10QSB 1 qsb83101.txt SECURITIES AND EXCHANGE COMMISSION Washington DC 20549 FORM 10-QSB Quarterly Report Under Section 13 or 15(d) of the Securities Exchange Act of 1934 For Quarter Ended August 31, 2001 Commission File No. 0-5920 LANCER ORTHODONTICS, INC. (Exact Name of Small Business Issuer as Specified in its Charter) CALIFORNIA 95-2497155 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 253 Pawnee Street, San Marcos, California 92069 (Address of Principal Executive Offices) Issuer's telephone number, including area code: (760) 744-5585 Check whether the issuer: (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act during the preceding 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 X No State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practicable date: 2,098,620 Traditional small business disclosure format (check one): Yes X No PART I. FINANCIAL INFORMATION Item 1. SUMMARIZED FINANCIAL INFORMATION LANCER ORTHODONTICS, INC. CONDENSED BALANCE SHEET (UNAUDITED) 8/31/01 ASSETS CURRENT ASSETS: Cash $ 112,219 Accounts receivable, less allowances for sales returns and doubtful receivables of $172,941 1,219,736 Inventories, net of reserve of $248,201 2,281,270 Prepaid expenses 20,374 Total current assets 3,633,599 PROPERTY AND EQUIPMENT, at cost 2,413,035 Less: Accumulated depreciation (2,343,119) 69,916 INTANGIBLE ASSETS: Marketing and distribution rights, net 78,850 Technology use rights, net 64,903 143,753 OTHER ASSETS 26,935 Total assets $3,874,203 LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 725,102 Accrued payroll and related benefits 93,771 Other current liabilities 66,493 Line of credit 160,000 Total current liabilities 1,045,366 Mandatorily redeemable convertible preferred stock Series C, $.06 Noncumulative annual dividend, $.75 par value, 250,000 shares authorized; 0 shares issued and outstanding in 2001($.75 liquidation preference) -- COMMITMENTS AND CONTINGENCIES -- STOCKHOLDERS' EQUITY: Redeemable convertible preferred stock, Series D, $.04 noncumulative annual dividend; $.50 par value: Authorized 500,000 shares; 0 shares issued and outstanding ($.50 liquidation preference per share) -- Common stock, no par value: authorized 50,000,000 shares; issued and outstanding 2,098,620 4,815,074 Accumulated deficit (1,986,237) Total stockholders' equity 2,828,837 Total liabilities and stockholders' equity $3,874,203 LANCER ORTHODONTICS, INC. CONDENSED STATEMENTS OF OPERATIONS AND CONDENSED STATEMENTS OF COMPREHENSIVE LOSS (UNAUDITED) FOR THE THREE MONTHS ENDED 8/31/01 8/31/00 NET SALES $1,434,788 $1,331,099 COST OF SALES 1,077,398 925,582 Gross Profit 357,390 405,517 OPERATING EXPENSES: Selling, General & Administrative 483,265 467,325 Product Development -- 36,240 TOTAL OPERATING EXPENSES 483,265 503,565 LOSS FROM OPERATIONS ( 125,875) ( 98,048) OTHER INCOME (EXPENSE): Interest Expense ( 3,222) ( 5,207) Other Income (Expense), net 760 474 TOTAL OTHER INCOME (EXPENSE) ( 2,462) ( 4,733) LOSS BEFORE INCOME TAXES ( 128,337) ( 102,781) INCOME TAXES 0 0 NET LOSS ( 128,337) ( 102,781) OTHER COMPREHENSIVE INCOME -- -- COMPREHENSIVE LOSS $( 128,337) $( 102,781) NET LOSS PER WEIGHTED AVERAGE OF COMMON SHARES Weighted average number of common shares 2,098,620 2,098,618 BASIC $( .06) $( .05) Weighted average number of shares used in calculation of diluted earnings per share 2,098,620 2,098,618 DILUTED $( .06) $( .05) LANCER ORTHODONTICS, INC. CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE THREE MONTHS ENDED 8/31/01 8/31/00 Cash flows from operating activities: Net loss $(128,337) $(102,781) Adjustments to reconcile net loss to net cash (used in) provided by operating activities: Depreciation and amortization 26,856 30,192 Provision for losses on accounts receivable ( 2,059) (17,419) Provision for losses on inventory 9,000 9,000 Net change in operating assets and liabilities: Accounts receivable ( 56,726) ( 52,726) Inventories (150,427) 21,539 Prepaid expenses 24,244 19,099 Accounts payable 263,750 96,687 Accrued payroll ( 23,954) ( 3,750) Other current liabilities 6,108 ( 4,290) Net cash used in operating activities ( 31,545) ( 4,449) Cash flows from investing activities: Purchases of property and equipment -- ( 2,400) Other assets ( 7,786) -- Net cash used in investing activities ( 7,786) ( 2,400) Cash flows from financing activities: Increase in line of credit 20,000 40,000 Cash flows provided by financing activities 20,000 40,000 Net change in cash ( 19,331) 33,151 Cash, beginning of period 131,550 103,207 Cash, end of period $112,219 $136,358 Supplemental disclosure of cash flow information: Cash paid for: Interest $ 3,222 $ 5,207 LANCER ORTHODONTICS, INC. Notes to Financial Statements (A) Basis of Presentation The accompanying unaudited condensed financial statements have been prepared in accordance with the instructions to Form 10-QSB and therefore do not include all information and notes necessary for a fair presentation of financial position, results of operations, and cash flows in conformity with generally accepted accounting principles. The unaudited condensed financial statements include the accounts of Lancer Orthodontics, Inc. (the "Company"). The operating results for interim periods are unaudited and are not necessarily an indication of the results to be expected for the full fiscal year. In the opinion of management, the results of operations as reported for the interim periods reflect all adjustments which are necessary for a fair presentation of operating results. (B) Organization The Company was incorporated on August 25, 1967, in the state