SECURITIES AND EXCHANGE COMMISSION
Washington DC 20549
FORM 10-QSB
Quarterly Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934
For Quarter Ended August 31, 2004 Commission File No. 0-5920
LANCER ORTHODONTICS, INC.
(Exact Name of Small Business Issuer as Specified in its Charter)
CALIFORNIA 95-2497155
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
253 Pawnee Street, San Marcos, California 92069
(Address of Principal Executive Offices)
Issuer's telephone number, including area code: (760) 744-5585
Check whether the issuer: (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act during the preceding 12
months (or for such shorter period that the Registrant was required to file
such reports, and (2) has been subject to such filing requirements for the
past 90 days.
Yes X No
State the number of shares outstanding of each of the issuer's classes of
common equity, as of September 17, 2004: 2,768,820
Transitional small business disclosure format (check one):
Yes X No
LANCER ORTHODONTICS, INC.
FORM 10-QSB
QUARTERLY REPORT
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Page(s)
Item 1 Financial Statements (Unaudited)
Consolidated Balance Sheet 3
Consolidated Statements of Operations 4
Consolidated Statements of Cash Flows 5
Notes to Consolidated Financial Statements 6-17
Item 2 Management's Discussion and Analysis of Financial Condition and
Results of Operations 17-20
Item 3 Quantitative and Qualitative Disclosures about Market Risk 20-21
Item 4 Procedures and Controls 21
PART II - OTHER INFORMATION
Item 1 Legal Proceedings 21
Item 2 Changes in Securities and Use of Proceeds 21
Item 3 Defaults Upon Senior Securities 21
Item 4 Submission of Matters to a Vote of Security Holders 21
Item 5 Other Information 21
Item 6 Exhibits and Reports on Form 8-K 21
Signature 22
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS (UNAUDITED)
LANCER ORTHODONTICS, INC.
CONSOLIDATED BALANCE SHEET (UNAUDITED)
08/31/04
ASSETS
CURRENT ASSETS:
Cash $126,905
Accounts receivable, less allowances for sales
returns and doubtful receivables of $97,829 1,275,954
Inventories, net of reserve of $144,135 2,006,068
Related party receivables 3,844
Prepaid expenses 59,638
Other receivables 50,728
Total current assets 3,523,137
PROPERTY AND EQUIPMENT, at cost 3,067,377
Less: Accumulated depreciation (2,458,888)
608,489
INTANGIBLE ASSETS:
Marketing and distribution rights, net 4,150
OTHER ASSETS 48,821
Total assets $4,184,597
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $505,477
Accrued payroll and related benefits 164,307
Accrued professional fees 31,881
Accrued royalties 34,289
Other current liabilities 40,938
Related party payable 200
Total current liabilities 777,092
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, various series; 750,000 shares authorized;
no shares issued and outstanding --
Common stock, no par value; 50,000,000 authorized;
2,768,820 shares issued and outstanding 5,162,095
Common stock subscribed, 51,041 shares subscribed 28,750
Accumulated deficit (1,783,340)
Total stockholders' equity 3,407,505
Total liabilities and stockholders' equity $4,184,597
LANCER ORTHODONTICS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS UNAUDITED
FOR THE THREE MONTHS ENDED
8/31/04 8/31/03
NET SALES $1,480,863 $1,318,107
COST OF SALES 1,072,427 975,267
Gross Profit 408,436 342,840
OPERATING EXPENSES:
Selling 343,952 344,946
General & Administrative 118,594 111,019
Product Development 27,108 32,502
TOTAL OPERATING EXPENSES 489,654 488,467
LOSS FROM OPERATIONS (81,218) (145,627)
OTHER INCOME:
Interest Expense -- --
Other Income, net 17,868 5,412
TOTAL OTHER INCOME 17,868 5,412
LOSS BEFORE INCOME TAXES (63,350) (140,215)
INCOME TAXES -- --
NET LOSS $(63,350) $(140,215)
PER SHARE DATA:
Basic $(.02) $(.06)
Diluted $(.02) $(.06)
WEIGHTED AVERAGE NUMBER OF COMMON AND COMMON EQUIVALENT SHARES:
Basic 2,807,362 2,266,476
Diluted 2,807,362 2,266,476
LANCER ORTHODONTICS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
FOR THE THREE MONTHS ENDED
08/31/04 08/31/03
Cash flows from operating activities:
Net loss $(63,350) $(140,215)
Adjustments to reconcile net loss to net
cash (used in) provided by operating activities:
Depreciation and amortization 25,689 11,461
Provision for losses on accounts receivable (2,171) (5,142)
Provision for losses on inventory 15,000 15,000
Common stock issued in lieu of salary 22,500 3,750
Net change in operating assets and liabilities:
Accounts receivable (139,649) 202,926
Inventories (173,538) (39,531)
Related party receivables 3,436 4,447
Prepaid expenses 64,539 (11,204)
Other receivables (4,388) (1,497)
Accounts payable 123,447 (126,562)
Accrued payroll and related benefits 38,158 28,142
Other current liabilities (25,327) (13,818)
Net cash used in operating activities (115,654) (72,243)
Cash flows from investing activities:
Purchases of property and equipment (61,586) (147,760)
Other assets -- (3,651)
Net cash used in investing activities (61,586) (151,411)
Cash flows from financing activities:
Net decrease in line of credit -- (5)
Cash flows used in financing activities -- (5)
Net change in cash (177,240) (223,659)
Cash, beginning of period 304,145 511,407
Cash, end of period $126,905 $287,748
Supplemental disclosure of cash flow information:
Cash paid for:
Interest $-- $--
LANCER ORTHODONTICS, INC.
