UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington DC 20549
Form 10-KSB
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
(No fee required)
For the Fiscal Year Ended May 31, 1998 Commission File No. 0-5920
LANCER ORTHODONTICS, INC.
(Name of small business issuer 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 92069-2437
(Address of principal executive offices) (Zip Code)
Issuer's telephone number, including area code: (760) 744-5585
Securities Registered Pursuant to Section 12(b) of the Act: NONE
Securities Registered Pursuant to Section 12(g) of the Act: Common Stock,
Without Par Value
(Title of Class)
Check whether the Issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the preceding 12 months (or for such
shorter period that the Issuer was required to file such reports), and (2) has
been subject to such filing requirements for the past 90 days. Yes X No
<PAGE>
Check if there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained to
the best of Issuer's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-KSB or any amendment to
this Form 10-KSB. X
Issuer's revenue for its most recent fiscal year $6,194,183.
The aggregate market value of the voting stock held by non-affiliates of Issuer,
based upon the closing sale price of the common stock as reported on NASDAQ, on
August 14, 1998, was approximately $1,149,266.
The number of shares of Issuer's no par value common stock outstanding as of
August 14, 1998, was 2,117,540.
Documents Incorporated by Reference:
1. Portions of Issuer's Proxy Statement for the Annual Meeting of
Shareholders to be held on November 10, 1998, are incorporated by reference into
Part III.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
GENERAL DEVELOPMENT OF BUSINESS
Lancer Orthodontics, Inc. ("Lancer") was incorporated in California on August
25, 1967. Lancer conducts its operations at one facility which is located at
253 Pawnee Street, San Marcos, California 92069-2347. Since its inception,
Lancer has been engaged in the business of manufacturing and marketing
orthodontic products.
<PAGE>
In May 1990, Lancer entered into a manufacturing subcontractor agreement
whereby the subcontractor agreed to provide manufacturing services to Lancer
through its affiliated entities located in Mexicali, B.C., Mexico. During
fiscal 1992 and 1991, Lancer moved the majority of its manufacturing
operations to Mexico. Under the terms of the original agreement, the
subcontractor manufactured Lancer's products charging Lancer an hourly rate
per employee based on the number of employees in the subcontractor's
workforce. As the number of employees increased, the hourly rate decreased.
In December 1992, Lancer renegotiated the agreement changing from an hourly
rate per employee cost to a pass through of actual costs plus a weekly
administrative fee. The new agreement gives Lancer greater control over all
costs associated with the manufacturing operation. In July 1994, Lancer
again renegotiated the agreement reducing the administrative fee and
extending the agreement through June 1998. In March 1996, Lancer agreed to
extend the agreement through October 1998, to coincide with the building
lease. Effective April 1, 1996, Lancer leased the Mexicali facility under a
separate agreement. Lancer has retained the option to convert the
manufacturing operation to a wholly owned subsidiary at any time without
penalty. Should Lancer discontinue operations in Mexico, it is responsible
for accumulated employee seniority obligations as prescribed by Mexican law.
At May 31, 1998, this obligation was approximately $226,000. Such obligation
is contingent in nature and accordingly has not been accrued in Lancer's
financial statements.
Lancer has undergone no material change in the mode of conducting its
business other than as described above and it did not dispose of any material
amount of its assets during the fiscal year ended May 31, 1998.
NARRATIVE DESCRIPTION OF THE BUSINESS
PRINCIPAL PRODUCTS AND INDUSTRY SEGMENTS. Lancer's manufactured product line
includes preformed bands, direct bonding brackets, buccal tubes, arch wires,
<PAGE>
lingual attachments, and related accessories. The foregoing are assembled to
the orthodontists' prescriptions or the specifications of private label
customers. Lancer's manufactured products are also sold to distributors and
private label customers. Lancer also markets products which are purchased
and resold to orthodontists, including sealants, adhesives, elastomerics,
headgear cases, retainer cases, orthodontic wire, and preformed arches.
Lancer sells its products directly to orthodontists through company-paid
sales representatives in the United States. At the end of its 1998 fiscal
year, Lancer had eight sales representatives, all in the United States, all
of whom are employees of Lancer.
In selected foreign countries, Lancer sells its products directly to
orthodontists through its international marketing division. Lancer also
sells its products through distributors in certain foreign countries and to
other companies on a private label basis. Lancer has entered into a number
of distributor agreements whereby it granted the marketing rights to its
products in certain sales territories in Mexico, Central America, South
America, Europe, Canada, Australia, and Japan. The distributors complement
the international marketing department which was established in 1982 and
currently employs three people.
For the fiscal years ended May 31, 1998 and 1997, sales by class of product
are:
Class of Product 1998 1997
Manufactured Products $5,155,000 $5,196,000
Resale Products 1,039,000 1,138,000
<PAGE>
TOTAL $6,194,000 $6,334,000
Lancer has only one industry segment, which is the manufacture and
distribution of orthodontic products.
FINANCIAL INFORMATION ABOUT FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES.
For the fiscal years ended May 31, 1998 and 1997:
1998 1997
Sales to unaffiliated customers:
United States $3,456,000 $3,764,000
Europe 1,392,000 1,276,000
South America 747,000 710,000
Other Foreign 599,000 584,000
$6,194,000 $6,334,000
No other geographic concentrations exist where net sales exceed 10% of total
net sales.
Sales or transfers between geographic areas none none
Operating profit:
United States $ 78,000 $ 82,000
Europe 105,000 97,000
South America 56,000 52,000
Other Foreign 45,000 45,000
$ 284,000 $ 276,000
Identifiable assets:
United States $2,466,000 $2,300,000
Mexico 1,623,000 1,650,000
$4,089,000 $3,950,000
<PAGE>
Export sales $2,738,000 $2,570,000
CE CERTIFICATION - Effective June 18, 1998, fifteen major European countries
are requiring a CE (European Community) certification to sell products within
their countries. In order to obtain this CE certification, Lancer retained
British Standards Institution (BSI) to evaluate Lancer's quality system.
Lancer's quality system is imaged under International Standards Organization
(ISO) 9002. ISO 9002 is an internationally recognized standard in which
companies establish their methods of operation and commitment to quality.
There are 20 clauses for which Lancer has developed standard operating
procedures in accordance with these ISO 9002 requirements.
EN 46002 is the medical device directive (MDD) for the European Community.
Strict standards and clauses within the MDD are required to be implemented to
sell within the European Community. In order for Lancer's medical devices to
be sold within the European Community with a CE Mark, Lancer must fully
comply with the EN 46002 requirements. Lancer has also constructed a
technical file that gives all certifications and risk assessments for
Lancer's products as a medical device (the "Product Technical Files").
