6.08%.  As ofMarch 30, 2008, Cherokee Europe was in compliance with all covenants. OnApril 28, 2008, Cherokee Europe borrowed $0.8 million, with an interest rate of5.65%, subject to change upon quarterly renewals, from their line of creditwith ING Belgie NV. The outstanding balance on the line of credit as of May 2,2008 was $2.9 million.

 

InJanuary 2007, Cherokee China entered into a loan contract with Industrial andCommercial Bank of China Ltd. (“ICBC”) for a working capital line ofcredit. Pursuant to the contract, ICBC agreed to make advances up to theequivalent of approximately $3.6 million, expressed as RMB 25.0 million.The line of credit is collateralized by the Company’s building in Shanghai,China. In April 2008, Cherokee China renegotiated the borrowing capacity ontheir line of credit with ICBC, from RMB 25 million to RMB 28 million toreflect the increased market value of the building, with the interest rate ofLIBOR plus 12%, which is effective from April 21, 2008 through April 20,2011.  As of May 2, 2008, RMB 28 millionwas equivalent to $4.0 million in US dollars. Interest is payable monthly at afixed rate based on the transaction date of our borrowings, the rates varyaccording to the specific dates and are announced by the People’s Bank ofChina, which was 6.55% at January 29, 2007 and 6.04% at March 20,2007, based on the dates amounts were borrowed. Beginning with its initialborrowing under the contract, Cherokee China agreed to deposit in the ICBCShanghai Branch at least 90% of the operating revenue it collects. The cashfrom these deposits made into our bank account are not restricted from ourusage of these funds. During the quarter ended March 30, 2008, Cherokee Chinapaid the outstanding balance on their line of credit.  As of March 30, 2008, there were noborrowings outstanding under their line of credit, and Cherokee China was incompliance with all of the covenants.

 

 In January 2008, Cherokee Europe borrowedshort-term funds of $0.6 million from ING Belgie NV. The loanarrangement is over twelve months, with monthly payments of $54,000 to berepaid by December 26, 2008. The loan bears a 6.3% interest rate.

 

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7.                  OTHER LONG-TERMOBLIGATIONS

 

Other long-term obligations consist of the followingat March 30, 2008 and December 30, 2007 (in thousands):

 
| ** **                                   | ** ** | **March 30, 2008** | ** ** | **December 30, 2007** | ** ** |
|----------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| 1999 Europe restructuring liabilities        |       | $                            | 337        |                            | $          | 397 |   |
| 2003 Europe restructuring liabilities        |       | 1,082                        |       | 1,064                           |       |
| Long service award liabilities               |       | 974                          |       | 910                             |       |
| Pension liability-SFAS 158                   |       | 1,431                        |       | 1,337                           |       |
| Deferred compensation                        |       | 204                          |       | 237                             |       |
| Advances for research & development |       | 631                          |       | 589                             |       |
| Total other long-term obligations            |       | $                            | 4,659      |                            | $          | 4,534 |   |

 

The Company has agreements with a local governmentagency in Belgium for funding in advances to Cherokee Europe for research anddevelopment expenses. These advances are interest free and expected to be repaidto the agency; either as a percentage of the revenues generated by the productsdeveloped or through a minimum fixed amount on an annual basis.

 

As of March 30, 2008, the Company has a recordedliability of $0.6 million, for employee and non-employee contributions andinvestment activity to date under the deferred compensation plan, the currentportion of $0.4 million is recorded under accrued compensation and benefits andthe long-term portion of $0.2 million is recorded in other long-term liabilities.

 

8.                  CUSTOMERCONCENTRATION

 

For the quarter ended March 30, 2008, one customeraccounted for 11.7% of net sales, and no other customer accounted for more than10% of net sales. For the quarter ended April 1, 2007, no customer accountedfor more than 10% of net sales. A decision by a major customer to decrease theamount purchased from the Company or to cease purchasing the Company’s productscould have a material adverse effect on the Company’s financial position andresults of operations.

 

As of March 30, 2008, one customer accounted for 14.2%of net accounts receivable, and no other customer accounted for more than 10%of net accounts receivable.  As ofDecember 30, 2007, one customer accounted for 10.6% of net accounts receivable.

 

9.                  COMMITMENTS ANDCONTINGENCIES

 

Guarantees and Indemnities

 

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

 

The Company has not incurred significant amountsrelated to these guarantees and indemnifications, and no liability has beenrecorded in the consolidated financial statements for guarantees and indemnificationsas of March 30, 2008 and December 30, 2007.

 

**Cash Incentive Compensation Programand Severance Agreements**

** **

The Company adopted a cash incentive program forcertain executives, which provides for cash incentive payments of up to 123% ofbase salary subject to attainment of corporate goals and objectives approved bythe Company’s board of directors. In addition, the Company has entered intoseverance agreements with certain executives and managers, which providepayments to the executives or managers if they are terminated (i) other thanfor cause or (ii) because of a change in control, as defined in the applicableseverance agreement. Certain of the severance agreements provide additionalbenefits, including acceleration of stock options, in the event of terminationin connection with a change of control, as defined in the applicable severanceagreement.

 

OnFebruary 29, 2008, the Company entered into an amendment to the Company’sexisting severance agreement with each of Jeffrey M. Frank, the Company’sPresident and Chief Executive Officer, Linster W. Fox, the Company’s Executive

 

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Vice President, ChiefFinancial Officer and Secretary, and Mukesh Patel, the Company’s Executive VicePresident of Global Operations. These executives’ severance agreements providefor certain severance payments to be made in the event that the Companyterminates the executive’s employment without cause. The amendments providethat, if severance is triggered under the executive’s severance agreement, theexecutive’s severance benefit will consist of a cash payment equal to two timesthe executive’s current base salary at the time of termination and continuedmedical benefits for up to two years. In the case of Mr. Patel, theamendment further amends his severance agreement to provide that if heterminates his employment with the Company for good reason within one yearfollowing a change in control event, he will be entitled to the severancebenefits described above. The amendments further amend Mr. Frank’s andMr. Fox’s severance agreements to provide that each of them may terminateemployment for any reason within two years following a change in control of theCompany and, in such event, they will be entitled to: a cash payment equal totwo times the executive’s current base salary at the time of termination; aprorata cash payment equal to the executive’s annual bonus at the time oftermination (calculated as if the Company achieved financial performance equalto that set forth in the then-most current budget approved by the Company’sBoard of Directors); immediate vesting of all outstanding stock options;continued medical benefits for up to two years; a cash payment equal to theamount forfeited by the executive under the Company’s 401(k) or similar plan;use of an executive outplacement service in an amount not to exceed $50,000 ora lump-sum cash payment in lieu thereof; and any additional benefits then dueor earned under applicable plans or programs of the Company. The severanceagreements also include certain confidentiality, non-solicitation andinventions covenants in favor of the Company.

 

OnFebruary 29, 2008, the Company also entered into a severance agreementwith Alex Patel, the Company’s Vice President of Engineering. The severanceagreement provides that, in the event Mr. Patel’s employment is terminatedeither by the Company without cause or by Mr. Patel for good reason withinone year following a change in control event, Mr. Patel will be entitledto receive a cash payment equal to one times his then current annual basesalary and continued medical benefits for up to one year. Mr. Patel’sright to receive severance benefits under the severance agreement is subject tohis execution of a release of claims in favor of the Company upon thetermination of his employment. The severance agreement also includes certainconfidentiality, non-solicitation and inventions covenants in favor of theCompany.

 

TransactionBonus Agreements

 

On April 14, 2008,Cherokee International Corporation (the “Company”) entered into transactionbonus agreements with each of Jeffrey M. Frank, the Company’s President andChief Executive Officer, Linster W. Fox, the Company’s Executive VicePresident, Chief Financial Officer and Secretary, and Mukesh Patel, theCompany’s Executive Vice President of Global Operations (each, an“executive”).  The transaction bonus agreements provide that, in the eventof a company sale (defined in the agreements as a sale in one or a series ofrelated transactions of all or substantially all of the Company’s assets, or ofmore than 50% of the issued and outstanding voting equity securities of theCompany other than to the Company or certain major shareholders), the executivewill be entitled to receive a transaction bonus, provided that the executive iseither employed by the Company at the time of the company sale, the Companyterminates the executive’s employment without cause (as defined in theagreements) within six months prior to the company sale, or the executiveterminates his employment for good reason (as defined in the agreements) withinsix months prior to the company sale.  If the executive terminates hisemployment with the Company voluntarily or is terminated by the Company forcause prior to the company sale, the executive is not eligible for a bonusunder the transaction bonus agreement.  Further, the executive mustexecute a general release of claims in favor of the Company following thecompany sale in order to receive his transaction bonus.

