Introduction

Cherokee Inc. (which may be referred to as we, us or our) is in the business of marketing and licensing the Cherokee and Sideout brands and related trademarks and other brands it owns or represents. We are one of the leading licensors of brand names and trademarks for apparel, footwear and accessories in the United States. Our operating strategy emphasizes domestic and international retail direct and wholesale licensing whereby we grant retailers and wholesalers the license to use the trademarks held by us on certain categories of merchandise in their respective territories.

We and our wholly owned subsidiary, SPELL C. LLC (“Spell C”) own several trademarks, including Cherokee ^® , Sideout ^® , Sideout Sport ^® , Carole Little ^® , CLII ^® , Saint Tropez-West ^® , Chorus Line ^® , All that Jazz ^® , Molly Malloy ^® and others. The Cherokee brand, which began as a footwear brand in 1973, has been positioned to connote quality, comfort, fit, and a “Casual American” lifestyle with traditional wholesome values. The Sideout brand and related trademarks represent a young active lifestyle and were acquired by us in November 1997. The Carole Little and Chorus Line brands and trademarks were acquired by us in December 2002. These brands are recognized women’s brands that we have begun to market in apparel, accessories, and home products. As of January 31, 2004, we had twelve continuing license agreements covering both domestic and international markets, of which two are expected to expire in 2004.

Our retail direct licensing strategy is premised on the proposition that around the world nearly all aspects of the moderately priced apparel, footwear and accessories business can be sourced most effectively by large retailers, who not only command significant economies of scale, but also interact daily with the end consumer. In addition, we believe that these retailers in general may be able to obtain higher gross margins on sales and increase store traffic by directly sourcing, stocking and selling licensed products bearing widely recognized brand names, such as our brands, than through carrying strictly private label goods or branded products from third-party vendors. Our strategy globally is to capitalize on these ideas by licensing our portfolio of brands primarily to strong and growing retailers, such as Target Stores and TJX Companies in the U.S., Tesco and Carrefour in Europe, and Bolderway in China, who work in conjunction with us to develop merchandise for their stores.

Parties seeking to sell their brands and related trademarks frequently approach us. Should an established and marketable brand or equity become available on favorable terms, we would be interested in pursuing such an acquisition. For example, in December 2002, we acquired out of bankruptcy the trademarks of CL Fashion Inc., which included Carole Little, CLII, Saint Tropez-West, Chorus Line, All that Jazz, and Molly Malloy, for an aggregate purchase price of $2.7 million. Concurrently, we entered into a five-year licensing agreement with TJX Companies for the Carole Little, CLII and Saint Tropez-West brands and a five-year master licensing agreement with Gilrichco, Inc. for the remaining acquired brands. We subsequently terminated the licensing agreement with Gilrichco during fiscal 2004.

In addition to acquiring brands and licensing our own brands, we assist other companies, wholesalers and retailers in identifying licensees or licensors for their brands or stores. Generally, as an exclusive consultant, we perform a range of services, including marketing of brands, solicitation of licensees, and other related services. In return for our services we normally charge a certain percentage of the net royalties generated by the brands we represent and manage. For example, in 2000 we introduced Mossimo to Target Stores, and in 2003 we introduced the House Beautiful brand to May Company department stores.

Cherokee was incorporated in Delaware in 1988. Our principal executive offices are located at 6835 Valjean Avenue, Van Nuys, California 91406, telephone (818) 908-9868. We maintain a website with the address www.thecherokeegroup.com. We are not including the information contained on our website as part of, or incorporating it by reference into, this Annual Report on Form 10-K. We make available free of charge through

1

Table of Contents

our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission.

Overview of Licensing Business

The Cherokee brand, which began as a footwear brand in 1973, has been positioned to connote quality, comfort, fit, and a “Casual American” lifestyle with traditional, wholesome values. We acquired the Sideout brand and related trademarks, which represent a young active lifestyle, in November 1997. See “Sideout Agreement” below. Our primary emphasis for the past seven years has been directed toward domestic and international retail direct and wholesale licensing. As of January 31, 2004, we had twelve continuing license agreements (two of which are expected to expire in 2004), covering both domestic and international markets, five of which pertained to the Cherokee brand.

Our license agreements are with retailers, wholesalers and global trading companies on an exclusive or non-exclusive basis. Of our twelve licensing agreements, eight are with domestic or international retailers, two are with international wholesalers, and two are brand representations with contracts with domestic retailers. In retail direct licensing, we grant retailers a license to use the trademarks on certain categories of merchandise. Although we provide design direction, most of our licensees modify or amplify the designs to suit their seasonal, regional and category needs. In all cases, all products are subject to our pre-approved packaging, graphics and quality control standards. The retailer is responsible for manufacturing the merchandise. We refer to this practice as our “retail direct” licensing strategy. Wholesale licensees manufacture and import various categories of apparel, footwear and accessories under our trademarks and sell the licensed products to retailers. Our retail, wholesale and international license agreements provide us with final approval of pre-agreed upon quality standards, packaging and, in most cases, marketing of licensed products. We have the right to conduct periodic quality control inspections to ensure that the image and quality of licensed products remain consistent. We will continue to solicit new licensees through our executive employees as well as using outside consultants.

