**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-Q**

**x**                              QUARTERLY REPORT PURSUANT TO SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

**Forthe quarterly period ended October 2, 2005**

**OR**

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

**Forthe transition period             to             **

**Commissionfile number 000-50593**

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**CHEROKEE INTERNATIONAL CORPORATION**

(Exact name of Registrantas specified in its charter)

| **Delaware**                             |   | **95-4745032**          |
|------------------------------------------|--------|-------------------------|
| (State or other  jurisdiction of         |   | (I.R.S. Employer        |
| incorporation or  organization)          |   | Identification  Number) |
| **2841 Dow Avenue, Tustin, California**  |   | **92780**               |
| (Address of  principal executive office) |   | (Zip Code)              |

 

**(714) 544-6665**

(Registrant’s telephonenumber, including area code)

**N/A**

(Former name, formeraddress and former fiscal year, if changed since last report)

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Indicate by check markwhether the registrant: (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days:  Yes  x  No  o

Indicate by check markwhether the registrant is an accelerated filer (as defined in Rule 12b-2of the Exchange Act).  Yes  o  No  x

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

Asof October 31, 2005, 19,232,111 shares of the registrant’s common stock,$0.001 par value, were outstanding.

 

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**TABLE OF CONTENTS**

| PART I FINANCIAL  INFORMATION                                                                  | 3  |   |
|-----------------------------------------------------------------------------------------------------|----|--------|
| Item 1. Condensed  Consolidated Financial Statements (unaudited):                                   | 3  |   |
| Condensed Consolidated  Balance Sheets                                                              | 3  |   |
| Condensed Consolidated  Statements of Operations                                                    | 4  |   |
| Condensed Consolidated  Statements of Comprehensive Operations                                      | 5  |   |
| Condensed Consolidated  Statements of Cash Flows                                                    | 6  |   |
| Notes to Condensed  Consolidated Financial Statements                                               | 7  |   |
| Item 2. Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 16 |   |
| Item 3. Quantitative and  Qualitative Disclosures About Market Risk                                 | 25 |   |
| Item 4. Controls and Procedures                                                                     | 25 |   |
| PART II OTHER INFORMATION                                                                      | 27 |   |
| Item 1. Legal Proceedings                                                                           | 27 |   |
| Item 2. Unregistered Sales  of Equity Securities and Use of Proceeds                                | 27 |   |
| Item 6. Exhibits                                                                                    | 27 |   |
| Signatures                                                                                          | 28 |   |

 

2

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**PART I.   FINANCIAL INFORMATION**

**Item 1.**                        CondensedConsolidated Financial Statements.

**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATEDBALANCE SHEETS(In Thousands, Except Share Data)(Unaudited)**

| ** **                                                                                                                                                                                             | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ASSETS                                                                                                                                                                                                 |       |                         |       |                        |       |   |   |   |   |
| CURRENT ASSETS:                                                                                                                                                                                        |       |                         |       |                        |       |   |   |   |   |
| Cash and cash  equivalents                                                                                                                                                                             |       |                         | $          | 11,411                      |       |   |   | $ | 14,585 |   |   |
| Short-term  investments                                                                                                                                                                                |       |                         | 325        |                        |       |   | 4,178 |   |   |
| Accounts  receivable, net                                                                                                                                                                              |       |                         | 24,415     |                        |       |   | 27,929 |   |   |
| Inventories, net                                                                                                                                                                                       |       |                         | 28,514     |                        |       |   | 28,278 |   |   |
| Prepaid expenses  and other current assets                                                                                                                                                             |       |                         | 1,641      |                        |       |   | 2,056 |   |   |
| Total current  assets                                                                                                                                                                                  |       |                         | 66,306     |                        |       |   | 77,026 |   |   |
| Property and equipment, net                                                                                                                                                                            |       |                         | 16,625     |                        |       |   | 15,028 |   |   |
| Deposits and  other assets                                                                                                                                                                             |       |                         | 1,297      |                        |       |   | 965 |   |   |
| Deferred  financing costs, net                                                                                                                                                                         |       |                         | 378        |                        |       |   | 476 |   |   |
| Goodwill                                                                                                                                                                                               |       |                         | 6,317      |                        |       |   | 6,317 |   |   |
|                                                                                                                                                                                                   |       |                         | $          | 90,923                      |       |   |   | $ | 99,812 |   |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                             |       |                         |       |                        |       |   |   |   |   |
| CURRENT LIABILITIES:                                                                                                                                                                                   |       |                         |       |                        |       |   |   |   |   |
| Accounts payable                                                                                                                                                                                       |       |                         | $          | 8,436                       |       |   |   | $ | 12,803 |   |   |
| Accrued  liabilities                                                                                                                                                                                   |       |                         | 8,850      |                        |       |   | 6,733 |   |   |
| Accrued  compensation and benefits                                                                                                                                                                     |       |                         | 6,098      |                        |       |   | 6,987 |   |   |
| Accrued restructuring  costs                                                                                                                                                                           |       |                         | 230        |                        |       |   | 259 |   |   |
| Total current  liabilities                                                                                                                                                                             |       |                         | 23,614     |                        |       |   | 26,782 |   |   |
| Long-term debt, net of current portion                                                                                                                                                                 |       |                         | 46,630     |                        |       |   | 46,630 |   |   |
| Other long-term  obligations                                                                                                                                                                           |       |                         | 3,998      |                        |       |   | 4,266 |   |   |
| COMMITMENTS AND  CONTINGENCIES (Note 10)                                                                                                                                                               |       |                         |       |                        |       |   |   |   |   |
| STOCKHOLDERS’  EQUITY                                                                                                                                                                             |       |                         |       |                        |       |   |   |   |   |
| Preferred  stock: $0.001 par value; 10,000,000 shares authorized; none issued and  outstanding                                                                                               |       |                         | —     |                        |       |   | — |   |   |
| Common  stock: $0.001 par value; 60,000,000 shares authorized; 19,232,111 and 19,206,207  shares issued and outstanding at September 30, 2005 and December 31,  2004, respectively |       |                         | 19         |                        |       |   | 19 |   |   |
| Paid-in capital                                                                                                                                                                                        |       |                         | 183,803    |                        |       |   | 183,713 |   |   |
| Accumulated  deficit                                                                                                                                                                                   |       |                         | (168,976   | )                           |       |   | (165,666 | ) |   |
| Accumulated other  comprehensive income                                                                                                                                                                |       |                         | 1,835      |                        |       |   | 4,068 |   |   |
| Net stockholders’ equity                                                                                                                                                                          |       |                         | 16,681     |                        |       |   | 22,134 |   |   |
|                                                                                                                                                                                                   |       |                         | $          | 90,923                      |       |   |   | $ | 99,812 |   |   |

 

See notes to condensed consolidated financial statements.

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**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATEDSTATEMENTS OF OPERATIONS(In Thousands, Except Per Share Amounts)(Unaudited)**

| ** **                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                   | ** ** | **2005**                         | ** ** | **2004**                        | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net sales                                    |       |                             | $          | 26,418                          |       |   |   | $ | 36,375 |   |   |   | $ | 89,420 |   |   |   | $ | 111,829 |   |   |
| Cost of sales                                |       |                             | 21,753     |                            |       |   | 26,434 |   |   |   | 70,801 |   |   |   | 77,613 |   |   |
| Gross profit                                 |       |                             | 4,665      |                            |       |   | 9,941 |   |   |   | 18,619 |   |   |   | 34,216 |   |   |
| Operating Expenses:                          |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Engineering and  development                 |       |                             | 2,116      |                            |       |   | 2,462 |   |   |   | 6,822 |   |   |   | 7,128 |   |   |
| Selling and  marketing                       |       |                             | 1,631      |                            |       |   | 1,945 |   |   |   | 5,633 |   |   |   | 5,775 |   |   |
| General and  administrative                  |       |                             | 2,560      |                            |       |   | 2,180 |   |   |   | 8,736 |   |   |   | 6,281 |   |   |
| Stock  compensation expense                  |       |                             | —     |                            |       |   | 227 |   |   |   | — |   |   |   | 227 |   |   |
| Gain from  insurance proceeds                |       |                             | —     |                            |       |   | — |   |   |   | (2,490 | ) |   |   | — |   |   |
| Total operating  expenses                    |       |                             | 6,307      |                            |       |   | 6,814 |   |   |   | 18,701 |   |   |   | 19,411 |   |   |
| Operating income (loss)                      |       |                             | (1,642     | )                               |       |   | 3,127 |   |   |   | (82 | ) |   |   | 14,805 |   |   |
| Interest expense                             |       |                             | (643       | )                               |       |   | (713 | ) |   |   | (2,035 | ) |   |   | (4,509 | ) |   |
| Other income, net                            |       |                             | 50         |                            |       |   | 93 |   |   |   | 75 |   |   |   | 40 |   |   |
| Income (loss)  before income taxes           |       |                             | (2,235     | )                               |       |   | 2,507 |   |   |   | (2,042 | ) |   |   | 10,336 |   |   |
| Provision for  income taxes                  |       |                             | (73        | )                               |       |   | 818 |   |   |   | 1,268 |   |   |   | 2,118 |   |   |
| Net income (loss)                            |       |                             | $          | (2,162                          | )          |   |   | $ | 1,689 |   |   |   | $ | (3,310 | ) |   |   | $ | 8,218 |   |   |
| Net income (loss)  per share:                |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                        |       |                             | $          | (0.11                           | )          |   |   | $ | 0.09 |   |   |   | $ | (0.17 | ) |   |   | $ | 0.51 |   |   |
| Diluted                                      |       |                             | $          | (0.11                           | )          |   |   | $ | 0.09 |   |   |   | $ | (0.17 | ) |   |   | $ | 0.50 |   |   |
| Weighted average  common shares outstanding: |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                        |       |                             | 19,232     |                            |       |   | 19,182 |   |   |   | 19,220 |   |   |   | 15,970 |   |   |
| Diluted                                      |       |                             | 19,232     |                            |       |   | 19,463 |   |   |   | 19,220 |   |   |   | 18,397 |   |   |

 

See notes to condensed consolidated financial statements.