 

The amount of thetransaction bonus that each executive is eligible for pursuant to his agreementvaries and is tied to the net proceeds from the company sale.  The maximumamount of the transaction bonus for each of Messrs. Frank, Fox and Patelare $5 million, $3 million and $450,000, respectively, based on a net salesprice of $10.00 per share.  The agreements also contain a non-solicitationcovenant in favor of the Company.

 

SynQor

 

OnNovember 16, 2007, SynQor announced that it had filed a lawsuit againstseveral of its competitors, including Cherokee International Corporation whowas named in the complaint, for infringement of two patents relating to busconverters and/or non-isolated point of load converters used in intermediatebus architectures. The patents at issue are U.S. patents 7,072,190 and7,272,021. The suit was filed in Federal Court in the Eastern District ofTexas. The Company intends to vigorously defend this lawsuit. Although theultimate aggregate amount of monetary liability or financial impact withrespect to this lawsuit is subject to many uncertainties and is therefore notpredictable with assurance, the final outcome of this lawsuit, if adverse,could have a material adverse effect on our financial position, results ofoperations or cash flows.

 

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10.            RESTRUCTURINGCOSTS AND ASSET IMPAIRMENT CHARGES FOR CLOSURE OF GUADALAJARA, MEXICO FACILITY

 

Duringthe quarter ended October 1, 2006, the Company announced the plannedclosure of its Mexican facilities and a related restructuring plan, which wasaccounted for in accordance with SFAS 146, *Accounting for Costs Associated with Exit or Disposal Activities*.The Mexico Facility encompassed 35,000 square feet in one building and had beenin operation since 1988, employing approximately 250 full-time and temporaryemployees in the production of power supplies.

 

Therestructuring and closure of our Mexico Facility was completed by the end ofthe second quarter of 2007. The cumulative costs for the closure of the MexicoFacility were $1.5 million ($1.3 million of which were recorded in2006). This was made up of $0.9 million restructuring, $0.3 millionasset impairment and $0.3 million additional excess and obsolescence reserve.During the third quarter ended July 1, 2007, there was a reversal of$38,000 to severance costs due to the transfer and relocation of an employeefrom the Mexico Facility to our Tustin Facility. The remaining accrued balancefor severance and stay bonuses was paid on July 1, 2007 to the remainingemployees.

 

*Assets held for sale—Mexico Facilitybuilding sold*

* *

TheCompany began actively searching for a buyer for the Mexico Facility buildingduring the quarter ended October 1, 2006; however, in accordance withSFAS 144, *Accounting for the Impairmentor Disposal of Long-Lived Assets*, the related assets were notclassified as assets held for sale in the condensed consolidated balance sheetsprior to April 1, 2007, because the Company did not meet the criterionthat “the asset (disposal group) is available for immediate sale in its presentcondition subject only to terms that are usual and customary for sales of suchassets”, due to our continued utilization of assets in our ongoing operationsat our Mexico Facility.

 

TheCompany ceased operations in Mexico in March 2007, and reclassified the netbook value of $0.7 million for the building and the related assets to *assets held for sale* on the condensedconsolidated balance sheet as of April 1, 2007, in accordance withSFAS 144. In addition, depreciation of the assets related to this sale wassuspended as of April 1, 2007. There was no impairment charge to therelated assets because management determined that the measurement value, thenet book value, was lower than the estimated fair value less cost to sell.

 

OnFebruary 22, 2007, Cherokee Electronica, S.A. de C.V. (“CherokeeMexico”), a subsidiary of Cherokee International Corporation, a Delawarecorporation (the “Company”), entered into a Purchase and Sale Agreement (the“Agreement”) with Inmobiliaria Hondarribia, S.A. de C.V. (the “Buyer”) forthe sale of Cherokee Mexico’s 35,000-foot manufacturing facility inGuadalajara, Mexico. The Agreement provided that the Buyer pay Cherokee Mexicoan aggregate purchase price of approximately US $1.2 million of which a15% deposit, approximately US $182,000, was paid on February 22, 2007. OnMay 24, 2007, the sale of the building was completed, and the remaining85% of the sales price was transferred into the Company’s bank account. TheCompany also collected the value added tax on the building in addition to thesales price and paid the taxes collected to the Mexican government in June2007. The net gain of the sale recorded during the quarter ended July 1,2007, was $0.4 million, net of $0.1 million related to the cost tosell the assets which was deducted from the gain.

 

*Sale of Mexico Corporation*

 

OnDecember 12, 2007, Cherokee International Corporation sold the CherokeeElectronica, S.A. de C.V. corporation and capital stock. The Company receivedthe proceeds from the sale on December 13, 2007. The net gain of the salewas $0.4 million.

 

*Asset Impairment Charges related toOther Assets*

* *

Duringthe quarter ended October 1, 2006, the Company performed an impairmentreview in accordance with SFAS 144, *Accountingfor the Impairment and Disposal of Long-Lived Assets,* to determinewhether any of its long-lived assets located at the Mexico Facility wereimpaired. The Company identified certain long-lived assets associated with therestructuring and closure of the Mexico Facility whose carrying value would notbe recoverable from future cash flows and recorded an impairment charge of$0.3 million for these assets. These assets consisted of machinery andequipment, computer technology and equipment, and office furniture andequipment. The majority of these assets were written off because the Companyconsidered them to have no market value. None of the impairment chargesincluded cash components.

 

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*Restructuring Costs*

* *

Inaccordance with SFAS 146, employee severance, contract termination andother exit costs are recorded at their estimated fair value when they areincurred. During the quarter ended July 1, 2007, there was a reversal of$38,000 to severance costs due to the transfer and relocation of an employeefrom the Mexico Facility to our Tustin Facility.

 

Therewere $0.2 million of employee severance and stay bonus costs during thefirst six months of 2007, which included a pro-rata portion from August 10,2006, the communication date, through July 1, 2007, of an estimated amountof statutorily required severance payments and management performance stay-onbonuses incurred for employees at the Mexico Facility. The Company paid$0.6 million of severance and related expenses to the remainder ofemployees terminated during the quarter ended July 1, 2007. All severancecharges were settled with cash as of July 1, 2007.

 

11.            STOCK ANDDEFERRED COMPENSATION PLANS

 

2002 Stock Option Plan

 

InJuly 2003, the Company adopted the Cherokee International Corporation 2002Stock Option Plan (the “2002 Stock Option Plan”) under which up to 1,410,256shares of the Company’s common stock may be issued pursuant to the grant ofnon-qualified stock options to the directors, officers, employees, consultantsand advisors of the Company and its subsidiaries. In connection with theadoption of the 2002 Stock Option Plan, the Company granted 1,087,327 stockoptions. The options typically vest over a four-year period, have a ten-year contractuallife, range in exercise price from $5.85 to $10.34 per share and were grantedwith exercise prices at or above fair value as determined by Cherokee’s Boardof Directors based on income and market valuation methodologies. In February2004, the Company granted options to purchase 328,320 shares of common stock atan exercise price of $14.50 and terminated the 2002 Stock Option Plan. As ofMarch 30, 2008, the Company had granted a total of 1,415,647 options topurchase shares of common stock under the 2002 Stock Option Plan, whichincludes options to purchase shares that were cancelled and subsequentlyre-granted.

