SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) X Annual report pursuant to section 13 or 15(d) of the Securities Exchange - --- Act of 1934 for the fiscal year ended June 30, 1998 - --- Transition report pursuant to section 13 or 15(d) of the Securities Ex- change Act of 1934 for the transition period from__________to_________ Commission file number 0-8864 ------ PACER TECHNOLOGY --------------------------------------------------------- (Exact name of the registrant as specified in its charter) California 77-0080305 ------------------------------- -------------------------------- (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 9420 Santa Anita Avenue Rancho Cucamonga, California 91730 ---------------------------------------- --------------- (Address of principal executive offices) (Zip Code) Issuer's telephone number (909) 987-0550 -------------- Securities registered under Section 12(b) of the Exchange Act: None Securities registered under Section 12(g) of the Exchange Act: COMMON STOCK, no par value -------------------------- (Title of Class) Indicate by check mark whether the registrant(1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 xxx No --- ------ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. The aggregate market value of the voting stock held by non-affiliates of the registrant as of August 1, 1998 was $19,057,333 (computed by reference to the average bid and asked prices of such stock on August 1, 1998, as reported in the over-the-counter market.) The number of shares outstanding of the registrant's Common Stock, as of August 1, 1998, was 15,864,975 shares. Documents incorporated by reference. Pacer Technology's definitive Proxy Statement dated September 24, 1998 for the 1998 annual meeting of shareholders - --Part III. PART I ------ Item 1. Description of Business Background - ---------- Pacer Technology (the "Company") is engaged in the business of manufacturing and marketing high performance adhesives, sealants, and related products. The Com- pany sells these products worldwide under both private label and proprietary trademarks to industrial, consumer, automotive aftermarket and hobby markets. The Company was formed in 1975 as a Wyoming corporation and was reincorporated in California in 1984. On August 1, 1992, the Company acquired Novest, Inc., a privately-held cor- poration. This product line includes adhesives, sealants and lubricants for engine and body parts, trim applications and accessories. On October 15, 1993, Pacer acquired the assets of MEXLONIC (formerly Super Glue Corporation), a manufacturer and packager of adhesive products and plastic molded clips for use in automotive, stationery, hardware, home, office and school applications. On July 15, 1997, Pacer acquired California Chemical Specialties, Inc., a producer of proprietary sculptured acrylic nail liquids and powders and related products for the nail care industry. On March 4, 1998, the Company acquired Cook Bates, a Division of London Inter- national Group, Inc., a manufacturer and a designer of an extensive line of manicure products. These products are marketed under such name brands as Gem and Mr. Mustache. The Company holds numerous patents and also licenses such brand-name products as Oleg Cassini and Brut. Major Customers And Export Sales - -------------------------------- Pacer did not have net sales to any one individual customer greater than 10% of total net sales in either 1998, 1997 or 1996. Principal Markets for Adhesive Products ======================================= Industrial - ---------- The Company's products are sold in the industrial market for use in automotive, aerospace, electronic, O.E.M. and maintenance repair applications. Consumer - -------- The major thrust of Pacer's consumer division consists of products from Super Glue Corporation. These products include a nationally known brand of adhesives, sealants, and related products for use in automotive, stationery, hardware, home, office and school applications. The remaining lines in the division consist primarily of products demanded by customers who have existing product lines other than adhesives and wish to expand their product base to include adhesive products. In these cases, the Company packages the product requested in containers labeled with the customer's private label trademark. Hobby - ----- The Company markets several types of adhesives and related products which may be used for various project and model assembly requirements. Automotive Aftermarket - ---------------------- Pacer's automotive aftermarket product line, PRO SEAL (R), includes adhesives, sealants and lubricants for engine and body parts, trim applications and acces- sories. Marketing - --------- Pacer's products are marketed domestically and internationally. Foreign sales accounted for 17% of total revenues in 1998, 18% of total revenues in 1997, and 16% in 1996. Company products are sold to the industrial market by Pacer sales personnel and through independent distributors. The Company provides technical service and sales support using factory trained personnel and sales representatives. Pacer products are sold to dealers and model shops in the hobby market through a network of master distributors. In the consumer market sector, products are sold by Pacer sales personnel and independent represen- tatives and distributed through mass merchandising retail outlets. Automotive aftermarket products are sold by Pacer sales personnel and independent repre- sentatives and distributed through retail automotive, professional repair and installation, agri-business and heavy duty truck outlets. Backlog - ------- The backlog of firm orders as of June 30, 1998 was $5.2 million versus $2.1 million as of June 30, 1997. This increase was primarily atrributed to the acquisition of Cook Bates. The current backlog is expected to be substantial- ly filled within the current year. Research and Development - ------------------------ Research and Development expenditures were approximately $441,000, $348,000 and $245,000 in fiscal years 1998, 1997 and 1996, respectively. Source and Availability of Raw Materials - ---------------------------------------- The Company's primary source of raw material is subject to tariff and quota controls, fluctuations in the value of the U.S. dollar on foreign currency exchanges and related constraints associated with international trade. This material is readily available from several suppliers. Other raw materials are also purchased from suppliers for manufacture of the Company's plastic packaging. Supply of these materials is subject to availability of petroleum by-products. Competitive Conditions Affecting the Company - -------------------------------------------- The principal competitive factors affecting the Company's products are tech- nology, market coverage, price and service. Some of Pacer's competitors are larger and have substantially greater financial resources. The Company believes it is on the leading edge of technology and is price competitive. Subsidiaries - ------------ The Company has one wholly owned subsidiary. Pacer Tech Ltd., based in the United Kingdom, distributes products in the industrial, hobby, consumer, auto- motive aftermarket and private label markets in the United Kingdom and Europe. Government Regulations - ---------------------- Compliance with federal, state and local provisions regarding the production and discharge of materials into the environment is expected to have a minimal adverse effect on capital expenditures, earnings and the competitive position of the Company. Employees - --------- At August 1, 1998, the Company employed 130 people on a regular full-time basis. Patents and Licenses - -------------------- The Company owns a number of United States patents and trademarks relating to its adhesives, sealants and manicure implements business. These patents expire on various dates from 1999 to 2013. The Company also owns several pending patent applications. Pacer has obtained patents, and regularly files new patent applications, in foreign countries, particularly the industrialized countries of Western and Eastern Europe, South America, Africa, the Middle East and the Far East. Since applications have not been filed in all foreign countries and due to the vary- ing degress of protection afforded by foreign patent laws, the Company has somewhat less patent protection abroad than in the United States. The Company has obtained protection for its major trademarks in essentially all countries where the trademarks are of commercial importance and regularly files new trademark applications on a worldwide basis. In addition, the Company has entered into trademark license agreements from others in those cases where the Company believes it will obtain a competitive advantage thereby. Item 2. Description of Property The Company's executive office, manufacturing facility and research and deve- lopment facility are housed in a 50,000 square foot site in Rancho Cucamonga, California. This facility is leased under an operating lease expiring in June 2009. The Company leases a 10,000 square foot facility in Ontario, California to manufacture certain flammable products. This lease expires October, 2004. The Company also leases a 27,000 square foot facility in Memphis, Tennessee to warehouse and distribute products to customers located in the Midwest and Eastern part of the