SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 3, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to ______________
Commission file number: 333-82713
CHEROKEE INTERNATIONAL, LLC
(Exact name of registrant as specified in its charter)
CALIFORNIA 33-0696451
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2841 DOW AVENUE
TUSTIN, CALIFORNIA 92780
(Address of principal executive offices)
(714) 544-6665
(Registrant's telephone number, including area code)
N/A
- -------------------------------------------------------------------------------
(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the past 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes No X
--- ---
CHEROKEE INTERNATIONAL, LLC
TABLE OF CONTENTS
PAGE
PART I--FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements:
Consolidated Balance Sheets--
September 30, 1999 and December 31, 1998...........................3
Consolidated Statements of Income--
For the Three and Nine Months Ended September 30, 1999 and 1998....4
Consolidated Statements of Cash Flows--
For the Nine Months Ended September 30, 1999 and 1998..............5
Notes to Consolidated Financial Statements .............................7
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................10
PART II--OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.....................................17
SIGNATURES....................................................................18
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
SEPTEMBER 30, DECEMBER 31,
----------------------- -----------------------
1999 1998
----------------------- -----------------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents . . . . . . . . . . . . . . . . . . . $ 3,992,113 $ 2,784,828
Accounts receivable, net of allowance for doubtful accounts
of $175,000 in 1999 and 1998 . . . . . . . . . . . . . . . . 17,940,139 14,861,816
Inventories, net . . . . . . . . . . . . . . . . . . . . . . . . 19,071,731 15,467,183
Prepaid expenses and other current assets. . . . . . . . . . . . 105,168 67,576
----------------------- -----------------------
Total current assets . . . . . . . . . . . . . . . . . . . . 41,109,151 33,181,403
PROPERTY AND EQUIPMENT, net of accumulated depreciation
and amortization of $5,730,529 and $3,984,245 in
1999 and 1998, respectively . . . . . . . . . . . . . . . . . 8,993,063 7,457,096
DEPOSITS . . . . . . . . . . . . . . . . . . . . . . . . . . . . 281,503 207,526
DEFERRED FINANCING COSTS, net of accumulated amortization
of $338,774 in 1999 . . . . . . . . . . . . . . . . . . . . . 4,849,571 0
----------------------- -----------------------
$ 55,233,288 $ 40,846,025
----------------------- -----------------------
----------------------- -----------------------
LIABILITIES AND MEMBERS' EQUITY
CURRENT LIABILITIES:
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . $ 3,783,302 $ 5,896,016
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . 1,432,447 825,113
Accrued compensation and benefits . . . . . . . . . . . . . . . 1,924,040 2,054,736
Accrued interest payable . . . . . . . . . . . . . . . . . . . . 5,106,986 0
Current portion of long-term debt . . . . . . . . . . . . . . . 1,851,562 240,000
Current portion of capital lease obligations . . . . . . . . . . 761,319 467,694
----------------------- -----------------------
Total current liabilities . . . . . . . . . . . . . . . . . . 14,859,656 9,483,559
LONG-TERM DEBT, net of current portion . . . . . . . . . . . . . 146,906,250 540,000
CAPITAL LEASE OBLIGATIONS, net of current portion . . . . . . . 2,222,062 793,937
MEMBERS' EQUITY (DEFICIT)
Class A units: 300,000 units issued and outstanding
in 1999 and 1998. . . . . . . . . . . . . . . . . . . . . . . 14,000 14,000
Class B units: 30,002,000 units and 29,700,000 units issued
and outstanding in 1999 and 1998, respectively. . . . . . . . 2,594,000 1,386,000
Retained Earnings (Deficit). . . . . . . . . . . . . . . . . . . (111,362,680) 28,628,529
----------------------- -----------------------
Total members' equity (deficit) . . . . . . . . . . . . . . . (108,754,680) 30,028,529
----------------------- -----------------------
$ 55,233,288 $ 40,846,025
----------------------- -----------------------
----------------------- -----------------------
See notes to consolidated financial statements.
