-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, QXoUznjbMNqlfQaoV67SBdaIACiDvLl8R+S8kxLqo/JlO+Bs8ZCvJk7BehFYuRqy YYWIOjcnpts5pZ5OHxh3yw== 0000944209-98-000836.txt : 19980424 0000944209-98-000836.hdr.sgml : 19980424 ACCESSION NUMBER: 0000944209-98-000836 CONFORMED SUBMISSION TYPE: 10-KT PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19980131 FILED AS OF DATE: 19980422 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: CHEROKEE INC CENTRAL INDEX KEY: 0000844161 STANDARD INDUSTRIAL CLASSIFICATION: WOMEN'S, MISSES', AND JUNIORS OUTERWEAR [2330] IRS NUMBER: 954182437 STATE OF INCORPORATION: DE FISCAL YEAR END: 0131 FILING VALUES: FORM TYPE: 10-KT SEC ACT: SEC FILE NUMBER: 033-26165 FILM NUMBER: 98598763 BUSINESS ADDRESS: STREET 1: 6835 VALJEAN AVE CITY: VAN NUYS STATE: CA ZIP: 91406-4713 BUSINESS PHONE: 8189511002 MAIL ADDRESS: STREET 1: 6835 VALJEAN AVE CITY: VAN NUYS STATE: CA ZIP: 91406-4713 FORMER COMPANY: FORMER CONFORMED NAME: GREEN ACQUISITION CO DATE OF NAME CHANGE: 19900814 10-KT 1 TRANSITION REPORT FOR FORM 10-K - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------- FORM 10-K ---------------- [ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 OR [X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM JUNE 1, 1997 TO JANUARY 31, 1998 COMMISSION FILE NO. 0-18640 ---------------- CHEROKEE INC. (Exact name of registrant as specified in charter) DELAWARE 95-4182437 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 6835 VALJEAN AVENUE VAN NUYS, CA 91406 (Address of principal executive (Zip Code) office) (818) 908-9868 (Registrant's telephone number, including area code) ---------------- SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, $.02 per share 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 preceding 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. (1) Yes X No - -- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] APPLICABLE ONLY TO REGISTRANTS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes X No - -- As of April 15, 1998, the registrant had 8,612,657 shares of its Common Stock, par value $.02 per share, issued and outstanding. As of April 15, 1998, the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $66,724,000 (computed on the basis of the last trade of the Common Stock on the NASDAQ Small Cap Issue Market on April 15, 1998). Certain portions of the registrant's proxy statement for the Annual Meeting of Stockholders to be held on June 8, 1998 are incorporated by this reference into Part III as set forth herein. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- CHEROKEE INC. INDEX
PAGE ---- PART I Item 1. Business...................................................... 3 Item 2. Properties.................................................... 14 Item 3. Legal Proceedings............................................. 14 Item 4. Submission of Matters to a Vote of Security Holders........... 14 PART II Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters........................................... 15 Item 6. Selected Financial Data....................................... 16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation...................................... 17 Item 7A. Qualitative and Quantitative Risk............................. 23 Item 8. Consolidated Financial Statements and Supplementary Data...... 24 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...................................... 25 PART III Item 10. Executive Officers of the Registrant.......................... 25 Item 11. Executive Compensation........................................ 26 Item 12. Security Ownership of Certain Beneficial Owners and Management.................................................... 26 Item 13. Certain Relationships and Related Transactions................ 26 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K........................................................... 26
2 PART I ITEM 1. BUSINESS INTRODUCTION Cherokee Inc. (the "Company") is in the business of marketing and licensing the Cherokee and Sideout brands and related trademarks and other brands it owns. The Company is one of the leading licensors of brand names and trademarks for apparel, footwear and accessories in the United States. The Company's operating strategy emphasizes retail direct, wholesale and international licensing whereby the Company grants retailers and wholesalers the license to use the trademarks held by the Company on certain categories of merchandise, and the licensees are responsible for designing and manufacturing the merchandise. The Company and its wholly-owned subsidiary, SPELL C. LLC ("Spell C"), hold several trademarks including Cherokee(TM), Sideout(TM), Sideout Sport(TM), King of the Beach(TM) and others. The Cherokee brand, which began as a footwear brand in 1973, has been positioned to connote quality, comfort, fit, and a "Casual American" lifestyle with traditional wholesome values. The Sideout brand and related trademarks, which represent a beach- oriented, active, "California" lifestyle, were acquired by the Company in November 1997. As of January 31, 1998, the Company had twenty-five continuing license agreements, covering both domestic and international markets. In November 1997 the Company reaffirmed its relationship with Target Stores, a division of Dayton Hudson Corporation ("Target"), by entering into an amended licensing agreement (the "Amended Target Agreement") which grants Target the exclusive right in the United States to use the Cherokee trademarks on certain specified categories of merchandise. Under the Amended Target Agreement, Target is obligated to pay a royalty based upon a percentage of its net sales of Cherokee brand products, with a minimum guaranteed royalty of $60.0 million over the six-year initial term of the agreement. In December 1997 the Company completed a series of transactions whereby it sold its rights to the Cherokee brand and related trademarks in the United States to Spell C, its wholly-owned subsidiary, and also assigned to Spell C its rights in the Amended Target Agreement. In return the Company received the gross proceeds resulting from the sale by Spell C, for an aggregate of $47.9 million, of privately placed Zero Coupon Secured Notes (the "Secured Notes"), which yield 7.0% interest per annum, mature February 20, 2004 and are secured by the Amended Target Agreement and by the United States Cherokee trademarks. The aggregate scheduled amortization under the Secured Notes ($60.0 million) equals the aggregate minimum guaranteed royalty payable under the Amended Target Agreement ($60.0 million). Therefore, unless royalties under the Amended Target Agreement exceed the minimum guaranteed royalty, no revenues derived from the Amended Target Agreement can be distributed to the Company by Spell C. Using the proceeds from the sale of the Secured Notes, the Company's Board declared a special dividend of $5.50 per share which was paid on January 15, 1997. At a meeting held December 19, 1997, the Board of Directors of the Company (the "Board") changed the fiscal year end of the Company to a 52 or 53 week fiscal year ending on the Saturday nearest to January 31 in order to better align the Company with its licensees who also generally operate and plan using such a fiscal year. Prior to this change, the Company's fiscal year was a 52 or 53 week fiscal year ending on the Saturday nearest to May 31. This Transition Report on Form 10-K is made with respect to the eight (8) month fiscal period beginning June 1, 1997 and ending January 31, 1998, (referred to herein as the "Eight Month Fiscal Period") resulting from such change. HISTORY AND RESTRUCTURINGS On April 24, 1995, a group including Robert Margolis, who founded the Company's Apparel Division in 1981, and who had been the Company's Chairman and Chief Executive Officer from May 1989 to October 1993, purchased 1,358,000 shares, or approximately 22.3% of the Company's then outstanding Common Stock ("Common Stock"). On May 5, 1995, Mr. Margolis was appointed Chairman and Chief Executive Officer of the Company. After a period of assessment, Mr. Margolis set in motion a strategy which resulted in the 3 Company's principal business being a marketer and licensor of the Cherokee brand and other brands it owns or may acquire in the future. The Company stopped manufacturing and importing apparel and footwear, sold its inventories of apparel and footwear, and on July 28, 1995 sold the assets of its Uniform Division. The proceeds from these sales were used to pay off all of the Company's indebtedness. As a result of discontinuing the apparel and footwear business and selling the Uniform Division, the number of employees was reduced from approximately 345 on May 28, 1994 to 15 by November 1, 1995. Prior to this major strategic change, the Company was a designer, manufacturer, and marketer of casual apparel and footwear primarily under the Cherokee name. The Company operated four divisions during the fiscal year ended June 3, 1995 ("Fiscal 1995"): the Apparel Division, the Footwear Division, the Uniform Division, and the Licensing Division. The Apparel Division designed, manufactured, imported and marketed moderately priced, natural fiber women's and young girls' clothing. The Footwear Division designed, arranged for the manufacture, imported and marketed Cherokee brand and a broad line of private label footwear for women, men and children. The Uniform Division designed, manufactured and marketed Cherokee brand uniforms primarily for the medical industry. The Licensing Division continues to license the use of the Company's proprietary brand names to domestic and international licensees for a variety of apparel, footwear, accessories, home products and other lifestyle related products. The 1993 Plan The Company, which was founded in 1973 and whose shares first became publicly traded in 1983, was acquired in a leveraged buy-out in 1989. In connection with the acquisition, the Company incurred substantial debt. As a result of a significant decrease in its earnings, the Company was unable to service its debt. On April 23, 1993, the Company and its then wholly-owned operating subsidiary, The Cherokee Group ("Group"), filed a petition with the United States Bankruptcy Court in the District of Delaware (the "Bankruptcy Court") for relief under Chapter 11 of the United States Bankruptcy Code ("Chapter 11"). Concurrent with such filing, the Company and Group filed a joint "prepackaged" Plan of Reorganization (the "1993 Plan") which was the result of negotiations among the Company and unofficial representatives of its subordinated debt-holders and stockholders. On May 28, 1993, the Bankruptcy Court confirmed the 1993 Plan, and on June 1, 1993, the 1993 Plan became effective. As a result of the 1993 Plan, Group was merged into the Company. Furthermore, subsequent to the effective date of the 1993 Plan, the Apparel Division (including the Uniform Division), the Footwear Division, the Licensing Division, and prior to its sale in May 1994, the Priority Finishing Division, were operated by the Company. The 1994 Plan It became apparent by October 1994 that the Company's business was not generating sufficient cash flow to service its existing debt. On November 7, 1994, the Company filed a petition with the Bankruptcy Court for relief under Chapter 11. Concurrent with such filing, the Company filed a "prepackaged" Plan of Reorganization (the "1994 Plan") which was the result of negotiations among the Company and unofficial representatives of its debt-holders and stockholders. On December 14, 1994, the Bankruptcy Court confirmed the 1994 Plan, and on December 23, 1994, the 1994 Plan became effective (the "Effective Date"). For financial statement purposes the effective date of the 1994 Plan was assumed to be February 25, 1995. The consummation of the 1994 Plan resulted in the following: (1) a new credit agreement with the Company's sole secured creditor, the CIT Group/Business Credit, Inc. ("CIT"), the proceeds of which were used to satisfy the claims of the secured creditor under the prior credit facility; (2) the cancellation of all outstanding shares of the Company's common stock, par value $.01 (the "Old Common Stock") and the Series A, B, and C warrants to purchase Old Common Stock; (3) the issuance of 4,900,000 shares of Common Stock to the holders of 11% Senior Subordinated Notes due 2004 (the "Old Notes") in exchange for the principal amount of $76,565,000 (with accrued and unpaid interest of approximately $4,211,000 as of November 1, 1994) of Old Notes; (4) the issuance of 100,000 shares of Common Stock to the holders of Old Common Stock; and (5) the 4 agreement to issue to the Company's general unsecured creditors 60.5504 shares of Common Stock for each $1,000 of such creditors' claims which were allowed by the Bankruptcy Court. RECENT DEVELOPMENTS Recapitalization; Sale of Cherokee Trademarks to Spell C; Issuance of Secured Notes In September 1997, the Company's Board authorized Libra Investments, Inc. ("Libra"), to explore ways to maximize shareholder value, including a recapitalization and sale of the Company. On December 23, 1997, the Company completed the recapitalization described below and publicly announced that it would declare a special dividend of $5.50 per share, which was subsequently paid on January 15, 1998. To facilitate the recapitalization, the Company formed Spell C. LLC, a special purpose, bankruptcy remote, single member Delaware limited liability company, wholly owned by the Company. Pursuant to a Trademark Purchase and License Assignment Agreement, dated December 23, 1997, between the Company and Spell C (the "Assignment Agreement") the Company assigned to Spell C all of its right, title and interest in the Amended Target Agreement and sold to Spell C all if its right, title and interest in the Cherokee brand name and related trademarks in the United States. The sale of the rights to the Cherokee trademarks in the United States was subject to certain exceptions which (i) allow the Company to continue to use the trademarks in the United States in conjunction with the Company's then-existing license agreements, and (ii) allow the Company to use the trademarks in the United States in conjunction with retail license agreements in the category of cosmetics, bath and body products. The Company may extend existing Cherokee brand license agreements only if the Company assigns 50% of the royalties payable during the extended term to Spell C. Pursuant to the Assignment Agreement, except for these exceptions, the Company no longer has the right to license the Cherokee brand and related trademarks in the United States, but retains all rights to do so outside of the United States. Concurrently with the Assignment Agreement, the Company and Spell C entered into an administrative services agreement under which the Company will perform certain administrative duties on behalf of Spell C in connection with, among other things, the Cherokee trademarks and the Assignment Agreement for a nominal administrative fee. On December 23, 1997 Spell C also issued for gross proceeds of $47.9 million, privately placed Zero Coupon Secured Notes, yielding 7.0% interest per annum and maturing on February 20, 2004. The Secured Notes amortize quarterly from May 20, 1998 through February 20, 2004, in the amount of $9.0 million per year the first two years and $10.5 million per year the third through sixth years. The Secured Notes are secured by the Amended Target Agreement and the United States Cherokee trademarks and brand names. The Secured Notes indenture (the "Indenture") requires that any proceeds due to Spell C under the Amended Target Agreement and certain other license agreements must be deposited directly into a collection account controlled by the trustee under the Indenture. The trustee will distribute from the collection account the amount of principal due and payable on the Secured Notes to the holders thereof on quarterly note payment dates. Excess amounts on deposit in the collection account may only be distributed to Spell C if the amount on deposit in the collection account exceeds the amount of principal due and payable on the next quarterly note payment date. Such excess amounts, if any, may then be distributed by Spell C to the Company. The minimum guaranteed royalty under the Amended Target Agreement is $9.0 million for each of the two fiscal years ending January 31, 1999 and 2000 and $10.5 million for each of the four fiscal years ending January 31, 2001 through 2004. The aggregate scheduled amortization under the Secured Notes ($60.0 million) equals the aggregate minimum guaranteed royalty payable under the Amended Target Agreement ($60.0 million). While the Company believes that royalties payable under the Amended Target Agreement may exceed the Minimum Guaranteed Royalty, the Company cannot predict with accuracy whether such royalties will exceed the Minimum Guaranteed Royalty, and if they do not, the Company will not receive distributions from Spell C during the term of the Amended Target Agreement. See "--Certain Business Considerations and Risk Factors-- Restrictions on Distributions by Spell C." Pursuant to the Assignment Agreement, the gross proceeds of the Secured Notes, which totaled approximately $47.9 million were paid to the Company. On December 23, 1997 the Company's Board declared 5 a special dividend of $5.50 per share which was paid on January 15, 1997. The aggregate amount of the dividend paid was approximately $47.4 million. Sideout Agreement On November 7, 1997, the Company entered into an Agreement of Purchase and Sale of Trademarks and Licenses (the "Sideout Agreement") with Sideout Sport Inc., pursuant to which the Company agreed to purchase all of Sideout Sport Inc.'s trademarks, copyrights, trade secrets and license agreements with respect thereto (the "Assets"). The trademarks acquired from Sideout Sport Inc. include, among others, Sideout, Sideout Sport and King of the Beach. Pursuant to the Sideout Agreement, Cherokee paid $1.5 million at the closing of the acquisition and agreed to pay an additional $500,000 upon release of certain liens on the Assets. Most of the liens have since been released and $450,000 of the $500,000 holdback has been paid. Under the terms of the Sideout Agreement, the Company will also pay Sideout Sport Inc., on a quarterly basis, 40% of the first $10.0 million, 10% of the next $5.0 million and 5% of the next $20.0 million, of royalties and license fees received by the Company through licensing of the Sideout trademarks. Upon the earlier of such time as Cherokee has paid Sideout a total of $7.5 million or October 22, 2004, Cherokee will have no further obligation to pay royalties to Sideout. The Sideout brand currently generates licensing revenues from existing contracts of approximately $500,000 per year. The Company intends to further develop the Sideout brand through retail direct, wholesale and international licensing; however, there can be no assurance that the Company's efforts will result in significant increases in royalty payments. See "--Certain Business Considerations and Risk Factors--Uncertainty Regarding Development of Sideout Brand." The Company is currently in discussions with prospective licensees concerning significant new licensing agreements for the Sideout brand. There can be no assurance, however, that these discussions will result in definitive agreements. LICENSING BUSINESS The Company is one of the leading licensors of brand names and trademarks for apparel, footwear and accessories in the United States. The Cherokee name, which began as a footwear brand in 1973, has been positioned to connote quality, comfort, fit, and a "Casual American" lifestyle with traditional, wholesome values. The Company's primary emphasis for the past three years has been directed toward retail direct, wholesale and international licensing. As of January 31, 1998, the Company had twenty-five continuing license agreements, including both domestic and international markets, seventeen of which pertained to the Cherokee name. The Sideout brand and related trademarks, which represent a beach-oriented, active, "California" lifestyle, were acquired by the Company in November 1997. The Company's license agreements are with wholesalers and retailers and are either international masters or category-specific exclusives or non- exclusives. Of the twenty-five licensing agreements, five are with retailers, seven are with domestic wholesale licensees and thirteen are with international wholesale and/or retail licensees. Wholesale licensees manufacture and import various categories of apparel, footwear and accessories under the Company's trademarks which include Cherokee, Sideout, Sideout Sport, King of the Beach and others, and sell the licensed products to retailers. In retail direct licensing, the Company grants retailers the license to use the trademarks on certain categories of merchandise, including those products that the Company previously manufactured, generally on a non-exclusive basis, and the retailer is responsible for designing and manufacturing the merchandise (the "Retail Direct" licensing strategy). The Company's license agreements, wholesale, retail and international, provide the Company with final approval of pre-agreed upon quality standards, packaging and marketing of licensed products. The Company has the right to conduct periodic quality control inspections to ensure that the image and quality of licensed products remain consistent. The Company will continue to solicit new licensees through a small number of executive employees and may retain the services of outside consultants to assist the Company in this regard. The Company's current business strategy is to maximize the value of its existing and future brands by exploiting them in a manner that recognizes the relative market power, in different areas of the world, of the various participants--manufacturer, wholesaler and retailer--in the chain of supply to the ultimate consumer. In 6 the United States and Canada, that market power, and accompanying economies of scale, is generally and increasingly held by a few dominant retailers of moderately priced merchandise, and, accordingly, in North America the Company has pursued its Retail Direct licensing strategy. In contrast to the retailing market in North America, in certain international markets the Company has sought to develop its brands through wholesale licenses with manufacturers or other companies who have market power and economies of scale in their respective markets. Finally, in certain countries, the Company believes that an owner or licensee of one or more well-known U.S. brands has the opportunity to become a dominant, vertically integrated manufacturer and/or retailer of branded apparel, footwear and accessories. Accordingly, in those areas the Company has begun to pursue licensing or strategic alignments whereby its brands can become the basis for such a vertically integrated manufacturer/retailer. This strategy permits the Company to operate with minimal working capital, virtually no capital expenditures (other than those associated with acquiring new brands and related trademarks), no production costs, significantly reduced design, marketing, distribution and other operating expenses, and a small group of core employees. NORTH AMERICAN RETAIL DIRECT LICENSING The Company's Retail Direct licensing strategy is premised on the proposition that in the United States and Canada nearly all aspects of the moderately priced apparel, footwear and accessories business, from product development and design, to merchandising, to sourcing and distribution, can be executed most effectively by large retailers, who not only command significant economies of scale, but also interact daily with the end consumer. In addition, the Company believes that these retailers in general may be able to obtain higher gross margins on sales through stocking and selling "quasi- private label" licensed products bearing widely recognized brand names (such as the Company's brands) than through carrying strictly private label goods on the one hand or branded product from third-party vendors on the other. The Company also expects that the enhanced profitability to retailers of private label products and in-store brands, coupled with the substantial and increasing marketing costs to establish and maintain a widely recognized apparel brand, will result in further erosion of revenues and profitability for mid-sized and small apparel manufacturers and corresponding increased desirability to retailers of well-established brands with broad appeal. The Company's strategy in the United States and Canada is to capitalize on these trends by licensing its portfolio of brand names primarily directly to strong and growing retailers for their in-store branded merchandise, and to augment that portfolio by acquiring additional brands which have high consumer awareness, broad appeal and applicability to a range of merchandise categories. On August 15, 1995, the Company entered into a major strategic alliance with Target Stores, a division of Dayton Hudson Corporation. Target was granted the exclusive right in the United States to use the Cherokee trademarks in connection with the sale of the following female products in Target Stores: 5- pocket denim jeans and shorts, all female footwear, all 0-14 girlswear, and all women's and girls fashion accessories. On November 1, 1995, the Company entered into a second agreement with Target, whereby Target was granted a non- exclusive right to use the Cherokee trademarks in connection with the sale of merchandise in the following categories in Target Stores: women's casual denim & sportswear, activewear, golfwear, tenniswear, bodywear, careerwear, daywear, sleepwear, robes, loungewear, boys' activewear sizes 0-7, junior casual & denim sportswear, activewear, swimwear, dresses, and home textiles. The August 15, 1995 and November 1, 1995 agreements with Target expired as of February 1, 1998. On November 12, 1997, the Company entered into the Amended Target Agreement with Target. This agreement was subsequently assigned to Spell C and pledged as collateral for the Secured Notes. The Amended Target Agreement grants Target the exclusive right in the United States to use the Cherokee trademarks in certain specified categories of merchandise, including (i) men's, women's and children's apparel, including intimate apparel, foundations and sleepwear, (ii) men's, women's and children's fashion accessories, (iii) bed and bath products and accessories, (iv) luggage, sports bags and backpacks, (v) home textiles, (vi) domestics and home decor, (vii) home furnishings, (viii) sporting goods, and (ix) cosmetics, bath and body products (collectively, the "Merchandise"). Certain of the above-listed categories are subject to unexpired license agreements 7 between the Company and third parties. The Amended Target Agreement provides that upon the expiration or termination of such agreements, the categories of Merchandise subject to such agreements will become exclusive to Target in the United States. Also, the Company and Spell C cannot license the Cherokee trademark, and/or renew or otherwise extend existing license agreements relating to the Cherokee trademark with third parties, in the United States, in any merchandise category whatsoever except for certain limited exceptions covering (a) existing license agreements with Brylane L.P. ("Brylane"), The Caldor Corporation ("Caldor") or Pamida, Inc. ("Pamida"), (b) retail license agreements with certain drug store chains and (c) certain then-existing wholesale license agreements. Due to the broad nature of the rights granted to Target in the United States, and the restrictions contained in the Amended Target Agreement, neither the Company nor Spell C anticipate entering into additional licensing agreements in the United States with respect to the Cherokee brand during the term of the Amended Target Agreement (except for those specifically allowed above) and are in fact prohibited from doing so in most instances. Under the terms of the Amended Target Agreement, Target will pay a royalty each fiscal year for the fiscal years ending January 31, 1999 through 2004 equal to the greater of (i) the Minimum Guaranteed Royalty (as defined below) for such year or (ii) a percentage of Target's net sales of Merchandise during such fiscal year which percentage varies according to the volume of sales of Merchandise during such fiscal year. The "Minimum Guaranteed Royalty" is $9.0 million for each of the two fiscal years ending January 31, 1999 and 2000 and $10.5 million for each of the four fiscal years ending January 31, 2001 through 2004. The initial term of the Amended Target Agreement commenced on February 1, 1998 and ends January 31, 2004. If Target is current in its payments of the Minimum Guaranteed Royalty, the Amended Target Agreement will automatically renew for the fiscal year ending in 2005, and will continue to automatically renew for successive fiscal year terms provided that Target has paid a Minimum Guaranteed Royalty equal to or greater than $9.0 million for the preceding fiscal year. Target commenced the initial sales of Cherokee brand merchandise in July 1996 and paid the Company $5,935,000 during the fiscal year ended May 31, 1997, and $6,428,000 during the Eight Month Fiscal Period, which accounted for 68% and 75%, respectively, of the Company's revenues during such periods. See "--Certain Business Considerations and Risk Factors--Dependence on a Single Licensee." On August 22, 1997, the Company entered into an international retail direct licensing agreement (the "Hudson's Bay Agreement") with Hudson's Bay Company and Zellers Inc., a Canadian corporation ("Hudson's Bay"). Hudson's Bay was granted the exclusive right in Canada to use the Cherokee brand and related trademarks in connection with a broad range of categories of merchandise, including women's, men's and children's apparel and footwear, women's intimate apparel, fashion accessories, home textiles, cosmetics and recreational products. The term of the contract is for five years, with automatic renewal options, provided that certain minimums are met each contract year. Under the Hudson Agreement, Hudson's Bay will pay the Company a minimum guaranteed royalty of $10.0 million over the five-year initial term of the agreement. Other than the Amended Target Agreement, the Company currently has five retail direct non-exclusive Cherokee brand licensing agreements covering the United States and Canada ("North America"). North American retail licensees include, among others, Caldor, Brylane, Pamida and Hudson's Bay. Generally, royalties on non-exclusive domestic retail licenses begin at 3% of the retailer's net sales of licensed product and may decrease depending on the retailer's annual sales of licensed products and/or the retailer's guaranteed annual sales of licensed product. All of the current United States Cherokee brand retail license agreements will expire during the term of the Amended Target Agreement and due to the exclusivity provisions contained in the Amended Target Agreement, there is no assurance the Company will renew or extend such Agreements after 2002 and in many circumstances will not be permitted to do so under terms of the Amended Target Agreement. Further, under the Assignment Agreement, if the Company extends any existing United States license agreement after January 31, 2002, the Company must assign 50% of the royalties payable during the extended term to Spell C. The above restrictions under the Amended Target Agreement and Assignment Agreement do no apply to Canada; however, under the Hudson's Bay Agreement, Hudson's Bay has the exclusive right to use the Cherokee brand on a broad range of products in Canada. 8 The Company currently has no retail direct non-exclusive Sideout brand licensing agreements covering the United States. All categories of merchandise are still available for domestic non-exclusive retail license agreements and the Company intends to actively pursue its Retail Direct licensing strategy to further develop the Sideout brand in the United States. During the Eight Month Fiscal Period, the Company received $7,492,000 in aggregate royalties from its United States retail license agreements, which accounted for 87.6% of the Company's revenues during such periods. NORTH AMERICAN WHOLESALE LICENSING The Company currently has four Cherokee brand wholesale license agreements that grant unaffiliated manufacturers the license to manufacture and market women's intimate apparel, socks, sunglasses, watches, and men's activewear under the Cherokee trademarks in the United States. The Company's wholesale license agreements typically require the wholesale licensee to pay royalties on revenues against a guaranteed minimum royalty that generally increases over the term of the agreement. All of the current United States wholesale license agreements will expire during the term of the Amended Target Agreement, and due to the exclusivity provisions contained in the Amended Target Agreement, there is no assurance the Company will renew or extend such agreements and in many circumstances will not be permitted to do so under terms of the Amended Target Agreement Pursuant to the Sideout Agreement, the Company acquired several existing wholesale licensing contracts. The Company terminated or amended certain of these agreements and, as a result, the net number of wholesale licensing agreements acquired by the Company was three. The Company's wholesale license agreements for the Sideout brand are for product categories including menswear, childrens wear, toddlers and boys 4-7, footwear, volleyballs, bags and accessories. The agreements have various expiration dates and contain three to five-year renewal options. One of the wholesale licensees is currently manufacturing Sideout brand men's and boys activewear and sportswear for several department stores. The footwear licensee sells men's, women's and children's footwear to many of the better department and specialty stores, including Nordstrom, Sportmart, Champs, Lady Footlocker, Bob's Stores and Miller's Outpost. The footwear license has experienced substantial growth during the last two years. Minimum royalty guarantees total $877,500 for the remaining term of these agreements. Renewal options held both by the licensee and the Company provide for minimum guaranteed royalties of $3,126,000 to the Company if such contracts are renewed. During the Eight Month Fiscal Period, the Company received $513,000 in aggregate royalties from its wholesale licensing agreements, which accounted for 6% of the Company's revenues during such period. INTERNATIONAL LICENSING The Amended Target Agreement only grants Target exclusive rights to the Cherokee trademarks in the United States with respect to certain product categories. Additionally, the Company sold Spell C the United States but not the international rights to the Cherokee trademarks. Therefore, the Company will continue to seek to develop in certain international markets both its Cherokee and Sideout brands through wholesale licenses with manufacturers or other companies who have market power and economies of scale in their respective markets. In certain countries, the Company believes that an owner or licensee of one or more well-known United States brands has the opportunity to become a dominant, vertically integrated manufacturer and/or retailer of branded apparel, footwear and accessories. Accordingly, in those areas the Company has begun to pursue licensing or strategic alignments whereby its brands can become the basis for such a vertically integrated manufacturer/retailer. 9 Suzuya Co. Ltd. ("Suzuya"), the Company's Far East licensee for the past ten years, operated twenty-one Cherokee retail stores in Japan, and had eight sub- licensees that manufactured and sold Cherokee brand apparel and accessories to the Cherokee stores and to other unaffiliated retailers. In April 1997, the Suzuya licensing agreement was terminated and a new master licensing agreement was signed with Vantex, Inc ("Vantex"). Under the new agreement Vantex will pay the Company a minimum guaranteed royalty of $5.0 million over the five- year term of the agreement. During the Eight Month Fiscal Period, Vantex entered into three sub-licensing agreements for the further development of the Cherokee brand in Japan. The Company currently has thirteen international wholesale and/or retail license agreements, which include a master licensing agreement for South Korea with Kum Kyung Co., Ltd., a South Korean based company, a wholesale licensing agreement with Joosung Enterprises Co., Ltd., a South Korean based company which manufactures handbags and handbag related items, and a master license agreement with Mondragon, a Philippines based company. Due to the poor economy in Korea, the Company expects to terminate the licensing agreements with Kum Kyung Co. Ltd. and Joosung Enterprises Co., Ltd. Pursuant to the Sideout Agreement, the Company acquired five international licensing agreements with respect to the Sideout brand and related trademarks. The Company's international licensing agreements for the Sideout brand are all exclusive and cover countries including Argentina, Uruguay, Japan, Italy, Mexico, Australia and New Zealand for product categories for the Sideout and King of the Beach brands for volleyballs, men's, boy's and women's apparel and footwear. Sideout Mexico, the Company's Mexican licensee, currently distributes to department and specialty stores and has six Sideout flagship stores throughout Mexico. Minimum guaranteed royalties for the remaining initial term of the current licensing agreements total $1,974,000. During the Eight Month Fiscal Period, the Company received $548,000 in aggregate royalties from the Sideout international license agreements, which accounted for 6.4% of the Company's revenues during such period. TRADEMARKS The Company holds various trademarks including Cherokee, Sideout, Sideout Sport, King of the Beach and others, in connection with certain apparel and other goods. These trademarks are registered with the United States Patent and Trademark Office and in certain other countries. The Company also holds trademark applications for Cherokee, Sideout, Sideout Sport and King of the Beach in numerous countries. The Company intends to renew these registrations as appropriate prior to expiration. The Company monitors on an ongoing basis unauthorized uses of its trademarks and the Company relies primarily upon a combination of trademark, copyright, know-how, trade secrets, and contractual restrictions to protect its intellectual property rights both domestically and internationally. See "--Certain Business Considerations and Risk Factors-- Dependence on and Protection of Intellectual Property Rights." MARKETING The Cherokee name has been positioned by the Company to connote quality, comfort, fit and a "Casual American" lifestyle with traditional, wholesome values. The Sideout brand and related trademarks represent a beach-oriented, active, "California" lifestyle. Advertising, product, labeling and presentation are integrated to reinforce these brand images. The Company intends to continue to promote a positive image in marketing the Cherokee and Sideout brands through licensee sponsored advertising. The Company's wholesale, retail and international license agreements provide the Company with final approval of pre-agreed upon quality standards, packaging and marketing of licensed product. The Company has the right to conduct periodic quality control inspections to ensure that the image and quality of licensed products remain consistent. Historically, the Company spent between 3% and 4% of its revenues on advertising. Since the time the Company switched its principal business to that of a marketer and licensor of its brands, it has principally relied on its licensees to advertise the Cherokee brand, and as a result the Company's advertising costs have been minimal. 10 The Company intends to attempt to implement its Retail Direct licensing strategy in the United States with respect to the Sideout brand; however, there can be no assurance that the Company's efforts will result in significant increases in royalty payments. Internationally, the Company intends to continue to seek to develop both of its brands through license agreements and strategic alliances with manufacturers or other companies who have market power and economies of scale in their respective markets. The Company will continue to market its brands and solicit new licensees through a small number of executive employees and may retain the services of outside consultants to assist the Company in this regard. The Company recently hired additional marketing staff to intensify the Company's international efforts to negotiate new license agreements and provide support and advice regarding advertising and merchandising concepts to existing licensees. COMPETITION Although the Company no longer manufactures or sells products, royalties paid to the Company under its licensing agreements are generally based on a percentage of the licensee's net sales of licensed products. Cherokee and Sideout brand footwear, apparel, and accessories, which are manufactured and sold by both domestic and international wholesalers and retail licensees, are subject to extensive competition by numerous domestic and foreign companies. Such competitors with respect to the Cherokee brand include Levi Strauss & Co., Liz Claiborne and VF Corp. and private labels developed for retailers and competitors with respect to the Sideout brand include Quicksilver, Mossimo, Nike and other activewear companies. Factors which shape the competitive environment include quality of garment construction and design, brand name, style and color selection, price and the manufacturer's ability to respond quickly to the retailer on a national basis. In recognition of the increasing trend towards consolidation of retailers and greater emphasis by retailers on the manufacture of private label merchandise, in the United States the Company's business plan focuses on creating strategic alliances with major retailers for their sale of products bearing the Company's brands through the licensing of the Company's trademarks directly to retailers. Therefore, the success of the Company is dependent on its licensees' ability to design, manufacture and sell products bearing the Company's brands and to respond to ever changing consumer demands. Other companies owning established trademarks could also enter into similar arrangements with retailers. See "--Certain Business Considerations and Risk Factors--Competition." EMPLOYEES As of January 31, 1998, the Company employed 12 persons all of whom are involved in the Company's licensing business. None of the Company's employees are represented by labor unions and the Company believes that its employee relations are satisfactory. CERTAIN BUSINESS CONSIDERATIONS AND RISK FACTORS Restrictions on Distributions by Spell C: There is no assurance that Spell C will distribute any significant amount of cash or property to the Company until after the maturity of the Secured Notes, if then. The Secured Notes Indenture provides that any royalties payable under the Amended Target Agreement will be deposited directly into a collection account controlled by the trustee under the Indenture. The trustee will distribute from the collection account the amount of principal due and payable on the Secured Notes to the holders thereof on quarterly note payment dates. Excess amounts in the collection account may only be distributed to Spell C if the amount in the collection account exceeds the aggregate amount of principal due and payable on the next quarterly note payment date. Such excess amounts, if any, may then be distributed by Spell C to the Company. The aggregate scheduled amortization under the Secured Notes ($60.0 million) equals the aggregate minimum guaranteed royalty payable under the Amended Target Agreement ($60.0 million). See "--Recent Developments" and "--North American Retail Direct Licensing." There is no assurance, therefore, that there will be any excess amounts to be distributed to the Company. The Company does not expect revenues deposited in the collateral account from sources other than the Amended Target Agreement to be significant during Fiscal year 1999. The Company cannot predict with accuracy whether payments under the Amended Target Agreement will exceed the minimum guaranteed royalty, and if they do not, no distribution will be made 11 to Spell C from the collateral account, and in turn, Spell C will have no funds available to distribute to the Company. Further, the initial term of the Amended Target Agreement expires concurrently with the maturity of the Secured Notes. Therefore, even after the maturity of the Secured Notes, the likelihood of significant distributions from Spell C to the Company is contingent upon the extension of the Amended Target Agreement. See "--North American Retail Direct Licensing." Uncertainty Regarding Development of Sideout Brand: The Sideout brand and related trademarks were acquired by the Company in November 1997. See "-- Recent Developments--Sideout Agreement." The Company intends to develop the Sideout brand through both domestic and international retail direct and wholesale licensing. Although the Sideout brand is a well recognized, authentic beach volleyball brand, there can be no assurance that the Company's efforts to develop and market the Sideout brand will result in significant increases in royalty payments. Competition: Although the Company no longer manufactures or sells products, royalties paid to the Company under its licensing agreements are generally based on a percentage of the licensee's net sales of licensed products. Cherokee and Sideout brand footwear, apparel, and accessories, which are manufactured and sold by both domestic and international wholesalers and retail licensees, are subject to extensive competition by numerous domestic and foreign companies. Such competitors with respect to the Cherokee brand include Levi Strauss & Co., Liz Claiborne and VF Corp. and private labels developed for retailers and competitors with respect to the Sideout brand include Quicksilver, Mossimo, Nike and other activewear companies. Factors which shape the competitive environment include quality of garment construction and design, brand name, style and color selection, price and the manufacturer's ability to respond quickly to the retailer on a national basis. In recognition of the increasing trend towards consolidation of retailers and greater emphasis by retailers on the manufacture of private label merchandise, in the United States the Company's business plan focuses on creating strategic alliances with major retailers for their sale of products bearing the Company's brands through the licensing of the Company's trademarks directly to retailers. Therefore, the success of the Company is dependent on its licensees' ability to design, manufacture and sell products bearing the Company's brands and to respond to ever changing consumer demands; failure by the Company's licensees to do so could have a material adverse effect on the Company's business or financial condition. Other companies owning established trademarks could also enter into similar arrangements with retailers. See "-- Competition." Dependence on Single Licensee: During the Eight Month Fiscal Period 75% of the Company's and Spell C's consolidated licensing revenues were generated from a single source, Target Stores, a division of Dayton Hudson Corporation. See "--North American Retail Direct Licensing." Under the Assignment Agreement the Company assigned all its rights in the Amended Target Agreement to Spell C, which in turn pledged the Amended Target Agreement as collateral for the Secured Notes. Spell C will be dependent on revenues from the Amended Target Agreement for most, if not all, of its revenues. Although the Amended Target Agreement provides for minimum annual royalty payments, if for any reason, Target does not pay the minimum royalties, Spell C will likely be unable to meet, and will default on, its payment obligations under the Indenture for the Secured Notes. The Company currently has no reason to anticipate or expect a default by Target as it has timely paid all of the royalty commitments due under the prior Target Agreements. The Cherokee marks are diversified over a broad range of categories of merchandise presently manufactured and marketed by Target. Therefore, while it is possible that Target could altogether cease manufacturing and marketing Cherokee brand products, the Company believes that is unlikely to happen. The Company is not a guarantor of the Secured Notes; however, the United States Cherokee trademarks have been pledged as security for the Secured Notes and the permanent loss of such trademarks as a result of a default would have a material adverse effect on the Company's business or financial condition. The Secured Notes mature and the initial term of the Amended Target Agreement expires at approximately the same time. At such time payments from the Amended Target Agreement, if extended or renewed, may be distributed by Spell C to the Company. If Target elects not to extend or renew the Amended Target License Agreement upon the expiration of its initial term, the Company's business and operations could be adversely affected. There can be no guarantee that the Company could be able to replace the Target royalty payments from other sources. 12 Dependence on and Protection of Intellectual Property Rights: The Company and Spell C hold various trademarks including Cherokee, Sideout, Sideout Sport, King of the Beach and others in connection with apparel, footwear and accessories. These trademarks are vital to the success and future growth of the Company's business. These trademarks are registered with the United States Patent and Trademark Office and in certain other countries. The Company and Spell C also hold several trademark applications for Cherokee, Sideout, Sideout Sport and King of the Beach in numerous countries. The Company monitors on an ongoing basis unauthorized uses of its trademarks, and the Company relies primarily upon a combination of trademark, copyright, know-how, trade secrets, and contractual restrictions to protect its intellectual property rights. The Company believes that such measures afford only limited protection and, accordingly, there can be no assurance that the actions taken by the Company to establish and protect its trademarks and other proprietary rights will prevent imitation of its products or infringement of its intellectual property rights by others, or prevent the loss of licensing revenue or other damages caused thereby. In addition, the laws of certain countries in which the Company has licensed its intellectual property may not protect the Company's intellectual property rights to the same extent as the laws of the United States. Despite the Company's efforts to protect its intellectual property rights, unauthorized parties may attempt to copy aspects of the Company's intellectual property which could have a material adverse effect on the Company's business or financial condition. The Company is currently involved in one infringement action with respect to the use by a third party of the name Cherokee on two-way radios, which it believes will not have a material adverse effect on the Company's business or financial condition. However, in the future the Company may be required to assert infringement claims against third parties, and there can be no assurance that one or more parties will not assert infringement claims against the Company. While the Company currently has the resources to pursue or defend most infringement claims, any resulting litigation could result in significant expense to the Company and divert the efforts of the Company's management personnel whether or not such litigation is determined in favor of the Company. Dependence on Key Management: The overall business and marketing strategy and current direction of the Company was principally conceived and implemented by Robert Margolis, its current Chairman and Chief Executive Officer, Patricia Warren, its former President and Carol Gratzke, its current Chief Financial Officer. On March 3, 1998, the Company announced the resignation of Patricia Warren as President of the Company. Ms. Warren will continue to work with the Company through 1998 in selected special projects. Mr. Margolis will assume Ms. Warren's responsibilities until a new president is appointed. Because Ms. Warren will still be available through 1998 for selected special projects and because the Company believes that it has sufficiently implemented the business plan set in motion by its management team over the last three years, the Company believes that it can successfully continue to implement its business plans notwithstanding the departure of Ms. Warren. Prior to the hiring and training of a new president, the loss of the services of either Robert Margolis or Carol Gratzke could have a material adverse effect upon the Company's business or financial condition. ITEM 2. PROPERTIES The Company owned a building of approximately 100,000 square feet on ten acres of land in Sunland, California, which housed its principal offices and fabric cutting facility. The property was sold for $3,900,000 in April 1997. By October 15, 1995, the Company moved all its employees out of this facility and into a 3,000 square foot office facility in Van Nuys, California. This facility is leased by The Wilstar Group ("Wilstar"), a business name used by The Newstar Group, to which Mr. Margolis serves as Chief Executive Officer. The Company uses approximately one-half of such space and pays Wilstar for such usage at the rate of $.75 per square foot or $1,125 per month. In addition, the Company reimbursed Wilstar for one-half of certain costs relating to this office space. Beginning November 1, 1997, the Company increased its rental space to 3,685 square feet and currently pays Wilstar $2,762 in rent per month (which includes costs relating to the office space). The Company believes that its rental of such space from Wilstar is on terms of no less favorable than could be obtained from an unaffiliated third party. The Company believes this facility is currently adequate for its expected requirements for the next few years and when the lease held by Wilstar has expired, the Company currently anticipates negotiating a new lease with the facility's owner. The Company leases a 1,158 square foot showroom facility in Dallas, Texas, which it no longer occupies. The Company has subleased this facility. The lease expired 13 on February 28, 1998. The Company also rents 4,000 square feet of Wilstar's warehouse as a storage facility and pays rent at a rate of $.50 per square foot. ITEM 3. LEGAL PROCEEDINGS In connection with the 1994 Plan, the Company has settled all claims submitted by trade creditors and other claimants. A Final Decree was entered by the Company and approved by the Bankruptcy Judge on August 15, 1996. In the ordinary course of business, the Company becomes involved in certain legal claims and litigation. In the opinion of Management, based upon consultations with legal counsel, the disposition of litigation currently pending against the Company will not have, individually or in the aggregate, a materially adverse effect on its consolidated financial position or results of operations. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The Company did not submit any matters to a vote of holders of Common Stock during the final quarter of the Eight Month Fiscal Period. 14 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Common Stock trades on the NASDAQ Small Cap Issues Market under the symbol CHKE. The table below sets forth for each of the fiscal quarters during the Company's last two fiscal years the range of the high and low bid information for the Common Stock.
HIGH LOW ------ ------ FISCAL 1997 Quarter ended August 31, 1996.............................. 6 1/2 4 1/2 Quarter ended November 30, 1996............................ 6 7/8 5 1/4 Quarter ended March 1, 1997................................ 7 3/4 5 1/4 Quarter ended May 31, 1997................................. 7 1/8 5 3/4 FISCAL 1998 Quarter ended August 30, 1997.............................. 12 6 3/4 Quarter ended November 29, 1997............................ 15 1/8 10 3/4 Two months ended January 31, 1998.......................... 17 1/4 7 1/4*
On April 15, 1998, the latest bid price for the Common Stock reported on the NASDAQ Small Cap Issues Market was $9.50 per share. As of April 15, 1998, the number of stockholders of record of the Common Stock was 151. This figure does not include beneficial holders whose shares may be held of record by brokerage firms and clearing agencies. On January 28, 1997, the Company's Board established a quarterly dividend policy of $0.15 per share. The first dividend payment was made on March 17, 1997 to all shareholders of record as of February 25, 1997. Subsequent dividend payments of $0.20 per share were made on May 30, 1997 and August 29, 1997 to shareholders of record as of May 14, 1997 and August 15, 1997, respectively. On December 23, 1997, the Company's Board declared a special dividend of $5.50 per share, which was paid on January 15, 1998 to all shareholders of record as of January 2, 1998. On April 6, 1998, the Company's Board declared a cash dividend of $0.50 per share payable on May 1, 1998 to shareholders of record as of April 17, 1998. On April 6, 1998 the Company's Board established a quarterly dividend policy of $0.25 per share through its fiscal year ended January 30, 1999; however, the payment of such dividends will be at the discretion of the Company's Board and will be dependent upon the Company's financial condition, results of operations, capital requirements and other factors deemed relevant by the Company's Board. On May 30, 1996, the Company made a distribution of capital to all shareholders of record as of May 15, 1996. The distribution was $0.60 per share on Common Stock and was made in accordance with Section 316 of the Internal Revenue Code of 1986. - -------- *The current stock price reflects a $5.50 price adjustment due to the payment of the $5.50 special dividend on January 15, 1998. 15 ITEM 6. SELECTED FINANCIAL DATA The following selected consolidated financial information, except as noted herein, has been taken or derived from the audited consolidated financial statements of the Company and its predecessor and should be read in conjunction with the consolidated financial statements included elsewhere herein. See "--Item 8. Consolidated Financial Statements and Supplementary Data." Given the recent developments involving the Company, such as the assignment of the Amended Target Agreement to Spell C, the sale of the rights to the Cherokee trademarks in the United States to Spell C and the issuance of the Secured Notes, the future results of the Company are expected to differ significantly from the Company's historical results, and therefore undue reliance should not be placed on the following selected consolidated financial information as indicative of such future results.
SUCCESSOR COMPANY PREDECESSOR COMPANY ----------------------------------------- --------------------- EIGHT MONTHS YEAR YEAR 3 MONTHS 9 MONTHS YEAR ENDED ENDED ENDED ENDED ENDED ENDED JANUARY 31, MAY 31, JUNE 1, JUNE 3, FEB. 25, MAY 28, 1998 1997 1996 1995 1995 1994 ------------ ------- ------- -------- ----------- -------- STATEMENT OF OPERATIONS DATA: ($ IN THOUSANDS EXCEPT PER SHARE DATA) Royalty revenues/Net sales.................. $ 8,553 $ 8,718 $13,899 $20,264 $65,623 $114,087 Cost of goods sold...... -- 184 10,445 16,310 54,994 83,225 -------- ------- ------- ------- ------- -------- Gross profit............ 8,553 8,534 3,454 3,954 10,629 30,862 Selling, general and administrative expenses............... 4,192 3,406 4,460 5,153 19,097 30,974 Performance option expense................ -- -- 4,567(4) -- -- -- Amortization of trademarks and goodwill............... 43 -- -- -- 819 1,691 Operational restructuring.......... -- -- -- 3,165 -- 6,052 Write-off of reorganization value in excess of amounts allocable to identifiable assets.... -- -- -- -- -- 9,281 -------- ------- ------- ------- ------- -------- Operating income (loss). 4,318 5,128 (5,573) (4,364) (9,287) (17,136) Other (income) expense.. (422) (75) (96) (116) (167) 141 Interest expense........ 330 3 355 587 5,467 11,914(1) Investment and interest income................. (525) (460) (543) (24) (107) (55) Gain on sale of Uniform Div. and other assets . -- (220) (3,840) -- -- -- Reorganization items.... -- -- -- -- 54,093(2) -- -------- ------- ------- ------- ------- -------- Income (loss) before income taxes........... 4,935 5,880 (1,449) (4,811) (68,573) (29,136) Income tax benefit...... (782) (771) -- (400) (5,230) (4,306) -------- ------- ------- ------- ------- -------- Income (loss) before extraordinary item..... 5,717 6,651 (1,449) (4,411) (63,343) (24,830) Extraordinary item (net of income taxes)....... -- -- -- -- 88,291(2) -- -------- ------- ------- ------- ------- -------- Net income (loss)....... 5,717 6,651 (1,449) (4,411) 24,948 (24,830) Preferred dividend requirement............ -- -- -- -- -- -- Net income (loss) applicable to common stock.................. $ 5,717 $ 6,651 $(1,449) $(4,411) $24,948 $ 24,830) Basic earnings (loss) per share (3).......... $ 0.73 $ 0.87 $ (0.22) $ (0.72) -- (3) -- (3) Diluted earnings (loss) per share.............. $ 0.68 $ 0.82 $ (0.21) $ (0.72) -- -- Cash distribution of capital per share...... $ 5.50 -- $ 0.60 -- -- -- Cash dividends per share.................. $ 0.20 $ 0.35 -- -- -- -- JANUARY 31, MAY 31, JUNE 1, JUNE 3, FEB. 25,(2) MAY 28, 1998 1997 1996 1995 1995 1994 ------------ ------- ------- -------- ----------- -------- BALANCE SHEET DATA: Working capital......... $ 4,445 $ 9,148 $ 227 $ 2,836 $27,321 $ 26,517 Total assets............ 24,471 13,601 8,320 28,260 41,527 93,700 Long-term debt, net of current maturities..... 41,675 -- -- -- 18,995 83,204 Stockholders' equity (deficit).............. (25,646) 12,224 6,070 7,222 11,825 (11,630)
16 NOTES TO SELECTED FINANCIAL DATA (1) Interest expense includes non-cash charges of $9,420 for the year ended May 28, 1994 and $4,361 for the nine months ended February 25, 1995. (2) On December 14, 1994, the 1994 Plan was confirmed by the Bankruptcy Court and became effective on December 24, 1994. For financial statement purposes the effective date of the 1994 Plan was assumed to be February 25, 1995, the last day of the third quarter of the Company's fiscal 1994 year. The Company has implemented "fresh start" reporting; therefore all assets and liabilities have been restated to reflect the reorganization value of the Company and as such the June 3, 1995 balance sheet is that of a successor company. See Notes 1 and 2 to the accompanying Financial Statements. (3) Earnings per share for periods subsequent to the adoption of fresh-start reporting as of February 25, 1995 is based on the weighted average number of common shares, including those yet to be distributed by the Disbursing Agent during the relevant periods. (See Note 1 to the Financial Statements). Per share data is not presented for periods ending prior to June 3, 1995, due to the general lack of comparability as a result of the revised capital structure of the Company under the 1994 Plan. (4) Represents a non-cash charge of $4,567,000 resulting from the exercise of Wilstar performance options. Wilstar is a related party, and Robert Margolis is the majority shareholder and Chief Executive Officer of Wilstar. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION OVERVIEW Since May 1995, the Company has principally been in the business of marketing and licensing the Cherokee brand and related trademarks and other brands it owns. Prior to May 1995, the Company's principal business was manufacturing, importing and wholesaling casual apparel and footwear primarily under the Cherokee brand, and licensing the Cherokee trademark to unaffiliated manufacturers for the production and marketing of apparel, footwear, and accessories that the Company did not manufacture, import or market. In previous years, the Company's licensing division operated primarily a wholesale licensing program; it licensed the Cherokee trademarks to unaffiliated manufacturers for the production and marketing of apparel, footwear, and accessories that the Company did not manufacture, import or market. In May 1995, the Company stopped manufacturing and importing apparel and footwear, sold most of its inventories, and on July 28, 1995, sold the assets of its uniform division. The Company's current operating strategy emphasizes domestic and international wholesale and retail direct licensing, whereby the Company grants wholesalers and retailers the license to use its trademark on certain categories of merchandise. The Company's current licensing agreements are either non-exclusive, category-specific exclusive or international masters, and all provide the Company with final approval of pre-agreed upon quality standards, packaging, and marketing of licensed products. The Company has the right to conduct periodic quality control inspections to ensure that the image and quality of licensed products remain consistent. Under this operating strategy, the Company has been able to significantly reduce its overhead and ongoing operating costs as compared to before May 1995. In November 1997, the Company reaffirmed its strategic relationship with Target Stores, a division of Dayton Hudson Corporation, by entering into the Amended Target Agreement, which grants Target the exclusive right in the United States to use the Cherokee trademarks in certain categories of merchandise. See "--Item 1. Business. North American Retail Direct Licensing." Target will pay a royalty each fiscal year for the fiscal years ending January 31, 1999 through 2004, equal to the greater of (i) the Minimum Guaranteed Royalty for such year, or (ii) a percentage of Target's net sales of Merchandise during such fiscal year which percentage varies according to the volume of sales of Merchandise during such fiscal year. The Minimum Guaranteed Royalty is 17 $9.0 million for each of the two fiscal years ending January 31, 1999 and 2000, and $10.5 million for each of the four fiscal years ending January 31, 2001 through 2004. In September 1997, the Company's Board authorized Libra Investment, Inc. to explore ways to maximize shareholder value, including a recapitalization and sale of the Company. On December 23, 1997, the Company completed the recapitalization described below and publicly announced that it would declare a special dividend of $5.50 per share, which was subsequently paid on January 15, 1998. See "--Item 1. Business. Recent Developments." As part of the recapitalization, the Company sold to Spell C, its wholly- owned subsidiary, all of its rights to the Cherokee brand and related trademarks in the United States and assigned to Spell C all of its rights in the Amended Target Agreement in exchange for the proceeds from the sale of the Secured Notes. See "Item 1. Business. Recent Developments." Spell C issued for an aggregate of $47.9 million, privately placed Zero Coupon Secured Notes, yielding 7.0% interest per annum and maturing on February 20, 2004. The Secured Notes amortize quarterly from May 20, 1998 through February 20, 2004, in the amount of $9.0 million per year the first two years and $10.5 million per year the third through sixth years. The Secured Notes are secured by the Amended Target Agreement and the United States Cherokee brand name and trademarks. The Secured Notes Indenture provides that any royalties generated by the Amended Target Agreement must be deposited directly into a collection account controlled by the trustee under the Indenture for distribution to holders of the Secured Notes. Excess amounts in the collection account may be distributed to Spell C only if the excess amounts exceed the aggregate amount of principal due and payable on the next quarterly note payment date. Such excess amounts, if any, will then be distributed by Spell C to the Company. Since the aggregate payments due under the Amended Target Agreement ($60.0 million) match the aggregate Minimum Guaranteed Royalty under the Amended Target Agreement ($60.0 million), there is no assurance that there will be any excess amounts to be distributed. While the Company believes that royalties payable under the Amended Target Agreement may exceed the Minimum Guaranteed Royalty, the Company cannot predict with accuracy whether royalties will exceed the Minimum Guaranteed Royalty. Target commenced the initial sales of Cherokee brand merchandise in July 1996, and paid the Company $5,935,000 million during the fiscal year ended May 31, 1997, and $6,428,000 million during the Eight Month Fiscal Period, which accounted for 68% and 75%, respectively, of the Company's revenues during such periods. Royalties payable under the Amended Target Agreement appear in the Company's consolidated financial statements for the Eight Month Fiscal Period. However, on a going-forward basis, most, if not all of such royalties will be distributed to the holders of the Secured Notes. See "Item 1. Business. Certain Business Considerations and Risk Factors Restrictions on Distributions by Spell C." Prior to the maturity of the Secured Notes, royalties from the Amended Target Agreement will be offset by principal payments to the holders of the Secured Notes in the amount of $9.0 million per year during the first two years and $10.5 million per year during the third through sixth years of Spell C's obligations under the Indenture. The revenues generated from all other licensing agreements during the fiscal year ended May 31, 1997 were $2,783,000 and during the Eight Month Fiscal Period were $2,125,000, which accounted for 32% and 25% respectively, of the Company's revenues during such periods. In November 1997, the Company purchased the Sideout brand and related trademarks from Sideout Sport, Inc. for approximately $2.0 million and a portion of the future royalties generated by the Sideout brand. The Sideout brand represents a beach-oriented active, "California" lifestyle. As part of the purchase, the Company acquired several existing domestic and international retail and wholesale license agreements. The Sideout brand currently generates licensing revenues from existing contracts of approximately $500,000 per year. See "--Item 1. Business. Recent Developments." The Company intends to further develop the Sideout brand both in the United States and internationally through retail direct and wholesale licensing. Due to the restrictions in the Amended Target Agreement, neither the Company nor Spell C anticipate entering into additional licensing agreements in the United States with respect to the Cherokee brands during the term of the agreement. The Company's current focus with respect to the Cherokee brand is to continue to develop that brand in certain international markets through retail direct or 18 wholesale licenses with manufacturers or other companies who have market power and economies of scale in the respective markets. In April 1997, the Company entered into a new master licensing agreement for Japan with Vantex under which the Company is to receive a minimum guaranteed royalty of $5.0 million over the five year term of the agreement. In August 1997, the Company also entered into an international retail direct licensing agreement granting Hudson's Bay the exclusive right in Canada to use the Cherokee brand in connection with a broad range of categories of merchandise. Hudson's Bay will pay the Company a minimum guaranteed royalty of $10.0 million over the five year initial term of the agreement. Currently, the Company is not actively seeking to acquire other brands, however, the Company is frequently approached by parties seeking to sell brands and related trademarks. Should an established and marketable brand become available on favorable terms, the Company currently has significant assets with which to pursue such an acquisition. At a meeting held December 19, 1997, the Company's Board changed the fiscal year end of the Company to a 52 or 53 week fiscal year ending on the Saturday nearest to January 31 in order to better align the Company with its licensees who generally also operate and plan using such a fiscal year. Prior to this change the Company's fiscal year was a 52 or 53 week fiscal year ending on the Saturday nearest May 31. RESULTS OF OPERATIONS The following table sets forth for the periods indicated certain consolidated financial data of the Company. In December 1997, the Company entered into the Assignment Agreement and Spell C entered into the Indenture. In addition, the Company's historical financial statements (presented below) relating to the Year Ended May 31, 1997 and the Year Ended June 1, 1996, include operating results relating to the Apparel Division, Footwear Division and Uniform Division, all of which have been terminated or sold. Therefore, the historical financial statements are not indicative of the results of operations attributable to the ongoing Licensing Division or after giving effect to the Assignment Agreement or the Indenture. Further, during the fiscal year ended January 31, 1999, $9.0 million in royalty revenues from the Licensing Division are expected to be distributed to the holders of the Secured Notes.
