UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark one)
ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
		OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended September 30, 2004
		OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
		OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _______ to _______

 

Commission file number 0-13875

 

LANCER CORPORATION

(Exact name of registrant as specified in its charter)

 

 

6655 LANCER BLVD.

SAN ANTONIO, TEXAS

 (Address of principal executive offices)

 

(210) 310-7000

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ý   No o

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).  Yes o   No ý

 

The number of shares of registrant’s common stock outstanding as of October 22, 2004 was 9,426,028.

 

 

PART I

FINANCIAL INFORMATION

 

Item 1.  Financial Statements.

 

LANCER CORPORATION

CONSOLIDATED BALANCE SHEETS

 

(Amounts in thousands, except share data)

 

ASSETS

 

		September 30,			December 31,
		2004			2003
		(Unaudited)
Current assets:
Cash		$	10,478		$	1,129
Receivables:
Trade accounts and notes		17,656			14,226
Other		832			1,268
		18,488			15,494
Less allowance for doubtful accounts		(518		)	(745		)
Net receivables		17,970			14,749
Inventories, net		25,365			24,502
Prepaid expenses		826			474
Tax refund receivable		—			225
Deferred tax asset		547			568
Total current assets		55,186			41,647
Property, plant and equipment, at cost:
Land		1,432			1,432
Buildings		22,261			22,211
Machinery and equipment		23,493			22,769
Tools and dies		10,933			12,709
Leaseholds, office equipment and vehicles		10,605			10,796
Assets in progress		1,518			2,597
		70,242			72,514
Less accumulated depreciation and amortization		(39,862		)	(38,395		)
Net property, plant and equipment		30,380			34,119
Long-term investments		2,505			1,786
Intangibles and other assets, at cost, less accumulated amortization		4,730			4,726
		$	92,801		$	82,278

 

See accompanying notes to consolidated financial statements.

 

 

2

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

 

		September 30,			December 31,
		2004			2003
		(Unaudited)
Current liabilities:
Accounts payable		$	7,677		$	6,609
Current installments of long-term debt		2,743			2,735
Line of credit with bank		—			1,000
Deferred licensing and maintenance fees		369			1,021
Accrued expenses and other liabilities		8,995			6,964
Taxes payable		2,695			—
Total current liabilities		22,479			18,329
Deferred tax liability		1,992			1,175
Long-term debt, excluding current installments		7,107			8,268
Deferred licensing and maintenance fees		1,108			2,396
Other long-term liabilities		36			147
Total liabilities		32,722			30,315
Commitments and contingencies
Shareholders’ equity:
Preferred stock, without par value 5,000,000 shares authorized; none issued		—			—
Common stock, $.01 par value: 50,000,000 shares authorized; 9,480,254 issued and 9,416,028 outstanding in 2004, and 9,426,121 issued and 9,361,895 outstanding in 2003		94			94
Additional paid-in capital		13,054			12,848
Accumulated other comprehensive income (loss)		(329		)	6
Deferred compensation		(40		)	(92		)
Retained earnings		47,660			39,467
Less common stock in treasury, at cost; 64,226 shares in 2004 and 2003		(360		)	(360		)
Total shareholders’ equity		60,079			51,963
		$	92,801		$	82,278

 

 

See accompanying notes to consolidated financial statements.

 

 

3

 

LANCER CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

(Amounts in thousands, except share data)

 

		Three Months Ended							Nine Months Ended
		September 30,				September 30,			September 30,		September 30,
		2004				2003			2004		2003
Net sales		$	31,264			$	30,237		92,467		$	86,481
Cost of sales		22,368				21,855			64,772		64,615
Gross profit		8,896				8,382			27,695		21,866
Selling, general and administrative expenses		7,168				7,722			22,560		20,996
Operating income		1,728				660			5,135		870
Other (income) expense:
Interest expense		204				103			457		427
(Income) loss from joint ventures		(571			)	(427		)	(824	)	60
Other (income) expense, net		(6,796			)	20			(7,115	)	(206		)
		(7,163			)	(304		)	(7,482	)	281
Income from continuing operations before income taxes		8,891				964			12,617		589
Income tax expense (benefit):
Current		3,189				447			4,747		1,328
Deferred		(124			)	(90		)	(323	)	(616		)
		3,065				357			4,424		712
Income (loss) from continuing operations		5,826				607			8,193		(123		)
Discontinued operations:
Loss from operations of discontinued Brazilian subsidiary		—				40			—		160
Income tax benefit		—				(7		)	—		(770		)
(Income) loss from discontinued operations		—				33			—		(610		)
Net earnings		$		5,826		$	574		8,193		$	487
Common Shares Outstanding:
Basic		9,380,558				9,360,893			9,371,993		9,353,912
Diluted		9,506,649				9,431,772			9,480,633		9,460,611
Earnings Per Share:
Basic
Earnings (loss) from continuing operations		$		0.62		$	0.07		0.87		$	(0.01	)
Earnings (loss) from discontinued operations		$		—		$	(0.01	)	—		$	0.06
Net earnings		$		0.62		$	0.06		0.87		$	0.05
Diluted
Earnings (loss) from continuing operations		$		0.61		$	0.07		0.86		$	(0.01	)
Earnings (loss) from discontinued operations		$		—		$	(0.01	)	—		$	0.06
Net earnings		$		0.61		$	0.06		0.86		$	0.05