With ISO 9002, EN 46002, and the Product Technical Files, Lancer applied for
and was granted certification under ISO 9002, EN 46002, and CE. With the CE
certification, Lancer is now permitted to sell its products within the
European Community.
COMPETITION. Lancer encounters intense competition in the sale of
orthodontic products. Lancer's management believes that Lancer's seven major
competitors are Unitek, a subsidiary or division of 3M; "A" Company and
Ormco, subsidiaries or divisions of Sybron; RMO, Inc., a private company;
American Orthodontics, a private company; GAC, a private company; and
Dentaurum, a foreign company. Lancer estimates that these seven competitors
account for approximately 80% of the orthodontic products manufactured and
<PAGE>
sold in the United States. Lancer's management also believes that each of
these seven competitors is larger than Lancer, has more diversified product
lines, and has financial resources exceeding those of Lancer. While there is
no assurance that Lancer will be successful in meeting the competition of its
major competitors, Lancer has, in the past, successfully competed in the
orthodontic market and has achieved wide recognition of both its name and its
products.
SOURCES AND AVAILABILITY OF RAW MATERIALS. The principal raw materials used
by Lancer in the manufacture of its products include: stainless steel, which
is available from several commercial sources; nickel titanium, which is
available from three sources; and lucolux translucent ceramic, which is
currently only available from one source, General Electric, and is purchased
on open account. Ceramic material similar to General Electric's lucolux
translucent ceramic is available from other sources. Lancer had no
difficulty in obtaining an adequate supply of raw materials during its 1998
fiscal year, and does not anticipate that there will be any interruption or
cessation of supply in the future.
CUSTOMERS, BACKLOG, AND SEASONALITY OF BUSINESS. Lancer sells its products
directly or indirectly through its sales representatives, to a relatively
large number of customers. No customer of Lancer's accounted for 10% or more
of Lancer's sales in the fiscal years ended May 31, 1998 and 1997. Lancer's
backlog at May 31, 1998 and 1997, was $268,000 and $237,000, respectively.
Lancer's business has not been subject to significant seasonal fluctuations.
PATENTS AND TRADEMARKS, LICENSES, FRANCHISES, AND CONCESSIONS HELD. On April
4, 1989, Lancer was granted a patent on its Counter Force design of a nickel
<PAGE>
titanium orthodontic archwire. On August 1, 1989, Lancer was granted a
patent on its bracket design used in the manufacturing of Sinterline and
Intrigue orthodontic brackets. On September 17, 1996, Lancer was granted a
patent on its method of laser annealing marking of orthodontic appliances.
On March 4, 1997, Lancer was granted a patent on an orthodontic bracket and
method of mounting. All of the patents are for a duration of seventeen
years. Lancer has entered into license agreements expiring in 2006 whereby,
for cash consideration, the counter party has obtained the rights to
manufacture and market certain products patented by Lancer. Lancer has also
entered into a number of license and/or royalty agreements pursuant to which
it has obtained rights to certain of the products which it manufactures
and/or markets. The patents and agreements have had a favorable effect on
Lancer's image in the orthodontic marketplace and Lancer's sales.
Lancer has made a practice of selling its products under trademarks and of
obtaining protection for those trademarks in the United States and certain
foreign countries. Lancer considers these trademarks to be of importance in
the operation of its business.
PRODUCT DEVELOPMENT AND IMPROVEMENT. Lancer is engaged in, and intends to
continue development programs directed toward improving its orthodontic
products and production techniques. To this end, Lancer maintains a close
liaison and consults frequently with practicing orthodontists. The costs
incurred by Lancer on product development activities were approximately
$188,000 and $93,000 for the fiscal years ended May 31, 1998 and 1997,
respectively.
GOVERNMENT REGULATIONS. Lancer is licensed to design, manufacture, and sell
orthodontic appliances and is subject to the Code of Federal Regulations,
Section 21, parts 800-1299. The Food and Drug Administration (the "FDA") is
the governing body that assesses and issues Lancer's license to assure that
it complies with these regulations. Lancer is currently licensed, and its
<PAGE>
last assessment was in November 1997. Also, Lancer is registered and
licensed with the state of California's Department of Health Services.
EFFECT OF ENVIRONMENTAL REGULATIONS. Compliance with Federal, State, and
local environmental regulations has not had a material effect on Lancer's
operations to date.
YEAR 2000 ISSUES. Certain computerized systems use only two digits to record
the year in date fields. Such systems may not be able to accurately process
dates ending in the year 2000 and after. The effects of this issue will vary
from system to system and may adversely affect an entity's operations as well
as its ability to prepare financial statements. The Company has begun the
process of upgrading its hardware and software in order to obtain year 2000
compliance in 1999 and does not anticipate to incur significant additional
costs to be year 2000 compliant.
EMPLOYEES. As of August 14, 1998, Lancer had 44 employees, 3 of whom are
employed on a part-time basis. Additionally, Lancer, through its Mexican
subcontractor, employed approximately 202 people in Mexico.
ITEM 2. PROPERTIES
Lancer conducts its operations in leased facilities located in San Marcos,
California and Mexicali, Mexico. The San Marcos facility consists of a 9,240
square foot manufacturing and office building. The term of the initial lease
was for five years commencing January 1, 1994 and ending December 31, 1998.
In 1998, Lancer renegotiated the lease and extended the terms to December 31,
2003. The Mexicali facility consists of a 16,000 square foot manufacturing
and office building. The term of the lease is for thirty-one months
commencing April 1, 1996 and ending October 31, 1998. Management believes
that the properties are currently suitable and adequate for Lancer's
<PAGE>
operations. Future aggregate minimum annual cash lease payments are as
follows:
Years ending
May 31, 1999 $76,031
May 31, 2000 $65,880
May 31, 2001 $68,512
May 31, 2002 $71,251
May 31, 2003 $74,105
Thereafter $44,219
ITEM 3. LEGAL PROCEEDINGS - Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of Lancer's security holders during the
quarter ended May 31, 1998.
PART II
ITEM 5. MARKET FOR LANCER'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
On November 15, 1996, Lancer effected a one-for-seven reverse stock split of
its common stock. High and low sales prices for Lancer's common stock, after
giving effect for its one-for-seven reverse stock split, as reported by
NASDAQ for the last two years are presented below. Lancer's stock is sold
under the symbol LANZ.
Quarter Ended High Low
August 31, 1996 $2.84 $1.31
November 30, 1996 $2.41 $ .50
February 28, 1997 $1.50 $ .50
<PAGE>
May 31, 1997 $1.50 $ .63
August 31, 1997 $1.06 $ .50
November 30, 1997 $1.25 $ .88
February 28, 1998 $1.063 $ .531
May 31, 1998 $1.375 $ .625
The approximate number of beneficial holders of Lancer's common stock and
Series D preferred stock at May 31, 1998, was 636 and one, respectively.