of California, for the purpose of engaging in the design, manufacture, and distribution of orthodontic products. The Company has a manufacturing facility in Mexico where a majority of its inventory is manufactured (Note F). The Company also purchases certain orthodontic and dental products for purposes of resale. Sales are made directly to orthodontists world-wide through Company representatives and independent distributors. The Company also sells certain of its products on a private label basis. (C) Use of Estimates in the Preparation of Financial Statements The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America ("GAAP"), requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the 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. Significant estimates made by the Company's management include, but are not limited to, allowances for doubtful accounts, allowances for sales returns, the valuation of inventories, and the realizeability of property and equipment through future operations. Actual results could materially differ from those estimates. (D) Liquidity At August 31, 2001, the Company was not in compliance with its required minimum tangible net worth ratio and is in technical default under the compliance provisions of the bank line of credit. The line of credit expired on September 30, 2001. As of the date of this filing, the Company has obtained approval of a new line of credit with a new lender, however, final documents have not been executed. (E) Stock Based Compensation The Company accounts for stock based compensation under Statement of Financial Accounting Standards No. 123 ("SFAS 123"). SFAS 123 defines a fair value based method of accounting for stock based compensation. However, SFAS 123 allows an entity to continue to measure compensation cost related to stock and stock options issued to employees using the intrinsic LANCER ORTHODONTICS, INC. Notes to Financial Statements - continued (E) Stock Based Compensation - continued method of accounting prescribed by Accounting Principles Board Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees". Entities electing to remain with the accounting method of APB 25 must make pro forma disclosures of net income and earnings per share, as if the fair value method of accounting defined in SFAS 123 had been applied. The Company has elected to account for its stock based compensation to employees under APB 25. (F) Line of Credit At August 31, 2001, the Company has a $300,000 line of credit with a bank. Borrowings are made at prime plus 1.25% (7.75% at August 31, 2001) and are limited to specified percentages of eligible accounts receivable. The unused portion available under the line of credit at August 31, 2001 was $140,000. The line of credit expired on September 30, 2001. The line of credit was collateralized by substantially all the assets of the Company, including inventories, receivables, and equipment. The lending agreement for the line of credit requires, among other things, that the Company maintain a tangible net worth of $2,800,000 and a debt to tangible net worth ratio of no more than 1 to 1. The Company is not required to maintain compensating balances in connection with this lending agreement. The Company was in violation of certain of its debt covenants at August 31, 2001. As of the date of this filing, the Company has obtained approval of a new line of credit with a new lender, however, final documents have not been executed. (G) Commitments and Contingencies Manufacturing Agreement - In May 1990, the Company entered into a manufacturing subcontractor agreement whereby the subcontractor agreed to provide manufacturing services to the Company through its affiliated entities located in Mexicali, B.C., Mexico. During fiscal 1992 and 1991, the Company moved the majority of its manufacturing operations to Mexico. In December 1992, the Company renegotiated the agreement changing from an hourly rate per employee to a pass through of actual costs plus a weekly administrative fee. The amended agreement gave the Company greater control over all costs associated with the manufacturing operation. In July 1994, the Company again renegotiated the agreement, reducing the administrative fee. Effective April 1, 1996, the Company leased the Mexicali facility under a separate arrangement. In November 1998, the Company extended the Manufacturing Agreement through October 2000. Should the Company discontinue operations in Mexico, it is responsible for the accumulated employee seniority obligation as prescribed by Mexican law. At August 31, 2001, this obligation was approximately $352,000. Such obligation is contingent in nature and accordingly has not been accrued in the accompanying balance sheet. The Company is in the process of converting Mexican assets and obligations to its own division, a Mexican corporation named Lancer Orthodontics de Mexico (Lancer de Mexico). This division will administer services previously provided by an independent manufacturing contractor. A new lease was negotiated effective April 1, 2001, for the 16,000 square foot LANCER ORTHODONTICS, INC. Notes to Financial Statements - continued (G) Commitments and Contingencies - continued facility used for Lancer's Mexican operations. Utility and Mexican vendor obligations have been converted to the Lancer de Mexico name. This conversion will eliminate the expense of an administrative fee and is expected to provide better control in meeting obligations. Leases - The Company leases its main facility under a non-cancelable operating lease expiring December 31, 