**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C.20549**

 

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**FORM 10-Q**

 

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

 

**For the quarterlyperiod ended March 31, 2002**

 

**OR**

** **

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

 

**For the transitionperiod from         to         **

 

**Commission filenumber: 333-82713**

 

**CHEROKEE INTERNATIONAL, LLC**

(Exact name of registrant as specified in its charter)

 

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

 

Indicate by check mark whether the registrant (1) has filed all reportsrequired to be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the past 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes ý  No o

 

 

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CHEROKEE INTERNATIONAL, LLC

 

TABLE OF CONTENTS

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

 

2

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PART I.  FINANCIAL INFORMATION

Item 1.  Financial Statements

 

CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 
|                                                                                                                                                                     |   | **March 31,  2002** |       | **December 31,****2001** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|------------|-------------------------------|--------|
|                                                                                                                                                                     |   |                |       |                          |   |
| ASSETS                                                                                                                                                                   |   |                |       |                          |   |
| CURRENT ASSETS:                                                                                                                                                          |   |                |       |                          |   |
| Cash and cash equivalents                                                                                                                                                |   | $                   | 3,408,463  |                          | $      | 2,592,489 |   |
| Short-term investments                                                                                                                                                   |   | 1,199,979           |       | 1,155,096                     |   |
| Accounts receivable, net of allowance for  doubtful accounts of $241,707 and $237,307 as of  March 31, 2002 and December 31, 2001, respectively                     |   | 17,999,614          |       | 17,587,062                    |   |
| Inventories, net                                                                                                                                                         |   | 16,821,237          |       | 21,291,787                    |   |
| Prepaid expenses and other current assets                                                                                                                                |   | 825,473             |       | 1,108,833                     |   |
|                                                                                                                                                                     |   |                |       |                          |   |
| Total current assets                                                                                                                                                     |   | 40,254,766          |       | 43,735,267                    |   |
| PROPERTY AND EQUIPMENT, net of accumulated  depreciation and amortization of $13,977,953 and $13,146,218 as of  March 31, 2002 and December 31, 2001,  respectively |   | 13,851,464          |       | 14,690,370                    |   |
| DEPOSITS                                                                                                                                                                 |   | 396,014             |       | 402,990                       |   |
| DEFERRED INCOME TAXES                                                                                                                                                    |   | 316,237             |       | 316,237                       |   |
| DEFERRED FINANCING COSTS, net of  accumulated amortization of $2,800,274 and $2,530,698 as of  March 31, 2002 and December 31, 2001,  respectively                  |   | 3,313,904           |       | 3,583,480                     |   |
| GOODWILL, net of accumulated amortization  of $4,691,078 in 2002 and 2001                                                                                                |   | 40,916,922          |       | 40,916,922                    |   |
|                                                                                                                                                                     |   |                |       |                          |   |
|                                                                                                                                                                     |   | $                   | 99,049,307 |                          | $      | 103,645,266 |   |
|                                                                                                                                                                     |   |                |       |                          |   |
| LIABILITIES AND MEMBERS’ EQUITY (DEFICIT)                                                                                                                           |   |                |       |                          |   |
| CURRENT LIABILITIES:                                                                                                                                                     |   |                |       |                          |   |
| Accounts payable                                                                                                                                                         |   | $                   | 6,360,588  |                          | $      | 6,325,785 |   |
| Accrued liabilities                                                                                                                                                      |   | 5,767,789           |       | 6,758,971                     |   |
| Accrued compensation and benefits                                                                                                                                        |   | 5,709,063           |       | 6,044,568                     |   |
| Accrued interest payable                                                                                                                                                 |   | 4,819,547           |       | 2,214,097                     |   |
|                                                                                                                                                                     |   |                |       |                          |   |
| Revolving lines of credit                                                                                                                                                |   | 10,953,043          |       | 13,182,146                    |   |
| Current portion of long-term debt                                                                                                                                        |   | 7,931,746           |       | 7,728,098                     |   |
| Current portion of capital lease obligations                                                                                                                             |   | 1,172,936           |       | 1,156,795                     |   |
| Deferred income taxes                                                                                                                                                    |   | 372,505             |       | 372,505                       |   |
|                                                                                                                                                                     |   |                |       |                          |   |
| Total current liabilities                                                                                                                                                |   | 43,087,217          |       | 43,782,965                    |   |
| LONG-TERM DEBT, net of current portion                                                                                                                                   |   | 132,039,318         |       | 134,073,166                   |   |
| CAPITAL LEASE OBLIGATIONS, net of current  portion                                                                                                                       |   | 1,610,900           |       | 1,921,018                     |   |
| MEMBERS’ EQUITY (DEFICIT)                                                                                                                                           |   |                |       |                          |   |
| Class A units: 347,671 units issued and  outstanding in 2002 and 2001                                                                                                    |   | 354,371             |       | 354,371                       |   |
| Class B units: 36,035,065 units issued and  outstanding in 2002 and 2001                                                                                                 |   | 37,037,827          |       | 37,037,827                    |   |
| Paid-in capital                                                                                                                                                          |   | 5,330,000           |       | 5,330,000                     |   |
| Retained earnings (deficit)                                                                                                                                              |   | (119,491,662        | )          | (118,064,169                  | )      |
| Accumulated other comprehensive loss                                                                                                                                     |   | (918,664            | )          | (789,912                      | )      |
|                                                                                                                                                                     |   |                |       |                          |   |
| Total members’ deficit                                                                                                                                              |   | (77,688,128         | )          | (76,131,883                   | )      |
|                                                                                                                                                                     |   |                |       |                          |   |
|                                                                                                                                                                     |   | $                   | 99,049,307 |                          | $      | 103,645,266 |   |

