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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington DC 20549
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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, 2000 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 [ ]
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. [ ]
Issuer's revenue for its most recent fiscal year $5,650,512.
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 11, 2000, was approximately $1,096,530.
The number of shares of Issuer's no par value common stock outstanding as of
August 11, 2000, was 2,098,618.
Documents Incorporated by Reference:
1. Portions of Issuer's Proxy Statement for the Annual Meeting of
Shareholders to be held on November 20, 2000, are incorporated by reference into
Part III.
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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.
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. Effective April 1, 1996, Lancer
leased the Mexicali facility under a separate agreement. Effective November
1, 1998, the subcontractor agreement and lease were extended to October 31,
2000. 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,
2000, this obligation was approximately $256,000. 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, 2000.
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, lingual attachments, related accessories, and dental amalgams. 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 and dentists through
company-paid sales representatives in the United States. At the end of its
2000 fiscal year, Lancer had five sales representatives, all in the United
States, all of whom are employees of Lancer.
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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, 2000 and 1999, sales by class of product
are:
Class of Product 2000 1999
---------------- ---------- ----------
Manufactured Products $4,641,000 $5,227,000
Resale Products 1,010,000 932,000
--------- ----------
TOTAL $5,651,000 $6,159,000
========== ==========
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, 2000 and 1999:
2000 1999
---------- ----------
Sales to unaffiliated customers:
United States $3,133,000 $3,413,000
Europe 1,379,000 1,436,000
South America 489,000 685,000
Other Foreign 650,000 625,000
---------- ----------
$5,651,000 $6,159,000
========== ==========
No other geographic concentrations exist where net sales exceed 10% of
total net sales.
Sales or transfers between geographic areas none none
Operating profit (loss):
United States $ (406,000) $ (91,000)
Europe (54,000) 79,000
South America (19,000) 38,000
Other Foreign (25,000) 34,000
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$ (504,000) $ 60,000
=========== ===========
Identifiable assets:
United States $ 1,930,000 $2,240,000
Mexico 1,590,000 1,778,000
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$ 3,520,000 $4,018,000
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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 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 2000
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, 2000 and 1999.
Lancer's backlog at May 31, 2000 and 1999, was $146,000 and $213,000,
respectively. Lancer's business has not been subject to significant
seasonal fluctuations.
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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 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. The development of dental amalgam has
been halted due to the discovery that it does not expand as expected. In
fiscal 2000, amalgam development costs of $59,000 were incurred and
$125,000 on orthodontic products. The total costs incurred by Lancer on
product development activities were approximately $184,000 and $165,000 for
the fiscal years ended May 31, 2000 and 1999, 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
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.
EMPLOYEES. As of August 11, 2000, Lancer had 39 employees. Additionally,
Lancer, through its Mexican subcontractor, employed approximately 105
people in Mexico.
5
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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
sixty months commencing November 1, 1998 and ending October 31, 2003.
Management believes that the properties are currently suitable and adequate
for Lancer's operations. Future aggregate minimum annual cash lease
payments are as follows:
Years ending
------------
May 31, 2001 $142,808
May 31, 2002 145,547
May 31, 2003 148,401
Thereafter 75,651
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$512,407
========
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, 2000.
PART II
ITEM 5. MARKET FOR LANCER'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
High and low bid 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. The market for Lancer's stock is limited and
sporadic and is traded under the symbol LANZ.
Quarter Ended High Low
----------------- ------ ------
August 31, 1998 $1.13 $ .75
November 30, 1998 $1.50 $ .88
February 28, 1999 $1.19 $ .56
May 31, 1999 $1.13 $ .50
August 31, 1999 $1.13 $ .63
November 30, 1999 $1.00 $ .72
February 28, 2000 $2.13 $ .50
May 31, 2000 $1.81 $ .06
During fiscal 1999, Lancer's Board of Directors approved the issuance of
10,625 new shares of common stock to Biomerica, Inc., in lieu of payment of
$8,500 in accrued administrative support fees. At May 31, 2000, Biomerica,
Inc. owned approximately 30% of Lancer's outstanding common stock.
6
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During fiscal 2000 Lancer's Board of Directors approved the issuance of
54,725 shares of common stock to directors of the Company, in lieu of
payment of $50,631 in accrued directors' fees.
In May 2000, all 370,483 issued and outstanding shares of Series D
preferred stock were converted to 52,926 shares of common stock. At May 31,
2000, there were no preferred shares issued and outstanding.
