SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
For the quarterly period ended February 28, 1998
Commission File No. 0-19369
LITTLE SWITZERLAND, INC.
(Exact name of registrant as specified in its charter)
Delaware 66-0476514
(State of Incorporation) (I.R.S Employer
Identification No.)
161-B Crown Bay Cruise Ship Port
St. Thomas U.S.V.I. 00802
(Address of Principal Executive Offices) (Zip Code)
(340) 776-2010
(Registrant's Telephone Number, Including Area Code)
Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES X NO
At March 30, 1998, 8,554,202 shares of $.01 par value common stock of the
registrant were outstanding.
LITTLE SWITZERLAND, INC.
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED February 28, 1998
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of
February 28, 1998 (unaudited) and
May 31, 1997 3
Consolidated Statements of Income (unaudited)
for the three and nine months ended
February 28, 1998 and March 1, 1997 4
Consolidated Statements of Cash Flows (unaudited)
for the nine months ended February 28,1998 and
March 1, 1997 5
Notes to Consolidated Financial
Statements (unaudited) 6-13
Item 2. Management's Discussion and Analysis
of Financial Condition and Results
of Operations 14-19
Item 3. Quantitative and Qualitative Disclosures
about Market Risk 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 20
Item 5. Other Information 20
Item 6. Exhibits and Reports on Form 8-K 21
Signature Page 22
PART I. FINANCIAL INFORMATION FORM 10-Q
Item 1. Financial Statements Page 3
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands except per share data)
(unaudited)
February 28, May 31,
ASSETS 1998 1997
Current assets: (unaudited)
----------- -----------
Cash and cash equivalents.......................$ 3,284 $ 1,710
Accounts receivable............................. 2,483 2,083
Inventory....................................... 47,447 44,728
Prepaid expenses and other current assets....... 3,725 2,172
-------- ---------
Total current assets...................... 56,939 50,693
-------- ---------
Property, plant and equipment, at cost............. 39,509 38,565
Less -- Accumulated depreciation................ (17,178) (15,201)
-------- ---------
22,331 23,364
-------- ---------
Other assets....................................... 3,084 3,334
-------- ---------
Total assets..............................$ 82,354 $ 77,391
========= =========
LIABILITIES AND STOCKHOLDERS EQUITY
Current liabilities:
Current portion of long term debt...............$ 2,225 $ 2,225
Unsecured notes payable......................... 9,700 8,100
Accounts payable................................ 9,926 7,002
Accrued and currently deferred income taxes..... 319 429
Other accrued expenses and deferred income...... 2,763 2,431
--------- ---------
Total current liabilities................. 24,933 20,187
Long term debt..................................... 4,450 6,119
Deferred income taxes.............................. 186 186
--------- ---------
Total liabilities......................... 29,569 26,492
Commitments and contingencies...................... --- ---
Minority interest.................................. 1,619 1,619
--------- ---------
Stockholders' equity:
Preferred stock, $.01 par value--
Authorized--5,000 shares
Issued and outstanding--none................... --- ---
Common stock, $.01 par value--
Authorized--20,000 shares
Issued and outstanding--8,549 shares
at February 28, 1998 and 8,462 shares at
May 31, 1997 ................................ 85 85
Capital in excess of par........................... 15,234 14,811
Retained earnings.................................. 35,847 34,384
--------- ---------
Total stockholders' equity................... 51,166 49,280
--------- ---------
Total liabilities, minority interest
and stockholders' equity..................$ 82,354 $ 77,391
========= =========
See accompanying notes to consolidated financial statements
PART I. FINANCIAL INFORMATION FORM 10-Q
Item 1. Financial statements Page 4
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Consolidated Statements of Income
(in thousands except per share data)
(unaudited)
For the three For the nine
months ended months ended
February 28, March 1, February 28, March 1,
1998 1997 1998 1997
------ ------ ------ ------
Net sales...................$ 34,925 $ 32,624 $ 76,329 $ 65,950
Cost of sales............... 19,901 18,126 43,612 36,918
------ ------ ------ ------
Gross profit................ 15,024 14,498 32,717 29,032
Selling, general and