 

See notes to condensed consolidated financial statements.

 

3

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CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 
|                                |   | **Three  Months Ended** |       |
|-------------------------------------|--------|-------------------------|------------|
|                                |   | **March 31,  2002**     |       | **March 31,  2001** |   |
|                                |   |                    |       |   |   |
| NET SALES                           |   | $                       | 24,564,338 |   | $ | 39,419,797 |   |
| COST OF SALES                       |   | 17,220,352              |       | 27,340,923 |   |
|                                |   |                    |       |   |   |
| GROSS PROFIT                        |   | 7,343,986               |       | 12,078,874 |   |
| OPERATING EXPENSES:                 |   |                    |       |   |   |
| Engineering and development         |   | 1,537,971               |       | 1,886,255 |   |
| Selling and marketing               |   | 932,390                 |       | 1,060,417 |   |
| General and administrative          |   | 2,539,399               |       | 2,970,076 |   |
| Amortization of goodwill            |   | —                  |       | 759,000 |   |
|                                |   |                    |       |   |   |
| Total operating expenses            |   | 5,009,760               |       | 6,675,748 |   |
|                                |   |                    |       |   |   |
| OPERATING INCOME                    |   | 2,334,226               |       | 5,403,126 |   |
| OTHER INCOME (EXPENSE):             |   |                    |       |   |   |
| Interest expense                    |   | (3,723,568              | )          | (4,370,508 | ) |
| Other income                        |   | 23,151                  |       | 24,583 |   |
|                                |   |                    |       |   |   |
| Total other expense, net            |   | (3,700,417              | )          | (4,345,925 | ) |
|                                |   |                    |       |   |   |
| Income (loss) before income taxes   |   | (1,366,191              | )          | 1,057,201 |   |
| Provision for income taxes          |   | 61,302                  |       | 95,000 |   |
| NET INCOME (LOSS)                   |   | $                       | (1,427,493 | ) | $ | 962,201 |   |
|                                |   |                    |       |   |   |
| NET INCOME (LOSS) PER UNIT:         |   |                    |       |   |   |
| Basic                               |   | $                       | (.04       | ) | $ | .03 |   |
| Diluted                             |   | $                       | (.04       | ) | $ | .03 |   |
|                                |   |                    |       |   |   |
| WEIGHTED AVERAGE UNITS OUTSTANDING: |   |                    |       |   |   |
| Basic                               |   | 36,382,736              |       | 36,382,736 |   |
| Diluted                             |   | 36,382,736              |       | 36,723,108 |   |

 

See notes to condensed consolidated financial statements

 