Notes to Consolidated Financial Statements
(A) Basis of Presentation
The accompanying unaudited consolidated financial statements have been
prepared in accordance with the instructions to Form 10-QSB and therefore
do not include all information and notes necessary for a fair presentation of
consolidated financial position, results of operations, and cash flows in
conformity with generally accepted accounting principles. The unaudited
consolidated financial statements include the accounts of Lancer
Orthodontics, Inc. (the "Company" or "Lancer") and its wholly-owned subsidiary
Lancer Orthodontics de Mexico. The consolidated operating results for interim
periods are unaudited and are not necessarily an indication of the results to
be expected for the full fiscal year. In the opinion of management, the
results of operations as reported for the interim periods reflect all
adjustments which are necessary for a fair presentation of operating results.
Reference is made to Note 2 of the Notes to the Consolidated Financial
Statements contained in Lancer's Annual Report on Form 10-KSB for the fiscal
year ended May 31, 2004, for a summary of significant accounting policies
utilized by Lancer.
(B) Organization
Lancer Orthodontics, Inc. 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. Lancer has a manufacturing facility in
Mexico where a majority of its inventory is manufactured (Note G). The
facility is incorporated and is a wholly-owned and consolidated subsidiary of
Lancer. This subsidiary now also administers services previously provided by
an independent manufacturing contractor. The conversion had no material
effect on manufacturing operations. Lancer also purchases certain orthodontic
and dental products for purposes of resale. Sales are made directly to
orthodontists world-wide through Company representatives and independent
distributors. Lancer 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's direct ownership percentage of Lancer is
24.7% and its direct and indirect (via agreements with certain shareholders)
voting control over Lancer is greater than 50% as of August 31, 2004.
(C) Use of Estimates in the Preparation of Financial Statements
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
("GAAP"), requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the consolidated financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Significant estimates made by Lancer's management include,
but are not limited to, allowances for doubtful accounts, allowances for
sales returns, valuation of inventories, realizeability of property and
equipment through future operations, and realizeability of deferred tax
assets. Actual results could materially differ from those estimates.
LANCER ORTHODONTICS, INC.
Notes to Consolidated Financial Statements - continued
(D) Stock Based Compensation
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," which amended SFAS No. 123
"Accounting for Stock-Based Compensation." The new standard provides
alternative methods of transition for a voluntary change to the fair value
based method of accounting for stock-based employee compensation.
Additionally, the statement amends the disclosure requirements of SFAS No.
123 to require prominent disclosures in the annual and interim financial
statements about the method of accounting for stock-based employee
compensation and the effect of the method used on reported results. This
statement is effective for financial statements for fiscal years ending after
December 15, 2002. In compliance with SFAS No. 148, the Company has elected
to continue to follow the intrinsic value method in accounting for our stock-
based employee compensation plan as defined by APB No. 25, "Accounting for
Stock Issued to Employees".
Pro forma information regarding net income and income per share is required
by SFAS 148, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of SFAS 148. 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 for the three months ended August 31, 2004 and 2003: risk free
interest rates between 2% and 4%; dividend yield of 0%; expected life of the
option of two to four years; and volatility factor of the expected market
price of the Company's common stock of between 40% and 100%.
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 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 loss, and net loss 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 148, for the three months ended August 31, 2004 and 2003 as follows:
LANCER ORTHODONTICS, INC.
Notes to Consolidated Financial Statements - continued
(D) Stock Based Compensation - continued
FOR THE THREE MONTHS ENDED
8/31/04 8/31/03
Net loss, as reported $(63,350) $(140,215)
Add: Stock-based employee compensation expense -- --
Less: Stock-based employee compensation expense
determined under fair value calculations (9,461) (14,218)
Net loss pro forma $(72,811) $(154,433)
Basic loss per share, as reported: $(0.02) $(0.06)
Add: Stock-based employee compensation expense recorded -- --
Less: Stock-based employee compensation expense
determined under fair value calculations (0.00) (0.01)
Pro forma $(0.02) $(0.07)
Diluted loss per share, as reported: $(0.02) $(0.06)
Add: Stock-based employee compensation expense recorded -- --
Less: Stock-based employee compensation expense
determined under fair value calculations (0.00) (0.01)
Pro forma $(0.02) $(0.07)
(E) Property and Equipment
Costs in construction in progress consist of eight projects; five for new
product lines and three for the replacement of existing equipment. Costs
capitalized into the new product lines at August 31, 2004 are $52,834, with
approximately $280,000 required for completion. Costs capitalized for the
replacement equipment are $31,869, with approximately $47,000 required for
completion.
