ITEM 1. BUSINESS
GENERAL
Little Switzerland, Inc. ("Little Switzerland" or the "Company") is a specialty retailer of luxury items. The Company operates 26 distinctively- designed retail stores on ten islands and Alaska and has eight franchise locations in the Bahamas. For a description of the Company's properties see Item 2
Item 2 "Property." The Company markets a wide selection of high quality products including watches, jewelry, crystal, china, fragrances, gifts and accessories. The Company is the exclusive retailer of certain brand name products on some islands. The Company's customers are primarily tourists from the United States.
Little Switzerland was incorporated in the state of Delaware on May 23, 1991. On July 17, 1991, approximately 68% of the outstanding common stock, par value $.01 per share (the "Common Stock"), of Little Switzerland was sold in a public offering. L.S. Wholesale, Inc. ("L.S. Wholesale") and L.S. Holding, Inc. ("L.S. Holding") are wholly-owned subsidiaries of Little Switzerland. As of August 14, 1998, there were ten subsidiaries of L.S. Holding incorporated in various jurisdictions. L.S. Wholesale acts as purchasing agent for items sold by the Company's stores. The subsidiaries of L.S. Holding are as follows:
Montres et Bijoux, S.A.R.L. St. Martin/St. Barths France, 1986
World Gift Imports N.V. St. Maarten Netherlands Antilles, 1984
LS Holding (Aruba) N.V. Aruba, 1987
LS Holding (Curacao) N.V. Netherlands Antilles, 1987
Little Switzerland (Antigua) Limited Antigua, 1988
Little Switzerland (St. Kitts and Nevis) Limited St. Kitts, 1992
Little Switzerland (St. Lucia) Limited St. Lucia, 1992
Little Switzerland (BVI) Limited British Virgin Islands, 1993
L.S. Holding (USA), Inc. Ketchikan, Alaska, 1994
World Gift Imports (Barbados) Limited Barbados, 1996
The Company's executive offices are located at 161-B Crown Bay Cruise Ship Port, St. Thomas, U.S.V.I. 00802, and its telephone number is (340) 776-2010. The terms "Little Switzerland" and the "Company" as used in this Annual Report include, where the context so requires, its subsidiaries.
As used throughout this report on Form 10-K, the terms fiscal 1998, 1997 and 1996 refer to the Company's twelve month periods ended May 30, 1998, May 31, 1997 and June 1, 1996, respectively.
MERCHANDISING
High-Quality Merchandise. Little Switzerland offers high-quality ------------------------ merchandise generally available in the world's finest stores and, on some islands, is the exclusive retailer of certain brand name products. The Company sells internationally renowned product lines such as Rado, Omega, Tag-Heuer, Breitling and Cartier watches, Baccarat, Waterford, Lalique and Swarovski crystal and Rosenthal, Lladro and Herend china gifts.
Presentation of Merchandise. The Company places particular emphasis on --------------------------- effective marketing and merchandise presentation through well-designed stores situated in prime retail locations. The layout, fixtures and upscale presentation of merchandise create an inviting and relaxed atmosphere which is conducive to shopping for luxury items. Superior customer service is a high priority, and a knowledgeable and courteous sales staff is available to assist customers.
Availability of Merchandise. Little Switzerland's customers are tourists --------------------------- who may be staying in one location only a short time. Often they travel as couples or families and while on vacation they find time to shop. To meet the demands and interests of these tourists, the Company stocks a broad selection of luxury products and carries a significant inventory so that most items offered by a particular store are available for immediate delivery.
Name Recognition. Little Switzerland enjoys excellent name recognition in ---------------- the United States and locally in the Caribbean. It has an established reputation for providing a wide variety of high-quality product lines, and its stores are recognized as desirable places to purchase luxury products.
PRODUCT LINES
The principal product lines offered by the Company are watches, jewelry, crystal, china, fragrances, gifts and accessories.
Watches. The most significant product line for Little Switzerland is ------- watches. Sales of watches comprised approximately 47%, 44% and 43% of sales in fiscal 1998, 1997 and 1996, respectively. The primary watch lines marketed by Little Switzerland during the last three fiscal years included such quality brand names as Rolex, Rado, Omega, Raymond Weil, Cartier, Tag-Heuer, Breitling, Citizen and Tissot, prices for which generally range from $200 to $30,000. 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. Rolex is the only manufacturer whose products accounted for more than 10% of the Company's sales in any of the last three fiscal years. 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 is expanding the number of stores carrying Breitling products. In addition, the Company is increasing 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, pearls and pearl accent classifications. See Item 7 "Management's Discussion and Analysis of Financial Conditions and Results of Operations--Recent Developments--Rolex."
Jewelry. The second most significant product line for Little Switzerland is ------- jewelry. Most of the jewelry is produced by international manufacturers and sales of such items accounted for 27%, 27% and 24% of sales in fiscal 1998, 1997 and 1996, respectively. Jewelry items include rings, earrings, bracelets, necklaces, pendants and charms, which generally range in price from $100 to $5,000.
Crystal, China, Gifts and Flatware. The Company sells numerous lines of ---------------------------------- crystal, china, gifts and flatware, including Baccarat, Lalique, Swarovski, Goebel, Waterford, Orrefors, Kosta Boda, Daum, Lladro, Herend, Portmeirion, Christofle and Rosenthal, prices for which generally range from $20 to $3,000. Sales of this product category accounted for 16%, 17% and 22% of sales in fiscal 1998, 1997 and 1996, respectively.
Fragrances and Accessories. Little Switzerland carries in excess of 90 -------------------------- fragrance lines, including Yves Saint-Laurent, Estee Lauder, Chanel, Calvin Klein, Guerlain and Christian Dior, prices for which generally range from $15 to $150. The Company also offers leather lines including Paloma Picasso, Versace and Bally, and writing instruments from Mont Blanc.
PRICING
Little Switzerland seeks to price its merchandise at levels which compare favorably to prices generally available for the same products in the United States. The cost of much of the inventory purchased by the Company is often lower than the cost to retail stores in other markets because the Company is not required to pay a duty or tariff on most incoming products in the Caribbean. In addition, Little Switzerland can offer price advantages because inventory purchases are generally directly from manufacturers and large quantities are purchased at the same time for multiple store locations. Within the Caribbean, there are no sales taxes in the jurisdictions in which the Company operates. In addition, tourists from the United States may bring certain amounts of merchandise home from the Caribbean duty-free. The Company regularly monitors prices available for comparable merchandise in the United States and adjusts pricing structures to maintain Little Switzerland's competitive advantage.
Little Switzerland makes manufacturers' warranties available to its customers and generally accepts the return of merchandise within 30 days of its purchase. Merchandise returns historically have been nominal.
PURCHASING AND DISTRIBUTION
Little Switzerland purchases its merchandise from suppliers worldwide. The Company has developed long-term relationships with a number of its key suppliers. The Company believes that these relationships are an important factor in its success and have enabled it to become the exclusive authorized retailer of certain important brands of merchandise on certain islands. Most of these exclusive relationships are not based on binding agreements with suppliers, but rather are based on factors such as the Company's effective representation of product lines, its prompt payment for inventory and the suppliers' long-standing relationships with the Company. The Company believes that the loss of any major supplier could adversely affect the Company's results of operations.
Many of the Company's suppliers manufacture merchandise only to specific order, and the time required for manufacture may be considerable. As a result, orders for many key items may be placed only two or three times a year. The Company's inventory levels are typically high, particularly as the winter tourist season approaches, to assure tourists immediate delivery of items. The Company's buyers continually seek to identify new product lines with an emphasis on non-branded items which usually carry more attractive margins. Little Switzerland utilizes its information on buying patterns in each store and management experience and expertise to anticipate trends in customer demand.
Little Switzerland merchandise is shipped by vendors to four distribution centers owned by the Company which supply the stores in their respective region.
Little Switzerland stores are designed to place the customer in an environment which is conducive to the purchasing of luxury items. Most stores are designed by the same architectural firm and decorated in similar
fashion to present a consistent theme of luxury retailing throughout the network of stores. Stores are located in areas which are easily accessible to tourists, often in so-called "duty-free" ports which are visited by cruise ships. The quantity and mix of products carried by Little Switzerland stores vary from location to location based on store size and tourist buying patterns and preferences.
MARKETING AND ADVERTISING
The Company's marketing plan includes targeted advertising in national, high-circulation travel magazines and in a large selection of local publications which are distributed to overnight guests wherever Little Switzerland stores are located and elsewhere throughout the Caribbean. The Company's choices of print media are shaped by customer and tourist demographics, local and historical sales trends which provide information about the types of tourists who are likely to purchase merchandise, and by retail buying patterns in the United States.
Participation in promotional programs offered by many of the world's largest cruise ship lines is another key element in the Company's strategy to gain greater name recognition for Little Switzerland and increase store traffic. Presentations by "Port Lecturers" aboard the major cruise ships provide cruise ship passengers with highly targeted shopping information on retailers who participate in the program before the passengers disembark at each port of call. Similar hotel promotions which focus on overnight guests also contribute to the Company's overall effort to increase its market share of the Caribbean retail industry.
INVENTORY CONTROL AND SECURITY
Little Switzerland management utilizes modern inventory control and security systems, careful personnel screening and well-articulated policies and procedures to control losses and shrinkage. The Company has inventory control and management information systems which integrate sales, inventory and financial reporting and control. These systems provide vital management information such as store-by-store data, which includes sales, profitability and inventory levels by product category.
