Christmas came early to Cherokee Inc., which wasn’t the best news for the company’s third quarter performance. Net income at the Van Nuys-based licensing and marketing company was relatively flat in the just-closed quarter compared to the year-ago period, but rather than a weak performance, the quarter reflected especially strong sales in the first half of the year. “The way our contracts work there’s a declining royalty rate as companies reach various retail thresholds,” said Russell J. Riopelle, Cherokee’s CFO. “Last year they hit the threshold at the end of the third quarter. This year they hit at the beginning of the third quarter.” Cherokee operates with a somewhat unusual business model, acquiring brands which it then licenses to retail chains or brokering licensing arrangements between manufacturers and retailers. Among the company’s largest is its namesake brand sold at Target, Canadian retailer Zellers and other retailers in Europe and Mexico; Mossimo also sold at Target and Sideout, sold at Mervyns and in China. The company receives royalties based upon sales at retail at percentage rates that decline as the retailers’ sales volume increases. This year, because its retailers achieved especially high sales volumes on Cherokee’s brands in the first half of the year, it saw a decline in the royalties it received beginning with the second half. For the third quarter ended Oct. 29, Cherokee reported net income of $3.3 million or $0.37 per diluted share on revenues of $8.4 million. That compares with net income of $3.3 million or $0.38 per share on revenues of $8.0 million in the third quarter of 2004. The performance didn’t faze analysts, who were anticipating the results reported, and who, by and large, have been impressed with Cherokee’s formula and its performance on The Street. Cherokee is currently trading in the mid-$30 range, up from the low-$30 range a year ago. “It’s a hugely profitable company,” said J.P. Mark, president of Farmhouse Equity Research, an independent equity research company in Rhode Island. “On paper, it’s the most amazing company.” Indeed, Cherokee operates with just a handful of employees, no inventory to manage and an expense structure that is enviable. The company has been regularly pumping back profits to shareholders in the form of dividends. Cherokee’s niche is also well suited to the direction many retailers have recently taken, seeking out brands that they can carry exclusively, a move that strengthens marketing efforts and gross margins. “I think the trend in retail is this direct-to-retail licensing as opposed to third party licensing,” said Marty Brochstein, editorial director at EPM Communications, a publisher of trade journals, research and newsletters on licensing and other marketing-related topics. “Target knows you can’t go to Wal-Mart to compare prices, so the Cherokee setup is becoming a growing part of the retail business.” The Cherokee brand, the largest segment of the company’s business, accounted for $2.5 billion in sales at retail, making it the No. 1 licensed apparel brand in the world, according to research compiled by Brean Murray, Carret & Co., an institutional brokerage in New York. Brean Murray & Carret estimates that this year, Cherokee will account for about 4 percent of Target’s sales, making it the largest brand in the chain. But Cherokee’s business model also relies on a continual flow of new brands, and the company’s efforts so far have not produced a franchise as strong as Cherokee. The agreement for its House Beautiful brand, sold through May Department Stores Co., is not expected to be renewed as a result of Federated’s acquisition of May; and the announced closure of many Mervyn’s stores will also affect the Sideout brand. Two other brands, Latina, which is sold at Sears; and Carole Little, sold at TJX stores, are too new to evaluate. “The Cherokee brand is probably getting close to being saturated, and the question is what is next?” said Eric Beder, senior vice president at Brean Murray Carret. “We have high single digit top and bottom line growth (projections for the future) simply because we don’t see any new agreements.” The long term questions may well have affected Cherokee’s efforts to sell the company. Earlier this year, Cherokee hired UBS Investment Bank to help explore a possible sale of the company but so far, not deal has been reached. “We’re always for sale if someone provides a compelling price,” said Riopelle. “But at this point, we haven’t seen any compelling bid.” Cherokee officials concede that their latest efforts have not matched the brands the company is built upon, but they add that they still have a number of opportunities to explore. “Those big ideas are tough to come by,” said Riopelle. “We’re working on things outside the (apparel) industry, but there are also a fair amount of territories for Cherokee that are not signed up Germany and China. The Cherokee brand itself still has a number of territories that still provide exciting opportunities.”