administrative expenses..... 12,352 11,263 29,657 27,211
Business interruption
insurance (proceeds)........ --- --- -- (560)
------ ------ ------ ------
Operating income.......... 2,672 3,235 3,060 2,381
Interest expense, net....... 481 398 1,278 1,166
------ ------ ------ ------
Income before
income taxes.......... 2,191 2,837 1,782 1,215
Provision for
income taxes................ 402 426 320 133
------ ------ ------ ------
Net income..................$ 1,789 $ 2,411 $ 1,462 $ 1,082
======== ======== ========= ========
Basic earnings
per share................$ 0.21 $ 0.28 $ 0.17 $ 0.13
======== ======== ========= ========
Fully diluted earnings
per share................$ 0.21 $ 0.28 $ 0.17 $ 0.13
======== ======== ========= ========
See accompany notes to consolidated financial statements
PART I. FINANCIAL INFORMATION FORM 10-Q
Item 1. Financial statements Page 5
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
For the nine months ended
February 28, March 1,
Cash flows from operating activities: 1998 1997
-------- --------
Net income............................................$ 1,462 $ 1,082
Adjustments to reconcile net income to net cash
provided by (used in) operating activities--
Depreciation................................... 1,977 2,341
Changes in assets and liabilities:
(Increase) decrease in accounts receivable... (400) 49
(Increase) in inventory...................... (2,720) (2,705)
(Increase) in prepaid expenses
and other current assets................... (1,553) (2,025)
Decrease in other assets.................... 251 200
Increase in accounts payable................ 2,925 4,017
Increase (decrease) in other accrued
expenses and deferred income.............. 332 (950)
(Decrease) in accrued and currently
deferred income taxes...................... (110) (974)
------- -------
Net cash provided by operating activities.......... 2,164 1,035
------- -------
Cash flows from investing activities:
Capital expenditures............................. (944) (3,627)
------- -------
Net cash (used in) investing activities............ (944) (3,627)
------- -------
Cash flows from financing activities:
Proceeds from unsecured notes payable............ 26,825 21,500
Repayments of unsecured notes payable............ (25,225) (19,500)
Repayments of long term borrowings............... (1,669) --
Issuance of common stock......................... 423 19
------- -------
Net cash provided by financing activities............. 354 2,019
------- -------
Net increase (decrease) in cash and cash equivalents.. 1,574 (573)
Cash and cash equivalents, beginning of period........ 1,710 5,393
------- -------
Cash and cash equivalents, end of period..............$ 3,284 $ 4,820
======= =======
During the nine months ended February 28, 1998 and March 1, 1997, the Company
paid income taxes of $429 and $1,354, respectively, and paid interest of $1,283
and $1,100, respectively.
See accompanying notes to consolidated financial statements
FINANCIAL INFORMATION FORM 10-Q
Item 1. Financial statements Page 6
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
1. CONSOLIDATED FINANCIAL STATEMENTS
The accompanying consolidated financial statements include the
operations of Little Switzerland, Inc. (the "Company") and its wholly owned
subsidiaries, L.S. Holding, Inc. and L.S. Wholesale, Inc. All significant
intercompany balances have been eliminated in consolidation. The interim
financial statements are unaudited and, in the opinion of management, contain
all adjustments necessary to present fairly the Company's financial position as
of February 28, 1998 and March 1, 1997 and the results of its operations and
cash flows for the interim periods presented. It is suggested that these interim
financial statements be read in conjunction with the financial statements and
the notes thereto included in the Company's latest report on Form 10-K/A.
The results of operations for the interim periods presented are not
necessarily indicative of the results to be expected for a full fiscal year, due
to the seasonal nature of the Company's operations.
2. USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
3. TRANSACTIONS WITH AFFILIATES
The Company enters into a number of transactions with Town & Country
Corporation and its affiliates ("Town & Country"), of which one of the Company's
directors is a controlling shareholder. The Company purchases a portion of its
merchandise from Town & Country at prices that management believes approximate
arm's-length transactions.