3
CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------------------- -------------------------------------
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
--------------------- ------------------ ------------------ ------------------
1999 1998 1999 1998
--------------------- ------------------ ------------------ ------------------
NET SALES. . . . . . . . . . . . . . . . $ 27,601,575 $ 22,203,517 $ 94,097,923 $ 60,306,198
COST OF SALES. . . . . . . . . . . . . . 18,070,263 13,796,425 59,569,445 37,327,754
--------------------- ------------------ ------------------ ------------------
GROSS PROFIT . . . . . . . . . . . . . . 9,531,312 8,407,092 34,528,478 22,978,444
OPERATING EXPENSES:
Engineering expenses . . . . . . . . . . 1,009,742 882,767 3,071,371 2,756,689
Selling and marketing expenses . . . . . 687,540 482,658 1,981,647 1,389,932
General & administrative expenses. . . . 954,834 705,145 2,837,863 2,020,051
Special bonus distribution . . . . . . . 0 0 5,330,000 0
--------------------- ------------------ ------------------ ------------------
Total operating expenses. . . . . . . 2,652,116 2,070,570 13,220,881 6,166,672
--------------------- ------------------ ------------------ ------------------
OPERATING INCOME . . . . . . . . . . . . 6,879,196 6,336,522 21,307,597 16,811,772
OTHER INCOME (EXPENSE):
Interest expense . . . . . . . . . . . . (3,938,596) (116,067) (6,849,719) (325,812)
Other income (expense) . . . . . . . . . (196,222) 168,846 (715,087) 178,453
--------------------- ------------------ ------------------ ------------------
NET INCOME . . . . . . . . . . . . . . . $ 2,744,378 $ 6,389,301 $ 13,742,791 $ 16,664,413
--------------------- ------------------ ------------------ ------------------
--------------------- ------------------ ------------------ ------------------
BASIC AND DILUTED
INCOME PER UNIT. . . . . . . . . . . . $ .09 $ .21 $ .46 $ .56
--------------------- ------------------ ------------------ ------------------
--------------------- ------------------ ------------------ ------------------
WEIGHTED AVERAGE
OUTSTANDING UNITS . . . . . . . . . . 30,195,143 30,000,000 30,065,047 30,000,000
--------------------- ------------------ ------------------ ------------------
--------------------- ------------------ ------------------ ------------------
See notes to consolidated financial statements.
4
CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
NINE MONTHS ENDED
--------------------------------------------
SEPTEMBER 30, SEPTEMBER 30,
-------------------- --------------------
1999 1998
-------------------- --------------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 13,742,791 $ 16,664,413
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization . . . . . . . . . . . . . . . . . . . . . 1,746,284 1,217,399
Amortization of deferred financing costs. . . . . . . . . . . . . . . . 338,774 0
Net change in operating assets and liabilities:
Accounts receivable, net . . . . . . . . . . . . . . . . . . . . . . (3,078,323) (3,644,677)
Inventories, net . . . . . . . . . . . . . . . . . . . . . . . . . . (3,604,548) (1,199,391)
Prepaid expenses and other current assets. . . . . . . . . . . . . . (37,592) 115,581
Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . (73,977) (39,689)
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . . . . (2,112,714) 639,603
Accrued liabilities. . . . . . . . . . . . . . . . . . . . . . . . . 607,334 (301,925)
Accrued compensation and benefits. . . . . . . . . . . . . . . . . . (130,696) (984,791)
Accrued interest payable . . . . . . . . . . . . . . . . . . . . . . 5,106,986 0
-------------------- --------------------
Net cash provided by operating activities . . . . . . . . . . . . 12,504,319 12,466,523
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment . . . . . . . . . . . . . . . . . . (971,937) (1,235,851)
-------------------- --------------------
Net cash used in investing activities. . . . . . . . . . . . . (971,937) (1,235,851)
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowing on revolving line of credit . . . . . . . . . . . . . . . . . 4,699,935 3,097,520
Payments on revolving line of credit and term loan. . . . . . . . . . . (4,699,935) (3,127,365)
Payments on obligations under capital leases. . . . . . . . . . . . . . (588,564) (214,871)
Borrowing on long-term debt . . . . . . . . . . . . . . . . . . . . . . 150,000,000 0
Payment on long-term debt . . . . . . . . . . . . . . . . . . . . . . . (2,022,188) 0
Deferred financing costs . . . . . . . . . . . . . . . . . . . . . . . (5,188,345) 0
Equity distribution . . . . . . . . . . . . . . . . . . . . . . . . . (157,856,000) (12,240,000)
Capital contribution to fund special bonus distribution . . . . . . . . 5,330,000 0
-------------------- --------------------
Net cash used in financing activities . . . . . . . . . . . . . (10,325,097) (12,484,716)
-------------------- --------------------
NET INCREASE (DECREASE) IN CASH . . . . . . . . . . . . . . . . . . . . 1,207,285 (1,254,044)
CASH AND CASH EQUIVALENTS, beginning of period. . . . . . . . . . . . . 2,784,828 873,410
-------------------- --------------------
CASH AND CASH EQUIVALENTS, end of period. . . . . . . . . . . . . . . . $ 3,992,113 $ (380,634)
-------------------- --------------------
-------------------- --------------------
See notes to consolidated financial statements.
