Table of Contents

 

 

 

**SECURITIESAND 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 June 29, 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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**CherokeeInternational 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 by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days.

 

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 “largeaccelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2of 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 ofeach of the issuer’s classes of common stock, as of the latest practicabledate.

 
| **Title**                                 | ** ** | **Shares Outstanding as of July 31, 2008** |
|-------------------------------------------|------------|--------------------------------------------------------------------------|
| Common  Stock, par value $0.001 per share |       | 19,475,892  shares                                                       |

 

 

 

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Tableof Contents

 

TABLEOF CONTENTS

 
| ** **                                                                                           | **Page** |
|------------------------------------------------------------------------------------------------------|----------|
| PART I. FINANCIAL INFORMATION                                                                   | 1        |
| 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                                  | 28       |
| Item 4T. Controls  and Procedures                                                                    | 28       |
| PART II OTHER  INFORMATION                                                                      | 30       |
| Item 1. Legal Proceedings                                                                            | 30       |
| Item 1A. Risk Factors                                                                                | 31       |
| Item 4. Submission  of Matters to a Vote of Security Holders                                         | 37       |
| Item 6. Exhibits                                                                                     | 37       |
| Signatures                                                                                           | 39       |

 

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Table of Contents

 

PART I.   FINANCIAL INFORMATION

 

Item1.   FINANCIAL STATEMENTS.

 

CHEROKEE INTERNATIONAL CORPORATION ANDSUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands, Except Share and Per Share Data)

(Unaudited)

 
| ** **                                                                                                                                                                                  | ** ** | **June 29, 2008** | ** ** | **December 30, 2007** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| ASSETS                                                                                                                                                                                      |       |                        |       |                            |       |
| CURRENT ASSETS:                                                                                                                                                                             |       |                        |       |                            |       |
| Cash and cash equivalents                                                                                                                                                                   |       | $                           | 9,283      |                            | $          | 8,484 |   |
| Accounts receivable, net of allowance for doubtful accounts of $332  and $297 at June 29, 2008 and December 30, 2007, respectively                                           |       | 33,804                      |       | 31,237                          |       |
| Inventories, net                                                                                                                                                                            |       | 30,973                      |       | 28,021                          |       |
| Prepaid expenses and other current assets                                                                                                                                                   |       | 1,730                       |       | 1,583                           |       |
| Deferred income taxes                                                                                                                                                                       |       | —                      |       | 363                             |       |
| Total current assets                                                                                                                                                                        |       | 75,790                      |       | 69,688                          |       |
|                                                                                                                                                                                        |       |                        |       |                            |       |
| Property and equipment, net                                                                                                                                                                 |       | 18,511                      |       | 19,194                          |       |
| Deposits and other assets                                                                                                                                                                   |       | 1,161                       |       | 1,515                           |       |
| Deferred financing costs, net of accumulated amortization of $558 and  $494 at June 29, 2008 and December 30, 2007, respectively                                             |       | 379                         |       | 86                              |       |
| Deferred income taxes-long-term portion                                                                                                                                                     |       | —                      |       | 1,257                           |       |
| Goodwill                                                                                                                                                                                    |       | —                      |       | 1,120                           |       |
| Total Assets                                                                                                                                                                                |       | $                           | 95,841     |                            | $          | 92,860 |   |
|                                                                                                                                                                                        |       |                        |       |                            |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                   |       |                        |       |                            |       |
| CURRENT LIABILITIES:                                                                                                                                                                        |       |                        |       |                            |       |
| Accounts payable                                                                                                                                                                            |       | $                           | 16,244     |                            | $          | 15,140 |   |
| Accrued liabilities                                                                                                                                                                         |       | 4,253                       |       | 4,667                           |       |
| Accrued compensation and benefits                                                                                                                                                           |       | 7,970                       |       | 6,876                           |       |
| Accrued restructuring costs                                                                                                                                                                 |       | 545                         |       | 431                             |       |
| Other short-term borrowings                                                                                                                                                                 |       | 319                         |       | —                          |       |
| Borrowings under revolving line of credit                                                                                                                                                   |       | 3,502                       |       | 3,395                           |       |
| Current debt                                                                                                                                                                                |       | 24,485                      |       | 24,485                          |       |
| Current debt payable to affiliates                                                                                                                                                          |       | 22,145                      |       | 22,145                          |       |
| Total current liabilities                                                                                                                                                                   |       | 79,463                      |       | 77,139                          |       |
|                                                                                                                                                                                        |       |                        |       |                            |       |
| Other long-term liabilities                                                                                                                                                                 |       | 4,511                       |       | 4,534                           |       |
| Total Liabilities                                                                                                                                                                           |       | 83,974                      |       | 81,673                          |       |
|                                                                                                                                                                                        |       |                        |       |                            |       |
| Commitments and contingencies (Note 9)                                                                                                                                                      |       |                        |       |                            |       |
|                                                                                                                                                                                        |       |                        |       |                            |       |
| STOCKHOLDERS’ EQUITY:                                                                                                                                                                  |       |                        |       |                            |       |
| Common stock: $0.001 par value; 60,000,000 shares authorized;  19,475,892 and 19,453,557 shares issued and outstanding at June 29, 2008  and December 30, 2007, respectively |       | 19                          |       | 19                              |       |
| Paid-in capital                                                                                                                                                                             |       | 186,601                     |       | 186,035                         |       |
| Accumulated deficit                                                                                                                                                                         |       | (178,880                    | )          | (178,323                        | )          |
| Accumulated other comprehensive income                                                                                                                                                      |       | 4,127                       |       | 3,456                           |       |
| Total stockholders’ equity                                                                                                                                                             |       | 11,867                      |       | 11,187                          |       |
| Total Liabilities and Stockholders’ Equity                                                                                                                                             |       | $                           | 95,841     |                            | $          | 92,860 |   |

 

See notes to condensed consolidated financial statements.

 

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CHEROKEE INTERNATIONAL CORPORATION ANDSUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands, Except Per Share Amounts)(Unaudited)

 
| ** **                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                               | ** ** | **June 29, 2008**      | ** ** | **July 1, 2007**     | ** ** | **June 29, 2008** | ** ** | **July 1, 2007** | ** ** |
| Net sales                                |       | $                                | 40,549     |                           | $          | 29,574 |   | $ | 75,287 |   | $ | 59,594 |   |
| Cost of sales                            |       | 29,214                           |       | 24,023                         |       | 55,311 |   | 48,326 |   |
| Gross profit                             |       | 11,335                           |       | 5,551                          |       | 19,976 |   | 11,268 |   |
| Operating expenses:                      |       |                             |       |                           |       |   |   |   |   |
| Engineering and development              |       | 2,900                            |       | 2,837                          |       | 5,681 |   | 5,479 |   |
| Selling and marketing                    |       | 2,100                            |       | 1,873                          |       | 3,835 |   | 3,737 |   |
| General and administrative               |       | 3,396                            |       | 3,380                          |       | 6,989 |   | 6,517 |   |
| Goodwill impairment                      |       | 1,120                            |       | —                         |       | 1,120 |   | — |   |
| Restructuring costs                      |       | —                           |       | (38                            | )          | — |   | 155 |   |
| Total operating expenses                 |       | 9,516                            |       | 8,052                          |       | 17,625 |   | 15,888 |   |
| Operating income (loss)                  |       | 1,819                            |       | (2,501                         | )          | 2,351 |   | (4,620 | ) |
| Interest expense                         |       | (717                             | )          | (692                           | )          | (1,459 | ) | (1,377 | ) |
| Gain on sale of Mexico Facility building |       | —                           |       | 430                            |       | — |   | 430 |   |
| Other income, net                        |       | 26                               |       | 152                            |       | 239 |   | 314 |   |
| Income (loss) before income taxes        |       | 1,128                            |       | (2,611                         | )          | 1,131 |   | (5,253 | ) |
| Income tax provision (benefit)           |       | 1,697                            |       | (958                           | )          | 1,688 |   | (1,578 | ) |
| Net loss                                 |       | $                                | (569       | )                              | $          | (1,653 | ) | $ | (557 | ) | $ | (3,675 | ) |
| Net loss per share:                      |       |                             |       |                           |       |   |   |   |   |
| Basic                                    |       | $                                | (0.03      | )                              | $          | (0.09 | ) | $ | (0.03 | ) | $ | (0.19 | ) |
| Diluted                                  |       | $                                | (0.03      | )                              | $          | (0.09 | ) | $ | (0.03 | ) | $ | (0.19 | ) |
| Weighted average shares outstanding:     |       |                             |       |                           |       |   |   |   |   |
| Basic                                    |       | 19,465                           |       | 19,359                         |       | 19,459 |   | 19,350 |   |
| Diluted                                  |       | 19,465                           |       | 19,359                         |       | 19,459 |   | 19,350 |   |

 

See notes to condensed consolidated financial statements.

 

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CHEROKEE INTERNATIONAL CORPORATION ANDSUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OFCOMPREHENSIVE OPERATIONS

(In Thousands)

(Unaudited)

 
| ** **                               | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                               | ** ** | **June 29, 2008**      | ** ** | **July 1, 2007**     | ** ** | **June 29, 2008** | ** ** | **July 1, 2007** | ** ** |
| Net loss                                 |       | $                                | (569       | )                              | $          | (1,653 | ) | $ | (557 | ) | $ | (3,675 | ) |
| Other comprehensive income (loss):       |       |                             |       |                           |       |   |   |   |   |
| Foreign currency translation adjustments |       | (98                              | )          | 135                            |       | 670 |   | 298 |   |
| Comprehensive income (loss)              |       | $                                | (667       | )                              | $          | (1,518 | ) | $ | 113 |   | $ | (3,377 | ) |

 

See notes to condensed consolidated financial statements.

 

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CHEROKEE INTERNATIONAL CORPORATION ANDSUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS

(In Thousands)

(Unaudited)

 
| ** **                                                                                 | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                 | ** ** | **June 29, 2008**    | ** ** | **July 1, 2007** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                      |       |                           |       |   |   |
| Net loss                                                                                   |       | $                              | (557       | ) | $ | (3,675 | ) |
| Adjustments to reconcile net loss to net cash provided by (used in)  operating activities: |       |                           |       |   |   |
| Depreciation and amortization                                                              |       | 1,377                          |       | 1,610 |   |
| Goodwill impairment                                                                        |       | 1,120                          |       | — |   |
| Gain on sale of property and equipment                                                     |       | —                         |       | (430 | ) |
| Amortization of deferred financing costs                                                   |       | 64                             |       | 65 |   |
| Stock-based compensation                                                                   |       | 519                            |       | 341 |   |
| Deferred income taxes                                                                      |       | 1,650                          |       | — |   |
| Net change in operating assets and liabilities:                                            |       |                           |       |   |   |
| Accounts receivable, net                                                                   |       | (1,756                         | )          | 3,968 |   |
| Inventories, net                                                                           |       | (2,261                         | )          | (3,241 | ) |
| Prepaid expenses and other current assets                                                  |       | (108                           | )          | 647 |   |
| Deposits and other assets                                                                  |       | 353                            |       | (7 | ) |
| Accounts payable                                                                           |       | 663                            |       | 338 |   |
| Accrued liabilities and restructuring costs                                                |       | (372                           | )          | (2,492 | ) |
| Accrued compensation and benefits                                                          |       | 852                            |       | (876 | ) |
| Accrued interest payable                                                                   |       | (35                            | )          | 12 |   |
| Other long-term obligations                                                                |       | (324                           | )          | 136 |   |
| Net cash provided by (used in) operating activities                                        |       | 1,185                          |       | (3,604 | ) |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                      |       |                           |       |   |   |
| Additions to property and equipment                                                        |       | (201                           | )          | (1,505 | ) |
| Proceeds from sale of property and equipment                                               |       | —                         |       | 1,229 |   |
| Net cash used in investing activities                                                      |       | (201                           | )          | (276 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                      |       |                           |       |   |   |
| Other short-term borrowings, net                                                           |       | 319                            |       | — |   |
| Borrowings (repayments) on revolving lines of credit, net                                  |       | (38                            | )          | 1,307 |   |
| Deferred financing costs                                                                   |       | (357                           | )          | — |   |
| Net proceeds from employee stock purchases and the exercise of stock  options              |       | 47                             |       | 219 |   |
| Net cash (used in) provided by financing activities                                        |       | (29                            | )          | 1,526 |   |
| Effect of exchange rate changes on cash                                                    |       | (156                           | )          | 97 |   |
| Net increase (decrease) in cash and cash equivalents                                       |       | 799                            |       | (2,257 | ) |
| Cash and cash equivalents, beginning of period                                             |       | 8,484                          |       | 8,881 |   |
| Cash and cash equivalents, end of period                                                   |       | $                              | 9,283      |   | $ | 6,624 |   |
| SUPPLEMENTAL INFORMATION                                                                   |       |                           |       |   |   |
| Cash paid during the period for interest                                                   |       | $                              | 1,408      |   | $ | 1,278 |   |
| Cash paid during the period for income taxes                                               |       | $                              | 299        |   | $ | 198 |   |

 

Seenotes to condensed consolidated financial statements.

 

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CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.      NATUREOF OPERATIONS

 

Cherokee InternationalCorporation (the “Company”) is a designer and manufacturer of power suppliesfor original equipment manufacturers (“OEMs”). Its advanced power supplyproducts are typically custom designed into mid- to high-end commercialapplications in the computing and storage, wireless infrastructure, enterprisenetworking, telecom, medical and industrial markets.

 

2.       BASISOF PRESENTATION 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 three and six months ended June 29, 2008 and July 1, 2007, arenot necessarily indicative of the results to be expected for the entire fiscalyear ending December 28, 2008 (“fiscal 2008”). The accompanying condensedconsolidated financial statements should be read in conjunction with theaudited consolidated 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 tosatisfy this obligation. We also cannot be certain that we will have sufficientassets or cash flow available to support refinancing these notes at currentmarket rates or on terms that are satisfactory to us. If we are unable torefinance on terms satisfactory to us, we may be forced to refinance on termsthat are materially less favorable, seek funds through other means such as asale of some of our assets, or otherwise significantly alter our operatingplan, any of which could have a material adverse effect on our business,financial condition and results of operation. These circumstances createsubstantial doubt 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.

 

Useof Estimates

 

The preparation of financial statements in accordancewith accounting principles generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect the reported amountsof assets and liabilities and disclosure of contingent liabilities at the dateof the financial statements and the amounts of revenues and expenses during thereporting period. Actual results could differ from such estimates.

 

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Stock-BasedCompensation

 

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, compensationcost is recognized in the financial statements beginning with the effectivedate, based on the requirements of SFAS 123R for all share-based paymentsgranted after that date, and based on the requirements of SFAS 123 for allunvested awards granted prior to the effective date of SFAS 123R. Under the“*modified retrospective*” method,the requirements are the same as under the “*modifiedprospective*” method, but also permits entities to restate financialstatements of previous periods based on proforma disclosures made in accordancewith SFAS 123.

 

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 stock options.

 

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) compensationcost for all share-based payments granted subsequent to January 1, 2006,based on the grant-date fair value estimated in accordance with the provisionsof SFAS 123R. In accordance with the modified prospective method ofadoption, the Company’s results of operations and financial position for priorperiods have not been restated. At the date of the adoption, the unamortizedexpense for options issued prior to January 2, 2006 was $2.3 million,which will be amortized as stock compensation costs through December 2010.Stock based compensation costs expensed during the quarters ended June 29,2008 and July 1, 2007, were $0.3 million and $0.1 million, respectively.During the six months ended June 29, 2008 and July 1, 2007, the costsrecorded were $0.5 million and $0.3 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 records compensation expense for employeestock options based on the estimated fair value of the options on the date ofgrant using the Black-Scholes option pricing formula with the assumptionsincluded in the table below. The Company uses historical data, among otherfactors, to estimate the expected price volatility and the expected forfeiturerate. For options granted prior to January 2, 2006, the Company used theexpected option life of 5 years. For options granted following the Company’sadoption of SFAS 123R, the expected life was increased to 6.25 yearsusing the “simplified method” under SAB 107 (an expected term based on themid-point between the vesting date and the end of the contractual term). Theuse of the simplified 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 withSFAS 123R. SAB 110 was effective for the Company beginning December 31,2007. The Company will continue to use the simplified method until it has thehistorical data necessary to provide a reasonable estimate of expected life, inaccordance with SAB 107, as amended by SAB 110. The options have amaximum contractual term of 10 years and generally vest pro-rata over twoto four years. The risk-free rate is based on the U.S. Treasury yield curve ineffect at the time of grant for the estimated life of the option.