(F) Financing
At August 31, 2004, Lancer has a $400,000 line of credit with Cuyamaca Bank,
which expires January 8, 2005. Borrowings are made at prime plus 2.0%, (6.5%
at August 31, 2004) and are limited to 80% of accounts receivable less than
90 days old. The outstanding balance at August 31, 2004, is $0 and the unused
portion available is approximately $340,000. The Company requested that
Cuyamaca Bank reserve $60,000 of Lancer's available credit line as a guarantee
of credit with a European supplier. Lancer is in compliance with its debt
covenants at August 31, 2004.
The line of credit is collateralized by substantially all the assets of
Lancer, including inventories, receivables, and equipment. The lending
agreement for the line of credit requires, among other things, that Lancer
maintain a balance sheet net worth of $2,700,000 and that a zero outstanding
balance be maintained for 30 consecutive days during the term.
Lancer also had a term loan for $100,000 with Cuyamaca Bank that was paid off
in May 2004. This loan required monthly payments of approximately $2,300
(principal and interest) at an interest rate of prime plus 2% (6% at May 31,
2004).
(G) Commitments and Contingencies
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. Effective
April 1, 1996, Lancer leased the Mexicali facility under a separate agreement.
Since October 2000, the manufacturing agreement has operated on a month-to-
month basis.
During fiscal 2003, the facility in Mexico was incorporated as Lancer
Orthodontics de Mexico, ("Lancer de Mexico"), a wholly-owned subsidiary of the
Company. This subsidiary now administers services previously provided by an
independent manufacturing contractor. A new lease was negotiated in the name
of Lancer de Mexico, effective April 1, 2001, for the 16,000 square foot
facility already in use for the Mexican operations. Mexican utilities and
vendor obligations were also converted to the Lancer de Mexico name. This
conversion eliminated the expense of an administrative fee and is expected to
provide better control in meeting future obligations. The conversion had no
material effect on manufacturing operations. Should Lancer discontinue
operations in Mexico, it is responsible for accumulated employee seniority
obligations as prescribed by Mexican law. At August 31, 2004, this obligation
was approximately $338,000. Such obligation is contingent in nature and
accordingly has not been accrued in Lancer's consolidated financial
statements.
Lancer has undergone no material change in the mode of conducting its business
other than described above and it did not dispose of any material amount of
its assets during the three months ended August 31, 2004 and 2003.
Leases - Lancer leases its corporate facility under a non-cancelable
operating lease expiring April 30, 2009, as extended, which requires monthly
rentals that increase annually, from $6,688 per month in 2004 to $7,527 per
month in 2009. 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 $20,589 at August 31, 2004, and is included in
accrued liabilities in the accompanying consolidated balance sheet. Total
rental expense for this facility for the three months ended August 31, 2004,
was approximately $20,000.
LANCER ORTHODONTICS, INC.
Notes to Consolidated Financial Statements - continued
(G) Commitments and Contingencies - continued
Effective December 1, 2002, Lancer Orthodontics de Mexico entered into a non-
cancelable operating lease for its Mexico facility through March 31, 2009.
The new lease encompasses the approximately 16,000 square feet of the
previous lease, plus additional square footage of approximately 10,000 feet,
for a total of approximately 26,000 square feet. Lancer Orthodontics
de Mexico will provide sub-contracted manufacturing services to Biomerica,
Inc., a related party, using a portion of the additional square footage.
The new lease requires monthly payments of approximately $9,600 through
March 2009. An agreement has been negotiated between Lancer Orthodontics de
Mexico and Biomerica for lease reimbursement of approximately $2,000 per
month. The remainder of approximately $7,600 monthly lease will be borne by
Lancer. Total rental expense for this facility for the three months ended
August 31, 2004, was approximately $26,000.
The new Lancer Orthodontics de Mexico lease also requires an additional
refundable security deposit of $26,550. Lancer Orthodontics, Inc. is paying
half and Biomerica, Inc. the other half. This is in addition to the $31,146
refundable security deposit paid in fiscal 2003. At August 31, 2004, other
assets on the consolidated balance sheet includes approximately $44,400 for
security deposit paid on the Mexico location and approximately $4,400 paid
on the San Marcos location previously.
The Company entered into a non-cancelable operating lease for a copier in
February 2003 that expires in February 2006, and requires monthly payments
of $214. Total expense for the copier was approximately $674 and $662 during
the three months ended August 31, 2004 and 2003, respectively.
The Company entered into a non-cancelable operating lease for a postage
machine in July 2003 that expires in September 2008, and requires monthly
payments of $208. Total expense for the postage machine was approximately
$691 and $208 in the three months ended August 2004 and 2003, respectively.
The Company entered into a lease for a phone system in July 2003 that expires
in June 2008, and requires monthly payments of $887. Total expense for the
phone system was approximately $3,126 and $1,892 in the three months ended
August 31, 2004 and 2003, respectively.
At May 31, 2004, future aggregate minimum lease payments are as follows:
Years ending May 31,
2005 223,000
2006 225,000
2007 228,000
2008 228,000
2009 191,000
Total $1,095,000
LANCER ORTHODONTICS, INC.