Given the high value of the merchandise offered by the Company, security is a high priority. Sophisticated alarm systems are in place in each location, and security guards are assigned at individual stores as needs dictate. Most jewelry and watches are returned to vaults each day at closing under close scrutiny. The Company's cycle count inventory program provides the Company with periodic verification of merchandise. The Company carries insurance coverage on its inventory in amounts which it believes to be customary and adequate.
COMPETITION
The Company's markets contain numerous retail stores and the competition for tourist dollars is intense. Little Switzerland also competes with stores selling similar products in the United States and in other markets where tourists travel. The majority of the Company's local competitors are independently owned stores and do not offer the variety of brand name luxury products which Little Switzerland markets. The Company believes that its status as the exclusive authorized retailer of certain brand name products in a number of markets enhances its competitive position. The loss of one or more of these exclusive relationships could adversely affect the Company's ability to compete.
EMPLOYEES
As of May 30, 1998, Little Switzerland employed approximately 500 people. The number of employees, including the number of sales personnel, varies from season to season based on the Company's needs. Currently, the Company has no collective bargaining agreements and has never experienced a work stoppage. In February 1995, the employees of the Company's subsidiary in St. Maarten, Netherlands Antilles voted to be represented by a local labor union. The Company engaged in negotiations with the union but no collective bargaining agreement was consummated. The Company considers relations with its employees to be good.
Since August, 1998, the Company has experienced certain management changes. See Item 7 "Management's Discussion and Analysis of Financial Conditions and Results of Operations--Management Changes." In addition to these changes, on August 25, 1998, Michael M. Poole joined the Company as its Vice President, General Merchandise Manager. Mr. Poole brings more than 30 years of jewelry and watch retailing experience to this position.
WORKING CAPITAL AND SEASONALITY
The Company's primary needs for working capital are to support its inventory requirements, which fluctuate during the year due to the seasonal nature of the Company's business, to maintain and remodel its existing stores and to finance the opening or acquisition of new stores. In addition, a significant investment in inventory is required at all times in order to meet the demands of its customers who, as tourists, require immediate delivery of purchased goods.
As a general policy, the Company does not sell merchandise on account. Virtually all sales are paid by cash, check or major credit card.
On the basis of its current operating plan, the Company anticipates that its cash flow from operations together with funds available from bank financing will be sufficient to fund its operations and expansion for the foreseeable future. See Item 7 "Management's Discussion and Analysis of Financial Conditions and Results of Operations--Liquidity and Capital Resources."
The Company's business is seasonal in nature, reflecting travel patterns to the Caribbean. The peak selling season in the Caribbean runs from late fall through spring. The peak selling season in Alaska runs from late spring through the summer. Working capital requirements generally reflect this seasonality as the Company increases its inventory in anticipation of the peak selling season. Since the Company has less cash available from operations in the off-season, it may be required to borrow to finance its build-up of inventory and any expansion of Company operations. See Item 7 "Management's Discussion and Analysis of Financial Conditions and Results of Operations--Seasonality."
INFLATION
Historically, the Company has generally been able to increase prices to reflect cost increases resulting from inflation and expects to be able to do so in the future. While the Company cannot precisely determine the effect of inflation on its operations, the Company does not believe that its operations have been materially affected by inflation during the three most recent fiscal years.
OTHER MATTERS
Foreign and Domestic Operations. See Note 2 of Notes to Consolidated ------------------------------- Financial Statements.
Environmental. In the opinion of Little Switzerland, compliance with ------------- current laws and regulations pertaining to the environment, health and safety has not materially affected its business or financial condition and will not do so in the foreseeable future.
Customers. Little Switzerland is not dependent upon any single customer or --------- upon any single group of customers, the loss of which would have a material effect on Little Switzerland.
Patents and Trademark. Little Switzerland holds a number of licenses, --------------------- trademarks and trade names. None of the foregoing is believed to be material to Little Switzerland.
Other. Little Switzerland does not have significant research and ----- development expenditures.
Little Switzerland does not have significant backlog of orders and inventory. Little Switzerland must carry adequate inventory to enable tourists to receive immediate delivery of items.
Little Switzerland does not have any business under government contract.
ITEM 2. PROPERTY
Little Switzerland's 26 stores are all situated in prime retail locations. The Company owns its facility in Philipsburg, St. Maarten and leases the 25 other stores it operates. Most of its stores are free-standing. In addition to approximately 68,000 square feet of selling space, the Company has approximately 33,000 square feet of warehouse space, 11,000 square feet of which is at the Company's main warehouse on St. Thomas. The Company owns the building which houses its headquarters and warehouse on St. Thomas and leases the underlying real property from the Virgin Islands Port Authority under a ten-year ground lease, which expires in April, 2000. The ground lease is subject to two five- year renewal terms and may be terminated by the lessor prior to the expiration of its term subject to payment to the Company of the fair market value of the Company's improvements. The Company anticipates that in most cases retail space for new stores opened or acquired will be leased. This arrangement provides the Company not only with greater flexibility in selecting prime retail locations for its stores, but also allows the Company to utilize its capital to more effectively design and decorate its stores with quality furnishings commensurate with the prestigious image the Company maintains.
Little Switzerland also has eight franchise locations in the Bahamas. In return for the use of the Little Switzerland name and the services provided by Little Switzerland, the Company receives a minimum annual franchise fee of $100,000. The franchise agreement pursuant to which these locations are maintained has been terminated effective as of November 1, 1998.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
On June 10, 1998, the Company filed a civil action 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 Jewellery 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 the grounds that the court lacks subject matter jurisdiction over the claims. In addition, Mr. Crane moved to dismiss the Complaint on the grounds that the court lacks personal jurisdiction over him. The court has now ruled that the Company may pursue certain discovery before responding to these motions and the parties are currently engaging in such discovery. See Item 7 "Management's Discussion and Analysis of Financial Conditions and Results of Operations--Recent Developments--Litigation Against DRHC."
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. See Item 7 "Management's Discussion and Analysis of Financial Conditions and Results of Operations--Recent Developments--Employee Defalcation Loss."
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.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the stockholders of the Company during the fourth quarter of the fiscal year ended May 30, 1998.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The Company's Common Stock is traded on the NASDAQ National Market System under the symbol "LSVI." The following table sets forth for the periods indicated the high and low sale prices per share of the Common Stock on the NASDAQ National Market System, as reported by NASDAQ. The Company's initial public offering of its Common Stock at $ 12.00 per share occurred on July 18, 1991.
The Company has never paid cash dividends on its Common Stock. The Company presently intends to retain earnings for use in the operation and expansion of its business and, therefore, does not anticipate paying any cash dividends in the foreseeable future.
On August 14, 1998, there were 132 holders of record of the Company's Common Stock.
RECENT SALES OF UNREGISTERED SECURITIES
Little Switzerland has not sold any securities within the past three years that were not registered under the Securities Act of 1933, as amended.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
______________________ (1) See Note 2 of Notes to Consolidated Financial Statements. (2) In addition to the stores described, the Company's franchisee, Solomon Brothers Ltd., currently has eight stores in the Bahamas which are operated pursuant to a franchise agreement entered into in fiscal 1988. This franchise agreement has been terminated effective as of November 1, 1998. (3) Comparable store sales are calculated using sales of stores which were open for the full period. (4) In fiscal 1998, the Company closed one store in Aruba for renovation. (5) In fiscal 1997, the Company opened a new Little Switzerland store on the island of St. Lucia and in Skagway, Alaska. Also, it closed a Little Treasures store in Curacao and its accessories store in Aruba. (6) In fiscal 1996, the Company opened two new stores in Aruba and one in Juneau, Alaska. In addition, it acquired two stores previously operating under the name "Louis Bayley" on the island of Barbados. It also closed its American Yacht Harbor and Little Treasures stores on St. Thomas. (7) In fiscal 1995, the Company opened a new Little Switzerland store on the island of St. Martin on the French side and in Ketchikan, Alaska. Also, it closed one store in St. Thomas due to the expiration of its lease. (8) In fiscal 1994, the Company opened two "Little Treasures" stores in Curacao and St. Thomas, a Little Switzerland store in St. Thomas and reopened a Little Switzerland store in Aruba which had been closed since November 1992 due to remodeling of the hotel in which it is located. In April 1994, the Company acquired "La Parfumerie", a fragrance store in Antigua. (9) This decrease was primarily the result of forced store closures due to damage to several of the Company's stores caused by Hurricanes Luis and Marilyn. See Item 7
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
This Annual Report contains certain statements that are "forward-looking statements" as that term is defined under the Private Securities Litigation Reform Act of 1995 (the "Act") 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) 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, (iv) weather in the Company's markets, (v) actions of the Company's competitors and the Company's ability to respond to such actions, (vi) economic conditions that affect the buying patterns of the Company's customers and (vii) 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.
The following represents the components of operating results for the three years ended:
RECENT DEVELOPMENTS
Employee Defalcation Loss - -------------------------
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. 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. Accordingly, the comparative consolidated statements of income for the three month period ended November 30, 1996 reflect a net loss of $560,000 or $0.07 per share, including a charge to administrative expense of $481,000 which, after tax, negatively impacted net income and earnings per share by $394,000 and $.05, respectively. For the six month period ended November 30, 1996, the comparative consolidated statements of income reflect a net loss of $1.3 million or $0.16 per share, including a charge to administrative expense of $758,000 which, after tax, negatively impacted net income and earnings per share by $621,000 and $0.08, respectively.
