1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2000 COMMISSION FILE NUMBER 0-13875 LANCER CORPORATION (Exact name of registrant as specified in its charter) TEXAS 74-1591073 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 6655 LANCER BLVD., SAN ANTONIO, TEXAS 78219 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (210) 310-7000 Securities registered pursuant to Section 12 (b) of the Act: NONE Securities registered pursuant to Section 12 (g) of the Act: COMMON STOCK, PAR VALUE $.01 PER SHARE (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 X 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 registrant's common stock, par value $.01 per share, as of March 9, 2001, held by non-affiliates of the registrant was approximately $24,572,535 based on the closing sale price. For purposes of this computation, all executive officers, directors and 5% beneficial owners of the registrant are deemed to be affiliates. Such determination should not be deemed to be an admission that such officers, directors or 5% beneficial owners are, in fact, affiliates of the Company. The number of shares of the registrant's common stock outstanding as of March 9, 2001 was 9,126,557. DOCUMENTS INCORPORATED BY REFERENCE Portions of the registrant's definitive proxy statement to be filed with the Securities and Exchange Commission (the "Commission") not later than 120 days after the end of the fiscal year covered by this report and prepared for the 2001 annual meeting of shareholders are incorporated by reference into Part III of this report. 2 This document contains certain "forward-looking" statements as such term is defined in the Private Securities Litigation Reform Act of 1995 and information relating to the Company and its subsidiaries that are based on the beliefs of the Company's management. When used in this report, the words "anticipate," "believe," "estimate," "expect," "forecast," "plan," and "intend" and words or phrases of similar import, as they relate to the Company or its subsidiaries or Company management, are intended to identify forward-looking statements. Such statements reflect the current risks, uncertainties and assumptions which exist or must be made as a result of certain factors including, without limitation, competitive factors, general economic conditions, customer relations, relationships with vendors, the interest rate environment, governmental regulation and supervision, seasonality, distribution networks, product introductions and acceptance, one-time events and other factors described herein and in other filings made by the Company with the Securities and Exchange Commission. Based upon changing conditions, should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected, forecast, planned or intended. The Company does not intend to update these forward-looking statements. PART I ITEM 1. BUSINESS GENERAL Lancer designs, engineers, manufactures and markets fountain soft drink, beer and citrus beverage dispensing systems, and other equipment for use in the food service and beverage industry. Lancer also markets frozen beverage dispensers manufactured by a joint venture that is 50% owned by the Company. Lancer's products are sold by Company personnel and through independent distributors and agents principally to major soft drink companies (primarily The Coca-Cola Company), bottlers, equipment distributors, beer breweries and food service chains for use in various food and beverage operations. The Company is a vertically integrated manufacturer whose tooling, production, assembly and testing capabilities enable it to fabricate a substantial portion of the components used in Company products. In addition, the Company is an innovator of new products in the beverage dispensing industry and has a large technical staff supported by state-of-the-art engineering facilities to develop these new products and to enhance existing product lines in response to changing industry requirements and specific customer demands. The Company was incorporated in Texas on December 18, 1967, and initially manufactured parts for beverage dispensing equipment. The Company designed, engineered, manufactured and marketed its first mechanically cooled soft drink dispensing system in 1971. Since that time, the Company has expanded its engineering and production facilities and has developed new products, including various configurations of the Company's mechanically and ice cooled beverage dispensing systems, syrup pumps, carbonators and other related equipment, accessories and parts. THE BEVERAGE DISPENSING INDUSTRY The manufacture of fountain soft drink and other beverage dispensing systems is a rapidly changing industry. Technological changes and improvements continue to be reflected in the development, manufacture and introduction of new products and processes. Manufacturers of such beverage dispensing systems generally sell most of their products to one or more major soft drink companies, licensed bottlers, large international breweries, equipment distributors and food service chains. In order to facilitate sales of their beverage products to end-users, soft drink companies and some breweries, and their respective affiliates, in turn sell or lease the dispensing systems to restaurants, convenience stores, concessionaires and other food and beverage operators. Soft drink companies generally recommend that their affiliates purchase beverage dispensing systems from approved manufacturers. Informal, long-term relationships between certain manufacturers and soft drink companies have become the norm in the industry. PRODUCTS The Company's products can be divided into four major categories: (i) fountain soft drink, citrus, and frozen beverage dispensers; (ii) post-mix dispensing valves; (iii) beer dispensing systems; and (iv) other products and services. 1 3 Soft Drink, Citrus, and Frozen Beverage Dispensers The Company manufactures and sells a broad range of mechanically cooled and ice cooled soft drink and citrus dispensing systems. These systems are non-coin operated. The type of equipment and configuration of each model varies according to intended use and specific customer needs. The Company's mechanically cooled dispensing systems chill beverages as they run through stainless steel tubing inside a self-contained refrigeration unit. In the Company's ice cooled dispensing systems, the beverage is cooled as it runs through stainless steel tubing encased in an aluminum cold plate which serves as the heat transfer element when covered with ice. Several of the ice cooled systems also dispense ice. The Company manufactures both post-mix and pre-mix dispensing equipment for each of the mechanically cooled and ice cooled fountain systems. Lancer manufactures several models of mechanically cooled citrus dispensing systems for counter top use. The Minute Maid Company, a division of The Coca Cola Company, is the primary customer for the Company's citrus dispensing products. Lancer FBD Partnership, Ltd., a joint venture in which Lancer owns a 50% interest, manufactures frozen beverage dispensers. The joint venture sells its production to Lancer, and Lancer markets and distributes the equipment to third parties. The prices of the Company's dispensing systems vary depending on dispensing capacity, number of drink selections, speed of beverage flow and other customer requirements. Sales of soft drink, citrus, and frozen beverage dispensers for the years ended December 31, 2000, 1999 and 1998, accounted