Notes to Consolidated Financial Statements - continued
(G) Commitments and Contingencies - continued
A sub-lease agreement for approximately 459 square feet of Lancer's main
facility was entered into in April 2003, effective through November 2003,
and extended through November 2004, with an unrelated third party. The
leased space is to be used for a machine shop and requires monthly payments
of $344. Rental income for the three months ended August 31, 2004 and
2003 was $1,107 and $1,032, respectively.
Employment Agreement - Pursuant to the terms of the employment agreement
between the Company and Dan Castner, the Vice President of Sales and
Marketing of the Company, dated as of May 20, 2003, the Company agreed to pay
Mr. Castner an annual base salary of $135,000. In addition, the Company
granted Mr. Castner stock options on June 2, 2003, to purchase an aggregate
of 120,000 shares of the Company's common stock at an exercise price of $0.38
per share. The stock options have a term of five years and will vest over
four years as follows: (i) 25% vesting on the first anniversary of the date
of the grant; (ii) 25% vesting on the second anniversary of the date of the
grant; (iii) the remaining 50% vesting as to one-twenty fourth (1/24th) per
month each month thereafter for the next two years. Should the Company be
purchased by an unaffiliated third party, the options shall vest 100%.
Common Stock - Lancer's stock is traded on the OTC Bulletin Board.
(H) Income Taxes
At May 31, 2004, Lancer had net tax operating loss carryforwards of
approximately $1,997,000 and business tax credits of approximately $63,000
available to offset future Federal taxable income and tax liabilities,
respectively. The Federal carryforwards expire in varying amounts through
the year 2021. As of May 31, 2004, Lancer had net tax operating loss
carryforwards of approximately $70,000 and business tax credits of
approximately $10,000 available to offset future state income tax
liabilities. The state carryforwards expire through the year 2011.
On September 11, 2002, California passed one of the budget trailer bills that
implemented the state's 2002-2003 Budget Bill (A415). The law suspended the
net operating loss ("NOL") carryover deduction for tax years 2002 and 2003.
To compensate for the deduction suspension, the period of availability for
these NOL deductions has been extended for two years.
(I) Stockholders' Equity
Common Stock
During fiscal 2003, the Company issued 37,595 shares of its common stock
valued at $8,271 to Biomerica for certain management and consulting services
rendered in fiscal 2002. These shares were classified at May 31, 2002 as
common stock subscribed.
During fiscal 2003, the Company issued 25,000 shares of its common stock
valued at $8,750 to its Chief Executive Officer for services rendered in
fiscal 2002. These shares were classified at May 31, 2002 as common stock
subscribed.
LANCER ORTHODONTICS, INC.
Notes to Consolidated Financial Statements - continued
(I) Stockholders' Equity - continued
During fiscal 2004, the Company issued 91,346 shares of its common stock
valued at $29,000 to its Chief Executive Officer for services rendered. At
May 31, 2003, 69,471 of these shares were reported as subscribed stock.
During fiscal 2004, the Company agreed to issue 13,541 shares of its common
stock to the Chairman of the Board for services rendered from January 2004 to
May 2004 and 31,250 shares of common stock to the Chief Executive Officer for
services rendered per agreement. At May 31, 2004, these shares are reported
as subscribed stock.
The Lancer Board of Directors approved a private offering of common stock,
effective March 23, 2004, and ending April 12, 2004. The offering, to
officers, board members, and key employees resulted in the sale of 450,000
new shares at $.60 per share with total proceeds received of $270,000. In
addition, one warrant exercisable for each share purchased (450,000 warrants)
was issued at $.85 per share. These warrants shall be exercisable until
April 12, 2009.
Stock Option Agreements and Warrants
The Company has incentive stock option and non-qualified stock option plans
for directors, officers, and key employees. The 1993 Stock Option Plan
authorized 357,143 shares to be issued. Options granted under the 1993 plan
were required to be granted at an option price not less than 85% of the fair
market value for options granted to employees, or less than 100% of the fair
market value for options granted to non-employees. The fair market value of
the stock was the share price of the Company's common stock at the date the
options were granted. Most options granted under this Plan had an expiration
period of five years from the date of their respective grant and all were
granted at fair market value at the date of grant. At August 31, 2004 there
were 328,500 options outstanding under this plan. The 1993 Stock Option Plan
expired in March 2004 and no new options could be granted under this Plan,
but the outstanding options remain effective until exercised or forfeited.
The 2000 Stock Incentive Plan authorized 450,000 initial shares to be issued,
increasing by the lower of 1.5% of the total number of common shares
outstanding or 225,000 shares, each year on January 1, beginning in 2001. The
total shares authorized at August 31, 2004 were 581,023. Incentive stock
options granted under the 2000 Plan are required to be granted at an option
price not less than 100% of the fair market value of the Company's common
stock on the date of grant, with an exercise period not exceeding ten years
from grant date. The option price of non-statutory stock options granted under
the 2000 Plan are required to be granted at an option price not less than 85%
of the fair market value of the Company's common stock on the date of grant.