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 accompanying 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 the employee and certain other parties alleged to be involved in the defalcation 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 employee and such other parties. See Item 3 "Legal Proceedings."
Although the Company continues to work to improve its accounting and reconcilation methods, since the defalcation, certain of these methods have been revised to improve monitoring of the Company's systems. For example, the Company's accounting system has been revised to facilitate the closer monitoring of detail transactions, so that each separate transaction is posted rather than posting totals by category. In addition, the Company's Treasury and Accounting staffs have been increased and their functions upgraded and reorganized in an attempt to provide adequate segregation of duties and more timely bank account reconciliations. Accordingly, unlike at the time of the defalcation, no one person has control over cash deposits and disbursements, inter-bank transfers and bank account reconciliations. As part of its sales audit, the Company also has begun reconciling cash register deposits for each of its stores. As an additional check on the system, a new cash flow report is prepared daily and reviewed by management of the Company. This cash flow report sets forth, for each day, the bank balance, the book balance, disbursements, transfers and float (i.e., checks outstanding against the Company's credit line).
Merger Transaction - ------------------
In the fall of 1997, the Board of Directors of the Company decided to explore various strategic alternatives, including potential business combinations with third parties. In this regard, the Company, through
its financial advisor, Wasserstein Perella & Co., Inc., conducted a controlled sales process to determine the interest of third parties in acquiring the Company. As part of this process, the Company engaged in discussions with DRHC as well as other third parties concerning a potential sale of the Company. Following extensive negotiations, the Company entered into the Merger Agreement, dated as of February 4, 1998, with DRHC and certain of its affiliates, pursuant to which DRHC would acquire all of the issued and outstanding shares of the Common Stock of the Company at the effective time of the proposed merger for $8.10 per share in cash. As required under the Merger Agreement, the Board of Directors scheduled a Special Meeting of Stockholders for May 8, 1998 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 April 3, 1998.
On May 4, 1998, the Company announced that it had received correspondence from DRHC's counsel indicating that DRHC's financing commitment letters from Donaldson Lufkin & Jenrette, Inc. and DLJ Bridge Finance, Inc. (collectively, "DLJ") had terminated on April 30, 1998 in accordance with their terms and that DLJ, at that particular time, did not intend to extend or renew the commitment letters. On May 8, 1998, following stockholder approval of the proposed merger, the Company notified DRHC that the Company had satisfied all of the conditions to the Merger Agreement and informed DRHC that it was prepared to close the proposed merger at that time. In response, DRHC informed the Company that it was not yet prepared to close the proposed merger, indicated that it did not have the financing necessary to consummate the proposed merger and requesting an extension of between 90 and 120 days. On May 21, 1998, the Company announced that it had received a second request by DRHC for a ninety day extension in exchange for certain limited concessions. In response, the Company indicated that it was prepared to grant a two week extension in exchange for DRHC's acknowledgment that all conditions to the merger had been satisfied and the concessions offered by DRHC. Although, the Company had the contractual right to terminate the Merger Agreement, the Company continued to work diligently with DRHC and its representatives to understand the structure, timing and likelihood of Destination's financing. In connection with the extension negotiations, DRHC repeatedly refused to provide the Company with financial or other form of security or to reimburse the Company's merger-related expenses going forward in exchange for the Company granting an extension. As a result of its diligence and these negotiations, it became clear to the Board of Directors that it was highly unlikely that DRHC would be able to raise the funds necessary to consummate the proposed merger. On June 9, 1998, the Company terminated the Merger Agreement because of DRHC's inability to raise the financing necessary to consummate the proposed merger.
Litigation Against DRHC - -----------------------
As a result of the Company's losses associated with the termination of the Merger Agreement, on June 10, 1998 the Company filed a civil action in the United States District Court for the District of Delaware (Civil Action No. 98- 315-SLR) against DRHC, Stephen Crane, DRHC's controlling stockholder, and certain of DRHC's affiliates. The Company alleges breach of the Merger Agreement 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 the grounds that the court lacks subject matter jurisdiction over the claims. In addition, Mr. Crane moved to dismiss the Complaint on the grounds that the court lacks personal jurisdiction over him. The court has now ruled that the Company may pursue certain discovery before responding to these motions and the parties are currently engaging in such discovery.
Rolex - -----
Prior to entering into the Merger Agreement with DRHC, the Company was the exclusive authorized retailer for Rolex watches on the islands on which the Company operates. Following the execution of the Merger Agreement with DRHC, 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. The Company received its last shipment of Rolex products in January, 1998. Following the 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. The Company believes that the loss of Rolex will have a material adverse effect on the Company's results of operations for the fiscal year ending May 29, 1999 and beyond. In order to mitigate the impact on sales of the loss of Rolex as a supplier, the Company is actively exploring opportunities for expanding existing, and adding new, world class product lines in both watches and jewelry. See Item 1 "Business--Product Lines--Watches." There can be no assurances 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.
Management Changes - ------------------
On August 14, 1998, the Company announced the resignation of John E. Toler, Jr., the President and Chief Executive Officer of the Company, effective August 31, 1998. At the request of the Company's Board of Directors, Mr. Toler will remain a director of the Company until the next stockholders' meeting. Mr. Toler's decision to resign was motivated by his as well as his wife's desire to return to the continental United States. The Company has commenced the selection process for a new President and Chief Executive Officer, and will hire a nationally recognized executive search firm to assist in this process. The Board of Directors appointed C. William Carey as Acting Chief Executive Officer until such time as a successor President and Chief Executive Officer is identified. In connection with accepting this interim position, Mr. Carey has resigned as the Chairman of the Board of Directors, effective September 1, 1998.
FISCAL 1998 COMPARED TO FISCAL 1997
Net sales for the fiscal year ended May 30, 1998 were $100.4 million, an increase of $12.1 million or approximately 13.7% from $88.3 million in fiscal 1997. Sales for stores open in all of fiscal 1998 and 1997 increased $7.2 million or 8.7% from $82.7 million in fiscal 1997 to $89.9 million in fiscal 1998. The increase in total Company sales and comparable store sales is attributed to an especially strong sales performance in the watch and jewelry classifications resulting from more focused assortments and maintaining a much better "in-stock" position in core suppliers as compared to fiscal year 1997. All of the Company's market areas experienced sales growth during fiscal year 1998 with the Virgin Islands, St. Maarten/St. Martin, Antigua and Alaska reporting strong double digit gains.
Gross profit margin decreased from 43.7% of net sales in fiscal 1997 to 42.5% of net sales in fiscal 1998. Management attributes the reduction in gross margin of 1.2% to the significant growth of the watch category which generates lower margins and the impact of lower margins realized in the Alaska market. In addition, inventory reductions continued in the china, crystal, gift and accessory categories for repositioning purposes.
Selling, general and administrative expenses ("SG&A") for the year ended May 30, 1998 increased 20% from $36.5 million in fiscal 1997 to $43.8 million in fiscal 1998. The increase is due primarily to $2.7 million in charges incurred as the result of the failed merger with DRHC (see "--Merger Transaction"), and a $2.5 million non-cash charge resulting from the Company's recognition of impaired asset values related to the goodwill at the World Gift Import (Barbados) Limited subsidiary. Also contributing to the increased expenses were charges associated with the employee defalcation of $0.6 million. See "-- Employee Defalcation Loss."
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 the preopening, preoperating and organization activities to be expensed as incurred. The Company has elected to adopt SOP 98-5 during fiscal 1998. As required by SOP 98-5, the Company has recorded a one-time non-cash charge of approximately $0.2 million (net of applicable tax) to expense previously capitalized start-up costs. This charge has been classified in the accompanying consolidated financial statements for fiscal year ended May 30, 1998 as a cumulative effect of a change in accounting principle.
Net interest expense remained at $1.5 million in fiscal 1998 which was consistent with the Company's average short term borrowing used to acquire additional inventory to support the Company's sales growth. The weighted average interest rate was 7.9% in fiscal 1997 compared to 8.1% in fiscal 1998.
The Company's income is subject to taxation in each of the jurisdictions in which it operates at rates ranging from 3.7% to 42%, and, accordingly, the effective tax rate for any given year is a function of the relative mix of taxable income generated at each of the Company's locations. The Company's wholly-owned subsidiary, L.S. Wholesale which acts as a purchasing agent for items sold by the Company's stores and charges fees for acting as such an agent, has elected to be treated as a "936 Company" under section 936 of the Internal Revenue Code of 1986, as amended. Under an agreement which expires at the end of August, 1998 (subject to renewal), L.S. Wholesale benefits from a lower tax rate on its income earned outside the U.S. Virgin Islands, which is taxed at a rate of 3.74%. The lower tax rate had the effect of increasing earnings per share by $0.22 in fiscal year 1998 and $0.12 in fiscal year 1997. The Company has submitted its application for renewal of benefits, and anticipates that it will be notified with respect to the renewal sometime during the second quarter of fiscal 1999. If the renewal is granted, then the lower tax rate will be applied retroactively to the end of August, 1998. The Company anticipates that the agreement will be renewed at the same or less favorable benefit. It, however, has no assurance at this time that such a renewal will be granted. If it is not renewed, all of the Company's U.S.V.I. based income will be taxed at the statutory rate of 37.4%. 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.
