ITEM 1. BUSINESS
Cherokee International, LLC is a leading
designer and manufacturer of a broad range of switch mode power supplies for
original equipment manufacturers, or OEMs, in the telecommunications,
networking, high-end workstation and other electronic equipment industries.
Power supplies perform many essential functions relating to the supply,
distribution and regulation of electrical power and are used in virtually all
electronic equipment. Basic power supplies convert AC from a utility source
such as a wall outlet, into the DC required for electronic systems.
STRATEGIC ADVANTAGES
We believe that our strategic advantages
include the following:
• TIME TO MARKET: A critical factor
in a customer’s selection of a power supply manufacturer is the time to market
of the power supply. Time to market is the time required to design, engineer,
manufacture and deliver the product to a customer. We have established a track
record of consistently providing high quality products with short times to
market. We streamline the design and production processes by employing
experienced personnel, providing them with sophisticated state of the art
equipment and tools and encouraging our engineers to communicate directly with
our customers’ engineers throughout the design and manufacturing process. In
addition, we are one of the few companies in the industry with the ability to
self certify our products for virtually all safety agencies. Our unique design
and production methodologies, along with strategically located operations in
North America and Europe, help increase production efficiency, enhance our
customer relationships and avoid delays in communication and the exchange of
designs and prototypes that burden many of our competitors that depend on their
overseas manufacturing facilities.
• STRONG PARTNERSHIPS WITH BLUE CHIP
CUSTOMER BASE: We provide products to leading OEMs such as Alcatel, Brocade,
Cisco, Hewlett-Packard, IBM, Juniper, Lucent, Motorola, Network Appliance,
Nortel, Riverstone and Silicon Graphics. We have been doing business with many
of our customers for over 10 years. We believe that our customers continue to
seek long-term partnerships with a small number of core suppliers like
Cherokee. Our relationships are strengthened by the fact that we work jointly
with many of our customers in the design and development of new products, which
our customers partially fund. We believe that as a result of these factors we
have been successful in building our share with many of these customers over
the last several years.
• RECURRING SALES: Our products are
generally used for the entire life cycle of a customer’s end products,
providing a base of recurring sales from year to year. We have found that OEMs
generally prefer not to change suppliers once a power supply has been designed
into a product, due to the fact that such a change often requires
time-consuming and costly re-testing and re-certification by the customer and
one or more regulatory agencies. It is also very difficult for another
manufacturer to precisely and economically replicate a power supply unit which
is already incorporated into a product. The life cycle of our customers’
products range from approximately 2 to 10 years.
• LOW COST STATE OF THE ART
OPERATIONS: Our sophisticated engineering capabilities, in-house production of
certain critical components, highly automated manufacturing processes and state
of the art testing equipment enable us to operate extremely efficiently,
thereby enhancing profitability, flexibility and competitiveness. The following
initiatives have lowered our overall cost of production and enhanced profit
margins:
• in-house manufacturing of labor
intensive magnetic sub-assemblies at our facilities in India;
• use of common componentry in our
product designs, including in our highly customized products, thereby reducing
development and production costs;
• procurement of raw materials and
components directly from manufacturers, rather than distributors;
• use of continuous flow
manufacturing lines and computer controlled
surface mount assembly, or SMT, machines to improve quality and yield rates;
• procurement and maintenance of
state of the art equipment resulting in limited maintenance capital
expenditures; and
• refinement of our systems and
processes to increase overall operational efficiency.
• COMMITMENT TO QUALITY AND SERVICE:
We believe that in addition to short lead times and competitive prices, our
commitment to provide consistent, high quality products and services forms the
basis of our strong customer relationships. We manufacture high quality
products using advanced testing methods to monitor our sophisticated design and
manufacturing techniques (such as Computer Aided Design and Computer Aided
Engineering). In addition to testing performed during the design and
manufacturing process, we test 100% of our finished products using automated
test equipment.
With the exception of a facility in India,
all of our facilities and manufacturing processes are ISO 9000 certified.
• EXPERIENCED MANAGEMENT: Pat Patel,
our Chairman, founded Cherokee Corporation in 1978, formed Cherokee
International, LLC as a California limited liability company on March 28, 1996,
and has over 30 years experience in the industry. Jeff Frank, our President and
Chief Executive Officer, joined Cherokee in September 2001 and has over 18
years experience in the electronics industry. Mr. Frank is supported by a senior
management team including Bud Patel (no relationship to Pat Patel), Dennis
Pouliot, Howard Ribaudo and Van Holland who have combined industry experience
of over 100 years.
BUSINESS STRATEGY
Our objective is to be the supplier of choice
to a targeted group of industry leading OEMs who require sophisticated power
supply solutions and who are likely to have substantial volume requirements. To
achieve this objective, our strategy is to continue to differentiate ourselves
through advanced design and engineering, shorter time to market and superior
product performance, quality and service. Our strategy focuses on maximizing
profitability and expanding the business through:
• FOCUSING ON HIGH GROWTH, HIGH
MARGIN, MARKETS: A substantial majority of our 2001 sales were to the
networking, telecommunications and high-end workstations markets, which are
expected to grow over the long term primarily due to the increase in demand for
internet/intranet, wireless and other communications. We achieve higher margins
in these markets due to their highly sophisticated design and engineering
requirements and the high demands for technical expertise required to serve
them. Focusing on these high growth areas also allows us to work with the most
sophisticated customers, which further improves our technological and knowledge
base and enables us to create products that can form the basis for an expanding
and more sophisticated product catalog.
• LEVERAGING CUSTOMER RELATIONSHIPS:
We have strong relationships with industry leaders in the high growth
networking, telecommunications and high-end workstations. We plan to leverage
our in-depth knowledge of our customers and
their needs and continue to increase our
share of our customers’ business. We believe that our long-standing customer
relationships, coordinated engineering services and flexible manufacturing
capabilities provide us with a significant advantage when bidding for new
business.
• EXPANDING PRODUCT OFFERING AND MARKET APPLICATIONS: We plan to
continue to broaden our existing product line to attract new customers and to
capture a larger portion of our existing customers’ business. Although we may
at any time decide otherwise, products we presently plan to offer in the future
include a larger catalog of higher margin product offerings for multiple
applications, higher power range products for the increased requirements of
internet/intranet, telecommunications and wireless and other applications and
new DC to DC products to provide more complete power solutions for
communication systems such as telecommunication switches.
• EXPANDING CUSTOMER BASE: We have
leveraged our reputation and success with our existing blue chip customer base
to attract new customers with significant growth prospects and high-margin
product requirements. We plan to continue expanding our customer base through
increased marketing, heightened use of our network of independent sales
representatives and further development of collaborative relationships in
design and engineering. To help achieve this expansion, we compensate our
independent sales representatives with additional incentives to attract new
customers and provide them with a significant level of support.
• CONTINUALLY REDUCING COSTS THROUGH DISCIPLINED
DESIGN AND LOW COST PROCUREMENT: We seek to remain a low cost provider through
continued disciplined design techniques that incorporate common componentry and
circuitry and through the negotiation of long-term contracts for the
procurement of raw materials and components directly with certain suppliers
rather than purchasing through distributors. In addition, where appropriate we
will continue to invest in new technologies to increase automation and lower
costs.
POWER SUPPLY INDUSTRY
OVERVIEW
Power supplies perform many essential
functions relating to the supply, regulation and distribution of electrical
power in electronic equipment. Electronic systems require a precise and
constant supply of electrical power at one or more voltage levels. Traditional
AC/DC power supplies convert alternating current, or AC, from a primary power
source, such as a utility company, into a precisely controlled direct current,
or DC. Virtually every electronic device that plugs into an AC wall socket
requires some type of AC/DC power supply. DC/DC converters modify one DC
voltage level to other DC levels to meet the needs of various electronic
subsystems and components. Power supplies are also used to regulate and monitor
voltages to protect the electronic components from surges or drops in voltage,
to perform functions that prevent electronic equipment from being damaged by
their own malfunction, or to provide back-up power in the event that a primary
power source fails.
The latest technology now used in power
supplies is higher frequency switch mode topology. Switch mode power supplies,
which comprise our entire product line, are preferred over linear power
supplies, with comparable power outputs, due to their higher energy efficiency,
considerably smaller size and lighter weight. The market for switch mode power
supplies is the fastest growing segment of the overall external power
conversion product market, according to industry sources.
CAPTIVE VERSUS MERCHANT MANUFACTURERS
Captive power supply manufacturers design and
manufacture power supplies for in-house use for their own products. Merchant
power supply manufacturers design and manufacture power supplies for use by
third parties. According to industry sources, the merchant segment of the
market is expected to grow faster than the captive segment as OEMs increasingly
focus on core competencies and outsource power supply products to more
efficient suppliers. As a leading merchant manufacturer, we expect to significantly
benefit from this shift.
PRODUCT TYPES-CUSTOM, STANDARD AND MODIFIED
STANDARD
Custom power supplies are designed for a
specific customer to meet the exact form, fit and function for a specific
application. Custom products are characterized by (1) lead times of 4 to 12
months from initial prototype to full
production; (2) up-front engineering costs; and (3) relatively high
volume production requirements. They are attractive to OEMs because they
provide maximum design flexibility and allow the use of special features.
Standard “off-the-shelf” power supplies are products designed to appeal to a
wide range of customers for use in a variety of different applications.
Standard power supplies offer benefits to the OEM because there are no up-front
engineering charges or minimum order quantities and the product is readily
available, which allows the OEM to reduce its time-to-market for new products.
In addition, standard products have lower risks associated with technology,
production ramps, and customer product qualification. Modified standard power
supplies are standard products that have been altered in a way that does not
change the basic product architecture. Modified standard products, as compared
with custom products, are characterized by (1) shorter lead times; (2) lower
up-front engineering costs; and (3) smaller minimum order quantities.
PRODUCT LINE
Over our more than 20-year history, we have
developed an extensive range of switch mode power supply products. These
products, containing magnetic assemblies, circuits and components, convert AC
power to DC power and maintain voltage levels within specific limits. Our
products cover a broad range of applications, from 10 to 14,000 watts for AC/DC
power supplies, and from 20 to 1,000 watts for DC/DC converters. Our power
supplies are self-contained units, range in weight from one half of a pound to
thirty pounds and are normally incorporated inside our customers’ end products.
We plan to continue to broaden our existing
product line to include a larger
catalog of higher margin product offerings for multiple applications,
higher power range products for the increased requirements of internet/intranet,
wireless and other communications applications and new DC to DC products to
provide distributed power architecture capability for telecommunication
systems.
CUSTOMERS AND APPLICATIONS
Our base of OEM customers are in diverse
markets such as telecommunications, networking, high-end workstations
(excluding PCs), industrial process controls and other electronic equipment
industries. Many of the OEMs are Fortune 500 companies and leaders in their
respective industries.
During 2001, our top 10 customers accounted
for approximately 54% of our sales.
SALES AND MARKETING
We market our products and services in North
America through an integrated sales approach involving account managers and
independent sales representatives with active support from design, engineering
and production personnel. Our in-house account managers supervise customer
relationships and oversee a nation-wide network of commission-based independent
sales representatives whose main purpose is to source new customers. We market
our products in Europe primarily using our in-house account managers.
We focus our efforts on expanding
relationships with existing customers and aggressively targeting emerging OEM
industry leaders with whom the opportunity exists to provide products and
services across a number of product families and through successive product
generations. We focus our resources on markets that are growing relatively
quickly and have the potential for significant profit margins. Potential
customers are assigned to our in-house account managers who evaluate the
customer against our customer selection criteria.
On an ongoing basis, our engineering
personnel provide technical support to customers in the areas of product design
changes, field performance and testing. Our collaborative relationships allow
us to gain valuable knowledge about an existing customer and its processes,
which we believe gives us an advantage in obtaining future business from that
customer. Historically, we have had substantial recurring sales from existing
customers.
BACKLOG
Backlog consists of purchase orders on hand
generally having delivery dates scheduled within the next four months. Our
backlog was approximately $25.1
million at December 31, 2001, $75.0 million at December 31, 2000, and
$35.1 million at December 31, 1999. In addition, we are currently working on
numerous customer initiated engineering and design projects, which we expect
will result in additional future revenue.
Although customers are generally able to
cancel or reschedule deliveries, subject to cancellation fees or carrying cost
charges in certain circumstances, our backlog has historically been a reliable
indicator of our future revenues. However, subsequent to December 31, 2000, we
began to experience an industry-wide slowdown which caused many of our
customers to reschedule or cancel certain orders with us. As a result, revenues
for 2001 were adversely affected by these deferrals or cancellations of orders.
We believe unstable and unpredictable economic and industry conditions may
continue. If these conditions persist, our operating results and financial
condition could be adversely affected.
MANUFACTURING PROCESS AND QUALITY CONTROL
A typical power supply consists primarily of
one or more printed circuit boards, electronic and electromagnetic components
and a sheet metal chassis. The production of our power supplies entails the
assembly of structural hardware combined with a sophisticated assembly of
circuit boards encompassing highly automated SMT.
In response to market demands for increased
quality and reliability, design complexity, and sophisticated technology, we
have automated many electronic assembly and testing processes which were
traditionally performed manually and we have standardized our manufacturing
processes to efficiently utilize our resources and optimize our capacities. We
have seven SMT lines located throughout our facilities. SMT permits reduction
in board size by eliminating the need for holes in the printed circuit boards
and by allowing components to be placed on both sides of a board. Each SMT line
is capable of placing as many as 40,000 parts per hour, with each machine hour
equating to approximately 50 labor hours.
In addition to increasing automation of our
facilities, we have standardized our operations to include self-contained
continuous flow manufacturing lines, which incorporate flow solder machines,
in-circuit test machines, highly advanced computer controlled burn-in
equipment, automated final test machines, ongoing reliability test equipment,
standardized processes and measurements on all lines.
