Cherokee Global Brands Earnings Plummet As Challenges Mount

Cherokee Global Brands Earnings Plummet As Challenges Mount

Cherokee Global Brands reported a fourth-quarter loss of $45.6 million, or $3.26 per share, reflecting the impact of a one-time impairment charge of $35.5 million.

Fourth Quarter Highlights:

  • Revenues of $6.9 million from continuing operations
  • Net loss of $45.6 million, or $3.26 per diluted share, reflecting the impact of a one-time impairment charge of $35.5 million

Full-Year Highlights:

  • Revenues of $29.4 million from continuing operations
  • Net loss of $56.0 million or $4.17 per diluted share, reflecting the impact of a one-time impairment charge of $35.5 million
  • Adjusted EBITDA of $3.9 million

“2018 was a difficult year as we continued transitioning our namesake brand from our legacy partner and admittedly under-estimated the challenges of integrating Hi-Tec, a vast global operating business, into our historical licensing model,” said Henry Stupp, chief executive officer. “We are fortunate that our brands and portfolio and our team are poised to achieve meaningful future progress and profitability for Cherokee Global Brands. We took actions to shore up our financial controls this past year and strengthen our brand portfolio. Importantly, we successfully converted our Hi-Tec indirect sales business to a fully licensed model, and while doing so, we restructured our Hi-Tec operations. This resulted in a 60% reduction in headcount and a significantly improved cost structure. We will continue to evaluate the costs associated with our infrastructure as we focus our efforts on revenue growth.”

Fiscal Year 2019 Guidance:

  • Guidance updated to reflect conversion of Hi-Tec sales to licensed royalty model
  • Consolidated revenues expected to range from $29.0 – $31.0 million
  • Adjusted EBITDA expected to range from $8.0 – $10.0 million
  • SG&A run rate expected to approximate $21.0 million

Non-GAAP Financial Measures

This press release includes non-GAAP financial measures as that term is defined in Regulation G. Reconciliations of amounts on a GAAP basis to amounts on a non-GAAP basis are presented in tabular form later in this release under the heading “Reconciliation of GAAP to Non-GAAP Financial Data.”

Brand Developments 

Cherokee

Cherokee brand revenues for the fourth quarter were $2.4 million, a decrease of $2.2 million from the fourth quarter in the prior year. Cherokee brand revenues for fiscal 2018 were $11.1 million compared to $23.0 million in the prior year. For both the fourth quarter and fiscal 2018, the year-over-year declines reflect the transition of Cherokee brand’s U.S. business from a direct-to-retail model, or “DTR,” to a wholesale model. Through fiscal 2017, the company earned substantial royalties from its primary DTR license with Target Corporation in the U.S.  Beginning with fiscal 2018, the company has been transitioning from this DTR license to a wholesale model whereby the company now has license agreements with multiple manufacturers and wholesalers who sell a broad assortment of Cherokee branded products to various retailers, including all major e-commerce platforms in the U.S. The company believes its licensees are experts in the category of products they manufacture under the Cherokee brand, and that royalty revenues from these licensees will grow over time.

The company also announced its partnership with Lidl, a German global discount supermarket chain, to launch a broad family-assortment of Cherokee lifestyle products in Lidl stores throughout Western Europe and Scandinavia. Cherokee’s family fashion assortment launch will be one of its most comprehensive yet, offering a full assortment of men’s, women’s and children’s fall and winter apparel, footwear and accessories categories. Cherokee’s debut at Lidl in Fall 2018 will be accompanied by a fully-integrated marketing campaign, which will include in-store branded signage, social and digital media and consumer-focused promotions.

Tony Hawk

Tony Hawk brand revenues for the fourth quarter were $1.4 million, which was consistent with $1.4 million in the fourth quarter of the prior year. Tony Hawk brand revenues for fiscal 2018 were $5.5 million compared to $5.1 million in the prior year.

Hi-Tec Indirect Sales and Conversion to Royalty Model

Effective January 2018, the company completed the conversion of Hi-Tec indirect sales to a licensed royalty model, with the International Brand Group assuming the legacy Hi-Tec distribution business in Latin America, Asia Pacific and Eastern Europe.  In the past, the company sold product to distributors in certain territories and reported indirect sales and cost of goods sold.  Going forward, these territories are now licensed to International Brand Group, who has taken over the related sales and distribution operations, and as the brand owner, the company will earn royalties from these sales. The indirect sales and associated cost of goods sold previously reflected in the company’s  P&L are now classified as “discontinued operations.” As part of this transition, the company completed a restructuring of Hi-Tec operations, resulting in a 60% reduction in headcount and a significantly reduced cost structure.

Hi-Tec brand revenues for the fourth quarter were $2.7 million compared to $1.2 million in the fourth quarter of the prior year, which reflected only a partial quarter of revenue contribution from the company’s December 2017 acquisition of Hi-Tec. Revenues for the current and prior year period are only comprised of royalty revenues. Previously-reported indirect sales have been reclassified as discontinued operations. Hi-Tec brand royalty revenues for fiscal 2018 were $9.7 million.