The Company utilizes software and related technologies throughout its business that may be affected by the "Year 2000 problem," which is common to most corporations, and concerns the inability of information systems, primarily computer software programs, to recognize and process date sensitive information properly as of and subsequent to January 1, 2000. An internal study has been completed resulting in an action plan which is designed to ensure that the Company's systems continue to meet its internal needs and those of its customers. The Company believes that this plan provides for modifications or replacements that will be accomplished in time to minimize any detrimental effects on operations. While it is not possible to give an accurate estimate of the cost of this work, the Company expects that such costs will not be material to its results of operations in one or more fiscal quarters or years, and these costs will not have a material adverse impact on the long-term results of operations, liquidity or consolidated financial position of the Company. System maintenance or software modification costs will be expensed as incurred, while the costs of new software will be capitalized and amortized over the software's useful life.
FISCAL 1997 COMPARED TO FISCAL 1996
Net sales for the fiscal year ended May 31, 1997 increased approximately $25.4 million or 40% from $62.9 million in fiscal 1996 to $88.3 million in fiscal 1997. Sales for stores open in all of fiscal 1997 and 1996 decreased approximately $3.5 million or 14.3% from $24.7 million in fiscal 1996 to $21.1 million in fiscal 1997. Both the large increase in overall sales and the comparable store sales decline are attributable to the impact in fiscal 1996 of hurricanes Luis and Marilyn which inflicted damage to several of the Company's stores and caused significant damage to various islands' infrastructures. Those stores that were not damaged and did remain open in fiscal 1996 benefited from the closure of neighboring stores and thus reported higher than normal sales. The store located on the harbor in Marigot, St. Martin, the last of the hurricane damaged stores, reopened in November, 1996. While the reopening of the Company's hurricane damaged stores and the opening of two new stores in fiscal 1997 contributed to the overall increase in sales in fiscal 1997 compared to fiscal 1996, management believes that the impact of the hurricanes continued to have a negative impact on sales into fiscal 1997.
Gross profit margin improved from 42.5% of net sales in fiscal 1996 to 43.7% of net sales in fiscal 1997. Management attributes this improvement to the stronger US dollar measured against European currencies partially offset by the impact on margins of certain inventory liquidation efforts.
SG&A expenses for the year ended May 31, 1997 increased 23% from $29.8 million in fiscal 1996 to $36.5 million in fiscal 1997. The increase is largely due to the estimated loss of approximately $2.4 million resulting from the employee theft described above, which has been classified as a general and administrative
expense in the accompanying consolidated financial statements for the fiscal year ended May 31, 1997. See "--Employee Defalcation Loss." In addition, management further attributes the increase to the lower than normal SG&A expenses in the prior year from the closed stores as well as additional expense associated with its new store in Alaska. Management also noted higher depreciation associated with stores remodeled after the hurricanes.
Net interest expense increased from $558,000 in fiscal 1996 to $1.5 million in fiscal 1997 primarily due to higher average borrowings, caused by the Company's acquisition of the inventory, leasehold rights, and fixed assets of its two stores in Barbados. Additionally, the weighted average interest rate increased from 6.5% in fiscal 1996 to 7.9% in fiscal 1997.
The Company's income is subject to taxation in each of the jurisdictions in which it operates at rates ranging from 3.7% to 42%, and, accordingly, the effective tax rate for any given year is a function of the relative mix of taxable income generated at each of the Company's locations. Under an agreement which expires in 1998 (subject to renewal), L.S. Wholesale benefits from a lower tax rate on its income earned outside the U.S. Virgin Islands, which is taxed at a rate of 3.74%. The lower tax rate had the effect of increasing earnings per share by $0.12 in both fiscal years 1997 and 1996. See "--Fiscal 1998 Compared to Fiscal 1998." The Company's effective tax rate was 0.0% and 17.4% in the fiscal years ended May 31, 1997 and June 1, 1996, respectively.
FISCAL 1996 COMPARED TO FISCAL 1995
In September, 1995, Hurricanes Luis and Marilyn inflicted damage on several of the Company's stores and caused significant damage to various islands' infrastructures, including hotels and other tourist facilities. The Company has reopened all stores damaged by such hurricanes.
The Company has settled all outstanding claims related to the hurricanes with its insurance carriers. In connection with the final settlement, the Company received approximately $13.4 million in property and business interruption 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 lost profits for the then unopened Marigot store related to fiscal 1997, was recorded as deferred income on the Company's consolidated balance sheet as of June 1, 1996.
Net sales for the fiscal year ended June 1, 1996, decreased approximately $9.3 million or 13% from $72.2 million in fiscal 1995 to $62.9 million in fiscal 1996. Sales for stores open in all of fiscal 1995 and 1996 increased approximately $3.6 million or 17.3% from $20.6 million in fiscal 1995 to $24.2 million in fiscal 1996. The sales trends were dictated by the impact of hurricanes Luis and Marilyn, which struck the Caribbean in September 1995, forcing stores closures on the island of St. Thomas, St. Maarten, St. Barths, St. Kitts and Antigua. As of June 1, 1996, all but two little Switzerland stores reopened. One Marigot, St. Martin store reopened in mid-June 1996, with the other Marigot store reopened in November, 1996. As a result of the store closures and damaged island infrastructures management believes tourism was redirected to other destinations, thereby benefitting Little Switzerland stores on undamaged islands.
Gross profit margin decreased from 42.8% of sales in fiscal 1995 to 42.5% of sales in fiscal 1996. The Company attributed this decline to the weak U.S. Dollar as compared to European currencies during the early portion of fiscal 1996 as well as the impact of certain fixed components of cost-of-sales as measured against a much lower sales base.
SG&A expenses were $29.8 million or $3.6 million and 13.6% higher than a year ago. Management attributed these increases mostly to new stores opened during fiscal 1996.
Net interest expense increased from $240,000 in fiscal 1995 to $558,000 in fiscal 1996. The increase reflects higher average borrowings, primarily due to the Company's acquisition of the inventory, leasehold
rights and fixed assets of two stores in Barbados in February 1996. The weighted average interest rate decreased from 7.9% in fiscal 1995 to 6.5% in fiscal 1996.
The Company's income is subject to taxation in each of the jurisdictions in which it operates at rates currently ranging from 3.7% to 42.0%, and, accordingly, the effective tax rate for any given year is a function of the relative mix of taxable income generated at each of the Company's locations. Under an agreement which expires in 1998 (subject to renewal), L.S. Wholesale benefits from a lower tax rate on its income earned outside the U. S. Virgin Islands, which is taxed at a rate of 3.74%. See "--Fiscal 1998 Compared to Fiscal 1998." The lower tax rate had the effect of increasing earnings per share by $0.12 and $0.11 in fiscal years 1996 and 1995, respectively. The Company's effective tax rate was 17.8% in fiscal 1995 and 17.4% in fiscal 1996.
LIQUIDITY AND CAPITAL RESOURCES
The Company's primary needs for liquidity are to support its inventory requirements, which fluctuate during the year due to the seasonal nature of the Company's business, and to maintain and remodel its existing stores and finance the opening or acquisition of new stores. Inventory is maintained at levels to adequately meet the demands of customers who, as tourists, require immediate delivery of purchased goods.
Cash provided by operations during fiscal 1998, 1997 and 1996 was $3.4 million, $0.4 million and $3.8 million, respectively. The decrease in fiscal 1997 was primarily due to the loss of approximately $2.4 million in cash as a result of the employee defalcation during fiscal 1997. See "--Employee Defalcation Loss."
The Company has available unsecured credit facilities of $19.7 million of which $7.8 million in borrowings were outstanding as of May 30, 1998. These credit facilities with the Company's two lead banks are up for renewal during the second and third quarters of fiscal 1999. Management anticipates that these credit facilities will be renewed in due course. It, however, has no assurance at this time the such renewals will be granted. If these credit facilities are not renewed or the terms of these credit facilities are materially changed, it could have a material adverse effect on the Company's results of operations. Additionally, on August 11, 1998, the Chase Manhattan Bank approved a $3.0 million line of credit (the "Chase Credit Facility"), which the Company will use to support its inventory requirements for the peak selling season. According to the term sheet, the Chase Credit Facility expires 180 days from the date of the initial drawdown, which must occur no later than October 30, 1998. The Company has not entered into definitive loan documents with Chase Manhattan Bank, and there is no assurances that such loan documents will be entered into. Further, in February 1996, the Company secured term debt of approximately $8.9 million from its two lead banks to finance its acquisition of the fixtures, leasehold rights and inventories of two stores in Barbados. Interest on this debt is payable monthly and the principal is payable in equal quarterly payments over a four year period commencing March 1997. The Company is in compliance with, or has obtained waivers for, all restrictive covenants related to its unsecured and term debt agreements. Additionally, the Company has available separate facilities for foreign exchange contracts. It remains management's expectation that funds available from operations and existing credit facilities will be sufficient to fund operations and expansion for the foreseeable future.
Capital expenditures (excluding acquisitions) during fiscal 1998, 1997 and 1996 were approximately $1.1 million, $4.4 million and $6.8 million, respectively. Capital expenditures during fiscal 1998 included approximately $900,000 for store refurbishments and $200,000 for computer hardware and software upgrades. Capital expenditures during fiscal 1997 included approximately $3.6 million for the refurbishment of existing stores and approximately $800,000 for computer and point-of-sale hardware and software upgrades.