FORM 10-Q
Page 7
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
4. CREDIT ARRANGEMENTS
The Company has available a total of $23.7 million in unsecured credit
facilities, of which $9.8 million is available for borrowing. Approximately $4.2
million of the credit facilities is utilized to secure customs bonds and other
bank guarantees required in the normal course of business. Any unfunded portion
of the facilities can be withdrawn at the bank's discretion. Outstanding
borrowings against these credit facilities totaled approximately $9.7 million as
of February 28, 1998. Additionally, in February 1996, the Company secured term
debt of approximately $8.9 million from its two lead banks to finance the
acquisition of the fixtures, leasehold rights and inventories of two stores in
Barbados. Interest on this debt accrues at an annual interest rate of
approximately 7.25%, and is payable monthly. The principal is payable in equal
quarterly payments over a four year period, commencing March 1997. As of
February 28, 1998, the Company had $6.7 million of term debt outstanding. The
Company has been notified by one of its primary banks, The Chase Manhattan Bank
("Chase"), that the consummation of the merger with Destination Retail Holdings
Corporation. ("DRHC") may trigger defaults of certain covenants in its $4.4
million term loan agreement with the Company (which had an outstanding balance
of $3.3 million at February 28, 1998). Additionally, the Company's other primary
bank, Bank of Nova Scotia ("Scotia"), has agreed to extend its $4.5 million term
loan agreement (with an outstanding balance of $3.4 million at February 28,
1998) to April 30, 1998. In connection with such extention, the Company was
notified by Scotia that its decision to extend did not constitute acceptance or
waiver of any potential breach of its loan agreement should the merger with DRHC
be consummated as planned. The Company plans to negotiate a further extension of
the Scotia term loan to the date of the merger, but no assurances can be given
as to whether Scotia will grant such an extension. Representatives of the
Company and DRHC have been in contact with Chase and Scotia to discuss these
matters. The Company is in compliance with all other restrictive covenants
related to its unsecured and term debt agreements. Additionally, the Company has
available separate facilities for foreign exchange contracts.
FORM 10-Q
Page 8
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
5. EARNINGS PER SHARE
The Company adopted SFAS No. 128, Earnings per Share, effective
December 15, 1997. In accordance with the requirements of SFAS No. 128, basic
earnings per share is computed by dividing net income by the weighted average
number of shares outstanding and diluted earnings per share reflects the
dilutive effect of stock options (as calculated utilizing the "Treasury
Method"). The weighted average number of shares outstanding, the dilutive
effects of outstanding stock options, and the shares under option plans which
were anti-dilutive for the periods included in this report are as follows (in
thousands):
Three Month Ended Nine Month Ended
2/28/98 3/1/97 2/28/98 3/1/97
------- ------ ------- ------
Weighted average number of
shares used in basic
earnings per share
calculation..........................8,494 8,461 8,473 8,460
Dilutive effects of options............ 229 79 221 38
Weighted average number of
shares used in diluted
earnings per share
calculation..........................8,723 8,540 8,694 8,498
Shares under option plans
excluded in computation
of diluted earnings per
share due to anti-dilutive
effects ..................... 256 550 256 750
6. ACCOUNTING FOR INCOME TAXES
The Company follows the liability method of accounting for
income taxes as set forth in Statement of Financial Accounting
Standards ("SFAS") No. 109, Accounting for Income Taxes. Under
FORM 10-Q
Page 9
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
SFAS No. 109, deferred tax assets and liabilities are recognized for the
expected future tax consequences of events that have been included in the
financial statements or tax returns. The amount of deferred tax asset or
liability is based on the difference between the financial statement and tax
bases of assets and liabilities using enacted tax rates in effect for the year
in which the differences are expected to reverse.
7. OTHER ASSETS
Other assets consist primarily of amounts related to non-competition
agreements, rental deposits and the excess of cost over the fair market value of
the net assets of the business acquired (goodwill). Amounts related to
non-competition agreements are amortized over the lives of the respective
agreements. Amounts related to goodwill are being amortized over periods of up
to ten years. Accumulated amortization totaled approximately $572,000 and
$340,000 at February 28, 1998 and May 31, 1997, respectively.