 

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The following weighted-average assumptions were usedto estimate the fair value of options granted during the three and six-monthperiods ended June 29, 2008 and July 1, 2007, using the Black-Scholesoption pricing formula.

 
| ** **              | ** ** | **Quarter Ended**      | ** ** | **Six Months Ended** | ** ** |
|-------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **              | ** ** | **June 29, 2008** | ** ** | **July 1, 2007**     | ** ** | **June 29, 2008** | ** ** | **July 1, 2007** | ** ** |
| Dividend yield          |       | 0.0                         | %          | 0.0                            | %          | 0.0 | % | 0.0 | % |
| Expected volatility     |       | 61.5                        | %          | 54.8                           | %          | 61.5 | % | 54.8 | % |
| Risk free interest rate |       | 3.99                        | %          | 5.03                           | %          | 3.99 | % | 5.02 | % |
| Expected lives          |       | 6.25  years                 |       | 6.25  years                    |       | 6.25  years |   | 6.25  years |   |
| Forfeiture rates        |       | 11.24%  - 25.72             | %          | 12.58%  - 21.71                | %          | 11.24%  - 25.72 | % | 12.58%  - 21.71 | % |

 

The following tablesummarizes the Company’s activities with respect to its stock option plans forthe six months ended June 29, 2008 as follows:

 
| **Options**                                                     | ** ** | **Number  of  Shares** | ** ** | **Weighted-  Average  Exercise Price  Per Share** | ** ** | **Weighted-  Average  Remaining  Contractual  Term  (in years)** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|-----------------------------------------------------------------|------------|------------------------|------------|-------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|---------------------------------|------------|
| Outstanding at December 30, 2007                                |       | 2,791,579              |       | $                                                           | 5.97       |                                                                  | 7.49       |                            | $          | — |   |
| Granted                                                         |       | 70,000                 |       | $                                                           | 2.33       |                                                                  | 9.94       |                            | $          | 2,000 |   |
| Exercised                                                       |       | —                 |       | $                                                           | —     |                                                                  | —     |                            | $          | — |   |
| Forfeited                                                       |       | (243,371               | )          | $                                                           | 6.99       |                                                                  | 6.29       |                            | $          | — |   |
| Outstanding at June 29, 2008                               |       | 2,618,208              |       | $                                                           | 5.78       |                                                                  | 7.12       |                            | $          | 2,000 |   |
| Vested and expected to vest in the future at June 29, 2008 |       | 2,360,420              |       | $                                                           | 5.94       |                                                                  | 6.94       |                            | $          | 1,072 |   |
| Exercisable at June 29, 2008                               |       | 1,579,883              |       | $                                                           | 6.72       |                                                                  | 6.27       |                            | $          | — |   |

 

Since its inception on February 16, 2004, a totalof 400,000 shares of common stock have been reserved for issuance under the 2004Employee Stock Purchase Plan (“ESPP”), subject to annual increases as describedunder 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 have up to amaximum of 15% of their eligible annual base earnings withheld, subject to anannual maximum of $25,000 or 2,100 shares per offering period, to purchase ourcommon stock. The purchase price of the stock is 85% of the lower of theclosing price at the beginning of each six-month offering period or at the endof each six-month offering period. The Company recognizes compensation cost forits ESPP under SFAS 123R.

 

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**      | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                                                           | ** ** | **June 29, 2008** | ** ** | **July 1, 2007**     | ** ** | **June 29, 2008** | ** ** | **July 1, 2007** | ** ** |
| Net loss, as reported                                                                                                                                                |       | $                           | (569       | )                              | $          | (1,653 | ) | $ | (557 | ) | $ | (3,675 | ) |
| Stock-based employee compensation related to stock options included  in net 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) |       | —                      |       | (87                            | )          | (40 | ) | (182 | ) |
| Net loss—pro forma                                                                                                                                              |       | $                           | (569       | )                              | $          | (1,740 | ) | $ | (597 | ) | $ | (3,857 | ) |
| Net loss per share, as reported:                                                                                                                                     |       |                        |       |                           |       |   |   |   |   |
| Basic                                                                                                                                                                |       | $                           | (0.03      | )                              | $          | (0.09 | ) | $ | (0.03 | ) | $ | (0.19 | ) |
| Diluted                                                                                                                                                              |       | $                           | (0.03      | )                              | $          | (0.09 | ) | $ | (0.03 | ) | $ | (0.19 | ) |
| Pro forma net loss per share:                                                                                                                                        |       |                        |       |                           |       |   |   |   |   |
| Basic                                                                                                                                                                |       | $                           | (0.03      | )                              | $          | (0.09 | ) | $ | (0.03 | ) | $ | (0.20 | ) |
| Diluted                                                                                                                                                              |       | $                           | (0.03      | )                              | $          | (0.09 | ) | $ | (0.03 | ) | $ | (0.20 | ) |

 

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(a)    During 2008 and 2007, theCompany accounted for stock-based compensation for options granted prior to February 25,2004, the date of our initial public offering, to employees and directors usingthe intrinsic value method prescribed in APB 25 and adopted the disclosure-onlyalternative of SFAS 123, as amended by SFAS 148 for these options.

 

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Translationof Foreign Currency

 

Foreignsubsidiary assets and liabilities denominated in foreign currencies are translatedat the exchange rate in effect on the balance sheet date. Revenues, costs andexpenses are translated at the average exchange rate during the period.Transaction gains and losses are included in results of operations and have notbeen significant for the periods presented. The functional currency of CherokeeEurope is the Euro. The functional currency of Cherokee India, Powertel andCherokee China is the U.S. dollar, as the majority of transactions aredenominated in U.S. dollars. Translation adjustments related to Cherokee Europeare reflected as a component of stockholders’ equity in other comprehensiveincome (loss).

 

RecentAccounting Pronouncements

 

InSeptember 2006, the FASB issued SFAS 157, *Fair Value Measurements*. This Statement defines fair value,establishes a framework for measuring fair value in generally acceptedaccounting principles (GAAP), and expands disclosures about fair valuemeasurements. This Statement applies to accounting pronouncements that requireor permit fair value measurements, except for share-based payments transactionsunder FASB Statement No. 123 (Revised) *Share-BasedPayment*. This Statement is effective for financial statements issuedfor fiscal years beginning after November 15, 2007, except fornon-financial assets and liabilities, for which this Statement will beeffective for years beginning after November 15, 2008. The Company adoptedSFAS 157 on December 31, 2007, and the impact of this adoption on ourfinancial position and results of operations was immaterial.

 

InFebruary 2007, the FASB issued SFAS 159, *The Fair Value Option for Financial Assets and Financial Liabilities*.This Statement permits entities to choose to measure many financial 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 after December 15,2008. Early adoption is prohibited; thus the provisions of these pronouncementswill be effective for us in fiscal year 2009. We do not have any minorityinterests. We do not expect the adoption of SFAS 141 (R) and SFAS 160to have a material effect on our financial position or results of operations.

 

InDecember 2007, the SEC published SAB 110, *Share-Based Payment*. The interpretations in SAB 110express the SEC staff’s views regarding the acceptability of the use of a “simplified”method, as discussed in SAB 107, in developing an estimate of expectedterm of share options 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 beginning December 31,2007. The Company will continue to use the simplified method until it has thehistorical data necessary to provide a reasonable estimate of expected life, inaccordance with SAB 107, as amended by SAB 110.

 

InMarch 2008, the FASB issued SFAS 161, *Disclosures about Derivative Instruments and Hedging Activities,*an amendment of SFAS 133. This Statement requires enhanced disclosuresabout derivative instruments and hedging activities within an entity byrequiring the disclosure of the fair values of derivative instruments and theirgains and losses in a tabular format. It provides more information about anentity’s liquidity by requiring disclosure of derivative features that arecredit risk-related, and it requires cross-referencing within footnotes toenable financial statement users to locate important information about derivativeinstruments. It is effective for financial statements issued for fiscal yearsand interim periods beginning after November 15, 2008, with early adoptionpermitted. The Company is evaluating the impact of the adoption ofSFAS 161 and believes there will be no material impact on our consolidatedfinancial statements or financial operations.

 

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In May 2008,the FASB issued SFAS 162, *The Hierarchy ofGenerally Accepted Accounting Principles*. SFAS 162 identifies thesources of accounting principles and the framework for selecting the principlesto be used in the preparation of financial statements of nongovernmentalentities that are presented in conformity with generally accepted accountingprinciples in the United States.  It is effective 60 days followingthe SEC’s approval of the Public Company Accounting Oversight Board amendmentsto AU Section 411, *The Meaning ofPresent Fairly in Conformity With Generally Accepted Accounting Principles*.The adoption of this Statement is not expected to have a material effect on theCompany’s consolidated financial statements.

 

In May 2008,the FASB issued SFAS 163, *Accounting forFinancial Guarantee Insurance Contracts – An interpretation of FASB Statement No. 60*.  SFAS 163 requires that an insurance enterprise recognize a claimliability prior to an event of default when there is evidence that creditdeterioration has occurred in an insured financial obligation. It alsoclarifies how Statement 60 applies to financial guarantee insurance contracts,including the recognition and measurement to be used to account for premiumrevenue and claim liabilities, and requires expanded disclosures aboutfinancial guarantee insurance contracts. It is effective for financialstatements issued for fiscal years beginning after December 15, 2008,except for some disclosures about the insurance enterprise’s risk-managementactivities.****SFAS 163 requiresthat disclosures about the risk-management activities of the insuranceenterprise be effective for the first period beginning after issuance. Exceptfor those disclosures, earlier application is not permitted.  Theadoption of this Statement is not expected to have a material effect on theCompany’s consolidated financial statements.

 

Inventories

 

Inventories are valued atthe lower of weighted average cost or market. Inventory costs include the costsof material, labor and manufacturing overhead and consist of the following, netof reserve for surplus and obsolescence (in thousands):

 
| ** **       | ** ** | **June 29, 2008** | ** ** | **December 30, 2007** | ** ** |
|------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Raw material     |       | $                           | 17,737     |                            | $          | 16,547 |   |
| Work-in-process  |       | 5,217                       |       | 4,696                           |       |
| Finished goods   |       | 8,019                       |       | 6,778                           |       |
| Inventories, net |       | $                           | 30,973     |                            | $          | 28,021 |   |

 

As of June 29, 2008 andDecember 30, 2007, the reserve for excess inventory and obsolescence was$3.4 million and $3.1 million, respectively, including management’s assessmentof reserves for surplus and obsolescence for non-compliant material related tothe Restriction of Hazardous Substances in Electrical and Electronic Equipmentdirective.

 

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

 

(1)  Restriction of HazardousSubstances in Electrical and Electronic Equipment, more commonly known as RoHS.This European directive bans the use of certain elements that are commonlyfound in components used to manufacture electrical and electronic assemblies.This directive became effective on July 1, 2006. The Company beganmanufacturing compliant products in 2006 and continues to work actively withits customers to ensure compliance. The Company is focused on consuming allnon-compliant material on-hand within a reasonable period. However, the Companymay have to dispose of non-compliant materials in the future, which couldadversely affect the financial performance of the Company. There is also a riskof fines associated with non-compliance with the RoHS directive; however, theCompany is not aware of any specific potential fines, and the Companyanticipates complying with all provisions of this legislation.

 

(2)  Waste Electrical andElectronic Equipment, also known as WEEE. This directive became effective August 13,2005 and requires manufacturers and importers to properly recycle or dispose ofsuch equipment at the end of its useful life. The Company believes it haslimited exposure to the WEEE directive because its products are usually installedinto another 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.

 

As of June 29, 2008,the Company does not foresee any material estimated capital expenditures forenvironmental remediation or related costs to its manufacturing facilities inthe future.

 

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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 of December 30,2007, deferred tax assets included $27.8 million relating to a tax basis stepup from a re-capitalization transaction in 1999 and $22.8 million of netoperating 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 sheetgenerated by our European operations. Cherokee Europe has a history of profits.  Recovery has been dependent upon achieving ourforecast of future operating income over a protracted period of time.  During the quarter ended June 29, 2008,management revised the forecast of our European revenues based on changes madein the orders by our European customers and a valuation allowance was recordedagainst all of Europe’s deferred tax assets. Provision (benefit) for income taxes for the quarter ended June 29,2008, and the comparable period of July 1, 2007, were a $ 1.7 millionprovision and a $1.0 million benefit, respectively.   Provision(benefit) for income taxes for the six months ended June 29, 2008 and thecomparable period of July 1, 2007, were a $1.7 million provision and a$1.6 million benefit, respectively.  The provision for the six monthsended June 29, 2008 is higher by $3.3 million than the comparable periodof July 1, 2007 due to the recording of a valuation allowance against theCompany’s European deferred tax assets in the quarter ended June 29, 2008of $1.6 million.  Based on available evidence including changes to ourforecasted revenues in Europe, management can no longer conclude it is morelikely than not that the deferred tax assets will be realizable.

 

Provision (benefit) for income taxes for the quarterand six months ended June 29, 2008 was calculated using an effective taxrate of less than one percent for the full fiscal year in addition to thevaluation allowance recorded as a discrete item in the quarter ended June 29,2008.

 

The Company adopted FIN 48, *Accounting for Uncertainty in Income Taxes,* on January 1,2007.  As a result of adoption, the Company recognized a cumulative effectadjustment of less than $0.1 million to the January 1, 2007 accumulateddeficit balance.  As of June 29, 2008, we have approximately $0.3million of gross unrecognized tax benefits, of which $0.3 million would reduceour effective tax rate if recognized.  The Company’s continuing practice is torecognize interest and/or penalties related to income tax matters in income taxexpense.

 

The tax years 1997 to 2006 remain open to examinationby the major taxing jurisdictions to which we are subject. The Company iscurrently under examination in India for certain years between 2000 and 2005and Belgium for years 2005 and 2006. During the quarter ended June 29, 2008, the IRS completed its auditof the year 2005.  The Company does notbelieve the amount of unrecognized tax benefits as of June 29, 2008 willsignificantly increase or decrease within the next twelve months.

 

United States income taxes are not provided onundistributed earnings from certain foreign subsidiaries. Those earnings areconsidered to be permanently re-invested in accordance with the AccountingPrinciples 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 ended and sixmonths ended June 29, 2008, stock options to purchase 2,618,208 shares ofour common stock were excluded from the calculation of diluted income (loss)per share as their effect would have been anti-dilutive due to the net loss forthe periods. For the quarter ended and six months ended July 1, 2007,stock options to purchase 2,777,057 shares of our common stock were excludedfrom the calculation of diluted income (loss) per share as their effect wouldhave been anti-dilutive due to the net loss for the periods.

 

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

 
| ** **                                              | ** ** | **Quarter Ended**      | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| ** **                                              | ** ** | **June 29, 2008** | ** ** | **July 1, 2007**     | ** ** | **June 29, 2008** | ** ** | **July 1, 2007** | ** ** |
| Net loss                                                |       | $                           | (569       | )                              | $          | (1,653 | ) | $ | (557 | ) | $ | (3,675 | ) |
| Shares:                                                 |       |                        |       |                           |       |   |   |   |   |
| Weighted-average common shares outstanding—basic   |       | 19,465                      |       | 19,359                         |       | 19,459 |   | 19,350 |   |
| Effect of dilutive securities:                          |       |                        |       |                           |       |   |   |   |   |
| Stock options                                           |       | —                      |       | —                         |       | — |   | — |   |
| Weighted-average common shares outstanding—diluted |       | 19,465                      |       | 19,359                         |       | 19,459 |   | 19,350 |   |
| Net loss per share:                                     |       |                        |       |                           |       |   |   |   |   |
| Basic                                                   |       | $                           | (0.03      | )                              | $          | (0.09 | ) | $ | (0.03 | ) | $ | (0.19 | ) |
| Diluted                                                 |       | $                           | (0.03      | )                              | $          | (0.09 | ) | $ | (0.03 | ) | $ | (0.19 | ) |

 

5.      DEFERREDFINANCING COSTS

 

The Company capitalizescosts directly related to financing agreements and certain qualified debtrestructuring costs, and amortizes these costs as additional interest expenseover the terms of the related debt.

