10-Q

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

xQuarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended July 28, 2012.

oTransition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Transition Period From              to             .

Commission file number 0-18640

CHEROKEE INC.

(Exact name of registrant as specified in its charter)

Delaware	95-4182437
(State or other jurisdiction of Incorporation or organization)	(IRS employer identification number)
5990 Sepulveda Boulevard, Sherman Oaks, CA	91411
(Address of principal executive offices)	Zip Code

Registrant’s telephone number, including area code  (818) 908-9868

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.  Yes x  No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o	Accelerated filer x
Non-accelerated filer o	Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class	Outstanding at September 5, 2012
Common Stock, $.02 par value per share	8,394,667

CHEROKEE INC.

INDEX

PART I. FINANCIAL INFORMATION
ITEM 1. Consolidated Financial Statements (unaudited):
Consolidated Balance Sheets July 28, 2012 and January 28, 2012	2
Consolidated Statements of Operations Three and Six Month periods ended July 28, 2012 and July 30, 2011	3
Condensed Consolidated Statement of Stockholders’ Equity Six Month period ended July 28, 2012	4
Consolidated Statements of Cash Flows Six Month periods ended July 28, 2012 and July 30, 2011	5
Notes to Consolidated Financial Statements	6
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
ITEM 3. Quantitative and Qualitative Disclosure about Market Risk	22
ITEM 4. Controls and Procedures	22
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings	23
ITEM 1A. Risk Factors	23
ITEM 6. Exhibits	28
Signatures	29
Certifications

1

Part 1. Financial Information

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

CHEROKEE INC.

CONSOLIDATED BALANCE SHEETS

Unaudited

	July 28, 2012			January 28, 2012
Assets
Current assets:
Cash and cash equivalents	$	2,089,000		$	7,421,000
Receivables	5,963,000			5,320,000
Income taxes receivable	475,000			672,000
Prepaid expenses and other current assets	217,000			152,000
Deferred tax asset	101,000			100,000
Total current assets	8,845,000			13,665,000
Deferred tax asset	1,223,000			1,230,000
Property and equipment, net	937,000			733,000
Trademarks, net	5,075,000			5,596,000
Other assets	204,000			—
Total assets	$	16,284,000		$	21,224,000
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	1,571,000		$	850,000
Deferred Revenue – Current	100,000			320,000
Accrued compensation payable	124,000			268,000
Income taxes payable	1,119,000			—
Accrued dividends	1,679,000			1,677,000
Deferred tax liability – current	38,000			38,000
Short term debt	—			500,000
Total current liabilities	4,631,000			3,653,000
Long term liabilities:
Deferred Revenue – Non-Current	125,000			382,000
Long term debt	—			6,438,000
Total liabilities	4,756,000			10,473,000
Commitments and Contingencies
Stockholders’ Equity
Preferred stock, $.02 par value, 1,000,000 shares authorized, none issued and outstanding	—			—
Common stock, $.02 par value, 20,000,000 shares authorized, 8,394,667 issued and outstanding at July 28, 2012 and 8,387,167 issued and outstanding at January 28, 2012	167,000			167,000
Additional paid-in capital	19,726,000			19,271,000
Retained earnings (deficit)	(8,365,000		)	(8,687,000		)
Total stockholders’ equity	11,528,000			10,751,000
Total liabilities and stockholders’ equity	$	16,284,000		$	21,224,000

See the accompanying notes which are an integral part of these consolidated financial statements.

2

CHEROKEE INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

Unaudited

	Three months ended						Six months ended
	July 28, 2012			July 30, 2011			July 28, 2012			July 30, 2011
Royalty revenues	$	6,306,000		$	6,658,000		$	13,821,000		$	13,602,000
Selling, general and administrative expenses	3,644,000			3,954,000			7,799,000			7,258,000
Operating income	2,662,000			2,704,000			6,022,000			6,344,000
Other income:
Interest expense	(23,000		)	(68,000		)	(73,000		)	(134,000		)
Investment and interest income	—			2,000			12,000			22,000
Total other income	(23,000		)	(66,000		)	(61,000		)	(112,000		)
Income before income taxes	2,639,000			2,638,000			5,961,000			6,232,000
Income tax provision	1,031,000			966,000			2,282,000			1,309,000
Net income	$	1,608,000		$	1,672,000		$	3,679,000		$	4,923,000
Basic earnings per share	$	0.19		$	0.20		$	0.44		$	0.58
Diluted earnings per share	$	0.19		$	0.20		$	0.44		$	0.58
Weighted average shares outstanding
Basic	8,390,417			8,504,247			8,388,791			8,501,867
Diluted	8,405,788			8,534,518			8,396,338			8,528,301

See the accompanying notes which are an integral part of these consolidated financial statements.

3

CHEROKEE INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

Unaudited

	Common Stock			Additional Paid-in		Retained
	Shares	Par Value		Capital		Earnings (Deficit)			Total
Balance at January 28, 2012	8,387,167	$	167,000	$	19,271,000	$	(8,687,000	)	$	10,751,000
Stock-based compensation				455,000					455,000
Stock options exercised
Stock issuance	7,500
Accrued and unpaid dividends						(3,357,000		)	(3,357,000		)
Net income						3,679,000			3,679,000
Balance at July 28, 2012	8,394,667	$	167,000	$	19,726,000	$	(8,365,000	)	$	11,528,000

See the accompanying notes which are an integral part of these consolidated financial statements.

4

CHEROKEE INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

Unaudited

	July 28, 2012			July 30, 2011
Operating activities
Net income	$	3,679,000		$	4,923,000
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	82,000			43,000
Amortization of trademarks	674,000			681,000
Deferred income taxes	6,000			656,000
Net loss on retirement of assets	76,000			—
Stock-based compensation	455,000			389,000
Changes in current assets and liabilities:
Decrease (increase) in accounts receivable	(643,000		)	513,000
Decrease (increase) in prepaid expenses and other assets	(269,000		)	(73,000		)
Decrease (increase) in income taxes receivable	197,000			1,102,000
Increase (decrease) in accounts payable	721,000			(26,000		)
Increase (decrease) in deferred revenue	(477,000		)	—
Increase (decrease) in accrued compensation	(144,000		)	(4,238,000		)
Increase (decrease) in income taxes payable and other accrued liabilities	1,121,000			(562,000		)
Net cash provided by operating activities	5,478,000			3,408,000
Investing activities
Purchase of property and equipment	(362,000		)	(133,000		)
Purchase of trademarks, registration and renewal costs	(153,000		)	(174,000		)
Net cash used in investing activities	(515,000		)	(307,000		)
Financing activities
Proceeds from term loan	—			10,000,000
Payment of term loan	(6,438,000		)	(1,537,000		)
Proceeds from exercise of stock options	—			161,000
Issuance of common stock	—			200,000
Repurchase of common stock	—			(395,000		)
Payment of short term notes payable	(500,000		)	(7,260,000		)
Payment of Dividends	(3,357,000		)	(3,391,000		)
Net cash used in financing activities	(10,295,000		)	(2,222,000		)
Increase (decrease) in cash and cash equivalents	(5,332,000		)	879,000
Cash and cash equivalents at beginning of period	7,421,000			9,587,000
Cash and cash equivalents at end of period	$	2,089,000		$	10,466,000
Cash paid during period for:
Income taxes	$	1,002,000		$	1,914,000
Declaration of dividends	$	1,679,000		$	1,690,000

See the accompanying notes which are an integral part of these consolidated financial statements.

5

CHEROKEE INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(1)   Basis of Presentation

The accompanying unaudited condensed consolidated financial statements as of July 28, 2012 and for the three and six month periods ended July 28, 2012 and July 30, 2011 have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). These consolidated financial statements have not been audited by independent registered public accountants but include all adjustments, consisting of normal recurring accruals, which in the opinion of management of Cherokee Inc. (“Cherokee” or the “Company”) are necessary for a fair statement of the financial position and the results of operations for the periods presented.  The accompanying consolidated balance sheet as of January 28, 2012 has been derived from audited consolidated financial statements, but does not include all disclosures required by GAAP.  The results of operations for the three and six month periods ended July 28, 2012 are not necessarily indicative of the results to be expected for the fiscal year ending February 2, 2013.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2012.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates.

As used herein, the term “First Quarter” refers to the three months ended April 28, 2012; the term “Second Quarter” refers to the three months ended July 28, 2012; the term “Six Months” refers to the six months ended July 28, 2012; the term “Fiscal 2013” refers to our fiscal year ending February 2, 2013; the term “Fiscal 2012” refers to our most recent past fiscal year ended January 28, 2012; and the term “Fiscal 2011” refers to our fiscal year ended January 29, 2011.

(2)   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.

Allowance for Doubtful Accounts

The Company records its allowance for doubtful accounts based upon its assessment of various factors, such as: historical experience, age of accounts receivable balances, credit quality of our licensees, current economic conditions, bankruptcy, and other factors that may affect our licensees’ ability to pay.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires us 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

We consider all highly liquid debt instruments purchased and money market funds purchased with an original maturity date of three months or less to be cash equivalents.

6

Revenue Recognition

Revenues from royalty and brand representation agreements are recognized when earned by applying contractual royalty rates to quarterly point of sale data received from our licensees. Our royalty recognition policy provides for recognition of royalties in the quarter earned, although a large portion of such royalty payments are actually received during the month following the end of a quarter. Revenues are not recognized unless collectability is reasonably assured. Our agreement with Target for the Cherokee brand in the U.S. accounts for the majority of our historical revenues and is structured to provide royalty rate reductions once certain cumulative levels of sales are achieved. With respect to Target’s sales in the U.S., revenue is recognized by applying the reduced contractual royalty rates prospectively to point of sale data as defined sales thresholds are exceeded. The royalty rate reductions do not apply retroactively to sales since the beginning of the fiscal year. As a result, our royalty revenues as a percentage of Target’s retail sales in the U.S. are highest at the beginning of each fiscal year and decrease during the fiscal year as Target exceeds sales thresholds as set forth in our agreement with Target. The amount of royalty revenue earned by us from Target in any quarter is dependent not only Target’s retail sales of Cherokee branded products in the U.S. in each quarter, but also on the royalty rate then in effect after considering Target’s cumulative level of retail sales for Cherokee branded products in the U.S. for the fiscal year. Historically this has caused our first quarter to be our highest revenue and profitability quarter; our second quarter to be our next highest quarter; and our third and fourth quarters to be our lowest quarters. However, such historical patterns may vary in the future, depending upon the execution of new license agreements and retail sales volumes achieved in each quarter from Target and also on the revenues we receive from other licensees that do not pay us reduced royalty rates based upon cumulative sales.

Deferred Revenue

Deferred revenues represent minimum licensee revenue royalties paid in advance, the majority of which are non-refundable to the licensee. Historically, deferred revenue was combined with accounts payable; however, deferred revenue is currently presented separately as current and non-current items on our balance sheet. The values and timing of recognition of deferred revenues are outlined in our license agreements.

Earnings Per Share Computation

The following table provides a reconciliation of the numerator and denominator of the basic and diluted per-share computations for the three and six month periods ended July 28, 2012 and July 30, 2011:

	Three Months Ended				Six Months Ended
	July 28, 2012		July 30, 2011		July 28, 2012		July 30, 2011
Numerator:
Net income-numerator for net income per common share and net income per common share assuming dilution	$	1,608,000	$	1,672,000	$	3,679,000	$	4,923,000
Denominator:
Denominator for net income per common share — weighted average Shares	8,390,417		8,504,247		8,388,791		8,501,867
Effect of dilutive securities:
Stock options	15,371		30,271		7,547		26,434
Denominator for net income per common share, assuming dilution:
Adjusted weighted average shares and assumed exercises	8,405,788		8,534,518		8,396,338		8,528,301

7

The computation for diluted number of shares excludes unexercised stock options which are anti-dilutive. There were 780,499 and 637,000 anti-dilutive shares for the three and six months ended July 28, 2012 and July 30, 2011, respectively. Consequently, the diluted weighted average number of shares for the three and six month periods ended July 28, 2012 and July 30, 2011 excludes 780,499 and 637,000 shares, respectively.

Significant Contracts

In 1997, we entered into an agreement with Target that grants Target the exclusive right in the United States to use the Cherokee trademarks in certain categories of merchandise. The current terms of our relationship with Target are set forth in a restated license agreement with Target, which was entered into effective as of February 1, 2008 and amended on December 1, 2011 (the “Restated Target Agreement”). The Restated Target Agreement grants Target the exclusive right in the United States to use the Cherokee trademarks in various specified categories of merchandise. In addition, pursuant to a Canada Affiliate Agreement between Cherokee and Target Canada Co., dated December 1, 2011 (the “Target Canada Agreement”), and subject to our agreement with Zellers, the terms of the Restated Target Agreement will apply to the territory of Canada effective as of February 1, 2013 and Target will have exclusive rights to the Cherokee brand within the territory of Canada effective as of January 31, 2014 (or earlier if our agreement with Zellers terminates before such date). The term of the Restated Target Agreement continues through January 31, 2013. However, the Restated Target Agreement provides that if Target remains current in its payments of the minimum guaranteed royalty of $9.0 million for Fiscal 2013, then the term of the Restated Target Agreement will continue to renew automatically for successive fiscal year terms provided that Target does not give notice of its intention to terminate the Restated Target Agreement during February of the calendar year prior to termination. In addition, effective as of February 1, 2013, the minimum guaranteed royalty for Target will increase to $10.5 million and will apply to all sales made by Target in the United States or in Canada as contemplated by the Target Canada Agreement. Under the Restated Target Agreement, Target has agreed to pay royalties based on a percentage of Target’s net sales of Cherokee branded merchandise in the U.S. during each fiscal year ended January 31st, which percentage varies according to the volume of sales of merchandise. Under the Target Canada Agreement, Target has agreed to pay a fixed royalty rate based on a percentage of Target’s net sales of Cherokee branded merchandise in Canada during each fiscal quarter. Royalty revenues from Target totaled $13.8 million in Fiscal 2012, $13.0 million in Fiscal 2011 and $13.2 million in Fiscal 2010.

We also have other licensing agreements regarding our brands, including with Tesco for our Cherokee brand in the United Kingdom, Ireland, the Czech Republic, Slovakia, Poland, Hungary and Turkey. For a more complete description of certain of our license agreements and other commercial agreements, please see our Annual Report on Form 10-K for Fiscal 2012, which was filed with the Securities and Exchange Commission (the “Commission”) on April 12, 2012.

On September 4, 2012, Cherokee and LLM Management Co., LLC entered into an Asset Purchase Agreement pursuant to which Cherokee acquired assets related to the Liz Lange and Completely Me by Liz Lange brands.  See Note 6. (“Subsequent Events”) below.

Stock-Based Compensation

We currently maintain two equity-based compensation plans:  (i) the 2003 Incentive Award Plan as amended in 2006 with the adoption of the 2006 Incentive Award Plan (the “2003 Plan”); and (ii) the 2006 Incentive Award Plan (the “2006 Plan”).  Each of these equity based compensation plans provide for the issuance of equity-based awards to officers and other employees and directors, and they have previously been approved by our stockholders.  Stock options issued to employees are granted at the market price on the date of grant, generally vest over a three-year period, and generally expire seven to ten years from the date of grant.  We issue new shares of common stock upon exercise of stock options.

2003 Plan—The 2003 Plan was approved at the June 9, 2003 Annual Meeting of Stockholders, and amended on June 13, 2006 with the adoption of the 2006 Plan by the Company’s Stockholders at the June 2006 Annual Meeting of Stockholders.  Under the 2003 Plan, the Company is authorized to grant up to 250,000 shares of common stock in the form of incentive and nonqualified options and restricted stock awards.  The maximum number of shares which may be subject to grants under the 2003 Plan to any individual in any calendar year cannot exceed 100,000.  During the First Quarter, we granted to certain employees stock options with a seven-year term to purchase a total of 70,000 shares of our common stock at an exercise price of $10.92 per share (the closing price on the date of grant) pursuant to the 2003 Plan. During the Second Quarter, we did not make any grants pursuant to the 2003 Plan. As of July 28, 2012, there were 34,982 shares available for issuance under the 2003 Plan.

8

2006 Plan—The 2006 Plan was approved at the June 2006 Annual Meeting of Stockholders and amended at the June 2010 Annual Meeting of Stockholders, under which the Company is authorized to grant up to 750,000 shares of common stock in the form of incentive and nonqualified options and restricted stock awards. The maximum number of shares that may be subject to grant under the 2006 Plan to any individual in any calendar year cannot exceed 100,000. During the First Quarter, we granted to certain employees stock options with a seven-year term to purchase 10,000 shares of our common stock at an exercise price of $10.92 per share (the closing price on the date of grant) pursuant to the 2006 Plan. During the Second Quarter, we granted to certain employees and non-employee directors stock options with a seven-year term to purchase a total of 213,000 shares of our common stock at exercise prices of $13.06 and $14.12 per share (which were the closing prices on the date of each applicable grant) pursuant to the 2006 Plan.   In addition, during the Second Quarter, we granted to each of our non-employee directors restricted stock awards of 1,500 shares, or 7,500 shares in total, of our common stock pursuant to the 2006 Plan.  As of July 28, 2012, there were 55,334 shares available for issuance under the 2006 Plan.

Following the approval by Cherokee’s stockholders, on June 4, 2010, we issued to Robert Margolis, our former Executive Chairman, a non-qualified stock option to purchase 100,000 shares of our Common Stock (the “Margolis Option”) at an exercise price of $18.49, which was the closing price of our Common Stock on June 4, 2010. The Margolis Option was not issued pursuant to any of Cherokee’s existing equity incentive plans. Pursuant to its original terms, the Margolis Option was to vest contingent on Mr. Margolis’ continued service as a member of our Board of Directors in two equal installments of 50,000, on January 31, 2011 and January 31, 2012; however, pursuant to our separation with Mr. Margolis, the vesting applicable to the Margolis Option was accelerated in full. The Margolis Option is exercisable until June 4, 2015.

In addition, in connection with appointment of Mr. Stupp as our Chief Executive Officer, on August 26, 2010, we granted to Mr. Stupp an option to purchase shares (the “Stupp Option”) of Cherokee’s common stock as an inducement grant outside of the 2006 Plan, subject to vesting requirements and other terms. The Stupp Option was originally exercisable for up to a total of 300,000 shares and the maximum number of shares for which the Stupp Option may exercise is 187,500 as of the date of this report (subject to applicable vesting conditions set forth in the Stupp Option). This grant of stock options was entered into as an inducement material for Mr. Stupp to enter into employment with Cherokee. While the grant of the Stupp Option was made outside of the 2006 Plan, the grant is consistent with applicable terms of the 2006 Plan. See the description of the Stupp Option in Note 4. Related Party Transactions.

Stock-based compensation expense recognized for the Six Months was $452,000, as compared to $389,000 for the comparable period in the prior year.

The estimated fair value of options granted during Fiscal 2013 and Fiscal 2012 as of each grant date was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Fiscal 2013	Fiscal 2012
Expected Dividend Yield	5.67% to 7.33%	4.65% to 6.67%
Expected Volatility	51.63 to 53.33	49.28 to 51.95
Avg. Risk-Free Rate	0.57% to 1.01%	0.74% to 1.1%
Expected Life (in years)	4.5	4.5 to 5.0
Estimated Forfeiture Rate	15%	30%

9

The expected term of the options represents the estimated period of time until exercise and is based on historical experience of similar options, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. Expected stock price volatility is based on the historical volatility of our stock price. The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of grant with an equivalent remaining term. Our dividend yield is based on the past dividends paid and the current dividend yield at the time of grant.

