SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
-----------------------
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the quarterly period ended February 27, 1999
or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from ___________ to ____________
Commission File No. 0-19369
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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 April 8, 1999, 8,624,516 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 27, 1999
PAGE
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
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Consolidated Balance Sheets as of February 27, 1999 (unaudited) and May 30, 1998 3
Consolidated Statements of Income (unaudited) for the three and nine months ended
February 27, 1999 and February 28, 1998 4
Consolidated Statements of Cash Flows (unaudited) for the nine months ended
February 27, 1999 and February 28, 1998 5
Notes to Consolidated Financial Statements (unaudited) 6-11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations 12-16
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Item 3. Quantitative and Qualitative Disclosures about Market Risk 16
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings 17
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Item 5. Other Information 18
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Item 6. Exhibits and Reports on Form 8-K 18
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Signature Page 19
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands except per share data)
(unaudited)
February 27, May 30,
1999 1998
----------- ---------
(unaudited)
ASSETS
Current assets:
Cash and cash equivalents........................ $ 2,781 $ 2,278
Accounts receivable.............................. 2,458 1,999
Inventory........................................ 42,991 49,178
Prepaid expenses and other current assets........ 2,163 1,944
--------
Total current assets....................... 50,393 55,399
-------- --------
Property, plant and equipment, at cost.............. 37,872 39,688
Less -- Accumulated depreciation................. (19,316) (18,230)
-------- --------
18,556 21,458
-------- --------
Other assets........................................ 292 294
-------- --------
Total assets............................... $ 69,241 $ 77,151
======== ========
LIABILITIES AND STOCKHOLDERS EQUITY
Current liabilities:
Current portion of long term debt................ $ 2,225 $ 2,225
Unsecured notes payable.......................... 10,200 7,825
Accounts payable................................. 8,373 10,840
Accrued and currently deferred income taxes...... 1,620 777
Other accrued expenses and deferred income....... 4,047 3,500
-------- --------
Total current liabilities.................. 26,465 25,167
Long term debt...................................... 2,225 3,894
Deferred income taxes............................... 202 202
-------- --------
Total liabilities.......................... 28,892 29,263
-------- --------
Commitments and contingencies....................... --- ---
Minority interest................................... 1,619 1,619
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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--8,624 shares
at February 27, 1999 and at May 30, 1998...... 87 87
Capital in excess of par............................ 15,601 15,601
Retained earnings................................... 23,042 30,581
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Total stockholders' equity.................... 38,730 46,269
-------- --------
Total liabilities, minority interest
and stockholders' equity................... $ 69,241 $ 77,151
======== ========
See accompanying notes to consolidated financial statements
3
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 27, February 28, February 27, February 28,
1999 1998 1999 1998
------------- ------------ ------------- ------------
Net sales.............................. $25,787 $34,925 $57,574 $76,329
Cost of sales.......................... 15,253 19,901 33,444 43,612
------- ------- ------- -------
Gross profit........................... 10,534 15,024 24,130 32,717
Selling, general and
administrative expenses................ 11,265 12,352 29,751 29,657
------- ------- ------- -------
Operating (loss) income.............. (731) 2,672 (5,621) 3,060
Interest expense, net.................. 307 481 1,018 1,278
------- ------- ------- -------
(Loss) income before
income taxes..................... (1,038) 2,191 (6,639) 1,782
Provision for
income taxes........................... 300 402 900 320
------- ------- ------- -------
Net (loss) income...................... $(1,338) $ 1,789 $(7,539) $ 1,462
======= ======= ======= =======
Basic and diluted net (loss) earnings
per share........................... $(0.16) $0.21 $(0.87) $0.17
======= ======= ======= =======
See accompany notes to consolidated financial statements
4
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
For the nine months ended
February 27, February 28,
Cash flows from operating activities: 1999 1998
------------- -----------
Net (loss) income........................................ $ (7,539) $ 1,462
Adjustments to reconcile net (loss) income to net cash
provided by operating activities--
Depreciation............................................ 1,848 1,977
Store closing expense................................... 1,668 --
Changes in assets and liabilities:
(Increase) in accounts receivable....................... (459) (400)
Decrease (increase) in inventory 6,187 (2,720)
(Increase) in prepaid expenses
and other current assets.............................. (219) (1,553)
Decrease in other assets................................ 2 251
(Decrease) increase in accounts payable (2,467) 2,925
Increase in other accrued expenses
and deferred income................................... 547 332
Increase (decrease) in accrued and currently
deferred income taxes 843 (110)
-------- --------
Net cash provided by operating activities 411 2,164
-------- --------
Cash flows from investing activities:
Capital expenditures................................... (614) (944)
-------- --------
Net cash (used in) investing activities................... (614) (944)
-------- --------
Cash flows from financing activities:
Proceeds from unsecured notes payable.................. 24,998 26,825
Repayments of unsecured notes payable.................. (22,623) (25,225)
Repayments of long term borrowings..................... (1,669) (1,669)
Issuance of common stock............................... -- 423
-------- --------
Net cash provided by financing activities................. 706 354
-------- --------
Net increase (decrease) in cash and cash equivalents...... 503 1,574
Cash and cash equivalents, beginning of period............ 2,278 1,710
-------- --------
Cash and cash equivalents, end of period.................. $ 2,781 $ 3,284
======== ========
During the nine months ended February 27, 1999 and February 28, 1998, the
Company paid income taxes of $56 and $429, respectively, and paid interest of
$1,114 and $1,283, respectively.