 

Net deferred financing costsare comprised of the following as of June 29, 2008 and December 30,2007 (in thousands):

 
| ** **                    | ** ** | **June 29, 2008** | ** ** | **December 30, 2007** | ** ** |
|-------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| Deferred financing costs      |       | $                           | 937        |                            | $          | 580 |   |
| Accumulated amortization      |       | (558                        | )          | (494                            | )          |
| Deferred financing costs, net |       | $                           | 379        |                            | $          | 86 |   |

 

For the six months ended June 29,2008, the Company capitalized $0.4 million of financing costs related to therefinancing of the senior notes due to mature on November 1, 2008.

 

6.      DEBT

 

Debt consists of thefollowing at June 29, 2008 and December 30, 2007 (in thousands):

 
| ** **                                            | ** ** | **June 29, 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 and November 1of each year. On May 1, 2008, we paid $1.2 million of interest to thebondholders as required. The senior notes are secured by a second-priority lienon substantially all of the Company’s domestic assets and by a pledge of 65% ofthe equity of certain of the Company’s foreign subsidiaries. As of June 29,2008, the Company was in compliance with all of the covenants set forth in theprincipal agreements governing the 5.25% senior notes due in 2008. The Companydoes not currently have sufficient funds to repay these notes and is activelyworking to either refinance this obligation or to satisfy it through a numberof strategic alternatives currently being explored. The Company acknowledgesthat if it does refinance the obligation, the interest rate may besubstantially higher than the current interest rate of 5.25% and anyrefinancing may be on terms that are materially less favorable. In addition, ifthe Company is not able to obtain satisfactory financing, the Company may beforced to sell some of its assets or to otherwise significantly alter itsoperating plan.

 

TheCompany’s primary line of credit is its senior revolving credit facility withGeneral Electric Capital Corporation (the “Credit Facility”). The CreditFacility expires on August 25, 2008. The company plans to renew this linewith a new lender after our senior note obligations have been repaid orrenegotiated. During the fourth quarter of 2007, the Company approached GeneralElectric Capital Corporation about re-negotiating the Credit Facility in orderto increase the borrowing capacity that had been lowered by the Company’shistorical earnings before interest, taxes, depreciation and amortizationexpense (“EBITDA”) covenant.

 

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On November 1, 2007,the Company and General Electric Capital Corporation amended the creditagreement for the revolving line of credit dated February 24, 2004. Theamended Credit Facility provides for borrowings of up to the lesser of$7.5 million or 85% of eligible domestic accounts receivable. As of June 29,2008, our borrowing base was $7.5 million, and our eligible accountsreceivable was $10.7 million. Prior to November 1, 2007, theborrowings bore interest, at the Company’s option, at a rate per annum equal toLIBOR plus 2.5% or the agent bank’s base rate plus 1.0%. Effective November 1,2007, the borrowings bear interest, at the Company’s option, at a rate perannum equal to LIBOR plus 3.5% or the agent bank’s base rate plus 2.0%. Inaddition to paying interest on outstanding principal, the Company is requiredto pay a commitment fee to the lender under the Credit Facility in respect ofthe average daily balance of unused loan commitments at a rate of 1.0% perannum effective November 1, 2007. Prior to November 1, 2007, the ratewas 0.5% per annum. In lieu of a maximum senior leverage multiple covenant, thenew amended Credit Facility effective November 1, 2007 includes a minimumEBITDA target for the trailing quarters starting with the fourth quarter of2007, which the Company was in compliance with at June 29, 2008. Prior to November 1,2007, the EBITDA covenant limited our borrowing to the lower of the borrowingbase or two times our EBITDA as defined by the prior credit agreement. TheCredit Facility is secured by a first-priority lien, subject to permittedencumbrances, on substantially all of the Company’s domestic assets and by apledge of 65% of the equity of certain of the Company’s foreign subsidiaries.The Credit Facility contains certain restrictive covenants including theminimum EBITDA target. In March 2008, General Electric Capital Corporationmodified the amended credit agreement effective as of December 30, 2007for a balance sheet covenant issue resulting from the capitalization ofintercompany debt with our Dutch holding company during 2007. As of June 29,2008, there were no borrowings outstanding under the Credit Facility, and the Companywas in 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. In November 2007,ING Belgie NV restricted the Company from transferring funds from Europeto the U.S. in the form of management and dividend fees. During the quarterended September 30, 2007, Cherokee Europe borrowed $2.2 million fromthe line of credit with an interest rate of 6.02%, subject to change uponquarterly renewals, which remained outstanding as of June 29, 2008. Theinterest rate for the second quarter of 2008 was renewed at 6.08%.  On April 28, 2008, Cherokee Europeborrowed $0.8 million, with an interest rate of 5.65%, subject to change uponquarterly renewals, from its line of credit with ING Belgie NV. The outstandingbalance on the line of credit as of June 29, 2008 was $3.0 million. As of June 29,2008, Cherokee Europe was in compliance with all covenants.

 

InJune 2008, ING Belgie NV restricted our borrowing capacity to $3.0million, expressed as Euros 1.9 million. By the end of the third quarter in2008, Cherokee Europe’s line of credit will be converted into a new factoringarrangement with ING Belgie NV.  Thearrangement will be based on the factoring of 85% of the majority of CherokeeEurope’s current outstanding accounts receivable balances with an aging of 30days or less at each borrowing date.  The85% of accounts receivable balances will include sales generated by companieslocated in Belgium and bordering countries including Austria, Switzerland andIreland, Europe, North America, and Canada. The remaining accounts receivablebalances generated by companies located in the remaining countries will befactored at 10%.  The effective interestrate of the new factoring arrangement will be Euribor plus 1%. There will alsobe a 0.07% loan fee on the outstanding accounts receivable balance at eachborrowing.

 

InJanuary 2007, Cherokee China entered into a loan contract with Industrialand Commercial 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 RMB25.0 million. The line of credit is collateralized by the Company’sbuilding in Shanghai, China. In April 2008, Cherokee China renegotiatedthe borrowing capacity on its line of credit with ICBC, from RMB 25 million toRMB 28 million to reflect the increased market value of the building, with theinterest rate of LIBOR plus 12%, which is effective from April 21, 2008through April 20, 2011.  As of June 29,2008, RMB 28 million was equivalent to $4.1 million in US dollars. Interest ispayable monthly at a fixed rate based on the transaction date of ourborrowings, the rates vary according to the specific dates and are announced bythe People’s Bank of China. Beginning with its initial borrowing under thecontract, Cherokee China agreed to deposit in the ICBC Shanghai Branch at least90% of the operating revenue it collects. The cash from these deposits madeinto our bank account are not restricted from our usage of these funds. During May 2008,Cherokee China borrowed $0.5 million on its line of credit with an interestrate of 6.8985% for the subsequent six-month period.

 

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As of June 29, 2008, the outstanding balance on the line of creditwas $0.5 million, and Cherokee China was in compliance with all of the covenants.

 

In January 2008, Cherokee Europeborrowed short-term funds of $0.6 million from ING Belgie NV. Theloan arrangement is over twelve months, with monthly payments of $54,000 to berepaid by December 26, 2008. The loan bears a 6.3% interest rate. The outstandingbalance as of June 29, 2008 was $0.3 million.

 

7.                  OTHER LONG-TERM OBLIGATIONS

 

Other long-term obligations consist of the following at June 29,2008 and December 30, 2007 (in thousands):

 
| ** **                                    | ** ** | **June 29, 2008** | ** ** | **December 30, 2007** | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|---------------------------------|------------|
| 1999 Europe restructuring liabilities         |       | $                           | 247        |                            | $          | 397 |   |
| 2003 Europe restructuring liabilities         |       | 1,022                       |       | 1,064                           |       |
| Long service award liabilities                |       | 972                         |       | 910                             |       |
| Pension liability-SFAS 158                    |       | 1,431                       |       | 1,337                           |       |
| Deferred compensation                         |       | 198                         |       | 237                             |       |
| Advances for research &  development |       | 641                         |       | 589                             |       |
| Total other long-term obligations             |       | $                           | 4,511      |                            | $          | 4,534 |   |

 

The Companyhas agreements with a local government agency in Belgium for funding inadvances to Cherokee Europe for research and development expenses. Theseadvances are interest free and expected to be repaid to the agency; either as apercentage of the revenues generated by the products developed or through aminimum fixed amount on an annual basis.

 

As of June 29,2008, the Company has a recorded liability of $0.6 million, for employee andnon-employee contributions and investment activity to date under the deferredcompensation plan, the current portion of $0.4 million is recorded underaccrued compensation and benefits and the long-term portion of $0.2 million isrecorded in other long-term liabilities.

 

8.                  CUSTOMER CONCENTRATION

 

For thequarter ended June 29, 2008, one customer accounted for 11.4% of netsales, and another customer accounted for 10.5% of net sales. For the quarterended July 1, 2007, one customer accounted for 11.8% of net sales, and noother customer accounted for more than 10% of net sales. For the six monthsended June 29, 2008, one customer accounted for 11.1% of net sales, and noother customer accounted for more than 10% of net sales.  For the six months ended July 1, 2007,one customer accounted for 10.9% of net sales, and no other 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 June 29,2008, one customer accounted for 9.7% of net accounts receivable, and no othercustomer accounted for more than 10% of net accounts receivable.  As of December 30, 2007, one customeraccounted for 10.6% of net accounts receivable.

 

9.                  COMMITMENTS AND CONTINGENCIES

 

Guarantees and Indemnities

 

The Company has agreed toindemnify the former owners of Cherokee Europe for product liability,environmental hazard and employment practice claims relating solely topost-acquisition business. The Company also indemnifies its directors andofficers, to the maximum extent permitted under the laws of the State ofDelaware, and various lessors in connection with facility leases for certainclaims arising from such facility or lease. The maximum amount of potentialfuture payments under such indemnifications is not determinable.

 

The Company has notincurred significant amounts related to these guarantees and indemnifications,and no liability has been recorded in the consolidated financial statements forguarantees and indemnifications as of June 29, 2008 and December 30,2007.

 

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**Cash Incentive Compensation Programand Severance Agreements**

 

The Company adopted acash incentive program for certain executives, which provides for cashincentive payments of up to 123% of base salary subject to attainment ofcorporate goals and objectives approved by the Company’s board of directors. Inaddition, the Company has entered into severance agreements with certainexecutives and managers, which provide payments to the executives or managersif they are terminated (i) other than for cause or (ii) because of achange in control, as defined in the applicable severance agreement. Certain ofthe severance agreements provide additional benefits, including acceleration ofstock options, in the event of termination in connection with a change ofcontrol, as defined in the applicable severance agreement.

 

On February 29, 2008, the Companyentered into an amendment to the Company’s existing severance agreement witheach of Jeffrey M. Frank, the Company’s President and Chief Executive Officer,Linster W. Fox, the Company’s Executive

Vice President, Chief Financial Officer and Secretary, and MukeshPatel, the Company’s Executive Vice President of Global Operations. Theseexecutives’ severance agreements provide for certain severance payments to bemade in the event that the Company terminates the executive’s employmentwithout cause. The amendments provide that, if severance is triggered under theexecutive’s severance agreement, the executive’s severance benefit will consistof a cash payment equal to two times the executive’s current base salary at thetime of termination and continued medical benefits for up to two years. In thecase of Mr. Patel, the amendment further amends his severance agreement toprovide that if he terminates his employment with the Company for good reasonwithin one year following a change in control event, he will be entitled to theseverance benefits described above. The amendments further amend Mr. Frank’sand Mr. Fox’s severance agreements to provide that each of them mayterminate employment for any reason within two years following a change incontrol of the Company and, in such event, they will be entitled to: a cashpayment equal to two times the executive’s current base salary at the time oftermination; a prorata cash payment equal to the executive’s annual bonus atthe time of termination (calculated as if the Company achieved financialperformance equal to that set forth in the then-most current budget approved bythe Company’s Board of Directors); immediate vesting of all outstanding stockoptions; continued medical benefits for up to two years; a cash payment equalto the amount forfeited by the executive under the Company’s 401(k) orsimilar plan; use of an executive outplacement service in an amount not toexceed $50,000 or a lump-sum cash payment in lieu thereof; and any additionalbenefits then due or earned under applicable plans or programs of the Company.The severance agreements also include certain confidentiality, non-solicitationand inventions covenants in favor of the Company.

 

On February 29, 2008, the Company alsoentered into a severance agreement with Alex Patel, the Company’s VicePresident of Engineering. The severance agreement provides that, in the event Mr. Patel’semployment is terminated either by the Company without cause or by Mr. Patelfor good reason within one year following a change in control event, Mr. Patelwill be entitled to receive a cash payment equal to one times his then currentannual base salary 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 the terminationof his employment. The severance agreement also includes certainconfidentiality, non-solicitation and inventions covenants in favor of theCompany.

 

Transaction Bonus Agreements

 

On April 14, 2008, the Company entered into transaction bonusagreements with each of Jeffrey M. Frank, the Company’s President and ChiefExecutive Officer, Linster W. Fox, the Company’s Executive Vice President,Chief Financial Officer and Secretary, and Mukesh Patel, the Company’sExecutive Vice President of Global Operations (each, an “executive”).  Thetransaction bonus agreements provide that, in the event of a company sale(defined in the agreements as a sale in one or a series of related transactionsof all or substantially all of the Company’s assets, or of more than 50% of theissued and outstanding voting equity securities of the Company other than tothe Company or certain major shareholders), the executive will be entitled toreceive a transaction bonus, provided that the executive is either employed bythe Company at the time of the company sale, the Company terminates theexecutive’s employment without cause (as defined in the agreements) within sixmonths prior to the company sale, or the executive terminates his employmentfor good reason (as defined in the agreements) within six months prior to thecompany sale.  If the executive terminates his employment with the Companyvoluntarily or is terminated by the Company for cause prior to the companysale, the executive is not eligible for a bonus under the transaction bonusagreement.  Further, the executive must execute a general release ofclaims in favor of the Company following the company sale in order to receivehis transaction bonus.

 

The amount of the transaction bonus that each executive is eligible forpursuant to his agreement varies and is tied to the net proceeds from thecompany sale.  The maximum amount of the transaction bonus for each of Messrs. Frank,Fox and Patel is $5 million, $3 million and $450,000, respectively, based on anet sales price of $10.00 per share.  The agreements also contain anon-solicitation covenant in favor of the Company.

 

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SynQor

 

On November 16, 2007, SynQor announcedthat it had filed a lawsuit against several of its competitors, including theCompany who was named in the complaint, for infringement of two patentsrelating to bus converters and/or non-isolated point of load converters used inintermediate bus architectures. The patents at issue are U.S. patents 7,072,190and 7,272,021. 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.

 

10.    RESTRUCTURING COSTS AND ASSETIMPAIRMENT CHARGES FOR CLOSURE OF GUADALAJARA, MEXICO FACILITY

 

During the quarter ended October 1,2006, the Company announced the planned closure of its Mexican facilities and arelated restructuring plan, which was accounted for in accordance withSFAS 146, *Accounting for CostsAssociated with Exit or Disposal Activities*. The Mexico Facilityencompassed 35,000 square feet in one building and had been in operation since1988, employing approximately 250 full-time and temporary employees in theproduction of power supplies.

 

The restructuring and closure of our MexicoFacility was completed by the end of the second quarter of 2007. The cumulativecosts for the closure of the Mexico Facility were $1.5 million($1.3 million of which were recorded in 2006). This was made up of$0.9 million restructuring, $0.3 million asset impairment and$0.3 million additional excess and obsolescence reserve. During the secondquarter ended July 1, 2007, there was a reversal of $38,000 to severancecosts due to the transfer and relocation of an employee from the MexicoFacility to our Tustin Facility. The remaining accrued balance for severanceand stay bonuses was paid on July 1, 2007 to the remaining employees.