U.S. This lease expires May 2003. To accommodate the increase in products and services the Company acquired from Cook Bates, Pacer leased another 62,000 square foot facility in Rancho Cucamonga. This lease expires May 2009. The Company's subsidiary, Pacer Tech Ltd., maintains its sales and distribution office at a leased facility in Essex, England. This lease expires December, 1999. The Company believes that its present facilities are in good operating condition and are adequate for the Company's present and anticipated future needs. Item 3. Legal Proceedings ----------------- None Item 4. Submission of Matters to a Vote of Security Holders --------------------------------------------------- None PART II Item 5. Market for Common Equity and Related Stockholder Matters -------------------------------------------------------- Pacer Technology common stock is traded in the over-the-counter market and is listed on the National Association of Securities Dealers Automated Quotation System (NASDAQ) under the symbol "PTCH". High and low bid quotations are listed below: For the year ended June 30, 1998 1997 -------------------------------- HIGH LOW HIGH LOW ------ ------- ------- ----- First Quarter 1 17/32 1 5/32 1 7/16 7/8 Second Quarter 1 7/16 7/8 1 3/16 27/32 Third Quarter 1 17/32 1 1 17/32 25/32 Fourth Quarter 2 1/32 1 3/16 1 5/16 15/16 The foregoing quotations reflect inter-dealer prices without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. The approximate number of shareholders of record of the Company's common stock as of August 1, 1998 was 2,142. Since its incorporation, the Company has not paid any dividends on its common stock and does not anticipate dividend payments in the foreseeable future. Item 6. Selected Financial Data ----------------------- FINANCIAL HIGHLIGHTS YEAR ENDED JUNE 30 (000'S) 1998 1997 1996 1995 1994 -------- -------- -------- ------- -------- Income (loss) Statement Data: - ---------------------------- Net Sales $ 31,939 25,678 22,278 20,584 19,884 Gross Profit 11,346 9,158 7,507 6,622 7,250 Operating Income 2,972 2,562 1,844 136 805 Net Income 1,541 1,217 925 (200) 452 Other Financial Data: - -------------------- Total Assets $ 27,799 14,026 13,281 14,629 14,431 Working Capital 14,504 5,778 4,515 3,191 2,863 Debt Obligations 9,869 1,276 2,406 5,118 4,410 Stockholders' Equity 10,632 8,762 7,331 6,290 6,108 Earnings per share: Basic 0.10 0.08 0.06 (0.01) 0.04 Diluted 0.09 0.07 0.06 (0.01) 0.03 Item 7. Management's Discussion and Analysis of Financial Conditions and Results of Operations Results of Operations - --------------------- Table 1 - Cost of Sales and Gross Margin as a Percentage of Sales 1998 1997 1996 ---- ------ ------ Net Sales 100% 100% 100% Cost of Sales 64% 64% 66% Gross Profit 36% 36% 34% Comparison of 1998 to 1997 - -------------------------- Net sales improved $6,260,674 to $31,938,514, or 24% over the prior year. Domestic sales increased 27% to $26,503,842, and represented 83% of total revenues for fiscal year 1998. The domestic revenue growth was primarily attri- butable to sales from California Chemical and Cook Bates, Pacer's most recent acquisitions. International sales increased 16% to $5,434,672, and represented 17% of total revenues for fiscal year 1998. The international revenue growth was attributed to the Company's cosmetic nail care sales to private label customers in the U.K. and Western Europe, and by gains in Super Glue sales to customers in the Middle East and Central America. Cost of sales for the year was $20,592,723, or 64% of sales. This represents an increase of $4,072,429, or 25% over the prior year. This rise was attributed primarily to increased volume and higher manufacturing costs as Pacer and Cook Bates ran parallel operations from March 1998 (the date of acquisition) through June 1998. Selling, General & Administrative expenses were $8,373,526, or 26% of sales. This represents an increase of $1,778,013, or 27% over the prior year. This increase was related to sales and marketing expenses required to support the additional sales volume, and the result of running Pacer and Cook Bates facili- ties parallel from March 1998 through June 1998. The Cook Bates facilities were closed in the latter part of June 1998 and relocated to Pacer locations in California and Tennessee. It is anticipated that cost reductions related to this consolidation will favorably impact the Company's financial results by the end of calendar year 1998. The rise in administrative expenses was attribu- ted to Cook Bates expenses and a significant increase of 27% in Research and Development spending, primarily to support the growth in the Company's cosmetic nail care business. Spending increases for public relations and goodwill per- taining to the acquisition of California Chemical also contributed to the rise in administrative expenses. Goodwill related to the Super Glue acquisition is being amortized over 14 years. Amortization costs of $133,354 were recorded in fiscal year 1998. Goodwill related to California Chemical is being amortized over 20 years. Amortization costs of $109,064 were recorded during the period of fiscal year 1998. Manage- ment believes the Super Glue and California Chemical product lines will continue to generate profits that will significantly exceed the goodwill amortization. Other expenses for the year were $309,333, or 1% of sales. This represents an increase of $233,581, or 308% over the prior year. This increase was primarily attributed to bank borrowings utilized to finance the acquisition of Cook Bates and California Chemical during the 1998 fiscal year. The Company's effective tax rate was approximately 42% for fiscal year 1998. Comparison of 1997 to 1996 - --------------------------- Net sales increased $3,399,343 to $25,677,840, or 15% over the prior year. Domestic sales increased 13% to $20,988,623, and represented 82% of total revenues for fiscal year 1997. The domestic revenue growth was attributable to a substantial increase in sales of Super Glue, rapid growth in the cosmetic nail care sales to private label customers and steady sales of the ZAP Hobby line. International sales increased 28% to $4,689,217, and represented 18% of total revenues for fiscal year 1997. The international revenue growth was at- tributed to the Company's cosmetic nail care sales to private label customers in Western Europe and by significant gains in automotive aftermarket Pro Seal sales to customers in Eastern Europe. Cost of sales for the year was $16,520,294, or 64% of sales. This represents an increase of $1,748,579, or 12% over the prior year. This rise was attributed primarily to increased volume, as the Company experienced nominal increases in the cost of raw materials during fiscal year 1997. Cost of sales was favor- ably impacted by a reduction in manufacturing costs driven by continued verti- cal integration of the Company's manufacturing operations. Selling, General & Administrative expenses were $6,595,513, or 26% of sales. This represents an increase of $932,558, or 16% over the prior year, of which 9% was related to sales and marketing expenses required to support the addi- tional sales volume. The change in administrative expenses was led by a sig- nificant increase of 42% in Research and Development spending, primarily to support the growth in the Company's cosmetic nail care business. Spending increases for public relations, legal and accounting fees also contributed to the change in administrative expenses. Goodwill related to the Super Glue acquisition is being amortized over 14 years. Amortization costs of $133,354 were recorded in fiscal year 1997. Management believes the Super Glue product line will continue to generate profits that will significantly exceed the goodwill amortization. Other expenses for the year were $75,752, or less than 1% of sales. This represents a decrease of $290,916, or 79% below the prior year. This improve- ment was primarily attributed to a reduction in interest expense for the utili- zation of the Company's credit facility. A substantial improvement in profit- ability allowed the Company to reduce its reliance on bank borrowings during fiscal year 1997. Other income improved due to a one time gain of approximate- ly $76,000 from the disposition of surplus equipment during fiscal year 1997. Pacer Technology is currently undergoing a tax audit by the Internal Revenue Service for fiscal years 1994 and 1995. While the results have not been concluded, the Company has recorded an additional provision for a potential liability related to this audit. The Company's effective tax rate, excluding the additional provision, was approximately 45% for fiscal year 1997. Liquidity and Capital Resources - ------------------------------- Net cash used by all activities in fiscal year 1998 was $16,928 versus cash provided of $86,303 in the prior year. Cash consumed by operating activities during 1998 was $1,296,691 compared to cash provided of $1,480,864 in fiscal year 1997. The significant rise of 27% in net income in fiscal year 1998 from fiscal year 1997 was a positive contri- butor to this change. The increases in trade accounts receivable, inventory, and accounts payable were primarily volume generated by the Cook Bates acqui- sition. The increase in prepaid expenses and other assets during fiscal year 1998 was caused primarily by advances to suppliers for capital equipment purchases, and