4

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CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 
|                                                                                             |   | **Three  Months Ended** |       |
|--------------------------------------------------------------------------------------------------|--------|-------------------------|------------|
|                                                                                             |   | **March 31,2002**       |       | **March 31,2001** |   |
|                                                                                             |   |                    |       |   |   |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                            |   |                    |       |   |   |
| Net income (loss)                                                                                |   | $                       | (1,427,493 | ) | $ | 962,201 |   |
| Adjustments to reconcile net income (loss)  to net cash  provided by operating  activities: |   |                    |       |   |   |
| Depreciation and amortization                                                                    |   | 849,849                 |       | 1,763,319 |   |
| Amortization of deferred financing costs                                                         |   | 269,576                 |       | 242,751 |   |
| Net change in operating assets and  liabilities:                                                 |   |                    |       |   |   |
| Accounts receivable, net                                                                         |   | (525,982                | )          | 3,022,656 |   |
| Inventories, net                                                                                 |   | 4,368,053               |       | 1,726,703 |   |
| Prepaid expenses and other current assets                                                        |   | 276,684                 |       | (84,192 | ) |
| Deposits                                                                                         |   | 782                     |       | 1,096 |   |
| Accounts payable                                                                                 |   | 104,223                 |       | (3,885,300 | ) |
| Accrued liabilities                                                                              |   | (946,276                | )          | (22,928 | ) |
| Accrued compensation and benefits                                                                |   | (280,368                | )          | (1,121,900 | ) |
| Accrued interest payable                                                                         |   | 2,605,835               |       | 2,402,265 |   |
| Net cash provided by operating activities                                                        |   | 5,294,883               |       | 5,006,671 |   |
|                                                                                             |   |                    |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                            |   |                    |       |   |   |
| Additions to property and equipment                                                              |   | (89,461                 | )          | (297,022 | ) |
| Net change in short-term investments                                                             |   | (44,883                 | )          | 8,058 |   |
|                                                                                             |   |                    |       |   |   |
| Net cash used in investing activities                                                            |   | (134,344                | )          | (288,964 | ) |
|                                                                                             |   |                    |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                            |   |                    |       |   |   |
| Borrowings on revolving lines of credit                                                          |   | 3,210,347               |       | 2,969,648 |   |
| Payments on revolving lines of credit                                                            |   | (5,407,550              | )          | (4,600,000 | ) |
| Payments on obligations under capital  leases                                                    |   | (281,224                | )          | (188,208 | ) |
| Payments on long-term debt                                                                       |   | (1,830,200              | )          | (1,427,651 | ) |
| Borrowings on long-term debt                                                                     |   | —                  |       | 208,000 |   |
|                                                                                             |   |                    |       |   |   |
| Net cash used in financing activities                                                            |   | (4,308,627              | )          | (3,038,211 | ) |
| Cash effect of exchange rate changes                                                             |   | (35,938                 | )          | (31,000 | ) |
|                                                                                             |   |                    |       |   |   |
| NET INCREASE IN CASH AND CASH EQUIVALENTS                                                        |   | 815,974                 |       | 1,648,496 |   |
| CASH AND CASH EQUIVALENTS, beginning of  period                                                  |   | 2,592,489               |       | 852,966 |   |
|                                                                                             |   |                    |       |   |   |
| CASH AND CASH EQUIVALENTS, end of period                                                         |   | $                       | 3,408,463  |   | $ | 2,501,462 |   |

 

See notes to condensed consolidated financial statements.

 

5

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CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.       Basis of Presentation

 

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

 

Results of operations for theinterim three months ended March 31, 2002 and 2001 are not necessarily indicativeof the results of operations for the full fiscal year. The Company’s firstquarter represented the 13-week periods ended on March 31 in 2002 and April 1in 2001. For presentation purposes, these fiscal quarters have been referred toas ending on March 31.

 

The condensed consolidatedfinancial statements include the financial statements of the Company and itswholly-owned subsidiaries. One such subsidiary, Cherokee International Finance,Inc., was formed in April 1999 as a wholly-owned finance subsidiary to act as aco-obligor of the 10 1/2% senior subordinated notes and has no independentassets or operations. All significant intercompany accounts and transactionshave been eliminated.

 

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

 

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

 

Certain reclassifications havebeen made to the 2001 presentation to conform with the 2002 presentation.

 

2.       Inventories

 

Inventories are valued at thelower of cost (first-in, first-out) or market. Inventory costs include the costof material, labor and manufacturing overhead and consist of the following:

 
|            |   | **March 31, 2002** |             | **December 31, 2001** |   |
|-----------------|--------|--------------------|------------------|-----------------------|--------|
|            |   |               |             |                  |   |
| Raw material    |   | $                  |  12,784,539 |                  | $      |  14,061,789 |   |
| Work-in-process |   | 2,138,107          |             | 3,526,256             |   |
| Finished goods  |   | 1,898,591          |             | 3,703,742             |   |
|            |   |               |             |                  |   |
|            |   | $                  |  16,821,237 |                  | $      |  21,291,787 |   |

 

6

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3.       Income Taxes

 

The Company is a limitedliability company under the provisions of the federal and state tax codes.Under federal laws, taxes based  onincome of a limited liability company are payable by the Company’s  individual members. Accordingly, noprovision for U.S. federal income taxes has been provided in the accompanying financial statements. Provisionsfor California franchise tax and fees are not significant for any periodpresented. The Company’s provision for income taxes primarily relates tooperations in Mexico, Belgium and India which are subject to income taxes onearnings generated in those countries.