 

*Assets held for sale—Mexico Facility building sold*

 

The Company began actively searching for abuyer for the Mexico Facility building during the quarter ended October 1,2006; however, in accordance with SFAS 144, *Accounting for the Impairment or Disposal of Long-Lived Assets*,the related assets were not classified as assets held for sale in the condensedconsolidated balance sheets prior to April 1, 2007, because the Companydid not meet the criterion that “the asset (disposal group) is available forimmediate sale in its present condition subject only to terms that are usualand customary for sales of such assets”, due to our continued utilization ofassets in our ongoing operations at our Mexico Facility.

 

The Company ceased operations in Mexico in March 2007,and reclassified the net book value of $0.7 million for the building andthe related assets to *assets held for sale*on the condensed consolidated balance sheet as of April 1, 2007, inaccordance with SFAS 144. In addition, depreciation of the assets relatedto this sale was suspended as of April 1, 2007. There was no impairmentcharge to the related assets because management determined that the measurementvalue, the net book value, was lower than the estimated fair value less cost tosell.

 

On February 22, 2007, CherokeeElectronica, S.A. de C.V. (“Cherokee Mexico”), a subsidiary of theCompany, entered into a Purchase and Sale Agreement (the “Agreement”) withInmobiliaria Hondarribia, S.A. de C.V. (the “Buyer”) for the sale ofCherokee Mexico’s 35,000-foot manufacturing facility in Guadalajara, Mexico.The Agreement provided that the Buyer pay Cherokee Mexico an aggregate purchaseprice of approximately US $1.2 million of which a 15% deposit,approximately US $182,000, was paid on February 22, 2007. On May 24,2007, the sale of the building was completed, and the remaining 85% of thesales price was transferred into the Company’s bank account. The Company alsocollected the value added tax on the building in addition to the sales priceand paid the taxes collected to the Mexican government in June 2007. Thenet gain of the sale recorded during the quarter ended July 1, 2007, was$0.4 million, net of $0.1 million related to the cost to sell theassets which was deducted from the gain.

 

*Sale of MexicoCorporation*

 

On December 12, 2007, the Company soldits ownership in the capital stock of Cherokee Mexico. The Company received theproceeds from the sale on December 13, 2007. The net gain of the sale was$0.4 million.

 

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*Asset Impairment Charges related to Other Assets*

 

During the quarter ended October 1, 2006,the Company performed an impairment review in accordance with SFAS 144, *Accounting for the Impairment and Disposal ofLong-Lived Assets,* to determine whether any of its long-lived assetslocated at the Mexico Facility were impaired. The Company identified certainlong-lived assets associated with the restructuring and closure of the MexicoFacility whose carrying value would not be recoverable from future cash flowsand recorded an impairment charge of $0.3 million for these assets. Theseassets consisted of machinery and equipment, computer technology and equipment,and office furniture and equipment. The majority of these assets were writtenoff because the Company considered them to have no market value. None of theimpairment charges included cash components.

 

*Restructuring Costs*

 

In accordance with SFAS 146, employeeseverance, contract termination and other exit costs are recorded at theirestimated fair value when they are incurred. During the quarter ended July 1,2007, there was a reversal of $38,000 to severance costs due to the transferand relocation of an employee from the Mexico Facility to our Tustin Facility.

 

There were $0.2 million of employeeseverance and stay bonus costs during the first six months of 2007, whichincluded a pro-rata portion from the commencement date of August 10, 2006through July 1, 2007, of an estimated amount of statutorily requiredseverance payments and management performance stay-on bonuses incurred foremployees at the Mexico Facility. The Company paid $0.6 million ofseverance and related expenses to the remainder of employees terminated duringthe quarter ended July 1, 2007. All severance charges were settled withcash as of July 1, 2007.

 

11.            STOCK AND DEFERRED COMPENSATION PLANS

 

2002 Stock Option Plan

 

In July 2003, the Company adopted theCherokee International Corporation 2002 Stock Option Plan (the “2002 StockOption Plan”) under which up to 1,410,256 shares of the Company’s common stockmay be issued pursuant to the grant of non-qualified stock options to thedirectors, officers, employees, consultants and advisors of the Company and itssubsidiaries. In connection with the adoption of the 2002 Stock Option Plan,the Company granted 1,087,327 stock options. The options typically vest over afour-year period, have a ten-year contractual life, range in exercise pricefrom $5.85 to $10.34 per share and were granted with exercise prices at orabove fair value as determined by the Company’s Board of Directors based onincome and market valuation methodologies. In February 2004, the Companygranted options to purchase 328,320 shares of common stock at an exercise priceof $14.50 and terminated the 2002 Stock Option Plan. As of June 29, 2008,the Company had granted a total of 1,415,647 options to purchase shares ofcommon stock under the 2002 Stock Option Plan, which includes options topurchase shares that were cancelled and subsequently re-granted.

 

2004 Omnibus Stock Incentive Plan

 

On February 16,2004, the Company adopted the 2004 Omnibus Stock Incentive Plan (the “2004 Plan”),which provided for the issuance of 800,000 shares of common stock. The 2004Plan also provides for an annual increase to be added on the first day of theCompany’s fiscal year equal to the lesser of (i) 450,000 shares or (ii) 2%of the number of outstanding shares on the last day of the immediatelypreceding fiscal year. As of June 29, 2008, a total of 3,315,141 shares ofthe Company’s common stock were reserved for issuance under the 2004 Plan. Anyofficer, director, employee, consultant or advisor of the Company is eligibleto participate in the 2004 Plan. The 2004 Plan provides for the issuance ofstock-based incentive awards, including stock options, stock appreciationrights, restricted stock, deferred stock, and performance shares. As of June 29,2008, the Company had granted options to purchase 2,399,489 shares of commonstock under the 2004 Plan, which included 378,153 options issued as partialcompensation to non-employee directors. During the quarter ended and six monthsended June 29, 2008, the Company granted options to purchase 70,000 sharesto non-employee directors.

 

2004 Employee Stock Purchase Plan

 

On February 16, 2004, the Companyadopted the 2004 Employee Stock Purchase Plan (the “ESPP”). The ESPP providesfor an annual increase to be added on the first day of the Company’s fiscalyear equal to the lesser of (i) 250,000 shares or (ii) 1% of thenumber of outstanding shares on the last day of the immediately precedingfiscal year. As of June 29, 2008, a total of 914,220 shares of commonstock were reserved for issuance under the plan. The ESPP, which is intended toqualify as an “employee stock purchase plan” under Section 423 of theInternal Revenue Code of 1986, is implemented utilizing six-month offeringswith purchases occurring at six-month intervals, with a new offering periodcommencing on the first trading day on or after May 15 and November 15and ending on the last trading day on or before November 14 or May 14,respectively. The Compensation Committee of the Company’s Board of Directorsoversees administration of the ESPP. Employees are eligible to participate ifthey are employed for at least 20 hours per week and more than5 months in a calendar year by the Company, subject to certainrestrictions.

 

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The ESPPpermits eligible employees to purchase common stock through payroll deductions,which may not exceed 15% of an employee’s compensation. The price of commonstock purchased under the ESPP is 85% of the lower of the fair market value ofthe common stock at the beginning of each six-month offering period or on theapplicable purchase date. Employees may end their participation in an offeringat any time during the offering period, and participation ends automaticallyupon termination of employment. The Compensation Committee may at any timeamend or terminate the ESPP, except that no such amendment or termination mayadversely affect shares previously issued under the ESPP. As of June 29,2008, 258,351 shares of common stock had been issued under the ESPP.

 

Deferred Compensation Plan

 

On February 16, 2004, the Companyadopted two executive deferred compensation plans for the benefit of certaindesignated employees and non-employee directors of the Company. The plans wereamended on January 1, 2008 to comply with the regulations for nonqualifieddeferred compensation arrangements under Internal Revenue Code (IRC) Section 409A.The plans allow participating employees and non-employee directors to makepre-tax deferrals of up to 100% of their annual base salary and bonuses, andretainer fees and meeting fees, respectively. The plans allow the Company tomake matching contributions and employer profit sharing credits at the solediscretion of the Company. A participant’s interest in each matchingcontribution and employer profit sharing credit, if any, vests in full no laterthan after 3 years.

 

As of June 29, 2008, the Company has arecorded liability of $0.6 million for employee and non-employee directorcontributions and investment activity to date; the current portion of$0.4 million is recorded under accrued compensation and benefits and thelong-term portion of $0.2 million is recorded in other long-termliabilities. As of December 30, 2007, the Company had a recorded liabilityof $1.4 million, of which $1.1 million was recorded under accruedcompensation and benefits and the long-term portion of $0.2 million wasrecorded in other long-term liabilities. The Company has not provided anymatching contributions under the plans.

 

During the six months ended June 29,2008, the Company paid $0.6 million of scheduled distributions to participantsfrom the deferred compensation plan.  TheCompany also made partial surrenders on two policies during the first quarterof 2008 in the amount of $0.4 million. The partial surrenders did not change the face amount of the policies.During July 2008, the Company paid $0.2 million of scheduled distributionsto participants from the deferred compensation plan.  The Company anticipates making additionalpartial surrenders on the policies during the third quarter of 2008 for thereimbursement of these distributions.

 

12.            RETIREMENTPLANS

 

CherokeeEurope maintains a pension plan for certain levels of staff and management thatinclude a defined benefit feature. The following represents the amounts relatedto this defined benefit plan for the quarter and six months ended June 29,2008 and July 1, 2007, respectively (in thousands):

 
| ** **                                                           | ** ** | **Quarter Ended**      | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------------|------------|--------------------------------|------------|
| **Components of Net Periodic Benefit Cost** | ** ** | **June 29, 2008** | ** ** | **July 1, 2007**     | ** ** | **June 29, 2008** | ** ** | **July 1, 2007** | ** ** |
| Service cost                                                         |       | $                           | 73         |                           | $          | 90 |   | $ | 146 |   | $ | 177 |   |
| Interest cost                                                        |       | 109                         |       | 105                            |       | 219 |   | 207 |   |
| Expected return on plan assets                                       |       | (68                         | )          | (59                            | )          | (137 | ) | (116 | ) |
| Net periodic benefit cost                                            |       | $                           | 114        |                           | $          | 136 |   | $ | 228 |   | $ | 268 |   |

 

13.            GOODWILL IMPAIRMENT CHARGE

 

Based on our annual assessment of the fairvalue of our Cherokee Europe subsidiary in accordance with SFAS 142, werecorded a goodwill impairment charge of $5.2 million during the yearended December 30, 2007, to properly report goodwill at its fair value atthat period in time.

 

Due to the decline in our European operation’srevenue volumes during the six months ended June 29, 2008, the Companyperformed a revised forecast for the remaining year of 2008 and the next threeyears.  Since our actual and futurerevenues were trending lower than anticipated revenues of our original businessplan, the Company engaged a professional consulting firm to perform a SFAS 142valuation and analysis study of our goodwill. As a result of this study, an impairment charge of $1.1 million wasrecorded during the quarter ended June 29, 2008 due to the decrease in fairvalue of our Cherokee Europe subsidiary. As of June 29, 2008 the Company no longer has any goodwillrecorded.

 

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Item 2.   MANAGEMENT’S DISCUSSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

FORWARD-LOOKING STATEMENTS

 

Certain statements in this Quarterly Reporton Form 10-Q, other than purely historical information, includingestimates, projections, statements relating to our business plans, objectivesand expected operating results, and the assumptions upon which those statementsare based, are “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995, Section 27A of the SecuritiesAct of 1933 and Section 21E of the Securities Exchange Act of 1934. Theseforward-looking statements are based upon our current expectations about futureevents. When used in this Quarterly Report, the words “believes,” “projects,” “expects,”“anticipates,” “estimates,” “intends,” “strategy,” “plan,” “may,” “will,” “would,”“will be,” “will continue,” “will likely result,” and similar expressions, orthe negative of such words and expressions, are intended to identifyforward-looking statements, although not all forward-looking statements containsuch words or expressions. These forward-looking statements generally relate toour plans, objectives and expectations for future operations and includestatements in this Quarterly Report regarding the following: our expectationsthat cash flows will be sufficient to meeting our operating requirements for atleast the next twelve months; our expectations regarding our working capitaland capital expenditure requirements; and our expectations regarding therefinancing or payment of our senior note obligations. However, thesestatements are subject to a number of risks and uncertainties affecting ourbusiness. You should read this Quarterly Report completely and with theunderstanding that actual future results may be materially different from whatwe expect as a result of these risks and uncertainties and other factors, whichinclude, but are not limited to: (1) the potential delisting of theCompany’s common stock from the NASDAQ Global Market, (2) changes ingeneral economic and business conditions, domestically and internationally, (3) reductionsin sales to, or the loss of, any of the Company’s significant customers or incustomer capacity generally, (4) changes in the Company’s sales mix tolower margin products, (5) increased competition in the Company’sindustry, (6) disruptions of the Company’s established supply channels, (7) theCompany’s level of debt and restrictions imposed by its debt agreements, and (8) theadditional risk factors included in Part II, Item 1A of this QuarterlyReport. Except as required by law, the Company undertakes no obligation toupdate any forward-looking statements, even though the Company’s situation maychange in the future.

 

INTRODUCTION

 

The following discussion should be read inconjunction with the unaudited condensed consolidated financial statement andnotes of Cherokee International Corporation included above in this QuarterlyReport on Form 10-Q and with the audited financial statements, footnotesand Management Discussion and Analysis of Financial Condition and Results ofOperations included in the Company’s Annual Report on Form 10-K.

 

OVERVIEW

 

Business

 

We are a designer and manufacturer of powersupplies for OEMs. Our 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.

 

We operate worldwide and have facilities inOrange County, California; Bombay, India; Wavre, Belgium (Europe) and Shanghai,China. In March 2007, we closed our facility in Guadalajara, Mexico (the “MexicoFacility”). In May 2007, we sold our manufacturing facility inGuadalajara, Mexico and on December 12, 2007, we sold our subsidiary,Cherokee Electronica, S.A. de C.V. (“Cherokee Mexico”). We were founded in1978 in Orange County, California. As we expanded our business and customerbase, we opened facilities in Bombay, India, Guadalajara, Mexico, and Shanghai,China. In June 2000, we acquired Cherokee Europe SCA and related entities(“Cherokee Europe”), which added a manufacturing facility in Wavre, Belgium toour manufacturing capacity and enabled us to better serve the European market.

 

We generate the majority of our sales in fourmarket sectors, datacom, telecom, industrial and medical. For the quarter endedJune 29, 2008, our revenues by market sector consisted of 47% datacom, 24%telecom, and 29% for the industrial and medical sectors.

 

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Basis of Reporting

 

**Principles of Consolidation**

 

The condensed consolidated financial statementsinclude the financial statements of the Company and its wholly ownedsubsidiaries, Cherokee Europe, Cherokee India Pvt. Ltd. (“Cherokee India”),Powertel India Pvt. Ltd. (“Powertel”), and Cherokee International (China)Power Supply LLC (“Cherokee China”), and the financial statements of itsformerly owned subsidiary Cherokee Mexico were included in the year ended December 30,2007. Inter-company accounts and transactions have been eliminated.

 

Net Sales

 

See**Revenue Recognition of Critical AccountingPolicies section below for Company description.

 

Cost of Sales

 

The principal elementscomprising cost of sales are raw materials, labor and manufacturing overhead.Raw materials account for a large majority of our costs of sales. Raw materialsinclude magnetic sub-assemblies, sheet metal, electronic and other components,mechanical parts and electrical wires. Direct labor costs primarily includecosts of hourly employees. Manufacturing overhead includes salaries, and thedirect expense and allocation of costs attributable to manufacturing for leasecosts, depreciation on property, plant and equipment, utilities, property taxesand repairs and maintenance.