A summary of activity for the Company’s stock options for the Six Months is as follows:

					Weighted
					Average
					Remaining
			Weighted		Contractual	Aggregate
			Average		Term	Intrinsic
	Shares		Price		(in years)	Value
Outstanding, at January 28, 2012	973,833		$	17.92
Granted	293,000		$	11.75
Exercised
Canceled/forfeited	(163,334	)	$	19.23
Outstanding, at July 28, 2012	1,103,499		$	16.28	4.94	$	577,600
Vested and Exercisable at July 28, 2012	445,663		$	17.68	3.11	$	34,100
Non-vested and not exercisable at July 28, 2012	657,836		$	15.35	5.65	$	543,500

As of July 28, 2012, total unrecognized stock-based compensation expense related to non-vested, equity based awards was approximately $2,209,602 for stock options and $97,150 for restricted stock awards, which is expected to be recognized over a weighted average period of approximately 2.8 and 2.9 years, respectively.  The total fair value of all options which vested during the Six Months was $694,527. There were no restricted stock awards vested during the Six Months.

Trademarks

During the Second Quarter and Six Months, the Company did not acquire any trademarks, nor were there any trademark acquisitions during the comparable period last year.  Trademark registration and renewal fees which were capitalized during the Second Quarter and Six Months totaled $75,000 and $153,000, respectively.  In comparison, for the second quarter and six months of last year, the total trademark registration and renewal fees capitalized totaled $66,000 and $174,000, respectively.

Income Taxes

Income tax expense of $1,031,000 was recognized for the Second Quarter, resulting in an effective tax rate of 39.1% in the Second Quarter, as compared to an effective tax rate of 36.6% in the second quarter of last year and compared to 28.0% for the full year of Fiscal 2012. Our lower effective tax rate in Fiscal 2012 was primarily the result of settling income tax examinations with the California Franchise Tax Board related to our apportionment of income.

The Company files U.S. federal and state income tax returns. For our federal income tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to Fiscal 2011. With limited exception, our significant state tax jurisdictions are no longer subject to examinations by the various tax authorities for fiscal years prior to 2008. Although the outcome of tax audits is always uncertain, we believe that adequate amounts of tax, interest and penalties, if any, have been provided for in our income tax reserve for any adjustments that may result from future tax audits. We recognize interest and penalties, if any, related to unrecognized tax benefits within the provision for income taxes in our consolidated statement of income. As of January 28, 2012 and July 28, 2012, respectively, accrued interest on a gross basis was $130,000 and $161,000.

10

As of January 28, 2012 and July 28, 2012, respectively, the total amount of gross unrecognized tax benefits was approximately $900,000 and $917,000, of which approximately $596,000 represents the amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate. It is reasonably possible that $700,000 of the $917,000 of unrecognized tax benefits will settle in the next twelve months. We do not expect this change to have a significant impact on the results of operations or the financial position of the Company.

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued an update to ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. ASC 820 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years, with early adoption permitted. We adopted ASC 820 on the first day of Fiscal 2009, and this adoption did not have a material impact on our consolidated financial statements.

(3)    Dividends

On January 28, 2012, our Board of Directors declared a dividend of $1.7 million, or $0.20 per share, which was paid on March 12, 2012.  On April 28, 2012, our Board of Directors declared a dividend of $1.7 million, or $0.20 per share, which was paid on June 15, 2012 to stockholders of record as of June 1, 2012.  On July 28, 2012, our Board of Directors declared a dividend of $1.7 million, or $0.20 per share, which is to be paid on September 15, 2012 to stockholders of record as of September 1, 2012.

(4)    Related Party Transactions

Employment Agreement with our Chief Executive Officer

On August 26, 2010, we entered into an Employment Agreement with our Chief Executive Officer, Henry Stupp, which has been subsequently amended pursuant to amendment agreements on each of January 28, 2011, April 13, 2011 and July 27, 2011 (such employment agreement, as amended, the “Employment Agreement”). Pursuant to the Employment Agreement, (i) on August 26, 2010, Mr. Stupp purchased 81,967 shares of our common stock at a per share price of $18.30 (which was equal to the closing price of Cherokee’s common stock on such date), for aggregate proceeds of $1,500,000 and (ii) on July 28, 2011, Mr. Stupp purchased 12,562 shares of Cherokee’s common stock at a per share price of $15.92 (which was equal to the closing price of Cherokee’s common stock on such date), for aggregate proceeds of approximately $200,000 (all such shares purchased by Mr. Stupp, collectively, the “Shares”). The sales of the Shares were made pursuant to an exemption from registration provided by Section 4(2) of the Act, including pursuant to Rule 506 thereunder (as Mr. Stupp is an “accredited investor” under Rule 506 and the sales were made without any form of general solicitation and with full access to any information requested by Mr. Stupp regarding Cherokee or its common stock). In addition, pursuant to the Employment Agreement, Mr. Stupp agreed to purchase an aggregate of $600,000 of our common stock in increments of $200,000 on or before October 31, 2011, January 31, 2012 and April 30, 2012 (such additional shares, the “Subsequent Shares”). Mr. Stupp elected not purchase the Subsequent Shares to be purchased on or before October 31, 2011, January, 31, 2012 and April 30, 2012, and, as a result, a total of 112,500 of the shares subject to the Option (as described below) have been forfeited, leaving a balance of 187,500 shares subject to the Option. In addition, on June 18, 2012, the Committee awarded Mr. Stupp with an additional option to purchase up to 90,000 shares of the Company’s common stock under the 2006 Plan with an exercise price of $13.06, which was the closing price of the Company’s common stock on the Nasdaq Global Select Market on the date of grant. These stock options vest in equal annual installments over the next three years and are subject to a seven year term.

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On June 18, 2012, the Committee approved an increase of Mr. Stupp’s base salary to $600,000, with such salary increase to be retroactive to February 1, 2012. In addition, for Fiscal 2012, Mr. Stupp was entitled to receive a performance bonus (the “Performance Bonus”) equal to five percent of Cherokee’s pre-tax income during such fiscal year in excess of a threshold amount of $20,000,000, subject to a maximum of $650,000 per fiscal year. Mr. Stupp did not receive any portion of the Performance Bonus for Fiscal 2012. For Fiscal 2013, the Committee determined that Mr. Stupp will be eligible to receive a cash bonus with a bonus target of $200,000 and a maximum of $400,000, subject to the Company achieving certain performance targets during Fiscal 2013 and other factors the Committee may deem appropriate. The amount of any such bonus will be determined by the Committee within 75 days of the end of Fiscal 2013.  Mr. Stupp’s services as our Chief Executive Officer are at will. The Employment Agreement expires as of January 31, 2014, unless earlier terminated by Cherokee or by Mr. Stupp or extended by mutual agreement.

Pursuant to the Employment Agreement, Cherokee has agreed to certain indemnification obligations to Mr. Stupp related to his service to Cherokee in his capacity as an officer or director of Cherokee. In addition, pursuant to the Employment Agreement, Cherokee filed with the SEC a registration statement to effect the registration for resale of the shares purchased by Mr. Stupp pursuant to the Employment Agreement and the shares of Common Stock that may be acquired upon exercise of the Option (as described below).

In connection with Mr. Stupp’s appointment, on August 26, 2010, we granted Mr. Stupp an option to purchase up to 300,000 shares of our common stock (the “Option”) pursuant to a Stock Option Agreement (the “Stock Option Agreement”) as an inducement grant outside of the 2006 Plan, which was subsequently amended on July 26, 2012 to transfer fifty percent of the shares subject to the Option to Mr. Stupp’s former spouse. The maximum number of shares subject to the Option is currently 187,500 as a result of the forfeiture of a total of 112,500 shares described above. The Stock Option Agreement was entered into as an inducement material for Mr. Stupp to enter into employment with Cherokee. While the grant of the Option was made outside of the 2006 Plan, the grant is consistent with applicable terms of the 2006 Plan. The Option has an exercise price of $18.30 per share, which was the closing price of Cherokee’s common stock on the Nasdaq Global Select Market on the date of grant. The Option vests in five equal annual installments beginning on January 31, 2012, and vesting in four additional increments on each yearly anniversary thereafter. In addition, in the event of a change in control of Cherokee, an additional twenty percent of the total shares subject to the Option shall vest. The Option has a term of six years and will be forfeited if not exercised before the expiration of the term. Except as noted above, the Option is not transferable and is not exercisable by anyone other than Mr. Stupp or his former spouse during their lifetimes. If Mr. Stupp’s service to Cherokee is terminated for any reason, the Option shall cease vesting upon such termination.

(5) Debt

On February 16, 2011, Cherokee and U.S. Bank National Association (“U.S. Bank”) entered into a Term Loan Agreement which was restated on December 7, 2011. The restated loan agreement consisted of (i) a term loan in the principal amount of $5,000,000 and a two year maturity date and (ii) a term loan in the principal amount of $2,000,000 and a four year maturity. On June 5, 2012, Cherokee prepaid all outstanding principal and interest on the restated loan agreement. As a result, Cherokee currently has no outstanding borrowings under the Term Loan Agreement with U.S. Bank.

On September 4, 2012, Cherokee and JPMorgan Chase Bank, N.A. (“JPMorgan Chase”) entered into a Credit Agreement (the “Credit Agreement”).  See Note 6. (“Subsequent Events”) below.

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(6) Subsequent Events

Acquisition of Assets Related to the Liz Lange and Completely Me by Liz Lange Brands

On September 4, 2012, Cherokee and LLM Management Co., LLC (the “Seller”) entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”), pursuant to which Cherokee acquired various assets related to the “Liz Lange” and “Completely Me by Liz Lange” brands (the “Assets” and such transaction, the “Acquisition”). The Acquisition closed on September 4, 2012.   As consideration for the Acquisition, Cherokee agreed to pay a cash purchase price equal to $13.1 million, with $12.6 million paid by Cherokee concurrently with the closing and with $500,000 of which we agreed to place in an escrow fund that is to be released no later than March 31, 2013, subject to any funds which we recover or that are to be retained pursuant to indemnification claims.  In addition, Cherokee agreed to pay to the Seller additional earn-out payments of $400,000 and $500,000 (for a total of up to $900,000 in contingent consideration), which consideration is payable upon our achievement of specified revenue targets attributable to the Assets during the remainder of 2012 and during 2013.  In addition, as part of the Acquisition, Cherokee agreed to assume the Seller’s obligations under various agreements, which include a consulting agreement with Ms. Lange as well as certain existing license agreements relating to the Assets, including a license agreement with Target.  The Asset Purchase Agreement contains various covenants, indemnities and representations and warranties that are customary for transactions of this type.  For additional information regarding the Acquisition and the Asset Purchase Agreement, please see Cherokee’s Current Report on Form 8-K dated September 4, 2012 and filed with the Commission on September 6, 2012.

Credit Agreement with JPMorgan Chase

On September 4, 2012, and in connection with the Acquisition, Cherokee and JPMorgan Chase entered into the Credit Agreement.  Pursuant to the Credit Agreement, JPMorgan Chase agreed to lend to Cherokee up to $15 million in principal (the “Loan”).  The Loan is comprised of (i) a term loan in the principal amount of $13 million (the “Term Loan”), with interest on each advance equal to either: (i) an adjusted annual LIBOR rate reset monthly, bi-monthly or quarterly, plus of 2.75% or (ii) JPMorgan’s annual prime rate minus 0.25%, with a floor equal to the 1 month LIBOR Rate plus 2.5%, and (ii) a revolving line of credit in the principal amount of $2 million (the “Revolver”), with interest on each advance equal to either: (i) an adjusted annual LIBOR rate-reset monthly, bi-monthly or quarterly, plus 2.25% or (ii) JPMorgan’s annual prime rate minus 0.25%, with a floor equal to the 1 month LIBOR Rate plus 2.5%.  The Term Loan is subject to a five year maturity date and is to be repaid in equal quarterly payments of principal in the amount of $650,000, together with interest payments made monthly as set forth in the Term Loan.  The Revolver is subject to a three year maturity date and is to be repaid in monthly interest payments on any principal then outstanding, with the balance of any then-outstanding principal and interest to be repaid at maturity.  Cherokee paid an upfront fee equal to $65,000 in connection with the issuance of the Term Loan and is obligated to pay a monthly non-usage fee of 0.25% per annum, in arrears, computed on the average daily unused portion of the Revolver, subject to Cherokee’s right to terminate the Revolver prior to maturity.  In addition, Cherokee is obligated to pay an unspecified amount to be determined by JPMorgan Chase to compensate it for its loss in the event that Cherokee elects to repay all or a portion of the Loan prior to its maturity.  The proceeds from the Term Loan were borrowed to fund the Acquisition.

The Loan is evidenced by a term note in the principal amount of $13,000,000 and a line of credit note in the principal amount of up to $2,000,000, is secured by a continuing security agreement and a trademark security agreement executed by Cherokee and is supported by a continuing guaranty executed by Cherokee’s wholly owned subsidiary, Spell C. LLC (collectively, with the Credit Agreement, the “Loan Documents”). The Credit Agreement contains various affirmative and negative covenants that are customary for loan agreements and transactions of this type, including limitations on our ability to incur debt or other liabilities and limitations on our ability to consummate acquisitions in excess of $5,000,000 in the aggregate at any time while the Loan is outstanding. In addition, the Credit Agreement prohibits us, without first obtaining JPMorgan’s consent, from (i) issuing any equity securities other than pursuant to our employee equity incentive plans and (ii) repurchasing or redeeming any outstanding shares of our common stock or paying dividends or other distributions, other than stock dividends, to our stockholders, unless such repurchases or other distributions would not cause us to be violation of the “fixed charge coverage ratio” (described below) after giving pro forma effect thereto.  The Loan Agreement also imposes the following financial covenants, as specifically defined therein, including: (i) a minimum “fixed charge coverage ratio” of at least 1.2 to 1.0 to be calculated quarterly on a trailing four quarter basis and (ii) a limitation of Cherokee’s “senior funded debt ratio” not to exceed 2.0 to 1.0, measured at any time and based on the ratio of Cherokee’s consolidated total debt to Cherokee’s EBITDA for its most recently completed four-quarter test period. Further, as collateral for the Loan, we granted a security interest in favor of the Bank in all of Cherokee’s assets (including trademarks), and the Loan is guaranteed by Cherokee’s wholly owned subsidiary, Spell C. LLC. In the event of a default under the Credit Agreement, JPMorgan Chase has the right to terminate its obligations under the Credit Agreement, accelerate the payment on any unpaid balance of the Credit Agreement and exercise its other rights under the Loan Documents, including foreclosing on our assets under the security agreement. For additional information regarding the Loan Documents, please see Cherokee’s Current Report on Form 8-K dated September 4 and filed with the Commission on September 6, 2012.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary note regarding forward looking statements

This quarterly report on Form 10-Q and other filings which we make with the Securities and Exchange Commission (the “Commission”), as well as press releases and other written or oral statements we may make may contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. When used, the words “anticipates”, “believes”, “estimates”, “objectives”, “goals”, “aims”, “hopes”, “may”, “likely”, “should” and similar expressions are intended to identify such forward-looking statements. In particular, the forward-looking statements in this Form 10-Q include, among others, statements regarding our goals or expectations regarding our future revenues and earnings, the likelihood of increased retail sales by our current and future licensees, such as Target and Tesco, the likelihood that our licensees will achieve royalty rate reductions, our prospects for obtaining new licensees and our prospects for obtaining new brands to acquire or represent. Forward-looking statements involve known and unknown risks and uncertainties that may cause our actual results, performance, achievements or share price to be materially different from any future results, performance, achievements or share price expressed or implied by any forward-looking statements. Such risks and uncertainties include, but are not limited to, the financial condition of the apparel industry and the retail industry, the overall level of consumer spending and our exposure to general economic conditions, the effect of intense competition we face from other apparel lines both within and outside of Target, adverse changes in licensee or consumer acceptance of products bearing the Cherokee brand or our other brands as a result of fashion trends or otherwise, our ability to protect our intellectual property rights,  the ability and/or commitment of our licensees to design, manufacture and market Cherokee or our other branded products, our dependence on Target for a substantial portion of our revenues, our dependence on our key management personnel, the success of our strategic and marketing initiatives, the benefits to us of our recently acquired assets related to the Liz Lange and Completely Me by Liz Lange brands, the possibility that we may engage in additional strategic transactions that could impact our liquidity, increase our expenses or present significant distractions to our management, any adverse determination of claims, liabilities or litigation, the requirements under our credit agreement with JPMorgan Chase Bank, our ability to issue preferred stock with rights and privileges that are superior to those of our common stock, our payment or non-payment of dividends in future periods and the volatility in the trading price of our common stock. Several of these risks and uncertainties are discussed in more detail under “Item 1A. Risk Factors” of Part II of this Report on Form 10-Q or in the discussion and analysis below. You should, however, understand that it is not possible to predict or identify all risks and uncertainties and you should not consider the risks and uncertainties identified by us to be a complete set of all potential risks or uncertainties that could materially affect us. You should not place undue reliance on the forward-looking statements we make herein because some or all of them may turn out to be wrong. We undertake no obligation to update any of the forward-looking statements contained herein to reflect future events and developments.

Introduction

The following discussion should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Report on Form 10-Q.  See “Item 1. Consolidated Financial Statements” and our Form 10-K for our fiscal year ended January 28, 2012 (“Fiscal 2012”).

Cherokee Inc. (which may be referred to as we, us, our or the Company) is a global marketer and manager of a portfolio of lifestyle brands it owns or represents, licensing the Cherokee, Sideout and Carole Little brands and related trademarks and other brands in multiple consumer product categories and sectors. We are one of the leading licensors of style-focused lifestyle brands for apparel, footwear, home and accessories in the world.

Cherokee was incorporated in Delaware in 1988. Our principal executive offices are located at 5990 Sepulveda Boulevard, Sherman Oaks, California 91411, telephone (818) 908-9868. We maintain a website with the address www.thecherokeegroup.com. We are not including the information contained on our website as part of, or incorporating it by reference into, this Quarterly Report on Form 10-Q.

We own several trademarks, including Cherokee®, Sideout®, Sideout Sport®, Carole Little®, Saint Tropez-West®, Chorus Line®, All That Jazz® and others. As of July 28, 2012, we had twenty-seven continuing license agreements covering both domestic and international markets. As part of our business strategy, we frequently evaluate other brands and trademarks for acquisition into our portfolio.

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In addition to licensing our own brands, we also assist other brand-owners, companies, wholesalers and retailers in identifying opportunities as a licensee or licensor for their brands or stores.

We have a 52 or 53 week fiscal year ending on the Saturday nearest to January 31, which aligns us with our retailer licensees who generally also operate and plan using such a fiscal year. This results in a 53 week fiscal year approximately every four or five years. We do not believe that the extra week in the occasionally reported 53-week fiscal year results in any material impact on our financial results. In addition, certain of our international licensees report royalties to us for quarterly and annual periods which may differ from ours. We do not believe that the varying quarterly or annual period ending dates applicable to our international licensees have a material impact upon our reported financial results, as these international licensees maintain comparable annual periods in which they report retail sales and royalties to us on a year-to-year basis.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, management evaluates its estimates, including those related to revenue recognition, deferred taxes, impairment of long-lived assets, contingencies and litigation. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We consider accounting policies relating to the following areas to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment:

·     Revenue recognition;

·     Provision for income taxes and deferred taxes;

·     Impairment of long-lived assets;

·     Contingencies and litigation; and

·     Accounting for stock-based compensation.