 

2004 Omnibus Stock IncentivePlan

 

On February 16, 2004, the Company adopted the2004 Omnibus Stock Incentive Plan (the “2004 Plan”), which provided for theissuance of 800,000 shares of common stock. The 2004 Plan also provides for anannual increase to be added on the first day of the Company’s fiscal year equalto the lesser of (i) 450,000 shares or (ii) 2% of the number of outstandingshares on the last day of the immediately preceding fiscal year. As ofMarch 30, 2008, a total of 3,315,141 shares of the Company’s common stockwere reserved for issuance under the 2004 Plan. Any officer, director,employee, consultant or advisor of the Company is eligible to participate inthe 2004 Plan. The 2004 Plan provides for the issuance of stock-based incentiveawards, including stock options, stock appreciation rights, restricted stock,deferred stock, and performance shares. As of March 30, 2008, the Companyhad granted options to purchase 2,329,489 shares of common stock under the 2004Plan, which included 308,153 options issued as partial compensation tonon-employee directors. During the quarter ended March 30, 2008, theCompany did not grant any options to purchase.

 

2004 Employee Stock PurchasePlan

 

OnFebruary 16, 2004, the Company adopted the 2004 Employee Stock PurchasePlan (the “ESPP”). The ESPP provides for an annual increase to be added on thefirst day of the Company’s fiscal year 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. As of March 30, 2008, a total of936,555 shares of common stock were reserved for issuance under the plan. The ESPP,which is intended to qualify as an “employee stock purchase plan” underSection 423 of the Internal Revenue Code of 1986, is implemented utilizingsix-month offerings with purchases occurring at six-month intervals, with a newoffering period commencing on the first trading day on or after May 15 andNovember 15 and ending on the last trading day on or beforeNovember 14 or May 14, respectively. The Compensation Committee ofthe Company’s Board of Directors oversees administration of the ESPP. Employeesare eligible to participate if they are employed for at least 20 hours perweek and more than 5 months in a calendar year by the Company, subject tocertain restrictions. The ESPP permits eligible employees to purchase commonstock through payroll deductions, which may not exceed 15% of an employee’scompensation. The price of common stock purchased under the ESPP is 85% of thelower of the fair market value of the common stock at the beginning of eachsix-month offering period or on the applicable purchase date. Employees may endtheir participation in an offering at any time during the offering period, andparticipation ends automatically upon termination of employment. TheCompensation Committee may at any time amend or terminate the ESPP, except thatno such amendment or termination may adversely 

 

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affect shares previouslyissued under the ESPP. As of March 30, 2008, 236,016 shares of commonstock had been issued under the ESPP.

 

Deferred Compensation Plan

 

OnFebruary 16, 2004, the Company adopted two executive deferred compensationplans for the benefit of certain designated employees and non-employeedirectors of the Company. The plans were amended on January 1, 2008 tocomply with the regulations for nonqualified deferred compensation arrangementsunder Internal Revenue Code (IRC) Section 409A. 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 credit, if any, vests in full no later than after 3 years.

 

As ofMarch 30, 2008, the Company has a recorded liability of $0.6 millionfor employee and non-employee director contributions and investment activity todate; the current portion of $0.4 million is recorded under accruedcompensation and benefits and the long-term portion of $0.2 million isrecorded in other long-term liabilities. As of December 30, 2007, theCompany had a recorded liability of $1.4 million, of which $1.1 millionwas recorded under accrued compensation and benefits and the long-term portionof $0.2 million was recorded in other long-term liabilities. The Companyhas not provided any matching contributions under the plans.

 

Duringthe quarter ended March 30, 2008, we paid $0.6 million of scheduleddistributions to participants from the deferred compensation plan.  The Company also made partial surrenders ontwo of our policies during the quarter in the amount of $0.4 million.  The partial surrenders did not change theface amount of the policies.

 

12.            RETIREMENT PLANS

 

Cherokee Europe maintains a pension plan for certainlevels of staff and management that include a defined benefit feature. Thefollowing represents the amounts related to this defined benefit plan for thequarter ended March 30, 2008 and April 1, 2007, respectively  (in thousands):

 
| ** **                                                       | ** ** | **Three Months Ended** | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| **Components  of Net Periodic Benefit Cost** | ** ** | **March 30, 2008**     | ** ** | **April 1, 2007**      | ** ** |
| Service cost                                                     |       | $                                | 73         |                             | $          | 88 |   |
| Interest cost                                                    |       | 110                              |       | 103                              |       |
| Expected return on plan assets                                   |       | (69                              | )          | (57                              | )          |
| Net periodic benefit cost                                        |       | $                                | 114        |                             | $          | 134 |   |

 

13.            SUBSEQUENT EVENTS

 

TransactionBonus Agreements

 

On April 14, 2008,the Company entered into transaction bonus agreements with each of Jeffrey M.Frank, the Company’s President and Chief Executive Officer, Linster W. Fox, theCompany’s Executive Vice President, Chief Financial Officer and Secretary, andMukesh Patel, the Company’s Executive Vice President of Global Operations asdescribed above in the subsection entitled “Commitments and Contingencies”contained in Note 9 to the accompanying Notes to the CondensedConsolidated Financial Statements included in Item 1, “FinancialStatements.”

 

Increase in CherokeeChina’s Line of Credit

 

In April 2008, CherokeeChina renegotiated the borrowing capacity on its line of credit with CommercialBank of China Ltd., from RMB 25 million to RMB 28 million to reflect theincreased market value of the building, with the interest rate of LIBOR plus12%, which is effective from April 21, 2008 through April 20, 2011.  As of May 2, 2008, RMB 28 million wasequivalent to $4.0 million in US dollars.

 

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Item 2.   MANAGEMENT’S DISCUSSSION ANDANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

FORWARD-LOOKING STATEMENTS

 

Certainstatements in this Quarterly Report on Form 10-Q, 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 are basedupon our current expectations about future events. When used in this QuarterlyReport, the words “believes,” “projects,” “expects,” “anticipates,”“estimates,” “intends,” “strategy,” “plan,” “may,” “will,” “would,” “will be,”“will continue,” “will likely result,” and similar expressions, or the negativeof such words and expressions, are intended to identify forward-lookingstatements, although not all forward-looking statements contain such words orexpressions. These forward-looking statements generally relate to our plans,objectives and expectations for future operations and include statements inthis Quarterly Report regarding the following: our expectations that cash flowswill be sufficient to meeting our operating requirements for at least the nexttwelve months; our expectations regarding our working capital and capitalexpenditure requirements; and our expectations regarding the refinancing orpayment of our senior bond obligations. However, these statements are subjectto a number of risks and uncertainties affecting our business. You should readthis Quarterly Report completely and with the understanding that actual futureresults may be materially different from what we expect as a result of theserisks and uncertainties and other factors, which include, but are not limitedto: (1) the potential delisting of the Company’s common stock from theNASDAQ Global Market, (2) changes in general economic and businessconditions, domestically and internationally, (3) reductions in sales to,or the loss of, any of the Company’s significant customers or in customercapacity generally, (4) changes in the Company’s sales mix to lower marginproducts, (5) increased competition in the Company’s industry, (6) disruptionsof the Company’s established supply channels, (7) the Company’s level ofdebt and restrictions imposed by its debt agreements, and (8) theadditional risk factors in our filings with the Securities and ExchangeCommission, including our Annual Report on Form 10-K (Commission FileNo. 000-50593). Except as required by law, the Company undertakes noobligation to update any forward-looking statements, even though the Company’ssituation may change in the future.

 

INTRODUCTION

 

Thefollowing discussion should be read in conjunction with the unaudited condensedconsolidated financial statement and notes of Cherokee InternationalCorporation included above in this Quarterly Report on Form 10-Q and with theaudited financial statements, footnotes and Management Discussion and Analysisof Financial Condition and Results of Operations included in the Company’sAnnual Report on Form 10-K.

 

OVERVIEW

 

Business

 

Weare a designer and manufacturer of power supplies for OEMs. Our advancedpower supply products are typically custom designed into mid- to high-endcommercial applications in the computing and storage, wireless infrastructure,enterprise networking, telecom, medical and industrial markets.

 

Weoperate worldwide and have facilities in Orange County, California; Bombay, India;Wavre, Belgium (Europe) and Shanghai, China. In March 2007, we closed ourfacility in Guadalajara, Mexico. In May 2007, we sold our manufacturingfacility in Guadalajara, Mexico and on December 12, 2007, we sold oursubsidiary, Cherokee Electronica, S.A. de C.V. We were founded in 1978 inOrange County, California. As we expanded our business and customer base, weopened facilities in Bombay, India, Guadalajara, Mexico, and Shanghai, China.In June 2000, we acquired Cherokee Europe, which added a manufacturing facilityin Wavre, Belgium to our manufacturing capacity and enabled us to better servethe European market.