The approximate number of beneficial holders of Lancer's common stock at
May 31, 2000, was 498.
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. 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.
RESULT OF OPERATIONS
For the fiscal year ended May 31, 2000, net sales decreased $508,984 (8.3%) from
$6,159,496 in 1999 to $5,650,512 in 2000. International net sales decreased
$228,689 (8.3%) from $2,746,469 in 1999 to $2,517,780 in 2000. This decrease is
primarily attributable to economic conditions in Europe and South America.
Domestic net sales decreased $280,295 (8.2%) from $3,413,027 in 1999 to
$3,132,732 in 2000. This decrease is primarily attributable to increased
discounting due to competition pressures. Management believes the trend in
increased discounting will be significant to ongoing operations. Lancer
continues to search for new sales representatives, distributors, private label
customers, products, and product ideas, any of which, if successful, should
result in increased sales.
Cost of sales, as a percentage of sales, increased 7.0% from 61.4% in fiscal
1999 to 68.4% in fiscal 2000. The increase is primarily attributable to fixed
costs of the Mexicali location not producing at full capacity. Lancer continues
its program to improve manufacturing by adding new equipment and improving
processes and efficiencies. Cost of sales for fiscal 1999 includes Mexican tax
assessed to Lancer's subcontractor of $65,000, $50,000 of which was reversed and
recognized as other income in fiscal 2000.
Selling expenses decreased $85,222 (4.9%) from $1,724,026 in 1999 to $1,638,804
in 2000. The decrease is primarily attributable to decreases in commissions of
$56,755 and bad debt expense of $48,679, partially offset by increases in show
expense and other expenses. In fiscal 1999, an additional $50,000 of bad debt
expense was incurred as a reserve for international receivables.
General and Administrative expenses increased $34,198 (7.9%) from $431,189 in
1999 to $465,387 in 2000. The increase is primarily attributable to an increase
in labor costs of $35,931, offset by a decrease in other expenses.
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Product Development expenses increased $19,211 (11.6%) from $165,038 in 1999 to
$184,249 in 2000. The increase is primarily attributable to an increase in
payroll costs and development costs of new products.
Interest expense increased $3,955 (25.3%) from $15,607 in 1999 to $19,562 in
2000. The increase is primarily attributable to borrowings against the line of
credit to finance development costs and an increase in the interest rate.
For the year ended May 31, 2000, other income of $169,672 was realized from the
insurance claim settlement of $279,672 for the theft of inventory at the
Company's Mexicali facility, less $110,000 insurance claim receivable valued at
cost at May 31, 1999.
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
During fiscal 2000, management negotiated a renewal of Lancer's line of credit
through November 3, 2000. The line of credit allows for borrowing up to $500,000
and is limited to specified percentages of eligible accounts RECEIVABLE. The
unused portion available under the line of credit at May 31, 2000, was
approximately $173,000. Borrowings bear interest at prime plus 1.25% per annum
(10.75% at May 31, 2000).
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 decreased $223,636 (7.6%) from $2,938,191 in 1999 to $2,714,555
in 2000. The decrease is primarily attributable to a decrease in receivables and
inventories, partially offset by a decrease in payables, accrued liabilities,
and line of credit.
In March 1998, Lancer's Board of Directors approved the repurchase of up to 4%
of Lancer's outstanding common stock through February 1999. The repurchase was
extended on June 1, 1999 for an additional 3% through May 31, 2000. Such
repurchases were at the discretion of management when management believed
Lancer's common stock to be undervalued. Repurchases were made out of current
cash flow and all repurchased shares were retired. During fiscal 2000, the
Company repurchased 114,998 shares of its common stock for an aggregate
consideration of $117,914. During fiscal 1999, the Company repurchased 25,372
shares of its common stock for aggregate consideration of $25,950.
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
8
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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 20, 2000, which will be filed with the
Commission not later than 120 days after the end of Lancer's fiscal year period
ended May 31, 2000, 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 20, 2000, which will be filed with the
Commission not later than 120 days after the end of Lancer's fiscal year ended
May 31, 2000, 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
November 20, 2000, which will be filed with the Commission not later than 120
days after the end of Lancer's fiscal year ended May 31, 2000, 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 20,
2000, which will be filed with the Commission not later than 120 days after the
end of Lancer's fiscal year ended May 31, 2000, 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 20, 2000,
which will be filed with the Commission not later than 120 days after the end of
Lancer's fiscal year ended May 31, 2000, 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
-----------------------------------------------------------
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, 2000.