 

See accompanying notes to consolidated financial statements.

 

 

4

 

LANCER CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

(Amounts in thousands)

		Nine Months Ended
		September 30,			September 30,
		2004			2003
Cash flow from operating activities:
Net earnings		$	8,193		$	487
Adjustments to reconcile net earnings to net cash provided by (used in) operating activities
Depreciation and amortization		3,609			4,087
Deferred licensing and maintenance fees		(488		)	(419		)
Deferred income taxes		829			(776		)
Loss (gain) on sale and disposal of assets		(622		)	55
Loss on impairment of Assets		405			—
Gain on sales of long-term investment		—			(220		)
(Income) loss from joint ventures		(824		)	59
Stock-based compensation expense		52			56
Changes in assets and liabilities:
Receivables		(3,401		)	2,714
Prepaid expenses		(352		)	(623		)
Income taxes receivable		225			(2,505		)
Inventories		(968		)	2,806
Other assets		(195		)	(446		)
Accounts payable		1,382			(2,832		)
Accrued expenses		1,907			267
Income taxes payable		2,694			(161		)
Net cash provided by operating activities		12,446			2,549
Cash flow from investing activities:
Proceeds from sale of assets		525			28
Acquisition of property, plant and equipment		(1,488		)	(3,059		)
Proceeds from sale of long-term investments		—			319
Net distributions from joint ventures		105			—
Net cash used in investing activities		(858		)	(2,712		)
Cash flow from financing activities:
Net borrowings under line of credit agreements		(1,000		)	(300		)
Retirement of long-term debt, net of proceeds		(1,153		)	(1,147		)
Net proceeds from exercise of stock options		207			135
Net cash used in financing activities		(1,946		)	(1,312		)
Effect of exchange rate changes on cash		(293		)	209
Net increase (decrease) in cash		9,349			(1,266		)
Cash at beginning of period		1,129			3,241
Cash at end of period		$	10,478		$	1,975
Supplemental cash flow informaton:
Cash paid for interest		$	958		$	427
Cash paid (refunded) for income taxes		—			—

 

See accompanying notes to consolidated financial statements.

 

 

5

LANCER CORPORATION

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1.  Organization and Basis of Presentation.

 

Lancer Corporation (the “Company”) designs, engineers, manufactures and markets fountain soft drink and other beverage dispensing systems and related equipment for use in the food service and beverage industry. The Company sells its products through Company personnel, and through independent distributors and agents, principally to major soft drink companies (primarily The Coca-Cola Company, which influences substantially more than half of the Company’s sales), bottlers, equipment distributors, beer breweries and food service chains for use in various food and beverage operations. Lancer is a vertically integrated manufacturer, fabricating a significant portion of the components used in Company products.  Lancer was incorporated in Texas in 1967.

 

The accompanying unaudited consolidated financial statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  In the opinion of management, these financial statements contain all adjustments, consisting of normal recurring accruals unless otherwise disclosed, necessary to present fairly the financial position, results of operations and cash flows for the periods indicated.  Significant accounting policies followed by the Company were disclosed in the notes to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, and no material changes have occurred with respect to these policies.  The year-end consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States.  The consolidated results of operations for the periods reported are not necessarily indicative of the results to be experienced for the entire current year.

 

Certain amounts in the consolidated financial statements for prior periods have been reclassified to conform with the current year’s presentation.

 

 

2.              New Accounting Pronouncements.

 

In December 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46 (revised December 2003) (“Interpretation 46”), “Consolidation of Variable Interest Entities.”  Application of this interpretation is required in our financial statements for interests in variable interest entities that are considered to be special-purpose entities for the year ended December 31, 2003.  The Company determined that it does not have any arrangements or relationships with special-purpose entities.  Application of Interpretation 46 for all other types of variable entities is required for our Company effective March 31, 2004.

 

SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities,” issued in April 2003, amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities.”  SFAS No. 149 is generally effective for contracts entered into or modified after June 30, 2003.  The adoption of SFAS No. 149 did not have a material impact on the Company’s financial statements.