 

Wegenerate the majority of our sales in four market sectors, datacom, telecom,industrial and medical. For the quarter ended March 30, 2008, our revenuesby market sector consisted of 38% datacom, 36% telecom, and 26% for theindustrial and medical sectors.

 

Basis of Reporting

 

**Principlesof Consolidation**

** **

Thecondensed consolidated financial statements include the financial statements ofthe Company and its wholly owned subsidiaries, Cherokee Europe SCA and relatedentities (“Cherokee Europe”), Cherokee India Pvt. Ltd. (“Cherokee India”),Powertel India Pvt. Ltd. (“Powertel”), and Cherokee International (China)Power Supply LLC (“Cherokee China”), and the

 

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financial statements ofits formerly owned subsidiary Cherokee Electronica, S.A. DE C.V.(“Cherokee Mexico”) were included in the year ended December 30, 2007.Inter-company accounts and transactions have been eliminated.

 

Net Sales

 

Werecognize revenue when persuasive evidence of an arrangement exists, titletransfer has occurred, the price is fixed or readily determinable, andcollectability is probable. We recognize revenue in accordance with StaffAccounting Bulletin No. 104, *RevenueRecognition.* Sales are recorded net of discounts, which areestimated at the time of shipment based upon historical data. Changes inassumptions regarding the rate of sales discounts earned by our customers couldimpact our results.

 

Wegenerally recognize revenue at the time of shipment because this is the pointat which revenue is earned and realizable and the earnings process is complete.For most shipments, title to shipped goods transfers at the shipping point, sothe risks and rewards of ownership transfer once the product leaves ourfacility or third-party hub. Revenue is only recognized when collectability isreasonably assured. Shipping and handling fees are included in revenue, withrelated costs recorded to cost of sales.

 

Cost of Sales

 

The principal elements comprising cost of sales areraw materials, labor and manufacturing overhead. Raw materials account for alarge majority of our costs of sales. Raw materials include magneticsub-assemblies, sheet metal, electronic and other components, mechanical partsand electrical wires. Direct labor costs primarily include costs of hourlyemployees. Manufacturing overhead includes salaries, and the direct expense andallocation of costs attributable to manufacturing for lease costs, depreciationon property, plant and equipment, utilities, property taxes and repairs andmaintenance.

 

Operating Expenses

 

Operatingexpenses include engineering costs, selling and marketing costs and general andadministrative expenses. Engineering costs primarily include salaries andbenefits of engineering personnel, safety approval and quality certificationfees, and depreciation on equipment and consulting and professional services.Selling and marketing expenses primarily include salaries and benefits toaccount managers and commissions to independent sales representatives.Administrative expenses primarily include salaries and benefits for certainmanagement and administrative personnel, professional fees and informationsystem costs. Operating expenses also include the direct expense and allocationof costs attributable to these departments for lease costs, depreciation onproperty, plant and equipment, utilities, property taxes and repairs andmaintenance.

 

Critical Accounting Policies

 

Weprepare our condensed consolidated financial statements in conformity withaccounting principles generally accepted in the United States. As such, we arerequired to make certain estimates, judgments and assumptions that we believeare reasonable based upon the information currently available. These estimatesand assumptions affect the reported amounts of assets and liabilities at thedate of the condensed consolidated financial statements and the reportedamounts of revenues and expenses during the periods presented. Any futurechanges to these estimates and assumptions could have a material effect on ourreported amounts of revenue, expenses, assets and liabilities. The significantaccounting policies that we believe are the most critical to aid in fullyunderstanding and evaluating our reported financial results include thefollowing:

 

RevenueRecognition

 

Werecognize revenue when persuasive evidence of an arrangement exists, titletransfer has occurred, the price is fixed or readily determinable, andcollectability is probable. We recognize revenue in accordance with StaffAccounting Bulletin No. 104, RevenueRecognition. Sales are recorded net of discounts, which are estimated atthe time of shipment based upon historical data. Changes in assumptionsregarding the rate of sales discounts earned by our customers could impact ourresults.

 

Wegenerally recognize revenue at the time of shipment because this is the pointat which revenue is earned and realizable and the earnings process is complete.For most shipments, title to shipped goods transfers at the shipping point, sothe risks and rewards of ownership transfer once the product leaves ourfacility or third-party hub. Revenue is only

 

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recognized whencollectability is reasonably assured. Shipping and handling fees are includedin revenue with related costs recorded to cost of sales.

 

TheCompany has entered into arrangements with certain customers whereby productsare delivered to a third-party warehouse location for interim storage untilsubsequently shipped and accepted by our customers. Revenues from these salesare recognized upon shipment from the third-party warehouse location to thecustomers, when title has passed. The Company generally offers a one-yearwarranty for defective products. Warranty charges have been insignificantduring the periods presented.

 

Accounts Receivable

 

In our North American and European operations weperform ongoing credit evaluations of our customers, the customer’s currentcredit worthiness and various other factors, as determined by our review oftheir current credit information. We continuously monitor collections andpayments from our customers and maintain a provision for estimated credit lossesbased upon our historical experience and any specific customer collectionissues that we have identified. While credit losses have historically beenwithin our expectations and the provisions established, we might not continueto experience the same credit loss rates that we have in the past. Asignificant portion of our accounts receivable are concentrated in a smallnumber of customers. A significant change in the liquidity or financialposition of any one of these customers could have a material adverse effect onthe collectability of our accounts receivable, our liquidity and our futureoperating results.  As of March 30, 2008and December 30, 2007, our top ten customers accounted for approximately41% and 50% of our accounts receivables, respectively.

 

**Credit Risk**

** **

TheCompany performs ongoing credit evaluations of its customers and generally doesnot require collateral. The Company maintains reserves for estimated creditlosses. The Company generally does not charge interest on customer balances.

 

**Translationof Foreign Currencies**

** **

Foreignsubsidiary assets and liabilities denominated in foreign currencies aretranslated at the exchange rate in effect on the balance sheet date. Revenues,costs and expenses are translated at the average exchange rate during theperiod. Transaction gains and losses are included in results of operations andhave not been significant for the periods presented. The functional currency ofCherokee Europe is the Euro. The functional currency of Cherokee India,Powertel and Cherokee China is the U.S. dollar, as the majority of transactionsare denominated in U.S. dollars. Translation adjustments related to CherokeeEurope are reflected as a component of stockholders’ equity in othercomprehensive income (loss).

 

Inventories

 

We valueour inventory at the lower of the actual cost to purchase and/or manufacturethe inventory and the current estimated market value of the inventory using theweighted average cost method. We regularly review inventory quantities on handand record a provision for excess and obsolete inventory based primarily on ourhistorical usage data and estimates of future demand. Since substantially allof our products are manufactured according to firm purchase orders and customerforecasts, we evaluate the potential of recovery from our customers whencustomized products approach end-of-life. Our customers are generally liablefor inventory costs we incur for order cancellations that occur after we havecommitted resources to procure or manufacture product. We also regularlyevaluate inventory that is non-compliant with the EEC’s RoHS directiveregarding hazardous substances in electric and electronic equipment, todetermine if additional reserves are needed to cover for potentialobsolescence. We have not established a separate reserve for non-RoHS compliantinventory above what our normal calculations would require.