for approximately 38%, 48% and 50% of total sales, respectively. Post-Mix Dispensing Valves The Company manufactures and sells post-mix dispensing valves which mix syrup and carbonated water at a preset ratio. The valves are designed to be interchangeable with existing post-mix valves used with Coca-Cola products. The Company manufactures accessories for the valves, including push-button activation, water-only dispensing mechanisms, portion controls and other automatically activated valve controls. The Company's primary valve, the LEV, has been designated by The Coca-Cola Company as the standard valve for the U.S. market. Lancer uses the LEV in many of its own dispensing systems, and also sells the valve to competing equipment makers. For the years ended December 31, 2000, 1999 and 1998, sales of valves and related accessories accounted for approximately 12%, 12%, and 14% of total net sales, respectively. Beer Dispensing Systems The Company manufactures and markets beer dispensing equipment and related accessories. Products include chillers, taps, fonts, dispensers and kegs. Lancer's operations in Australia, Brazil and New Zealand account for most of the Company's sales of beer related equipment. Sales of beer equipment represented 7%, 7% and 6% of total net sales in the years ended December 31, 2000, 1999 and 1998, respectively. Other Related Products and Services The Company remanufactures various dispensing systems and sells replacement parts in connection with the remanufacturing process. Revenues from remanufacturing activities were 4%, 3%, and 4% of net sales in the years ended December 31, 2000, 1999 and 1998. The Company manufactures and/or markets a variety of other products including syrup pumps, carbonators, stainless steel and brass fittings, carbon dioxide regulator components, ice bagger machines, water filtering systems, and a variety of other products, parts and accessories for use with beverage dispensing systems. Lancer also provides logistics services to certain of its customers. Together, these parts and services constitute 39%, 30% and 26% of the Company's total net sales for the years ended December 31, 2000, 1999 and 1998, respectively. 2 4 PRODUCT RESEARCH AND DEVELOPMENT In order to maintain its competitive position, the Company continuously seeks to improve and enhance its line of existing beverage dispensing systems and equipment, and to develop new products to meet the demands of the food and beverage industry. Some projects are originated by Company personnel while others are initiated by customers, primarily The Coca-Cola Company. The Company has, from time to time, entered into agreements with customers to design and develop new products. For the years ended December 31, 2000, 1999 and 1998, Company-sponsored research and development expenses were $3.8 million, $2.7 million, and $2.2 million, respectively. PRODUCTION, INVENTORY AND RAW MATERIALS The Company's major products typically contain a number of metal and/or plastic parts that are manufactured by the Company. The production of these parts usually requires metal dies, fixtures, thermal plastic injection molds, and other tooling, some of which are produced in the Company's tool and die and mold departments. Other manufacturing processes include welding, polishing, painting, tube bending, metal turning, stamping, and assembling of printed circuit boards and wire harnesses. The Company assembles the various parts and components into finished products, or sells them as spare parts. Substantially all raw materials and parts not manufactured internally are readily available from other commercial sources. The Company has not experienced any significant shortages in the supply of its raw materials and parts over the past several years. Shortages can occur from time to time, however, and could delay or limit the manufacture of the Company's products. Such a disruption could adversely affect the Company's operations. The Company does not stockpile large amounts of raw materials and parts, but attempts to control its inventory through extrapolation of historical production requirements and by using its specific knowledge of the market. In addition, the Company would be able to manufacture some purchased parts if shortages of these parts were to occur. There can be no assurances, however, that these measures will be entirely successful or that disruptive shortages will not occur in the future. BACKLOG The Company's manufacturing operations are driven by actual and forecasted customer demand. The Company's backlog of unfilled orders was approximately $6.0 million, $10.1 million and $13.0 million at December 31, 2000, 1999 and 1998, respectively. It is anticipated that 2000 backlog orders will be filled in 2001. MARKETING AND CUSTOMERS The Company's products are marketed on a wholesale basis in the United States through a network of independent distributors and salaried sales representatives. The principal purchasers of Company products are major soft drink companies, bottlers, breweries, beverage equipment dealers, restaurants, convenience stores, and other end users. Substantially all of the Company's sales are derived from, or influenced by, The Coca-Cola Company. Lancer is a preferred supplier to The Coca-Cola Company. Direct sales to The Coca-Cola Company, the Company's largest customer, accounted for approximately 26%, 25% and 23% of the Company's total net sales for the years ended December 31, 2000, 1999 and 1998, respectively. None of the Company's customers, including The Coca-Cola Company, are contractually obligated to purchase minimum quantities of Lancer products. Consequently, The Coca-Cola Company has the ability to adversely affect, directly or indirectly, the volume and price of the products sold by the Company. Lancer does not expect any significant volume or price reductions in its business with The Coca-Cola Company. If they were to occur, however, such reductions would have a material adverse impact on the Company's financial position and its results of operations. 3 5 The Company and The Coca-Cola Company have entered into a master development agreement which governs development of various products. Products that are developed pursuant to this agreement may be sold only to The Coca-Cola Company or its designated agents. The agreement generally provides that The Coca-Cola Company will also retain the rights to any tooling it pays for and any resulting patents. The Company is obligated under the development agreement to make its manufacturing capabilities available for the benefit of The Coca-Cola Company as they relate to, and are required for, selected projects. The Company supplies engineering and research and development personnel, designs, develops and creates prototypes, and obtains either an exclusive or a non-exclusive license to manufacture and market the resulting products. Generally, the Company warrants all such products for one year. The Coca-Cola Company may terminate the development agreement at any time, subject to certain conditions. The Company and The Coca-Cola Company have entered into certain logistics support agreements under which the Company warehouses and distributes new and used products owned by The Coca-Cola Company. The two parties also have entered into agreements which provide for the remanufacturing of used dispensing equipment owned by The Coca-Cola Company. INTERNATIONAL SALES For the years ended December 31, 2000, 1999 and 1998, the Company's