 

SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” issued in May 2003, establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity.  The Statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities.  The adoption of SFAS No. 150 did not have a material impact on the Company’s financial statements.

 

 

6

 

3.  Discontinued Operations.

 

During the quarter ended June 30, 2002, the Company decided to close its Brazilian subsidiary. Accordingly, the Company has reported the results of operations of the Brazilian subsidiary as discontinued operations in the Consolidated Statements of Operations.

 

Certain information with respect to the discontinued Brazilian operation for the three months and nine months ended September 30, 2004 and 2003 is as follows (amounts in thousands):

 

		Three Months Ended						Nine Months Ended
		September 30,			September 30,			September 30,			September 30,
		2004			2003			2004			2003
Net sales		$	—		$	—		$	—		$	—
Pretax loss from discontinued operations		—			40			—			160
Income tax benefit		—			(7		)	—			(770		)
(Income) loss from discontinued operations		$	—		$	33		$	—		$	(610	)

 

During the first quarter of 2003, the IRS completed its audit of the Company’s deduction of its investment in the Brazilian operations, and other matters.  As a result, the Company reversed certain tax accruals resulting in a tax benefit of  $0.7 million from discontinued operations for the year ended December 31, 2003.  See Note 8 — Income Taxes, below.

 

Assets and liabilities of the discontinued operation are as follows (amounts in thousands):

 

		September 30,				December 31,
		2004				2003
Current assets		$		—		$	—
Property, plant and equipment, net		—				—
Current liabilities		(1,227			)	(1,208			)
Net liabilities of discontinued operation		$	(1,227		)	$		(1,208	)

 

Current liabilities include a $1.196 million principal amount of debt payable in relation to the Company’s discontinued Brazilian operations that was due on December 31, 2001.  The Company has not repaid the debt, pending discussions with the payee relating to settlement of the debt, but has recorded the balance of the debt, plus interest accrued through September 30, 2004, in its financial statements.  During the second quarter of 2003, the payee demanded payment of the debt.  The Company has not paid the debt, but has chosen to continue to discuss the status of the debt in an attempt to reach a settlement.  The Company can make no assurance that it will be successful in negotiating such a settlement of the debt.  The Company believes that it has the liquidity available to pay the debt if the circumstances so require, assuming that the Company’s ability to access cash through its credit facility remains unimpeded. Nonpayment of a material obligation is an event of default under the Company’s Amended and Restated Credit Agreement (the “Current Credit Agreement”).  The Company’s Current Credit Agreement provides, however, that non-payment of this debt shall not be an event of default, unless additional collection actions are commenced and non-payment by Lancer continues for more than twenty (20) business days after Lancer has knowledge of the additional collection action.

 

 

4.   Inventory Components.

 

Inventories are stated at the lower of cost (on a first-in, first-out basis for finished goods and work in process, and an average cost basis for raw materials and supplies) or market. Inventory components are as follows (amounts in thousands):

 

 

7

 

		September 30,			December 31,
		2004			2003
Finished goods		$	8,594		$		9,327
Work in process		6,287			6,504
Raw material and supplies		10,484			8,671
		$	25,365		$	24,502

 

 

5.   Net Earnings Per Share.

 

Basic earnings per share is calculated using the weighted average number of common shares outstanding and diluted earnings per share is calculated assuming the issuance of common shares for all potential dilutive common shares outstanding during the reporting period.  The dilutive effect of stock options approximated 126,090 and 70,879 shares for the three months ended September 30, 2004 and 2003, respectively.  The dilutive effect of stock options approximated 108,640 and 106,699 for the nine months ended September 30, 2004 and 2003, respectively.

 

 

6.   Stock Compensation Plans.

 

The Company utilizes the intrinsic value method required under provisions of APB Opinion No. 25 and related interpretations in measuring stock-based compensation for employees. If the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by SFAS No. 123, net earnings and net earnings per share would have been adjusted to the pro forma amounts indicated in the table below (amounts in thousands, except share data):

 

		Three Months Ended								Nine Months Ended
		September 30,				September 30,				September 30,			September 30,
		2004				2003				2004			2003
Net earnings - as reported		$		5,826		$	574			$	8,193		$	487
Add: Total stock-based compensation expense determined under the intrinsic value method, net of tax		8				10				35			37
Deduct: Total stock-based compensation expense determined under fair value based method for all awards, net of tax		(18			)	(32			)	(65		)	(89		)
Net earnings - pro forma		$	5,816			$		552		$	8,163		$	435
Net earnings per basic share-as reported		$	0.62			$		0.06		$	0.87		$	0.05
Net earnings per basic share-pro forma		$	0.62			$		0.06		$	0.87		$	0.05
Net earnings per diluted share-as reported		$	0.61			$		0.06		$	0.86		$	0.05
Net earnings per diluted share-pro forma		$	0.61			$		0.06		$	0.86		$	0.05
Weighted-average fair value of options, granted during the period		$	—		(1)	$		—	(2)	$	—	(1)	$	4.16