Options granted to non-executive directors under the 2000 Plan are required to
be granted at an option price not less than 100% of the fair market value
determined by the Board of Directors, with an exercise period not exceeding
ten years from grant date. The majority of options granted under this plan
vest pro rata over a period of three years. At August 31, 2004 there were
300,500 options outstanding under this plan.
LANCER ORTHODONTICS, INC.
Notes to Consolidated Financial Statements - continued
(I) Stockholders' Equity (continued)
During the year ended May 31, 2003, the Company granted 70,000 options to
purchase shares of the Company's common stock at an exercise price of $0.26
to certain employees of the Company for services rendered. The options vest
over four years and have a term of five years. Management assigned a value of
$0 to the options.
During the year ended May 31, 2003, the Company granted 40,000 options to
purchase shares of the Company's common stock at an exercise price of $0.28
to an employee of the Company for services rendered. The options vest over
four years and have a term of five years. Management assigned a value of $0
to the options.
During the year ended May 31, 2003, the Company granted 30,000 options to
purchase shares of the Company's common stock at an exercise price of $0.28
to certain employees of the Company for services rendered. The options vest
over four years and have a term of five years. Management assigned a value
of $0 to the options.
On June 2, 2003, the Company granted 120,000 stock options to purchase shares
of the Company's common stock at an exercise price of $0.38 per share as
pursuant to terms of the employment agreement between the Company and Dan
Castner, the Vice President of Sales and Marketing. The options vest over
four years and have a term of five years. Management assigned a value of $0
to the options.
On June 2, 2003, the Company granted its Chief Executive Officer 75,000 stock
options to purchase shares of the Company's common stock at an exercise price
of $.38. The options vest over 3 years and have a term of five years.
Management assigned a value of $0 to the options.
On June 2, 2003, the Company granted directors 52,500 stock options to
purchase shares of the Company's common stock at an exercise price of $.38.
The options vest over 2 years and have a term of five years. Management
assigned a value of $0 to the options.
On June 30, 2003, the Company granted 8,000 stock options to purchase shares
of the Company's common stock at an exercise price of $.50 to an employee of
the Company for services rendered. The options vest over 3 years beginning
June 30, 2004 and have a term of five years. Management assigned a value of
$0 to the options.
On March 30, 2004, the Company granted 40,000 stock options to purchase
shares of the Company's common stock at an exercise price of $.57 to an
employee of the Company for services rendered. The options vest over four
years and have a term of five years. Management assigned a value of $0 to
the options.
On April 12, 2004, the Company granted 17,500 stock options to purchase
shares of the Company's common stock at an exercise price of $.60 to a new
member of its Board of Directors for services to be rendered. The options
vest over 2 years and have a term of five years. Management assigned a value
of $0 to the options.
LANCER ORTHODONTICS, INC.
Notes to Consolidated Financial Statements - continued
(I) Stockholders' Equity (continued)
On April 12, 2004, the Company issued 450,000 warrants to officers, directors,
and key employees who purchased 450,000 shares of the Company's common stock
in a private placement. The warrants have an exercise price of $.85 and have
a term of five years.
The following summary presents the options and warrants granted, exercised,
expired, and outstanding as of August 31, 2004:
Weighted
Number of Shares Average
Employee Non- Exercise
& Directors employee Total Price
Outstanding, May 31, 2004 1,097,500 0 1,097,500 $0.60
Granted -- -- -- $--
Exercised -- -- -- --
Expired (18,500) 0 (18,500) $0.80
Outstanding, August 31, 2004 1,079,000 0 1,079,000 $0.59
(J) Net Loss per Common Share and Dividends
Lancer calculates earnings per share in accordance with Statement of Financial
Accounting Standards ("SFAS 128"). SFAS 128 replaces the presentation of
primary and fully diluted earnings per share with the presentation of basic
and diluted earnings per share. Basic earnings per share excludes dilution
and is calculated by dividing income available to common stockholders by the
weighted-average number of common shares outstanding for the period.
Diluted earnings per share reflects the potential dilution that could occur if
securities or other contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the entity. For all periods presented, no
common stock equivalents have been included in the computation of diluted
earnings per share as they were determined to be anti-dilutive.
Basic and diluted net loss per share is computed using the weighted average
number of common shares outstanding during the period. Potentially dilutive
securities are excluded from the diluted net loss per share calculation, as
the effect would be antidilutive. Potentially dilutive shares not included
are 577,500 shares for outstanding employee stock options.
LANCER ORTHODONTICS, INC.
Notes to Consolidated Financial Statements - continued
(K) Financial Information About Foreign and Domestic Operations and Export
Sales
FOR THE THREE MONTHS ENDED
8/31/04 8/31/03
Sales to unaffiliated customers:
United States $830,690 $734,117
Europe 378,004 308,628
Central and South America 80,491 98,896
Middle East 67,041 56,781
Other Foreign 124,637 119,685
$1,480,863 $1,318,107
No other geographic concentrations exist where net sales exceed 10% of total
net sales.