No dividends have been declared or paid on Lancer's common stock since its
inception.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Except for historical information contained herein, the statements in this Form
10-KSB 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 Lancer's actual results in future periods to differ 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.
RESULT OF OPERATIONS
For the fiscal year ended May 31, 1998, net sales were $6,194,183, a decrease of
$139,615 (2.2%) from the prior year. The sales decrease experienced from 1997
to 1998 is primarily attributable to: (1) increased discounting and (2) a
general reduction in domestic sales. Although net domestic sales decreased in
1998, units sold increased. While the unfavorable trend in discounts continues,
it has slowed, partially the result of industry consolidation. Management
believes the trend in increased discounting will be insignificant to ongoing
<PAGE>
operations. Lancer continues to search for new sales representatives,
distributors, private label customers, products, and product ideas, all of
which, if successful, will result in increased sales. In addition, Lancer has
incorporated a subsidiary in Mexico. This subsidiary will allow Lancer to
distribute its products through Mexico and other parts of Latin America at much
more competitive prices. This subsidiary will also assume the duties of the
subcontractor, which is expected to reduce costs. Any costs will be paid out of
cash flow and available borrowings, if necessary.
Cost of sales, as a percentage of sales, decreased from 60.6% in fiscal 1997 to
58.6% in fiscal 1998. The decrease is primarily attributable to: (1)
manufacturing problems that were resolved in fiscal 1997; (2) the removal of
ineffective plant management; and (3) the implementation of procedures resulting
in reduced expenditures. Lancer continues its program to improve manufacturing
by adding new equipment and improving processes and efficiencies.
Selling expenses, as a percentage of sales, increased from 26.2% in fiscal 1997
to 27.6% in fiscal 1998. Of the increase, 45% is attributed to advertising
costs, 37% to payroll and related costs, and 18% is attributable to bad debt
expense partially offset by other minor decreases.
General and Administrative expenses, as a percentage of sales, decreased from
7.4% in fiscal 1997 to 6.2% in fiscal 1998. Of the decrease, 49% can be
attributed to a reduction in payroll and related costs and 41% can be attributed
to a reduction in professional fees.
Product Development expenses, as a percentage of sales, increased from 1.5% in
fiscal 1997 to 3.0% in fiscal 1998. The increase is primarily attributable to
an increase in the number of employees. Lancer's management believes product
development is vital to its future, and expects expenditures to increase over
the next few years.
<PAGE>
Interest expense, as a percentage of sales, decreased from .9% in fiscal 1997 to
.4% in fiscal 1998. The decrease is attributable the payoff of certain term
debt and capital lease obligations, as discussed below.
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
During fiscal 1998, Lancer paid off the remaining $200,000, plus all accrued
interest it owed on its term bank loan. Management negotiated a renewal of
Lancer's line of credit through October 1, 1998. The line of credit allows for
borrowing up to $300,000 and is limited to specified percentages of eligible
accounts receivable. The unused portion available under the line of credit at
May 31, 1998, was $200,000. Borrowings bear interest at prime plus 1% per annum
(9.5% at May 31, 1998).
Lancer's inventory and sales practices affect its financing requirements,
however, management believes that the working capital relating to these are
within normal ranges for Lancer's business.
Working capital and cash, as of May 31, 1998, increased by $387,208 and
$166,275, respectively, as compared to the prior year. The improvements in
liquidity are primarily the result of slightly higher net income, and the
reduction in debt of $315,848.
In March 1998, Lancer's Board of Directors approved the repurchase of up to 4%
of Lancer's outstanding common stock over the next twelve months. Such
repurchases are at the discretion of management when management believes
Lancer's common stock is undervalued. Repurchases will be made out of current
cash flow and all repurchased shares will be retired. Through August 14, 1998,
<PAGE>
a total of 8,172 shares have been repurchased for an aggregate consideration of
$9,115.
Lancer's management believes that it will be able to finance Lancer's operations
through cash flow and available borrowings for the foreseeable future.
ITEM 7. FINANCIAL STATEMENTS
Reference is made to Exhibit A attached hereto wherein Lancer's financial
statements are contained which are incorporated herein by reference.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURES
Not applicable.
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF LANCER
Information regarding directors, set forth under the caption "Election of
Directors" in Lancer's annual proxy statement for the annual meeting of
shareholders to be held November 10, 1998, which will be filed with the
Commission not later than 120 days after the end of Lancer's fiscal year period
ended May 31, 1998, is incorporated herein by reference. Information regarding
executive officers, set forth under caption "Executive Compensation and Other
Information" in the annual proxy statement for the annual meeting of
shareholders to be held November 10, 1998, which will be filed with the
Commission not later than 120 days after the end of Lancer's fiscal year ended
May 31, 1998, is also incorporated herein by reference. Information regarding
Section 16 compliance, set forth under caption "Section 16 Compliance" in the
annual proxy statement for the annual meeting of shareholders to be held
<PAGE>
November 10, 1998, which will be filed with the Commission not later than 120
days after the end of Lancer's fiscal year ended May 31, 1998, is incorporated
herein by reference.
ITEM 10. EXECUTIVE COMPENSATION
Information regarding executive compensation, set forth under the caption
"Compensation Committee Report on Executive Compensation" in Lancer's annual
proxy statement for the annual meeting of shareholders to be held November 10,
1998, which will be filed with the Commission not later than 120 days after the
end of Lancer's fiscal year ended May 31, 1998, is incorporated herein by
reference.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information regarding security ownership, set forth under the caption
"Beneficial Ownership of the Company's Securities" in Lancer's annual proxy
statement for the annual meeting of shareholders to be held November 10, 1998,
which will be filed with the Commission not later than 120 days after the end of
Lancer's fiscal year ended May 31, 1998, is incorporated herein by reference.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Documents filed as a part of the report
1. Financial Statements
See Index to Financial Statements Exhibit A, attached hereto, wherein
Lancer's financial statements are contained.
2. Exhibits Required to be Filed by Item 601 of Regulation S-B
<PAGE>
3(i) Articles of Incorporation as amended - Incorporated herein by
reference to Exhibit 4.5 of Lancer's S-8 filed March 8, 1994.
3(ii) By-laws as amended - Incorporated herein by reference to Exhibit
4.6 of Lancer's S-8 filed March 8, 1994.
10 1993 Stock Option Plan as amended - Incorporated herein by
reference to Exhibit 4.1 of Lancer's S-8 filed March 8, 1994.
(b) Reports on Form 8-K
No reports on Form 8-K were filed in the quarter ended May 31, 1998.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Dated: August 14, 1998
LANCER ORTHODONTICS, INC.