 

The fair value of each option granted in the three and nine months ended September 30, 2004 and 2003, respectively, is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions:

 

 

8

 

		Three Months Ended				Nine Months Ended
		September 30,		September 30,		September 30,		September 30,
		2004		2003		2004		2003
Expected life (years)		—	(1)	—	(2)	—	(1)	7
Interest rate		—	(1)	—	(2)	—	(1)	3.3	%
Volatility		—	(1)	—	(2)	—	(1)	47.2	%
Dividend yield		None		None		None		None

 

(1) No options were granted during the three and nine months ended September 30, 2004.

(2) No options were granted during the three months ended September 30, 2003.

 

 

7.   Comprehensive Income.

 

The following are the components of comprehensive income (amounts in thousands):

 

		Three Months Ended						Nine Months Ended
		September 30,			September 30,			September 30,			September 30,
		2004			2003			2004			2003
Net earnings		$	5,826		$	574		$	8,193		$	487
Foreign currency gain (loss) arising during the period		395			66			(335		)	1,467
Unrealized gain on investment, net of tax		—			—			—			40
Reclassification adjustment for gain included in other income		—			—			—			(45		)
Comprehensive income		$	6,221		$	640		$	7,858		$	1,949

 

The line item, “Accumulated other comprehensive (income) loss” on the accompanying consolidated balance sheets includes foreign currency gains, unrealized gain (loss) on investment and unrealized loss on derivative instruments.

 

 

8.   Income Taxes.

 

The actual tax benefit for the three and nine months ended September 30, 2004 approximates the “expected” tax expense (computed by applying U.S. Federal corporate rate of 34% to earnings before income taxes). The actual tax benefit for the three and nine months ended September 30, 2003 differs from the “expected” tax expense primarily as a result of the factors described below.

 

In accordance with SFAS No. 109, no federal income taxes had been provided for the accumulated undistributed earnings of the Company’s Domestic International Sales Corporation (the “DISC”) as of December 31, 1992.  On December 31, 1992, the accumulated undistributed earnings of the DISC totaled $2.4 million. During the three months ended March 31, 2003, the Company decided to terminate the DISC election and recorded $0.8 million in income tax expense for the taxes due prior to December 31, 1992.

 

During the first quarter of 2003, the IRS completed its audit of the Company’s deduction of its investment in the Brazilian operations, and other matters.  As a result, the Company reversed certain tax accruals in the three months ended March 31, 2003, resulting in an income tax benefit of $1.1 million. Of this benefit, $0.7 million related to the Brazilian operations was reclassified from tax benefits of continuing operations to tax benefits of discontinued operations for the three months ended March 31, 2003.  See Note 3 — Discontinued Operations, above.

 

 

9

 

9.   Segment and Geographic Information.

 

The Company is engaged in the manufacture and distribution of beverage dispensing equipment and related parts and components.  The Company manages its operations geographically.  Sales are attributed to a region based on the ordering location of the customer.

 

		North			Latin			Asia/
(Amounts in thousands)		America			America			Pacific			Europe			Corporate			Total
Three months ended September 30, 2004
Total revenues		$	20,338		$	1,582		$	6,970		$	2,374		$	—		$	31,264
Operating income (loss)		4,223			170			804			220			(3,689		)	1,728
Three months ended September 30, 2003
Total revenues		$	20,820		$	2,172		$	5,392		$	1,853		$	—		$	30,237
Operating income (loss)		4,709			(210		)	228			(156		)	(3,911		)	660
Nine months ended September 30, 2004
Total revenues		$	59,292		$	4,057		$	19,793		$	9,325		$	—		$	92,467
Operating income (loss)		13,948			(137		)	1,946			1,235			(11,857		)	5,135
Nine months ended September 30, 2003
Total revenues		$	60,032		$	5,863		$	15,086		$	5,500		$	—		$	86,481
Operating income (loss)		10,009			236			832			98			(10,305		)	870

 

All intercompany revenues are eliminated in computing revenues and operating income.  The corporate component of operating income represents corporate general and administrative expenses.