The Company currently leases 25 of its 26 stores and anticipates obtaining retail space for new stores through leases. This arrangement allows the Company to more effectively design and decorate its stores with quality furnishings consistent with the prestigious image the Company maintains.
SEASONALITY
The Company's business is seasonal in nature, reflecting travel patterns to the Caribbean. The peak selling season in the Caribbean runs from late fall through spring. Accordingly, approximately one-third of the
Company's sales have historically occurred during the third fiscal quarter, and the Company may incur losses in the first and second fiscal quarters. Working capital requirements generally reflect this seasonality as the Company increases its inventory in anticipation of the peak selling season. Since the Company has less cash available in the off season, it may be necessary to borrow to finance its build-up of inventory and any expansion of the Company's operations. Unaudited quarterly financial information for the Company for fiscal 1998 and 1997 is included in Note 9 of Notes to Consolidated Financial Statements.
INFLATION
Historically, the Company has generally been able to increase prices to reflect cost increases resulting from inflation and expects to be able to do so in the future. While the Company cannot precisely determine the effect of inflation on its operations, the Company does not believe that its operations have been materially affected by inflation during the three most recent years.
EXCHANGE RATES
While the Company receives United States dollars for most of its sales, a significant portion of the Company's inventory purchases are transacted in foreign currencies. Because of the Company's need to maintain adequate levels of inventory, the Company must place large orders for merchandise many months in advance of when it will receive payment for the merchandise from customers. The Company's ability to offer attractive pricing of luxury goods purchased in foreign currency depends in part on the relative exchange rates between the United States dollar and the various foreign currencies. The Company engages in hedging transactions to minimize the effects of fluctuating foreign exchange rates on the Company's results of operations. The Company enters into foreign exchange contracts to hedge against foreign currency fluctuations for purchase commitments and accounts payable denominated in foreign currencies. The Company believes that foreign currency hedging has been effective in minimizing the impact of foreign currency fluctuations on gross margin in prior years and expects to continue this program. See Note 2 of Notes to Consolidated Financial Statements.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Index To Consolidated Financial Statements
Arthur Andersen LLP
Report of Independent Public Accountants
To Little Switzerland, Inc.:
We have audited the accompanying consolidated balance sheets of Little Switzerland, Inc. (a Delaware corporation) and subsidiaries as of May 30, 1998 and May 31, 1997, and the related consolidated statements of operations, changes in stockholders' equity and cash flows for each of the fiscal years ended May 30, 1998, May 31, 1997 and June 1, 1996. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance that the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Little Switzerland, Inc. and subsidiaries as of May 30, 1998 and May 31, 1997, and the results of their operations and their cash flows for each of the fiscal years ended May 30, 1998, May 31, 1997 and June 1, 1996, in conformity with generally accepted accounting principles.
As explained in Note 2 to the consolidated financial statements, effective June 1, 1997, the Company changed its method of accounting for start-up activities.
/s/ Arthur Andersen LLP
Boston, Massachusetts August 3, 1998
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(In Thousands, Except Per Share Amounts)
The accompanying notes are an integral part of these consolidated financial statements.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
(In Thousands, Except Per Share Amounts)
The accompanying notes are an integral part of these consolidated financial statements.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
(In Thousands)
The accompanying notes are an integral part of these consolidated financial statements.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In Thousands)
The accompanying notes are an integral part of these consolidated financial statements.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes To Consolidated Financial Statements May 30, 1998
(1) Organization
Little Switzerland, Inc. (the Company) was incorporated in May 1991. A wholly owned subsidiary of Town & Country Corporation (Town & Country) contributed to the Company all of the outstanding shares of L.S. Holding, Inc. and L.S. Wholesale, Inc. in exchange for 10,000,000 shares of the Company's Common Stock. On June 3, 1991, the Company declared an 84 for 100 reverse stock split resulting in outstanding shares of Common Stock of 8,400,000.
L.S. Holding, Inc. was incorporated in July 1980 and, as of May 30, 1998, had 10 operating subsidiaries: Montres et Bijoux, S.A.R.L.; World Gifts Imports N.V.; L.S. Holding (Aruba) N.V.; L.S. Holding (Curacao) N.V.; Little Switzerland (St. Kitts & Nevis) Limited; Little Switzerland (Antigua) Limited; Little Switzerland (St. Lucia) Limited, Little Switzerland (BVI) Limited, L.S. Holding (USA), Inc. and World Gift Imports (Barbados) Limited, (Note 3) which operate retail stores in the Virgin Islands, Aruba, St. Kitts, Antigua, St. Lucia, the French and Netherlands Antilles, and Barbados. Little Switzerland (BVI) Limited, incorporated in the British Virgin Island, was not yet in operation at May 30, 1998. L.S. Wholesale, Inc. was incorporated in October 1987 and purchases inventory for distribution to L.S. Holding, Inc.'s retail stores.
In July 1991, the Company completed an initial public offering (the Offering) whereby Switzerland Holding Inc., a wholly owned subsidiary of Town & Country, sold 5,700,000 shares of the Company's Common Stock at $12 per share. Switzerland Holding, Inc. received all of the proceeds and paid substantially all of the costs of the Offering.
Subsequent to the Offering, Switzerland Holding Inc. owned 2,700,000 shares of the Company's Common Stock (approximately 32% of the issued and outstanding Common Stock as of May 31, 1994) which were not registered in the Offering. In connection with the consummation of the recapitalization of Town & Country in May 1993 (the Recapitalization), Switzerland Holding Inc. was dissolved and 2,533,279 shares of the Company's Common Stock were transferred to a trust (the Trust) established for the benefit of Town & Country and the holders of Town & Country's Exchangeable Preferred Stock (the T&C Exchangeable Preferred Stock). Each holder of a share of T&C Exchangeable Preferred Stock may exchange such share for one share of the Company's Common Stock held in the Trust.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
In November 1994, holders of an aggregate of 2,381,038 shares of Town & Country Exchangeable Preferred Stock exercised their right to exchange such shares for Little Switzerland Common Stock on a share-for-share basis. Accordingly, as of May 30, 1998, the Trust held 127,217 shares of Little Switzerland Common Stock for the benefit of Town & Country and the holders of Town & Country Exchangeable Preferred Stock.
Merger Agreement
On February 4, 1998, the Company entered into an Agreement and Plan of Merger (the Merger) with Destination Retail Holdings Corporation (DRHC) and certain subsidiaries, pursuant to which each stockholder of the Company would receive $8.10 in cash for each share of common stock held as of the effective date of the merger. In addition, the holders of an option to purchase common stock would receive, in cash, the difference between $8.10 and the option's exercise price. The consummation of the Merger was subject to certain conditions, including, among other provisions, approval by the Company's stockholders. The Company's stockholders approved the Merger at a Special Meeting of Stockholders on May 8, 1998. On June 9, 1998, the Company terminated its merger agreement with DRHC (see Note 14).
(2) Summary of Significant Accounting Policies
Presentation
The accompanying consolidated financial statements include the operations of the Company and its wholly owned subsidiaries, L.S. Holding, Inc. and L.S. Wholesale, Inc. Certain reclassifications have been made to prior years' consolidated financial statements to conform to the May 30, 1998 presentation. All significant intercompany balances have been eliminated in consolidation. The Company's fiscal year ends on the Saturday closest to May 31.
Risks and Uncertainties
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.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
Foreign Operations
Net sales and operating income (loss) from foreign operations (non-U.S. possessions) amounted to 61%, 62% and 61%, and 162%, 22% and 174% of total net sales and operating income (loss), respectively, in fiscal 1998, 1997 and 1996, respectively. Intersegment sales were not material for all periods presented. Identifiable assets of foreign operations amounted to 56%, 63% and 53% of total assets as of May 30, 1998, May 31, 1997 and June 1, 1996, respectively.
Inventory
Inventory is valued at the lower of cost (first-in, first-out) or market value and consists almost entirely of finished merchandise purchased for resale.
Advertising
The Company expenses the costs of advertising as advertisements are printed and distributed. The Company's advertising consists primarily of advertisements with local and national travel magazines, which are produced on a periodic basis and are distributed to visiting tourists. Additionally, fees are expensed as paid for promotional "port lecturer" programs directed primarily at cruise passengers.
Advertising expense for fiscal 1998, 1997 and 1996 was approximately $3,401,000, $3,138,000 and $3,008,000, respectively. Prepaid advertising of approximately $585,000 and $663,000 at May 30, 1998 and May 31, 1997, respectively, is included in the consolidated balance sheets as prepaid expenses and other current assets.
Property, Plant and Equipment
Fixed assets are depreciated over their estimated useful lives, principally using the straight-line method. Maintenance and repair costs are charged to expense as incurred. Property, plant and equipment consist of the following:
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
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 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 basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse.
Other Assets
Other assets have consisted primarily of amounts related to noncompetition agreements, preopening and organization costs, rental deposits and the excess of cost over the fair market value of the net assets of the business acquired (goodwill). Amounts related to noncompetition agreements are amortized over the lives of the respective agreements. Amounts related to goodwill and preopening and organization costs are being amortized over periods of up to 10 years (see below).