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**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATEDSTATEMENTS OF COMPREHENSIVE OPERATIONS(In Thousands)(Unaudited)**

| ** **                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                | ** ** | **September 30,  2005**     | ** ** | **September 30,  2004**    | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| Net income (loss)                         |       |                             | $          | (2,162                          | )          |   |   | $ | 1,689 |   |   |   | $ | (3,310 | ) |   |   | $ | 8,218 |   |   |
| Other comprehensive  income (loss):       |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Foreign currency  translation adjustments |       |                             | 229        |                            |       |   | 1,141 |   |   |   | (2,233 | ) |   |   | 115 |   |   |
| Comprehensive income  (loss)              |       |                             | $          | (1,933                          | )          |   |   | $ | 2,830 |   |   |   | $ | (5,543 | ) |   |   | $ | 8,333 |   |   |

 

See notes to condensed consolidated financial statements.

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**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESCONDENSED CONSOLIDATEDSTATEMENTS OF CASH FLOWS(In Thousands)(Unaudited)**

| ** **                                                                                               | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                               | ** ** | **September 30,  2005**    | ** ** | **September 30,  2004** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                    |       |                            |       |   |   |   |   |   |   |
| Net income (loss)                                                                                        |       |                            | $          | (3,310 | ) |   |   | $ | 8,218 |   |   |
| Adjustments to reconcile net income (loss) to net  cash provided by (used in) operating activities: |       |                            |       |   |   |   |   |   |   |
| Depreciation and  amortization                                                                           |       |                            | 2,335      |   |   |   | 2,261 |   |   |
| Stock compensation  expense                                                                              |       |                            | —     |   |   |   | 227 |   |   |
| Gain on sale of  property and equipment                                                                  |       |                            | (30        | ) |   |   | — |   |   |
| Amortization of  deferred financing costs                                                                |       |                            | 97         |   |   |   | 118 |   |   |
| Write-off of  unamortized deferred financing costs and debt discount                                     |       |                            | —     |   |   |   | 224 |   |   |
| Net change in operating assets and liabilities:                                                          |       |                            |       |   |   |   |   |   |   |
| Accounts  receivable, net                                                                                |       |                            | 2,030      |   |   |   | (2,810 | ) |   |
| Inventories, net                                                                                         |       |                            | (1,128     | ) |   |   | (3,078 | ) |   |
| Prepaid expenses  and other current assets                                                               |       |                            | 269        |   |   |   | (385 | ) |   |
| Deposits and other  assets                                                                               |       |                            | (332       | ) |   |   | (582 | ) |   |
| Accounts payable                                                                                         |       |                            | (3,541     | ) |   |   | 125 |   |   |
| Accrued  liabilities and accrued restructuring costs                                                     |       |                            | 571        |   |   |   | (2,332 | ) |   |
| Accrued  compensation and benefits                                                                       |       |                            | (343       | ) |   |   | (65 | ) |   |
| Accrued interest  payable                                                                                |       |                            | 585        |   |   |   | 327 |   |   |
| Other long-term  obligations                                                                             |       |                            | 122        |   |   |   | (1,655 | ) |   |
| Net cash provided  by (used in) operating activities                                                     |       |                            | (2,675     | ) |   |   | 593 |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                    |       |                            |       |   |   |   |   |   |   |
| Additions to  property and equipment                                                                     |       |                            | (4,799     | ) |   |   | (3,075 | ) |   |
| Net change in  short-term investments                                                                    |       |                            | 3,853      |   |   |   | (68 | ) |   |
| Proceeds from sale  of property and equipment                                                            |       |                            | 34         |   |   |   | — |   |   |
| Net cash used in  investing activities                                                                   |       |                            | (912       | ) |   |   | (3,143 | ) |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                    |       |                            |       |   |   |   |   |   |   |
| Borrowings on  revolving lines of credit                                                                 |       |                            | —     |   |   |   | 11,301 |   |   |
| Payments on  revolving lines of credit                                                                   |       |                            | —     |   |   |   | (17,433 | ) |   |
| Payments on  obligations under capital leases                                                            |       |                            | —     |   |   |   | (665 | ) |   |
| Payments on  long-term debt                                                                              |       |                            | —     |   |   |   | (65,519 | ) |   |
| Deferred financing  costs                                                                                |       |                            | —     |   |   |   | (249 | ) |   |
| Proceeds from  employee stock purchases and the exercise of warrants and stock options                   |       |                            | 90         |   |   |   | 16 |   |   |
| Short-term  advances for construction costs                                                              |       |                            | 1,217      |   |   |   | — |   |   |
| Net proceeds from  sale of common stock                                                                  |       |                            | —     |   |   |   | 86,470 |   |   |
| Net cash provided  by financing activities                                                               |       |                            | 1,307      |   |   |   | 13,921 |   |   |
| Cash effect of  exchange rate changes                                                                    |       |                            | (894       | ) |   |   | 157 |   |   |
| Net increase  (decrease) in cash and cash equivalents                                                    |       |                            | (3,174     | ) |   |   | 11,528 |   |   |
| Cash and cash  equivalents, beginning of period                                                          |       |                            | 14,585     |   |   |   | 4,887 |   |   |
| Cash and cash  equivalents, end of period                                                                |       |                            | $          | 11,411 |   |   |   | $ | 16,415 |   |   |
| SUPPLEMENTAL INFORMATION                                                                                 |       |                            |       |   |   |   |   |   |   |
| Conversion of  senior convertible notes into common stock                                                |       |                            | $          | — |   |   |   | $ | 53,370 |   |   |
| Interest paid                                                                                            |       |                            | $          | 1,300 |   |   |   | $ | 3,721 |   |   |
| Income taxes paid                                                                                        |       |                            | $          | 364 |   |   |   | $ | 1,591 |   |   |

 

See notes to condensed consolidated financial statements.

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**CHEROKEE INTERNATIONAL CORPORATION AND SUBSIDIARIESNOTES TO CONDENSEDCONSOLIDATED FINANCIAL STATEMENTS(Unaudited)**

**1.   Nature of Operations**

Cherokee InternationalCorporation (the “Company”) is a designer and manufacturer of power suppliesfor original equipment manufacturers (OEMs). Its advanced power supply productsare typically custom designed into mid- to high-end commercial applications inthe computing and storage, wireless infrastructure, enterprise networking,medical and industrial markets.

*Initial PublicOffering*

The Company completed itsinitial public offering of 6,600,000 shares of its common stock, par value$0.001 per share (“Common Stock”), on February 25, 2004, at a price of$14.50 per share. The net proceeds to the Company from this offering afteroffering costs of $9.2 million were $86.5 million. The Company usedapproximately $73.2 million of the net proceeds to repay certain outstandingindebtedness and accrued interest. Immediately prior to the consummation of theoffering, the Company completed a 1 for 3.9 reverse stock split of itsoutstanding Common Stock. All share and per share amounts for all periodspresented in this report reflect this reverse stock split. Also in connectionwith the offering, the Company issued 6,283,796 shares of Common Stock uponconversion of the original principal amount of its outstanding seniorconvertible notes of $53.4 million, and issued 4,071,114 shares of Common Stockupon the exercise of outstanding warrants.

**2.   Basisof Presentation and Summary of Significant Accounting Policies**

*Basis ofPresentation*

The information set forth in the accompanyingcondensed consolidated financial statements is unaudited and, in the opinion ofmanagement, reflects all adjustments, consisting only of normal recurring adjustments,considered necessary to present fairly the financial position, results ofoperations and cash flows of the Company for the periods indicated.

Results of operations for the interim three month andnine month periods ended September 30, 2005 and 2004 are not necessarilyindicative of the results of operations for the full fiscal year. The Company’sthird quarter represented the 13-week period ended on October 2,2005 and the 14-week period ended on October 3, 2004. Forpresentation purposes, these fiscal quarters, and the nine month periods thenended, have been referred to as ending on September 30.

The condensed consolidated financial statementsinclude the financial statements of the Company and its wholly ownedsubsidiaries. All intercompany accounts and transactions have been eliminated.

Certain informationnormally included in footnote disclosures to the financial statements has beencondensed or omitted in accordance with the rules and regulations of theSecurities and Exchange Commission. Accordingly, the financial statements donot include all the information and note disclosures normally included inannual consolidated financial statements prepared in accordance with accountingprinciples generally accepted in the United States of America. These unauditedcondensed consolidated financial statements should be read in conjunction withthe other disclosures contained herein and with the Company’s auditedconsolidated financial statements and notes thereto for the year ended December 31,2004, contained in the Company’s Annual Report on Form 10-K (File No. 000-50593)filed on April 1, 2005.

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*Use of Estimates*

The preparation offinancial statements in accordance with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent liabilities at the date of the financial statementsand the amounts of revenues and expenses during the reporting period. Actualresults could differ from such estimates.

*Stock-BasedCompensation*

As permitted by SFAS No. 123, “Accounting forStock-Based Compensation,” the Company accounts for its employee stock-basedcompensation plan using the intrinsic value method under APB Opinion No. 25,“Accounting for Stock Issued to Employees,” and provides the expandeddisclosures specified in SFAS No. 123, as amended by SFAS No. 148, “Accountingfor Stock-Based Compensation—Transition and Disclosure.”