The Company accounts for long-lived and intangible assets in accordance
with SFAS No. 121, Accounting for the Impairment of Long-lived Assets and for
Long-lived Assets to be Disposed of. The Company continually reviews applicable
assets for events or changes in circumstances which might indicate the carrying
amount of the assets may not be recoverable. The Company assesses the
recoverability of these assets by determining whether the amortization over
their remaining lives can be recovered through projected undiscounted future
results. The amount of impairment, if any, is measured based on projected
discounted future results using a discount rate commensurate with the risks
involved. No such impairment existed as of February 28, 1998.
8. STATEMENT OF FINANCIAL ACCOUNTING STANDARDS NO. 123 -
ACCOUNTING FOR STOCK-BASED COMPENSATION
In December 1995, the Financial Accounting Standards Board
issued SFAS No. 123, Accounting for Stock-Based Compensation, which
became effective for fiscal years beginning after December 15,
1995. SFAS No. 123 requires employee stock-based compensation to
FORM 10-Q
Page 10
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
be either recorded or disclosed at its fair value. Management continues to
account for employee stock-based compensation under Accounting Principles Board
Opinion No. 25 and did not adopt the new accounting provision for employee
stock-based compensation under SFAS No. 123. The additional required disclosures
will be included in the Company's fiscal year end financial statements.
9. ADVERTISING
The Company expenses the costs of advertising as advertisements are
printed and distributed. The Company's advertising expenses consist primarily of
advertisements with local, regional and national travel magazines, which are
produced on a periodic basis and distributed to visiting tourists, and fees paid
for promotional "port lecturer" programs directed primarily at cruise ship
passengers.
10. COMMITMENTS AND CONTINGENCIES
Merger Agreement
On February 4, 1998, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement") with Destination Retail Holdings Corporation
("DRHC"), LSI Acquisition Corp. ("Sub"), Young Caribbean Jewellery Company
Limited, Alliance International Holdings Limited and CEI Distributors, Inc. The
Merger Agreement provides that Sub will be merged with and into the Company (the
"Merger"), pursuant to which the holders of the issued and outstanding shares of
the common stock, par value $.01 per share, of the Company will receive $8.10 in
cash per share. The consummation of the Merger is subject to certain conditions,
including, among others, approval by the Company's stockholders. The Board of
Directors of the Company has unanimously approved the Merger Agreement and has
scheduled a Special Meeting of Stockholders on May 8, 1998 in Boston,
Massachusetts to request stockholder approval of the Merger Agreement. In
connection with the Special Meeting of Stockholders, the Company mailed proxy
materials to the stockholders of the Company on or about April 3, 1998.
FORM 10-Q
Page 11
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
The Company's Relationship with Rolex
The Company typically orders and receives products from Montrex Rolex,
S.A. and its affiliates (collectively, "Rolex") during most months of the year.
Since the last shipment of Rolex products in January, 1998, Rolex has suspended
shipments of its products to the Company and has orally informed the Company
that it will continue to suspend all shipments unless and until the Merger
Agreement with Destination Retail Holdings Corp. ("DRHC") is terminated. In that
regard, the Company has received copies of correspondence from Rolex to DRHC,
which indicate that Rolex does not believe it would be in its best interest to
begin a business relationship with DRHC.
The Company believes that the loss of any major supplier, including
Rolex, could adversely affect the Company's results of operations. Sales of
Rolex watches accounted for 24%, 23% and 25% of the Company's sales in fiscal
1997, fiscal 1996 and fiscal 1995, respectively. In order to mitigate the impact
on sales during fiscal 1998 of the suspension of shipments of Rolex products,
the Company has redistributed Rolex products from lower traffic stores to higher
traffic stores. There can be no assurances that Rolex will resume shipments of
its products in the future or that the effect on the Company's sales will be
mitigated by such redistribution efforts.
EMPLOYEE DEFALCATION
In July 1997, management disclosed to its independent auditors that
certain transactions may have been recorded in error on the books of the Company
for the fiscal year ended May 31, 1997. As a result, the Company engaged Arthur
Andersen LLP to evaluate the matter and determine the impact, if any, on the
Company's previously and currently reported consolidated financial statements.