EIGHT MONTHS EIGHT MONTHS ENDED ENDED FEBRUARY 1, YEAR ENDED YEAR ENDED JANUARY 31, 1997 MAY 31, JUNE 1, 1998 (UNAUDITED) 1997 1996 ------------ ------------ ---------- ----------- ROYALTY REVENUES/NET SALES Apparel Division......... $ -- $ -- $ -- $ 7,846,000 Footwear Division........ -- -- -- 2,331,000 Licensing Division....... 8,553,000 4,723,000 8,333,000 1,421,000 Other(2)/Uniforms........ -- 366,000 385,000 2,301,000 ---------- ---------- ---------- ----------- Total Company.......... $8,553,000 $5,089,000 $8,718,000 $13,899,000 ========== ========== ========== =========== GROSS PROFIT Apparel Division......... $ -- $ -- $ -- $ 1,217,000 Footwear Division........ -- -- -- 56,000 Licensing Division....... 8,553,000 4,723,000 8,333,000 1,421,000 Other(2)/Uniforms........ -- 183,000 201,000 760,000 ---------- ---------- ---------- ----------- Total Company.......... $8,553,000 $4,906,000 $8,534,000 $ 3,454,000 ========== ========== ========== =========== SELLING, GENERAL , ADMINISTRATIVE AND AMORTIZATION EXPENSES..... $4,235,000 $1,778,000 $3,406,000 $ 4,460,000 PERFORMANCE OPTION EXPENSE. -- -- -- $ 4,567,000(1) OPERATING INCOME (LOSS).... $4,318,000 $3,128,000 $5,128,000 $(5,573,000)
19 - -------- (1) A non-cash charge of $4,567,000 resulting from the exercise of performance options for the year ended June 1, 1996. (2) Other sales include the liquidation of the remaining sweatshirt inventory during fiscal year ended May 31, 1997. EIGHT MONTHS ENDED JANUARY 31, 1998 COMPARED TO EIGHT MONTHS ENDING FEBRUARY 1, 1997 Net revenues for the Eight Month Fiscal Period ended January 31, 1998 were $8,553,000, 100% of which represented licensing revenues. In comparison, net sales for the eight months ended February 1, 1997 (the "1997 Eight Months") were $5,089,000, which included $4,723,000 in licensing revenues with the remaining sales from the liquidations of apparel and footwear inventories. As a percentage of total revenues for the 1997 Eight Months, licensing revenues represented 93%. Revenues from Target for the Eight Month Fiscal Period were $6,428,000, which represented 75% of net revenues. Revenues from all other sources for the Eight Month Fiscal Period were $2,125,000, which represented 25% of net revenues. The Company's gross profit margin for the Eight Month Fiscal Period was $8,553,000 or 100% of net revenues compared to $4,906,000 or 96% of net sales for the 1997 Eight Months. The gross profit percentage is not comparable to historical levels as a result of the Company ceasing to manufacture and import apparel and footwear and selling its inventories. Selling, general and administrative expenses (excluding amortization expense of $43,000) for the Eight Month Fiscal Period were $4,192,000 or 49% of net revenues compared to $1,778,000 (net of certain other liabilities totaling $700,000 which were deemed no longer necessary), or 35% of net sales for the 1997 Eight Months. During the Eight Month Fiscal Period, selling, general and administrative expenses increased due to the payment of $474,000 in financial advisory services, $240,000 in staff bonuses, the addition of marketing staff to intensify the Company's international efforts to negotiate contracts, and the development of advertising materials to expand the Company's global marketing and to maintain the synergy of the Cherokee brand image on a worldwide basis. The Company anticipates that selling, general and administrative expenses for fiscal year ("Fiscal") 1999 will account for a lower percentage of net revenues than in the Eight Month Fiscal Period due to the absence of certain extraordinary expenses totaling $474,000 incurred in the Eight Month Fiscal Period. Based on the Company's anticipated results for Fiscal 1999, management believes that the Company's tax liabilities will be immaterial in Fiscal 1999 because its federal and California tax net operating loss carryovers of approximately $14,900,000 and $5,300,000, respectively, are expected to offset taxable income. FISCAL 1997 COMPARED TO FISCAL 1996 Net revenues for Fiscal 1997 were $8,718,000, of which $8,333,000 represented licensing revenues in comparison to net sales of $13,899,000 for Fiscal 1996, which included $1,421,000 in licensing revenues with the remaining sales from the liquidations of apparel and footwear inventories. As a percentage of total revenues for Fiscal 1997 and Fiscal 1996, licensing revenues represented 95.6% and 10.2%, respectively, and the terminated businesses represented 4.4% and 89.8%, respectively. The Company's gross profit margin for Fiscal 1997 was $8,534,000 or 98% of net revenues compared to $3,454,000 or 25% of net sales for Fiscal 1996. The gross profit percentage is not comparable to historical levels as a result of the Company ceasing to manufacture and import apparel and footwear and selling its inventories. Selling, general and administrative expenses for Fiscal 1997 were $3,406,000 or 39% of net revenues compared to $4,460,000 or 32% of net sales for Fiscal 1996. During Fiscal 1997, certain other accruals totaling $750,000 were deemed no longer required and were reversed. In Fiscal 1996, the Company recorded a non-cash charge to expense of $4,567,000 for Wilstar performance options, which was the difference between the market price of the Common Stock at exercise date and exercise price of the options. (See Notes to the Financial Statements Note 11: Employment and Management Agreements). During Fiscal 1997, selling, general and administrative expenses declined from historical levels primarily as a result of the termination of the manufacturing and importing of apparel and footwear and the sale of its Uniform Division. These actions enabled the Company to significantly reduce its work force, space requirements and other operating expenses. 20 For Fiscal 1997, the Company gains on sale of assets was attributable to the sale of a trademark asset and the Company's Wentworth Street facility, its former headquarters from August 1988 to October 1995. For Fiscal 1996, the Company's gain on sale of assets was attributable to the sale of the Uniform Division and the "Rockers" trademark. On July 28, 1995, the Company sold the assets of the Uniform Division to Strategic Partners. The assets sold included accounts receivable, inventory, furniture and fixtures, equipment and the exclusive right to use the Cherokee trademark with respect to the manufacture and sale of uniforms. The sales price was $11,700,000, which was $4,000,000 greater than the book value of the assets that were sold. Of the purchase price, $9,575,000 was paid in cash and $2,125,000 was paid by a 10% subordinated promissory note (the "Note"). The Note required quarterly payments of interest and annual principal payments of $300,000 on July 27, 1997, 1998, 1999 and 2000 with the remaining principal amount due on July 27, 2001. The Company recorded the note at its estimated fair value of $1,588,000, which represented a discount of $537,000. In addition, Strategic Partners agreed to pay the Company royalties with respect to its sales of Cherokee brand uniform footwear, and beginning in June 2001, agreed to pay Cherokee, subject to certain conditions, a royalty equal to 2% of annual sales of Cherokee brand uniform in excess of $30,000,000. On December 1, 1995, the Company sold its patents and trademarks related to the "Rockers" brand footwear to Strategic Partners for $250,000. Strategic Partners also agreed to pay the Company a royalty if the "Rockers" trademark was used in connection with the sale of Cherokee footwear to the uniform trade. On April 3, 1997, Strategic Partners and the Company negotiated a 10% discount to pay off the $2,125,000 Note due 2001 and in addition, Strategic Partners agreed to pay $100,000 in royalty income to buy back all future royalty obligations for the Cherokee branded uniform apparel and uniform shoes. Strategic Partners delivered a payment of $1,912,500 and $100,000 on May 14, 1997 in full satisfaction of the Note and royalty income buy back. The Company's interest expense for the Eight Month Fiscal Period ended January 31, 1998, Fiscal 1997 and Fiscal 1996 was $330,000, $3,000 and $355,000, respectively. The Company's investment and interest income for the Eight Month Fiscal Period ended January 31, 1998, Fiscal 1997 and Fiscal 1996 was $525,000, $460,000 and $543,000, respectively. LIQUIDITY AND CAPITAL RESOURCES On January 31, 1998, the Company had $10,275,000 in cash and cash equivalents. Cash flow needs over the next twelve months are expected to be met through the operating cash flows generated from licensing revenues and the Company's cash and cash equivalents. During the Eight Month Fiscal Period, cash provided by operations was $4,488,000. During the Eight Month Fiscal Period, cash used in investing activities was $3,423,000 due to the initial payment made in the Sideout Agreement and the costs associated with the leveraged recapitalization. During the Eight Month Fiscal Period, cash used in financing activities was $181,000 which represented the net from the proceeds received from the exercise of warrants and stock options, the net proceeds from the issuance of long-term debt and the cash dividend distributions made during the Eight Month Fiscal Period. INFLATION AND CHANGING PRICES Inflation, traditionally, has not had a significant effect on the Company's operations. Since most of the Company's future revenues are based upon a percentage of sales of the licensed products by the Company's licensees, the Company does not anticipate that inflation will have a material impact on future operations. YEAR 2000 COMPLIANCE The Year 2000 issue is a result of computer programs being written using two digits, e.g. "98", to define a year. Date-sensitive software may recognize the year "00" as the year 1900 rather than the year 2000. This would result in errors and miscalculations or even system failure causing disruptions in everyday business activities and transactions. Software is termed "Year 2000 compliant" when it is capable of performing transactions correctly in the year 2000. 21 Based on a recent assessment of the Company's computer systems software, it has been determined that more than 95% of the Company's hardware and software systems are either currently Year 2000 compliant or have an existing upgrade available from the software vendor that is Year 2000 compliant. All systems that are not currently Year 2000 compliant will either be upgraded to be Year 2000 compliant or replaced with alternative systems that are Year 2000 compliant over the next eighteen months. The Company does not expect the achieving of Year 2000 compliance to have a material impact on its financial condition or results of operations. NEW ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting standards ("SFAS") No. 130 "Reporting Comprehensive Income," which establishes standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains and losses) in a full set of generalpurpose financial statements. Comprehensive income includes net income and other comprehensive income components which under generally accepted accounting principles ("GAAP") bypass the income statement and are reported in the balance sheet as a separate component of equity. For the eight months ended January 31, 1998 and the three years ended May 31, 1997, June 1, 1996 and June 3, 1995, the Company had no other comprehensive income components as defined in SFAS No. 130. SFAS No. 130 does not apply to an enterprise that has no items of other comprehensive income in any of the periods presented. In June 1997, the FASB issued SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information," which changes current practice and established a new framework, referred to as the "management" approach, on which to base segment reporting. The management approach requires that management identify the "operating segments" based on the way that management disaggregates the entity for internal operating decisions. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997 and is not required for interim statements in the first year of adoption. Management believes that the adoption of this new standard will not have any material impact on the Company's financial position or results of operations. In February 1998, The FASB issued SFAS No. 132 "Employers' Disclosures About Pensions and Other Post-retirement Benefits" which revises employers' disclosures about pension and post-retirement benefit plans. This statement is effective for fiscal years beginning after December 15, 1997. This statement is not anticipated to have any effect on the Company. SUBSEQUENT EVENTS On March 3, 1998, the Company announced the resignation of Patricia Warren as President of the Company. She will continue to work with the Company through 1998 in selected special projects. Mr. Margolis will assume Ms. Warren's responsibilities until a new president is appointed. On April 6, 1998, the Company announced that its Board of Directors had declared a cash dividend of $0.50 per share to be distributed on May 1, 1998 to the Company's shareholders of record on the close of business on April 17, 1998. Assuming the Company's cash position continues to be favorable, the Company intends to maintain a quarterly cash dividend of $0.25 per share for the balance of the fiscal year ending January 30, 1999; however, the declaration of such dividends remains subject to the discretion of the Company's Board. ITEM 7A. QUALITATIVE AND QUANTITATIVE RISK Not applicable SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This Transition Report on Form 10-K contains certain forward-looking statements, including without limitation, statements containing the words, "believes," "anticipates," "estimates," "expects," and words of similar import. Such forward-looking statements involve known and unknown risks, uncertainties and other 22 factors which 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. The Company is subject to certain risk factors, which include, but are not limited to, restrictions on distributions by Spell C, uncertainty regarding the Sideout brand, competition, dependence on a single licensee, dependence on intellectual property rights, and dependence on key management and other factors referenced in this Form 10-K. Certain of these factors are discussed in more detail elsewhere in this Form 10-K, including without limitation under the captions, "Certain Business Considerations and Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operation," and "Business." The forward-looking information provided by the Company pursuant to the safe harbor established under the Private Securities Litigation Reform Act of 1995 should be evaluated in conjunction with the risk factors listed under "Certain Business Considerations and Risk Factors." Given the known and unknown risks and uncertainties, undue reliance should not be placed on the forward-looking statements contained herein. In addition, the Company disclaims any intent or obligation to update any of the forward- looking statements contained herein to reflect future events and developments. ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA INDEX TO FINANCIAL STATEMENTS
PAGE ---- CHEROKEE INC. Report of Independent Accountants......................................... F-1 Consolidated Balance Sheets At January 31, 1998, May 31, 1997 and June 1,1996........................ F-2 Consolidated Statements of Operations For the Eight Months Ended January 31, 1998 and February 1, 1997 (unaudited) (Successor Company), and for the Years Ended May 31, 1997 and June 1, 1996 (Successor Company), and for the Three Months Ended June 3, 1995 (Successor Company), and for the Nine Months Ended February 25, 1995 (Predecessor Company).................................................... F-3 Consolidated Statements of Stockholders' Equity (Deficit) for the Eight Months Ended January 31, 1998 and February 1, 1997 (unaudited) (Successor Company), and for the Years Ended May 31, 1997 and June 1, 1996 (Successor Company), and for the Three Months Ended June 3, 1995 (Successor Company), and for the Nine Months Ended February 25, 1995 (Predecessor Company).................................................... F-4 Consolidated Statements of Cash Flows For the Eight Months Ended January 31, 1998 and February 1, 1997 (unaudited) (Successor Company), and for the Years Ended May 31, 1997 and June 1, 1996 (Successor Company), and for the Three Months Ended June 3, 1995 (Successor Company), and for the Nine Months Ended February 25, 1995 (Predecessor Company).................................................... F-5 Notes to Financial Statements............................................. F-7 SCHEDULES II Valuations and Qualifying Accounts and Reserves....................... F-27
All other schedules for which provision is made in the applicable accounting regulation of the SEC have been omitted since the required information is not applicable or is not present in amounts sufficient to require submission of the schedule, or because the information required is included in the Consolidated Financial Statements and related notes. 23 REPORT OF INDEPENDENT ACCOUNTANTS The Board of Directors and Stockholders Cherokee Inc. We have audited the accompanying consolidated balance sheets of Cherokee Inc. (the "Company") as of January 31, 1998, May 31, 1997 and June 1, 1996, and the related consolidated statements of operations, stockholders' equity (deficit), and cash flows for the eight months ended January 31, 1998, the years ended May 31, 1997 and June 1, 1996, the three months ended June 3, 1995 and the nine months ended February 25, 1995. Our audits also included the financial statement schedule listed in the accompanying index. These financial statements and schedule are the responsibility of management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. As discussed in Note 1 to the financial statements, the Company's reorganization plan became effective on February 25, 1995 for financial reporting purposes. In accordance with the American Institute of Certified Public Accountants Statement of Position No. 90-7, "Financial Reporting by Entities in Reorganization Under the Bankruptcy Code," the Company was required to account for the reorganization using "Fresh-Start Reporting." Accordingly, all financial statements prior to February 25, 1995, are not comparable to the financial statements for periods after the implementation of fresh-start reporting. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Cherokee Inc. at January 31, 1998, May 31, 1997 and June 1, 1996, and the results of its operations and its cash flows for the eight months ended January 31, 1998, for the years ended May 31, 1997 and June 1, 1996, the three months ended June 3, 1995 and the nine months ended February 25, 1995, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. Coopers & Lybrand L.L.P. Los Angeles, California April 6, 1998 F-1 CHEROKEE INC. CONSOLIDATED BALANCE SHEETS
JANUARY 31, MAY 31, JUNE 1, 1998 1997 1996 ------------ ----------- ----------- ASSETS Current assets: Cash and cash equivalents............. $ 10,275,000 $ 9,391,000 $ 1,207,000 Restricted cash....................... -- -- 310,000 Receivables, net...................... 2,347,000 1,024,000 694,000 Inventories........................... 45,000 80,000 256,000 Other current assets.................. 220,000 30,000 10,000 ------------ ----------- ----------- Total current assets................ 12,887,000 10,525,000 2,477,000 Assets held for sale.................... -- -- 3,576,000 Notes receivable........................ -- -- 1,961,000 Securitization fees..................... 1,218,000 -- -- Deferred tax asset...................... 7,576,000 2,408,000 -- Other assets............................ 2,790,000 668,000 306,000 ------------ ----------- ----------- Total assets........................ $ 24,471,000 $13,601,000 $ 8,320,000 ============ =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable...................... $ 645,000 $ 210,000 $ 112,000 Other accrued liabilities............. 522,000 417,000 638,000 Current portion of long term Notes payable.............................. 6,525,000 -- -- ------------ ----------- ----------- Total current liabilities........... 7,692,000 627,000 750,000 Other liabilities....................... 750,000 750,000 1,500,000 Notes payable less current portion...... 41,675,000 -- -- ------------ ----------- ----------- Total liabilities................... 50,117,000 1,377,000 2,250,000 ------------ ----------- ----------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' (DEFICIT) EQUITY Common stock, $.02 par value, 20,000,000 shares authorized, 8,612,657, 7,726,986 and 7,650,813 shares issued and outstanding at January 31, 1998, May 31, 1997 and June 1, 1996, respectively........................... 173,000 155,000 153,000 Additional paid-in capital.............. (23,806,000) 11,334,000 11,977,000 Retained earnings....................... -- 735,000 (5,916,000) Note receivable from stockholder........ (2,013,000) -- (144,000) ------------ ----------- ----------- Total stockholders' (deficit) equity............................. (25,646,000) 12,224,000 6,070,000 ------------ ----------- ----------- Total liabilities and stockholders' equity............................. $ 24,471,000 $13,601,000 $ 8,320,000 ============ =========== ===========
The accompanying notes are an integral part of these financial statements. F-2 CHEROKEE INC. CONSOLIDATED STATEMENTS OF OPERATIONS
PREDECESSOR SUCCESSOR COMPANY COMPANY --------------------------------------------------------------- ------------ EIGHT MONTHS EIGHT MONTHS NINE MONTHS ENDED ENDED YEAR ENDED YEAR ENDED THREE MONTHS ENDED JANUARY 31, FEBRUARY 1, MAY 31, JUNE 1, ENDED FEBRUARY 25, 1988 1997 1997 1996 JUNE 3, 1995 1995 ------------ ------------ ---------- ----------- ------------ ------------ (UNAUDITED) REVENUES: Product sales, net...... $ -- $ 366,000 $ 385,000 $12,478,000 $19,939,000 $ 64,138,000 Licensing revenues...... 8,553,000 4,723,000 8,333,000 1,421,000 325,000 1,485,000 ---------- ---------- ---------- ----------- ----------- ------------ Total net sales....... 8,553,000 5,089,000 8,718,000 13,899,000 20,264,000 65,623,000 Cost of goods sold...... -- 183,000 184,000 10,445,000 16,310,000 54,994,000 ---------- ---------- ---------- ----------- ----------- ------------ Gross profit............ 8,553,000 4,906,000 8,534,000 3,454,000 3,954,000 10,629,000 Selling, general and administrative expenses............... 4,192,000 1,778,000 3,406,000 4,460,000 5,153,000 19,097,000 Performance option expense................ -- -- -- 4,567,000 -- -- Amortization of trademarks and goodwill............... 43,000 -- -- -- -- 819,000 Operational restructuring charge... -- -- -- -- 3,165,000 -- ---------- ---------- ---------- ----------- ----------- ------------ Operating income (loss). 4,318,000 3,128,000 5,128,000 (5,573,000) (4,364,000) (9,287,000) OTHER INCOME (EXPENSES): Interest expense........ (330,000) (2,000) (3,000) (355,000) (587,000) (5,467,000) Investment and interest income................. 525,000 293,000 460,000 543,000 24,000 107,000 Gain on sale of Uniform Division and other assets................. -- -- 220,000 3,840,000 -- -- Other income............ 422,000 -- 75,000 96,000 116,000 167,000 ---------- ---------- ---------- ----------- ----------- ------------ Total other income (expenses), net...... 617,000 291,000 752,000 4,124,000 (447,000) (5,193,000) REORGANIZATION ITEMS: Professional fees and expenses............... -- -- -- -- -- (3,429,000) Fresh start adjustments. -- -- -- -- -- (50,664,000) ---------- ---------- ---------- ----------- ----------- ------------ Total reorganization items................ -- -- -- -- -- (54,093,000) Income (loss) before income taxes and extraordinary item..... 4,935,000 3,419,000 5,880,000 (1,449,000) (4,811,000) (68,573,000) Income tax benefit...... (782,000) -- (771,000) -- (400,000) (5,230,000) ---------- ---------- ---------- ----------- ----------- ------------ Income (loss) before extraordinary item..... 5,717,000 3,419,000 6,651,000 (1,449,000) (4,411,000) (63,343,000) EXTRAORDINARY ITEM: Gain on extinguishment of debt................ -- -- -- -- -- 88,291,000 ---------- ---------- ---------- ----------- ----------- ------------ Net income (loss)....... $5,717,000 $3,419,000 $6,651,000 $(1,449,000) $(4,411,000) $ 24,948,000 ========== ========== ========== =========== =========== ============ Basic earnings (loss) per share.............. $ 0.73 $ 0.45 $ 0.87 $ (0.22) $ (0.72) * ========== ========== ========== =========== =========== Diluted earnings (loss) per share.............. $ 0.68 $ 0.42 $ 0.82 $ (0.21) $ (0.72) ========== ========== ========== =========== =========== WEIGHTED AVERAGE SHARES OUTSTANDING: Basic................. 7,866,862 7,660,813 7,688,521 6,480,443 6,096,000 Diluted............... 8,412,768 8,080,100 8,154,311 6,945,360 6,131,590
- -------- * Per share results are not presented for periods prior to June 3, 1995, due to the general lack of comparability as a result of the revised capital structure of the Company. The accompanying notes are an integral part of these financial statements. F-3 CHEROKEE INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' (DEFICIT) EQUITY
COMMON STOCK ACCUMULATED NOTES -------------------- ADDITIONAL (DEFICIT)/ RECEIVABLE PAR PAID-IN RETAINED FROM SHARES VALUE CAPITAL EARNINGS STOCKHOLDERS TOTAL ---------- -------- ----------- ----------- ------------ ----------- Predecessor Company balance at May 28, 1994................... 5,016,298 50,000 13,150,000 (24,830,000) -- (11,630,000) ========== ======== =========== =========== ========== =========== Net loss for the nine months ended prior to fresh start adjustments............ -- -- -- (12,679,000) -- (12,679,000) Recapitalization and fresh start adjustments (Notes 1 and 2) Cancellation of old common stock.......... (5,016,298) (50,000) (13,150,000) -- -- (13,200,000) Issuance of new common stock................. 6,096,000 122,000 11,703,000 -- -- 11,825,000 Issuance of note receivable to stockholder........... -- -- -- -- (192,000) (192,000) Fresh start adjustments........... -- -- -- 37,509,000 -- 37,509,000 ---------- -------- ----------- ----------- ---------- ----------- Successor Company balance at February 25, 1995...... 6,096,000 122,000 11,703,000 -- (192,000) 11,633,000 Net loss for three months ended June 3, 1995................... -- -- -- (4,411,000) -- (4,411,000) ---------- -------- ----------- ----------- ---------- ----------- BALANCE AT JUNE 3, 1995. 6,096,000 122,000 11,703,000 (4,411,000) (192,000) 7,222,000 ========== ======== =========== =========== ========== =========== Issuance of new common stock.................. 366,667 7,000 (7,000) -- -- -- Exercise of director warrants, employee stock options and performance options.... 1,694,739 35,000 4,620,000 -- -- 4,655,000 Purchase and retirement of treasury shares..... (31,593) (1,000) (60,000) (56,000) -- (117,000) Cancellation of shares held and returned by disbursing agent....... (475,000) (10,000) 10,000 -- -- -- Distribution of capital. -- -- (4,289,000) -- -- (4,289,000) Repayment on note receivable............. -- -- -- -- 48,000 48,000 Net loss for the year ended June 1, 1996..... -- -- -- (1,449,000) -- (1,449,000) ---------- -------- ----------- ----------- ---------- ----------- BALANCE AT JUNE 1, 1996. 7,650,813 153,000 11,977,000 (5,916,000) (144,000) 6,070,000 ========== ======== =========== =========== ========== =========== Exercise of director warrants, employee stock options and...... 95,000 2,000 404,000 -- -- 406,000 Cancellation of shares held and returned by disbursing agent....... (18,827) -- -- -- -- -- Cash dividend distributions.......... -- -- (2,529,000) -- -- (2,529,000) Utilization of pre- bankruptcy NOL carryforwards.......... -- -- 1,482,000 -- -- 1,482,000 Repayment on note receivable............. -- -- -- -- 144,000 144,000 Net income for the year ended May 31, 1997..... -- -- -- 6,651,000 -- 6,651,000 ---------- -------- ----------- ----------- ---------- ----------- BALANCE AT MAY 31, 1997. 7,726,986 155,000 11,334,000 735,000 -- 12,224,000 ========== ======== =========== =========== ========== =========== Exercise of director warrants and employee stock options.......... 885,671 18,000 2,850,000 -- -- 2,868,000 Cash dividend distributions.......... -- -- (42,467,000) (6,452,000) -- (48,919,000) Utilization of pre- bankruptcy NOL carryforwards.......... -- -- 1,727,000 -- -- 1,727,000 Stock option tax benefit................ -- -- 2,750,000 -- -- 2,750,000 Note receivable from stockholder............ -- -- -- -- (2,013,000) (2,013,000) Net income for the eight months ended January 31, 1998....... -- -- -- 5,717,000 -- 5,717,000 ---------- -------- ----------- ----------- ---------- ----------- BALANCE AT JANUARY 31, 1998................... 8,612,657 173,000 (23,806,000) -- (2,013,000) (25,646,000) ========== ======== =========== =========== ========== =========== COMPARATIVE TRANSITION PERIOD (UNAUDITED) BALANCE AT JUNE 1, 1996. 7,650,813 153,000 11,977,000 (5,916,000) (144,000) 6,070,000 ========== ======== =========== =========== ========== =========== Exercise of director warrants, employee stock options and...... 80,000 2,000 336,000 -- -- 338,000 Cancellation of shares held and returned by disbursing agent....... (18,827) -- -- -- -- -- Interest on note receivable from stockholder............ -- -- -- -- (6,000) (6,000) Dividend distribution adjustment............. -- -- (7,000) -- -- (7,000) Cash dividend distributions.......... -- -- -- -- -- -- Net income for the eight months ended February 1, 1997....... -- -- -- 3,419,000 -- 3,419,000 ---------- -------- ----------- ----------- ---------- ----------- BALANCE AT FEBRUARY 1, 1997................... 7,711,986 155,000 12,306,000 (2,497,000) (150,000) 9,814,000 ========== ======== =========== =========== ========== ===========
The accompanying notes are an integral part of these financial statements. F-4 CHEROKEE INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
PREDECESSOR SUCCESSOR COMPANY COMPANY -------------------------------------------------------------- ------------ EIGHT EIGHT THREE NINE MONTHS MONTHS YEAR YEAR MONTHS MONTHS ENDED ENDED ENDED ENDED ENDED ENDED JANUARY 31, FEBRUARY 1, MAY 31, JUNE 1, JUNE 3, FEBRUARY 25, 1988 1997 1997 1996 1995 1995 ----------- ----------- ---------- ----------- ----------- ------------ UNAUDITED OPERATING ACTIVITIES Net (loss) income....... $ 5,717,000 $3,419,000 $6,651,000 $(1,449,000) $(4,411,000) $24,948,000 Adjustments to reconcile net (loss) income to net cash provided by (used in) operating activities: Depreciation and amortization.......... 23,000 6,000 19,000 18,000 26,000 690,000 Amortization of goodwill and trademarks............ 43,000 -- -- -- -- 819,000 Provision for bad debts................. -- -- (112,000) 112,000 72,000 696,000 Operational restructuring charge.. -- -- -- -- 2,551,000 -- Gain on Sale of Uniform Division.............. -- -- -- (1,588,000) -- -- Change in other liabilities........... -- (750,000) (750,000) -- -- -- Interest income on note receivable from stockholder........... (13,000) (6,000) -- -- -- -- Deferred taxes......... (3,058,000) -- (926,000) -- (500,000) (5,230,000) Stock option tax benefit............... 2,367,000 -- -- -- -- -- Amortization of deferred financing costs and debt discount..... 347,000 -- -- -- -- 85,000 Gain on extinguishment of debt............... -- -- -- -- -- (88,291,000) Fresh start adjustments........... -- -- -- -- -- 50,664,000 Amortization of discount on note receivable............ -- (83,000) -- 108,000 -- -- Performance option exercise expense...... -- -- -- 4,567,000 -- -- Changes in current assets and liabilities: Receivables........... (1,323,000) (1,014,000) (218,000) 10,747,000 5,010,000 (2,441,000) Inventories........... 35,000 179,000 176,000 11,274,000 5,724,000 (1,880,000) Other current assets.. (190,000) (89,000) (20,000) 496,000 (141,000) (88,000) Accounts payable...... 540,000 (181,000) (122,000) (1,348,000) (1,794,000) 7,787,000 Accrued payroll and related expenses..... -- -- -- (1,559,000) 1,152,000 (227,000) Other liabilities..... -- -- -- (1,668,000) (521,000) 364,000 ----------- ---------- ---------- ----------- ----------- ----------- Net cash provided by (used in) operating activities............. 4,488,000 1,481,000 4,698,000 19,710,000 7,168,000 (12,104,000) INVESTING ACTIVITIES Purchases of trademark.. $(2,000,000) $ -- $ -- $ -- $ -- $ -- Proceeds from sales of assets held for sale... -- -- 3,576,000 89,000 -- 435,000 Purchase of treasury shares................. -- -- -- (117,000) -- -- Restricted cash......... -- 310,000 310,000 (310,000) -- -- Repayment on note receivable from stockholder............ -- -- 144,000 48,000 -- -- Change in other assets.. (1,673,000) (197,000) (382,000) (84,000) 95,000 87,000 Collection of notes receivable............. 250,000 -- 1,961,000 -- -- -- ----------- ---------- ---------- ----------- ----------- ----------- Net cash (used in) provided by investing activities............. (3,423,000) 113,000 5,609,000 (374,000) 95,000 522,000 FINANCING ACTIVITIES Payment of long-term debt, including revolving credit which was classified as current at June 3, 1995................... -- -- -- -- (7,065,000) (2,383,000) Net proceeds from the issuance of long-term debt................... 47,870,000 -- -- -- -- 14,719,000 Net (payments on) proceeds from revolving credit and other....... -- -- -- (14,213,000) 64,000 (1,232,000) Note receivable from stockholder............ (2,000,000) -- -- -- -- -- Proceeds from exercise of stock options....... 2,786,000 281,000 336,000 64,000 -- -- Proceeds from exercise of warrants............ 82,000 57,000 70,000 24,000 -- -- Cash Distributions...... (48,919,000) -- (2,529,000) (4,289,000) -- -- ----------- ---------- ---------- ----------- ----------- ----------- Net cash (used in) provided by financing activities............. (181,000) 338,000 (2,123,000) (18,414,000) (7,001,000) 11,104,000 ----------- ---------- ---------- ----------- ----------- ----------- Increase (decrease) in cash and cash equivalents............ 884,000 1,932,000 8,184,000 922,000 262,000 (478,000) Cash and cash equivalents at beginning of period.... 9,391,000 1,207,000 1,207,000 285,000 23,000 501,000 ----------- ---------- ---------- ----------- ----------- ----------- Cash and cash equivalents at end of period................. $10,275,000 $3,139,000 $9,391,000 $1,207,000 $285,000 $23,000 =========== ========== ========== =========== =========== =========== TOTAL PAID DURING PERIOD: Income taxes........... $ 64,000 $ 4,600 $ 4,600 $ -- $ 92,000 $ 17,000 Interest............... $ -- $ 2,000 $ 3,000 $ 355,000 $ 587,000 $ 1,644,000 NON-CASH TRANSACTIONS: Declaration of cash dividend.............. $ -- $1,159,000 $ -- $ -- $ -- $ -- Utilization of pre- bankruptcy NOL carryforwards......... $ 1,727,000 $ -- $1,482,000 $ -- $ -- $ --
The accompanying notes are an integral part of these financial statements. F-5 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. REORGANIZATION Cherokee Inc. (the "Company") is in the business of marketing and licensing the Cherokee and Sideout brands and related trademarks and other brands it owns. The Company is one of the leading licensors of brand names and trademarks for apparel, footwear and accessories in the United States. The Company's operating strategy emphasizes retail direct, wholesale and international licensing whereby the Company grants retailers and wholesalers the license to use the trademarks held by the Company on certain categories of merchandise and the licensees are responsible for designing and manufacturing the merchandise. The Company and its wholly-owned subsidiary, Spell C. LLC ("Spell C"), hold several trademarks including Cherokee(TM), Sideout(TM), Sideout Sport(TM), King of the Beach(TM), and others. The Cherokee brand, which began as a footwear brand in 1973, has been positioned to connote quality, comfort, fit, and a "Casual American lifestyle with traditional wholesome values. The Sideout brand and related trademarks, which represent a beach-oriented active, "California" lifestyle, were acquired by the Company in November 1997. As of January 31, 1998 the Company had twenty-five continuing license agreements, covering both domestic and international markets. On April 24, 1995, a group including Robert Margolis, who founded the Company's Apparel Division in 1981, and who had been the Company's Chairman and Chief Executive Officer from May 1989 to October 1993, purchased 1,358,000 shares, or approximately 22.3% of the Company's then outstanding Common Stock ("Common Stock"). On May 5, 1995, Mr. Margolis was appointed Chairman and Chief Executive Officer of the Company. After a period of assessment, Mr. Margolis set in motion a strategy which resulted in the Company's principal business being a marketer and licensor of the Cherokee brand and other brands it owns or may acquire in the future. The Company stopped manufacturing and importing apparel and footwear, sold its inventories of apparel and footwear and on July 28, 1995 sold the assets of its Uniform Division. The proceeds from these sales were used to pay off all of the Company's indebtedness. As a result of discontinuing the apparel and footwear business and selling the Uniform Division, the number of employees was reduced from approximately 345 on May 28, 1994 to 15 by November 1, 1995. The Company filed a prepackaged plan of reorganization (the "1994 Plan") pursuant to Chapter 11 of the United States Bankruptcy Code ("Chapter 11") with the United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court") on November 7, 1994. An order confirming the 1994 Plan was entered by the Court on December 14, 1994 and the Plan became effective on December 23, 1994 (the "Effective Date"). The confirmed 1994 Plan provided for the following: Common Stock: On the Effective Date Cherokee issued 5,000,000 shares of Common Stock, par value of $.02 per share, ("Common Stock") to holders of 11% Senior Subordinated Notes due 1999 ("Old Notes") and common stock par value $.01 per share ("Old Common Stock"). The Company also issued 1,000,000 shares of Common Stock to a disbursing agent, which shares were to be issued to Holders of Allowed General Unsecured Claims following allowance and settlement of such Claims. To implement distribution of Common Stock to general unsecured creditors, 1,000,000 shares of Common Stock were issued to Cherokee's disbursing agent (the "Disbursing Agent"). The Disbursing Agent distributed 517,795 shares of Common Stock to general unsecured creditors and returned 482,205 shares to the Company since they were determined not to be distributable to creditors, and subsequently, were canceled at the Company's request. Having settled all claims, the Company sent in a Final Decree to the Bankruptcy Court, which was signed and approved by the Bankruptcy Judge on August 15, 1996. In accordance with the 1994 Plan, the Company's Certificate of Incorporation was amended to authorize 20,000,000 shares of Common Stock par value $.02 per share, and 1,000,000 shares of Preferred Stock par value $.02 per share. The terms and conditions of the Preferred Stock shall be determined from time to time by the Company's Board of Directors. F-6 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Old Notes: For each $1,000 principal amount of Old Notes (an aggregate of $76,565,000), Holders received 63.9978 shares of Common Stock (or an aggregate of 4,900,000 shares of Common Stock). Accrued and unpaid interest through the petition date was taken into account in determining the exchange ratio. Having settled all claims, the remaining 10,954 shares were returned and canceled by the Disbursing Agent on February 24, 1997. Allowed General Unsecured Claims: Holders of Allowed General Unsecured Claims have received 60.5504 shares of Common Stock for each $1,000 amount of Allowed General Unsecured Claims. Allowed General Unsecured Claims of Less than $1,000: Holders of Allowed General Unsecured Claims of Less than $1,000 received full payment in cash. Old Common Stock: Holders of Old Common Stock received.019935 shares of Common Stock for each share of Old Common Stock (or an aggregate of 100,000 shares of Common Stock). Having settled all claims, the remaining 668 shares were returned and canceled by the Disbursing Agent on February 24, 1997. Old Warrants: Series A, Series B and Series C Warrants were cancelled and holders received no consideration under the Plan. 2. BASIS OF PRESENTATION Bankruptcy Reorganization For financial reporting purposes, the effective date of the 1994 reorganization was assumed to be February 25, 1995, the last day of the third quarter of the Company's fiscal year. The Company has implemented the recommended accounting principles for entities emerging from Chapter 11 set forth in the American Institute of Certified Public Accountants Statement of Position 90-7 on Financial Reporting by Entities in Reorganization under the Bankruptcy Code ("SOP 90-7"). This results in the use of "fresh start" reporting, since the reorganization value, as defined, was less than the total of all post-petition liabilities and pre- petition claims, and holders of voting shares immediately before confirmation of the 1994 Plan received less than fifty percent of the voting shares of the emerging entity. Under this concept, all assets and liabilities are restated to reflect the reorganization value of the reorganized entity, which approximates its fair value at the date of reorganization. In addition, the accumulated deficit of the Company was eliminated and its capital structure was recast in conformity with the 1994 Plan. F-7 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) BALANCE SHEETS FEBRUARY 25, 1998 ($000 OMITTED)
PRE-FRESH START FRESH START FRESH START BALANCE SHEET CANCELLATION DEBT FAIR VALUE BALANCE SHEET FEB. 25, 1995 OF STOCK DISCHARGE ADJUSTMENT FEB. 25, 1995 --------------- ------------ --------- ----------- ------------- ASSETS CURRENT ASSETS: Cash and cash equivalents............ $ 23 $-- $ -- $ -- $ 23 Receivables, net........ 16,857 -- -- (622)(3) 16,235 INVENTORIES: Raw materials........... 5,643 -- -- (1,831)(3) 3,812 Work in process......... 1,802 -- -- (41)(3) 1,761 Finished goods.......... 16,616 -- -- (2,833)(3) 13,783 ------- ---- ------- -------- ------- 24,061 -- -- (4,705)(3) 19,356 Deferred income taxes... 2,511 -- -- (2,511)(4) -- Other current assets.... 415 -- -- (1)(3) 414 Total current assets.. 43,867 -- -- (7,839) 36,028 Property & Equipment.... 12,578 -- -- (8,863)(1) 3,715 Less accumulated depreciation and amortization........... (1,455) -- -- 1,455(3) -- ------- ---- ------- -------- ------- 11,123 -- -- (7,408)(3) 3,715 ------- ---- ------- -------- ------- Trademarks, net of amortization........... 36,290 -- -- (36,290)(5) -- Other assets............ 3,156 192(2) -- (1,564)(3) 1,784 ------- ---- ------- -------- ------- Total assets.......... $94,436 $192(2) $ -- $(53,101) $41,527 ======= ==== ======= ======== ======= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES: Short-term revolving credit and other....... $ 439 $-- $ -- $ -- $ 439 Current maturities of long-term debt......... 1,780 -- -- -- 1,780 Accounts payable and accrued expenses....... 13,754 -- (7,365)(2) 29(3) 6,418 Accrued interest payable................ 4,361 -- (4,361)(2) -- -- Income tax payable...... 70 -- -- -- 70 Senior subordinated notes due 1999......... 76,565 -- (76,565)(2) -- -- ------- ---- ------- -------- ------- Total current liabilities.......... 96,969 -- (88,291) 29 8,707 Long-term debt, net of current maturities..... 18,995 -- -- -- 18,995 Deferred incomes taxes.. 2,781 -- -- (781)(4) 2,000 ------- ---- ------- -------- ------- Total liabilities..... 118,745 -- (88,291) (752) 29,702 STOCKHOLDERS' EQUITY (DEFICIT): Common stock, $.01 par value, 20,000,000 authorized, 5,016,298 shares issued and outstanding............ 50 (50)(1) -- -- -- Common stock, $.02 par value, 20,000,000 authorized, 6,096,000 shares issued and outstanding............ -- 4(1) 118(2) -- 122 Additional paid-in capital................ 13,150 238(1) (1,685)(2) 11,703 Deficit................. (37,509) -- 88,173(2) (50,664)(3) -- ------- ---- ------- -------- ------- Stockholders' Equity (Deficit)............ (24,309) 192 88,291 (52,349) 11,825 ------- ---- ------- -------- ------- Total liabilities and Stockholders' Equity (Deficit)............ $94,436 $192 $ -- $(53,101) $41,527 ======= ==== ======= ======== =======