See accompanying notes to consolidated financial statements
5
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 27, 1999 and
February 28, 1998 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 annual report on Form 10-K/A for the
fiscal year ended May 30, 1998.
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. Store Closing Expense
---------------------
During the quarter ended November 28, 1998, the Company recorded a charge
associated with the closure of its store in Ketchikan, Alaska, as well as one
store in each of Antigua and St. Kitts. The store in St. Kitts was closed due
to damage inflicted by Hurricane Georges. The charge amounted to approximately
$1.7 million and has been included in selling, general and administrative
expenses in the accompanying consolidated statements of income. Approximately
$1.5 million of the charge relates to the impairment of fixed assets and
leasehold improvements at the closed stores.
4. Credit Arrangements
-------------------
The Company has unsecured credit facilities of $15.7 million, of which
approximately $14.4 million in borrowings were outstanding as of February 27,
1999. Approximately $4.2 million of these outstanding borrowings is utilized to
secure customs bonds and other bank guarantees required in the normal course of
business. Additionally, the Company has a term loan of approximately $8.9
million which it obtained in February 1996 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 currently accrues at an annual rate of 7.02%,
and is payable monthly. The principal under the term loan is payable in equal
quarterly payments over a four year period, which commenced in March 1997. As of
February 27, 1999, the Company had $4.5 million of term debt outstanding against
this term loan.
As a result of a notification of a renewal proposal received from one of the
Company's lead banks reducing its commitment from a $7.0 million facility to a
$3.0 million facility, the Company's unsecured credit facilities decreased from
$19.7 million as of November 28, 1998 to $15.7 million as of February 27, 1999.
This credit facility with one of the Company's lead banks expired in March 1999
and has not been renewed by the bank. The Company currently is not in compliance
with certain financial covenants contained in the original loan agreement with
one of its banks and was unable to make payments totaling approximately $1.5
million under the revolving term loans with one of its banks upon the maturity
dates of such loans. As a result of these events, (i) the banks may demand
immediate repayment of all amounts outstanding under its credit facilities and
(ii) the Company is unable to borrow any additional funds under its credit
facilities.
6
The Company is in active negotiations with both of its banks concerning a
potential standstill agreement pursuant to which the banks would agree not to
exercise their rights and remedies under the loan documents, including declaring
all amounts outstanding under the loans immediately due and offsetting any
balances in the Company's accounts in the banks as permitted under the loan
agreements. The banks have indicated their willingness to enter into a
standstill agreement for a period of 120 days in exchange for, among other
things, the Company granting a security interest to the banks in certain of its
personal property and, with certain exceptions, the Company complying with the
existing loan agreements. In connection with the standstill agreement, it is
anticipated the banks will consent to the Company, to allow the Company to
generate funds for working capital, seeking a mortgage financing on its real
property. There can be no assurance, however, that the Company will be
successful in obtaining a standstill agreement with its banks or that such
agreement will be on terms favorable to the Company. If the Company is not
successful in obtaining such agreement, the banks may declare amounts
outstanding under these loans immediately due. If either of the banks declares
amounts outstanding under such loan agreements immediately due and offset any
balances in the Company's accounts in the banks, the Company does not believe
that it will have sufficient funds available to make such payments and such
action by the banks will have a material adverse effect on the Company.
5. Earnings Per Share
------------------
The Company adopted Statement of Financial Accounting Standards ("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 Months Ended Nine Months Ended
------------------ -----------------
2/27/99 2/28/98 2/27/99 2/28/98
------- ------- ------- -------
Weighted average number of shares
used in basic earnings per share
calculation................................ 8,624 8,494 8,624 8,473
Dilutive effects of options................. --- 229 --- 221
Weighted average number of shares
used in diluted earnings per share
calculation................................ 8,624 8,723 8,624 8,694
Shares under option plans or outside
such option plans excluded in computation
of diluted earnings per share due to
anti-dilutive effects...................... 904 256 904 256
7
6. Accounting for Income Taxes
---------------------------
The Company follows the liability method of accounting for income taxes as
set forth in SFAS No. 109, Accounting for Income Taxes. Under 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. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount that is realizable, based
upon the realization criteria defined in SFAS No. 109.
7. Other Assets
------------
Other assets consist primarily of amounts related to rental deposits.
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 27, 1999.
In April 1998, the AICPA issued Statement of Position (SOP) 98-5, Reporting
on the Costs of Start-up Activities. SOP 98-5 requires all costs associated
with preopening, preoperating and organization activities to be expensed as
incurred. The Company elected to adopt SOP 98-5 as of June 1, 1997.
