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Executives

Kimberly Esterkin

Jason Boling - Chief Financial Officer and Principal Accounting Officer

Henry Stupp - Chief Executive Officer and Director

Analysts

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

James Fronda - Sidoti & Company, LLC

Jonathan Abodeely

Jason Gordon Stankowski - Clayton Partners LLC

Cherokee (CHKE) Q1 2014 Earnings Call June 13, 2013 4:30 PM ET

Operator

Greetings, and welcome to the Cherokee Inc. First Quarter 2014 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Kimberly Esterkin of ADDO Communications. Thank you. Ms. Esterkin, you may begin.

Kimberly Esterkin

Thank you. Speaking today will be the company’s Chief Executive Officer, Henry Stupp; and Chief Financial Officer, Jason Boling. Before I hand the call over to management, please note that on this call, certain information presented contains forward-looking statements.

Certain statements contained herein may contain forward-looking statements for purposes of the Safe Harbor provided by the Private Securities Litigation Reform Act of 1995. When used, the words anticipates, believes, expects, may, should and similar expressions are intended to identify such forward-looking statements. Forward-looking statements included in this conference call involve known and unknown risks and uncertainties that may cause the actual results, performance or achievements of the company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.

A further list and description of these risks, uncertainties and other matters can be found in the company’s Annual Report on Form 10-K for fiscal year 2013, and its periodic reports on Forms 10-Q and 8-K. Given these risks and uncertainties, you should not place undue reliance on forward-looking statements as a prediction of actual results. The company disclaims any intent or obligation to update any of the forward-looking statements contained herein to reflect future events and developments.

This call also includes a discussion of non-GAAP financial measure, as that term is defined in Regulation G, including non-GAAP SG&A and earnings per share. The most directly comparable GAAP financial measures and information reconciling these non-GAAP financial measures to the company's financial results prepared in accordance with GAAP are included in the earnings release, which is posted on the company's website at www.cherokeegroup.com.

And with that, I’ll hand the call over to Cherokee’s Chief Financial Officer, Jason Boling.

Jason Boling

Good afternoon, everyone, and thank you for joining us today on the first quarter fiscal 2014 call. I will begin today's call by discussing our financial results for the quarter. I will then turn the call over to Henry Stupp, our Chief Executive Officer, to speak in further detail about our brands and our partners before we open up the call to your questions.

Turning to our first quarter results. Net revenues for the first quarter were $8.1 million, or up 7.2% from $7.5 million in the prior year quarter. The growth in revenues is primarily from increased revenues from Liz Lange and other Cherokee international licenses, while offset by a significant decrease in royalty revenues at Zellers due to their recent closing. In general, the Cherokee brand continues to see strong international growth. As I will discuss later, the growth at Tesco during the first quarter is not yet visible due to the recent relaunch. However, international revenues, particularly Asia and South America, for the first quarter 2014, excluding Tesco and Zellers, increased 31% over the prior year period. Specifically, revenues from China increased 46% year-over-year. Japan saw a 41% increase in revenues over Q1 2013. And revenues in South America increased 45% over the prior year period. Tottus in particular, our exclusive retail partner in Peru and Chile, showed outstanding results for the quarter with retail sales increasing 83% in Peru and 61% in Chile over the first quarter of fiscal 2013. Sales of women's clothing in Peru and footwear in Chile were strong drivers of these increases. Henry will provide further detail on the international progress later in the call.

Selling, general and administrative expenses for the first quarter totaled $5.4 million as compared to $4.2 million in the similar period last year. Included in this increase in SG&A for the quarter are $1 million of fees that we believe will not recur and are related to the identification and remediation of weaknesses highlighted in the company's 10-KA for the fiscal year 2013. These fees included audit fees, legal fees and consulting fees to evaluate Cherokee's control systems and procedures, perform SOX-related testing and compliance work and provide additional analysis around our tax provision, expense oversight and reconciliation analysis.

Excluding this $1 million of expenses, our SG&A would've been $4.4 million or 55% of revenues, an increase of approximately $250,000 over last year. This increase was primarily due to higher personnel expenses, offset by decreases in marketing, travel and recurring professional fees. We believe these expenses, which should not recur, make it difficult for investors to evaluate the underlying performance of the business. We believe that non-GAAP net income, excluding these expenses, and related tax effects, provides a useful measure of performance for the quarter, as it offers consistency and comparability with Cherokee's past financial performance, facilitates period-to-period comparisons and enables better comparisons with other peer companies. With that in mind, excluding these charges, we ended the first quarter with non-GAAP net income of $2.2 million or $0.27 per diluted share, compared to non-GAAP net income of $2.1 million or $0.25 per diluted share in the first quarter last year.