5
CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited)
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest $1,382,749 $ 319,812
--------- ---------
--------- ---------
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITY:
During the nine months ended September 30, 1999, the Company financed the
purchase of $2,310,314 of fixed assets through a capital equipment lease.
See notes to consolidated financial statements.
6
CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES
NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
September 30, 1999
(Unaudited)
1. Basis of Presentation
The information set forth in the accompanying financial statements is
unaudited and may be subject to normal year-end adjustments. In the
opinion of management, the unaudited financial statements reflect all
adjustments, consisting only of normal recurring adjustments, necessary
to present fairly the financial position and results of operations of
Cherokee International, LLC (the "Company") for the periods indicated.
Results of operations for the interim three and nine months ended
September 30, 1999 and 1998 are not necessarily indicative of the
results of operations for the full fiscal year. The Company's third
quarter represented the 13-week period ended on October 3 in 1999 and
October 4 in 1998. For presentation purposes, these fiscal quarters
have been referred to as September 30.
The consolidated financial statements include the financial statements
of the Company and its wholly-owned subsidiaries Cherokee Electronica,
S.A. DE C.V. (Electronica), Cherokee India Pvt. Ltd. (India), Powertel
India Pvt. Ltd. (Powertel) and Cherokee International Finance, Inc.
(Finance). Finance was formed in April 1999 as a wholly-owned finance
subsidiary to act as a co-obligor of the 10 1/2% Senior Subordinated
Notes (see Note 4) and has no independent assets or operations. All
material intercompany accounts and transactions have been eliminated.
Certain information normally included in footnote disclosure to the
financial statements has been condensed or omitted in accordance with
the rules and regulations of the Securities and Exchange Commission.
2. Inventories
Inventories are valued at the lower of cost (first-in, first-out) or
market. Inventory costs include the cost of material, labor and
manufacturing overhead and consist of the following:
September 30, 1999 December 31, 1998
------------------ -----------------
Raw Material $ 16,024,714 $ 13,223,720
Work-in-process 3,228,114 2,369,463
Finished goods 397,213 452,310
Reserve for obsolescence (578,310) (578,310)
------------------ -----------------
$19,071,731 $ 15,467,183
------------------ -----------------
------------------ -----------------
3. Income Taxes
The Company is taxed as a limited liability company under the
provisions of the United States federal and state tax codes. Under
United States federal law, taxes based on income of a limited liability
company are payable by the Company's members individually. Accordingly,
no provision for United States federal income taxes or for California
franchise taxes has been provided in the accompanying financial
statements.
4. Certain Transactions
7
On April 30, 1999, a group of investors (the "Investors") purchased
60% of Cherokee's issued and outstanding membership units (the
"Acquired Interest") directly from the Company's existing members (the
"Existing Members"). The aggregate consideration paid by the Investors
was $180.0 million. Of the $180.0 million, $160.0 million was paid in
cash and $20.0 million was in the form of promissory notes.