sales to customers outside the United States were approximately 40%, 35% and 48% of total net sales, respectively. The Company has sales employees, distributors, and/or licensees in Latin America, Europe, Africa and Asia. The Company manufactures products in Australia, Brazil, and Mexico, and operates warehouses in Belgium, Ecuador, New Zealand, and Russia. The Company's foreign sales and operations could be adversely affected by foreign currency fluctuations, exchange controls, tax policies, deterioration of foreign economies, the expropriation of Company property, and other political actions and economic events. Although the Company attempts to limit such risks, there can be no assurance that these efforts will be successful. FINANCIAL INFORMATION ABOUT SEGMENTS AND GEOGRAPHIC AREAS The Company organizes its business into the following geographical segments: the North America region, the Latin America region, the Brazil region, the Europe region, the Asia region, and the Pacific region. The North America region consists of the United States and Canada. The Europe region includes the Middle East and Africa. The Company's net sales and operating income (loss) for 2000, 1999, and 1998 follow (amounts in thousands): North Latin America America Pacific Brazil Europe Asia ------- ------- ------- ------- ------- ------- Net sales: 2000 $73,618 $ 7,882 $16,639 $ 1,538 $10,897 $ 2,956 1999 85,889 11,225 15,407 2,065 9,471 5,783 1998 72,372 21,624 15,459 6,142 11,446 11,380 Operating income (loss): $11,272 $ 1,219 $ 2,196 $ 10 $ 1,113 973 2000 8,451 528 1,535 (6,819) 1,023 845 1999 15,691 3,282 2,199 (1,743) 2,273 2,153 1998 Additional financial information about segments and geographic areas is set forth in Note 14 to the Consolidated Financial Statements. 4 6 COMPETITION The business of manufacturing and marketing beverage dispensing systems and related equipment is highly competitive and is characterized by rapidly changing technology. Competition is primarily based upon product suitability, reliability, technological development and expertise, price, product warranty and delivery time. In addition, the Company frequently competes with companies having substantially greater financial resources than the Company. The Company has been able to compete successfully in the past, and believes it will be able to do so in the future. EMPLOYEES As of December 31, 2000, the Company had 1,452 full-time employees of whom 78 were engaged in engineering and technical support, 1,166 in manufacturing, 79 in marketing and sales and 129 in general management and administrative positions. 610 employees work in the United States, primarily at the Company's facilities in San Antonio, Texas. 677 employees work at the Company's facility in Piedras Negras, Mexico, 20 are employed by the Company's Brazilian subsidiary, and a total of 93 people are employed by the Company's subsidiaries in Australia and New Zealand. Certain sales representatives are located in various parts of the United States, Latin America, Europe and Asia. None of the U.S. employees are represented by a union or are subject to collective bargaining agreements. Substantially all full-time United States employees are eligible to participate in the Company's employee profit sharing plan and various other benefit programs. INTELLECTUAL PROPERTY The Company presently owns 58 United States patents and numerous corresponding foreign patents. It has 28 pending U.S. patent applications and corresponding foreign patent applications. The Company's products covered by patents or pending patent applications include food, beverage and ice beverage dispensing equipment and components. The patents have a remaining life of 2 to 19 years. Management does not believe the expiration of such patents will have a significant adverse impact on continuing operations. The Company seeks to improve its products and to obtain patents on these improvements. As a result, the Company believes its patent portfolio will expand, thereby lessening its reliance on any one particular patent. The Company also believes its competitive position is enhanced by its existing patents and that any future patents will continue to enhance this position. There can be no assurance, however, that the Company's existing or future patents will continue to provide a competitive advantage, nor can there be any assurance that the Company's competitors will not produce non-infringing competing products. In addition to Company-owned patents, Lancer has assigned patents to the Company's customers, primarily The Coca-Cola Company. These patents are the result of special development projects between Lancer and its customers. These projects are typically paid for by the customer, with Lancer either retaining licenses to manufacture the products covered by these patents for the customer, or granting such licenses to the customer. The Company occasionally acquires patent protection for products that are complimentary to products whose patents are controlled by third parties. The name "Lancer" is the federally registered trademark of the Company. It is also registered in many foreign countries. In certain instances, the Company grants a non-exclusive license to its distributors, primarily foreign, to use the trademark subject to control by the Company. ENVIRONMENTAL MATTERS The Company's operations are subject to increasingly stringent federal, state, local, and foreign laws and regulations relating to the protection of the environment. In the United States, these environmental laws and regulations, which are implemented by the Environmental Protection Agency and comparable state agencies, govern the management of hazardous waste, the discharge of pollutants into the air and into surface and ground water, and the manufacture and disposal of certain substances. 5 7 There are no material environmental claims pending or, to the Company's knowledge, threatened against the Company. The Company also believes that its operations are in material compliance with current U.S., state, and foreign laws and regulations. The Company estimates that any expenses incurred in maintaining compliance with current laws and regulations will not have a material effect on the Company's earnings or capital expenditures. The Company can provide no assurance, however, that the current regulatory requirements will not change, or that currently unforeseen environmental incidents will not occur, or that past non-compliance with environmental laws will not be discovered on the Company's properties. ITEM 2. PROPERTIES The Company's primary manufacturing and administrative facilities are located in several buildings in San Antonio, Texas, totaling approximately 583,000 square feet, including three buildings owned by Lancer covering approximately 409,000 square feet of space, the largest of which is located on a 40-acre tract of land in the southeast sector of San Antonio. The Company owns and operates facilities located in Piedras Negras, Mexico consisting of 195,000 square feet of completed space. The Company also leases a 75,000 square foot plant in Sao Paulo, Brazil, a 41,000 square foot plant in Auckland, New Zealand, a 43,000 square foot plant in Beverley, South Australia, a suburb of Adelaide, and small facilities in Sydney, Australia; Brussels, Belgium; Quito, Ecuador; Moscow, Russia; and Monterrey, Mexico. The Company leases approximately 404,000 square feet of space throughout the world. Total net rent expense for real estate was $1.5 million, $1.5 million and $1.4 million in 2000, 1999 and 1998, respectively. Included in total rent expense in 2000 is $89,000 for certain properties that are leased from a partnership controlled by certain shareholders. See Note 7 of Notes to Consolidated Financial Statements and "Certain Relationships and Related Transactions" for more information. ITEM 3. LEGAL PROCEEDINGS There are no claims or legal actions pending against the Company other than claims arising in the ordinary course of business. The Company believes these claims, taking into account reserves and applicable insurance, will not have a material adverse effect on the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to the security holders for a vote by proxy or otherwise during the fourth quarter of the year ended December 31, 2000. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock is currently traded on the American Stock Exchange ("ASE") under the symbol "LAN." The following table sets forth the range of high and low market price as reported by the ASE for the periods indicated. Market Price For Common Stock 2000 1999 Quarter High Low High Low --------- --------- --------- --------- First $ 5.63 $ 4.13 $ 12.94 $ 8.50 Second 4.75 3.50 9.00 6.88 Third 4.88 3.56 10.13 5.63 Fourth 6.50 4.25 6.00 4.00 6 8 On March 9, 2001, the closing price of the Company's common stock, as reported by the ASE, was $5.00 per share. On that date, there were 253 holders of record of the Company's common stock, not including shares held by brokers and nominees. The Company has not declared a cash dividend on the common stock to date. It is a general policy of the Company to retain earnings to support future growth. ITEM 6. SELECTED FINANCIAL DATA (In thousands, except per share amounts) Years Ended December 31, ------------------------------------------------------------------------------ 2000 1999 1998 1997 1996 ----------- ----------- ----------- ----------- ----------- Operating Data: Net sales $ 113,530 $ 129,840 $ 138,423 $ 119,367 $ 103,295 Gross profit 25,867 21,686 33,407 31,350 25,088 Selling, general and administrative expenses 22,084 22,153 19,911 20,439 14,512 Write-down of Brazilian assets -- 5,956 -- -- -- Operating income (loss) 3,783 (6,423) 13,496 10,911 10,576 Interest expense 3,297 3,464 3,899 2,815 1,588 Interest and other income, net (427) (2,819) (324) (1,027) (160) Earnings (loss) before income taxes 913 (7,068) 9,921 9,123 9,148 Income tax expense (benefit) 355 (2,501) 4,078 3,037 3,415 Net earnings (loss) 558 (4,567) 5,843 6,086 5,733 Net earnings (loss) per share Basic $ 0.06 $ (0.50) $ 0.64 $ 0.69 $ 0.66 Diluted $ 0.06 $ (0.50) $ 0.63 $ 0.65 $ 0.63 Weighted average shares outstanding Basic 9,125 9,124 9,060 8,863 8,722 Diluted 9,290 9,124 9,306 9,338 9,052 As of December 31, ------------------------------------------------------------ 2000 1999 1998 1997 1996 -------- -------- -------- -------- -------- Balance Sheet Data: Total assets $102,392 $103,054 $112,840 $110,669 $ 82,009 Short-term debt 24,129 22,683 27,094 23,444 13,553 Long-term debt, less current installments 12,724 13,922 17,568 21,565 15,459 Shareholders' equity 43,533 44,476 48,258 42,961 37,036 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This document contains certain "forward-looking" statements as such term is defined in the Private Securities Litigation Reform Act of 1995 and information relating to the Company and its subsidiaries that are based on the beliefs of the Company's management. When used in this report, the words "anticipate," "believe," "estimate," "expect," "forecast," "plan," and "intend" and words or phrases of similar import, as they relate to the Company or its subsidiaries or Company management, are intended to identify forward-looking statements. Such statements reflect the current risks, uncertainties and assumptions which exist or must be made as a result of certain factors including, without limitation, competitive factors, general economic conditions, customer relations, relationships with vendors, the interest rate environment, governmental regulation and supervision, seasonality, distribution networks, product introductions and acceptance, one-time events and other factors described herein and in other filings made by the Company with the Securities and Exchange Commission. Based upon changing conditions, should any one or more of these risks or uncertainties materialize, or should any underlying assumptions prove incorrect, actual results may vary materially from those described herein as anticipated, believed, estimated, expected, forecast, planned or intended. The Company does not intend to update these forward-looking statements. 7 9 The following discussion should be read in connection with the Company's Consolidated Financial Statements, related notes and other financial information included elsewhere in this filing. RESULTS OF OPERATIONS Comparison of the Years Ended December 31, 2000 and December 31, 1999 Net sales for the year ended December 31, 2000 were $113.5 million, down $16.3 million, or 13%, from $129.8 million in 1999. Sales in the North America region declined $12.3 million, or 14%. Substantially all of the decline was caused by lower sales of frozen beverage equipment. During 1999, the Company shipped a large, non-recurring order of frozen beverage equipment to a single customer. Revenue in Latin America (excluding Brazil) fell $3.3 million, or 30%, while sales in Brazil fell $0.5 million, or 26%. Sales in Asia declined $2.8 million, or 49%. Results in Latin America and Asia continued to suffer from poor economic conditions. Sales rose $1.4 million (15%) in Europe partly because of improved sales of frozen beverage equipment. The Company's business in the Pacific region continued to benefit from activity related to the 2000 Olympic Games in Australia, rising $1.2 million, or 8%. Sales to customers outside the United States were 40% of net sales in 2000, and 35% of net sales in 1999. Gross margin for the year ended December 31, 2000 was 22.8%, compared to 16.7% in 1999. In the 1999 period, gross margin was negatively impacted by factors including reduced production levels that led to insufficient overhead absorption, an $0.8 million reserve for certain types of equipment whose marketability had become impaired, and changes in the sales mix toward lower margin products, particularly frozen beverage equipment. The lower gross margin on frozen beverage equipment stems from the fact that the Company buys the dispensers from a joint venture of which the Company owns 50%. The Company resells the dispensers and earns a distribution profit, which is reflected in gross margin. The Company's 50% share of the manufacturing profit, after elimination of profit in ending inventory, is included in other income. Selling, general and administrative expenses were $22.1 million in 2000, down from $22.2 million in 1999. Increases in research and development spending and employment costs in 2000 were offset by reductions in a number of discretionary spending categories. In 1999, the Company expensed $6.0 million relating to the impairment of substantially all of the Company's investment in its Brazilian subsidiary. The Company substantially reduced its Brazilian operations in an effort to limit continued losses caused by the depressed business environment in much of Latin America. Interest expense was $3.3 million in 2000, down from $3.5 million in the prior year, reflecting lower