 

4.       Comprehensive Income (Loss)

 

Comprehensive income (loss) isdefined as all changes in a company’s net assets except changes resulting fromtransactions with shareholders. It differs from net income (loss) in thatcertain items currently recorded through equity are included in comprehensiveincome (loss). Comprehensive loss for the three months ended March 31, 2002 was$1,556,245, which included a net loss of $1,427,493 and a loss from foreigncurrency translation adjustments of $128,752. Comprehensive income for thethree months ended March 31, 2001 was $398,110, which included net income of$962,201 and a loss from foreign currency translation adjustments of  $564,091.

 

5.       Net Income (Loss) Per Unit

 

The following table sets forththe computation of basic and diluted income (loss) per unit:

 
|                                            |   | **Three Months Ended** |             |
|-------------------------------------------------|--------|------------------------|------------------|
|                                            |   | **March 31, 2002**     |             | **March 31, 2001** |   |
|                                            |   |                   |             |   |   |
| Net income (loss)                               |   | $                      |  (1,427,493 | ) | $ |  962,201 |   |
|                                            |   |                   |             |   |   |
| Units:                                          |   |                   |             |   |   |
| Weighted-average units outstanding—basic   |   | 36,382,736             |             | 36,382,736 |   |
| Effect of dilutive options                      |   | —                 |             | 340,372 |   |
|                                            |   |                   |             |   |   |
| Weighted-average units outstanding—diluted |   | 36,382,736             |             | 36,723,108 |   |
|                                            |   |                   |             |   |   |
| Net income (loss) per unit:                     |   |                   |             |   |   |
| Basic                                           |   | $                      |  (.04       | ) | $ |  .03 |   |
|                                            |   |                   |             |   |   |
| Diluted                                         |   | $                      |  (.04       | ) | $ |  .03 |   |

 

In calculating net loss perunit for the three months ended March 31, 2002, the effect of dilutive optionsis excluded because it is antidilutive.

 

6.       New Accounting Pronouncements

 

In June 2001, the FinancialAccounting Standards Board (“FASB”) issued two new pronouncements: SFAS No.141, “Business Combinations”, and SFAS No. 142, “Goodwill and Other IntangibleAssets”.  SFAS No. 141 prohibits the useof the pooling-of-interest method for business combinations initiated afterJune 30, 2001 and also applies to all business combinations accounted for bythe purchase method that are completed after June 30, 2001.  There are also transition provisions thatapply to business combinations completed before July 1, 2001, that were accounted for by the purchasemethod.  The Company has adopted SFASNo. 141 and has determined that there was no material impact on theconsolidated financial statements as a result of the adoption. SFAS No. 142 iseffective for fiscal years beginning after December 15, 2001 to all goodwilland other intangible assets recognized in an entity’s statement of financialposition at that date, regardless of when those assets were initiallyrecognized. SFAS No. 142 requires that goodwill and other intangible assetswith indefinite useful lives no longer be amortized, but instead be tested forimpairment at least annually. The Company adopted FAS No. 142 effective January1, 2002. The Company no longer amortizes goodwill but will evaluate theircarrying value on an annual basis or when events or circumstances indicate thattheir carrying value may be impaired. The adoption of  SFAS No. 142 resulted in reduced amortization expense ofapproximately $759,000 during the first quarter of 2002 compared to the firstquarter of 2001.

 

7

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In August 2001, FASB issuedSFAS No. 144, “Accounting for Impairment or Disposal of Long-Lived Assets.”This statement addresses financial accounting and reporting for the impairmentof long-lived assets and for long-lived assets to be disposed of. SFAS No. 144supercedes SFAS No. 121, “Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to be Disposed of,” and is effective for fiscal yearsbeginning after December 15, 2001.  The adoptionof this standard at January 1, 2002 did not have a material impact on theCompany's financial position and results of operations.

 

7.       Goodwill

 

In connection with theacquisition of Cherokee Europe in June 2000, the excess purchase price amountallocated to goodwill was approximately $46 million which was being amortizedover a useful life of 15 years. This amortization cost was recorded inoperating expenses. The Company ceased amortizing goodwill as of the beginningof the first quarter of 2002 in compliance with SFAS No. 142 and did notrecognize approximately $759,000 of amortization expense that was recognized inthe first quarter of 2001.  Inaccordance with SFAS No. 142, the Company will evaluate the carrying value ofgoodwill for impairment initially as of June 30, 2002, and at least annuallythereafter or when events or circumstances indicate that their carrying valuemay be impaired.