By: /s/ Douglas D. Miller /s/
Douglas D. Miller Catherine Wyss
President and Chief Operating Officer Accounting Manager
(Principal Financial Officer,
Principal Accounting Officer)
<PAGE>
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 on the dates indicated.
Signature Title Date
/s/ Zackary Irani August 14, 1998
Zackary Irani Chairman of the Board
& Director
/s/ Douglas D. Miller August 14, 1998
Douglas D. Miller President, Chief Operating
Officer & Director
/s/ Janet Moore August 14, 1998
Janet Moore Secretary & Director
Robert Orlando Director
EXHIBIT A
LANCER ORTHODONTICS, INC.
INDEX TO FINANCIAL STATEMENTS
Page
Independent Auditors' Report FS-2
<PAGE>
Balance Sheet - May 31, 1998 FS-3
Statements of Operations - For Each of the Years in the
Two-Year Period Ended May 31, 1998 FS-4
Statements of Stockholders' Equity - For Each of the Years
in the Two-Year Period Ended May 31, 1998 FS-4
Statements of Cash Flows - For Each of the Years in the
Two-Year Period Ended May 31, 1998 FS-5
Notes to Financial Statements - For Each of the Years in the
Two-Year Period Ended May 31, 1998 FS-6
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Lancer Orthodontics, Inc.:
We have audited the accompanying balance sheet of Lancer Orthodontics, Inc. (the
"Company") as of May 31, 1998, and the related statements of operations,
shareholders' equity and cash flows for each of the years in the two-year period
then ended. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
<PAGE>
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether 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 financial statements referred to above present fairly, in
all material respects, the financial position of Lancer Orthodontics, Inc. as of
May 31, 1998, and the results of its operations and its cash flows for each of
the years in the two-year period then ended in conformity with generally
accepted accounting principles.
Irvine, California CORBIN & WERTZ
July 24, 1998
<PAGE>
FS-2
BALANCE SHEET
May 31, 1998
ASSETS
CURRENT ASSETS:
Cash $ 321,036
Accounts receivable, less allowance for sales returns
and doubtful receivables of $120,000 1,302,850
Inventories 1,796,794
Prepaid expenses 67,757
Total current assets 3,488,437
PROPERTY AND EQUIPMENT, Net 210,833
INTANGIBLE ASSETS, Net 382,940
OTHER ASSETS 6,560
$4,088,770
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued liabilities $ 584,222
Line of credit 100,000
Total current liabilities 684,222
COMMITMENTS AND CONTINGENCIES --
<PAGE>
STOCKHOLDERS' EQUITY:
Redeemable convertible preferred stock, Series C, $.06 noncumulative
annual dividend; $.75 par value; Authorized 250,000 shares; no shares
issued and outstanding ($.75 liquidation preference) --
Redeemable convertible preferred stock, Series D, $.04 noncumulative
annual dividend; $.50 par value; Authorized 500,000 shares; 370,483
shares issued and outstanding ($.50 liquidation preference per share:
aggregate liquidation preference) 185,242
Common stock, no par value: Authorized 50,000,000 shares; 2,120,712
shares issued and outstanding 4,705,394
Accumulated deficit (1,486,088)
Total stockholders' equity 3,404,548
$4,088,770
The accompanying notes are an integral part of these financial statements.
FS-3
STATEMENTS OF OPERATIONS
For Each of the Years in the Two-Year Period Ended May 31, 1998
1998 1997
NET SALES $6,194,183 $6,333,798
COST OF SALES 3,628,486 3,839,967
Gross profit 2,565,697 2,493,831
OPERATING EXPENSES:
Selling 1,710,109 1,656,484
General and administrative 383,073 468,239
Product development 188,320 93,157
TOTAL OPERATING EXPENSES 2,281,502 2,217,880
INCOME FROM OPERATIONS 284,195 275,951
OTHER INCOME (EXPENSE):
<PAGE>
Interest expense ( 25,360) ( 58,659)
Other income, net 1,450 6,833
TOTAL OTHER INCOME (EXPENSE) ( 23,910) ( 51,826)
INCOME BEFORE INCOME TAXES 260,285 224,125
INCOME TAXES 800 800
NET INCOME $ 259,485 $ 223,325
WEIGHTED AVERAGE SHARES OF COMMON STOCK
Basic $ .12 $ .11
Diluted $ .12 $ .10
<PAGE>
<TABLE>
STATEMENTS OF STOCKHOLDERS' EQUITY
For Each of the Years in the Two-Year Period Ended May 31, 1998
<CAPTION>
Series D Preferred Stock Common Stock Accumulated
Shares Amount Shares Amount Deficit Total
<S> <C> <C> <C> <C> <C> <C>
Balance at May 31, 1996 370,483 185,242 2,121,714 4,701,182 (1,968,898) 2,917,526
Conversion of Accrued
Royalties -- -- 3,998 9,432 -- 9,432
Net Income -- -- -- -- 223,325 223,325
Balance at May 31, 1997 370,483 $185,242 2,125,712 $4,710,614 $(1,745,573) $3,150,283
Repurchase of Common
Stock -- -- (5,000) (5,220) -- (5,220)
Net Income -- -- -- -- 259,485 259,485
Balance at May 31, 1998 370,483 $185,242 2,120,712 $4,705,394 $(1,486,088) $3,404,548
<FN>
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
FS-4
STATEMENTS OF CASH FLOWS
For Each of the Years in the Two-Year Period Ended May 31, 1998
1998 1997
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $259,485 $223,325
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 180,490 193,347
Provision for losses on accounts receivable 15,000 ( 10,000)
Provision for inventory 10,000 15,000
Net change in operating assets and liabilities:
(Increase) decrease in accounts receivable (139,014) 296,581
Decrease (increase) in inventories 38,860 (274,691)
(Increase) decrease in prepaid expenses ( 29,951) 3,704
Increase in accounts payable and accrued
liabilities 200,020 5,762
NET CASH FLOWS PROVIDED BY OPERATING ACTIVITIES 534,890 453,028
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment ( 45,387) ( 51,351)
Additions to deposits ( 2,160) --
NET CASH FLOWS USED IN INVESTING ACTIVITIES ( 47,547) ( 51,351)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net (payments) under line of credit agreement (100,000) ( 50,000)
Principal payments on note payable to bank (200,000) (240,000)
Principal payments on capital leases ( 15,848) ( 21,647)
Repurchase of common stock ( 5,220) --
<PAGE>
NET CASH FLOWS USED IN FINANCING ACTIVITIES (321,068) (311,647)
NET INCREASE IN CASH 166,275 90,030
CASH AT BEGINNING OF PERIOD 154,761 64,731
CASH AT END OF PERIOD $321,036 $154,761
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $25,360 $58,020
Income taxes $ 1,230 $ 1,240
Supplemental disclosure of non-cash financing and investing activities:
In fiscal 1997, the Company issued 3,998 shares of its common stock in
satisfaction of $9,432 in accrued royalties .