8. Statement of Financial Accounting Standards No. 123 - Accounting for Stock-
---------------------------------------------------------------------------
Based Compensation
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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 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. Accounting for Derivative Instruments and Hedging Activities
------------------------------------------------------------
In June 1998, the Financial Account Standards Board issued SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities. The SFAS No. 133
establishes accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or liability
measured at its fair value. SFAS No. 133 requires that changes in the
derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the income statement, and requires that a company must formally
document, designate, and assess the effectiveness of transactions that receive
hedge accounting.
8
SFAS No. 133 is effective for fiscal years beginning after June 15, 1999. A
company may also implement SFAS No. 133 as of the beginning of any fiscal
quarter after issuance (that is, fiscal quarters beginning June 16, 1998 and
thereafter). SFAS No. 133 cannot be applied retroactively. SFAS No. 133 must
be applied to (a) derivative instruments and (b) certain derivative instruments
embedded in hybrid contracts that were issued, acquired, or substantively
modified after December 31, 1997 (and, at the company's election, before January
1, 1998).
The Company has not yet quantified the impact of adopting SFAS No. 133 on
its financial statements and has not determined the timing of or method of its
adoption of SFAS No. 133. However, SFAS No. 133 could increase volatility in
earnings and other comprehensive income.
10. 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.
11. Commitments and Contingencies
-----------------------------
The Company's Relationship with Rolex
- -------------------------------------
Historically, the Company was the exclusive authorized retailer for Rolex
watches on the islands on which the Company operates. Following the execution
of the Agreement and Plan of Merger, dated as of February 4, 1998 (the "Merger
Agreement"), with Destination Retail Holdings Corporation ("DRHC") and certain
of its affiliates, Rolex suspended shipments of its products to the Company
because Rolex indicated that it did not believe it would be in its best interest
to begin a business relationship with DRHC. Following termination of the Merger
Agreement, on June 9, 1998, the Company made numerous attempts to rebuild its
business relationship with Rolex. However, on July 15, 1998, the Company
announced that it had learned that Rolex had decided not to resume shipments of
its watches to the Company for retail sale through Little Switzerland's stores.
Sales of Rolex watches accounted for 26%, 24% and 23% of the Company's sales in
fiscal 1998, 1997 and 1996, respectively. In order to mitigate the impact on
sales of the loss of Rolex products, the Company is actively exploring
opportunities for expanding existing, and adding new, world class product lines
in both watches and jewelry. In connection with these efforts, the Company has
added Movado, Baume & Mercier and Mont Blanc time pieces to its watch lines and
has added Breitling products to its flagship store in Aruba. At this time, the
Company does not anticipate adding Breitling products to its other stores. In
addition, the Company has increased the showcase space allocated to jewelry in
certain of its larger stores to accommodate a greater variety of moderate to
higher priced fashion merchandise, including diamond, tanzanite, pearl and
certain designer name classifications. There can be no assurance that the
Company's actions in replacing Rolex products with new or expanded watch and
jewelry products will be successful or that the sales of these new or expanded
products will reduce the effect of the loss of Rolex as a supplier on the
Company's sales.
On September 25, 1998, at Rolex's request, the Company returned its
remaining Rolex inventory valued at $1.4 million to Rolex for credit. On March
30, 1999, the Company received a payment of approximately $1.0 million from
Rolex in full settlement of the outstanding credit. The Company recorded a loss
of $.4 million in the three months and nine months ended February 27, 1999
attributable to this settlement.
9
Aruba Audit
- -----------
During 1997, the Company received an assessment from the local government in
Aruba that relates to the Company's local income tax returns regarding certain
consulting fees paid and service fees assessed by L.S. Wholesale, Inc., a
wholly-owned subsidiary of the Company, to Aruba. During 1998, the Company met
with the tax authorities in Aruba. The Company has entered into a final
settlement with the tax authorities regarding its 1988-1996 local tax returns
and recorded a tax expense of $0.6 million in the three-month and six-month
periods ended November 28, 1998 for the incremental cost of this settlement.
Pursuant to this settlement, the Company has been assessed a profit tax in the
amount of $650,000, which is payable in ten equal installments of $65,000 per
month commencing on March 1, 1999. Interest of 6% per annum is being charged on
the outstanding amount as of March 1, 1999. The Company also has been assessed
a wage tax in the amount of $550,000, which is payable in six installments
commencing in June 1999. Interest of 6% per annum will be charged on the
outstanding amount starting on June 1, 1999. The Company may be subject to an
additional assessment for the Company's fiscal years 1997 and 1998 local income
tax returns. At this time the Company is unable to quantify the related
financial exposure, if any. In the opinion of management of the Company, this
assessment may have a material adverse effect on the Company's financial
condition or results of operations.
IDC Benefit
- ------------
Under an agreement which expired at the end of August, 1998, the Company's
wholly-owned subsidiary, L.S. Wholesale, Inc., which acts as a purchasing agent
for items sold by the Company's stores and charges fees for acting as such an
agent, benefited from a lower tax rate on its income earned outside the U.S.