Immediately after the purchase by the Investors of the Acquired
Interest, the Company made a $150 million distribution (the
"Distribution") to its members, of which $90 million was received by
the Investors and $60 million was received by the Existing Members.
The Distribution was financed by (1) a portion of the proceeds of a new
senior credit agreement entered into with Heller Financial, Inc. and
certain other financial institutions (the "Credit Agreement"); and (2)
the proceeds of $100 million of 10.50% Senior Subordinated Notes due
2009 issued in an offering under Rule 144A of the Securities Act.
The Credit Agreement provides for a $50 million term loan facility (all
of which was drawn to fund the Distribution and related expenses) and a
$25 million revolving credit facility ($4.6 million of which was drawn
to fund the Distribution and related expenses). The Credit Agreement
has a maturity of six years, and the term loan will amortize over such
period with annual principal payments ranging from $2.5 million to
$13.5 million. The Credit Agreement is secured by substantially all of
the Company's assets and by a non-recourse pledge of 100% of the
Company's membership units held by the Investors and the Existing
Members. As of September 30, 1999, there was $48.8 million outstanding
under the term loan and no borrowings were outstanding under the
revolving credit facility.
8
5. Deferred Financing Costs
During the nine months ended September 30, 1999, the Company incurred
approximately $6.0 million of fees and expenses related to the issuance
of senior subordinated notes and the execution of a new term loan and
credit facility. Of such fees and expenses approximately $5.2 million
was capitalized as deferred financing costs and approximately $0.8
million was directly expensed and included in other income (expense) in
the accompanying consolidated statements of income. Deferred financing
costs are being amortized over 6 years.
6. Special Bonus Distribution
In connection with the transactions described in Note 4 above, the
Company's management committee authorized approximately $5.3 million of
special bonus payments to certain key employees for their role in the
Company's growth and success over the previous years. These bonus
payments were entirely funded by capital contributions made by the
Company's then existing members.
7. Membership Units
Effective June 28, 1999, the Company's management committee approved a
75-for-1 split of the outstanding Class A Units and Class B Units.
Accordingly, all unit and income per unit figures have been restated to
reflect this split.
8. Unit Purchase Plan
In June 1999, the Company adopted the 1999 Unit Purchase Plan covering
an aggregate of 1,500,000 shares of Class B membership units. At June
30, 1999, the Company had provided an opportunity to purchase an
aggregate of 302,000 Class B units to certain key employees at $4.00
per unit. During the three months ended September 30, 1999, all such
granted awards were exercised by these employees whereby the Company
received aggregate proceeds of $1,208,000.
9. Income Per Unit
In accordance with SFAS No. 128, EARNINGS PER SHARE, basic income per
unit calculations are determined by dividing net income by the weighted
average units outstanding. There were no dilutive units outstanding at
the end of any period presented.
10. Comprehensive Income
During fiscal 1998, the Company adopted SFAS No. 130, REPORTING
COMPREHENSIVE INCOME, which establishes standards for the reporting and
display of comprehensive income. Comprehensive income is defined as all
changes in a company's net assets except changes resulting from
transactions with shareholders. It differs from net income in that
certain items currently recorded through equity are included in
comprehensive income. The Company's net income was the same as
comprehensive income for all periods presented.
9
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
OVERVIEW
Cherokee is a leading designer and manufacturer of a broad range of
switch mode power supplies for original equipment manufacturers primarily in
the high growth telecommunications, networking and high-end workstation
industries. The Company produces its products and related components in four
sophisticated manufacturing facilities located in Tustin, California, Irvine,
California, Guadalajara, Mexico and Bombay, India.
The Company's net sales are principally driven by growth in its
customers' industries. The telecommunications, networking and high-end
workstation segments are benefiting from the proliferation of internet/intranet,
wireless and other communications.
The principal elements comprising cost of sales are raw materials,
labor and manufacturing overhead. During 1998 and 1999, raw materials accounted
for a large majority of cost of sales. Raw materials include magnetic
subassemblies, sheet metal, electronic and other components, mechanical parts
and electrical wires. Labor costs include employee costs of salaried and hourly
employees. Manufacturing overhead includes lease costs, depreciation on
property, plant and equipment, utilities, property taxes and repairs and
maintenance.