08/31/04 08/31/03
Sales or transfers between geographic areas None None
Long-lived Assets:
United States $498,040 $279,396
Mexico 110,449 86,435
$608,489 $365,831
(L) Related Party Transactions
In April 2003, Lancer de Mexico entered into a manufacturing subcontractor
agreement with Biomerica, Inc., to provide manufacturing services in Mexicali,
Mexico. The agreement requires reimbursement from Biomerica for discrete
expenses such as payroll, shipping, and customs fees; lease and security
deposits of approximately $2,000 and $1,100 per month, respectively;
and service fees of approximately $2,900 per month. There was no balance due
from Biomerica at August 31, 2004.
(M) Directors and Officers Insurance
Under its bylaws, the Company has agreed to indemnify its officers and
directors for certain events or occurrences arising as a result of the officer
or director's serving in such capacity. The term of the indemnification period
is for the officer's or director's lifetime. The maximum potential amount of
future payments the Company could be required to make under these
indemnification agreements is unlimited. However, the Company has a directors
and officer liability insurance policy that limits its exposure and enables it
to recover a portion of any future amounts paid.
LANCER ORTHODONTICS, INC.
Notes to Consolidated Financial Statements - continued
(M) Directors and Officers Insurance - continued
As a result of its insurance policy coverage, the Company believes the
estimated fair value of these indemnification agreements is minimal and has no
liabilities recorded for these agreements as of August 31, 2004. The Company
enters into indemnification provisions under (i) its agreements with other
companies in its ordinary course of business, typically with business
partners, contractors, and customers, landlords and (ii) its agreements with
investors. Under these provisions the Company generally indemnifies and hold
harmless the indemnified party for losses suffered or incurred by the
indemnified party as a result of the Company's activities or, in
some cases, as a result of the indemnified party's activities under the
agreement. These indemnification provisions often include indemnifications
relating to representations made by the Company with regard to intellectual
property rights. These indemnification provisions generally survive
termination of the underlying agreement. In addition, in some cases, the
Company has agreed to reimburse employees for certain expenses and to provide
salary continuation during short-term disability. The maximum potential amount
of future payments the Company could be required to make under these
indemnification provisions is unlimited. The Company has not incurred material
costs to defend lawsuits or settle claims related to these indemnification
agreements. As a result, the Company believes the estimated fair value of
these agreements is minimal. Accordingly, the Company has no liabilities
recorded for these agreements as of August 31, 2004.
(N) 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.
LANCER ORTHODONTICS, INC.
Notes to Consolidated Financial Statements - continued
(N) Risks and Uncertainties - continued
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 has
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.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Certain information contained herein (as well as information included in oral
statements or other written statements made or to be made by Lancer) contains
statements that are forward-looking, such as statements relating to
anticipated future revenues of the Company and success or current product
offerings. Such forward-looking information involves important risks and
uncertainties that could significantly affect anticipated results in the
future, and accordingly, such results may differ materially from those
expressed in any forward-looking statements made by or on behalf of Lancer.
The potential risks and uncertainties include, among others, fluctuations in
the Company's operating results. These risks and uncertainties also include
the success of the Company in raising needed capital, the continual demand
for the Company's products, competitive and economic factors of the
marketplace, availability of raw materials, and the state of the economy.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof, and the Company
undertakes no obligation to update these forward-looking statements.
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of our financial condition and results of
operations are based on the consolidated financial statements, which have
been prepared in accordance with accounting principles generally accepted in
the United States. The preparation of these consolidated financial
statements requires estimates and assumptions that affect the reported
amounts and disclosures.
We believe the following to be critical accounting policies as they require
more significant judgments and estimates used in the preparation of our
consolidated financial statements. Although we believe that our judgments
and estimates are appropriate and correct, actual future results may differ
from our estimates.
In general, the critical accounting policies that may require judgments or
estimates relate specifically to the recognition of revenue, the Allowance for
Doubtful Accounts, Inventory Reserves for Obsolescence and Declines in Market
Value, Impairment of Long-Lived Assets, Stock Based Compensation, and Deferred
Income Tax Valuation and Allowances.
We recognize product revenues when an arrangement exists, delivery has
occurred, the price is determinable and collection is reasonably assured.
The Allowance for Doubtful Accounts is established for estimated losses
resulting from the inability of our customers to make required payments. The
assessment of specific receivable balances and required reserves is performed
by management and discussed with the audit committee. We have identified
specific customers where collection is probable and have established specific
reserves, but to the extent collection is made, the allowance will be
released. Additionally, if the financial condition of our customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required.
Reserves are provided for excess and obsolete inventory, which are estimated
based on a comparison of the quantity and cost of inventory on hand to
management's forecast of customer demand. Customer demand is dependent on
many factors and requires us to use significant judgment in our forecasting
process. We must also make assumptions regarding the rate at which new
products will be accepted in the marketplace and at which customers will
transition from older products to newer products. Once a reserve is
established, it is maintained until the product to which it relates is sold
or otherwise disposed of, even if in subsequent periods we forecast demand
for the product.