After extensive review, analysis and evaluation, which focused on unlocated
differences in cash balances, management believes that an employee defalcation
occurred during the 1997 fiscal year. The employee was able to circumvent
existing internal controls largely due to lapses in appropriate segregation of
duties
FORM 10-Q
Page 12
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
regarding cash deposits and disbursements, inter-bank transfers and bank account
reconciliations. These lapses in the segregation of such duties were further
exacerbated by the resignation of the Company's Assistant Treasurer on February
28, 1997, which office was not filled until April 29, 1997. Two individuals, one
of whom was an employee of the Company, were arrested on February 10, 1998 in
connection with this defalcation and charged with embezzlement and
misappropriation of the property of the Company.
The estimated loss of approximately $2.4 million was classified as
Selling, general and administrative expense in the consolidated financial
statements for the fiscal year ended May 31, 1997. SG&A for the three and nine
month periods ended March 1, 1997 include $935,000 and $1.7 million
respectively, of defalcation loss expense.
The Company has insurance coverage with a maximum claim limitation of
$1,000,000 (less a $25,000 deductible). A claim for the full amount of the loss
has been submitted and an interim payment of $305,000 has been received by the
Company. The Company also intends to seek full restitution from the charged
individuals, however, the Company does not know what, if any, of the funds are
still in the possession of such individuals. The Company has, to date, received
$65,000 in restitution from the employee. In addition to pursuing criminal
charges, the Company commenced civil proceedings against the two individuals on
March 12, 1998 in an effort to reclaim any such funds. The Company also has
received $305,000 from its insurance carrier as partial settlement of its claim.
Recoveries relating to these losses are recorded as credits to Selling, general
and administrative expense in the periods received.
HURRICANE DAMAGE
In September 1995, Hurricanes Luis and Marilyn inflicted damage to
several of the Company's stores and caused significant damage to various
islands' infrastructures, including hotels and other tourist facilities. As of
November 20, 1996, all stores had reopened.
FORM 10-Q
Page 13
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(unaudited)
The Company has settled all outstanding claims related to the
hurricanes with its insurance carrier. In connection with this final settlement,
the Company received approximately $13.4 million in property and business
interruption insurance proceeds. The Company recorded a net gain of
approximately $4.7 million in fiscal 1996, after write-offs related to damaged
assets of approximately $8.1 million, including furniture and fixtures,
inventory and other assets related to stores affected by the hurricanes. In
addition, approximately $560,000, representing fiscal 1997 lost profits for a
store in Marigot that was not reopened until November 1996, was recorded as
deferred income on the Company's consolidated balance sheet as of June 1, 1996.
In the nine month period ended March 1, 1997, the Company recorded $560,000 as
business interruption insurance proceeds.
FORM 10-Q
Page 14
PART I. FINANCIAL INFORMATION
ITEM 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
RESULTS OF OPERATIONS
NET SALES
Net sales for the third quarter ended February 28, 1998 were $34.9
million or 7.1% higher than net sales of $32.6 million for the corresponding
period last year. Net sales of $76.3 million for the nine month period ended
February 28, 1998 were 15.7% higher than net sales of $66.0 million for the
corresponding period last year.
Net sales for the stores which were open for the full three month
period this year and last year improved to $33.4 million or 5.6% from $31.6
million last year. Net sales of $72.1 million for stores which were open for the
full nine month period this year and last year increased 11.4% from net sales of
$64.7 million for the corresponding period last year.
Management attributes these improvements to an increase in tourism in
the Caribbean, improved sales in Alaska, concentration on core product lines and
suppliers and the Company's aggressive promotional programs directed toward
Caribbean cruise ships, hotels and resorts.
GROSS PROFIT
Gross profit as a percentage of net sales during the three and nine
month periods ended February 28, 1998 were 43.0% and 42.9%, respectively,
compared to the three and nine month periods ended March 1, 1997 of 44.4% and
44.0%, respectively. Management attributes the decline in gross margin
percentage to clearance markdowns to liquidate discontinued product lines and
the effect of relative changes in the sales mix between the this year and last
year periods.