Operating expenses include engineering costs, selling and marketing
costs and administrative expenses. Engineering costs primarily include salaries
and benefits of engineering personnel, safety approval and quality certification
fees, depreciation on equipment and subcontract costs for third party
contracting services. Selling and marketing expenses primarily include salaries
and benefits to account managers and commissions to independent sales
representatives. Administrative expenses primarily include salaries and benefits
for certain management and administrative personnel, professional fees and
information system costs.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1998
NET SALES
Net sales increased by approximately 24.3% or $5.4 million to $27.6
million for the three months ended September 30, 1999 from $22.2 million for the
three months ended September 30, 1998.
This increase in net sales was primarily attributable to growth in
business with existing customers, along with a broadening of the Company's
customer base resulting in additional sales from projects with new customers.
10
GROSS PROFIT
Gross profit increased by approximately 13.4% or $1.1 million to
$9.5 million for the three months ended September 30, 1999 from $8.4 million
for the three months ended September 30, 1998. Gross margin for the quarter
decreased to 34.5% from 37.9% in the prior year.
The increase in gross profit was primarily due to the increase in
sales. The decrease in gross margin compared to the prior year was primarily
due to increased pricing pressure from certain key existing customers and a
change in product mix. This decrease was partially offset by improved
operating leverage due to higher sales volume and improved operating
efficiencies due to increased automation.
OPERATING EXPENSES
Operating expenses for the three months ended September 30, 1999
increased by approximately 28.1% or $.6 million to $2.7 million for the three
months ended September 30, 1999 from $2.1 million for the three months ended
September 30, 1998. As a percentage of sales, operating expenses increased to
9.6% from 9.3% in the prior year.
The increase in operating expenses was primarily due to the increased
costs to support the higher sales volume. The increase in operating expenses
as a percentage of net sales was primarily attributable to having the
resources in place to support sales levels commensurate with those achieved
in the immediately preceding quarters.
OPERATING INCOME
Operating income increased by approximately 8.6% or $.5 million to
$6.9 million for the three months ended September 30, 1999 from $6.3 million
for the three months ended September 30, 1998. Operating margin for the
current quarter decreased to 24.9% from 28.5% in the prior year.
The increase in operating income was primarily due to the increase
in gross profit, partially offset by higher operating expenses. The decrease
in operating margin was primarily attributable to the decrease in gross
margin discussed above.
11
INTEREST EXPENSE
Interest expense for the three months ended September 30, 1999 was
$3.9 million compared to $0.1 million for the three months ended September
30, 1998. This substantial increase was primarily due to the issuance of $100
million of 10 1/2% senior subordinated notes and a new $50 million term loan,
all of which occurred in April 1999 in connection with certain transactions
(see Note 4 to Consolidated Financial Statements).
PRETAX INCOME
Pretax income decreased by approximately 57.0% or $3.6 million to
$2.7 million for the three months ended September 30, 1999 from $6.4 million
for the three months ended September 30, 1998. Pretax income margin for the
current quarter, was 9.9% compared to 28.8% in the prior period.
The decrease in pretax income margin was primarily due to the
substantially higher interest expense discussed above.
NINE MONTHS ENDED SEPTEMBER 30, 1999 COMPARED TO NINE MONTHS ENDED SEPTEMBER
30, 1998
NET SALES
Net sales increased by approximately 56.0% or $33.8 million to $94.1
million for the nine months ended September 30, 1999 from $60.3 million for
the nine months ended September 30, 1998.
This increase in net sales was primarily attributable to growth in
business with existing customers, along with a broadening of the Company's
customer base resulting in additional sales from projects with new customers.
GROSS PROFIT
Gross Profit increased by approximately 50.3% or $11.6 million to
$34.5 million for the nine months ended September 30, 1999 from $23.0 million
for the nine months ended September 30, 1998. Gross margin for the nine-month
period decreased to 36.7% from 38.1% in the prior year.