9
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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: September 13, 2000
LANCER ORTHODONTICS, INC.
By: /s/ Douglas D. Miller /s/ Catherine Wyss
------------------------------------- --------------------------------
Douglas D. Miller Catherine Wyss
President and Chief Operating Officer Accounting Manager
(Principal Financial Officer,
Principal Accounting Officer)
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 September 13, 2000
-------------------------- ------------------
Zackary Irani Chairman of the Board
& Director
/s/ Douglas D. Miller September 13, 2000
-------------------------- ------------------
Douglas D. Miller President, Chief Operating
Officer & Director
/s/ Janet Moore September 13, 2000
-------------------------- ------------------
Janet Moore Secretary & Director
/s/ Robert Orlando September 13, 2000
-------------------------- ------------------
Robert Orlando Director
10
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LANCER ORTHODONTICS, INC.
Financial Statements
As of May 31, 2000 and
For Each of the Years in the Two-Year Period Then Ended
Report of Independent Certified Public Accountants,
BDO Seidman, LLP FS-2
Financial Statements
Balance Sheet FS-3
Statements of Operations FS-4
Statements of Stockholders' Equity FS-5
Statements of Cash Flows FS-6
Notes to Financial Statements FS7 - 18
FS-1
<PAGE>
Report of Independent Certified Public Accountants
The Board of Directors
Lancer Orthodontics, Inc.
We have audited the accompanying balance sheet of Lancer Orthodontics, Inc. (the
"Company") as of May 31, 2000, and the related statements of operations,
stockholders' equity and cash flows for each of the years in the two-year period
ended May 31, 2000. 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.
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, 2000, and the results of its operations and its cash flows for each of
the years in the two-year period ended May 31, 2000 in conformity with generally
accepted accounting principles.
/s/ BDO SEIDMAN, LLP
BDO SEIDMAN, LLP
Orange County, California
July 21, 2000, except
for Note 8 as to which
the date is July 31, 2000
FS-2
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<TABLE>
LANCER ORTHODONTICS, INC.
BALANCE SHEET
<CAPTION>
MAY 31, 2000
------------
<S> <C>
ASSETS
CURRENT ASSETS
Cash $ 103,207
Accounts receivable, net of allowance for doubtful accounts of $175,000 1,232,770
Inventories, net of reserve of $110,167 2,013,245
Prepaid expenses 46,700
------------
Total current assets 3,395,922
PROPERTY AND EQUIPMENT, NET 117,170
INTANGIBLE ASSETS, NET 235,748
OTHER ASSETS 6,560
------------
$ 3,755,400
============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable and accrued liabilities $ 521,367
Line of credit 160,000
------------
Total current liabilities 681,367
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Redeemable convertible preferred stock, Series C, $.06 noncumulative annual
dividend; $.75 par value; 250,000 shares authorized; 0 shares issued and
outstanding in 2000 ($.75 liquidation preference) -
Redeemable convertible preferred stock, Series D, $.04 noncumulative annual
dividend; $.50 par value; 500,000 shares authorized; 0 shares issued and
outstanding in 2000 ($.50 liquidation preference per share) -
Common stock, no par value; 50,000,000 shares authorized; 2,098,618 shares
issued and outstanding 4,815,074
Accumulated deficit (1,741,041)
------------
Total stockholders' equity 3,074,033
------------
$ 3,755,400
============
</TABLE>
See accompanying notes to financial statements.
FS-3
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LANCER ORTHODONTICS, INC.
STATEMENTS OF OPERATIONS
YEARS ENDED MAY 31, 2000 1999
------------ ------------
NET SALES $ 5,650,512 $ 6,159,496
COST OF SALES 3,866,001 3,779,010
------------ ------------
GROSS PROFIT 1,784,511 2,380,486
----------- -----------
OPERATING EXPENSES:
Selling 1,638,804 1,724,026
General and administrative 465,387 431,189
Product development 184,249 165,038
------------ ------------
TOTAL OPERATING EXPENSES 2,288,440 2,320,253
------------ ------------
OPERATING (LOSS) INCOME (503,929) 60,233
OTHER INCOME (EXPENSE):
Interest expense (19,562) (15,607)
Interest income 36 -
Other income, net 227,270 2,010
------------ ------------
TOTAL OTHER INCOME (EXPENSE) 207,744 (13,597)
------------ ------------
(LOSS) INCOME BEFORE INCOME TAXES (296,185) 46,636
INCOME TAXES 800 4,604
------------ ------------
NET (LOSS) INCOME $ (296,985) $ 42,032
============ ============
PER SHARE DATA:
Basic $ (.15) $ .02
============ ============
Diluted $ (.15) $ .02
============ ============
See accompanying notes to financial statements.