On a non-GAAP basis, EPS grew from $0.25 to $0.27 per share or 7%. On a GAAP basis, net income for the first quarter 2014 was $1.6 million or $0.19 per diluted share, a decrease of approximately $500,000 or $0.06 per share from $2.1 million and $0.25 per diluted share in the same period last year. A reconciliation of our GAAP to non-GAAP financials can be found in our earnings release for the quarter.

Operating income for Q1 totaled $2.7 million versus $3.4 million in the same period last year. Our overall operating margins for the quarter were 33% of total revenues, compared to 45% of total revenues in the first quarter of fiscal 2013. The decrease in margin was related to the $1 million of SG&A expenses described earlier. As such, for comparative purposes, our non-GAAP operating margin, excluding these expenses, would have been 45%. For the quarter ended May 4, 2013, we recorded a tax provision of $900,000, which equates to an effective tax rate of 36.1%, compared to $1.3 million or an effective tax rate of 38% recorded in the first quarter of last year.

Turning to our balance sheet and related metrics, total cash and cash equivalents as of May 4, 2013, were $1.1 million, down from $2.4 million at the end of fiscal 2013, due to the timing of our receipt of royalty payments. Cash flow from operations totaled $900,000 for the quarter versus $1.7 million for the prior year period, which is impacted by the timing of the payment of royalty revenues as well. These are received after the end of the first quarter. We remain in solid financial position to meet our cash requirements for the remainder of fiscal 2014, which will primarily be for our operations, debt service, as well as paying dividends as determined by our Board of Directors. A quarterly dividend payment of approximately $840,000 or $0.10 per share will be paid on or around June 15 to shareholders of record as of June 1, 2013 and reflects an annualized dividend yield of roughly 3%.

Thank you all for your time. I will now turn the call over to Henry to speak in further detail about our partners and brands.

Henry Stupp

Thank you, Jason. With the completion of the first quarter, we are off to a solid start to the fiscal year, particularly with several of our international partners and here at home in the U.S. with Target, where our business is shaping up to be even stronger than last year. As Jason mentioned, despite less than favorable foreign exchange rates, our international progress during the first quarter was particularly remarkable with Asian and South American revenues growing over 44% year-over-year. The Cherokee family of brands is licensed in over 40 countries, and global retail sales are approaching $2 billion in more than 4,000 locations worldwide.

We had a particularly strong first quarter in Asia. Retail sales at our exclusive Chinese partner, RT-Mart, increased 46% over Q1 of 2013. The Cherokee brand is currently sold at 221 RT-Mart stores across Mainland China, as well as recently, the introduction through the online retailer tmall.com. Through the launch of our RT Mart's Cherokee boutiques on tmall.com this past February, we are leveraging a fast-growing e-commerce movement in China. We now plan to further expand the Internet sales growth and exposure of the Cherokee brand in China by enlisting the expertise of RT-Mart and other dotcom retail partners throughout China. We also look forward to further our growth at RT-Mart's brick-and-mortar stores through the introduction of additional product categories over the coming months and the opening of additional RT-Mart locations throughout China.

In fact, one of our key corporate initiatives is to launch new categories with all of our partners on a global basis. And we are in frequent discussions with each of our retail partners to bring new and exciting Cherokee products to their consumers. We are currently working to expand our essentials offering or Cherokee undergarments, as well as swimwear, rain boots and jackets for our children's line. We will keep you posted as we make further progress.

Speaking of category expansion, at Nishimatsuya in Japan, we recently introduced Cherokee bedding and an expanded baby product assortment. Nishimatsuya now sells Cherokee baby, children's wear accessories and bedding in all 840 of its stores throughout Japan. And we have seen incredible growth with this Japanese retailer. In fact, for the first quarter alone, retail sales increased 21% year-over-year in U.S. dollars, despite a huge reduction in the value of the yen.

Moving to the Middle East. This past weekend, we were very excited to launch the Cherokee brand at 48 stores throughout the United Arab Emirates, Saudi Arabia and Kuwait as part of an exclusive partnership with Landmark Group's Max stores, which we've entered into in July of 2012. Cherokee partners with some of the most innovative retail pioneers across the globe and Max is no exception. Max, the largest value fashion branch chain in the Middle East, is an incredible organization with a lot of depth. Their team knows how to sell, make and market product. And we expect great things from this retail in the feature.