Thetable below reconciles net income (loss) as reported and pro forma net income(loss) had compensation cost been determined using the provisions of SFAS No. 123for the three month and nine month periods ended September 30, 2005 and2004 (in thousands, except per share data):

| ** **                                                                                                                | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                | ** ** | **September 30,  2005**     | ** ** | **September 30,  2004**    | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| Net income  (loss), as reported                                                                                           |       |                             | $          | (2,162                          | )          |   |   | $ | 1,689 |   |   |   | $ | (3,310 | ) |   |   | $ | 8,218 |   |   |
| Stock-based  employee compensation included in net income (loss), net of tax                                              |       |                             | —     |                            |       |   | 227 |   |   |   | — |   |   |   | 227 |   |   |
| Total stock-based  employee compensation expense determined under the fair value based method  for all awards, net of tax |       |                             | (274       | )                               |       |   | (263 | ) |   |   | (890 | ) |   |   | (587 | ) |   |
| Net income (loss)  pro forma                                                                                              |       |                             | $          | (2,436                          | )          |   |   | $ | 1,653 |   |   |   | $ | (4,200 | ) |   |   | $ | 7,858 |   |   |
| Net income (loss)  per share, as reported:                                                                                |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                                                     |       |                             | $          | (0.11                           | )          |   |   | $ | 0.09 |   |   |   | $ | (0.17 | ) |   |   | $ | 0.51 |   |   |
| Diluted                                                                                                                   |       |                             | $          | (0.11                           | )          |   |   | $ | 0.09 |   |   |   | $ | (0.17 | ) |   |   | $ | 0.50 |   |   |
| Pro forma net income  (loss) per share:                                                                                   |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                                                                                     |       |                             | $          | (0.13                           | )          |   |   | $ | 0.09 |   |   |   | $ | (0.22 | ) |   |   | $ | 0.49 |   |   |
| Diluted                                                                                                                   |       |                             | $          | (0.13                           | )          |   |   | $ | 0.08 |   |   |   | $ | (0.22 | ) |   |   | $ | 0.48 |   |   |

 

For the purpose of estimating the compensation cost ofthe Company’s option grants in accordance with SFAS No. 123, the fairvalue of each option grant is estimated on the date of grant using theBlack-Scholes option-pricing model. The number of shares to be granted underthe employee stock purchase plan is estimated until the period in whichsettlement occurs, as the actual number of shares awarded and purchase priceare not known until settlement.

The weighted average assumptions used to value optiongrants during the nine months ended September 30, 3005 were: expected stockprice volatility of 43%; risk-free interest rate of 3.67%; no dividends; and expectedlives of five years. The assumptions used for the nine months ended September 30,2004 were: expected stock price volatility of 53%; risk-free interest rate of3.51%; no dividends; and expected lives of five years.

Since its inception on February16, 2004, 592,062 shares of common stock have been authorized for issuanceunder the 2004 Employee Stock Purchase Plan (“ESPP”). Under the terms of theESPP, our employees can choose to have up to a maximum of 15% of their eligibleannual base earnings withheld, subject to an annual maximum of $25,000 or 2,100shares per offering period, to purchase our common 

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stock.The purchase price of the stock is 85% of the lower of the closing price at thebeginning of each six-month offering period or at the end of each six-monthperiod. The Company accounts for its ESPP under APB Opinion No. 25 and does notrecognize compensation cost related to employee rights under this plan.

*Translation ofForeign Currency*

Foreign subsidiary assetsand liabilities denominated in foreign currencies are translated at theexchange rate on the balance sheet date. Revenues, costs and expenses aretranslated at the average exchange rate during the period. Transaction gainsand losses are included in results of operations and have not been significantfor the periods presented. The functional currency of the Company’s operatingsubsidiary in Europe, Cherokee Europe SCA (“Cherokee Europe”), is the Euro. Thefunctional currency of the Company’s operating subsidiaries in Mexico (CherokeeElectronica, S.A. DE C.V.), India (Cherokee India Pvt. Ltd. and Powertel IndiaPvt. Ltd.), and China (Cherokee International (China) Power Supply Ltd.) is theU.S. dollar, as the majority of transactions are denominated in U.S. dollars. Translationadjustments related to Cherokee Europe are reflected as a component ofstockholders’ equity in accumulated other comprehensive income.

*Recent AccountingPronouncements*

In November 2004, the Financial AccountingStandards Board (“FASB”) issued SFAS No. 151, “Inventory Costs—anamendment of ARB No. 43, Chapter 4.” This statement amends the guidance inARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting forabnormal amounts of idle facility expense, freight, handling costs, and wastedmaterial (spoilage). Abnormal amounts of these costs should be recognized ascurrent period charges rather than as a portion of inventory costs. Inaddition, SFAS 151 requires that allocation of fixed production overheads tothe costs of manufacturing be based on the normal capacity of the productionfacilities. The provisions of SFAS 151 are effective for inventory costsincurred during fiscal years beginning after June 15, 2005. The Company iscurrently evaluating the effect that the adoption of this new standard may haveon the Company’s consolidated financial position and results of operations.

In December 2004, the FASB issued SFAS 123R(Revised 2004), “Share-Based Payment,” which requires that the compensationcost relating to share-based payment transactions be recognized in financialstatements based on the fair value of the award on the date of grant. The costwill be recognized over the period during which the employee is required toprovide service in exchange for the award (usually the vesting period). TheCompany currently discloses pro forma compensation expense quarterly andannually. Upon adoption, the pro forma disclosures previously permitted underSFAS 123 will no longer be an alternative to financial statement recognition.The provisions of SFAS 123R are effective as of the beginning of the firstinterim or annual reporting period that begins after December 15, 2005.The Company is currently evaluating the method of adoption and the effect thatthe adoption of SFAS 123R will have on the Company’s consolidated financialposition and results of operations.

In December 2004, the FASB issued SFAS No. 153,“Exchanges of Nonmonetary Assets—an amendment of APB Opinion No. 29.” Theamendment eliminates the exception to fair value accounting for nonmonetaryexchanges of similar productive assets and replaces it with a broader exceptionfor exchanges of nonmonetary assets that do not have commercial substance.Under APB 29, accounting for an exchange of a productive asset for a similarproductive asset or an equivalent interest in the same or similar productiveasset is to be based upon the recorded amount of the asset relinquished(carryover basis with no gain or loss recognition). The transaction will now beaccounted for based upon the fair value of the assets exchanged. The Statementis effective for exchanges occurring in fiscal years beginning after June 15,2005 and is to be applied prospectively. The adoption of SFAS 153 is notexpected to have a material impact on the Company’s consolidated financialposition and results of operations.

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In December 2004, the FASB issued Staff Position No. 109-2,“Accounting and Disclosure Guidance for the Foreign Earnings RepatriationProvision within the American Jobs Creation Act of 2004” (“FSP 109-2”).In October 2004, the American Jobs Creation Act of 2004 (the “Act”) wassigned into law. The Act contains a number of provisions that may affect theCompany’s future effective income tax rate. The most significant provisionwould allow the Company to elect to deduct from its taxable income 85% ofcertain eligible dividends received by the Company from its non-U.S.subsidiaries before the end of 2005. FSP 109-2 provides entitiesadditional time, beyond the financial reporting period in which the Act wasenacted, to evaluate the effects of the Act on the Company’s plan forreinvestment or repatriation of foreign earnings. The Company has not yetcompleted its evaluation of the impact, if any, of the repatriation provisionsof this Act nor has it determined the related range of income tax effects ofsuch repatriation. That evaluation is expected to be complete by the end offiscal year 2005.

In June 2005, theFASB issued SFAS No. 154, “Accounting Changes and Error Corrections,”which changes the requirements for the accounting for and reporting ofvoluntary changes in accounting principle. SFAS 154 requires retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple, unless impracticable. SFAS 154 supersedes Accounting PrinciplesBoard Opinion No. 20, Accounting Change (APB 20), which previouslyrequired that most voluntary changes in accounting principle be recognized byincluding in the current period’s net income the cumulative effect of changingto the new accounting principle. SFAS 154 also makes a distinction betweenretrospective application of an accounting principle and the restatement offinancial statements to reflect correction of an error. SFAS 154 carriesforward without changing the guidance contained in APB 20 for reporting thecorrection of an error in previously issued financial statements and a changein accounting estimate. SFAS 154 applies to voluntary changes inaccounting principle that are made in fiscal years beginning after December 15,2005. The adoption of SFAS 154 is not expected to have a material impact on theCompany’s consolidated financial condition or results of operations.

*Inventories*

Inventoriesare valued at the lower of weighted average cost or market. Inventory costsinclude the cost of material, labor and manufacturing overhead and consist ofthe following, net of reserve for obsolescence (in thousands):

| ** **       | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|------------------|------------|------------------------------|------------|-----------------------------|------------|
| Raw material     |       |                         | $          | 18,124                      |       |   |   | $ | 20,788 |   |   |
| Work-in-process  |       |                         | 4,791      |                        |       |   | 4,741 |   |   |
| Finished goods   |       |                         | 5,599      |                        |       |   | 2,749 |   |   |
| Inventories, net |       |                         | $          | 28,514                      |       |   |   | $ | 28,278 |   |   |

 

As of September 30,2005 and December 31, 2004, the reserve for inventory obsolescence was$4.4 million and $4.5 million, respectively.

**3.   Income Taxes**

The Company accounts for income taxes in accordance withSFAS No. 109, “Accounting for Income Taxes.” In accordance with SFAS No. 109,deferred tax assets and liabilities are recorded for the estimated future taxeffects of temporary differences between the carrying value of assets andliabilities for financial reporting and their tax basis, and carryforwards tothe extent they are realizable. A deferred tax provision or benefit resultsfrom the net change in deferred tax assets and liabilities during the period. Adeferred tax asset valuation allowance is recorded if it is more likely thannot that all or a portion of the recorded deferred tax assets will not berealized. As of December 31, 2004, deferred tax assets include $38.5million 

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relating to a tax basisstep up from a recapitalization transaction in 1999 and $15.0 million of netoperating loss carryforwards. The Company has recorded a full valuationallowance against its deferred tax assets.