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. In accordance with the requirements of SFAS No. 121, the Company periodically assesses whether events or circumstances have occurred that may indicate the carrying value of its long-lived assets may not be recoverable. When such events or circumstances indicate the carrying value of an asset may be impaired, the Company uses an estimate of the future undiscounted cash flows to be derived from the asset over the remaining useful life of the asset to assess whether or not the asset is recoverable. If the future undiscounted cash flows to be derived over the life of the asset do not exceed the asset's net book value, the Company recognizes an impairment loss for the amount by which the net book value of the asset exceeds its estimated fair market value. Due to several factors, including the event discussed further in Note 14, the Company recognized an impairment loss relating to the goodwill at the Company's World Gift Imports (Barbados) Limited subsidiary that totaled approximately $2,508,000 during the year ended May 30, 1998. The impairment loss has been classified as a component of selling, general and administrative expense for the year ended May 30, 1998. No other impairment losses were recognized during the year ended May 30, 1998.
Accumulated amortization (including the above write-off) totaled $3,137,193 and $340,821 at May 30, 1998 and May 31, 1997, respectively.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
Cumulative Effect of Change in Accounting Principle
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 has elected to adopt SOP 98-5 as of June 1, 1997. As required by SOP 98-5, the Company has recorded a charge of approximately $235,000 (net of applicable tax) to expense previously capitalized start-up costs. This charge has been classified in the accompanying consolidated financial statements as a cumulative effect of a change in accounting principle.
Foreign Exchange Contracts
The Company enters into foreign exchange contracts to hedge against foreign currency fluctuations for purchase commitments and accounts payable denominated in foreign currencies. Gains and losses on contracts to hedge purchase commitments are included in the cost basis of the related purchases. Gains (losses) of approximately $140,000 and $(296,000), respectively, are included in the inventory balances at May 30, 1998 and May 31, 1997, respectively. The Company had no foreign exchange contracts outstanding at May 30, 1998.
The Company's functional currency, under SFAS No. 52, Foreign Currency Translations, for all foreign locations is the U.S. dollar. Accordingly, all transaction and translation gains and losses are included in the accompanying consolidated income statements. Gains and losses for all periods presented were not material.
The Financial Accounting Standards Board issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, in June 1998. The new statement is effective for fiscal years beginning after June 15, 1999; however, earlier adoption is allowed. The statement requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. The Company has not yet determined the effect that adoption of SFAS No. 133 will have or when the provisions of the statement will be adopted. However, the Company currently expects that, due to its limited use of derivative instruments, the adoption of SFAS No. 133 will not have a material effect on the Company's results of operations or financial position.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
Other Accrued Expenses
Other accrued expenses are comprised of the following:
Fair Value of Financial Instruments
In accordance with the requirements of SFAS No. 107, Disclosures About Fair Value of Financial Instruments, the Company has determined the estimated fair value amounts of its financial instruments using appropriate market information and valuation methodologies. Considerable judgement is required to develop the estimates of fair value; thus, the estimates are not necessarily indicative of the amounts that could be realized in a current market exchange. The Company's financial instruments consist of cash, accounts receivable, accounts payable and bank debt. The carrying value of these assets and liabilities are a reasonable estimate of their fair value at May 30, 1998 and May 31, 1997.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
Net Income per Share
The Company adopted SFAS No. 128, Earnings per Share, effective February 28, 1998. 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 stock method). The weighted average number of shares outstanding, the dilutive effects of outstanding stock options, and the shares under option plans which were antidilutive for the periods included in this report are as follows (in thousands):
Cash Flows
For the purpose of the consolidated statements of cash flows, the Company considers all highly liquid instruments with a purchased maturity of three months or less to be cash equivalents. The carrying amount of cash and cash equivalents approximates fair value due to the short maturities.
New Accounting Pronouncements
The Financial Accounting Standards Board (FASB) issued SFAS No. 130, Reporting Comprehensive Income, which is required to be adopted by the Company no later than fiscal year 1999. This statement establishes standards for the reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive income is the total of net income and all other nonowner changes in equity. The Company plans to adopt this statement in fiscal year 1999.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
The FASB issued SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information, which is required to be adopted by the Company no later than fiscal year 1999. This statement introduces a new model for segment reporting, called the management approach. The management approach is based on the way that the chief operating decision maker organizes segments within a company for making operating decisions and assessing performance. Reportable segments are defined in any manner in which management disaggregates the company, e.g. based on products and services, geography, legal structure, etc. The Company plans to adopt this statement in fiscal year 1999.
(3) Transactions with Affiliates
The Company enters into a number of transactions with Town & Country. During a portion of fiscal 1998 and all of fiscal years 1997 and 1996, one or more of the Company's Directors was an Executive Officer of Town & Country. The Company purchases a portion of its merchandise from Town & Country and its affiliated companies at prices that management believes approximate arm's-length transactions. Such purchases totaled approximately $560,000, $640,000 and $1,443,000 in fiscal 1998, 1997 and 1996, respectively.
(4) Credit Arrangements
The Company has available a total of $19.7 million in unsecured credit facilities, of which $7.5 million is available for borrowing with maturities ranging from one to three years from May 30, 1998. Any unfunded portion of the facilities can be withdrawn at the bank's discretion. These credit facilities with the Company's two lead banks are renewable at the Bank's discretion during the second and third quarters of fiscal 1999. Management anticipates that these credit facilities will be renewed, however, it has no assurance that such renewals will be granted. Outstanding borrowings against these credit facilities totaled $7.8 million and $8.1 million as of May 30, 1998 and May 31, 1997, respectively. Outstanding letters of credit against these credit facilities totaled $4.1 million and $3.6 million as of May 30, 1998 and May 31, 1997, respectively. Additionally, in February 1996, the Company secured term debt of approximately $8.9 million from its two lead banks to finance its 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 May 30, 1998 and May 31, 1997, the principal outstanding on the term debt was approximately $6.1 million and $8.3 million respectively. As of May 30, 1998, the Company was in compliance with, or had obtained waivers for, all restrictive covenants related to its unsecured and term debt arrangements. Additionally, the Company has available separate facilities for foreign exchange contracts. The weighted average interest rates incurred during fiscal 1998, 1997 and 1996 were approximately 8.1%, 7.9% and 6.5%, respectively.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
(5) Income Taxes
The domestic (United States Virgin Islands USVI, and Ketchikan, Juneau and Skagway, Alaska) and foreign components of income (loss) before income taxes and cumulative effect of change in accounting principle are as follows:
The components of the provision (benefit) for income taxes are as follows:
The deferred tax provision (benefit) results primarily from the use of different depreciation methods for financial reporting and tax purposes as well as the difference in timing as to when insurance recoveries are taxable and when they are recorded as income in the financial statements.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
The Company's effective tax rate is less than the USVI statutory rate of 37.4% due to the following:
The lower tax rate in effect on certain of the income of a subsidiary in the USVI expires, subject to renewal, in calendar 1998 and had the effect of increasing earnings per share by $0.22, $0.12 and $0.12 in fiscal 1998, 1997 and 1996, respectively. The Company has applied for renewal of this lower rate with a decision expected to be reached in the second fiscal quarter of 1999.
The deferred tax liability of $202,000 and $186,000 at May 30, 1998 and May 31, 1997, respectively, is the result of the use of accelerated depreciation methods for tax purposes as well as the difference in timing as to when insurance proceeds are taxable and when they are recorded as income in the financial statements. The Company's only deferred tax assets consist of net operating loss carryforwards of certain subsidiaries totaling approximately $5,025,000 and $1,756,000 as of May 30, 1998 and May 31, 1997, for which a full valuation reserve has been recorded. The valuation allowance relates to uncertainty surrounding the realizability of the deferred tax assets in excess of the deferred tax liabilities, principally the net operating loss carryforwards. For tax reporting purposes, the Company has net operating loss carryforwards of approximately $8,188,000 and $2,402,000 as of May 30, 1998 and May 31, 1997, respectively. Utilization of the net operating loss carryforward is contingent on the Company's ability to generate income in future years. The net operating loss carryforwards will expire from 2011 to 2013 if not utilized.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
(6) Commitments and Contingencies
Lease Commitments
Certain of the Company's facilities and retail stores are occupied under operating leases expiring at various dates. The Company's rental commitments under the noncancelable portion of these leases for each of the next five years and, in total, thereafter at May 30, 1998 are as follows:
Rental expense included in the accompanying consolidated statements of operations amounted to approximately $4,104,000, $4,167,000 and $3,345,000 in fiscal 1998, 1997 and 1996, respectively.
The Company owns the building which houses its headquarters and warehouse on St. Thomas and leases the underlying real property from the Virgin Islands Port Authority under a ten-year ground lease which expires in April 2000. The ground lease is subject to two five-year renewal terms and may be terminated by the lessor prior to the expiration of its term subject to payment to the Company of the fair market value of the Company's improvements.
Transactions with Affiliates
Prior to the Company's initial public offering, Town & Country and several of its wholly-owned subsidiaries had supplied the Company with jewelry. Pursuant to written agreements entered into between Town & Country and each of its subsidiaries and the Company, the subsidiaries have continued to supply jewelry to the Company at the Company's option on the same terms and conditions as were in effect prior to the initial public offering (Note 1). These agreements are automatically renewed each year unless either party terminates upon 60 days' notice prior to the end of a year.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
Legal
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. to Aruba. During 1998, the Company met with the tax authorities in Aruba. The authorities have decided to focus on the Company's 1995-1996 local income tax returns. The outcome of this matter is uncertain, and as a result, management is not able to quantify the related financial exposure, if any, at this time. However, in the opinion of management of the Company, this assessment should not result in a final judgment which would have a material adverse effect on the Company's financial condition or results of operations.
