License to Make Money

More than a decade ago, Cameron Diaz adorned billboards as a "Cherokee Girl" for the line of apparel. But by the mid-'90s, Cherokee Group (Nasdaq: CHKE  ) CEO Robert Margolis shuttered the $150 million wholesale apparel business, slashed payroll by more than 90%, sold off assets, and shed inventory. Cherokee then licensed its sole remaining asset, its trademark name, to tap into a steady stream of revenue.

Today, Cherokee is the third-largest licensed brand in the world, with retail sales of more than $2 billion, and it generates about $30 million a year in royalty revenue. Last year, the now debt-free company earned $14.2 million on sales of $36.3 million -- all of this with only one office and a 16-person staff. Since implementing the retail-direct strategy eight years ago, Cherokee's stock has soared more than 700%. In the first part of a two-part series, Matt Logan speaks with Russell Riopelle, Cherokee's chief financial officer, to talk about Target and helping other brands go retail direct.

TMF: Let's get the $64,000 question out of the way: Target (NYSE: TGT  ) is a huge customer of yours, accounting for 57% of your revenue in your last fiscal year. How is your relationship with the company? I understand Target has been allocating less floor space to Cherokee recently.

Riopelle: Our relationship is good. We're in constant contact with them, every quarter, about ideas for new Cherokee-branded products and -related items. We meet with them probably once a quarter, if not more. We're obviously trying to turn around the current situation and get our revenues growing again from them. You're going to have some ups and down with any client. Right now we're in a little bit of a decline, but hopefully we'll be able to change that.

TMF: What's behind Target's decision to give less floor space to Cherokee?

Riopelle: They have a couple of different brands that they are working on with floor space as well. It's not necessarily less floor space. It really depends upon what's happening in each department. For example, we've been up in a couple of different departments, but we're down in women's with them. And that's been overshadowing some of the other stuff. So it really depends upon their specific in-season marketing plans in terms of what they've got for each one of the brands.

TMF: Realistically, what would happen if Target decided to not renew its contract with Cherokee?

Riopelle: There are several other retailers that have expressed a strong interest in the Cherokee brand. So we don't think there would be any difficulty in signing a new licensing agreement for a brand that does nearly $2 billion in retail at Target. I know there are several other retailers that would love to be doing as well as Target is right now.

TMF: Would they be of Target's size, as far as being able to achieve $2 billion in Cherokee-branded apparel sales?

Riopelle: Oh, sure. And I think you know who those retailers are.

TMF: So we're talking about the Kmarts (Nasdaq: KMRT  ) and Wal-Marts (NYSE: WMT  ) of the world?

Riopelle: You said it. I didn't.

TMF: Wal-Mart's private-label Ol' Roy dog food has become the world's top-selling dog food, beating out Nestle's Purina (Pink Sheets: NSRGY). This shows that distribution and price matter a lot more than brand for certain products. In the case of Cherokee, are shoppers truly seeking out the Cherokee brand, or are the sales occurring more because of Target's massive distribution and low prices?

Riopelle: I don't know. I guess you'd have to run a market research report for Target. But considering that Cherokee did more than $500 million at retail when it was a stand-alone brand itself in the late '80s, you have to believe that there's a lot of brand equity associated with the Cherokee label. And also considering that it's the Cherokee label that propelled those sales at Target in the mid-90s when the license agreement was first signed.

I suppose some people could be of the view that they could throw any label on any clothes at Target, and they would sell, but historically, that's not been the case. There've been a number of retailers over the years that have tried to develop private-label brands that just try to create brand equity out of the thin air, and it didn't work. So I think that theory is a bit flawed.

TMF: And since your company only charges a few percentage points in royalties, the Cherokee label doesn't have to increase Target's sales that much to justify your fee. If they were to see the average selling price go down 5% if they switched to a private label, they're already worse off.

Riopelle: Correct. It's not easy to build up a $2 billion brand at retail; it's very difficult to build up a private-label brand and get it going in that size. It's much less expensive to adopt a legacy brand like a Cherokee that already has built-in equity with the consumers and grow that brand than it is to try to build something out of scratch.

TMF: I understand that Cherokee approves designs, but Target is really the one coming up with the designs and marketing everything. How does your company watch the brand to make sure it doesn't lose value?

Riopelle: As you say, we have approval rights over everything they do, but Target's a very sophisticated design out, and they have their own department for that. They do a very good job of designing and sourcing and knowing what's moving in their stores and what the consumer wants. So we keep a watchful eye, but for the most part, we let them do their thing. We help give them ideas on different product ideas that may be working at other retailers that they may or may not have considered for the Cherokee brand.

TMF: Target only has an exclusive to sell the Cherokee brand in the U.S. Tell us about your overseas operations.

Riopelle: Right now, our largest overseas growth engine is Tesco (Pink Sheets: TSCDY), the big U.K. retailer. They accounted for over $5 million of our royalty revenues last year, and they're showing good growth this year for us as well. Brands overseas, for the most part, is the Cherokee brand with Tesco. In terms of other international revenues, we have Cherokee-branded revenues from Zeller's (Toronto: HBC.TO) in Canada as well, but those are the larger international entities. We have an international licensing agreement with Sideout [another brand Cherokee owns] in China, that's just starting to get going. We're hopeful that will develop into some meaningful revenues here a couple years down the line. But these things take time.

TMF: Cherokee is a "Casual American" brand, as you folks call it. How has the anecdotal anti-American sentiment affected or will affect the brand overseas? Is it a real risk or a short-term perceived fear?

Riopelle: I think more of a short-term fear. We're not really seeing any of that concern from Tesco. I'm not aware of any of it in Canada at Zeller's either. So I suppose that's always a concern, depending upon where our foreign policy initiatives are and whether we distance ourselves from the international community. But for the most part, Cherokee is a well-known, worldwide brand, and it continues to grow.

TMF: Russell, tell us what sets Cherokee apart from your competitors.

Riopelle: One thing that distinguishes us from other apparel manufactures is we don't manufacture anything. We have no inventory. We have no cost of goods sold. We have none of the risks that go along with being an apparel manufacturer. If a typical apparel manufacturer misses a fashion season, you know what? He's in default on his bank lines all of a sudden, because he's got a bunch of excess inventory that he has to get rid of at a loss and can't move. So we have a very different risk profile than what we did 10 or 12 years ago as an apparel manufacturer and as do other apparel manufacturers have now. So it's a significantly different type of company. We're doing $36 million of revenues on 16 employees. It's a pretty unique situation.

In Dealing in Brand Appeal, CFO Russell Riopelle talks about dividends, CEO compensation, and Cameron Diaz.

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Fool contributor Matt Logan does not own shares in any of the companies mentioned.The Motley Fool isFools writing for Fools.


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