Provision for income taxesof $1.3 million for the nine months ended September 30, 2005 was calculated byestimating the full-year 2005 taxable income separately for each taxjurisdiction and allocating the related income tax provision to the periodduring which the income was generated. For the nine months ended September 30,2005, our consolidated loss before income taxes was $2.2 million; however, becausea portion of taxable income for 2005 is generated in tax jurisdictions withoutoperating loss carryforwards, while taxable losses are generated in certainother tax jurisdictions, with no available tax benefit related to these lossesincluded in the provision for income taxes, we recorded a provision for incometaxes of $1.3 million.

**4.**   Net Income (Loss)Per Share

In accordance with SFAS No. 128, “Earnings PerShare,” basic earnings per share is based upon the weighted average number ofcommon shares outstanding. Diluted earnings per share is based upon theweighted average number of common and potential shares of common stock for eachperiod presented, except for periods that reflect net losses, in which caseadding potential shares of common stock would be anti-dilutive. Potentialcommon shares include the dilutive effect, if any, of stock options, warrantsand the employee stock purchase plan under the treasury stock method and seniorconvertible notes under the if-converted method. For purposes of the dilutedearnings per share calculation for the three month and nine month periods endedSeptember 30, 2005, potential common shares of 18,927 and 21,565,respectively, were excluded because their effect would be anti-dilutive. Forpurposes of the diluted earnings per share calculation for the nine monthperiod ended September 30, 2004, the senior convertible notes are assumedto have been converted at the beginning of the period, and as a result, netincome has been increased by $1.0 million for the reduction in interest expenserelated to the senior convertible notes.

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

| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                   | ** ** | **September 30,  2005**     | ** ** | **September 30,  2004**    | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| Net income (loss)                                            |       |                             | $          | (2,162                          | )          |   |   | $ | 1,689 |   |   |   | $ | (3,310 | ) |   |   | $ | 8,218 |   |   |
| Adjustment for  interest expense on senior convertible notes |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   | 1,036 |   |   |
| Net income  (loss), adjusted                                 |       |                             | $          | (2,162                          | )          |   |   | $ | 1,689 |   |   |   | $ | (3,310 | ) |   |   | $ | 9,254 |   |   |
| Shares:                                                      |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Weighted-average  common shares outstanding—basic       |       |                             | 19,232     |                            |       |   | 19,182 |   |   |   | 19,220 |   |   |   | 15,970 |   |   |
| Effect of dilutive  securities:                              |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Senior  convertible notes and warrants                       |       |                             | —     |                            |       |   | — |   |   |   | — |   |   |   | 1,960 |   |   |
| Outstanding stock  options                                   |       |                             | —     |                            |       |   | 281 |   |   |   | — |   |   |   | 467 |   |   |
| Weighted-average  common shares outstanding—diluted     |       |                             | 19,232     |                            |       |   | 19,463 |   |   |   | 19,220 |   |   |   | 18,397 |   |   |
| Net income (loss)  per share:                                |       |                             |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Basic                                                        |       |                             | $          | (0.11                           | )          |   |   | $ | .09 |   |   |   | $ | (0.17 | ) |   |   | $ | .51 |   |   |
| Diluted                                                      |       |                             | $          | (0.11                           | )          |   |   | $ | .09 |   |   |   | $ | (0.17 | ) |   |   | $ | .50 |   |   |

 

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**5.   DeferredFinancing Costs**

Netdeferred financing costs are comprised of the following as of September 30,2005 and December 31, 2004 (in thousands):

| ** **                     | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|--------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Deferred  financing costs      |       |                         | $          | 580                         |       |   |   | $ | 580 |   |   |
| Accumulated  amortization      |       |                         | (202       | )                           |       |   | (104 | ) |   |
| Deferred  financing costs, net |       |                         | $          | 378                         |       |   |   | $ | 476 |   |   |

 

The Company amortizes deferred financing costs overthe life of the related debt.

**6.   Long-Term Debt**

Long-termdebt consists of the following as of September 30, 2005 and December 31,2004 (in thousands):

| ** **                                    | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|-----------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| 5.25% senior  notes payable to third parties: |       |                         |       |                        |       |   |   |   |   |
| Non-current                                   |       |                         | $          | 24,485                      |       |   |   | $ | 24,485 |   |   |
| 5.25% senior  notes payable to affiliates:    |       |                         |       |                        |       |   |   |   |   |
| Non-current                                   |       |                         | 22,145     |                        |       |   | 22,145 |   |   |
| Total long-term debt                          |       |                         | $          | 46,630                      |       |   |   | $ | 46,630 |   |   |

 

The senior notes mature on November 1, 2008. Intereston the senior notes is payable in cash on May 1 and November 1 ofeach year. The senior notes are secured by a second priority lien onsubstantially all of the Company’s domestic assets and by a pledge of 65% ofthe equity of certain of its foreign subsidiaries. As of September 30,2005, the Company was in compliance with all of the covenants set forth in theprincipal agreements governing the 5.25% senior notes.

In connection with the Company’s initial publicoffering completed February 25, 2004, the Company amended and restated itsexisting senior revolving credit facility with General Electric CapitalCorporation. The amended facility (the “Credit Facility”) provides forborrowings of up to $20.0 million that are subject to a borrowing basecomprised of eligible accounts receivable and inventory, which was $13.3million at September 30, 2005. The Credit Facility matures in August 2008and borrowings bear interest, at the Company’s option, at a rate per annumequal to LIBOR plus 2.5% or the agent bank’s base rate plus 1.0%. In additionto paying interest on outstanding principal, the Company is required to pay acommitment fee to the lenders under the credit facility in respect of theaverage daily balance of unused loan commitments at a rate of 0.5% per annum.The Credit Facility is secured by a first-priority lien, subject to permittedencumbrances, on substantially all of the Company’s domestic assets and by apledge of 65% of the equity of certain of the Company’s foreign subsidiaries.The Credit Facility contains restrictive covenants requiring the Company to,among other things, maintain certain senior leverage ratios. As of September 30,2005, there were no borrowings outstanding under the Credit Facility, and theCompany was in compliance with all of the covenants under the Credit Facility.

Cherokee Europe maintainsa working capital line of credit of approximately $3.7 million with a Belgianbank, BBL, which is denominated in Euros, is collateralized by a pledge infirst and second rank over a specific amount of business assets, requiresCherokee Europe to maintain a certain specific minimum solvency ratio and iscancelable at any time. As of September 30, 2005, Cherokee Europe had nooutstanding borrowings under the line of credit and was in compliance with allcovenants.

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**7.   Other Long-Term Obligations**

Otherlong-term obligations consist of the following as of September 30, 2005and December 31, 2004 (in thousands):

| ** **                                                    | ** ** | **September 30,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| Long term portion  of European restructuring cost liabilities |       |                         | $          | 1,078                       |       |   |   | $ | 1,508 |   |   |
| Long service  award liabilities                               |       |                         | 1,977      |                        |       |   | 2,057 |   |   |
| Deferred  compensation                                        |       |                         | 943        |                        |       |   | 701 |   |   |
| Total other long-term  obligations                            |       |                         | $          | 3,998                       |       |   |   | $ | 4,266 |   |   |

 

**8.   CherokeeEurope Restructuring**

In June 2003, the Company received approval for arestructuring plan (the “European Restructuring”) of its operations in Europefrom the Workers Union and the appropriate governmental authorities in Belgium.The European Restructuring involved the elimination of 61 operational andadministrative positions at the Cherokee Europe facility in Belgium due tounfavorable economic conditions in that market. All of the terminations werecompleted in 2003. Pursuant to the European Restructuring, the Company recordeda restructuring charge of $4.5 million in operating expenses in the statementof operations during fiscal year 2003. The European Restructuring costs arecomprised entirely of one-time termination benefits to be paid through 2010. TheCompany has paid $0.3 million during the nine month period ended September 30,2005 under the European Restructuring.

Areconciliation of the European Restructuring accrual for the period January 1,2005 through September 30, 2005 is as follows (in thousands):

| Balance as of  December 31, 2004  |   |   | $      | 1,767  |   |   |
|----------------------------------------|--------|--------|--------|--------|--------|--------|
| Provision                              |   |   | — |   |   |
| Payments                               |   |   | (266   | )      |   |
| Foreign exchange  rate effect          |   |   | (193   | )      |   |
| Balance as of  September 30, 2005 |   |   | 1,308  |   |   |
| Less current  portion                  |   |   | (230   | )      |   |
| Due after one year                     |   |   | $      | 1,078  |   |   |

 

**9.   CustomerConcentration**

For the threemonths ended September 30, 2005, no customer accounted for more than 10%of net sales. For the nine months ended September 30, 2005, one customeraccounted for 11% of net sales. For the three months and nine months endedSeptember 30, 2004, one customer accounted for 18% of net sales, and no othercustomer accounted for more than 10% of net sales. A decision by a majorcustomer to decrease the amount purchased from the Company or to ceasepurchasing the Company’s products could have a material adverse effect on theCompany’s consolidated financial position and results of operations.

Asof September 30, 2005, no customer accounted for more than 10% of our netaccounts receivable.