FS-4
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<TABLE>
LANCER ORTHODONTICS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<CAPTION>
SERIES D PREFERRED STOCK COMMON STOCK ACCUMULATED
SHARES AMOUNT SHARES AMOUNT DEFICIT TOTAL
------------ ------------ ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Balances, May 31, 1998 370,483 $ 185,242 2,120,712 $ 4,705,394 $(1,486,088) $ 3,404,548
Repurchase of common stock - - (25,372 ) (25,950 ) - (25,950 )
Common stock issued for
services - - 10,625 8,500 - 8,500
Compensation expense related
to options issued for
services rendered - - - 9,171 - 9,171
Net income - - - - 42,032 42,032
------------ ------------ ------------ ------------ ------------ -------------
Balances, May 31, 1999 370,483 185,242 2,105,965 4,697,115 (1,444,056) 3,438,301
Common stock issued for
services - - 54,725 50,631 - 50,631
Conversion of preferred stock (370,483) (185,242) 52,926 185,242 - -
Repurchase of common stock - - (114,998) (117,914) - (117,914)
Net loss - - - - (296,985) (296,985)
------------ ------------ ------------ ------------ ------------ -------------
Balances, May 31, 2000 - $ - 2,098,618 $ 4,815,074 $(1,741,041) $ 3,074,033
============ ============ ============ ============ ============ =============
</TABLE>
See accompanying notes to financial statements.
FS-5
<PAGE>
<TABLE>
LANCER ORTHODONTICS, INC.
STATEMENTS OF CASH FLOWS
<CAPTION>
YEARS ENDED MAY 31, 2000 1999
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net (loss) income $(296,985) $ 42,032
Adjustment to reconcile net (loss) income to net cash provided by
(used in) operating activities:
Depreciation and amortization 151,117 171,589
Provision for losses on accounts receivable (986) 55,986
Options issued for services rendered - 9,171
Common stock issued for services 50,631 8,500
Net change in operating assets and liabilities:
Accounts receivable 119,936 (104,856)
Inventories 193,909 (410,360)
Prepaid expenses 5,145 15,912
Insurance claim receivable 110,000 (110,000)
Accounts payable and accrued liabilities (187,453) 124,598
---------- ----------
Net cash provided by (used in) operating activities 145,314 (197,428)
---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (10,485) (71,366)
---------- ----------
Net cash used in investing activities (10,485) (71,366)
---------- ----------
Cash flows from financing activities:
Net increase (decrease) in line of credit agreement (20,000) 80,000
Repurchase of common stock (117,914) (25,950)
---------- ----------
Net cash (used in) provided by financing activities (137,914) 54,050
---------- ----------
Net decrease in cash (3,085) (214,744)
Cash, beginning of period 106,292 321,036
---------- ----------
Cash, end of period $ 103,207 $ 106,292
========== ==========
Supplemental disclosures of cash flow information:
Cash paid during the year for:
Interest $ 19,562 $ 15,607
========== ==========
Income taxes $ 800 $ 800
========== ==========
Supplemental disclosures of non-cash investing and
financing activities:
Conversion of 370,483 shares of Convertible Preferred Stock
Series D to 52,926 shares of common stock $ 185,242 $-
========== ==========
</TABLE>
See accompanying notes to financial statements.
FS-6
<PAGE>
LANCER ORTHODONTICS, INC.
NOTES TO FINANCIAL STATEMENTS
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 9). The Company also purchases certain
orthodontic and dental products for purposes of resale. Sales of
manufactured and resale products comprise approximately 82% and 18% of
total sales, respectively, for fiscal 2000 and 86% and 14% of total
sales, respectively, for fiscal 1999.
Sales are made directly to orthodontists worldwide through Company
representatives and independent distributors, with approximately 55% and
55% during fiscal 2000 and 1999, 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.
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,
2000.
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 materially differ from those
estimates.
CONCENTRATIONS OF CREDIT RISK
The Company, at times, maintains cash balances at certain financial
institutions in excess of the federally insured deposits.