 

Operating Expenses

 

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

 

Critical Accounting Policies

 

We prepare our condensed consolidatedfinancial statements in conformity with accounting principles generallyaccepted in the United States. As such, we are required to make certainestimates, judgments and assumptions that we believe are reasonable based uponthe information currently available. These estimates and assumptions affect thereported amounts of assets and liabilities at the date of the condensedconsolidated financial statements and the reported amounts of revenues andexpenses during the periods presented. Any future changes to these estimatesand assumptions could have a material effect on our reported amounts ofrevenue, expenses, assets and liabilities. The significant accounting policiesthat we believe are the most critical to aid in fully understanding andevaluating our reported financial results include the following:

 

Revenue Recognition

 

We recognize revenue when persuasive evidenceof an arrangement exists, title transfer has occurred, the price is fixed orreadily determinable, and collectability is probable. We recognize revenue inaccordance with Staff Accounting Bulletin No. 104, Revenue Recognition. Sales are recorded net of discounts, whichare estimated at the time of shipment based upon historical data. Changes inassumptions regarding the rate of sales discounts earned by our customers couldimpact our results.

 

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

 

The Company has entered into arrangementswith certain customers whereby products are delivered to a third-partywarehouse location for interim storage until subsequently shipped and acceptedby our customers. Revenues from these sales are recognized upon shipment fromthe third-party warehouse location to the customers, when title has passed. TheCompany generally offers a one-year warranty for defective products. Warrantycharges have been insignificant during the periods presented.

 

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Accounts Receivable

 

In our North American andEuropean operations we perform ongoing credit evaluations of our customers, thecustomer’s current credit worthiness and various other factors, as determinedby our review of their current credit information. We continuously monitorcollections and payments from our customers and maintain a provision forestimated credit losses based upon our historical experience and any specificcustomer collection issues that we have identified. While credit losses havehistorically been within our expectations and the provisions established, wemight not continue to experience the same credit loss rates that we have in thepast. A significant portion of our accounts receivable are concentrated in asmall number 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 June 29, 2008and December 30, 2007, our top ten customers accounted for  42% and 50% of our accounts receivables,respectively.

 

**CreditRisk**

** **

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

 

**Translation of Foreign Currencies**

** **

Foreign subsidiary assets and liabilitiesdenominated in foreign currencies are translated at the exchange rate in effecton the balance sheet date. Revenues, costs and expenses are translated at theaverage exchange rate during the period. Transaction gains and losses areincluded in results of operations and have not been significant for the periodspresented. The functional currency of Cherokee Europe is the Euro. Thefunctional currency of Cherokee India, Powertel and Cherokee China is the U.S.dollar, as the majority of transactions are denominated in U.S. dollars.Translation adjustments related to Cherokee Europe are reflected as a componentof stockholders’ equity in other comprehensive income (loss).

 

Inventories

 

We value our inventory at the lower of theactual cost to purchase and/or manufacture the inventory and the currentestimated market value of the inventory using the weighted average cost method.We regularly review inventory quantities on hand and record a provision forexcess and obsolete inventory based primarily on our historical usage data andestimates of future demand. Since substantially all of our products aremanufactured according to firm purchase orders and customer forecasts, weevaluate the potential of recovery from our customers when customized productsapproach end-of-life. Our customers are generally liable for inventory costs weincur for order cancellations that occur after we have committed resources toprocure or manufacture product. We also regularly evaluate inventory that isnon-compliant with the European Commission’s RoHS directive regarding hazardoussubstances in electric and electronic equipment, to determine if additionalreserves are needed to cover for potential obsolescence. We have notestablished a separate reserve for non-RoHS compliant inventory above what ournormal calculations would require.

 

Our industry is characterized by rapidtechnological change, frequent new product development, and rapid productobsolescence that could result in an increase in the amount of obsoleteinventory quantities on hand. As demonstrated during the past five years,demand for our products can fluctuate significantly. A significant increase inthe demand for our products could result in a short-term increase in the costof inventory purchases while a significant decrease in demand could result inan increase in the amount of excess inventory quantities on hand. In addition,our estimates of future product demand may prove to be inaccurate, in whichcase we may have understated or overstated the provision required for excessand obsolete inventory. In the future, if our inventory were determined to beovervalued, we would be required to recognize additional expense in our cost 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 taxassets and liabilities based on the differences between the financial statementcarrying values and the tax bases of assets and liabilities. We regularlyreview our deferred tax assets for recoverability and establish a valuationallowance based on historical taxable income, projected future taxable income,and the expected timing of the reversals of existing temporary differences.

 

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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 taxesinclude $1.6 million of tax benefits on the balance sheet generated by ourEuropean operations.  Cherokee Europe hasa history of profits.  Recovery has beendependent upon achieving our forecast of future operating income over a protractedperiod of time.  During the quarter endedJune 29, 2008, management revised the forecast of our European revenuesbased on changes made in the orders by our European customers and a valuationallowance was recorded against all of Europe’s deferred tax assets.  Based on available evidence including changesto our forecasted revenues in Europe, management can no longer conclude it ismore likely than not that the deferred tax assets will be realizable.

 

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

 

The Company adopted theprovisions of FASB Interpretation (FIN) 48, *Accounting for Uncertainty in Income Taxes* (FIN 48), on January 1,2007. FIN 48 clarifies the accounting for uncertainty in income taxesrecognized in an enterprise’s financial statements in accordance withSFAS 109, *Accounting for Income Taxes*,by prescribing a recognition threshold and measurement attribute for thefinancial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. Under FIN 48, the financial statementeffects of a tax position should initially be recognized when it is more likelythan not, based on the technical merits, that the position will be sustainedupon examination. A tax position that meets the more-likely-than-notrecognition threshold should initially and subsequently be measured as thelargest amount of tax benefit that has a greater than fifty percent likelihoodof being realized upon ultimate settlement with a taxing authority. FIN 48 iseffective for fiscal years beginning after December 15, 2006. See Note 3, “Provisionfor Income Taxes” in Notes to Condensed Consolidated Financial Statements foradditional information regarding the impact of adoption.

 

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

** **

**OtherComprehensive Income**

 

Belgium taxes for unrealizedforeign exchange gains on an intercompany loan considered permanentlyre-invested are provided for as a component of other comprehensive income orloss.

 

Goodwilland Long Lived Assets

 

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

 

We also review the recoverability of thecarrying value of long-lived assets whenever events or changes in circumstancesindicate that the carrying amount of an asset may not be recoverable.Recoverability of these assets is determined based upon the forecastedundiscounted future net cash flows from the operations to which the assetsrelate, utilizing management’s best estimates, based on appropriate assumptionsand current projections.

 

These projected future cash flows may varysignificantly over time as a result of increased competition, changes intechnology, fluctuations in demand, consolidation of our customers andreductions in average selling prices. If the carrying value is determined notto be recoverable from future operating cash flows, the asset would be deemedimpaired and an impairment loss would be recognized on the date ofdetermination to the extent the carrying value exceeded the estimated fairmarket value of the asset.

 

Based on our annual assessment of the fairvalue of our Cherokee Europe subsidiary in accordance with SFAS 142, werecorded a goodwill impairment charge of $5.2 million during the yearended December 30, 2007, to properly report goodwill at its fair value atthat period in time.

 

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During the quarter ended June 29, 2008,the remaining balance of $1.1 million of goodwill was deemed impaired. Animpairment charge was recorded due to the decrease in fair value of ourCherokee Europe subsidiary due to lower revenues than anticipated.  As of June 29, 2008 the Company nolonger has any goodwill recorded. Details are included under Note 13 to the accompanying Notes to theCondensed Consolidated Financial Statements included in Item 1, “FinancialStatements.”

 

**Stock-Based Compensation**

** **

The Company adopted SFAS 123R on January 2,2006 using the “modified prospective” method as permitted by SFAS 123R.Under this transition method, stock compensation cost recognized beginning inthe first quarter of fiscal year 2006 includes: (a) compensation cost forall share-based payments granted subsequent to February 25, 2004 and priorto January 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 to January 2,2006 was $2.3 million, which will be amortized as stock compensation coststhrough December 2010. All grants are made at prices based on the fair marketvalue of the stock on the date of grant. Outstanding options generally vestfour years from the grant date, with certain limited exceptions, and expire upto ten years after the grant date.

 

The Companyrecords compensation expense for employee stock options based on the estimatedfair value of the options on the date of grant using the Black-Scholes optionpricing formula with the assumptions included in the table under “Stock-BasedCompensation” in Note 3 to the accompanying Condensed Consolidated FinancialStatements.  The Company uses historicaldata, among other factors, to estimate the expected price volatility and theexpected forfeiture rate. For options granted prior to January 2, 2006,the Company used the expected option life of 5 years. For options grantedfollowing the Company’s adoption of SFAS 123R, the expected life wasincreased to 6.25 years using the “simplified method” under SAB 107(an expected term based on the mid-point between the vesting date and the endof the contractual term). The options have a maximum contractual term of10 years and generally vest as to 25% of the underlying stock on eachanniversary of the date of grant, subject to accelerated vesting in the eventof a change in control of the Company. The risk-free rate is based on the U.S.Treasury yield curve in effect at the time of grant for the estimated life ofthe option.

** **

**RESULTSOF OPERATIONS FOR THE QUARTER ENDED JUNE 29, 2008 COMPARED TO THE QUARTER ENDEDJULY 1, 2007**

** **

NET SALES

 

Net sales increased byapproximately 37.1%, or $11.0 million, to $40.5 million for the quarter ended June 29,2008 from $29.6 million for the quarter ended July 1, 2007. During thequarter ended June 29, 2008, net datacom sales were higher by $4.4million, primarily driven by new programs from new designs awarded in prioryears.  Telecom net sales were higher by$2.3 million, primarily driven by one large triple play customer. Industrial,medical and other net sales were higher by $4.3 million from the prior perioddue to new customers and new programs. Overall, revenues from all of ourmarkets were higher for the quarter ended June 29, 2008 compared to thequarter ended July 1, 2007. Included in the above increases is a $1.7million benefit related to the foreign currency exchange rate fluctuations fromour Cherokee Europe operation.

 

GROSS PROFIT

 

Gross profit increased byapproximately 104.2%, or $5.8 million, to $11.3 million for the quarter ended June 29,2008 from $5.5 million for the quarter ended July 1, 2007. Gross marginfor the quarter ended June 29, 2008 increased to 28.0% from 18.8% in theprior year period.  Gross profit washigher during the quarter ended June 29, 2008 due primarily to higher netsales from new programs with better gross margins which provided betterabsorption of fixed costs. Gross margins were better due to increasedproduction volumes in China, the introduction of new models which represented apositive mix and better overall volumes of products.

 

For the quarter ended June 29,2008, the increase in gross profit included $0.2 million of foreign currencyexchange rate fluctuations related to our Cherokee Europe operation.

 

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OPERATING EXPENSES

 

Operatingexpenses for the quarter ended June 29, 2008 increased approximately18.2%, or $1.5 million, to $9.5 million from $8.1 million for the quarter endedJuly 1, 2007. As a percentage of net sales, operating expenses decreasedto 23.5% from 27.2% in the prior year period. The increase in operatingexpenses in 2008 from 2007are as follows:

 

Engineering anddevelopment costs increased by $0.1 million due to $0.2 million in foreigncurrency exchange rate fluctuations from our Cherokee Europe operation, $0.1million in bonuses, offset by a decrease of $0.2 million in overhead anddevelopment costs in Europe.

 

Selling and marketingexpense increased by $0.2 million due to an increase of $0.1 million in bonusesand commissions and $0.1 million in foreign currency exchange rate fluctuationsfrom our Cherokee Europe operation.

 

General andadministrative expense was the same for both quarters ended June 29, 2008and July 1, 2007.  Professional feesfor the quarter ended June 29, 2008 compared to July 1, 2007 werelower by $0.3 million because the prior period in 2007 included professionalfees from the additional work required to file our Form 10-K for fiscalyear-end 2006.  Permits and taxes for thequarter ended June 29, 2008 were lower by $0.1 million compared to thequarter ended July 1, 2007. Personnel expenses were lower by $0.1 million for the quarter ended June 29,2008 compared to the quarter ended July 1, 2007 due to headcount relatedto the closure of the Mexico Facility completed in 2007.  During the quarter ended July 1, 2007 weincurred $0.1 million of costs related to the closure of the Mexico facility,compared to no expense during the quarter ended June 29, 2008. Offsettingthe above decreases were higher expenses of $0.3 million in bonuses, $0.2million in foreign currency exchange rate fluctuations from our Cherokee Europeoperations and $0.1 million in stock compensation expense for the quarter endedJune 29, 2008 compared to the quarter ended July 1, 2007.

 

During the quarter ended June 29,2008, the remaining balance of $1.1 million of goodwill was deemed impaired. Animpairment charge was recorded due to the decrease in fair value of ourCherokee Europe subsidiary due to lower revenues than anticipated.  Details are included under Note 13 to theaccompanying Notes to the Condensed Consolidated Financial Statements includedin Item 1, “Financial Statements.”

 

OPERATING INCOME (LOSS)

 

As a result ofthe factors discussed above, operating income increased by $4.3 million to $1.8million for the quarter ended June 29, 2008, compared to a loss of $2.5million for the quarter ended July 1, 2007. Operating margin increased to4.5% income from a 8.5% loss in the prior year period.

 

INTEREST EXPENSE

 

Interest expense for both quarters ended June 29,2008 and July 1, 2007 was $0.7 million. The interest expense is primarily related to interest payments on our$46.6 million of senior notes, which bear interest at 5.25% annually.

 

OTHERINCOME

 

Forthe quarter ended July 1, 2007, the Company recorded a net gain of $0.4million to other income related to the sale of the Mexico Facilitybuilding.  See Note 10 to theaccompanying Notes to Condensed Consolidated Financial Statements included inItem 1, “Financial Statements” for additional information.

 

INCOME TAXES

 

Provision (benefit) forincome taxes for the quarter ended June 29, 2008 and the comparable periodof July 1, 2007 was a $1.7 million provision and $1.0 million benefit,respectively. The provision for the quarter ended June 29, 2008 was higherby $2.7 million than the comparable period of July 1, 2007 due to therecording of a full valuation allowance against the Company’s European deferredtax assets in the quarter ended June 29, 2008.  The benefit from thecomparable period of July 1, 2007 was primarily a result of the Europeanoperating loss.  Based on availableevidence, including changes to our forecasted revenues in Europe, managementcan no longer conclude that it is more likely than not that the Company willrealize its deferred tax assets.

 

Provision (benefit) forincome taxes for the quarter ended June 29, 2008 was calculated using aneffective tax rate of less than one percent for the full fiscal year inaddition to the valuation allowance of $1.6 million recorded as a discrete itemin the quarter ended June 29, 2008.

 

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NET INCOME (LOSS)

 

As a result ofthe factors discussed above, we recorded a net loss of $0.6 million for thequarter ended June 29, 2008, compared to a $1.7 million net loss for thequarter ended July 1, 2007.

 

**RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE29, 2008 COMPARED TO THE SIX MONTHS ENDED JULY 1, 2007**

** **

NETSALES

 

Netsales increased by approximately 26.3%, or $15.7 million, to $75.3 million forthe six months ended June 29, 2008 from $59.6 million for the six monthsended July 1, 2007.  During the sixmonths ended June 29, 2008, net telecom sales were higher by $5.5 million,primarily driven by one large triple play customer, datacom sales were higherby $4.9 million, primarily driven by new programs from new designs awarded inprior years, and industrial, medical and other net sales were higher by $5.3million due to new customers and new programs. Overall, revenues from all ofour markets were higher for the six months ended June 29, 2008 compared tothe six months ended July 1, 2007. Included in the above increases is a$3.3 million benefit related to foreign currency exchange rate fluctuationsfrom our Cherokee Europe operation.

 

GROSSPROFIT

 

Grossprofit increased by approximately 77.3%, or $8.7 million, to $20.0 million forthe six months ended June 29, 2008 from $11.3 million for the six monthsended July 1, 2007. Gross margin for the six months ended June 29,2008 increased to 26.5% from 18.9% in the prior year period.

 

The increase in grossprofit for the six months ended June 29, 2008 compared to the six monthsended July 1, 2007 was primarily related to overall higher revenues in thesecond quarter of this year which provided better absorption of fixed costs.Gross margins were better due to increased production volumes in China, theintroduction of new models and better overall volumes of products.

 

Included in the increasein gross profit for the six months ended June 29, 2008 is $0.5 million offoreign currency exchange rate fluctuations related to our Cherokee Europeoperation.