prepayments related to the acquisition of Cook Bates. The increase in deferred income taxes during fiscal year 1998 was due to timing differences for Cook Bates related tax deductible expenses. Accrued expenses and other liabilities were higher in fiscal year 1998 due to volume related sales and marketing expenses, and costs reserved in anticipation of closing and relocating Cook Bates facilities to Pacer facilities in California and Tennessee. Cash consumed by investing activities in 1998 was $7,899,172 compared to $478,560 in the prior year. This increase was the result of the Cook Bates and California Chemical acquisitions, as well as additional expenditures for capital equipment to further enhance the vertical integration of Pacer's manu- facturing operations. Cash provided by financing activities in 1998 was $9,178,935, compared to cash consumed of $916,000 in the prior year. The increase was primarily due to bank borrowings to finance the all cash acquisitions of Cook Bates and California Chemical. The exercise of certain stock options by officers and repayment of notes by Directors provided a source of cash for the Company during fiscal year 1998. Pacer anticipates continued utilization of its new credit facility with its predominant bank to supplement cash requirements for working capital, capital equipment purchases and potential acquisitions during the coming year. Management is of the opinion that such sources of cash are sufficient for the ensuing fiscal year. Certain Trends and Uncertainties - -------------------------------- The Company has in the past and may in the future make forward looking state- ments. These statements are subject to risks and uncertainties that could cause actual results to differ materially from those predicted. Such risks and uncertainties include, but are not limited to the following: Technological Change and Competition - ------------------------------------ The markets for the Company's products are characterized by frequent new product introductions and declining average selling prices over product life cycles. The Company's future success is highly dependent upon the timely completion and introduction of new products at competitive prices and performance levels. In addition, the Company must respond to competitors in the Company's markets. If the Company is not able to make timely introduction of new products or to respond effectively to competition, its business and operating results could be adversely affected. Variable Demand - --------------- The consumer adhesives industry has historically been reasonably stable and not characterized by cyclical product demand. The manicure implement business (Cook Bates) has had seasonal demand peaks during the last half of the calendar year. Political and Economic Considerations - ------------------------------------- In recent years, a significant portion of the Company's net sales and operating profit growth have come from international revenues. As a result, the Company's business activities and its results could be significantly affected by the policies of foreign governments and prevailing political, social, and economic conditions. The Company's revenue during fiscal year 1998 was not materially impacted by the widespread weakness in Asian currencies and it is not certain what the long-term effect of the weakness of Asian currencies and the liquidity situation will be on our business. Availability of Raw Materials - ----------------------------- The consumer adhesive and manicure implement industries have ample manufactur- ing capacity and are expected to continue to do so in the future. The Company's results of operations could be adversely affected if its raw material suppliers are unwilling or unable to supply a timely and sufficient supply of product to the Company. Intellectual Property Matters - ----------------------------- The consumer adhesive industry is characterized by minimal litigation regarding patent and other intellectual property rights. The Company has on occasion been notified that it may be infringing patent and other intellectual property rights of others. In addition, customers purchasing products from the Company have rights to indemnification and may, under certain circumstances violate the intellectual property rights of others. Although licenses are generally offered in such situations, and the Company has successfully resolved these situations in the past, there can be no assurance that the Company will not be subject to future litigation alleging intellectual property rights infringement, or that the Company will be able to obtain licenses on acceptable terms. An unfavorable outcome regarding one of these matters could have an adverse effect on the Company's business and operating results. Year 2000 Risks - --------------- The 'Year 2000' issue concerns the potential exposures related to the automated generation of business and financial misinformation resulting from the appli- cation of computer programs which have been written using two digits, rather than four, to define the applicable year of business transactions. Most of the Company's operating systems with Year 2000 issues have been modified to address those issues; accordingly, management does not anticipate any significant costs, problems or uncertainties associated with becoming Year 2000 compliant. The Company is currently developing a plan to assure that its internal suppliers, customers and creditors successfully face the Year 2000 issue. A failure to successfully address the Year 2000 issue could have a material adverse effect on the Company's business or results of operations. Therefore, the Company is in the process of developing contingency plans along with its remediation efforts for continuing operations in the event such problems arise. Impact of Recently issued Accounting Pronouncements - --------------------------------------------------- In June 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards Nos. 130 and 131, "Reporting Comprehensive Income" ("SFAS No. 130") and "Disclosures about Segments of an Enterprise and Related Information" ("SFAS No.131"), respectively (collectively, the "Statements"). The Statements are effective for fiscal years beginning after December 15, 1997. SFAS No. 130 established standards for reporting of comprehensive income and its components in annual financial statements. SFAS No. 131 establishes standards for reporting financial and descriptive information about an enterprise's operating segments in its annual financial statements and selected segment information in interim financial reports. Reclassification or restatement of comparative financial statements or financial information for earlier periods is required upon adoption of SFAS No. 130 and SFAS No. 131, respectively. The Company is currently evaluating its options for disclosure under this new standard and will implement the statement during its fiscal year ending June 30, 1999. Application of the Statements' require- ments is not expected to have a material impact on the Company's consolidated financial position, results of operations or liquidity. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"). SFAS 133 is effective for all fiscal quarters or fiscal years beginning after June 15, 1999. SFAS 133 establishes accounting and reporting standards for derivative instruments embedded in other contracts and for hedging activities. Application of this accounting standard is not expected to have a material impact on the Company's consolidated financial position, results of operations or liquidity. Item 7A. Quantitative and Qualitative Disclosures about Market Risk Non - Applicable. Item 8. Financial Statements and Supplementary Data The following consolidated financial statements are included herein: Independent Auditors' Report Consolidated Balance Sheets - June 30, 1998 and 1997. Consolidated Statements of Operations - Years Ended June 30, 1998, 1997 and 1996. Consolidated Statements of Stockholders' Equity - Years EndedJune 30, 1998, 1997 and 1996. Consolidated Statements of Cash Flows - Years Ended June 30, 1998, 1997 and 1996. Notes to Consolidated Financial Statements. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None Independent Auditors' Report ---------------------------- To the Board of Directors Pacer Technology: We have audited the accompanying consolidated balance sheets of Pacer Technology and subsidiaries as of June 30, 1998 and 1997, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the years in the three-year period ended June 30, 1998. These consolidated finan- cial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial state- ments based on our audits. We did not audit the financial statements of Pacer Tech. Limited, a wholly owned subsidiary, which statements reflect total assets constituting 5 percent and 11 percent and total revenues constituting 8 percent and 9 percent in 1998 and 1997, respectively, of the related consolidated totals. Those statements were audited by other auditors whose report has been furnished to us, and our opinion, insofar as it relates to the amounts for Pacer Tech. Limited, is based solely on the report of the other auditors. 