You should refer to our Annual Report on Form 10-K for Fiscal 2012, for a discussion of our policies on revenue recognition, deferred taxes, impairment of long-lived assets, contingencies and litigation and accounting for stock-based compensation.

Recent Accounting Pronouncements

We describe recent accounting pronouncements in Item 1 — “Consolidated Financial Statements — Notes to Consolidated Financial Statements.”

Results of Operations

Retail Sales

During the quarterly period ended July 28, 2012 (the “Second Quarter”), total U.S. dollar based retail sales of merchandise bearing the Cherokee brand were 5.8% above the total U.S. dollar based retail sales for the second quarter of last year, with U.S. dollar based retail sales totaling approximately $287.7 million in our Second Quarter versus approximately $271.9 million in total U.S. dollar based retail sales for the second quarter of last year.   During the six month period ended July 28, 2012 (the “Six Months”), total U.S. dollar based retail sales of merchandise bearing the Cherokee brand were 8.5% above the total U.S. dollar based retail sales for the comparable six month period of last year, with U.S. dollar based retail sales totaling approximately $623.0 million in the Six Months versus approximately $574.2 million in total U.S. dollar based retail sales for the comparable period of last year.  Most of this increase is the result of an increase in sales of Cherokee branded products at Target and Zellers, as compared to the comparable periods of last year. The increase in sales at Target and Zellers was partially offset by a decrease in sales for Cherokee branded products at Tesco as compared to the comparable periods of last year.

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Pursuant to our typical arrangements with our licensees, we receive quarterly royalty statements and periodic retail sales information for Cherokee branded products and other product brands that we own or represent. However, our licensees are generally not required to provide, and typically do not provide, information that would enable us to determine the specific reasons for period-to-period fluctuations in retail sales of our branded products by our licensees in the specific territories in which they operate. As a result, and except as noted elsewhere in Cherokee’s comparisons of its financial results discussed herein, Cherokee does not have sufficient information required to determine the effects on our operations of changes in price, volume or product mix by our licensees. Fluctuations in retail sales of Cherokee branded products or other product brands that we own or represent may be the result of a variety of factors, including, without limitation: (i) changes in the number of product categories for which a licensee chooses to use our brands from period-to-period, which generally results in changes in the amount of inventory (utilizing our brands) available for sale from period-to-period; (ii) the number of geographical markets/territories or number of stores in which our licensees are currently selling Cherokee or our other branded products from period-to-period; or (iii) our licensees experiencing changes in retail sales levels as a result of a variety of factors, including fashion-related and general retail sales trends (See Item 1A of Part II—“Risk Factors”).

During the Second Quarter and Six Months, retail sales of Cherokee branded products by Target Stores totaled approximately $200.4 million and $462.0 million, respectively, compared to approximately $148.0 million and $337.6 million for the second quarter and six months of last year, or an increase of 35.4% and 36.9%, respectively.  As a result, our royalty revenues for the Second Quarter and Six Months from Target Stores increased compared to the comparable periods last year.

Tesco’s U.S. dollar based retail sales of merchandise bearing the Cherokee brand, which for the Second Quarter and last year’s comparable period included the U.K., Ireland, Poland, the Czech Republic, Hungary and Slovakia, were $5.4 million in our Second Quarter, compared to $60.0 million in the second quarter of last year, representing a total decline of 91.0%.  Tesco’s U.S. dollar based retail sales of merchandise bearing the Cherokee brand for the Six Months was $13.5 million compared to $119.9 million for the comparable period last year, representing a decline of 88.7%.  These declines were due to continuing reductions of Cherokee branded product categories in the UK and Central European countries during the Second Quarter and Six Months as compared to the comparable periods of the prior year.  Retail sales in the United Kingdom, as measured in British Pounds Sterling, were down 90.1% and 88.1% in the Second Quarter and Six Months, respectively, as compared to the comparable periods in the prior year.  Hence, retail sales in U.S. dollars for the United Kingdom totaled $4.2 million and $10.7 million in the Second Quarter and the Six Months, respectively, as compared to $42.3 million and $89.7 million in the comparable periods of last year.  The Tesco Central European countries of  the Czech Republic, Slovakia, Poland and Hungary, as measured in their respective local currencies, reflected decreases in retail sales ranging from 92% to 94% during the Second Quarter and the Six Months.  As a consequence, the collective U.S. dollar based retail sales from Tesco Central Europe for the Second Quarter and Nine Months were $1.0 million and $2.2 million, respectively, as compared to $13.9 million and $25.2 million in the comparable periods of last year.  While we continue to work with Tesco in an effort to reverse the trend of its sales of Cherokee branded products in recent periods, we cannot provide assurances that we will be successful or that additional declines will not be forthcoming.

Zeller’s retail sales of merchandise bearing the Cherokee brand, in U.S. dollars, were approximately $33.4 million and $59.4 million during the Second Quarter and Six Months, respectively, compared to $23.3 million and $45.1 million for the comparable periods of last year, representing increases of 43.3% and 31.5%, respectively.  We attribute this increase primarily due to the reintroduction of the adult apparel category at Zellers and the generally positive acceptance of the Cherokee brand in the Canadian marketplace.

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In addition, on a U.S. dollar basis we experienced retail sales increases during the Second Quarter and the Six Months with several other of our foreign licensees, including the countries of China, Japan, Russia, Peru and Colombia.  We expect that several of our foreign territories may continue to show growth throughout the remainder of Fiscal 2013.

Royalty Revenues

Total royalty revenues received by Cherokee for all brands were $6.3 million and $13.8 million during the Second Quarter and Six Months, respectively, as compared to $6.7 million and $13.6 million for the comparable periods of last year.  We attribute the decrease in total royalty revenues during the Second Quarter primarily to the reduced amount of revenues we received during such periods as a result of our brand representation business (discussed below), together with the decrease in royalty revenues we received from Tesco during such period. We attribute the overall increase in royalty revenues we received during the Six Months primarily to the significant increase in sales at Target that occurred throughout the Six Months.  Revenues from the Cherokee brand were $5.8 million and $12.9 million during the Second Quarter and Six Months, respectively, as compared to $5.7 million and $11.8 million for the comparable periods of last year.  We attribute the increases royalties that we received for Cherokee branded products primarily due to an increase in royalty revenues from Target and Zellers in both the Second Quarter and the Six Months. Such increased sales at Target and Zellers partially offset the declines in royalties we received from Tesco for the Cherokee brand during the Second Quarter and entirely offset such declines during the Six Months.

During the Second Quarter and Six Months, revenues of $3.1 million and $8.3 million, respectively were recognized from Target stores compared to $2.8 million and $6.6 million for the comparable periods last year. This accounted for 49% and 60% of our total revenues for the Second Quarter and Six Months, respectively, versus 42% and 48% for the comparable periods last year.

Revenues from all of the Tesco countries were $0.2 million and $0.4 million during the Second Quarter and Six Months, respectively, compared to $1.2 million and $2.1 million for the comparable periods last year.  Royalty revenues from Tesco U.K. totaled $0.1 million and $0.2 million during the Second Quarter and Six Months, respectively, as compared to $0.8 million and $1.4 million for the comparable periods last year.  The decline in royalties from Cherokee branded products in all other Tesco countries (Ireland, Central Europe and Turkey) during the Second Quarter and Six Months was about 93% and 80%, respectively, resulting in royalties of $0.1 million and $0.2 million for the Second Quarter and Six Months, respectively, as compared to $0.4 million and $0.8 million for the comparable periods of last year.  We attribute the decrease in royalties from all Tesco territories primarily to the decrease in several Cherokee branded product categories for apparel during the Second Quarter and Six Months as compared to the comparable periods of last year.

Revenues from Zellers increased 39% and 31% during the Second Quarter and Six Months, respectively, resulting in royalties of $669,000 and $1,198,000 compared to $480,000 and $916,000 for the comparable periods of last year.

Revenues from our brand representation licensing arrangements totaled $4,000 and $39,000 in our Second Quarter and Six Months, respectively, as compared to $542,000 and $1,089,000 for the comparable periods last year.

Most of our international licensees are required to pay the royalty revenues owed to us in U.S. dollars. As a consequence, any weakening of the U.S. dollar benefits us in that the total royalty revenues reported from our international licensees increases when the dollar weakens against such foreign currencies.  Conversely, any strengthening of the U.S. dollar against such licensee’s foreign currency results in lower royalty revenues from such licensee. We do not anticipate that the exchange rate fluctuation will have a material impact, positive or negative, on our business as a whole.

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Our disclosure related to the sales of our international licensees throughout this Quarterly Report on Form 10-Q is denominated in U.S. dollars unless otherwise noted. In arriving at such denominations, Cherokee receives a schedule of retail sales on a monthly and/or quarterly basis from each of our licensees which are denominated in the applicable foreign currency. These amounts are then converted by us to U.S. dollars using an average monthly and/or quarterly exchange rate for the purpose of the disclosure of the retail sales denominated in U.S. dollars. In all periods presented in this report, Cherokee does not consider the period fluctuations in foreign currency exchange rates to have had a significant effect on accuracy of the U.S. dollar-denominated figures presented in this Form 10-Q.

Our license agreement with Target for the Cherokee brand in the U.S. provides for reduced royalty rates based on volume thresholds once specified cumulative levels of retail sales are achieved during each fiscal year. The royalty rate reductions do not apply retroactively to Target’s retail sales since the beginning of the year. As a result, for such license agreement our royalty revenues as a percentage of Target’s retail sales in the U.S. are highest at the beginning of each fiscal year and decrease during the fiscal year as licensees exceed sales thresholds as outlined in their respective license agreements. The amount of royalty revenue earned by us in any quarter is dependent not only on retail sales in each quarter, but also on the royalty rate then in effect after considering the cumulative level of retail sales for the fiscal year. Royalty revenues during the First Quarter benefitted from higher royalty rates applied under our contract with Target for the Cherokee brand in the U.S. during the period because the cumulative retail sales during the First Quarter had not exceeded the applicable thresholds for reduced royalty rates during Fiscal 2013. By contrast, royalty revenues were lower during the Second Quarter in comparison to the First Quarter in part as a result of Target paying us a lower royalty rate on its sales of Cherokee branded products in the U.S. during such period. In the event that Target’s cumulative retail sales of Cherokee branded products in the U.S. in future quarters in Fiscal 2013 exceed the applicable thresholds for reduced royalty rates, we will then be entitled to a reduced royalty rate on incremental retail sales by Target that are in excess of such thresholds. Historically, this has caused our first quarter to be our highest revenue and profitability quarter; our second quarter to be our next highest quarter; and our third and fourth quarters to be our lowest quarters. However, such historical patterns may vary in the future, depending upon the product mix and retail sales volumes achieved in each quarter by Target for Cherokee branded merchandise in the U.S. and also on the revenues we receive from other licensees that do not pay us reduced royalty rates based upon cumulative sales.

We believe that our future revenues from Target, for the remaining six months of Fiscal 2013, will likely be higher when compared to our revenues from Target in Fiscal 2012 during such period, as we expect our presence in certain apparel categories and existing categories at Target may continue to grow.  Based on Tesco’s sales of Cherokee branded products in Fiscal 2012 and the Six Months, it is likely that our revenues in Fiscal 2013 from Tesco will decline from those of Fiscal 2012.

Our revenue recognition policy provides for recognition of royalties in the quarter royalties are earned, although a large portion of such royalty payments are actually received during the month following the end of a quarter.  Our trade receivables balance of $6.0 million and $6.1 million as of the end of the Second Quarter and the end of the second quarter of last year, respectively, included an accrual for royalty revenues earned and these receivables were subsequently received in the following quarter.

Expenses

Selling, general and administrative expenses for the Second Quarter and Six Months were $3.6 million and $7.8 million, or 57.7% and 56.4% of revenues, respectively, in comparison to selling, general and administrative expenses of $3.9 million and $7.3 million, or 59.4% and 53.4%, respectively, of revenues during the comparable periods last year.  The decrease in our selling, general and administrative expenses during the Second Quarter of approximately $0.3 million in comparison to the second quarter of last year was primarily attributable to lower personnel expenditures and lower marketing expenses. The increase in our selling, general and administrative expenses during the Six Months of approximately $0.5 million in comparison to the comparable period of last year was primarily attributable to higher Director stock option expense.

During the Second Quarter and Six Months, our investment and interest income was $0 and $12,000 compared to $2,000 and $22,000 for the comparable periods last year.

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During the Second Quarter and Six Months, we recorded a tax provision of $1,301,000 and $2,282,000, respectively, which equates to an effective tax rate of 39.1% and 38.3%, compared to a tax provision of $966,000 and $1,309,000, respectively, and an effective tax rate of 36.6% and 21%, respectively, recorded for the comparable periods last year. The increase in the tax rate was because in the first quarter of Fiscal 2012 the tax provision was offset by a tax benefit of $1.2 million that resulted from the payment to us of a refund from the California Franchise Tax Board of $2.0 million, plus interest.  The refund related to our fiscal 2004 through fiscal 2008 tax years.  During the Second Quarter and Six Months, our net income was $1,608,000 and $3,679,000 or $0.19 and $0.44 per diluted share, respectively, compared to $1.7 million and $4.9 million, or $0.20 and $0.58 per diluted share, respectively, for the comparable periods last year.

Acquisition of Assets Related to the Liz Lange and Completely Me by Liz Lange Brands

On September 4, 2012, Cherokee and LLM Management Co., LLC (the “Seller”) entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”), pursuant to which Cherokee acquired various assets related to the “Liz Lange” and “Completely Me by Liz Lange” brands (the “Assets” and such transaction, the “Acquisition”). The Acquisition closed on September 4, 2012.   As consideration for the Acquisition, Cherokee agreed to pay a cash purchase price equal to $13.1 million, with $12.6 million paid by Cherokee concurrently with the closing and with $500,000 of which we agreed to place in an escrow fund that is to be released no later than March 31, 2013, subject to any funds which we recover or that are to be retained pursuant to indemnification claims.  In addition, Cherokee agreed to pay to the Seller additional earn-out payments of $400,000 and $500,000 (for a total of up to $900,000 in contingent consideration), which consideration is payable upon our achievement of specified revenue targets attributable to the Assets during the remainder of 2012 and during 2013. In addition, as part of the Acquisition, Cherokee agreed to assume the Seller’s obligations under various agreements, which include a consulting agreement with Ms. Lange as well as certain existing license agreements relating to the Assets, including a license agreement with Target.  The Asset Purchase Agreement contains various covenants, indemnities and representations and warranties that are customary for transactions of this type.  For additional information regarding the Acquisition and the Asset Purchase Agreement, please see Cherokee’s Current Report on Form 8-K dated September 4, 2012 and filed with the Commission on September 6, 2012.

Cherokee’s Board of Directors approved the Acquisition following its determination that the Acquisition is in the best interests of Cherokee and its stockholders.  We believe the Assets have the potential to be complimentary to Cherokee’s other brands and expect to begin to market the assets and consider additional potential licensing opportunities with retailers during the remainder of Fiscal 2013.

Liquidity and Capital Resources

Cash Flows.  On July 28, 2012, we had cash and cash equivalents of $2.1 million.  On January 28, 2012, we had cash and cash equivalents of $7.4 million. The decrease of $5.3 million was primarily due to our prepayment of all outstanding principal and interest then outstanding under our former loan agreement with U.S. Bank (the “Prior Loan”).

During the Six Months, cash provided by our operations was $5.5 million, compared to cash provided by our operations of $3.4 million for the comparable period of last year.  The cash provided by operations of $5.5 million during the Six Months was primarily due to the changes in:  (i) accrued compensation, which was reduced by $0.1 million in the Six Months, as compared to a decrease of $4.2 million in the six months of last year; (ii) accounts receivable, which increased by $0.6 million in the Six Months, as compared to a decrease of $0.5 million in the six months of last year; and (iii) an increase in accounts payable of $0.7 million in the Six Months, as compared to a decrease of $0.03 million in the six months of last year.  In addition, our cash from operations includes non-cash stock-based compensation expense of $455,000 in our Six Months as compared to $389,000 in the six months of last year, and our deferred tax assets decreased by $6,000 in the Six Months, as compared to a decrease of $656,000 last year.

Cash used by investing activities during the Six Months was $515,000, which was comprised of $362,000 of capital expenditures of office equipment, and $153,000 in trademark registration and renewal fees for the Cherokee, Sideout and Carole Little brands.  In comparison, during the comparable period of last year, cash used by investing activities was $307,000, which was comprised of $133,000 of capital expenditures of office equipment, and $174,000 in trademark registration and renewal fees for the Cherokee, Sideout and Carole Little brands.

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Cash used by financing activities was $10.3 million during the Six Months, which consisted of our payment of $6.9 million to repay in full the Prior Loan and the payment of two dividends totaling $3.4 million.   In comparison, during the comparable period last year, cash used in financing activities was $2.2 million, which consisted of proceeds of $10 million from the Prior Loan, and the investment of $200,000 by our Chief Executive Officer in our Common Stock pursuant to his employment agreement, offset by our payment of $1.5 million pursuant to the Prior Loan, the payment of two dividends totaling $3.4 million and the payment of $7.6 million for the repurchase and retirement of stock from our former executive chairman.

Uses of Liquidity.  Our cash requirements through the end of Fiscal 2013 are primarily to fund operations, working capital, and at our discretion and, subject to the terms of our credit agreement (the “Credit Agreement”) with JPMorgan Chase Bank, N.A. (the “Bank”), repurchase shares of our common stock or pay dividends as determined by our Board of Directors, and, to a lesser extent, for capital expenditures. Our Board may reduce or discontinue the payment of dividends at any time for any reason it deems relevant and the Credit Agreement contains additional restrictions on our ability to pay dividends. The declaration and payment of any future dividends or repurchases of our common stock are subject to negative covenants contained in the Credit Agreement and, assuming the satisfaction or waiver by the Bank of such covenants, will be made at the discretion of our Board and will be dependent upon our financial condition, results of operation, cash flow, capital expenditures and other factors that may be deemed relevant by our Board.

We are frequently approached by parties seeking to sell their brands and related trademarks. Should an established and marketable brand or similar equity property become available on favorable terms, we would consider such an acquisition opportunity.

Sources of Liquidity.  Our primary source of liquidity is expected to be cash flow generated from operations, cash and cash equivalents currently on hand and funds made available to us pursuant to our revolving line of credit with the Bank (the “Revolver”).  We believe our cash flow from operations together with our cash and cash equivalents currently on hand and access to funds pursuant to the Revolver will be sufficient to meet our working capital, capital expenditure and other commitments through the end of Fiscal 2013. We cannot predict our revenues and cash flow generated from operations.  Some of the factors that could cause our revenues and cash flows to be materially lower are described under the caption titled “Risk Factors” in Item 1A of Part II of this Report on Form 10-Q.

As of July 28, 2012, we were not the guarantor of any other material third-party obligations. As of July 28, 2012, we did not have any irrevocable repurchase obligations.

If our revenues and cash flows during Fiscal 2013 are lower than Fiscal 2012, and subject to the terms of the Credit Agreement, we would have less cash available to pay dividends, repurchase shares of our common stock or to explore or consummate the acquisition of other brands.  In addition, if our revenues and cash flows during Fiscal 2013 are materially lower than Fiscal 2012, we may need to take steps to reduce expenditures by scaling back operations and reducing staff.  We believe that we will have sufficient cash generated from our business activities to support our operations for the next twelve months.