 

Summarized below is the effecton net income (loss) per share data, if the Company had followed the amortizationprovisions of SFAS 142 for all periods presented (in thousands, except pershare amounts):

 
|                                          |   | **Three  Months Ended** |         |
|-----------------------------------------------|--------|-------------------------|--------------|
|                                          |   | **March 31, 2002**      |         | **March 31, 2001** |   |
| Net (loss) income:                            |   |                    |         |   |   |
| As reported                                   |   | $                       |  (1,427 | ) | $ |  962 |   |
| Add: goodwill amortization                    |   | —                  |         | 759 |   |
| Adjusted net (loss) income                    |   | $                       |  (1,427 | ) | $ |  1,721 |   |
|                                          |   |                    |         |   |   |
| Basic net income (loss) per share:            |   |                    |         |   |   |
| As reported                                   |   | $                       |  (.04   | ) | $ |  .03 |   |
| Add: goodwill amortization                    |   | —                  |         | .02 |   |
| Adjusted basic net income (loss) per share    |   | $                       |  (.04   | ) | $ |  .05 |   |
|                                          |   |                    |         |   |   |
| Diluted net income (loss) per share:          |   |                    |         |   |   |
| As reported                                   |   | $                       |  (.04   | ) | $ |  .03 |   |
| Add: goodwill amortization                    |   | —                  |         | .02 |   |
| Adjusted diluted net income (loss) per  share |   | $                       |  (.04   | ) | $ |  .05 |   |

 

8

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8.       Long-Term Debt

 

In September2001, the Company's credit agreement with its lenders was amended to includeprovisions that specify among other things, (1) that some of the Company'sunitholders, or their equity members, will guarantee $10.5 million of theCompany's senior debt principal until specific financial ratios are attained,(2) that the Company will be restricted from making cash distributions to itsunitholders until specific financial ratios are attained, (3) that the Companywill be permitted to make its interest payment due in November 2002 relating toits $100 million of senior subordinated notes so long as specified financialratios are attained, (4) that the maximum availability under the revolving lineof credit is reduced until approximately April 30, 2002, (5) that LIBOR andbase rate margins have been increased for revolver borrowings and term loans,and (6) that financial covenants ratios required in future periods have beenmodified, including provisions allowing the Company's unitholders to makecapital contributions to the Company which will be treated as earnings (asdefined) for purposes of calculating debt covenants.  As of March 31, 2002 the Company was in compliance with its debtcovenants.

 

Based upon ourpresent expectations, the Company anticipates that it may not be in compliancewith certain financial covenants under its credit agreement at June 30, 2002without additional financing from its unitholders.  In addition, the Company believes that cash flow from operationsand available borrowing capacity may not be adequate to meet its anticipatedcash requirements, including operating requirements, planned capitalexpenditures and debt service, for the last six months of the year, or earlier,without additional financing from its unitholders.

 

The Company iscurrently considering alternatives to address these issues, which may include(i) an amendment or restructuring of its credit agreement to provide additionalliquidity and room under certain financial covenants, (ii) a refinancing of itscredit agreement, (iii) the infusion of additional equity by its unitholders,or (iv) some combination of the above. Based upon the Company’s current business plans and prospects,management expects that its restructuring alternatives, the $10.5 millionguaranty by certain unitholders and funding from its unitholders, if necessary,will enable the Company to meet its obligations and comply with its debtcovenants through December 31, 2002.

 

Managementcannot provide any assurances that the Company will be successful in obtainingany desired results on satisfactory terms or as to what effect any of theforegoing, if obtained, may have on its future business operations.  In the event of a covenant or paymentdefault under the credit agreement or a payment default under the indenturegoverning the Company's senior subordinated notes, the lenders under the creditagreement would become entitled to certain rights, including the right toaccelerate the debt and to require the Company's unitholders, or their equitymembers, to contribute $10.5 million to repay senior debt principal under theterms of the guaranty they provided. The guarantors would be subrogated to rights of the lenders under thecredit agreement, on the basis senior to the senior subordinated notes.  In the event of a payment default under theindenture or the credit agreement or in the event of an acceleration of amountsdue under the credit agreement, the holders of the senior subordinated notescould also accelerate the maturity of the outstanding senior subordinatednotes.

 

9.       Unit Option Plan

 

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

 

9

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MANAGEMENT’S DISCUSSION ANDANALYSIS OF

FINANCIAL CONDITION AND RESULTSOF OPERATIONS

 

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

 

OVERVIEW

 

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

 

The principalelements comprising cost of sales are raw materials, labor and manufacturingoverhead. Raw materials account for a majority of cost of sales. Raw materialsinclude magnetic subassemblies, sheet metal, electronic and other components,mechanical parts and electrical wires. Labor costs include employee costs ofsalaried and hourly employees. Manufacturing overhead includes lease costs,depreciation on property, plant and equipment, utilities, property taxes andrepairs and maintenance.