The Company is also party to various pending legal claims and proceedings (see Notes 13 and 14). In the opinion of management of the Company, these suits and claims should not result in final judgments or settlements which, in the aggregate, would have a material adverse effect on the Company's financial condition or results of operations.
Relationship with Rolex
The Company had historically ordered and received products from Montrex Rolex, S.A. and its affiliates (collectively, Rolex) during most months of the year. Following execution of the merger agreement with DRHC, Rolex suspended shipments of its products to the Company and indicated that it did not believe it would be in its best interest to begin a business relationship with DRHC. The Company received its last shipment of Rolex products in January 1998.
Sales of Rolex watches accounted for 26%, 24% and 23% of the Company's sales for fiscal 1998, 1997, and 1996, 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. On July 15, 1998, the Company announced that it had learned that Rolex had decided not to resume shipments to the Company (see Note 14).
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
(7) Franchise Agreement
In fiscal 1988, the Company entered into a 10-year franchise agreement with Solomon Brothers Limited (Solomon), a Bahamian company engaged in the wholesale and retail distribution of jewelry, gift items and consumables in the Bahamas. The Company signed a new franchise agreement with Solomon, effective November 1, 1996, with a two year term and option to renew for an additional two years. Solomon is responsible for developing each store, in accordance with the Company's specifications, once a new location has been agreed upon. The Company provides ongoing assistance in retail and merchandising methods. Solomon is responsible for the operation of each store, but the general operating methods are dictated by the Company. Currently, Solomon operates eight locations in the Bahama Islands under the name of Little Switzerland.
In return for the use of the Little Switzerland name and the services provided by Little Switzerland, the Company receives an annual franchise fee which enables the Company to participate in the revenue of both Little Switzerland stores operated by Solomon and other Solomon retail stores which are not operated under the Little Switzerland name. Franchise fees are accrued by the Company as earned based upon Solomon's revenues, as defined, or a minimum annual fee of $100,000. These fees totaled approximately $100,000 for fiscal 1998, 1997 and 1996 (see Note 14).
(8) Employee Benefit Plans
The Company provided a tax-qualified discretionary contribution retirement plan for eligible USVI employees to which the Company, at its discretion, contributed. Each employee became a participant following completion of one year's employment, or, if later, the attainment of age 21. All participants became fully vested after seven years of service.
Effective June 1, 1996, the Company replaced its Discretionary Contribution Plan with a 401(k) Plan under which the Company matches each employee's contribution up to 50% of the first 3% of the employee's contribution. During fiscal 1998, 1997 and 1996 the Company's matching totaled approximately $86,000, $82,000 and $92,000, respectively. The Company's contributions vest based on the employee's years of service, with full vesting after five years of service.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
(9) Quarterly Data (Unaudited)
The following presents the unaudited quarterly results of operations for the fiscal years ended May 30, 1998 and May 31, 1997 (in thousands except per share data):
(10) Stockholders' Equity
Stock Options
During 1991, the Company established the 1991 Option Plan to cover option awards to key employees and directors who are also full time employees of the Company. Under this plan, the Company may grant stock options for the purchase of up to 500,000 shares of the Company's Common Stock at an exercise price equal to the fair market value of the Common Stock on the date of grant. During 1996, the Company amended the 1991 Option Plan to increase the aggregate number of shares of the Common Stock of the Company available for grant under the Plan from 500,000 to 900,000. As of May 30, 1998, 612,000 option shares were outstanding under the 1991 Plan. Options granted under the Plan vest ratably over a three to five year period and must be exercised within ten years of the date of grant. Each outstanding unvested option automatically vested upon the execution of the merger agreement with DRHC pursuant to the terms of the 1991 Option Plan.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
During 1992, the Company established the 1992 Option Plan for nonemployee directors of the Company. Under this plan, the Company may grant stock options for the purchase of up to 150,000 shares of the Company's Common Stock at an exercise price equal to the fair market value of the Common Stock on the date of grant. As of May 30, 1998, 100,000 option shares have been granted and were outstanding under the 1992 Option Plan. Options granted under the 1992 Option Plan vest immediately and must be exercised within 10 years of the date of grant.
A summary of the status of the Company's stock option plans at May 30, 1998, May 31, 1997 and June 1, 1996, together with changes during the periods then ended, are presented in the following table:
Statement of Financial Accounting Standards No. 123 (SFAS No. 123)
During 1995, the FASB issued SFAS No. 123, Accounting for Stock Based Compensation, which defines a fair value based method of accounting for an employee stock option or similar equity instruments and encourages all entities to adopt that method of accounting for all of their employee stock compensation plans.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
The Company has elected to account for its stock-based compensation plans under APB No. 25; however, the Company has computed for pro forma disclosure purposes the value of all options granted during fiscal 1998, 1997 and 1996, using the Black-Scholes option pricing model as prescribed by SFAS No. 123 and the following weighted average assumptions used for grants:
Adjustments are made for options forfeited prior to vesting. As a result of the Merger Agreement, all options under the 1991 Option Plan became fully vested and exercisable. The total value of options granted during fiscal 1996, 1997 and 1998, which were being amortized on a straight-line basis over the vesting period of the options, was accelerated into fiscal year 1998. The weighted average fair value of options granted during fiscal years 1998, 1997 and 1996 was $3.25, $2.78 and $2.30, respectively. If the Company had accounted for these plans in accordance with SFAS No. 123, the Company's net income and earnings per share would have been reduced to the following pro forma amounts:
Employee Stock Purchase Plan
During 1992, the Company approved an Employee Stock Purchase Plan permitting eligible employees to purchase Common Stock, semiannually on June 30 and December 31, at the average trading price during the six-month period, but not less than specified minimums. Under this plan, 26,259 shares have been issued as of May 30, 1998.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
Shareholder Rights Agreement
On July 24, 1991, the Board of Directors adopted a Shareholder Rights Plan and declared a dividend distribution of one preferred stock purchase right for each outstanding share of Common Stock to stockholders of record as of the close of business on July 25, 1991. Such rights only become exercisable, and transferable apart from the Common Stock upon the earliest to occur of (i) 10 business days after the first public announcement that a person or group of affiliated or associated persons has acquired beneficial ownership of 15% or more of the outstanding shares of Common Stock (an Acquiring Person) (the date of the public announcement is hereinafter referred to as the Stock Acquisition Date); (ii) 10 business days following the commencement of tender or exchange offer that would result in a person or group becoming an Acquiring Person; or (iii) the declaration by the Board of Directors that any person is an Adverse Person. A Grandfathered Person (as defined below) shall not become an Acquiring Person unless such Person shall become the beneficial owner of more than the Grandfathered Percentage (as defined below) of the outstanding shares of Common Stock. In the event that a person becomes an Acquiring Person or the Board of Directors determines that a person is an Adverse Person, proper provision will be made so that each holder of a Right will thereafter have the right to receive upon exercise that number of Units of Series A Preferred Stock having a market value of two times the exercise price of the Right. In the event that, at any time following the Stock Acquisition Date, the Company is acquired in a merger or other business combination transaction or 50% of the Company's assets or earning power is sold, the rights entitle holders to acquire common stock of the acquiring company having a value equal to two times the exercise price of the rights (such right is referred to as the Merger Right). The rights may be redeemed in whole by the Company at $.01 per right at any time prior to (i) the date on which a person is declared an Adverse Person, (ii) the 10th business day after the Stock Acquisition Date or (iii) the occurrence of an event giving right to a Merger Right. The rights will expire on July 24, 2001.
A Grandfathered Person is generally defined as any person who or which, together with its affiliates and associates, was, as of the close of business on July 25, 1991, the beneficial owner of 15% or more of the shares of Common Stock then outstanding. The Grandfathered Percentage is generally defined as the percentage of outstanding shares of Common Stock beneficially owned by a Grandfathered Person as of the close of business on July 25, 1991 plus an additional two percentage points.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
(11) Acquisitions
On February 16, 1996, World Gift Imports (Barbados), Inc., a subsidiary of LS Holding, Inc. which is a subsidiary of the Company, purchased the leasehold rights, fixtures and inventories of two retail stores located in Barbados, West Indies from Dacosta Mannings Inc., a subsidiary of Barbados Shipping & Trading Company Limited. The two stores were previously operated under the name of Louis Bayley and sold merchandise similar to that carried in the Company's retail stores such as name brand watches, jewelry, china, crystal and gift items at duty free prices. The Company began operating the two stores as Little Switzerland stores on February 19, 1996.
The purchase price of approximately $10.6 million was financed by bank borrowing provided by the Company's two primary banks, Chase Bank and Bank of Nova Scotia, of approximately $9 million and the issuance of preferred stock of approximately $1.6 million by World Gift Imports (Barbados), Limited to the seller. The preferred stock has been presented as a minority interest in a consolidated subsidiary in the accompanying financial statements. The purchase price is subject to adjustment three and four years after the closing date, based on the sales performance of the two purchased stores and any additional stores that may be opened by the Company in Barbados during that period. No dividends or interest are paid or accrued on the preferred stock. The Company pays to the seller a management fee of 2.5% of its Barbados stores annual sales up to $15 million and 1.25% of annual sales in excess of $15 million, so long as the preferred stock is unredeemed. These management fees totaled approximately $202,000 $190,000 and $55,000 for the fiscal 1998, 1997 and 1996, respectively, and are included in selling, general and administrative expenses in the accompanying consolidated statements of operations. The preferred stock may be redeemed by the Company at face value at any time after three years from the date of close through nine years from the date of close. Following that period, the Company retains the right of first refusal to match any bona fide offer from a third party to purchase the preferred stock.