Former Loan Agreement with U.S. Bank

During the First Quarter and continuing until June 5, 2012, we were subject to an amended and restated loan agreement with U.S. Bank, which was entered into as of December 7, 2011, and which we recently prepaid in full on June 5, 2012 (such agreement, the “Restated Prior Loan Agreement”). Pursuant to the Restated Prior Loan Agreement, we re-financed our previous loan agreement with the Bank, which we originally entered into as of February 16, 2011 (the “Original Prior Loan Agreement”), to constitute two term loans, for an aggregate principal amount of $7,000,000 (the “Prior Loan”) consisting of (i) a term loan in the principal amount of $5,000,000, which loan was to be repaid in full on or before November 30, 2013 (the “Prior Two Year Facility”) and (ii) a term loan in the principal amount of $2,000,000, which loan was to be repaid in full on or before November 30, 2015 (the “Prior Four Year Facility”). On June 5, 2012, we prepaid all outstanding principal and interest on both the Prior Four Year Facility and the Prior Two Year Facility and, as a result of such prepayment, no portion of the Prior Loan is currently outstanding.

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Credit Agreement with JPMorgan Chase

On September 4, 2012, and in connection with the Acquisition, Cherokee and JPMorgan Chase entered into the Credit Agreement.  Pursuant to the Credit Agreement, JPMorgan Chase agreed to lend to Cherokee up to $15 million in principal (the “Loan”).  The Loan is comprised of (i) a term loan in the principal amount of $13 million (the “Term Loan”), with interest on each advance equal to either: (i) an adjusted annual LIBOR rate reset monthly, bi-monthly or quarterly, plus of 2.75% or (ii) JPMorgan’s annual prime rate minus 0.25%, with a floor equal to the 1 month LIBOR Rate plus 2.5%, and (ii) a revolving line of credit in the principal amount of $2 million (the “Revolver”), with interest on each advance equal to either: (i) an adjusted annual LIBOR rate-reset monthly, bi-monthly or quarterly, plus 2.25% or (ii) JPMorgan’s annual prime rate minus 0.25%, with a floor equal to the 1 month LIBOR Rate plus 2.5%.  The Term Loan is subject to a five year maturity date and is to be repaid in equal quarterly payments of principal in the amount of $650,000, together with interest payments made monthly as set forth in the Term Loan.  The Revolver is subject to a three year maturity date and is to be repaid in monthly interest payments on any principal then outstanding, with the balance of any then-outstanding principal and interest to be repaid at maturity.  Cherokee paid an upfront fee equal to $65,000 in connection with the issuance of the Term Loan and is obligated to pay a monthly non-usage fee of 0.25% per annum, in arrears, computed on the average daily unused portion of the Revolver, subject to Cherokee’s right to terminate the Revolver prior to maturity.  In addition, Cherokee is obligated to pay an unspecified amount to be determined by JPMorgan Chase to compensate it for its loss in the event that Cherokee elects to repay all or a portion of the Loan prior to its maturity.  The proceeds from the Term Loan were borrowed to fund the Acquisition.

The Loan is evidenced by a term note in the principal amount of $13,000,000 and a line of credit note in the principal amount of up to $2,000,000, is secured by a continuing security agreement and a trademark security agreement executed by Cherokee and is supported by a continuing guaranty executed by Cherokee’s wholly owned subsidiary, Spell C. LLC (collectively, with the Credit Agreement, the “Loan Documents”). The Credit Agreement contains various affirmative and negative covenants that are customary for loan agreements and transactions of this type, including limitations on our ability to incur debt or other liabilities and limitations on our ability to consummate acquisitions in excess of $5,000,000 in the aggregate at any time while the Loan is outstanding. In addition, the Credit Agreement prohibits us, without first obtaining JPMorgan’s consent, from (i) issuing any equity securities other than pursuant to our employee equity incentive plans and (ii) repurchasing or redeeming any outstanding shares of our common stock or paying dividends or other distributions, other than stock dividends, to our stockholders, unless such repurchases or distributions would not cause us to be violation of the “fixed charge coverage ratio” (described below) after giving pro forma effect thereto.  The Loan Agreement also imposes the following financial covenants, as specifically defined therein, including: (i) a minimum “fixed charge coverage ratio” of at least 1.2 to 1.0 to be calculated quarterly on a trailing four quarter basis and (ii) a limitation of Cherokee’s “senior funded debt ratio” not to exceed 2.0 to 1.0, measured at any time and based on the ratio of Cherokee’s consolidated total debt to Cherokee’s EBITDA for its most recently completed four-quarter test period. Further, as collateral for the Loan, we granted a security interest in favor of the Bank in all of Cherokee’s assets (including trademarks), and the Loan is guaranteed by Cherokee’s wholly owned subsidiary, Spell C. LLC. In the event of a default under the Credit Agreement, JPMorgan Chase has the right to terminate its obligations under the Credit Agreement, accelerate the payment on any unpaid balance of the Credit Agreement and exercise its other rights under the Loan Documents, including foreclosing on our assets under the security agreement. For additional information regarding the Loan Documents, please see Cherokee’s Current Report on Form 8-K dated September 4 and filed with the Commission on September 6, 2012.

Inflation and Changing Prices

The benign rate of inflation over the past several years has not had a material effect on our revenues and profits. Since most of our future revenues are based upon a percentage of sales of the licensed products by our licensees, we do not anticipate that short term future inflation will have a material impact, positive or negative, on future financial results.

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Seasonality

We have agreed to certain contractual royalty rate reductions with Target for its sales of Cherokee branded products in the U.S. in each fiscal year, which apply for future sales as certain sales volume thresholds are achieved. Historically, this has caused our first quarter to be our highest revenue and profitability quarter; our second quarter to be our next highest quarter, and our third and fourth quarters to be our lowest quarters. However, such historical patterns may vary in the future.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Market risk generally represents the risk that losses may occur in the values of financial instruments as a result of movements in interest rates, foreign currency exchange rates and commodity prices.  We do not enter into derivatives or other financial instruments for trading or speculative purposes.

Interest:  From time to time we invest our excess cash in interest-bearing temporary investments of high-quality issuers.  Due to the short time the investments are outstanding and their general liquidity, these instruments are classified as cash equivalents in our consolidated balance sheet and do not represent a material interest rate risk to us.  As of July 28, 2012, we had no long term debt obligations under our Restated Prior Loan Agreement following our prepayment in full on June 5, 2012 of all amounts then outstanding. On September 4, 2012, we entered into the Credit Agreement with JPMorgan Chase, the terms of which are described above.

Foreign Currency:  We conduct business in various parts of the world.  We are exposed to fluctuations in exchange rates to the extent that the foreign currency exchange rate fluctuates in countries where our licensees do business, and significant fluctuations in exchange rates could result in a material effect on our results of operations or cash flow.  For Fiscal 2012, revenues from international licensing comprised 46.7% of our consolidated revenues.  For the Six Months, international licensing royalties comprised 33.9% of our total revenues.  A hypothetical 10% strengthening of the U.S. dollar relative to the foreign currencies of countries where we operate would have negatively affected the Six Months revenues by approximately $0.5 million, which represents 3.4% of the total revenues reported for the Six Months.

Most of our international licensees are required to pay the royalty revenues owed to us in U.S. dollars. As a consequence, the past weakening of the U.S. dollar has benefited us in that the total royalty revenues reported from our international licensees increases when the dollar weakens against such foreign currencies. Conversely, any strengthening of the U.S. dollar has not benefited us. In the future, should the dollar strengthen against such foreign currencies, the total royalty revenues reported by us from such licensees would reflect such changes in the currency exchange rates. Accordingly, a strengthening dollar, compared to current exchange rates, would likely result in lower reported royalty revenues than otherwise would be reported as a result of such unfavorable exchange rate movements.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures. Cherokee maintains “disclosure controls and procedures,” as such term is defined under Exchange Act Rule 13a-15 (e) that are designed to ensure that information required to be disclosed in Cherokee’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to Cherokee’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

We have carried out an evaluation under the supervision and with the participation of Cherokee’s management, including Cherokee’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Cherokee’s disclosure controls and procedures.  Based upon their evaluation and subject to the foregoing, the Chief Executive Officer and Chief Financial Officer concluded that Cherokee’s disclosure controls and procedures were effective as of July 28, 2012.

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(b) Changes in internal controls.  During our most recent fiscal quarter, there were no changes in our internal control over financial reporting identified in connection with the evaluation described above that have materially affected or are reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the ordinary course of business, from time to time we become involved in legal claims and litigation. In the opinion of management, based on consultations with legal counsel, the disposition of litigation currently pending against us is unlikely to have, individually or in the aggregate, a materially adverse effect on our business, financial position or results of operations.

ITEM 1A.           RISK FACTORS

In addition to the other information contained herein or incorporated herein by reference, the risks and uncertainties and other factors described below could have a material adverse effect on our business, financial condition, results of operations and share price and could also cause our future business, financial condition and results of operations to differ materially from the results contemplated by any forward-looking statement we may make herein, in any other document we file with the Securities and Exchange Commission, or in any press release or other written or oral statement we may make. Please also see “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Cautionary Note Regarding Forward-Looking Statements” for additional risks and uncertainties applicable to us.

Our business is subject to intense competition.

Royalties paid to us under our licensing agreements are generally based on a percentage of our licensee’s net sales of licensed products. Cherokee, Carole Little and Sideout brand footwear, apparel, and accessories, together with merchandise bearing our recently acquired  Liz Lange and Completely Me by Liz Lange brands, all of 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 Polo Ralph Lauren, Tommy Hilfiger, Liz Claiborne, and private label brands such as Faded Glory, Arizona, and Route 66, developed by retailers. 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 what appears to be a de-emphasis by retailers on the manufacture of private label merchandise, in the United States our business plan focuses on creating strategic alliances with major retailers for their sale of products bearing our brands through the licensing of our trademarks directly to retailers. Therefore, our degree of success is dependent on the strength of our brands, consumer acceptance of and desire for our brands, our licensees’ ability to design, manufacture and sell products bearing our brands and to respond to ever-changing consumer demands, and any significant failure by our licensees to do so could have a material adverse effect on our business prospects, financial condition, results of operations and liquidity. We cannot control the level of resources that our licensees commit to supporting our brands, and our licensees may choose to support other brands to the detriment of ours.

There are numerous risk factors that apply to the businesses of retailers that can affect their level of sales of products that carry our brands. Any decline in sales by our licensees can adversely affect our revenues. Factors that may adversely affect retailers include the following: weather; changes in the availability or cost of capital; shifts in the seasonality of shopping patterns; labor strikes or other work interruptions including work interruptions that impact supply chains and transport vendors; the impact of excess retail capacity; changes in the cost of accepting various payment methods and changes in the rate of utilization of these payment methods; material acquisitions or dispositions; investments in new business strategies; the success or failure of significant new business ventures or technologies; actions taken or omitted to be taken by legislative, regulatory, judicial and other governmental authorities and officials; and natural disasters, the outbreak of war, acts of terrorism or other significant national or international events.

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In addition, other companies owning established trademarks could also enter into similar arrangements with retailers, including our existing retail partners, competing for limited floor pad and rack space.

Our business is largely dependent on royalties from one licensee, Target, which accounted for 54%, 49%, and 60% of our consolidated licensing revenues for Fiscal 2012, the Second Quarter, and the Six Months, respectively.

During Fiscal 2012, 54% of our licensing revenues were generated from Target. We could suffer substantially decreased royalty revenues and cash flow under the Restated Target Agreement if Target were to reduce its sales of Cherokee branded products while continuing to pay the minimum royalties of $9.0 million per fiscal year required under such agreement. Replacing the royalty payments received from Target would be a significant challenge and no assurances can be made that we would be successful in doing so. The termination of this license agreement would have a material adverse effect upon our revenues and cash flow. In addition, we have recently expanded our relationship with Target as a result of our assumption of an additional license agreement with Target for the Liz Lange and Completely Me by Liz Lange brands (the “Assumed Target Agreement”), which we assumed in connection with our acquisition of assets related to such brands (the “Acquisition”). We consummated the Acquisition in part based upon our expectation that revenues under the Assumed Target Agreement will grow in future periods, although we can provide no assurances that such revenue growth will occur or that the Assumed Target Agreement will be renewed.

We recently consummated an asset acquisition and such acquisition may not be beneficial to us.

On September 4, 2012, we consummated the Acquisition. As consideration for the Acquisition, we agree to pay a purchase price of $13.1 million in cash, $12.6 million of which we previously paid to the seller and $500,000 of which we agreed to place in an escrow fund that is to be released no later than March 31, 2013, subject to any funds which we recover or that are to be retained pursuant to indemnification claims. In addition, we agreed to pay the seller up to $900,000 in earn-out consideration, which is payable by us in two installments in the event that we achieve specified revenue targets attributable to the acquired assets during the remainder of 2012 and during 2013. As financing for the Acquisition, we concurrently borrowed $13 million from JPMorgan Chase pursuant to the Credit Agreement. We consummated the Acquisition based in part on our belief that we will be able to grow the revenue stream associated with such assets; however, we do not have any direct experience in marketing or licensing these assets and our efforts to further commercialize the acquired assets may not be successful. In addition, our management may be required to incur significant time integrating the acquired assets into our brand portfolio and such efforts may be unsuccessful or may disrupt our management or business, which could adversely affect our operations and financial results.

Our business may be negatively impacted by general economic conditions.

Our performance is subject to worldwide economic conditions and its corresponding impact on the levels of consumer spending which may affect our licensees’ sales. Consumer spending is showing signs of stabilization and in some cases improvement; however it is difficult to predict future levels of consumer spending and any such predictions are inherently uncertain. The worldwide apparel industry is heavily influenced by general economic cycles. Purchases of apparel and accessories tend to decline in periods of recession or uncertainty regarding future economic prospects, as disposable income typically declines. Many factors affect the level of consumer spending in the apparel industries, including, among others, prevailing economic conditions, levels of employment, salaries and wage rates, energy costs, interest rates, the availability of consumer credit, taxation and consumer confidence in future economic conditions. During periods of economic uncertainty, we may not be able to maintain, or increase our revenues. As a result, our operating results may be materially affected by trends in the United States or global economy.

The risks associated with our business are more acute during periods of economic slowdown or recession. In addition to other consequences, these periods may be accompanied by decreased consumer spending generally, as well as decreased demand for, or additional downward pricing pressure on, the products carrying our brands. Accordingly, any prolonged economic slowdown or a lengthy or severe recession with respect to either the U.S. or the global economy is likely to have a material adverse effect on our results of operations, financial condition and business prospects.

Our business and the success of our products could be harmed if we are unable to maintain the strength of our brands.

Our success to date has been due in large part to the strength of our brands. If we are unable to timely and appropriately respond to changing consumer demand, the strength of our brands may be impaired. Even if we react appropriately to changes in consumer preferences, consumers may consider one or more of our brands to be outdated or associate one or more of our brands with styles that are no longer popular. In the past, many apparel companies have experienced periods of rapid growth in sales and earnings followed by periods of declining sales and losses. Our business may be similarly affected in the future.

We are dependent on our intellectual property, and we cannot assure you that we will be able to successfully protect our rights.

We hold various trademarks including Cherokee, Sideout, Liz Lange, Completely Me by Liz Lange, Carole Little and others in connection with apparel, footwear, home and accessories. These trademarks are vital to the success and future growth of our business. These trademarks are registered with the United States Patent and Trademark Office and in numerous other countries. We also hold several trademark applications for Cherokee and Sideout in approximately 100 countries. There can be no assurance that the actions taken by us to establish and protect our trademarks and other proprietary rights will prevent imitation of our products or infringement of our intellectual property rights by others, or prevent the loss of licensing revenue or other damages caused thereby. In addition, the laws of several countries in which we have licensed our intellectual property may not protect our intellectual property rights to the same extent as the laws of the United States. Despite our efforts to protect our intellectual property rights, unauthorized parties may attempt to copy aspects of our intellectual property, which could have a material adverse effect on our business prospects, financial condition, results of operations and liquidity. In the future we 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 us. Any resulting litigation could result in significant expense and divert the efforts of our management personnel whether or not such litigation is determined in our favor.

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We must successfully maintain and/or upgrade our information technology systems.

We rely on various information technology systems, including our Enterprise Resource Planning (ERP) system, to manage our operations, which subjects us to inherent costs and risks associated with maintaining, upgrading, replacing and changing these systems, including impairment of our information technology, potential disruption of our internal control systems, substantial capital expenditures, demands on management time and other risks of delays or difficulties in upgrading, transitioning to new systems or of integrating new systems into our current systems.

We are dependent on our key management personnel.

Our success is highly dependent upon the continued services of our key executives, including, Henry Stupp, our Chief Executive Officer, Howard Siegel, our President and Chief Operating Officer, and Mark DiSiena, our Chief Financial Officer. We have a limited number of employees and Mr. Stupp’s and our other executives’ leadership and experience in the apparel licensing industry is important to the successful implementation of our business and marketing strategy. We do not carry key person life insurance covering any of our executives. The loss of the services of Mr. Stupp or our other key executives could have a material adverse effect on our business prospects, financial condition, results of operations and liquidity.

We may engage in additional strategic transactions that could impact our liquidity, increase our expenses and present significant distractions to our management.

From time to time we may consider engaging in strategic transactions, such as acquisitions of companies, asset purchases and out-licensing or in-licensing of brands, intellectual property rights or other assets. Any such transaction may require us to incur non-recurring or other charges, may increase our near and long-term expenditures and may pose significant integration challenges or disrupt our management or business, which could adversely affect our operations and financial results. For example, these transactions may entail numerous operational and financial risks, including, among others, exposure to unknown liabilities, disruption of our business and diversion of our management’s time and attention in order to develop acquired brands, intellectual property rights or other assets, difficulty and cost in combining the operations and personnel of any acquired businesses with our operations and personnel, and inability to retain key employees of any acquired businesses. Accordingly, although we may not choose to undertake or may not be able to successfully complete any transactions of the nature described above, any transactions that we do complete could have a material adverse effect on our business, results of operations, financial condition and prospects.

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In September 2012 we consummated a debt financing of up to $15,000,000 in principal in order to enable us to fund our recent asset acquisition.

In order to fund the Acquisition, on September 4, 2012, we entered into a credit agreement (the “Credit Agreement”) with JPMorgan Chase Bank, N.A. (“JPMorgan Chase”). Pursuant to the Credit Agreement, Cherokee borrowed up to $15 million in principal from JPMorgan Chase (the “Loan”).  The Loan is comprised of (i) a term loan in the principal amount of $13 million (the “Term Loan”), with interest on each advance equal to either: (i) an adjusted annual LIBOR rate reset monthly, bi-monthly or quarterly, plus of 2.75% or (ii) JPMorgan’s annual prime rate minus 0.25%, with a floor equal to the 1 month LIBOR Rate plus 2.5%, and (ii) a revolving line of credit in the principal amount of $2 million (the “Revolver”), with interest on each advance equal to either: (i) an adjusted annual LIBOR rate reset monthly, bi-monthly or quarterly, plus 2.25% or (ii) JPMorgan’s annual prime rate minus 0.25%, with a floor equal to the 1 month LIBOR Rate plus 2.5%.  The Term Loan is subject to a five year maturity date and is to be repaid in equal quarterly payments of principal in the amount of $650,000, together with interest payments made monthly as set forth in the Term Loan.  The Revolver is subject to a three year maturity date and is to be repaid in monthly interest payments on any principal then outstanding, with the balance of any then-outstanding principal and interest to be repaid at maturity.  Cherokee paid an upfront fee equal to $65,000 in connection with the issuance of the Term Loan and is obligated to pay a monthly non-usage fee of 0.25% per annum, in arrears, computed on the average daily unused portion of the Revolver, subject to Cherokee’s right to terminate the Revolver prior to maturity.