 

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

 

During 2001and the first quarter of 2002, the Company continued to generate the majority of its sales from thecommunications market segment, particularly the networking andtelecommunications sectors.   As aresult of unfavorable economic conditions and reduced capital spending bycommunication service providers that purchase our customers’ products, the Company’ssales decreased in each quarter of 2001, compared to the immediately precedingquarter.  Sales in the first quarter of2002 increased slightly from the fourth quarter of 2001. The Company believesunstable and unpredictable economic and industry conditions may continue.  If these conditions persist, the Company’soperating results and financial condition could be adversely affected.

 

RESULTS OF OPERATIONS

 

THREE MONTHS ENDED MARCH 31,2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001

 

NET SALES

 

Net salesdecreased by approximately 37.7% or $14.9 million to $24.6 million for thethree months ended March 31, 2002 from last year’s $39.4 million for the threemonths ended March 31, 2001.  Sales ofour North American operations decreased by approximately 45.8% or $11.7 millioncompared to the prior year, while sales of Cherokee Europe decreased byapproximately 22.7% or $3.1 million. These decreases were primarily due tolower customer demand as a result of unfavorable economic conditions andreduced capital spending by communication service providers.

 

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GROSS PROFIT

 

Gross profitdecreased by approximately 39.2% or $4.7 million to $7.3 million for the threemonths ended March 31, 2002 from $12.1 million for the three months ended March31, 2001. Gross margin for the quarter decreased to 29.9% from 30.6% in theprior year’s quarter.

 

The decreasein gross profit was primarily due to significantly lower gross profitcontributed by the North American operations which was attributable to thelower sales.   The decrease in grossmargin compared to the prior year was primarily a result of a lower grossmargin for our North American operations due mainly to an increase in factoryoverhead expenses as percentage of net sales. This was partially offset byhigher gross margins for Cherokee Europe due to a favorable change in productmix.

 

OPERATING EXPENSES

 

Operatingexpenses for the three months ended March 31, 2002 decreased by approximately25.0% or $1.7 million to $5.0 million from $6.7 million for the three monthsended March 31, 2001. As a percentage of sales, operating expenses increased to20.4% from 16.9% in the first quarter of the prior year.

 

The decreasein operating expenses was primarily attributable to reductions in our workforceand other cost control measures implemented mainly during 2001 in response tounfavorable economic conditions.  Inaddition, as a result of adopting SFAS No. 142 as of January 1, 2002, thecompany ceased amortizing goodwill in the first quarter of 2002. Amortizationof goodwill in the prior year’s quarter was approximately $0.8 million.

 

OPERATING INCOME

 

Operatingincome decreased by approximately 56.8% or $3.1 million to $2.3 million for thethree months ended March 31, 2002 from $5.4 million for the three months endedMarch 31, 2001. Operating margin decreased to 9.5% for the first quarter from13.7% in the prior year.

 

The decreasein operating income was primarily attributable to a decline in operating incomeof the North American operations  due tothe lower sales and decreased gross margin. Operating income contributed by Cherokee Europe in the first quarterincreased from the prior year due to a favorable change in product mix. Thedecrease in operating margin was primarily attributable to the decrease ingross margin combined with higher operating expenses as a percentage of salesdiscussed above.

 

INTEREST EXPENSE

 

Interestexpense for the three months ended March 31, 2002 was $3.7 million compared to$4.4 million for the three months ended March 31, 2001. The effect of increaseddebt during the three months ended March 31, 2002 compared to the prior year’squarter was offset by lower interest rates on the Company’s revolver borrowingsand term loans in the current year compared to the prior year.

 

NET INCOME (LOSS)

 

As a result ofthe items discussed above, the Company recorded a net loss of $1.4 million forthe three months ended March 31, 2002 compared to net income of $1.0 millionfor the three months ended March 31, 2001.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

CASH FLOWS

 

THREE MONTHS ENDED MARCH 31,2002 COMPARED TO THREE MONTHS ENDED MARCH 31, 2001

 

Net cashprovided by operating activities was $5.3 million for the three months endedMarch 31, 2002 compared to $5.0 million for the three months ended March 31,2001. Cash provided by operating activities for 2002 reflects a net loss ofapproximately $1.4 million, depreciation and amortization of $0.9 million, adecrease in inventories of  $4.4million, and an increase in accrued interest payable of $2.6 million, partiallyoffset by a decrease of $0.9 million in accrued liabilities. Cash provided byoperating activities for 2001 reflects net income of $1.0 million, depreciationand amortization of  $1.8 million,decreases of $3.0 million in accounts receivables and $1.7 million ininventory, and an increase in accrued interest payable of $2.4 million,partially offset by decreases of $3.9 million in accounts payable and $1.1 millionin accrued compensation and benefits.