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 materially differ from the estimated amounts. As of May
31, 2000, reserves for credit losses totaled $125,000. Reserves for
sales returns totaled $50,000. At May 31, 2000, two customers accounted
for approximately 13% and 13.5% of gross accounts receivable. No one
customer accounted for 10% or more of revenues for the years ended May
31, 2000 and 1999.
SUPPLIERS - At May 31, 2000, no one company accounted for more than 10%
of accounts payable. No one company accounted for more than 10% of
purchases for the years ended May 31, 2000 and 1999.
FS-7
<PAGE>
LANCER ORTHODONTICS, INC.
NOTES TO FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RISKS AND UNCERTAINTIES
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 from the commencement of
the agreement 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, 2000, 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.
GOVERNMENT REGULATIONS
The Company's products are subject to regulation by the FDA under the
Medical Device Amendments of 1976 (the "Amendments"). The Company has
registered with the FDA as required by the Amendments. There can be no
assurance that the Company will be able to obtain regulatory clearances
for its current or any future products in the United States or in
foreign markets.
EUROPEAN COMMUNITY
The Company is required to obtain certification in the European
community to sell products in those countries. The certification
requires the Company to maintain certain quality standards. The Company
had been granted certification. However, there is no assurance that the
Company will be able to retain its certification in the future.
RISK OF PRODUCT LIABILITY
Testing, manufacturing and marketing of the Company's products entail
risk of product liability. The Company currently has product liability
insurance. There can be no assurance, however, that the Company will be
able to maintain such insurance at a reasonable cost or in sufficient
amounts to protect the Company against losses due to product liability.
An inability could prevent or inhibit the commercialization of the
Company's products. In addition, a product liability claim or recall
could have a material adverse effect on the business or financial
condition of the Company.
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.
FS-8
<PAGE>
LANCER ORTHODONTICS, INC.
NOTES TO FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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.
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, 2000.
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 (Note 10).
REVENUE RECOGNITION
Revenues from product sales are recognized at the time the product is
shipped.
RESEARCH AND DEVELOPMENT
Research and development expenses are expensed as incurred. The Company
expensed $184,000 and $165,000 during the years ended May 31, 2000 and
1999, respectively.
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 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 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.
FS-9
<PAGE>
LANCER ORTHODONTICS, INC.
NOTES TO FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 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. Potential common shares, which
relate to shares issuable upon the exercise of common stock purchase
options, were not included in the per share calculations for fiscal 2000
and 1999 as their effect was anti-dilutive. Potential common shares,
which relate to shares issuable upon the conversion of preferred stock
into common stock, were included in the per share calculations for
fiscal 1999 as their effect was dilutive.
Earnings per share for the years ended May 31, 2000 and 1999 are as
follows:
<TABLE>
<CAPTION>
MAY 31, 2000 1999
-------------- -------------
<S> <C> <C>
Basic (loss) earnings per share:
Net (loss) income $ (296,985) $ 42,032
============== =============
Net (loss) income applicable to common shareholders $ (296,985) $ 42,032
============== =============
Weighted average number of common shares 2,047,687 2,117,128
============== =============
Basic (loss) earnings per share $ (.15) $ .02
============== =============
Diluted (loss) earnings per share:
Net (loss) income from primary income per common share $ (296,985) $ 42,032
============== =============
Net (loss) income for diluted earnings per share $ (296,985) $ 42,032
============== =============
Weighted average number of shares used in calculating basic earnings per
common share 2,047,687 2,117,128
Add:
Stock options - -
Convertible preferred stock - 52,926
-------------- -------------
Weighted average number of shares used in calculating diluted earnings
per share 2,047,687 2,170,054
============== =============
Diluted (loss) earnings per share $ (.15) $ .02
============== =============
</TABLE>
FS-10
<PAGE>
LANCER ORTHODONTICS, INC.
NOTES TO FINANCIAL STATEMENTS
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
NEW ACCOUNTING PRONOUNCEMENTS
SEGMENT REPORTING - 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 requires public companies to 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
products and services an entity provides, the material countries in
which it holds assets and reports revenues, and its major customers. The
Company adopted the provisions of this statement for 1999 annual
reporting. These disclosure requirements had no impact on the Company's
financial position or results of operations, or the Company's existing
segment disclosures.
REPORTING COMPREHENSIVE INCOME - In June 1997, the FASB issued SFAS No.