Virgin Islands. Under this agreement such income was taxed at a rate of 3.74%.
The Company has submitted its application for renewal of benefits and has been
verbally notified that the IDC Commission has recommended to the Governor of the
U.S.V.I. that the Company be awarded up to 75% of the IDC benefits which it has
enjoyed in the past. The Company anticipates that it will be notified with
respect to such renewal within the 60 day period in which the Governor is
permitted under applicable law to determine the extent of the benefits the
Company will receive. Until it receives notification with respect to this
renewal, the Company must pay taxes on all of the Company's U.S.V.I. based
income at the statutory rate of 37.4%. However, if the renewal is granted, then
management believes that the lower tax rate will be applied retroactively to the
end of August, 1998 and the Company will be reimbursed for any excess tax
payments; however, there is no assurance that this will occur. If the renewal
is not granted, then all of the Company's U.S.V.I. based income will be taxed at
the statutory rate of 37.4% and the Company will be subject to a gross receipts
tax. Such non-renewal may have a material adverse effect on the Company's
results of operations. The Company's effective tax rate was 31.9% and 0.0% in
the fiscal years ended May 30, 1998 and May 31, 1997, respectively.
Hurricane Damage
- ----------------
In September 1998, Hurricane Georges inflicted minor damage to several of
the Company's stores and caused significant damage to its St. Kitts store and to
various islands' infrastructures, including hotels and other tourist facilities.
As of October 16, 1998, all of the Company's stores have reopened with the
exception of the St. Kitts store, which sustained major damage and has been
permanently closed. At this time, the financial impact of Hurricane Georges on
the Company's Caribbean operations is difficult to quantify. The Company is
currently in the process of completing and filing insurance claims with its
insurance carrier in connection with the hurricane damage to certain of the
Company's properties. As of April 12, 1999, the Company has received
approximately $960,000 in payments on its claims from its insurance carrier
relative to its claim for the St. Kitts store.
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
10
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. This lapse in the segregation of such duties was 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 appropriation
of the property of the Company. Lorraine Quetel, the former employee, has pled
guilty to the embezzlement of $1.85 million. The criminal action against Lydia
Magras is still pending.
The estimated loss of approximately $2.4 million has been classified as a
general and administrative expense in the consolidated financial statements for
the fiscal year ended May 31, 1997. As a result of the charge, the Company
filed amended financial statements on Form 10-Q for each of the quarters within
fiscal 1997.
The Company has insurance coverage which calls for a maximum claim
limitation of $1,000,000. A claim for the full amount of the loss has been
submitted and payment of the $1,000,000 has been received. The amount of
insurance recovery from its insurance carrier relating to these losses has been
reflected in the selling, general and administrative expenses in the
consolidated financial statements for the year ended May 30, 1998. To date, the
Company has received $65,000 in restitution from the employee. On March 11,
1998, the Company filed a civil action against Lorraine Quetel, the former
employee of the Company, Lydia Magras and Bon Voyage Travel, Inc. seeking full
restitution from such parties, however, the Company does not know what, if any,
of the funds are still in the possession of the former employee and such other
parties. See Part II - Other Information, Item 1 "Legal Proceedings."
DRHC Litigation
- ---------------
On June 10, 1998, the Company filed a civil action in the United States
District Court for the District of Delaware against DRHC, Stephen Crane, DRHC's
controlling shareholder, Young Caribbean Jewelry Company Limited, a Cayman
Islands corporation, Alliance International Holdings Limited, a Bahamian
corporation, and CEI Distributors Inc., a British Virgin Islands corporation,
each an affiliate of DRHC. The Company alleges breach of the Merger Agreement
among the Company, DRHC and certain affiliates of DRHC and also alleges claims
of misrepresentation and civil conspiracy, among other causes of action. The
Company is seeking monetary damages, including, without limitation,
consequential damages relating to harm to its business. On July 15, 1998, the
defendants moved to dismiss the complaint on jurisdictional grounds. On March
31, 1999, the court issued an order denying the defendants' motions to dismiss.
The Company will continue to pursue its claims against the defendants in this
matter.
Class Action Lawsuit
- --------------------
On March 22, 1999, a class action complaint was filed in the United States
District Court for the District of Delaware against the Company, certain of its
existing and former officers and directors, DRHC and Stephen G.E. Crane. The
complaint alleges that the defendants violated federal securities laws by
failing to disclose that DRHC's financing commitment to purchase the Company's
shares expired on April 30, 1998, before the Company's stockholders were
scheduled to vote to approve the merger between the Company and DRHC at the May
8, 1998 special meeting of stockholders. The Company currently is in the
process of reviewing this complaint and intends to defend these claims
vigorously. The outcome of this matter is uncertain and as a result at this
time management is not able to quantify the related financial exposure, if any.