Similar to our partnership with Nishimatsuya, Cherokee's partnership with Max came into place in our new management structure. Max has fully embraced Cherokee 360-degree approach, which is evolving each and every month, including our product development, marketing and service infrastructure. We are proud to debut a collection of men's, women's and kids' clothing, fully conceptualized and designed in California for Max by a very talented in-house Cherokee team. Over the coming months, Max will roll out the Cherokee brand in additional short locations. We'll keep you updated, as we share our family lifestyle brand with even more Max shoppers.

Max is just one of many retailers that are benefiting from our 360-degree turnkey retail approach. Tesco has also reinvigorated its relationship with Cherokee through our new and improved direct-to-retail model. Toward the end of the first quarter, Cherokee's enhanced premium lifestyle collection for men, women and children relaunched at 279 Tesco stores throughout Central Europe, the U.K. and as well on tesco.com. Cherokee's in-house design team conceived the debut collection for Tesco. And Tesco supported Cherokee's product design and manufacturer recommendations, with all products purchased directly by Tesco from leading best-in-class manufacturers that have been identified by the Cherokee development group. We are thrilled to see our 360-degree approach come to life. For the first time in company history, many of our partners are buying product from the same factories, resulting in consistent branding and improved product quality on a global basis. The emphasis placed on product consistency, improved quality and branding is a key component to drive future growth and has led to the [indiscernible] of many of our partnerships and the turnaround of our Cherokee business.

With respect to the Tesco relaunch, which is a major brand reintroduction. As you know, Cherokee has been severely diminished in Tesco stores for quite some time. Sales have grown each week since our launch at Tesco nearly 7 weeks ago. With new products hitting stores every few weeks, Tesco sales of Cherokee-branded products are up double digits on a year-over-year business in local currency. Cherokee's brand awareness remains extremely high, over 80%, amongst Tesco customers. And we are earning high marks for the quality of our offering as we have positioned Cherokee as a premium brand at Tesco. We are now in discussions with Tesco to expand into further product categories, as well as into additional stores in the future. While we know it takes some time to revitalize a relationship, we are certainly off to a solid start and we remain cautiously optimistic about our future growth with Tesco. I would like to thank Tesco and its customers for the growing support of our brand. And we look forward to continued success for both Tesco and Cherokee.

In addition to our recent progress at Tesco, during the first quarter, we continued to see success with our exclusive North American partner, Target. Despite a difficult first quarter for Target, particularly related to seasonal growth in soft apparel sales, nonetheless the Cherokee brand at Target continues to see growth as retail sales were up approximately 2% year-over-year. Domestic retail sales of Cherokee brand in products of target for the first quarter totaled $266 million, an increase of $4 million over the same period last year. And as I mentioned earlier, Q2 is off to an even stronger start. Target sales of Cherokee branded merchandise for the month of May experienced a double-digit increase.

Target has positioned Cherokee as one of their premier brands, and we continue to collectively plan our business in a more strategic, long-term fashion. We recently presented several new and exciting initiatives for the Cherokee brand to Target, and we are looking forward to continuing to strengthen and evolve our partnership over time. Additional details relating to contractual amendments to the master license agreement for the Cherokee brand at Target can be found in our 10-Q.

Turning our attention over to Canada. During the first quarter of fiscal 2014, Zellers Canada formally exited the Cherokee business through the acceleration of their store closures. This rapid wind down ensured a smooth transition to Target Canada. Unfortunately, for the first quarter, with the completion of the closing of over 275 Zellers Canada stores, this did result in a decrease of $23 million in retail sales and a corresponding decrease of $470,000 in revenue to Cherokee. Despite this, the Cherokee brand is now seeing exceptional progress with Target Canada, which launched during the latter part of March with 25 locations in Ontario. Additional locations are being added throughout the year, and Target has indicated that 125 stores will be operational during fiscal 2014.

We are very excited about Target Canada's productivity per store, which is already surpassing that of Zellers. Cherokee's success in Canada is not surprising, given the excitement over Target's recent launch as Cherokee is positioning as one of Canada's top-selling children's brands. We look further to further rollouts of Target Canada stores in the future. And we will keep you informed as we launch in additional locations.

Each of our accomplishments in the first quarter has positioned us well for continued growth throughout fiscal 2014. As I previously noted, we are already seeing success in our second quarter, and there are a lot of exciting developments underway for Cherokee. We look forward to continuing to share our story with the investment community on next quarter's call. In addition, we hope to see many of you at the Canaccord Genuity conference in Boston this August.