Flip Flop Shops and Other Brands

Flip Flop Shops and other brand revenues for the fourth quarter were $0.4 million, compared to $1.2 million in the fourth quarter of the prior year. Flip Flop Shops and other brand revenues for fiscal 2018 were $3.1 million compared to $4.7 million in the prior year. The company is finalizing a shop-in-shop program with a national retailer that is set to launch this Summer.

Trademark Impairments 

In the fourth quarter of fiscal 2018, the company conducted the annual evaluation of goodwill and indefinite lived trademarks as required under accounting standards. It was determined that the indefinite lived trademarks related to four of the company’s brands were impaired, and as a result, the company recognized an impairment charge of $35.5 million related to its Tony Hawk, Liz Lange, Flip Flop Shops and Everyday California trademarks. These impairment charges were the outcome of significant changes to the company’s cash flow projections based on recent experience, which resulted in reduced estimates of fair value. In conjunction with these impairment assessments, the company concluded that the competitive and economic environment for the use of these trademarks no longer supported indefinite useful lives. Accordingly, these trademarks will be amortized prospectively over their estimated remaining useful lives.

Operating Expenses

Selling, general and administrative expenses for the fourth quarter, which comprise the company’s normal operating expenses, were $6.9 million, compared to $5.7 million in the fourth quarter of the prior year. Selling, general and administrative expenses were $25.4 million for fiscal 2018, compared to $19.1 million in the prior year. Hi-Tec is included in the company’s results for the full year of fiscal 2018 compared to only a partial quarter in fiscal 2017, which is the primary driver of the year-over-year increase in operating expenses.

The company incurred restructuring charges of $2.0 million in the fourth quarter of fiscal 2018 as the company completed the conversion of Hi-Tec to a fully licensed model and took steps to align staffing to appropriately support the company’s current operations. Business acquisition and integration costs related to the integration of the Hi-Tec acquisition totaled $2.2 million in the fourth quarter of fiscal 2018. The company expects business acquisition and integration costs in fiscal 2019 to be significantly less. In addition, the company incurred non-cash stock warrant charges related to debt refinancings, which totaled $1.3 million in fiscal 2018.

Net Loss and Adjusted EBITDA

The company’s net loss for the fourth quarter was $45.6 million, or $3.26 per share on a diluted basis with 14.0 million average shares outstanding, reflecting the $35.5 million impairment charge described above. Net loss in the fourth quarter of the prior year was $11.1 million, or $0.96 per share on a diluted basis, with 11.5 million average shares outstanding.

Net loss for fiscal 2018 was $56.0 million, or $4.17 per share on a diluted basis, with 13.4 million average shares outstanding, compared to a net loss in fiscal 2017 of $7.9 million, or $0.84 per share on a diluted basis, with 9.4 million average shares outstanding.

After adding back the non-cash charges and the business acquisition and integration costs, fiscal 2018 Adjusted EBITDA was $3.9 million compared to adjusted EBITDA of $14.9 million in the prior year. This decrease was primarily due to the company’s transition from a previous DTR license agreement with Target Corporation to a wholesale model, which began contributing to royalty revenues at the beginning of fiscal 2018 and is expected to grow as Cherokee branded products begin to gain traction with new retailers and their customers.

Balance Sheet

At February 3, 2018, the company had cash and cash equivalents of $3.2 million and $49.5 million of debt.

Going Concern

Based on the company’s current forecasts, management anticipates that the company will violate the liquidity covenant in the company’s credit agreement within the next twelve months, which raises substantial doubt about the ability of Cherokee to continue as a going concern. The company has disclosed this information in the audited financial statements and has classified debt obligations as current liabilities as of February 3, 2018.

The company is in the process of negotiating with a lender to amend the company’s credit agreement and give the company incremental liquidity, either through an increase in borrowing capacity, or through additional liquidity from another lender. The company expects these discussions to result in an acceptable amendment.

As a result of the company’s projections, the company’s independent registered public accounting firm has included an explanatory paragraph in the audit opinion related to the company’s fiscal 2018 financial statements, which indicates that there is substantial doubt about the company’s ability to continue as a going concern. Such paragraph in the independent auditor’s report causes the company to fail to comply with the affirmative covenants of the credit facility with Cerberus, and as a result of such failure to comply, Cerberus has the right to terminate obligations under the credit facility, declare all or any portion of the borrowed amounts then outstanding to be accelerated and due and payable and/or exercise any other rights or remedies the firm may have under applicable law, including foreclosing on the company’s and/or its subsidiaries assets that serve as collateral for the borrowed amounts.

Notwithstanding the foregoing, the company’s financial statements have been prepared on a going concern basis, meaning that the company will be able to realize assets and discharge liabilities in the normal course of business. The financial statements do not reflect adjustments that would be necessary if the going concern assumption was not appropriate. If the going concern assumption was not appropriate for these financial statements, adjustments to the carrying value of the assets and liabilities, reported expenses and statement of financial position classifications would be necessary. Such adjustments could be material.

Fiscal 2019 Outlook

Cherokee Global Brands is updating its guidance for the fiscal year ending February 2, 2019, which accounts for the transition of Hi-Tec’s indirect sales to a licensing model.

  • Revenues are anticipated to range from $29.0 to $31.0 million
  • Adjusted EBITDA is anticipated to range from $8.0 to $10.0 million
  • SG&A run rate is expected to approximate $21.0 million