Most of our customers require that their
power supplies meet or exceed established international safety and quality
standards. In response to this need, we design and manufacture power supplies
in accordance with the certification requirements of many international
agencies, including Underwriters Laboratories Incorporated (UL) in the United
States; the Canadian Standards Association (CSA) in Canada; Technischer
Uberwachungs-Verein (TUV) and Verband Deutscher Electrotechniker (VDE), both in
Germany; the British Approval Board for Telecommunications (BABT) in the United
Kingdom; and International Electrotechnical Committee (IEC), a European
standards organization.
Quality and reliability are emphasized in
both the design and manufacture of our products. In addition to testing
throughout the design and manufacturing process, we test and burn-in 100% of
all products using automated equipment and customer-approved processes. An
additional out-of-box test or pre-ship audit is performed on randomly selected
units, which are ready for shipment, further ensuring manufacturing quality and
integrity.
Our sophisticated manufacturing facilities in
Tustin, California; Irvine, California; Guadalajara, Mexico; and Wavre,
Belgium, are ISO 9000 certified. Our facilities in India manufacture
labor-intensive magnetic sub-assemblies that are distributed to our other facilities
for incorporation into many of our final products.
SUPPLIERS
Our high quality products and reduced
time-to-market are the result of a well managed supply chain network. We
typically design products using common components thereby increasing our
purchasing power and reducing inventory risk. Most of our raw materials,
including electronic and other components, sheet metal, transistors, mechanical
parts and electrical wires, are readily available from several sources.
Although some of our raw materials are sourced from only one manufacturer, they
are generally available in large quantities from a number of different
suppliers.
COMPETITION
The merchant power supply manufacturing
industry is highly fragmented and characterized by intense competition. No
single company dominates the overall power supplies market and our competitors
vary depending upon the particular power conversion product category. Our
competition includes companies located throughout the world, including Delta,
Astec, Tyco, Artesyn, Power One and many smaller companies. We also view as
competitive threats the potential that our customers may decide to produce
their own power supplies and that OEMs with captive manufacturing capabilities
may compete in the merchant market. However, several large OEMs have divested
their captive power supply manufacturing operations, including IBM, Nortel,
NCR, TRW and Digital Equipment.
ENGINEERING AND PRODUCT DEVELOPMENT
Our engineering and product development
activities are principally directed to the development of new power supplies to
satisfy customer needs. As part of the collaborative relationships established
by us with our key customers, we work closely with our customers to develop new
products. Product development is performed by a group of approximately 80
engineers and technicians located primarily in Tustin, California and Wavre,
Belgium.
Our total expenditures for engineering and
product development were $6.5 million, $6.1 million, and $4.1 million for the
years ended December 31, 2001, 2000, and 1999, respectively.
INTELLECTUAL PROPERTY MATTERS
We do not believe that intellectual property
or branding is a significant competitive factor in the power supply industry.
As a result, we do not rely to a significant extent upon proprietary rights in
the conduct of our business.
EMPLOYEES
At December 31, 2001, we employed
approximately 973 full-time employees
at our facilities in the following capacities:
None of our domestic employees is represented
by a labor organization. Some of our employees who work in our Guadalajara,
Mexico Facility are represented by a union as required under Mexican law. Some
of our employees who work in our Wavre, Belgium facility are represented by
trade unions and work subject to a collective bargaining agreement. We believe
that our relations with our employees, including in our Mexico and Belgium
facilities, are excellent.
ITS ACQUISITION
On June 15, 2000, we completed the
acquisition of Industrial and Telecommunication Systems, or ITS, which we have
subsequently named Cherokee Europe. The acquisition of ITS substantially
increased our European presence and strengthened our capabilities in the
telecommunications system market. ITS is primarily a leading designer and
manufacturer of custom designed power supplies for OEMs of telecommunications
systems, Internet infrastructure, and medical and industrial applications.
RISK FACTORS
We are subject to a variety of risks in our
business, including the following:
OUR SUBSTANTIAL INDEBTEDNESS AND DEBT SERVICE OBLIGATIONS COULD IMPEDE
OUR OPERATIONS AND FLEXIBILITY
We have a large amount of outstanding debt
compared to the net book value of our assets and we have substantial repayment
obligations and interest expense. As of December 31, 2001, we had:
• total consolidated debt of
approximately $158.1 million; and
• members’ deficit of approximately
$76.1 million.
Our level of debt and the limitations imposed
on us by our debt agreements could have other important consequences to us,
including the following:
• we have less ability to satisfy our
obligations with respect to our 10 1/2% Senior Subordinated Notes due 2009;
• we have to use a substantial
portion of our cash flow from operations for debt service rather than for our
operations;
• we may not be able to obtain
additional debt financing for future working capital, capital expenditures or
other corporate purposes;
• we could be less able to take
advantage of significant business opportunities, such as acquisition
opportunities, and react to changes in market or industry conditions;
• we are more vulnerable to general
adverse economic and industry conditions;
and
• we are disadvantaged compared to
competitors with lower levels of outstanding debt compared to net book value of
assets.
OUR BUSINESS OPERATIONS ARE RESTRICTED BY PROVISIONS OF OUR DEBT
AGREEMENTS; FAILURE TO COMPLY COULD RESULT IN ACCELERATION OF INDEBTEDNESS
The indenture governing our 10 1/2% Senior
Subordinated Notes due 2009, the notes, and our credit agreements contain a
number of covenants that significantly restrict our ability to dispose of
assets, incur additional indebtedness, incur guarantee obligations, repay other
indebtedness or amend other debt instruments, pay dividends, create liens on
assets, enter into capital leases, make investments, loans or advances, make
acquisitions, engage in mergers or consolidations, make capital expenditures,
engage in certain transactions with subsidiaries and affiliates and otherwise
restrict business operations. In addition, under our credit agreement, we are
required to meet a number of financial ratios and tests.
Our ability to comply with these agreements
may be affected by events beyond our control, including prevailing economic,
financial and industry conditions. The breach of any of these covenants or
restrictions could result in an event of default under our credit agreement or
the indenture. In either case, certain lenders could declare all amounts borrowed
under those agreements to be immediately due and payable, together with accrued
and unpaid interest. Additionally, the senior lenders could terminate their
commitments to make
further extensions of credit under our credit agreement.
If we are unable to repay indebtedness to our senior lenders, they can proceed
against the collateral securing indebtedness under our credit agreement.
WE MAY FAIL TO COMPLY WITH CERTAIN FINANCIAL COVENANTS AND MAY HAVE A
SHORTAGE IN LIQUIDITY, EITHER OF WHICH COULD MATERIALLY ADVERSELY AFFECT OUR
BUSINESS AND OUR FINANCIAL RESULTS
On September 26, 2001, our credit agreement
with our lenders was amended to include provisions that specify among other
things, (1) that some of our unitholders, or their equity members, will
guarantee $10.5 million of our senior debt principal until specific financial
ratios are attained, (2) that we will be restricted from making cash
distributions to our unitholders until specific financial ratios are attained,
(3) that we will be permitted to make our interest payments due in November
2002 relating to our $100 million of senior subordinated notes so long as
specific financial ratios are attained, (4) that the maximum availability under
our revolving line of credit is reduced until approximately April 30, 2002, (5)
that LIBOR and base rate margins have been increased for revolver borrowings
and term loans, and (6) that financial covenant ratios required in future
periods have been modified, including provisions allowing our unitholders to
make capital contributions to us which will be treated as earnings (as defined)
for purposes of calculating debt covenants.
Based upon our present expectations, we
anticipate that we may not be in compliance with certain financial covenants
under our credit agreement at June 30, 2002, or earlier, without additional
financing from our majority unitholders. In addition, we believe that cash flow
from operations and available borrowing capacity may not be adequate to meet
our anticipated cash requirements, including operating requirements, planned
capital expenditures and debt service, for the last six months of the year, or
earlier, without additional financing from our majority unitholders.
We are currently considering alternatives to
address these issues, which may include (i) an amendment or restructuring of
our credit agreement to provide additional liquidity and room under certain
financial covenants, (ii) a refinancing of our credit agreement, (iii) the
infusion of additional equity by our unitholders, or (iv) some combination of
the above. Based upon the Company's
current business plans and prospects, management expects that its restructuring
alternatives, the $10.5 million guaranty by certain unitholders and funding
from its unitholders, if necessary, will enable the Company to meet its
obligations and comply with its debt covenants through December 31, 2002.
We cannot provide any assurances that we will
be successful in obtaining any desired results on satisfactory terms or as to
what effect any of the foregoing, if obtained, may have on our future business
operations. In the event that we do not succeed in improving our liquidity and
avoiding a covenant or payment default under our credit agreement or a payment
default under the indenture governing our senior subordinated notes, the
lenders under the credit agreement would become entitled to certain rights,
including the right to accelerate the debt and require our unitholders, or
their equity members, to contribute $10.5 million to our senior debt principal
under the terms of the guaranty they provided. The guarantors would be
subrogated to rights of the lenders under the credit agreement, on a basis
senior to the senior subordinated notes. In the event of a payment default
under the indenture or the credit agreement or in the event of an acceleration
of amounts due under our credit agreement, the holders of the senior
subordinated notes could also accelerate the maturity of the outstanding senior
subordinated notes.
THE LOSS OF ONE OR MORE MAJOR CUSTOMERS COULD MATERIALLY AND ADVERSELY
AFFECT OUR RESULTS OF OPERATIONS
During 2001, our top ten customers accounted
for approximately 54% of our sales. The loss of any of our major customers
could have a material adverse effect on our financial condition or results of
operations. We do not have long-term contracts with our customers. As a result,
we cannot assure that a customer will not transfer, reduce the volume of, or
cancel a purchase order, each of which could adversely affect our financial
condition or results of operations. In addition, as a provider of power
supplies to OEMs, our sales are dependent upon the success of the underlying
products of which our power supplies are a component.
WE COULD LOSE BUSINESS IF WE FAIL TO KEEP UP WITH RAPID TECHNOLOGICAL
CHANGE IN THE ELECTRONIC EQUIPMENT INDUSTRY
Many of our existing customers are in the
electronic equipment industry, especially telecommunications and networking,
and produce products that are subject to rapid technological change,
obsolescence and large fluctuations in world-wide product demand. These
industries are characterized by intense competition and end-user demand for
increased product performance at lower prices. Our customers make similar
demands on us. We cannot assure that we will properly assess developments in
the electronic equipment industries and identify product groups and customers
with the potential for continued and future growth. Factors affecting the
electronic equipment industries, in general, or any of our major customers or
their products, in particular, could have a material adverse effect on our
financial condition or results of operations.
The markets for our products are
characterized by:
• rapidly changing technologies;
• increasing customer demands;
• evolving industry standards;
• frequent new product introductions; and
• in some cases, shortening product life cycles.
Generally, our customers purchase power supplies from us for the life
cycle of a
product. The development of new, technologically advanced products is a
complex and uncertain process requiring high levels of innovation and cost, as
well as the accurate anticipation of technological and market trends. As the
life cycle of our customers’ products shorten, we will be required to bid on
contracts for replacement or next generation products to replace revenues
generated from discontinued products more frequently. We cannot assure that we
will successfully develop, introduce or manage the transition of new products.
The failure of or the delay in anticipating technological advances or
developing and marketing product enhancements or new products that respond to
any significant technological change or change in customer demand could have a
material adverse effect on our financial condition or results of operations.
WE FACE SIGNIFICANT COMPETITION; OUR FAILURE TO EFFECTIVELY COMPETE
COULD MATERIALLY AND ADVERSELY AFFECT RESULTS OF OPERATIONS AND MARKET SHARE
The design, manufacture and sale of power
supplies is highly competitive. Our competition includes numerous companies
located throughout the world, some of which have advantages over us in terms of
labor and component costs and technology. Many of our competitors have
substantially greater resources and geographic presence than we do. We cannot
assure that competition from existing competitors or new market entrants will
not increase. We also face competition from current and prospective customers
that may design and manufacture their own power supplies. In times of an
economic downturn, or when dealing with high-volume orders, price may become an
increasingly important competitive factor, which could cause us to reduce
prices and thereby adversely affect our results of operations. Some of our
major competitors have also been engaged in merger and acquisition
transactions. Such consolidations by competitors are likely to create entities
with increased market share, customer bases, technology and marketing
expertise, and/or sales force size. These developments may adversely affect our
ability to compete. We cannot assure that we will continue to be able to
compete successfully against current or future competitors in the market.
OUR DEPENDENCE ON INTERNATIONAL OPERATIONS SUBJECTS US TO VARIOUS RISKS
ASSOCIATED WITH, AMONG OTHER THINGS, FOREIGN LAWS, POLICIES, ECONOMIES AND
EXCHANGE RATE FLUCTUATIONS
We have manufacturing operations located in
Mexico, Belgium and India. These operations are subject to inherent risks,
including variations in tariffs, quotas, taxes and other market barriers,
political and economic instability, work stoppages or strikes, unexpected
changes in regulatory requirements,
restrictions on the export or import of technology, and difficulties in
staffing and managing international operations, which could have a material
adverse effect on our financial condition or results of operations. Although we
transact business primarily in United States dollars, a portion of our sales
and/or expenses, including labor costs, are denominated in the Mexican peso,
the Indian rupee, the Euro and other European currencies. Fluctuations in the
value of the U.S. dollar relative to these foreign currencies, or increased
import duties, the imposition of tariffs or import quotas or interruptions in
transportation, could affect our revenues, costs of goods sold and operating
margins and could result in exchange losses or delays in shipments.
Historically, we have not actively engaged in substantial exchange rate hedging
activities and do not intend to do so in the future.