11
PART I. FINANCIAL INFORMATION
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
-----------------------------------------------------------------------
of Operations
-------------
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 Company's ability to design and implement a strategic restructuring
plan, (ii) the Company's ability to negotiate with its lenders with respect to a
standstill agreement under which the lenders would agree not to exercise their
rights and remedies under the existing loan documents, including declaring all
amounts outstanding under the loans immediately due, and with respect to
amendments to its credit facilities, (iii) the frequency of tourist visits to
the locations where the Company maintains retail stores, (iv) the Company's
ability to retain relationships with its major suppliers of product for resale,
(v) the Company's ability to mitigate the impact on sales of the loss of Rolex
products by expanding existing, and adding new, world class product lines in
both watches and jewelry, (vi) weather in the Company's markets, (vii) actions
of the Company's competitors and the Company's ability to respond to such
actions, (viii) economic conditions that affect the buying patterns of the
Company's customers and (ix) availability of new tourist markets for expansion.
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.
YEAR 2000 READINESS DISCLOSURE
The statements in the following section include "Year 2000 readiness
disclosure" within the meaning of the Year 2000 Information and Readiness
Disclosure Act.
Many existing computer programs and databases use two digits to identify a
year in the date field (i.e., 98 would represent 1998). These programs and
databases were designed and developed without considering the impact of the
upcoming millennium. If not corrected, many computer systems could fail or
create erroneous results relating to the year 2000. If the Company or its
significant suppliers fail to make necessary modifications and conversions on a
timely basis, the year 2000 issue could have a material adverse effect on
Company operations. However, the impact cannot be quantified at this time. The
Company believes that its competitors face a similar risk.
The Company has developed plans to address the possible exposures related to
the impact on its computer systems of the year 2000 issue. Key financial,
information and operational systems, including equipment with embedded
microprocessors, have been or are currently being inventoried and assessed, and
detailed plans have been or are currently being developed for the required
systems modifications or replacements. Progress against these plans is
monitored and reported to management on a regular basis. Implementation of
required changes to critical systems is expected to be completed during fiscal
1999. The Company is also focusing on major suppliers to assess their
compliance. The Company has received assurances from certain suppliers that such
suppliers expect to be year 2000 compliant and is seeking such assurances from
its other material suppliers. Nevertheless, there can be no assurance that
there will not be a material adverse effect on the Company if third party
governmental or business entities do not convert or replace their systems in a
timely manner and in a way that is compatible with the Company's systems. In
the event a material supplier is not year 2000 compliant, the Company's
business, financial condition and results of operations could be materially and
adversely affected.
12
The costs incurred to date related to these programs have not been material
and the Company does not expect its future costs related to these programs to be
material. Such costs have been and will continue to be funded through operating
cash flows. The Company presently believes that the total cost of achieving year
2000 compliant systems is not expected to be material to its financial
condition, liquidity, or results of operations.
Time and cost estimates are based on currently available information.
Developments that could affect estimates include, but are not limited to, the
availability and cost of trained personnel; the ability to locate and correct
all relevant computer code and systems; and remediation success of the Company's
customers and suppliers.
The preceding "Year 2000 Readiness Disclosure" contains various forward-
looking statements within the meaning of Section 21E of the Securities Exchange
Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as
amended. These forward-looking statements represent the Company's beliefs or
expectations regarding future events. When used in the "Year 2000 Readiness
Disclosure", the words "believes," "expects," "estimates" and similar
expressions are intended to identify forward-looking statements. Forward-looking
statements include, without limitation, the Company's expectations as to when it
will complete the modification and testing phases of its year 2000 project plan
as well as its year 2000 contingency plans; its estimated cost of achieving Year
2000 readiness; and the Company's belief that its internal systems will be year
2000 compliant in a timely manner. All forward-looking statements involve a
number of risks and uncertainties that could cause the actual results to differ
materially from the projected results. Factors that may cause these differences
include, but are not limited to, the availability of qualified personnel and
other information technology resources; the ability to identify and remediate
all date sensitive lines of computer code or to replace embedded computer chips
in affected systems or equipment; and the actions of governmental agencies or
other third parties with respect to year 2000 problems.
RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTH PERIOD ENDED FEBRUARY 27,
1999
GENERAL
The Company currently operates 23 luxury gift and jewelry stores. Last year
at this time, the Company operated 27 stores. The Company closed one store in
Ketchikan, Alaska, and one store each in Antigua and St. Kitts during the nine-
month period ended February 27, 1999. The store in St. Kitts was closed due to
damage inflicted by Hurricane Georges. In addition, the Company closed one
store in Aruba in its fourth quarter ended May 30, 1998.
NET SALES
Net sales for the three-month period ended February 27, 1999 were $25.8
million, a 26.2% reduction from net sales of $34.9 million for the corresponding
three-month period last year. Net sales for the nine-month period ended
February 27, 1999 were $57.6 million, a 24.6% reduction from net sales of $76.3
million for the corresponding nine-month period last year. Net sales in
comparable stores fell 23.7% in the three-month period ended February 27, 1999
and 23.3% in the nine-month period ended February 27, 1999.