Our current business strategy is to maximize the value of our existing and future brands by marketing them in a manner that recognizes the relative market power, in different areas of the world, of the various participants—manufacturer, wholesaler and retailer—in the chain of supply to the ultimate consumer. In the United States, market power and accompanying economies of scale are generally held by a few dominant retailers of moderately priced merchandise, and, accordingly, in the United States we have pursued our retail direct licensing strategy. In contrast to the retail market in the United States, as well as in Canada, in selected international markets we have sought to develop our brands through wholesale licenses with manufacturers or other companies who have market power and economies of scale in their respective markets. Finally, in some countries, we believe that an owner or licensee of one or more well-known U.S. brands has the opportunity to become a dominant, vertically integrated manufacturer or retailer or both of branded apparel, footwear and accessories. Accordingly, in those countries we have begun to pursue licensing or strategic alignments whereby our brands can become the basis for such a vertically integrated manufacturer/retailer. These various licensing strategies permit us to operate with minimal working capital, virtually no capital expenditures (other than those associated with acquiring new brands and related trademarks, and maintaining our trademark registrations in certain countries), no production costs, significantly reduced design, marketing, distribution and other operating expenses, and a small group of core employees.

United States Licensing

Our retail direct licensing strategy is premised on the proposition that in the United States nearly all aspects of the moderately priced apparel, footwear and accessories business, from product development and design, to merchandising, to sourcing and distribution, can be executed most effectively by large retailers, who not only command significant economies of scale, but also interact daily with the end consumer. We believe that these retailers in general may be able to obtain higher gross margins on sales and increase store traffic by directly

2

Table of Contents

sourcing, stocking and selling licensed products bearing widely recognized brand names (such as our brands) than through carrying strictly private label goods or branded products from third-party vendors. We also expect that the enhanced profitability to retailers of private label products and in-store brands, coupled with the substantial marketing costs to establish and maintain a widely recognized apparel brand, will continue to increase the desirability to retailers of well-established brands with broad appeal. Our primary strategy in the United States is to capitalize on these trends by licensing our portfolio of brand names directly to retailers, who, working in conjunction with us, develop merchandise for their stores, and to augment that portfolio by acquiring additional brands which have high consumer awareness, broad appeal and applicability to a range of merchandise categories.

Our most significant retail relationship in the United States is with Target Stores. The terms of our relationship with Target Stores are set forth in an amended licensing agreement (the “Amended Target Agreement”) between Cherokee and Target Stores entered into on November 12, 1997. This agreement was subsequently assigned to Spell C and pledged as collateral for the Zero Coupon Secured Notes (the “Secured Notes”) issued by Spell C in connection with a transaction that monetized future minimum payments from Target Stores under the Amended Target Agreement. See “Recapitalization; Sale of Cherokee Trademarks to Spell C; Issuance of Secured Notes” below. The Amended Target Agreement grants Target Stores the exclusive right in the United States to use the Cherokee trademarks in certain specified categories of merchandise including:

Some of the above-listed categories were subject to license agreements between us and third parties, which expired prior to or during our fiscal year ended January 31, 2004 (“fiscal 2004”). The Amended Target Agreement provides that upon the expiration or termination of such agreements, the categories of merchandise subject to such agreements will become exclusive to Target Stores in the United States. Due to the broad nature of the rights granted to Target Stores in the United States, and the restrictions contained in the Amended Target Agreement, we cannot enter into new retail or wholesale licensing agreements in the United States with respect to the Cherokee brand, except for retail license agreements for cosmetics, bath and body products with several drug store chains.

The initial term of the Amended Target Agreement commenced on February 1, 1998 through January 31, 2004. The Amended Target Agreement provides that if Target Stores is current in its payments of the minimum guaranteed royalty under the agreement, then the term of the agreement will automatically renew for the fiscal year ending in 2005, and will continue to automatically renew for successive fiscal year terms provided that Target Stores has paid a minimum guaranteed royalty equal to or greater than $9.0 million for the preceding fiscal year and Target Stores does not give notice of its intention to terminate the agreement. In February 2004, Target Stores elected to allow the term of the Amended Target Agreement to be renewed for one additional year. As a result, the term of the Amended Target Agreement currently continues through January 2006 and remains subject to the automatic renewal provisions described above. Target Stores may terminate the Amended Target Agreement effective February 2006 if it gives us written notice of its intent to do so by February 28, 2005, and may terminate at the end of any fiscal year thereafter, if it gives us written notice of its intent to do so during February of the calendar year prior to termination.

3

Table of Contents

Under the Amended Target Agreement, Target Stores has agreed to pay royalties based on a percentage of Target Stores’ net sales of Cherokee branded merchandise during each fiscal year ended January 31 ^st , which percentage varies according to the volume of sales of merchandise. Target Stores has agreed to pay a minimum guaranteed royalty of $9.0 million for each of the two years ending January 31, 1999 and 2000, $10.5 million for each of the four years ending January 31, 2001 through 2004, and $9.0 million for the year ended January 31, 2005 and each fiscal year thereafter, if any, that the term of Amended Target Agreement is extended.

Royalty revenues from our Cherokee brand at Target Stores were $6.4 million during our eight-month fiscal period ended January 31, 1998, $14.6 million during our fiscal year ended January 30, 1999, $16.3 million during our fiscal year ended January 29, 2000, $19.3 million during our fiscal year ended February 3, 2001, $20.7 million during our fiscal year ended February 2, 2002 , $21.4 million during fiscal 2003 and $20.6 million during fiscal 2004 which accounted for 75%, 76%, 66%, 68%, 67%, 65% and 57% respectively, of our consolidated revenues during such periods. Royalty revenues in fiscal 2004 from Target Stores were 196% of the guaranteed minimum royalty under the Amended Target Agreement. See “Risk Factors.”

Our retail direct licensees for the Sideout brand continued to achieve good results from sales of merchandise bearing the Sideout brand. Categories of merchandise under license include men’s, women’s and children’s sportswear, accessories, luggage, sports bags and backpacks, skin care products and hats. During fiscal 2004, royalty revenues from retail direct licensees for the Sideout brand totaled $2.9 million as compared to $3.1 million during fiscal 2003. During fiscal 2004, our non-exclusive United States retail direct licensees for the Sideout brand included Mervyn’s and Bob’s Stores. The term of our agreement with Mervyn’s continues until January 31, 2005. In fiscal 2004, Bob’s Stores was acquired by TJX Companies Inc. Our agreement with Bob’s Stores continues to January 31, 2005. We continue to actively pursue our retail direct licensing strategy to further develop the Sideout brand in the United States.