 

 

10.       Product Warranties.

 

The Company generally warrants its products against certain manufacturing and other defects.  These product warranties are provided for specific periods of time from the date of sale.  As of September 30, 2004 and December 31, 2003, the Company has accrued $1.2 million and $0.6 million, respectively, for estimated product warranty claims.  The accrued product warranty costs are based primarily on actual warranty claims as well as current information on repair costs.  Warranty claims expense for the three and nine months ended September 30, 2004 was $0.04 million and $0.29 million, respectively.  Warranty claims expense for the three and nine months ended September 30, 2003 was $0.25 million and $0.70 million, respectively.

 

(Amounts in thousands)
Accrued product warranty costs as of January 1, 2004		$	586
Liabilities accrued for warranties issued during the period		938
Warranty claims paid during the period		(288		)
Accrued product warranty costs as of September 30, 2004		$	1,236

 

 

11.  Other Guaranties.

 

On January 31, 2003, Lancer FBD Partnership, Ltd., a partnership in which the Company owns a 50% partnership interest, obtained a $1.5 million revolving credit facility from a bank.  The Company entered into a Continuing Guarantee Agreement with the lender pursuant to which it guaranteed the repayment of the partnership’s debt.  In accordance with FIN 45, the Company has recorded a liability of $22,500, which represents the estimated value of the guaranty.  As of September 30, 2004, there were no amounts outstanding under the credit facility.

 

 

10

 

On March 5, 2003, Moo Technologies, LLC, a limited liability company in which the Company owns 50% of the outstanding equity, obtained a $0.75 million revolving credit facility from a bank.  The Company entered into a Commercial Guarantee with the lender pursuant to which it guaranteed the repayment of the Moo Technologies, LLC debt.  The Company recorded a liability of $11,250 in 2003, which represents the estimated value of the guaranty.  As of September 30, 2004, the balance of the credit facility was $0.75 million.  Moo Technologies, LLC is a developmental stage company that reported no operating revenue in 2003 and the first nine months of 2004.  Moo Technologies, LLC incurred a net loss of $0.3 million in 2003, and a net loss of $0.4 million in the first nine months of 2004.  The Company invested $0.2 million in Moo Technologies, LLC during the first nine months of 2004, bringing its net investment in the company to $0.3 million as of September 30, 2004.

 

 

12.       Other Matters.

 

In June 2003, the Audit Committee of the Company’s Board of Directors (the “Audit Committee”) began conducting an internal investigation (the “Investigation”). The Investigation was related to allegations raised by a lawsuit against The Coca-Cola Company by a former Coca-Cola employee, Matthew Whitley. Although the Company was not a defendant to the lawsuit, certain allegations contained in the lawsuit specifically involved the Company. The Investigation was later expanded to include allegations raised in certain press articles.

 

The Company’s former independent auditor advised that, until the Investigation was complete, it would not be able to complete its review of the Company’s consolidated financial statements for the second and third quarters of 2003. Therefore, the Company was unable to file its quarterly reports for the second and third quarters of 2003 with the Securities and Exchange Commission (the “SEC”). On December 5, 2003, the Company provided financial information for the second and third quarters of 2003 in exhibits to a Form 8-K, in order to provide information to the investing public while the Investigation continued.

 

The Company’s inability to file its quarterly report for the second quarter of 2003 with the SEC on a timely basis violated the American Stock Exchange (“AMEX”) continued listing standards, specifically Section 1003(d) of the AMEX Company Guide. The Company submitted a formal action plan to regain compliance with AMEX on September 30, 2003 and AMEX accepted the plan on October 8, 2003. After the initial acceptance, the Company revised the plan with the approval of AMEX in order to accommodate new developments, including the Company’s inability to file its annual report on Form 10-K for 2003 and its quarterly report on Form 10-Q for the first quarter 2004.

 

In August 2003, the United States Attorney’s Office for the Northern District of Georgia (the “US Attorney’s Office”) informed the Company that it was conducting an investigation arising from allegations raised in a lawsuit against The Coca-Cola Company by a former Coca-Cola employee, Matthew Whitley, and requested certain information, which the Company supplied. In January 2004, the Company received written notice that the SEC had issued a formal order of investigation that appeared to concern matters which were the subject of the Investigation. The Company has fully cooperated, and intends to continue to cooperate fully, with both the US Attorney’s Office and the SEC investigations. Although the Company is unable at this point to predict the scope or outcome of these investigations, it is possible that it could result in the institution of administrative, civil injunctive or criminal proceedings, the imposition of fines and penalties, and/or other remedies and sanctions.  The conduct of these proceedings could adversely affect the Company’s business. In addition, the Company expects to continue to incur expenses associated with responding to these agencies, regardless of the outcome, and the efforts and attention of the Company’s management team may be diverted from normal business operations. This could adversely affect the business, financial condition, operating results, and cash flow of the Company.