AN INTERRUPTION IN DELIVERY OF COMPONENT SUPPLIES COULD LEAD TO SUPPLY
SHORTAGES OR A SIGNIFICANT INCREASE IN PRICES OF COMPONENT SUPPLIES, WHICH
COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS
We are dependent on our suppliers for timely
shipments of components. We typically use a primary source of supply for each
component used in our products. Establishing alternate primary sources of
supply, if needed, could take a significant period of time which could result
in supply shortages and could result in increased prices. In some cases
components are sourced from only one manufacturer and an interruption in supply
could materially adversely affect our operations. Any shortages of particular
components, including components manufactured in our India facilities, could
increase product delivery times and/or costs associated with manufacturing,
reducing gross margins. For more details, see the heading “Our Dependence on
International Operations Subjects us to Various Risks Associated With, Among
Other Things, Foreign Laws, Policies, Economies and Exchange Rate Fluctuations”
above. Additionally, such shortages could cause a substantial loss of business
due to shipment delays. Any significant shortages or price increases of
components could have a material adverse effect on our financial condition or
results of operations.
OUR QUARTERLY SALES MAY FLUCTUATE WHILE OUR EXPENDITURES REMAIN
RELATIVELY FIXED, POTENTIALLY RESULTING IN LOWER GROSS MARGINS
Our quarterly results of operations have
fluctuated in the past and may continue to fluctuate in the future. Variations
in volume production orders and in the mix of products sold by us have
significantly affected sales and gross profit. Sales generally may also be
affected by other factors. These factors include:
• the receipt and shipment of large
orders;
• raw material availability and pricing;
• product and price competition; and
• the length of sales cycles and
economic conditions in the electronics industry.
Many of these factors are outside our
control.
We do not obtain long term purchase orders or
commitments from our customers, and a substantial portion of sales in a given
quarter may depend on obtaining orders for products to be manufactured and
shipped in the same quarter in which those orders are received. Sales for
future quarters may be difficult to predict. We rely on our estimates of
anticipated future volumes when making commitments regarding the level of
business that we will seek and accept, the mix of products that we intend to
manufacture, the timing of production schedules and the levels and utilization
of personnel, inventory and other resources.
A variety of conditions, both specific to the
individual customer and generally affecting the customer’s industry, may cause
customers to cancel, reduce or delay orders that were previously made or
anticipated. At any time, a significant portion of our backlog may be subject
to cancellation or postponement. We cannot assure that we will be able to
timely replace cancelled, delayed or reduced orders. Significant or numerous cancellations,
as well as reductions or delays in orders by a customer or group of customers,
could materially adversely affect our financial condition or results of
operations.
Our expense levels are relatively fixed and
are based, in part, on expectations of future revenues. Consequently, if
revenue levels are below expectations, our financial condition or results of
operations could be materially adversely affected. Due to all of the preceding
factors, in some future quarter or quarters our financial condition or results
of operations may be below our expectations and our gross margins may decrease.
For details concerning our financial condition, see Item 7, “Management’s
Discussion and Analysis of Financial Condition and Results of Operations.”
OUR ABILITY TO MAINTAIN AND ENHANCE PRODUCT AND MANUFACTURING
TECHNOLOGIES AND TO SUCCESSFULLY OPERATE OUR BUSINESS IS DEPENDENT UPON OUR
CONTINUED ABILITY TO ATTRACT AND RETAIN KEY PERSONNEL
Our success depends to a significant degree
on the efforts of Pat Patel, our Chairman, and Jeff Frank, our President and
Chief Executive Officer, and the other members of our senior management team.
We have no employment agreements with our key management executives and do not
maintain key person life insurance for any of our officers or Management
Committee members other than Mr. Patel. We believe that the loss of service of
any of these executives could have
a material adverse effect on our business.
Our ability to maintain and enhance product
and manufacturing technologies and to manage any future growth will also depend
on our success in attracting and retaining personnel with highly technical
skills. The competition for these qualified technical personnel may be intense if
the relatively limited number of qualified and available power engineers
continues. We cannot assure that we will be able to attract and retain
qualified management or other highly technical personnel.
CHANGES IN GOVERNMENT REGULATIONS OR PRODUCT CERTIFICATION COULD RESULT
IN DELAYS IN SHIPMENT OR IN LOST SALES, THEREBY MATERIALLY AND ADVERSELY
AFFECTING OUR RESULTS OF OPERATIONS
Our operations are subject to general laws,
regulations and government policies in the United States and abroad relating to
items such as minimum wage, employee safety and other health and welfare
regulations. Additionally, our product standards are certified by agencies in
various countries including the United States, Canada, Germany and the United
Kingdom among others. As many customers will not order uncertified products,
changes in such certification standards could negatively affect the demand for
our products, result in the need to modify our existing products or affect the
development of new products, each of which may involve substantial costs or
delays in sales and could have a material adverse effect on our financial
condition or results of operations.
ENVIRONMENTAL COMPLIANCE COULD REQUIRE SIGNIFICANT EXPENDITURES,
THEREBY MATERIALLY AND ADVERSELY AFFECTING OUR RESULTS OF OPERATIONS
We are subject to federal, state and local
environmental laws and regulations (in both the United States and abroad) that
govern the handling, transportation and discharge of materials into the
environment, including into the air, water and soil. Environmental laws could
become more stringent over time, imposing greater compliance costs and
increasing risks and penalties associated with violation. Should there be an
environmental occurrence, incident
or violation, our financial condition or results of operations may be
adversely affected. We could be held liable for significant damages for
violation of environmental laws and could also be subject to a revocation of
licenses or permits, thereby materially and adversely affecting our financial
condition or results of operations.
ITEM 2.
ITEM 2. PROPERTIES
The following table identifies our
facilities.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We
are subject to disputes and potential claims by third parties that are
incidental to the conduct of our business. We do not believe that the outcome
of any such matters, pending at December 31, 2001, will have a material adverse
effect on our financial condition or results of operations.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS
None.
PART II
ITEM 5.
ITEM 5. MARKET
FOR REGISTRANT’S COMMON EQUITY AND RELATED UNITHOLDER MATTERS
There is no established public trading market
for our membership units.
As of March 15, 2002, there were 23 holders
of record of our membership units.
Pursuant to our Second Amended and Restated
Operating Agreement, as amended, subject to certain qualifications, we may make
distributions of cash on our membership units at times, and in amounts,
determined by our Management Committee. Subject to compliance with our amended
credit agreement, however, we must make quarterly tax distributions on our
membership units to enable our members to pay taxes on our income. For the
fiscal years ended December 31, 2001 and 2000, we made the following
distributions:
On June 14, 2000, we consummated an offering
of an aggregate of 47,671 of our Class A Voting Units and an aggregate of
5,948,264 of our Class B Non-voting Units, pursuant to exemptions from, or
transactions not subject to the registration requirements of the Securities Act
of 1933, as amended, and applicable state securities laws. The net proceeds of
the offering were approximately $34 million. The offering was effected pursuant
to Section 4(2) of the Securities Act and Rule 506 promulgated thereunder, and
the purchasers were those holders of our membership units who were on the date
of purchase Accredited Investors, as that term is defined by Securities Act
Rule 501, and who elected to participate in the offering.
We used the net proceeds together with
borrowings under our credit facility to fund the purchase for approximately $55
million, including assumption of debt, of all of the outstanding stock of ITS.
For more information regarding the purchase of ITS, see “Business-ITS
Acquisition.”
On April 30, 1999, we consummated an offering
of $100 million aggregate principal amount of notes, pursuant to exemptions
from, or transactions not subject to, the registration requirements of the
Securities Act and applicable state securities laws. The net proceeds of the
offering were approximately $96.4 million. The offering was effected pursuant
to Section 4(2) of the Securities Act and Rule 144A promulgated thereunder, and
the initial purchaser was Credit Suisse First Boston Corporation. Following the
offering, we effected an exchange offer, registered under the Securities Act,
pursuant to which the 10 1/2% Series A Senior Subordinated Notes due 2009 were
exchanged for 10 1/2% Series B Senior Subordinated Notes due 2009 with
substantially the same terms and conditions as the 10 1/2% Series A Senior
Subordinated Notes due 2009.
We used the net proceeds together with
borrowings under our credit facility to fund a $150 million cash distribution
to our members made in connection with the acquisition by Cherokee Investor
Partners, LLC of 60% of our then outstanding membership units. Collectively, we
refer to the issuance of the notes, the entrance into our current credit
facility, the acquisition by Cherokee Investors of 60% of our then outstanding
membership units and the $150 million cash distribution as the “Transactions.”
ITEM
6.
ITEM
6. SELECTED FINANCIAL DATA
You should read the following selected
historical consolidated financial information in conjunction with our audited
consolidated financial statements beginning on page of this Annual Report
on Form 10-K. We derived our selected historical consolidated financial
information from our audited consolidated financial statements.
(a) EBITDA represents operating income plus depreciation and
amortization and, for the year ended December 31, 1999, plus a special bonus of
$5,330,000 made by Cherokee in connection with the Transactions. We consider
EBITDA to be a widely accepted financial indicator of our company’s ability to
service debt, fund capital expenditures and expand its business; however,
EBITDA is not calculated in the same way by all companies and is neither a
measurement required, nor represents cash flow from operations as defined, by
generally accepted accounting principles. You should not consider EBITDA to be
an alternative to net income, an indicator of operating performance or an alternative
to cash flow as a measure of liquidity.
(b) EBITDA Margin represents EBITDA as a percentage of net sales.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
You should read the following discussion and
analysis of our results of operations, financial condition and liquidity in
conjunction with the audited consolidated financial statements beginning on
page of this Annual Report on Form 10-K.
OVERVIEW
We are a leading designer and manufacturer of
a broad range of switch mode power supplies for OEMs primarily in the
telecommunications, networking and high-end workstation industries. We produce
our products and related components in sophisticated manufacturing facilities
located in Tustin and Irvine, California; Wavre, Belgium; Guadalajara, Mexico;
and Bombay, India.
The principal elements comprising cost of
sales are raw materials, labor and manufacturing overhead. Raw materials
account for a large majority of cost of sales. Raw materials include magnetic
subassemblies, sheet metal, electronic and other components, mechanical parts
and electrical wires. Labor costs include employee costs of salaried and hourly
employees. Manufacturing overhead includes lease costs, depreciation on
property, plant and equipment, utilities, property taxes and repairs and
maintenance.
Operating expenses include engineering costs,
selling and marketing costs and administrative expenses. Engineering costs primarily
include salaries and benefits of engineering personnel, safety approval and
quality certification fees, depreciation on equipment and subcontract costs for
third party contracting services. Selling and marketing expenses primarily
include salaries and benefits to account managers and commissions to
independent sales representatives. Administrative expenses primarily include
salaries and benefits for certain management and administrative personnel,
professional fees and information system costs.
Cherokee is organized as a California limited
liability company and treated as a partnership for United States federal income
tax purposes. Under this treatment, Cherokee is not itself subject to United States
federal income taxation. Each member of Cherokee, however, is subject to tax on
its allocable share of Cherokee’s income. In general, Cherokee makes
distributions to its members in an amount sufficient to pay their United States
federal and state income taxes resulting from their allocable share of
Cherokee’s income.
On June 15, 2000, the Company acquired
Industrial and Telecommunication Systems and related entities (“ITS”) for
approximately $55 million, including assumption of debt. The acquisition was
accounted for using the purchase method of accounting.
During 2001, the Company continued to
generate the majority of its sales from the communications market segment,
particularly the networking and telecommunications sectors. As a result of
unfavorable economic conditions and reduced capital spending by communication
service providers that purchase our customers’ products, the Company’s sales
have decreased in each quarter of 2001, compared to the immediately preceding
quarter. The Company believes unstable and unpredictable economic and industry
conditions may continue. If these conditions persist, the Company’s operating
results and financial condition could be adversely affected.
CRITICAL ACCOUNTING POLICIES
The Company's consolidated financial
statements have been prepared in accordance with accounting principles
generally accepted in the United States of America. As such, management is
required to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent liabilities at the date of
the financial statements and the amounts of revenues and expenses during the
reporting period. Actual results could differ from such estimates.
The accounting policies which the Company
believes are the most critical to aid in fully understanding and evaluating our
reported financial results include the following:
Revenue Recognition: The Company recognizes revenue from product sales upon
shipment to the customer provided that persuasive evidence of an arrangement
exists, the price is fixed, title has transferred, collection of resulting
receivables is reasonably assured, there are no customer acceptance
requirements, and there are no remaining significant obligations.
Credit Risk: The
Company performs ongoing credit evaluations of its customers and generally does
not require collateral. The Company continuously monitors collections and
payments from its customers and maintains a provision for estimated credit
losses based on any specific customer collection issues identified, as well as
historical experience.
Inventories: Inventories
are valued at the lower of cost ( first-in, first out) or market. The Company
regularly reviews inventory quantities on hand and writes down excess and
obsolete inventories to net realizable value based on forecasted demand and
market conditions. Actual demand and market conditions may be different from
those projected by management.
Long-Lived Assets: The Company accounts for the impairment and disposition
of long-lived assets in accordance with SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of." In accordance with SFAS No 121, long-lived assets to be held are
reviewed for events or changes in circumstances that indicate that their
carrying value may not be recoverable. In August 2001, FASB issued SFAS No.
144, "Accounting for Impairment or Disposal of Long-Lived Assets."
This statement addresses financial accounting and reporting for the impairment
of long-lived assets and for the disposal of long-lived assets. SFAS No. 144
supersedes SFAS No. 121 and is effective for fiscal years beginning after
December 15, 2001. The Company evaluates the carrying value of intangible assets
for impairment based on undiscounted future cash flows. While the Company has
not experienced impairment of intangible assets in prior periods, the Company
cannot guarantee that there will not be impairment in the future.
RESULTS OF OPERATIONS
FISCAL 2001 COMPARED TO FISCAL 2000
NET SALES
Net sales decreased by approximately 14.8% or
$21.2 million to $122.0 million for the year ended December 31, 2001 from
$143.2 million for the year ended December 31, 2000.
Sales of our North American operations
decreased by approximately 38.1% or $42.5 million primarily due to lower
customer demand as a result of unfavorable economic conditions and reduced
capital spending by communication service providers. This was partially offset
by increased sales attributable to the acquisition of ITS, which contributed
$52.8 million of sales for 2001, compared to $31.5 million of sales contributed
for the period June 16 to December 31, 2000.