130, "REPORTING COMPREHENSIVE INCOME". This statement establishes
standards for reporting the components of comprehensive income and
requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be included
in a financial statement that is displayed with the same prominence as
other financial statements. Comprehensive income includes net income as
well as certain items that are reported directly within a separate
component of stockholders' equity and bypass net income. The Company
adopted the provisions of this statement in 1999. These disclosure
requirements had no impact on the Company's results of operations. The
Company has no elements of other comprehensive income, as defined by
SFAS No. 130, for the periods presented.
3. OTHER INCOME
Management of the Company completed an assessment of a theft of
inventory located at its facility in Mexicali Mexico on April 6, 1999.
The carrying value of the inventory stolen approximated $110,000, valued
at standard cost, which has been reflected in the accompanying financial
statements as a reduction in inventories and an addition to insurance
claim receivable. During the year ended May 31, 2000, the Company
settled the claim with the insurance carrier and received approximately
$280,000. This amount represents the value of the stolen inventory at
net average selling price, less commissions and royalties. The $170,000
received in excess of the $110,000 estimated carrying value was
recognized as other income for the year ended May 31, 2000.
During 1999, the Company was assessed $64,724 in pass through net asset
taxes by their subcontractor under their Manufacturing Agreement (Note
9). During 2000, legal counsel determined the Company was not liable for
portions of the assessment. Accordingly, approximately $50,000 of the
prior year accrual was reversed and recognized as other income during
the year ended May 31, 2000.
4. INVENTORIES
The components of inventories at May 31, 2000 are as follows:
Raw materials $ 416,951
Work in progress 104,403
Finished products 1,602,058
Inventory reserves (110,167)
--------------
Total $ 2,013,245
==============
FS-11
<PAGE>
LANCER ORTHODONTICS, INC.
NOTES TO FINANCIAL STATEMENTS
5. PROPERTY AND EQUIPMENT
The components of property and equipment at May 31, 2000 are as follows:
Machinery and equipment $ 1,888,562
Dies, tools, and patterns 375,518
Furniture and fixtures 123,663
Leasehold improvements 8,586
Construction in progress 7,400
--------------
2,403,729
Less accumulated depreciation and amortization (2,286,559)
--------------
Total $ 117,170
==============
Approximately $70,000 of property and equipment, net of accumulated
depreciation and amortization, is located at the Company's manufacturing
facility in Mexico (Note 9).
Depreciation expense for the years ended May 31, 2000 and 1999, totaled
$77,521 and $97,993, respectively.
6. INTANGIBLE ASSETS
The components of intangible assets at May 31, 2000 are as follows:
Marketing and distribution rights $ 442,750
Technology use rights 858,328
--------------
Subtotal 1,301,078
Less accumulated amortization (1,065,330)
--------------
Total $ 235,748
==============
Amortization expense for each of the years ended May 31, 2000 and 1999
totaled $73,596.
7. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
The components of accounts payable and accrued liabilities at May 31,
2000 are as follows:
Trade accounts payable $ 350,124
Accrued payroll and related benefits 101,563
Other accrued liabilities 69,680
--------------
Total $ 521,367
==============
8. LINE OF CREDIT
At May 31, 2000, the Company had a line of credit with a bank for
borrowings up to $500,000. The line of credit bears interest at prime
plus 1.25% per annum (10.75% at May 31, 2000). Allowable borrowings are
limited to specified percentages of eligible accounts receivable. The
unused portion available under the line of credit at May 31, 2000, was
$172,707. The line of credit expires on November 3, 2000.
FS-12
<PAGE>
LANCER ORTHODONTICS, INC.
NOTES TO FINANCIAL STATEMENTS
8. LINE OF CREDIT (CONTINUED)
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 $2,800,000, a debt to
tangible net worth ratio of no more than 1 to 1, and a current ratio in
excess of 2 to 1. The Company is not required to maintain compensating
balances in connection with this lending agreement. The Company was in
compliance with its bank covenants as of May 31, 2000. The Company was
in violation of certain of its debt covenants at July 31, 2000, for
which a waiver has not been received.
The following summarizes information on short-term borrowings for the
year ended May 31, 2000:
MAY 31, 2000
--------------
Average month end balance $ 203,333
==============
Maximum balance outstanding at any month end $ 220,000
==============
Weighted average interest rate (computed by dividing
interest expense by average monthly balance) 9.62%
==============
Interest rate at year end 10.75%
==============
9. 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 $10,431 at May 31,
2000, 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, 2000 and 1999 was approximately $69,000 and $56,000,
respectively.