This concludes our prepared remarks. Operator, please open up the call to questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question is from Jeff Van Sinderen of B. Riley.

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

So just looking at your SG&A, if we back out the one-time expenses, your SG&A barely increased in dollars versus last year and that's with sales growth. So I guess my question is, at this point, do you feel like the one-time SG&A charges are behind you? And also, as you are growing revenues, wouldn't you think that you could start to leverage SG&A over the next couple of years as sales growth outpaces SG&A dollar growth?

Jason Boling

So this is Jason. Yes, we believe that the one-time charges are behind us at this point. We incurred them. We've resolved most of the issues. And we do believe that our current trend in SG&A will continue, although it will grow as we have revenue growth in the future based upon -- as we need it.

Jeffrey Wallin Van Sinderen - B. Riley Caris, Research Division

Okay. And then, Henry, maybe you can just touch on what you feel at this point are the key organic growth opportunities that you're focused on? And then maybe you can also speak to what you're seeing in terms of potential acquisitions and how you feel you're positioned to take advantage of opportunities in terms of acquisitions?

Henry Stupp

Okay. Well, we're -- we have 3 platforms for growth. The first platform for us is organic growth with our existing partners and licensees through the introduction of new categories, expanding the assortments and adding stores and doors where we can. So we have identified initiatives with each and every one of our partners. Separately, we have some global initiatives, we have to introduce new categories, for example, we have a large undertaking right now related to the, what we call, Cherokee essentials, which is socks, underwear and T-shirts. We look at that as an opportunity on a global basis, we've seen in the past that retailers who buy essentials can garner up to 20% of their sales just in socks and underwear; not all of our partners are in it. So that's a good example of an organic growth opportunity. Secondly, on our existing portfolio of brands, we concentrate on several new markets. We are hopefully wrapping up, in the next few weeks, several exciting new expansion opportunities into new territories. And thirdly, we are coordinating – we are constantly reviewing new brands that we could bring into what we call our style-focused lifestyle assortment. And as we acquired Liz Lange, for an example, that was a great fit and we're looking at ways of expanding that brand, not only organically with Target through the introduction of new categories, but also bringing Liz Lange to new markets. So we're in a lot of discussions there. We're very excited by the introduction of Liz into our portfolio, and the partners are thrilled that we're involved, so it's been a good experience.

Operator

The next question is from James Fronda of Sidoti & Company.

James Fronda - Sidoti & Company, LLC

So you guys don't break out, I guess, how much RT-Mart and Nishimatsuya are as a percent of sales, right? I mean they're less than 5%?

Jason Boling

So we don't break those out, that's correct.

James Fronda - Sidoti & Company, LLC

Okay. Did weather play a factor at all during the quarter?

Henry Stupp

With respect to Target, absolutely. Target had a very soft Q1, particularly related to seasonal and softer-than-expected sales in apparel. However, Cherokee did outperform the brands as we were up. So as Target, overall, in apparel was down, yet Cherokee was up. And as we're well underway in our second quarter, we've had a very strong double-digit increase in second quarter. So we're actually really pleased with our comp growth right now. That's all.

James Fronda - Sidoti & Company, LLC

Okay, okay. And I guess the strong revenue growth that you're seeing, do you think that's all directly correlated to your customers as being new? And if not, do you think going into new categories with them, you'll be able to keep up the similar growth going forward into the year?

Henry Stupp

I think generally, our partners are very excited about what we're doing as a company, and they doubled up their efforts and they're doubling down on Cherokee as a brand. They like what we're doing. They -- at the end of the day, we think that we have to have great products and the consumers are responding to it. So if we go back to our 360-degree approach, we're offering better product than we've ever offered before, better quality, in a better in-store environment and the consumers are responding to it. We're also working very closely on a strategic basis with all of our partners. I always refer to partners like Comercial Mexicana as being great linkage with us, where we're expanding our -- we mentioned the last call that we're expanding our in-store presence with them by adding more turnkey shops. With every one of our partners, we have initiatives like that.

Operator

The next question is from Jonathan Abodeely of XLCR Capital.

Jonathan Abodeely

I was just curious if you could talk about the business globally. It sounds like you're having a lot of traction in Asia. Can you just talk about some of the initiatives that you have in Asia and some of the resources that Cherokee has to allow growth in that particular geography?