average borrowings. The Company reported a loss of $0.1 million from its frozen beverage joint venture in 2000, compared to income of $1.7 million in 1999. The decline in joint venture income was caused by the joint venture producing fewer dispensers in 2000 than in 1999. The Company recorded a gain of $0.9 million in 1999 on the sale of its investment in Victory Refrigeration, a manufacturer of refrigerated coolers. The minority interest benefit of $0.2 million in 2000 and $0.1 million in 1999 stems from the Company's majority ownership position in Lancer Ice Link, LLC, and represents the minority partner's share of the subsidiary's losses. Lancer Ice Link's financial statements are consolidated with those of the Company. The provision for income taxes was $0.4 million in 2000. The Company recorded a tax benefit of $2.5 million in 1999 because of the pretax loss of $7.1 million. The effective rate rose in 2000 because nondeductible expenses were a larger percentage of pretax income in 2000 than in 1999. Additionally, a larger proportion of income was earned in high tax jurisdictions in 2000. Net income in 2000 was $0.6 million, compared to a net loss of $4.6 million in 1999. Comparison of the Years Ended December 31, 1999 and December 31, 1998 Net sales for the year ended December 31, 1999 decreased by $8.6 million, or 6%, to $129.8 million from $138.4 million in 1998. Sales in the Latin America region fell $10.4 million, or 48%, because of currency devaluations and weak economic conditions throughout the region. Brazilian sales declined $4.1 million, or 66%, due largely to weak local economic conditions and the effects of a devaluation of the Brazilian currency in early 1999. Asian sales were also weak in 1999. Sales in the United States rose $13.5 million, or 18.7%. Much of the growth in the domestic market came from strong sales of frozen beverage dispensing equipment, which benefited from a large order from a single customer. 8 10 Sales to customers outside the United States were 35% of net sales in 1999, and 48% of net sales in 1998. Gross margin for the year ended December 31, 1999 was 16.7%, down from 24.1 % in 1998. Reduced production levels at plants in the United States and Mexico negatively affected overhead absorption rates during the year. Gross margin was further reduced by changes in the sales mix, particularly by higher sales of frozen beverage dispensers. Additionally, the Company made a provision of approximately $0.8 million in 1999 for certain types of equipment whose marketability has been impaired. Selling, general and administrative expenses were $22.2 million in 1999, compared to $19.9 million in 1998. Product development costs rose, along with costs associated with the newly acquired Allbar operation and the new Lancer Ice Link subsidiary. The Company acquired Allbar in the second quarter of 1999, and formed Lancer Ice Link in the third quarter of 1999. In 1999, the Company expensed $6.0 million relating to the impairment of substantially all of the Company's investment in its Brazilian subsidiary. The Company has substantially reduced its Brazilian operations in an effort to limit continued losses caused by the depressed business environment in much of Latin America. Interest expense was $3.5 million in 1999, down from $3.9 million in the prior year, reflecting lower average borrowings. The Company reported income from its frozen beverage joint venture of $1.7 million in 1999, versus $0.2 million in 1998. Also during 1999, the Company recorded a gain of $0.9 million on the sale of its investment in Victory Refrigeration, a manufacturer of refrigerated coolers. The minority interest benefit of $0.1 million stems from the Company's majority ownership position in Lancer Ice Link, LLC, and represents the minority partner's share of the subsidiary's losses. Lancer Ice Link's financial statements are consolidated with those of the Company. The Company recorded a tax benefit of $2.5 million in 1999 because of the pretax loss of $7.1 million. The provision for income taxes was $4.1 million in 1998. The effective tax rate fell in 1999 from the rate in 1998 because of nondeductible losses incurred by foreign operations in 1998, which were partially deducted in 1999. The net loss for 1999 was $4.6 million, compared to net income of $5.8 million in the prior year. LIQUIDITY AND CAPITAL RESOURCES The Company's principal sources of liquidity are cash flows from operations and amounts available under the Company's existing lines of credit. The Company has met, and currently expects that it will continue to meet, substantially all of its working capital and capital expenditure requirements as well as its debt service requirements with funds provided by operations and borrowings under its credit facilities. Lancer generated $4.5 million of net cash from operating activities in 2000, compared to $13.1 million in 1999. Changes in inventory levels consumed $4.6 million of cash in 2000, and generated $9.4 million in 1999. Capital spending was $5.2 million during 2000. The Company's investment in production tooling and equipment accounted for most of the spending. Capital spending was financed with cash from operations, increased borrowings, and with cash on hand. During 2000, the Company amended its credit facilities with its primary lenders. The primary changes were the following: the expiration of the facilities was extended until July 15, 2002, certain financial covenants were adjusted, scheduled quarterly principal payments were reduced to $0.35 million, the facilities were collateralized by substantially all of the Company's assets in the United States, and the revolving credit facility was reduced to $30.0 million. The Company's bank facilities require that the Company maintain certain financial ratios and other covenants. The Company is in compliance with, or has obtained waivers of, the financial ratios and covenants contained in the credit agreement. INFLATION Management believes inflation has not had a significant impact on its business or operations. 9 11 SEASONALITY The Company's net sales in the fourth quarter of its fiscal years have frequently been lower than in other quarters because of seasonality in the capital spending budgets of many of the Company's customers. ACCOUNTING MATTERS The Company established a DISC in 1979 in order to defer federal income taxes on its foreign sales. In late 1984, the Internal Revenue Code (the "Code") was amended to limit the benefits of a DISC, primarily by imposing an interest charge on the accumulated deferred federal income taxes of a DISC. At the same time, the Code was amended to permit the creation of a Foreign Sales Corporation ("FSC"). Under the Code, as amended, a portion of a FSC's income is subject to federal income taxes, while a portion is permanently exempt from federal income taxes. As a result, at some point, the interest charge the Company incurs on the deferred federal income taxes of its DISC will equal or exceed the taxes it would have incurred had it operated a FSC. Current tax regulations prevent the Company from maintaining the DISC and a FSC concurrently. The Company does not plan to convert from the DISC to a FSC in 2001. At the time of such a conversion, the Company would be required to provide for federal income taxes on the $2.4 million of undistributed earnings of the DISC, for which federal income taxes have not previously been provided. The Company would be able to pay such federal income taxes over a ten-year period. If the DISC had been converted on December 31, 2000, it would have resulted in a reduction of approximately $0.8 million in the Company's net earnings. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities." The Statement provides guidance on accounting and financial reporting for derivative instruments and hedging activities. The Statement requires the recognition of all derivatives as either assets or liabilities in the consolidated balance sheet, and the periodic measurement of those instruments at fair value. The Company will adopt SFAS No. 133 effective January 1, 2001. Under the transition provisions of SFAS No. 133, on January 1, 2001 the Company will record an after-tax, cumulative-effect-type expense to net income of approximately $34,000 related to certain derivative instruments consisting principally of interest rate swap agreements. The Company has determined that hedge accounting will not be elected for derivatives existing at January 1, 2001. Future changes in the fair value of those derivatives will be recorded in income. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK On December 31, 2000, substantially all of the Company's $36.9 million of debt outstanding was variable rate debt. The Company uses interest rate swap agreements (the "Swap Agreements") to hedge a portion of the interest rate risk associated with the Company's variable rate debt. The Company has entered into Swap Agreements with a combined notional amount of $15.0 million. Under the Swap Agreements, the Company pays fixed interest rates ranging from 5.98% to 6.345%, while receiving a floating rate payment equal to the three month LIBOR rate determined on a quarterly basis with settlement occurring on specific dates. Based on exposures on December 31, 2000, if interest rates were to change by one percentage point, the Company's annual pretax income would be impacted by approximately $0.2 million. The Company does not trade in interest rate swaps with the objective of earning financial gain on interest rate fluctuations. The Company had no additional derivative financial instruments at December 31, 2000. In 2000, $2.2 million of the Company's operating income was incurred by foreign subsidiaries with a functional currency other than the United States dollar. If the average annual exchange rate of the functional currencies of those subsidiaries were to fluctuate by 10% against the United States dollar, the operating profit of those subsidiaries could be impacted by as much as $0.2 million, when translated to United States dollars. This analysis does not consider the effect of changes in costs, demand, asset values, or other unpredictable factors that could result from currency fluctuations. 10 12 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See "Index to Consolidated Financial Statements and Schedule" included herein for information required for Item 8. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information set forth under the caption "Election of Directors" in the Company's proxy statement for its May 15, 2001 Annual Meeting of Shareholders, which is to be filed with the Commission, describes all persons to be nominated to become directors of the Company as required in response to this item and is incorporated herein by reference. The information set forth under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in the Company's proxy statement which is to be filed with the Commission is incorporated herein by reference. The following table sets forth certain information concerning the executive officers and directors of the Company: NAME AGE POSITION WITH THE COMPANY ---- --- ------------------------- Alfred A. Schroeder 64 Chairman of the Board George F. Schroeder 61 President, Chief Executive Officer and Director Christopher D. Hughes 54 Chief Operating Officer Mark L. Freitas 40 Corporate Controller Walter J. Biegler 59 Director Jean M. Braley 71 Director Charles K. Clymer 64 Director Olivia F. Kirtley 50 Director Michael E. Smith 59 Director E.T. (Toby) Summers, III 53 Director Mr. Alfred A. Schroeder is a co-founder of the Company and has served as Chairman of the Board of Directors of the Company since its inception in 1967. His primary responsibilities include conceptual engineering design, new product development and corporate planning. He is the brother of George F. Schroeder, and is also a partner in Lancer Properties. See "Certain Relationships and Related Transactions." Mr. George F. Schroeder is a co-founder of the Company and has served as Chief Executive Officer, President and a director of the Company since 1967. His primary responsibilities include strategic planning, marketing, overall production management and corporate administration. He is the brother of Alfred A. Schroeder, and is also a partner in Lancer Properties. See "Certain Relationships and Related Transactions." Mr. Christopher D. Hughes, Chief Operating Officer, joined the Company in 2000. Prior to joining Lancer, Mr. Hughes worked for 17 years with Enodis Corporation and its predecessor entity, Scotsman Industries. He served in a variety of senior management positions with Enodis, including Vice President-Operations of Kysor Warren, President of Booth/Crystal Tips, President of Halsey Taylor, and Vice President-Operations of Scotsman Ice Systems. Prior to his association with Enodis, Mr. Hughes served as Vice-President-General Manager of Morrison-Knudsen's Central and Western Transit Operations, and as Vice President-Operations of Mooney Aircraft Corporation in Kerrville, Texas. Mr. Mark L. Freitas joined the Company in 1998 and serves as Corporate Controller. Before joining Lancer, Mr. Freitas worked for three years with Bausch & Lomb, Inc., as a Senior Corporate Auditor and Cost Manager, and ten years in public accounting with various firms. 11 13 Mr. Walter J. Biegler has served as a director of the Company since 1985. Mr. Biegler is a private investor. From 1991 until 1998, he was Chief Financial Officer of Periodical Management Group, Inc., a San Antonio, Texas distributor of periodicals, books and specialty items in the United States, Mexico and the Virgin Islands. Prior to November 1991, he served as the Chief Financial Officer and Senior Vice President-Finance of La Quinta Motor Inns, Inc. of San Antonio, Texas, a national hotel chain. Ms. Jean M. Braley has served as a director of the Company since 1976. She served as Secretary of the Company from 1982 to 1985. Ms. Braley has been a private investor since 1985. She is also a partner in Lancer Properties. See "Certain Relationships and Related Transactions." Mr. Charles K. Clymer has served as a director of the Company since 1996. Mr. Clymer retired from The Coca-Cola Company in 1993 after 31 years of service. He held managerial positions with Coca-Cola International including Manager of Chile, Director and Senior Vice President of Coca-Cola (Japan) Company Limited, and Vice President of On Premise Market Development and Customer Service for the Latin America Group. Ms. Olivia F. Kirtley has served as a director of the Company since 1999. She currently is Chair of the Board of the American Institute of Certified Public Accountants (AICPA) Board of Examiners, which oversees the uniform CPA Examination for the United States. The AICPA is the national professional organization for over 350,000 CPAs in business and industry, public practice, government and education. From 1998-1999, Ms. Kirtley served as