**10.**   Commitments andContingencies

*Guarantees andIndemnities*

The Company has agreed to indemnify the former ownersof Cherokee Europe for product liability, environmental hazard and employmentpractice claims relating solely to post-acquisition business. The Company alsoindemnifies its directors and officers to the maximum extent permitted underthe laws of the 

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State of Delaware, andvarious lessors in connection with facility leases for certain claims arisingfrom such facility or lease. No claims are currently pending against theCompany for such indemnifications. The maximum amount of potential futurepayments 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 financial statements for guaranteesand indemnifications as of September 30, 2005.

*Legal Matters*

The Company is currently in the process of anarbitration proceeding against a former executive. This person has disputed theamount due under their 2003 Stock Option Plan Agreement at the time of theirresignation from the Board in July 2004. The amount in dispute is approximately$300,000. In the event that the arbitration is decided against the Company, theCompany will be liable to this former executive for the disputed amount, plusthe Company may be liable for this person’s legal costs and expenses. 

In addition, the Companyis, in the normal course of business, subject to various other legal matters,and believes they will not individually or collectively have a material adverseeffect on our consolidated financial condition, results of operations or cashflows.

**11.**   Stockand Deferred Compensation Plans

*2004 Employee StockPurchase Plan*

On February 16, 2004,the Company adopted the 2004 Employee Stock Purchase Plan (the “ESPP”). As of September 30,2005, a total of 592,062 shares of Common Stock were authorized for issuanceunder the plan. The number of shares authorized under the plan will increaseannually on the first day of the Company’s fiscal year in an amount equal tothe lesser of (i) 250,000 shares or (ii) 1% of the number of outstandingshares on the last day of the immediately preceding fiscal year. The ESPPutilizes six-month offerings with employee purchases occurring at six-monthintervals, with a new offering period commencing on the first trading day on orafter May 15 and November 15 and ending on the last trading day on orbefore November 14 or May 14, respectively. The CompensationCommittee of the Company’s Board of Directors oversees administration of theESPP. Employees are eligible to participate if they are employed for at least20 hours per week and more than 5 months in a calendar year by the Company,subject to certain restrictions. The ESPP permits eligible employees topurchase Common Stock through payroll deductions, which may not exceed 15% ofan employee’s compensation. The price of Common Stock purchased under the ESPPis 85% of the lower of the fair market value of the Common Stock at thebeginning of each six-month offering period or on the applicable purchase date.Employees may end their participation in an offering at any time during theoffering period, and participation ends automatically upon termination ofemployment. The Compensation Committee may at any time amend or terminate theESPP, except that no such amendment or termination may adversely affect sharespreviously granted under the ESPP. As of September 30, 2005, 44,570 shareshave been issued under the ESPP.

*2004 Omnibus StockIncentive Plan*

On February 16, 2004,the Company adopted the 2004 Omnibus Stock Incentive Plan (the “2004 Plan”). Asof September 30, 2005, a total of 1,184,124 shares of the Company’s CommonStock were authorized for issuance under the 2004 Plan. The number of sharesauthorized under the 2004 Plan will increase annually on the first day of theCompany’s fiscal year in an amount equal to the lesser of (i) 450,000shares or (ii) 2% of the number of outstanding shares on the last day ofthe immediately preceding fiscal year. Any officer, director, employee,consultant or advisor of the Company is eligible to participate in the 2004Plan. The 2004 Plan provides for the issuance of stock-based incentive awards,including stock options, stock appreciation rights, restricted stock, deferredstock, and performance shares. 

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As of September 30,2005, the Company has granted options to purchase 789,089 shares of CommonStock under the 2004 Plan, which included 135,589 options granted tonon-employee directors. As of September 30, 2005, no shares have beenissued under the 2004 Plan.

*DeferredCompensation Plans*

On February 16, 2004,the Company adopted two executive deferred compensation plans for the benefitof certain designated employees and non-employee directors of the Company. Theplans allow participating employees and non-employee directors to make pre-taxdeferrals of up to 100% of their annual base salary and bonuses and retainerfees and meeting fees, respectively. The plans allow the Company to makematching contributions and employer profit sharing credit at the solediscretion of the Company. A participant’s interest in each matchingcontribution and employer profit sharing credits, if any, vests in full nolater than after 3 years. As of September 30, 2005, the Company hasrecorded a liability of $0.9 million for employee and non-employee directorcontributions and investment activity to date, which is recorded in otherlong-term liabilities. The Company has provided no contribution matches to dateas of September 30, 2005.

**12.   Retirement Plans**

CherokeeEurope maintains a pension plan for certain levels of staff and management thatincludes a defined benefit feature. The following represents the amountsrelated to this defined benefit plan for the three month and nine month periodsended September 30, 2005 and 2004 (in thousands):

| ** **                                                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| **Components of Net Periodic Benefit Cost** | ** ** | ** **                       | ** ** | **September 30,  2005**    | ** ** | **September 30,  2004** | ** ** | **September 30,  2005** | ** ** | **September 30,  2004** | ** ** |
| Service cost                                                         |       |                             | $          | 37                              |       |   |   | $ | 41 |   |   |   | $ | 115 |   |   |   | $ | 118 |   |   |
| Interest cost                                                        |       |                             | 60         |                            |       |   | 63 |   |   |   | 187 |   |   |   | 182 |   |   |
| Expected return  on plan assets                                      |       |                             | (34        | )                               |       |   | (36 | ) |   |   | (105 | ) |   |   | (105 | ) |   |
| Net periodic benefit  cost                                           |       |                             | $          | 63                              |       |   |   | $ | 68 |   |   |   | $ | 197 |   |   |   | $ | 195 |   |   |
|                                                                      |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

Cherokee Europe presentlyanticipates contributing $0.3 million to fund its pension plan in 2005.

**13.**   Gain From InsuranceProceeds

On January 19, 2004, the Company experienced afire in part of its facility in Belgium, which destroyed certain inventory,property and equipment. As of September 30, 2005, the Company has received$6.3 million in insurance proceeds. Included in the statement of operations forthe nine months ended September 30, 2005 is a gain from insurance proceedsof $2.5 million, which represents the excess of insurance proceeds receivedover the net book value of assets destroyed and related expenditures.

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MANAGEMENT’S DISCUSSIONAND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

**Item2.**                        Management’sDiscussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

We are a designer andmanufacturer of power supplies for OEMs. Our advanced power supplyproducts are typically custom designed into mid- to high-end commercialapplications in the computing and storage, wireless infrastructure, enterprisenetworking, medical and industrial markets.

We operate worldwide andhave facilities in Orange County, California; Bombay, India; Guadalajara,Mexico; Wavre, Belgium; and Shanghai, China. We were founded in 1978 in OrangeCounty, California. As we expanded our business and customer base, we openedfacilities in Bombay, India and in Guadalajara, Mexico. In June 2000, weacquired Cherokee Europe, which added a manufacturing facility in Wavre,Belgium and enabled us to better serve the European market. In 2005, we startedoperations in China to better serve that market and improve our materialssourcing.

We generate a significantportion of our sales from OEMs in the communications and computing marketsegment, particularly the wireless infrastructure and networking sectors.During 2001, 2002 and the first quarter of 2003, our operating results werenegatively affected by unfavorable economic conditions and reduced capitalspending by communication service providers that purchase our customers’products. Although we saw improvement in these economic conditions throughoutthe balance of 2003 and into 2004, we experienced lower sales during the secondhalf of 2004, which has continued into the nine months ended September 30,2005. If conditions do not improve, or instead deteriorate further, ouroperating results and financial condition could be adversely affected.

Gross margins in thesecond half of 2004 and the nine months ended September 30, 2005 reflect ashift in our sales mix, with increased sales coming from certain programs withhigher material cost.

We completed our initialpublic offering of 6,600,000 shares of our common stock on February 25, 2004.The net proceeds from the offering were $86.5 million. We used approximately$73.2 million of the net proceeds to repay outstanding indebtedness andrelated interest. In connection with the offering, we issued 6,283,796 sharesof our common stock upon conversion of the original principal amount of ourthen outstanding senior convertible notes, and issued 4,071,114 shares ofcommon stock upon exercise of outstanding warrants.

In addition, in connectionwith the offering, we amended and restated our existing senior revolving creditfacility with General Electric Capital Corporation. The amended facility (the “CreditFacility”) provides for borrowings of up to $20.0 million that are subject to aborrowing base comprised of eligible accounts receivable and inventory, whichwas $13.3 million at September 30, 2005. Please refer to “Liquidity andCapital Resources” below for additional information regarding our outstandingindebtedness.

During 2005 and early2006, we are expanding operations in China by constructing a 100,000 squarefoot facility near Shanghai, which will result in capital expenditures in 2005being significantly higher than previous years’ levels. We began constructionof this facility in the second quarter of 2005 and have recorded $.6 million ofconstruction-in-progress for the three month period ended September 30,2005 and $1.6 million for the nine month period ended September 30, 2005.

BASIS OF REPORTING

*Net Sales*

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

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*Cost of Sales*

The principal elementscomprising cost of sales are raw materials, labor and manufacturing overhead.Raw materials account for a large majority of costs of sales. Raw materialsinclude magnetic sub-assemblies, sheet metal, electronic and other components,mechanical parts and electrical wires. Direct labor costs include costs ofhourly employees. Manufacturing overhead includes salaries and the directexpense and allocation of costs attributable to manufacturing for lease costs,depreciation on property, plant and equipment, utilities, property taxes andrepairs and maintenance.

*Operating Expenses*

Operating expenses includeengineering costs, selling and marketing costs and general and administrativeexpenses. Engineering costs primarily include salaries and benefits ofengineering personnel, safety approval and quality certification fees,depreciation on equipment and subcontract costs for third-party contractingservices. Selling and marketing expenses primarily include salaries andbenefits to account managers and commissions to independent salesrepresentatives. Administrative expenses primarily include salaries andbenefits for certain management and administrative personnel, professional feesand information system costs. Operating expenses also include the directexpense and allocation of costs attributable to these departments for leasecosts, depreciation on property, plant and equipment, utilities, property taxesand repairs and maintenance.