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, based on our audits and the report of the other auditors, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Pacer Technology and subsidiaries as of June 30, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three-year period ended June 30, 1998, in conformity with generally accepted accounting principles. /s/ KPMG Peat Marwick LLP Orange County, California August 14, 1998 PACER TECHNOLOGY AND SUBSIDIARIES Consolidated Balance Sheets June 30, 1998 and 1997 1998 1997 ASSETS --------- -------- ======= Current assets: Cash $ 277,370 294,298 Trade receivables, less allowance for doubtful accounts of $524,596 in 1998 and $383,170 in 1997 (notes 2 and 6) 8,591,327 4,719,970 Other receivables 146,299 198,855 Notes receivable - Current (note 2) 188,642 248,220 Inventories (notes 3 and 6) 10,974,578 4,347,497 Prepaid expenses 810,451 390,331 Deferred income taxes (note 10) 1,146,769 621,804 ---------- ---------- Total current assets 22,135,436 10,820,975 Equipment and leasehold improvements, net (notes 4, 6 and 8) 1,819,783 1,444,631 Deferred income taxes (note 10) 124,065 60,222 Costs in excess of net assets of businesses acquired, net (note 1) 3,689,516 1,690,878 Other assets (note 5) 30,125 9,344 ---------- ---------- $27,798,925 14,026,051 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY ==================================== Current liabilities: Bank borrowings (note 6) $ - 792,000 Current installments of long-term debt (note 6) 333,333 262,866 Accounts payable 4,135,472 2,367,245 Accrued payroll and related expenses 494,780 386,952 Other accrued expenses (note 7) 2,667,486 1,233,439 Total current liabilities 7,631,071 5,042,502 Long-term debt, excluding current installments (note 6) 9,535,889 221,202 ---------- ---------- Total liabilities 17,166,960 5,263,704 Stockholders' equity (notes 11, and 16): Common stock, no par value. Authorized 50,000,000 shares; issued and outstanding 15,864,975 shares in 1998 and 15,849,975 shares in 1997 8,270,633 8,260,973 Retained earnings 2,613,453 1,072,404 Notes receivable from directors (notes 11 and 13) (265,257) (571,030) Foreign currency translation adjustment 13,136 - Total stockholders' equity 10,631,965 8,762,347 ---------- --------- Commitments and contingencies (notes 7,8,13,16 and 17) $27,798,925 14,026,051 ========== ========== See accompanying notes to consolidated financial statements. PACER TECHNOLOGY AND SUBSIDIARIES Consolidated Statements of Operations Years ended June 30, 1998, 1997 and 1996 1998 1997 1996 ---------- ---------- ---------- Net sales (note 9) $31,938,514 25,677,840 22,278,497 Cost of sales 20,592,723 16,520,294 14,771,715 ---------- ---------- ---------- Gross profit 11,345,791 9,157,546 7,506,782 Selling, general and administrative expenses 8,373,526 6,595,513 5,662,955 ---------- --------- --------- Operating income 2,972,265 2,562,033 1,843,827 Other (income) expense: Interest expense, net 520,847 161,716 267,338 Other, net (211,514) (85,964) 99,330 --------- --------- --------- Income before income taxes 2,662,932 2,486,281 1,477,159 Income tax expense (note 10) 1,121,883 1,268,879 552,092 ---------- --------- --------- Net income $ 1,541,049 1,217,402 925,067 ========== ========= ========= Weighted Average Shares - basic (note 12) 15,852,475 15,549,392 15,001,558 ---------- ---------- ---------- Basic Earnings Per Share $ .10 .08 .06 ========== ========== ========== Adjusted Weighted Average Shares - diluted (note 12) 17,554,113 16,484,119 16,104,712 ---------- ---------- ---------- Diluted Earnings Per share $ .09 .07 .06 ========== ========== ========= See accompanying notes to consolidated financial statements. PACER TECHNOLOGY AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity Years ended June 30, 1998, 1997 and 1996 Number of Notes Foreign Total issued and Retained Receivable Currency Stock- outstanding Common Earnings From translation holders' shares Stock (Deficit) Directors Adjustment Equity ----------- ------- -------- ---------- ----------- -------- Balances at June 30, 1995 14,403,975 $7,844,535 (1,070,065) (484,500) - 6,289,970 Net income - - 925,067 - - 925,067 Shares issued upon exer- cise of options (Note 11) 175,000 55,845 - - - 55,845 Shares issued upon exer- cise of warrants (Note 11) 624,000 198,120 - - - 198,120 Shares issued to employees (Note 11) 10,500 6,615 - - - 6,615 Promissory Note from Directors (Note 11) - - - (144,968) - (144,968) ---------- -------- -------- --------- -------- -------- Balances at June 30, 1996 15,213,475 8,105,115 (144,998) (629,468) - 7,330,649 Net income - - 1,217,402 - - 1,217,402 Shares issued upon exercise of options (Note 11) 629,500 150,958 - - - 150,958 Shares issued to employees (Note 11) 7,000 4,900 - - - 4,900 Promissory Note from Directors (Note 11) - - - 58,438 - 58,438 ----------- --------- --------- ---------- --------- --------- Balances at June 30, 1997 15,849,975 8,260,973 1,072,404 (571,030) - 8,762,347 Net income - - 1,541,049 - - 1,541,049 Shares issued upon exer- cise of options (Note 11) 7,500 3,510 - - - 3,510 Shares issued to employees (Note 11) 7,500 6,150 - - - 6,150 Foreign currency translation adjustment - - - - 13,136 13,136 Promissory Note from Directors (Note 11) - - - 305,773 - 305,773 ---------- ---------- --------- ---------- -------- ---------- Balances at June 30, 1998 15,864,975 $8,270,633 2,613,453 (265,257) 13,136 10,631,965 ========== ========= ========= ========= ======= ========== See accompanying notes to consolidated financial statements. PACER TECHNOLOGY AND SUBSIDIARIES Consolidated Statements of Cash Flows Years ended June 30, 1998, 1997 and 1996 1998 1997 1996 ========== ========== ========= Net income $1,541,049 1,217,402 925,067 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation 532,248 505,315 468,142 Amortization of other assets 281,013 189,612 189,612 Gain on sale of property and equipment (1,295) (76,000) (4,742) Provision for doubtful accounts 141,426 (5,355) (11,276) Changes in operating assets and liabilities, excluding the effects of acquisitions: Increase in trade accounts receivable (4,012,782) (199,488) (657,860) Decrease (increase) in other receivables 65,693 (10,118) (63,372) Decrease (increase) in notes receivable 59,577 (30,055) 114,529 (Increase) decrease in inventory (1,746,282) (393,452) 1,554,084 Increase in prepaid expenses and other assets (366,943) (49,583) (202,732) (Increase) decrease in deferred income taxes (588,808) (111,547) 293,521 Increase (decrease) in accounts payable 1,768,227 (15,473) 615,616 Increase in accrued payroll and related expenses 107,828 88,946 41,767 Increase (decrease) in accrued expenses and other liabilities 922,358 370,662 (334,858) --------- --------- --------- Net cash provided by (used in) operating activities (1,296,691) 1,480,864 2,927,498 --------- --------- --------- Cash flows from investing activities: Payments for acquisitions (7,368,067) - - Proceeds from sale of property and equipment - 76,000 3,450 Capital expenditures (531,105) (554,560) (246,465) ---------- --------- -------- Net cash used in investing activities (7,899,172) (478,560) (243,015) --------- ------- ------- Cash flows from financing activities: Principal payments on long-term debt (11,593,229) (247,296) (229,333) Borrowings on long-term debt 21,248,731 - - Borrowings on line of credit - 10,179,500 8,325,000 Repayments on line of credit (792,000)(11,062,500) (10,807,000) Notes receivable from directors 305,773 58,438 (144,968) Issuance of common stock 9,660 155,858 260,580 ----------- ----------- ---------- Net cash provided by (used in) financing activities 9,178,935 (916,000) (2,595,721) --------- ------- --------- Net increase (decrease) in cash (16,928) 86,303 88,762 Cash at beginning of year 294,298 207,995 119,233 ---------- --------- --------- Cash at end of year $ 277,370 294,298 207,995 ========== ========= ======== Supplemental disclosures of cash flow information: Cash paid during the year for interest $ 497,418 161,716 267,338 ========= ========= ======== Cash paid during the year for income tax $ 1,259,000 1,083,939 385,250 ========= ========= ======== See accompanying notes to consolidated financial statements. PACER TECHNOLOGY AND SUBSIDIARIES Notes to Consolidated Financial Statements Years ended June 30, 1998, 1997 and 1996 (1) The Company and Summary of Significant Accounting Policies The Company - ----------- Pacer Technology ("Pacer") is a vertically integrated manufacturer, formulator and packager of adhesives, sealants and other related products used in hobby, cosmetic, industrial, automotive aftermarket, consumer and private label applications. Pacer produces nearly all of the plastic containers used to package their adhesives and also produces plastic containers for other customers. Pacer also manufactures and markets manicure implements for the retail consumer markets. Principles of Consolidation - --------------------------- The consolidated financial statements include the accounts of Pacer and its subsidiaries, Pacer Tech Limited ("Pacer Tech") and Recap Limited ("Recap"). Pacer Tech was formed in 1986 to conduct business operations as a distributor of adhesives in the United Kingdom. Recap was formed in 1992 and is currently inactive. All significant intercompany accounts and transactions have been eliminated in consolidation. Use of Estimates - ---------------- 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 disclosure of con- tingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Inventories - ----------- Inventories are stated at the lower of cost (first-in, first-out) or