The increase in gross profit was primarily due to the increase in
sales. The decrease in gross margin compared to the prior year was primarily
due to increased pricing pressure from certain key existing customers and a
change in product mix. This decrease was partially offset by improved
operating leverage due to higher sales volume and improved operating
efficiencies due to increased automation.
OPERATING EXPENSES
Operating expenses for the nine months ended September 30, 1999 of
$13.2 million included a $5.3 million special bonus distribution. This bonus
payment was in addition to the Company's discretionary annual management
bonus plan and was funded by capital contributions made by the Company's then
existing members (see Note 6 to Consolidated Financial Statements). No such
special bonus distribution was made in the prior year.
Operating expenses, excluding the special bonus distribution, increased
by approximately 28.0% or $1.7 million to $7.9 million for the nine months
ended
12
September 30, 1999 from $6.2 million for the nine months ended September 30,
1998. As a percentage of sales, operating expenses, before the special bonus
distribution, declined to 8.4% from 10.2% in the prior year.
The increase in operating expenses was primarily due to the increased
costs to support the higher sales volume. The decline in operating expenses
as a percentage of net sales was primarily attributable to increased
operating leverage as a result of the higher sales volume.
OPERATING INCOME
Operating income for the nine months ended September 30, 1999 of
$21.3 million includes the effect of the $5.3 million special bonus
distribution. Excluding the effect of the special bonus distribution,
operating income increased by approximately 58.4% or $9.8 million to $26.6
million for the nine months ended September 30, 1999 from $16.8 million for
the nine months ended September 30, 1998. Operating margin for the nine-month
period, before the special bonus distribution, improved to 28.3% from 27.9%
in the prior year.
The increase in operating income was primarily due to the increase
in gross profit, partially offset by higher operating expenses. The increase
in operating margin was primarily due to improved operating leverage due to
increased sales volume, partially offset by a decrease in gross margin.
INTEREST EXPENSE
Interest expense for the nine months ended September 30, 1999 was
$6.8 million compared to $0.3 million for the nine months ended September 30,
1998. This substantial increase was primarily due to the issuance of $100
million of 10 1/2% senior subordinated notes and a new $50 million term loan,
all of which occurred in April 1999 in connection with certain transactions
(see Note 4 to Consolidated Financial Statements).
PRETAX INCOME
Pretax income for the nine months ended September 30, 1999 was $13.7
million, which includes the effect of the $5.3 million special bonus
distribution. Excluding the effect of the special bonus distribution, pretax
income increased by approximately 14.5% or $2.4 million to $19.1 million for
the nine months ended September 30, 1999 from $16.7 million for the nine
months ended September 30, 1998. Pretax income margin for the current
nine-month period, before the special bonus distribution, was 20.3% compared
to 27.6% in the prior period.
The increase in pretax income was primarily due to the same factors
contributing to the increase in operating income as discussed above,
partially offset by the substantially higher interest expense discussed above.
13
LIQUIDITY AND CAPITAL
CASH FLOWS
Nine Months Ended September 30, 1999 Compared to Nine Months Ended September
30, 1998
Net cash provided by operating activities was $12.5 million for both
the nine months ended September 30, 1999 and the nine months ended September
30, 1998. The amount for 1999 includes the negative cash flow effect of a
$5.3 million special bonus distribution which was funded by capital
contributions made by the existing members. Excluding the effect of the
special bonus distribution, cash provided by operating activities was $17.8
million for the nine months ended September 30, 1999, which increased 43.1%
or $5.4 million from the same period in the prior year. This increase was
primarily the result of a $3.3 million increase in cash earnings from
operations (net income, excluding the effect of the special bonus
distribution, plus depreciation and amortization including amortization of
deferred financing costs). Cash provided by operating activities for 1999
reflects a $5.1 million increase in accrued interest payable, offset by
increases of $3.1 million in accounts receivable and $3.6 million in
inventory and a decrease of $2.1 million in accounts payable. Cash provided
by operating activities for 1998 includes the effect of increases of $3.6
million in accounts receivable and $1.2 million in inventory.