Our retail direct licensing agreement with TJX Companies for the Carole Little, CLII and Saint Tropez-West brands provides us with minimum guaranteed annual royalties during the five-year term of the agreement and provides TJX with the option at the expiration of the initial term of the agreement to either renew the agreement for an additional five years or buy the trademarks covered by the agreement from us pursuant to an agreed-upon formula. After we recover our investment of $2.7 million from the Carole Little brands (Carole Little, CLII, and Saint Tropez-West), then 45% of any additional monies received from the Carole Little brands must be paid by us to Ms. Carole Little (StudioCL Corporation), the founder of CL Fashion Inc.

Generally, royalties on non-exclusive domestic retail licenses begin at 3% of the retailer’s net sales of licensed products and may decrease depending on the retailer’s annual sales of licensed products and the retailer’s guaranteed annual sales of licensed products. As an incentive for our licensees to achieve higher retail sales of Cherokee or Sideout branded products, many of our existing exclusive and non-exclusive license agreements, including the Amended Target Agreement, are structured to provide royalty rate reductions for the licensees after they achieve certain levels of retail sales of Cherokee or Sideout branded products during each fiscal year. As a result, our royalty revenues as a percentage of our licensees’ retail sales of branded products are highest at the beginning of each fiscal year and decrease throughout each fiscal year as licensees reach certain retail sales thresholds contained in their respective license agreements. Therefore, the amount of royalty revenue received by us in any quarter is dependent not only on retail sales of branded products in such quarter, but also on the cumulative level of retail sales, and the resulting attainment of royalty rate reductions in any preceding quarters in the same fiscal year. The size of the royalty rate reductions and the level of retail sales at which they are achieved vary in each licensing agreement.

During fiscal 2004, we received $23.7 million in aggregate royalties from our United States retail direct license agreements (excluding revenues from Mossimo), which accounted for 65% of our consolidated revenues during such period.

4

Table of Contents

International Licensing

We will continue to seek to develop in several international markets both our Cherokee and Sideout brands and other brands we own or represent through retail direct, master or wholesale licenses with manufacturers or other companies that have market power and economies of scale in their respective markets.

On August 22, 1997, we entered into an exclusive international retail direct licensing agreement with Zellers Inc., a Canadian corporation, which is a division of Hudson’s Bay Company. Zellers was granted the exclusive right in Canada to use the Cherokee brand and related trademarks in connection with a broad range of categories of merchandise, including women’s, men’s and children’s apparel and footwear, women’s intimate apparel, fashion accessories, home textiles, cosmetics and recreational products. The term of the agreement was for five years, with automatic renewal options, provided that specified minimums are met each contract year. Under the agreement, Zellers agreed to pay us a minimum guaranteed royalty of $10.0 million over the five-year initial term of the agreement. Royalty revenues from Zellers totaled $3.3 million during fiscal 2004. In 2003 Zellers renewed their agreement for an additional five year period, through January 31, 2008. Under the terms of the renewal, Zellers agreed to pay us a minimum guaranteed royalty of $15.6 million over the new five-year term under the same conditions of the original agreement. Zellers has the option to renew this agreement for an additional five years beyond the most recent renewal.

In early September 2000, we entered into an exclusive international retail direct licensing agreement for the Cherokee brand with France based Carrefour, the second largest retailer in the world. The Carrefour Group was granted the exclusive right to manufacture, promote, sell and distribute a wide range of products bearing our Cherokee brand in Spain, Mexico and Brazil and subsequently Italy, France, China, Taiwan, Greece and Portugal have been added. The Carrefour Group pays us a royalty based upon a percentage of its net sales of Cherokee branded products in those countries, which includes a minimum annual guaranteed royalty. Royalty revenues from the Carrefour Group totaled $691,000 in fiscal 2004. There can be no assurances that future royalties from Carrefour Group will be significant. If the Carrefour Group exceeds certain retail sales thresholds for Cherokee branded products, then the scope of the agreement will be automatically expanded to grant the Carrefour Group the exclusive right to manufacture, promote, sell and distribute products bearing the Cherokee brand in a number of other European, South American and Asian countries not already covered by the agreement, including, among others, Poland, Argentina, Chile, Colombia and Turkey, but excluding the United Kingdom, Ireland and Germany. Further, with respect to Japan and several other Asian countries, the Carrefour Group may elect to add any of those countries to the territory covered by the agreement, provided that at the time of such election we do not already have an existing license agreement covering the country to be added. Even if the retail sales thresholds are not met during the term of the agreement, the Carrefour Group also has the right of first refusal to add any of the European or South American countries to the territory covered by the agreement. As an incentive for Carrefour Group to expand its sales of Cherokee branded products into other countries, we agreed to waive the royalty commitment during the initial six-month start-up period for any added countries. The initial term of the agreement was to expire December 31, 2003, but was renewed in July 2003 for three more years, through December 31, 2006. If the Carrefour Group meets certain retail sales thresholds with respect to Cherokee branded products, then the Carrefour Group may extend the agreement indefinitely for successive three-year terms.