market (net realizable value). Equipment and Leasehold Improvements - ------------------------------------ Equipment and leasehold improvements are stated at cost less accumulated de- preciation or amortization. Equipment depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or estimated useful life of the asset. Costs in Excess of Net Assets of Businesses Acquired - ---------------------------------------------------- Costs in excess of net assets of businesses acquired are amortized on the straight-line method over a 14-year to 20-year life. Pacer assesses the re- coverability of this intangible asset by determining whether the amortization of the asset balance over its remaining useful life can be recovered through undiscounted future operating cash flows of the acquired operations. Earnings per Share - ------------------ The Company adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share"("SFAS 128")in fiscal year 1998. This statement replaced the previously reported primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options. Diluted earnings per share is very similar to the previously reported fully diluted earnings per share. All earnings per share amounts for all periods have been presented and restated to conform to the SFAS No. 128 requirements (see note 12). Income Taxes - ------------ Pacer reports income taxes in accordance with Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes," (FASB 109) which requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are deter- mined based on the difference between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse (see note 10). Foreign Currency Translation - ---------------------------- Assets and liabilities denominated in a functional currency other than U.S. dollars are translated into U.S. dollars at the current rate of exchange exist- ing at year-end, and revenues and expenses are translated at the average monthly exchange rates. Translation adjustments are included as a separate component of stockholders' equity. Transaction gains and losses included in net income are immaterial. Fair Value of Financial Instruments - ------------------------------------ In December 1991, the FASB issued SFAS No. 107, "Disclosures about Fair Value of Financial Instruments." SFAS No. 107 requires all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized on the balance sheet, for which it is practicable to estimate fair value. SFAS No. 107 defines fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties. As of June 30, 1998, the fair value of all financial instruments approximated carrying value. Research and Development - ------------------------ Research and development costs are charged to selling, general and adminis- trative expenses as incurred and amounted to $440,861, $347,691 and $245,375 in 1998, 1997 and 1996, respectively. Product Warranties - ------------------ Pacer provides warranties for some products for periods generally ranging from 6 to 12 months. Estimated warranty costs are recognized at the time of the sale. Statement of Cash Flows - ----------------------- Cash and cash equivalents represent cash and short-term, highly liquid invest- ments with original maturities of three months or less. Impairment of Long-Lived Assets and Long-Lived Assets To Be Disposed Of - ----------------------------------------------------------------------- The Company adopted the provisions of SFAS No. 121, "Accounting for the Impair- ment of Long-Lived Assets and for Long-Lived Assets To Be Disposed Of", during the fiscal year ended June 30, 1997. This Statement requires that long-lived assets and certain identifiable intangibles be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net un- discounted operating cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is mea- sured by the amount by which the carrying amount of the assets exceed the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Adoption of this Statement did not have a material impact on the Company's financial position results of operations, or liquidity. Stock Based Compensation - ------------------------ Prior to July 1, 1996, the Company accounted for its stock option plans in accordance with the provisions of Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and related interpretations. As such, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. During the fiscal year ended June 30, 1997, the Company adopted SFAS No. 123, "Accounting for Stock-Based Compensation", which permits entities to recognize as expense over the vesting period the fair value of all stock-based awards on the date of grant. Alternatively, SFAS No. 123 also allows entities to continue to apply the provisions of APB Opinion No. 25 and provide pro forma net income and pro forma earnings per share disclosures for employee stock option grants made in 1995 and future years as if the fair-value-based method defined in SFAS No. 123 had been applied. The Company has elected to continue to apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure provisions of SFAS No. 123. (2) Notes Receivable Several customers have converted trade receivable balances to term notes. The notes are payable in monthly installments of principal and interest at a rate higher than the rate of interest charged to Pacer for its borrowing of funds from its predominant bank. (3) Inventories Inventories are summarized as follows: 1998 1997 ========== ========== Raw materials $ 5,103,266 1,665,877 Work-in-process 542,489 249,646 Finished goods 5,328,823 2,431,974 ---------- --------- $10,974,578 4,347,497 (4) Equipment and Leasehold Improvements Equipment and leasehold improvements and the useful lives used for computing depreciation and amortization are summarized as follows: Estimated Useful Lives 1998 1997 --------- --------- ----------- Shop equipment 5-10 $4,689,188 3,891,784 Office furniture and equipment 5-7 588,449 526,716 Leasehold improvements 10 863,998 834,012 Transportation equipment 3 124,328 104,865 Construction in progress - 10,903 13,194 --------- --------- $6,276,866 5,370,571 Less accumulated depreciation and amortization (4,457,083) (3,925,940) --------- --------- $1,819,783 1,444,631 ========= ========= (5) Other Assets Other assets (net of amortization) consist of the following: 1998 1997 ======== ======== Cook Bates-Patents & trademarks, net $ 24,405 1,666 Patents and trademarks, net 5,312 6,586 Other 408 1,092 ------- ------- $ 30,125 9,344 ======== ======= (6) Line of Credit and Long-Term Debt On June 25, 1997, the Company entered into a promissory note agreement with its primary bank whereby Pacer can borrow up to $8,000,000 to be utilized for work- ing capital, capital expenditures and acquisitions. On May 18, 1998 this note was increased to $17,000,000 and is cross-collateralized by trade accounts receivable, inventory and certain equipment. The interest is at the bank's prime rate (8.5% at June 30, 1998) plus .5%. The note requires monthly interest payments only and has a maturity date of July 1, 2000. Prepayments of the principal balance are permitted without penalty. This new credit facility was utilized to retire in July 1997 the Company's line of credit balance ($792,000 at June 30, 1997) and two (2) term loans ($484,068 total at June 30, 1997), as well as to finance capital equipment purchases and working capital. In addition to the above, on May 18, 1998 the Company entered into two (2) other agreements as follows: (1) Letter of credit: $5,000,000 from May 1, 1998 to September 30, 1998 and $2,000,000 from October 1, 1998 to April 30, 1999. This agreement in- cludes issuance fees of 1/8% for each letter of credit. (2) Term loan of $1,000,000 with a maturity date of July 1, 2000 bearing interest at the prime rate (8.5% at June 30, 1998)plus .5%. This term loan will be used to finance leasehold improvements, capital expenditures, and all other costs related to closing and relocating Cook Bates facili- ties to Pacer locations. This term loan has a maturity date of 3 years from funding and is payable in monthly installments of principal and interest. The agreements require maintenance of certain financial ratios and contains other restrictive covenants. Pacer Technology was in compliance with all debt covenants on June 30, 1998. Long-term debt consists of the following: 1998 1997 ========== ========== Note Payable at prime plus 2%, secured by certain assets, due in monthly installments of principal plus interest, through December 1, 1998. - $ 350,735 Note Payable at prime plus 1.5%, secured by certain equipment, due in 60 monthly principal installments of $4,167 plus interest, through February 2000. - 133,333 Term Loan at prime plus .5%, secured by certain assets, due in monthly install- ments of principal plus interest through July 1, 2000. $ 972,222 - Promissory note agreement with monthly interest payments at prime plus .5%, secured by certain assets. This note matures July 1, 2000. 