Net cash used in financing activities was $10.3 million for the nine
months ended September 30, 1999 compared to $12.5 million for the nine months
ended September 30, 1998. The amount for 1999 includes the favorable cash
flow effect of a $5.3 million capital contribution made by the existing
members to fund the special bonus distribution discussed above. This was
partially offset by payment in 1999 of $5.2 million of deferred financing
costs (see Note 5 to Consolidated Financial Statements).
LIQUIDITY
Historically, the Company has financed its operations with cash from
operations supplemented by borrowings from credit facilities. As a result of
certain transactions (see Note 4 to Consolidated Financial Statements), the
Company's current and future liquidity needs primarily arise from debt
service on indebtedness, working capital requirements, capital expenditures
and distributions to pay taxes. As of September 30, 1999, the Company's
borrowings consisted of $100 million of senior subordinated notes, $48.8
million of borrowings under a term loan facility, and $3.0 million under
capital leases. The Company had no borrowings outstanding under its $25
million revolving credit facility. The Company is not subject to any
amortization requirements under the notes prior to maturity in 2009, but it
is required to make scheduled repayments under the term loan facility.
Management believes that cash flow from operations and available
borrowing capacity will be adequate to meet the Company's anticipated cash
requirements, including operating requirements, planned capital expenditures,
debt service and distributions to pay taxes, for the next twelve months.
The Company's historical capital expenditures have substantially
resulted from investments in equipment to increase manufacturing capacity and
improve manufacturing efficiencies. For fiscal 1999, the Company expects
capital expenditures to be between $3-4 million, of which approximately $2.3
million has been financed under a capital lease.
YEAR 2000 COMPLIANCE
The "Year 2000" ("Y2K") issue is the result of computer programs
using two digits rather than four to define the applicable year. Because of
this programming convention, software or hardware may recognize a date using
"00" as the year 1900 rather than year 2000. Use of non-Year 2000 compliant
programs could result in system failures, miscalculations or errors causing
disruptions
14
of operations or other business problems, including, among others, a
temporary inability to process transactions and invoices or an inability to
engage in similar normal business activities.
CHEROKEE INTERNATIONAL LLC INITIATIVES PROGRAM. Historically, all of
the locations of the Company have operated on separate information systems,
using different software platforms. In calendar 1997, the Company analyzed
its system for Year 2000 compliance with a view to replacing non-compliant
systems and creating an integrated Year 2000 compliant system. In addition,
the Company has developed a comprehensive program to address the Year 2000
issue with respect to the following non-system areas: (1) network switching;
(2) the Company's non-information technology systems (such as building,
plant, equipment and other infrastructure systems that may contain embedded
microprocessor technology); and (3) the status of major vendors, third-party
network service providers and other material service providers (insofar as
they relate to the Company's business). As explained below, the Company's
effort to assess its systems as well as non-system areas related to Year 2000
compliance involve: (1) a wide-ranging assessment of the Year 2000 problems
that may affect the Company; (2) the development of remedies to address the
problems discovered in the assessment phase; and (3) testing of the remedies.
ASSESSMENT PHASE. The Company has identified substantially all of
its major hardware and software platforms in use as well as the relevant
non-system areas described above. The Company has determined its system
requirements on a company-wide basis and has begun the implementation of an
enterprise resource planning ("ERP") system , which is intended to be a
single system database onto which all the Company's individual systems will
be migrated. In relation thereto, the Company has obtained written
verification from the hardware, software and other equipment vendors and
third-party network service providers relating to Year 2000 compliance.
REMEDIATION AND TESTING PHASE. In implementing the ERP system, the
Company undertook and has completed a remediation and testing phase of all
internal systems, LANs, WANs, and PBXs. This phase was intended to address
potential Year 2000 problems of the ERP system in relation to both
information technology and non-information technology systems and then to
demonstrate that the ERP software was Year 2000 compliant. ERP system
software was selected and application implemented by a team of internal users
and outside ERP application experts. The ERP system was tested from July 1998
to present by this team of experts. All four locations have now been fully
implemented on the ERP system.