On August 1, 2001, we entered into an exclusive international retail direct licensing agreement for the Cherokee brand with Great Britain’s Tesco Stores Limited. Tesco was granted the exclusive right to manufacture, promote, sell and distribute a wide range of products bearing our Cherokee brand in the United Kingdom and Ireland and is obligated to pay us a royalty based upon a percentage of its net sales of Cherokee branded products in those countries. Royalty revenues from Tesco totaled $5.2 million during fiscal 2004. Tesco also has a right to add a number of other countries to the territories covered by the agreement, assuming we have not already entered into exclusive licensing agreements covering such countries, and subject to the existing rights given to the Carrefour Group. In January 2004, we granted Tesco the rights to Taiwan, Korea, Malaysia, Thailand, Slovakia, and Hungary. The initial term of the agreement expires on January 31, 2005. If Tesco meets certain retail sales thresholds with respect to Cherokee branded products, then Tesco may extend the agreement

5

Table of Contents

indefinitely for successive three-year terms. Based upon Tesco’s current retail sales levels, we believe that Tesco is likely to meet or surpass such retail sales thresholds and hence will extend the agreement for an additional three-year term.

Including the Carrefour Group and Tesco agreements, as of January 31, 2004, we had four international license agreements for the Cherokee brand. In January 2004, Cherokee entered into a wholesale license agreement for the Cherokee brand in Mexico with Grupo Aviara SA. The country of Mexico was previously part of our licensing agreement with Carrefour. We expect to continue to solicit additional licensees for the Cherokee brand in Asia, Europe and South America, subject to the Carrefour Group’s rights and Tesco’s rights under their respective agreements.

During fiscal 2004, with respect to the Sideout brand and related trademarks, we have three international licensing agreements with The Forzani Group, Sport Scheck and Guangdong Bolderway Trading Development Co. Ltd. Our agreements with Forzani and Sport Scheck will expire in fiscal 2005. We have not received a meaningful amount of revenues from these contracts. Our international licensing agreements for the Sideout brand are all exclusive and cover several countries that include, Canada, Germany, Switzerland, Austria and China and product categories including men’s, boy’s and women’s apparel and footwear. In December 2002, we signed a multi year international licensing agreement with Shanghai Bolderway, Fashion Inc., a division of Guangdong Bolderway Trading Development Co., Ltd., covering a wide range of categories for the Sideout brand. These products will launch in China in fiscal 2005.

During fiscal 2004, we received $9.4 million in aggregate royalties from our international license agreements, which accounted for 26% of our consolidated revenues during such period.

Other Businesses and Brand Opportunities

We are frequently approached by parties seeking to sell their brands and related trademarks. Should an established and marketable brand or equity become available on favorable terms, we would be interested in pursuing such an acquisition. For example, in December 2002, we acquired out of bankruptcy the trademarks of CL Fashion Inc. which included Carole Little, CLII, Saint Tropez-West, Chorus Line, All that Jazz, and Molly Malloy for an aggregate purchase price of $2.7 million. Concurrently, we entered into a five-year licensing agreement with TJX Companies for the Carole Little, CLII and Saint Tropez-West brands and a five-year master licensing agreement with Gilrichco, Inc. for the remaining brands. The licensing agreement with TJX provides us with minimum guaranteed annual royalties during the term of the agreement and provides TJX with the option at the expiration of the initial term of the agreement to either renew the agreement for an additional five years or buy the trademarks covered by the agreement from us pursuant to an agreed-upon formula. After we recover our investment of $2.7 million from the Carole Little brands (Carole Little, CLII and Saint Tropez-West), then 45% of any additional monies received from the Carole Little brands must be paid by us to Ms. Carole Little (StudioCL Corporation), the founder of CL Fashion Inc. The Gilrichco agreement was terminated in October 2003 due to under-performance by our licensee, and we are currently exploring opportunities to license the Chorus Line, All that Jazz and Molly Malloy brands.

In addition to acquiring brands and licensing our own brands, we assist other companies in identifying licensees for their brands. Generally, as an exclusive consultant, we perform a range of services including marketing of brands, solicitation of licensees, contract negotiations and administration and maintenance of license or distribution agreements. In return for our services, we normally receive a certain percentage of the net royalties generated by the brands we represent and manage.

For example, during fiscal 2001 we assisted Mossimo in locating Target Stores as a licensee of the Mossimo brand and entered into a finder’s agreement with Mossimo, which provides that we will receive 15% of all monies paid to Mossimo by Target Stores. Under Mossimo’s agreement with Target Stores, Target Stores is obligated to pay Mossimo a royalty based on a percentage of net sales of Mossimo branded products, with a

6

Table of Contents

minimum guaranteed royalty, beginning in 2001, of approximately $27.8 million over the initial three-year term of the agreement. Mossimo’s agreement with Target Stores is subject to early termination under certain circumstances. In February 2003, the agreement between Mossimo and Target was renewed until January 31, 2006, but continues to contain early termination provisions. In fiscal 2003 we assisted House Beautiful in locating May Company Department Stores as a licensee of the House Beautiful brand. In addition, during fiscal 2003, we entered into an exclusive consulting agreement to represent the brand Latina domestically. Other active consulting agreements include Shabby Chic and HotKiss.