The Loan is evidenced by a term note in the principal amount of $13,000,000, a line of credit note in the principal amount of up to $2,000,000, a security agreement, a trademark security agreement and a continuing guaranty executed by Cherokee’s wholly owned subsidiary, Spell C. LLC (collectively, with the Credit Agreement, the “Loan Documents”). The Credit Agreement contains various affirmative and negative covenants that are customary for loan agreements and transactions of this type, including limitations on our ability to incur debt or other liabilities and limitations on our ability to consummate acquisitions in excess of $5,000,000 in the aggregate at any time while the Loan is outstanding. In addition, the Credit Agreement prohibits us, without first obtaining JPMorgan’s consent, from (i) issuing any equity securities other than pursuant to our employee equity incentive plans and (ii) repurchasing or redeeming any outstanding shares of our common stock or paying dividends or other distributions, other than stock dividends, to our stockholders, unless such repurchases or distributions would not cause us to be violation of the “fixed charge coverage ratio” (described below) after giving pro forma effect thereto.  The Loan Agreement also imposes the following financial covenants, as specifically defined therein, including: (i) a minimum “fixed charge coverage ratio” of at least 1.2 to 1.0 to be calculated quarterly on a trailing four quarter basis and (ii) a limitation of Cherokee’s “senior funded debt ratio” not to exceed 2.0 to 1.0, measured at any time and taking the ratio of Cherokee’s consolidated total debt to Cherokee’s EBITDA for its most recently completed fiscal quarter. Further, as collateral for the Loan, we granted a security interest in favor of the Bank in all of Cherokee’s assets (including trademarks), and the Loan is guaranteed by Cherokee’s wholly owned subsidiary, Spell C. LLC. In the event of a default under the Credit Agreement, JPMorgan Chase has the right to terminate its obligations under the Credit Agreement, accelerate the payment on any unpaid balance of the Credit Agreement and exercise its other rights under the Loan Documents, including foreclosing on our assets under the security agreement. Our failure to comply with the terms of our Loan Documents could result in a material adverse effect to our business, including our financial condition and our liquidity.

Our strategic and marketing initiatives may not be successful.

In recent periods, we have invested significant funds and management time in furtherance of our global strategic and marketing initiatives, which are designed to strengthen our brands, assist our licensees in generating increased sales of applicable Cherokee-branded products and build value for our stockholders over the long term. We expect to continue and, in some cases, expand such initiatives in future periods. While we are hopeful that our efforts in executing on such initiatives will expand our business and build stockholder value over the long term, there can be no assurances that we will be successful in doing so or that such initiatives will result in the benefits to us that they are intended to generate. Any failure by us to execute on our strategic initiatives, or the failure of such initiatives to cause our revenues to grow, could have a materially adverse impact on our operating results and financial performance.

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We may not pay dividends regularly or at all in the future.

Although we have paid dividends during each quarter since December 2003, and including during the first and second quarters of Fiscal 2013, our Board of Directors may reduce or discontinue dividends at any time for any reason it deems relevant and there can be no assurances that we will continue to generate sufficient cash to pay dividends, or that we will continue to pay dividends with the cash that we do generate as a result of a various factors, such as our existing debt and any business or strategic opportunities that may arise, as determined by our Board of Directors. In addition, pursuant to our Credit Agreement with JPMorgan Chase, we are prohibited from paying dividends in the event that we would be in violation of our covenant regarding our “fixed charge coverage ratio” after giving effect any proposed dividend or are otherwise then in default of such agreement.  Our ability to generate excess cash from our operations in the future is dependent upon a variety of factors, including Cherokee’s financial condition, results of operations, cash flow, capital requirements and other factors. In Fiscal 2012, we paid a total of $6.7 million in dividends, which was less than our net income of $7.5 million for Fiscal 2012. Should our cash from operations be lower in future periods, we will reduce the excess cash on our balance sheet and our Board of Directors may elect to further reduce or eliminate future dividend payments. Furthermore, should the dividend tax laws change such that taxes on dividends become higher than they currently are, we may further reduce or eliminate the dividends we pay to our stockholders in favor of other ways to increase value for our stockholders.

The trading price of our stock may be volatile.

The trading price of our common stock is likely to be subject to fluctuations as a result of various factors impacting our business, including (i) our financial results, (ii) announcements by us, our retail partners or by our competitors, as applicable, regarding or affecting the retail environment either domestically or internationally, our existing license agreements, our existing brand representations, new license agreements, new brand representations or strategic alliances or other agreements, (iii) recruitment or departure of key personnel, (iv) changes in the estimates of our financial results or changes in the recommendations of any securities analysts that elect to follow our common stock, and (v) market conditions in the retail industry and the economy as a whole.

Our Certificate of Incorporation allows our Board of Directors to issue up to 1,000,000 shares of “blank check” preferred stock.

Our Certificate of Incorporation allows our Board of Directors to issue up to 1,000,000 shares of “blank check” preferred stock, without action by our stockholders.  Subject to the approval of JPMorgan Chase pursuant to the Credit Agreement, such shares of preferred stock may be issued on terms determined by our Board of Directors, and may have rights, privileges and preferences superior to those of our common stock.  Without limiting the foregoing, (i) such shares of preferred stock could have liquidation rights that are senior to the liquidation preference applicable to our common stock, (ii) such shares of preferred stock could have voting or conversion rights, which could adversely affect the voting power of the holders of our common stock and (iii) the ownership interest of holders of our common stock will be diluted following the issuance of any such shares of preferred stock.

27

ITEM 6.  EXHIBITS

(a)Exhibits

Exhibit Number	Description of Exhibit
10.1(1)	Form of Indemnification Agreement.
10.2(2)	Form of Restricted Stock Award.
10.3*	Amendment to Stock Option Agreement, by and between Cherokee and Henry Stupp, dated as of July 26, 2012.
31.1*	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2*	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101†	The following materials from the Company’s Quarterly Report on Form 10-Q for the quarter ended July 28, 2012, formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets at July 28, 2012 and January 28, 2012; (ii) Consolidated Statement of Operations for the three months and six months ended July 28, 2012 and July 30, 2011; (iii) Condensed Consolidated Statement of Stockholders’ Equity for the six months ended July 28, 2012; (iv) Consolidated Statements of Cash Flows for the six months ended July 28, 2012 and July 30, 2012; and (v) Notes to Condensed Consolidated Financial Statements, tagged as block of text.

(1)	Incorporated by reference to Exhibit 10.1 of Cherokee’s Current Report on Form 8-K dated June 5, 2012.
(2)	Incorporated by reference to Exhibit 10.1 of Cherokee’s Current Report on Form 8-K dated June 18, 2012.
*	Filed herewith.

† Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

28

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated:  September 6, 2012

CHEROKEE INC.
By:	/s/ Henry Stupp
	Henry Stupp
	Chief Executive Officer
	(Principal Executive Officer)
By:	/s/ Mark DiSiena
	Mark DiSiena
	Chief Financial Officer
	(Principal Financial Officer and Principal Accounting Officer)

29

EX-10.3

Exhibit 10.3

AMENDMENT TO STOCK OPTION AGREEMENT

This Amendment to the Stock Option Agreement (this “Amendment”) is entered into as of July 26, 2012 by and between Cherokee Inc., a Delaware corporation (the “Company”) and Henry Stupp (“Stupp”).

WHEREAS, pursuant to a Stock Option Agreement, dated as of August 26, 2010, by and between the Company and Stupp, as amended (the “Existing Agreement”), the Company awarded Stupp an option (the “Option”) to purchase shares of the Company’s common stock (“Shares”) at an exercise price of $18.30 per share;

WHEREAS, pursuant to the Existing Agreement, and pursuant to the terms of that certain Employment Agreement, dated as of August 26, 2010, by and between the Company and Stupp, as amended to date (the “Employment Agreement”), the Option is currently exercisable for up to a maximum number of Shares equal to 187,500;

WHEREAS, Stupp has requested that the Existing Agreement be amended to permit the transfer of up to fifty percent (50%) of the Shares subject to the Option to his spouse in the event the termination of their marriage pursuant to a marital property settlement; and

WHEREAS, the parties now desire to amend the Existing Agreement in the manner set forth herein.

NOW, THEREFORE, in consideration of the premises, the mutual covenants contained herein and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto hereby agree as follows:

1.Definitions; Construction.  Capitalized terms not otherwise defined herein shall have the meanings set forth in the Existing Agreement.  References in the Existing Agreement (including references to the Existing Agreement as amended hereby) to the “Agreement” or “Option” (and indirect references such as “hereunder”, “hereby”, “herein” and “hereof”) shall be deemed to be references to such terms as amended hereby.

2.Amendment to Section 4.2.  Section 4.2 of the Existing Agreement is hereby amended to add a new Section 4.2(c) as set forth below:

“(c)Notwithstanding the foregoing, the Optionee may transfer the right to exercise up to fifty percent (50%) of the shares subject to the Option (rounded up to the nearest whole share) to his former spouse in connection with the termination of their marriage pursuant to a marital property settlement (such transferred rights, the “Transferred Option”).  In such event, (i) the Transferred Option may only be exercised by the Transferee during her lifetime or thereafter in accordance with Section 3.1 and Section 4.2(b) and (ii) all of the other terms and conditions of this Option, and each of them, shall continue to apply to the Transferee (including, without limitation, the vesting conditions applicable to the Option set forth in Section 2, which are specific to the services of Mr. Henry Stupp to the Company).  In addition, as a condition precedent to the effectiveness of such transfer, the Optionee and the Transferee shall execute and provide such other documents and agreements as the Company may require in its discretion to properly confirm, effect and memorialize the transfer of the Transferred Option. Without limiting the foregoing, the Optionee and the Transferee shall be obligated to covenant, represent and warrant to the Company that (i) upon exercise of the Transferred Option, the Transferee shall provide the Company with funds sufficient to cover the Company’s withholding obligations applicable to the Transferee, including with respect to the income tax attributable to the Transferee as a result of such exercise, (ii) the Optionee shall provide the Company with funds sufficient to cover the Company’s withholding obligations attributable to the Optionee, including the Company’s withholding obligations under FICA and other applicable obligations and (iii) each of the Optionee and the Transferee shall each indemnify the Company for any failure to provide the Company with sufficient funds to meet its withholding obligations under applicable law that are applicable to the Optionee or the Transferee.”

1

3.Effect of Amendment.  Except as set forth in this Amendment, the Existing Agreement shall remain unchanged and in full force and effect pursuant to the terms thereof.

4.Miscellaneous.  This Amendment shall be governed by and construed in accordance with the laws of the State of California.  The headings of the sections of this Amendment have been inserted for convenience and reference only and do not constitute a part of this Amendment.  This Amendment may be executed in any number of counterparts and by different persons in separate counterparts, with the same effect as if all parties had signed the same document; all such counterparts shall be deemed to be an original, shall be construed together and shall constitute one and the same instrument.  Any signature page delivered by facsimile or e-mail transmission of images in Adobe PDF or similar format shall be binding to the same extent as an original signature page, with regard to any agreement subject to the terms hereof or any amendment thereto.  This Amendment, together with the Existing Agreement as amended hereby, shall supersede and replace any prior agreement between the Company and Stupp relating to the subject matter hereof.

[Remainder of Page Intentionally Left Blank]

2

IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed as of the date first above written.

CHEROKEE INC.

/s/ Mark DiSiena

Mark DiSiena, Chief Financial Officer

STUPP

/s/ Henry Stupp

Henry Stupp

3

EX-31.1

Exhibit 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Henry Stupp, certify that:

1.I have reviewed this quarterly report on Form 10-Q of Cherokee Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated: September 6, 2012	By:	/s/ Henry Stupp
		Henry Stupp
		Chief Executive Officer
		(Principal Executive Officer)

EX-31.2

Exhibit 31.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Mark DiSiena, certify that:

1.I have reviewed this quarterly report on Form 10-Q of Cherokee Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Dated: September 6, 2012	By:	/s/ Mark DiSiena
		Mark DiSiena
		Chief Financial Officer
		(Principal Financial Officer and
		Principal Accounting Officer)

EX-32.1

Exhibit 32.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Pursuant to 18 U.S.C. § 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Cherokee Inc. (the “Company”) hereby certifies, to such officer’s knowledge, that:

(i) the accompanying Quarterly Report on Form 10-Q of the Company for the quarterly period ended July 28, 2012 (the “Report”) fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and

(ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: September 6, 2012	By:	/s/ Henry Stupp
		Henry Stupp
		Chief Executive Officer
		(Principal Executive Officer)

This certification has not been, and shall not be deemed, “filed” with the Securities and Exchange Commission.

EX-32.2

Exhibit 32.2

CERTIFICATION OF CHIEF FINANCIAL OFFICER

PURSUANT TO 18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

Pursuant to 18 U.S.C. § 1350, as adopted by Section 906 of the Sarbanes-Oxley Act of 2002, the undersigned officer of Cherokee Inc. (the “Company”) hereby certifies, to such officer’s knowledge, that:

(i) the accompanying Quarterly Report on Form 10-Q of the Company for the quarterly period ended July 28, 2012 (the “Report”) fully complies with the requirements of Section 13(a) or Section 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and

(ii) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: September 6, 2012	By:	/s/ Mark DiSiena
		Mark DiSiena
		Chief Financial Officer
		(Principal Financial Officer and
		Principal Accounting Officer)

This certification has not been, and shall not be deemed, “filed” with the Securities and Exchange Commission.

XML

Dividends

6 Months Ended

Jul. 28, 2012

Dividends

Dividends

(3)    Dividends

On January 28, 2012, our Board of Directors declared a dividend of $1.7 million, or $0.20 per share, which was paid on March 12, 2012.  On April 28, 2012, our Board of Directors declared a dividend of $1.7 million, or $0.20 per share, which was paid on June 15, 2012 to stockholders of record as of June 1, 2012.  On July 28, 2012, our Board of Directors declared a dividend of $1.7 million, or $0.20 per share, which is to be paid on September 15, 2012 to stockholders of record as of September 1, 2012.

XML

Summary of Significant Accounting Policies

6 Months Ended

Jul. 28, 2012

Summary of Significant Accounting Policies

Summary of Significant Accounting Policies

(2)   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.

Allowance for Doubtful Accounts

The Company records its allowance for doubtful accounts based upon its assessment of various factors, such as: historical experience, age of accounts receivable balances, credit quality of our licensees, current economic conditions, bankruptcy, and other factors that may affect our licensees’ ability to pay.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires us 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

We consider all highly liquid debt instruments purchased and money market funds purchased with an original maturity date of three months or less to be cash equivalents.

Revenue Recognition

Revenues from royalty and brand representation agreements are recognized when earned by applying contractual royalty rates to quarterly point of sale data received from our licensees. Our royalty recognition policy provides for recognition of royalties in the quarter earned, although a large portion of such royalty payments are actually received during the month following the end of a quarter. Revenues are not recognized unless collectability is reasonably assured. Our agreement with Target for the Cherokee brand in the U.S. accounts for the majority of our historical revenues and is structured to provide royalty rate reductions once certain cumulative levels of sales are achieved. With respect to Target’s sales in the U.S., revenue is recognized by applying the reduced contractual royalty rates prospectively to point of sale data as defined sales thresholds are exceeded. The royalty rate reductions do not apply retroactively to sales since the beginning of the fiscal year. As a result, our royalty revenues as a percentage of Target’s retail sales in the U.S. are highest at the beginning of each fiscal year and decrease during the fiscal year as Target exceeds sales thresholds as set forth in our agreement with Target. The amount of royalty revenue earned by us from Target in any quarter is dependent not only Target’s retail sales of Cherokee branded products in the U.S. in each quarter, but also on the royalty rate then in effect after considering Target’s cumulative level of retail sales for Cherokee branded products in the U.S. for the fiscal year. Historically this has caused our first quarter to be our highest revenue and profitability quarter; our second quarter to be our next highest quarter; and our third and fourth quarters to be our lowest quarters. However, such historical patterns may vary in the future, depending upon the execution of new license agreements and retail sales volumes achieved in each quarter from Target and also on the revenues we receive from other licensees that do not pay us reduced royalty rates based upon cumulative sales.

Deferred Revenue

Deferred revenues represent minimum licensee revenue royalties paid in advance, the majority of which are non-refundable to the licensee. Historically, deferred revenue was combined with accounts payable; however, deferred revenue is currently presented separately as current and non-current items on our balance sheet. The values and timing of recognition of deferred revenues are outlined in our license agreements.

Earnings Per Share Computation

The following table provides a reconciliation of the numerator and denominator of the basic and diluted per-share computations for the three and six month periods ended July 28, 2012 and July 30, 2011:

	Three Months Ended				Six Months Ended
	July 28, 2012		July 30, 2011		July 28, 2012		July 30, 2011
Numerator:
Net income-numerator for net income per common share and net income per common share assuming dilution	$	1,608,000	$	1,672,000	$	3,679,000	$	4,923,000
Denominator:
Denominator for net income per common share — weighted average Shares	8,390,417		8,504,247		8,388,791		8,501,867
Effect of dilutive securities:
Stock options	15,371		30,271		7,547		26,434
Denominator for net income per common share, assuming dilution:
Adjusted weighted average shares and assumed exercises	8,405,788		8,534,518		8,396,338		8,528,301

The computation for diluted number of shares excludes unexercised stock options which are anti-dilutive. There were 780,499 and 637,000 anti-dilutive shares for the three and six months ended July 28, 2012 and July 30, 2011, respectively. Consequently, the diluted weighted average number of shares for the three and six month periods ended July 28, 2012 and July 30, 2011 excludes 780,499 and 637,000 shares, respectively.

Significant Contracts

In 1997, we entered into an agreement with Target that grants Target the exclusive right in the United States to use the Cherokee trademarks in certain categories of merchandise. The current terms of our relationship with Target are set forth in a restated license agreement with Target, which was entered into effective as of February 1, 2008 and amended on December 1, 2011 (the “Restated Target Agreement”). The Restated Target Agreement grants Target the exclusive right in the United States to use the Cherokee trademarks in various specified categories of merchandise. In addition, pursuant to a Canada Affiliate Agreement between Cherokee and Target Canada Co., dated December 1, 2011 (the “Target Canada Agreement”), and subject to our agreement with Zellers, the terms of the Restated Target Agreement will apply to the territory of Canada effective as of February 1, 2013 and Target will have exclusive rights to the Cherokee brand within the territory of Canada effective as of January 31, 2014 (or earlier if our agreement with Zellers terminates before such date). The term of the Restated Target Agreement continues through January 31, 2013. However, the Restated Target Agreement provides that if Target remains current in its payments of the minimum guaranteed royalty of $9.0 million for Fiscal 2013, then the term of the Restated Target Agreement will continue to renew automatically for successive fiscal year terms provided that Target does not give notice of its intention to terminate the Restated Target Agreement during February of the calendar year prior to termination. In addition, effective as of February 1, 2013, the minimum guaranteed royalty for Target will increase to $10.5 million and will apply to all sales made by Target in the United States or in Canada as contemplated by the Target Canada Agreement. Under the Restated Target Agreement, Target has agreed to pay royalties based on a percentage of Target’s net sales of Cherokee branded merchandise in the U.S. during each fiscal year ended January 31st, which percentage varies according to the volume of sales of merchandise. Under the Target Canada Agreement, Target has agreed to pay a fixed royalty rate based on a percentage of Target’s net sales of Cherokee branded merchandise in Canada during each fiscal quarter. Royalty revenues from Target totaled $13.8 million in Fiscal 2012, $13.0 million in Fiscal 2011 and $13.2 million in Fiscal 2010.