Effective April 1, 1996, the Company entered into a non-cancelable
operating lease for its Mexico facility which expired October 31, 1998,
which required average monthly rentals of approximately $5,200. The
lease has been extended to October 2003, which requires average monthly
rentals of approximately $6,000. 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, as discussed in the following paragraph. Total
expense for this facility for the years ended May 31, 2000 and 1999, was
approximately $74,000 and $69,000, respectively.
At May 31, 2000, future aggregate minimum lease payments are as follows:
YEARS ENDING MAY 31, Amount
--------------
2001 $ 142,808
2002 145,547
2003 148,401
2004 75,651
--------------
Total $ 512,407
==============
FS-13
<PAGE>
LANCER ORTHODONTICS, INC.
NOTES TO FINANCIAL STATEMENTS
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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 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. During
1999, the Company extended the Manufacturing Agreement through December
2003. The Company has retained the option to convert the manufacturing
operation to a wholly owned subsidiary at any time without penalty.
Should the company discontinue operations in Mexico, it is responsible
for the accumulated employee seniority obligation as prescribed by
Mexican law. At May 31, 2000, this obligation was approximately
$256,000. 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.
10. STOCKHOLDERS' EQUITY
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, 2000, there were no shares issued and outstanding. There were no
dividends declared or paid in 2000 or 1999.
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. In May 2000,
all 370,483 issued and outstanding shares were converted into 52,926
shares of common stock. At May 31, 2000, there were no shares issued and
outstanding. There were no dividends declared or paid in 2000 or 1999.
FS-14
<PAGE>
LANCER ORTHODONTICS, INC.
NOTES TO FINANCIAL STATEMENTS
10. STOCKHOLDERS' EQUITY (CONTINUED)
COMMON STOCK
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 following
twelve months. Such repurchases are at the discretion of management and
all repurchased shares will be retired. During 2000, the Company
repurchased 114,998 shares of its common stock for aggregate
consideration of $117,914. During 1999, the Company repurchased 25,372
shares of its common stock for aggregate consideration of $25,950.
During 1999, the Company issued 10,625 shares of its common stock valued
at $8,500 for certain management and consulting services.
During 2000, the Company issued 54,725 shares of its common stock valued
at $50,631 for certain management and consulting services.
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 through August 1999.
During 1999, the Company granted 138,500 options to purchase shares of
the Company's common stock at an exercise price of $1.00 to certain
employees of the Company, which vested immediately and have a term of
five years.
During the year ended May 31, 2000, the Company granted 15,000 options
to purchase shares of the Company's common stock at an exercise price of
$0.85 to certain employees of the Company, which vest ratably over a
term of one year and have a term of five years.
During 1999, the Company granted 29,000 options to purchase shares of
the Company's common stock at an exercise price of $1.00 to certain
non-employees of the Company, which vested immediately and have a term
of five years. The Company recorded $9,171 of compensation expense based
on the fair value of these non-employee options during the year ended
May 31, 1999.
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 average assumptions: risk free interest rate of 4.5%; 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
40%.
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
FS-15
<PAGE>
LANCER ORTHODONTICS, INC.
NOTES TO FINANCIAL STATEMENTS
10. STOCKHOLDERS' EQUITY (CONTINUED)
forma disclosure, 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, 2000 and 1999, are as follows:
<TABLE>
<CAPTION>
MAY 31, 2000 1999
------------- ------------
<S> <C> <C>
Net (loss) income, as reported $ (296,985) $ 42,032
Adjustment to compensation expense under SFAS 123 6,505 42,837
------------- ------------
Net (loss) income, pro forma $ (303,490) $ (805)
============= ============
Net (loss) income, per common and common equivalent share, as reported $ (.15) $ .02
============= ============
Net (loss) income per common and common equivalent share, pro forma $ (.15) $ (.00)
============= ============
</TABLE>
The following summary presents the options granted, exercised, expired,
and outstanding as of May 31, 2000:
<TABLE>
<CAPTION>
Number of Shares Weighted Average
Employee Non-employee Total Exercise Price
--------------------------------- --------------- -------------------
<S> <C> <C> <C> <C>
Outstanding,
May 31, 1998 14,286 - 14,286 $ 1.75
Granted 138,500 29,000 167,500 1.00
Exercised - - - -
Expired (3,000) - (3,000) 6.00
-------------- --------------- --------------- -------------
Outstanding,
May 31, 1999 149,786 29,000 178,786 1.06
Granted 15,000 - 15,000 0.85
Exercised - - - -
Expired - - - -
-------------- --------------- --------------- -------------
Outstanding,
May 31, 2000 164,786 29,000 193,786 $ 1.04
============== =============== =============== =============
</TABLE>
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, 2000:
Contractual
Number of Options Life
------------------------------- Remaining
Exercise Price Outstanding Exercisable Years
------------------------------- ---------------
$ 0.85 15,000 3,750 4.3
$ 1.00 164,500 164,500 3.25
$ 1.75 14,286 7,142 1.4
------------------------------- ---------------
Total 193,786 175,392
===============================
FS-16
<PAGE>
LANCER ORTHODONTICS, INC.