 

Ourindustry is characterized by rapid technological change, frequent new productdevelopment, and rapid product obsolescence that could result in an increase inthe amount of obsolete inventory quantities on hand. As demonstrated during thepast five years, demand for our products can fluctuate significantly. Asignificant increase in the demand for our products could result in ashort-term increase in the cost of inventory purchases while a significantdecrease in demand could result in an increase in the amount of excessinventory quantities on hand. In addition, our estimates of future productdemand may prove to be inaccurate, in which case we may have understated oroverstated the provision required for excess and obsolete inventory. In thefuture, if our inventory were determined to be overvalued, we would be requiredto recognize additional

 

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expense in our cost ofsales at the time of such determination. Likewise, if our inventory isdetermined to be undervalued, we may have over reported our costs of sales inprevious periods and would be required to recognize additional operating incomeat the time such inventory is sold. 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 tax assets and liabilities basedon the differences between the financial statement carrying values and the taxbases of assets and liabilities. We regularly review our deferred tax assetsfor recoverability and establish a valuation allowance based on historicaltaxable income, projected future taxable income, and the expected timing of thereversals of existing temporary differences. If our future taxable income is significantly higher than expectedand/or we are able to utilize our tax credits, we may be required to reverseall or a significant part of our valuation allowance against such deferred taxassets which 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.  As of December 30, 2007, deferred taxesincluded $1.6 million of tax benefits on the balance sheet generated by ourEuropean operations.   Cherokee Europehas a history of profits and in the opinion of management, it is more likelythan not the deferred tax assets will be realized therefore a valuationallowance is not required with respect to these deferred tax assets.  Recovery is dependent on achieving ourforecast of future operating income over a protracted period of time.  The Company reviews the forecast in relationto actual results and expected trends on an ongoing basis.  Failure to achieve our operating incometargets may change the Company’s assessment regarding the recoverability of itsnet deferred tax assets and such change could result in a valuation allowancebeing recorded against some or all of the deferred tax assets.  Any increase in valuation allowance wouldresult in additional tax expense and could have a significant impact on theCompany’s earnings in future periods.

 

The preparation of condensed consolidated financialstatements in conformity with generally accepted accounting principles in theUnited States requires us to make estimates and assumptions that affect thereported amount of tax-related assets and liabilities and income tax provisions.The Company’s effective tax rate may be subject to fluctuations during thefiscal year as new information is obtained which may affect the assumptionsmanagement uses to estimate the annual effective tax rate including mix ofpre-tax earnings in the various tax jurisdictions in which it operates.

 

The Company adopted the provisions of FASBInterpretation (FIN) 48, *Accounting forUncertainty in Income Taxes* on January 1, 2007. FIN 48clarifies the accounting for uncertainty in income taxes recognized in anenterprise’s financial statements in accordance with SFAS 109, *Accounting for Income Taxes*, byprescribing a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. Under FIN 48, the financial statement effects of a taxposition should initially be recognized when it is more likely than not, basedon the technical merits, that the position will be sustained upon examination.A tax position that meets the more-likely-than-not recognition threshold shouldinitially and subsequently be measured as the largest amount of tax benefitthat has a greater than fifty percent likelihood of being realized uponultimate settlement with a taxing authority. FIN 48 is effective for fiscalyears beginning after December 15, 2006. See Note 3, “Income Taxes” inNotes to Condensed Consolidated Financials Statements.

 

United States income taxes are not provided onundistributed earnings from certain foreign subsidiaries. The Company hasneither plans nor intentions to repatriate such undistributed earnings. Thoseearnings are considered to be permanently re-invested in accordance with theAccounting Principles Board (APB) Opinion 23.

 

**Other Comprehensive Income**

** **

Belgium taxes for unrealized foreign exchange gains onan intercompany loan considered permanently re-invested are provided for as acomponent of other comprehensive income.

 

Goodwill and Long LivedAssets

 

Wereview the recoverability of the carrying value of goodwill on an annual basisor more frequently when an event occurs or circumstances change to indicatethat an impairment of goodwill has possibly occurred. The determination ofwhether any potential impairment of goodwill exists is based upon a comparisonof the estimated fair value of the reporting unit to the accounting value ofits net assets.

 

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Wealso review the recoverability of the carrying value of long-lived assetswhenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Recoverability of these assets isdetermined based upon the forecasted undiscounted future net cash flows fromthe operations to which the assets relate, utilizing management’s bestestimates, based on appropriate assumptions and current projections.

 

Theseprojected future cash flows may vary significantly over time as a result ofincreased competition, changes in technology, fluctuations in demand,consolidation of our customers and reductions in average selling prices. If thecarrying value is determined not to be recoverable from future operating cashflows, the asset would be deemed impaired and an impairment loss would berecognized on the date of determination to the extent the carrying valueexceeded the estimated fair market value of the asset.

 

Basedon our annual assessment of the fair value of our Cherokee Europe subsidiary inaccordance with SFAS 142, we recorded a goodwill impairment charge of$5.2 million during the year ended December 30, 2007, to properlyreport goodwill at its fair value.

 

**Stock-BasedCompensation**

** **

TheCompany adopted SFAS 123R on January 2, 2006 using the “modifiedprospective” method as permitted by SFAS 123R. Under this transitionmethod, stock compensation cost recognized beginning in the first quarter offiscal year 2006 includes: (a) compensation cost for all share-basedpayments granted subsequent to February 25, 2004 and prior toJanuary 2, 2006 but not yet vested as of January 2, 2006, based onthe grant-date fair value estimated in accordance with the provisions ofSFAS 123R, and (b) compensation cost for all share-based paymentsgranted subsequent to January 1, 2006, based on the grant-date fair valueestimated in accordance with the provisions of SFAS 123R. In accordancewith the modified prospective method of adoption, the Company’s results ofoperations and financial position for prior periods have not been restated. Atthe date of the adoption, the unamortized expense for options issued prior toJanuary 2, 2006 was $2.3 million, which will be amortized as stockcompensation costs through December 2010. All grants are made at prices basedon the fair market value of the stock on the date of grant. Outstanding optionsgenerally vest four years from the grant date, with certain limited exceptions,and expire up to ten years after the grant date.

 

The Company records compensation expense for employeestock options based on the estimated fair value of the options on the date ofgrant using the Black-Scholes option pricing formula with the assumptionsincluded in the table under “Stock-Based Compensation” in Note 3 to theaccompanying Condensed Consolidated Financial Statements.  The Company uses historical data, among otherfactors, to estimate the expected price volatility and the expected forfeiturerate. For options granted prior to January 2, 2006, the Company used theexpected option life of 5 years. For options granted following theCompany’s adoption of SFAS 123R, the expected life was increased to6.25 years using the “simplified method” under SAB 107 (an expectedterm based on the mid-point between the vesting date and the end of thecontractual term). The options have a maximum contractual term of 10 yearsand generally vest as to 25% of the underlying stock on each anniversary of thedate of grant, subject to accelerated vesting in the event of a change incontrol of the Company. The risk-free rate is based on the U.S. Treasury yieldcurve in effect at the time of grant for the estimated life of the option.

 

**RESULTSOF OPERATIONS FOR THE QUARTER ENDED MARCH 30, 2008 COMPARED TO THE QUARTERENDED APRIL 1, 2007**

** **

NETSALES

 

Net sales increased by approximately 15.7%, or $4.7million, to $34.7 million for the quarter ended March 30, 2008 from $30.0million for the quarter ended April 1, 2007. During the quarter endedMarch 30, 2008, net telecom sales were higher by $3.2 million, primarilydriven by one large triple play customer, datacom net sales were higher by $0.5million, industrial, medical and other net sales were higher by $1.0 millionfrom the prior period. Overall, our markets were higher for the quarter endedMarch 30, 2008 compared to the quarter ended April 1, 2007. Included in theabove increases is a $1.7 million benefit related to the foreign currencyexchange rate fluctuations from our Cherokee Europe operation.

 

GROSS PROFIT

 

Gross profit increased by approximately 51.1%, or $2.9million, to $8.6 million for the quarter ended March 30, 2008 from $5.7 millionfor the quarter ended April 1, 2007. Gross margin for the quarter endedMarch 30, 2008 increased to 24.9% from 19.0% in the prior year period.  Gross profit was higher during the quarterended March 30, 2008 due primarily to

 

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higher net sales and overall lower material costs.Lower material costs were the result of the increased sourcing from China, theintroduction of new models and a better overall mix of products.

 

For the quarter ended March 30, 2008, theincrease in gross profit included $0.3 million of foreign currency exchangerate fluctuations related to our Cherokee Europe operation.

 

OPERATING EXPENSES

 

Operating expenses for the quarter ended March 30,2008 increased approximately 3.5%, or $0.3 million, to $8.1 million from $7.8million for the quarter ended April 1, 2007. As a percentage of net sales,operating expenses decreased to 23.3% from 26.1% in the prior year period. Theincrease in operating expenses in 2008 from 2007 are as follows:

 

Engineering and development costs increased by $0.1million due to foreign currency exchange rate fluctuations from our CherokeeEurope operation.