PROGRAM TO ASSESS AND MONITOR PROGRESS OF THIRD PARTIES. As noted
above, the Company has also undertaken an action plan to assess and monitor
the progress of third-party vendors in resolving Year 2000 issues. To date,
the Company has sent a "Y2K" questionnaire to its vendors and is currently
following up on non-responsive vendors. The Company believes that the
majority of required compliance and remediation with respect to these vendors
will be completed prior to January 1, 2000.
CONTINGENCY PLANS. The Company has begun to analyze contingency
plans to handle the worst-case Year 2000 scenarios that the Company
reasonably believes could occur and, if necessary, intends to develop a
timetable for completing such contingency plans.
COST RELATED TO THE YEAR 2000 ISSUE. To date, the Company has
incurred approximately $180,000 in costs related to the implementation of the
ERP system. The Company currently estimates the total ERP implementation will
cost approximately $200,000 and a portion of the costs have and will be
capitalized to the extent permitted under generally accepted accounting
15
principles.
RISKS RELATED TO THE YEAR 2000 ISSUE. Although the Company's efforts
to be Year 2000 compliant are intended to minimize the adverse effects of the
Year 2000 issue on the Company `s business and operations, the actual effects
of the issue will not be known until the Year 2000. Failure of the Company's
major vendors, third-party network service providers or other material
service providers and customers to adequately address their respective Year
2000 issues in a timely manner could have a material adverse effect on the
Company's business, results of operations and financial condition.
FORWARD-LOOKING STATEMENTS
Statements in this report containing the words "believes,"
"anticipates," "expects," and words of similar meaning, and any other
statements which may be construed as a prediction of future performance or
events, constitute "forward-looking statements" within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-looking
statements involve known and unknown risks, uncertainties, and other factors
that may cause the actual results, performance, or achievements of the
Company, or industry results, to be materially different from any future
results, performance, or achievements expressed or implied by such
forward-looking statements. Such factors include, among others, (1)
restrictions imposed by the Company's substantial leverage and restrictive
covenants in its debt agreements, (2) reductions in sales to any of the
Company's significant customers or in customer capacity generally, (3)
changes in the Company's sales mix to lower margin products, (4) increased
competition, (5) disruptions of the Company's established supply channels,
(6) the Company's ability to accurately estimate the cost of successful
systems preparation and implementation for Year 2000 compliance and (7) the
additional risk factors identified in the Company's Registration Statement on
Form S-4 (No. 333-82713) and those described from time to time in the
Company's other filings with the SEC, press releases and other
communications. The Company disclaims any obligations to update any such
factors or to announce publicly the result of any revisions to any of the
forward-looking statements contained or incorporated by reference herein to
reflect future events or developments.
16
PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS:
3.1* Second Amended and Restated Operating Agreement of Cherokee
International, LLC, dated as of April 30, 1999.
3.2* Amendment No. 1 to the Second Amended and Restated Operating
Agreement of Cherokee International, LLC, dated as of
June 28, 1999.
3.3* Amendment No. 2 to the Second Amended and Restated Operating
Agreement of Cherokee International, LLC, dated as of
June 28, 1999.
4.1* Indenture, dated as of April 30, 1999, among Cherokee
International, LLC, Cherokee International Finance, Inc. and
Firstar Bank of Minnesota, N.A., as trustee, relating to the
notes.
4.2* Form of 10 1/2% Series A Subordinated Notes due 2009 (included
in Exhibit 4.1).
4.3* Form of 10 1/2% Series B Senior Subordinated Note due 2009
(included in Exhibit 4.1).
4.4* Registration Rights Agreement, dated as of April 30, 1999,
among Cherokee International, LLC, Cherokee International
Finance, Inc. and Credit Suisse First Boston Corporation.
27.1 Financial Data Schedule.
(b) REPORTS ON FORM 8-K
The Company did not file any reports on Form 8-K during the 13-week
period ended October 3, 1999.
- ----------------------
* Incorporated by reference to designated exhibit to the Company's Registration
Statement on Form S-4 (File No. 333-82713).
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act
of 1934, as amended, the registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
Cherokee International, LLC
Date: November 16, 1999 /s/ R. Van Ness Holland, Jr.
-------------------------------------
R. Van Ness Holland, Jr.
Chief Financial Officer
18