Chair of the AICPA. Until 2000, Ms. Kirtley was Vice President of Vermont American Corporation, a leading global manufacturer and marketer of power tool accessories, headquartered in Louisville, Kentucky. Ms. Kirtley was with Vermont American over 20 years and held the positions of Chief Financial Officer, Treasurer and Director of Tax. Ms. Kirtley has served on the Board of Directors of Res Care, Inc. since 1998. Mr. Michael E. Smith has served as a director of the Company since 1985. Mr. Smith is presently a principal shareholder and Executive Vice President of Gosling & Sachse, an insurance brokerage firm. He has been employed by the same firm since 1968. Mr. Smith has been the Company's insurance broker since 1981. Mr. E.T. (Toby) Summers, III has served as a director of the Company since 1999. Mr. Summers is a private investor and principal in The Harvest Group, Inc., a private equity investment firm. Mr. Summers served in a variety of leadership positions with Coca-Cola Bottling Company of the Southwest from 1973 through 1998. Most recently he held the position of President and Chief Operating Officer from 1988 through 1998 until the company's merger with Coca-Cola Enterprises. Mr. Summers also served as Chairman of the Board of Directors of Western Container Corporation, a manufacturer of plastic bottles for the beverage industry, and as a member of the Board of Governors of the National Coca-Cola Bottlers' Association from 1989-1998. All directors of the Company are elected annually. The executive officers are elected annually by, and serve at the discretion of, the Company's Board of Directors. During 2000, the Board of Directors of the Company maintained an Audit Committee, a Compensation Committee and a Stock Option Committee. The members of the Audit Committee were Walter J. Biegler, Olivia F. Kirtley and E.T. Summers, III. The Audit Committee met four times in 2000. The members of the Compensation Committee were Jean M. Braley, Charles K. Clymer and Michael E. Smith. No member of the Compensation Committee was an executive officer of the Company. The Compensation Committee met three times in 2000. The members of the Stock Option Committee were Jean M. Braley, Charles K. Clymer and Michael E. Smith. The Stock Option Committee met five times in 2000. ITEM 11. EXECUTIVE COMPENSATION The information set forth under the caption "Compensation and Certain Transactions" in the Company's proxy statement for its May 15, 2001 Annual Meeting of Shareholders, which is to be filed with the Commission, sets forth information regarding executive compensation and certain transactions as required in response to this item and is incorporated herein by reference. 12 14 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information set forth under the captions "Principal Shareholders" and "Election of Directors" in the Company's proxy statement for its May 15, 2001 Annual Meeting of Shareholders, which is to be filed with the Commission, describes the security ownership of certain beneficial owners and management as required in response to this item and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information set forth under the caption "Certain Relationships and Related Transactions" in the Company's proxy statement for its May 15, 2001 Annual Meeting of Shareholders, which is to be filed with the Commission, sets forth information regarding certain relationships and related transactions as required in response to this item and is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) 1. The following documents are filed as part of this Annual Report on Form 10-K: (1) Financial statements: The financial statements filed as a part of this report are listed in the "Index to Consolidated Financial Statements and Schedule" referenced in Item 8. (2) Financial statement schedule: The financial statement schedule filed as a part of this report is listed in the "Index to Consolidated Financial Statements and Schedule" referenced in Item 8. (3) Exhibits: 3.1* Registrants Articles of Incorporation and amendments thereto 3.2* Bylaws of the Registrant 4.1* Specimen Common Stock Certificate, $0.01 par value, of Registrant 10.1* Lancer Corporation Profit Sharing Plan 10.2* 1992 Non-Statutory Stock Option Plan 10.3* 1987 Incentive Stock Option Plan 10.4* Master Development Agreement, dated January 12, 1984, between Lancer Corporation and The Coca-Cola Company 10.5* Net Lease Agreement, dated July 1, 1974, between Lancer Corporation and Lancer Properties dated as of June 3, 1977 10.13* Development and Manufacturing Agreement, dated April 13, 1993, between Lancer Corporation and Packaged Ice, Inc. 10.14* Manufacturer's Representation Agreement, dated June 1993, between Lancer Corporation and Middleby Marshall Inc., doing business as Victory - A Middleby Company 10.15* Form of Notice of Grant of Stock Option under the 1987 Incentive Stock Option Plan 10.16* Form of Nonstatutory Stock Option Agreement under the 1992 Non-Statutory Stock Option Plan 10.27++ Credit Agreement, dated July 15,1996, between Lancer Corporation and The Frost National Bank and The Boatmen's National Bank of St. Louis 10.28++ Term A Note, dated July 15,1996, between Lancer Corporation and The Frost National Bank and The Boatmen's National Bank of St. Louis 10.29++ Term B Note, dated July 15,1996, between Lancer Corporation and The Frost National Bank and The Boatmen's National Bank of St. Louis 10.30++ Revolving Note, dated July 15,1996, between Lancer Corporation and The Frost National Bank and The Boatmen's National Bank of St. Louis 13 15 10.31++ Acquisition Note, dated July 15,1996, between Lancer Corporation and The Frost National Bank and The Boatmen's National Bank of St. Louis 10.32++ Stock Pledge, dated July 15,1996, between Lancer Corporation and The Frost National Bank 10.33++ Parent and Affiliate Guaranties, dated July 15,1996, between Lancer Corporation or its subsidiaries and The Frost National Bank 10.34# Lancer Corporation Stock Incentive Plan, Effective Date March 1, 1996 10.35+++ Master Lease Agreement dated September 4, 1996 between Lancer Partnership, Ltd. and CCA Financial, Inc. 10.36## First Amendment to Credit Agreement dated May 12, 1997 between Lancer Partnership, Ltd. and The Frost National Bank and NationsBank, N.A. 10.37## Second Amendment to Credit Agreement dated December 31, 1997 between Lancer Partnership, Ltd. and The Frost National Bank and NationsBank, N.A. 10.38### Third Amendment to Credit Agreement dated July 15, 1998 between Lancer Corporation and The Frost National Bank and NationsBank, N.A. 10.39** Fourth Amendment to Credit Agreement dated March 15, 1999 between Lancer Corporation and The Frost National Bank and NationsBank, N.A. 10.40*** Seventh Amendment and Restated Credit Agreement dated October 26, 2000 between Lancer Corporation and The Frost National Bank, Harris Trust and Savings Bank, and Whitney National Bank. 10.41*** Security Agreement between Lancer Corporation and The Frost National Bank, Harris Trust and Savings Bank, and Whitney National Bank. 21.1 List of Significant Subsidiaries of the Registrant 23.1 Consent of KPMG LLP 23.2 Consent of Arthur Andersen LLP * These exhibits are incorporated by reference to the same Exhibit to the Registrant's Registration Statement No. 33-82434 filed on Form S-1 with the Securities and Exchange Commission (the "Commission") on August 5, 1994, as amended by Amendment No. 1 to Form S-1 Registration Statement with the Commission on