 

On January 30, 2004, the Company announced that the Investigation had concluded and the Audit Committee released a general summary of the Investigation findings. On February 2, 2004, our former auditor resigned from its position and subsequently withdrew its audit reports for the periods ended December 31, 2002, 2001 and 2000, advising the Company that the financial statements and related audit reports should no longer be relied upon. The former auditors stated in a letter to the Company that it had determined that likely “illegal acts”, which had been the subject of the Investigation, had come to its attention and that these illegal acts would have a material effect on the Company’s financial statements. Additionally, our former auditor indicated that information had come to its attention that caused it to conclude that the Company’s accounting for revenue recognition in connection with sales of

 

 

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equipment to Coca-Cola North America Fountain in the years ended December 31, 2001 and 2002 is “not correct” and had raised concerns that the accounting is not correct in each of the three quarters of fiscal year 2003. The Company has filed the letters from its former auditors which outline these assertions and have responded to them in an 8-K, filed with the SEC on February 10, 2004, and two subsequent amendments to that Form 8-K, filed with the SEC on February 24, 2004 and March 10, 2004.

 

On May 14, 2004, a purported class action, cause number 04-CV-427, naming as defendants the Company, George F. Schroeder, David F. Green and The Coca-Cola Company was filed in the United States District Court for the Western District of Texas by TDH Partners. The action alleges that the defendants violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. No specific amount of damages was claimed and the action was voluntarily dismissed by the plaintiff, without prejudice, on July 15, 2004. See “Part II — Other Information — Item 1 — Legal Proceedings.”

 

On March 1, 2004, the Audit Committee engaged BDO Seidman as the Company’s new independent auditor to audit the Company’s financial information for 2003, as well as for prior periods for which the former auditor had withdrawn its audit reports, and to review financial information for prior quarterly periods. This process of audit and review was completed by BDO Seidman on June 16, 2004, which enabled Lancer to file all past due and current periodic reports with the SEC on July 1, 2004 and to regain compliance with Section 1003(d) of the AMEX Company Guide. The reaudit did not result in any adjustment to the Company’s previously disclosed financial statements for the prior periods.

 

Due to its inability to deliver audited financial statements for the year 2003 to its lenders and other events and circumstances, the Company was in default under the terms of the Seventh Amendment and Restated Credit Agreement, as amended (the “Former Credit Agreement”). Due mainly to certain “cross-default” provisions, the Company also came into default under certain of its guaranties and a capital lease.

 

Effective June 30, 2004, the Company and its lenders entered into the Current Credit Agreement.  The known defaults under the Company’s guarantees and capital lease have been waived as of June 30, 2004. For further discussion relating to the Former Credit Agreement and the Current Credit Agreement, see Part I — Financial Information — Item 2 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Debt.”

 

On September 13, 2004, the Company entered into an agreement with The Coca-Cola Company relating to the joint development of the iFountain line of dispensers.  Pursuant to the agreement, The Coca-Cola Company paid Lancer a total of $7.0 million in consideration of (i) Lancer’s engineering, research and development and other costs incurred by Lancer on the project,  (ii) Lancer’s inventory related to the project that could not be used as intended and did not have feasible alternate uses, and (iii) certain covenants and releases relating to the project.  Lancer had previously written-off $1.2 million of inventory associated with the project during the fourth quarter of 2003.  The Company recorded the $7.0 million payment as other income when it received the payment in the third quarter of 2004.

 

 

Item 2 - Management’s Discussion And Analysis Of Financial Condition And Results Of Operations.

 

This report contains certain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The Company desires to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 and is including this statement for the expressed purpose of availing itself of the protection of the safe harbor with respect to all of such forward-looking statements. These forward-looking statements describe future plans or strategies and include the Company’s expectations of future financial results and often include words such as “may,” “will,” “should,” “expect,” “intend,” “estimate,” “anticipate,” “believe,” “predict,” “plan,” “potential,” and “continue,” and the negatives of these terms and variations of them or similar terminology. The Company’s ability to predict results or the effect of future plans or strategies is inherently uncertain and the Company can give no assurance that those results or expectations will be attained. Factors that could affect actual results include but are not limited to:

 

 

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•                  general economic trends;

•                  ability to service its debt;

•                  availability of capital sources;

•                  currency fluctuations;

•                  fluctuations in operating costs;

•                  competitive practices in the industry in which it competes;

•                  changes in labor conditions;

•                  its capital expenditure requirements;

•                  technological changes and innovations;

•                  legislative or regulatory requirements;

•                  operating changes and product needs of its main customer, The Coca-Cola Company;

•                  losses from litigation; and

•                  all other factors described herein under “Risk Factors.”