The accompanying notes are an integral part of these financial statements.
FS-5
NOTES TO FINANCIAL STATEMENTS
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (1) ORGANIZATION
Lancer Orthodontics, Inc. (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 8). The Company also purchases certain orthodontic and
dental products for purposes of resale. Sales of manufactured and resale
products comprise approximately 83% and 17% of total sales, respectively, for
fiscal 1998 and 82% and 18% of total sales, respectively, for fiscal 1997.
<PAGE>
Sales are made directly to orthodontists worldwide through Company
representatives and independent distributors, with approximately 56% and 59%
during fiscal 1998 and 1997, respectively, being domestic in nature. The
Company also sells certain of its products on a private label basis.
The Company is a partially owned and consolidated subsidiary of Biomerica, Inc.
("Biomerica"). Biomerica exercises significant financial control over the
Company and its operations.
NOTE (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTING METHODS - The Company uses the accrual method of accounting for
financial and income tax reporting purposes.
FAIR VALUE OF FINANCIAL INSTRUMENTS _ The Company has financial instruments
whereby the fair value of the financial instruments could be different than that
recorded on a historical basis on the accompanying balance sheet. The Company's
financial instruments consist of cash, accounts receivable, accounts payable,
and a line of credit. The carrying amounts of the Company's financial
instruments generally approximate their fair values at May 31, 1998.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS - 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 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 differ from those estimates.
<PAGE>
CONCENTRATIONS OF CREDIT RISK:
The Company at times maintains cash balances at certain financial institutions
in excess of the federally insured deposits.
FS-6
NOTES TO FINANCIAL STATEMENTS - CONTINUED
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES _ CONTINUED
Customers - The Company performs periodic credit evaluations of its customers
and maintains allowances for potential credit losses and returns. The Company
estimates credit losses and returns based on management's evaluation of
historical experience and current industry trends. Although the Company expects
to collect amounts due, actual collections may differ from the estimated
amounts. As of May 31, 1998, reserves for credit losses totaled $70,000.
Reserves for sales returns totaled $50,000. At May 31, 1998, one customer
accounted for approximately 15% of accounts receivable. No one customer
accounted for 10% or more of revenues for the years ended May 31, 1998 and 1997.
Suppliers - At May 31, 1998, one company accounted for approximately 10% of
accounts payable. No one company accounted for more than 10% of purchases for
the years ended May 31, 1998 and 1997.
RISKS AND UNCERTAINTIES:
<PAGE>
License Agreements - Certain of the Company's sales of products are governed by
license agreements with outside third parties. All of such license agreements
to which the Company currently is a party are for fixed terms which will expire
after ten years or upon the expiration of the underlying patents. After the
expiration of the agreements or the patents, the Company is free to use the
technology that had been licensed. There can be no assurance that the Company
will be able to obtain future license agreements as deemed necessary by
management. The loss of some of the current licenses or the inability to obtain
future licenses could have an adverse affect on the Company's financial position
and operations. Historically, the Company has successfully obtained all the
licenses it believed necessary to conduct its business.
Distribution _ The Company has entered into various exclusive and non-exclusive
distribution agreements (the "Agreements") which generally specify territories
of distribution. The Agreements range in term from one to five years. The
Company may be dependent upon such distributors for the marketing and selling of
its products worldwide during the terms of these agreements. Such distributors
are generally not obligated to sell any specified minimum quantities of the
Company's product. There can be no assurance of the volume of product sales
that may be achieved by such distributors.
Listing Requirements _ the Company must maintain a minimum bid price and certain
capitalization levels as required by the NASD Marketplace Rule 4310(c). As of
May 31, 1998, the Company was in compliance with these requirements. There can
be no assurance that the Company will continue to comply with these requirements
which could impair the Company's ability to be listed on the NASDAQ Stock
Market.
Year 2000 _ Certain computerized systems use only two digits to record the year
in date fields. Such systems may not be able to accurately process dates ending
in the year 2000 and after. The effects of this issue will vary from system to
<PAGE>
system and may adversely affect an entity's operations as well as its ability to
prepare financial statements. The Company has begun the process of upgrading
its hardware and software in order to obtain year 2000 compliance in 1999 and
does not anticipate to incur significant additional costs to be year 2000
compliant.
FS-7
NOTES TO FINANCIAL STATEMENTS - CONTINUED
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES _ CONTINUED
INVENTORIES - Inventories are stated at the lower of cost or market. Cost is
determined on the first-in, first-out method. Costs include materials, direct
labor, and an allocable portion of direct and indirect manufacturing overhead
based upon standard rates derived from historical trends and experience factors.
Market is determined by comparison with recent sales prices or net realizable
value.
PROPERTY AND EQUIPMENT - Property and equipment are recorded at cost and are
depreciated using straight-line method over the estimated useful lives of the
related assets, generally five years. Leasehold improvements are amortized over
the lesser of the estimated useful life of the asset or the term of the lease.
Maintenance and repairs are charged to expense as incurred. Major renewals and
improvements are capitalized. At the time of retirement or other disposition of
property and equipment, the cost and accumulated depreciation are removed from
the accounts and any resulting gains or losses are reflected in income.
<PAGE>
INTANGIBLE ASSETS - Assets are being amortized using the straight-line method
over 18 years for the marketing and distribution rights. Marketing and
distribution rights include repurchased sales territories. Technology use
rights include the 1985 purchase of the assets and technology of Titan Research
Associates, Ltd.
IMPAIRMENT OF LONG-LIVED ASSETS - The Company assesses the recoverability of
long-lived assets by determining whether the depreciation and amortization of
the asset's balance over its remaining life can be recovered through projected
undiscounted future cash flows. The amount of impairment, if any, is measured
based on fair value and charged to operations in the period in which the
impairment is determined by management. Management has determined that there is
no impairment of long-lived assets as of May 31, 1998.
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 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.
REVENUE RECOGNITION - Revenues from product sales are recognized at the time the
product is shipped.
INCOME TAXES - The Company accounts for income taxes using the asset and
liability approach under Statement of Financial Accounting Standards No. 109,
("SFAS 109"). Deferred tax assets and liabilities are recognized for the future
<PAGE>
tax consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. Under SFAS 109, the effect
on deferred tax assets and liabilities of a change
FS-8
NOTES TO FINANCIAL STATEMENTS - CONTINUED
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES _ CONTINUED
in tax rates is recognized in income in the period that includes the enactment
date. A valuation allowance is provided for certain deferred tax assets if it
is more likely than not that the Company will not realize tax assets through
future operations.