During fiscal 2003 and 2004, we recognized revenues from Mossimo of $2.7 million and $2.5 million, respectively, which does not include interest on such amounts owing. However, Mossimo refused to pay the $5.2 million in aggregate finder’s fees due to us from fiscal 2003 through fiscal 2004. An arbitration was held between the parties in mid-October, 2002 on this matter. An arbitration panel ruled in favor of Cherokee on November 11, 2002, issuing an interim arbitration award directing Mossimo to pay all monies owed Cherokee plus interest on any of the monies withheld, along with legal fees. The arbitrators also reaffirmed the finder’s agreement. This interim award was reaffirmed in total in a final award dated January 16, 2003 of over $2.9 million. This final arbitration award stated that Cherokee was owed $2.4 million in finder’s fees from Mossimo, plus $420,272 in legal fees plus $95,305 of interest. On June 17, 2003, the Los Angeles Superior Court confirmed the arbitration award and entered judgment in Cherokee’s favor in the total amount of nearly $3.1 million, which included the past money due to us from the final arbitration award, plus additional interest expense from January 2003 to June 17, 2003. Mossimo then appealed this judgment to the Appellate Court. In conjunction with the appeal, Mossimo posted financial security satisfactory to the court of over $4.5 million, which is equal to one and one half times the amount of the Judgment. The appeal was heard by the Appellate Court on December 12, 2003 and on January 2, 2004 the Appellate court ruled in Cherokee’s favor and upheld the lower court’s finding. On February 6, 2004 Mossimo asked the California Supreme Court to review the unanimous decision of the California Court of Appeal. This appeal was denied on March 17, 2004. Shortly thereafter, Cherokee and Mossimo began discussions about determining the total outstanding amounts owed to Cherokee in this matter (including interest at the statutory rate of 10% on all past revenues and previously awarded interest and legal fees outstanding), and in the afternoon on March 24, 2004 Mossimo presented Cherokee’s attorneys with a check for over $1.7 million along with a letter of release pertaining to the court deposit that Mossimo previously posted with the court (totaling over $4.5 million). Cherokee is in the process of obtaining a court order to receive this deposit. We have not been awarded the reimbursement of our legal fees incurred since January 17, 2003 (the date of the final arbitration award) and the amount of legal expenses and costs incurred since that date currently exceeds $410,000. We are continuing to litigate with Mossimo to receive the full reimbursement of all of our legal expenses and costs incurred in this matter, which Mossimo is currently challenging. During the Fourth Quarter and Twelve Months ended January 31, 2004, we recognized revenues from Mossimo of $308,000 and $2.5 million and an additional $128,000 and $428,000 in interest income, respectively. As of January 31, 2004 past amounts due from Mossimo totaled approximately $6.2 million, which included approximately $5.2 million in finder’s fees owed, and over $1.0 million of interest on such monies owed and reimbursement of legal fees previously awarded, but does not include our legal expenses and costs of over $410,000 incurred since January 17, 2003. We believe that based upon the rulings to date we will eventually receive reimbursement of all of our legal fees incurred in this matter from Mossimo. We have made no provision for reserves against the accounts receivable from Mossimo. Based upon the $1.7 million check received on March 24, 2004 and the release by Mossimo to us of the court deposit of over $4.5 million previously posted by Mossimo (but not yet received by us), we believe that we will receive at least $6.2 million in the resolution of this matter to fully recover the recorded amount of the receivable from Mossimo at January 31, 2004, and possibly the full reimbursement of our legal expenses not yet awarded, which is currently over $410,000. See “—Risk Factors” and “Item 3 Legal Proceedings.”

During fiscal 2004, we recognized $3.2 million in aggregate royalties from other business opportunities (which includes revenues from Mossimo), which accounted for 9% of our consolidated revenues during such period.

7

Table of Contents

Recapitalization; Sale of Cherokee Trademarks to Spell C; Issuance of Secured Notes

On December 23, 1997, we completed a recapitalization that resulted in the issuance of a special dividend to Cherokee stockholders of $5.50 per share on January 15, 1998. To facilitate the recapitalization, we formed SPELL C. LLC, a special purpose, bankruptcy remote, single member Delaware limited liability company, wholly owned by us. We assigned to Spell C all of our right, title and interest in the Amended Target Agreement and sold to Spell C all of our right, title and interest in the Cherokee brand name and related trademarks in the United States. The sale of the rights to the Cherokee trademarks in the United States was subject to certain exceptions which allow us to continue to use the trademarks in the United States in conjunction with our then-existing license agreements and allow us to use the trademarks in the United States in conjunction with retail license agreements in the category of cosmetics, bath and body products. Except for these exceptions, we no longer have the right to license the Cherokee brand and related trademarks in the United States, but retain all rights to do so outside of the United States.

On December 23, 1997, Spell C issued for gross proceeds of $47.9 million, privately placed Zero Coupon Secured Notes (the “Secured Notes”), yielding 7.0% interest per annum and maturing on February 20, 2004. The proceeds from the sale of the Secured Notes were used to pay the special dividend to Cherokee stockholders described above. The Secured Notes subsequently have been paid in full out of royalties received under the Amended Target Agreement, with the final payment of principal and interest being made on February 20, 2004. During fiscal 2004, of the $20.6 million in royalty revenues from Target Stores, $10.5 million was paid to the holders of the Secured Notes, and the remainder of the royalty revenues were distributed to us. Spell C will continue to receive all royalties paid under the Amended Target Agreement but we expect all such royalties will be distributed to Cherokee.

Sideout Agreement

On November 7, 1997, we entered into an Agreement of Purchase and Sale of Trademarks and Licenses (the “Sideout Agreement”) with Sideout Sport Inc., pursuant to which we agreed to purchase all of Sideout Sport Inc.’s trademarks, copyrights, trade secrets and associated license agreements. Steven Ascher, a former Executive Vice President who left the Company in November of 2003, beneficially owns 37.2% of Sideout Sport Inc. and Mr. Ascher’s father and father-in-law beneficially own 8.9% and 5.0%, respectively, of Sideout Sport Inc. The trademarks acquired from Sideout Sport Inc. include, among others, Sideout ^® and Sideout Sport ^® . Pursuant to the Sideout Agreement, we paid $1.5 million at the closing of the acquisition and agreed to pay an additional $500,000 upon release of liens on the assets that were purchased. Most of the liens have since been released and $495,000 of the $500,000 holdback has been paid. Under the terms of the Sideout Agreement, we will also pay Sideout Sport Inc., on a quarterly basis, contingent payments of 40% of the first $10.0 million, 10% of the next $5.0 million and 5% of the next $20.0 million, of royalties and license fees received by us through licensing of the Sideout trademarks. Upon the earlier of such time as we have paid Sideout total contingent payments of $5.5 million or October 22, 2004, we will have no further obligation to pay Sideout Sport Inc. During fiscal 2004 we made payments of $315,000 under the Sideout Agreement, and since January 1999 we have paid in total over $4.6 million in contingent payments under the Sideout Agreement.