 

These and other factors should be considered in evaluating the forward-looking statements, and undue reliance should not be placed on such statements.

 

The Company does not undertake and specifically disclaims any obligation to update any forward-looking statements to reflect occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

 

The following discussion should be read in connection with the Company’s Consolidated Financial Statements, related notes and other financial information included elsewhere in this document.

 

 

Overview

 

General.  Lancer Corporation (“Lancer” or the “Company”) designs, engineers, manufactures and markets fountain soft drink, beer and citrus beverage dispensing systems, and other equipment for use in the food service and beverage industry.  The Company also markets frozen beverage dispensers manufactured by Lancer FBD Partnership, Ltd. (“Lancer FBD”), a partnership in which the Company owns a 50% partnership interest.  The Company’s products are sold by Company personnel and through independent distributors and agents principally to major soft drink companies (primarily The Coca-Cola Company, which influences substantially more than half of the Company’s sales), bottlers, equipment distributors, beer breweries, restaurants and convenience stores for use in various food and beverage operations. The Company’s primary manufacturing and administrative facility is located in San Antonio, Texas. The Company has sales employees, distributors, and/or licensees in Latin America, Europe, Africa and Asia. The Company manufactures products in Australia and Mexico, and operates warehouses in Belgium, New Zealand, and the United Kingdom.

 

The Company is a vertically integrated manufacturer whose tooling, production, assembly and testing capabilities enable it to fabricate a substantial portion of the components used in Company products.  In addition, the Company is an innovator of new products in the beverage dispensing industry and has a large technical staff supported by state-of-the-art engineering facilities to develop these new products and to enhance existing product lines in response to changing industry requirements and specific customer demands.

 

 The Company’s products can be divided into four major categories: (i) fountain soft drink, citrus, and frozen beverage dispensers, which includes a broad range of mechanically cooled and ice cooled soft drink and citrus dispensing systems; (ii) post-mix dispensing valves, which mix syrup and carbonated water at a preset ratio; (iii) beer dispensing systems and related accessories; and (iv) other products and services, which includes various dispensing systems and replacement parts in connection with the remanufacturing process.

 

Events. On January 30, 2004, the Company announced that the Audit Committee of its Board of Directors (the “Audit Committee”) had concluded its internal investigation (the “Investigation”) and released a general summary of the Investigation findings. On February 2, 2004, the Company’s former auditor resigned from its position and subsequently withdrew its audit reports for the periods ended December 31, 2002, 2001 and 2000, advising the Company that the financial statements and related audit reports should no longer be relied upon.

 

 

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On March 1, 2004, the Audit Committee engaged BDO Seidman as the Company’s new independent auditor to audit the Company’s financial information for 2003, as well as for prior periods for which the former auditor had withdrawn its audit reports, and to review financial information for prior quarterly periods. This process of audit and review was completed by BDO Seidman on June 16, 2004. The reaudit did not result in any adjustment to the Company’s previously disclosed financial statements for the prior periods.

 

On July 1, 2004, the Company filed the following reports with the SEC: Form 10-K/A for the 2002 fiscal year, Form 10-Q/A for the 2003 first quarter, Forms 10-Q for the 2003 second and third quarters, Form 10-K for the fiscal year 2003 and Form 10-Q for the 2004 first quarter. The filing of these reports enabled the Company to become current in its filing obligations with the SEC and to regain compliance with Section 1003(d) of the AMEX Company Guide.

 

Effective June 30, 2004, the Company and its lenders entered into the new Credit Facility, providing for, among other things a waiver for all past defaults under the prior Credit Facility.  See Part I — Financial Information — Item 2 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Debt.”

 

On September 13, 2004, the Company entered into an agreement (the “Settlement Agreement”) with The Coca-Cola Company relating to the joint development of the iFountain line of dispensers.  Pursuant to the Settlement Agreement, The Coca-Cola Company paid Lancer a total of $7.0 million in consideration of (i) Lancer’s engineering, research and development and other costs incurred by Lancer on the project,  (ii) Lancer’s inventory related to the project that could not be used as intended and did not have feasible alternate uses, and (iii) certain covenants and releases relating to the project.  Lancer had previously written-off $1.2 million of inventory associated with the project during the fourth quarter of 2003.  The Company recorded the $7.0 million payment as other income when it received the payment in the third quarter of 2004.

 

Accounting Policies. The Company has listed what it believes to be its most important accounting policies below.   See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies” and “Note 1 — Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements” contained in the 2003 Annual Report on Form 10-K filed with the SEC on July 1, 2004.