CRITICAL ACCOUNTING POLICIES

We prepare ourconsolidated financial statements in conformity with accounting principlesgenerally accepted in the United States. As such, we are required to makecertain estimates, judgments and assumptions that we believe are reasonablebased upon the information currently available. These estimates and assumptionsaffect the reported amounts of assets and liabilities at the date of thefinancial statements and the reported amounts of revenues and expenses duringthe periods presented. Any future changes to these estimates and assumptionscould have a material effect on our reported amounts of revenue, expenses,assets and liabilities. The significant accounting policies that we believe arethe most critical to aid in fully understanding and evaluating our reportedfinancial results include the following:

*Revenue Recognition*

We recognize revenue fromproduct sales at the time of shipment and passage of title. We also offer ourcustomers the right to return products that do not function properly within alimited time after delivery. We monitor and track product returns and record aprovision for warranty costs based on historical experience, which has beeninsignificant to our financial condition and results of operations. Any significantincrease in product failure rates could have a material adverse effect on ouroperating results for the period or periods in which those returns materialize.

*Accounts Receivable*

We perform ongoing creditevaluations of our customers and adjust credit limits based upon paymenthistory, the customer’s current credit worthiness and various other factors, asdetermined by our review of their current credit information. We continuouslymonitor collections and payments from our customers and maintain a provisionfor estimated credit losses based upon our historical experience and anyspecific customer collection issues that we have identified. While creditlosses have historically been within our expectations and the provisionsestablished, we may not continue to experience the same credit loss rates thatwe have in the past. A significant portion of our accounts receivable isconcentrated in a small number of customers. A significant change in theliquidity or financial position of any one of these customers could have amaterial adverse effect on the collectibility of our accounts receivable, ourliquidity and our future operating results.

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*Inventories*

We value our inventory atthe lower of the actual cost to purchase and/or manufacture the inventory andthe current estimated market value of the inventory using the weighted averagecost method. We regularly review inventory quantities on hand and record aprovision for excess and obsolete inventory based primarily on our historicalusage data and estimates of future demand. Our industry is characterized byrapid technological change, frequent new product development, and rapid productobsolescence that could result in an increase in the amount of obsoleteinventory quantities on hand. As demonstrated during the past five years,demand for our products can fluctuate significantly. A significant increase inthe demand for our products could result in a short-term increase in the costof inventory purchases while a significant decrease in demand could result inan increase in the amount of excess inventory quantities on hand. In addition,our estimates of future product demand may prove to be inaccurate, in whichcase we may have understated or overstated the provision required for excessand obsolete inventory. In the future, if our inventory is determined to beovervalued, we would be required to recognize additional expense in our cost ofgoods sold at the time of such determination. Likewise, if our inventory isdetermined to be undervalued, we may have over reported our costs of goods soldin previous periods and would be required to recognize additional operatingincome at the time such inventory is sold. Therefore, although we make everyreasonable effort to ensure the accuracy of our estimates of future productdemand, any significant unanticipated changes in demand or technologicaldevelopments could have a material effect on the value of our inventory and ourreported operating results.

*Deferred Taxes*

We recognize deferred taxassets and liabilities based on the differences between the financial statementcarrying values and the tax basis of assets and liabilities. We regularlyreview our deferred tax assets for recoverability and establish a valuationallowance based on historical taxable income, projected future taxable income,and the expected timing of the reversals of existing temporary differences. Ifour future taxable income is significantly higher than expected and/or we areable to utilize our tax credits, we may be required to reverse all or a significantpart of our valuation allowance against such deferred tax assets which couldsubstantially reduce our effective tax rate for such period. Therefore, anysignificant changes in statutory tax rates or the amount of our valuationallowance could have a material effect on the value of our deferred tax assetsand liabilities and our reported financial results.

*Goodwill and Long Lived Assets*

We review therecoverability of the carrying value of goodwill on an annual basis or morefrequently when an event occurs or circumstances change to indicate that animpairment of goodwill has possibly occurred. The determination of whether anypotential impairment of goodwill exists is based upon a comparison of the fairvalue of the reporting unit to the accounting value of its net assets.

We also review therecoverability of the carrying value of long-lived assets whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. Recoverability of these assets is determined based upon theforecasted undiscounted future net cash flows from the operations to which theassets relate, utilizing our best estimates, appropriate assumptions andprojections at the time. 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 to the extent the carryingvalue exceeded the estimated fair market value of the asset.

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RESULTS OFOPERATIONS

THREE MONTHS ENDEDSEPTEMBER 30, 2005 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2004

NET SALES

Net sales decreased by approximately 27.4%, or $10million, to $26.4 million for the three months ended September 30, 2005from $36.4 million for the three months ended September 30, 2004.

Thedecrease in net sales is due primarily to a reduction in demand from a few ofour larger programs in the datacom and telecom market segments. Sales to one ofour largest customers declined by $3.6 million compared to the prioryear’s quarter.

**GROSSPROFIT**

Gross profit decreased by approximately 53.1%, or $5.3million, to $4.7 million for the three months ended September 30, 2005from $9.9 million for the three months ended September 30, 2004. Grossmargin for the three months ended September 30, 2005 decreased to 17.7%from 27.3% in the prior year period.

The decrease in grossprofit was due primarily to the decrease in revenues and the resulting loss ofcontribution margin on those revenues, combined with a different product mixduring the third quarter of 2005 that included programs with higher materialcontent than the three months ended September 30, 2004. The decrease ingross margin was due primarily to higher labor and overhead costs as apercentage of net sales resulting from the lower revenue level, combined withthe change in product mix.

**OPERATINGEXPENSES**

Operating expenses for the three months ended September 30,2005, decreased by approximately 7.4%, or $.5 million, to $6.3 million from$6.8 million for the three months ended September 30, 2004. As apercentage of sales, operating expenses increased to 23.9% from 18.7% in theprior year period.

Thedecrease in operating expenses is due primarily to lower sales commissions andsalary costs, due generally to lower revenues, partially offset by higherprofessional fees associated with readiness efforts for compliance with Section404 of the Sarbanes-Oxley Act.

**OPERATINGINCOME (LOSS)**

As a result of the factorsdiscussed above, we reported an operating loss of $1.6 million for the threemonths ended September 30, 2005 compared to operating income of $3.1million for the three months ended September 30, 2004. Operating margindecreased to (6.2)% from 8.6% in the third quarter of 2004.

**INTERESTEXPENSE**

Interest expense for thethree months ended September 30, 2005 was $0.6 million compared to $0.7million for the three months ended September 30, 2004. There was noappreciable change compared to the prior year’s quarter.

**INCOMETAXES**

Provision for income taxeswas a negative $0.1 million for the three months ended September 30, 2005compared to $0.8 million for the comparable period in 2004. Provision forincome taxes for the three months ended September 30, 2005 was calculatedby estimating full-year 2005 taxable income separately for each taxjurisdiction and allocating the related income tax provision to the quarterduring which the income was generated. A portion of our taxable income for 2005is being generated in tax jurisdictions 

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withoutoperating loss carryforwards, while we are generating taxable losses in certainother tax jurisdictions, with no available tax benefit related to these lossesincluded in the provision for income taxes.

**NETINCOME (LOSS)**

As a result of the factorsdiscussed above, we recorded a net loss of $2.2 million for the three monthsended September 30, 2005, compared to net income of $1.7 million for thethree months ended September 30, 2004.

**NINE MONTHS ENDED SEPTEMBER 30,2005 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2004**

**NETSALES**

Net sales decreased by approximately 20.0%, or $22.4 million,to $89.4 million for the nine months ended September 30, 2005 from $111.8million for the nine months ended September 30, 2004.

The decrease in net salesis due primarily to a reduction in demand from a few of our larger programs inthe datacom and telecom market segments. The majority of the decline in saleswas related to the net decrease in sales by some of our larger customers in2005, offset by increased sales from other customers in comparison to the ninemonths ended September 30, 2004. During the nine months ended September 30,2005, one of our largest customers declined by $10.9 million compared to thenine months ended September 30, 2004. Also contributing to the declinewere the effect of material shortages and the transitioning of certain customerprograms to consignment hub arrangements. Revenue recognition on shipments tothe consignment hubs is delayed until the customer pulls the product from thehub for their production requirements.

**GROSSPROFIT**

Gross profit decreased by approximately 45.6%, or$15.6 million, to $18.6 million for the nine months ended September 30,2005 from $34.2 million for the nine months ended September 30, 2004. Grossmargin for the nine months ended September 30, 2005 decreased to 20.8%from 30.6% in the prior year period.

The decrease in grossprofit was due primarily to the decrease in revenues and the resulting loss ofcontribution margin on those revenues, combined with a change in product mixduring 2005 that included programs with higher material content than prior year.The decrease in gross margin was due primarily to higher labor and overheadcosts as a percentage of net sales resulting from the lower revenue level,combined with the change in product mix. Higher logistics costs related tocertain materials sourcing issues experienced during the first half of 2005also contributed to the gross margin decline.

**OPERATINGEXPENSES**

Operating expenses for the nine months ended September 30,2005, decreased by approximately 3.7%, or $0.7 million, to $18.7 million from$19.4 million for the nine months ended September 30, 2004. As apercentage of net sales, operating expenses increased to 20.9% from 17.4% inthe prior year period.

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The decrease in operatingexpenses is due primarily to a gain from insurance proceeds of $2.5 million receivedin 2005 related to a fire damage experienced in the Belgium facility inFebruary 2004, offset mainly by higher professional fees associated with readinessefforts for compliance with Section 404 of the Sarbanes-Oxley Act.