 

OPERATINGEXPENSES

 

Operatingexpenses for the six months ended June 29, 2008 increased by approximately10.9%, or $1.7 million, to $17.6 million from $15.9 million for the six monthsended July 1, 2007.  As a percentage of net sales, operating expensesdecreased to 23.4% from 26.7% in the prior year period.

 

For the six months ended June 29,2008, engineering and development expense increased by $0.2 million compared tothe six months ended July 1, 2007, due to an increase of $0.1 million inbonuses, $0.1 million increase in China’s personnel expense related toadditional headcount to support our increase in new product development, and anincrease of $0.3 million of foreign currency exchange rate fluctuations relatedto our Cherokee Europe operation. Offsetting these increases was a decrease of $0.3 million in personneland development expenses in Europe.

 

Selling and marketingexpense consists primarily of sales salaries and commissions, travel,advertising and marketing expenses. For the six months ended June 29,2008, selling and marketing expense increased by $0.1 million compared to thesix months ended July 1, 2007. Bonuses and commissions were higher by $0.2 million for the six monthsended June 29, 2008 compared to the six months ended July 1, 2007 dueto higher sales.  For the six monthsended June 29, 2009, the increase in selling and marketing expenseincluded $0.2 million of foreign currency exchange rate fluctuations related toour Cherokee Europe operation. Offsetting these increases were a decrease of $0.1 million in customerpromotional expenses and a decrease of $0.2 million in overhead and marketingexpenses in Europe.

 

General andadministrative expense consists primarily of salaries and other expense formanagement, finance, human resources and information systems. For the sixmonths ended June 29, 2008, general and administrative expense increasedby $0.5 million compared to the six months ended July 1, 2007, due to anincrease of $0.4 million in bonuses, an increase of $0.3 million in foreigncurrency exchange rate fluctuations from our Cherokee Europe operations and anincrease of $0.1 million in stock compensation expense.  Offsetting these increases was a decrease of$0.3 million in the six months ended June 29, 2008 compared to the priorperiod in 2007 related to redundant general and administrative costs incurredin 2007 for the closure of the Mexico Facility and transition of its operationsto China.

 

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During the six monthsended July 1, 2007, professional fees were higher by $0.3 million due to theadditional work required to file our Form 10-K for the fiscal year ended December 31,2006, compared to no additional work and expense in 2008 for the filing of our Form 10-Kfor the fiscal year ended December 30, 2007. However, this savings for thesix months ended June 29, 2008 was offset by an increase of $0.2 millionin legal and professional expenses; $0.1 million was related to professionalfees for the engagement of an investment banker to assist the Company inexploring strategic alternatives in resolving our senior notes debt, and $0.1million of legal and professional fees to support and complete an IRS audit andour defense in the SynQor litigation.

 

For the six months ended July 1,2007, there was $0.2 million of operating costs related to severance and facilityclosure costs for the Mexico Facility, compared to no expense in 2008.

 

OPERATINGINCOME (LOSS)

 

As aresult of the factors discussed above, operating income was $2.3 million forthe six months ended June 29, 2008 compared to an operating loss of $4.6million for the six months ended July 1, 2007.  Operating marginincreased to income of 3.1% from a loss of 7.8% in the prior year period.

 

INTERESTEXPENSE

 

Interestexpense for the six months ended June 29, 2008 was $1.5 million comparedto $1.4 million for the six months ended July 1, 2007.  The interestexpense is mainly related to our 5.25% senior notes and commitment fees on oursenior revolving credit line.

 

OTHERINCOME

 

Forthe six months ended July 1, 2007, the Company recorded a net gain of $0.4million to other income related to the sale of the Mexico Facilitybuilding.  See Note 10 to theaccompanying Notes to Condensed Consolidated Financial Statements included inItem 1, “Financial Statements” for additional information.

 

INCOMETAXES

 

Provision for income taxesfor the six months ended June 29, 2008 and the comparable period of July 1,2007 was a $1.7 million expense and a $1.6 million benefit, respectively. The expense for the six months ended June 29, 2008 was higher by $3.3million than the comparable period of July 1, 2007 due to the recording ofa full valuation allowance against the Company’s European deferred tax assetsin the quarter ended June 29, 2008.  The benefit from the comparableperiod of July 1, 2007 was primarily the result of the European operatingloss.  Based on available evidence,including changes to our forecasted revenues in Europe, management can nolonger conclude that it is more likely than not that the Company will realize itsdeferred tax assets.

 

Provision (benefit) forincome taxes for the six months ended June 29, 2008 was calculated usingan effective tax rate of less than 1% for the full fiscal year in addition tothe valuation allowance of $1.6 million recorded as a discrete item in thequarter ended June 29, 2008.

 

NETINCOME (LOSS)

 

 Asa result of the factors discussed above, we recorded a net loss of $0.6 millionfor the six months ended June 29, 2008, compared to the net loss of $3.7million for the six months ended July 1, 2007.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

CASH FLOWS

 

**FOR THE SIX MONTHS ENDED JUNE 29,2008 COMPARED TO THE SIX MONTHS ENDED JULY 1, 2007**

 

Netcash provided by operating activities for the six months ended June 29,2008 was $1.2 million compared to net cash used in operating activities of $3.6million for the six months ended July 1, 2007.

 

Netcash provided by operating activities for the six months ended June 29,2008 reflected a net loss of $0.6 million, $1.4 million in depreciation andamortization, $1.1 million in goodwill impairment, $0.5 million ofstock-based compensation, a $1.7 million increase in the valuation allowancefor deferred income taxes, a $0.4 million decrease in deposits and otherassets, a $0.7 million increase in accounts payable, and a $0.9 millionincrease in accrued compensation and benefits. This was offset by a $1.8 million decrease in accounts receivable, a$2.3 million increase in inventories, $0.1 million increase in prepaid expensesand other current assets, a $0.4 million decrease in accrued liabilities andrestructuring costs, and a $0.3 million decrease in other long-termobligations.

 

Netcash used in operating activities for the six months ended July 1, 2007reflected a net loss of $3.7 million which was primarily a result of $14.8million lower revenues of $14.8 million in 2007 compared to 2006, offset by a$0.4 million gain in the sale of assets held for sale related to the sale ofthe Mexico Facility building, a $3.2 million increase in inventory, a $2.5million decrease in accrued liabilities and restructuring costs, and a $0.9million decrease in accrued compensation. This was offset by $1.6 million in depreciation and amortization, $0.3million of stock-based compensation related to SFAS 123R, a $4.0 milliondecrease in accounts receivable, a $0.6 million decrease in prepaid expensesand other current assets, a $0.4 million increase in accounts payable, and a$0.1 million increase in other long-term obligations.

 

Netcash used in investing activities for the six months ended June 29, 2008was $0.2 million, which was related to capital expenditures.  Net cash used in investing activities for thesix months ended July 1, 2007 was $0.3 million, in which $1.5 million wasrelated to capital expenditures.  Weinvested $1.4 million in our China facility. We received $1.2 million ofproceeds from the sale of the Mexico Facility building.

 

Netcash used in financing activities for the six months ended June 29, 2008was less than $0.1 million, which included a $1.3 million payment with respectto Cherokee’s China’s line of credit with Industrial and Commercial Bank ofChina Ltd. during the first quarter of 2008, or ICBC, $0.4 million of deferredfinancing costs incurred related to the senior notes, and payments of $0.3million by Cherokee Europe on its short-term loan.  This was offset by Cherokee Europe’sborrowing of $0.6 million in a short-term loan and $0.8 million borrowings fromits line of credit with ING Belgie NV, and $0.5 million borrowings by CherokeeChina from its line of credit with Industrial and Commercial Bank of China Ltd.

 

 Net cash provided by financing activities forthe six months ended July 1, 2007 was $1.5 million. During the first threemonths of 2007, Cherokee China borrowed $1.3 million under the credit facilityto support working capital requirements as our China subsidiary built inventoryand incurred value-added tax on local purchases. As of July 1, 2007, theoutstanding balance of $1.3 million due to ICBC remained due. During the sixmonths ended July 1, 2007, $0.2 million of employee stock purchase planproceeds were received.

 

LIQUIDITY

 

We expect our liquidity requirements will beprimarily for working capital and capital expenditures, including repayment ofour senior notes due November 1, 2008. As of June 29, 2008, we hadcash and cash equivalents of $9.3 million, negative working capital of$3.7 million due, in part, to the $46.6 million of senior notes due November 1,2008 being classified as current liabilities, no outstanding borrowings underour main revolving credit facility and borrowing base availability of$7.5 million under the same facility. Our revolving line of credit withGeneral Electric Capital Corporation matures on August 25, 2008. TheCompany plans to renew this line with a new lender after our senior noteobligations have been repaid or renegotiated. Historically, we have financedour operations with cash from operations supplemented by borrowings from creditfacilities and debt and equity issuances. Besides our credit line in the UnitedStates, Cherokee Europe also maintains a working capital line of credit ofapproximately $4.8 million, expressed as Euros 3.0 million, with BankBrussels Lambert, a subsidiary of ING Belgie NV, a bank in Brussels, whichis denominated in Euros, and is collateralized by a pledge in first and secondrank over a specific amount of business assets. In June 2008, ING BelgieNV restricted our borrowing capacity to $3.0 million, expressed as Euros 1.9million. The facility requires Cherokee Europe to maintain a certain solvencyratio and is cancelable at any time. The current revolving line of credit withING Belgie NV prohibits the transfer of cash outside of Belgium to theU.S. in the form of management and dividend fees. During the third quarterended September 30, 2007, Cherokee Europe borrowed $2.2 million fromthe line of credit which remained outstanding as of June 29, 2008. On April 28,2008, Cherokee Europe borrowed $0.8 million from its line of credit with INGBelgie NV. The outstanding balance on the line of credit as of June 29,2008 was $3.0 million. By the end of the third quarter in 2008, Cherokee Europe’sline of credit will be converted into a new factoring arrangement with INGBelgie NV, as described under Note 6 to the accompanying Notes to theCondensed Consolidated Financial Statements included in Item 1, “FinancialStatements.”

 

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In January 2008, Cherokee Europeborrowed short-term funds of $0.6 million from ING Belgie NV; theoutstanding balance was $0.3 million as of June 29, 2008.

 

In January 2007, we opened a creditfacility with the Industrial and Commercial Bank of China Ltd., or ICBC,as described under Note 6 to the accompanying Notes to the CondensedConsolidated Financial Statements included in Item 1, “FinancialStatements.”  This facility is intendedfor working capital requirements in China, especially as our China subsidiarybuilds inventory for export to the United States and Europe and incursvalue-added tax on local purchases that can only be recovered throughin-country sales of our product. During the quarter ended June 29, 2008,Cherokee China borrowed $0.5 million from its line of credit.  As of June 29, 2008, Cherokee China hadoutstanding borrowings of $0.5 million under this line of credit.

 

Subject to the refinancing risk describedbelow under Contractual Obligations, we believe our cash flow from operationsand our credit lines in the United States, Europe and China are sufficient tomeet our operating cash requirements for at least the next twelve months.However, this assumes that we are successful in securing refinancing or paymentof our senior notes when they mature in November 2008.

 

Having completed the China plant constructionand replacement of destroyed assets in Cherokee Europe, ongoing current andfuture liquidity needs are expected to arise primarily from working capitalrequirements 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.

 

***CONTRACTUAL OBLIGATIONS***

*** ***

As of June 29, 2008, our borrowings consisted of approximately$46.6 million of senior notes, $3.0 million of outstanding borrowings onour Cherokee Europe line of credit, $0.3 million of outstanding borrowings ofshort-term funds, and $0.5 million of outstanding borrowings under CherokeeChina’s credit facility and line of credit. For a more detailed discussion related to the financial instruments andobligations, see Note 6, “Debt” to the accompanying Notes to the CondensedConsolidated Financial Statements included in Item 1, “FinancialStatements.”

 

We have operating lease obligations relatingto our facilities in Tustin and Irvine, California and Bombay, India.

 

We have purchase commitments primarily withvendors and suppliers for the purchase of inventory and for other goods,services, and equipment as part of the normal course of business. Thesecommitments are generally evidenced by purchase orders that may or may notinclude cancellation provisions. Based on current expectations, we do notbelieve that any cancellation penalties we incur under these obligations wouldhave a material adverse effect on our consolidated financial condition orresults of operations.

 

The majority of the $0.3 million ofscheduled deferred compensation distributions listed in the below table to bepaid in the second half of 2008 were paid in July 2008. The funds for theremaining balance in this plan have been reserved and deposited into aninvestment account with funds that closely mirror investment funds similar tothe participants’ investment selections.

 

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The maturities of ourlong-term debt, including capital leases, and future payments relating to ouroperating leases and other obligations as of June 29, 2008 are as follows(in thousands):

 
| **Contractual Obligations**      | ** ** | **June 30, 2008 to  December 28, 2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|---------------------------------------|------------|------------------------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Debt-senior notes                     |       | $                                                                | 46,630     |     | $          | —   |       | $        | —     |     | $          | —         |       | $         | —     |   | $ | — |   | $ | 46,630 |   |
| Operating leases                      |       | 806                                                              |       | 568      |       | 43       |       | 18       |       | —   |       | 109            |       | 1,544     |       |
| Purchase order commitments            |       | 18,853                                                           |       | —   |       | —   |       | —   |       | —   |       | —         |       | 18,853    |       |
| 1999 Europe restructuring             |       | 84                                                               |       | 372      |       | 61       |       | —   |       | —   |       | —         |       | 517       |       |
| 2003 Europe restructuring             |       | 134                                                              |       | 282      |       | 260      |       | 213      |       | 167      |       | 241            |       | 1,297     |       |
| Long service award                    |       | 34                                                               |       | 126      |       | 236      |       | 27       |       | 23       |       | 593            |       | 1,039     |       |
| Deferred compensation                 |       | 342                                                              |       | 57       |       | 19       |       | 19       |       | 19       |       | 121            |       | 577       |       |
| Advances for research and development |       | 84                                                               |       | 65       |       | 65       |       | 68       |       | 69       |       | 364            |       | 715       |       |
| Unrecognized  tax benefits            |       | 307                                                              |       | —   |       | —   |       | —   |       | —   |       | —         |       | 307       |       |
| Total                                 |       | $                                                                | 67,274     |     | $          | 1,470    |       | $        | 684        |     | $          | 345            |       | $         | 278        |   | $ | 1,428 |   | $ | 71,479 |   |

 

The long-term liability for accrued pensioncosts included on the condensed consolidated balance sheet is excluded from thetable above. Cherokee is unable to estimate the timing of payments for thesecosts. During the six months ended June 29, 2008, the Company contributedapproximately $0.2 million.  In2008, the Company expects to contribute $0.4 million.

 

RECENT ACCOUNTING PRONOUNCEMENTS

 

For adiscussion of the impact of recently issued accounting pronouncements, see thesubsection entitled “Recent Accounting Pronouncements” contained in Note 2 ofthe Notes to Condensed Consolidated Financial Statements under Item 1. “FinancialStatements.”

 

Item3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market risk relating to our operationsresults primarily from changes in foreign currency exchange rates andshort-term interest rates. We did not have any derivative financial instrumentsat June 29, 2008.

 

We had no variable rate debt outstanding at June 29,2008. However, any debt we incur under the Credit Facility and the CherokeeEurope line of credit will bear interest at a variable rate. We cannot predictmarket fluctuations in interest rates and their impact on any variable ratedebt we may incur in the future, nor can there be any assurance that fixed ratelong-term debt will be available to us at favorable rates, if at all.

 

The functional currency for our Europeanoperations is the Euro. We are, therefore, subject to a certain degree ofmarket risk associated with changes in foreign currency exchange rates. Thisrisk is mitigated by the fact that our revenues and expenses are generally bothtransacted in Euros, thereby reducing the risk of foreign currency exchangerate fluctuation on our European operations. The net effect on our operatingincome for foreign currency exchange rate fluctuations for the six months endedJune 29, 2008, was a $0.3 million decrease in our income. Historically, wehave not actively engaged in exchange rate-hedging activities.