2003, as extended, which requires monthly rentals that increase annually, from $2,900 per month in 1994 to $6,317 per month in 2004. The lease expense is being recognized on a straight-line basis over the term of the lease. The excess of the expense recognized over the cash paid aggregates $10,792 at August 31, 2001, and is included in accrued liabilities in the accompanying balance sheet. Total rental expense for this facility for the three months ended August 31, 2001 was approximately $17,000. The Company has entered into a non-cancelable operating lease for its Mexico facility which expires in March 2006 and requires average monthly rentals of approximately $6,000. Total expense for this facility for the three months ended August 31, 2001 was approximately $17,000. At May 31, 2001, future aggregate minimum lease payments are as follows: Years ending May 31, 2002 $133,543 2003 136,397 2004 106,511 2005 62,292 2006 51,910 Total $490,653 Common Stock - The Company's stock is now traded on the OTC Bulletin Board. (H) Income Taxes At May 31, 2001, the Company had net tax operating loss carryforwards of approximately $2,049,000 and business tax credits of approximately $98,000 available to offset future Federal taxable income and tax liabilities, respectively. The Federal carryforwards expire in varying amounts through the year 2021. As of May 31, 2001, the Company had net tax operating loss carryforwards of approximately $205,000 and business tax credits of approximately $23,000 available to offset future state income tax liabilities. The state carryforwards expire through the year 2011. (I) Stockholders' Equity The Company has incentive stock option and non-qualified stock option plans for directors, officers, and key employees. The plans provide for the granting of options for common shares at exercise prices equal to or exceeding the fair market value at the date of grant, as determined by the Board of Directors. Options may become exercisable over a period of up to four years from LANCER ORTHODONTICS, INC. Notes to Financial Statements - continued (I) Stockholders' Equity - continued the date of grant and may be exercised over a period of three to seven years from the date of the grant, as determined by the Board of Directors. The Company's shareholders have authorized a total of 450,000 shares to be available for grant under the Company's stock option plan. Options granted prior to May 31, 1995, generally vested on the date of grant and expired through August 1999. During the quarter ended August 31, 2001, no options were granted. (J) Net Loss per Common Share and Dividends The Company calculates earnings per share in accordance with Statement of Financial Accounting Standards ("SFAS 128"). SFAS 128 replaces the presentation of primary and fully diluted earnings per share with the presentation of basic and diluted earnings per share. Basic earnings per share excludes dilution and is calculated by dividing income available to common stockholders by the weighted-average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the entity. For all periods presented, no common stock equivalents have been included in the computation of diluted earnings per share as they were determined to be anti-dilutive. EARNINGS PER SHARE (UNAUDITED) FOR THE THREE MONTHS ENDED 8/31/01 8/31/00 Basic Loss per Share: Net loss $( 128,337) $( 102,781) Net loss applicable to common shareholders $( 128,337) $( 102,781) Weighted average number of common shares 2,098,620 2,098,618 Basic loss per Share $( .06) $( .05) Diluted Loss per Share: Net loss from primary income per common share $( 128,337) $( 102,781) Net loss for diluted earnings per share $( 128,337) $( 102,781) Weighted average number of shares used in calculation of diluted earnings per share 2,098,620 2,098,618 Diluted loss per share $( .06) $( .05) LANCER ORTHODONTICS, INC. Notes to Financial Statements - continued (K) Financial Information About Foreign and Domestic Operations and Export Sales FOR THE THREE MONTHS ENDED 8/31/01 8/31/00 Sales to unaffiliated customers: United States $ 742,271 $ 684,591 Europe 439,879 394,817 Central and South America 91,889 106,434 Other Foreign 160,749 145,257 $1,434,788 $1,331,099 No other geographic concentrations exist where net sales exceed 10% of total net sales. Sales or transfers between geographic areas none none (L) Recent Accounting Pronouncements In December 1999, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 101, Revenue Recognition in Financial Statements ("SAB 101"). SAB 101 summarizes certain areas of the Staff's views in applying generally accepted accounting principles to revenue recognition in financial statements. The Company believes that its current revenue recognition policies comply with SAB 101. In March 2000, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 44 ("FIN 44"), "Accounting for Certain Transactions involving Stock Compensation." The adoption of this Interpretation did not have a material impact on the consolidated results of operations or financial position of the Company. In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 141 ("SFAS 141"), "Business Combinations", which eliminates the pooling method of accounting for business combinations initiated after June 30, 2001. In addition, SFAS 141 addresses the accounting for intangible assets and goodwill acquired in a business combination. This portion of SFAS 141 is effective for business combinations completed after June 30, 2001. The Company does not expect SFAS 141 will have a material impact on the Company's financial position or results of operations. In July 2001, the FASB issued Statement of Financial Accounting Standards No. 142 ("SFAS 142"), "Goodwill and Intangible Assets", which revises the accounting for purchased goodwill and intangible assets. Under SFAS 142, goodwill and intangible assets with indefinite lives will no longer be amortized and will be tested for impairment annually. SFAS 142 is effective for fiscal years beginning after December 15, 2001, with earlier adoption permitted. The Company does not expect SFAS 142 will have a material impact on the Company's financial position or results of operations. Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Except for historical information contained herein, the statements in this Form 10-QSB are forward-looking statements that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties which may cause the Company's actual results in future periods to differ materially from forecasted results. These risks and uncertainties include, among other things, the continued demand for the Company's products, availability of raw materials and the state of the economy. These and other risks are described in the Company's Annual Report on Form 10-KSB and in the Company's other filings with the Securities and Exchange Commission. RESULTS OF OPERATIONS For the three months ended August 31, 2001, net loss increased $25,556 as compared to the year earlier period. The increase in net loss is primarily attributable to an increase in costs of sales and marketing costs. For the three months ended August 31, 2001, net sales increased $103,689 (7.8%) as compared to the year earlier period. International net sales increased $46,009, primarily in Europe. The domestic net sales increased $57,680, primarily in the western region. For the three months ended August 31, 2001, cost of sales as a percentage of sales totaled 75.1%, an increase of 5.6% as compared to the year earlier period which totaled 69.5%. This increase is attributable to increased discounting due to competition pressures. For the three months ended August 31, 2001, selling and general and administrative expenses increased $15,940 (3.4%) as compared to the year earlier period. The increase is primarily attributable to an increase in marketing costs. For the three months ended August 31, 2001, product development expenses decreased $36,240 (100.00%) as compared to the year earlier period. The decrease is primarily attributable to the reduction of product development expense. For the three months ended August 31, 2001, interest expense decreased $1,985 (38.1%) as compared to the year earlier period. The decrease is primarily attributable to a decrease in the average outstanding loan balance. FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES The Company's financial condition at August 31, 2001 and its previous two fiscal year ends was as follows: 08/31/01 05/31/01 05/31/00 Current Assets $3,633,599 $3,476,962 $3,395,922 Current Liabilities 1,045,366 779,462 681,367 Working Capital 2,588,233 2,697,500 2,714,555 Bank Debt 160,000 140,000 160,000 Shareholder Equity 2,828,837 2,957,174 3,074,033 Total Assets 3,874,203 3,736,636 3,755,400 Cash decreased $19,331 during the three months ended August 31, 2001. Working capital decreased $109,267 during the three months ended August 31, 2001, primarily attributable to an increase in accounts payable. The Company expects to meet all of its cash requirements for the foreseeable future out of its cash reserves, cash flow, and line of credit. At August 31, 2001, the Company was not in compliance with its required minimum tangible net worth ratio and is in technical default under the compliance provisions of the bank line of credit. The line of credit expired on September 30, 2001. As of the date of this filing, the Company has obtained approval of a new line of credit with a new lender, however, final documents have not been executed. We may face interruption of production and services due to increased security measures in response to terrorism. Our business depends on the free flow of products and services through the channels of commerce. Recently, in response to terrorists' activities and threats aimed at the United States, transportation, mail, financial and other services have been slowed or stopped altogether. Further delays or stoppages in transportation, mail, financial or other services could have a material adverse effect on our business, results of operations and financial condition. Furthermore, we may experience an increase in operating costs, such as costs for transportation, insurance and security as a result of the activities and potential activities. We may also experience delays in receiving payments from payers that have been affected by the terrorist activities and potential activities. The U. S. economy in general is being adversely affected by the terrorist activities and potential activities and any economic downturn could adversely impact our results of operations, impair our ability to raise capital or otherwise adversely affect our ability to grow our business. PART II. OTHER INFORMATION Item 1. LEGAL PROCEEDINGS Not Applicable Item 2. CHANGES IN SECURITIES Not Applicable Item 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable Item 5. OTHER INFORMATION Not Applicable Item 6. EXHIBITS AND REPORTS ON FORM 8-K There were no Form 8-k reports filed during the quarter. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LANCER ORTHODONTICS, INC. Registrant Date October 22, 2001 By /s/ Zackary Irani Zackary Irani, Chief Executive Officer 9