F-8 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) - -------- (1) Exchange Common Stock for Old Common Stock. (2) Exchange of Old Notes and accounts payable for Common Stock and related gain on debt extinguishment. (3) Record assets and liabilities at their fair value pursuant to the reorganization value of the Company and eliminate any retained earnings or deficit. (4) Record income tax effect of fresh start adjustments. (5) Based on the Company's continued poor operating performance and its second bankruptcy reorganization since fiscal year 1993, no value was attributed to trademarks in connection with the fresh start accounting for the 1994 Plan. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, SPELL C. LLC, a Delaware limited liability corporation. All significant intercompany accounts and transactions have been eliminated in consolidation. COMPANY YEAR END On December 19, 1997, the Company determined to change its fiscal year to a 52 or 53 week fiscal year ending on the Saturday nearest to January 31 in order to better align the Company with its licensees who also generally operate and plan using a fiscal year ending nearest to January 31. Prior to this change, the Company's fiscal year was a 52 or 53 week fiscal year ending on the Saturday nearest to May 31. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and revenues and expenses during the reporting periods. Actual results could differ from those estimates. CASH AND CASH EQUIVALENTS The Company considers all highly liquid debt instruments purchased and money market funds with an original maturity date of three months or less to be cash equivalents. The Company had restricted cash of $310,000 at June 1, 1996, held as collateral for a stand by letter of credit ("LC"). The LC secured a custom's bond in the Company's name. The LC was returned and the cash was released to the Company on August 23, 1996. INVENTORIES Inventories are valued at the lower of cost or market, determined by the use of the first-in, first-out method. REVENUE RECOGNITION Product sales are recognized on the date of shipment. Royalty revenues are recognized when earned based upon contractual agreement. F-9 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) DEPRECIATION AND AMORTIZATION In accordance with fresh start reporting related to the 1994 Plan, the pre- effective date accumulated depreciation and amortization of $1,455,000 at February 25, 1995 was eliminated and a new depreciation and amortization base was established equal to the estimated fair market value of the existing fixed assets at that date. Depreciation of furniture and fixtures, stated at cost, is provided on a straight-line method over the estimated useful lives of the assets ranging from three to eight years. OTHER ASSETS AND ASSETS HELD FOR SALE Other assets is comprised of property, plant and equipment and intangible assets. Property and equipment are stated at cost, less accumulated depreciation and amortization. Other assets includes the Sideout trademarks acquired on November 7, 1997 for $2,000,000. Based on the Company's continued poor operating performance and its second bankruptcy reorganization since fiscal year 1993, no value was attributed to trademarks in connection with the fresh start accounting for the 1994 Plan. Subsequent to 1994, the Company capitalizes all fees incurred in filing trademark registrations and renewals. Trademark registrations, renewal fees and acquired trademarks are amortized over the life of the registrations ranging from five to ten years. Assets held for sale at June 1, 1996 included the Company facility in Sunland, California, which was sold on April 22, 1997. Securitization fees are the costs associated with the leveraged recapitalization which have been capitalized and are being amortized over the term of the Note Agreement. LONG-TERM ASSETS The carrying value of long-term assets is periodically reviewed by management, and impairment losses, if any, are recognized when the expected nondiscounted future operating cash flows derived from such assets are less than their carrying value. Based on current information management believes no impairment exists. INCOME TAXES Income tax expense is the tax payable for the period and the change during the period in deferred tax assets and liabilities. Deferred income taxes are determined based on the difference between the financial reporting and tax bases of assets and liabilities using enacted rates in effect during the year in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Under fresh-start reporting and SFAS No. 109, the tax benefits realized from net operating loss carryforwards that survive the reorganization will be a direct credit to additional paid-in-capital. CONCENTRATIONS OF CREDIT RISK Financial instruments which potentially subject the Company to concentration of credit risk consist principally of cash and cash equivalents and trade receivables. The Company limits its credit risk with respect to F-10 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) cash by maintaining cash balances with quality financial institutions. At January 31, 1998, May 31, 1997 and June 1, 1996, the Company's cash and cash equivalents exceeded FDIC limits. Concentrations of credit risk with respect to trade receivables are minimal due to the limited amount of open receivables and due to the nature of the Company's licensing royalty revenue program. Generally, the Company does not require collateral or other security to support customer receivables. As of January 31, 1998, the Company had twenty- five continuing license agreements; five of which were with retailers, seven of which were with domestic licensees and thirteen of which were with international licensees. One customer accounted for approximately 96% and 83%, respectively, of the Company's trade receivables at January 31, 1998 and May 31, 1997 and approximately 75% and 68%, respectively, of the Company's revenues during the fiscal year ended January 31, 1998 and May 31, 1997. No customer accounted for more than 10% of trade receivables at June 1, 1996 or of sales during the period ended June 1, 1996. STOCK-BASED COMPENSATION In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123"). SFAS 123 established a fair value-based method of accounting for compensation cost related to stock options and other forms of stock-based compensation plans. However, SFAS 123 allows an entity to continue to measure compensation costs using the principles of APB 25 if certain pro forma disclosures are made. The Company has elected to account for its stock compensation arrangements under the provisions of APB 25, "Accounting for Stock Issued to Employees." The Company adopted the provisions for pro forma disclosure requirements of SFAS 123 in Fiscal 1997. (See Note 13.) ADVERTISEMENT The Company's retail direct licensees fund their own advertisement programs. The Company's advertising and promotional costs are immaterial and are expensed as incurred. EARNINGS PER SHARE In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS 128"). SFAS 128 supersedes and simplifies the previous computational guidelines under Accounting Principles Board Opinion No. 15, "Earnings Per Share". Among other changes, SFAS 128 eliminates the presentation of primary EPS and replaces it with basic EPS for which common stock equivalents are not considered in the computation. It also revises the computation of diluted EPS. Basic earnings per share is computed by dividing the net income attributable to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed by dividing the net income attributable to common shareholders by the weighted average number of common and common equivalent shares outstanding during the period. Common share equivalents included in the diluted computation represent shares issuable upon assumed exercise of stock options using the treasury stock method. Earnings per share and weighted average shares outstanding for all prior periods have been restated in accordance with SFAS 128. For the eight months ended January 31, 1998, the Company, in consolidation, recorded as a charge against income, $474,000 in financial advisory services, resulting in a reduction in basic and diluted earnings per share of $0.06 and $0.05, respectively. For the year ended June 1, 1996, the Company recorded a non-cash charge to F-11 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) recognize performance option expense of $4,567,000, resulting in a reduction in basic and diluted earnings per share of $0.70 and $0.66, respectively. RECLASSIFICATIONS Certain prior year amounts have been reclassed to conform with current period presentation. 4. RECEIVABLES Receivables consist of the following:
JANUARY 31, MAY 31, JUNE 1, 1998 1997 1996 ----------- ---------- ---------- Trade........................................ $2,289,000 $ 657,000 $ 621,000 Due from Factor.............................. -- -- 43,000 Note Receivable, Current..................... -- 250,000 -- Other........................................ 58,000 117,000 621,000 ---------- ---------- ---------- 2,347,000 1,024,000 1,285,000 Less allowance for doubtful accounts......... -- -- (591,000) ---------- ---------- ---------- $2,347,000 $1,024,000 $ 694,000 ========== ========== ==========
5. LONG-TERM DEBT In September 1997, the Company's Board authorized Libra Investments, Inc. ("Libra") to explore ways to maximize shareholder value, including a recapitalization or sale of the Company. On December 23, 1997, the Company completed the recapitalization described below and publicly announced that it would declare a special dividend of $5.50 per share, which was subsequently paid on January 15, 1998. As part of the recapitalization, the Company, in exchange for the proceeds from the Secured Notes (as defined below), sold to its wholly-owned subsidiary, Spell C, all its rights to the Cherokee brand and related trademarks in the United States and assigned to Spell C all of its rights in an amended licensing agreement (the "Amended Target Agreement") with Target Stores, a division of Dayton Hudson Corporation ("Target"). Spell C issued for gross proceeds of $47.9 million, privately placed Zero Coupon Secured Notes (the "Secured Notes"), yielding 7.0% interest per annum and maturing on February 20, 2004. The Secured Notes amortize quarterly from May 20, 1998 through February 20, 2004. The Secured Notes are secured by the Amended Target Agreement and the domestic Cherokee brand name and trademarks. The Secured Notes indenture (the "Indenture") requires that any proceeds due to Spell C under the Amended Target Agreement must be deposited directly into a collection account controlled by the trustee under the Indenture. The trustee will distribute from the collection account the amount of principal due and payable on the Secured Notes to the holders thereof on quarterly note payment dates. Excess amounts on deposit in the collection account may only be distributed to Spell C if the amount on deposit in the collection account exceeds the aggregate amount of principal due and payable on the next quarterly note payment date. Such excess amounts, if any, may then be distributed by Spell C to the Company. The minimum guaranteed royalty under the Amended Target Agreement is $9.0 million per year for each of the two fiscal years ending January 29, 1999 and 2000 and $10.5 million per year for each of the four fiscal years ending January 31, 2001 through 2004, therefore, the aggregate scheduled amortization under the Secured Notes ($60.0 million) equals the aggregate minimum guaranteed royalty payable under the Amended Target Agreement ($60.0 million). F-12 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) MATURITY SCHEDULE OF SECURED NOTES
FACE VALUE ----------- 1999......................................................... $ 6,750,000 2000......................................................... 9,000,000 2001......................................................... 10,125,000 2002......................................................... 10,500,000 2003......................................................... 10,500,000 Thereafter................................................... 13,125,000 ----------- Total.................................................... $60,000,000 Less unamortized Note Discount............................... 11,800,000 ----------- 42,800,000 Less current portion of long term debt....................... 6,525,000 ----------- Long term obligation......................................... $41,625,000
6. INCOME TAXES The income tax benefit as shown in the statements of operations includes the following:
SUCCESSOR PREDECESSOR SUCCESSOR COMPANY COMPANY COMPANY ------------------------------------ ------------ ------------ EIGHT MONTHS NINE MONTHS ENDED YEAR ENDED YEAR ENDED THREE MONTHS ENDED JANUARY 31, MAY 31, JUNE 1, ENDED FEBRUARY 25, 1998 1997 1996 JUNE 3, 1995 1995 ------------ ---------- ---------- ------------ ------------ Current: Federal............... $ 1,892,000 $ 96,000 $-- $ -- $ -- State................. 353,000 32,000 -- 100,000 -- Foreign............... 31,000 27,000 -- -- -- ----------- --------- ---- --------- ----------- 2,276,000 155,000 -- 100,000 -- Deferred: Federal............... (3,058,000) (785,000) -- (250,000) (3,355,000) State................. -- (141,000) -- (250,000) (1,875,000) Foreign............... -- -- -- -- -- ----------- --------- ---- --------- ----------- (3,058,000) (926,000) -- (500,000) (5,230,000) ----------- --------- ---- --------- ----------- $ (782,000) $(771,000) $-- $(400,000) $(5,230,000)
F-13 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Deferred income taxes are comprised of the following:
JANUARY 31, 1998 MAY 31, 1997 ------------------- ------------------- CURRENT NON-CURRENT CURRENT NON-CURRENT ------- ----------- ------- ----------- Deferred tax assets: Fixed assets.......................... -- -- -- -- Inventory reserve..................... -- -- -- -- Uniform capitalization................ -- -- -- -- Bad debt reserve...................... -- -- -- -- Accrued liabilities................... -- -- -- -- Tax effect of NOL carryovers.......... -- 9,110,000 -- 8,648,000 Other................................. -- 324,000 -- 218,000 Valuation allowance................... -- (1,858,000) -- (6,458,000) ---- ----------- ---- ----------- Total deferred tax assets......... $-- $ 7,576,000 $-- $ 2,408,000 ==== =========== ==== ===========
JUNE 1, 1996 JUNE 3, 1995 -------------------- ------------------------- CURRENT NON-CURRENT CURRENT NON-CURRENT ------- ------------ ----------- ------------ Deferred tax assets: Fixed assets................ -- -- -- 442,000 Inventory reserve........... -- -- 2,583,000 -- Uniform capitalization...... -- -- 418,000 -- Bad debt reserve............ -- -- 436,000 -- Accrued liabilities......... -- -- 967,000 -- Tax effect of NOL carryovers................. -- 10,624,000 -- 14,823,000 Other....................... -- 90,000 -- 232,000 Valuation allowance......... -- (10,714,000) (4,404,000) (15,497,000) ---- ------------ ----------- ------------ Total deferred tax assets................. $-- $ -- $ -- $ -- ==== ============ =========== ============
The Company's deferred tax asset is primarily related to net operating loss carryforwards. The Company believes that it is more likely than not that the majority of the deferred tax asset will be realized based upon the expected future income from the Amended Target Agreement. Accordingly, with the exception of the amount attributable to IRC Section 382 net operating losses (as described below) which cannot be utilized until after the Target Agreement expires, the valuation allowance has been reduced during the short period ended January 31, 1998. The reduction in the valuation allowance relating to pre-reorganization carryovers has been credited to additional paid-in-capital. F-14 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) A reconciliation of the actual income tax rates to the federal statutory rate follows:
PREDECESSOR SUCCESSOR COMPANY COMPANY ----------------------------------------------- ------------ EIGHT MONTHS NINE MONTHS ENDED YEAR ENDED YEAR ENDED THREE MONTHS ENDED JANUARY 31, MAY 31, JUNE 1, ENDED FEBRUARY 25, 1998 1997 1996 JUNE 3, 1995 1995 ------------ ---------- ---------- ------------ ------------ Tax (benefit) expense at U.S. statutory rate.... 34.0% 34.0% (34.0)% (34.0)% 34.0% Additional paid-in- capital................ 35.2 25.2 -- -- -- Net gain from extraordinary gain from extinguishment of debt not taxable............ -- -- -- -- (51.2) Net operating loss for which no tax benefit was recognized......... -- -- 34.0 33.9 12.5 Writedown of net deferred taxes......... -- -- -- (5.2) (21.0) Utilization of net operating loss carryforward........... -- (33.6) -- -- -- Valuation Allowance..... (93.8) (41.0) -- -- -- Foreign taxes........... .6 .5 -- -- -- Nondeductible reorganization costs... -- -- -- -- 4.7 State income tax benefit net of federal income tax.................... 4.8 .4 -- (3.1) -- Minority interest and others................. 3.2 1.4 -- .4 -- ----- ----- ----- ----- ----- Tax benefit............. (16.0)% (13.1)% -- (8.0)% (21.0)% ===== ===== ===== ===== =====
At January 31, 1998 the Company has federal and California tax net operating loss carryovers ("NOL's"), generated subsequent to the Company's 1994 reorganization, of approximately $14,900,000 and $5,300,000, respectively, which will begin to expire in 2010 and 2000, respectively. The Company believes utilization of these losses is not subject to Internal Revenue Code ("IRC") Section 382 limitations. As a result of the 1994 Plan discussed in Note 1, an ownership change occurred and the annual utilization of pre-reorganization NOL's and built-in losses (i.e. the tax bases of assets exceeded their fair market value at the date of the ownership change) has been substantially limited under IRC Section 382. The annual limitation amount, computed pursuant to IRC Section 382(1)(6), is approximately $780,000. Any unused IRC Section 382 annual loss limitation amount may be carried forward to the following year. Those unused limitation losses are then added to the current IRC Section 382 annual limitation amount. Given the IRC Section 382 limitations, a substantial portion of the pre reorganization losses will expire unused. Such deferred tax assets have been written off against the valuation allowance. 7. OPERATIONAL RESTRUCTURING CHARGE The operational restructuring charge of $3,165,000 which was taken in the three months ended June 3, 1995, covers the costs and charges of exiting from apparel and footwear manufacturing, importing and wholesaling businesses in order to implement the Company's new licensing strategy. Historically, the Company operated a wholesale licensing program; it licensed the Cherokee trademark to unaffiliated manufacturers for the production and marketing of apparel, footwear and accessories that the Company did not manufacture, import or market. The Company's current operating strategy includes retail direct licensing whereby the Company grants retailers the license to use the Cherokee trademark on certain categories of merchandise, including those products that the Company previously manufactured. Under its licensing operating strategy, the Company was transformed into a significantly smaller, more focused organization. F-15 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) The Company completed the transition out of the apparel and footwear manufacturing and importing businesses in November 1995. The $3,165,000 restructuring charge includes $614,000 in severance payments, $2,027,000 in writedowns of inventory to estimated realizable values, and $524,000 for cancellation of inventory orders, prepaid expenses, deposits and others. The Company's work force was reduced from approximately 165 on June 3, 1995 to approximately 15 by November 1, 1995. As of June 3, 1995, approximately $1,504,000 of the $3,165,000 was included in liability accounts and has since been paid. Revenues and gross profit for the Company's terminated businesses were $84,077,000 and $12,772,000 in Fiscal 1995. 8. COMMITMENT AND CONTINGENCIES LEASES The Company leases real property in Dallas Texas under a lease agreement expiring on February 28, 1998. The Company has no plans to renew the lease for these premises. Monthly rent is $1,496 plus operating expenses. The Company entered into a sublease agreement on August 30, 1995 with an unaffiliated third party. The term of this sublease is from September 1, 1995 to February 28, 1998. Sublessee is to pay rent of $1,280 per month for the property. From May 26, 1995 to October 31, 1997, the Company has rented approximately 1,500 square feet of office space from The Newstar Group d/b/a The Wilstar Group ("Wilstar") and paid Wilstar $.75 per square foot or $1,125 per month. In addition, the Company reimbursed Wilstar for one-half of certain costs relating to this office space. Beginning November 1, 1997, the Company increased its rental space to 3,685 square feet and currently pays Wilstar $2,762 in rent per month. The Company believes that its rental of such space from Wilstar is on terms no less favorable than could be obtained from an unaffiliated third party. The rent and costs are prorated based upon square footage used by Cherokee and Wilstar does not profit from this reimbursement. Since May 4, 1996, the Company has rented 4,000 feet of Wilstar's warehouse space at $.50 per square foot as storage space for its financial records. Both rental agreements are on a month to month basis. Total rent expense was $48,000, $60,000 and $198,000 for the eight months ended January 31, 1998 and the years ended May 31, 1997 and June 1, 1996, respectively. 9. NEW ACCOUNTING STANDARDS In June 1997, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting standards ("SFAS") No. 130 "Reporting Comprehensive Income," which establishes standards for reporting and displaying comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general-purpose financial statements. Comprehensive income includes net income and other comprehensive income components which under generally accepted accounting principles ("GAAP") bypass the income statement and are reported in the balance sheet as a separate component of equity. For the eight months ended January 31, 1998 and the three years ended May 31, 1997, June 1, 1996 and June 3, 1995, the Company had no other comprehensive income components as defined in SFAS No. 130. In June 1997, the FASB issued SFAS No. 131 "Disclosures About Segments of an Enterprise and Related Information," which changes current practice and established a new framework, referred to as the "management" approach, on which to base segment reporting. The management approach requires that management identify the "operating segments" based on the way that management disaggregates the entity for internal operating decisions. SFAS No. 131 is effective for fiscal years beginning after December 15, 1997 and F-16 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) is not required for interim statements in the first year of adoption. Management believes that the adoption of this new standard will not have any material impact on the Company's financial position or results of operations. Prior to implementing its strategy to change its business to that of a licensor, the Company was primarily engaged in the manufacturing, importing and the distribution of apparel and shoes; therefore, its business is within one industry segment. In February 1998, the FASB issued SFAS No. 132 "Employers' Disclosures About Pensions and Other Post-retirement Benefits" which revises employers' disclosures about pension and post-retirement benefit plans. This statement is effective for fiscal years beginning after December 15, 1997. This statement is not anticipated to have any effect on the Company. 10. EMPLOYMENT AND MANAGEMENT AGREEMENTS On April 24, 1995, a group which included Mr. Margolis (a former Chairman and Chief Executive Officer of the Company) acquired approximately 22.3% of the Company's then outstanding Common Stock (the "Group"). The Group sought to have Mr. Margolis installed as Chief Executive Officer of the Company and to have Mr. Margolis appointed a director of the Company. On May 4, 1995, the Company and Wilstar entered into a Management Agreement (the "Agreement") pursuant to which Wilstar agreed to provide executive management services to the Company by providing the services of Robert Margolis as Chief Executive Officer. The Agreement originally provided it would terminate on May 31, 1998; however, the Agreement provided an automatic extension for additional one-year terms as long as the Company's pre-tax earnings are equal to at least 80% of the pre-tax earnings contained in the budget submitted to and approved by the Board of Directors for such fiscal year. During Fiscal 1996, Wilstar met the 80% pre-tax earning requirement; hence, the contract was extended for an additional one year term. In addition, Wilstar received an option to purchase 7 1/2% of the Common Stock on a fully diluted basis (675,700 shares) at a purchase price of $3.00 per share (the "Wilstar Options"). The Wilstar options were exercised on December 29, 1997. Subsequent to the exercise date and pursuant to a redemption agreement entered into by all its principals, Wilstar transferred to each principal individually his pro-rata share of the Common Stock as consideration for redeeming his Wilstar shares. On April 24, 1996, the Board of Directors revised the Agreement to accelerate the vesting of Wilstar's performance options so that Wilstar was immediately vested in its right to purchase up to 20% of the Company's fully diluted Common Stock. Wilstar agreed to relinquish its rights to purchase up to an additional 2.5% of the Company's fully diluted stock pursuant to the performance options. Wilstar exercised the performance options in full on April 25, 1996 and purchased 1,674,739 shares. The Company accounted for this transaction as a non cash charge to earnings of $4,567,000. During Fiscal 1997, Wilstar transferred to its principals an aggregate of 874,739 shares of the Common Stock in satisfaction of principal and interest due on indebtedness, bonuses and Subchapter S distributions owed to its principals and shareholders. During Fiscal 1998, Wilstar transferred 17,500 shares of the Common Stock to certain employees and 384,386 shares of the Common Stock to its principals, whereby, pursuant to a redemption agreement, each principal received his pro-rata share individually as consideration for redeeming his Wilstar shares. The Agreement further provides that Wilstar and the Group each have the right to elect two members of the Company's Board of Directors. Effective for services rendered on or after June 1, 1997, the Compensation Committee and the Board of Directors amended the Agreement by the adoption of two amendments, designated, respectively, the Second Amendment and the Third Amendment. The changes to the Agreement made by the Second Amendment include (i) extension of the specified term of the Agreement to May 31, 2000; (ii) modification of the existing provision of the Agreement for automatic extension of its term for an additional year for each year after fiscal year 1997 in F-17 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) which the Company achieves specified levels of pre-tax earnings; (iii) increase in the annual base compensation of Wilstar from $400,000 to $550,000; (iv) provision for an annual cost-of-living increase in base compensation after fiscal year 1998; and (v) increase in the annual performance bonus percentage payable to Wilstar based on the Company's earnings before interest, taxes, depreciation and amortization above specified levels from 10% to 15% of such earnings in excess of $10,000,000. At January 31, 1998 and May 31, 1997, the Company had accrued the bonus payable under Other Accrued Liabilities. The Third Amendment, approved by a majority of shareholders on September 15, 1997 at the 1997 Annual Meeting, further provided changes to the Agreement including, (i) provision for payment of an "acquisition bonus" to Wilstar in the event of an acquisition of the Company for a price per share of not less than $12 pursuant to an acquisition agreement entered into by the end of fiscal year 2000 (the amount of such acquisition bonus ranges from $1,000,000 to $2,500,000 in the event of an acquisition of the Company for a price per share ranging from $12 to $15 or more and automatically decreases by one-third per year if the acquisition agreement is not entered into by the end of May 31, 1998, 1999, or 2000); and (ii) provision for payment of $3,000,000 to Wilstar in consideration for an agreement not to compete with the Company for a specified period of time by Wilstar and Mr. Margolis in the event of an acquisition of the Company pursuant to an acquisition agreement entered into by the end of May 31, 2000 (the amount of such payment automatically decreases by one-third per year if the acquisition agreement is not entered into by the end of May 31, 1998, 1999, or 2000); and (iii) provision for reduction of payments under the Agreement that are contingent on a change in control if it is determined that such payments would result in the nondeductibility of some or all of such payments under the provisions of Section 280G of the Internal Revenue Code. During the eight months ended January 31, 1998 and the year ended May 31,1997, the Company made compensation payments in lieu of cash dividends to Wilstar totalling $135,134 and $375,100, respectively. Mr. Margolis was employed pursuant to an employment agreement which would have expired on May 31, 1994. Under such agreement, Mr. Margolis would have received an annual salary of $780,550 during Fiscal 1994; Mr. Margolis was actually paid $345,140 in salary prior to his resignation. Mr. Margolis resigned all of his positions with the Company on October 31, 1993 and entered into a consulting agreement with the Company pursuant to which he agreed to make himself available as a consultant to the Company for a period of one year for a fee of $1,130,000 of which $880,000 was paid during Fiscal 1994. The $250,000 which was owed to Mr. Margolis became an unsecured creditor's claim in the Company's 1994 Plan; Mr. Margolis received the same treatment as all other unsecured creditors and received 15,259 shares of the Company's Common Stock in full satisfaction of such claim. Mr. Seyhun, the former Chief Operating Officer and the former Chief Financial Officer of the Company, was employed pursuant to a 28 month agreement expiring May 31, 1997. In connection with the agreement on February 1, 1995, Mr. Seyhun purchased 96,000 shares of Common Stock from the Company at a price of $2.00 per share. Mr. Seyhun paid for these shares with a $192,000, 7% Promissory Note for which $48,000 was paid in May 1996. Proceeds from the sale of such stock must be applied first to accrued and unpaid interest and then to unpaid principal. The note was recorded as a reduction to stockholders equity. Mr. Seyhun repaid the note in full on February 19, 1997. Mr. Seyhun also received an option to purchase 96,000 shares for a price of $2.00 per share which was cancelled upon termination of his employment agreement. Mr. Seyhun terminated his employment on January 5, 1996. Mr. Seyhun paid the remaining principal and interest on the Promissory Note on February 19, 1997. Ms. Warren, the former President of the Company, who resigned March 3, 1998, was employed pursuant to a three-year agreement expiring on May 30, 1998 which provided for a salary at an annual rate of $100,000 from June 21, 1995 to May 31, 1996 and $325,000 from June 1, 1996 to May 31, 1998. Ms. Warren will continue F-18 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) to work with the Company on selected special projects through November 1998 and will be paid through December 4, 1998. Ms. Warren could earn bonuses ranging from 10% of her salary up to $175,000 based upon the Company's earnings before interest and taxes. 11. RELATED PARTY TRANSACTIONS On December 23, 1997 the Company loaned $2.0 million to Robert Margolis, who is a Director, the Chairman of the Board of Directors and the Chief Executive Officer of the Company. The loan was approved by a majority of the disinterested members of the Company's Board of Directors on December 19, 1997. Mr. Margolis executed a note, dated December 23, 1997, in favor of the Company for $2.0 million which yields 6.0% interest per annum, which has been recorded as a reduction to stockholders' equity on the January 31, 1998 Balance Sheet. The principal amount of the note and all accrued interest thereon is due and payable on December 23, 2002. The note may be repaid in whole or in part at any time without penalty. In connection with the Securitization and issuance of the Secured Notes, the Company paid to Libra Investments, Inc. ("Libra") fees totaling $1,432,000. Mr. Jess Ravich, the Chairman of Libra, is a member of the Board of Directors of the Company. In fiscal years ended May 31, 1997 and June 1, 1996, Wilstar purchased apparel and trim from the Company totalling $87,000 and $154,000, respectively. 12. WARRANTS AND OPTIONS On February 1, 1995, the Company granted warrants to purchase 5,000 shares of Common Stock at an exercise price of $2.43 to each of the Company's five outside directors of the Board. On July 25, 1995, the Company granted warrants to purchase 5,000 shares of Common Stock at an exercise price of $3.00 to any new outside directors of the Board. The warrants expire on January 31, 2000 and June 30, 2000, respectively. On April 25, 1996 two Board members exercised their warrants in full and each purchased 5,000 shares. On various dates during Fiscal 1997, five Board members exercised their warrants in full and each purchased 5,000 shares. During Fiscal 1998, two Board members exercised their warrants in full and each purchased 5,000 shares. On October 14, 1996, the Company granted options to purchase 10,000 shares of Common Stock at an exercise price of $5.50 to each of the Company's seven directors of the Board. On various dates during Fiscal 1997, five Board members exercised their options in full and each purchased 10,000 shares. During Fiscal 1998, two Board members exercised their options in full and each purchased 10,000 shares. On September 15, 1997, the Company granted options to purchase 5,000 shares of Common stock at an exercise price of $11.25 to each of the Company's six directors of the Board. The Company granted options to purchase 20,000 shares of Common Stock at an exercise price of $11.25 to one retiring director. The option plan provided an adjustment to the exercise price, in the event the Company distributed to all shareholders an extraordinary dividend. The option grants were adjusted from 5,000 and 20,000 shares to 8,277 and 33,109 shares, respectively, and the exercise price was adjusted from $11.25 to $6.80 per share in accordance with Internal Revenue Code Section 425. The adjustment did not result in a compensation charge to earnings. None of the directors exercised any of these options during Fiscal 1998. F-19 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 13. STOCK OPTION PLAN The Company's 1995 Incentive Stock Option Plan (the "Plan") was approved at the October 30, 1995 Annual Meeting of Stockholders. The purpose of the Plan is to further the growth and development of the Company by providing an incentive to officers and other key employees who are in a position to contribute materially to the prosperity of the Company. Two types of stock options (the "Option") may be granted under the plan--Incentive and Non- Qualified stock options. Any employee is eligible to receive an Option under the Plan; provided, however that no person who owns stock possessing more than 10% of the total combined voting power of all classes of stock of the Company shall be eligible to receive an Incentive Stock Option unless at the time such Option is granted the Option price is at least 110% of the fair market value of the shares subject to the Option. The aggregate number of shares which may be issued upon the exercise of Options granted under the Plan shall not exceed 600,000 shares of Common Stock. The Options are vested in equal installments over a three year period, starting from the date of grant and have a term of ten years. On November 10, 1997, the Compensation Committee determined to grant Options to certain of its employees pursuant to the Company's Plan. The Board of Directors adopted an amendment to the Plan, pursuant to which any Option granted shall provide that upon the Company's payment of an extraordinary cash dividend to the Company's shareholders, the exercise price of each of the Options shall be adjusted in accordance with Section 7.13 of the Plan. Pursuant to the Company's declaration of the $5.50 dividend, on December 29, 1997 and January 2, 1998, certain directors, officers, employees and related parties exercised options and purchased 819,004 shares of Cherokee common stock. The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related Interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under SFAS 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, when the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is recognized. During the fiscal year ended May 31, 1997, the Board of Directors adopted a plan for compensation of officers of the Company, employees of the Company, and Wilstar in lieu of cash dividends. If and when cash dividends are paid on outstanding shares of common stock of the Company, compensation will be paid to each plan participant in an amount equal to the cash dividends which would have been paid on the vested option shares covered by stock options of the Company held by such participant as if such shares had been purchased by such participant prior to, and were outstanding and owned by such participant on, the record date and the payment date for such cash dividend. The plan began on January 15, 1997 and will terminate on December 31, 1998 or such earlier or later date as may be determined by the Board of Directors. During the eight months ended January 31, 1998 and the year ended May 31, 1997, an aggregate of $150,801 and $391,850, respectively, was paid to participants in the plan. Pro forma information regarding net income and earnings per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of SFAS 123. The fair value for these options was estimated at the date of grant using a Black- Scholes option pricing model with the following weighted-average assumptions for 1996 and 1997: weighted-average risk-free interest F-20 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) rate range between 5.27% and 6.57%; dividend yields of 12.80%; weighted- average volatility factors of the expected market price of the Company's common stock of 99.24%; and a weighted average expected life of the option of three years. For 1998, the weighted average assumptions were as follows: weighted-average risk-free interest rate range between 5.80% and 6.35%; dividend yields of 7.50%; weighted-average volatility factors of the expected market price of the Company's common stock of 68.97%; and a weighted-average expected life of the option of three years. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimates, in the management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
1998 1997 1996 ---------- ---------- ----------- Pro Forma net income (loss)................. $5,179,000 $6,546,000 $(1,502,000) Pro Forma basic earnings (loss) per share... $ 0.66 $ 0.85 $ (0.23) Pro Forma diluted earnings (loss) per share. $ 0.62 $ 0.80 $ (0.22)
A summary of the Company's stock option activity, and related information for the eight months ended January 31, 1998 and the years ended May 31, 1997 and June 1, 1996 follows:
1998 1997 1996 ------------------------- ----------------------- ----------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE ------- -------------- ------- -------------- ------- -------------- Outstanding at beginning of year................ 180,000 $3.91 180,000 $3.29 -- $.00 Granted............... 480,083(1) 9.46(1)(2) 35,000 6.25(1) 210,000 3.27(1) Exercised............. 180,000 3.91 (20,000) 3.03 (10,000) 3.00 Forfeited............. -- -- (15,000) 3.13 (20,000) 3.00 ------- ----- ------- ----- ------- ---- Outstanding at end of year................... 480,083 9.46 180,000 3.91 180,000 3.29 ======= ===== ======= ===== ======= ==== Exerciseable at end of year................... 78,635 9.46 45,003 3.35 -- --
- -------- (1) Weighted average grant date fair value of options granted during the year (2) The Options have exercise prices and become exercisable in four installments upon the following dates, subject to the optionee's continued employment by the Company on each vesting date installments: (i) 25% of the number of shares vest immediately with an adjusted exercise price of $8.15, (ii) 25% of the number of shares vest November 10, 1998 with an adjusted exercise price of $8.97, (iii) 25% of the number of shares vest November 10, 1999 with an adjusted exercise price of $9.86 and (iv) 25% of the number of shares vest November 10, 2000 with an adjusted exercise price of $10.85. As a result of the Company's payment of an extraordinary cash dividend to the Company's shareholders, the exercise price of each of the Options has been adjusted in accordance with Section 7.13 of the Plan. F-21 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 14. SALE OF UNIFORM DIVISION On July 28, 1995, the Company sold the Uniform Division to Strategic Partners, Inc. ("Strategic Partners"), a corporation which was formed by Michael Singer and investors unaffiliated with Cherokee. Mr. Singer was the President of Cherokee's Uniform Division until the sale of the Uniform Division and is the President and Chief Executive Officer of Strategic Partners. The assets sold included accounts receivable, inventory, furniture and fixtures, equipment, and the exclusive right to use the Cherokee trademark with respect to the manufacture and sale of uniforms. The sales price was approximately $11,700,000, which was $4,000,000 greater than the book value of the assets that were sold. Of the purchase price, approximately $9,575,000 was paid in cash and $2,125,000 was paid by a 10% subordinated promissory note ("Note"). The Company has recorded the Note at its estimated fair value of $1,588,000, which represents a discount of $537,000, resulting in an effective interest rate of 16%. The Note requires quarterly payments of interest and principal payments of $300,000 on July 27, 1997, 1998, 1999 and 2000 with the remaining principal amount due on July 27, 2001. On April 3, 1997, Strategic Partners and the Company negotiated a 10% discount to pay off the $2,125,000 note due 2001. Strategic Partners delivered a payment of $1,912,500 on May 14, 1997 in full satisfaction of the note. 15. SUBSEQUENT EVENT On March 3, 1998, the Company announced the resignation of Patricia Warren as President of the Company. She will continue to work with the Company through 1998 in selected special projects. Mr. Margolis will assume Ms. Warren's responsibilities until a new president is chosen. On April 6, 1998, the Company announced that its Board of Directors had declared a cash dividend of $0.50 per share to be distributed on May 1, 1998 to the Company's shareholders of record on the close of business on April 17, 1998. Assuming the Company's cash position continues to be favorable, the Company intends to maintain a quarterly cash dividend of $0.25 per share for the balance of the fiscal year ending January 30, 1999; however, the declaration of such dividends remains subject to the discretion of the Company's Board. F-22 CHEROKEE INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) CHEROKEE INC. SCHEDULE II VALUATIONS AND QUALIFYING ACCOUNTS AND RESERVES
CHARGED/ BALANCE AT (CREDITED) TO CHARGED TO BALANCE AT BEGINNING COSTS AND OTHER END DESCRIPTION OF PERIOD EXPENSES ACCOUNTS DEDUCTIONS OF PERIOD ----------- ----------- ------------- ----------- ---------- ----------- DEDUCTED FROM ASSETS TO WHICH THEY APPLY: ALLOWANCE FOR DOUBTFUL ACCOUNTS Year ended Jan 31, 1998................. $ -- $ -- $ -- $ -- $ -- Year ended May 31, 1997................. $ 591,000 $ (112,000) $ -- $ 479,000(1) $ -- Year ended June 1, 1996................. $ 1,006,000 $ 112,000 $ -- $ 527,000(1) $ 591,000 Year ended June 3, 1995................. $ 2,885,000 $1,602,000 $ -- $3,481,000(1) $ 1,006,000 INVENTORY RESERVE Year ended Jan 31, 1998................. $ -- $ -- $ -- $ -- $ -- Year ended May 31, 1997................. $ -- $ -- $ -- $ -- $ -- Year ended June 1, 1996................. $ 6,011,000 $ -- $ -- $6,011,000 $ -- Year ended June 3, 1995................. $ 2,146,000 $3,865,000 $ -- $ -- $ 6,011,000 TAX VALUATION ALLOWANCE Year ended Jan 31, 1998................. $ 6,458,000 $2,559,000 $ 2,041,000 $ -- $ 1,858,000 Year ended May 31, 1997................. $10,714,000 $2,408,000 $ 1,848,000 $ -- $ 6,458,000 Year ended June 1, 1996................. $19,901,000 $ -- $ 5,702,000 $3,485,000 $10,714,000 Year ended June 3, 1995................. $ -- $ -- $19,901,000 $ -- $19,901,000
- -------- (1) Uncollectible accounts receivable written off against the allowance. F-23 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item with respect to directors and compliance with Section 16(a) of the Exchange Act is incorporated herein by reference to the information contained in the Proxy Statement relating to the Company's Annual Meeting of Stockholders scheduled to be held on June 8, 1998, which will be filed with the SEC no later than 120 days after the close of the Eight Months Fiscal Period ended January 31, 1998. The following table sets forth information with respect to each of the Company's executive officers.
NAME, AGE AND PRINCIPAL OCCUPATION FOR PAST FIVE YEARS; PRESENT POSITION WITH THE COMPANY BUSINESS EXPERIENCE --------------------------------- ----------------------------------------- Robert Margolis, 50 Mr. Margolis was appointed Chairman of the Board Director, Chairman of the Board of and Chief Executive Officer of the Company on Directors and Chief Executive Officer May 5, 1995. Mr. Margolis was the co-founder of the Company's Apparel Division in 1981. He had been the Co-Chairman of the Board of Directors, President and Chief Executive Officer of the Company since June 1990 and became Chairman of the Board on June 1, 1993. Mr. Margolis resigned all of his positions with the Company on October 31, 1993 and entered into a one-year consulting agreement with the Company. Since 1994 Mr. Margolis has been Chief Executive Officer and a Director of a privately owned company operates various textiles and apparel related enterprises, including a private label manufacturing operation. Wilstar's private label manufacturing operations were sold to an unrelated party in April 1997. Wilstar provides Mr. Margolis' services as Chief Executive Officer of the Company pursuant to the terms of a management agreement between the Company and Wilstar (the "Wilstar Management Agreement"). Patricia Warren, 51 Ms. Warren has been employed by Cherokee since President May 1995 and became its President on June 21, 1995. Ms. Warren resigned as President on March 3, 1998, but will continue to work with the Company on selected projects through the end of 1998. From October 1989 to May 1993 she was Senior Vice President and General Merchandise Manager of The Bon Marche, a division of Federated Department Stores. From May 1993 to May 1994, she was Executive Vice President, Merchandising for The Broadway Department Stores. From September 1994 until May 1995, she was an independent consultant to wholesalers and retailers.
24
NAME, AGE AND PRINCIPAL OCCUPATION FOR PAST FIVE YEARS; PRESENT POSITION WITH THE COMPANY BUSINESS EXPERIENCE --------------------------------- ----------------------------------------- Carol Gratzke, 49 Ms. Gratzke returned to Cherokee in November Chief Financial Officer 1995 as its Chief Financial Officer. From August 1986 to July 1994, she was the Controller and, for a portion of such period, the Chief Financial Officer of the Apparel & Uniform Divisions. From July 1994 to September 1995, she was Executive Vice President of Finance for a Los Angeles based apparel manufacturing company.
ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated herein by reference to the information contained in the Proxy Statement relating to the Company's Annual Meeting of Stockholders scheduled to be held on June 8, 1998, which will be filed with the SEC no later than 120 days after the close of the Eight Month Fiscal Period ended January 31, 1998. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated herein by reference to the information contained in the Proxy Statement relating to the Company's Annual Meeting of Stockholders scheduled to be held on June 8, 1998, which will be filed with the SEC no later than 120 days after the close of the Eight Month Fiscal Period ended January 31, 1998. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this Item is incorporated herein by reference to the information contained in the Proxy Statement relating to the Company's Annual Meeting of Stockholders scheduled to be held on June 8, 1998, which will be filed with the SEC no later than 120 days after the close of the Eight Month Fiscal Period ended January 31, 1998. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) The List of Financial Statements are filed as Item 8 of Part II of this Form 10-K. (2) List of Financial Statement Schedules. II. Valuations and Qualifying Accounts and Reserves [included in the Financial Statements filed as Item 8 of Part II of this Form 10-K]. (3) List of Exhibits. The exhibits listed in the accompanying Index to Exhibits are filed as part of this Form 10-K. 25
EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------- ---------------------- 2.1 Plan of Reorganization of Cherokee Inc. as confirmed on December 14, 1994 (incorporated by reference from Exhibit 2.1 to Cherokee Inc.'s Current Report on Form 8-K dated January 5, 1995). 3.1 Amended and Restated Certificate of Incorporation of Cherokee Inc. (incorporated by reference from Exhibit 3.1 of Cherokee Inc.'s Form 10 dated April 24, 1995). 3.2 Bylaws of Cherokee Inc. (incorporated by reference from Exhibit 3.2 of Cherokee Inc.'s Form 10 dated April 24, 1995). 4.1 Financing Agreement dated as of December 23, 1994, between Cherokee Inc. and The CIT Group/Business Credit, Inc. (incorporated by reference from Exhibit 4.1 of Cherokee Inc.'s Form 10 dated April 24, 1995). 4.2 Amendment to Financing Agreement dated June 2, 1995 between Cherokee Inc. and The CIT Group/Business Credit Inc. (incorporated by reference from Exhibit 4.1 of Cherokee Inc.'s Form 10 dated April 24, 1995). 4.3 Indenture, dated December 23, 1997, among SPELL C. LLC, as issuer, and Wilmington Trust Company, as trustee, with respect to the Zero Coupon Secured Notes. 4.4 Security Agreement dated December 23, 1997, between SPELL C. LLC and Wilmington Trust Company. 10.1 Form of Director Warrant (incorporated by reference from Exhibit 10.3 of Cherokee Inc.'s Form 10 dated April 24, 1995). 10.2 Management Agreement dated as of May 4, 1995 between Cherokee Inc. and The Newstar Group Inc., d/b/a The Wilstar Group ("Wilstar") (incorporated by reference from Exhibit 10.5 of Cherokee Inc.'s Form 10-K dated June 3, 1995). 10.3 Option Agreement dated as of May 4, 1995 between Cherokee Inc. and Wilstar (incorporated by reference from Exhibit 10.5 of Cherokee Inc.'s Form 10-K dated June 3, 1995). 10.4 Registration Rights Agreement dated as of May 4, 1995 between Cherokee Inc. and Wilstar (incorporated by reference from Exhibit 10.6 of Cherokee Inc.'s Form 10-K dated June 3, 1995). 10.5 Amendment No. 1 to the Non-Qualified Stock Option Agreement dated October 30, 1995. (incorporated herein by reference from Exhibit 10.7 of Cherokee Inc.'s Form 10-K dated June 1, 1996). 10.6 Amendment No. 2 to the Non-Qualified Stock Option Agreement dated March 23, 1996. (incorporated herein by reference from Exhibit 10.7 of Cherokee Inc.'s Form 10-K dated June 1, 1996). 10.7 Amendment No. 1 to the Revised and Restated Wilstar Management Agreement dated April 26, 1996. (incorporated herein by reference from Exhibit 10.7 of Cherokee Inc.'s Form 10-K dated June 1, 1996). 10.8 Asset Purchase Agreement dated July 17, 1995 between Cherokee Inc. and Strategic Partners, Inc. (incorporated herein by reference from Exhibit 2.1 to Cherokee Inc.'s Current Report on Form 8-K dated August 10, 1995). 10.9 Stock Purchase Agreement dated July 28, 1995 between Cherokee Inc. and Axicom Capital Group (incorporated by reference from Exhibit 10.8 of Cherokee Inc.'s Form 10-K dated June 3, 1995). 10.10 License Agreement between Cherokee Inc. and Target Stores, a division of Dayton-Hudson Corporation, dated August 15, 1995 (incorporated by reference from Exhibit 10.9 of Cherokee Inc.'s Form 10-K dated June 3, 1995).