FORM 10-Q
Page 15
PART I. FINANCIAL INFORMATION
ITEM 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
SG&A increased 9.7% to $12.4 million for the three month period ended
February 28, 1998 from $11.3 million for the same period last year. As a percent
to net sales, SG&A increased to 35.4% for the quarter ended February 28, 1998
from 34.5% for the corresponding quarter last year. SG&A increased 9.0% to $29.7
million for the nine month period ended February 28, 1998 from $27.2 million for
the corresponding period last year. As a percent to net sales, SG&A decreased to
38.9% for the nine month period this year from 41.3% for the corresponding
period last year. The dollar increases for both periods this year are primarily
due to new stores in St. Lucia and in Skagway, Alaska, and non-recurring
professional fees of approximately $1.6 million for the three month period and
$2.2 million for the nine month period ended February 28, 1998, which are
primarily related to the Company's strategic planning efforts. The three and
nine month periods last year include $935,000 and $1.7 million respectively, of
defalcation loss expense. The percent to sales decrease is primarily due to the
effect of the sales increases on fixed expenses.
THE COMPANY'S RELATIONSHIP WITH ROLEX
The Company typically orders and receives products from Montrex Rolex,
S.A. and its affiliates (collectively, "Rolex") during most months of the year.
Since the last shipment of Rolex products in January, 1998, Rolex has suspended
shipments of its products to the Company and has orally informed the Company
that it will continue to suspend all shipments unless and until the Merger
Agreement with Destination Retail Holdings Corp. ("DRHC") is terminated. In that
regard, the Company has received copies of correspondence from Rolex to DRHC,
which indicate that Rolex does not believe it would be in its best interest to
begin a business relationship with DRHC.
The Company believes that the loss of any major supplier, including
Rolex, could adversely affect the Company's results of operations. Sales of
Rolex watches accounted for 24%, 23% and 25%
FORM 10-Q
Page 16
PART I. FINANCIAL INFORMATION
ITEM 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
of the Company's sales in fiscal 1997, fiscal 1996 and fiscal 1995,
respectively. In order to mitigate the impact on sales during fiscal 1998 of the
suspension of shipments of Rolex products, the Company has redistributed Rolex
products from lower traffic stores to higher traffic stores. There can be no
assurances that Rolex will resume shipments of its products in the future or
that the effect on the Company's sales will be mitigated by such redistribution
efforts.
EMPLOYEE DEFALCATION
In July 1997, management disclosed to its independent auditors that
certain transactions may have been recorded in error on the books of the
Company. As a result, the Company engaged Arthur Andersen, LLP to evaluate the
matter and determine the impact, if any, on the Company's previously and
currently reported consolidated financial statements. After extensive review,
analysis and evaluation, which focused on unlocated differences in cash
balances, management believes that an employee defalcation occurred during
fiscal 1997. The employee was able to circumvent existing internal controls
largely due to lapses in appropriate segregation of duties regarding cash
deposits and disbursements, inter-bank transfers and bank account
reconciliations. These lapses in the segregation of such duties were further
exacerbated by the resignation of the Company's Assistant Treasurer on February
28, 1997, which office was not filled until April 29, 1997.
Two individuals, one of whom was an employee of the Company, were
arrested on February 10, 1998 in connection with this defalcation and charged
with embezzlement and misappropriation of the property of the Company. The
Company will continue to pursue all possible remedies to the fullest extent of
the law in the prosecution of these two individuals and any other persons
determined to be involved in the theft. The estimated loss of approximately $2.4
million has been classified as SG&A in the consolidated financial statements for
the fiscal year ended May 31, 1997. For the three and nine month periods ended
March 1, 1997, the estimated defalcation losses of $935,000 and $1.7 million,
respectively, have been included in general and administrative expense in the
accompanying consolidated statements of income.
FORM 10-Q
Page 17
PART I. FINANCIAL INFORMATION
ITEM 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
The Company has insurance coverage which calls for a maximum claim
limitation of $1,000,000 (with a $25,000 deductible). A claim for the full
amount of the loss has been submitted and an interim payment of $305,000 has
been received by the Company. The Company also intends to seek full restitution
from the charged individuals, however, the Company does not know what, if any,
of the funds are still in the possession of such individuals. To date, the
Company has received $65,000 in restitution from the employee. In addition to
pursuing criminal charges, the Company commenced civil proceedings against the
two individuals on March 12, 1998 in an effort to reclaim any such funds.