 

Item4T.   CONTROLS AND PROCEDURES

 

*Disclosure Controlsand Procedures*

 

Our management, with the participation of ourPresident and Chief Executive Officer, and our Executive Vice President andChief Financial Officer, has evaluated the effectiveness of our disclosurecontrols and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)), as of the end of the period covered by this report. The evaluationincluded certain control areas in which we have made, and are continuing tomake, changes to improve and enhance controls. As described below, we haveidentified material weaknesses and significant deficiencies in our internalcontrol over financial reporting as of December 30, 2007, and as of June 29,2008, these material weaknesses and significant deficiencies have not beenfully remediated.

 

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As a result, our President and Chief Executive Officer and ourExecutive Vice President and Chief Financial Officer have concluded that, as ofJune 29, 2008, our disclosure controls and procedures were not effective.

 

A material weakness is a deficiency or acombination of deficiencies in internal control over financial reporting suchthat there is a reasonable possibility that a material misstatement of theannual or interim consolidated financial statements will not be prevented ordetected on a timely basis.  Since theCompany conducted its assessment of the effectiveness of our internal controlover financial reporting as of December 30, 2007, our management hasimplemented some changes to its internal control over financial reporting inresponse to the following material weaknesses that were identified as of December 30,2007, as described below:

 

*Architecture ofCompany’s IT systems does not presently support the financial reporting requirementsof the Company’s international operations*

 

Our subsidiaries in India and China stillmaintain disparate financial accounting systems that do not completelyinterface with the Company’s primary ERP system, resulting in duplicateaccounting entries on multiple systems. This causes a protracted reportingcycle which limits the oversight from corporate headquarters of transactionaldetails at our international sites. Site level financial statements aredelivered on spreadsheets to the corporate office for consolidation.

 

Our European operation has its own separateERP system that is integrated into the local accounting system; however thissystem does not automatically interface financially with our corporateheadquarters. Therefore, financial results are also delivered to our corporateoffice by means of spreadsheets, and the corporate office also has insufficientvisibility to transactional details.

 

The consolidation of all these local resultsdelivered on spreadsheets is in turn prepared on spreadsheets at our corporateoffice. Consolidations performed on spreadsheets are prone to human error andare difficult to review. As such, the existing consolidation process requiresadditional monitoring and oversight. Oversight and monitoring are discussed inmore detail below.

 

The Company has completed its development andimplementation of IT interface solutions for key activities in China. Thecompany will now begin to focus on determining what IT solutions will berequired for our other locations.  Untilthis is completed, the Company will continue to supplement these technical ITsolutions with additional staffing and internal monitoring procedures.

 

*The methodology andsupport for valuing and capitalizing inventory costs, and determining inventoryreserves*

 

As remediated in the second quarter of 2007,the Company now evaluates historical and projected labor and overhead costs todetermine their reasonableness. This process is subject to finance managementoversight and review. The Company still does not track labor by product modelat most locations.

 

*Oversight and monitoring controls*

 

The lack of an integrated financial reporting system creates the needfor significant manual intervention and staffing to prepare spreadsheets,create eliminating entries, make tax adjustments, and U.S. GAAPadjustments. Additionally, our remote locations, other than Europe, have onelocal controller 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.

 

We have identified and have performed or areworking on the following remediation to resolve the weakness in oversight andmonitoring controls over international financial reporting:

 

·     The processof adding structure and uniformity of accounting standards and process amongour site controllers continues through distribution of corporate policies andprocedures, 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.

 

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·     Due topersonnel changes, the Company expects to rely on outside professionals for asignificant portion of its SOX compliance review.  During the second quarter, we engaged GrantThornton to assist the Company in its SOX compliance.  Initial planning has begun and preliminaryfieldwork is now expected to begin in the third quarter of 2008.

 

·     An improvedconsolidated reporting package is now provided to corporate management andsignificant items are being reviewed with local management.

 

*SOX Compliance*

 

As a non-accelerated filer, 2007 marked thefirst year of SOX compliance for the Company. The Company completed an internalassessment of controls. While the vast majority of the Company’s controls wereoperating properly, the Company did identify control deficiencies forremediation. The corporate office worked closely with the site accountingpersonnel to remediate these deficiencies. The vast majority of thedeficiencies were remediated during 2007, but some did remain at year end.While efforts to remediate these deficiencies have continued into 2008,management assessed the remaining deficiencies to determine if any additionalmaterial weakness existed. The Company concluded that none of the opendeficiencies at 2007 fiscal year end could result in a material weakness, butdid believe that one could be classified as a significant deficiency. Asignificant deficiency is a deficiency, or combination of deficiencies, ininternal control over financial reporting that is less severe than a materialweakness; yet important enough to merit the attention of those responsible foroversight over the Company’s financial reporting. Since the Company conductedits assessment of the effectiveness of our internal control over financialreporting as of December 30, 2007, our management has implemented thefollowing changes to its internal control over financial reporting in responseto the significant deficiencies that were identified as of December 30,2007, as described below:

 

1)    Inadequatefixed asset management systems and procedures

 

During the second quarter, the Companyimplemented new IT system controls that we believe will remediate theinadequate controls over shipping cutoffs which was identified as a significantdeficiency during 2007 SOX compliance. Remediation efforts on the fixed asset systems are expected to continueover several 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.

 

The Company is committed to remediating allmaterial weaknesses and significant deficiencies presently identified and anyadditional deficiencies that may be identified in the future.

 

In connection with the Company’s filing ofits financial statements for its fiscal year ending December 28, 2008, theCompany’s internal control over financial reporting will not be subject toattestation by the Company’s registered public accounting firm due to thedeferral of the effective date of these requirements. This date has beendelayed for non-accelerated filers; the provision will now apply to fiscalyears ending on or after December 15, 2009.

 

*Changes in Internal Control Over FinancialReporting*

 

Except as described above, there have notbeen any changes in our internal control over financial reporting (as such termis defined in Rules 13a-15(f) and 15(d)-15(f) under the ExchangeAct) during our second fiscal quarter of 2008 that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting.

 

PART II   OTHERINFORMATION

 

Item 1.   Legal Proceedings

 

On November 16, 2007, SynQor announcedthat it had filed a lawsuit against several of its competitors, includingCherokee International Corporation who was named in the complaint, forinfringement of two patents relating to bus converters and/or non-isolatedpoint of load converters used in intermediate bus architectures. The patents atissue are U.S. patents 7,072,190 and 7,272,021. The suit was filed in FederalCourt in the Eastern District of Texas. The Company intends to vigorouslydefend this lawsuit. Although the ultimate aggregate amount of monetaryliability or financial impact with respect to this lawsuit is subject to manyuncertainties and is therefore not predictable with assurance, the finaloutcome of this lawsuit, if adverse, could have a material adverse effect onour financial position, results of operations or cash flows.

 

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During the six months ended June 29,2008, we were not a party to any other material legal proceedings. We areoccasionally a party to lawsuits relating to routine matters incidental to ourbusiness. As with all litigation, we can provide no assurance as to the outcomeof any particular lawsuit, and we note that litigation inherently involvessignificant costs.

 

Item 1A.   RiskFactors

 

We have updated the riskfactors discussed in Item 1A of our Annual Report on Form 10-K forthe year ended December 30, 2007, as set forth below. We do not believeany of the updates constitute material changes from the risk factors previouslydisclosed in our Annual Report on Form 10-K for the year ended December 30,2007.

 

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

 

**Risks Relating to Our Company and Industry**

 

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

 

Our top ten customers accounted forapproximately 50% of our net sales for the six months ended June 29, 2008and approximately 50% of our net sales for the year ended December 30,2007. In addition, one customer accounted for more than 10% of net sales in thesix months ended June 29, 2008 and for the year ended December 30,2007. The loss of any of our major customers could have a material adverseeffect on our financial condition or results of operations. We do not havelong-term contracts with our customers, and our customers use alternative powersupply providers for some or all of their products. We may not be able tomaintain our customer relationships, and our customers may reduce or canceltheir purchase orders, purchase power supplies elsewhere or developrelationships with additional providers of power supplies, any of which couldadversely affect our financial condition or results of operations. Asignificant change in the liquidity or financial position of any of thesecustomers could also have a material adverse effect on the collectibility ofour accounts receivables, our liquidity and our future operating results. Priorto, or at the end of, a product’s life cycle, any of our customers may decideto discontinue or modify any of its products. In that event, the customer mayno longer have a need for our products or may choose to integrate a competitor’spower supply into the customer’s new or modified product. The resulting loss ofrevenues could also adversely affect our financial condition or results of ouroperations.

 

**Failure by our customers or us to keep upwith rapid technological change in the electronic equipment industries couldresult in reduced sales for us.**

 

Many of our existing customers are in theelectronic equipment industries, especially wireless infrastructure andnetworking, and produce products that are subject to rapid technologicalchange, obsolescence and large fluctuations in world-wide product demand. Theseindustries are characterized by intense competition and end-user demand forincreased product performance at lower prices. We may not be able to properlyassess developments in the electronic equipment industries or identify productgroups or customers with the potential for continued and future growth. Factorsaffecting the electronic equipment industries, in general, or any of our majorcustomers or their products, in particular, could have a material adverseeffect on our financial condition or results of operations. For instance, as aprovider of power supplies to OEMs in the electronic equipment industries,our sales are dependent upon the success of the underlying products of whichour power supplies are a component. We have no control over the demand for orsuccess of these products. If our customers’ products are not well received by,or if demand for their products fails to develop among end-users, our customersmay discontinue or modify the product or reduce the production of the product.Any of these events could lead to the cancellation or reduction of orders forour power supplies that were previously made or anticipated, which couldmaterially adversely affect our financial condition or results of operation.See “Cancellations, reductions or delays in customers’ orders or commitments,or an increase in the number of warranty product returns could have a materialadverse impact on our financial condition and results of operations” for moreinformation. The markets for our products are characterized by rapidly changingtechnologies, increasing customer demands, evolving industry standards,frequent new product introductions and shortening product life cycles.Generally, our customers purchase our power supplies for the life cycle of aproduct, which can range anywhere from two to fifteen years. The development ofnew, technologically advanced products is a complex and uncertain processrequiring high levels of innovation and cost, as well as the accurateanticipation of technological and market trends. As the lifecycle of ourcustomers’ products shorten, we will be required to bid on contracts forreplacement or next generation products to replace revenues generated fromdiscontinued products more frequently.

 

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These bids may not be successful. Even if we are successful, we may notbe able to successfully develop, introduce or manage the transition of newproducts. Any failure or delay in anticipating technological advances ordeveloping and marketing new products that respond to any significanttechnological change or significant changes in customer demand could have amaterial adverse effect on our financial condition or results of operations.

 

**We face significant competition, includingfrom some competitors with greater resources and geographic presence than us.Our failure to adequately compete could have a material adverse effect on ourbusiness.**

 

The design, manufacture and sale of powersupplies are highly competitive and characterized by increasing customerdemands for product performance, shorter manufacturing cycles and lower prices.Our competition includes numerous companies throughout the world, some of whichhave advantages over us in terms of labor and component costs and technology.Our principal competitors are Emerson Network Power, Delta Electronics, TDK(Lambda), Power One, Lineage Power, Murata, Eltek-Valere, and Vicor. Some ofour competitors have substantially greater net sales, resources and geographicpresence than we do. Competition from existing competitors or new marketentrants may increase at any time. We also face competition from current andprospective customers that may design and manufacture their own power supplies.In times of an economic downturn, or when dealing with high-volume orders,price may become a more important competitive factor, forcing us to reduce pricesand thereby adversely affecting our financial results. Some of our majorcompetitors have also consolidated through merger and acquisition transactions.Consolidation among our competitors is likely to create companies withincreased market share, customer bases, proprietary technology and marketingexpertise, and an expanded sales force. These developments may adversely affectour ability to compete.

 

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

 

We do not obtain long-term purchase orders orcommitments from our customers and customers may generally cancel, reduce orpostpone orders or commitments. A variety of conditions, both specific to theindividual customer and generally affecting the customer’s industry, may causecustomers to cancel, reduce or delay orders or commitments that were previouslymade or anticipated. At any time, a significant portion of our backlog may besubject to cancellation or postponement. For example, our entire$54.1 million backlog as of June 29, 2008 was subject to cancellationupon the payment by our customers of cancellation fees that vary depending onindividual purchase orders. We also enter into certain warehousing arrangementswith some of our customers, whereby we agree to bear the risk and cost ofcarrying inventory. Under these arrangements, we deliver the power suppliesordered by such customers to a third-party location, permit these customers totake delivery of the power supplies within a specified time period after ourdelivery of the products, and invoice these customers for the products onlyafter they have taken ultimate delivery and title has passed. We may not beable to replace cancelled, delayed or reduced orders or commitments in a timelymanner or at all and in some instances may need to write-off inventory.Significant or numerous cancellations, as well as reductions or delays in ordersor commitments, including as a result of delays in or the failure to takedelivery of products that are subject to such arrangements, by a customer orgroup of customers, could materially adversely affect our financial conditionor results of operations.

 

We also offer our customers a warranty forproducts that do not function properly within a limited time after delivery. Weregularly monitor and track warranty product returns and record a provision forthe estimated amount of future warranty returns based on historical experienceand any notification we receive of pending warranty returns. We may experiencegreater warranty return rates than we have in the past. Any significantincrease in product failure rates and the resulting warranty credit returnscould have a material adverse effect on our operating results for the period orperiods in which those warranty returns occur.

 

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

 

We have manufacturing operations located inEurope, India, and China. We may expand our operations into other foreigncountries in the future. In addition, international sales have been, and areexpected to continue to be, an important component of our total sales.International sales represented 53% of our net sales for the year ended June 29,2008 and 50% of our net sales for the year ended December 30, 2007. Ourmanufacturing operations and international sales are subject to inherent risks,all of which could have a material adverse effect on our financial condition orresults of operations. For example, our European Division (Cherokee Europe) hastwo restructuring plans in place. The first one (the 1999 Europerestructuring) was inherited by us in 2000 when we purchased this division fromPanta Electronics, and the second (the 2003 Europe restructuring) wasimplemented in 2003 by us.

 

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Both of these plans were significantly impacted by local labor laws andunion labor negotiations, and required termination benefits. When we acquiredCherokee Europe in 2000, we inherited a liability of approximately$2.2 million to be paid through 2010 as a result of the 1999 Europerestructuring. When we implemented the 2003 Europe restructuring, werecorded a $4.5 million expense to be paid through 2016. See “Management’sDiscussion and Analysis of Financial Condition and Results ofOperations—Results of Operations.” Other risks affecting our internationaloperations include:

 

·                  differences or unexpected changes inregulatory requirements;

 

·                  political and economic instability;

 

·                  terrorism and civil unrest;

 

·                  work stoppages or strikes;

 

·                  interruptions in transportation;

 

·                  restrictions on the export or import of technology;

 

·                  difficulties in staffing and managing international operations;

 

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

 

·                  longer payment cycles;

 

·                  problems in collecting accounts receivables;

 

·                  changes in economic conditions in the international markets in whichour products are sold; and

 

·                  greater fluctuations in sales to customers in developing countries.

 

Although we transact business primarily inU.S. dollars, a portion of our sales and expenses, including labor costs, aredenominated in the Indian rupee, the Chinese renminbi (“RMB”), the Euro andother European currencies. For the six months ended and the year ended June 29,2008 and December 30, 2007, net sales in Europe accounted for 33% and 35%of our net sales, respectively. Declines in the value of the U.S. dollarrelative to the Euro impacted our revenue, cost of goods sold and operatingmargins for these periods and resulted in foreign currency transaction gainsand losses. Foreign currency translation gains or losses recorded in othercomprehensive income, a component of equity, for the six months ended June 29,2008 and for the year ended December 30, 2007 were a gain of$0.7 million and a gain of $1.2 million, respectively. Historically,we have not actively engaged in substantial exchange rate hedging activitiesand do not intend to do so in the future.