 

Net cash usedin financing activities of $4.3 million for the three months ended  March 31, 2002 primarily reflects a netreduction of $2.2 million in revolving credit borrowings and $1.8 million ofpayments on long-term debt. Net cash used in financing activities of  $3.0 million for the three months endedMarch 31, 2001 primarily reflects a net reduction of  $1.6 million in revolving credit borrowings and $1.4 million ofpayments on long-term debt.

 

LIQUIDITY

 

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

 

The Company’shistorical capital expenditures have substantially resulted from investments inequipment to increase manufacturing capacity and improve manufacturingefficiencies. For fiscal 2002, the Company expects capital expenditures to beapproximately $1-2 million.

 

As of  March 31, 2002, the Company’s borrowingsconsisted of $100 million of senior subordinated notes and $50.9 million ofborrowings under its various credit facilities, including $9.6 million drawnunder its $25 million domestic revolving credit facility. The Company is notsubject to any amortization requirements under the senior subordinated notesprior to maturity in 2009, but it is required to make scheduled principal paymentsunder certain term loans.

 

In September2001, the Company's credit agreement with its lenders was amended to includeprovisions that specify among other things, (1) that some of the Company'sunitholders, or their equity members, will guarantee $10.5 million of theCompany's senior debt principal until specific financial ratios are attained,(2) that the Company will be restricted from making cash distributions to itsunitholders until specific financial ratios are attained, (3) that the Companywill be permitted to make its interest payment due in November 2002 relating toits $100 million of senior subordinated notes so long as specified financialratios are attained, (4) that the maximum availability under the revolving lineof credit is reduced until approximately April 30, 2002, (5) that LIBOR andbase rate margins have been increased for revolver borrowings and term loans,and (6) that financial covenants ratios required in future periods have beenmodified, including provisions allowing the Company's unitholders to makecapital contributions to the Company which will be treated as earnings (asdefined) for purposes of calculating debt covenants.  As of March 31, 2002 the Company was in compliance with its debtcovenants.

 

Based uponpresent expectations, the Company anticipates that it may not be in compliancewith certain financial covenants under its credit agreement at June 30, 2002without additional financing from its unitholders.  In addition, the Company believes that cash flow from operations andavailable borrowing capacity may not be adequate to meet its anticipated cashrequirements, including 

 

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operating requirements, plannedcapital expenditures and debt service, for the last six months of the year, orearlier, without additional financing from its unitholders.

 

The Company iscurrently considering alternatives to address these issues, which may include(i) an amendment or restructuring of its credit agreement to provide additionalliquidity and room under certain financial covenants, (ii) a refinancing of itscredit agreement, (iii) the infusion of additional equity by its unitholders,or (iv) some combination of the above. Based upon the Company’s current business plans and prospects, managementexpects that its restructuring alternatives, the $10.5 million guaranty bycertain unitholders and funding from its unitholders, if necessary, will enablethe Company to meet its obligations and comply with its debt covenants throughDecember 31, 2002.

 

Managementcannot provide any assurances that the Company will be successful in obtainingany desired results on satisfactory terms or as to what effect any of theforegoing, if obtained, may have on its future business operations.  In the event of a covenant or paymentdefault under the credit agreement or a payment default under the indenturegoverning the Company's senior subordinated notes, the lenders under the creditagreement would become entitled to certain rights, including the right to acceleratethe debt and to require the Company's unitholders, or their equity members, tocontribute $10.5 million to repay senior debt principal under the terms of theguaranty they provided.  The guarantorswould be subrogated to rights of the lenders under the credit agreement, on thebasis senior to the senior subordinated notes. In the event of a payment default under the indenture or the creditagreement or in the event of an acceleration of amounts due under the creditagreement, the holders of the senior subordinated notes could also acceleratethe maturity of the outstanding senior subordinated notes.