GROSS PROFIT
Gross profit decreased by approximately 28.7%
or $14.0 million to $34.7 million for the year ended December 31, 2001 from
$48.7 million for the year ended December 31, 2000. Gross margin for the year
ended December 31, 2001 decreased to 28.4% from 34.0% in the prior year.
The decrease in gross profit was primarily
due to a decrease in gross profit contributed by the North American operations
resulting primarily from lower sales, partially offset by an increase in gross
profit contributed by the European operations acquired in June 2000. The
decrease in gross margin compared to the prior year was primarily due to lower
gross margin for the North American operations mainly as a result of a change
in product mix and increased factory overhead expenses as a percentage of net
sales.
OPERATING EXPENSES
Operating expenses for the year ended
December 31, 2001 increased by approximately 17.6% or $3.6 million to $24.2
million from $20.5 million for the year ended December 31, 2000. As a
percentage of sales, operating expenses increased to 19.8% from 14.3% in the
prior year.
The increase in operating expenses, as
expressed in dollars as well as a percentage of net sales, was primarily
attributable to the inclusion in 2001 of a full year of ITS operations and
amortization of goodwill and other related intangibles associated with the ITS
acquisition. Partially offsetting the increase in dollars relating to the ITS
operations was a decrease in operating expenses for the North American
operations resulting primarily from reductions in our workforce and other cost
control measures implemented during 2001.
OPERATING INCOME
Operating income decreased by approximately
62.6% or $17.6 million to $10.5 million for the year ended December 31, 2001
from $28.1 million for the year ended December 31, 2000. Operating margin
decreased to 8.6% for 2001 from 19.6% in 2000.
The decrease in operating income was
primarily attributable to a decrease in the operating income of the North
American operations resulting mainly from lower sales and decreased gross
margin. Operating income contributed by ITS in 2001 was offset by amortization
of goodwill and other related intangibles associated with the ITS acquisition.
The decrease in operating margin was primarily attributable to the decrease in
gross margin combined with higher operating expenses as a percentage of sales
discussed above.
INTEREST EXPENSE
Interest expense for the year ended December
31, 2001 was $16.5 million compared to $16.8 million for the year ended
December 31, 2000. This decrease was primarily due to lower interest rates on
the Company’s revolver borrowings and term loans in 2001 compared to 2000.
NET INCOME
As a result of the items discussed above, the
Company reported a net loss of $6.5 million for the year ended December 31, 2001
compared to net income of $11.7 million for the year ended December 31, 2000.
FISCAL 2000 COMPARED TO FISCAL 1999
NET SALES
Net sales increased by approximately 17.9% or
$21.7 million to $143.2 million for the year ended December 31, 2000 from $121.5
million for the year ended December 31, 1999.
The inclusion of ITS operations from June 16,
2000 to December 31, 2000 contributed approximately $31.5 million of sales for
2000. This was partially offset by lower sales for the North American
operations primarily due to decreased demand from certain major customers in
2000 compared with particularly strong demand from those same customers in the
prior year. A decline in sales to IBM, one of the Company’s largest customers,
accounted for substantially all of the North American sales decrease from 1999.
GROSS PROFIT
Gross profit increased by approximately 10.9%
or $4.8 million to $48.7 million for the year ended December 31, 2000 from
$43.9 million for the year ended December 31, 1999. Gross margin for 2000
decreased to 34.0% from 36.1% in the prior year.
The increase in gross profit was primarily
due to inclusion of ITS in the current year, partially offset by lower gross
profit from the North American operations due to decreased sales as discussed
above. The decrease in gross margin compared to 1999 was primarily due to the
inclusion in 2000 of the ITS operations, which had lower gross margins than the
North American operations.
OPERATING EXPENSES
Operating expenses for the year ended
December 31, 1999 of $15.9 million included a $5.3 million special bonus
distribution. This bonus payment was in addition to our discretionary annual
management bonus plan and was funded by capital contributions made by our then
existing members. No such special bonus distribution was made for the year
ended December 31, 2000.
Operating expenses increased by approximately
93.7% or $9.9 million to $20.5 million for the year ended December 31, 2000
from $10.6 million, excluding the special bonus distribution, for the year
ended December 31, 1999. As a percentage of sales, operating expenses, before
the special bonus distribution, increased to 14.3% from 8.7% in the prior year.
The increase in operating expenses, as
expressed in dollars as well as a percentage of net sales, was primarily
attributable to the inclusion of ITS’s operations from June 16, 2000 to
December 31, 2000, and amortization of goodwill and other related intangibles
related to the ITS acquisition. The increase in operating expenses as expressed
as a percentage of net sales was also attributable to having the resources in
place at the North American operations to support sales levels commensurate
with those achieved in 1999.
OPERATING INCOME
Operating income decreased by approximately
15.4% or $5.1 million to $28.1 million for the year ended December 31, 2000
from $33.3 million, excluding the special bonus distribution, for the year
ended December 31, 1999. Operating margin for the year ended December 31, 2000,
declined to 19.6% from 27.4% in the prior year.
The decrease in operating income was
primarily due to the same factors contributing to our decrease in gross profit
and increase in operating expenses as discussed above.
INTEREST EXPENSE
Interest expense for the year ended December
31, 2000 was $16.8 million compared to $10.7 million for the year ended
December 31, 1999. This substantial increase was primarily due to the issuance
of $100 million of 10 1/2% senior subordinated notes and a $50 million term
loan, all of which occurred in April 1999 in connection with the Transactions,
and $8.0 million of new term debt in connection with the ITS acquisition in
June 2000.
NET INCOME
Net income for the year ended December 31,
2000 was $11.7 million. Net income decreased by approximately 46.7% or $10.2
million from $21.9 million, excluding the effect of the special bonus
distribution, for the year ended December 31, 1999. Net income margin for 2000
was 8.1% compared to 18.0% for 1999.
The decrease in net income and net income
margin was primarily due to the factors discussed above.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOWS
FISCAL 2001 COMPARED TO FISCAL 2000
Net cash provided by operating activities was
$17.0 million for the year ended December 31, 2001 compared to $6.7 million for
the year ended December 31, 2000. Cash provided by operating activities for
2001 reflects net loss of approximately $6.5 million, depreciation and
amortization of $6.7 million, decreases of $14.4 million in accounts receivable
and $14.1 million in inventories and an increase in accrued liabilities of $2.2
million, partially offset by decreases of $12.6 million in accounts payable and
$1.3 million in accrued compensation and benefits. Cash provided by operating
activities for 2000 reflects net income of $11.7 million, depreciation and
amortization of $4.8 million, partially offset by increases of $7.0 million in
accounts receivable and $4.7 million in inventory.
Net cash used in investing activities for the
year ended December 31, 2001 primarily consists of $1.7 million of additions to
property and equipment. The amount for 2000 reflects $4.9 million of additions
to property and equipment and $51.5 million invested in the ITS acquisition,
net of cash acquired.
Net cash used in financing activities of
$13.2 million for the year ended December 31, 2001 primarily reflects a net
reduction of $3.2 million in revolving credit borrowings, $6.4 million of
payments on long-term debt and an equity distribution of $2.1
million. Net cash provided by financing activities of $43.5 million for the
year ended December 31, 2000 primarily reflects proceeds from bank borrowings
aggregating $13.0 million and $34.8 million from the sale of units, which were
used to finance the purchase of ITS, partially offset by payments on long-term
debt of $5.2
million and equity distributions of $7.2 million.
FISCAL 2000 COMPARED TO FISCAL 1999
Net cash provided by operating activities was
$6.7 million for the year ended December 31, 2000 compared to $19.2 million for
the year ended December 31, 1999. Cash provided by operating activities for
2000 reflects increased depreciation and amortization, partially offset by
increases in accounts receivable of $7.0 million and inventories of $4.7
million. Cash provided by operating activities for 1999 reflects increased
depreciation and amortization as well as increased accrued interest payable of
$2.4 million, partially offset by increased inventories of $3.4 million.
Net cash used in investing activities was
$56.7 million for the year ended December 31, 2000 compared to $1.1 million for
the year ended December 31, 1999. The amount for 2000 reflects $4.9 million of
additions to property and equipment and $51.5 million invested in the ITS
acquisition, net of cash acquired.
Net cash provided by financing activities was
$43.5 million for the year ended December 31, 2000 compared to $13.4 million
used for the year ended December 31, 1999. The amount for 2000 reflects $34.8
million of cash proceeds from the sale and issuance of new members’ equity
units and $8.0 million of borrowings under a new term loan, both done primarily
in connection with the ITS acquisition. A net increase in revolving credit
borrowings of $14.4 million was offset by payments on long-term debt of $5.2
million and equity distributions of $7.2 million. The amount for 1999 includes
the favorable cash flow effect of a $5.3 million capital contribution made by
the existing members to fund the special bonus distribution discussed above.
This was partially offset by payment in 1999 of $5.4 million of deferred
financing costs.
LIQUIDITY
Historically, we have financed our operations
with cash from operations supplemented by borrowings from our credit
facilities. Our liquidity needs primarily arise from debt service on our
indebtedness, working capital requirements, capital expenditures and
distributions to our members so that they may satisfy their obligations to pay
taxes on our income. Our liquidity in 2000 was also affected by the acquisition
of ITS. As of December 31, 2001, our borrowings consisted of $100 million of
senior subordinated notes and $55.0 million of borrowings under our various
credit facilities, including $41.8 million under the term loan facilities and
$10.5 million drawn under the $25 million revolving credit facility. We are not
subject to any amortization requirements under the notes prior to maturity but
we are required to make scheduled repayments under the term loan facilities.
Our historical capital expenditures have
substantially resulted from investments in equipment to increase our
manufacturing capacity and improve manufacturing efficiencies. Our cash capital
expenditures were $1.7 million, $4.9 million and $0.5 million for fiscal 2001,
2000 and 1999, respectively. Capital expenditures under capital leases were
$0.0 million in 2001, $1.3 million in 2000 and $3.2 million in 1999. For fiscal
2002, we expect capital expenditures to be approximately $1-2 million, which
will relate principally to investments in manufacturing equipment.
On September 26, 2001, our credit agreement
with our lenders was amended to include provisions that specify among other
things, (1) that some of our unitholders, or their equity members, will
guarantee $10.5 million of our senior debt principal until specific financial
ratios are attained, (2) that we will be restricted from making cash
distributions to our unitholders until specific financial ratios are attained,
(3) that we will be permitted to make our interest payments due in November
2002 relating to our $100 million of senior subordinated notes so long as
specified financial ratios are attained, (4) that the maximum availability
under our revolving line of credit is reduced until approximately April 30,
2002, (5) that LIBOR and base rate margins have been increased for revolver
borrowings and term loans, and (6) that financial covenant ratios required in
future periods have been modified, including provisions allowing our
unitholders to make capital contributions to us which will be treated as
earnings (as defined) for purposes of calculating debt covenants.
Based upon our present expectations, we anticipate
that we may not be in compliance with certain financial covenants under our
credit agreement at June 30, 2002, or earlier, without additional financing
from our unitholders. In addition, we believe that cash flow from operations
and available borrowing capacity may not be adequate to meet our anticipated
cash requirements, including operating requirements, planned capital
expenditures and debt service, for the last six months of the year, or earlier,
without additional financing from our unitholders.
We are currently considering alternatives to
address these issues, which may include (i) an amendment or restructuring of
our credit agreement to provide additional liquidity and room under certain
financial covenants, (ii) a refinancing of our credit agreement, (iii) the
infusion of additional equity by our unitholders, or (iv) some combination of
the above. Based
upon the Company's current business plans and prospects, management expects
that its restructuring alternatives, the $10.5 million guaranty by certain
unitholders and funding from its unitholders, if necessary, will enable the
Company to meet its obligations and comply with its debt covenants through
December 31, 2002.
We cannot provide any assurances that we will
be successful in obtaining any desired results on satisfactory terms or as to
what effect any of the foregoing, if obtained, may have on our future business
operations. In the event of a covenant or payment default under our credit
agreement or a payment default under the indenture governing our senior
subordinated notes, the lenders under the credit agreement would become
entitled to certain rights, including the right to accelerate the debt and to
require our unitholders, or their equity members, to contribute $10.5 million
to our senior debt principal under the terms of the guaranty they provided. The
guarantors would be subrogated to rights of the lenders under the credit
agreement, on a basis senior to the senior subordinated notes. In the event of
a payment default under the indenture or the credit agreement or in the event
of an acceleration of amounts due under our credit agreement, the holders of
the senior subordinated notes could also accelerate the maturity of the
outstanding senior subordinated notes.
The maturities of our long-term debt,
including capital leases, and future payments under our operating leases as of
December 31, 2001 are as follows (in millions):
We are organized as a California limited liability company and
treated as a partnership for United States federal income tax purposes. Under
this treatment,
we are not subject to United States federal income taxation; however, our
foreign subsidiaries are subject to income tax. Each of our members, however,
is subject to tax on its allocable share of our income. In general, we make
distributions to our members in an amount sufficient to pay their United States
federal and state income taxes resulting from their allocable share of our
income. During 2001, 2000 and 1999, we made distributions to our members of
approximately $0.0 million, $7.6 million and $160.8 million, respectively. The
1999 distribution included the $150 million distribution made in connection
with the Transactions.
NEW ACCOUNTING PRONOUNCEMENTS
SFAS No. 133, “Accounting for Derivative
Instruments and Hedging Activities,” is effective for all fiscal years
beginning after June 15, 2000. SFAS No. 133, as amended, establishes accounting
and reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts and for hedging activities.
Under SFAS No. 133, certain contracts that were not formerly considered
derivatives may now meet the definition of a derivative and all derivatives are
to be reported on the balance sheet at fair market value. The Company adopted
SFAS No. 133 effective January 1, 2001. The adoption of SFAS No. 133 did not
have a significant impact on the financial position, results of operations, or
cash flows of the Company.