**OPERATINGINCOME**

As a result of the factorsdiscussed above, operating income decreased to a loss of $.1 million for thenine months ended September 30, 2005 compared to operating income of $14.8million for the nine months ended September 30, 2004. Operating margindecreased to (.1%) from 13.2% in the prior year period.

**INTERESTEXPENSE**

Interest expense for thenine months ended September 30, 2005 was $2.0 million compared to $4.5million for the nine months ended September 30, 2004. The decrease ininterest expense is due to the repayment of debt and conversion to equity ofour senior convertible notes in connection with our initial public offering.

**INCOMETAXES**

Provision for income taxeswas $1.3 million for the nine months ended September 30, 2005 compared to$2.1 million for the comparable period in 2004. Provision for income taxes forthe nine months ended September 30, 2005 was calculated by estimatingfull-year 2005 taxable income separately for each tax jurisdiction andallocating the related income tax provision to the period during which theincome was generated. A portion of our taxable income for 2005 is beinggenerated in tax jurisdictions without operating loss carryforwards, while weare generating taxable losses in certain other tax jurisdictions, with noavailable tax benefit related to these losses included in the provision forincome taxes.

**NET INCOME (LOSS)**

As a result of the factorsdiscussed above, we recorded a net loss of $3.3 million for the nine monthsended September 30, 2005, compared to net income of $8.2 million for thenine months ended September 30, 2004.

**LIQUIDITY AND CAPITAL RESOURCES**

**CASHFLOWS**

Net cash usedin operating activities was $2.7 million for the nine months ended September30, 2005, compared to net cash provided in operating activities of $0.6 millionfor the nine months ended September 30, 2004. Cash used in operatingactivities for the nine months ended September 30, 2005 reflected a reductionin accounts payable of $3.5 million, due to lower revenue levels during thethird quarter of 2005 compared to the fourth quarter of 2004, an increase ininventories of $1.1 million, due primarily to an increase in consignment hubinventories partially offset by a decrease in raw materials, and a net lossbefore depreciation and amortization of $1.0 million. These items were partiallyoffset by a decrease in accounts receivable of $2.0 million, due to lowerrevenue levels during the third quarter of 2005 compared to the fourth quarterof 2004, as well as an increase in accrued liabilities and accruedrestructuring costs of $.6 million. Net cash used in operating activitiesof $0.6 million for the nine months ended September 30, 2004 reflected thepositive effect of $8.2 million of net income and $2.3 million of depreciationand amortization, as well as the negative impact of increases in accountsreceivable, inventories, prepaid expenses and deposits and other assets of $2.8million, $3.1 million, and $.4 million, and $.6 million respectively. Inaddition, a decrease in accrued liabilities and accrued restructuring costs of 

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$2.3million and a decrease in other long-term obligations of $1.7 millioncontributed to net cash used in operating activities for the nine months endedSeptember 30, 2004.

Net cash used in investing activities for the ninemonths ended September 30, 2005 was $0.9 million compared to net cash usedin investing activities of $3.1 million for the comparable period in 2004. Netcash used in investing activities for the nine months ended September 30,2005 reflected net sales of short-term investments of $3.9 million, more than offsetby capital expenditures of $4.8 million related to manufacturing equipment,construction-in-progress in China, and leasehold improvements. Net cash used ininvesting activities of $3.1 million for the nine months ended September 30,2004 was comprised primarily of capital expenditures.

Net cash provided by financing activities for the ninemonths ended September 30, 2005 was $1.3 million and was related primarilyto a short-term advance of $1.2 million received from the industrial park inChina in connection with the construction costs of the Company’s new facilityin China. Net cash provided by financing activities of $13.9 million for thenine months ended September 30, 2004 reflected the net proceeds from ourinitial public offering of $87.6 million, excluding $1.1 million of accrued andunpaid offering costs, offset by payments on long-term debt of $65.5 millionand net payments under the old revolving lines of credit of $6.1 million.

**LIQUIDITY**

As of September 30, 2005, we had cash and cashequivalents of $11.4 million, working capital of $42.7 million and no borrowingsunder the Credit Facility. We believe these amounts, will be sufficient to meetour cash requirements for at least the next twelve months. Historically, wehave financed our operations with cash from operations supplemented byborrowings from credit facilities and debt issuances. Our current and futureliquidity needs primarily arise from working capital requirements and capitalexpenditures, including our current expansion into China. Our historicalcapital expenditures have primarily resulted from investments in equipment toincrease manufacturing capacity and to improve manufacturing efficiencies. For2005, we expect capital expenditures to be approximately $8.0 million to $9.0million, which will relate primarily to our purchase of a building andequipment in China and investments in manufacturing equipment at otherfacilities. We invested $4.8 million in property, plant and equipment duringthe nine month period ended September 30, 2005, of which $1.8 million relatedto our China facility.

As of September 30, 2005, our borrowingsconsisted of approximately $46.6 million of senior notes bearing interest at5.25% annually, and no borrowings under the Credit Facility. We are required tomake semi-annual interest payments to holders of the senior notes.

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

We have purchase commitments primarily with vendorsand suppliers for the purchase of inventory, and for other goods, services, andequipment as part of the normal course of business. These commitments aregenerally evidenced by purchase orders that may or may not include cancellationprovisions. Based on current expectations, we do not believe that anycancellation penalties we incur under these obligations would have a materialadverse effect on our financial condition or results of operations.

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Thematurities of our long-term debt and future payments relating to our operatingleases and other obligations as of September 30, 2005 are as follows (inthousands):

| **Contractual Obligations** | ** ** | ** ** | ** ** | **October to  December  2005** | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
|----------------------------------|------------|------------|------------|-------------------------------------|------------|----------|------------|----------|------------|----------|------------|----------|------------|----------------|------------|-----------|------------|
| Long-term debt                   |       |       | $          | —                              |       |     | $          | —   |       | $        | —     |     | $          | 46,630         |       | $         | —     |   |   | $ | — |   |   | $ | 46,630 |   |
| Operating leases                 |       |       | 376        |                                |       | 1,511    |       | 1,523    |       | 1,534    |       | 515      |       |           | —     |      |       | 5,459 |   |
| Purchase order  commitments      |       |       | 15,166     |                                |       | 1,874    |       | —   |       | —   |       | —   |       |           | —     |      |       | 17,040 |   |
| European  restructuring          |       |       | 42         |                                |       | 227      |       | 204      |       | 181      |       | 175      |       |           | 479        |      |       | 1,308 |   |
| Long service  award              |       |       | 5          |                                |       | 48       |       | 95       |       | 186      |       | 294      |       |           | 1,367      |      |       | 1,995 |   |
| Deferred  compensation           |       |       | —     |                                |       | —   |       | —   |       | —   |       | —   |       |           | 943        |      |       | 943 |   |
| Total                            |       |       | $          | 15,589                              |       |     | $          | 3,660    |       | $        | 1,822      |     | $          | 48,531         |       | $         | 984        |   |   | $ | 2,789 |   |   | $ | 73,375 |   |

 

Long-term debt includes our senior notes, which matureon November 1, 2008. Interest on the senior notes is payable in cash on May 1and November 1 of each year. The senior notes are secured by asecond-priority lien on substantially all of our domestic assets and by apledge of 65% of the equity of certain of our foreign subsidiaries.

In connection with our initial public offering in February of2004, we amended our existing senior revolving credit facility with GeneralElectric Capital Corporation. The Credit Facility provides for borrowings of upto $20.0 million, subject to a borrowing base comprised of eligible accountsreceivable and inventory, which was $13.3 million at September 30, 2005.We plan to use funds available under this credit facility to finance workingcapital and other cash requirements as needed. The credit facility matures in August 2008and bears interest, at our option, at a rate per annum equal to LIBOR plus 2.5%or the agent bank’s base rate plus 1.0%. In addition to paying interest onoutstanding principal, we are required to pay a commitment fee to the lendersunder the credit facility in respect of the average daily balance of unusedloan commitments at a rate of 0.5% per annum. The Credit Facility is our seniorobligation and ranks equal in right of payment with our existing and futurepermitted senior debt (including our senior notes), and senior in right ofpayment to our future permitted subordinated debt. The Credit Facility issecured by a first-priority lien, subject to permitted encumbrances, onsubstantially all of our domestic assets and by a pledge of 65% of the equityof certain of our foreign subsidiaries.

The agreements governing the Credit Facility and oursenior notes contain covenants that restrict our business operations, includingcovenants limiting our ability to make investments, enter into mergers oracquisitions, dispose of assets, incur additional debt, grant liens, enter intotransactions with affiliates, redeem or repurchase our capital stock, repayother debt and pay dividends. The agreements also contain a financial ratiotest based on senior leverage, and customary events of default, includingdefaults in the payment of principal or interest, defaults in the compliancewith the covenants described above, cross defaults to other material debt andbankruptcy or other insolvency events.

As of September 30,2005, we were in compliance with all of the financial covenants set forth inthe principal agreements governing our debt. Based on our present expectations,we believe that our existing cash and cash equivalents, working capital andavailable borrowing capacity at September 30, 2005 will be sufficient tomeet our anticipated cash requirements for at least the next twelve months,including operating requirements, contractual obligations, planned capitalexpenditures and debt service.

**RECENTACCOUNTING PRONOUNCEMENTS**

In November 2004, the FASB issued SFAS No. 151,“Inventory Costs—an amendment of ARB No. 43, Chapter 4.” This statementamends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” toclarify the accounting for abnormal amounts of idle facility expense, freight,handling costs, and wasted 

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material (spoilage).Abnormal amounts of these costs should be recognized as current period chargesrather than as a portion of inventory costs. In addition, SFAS 151 requiresthat allocation of fixed production overheads to the costs of manufacturing bebased on the normal capacity of the production facilities. The provisions ofSFAS 151 are effective for inventory costs incurred during fiscal yearsbeginning after June 15, 2005. We are currently evaluating the effect thatthe adoption of this new standard may have on our consolidated financialposition and results of operations.