Management attributes the reduction in sales for both the three-month and
nine-month periods ended February 27, 1998 primarily to the absence of Rolex
products in the Company's stores. The Company has not received any shipments of
Rolex products since January 1998. Historically, the Company was the exclusive
authorized retailer for Rolex watches on the islands on which the Company
operates. On July 15, 1998, the Company announced that it had learned that
Rolex had decided not to resume shipments of its watches to the Company for
retail sale through the Company's stores. See Part I, Item I "Footnote 11 to
Consolidated Financial Statements (unaudited)." The overall impact of operating
without Rolex was similar throughout most of the Company's market areas.
Excluding the impact of Rolex sales, sales in comparable stores increased 6.1%
in the three-month period ended February 27, 1999 and 2.3% in the nine-month
period ended February 27, 1999.
In addition, the Company closed three stores in the quarter ended November
28, 1998. These store closings and the resulting lost revenue contributed to
the sales reduction by approximately $1.0 million in the three-month period
ended February 27, 1999 and by approximately $1.2 million in the nine-month
period ended February 27, 1999.
13
GROSS PROFIT
Gross profit, as a percentage of net sales, was 40.9% for the three-month
period ended February 27, 1999 and 41.9% for the nine-month period ended
February 27, 1999 as compared to 43.0% and 42.9%, respectively, for the
corresponding periods last year. Management attributes the decrease in gross
profit as a percentage of net sales for both the three-month and the nine-month
periods ended February 27, 1999 to the impact of markdowns taken for competitive
reasons and to stimulate sales of slow-moving inventory.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses ("SG&A") for the three-month
period ended February 27, 1999 were $11.3 million, or 43.7% of net sales, and
for the nine-month period ended February 27, 1999 were $29.8 million, or 51.7%
of net sales. For the corresponding periods last year, SG&A was $12.4 million,
or 35.4% of net sales, and $29.7 million, or 38.9% of net sales, respectively.
Included in SG&A for the three-month and nine-month periods ended February 27,
1999 were one-time charges relating to expenses to settle a shareholder
litigation and a potential proxy contest, create a valuation reserve for a
receivable due from Rolex and to recognize certain severance and tax (non-
income) expenses. Included in SG&A for the nine-month period ended February 27,
1999 was $1.7 million representing a charge recorded by the Company for the
closing of three stores. The charge was for impairment of fixed assets and
leasehold improvements at the closed stores of approximately $1.5 million, and
the remaining portion related to a rental obligation at an abandoned location.
The increase in SG&A as a percentage to net sales, exclusive of store closing
costs, is primarily attributable to the reduction in net sales for the three-
month and the nine-month period ended February 27, 1999 and due to certain
expenses as explained above.
OTHER
Net interest expense was $307,000 for the three-month period ended February
27, 1999 and $1,018,000 for the nine-month period ended February 27, 1999
compared to $481,000 and $1,278,000, respectively, for the corresponding periods
last year. The decrease in net interest expense reflects lower average
borrowings as compared to the corresponding periods last year.
The Company's effective tax rate was essentially 0.0% for the three-month
and nine-month periods ended February 27, 1999 compared to 18.3% and 18.0%,
respectively, for the corresponding periods last year. However, a tax expense of
$300,000 and $ 900,000 was recorded in the three-month and nine-month periods
ended February 27, 1999, respectively, representing expected current liability
of certain unaudited and unfiled tax returns and the incremental cost of the tax
settlement with the government of Aruba.
LIQUIDITY AND CAPITAL RESOURCES
Net cash provided by operations during the nine-month period ended February
27, 1999 was $.4 million, compared to $2.2 million for the corresponding period
last year. The change in net cash provided by operations reflects a net
operating loss for the nine-month period ended February 27, 1999 compared to a
net operating profit during the corresponding period last year and a net
decrease in both inventory and accounts payable.
During 1997, the Company received an assessment from the local government in
Aruba that relates to the Company's local income tax returns regarding certain
consulting fees paid and service fees assessed by L.S. Wholesale, Inc., a
wholly-owned subsidiary of the Company, to Aruba. During 1998, the Company met
with the tax authorities in Aruba. The Company has entered into a final
settlement with the tax authorities regarding its 1988-1996 local tax returns
and recorded a tax expense of $0.6 million in the three-month and six-month
periods ended November 28, 1998 for the incremental costs of this settlement.
Pursuant to this settlement, the Company has been assessed a profit tax in the
amount of $650,000, which is payable in ten equal installments of $65,000 per
month commencing on March 1, 1999. Interest of 6% per annum is being charged
on the outstanding amount as of March 1, 1999. The Company also has been
assessed a wage tax in the amount of $550,000, which is payable in six
installments commencing in June 1999. Interest of 6% per annum will be charged
on the outstanding amount starting on June 1, 1999. The Company may be subject
to an additional assessment for the Company's fiscal years 1997 and 1998 local
income tax returns. At this time the Company is unable to quantify the related
financial exposure, if any. In the opinion of management of the Company, this
assessment may have a material adverse effect on the Company's financial
condition or results of operations.