 

**An interruption in delivery of componentsupplies could lead to supply shortages or a significant increase in our costof materials.**

 

We are dependent on our suppliers for timelyshipments of components, including components manufactured by us in our Indiafacilities. We typically use a primary source of supply for each component usedin our products. Changing suppliers or establishing alternate primary sourcesof supply, if needed, could take a significant period of time, which in turncould result in supply shortages and increased prices. In some cases, we sourcecomponents from only one manufacturer. Substantially all of our revenues arederived from the sale of products that include components that we source fromonly one manufacturer. In addition, many of our suppliers are located outsideof the United States, and timely delivery from these suppliers may not occurdue to interruptions in transportation, import-export controls, tariffs,quotas, taxes and other market barriers, and political and economic stabilityin the country in which the components used in our products are produced or thesurrounding region. An interruption in supply could have a material adverseeffect on our operations. Any shortages of particular components could increaseproduct delivery times and costs associated with manufacturing, therebyreducing gross margins. Additionally, these shortages could cause a substantialloss of business due to shipment delays. Any significant shortages or priceincreases of components could have a material adverse effect on our financialcondition or results of operations.

 

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

 

Our quarterlyresults of operations have fluctuated in the past and may continue to fluctuatein the future. Fluctuations in customer needs, cancellations, reductions anddelays in orders and commitments may cause our quarterly results to fluctuate.See the risk factor above entitled “Cancellations, reductions or delays incustomers’ orders or commitments or an increase in the number of warrantyproduct returns could have a material adverse impact on our financial conditionand results of operations.” Variations in volume production orders and in themix of products sold by us have also significantly affected sales and grossprofit. Sales are generally impacted by a combination of these items and mayalso be affected by other factors. These factors include:

 

·                  the receipt and shipment of large orders or reductions in these orders(including the impact of any customer warehousing arrangements);

 

·                  raw material availability and pricing;

 

·                  product and price competition; and

 

·                  the length of sales cycles.

 

Many of these factors are outside of ourcontrol. In addition, a substantial portion of our sales in a given quarter maydepend on obtaining orders for products to be manufactured and shipped in thesame quarter in which those orders are received. As a result of this and otherfactors described above, sales for future quarters are difficult to predict andour financial condition or results of operations in a given quarter may bebelow our expectations and our gross margins may decrease. Our expense levelsare relatively fixed and are based, in part, on expectations of futurerevenues. If revenue levels are below expectations, the market price of ourcommon stock could fall substantially, and our financial condition or resultsof operations could be materially adversely affected.

 

**Our ability to successfully implement ourbusiness strategy is dependent on our ability to retain and attract keypersonnel.**

 

Our ability to successfully implement ourbusiness strategy depends to a significant degree on the efforts of Jeffrey M.Frank, President, Chief Executive Officer, and Director, Linster W. Fox,Executive Vice President, Chief Financial Officer and Secretary, and MukeshPatel, Executive Vice President, Global Operations, along with other members ofour senior management team. We believe that the loss of service of any of theseexecutives could have a material adverse effect on our business. In addition,we depend on highly skilled engineers and other personnel with technical skillsthat are in high demand and are difficult to replace. As a result, our abilityto maintain and enhance product and manufacturing technologies and to manageany future growth also depends on our success in attracting and retainingpersonnel with highly technical skills. The competition for these qualifiedtechnical personnel may be intense if the relatively limited number ofqualified and available power engineers continues. We may not be able toattract and retain qualified technical personnel.

 

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

 

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

 

**Environmental compliance could requiresignificant expenditures and failure to so comply could result in fines orrevocation of licenses or permits, any of which could materially and adverselyaffect our financial condition or results of operations.**

 

We are subject to federal, state and localenvironmental laws and regulations (in both the United States and abroad) thatgovern the handling, transportation and discharge of materials into theenvironment, including into the air, water and soil. Environmental laws couldbecome even more stringent in the future, imposing greater compliance costs andincreasing risks and penalties associated with their violation or thecontamination of the environment.

 

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Should there be an environmental accident or violation related to ouroperations, our financial condition or results of operations may be adverselyaffected. We could be held liable for significant penalties and damages underenvironmental laws and could also be subject to a revocation of licenses orpermits, which could materially and adversely affect our financial condition orresults of operations.

 

The following are two European EconomicCommunity (“EEC”) directives that are having an effect on the entireelectronics 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 in componentsused to manufacture electrical and electronic assemblies. This directive becameeffective on July 1, 2006. The Company began manufacturing compliantproducts in 2006 and continues to work actively with its customers to ensurecompliance. The Company is focused on consuming all non-compliant materialon-hand within a reasonable period. However, the Company may have to dispose ofnon-compliant materials in the future, which could adversely affect thefinancial performance of the Company. There is also a risk of fines associatedwith non-compliance with the RoHS directive; however, the Company is not awareof any specific potential fines, and the Company anticipates complying with allprovisions 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.

 

**Our operations are vulnerable to interruptionby fire, earthquake, power loss, telecommunications failure and other eventsbeyond our control.**

 

Our operations are vulnerable to interruptionby earthquakes, fires, electrical blackouts, power losses, telecommunicationsfailures and other events beyond our control. Our executive offices and keymanufacturing and engineering facilities are located in Southern California.Because Southern California is an earthquake-prone area, we are particularlysusceptible to the risk of damage to, or total destruction of, our facilities inSouthern California and the surrounding transportation infrastructure, whichcould affect our ability to make and transport our products. In addition,California continues to face periodic shortages in its power supply. If rollingblackouts or other disruptions in power were to occur, our business andoperations would be disrupted and our business would be adversely affected. Ourbusiness interruption insurance may not be sufficient to compensate us forlosses that may occur and would not compensate us for the loss of consumergoodwill due to disruption of service.

 

**Third parties may sue us for allegedinfringement of their proprietary rights.**

 

We have received, from time to time, noticesof alleged infringement and/or invitations to take licenses from third partiesasserting that they have patents (or other intellectual property rights) thatare relevant to our present or contemplated business operations. There is noguarantee that we will be able to avoid incurring litigation costs related tosuch assertions. Intellectual property claims could be successfully assertedagainst us, preventing us from using certain of our technologies, or forcing usto modify our technology or to pay license fees for use of that technology.Such additional engineering expenses or licensing costs could have an adverseeffect on the results of our operations. In addition, we could incursubstantial expenses in defending against these claims, whether or not weultimately prevail against these claims.

 

On November 16, 2007, SynQor announcedthat it had filed a lawsuit against several of its competitors, includingCherokee International Corporation who was named in the complaint, forinfringement of two patents relating to bus converters and/or non-isolatedpoint of load converters used in intermediate bus architectures. The patents atissue are U.S. patents 7,072,190 and 7,272,021. The suit was filed in FederalCourt in the Eastern District of Texas. The Company intends to vigorouslydefend this lawsuit. Although the ultimate aggregate amount of monetaryliability or financial impact with respect to this lawsuit is subject to manyuncertainties and is therefore not predictable with assurance, the finaloutcome of this lawsuit, if adverse, could have a material adverse effect onour financial position, results of operations or cash flows.

 

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**Provisions of the agreements governing ourdebt will restrict our business operations.**

 

At June 29, 2008, we had$46.6 million of 5.25% senior notes outstanding, and we had in place a$7.5 million senior revolving credit facility (with no amountsoutstanding) that is subject to a borrowing base comprised of eligible accountsreceivable. Our outstanding indebtedness, including our 5.25% senior notes andany debt incurred pursuant to the senior revolving credit facility, is securedby substantially all of our assets.

 

Cherokee Europe maintains a working capitalline of credit of approximately $4.8 million with Bank Brussels Lambert, asubsidiary of ING Belgie NV, a bank in Brussels, which is denominated inEuros, collateralized by a pledge in first and second rank over a specificamount of business assets, requires Cherokee Europe to maintain a certainspecific minimum solvency ratio, and is cancelable at any time. In November 2007,ING Belgie NV restricted the Company from transferring funds from Europeto the US in the form of management and dividend fees. As of June 29,2008, Cherokee Europe had $3.0 million of outstanding borrowings under theline of credit.

 

Cherokee China entered into a loan contractin January 2007 with Industrial and Commercial Bank of China Ltd. (“ICBC”)for a working capital line of credit. Pursuant to the contract, ICBC agreed tomake advances up to the equivalent of approximately $4.0 million,expressed as RMB 28.0 million. The line of credit is collateralized by theCompany’s building in Shanghai, China. Beginning with its initial borrowingunder the contract, Cherokee China has agreed to deposit in the ICBC ShanghaiBranch at least 90% of the operating revenue it collects. The cash from thesedeposits made into our bank account are not restricted from our usage of thesefunds. As of June 28, 2008, Cherokee China had $0.5 million ofoutstanding borrowings under the line of credit and was in compliance with allcovenants.

 

We may need to incur additional debt tocontinue to grow our business in the future. The agreements governing our debtcontain a number of covenants that restrict our business operations, includingcovenants limiting our ability to make investments, enter into mergers oracquisitions, dispose of assets, incur additional debt, grant liens, enter intotransactions with affiliates, redeem or repurchase our capital stock, repayother debt and pay dividends. As of June 29, 2008, we were in compliancewith our covenants set forth in the agreements.

 

Our ability to comply with covenants underagreements governing our debt may be affected by events that are beyond ourcontrol, including prevailing economic, financial and industry conditions. Ourfailure to comply with the covenants or restrictions contained in agreementsgoverning our debt could result in an event of default under these agreements,which could result in our debt, together with accrued and unpaid interest,being declared immediately due and payable.

 

**Our 5.25% Senior Notes mature on November 1,2008, and we may be unable to repay or refinance this indebtedness uponmaturity.**

 

On November 1, 2008, the$46.6 million aggregate principal amount outstanding under our 5.25%Senior Notes will become due and payable. We do not expect to have sufficientcash available at the time of maturity to repay this indebtedness and arecurrently working with an investment banker to extend the maturity of thesenotes. We also cannot be certain that we will have sufficient assets or cashflow available to support refinancing these notes at current market rates or onterms that are satisfactory to us. If we are unable to refinance on termssatisfactory to us, we may be forced to refinance on terms that are materiallyless favorable, seek funds through other means such as a sale of some of ourassets, or otherwise significantly alter our operating plan, any of which couldhave a material adverse effect on our business, financial condition and resultsof operation.

 

**Credit risks could materially and adverselyaffect our operations and financial condition.**

 

Negative or declining economic conditions canincrease our exposure to our customers’ credit risk. In particular, sales tolarger customers are sometimes made through contract manufacturers that do nothave the same resources as those customers. Additionally, if one of our majorcustomers experienced financial difficulties, losses could be in excess of ourcurrent allowance. At June 29, 2008, one of our customers accounted forapproximately 9.7% of our total net receivables and at December 30, 2007,another one of our customers accounted for 10.9% of our total net receivables.For the periods ended June 29, 2008, and December 30, 2007, ouraccounts receivable write-offs amounted to less than 1% of our net accountsreceivable balance. In the event our customers or those contract manufacturersexperience financial difficulties and fail to meet their financial obligationsto us, or if our recorded bad debt provisions with respect to receivablesobligations do not accurately reflect future customer payment levels, we couldincur additional write-offs of receivables that are in excess of ourprovisions, which could have a material adverse effect on our operations andfinancial condition.

 

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In addition, we depend on the continuing willingness of our suppliersto extend credit to us to finance our inventory purchases. If suppliers becomeconcerned about our ability to generate cash and service our debt, they maydelay shipments to us or require payment in advance.

 

**If we fail to meet the listing requirementsof the NASDAQ Global Market and the NASDAQ determines to delist our commonstock, the delisting would adversely affect the liquidity of our common stockand the market price of our common stock could decline.**

 

Our Common stock is listed on the NASDAQGlobal Market. In order to maintain that listing we must satisfy certainperiodic reporting requirements under Marketplace Rule 4310(c) (14).If we fail to file our Quarterly Reports on Form 10-Q or Annual Reports onForm 10-K timely, NASDAQ could delist our common stock from the NASDAQGlobal Market. If our common stock is delisted from the NASDAQ Global Market,the price of our common stock and the ability of our stockholders to trade inour common stock would be adversely affected. In addition, such delisting couldadversely affect our ability to obtain financing and could result in the lossof confidence by our investors, suppliers and employees.

 

**Item 4.  Submission of Matters to a Vote of Security Holders**

 

At our annual meeting of stockholders, held June 17, 2008, there were 16,759,477 shares, or 86.15% of the 19,453,557 shares outstanding and entitled to vote, represented either in person or by proxy.  Two proposals were presented to a vote of stockholders:

 

*Proposal* 1.   To elect seven members to the board of directors, each to serve until the next annual meeting of stockholders and until his or her successor has been elected and qualified.  All nominees were elected.

 
| **Name of Director**    | ** ** | **Position**                 | ** ** | **Total Number of  Votes Cast For** | ** ** | **Total Number of  Votes Withheld** | ** ** |
|-------------------------|------------|------------------------------|------------|-----------------------------------------------|------------|-----------------------------------------------|------------|
| Raymond  Meyer          |       | Chairman  of the Board       |       | 16,712,604                                    |       | 46,873                                        |       |
| Jeffrey  Frank          |       | President,  CEO and Director |       | 16,720,026                                    |       | 39,451                                        |       |
| John  Michal Conaway    |       | Director                     |       | 16,720,628                                    |       | 38,849                                        |       |
| Clark  Michael Crawford |       | Director                     |       | 16,720,026                                    |       | 39,451                                        |       |
| Daniel  Lukas           |       | Director                     |       | 16,720,026                                    |       | 39,451                                        |       |
| Larry  Schwerin         |       | Director                     |       | 16,712,304                                    |       | 47,173                                        |       |
| Edward  Phillip Smoot   |       | Director                     |       | 16,712,304                                    |       | 47,173                                        |       |

 

There were no broker non-votes and abstentions.

 

On June 17, 2008, Daniel Lukas resigned from the board of directors of Cherokee International Corporation (the “Company”). Mr. Lukas’ decision to resign was based on his decision to leave GSC Partners, a significant stockholder of the Company and not the result of any disagreement relating to the Company’s operations, policies or practices.

 

*Proposal* 2.  To ratify the selection of Mayer Hoffman McCann P.C. as our independent auditors for the fiscal year ending December 28, 2008.

 

Voting to adopt were 16,724,821 shares. Voting against the adoption were 4,793 shares. There were no broker non-votes. Abstentions totaled 29,863 shares.

 

Item 6.   EXHIBITS

 

EXHIBIT INDEX

 

Exhibits haveheretofore been filed with the SEC and are incorporated herein by reference.Management contracts or compensatory plans or arrangements are marked with anasterisk.

 

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| **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                |       | Transaction  Bonus Agreement, dated April 14, 2008, between Cherokee International  Corporation and Jeffrey M.   Frank.(4)                                                      |
| *10.2                |       | Transaction Bonus Agreement, dated April 14, 2008, between  Cherokee International Corporation and Linster W. Fox.(4)                                                                |
| *10.3                |       | Transaction Bonus Agreement, dated April 14, 2008, between  Cherokee International Corporation and Mukesh Patel.(4)                                                                  |
| 31.1                 |       | Certification of President and Chief Executive Officer pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                                                                   |
| 31.2                 |       | Certification of Executive Vice President of Finance, Chief Financial  Officer and Secretary pursuant to Section 302 of the Sarbanes-Oxley Act  of 2002.                             |
| 32.1                 |       | Certification of CEO and CFO Pursuant to 18 U.S.C. Section 1350,  as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                         |

 

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

 

(2)                                  Incorporatedby reference from the Registration Statement on Form S-1 (File No. 333-110723),filed by the Registrant on November 25, 2003.

 

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

 

(4)                                  Incorporatedby reference from the Quarterly Report on Form 10-Q for the period ended March 30,2008, filed by the Registrant on May 12, 2008.

 

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SIGNATURES

 

Pursuant tothe requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned,thereunto duly authorized.

 
|                             | CHEROKEE  INTERNATIONAL CORPORATION |
|-----------------------------|-------------------------------------|
|                        |                                |   |
| Date: August 12,  2008 | By:                            | /s/ JEFFREY  M. FRANK |
|                        |                                | Jeffrey M.  Frank |
|                        |                                | President  and Chief Executive Officer |
|                        |                                | (Principal  Executive Officer) |
|                        |                                |   |
| Date: August 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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