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EXHIBIT NUMBER DESCRIPTION OF EXHIBIT ------- ---------------------- 10.11 Amendment No. 2 to the Revised and Restated Wilstar Management Agreement dated July 21, 1997 (incorporated by reference from Exhibit 10.11 of Cherokee Inc.'s Form 10-K dated May 31, 1997). 10.12 Amendment No. 3 to the Revised and Restated Wilstar Management Agreement dated July 21, 1997 (incorporated by reference from Exhibit 10.12 of Cherokee Inc.'s Form 10-K dated May 31, 1997). 10.13 Plan for Compensation in Lieu of Cash Dividends, dated January 15, 1997 (incorporated by reference from Exhibit 10.13 of Cherokee Inc.'s Form 10-K dated May 31, 1997). 10.14 Agreement of Purchase and Sale of Trademarks and Licenses between Cherokee Inc. and Sideout Sport, Inc. dated November 7, 1997 (incorporated by reference from Exhibit 2.1 of Cherokee Inc.'s Current Report on Form 8-K dated November 7, 1997). 10.15 License Agreement between Cherokee Inc. and Dayton Hudson Stores dated November 12, 1997 (incorporated by reference from Exhibit 10.1 of Cherokee Inc.'s Current Report on Form 8-K dated November 7, 1997). 10.16 Note Purchase Agreement dated December 23, 1997, between SPELL C. LLC and the purchasers listed on the signature pages thereto. 10.17 Trademark Purchase and License Assignment Agreement dated December 23, 1997 between SPELL C. LLC and Cherokee Inc. 10.18 Administrative Services Agreement dated December 23, 1997, between SPELL C. LLC and Cherokee Inc. 10.19 Limited Liability Company Agreement of SPELL C. LLC dated as of December 23, 1997, between SPELL C. LLC and Cherokee Inc. 16.1 Letter of Ernst & Young L.L.P. regarding change in accountants (incorporated herein by reference from Exhibit 16.1 to Cherokee Inc.'s Current Report on Form 8-K dated June 5, 1995). 21.1 Subsidiaries of Cherokee Inc. 23.1 Consent of Independent Auditors dated April 20, 1998. 27.1 Article 5 of Regulation S-X--Financial Data Schedule
(b) Reports on Form 8-K. On December 23, 1997, the Company filed a report on Form 8-K regarding (1) the Board of Director's declaration of the January 15, 1998 cash dividend of $5.50, (2) the completion of a leveraged recapitalization and (3) the change in the Company's fiscal year end. 27 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. CHEROKEE INC. /s/ Robert Margolis By----------------------------------- Robert Margolis Chairman and Chief Executive Officer Date: April 20, 1998 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Robert Margolis Chairman and Chief Executive April 20, 1998 - ----------------------------- Officer and Director Robert Margolis /s/ Carol Gratzke Chief Financial Officer/Chief April 20, 1998 - ----------------------------- Accounting Officer Carol Gratzke /s/ Timothy Ewing Director April 20, 1998 - ----------------------------- Timothy Ewing /s/ Keith Hull Director April 20, 1998 - ----------------------------- Keith Hull /s/ Douglas Weitman Director April 20, 1998 - ----------------------------- Douglas Weitman /s/ Jess Ravich Director April 20, 1998 - ----------------------------- Jess Ravich /s/ Avi Dan Director April 20, 1998 - ----------------------------- Avi Dan
28 EX-4.3 2 INDENTURE DATED AS OF DECEMBER 23, 1997 CONFORMED COPY INDENTURE dated as of December 23, 1997 between SPELL C. LLC, Issuer and WILMINGTON TRUST COMPANY, Trustee __________________________________ Zero Coupon Secured Notes TABLE OF CONTENTS
Page ---- ARTICLE 1 Definitions Section 1.01. Definitions 3 Section 1.02. Rules of Construction 13 Section 1.03. Legal Holidays 13 ARTICLE 2 Issue, Execution, Form and Registration of Notes Section 2.01. Authentication and Delivery of Notes 13 Section 2.02. Execution of Notes 14 Section 2.03. Certificate of Authentication 14 Section 2.04. Form, Denomination and Date of the Notes 14 Section 2.05. Payment of Notes 15 Section 2.06. Registration, Transfer or Exchange of Notes 16 Section 2.07. Replacement of Lost, Mutilated or Stolen Notes 19 Section 2.08. Tax Purposes 19 Section 2.09. Cancellation 19 Section 2.10. Quarterly Report 19 ARTICLE 3 The Collection Account Section 3.01. Collection Account 20 Section 3.02. Distribution of Amounts on Deposit in the Collection Account on the Closing Date 20 Section 3.03. Distribution of Amounts on Deposit in the Collection Account on Note Payment Dates 20 Section 3.04. Distribution of Excess Amounts on Deposit in the Collection Account 21 Section 3.05. Other Existing Licenses 21 Section 3.06. Investments in the Collection Account 21
Page ---- ARTICLE 4 Reserve Account Section 4.01. Reserve Account 22 Section 4.02. Withdrawals from the Reserve Account 23 Section 4.03. Investments in the Reserve Account 23 ARTICLE 5 Information ARTICLE 6 Inspection of Books and Records ARTICLE 7 Covenants of the Issuer Section 7.01. Payment of Principal and Make-Whole Amount 26 Section 7.02. Legal Existence; Payment of Taxes; Compliance with Laws 26 Section 7.03. Consolidation or Merger 27 Section 7.04. Protection of Trust Estate 27 Section 7.05. Performance under the Basic Documents 28 Section 7.06. Negative Covenants 28 ARTICLE 8 Events of Default Section 8.01. Events of Default 29 Section 8.02. Application of Proceeds 32 Section 8.03. Waiver of Past Specified Events 33 Section 8.04. Provisions Relating to the Trust Estate 33 ARTICLE 9 Satisfaction and Discharge of Indenture; Unclaimed Moneys Section 9.01. Satisfaction and Discharge of Indenture 37 Section 9.02. Application by Trustee of Funds Deposited for Payment of Notes 37
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Page ---- Section 9.03. Repayment of Moneys and Transfer of Eligible Investments Held by Trustee 38 Section 9.04. Return of Moneys Held by Trustee 38 ARTICLE 10 Concerning the Trustee Section 10.01. Duties of the Trustee; Certain Rights of the Trustee 38 Section 10.02. Trustee Not Liable for Trademark Licenses; Performance of Trustee's Duties 40 Section 10.03. Resignation and Removal; Appointment of Successor Trustee 41 Section 10.04. Acceptance of Appointment by Successor Trustee 42 Section 10.05. Merger or Consolidation of Trustee 42 Section 10.06. Certain Procedural Matters 42 Section 10.07. Trustee Fees and Indemnification 43 Section 10.08. Information 43 ARTICLE 11 Supplemental Indenture Section 11.01. Supplemental Indenture Without Consent of Noteholders 44 Section 11.02. Supplemental Indenture with Consent of Noteholders 44 Section 11.03. Effect of Supplemental Indenture 45 Section 11.04. Documents to Be Given to Trustee 45 Section 11.05. Notation on Notes in Respect of Supplemental Indenture 45 ARTICLE 12 Concerning the Holders Section 12.01. Control by Majority Holders 46 Section 12.02. Evidence of Action Taken by Holders 46 Section 12.03. Proof of Execution of Instruments 46 Section 12.04. Notes Owned by the Issuer 47 Section 12.05. Right of Revocation of Action Taken 47 Section 12.06. Right to Vote Notes in Part 47
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Page ---- ARTICLE 13 Redemption of Notes Section 13.01. Optional Redemptions 47 Section 13.02. Notice of Redemption; Make-Whole Computations 47 Section 13.03. Surrender of Notes; Notation Thereon 48 Section 13.04. Purchase of Notes 48 ARTICLE 14 Miscellaneous Section 14.01. Binding Upon Assigns 48 Section 14.02. Notices 48 Section 14.03. Effect of Headings 50 Section 14.04. Severability 50 Section 14.05. Counterparts 50 Section 14.06. Further Assurance 50 Section 14.07. Governing Law 50 Section 14.08. Limitation on Recourse 50 Section 14.09. Jurisdiction and Process 50 Schedule I - Note Payment Dates Exhibit A - Form of Note Exhibit B - Form of Transferee Certificate Exhibit C - Form of Transferor Certificate
iv INDENTURE, dated as of December 23, 1997 (this "INDENTURE"), between SPELL C. LLC, a Delaware limited liability company (together with its successors, the "ISSUER"), and Wilmington Trust Company, a Delaware banking corporation, in its capacity as indenture trustee (the "TRUSTEE"), providing among other things for the issuance by the Issuer of $60,000,000 aggregate principal amount of its Zero Coupon Secured Notes (the "NOTES"). W I T N E S S E T H: WHEREAS, Cherokee, Inc., a Delaware corporation ("CHEROKEE"), and Dayton Hudson Corporation, a Delaware corporation ("LICENSEE"), entered into a License Agreement dated as of November 12, 1997 (the "LICENSE AGREEMENT"), whereby Cherokee granted Licensee certain rights to use the Trademark, as such term is defined below; WHEREAS, the Issuer is a bankruptcy-remote limited purpose entity whose sole member is Cherokee; WHEREAS, the Issuer and Cherokee have entered into a Trademark Purchase and License Assignment Agreement dated as of the date hereof (together with the license from SPV to Cherokee entered into pursuant to Section 4.01 thereof, the "TRADEMARK PURCHASE AND LICENSE ASSIGNMENT AGREEMENT"), whereby Issuer will purchase on the Closing Date with the proceeds of the Notes the Assigned Rights (as defined therein) from Cherokee and Cherokee will sell and assign the Assigned Rights to Issuer; WHEREAS, the Issuer has authorized an issue of Zero Coupon Secured Notes in an aggregate principal amount of $60,000,000, the proceeds of which will be used to finance the purchase of the Assigned Rights from Cherokee; WHEREAS, the Notes will be secured by all of the Issuer's right, title and interest in the Assigned Rights and other collateral pledged by the Issuer, pursuant to this Indenture and the Security Agreement between the Issuer and the Trustee dated as of the date hereof; WHEREAS, the execution and delivery of this Indenture have been duly authorized by the Issuer; WHEREAS, the Trustee hereunder has accepted the trusts created by this Indenture and in evidence thereof has joined in the execution hereof; and WHEREAS, all things necessary to make the Notes when issued by the Issuer and authenticated by the Trustee hereunder as in this Indenture provided the legal, valid and binding obligations of the Issuer and to provide a security interest in the Trust Estate (as hereinafter defined) have been done and performed. NOW, THEREFORE, THIS INDENTURE WITNESSETH, that in consideration of the premises, of the acceptance by the Trustee of the trusts hereby created, and of the purchase and acceptance of the Notes by the owners thereof, the receipt and sufficiency of which is hereby acknowledged, and for the purpose of fixing and declaring the terms and conditions upon which the Notes are to be issued, authenticated, delivered, secured and accepted by all Persons who shall from time to time be or become owners thereof, and in order to secure the payment of principal of all the Notes at any time issued and outstanding and interest, if any, and Make-Whole Amount, if any, thereon according to their tenor, purpose and effect, and in order to secure the performance and observance of all the covenants, agreements and conditions contained therein, herein and in the other Basic Documents and all Secured Obligations, the Issuer has executed and delivered this Indenture and has Granted and does hereby Grant, pledge, assign, transfer and convey to the Trustee hereunder on and subject to the terms set forth in this Indenture: GRANTING CLAUSES: A security interest by way of a lien over, a pledge of and a lien on all right, title and interest of the Issuer, whether now owned or hereafter acquired, in, to and under (a) all moneys and securities including, without limitation, all Eligible Investments (as hereinafter defined) from time to time held by, or on behalf of, the Trustee under the terms of this Indenture, including amounts set apart and transferred to any of the Trust Accounts (as hereinafter defined) and all investment earnings of any of the foregoing, subject to and until disbursements from the Trust Accounts in accordance with the provisions of this Indenture; (b) the Assigned Rights; (c) all other Trademark Collateral (as defined in the Security Agreement); (d) the Trademark Purchase and License Assignment Agreement and the Administrative Services Agreement (including the right (but not the obligation) to make requests, give consents and take other actions on behalf of the Issuer, all as permitted or required thereunder); (e) any and all other property of every kind and nature from time to time which was heretofore or hereafter is by delivery or by writing of any kind conveyed, mortgaged, pledged, assigned or transferred, as and for additional security hereunder, by the Issuer or by any other Person, with or without the consent of the Issuer, to the Trustee, which is hereby authorized to receive any and all such property at any time and at all times to hold and apply the same subject to the terms hereof, subject to and until disbursed from the Trust Accounts in accordance with the provisions of this 2 Indenture; and (f) all proceeds of any of the foregoing, subject to and until disbursed from the Trust Accounts in accordance with the provisions of this Indenture. Except as contemplated by the definition of Trademark License, the Trust Estate does not include any interest in the Cherokee Licenses. TO HAVE AND TO HOLD all the same absolutely with all privileges and appurtenances hereby conveyed, transferred and assigned, or agreed or intended so to be (collectively, the "TRUST ESTATE"), to the Trustee hereunder and its successors as trustee and to them and their assigns for the benefit of the Noteholders until such time as the Notes and all Secured Obligations payable with respect thereto are paid in full in accordance with Article 9 hereof; IN TRUST NEVERTHELESS, upon the terms and trusts herein set forth for the equal and proportionate benefit, security and protection of all Holders of the Notes issued under and secured by this Indenture without privilege, priority or distinction as to lien or otherwise of any of the Notes over any of the other Notes, except as otherwise expressly provided in this Indenture, and for the benefit, security and protection of the Noteholders, and the Trustee, with respect to the payment of all amounts payable to the Noteholders or the Trustee out of the Trust Accounts to the extent provided in this Indenture; provided, however, that if the Issuer, its successors or assigns, shall pay, or cause to be paid, the applicable principal of, default interest, if any, on, and Make- Whole Amount, if any, in respect of the Notes and all other Secured Obligations at the times and in the manner provided in the Notes and in the other Basic Documents according to the true intent and meaning thereof and there shall be made all the payments into the Trust Accounts as required under this Indenture, and shall pay to the Trustee all sums of money due or to become due to it in accordance with the terms and provisions hereof, and if all amounts payable to the Noteholders and the Trustee, to the extent provided in this Indenture shall have been paid in full, then upon such final payments this Indenture and the rights hereby granted shall cease, determine and be void; otherwise, this Indenture shall be and remain in full force and effect. ARTICLE 1 Definitions Section 1.01. Definitions. The following terms, as used herein, have the following meanings: 3 "ADMINISTRATIVE SERVICES AGREEMENT" means the Administrative Services Agreement dated as of the date hereof between the Issuer and Cherokee. "AFFILIATE" means with respect to any Person, any Person that directly or indirectly through one or more intermediaries, controls such Person, is controlled by such Person or is under direct or indirect common control with such Person. As used herein, the term "CONTROL" means possession, directly or indirectly, of the power to direct or cause the direction of the management or policies of a Person, whether through the ownership of voting securities, by contract or otherwise. "ASSIGNED RIGHTS" has the meaning assigned to that term in the Trademark Purchase and License Assignment Agreement. "AUTHORIZED OFFICER" means (i) in the case of the Issuer, the Persons specified by the Issuer as such in an Officers' Certificate signed by a Senior Officer or, for purposes of Section 2.02, a certificate of the Secretary or Assistant Secretary of the Issuer delivered from time to time to the Trustee and (ii) in the case of the Trustee, a Responsible Officer or such other Persons as may from time to time be designated as such by the Trustee in writing to the Issuer. "BASIC DOCUMENTS" means this Indenture, the Note Purchase Agreement, the Security Agreement, the Notes, the Trademark Purchase and License Assignment Agreement and the Administrative Services Agreement. "BUSINESS DAY" means any day other than Saturday or Sunday and any day on which commercial banking institutions in New York, New York or Wilmington, Delaware are authorized or obligated by law or executive order to close. "CHEROKEE" has the meaning assigned to that term in the first recital hereof. "CHEROKEE LICENSES" has the meaning assigned to that term in the Trademark Purchase and License Assignment Agreement. "CLOSING DATE" means the closing date for the issuance of the Notes pursuant to the Note Purchase Agreement. "CODE" means the Internal Revenue Code of 1986, as amended. "COLLECTION ACCOUNT" has the meaning assigned to that term in Section 3.01. 4 "CURRENT VALUE" means, with respect to any Note at any date (the "DATE OF DETERMINATION"), the sum of (i) for each unpaid installment of principal of such Note due on a Note Payment Date on or prior to the date of determination, the principal amount of such installment together with, if such unpaid installment is past due, interest thereon at the Default Rate from and including the Note Payment Date on which such principal amount was due to but not including the date of determination and (ii) for each unpaid installment of principal of such Note due on a Note Payment Date subsequent to the date of determination, the sum of the Original Value of such installment plus earned Original Issue Discount with respect thereto as of the date of determination. Calculations of amounts due hereunder which are stated to include default interest shall not duplicate amounts, if any, of default interest included in Current Value. "DEFAULT" means any event or occurrence which with the giving of notice or lapse of time or both would become an Event of Default. "DEFAULT RATE" means the higher of (i) 9.00% per annum, and (ii) the rate announced by the bank acting as the Trustee as of any date of determination as its "prime rate" plus 2% per annum, in each case compounded semi-annually. "DOLLARS" and the sign "$" mean lawful currency of the United States of America. "ELIGIBLE INVESTMENT" means any investment in (i) direct obligations of the United States or any agency thereof, or obligations fully guaranteed by the United States or any agency thereof, (ii) commercial paper rated at least A-1 by Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc. ("S&P") and P-1 by Moody's Investors Service, Inc. ("MOODY'S") which is payable in full within 183 days from the date of original issue thereof (without regard to the period held by the Trustee), (iii) time deposits with, including certificates of deposit issued by, any office located in the United States of any bank or trust company (including Wilmington Trust Company) which is organized under the laws of the United States or any state thereof and has total shareholder equity aggregating at least $500,000,000 and the long term unsecured senior debt of which (or of the holding company thereof) is rated at least AA- by S&P and at least Aa3 by Moody's and (iv) money market mutual funds rated AAAm by S&P (or an equivalent rating by Moody's), provided that: (a) each Eligible Investment shall be evidenced by negotiable certificates or instruments, or if non-negotiable or in book entry form, then issued or registered in the name of the Trustee, or its nominee, as secured party; 5 (b) each Eligible Investment (together with any appropriate instruments of transfer) shall be delivered to, and held by, the Trustee or an agent thereof (which shall not be the Issuer or any of its Affiliates) (other than any Eligible Investment in book entry form); (c) each Eligible Investment shall mature not later than the next succeeding Note Payment Date; provided that Eligible Investments in an amount not less than the amounts required to be withdrawn by the Trustee pursuant to Section 3.03 shall mature not later than one Business Day prior to the next succeeding Note Payment Date. "EMPLOYEE BENEFIT PLAN" means any "EMPLOYEE BENEFIT PLAN" as defined in (S)3(3) of ERISA, or any "PLAN" as defined in Section 4975(e)(1) of the Code. "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. "EVENT OF DEFAULT" has the meaning assigned to that term in Section 8.01. "GAAP" means generally accepted accounting principles as in effect from time to time in the United States of America. "GOVERNMENTAL APPROVAL" means any authorization, consent, approval, license, lease, ruling, permit, certification, exemption, filing for, or registration by or with any Governmental Body in connection with (a) the execution, delivery and performance of the Basic Documents by the Issuer, (b) the validity or enforceability of the Basic Documents or (c) the grant by the Issuer of any Lien granted hereunder or under the Security Agreement and the validity, perfection and priority of such Lien. "GOVERNMENTAL BODY" means any Federal, state, municipal or other governmental department, commission, board, bureau, agency, ministry, authority or other instrumentality of any jurisdiction, domestic or foreign, including but not limited to the United States of America; and the term "ORDER" includes any order, writ, injunction, decree, judgment, award, determination, direction or demand. "GRANT" means to grant, bargain, sell, warrant, alienate, remise, demise, release, convey, assign, transfer, mortgage, pledge, create and grant a security interest in and right of set-off against, deposit, set over and confirm. A Grant of the Trust Estate or of any other instruments shall include all rights, powers and options (but none of the obligations) of the granting party thereunder, including the immediate continuing right to claim for, collect, receive and receipt for principal and interest payments in respect to the Trust Estate and all other monies 6 payable thereunder, to give and receive notices and other communications, to make waivers or other agreements, to exercise all rights and options, to bring proceedings in the name of the granting party or otherwise and generally to do and receive anything that the granting party is or may be entitled to do or receive thereunder or with respect thereto. "GUARANTEE" by any Person means any obligation, contingent or otherwise, of such Person directly or indirectly guaranteeing any Indebtedness or other obligation of any other Person and, without limiting the generality of the foregoing, any obligation, direct or indirect, contingent or otherwise, of such Person (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness or other obligation (whether arising by virtue of partnership arrangements, by agreement to keep-well, to purchase assets, goods, securities or services, to take-or-pay, or to maintain financial statement conditions or otherwise) or (ii) entered into for the purpose of assuring in any other manner the obligee of such Indebtedness or other obligation of the payment thereof or to protect such obligee against loss in respect thereof (in whole or in part), provided that the term Guarantee shall not include endorsements for collection or deposit in the ordinary course of business. The term "GUARANTEE" used as a verb has a meaning correlative to the foregoing. "HOLDERS" and "NOTEHOLDERS" and "HOLDERS" mean the registered holders from time to time of any of the Notes. "INDEBTEDNESS" of any Person means, without duplication, (A) all obligations for borrowed money of such Person, (B) all obligations for the deferred purchase price of property acquired by such Person (excluding accounts payable arising in the ordinary course of business but including all obligations of such Person created or arising under any conditional sale or other title retention agreement with respect to any property acquired by such Person), (C) all obligations of such Person to pay rent or other amounts under a lease of (or other agreement conveying the right to use) property which are required to be classified and accounted for as a capital lease or financial lease on a balance sheet of such Person in accordance with GAAP, (D) all obligations for borrowed money secured by any Lien upon or in any property owned by such Person whether or not such Person has assumed or become liable for the payment of such obligations for borrowed money and (E) all obligations of the type described in any of clauses (A) through (D) above which are Guaranteed, directly or indirectly, or endorsed (otherwise than for collection or deposit in the ordinary course of business) or discounted with recourse by such Person. "INDENTURE" has the meaning assigned to that term in the first paragraph hereof. 7 "INDEPENDENT COUNSEL" means Davis Polk & Wardwell, or any other law firm reasonably acceptable to the Majority Holders which is recognized nationally as specializing in the substantive area of law to be opined to in the opinion in question. "INVESTMENT COMPANY ACT" means the Investment Company Act of 1940, as amended. "ISSUER" has the meaning assigned to that term in the first paragraph hereof. "LICENSE AGREEMENT" has the meaning assigned to that term in the recitals hereof. "LICENSEE" has the meaning assigned to that term in the recitals hereof. "LIEN" means, as applied to property or assets, real or personal, tangible or intangible, any pledge, mortgage, lien, charge, security interest or encumbrance of any kind thereon (including, without limitation, any agreement to give any of the foregoing, any conditional sale or other title retention agreement or the interest of the lessor under any capitalized lease and the filing of or agreement to give any financing statement or similar document to perfect any security interest under the Uniform Commercial Code of any jurisdiction or any other similar filing to perfect any security interest). "LLC AGREEMENT" means the Limited Liability Company Agreement of the Issuer dated as of the date hereof. "MAJORITY HOLDERS" or "MAJORITY NOTEHOLDERS" means at any time Noteholders holding collectively Outstanding Notes evidencing at least 66 2/3% of the aggregate unpaid principal amount of the Outstanding Notes. "MAKE-WHOLE AMOUNT" means, at any time, in connection with any redemption of a Note pursuant to Section 13.01 or any acceleration of a Note pursuant to Section 8.01, the amount (but not less than zero) equal to: (A) the sum of the Present Values (as hereinafter defined) of the amounts which would have been payable in respect of such Note on each subsequent Note Payment Date, MINUS (B) the amount calculated pursuant to clause (ii) of the definition of Current Value with respect to such Note at such time. 8 For purposes of this definition, "PRESENT VALUE" shall be determined in accordance with generally accepted financial practice in the United States of America on a semi-annual basis at a discount rate equal to the sum of the applicable Treasury Yield PLUS .40%; and the "TREASURY YIELD" for such purpose shall be determined by reference to the yield for U.S. Treasury securities as indicated by Telerate Access Service (page 500 or the relevant page at the date of determination indicating such yields) (or, if such data ceases to be available, any publicly available source of similar market data) at approximately 11:00 A.M., New York City time, 3 Business Days prior to the date of such redemption or acceleration of such Note, and shall be the yield on actively traded U.S. Treasury securities having a constant maturity equal to the then-remaining weighted average life to maturity (determined in accordance with generally accepted financial practice in the United States of America) of such Note; provided that if such then-remaining weighted average life to maturity is not equal to the maturity of an actively traded U.S. Treasury security, such yield shall be obtained by linear interpolation (calculated to the nearest one- twelfth of a year) from the yields of actively traded U.S. Treasury securities having a constant maturity closest to such then-remaining weighted average life to maturity. "MATERIAL ADVERSE EFFECT" means (A) a material adverse effect on the validity, enforceability or value of the Assigned Rights, (B) a material adverse effect on the ability of the Issuer to perform its obligations under any Basic Document or (C) any adverse effect which a Noteholder could reasonably deem to be material on the legality, validity or enforceability of any Basic Document, the validity, perfection or priority of the Liens securing the Notes or the rights and remedies of the Trustee or the Noteholders thereunder. "MINIMUM GUARANTEED ROYALTY" has the meaning assigned to that term in the License Agreement. "NOTE PAYMENT DATE" means each date set forth in Schedule I. "NOTE PURCHASE AGREEMENT" means the Note Purchase Agreement dated as of the date hereof between the Issuer and the parties listed on the signature page thereto. "NOTE REGISTER" has the meaning assigned to that term in Section 2.06. "NOTES" has the meaning assigned to that term in the first paragraph hereof. 9 "OFFICERS' CERTIFICATE" means a certificate signed by an Authorized Officer or a Senior Officer, as applicable, and a Secretary or Assistant Secretary of the Issuer and delivered to the Trustee. "OPINION OF COUNSEL" means an opinion in writing signed by legal counsel and delivered to the Trustee, which counsel may be an employee of the Issuer or other counsel satisfactory to the Trustee. "ORIGINAL ISSUE DISCOUNT" means, as to any installment of principal of any Note due on any Note Payment Date, the difference between the Original Value of such installment and the principal amount of such installment. Determinations of earned Original Issue Discount shall be made in accordance with generally accepted financial practice on the constant interest method at an annual rate of 7.00% from the Closing Date to the date as of which earned Original Issue Discount is to be determined. "ORIGINAL VALUE" means, with respect to any installment of principal of any Note due on any Note Payment Date, the amount of such installment discounted to present value at the Closing Date at the rate of 7.00% per annum, compounded semi-annually. The aggregate Original Values for the aggregate principal amount of the Notes due on each Note Payment Date are set forth in Schedule I hereto. "OTHER EXISTING LICENSES" has the meaning assigned to that term in the Trademark Purchase and License Assignment Agreement. "OTHER PERMITTED LICENSES" has the meaning assigned to that term in the Trademark Purchase and License Assignment Agreement. "OUTSTANDING", used with reference to the Notes, means at any time, subject to the provisions of Section 12.04, all Notes authenticated and delivered by the Trustee under the Indenture, except (A) Notes theretofore canceled by the Trustee or delivered to the Trustee for cancellation; (B) Notes, or portions thereof, for the payment of which moneys in the necessary amount shall have been deposited in trust with the Trustee; provided that if such Notes are to be redeemed prior to the maturity thereof, notice of such redemption shall have been given as herein provided, or provision satisfactory to the Trustee shall have been made for the giving of such notice; and 10 (C) Notes in substitution or exchange for which other Notes shall have been authenticated and delivered. "PERMITTED LIEN" means a Lien on all or a portion of the Trust Estate permitted by Section 7.06(a)(ii) hereof. "PERSON" means an individual, a corporation, a partnership, an association, a trust or any other entity or organization, including a government or political subdivision or an agency or instrumentality thereof. "RECORD DATE" means the first day of the month in which any Note Payment Date occurs. "REGISTRAR" shall mean the entity appointed by the Issuer to act as registrar for any Notes, which shall initially be the Trustee. "RESERVE ACCOUNT" has the meaning assigned to such term in Section 4.01. "RESPONSIBLE OFFICER" means, with respect to the Trustee, any Vice President or Assistant Vice President, Assistant Secretary, Assistant Treasurer, and, with respect to a particular corporate trust matter, any other officer to whom such matter is referred because of his knowledge of and familiarity with the particular subject. "RULE 144A INFORMATION" has the meaning assigned to that term in Section 2.06(j). "SECURED OBLIGATIONS" has the meaning assigned to that term in Section 1 of the Security Agreement. "SECURITIES ACT" means the Securities Act of 1933, as amended. "SECURITY AGREEMENT" means the Security Agreement dated as of the date hereof, between the Issuer and the Trustee. "SENIOR OFFICER" means any of the following officers of the Issuer: President and Treasurer. "SUBSIDIARY" means with respect to any Person any corporation or other entity of which securities or other ownership interests having ordinary voting power to elect a majority of the board of directors or other individuals performing similar functions, are at the time directly or indirectly owned by such Person. 11 "TAX" means any tax (whether income, documentary, sales, stamp, registration, issue, capital, property, excise or otherwise), duty, levy, impost, fee, charge or withholding, directly or indirectly, imposed, assessed, levied or collected by or for the account of any Governmental Body, excluding net income and franchise taxes imposed on the Holder by the jurisdiction under the laws of which such Holder is organized or any political subdivision thereof or by any jurisdiction in which the office at which the Holder has acquired or booked the Notes is located or any political subdivision thereof. "TRADEMARK" has the meaning assigned to that term in the Trademark Purchase and License Assignment Agreement. "TRADEMARK LICENSE" means (i) the License Agreement and (ii) to the extent the same shall have been assigned to the Issuer as contemplated by Section 4.02 of the Trademark Purchase and License Assignment Agreement, any of the Other Existing Licenses with Brylane, Caldor and/or Pamida. "TRADEMARK PURCHASE AND LICENSE ASSIGNMENT AGREEMENT" has the meaning assigned to that term in the third recital hereof. "TRANSFEREE CERTIFICATE" has the meaning assigned to that term in Section 2.06(f). "TRANSFEROR CERTIFICATE" has the meaning assigned to that term in Section 2.06(f). "TRUST ACCOUNTS" means the Collection Account and the Reserve Account. "TRUST ESTATE" has the meaning assigned to that term in the Granting Clauses. "TRUST OFFICE" means the principal office in Wilmington, Delaware, at which at any particular time the corporate trust business of the Trustee shall be administered, which office is located at the time of the execution of this Indenture at Rodney Square North, 1100 North Market Street, Wilmington, Delaware 19890 or such other office as the Trustee or any successor Trustee may from time to time designate in writing to the Issuer and the Noteholders. "TRUSTEE" means Wilmington Trust Company in its capacity as Trustee under this Indenture, and its successors in such capacity. 12 "UNITED STATES" means the States, District of Columbia, territories, possessions and territorial waters of the United States of America. Section 1.02. Rules of Construction. Words of the masculine gender shall be deemed and construed to include correlative words of the feminine and neuter genders. Unless the context shall otherwise indicate, the words "Note", "owner", "Holder", "holder", "Noteholders" and "Person" shall include the plural as well as the singular number. References herein to specific Persons include their legal successors (or their successors fulfilling the function specified herein) and permitted assigns, and references herein to specific agreements and contracts include references to such agreements and contracts as amended or supplemented from time to time, to the extent herein and therein permitted. Except as otherwise expressly provided herein, all accounting terms used herein shall be interpreted, and all financial statements and certificates and reports as to financial matters required to be delivered to the Trustee hereunder shall be prepared, in accordance with GAAP. All calculations made for the purposes of determining compliance with this Indenture shall (except as otherwise expressly provided herein) be made by application of GAAP. Section 1.03. Legal Holidays. In any case where any Note Payment Date or any date for the making of a deposit or distribution hereunder shall fall on a day which is not a Business Day, such payment, deposit or distribution need not be made on such date, but may be made on the next succeeding day that is a Business Day with the same force and effect as if made on such Note Payment Date or other date for a deposit or distribution. ARTICLE 2 Issue, Execution, Form and Registration of Notes Section 2.01. Authentication and Delivery of Notes. Upon the execution and delivery of this Indenture, Notes in an aggregate principal amount not in excess of U.S.$60,000,000, at any one time Outstanding will be issued and executed by the Issuer in the manner prescribed in Section 2.02 and delivered by the Issuer to the Trustee for authentication, accompanied by a certificate of an Authorized Officer of the Issuer directing such authentication and the Trustee shall thereupon authenticate and deliver, or cause the authentication and delivery of, such Notes to the respective Holders thereof upon the written order of the 13 Issuer signed by an Authorized Officer of the Issuer, without any further action by the Issuer. Section 2.02. Execution of Notes. The Notes shall be executed on behalf of the Issuer by an Authorized Officer of the Issuer. Such signature may be the manual or facsimile signature of any present or any future such Authorized Officer. With the delivery of this Indenture, the Issuer is furnishing to the Trustee a certificate of a Secretary or Assistant Secretary of the Issuer, and from time to time thereafter may furnish to the Trustee, an Officers' Certificate, in each case identifying and certifying the incumbency and specimen signature(s) of the Authorized Officers. Until the Trustee receives a subsequent Officers' Certificate, the Trustee shall be entitled to rely on the last such Officers' Certificate delivered to it for purposes of determining the Authorized Officers. In case any Authorized Officer who shall have signed any of the Notes shall cease to be such Authorized Officer before the Note so signed shall be authenticated and delivered by the Trustee or disposed of by or on behalf of the Issuer, such Note nevertheless may be authenticated and delivered or disposed of as though the Person who signed such Note had not ceased to be such Authorized Officer; and any Note may be signed on behalf of the Issuer by such Persons as, at the actual date of the execution of such Note, shall be an Authorized Officer, and such Note shall be a valid and binding obligation of the Issuer notwithstanding that at the date of the execution and delivery of this Indenture any such Person was not an Authorized Officer. Section 2.03. Certificate of Authentication. Only such Notes as shall bear thereon a certification of authentication substantially as set forth in the form of the Note annexed as Exhibit A hereto, such certification to be executed by the Trustee by manual signature of one of its Authorized Officers, shall be entitled to the benefits of this Indenture or be valid or obligatory for any purpose. Such certification by the Trustee upon any Note executed by or on behalf of the Issuer shall be conclusive evidence that the Note so authenticated has been duly authenticated and delivered hereunder and that the Holder is entitled to the benefits of this Indenture. Section 2.04. Form, Denomination and Date of the Notes. (a) The Notes will be issued in fully registered form substantially in the form of Exhibit A hereto. The Notes shall be numbered, lettered, or otherwise distinguished in such manner as the Authorized Officer of the Issuer executing the same may determine with the approval of the Trustee prior to the issuance of the Notes. Any of the Notes may be issued with appropriate insertions, omissions, substitutions and variations, and may have imprinted or otherwise reproduced thereon such legend or legends, not inconsistent with the provisions of this Indenture, as may be 14 required to comply with any law or with any rules or regulations pursuant thereto, or to conform to general usage. (b) The final maturity of the Notes shall be February 20, 2004. Prior to such final maturity, installments of principal on the Notes shall be due on each Note Payment Date in the aggregate amount specified in Schedule I. The Notes shall bear interest, to the extent enforceable under applicable law, on any overdue principal and Make-Whole Amount, if any, at the Default Rate. (c) Except as provided in the last sentence of subsection (b) above, the Notes shall not bear interest. Instead, Original Issue Discount shall accrete thereon from the Closing Date to the respective Note Payment Dates. The amount payable by the Issuer in respect of principal of any Note (exclusive of any Make-Whole Amount) at any date shall not exceed the Current Value of such Note at such date. (d) Each Note shall be dated the date of its authentication and shall take effect therefrom. (e) The Notes shall be issuable in registered form without coupons in minimum denominations of $500,000. Section 2.05. Payment of Notes. (a) Payments at Trust Office. The principal of and Make-Whole Amount, if any, on the Notes shall be payable to the Holder of record as of the Record Date at the Trust Office in lawful money of the United States of America, in funds immediately available at such office against surrender of such Notes in the case of payment in full, except as provided in Section 2.05(b). (b) Home Office Payment. Notwithstanding any provision of this Indenture or the Notes to the contrary, payments of all amounts which become due and payable in respect of any Note shall be made by the Trustee, by wire transfer of immediately available funds for receipt not later than 2:00 p.m. New York time on the date any such payment is due, directly to the Holder of such Note, without surrender or presentation thereof to the Trustee (except that upon written request of the Trustee or the Issuer made concurrently with or reasonably promptly after payment or prepayment in full of any Note, each Holder shall surrender its Note for cancellation to the Trustee at its Trust Office or at such other location as is specified by the Trustee and the Issuer), if there shall be filed with the Trustee a copy of an agreement between the Issuer and such Noteholder (or the person for whom such Noteholder is a nominee) providing that such payments will be so made and such Noteholder agrees not to sell, transfer or otherwise dispose of such Note unless the amount of all prepayments of principal 15 previously made thereon shall be noted thereon. The Trustee shall have no responsibility regarding notations of payment by any Noteholder who has entered into such an agreement and the Trustee shall be responsible only for maintaining its records in accordance with this Indenture and absent manifest error the records of the Trustee shall be controlling as to payments and prepayments in respect of the Notes. Section 2.06. Registration, Transfer or Exchange of Notes. (a) The Issuer shall keep or cause to be kept at the Trust Office one or more books (herein called the "NOTE REGISTER") for the registration and registration of transfer or exchange of any of the Notes. The Issuer hereby appoints the Trustee its registrar to keep the Note Register and the Trustee hereby accepts such appointment. The Note Register shall contain the following information regarding all Noteholders: (i) the names and addresses of such Holders; (ii) the percentage of the aggregate principal amount of the Notes held by each Holder; (iii) the date on which the name of each Person was entered on such register as a Holder; and (iv) the date on which any Person ceased to be a Holder; provided that registration as provided under this Section shall be made within 30 days of the date of issuance of each Note as provided under this Indenture. Any Note may be surrendered for transfer or exchange at the Trust Office, accompanied in the case of a transfer by a Transferor Certificate and Transferee Certificate in form reasonably acceptable to the Trustee, duly executed by the Holder of such Note, and thereupon the Issuer shall execute, in the case of a transfer in the name of the transferee or transferees, and the Trustee shall authenticate and deliver, a new Note or Notes for the same aggregate unpaid principal amount as the Note so surrendered. (b) The ownership of any Note shall be proved by the Note Register. The Trustee may deem and treat the registered Holder of any Note as the absolute owner of such Note for all purposes and, prior to due presentment for registration of transfer, shall not be affected by any notice to the contrary. 16 (c) No fee shall be charged to any Holder for any registration of transfer or exchange, but the Trustee or the Issuer may require payment by the Holder requesting such registration of a sum sufficient to reimburse it for any governmental, regulatory, or other similar charge or other expense to which the Trustee or the Issuer is subject in connection therewith. (d) All Notes authenticated and delivered by the Trustee upon any transfer or exchange pursuant to this Indenture shall be entitled to the same benefits under this Indenture as the Note or Notes surrendered upon such transfer or exchange. (e) The Trustee shall permit each Holder of a Note to inspect and copy the Note Register and the other books and records of the Trustee relating to the Notes upon written request during regular business hours of the Trustee. (f) No Note may be sold or transferred (including, without limitation, by pledge or hypothecation) unless such sale or transfer is exempt from the registration requirements of the Securities Act and is exempt under applicable state securities laws. The Trustee shall require, prior to any sale or other transfer of a Note, that the Noteholder's prospective transferee deliver to the Trustee and the Issuer a certificate relating to such transfer substantially in the form of Exhibit B annexed hereto (the "TRANSFEREE CERTIFICATE"). In addition, the Trustee shall require, prior to any sale or other transfer of a Note, that the Noteholder deliver to the Trustee and the Issuer a certificate relating to such transfer substantially in the form of Exhibit C (the "TRANSFEROR CERTIFICATE"). The Transferee Certificates and the Transferor Certificates furnished pursuant to this Section 2.06(f) hereof may be relied on conclusively by the Trustee in determining whether the provisions of this Section 2.06(f) hereof have been complied with. None of the Issuer, the Trustee or any other person shall be required or obligated to register the Notes under the Securities Act or any state securities laws. (g) Subject to its prior receipt of a Transferee Certificate from a transferee, the Issuer shall be deemed to have made the representations set forth in the second paragraph of Section 2.10 of the Note Purchase Agreement to such transferee as of the date such transferee acquired a Note that is the subject of such Transferee Certificate; provided, however, that the Issuer shall have five (5) business days to review such Transferee Certificate and to notify the Trustee that due to either (x) a change in an applicable provision of ERISA or the Code or (y) the disclosure made to the Issuer pursuant to Item (e)(iv) of the Transferee Certificate, the Issuer is unable to make the representations set forth in such second paragraph. 17 (h) No Note may be sold or transferred in denominations of less than U.S. $500,000, provided that if necessary to enable the registration of transfer by a holder of its entire holding of Notes, one Note may be in a denomination of less than U.S. $500,000. (i) No Note may be sold or transferred (including, without limitation, by pledge or hypothecation) unless the prospective transferee represents in the Transferee Certificate that the purchaser is a "qualified purchaser" for purposes of Section 3(c)(7) of the Investment Company Act. Notwithstanding anything to the contrary in this Indenture, no transfer of a Note may be made if such transfer would require registration of the Issuer under the Investment Company Act. (j) At any time when the Issuer is not subject to Section 13 or 15(d) of the United States Securities Exchange Act of 1934, as amended, upon the request of any Noteholder, the Issuer shall promptly furnish to such Noteholder or to a prospective purchaser of any Note designated by such Noteholder, as the case may be, the information which the Issuer determines to be required to be delivered pursuant to Rule 144A(d)(4) under the Securities Act ("RULE 144A INFORMATION") in order to permit compliance by such Noteholder with Rule 144A in connection with the resale of such Note by such Noteholder. Upon request by the Issuer, the Trustee shall reasonably cooperate with the Issuer in mailing or otherwise distributing (at the Issuer's expense) to such Noteholders or prospective purchasers, at and pursuant to the Issuer's written direction, the foregoing materials prepared and provided by the Issuer; provided, however, that the Trustee shall be entitled to affix thereto or enclose therewith such disclaimers as the Trustee reasonably shall deem appropriate, at its discretion (such as, for example, a disclaimer that such Rule 144A Information was assembled by the Issuer and not by the Trustee, that the Trustee has not reviewed or verified the accuracy thereof, and that it makes no representation as to the sufficiency of such information under Rule 144A or for any other purpose). (k) Notwithstanding any terms herein to the contrary, the Trustee shall not be responsible for ascertaining whether any transfer complies with, or otherwise to monitor or determine compliance with, the requirements or terms of the Securities Act, applicable state securities laws, ERISA, the Code or the Investment Company Act; except that if a certificate is specifically required by the terms of this Section 2.06 to be provided to the Trustee, the Trustee shall be under a duty to receive and examine the same to determine whether it substantially conforms on its face to the applicable requirements of this Section. (l) No Noteholder may sell or transfer a Note to a Person that such Noteholder reasonably should know is a competitor of the Issuer, Cherokee or the Licensee; provided that such Noteholder may rely conclusively on the transferee 18 certification in subsection (m) of the relevant Transferee Certificate. For purposes of this subsection (l), "competitor" shall mean any manufacturer, distributor or retailer of goods of the type covered by the Trademark or the License Agreement or the owner or licensor of a trademark for goods of such type. Section 2.07. Replacement of Lost, Mutilated or Stolen Notes. In case any Note shall become mutilated or defaced or be lost, destroyed or stolen, then on the terms herein set forth, and not otherwise, the Issuer shall execute and the Trustee shall authenticate and deliver to the Holder a new Note of like tenor and date, and bearing such identifying number or designation as the Trustee may determine, in exchange and substitution for, and upon cancellation of, the mutilated or defaced Note, or in lieu of and in substitution for the same if lost, destroyed or stolen. The applicant for a new Note pursuant to this Section 2.07 shall, in the case of any mutilated or defaced Note, surrender such Note to the Trustee and furnish to the Trustee, in the case of any lost, destroyed or stolen Note, evidence reasonably satisfactory to the Trustee of such loss, destruction or theft and, in each case, evidence satisfactory to the Trustee of the ownership and authenticity of such Note and furnish such security or indemnity as may be reasonably required by the Trustee and the Issuer to indemnify and defend and save them harmless (provided that if such Noteholder is an original Holder of any Note, or a nominee or affiliate thereof, or any other institutional Holder of a Note, such Holder's own unsecured agreement of indemnity shall be deemed satisfactory to the Issuer). Any defaced or mutilated Note shall be destroyed by the Trustee, or retained in accordance with its standard retention policy, upon delivery by it of a new Note to the Holder. Section 2.08. Tax Purposes. Each Holder by acceptance of its Note agrees to treat its Note as debt for United States federal income tax purposes. Section 2.09. Cancellation. All Notes surrendered for payment, registration of transfer, exchange or redemption, or deemed lost or stolen, shall, if surrendered to any Person other than the Trustee, be delivered to the Trustee and shall be promptly cancelled by it. All canceled Notes held by the Trustee shall be destroyed or held by the Trustee in accordance with its standard retention policy. Section 2.10. Quarterly Report. The Trustee shall deliver to each Holder of a Note and the Issuer a quarterly report immediately following each Note Payment Date detailing the Outstanding principal amount of the Notes and the status of each of the Trust Accounts including receipts and disbursements therefrom since the preceding Note Payment Date and the amount of the funds and the types of Eligible Investments then held by the Trustee under this Indenture. Each Holder of a Note and the Issuer may, from time to time, on a 19 reasonable basis, request any additional reports and information regarding activity in the Trust Accounts regularly prepared or maintained by the Trustee. ARTICLE 3 The Collection Account Section 3.01. Collection Account. The Trustee will establish a special purpose trust account (Account No. 43558-1) designated as Wilmington Trust Company, as Trustee--account u/i/d December 23, 1997 made by SPELL C. LLC-- Collection Account (the "COLLECTION ACCOUNT") over which the Trustee shall have sole and exclusive control and sole and exclusive right of withdrawal and into which payments due to the Issuer under any Trademark License, including all cash proceeds thereof, shall be made directly. In addition, the Trustee shall deposit into the Collection Account (i) the proceeds of the issuance of the Notes, which shall be distributed pursuant to Section 3.02 hereof and (ii) any principal, interest or other payment or distribution received by the Trustee from time to time in respect of Eligible Investments made with amounts on deposit in the Reserve Account. All right, title and interest in and to the cash amounts on deposit from time to time in the Collection Account shall constitute part of the Trust Estate and shall be held for the benefit of the Noteholders, the Trustee, and the Issuer as their interests shall appear hereunder and shall not constitute payment of the Secured Obligations (or any other obligations to which such funds are provided hereunder to be applied) until applied thereto as hereinafter provided. Section 3.02. Distribution of Amounts on Deposit in the Collection Account on the Closing Date. On the Closing Date, the Trustee shall make the following transfers from the Collection Account: (i) to the account specified pursuant to Section 3.03 of the Trademark Purchase and License Assignment Agreement, $47,845,558.83; (ii) to the Reserve Account in escrow to fund the Trustee's fees, indemnities and expenses as provided in Section 10.07, $24,000; and (iii) the balance to or as directed by the Issuer. Section 3.03. Distribution of Amounts on Deposit in the Collection Account on Note Payment Dates. Amounts deposited into the Collection Account on any date shall be held therein and applied or transferred by the 20 Trustee on the immediately succeeding Note Payment Date in the following order of priorities: (i) to the payment of any overdue principal owing on the Notes, for receipt not later than 2:00 p.m., New York time; (ii) to the ratable payment of the aggregate amount of principal due and payable on the Notes on such Note Payment Date, for receipt not later than 2:00 p.m., New York time; (iii) to the ratable payment of the Make-Whole Amount, if any, payable on the Notes on such Note Payment Date, for receipt not later than 2:00 p.m., New York time; (iv) to the ratable payment of any other amounts, if any, payable on the Notes pursuant to the terms of this Indenture or any other Basic Document, for receipt not later than 2:00 p.m., New York time; (v) (A) if a Default or Event of Default shall have occurred and be continuing, to retain the balance in the Collection Account until such Default or Event of Default shall have been cured or waived or such balance shall have been otherwise applied in accordance with this Indenture or (B) otherwise, to the Issuer or to such other Person as the Issuer shall direct in writing to the Trustee. Section 3.04. Distribution of Excess Amounts on Deposit in the Collection Account. If on any date other than a Note Payment Date (a) the amount on deposit in the Collection Account exceeds the aggregate amount of principal of the Notes due and payable on the next succeeding Note Payment Date, and (b) no Default or Event of Default has occurred and is then continuing, such excess amount shall be distributed to the Issuer or to such other Person as the Issuer shall direct in writing to the Trustee. Section 3.05. Other Existing Licenses. Notwithstanding anything to the contrary in this Article 3, if at any time any Other Existing Licenses become Trademark Licenses, then all payments received by the Trustee for the account of the Issuer in accordance with Section 4.02 of the Trademark Purchase and License Assignment Agreement shall be transferred to the Reserve Account promptly after the receipt of such funds, and shall not be available for distribution pursuant to Sections 3.03 and 3.04 hereof. Section 3.06. Investments in the Collection Account. (a) Any income received by, or on behalf of, the Trustee with respect to the balance from time to 21 time on deposit in the Collection Account, including any interest or capital gains on Eligible Investments made with amounts on deposit therein, shall remain, or be deposited, in such Trust Account until transferred or paid in accordance with this Indenture. All rights, title and interest in and to the cash amounts on deposit from time to time in the Collection Account, together with any Eligible Investments from time to time made pursuant to this Section shall constitute part of the Trust Estate and shall be held for the benefit of the Noteholders, the Trustee, and the Issuer as their interests shall appear hereunder and shall not constitute payment of the Secured Obligations (or any other obligations to which such funds are provided hereunder to be applied) until applied thereto as hereinafter provided. (b) If immediately available cash on deposit in the Collection Account is not sufficient to make any distribution or application referred to in Section 3.03, the Trustee shall liquidate as promptly as practicable Eligible Investments made with amounts on deposit in the Collection Account as required to obtain cash to make such distribution or application. Upon the occurrence and continuation of an Event of Default, the Trustee shall, if so instructed in writing by the Majority Holders, apply or cause to be applied (subject to collection) any or all of the balance from time to time on deposit in the Collection Account in the manner specified in Section 8.02. (c) Amounts on deposit in the Collection Account shall be invested and re- invested from time to time in such Eligible Investments as the Issuer shall timely direct the Trustee in writing, which Eligible Investments shall be held in the name and be under the control of the Trustee. (d) All amounts on deposit in the Collection Account shall be paid to the Issuer upon payment of all amounts due under the Notes in accordance with the terms hereof and thereof and all other Secured Obligations. ARTICLE 4 Reserve Account Section 4.01. Reserve Account. The Trustee will establish a special purpose trust account (Account No. 43558-2) designated as "Wilmington Trust Company, as Trustee--account--u/i/d December 23, 1997 made by SPELL C. LLC -- Reserve Account" (the "RESERVE ACCOUNT") over which the Trustee shall have sole and exclusive control and sole and exclusive right of withdrawal. The Trustee shall deposit into the Reserve Account amounts transferred from the Collection Account pursuant to Sections 3.02(ii) and 3.05. 22 Section 4.02. Withdrawals from the Reserve Account. Except as elsewhere provided in this Indenture, all amounts in the Reserve Account shall be applied by the Trustee upon the instruction of the Issuer (i) in the case of amounts transferred to the Reserve Account pursuant to Section 3.05, to make payments to Licensee as required pursuant to Section 7(b)(v)(a) of the License Agreement, and (ii) in the case of amounts transferred to the Reserve Account pursuant to Section 3.02(ii), to make payments of the expenses in respect of which such reserve was established. Section 4.03. Investments in the Reserve Account. (a) Any income received by, or on behalf of, the Trustee with respect to the balance from time to time on deposit in the Reserve Account, including any interest or capital gains on Eligible Investments made with amounts on deposit therein, shall remain, or be deposited, in such Trust Account until transferred or paid in accordance with this Indenture. All right, title and interest in and to the cash amounts on deposit from time to time in the Reserve Account, together with any Eligible Investments from time to time made pursuant to this Section shall constitute part of the Trust Estate and shall be held for the benefit of the Noteholders, the Trustee, and the Issuer as their interests shall appear hereunder and shall not constitute payment of the Secured Obligations (or any other obligations to which such funds are provided hereunder to be applied) until applied thereto as hereinafter provided. (b) If immediately available cash on deposit in the Reserve Account is not sufficient to make any distribution or application referred to in Section 8.02, the Trustee shall liquidate as promptly as practicable Eligible Investments made with amounts on deposit in the Reserve Account as required to obtain cash to make such distribution or application. Upon the occurrence and continuation of an Event of Default, the Trustee shall, if so instructed in writing by the Majority Holders, apply or cause to be applied (subject to collection) any or all of the balance from time to time on deposit in the Reserve Account in the manner specified in Section 8.02. (c) Amounts on deposit in the Reserve Account shall be invested and re- invested from time to time in such Eligible Investments as the Issuer shall timely direct the Trustee in writing, which Eligible Investments shall be held in the name and be under the control of the Trustee. (d) All amounts on deposit in the Reserve Account shall be paid to the Issuer upon payment of all amounts due under the Notes in accordance with the terms hereof and thereof and all other Secured Obligations. 23 ARTICLE 5 Information The Issuer will furnish to the Trustee sufficient copies and the Trustee will furnish to each Noteholder: (a) promptly, but in any event within five Business Days after an officer of the Issuer becomes aware thereof, notice of (i) the occurrence of any Default or Event of Default, (ii) any litigation or governmental proceeding pending or threatened against the Issuer which could reasonably be expected to have a Material Adverse Effect, (iii) any action by any Governmental Body to condemn, seize or appropriate all or any part of the assets of the Issuer if such action could reasonably be expected to have a Material Adverse Effect and (iv) any other event, act or condition (excluding general economic conditions) which could reasonably be expected to have Material Adverse Effect; (b) promptly after delivery or receipt thereof, a copy of all notices or documents given or received by the Issuer pursuant to any of the Trademark Licenses concerning (i) any default or alleged default under, breach or alleged breach of, or other noncompliance with, any Trademark License in any material respect, (ii) any prospective inability to perform under any Trademark License in any material respect, (iii) any termination or attempted termination of any Trademark License, (iv) any amendment, supplement or other modification of any Trademark License which the parties propose or (v) any claim against the Issuer arising under any Trademark License; (c) promptly upon receipt thereof, copies of all materials delivered to the Issuer pursuant to Section 3(h) of the Administrative Services Agreement or Section 5(e) of the License Agreement and copies of all notices given to the Issuer pursuant to Section 3(b) or 3(c) of the Administrative Services Agreement; and (d) promptly, such other information, including financial statements and computations, relating to the performance of the provisions of this Indenture and the other Basic Documents and the affairs of the Issuer as the Trustee at the request of any such Holder may from time to time reasonably request. If at any time Licensee ceases to be a company required to provide public financial information pursuant to the reporting requirements of the Securities and Exchange Commission, the Issuer shall timely request interim and audited financial statements from the Licensee pursuant to Section 5(e) of the License Agreement. 