We also have other licensing agreements regarding our brands, including with Tesco for our Cherokee brand in the United Kingdom, Ireland, the Czech Republic, Slovakia, Poland, Hungary and Turkey. For a more complete description of certain of our license agreements and other commercial agreements, please see our Annual Report on Form 10-K for Fiscal 2012, which was filed with the Securities and Exchange Commission (the “Commission”) on April 12, 2012.

On September 4, 2012, Cherokee and LLM Management Co., LLC entered into an Asset Purchase Agreement pursuant to which Cherokee acquired assets related to the Liz Lange and Completely Me by Liz Lange brands.  See Note 6. (“Subsequent Events”) below.

Stock-Based Compensation

We currently maintain two equity-based compensation plans:  (i) the 2003 Incentive Award Plan as amended in 2006 with the adoption of the 2006 Incentive Award Plan (the “2003 Plan”); and (ii) the 2006 Incentive Award Plan (the “2006 Plan”).  Each of these equity based compensation plans provide for the issuance of equity-based awards to officers and other employees and directors, and they have previously been approved by our stockholders.  Stock options issued to employees are granted at the market price on the date of grant, generally vest over a three-year period, and generally expire seven to ten years from the date of grant.  We issue new shares of common stock upon exercise of stock options.

2003 Plan—The 2003 Plan was approved at the June 9, 2003 Annual Meeting of Stockholders, and amended on June 13, 2006 with the adoption of the 2006 Plan by the Company’s Stockholders at the June 2006 Annual Meeting of Stockholders.  Under the 2003 Plan, the Company is authorized to grant up to 250,000 shares of common stock in the form of incentive and nonqualified options and restricted stock awards.  The maximum number of shares which may be subject to grants under the 2003 Plan to any individual in any calendar year cannot exceed 100,000.  During the First Quarter, we granted to certain employees stock options with a seven-year term to purchase a total of 70,000 shares of our common stock at an exercise price of $10.92 per share (the closing price on the date of grant) pursuant to the 2003 Plan. During the Second Quarter, we did not make any grants pursuant to the 2003 Plan. As of July 28, 2012, there were 34,982 shares available for issuance under the 2003 Plan.

2006 Plan—The 2006 Plan was approved at the June 2006 Annual Meeting of Stockholders and amended at the June 2010 Annual Meeting of Stockholders, under which the Company is authorized to grant up to 750,000 shares of common stock in the form of incentive and nonqualified options and restricted stock awards. The maximum number of shares that may be subject to grant under the 2006 Plan to any individual in any calendar year cannot exceed 100,000. During the First Quarter, we granted to certain employees stock options with a seven-year term to purchase 10,000 shares of our common stock at an exercise price of $10.92 per share (the closing price on the date of grant) pursuant to the 2006 Plan. During the Second Quarter, we granted to certain employees and non-employee directors stock options with a seven-year term to purchase a total of 213,000 shares of our common stock at exercise prices of $13.06 and $14.12 per share (which were the closing prices on the date of each applicable grant) pursuant to the 2006 Plan.   In addition, during the Second Quarter, we granted to each of our non-employee directors restricted stock awards of 1,500 shares, or 7,500 shares in total, of our common stock pursuant to the 2006 Plan.  As of July 28, 2012, there were 55,334 shares available for issuance under the 2006 Plan.

Following the approval by Cherokee’s stockholders, on June 4, 2010, we issued to Robert Margolis, our former Executive Chairman, a non-qualified stock option to purchase 100,000 shares of our Common Stock (the “Margolis Option”) at an exercise price of $18.49, which was the closing price of our Common Stock on June 4, 2010. The Margolis Option was not issued pursuant to any of Cherokee’s existing equity incentive plans. Pursuant to its original terms, the Margolis Option was to vest contingent on Mr. Margolis’ continued service as a member of our Board of Directors in two equal installments of 50,000, on January 31, 2011 and January 31, 2012; however, pursuant to our separation with Mr. Margolis, the vesting applicable to the Margolis Option was accelerated in full. The Margolis Option is exercisable until June 4, 2015.

In addition, in connection with appointment of Mr. Stupp as our Chief Executive Officer, on August 26, 2010, we granted to Mr. Stupp an option to purchase shares (the “Stupp Option”) of Cherokee’s common stock as an inducement grant outside of the 2006 Plan, subject to vesting requirements and other terms. The Stupp Option was originally exercisable for up to a total of 300,000 shares and the maximum number of shares for which the Stupp Option may exercise is 187,500 as of the date of this report (subject to applicable vesting conditions set forth in the Stupp Option). This grant of stock options was entered into as an inducement material for Mr. Stupp to enter into employment with Cherokee. While the grant of the Stupp Option was made outside of the 2006 Plan, the grant is consistent with applicable terms of the 2006 Plan. See the description of the Stupp Option in Note 4. Related Party Transactions.

Stock-based compensation expense recognized for the Six Months was $452,000, as compared to $389,000 for the comparable period in the prior year.

The estimated fair value of options granted during Fiscal 2013 and Fiscal 2012 as of each grant date was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Fiscal 2013	Fiscal 2012
Expected Dividend Yield	5.67% to 7.33%	4.65% to 6.67%
Expected Volatility	51.63 to 53.33	49.28 to 51.95
Avg. Risk-Free Rate	0.57% to 1.01%	0.74% to 1.1%
Expected Life (in years)	4.5	4.5 to 5.0
Estimated Forfeiture Rate	15%	30%

The expected term of the options represents the estimated period of time until exercise and is based on historical experience of similar options, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. Expected stock price volatility is based on the historical volatility of our stock price. The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of grant with an equivalent remaining term. Our dividend yield is based on the past dividends paid and the current dividend yield at the time of grant.

A summary of activity for the Company’s stock options for the Six Months is as follows:

					Weighted
					Average
					Remaining
			Weighted		Contractual	Aggregate
			Average		Term	Intrinsic
	Shares		Price		(in years)	Value
Outstanding, at January 28, 2012	973,833		$	17.92
Granted	293,000		$	11.75
Exercised
Canceled/forfeited	(163,334	)	$	19.23
Outstanding, at July 28, 2012	1,103,499		$	16.28	4.94	$	577,600
Vested and Exercisable at July 28, 2012	445,663		$	17.68	3.11	$	34,100
Non-vested and not exercisable at July 28, 2012	657,836		$	15.35	5.65	$	543,500

As of July 28, 2012, total unrecognized stock-based compensation expense related to non-vested, equity based awards was approximately $2,209,602 for stock options and $97,150 for restricted stock awards, which is expected to be recognized over a weighted average period of approximately 2.8 and 2.9 years, respectively.  The total fair value of all options which vested during the Six Months was $694,527. There were no restricted stock awards vested during the Six Months.

Trademarks

During the Second Quarter and Six Months, the Company did not acquire any trademarks, nor were there any trademark acquisitions during the comparable period last year.  Trademark registration and renewal fees which were capitalized during the Second Quarter and Six Months totaled $75,000 and $153,000, respectively.  In comparison, for the second quarter and six months of last year, the total trademark registration and renewal fees capitalized totaled $66,000 and $174,000, respectively.

Income Taxes

Income tax expense of $1,031,000 was recognized for the Second Quarter, resulting in an effective tax rate of 39.1% in the Second Quarter, as compared to an effective tax rate of 36.6% in the second quarter of last year and compared to 28.0% for the full year of Fiscal 2012. Our lower effective tax rate in Fiscal 2012 was primarily the result of settling income tax examinations with the California Franchise Tax Board related to our apportionment of income.

The Company files U.S. federal and state income tax returns. For our federal income tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to Fiscal 2011. With limited exception, our significant state tax jurisdictions are no longer subject to examinations by the various tax authorities for fiscal years prior to 2008. Although the outcome of tax audits is always uncertain, we believe that adequate amounts of tax, interest and penalties, if any, have been provided for in our income tax reserve for any adjustments that may result from future tax audits. We recognize interest and penalties, if any, related to unrecognized tax benefits within the provision for income taxes in our consolidated statement of income. As of January 28, 2012 and July 28, 2012, respectively, accrued interest on a gross basis was $130,000 and $161,000.

As of January 28, 2012 and July 28, 2012, respectively, the total amount of gross unrecognized tax benefits was approximately $900,000 and $917,000, of which approximately $596,000 represents the amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate. It is reasonably possible that $700,000 of the $917,000 of unrecognized tax benefits will settle in the next twelve months. We do not expect this change to have a significant impact on the results of operations or the financial position of the Company.

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued an update to ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. ASC 820 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years, with early adoption permitted. We adopted ASC 820 on the first day of Fiscal 2009, and this adoption did not have a material impact on our consolidated financial statements.

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CONSOLIDATED BALANCE SHEETS (USD $)	Jul. 28, 2012	Jan. 28, 2012
Current assets:
Cash and cash equivalents	$ 2,089,000	$ 7,421,000
Receivables	5,963,000	5,320,000
Income taxes receivable	475,000	672,000
Prepaid expenses and other current assets	217,000	152,000
Deferred tax asset	101,000	100,000
Total current assets	8,845,000	13,665,000
Deferred tax asset	1,223,000	1,230,000
Property and equipment, net	937,000	733,000
Trademarks, net	5,075,000	5,596,000
Other assets	204,000
Total assets	16,284,000	21,224,000
Current liabilities:
Accounts payable	1,571,000	850,000
Deferred Revenue - Current	100,000	320,000
Accrued compensation payable	124,000	268,000
Income taxes payable	1,119,000
Accrued dividends	1,679,000	1,677,000
Deferred tax liability - current	38,000	38,000
Short term debt		500,000
Total current liabilities	4,631,000	3,653,000
Long term liabilities:
Deferred Revenue - Non-Current	125,000	382,000
Long term debt		6,438,000
Total liabilities	4,756,000	10,473,000
Commitments and Contingencies
Stockholders' Equity
Preferred stock, $.02 par value, 1,000,000 shares authorized, none issued and outstanding
Common stock, $.02 par value, 20,000,000 shares authorized, 8,394,667 issued and outstanding at July 28, 2012 and 8,387,167 issued and outstanding at January 28, 2012	167,000	167,000
Additional paid-in capital	19,726,000	19,271,000
Retained earnings (deficit)	(8,365,000)	(8,687,000)
Total stockholders' equity	11,528,000	10,751,000
Total liabilities and stockholders' equity	$ 16,284,000	$ 21,224,000

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CONSOLIDATED STATEMENTS OF CASH FLOWS (USD $)	6 Months Ended
	Jul. 28, 2012	Jul. 30, 2011
Operating activities
Net income	$ 3,679,000	$ 4,923,000
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	82,000	43,000
Amortization of trademarks	674,000	681,000
Deferred income taxes	6,000	656,000
Net loss on retirement of assets	76,000
Stock-based compensation	455,000	389,000
Changes in current assets and liabilities:
Decrease (increase) in accounts receivable	(643,000)	513,000
Decrease (increase) in prepaid expenses and other assets	(269,000)	(73,000)
Decrease (increase) in income taxes receivable	197,000	1,102,000
Increase (decrease) in accounts payable	721,000	(26,000)
Increase (decrease) in deferred revenue	(477,000)
Increase (decrease) in accrued compensation	(144,000)	(4,238,000)
Increase (decrease) in income taxes payable and other accrued liabilities	1,121,000	(562,000)
Net cash provided by operating activities	5,478,000	3,408,000
Investing activities
Purchase of property and equipment	(362,000)	(133,000)
Purchase of trademarks, registration and renewal costs	(153,000)	(174,000)
Net cash used in investing activities	(515,000)	(307,000)
Financing activities
Proceeds from term loan		10,000,000
Payment of term loan	(6,438,000)	(1,537,000)
Proceeds from exercise of stock options		161,000
Issuance of common stock		200,000
Repurchase of common stock		(395,000)
Payment of short term notes payable	(500,000)	(7,260,000)
Payment of Dividends	(3,357,000)	(3,391,000)
Net cash used in financing activities	(10,295,000)	(2,222,000)
Increase (decrease) in cash and cash equivalents	(5,332,000)	879,000
Cash and cash equivalents at beginning of period	7,421,000	9,587,000
Cash and cash equivalents at end of period	2,089,000	10,466,000
Cash paid during period for:
Income taxes	1,002,000	1,914,000
Declaration of dividends	$ 1,679,000	$ 1,690,000

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Debt (Details) (USD $)	1 Months Ended
	Dec. 31, 2011	Dec. 07, 2011
Prior Two Year Facility
Debt
Principal amount		$ 5,000,000
Term of loan	2 years
Prior Four Year Facility
Debt
Principal amount		$ 2,000,000
Term of loan	4 years

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Basis of Presentation

6 Months Ended

Jul. 28, 2012

Basis of Presentation

Basis of Presentation

(1)   Basis of Presentation

The accompanying unaudited condensed consolidated financial statements as of July 28, 2012 and for the three and six month periods ended July 28, 2012 and July 30, 2011 have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). These consolidated financial statements have not been audited by independent registered public accountants but include all adjustments, consisting of normal recurring accruals, which in the opinion of management of Cherokee Inc. (“Cherokee” or the “Company”) are necessary for a fair statement of the financial position and the results of operations for the periods presented.  The accompanying consolidated balance sheet as of January 28, 2012 has been derived from audited consolidated financial statements, but does not include all disclosures required by GAAP.  The results of operations for the three and six month periods ended July 28, 2012 are not necessarily indicative of the results to be expected for the fiscal year ending February 2, 2013.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2012.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of sales and expenses during the reporting period. Actual results could differ from those estimates.

As used herein, the term “First Quarter” refers to the three months ended April 28, 2012; the term “Second Quarter” refers to the three months ended July 28, 2012; the term “Six Months” refers to the six months ended July 28, 2012; the term “Fiscal 2013” refers to our fiscal year ending February 2, 2013; the term “Fiscal 2012” refers to our most recent past fiscal year ended January 28, 2012; and the term “Fiscal 2011” refers to our fiscal year ended January 29, 2011.

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CONSOLIDATED BALANCE SHEETS (Parenthetical) (USD $)	Jul. 28, 2012	Jan. 28, 2012
CONSOLIDATED BALANCE SHEETS
Preferred stock, par value (in dollars per share)	$ 0.02	$ 0.02
Preferred stock, shares authorized	1,000,000	1,000,000
Preferred stock, shares issued	0	0
Preferred stock, shares outstanding	0	0
Common stock, par value (in dollars per share)	$ 0.02	$ 0.02
Common stock, shares authorized	20,000,000	20,000,000
Common stock, shares issued	8,394,667	8,387,167
Common stock, shares outstanding	8,394,667	8,387,167

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Summary of Significant Accounting Policies (Details 3) (USD $)	6 Months Ended		12 Months Ended	6 Months Ended	12 Months Ended	6 Months Ended	12 Months Ended	1 Months Ended			6 Months Ended		1 Months Ended		6 Months Ended				6 Months Ended	3 Months Ended		6 Months Ended	3 Months Ended
	Jul. 28, 2012 item	Jul. 30, 2011	Jan. 28, 2012	Jul. 28, 2012 Minimum	Jan. 28, 2012 Minimum	Jul. 28, 2012 Maximum	Jan. 28, 2012 Maximum	Jun. 30, 2010 Non-Qualified Stock Option Robert Margolis installment	Jan. 31, 2012 Non-Qualified Stock Option Robert Margolis	Jan. 31, 2011 Non-Qualified Stock Option Robert Margolis	Jul. 28, 2012 Stock Options	Jan. 28, 2012 Stock Options	Aug. 31, 2010 Stock Options Mr. Stupp	Jul. 28, 2012 Stock Options Mr. Stupp	Jul. 28, 2012 Stock Options Employees	Jul. 28, 2012 Stock Options Minimum Employees	Jul. 28, 2012 Stock Options Maximum Employees	Jul. 28, 2012 2003 Plan	Jul. 28, 2012 2003 Plan Maximum	Apr. 28, 2012 2003 Plan Stock Options Employees	Jul. 28, 2012 2006 Plan	Jul. 28, 2012 2006 Plan Maximum	Jul. 28, 2012 2006 Plan Stock Options Employees	Apr. 28, 2012 2006 Plan Stock Options Employees	Jul. 28, 2012 2006 Plan Stock Options Non-employee directors	Jul. 28, 2012 2006 Plan Stock Options Employees and non-employee directors	Jul. 28, 2012 2006 Plan Restricted stock awards Non-employee directors
Summary of Significant Accounting Policies
Number of equity-based compensation plans	2
Stock-based compensation
Vesting period															3 years
Expiration period																7 years	10 years			7 years				7 years		7 years
Number of shares authorized for grant																			250,000			750,000
Maximum number of shares which may be granted to an individual in any calendar year																			100,000			100,000
Number of stock options granted (in shares)								100,000			293,000		300,000							70,000				10,000		213,000
Exercise price of stock option granted (in dollars per share)								$ 18.49			$ 11.75		$ 18.30							$ 10.92			$ 13.06	$ 10.92	$ 14.12
Number of shares available for issuance																		34,982			55,334
Restricted stock awards granted																											7,500
Restricted stock awards granted to each non-employee director																											1,500
Number of equal installments for vesting of option								2
Amount of shares that vest in each equal installment									50,000	50,000
Number of shares subject to option											1,103,499	973,833		187,500
Stock-based compensation expense recognized	$ 452,000	$ 389,000
Weighted average assumptions
Expected Dividend Yield (as a percent)				5.67%	4.65%	7.33%	6.67%
Expected Volatility (as a percent)				51.63%	49.28%	53.33%	51.95%
Avg. Risk-Free Rate (as a percent)				0.57%	0.74%	1.01%	1.10%
Expected Life	4 years 6 months				4 years 6 months		5 years
Estimated Forfeiture Rate (as a percent)	15.00%		30.00%

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Document and Entity Information	6 Months Ended
	Jul. 28, 2012	Sep. 05, 2012
Document and Entity Information
Entity Registrant Name	CHEROKEE INC
Entity Central Index Key	0000844161
Document Type	10-Q
Document Period End Date	Jul. 28, 2012
Amendment Flag	false
Current Fiscal Year End Date	--02-02
Entity Current Reporting Status	Yes
Entity Filer Category	Accelerated Filer
Entity Common Stock, Shares Outstanding		8,394,667
Document Fiscal Year Focus	2013
Document Fiscal Period Focus	Q2