Recoveries relating to these losses are recorded as credits to Selling, general
and administrative expenses in the periods received.
OTHER
Net interest expense for the three month period ended February 28, 1998
was $481,000 compared to $398,000 in the corresponding period last year. For the
nine month period, net interest expense was $1.3 million compared to $1.2
million in the corresponding period last year. These increases reflect higher
average borrowings this year due to higher average inventories required to
support increased sales.
The Company's effective tax rates for the three and nine month periods
ended February 28, 1998 were approximately 18%. For the three and nine month
periods ended March 1, 1997, the effective tax rates were approximately 15% and
11%, respectively.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operations during the nine month period ended
February 28, 1998 was $2.2 million, compared to $1.0 million for the
corresponding nine month period last year. The increase in net cash provided by
operations primarily reflects a smaller increase in Prepaid expenses and an
increase in Other accrued income expenses and deferred income, compared to a
decrease last year.
FORM 10-Q
Page 18
PART I. FINANCIAL INFORMATION
ITEM 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
The Company's working capital position as of February 28, 1998
increased to $32.0 million from $30.5 million at May 31, 1997. Current ratios
were 2.3 and 2.5 as of the corresponding periods, respectively. Capital
expenditures were approximately $944 thousand during the nine month period ended
February 28, 1998, compared to $3.6 million during the corresponding period last
year.
The Company has available a total of $23.7 million in unsecured credit
facilities, of which $9.8 million is available for borrowing. Approximately $4.2
million of the credit facilities is utilized to secure customs bonds and other
bank guarantees required in the normal course of business. Any unfunded portion
of the facilities can be withdrawn at the bank's discretion. Outstanding
borrowings against these credit facilities totaled approximately $9.7 million as
of February 28, 1998. Additionally, in February 1996, the Company secured term
debt of approximately $8.9 million from its two lead banks to finance the
acquisition of the fixtures, leasehold rights and inventories of two stores in
Barbados. Interest on this debt accrues at an annual interest rate of
approximately 7.25%, and is payable monthly. The principal is payable in equal
quarterly payments over a four year period, commencing March 1997. As of
February 28, 1998, the Company had $6.7 million of term debt outstanding. The
Company has been notified by one of its primary banks, The Chase Manhattan Bank
("Chase"), that the consummation of the merger with Destination Retail Holdings
Corporation ("DRHC") may trigger defaults of certain covenants in its $4.4
million term loan agreement with the Company (which had an outstanding balance
of $3.3 million at February 28, 1998). Additionally, the Company's other primary
bank, Bank of Nova Scotia ("Scotia"), has agreed to extend its $4.5 million term
loan agreement (with an outstanding balance of $3.4 million at February 28,
1998) to April 30, 1998. In connection with such extension, the Company was
notified by Scotia that its decision to extend did not constitute acceptance or
waiver of any potential breach of its loan agreement should the merger with DRHC
be consummated as planned. The Company plans to negotiate a further extension of
the Scotia term loan to the date of the merger but no assurances can be given as
to whether Scotia will grant such an extension. Representatives of the Company
and DRHC have been in contact with Chase and Scotia to discuss these matters.
The Company is in compliance with all other restrictive covenants related to its
unsecured and term debt agreements. Additionally, the Company
FORM 10-Q
Page 19
PART I. FINANCIAL INFORMATION
ITEM 2. Management's Discussion and Analysis
of Financial Condition and Results of Operations
has available separate facilities for foreign exchange contracts. It remains
management's expectation that funds available from operations and bank financing
will be sufficient to fund operations and expansion for at least the next three
years.
FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q contains certain statements that are
"forward-looking statements" as that term is defined under the Private
Securities Litigation Reform Act of 1995 and releases issued by the Securities
and Exchange Commission. The words "believe," "expect," "anticipate," "intend,"
"estimate" and other expressions which are predictions of or indicate future
events and trends and which do not relate to historical matters identify
forward-looking statements. Forward-looking statements involve known and unknown
risks, uncertainties and other factors, which may cause the actual results,
performance or achievements of the Company to differ materially from anticipated
future results, performance or achievements expressed or implied by such
forward- looking statements. The Company undertakes no obligation to publicly
update or revise any forward-looking statement, whether as a result of new
information, future events or otherwise.