Trademarks

We and our wholly-owned subsidiary Spell C hold various trademarks including Cherokee ^® , Sideout ^® , Sideout Sport ^® , Carole Little ^® , CL II ^® , Saint Tropez-West ^® , Chorus Line ^® , All that Jazz ^® , Molly Malloy ^® and others, in connection with numerous categories of apparel and other goods. These trademarks are registered with the United States Patent and Trademark Office and in a number of other countries. We intend to renew these registrations as appropriate prior to expiration. We also hold trademark applications for Cherokee, Sideout and Sideout Sport, Carole Little, CLII, Saint Tropez-West, Chorus Line, All that Jazz, and Molly Malloy in numerous countries. We monitor on an ongoing basis unauthorized filings of our trademarks, and we rely primarily upon a combination of trademark, know-how, trade secrets, and contractual restrictions to protect our intellectual property rights both domestically and internationally. See “Risk Factors.”

8

Table of Contents

Marketing

We have positioned the Cherokee name to connote quality, comfort, fit and a “Casual American” lifestyle with traditional, wholesome values. The Sideout brand and related trademarks represent a young active lifestyle. We integrate our advertising, product, labeling and presentation to reinforce these brand images. We intend to continue to promote a positive image in marketing the Cherokee and Sideout brands through licensee-sponsored advertising. Our retail, wholesale and international license agreements provide us with final approval of pre-agreed upon quality standards, packaging and marketing of licensed products. We principally rely on our licensees to advertise the Cherokee and Sideout brands, and as a result our advertising costs have been minimal.

We developed a website with the address of www.thecherokeegroup.com, which utilizes a business-to-business E-commerce strategy. The information regarding our website address is provided for convenience and we are not including the information contained on our website as part of, or incorporating it by reference into, this Annual Report on Form 10-K. Our goal in developing the website is to enhance communication, information flow and networking with existing and prospective licensees. The website currently includes our profiles and our brands, certain of our financial statements and press releases, as well as a secured area to support our licensees with graphics, packaging and trim items, design concepts, new developments and other administrative needs.

Internationally, we intend to continue to seek to develop both of our principal brands through license agreements and strategic alliances with manufacturers or other companies who have market power and economies of scale in their respective markets. We are also seeking to assist other companies in identifying licensees for their brands. We will continue to market our brands and solicit new licensees through a small number of executive employees and may retain the services of outside consultants from time to time to assist us in this effort.

Competition

Royalties paid to us under our licensing agreements are generally based on a percentage of the licensee’s net sales of licensed products. Cherokee and Sideout brand footwear, apparel, and accessories, which are manufactured and sold by both domestic and international wholesalers and retail licensees, are subject to extensive competition by numerous domestic and foreign companies. Such competitors with respect to the Cherokee brand include Levi Strauss & Co., The Gap, Old Navy, Liz Claiborne and VF Corp. and private labels, such as Faded Glory, Arizona, and Route 66, developed by retailers. Competitors with respect to the Sideout brand include Quicksilver, Mossimo, Nike and other active wear companies. Factors which shape the competitive environment include quality of garment construction and design, brand name, style and color selection, price and the manufacturer’s ability to respond quickly to the retailer on a national basis. In recognition of the increasing trend towards consolidation of retailers and greater emphasis by retailers on the manufacture of directly sourced merchandise, in the United States our business plan focuses on creating strategic alliances with major retailers for their sale of products bearing our brands through the licensing of our trademarks directly to retailers. Therefore, our success is dependent on our licensees’ ability to design, manufacture and sell products bearing our brands and to respond to ever-changing consumer demands. Companies such as Mossimo have entered into, and other companies owning established trademarks could also enter into, similar arrangements with retailers. See “Risk Factors.”

Employees

As of January 31, 2004, we employed seventeen persons. None of our employees are represented by labor unions and we believe that our employee relations are satisfactory.

Code of Ethics

We have adopted a code of ethics that applies to all of our directors, officers and employees.

9

Table of Contents

Risk Factors

In addition to the other information contained herein or incorporated herein by reference, the risks and uncertainties and other factors described below could have a material adverse effect on our business, financial condition, results of operations and share price and could also cause our future business, financial condition and results of operations to differ materially from the results contemplated by any forward-looking statement we may make herein, in any other document we file with the Securities and Exchange Commission, or in any press release or other written or oral statement we may make. Please also see “Item 7. Management’s Discussion and Analysis of Financial Condition And Results of Operations—Cautionary Note Regarding Forward-Looking Statements” for additional risks and uncertainties applicable to us.

Our business is subject to intense competition.

Royalties paid to us under our licensing agreements are generally based on a percentage of our licensee’s net sales of licensed products. Cherokee and Sideout brand footwear, apparel, and accessories, which are manufactured and sold by both domestic and international wholesalers and retail licensees, are subject to extensive competition by numerous domestic and foreign companies. Such competitors with respect to the Cherokee brand include Levi Strauss & Co., The Gap, Old Navy, Liz Claiborne and VF Corp. and private labels, such as Faded Glory, Arizona and Route 66, developed by retailers. Competitors with respect to the Sideout brand include Quicksilver, Mossimo, Nike and other active wear companies. Factors which shape the competitive environment include quality of garment construction and design, brand name, style and color selection, price and the manufacturer’s ability to respond quickly to the retailer on a national basis. In recognition of the increasing trend towards consolidation of retailers and greater emphasis by retailers on the manufacture of private label merchandise, in the United States our business plan focuses on creating strategic alliances with major retailers for their sale of products bearing our brands through the licensing of our trademarks directly to retailers. Therefore, our success is dependent on our licensees’ ability to design, manufacture and sell products bearing our brands and to respond to ever-changing consumer demands, and any significant failure by our licensees to do so could have a material adverse effect on our business prospects, financial condition, results of operations and liquidity. Other companies owning established trademarks could also enter into similar arrangements with retailers.