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Summary of Significant Accounting Policies (Details 4) (USD $)	6 Months Ended
	Jul. 28, 2012
Stock Options
Shares
Outstanding at the beginning of the period (in shares)	973,833
Granted (in shares)	293,000
Canceled/forfeited (in shares)	(163,334)
Outstanding at the end of the period (in shares)	1,103,499
Vested and Exercisable at the end of the period (in shares)	445,663
Non-vested and not exercisable at the end of the period (in shares)	657,836
Weighted Average Price
Outstanding at the beginning of the period (in dollars per share)	$ 17.92
Granted (in dollars per share)	$ 11.75
Canceled/forfeited (in dollars per share)	$ 19.23
Outstanding at the end of the period (in dollars per share)	$ 16.28
Vested and Exercisable at the end of the period (in dollars per share)	$ 17.68
Non-vested and not exercisable at the end of the period (in dollars per share)	$ 15.35
Weighted Average Remaining Contractual Term (in years)
Outstanding	4 years 11 months 8 days
Vested and Exercisable at the end of the period	3 years 1 month 10 days
Non-vested and not exercisable at the end of the period	5 years 7 months 24 days
Aggregate Intrinsic Value
Outstanding at the end of the period	$ 577,600
Non-vested and not exercisable at the end of the period	543,500
Vested and Exercisable at the end of the period	34,100
Unrecognized stock-based compensation
Unrecognized stock-based compensation expense	2,209,602
Weighted average period for recognition of unrecognized stock-based compensation expense	2 years 9 months 18 days
Fair value
Total fair value of vested options	694,527
Restricted Stock Awards
Unrecognized stock-based compensation
Unrecognized stock-based compensation expense	$ 97,150
Weighted average period for recognition of unrecognized stock-based compensation expense	2 years 10 months 24 days

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CONSOLIDATED STATEMENTS OF OPERATIONS (USD $)	3 Months Ended		6 Months Ended
	Jul. 28, 2012	Jul. 30, 2011	Jul. 28, 2012	Jul. 30, 2011
Royalty revenues	$ 6,306,000	$ 6,658,000	$ 13,821,000	$ 13,602,000
Selling, general and administrative expenses	3,644,000	3,954,000	7,799,000	7,258,000
Operating income	2,662,000	2,704,000	6,022,000	6,344,000
Other income:
Interest expense	(23,000)	(68,000)	(73,000)	(134,000)
Investment and interest income		2,000	12,000	22,000
Total other income	(23,000)	(66,000)	(61,000)	(112,000)
Income before income taxes	2,639,000	2,638,000	5,961,000	6,232,000
Income tax provision	1,031,000	966,000	2,282,000	1,309,000
Net income	$ 1,608,000	$ 1,672,000	$ 3,679,000	$ 4,923,000
Basic earnings per share (in dollars per share)	$ 0.19	$ 0.20	$ 0.44	$ 0.58
Diluted earnings per share (in dollars per share)	$ 0.19	$ 0.20	$ 0.44	$ 0.58
Weighted average shares outstanding
Basic (in shares)	8,390,417	8,504,247	8,388,791	8,501,867
Diluted (in shares)	8,405,788	8,534,518	8,396,338	8,528,301

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Subsequent Events

6 Months Ended

Jul. 28, 2012

Subsequent Events

Subsequent Events

(6) Subsequent Events

Acquisition of Assets Related to the Liz Lange and Completely Me by Liz Lange Brands

On September 4, 2012, Cherokee and LLM Management Co., LLC (the “Seller”) entered into an Asset Purchase Agreement (the “Asset Purchase Agreement”), pursuant to which Cherokee acquired various assets related to the “Liz Lange” and “Completely Me by Liz Lange” brands (the “Assets” and such transaction, the “Acquisition”). The Acquisition closed on September 4, 2012.   As consideration for the Acquisition, Cherokee agreed to pay a cash purchase price equal to $13.1 million, with $12.6 million paid by Cherokee concurrently with the closing and with $500,000 of which we agreed to place in an escrow fund that is to be released no later than March 31, 2013, subject to any funds which we recover or that are to be retained pursuant to indemnification claims.  In addition, Cherokee agreed to pay to the Seller additional earn-out payments of $400,000 and $500,000 (for a total of up to $900,000 in contingent consideration), which consideration is payable upon our achievement of specified revenue targets attributable to the Assets during the remainder of 2012 and during 2013.  In addition, as part of the Acquisition, Cherokee agreed to assume the Seller’s obligations under various agreements, which include a consulting agreement with Ms. Lange as well as certain existing license agreements relating to the Assets, including a license agreement with Target.  The Asset Purchase Agreement contains various covenants, indemnities and representations and warranties that are customary for transactions of this type.  For additional information regarding the Acquisition and the Asset Purchase Agreement, please see Cherokee’s Current Report on Form 8-K dated September 4, 2012 and filed with the Commission on September 6, 2012.

Credit Agreement with JPMorgan Chase

On September 4, 2012, and in connection with the Acquisition, Cherokee and JPMorgan Chase entered into the Credit Agreement.  Pursuant to the Credit Agreement, JPMorgan Chase agreed to lend to Cherokee up to $15 million in principal (the “Loan”).  The Loan is comprised of (i) a term loan in the principal amount of $13 million (the “Term Loan”), with interest on each advance equal to either: (i) an adjusted annual LIBOR rate reset monthly, bi-monthly or quarterly, plus of 2.75% or (ii) JPMorgan’s annual prime rate minus 0.25%, with a floor equal to the 1 month LIBOR Rate plus 2.5%, and (ii) a revolving line of credit in the principal amount of $2 million (the “Revolver”), with interest on each advance equal to either: (i) an adjusted annual LIBOR rate-reset monthly, bi-monthly or quarterly, plus 2.25% or (ii) JPMorgan’s annual prime rate minus 0.25%, with a floor equal to the 1 month LIBOR Rate plus 2.5%.  The Term Loan is subject to a five year maturity date and is to be repaid in equal quarterly payments of principal in the amount of $650,000, together with interest payments made monthly as set forth in the Term Loan.  The Revolver is subject to a three year maturity date and is to be repaid in monthly interest payments on any principal then outstanding, with the balance of any then-outstanding principal and interest to be repaid at maturity.  Cherokee paid an upfront fee equal to $65,000 in connection with the issuance of the Term Loan and is obligated to pay a monthly non-usage fee of 0.25% per annum, in arrears, computed on the average daily unused portion of the Revolver, subject to Cherokee’s right to terminate the Revolver prior to maturity.  In addition, Cherokee is obligated to pay an unspecified amount to be determined by JPMorgan Chase to compensate it for its loss in the event that Cherokee elects to repay all or a portion of the Loan prior to its maturity.  The proceeds from the Term Loan were borrowed to fund the Acquisition.

The Loan is evidenced by a term note in the principal amount of $13,000,000 and a line of credit note in the principal amount of up to $2,000,000, is secured by a continuing security agreement and a trademark security agreement executed by Cherokee and is supported by a continuing guaranty executed by Cherokee’s wholly owned subsidiary, Spell C. LLC (collectively, with the Credit Agreement, the “Loan Documents”). The Credit Agreement contains various affirmative and negative covenants that are customary for loan agreements and transactions of this type, including limitations on our ability to incur debt or other liabilities and limitations on our ability to consummate acquisitions in excess of $5,000,000 in the aggregate at any time while the Loan is outstanding. In addition, the Credit Agreement prohibits us, without first obtaining JPMorgan’s consent, from (i) issuing any equity securities other than pursuant to our employee equity incentive plans and (ii) repurchasing or redeeming any outstanding shares of our common stock or paying dividends or other distributions, other than stock dividends, to our stockholders, unless such repurchases or other distributions would not cause us to be violation of the “fixed charge coverage ratio” (described below) after giving pro forma effect thereto.  The Loan Agreement also imposes the following financial covenants, as specifically defined therein, including: (i) a minimum “fixed charge coverage ratio” of at least 1.2 to 1.0 to be calculated quarterly on a trailing four quarter basis and (ii) a limitation of Cherokee’s “senior funded debt ratio” not to exceed 2.0 to 1.0, measured at any time and based on the ratio of Cherokee’s consolidated total debt to Cherokee’s EBITDA for its most recently completed four-quarter test period. Further, as collateral for the Loan, we granted a security interest in favor of the Bank in all of Cherokee’s assets (including trademarks), and the Loan is guaranteed by Cherokee’s wholly owned subsidiary, Spell C. LLC. In the event of a default under the Credit Agreement, JPMorgan Chase has the right to terminate its obligations under the Credit Agreement, accelerate the payment on any unpaid balance of the Credit Agreement and exercise its other rights under the Loan Documents, including foreclosing on our assets under the security agreement. For additional information regarding the Loan Documents, please see Cherokee’s Current Report on Form 8-K dated September 4 and filed with the Commission on September 6, 2012.

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Debt

6 Months Ended

Jul. 28, 2012

Debt

Debt

(5) Debt

On February 16, 2011, Cherokee and U.S. Bank National Association (“U.S. Bank”) entered into a Term Loan Agreement which was restated on December 7, 2011. The restated loan agreement consisted of (i) a term loan in the principal amount of $5,000,000 and a two year maturity date and (ii) a term loan in the principal amount of $2,000,000 and a four year maturity. On June 5, 2012, Cherokee prepaid all outstanding principal and interest on the restated loan agreement. As a result, Cherokee currently has no outstanding borrowings under the Term Loan Agreement with U.S. Bank.

On September 4, 2012, Cherokee and JPMorgan Chase Bank, N.A. (“JPMorgan Chase”) entered into a Credit Agreement (the “Credit Agreement”).  See Note 6. (“Subsequent Events”) below.

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Subsequent Events (Details) (Subsequent event, USD $)	1 Months Ended
	Sep. 30, 2012 quarter	Sep. 04, 2012
Credit Agreement
Subsequent Events
Maximum borrowing capacity		$ 15,000,000
Aggregate amount of acquisitions that can be consummated while the original loan is outstanding	5,000,000
Number of trailing quarters for calculating fixed charge coverage ratio	4
Credit Agreement | Minimum
Subsequent Events
Fixed charge coverage ratio to be maintained	1.2
Credit Agreement | Maximum
Subsequent Events
Senior funded debt ratio	2.0
Term Loan
Subsequent Events
Maximum borrowing capacity		13,000,000
Term of loan	5 years
Equal quarterly payments of principal	650,000
Upfront fee		65,000
Term Loan | Adjusted annual LIBOR
Subsequent Events
Variable rate basis	Adjusted annual LIBOR
Interest rate added to the reference rate (as a percent)		2.75%
Term Loan | Annual prime rate
Subsequent Events
Variable rate basis	Prime rate
Interest rate subtracted from the reference rate (as a percent)		0.25%
Term Loan | 1 month LIBOR | Minimum
Subsequent Events
Variable rate basis	1 month LIBOR
Interest rate added to the reference rate (as a percent)		2.50%
Revolving line of credit
Subsequent Events
Maximum borrowing capacity		2,000,000
Term of loan	3 years
Monthly non-usage fee percentage	0.25%
Revolving line of credit | Adjusted annual LIBOR
Subsequent Events
Variable rate basis	Adjusted annual LIBOR
Interest rate added to the reference rate (as a percent)		2.25%
Revolving line of credit | Annual prime rate
Subsequent Events
Variable rate basis	Prime rate
Interest rate subtracted from the reference rate (as a percent)		0.25%
Revolving line of credit | 1 month LIBOR | Minimum
Subsequent Events
Variable rate basis	1 month LIBOR
Interest rate added to the reference rate (as a percent)		2.50%
Liz Lange and Completely Me by Liz Lange brands
Subsequent Events
Purchase price		13,100,000
Purchase price paid concurrently with closing		12,600,000
Amount placed under escrow fund		500,000
Earn-out payments during the remainder of 2012		400,000
Earn-out payments during 2013		500,000
Contingent consideration		$ 900,000

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Summary of Significant Accounting Policies (Details 5) (USD $)	3 Months Ended		6 Months Ended		12 Months Ended
	Jul. 28, 2012	Jul. 30, 2011	Jul. 28, 2012	Jul. 30, 2011	Jan. 28, 2012
Trademarks
Trademark registration and renewal fees capitalized	$ 75,000	$ 66,000	$ 153,000	$ 174,000
Income Taxes
Income tax expense	1,031,000	966,000	2,282,000	1,309,000
Effective tax rate (as a percent)	39.10%	36.60%			28.00%
Accrued interest on gross basis	161,000		161,000		130,000
Total amount of gross unrecognized tax benefits	917,000		917,000		900,000
Amount of unrecognized tax benefit that, if recognized, would affect the effective tax rate	596,000		596,000
Reasonably possible decrease in unrecognized tax benefits will settle in next twelve months	$ (700,000)		$ (700,000)

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Summary of Significant Accounting Policies (Details) (USD $)	3 Months Ended		6 Months Ended
	Jul. 28, 2012	Jul. 30, 2011	Jul. 28, 2012	Jul. 30, 2011
Numerator:
Net income-numerator for net income per common share and net income per common share assuming dilution	$ 1,608,000	$ 1,672,000	$ 3,679,000	$ 4,923,000
Denominator:
Denominator for net income per common share - weighted average shares	8,390,417	8,504,247	8,388,791	8,501,867
Effect of dilutive securities:
Stock options (in shares)	15,371	30,271	7,547	26,434
Denominator for net income per common share, assuming dilution:
Adjusted weighted average shares and assumed exercises (in shares)	8,405,788	8,534,518	8,396,338	8,528,301
Anti-dilutive shares
Number of anti-dilutive shares	780,499	637,000	780,499	637,000

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Summary of Significant Accounting Policies (Policies)

6 Months Ended

Jul. 28, 2012

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.

Allowance for Doubtful Accounts

The Company records its allowance for doubtful accounts based upon its assessment of various factors, such as: historical experience, age of accounts receivable balances, credit quality of our licensees, current economic conditions, bankruptcy, and other factors that may affect our licensees’ ability to pay.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires us 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

We consider all highly liquid debt instruments purchased and money market funds purchased with an original maturity date of three months or less to be cash equivalents.

Revenue Recognition

Revenues from royalty and brand representation agreements are recognized when earned by applying contractual royalty rates to quarterly point of sale data received from our licensees. Our royalty recognition policy provides for recognition of royalties in the quarter earned, although a large portion of such royalty payments are actually received during the month following the end of a quarter. Revenues are not recognized unless collectability is reasonably assured. Our agreement with Target for the Cherokee brand in the U.S. accounts for the majority of our historical revenues and is structured to provide royalty rate reductions once certain cumulative levels of sales are achieved. With respect to Target’s sales in the U.S., revenue is recognized by applying the reduced contractual royalty rates prospectively to point of sale data as defined sales thresholds are exceeded. The royalty rate reductions do not apply retroactively to sales since the beginning of the fiscal year. As a result, our royalty revenues as a percentage of Target’s retail sales in the U.S. are highest at the beginning of each fiscal year and decrease during the fiscal year as Target exceeds sales thresholds as set forth in our agreement with Target. The amount of royalty revenue earned by us from Target in any quarter is dependent not only Target’s retail sales of Cherokee branded products in the U.S. in each quarter, but also on the royalty rate then in effect after considering Target’s cumulative level of retail sales for Cherokee branded products in the U.S. for the fiscal year. Historically this has caused our first quarter to be our highest revenue and profitability quarter; our second quarter to be our next highest quarter; and our third and fourth quarters to be our lowest quarters. However, such historical patterns may vary in the future, depending upon the execution of new license agreements and retail sales volumes achieved in each quarter from Target and also on the revenues we receive from other licensees that do not pay us reduced royalty rates based upon cumulative sales.

Deferred Revenue

Deferred revenues represent minimum licensee revenue royalties paid in advance, the majority of which are non-refundable to the licensee. Historically, deferred revenue was combined with accounts payable; however, deferred revenue is currently presented separately as current and non-current items on our balance sheet. The values and timing of recognition of deferred revenues are outlined in our license agreements.

Earnings Per Share Computation

The following table provides a reconciliation of the numerator and denominator of the basic and diluted per-share computations for the three and six month periods ended July 28, 2012 and July 30, 2011:

	Three Months Ended				Six Months Ended
	July 28, 2012		July 30, 2011		July 28, 2012		July 30, 2011
Numerator:
Net income-numerator for net income per common share and net income per common share assuming dilution	$	1,608,000	$	1,672,000	$	3,679,000	$	4,923,000
Denominator:
Denominator for net income per common share — weighted average Shares	8,390,417		8,504,247		8,388,791		8,501,867
Effect of dilutive securities:
Stock options	15,371		30,271		7,547		26,434
Denominator for net income per common share, assuming dilution:
Adjusted weighted average shares and assumed exercises	8,405,788		8,534,518		8,396,338		8,528,301

The computation for diluted number of shares excludes unexercised stock options which are anti-dilutive. There were 780,499 and 637,000 anti-dilutive shares for the three and six months ended July 28, 2012 and July 30, 2011, respectively. Consequently, the diluted weighted average number of shares for the three and six month periods ended July 28, 2012 and July 30, 2011 excludes 780,499 and 637,000 shares, respectively.

Significant Contracts

In 1997, we entered into an agreement with Target that grants Target the exclusive right in the United States to use the Cherokee trademarks in certain categories of merchandise. The current terms of our relationship with Target are set forth in a restated license agreement with Target, which was entered into effective as of February 1, 2008 and amended on December 1, 2011 (the “Restated Target Agreement”). The Restated Target Agreement grants Target the exclusive right in the United States to use the Cherokee trademarks in various specified categories of merchandise. In addition, pursuant to a Canada Affiliate Agreement between Cherokee and Target Canada Co., dated December 1, 2011 (the “Target Canada Agreement”), and subject to our agreement with Zellers, the terms of the Restated Target Agreement will apply to the territory of Canada effective as of February 1, 2013 and Target will have exclusive rights to the Cherokee brand within the territory of Canada effective as of January 31, 2014 (or earlier if our agreement with Zellers terminates before such date). The term of the Restated Target Agreement continues through January 31, 2013. However, the Restated Target Agreement provides that if Target remains current in its payments of the minimum guaranteed royalty of $9.0 million for Fiscal 2013, then the term of the Restated Target Agreement will continue to renew automatically for successive fiscal year terms provided that Target does not give notice of its intention to terminate the Restated Target Agreement during February of the calendar year prior to termination. In addition, effective as of February 1, 2013, the minimum guaranteed royalty for Target will increase to $10.5 million and will apply to all sales made by Target in the United States or in Canada as contemplated by the Target Canada Agreement. Under the Restated Target Agreement, Target has agreed to pay royalties based on a percentage of Target’s net sales of Cherokee branded merchandise in the U.S. during each fiscal year ended January 31st, which percentage varies according to the volume of sales of merchandise. Under the Target Canada Agreement, Target has agreed to pay a fixed royalty rate based on a percentage of Target’s net sales of Cherokee branded merchandise in Canada during each fiscal quarter. Royalty revenues from Target totaled $13.8 million in Fiscal 2012, $13.0 million in Fiscal 2011 and $13.2 million in Fiscal 2010.

We also have other licensing agreements regarding our brands, including with Tesco for our Cherokee brand in the United Kingdom, Ireland, the Czech Republic, Slovakia, Poland, Hungary and Turkey. For a more complete description of certain of our license agreements and other commercial agreements, please see our Annual Report on Form 10-K for Fiscal 2012, which was filed with the Securities and Exchange Commission (the “Commission”) on April 12, 2012.

On September 4, 2012, Cherokee and LLM Management Co., LLC entered into an Asset Purchase Agreement pursuant to which Cherokee acquired assets related to the Liz Lange and Completely Me by Liz Lange brands.  See Note 6. (“Subsequent Events”) below.

Stock-Based Compensation

We currently maintain two equity-based compensation plans:  (i) the 2003 Incentive Award Plan as amended in 2006 with the adoption of the 2006 Incentive Award Plan (the “2003 Plan”); and (ii) the 2006 Incentive Award Plan (the “2006 Plan”).  Each of these equity based compensation plans provide for the issuance of equity-based awards to officers and other employees and directors, and they have previously been approved by our stockholders.  Stock options issued to employees are granted at the market price on the date of grant, generally vest over a three-year period, and generally expire seven to ten years from the date of grant.  We issue new shares of common stock upon exercise of stock options.