14
The Company has unsecured credit facilities of $15.7 million, of which
approximately $14.4 million in borrowings were outstanding as of February 27,
1999. Additionally, the Company has a term loan of approximately $8.9 million
which it obtained in February 1996 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 currently accrues at an annual rate of 7.02%,
and is payable monthly. The principal under the term loan is payable in equal
quarterly payments over a four year period, which commenced in March 1997. As of
February 27, 1999, the Company had $4.5 million of term debt outstanding against
this term loan.
As a result of a notification of a renewal proposal received from one of the
Company's lead banks reducing its commitment from a $7.0 million facility to a
$3.0 million facility, the Company's unsecured credit facilities decreased from
$19.7 million as of November 28, 1998 to $15.7 million as of February 27, 1999.
This credit facility with one of the Company's lead banks expired in March 1999
and has not been renewed by the bank. The Company currently is not in compliance
with certain financial covenants contained in the original loan agreement with
one of the Company's banks and was unable to make payments totaling
approximately $1.5 million under the revolving term loans with one of its banks
upon the maturity dates of such loans. As a result of these events, (i) the
banks may demand immediate repayment of all amounts outstanding under its credit
facilities and (ii) the Company is unable to borrow any additional funds under
its credit facilities.
The Company is in active negotiations with both of its banks concerning a
potential standstill agreement pursuant to which the banks would agree not to
exercise their rights and remedies under the loan documents, including declaring
all amounts outstanding under the loans immediately due and offsetting any
balances in the Company's accounts in the banks as permitted under the loan
agreements. The banks have indicated their willingness to enter into a
standstill agreement for a period of 120 days in exchange for, among other
things, the Company granting a security interest to the banks in certain of its
personal property and, with certain exceptions, the Company complying with the
existing loan agreements. In connection with the standstill agreement, it is
anticipated the banks will consent to the Company, to allow the Company to
generate funds for working capital, seeking a mortgage financing on its real
property. There can be no assurance, however, that the Company will be
successful in obtaining a standstill agreement with its banks or that such
agreement will be on terms favorable to the Company. If the Company is not
successful in obtaining such agreement, the banks may declare amounts
outstanding under these loans immediately due. If either of the banks declares
amounts outstanding under such loan agreements immediately due or offset any
balances in the Company's accounts in the banks, the Company does not believe
that it will have sufficient funds available to make such payments and such
action by the banks will have a material adverse effect on the Company.
In addition to addressing the status of its credit arrangements with its
existing lenders, the Company is actively exploring other financing
alternatives, including, without limitation, entering into discussions with
other lenders and pursing potential equity investments by certain third parties.
At this time, the Company does not have any firm commitments from other lenders
or third parties to provide it with funds that would be used to finance its
working capital or to pay amounts outstanding under the loans which the
Company's banks may declare immediately due. There is no assurance that the
Company will be successful in obtaining any other financing. Because the
Company's existing lenders will not permit the Company to increase its
borrowings under the existing credit facilities and have indicated that at this
time they will not increase the Company's availability in connection with a
potential standstill agreement, other than any potential future mortgage
financing on its real property, the Company's only source of working capital is
from funds from operations. At this time, the Company does not believe that
funds from operations will be sufficient to adequately support its operations
past the end of fiscal 1999. If the Company is unable to obtain other financing
that will provide it with funds for working capital purposes by the end of
fiscal 1999, it will have a material adverse effect on the Company.
Capital expenditures for the nine months ended February 27, 1999 were
approximately $614,000 compared to $944,000 for the corresponding period last
year.
15
RESTRUCTURING PLAN
The Company is in the process of developing a strategic plan that will
attempt to address its present financial situation and prepare it for the
future. The Company anticipates that it will face a significant restructuring in
the near future and that the restructuring plan will be completed sometime
during the Company's fourth quarter of fiscal 1999. The following is a brief
summary of certain of the aspects of the Company's business that this
restructuring plan will attempt to address.
In connection with this restructuring, the Company will evaluate whether to
maintain its current store locations based on several factors, including, most
importantly, the profitability of the store. Although at this time the Company
is unable to estimate the number of stores that may be impacted by this
restructuring plan, the Company does anticipate that it may close or relocate
several unprofitable stores.
The Company also will survey its product mix to more closely align its sales
efforts with its customer base. The Company will attempt to identify those
products that will be in demand by its customers. It also will seek to implement
more efficient distribution channels for the Company's products.
Additionally, the restructuring plan will attempt to address the Company's
liquidity and capital resources needs. As more fully discussed above in
"--Liquidity and Capital Resources," the Company currently is in active
negotiations with its banks regarding the status of its lending arrangements.
This restructuring plan also will address the Company's need for additional
capital.
Finally, the restructuring plan will seek to strengthen and replenish the
Company's management team, while retaining and motivating its valued employees.
The Company has hired a nationally recognized search firm to assist it in the
process of finding a permanent Chief Executive Officer. Finding the right
individual to fill this position will be a strong priority for the Company.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk.
----------------------------------------------------------
None.