24 Notwithstanding anything to the contrary in this Article 5, the Issuer shall not be required to provide any information to the Trustee or the Noteholders that the Issuer reasonably determines would cause it to violate the License Agreement, it being understood that provision of the materials specified in subsections (b) and (c) above would not cause such a violation. ARTICLE 6 Inspection of Books and Records Prior to the occurrence of a Default or an Event of Default, the Trustee and each Holder of a Note shall have the right to discuss the affairs, finances and accounts of the Issuer with, and to be advised as to the same by, the Issuer's officers and employees upon reasonable notice, at such reasonable times during regular business hours and intervals and to such reasonable extent as the Trustee or such Holder may desire. Following the occurrence and during the continuance of a Default or an Event of Default, the Trustee and each Holder of a Note shall have the right to visit and inspect any of the offices of the Issuer, to examine the books of account and records of the Issuer, to make or be provided with copies and extracts therefrom and, to discuss the affairs, finances and accounts of the Issuer with, and to be advised as to the same by, its officers and employees all at such reasonable times during regular business hours and intervals and to such reasonable extent as the Trustee or such Holder may desire. The Trustee agrees and each Holder of a Note shall be deemed to have agreed by acceptance of such Note, that all information (other than publicly available information) received pursuant to this Indenture or otherwise in connection herewith or with any Basic Document, will be held by the Trustee and such Holder as confidential in accordance with its customary procedures for handling confidential information, but such Holder may make disclosure to the extent necessary to any bona fide prospective institutional investor transferee in connection with the contemplated transfer of Notes (provided that (i) prior to disclosure by such Holder after the date hereof to any prospective transferee of a Note of any information covered by this paragraph, such Holder will obtain from such prospective transferee in favor of the Issuer its agreement to be bound by the provisions of this paragraph provided that such Holder shall not in any event be liable to any Person because of the failure of such prospective transferee to comply with such provisions and (ii) at such time as any disclosure is made to a transferee, such Holder will notify the Issuer in writing of the information released and the identity of the recipient of such information) or as required by, in appropriate response to a request by, or as otherwise customarily disclosed to, any 25 Governmental Body (including without limitation the National Association of Insurance Commissioners or any successor thereto) or representative thereof, or pursuant to legal process or pursuant to any litigation that any Holder is involved in, or to the accountants, counsel or other professional advisers of such Holder in the course of their respective duties (provided that such Holder requests any such adviser to whom it discloses such information to treat all such information as non-public data). ARTICLE 7 Covenants of the Issuer The Issuer agrees that so long as any amount payable hereunder or under any Note remains unpaid: Section 7.01. Payment of Principal and Make-Whole Amount. The Issuer shall duly and punctually pay the principal of and Make-Whole Amount, if any, on the Notes in accordance with the terms of, and to the extent provided under, the Notes and this Indenture. The Issuer's obligations to make such payments on any date shall be satisfied if on such date immediately available funds in an amount sufficient to make all payments then due are on deposit in the Collection Account and available for such purpose and not subject to any legal restraint on payment by the Trustee from the Collection Account to the Holders. All payments of amounts due and payable with respect to any Notes that are to be made from amounts withdrawn from the Collection Account shall be made on behalf of the Issuer by the Trustee. Section 7.02. Legal Existence; Payment of Taxes; Compliance with Laws. The Issuer shall: (a) do or cause to be done all things necessary to preserve and keep in full force and effect its legal existence, rights (charter and statutory), franchises, permits and licenses and all necessary Governmental Approvals; provided, however, that the Issuer shall not be required to preserve any right, franchise, permit or license of the Issuer if the board of directors of the Issuer shall determine that the preservation thereof is no longer desirable in the conduct of the business of the Issuer and that the loss thereof could not, individually or in the aggregate, have a Material Adverse Effect; (b) pay and discharge or cause to be paid and discharged all taxes, assessments and governmental charges or levies imposed upon it or upon its 26 income or profits or upon any of its property, or upon any part thereof, when due, as well as all lawful claims for labor, materials and supplies which, if unpaid, might by law become a Lien upon its property; provided, however, that the Issuer shall not be required to pay any such tax, assessment, charge, levy or claim if (i) the amount, applicability or validity thereof shall currently be contested in good faith by appropriate proceedings, and if such reserve or other appropriate provision, if any, as shall be required by GAAP shall have been made therefor or (ii) such nonpayment could not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect; (c) comply in all material respects with all applicable statutes, regulations and Orders of, and all applicable restrictions imposed by, any Governmental Body, necessary to the conduct of its business and the ownership of its properties, except such as are being contested in good faith by appropriate proceedings; and (d) not alter the provisions of the LLC Agreement. Section 7.03. Consolidation or Merger. The Issuer shall not, directly or indirectly, consolidate with or merge with or into, or sell, lease or otherwise dispose of its assets as an entirety or substantially as an entirety to, any Person. Section 7.04. Protection of Trust Estate. (a) The Issuer shall from time to time at the reasonable request of the Trustee upon the instruction of the Majority Holders execute and deliver all such instruments of further assurance and other instruments and take such other action as may be necessary or advisable to: (i) Grant more effectively all or any portion of the Trust Estate; (ii) maintain or preserve the Lien (and the priority thereof) of this Indenture or to carry out more effectively the purposes hereof; (iii) perfect, publish notice of, or protect the validity of any Grant made or to be made by this Indenture; (iv) enforce the Trademark Licenses in accordance with their terms; (v) preserve and defend title to the Trust Estate and the rights therein of the Trustee and the Noteholders against the claims of all persons and parties; and 27 (vi) promptly upon request, provide to the Trustee all information and evidence it may reasonably request concerning the Trust Estate to enable the Trustee to enforce the provisions of this Indenture and the Security Agreement. (b) Promptly upon receipt thereof, the Issuer shall furnish to the Trustee a copy of any notice of default given pursuant to Section 8 of the License Agreement. Section 7.05. Performance under the Basic Documents. The Issuer shall perform all of its obligations under, and observe all of the limitations imposed on it by, each Basic Document, the License Agreement and the LLC Agreement. Section 7.06. Negative Covenants. (a) The Issuer shall not, without the prior written consent of the Majority Noteholders, (i) sell, lease, license, exchange, assign or otherwise dispose of, or grant any option with respect to, any of the Assigned Rights, except pursuant to or as expressly permitted by the Basic Documents (including, without limitation, the Other Permitted Licenses), (ii) create, assume, incur or suffer to exist any Lien upon or with respect to the Trust Estate, except for the Liens created pursuant to the Basic Documents (including, without limitation, the Other Permitted Licenses), (iii) agree or consent to any amendment, modification or termination of or material forbearance or written waiver with respect to any provision of any Basic Document, Trademark License or (to the extent the Issuer's consent thereto is required under the Trademark Purchase and License Assignment Agreement) Other Permitted License or (iv) take any action that would cause the Lien in favor of the Trustee on behalf of the Noteholders contemplated by this Indenture and the Security Agreement not to constitute a valid first priority perfected security interest in the Trust Estate. (b) The Issuer shall not acquire directly or indirectly (by purchase, participation, prepayment or otherwise) any of the Outstanding Notes except by way of payment or prepayment in accordance with the provisions of the Notes and of this Indenture. (c) The Issuer shall not incur or have outstanding, assume, or Guarantee any Indebtedness, or assume or Guarantee any Indebtedness of any Person other than the Notes, or issue any membership or other equity interest to any Person other than Cherokee, or any successor thereof by merger, consolidation or sale of substantially all assets. 28 (d) The Issuer shall not engage in any business or activity other than (i) the issuance, selling and redemption of the Notes and the performance of its obligations under this Indenture and the Notes and any other instrument or property included in the Trust Estate in connection therewith, (ii) activity necessary to consummate the transactions contemplated by the Basic Documents and to perform its obligations and preserve and enforce its rights thereunder and (iii) other activities that are reasonably necessary to accomplish the foregoing or are incidental thereto. (e) The Issuer shall not create any Subsidiaries. (f) The Issuer shall not voluntarily appoint or cause to be appointed or commence any proceeding to appoint any receiver or liquidator over all or any of its property. ARTICLE 8 Events of Default Section 8.01. Events of Default. If one or more of the following events (herein referred to as "EVENTS OF DEFAULT") (whatever the reason for such Events of Default and whether it shall be voluntary or involuntary or be effected by operation of law or pursuant to any judgment, decree or order of any court or any order, rule or regulation of any administrative or governmental body) shall have occurred and be continuing: (a) default shall be made in the due and punctual payment of all or any part of the principal of, or Make-Whole Amount (if any) on, any Note, when and as the same shall became due and payable, whether at stated maturity, by acceleration, by prepayment or otherwise; (b) default shall be made by the Issuer in the observance of any of its obligations or undertakings contained in any of Article 5(a)(i) or Sections 7.03, 7.04(b) and 7.06; (c) default shall be made by the Issuer in the observance of any of its other obligations or undertakings under this Indenture or any other Basic Document and such default shall have continued for a period of at least 30 days after the Trustee, acting upon the instruction of the Majority Holders, shall have notified the Issuer thereof; provided that unless such default could reasonably be expected to have a Material Adverse Effect, 29 no Event of Default shall arise under this subsection (c) with respect thereto for so long as the Issuer shall be diligently attempting to cure such default; (d) any representation or warranty made by the Issuer in this Indenture or in any other Basic Document or in any certificate or other instrument delivered hereunder or thereunder or pursuant hereto or thereto or in connection with any provision hereof shall prove to be false, incorrect or breached on the date as of which made in any respect material to the transactions contemplated hereby; (e) the License Agreement shall have been terminated or any party shall be in default thereunder in a manner that could reasonably be expected to have a Material Adverse Effect; (f) the Issuer or the Licensee shall (1) apply for or consent to the appointment of, or the taking of possession by, a receiver, custodian, trustee, liquidator or administrator of itself or of all or a substantial part of its property, (2) be generally unable to pay its debts as such debts become due, (3) make a general assignment for the benefit of its creditors, (4) commence a voluntary case under the United States Bankruptcy Code (as now or hereafter in effect), (5) file a petition seeking to take advantage of any other law providing for the relief of debtors, (6) fail to controvert in a timely or appropriate manner, or acquiesce in writing to, any petition filed against it in an involuntary case under the United States Bankruptcy Code, (7) take any action under the laws of its jurisdiction of organization (or any other jurisdiction) analogous to any of the foregoing, or (8) take any corporate or entity action for the purpose of effecting any of the foregoing; (g) a proceeding or case in respect of the Issuer or the Licensee shall be commenced, without the application or consent of the Issuer or the Licensee in any court of competent jurisdiction, seeking (1) liquidation, reorganization, dissolution, winding up, or composition or readjustment of its debts, (2) the appointment of a trustee, receiver, custodian, liquidator, administrator or the like of it or of all or any substantial part of its properties, or (3) similar relief in respect of it, under any law providing for the relief of debtors and such proceeding or case shall continue undismissed, or unstayed and in effect, for a period of 60 days; or an order for relief shall be entered in an involuntary case under the United States Bankruptcy Code against the Issuer or the Licensee; or action under the laws of the jurisdiction of incorporation of the Issuer or the Licensee (or any other jurisdiction) analogous to any of the foregoing shall be taken 30 with respect to the Issuer or the Licensee and shall continue unstayed and in effect for any period of 60 consecutive days; (h) any judgment or judgments of a court or courts of competent jurisdiction shall be rendered against the Issuer for the payment of money in excess of U.S.$100,000 in the aggregate and any one or more of such judgments exceeding such amount in the aggregate shall not be discharged or execution thereof stayed pending appeal, within 30 days after entry thereof, or, in the event of such a stay, such judgment or judgments shall not be discharged within 30 days after such stay expires; (i) the Liens created by this Indenture and the Security Agreement shall at any time not constitute valid and perfected Liens on the Trust Estate intended to be covered thereby in favor of the Trustee (except by reason of the failure of the Trustee to retain possession of property required to be retained by it hereunder), free and clear of any other Liens, or, except for expiration in accordance with its terms, the Security Agreement shall for whatever reason be terminated or cease to be in full force and effect, or the enforceability thereof shall be contested by the Issuer; or (j) there shall be a vacancy in the position of Independent Director (as defined in the LLC Agreement), and such vacancy shall not be filled with an individual meeting the criteria specified in the LLC Agreement within 60 days; then (1) upon the occurrence of any Event of Default described in Subsection (f) or (g) above the Current Value of each Note, and, to the extent permitted by law, the Make-Whole Amount in respect of such Note and all other amounts payable by the Issuer hereunder in respect of each such Note, shall automatically become immediately due and payable, (2) upon the occurrence of any Event of Default described in Subsection (a) above with respect to any Note, the Holder of such Note may, by written notice to the Issuer (with a copy to the Trustee), declare the Current Value of such Note to be, and the same shall forthwith become, due and payable and, to the extent permitted by law, the Make-Whole Amount in respect of such Note and all other amounts payable by the Issuer hereunder in respect of each such Note or (3) upon the occurrence of any Event of Default (other than as described in Subsection (f) or (g) above), the Majority Holders may, and the Trustee shall, upon the direction of such Holders, in each case by written notice to the Issuer, declare the aggregate Current Values of all Notes to be, and the same shall forthwith become, due and payable and, to the extent permitted by law, the Make-Whole Amount in respect of each such Note and all other amounts payable by the Issuer hereunder in respect of each such Note, in each case under the 31 foregoing clauses (1), (2) and (3) without presentment, demand, protest or other requirements of any kind, all of which are hereby expressly waived by the Issuer. If any Holder of any Note shall exercise the option specified in clause (2) above, the Issuer will forthwith give written notice thereof to the Holders of all other outstanding Notes and each such Holder (including such original Holder) may (whether or not such notice is given or received), by written notice to the Issuer (with a copy to the Trustee) declare the aggregate Current Values of all Notes held by it (but not a portion thereof) to be, and the same shall forthwith become, due and payable, and, to the extent permitted by law, the Make-Whole Amount in respect of each such Note, and all other amounts payable by the Issuer hereunder in respect of each such Note, all without presentment, demand, protest or other requirements of any kind, all of which are hereby expressly waived by the Issuer. The provisions of this Section are subject, however, to the condition that if, within 30 days after any Note shall have become due and payable, the Issuer shall pay all principal of and Make-Whole Amount (if any) on the Notes which shall have become due otherwise than by acceleration (with interest on such principal and Make-Whole Amount (if any) at the Default Rate) and all Events of Default (other than nonpayment of principal and Make-Whole Amount (if any) due and payable solely by virtue of acceleration) shall be remedied or waived, then, and in every such case, the Holders of 66 2/3% of the aggregate unpaid principal amount of the Outstanding Notes, by written notice to the Issuer (with a copy to the Trustee) given within 90 days after such amounts shall have become due and payable, may rescind and annul any such acceleration and its consequences; but no such action shall affect any subsequent Default or Event of Default or impair any right consequent thereon. Section 8.02. Application of Proceeds. Any moneys collected by the Trustee pursuant to this Article, any moneys held by the Trustee pursuant to the terms of the Indenture or the Security Agreement and all moneys at the time on deposit in the Collection Account and the Reserve Account shall at the direction of the Majority Holders, upon the occurrence and during the continuance of an Event of Default, be applied in the following order at the date or dates fixed by the Trustee: (i) to the payment of all amounts due to the Trustee under Section 10.07; (ii) to the payment of the whole amount then due and unpaid upon all the Notes for principal or Make-Whole Amount, if any, as the case may be, with interest upon any such overdue amounts at the Default Rate; and in case such moneys shall be insufficient to pay in full the whole amount so due and unpaid upon the Notes, then to the payment of such 32 interest, principal and Make-Whole Amount, if any, and, without preference or priority of any Note over any other Note, ratably to the aggregate of such unpaid interest, principal and Make-Whole Amount, if any; and (iii) to the payment of the remainder, if any, to the Issuer or any other Person lawfully entitled thereto. Section 8.03. Waiver of Past Specified Events. Prior to the declaration of the acceleration of the Notes as provided in Section 8.01, the Majority Holders may on behalf of the Holders of all the Notes waive any past Event of Default hereunder and its consequences, except a default (a) in the payment of principal of or Make-Whole Amount, if any, on any of the Notes or (b) in respect of a covenant or provision hereof which cannot be modified or amended without the consent of the Holder of each Note affected. In the case of any such waiver, the Issuer, the Trustee and the Noteholders shall be restored to their former positions and rights hereunder, respectively, and the relevant Event of Default shall cease to exist and be deemed to have been cured and not to have occurred for every purpose of this Indenture; but no such waiver shall extend to any subsequent or other Event of Default or impair any right consequent thereon. Section 8.04. Provisions Relating to the Trust Estate. (a) Proceedings in Event of Default. In addition to the actions provided in Section 8.01 and under the Security Agreement, upon the occurrence of any Event of Default the Trustee may, at the direction of the Majority Holders, institute proceedings to seek or enforce any remedy to protect and enforce any of its rights or powers with respect to the Trust Estate, including to foreclose upon the Trust Estate under a decree of a court or courts of competent jurisdiction, and may, at the direction of the Majority Holders, to the extent permitted by applicable law take any other action of a secured party under such law. The Trustee shall not be bound to institute any such proceedings or take any other action, unless (i) it shall have been so directed in writing by the Majority Holders and (ii) it shall have been furnished, by the Noteholders or otherwise, indemnity to its reasonable satisfaction. (b) Trustee's Actions in Event of Default Proceedings. At any time after the occurrence and during the continuance of an Event of Default the following, in each case subject to Section 14.08, shall be applicable: (i) the Trustee in its own name, and as trustee of an express trust, shall be entitled and empowered to institute any suits, actions or proceedings at law, in equity or otherwise, to recover judgment against the 33 Issuer on this Indenture or the Notes or against any other party to a Trademark License, for the whole amount due and unpaid from the Issuer or any other party to such Trademark License under the applicable agreement, and may prosecute any such claims or proceedings to judgment or final decree against the Issuer or any other party to such Trademark License, and collect the moneys adjudged or decreed to be payable in any manner provided by law, whether before or after or during the pendency of any proceedings for the enforcement of the Lien of this Indenture or under the Security Agreement, or of any of the Trustee's rights or the rights of the Holders under this Indenture or under the Security Agreement, and such power of the Trustee shall not be affected by the exercise of any other right, power or remedy for the enforcement of the provisions of this Indenture or the Security Agreement or for the foreclosure of the Lien hereof; (ii) the Trustee in its own name, or as trustee of an express trust, as the case may be, or in any one or more of such capacities shall be entitled and empowered to file such proofs of claim and other papers or documents as may be necessary or advisable in order to have the claims of the Trustee and of the Holders (whether such claims be based upon the provisions of such Notes or of this Indenture or the Security Agreement) allowed in any receivership, insolvency, bankruptcy, moratorium, liquidation, readjustment, reorganization or any other judicial or other proceedings relative to the Issuer, the creditors of the Issuer or any other party to a Trademark License and any receiver, assignee, trustee, liquidator, sequestrator (or other similar official) in any such judicial or other proceeding is hereby authorized to make such payments to the Trustee and, in the event that the Trustee shall consent to the making of such payments directly to the Holders, to pay to the Trustee any amount due to it for the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel; (iii) all rights of action and of asserting claims under this Indenture, the Security Agreement or any Trademark License or under any of the Notes enforceable by the Trustee may be enforced by the Trustee to the extent permitted by law without possession of any of such Notes or the production thereof at the trial or other proceedings relative thereto; (iv) in the case the Trustee shall have proceeded to enforce any right under this Indenture or any Trademark License by suit, foreclosure or otherwise and such proceedings shall have been discontinued or abandoned for any reason, or shall have been determined adversely to the Trustee, then in every such case the Issuer and the Trustee shall, to the 34 extent permitted by law, be restored without further act to their respective former positions and rights under this Indenture, and all rights, remedies and powers of the Trustee shall continue as though no such proceedings had been taken, except to the extent determined in litigation adversely to the Trustee; and (v) the Trustee shall incur no liability as a result of the sale of the Trust Estate, or any part thereof, at any private sale conducted in a commercially reasonable manner. The Issuer hereby waives any claims against the Trustee arising by reason of the fact that the price at which the Trust Estate may have been sold at such a private sale was less than the price that might have been obtained at a public sale or was less than the aggregate amount of the Notes, even if the Trustee accepts the first offer received and does not offer the Trust Estate to more than one offeree; provided such sale was conducted in a commercially reasonable manner. (c) Waiver of Appraisement, Valuation and Right to Marshalling. To the extent it may lawfully do so, the Issuer for itself and for any Person who may claim through or under it hereby: (i) agrees that neither it nor any such Person will plead, claim or in any manner whatsoever take advantage of, any appraisement, valuation or redemption laws, now or hereafter in force in any jurisdiction, which may delay, prevent or otherwise hinder (A) the performance, enforcement or foreclosure of this Indenture or of the Security Agreement, or (B) the sale or other enforcement of the Trust Estate as provided herein and therein; (ii) waives all benefit or advantage of any such laws; (iii) waives and releases all rights to have the Trust Estate marshalled upon any foreclosure, sale or other enforcement of this Indenture or of the Security Agreement; and (iv) consents and agrees that, subject to the terms of this Indenture and the Security Agreement, the instruments constituting the Trust Estate and regulations applicable thereto, all the Trust Estate may upon any such sale be sold by the Trustee as an entirety. (d) Bankruptcy. In case of the pendency of any receivership, insolvency, liquidation, bankruptcy, reorganization, arrangement, adjustment, composition or other similar judicial proceeding relative to the Issuer or the property of the Issuer or its creditors, the Trustee (irrespective of whether the principal of the Notes 35 shall then be due and payable as therein expressed or by declaration or otherwise and irrespective of whether the Trustee shall have made demand on the Issuer for the payment of overdue principal or Make-Whole Amount, if any, or default interest, if any) shall be entitled and empowered, by intervention in such proceeding or otherwise: (i) to file and prove a claim for the whole amount of principal, Make-Whole Amount, if any, and default interest, if any, owing and unpaid in respect of the Notes and to file such other papers or documents as may be necessary or advisable in order to have the claims of the Trustee (including any claims for the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel) and of the Holders allowed in such judicial proceeding; and (ii) to collect and receive any moneys or other property payable or deliverable on any such claims and to distribute the same; and any custodian, receiver, assignee, trustee, liquidator, sequestrator or similar official in any such judicial proceeding is hereby authorized by each Holder to make such payments to the Trustee and, in the event the Trustee shall consent to the making of such payments directly to the Holders, to pay the Trustee any amount due it for the reasonable compensation, expenses, disbursements and advances of the Trustee, its agents and counsel, and any other amounts due the Trustee. Nothing herein contained shall be deemed to authorize the Trustee to authorize or consent to or accept or adopt on behalf of any Holder any proposal, plan of reorganization, arrangement, adjustment or composition or other similar arrangement affecting the Notes or the rights of any Holder thereof, or to authorize the Trustee to vote in respect of the claim of any Holders in any such proceeding. (e) Remedies Cumulative; Delay or Omission Not a Waiver. To the extent permitted by law, every remedy given hereunder or under the Security Agreement to the Trustee or to any of the Holders shall not be exclusive of any other remedy or remedies, and every such remedy shall be cumulative and in addition to every other remedy given hereunder or now or hereafter given by statute, law, equity or otherwise. The Trustee may exercise all or any of the powers, rights or remedies given to it hereunder or which may be now or hereafter given by statute, law, equity or otherwise, in its absolute discretion. No course of dealing between the Issuer and the Trustee or the Holders or any delay or omission of the Trustee or of the Holders to exercise any right, remedy or power accruing upon any Event of Default shall impair any right, remedy or power or shall be construed to be a waiver of any such Event of Default or of any right of 36 the Trustee or of any Holder or acquiescence therein, and every right, remedy and power given by this Article 8 to the Trustee or to the Holders may, to the extent permitted by law, be exercised from time to time and as often as may be deemed expedient by the Trustee or by the Holders. (f) Control by the Holders. The Majority Holders shall have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Trustee, or exercising any trust or power conferred on the Trustee; provided that: (i) such direction shall not be in conflict with any rule of law or with this Indenture or expose the Trustee to personal expense or liability; and (ii the Trustee may take any other action deemed proper by the Trustee which is not inconsistent with such direction. ARTICLE 9 Satisfaction and Discharge of Indenture; Unclaimed Moneys Section 9.01. Satisfaction and Discharge of Indenture. If at any time (a) the Issuer shall have paid the principal of and Make-Whole Amount, if any, on all the Notes Outstanding hereunder and other amounts, if any, due hereunder or under any of the other Basic Documents as and when the same shall have become due and payable, by prepayment or otherwise or (b) the Issuer shall have delivered to the Trustee for cancellation all Notes theretofore authenticated (other than any Notes which shall have been destroyed, lost or stolen and which shall have been replaced or paid as provided in Section 2.07), the Trustee, at the cost and expense of the Issuer, shall execute instruments prepared by the Issuer acknowledging such satisfaction of and discharging this Indenture and releasing the assignments made pursuant to this Indenture and the Security Agreement. The Issuer agrees to reimburse or cause the reimbursement of the Trustee hereunder for any documented costs or expenses thereafter reasonably and properly incurred and to compensate the Trustee hereunder for any services thereafter reasonably and properly rendered by the Trustee in connection with this Indenture or the Notes. Section 9.02. Application by Trustee of Funds Deposited for Payment of Notes. Subject to Section 9.04, all moneys deposited with the Trustee to accomplish the purposes of Section 9.01 shall be held in trust by the Trustee and applied by it first to the payment of all sums payable hereunder by the Issuer (other than the amounts referred to in clause second) and second to the Holders of the particular Notes for the payment of which such moneys have been deposited with the Trustee, of all sums due and to become due thereon as principal or Make- 37 Whole Amount, if any, but such money need not be segregated from other funds except to the extent required by law. Section 9.03. Repayment of Moneys and Transfer of Eligible Investments Held by Trustee. Following the satisfaction and discharge of this Indenture, all moneys and Eligible Investments then held by the Trustee under the provisions of this Indenture shall, upon written demand of the Issuer, be repaid or, as the case may be, assigned or transferred to the Issuer and upon receipt thereof by the Issuer, the Trustee shall be released from all further liability with respect to such moneys and such Eligible Investments. Section 9.04. Return of Moneys Held by Trustee. Any moneys deposited with or paid to the Trustee for the payment of the principal of or Make-Whole Amount, if any, on any Note and not applied but remaining unclaimed for three years after the date upon which such principal or Make-Whole Amount, if any, shall have become due and payable shall be repaid to or for the account of the Issuer by the Trustee (upon receipt of a written request from the Issuer), the receipt of such repayment to be confirmed promptly in writing by or on behalf of the Issuer, and, to the extent permitted by law, the Holder of such Note shall thereafter look only to the Issuer for any payment which such Holder may be entitled to collect, and all liability of the Trustee with respect to such moneys shall upon receipt thereof by the Issuer cease. ARTICLE 10 Concerning the Trustee Section 10.01. Duties of the Trustee; Certain Rights of the Trustee. (a) The Trustee undertakes to perform such duties and only such duties as are specifically set forth in this Indenture. Neither the Trustee, its agents nor Affiliates shall be liable for any act or omission made in connection with this Indenture or the other Basic Documents or any Trademark License except in the case of its gross negligence or willful misconduct. In furtherance, and not in limitation, of the Trustee's rights, duties and protections hereunder, and unless otherwise specifically provided in this Indenture, the Trustee shall (subject to the terms hereof) grant such consents, make such requests and determinations and take or refrain from taking such actions (including, without limitation, actions with respect to an Event of Default, of which the Trustee has notice) as are permitted (but not expressly required) to be granted, made or taken by the Trustee under this Indenture, as the Majority Holders shall direct in writing. No provision 38 of this Indenture shall be construed to relieve the Trustee from liability for its own gross negligence or willful misconduct; provided, however, that: (i) the duties and obligations of the Trustee shall be determined solely by the express provisions of this Indenture to which the Trustee is a party and the Trustee shall not be liable except for the performance of such duties and obligations as are specifically set forth herein, and no implied covenants or obligations shall be read into this Indenture against the Trustee; (ii) in the absence of gross negligence or bad faith on the part of the Trustee, the Trustee may conclusively rely as to the truth of the statements and the correctness of the opinions expressed therein, upon any statements, certificates or opinions furnished to the Trustee pursuant to this Indenture and conforming to the requirements of this Indenture; (iii) the Trustee shall not be liable with respect to any action taken, suffered or omitted to be taken by it in good faith in accordance with the written direction of the Majority Holders under, or reasonably believed by it to be authorized or permitted by, this Indenture, and shall not be liable for accepting, or acting on, any decision made by the Holders in accordance with the provisions hereof; and (iv) the Trustee shall be under no duty to verify, recompute or recalculate information supplied to it by any Person; provided that, in accordance with Section 10.08, the Trustee shall forward to Noteholders any calculations received from the Issuer pursuant to the terms of this Indenture; and provided further that the Trustee shall verify amounts in the Trust Accounts in accordance with its customary business practice and as required by the terms hereof. (b) Certain Rights of Trustee. (i) The Trustee may request and rely upon, and shall be protected in acting or refraining from acting upon, and shall not be bound to make any investigation into the facts or matters stated in, any resolution, certificate, statement, instrument, opinion, report, notice, request, consent, order, note, guaranty or other paper or document believed by it to be genuine and to have been signed or presented by the proper party or parties, but the Trustee in its sole discretion may make such further inquiry or investigation into such facts or matters as it may see fit; (ii) the Trustee shall be under no obligation to exercise any of the rights or powers vested in it by this Indenture at the request, order or direction of any of the Holders, including the Majority Holders, pursuant 39 to the provisions of this Indenture or any of the other Basic Documents, unless such Holders shall have furnished to the Trustee reasonable security or indemnity (including reasonable advances) against the costs, expenses and liabilities (including, without limitation, attorneys' fees and expenses) which might be incurred therein or thereby; (iii) none of the provisions contained in this Indenture shall require the Trustee to expend or risk its own funds or otherwise incur personal financial liability in the performance of any of its duties or in the exercise of any of its rights or powers; (iv) as a condition to the taking or omitting of any action by it hereunder for the benefit of the Holders, the Trustee may consult with counsel or other professionals and the advice of such counsel or other professionals or any Opinion of Counsel shall be full and complete authorization and protection in respect of any action taken or omitted by it hereunder in good faith and in reliance thereon; and (v) for all purposes under this Indenture, the Trustee shall not be deemed to have notice or knowledge of any Default or Event of Default (other than the Event of Default specified in Section 8.01(a)) unless a Responsible Officer assigned to and working in the Trust Office has received written notice of such a Default or Event of Default and such notice references the Notes generally, the Issuer, the Trust Estate or this Indenture. Section 10.02. Trustee Not Liable for Trademark Licenses; Performance of Trustee's Duties. (a) Neither the Trustee nor its agents shall be liable to any Person for any delay in or failure of the payment under any Trademark License or for any nonperformance or default on the part of any party (other than the Trustee) under the Basic Documents. THE TRUSTEE MAKES NO REPRESENTATION OR WARRANTY EXPRESS OR IMPLIED AS TO THE EXISTENCE, TITLE, VALUE, CONDITION, OR COLLECTABILITY OF ANY TRADEMARK LICENSE OR THE VALIDITY, PERFECTION, PRIORITY OR ENFORCEABILITY OF ANY INTERESTS THEREIN OR IN RESPECT OF ANY OF THE BASIC DOCUMENTS, WHETHER BY OPERATION OF LAW OR BY REASON OF ANY ACTION OR OMISSION TO ACT ON ITS PART HEREUNDER OR ANY OTHER REPRESENTATION OR WARRANTY, EXPRESS OR IMPLIED, WITH RESPECT TO ANY TRADEMARK LICENSE WHATSOEVER. (b) The Trustee may, in the execution and exercise of all or any of the trusts, powers, authorities and discretions vested in it by this Indenture, act by 40 Responsible Officers or a Responsible Officer of the Trustee or its Affiliates, and the Trustee may also whenever it deems it expedient in the interests of the Noteholders, whether by power of attorney or otherwise, delegate to any Person or fluctuating body of Persons all or any of the trusts, powers, authorities and discretions vested in it by the Basic Documents and any such delegation may be made upon such terms and conditions and subject to such regulations (including power to subdelegate) as the Trustee may deem fit and it shall not be bound to supervise the proceedings and shall not in any way or to any extent be responsible for any loss incurred by any misconduct or default on the part of such delegate or subdelegate; provided that the Trustee shall have exercised reasonable care in the selection of such delegate and provided further that the Trustee shall not delegate its disbursement obligations or its obligations to hold the Trust Accounts contained in Articles 3 and 4 hereunder. The Trustee shall give prompt notice to the Issuer of the appointment (and termination thereof) of any delegate as aforesaid and shall procure that any delegate shall also give prompt notice to the Issuer of any subdelegate. (c) Neither the Trustee nor any director or officer of the Trustee shall be precluded from underwriting, guaranteeing the subscription of or subscribing for some or all of the Notes with or without a commission or other remuneration or from purchasing or otherwise acquiring, holding, dealing in or disposing of the Notes or any of them or any notes, bonds, debentures, debenture stock, shares or securities whatsoever of, or from acting as banker (including, without limitation, engaging in normal banking, trust and investment banking business), paying agent or process agent for or with, the Issuer and any Affiliate thereof or from otherwise at any time contracting or entering into any financial or other transactions with the Issuer or any Affiliate thereof. Section 10.03. Resignation and Removal; Appointment of Successor Trustee. (a) The Trustee may resign and be discharged of the trusts created by this Indenture by giving 30 days' written notice to the Issuer and the Holders, and such resignation shall take effect upon receipt by the Trustee of an instrument of acceptance of appointment executed by a successor trustee as herein provided in Sections 10.04 and 10.05. (b) The Trustee may be removed from its duties under the Indenture upon written notice by the Majority Holders delivered to the Trustee and to the Issuer. (c) If at any time the Trustee shall resign or be removed or otherwise become incapable of acting, or if at any time a vacancy shall occur in the office of the Trustee for any other cause, the Issuer shall use its best efforts to locate and recommend a qualified successor trustee to act under this Indenture and a 41 successor trustee may be appointed by the Majority Holders to act under this Indenture (whether or not such successor shall have been located or recommended by the Issuer) upon written notice to the Issuer and the Trustee. If the successor trustee is to be appointed by the Majority Holders as provided in the preceding sentence, such appointment shall be subject to the receipt of the consent of the Issuer, such consent not to be unreasonably withheld. In the event that no such successor trustee is appointed by the Majority Holders to act under this Indenture, the Trustee may request a court to make such appointment. Any successor trustee appointed pursuant to this Section 10.03 shall be a licensed bank or trust company organized under the law of the United States or any State thereof having a corporate trust department and a total shareholder equity aggregating at least $500,000,000 if there be such an institution willing and able to accept the trust upon reasonable or customary terms. Section 10.04. Acceptance of Appointment by Successor Trustee. Any successor trustee appointed as provided in Section 10.03 shall execute, acknowledge and deliver to the Issuer and to its predecessor trustee an instrument accepting such appointment hereunder, and, subject to the provisions of Section 10.03, thereupon the resignation or removal of the predecessor Trustee shall become effective and such successor trustee, without any further act, deed or conveyance, shall become vested with all the rights, powers, duties and obligations of its predecessor hereunder, with like effect as if originally named as Trustee herein; but, nevertheless, at the written direction of the Majority Holders or written request of the successor trustee, the Trustee ceasing to act shall execute and deliver an instrument transferring to such successor Trustee all the rights and powers of the Trustee so ceasing to act. Upon written request of any such successor Trustee, the Holders shall execute any and all instruments in writing for more fully and certainly vesting in and confirming to such successor Trustee all such rights and powers. Any predecessor Trustee shall nevertheless retain a Lien upon all property or funds held or collected by such Trustee to secure any amounts then due it pursuant to the provisions of the Indenture and shall remain liable for any willful misconduct or gross negligence on its part while acting as Trustee. Section 10.05. Merger or Consolidation of Trustee. Any corporation into which the Trustee may be merged or converted or with which it may be consolidated or any corporation resulting from any merger, conversion or consolidation to which the Trustee shall be a party shall be the successor of the Trustee hereunder, provided that such corporation shall be qualified under the provisions of Section 10.03(c), without the execution or filing of any paper or any further act on the part of any of the parties hereto or the Holders, notwithstanding anything contained herein to the contrary. 42 Section 10.06. Certain Procedural Matters. The Trustee, in its own name and as trustee of an express trust, at the written direction of the Majority Holders, shall be entitled and empowered to institute any action or proceeding at law or in equity for the collection of any amounts due and unpaid or the enforcement of any other rights of the Holders, prosecute any such action or proceeding to judgment or final decree, and shall at the written direction of the Majority Holders enforce any such judgment or final decree and collect in the manner provided by law the moneys adjudged or decreed to be payable. Section 10.07. Trustee Fees and Indemnification. (a) The Issuer covenants and agrees to pay to the Trustee from time to time, and the Trustee shall be entitled to, compensation as agreed between the Issuer and the Trustee in writing (which shall not be limited by any provision of law in regard to the compensation of a trustee of an express trust). Such compensation and the reasonable fees and expenses of Richards Layton & Finger, P.A., counsel to the Trustee, shall be payable for the first time upon the Closing Date. (b) The Issuer covenants and agrees to pay or reimburse the Trustee, and each successor Trustee, upon its request for all documented expenses, disbursements and advances reasonably incurred or made by or on behalf of it in accordance with any of the provisions of this Indenture or the other Basic Documents (including, without limitation, the compensation, documented expenses and disbursements reasonably incurred of its counsel and of all agents except any such expense, disbursement or advance as may arise from its gross negligence or willful misconduct). (c) The Issuer covenants and agrees to indemnify, or cause to be indemnified, the Trustee and each of its officers, directors, agents and employees for, and to hold it, and its officers, directors, agents and employees harmless against, any loss, liability or reasonable expense incurred without gross negligence, wilful misconduct or bad faith, on its part, arising out of or in connection with the execution, delivery, performance or enforcement of this Indenture. The Trustee shall notify the Issuer promptly of any claim for which it may seek indemnity. The Issuer shall defend the claim and the Trustee shall cooperate in the defense. The Trustee may have separate counsel and the Issuer will pay the reasonable fees and expenses of such counsel. The Issuer need not pay for any settlement made without its consent. This indemnity shall survive the resignation or removal of the Trustee and termination of this Indenture. Section 10.08. Information. The Trustee will promptly forward to the Noteholders any Issuer notices, financial statements, Officers' Certificates or other forms of written communication that it receives pursuant to the terms of this Indenture. 43 ARTICLE 11 Supplemental Indenture Section 11.01. Supplemental Indenture Without Consent of Noteholders. The Issuer and the Trustee may from time to time and at any time enter into an indenture or indentures supplemental hereto for one or more of the following purposes: (a) to convey, transfer, assign, mortgage or pledge to the Trustee as security for the Notes any property or assets; and (b) to cure any ambiguity or to correct or supplement any provision contained herein, in the Notes, in any Trademark License or other Basic Document or in any supplemental indenture which may be defective or inconsistent with any other provision contained herein or in the Notes or in any supplemental indenture; or to make such other provisions in regard to matters or questions arising under this Indenture, the Notes or under any supplemental indenture as the Issuer and the Trustee may deem necessary or desirable and which shall not adversely affect the interests of the Noteholders; provided, however, that an opinion of Independent Counsel shall be addressed and delivered to the Trustee and the Noteholders opining that such supplemental indenture does not adversely affect the rights of the Noteholders under this Indenture. The Trustee is hereby authorized to join in the execution of any such supplemental indenture, to make any further appropriate agreements and stipulations which may be therein contained and to accept the conveyance, transfer, assignment, mortgage or pledge of any property thereunder, but the Trustee shall not be obligated to enter into any such supplemental indenture which affects the Trustee's own rights, duties or immunities under this Indenture or under the other Basic Documents or otherwise. Any supplemental indenture authorized by the provisions of this Section may be executed without the consent of the Holders of any of the Notes at the time Outstanding, notwithstanding any of the provisions of Section 11.02. Section 11.02. Supplemental Indenture with Consent of Noteholders. With the consent (evidenced as provided in Article 12) of the Majority Holders, the Issuer and the Trustee may, from time to time and at any time, enter into an indenture or indentures supplemental hereto for the purpose of adding any provisions to or changing in any manner or eliminating any of the provisions of this Indenture, the Notes or of any supplemental indenture or of modifying in any manner the rights of the Noteholders, provided, that no such supplemental 44 indenture shall (a) change the final maturity of any Note or the time of payment of any principal thereof, or reduce the principal amount thereof, or any Make- Whole Amount thereon or reduce any amount payable on redemption thereof or reduce the amount of principal or Make-Whole Amount that would be due and payable upon the occurrence of an Event of Default, or impair or affect the rights of any Noteholder to institute suit for the payment thereof without the consent of each Noteholder so affected, (b) reduce any amount required to be collected or retained in any Trust Account, (c) except as provided in Articles 3 and 4, release any part of the Trust Estate or (d) reduce the aforesaid percentage of Notes the consent of the Holders of which is required for any supplemental indenture, acceleration or rescission without the consent of the Holders of each Note so affected. Upon the request of the Issuer, accompanied by a copy of the supplemental indenture and upon the filing with the Trustee of evidence of the consent of the Majority Holders or any greater percentage of Holders as required by this Section 11.02 and other documents, if any, required by Section 12.02, the Trustee shall join with the Issuer in the execution of such supplemental indenture unless such supplemental indenture affects the Trustee's own rights, duties or immunities under the Indenture or otherwise, in which case the Trustee may in its discretion, but shall not be obligated to, enter into such supplemental indenture. Section 11.03. Effect of Supplemental Indenture. Upon the execution of any supplemental indenture pursuant to the provisions hereof, this Indenture and the Notes shall be and be deemed to be modified and amended in accordance therewith and the respective rights, limitations of rights, obligations, duties and immunities under this Indenture of the Trustee, the Issuer and the Noteholders shall thereafter be determined, exercised and enforced hereunder subject in all respects to such modifications and amendments, and all the terms and conditions of any such supplemental indenture shall be and be deemed to be part of the terms and conditions of this Indenture for any and all purposes. Section 11.04. Documents to Be Given to Trustee. The Trustee, subject to the provisions of Sections 11.01 and 11.02, shall be entitled to receive one or more certificate or certificates of an Authorized Officer and Opinion or Opinions of Counsel as evidence that any such supplemental indenture complies with the applicable provisions of this Indenture. Section 11.05. Notation on Notes in Respect of Supplemental Indenture. Notes authenticated and delivered after the execution of any supplemental indenture pursuant to the provisions of this Article may bear a notation in form and manner approved by the Trustee as to any matter provided for by such supplemental indenture. If the Issuer or the Trustee shall so determine, new Notes so modified as to conform to any modification of this Indenture contained in any 45 such supplemental indenture may be prepared by the Issuer at its expense, authenticated by the Trustee and delivered in exchange for the Notes then Outstanding. ARTICLE 12 Concerning the Holders Section 12.01. Control by Majority Holders. Except as provided below, the Majority Holders, by a written direction to the Trustee, shall have the right to direct the time, method, and place of conducting any proceeding for any remedy available to the Trustee or exercising any trust or power conferred on the Trustee; provided, however, that the Trustee shall have the right to decline to follow any such direction (i) if the Trustee shall be advised by counsel that the action so directed may not lawfully be taken or (ii) if the Trustee shall be advised by counsel that the action so directed may involve it in personal liability unless it shall have been furnished a reasonably satisfactory indemnity or security therefor. Section 12.02. Evidence of Action Taken by Holders. Whenever in this Indenture or in any other Basic Document it is provided that the Majority Holders may take any action (including the making of any demand or request, the giving of any notice, direction, instruction, consent or waiver or the taking of any other action), the fact that at the time of taking any such action the Majority Holders have joined therein shall be evidenced in writing by one or more instruments of similar tenor executed by such Holders in person or by agent or proxy appointed in writing. Such action by the Majority Holders shall become effective when such instrument or instruments are delivered to and received by the Trustee. The Trustee shall thereafter notify the Issuer of the effectiveness of such action. Section 12.03. Proof of Execution of Instruments. The fact and date of the execution of any instrument by a Holder or his agent or proxy may be proved by the certificate of any notary public or other officer of any jurisdiction within or without the United States authorized to take acknowledgments of deeds to be recorded in such jurisdiction that the person executing such instrument acknowledged to him the execution thereof, or by an affidavit of a witness to such execution sworn to before any such notary or other such officer. Where such execution is by or on behalf of any legal entity other than an individual, such certificate or affidavit shall also constitute proof of the authority of the individual executing the same. 46 Section 12.04. Notes Owned by the Issuer. In determining whether the Holders have concurred in any direction, request, consent or waiver under the Indenture, Notes which are owned by the Issuer or any of its Affiliates shall be disregarded in both the numerator and denominator of the fraction used to determine the requisite percentage. Section 12.05. Right of Revocation of Action Taken. At any time prior to (but not later than) the evidencing to the Trustee, as provided in Section 12.02, of the taking of any action by the Holders, any Holder of a Note the serial number of which is shown by the evidence to be included in those Notes the Holders of which have consented to such action may, by filing written notice with the Trustee at the Trust Office and upon proof of holding as provided in Section 2.06, revoke such action insofar as it concerns such Note. Unless revoked pursuant to the foregoing provisions, any such action taken by a Holder shall be conclusive and binding upon such Holder and upon all future Holders and owners of such Note and of any Note issued in exchange or substitution therefor, irrespective of whether or not any notation in regard thereto is made upon such Note. Except as otherwise provided herein, any action taken by the Majority Holders shall be conclusive and binding upon the Issuer, the Trustee and the Holders of all Notes. Section 12.06. Right to Vote Notes in Part. Notwithstanding anything in this Indenture to the contrary, each Holder may deliver directions to the Trustee with respect to a portion of the principal amount of the Note or Notes held by such Holder. ARTICLE 13 Redemption of Notes Section 13.01. Optional Redemptions. Upon notice given as provided in Section 13.02 of this Indenture, the Issuer, at its option, may redeem the Notes at any time as a whole (but not in part) at an optional redemption price equal to the aggregate Current Values of the Notes at the date of redemption, together with a premium equal to the Make-Whole Amount. Section 13.02. Notice of Redemption; Make-Whole Computations. The Issuer shall call Notes for redemption under Section 13.01 by giving written notice thereof to each Holder (with a copy of such notice to the Trustee), which notice shall be given not less than 30 nor more than 60 days prior to the date fixed for such redemption and shall specify the date fixed for such redemption. Upon the giving of such notice of redemption, the aggregate Current Values of the 47 Notes plus the Make-Whole Amount shall become due and payable on the specified redemption date. Any notice of redemption pursuant to this Section 13.02 shall include computations in reasonable detail showing the manner of calculation of what the applicable Make-Whole Amount would have been if the Notes had been redeemed on the date of such notice. The Issuer shall determine the Make-Whole Amount on the third Business Day prior to the date fixed for any redemption under Section 13.02. Two Business Days prior to such redemption date, the Issuer will furnish to the Holders and the Trustee a certificate signed by an Authorized Officer of the Issuer setting forth computations in reasonable detail showing the manner of calculation of such Make-Whole Amount and attaching a copy of the source of the market data by reference to which the Treasury Yield was determined in connection with such computations. In the event of any disagreement between the Holders and the Issuer as to the calculation of any Make-Whole Amount, the calculation thereof by the Required Holders shall, absent manifest error, be conclusive. Section 13.03. Surrender of Notes; Notation Thereon. Subject to the provisions of Section 2.05(b), the Issuer may, as a condition of payment on account of any Note, require the Holder to present the Note for notation of such payment and, if such Note be paid in full, require the surrender thereof. Section 13.04. Purchase of Notes. The Issuer will not acquire directly or indirectly by purchase or redemption or otherwise any of the Outstanding Notes except by way of payment or redemption in accordance with the provisions of the Notes and of the Indenture. ARTICLE 14 Miscellaneous Section 14.01. Binding Upon Assigns. Except as otherwise provided herein, the provisions of this Indenture (including any amendments, modifications and waivers hereof properly adopted) shall be binding upon and shall inure to the benefit of the parties hereto, the holders and their respective successors and assigns. Section 14.02. Notices. (a) Except as otherwise expressly provided herein, all notices, request, demands, directions or other communications to or upon the respective parties hereto, and the Holders shall be in writing, with a copy 48 sent by facsimile on the date the notice is sent in each case, and shall become effective when received. Any written notice shall either be (i) mailed (by certified or registered mail, return receipt requested with proper postage for airmail prepaid), (ii sent in the form of a telex (with answerback received) or facsimile (with confirmation that the appropriate number of pages has been received by the addressee, and promptly followed by hard copy mailed as provided in clause (iii)), (iii) delivered by overnight delivery service (providing for delivery receipts) or (iv) delivered by hand. (b) All notices, requests, demands, directions or other communications under this Indenture shall be addressed as follows (or to such other address as a party hereto may hereafter specify for such purpose by notice to the other parties hereto): To the Trustee: Wilmington Trust Company Rodney Square North 1100 North Market Street Wilmington, Delaware 19890 Attention: Corporate Trust Administration Telephone: 302-651-1000 Facsimile: 302-429-4749 If to the Issuer: SPELL C. LLC 625 Landor Lane Pasadena, CA 91106 Attention: Carol Gratzke With a copy to: Cherokee, Inc., Administrator 6835 Valjean Avenue Van Nuys, CA 91406 Telephone: 818-908-9868 Facsimile: 818-908-9191 (c) The Trustee shall not be liable for any error or failure in the sending, dispatching or transmission of any notice, request, demand, direction or other communication under this Indenture. 49 Section 14.03. Effect of Headings. The Table of Contents hereto and the Article and Section headings herein are for convenience only and shall not affect the construction hereof. Section 14.04. Severability. Any provision of this Indenture which is prohibited or unenforceable in any jurisdiction shall, as to such jurisdiction, be ineffective to the extent of such prohibition or unenforceability without invalidating the remaining provisions hereof, and any such prohibition or unenforceability in any jurisdiction shall not invalidate or render unenforceable such provision in any other jurisdiction. Section 14.05. Counterparts. This Indenture may be executed in any number of counterparts, each of which shall be an original; but such counterparts shall together constitute but one and the same instrument. Section 14.06. Further Assurance. The Issuer shall, from time to time on being required to do so by the Trustee, now or at any time in the future, do or procure the doing of all such acts and/or execute all such documents in a form reasonably satisfactory to the Trustee as the Trustee may reasonably consider necessary for giving full effect to this Indenture and securing to the Trustee the full benefit of the rights, powers and remedies conferred upon the Trustee in this Indenture. Section 14.07. Governing Law. THIS INDENTURE AND THE NOTES SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH LAW OF THE STATE OF NEW YORK. Section 14.08. Limitation on Recourse. No recourse under or upon any obligation, covenant or agreement contained in this Indenture, or in any Note, or because of any indebtedness evidenced thereby shall be had against any incorporator or any past or present or future stockholder, officer or director, as such, of the Issuer or of any successor entity, either directly or through the Issuer or any successor entity, under any rule of law, statute or constitutional provision or by the enforcement of any assessment or by any legal or equitable proceeding or otherwise, all such liability being expressly waived and released by the acceptance of the Notes by the Holders and as part of the consideration for the issue of the Notes. Section 14.09. Jurisdiction and Process. THE ISSUER AGREES THAT ANY LEGAL ACTION OR PROCEEDING ARISING OUT OF THIS INDENTURE OR ANY DOCUMENT EXECUTED IN CONNECTION HEREWITH, OR ANY LEGAL ACTION OR PROCEEDING TO EXECUTE 50 OR OTHERWISE ENFORCE ANY JUDGMENT OBTAINED AGAINST THE ISSUER, FOR BREACH HEREOF OR THEREOF, OR AGAINST ANY OF ITS PROPERTIES, MAY BE BROUGHT IN THE COURTS OF THE STATE OF NEW YORK OR THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK BY OR ON BEHALF OF THE TRUSTEE OR BY OR ON BEHALF OF ANY HOLDER OF A NOTE, AS SUCH HOLDER MAY ELECT, AND THE ISSUER HEREBY IRREVOCABLY AND UNCONDITIONALLY SUBMITS TO THE NON-EXCLUSIVE JURISDICTION OF SUCH COURTS (WITHOUT LIMITING THE JURISDICTION OF OTHER COURTS) FOR PURPOSES OF ANY SUCH LEGAL ACTION OR PROCEEDING. THE ISSUER HEREBY IRREVOCABLY AND UNCONDITIONALLY AGREES THAT SERVICE OF PROCESS IN ANY LEGAL ACTION OR PROCEEDING RELATING TO THE BASIC DOCUMENTS MAY BE EFFECTED BY MAILING A COPY THEREOF BY REGISTERED OR CERTIFIED MAIL (OR ANY SUBSTANTIALLY SIMILAR FORM OF MAIL), POSTAGE PREPAID, TO THE ISSUER AT ITS ADDRESS SET FORTH IN SECTION 14.02 OR AT SUCH OTHER ADDRESS OF WHICH THE TRUSTEE SHALL HAVE BEEN NOTIFIED PURSUANT THERETO. IN ADDITION, THE ISSUER (A) HEREBY IRREVOCABLY WAIVES TO THE FULLEST EXTENT PERMITTED BY LAW, ANY OBJECTION WHICH IT MAY NOW OR HEREAFTER HAVE TO THE LAYING OF VENUE OF ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS INDENTURE OR ANY OTHER DOCUMENT EXECUTED IN CONNECTION HEREWITH OR THEREWITH BROUGHT IN THE COURTS OF THE STATE OF NEW YORK OR THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK, AND ANY CLAIM THAT ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN ANY SUCH COURT HAS BEEN BROUGHT IN AN INCONVENIENT FORUM; AND (B) HEREBY WAIVES ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF OR RELATING TO THIS INDENTURE OR THE TRANSACTIONS CONTEMPLATED HEREBY. 51 IN WITNESS WHEREOF, the undersigned have caused this Indenture to be duly executed as a deed as of the date hereof by their respective officers hereunto duly authorized. SPELL C. LLC as Issuer By: /s/ Carol Gratzke -------------------------------- Name: Carol Gratzke Title: Secretary and Treasurer WILMINGTON TRUST COMPANY as Trustee By: /s/ Donald G. MacKelcan -------------------------- Name: Donald G. MacKelcan Title: Assistant Vice President 52 Schedule I ---------- Note Payment Dates
Date Principal Amount Due Original Value - ---- -------------------- -------------- May 20, 1998 $ 2,250,000 $ 2,187,667.08 August 20, 1998 $ 2,250,000 $ 2,150,359.43 November 20, 1998 $ 2,250,000 $ 2,113,688.00 February 20, 1999 $ 2,250,000 $ 2,077,641.96 May 20, 1999 $ 2,250,000 $ 2,042,210.63 August 20, 1999 $ 2,250,000 $ 2,007,383.54 November 20, 1999 $ 2,250,000 $ 1,973,150.37 February 20, 2000 $ 2,250,000 $ 1,939,501.00 May 20, 2000 $ 2,625,000 $ 2,224,163.06 August 20, 2000 $ 2,625,000 $ 2,186,233.01 November 20, 2000 $ 2,625,000 $ 2,148,949.81 February 20, 2001 $ 2,625,000 $ 2,112,302.43 May 20, 2001 $ 2,625,000 $ 2,076,280.01 August 20, 2001 $ 2,625,000 $ 2,040,871.91 November 20, 2001 $ 2,625,000 $ 2,006,067.65 February 20, 2002 $ 2,625,000 $ 1,971,856.92 May 20, 2002 $ 2,625,000 $ 1,938,229.61 August 20, 2002 $ 2,625,000 $ 1,905,175.77 November 20, 2002 $ 2,625,000 $ 1,872,685.61 February 20, 2003 $ 2,625,000 $ 1,840,749.53 May 20, 2003 $ 2,625,000 $ 1,809,358.08 August 20, 2003 $ 2,625,000 $ 1,778,501.96 November 20, 2003 $ 2,625,000 $ 1,748,172.06 February 20, 2004 $ 2,625,000 $ 1,718,359.39 -------------- $60,000,000 $47,869,558.83