2003 Plan—The 2003 Plan was approved at the June 9, 2003 Annual Meeting of Stockholders, and amended on June 13, 2006 with the adoption of the 2006 Plan by the Company’s Stockholders at the June 2006 Annual Meeting of Stockholders.  Under the 2003 Plan, the Company is authorized to grant up to 250,000 shares of common stock in the form of incentive and nonqualified options and restricted stock awards.  The maximum number of shares which may be subject to grants under the 2003 Plan to any individual in any calendar year cannot exceed 100,000.  During the First Quarter, we granted to certain employees stock options with a seven-year term to purchase a total of 70,000 shares of our common stock at an exercise price of $10.92 per share (the closing price on the date of grant) pursuant to the 2003 Plan. During the Second Quarter, we did not make any grants pursuant to the 2003 Plan. As of July 28, 2012, there were 34,982 shares available for issuance under the 2003 Plan.

2006 Plan—The 2006 Plan was approved at the June 2006 Annual Meeting of Stockholders and amended at the June 2010 Annual Meeting of Stockholders, under which the Company is authorized to grant up to 750,000 shares of common stock in the form of incentive and nonqualified options and restricted stock awards. The maximum number of shares that may be subject to grant under the 2006 Plan to any individual in any calendar year cannot exceed 100,000. During the First Quarter, we granted to certain employees stock options with a seven-year term to purchase 10,000 shares of our common stock at an exercise price of $10.92 per share (the closing price on the date of grant) pursuant to the 2006 Plan. During the Second Quarter, we granted to certain employees and non-employee directors stock options with a seven-year term to purchase a total of 213,000 shares of our common stock at exercise prices of $13.06 and $14.12 per share (which were the closing prices on the date of each applicable grant) pursuant to the 2006 Plan.   In addition, during the Second Quarter, we granted to each of our non-employee directors restricted stock awards of 1,500 shares, or 7,500 shares in total, of our common stock pursuant to the 2006 Plan.  As of July 28, 2012, there were 55,334 shares available for issuance under the 2006 Plan.

Following the approval by Cherokee’s stockholders, on June 4, 2010, we issued to Robert Margolis, our former Executive Chairman, a non-qualified stock option to purchase 100,000 shares of our Common Stock (the “Margolis Option”) at an exercise price of $18.49, which was the closing price of our Common Stock on June 4, 2010. The Margolis Option was not issued pursuant to any of Cherokee’s existing equity incentive plans. Pursuant to its original terms, the Margolis Option was to vest contingent on Mr. Margolis’ continued service as a member of our Board of Directors in two equal installments of 50,000, on January 31, 2011 and January 31, 2012; however, pursuant to our separation with Mr. Margolis, the vesting applicable to the Margolis Option was accelerated in full. The Margolis Option is exercisable until June 4, 2015.

In addition, in connection with appointment of Mr. Stupp as our Chief Executive Officer, on August 26, 2010, we granted to Mr. Stupp an option to purchase shares (the “Stupp Option”) of Cherokee’s common stock as an inducement grant outside of the 2006 Plan, subject to vesting requirements and other terms. The Stupp Option was originally exercisable for up to a total of 300,000 shares and the maximum number of shares for which the Stupp Option may exercise is 187,500 as of the date of this report (subject to applicable vesting conditions set forth in the Stupp Option). This grant of stock options was entered into as an inducement material for Mr. Stupp to enter into employment with Cherokee. While the grant of the Stupp Option was made outside of the 2006 Plan, the grant is consistent with applicable terms of the 2006 Plan. See the description of the Stupp Option in Note 4. Related Party Transactions.

Stock-based compensation expense recognized for the Six Months was $452,000, as compared to $389,000 for the comparable period in the prior year.

The estimated fair value of options granted during Fiscal 2013 and Fiscal 2012 as of each grant date was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Fiscal 2013	Fiscal 2012
Expected Dividend Yield	5.67% to 7.33%	4.65% to 6.67%
Expected Volatility	51.63 to 53.33	49.28 to 51.95
Avg. Risk-Free Rate	0.57% to 1.01%	0.74% to 1.1%
Expected Life (in years)	4.5	4.5 to 5.0
Estimated Forfeiture Rate	15%	30%

The expected term of the options represents the estimated period of time until exercise and is based on historical experience of similar options, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. Expected stock price volatility is based on the historical volatility of our stock price. The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of grant with an equivalent remaining term. Our dividend yield is based on the past dividends paid and the current dividend yield at the time of grant.

A summary of activity for the Company’s stock options for the Six Months is as follows:

					Weighted
					Average
					Remaining
			Weighted		Contractual	Aggregate
			Average		Term	Intrinsic
	Shares		Price		(in years)	Value
Outstanding, at January 28, 2012	973,833		$	17.92
Granted	293,000		$	11.75
Exercised
Canceled/forfeited	(163,334	)	$	19.23
Outstanding, at July 28, 2012	1,103,499		$	16.28	4.94	$	577,600
Vested and Exercisable at July 28, 2012	445,663		$	17.68	3.11	$	34,100
Non-vested and not exercisable at July 28, 2012	657,836		$	15.35	5.65	$	543,500

As of July 28, 2012, total unrecognized stock-based compensation expense related to non-vested, equity based awards was approximately $2,209,602 for stock options and $97,150 for restricted stock awards, which is expected to be recognized over a weighted average period of approximately 2.8 and 2.9 years, respectively.  The total fair value of all options which vested during the Six Months was $694,527. There were no restricted stock awards vested during the Six Months.

Trademarks

During the Second Quarter and Six Months, the Company did not acquire any trademarks, nor were there any trademark acquisitions during the comparable period last year.  Trademark registration and renewal fees which were capitalized during the Second Quarter and Six Months totaled $75,000 and $153,000, respectively.  In comparison, for the second quarter and six months of last year, the total trademark registration and renewal fees capitalized totaled $66,000 and $174,000, respectively.

Income Taxes

Income tax expense of $1,031,000 was recognized for the Second Quarter, resulting in an effective tax rate of 39.1% in the Second Quarter, as compared to an effective tax rate of 36.6% in the second quarter of last year and compared to 28.0% for the full year of Fiscal 2012. Our lower effective tax rate in Fiscal 2012 was primarily the result of settling income tax examinations with the California Franchise Tax Board related to our apportionment of income.

The Company files U.S. federal and state income tax returns. For our federal income tax returns, the Company is generally no longer subject to tax examinations for fiscal years prior to Fiscal 2011. With limited exception, our significant state tax jurisdictions are no longer subject to examinations by the various tax authorities for fiscal years prior to 2008. Although the outcome of tax audits is always uncertain, we believe that adequate amounts of tax, interest and penalties, if any, have been provided for in our income tax reserve for any adjustments that may result from future tax audits. We recognize interest and penalties, if any, related to unrecognized tax benefits within the provision for income taxes in our consolidated statement of income. As of January 28, 2012 and July 28, 2012, respectively, accrued interest on a gross basis was $130,000 and $161,000.

As of January 28, 2012 and July 28, 2012, respectively, the total amount of gross unrecognized tax benefits was approximately $900,000 and $917,000, of which approximately $596,000 represents the amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate. It is reasonably possible that $700,000 of the $917,000 of unrecognized tax benefits will settle in the next twelve months. We do not expect this change to have a significant impact on the results of operations or the financial position of the Company.

Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued an update to ASC Topic 820, Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements would be separately disclosed by level within the fair value hierarchy. ASC 820 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years, with early adoption permitted. We adopted ASC 820 on the first day of Fiscal 2009, and this adoption did not have a material impact on our consolidated financial statements.

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Summary of Significant Accounting Policies (Tables)

6 Months Ended

Jul. 28, 2012

Summary of Significant Accounting Policies

Schedule of reconciliation of the numerator and denominator of the basic and diluted per share computations

	Three Months Ended				Six Months Ended
	July 28, 2012		July 30, 2011		July 28, 2012		July 30, 2011
Numerator:
Net income-numerator for net income per common share and net income per common share assuming dilution	$	1,608,000	$	1,672,000	$	3,679,000	$	4,923,000
Denominator:
Denominator for net income per common share — weighted average Shares	8,390,417		8,504,247		8,388,791		8,501,867
Effect of dilutive securities:
Stock options	15,371		30,271		7,547		26,434
Denominator for net income per common share, assuming dilution:
Adjusted weighted average shares and assumed exercises	8,405,788		8,534,518		8,396,338		8,528,301

Schedule of weighted average assumptions under the Black- Scholes option-pricing model for estimation of fair value of options

	Fiscal 2013	Fiscal 2012
Expected Dividend Yield	5.67% to 7.33%	4.65% to 6.67%
Expected Volatility	51.63 to 53.33	49.28 to 51.95
Avg. Risk-Free Rate	0.57% to 1.01%	0.74% to 1.1%
Expected Life (in years)	4.5	4.5 to 5.0
Estimated Forfeiture Rate	15%	30%

Summary of activity for stock options

					Weighted
					Average
					Remaining
			Weighted		Contractual	Aggregate
			Average		Term	Intrinsic
	Shares		Price		(in years)	Value
Outstanding, at January 28, 2012	973,833		$	17.92
Granted	293,000		$	11.75
Exercised
Canceled/forfeited	(163,334	)	$	19.23
Outstanding, at July 28, 2012	1,103,499		$	16.28	4.94	$	577,600
Vested and Exercisable at July 28, 2012	445,663		$	17.68	3.11	$	34,100
Non-vested and not exercisable at July 28, 2012	657,836		$	15.35	5.65	$	543,500

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Summary of Significant Accounting Policies (Details 2) (USD $)	3 Months Ended		6 Months Ended		12 Months Ended
	Jul. 28, 2012	Jul. 30, 2011	Jul. 28, 2012	Jul. 30, 2011	Jan. 28, 2012 Target Corporation	Jan. 29, 2011 Target Corporation	Jan. 30, 2010 Target Corporation	Dec. 02, 2011 Restated Target Agreement Minimum	Dec. 02, 2011 Target Canada Agreement Minimum
Significant Contracts
Guaranteed royalty								$ 9,000,000	$ 10,500,000
Royalty Revenues for the Cherokee brand	$ 6,306,000	$ 6,658,000	$ 13,821,000	$ 13,602,000	$ 13,800,000	$ 13,000,000	$ 13,200,000

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Related Party Transactions (Details) (USD $)	6 Months Ended			1 Months Ended		21 Months Ended			1 Months Ended		6 Months Ended						6 Months Ended
	Jul. 30, 2011	Jul. 28, 2012 Stock Options	Jan. 28, 2012 Stock Options	Jun. 30, 2012 Henry Stupp Stock Options	Aug. 31, 2010 Henry Stupp Stock Options	Apr. 30, 2012 Henry Stupp Stock Options	Jul. 28, 2012 Henry Stupp Stock Options	Aug. 26, 2010 Henry Stupp Stock Options item	Jul. 30, 2011 Henry Stupp Employment Agreement	Aug. 31, 2010 Henry Stupp Employment Agreement	Jul. 28, 2012 Henry Stupp Employment Agreement	Apr. 30, 2012 Henry Stupp Employment Agreement	Jan. 31, 2012 Henry Stupp Employment Agreement	Oct. 31, 2011 Henry Stupp Employment Agreement	Jul. 28, 2011 Henry Stupp Employment Agreement	Aug. 26, 2010 Henry Stupp Employment Agreement	Jul. 28, 2012 Henry Stupp Employment Agreement Maximum	Jul. 26, 2012 Mr. Stupp's former spouse Employment Agreement
Related party transactions
Number of shares of common stock purchased									12,562	81,967
Share price of common stock purchased															$ 15.92	$ 18.30
Issuance of common stock	$ 200,000								$ 200,000	$ 1,500,000
Aggregate amount of subsequent shares agreed to be purchased																600,000
Incremental amount of subsequent shares agreed to be purchased on or before specified date												200,000	200,000	200,000
Number of shares subject to option forfeited		163,334				112,500					112,500
Granted (in shares)		293,000		90,000	300,000
Number of shares subject to option		1,103,499	973,833				187,500				187,500
Vesting period				3 years
Base salary after increase											600,000
Performance bonus as a percentage of per-tax income in excess of a threshold amount											5.00%
Threshold amount of the entity's pre-tax income used to calculate performance bonus											20,000,000
Performance bonus per fiscal year pursuant to the terms of the Employment Agreement																	650,000
Bonus target amount used to calculate cash bonus											$ 200,000						$ 400,000
Period after the end of fiscal year during which cash bonus amount will be determined											75 days
Percentage of the shares transferred																		50.00%
Exercise price of stock option granted (in dollars per share)		$ 11.75		$ 13.06	$ 18.30
Number of equal annual installments beginning on January 31, 2012, in which the options vest								5
Number of additional increments on each yearly anniversary thereafter in which the options vest								4
Additional vesting rate in the event of a change in control of the entity (as a percent)								20.00%
Term of option				7 years	6 years

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CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (USD $)	Total	Common Stock	Additional Paid-in Capital	Retained Earnings (Deficit)
Balance at Jan. 28, 2012	$ 10,751,000	$ 167,000	$ 19,271,000	$ (8,687,000)
Balance (in shares) at Jan. 28, 2012		8,387,167
Increase (Decrease) in Stockholders' Equity
Stock-based compensation	455,000		455,000
Stock issuance		7,500
Accrued and unpaid dividends	(3,357,000)			(3,357,000)
Net income	3,679,000			3,679,000
Balance at Jul. 28, 2012	$ 11,528,000	$ 167,000	$ 19,726,000	$ (8,365,000)
Balance (in shares) at Jul. 28, 2012		8,394,667

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Related Party Transactions

6 Months Ended

Jul. 28, 2012

Related Party Transactions

Related Party Transactions

(4)    Related Party Transactions

Employment Agreement with our Chief Executive Officer

On August 26, 2010, we entered into an Employment Agreement with our Chief Executive Officer, Henry Stupp, which has been subsequently amended pursuant to amendment agreements on each of January 28, 2011, April 13, 2011 and July 27, 2011 (such employment agreement, as amended, the “Employment Agreement”). Pursuant to the Employment Agreement, (i) on August 26, 2010, Mr. Stupp purchased 81,967 shares of our common stock at a per share price of $18.30 (which was equal to the closing price of Cherokee’s common stock on such date), for aggregate proceeds of $1,500,000 and (ii) on July 28, 2011, Mr. Stupp purchased 12,562 shares of Cherokee’s common stock at a per share price of $15.92 (which was equal to the closing price of Cherokee’s common stock on such date), for aggregate proceeds of approximately $200,000 (all such shares purchased by Mr. Stupp, collectively, the “Shares”). The sales of the Shares were made pursuant to an exemption from registration provided by Section 4(2) of the Act, including pursuant to Rule 506 thereunder (as Mr. Stupp is an “accredited investor” under Rule 506 and the sales were made without any form of general solicitation and with full access to any information requested by Mr. Stupp regarding Cherokee or its common stock). In addition, pursuant to the Employment Agreement, Mr. Stupp agreed to purchase an aggregate of $600,000 of our common stock in increments of $200,000 on or before October 31, 2011, January 31, 2012 and April 30, 2012 (such additional shares, the “Subsequent Shares”). Mr. Stupp elected not purchase the Subsequent Shares to be purchased on or before October 31, 2011, January, 31, 2012 and April 30, 2012, and, as a result, a total of 112,500 of the shares subject to the Option (as described below) have been forfeited, leaving a balance of 187,500 shares subject to the Option. In addition, on June 18, 2012, the Committee awarded Mr. Stupp with an additional option to purchase up to 90,000 shares of the Company’s common stock under the 2006 Plan with an exercise price of $13.06, which was the closing price of the Company’s common stock on the Nasdaq Global Select Market on the date of grant. These stock options vest in equal annual installments over the next three years and are subject to a seven year term.

On June 18, 2012, the Committee approved an increase of Mr. Stupp’s base salary to $600,000, with such salary increase to be retroactive to February 1, 2012. In addition, for Fiscal 2012, Mr. Stupp was entitled to receive a performance bonus (the “Performance Bonus”) equal to five percent of Cherokee’s pre-tax income during such fiscal year in excess of a threshold amount of $20,000,000, subject to a maximum of $650,000 per fiscal year. Mr. Stupp did not receive any portion of the Performance Bonus for Fiscal 2012. For Fiscal 2013, the Committee determined that Mr. Stupp will be eligible to receive a cash bonus with a bonus target of $200,000 and a maximum of $400,000, subject to the Company achieving certain performance targets during Fiscal 2013 and other factors the Committee may deem appropriate. The amount of any such bonus will be determined by the Committee within 75 days of the end of Fiscal 2013.  Mr. Stupp’s services as our Chief Executive Officer are at will. The Employment Agreement expires as of January 31, 2014, unless earlier terminated by Cherokee or by Mr. Stupp or extended by mutual agreement.

Pursuant to the Employment Agreement, Cherokee has agreed to certain indemnification obligations to Mr. Stupp related to his service to Cherokee in his capacity as an officer or director of Cherokee. In addition, pursuant to the Employment Agreement, Cherokee filed with the SEC a registration statement to effect the registration for resale of the shares purchased by Mr. Stupp pursuant to the Employment Agreement and the shares of Common Stock that may be acquired upon exercise of the Option (as described below).

In connection with Mr. Stupp’s appointment, on August 26, 2010, we granted Mr. Stupp an option to purchase up to 300,000 shares of our common stock (the “Option”) pursuant to a Stock Option Agreement (the “Stock Option Agreement”) as an inducement grant outside of the 2006 Plan, which was subsequently amended on July 26, 2012 to transfer fifty percent of the shares subject to the Option to Mr. Stupp’s former spouse. The maximum number of shares subject to the Option is currently 187,500 as a result of the forfeiture of a total of 112,500 shares described above. The Stock Option Agreement was entered into as an inducement material for Mr. Stupp to enter into employment with Cherokee. While the grant of the Option was made outside of the 2006 Plan, the grant is consistent with applicable terms of the 2006 Plan. The Option has an exercise price of $18.30 per share, which was the closing price of Cherokee’s common stock on the Nasdaq Global Select Market on the date of grant. The Option vests in five equal annual installments beginning on January 31, 2012, and vesting in four additional increments on each yearly anniversary thereafter. In addition, in the event of a change in control of Cherokee, an additional twenty percent of the total shares subject to the Option shall vest. The Option has a term of six years and will be forfeited if not exercised before the expiration of the term. Except as noted above, the Option is not transferable and is not exercisable by anyone other than Mr. Stupp or his former spouse during their lifetimes. If Mr. Stupp’s service to Cherokee is terminated for any reason, the Option shall cease vesting upon such termination.

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Dividends (Details) (USD $)	1 Months Ended					6 Months Ended
	Jul. 28, 2012	Jun. 30, 2012	Apr. 28, 2012	Mar. 31, 2012	Jan. 28, 2012	Jul. 28, 2012	Jul. 30, 2011
Dividends
Dividend declared	$ 1,700,000		$ 1,700,000		$ 1,700,000	$ 1,679,000	$ 1,690,000
Dividend declared (in dollars per share)	$ 0.20		$ 0.20		$ 0.20
Dividends paid		$ 1,700,000		$ 1,700,000		$ 3,357,000	$ 3,391,000
Dividend paid (in dollars per share)		$ 0.20		$ 0.20