In June 2001, FASB issued two new
pronouncements: SFAS No. 141, “Business Combinations,” and SFAS No. 142,
“Goodwill and Other Intangible Assets.” SFAS No. 141 prohibits the use of the
pooling-of-interest method for business combinations initiated after June 30,
2001 and also applies to all business combinations accounted for by the
purchase method that are completed after June 30, 2001. There are also
transition provisions that apply to business combinations completed before July
1, 2001, that were accounted for by the purchase method. SFAS No. 142 is
effective for fiscal years beginning after December 15, 2001 to all goodwill
and other intangible assets recognized in an entity’s statement of financial
position at that date, regardless of when those assets were initially
recognized. SFAS No. 142 requires that goodwill and other
intangible assets with indefinite useful lives no longer be amortized, but
instead be tested for impairment at least annually. The Company will no longer
amortize intangible assets but will evaluate their carrying value on an annual
basis or when events or circumstances indicate that their carrying value may be
impaired. The Company expects the adoption of SFAS No. 142 to result in reduced
amortization expense of approximately $3.0 million in 2002. The Company is currently evaluating
all the provisions of SFAS No. 141 and SFAS No. 142.
In August 2001, FASB issued SFAS No. 144,
“Accounting for Impairment or Disposal of Long-Lived Assets.” This statement
addresses financial accounting and reporting for the impairment of long-lived
assets and for the disposal of long-lived assets. SFAS No. 144 supersedes SFAS
No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of,” and is effective for fiscal years beginning after
December 15, 2001. The Company is currently evaluating the impact that the adoption
of this standard will have on its financial position and results of operations.
ITEM 7A.
ITEM 7A. QUANTITATIVE
AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to our operations result
primarily from changes in short-term interest rates. We do not have significant
foreign exchange or other market risk. We did not have any derivative financial
instruments at December 31, 2001.
Our exposure to market risk for changes in
interest rates relates primarily to our credit facility. In accordance with the
credit facility, we enter into variable rate debt obligations to support
general corporate purposes, including capital expenditures and working capital
needs. We continuously evaluate our level of variable rate debt with respect to
total debt and other factors, including assessment of the current and future
economic environment.
We had approximately $55 million in variable
rate debt outstanding at December 31, 2001. Based upon this year-end variable
rate debt level, a hypothetical 10% adverse change in interest rates would
increase interest expense by approximately $0.4 million on an annual basis, and
likewise decrease our earnings and cash flows. We cannot predict market
fluctuations in interest rates and their impact on our variable rate debt, nor
can there be any assurance that fixed rate long-term debt will be available to
us at favorable rates, if at all. Consequently, future results may differ
materially from the estimated adverse changes discussed above.
As a result of the ITS
acquisition in June 2000, the Company has European operations and is,
therefore, subject to a certain degree of market risk associated with changes
in foreign currency exchange rates. The Company has not actively engaged in
exchange rate hedging activities.
ITEM 8.
ITEM 8. FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATE
See the Index to Financial Statements on page .
ITEM 9.
ITEM 9. CHANGES
AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
ITEM 10. MANAGEMENT
EXECUTIVE OFFICERS AND MANAGEMENT COMMITTEE MEMBERS
Pursuant to our Second Amended and Restated
Operating Agreement, as amended, we are managed by an eight-member Management
Committee.
Set forth below is certain information
concerning our executive officers and members of our Management Committee.
PAT PATEL founded Cherokee Corporation in
1978, and served as President of Cherokee and its successor since its
inception. In April 1999, he became Chairman of the Management Committee. In
September 2001, he resigned as President and Chief Executive Officer. Prior to
founding Cherokee Corporation, Mr. Patel served as a Senior Project Engineer at
Burroughs Corp. (now Unisys) for four years. Mr. Patel also serves as President
and Chief Executive Officer of, and is a director of, Cherokee Finance.
JEFF FRANK joined Cherokee in September 2001
as President and Chief Executive Officer. Prior to joining Cherokee, Mr. Frank
was President of Lamda LEI for two years. In addition, Mr. Frank has over 18
years of experience in the electronics industry.
BUD PATEL has served as our Executive Vice
President since April 1996 and was a Vice President of Engineering of Cherokee
Corporation from 1987 to 1993. Mr. Patel served as President of Bikor from June
1993 through March 1996 when we acquired substantially all of the assets of
Bikor. Prior to joining the Company in 1987, Mr. Patel was a Director of
Engineering at Leland Electro Systems for over 25 years. Mr. Patel also serves
as a director of Cherokee Finance. Bud Patel is not related to Pat Patel.
DENNIS POULIOT has served as Vice President
in the sales and marketing departments of Cherokee and its predecessor since March
1991. Prior to joining us, Mr. Pouliot was a sales manager at Lambda Qualidyne
from June 1989 to March 1991 and a Director of International Sales and
Marketing from September 1978 through June 1989.
HOWARD RIBAUDO has served as Vice President
in the sales and marketing departments since March 1996 and served us in
various other capacities for Cherokee from 1988 through September 1993. Mr.
Ribaudo served as Vice President of Sales and Marketing for Bikor from
September 1993 through March 1996.
VAN HOLLAND became our Chief Financial
Officer in August 1999. Prior to joining Cherokee, Mr. Holland served as
Executive Vice President and Chief Financial Officer of Wyle Electronics, a
$1.5 billion electronics distributor. From 1979 to May 1999, Mr. Holland served
in various senior financial management positions at Wyle. Prior to that, Mr.
Holland was an auditor with Arthur Andersen & Co.
KEN KING served as Executive Vice President
of Cherokee and its predecessor from September 1982 until April 2000. Mr. King
joined us after serving as the President of Delphi Communications Corp. from
September 1972 until September 1982.
IAN SCHAPIRO became our Vice President and a
member of our Management Committee in April 1999. Mr. Schapiro became a
founding principal of GFI Energy Ventures in June 1995. From November 1985 to
June 1995 he was a partner of Venture Associates and of Arthur Andersen &
Co. following that firm’s acquisition of Venture Associates. From 1984 to 1985,
Mr. Schapiro was Chief Financial Officer of a technology company, and before
that, a commercial banker with The Bank of California whose portfolio was
concentrated in the energy sector. Mr. Schapiro is a member of the board of
directors of UtiliQuest Holdings, Inc., Linesoft Corporation, and Xantrex Technology,
Inc. Mr. Schapiro also serves as Vice President and Secretary of, and is a
director of, Cherokee Finance.
STEPHEN KAPLAN became a member of our
Management Committee in April 1999. Mr. Kaplan is a principal of Oaktree. Prior
to joining Oaktree in June 1995, Mr. Kaplan was a Managing Director of Trust
Company of the
West, or TCW. Prior to joining TCW in 1993, Mr. Kaplan was a partner in
the law firm of Gibson, Dunn & Crutcher. Mr. Kaplan serves on the boards of
directors of Collagenex Pharmaceuticals, Inc., General Maritime Corporation,
Forest Oil Corporation and various other private companies.
TONY BLOOM became a member of our Management
Committee in April 1999. Mr. Bloom is an international investor now based in
London. Prior to his relocation to London in July 1988, he lived in South
Africa where he was the Chairman and Chief Executive of The Premier Group (a
multi-billion dollar conglomerate involved in agribusiness, retail, and
consumer products), and a member of the boards of directors of Barclays Bank,
Liberty Life Assurance, and South African Breweries. Since moving to the United
Kingdom, Mr. Bloom has been a member of the board of directors of Rothschild,
Deputy Chairman of Sketchley plc. Mr. Bloom is currently a director of RIO
Narcea Gold Mines Ltd., Afri-Can Marine Minerals Corporation, Xantrex
Technology, Inc., Power Measurement, Inc., Caminus Corporation and is Chairman
of Cine-UK Ltd. Mr. Bloom’s association with GFI goes back to its inception in
1995.
CHRIS BROTHERS became a member of our
Management Committee in April 1999. Mr. Brothers is a Managing Director of
Oaktree. Prior to joining Oaktree in 1996, Mr. Brothers worked at the New York
headquarters of Salomon Brothers Inc, where he served as a Vice President in
the Mergers and Acquisitions group. Prior to 1992, Mr. Brothers was a Manager
in the Valuation Services group of Price Waterhouse. Mr. Brothers serves on the
boards of directors of National Mobile Television, Inc, Caminus Corporation,
Power Measurement, Inc., Ltd. and Xantrex Technology, Inc.
Our Second Amended and Restated Operating
Agreement, as amended, provides that Cherokee Investors has the right to
designate four members of our Management Committee. OCM/GFI Cherokee
Investments II, Inc. has the right to designate one member of our Management
Committee and our other members have the right to designate three members of
our Management Committee.
The individuals serving as members of our
Management Committee serve indefinite terms, and may be removed only by the
members that appointed that individual to the Management Committee.
NON-COMPETITION AGREEMENTS
In connection with the Transactions, each of
Messrs. Pat Patel, Bud Patel, Amrit Patel and Mukesh Patel, all of whom are not
directly related to each other, entered into Non-Competition and
Confidentiality Agreements. The Non-Competition Agreements are effective for
the longer of five years or the period during which the executive directly or
indirectly holds any equity interest in Cherokee.
Each Non-Competition Agreement prohibits the
applicable executive from directly or indirectly taking any action or
encouraging others to take any action, which advances or is intended to advance
the interest of any existing or potential competitor of ours or that would
otherwise affect the Company’s relationship with any existing or potential
customer in a manner that is not in our interest. Each Non-Competition
Agreement also contains confidentiality and non-solicitation provisions.
ITEM 11.
ITEM 11. COMPENSATION OF NAMED EXECUTIVE OFFICERS
The summary compensation table below sets
forth information concerning compensation paid in the fiscal year ended
December 31, 1999, 2000 and 2001 to our Chief Executive Officer and our four
other most highly compensated executive officers, referred to in this
prospectus as our named executive officers.
SUMMARY COMPENSATION TABLE
(1) For each named executive officer, the aggregate dollar amount of
other
annual compensation not properly categorized as salary or bonus did not
exceed the lesser of (1) $50,000 and (2) 10% of the total salary and bonus
reported by such named executive officer for such fiscal year.
(2) Represents matching contributions made by us on behalf of the named
executive officers under our 401(k) plan.
(3) $1,000,000 represents a special bonus paid by the Company’s members
in connection with the Transactions in 1999.
(4) Jeff Frank was hired as the Company’s new President and Chief
Executive Officer in September 2001 and his compensation as shown consists of
the last four months of 2001. Pat Patel agreed to remain in his position to
provide for a smooth transition.
(5) These options are currently in the process of being cancelled and
will be reissued at a later date.
UNIT OPTION PLAN
1999 UNIT OPTION PLAN. The Management
Committee adopted the 1999 Unit Option Plan (the “Plan”) on June 28, 1999,
which has been approved by a majority of our members holding Class A Units, for
the benefit of our officers, Management Committee members, employees, advisors
and consultants. The Plan covers an aggregate of 2,970,000 non-voting Class B
Units and provides for the issuance of unit options.
The Plan may be administered by the
Management Committee or a committee designated by the Management Committee
(either such committee sometimes referred to as the “plan administrator”). The
plan administrator may interpret the Plan and, subject to its provisions, may
prescribe, amend and rescind rules and make all other determinations necessary
or desirable for the administration of the Plan. The Plan permits the plan
administrator to select the officers, Management Committee representatives,
employees, advisors and consultants of the Company (including Management
Committee representatives who are also employees) who will receive unit options
and generally to determine the terms and conditions of such unit options.
The unit price of each unit option granted
under the Plan may generally not be less than 85% of the fair market value of a
Class B Unit on the date a unit option is granted. Unit options generally vest
at the rate of 25% per year over four years.
In the event that we (i) become incorporated
(or merged into a corporation or transfer all or substantially all of our
assets to a corporation) or (ii) become a publicly traded corporation (each, a
“Conversion Transaction”), the plan administrator will, prior to such
Conversion Transaction, take such action as it shall determine to be
appropriate with respect to the Plan and the outstanding unit options granted,
so as to equitably treat such options and the participants and to enable them
to retain the benefits of the unit options following such Conversion
Transaction. Such actions may, but need not, include adopting a new plan and
converting the unit options into comparable awards under that plan.
In connection with any proposed (i)
liquidation or dissolution of us, (ii) a sale of all or substantially all of
our assets other than in the ordinary course of our business or (iii) a merger
or consolidation involving us in which we are not the surviving entity or we
become a subsidiary of another corporation, excluding, however, any Conversion
Transaction, the plan administrator shall determine the appropriate treatment,
if any, of outstanding unit options and may make such amendments to the Plan as
are necessary to reflect such determination.
Except as otherwise provided, in the event of
any merger, reorganization, consolidation or other change in corporate
structure affecting the Class B Units, an equitable substitution or
proportionate adjustment, if any, as determined by the plan administrator, may
be made in (i) the aggregate number of Class B Units reserved for issuance
under the Plan, and (ii) the kind, numberand exercise price of Class B Units
subject to outstanding unit options granted under the Plan.
Except as otherwise provided, in the event of
any unit split, reverse unit split, distribution of units, recapitalization,
combination or reclassification of units, an equitable substitution or
proportionate adjustment, as determined by the plan administrator, shall be
made in (i) the aggregate number of Class B Units reserved for issuance under
the Plan, and (ii) the kind, number and exercise price of Class B Units subject
to outstanding unit options granted under the Plan.
In connection with any such event, the plan
administrator may provide for the cancellation of any outstanding unit options
that are vested but unexercised, or any portion thereof. In connection with any
such cancellation, we will make a payment to the participant in cash or other
property equal to the difference between the aggregate fair market value of the
Class B Units subject to the cancelled unit options, or portion thereof, and
the aggregate exercise price of the cancelled unit options, or portion thereof.
The terms of the Plan provide that the plan
administrator may amend, suspend
or terminate the Plan at any time,
provided, however, that certain amendments require approval of a majority of
the members holding
Class A Units. Further, no such action may be taken which adversely affects any
rights under outstanding unit options without the holder’s consent.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
There were no unit options granted to or
exercised by any of our executive officers in 2001.