In general, we are in a loss position for tax purposes, and have established
a valuation allowance against deferred tax assets, as we do not believe it is
likely that we will generate sufficient taxable income in future periods to
realize the benefit of our deferred tax assets. Predicting future taxable
income is difficult, and requires the use of significant judgment. At August
31, 2004, all of our deferred tax assets were reserved. Accruals are made
for specific tax exposures and are generally not material to our operating
results or financial position, nor do we anticipate material changes to these
reserves in the near future.
We have provided a full valuation reserve related to our substantial deferred
tax assets. In the future, if sufficient evidence of our ability to generate
sufficient future taxable income in certain tax jurisdictions becomes
apparent, we may be required to reduce our valuation allowances, resulting in
income tax benefits in our consolidated statement of operations. We evaluate
the realizability of the deferred tax assets and assess the need for
valuation allowance quarterly. The utilization of the net operating loss
carryforwards could be substantially limited due to restrictions imposed
under federal and state laws upon a change in ownership.
We have adopted SFAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure," which amended SFAS No. 123. Under SFAS No. 148,
we continue to measure compensation expense for our stock-based employee
compensation plan using the intrinsic value method prescribed in Accounting
Principles Board ("APB") No. 25, "Accounting for Stock Issued to Employees"
and its related interpretations. We provide pro forma disclosure of the
effect on net income or loss as if the fair value based method had been
applied in measuring compensation expense.
RESULTS OF OPERATIONS
For the three months ended August 31, 2004, net loss decreased $76,865 as
compared to the three months ended August 31, 2003. The decrease in net loss
is primarily attributable to the increase in sales.
For the three months ended August 31, 2004, net sales increased $162,756
(12.4%) as compared to the three months ended August 31, 2003. International
net sales increased $66,183 primarily in Europe and the Middle East. Domestic
net sales increased $96,573, primarily due to a price increase.
For the three months ended August 31, 2004, cost of sales as a percentage of
sales totaled 72.4%, a decrease of 1.6% as compared to the three months ended
August 31, 2003, which totaled 74.0%. This decrease is primarily attributable
to the domestic selling price increase.
For the three months ended August 31, 2004, selling expenses decreased $994
(.3%) as compared to the three months ended August 31, 2003. The decrease is
primarily attributable to a decrease in commissions, offset by an increase in
professional fees and brochure costs.
For the three months ended August 31, 2004, general and administrative
expenses increased $7,575 (6.8%) as compared to the three months ended August
31, 2003. The increase is primarily attributable to the cost of stock issued
to officers in lieu of salary.
For the three months ended August 31, 2004, product development expenses
decreased $5,394 as compared to the three months ended August 31, 2003. The
decrease is attributable to 2003 development projects starting production in
2004.
For the three months ended August 31, 2004 and 2003 there was no interest
expense.
For the three months ended August 31, 2004, other income increased $12,456
as compared to the three months ended August 31, 2003. The increase is due to
a refund of insurance premiums paid in prior years due to an audit by the
carrier and a decrease in financing costs.
For the three months ended August 31, 2004 and 2003, rental income of $1,107
and $1,032, respectively, was realized.
FINANCIAL CONDITION, LIQUIDITY, AND CAPITAL RESOURCES
Lancer's financial condition at August 31, 2004 (unaudited) and its previous
two fiscal year ends was as follows:
08/31/04 05/31/04 05/31/03
Current Assets $3,523,137 $3,463,606 $3,448,770
Current Liabilities 777,092 640,814 635,098
Working Capital 2,746,045 2,822,792 2,813,672
Line of Credit 0 0 426
Shareholder Equity 3,407,505 3,448,355 3,115,654
Total Assets 4,184,597 4,089,169 3,750,752
Cash decreased $177,240 during the three months ended August 31, 2004
primarily due to the purchase of new equipment and increases in inventories
and accounts receivable.
Working capital decreased $76,747 during the three months ended August 31,
2004, primarily attributable to the decrease in cash. Lancer's management
believes that it will be able to finance Lancer's operations through cash
flow and available borrowings through the current fiscal year and ensuing
fiscal years. This assumption is based upon a reasonable level of demand
for our products.
At August 31, 2004, Lancer has a $400,000 line of credit with Cuyamaca Bank,
which expires January 8, 2005. Borrowings are made at prime plus 2.0%, (6.5%
at August 31, 2004) and are limited to 80% of accounts receivable less than
90 days old. The outstanding balance at August 31, 2004, is $0 and the
unused portion available is approximately $340,000. The Company requested
that Cuyamaca Bank reserve $60,000 of Lancer's available credit line as a
guarantee of credit with a European supplier. Lancer is in compliance with
its debt covenants at August 31, 2004.
The line of credit is collateralized by substantially all the assets of
Lancer, including inventories, receivables, and equipment. The lending
agreement for the line of credit requires, among other things, that Lancer
maintain a balance sheet net worth of $2,700,000 and that a zero outstanding
balance be maintained for 30 consecutive days during the term.
Lancer also has a term loan for $100,000 with Cuyamaca Bank that was paid off
in May 2004. This loan required monthly payments of approximately $2,300
(principal and interest) at an interest rate of prime plus 2% (6% at May 31,
2004).