Our business is dependent on Target Stores, which accounted for 57% of our consolidated licensing revenues in fiscal 2004.

During fiscal 2004, 57% of our licensing revenues were generated from a single source, Target Stores, a division of Target Corp. See “Business — United States Licensing.” The term of the Amended Target Agreement currently extends until January 31, 2006 and, unless Target Stores gives us one year’s advance notice of its intention to terminate the agreement, the agreement will continue to automatically renew for successive one year terms provided that Target Stores has paid a minimum guaranteed royalty equal to or greater then $9.0 million for the preceding fiscal year. If Target Stores elects to terminate the agreement, effective after January 31, 2006 or at any other time, it would have a material adverse effect on our business, financial condition and results of operations. There can be no guarantee that we would be able to replace the Target Stores royalty payments from other sources. The Amended Target Agreement, however, requires one year’s advance notice of termination by Target Stores to prevent automatic renewal, during which period we believe we could enter into one or more licensing agreements for the Cherokee brand with either retailers and/or wholesalers, which we expect would enable us to replace some of the lost revenues from Target Stores. Nonetheless, we could suffer substantial decreased royalty revenues under the Amended Target Agreement if Target were to reduce its sales of Cherokee branded products while continuing to pay the minimum royalties required under such agreement.

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

We hold various trademarks including Cherokee, Sideout and others in connection with apparel, footwear and accessories. These trademarks are vital to the success and future growth of our business. These

10

Table of Contents

trademarks are registered with the United States Patent and Trademark Office and in several other countries. We also hold several trademark applications for Cherokee and Sideout in several countries. We monitor on an ongoing basis unauthorized filings of our trademarks, and we rely primarily upon a combination of trademark, know-how, trade secrets, and contractual restrictions to protect our intellectual property rights. We believe that such measures afford only limited protection and, accordingly, there can be no assurance that the actions taken by us to establish and protect our trademarks and other proprietary rights will prevent imitation of our products or infringement of our intellectual property rights by others, or prevent the loss of licensing revenue or other damages caused thereby. In addition, the laws of several countries in which we have licensed our intellectual property may not protect our intellectual property rights to the same extent as the laws of the United States. Despite our efforts to protect our intellectual property rights, unauthorized parties may attempt to copy aspects of our intellectual property, which could have a material adverse effect on our business prospects, financial condition, results of operations and liquidity. In the future we may be required to assert infringement claims against third parties, and there can be no assurance that one or more parties will not assert infringement claims against us. While we currently have the resources to pursue or defend most infringement claims, any resulting litigation could result in significant expense and divert the efforts of our management personnel whether or not such litigation is determined in our favor.

Target Corporation has announced that it is reviewing strategic alternatives for its Mervyn’s and Marshall Field’s divisions, which could result in the possible sale of one or both of these divisions as ongoing businesses to existing retailers or other buyers who might choose not to renew our Sideout license agreement.

During fiscal 2004, we generated $2.9 million, or approximately 8%, of our licensing revenues from our licensing agreement with Mervyn’s, a division of Target Corporation. See “—United States Licensing.” Our current licensing agreement with Mervyn’s, which is for our Sideout brand, currently extends until January 31, 2005. On March 10, 2004 Target Corporation announced that it was reviewing strategic alternatives for its Mervyn’s and Marshall Field’s divisions, and that it had engaged an investment banker to advise Target Corporation in this review. If Target Corporation elects to sell Mervyn’s to an existing retailer or other qualified buyer, or chooses to spin-off Mervyn’s or some other strategic alternative, such a transaction could adversely impact the likelihood that our existing licensing contract would be extended beyond the current term ending January 31, 2005. If this licensing contract with Mervyn’s is not extended, renewed, amended, or replaced with a new licensing contract, we would not receive licensing revenues from Mervyn’s during fiscal 2006. If this happens, we may not be able to replace the Mervyn’s royalty payments with revenues from other sources.

Mossimo Inc. has refused to make payment under the Finder’s Agreement and we have made no reserves with respect to withheld payments

During fiscal 2001, we assisted Mossimo Inc. in locating Target Stores as a licensee of the Mossimo brand and entered into a finder’s agreement with Mossimo, which provides that we will receive 15% of all monies paid to Mossimo by Target Stores. Under Mossimo’s agreement with Target Stores, Target Stores is obligated to pay Mossimo a royalty based on a percentage of net sales of Mossimo branded products, with a minimum guaranteed royalty, beginning in 2001, of approximately $27.8 million over the initial three-year term of the agreement. Mossimo’s agreement with Target Stores is subject to early termination under certain circumstances. In February 2003, the agreement between Mossimo and Target was renewed until January 31, 2006, but continues to contain early termination provisions. During fiscal 2003 and 2004, we recognized revenues from Mossimo of $2.7 million and $2.5 million, respectively, which does not include interest on such amounts owing. However, Mossimo refused to pay the $5.2 million in aggregate finder’s fees due to us from fiscal 2003 through fiscal 2004. An arbitration was held between the parties in mid-October, 2002 on this matter. An arbitration panel ruled in favor of Cherokee on November 11, 2002, issuing an interim arbitration award directing Mossimo to pay all monies owed Cherokee plus interest on any of the monies withheld, along with legal fees. The arbitrators also reaffirmed the finder’s agreement. This interim award was reaffirmed in total in a final award dated January 16, 2003 of over $2.9 million. This final arbitration award stated that Cherokee was owed $2.4 million in finder’s fees from Mossimo, plus $420,272 in legal fees plus $95,305 of interest. On June 17, 2003, the Los Angeles Superior Court confirmed the arbitration award and entered judgment in Cherokee’s favor in the total amount of