In December 2004, the FASB issued SFAS 123R(Revised 2004), “Share-Based Payment,” which requires that the compensationcost relating to share-based payment transactions be recognized in financialstatements based on the fair value of the award on the date of grant. The costwill be recognized over the period during which the employee is required toprovide service in exchange for the award (usually the vesting period). Wecurrently disclose pro forma compensation expense quarterly and annually. Uponadoption, the pro forma disclosures previously permitted under SFAS 123 will nolonger be an alternative to financial statement recognition. The provisions ofSFAS 123R are effective as of the beginning of the first interim or annualreporting period that begins after December 15, 2005. We are currentlyevaluating the method of adoption and the effect that the adoption of SFAS 123Rwill have on our consolidated financial position and results of operations.

In December 2004, the FASB issued SFAS No. 153,“Exchanges of Nonmonetary Assets—an amendment of APB Opinion No. 29.” Theamendment eliminates the exception to fair value accounting for nonmonetaryexchanges of similar productive assets and replaces it with a broader exceptionfor exchanges of nonmonetary assets that do not have commercial substance.Under APB 29, accounting for an exchange of a productive asset for a similarproductive asset or an equivalent interest in the same or similar productiveasset is to be based upon the recorded amount of the asset relinquished(carryover basis with no gain or loss recognition). The transaction will now beaccounted for based upon the fair value of the assets exchanged. The Statementis effective for exchanges occurring in fiscal years beginning after June 15,2005 and is to be applied prospectively. The adoption of SFAS 153 is notexpected to have a material impact on our consolidated financial position andresults of operations.

In December 2004, the FASB issued Staff Position No. 109-2,“Accounting and Disclosure Guidance for the Foreign Earnings RepatriationProvision within the American Jobs Creation Act of 2004” (“FSP 109-2”).In October 2004, the American Jobs Creation Act of 2004 (the “Act”) wassigned into law. The Act contains a number of provisions that may affect ourfuture effective income tax rate. The most significant provision would allow usto elect to deduct from our taxable income 85% of certain eligible dividendsreceived by us from our non-U.S. subsidiaries before the end of 2005. FSP 109-2provides additional time, beyond the financial reporting period in which theAct was enacted, to evaluate the effects of the Act on our plan for reinvestmentor repatriation of foreign earnings. We have not yet completed our evaluationof the impact, if any, of the repatriation provisions of this Act nor have wedetermined the related range of income tax effects of such repatriation. Ourevaluation is expected to be complete by the end of fiscal year 2005.

In June 2005, theFASB issued SFAS No. 154, “Accounting Changes and Error Corrections,”which changes the requirements for the accounting for and reporting ofvoluntary changes in accounting principle. SFAS 154 requires retrospectiveapplication to prior periods’ financial statements of changes in accountingprinciple, unless impracticable. SFAS 154 supersedes Accounting PrinciplesBoard Opinion No. 20, Accounting Change (APB 20), which previously requiredthat most voluntary changes in accounting principle be recognized by includingin the current period’s net income the cumulative effect of changing to the newaccounting principle. SFAS 154 also makes a distinction between retrospectiveapplication of an accounting principle and the restatement of financialstatements to reflect correction of an error. SFAS 154 carries forward withoutchanging the guidance contained in APB 20 for reporting the correction of anerror in previously issued financial statements and a change in accountingestimate. SFAS 154 applies to voluntary changes in accounting principlethat are made in fiscal years beginning after 

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December 15,2005. The adoption of SFAS 154 is not expected to have a material impact on ourconsolidated financial condition or results of operations.

**FORWARD-LOOKINGSTATEMENTS**

Statements in this reportcontaining the words “believes,” “anticipates,” “estimates,” “expects,” andsimilar expressions, or the negative of such words or expressions, and anyother statements which may be construed as a prediction of future performanceor events, constitute “forward-looking statements” within the meaning of thePrivate Securities Litigation Reform Act of 1995. These forward-lookingstatements are based upon our current expectations and projections about futureevents. Such forward-looking statements involve known and unknown risks,uncertainties, and other factors that may cause our actual results,performance, or achievements, or industry results, to be materially differentfrom any future results, performance, or achievements expressed or implied bysuch forward-looking statements. Such factors include, among others, (1) changesin general economic and business conditions, domestically and internationally, (2) reductionsin sales to, or the loss of, any of our significant customers or in customercapacity generally, (3) changes in our sales mix to lower margin products,(4) increased competition in our industry, (5) disruptions of ourestablished supply channels, (6) our level of debt and restrictionsimposed by our debt agreements, and (7) the additional risk factorsidentified in our filings with the Securities and Exchange Commission,including our Annual Report on Form 10-K (File No. 000-50593).Except as required by law, we undertake no obligation to update anyforward-looking statements even though our situation may change in the future.

**Item 3.**                        Quantitativeand Qualitative Disclosures About Market Risk.

Market risk relating to our operations result primarilyfrom changes in foreign currency exchange rates and short-term interest rates. Wedid not have any derivative financial instruments at September 30, 2005.

We had no variable rate debt outstanding at September 30,2005. However, any debt we incur under the Credit Facility will bear interestat a variable rate. We cannot predict market fluctuations in interest rates andtheir impact on any variable rate debt we may incur in the future, nor canthere be any assurance that fixed rate long-term debt will be available to usat favorable rates, if at all.

The functional currencyfor our European operations is the Euro. We are, therefore, subject to acertain degree of market risk associated with changes in foreign currencyexchange rates. This risk is mitigated by the fact that our European revenues,costs and expenses are all generally recorded in Euros, thereby reducing therisk of foreign currency translations on our European operations. The effect offoreign currency exchange rate fluctuations on our operating results as of andfor the three months ended September 30, 2005, was not material. Historically,we have not actively engaged in exchange rate hedging activities.

**Item 4.**                        Controlsand Procedures.

a)                *Disclosure Controls and Procedures*

Our management, with theparticipation of our Chief Executive Officer and Chief Financial Officer, hasevaluated the effectiveness of our disclosure controls and procedures (as suchterm is defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of theend of the period covered by this report. The evaluation included certaincontrol areas in which we have made changes to improve and enhance controls. Basedon such evaluation, our Chief Executive Officer and Chief Financial Officerhave concluded that, as of the end of such period, our disclosure controls andprocedures were effective to ensure that information required to be disclosedin 

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ourreports filed under the Exchange Act is recorded, summarized, and reportedwithin the time periods specified in the rules and forms of the Securitiesand Exchange Commission.

b)               *Internal Control Over Financial Reporting*

There have not been any changes in our internalcontrol over financial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under the Exchange Act) during the fiscal quarter to whichthis report relates that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

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**PART II.   OTHER INFORMATION**

**Item 1.**                        LegalProceedings

We are currently in theprocess of an arbitration proceeding against a former executive. This personhas disputed the amount due under their 2003 Stock Option Plan Agreement at thetime of their resignation from the Board in July 2004. The amount in dispute isapproximately $300,000. In the event that the arbitration is decided againstus, we will be liable to this former executive for the disputed amount, plus wemay be liable for this person’s legal costs and expenses. 

During the nine monthsended September 30, 2005, we were not a party to any other material legalproceedings. We are occasionally a party to lawsuits relating to routine matersincidental to our business. As with all litigation, we can provide no assuranceas to the outcome of any particular lawsuit, and we note that litigationinherently involves significant costs.

**Item 2.**                        UnregisteredSales of Equity Securities and Use of Proceeds.

On February 25, 2004, we closed the sale of6,600,000 shares of our Common Stock at a price of $14.50 per share in a firmcommitment underwritten initial public offering. The offering was effected pursuantto a Registration Statement on Form S-1 (File No. 333-110723),which the Securities and Exchange Commission declared effective on February 19,2004.

Of the $95.7 million in gross proceeds raised by us inthe offering:

1.     Approximately $6.7 million was paid to the underwriters inconnection with the underwriting discount;

2.     Approximately $2.5 million was paid by us in connection withoffering fees and expenses;

3.     Approximately $73.2 million was used to repay principal andinterest on our outstanding indebtedness;

4.     Approximately $8.9 million has been used as of September 30,2005, for general corporate purposes; and

5.     Approximately $4.4 million has been retained by us for generalcorporate purposes and is held in high-grade commercial paper with an originalmaturity of three months or less.

**Item 6.**                        Exhibits.

**EXHIBIT INDEX**
| 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 of Stock  Certificate(2)                                                                                                                 |            |
| 31.1             |       | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of  2002                                         |            |
| 31.2             |       | Certification of Chief  Financial Officer 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)          Previously filed withthe Registration Statement on Form S-8 filed by the Registrant onMarch 16, 2004.

(2)          Previously filed withAmendment No. 4 to the Registration Statement on Form S-1 filedby the Registrant on February 17, 2004.

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the Registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.

| Dated: November 16, 2005 |                                |                                                                          |
|------------------------------------|-------------------------------------|-------------------------------------------------------------------------------|
|                               | CHEROKEE  INTERNATIONAL CORPORATION |
|                               | By:                                 | /s/ JEFFREY M. FRANK                                                          |
|                               |                                | Jeffrey M. Frank                                                              |
|                               |                                | *President and Chief Executive Officer*                                       |
|                               | By:                                 | /s/ LINSTER W. FOX                                                            |
|                               |                                | Linster W. Fox                                                                |
|                               |                                | *Executive Vice President of Finance,  Chief Financial Officer and Secretary* |
|                               |                                | *(Principal Financial and Accounting Officer)*                                |

 

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