COMPENSATION OF DIRECTORS
The individuals serving on the Management
Committee who are not employees of Cherokee will receive no compensation so
long as they are affiliated with, or have a financial interest in, Cherokee. All
of our Management Committee members currently have these affiliations. The
Management Committee has sole discretion to determine to what extent, if any,
to compensate any individuals serving on the Management Committee.
No director of Cherokee Finance receives any
compensation with respect to his or her position as a director.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
After we completed the Transactions, our
Management Committee formed a compensation committee comprised of Pat Patel, Ian
Schapiro and Chris Brothers. No member of the compensation committee will
participate in the determination of his or her own compensation.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL
OWNERS AND MANAGEMENT
The following table sets forth the beneficial
ownership of our outstanding membership units as of March 15, 2002 by:
• each person who is known by us to
own beneficially more than 5% of our outstanding Class A Units;
• each of our Management Committee
members and named executive officers; and
• all of our Management Committee
members and named executive officers as a group.
(1) The Class A Units and
Class B Units are identical except that Class A Units have voting rights and
Class B Units have no voting rights.
(2) The owners of Cherokee
Investors Partners, LLC and OCM/GFI Cherokee Investors II include an affiliate
of GFI, an affiliate of Oaktree, Rothschild and an affiliate of the initial
purchaser of the outstanding notes. By virtue of their ownership of equity of
Cherokee Investors, these entities may be deemed to share beneficial ownership
of the membership units owned by Cherokee Investors. GFI, Oaktree, Rothschild and
the initial purchaser, and their affiliates, if appropriate, expressly disclaim
beneficial ownership of such units.
(3) c/o GFI Energy Ventures LLC, 11611 San Vicente Boulevard, Suite
710, Los Angeles, CA 90049.
(4) c/o Cherokee International, LLC, 2841 Dow Avenue, Tustin,
California 92780.
(5) Consists entirely of
membership units that Manju Patel holds jointly with her husband, Pat Patel, as
trustees of the Patel Family Trust (see note 6). Manju Patel expressly
disclaims beneficial ownership of any units beneficially owned by her as
trustee of that trust.
(6) Consists entirely of
membership units that Mr. Patel holds jointly with his wife, Manju Patel, as
trustees of the Patel Family Trust (see note 5). Mr. Patel expressly disclaims
beneficial ownership of any units beneficially
owned by him as trustee of that trust.
(7) Bud Patel may be
deemed to share beneficial ownership of the 23,719 Class A Units and 2,415,486
Class B Units owned by Bikor, by virtue of his ownership of Bikor’s common
stock. Bud Patel expressly disclaims beneficial ownership of any units
beneficially owned by him by virtue of his ownership of Bikor’s common stock.
(8) Ian Schapiro may be
deemed to share beneficial ownership of the 252,795 Class A Units and
25,937,441 Class B Units owned by Cherokee Investors and OCM/GFI Cherokee
Investors II by virtue of his status as a principal of GFI, which, through an
affiliate holds an equity interest in Cherokee Investors. Mr. Schapiro
expressly disclaims beneficial ownership of any units beneficially owned by him
by virtue of his status as a principal of GFI.
(9) c/o Oaktree Capital
Management, LLC, 333 South Grand Avenue, Los Angeles, California 90071.
(10) Stephen Kaplan and
Chris Brothers may be deemed to share beneficial ownership of the 252,795 Class
A Units and 25,937,441 Class B Units owned by Cherokee Investors and OCM/GFI
Cherokee Investors II by virtue of their status as principals of Oaktree,
which, through an affiliate holds an equity interest in Cherokee Investors. Mr.
Kaplan and Mr. Brothers expressly disclaim beneficial ownership of any units
beneficially owned by them by virtue of their status as principals of Oaktree.
(11) Tony Bloom may be
deemed to share beneficial ownership of the 252,795 Class A Units and
25,937,441 Class B Units owned by Cherokee Investors and OCM/GFI Cherokee
Investors II by virtue of his status as a principal of Rothschild, which holds
an equity interest in Cherokee Investors. Mr. Bloom expressly disclaims
beneficial ownership of any units beneficially owned by him by virtue of his
status as a principal of Rothschild.
(12) Effective March 15,
2002, these employees accepted the Company's offer to cancel all of their
outstanding options to purchase Class B Units with an exercise price equal to
or greater than $4.00 per unit in reliance on the Company's intent to grant to
the employee an option to purchase the same number of Class B Units sometime in
the future.
Our current credit facility is secured by a
non-recourse pledge of 100% of our outstanding membership units (other than
those issued to certain of our employees upon exercise of options or other
rights to purchase in the aggregate up to ten percent (10%) of our outstanding
membership units).
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We lease our facility located at 2841 Dow
Avenue in Tustin, California from Patel/King Investment, or PKI. The Principals
of PKI are Pat Patel and Ken King, our Chairman and our Management Committee
Member, respectively. Pursuant to the lease, we paid PKI $927,378 in 1999,
$975,382 in 2000, $1,004,446 in 2001,
and $253,665 for the first three months of 2002.
Our lease with PKI will run through April 30,
2009, with an extension for an additional 60 months at our option. Pursuant to
the lease, we will pay rent of approximately $84,555 per month to PKI, subject
to certain periodic adjustments.
PART IV
ITEM 14.
ITEM 14. EXHIBITS,
FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report:
(1) and (2) Financial
Statements and Financial Statement Schedules - The consolidated financial
statements and consolidated financial statement schedules of Cherokee
International, LLC and subsidiaries as of December 31, 2001 and 2000 and for
each of the three years in the period ended December 31, 2001 are included in
Part II, Item 8.
(3) Exhibits:
3.1*
Second Amended and Restated Operating
Agreement of Cherokee International, LLC, dated as of April 30, 1999.
3.2*
Amendment No. 1 to the Second Amended and
Restated Operating Agreement of Cherokee International, LLC, dated as of June
28, 1999.
3.3*
Amendment No. 2 to the Second Amended
Restated Operating Agreement of Cherokee International, LLC, dated as of June
28, 1999.
3.4***
Amendment No. 3 to the Second Amended and
Restated Operating Agreement of Cherokee International, LLC, dated as of June
12, 2000.
3.5***
Amendment No. 4 to the Second Amended and
Restated Operating Agreement of Cherokee International, LLC, dated as of June
14, 2000.
3.6*
Certificate of Incorporation of Cherokee
International,Finance, Inc.
3.7*
Bylaws of Cherokee International Finance,
Inc.
4.1*
Indenture, dated as of April 30, 1999,
among the Issuers and Firstar Bank of Minnesota, N.A., as trustee, relating
to the notes
4.2*
Form of 10 1/2% Series A Senior
Subordinated Notes due 2009 (included in Exhibit 4.1)
4.3*
Form of 10 1/2% Series B Senior
Subordinated Notes due 2009 (included in Exhibit 4.1)
4.4*
Registration Rights Agreement, dated as of
April 30, 1999 among the Issuers and Credit Suisse First Boston, Corporation
10.1*
Credit Agreement, dated as of April 30, 1999,
among Cherokee International, LLC, as borrower, Heller Financial, Inc., as
agent and lender, and Bank Austria Creditanstalt Corporate Finance, Inc.,
Fleet Capital Corporation, Finova Capital Corporation, Key Corporate Capital
Inc. and U.S. Bank, as lenders.
10.2*
Security Agreement, dated as of April 30,
1999, between Cherokee International, LLC and Heller Financial, Inc., as
agent.
10.3*
Security Agreement, dated as of April 30,
1999, between Cherokee International Finance, Inc. and Heller Financial,
Inc., as agent
10.4*
Cherokee International, LLC 1999 Unit
Option Plan.
10.5*
Form of Unit Option Agreement.
10.6*
Cherokee International, LLC 1999 Unit
Purchase Plan.
10.7*
Noncompetition and Confidentiality
Agreement, dated as of April 30, 1999, between Cherokee International, LLC
and Mukesh Patel.
10.8*
Noncompetition and Confidentiality
Agreement, dated as April 30, 1999, between Cherokee International, LLC and
Bud Patel.
10.9*
Noncompetition and Confidentiality
Agreement, dated as of April 30, 1999, between Cherokee International, LLC
and Pat Patel.
10.10*
Noncompetition and Confidentiality
Agreement, dated as of April 30, 1999, between Cherokee International, LLC
and Amrit Patel.
10.11***
Consent, Waiver and First Amendment to
Credit Agreement, dated as of June 15, 2000, by and between Cherokee
International, LLC, Heller Financial, Inc., and the Lenders signatory
thereto.
10.12****
Subscription Agreement, dated as of June
14, 2000, by and among Cherokee International, LLC and Cherokee Investor
Partners,LLC.
10.13****
Schedule of additional Subscription
Agreements, each dated as of June 14, 2000, by and among Cherokee
International, LLC and certain of its Members.
10.14*****
Second Amendment to Credit Agreement dated
as of March 30, 2001, by and between Cherokee International, LLC, Heller
Financial, Inc. and the Lenders signatory thereto.
10.15*****
Waiver and Third Amendment to Credit
Agreement dated as of September 26, 2001, by and between Cherokee
International, LLC, Heller Financial, Inc. and the Lenders signatory thereto.
12.1
Statement regarding the computation of
ratio of earnings to fixed charges for the Company.
21.1
List of Subsidiaries
23.1
Independent Auditors’ Consent
24.1
Powers of Attorney for each registrant.
(Included in Signature Page)
(b) Reports on Form 8-K
On October 4, 2001, the
Company filed a Current Report on Form 8-K, announcing under Item 5 an
amendment to the Company's credit agreement.
* Incorporated by reference to designated exhibit to our
Registration Statement on Form S-4, filed with the Securities and Exchange
Commission on July 13, 1999 (File No. 333-82713).
** Incorporated by
reference to designated exhibit to the Company’s Current Report on Form 8-K,
dated June 30, 2000.
*** Incorporated by
reference to designated exhibit to the Company’s Quarterly Report on Form 10-Q,
dated July 2, 2000.
**** Incorporated by
reference to designated exhibit to the Company's Annual Report on Form 10-K,
dated December 31, 2000.
***** Incorporated by reference
to designated exhibit to the Company's Current Report on Form 8-K, dated
October 4, 2001.
FORWARD-LOOKING STATEMENTS
Statements in this report containing the
words “believes,” “anticipates,” “expects,” and words of similar meaning, and
any other statements which may be construed as a prediction of future
performance or events, constitute “forward-looking statements” within the
meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements involve known and unknown risks, uncertainties, and
other factors that may cause the actual results, performance, or achievements
of the Company, or industry results, to be materially different from any future
results, performance, or achievements expressed or implied by such
forward-looking statements. Such factors include, among others, (1)
restrictions imposed by the Company’s substantial leverage and restrictive
covenants in its debt agreements, (2) reductions in sales to any of the
Company’s significant customers or in customer capacity generally, (3) changes
in the Company’s sales mix to lower margin products, (4) increased competition,
(5) disruptions of the Company’s established supply channels, and (6) the
additional risk factors identified under the heading “Risk Factors” in the
Section “Business”, and those described from time to time in the Company’s
other filings with the SEC, press releases and other communications. The
Company disclaims any obligations to update any such factors or to announce
publicly the result of any revision to any of the forward-looking statements
contained or incorporated by reference herein to reflect future events or
developments.
SIGNATURES
Pursuant to the requirements of Section 13 or
15(d) of the Securities Act of 1934, the registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
We, the undersigned officers and Management
Committee Members of Cherokee International, LLC, hereby severally constitute
Rita Patel and R. Van Ness Holland, Jr. and each of them singly, our true and
lawful attorneys with full power to them, and each of them singly, to sign for
us and in our names in the capacities indicated below, any and all amendments
to this Annual Report on Form10-K, and generally do all such things in our name
and behalf in such capacities to enable Cherokee International, LLC to comply
with the applicable provisions of the Securities Exchange Act of 1934, and all
requirements of the Securities and Exchange Commission, and we hereby ratify
and confirm our signatures as they may be signed by our said attorneys, or
either of them, to any and all such amendments.
Pursuant to the requirements of the
Securities Act of 1934, this report has been signed by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
Name
Title
Date
/s/ GANPAT I. PATEL
Chairman and member of Management Committee
April 1, 2002
Ganpat I. Patel
/s/ JEFFREY M. FRANK
President and Chief Executive Officer and
member of Management Committee
April 1, 2002
Jeffrey M. Frank
(Principal Executive Officer)
/s/ R. VAN NESS HOLLAND,
JR.
Chief Financial Officer
April 1, 2002
R. Van Ness Holland, Jr.
(Principal Financial and Accounting
Officer)
/s/ KENNETH KING
Member of Management Committee
April 1, 2002
Kenneth King
/s/ BAHECHAR S. PATEL
Executive Vice President and member
April 1, 2002
Bahechar S. Patel
of Management Committee
/s/ IAN A. SCHAPIRO
Member of Management Committee
April 1, 2002
Ian A. Schapiro
/s/ STEPHEN KAPLAN
Member of Management Committee
April 1, 2002
Stephen Kaplan
/s/ TONY BLOOM
Member of Management Committee
April 1, 2002
Tony Bloom
/s/ CHRISTOPHER BROTHERS
Member of Management Committee
April 1, 2002
Christopher Brothers
Independent Auditors’ Report
Consolidated Balance Sheets as of December 31, 2001 and 2000
Consolidated Statements of Operations for
each of the three years in the period ended December 31, 2001
Consolidated Statements of Members’ Equity
(Deficit) for each of the three years in the period ended December 31, 2001
Consolidated Statements of Cash Flows for
each of the three years in the period ended December 31, 2001
Notes to Consolidated Financial Statements
Independent Auditors’ Report on Schedule
Schedule of valuation and qualifying
accounts for each of the three years in the period ended December 31, 2001
INDEPENDENT AUDITORS’ REPORT
To the Members of
Cherokee International, LLC
We have audited the accompanying consolidated
balance sheets of Cherokee International, LLC and subsidiaries (the Company) as
of December 31, 2001 and 2000 and the related consolidated statements of
operations, members’ equity (deficit) and cash flows for each of the three
years in the period ended December 31, 2001. These consolidated financial
statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with
auditing standards generally accepted in the United States of America. Those
standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial
statements present fairly, in all material respects, the financial position of
Cherokee International, LLC and subsidiaries as of December 31, 2001 and 2000
and the results of their operations and their cash flows for each of the three
years in the period ended December 31, 2001 in conformity with accounting
principles generally accepted in the United States of America.