The transaction was accounted for as a purchase transaction whereby the purchase price, including transactions costs, was allocated to the tangible and intangible assets acquired, based on their estimated fair value as of February 16, 1996.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
Unaudited pro forma operating results of the Company for the year ended June 1, 1996 as adjusted for the debt financing and estimated effects of the acquisition as if it had occurred on June 1, 1995, are as follows:
(12) Gain on Insurance Proceeds
In September 1995, Hurricanes Luis and Marilyn inflicted damage on several of the Company's stores and caused significant damage to various islands' infrastructures, including hotels and other tourist facilities. All damaged stores had reopened by November 30, 1996.
The Company settled all outstanding claims related to the hurricanes with its insurance carrier. In connection with the final settlement, the Company received approximately $13.4 million in property and business interruption 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. Approximately $560,000 of deferred income as of June 1, 1996 representing fiscal 1997 lost profits for the Marigot store, was recorded as income in the Company's consolidated statement of income for fiscal 1997.
(13) Employee Defalcation Loss
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.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
The estimated loss of approximately $2.4 million is recorded in general and administrative expense in the accompanying 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 with a maximum claim limitation of $1 million. A claim for the full amount of the loss was submitted and payment of $1 million was 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 has classified the settlement from its insurance carrier as a credit to selling, general and administrative expense for the year ended May 30, 1998. The legal and accounting costs associated with this matter amounted to approximately $646,000 and have been recorded in selling, general and administrative expense in the accompanying consolidated financial statements for the fiscal year ended May 30, 1998.
(14) Subsequent Events
Termination of Merger Agreement
On June 9, 1998, the Company announced it had terminated its merger agreement with DRHC because of DRHC's inability to raise the financing necessary to complete the merger.
On June 10, 1998, the Company filed a civil action against DRHC, DRHC's owner and some of DRHC's corporate affiliates in Delaware federal court, alleging breach of the Agreement and Plan of Merger, dated February 4, 1998, as well as claims of misrepresentation and civil conspiracy. The Company is seeking substantial monetary damages, including, without limitations, consequential damages relating to the impairment of its business.
The costs associated with this matter, which consist primarily of legal and investment banking fees, amounted to approximately $2.7 million and have been recorded in selling, general and administrative expense in the accompanying consolidated financial statements for the fiscal year ended May 30, 1998.
LITTLE SWITZERLAND, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements May 30, 1998
(Continued)
Relationship with Rolex
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. Sales of Rolex products accounted for approximately 26%, 24% and 23% of Little Switzerland's total retail sales during fiscal 1998, 1997 and 1996, respectively. Little Switzerland has announced that it is actively exploring opportunities for expanding existing and adding new, world class product lines in both watches and jewelry. The Company believes that the loss of Rolex will have a material adverse effect on the Company's results of operations for the fiscal year ending May 29, 1999 and beyond.
Termination of Franchise Agreement
On July 21, 1998, the Company and Solomon mutually agreed to terminate the franchise agreement as of November 1, 1998.
Governance
On August 14, 1998, the Company announced the resignation of its President and Chief Executive Officer, John E. Toler, Jr., effective August 31, 1998. At the request of the Company's Board of Directors, Mr. Toler will remain a Director of the Company until the next annual stockholders' meeting. Mr. C. William Carey, Chairman of the Board of Directors, will act as interim Chief Executive Officer until such time as a successor is identified.
Mr. Toler's options, all of which are fully vested, to purchase 300,000 shares of the Company's common stock at $3.50 have been extended and can be exercised through September 1, 2000.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The firm of Arthur Andersen LLP has served as the Company's independent public accountants since its incorporation and has served as the accountant for certain of its subsidiaries since 1980. Accordingly, there have been no changes in the Company's accountants during the two most recent fiscal years and no material disagreements between the Company and its accountants.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS
The information called for by Item 10 is incorporated herein by reference to the Company's Definitive Proxy Statement for the 1998 Annual Meeting.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 11 is incorporated herein be reference to the Company's Definitive Proxy Statement for the 1998 Annual Meeting.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 12 is incorporated herein by reference to the Company's Definitive Proxy Statement for the 1998 Annual Meeting.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 13 is incorporated herein by reference to the Company's Definitive Proxy Statement for the 1998 Annual Meeting.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(1) Financial Statements
The financial statements filed as part of the report are listed on the Index to Consolidated Statements on page 17.
(2) Financial Statement Schedules
All schedules for which provision is made in the applicable accounting regulations of the Security and Exchange Commission are not required under the related instructions or are not material, and therefore have been omitted.
(c) Exhibits:
(3) Articles of Incorporation and By-Laws:
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.
(10) Material Contracts
10.1 The Little Switzerland, Inc. 1991 Stock Option Plan is incorporated herein by reference to Exhibit 10.1 to Amendment No. 1 to the Form S-1;
10.15 The Little Switzerland, Inc. 1992 Non-Employee Directors' Nonqualified Stock Option Plan is incorporated herein by reference to Exhibit 10.17 to the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission on May 26, 1993;
10.16 Employment Agreement between William Canfield and the Company is incorporated herein by reference to Exhibit 10.16 of the 10-K Report for the year ended May 31, 1995;
10.17 Form of Income Continuance Agreement between Ronald J. Lataille and the Company and Denis X. Comment and the Company is incorporated herein by reference to Exhibit 10.17 of the 10-K Report for the year ended May 31, 1994;
10.18 Asset Purchase Agreement by and among World Gift Imports (Barbados) Ltd. as Buyer, Dacosta Mannings Inc., as Seller and Barbados Shipping & Trading Company Limited dated as of December 28, 1995 is incorporated herein by reference to Item 7(c) of the 8-K report filed February 16, 1996;
10.19 Employment agreement between John E. Toler, Jr. and the Company is incorporated herein by reference to Exhibit 10.19 of the 10-K Report for the year ended June 1, 1996.
10.20 Consulting Agreement between C. William Carey and the Company is incorporated herein by reference to Exhibit 10.20 of the 10-K/A Report for the year ended May 31, 1997.
10.21 Employment Agreement, dated as of November 12, 1997, between Thomas S. Liston and the Company is filed herewith as Exhibit 10.21.
10.22 First Amendment to Employment Agreement, dated as of June 14, 1998, between Thomas S. Liston and the Company is filed herewith as Exhibit 10.22.
10.23 Letter Agreement, dated as of August 14, 1998, between the Company and John E. Toler, Jr. is filed herewith as Exhibit 10.23.
10.24 Franchise Agreement, dated as of November 1, 1996, among the Company, L.S. Wholesale, Inc. and Solomon Brothers, Limited is filed herewith as Exhibit 10.24.
10.25 Success Fee Agreement, dated as of February 4, 1998, between the Company and C. William Carey is filed herewith as Exhibit 10.25.
(21) Subsidiaries of Registrant: A list of Subsidiaries of the Company is incorporated herein by reference to Exhibit 21 of the 10-K/A Report for the year ended May 31, 1997.
(23) Consent of Experts and Counsel: Consent of Arthur Andersen LLP is filed herewith as Exhibit 23.
(b) Report on Form 8-K. The registrant filed the following Current Reports on Form 8-K during the three month period ended May 30, 1998:
1. On May 5, 1998, the Company filed a Current Report on Form 8-K announcing that the Company had received correspondence from DRHC's counsel indicating that DRHC's financing commitment letters from DLJ Bridge Finance, Inc. and Donaldson, Lufkin & Jenrette, Inc. had terminated on April 30, 1998.
2. On May 11, 1998, the Company filed a Current Report on Form 8-K announcing that the Agreement and Plan of Merger, dated as of February 4, 1998, with DRHC and certain of DRHC's subsidiaries and the transactions contemplated thereby had been adopted by the requisite affirmative vote of the Company's stockholders at the Special Meeting of the Stockholders held on May 8, 1998.
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) 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, this 28 day of August, 1998.
Little Switzerland, Inc.
By: /s/ John E. Toler, Jr. ----------------------- John E. Toler, Jr. Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated and on the dates indicated.
Signatures Title Date Signed - ---------- ----- -----------
/s/ Thomas S. Liston Chief Financial Officer, August 28, 1998 - -------------------- Vice President and Thomas S. Liston Treasurer (Principal Financial and Accounting Officer)
/s/ C. William Carey Chairman of the Board and August 28, 1998 - -------------------- Director C. William Carey
/s/ Timothy B. Donaldson Director August 28, 1998 - ------------------------ Timothy B. Donaldson
/s/ Ilene B. Jacobs Director August 28, 1998 - ------------------- Ilene B. Jacobs
/s/ Kenneth W. Watson Director August 28, 1998 - --------------------- Kenneth W. Watson
/s/ John E. Toler, Jr. Chief Executive Officer August 28, 1998 - ---------------------- and Director (Principal John E. Toler, Jr. Executive Officer)