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Factors That May Affect Future Results
You should read the following factors in conjunction with the factors
discussed elsewhere in this and our other filings with the SEC and in
materials incorporated by reference in these filings. The following is
intended to highlight certain factors that may affect the financial condition
and results of operations of Lancer and are not meant to be an exhaustive
discussion of risks that apply to companies such as Lancer. Like other
businesses, Lancer is susceptible to macroeconomic downturns in the United
States or abroad, that may affect the general economic climate and performance
of Lancer or its customers. Aside from general macroeconomic downturns, the
additional material factors that could affect future financial results
include, but are not limited to: terrorist attacks and the impact of such
events; diminished access to raw materials that directly enter into our
manufacturing process; shipping; labor disruption or other major degradation
of the ability to ship our products to end users; inability to successfully
control our margins which are affected by many factors including competition
and product mix; protracted shutdown of the US border due to an escalation of
terrorist or counter terrorist activity; the operating and financial covenants
contained in our credit line which could limit our operating flexibility, any
changes in our business relationships with international distributors or the
economic client they operate in; any event that has a material adverse impact
on our foreign manufacturing operations may adversely affect our operations as
a whole, failure to manage the future expansion of our business could have a
material adverse effect on our revenues and profitability; possible costs in
complying with government regulations and the delays in receiving required
regulatory approvals or the enactment of new adverse regulations or
regulatory requirements; numerous competitors, some of which have
substantially greater financial and other resources than we do; potential
claims and litigation brought by patients or dental professionals alleging
harm caused by the use of or exposure to our products; quarterly variations
in operating results caused by a number of factors, including business and
industry conditions and other factors beyond our control. All of these factors
make it difficult to predict operating results for any particular period.
Item 4. PROCEDURES AND CONTROLS
Within the 90 days prior to the date of this report, Lancer carried out an
evaluation, under the supervision and with the participation of Lancer's
management, including the Company's Chief Executive Officer and Director of
Financial Planning, of the effectiveness of the design and operation of
Lancer's disclosure controls and procedures pursuant to Exchange Act Rule
13a-14. Based upon that evaluation, the Chief Executive Officer and Director
of Financial Planning concluded that Lancer's disclosure controls and
procedures are effective. There were no significant changes in Lancer's
internal controls or in other factors that could significantly affect these
controls subsequent to the date of their evaluation.
PART II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS Not Applicable.
Item 2. CHANGES IN SECURITIOES AND USE OF PROCEEDS Not Applicable.
Item 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable.
Item 5. OTHER INFORMATION Not Applicable.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
A report on Form 8-K was filed on June 8, 2004 as amended, for the
change in accountants. Subsequent to the quarter ended August 31,
2004 a Form 8-K was filed on September 24, 2004 regarding the
departure of Dr. Robert Orlando from the Lancer Board of Directors.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LANCER ORTHODONTICS, INC.
Registrant
Date October 15, 2004 By /s/ Allen Barbieri
Allen Barbieri,
Chief Executive Officer
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, Allen Barbieri, certify that the Quarterly Report on Form 10-QSB for the
quarter ended August 31,2004 fully complies with the requirements in
Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, and that
the information contained in such Quarterly Report fairly presents, in all
material respects, the financial condition and results of operations of
Lancer Orthodontics, Inc. for the periods being presented.
/s/ Allen Barbieri
Allen Barbieri
Chief Executive Officer
Date: October 15, 2004
CERTIFICATION OF CHIEF FINANCIAL OFFICER
PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Allen Barbieri, certify that:
1. I have reviewed this Quarterly Report on Form 10-QSB of Lancer
Orthodontics, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects,
the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of our internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's
board of directors (or other persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
Date: October 15, 2004
/s/Allen Barbieri
Chief Executive Officer
CERTIFICATION OF DIRECTOR OF FINANCIAL PLANNING
PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
I, John Dodge, certify that the Quarterly Report on Form 10-QSB for
the quarter ended August 31,2004 fully complies with the requirements
in Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, and
that the information contained in such Quarterly Report fairly presents, in
all material respects, the financial condition and results of operations
of Lancer Orthodontics, Inc. for the periods being presented.
/s/ John Dodge
John Dodge
Director of Financial Planning
Date: October 15, 2004
CERTIFICATION OF DIRECTOR OF FINANCIAL PLANNING
PURSUANT TO 18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, John Dodge, certify that:
1. I have reviewed this Quarterly Report on Form 10-QSB of Lancer
Orthodontics, Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material respects,
the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
a) designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our supervision,
to ensure that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the end of
the period covered by this report based on such evaluation; and
c) disclosed in this report any change in the registrant's internal control
over financial reporting that occurred during the registrant's most recent
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation of our internal control over financial reporting,
to the registrant's auditors and the audit committee of the registrant's
board of directors (or other persons performing the equivalent functions):
a) all significant deficiencies and material weaknesses in the design or
operation of internal control over financial reporting which are reasonably
likely to adversely affect the registrant's ability to record, process,
summarize and report financial information; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal control
over financial reporting.
Date: October 15, 2004
/s/John Dodge
Director of Financial Planning