 

Selling and marketing expense decreased by $0.1million, of which $0.1 million was related to lower payroll costs and $0.1million was related to lower commissions, offset by a $0.1 million increase inforeign currency exchange rate fluctuations related to our Cherokee Europeoperation.

 

General and administrative expenses for the quarterended March 30, 2008 increased by $0.5 million compared to the quarter endedApril 1, 2007, due to increases of $0.4 million in audit, tax, legal andprofessional expenses and $0.1 million in foreign currency exchange ratefluctuations related to our Cherokee Europe operation. In relation to the $0.4million of higher audit, legal and professional fees; $0.1 million was relatedto professional fees for the engagement of an investment banker to assist theCompany in exploring strategic alternatives in resolving our senior notes debt,$0.1 million of legal and professional fees to support and complete an IRSaudit and our defense in the SynQor litigation, and an increase of $0.2 millionof audit and tax fees incurred during the quarter related to our 2007 fiscalyear-end compared to the prior period. For the quarter ended April 1, 2007, the 2006 fiscal year-end audit wasnot completed until the second quarter of 2007; therefore, audit fees were lessin the first quarter of 2007 and higher in the second quarter of 2007.  There will be no audit fees related to 2007fiscal year-end in the second quarter of 2008.

 

During the quarter ended April 1, 2007, the Companyincurred $0.2 million of severance and facility closure costs related tothe closure of its Mexico Facility, no such costs were incurred during thequarter ended March 30, 2008.

 

OPERATING INCOME (LOSS)

 

As a result of the factors discussed above, operatingincome increased by $2.7 million to $0.5 million for the quarter ended March30, 2008, compared to a loss of $2.1 million for the quarter ended April 1,2007. Operating margin increased to 1.5% income from a 7.1% loss in the prioryear period.

 

INTEREST EXPENSE

 

Interest expense for both quarters ended March 30,2008 and April 1, 2007 was $0.7 million. The interest expense is primarily related to interest payments for the$46.6 million of senior notes bearing interest at 5.25% annually.

 

INCOME TAXES

 

The income taxes benefit during the quarter endedMarch 30, 2008 and the comparable period of April 1, 2007, was $9,000 and $0.6million, respectively.   The benefit for the quarter ended March 30,2008 is lower by $0.6 million than the comparable period of April 1, 2007 dueto a reduction in operating losses that generated the tax benefit. Based onavailable evidence, management expects the benefit to be recognized as adeferred tax asset.

 

The benefit for income taxes for the quarter endedMarch 30, 2008 was calculated using a negative effective tax rate of 1.4% forthe full fiscal year.

 

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NET INCOME (LOSS)

 

As a result of the factors discussed above, werecorded net income of less than $0.1 million for the quarter ended March 30,2008, compared to a $2.0 million net loss for the quarter ended April 1,2007.

 

LIQUIDITY AND CAPITALRESOURCES

 

CASH FLOWS

 

**FOR THE QUARTER ENDED MARCH 30, 2008 COMPAREDTO THE QUARTER ENDED APRIL 1, 2007**

** **

Net cash provided byoperating activities for the quarter ended March 30, 2008, was $4.8 millioncompared to net cash provided by operating activities of $1.3 million for thequarter ended April 1, 2007.

 

Net cash provided byoperating activities for the quarter ended March 30, 2008 reflected netincome of less than $0.1 million, $0.7 million in depreciation andamortization, $0.3 million of stock-based compensation related toSFAS 123R, a $4.6 million decrease in accounts receivable, a $0.4 milliondecrease in deposits and other assets, a $0.1 million increase in accountspayable, a $0.7 million increase in accrued compensation and benefits and a$0.6 million increase in interest payable. This was offset by $1.3 million increase in inventories, $0.4 millionincrease in prepaid expenses and other current assets, a $0.8 million decreasein accrued liabilities and restructuring costs, and a $0.2 million decrease inother long-term obligations.

 

Net cash provided byoperating activities for the quarter ended April 1, 2007 reflected a net lossof ($2.0) million which was primarily a result of our lower revenue, a $2.3million increase in inventory, a $1.0 million decrease in accounts payable anda $1.1 million decrease in accrued liabilities and restructuring.  This was offset by $0.9 million indepreciation and amortization, $0.2 million of stock-based compensation relatedto SFAS 123R, a $4.7 million decrease in accounts receivable, a $1.1 millionincrease in accrued compensation, a $0.6 million increase in accrued interestpayable and a $0.3 million increase in other long-term obligations.

 

Net cash used ininvesting activities for the quarter ended March 30, 2008 was less than $0.1million, which was related to capital expenditures.  Net cash used in investing activities for thequarter ended April 1, 2007 was $0.7 million, which was primarily related tocapital expenditures for our China facility.

 

Net cash used infinancing activities for the quarter ended March 30, 2008 was $1.2 million,which included $1.3 million payment to Industrial and Commercial Bank of ChinaLtd., or ICBC, to pay the balance on the line of credit, and $0.3 million ofdeferred financing costs incurred related to the senior notes.  This was offset by $0.5 million of short-termborrowings by Cherokee Europe from ING Belgie NV.

 

 Net cash provided by financing activities was$1.3 million for the quarter ended April 1, 2007. In the first quarter of 2007,Cherokee China borrowed $1.3 million under this credit facility to supportworking capital requirements as our China subsidiary builds inventory and incurvalue-added tax on local purchases.

 

LIQUIDITY

 

Weexpect our liquidity requirements will be primarily for working capital andcapital expenditures, including repayment of our senior notes dueNovember 1, 2008. As of March 30, 2008, we had cash and cashequivalents of $12.0 million, negative working capital of$6.1 million due to the $46.6 million of senior notes dueNovember 1, 2008 reclassified from long-term debt to current liabilities,no outstanding borrowings under our main revolving credit facility andborrowing base availability of $7.5 million under the same facility. Ourrevolving line of credit with General Electric Capital Corporation matures inAugust 2008. The Company plans to renew this line with the existing lender or anew lender after our senior bond obligations have been repaid or renegotiated.Historically, we have financed our operations with cash from operationssupplemented by borrowings from credit facilities and debt and equityissuances. Besides our credit line in the United States, Cherokee Europe alsomaintains a working capital line of credit of approximately $4.8 million,expressed as Euros 3.0 million, with Bank Brussels Lambert, a subsidiaryof ING Belgie NV, a bank in Brussels, which is denominated in Euros, andis collateralized by a pledge in first and second rank over a specific amountof business assets. Our access to the line is limited to $4.2 millionbecause $0.6 million is committed to minimum guarantees on specificcollections and payments. The facility requires Cherokee Europe to maintain acertain solvency ratio and is cancelable at any time. The

 

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current revolving line ofcredit with ING Belgie NV prohibits the transfer of cash outside ofBelgium to the U.S. in the form of management and dividend fees until August2008. During the third quarter ended September 30, 2007, Cherokee Europeborrowed $2.2 million from the line of credit which remained outstandingas of March 30, 2008. On April 28, 2008, Cherokee Europe borrowed $0.8million from its line of credit with ING Belgie NV. The outstanding balance onthe line of credit as of May 2, 2008 was $2.9 million, and the remainingborrowing availability on the line of credit was $1.2 million.

 

InJanuary 2008, Cherokee Europe borrowed short-term funds of $0.6 millionfrom ING Belgie NV; the outstanding balance was $0.5 million as of March30, 2008.

 

InJanuary 2007, we opened a credit facility with the Industrial and CommercialBank of China Ltd., or ICBC, as described under Note 6 to theaccompanying Notes to the Condensed Consolidated Financial Statements includedin Item 1, “Financial Statements.” This facility is intended for working capital requirements in China,especially as our China subsidiary builds inventory for export to the UnitedStates and Europe and incur value-added tax on local purchases that can only berecovered through in-country sales of our product. During the quarter endedMarch 30, 2008, Cherokee China repaid the $1.3 million balance on its line ofcredit.  As of March 30, 2008,Cherokee China had no outstanding borrowings under this line of credit.