ONE-FOR-SEVEN REVERSE STOCK SPLIT _ On November 15, 1996, the Company effected a
one-for-seven reverse stock split of its common stock. For all periods
presented, the components of shareholders' equity have been adjusted to reflect
the reverse stock split.
NET INCOME PER COMMON SHARE AND DIVIDENDS _ The Company discloses 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
<PAGE>
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity.
Net income per common share is computed based on the weighted average number of
shares of common stock and, if applicable, common stock equivalents outstanding
during the year. Common stock equivalents, which relate to shares issuable upon
the exercise of common stock purchase options, were not included in the per
share calculations for fiscal 1998 as their effect was anti-dilutive and were
included in the per share calculations for 1997, as their effect was dilutive.
Common stock equivalents, which relate to shares issuable upon the conversion of
preferred stock into common stock, were included in the per share calculations
for fiscal 1998 and 1997 as their effect was dilutive.
Management determined that the adoption of SFAS 128 did effect net income (loss)
per common share as previously disclosed for fiscal 1997. Accordingly, such has
been restated under the provisions of SFAS 128. Earnings per share for the
years ended May 31, 1998 and 1997 are as follows:
1998 1997
BASIC EARNINGS PER SHARE:
Net income $ 259,485 $ 223,325
Net income applicable to common shareholders $ 259,485 $ 223,325
Weighted average number of common shares 2,125,325 2,125,378
Basic Earnings per Share $ .12 $ .11
FS-9
<PAGE>
NOTES TO FINANCIAL STATEMENTS - CONTINUED
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES _ CONTINUED
1998 1997
DILUTED EARNINGS PER SHARE:
Net income from primary income per common share $ 259,485 $ 223,325
Net income for diluted earnings per share $ 259,485 $ 223,325
Weighted average number of shares used in
calculating basic earnings per common share 2,125,325 2,125,378
Add: Stock options -- 29,935
Convertible preferred stock 52,926 52,926
Weighted average number of shares used in
calculating diluted earnings per share 2,178,251 2,208,239
Diluted earnings per share $ .12 $ .10
NEW ACCOUNTING PRONOUNCEMENTS -The Financial Accounting Standards Board has
issued Statement of Financial Accounting Standards No. 131 "Disclosures about
Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 131 will
change the way public companies report information about segments of their
business in their annual financial statements and requires them to report
selected segment information in their quarterly reports issued to shareholders.
It also requires entity-wide disclosures about the product, services an entity
provides, the material countries in which it holds assets and reports revenues,
and its major customers. SFAS 131 is effective for fiscal years beginning after
<PAGE>
December 15, 1997. The Company does not expect that the implementation of SFAS
131 will have a material effect upon the Company's financial statements.
RECLASSIFICATIONS _ Certain reclassifications have been made to the 1997
balances to conform to the 1998 presentation.
NOTE (3) INVENTORIES
The components of inventories at May 31, 1998, are as follows:
Raw materials $ 319,381
Work in process 116,146
Finished products 1,361,267
Total $1,796,794
Approximately $1,472,000 of inventory is located at the Company's manufacturing
facility in Mexico (Note 8).
FS-10
NOTES TO FINANCIAL STATEMENTS - CONTINUED
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (4) PROPERTY AND EQUIPMENT
The components of property and equipment at May 31, 1998, are as follows:
Machinery and equipment $1,806,926
Tooling, jigs, and fixtures 375,518
Furniture and fixtures 123,663
Construction in process 15,771
2,321,878
<PAGE>
Less accumulated depreciation and amortization (2,111,045)
Total $ 210,833
Approximately $79,000 of property and equipment, net of accumulated depreciation
and amortization, is located at the Company's manufacturing facility in Mexico
(Note 8).
Depreciation expense for the years ended May 31, 1998 and 1997, totaled $106,894
and $119,751, respectively.
NOTE (5) INTANGIBLE ASSETS
The components of intangible assets at May 31, 1998, are as follows:
Marketing and distribution rights $ 442,750
Technology use rights 858,328
1,301,078
Less accumulated amortization ( 918,138)
` $ 382,940
Amortization expense for each of the years ended May 31, 1998 and 1997 totaled
$73,596.
NOTE (6) ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
The components of accounts payable and accrued liabilities at May 31, 1998, are
as follows:
` Trade accounts payable $390,268
Accrued payroll and related benefits 79,409
Other accrued liabilities 114,545
Total $584,222
<PAGE>
FS-11
NOTES TO FINANCIAL STATEMENTS - CONTINUED
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (7) LINE OF CREDIT
At May 31, 1998, the Company had a line of credit with a bank for borrowings up
to $300,000. The line of credit bears interest at prime plus 1% per annum (9.5%
at May 31, 1998). Allowable borrowings are limited to specified percentages of
eligible accounts receivable. The unused portion available under the line of
credit at May 31, 1998, was $200,000. The line of credit expires on October 1,
1998.
The line of credit is 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 $2,750,000, a debt to tangible net worth ratio
of no more than .50 to 1, and a current ratio of at least 2 to 1. The Company
is not required to maintain compensating balances in connection with this
lending agreement.
The following summarizes information on short-term borrowings for the year ended
May 31, 1998:
Average month end balance $177,083
<PAGE>
Maximum balance outstanding at any month end $200,000
Weighted average interest rate (computed by dividing interest
expense by average monthly balance) 9.62%
Interest rate at year end 9.50%
NOTE (8) COMMITMENTS AND CONTINGENCIES
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
2003. 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 $4,060 at May 31, 1998, and is included in accrued liabilities in the
accompanying balance sheet. Total rental expense for this facility for each of
the years ended May 31, 1998 and 1997, was $45,840.
Effective April 1, 1996, the Company entered into a non-cancelable operating
lease for its Mexico facility expiring October 31, 1998, which requires average
monthly rentals of approximately $5,200. The rentals are subject to annual
increases based on the United States Consumer Price Index. Prior to April 1,
1996, such was included in amounts paid under the terms of the manufacturing
agreement, discussed in the following paragraph. Total expense for this for
this facility for the years ended May 31, 1998 and 1997, was $62,962 and $71,772
respectively.