 

Revenue Recognition. Revenue is recognized in accordance with the following methods:

 

(a)           At the time of shipment for all products except for those sold under agreements described in (b).  The Company requires a purchase order for all sales. At the time of the shipment, risk of ownership and title passes to the customer. The goods are completely assembled and packaged and the Company has no further performance obligations.

 

(b)           As produced and at time of title transfer, for certain products manufactured and warehoused under production and warehousing agreements with certain customers.  The Company had no such arrangements after March 31, 2002.

 

(c)           The Company has entered into an agreement with its major customer to receive partial reimbursement for design and development.  The reimbursement is offset against cost on a percentage of completion basis.

 

(d)           The Company has agreed to provide exclusive rights for use of certain tools to its major customer.  These tools are included in fixed assets and are depreciated over the life of the asset.  The corresponding license and maintenance fees are recorded as deferred income and recognized over the life of the agreement, which approximates the life of the corresponding asset.

 

Reserve for Slow Moving and Obsolete Inventory. The Company provides for slow moving inventory based on an analysis of the age and usage of the inventory. Additionally, management evaluates the inventory for obsolescence, and adds to the inventory reserve as appropriate.  The Company believes that the reserve as of September 30, 2004 is adequate to provide for expected losses.

 

 

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Results of Operations

 

Comparison of the Three-Month Periods Ended September 30, 2004 and 2003

 

Non-Recurring Payment:  During the third quarter of 2004, the Company recorded other income of $7.0 million from the Settlement Agreement.

 

Revenues by Geographic Segment

(Amounts in thousands)

 

		Quarter Ended September 30,						% Change
								Third Quarter
		2004			2003			2004 vs 2003
North America		$	20,338		$	20,820		-2	%
Latin America		1,582			2,172			-27	%
Asia/Pacific		6,970			5,392			29	%
Europe		2,374			1,853			28	%
		$	31,264		$	30,237		3	%

 

Revenues.  Net sales for the three months ended September 30, 2004 were $31.3 million, up 3% from sales in the third quarter of 2003.  Currency exchange rate fluctuations had a positive impact of 2% on 2004 third quarter sales.  In the North America region, quarterly sales declined 2% from 2003 levels, due mainly to a decline in the Company’s sales to soft drink bottlers during the third quarter of 2004.  Sales fell 27% in the Latin America region, due mainly to a continued weakening demand for our products in the region.  Market conditions appear likely to remain weak in most of Latin America.  Sales rose 32% in the Asia/Pacific region, including the positive effect of 9% from exchange rate fluctuations.  Most of the improvement in the Asia/Pacific region came in Australia, where beer and fountain equipment sales were strong.  Some of the strength in Australian fountain sales is attributable to a large project for a single customer that is not expected to recur in 2005.  Sales in the Europe region increased 28%, including an 11% positive effect from currency fluctuations.  Valve sales increased in Europe, after production issues with one of the Company’s valve products negatively impacted sales in the Europe region in the 2003 period. Incremental sales in the United Kingdom, where Lancer established an operation in 2003, also contributed to the improvement in the Europe region.

 

Gross Margin.  Gross margin was 28.5% in the third quarter of 2004, compared to 27.7% in the same period last year.  During the third quarter of 2004, the Company incurred a charge of $0.6 million for the impairment of certain inventory.  Additionally, the Company experienced rising costs for certain raw materials including stainless steel and plastic resin.  Those negative factors were more than offset by the positive effects of manufacturing cost reductions, including a reduction in the number of manufacturing employees, improved manufacturing efficiency, and a shift of some operations to a lower cost facility.

 

Operating Expenses.  Selling, general and administrative expenses were $7.2 million in the third quarter of 2004, compared to $7.7 million in the third quarter of 2003.  During the 2004 quarter, professional fees declined $1.1 million from 2003 levels.  The higher spending in 2003 related to the investigations conducted by the Securities and Exchange Commission, the United States Attorney’s Office, and the Audit Committee.  Compensation expense increased $0.7 million in the three months ended September 30, 2004, due mainly to variable compensation accruals based on the Company’s performance in 2004.

 

Non-Operating Income/Expenses.  The following information relates to certain of the Company’s non-operating income and expenses during the three-month periods ended September 30, 2004 and 2003:

 

•                  Other income included $7.0 million paid to Lancer pursuant to the Settlement Agreement.  See Part I — Financial Information — Item 2 — “Management’s Discussion And Analysis Of Financial Condition And Results Of Operations — Overview — Events.”  Additionally, the Company wrote-off certain tooling and related deferred licensing and maintenance fees, resulting in $0.4 million (net) of income.  The Company also wrote-off $0.4 million of tooling from another project, and $0.2 million of capitalized bank facility closing costs during the third quarter of 2004.

 

 

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