16
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
-----------------
On March 11, 1998, the Company filed a civil action in the Territorial Court
of the Virgin Islands (Civil Action No. 98-229) against Lorraine Quetel, a
former employee of the Company, Lydia Magras and Bon Voyage Travel, Inc. The
Company alleges that such parties were involved in the employee defalcation that
management believes occurred during the Company's fiscal year ended May 31,
1997. The Company is seeking a preliminary injunction and damages against the
former employee and the other parties allegedly involved in the theft against
the Company.
On January 19, 1999, the Defendant Lydia Magras filed a petition for
Bankruptcy (Chapter 7) in the United States Bankruptcy Court, District of St.
Thomas. A Notice of Appearance was filed on February 2, 1999 on behalf of the
Company. A trustee was appointed, but due to a conflict of interest, he has
withdrawn from the case. A new trustee has yet to be appointed. A meeting of
the creditors was scheduled for February 9, 1999, but had to be rescheduled as a
result of the trustee's conflict. A new date has not been scheduled.
On June 10, 1998, the Company filed a civil action (the "Complaint") in the
United States District Court for the District of Delaware (Civil Action No. 98-
315-SLR) against DRHC, Stephen Crane, DRHC's controlling shareholder, Young
Caribbean Jewelry Company Limited, a Cayman Islands corporation, Alliance
International Holdings Limited, a Bahamian corporation, and CEI Distributors
Inc., a British Virgin Islands corporation, each an affiliate of DRHC. The
Company alleges breach of the Merger Agreement among the Company, DRHC and
certain affiliates of DRHC and also alleges claims of misrepresentation and
civil conspiracy, among other causes of action. The Company is seeking
monetary damages, including, without limitation, consequential damages relating
to harm to its business. On July 15, 1998, the defendants moved to dismiss the
Complaint on jurisdictional grounds. On March 31, 1999, the court issued an
order denying the defendants' motions to dismiss. The Company will continue to
vigorously pursue its claims against the defendants in this matter.
On October 7, 1998, Jewelcor Management, Inc. ("Jewelcor"), a record
stockholder of the Company, filed an action in the Court of Chancery for the
State of Delaware (Civil Action No. 16688-NC) against the Company seeking an
order that a meeting of stockholders of the Company be held immediately for the
purposes of electing directors and conducting such other business as is brought
before the meeting. Jewelcor subsequently filed a motion for leave to file an
amended complaint alleging that the Company had inequitably manipulated the size
of the Board of Directors and seeking an election of four directors at the next
annual meeting of stockholders. On December 11, 1998, the court granted
Jewelcor's motion for leave to file an amended complaint. On January 26, 1999,
the Company entered into a settlement agreement with Jewelcor pursuant to which
Jewelcor dismissed this action. In connection with this settlement, the Company
reimbursed Jewelcor for legal fees and expenses incurred in this action in the
amount of $18,500.
On March 22, 1999, a class action complaint was filed in the United States
District Court for the District of Delaware (Civil Action No.99-176) against the
Company, certain of its existing and former officers and directors, DRHC and
Stephen G.E. Crane. The complaint alleges that the defendants violated federal
securities laws by failing to disclose that DRHC's financing commitment to
purchase the Company's shares expired on April 30, 1998, before the Company's
stockholders were scheduled to vote to approve the merger between the Company
and DRHC at the May 8, 1998 special meeting of stockholders. The Company
currently is in the process of reviewing this complaint and intends to defend
these claims vigorously.
In addition, the Company is involved in various other 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.
17
ITEM 5. Other Information
-----------------
David J. Nace, the Company's Chief Financial Officer, has informed the
Company that he will be resigning from his position. Mr. Nace will remain with
the Company until a successor Chief Financial Officer has been hired.
ITEM 6. Exhibits and Reports on Form 8-K
--------------------------------
(a) Exhibits
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 3.3 to the Current Report on Form 8-K
filed with the Securities and Exchange Commission on February 24,
1999.
10.37 Amendment of Employment Agreement, dated as of November 13, 1998,
between L.S. Wholesale, Inc. and William K. Canfield is filed herewith
as Exhibit 10.37.
27.1 Financial Data Schedule is filed herewith as Exhibit 27.1.
(b) Reports on Form 8-K during the quarter ended February 27, 1999
1. On December 15, 1998, the Company filed a Current Report on
Form 8-K confirming that it had scheduled an annual meeting of
stockholders to be held on February 25, 1999, with a record date
of January 8, 1999.
2. On January 29, 1999, the Company filed a Current Report on
Form 8-K announcing settlement of the lawsuit brought by Jewelcor
Management, Inc.
3. On February 24, 1999, the Company filed a Current Report on
Form 8-K announcing settlement of a potential proxy context with
its two largest stockholders, the rescheduling of the annual
meeting for April 7, 1999, the restructuring of the Board of
Directors, the resignation of its then Acting Chief Executive
Officer and the appointment of a new Acting Chief Executive
Officer.
18
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 16, 1999 By: /s/ David J. Nace
-----------------
David J. Nace
Chief Financial Officer,
Executive Vice President and Treasurer
[Authorized Officer and Principal
Financial and Accounting Officer]
19