 

Subjectto the refinancing risk described below under Contractual Obligations, webelieve our cash flow from operations and our credit lines in the UnitedStates, Europe and China are sufficient to meet our operating cash requirementsfor at least the next twelve months. However, this assumes that we aresuccessful in securing refinancing or payment of our senior bonds obligationwhen they mature in November 2008.

 

Fiscalyears 2006, 2005 and 2004 were unusual in that we financed the building,capital expenditures and start-up working capital requirements of our newShanghai facility entirely from internally generated cash, and replaced assetsdestroyed in the Cherokee Europe Fire. Having completed the China plantconstruction and replacement of destroyed assets in Cherokee Europe, ongoingcurrent and future liquidity needs are expected to arise primarily from workingcapital requirements and historical level capital expenditures, assuming wesuccessfully repay or renegotiate our senior bonds obligation. Our capitalexpenditures in 2007 and 2006 were $2.3 million and $3.6 million, respectively.In 2008, we expect our capital expenditures to range between $1.7 million to$2.1 million.

 

***CONTRACTUALOBLIGATIONS***

*** ***

As ofMarch 30, 2008, our borrowings consisted of approximately$46.6 million of senior notes, $2.2 million of outstanding borrowings onour Cherokee Europe line of credit, $0.5 million outstanding borrowings ofshort-term funds, and no outstanding borrowings under our Credit Facility andCherokee China line of credit.  For amore detailed discussion related to the financial instruments and obligations,see the subsection entitled “Debt” contained in Note 6, “Debt” to theaccompanying Notes to the Condensed Consolidated Financial Statements includedin Item 1, “Financial Statements.”

 

Wehave operating lease obligations relating to our facilities in Tustin andIrvine, California and Bombay, India.

 

Wehave purchase commitments primarily with vendors and suppliers for the purchaseof inventory and for other goods, services, and equipment as part of the normalcourse of business. These commitments are generally evidenced by purchaseorders that may or may not include cancellation provisions. Based on currentexpectations, we do not believe that any cancellation penalties we incur underthese obligations would have a material adverse effect on our consolidatedfinancial condition or results of operations.

 

As ofMarch 30, 2008, we have $0.4 million of scheduled distributions to be paidduring the remainder of the year to participants from the deferred compensationplan of which the funds for these payments have been reserved and depositedinto the Company’s deferred compensation plan.

 

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The maturities of our long-term debt, includingcapital leases, and future payments relating to our operating leases and otherobligations as of March 30, 2008 are as follows (in thousands):

 
| **Contractual Obligations**       | ** ** | **March 31, 2008 to  December 28, 2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|----------------------------------------|------------|-------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Debt-senior notes                      |       | $                                                                 | 46,630     |     | $          | —   |       | $        | —     |     | $          | —         |       | $         | —     |   | $ | — |   | $ | 46,630 |   |
| Operating leases                       |       | 1,209                                                             |       | 568      |       | 43       |       | 18       |       | —   |       | 109            |       | 1,947     |       |
| Purchase order  commitments            |       | 19,367                                                            |       | —   |       | —   |       | —   |       |     |       | —         |       | 19,367    |       |
| 1999 Europe  restructuring             |       | 131                                                               |       | 369      |       | 60       |       | —   |       |     |       | —         |       | 560       |       |
| 2003 Europe  restructuring             |       | 210                                                               |       | 280      |       | 258      |       | 211      |       | 164      |       | 239            |       | 1,362     |       |
| Long service  award                    |       | 46                                                                |       | 124      |       | 233      |       | 27       |       | 22       |       | 582            |       | 1,034     |       |
| Deferred  compensation                 |       | 438                                                               |       | 27       |       | 19       |       | 19       |       | 19       |       | 120            |       | 642       |       |
| Advances for  research and development |       | 84                                                                |       | 65       |       | 65       |       | 68       |       | 69       |       | 364            |       | 715       |       |
| Unrecognized tax benefits              |       | 307                                                               |       |     |       |     |       |     |       |     |       |           |       | 307       |       |
| Total                                  |       | $                                                                 | 68,422     |     | $          | 1,433    |       | $        | 678        |     | $          | 343            |       | $         | 274        |   | $ | 1,414 |   | $ | 72,564 |   |

 

Thelong-term liability for accrued pension costs included on the condensedconsolidated balance sheet is excluded from the table above. Cherokee is unableto estimate the timing of payments for these costs. During the quarter endedMarch 30, 2008, the Company contributed approximately $0.1 million.  In 2008, the Company expects to contribute$0.4 million.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

For a discussion of the impact of recently issuedaccounting pronouncements, see the subsection entitled “Recent AccountingPronouncements” contained in “Note 2 of the Notes to Condensed ConsolidatedFinancial Statements” under Item 1. “Financial Statements.”

 

Item 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUTMARKET RISK

 

Marketrisk relating to our operations results primarily from changes in foreigncurrency exchange rates and short-term interest rates. We did not have anyderivative financial instruments at March 30, 2008.

 

Wehad no variable rate debt outstanding at March 30, 2008. However, any debtwe incur under the Credit Facility and the Cherokee Europe line of credit willbear interest at a variable rate. We cannot predict market fluctuations ininterest rates and their impact on any variable rate debt we may incur in thefuture, nor can there be any assurance that fixed rate long-term debt will be availableto us at favorable rates, if at all.

 

Thefunctional currency for our European operations is the Euro. We are, therefore,subject to a certain degree of market risk associated with changes in foreigncurrency exchange rates. This risk is mitigated by the fact that our revenuesand expenses are generally both transacted in Euros, thereby reducing the riskof foreign currency exchange rate fluctuation on our European operations. Thenet effect on our operating income for foreign currency exchange ratefluctuations as of and for the quarter ended March 30, 2008, accounted fora $0.1 million decrease in our income. Historically, we have not activelyengaged in exchange rate-hedging activities.

 

Item 4T.   CONTROLAND PROCEDURES

 

*Disclosure Controls and Procedures*

 

Ourmanagement, with the participation of our President and Chief ExecutiveOfficer, and our Executive Vice President and Chief Financial Officer, 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. The evaluation included certain control areas in whichwe have made, and are continuing to make, changes to improve and enhancecontrols. As described below, we have identified material weaknesses andsignificant deficiencies in our internal control over financial reporting as ofDecember 30, 2007 and, as of March 30, 2008, these material weaknesses andsignificant deficiencies have not been fully remediated.  As a result, our President and ChiefExecutive Officer and our Executive Vice President and Chief Financial Officerhave concluded that, as of March 30, 2008, our disclosure controls and procedureswere not effective.

 

Amaterial weakness is a deficiency or a combination of deficiencies in internalcontrol over financial reporting such that there is a reasonable possibilitythat a material misstatement of the annual or interim consolidated financialstatements

 

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will not be prevented ordetected on a timely basis. In conducting its assessment of the effectivenessof our internal control over financial reporting, our management concluded thefollowing material weaknesses existed as of March 30, 2008:

* *

*Architecture of Company’s IT systems does not presentlysupport the financial reporting requirements of the Company’s internationaloperations*

 

Oursubsidiaries in India and China still maintain disparate financial accountingsystems that do not completely interface with the Company’s primary ERP system,resulting in duplicate accounting entries on multiple systems. This causes aprotracted reporting cycle which limits the oversight from corporate headquartersof transactional details at our international sites. Site level financialstatements are delivered on spreadsheets to the corporate office forconsolidation.

 

OurEuropean operation has its own separate ERP system that is integrated into thelocal accounting system; however this system does not automatically interfacefinancially with our corporate headquarters. Therefore, financial results arealso delivered to our corporate office by means of spreadsheets, and thecorporate office also has insufficient visibility to transactional details.

 

Theconsolidation of all these local results delivered on spreadsheets is in turnprepared on spreadsheets at our corporate office. Consolidations performed onspreadsheets are prone to human error and are difficult to review. As such, theexisting consolidation process requires additional monitoring and oversight.Oversight and monitoring are discussed in more detail below.

 

TheCompany is continuing to develop IT interface solutions for key activities inChina. After these solutions are fully implemented, we will determine what ITsolutions will be required for our other locations. In the interim, the Companyhas supplemented these technical IT solutions with additional staffing andimproved internal monitoring procedures.