DELOITTE & TOUCHE LLP
Costa Mesa, California
March 20, 2002
CHEROKEE INTERNATIONAL,
LLC AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See notes to consolidated
financial statements.
CHEROKEE INTERNATIONAL,
LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
OPERATIONS
See notes to consolidated
financial statements.
CHEROKEE INTERNATIONAL,
LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
MEMBERS’ EQUITY (DEFICIT)
See notes to consolidated
financial statements.
CHEROKEE INTERNATIONAL,
LLC AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF
CASH FLOWS
On June 15, 2000, the Company acquired Industrial and Telecommunication
Systems and related entities (“ITS”) for approximately $43.2 million in cash,
plus $1.0 million in acquisition costs and paid off $9.7 million of ITS’s debt.
In conjunction with the acquisition, liabilities were assumed as follows:
See notes to consolidated
financial statements.
CHEROKEE INTERNATIONAL, LLC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
1. GENERAL
FORMATION Cherokee International, LLC (the
Company) was formed on February 21, 1996, under the California Beverly-Killea
Limited Liability Company Act. After the acquisition described below, principal
operations commenced on March 30, 1996.
ACQUISITIONS On March 29, 1996, the Company
and Cherokee International, Inc., a California corporation, entered into an
asset purchase agreement whereby the Company purchased certain assets and
assumed certain liabilities of Cherokee International, Inc. for a total cash
payment of $15,264,383 and issuance of a subordinated note payable of
$5,885,218. The acquisition was accounted for under the purchase method of
accounting, with the total purchase price allocated to net tangible assets.
On March 29, 1996, the Company and Bikor
Corporation, a California corporation, entered into an asset transfer agreement
and operations transfer agreement whereby Bikor Corporation transferred all
operations and assets and certain liabilities to the Company in exchange for
75,000 Class A units of the Company with a fair market value of $400,000 and a
subordinated note payable of $476,166. The acquisition was accounted for under
the purchase method of accounting, with the total purchase price allocated to
net tangible assets.
On June 15, 2000, the Company completed its
acquisition of Industrial and Telecommunication Systems and related entities
(“ITS” or “Cherokee Europe”). The Company paid approximately $43 million in
cash, acquired net assets (excluding debt) at fair value of approximately $9
million, assumed debt of approximately $12 million, of which approximately $10
million was repaid at closing, and incurred transaction costs of approximately
$1 million. The Company accounted for the acquisition using the purchase method
of accounting and recorded goodwill and other related intangibles of
approximately $46 million in the transaction, which is being amortized over 15
years. The Company’s statements of operations are consolidated to include
Cherokee Europe’s operations from the date of acquisition.
LINE OF BUSINESS The Company designs,
develops, assembles and sells switch mode power supplies for original equipment
manufacturers (OEMs) in the telecommunications, data networking and high-end
workstation markets primarily in the United States and Europe.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION The accompanying
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America.
FINANCIAL CONDITION As shown in the
consolidated financial statements, the Company incurred a net loss of
$6,493,186 for the year ended December 31, 2001 and had negative working
capital of $47,698 at December 31, 2001. In addition, the Company was not in
compliance with certain debt covenants at June 30, 2001; however, such
noncompliance was waived upon execution of a Waiver and Third Amendment to the
Credit Agreement on September 26, 2001 (see Note 4). These negative trends have
resulted from unfavorable economic conditions and reduced capital spending by
industries in which the Company operates. The Company's sales have decreased in
each quarter of 2001, compared to the immediately preceding quarter. If the
unfavorable economic conditions continue, the Company's financial condition and
operating results could be adversely affected. Based on the Company's present
expectations, it anticipates that it may not be in compliance with certain
financial covenants under its credit agreement at June 30, 2002, or earlier,
without additional financing from its majority unitholders. In addition,
management believes that cash flow from operations and available borrowing
capacity may not be adequate to meet its anticipated cash requirements,
including operating requirements, planned capital expenditures and debt
service, for the last six months of fiscal year 2002, or earlier.
Management is currently considering
alternatives to address these issues, which include (a) an amendment or
restructuring of its credit agreement (b) a refinancing of its credit agreement
(c) the infusion of additional equity by its unitholders, or (d) some
combination of the above. Based upon the Company's current business plans and
prospects, management expects that its restructuring alternatives, the $10.5
million guaranty by certain unitholders and funding from its unitholders, if
necessary, will enable the Company to meet its obligations and comply with its
debt covenants through December 31, 2002. (See Note 4).
PRINCIPLES OF CONSOLIDATION The consolidated
financial statements include the financial statements of the Company and its
wholly-owned subsidiaries Cherokee Europe and related entities, (Note 10),
Cherokee Electronica, S.A. DE C.V., (Electronica), Cherokee India Pvt. Ltd.
(India), Powertel India Pvt. Ltd. (Powertel) and Cherokee International
Finance, Inc. (Finance). Finance was formed in April 1999 as a wholly-owned
finance subsidiary to act as a co-obligor of the 10 1/2% Senior Subordinated
Notes (see Note 4) and has no independent assets or operations. All material
intercompany accounts and transactions have been eliminated.
FISCAL YEAR The Company’s fiscal years 2001,
2000, and 1999 ended on December 30, 2001, December 31, 2000 and January 2,
2000, respectively. For convenience, the accompanying consolidated financial
statements have been shown as ending on the last day of the calendar month.
TRANSLATION OF FOREIGN CURRENCIES: Foreign
subsidiary assets and liabilities denominated in foreign currencies are
translated at the exchange rate on the balance sheet date. Revenues, costs and
expenses are translated at the average exchange rate during the year. Resulting
transaction gains and losses are included in results of operations. The
functional currency of Cherokee Europe is the Belgium Franc. The functional
currency of Electronica, Powertel and India is the U.S. dollar as the majority
of transactions are denominated in U.S. dollars. Translation adjustments
related to Cherokee Europe are reflected in other comprehensive income in
accordance with Statement of Financial Accounting Standards (SFAS) No. 130,
REPORTING COMPREHENSIVE INCOME. Transaction gains and losses were not
significant for the periods presented.
CASH AND CASH EQUIVALENTS For presentation
purposes in the consolidated financial statements, all highly liquid debt
instruments purchased with an original maturity date of three months or less
are considered to be cash equivalents.
SHORT-TERM INVESTMENTS Short-term
investments, which approximate fair value, consist principally of bank
certificates of deposit with original maturity dates of approximately 3-12
months.
INVENTORIES Inventories are valued at the
lower of cost (first-in, first-out) or market. Inventory costs include the cost
of material, labor, and manufacturing overhead and consist of the following at
December 31:
PROPERTY AND EQUIPMENT Depreciation and
amortization of property and equipment are provided using the straight-line
method over the following estimated useful lives:
DEFERRED FINANCING COSTS During 1999, the
Company incurred approximately $6.2 million of costs related to the issuance of
senior subordinated notes and the execution of a new term loan and credit
facility. Approximately $5.4 million of such costs were capitalized as deferred
financing costs and approximately $.8 million of such costs were directly
expensed in 1999 and included in other income (expense) in the accompanying
consolidated statements of operations. During 2000, the Company incurred
approximately $0.4 million of costs related to additional borrowings associated
with the acquisition of ITS. During 2001, the Company incurred approximately
$0.4 million of costs relating to an amendment of the credit agreement with its
lenders. Deferred financing costs are being amortized over the term of the
related debt.
LONG-LIVED ASSETS The Company accounts for
the impairment and disposition of long-lived assets in accordance with SFAS No.
121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS
TO BE DISPOSED OF. In accordance with SFAS No. 121, long-lived assets to be
held are reviewed for events or changes in circumstances which indicate that
their carrying value may not be recoverable. There was no impairment of the
value of such assets for the years ended December 31, 2001 and 2000.
DERIVATIVE INSTRUMENTS Statement of Financial
Accounting Standards (SFAS) No. 133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES, is effective for all fiscal years beginning after June 15,
2000. SFAS 133, as amended, establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts and for hedging activities. Under SFAS 133, certain contracts
that were not formerly considered derivatives may now meet the definition of a
derivative and all derivatives are to be reported on the balance sheet at fair
value. The Company adopted SFAS 133 effective January 1, 2001. The adoption of
SFAS 133 did not have a significant impact on the financial position, results
of operations, or cash flows of the Company.
FAIR VALUE OF FINANCIAL INSTRUMENTS The
amounts recorded for accounts receivable, accounts payable and accrued expenses
approximate their fair values based on their short-term nature. The amounts
recorded for long-term debt and capital lease obligations approximate fair
value, as interest is tied to or approximates market rates.
INCOME TAXES The Company is a limited
liability company under the provisions of the federal and state tax codes.
Under federal laws, taxes based on income of a limited liability company are
payable by the Company’s individual members. Accordingly, no provision for
federal income taxes has been provided in the accompanying financial
statements. Provisions for California franchise tax and fees are not
significant for any period presented. The Company’s operations in Mexico, India
and Belgium are subject to income taxes on earnings generated in those
countries.
The Company accounts for income taxes in
accordance with SFAS No. 109, ACCOUNTING FOR INCOME TAXES. In accordance with
SFAS No. 109, deferred tax assets and liabilities are recorded for the
estimated future tax effects of temporary differences between the carrying value
of assets and liabilities for financial reporting and their tax basis, and
carry-forwards to the extent they are realizable. A deferred tax provision or
benefit results from the net change in deferred tax assets and liabilities
during the year. A deferred tax asset valuation allowance is recorded if it is
more likely than not that all or a portion of the recorded deferred tax assets
will not be realized.
REVENUE RECOGNITION Revenues from product
sales are recognized upon passage of title and shipment of products to
customers. In December 1999, the Securities and Exchange Commission issued
Staff Accounting Bulletin 101, Revenue Recognition (“SAB 101”). SAB 101
summarizes certain of the SEC staff’s views in applying generally accepted
accounting principles to selected revenue recognition issues in financial
statements. Implementation of SAB 101 was required by the fourth quarter of
2000. The adoption of SAB 101 did not have an impact on the Company’s
consolidated financial statements.
CREDIT RISK The Company performs ongoing
credit evaluations of its customers and generally does not require collateral.
The Company maintains reserves for estimated credit losses.
STOCK-BASED COMPENSATION The Company accounts
for unit-based awards to employees using the intrinsic value method in
accordance with Accounting Principles Board (APB) Opinion No. 25, ACCOUNTING
FOR STOCK ISSUED TO EMPLOYEES.
INCOME PER UNIT In accordance with SFAS No.
128, EARNINGS PER SHARE, basic income per unit calculations are determined by
dividing net income by the weighted average Class A and B units outstanding.
Diluted income per unit reflects the potential dilutive effect, determined by
the treasury stock method, of additional Class B units that are issuable upon
exercise of outstanding unit options:
In calculating net loss per unit for 2001,
the effect of dilutive options is excluded because it is antidilutive.
SEGMENT INFORMATION The Company has adopted
SFAS No. 131, DISCLOSURES ABOUT SEGMENTS OF AN ENTERPRISE AND RELATED
INFORMATION. SFAS No. 131 established standards for reporting information about
operating segments in financial reports issued to stockholders. It also
established standards for related disclosures about products and services, geographic
areas and major customers. The Company is a leading designer and manufacturer
of a broad range of power supplies for original equipment manufacturers in the
telecommunications, data networking, high-end workstations and other electronic
industries. The Company's operating segments consist of Cherokee International,
LLC and its wholly owned subsidiaries located in Europe, Mexico and India.
These operating segments have been aggregated into a single reporting segment
based on their common operating characteristics.
COMPREHENSIVE INCOME (LOSS) Comprehensive
income (loss) is defined as all changes in a company’s net assets except
changes resulting from transactions with shareholders. It differs from net
income (loss) in that certain items currently recorded through equity are
included in comprehensive income (loss). Comprehensive income (loss), including
net income (loss) and losses from foreign currency translation adjustments, was
$(7,070,844) and $11,450,269 for the years ended December 31, 2001 and 2000,
respectively. Comprehensive income for the year ended December 31, 1999 was the
same as net income.
USE OF ESTIMATES The preparation of financial
statements in accordance with accounting principles generally accepted in the
United States of America requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent liabilities at the date of the financial statements and the amounts
of revenues and expenses during the reporting period. Actual results could
differ from such estimates.
RECLASSIFICATIONS Certain items in the prior
period consolidated financial statements have been reclassified to conform to
the current period presentation.
RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting
Standards Board (FASB) issued two new pronouncements: SFAS No. 141, Business Combinations, and
SFAS No. 142, Goodwill and Other Intangible Assets. SFAS
No. 141 prohibits the use of the pooling-of-interest method for
business combinations initiated after June 30, 2001 and also applies to
all business combinations accounted for by the purchase method that are
completed after June 30, 2001. There are also transition provisions that
apply to business combinations completed before July 1, 2001, that were
accounted for by the purchase method. SFAS No. 142 is effective for fiscal
years beginning after December 15, 2001 to all goodwill and other
intangible assets recognized in an entity’s statement of financial position at
that date, regardless of when those assets were initially recognized. SFAS
No. 142 requires that goodwill and other intangible assets with indefinite
useful lives no longer be amortized, but instead be tested for impairment at
least annually. The Company will no longer amortize intangible assets but will
evaluate their carrying value on an annual basis or when events or
circumstances indicate that their carrying value may be impaired. The Company
expects the adoption of SFAS No. 142 to result in reduced amortization expense
of approximately $3.0 million in 2002. The
Company is currently evaluating the impact that the adoption of all provisions
of these standards will have on its financial position and results of
operations on January 1, 2002.
