Buyout Now Haunts Cherokee : Apparel: The struggling maker of casual clothes is trying to restructure the oversize debt load it took on during an LBO in 1989.
Cherokee Inc. is a clothing company in trouble, and one of its many problems is visible during a stroll through a Mervyn’s department store--its biggest customer.
In the women’s section, which is Cherokee’s main market, the space Mervyn’s devotes to Cherokee’s casual shirts and pants has been shrinking in favor of the popular Dockers line made by apparel powerhouse Levi Strauss & Co.
“Our real estate was cut back,” concedes Robert Margolis, Cherokee co-chairman. The result: Cherokee’s sales to Mervyn’s in the fiscal first quarter ended Aug. 29 plunged 44% from a year earlier, to $5.1 million. That’s a big reason Cherokee’s overall sales dropped 24% that quarter.
All of which is depriving the Sunland-based company of the cash it needs to support its heavy $163-million debt load. The debt was incurred three years ago, when a group led by Santa Monica investor Jeffrey S. Deutschman, Margolis and other Cherokee executives took the company private in a $174-million leveraged buyout, meaning they borrowed most of the money. Deutschman is Cherokee’s other co-chairman.
Cherokee is thus another victim of the LBO craze of the 1980s, because it can’t support its debt as originally expected. The debt is dominated by $105 million worth of high-yield, high-risk “junk bonds” that cost the company a lofty 15.5% in annual interest.
Cherokee’s next interest payment on the debt--totaling $8.2 million--is due Sunday. But the company, despite claiming it can raise the cash, has not yet decided whether to make the payment because that could further deteriorate Cherokee’s balance sheet.
In the meantime, Cherokee is talking with the handful of investors that hold a majority of its bonds about a restructuring of the debt. “I’m quite confident that we will be able to negotiate something different than we have today,” said Cary D. Cooper, Cherokee’s chief financial officer.
A collapse of those talks could conceivably force the company to seek a reorganization in bankruptcy court, a threat Cherokee acknowledges. But Margolis said, “We’re not planning to go bankrupt.”
Make no mistake, if one excludes the debt, Cherokee is profitable. But that’s a big if because, since the debt is there, Cherokee is not profitable enough.
For the first three years, Cherokee managed the debt nicely. Its operating income--earnings before interest and taxes--jumped to $29.4 million in the fiscal year ended in May, 1991, from $15.1 million two years earlier. Although interest on the debt left it with net losses, Cherokee threw off plenty of cash to meet its debt payments.
But by fiscal 1992, Cherokee’s operating profit had fallen back to $15.8 million on an 18% drop in sales, to $194.9 million. And in this year’s fiscal first quarter, its operating profit plunged 85% from a year earlier, to a mere $1.1 million, on a sales decline to $41 million. After interest and taxes, Cherokee had a first-quarter loss of $4.3 million.
While trying to fix the debt, Margolis said he’s also taken steps to boost Cherokee’s performance.
The company abandoned a private-label business--whereby Cherokee made clothing for stores and others that put their own names on the apparel--because profits were too low. A new marketing campaign was launched in July. The company has laid off 20% of its work force over the past 18 months, leaving it with about 400 employees.
“We went astray when we opened the private-label division,” Margolis said.
Cherokee also split itself into separate divisions and placed a senior executive in charge of each one, including Margolis, who heads the missy (women ages 25 to 60) division, Cherokee’s largest.
“We’ve gone back into the ranks,” Margolis said. “We found the business outgrew our management in a sense, because our senior management was trying to do everything for all divisions. We felt we were becoming Jacks-of-all-trades and masters of none.”
The changes are paying off, he said, with orders and profit margins rising again.
“In the last two months we booked $48 million versus $24 million in the same period last year,” he said.
Margolis also contended that Cherokee is turning back Dockers at Mervyn’s and elsewhere.
“They’ve reached a saturation point, and sales have been slow for Dockers,” he said.
However, Levi Strauss spokeswoman Jill Novack said, “We’re having a very strong year.”
Indeed, Barry Strauss, a “selling agent” in Los Angeles who peddles small apparel makers’ lines to stores, said Mervyn’s was “probably just following their selling reports” in scaling back Cherokee’s space in favor of Levi’s Dockers brand.
“It’s nothing personal. But you have to perform for your space,” he said.
Still, some of Cherokee’s creditors view the company as a strong franchise that deserves to be saved via debt restructuring. “Cherokee, we believe, and I think the majority of bondholders believe, is a good company with a good brand name that has a bad balance sheet,” said Tony Ressler, a partner of Lion Advisors, a Los Angeles money manager for Altus Finance, a French investment firm that is one of largest holders of Cherokee’s junk bonds.
He declined to disclose the dollar amount of Cherokee bonds that Altus holds. However, other sources said Altus and the three other major investors--the mutual-fund companies Keystone, Franklin and American Express Co.’s IDS Financial unit--together hold roughly $70 million of the junk bonds.
Altus obtained its Cherokee bonds this year, when it led a French investment group that bought failed Executive Life Insurance Co., whose parent, First Executive Corp. in Los Angeles, was a major customer of former junk-bond specialist Drexel Burnham Lambert Inc. Cherokee’s leveraged buyout was among the many Drexel helped finance.
Now the bondholders need help. Standard & Poor’s Corp. this month cut its rating on Cherokee’s bonds to CCC-minus, just a notch above S&P;’s D rating for bonds in default.
And the bonds, which were initially priced at a discount of $850 for every $1,000 of their face value, are currently trading as low as $300 each, according to Drake Capital Securities in Santa Monica.
None of the parties would comment on the restructuring talks, but it would not be uncommon for the bondholders to swap at least some of their debt for stock in the company. If so, that probably would shift control of Cherokee from the Deutschman/Margolis group to the bondholders.
Cherokee again went public in June, 1991, by selling a minority equity stake to the public for $6.50 a share. At the moment, the Margolis/Deutschman group has a 67% stake. The stock has since plunged to $1.25 a share, as of Monday’s close on the NASDAQ market.
Despite the company’s problems, Cherokee’s managers haven’t gone without. In fiscal 1992, Margolis, CFO Cooper and four other Cherokee executives took home a combined $2.7 million in salaries and bonuses, including $1 million for Margolis. In addition, two other Deutschman companies earned $653,750 in fiscal 1992 for providing “management services” to Cherokee.
Cherokee defended the compensation. Margolis and Cooper said the executives voluntarily cut their bonuses in fiscal 1992, with Margolis’ $297,000 bonus being only 25% of what it could have been had Cherokee been more profitable.
And if Cherokee can fix its debt problems, Margolis is confident that the company can prosper by focusing on its brand-name apparel.
“By the third quarter, we expect our profit margins to be a lot higher,” he said.
Until then, “we’re in a recession and our earnings are low,” Margolis said. “We cut to order, so as a natural reflection of the economy, we’re producing less.”
Cherokee Inc. at a Glance
Cherokee Inc., a Sunland maker of casual apparel and shoes, incurred substantial debt when an investor group bought the company in a $174-million leveraged buyout in 1989. Cherokee has posted operating income since then--that is, earnings before paying debt interest and taxes--but the debt payments have offset that income and produced net losses for the company.
Source: Company reports