<PAGE>
FS-12
NOTES TO FINANCIAL STATEMENTS - CONTINUED
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (8) COMMITMENTS AND CONTINGENCIES - CONTINUED
At May 31, 1998, future aggregate minimum lease payments are as follows:
Years Ending May 31,
1999 $ 76,031
2000 65,880
2001 68,512
2002 71,251
2003 74,105
Thereafter 44,219
$399,998
MANUFACTURING AGREEMENT - In May 1990, the Company entered into a manufacturing
subcontractor agreement (the "Manufacturing Agreement"), whereby the
subcontractor agreed to provide manufacturing services to the Company through
its affiliated entities located in Mexicali, B.C., Mexico. The Company moved
the majority of its manufacturing operations to Mexico during fiscal 1992 and
1991. Under the terms of the original agreement, the subcontractor manufactured
the Company's products based on an hourly rate per employee based on the number
of employees in the subcontractor's workforce. As the number of employees
increase, the hourly rate decreases. In December 1992, the Company renegotiated
the Manufacturing Agreement changing from an hourly rate per employee cost to a
pass through of actual costs, plus a weekly administrative fee. The amended
Manufacturing Agreement gives the Company greater control over all costs
associated with the manufacturing operation. In July 1994, the Company again
renegotiated the Manufacturing Agreement reducing the administrative fee and
<PAGE>
extending the Manufacturing Agreement through June 1998. In March 1996, the
Company agreed to extend the Manufacturing Agreement through October 1998, to
coincide with the building lease. Effective April 1, 1996, the Company leased
the Mexicali facility under a separate arrangement, as discussed in the
preceding paragraph. The Company has retained the option to convert the
manufacturing operation to a wholly owned subsidiary at any time without
penalty. Such is anticipated to occur during fiscal 1999 (See note 13). Should
the Company discontinue operations in Mexico, it is responsible for the
accumulated employee seniority obligation as prescribed by Mexican law. At May
31, 1998, this obligation was approximately $226,000. Such obligation is
contingent in nature and accordingly has not been accrued in the accompanying
balance sheet.
LICENSE AND ROYALTY AGREEMENTS - The Company has entered into various license
and/or royalty agreements pursuant to which it has obtained rights to
manufacture and market certain products. The agreements are for various
durations expiring through 2007 and they require the Company to make payments
based on the sales of the individual licensed products.
The Company has entered into license agreements expiring in 2006 whereby, for
cash consideration, the counter party has obtained the rights to manufacture and
market certain products patented by the Company.
At May 31, 1998, the Company is negotiating to purchase certain technology and
development rights.
FS-13
NOTES TO FINANCIAL STATEMENTS - CONTINUED
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (9) STOCKHOLDERS' EQUITY
<PAGE>
On November 15, 1996, the Company effected a one-for-seven reverse stock split
of its common stock. For all periods presented, components of shareholders'
equity and share information have been adjusted to reflect the reverse stock
split.
REDEEMABLE CONVERTIBLE PREFERRED STOCK - SERIES C - The Company has authorized
250,000 shares of Series C preferred stock. Each share is entitled to a $.06
non-cumulative dividend and is convertible at the option of the holder into
common stock at the rate of seven shares of preferred stock for one and one-half
shares of common stock. The Company, at its option, can redeem outstanding
shares of the preferred stock for cash at $.75 per share after December 31,
1994. At May 31, 1998, there were no shares issued and outstanding. There
were no dividends declared or paid in 1998 or 1997.
REDEEMABLE CONVERTIBLE PREFERRED STOCK - SERIES D - The Company has authorized
500,000 shares of Series D preferred stock. Each share is entitled to a $.04
non-cumulative dividend and is convertible at the option of the holder into
common stock at the rate of seven shares of preferred stock for one share of
common stock. The Company, at its option, can redeem outstanding shares of the
preferred stock for cash at $.50 per share after December 31, 1994. There were
370,483 shares issued and outstanding at May 31, 1998. There were no dividends
declared or paid in 1998 or 1997.
COMMON STOCK - During 1997, the Company issued 3,998 shares of its common stock
in satisfaction of $9,432 in accrued royalties. In March 1998, the Company's
Board of Directors approved the repurchase of up to 4% of the Company's
outstanding common stock over the next twelve months. Such repurchases are at
the discretion of management and all repurchased shares will be retired. During
1998, the Company repurchased 5,000 shares of its common stock for aggregate
consideration of $5,220. See note 13 for discussion of shares repurchased
subsequent to May 31, 1998.
<PAGE>
STOCK OPTION AGREEMENTS - 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 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 357,143 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 in April 1998 or expire in August 1999. No options were granted during
the year ended May 31, 1998. During the year ended May 31, 1997, the Company
granted options to purchase 14,286 shares of common stock to a director and
21,429 shares of common stock to a former employee at $1.750 and $2.625 per
share, respectively. The options vest over four years and expire in 2001.
FS-14
NOTES TO FINANCIAL STATEMENTS - CONTINUED
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (9) STOCKHOLDERS' EQUITY _ CONTINUED
SFAS 123 PRO FORMA INFORMATION - Pro forma information regarding net income and
earnings per share is required by SFAS 123, and has been determined as if the
Company had accounted for its employee stock options under the fair value method
of SFAS 123. The fair value for these options was estimated at the date of
grant using the Black Scholes option pricing model with the following weighted
<PAGE>
average assumptions for the year ended May 31, 1997, (no options were issued
during the year ended May 31, 1998): risk free interest rate of 6.5%; dividend
yield of 0%; expected life of the option of 5 years; and volatility factor of
the expected market price of the Company's common stock of 70%.
The Black Scholes option valuation model was developed for use in estimating the
fair value of traded options which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Company's employee stock options have characteristics significantly
different from those of traded options, and because changes in the subjective
input assumptions can materially affect the fair value estimate, in management's
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options vesting period. Adjustments are made
for options forfeited prior to vesting. The effect on compensation expense, net
income, and net income per common share had compensation costs for the Company's
stock option plans been determined based on a fair value at the date of grant
consistent with the provisions of SFAS 123, for the years ended May 31, 1998 and
1997, are as follows:
1998 1997
Net income, as reported $259,485 $223,325
Adjustment to compensation expense under SFAS 123 3,961 3,961
Net income, pro forma $255,524 $219,364
Net income per common and common equivalent share,
as reported $ .12 $ .10
Net income per common and common equivalent share,
pro forma $ .12 $ .10
<PAGE>
The following summary presents the options granted, exercised, expired, and
outstanding as of May 31, 1998:
Number of Shares Weighted
average
Employee Nonemployee Total exercise
price
Outstanding, May 31, 1996 184,286 21,429 205,715 $1.51
Granted 35,715 -- 35,715 2.28
Expired ( 35,715) -- ( 35,715) 2.28
Outstanding, May 31, 1997 184,286 21,429 205,715 1.51
Granted -- -- -- --
Exercised -- -- -- --
Expired (170,000) (21,429) (191,429) 1.49
Outstanding, May 31, 1998 14,286 -- 14,286 1.75
FS-15
NOTES TO FINANCIAL STATEMENTS - CONTINUED
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (9) STOCKHOLDERS' EQUITY _ CONTINUED
The following table sets forth the exercise prices, the number of options
outstanding and exercisable, and the remaining contractual lives of the
Company's stock options at May 31, 1998:
Number of options
Exercise price Outstanding Exercisable Contractual
life remaining
1.75 14,286 3,571 3.4
<PAGE>
Total 14,286 3,571
WARRANTS - In 1994, the Company issued warrants to purchase 200,596 shares of
Common Stock at $1.75 per share to two major shareholders and a member of the
Board of Directors. These warrants expired in 1998. Based on the exercise
price of the warrants, the Board of Directors determined that no value should be
ascribed to the warrants at the date of issuance.