The future operating results and performance trends of the Company may
be affected by a number of factors, including, without limitation, the
following: (I) the frequency of tourist visits to the locations where the
Company maintains retail stores, (ii) the Company's ability to retain
relationships with its major suppliers of product for resale, (iii) weather in
the Company's markets, (iv) actions of the Company's competitors and the
Company's ability to respond to such actions, (v) economic conditions that
affect the buying patterns of the Company's customers, (vi) availability of new
tourist markets for expansion and (vii) the continued success of the Company's
efforts to implement its planned strategic initiatives. In addition to the
foregoing, the Company's actual future results could differ materially from
those projected in the forward-looking statements as a result of the risk
factors set forth in the Company's various filings with the Securities and
Exchange Commission and of changes in general economic conditions, changes in
interest rates and/or exchange rates and changes in the assumptions used in
making such forward-looking statements.
FORM 10-Q
Page 20
ITEM 3. Quantitative and Qualitative Disclosures about Market
Risk
None.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
The Company is involved in various legal proceedings which, in the
opinion of management, will not result in a material adverse effect on the
financial condition or results of operations of the Company.
ITEM 5. Other Information
On February 4, 1998, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement") with Destination Retail Holdings Corporation
("DRHC"), LSI Acquisition Corp. ("Sub"), Young Caribbean Jewellery Company
Limited, Alliance International Holdings Limited and CEI Distributors, Inc. The
Merger Agreement provides that Sub will be merged with and into the Company (the
"Merger"), pursuant to which the holders of the issued and outstanding shares of
the common stock, par value $.01 per share, of the Company will receive $8.10 in
cash per share. The consummation of the Merger is subject to certain conditions,
including, among others, approval by the Company's stockholders. The Board of
Directors of the Company has unanimously approved the Merger Agreement and has
scheduled a Special Meeting of Stockholders on May 8, 1998 in Boston,
Massachusetts to request stockholder approval of the Merger Agreement. In
connection with the Special Meeting of Stockholders, the Company mailed proxy
materials to the stockholders of the Company on about April 3, 1998.
FORM 10-Q
Page 21
PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports of Form 8-K
(a) Exhibits
2.1 The Merger Agreement between the Company, Destination
Retail Holdings Corporation, LSI Acquisition Corp.,
Young Caribbean Jewellery Company Limited, Alliance
International Holdings Limited and CEI Distributors,
Inc. is incorporated herein by reference to Exhibit
2.1 to the Current Report on Form 8-K filed with the
Securities and Exchange Commission on February 6,
1998.
3.1 The Amended and Restated Certificate of Incorporation
of the Company is incorporated herein by reference to
Exhibit 3.3 to Amendment No. 1 to the Company's
Registration Statement on Form S-1, Registration No.
33-40907, filed with the Securities and Exchange
Commission on July 10, 1992 ("Amendment No. 1 to the
Form S-1").
3.2 The Amended and Restated By-Laws of the Company are
incorporated herein by reference to Exhibit 3.4 to
Amendment No. 1 to the Form S-1 and the First
Amendment to the Amended and Restated Bylaws of the
Company is incorporated herein by reference to the
Current Report on Form 8-K filed with the Securities
and Exchange Commission on November 12, 1997.
(b) Reports on Form 8-K during the quarter ended February 28, 1998
1. On February 6, 1998, the Company filed a Current
Report on Form 8-K announcing that it had entered
into a Merger Agreement with DRHC and certain of its
affiliates, and that the annual meeting of
stockholders, previously scheduled for February 5,
1998, had been postponed pending stockholder approval
of the Merger Agreement.
FORM 10-Q
Page 22
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LITTLE SWITZERLAND, INC.
Date: April 14,1998 /s/ Thomas S. Liston
Thomas S. Liston
Chief Financial Officer,
Vice President and
Treasurer