8,897,000 - Less: Current installments (333,333) ( 262,866) ---------- --------- Total Long-Term Debt $ 9,535,889 $ 221,202 ========== ========= (7) Other Accrued Expenses Other accrued expenses at June 30, 1998 and 1997 consist of the following: 1998 1997 ======== ========= Sales and Marketing Expenses $ 831,912 $ 663,649 Legal and Accounting Expenses 67,000 52,000 Warranty 310,060 109,590 Income and Other Taxes 715,944 305,762 Relocation and Closure Costs 531,654 - Other 210,916 102,438 ---------- ----------- Total Accrued Liabilities $ 2,667,486 $ 1,233,439 ========== ========== (8) Lease Obligations Pacer leases three manufacturing facilities under operating leases expiring in June, 2009, October 2004, and May 2009. Pacer also leases two distribution facilities and office equipment under operating lease agreements. Leases for the two distribution facilities expire in December 1999 and May 2003. Future minimum lease payments under noncancellable operating leases as of June 30, 1998 are as follows: Operating Year ending June 30, Leases ---------- 1999 $ 770,107 2000 711,860 2001 735,562 2002 754,287 2003 712,287 Thereafter 3,313,477 --------- Minimum future lease payments $6,997,580 ========= Rent expense was $405,134, $383,936, and $404,107 in 1998, 1997 and 1996, respectively. (9) Major Customers and Export Sales Pacer did not have net sales to any individual customer greater than 10% of total net sales in either 1998, 1997 or 1996. Pacer's export sales represent approximately 17% of net sales in 1998, 18% of net sales in 1997 and 16% of net sales in 1996. (10) Income Taxes Income tax expense (benefit) from continuing operations for the years ended June 30, 1998, 1997 and 1996 consist of: 1998 1997 1996 --------- --------- -------- Federal: Current $1,423,861 1,139,387 208,331 Deferred (446,021) (94,828) 243,296 --------- --------- -------- 977,840 1,044,559 451,627 State: Current 286,830 241,039 50,240 Deferred (142,787) (16,719) 50,225 --------- --------- ------- $1,121,883 1,268,879 552,092 ========= ========= ======== The tax effects of temporary differences that give rise to significant portions of the deferred tax assets at June 30, 1998 and 1997 are presented below: Current deferred tax assets (liabilities): 1998 1997 ------- -------- Allowance for doubtful accounts $224,737 153,651 Inventory 259,110 120,102 Prepaid expenses (89,982) (68,314) Vacation accruals 64,272 59,204 Warranty accruals 132,829 43,946 Advertising accruals 71,340 65,975 Amortization 114,833 - Other accruals 369,630 247,240 --------- -------- Net current deferred tax assets $1,146,769 621,804 ========= ======== Non-current deferred tax assets: Depreciation $ 124,065 60,222 ======== ======== The Company believes that it is more likely than not that the net deferred tax assets will be realized. This belief is based on recent and anticipated future earnings. The total income tax expense differs from the "expected" tax expense (computed by applying the U.S. Federal corporate income tax rate of 34%) for 1998, 1997 and 1996 as follows: 1998 1997 1996 ======== ======== ======= Expected income tax provision $ 905,396 845,336 502,234 Non-deductible expenses 69,446 78,633 83,447 State income tax, net of Federal income tax benefit 95,068 148,051 63,462 Effect of foreign operations 33,745 19,303 (16,470) Other 18,228 177,556 - Reduction of liabilities previously accrued - - (80,581) --------- --------- -------- $1,121,883 1,268,879 552,092 ========= ========= ======== (11) Stockholders' Equity Notes Receivable from Directors - ------------------------------- On September 27, 1994, three Directors exercised options to purchase 100,000 shares each (300,000 total) of Pacer Technology common stock. Each Director signed a secured promissory note for the principal sum of $58,437.50 ($175,312.50 total) with interest of 7.8% per annum payable to Pacer Technology. One of these notes was paid in full on January 13, 1997, plus interest accrued as of the date of payment. On April 1, 1998, one Director paid $34,846.59 against the principal balance, plus accrued interest. The balance of this note, $23,590.91, is secured by 40,369 shares of the Company's common stock. The remaining note is secured by 100,000 shares of the Company's common stock as provided in a Security Agreement between the Company and the Director. On October 19, 1994, a Director exercised options to purchase 485,000 shares of Pacer Technology common stock. This director signed a secured promissory note for the principal sum of $309,187.50, plus simple interest of 7.89% per annum payable to Pacer Technology. This note was secured by 485,000 shares of the Company's common stock as provided in a Security Agreement between the Company and the Director. On August 14, 1997, the Director paid $149,988.45 against the principal balance, plus accrued interest. The balance of this note, $159,199.05, is secured by 249,724 shares of the Company's common stock. The remaining principal balances and all accrued interest will be due and pay- able in one lump sum on September 27, 1998 and October 19, 1998, respectively; subject to the provisions regarding prepayment noted below. Each Director may sell the shares securing the Note in whole or in part, without penalty, provided that the proceeds of sale are applied to the Note. The amount of each prepayment shall be applied as follows: (a) first, to interest accrued on the Note with respect to the shares sold, to the date of sale; (b) second, to the outstanding principal on the Note in the amount of $0.584375 and $0.6375 per share sold, respectively; and (c) third, to the seller or his designee. If all principal and accrued interest on the Notes is not paid in full on or before September 27, 1998 and October 19, 1998, respectively, the Company shall be entitled to exercise any and all remedies available to it under the Califor- nia Commercial Code, with full recourse to the personal assets of the Directors. On September 11, 1995, one Director exercised options to purchase 100,000 shares of Pacer Technology common stock. The Director signed a secured promissory note for the principal sum of $24,000 plus simple interest of 7.015% per annum payable to Pacer Technology. Principal and all accrued interest will be due and payable in one lump sum on September 11, 1999; subject to the provisions regarding prepayment noted below. The note is secured by 100,000 shares of the Company's common stock as provided in the Security Agreement between the Company and the Director. On November 20, 1995, a Director exercised warrants to purchase 381,000 shares of Pacer Technology common stock. This director signed a secured promissory note for the principal sum of $120,967.50, plus simple interest of 6.6939% per annum payable to Pacer Technology. This note was paid in full on August 14, 1997 plus interest accrued as of the date of payment. The Director may sell the shares securing the $24,000 Note in whole or in part, without penalty, provided that the proceeds of sale are applied to pre-pay the Note. The amount of each prepayment shall be applied as follows: (a) first, to interest accrued on the Note with respect to the shares sold, to the date of sale; (b) second, to the outstanding principal on the Note in the amount of $0.24 per share sold, and (c) third, to the seller or his designee. If the principal and accrued interest on the Note is not paid in full on or before September 11, 1999, the Company shall be entitled to exercise any and all remedies available to it under the California Commercial Code, with full recourse to the personal assets of the Directors. Common Stock - ------------ During the year ended June 30, 1994, Pacer adopted a stock incentive plan which awards shares of stock to employees for years of service. Under this plan, 500 shares of Pacer stock are granted to each employee for every five years of service. The shares are restricted for one year after the grant date. Pacer awarded 7,500, 7,000, and 10,500 shares to employees for past service and re- corded compensation expense of $6,150, $4,900, and $6,615 in 1998, 1997 and 1996, respectively. Stock Option and Incentive Stock Option Plans - --------------------------------------------- During the year ended June 30, 1995, Pacer adopted the 1994 Stock Option Plan to provide key employees and directors an opportunity to purchase the common stock of the Company pursuant to "non-qualified stock options" at the discretion of the Board of Directors. Under the 1994 Stock Option Plan, options to purchase up to 2,000,000 shares of Pacer Technology common stock can be granted. The purchase price shall be no less than fair market value on the grant date. The exercise period shall not exceed ten years from grant date and options vest immediately. In 1996, under this plan, Pacer granted an option to a director to purchase 100,000 shares of Pacer's common stock at $.88 per share. On the date of grant the market value of the stock was $.88 per share. There were no stock options granted during fiscal year 1997. The fair value of stock options granted during fiscal year 1996 was $.69 on the date of grant using the Black Scholes option-pricing model with the following assumptions: volatility rate of 66.03%, risk-free interest rate of 6.19%, and an expected life of 10 years. During the year ended June 30, 1995, Pacer adopted the 1994 Incentive Stock Option Plan that qualifies as "incentive stock options" under Section 422 of the Internal Revenue Service Code. Under the 1994 Incentive Stock Option Plan, options to purchase up to an aggregate of 2,000,000 shares of Pacer Technology common stock can be granted. The purchase price shall be no less than the fair market value of the common stock on the grant date. In the event such option is granted to an employee who, at the time the option is granted, owns common stock possessing more than 10% of the total