NOTES TO FINANCIAL STATEMENTS
11. 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.
12. INCOME TAXES
The provision for income taxes for the years ended May 31, 2000 and 1999
consists of the following:
MAY 31, 2000 1999
------------- -------------
CURRENT
U.S. Federal $ - $ -
State and Local 800 4,604
------------- -------------
$ 800 $ 4,604
============= =============
DEFERRED
U.S. Federal $ - $ -
State and Local - -
------------- -------------
$ - $ -
============= =============
The tax effect of temporary differences that give rise to significant
portions of the deferred tax assets and liabilities at May 31, 2000 are
presented below:
<TABLE>
<CAPTION>
MAY 31, 2000
-------------
<S> <C>
Deferred tax assets:
Accounts receivable, principally due to allowance for doubtful accounts
and sales returns $ 70,000
Inventories, principally due to additional costs inventoried for tax
purposes pursuant to the Tax Reform Act of 1986 and allowance for
inventory obsolescence 75,137
Compensated absences principally due to accrual for financial reporting 21,906
Net operating loss carryforwards 736,882
Business tax credit carryforwards 137,267
Less valuation allowance (997,202)
-------------
Net deferred tax assets 43,990
Deferred tax liabilities:
Unamortized marketing rights (43,990)
-------------
Net deferred tax liabilities $ -
=============
</TABLE>
Lancer has provided a valuation allowance with respect to substantially
all of its deferred tax assets as of May 31, 2000. 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.
FS-17
<PAGE>
LANCER ORTHODONTICS, INC.
NOTES TO FINANCIAL STATEMENTS
12. INCOME TAXES (CONTINUED)
Income tax expense for the years ended May 31, 2000 and 1999 differed
from the amounts computed by applying the U.S. Federal income tax rate of
35 % to pre-tax income as a result of:
<TABLE>
<CAPTION>
MAY 31, 2000 1999
------------- -------------
<S> <C> <C>
Computed "expected" tax (benefit) expense $ (103,945) $ 15,856
Income (reduction) in income taxes resulting from:
Meals and expenses 13,048 9,944
Change in beginning of the year balance of the valuation allowance for
deferred tax assets allocated to income tax expense 90,897 (25,800)
State and local income taxes, net of tax benefit 800 4,604
------------- -------------
$ 800 $ 4,604
============= =============
</TABLE>
As of May 31, 2000, the Company has net tax operating loss carryforwards
of approximately $2,101,000 and business tax credits of approximately
$114,735 available to offset future Federal taxable income and tax
liabilities, respectively. The Federal carryforwards expire in varying
amounts from 2000 to 2019. As of May 31, 2000, the Company has net tax
operating loss carryforwards of approximately $250,000 and business tax
credits of approximately $22,532 available to offset future state income
tax liabilities. The state carryforwards expire in 2004.
13. EXPORT SALES
The Company has significant export sales. The net sales and operating
activities are as follows:
MAY 31, 2000 1999
------------- -------------
NET SALES
Domestic $ 3,133,000 $ 3,413,000
Europe 1,379,000 1,436,000
South America 489,000 685,000
Other 650,000 625,000
------------- -------------
Total $ 5,651,000 $ 6,159,000
============= =============
OPERATING (LOSS) PROFIT
Domestic $ (406,000) $ (91,000)
Europe (54,000) 79,000
South America (19,000) 38,000
Other (25,000) 34,000
------------- -------------
Total $ (504,000) $ 60,000
============= =============
IDENTIFIABLE ASSETS
Domestic $ 1,930,000 $ 2,240,000
Mexico 1,590,000 1,778,000
------------- -------------
Total $ 3,520,000 $ 4,018,000
============= =============
FS-18