 

*The methodology and support for valuing and capitalizinginventory costs, and determining inventory reserves*

 

Asremediated in the second quarter of 2007, the Company now evaluates historicaland projected labor and overhead costs to determine their reasonableness. Thisprocess is subject to finance management oversight and review. The Companystill does not track labor by product model at most locations.

 

*Oversight and monitoring controls*

 

Thelack of an integrated financial reporting system creates the need forsignificant manual intervention and staffing to prepare spreadsheets, createeliminating entries, make tax adjustments, and U.S. GAAP adjustments.Additionally, our remote locations, other than Europe, have one localcontroller with little more than clerical support to maintain the localaccounting system, transport information from the ERP system to their localbooks, report financial statements to our headquarters in the U.S. and performroutine functions such as account reconciliations. As part of our SarbanesOxley Act of 2002 (SOX) 404 compliance efforts, the Company is performing adetailed review of procedures and personnel at each site location. The Companyis committed to resolving all deficiencies identified.

 

Wehave identified and have performed or are working on the following remediationto resolve the weakness in oversight and monitoring controls over internationalfinancial reporting:

 

· Theprocess of adding structure and uniformity of accounting standards and processamong our site controllers continues through distribution of corporate policiesand procedures, planned continued development and distribution of policies,reinforcement of management representations and corporate code of conduct, andregular visits by the corporate controller to various Company sites. Wecontinue critical self-review of how accounting is performed worldwide.

 

· Dueto personnel changes, the Company expects to rely on outside professionals fora significant portion of its SOX compliance review.  Planning and preliminary fieldwork isexpected to begin in the second quarter of 2008.

 

· Animproved consolidated reporting package is now provided to corporate managementand significant items are being reviewed with local management.

 

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*SOX Compliance*

 

As anon-accelerated filer, 2007 marked the first year of SOX compliance for theCompany. The Company completed an internal assessment of controls. While thevast majority of the Company’s controls were operating properly, the Companydid identify control deficiencies for remediation. The corporate office workedclosely with the site accounting personnel to remediate these deficiencies. Thevast majority of the deficiencies were remediated during 2007, but some didremain at year end. While efforts to remediate these deficiencies havecontinued into 2008, management assessed the remaining deficiencies todetermine if any additional material weakness existed. The Company concludedthat none of the open deficiencies at 2007 fiscal year end could result in amaterial weakness, but did believe that two could be classified as significantdeficiencies. A significant deficiency is a deficiency, or combination ofdeficiencies, in internal control over financial reporting that is less severethan a material weakness; yet important enough to merit the attention of thoseresponsible for oversight over the Company’s financial reporting.  The following significant deficiencies stillexisted as of March 30, 2008:

 

1) Inadequate fixed asset management systems andprocedures; and

 

2) Inadequate system controls over shippingcutoffs

 

Subsequentto the end of the quarter, the Company implemented new IT system controls thatwe believe will remediate the inadequate controls over shipping cutoffs.Remediation efforts on the fixed asset systems are expected to continue overseveral periods.  The issues of ITsystems, people and process are interrelated and difficult to separate.Striking the optimum balance between improved process, better trained andsupervised staff and mission critical IT improvements is essential for success.

 

TheCompany is committed to remediating all material weaknesses and significantdeficiencies presently identified and any additional deficiencies that may beidentified in the future.

 

Inconnection with the Company’s filing of its financial statements for its fiscalyear ending December 28, 2008, the Company’s internal control overfinancial reporting will be subject to attestation by the Company’s registeredpublic accounting firm.

 

*Changes in Internal Control Over Financial Reporting*

 

Exceptas described above, there have not been any changes in our internal controlover financial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during our first fiscal quarter of 2008 thathave materially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

PART II  OTHER INFORMATION

 

Item1.   Legal Proceedings

 

OnNovember 16, 2007, SynQor announced that it had filed a lawsuit againstseveral of its competitors, including Cherokee International Corporation whowas named in the complaint, for infringement of two patents relating to busconverters and/or non-isolated point of load converters used in intermediatebus architectures. The patents at issue are U.S. patents 7,072,190 and7,272,021. The suit was filed in Federal Court in the Eastern District ofTexas. The Company intends to vigorously defend this lawsuit. Although the ultimateaggregate amount of monetary liability or financial impact with respect to thislawsuit is subject to many uncertainties and is therefore not predictable withassurance, the final outcome of this lawsuit, if adverse, could have a materialadverse effect on our financial position, results of operations or cash flows.

 

Duringthe quarter ended March 30, 2008, we were not a party to any othermaterial legal proceedings. We are occasionally a party to lawsuits relating toroutine matters incidental to our business. As with all litigation, we canprovide no assurance as to the outcome of any particular lawsuit, and we notethat litigation inherently involves significant costs.

 

Item1A.   Risk Factors

 

There have been no material changes to the Company’s riskfactors from those disclosed in the Company’s 2007 Annual Report onForm 10-K.

 

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Item6.   EXHIBITS

 

EXHIBIT INDEX

 

Exhibits have heretofore been filed with the SEC andare incorporated herein by reference. Management contracts or compensatoryplans or arrangements are marked with an asterisk.

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                                                           |
|-----------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1             |       | Restated Certificate of  Incorporation of Cherokee International Corporation.(1)                                                                                                          |
| 3.2             |       | Amended and Restated  By-Laws of Cherokee International Corporation.(1)                                                                                                                   |
| 4.1             |       | Specimen certificate  for shares of common stock, par value $0.001 per share.(3)                                                                                                          |
| 4.2             |       | Indenture, dated as of  November 27, 2002, between Cherokee International Corporation, as  issuer, and U.S. Bank, N.A., as trustee, relating to the 5.25% Senior Notes  due 2008.(2) |
| 4.3             |       | Form of 5.25% Senior  Notes due 2008.(2)                                                                                                                                                  |
| *10.1           |       | Letter Agreement, dated  February 29, 2008, between Cherokee International Corporation and  Jeffrey M. Frank.(1)                                                                     |
| *10.2           |       | Letter Agreement, dated  February 29, 2008, between Cherokee International Corporation and  Linster W. Fox.(1)                                                                       |
| *10.3           |       | Letter Agreement, dated  February 29, 2008, between Cherokee International Corporation and Mukesh  Patel.(1)                                                                         |
| *10.4           |       | Severance Agreement,  dated February 29, 2008, between Cherokee International Corporation and  Alex Patel.(1)                                                                        |
| *10.5           |       | Transaction Bonus  Agreement, dated April 14, 2008, between Cherokee International  Corporation and Jeffrey M. Frank.                                                                |
| *10.6           |       | Transaction Bonus  Agreement, dated April 14, 2008, between Cherokee International Corporation  and Linster W. Fox.                                                                  |
| *10.7           |       | Transaction Bonus  Agreement, dated April 14, 2008, between Cherokee International  Corporation and Mukesh Patel.                                                                    |
| 31.1            |       | Certification of  President and Chief Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002.                                                                  |
| 31.2            |       | Certification of  Executive Vice President of Finance, Chief Financial Officer and Secretary  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                             |
| 32.1            |       | Certification of CEO  and CFO Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002.                                        |

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(1)                                  Incorporated by reference from theRegistration Statement on Form S-8, filed by the Registrant onMarch 16, 2004.

 

(2)                                  Incorporated by reference from theRegistration Statement on Form S-1 (File No. 333-110723), filed by theRegistrant on November 25, 2003.

 

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

 

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SIGNATURES

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
|                     | CHEROKEE  INTERNATIONAL CORPORATION |
|--------------------------|-------------------------------------|
|                     |                                |   |
| Date:  May 12, 2008 | By:                            | /s/ JEFFREY M.  FRANK |
|                     |                                | Jeffrey M. Frank |
|                     |                                | President and  Chief Executive Officer |
|                     |                                | (Principal  Executive Officer) |
|                     |                                |   |
| Date:  May 12, 2008 | By:                            | /s/ LINSTER W.  FOX |
|                     |                                | Linster W. Fox |
|                     |                                | Executive Vice  President, Chief Financial Officer, and Secretary

(Principal  Financial and Accounting Officer) |

 

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