53 CUSIP No. 84780P AA 2 EXHIBIT A THE ISSUER OF THE SECURITIES EVIDENCED HEREBY HAS NOT BEEN REGISTERED UNDER THE INVESTMENT COMPANY ACT OF 1940, AS AMENDED (THE "INVESTMENT COMPANY ACT"), AND SUCH SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND MAY NOT BE OFFERED, SOLD, PLEDGED OR OTHERWISE TRANSFERRED EXCEPT BY THE HOLDER HEREOF IN ACCORDANCE WITH THE SECURITIES ACT AND ANY APPLICABLE SECURITIES LAW OF ANY STATE OF THE UNITED STATES, AND PRIOR TO THE EXPIRATION OF THE HOLDING PERIOD APPLICABLE TO SALES OF SUCH SECURITIES UNDER RULE 144(k) UNDER THE SECURITIES ACT (OR ANY SUCCESSOR PROVISION), ONLY TO A PERSON (i)(A) WHOM SUCH HOLDER REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER WITHIN THE MEANING OF RULE 144A UNDER THE SECURITIES ACT OR (B) WHO IS AN INSTITUTIONAL ACCREDITED INVESTOR WITHIN THE MEANING OF RULE 501(a)(1), (2), (3) OR (7) UNDER THE SECURITIES ACT AND (ii) WHO IS PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A PERSON THAT IS EITHER (A) A QUALIFIED INSTITUTIONAL BUYER IN A TRANSACTION MEETING THE REQUIREMENTS OF RULE 144A OR (B) AN INSTITUTIONAL ACCREDITED INVESTOR. IN ADDITION, SUCH SECURITIES MAY ONLY BE SOLD OR OTHERWISE TRANSFERRED TO A PERSON WHO (i) IS A QUALIFIED PURCHASER AS SUCH TERM IS DEFINED IN THE INVESTMENT COMPANY ACT AND (ii) IS PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A PERSON THAT IS A QUALIFIED PURCHASER, AND WHO DELIVERS A DULY EXECUTED TRANSFEREE CERTIFICATE AND SUCH INFORMATION AS SET FORTH THEREIN TO THE TRUSTEE AND THE ISSUER, IN ACCORDANCE WITH ALL APPLICABLE SECURITIES LAWS OF THE STATES OF THE UNITED STATES AND OTHER JURISDICTIONS. IN CONNECTION WITH ANY TRANSFER OF THIS NOTE, THE HOLDER HEREOF AGREES TO DELIVER A DULY EXECUTED TRANSFEROR CERTIFICATE AND SUCH INFORMATION SET FORTH THEREIN TO THE TRUSTEE AND THE ISSUER. A-1 THE FOLLOWING INFORMATION IS PROVIDED PURSUANT TO UNITED STATES TREASURY REGULATION SECTION 1.1275-3(b): THIS NOTE HAS BEEN ISSUED WITH ORIGINAL ISSUE DISCOUNT FOR UNITED STATES FEDERAL INCOME TAX PURPOSES. THE HOLDER OF THIS NOTE MAY OBTAIN THE INFORMATION DESCRIBED IN UNITED STATES TREASURY REGULATION SECTION 1.1275-3(b)(1)(i) FROM THE TREASURER OF THE ISSUER, AT THE FOLLOWING ADDRESS: 625 LANDOR LANE, PASADENA, CALIFORNIA 91106. No. ____________________ U.S. $________________ SPELL C. LLC ------------ Zero Coupon Secured Note SPELL C. LLC, a Delaware limited liability company (the "Issuer"), for value received, hereby promises to pay to [_______________] or registered assigns, at the Trust Office of the Trustee, _________% of each of the respective principal amounts indicated on Schedule I hereto at the applicable times indicated on Schedule I hereto and to pay on demand interest at a rate per annum equal to the Default Rate on any overdue principal and Make-Whole Amount, if any, all in the manner provided in and subject to the terms of the Indenture (the "Indenture") dated as of December 23, 1997 among the Issuer and Wilmington Trust Company, as Trustee (the "Trustee"), in such coin or currency of the United States of America as at the time of payment shall be legal tender for the payment of public and private debts. This Note is one of the Notes referred to in the Indenture. Reference is made to the further provisions of this Note set forth on the following pages. Such further provisions shall for all purposes have the same effect as though fully set forth at this place. This Note shall not be valid or become obligatory for any purpose until the certificate of authentication hereon shall have been signed by the Trustee. A-2 IN WITNESS WHEREOF, SPELL C. LLC has caused this instrument to be duly executed. Dated: SPELL C. LLC By: _____________________________________ Name: ____________________________________ Title:____________________________________ A-3 THIS is one of the Notes referred to in the within-mentioned Indenture. Authenticated without recourse, warranty or liability WILMINGTON TRUST COMPANY as Trustee By __________________________________________________ Name: ____________________________________________ Title: ___________________________________________ Date of Authentication: _______________________ A-4 SPELL C. LLC Zero Coupon Secured Note This Note is one of a duly authorized issue of secured notes (herein called the "Notes") issued in one series by SPELL C. LLC (herein called the "Issuer"), with such series being issued under and pursuant to the Indenture dated as of December 23, 1997 (herein called the "Indenture"; terms defined in the Indenture being used herein as therein defined), duly executed and delivered by the Issuer and Wilmington Trust Company, as Trustee. Reference is hereby made to the Indenture and all indentures supplemental thereto for a description of the rights, limitations of rights, obligations, recourse, duties and immunities thereunder of the Trustee thereunder, the Issuer and the Noteholders. In case an Event of Default shall have occurred and be continuing, the Current Value hereof may be declared, or otherwise become, due and payable, in the manner, with the effect and subject to the conditions provided in the Indenture. The Notes shall bear interest, to the extent enforceable under applicable law, on any overdue principal and Make-Whole Amount, if any, at the Default Rate. The amount payable by the Issuer in respect of principal of this Note (exclusive of any Make-Whole Amount) at any date shall not exceed the Current Value of this Note at such date. The Indenture contains provisions permitting the Issuer and the Trustee to enter into supplemental indentures for one or more of the following purposes: (a) to convey, transfer, assign, mortgage or pledge to the Trustee as security for the Notes any property or assets; and (b) to cure any ambiguity or to correct or supplement any provision contained in the Indenture, in the Notes or in any Trademark License or other Basic Document or in any supplemental indenture which may be defective or inconsistent with any other provision contained in the Indenture or in the Notes or in any supplemental indenture; or to make such other provisions in regard to matters or questions arising under the Indenture, the Notes or under any supplemental indenture as the Issuer and the Trustee may deem necessary or desirable and which shall not adversely affect the interests of the Noteholders. A-5 The Indenture contains provisions permitting the Issuer and the Trustee, with the consent of the Majority Holders evidenced as in the Indenture provided, to execute supplemental indentures adding any provisions to or changing in any manner or eliminating any of the provisions of the Indenture, the Notes or of any supplemental indenture or modifying in any manner the rights of the Noteholders; provided, however, that no such supplemental indenture shall (i) change the final maturity of any Note or the time of payment of any principal thereof, or reduce the principal amount thereof, or any Make-Whole Amount thereon or reduce any amount payable on redemption thereof or reduce the amount of principal that would be due and payable upon the occurrence of an Event of Default, or impair or affect the rights of any Noteholder to institute suit for the payment thereof without the consent of each Noteholder so affected, (ii) reduce any amount required to be collected or retained in any Trust Account, (iii) release any part of the Trust Estate or (iv) reduce the aforesaid percentage of Notes the consent of the Holders of which is required for any supplemental indenture, acceleration or rescission without the consent of the Holders of each Note so affected. It is also provided in the Indenture that, prior to the declaration of the acceleration of the Notes as provided in Section 8.01 of the Indenture, the Majority Holders may on behalf of the Holders of all the Notes waive any past Event of Default under the Indenture and its consequences, except a default (i) in the payment of principal of or Make-Whole Amount, if any, on any of the Notes or (ii) in respect of a covenant or provision of the Indenture which cannot be modified or amended without the consent of the Holder of each Note affected. In the case of any such waiver, the Issuer, the Trustee and the Noteholders shall be restored to their former positions and rights under the Indenture, respectively, and the relevant Event of Default shall cease to exist and be deemed to have been cured and not to have occurred for every purpose under the Indenture; but no such waiver shall extend to any subsequent or other Event of Default or impair any right consequent thereon. No reference herein to the Indenture and no provision of this Note or of the Indenture shall alter or impair the obligation of the Issuer, which is absolute and unconditional, to pay the principal of this Note in the manner, at the respective times and in the coin or currency herein prescribed. The Notes are issuable in registered form without coupons in minimum denominations of $500,000 and in the manner and subject to the limitations provided in the Indenture. The Notes may be redeemed at the option of the Issuer at any time as a whole (but not in part) at a redemption price equal to the Current Value thereof plus the Make-Whole Amount. The Trustee may rely upon the Note Register as conclusive evidence of the aggregate Outstanding principal amount of the Notes. A-6 Upon due presentment for registration of transfer of this Note at the Trust Office a new Note or Notes of authorized denominations for an equal unpaid principal amount will be issued to the transferee in exchange therefor, subject to the limitations provided in the Indenture, without charge except for any tax or other governmental charge imposed in connection therewith; provided, that such transferor shall deliver a Transferor Certificate and transferee shall deliver a Transferee Certificate. The Issuer, the Trustee and any authorized agent of the Issuer or the Trustee may deem and treat the registered Holder hereof as the absolute owner of this Note for all purposes and, prior to due presentment for registration of transfer, shall not be affected by any notice to the contrary. This Note shall not be entitled to any benefit under the Indenture or be valid or become obligatory for any purpose until this Note shall be authenticated by the execution by the manual signature of a duly Authorized Officer of the Trustee of the Trustee's certificate of authentication hereon. It is hereby certified and recited that all conditions, acts and things required by law and the Indenture to exist, to have happened and to have been performed precedent to and in the issuance of this Note exist, have happened and have been performed in due time, form and manner as required by law and the Indenture, and that the issuance of this Note and the issue of which it forms a part are within every debt and other limit prescribed by the laws of the State of New York. THIS NOTE SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH NEW YORK LAW. A-7 EXHIBIT B FORM OF TRANSFEREE CERTIFICATE [Trustee's Address] [Issuer's Address] Attention: ____________ Re: Zero Coupon Secured Notes of SPELL C. LLC ------------------------- Ladies and Gentlemen: Reference is hereby made to Section 2.06(f) of the Indenture, dated as of December 23, 1997 (the "Indenture"), between SPELL C. LLC (the "Issuer") and Wilmington Trust Company, as trustee (the "Trustee"). Capitalized terms used but not defined herein shall have the meanings assigned to them in the Indenture. In connection with our proposed purchase of U.S. $_____________ aggregate principal amount of Zero Coupon Secured Notes of the Issuer, pursuant to Section 2.06(f) of the Indenture, we (the "Transferee") acknowledge, represent, agree and confirm, as of the date hereof, for your benefit and the benefit of the Issuer and the Transferee's transferor, that: (a) The Transferee is a "qualified purchaser" (as defined in the Investment Company Act of 1940, as amended (the "Investment Company Act") and related rules and is aware that the Issuer will not be registered as an investment company under the Investment Company Act and is acquiring the Notes for its own or one or more accounts, each of which is a qualified purchaser, and as to each of which the Transferee exercises sole investment discretion, and in a principal amount of not less than U.S. $500,000 for the Transferee and for each such account, in each case solely for investment and not with a view to resale or distribution thereof in violation of the Securities Act. (b) The Transferee is either (check one or more items in (i), (ii) or (iii) below as appropriate): (i) ___ acquiring the Notes from a transferor that qualifies under paragraph (a) of the Transferor Letter B-1 (ii) ___ a "qualified institutional buyer" (as defined in Rule 144A under the Securities Act) and is aware that the sale of the Notes to it is being made in reliance on the exemption from registration provided by Rule 144A under the Securities Act and is acquiring the Notes for its own account or for one or more accounts, each of which is a qualified institutional buyer that is aware that the sale of the Notes to it is being made in reliance on the exemption from registration provided by Rule 144A under the Securities Act. (iii) ___ a sophisticated investor who is an institutional "accredited investor," as defined in Rule 501(a)(1), (2), (3) or (7) under the Securities Act, that is acquiring the Notes for its own account (or for the account of another as specified in writing to the Trustee and the Issuer). If such Transferee is acquiring the Notes for the account of another, it confirms that such other investor is (x) a sophisticated institutional "accredited investor," as so defined, or (y) a "qualified institutional buyer" (as defined in Rule 144A under the Securities Act), and is aware of the restrictions on transfer of the Notes, and as to each such account the Transferee exercises sole investment discretion, and is acquiring Notes in a principal amount of not less than U.S. $500,000 for the Transferee and for each such account, in each case solely for investment and not with a view to resale or distribution thereof in violation of the Securities Act. (c) The Transferee has such knowledge and experience in financial and business matters as to be capable of evaluating the merits and risks of its investment in the Notes, and the Transferee and any accounts for which it is acting are each able to bear the economic risk of investing in the Notes. (d) The Transferee is not a defined contribution plan (such as a 401(k) plan), or a partnership or other investment vehicle (i) in which its partners or participants have or will have any discretion to determine whether or how much of the Transferee's assets are invested in any investment made or to be made by the Transferee (including the Transferee's investment in the Notes) or (ii) that is otherwise an entity managed to facilitate the individual decisions of its beneficial owners to invest in the Notes. (e) The Transferee hereby represents that at least one of the following statements is an accurate representation as to each source of funds (a "Source") to B-2 be used by the Transferee to pay the purchase price of the Notes to be purchased by the Transferee hereunder: (i) if the Transferee is an "insurance company" as defined in Section V(d) of Prohibited Transaction Exemption ("PTE") 95-60 (as issued by the United States Department of Labor) and the Source is an "insurance company general account" as defined in Section V(e) of PTE 95-60 then, in accordance with Section I(a) of PTE 95-60, there is no Employee Benefit Plan, treating as a single Employee Benefit Plan all plans maintained by the same employer or employee organization, with respect to which the amount of the reserves and liabilities for all general account contracts held by or on behalf of such Plan exceed ten percent (10%) of the total reserves and liabilities of such general account (exclusive of separate account liabilities) plus surplus; (ii) the Source is either an insurance company pooled separate account, within the meaning of PTE 90-1 (issued January 29, 1990) or a bank collective investment fund, within the meaning of the PTE 91-38 (issued July 12, 1991) and, except as the Transferee has disclosed to the Issuer in writing pursuant to this paragraph (ii), no Employee Benefit Plan or group of Employee Benefit Plans maintained by the same employer or employee organization beneficially owns more than 10% of all assets allocated to such pooled separate account or collective investment fund; or (iii) the Source constitutes assets of an "investment fund" (within the meaning of Part V of the QPAM Exemption) managed by a "qualified professional asset manager" or "QPAM" (within the meaning of Part V of the QPAM Exemption), no Employee Benefit Plan's assets that are included in such investment fund, when combined with the assets of all other employee benefit plans established or maintained by the same employer or by an affiliate (within the meaning of Section V(c)(1) of the QPAM Exemption) of such employer or by the same employee organization and managed by such QPAM, exceed 20% of the total client assets managed by such QPAM, the conditions of Part I(c) and (g) of the QPAM Exemption are satisfied, neither the QPAM nor a person controlling or controlled by the QPAM (applying the definition of "control" in Section V(e) of the QPAM Exemption) owns a 5% or more interest in the Issuer and the identity of such QPAM and the names of all Employee Benefit Plans whose assets are included in B-3 such investment fund have been disclosed to the Issuer in writing pursuant to this paragraph (iii); (iv) the Source is one or more Employee Benefit Plans, or a separate account or trust fund comprised of one or more Employee Benefit Plans, each of which has been identified expressly as such to the Issuer in writing pursuant to this paragraph (iv); (v) the Source constitutes assets of a Employee Benefit Plan managed by an "in-house asset manager" (within the meaning of Part IV(a) of PTE 96- 23) which has made or properly authorized the decision for such Plan to purchase the Notes under the circumstances described in PTE 96-23; or (vi) the Source does not include assets of any Employee Benefit Plan. As used in this Section (e), the term "separate account" shall have the meaning assigned to such term in Section 3 of ERISA. (f) The Transferee understands that the Notes were originally issued in a transaction not involving any public offering in the United States within the meaning of the Securities Act, the Notes have not been and will not be registered under the Securities Act and if in the future the Transferee decides to offer, resell, pledge or otherwise transfer the Notes, such Notes may be offered, resold, pledged or otherwise transferred only in accordance with the terms of the Indenture, the Note Purchase Agreement and the legend on such Notes. The Transferee acknowledges that no representation is made by the Issuer or its transferor as to the availability of any exemption under the Securities Act or any State securities laws for resale of the Notes. (g) In connection with the purchase of Notes by the Transferee and this Transferee Certificate and any other documentation relating to this Transferee Certificate to which the Transferee is a party or that the Transferee is required by this Transferee Certificate to deliver: (i) neither the Issuer nor its transferor is acting as a fiduciary or financial or investment adviser for the Transferee; (ii) the Transferee is not relying (for purposes of making any investment decision or otherwise) upon any advice, counsel or representations (whether written or oral) of the Issuer or its transferor (except as may be set forth in any agreement between the Transferee and its transferor); (iii) neither the Issuer nor its transferor has given to the Transferee (directly or indirectly through any other person) any assurance, guarantee, or representation whatsoever as to the expected or projected success, profitability, return, performance, result, effect, consequence, or benefit (including legal, regulatory, tax, financial, accounting, or otherwise) of this B-4 Transferee Certificate, the Basic Documents or other documentation (except as may be set forth in any agreement between the Transferee and its transferor); (iv) the Transferee has consulted with its own legal, regulatory, tax, business, investment, financial, and accounting advisers to the extent it has deemed necessary, and it has made its own investment decisions (including decisions regarding the suitability of any transaction pursuant to the Indenture) based upon its own judgment and upon any advice from such advisers as it has deemed necessary and not upon any view expressed by the Issuer or its transferor; (v) the Transferee is not relying on its transferor with respect to the appropriateness or fairness of the prices of the Notes (except as may be set forth in any agreement between the Transferee and its transferor), and all trading decisions have been the result of arms' length negotiations between the Transferee and its transferor; (vi) the Transferee is purchasing the Notes with a full understanding of all of the risks thereof (economic and otherwise), and it is capable of assuming and willing to assume (financially and otherwise) those risks; and (vii) the Transferee is a sophisticated investor. (h) (i) The Transferee understands that the Notes will bear a legend to the following effect: "THE ISSUER OF THE SECURITIES EVIDENCED HEREBY HAS NOT BEEN REGISTERED UNDER THE INVESTMENT COMPANY ACT OF 1940, AS AMENDED (THE "INVESTMENT COMPANY ACT"), AND SUCH SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND MAY NOT BE OFFERED, SOLD, PLEDGED OR OTHERWISE TRANSFERRED EXCEPT BY THE HOLDER HEREOF IN ACCORDANCE WITH THE SECURITIES ACT AND ANY APPLICABLE SECURITIES LAW OF ANY STATE OF THE UNITED STATES, AND PRIOR TO THE EXPIRATION OF THE HOLDING PERIOD APPLICABLE TO SALES OF SUCH SECURITIES UNDER RULE 144(k) UNDER THE SECURITIES ACT (OR ANY SUCCESSOR PROVISION), ONLY TO A PERSON (i)(A) WHOM SUCH HOLDER REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER WITHIN THE MEANING OF RULE 144A UNDER THE SECURITIES ACT OR (B) WHO IS AN INSTITUTIONAL ACCREDITED INVESTOR WITHIN THE MEANING OF RULE 501(a)(1), (2), (3) OR (7) UNDER THE SECURITIES ACT AND (ii) WHO IS PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A PERSON THAT IS EITHER (A) A QUALIFIED INSTITUTIONAL BUYER IN A TRANSACTION MEETING THE REQUIREMENTS OF RULE 144A OR (B) AN INSTITUTIONAL ACCREDITED INVESTOR. IN B-5 ADDITION, SUCH SECURITIES MAY ONLY BE SOLD OR OTHERWISE TRANSFERRED TO A PERSON WHO (i) IS A QUALIFIED PURCHASER AS SUCH TERM IS DEFINED IN THE INVESTMENT COMPANY ACT AND (ii) IS PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A PERSON THAT IS A QUALIFIED PURCHASER, AND WHO DELIVERS A DULY EXECUTED TRANSFEREE CERTIFICATE AND SUCH INFORMATION AS SET FORTH THEREIN TO THE TRUSTEE AND THE ISSUER, IN ACCORDANCE WITH ALL APPLICABLE SECURITIES LAWS OF THE STATES OF THE UNITED STATES AND OTHER JURISDICTIONS. IN CONNECTION WITH ANY TRANSFER OF THIS NOTE, THE HOLDER HEREOF AGREES TO DELIVER A DULY EXECUTED TRANSFEROR CERTIFICATE AND SUCH INFORMATION SET FORTH THEREIN TO THE TRUSTEE AND THE ISSUER. "THE FOLLOWING INFORMATION IS PROVIDED PURSUANT TO UNITED STATES TREASURY REGULATION SECTION 1.1275-3(b): THIS NOTE HAS BEEN ISSUED WITH ORIGINAL ISSUE DISCOUNT FOR UNITED STATES FEDERAL INCOME TAX PURPOSES. THE HOLDER OF THIS NOTE MAY OBTAIN THE INFORMATION DESCRIBED IN UNITED STATES TREASURY REGULATION SECTION 1.1275-3(b)(1)(i) FROM THE TREASURER OF THE ISSUER, AT THE FOLLOWING ADDRESS: 625 LANDOR LANE, PASADENA, CALIFORNIA 91106." (ii) The Transferee understands that the Notes will be represented by one or more fully registered Notes. Before any interest in any Note may be offered, resold, pledged or otherwise transferred to any person, both the transferor and the transferee will be required to provide the Trustee with a written certification (in the form provided in this Transferee Certificate, in the case of the Transferee) as to compliance with the transfer restrictions referred to in the legend set forth on the Notes. (i) The Transferee will not, at any time, offer to buy or offer to sell the Notes by any form of general solicitation or advertising, including, but nor limited to, any advertisement, article, notice or other communication published in any newspaper, magazine or similar medium or broadcast over television or radio or seminar or meeting whose attendees have been invited by general solicitations or advertising. B-6 (j) The Transferee understands that prior to any proposed transfer of Notes, the Transferee may be required to furnish to the Issuer such certifications, legal opinions or other information as the Issuer may reasonably require to confirm that the proposed transfer is being made pursuant to an exemption from, or in a transaction not subject to, the registration requirements of the Securities Act and applicable state securities laws. Any such legal opinion may be from the Transferee's internal counsel or, at the Issuer's expense, from such other counsel as the Issuer may select. (k) The Transferee's Taxpayer Identification Number is __________________. (l) The Transferee shall preserve copies of this letter and all related letters, certificates, legal opinions, notices and other documents, and upon request shall furnish you with copies thereof. You are entitled to rely on such documents, and the Transferee irrevocably authorizes you to produce such documents in connection with any administrative or legal proceeding or official inquiry with respect to the matters covered hereby. (m) The Transferee is not, to the best of its knowledge, a competitor of the Issuer, Cherokee or the Licensee. For purposes of this subsection (m), "competitor" shall mean any manufacturer, distributor or retailer of goods of the type covered by the Trademark or the License Agreement or the owner or licensor of a trademark for goods of such type. The undersigned represents and warrants that, as of the date hereof, the foregoing information is complete and accurate. [TRANSFEREE] By:___________________________ Name: Title: Dated: __________________ B-7 EXHIBIT C FORM OF TRANSFEROR CERTIFICATE [Trustee's Address] [Issuer's Address] Attention: ____________ Re: Zero Coupon Secured Notes of SPELL C. LLC ------------------- Ladies and Gentlemen: Reference is hereby made to Section 2.06(f) of the Indenture, dated as of December 23, 1997 (the "Indenture"), between SPELL C. LLC (the "Issuer") and Wilmington Trust Company (the "Trustee"). Capitalized terms used but not defined herein shall have the meanings assigned to them in the Indenture. This letter relates to U.S. $_________ aggregate principal amount of Zero Coupon Secured Notes (the "Notes") of the Issuer which are registered in the name of [insert name of transferor] (the "Transferor"). The Transferor has requested a transfer of such Notes for Notes registered in the name of [insert name of transferee] (the "Purchaser"). In connection with such request, and in respect of such Notes, the Transferor does hereby certify that such Notes are being transferred (x) to a Person that the Transferor reasonably believes is a "qualified purchaser" within the meaning of the Investment Company Act and that is purchasing such Notes for its own account or for the account of a Person that is a qualified purchaser, (y) in accordance with (i) the transfer restrictions set forth in Section 2.06 of the Indenture and the Notes and (ii) any applicable securities laws of any state of the United States or any other jurisdiction and (z) to a Person that either (check one or more items as appropriate): (a) ___ is eligible to purchase such Notes from the Transferor pursuant to Rule 144(k) under the Securities Act (or any successor provision); (b) ___ the Transferor reasonably believes that the Purchaser is a "qualified institutional buyer" within the meaning of Rule C-1 144A and that is aware that the sale to it is being made in reliance upon Rule 144A and is purchasing such Notes for its own account or for the account of a Person that is a qualified institutional buyer and that is aware that the sale to it is being made in reliance upon Rule 144A, in a transaction meeting the requirements of Rule 144A; or (c) ___ the Transferor reasonably believes that the Purchaser is an institutional "accredited investor" within the meaning of Rule 501(a)(1), (2), (3) or (7) of the Securities Act that is purchasing such Notes for its own account or for the account of a Person that is (x) an institutional accredited investor or (y) a "qualified institutional buyer" within the meaning of Rule 144A. This letter and the statements contained herein are made for your benefit. [Insert Name of Transferor] By______________________________________ Name: Title: Dated: ____________________ C-2 EX-4.4 3 SECURITY AGREEMENT DATED DECEMBER 23, 1997 CONFORMED COPY SECURITY AGREEMENT SECURITY AGREEMENT dated as of December 23, 1997 between SPELL C. LLC, a Delaware limited liability company (with its successors, "SPV"), and Wilmington Trust Company, a Delaware banking corporation, not in its individual capacity, but solely as Trustee (the "TRUSTEE"). W I T N E S S E T H : WHEREAS, SPV and Trustee are parties to an Indenture dated as of the date hereof (as the same may be amended from time to time, the "INDENTURE"); and WHEREAS, SPV has agreed to grant a continuing security interest in and to its Collateral (as hereafter defined) to secure its obligations under the Indenture and the Notes issued pursuant thereto; NOW, THEREFORE, in consideration of the premises and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: Section 1. Definitions. Terms defined in the Indenture and not otherwise defined herein have, as used herein, the respective meanings provided for therein. The following additional terms, as used herein, have the following respective meanings: "COLLATERAL" means the Trust Estate. "PROCEEDS" means all proceeds of, and all other profits, rentals or receipts, in whatever form, arising from the collection, sale, lease, exchange, assignment, licensing or other disposition of, or realization upon, collateral, including without limitation all claims against third parties for loss of or damage to any collateral, and any condemnation or requisition payments with respect to any collateral, in each case whether now existing or hereafter arising. "SECURED OBLIGATIONS" means the obligations of SPV secured under this Agreement consisting of (i) all amounts payable with respect to any Note issued pursuant to the Indenture, whether characterized as Original Value, Current Value, principal, Make-Whole Amount (if any), Original Issue Discount or default interest (if any) (including, without limitation, any Original Issue Discount or default interest which accrues after the commencement of any case, proceeding or other action relating to the bankruptcy, insolvency or reorganization of SPV) or otherwise, the amount thereof at any point in time as determined in accordance with the Indenture, (ii) all other amounts payable by SPV hereunder or under the Indenture, the Note Purchase Agreement or any Note and (iii) any renewals or extensions of any of the foregoing. "SECURITY INTERESTS" means the security interests in the Collateral granted hereunder and under the Indenture securing the Secured Obligations. "TRADEMARK COLLATERAL" means the collateral in which a security interest is granted by SPV pursuant to Section 3 hereof. "TRADEMARK RIGHTS" has the meaning assigned to that term in the Trademark Purchase and License Assignment Agreement. "TRADEMARK SECURITY AGREEMENT" means the Trademark Security Agreement executed and delivered by SPV in favor of Trustee, for the ratable benefit of the Noteholders, substantially in the form of Annex A hereto, as amended from time to time. "UCC" means the Uniform Commercial Code as in effect on the date hereof in the State of New York; provided that if by reason of mandatory provisions of law, the perfection or the effect of perfection or non-perfection of the Security Interest in any Collateral is governed by the Uniform Commercial Code as in effect in a jurisdiction other than New York, "UCC" means the Uniform Commercial Code as in effect in such other jurisdiction for purposes of the provisions hereof relating to such perfection or effect of perfection or non- perfection. Section 2. Representations and Warranties. SPV represents and warrants as of the date hereof as follows: (i) SPV is the sole owner of each item of its Collateral in which it purports to grant a security interest hereunder and has good and marketable title to all of such Collateral, free and clear of any Liens other than the Security Interests and the Other Permitted Licenses. (ii) Other than financing statements or other similar or equivalent documents or instruments with respect to the Security Interests, no financing statement, mortgage, security agreement or similar or equivalent document or instrument covering all or any part of the Collateral is on file 2 or of record in any jurisdiction in which such filing or recording would be effective to perfect a Lien on such Collateral. (iii) Not later than 30 days following the date hereof, SPV shall furnish to Trustee file search reports from the UCC filing offices of the Secretaries of State of California and Delaware confirming the filings contemplated by Section 4.08 of the Note Purchase Agreement. (iv) The Security Interests granted hereunder constitute valid security interests under the UCC securing the Secured Obligations. When UCC financing statements shall have been filed in the offices specified in clause (iii) above, the Security Interests shall constitute perfected security interests in the Collateral to the extent that a security interest therein may be perfected by filing pursuant to the UCC, prior to all other Liens and rights of others therein. When the Trademark Security Agreement shall have been recorded with the United States Patent and Trademark Office, the Security Interests granted hereunder shall constitute valid and perfected security interests in all right, title and interest of SPV in the Trademark to the extent that such security interests may be perfected under the United States Trademark Act, U.S. Code, Title 15, prior to all other Liens and rights of others therein. Section 3. The Security Interests. In order to secure the full and punctual payment of the Secured Obligations in accordance with the terms thereof, and to secure the performance of all of the obligations of SPV hereunder: (a) SPV hereby assigns and grants to Trustee, for its benefit and for the ratable benefit of the Noteholders, a continuing security interest in and to all of the following property of SPV, whether now owned or existing or hereafter acquired or arising: (i) all right, title and interest in the Trademark and the Trademark Rights, together with any extensions or renewals thereof, and all existing and future applications therefor and registrations thereof, together with the goodwill of the business connected with the use of or symbolized by the Trademark and the Trademark Rights and all applications therefor and registrations thereof, including without limitation any and all claims and causes of action which may arise by reason of unfair competition therewith, infringement, violation or dilution thereof or injury to the Trademark or any of the Trademark Rights or any registration thereof or application therefor or the goodwill associated with any of the foregoing; 3 (ii) all right, title and interest in and to each Trademark License, including, without limitation, all obligations and indebtedness owing to SPV under such Trademark Licenses (including, without limitation, any such obligation which might be characterized as an account, contract right or general intangible under the Uniform Commercial Code in effect in any jurisdiction), all monies, fees, income, royalties, revenues, rents or profits due or to become due to SPV under such Trademark Licenses (whether or not yet earned by performance by SPV), all claims of SPV arising under or pursuant to or in connection with such Trademark Licenses (whether for damages, indemnity, payments for past, present or future infringements thereof, unfair competition with or injury to the Trademark or any of the Trademark Rights or the goodwill associated therewith, or otherwise), all of SPV's right to perform thereunder or to compel performance or otherwise exercise remedies thereunder and all collateral security or guarantees of any kind given by any Person with respect to any of the foregoing; (iii) all of SPV's right, title and interest in and to any other intellectual property, goodwill, trade secrets, permits and licenses associated with the Trademark or any Trademark License; (iv) all of SPV's right, title and interest in and to the Administrative Services Agreement and the Trademark Purchase and License Assignment Agreement; (v) all books and records of SPV (including, without limitation, customer lists, marketing information, credit files, price lists, operating records, accounting records, sales or promotional literature, computer programs, printouts and other computer materials and records) pertaining to any of the foregoing; and (vi) all Proceeds of any of the foregoing; provided that except as contemplated by the definition of Trademark License, the Trademark Collateral does not include any interest in the Cherokee Licenses. (b) The Security Interests are granted as security only and shall not subject Trustee or any Noteholder to, or transfer or in any way affect or modify, any obligation or liability of SPV with respect to any of the Collateral or any transaction in connection therewith. 4 Section 4. Further Assurances; Covenants. (a) SPV will not change its name, identity or limited liability company structure in any manner unless it shall have given Trustee at least 30 days' prior notice thereof. SPV will not change the location of its chief executive office or chief place of business unless it shall have given Trustee at least 30 days' prior notice thereof. (b) SPV will, from time to time, at its expense, execute, deliver, file and record any statement, assignment, instrument, document, agreement or other paper and take any other action (including, without limitation, any filings with the United States Patent and Trademark Office and any filings of financing or continuation statements under the UCC), that from time to time may be necessary, or that Trustee may reasonably request, in order to create, preserve, perfect, confirm or validate the Security Interests or to enable Trustee and the Noteholders to obtain the full benefits of this Agreement, or to enable Trustee to exercise and enforce any of its rights, powers and remedies hereunder with respect to any of the Collateral. To the extent permitted by applicable law, SPV hereby authorizes Trustee to execute and file financing statements or continuation statements without SPV's signature appearing thereon. SPV agrees that a carbon, photographic, photostatic or other reproduction of this Agreement or of a financing statement is sufficient as a financing statement. SPV shall pay the costs of, or incidental to, any recording or filing of any financing or continuation statements concerning the Collateral. (c) SPV shall notify Trustee promptly if it knows, or has reason to know, that any registration relating to the Trademark Rights may become abandoned, or of any materially adverse determination or development (including, without limitation, the institution of, or any such determination or development in, any proceeding in the United States Patent and Trademark Office or any court) regarding SPV's ownership of the Trademark, its right to register the same, or to keep and maintain the same. In the event that the Trademark Rights or any Trademark License is materially breached, infringed, misappropriated or diluted by a third party, SPV shall notify Trustee promptly after it learns thereof and shall, unless SPV shall reasonably determine that any such action would be of negligible economic value, promptly take such action as SPV reasonably believes appropriate, including to sue for breach, infringement, misappropriation or dilution and to recover any and all damages for such breach, infringement, misappropriation or dilution, and take such other actions as SPV shall reasonably deem appropriate under the circumstances to protect the Trademark Rights or such Trademark License. In the event SPV shall, either itself or through any agent, employee or licensee, after the date hereof file a new application for the registration of the Trademark Rights purported to be or to become subject to the Lien hereof with the United States Patent and Trademark Office, it shall promptly thereafter notify the Trustee thereof and execute, deliver and file or record any and 5 all agreements, instruments, documents and papers as may be necessary or as Trustee may reasonably request to evidence the Security Interests in the Trademark Rights and the goodwill and general intangibles of SPV relating thereto or represented thereby. Section 5. Payments, Etc. in Respect of Collateral. SPV shall have the right to receive payments, income, royalties, profits, rents, proceeds or other distributions due or to become due, and all instruments and other property received, receivable or otherwise distributed in respect of, or in exchange for, any of its Collateral only in accordance with Articles 3 and 4 of the Indenture. Section 6. General Authority. SPV hereby irrevocably appoints Trustee its true and lawful attorney, with full power of substitution, in the name of SPV, to the extent permitted by law, to exercise, at any time and from time to time during the continuance of an Event of Default, all or any of the following powers with respect to all or any of the Collateral: (i) to demand, sue for, collect, receive and give acquittance for any and all monies due or to become due thereon or by virtue thereof, (ii) to file any claims or take any action or institute any proceeding to enforce the rights of Trustee with respect to any of such Collateral or to enforce compliance with the terms of the Trademark Licenses included in the Collateral; (iii) to settle, compromise, compound, prosecute or defend any action or proceeding with respect thereto, (iv) subject to the limitation as to commercial reasonableness specified in Section 8.04(b)(v) of the Indenture, to sell, license, transfer, assign or otherwise deal in or with the same or the proceeds or avails thereof, in whole or in part, as fully and effectually as if Trustee were the absolute owner thereof, and (v) to extend the time of payment of any or all thereof and to make any allowance and other adjustments with reference thereto; provided that Trustee shall give SPV not less than ten days' prior written notice of the time and place of any sale or other intended disposition of any of the Collateral, except any such Collateral which threatens to decline speedily in value or is of a type customarily sold on a recognized market. SPV agrees that such notice constitutes "reasonable notification" within the meaning of Section 9-504(3) of the UCC. 6 Section 7. Remedies upon Event of Default. (a) If any Event of Default has occurred and is continuing, Trustee may exercise on behalf of the Noteholders all rights of a secured party under the UCC (whether or not in effect in the jurisdiction where such rights are exercised) and, in addition, Trustee may, without being required to give any notice, except as herein provided or as may be required by mandatory provisions of law, (i) exercise any and all rights and remedies of SPV under or in connection with the Trademark Licenses or otherwise in respect of Collateral, including, without limitation, any and all rights of SPV to demand or otherwise require payment of any amount under or performance of any provision of any contract, license or agreement included in the Collateral, (ii) apply cash, if any, then held by it as Collateral as specified in Section 9 and (iii) if there shall be no such cash or if such cash shall be insufficient to pay all the Secured Obligations in full, sell such Collateral or any part thereof at public or private sale, for cash, upon credit or for future delivery, and at such price or prices and on such terms as Trustee may deem satisfactory; provided that Trustee shall not terminate Cherokee's service as Administrator under the Administrative Services Agreement unless it shall have retained a reasonably qualified successor Administrator thereunder. (b) Without limiting the generality of the foregoing, if any Event of Default has occurred and is continuing, (i) So long as doing so would not violate the terms of the License Agreement, Trustee may (subject to the rights of the licensees under the Cherokee Licenses) license, or sublicense, whether general, special or otherwise, and whether on an exclusive or non-exclusive basis, the Trademark anywhere in the United States of America for such term or terms, on such conditions and in such manner as Trustee shall in its sole discretion determine; (ii) Trustee may (without assuming any obligations or liability thereunder), at any time and from time to time, enforce (and shall have the exclusive right to enforce) against any licensor, franchisee, licensee or sublicensee all rights and remedies of SPV in, to and under the Trademark Licenses and take or refrain from taking any action under any thereof, and SPV hereby releases Trustee and each of the Noteholders from, and agrees to hold Trustee and each of the Noteholders free and harmless from and against any claims arising out of, any lawful action hereby permitted to be so taken or omitted to be taken with respect thereto; and (iii) In the event of any such disposition pursuant to this Section, SPV shall supply to Trustee SPV's records relating to the Trademark Rights (subject to the limitation specified in Article 5 of the Indenture). 7 Section 8. Limitation on Duty of Agent in Respect of Collateral. The powers conferred on Trustee hereunder are solely to protect its interest in the Collateral and shall not impose any duty upon it to exercise any such powers. Beyond the exercise of reasonable care of Collateral in its custody and the accounting for any monies actually received by it hereunder and under the Indenture, Trustee shall have no duty as to any Collateral in its possession or control or in the possession or control of any agent or any income thereon or as to the preservation of rights against prior parties or any other rights pertaining thereto, except as otherwise specified in the Indenture. Trustee shall be deemed to have exercised reasonable care in the custody of the Collateral in its possession if the Collateral is accorded treatment substantially equal to that which it accords its own property. Section 9. Application of Proceeds. Upon the occurrence and during the continuance of an Event of Default, the proceeds of any sale of, or other realization upon, all or any part of the Collateral and any cash held in respect thereof shall be applied by Trustee as specified in Section 8.02 of the Indenture. Section 10. Appointment of Co-Agents. At any time or times, in order to comply with any legal requirement in any jurisdiction, Trustee may appoint another bank or trust company or one or more other persons, either to act as co- agent or co-agents, jointly with Trustee, or to act as separate agent or agents on behalf of the Noteholders with such power and authority as may be necessary for the effectual operation of the provisions hereof and may be specified in the instrument of appointment (which may, in the discretion of Trustee, include provisions for the protection of such co-agent or separate agent similar to the provisions of Sections 8 and 11). Section 11. Expenses. In the event that SPV fails to comply with the provisions of the Indenture, such that the value of any of the Collateral or the validity, perfection, rank or value of any Security Interest therein is thereby diminished or potentially diminished or put at risk, Trustee if requested by the Majority Noteholders may, but shall not be required to, effect such compliance on behalf of SPV and SPV shall reimburse Trustee for the reasonable costs thereof on demand. All expenses of protecting, appraising, insuring and maintaining any Collateral, any and all excise, property, sales, and use taxes or other similar taxes imposed by any state, federal, or local authority on any of such Collateral, or in respect of the sale or other disposition thereof shall be borne and paid by SPV; and if SPV fails to promptly pay any portion thereof when due, Trustee or any Noteholder may, at its option, but shall not be required to, pay the same and charge SPV's account therefor, and SPV agrees to reimburse Trustee or such Noteholder therefor on demand. All sums so paid or incurred by Trustee or any 8 Noteholder for any of the foregoing and any and all other sums for which SPV may become liable hereunder and all costs and expenses (including attorneys' fees, legal expenses and court costs) reasonably incurred by Trustee or any Noteholder (i) in enforcing or protecting the Security Interests in the Collateral or any of their rights or remedies under this Agreement, (ii) in the exercise or enforcement of any of the rights of Trustee or the Noteholders hereunder and the exercise and enforcement by Trustee of any of the rights of SPV under the Trademark Licenses or any other Collateral or (iii) arising out of the failure by SPV to perform or observe its obligations hereunder, shall, together with interest thereon for each day until paid at a rate per annum equal to the Default Rate, be additional Secured Obligations of SPV hereunder. Section 12. Termination of Security Interests; Release of Collateral. Upon the repayment in full of all Secured Obligations in accordance with the terms thereof, of the Indenture and of the Note Purchase Agreement, the Security Interests shall terminate and all rights to the Collateral shall revert to SPV. At any time and from time to time prior to such termination of the Security Interests, Trustee may release any of the Collateral with the prior written consent of all Noteholders. Upon any such termination of the Security Interests or release of Collateral, Trustee will, at the expense of SPV, execute and deliver to SPV such documents as SPV shall reasonably request to evidence the termination of the Security Interests or the release of its Collateral, as the case may be. Section 13. Notices. All notices or other communications hereunder shall be in writing (including telecopy or similar writing) and shall be given to such party (x) in the case of Trustee, at its address or telecopy number specified in Section 14.02 of the Indenture or (y) in the case of SPV at the address or telecopy number of SPV specified in Section 14.02 of the Indenture (with copies in each case to the Administrator under the Administrative Services Agreement, at its address specified in Section 9 of the Administrative Services Agreement) or such other address or telecopy number as such party may hereafter specify for such purpose by notice to the other party. Each such notice, request or other communication shall become effective when received. Section 14. Waivers, Non-Exclusive Remedies. No failure on the part of Trustee to exercise, and no delay in exercising and no course of dealing with respect to, any right under this Agreement shall operate as a waiver thereof; nor shall any single or partial exercise by Trustee of any right under this Agreement or the Indenture preclude any other or further exercise thereof or the exercise of any other right. The rights in this Agreement and the Indenture are cumulative and are not exclusive of any other remedies provided by law. 9 Section 15. Successors and Assigns. This Agreement is for the benefit of Trustee and the Noteholders and their successors and assigns, and in the event of an assignment of all or any of the Secured Obligations, the rights hereunder, to the extent applicable to the indebtedness so assigned, shall be transferred with such indebtedness. This Agreement shall be binding on SPV and its respective successors and permitted assigns. Section 16. Changes in Writing. This Agreement and any provision hereof may be changed, waived, discharged or terminated only subject to the Indenture and as agreed in writing between the parties hereto. Section 17. New York Law. This Agreement shall be construed in accordance with and governed by the laws of the State of New York, except as otherwise required by mandatory provisions of law and except to the extent that remedies provided by the laws of any jurisdiction other than New York are governed by the laws of such jurisdiction. Section 18. Severability. If any provision hereof is invalid or unenforceable in any jurisdiction, then, to the fullest extent permitted by law, (i) the other provisions hereof shall remain in full force and effect in such jurisdiction and shall be liberally construed in favor of Trustee and the Noteholders in order to carry out the intentions of the parties hereto as nearly as may be possible; and (ii) the invalidity or unenforceability of any provision hereof in any jurisdiction shall not affect the validity or enforceability of such provision in any other jurisdiction. 10 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed by their respective authorized officers as of the day and year first above written. SPELL C. LLC By: /s/ Carol Gratzke ---------------------------- Name: Carol Gratzke Title: Secretary and Treasurer WILMINGTON TRUST COMPANY By: /s/ Donald G. MacKelcan --------------------------------- Name: Donald G. MacKelcan Title: Assistant Vice President 11 EX-10.16 4 NOTE PURCHASE AGREEMENT DATED DECEMBER 23, 1997 CONFORMED COPY SPELL C. LLC NOTE PURCHASE AGREEMENT Dated as of December 23, 1997 Zero Coupon Secured Notes TABLE OF CONTENTS
Page ---- ARTICLE 1 INTRODUCTORY MATTERS; ISSUANCE OF NOTES --------------------------------------- Section 1.01. Purchase and Sale of the Notes; the Closing.................. 1 - Section 1.02. Waiver of Closing Conditions................................. 1 - ARTICLE 2 REPRESENTATIONS OF THE ISSUER ----------------------------- Section 2.01. Organization; Power and Authority............................ 2 - Section 2.02. Authorization, Etc........................................... 2 - Section 2.03. Material Adverse Change...................................... 2 - Section 2.04. Capitalization; Subsidiaries................................. 2 - Section 2.05. Liabilities.................................................. 3 - Section 2.06. Compliance with Laws, Other Instruments of the Issuer, Etc.................................................. 3 - Section 2.07. Governmental Approvals....................................... 3 - Section 2.08. Litigation................................................... 3 - Section 2.09. Taxes........................................................ 4 - Section 2.10. Compliance with ERISA........................................ 4 - Section 2.11. Offering of Notes............................................ 4 - Section 2.12. Solvency..................................................... 5 - Section 2.13. Use of Proceeds; Margin Regulations.......................... 5 - Section 2.14. Foreign Assets Control Regulations, Inc...................... 5 - Section 2.15. Status Under Certain Statutes................................ 5 - Section 2.16. Ranking...................................................... 6 - Section 2.17. Existing Indebtedness........................................ 6 - Section 2.18. Trust Estate................................................. 6 - Section 2.19. Place of Business............................................ 6 - Section 2.20. Broker's Fees................................................ 6 - ARTICLE 3 REPRESENTATIONS OF THE PURCHASERS --------------------------------- Section 3.01. Purchase of the Notes........................................ 7 - Section 3.02. Source of Funds.............................................. 9 - Section 3.03. Sale of Notes................................................ 10 --
PAGE ARTICLE 4 ---- CONDITIONS OF CLOSING --------------------- Section 4.01. Proceedings Satisfactory..................................... 11 -- Section 4.02. Opinions of Special Counsel for the Purchasers............... 11 -- Section 4.03. Opinions of Counsel for the Issuer and Cherokee.............. 11 -- Section 4.04. Opinion of Counsel for the Trustee........................... 12 -- Section 4.05. License Agreement............................................ 12 -- Section 4.06. Dayton Hudson Documents...................................... 12 -- Section 4.07. Trademark Filing............................................. 12 -- Section 4.08. Collateral................................................... 12 -- Section 4.09. Basic Documents.............................................. 13 -- Section 4.10. Representations True, Etc.................................... 13 -- Section 4.11. Legality..................................................... 13 -- Section 4.12. Private Placement Number..................................... 13 -- Section 4.13. Other Purchasers............................................. 14 -- Section 4.14. Payment...................................................... 14 -- Section 4.15. Purchaser's Representations.................................. 14 -- Section 4.16. Opinion of Counsel for the Trustee........................... 14 -- Section 4.17. Legality..................................................... 14 -- ARTICLE 5 DEFINITIONS ----------- Section 5.01. Certain Definitions.......................................... 14 -- Section 5.02. Accounting Terms, Etc........................................ 16 -- ARTICLE 6 HOME OFFICE PAYMENT ------------------- ARTICLE 7 Liabilities of the Purchasers ARTICLE 8 Miscellaneous Section 8.01. Expenses..................................................... 17 --
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PAGE ---- Section 8.02. Reliance on and Survival of Representations; Covenants.................................................... 18 -- Section 8.03. Successors and Assigns....................................... 18 -- Section 8.04. Communications............................................... 18 -- Section 8.05. Indemnification.............................................. 19 -- Section 8.06. JURISDICTION AND PROCESS..................................... 20 -- Section 8.07. Governing Law................................................ 21 -- Section 8.08. Headings..................................................... 21 -- Section 8.09. Counterparts................................................. 21 -- Section 8.10. Severability................................................. 21 -- Section 8.11. Confidentiality.............................................. 21 --
EXHIBIT A-1 - Opinion of Davis Polk & Wardwell EXHIBIT A-2 - Opinion of Latham & Watkins with respect to corporate matters EXHIBIT A-3 - Opinion of Latham & Watkins with respect to bankruptcy law EXHIBIT A-4 - Opinion of Jeffer, Mangels, Butler & Marmaro LLP EXHIBIT A-5 - Opinion of Richards, Layton & Finger, P.A., special counsel to Trustee EXHIBIT A-6 - Opinion of counsel to Dayton Hudson EXHIBIT A-7 - Opinion of Richards, Layton & Finger, P.A., special counsel to Issuer EXHIBIT B - Letter Agreement Dayton Hudson iii ARTICLE 1 Introductory Matters; Issuance of Notes Section 1.01. Purchase and Sale of the Notes; the Closing. Subject to the terms and conditions hereof and of the Indenture and in reliance upon representations and warranties of the Purchasers contained herein or made pursuant hereto, the Issuer agrees to issue and sell to each Purchaser and, subject to the terms and conditions hereof and of the Indenture and in reliance on the representations and warranties of the Issuer contained herein and therein or made pursuant hereto or thereto, each Purchaser severally agrees to purchase from the Issuer, Notes in a principal amount equal to the respective percentage (such Purchaser's "PURCHASE PERCENTAGE") of aggregate principal amount of the Notes set forth opposite such Purchaser's name in Schedule I, at a purchase price equal to such Purchaser's Purchase Percentage of $47,869,558.83. The proceeds of the sale of the Notes will be used to pay Cherokee for the Assigned Rights and for any other lawful purposes. The closing of the purchase of the Notes hereunder shall take place at the office of Davis Polk & Wardwell at 11:00 A.M., New York City time, on the Closing Date. On the Closing Date, the Issuer will cause the Trustee to deliver to each Purchaser one or more Notes registered in such Purchaser's name or in the name of such Purchaser's nominee, in such denominations (minimum of U.S. $500,000), and in the aggregate principal amount to be purchased by such Purchaser, all as specified in Schedule I or as such Purchaser may otherwise specify by timely notice to the Issuer (or, in the absence of such notice and if not so specified in Schedule I, one Note registered in such Purchaser's name), duly executed and dated the Closing Date, against payment of such purchase price by wire transfer of immediately available funds to Wilmington Trust Company, Wilmington, Delaware, ABA No. 0311100092, for credit to the account of Cherokee, Account No. 43558-1, Attn: Ann Roberts, Corporate Trust Administration, (302) 651-8681, Reference: Cherokee Collection Account (and the Issuer agrees that, except to return funds to the Purchasers if the purchase of the Notes shall not occur on the Closing Date, none of the proceeds from the sale of the Notes shall be withdrawn from such account until all of the conditions precedent set forth in Article 4 shall have been satisfied or waived pursuant to Section 1.02). Section 1.02. Waiver of Closing Conditions. If on the Closing Date any of the conditions specified in Article 4 to the obligations hereunder of the Purchasers, on the one hand, or the Issuer, on the other hand, have not been fulfilled, the Purchasers or the Issuer, as the case may be, may waive compliance with any such condition to such extent as the Purchasers or the Issuer, as the case, may in their sole discretion determine but the Purchasers or the Issuer, as the case may be, shall have no obligation to do so. Nothing in this Section 1.02 shall operate to relieve any party of any of its obligations hereunder or to waive may be any of the rights of any party hereunder. ARTICLE 2 Representations of the Issuer The Issuer represents and warrants, as of the date hereof, as follows: Section 2.01. Organization; Power and Authority. The Issuer is a limited liability company duly organized and in good standing under the laws of Delaware. The Issuer has all requisite legal power and authority to own the properties it purports so to own or hold, to transact its business as proposed to be transacted, to execute and deliver each Basic Document to which it is a party and has all requisite legal power and authority to perform the provisions hereof and thereof. The Issuer is duly qualified or has been duly licensed as a foreign limited liability company and is (if applicable) in good standing and is authorized to do business in each jurisdiction in which the character of the properties owned by it or the nature of the business transacted by it requires such qualification. Section 2.02. Authorization, Etc.. Each Basic Document has been duly authorized by all necessary legal action on the part of the Issuer, and constitutes a legal, valid and binding obligation of the Issuer enforceable against the Issuer in accordance with its terms, except as the enforceability thereof may be limited by (i) bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the enforcement of creditors' rights generally and (ii general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law). Section 2.03. Material Adverse Change. The Issuer does not know of any fact (other than matters of a general economic or political nature) which, so far as the Issuer can reasonably foresee, the Issuer expects will have a Material Adverse Effect. Section 2.04. Capitalization; Subsidiaries. (a) The capital and reserves of the Issuer as of the date hereof are equal to $100,000. The sole member of --------- the Issuer is Cherokee, Inc., which is a Delaware corporation. (b) The Issuer has no Subsidiaries. 2 Section 2.05. Liabilities. There are no liabilities, contingent or otherwise, of the Issuer except (i) its obligations under the Basic Documents and the License Agreement and (ii) other liabilities which could not, individually or in the aggregate, reasonably be expected to have a Material Adverse Effect. Section 2.06. Compliance with Laws, Other Instruments of the Issuer, Etc.. The execution and delivery by the Issuer of each Basic Document do not, and the performance by the Issuer of each Basic Document and the transactions contemplated hereby and thereby will not, (i) contravene, result in any breach of, or constitute a default under, or result in the creation of any Lien in respect of any property of the Issuer under, any existing organizational or other governing document, or any other existing agreement or instrument to which the Issuer is bound or by which the Issuer or any of its properties may be bound or affected (other than any Lien created pursuant to the Indenture and the Security Agreement), (ii) conflict with or result in a breach of any of the terms, conditions or provisions of any existing Order of any court, arbitrator or Governmental Body applicable to the Issuer or (iii) violate any provision of any existing statute or other existing rule or regulation of any Governmental Body applicable to the Issuer. The Issuer is not in violation of any existing statute or other rule or regulation of any Governmental Body, or any Order of any court, arbitrator or Governmental Body. As used in this Agreement, the term "GOVERNMENTAL BODY" includes any Federal, state, municipal or other governmental department, commission, board, bureau, agency or instrumentality of any jurisdiction, domestic or foreign, including but not limited to the United States of America; and the term "ORDER" includes any order, writ, injunction, decree, judgment, award, determination, direction or demand. Section 2.07. Governmental Approvals. Except as contemplated by Section 2.18(b) and (c), no authorization, consent or approval of, and no filing or registration with, any Governmental Body is required in connection with the execution, delivery and performance of the Basic Documents or necessary for the validity or enforceability thereof or for the creation and perfection of the Liens intended to be created under the Indenture and the Security Agreement. Section 2.08. Litigation. There are no Proceedings pending or, to the knowledge of the Issuer, threatened against or affecting the Issuer or any property of the Issuer. 3 Section 2.09. Taxes. The Issuer is not separately subject to tax apart from Cherokee upon its income under the Code or under applicable Delaware law. Section 2.10. Compliance with ERISA. Neither the Issuer nor any ERISA Affiliate has (A) incurred any "ACCUMULATED FUNDING DEFICIENCY" with respect to any Employee Benefit Plan within the meaning of Section 412 of the Code and Section 302 of ERISA, whether or not waived, (B) incurred any material liability to the Pension Benefit Guaranty Corporation established under ERISA (other than for Pension Benefit Guaranty Corporation insurance premiums payable in the ordinary course) in connection with any Employee Benefit Plan established or maintained by it and no contribution which in the aggregate exceeds $1,000,000 to any such Plan subject to the funding requirements of Section 412 of the Code is due and payable by the Issuer or any ERISA Affiliate, (C) incurred any material withdrawal liability in connection with a complete or partial withdrawal from a Multiemployer Plan or (D) had any tax or penalty assessed against it by the United States Internal Revenue Service or United States Department of Labor for any alleged violation under Section 4975 of the Code or Section 406 of ERISA. The Issuer is not a "PARTY IN INTEREST" or a "DISQUALIFIED PERSON" (as defined in Section 3(14) of ERISA and Section 4975(e)(2) of the Code, respectively) with respect to any Employee Benefit Plan disclosed pursuant to Section 3.02. Assuming the accuracy of the representations and warranties of the Purchasers set forth in this Agreement, the transactions contemplated by this Agreement and the other Basic Documents will not constitute a nonexempt prohibited transaction (as such term is defined in Section 4975 of the Code or Section 406 of ERISA) and will not subject the Issuer or any holder of a Note to any tax or penalty on prohibited transactions imposed under said Section 4975 of the Code or by Section 502(i) of ERISA. The representations by the Issuer in the preceding sentence are made in reliance upon the representations by the Purchasers in Section 3.02. Section 2.11. Offering of Notes. Neither the Issuer nor any other Person appointed to act on behalf of the Issuer by the Issuer or Cherokee has offered the Notes or any similar securities for sale to, or solicited any offer to buy any of the same from any Person other than the Purchasers and not more than 20 other institutional investors. Neither the Issuer nor any such appointee has taken, or will take, any action which would subject the issuance or sale of the Notes to Section 5 of the United States Securities Act of 1933, as amended, or otherwise require the registration, filing or qualification of the Notes under any applicable laws of the United States of America. 4 Section 2.12. Solvency. The Issuer is, and upon giving effect to the issuance of the Notes and the transactions contemplated by this Agreement will be, a "solvent institution", as said term is used in Section 1405(c) of the New York Insurance Law, whose "obligations . . . are not in default as to principal or interest", as said terms are used in said Section 1405(c). The Issuer is not entering into the transactions contemplated by this Agreement and the other Basic Documents with an intent to hinder, delay, or defraud any present or future holder of any Indebtedness of the Issuer, and after giving effect to the consummation of such transactions, the fair value of the respective assets of the Issuer will not be less than its debts, the Issuer will be able to pay its debts as they mature and the Issuer will not have unreasonably small capital with which to conduct its business. Section 2.13. Use of Proceeds; Margin Regulations. The Issuer will use the proceeds of the sale of the Notes to purchase the Assigned Rights pursuant to the Trademark Purchase and License Assignment Agreement, to pay any other amounts due hereunder or under the other Basic Documents and, to the extent not required for such purposes, for any other lawful purpose. No part of the proceeds from the sale of the Notes hereunder will be used, directly or indirectly, by the Issuer for the purpose of buying or carrying any margin stock within the meaning of Regulation G of the Board of Governors of the United States Federal Reserve System (12 CFR 207), or for the purpose of purchasing or carrying or trading in any securities under such circumstances as to involve the Issuer in a violation of Regulation X of said Board (12 CFR 224) or to involve any broker or dealer in a violation of Regulation T of said Board (12 CFR 220). Margin stock does not constitute more than 25% of the assets of the Issuer and the Issuer has no present intention that margin stock will constitute more than 25% of the assets of the Issuer. As used in this Section, the terms "MARGIN STOCK" and "PURPOSE OF BUYING OR CARRYING" shall have the meanings assigned to them in said Regulation G. Section 2.14. Foreign Assets Control Regulations, Inc. Neither the sale of the Notes by the Issuer hereunder nor its use of the proceeds thereof will violate the Trading with the Enemy Act, as amended, or any of the foreign assets control regulations of the United States Treasury Department (31 CFR, Subtitle B, Chapter V, as amended) or any enabling legislation or executive order relating thereto. Section 2.15. Status Under Certain Statutes. The Issuer is not subject to regulation under the Public Utility Holding Company Act of 1935, as amended, the Transportation Acts, as amended, or the Federal Power Act, as amended, and the Issuer is not an investment company required to register under the Investment Company Act. 5 Section 2.16. Ranking. All obligations and liabilities of the Issuer under this Agreement and the Notes constitute and will constitute the direct and unconditional obligations of the Issuer. Section 2.17. Existing Indebtedness. The Issuer has no Indebtedness except pursuant to the Indenture. The assets of the Issuer are free and clear of all Liens except for Permitted Liens. Section 2.18. Trust Estate. The Issuer owns and has or will own and will have on the Closing Date and at the time of payment by the Purchasers of the purchase price for the Notes good, legal and valid title to the Trust Estate free and clear of all Liens, except Permitted Liens. Assuming performance by the Trustee of its duties under the Indenture in accordance with the terms thereof, the provisions of the Indenture, the Security Agreement and the Trademark Security Agreement are effective to create, in favor of the Trustee for the benefit of the holders of the Notes, a legal, valid and enforceable Lien on and security interest in all of the Trust Estate, and upon completion of the filings and recordations specified in subclauses (i) and (iii) of Section 4.08, all necessary and appropriate recordings and filings will have been made (and all related fees have been paid or will have been paid by the time such recordings and filings have been made) in all necessary and appropriate public offices in all appropriate jurisdictions, and all other necessary and appropriate action has been taken, so that the Indenture creates a perfected Lien on and security interest in all right, title, estate and interest of the Issuer in the Trust Estate named therein and all necessary and appropriate consents to the creation, perfection and enforcement of such Lien have been or, as of the Closing Date will have been, obtained. Section 2.19. Place of Business. The Issuer's sole place of business will as of the Closing Date be located at 625 Landor Lane, Pasadena, California 91106. Section 2.20. Broker's Fees. No broker's, finder's or similar fee in connection with the transactions contemplated hereby is payable except for a placement fee payable to Libra Investments, Inc., which will be paid by the Issuer. 