combined voting power of all classes of stock of the Company, the exercise price of the option shall be no less than 110% of the fair market value. The exercise period for the options shall not exceed ten years. The option agreement may provide (a) that the right to exercise the option in whole or in part shall not accrue until a certain date or the occurrence of an event; (b) that the right to exercise the option shall accrue over time in accordance with a vesting schedule; or (c) that such accrual shall be accelerated upon the occurrence of certain specified event(s). In fiscal year 1998, under this plan, Pacer granted an option to an employee to purchase 50,000 shares of Pacer's common stock at $1.406 per share. The market value of the stock was $ 1.25 per share on the date of grant. The fair value of the stock option granted during fiscal 1998 was $.95 on the date of grant using the Black Scholes option-pricing model with the following assumpt- ions: volatility rate of 64.88%, risk-free interest rate of 5.60%, and an expected life of 10 years. The Company applies APB Opinion No. 25 in accounting for its Plan and, accor- dingly, no compensation cost has been recognized for its stock options in the financial statements. Had the Comapny determined compensation cost based on the fair value at the grant date for its stock options under SFAS No. 123, the Company's net income would have been reduced to the pro forma amounts indicated below: 1998 1997 ======== ========= Net income As reported $ 1,541,049 $ 1,217,402 Pro forma 1,513,499 1,217,402 E.P.S. As reported 0.10 0.08 Pro forma-Basic 0.10 0.08 As reported-Diluted 0.09 0.07 Pro forma-Diluted 0.09 0.07 Pacer had 4,800,000 shares of common stock reserved for non-qualified and qualified incentive stock options under the Company's 1982 Stock Option Plan and the 1982 Incentive Stock Option Plan. These Plans expired in 1992, and no options were granted under these plans thereafter. Under the 1982 Stock Option Plan, options to purchase up to an aggregate of 1,800,000 shares of common stock could be granted to both directors and key employees. The purchase price was not normally less than the fair market value of the shares on the date the option was granted, and in no event was the purchase price less than 85% of the fair market value of the shares on the date the option was granted. The exercise period for an option could not exceed ten years, and options granted vested immediately. Under the 1982 Incentive Stock Option Plan, options to purchase an aggregate of 3,000,000 shares of common stock could be granted to key employees of Pacer. The purchase price was not less than the fair market value of the shares on the date the option was granted. These options generally expired in ten years and vested immediately. A summary of transactions under the stock option plans is as follows: 1982 Stock Option Plan & ISOP ============================================= Options Outstanding Options Available Exercise Aggregate for Grant Shares Price Value ---------- --------- ---------- ---------- Balances at June 30, 1995 - 1,551,500 $0.19-1.06 637,035 Options exercised - (175,000) 0.24-0.47 ( 55,845) Options expired - (100,000) 1.06 (106,300) ---------- ---------- ----------- -------- Balances at June 30, 1996 - 1,276,500 $0.19-0.55 474,890 Options exercised - (629,500) 0.19-0.55 (150,959) --------- ---------- ----------- -------- Balances at June 30, 1997 - 647,000 $0.19-0.55 323,931 Options exercised - (7,500) 0.47 (3,510) --------- --------- ---------- -------- Balances at June 30, 1998 - 639,500 $0.19-0.55 320,421 ========= ========= ========== ======== Other Stock Option Plan ============================================ Options Outstanding Options Available Exercise Aggregate for Grant Shares Price Value --------- -------- --------- ---------- Balances at June 30, 1995 - 1,100,000 $1.00-1.08 1,107,800 Options authorized 100,000 - - - Options granted ( 100,000) 100,000 1.06 106,000 -------- ---------- --------- --------- Balances at June 30, 1996 - 1,200,000 $1.00-1.08 1,213,800 Options cancelled - (100,000) 1.00 (100,000) -------- ---------- --------- --------- Balances at June 30, 1997 - 1,100,000 $1.00-1.08 1,113,800 -------- ---------- --------- --------- Balances at June 30, 1998 - 1,100,000 $1.00-1.08 1,113,800 ======== ========== ========= ========= 1994 SOP & ISOP ============================================== Options Outstanding Options Available Exercise Aggregate for Grant Shares Price Value ----------- ---------- ---------- ---------- Balances at June 30, 1995 400,000 3,600,000 $0.72-1.00 3,376,000 Options granted (100,000) 100,000 0.88 87,500 ------- --------- ---------- --------- Balances at June 30, 1996 300,000 3,700,000 $0.72-1.00 3,463,500 Balances at June 30, 1997 300,000 3,700,000 $0.72-1.00 3,463,500 ------- --------- ---------- --------- Options granted (50,000) 50,000 1.41 70,313 ------- --------- ---------- --------- Balances at June 30, 1998 250,000 3,750,000 $0.72-1.41 3,533,813 ======= ========= ========== ========= At June 30, 1998 and 1997, the options exercisable were 925,000 and 700,000 respectively. (12) Earnings Per Share As discussed in Note 1, the Company adopted SFAS No. 128 during fiscal year 1998. YEARS ENDED JUNE 30, JUNE 30, JUNE 30, 1998 1997 1996 ========== ========== ========== Numerator: Numerator for basic and diluted earnings per share--net income--........$1,541,049 $1,217,402 $ 925,067 Denominator: Denominator for basic earnings per share--weighted average number of common shares outstanding during the period..............................15,852,475 15,549,392 15,001,558 Incremental common shares attributable to exercise of outstanding options...... 1,701,638 934,727 1,103,154 ---------- ---------- ---------- Denominator for diluted earnings per share.............................. 17,554,113 16,484,119 16,104,712 ========== ========== ========== Basic earnings per share................. $ .10 $ .08 $ .06 ========= ========= ========= Diluted earnings per share............... $ .09 $ .07 $ .06 ========= ========= ========= Substantially all options were included in the computation of diluted earnings per share for 1998, 1997, and 1996. (13) 401(k) Plan Pacer's 401(k) plan is available to all full-time employees who have completed a minimum service of one year at January 1 or July 1 of each year. Employees who elect to participate in the plan may make contributions to the plan on a pre-tax basis from 2% to 16% of their annual compensation. Pacer contributions, when made, will match 50% of employee contributions up to 4% of salaries paid. Pacer contributions are accrued as participant contributions are withheld, and participants become fully vested in Pacer contributions after six years of service. Plan expense for the years ended June 30, 1998, 1997 and 1996 was $45,088, $35,740 and $28,707, respectively. (14) Quarterly Financial Data (Unaudited) NET INCOME Net Income Per Share Revenues Gross Profit Net Income Basic Diluted ---------- ------------- ----------- ------- -------- 1998 ===== First Quarter $ 7,375,150 2,734,141 450,872 .03 .03 Second Quarter 6,273,501 2,252,160 275,646 .02 .02 Third Quarter 8,321,050 2,972,304 428,217 .03 .03 Fourth Quarter 9,968,813 3,387,186 386,314 .02 .02 1997 ===== First Quarter $ 6,673,594 2,419,311 341,819 .02 .02 Second Quarter 5,898,868 2,090,178 140,916 .01 .01 Third Quarter 6,606,612 2,327,447 352,564 .02 .02 Fourth Quarter 6,498,766 2,320,610 382,103 .02 .02 (15) Acquisitions On July 15, 1997, the Company acquired the assets of California Chemical Specialties, Inc.,("CCSI"). The assets purchased primarily consisted of trade accounts receivable, inventory, fixed assets and proprietary formulas. In addition, Pacer assumed the liability for trade accounts payable as of the closing date. The total purchase price consisted of approximately $2,550,000 cash, including transaction costs. The acquisition of CCSI has been accounted for as a purchase and, accordingly, the results of operations of CCSI are included in the Company's consolidated statements of operations from the date of acquisition. The excess of fair value of net assets acquired was approximately $ 2,276,000 and is being amor- tized on a straight-line basis over 20 years. On March 4, 1998, the Company completed the acquisition of certain assets of Cook Bates, a Division of London International Group, Inc. ("LIG"). The assets purchased from Cook Bates primarily consisted of inventory, fixed assets, and intellectual property. The total cash purchase price was approximately $4,800,000. The acquisition of Cook Bates has been accounted for as a purchase and, accor- dingly, the results of operations of Cook Bates are included in the Company's consolidated statements of operations from the date of acquisition. The following summary represents the unaudited pro forma results of operations as if the acquisitions of California Chemical and Cook Bates had occurred at the beginning of the periods presented, after consideration for certain adjust- ments including the amortization of cost in excess of net assets acquired (if applicable) and interest expense: Twelve-months ended June 30, 1998 1997 (Unaudited) (Unaudited) ============ ============ Net Sales $ 51,667,711 $ 52,109,442 Net Income 1,153,874 1,111,594 Basic E.P.S. $ 0.07 $ 0.07 Diluted E.P.S. $ 0.07 $ 0.07 The pro forma data is provided for illustrative