Henry Stupp

Thanks, Jonathan. Basically, a few years ago, when I joined, when we started building our product development and marketing internally, the objective was to bring all of the assets and provide them to our licensees in a turnkey business. And that kind of separates us a little bit from our peer group, where we're not just showing trend books, we're actually bringing fully developed, fully complete product lines that have been fully vetted for each market that we're talking to. And we think that by bringing actual product with resources, manufacturing resources, combining it with marketing, knowing the local market in terms of pricing and affordability, we're bringing all of the tools necessary for them to see success and they're embracing the approach. And that's why when -- I was just looking at the slide show, and I'm looking at the slides from Max, and the slides from Nishimatsuya and the slides from RT-Mart, and for the first time, you're seeing the same imagery, with the same quality product, the same brand DNA, running across multiple countries. And that's allowing us to achieve a certain degree of global scale, which starts to feed on itself. And that's why we're getting more interest than ever before in new markets, particularly in Asia and in Europe, that are starting to see the success of the product offering at Tesco and the success in RT-Mart, the success in Japan. And we're getting a lot of incoming calls now saying, "We want to be part of this brand."

Jonathan Abodeely

And then specifically related to the Tesco revitalization, Henry, can you talk about some of your aspirations as you get that business -- continue to get that business on the right track? So what, in your mind, defines success there?

Henry Stupp

Well, what's most important for us is we're in 279 stores in the U.K. for example. We'd like to see the store count grow. And we'd like to see the assortment within the stores continue to grow. We are -- we've just launched our second delivery a couple of weeks ago under this reintroduction. The second delivery has really taken off. And we're very excited by the, not only the weekly sales but the fact that we're working ahead of forecast right now. That said, have to be cautiously optimistic about it because the U.K. economy is still worrisome to us. Tesco is also dealing with market pressures that they haven't had to deal with in the past. So we're doing a good job. We brought really great product. We get better every week and every season. We want to see more stores, more product, more advertising and as important, more of an online presence, which we're seeing around the world with all of our partners.

Operator

[Operator Instructions] The next question goes from Jason Stankowski of Clayton Partners.

Jason Gordon Stankowski - Clayton Partners LLC

I just have a quick question. Have you quantified the currency impact? I was surprised to see Japan grow with such a terrible yen. It was a -- overall, was currency a net drag to revenue for the quarter?

Jason Boling

So we haven't quantified it publicly. But yes, overall it was a net drag. But we did have so much growth that we had positive growth relating to revenue.

Jason Gordon Stankowski - Clayton Partners LLC

And with regard to Zellers, that sounds like basically, we made $30,000 or something like that, basically negligible. And did anything hit from Target Canada in the quarter or not at all?

Jason Boling

Nothing material whatsoever.

Henry Stupp

They launched with essentially 4 weeks left in the quarter, in only 25 locations.

Jason Gordon Stankowski - Clayton Partners LLC

Right. So basically have no contribution from -- or very negligible contribution from Canada, period, in the quarter?

Henry Stupp

Correct. So basically the organic growth in the Cherokee brand, plus the combination of Liz Lange made up for the dramatic falloff of Zellers, which frankly, they exited the Canadian business a lot sooner than they told us they were. So that came as a bit of surprise to us because we work with their information. That said, it's -- we know within a year, we're very confident that the 125 Target Canada stores are to replace all of the volume that we were doing with the 275 Zellers stores. We're already seeing incredible results on a per store basis. They now have 48 stores open in Canada. We're not completely surprised because the product offering is exceptional, and we already had great presence in Canada through Zellers. So our prospects obviously look very good in the Canadian market.

Jason Boling

Yes, And the current Target Canada markets are generating 2.5x that of what the Zellers were -- the Zellers store.

Jason Gordon Stankowski - Clayton Partners LLC

All right, that's great. And our license agreement does not fall under the normal waterfall. So we have the ability to actually get paid.

Jason Boling

That's correct.

Jason Gordon Stankowski - Clayton Partners LLC

Okay. And I guess, lastly, Jason, you were asked about the one-time charges being behind us with regard to socks and everything. You emphatically said yes. And then the other part of that question was, do you expect to see operating leverage as revenue continues to grow. And your answer was, we'll grow operating expenses as we need to. Is that...

Jason Boling

Sorry, sorry. Yes, we will be -- no, so we will be leveraging the revenue, and we will be growing operating income as we go forward.

Operator

Thank you. Ladies and gentlemen, that is all the time we have for questions. This now concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

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