6 ARTICLE 3 Representations of the Purchasers Each Purchaser severally represents (as to itself and no other Purchaser) to the Issuer that: Section 3.01. Purchase of the Notes. (a) Such Purchaser (i) is both a Qualified Purchaser and (x) a Qualified Institutional Buyer that is aware that the sale of the Notes to it is being made in reliance on Rule 144A or (y) an Accredited Investor and (ii) is acquiring such Notes for its own account or for the account of (x) a Qualified Institutional Buyer that is aware that the sale of such Notes is being made in reliance on Rule 144A and that is also a Qualified Purchaser in a transaction meeting the requirements of Rule 144A or (y) an Accredited Investor that is also a Qualified Purchaser. (b) Such Purchaser understands that the Notes will bear a legend to the following effect: "THE ISSUER OF THE SECURITIES EVIDENCED HEREBY HAS NOT BEEN REGISTERED UNDER THE INVESTMENT COMPANY ACT OF 1940, AS AMENDED (THE "INVESTMENT COMPANY ACT"), AND SUCH SECURITIES HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED (THE "SECURITIES ACT"), AND MAY NOT BE OFFERED, SOLD, PLEDGED OR OTHERWISE TRANSFERRED EXCEPT BY THE HOLDER HEREOF IN ACCORDANCE WITH THE SECURITIES ACT AND ANY APPLICABLE SECURITIES LAW OF ANY STATE OF THE UNITED STATES, AND PRIOR TO THE EXPIRATION OF THE HOLDING PERIOD APPLICABLE TO SALES OF SUCH SECURITIES UNDER RULE 144(k) UNDER THE SECURITIES ACT (OR ANY SUCCESSOR PROVISION), ONLY TO A PERSON (i)(A) WHOM SUCH HOLDER REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER WITHIN THE MEANING OF RULE 144A UNDER THE SECURITIES ACT OR (B) WHO IS AN INSTITUTIONAL ACCREDITED INVESTOR WITHIN THE MEANING OF RULE 501(a)(1), (2), (3) OR (7) UNDER THE SECURITIES ACT AND (ii) WHO IS PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A PERSON THAT IS EITHER (A) A QUALIFIED INSTITUTIONAL BUYER IN A TRANSACTION MEETING THE 7 REQUIREMENTS OF RULE 144A OR (B) AN INSTITUTIONAL ACCREDITED INVESTOR. IN ADDITION, SUCH SECURITIES MAY ONLY BE SOLD OR OTHERWISE TRANSFERRED TO A PERSON WHO (i) IS A QUALIFIED PURCHASER AS SUCH TERM IS DEFINED IN THE INVESTMENT COMPANY ACT AND (ii) IS PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A PERSON THAT IS A QUALIFIED PURCHASER, AND WHO DELIVERS A DULY EXECUTED TRANSFEREE CERTIFICATE AND SUCH INFORMATION AS SET FORTH THEREIN TO THE TRUSTEE AND THE ISSUER, IN ACCORDANCE WITH ALL APPLICABLE SECURITIES LAWS OF THE STATES OF THE UNITED STATES AND OTHER JURISDICTIONS. IN CONNECTION WITH ANY TRANSFER OF THIS NOTE, THE HOLDER HEREOF AGREES TO DELIVER A DULY EXECUTED TRANSFEROR CERTIFICATE AND SUCH INFORMATION SET FORTH THEREIN TO THE TRUSTEE AND THE ISSUER. "THE FOLLOWING INFORMATION IS PROVIDED PURSUANT TO UNITED STATES TREASURY REGULATION SECTION 1.1275-3(b): THIS NOTE HAS BEEN ISSUED WITH ORIGINAL ISSUE DISCOUNT FOR UNITED STATES FEDERAL INCOME TAX PURPOSES. THE HOLDER OF THIS NOTE MAY OBTAIN THE INFORMATION DESCRIBED IN UNITED STATES TREASURY REGULATION SECTION 1.1275-3(b)(1)(i) FROM THE TREASURER OF THE ISSUER, AT THE FOLLOWING ADDRESS: 625 LANDOR LANE, PASADENA, CALIFORNIA 91106." (c) Such Purchaser acknowledges that it shall have no rights to require the registration of the Notes under the Securities Act. (d) Such Purchaser has such knowledge and experience in financial and business matters that it is capable of evaluating the merits and risks of purchasing the Notes; it has previously invested in securities similar to the Notes and fully understands the limitations on transfer described herein; it is able to bear the economic risk of loss of its investment in the Notes; and it is presently able to afford the complete loss of such investment. (e) Such Purchaser is not acquiring the Notes with a view to or for sale in connection with any distribution thereof or with any present intention of offering or selling any of the Notes in a transaction that would violate the 8 Securities Act or the securities laws of any State of the United States or any other applicable jurisdiction; provided that the disposition of its property and the property of any accounts for which it is acting as fiduciary shall remain at all times within its control. (f) Such Purchaser acknowledges that it has access to such financial and other information, and has been afforded the opportunity to ask such questions of representatives of the Issuer and receive answers it deems necessary in connection with its decision to purchase the Notes; it has relied exclusively on its own investigation of the Issuer's and Cherokee's representations set forth in the Basic Documents and in the License Agreement and has not relied on any other representation of the Issuer or Cherokee, whether written or oral. Section 3.02. Source of Funds. Such Purchaser represents that at least one of the following statements is an accurate representation as to each source of funds (a "SOURCE") to be used by such Purchaser to pay the purchase price of the Notes to be purchased by such Purchaser hereunder: (a) if such Purchaser is an "INSURANCE COMPANY" as defined in Section V(d) of Prohibited Transaction Exemption ("PTE") 95-60 (as issued by the United States Department of Labor) and the Source is an "INSURANCE COMPANY GENERAL ACCOUNT" as defined in Section V(e) of PTE 95-60 then, in accordance with Section I(a) of PTE 95-60, there is no Employee Benefit Plan, treating as a single Employee Benefit Plan all plans maintained by the same employer or employee organization, with respect to which the amount of the reserves and liabilities for all general account contracts held by or on behalf of such Plan exceed ten (10%) percent of the total reserves and liabilities of such general account (exclusive of separate account liabilities) plus surplus; (b) the Source is either (i) an insurance company pooled separate account, within the meaning of PTE 90-1 (issued January 29, 1990) or (ii) a bank collective investment fund, within the meaning of the PTE 91-38 (issued July 12, 1991) and, except as such Purchaser has disclosed to the Issuer in writing pursuant to this paragraph (b), no Employee Benefit Plan or group of Employee Benefit Plans maintained by the same employer or employee organization beneficially owns more than 10% of all assets allocated to such pooled separate account or collective investment fund; or (c) the Source constitutes assets of an "INVESTMENT FUND" (within the meaning of Part V of the QPAM Exemption) managed by a "QUALIFIED PROFESSIONAL ASSET MANAGER" or "QPAM" (within the meaning of Part V of the QPAM Exemption), no Employee Benefit Plan's assets that are included in such investment fund, when combined with the assets of all other employee benefit 9 plans established or maintained by the same employer or by an affiliate (within the meaning of Section V(c)(1) of the QPAM Exemption) of such employer or by the same employee organization and managed by such QPAM, exceed 20% of the total client assets managed by such QPAM, the conditions of Part I(c) and (g) of the QPAM Exemption are satisfied, neither the QPAM nor a person controlling or controlled by the QPAM (applying the definition of "control" in Section V(e) of the QPAM Exemption) owns a 5% or more interest in the Issuer and (i) the identity of such QPAM and (ii) the names of all Employee Benefit Plans whose assets are included in such investment fund have been disclosed to the Issuer in writing pursuant to this paragraph (c); (d) the Source is one or more Employee Benefit Plans, or a separate account or trust fund comprised of one or more Employee Benefit Plans, each of which has been identified expressly as such to the Issuer in writing pursuant to this paragraph (d); (e) the Source constitutes assets of a Employee Benefit Plan managed by an "IN-HOUSE ASSET MANAGER" (within the meaning of Part IV(a) of the PTE 96-23) which has made or properly authorized the decision for such Plan to purchase the Notes under the circumstances described in PTE 96-23; or (f) the Source does not include assets of any Employee Benefit Plan. As used in this Section 3.02, the term "SEPARATE ACCOUNT" shall have the meaning assigned to such term in Section 3 of ERISA. Section 3.03. Sale of Notes. Such Purchaser understands that the Issuer has not been registered under the Investment Company Act and that the Notes have not been registered under the Securities Act. Such Purchaser understands and acknowledges that the Notes may not be reoffered, resold, pledged or otherwise transferred by such Purchaser except (a) to a Person that is a Qualified Purchaser acquiring for its own account or for the account of a person that is a Qualified Purchaser, (b) prior to the expiration of the holding period applicable to sales of such Notes under Rule 144(k) under the Securities Act, to either (i) a Qualified Institutional Buyer in a transaction meeting the requirements of Rule 144A acquiring for its own account or for the account of a person that is a Qualified Institutional Buyer in a transaction meeting the requirements of Rule 144A or (ii) an Accredited Investor acquiring for its own account or for the account of a person that is either (x) an Accredited Investor or (y) a Qualified Institutional Buyer and (c) if the transferor delivers to the Trustee a duly executed Transferor Certificate in the form of Exhibit C to the Indenture and the proposed transferee of such Notes delivers to the Trustee a duly executed Transferee 10 Certificate in the form of Exhibit B to the Indenture and such additional information as set forth therein. ARTICLE 4 Conditions of Closing Each Purchaser's obligation to purchase and pay for the Notes to be purchased by such Purchaser hereunder shall be subject to the conditions hereinafter set forth: Section 4.01. Proceedings Satisfactory. All proceedings taken in connection with the issuance of the Notes and the consummation of the transactions contemplated hereby, and all documents and papers relating thereto, shall be reasonably satisfactory to such Purchaser and the Purchasers' special counsel, and such Purchaser and the Purchasers' special counsel shall have received copies of such documents and papers, all in form and substance reasonably satisfactory to such Purchaser and the Purchasers' special counsel, as such Purchaser or they may reasonably request in connection therewith. Section 4.02. Opinions of Special Counsel for the Purchasers. Such Purchaser shall have received an opinion dated the Closing Date and addressed to such Purchaser and the Trustee from Davis Polk & Wardwell, the Purchasers' special counsel in substantially the form of Exhibit A-1 hereto and covering such other matters incident to the transactions contemplated hereby as such Purchaser may reasonably request. Section 4.03. Opinions of Counsel for the Issuer and Cherokee. Such Purchaser shall have received opinions dated the Closing Date and addressed to such Purchaser and the Trustee (a) from Latham & Watkins, special counsel to the Issuer and Cherokee, substantially in the form of Exhibit A-2 hereto with respect to corporate matters, (b) from Latham & Watkins, special counsel to the Issuer and Cherokee, substantially in the form of Exhibit A-3 hereto with respect to bankruptcy law matters, (c) from Jeffer, Mangels, Butler & Marmaro LLP, special counsel to the Issuer and Cherokee, substantially in the form of Exhibit A-4 hereto with respect to trademark matters and (d) from Richards, Layton & Finger, P.A., special counsel to the Issuer, substantially in the form of Exhibit A-7 hereto, and in the case of each such opinion covering such other matters incident to the transactions contemplated hereby as such Purchaser may reasonably request. 11 Section 4.04. Opinion of Counsel for the Trustee. Such Purchaser shall have received an opinion dated the Closing Date and addressed to such Purchaser from Richards, Layton & Finger, P.A., special counsel to the Trustee, substantially in the form of Exhibit A-5 hereto and covering such other matters incident to the transactions contemplated hereby as such Purchaser may reasonably request. Section 4.05. License Agreement. Such Purchaser shall have received a certificate of an officer of the Issuer certifying that the License Agreement is in full force and effect, in accordance with its terms, and attaching a copy of the License Agreement as duly executed and delivered by each of the parties thereto and certified as a true, correct and complete copy by such officer. Section 4.06. Dayton Hudson Documents. Such Purchaser shall have received a copy of (i) a letter duly executed and delivered by the Licensee in the form of Exhibit B hereto acknowledging the assignment of the License Agreement to the Issuer, agreeing to make payments thereunder directly to the Collection Account, stating that to the best knowledge of the Licensee, no defense to the obligations of the Licensee under the License Agreement and no claim of the Licensee against Cherokee which might be asserted as a potential offset thereto exists on the Closing Date and containing certain other agreements of the Licensee and (ii) an opinion of counsel for the Licensee, who may be an employee of the Licensee, substantially in the form of Exhibit A-6 hereto, to the effect that the License Agreement has been duly authorized, executed and delivered and constitutes a legal, valid and binding obligation of the Licensee enforceable in accordance with its terms (subject to customary exceptions). Section 4.07. Trademark Filing. Such Purchaser shall have received evidence satisfactory to such Purchaser that the Memorandum of Assignment contemplated by Section 5.03 of the Trademark Purchase and License Assignment Agreement shall have been tendered to the United States Patent and Trademark Office for recordation, and any required recording fee in connection therewith shall have been paid. Section 4.08. Collateral. The Security Agreement and the Trademark Security Agreement shall have been duly executed and delivered by the Issuer and the Trustee and shall be in full force and effect. In addition, such Purchaser shall have received evidence satisfactory to such Purchaser that the Issuer shall have taken all actions (including, without limitation, (i) delivery to special counsel for the Purchasers of the Trademark Security Agreement for recordation with the United States Patent and Trademark Office, together with payment of any required recording fees, (ii) the obtaining of a UCC file search report in the names of each of the Issuer and Cherokee from the Secretary of State of the State of 12 California and (ii delivery to special counsel for the Purchasers of UCC-1 financing statements in the name of the Issuer for filing with the Secretaries of State of California and Delaware) as may be necessary or as such Purchaser may reasonably request in order to create and perfect the security interests created pursuant to the Indenture, the Security Agreement and the Trademark Security Agreement. Section 4.09. Basic Documents. Each Basic Document shall have been duly executed and delivered by the parties thereto and shall be in full force and effect. Section 4.10. Representations True, Etc. All representations and warranties of the Issuer contained in Article 2 and of the Issuer or Cherokee contained in any other Basic Document or Trademark License shall be true on and as of the Closing Date; the Issuer shall have performed all agreements on its part required to be performed under this Agreement and in any other Basic Document on or prior to the Closing Date; no Default or Event of Default shall have occurred and be continuing; and such Purchaser shall have received a certificate from an officer of the Issuer and a certificate from an officer of Cherokee, each dated the Closing Date, certifying to the effect specified in this Section 4.10. Section 4.11. Legality. On the Closing Date the purchasing of the Notes to be purchased by such Purchaser shall (i) be permitted by the laws and regulations of each jurisdiction to which such Purchaser is subject, without recourse to provisions (such as Section 1405(a)(8) of the New York Insurance Law) permitting limited investments by insurance companies without restriction as to the character of the particular investment, (ii) not violate any applicable law or regulation (including, without limitation, Regulation G, T or X of the Board of Governors of the Federal Reserve System) and (iii) not subject such Purchaser to any tax, penalty or liability under or pursuant to any applicable law or regulation, which law or regulation was not in effect on the date hereof. If requested by such Purchaser, such Purchaser shall have received an Officer's Certificate from the Issuer certifying as to such matters of fact as such Purchaser may reasonably specify to enable such Purchaser to determine whether such purchase is permitted as contemplated in this Section 4.11. Section 4.12. Private Placement Number. Such Purchaser shall have received evidence satisfactory to such Purchaser that a private placement number with respect to the Notes shall have been obtained from Standard & Poor's CUSIP Service Bureau (in cooperation with the Securities Valuation Office of the National Association of Insurance Commissioners). 13 Section 4.13. Other Purchasers. All other Purchasers shall have purchased and made payment for the respective aggregate principal amounts of the Notes to be purchased by them hereunder. The obligations of the Issuer to issue and sell the Notes pursuant to this Agreement are subject to the satisfaction at the Closing Date of the following conditions: Section 4.14. Payment. Each Purchaser shall have paid the purchase price of the Notes to be purchased by it hereunder in accordance with Section 1.01. Section 4.15. Purchaser's Representations. The representations and warranties of each Purchaser contained herein shall be true on and as of the Closing Date as if made on and as of such time and each Purchaser shall have performed and complied in all material respects with all agreements required by this Agreement to be performed or complied with by such Purchaser at or prior to the Closing Date. Section 4.16. Opinion of Counsel for the Trustee. The Issuer shall have received an opinion dated the Closing Date and addressed to the Issuer from Richards, Layton & Finger, P.A., special counsel to the Trustee, substantially in the form of Exhibit A-5 hereto and covering such other matters incident to the transactions contemplated hereby as the Issuer may reasonably request. Section 4.17. Legality. The issue and sale of the Notes by the Issuer shall not be prohibited by any applicable law, court order or governmental regulation. ARTICLE 5 Definitions Section 5.01. Certain Definitions. Unless the context otherwise requires, any reference in this Agreement to any agreement, contract or document shall mean such agreement, contract or document and all schedules, exhibits and attachments thereto as amended, supplemented or modified and in effect from time to time, as permitted hereby. Unless otherwise stated, any reference in this Agreement to any Person shall include its permitted successors and assigns and, in the case of any Governmental Body, any Person succeeding to its functions and capacities. Defined terms in this Agreement shall include in the singular number 14 the plural and in the plural number the singular. The words "hereof", "herein" and "hereunder" and words of similar import when used in this Agreement shall, unless otherwise expressly specified, refer to this Agreement as a whole and not to any particular provisions of this Agreement and all references to sections shall be references to sections of this Agreement unless otherwise expressly specified. Terms defined in the Indenture are used herein as so defined except as otherwise defined herein. In addition, as used herein the following terms shall have the following respective meanings (all terms defined in this Section 5.01 and in the other provisions of this Agreement in the singular to have the same meanings when used in the plural and vice versa): "ACCREDITED INVESTOR" has the meaning specified in the introduction hereto. "AGREEMENT" means this Note Purchase Agreement. "CLOSING DATE" has the meaning specified in the introduction hereto. "EMPLOYEE BENEFIT PLAN" means any "EMPLOYEE BENEFIT PLAN" as defined in (S)3(3) of ERISA, or any "PLAN" as defined in Section 4975(e)(1) of the Code. "ERISA AFFILIATE" means any trade or business (whether or not incorporated) that is treated as a single employer together with the Issuer under section 414 of the Code. "GOVERNMENTAL BODY" has the meaning stated in Section 2.06. "INDENTURE" has the meaning specified in the introduction hereto. "INVESTMENT COMPANY ACT" has the meaning specified in the introduction hereto. "ISSUER" has the meaning specified in the introduction hereto. "MULTIEMPLOYER PLAN" means any Employee Benefit Plan that is a "MULTIEMPLOYER PLAN" (as such term is defined in section 4001(a)(3) of ERISA). "NOTES" has the meaning specified in the introduction hereto. "ORDER" has the meaning specified in Section 2.06. 15 "PROCEEDINGS" means all actions, suits, injunctions, writs, restraining orders, or other proceedings (including counterclaims) in any court or before any arbitrator of any kind or before or by any Governmental Body. "PURCHASER" has the meaning specified in the introduction hereto. "QUALIFIED INSTITUTIONAL BUYERS" has the meaning specified in the introduction hereto. "QUALIFIED PURCHASER" has the meaning specified in the introduction hereto. "RULE 144A" has the meaning specified in the introduction hereto. "SECURITIES ACT" has the meaning specified in the introduction hereto. "TRADEMARK SECURITY AGREEMENT" has the meaning assigned to that term in the Security Agreement. "TRUSTEE" has the meaning specified in the introduction hereto. "UNIFORM COMMERCIAL CODE" means the Uniform Commercial Code as from time to time in effect in the State of New York. Section 5.02. Accounting Terms, Etc.. All accounting terms used herein which are not expressly defined in this Agreement have the meanings respectively given to them in accordance with GAAP. Except as otherwise specifically provided herein, all computations made pursuant to this Agreement shall be made in accordance with GAAP, and all balance sheets and other financial statements shall be prepared in accordance with GAAP. ARTICLE 6 Home Office Payment In the case of any Note owned by a Holder who is either (i) a Purchaser or (ii) a subsequent Holder who has given written notice to the Issuer and the Trustee requesting that the provisions of this Section shall apply, the Issuer will, or will cause the Trustee to, make all payments in respect of the Notes of such Holder, without any presentment thereof, directly to such Holder at the address of such Holder set forth in Schedule I or at such other address as such Holder from time to 16 time designates in writing to the Issuer and the Trustee five or more Business Days prior to the date of payment or, if a bank account is designated for such Holder on Schedule I hereto or in any written notice to the Issuer and the Trustee from such Holder, the Issuer will, or will cause the Trustee to, make such payments in dollars in immediately available funds to such bank account, marked for attention as indicated, or by such other method of payment or to such other account of such Holder in any bank in the United States as such Holder may from time to time direct in writing to the Issuer and the Trustee five or more Business Days prior to the date of payment. The Holder of any Notes to which this Section applies agrees that in the event it shall sell or transfer any such Notes it will, prior to the delivery of such Notes (unless it has already done so), make a notation thereon of all principal paid on such Notes. With respect to Notes to which this Section applies, the Issuer and the Trustee shall be entitled to presume conclusively that such Purchaser or such subsequent Holder as shall have requested the provisions hereof to apply to its Notes remains the Holder of such Notes until such Notes shall have been presented to the Trustee for transfer. Each Holder of any Note that is paid in full shall deliver or cause to be delivered such Note to the Trustee or the Issuer promptly upon written request therefor. ARTICLE 7 Liabilities of the Purchasers Neither this Agreement nor any disposition of any of the Notes shall be deemed to create any liability or obligation of any Purchaser or any other holder of any Note to enforce any provision hereof or of any of the Notes for the benefit or on behalf of any other Person who may be the holder of any Note. ARTICLE 8 Miscellaneous Section 8.01. Expenses. The Issuer agrees, whether or not the transactions hereby contemplated shall be consummated, to pay all reasonable fees and disbursements of Davis Polk & Wardwell in connection with the preparation, negotiation and execution of the Basic Documents and the Trademark Licenses and the creation and perfection of the Liens on the Trust Estate contemplated by the Security Agreement. The Issuer also agrees to pay (i) all reasonable expenses incurred by each Holder (including reasonable counsel fees) in connection with any amendment or requested amendment (if requested by the 17 Issuer or the Trustee) of, or waiver or consent (if requested by the Issuer or the Trustee) or requested waiver or consent (if requested by the Issuer or the Trustee) under or with respect to, this Agreement or any other Basic Document, whether or not the same shall become effective and (ii) all reasonable expenses incurred by each Holder (including reasonable counsel fees) incurred in connection with the preservation of any Lien or realization on or pursuit of remedies with respect to any of the Trust Estate, in each case covered by this clause (ii) following the occurrence and during the continuance of any Default or Event of Default or any workout, restructuring or similar negotiations relating to the Notes; provided that this sentence shall not require the Issuer to pay counsel fees for more than one firm of counsel (together with any local counsel) representing all Holders. The obligations of the Issuer under this Section 8.01 shall survive the payment or prepayment of the Notes. In furtherance of the foregoing, on the Closing Date, the Issuer will pay or cause to be paid the reasonable fees and disbursements of the Purchasers' special counsel, which are reflected in the statement of such counsel submitted to the Issuer prior to the Closing Date. The Issuer will also pay or cause to be paid, promptly upon receipt of supplemental statements therefor, additional reasonable fees, if any, and disbursements of such special counsel in connection with the transactions hereby contemplated (including disbursements unposted as of the Closing Date). Section 8.02. Reliance on and Survival of Representations; Covenants. All representations and warranties of the Issuer herein and in any certificates or other instruments delivered pursuant to this Agreement are made as of the date hereof in the case of this Agreement or as of the date of any such certificate or instrument and shall (i) be deemed to be material and to have been relied upon by each Purchaser, notwithstanding any investigation heretofore or hereafter made by such Purchaser or on behalf of such Purchaser and (ii) survive the execution and delivery of this Agreement and the delivery of the Notes to each Purchaser. All covenants and agreements contained herein shall continue in effect so long as any Note is outstanding and thereafter as provided in Sections 8.01 and 8.05. Section 8.03. Successors and Assigns. This Agreement shall bind and inure to the benefit of and be enforceable by the Issuer and its permitted successors and assigns hereunder and each Purchaser and its successors and assigns, and, in addition, shall in every respect inure to the benefit of and be enforceable by all holders from time to time of the Notes. Section 8.04. Communications. All notices and other communications provided for in this Agreement shall be in writing and shall be sent, if practicable, by confirmed telecopy (with hard copy sent on the same day by overnight courier) 18 and, otherwise, by overnight courier service prepaid to a Person at its address specified below. A communication shall be addressed, until such time as a Person shall have notified the other parties and holders of Notes of a change of address (A) if to the Issuer, to: 625 Landon Lane Pasadena, California 91106 Attention: Carol Gratzke With a copy to: Cherokee, Inc., Administrator 6835 Valjean Avenue Van Nuys, California 91406 Telephone: 818-908-9868 Telecopy: 818-908-9191 (B) if to a Purchaser, at the address for such Purchaser set forth in Schedule I, (C) if to any other holder of a Note, at the address of such holder as it appears on the Note Register maintained pursuant to the Indenture, or (D) if to the Trustee, at the address specified therefor in the Indenture. Section 8.05. Indemnification. The Issuer agrees to indemnify, exonerate and hold each Purchaser and each other holder of a Note and each of their respective trustees, officers, directors, employees and agents (collectively herein called the "INDEMNITEES" and individually called an "INDEMNITEE") free and harmless from and against any and all actions, causes of action, suits, losses, liabilities and damages, and reasonable expenses in connection therewith, including without limitation reasonable counsel fees and disbursements (collectively herein called the "INDEMNIFIED LIABILITIES") incurred by the Indemnitees or any of them as a result of, or arising out of, or relating to any transaction financed or to be financed in whole or in part directly or indirectly with the proceeds from the sale of any of the Notes, or the execution, delivery, performance or enforcement of this Agreement or any other Basic Document or any instrument contemplated hereby or thereby by any of the Indemnitees, except for any such Indemnified Liabilities arising on account of such Indemnitee's gross 19 negligence or willful misconduct, and if and to the extent the foregoing undertaking may be unenforceable for any reason, the Issuer agrees to make the maximum contribution to the payment and satisfaction of each of the Indemnified Liabilities which is permissible under applicable law. The obligations of the Issuer under this Section 8.05 shall survive the payment or prepayment of the Notes. Section 8.06. JURISDICTION AND PROCESS. THE ISSUER AGREES THAT ANY LEGAL ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT OR ANY OTHER BASIC DOCUMENT OR ANY OTHER DOCUMENT EXECUTED IN CONNECTION HEREWITH OR THEREWITH, OR ANY LEGAL ACTION OR PROCEEDING TO EXECUTE OR OTHERWISE ENFORCE ANY JUDGMENT OBTAINED AGAINST THE ISSUER FOR BREACH HEREOF OR THEREOF, OR AGAINST ANY OF ITS PROPERTIES, MAY BE BROUGHT IN THE COURTS OF THE STATE OF NEW YORK OR THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK BY ANY PURCHASER OR ON BEHALF OF SUCH PURCHASER OR BY OR ON BEHALF OF ANY HOLDER OF A NOTE, AS SUCH PURCHASER OR HOLDER MAY ELECT, AND THE ISSUER HEREBY IRREVOCABLY AND UNCONDITIONALLY SUBMITS TO THE NON-EXCLUSIVE JURISDICTION OF SUCH COURTS (WITHOUT LIMITING THE JURISDICTION OF OTHER COURTS) FOR PURPOSES OF ANY SUCH LEGAL ACTION OR PROCEEDING. THE ISSUER HEREBY IRREVOCABLY AND UNCONDITIONALLY AGREES THAT SERVICE OF PROCESS IN ANY LEGAL ACTION OR PROCEEDING RELATING TO THE BASIC DOCUMENTS OR ANY OTHER DOCUMENT EXECUTED IN CONNECTION THEREWITH MAY BE EFFECTED BY MAILING A COPY THEREOF BY REGISTERED OR CERTIFIED MAIL (OR ANY SUBSTANTIALLY SIMILAR FORM OF MAIL), POSTAGE PREPAID, TO THE ISSUER AT ITS ADDRESS SET FORTH IN SECTION 8.04 OR AT SUCH OTHER ADDRESS OF WHICH THE TRUSTEE SHALL HAVE BEEN NOTIFIED PURSUANT THERETO. IN ADDITION, THE ISSUER (A) HEREBY IRREVOCABLY WAIVES TO THE FULLEST EXTENT PERMITTED BY LAW, ANY OBJECTION WHICH IT MAY NOW OR HEREAFTER HAVE TO THE LAYING OF VENUE OF ANY SUIT, ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT, ANY OTHER BASIC DOCUMENT OR ANY OTHER DOCUMENT EXECUTED IN CONNECTION HEREWITH OR THEREWITH BROUGHT IN THE COURTS OF THE STATE OF NEW YORK OR THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK, AND ANY CLAIM THAT ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN ANY SUCH COURT HAS BEEN BROUGHT 20 IN AN INCONVENIENT FORUM AND (B) HEREBY WAIVES ANY AND ALL RIGHT TO TRIAL BY JURY IN ANY LEGAL PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY. Section 8.07. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of New York. Section 8.08. Headings. The headings in this Agreement are for convenience of reference only and shall not limit or otherwise affect any of the terms hereof. Section 8.09. Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed to be an original but all of which together shall constitute one and the same instrument. Section 8.10. Severability. In case any one or more of the provisions contained in this Agreement or in any instrument contemplated hereby, or any application thereof, shall be invalid, illegal or unenforceable in any respect, the validity, legality and enforceability of the remaining provisions contained herein and therein, and any other application thereof, shall not in any way be affected or impaired thereby. Section 8.11. Confidentiality. Each Purchaser shall be deemed to have agreed by acceptance of the Notes, that all information (other than publicly available information) received pursuant to such Purchaser's status as a holder of Notes and identified to such Purchaser in writing by the Issuer as being confidential, will be held by the Purchaser in accordance with its customary procedures for handling confidential information, but such Purchaser may make disclosure to the extent necessary to any bona fide prospective institutional investor transferee in connection with the contemplated transfer of Notes (provided that (i) prior to disclosure by such Purchaser after the date hereof to any prospective institutional investor transferee of a Note of any information covered by this paragraph, such Purchaser will obtain from such prospective transferee in favor of the Issuer its written agreement to be bound by the provisions of this paragraph provided that such Purchaser shall not in any event be liable to any Person because of the failure of such prospective transferee to comply with such provisions and (ii) at such time as any disclosure is made to a transferee, such Purchaser will notify the Issuer in writing of the information released and the identity of the recipient of such information) or as required by, in appropriate response to a request by, or as otherwise customarily disclosed to, any Governmental Body (including without limitation the National Association of Insurance Commissioners or any successor thereto) or representative thereof or 21 pursuant to legal process or pursuant to any litigation that such Purchaser may be involved in, or to the accountants, counsel or other professional advisers of such Purchaser in the course of their respective duties (provided that such Purchaser requests any such adviser to whom it discloses such information to treat all such information as non-public data). 22 If you are in agreement with the foregoing, please sign the form of acceptance in the space provided below whereupon this Agreement shall become a binding agreement between you and the Issuer. Very truly yours, SPELL C. LLC By: /s/ Carol Gratzke Name: Carol Gratzke Title: Secretary and Treasurer 23 The foregoing Agreement is hereby accepted and agreed as of the date first above written : MORGAN GUARANTY TRUST COMPANY OF NEW YORK AS TRUSTEE OF A COMMINGLED PENSION TRUST FUND By: /s/ E. Clifford Cole -------------------------- Name: E. Clifford Cole Title: Vice President GREAT-WEST LIFE & ANNUITY INSURANCE COMPANY By: /s/ Julie Bock -------------------------- Name: Julie Bock Title: Assistant Vice President By: /s/ Wayne Hoffmann -------------------------- Name: Wayne Hoffmann Title: Vice President METROPOLITAN LIFE INSURANCE COMPANY By: /s/ James A. Wiriott -------------------------- Name: James A. Wiriott Title: Director 24 CANADA LIFE ASSURANCE COMPANY By: /s/ George Isaac -------------------------- Name: George Isaac Title: Associate Treasurer CANADA LIFE INSURANCE COMPANY OF AMERICA By: /s/ George Isaac -------------------------- Name: George Isaac Title: Associate Treasurer CANADA LIFE INSURANCE COMPANY OF NEW YORK By: /s/ George Isaac -------------------------- Name: George Isaac Title: Associate Treasurer 25 EX-10.17 5 TRADEMARK PURCHASE AND LICENSE ASSIGNMENT CONFORMED COPY TRADEMARK PURCHASE AND LICENSE ASSIGNMENT AGREEMENT TRADEMARK PURCHASE AND LICENSE ASSIGNMENT AGREEMENT (this "AGREEMENT") dated as of December 23, 1997, between Cherokee, Inc., a Delaware corporation ("CHEROKEE") and SPELL C. LLC, a Delaware limited liability company ("SPV"). W I T N E S S E T H: WHEREAS, Cherokee owns the Trademark (as defined below); WHEREAS, Cherokee and Licensee (as defined below) have entered into a License Agreement (as defined below), whereby Cherokee granted Licensee certain rights to use the Trademark pursuant to the License Agreement; WHEREAS, SPV is a direct, wholly-owned, bankruptcy-remote limited purpose subsidiary of Cherokee; and WHEREAS, Cherokee desires to sell, and SPV desires to purchase, the Trademark Rights (as defined below), and Cherokee desires to assign, and SPV desires to assume, the License Rights, in each case upon the terms and subject to the conditions hereinafter set forth; NOW, THEREFORE, the parties hereto agree as follows: ARTICLE 1 Definitions Section 1.0. Definitions. Capitalized terms used but not defined herein shall have the respective meanings given to such terms in the Indenture dated December 23, 1997 between SPV and Wilmington Trust Company, as Trustee (the "INDENTURE"). The following additional terms, as used herein, have the following respective meanings: "AGREEMENT" has the meaning assigned to that term in the first paragraph hereof. "ASSIGNED RIGHTS" has the meaning assigned to that term in Section 2.01. "ASSIGNMENT" has the meaning assigned to that term in Section 2.01. "CHEROKEE" has the meaning assigned to that term in the first paragraph hereof. "CHEROKEE LICENSES" has the meaning assigned to that term in Section 2.01. "INDIAN HEAD DESIGN" means the design included in Exhibit A. "INDENTURE" has the meaning assigned to that term in the introductory sentence to this Section 1.01. "LICENSE AGREEMENT" has the meaning assigned to that term in Section 2.01. "LICENSEE" has the meaning assigned to that term in Section 2.01. "LICENSE RIGHTS" has the meaning assigned to that term in Section 2.01. "OTHER EXISTING LICENSES" has the meaning assigned to that term in Section 2.01. "OTHER PERMITTED LICENSES" means the Cherokee Licenses and the license granted by SPV to Cherokee pursuant to Section 4.01 hereof. "SPV" has the meaning assigned to that term in the first paragraph hereof. "SPV INDEMNIFIED PARTIES" has the meaning assigned to that term in Section 8.11. "TRADEMARK" means all United States right, title and interest of Cherokee in and to the "Cherokee" trademark and other marks incorporating the name Cherokee, with various stylized designs, including the "Indian Head Design," as used and registered in the United States Patent and Trademark Office, copies of which registrations are attached as Exhibit A hereto. 2 "TRADEMARK RIGHTS" has the meaning assigned to that term in Section 2.01. ARTICLE 2 Sale, Assignment and Transfer Section 2.01. Transfer to SPV. On the terms set forth herein and subject to (i) the due execution and delivery of this Agreement by each of the parties hereto and (ii the receipt by Cherokee of the payment required to be made under Section 3.01 hereof, as of the date hereof Cherokee hereby: (a) assigns all of its rights and obligations as licensor under the License Agreement (the "LICENSE AGREEMENT") dated as of November 12, 1997 between Cherokee and Dayton Hudson Corporation (the "LICENSEE") together with all rights and privileges granted, secured and provided thereby (the "LICENSE RIGHTS"), such rights to be held and enjoyed by SPV from and after the date hereof, for its own use and benefit and for the use and benefit of its successors, assigns or other legal representatives, as fully and entirely as the same would have been held and enjoyed by Cherokee if this assignment and assumption had not been made; and (b) sells, assigns and transfers to SPV all of its right, title and interest in, to and under the Trademark, together with any United States extensions or renewals thereof, United States trademark registrations and trademark applications for the Cherokee trademark, any other mark incorporating the Cherokee name or the Indian Head Design, and United States common law rights to the Cherokee trademark, other marks incorporating the name Cherokee and the Indian Head Design, whether presently existing or hereafter arising or acquired, together with the good will of the business connected with the use of or symbolized by the foregoing, together with all rights and privileges granted and secured thereby, including without limitation any and all claims and causes of action which may hereafter arise by reason of unfair competition therewith, infringement, violation or dilution thereof or injury to the associated goodwill or otherwise, such rights to be held and enjoyed by SPV, for its own use and benefit and for the use and benefit of its successors, assigns or other legal representatives as fully and entirely as the same would have been held and enjoyed by Cherokee if this assignment had not been made (the "TRADEMARK RIGHTS" and, together with the License Rights, the "ASSIGNED RIGHTS"); provided, that the sale, assignment and transfer contemplated in this clause (b) is subject to (x) the License Agreement, (y) the other existing licenses of the Trademark set forth in 3 Schedule 2.01 (the "OTHER EXISTING LICENSES") and (z) retail license agreements (in the category of cosmetics, bath and body products only) hereafter granted by Cherokee as permitted by Section 7(b)(v)(b) of the License Agreement and Section 4.01 hereof (such other retail license agreements referred to in (z), together with the Other Existing Licenses, the "CHEROKEE LICENSES"), and conveys no interest in the Cherokee Licenses. The sale, assignment and transfer contemplated in this Section 2.01 shall together be referred to herein as the "ASSIGNMENT." Section 2.02. Acceptance and Assumption. SPV hereby acknowledges its acceptance and assumption of all right, title and interest in and to the Trademark and the License Agreement. SPV hereby expressly assumes all of Cherokee's liabilities and obligations under the License Agreement. Section 2.03. Absolute Transfer. Cherokee and SPV hereby agree and acknowledge that the Assignment is an absolute and irrevocable transfer of the Trademark and the License Agreement, and is not intended to be a transfer for purposes of security. Section 2.04. No Recourse. The Assignment shall be without recourse, representation or warranty except as expressly provided herein. Without limiting the generality of the foregoing, Cherokee shall have no responsibility for performance by the Licensee of its obligations under the License Agreement. ARTICLE 3 Payment of Purchase Price Section 3.01. Purchase Price. As consideration for the Assignment, SPV shall, by not later than 1:00 p.m. New York time on the date hereof, pay or cause to be paid to Cherokee an amount equal to $47,845,558.83. Section 3.02. Allocation. Cherokee and SPV agree that any payments due pursuant to the License Agreement after the date hereof shall be payable to, and for the account of, SPV, regardless of whether some portion thereof may have accrued prior to the date hereof. Section 3.03. Account Information. The payment hereunder to Cherokee shall be made in immediately available funds, without setoff, deduction or 4 counterclaim by payment to such bank account as Cherokee may specify for this purpose. ARTICLE 4 Other Permitted Licenses Section 4.01. License to Cherokee. SPV hereby grants to Cherokee, and Cherokee hereby accepts, the right and license to use the Trademark to the extent necessary or appropriate to enable Cherokee to grant and maintain the Cherokee Licenses and perform its obligations thereunder and receive the rights and benefits thereof, in each case subject to Section 4.02. Except as contemplated by Section 4.02, no royalty shall be payable by Cherokee for any license granted pursuant to this Section 4.01. The license granted pursuant to this Section 4.01 shall be memorialized in a license agreement in the form of Exhibit D. Section 4.02. Extension of Other Permitted Licenses. Cherokee will not grant, extend or amend any of the Cherokee Licenses in contravention of Section 7(b)(v) of the License Agreement. In addition, Cherokee will not, without the prior written consent of SPV, extend the term of the Other Existing Licenses with Brylane, Calder and/or Pamida or with Dayton Hudson Corporation; provided that notwithstanding the foregoing Cherokee may agree to extend the term of any of such Other Existing Licenses (other than the Other Existing License with Dayton Hudson Corporation) so long as, prior thereto, Cherokee shall have assigned to SPV, absolutely, the right to receive 50% of all royalties payable under such Other Existing License during its extended term, and made arrangements for the payment of such portion of the royalty directly to the Trustee for the account of SPV, all pursuant to documents reasonably satisfactory in form and substance to SPV and the Trustee. Upon and subject to such arrangements having been made, the license granted pursuant to Section 4.01 shall apply to the extended term of such Other Existing License. ARTICLE 5 Representations and Warranties of Cherokee Cherokee represents and warrants to SPV as of the date hereof that: Section 5.01. Trademark. (a) The Trademark is validly registered under the Lanham Act as set forth in Exhibit A. Except as set forth in Schedule 5.01, no 5 other registration or filing with any governmental authority is necessary or appropriate to maintain and protect the Trademark for the uses contemplated by the License Agreement. (b) Prior to the transfer and assignment contemplated in Section 2.01 hereof, Cherokee owns and possesses all right, title and interest in and to the Trademark, and, except for the License Agreement, the Other Permitted Licenses and the Strategic Partners Agreement dated July 17, 1995, between Cherokee and Strategic Partners, Inc., the Trademark Rights are not subject to any judgment, injunction, order, decree, pledge, encumbrance or agreement restricting the use thereof or restricting the licensing thereof to any Person. (c) To Cherokee's knowledge, there are no existing or threatened claims or proceedings alleging that use of the Trademark Rights by Cherokee or any of its licensees in the United States infringes any third party's rights or challenging the ownership of any registration of the Trademark in any jurisdiction in the United States and Cherokee is not aware of any grounds for any such claims or proceedings, except as set forth in Schedule 5.01. (d) The Trademark Rights include all trademarks or service marks owned and used by Cherokee in connection with the transactions described in the License Agreement, except as set forth in Schedule 5.01. (e) The use of the Trademark Rights permitted by the License Agreement does not infringe any rights owned or possessed by any third party. (f) To Cherokee's knowledge, no Person is infringing or misappropriating any of the Trademark Rights, except as set forth in Schedule 5.01. Section 5.02. License Agreement. The License Agreement is a valid and binding agreement of each of Cherokee and the Licensee and is in full force and effect, and neither Cherokee nor Licensee is in default or breach in any material respect under the terms of the License Agreement. A true and correct copy of the License Agreement as in effect on the date hereof is set forth in Exhibit B hereto. Section 5.03. Transfer Effective. This Agreement is effective in accordance with its terms to transfer the Assigned Rights to SPV, and upon satisfaction of the conditions specified in clauses (i) and (ii) of Section 2.01, SPV will be the owner of the Assigned Rights free and clear of any claim, judgment, injunction, order, decree, pledge, encumbrance or agreement restricting the use thereof or restricting licensing thereof to any Person, except as set forth in Section 5.01(b). Except for the recordation of a Memorandum of Assignment in 6 substantially the form of Exhibit C hereto with the United States Patent and Trademark Office, no registration or filing with any governmental authority is necessary or appropriate in connection with the transfer of the Assigned Rights by Cherokee to SPV pursuant to this Agreement. Section 5.04. Corporate Existence and Power. Cherokee is a corporation duly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation and has all corporate powers and all governmental licenses, authorizations, permits, consents and approvals required to carry on its business as now conducted. Section 5.05. Corporate Authorization. The execution, delivery and performance by Cherokee of this Agreement and the Administrative Services Agreement and the consummation of the transactions contemplated hereby and thereby are within Cherokee's corporate powers and have been duly authorized by all necessary corporate action on the part of Cherokee. This Agreement and the Administrative Services Agreement each constitutes a valid and binding agreement of Cherokee enforceable against Cherokee in accordance with its terms, except as the enforceability thereof may be limited by (i) bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the enforcement of creditors rights generally and (ii) general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law). Section 5.06. Governmental Authorization. The execution, delivery and performance by Cherokee of this Agreement and the Administrative Services Agreement and the consummation of the transactions contemplated hereby and thereby require no action by or in respect of, or filing with, any governmental body, agency or official, except, with respect to this Agreement, for the filing of an instrument of transfer in the form of Exhibit C with the United States Patent and Trademark Office. Section 5.07. Noncontravention. The execution, delivery and performance by Cherokee of this Agreement and the Administrative Services Agreement and the consummation of the transactions contemplated hereby and thereby do not and will not (i) violate the certificate of incorporation or bylaws of Cherokee, (ii) violate any applicable law, rule, regulation, judgment, injunction, order or decree or (iii) constitute a default under, require any consent under, or give rise to any right of termination, cancellation or acceleration of any right or obligation of Cherokee or to a loss of any benefit relating to the Trademark or the License Agreement to which Cherokee is entitled under, any provision of any agreement or other instrument binding upon Cherokee. 7 ARTICLE 6 Representations and Warranties of SPV SPV represents and warrants to Cherokee as of the date hereof that: Section 6.01. Limited Liability Company Existence and Power. SPV is a limited liability company duly formed, validly existing and in good standing under the laws of the State of Delaware and has all legal powers and all material governmental licenses, authorizations, permits, consents and approvals required to carry on its business as now conducted. Section 6.02. Limited Liability Company Authorization. The execution, delivery and performance by SPV of this Agreement and the Administrative Services Agreement and the consummation of the transactions contemplated hereby and thereby are within the legal powers of SPV and have been duly authorized by all necessary legal action on the part of SPV. This Agreement and the Administrative Services Agreement each constitutes a valid and binding agreement of SPV enforceable against SPV in accordance with its terms, except as the enforceability thereof may be limited by (i) bankruptcy, insolvency, reorganization, moratorium or other similar laws affecting the enforcement of creditors rights generally and (ii) general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law). Section 6.03. Governmental Authorization. The execution, delivery and performance by SPV of this Agreement and the Administrative Services Agreement and the consummation of the transactions contemplated hereby and thereby require no action by or in respect of, or filing with, any governmental body, agency or official. Section 6.04. Non-Contravention. The execution, delivery and performance by SPV of this Agreement and the Administrative Services Agreement and the consummation of the transactions contemplated hereby and thereby do not and will not (i) violate the certificate of formation or limited liability company agreement of SPV, (ii) violate any applicable law, rule, regulation, judgment, injunction, order or decree or (iii) constitute a default under, require any consent under, or give rise to any right of termination, cancellation or acceleration of any right or obligation of SPV or to a loss of any benefit relating to the Trademark or the License Agreement to which SPV is entitled under, any provision of any agreement or other instrument binding upon SPV. 8 ARTICLE 7 Confidentiality Section 7.01. Confidentiality. (a) The parties hereby agree that the disclosure of the arrangements and understandings contemplated hereby shall only be made at such time and in such manner as the parties shall specifically agree. (b) Notwithstanding clause (a) of this Section 7.01, disclosures of such arrangements and understandings may be made to the Noteholders and the Trustee to the extent necessary to allow the performance of the Basic Documents by the parties thereto, to the Licensee to the extent necessary to allow the performance of the License Agreement by the parties thereto and may be made to other third parties (i) if such arrangements and understandings are in the public domain and have entered the public domain through no fault of the party seeking to make such disclosure or its affiliates or representatives, or (ii) to the extent disclosure is compelled by law or court order. ARTICLE 8 Miscellaneous Section 8.01. Further Assurances. Cherokee will, from time to time, at its expense, execute, deliver, file and record any statement, assignment, instrument, document, agreement or other paper and take any other action (including, without limitation, any filings with the United States Patent and Trademark Office) that from time to time may be necessary, or that SPV may reasonably request, in furtherance of the purposes of this Agreement. Section 8.02. Notices. All notices and other communications hereunder shall be in writing (including telecopy or similar writing) and shall be given to such party (x) in the case of Cherokee, at 6835 Valjean Avenue, Van Nuys, CA 91406 or (y) in the case of SPV at 625 Landor Lane, Pasadena, CA 91106 (with copies in each case to Wilmington Trust Company, at its address set forth in the Indenture) or such other address or telecopy number as such party may hereafter specify for such purpose by notice given hereunder. Each such notice, request or other communication shall be effective when received. Section 8.03. Severability. Should any provision of this Agreement for any reason be declared invalid or unenforceable, such declaration shall not affect the validity or enforceability of any of the other provisions of this Agreement, which other provisions shall remain in full force and effect and the application of 9 such invalid or unenforceable provision to persons or circumstances other than those as to which it has been held invalid or unenforceable shall be valid and enforced to the fullest extent permitted by law. Section 8.04. Binding Effect; Assignment. This Agreement and all of the provisions hereof shall be binding upon and shall inure to the benefit of the parties hereto and their respective successors and permitted assigns. Neither this Agreement nor any of the rights, interests or obligations hereunder shall be assigned, directly or indirectly, including without limitation, by operation of law, by any party hereto without the prior written consent of the other party hereto; provided, that SPV may assign such rights, interests and obligations in accordance with the Security Agreement. Section 8.05. Dispute Resolution. Any action or proceeding seeking to enforce any provision of, or based on any right arising out of, this Agreement may be brought only in the courts of the State of New York and of the United States of America, in each case located in the County of New York, and each of the parties consents to the jurisdiction of such courts (and of the appropriate appellate courts) and waives any objection to venue laid therein. Each of the parties agrees that service of process in any such action or proceeding may be effected by mailing a copy thereof by registered or certified mail (or any substantially similar form of mail), postage prepaid, to such party at its address for notices under Section 8.02. Section 8.06. Entire Agreement. This Agreement constitutes the entire agreement among the parties with respect to the subject matter hereof, and supersedes all other prior agreements and understandings, both written and oral, between the parties with respect to the subject matter hereof. Section 8.07. Governing Law. This Agreement shall be governed by and construed in accordance with the laws of the State of California (regardless of the laws that might otherwise govern under applicable principles of conflicts of laws thereof) as to all matters, including but not limited to matters of validity, construction, effect, performance and remedies. Section 8.08. Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed to be an original, but all of which shall constitute one and the same agreement. Section 8.09. Waiver. Any failure by any party to comply with any obligation, covenant or agreement herein or to fulfill any condition herein may be waived only by a written notice from the party entitled to the benefits thereof. No failure by either party hereto to exercise, and no delay in exercising, any right hereunder shall operate as a waiver thereof, nor shall any single or partial exercise 10 of any right hereunder preclude any other or future exercise of that right or any other right hereunder by that party. Section 8.10. Expenses. Except as otherwise specifically provided in this Agreement, each of SPV and Cherokee will bear the cost of its own performance under this Agreement. Section 8.11. Indemnity. Cherokee shall indemnify and hold harmless SPV and its officers, directors, employees, agents and representatives (collectively, the "SPV INDEMNIFIED PARTIES") from and against any and all liabilities, losses, claims, suits, damages, reasonable costs and expense (including, without limitation, reasonable fees and disbursement of legal counsel, accountants and other experts) incurred by the SPV Indemnified Parties arising out of or in connection with (i) any breach by Cherokee of any of its representations and warranties or covenants under this Agreement or (ii) to the extent arising from transactions occurring or circumstances existing at or prior to the date of this Agreement any actual or alleged trademark infringement, unfair competition or infringement of similar proprietary rights, arising solely out of the use by SPV and/or the Licensee of the Trademark as authorized pursuant to the License Agreement. Section 8.12. No Petition. Cherokee hereby agrees that it shall not acquiesce in, petition or otherwise invoke or cause SPV to invoke the process of any court or governmental authority for the purpose of commencing or sustaining a case against SPV under any federal or state bankruptcy, insolvency or similar law or appointing a receiver, liquidator, assignee, trustee, custodian, sequestrator or other similar official of SPV or any substantial part of the property of SPV, or ordering the winding up or liquidation of the affairs of SPV. 11 IN WITNESS WHEREOF, the parties have each caused this Agreement to be executed by its duly authorized representative as of the day and year first above written. CHEROKEE, INC. By: /s/ Robert Margolis -------------------------- Name: Robert Margolis Title: Chairman of the Board of Directors and Chief Executive Officer SPELL C. LLC By: /s/ Carol Gratzke -------------------------- Name: Carol Gratzke Title: Secretary and Treasurer 12 EX-10.18 6 ADMINISTRATIVE SERVICES AGREEMENT ADMINISTRATIVE SERVICES AGREEMENT This ADMINISTRATIVE SERVICES AGREEMENT (this "Agreement") is entered into as of December 23, 1997, by and between SPELL C. LLC, a Delaware limited liability company (the "Company"), and Cherokee Inc., a Delaware corporation, as administrator hereunder (in such capacity, the "Administrator"). RECITALS WHEREAS, Cherokee Inc., a Delaware corporation ("Cherokee"), has transferred and assigned to the Company certain trademarks and rights under the License Agreement (as defined below) pursuant to that certain Trademark Purchase and License Assignment Agreement dated as of December 23, 1997 (as amended, restated, supplemented or otherwise modified from time to time, the "Trademark Agreement"), including all rights and obligations of Cherokee as licensor under that certain License Agreement dated as of November 12, 1997 (as amended, restated, supplemented or otherwise modified from time to time, the "License Agreement"), by and between Cherokee and Dayton Hudson Corporation (the "Licensee"); and WHEREAS, the Company has entered into that certain Indenture dated as of December 23, 1997 (as amended, restated, supplemented or otherwise modified from time to time, the "Indenture"), by and between the Company and the trustee named therein (in such capacity, the "Trustee"), pursuant to which the Company has issued certain Notes which are secured by a security interest in the Company's rights in the Trademark and the License Agreement; and WHEREAS, the Administrator has developed certain familiarity with and expertise in connection with establishing, maintaining and protecting the Trademark and the rights under the License Agreement, as well as the administration of the License Agreement; and WHEREAS, the Company has requested that the Administrator perform certain administrative duties on behalf of the Company in connection with, among other things, the Trademark and the License Agreement, and the Administrator is willing to so perform such duties, all on the terms set forth herein. NOW THEREFORE, for good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereto agree as follows: AGREEMENT 1. Definitions. Capitalized terms used and not otherwise defined ----------- herein shall have the meanings given in the Indenture. 2. Appointment of Administrator. Until such time as the Company ---------------------------- designates a new Administrator, Cherokee is hereby designated as, and hereby agrees to perform the duties and obligations of, the Administrator pursuant hereto. The Administrator shall perform its obligations pursuant hereto not as an agent of the Company but as an independent contractor and shall clearly identify to all third parties that it is acting in its capacity as the Administrator pursuant to this Agreement, and is not itself the owner of the Trademark or the License Agreement. The Administrator may, with the prior written consent of the Company (which consent shall not be unreasonably withheld or delayed), sub-contract certain of its administrative activities hereunder, provided that the Administrator shall not be relieved of its obligations and duties hereunder and shall remain fully liable therefor and for any action or inaction of any such subcontractor. 3. Administrator Duties. The Administrator shall perform the -------------------- following duties for the benefit of the Company, subject to the further direction of the Company: a. Quality Control. The Company shall consult with the --------------- Administrator and shall establish standards of quality for goods and services with which the Trademark is to be used by the Licensee. The Administrator shall monitor the quality of all goods and services in connection with which the Licensee (and any other licensee of the Trademark) uses the Trademark. From time to time, upon request of the Administrator, the Company shall direct the Licensee to submit to the Administrator, or to otherwise make available for inspection by the Administrator, specimens of goods and other materials on or in connection with which the Trademark is used. The Administrator shall report to the Company in the event the Administrator discovers that any goods or services in connection with which the Trademark is used fail to satisfy the Company's quality standards. The Administrator shall take such action as may be necessary or as the Company shall reasonably direct to cause Licensee to restore the quality of goods and/or services offered by the Licensee in connection with the Trademark to the Company's standards. Such action may include, without limitation, notifying the Licensee of its breach of covenant to maintain product quality, overseeing Licensee's efforts to restore product quality, and (only if the Company expressly so directs) taking action to terminate the license granted to the Licensee under License Agreement if Licensee's failure to satisfy the Company's quality standards continues. b. Applications and Registrations. The Administrator shall file ------------------------------ in the name of the Company and thereafter diligently prosecute such applications to register the Trademark in the United States in connection with such goods and/or services as may be required under the License Agreement or as the Company, after consulting with the Administrator, shall reasonably direct. The Administrator shall take such actions as it determines appropriate to maintain registrations for the Trademark in the United States. The Company shall cooperate with the Administrator as shall be reasonably necessary or as the Administrator may reasonably request to file, prosecute and maintain such applications and registrations for the Trademark. The fees and costs for filing, prosecuting and maintaining applications and registrations for the Trademark shall be borne in accordance with Section 6 of this Agreement. 