In August 2001, the FASB issued SFAS No. 144, Accounting for Impairment or Disposal
of Long-Lived Assets. This statement addresses financial accounting and reporting for the impairment of long-lived
assets and for long-lived assets to be disposed of. SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and
is effective for fiscal years beginning after December 15, 2001. The
Company is currently evaluating the impact that the adoption of this standard
will have on its financial position and results of operations on
January 1, 2002.
3. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31:
Included in property and equipment are assets
under capital leases of $5,344,992 and $6,493,278 as of December 31, 2001 and
2000, respectively. Accumulated amortization of
assets under capital leases was $2,385,902
and $2,465,190 as of December 31, 2001 and 2000, respectively.
4. DEBT
Long-term debt consists of the following at
December 31:
As of December 31, 2001, maturities of
long-term debt are as follows:
In June 2000, the Company amended its credit
agreement to provide for additional term loan borrowings of $8 million, the
proceeds of which were used to finance a portion of the purchase price of an
acquisition (see Note 10). The term loans are collateralized by substantially
all of the Company’s assets and contain certain financial covenants including
capital expenditures limitations, minimum fixed charge coverage and interest
coverage ratios, minimum debt to equity ratio requirements and restrictions on
dividends.
During April 1999, the Company entered into a
revolving line of credit agreement, which provides for borrowings, based on a
percentage of certain receivables and inventory, not to exceed $25,000,000.
Borrowings bear interest at LIBOR plus 3.50% or prime plus 2.25% (7.00% to
7.25% as of December 31, 2001). Interest rates are subject to change over time
based on the Company’s leverage ratio as defined. This revolving line of credit
is collateralized by substantially all of the Company’s assets and is subject
to the same financial covenants as the term loan discussed above. This
revolving line of credit required payment of commitment fees and expires in
2005. Outstanding borrowings under this line of credit were $10,535,146 and $11,827,138 at December 31,
2001 and 2000, respectively.
In September 2001, the Company’s credit
agreement with its lenders was amended to include provisions that specify among
other things, (1) that some of the Company’s unitholders, or their equity
members, will guarantee $10.5 million of the Company’s senior debt principal
until specific financial ratios are attained, (2) that the Company will be
restricted from making cash distributions to its equity members until specific
financial ratios are attained, (3) that the Company will be permitted to make
its interest payment due in November 2002 relating to its $100 million of
senior subordinated notes so long as specified financial ratios are attained,
(4) that the maximum availability under the revolving line of credit is reduced
until approximately April 30, 2002, (5) that LIBOR and base rate margins have
been increased for revolver borrowings and term loans, and (6) that financial
covenant ratios required in future periods have been modified, including provisions
allowing the Company's unitholders to make capital contributions to the Company
which will be treated as earnings (as defined) for purposes of calculating
certain debt covenants. Under the terms of the $10.5 million guaranty, the
guarantors would be subrogated to rights of the lenders under the credit
agreement, on a basis senior to the senior subordinated notes. As of December
31, 2001, the Company was in compliance with its debt covenants.
Based upon the Company's current business
plans and prospects, management expects that its restructuring alternatives,
the $10.5 million guaranty by certain unitholders and funding from its
unitholders, if necessary, will enable the Company to meet its obligations and
comply with its debt covenants through December 31, 2002.
Foreign credit facilities of $2,647,000 and
$4,771,000 at December 31, 2001 and 2000, respectively, included a working
capital line of credit with a Belgian bank, BBL, which is denominated in
Belgian Francs and is collateralized by a pledge in first rank over accounts
receivable. The loan is due on demand and bears interest based on variable
market rates (4.51% as of December 31, 2001) and requires ITS to maintain a
certain specific net assets ratio. ITS is in compliance with all loan requirements
as of December 31, 2001.
5. COMMITMENTS
The Company leases certain of its
manufacturing facilities under non-cancelable operating leases for an aggregate
monthly rental of approximately $112,600. These leases expire at various dates
through 2009. One of the manufacturing facilities is leased from an entity
controlled by two members of the Company’s management committee. Rental expense
for the years ended December 31, 2001, 2000, and 1999 totaled approximately $1,756,760, $1,433,243, and $1,375,845 ($1,004,446, $975,382, and $927,378 to a
related entity), respectively.
The Company has two capital lease contracts,
bearing interest ranging from 5.60% to 8.03%. The total monthly principal and
interest payments related to these capital leases are approximately $111,521.
The leases expire between November 2003 and December 2004.
A summary of lease commitments as of December
31, 2001 is as follows:
Of the $8,156,812 total minimum payments for operating leases,
$7,525,438 is payable to a related entity.
6. MEMBERS’ EQUITY (DEFICIT)
CAPITALIZATION The Company’s members’ equity
(deficit) consists of Class A and Class B units. Class A units are entitled to
one vote per unit and Class B Units are not entitled to vote.
UNIT OPTION PLAN In June 1999, the Company adopted the 1999 Unit Option
Plan (the Plan) which provides for the issuance to officers and key employees
of up to 2,970,000 options to purchase Class B units at an exercise price per
unit of not less than 85% of fair market value at the date of grant. At
December 31, 2001, 534,500 options were available for grant. Options expire no
later than ten years from the date of grant and generally become exercisable
over a four-year period.
As permitted by SFAS No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION, the Company accounts for its employee unit-based
compensation plan using the intrinsic value method under APB Opinion No. 25 and
provides the expanded disclosures specified in SFAS No. 123. On January 3,
2001, the Company granted 170,000 unit options at an exercise price of $5.71.
The exercise price represented the fair value of the Company’s Class B units at
the date of grant as determined by the Company’s Management Committee using
information contained in an independent appraisal. Accordingly, no compensation
expense was recorded for these unit option grants pursuant to APB Opinion No.
25.
Had compensation cost been determined using
the provisions of SFAS No. 123, the difference between net income (loss) and
net income (loss) per unit as reported and pro forma net income (loss) and net
income (loss) per unit would have been as follows:
For purposes of estimating the compensation
cost of the Company’s option grants in accordance with SFAS No. 123, the fair
value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model, with the following weighted average
assumptions used for grants during the years ended December 31, 2001, 2000, and
1999: expected volatility of zero; risk-free interest rate of 5% in 2001 and 6%
in 2000 and 1999; no dividends; and expected lives of five years.
A summary of activity for the Unit Option
Plan is presented below:
The following table summarizes information
about options as of December 31, 2001:
Effective March 15, 2002, the Company has
made an offer to all option holders to cancel all outstanding options to
purchase Class B Units with an exercise price equal to or greater than $4.00
per unit in reliance on the Company's intent to grant new options of an equal
number at the fair market value after six months and a day following
cancellation.
UNIT PURCHASE PLAN In June 1999, the Company
adopted the 1999 Unit Purchase Plan covering an aggregate of 1,500,000 shares
of Class B units. The purpose of the 1999 Unit Purchase Plan is to enable
selected officers, management committee members, employees, consultants and
advisors of the Company to purchase Class B units. The price of the Class B
units under the plan shall not be less than 85% of the fair market value of the
Class B units at the date of grant. No units were granted during 2001. During
2000 and 1999, the Company granted 84,801 units at $5.71 per unit and 302,000
units at $4.00 per unit, respectively, representing fair value consistent with
the unit option grants described above. At December 31, 2001, the Company had
1,113,199 units available for future grant.
7. RETIREMENT PLANS
In March 1996, the managers and members of
the Company approved the adoption of a supplemental retirement plan (the 401(k)
Plan) in which substantially all domestic employees are eligible to participate
after completing six months of employment. The 401(k) Plan allows participating
employees to contribute up to 15% of the employee’s pretax compensation, with
the Company making discretionary matching contributions. Company contributions
fully vest and are non-forfeitable after the participant has completed five
years of service. For the years ended December 31, 2001, 2000, and 1999, the
Company elected to contribute approximately $207,756, $276,833, and $237,764
respectively, to the 401(k) Plan. Administrative costs associated with the
401(k) Plan are paid by participants.
Cherokee Europe maintains a pension plan for certain levels of staff
and management that includes a defined benefit feature. The following
represents the amounts related to this defined benefit plan:
The weighted-average discount rate and rate of increase in future
compensation levels used in determining the actuarial present value of the
projected benefit obligations were 5.25% and 3.45% for the year ended
December 31, 2001 and 5.75% and 3.65% for the period June 16, 2000 (date
of acquisition) to December 31, 2000. The expected long-term rate of return on
assets was 5.5% for the year ended December 31, 2001 and for the period from
June 16, 2000 (date of acquisition) to December 31, 2000.
8. CONCENTRATION OF NET SALES
For the years ended December 31, 2001, 2000,
and 1999 approximately 40%, 48%, and 53%, respectively, of the Company’s net
sales were derived from six customers, of which zero, two and one customers,
respectively, individually exceeded 10%. For the years ended December 31, 2000,
and 1999, the Company’s largest customer accounted for approximately 13% and
27%, respectively, of net sales. A single customer in 2000 accounted for 11% of
net sales. Although not anticipated, a decision by a major customer to decrease
the amount purchased from the Company or to cease purchasing the Company’s
products would have an adverse effect on the Company’s financial position and
results of operations.
The Company sells its power supply products
to OEMs in the telecommunications, networking, high-end workstations and other
electronic industries. The Company uses information based on customers and
geographic location; however, these activities are managed as a single business
and have been aggregated into a single reportable operating segment. For the
years ended December 31, 2001, 2000 and 1999, net sales by region were as
follows:
The Company’s long-lived assets located
outside of the United States were $9,360,047 and $10,922,432 as of December 31,
2001 and 2000, respectively.
9. SPECIAL BONUS DISTRIBUTION
During 1999, the Company’s management
committee authorized approximately $5,330,000 of special bonus payments to
certain key employees for their role in the Company’s growth and success over
the previous years. These bonus payments were entirely funded by capital
contributions made by the Company’s then existing members.
10. ACQUISITION
On June 15, 2000, the Company completed its acquisition of Industrial
and Telecommunication Systems and related entities (“ITS), one of Europe’s
leading designers and manufacturers of custom power supplies for OEM’s
primarily in the telecommunications industry. The Company paid approximately
$43 million in cash, acquired net assets (excluding debt) at fair value of
approximately $9 million, assumed debt of approximately $12 million, of which
approximately $10 million was repaid at closing, and incurred transaction costs
of approximately $1 million. The company recorded goodwill and other related
intangibles of approximately $46 million in the transaction, which is being
amortized over 15 years.
The acquisition, including the repayment of certain assumed debt at
closing, was financed with approximately $34 million of cash proceeds from the
issuance and sale of new members’ equity units, approximately $13 million of
borrowings under the Company’s existing bank credit agreement, as amended, and
utilization of available cash.
The Company’s unaudited pro forma net sales, net income, and diluted
income per share as if the acquisition of ITS had occurred as of the beginning
of the years ended December 31, 2000 and 1999, are as follows:
The pro forma operating results above include
the results of operations for ITS for the years ended December 31, 2000 and
1999 with goodwill and other related intangibles amortization along with other
relevant adjustments to reflect fair value of the acquired assets.
Additionally, the pro forma operating results include pro forma interest
expense on the assumed acquisition borrowings and pro forma issuance of the
Company’s membership units reflected in the weighted average number of units
outstanding for the computations of pro forma diluted net income per unit.
The results of operations reflected in the
pro forma information above are not necessarily indicative of the results which
would have been reported if the acquisition had been effected at the beginning
of 1999.
11. INCOME TAXES
Income (loss) before income taxes consists of the following components:
The provision for current and deferred income taxes consists of the
following:
As described in Note 1, no federal income tax provision has been
provided because the Company is a limited liability company for U.S. income tax
purposes and is not subject to tax. State minimum franchise taxes and fees are
insignificant and have been recorded in general and administrative expenses. Foreign
income taxes have been provided for all applicable juridictions. Any U.S. or
state income tax liability on undistributed earnings of foreign subsidiaries
would accrue to the Company’s members.
Our effective tax rate differs from the Federal statutory rate of 35%
as follows:
Deferred income taxes are provided for net operating losses (NOL) of
all applicable European subsidiaries. As of December 31, 2001, this amount is
$8,097,000. The NOLs have an indefinite carry over period. In the opinion of
management, it is more likely than not that these NOLs will not be realized in
the foreseeable future. Accordingly, management has determined that a full
valuation allowance was required as of December 31, 2001 and 2000 for the
deferred tax assets related to the European subsidiaries.
The Company's deferred income taxes are comprised of the following at
December 31:
The change in the valuation allowance for the year ended December 31,
2001 is an increase of $958,000 and an increase of $570,000 for the period from
June 16, 2000 (date of acquisition of ITS) to December 31, 2000. Approximately
$2,217,000 of the Company’s valuation allowance relates to acquired deferred
tax assets at December 31, 2001 and 2000. If these acquired deferred tax assets
are realized in the future, the tax benefit will be credited to goodwill.
12. SELECTED QUARTERLY DATA (UNAUDITED)
INDEPENDENT AUDITORS’
REPORT ON SCHEDULE
To the Members of
Cherokee International, LLC:
We have audited the consolidated financial
statements of Cherokee International, LLC and subsidiaries (the Company) as of
December 31, 2001 and 2000 and for each of the three years in the period ended
December 31, 2001, and have issued our report thereon dated March 20, 2002.
Such consolidated financial statements and report are included elsewhere in
this Form 10-K. Our audits also included the consolidated financial statement
schedule of the Company listed in Item 14a. This consolidated financial
statement schedule is the responsibility of the Company’s management. Our responsibility
is to express an opinion based on our audits. In our opinion, such consolidated
financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly in all
material respects the information set forth therein.
DELOITTE & TOUCHE LLP
Costa Mesa, California
March 20, 2002
CHEROKEE INTERNATIONAL,
LLC
SCHEDULE II VALUATION AND
QUALIFYING ACCOUNTS