purposes only. It does not purport to be indicative of the results that would have actually occurred if the acquisitions of California Chemical and Cook Bates had been consummated on the dates indicated or that may be obtained in the future. (16) Related Party Transactions The Company has made loans to certain directors which are evidenced by promis- sory notes and secured by shares of common stock. The loans have maturities of 4 years. As of June 30, 1998, the outstanding principal amount on the notes was $265,257 and is included in stockholders' equity. (Note 11) (17) Commitments and Contingencies Pacer has entered into sales agreements in the ordinary course of business which include pricing terms, renewability clauses, and provisions which convey trade- mark rights. Each of these agreements is unique and may include one or more of these features as part of its terms. Pacer is involved in certain legal actions and claims arising in the ordinary course of business. It is the opinion of management (based on advice of legal counsel) that such litigation will be resolved without material effect on Pacer's financial position or results of operations. PART III Item 10. Directors and Executive Officers of the Registrant Identification of the directors and executive officers of the Company is incor- porated by reference from the "Election of Directors--Nominees" and "Executive Officers" sections of the Company's definitive Proxy Statement dated September 24, 1998 to be mailed to shareholders in connection with the 1998 Annual Share- holders Meeting and filed with the Securities and Exchange commission on or about September 24, 1998 (the "Proxy Statement"). Information regarding compli- ance with Section 16(a) of the Exchange Act is incorporated by reference from the "Section 16(a) Beneficial Ownership Reporting Compliance" section of the Proxy Statement. Item 11. Executive Compensation Incorporated by reference from the "Election of Directors--Executive Compensa- tion," "Report of Compensation Committee" and "Stock Price Performance Graph," sections of the Proxy Statement. Item 12. Security Ownership of Certain Beneficial Owners and Management Incorporated by reference from the "General Information--Share Ownership of Management" section of the Proxy Statement. Item 13. Certain Relationships and Related Transactions Incorporated by reference from the "Certain Transactions" section of the Proxy Statement. Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K (a)(1) Financial Statements: The following is a list of the exhibits filed with this Form 10-K. Exhibit 3.1 Articles of Incorporation (4) Exhibit 3.2 By-laws (4) Exhibit 10.3 Employment agreement dated November 21, 1989 between the Company and James Munn. (1) Exhibit 10.4 Warrants issued to directors in fiscal year ended June 30, 1987. (3) Exhibit 10.5 Lease Agreement for new facilities in Rancho Cucamonga, California, dated March 1, 1988. (2) Exhibit 10.6 Agreement To Extend Term of Executive Employment Agreement Exhibit 10.7 Agreement To Extend Term of lease agreement dated March 1, 1988 for facilities in Rancho Cucamonga. Exhibit 21 Subsidiaries of Registrant Exhibit 23 Consent of Independent Auditors (a)(2) Financial Statement Schedule: A. Independent Auditors' Report on Schedule Schedule -------- II. Valuation and Qualifying Accounts All other schedules have been omitted as the required information is reported or incorporated by reference elsewhere in this Annual Report or is not applicable. (b) Exibits, Financial Statement Schedules, and Reports on Form 8-K. On May 12, 1998, the registrant filed form 8-KA. The purpose of the filing was to amend the Form 8-K filed on March 13, 1998 disclosing the acquisition by the registrant of certain assets of Cook Bates, a division of London International Group, Inc., under Item 2 of form 8-K. The following financial statements were filed as part of this Form 8-KA: i) Financial Statements of Business Acquired - Independent Auditors' Report - Audited Balance Sheet as of February 28, 1998 - Audited Statement of Operations and Accumulated Deficit for the eleven months ended February 28, 1998 - Notes to Financial Statements for the eleven months ended February 28, 1998 ii) Pro Forma Combined Balance of Financial Information - Unaudited Pro Forma Combined Financial Information - Unaudited Pro Forma Combined Balance Sheet of Pacer Technology and Subsidiaries at December 31, 1997 - Unaudited Pro Forma Combined Statement of Income of Pacer Technology and Subsidiaries for the six months ended December 31, 1997 - Unaudited Pro Forma Combined Statement of Income of Pacer Technology and subsidiaries for the year ended June 30, 1997 - Notes to Unaudited Pro Forma Combined Financial Data as of December 31, 1997 and June 30, 1997 - --------------------------------- 1) Incorporated by reference to exhibits to Form 10-K for fiscal year ended June 30, 1990. 2) Incorporated by reference to exhibits to Form 10-K for fiscal year ended June 30, 1988. 3) Incorporated by reference to exhibits to Form 10-K for fiscal year ended June 30, 1987. 4) Incorporated by reference to exhibits to Form 10-K for fiscal year ended June 30, 1986. INDEPENDENT AUDITORS' REPORT ON SCHEDULE To the Board of Directors and Shareholders Pacer Technology: The audits referred to in our report dated August 14, 1998 included the related financial statement schedule as of June 30, 1998 and 1997, and for each of the years in the three-year period ended June 30, 1998, included in the an- nual report on Form 10-K of Pacer Technology. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits and the report of other auditors. In our opinion, such financial state- ment schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/KPMG Peat Marwick LLP Orange County, California August 14, 1998 SCHEDULE II - PACER TECHNOLOGY VALUATION AND QUALIFYING ACCOUNTS YEARS ENDED JUNE 30 (in thousands) Balance at Charged to Beginning Costs and Balance At Period Expenses Deductions End of Period ----------- ----------- ----------- -------------- FY 1996: ======= Allowance for Doubtful Accounts $ 400 $ 88 $ 100 $ 388 Allowance for Obsolescense 486 (104) 39 343 ----- ----- ----- ----- $ 886 $( 16) $ 139 $ 731 FY 1997: ======= Allowance for Doubtful Accounts $ 389 $ 219 $ 225 $ 383 Allowance for Obsolescense 343 78 166 255 ----- ----- ----- ----- $ 732 $ 297 $ 391 $ 638 FY 1998: ======= Allowance for Doubtful Accounts $ 383 $ 166 $ 24 $ 525 Allowance for Obsolescense 255 918 66 1,107 ----- ------ ----- ------ $ 638 $1,084 $ 90 $1,632 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. PACER TECHNOLOGY /s/ James T. Munn ------------------------ James T. Munn, President Date: September 25, 1998 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 regis- trant and in the capacities and on the dates indicated. Signature Title Date /s/ James T. Munn - ----------------- President/ September 25, 1998 James T. Munn Chief Executive Officer/Director /s/ Roberto J. Cavazos, Jr. - -------------------------- Chief Financial September 25, 1998 Robert J. Cavazos,Jr. Officer /s/ John G. Hockin II - --------------------- Chairman of the September 25, 1998 John G. Hockin II Board and Director /s/ DeVere W. McGuffin - ---------------------- Secretary and September 25, 1998 DeVere W. McGuffin Director /s/ Joe F. Brock - ---------------- Director September 25, 1998 Joe F. Brock /s/ Carl Hathaway - ----------------- Director September 25, 1998 Carl Hathaway /s/ Larry K. Reynolds - --------------------- Director September 25, 1998 Larry K. Reynolds INDEX TO EXHIBITS Number Name Exhibit 3.1 Articles of Incorporation (4) Exhibit 3.2 By-laws (4) Exhibit 10.3 Employment agreement dated November 21, 1989 between the Company and James Munn. (1) Exhibit 10.4 Warrants issued to directors in fiscal year ended June 30, 1987. (3) Exhibit 10.5 Lease Agreement for new facilities in Rancho Cucamonga, California, dated March 1, 1988. (2) Exhibit 10.6 Agreement To Extend Term of Executive Employment Agreement Exhibit 10.7 Agreement To Extend Term of lease agreement dated March 1, 1988 for facilities in Rancho Cucamonga Exhibit 21 Subsidiaries of Registrant Exhibit 23 Consent of Independent Auditors - ------------------------------- 1) Incorporated by reference to exhibits to Form 10-K for fiscal year ended June 30, 1990. 2) Incorporated by reference to exhibits to Form 10-K for fiscal year ended June 30, 1988. 3) Incorporated by reference to exhibits to Form 10-K for fiscal year ended June 30, 1987. 4) Incorporated by reference to exhibits to Form 10-K for fiscal year ended June 30, 1986. EXHIBIT 21 SUBSIDIARIES OF PACER TECHNOLOGY 1. Pacer Tech Ltd. A United Kingdom Corporation - 100% owned EXHIBIT 23 Consent of Independent Auditors ------------------------------- The Board of Directors and Stockholders Pacer Technology: We consent to incorporation by reference in the registration statement (No.33- 48090) on form S-8 of Pacer Technology of our report dated August 14, 1998, relating to the consolidated balance sheets of Pacer Technology and subsidiaries as of June 30, 1998 and 1997, and the related consolidated statements of oper- ations, stockholders' equity, and cash flows for each of the years in the three- year period ended June 30, 1998 which report appears in the June 30, 1998 annual report on Form 10-K of Pacer Technology. /s/ KPMG Peat Marwick LLP Orange County, California September 24, 1998