 

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NEW ACCOUNTING PRONOUNCEMENTS

 

In June 2001,the Financial Accounting Standards Board (“FASB”) issued two newpronouncements: SFAS No. 141, “Business Combinations”, and SFAS No. 142,“Goodwill and Other Intangible Assets”. SFAS No. 141 prohibits the use of the pooling-of-interest method forbusiness combinations initiated after June 30, 2001 and also applies to allbusiness combinations accounted for by the purchase method that are completedafter June 30, 2001.  There are alsotransition provisions that apply to business combinations completed  before July 1, 2001, that were accounted forby the purchase method.  The Company hasadopted SFAS No. 141 and has determined that there was no material impact onthe consolidated financial statements as a result of the adoption. SFAS No. 142is effective for fiscal years beginning after December 15, 2001 to all goodwilland other intangible assets recognized in an entity’s statement of financialposition at that date, regardless of when those assets were initiallyrecognized. SFAS No. 142 requires that goodwill and other intangible assetswith indefinite useful lives no longer be amortized, but instead be tested forimpairment at least annually. The Company adopted FAS No. 142 effective January1, 2002. The Company  no longeramortizes goodwill but will evaluate their carrying value on an annual basis orwhen events or circumstances indicate that their carrying value may beimpaired. The adoption of  SFAS No. 142resulted in reduced amortization expense of approximately $759,000 during thefirst quarter of 2002 compared to the first quarter of 2001.  See Note 7 of Notes to CondensedConsolidated Financial Statements.

 

In August2001, FASB issued SFAS No. 144, “Accounting for Impairment or Disposal ofLong-Lived Assets.” This statement addresses financial accounting and reportingfor the impairment of long-lived assets and for long-lived assets to bedisposed of. SFAS No. 144 supercedes SFAS No. 121, “Accounting for theImpairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of,”and is effective for fiscal years beginning after December 15, 2001. Theadoption of this standard at January 1, 2002 did not have a material impact onthe Company's financial position and results of operations.

 

FORWARD-LOOKING STATEMENTS

 

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

 

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ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK

 

Market risksrelating to our operations result primarily from changes in short-term interestrates. The Company did not have any derivative financial instruments at March31, 2002.

 

The Company’sexposure to market risk for changes in interest rates relates primarily to itscurrent domestic credit facility. In accordance with the credit facility, theCompany enters into variable rate debt obligations to support general corporatepurposes, including capital expenditures and working capital needs. The Companycontinuously evaluates its level of variable rate debt with respect to totaldebt and other factors, including assessment of the current and future economicenvironment.

 

The Companyhad approximately $51 million in variable rate debt outstanding at March 31,2002. Based upon these variable rate debt levels, a hypothetical 10% adversechange in interest rates would increase interest expense by approximately $0.4million on an annual basis, and likewise decrease our earnings and cash flows.The Company cannot predict market fluctuations in interest rates and theirimpact on its variable rate debt, nor can there be any assurance that fixedrate long-term debt will be available to the Company at favorable rates, if atall. Consequently, future results may differ materially from the estimatedadverse changes discussed above.

 

As a result ofthe Cherokee Europe acquisition in June 2000, the Company has Europeanoperations and is, therefore, subject to a certain degree of market riskassociated with changes in foreign currency exchange rates. The Company has notactively engaged in exchange rate hedging activities.

 

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PART II.       OTHER INFORMATION

 

ITEM 1.         LEGAL PROCEEDINGS

 

The Company issubject to disputes and potential claims by third parties that are incidentalto the conduct of its business. The Company does not believe that the outcomeof any such matters, pending at March 31, 2002 will have a material adverseeffect on its financial condition or results of operations.

 

ITEM 6.       EXHIBITS AND REPORTS ON FORM 8-K
| (a)    |   | EXHIBITS:                                                                                                                           |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                |
| 3.1*   |   | Second  Amended and Restated Operating Agreement of Cherokee International, LLC,  dated as of April 30, 1999.                       |
|   |   |                                                                                                                                |
| 3.2*   |   | Amendment  No. 1 to the Second Amended and Restated Operating Agreement of Cherokee  International, LLC, dated as of June 28, 1999. |
|   |   |                                                                                                                                |
| 3.3*   |   | Amendment  No. 2 to the Second Amended and Restated Operating Agreement of Cherokee  International, LLC, dated as of June 28, 1999. |
|   |   |                                                                                                                                |
| 3.4**  |   | Amendment  No. 3 to the Second Amended and Restated Operating Agreement of Cherokee  International, LLC, dated as of June 12, 2000. |
|   |   |                                                                                                                                |
| 3.5**  |   | Amendment  No. 4 to the Second Amended and Restated Operating Agreement of Cherokee  International, LLC, dated as of June 14, 2000. |
|   |   |                                                                                                                                |
| (b)    |   | REPORTS ON  FORM 8-K  None                                                                                                          |

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

 

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

 

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SIGNATURES

 

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

 
|                | Cherokee  International, LLC  |
|---------------------|-------------------------------|
|                |                          |
| Date: May  15, 2002 | /s/ R. Van  Ness Holland, Jr. |
|                |                          |
|                | R. Van Ness  Holland, Jr.     |
|                | Chief  Financial Officer      |

 

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