11

Table of Contents

nearly $3.1 million, which included the past money due to us from the final arbitration award, plus additional interest expense from January 2003 to June 17, 2003. Mossimo then appealed this judgment to the Appellate Court. In conjunction with the appeal, Mossimo posted financial security satisfactory to the court of over $4.5 million, which is equal to one and one half times the amount of the Judgment. The appeal was heard by the Appellate Court on December 12, 2003 and on January 2, 2004 the Appellate court ruled in Cherokee’s favor and upheld the lower court’s finding. On February 6, 2004 Mossimo asked the California Supreme Court to review the unanimous decision of the California Court of Appeal. This appeal was denied on March 17, 2004. Shortly thereafter, Cherokee and Mossimo began discussions about determining the total outstanding amounts owed to Cherokee in this matter (including interest at the statutory rate of 10% on all past revenues and previously awarded interest and legal fees outstanding), and in the afternoon on March 24, 2004 Mossimo presented Cherokee’s attorneys with a check for over $1.7 million along with a letter of release pertaining to the court deposit that Mossimo previously posted with the court (totaling over $4.5 million). Cherokee is in the process of obtaining a court order to receive this deposit. We have not been awarded the reimbursement of our legal fees incurred since January 17, 2003 (the date of the final arbitration award) and the amount of legal expenses and costs incurred since that date currently exceeds $410,000. We are continuing to litigate with Mossimo to receive the full reimbursement of all of our legal expenses and costs incurred in this matter, which Mossimo is currently challenging. During the Fourth Quarter and Twelve Months ended January 31, 2004, we recognized revenues from Mossimo of $308,000 and $2.5 million and an additional $128,000 and $428,000 in interest income, respectively. As of January 31, 2004 past amounts due from Mossimo totaled approximately $6.2 million, which included approximately $5.2 million in finder’s fees owed, and over $1.0 million of interest on such monies owed and reimbursement of legal fees previously awarded, but does not include our legal expenses and costs of over $410,000 incurred since January 17, 2003. We believe that based upon the rulings to date we will eventually receive reimbursement of all of our legal fees incurred in this matter from Mossimo. We have made no provision for reserves against the accounts receivable from Mossimo. Based upon the $1.7 million check received on March 24, 2004 and the release by Mossimo to us of the court deposit of over $4.5 million previously posted by Mossimo (but not yet received by us), we believe that we will receive at least $6.2 million in the resolution of this matter to fully recover the recorded amount of the receivable from Mossimo at January 31, 2004, and possibly the full reimbursement of our legal expenses not yet awarded, which is currently over $410,000. We believe that based upon the rulings to date we will eventually receive reimbursement of all of our legal fees incurred in this matter from Mossimo.

We are dependent on our key management personnel.

Our success is highly dependent upon the continued services of Robert Margolis, our Chairman and Chief Executive Officer, who is the primary person responsible for conceiving and implementing our overall business and marketing strategy. Mr. Margolis has served as Chairman and Chief Executive Officer since December 1994 when we emerged from bankruptcy. As of March 25, 2004, Mr. Margolis was the beneficial owner of approximately 16.8% of our outstanding common stock. We have only seventeen employees and Mr. Margolis’ leadership and experience in the apparel licensing industry is critical to the successful implementation of our business and marketing strategy. We do not carry key person life insurance covering Mr. Margolis. While Mr. Margolis’ services are provided pursuant to a management agreement with us, this agreement does not ensure Mr. Margolis’ continued services. The loss of the services of Mr. Margolis could have a material adverse effect on our business prospects, financial condition, results of operations and liquidity.

The management agreement with our Chief Executive Officer contains provisions that provide for a substantial cash payment to our Chief Executive Officer upon breach or termination of the management agreement by us.

Mr. Margolis’ services as Chairman and Chief Executive Officer are provided to us pursuant to a management agreement. The current term of the management agreement ends February 1, 2006; however, the term may be extended indefinitely for additional one-year terms so long as we meet certain pre-tax earnings thresholds. If we terminate the management agreement without cause or Mr. Margolis terminates the

12

Table of Contents

management agreement after we materially breach any of the terms and conditions thereof or fail to perform any material obligations there under, we would be obligated to pay Mr. Margolis, within sixty days after the date of termination, a lump sum in cash equal to three times the sum of the annual base compensation under the management agreement at the rate in effect at the time of the termination and the previous year’s performance bonus under the management agreement. Mr. Margolis’ annual base compensation in fiscal 2004 was $720,746 and his performance bonus for fiscal 2004 was approximately $3.1 million. Based on the amounts paid for fiscal 2004, the lump sum payment owed upon such a termination would be approximately $11.4 million.

The occurrence of the following events, among other things, will be deemed to be a material breach of the management agreement by us:

We do not have sufficient cash to make the lump sum payment to Mr. Margolis, and becoming obligated to make such payment would have a material adverse effect on our business prospects, financial condition, results of operations and liquidity. Under certain circumstances, the obligation to make such lump sum payment to Mr. Margolis could be triggered if a third party were to acquire us, which would increase such third party’s acquisition costs, but would also each year thereafter reduce our annual operating expenses due to the elimination of annual bonus payments to Mr. Margolis pursuant to the management agreement.

We may not pay dividends regularly in the future.

Although we have paid dividends during the fourth quarter of fiscal 2004 and during the first quarter of fiscal 2005, there can be no assurances that we will continue to generate excess cash to pay dividends, or that we will continue to pay dividends with such excess cash if other, more compelling business opportunities are available, as determined by our Board of Directors. Our ability to generate excess cash from our operations in the future is dependent upon a variety of factors, including Cherokee’s financial condition, results of operations, cash flow, capital requirements and other factors.