2 Notwithstanding the foregoing, the Administrator shall not be obligated to file or prosecute any application if (i) the Administrator has a reasonable belief that it is unlikely that such application would proceed to registration and (ii) it promptly notifies the Company in writing to such effect. c. Trademark Protection. The Company agrees to notify the -------------------- Administrator promptly in writing in the event it becomes aware that (i) any legal action is threatened or instituted against the Company or the Licensee relating to the use of the Trademark by the Company or the Licensee, or (ii) the Company or the Licensee become aware of any infringement or illegal use by any third party of the Trademark. The Administrator shall take such action (including without limitation engaging counsel, and filing lawsuits, cancellation petitions and notices of opposition) as may be necessary or as the Company may reasonably direct to protect the Trademark and the rights of the Company and the Licensee to use the Trademark. The Company shall cooperate with the Administrator as shall be reasonably required in stopping any infringement of the Trademark or defending or instituting action to protect the Trademark. The Company shall serve as a named party in any suit, action or proceeding brought by the Administrator to protect the Trademark. The cost and expense of any such suit, action or proceeding and otherwise relating to trademark quality and control, applications and registrations, and protection shall be borne in accordance with Section 6 below. Notwithstanding the foregoing, the Administrator shall not be required to institute legal action if (i) in the reasonable opinion of the Administrator and its counsel, the probability of success of such legal action does not justify the time and expense which would be incurred in instituting such legal action and (ii) it promptly notifies the Company in writing to such effect. d. Use of Trademark. The Administrator shall cooperate with the ---------------- Licensee as shall be reasonably necessary to enable the Licensee to establish use of the Trademark in connection with goods and services and as may be required under the License Agreement or as the Company shall from time to time reasonably direct. e. Licensor Duties. The Administrator shall generally review --------------- such reports and other communications from the Licensee it receives relating to the License Agreement, the Trademark, or the Licensee's performance or obligations under the License Agreement. The Administrator shall provide periodic reports to the Company, on its view of the status of the Licensee's performance under the License Agreement. At the Company's reasonable direction, the Administrator shall engage personnel to inspect the Licensee's books or records, and shall take other action on behalf of the Company as Administrator determines appropriate for it to take and which is authorized to be taken under the License Agreement. The Administrator shall otherwise generally assist the Company in performing the Company's obligations under the License Agreement, and in overseeing the Licensee's performance of its obligations under the License Agreement, as the Company shall reasonably direct. 3 f. Information. The Administrator shall keep the Company ----------- apprised of, and shall promptly notify the Company of, all matters that the Administrator is aware of that may have a material adverse effect on the validity or value of the Trademark or the License Agreement. g. Services. Unless the Company notifies the Administrator to -------- the contrary, the Administrator shall furnish or cause to be furnished to, the Company the administrative, monitoring and ministerial services specified in this Section 3(g); (i) accounting and financial management services, including advice in all required areas of accounting, internal and public financial statements and any required federal, state or local governmental reports; (ii) tax services, including regular and periodic advice and consultation with respect to tax matters related to the Company, and the preparation and filing of, and assistance with respect to, any required tax returns; (iii) insurance services, including the inclusion to the extent agreed upon by the Company, of the Company under the insurance policies of the Administrator including those relating to public liability, property damage, workers compensation and other matters and processing and administration of insurance claims; (iv) management information and other system services, including computer operations, data input systems and programming and technical support; (v) administration of legal formalities, including the matters specified in the LLC Agreement; (vi) other actions of the Company that are required or deemed necessary or appropriate under the Basic Documents, to the extent that the authority to perform such actions is not withheld pursuant to Section 4 hereof; and (vii) such other services as the Company and the Administrator may hereafter agree. h. Reports. Cherokee agrees to deliver promptly to the Company ------- copies of all reports which Cherokee files with the Securities and Exchange Commission pursuant to Sections 12 and 13 of the Securities Exchange Act of 1934, as amended. If Cherokee ceases to be a reporting company under such Act, it shall deliver to the Company, not less frequently than quarterly, reports and interim financial statements in scope reasonably satisfactory to the Company. 4. Authorities Withheld. The Company specifically withholds from the -------------------- Administrator the following specific authorities, unless superseded by written permission from the Company: 4 a. Execution of documents on behalf of the Company granting or perfecting any rights in the Trademark or the License Agreement; b. Any use of the Company's name by the Administrator or any representation by the Administrator that the Administrator is the Company or holds any ownership interest in (other than as licensee of the Company with respect to Cherokee Licenses) or with respect to the Trademark or the License Agreement; c. Other authorities or rights not expressly granted to the Administrator hereunder; and d. Other authorities or rights that expressly require the Company's approval hereunder. 5. Standard of Care. In performing its duties pursuant hereto, the ---------------- Administrator shall exercise that degree of skill and care consistent with the degree of skill and care that the Administrator exercises with respect to trademarks, trademark licenses and related rights held by the Administrator. 6. Expenses; Compensation. The Administrator shall be responsible ---------------------- to pay all expenses incurred by it in connection with the performance of the services provided by it hereunder. As compensation for the services provided by the Administrator hereunder, the Company shall pay the Administrator an Administration Fee, which is to be separately determined between the parties. Notwithstanding the foregoing, the Administration Fee shall accrue but not be payable (i) to the extent there are insufficient funds available to the Company pursuant to Section 3.03(v) or 3.04 of the Indenture, or (ii) during an Event of Default. 7. Indemnification by the Administrator. ------------------------------------ a. Indemnification. The Administrator agrees to indemnify and --------------- save the Company harmless from and against all loss, cost, liability and reasonable expense that arises from: (i) acts constituting theft, fraud, willful misconduct or gross negligence on the part of the Administrator or (ii) the Administrator's material breach of its obligations under this Agreement. Except for any of the aforementioned acts or failures to act by the Administrator or the Administrator's employees, agents and/or representatives, the Company shall indemnify, defend and hold harmless the Administrator from any loss, cost, liability and reasonable expense, relating to the Trademark or the License Agreement that arises from the Administrator's performance of the Administrator's obligations hereunder in accordance with the terms hereof, provided: (i) the Administrator notifies the Company and any insurance carrier (as required) promptly after the Administrator receives notice of any such loss, damage or injury; 5 (ii) the Administrator takes no action (such as admission of liability) that bars the Company from obtaining any protection afforded by any insurance policy the Company may hold or that might prejudice the Company in its defense to a claim based on such loss, damage or injury; and (iii) any indemnification of the Administrator by the Company hereunder shall be payable only from amounts available to the Company pursuant to Section 3.03(v) or 3.04 of the Indenture. The Administrator hereby agrees that it shall not acquiesce to, petition or otherwise invoke or cause the Company to invoke the process of any court or governmental authority for the purpose of commencing or sustaining a case against the Company under any federal or state bankruptcy, insolvency or similar law or appointing a receiver, liquidator, assignee, trustee, custodian, sequestrator or other similar official of the Company or any substantial part of the property of the Company, or ordering the winding up or liquidation of the affairs of the Company. b. Survival of Indemnification. The indemnifications set forth --------------------------- in this Section 7 shall survive the expiration or earlier termination of this Agreement with respect to acts, facts, circumstances or occurrences which exist or occur prior to such termination. 8. Term. This Agreement shall become effective as of the date ---- hereof, and shall continue in full force and effect until the earlier of (a) payment in full of the Notes and (b) the Company's termination of this Agreement and the appointment of Cherokee as Administrator hereunder for cause. For purposes of this Section 8, "cause" shall mean the occurrence of a material breach hereunder by the Administrator which is not cured within thirty (30) days of receipt by the Administrator of written notice of such breach from the Company, it being understood that a failure to perform the obligations set forth in Section 3 hereof shall constitute a material breach for purposes of this Section entitling the Company, in addition to its remedies under this Section, to recovery of expenses incurred in performing such obligations, to the extent that the Company has made a good faith determination that the incurrence of such expenses is necessary or appropriate. If so terminated, the Administrator shall be obligated to pay to the Company the amount, if any, by which the compensation to be paid to engage a reasonably qualified successor firm to provide the services hereunder for the remainder of the term of this Agreement exceeds the amount set forth in Section 6 hereof. Upon termination pursuant to this Section 8, the Administrator shall deliver to the successor firm books and records of the Company theretofore maintained by the Administrator, on behalf of the Company. 9. Notices. Any notice required under this Agreement shall be ------- written and shall be deemed to be delivered when deposited in the United States mail, postage prepaid, registered or certified mail, return receipt requested or, if delivered by hand, 6 when received by an officer or principal of the party receiving the same or, if transmitted by telecopy, when transmitted and receipt has been confirmed, in each case, addressed to the parties at the following addresses: If to the Company: SPELL C. LLC 625 Landor Lane Pasadena, California 91106 Attention: Carol Gratzke Telephone: 818-792-4880 If to the Administrator: Cherokee Inc. 6835 Valjean Avenue Van Nuys, California 91406 Fax: 818-908-9191 Attention: Robert Margolis Either party may change its address by giving notice to the other party of such change in writing in accordance herewith. 10. Entire Agreement. This Agreement represents the entire ---------------- agreement between the parties with respect to the subject matter hereof, and no alteration, modification or interpretation hereof shall be binding unless in writing and signed by both parties. 11. Interpretation. All headings are inserted in this Agreement -------------- only for convenience and ease of reference and are not to be considered in the construction or interpretation of this Agreement. Unless the context clearly requires otherwise: (a) words such as "include," "including," or "such as" shall be interpreted as if followed by the words "without limitation"; and (b) any reference to an Article, Section, or other subdivision, or Exhibit or Schedule, is intended to refer to an Article, Section, or other subdivision, or Exhibit or Schedule, of this Agreement. In the event of any inconsistency between the text of this Agreement and any Exhibit or Schedule attached hereto, the text shall govern. This Agreement shall be so construed that whenever applicable the use of the singular number shall include the plural number, and the use of the plural number shall include the singular number, and the use of the feminine, masculine, or neuter gender shall include the other genders. 12. Further Assurances. The Company and the Administrator agree to ------------------ execute such other documents and perform such other acts as may be necessary or desirable to carry out the purposes of this Agreement. 7 13. Third Parties. Neither this Agreement nor any provision hereof ------------- nor any service, relationship or other matter referred to herein shall inure to the benefit of any third party, to any trustee in bankruptcy, to any assignee for the benefit of creditors, to any receiver by reason of insolvency, to any another fiduciary or officer representing a bankrupt or insolvent estate of either party, or to the creditors or claimants of such an estate, except that the benefits of this Agreement may be assigned as collateral to the Trustee under the Indenture as security for the payment of the Notes. 14. No Interest or Lien. This Agreement does not constitute an ------------------- interest in or lien upon property of the Company. It shall not be recorded in the public records where any property of the Company is located and shall not constitute or establish any basis for claim, for filing of a lis pendens or notice of pendency or claim of lien. 15. Confidentiality. The Administrator shall not make any public --------------- announcement concerning the negotiation or consummation of this Agreement, or of any of the terms of this Agreement, without the Company's prior consent, which consent may be granted or denied in the Company's sole discretion. The Administrator shall keep confidential all information pertaining to the administration of the Trademark, the License Agreement and the Indenture and all financial information pertaining thereto and to the Company and the members of the and their affiliates. Except as (a) may be required by law or (b) may have been made publicly available by parties other than the Administrator or (c) may be required to perform its duties and services hereunder, the Administrator shall not disclose any such information which is designated by the Company as being confidential without the Company's prior consent, which consent may be granted or denied in the Company's sole discretion. 16. No Waiver. No consent or waiver, express or implied, by either --------- party to any breach or default by the other party in the performance of any of its obligations under this Agreement shall be deemed or construed to be a consent or waiver to or of any other breach or default in performance by such other party of such obligation or of any party of such obligation or of any other obligation under this Agreement. To be effective, any waiver must be in writing and be signed by the party intended to be bound thereby. 17. Exculpation. No member, officer or manager of the Company ----------- (direct or indirect) shall be personally liable for the performance of such party's obligations under this Agreement, it being understood that the liability of the Company for the Company's obligations under this Agreement shall be limited to its interest in the Trademark and the License Agreement and the proceeds thereof and the Administrator shall not look to any of the other assets of the Company or any assets of any of the aforesaid parties in seeking either to enforce the Company's obligations under this Agreement or to satisfy a judgment for the Company's failure to perform such No shareholder, officer or director of the Administrator (direct or indirect) shall be personally liable for the performance of such party's obligations under this Agreement, provided, however, nothing contained herein shall be deemed to exculpate the aforesaid parties 8 from liability arising out of theft, gross negligence or fraud on the part of the Administrator. 18. Additional Remedies. The rights and remedies of the parties ------------------- under this Agreement shall not be mutually exclusive. The exercise of one or more of the remedial provisions of this Agreement shall not preclude the exercise of any other remedial provisions hereof. 19. Company's Approval, Consent, Direction or Authorization. Any ------------------------------------------------------- reference to the Company's approval, consent, direction or authorization in this Agreement shall mean the written approval, consent, direction or authorization of the Company, which may (unless expressly provided otherwise herein) be granted or withheld in the Company's sole discretion. 20. Partial Invalidity. If any term, covenant, condition or ------------------ provision of this Agreement or the application thereof to any person or circumstance shall, to any extent be invalid, unenforceable or violate a party's legal rights, then such term, covenant, condition or provision shall be deemed to be null and void and unenforceable; however, all other provisions of this Agreement, or the application of such term or provision to persons or circumstances other than those to which are held invalid, unenforceable or violative of legal rights, shall not be affected thereby, and each and every other term, condition, covenant and provision of this Agreement shall be valid and be enforced to the fullest extent permitted by law. 21. Governing Law. This Agreement shall be governed by the internal ------------- laws of the State of California, without regard to conflicts of law principles. 9 IN WITNESS WHEREOF, the Company and the Administrator have executed this Administrative Services Agreement as of the date first set forth above. "Administrator" CHEROKEE INC.* By: /s/ Patricia Warren -------------------- Name: Patricia Warren Title: President "Company" SPELL C. LLC By: /S/ Robert Margolis -------------------- Name: Robert Margolis Title: President * Also known as Delaware Cherokee Inc. 10 EX-10.19 7 LIMITED LIABILITY COMPANY AGREEMENT LIMITED LIABILITY COMPANY AGREEMENT OF SPELL C. LLC This Limited Liability Company Agreement (together with the schedules attached hereto, this "Agreement") of SPELL C. LLC (the "Company"), is entered into by Cherokee Inc., a Delaware corporation, as the sole member (the "Member"). Capitalized terms used and not otherwise defined herein have the meanings set forth on Schedule A hereto. ---------- The Member, by execution of this Agreement, (i) hereby forms the Company as a limited liability company pursuant to and in accordance with the Delaware Limited Liability Company Act (6 Del.C. (S)18-101, et seq.), as amended ------ -- --- from time to time (the "Act"), and this Agreement and (ii) hereby agrees as follows: 1. Name. ---- The name of the limited liability company formed hereby is SPELL C. LLC. 2. Principal Business Office. ------------------------- The principal business office of the Company shall be located at 625 Landor Lane, Pasadena, California 91106, or such other location as may hereafter be determined by the Member. 3. Registered Office. ----------------- The address of the registered office of the Company in the State of Delaware is c/o RL&F Service Corp., One Rodney Square, 10th Floor, Tenth and King Streets, Wilmington, New Castle County, Delaware 19801. 4. Registered Agent. ---------------- The name and address of the registered agent of the Company for service of process on the Company in the State of Delaware is RL&F Service Corp., One Rodney Square, 10th Floor, Tenth and King Streets, Wilmington, New Castle County, Delaware 19801. 5. Member. ------ a. The mailing address of the Member is set forth on Schedule B ---------- attached hereto. b. Subject to Section 9j, the Member may act by written consent. 6. Certificates. ------------ James G. Leyden, Jr., is hereby designated as an "authorized person" within the meaning of the Act, and has executed, delivered and filed the Certificate of Formation of the Company with the Secretary of State of the State of Delaware. Upon the filing of the Certificate of Formation with the Secretary of State of the State of Delaware, his powers as an "authorized person" ceased, and the Member thereupon became the designated "authorized person" and shall continue as the designated "authorized person" within the meaning of the Act. The Member or an Officer shall execute, deliver and file any other certificates (and any amendments and/or restatements thereof) necessary for the Company to qualify to do business in California and in any other jurisdiction in which the Company may wish to conduct business. 7. Purposes. -------- Subject to Section 9j, the purposes of the Company are to engage in the following activities: a. (i) to acquire, own, hold, administer, service, grant or enter into agreements for the servicing of, finance, manage, sell, assign, pledge, collect amounts due on and otherwise deal with the Trademark, the Trademark License and other assets to be acquired pursuant to the Basic Documents and any proceeds or rights associated therewith and other licenses relating thereto and agreements pertaining thereto; (ii) to issue, sell, authorize and deliver the Notes and other evidences of the Indebtedness and to enter into any agreement or document providing for the authorization, issuance, sale and delivery of the Notes; (iii) to sell, exchange, pledge, encumber or otherwise dispose of all or any part of the Trademark, the Trademark License and the Company's other assets and property and, in connection therewith, to accept, collect, hold, sell, exchange or otherwise dispose of evidences of indebtedness or other property received pursuant thereto, including without limitation the granting of security interests to secure the Indebtedness; (iv) to execute, deliver and perform the Basic Documents; (v) to invest proceeds from the Trademark, the Trademark License and the Company's other assets and any capital and income of the Company in accordance with the Basic Documents or as otherwise determined by the Board and not inconsistent with this Section 7 or the Basic Documents; and 2 (vi) to do such other things and carry on any other activities which the Board determines to be necessary, convenient or incidental to any of the foregoing purposes, and have and exercise all of the power and rights conferred upon limited liability companies formed pursuant to the Act. b. The Company, by or through any Officer on behalf of the Company, may enter into and perform the Basic Documents, including without limitation the Note Issuance Documents (including without limitation the issuance of the Notes pursuant thereto) and the Administrative Services Agreement, and all documents, agreements, certificates, or financing statements contemplated thereby or related thereto, all without any further act, vote or approval of the Member or any Director or Officer notwithstanding any other provision of this Agreement, the Act or applicable law, rule or regulation. The foregoing authorization shall not be deemed a restriction on the powers of any Officer to enter into other agreements on behalf of the Company. 8. Powers. ------ Subject to Section 9j, the Company, and the Board of Directors and the proper Officers of the Company on behalf of the Company, (i) shall have and exercise all powers necessary, convenient or incidental to accomplish its purposes as set forth in Section 7 and (ii) shall have and exercise all of the powers and rights conferred upon limited liability companies formed pursuant to the Act. 9. Management. ---------- a. Board of Directors. Subject to Section 9j, the business and ------------------ affairs of the Company shall be managed by or under the direction of a Board of one or more Directors. Subject to Section 10, the Member may determine at any time in its sole and absolute discretion the number of Directors to constitute the Board. The authorized number of Directors may be increased or decreased by the Member at any time in its sole and absolute discretion, upon notice to all Directors, and subject in all cases to Section 10. The initial number of Directors shall be three, one of which shall be an Independent Director pursuant to Section 10. Each Director elected, designated or appointed shall hold office until a successor is elected and qualified or until such Director's earlier death, resignation or removal. Each Director shall execute and deliver the Management Agreement. Directors need not be a Member. b. Powers. Subject to Section 9j, the Board of Directors shall have ------ the power to do any and all acts necessary, convenient or incidental to or for the furtherance of the purposes described herein, including all powers, statutory or otherwise. Subject to Section 7, the Board of Directors has the authority to bind the Company. 3 c. Meeting of the Board of Directors. The Board of Directors of the --------------------------------- Company may hold meetings, both regular and special, within or outside the State of Delaware. Regular meetings of the Board may be held without notice at such time and at such place as shall from time to time be determined by the Board. Special meetings of the Board may be called by the President on not less than one day's notice to each Director by telephone, facsimile, mail, telegram or any other means of communication, and special meetings shall be called by the President or Secretary in like manner and with like notice upon the written request of any one or more of the Directors. d. Quorum; Acts of the Board. At all meetings of the Board, a ------------------------- majority of the Directors shall constitute a quorum for the transaction of business and, except as otherwise provided in any other provision of this Agreement, the act of a majority of the Directors present at any meeting at which there is a quorum shall be the act of the Board. If a quorum shall not be present at any meeting of the Board, the Directors present at such meeting may adjourn the meeting from time to time, without notice other than announcement at the meeting, until a quorum shall be present. Any action required or permitted to be taken at any meeting of the Board or of any committee thereof may be taken without a meeting if all members of the Board or committee, as the case may be, consent thereto in writing, and the writing or writings are filed with the minutes of proceedings of the Board or committee, as the case may be. e. Electronic Communications. Members of the Board, or any ------------------------- committee designated by the Board, may participate in meetings of the Board, or any committee, by means of telephone conference or similar communications equipment that allows all persons participating in the meeting to hear each other, and such participation in a meeting shall constitute presence in person at the meeting. If all the participants are participating by telephone conference or similar communications equipment, the meeting shall be deemed to be held at the principal place of business of the Company. f. Committees of Directors. ----------------------- (i) The Board may, by resolution passed by a majority of the whole Board, designate one or more committees, each committee to consist of one or more of the Directors of the Company. The Board may designate one or more Directors as alternate members of any committee, who may replace any absent or disqualified member at any meeting of the committee. (ii) In the absence or disqualification of a member of a committee, the member or members thereof present at any meeting and not disqualified from voting, whether or not such members constitute a quorum, may unanimously appoint another member of the Board to act at the meeting in the place of any such absent or disqualified member. 4 (iii) Any such committee, to the extent provided in the resolution of the Board, shall have and may exercise all the powers and authority of the Board in the management of the business and affairs of the Company. Such committee or committees shall have such name or names as may be determined from time to time by resolution adopted by the Board. Each committee shall keep regular minutes of its meetings and report the same to the Board when required. g. Compensation of Directors; Expenses. The Board shall have the ----------------------------------- authority to fix the compensation of Directors. The Directors may be paid their expenses, if any, of attendance at meetings of the Board, which may be a fixed sum for attendance at each meeting of the Board or a stated salary as Director. No such payment shall preclude any Director from serving the Company in any other capacity and receiving compensation therefor. Members of special or standing committees may be allowed like compensation for attending committee meetings. h. Removal of Directors. Unless otherwise restricted by law, any -------------------- Director or the entire Board of Directors may be removed, with or without cause, at any time by the Member, and, subject to Section 10, any vacancy caused by any such removal may be filled by action of the Member. i. Directors as Agents. To the extent of their powers set forth in ------------------- this Agreement and subject to Section 9j, the Directors are agents of the Company for the purpose of the Company's business, and the actions of the Directors taken in accordance with such powers set forth in this Agreement shall bind the Company. j. Limitations on the Company's Activities. --------------------------------------- (i) This Section 9j is being adopted in order to comply with certain provisions required in order to qualify the Company as a "special purpose entity" for the purpose of the Indebtedness. (ii) The Member shall not, so long as any Indebtedness is outstanding, amend, alter, change or repeal the definition of "Independent Director" or Sections 7, 8, 9, 10, 20, 21, 22, 23, 24, 26 or 31 or Schedule A of ---------- this Agreement without the unanimous written consent of the Board (including the Independent Director). Subject to this Section 9j, the Member reserves the right to amend, alter, change or repeal any provisions contained in this Agreement in accordance with Section 31. (iii) Notwithstanding any other provision of this Agreement and any provision of law that otherwise so empowers the Company, the Member or the Board, neither the Member nor the Board shall be authorized or empowered, nor shall they permit the Company, without the prior unanimous written consent of the Member and the Board (including the Independent Director), to take any Material Action. 5 (iv) The Board and the Member shall cause the Company to do or cause to be done all things necessary to preserve and keep in full force and effect its existence, rights (charter and statutory) and franchises; provided, -------- however, that the Company shall not be required to preserve any such right or - ------- franchise if the Board shall determine that the preservation thereof is no longer desirable for the conduct of its business and that the loss thereof is not disadvantageous in any material respect to the holders of the Indebtedness and the Company shall deliver to the Note Trustee an Officer's Certificate to that effect. The Board also shall cause the Company to: (1) maintain its own separate books and records and bank accounts; (2) at all times hold itself out to the public as a legal entity separate from the Member and any other Person; (3) have a Board composed differently from that of the Member and any other Person; (4) file its own tax returns, if any, as may be required under applicable law, to the extent (a) not part of a consolidated group filing a consolidated return or returns or (b) not treated as a division for tax purposes of another taxpayer, and pay any taxes so required to be paid under applicable law; (5) not commingle its assets with assets of any other Person; (6) conduct its business in its own name; (7) maintain separate financial statements; (8) pay its own liabilities only out of its own funds; (9) maintain an arm's length relationship with its Affiliates and the Member; (10) pay the salaries of its own employees, if any; (11) not hold out its credit as being available to satisfy the obligations of others; 6 (12) allocate fairly and reasonably any overhead for shared office space; (13) use separate stationery, invoices and checks; (14) not pledge its assets for the benefit of any other Person other than pursuant to the Note Issuance Documents; (15) correct any known misunderstanding regarding its separate identity; (16) maintain adequate capital in light of its contemplated business purposes; (17) cause its Board of Directors to meet at least annually or act pursuant to written consent and keep minutes of such meetings and actions and observe all other Delaware limited liability company formalities; and (18) not acquire any obligations or securities of the Member. (v) So long as any Indebtedness is outstanding, the Board shall not cause or permit the Company to: (1) guarantee any obligation of any Person, including any Affiliate; (2) engage, directly or indirectly, in any business other than that arising out of the issuance of the Indebtedness or the actions required or permitted to be performed under Section 7, the Note Issuance Documents or this Section 9j; (3) incur, create or assume any indebtedness other than the Indebtedness or as otherwise expressly permitted under the Note Issuance Documents; (4) make or permit to remain outstanding any loan or advance to, or own or acquire any stock or securities of, any Person, except that the Company may invest in those investments 7 permitted under the Note Issuance Documents and may make any advance required or expressly permitted to be made pursuant to any provisions of the Note Issuance Documents and permit the same to remain outstanding in accordance with such provisions; (5) to the fullest extent permitted by law, engage in any dissolution, liquidation, consolidation, merger, asset sale or transfer of ownership interests other than such activities as are expressly permitted pursuant to any provision of the Note Issuance Documents; or (6) form, acquire or hold any subsidiary (whether corporate, partnership, limited liability company or other). 10. Independent Director. -------------------- As long as any Indebtedness is outstanding, the Member shall cause the Company at all times to have at least one Independent Director who will be appointed by the Member. To the fullest extent permitted by Section 18-1101(c) of the Act, the Independent Director shall consider only the interests of the Company, including its respective creditors, in acting or otherwise voting on the matters referred to in Section 9j(iii). No resignation or removal of an Independent Director, and no appointment of a successor Independent Director, shall be effective until the successor Independent Director shall have accepted his or her appointment by a written instrument, which may be a counterpart signature page to the Management Agreement. All right, power and authority of the Independent Directors shall be limited to the extent necessary to exercise those rights and perform those duties specifically set forth in this Agreement. Except as provided in the second sentence of this Section 10, in exercising their rights and performing their duties under this Agreement, any Independent Director shall have a fiduciary duty of loyalty and care similar to that of a director of a business corporation organized under the General Corporation Law of the State of Delaware. 11. Officers. -------- a. Officers. The Officers of the Company shall be chosen by the -------- Board and shall consist of at least a President, a Secretary and a Treasurer. The Board of Directors may also choose one or more Vice Presidents, Assistant Secretaries and Assistant Treasurers. Any number of offices may be held by the same person. The Board shall choose a President, a Secretary and a Treasurer. The Board may appoint such other Officers and agents as it shall deem necessary or advisable who shall hold their offices for such terms and shall exercise such powers 8 and perform such duties as shall be determined from time to time by the Board. The salaries of all Officers and agents of the Company shall be fixed by or in the manner prescribed by the Board. The Officers of the Company shall hold office until their successors are chosen and qualified. Any Officer elected or appointed by the Board may be removed at any time, with or without cause, by the affirmative vote of a majority of the Board. Any vacancy occurring in any office of the Company shall be filled by the Board. b. President. The President shall be the chief executive officer of --------- the Company, shall preside at all meetings of the Member, if any, and the Board, shall be responsible for the general and active management of the business of the Company and shall see that all orders and resolutions of the Board are carried into effect. The President shall execute all bonds, mortgages and other contracts, except: (i) where required or permitted by law or this Agreement to be otherwise signed and executed, including Section 7b; (ii) where signing and execution thereof shall be expressly delegated by the Board to some other Officer or agent of the Company; and (iii) as otherwise permitted in Section 11c. c. Vice President. In the absence of the President or in the event -------------- of the President's inability to act, the Vice President, if any (or in the event there be more than one Vice President, the Vice Presidents in the order designated by the Directors, or in the absence of any designation, then in the order of their election), shall perform the duties of the President, and when so acting, shall have all the powers of and be subject to all the restrictions upon the President. The Vice Presidents, if any, shall perform such other duties and have such other powers as the Board may from time to time prescribe. d. Secretary and Assistant Secretary. The Secretary shall be --------------------------------- responsible for filing legal documents and maintaining records for the Company. The Secretary shall attend all meetings of the Board and all meetings of the Member, if any, and record all the proceedings of the meetings of the Company and of the Board in a book to be kept for that purpose and shall perform like duties for the standing committees when required. The Secretary shall give, or shall cause to be given, notice of all meetings of the Member, if any, and special meetings of the Board, and shall perform such other duties as may be prescribed by the Board or the President, under whose supervision the Secretary shall serve. The Assistant Secretary, or if there be more than one, the Assistant Secretaries in the order determined by the Board (or if there be no such determination, then in order of their election), shall, in the absence of the Secretary or in the event of the Secretary's inability to act, perform the duties and exercise the powers of the Secretary and shall perform such other duties and have such other powers as the Board may from time to time prescribe. e. Treasurer and Assistant Treasurer. The Treasurer shall have the --------------------------------- custody of the Company funds and securities and shall keep full and accurate 9 accounts of receipts and disbursements in books belonging to the Company and shall deposit all moneys and other valuable effects in the name and to the credit of the Company in such depositories as may be designated by the Board. The Treasurer shall disburse the funds of the Company as may be ordered by the Board, taking proper vouchers for such disbursements, and shall render to the President and to the Board, at its regular meetings or when the Board so requires, an account of all of the Treasurer's transactions and of the financial condition of the Company. The Assistant Treasurer, or if there shall be more than one, the Assistant Treasurers in the order determined by the Board (or if there be no such determination, then in the order of their election), shall, in the absence of the Treasurer or in the event of the Treasurer's inability to act, perform the duties and exercise the powers of the Treasurer and shall perform such other duties and have such other powers as the Board may from time to time prescribe. f. Officers as Agents. The Officers, to the extent of their powers ------------------ set forth in this Agreement or otherwise vested in them by action of the Board not inconsistent with this Agreement, are agents of the Company for the purpose of the Company's business and, subject to Section 9j, the actions of the Officers taken in accordance with such powers shall bind the Company. g. Duties of Board and Officers. Except to the extent otherwise ---------------------------- provided herein, each Director and Officer shall have a fiduciary duty of loyalty and care similar to that of directors and officers of business corporations organized under the General Corporation Law of the State of Delaware. 12. Limited Liability. ----------------- Except as otherwise expressly provided by the Act, the debts, obligations and liabilities of the Company, whether arising in contract, tort or otherwise, shall be the debts, obligations and liabilities solely of the Company, and neither the Member nor any Director shall be obligated personally for any such debt, obligation or liability of the Company solely by reason of being a Member or Director of the Company. 13. Capital Contributions. --------------------- The Member has contributed to the Company property of an agreed value as listed on Schedule B attached hereto. ---------- 14. Additional Contributions. ------------------------ The Member is not required to make any additional capital contribution to the Company. However, the Member may make additional capital contributions to the Company at any time upon the written consent of such Member. To the extent that the Member makes an additional capital contribution to the Company, the Member shall revise Schedule B of this Agreement. The provisions of this ---------- Agreement, including this Section 14, are intended solely to benefit the Member and, to the fullest extent permitted by law, 10 shall not be construed as conferring any benefit upon any creditor of the Company (and no such creditor of the Company shall be a third-party beneficiary of this Agreement) and the Member shall not have any duty or obligation to any creditor of the Company to make any contribution to the Company or to issue any call for capital pursuant to this Agreement. 15. Allocation of Profits and Losses. -------------------------------- The Company's profits and losses shall be allocated to the Member. 16. Distributions. ------------- Distributions shall be made to the Member at the times and in the aggregate amounts determined by the Board. Notwithstanding any provision to the contrary contained in this Agreement, the Company shall not be required to make a distribution to the Member on account of its interest in the Company if such distribution would violate Section 18-607 of the Act or any other applicable law or the Basic Documents. 17. Books and Records. ----------------- The Board shall keep or cause to be kept complete and accurate books of account and records with respect to the Company's business. The books of the Company shall at all times be maintained by the Board. The Member and its duly authorized representatives shall have the right to examine the Company books, records and documents during normal business hours. The Company, and the Board on behalf of the Company, shall not have the right to keep confidential from the Member any information that the Board would otherwise be permitted to keep confidential from the Member pursuant to Section 18-305(c) of the Act. The Company's books of account shall be kept using the method of accounting determined by the Member. The Company's independent auditor shall be an independent public accounting firm selected by the Member. 18. Reports. ------- a. Within 60 days after the end of each fiscal quarter, the Board shall cause to be prepared an unaudited report setting forth as of the end of such fiscal quarter: (i) unless such quarter is the last fiscal quarter, a balance sheet of the Company; and (ii) unless such quarter is the last fiscal quarter, an income statement of the Company for such fiscal quarter. b. The Board shall use diligent efforts to cause to be prepared and mailed to the Member, within 120 days after the end of each fiscal year, an audited or unaudited report setting forth as of the end of such fiscal year: (i) a balance sheet of the Company; 11 (ii) an income statement of the Company for such fiscal year; and (iii) a statement of the Member's capital account. c. The Board shall, after the end of each fiscal year, use reasonable efforts to cause the Company's independent accountants to prepare and transmit to the Member as promptly as such tax information as may be reasonably necessary to enable the Member to prepare its federal, state and local income tax returns relating to such fiscal year. 19. Other Business. -------------- The Member and any Affiliate of the Member may engage in or possess an interest in other business ventures (unconnected with the Company) of every kind and description, independently or with others. The Company shall not have any rights in or to such independent ventures or the income or profits therefrom by virtue of this Agreement. 20. Exculpation and Indemnification. ------------------------------- a. Neither the Member nor any Officer, Director, employee or agent of the Company and no employee, representative, agent or Affiliate of the Member (collectively, the "Covered Persons") shall be liable to the Company or any other Person who has an interest in or claim against the Company for any loss, damage or claim incurred by reason of any act or omission performed or omitted by such Covered Person in good faith on behalf of the Company and in a manner reasonably believed to be within the scope of the authority conferred on such Covered Person by this Agreement, except that a Covered Person shall be liable for any such loss, damage or claim incurred by reason of such Covered Person's gross negligence or willful misconduct. b. To the fullest extent permitted by applicable law, a Covered Person shall be entitled to indemnification from the Company for any loss, damage or claim incurred by such Covered Person by reason of any act or omission performed or omitted by such Covered Person in good faith on behalf of the Company and in a manner reasonably believed to be within the scope of the authority conferred on such Covered Person by this Agreement, except that no Covered Person shall be entitled to be indemnified in respect of any loss, damage or claim incurred by such Covered Person by reason of such Covered Person's gross negligence or willful misconduct with respect to such acts or omissions; provided, however, that any indemnity under this Section 20 shall be -------- ------- provided out of and to the extent of Company assets only, and the Member shall not have personal liability on account thereof; and provided further, that so -------- ------- long as any Indebtedness is outstanding, no indemnity payment from funds of the Company (as distinct from funds from other sources, such as insurance) of any indemnity under this Section 20 12 shall be payable except out of funds available for payment of Company expenses as provided in the Indenture. c. To the fullest extent permitted by applicable law, expenses (including legal fees) incurred by a Covered Person defending any claim, demand, action, suit or proceeding shall, from time to time, be advanced by the Company prior to the final disposition of such claim, demand, action, suit or proceeding upon receipt by the Company of an undertaking by or on behalf of the Covered Person to repay such amount if it shall be determined that the Covered Person is not entitled to be indemnified as authorized in this Section 20. d. A Covered Person shall be fully protected in relying in good faith upon the records of the Company and upon such information, opinions, reports or statements presented to the Company by any Person as to matters the Covered Person reasonably believes are within such other Person's professional or expert competence and who has been selected with reasonable care by or on behalf of the Company, including information, opinions, reports or statements as to the value and amount of the assets, liabilities, or any other facts pertinent to the existence and amount of assets from which distributions to the Member might properly be paid. e. To the extent that, at law or in equity, a Covered Person has duties (including fiduciary duties) and liabilities relating thereto to the Company or to any other Covered Person, a Covered Person acting under this Agreement shall not be liable to the Company or to any other Covered Person for its good faith reliance on the provisions of this Agreement or any approval or authorization granted by the Company or any other Covered Person. The provisions of this Agreement, to the extent that they restrict the duties and liabilities of a Covered Person otherwise existing at law or in equity, are agreed by the Member to replace such other duties and liabilities of such Covered Person. f. The foregoing provisions of this Section 20 shall survive any termination of this Agreement. 21. Assignments. ----------- Subject to Section 23, the Member may assign in whole or in part its limited liability company interest in the Company. If the Member transfers all of its limited liability company interest in the Company pursuant to this Section 21, the transferee shall be admitted to the Company as a member of the Company upon its execution of an instrument signifying its agreement to be bound by the terms and conditions of this Agreement, which instrument may be a counterpart signature page to this Agreement. Such admission shall be deemed effective immediately prior to the transfer and, immediately following such admission, the transferor Member shall cease to be a member of the Company. Notwithstanding anything in this Agreement to the contrary, any successor to the Member by merger or consolidation in compliance with the Basic 13 Documents shall, without further act, be the Member hereunder, and such merger or consolidation shall not constitute an assignment for purposes of this Agreement. 22. Resignation. ----------- So long as any Indebtedness is outstanding, the Member may not resign without the prior written consent of the Majority Holders (as defined in the Indenture). If the Member is permitted to resign pursuant to this Section 22, an additional member of the Company shall be admitted to the Company, subject to Section 23, upon its execution of an instrument signifying its agreement to be bound by the terms and conditions of this Agreement, which instrument may be a counterpart signature page to this Agreement. Such admission shall be deemed effective immediately prior to the resignation and, immediately following such admission, the resigning Member shall cease to be a member of the Company. 23. Admission of Additional Members. ------------------------------- One or more additional members of the Company may be admitted to the Company with the written consent of the Member; provided that, notwithstanding -------- the foregoing, so long as any Indebtedness remains outstanding, no additional Member may be admitted to the Company unless the Member retains a majority interest in the Company. 24. Dissolution. ----------- a. Subject to Section 9j, the Company shall be dissolved, and its affairs shall be wound up upon the first to occur of the following: (i) the retirement, resignation or dissolution of the Member or the occurrence of any other event which terminates the continued membership of the Member in the Company unless the business of the Company is continued in a manner permitted by the Act or (ii) the entry of a decree of judicial dissolution under Section 18- 802 of the Act. b. The bankruptcy (as defined in Sections 18-101(1) and 18-304 of the Act) of the Member shall not cause the Member to cease to be a member of the Company and upon the occurrence of such an event, the business of the Company shall continue without dissolution. c. In the event of dissolution, the Company shall conduct only such activities as are necessary to wind up its affairs (including the sale of the assets of the Company in an orderly manner), and the assets of the Company shall be applied in the manner, and in the order of priority, set forth in Section 18- 804 of the Act. d. The Company shall terminate when (i) all of the assets of the Company, after payment of or due provision for all debts, liabilities and obligations of the Company shall have been distributed to the Member in the manner provided for in this 14 Agreement and (ii) the Certificate of Formation shall have been canceled in the manner required by the Act. 25. Waiver of Partition; Nature of Interest. --------------------------------------- Except as otherwise expressly provided in this Agreement, to the fullest extent permitted by law, the Member hereby irrevocably waives any right or power that the Member might have to cause the Company or any of its assets to be partitioned, to cause the appointment of a receiver for all or any portion of the assets of the Company, to compel any sale of all or any portion of the assets of the Company pursuant to any applicable law or to file a complaint or to institute any proceeding at law or in equity to cause the dissolution, liquidation, winding up or termination of the Company. The Member shall not have any interest in any specific assets of the Company, and the Member shall not have the status of a creditor with respect to any distribution pursuant to Section 16 hereof. The interest of the Member in the Company is personal property. 26. Benefits of Agreement; No Third-Party Rights. -------------------------------------------- None of the provisions of this Agreement shall be for the benefit of or enforceable by any creditor of the Company or by any creditor of the Member. Nothing in this Agreement shall be deemed to create any right in any Person (other than Covered Persons) not a party hereto, and this Agreement shall not be construed in any respect to be a contract in whole or in part for the benefit of any third Person. 27. Severability of Provisions. -------------------------- Each provision of this Agreement shall be considered severable and if for any reason any provision or provisions herein are determined to be invalid, unenforceable or illegal under any existing or future law, such invalidity, unenforceability or illegality shall not impair the operation of or affect those portions of this Agreement which are valid, enforceable and legal. 28. Entire Agreement. ---------------- This Agreement constitutes the entire agreement of the parties with respect to the subject matter hereof. 29. Binding Agreement. ----------------- Notwithstanding any other provision of this Agreement, the Member agrees that this Agreement, including, without limitation, Sections 7, 8, 9, 10, 20, 21, 22, 23, 24, 26 and 31, constitutes a legal, valid and binding agreement of the Member, and is enforceable against the Member by the Independent Director, in accordance with its terms. 30. Governing Law. ------------- 15 This Agreement shall be governed by and construed under the laws of the State of Delaware (without regard to conflict of laws principles), all rights and remedies being governed by said laws. 31. Amendments. ---------- Subject to Section 9j, this Agreement may not be modified, altered, supplemented or amended except pursuant to a written agreement executed and delivered by the Member 32. Counterparts. ------------ This Agreement may be executed in any number of counterparts, each of which shall be deemed an original of this Agreement and all of which together shall constitute one and the same instrument. 33. Notices. ------- Any notices required to be delivered hereunder shall be in writing and personally delivered, mailed or sent by telecopy or other similar form of rapid transmission, and shall be deemed to have been duly given upon receipt (a) in the case of the Company, to the Company at its address in Section 2, (b) in the case of the Member, to the Member at its address as listed on Schedule B ---------- attached hereto and (c) in the case of either of the foregoing, at such other address as may be designated by written notice to the other party. 34. Effectiveness. ------------- Pursuant to Section 18-201(d) of the Act, this Agreement shall be effective as of the time of the filing of the Certificate of Formation with the Office of the Delaware Secretary of State on December 3, 1997. 16 IN WITNESS WHEREOF, the undersigned, intending to be legally bound hereby, has duly executed this Limited Liability Company Agreement as of the 3rd day of December, 1997. MEMBER: CHEROKEE INC.* By: /s/ Robert Margolis ------------------- Name: Robert Margolis Title: President *Also known as Delaware Cherokee Inc. 1 SCHEDULE A Definitions ----------- A. Definitions ----------- When used in this Agreement, the following terms not otherwise defined herein have the following meanings: "Act" has the meaning set forth in the preamble to this Agreement. --- "Administrative Services Agreement" means the Administrative Services --------------------------------- Agreement to be entered into between the Company and the Member, as administrator, as the same may be amended, restated, supplemented or otherwise modified from time to time. "Affiliate" means, with respect to any Person, any other Person --------- directly or indirectly Controlling or Controlled by or under direct or indirect common Control with such Person. "Agreement" means this Limited Liability Company Agreement, together --------- with the schedules attached hereto, as amended, restated or supplemented or otherwise modified from time to time. "Basic Documents" means the Indenture, the Trademark Agreement, the --------------- Administrative Services Agreement, the Note Purchase Agreement, the Security Agreement and all other documents and certificates delivered in connection therewith. "Board" or "Board of Directors" means the Board of Directors of the ----- ------------------ Company. "Certificate of Formation" means the Certificate of Formation of the ------------------------ Company filed with the Secretary of State of the State of Delaware on December 3, 1997, as amended or amended and restated from time to time. "Collection Account" means the special purpose trust account to be ------------------ established in the name of the Note Trustee pursuant to the Indenture and into which will be deposited the payments due to the Company under any Trademark License. "Company" means SPELL C. LLC, a Delaware limited liability company. ------- "Control" means the possession, directly or indirectly, or the power ------- to direct or cause the direction of the management or policies of a Person, whether through the ownership of voting securities or general partnership or managing member interests, by contract or otherwise. "Controlling" and "Controlled" shall have correlative meanings. Without limiting the generality of the foregoing, a Person shall be deemed to Control any other Person in which it owns, directly or indirectly, a majority of the ownership interests. A-1 "Covered Persons" has the meaning set forth in Section 20a. --------------- "Directors" means the directors elected to the Board of Directors from --------- time to time by the Member, including the Independent Director. A Director is hereby designated as a "manager" of the Company within the meaning of Section 18-101(10) of the Act. "Indebtedness" means the obligations of the Company arising under the ------------ Notes. "Indenture" means the Indenture to be entered into between the --------- Company, as issuer, and the Note Trustee, as trustee, restated, as the same may be amended, supplemented or otherwise modified from time to time. "Independent Director" means a natural person who, for the five-year -------------------- period prior to his or her appointment as Independent Director has not been, and during the continuation of his or her service as Independent Director is not: (i) an employee, director, stockholder, partner or officer of the Company or any of its Affiliates (other than his or her service as an Independent Director of the Company); (ii) a customer or supplier that derives more than ten percent of its revenues from the Company or any of its Affiliates; or (iii) any member of the immediate family of a person described in (i) or (ii). "Member" means Cherokee Inc., a Delaware corporation, as the sole ------ member of the Company. "Management Agreement" means the agreement of the Directors in the -------------------- form attached hereto as Schedule C. ---------- "Material Action" means to consolidate or merge the Company with or --------------- into any Person, or sell all or substantially all of the assets of the Company, or to institute proceedings to have the Company be adjudicated bankrupt or insolvent, or consent to the institution of bankruptcy or insolvency proceedings against the Company or file a petition seeking, or consent to, reorganization or relief with respect to the Company under any applicable federal or state law relating to bankruptcy, or consent to the appointment of a receiver, liquidator, assignee, trustee, sequestrator (or other similar official) of the Company or a substantial part of its property, or make any assignment for the benefit of creditors of the Company, or admit in writing the Company's inability to pay its debts generally as they become due, or, to the fullest extent permitted by law, take action in furtherance of any such action, or dissolve or liquidate the Company. "Member" means the Member and includes any Person admitted as an ------ additional member of the Company or a substitute member of the Company pursuant to the provisions of this Agreement. "Note Issuance Documents" means the collective reference to the ----------------------- Indenture, the Security Agreement and the other governing documents relating to the Indebtedness, as A-2 the same may be amended, restated, supplemented or otherwise modified from time to time. "Note Purchase Agreement" means the Note Purchase Agreement to be ----------------------- entered into between the Company and the parties listed on the signature pages thereto, as the same may be amended, restated, supplemented or otherwise modified from time to time. "Notes" means the notes at any time issued pursuant to the Indenture ----- or any indenture supplemental thereto. "Note Trustee" means the institution serving as trustee under the ------------ Indenture. "Officer" means an officer of the Company described in Section 11. ------- "Officer's Certificate" means a certificate signed by any Officer of --------------------- the Company who is authorized to act for the Company in matters relating to the Company. "Person" means any individual, corporation, partnership, joint ------ venture, limited liability company, limited liability partnership, association, joint-stock company, trust, unincorporated organization, or other organization, whether or not a legal entity, and any governmental authority. "Security Agreement" means the Security Agreement to be entered into ------------------ by the Company and the Note Trustee, as the same may be amended, restated, supplemented or otherwise modified from time to time. "Trademark" means all United States right, title and interest of --------- Cherokee in and to the "Cherokee" trademark and other marks incorporating the name Cherokee, with various stylized designs, including the "Indian Head Design," as used and registered in the United States Patent and Trademark Office. "Trademark Agreement" means the Trademark Purchase and License ------------------- Assignment Agreement to be entered into between the Company and the Member. "Trademark Documents" means the collective reference to the Trademark ------------------- Agreement and the agreements, instruments and documents contemplated thereby, as the same may be amended, restated, supplemented or otherwise modified from time to time. "Trademark License" means all rights and obligations of Cherokee as ----------------- licensor under that certain License Agreement dated as of November 12, 1997, by and between Cherokee and Dayton Hudson Corporation, together with all rights and privileges granted, secured and provided thereby. B. Rules of Construction --------------------- Definitions in this Agreement apply equally to both the singular and plural forms of the defined terms. The words "include" and "including" shall be deemed to be A-3 followed by the phrase "without limitation." The terms "herein," "hereof" and "hereunder" and other words of similar import refer to this Agreement as a whole and not to any particular Section, paragraph or subdivision. The Section titles appear as a matter of convenience only and shall not affect the interpretation of this Agreement. All Section, paragraph, clause, Exhibit or Schedule references not attributed to a particular document shall be references to such parts of this Agreement. A-4 SCHEDULE B Member ------
Agreed Value of Membership Name Mailing Address Capital Contribution Interest - ---- --------------- -------------------- -------- Cherokee Inc. 6835 Valjean Avenue $100,000 100% Van Nuys, CA 91406
B-1 SCHEDULE C Management Agreement -------------------- December 18, 1997 SPELL C. LLC 625 Landor Lane Pasadena, California 91106 Re: Management Agreement -- SPELL C. LLC ------------------------------------ Ladies and Gentlemen: For good and valuable consideration, each of the undersigned persons, who have been designated as managers of SPELL C. LLC, a Delaware limited liability company (the "Company"), in accordance with the Limited Liability Company Agreement of the Company, dated as of December 3, 1997, as it may be amended or restated from time to time (the "LLC Agreement"), hereby agree as follows: 1. Each of the undersigned accepts such person's rights and authority as a Director (as defined in the LLC Agreement) under the LLC Agreement and agrees to perform and discharge such person's duties and obligations as a Director under the LLC Agreement, and further agrees that such rights, authorities, duties and obligations under the LLC Agreement shall continue until such person's successor as a Director is designated or until such person's resignation or removal as a Director in accordance with the LLC Agreement. Each of the undersigned agrees and acknowledges that it has been designated as a "manager" of the Company within the meaning of the Delaware Limited Liability Company Act. 2. So long as any Indebtedness (as defined in the LLC Agreement) is outstanding, each of the undersigned agrees, solely in its capacity as a creditor of the Company on account of any indemnification or other payment owing to the undersigned by the Company, not to acquiesce, petition or otherwise invoke or cause the Company to invoke the process of any court or governmental authority for the purpose of commencing or sustaining a case against the Company under any federal or state bankruptcy, insolvency or similar law or appointing a receiver, liquidator, assignee, trustee, custodian, sequestrator or other similar official of the Company or any substantial part of the property of the Company, or ordering the winding up or liquidation of the affairs of the Company. C-1 3. THIS MANAGEMENT AGREEMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF DELAWARE, AND ALL RIGHTS AND REMEDIES SHALL BE GOVERNED BY SUCH LAWS WITHOUT REGARD TO PRINCIPLES OF CONFLICTS OF LAWS. This Management Agreement may be executed in any number of counterparts, each of which shall be deemed an original of this Management Agreement and all of which together shall constitute one and the same instrument. C-2 IN WITNESS WHEREOF, the undersigned have executed this Management Agreement as of the day and year first above written. /s/ Robert Margolis ------------------- Robert Margolis /s/ Jess Ravich --------------- Jess Ravich /s/ Richard Nevins ------------------ Richard Nevins C-3 EX-21.1 8 SUBSIDIARIES OF CHEROKEE INC. EXHIBIT 21.1 LIST OF SUBSIDIARIES OF CHEROKEE INC.
NAME JURISDICTION OF ORGANIZATION ---- ---------------------------- 1. SPELL C. LLC., a Delaware limited liability company.......................................... Delaware
EX-23.1 9 CONSENT OF INDEPENDENT AUDITORS EXHIBIT 23.1 CONSENT OF INDEPENDENT ACCOUNTANTS We consent to the incorporation by reference in the registration statements of Cherokee Inc. on Form S-3 (File No. 333-15545), on Form S-8 (File No. 333- 14533) and on Form S-8 (File No. 333-49865) on our report dated April 6, 1998, on our audits of the consolidated financial statements and the financial statement schedules of Cherokee Inc. as of January 31, 1998, May 31, 1997 and June 1, 1996, and for the eight months ended January 31, 1998 and the years ended May 31, 1997, June 1, 1996, the three months ended June 3, 1995 and the nine months ended February 25, 1997, which reports are included (or incorporated by reference) in this Transition Report on Form 10-K. Los Angeles, CA Coopers & Lybrand L.L.P. April 20, 1998 EX-27.1 10 ARTICLE 5 FINANCIAL DATA SCHEDULE
5 YEAR JUN-01-1996 JUN-04-1995 JUN-01-1996 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 (0.22) (0.21)
EX-27.2 11 ARTICLE 5 FINANCIAL DATA SCHEDULE
5 1,000 8-MOS YEAR JAN-31-1998 MAY-31-1997 JUN-01-1997 JUN-02-1996 JAN-31-1998 MAY-31-1997 10,275 0 0 0 2,347 0 0 0 45 0 12,887 0 112 0 63 0 24,471 0 7,692 0 0 0 0 0 0 0 173 0 (25,819) 0 24,471 0 8,553 0 8,553 0 0 0 4,235 0 0 0 0 0 330 0 4,935 0 (782) 0 5,717 0 0 0 0 0 0 0 5,717 0 0.73 0.87 0.68 0.82
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