No warrants were issued during the years ended 1995 through 1998.
NOTE (10) RETIREMENT SAVINGS PLAN
Effective September 1, 1986, the Company established a 401(k) plan for the
benefit of its employees. The plan permits eligible employees to contribute to
the plan up to the maximum percentage of total annual compensation allowable
under the limits of Internal Revenue Code Sections 415, 401(k), and 404. The
Company, at the discretion of its Board of Directors, may make contributions to
the plan in amounts determined by the Board each year. No contributions by the
Company have been made since the plan's inception.
NOTE (11) INCOME TAXES
The provision for income taxes for the years ended May 31, 1998 and 1997,
consists of the following:
Current Deferred Total
Year ended May 31, 1998:
U.S. Federal $ -- $ -- $ --
State and Local 800 -- 800
$ 800 $ -- $ 800
<PAGE>
Year ended May 31, 1997:
U.S. Federal $ -- $ -- $ --
State and Local 800 -- 800
$ 800 $ -- $ 800
FS-16
NOTES TO FINANCIAL STATEMENTS - CONTINUED
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (11) INCOME TAXES - CONTINUED
The tax effect of temporary differences that give rise to significant portions
of the deferred tax assets and liabilities at May 31, 1998 and 1997, are
presented below:
1998 1997
Deferred tax assets:
Accounts receivable, principally due to allowance
for doubtful accounts and sales returns $ 51,360 $ 42,000
Inventories, principally due to additional costs
Inventoried for tax purposes pursuant to the
Tax Reform Act of 1986 and allowance for
inventory obsolescence 69,913 89,978
Compensated absences principally due to accrual
for financial reporting 19,465 14,960
Net operating loss carryforwards 763,227 879,626
Business tax credit carryforwards 184,004 191,096
Less valuation allowance (1,019,585) (1,144,990)
Net deferred tax assets 68,384 72,670
<PAGE>
Deferred tax liabilities:
Unamortized marketing rights ( 68,384) ( 72,670)
$ -- $ --
Lancer has provided a valuation allowance with respect to substantially all of
its deferred tax assets as of May 31, 1998 and 1997. Management provided such
allowance as it is currently more likely than not that tax-planning strategies
will not generate taxable income sufficient to realize such assets in
foreseeable future reporting periods.
Income tax expense for the years ended May 31, 1998 and 1997, differed from the
amounts computed by applying the U.S. Federal income tax rate of 34 % to pre-tax
income as a result of:
1998 1997
Computed "expected" tax expense $ 88,497 $ 76,203
Income (reduction) in income taxes resulting from:
Meals and entertainment 4,864 9,860
Change in beginning of the year balance of the
valuation allowance for deferred tax assets
allocated to income tax expense ( 93,089) ( 85,791)
State and local income taxes, net of tax benefit 528 528
$ 800 $ 800
As of May 31, 1998, the Company has net tax operating loss carryforwards of
approximately $2,153,000 and business tax credits of approximately $161,000
available to offset future Federal taxable income and tax liabilities,
respectively. The Federal carryforwards expire in varying amounts from 1998 to
2008. As of May 31, 1998, the Company has business tax credits of approximately
$23,000 available to offset future state income tax liabilities. The Company's
state net operating loss carryforward totaling approximately $354,000 expired
during the year ended May 31, 1998.
FS-17
<PAGE>
NOTES TO FINANCIAL STATEMENTS - CONTINUED
For Each of the Years in the Two-Year Period Ended May 31, 1998
NOTE (12) EXPORT SALES
The Company has significant export sales. The net sales and operating
activities for the years ended May 31, 1998 and 1997, are as follows:
1998 1997
Net Sales:
Domestic $3,456,000 $3,764,000
Europe 1,364,000 1,276,000
South America 747,000 710,000
Other 627,000 584,000
Total $6,194,000 $6,334,000
Operating Profit:
Domestic $ 78,000 $ 82,000
Europe 105,000 97,000
South America 56,000 52,000
Other 45,000 45,000
Total $ 284,000 $ 276,000
NOTE (13) SUBSEQUENT EVENTS
ORGANIZATION _ In June 1998, the Company incorporated Lancer de Mexico S.A. de
C.V. The purpose of this Company is to continue existing manufacturing
operations and to sell, import and export medical, orthodontic, and dental
instruments upon the expiration of the Manufacturing Agreement in October 1998
(See note 8). Management of the Company anticipates that costs associated with
the transfer of operations under Lancer de Mexico will not be significant.
<PAGE>
STOCK REPURCHASE _ Subsequent to May 31, 1998, through the date of this report,
the Company repurchased and retired 3,172 shares of its common stock for cash of
$1.06 or $1.25 per share for an aggregate cost to the Company of $3,895.
FS-18
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Lancer
Orthodontics, Inc. annual 10-KSB and is qualified in its entirety by reference
to such 10-KSB.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> MAY-31-1998
<PERIOD-END> MAY-31-1998
<CASH> 321,036
<SECURITIES> 0
<RECEIVABLES> 1,422,850
<ALLOWANCES> 120,000
<INVENTORY> 1,796,794
<CURRENT-ASSETS> 3,488,437
<PP&E> 2,321,878
<DEPRECIATION> (2,111,045)
<TOTAL-ASSETS> 4,088,770
<CURRENT-LIABILITIES> 684,222
<BONDS> 0
0
185,242
<COMMON> 4,705,394
<OTHER-SE> (1,486,088)
<TOTAL-LIABILITY-AND-EQUITY> 4,088,770
<SALES> 6,194,183
<TOTAL-REVENUES> 6,194,183
<CGS> 3,628,486
<TOTAL-COSTS> 5,909,988
<OTHER-EXPENSES> (1,450)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 25,360
<INCOME-PRETAX> 260,285
<INCOME-TAX> 800
<INCOME-CONTINUING> 259,485
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 259,485
<EPS-PRIMARY> .12
<EPS-DILUTED> .12
</TABLE>