August 23, 1994. ++ These exhibits are incorporated by reference to the Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 1995. +++ This exhibit is incorporated by reference to the Exhibit to the Registrant's Form 10-K for the year ended December 31, 1996. # This exhibit is incorporated by reference to the Exhibit to the Registrant's Proxy dated April 22, 1996. ## These exhibits are incorporated by reference to the Exhibit to the Registrant's Form 10-K for the year ended December 31, 1997. ### This exhibit is incorporated by reference to the Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 1998. ** This exhibit is incorporated by reference to the Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 1999. *** This exhibit is incorporated by reference to the Exhibit to the Registrant's Form 10-Q for the quarter ended September 30, 2000. (b) Reports on Form 8-K: None 14 16 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. LANCER CORPORATION by: /s/ GEORGE F. SCHROEDER George F. Schroeder March 23, 2001 President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date -------------------------------- ---------------------------------- --------------------- /s/ ALFRED A. SCHROEDER Chairman of the Board March 23, 2001 -------------------------------- ---------------------------------- --------------------- Alfred A. Schroeder Date /s/ GEORGE F. SCHROEDER President and Director March 23, 2001 -------------------------------- ---------------------------------- --------------------- George F. Schroeder (principal executive officer) Date /s/ WALTER J. BIEGLER Director March 23, 2001 -------------------------------- ---------------------------------- --------------------- Walter J. Biegler Date /s/ JEAN M. BRALEY Director March 23, 2001 -------------------------------- ---------------------------------- --------------------- Jean M. Braley Date /s/ CHARLES K. CLYMER Director March 23, 2001 -------------------------------- ---------------------------------- --------------------- Charles K. Clymer Date /s/ OLIVIA F. KIRTLEY Director March 23, 2001 -------------------------------- ---------------------------------- --------------------- Olivia F. Kirtley Date /s/ MICHAEL E. SMITH Director March 23, 2001 -------------------------------- ---------------------------------- --------------------- Michael E. Smith Date /s/ E. T. SUMMERS, III Director March 23, 2001 -------------------------------- ---------------------------------- --------------------- E. T. Summers, III Date 15 17 LANCER CORPORATION AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE LANCER CORPORATION AND SUBSIDIARIES Independent Auditors' Report F-2 Consolidated Balance Sheets as of December 31, 2000 and 1999 F-3 Consolidated Statements of Operations for each of the years in the three-year period ended December 31, 2000 F-5 Consolidated Statements of Shareholders' Equity and Comprehensive Income (Loss) for each of the years in the three-year period ended December 31, 2000 F-6 Consolidated Statements of Cash Flows for each of the years in the three-year period ended December 31, 2000 F-7 Notes to Consolidated Financial Statements F-8 Schedule for the years ended December 31, 2000, 1999 and 1998 II-Reserve account F-22 LANCER FBD PARTNERSHIP, LTD. Report of Independent Public Accountants F-23 Balance Sheets as of December 31, 2000 and 1999 F-24 Statements of Income for the years ended December 31, 2000 and 1999 F-26 Statements of Partners' Capital for the years ended December 31, 2000 and 1999 F-27 Statements of Cash Flows for the years ended December 31, 2000 and 1999 F-28 Notes to Financial Statements F-29 All other schedules for which provision is made in the applicable rules and regulations of the Securities and Exchange Commission have been omitted as the schedules are not required under the related instructions, are not applicable, or the information required thereby is set forth in the consolidated financial statements or notes thereto. F-1 18 INDEPENDENT AUDITORS' REPORT The Board of Directors and Shareholders Lancer Corporation: We have audited the accompanying consolidated balance sheets of Lancer Corporation and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of operations, shareholders' equity and comprehensive income (loss), and cash flows for each of the years in the three year period ended December 31, 2000. These consolidated financial statements and consolidated financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and consolidated financial statement schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Lancer Corporation and subsidiaries as of December 31, 2000 and 1999 and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the related consolidated financial statement 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. KPMG LLP San Antonio, Texas February 28, 2001 F-2 19 LANCER CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 2000 and 1999 (Amounts in thousands, except share data) ASSETS 2000 1999 ------------ ------------ Current assets: Cash $ 771 $ 1,227 Receivables: Trade accounts and notes 16,222 17,483 Other 643 537 ------------ ------------ 16,865 18,020 Less allowance for doubtful accounts (379) (414) ------------ ------------ Net receivables 16,486 17,606 ------------ ------------ Inventories 40,224 36,166 Prepaid expenses 642 465 Income taxes receivable -- 3,505 Deferred tax asset 273 134 ------------ ------------ Total current assets 58,396 59,103 ------------ ------------ Property, plant and equipment, at cost: Land 1,260 1,260 Buildings 21,981 21,880 Machinery and equipment 21,838 20,531 Tools and dies 11,273 9,025 Leaseholds, office equipment and vehicles 10,143 8,941 Assets in progress 1,581 1,821 ------------ ------------ 68,076 63,458 Less accumulated depreciation and amortization (31,384) (27,795) ------------ ------------ Net property, plant and equipment 36,692 35,663 ------------ ------------ Long-term receivables ($529 and $746 due from officers, respectively) 761 1,029 Long-term investments 2,599 3,053 Intangibles and other assets, at cost, less accumulated amortization 3,944 4,206 ------------ ------------ $ 102,392 $ 103,054 ============ ============ See accompanying notes to consolidated financial statements. F-3 20 LANCER CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Continued) December 31, 2000 and 1999 (Amounts in thousands, except share data) LIABILITIES AND SHAREHOLDERS' EQUITY 2000 1999 ------------ ------------ Current liabilities: Accounts payable $ 8,962 $ 9,119 Current installments of long-term debt 3,129 5,083 Line of credit with bank 21,000 17,600 Deferred licensing and maintenance fees 774 619 Accrued expenses and other liabilities 5,071 4,091 Taxes payable 584 -- ------------ ------------ Total current liabilities 39,520 36,512 Deferred tax liability 2,448 3,102 Long-term debt, excluding current installments 12,724 13,922 Deferred licensing and maintenance fees 3,873 4,500 ------------ ------------ Total liabilities 58,565 58,036 ------------ ------------ Commitments and contingencies -- -- Minority interest 294 542 Shareholders' equity: Preferred stock, without par value: 5,000,000 shares authorized; none issued -- -- Common stock, $.01 par value: 50,000,000 shares authorized; 9,124,857 issued and outstanding in 2000 and 1999 91 91 Additional paid-in capital 11,933 11,933 Accumulated other comprehensive loss (3,317) (1,816) Retained earnings 34,826 34,268 ------------ ------------ Total shareholders' equity 43,533 44,476 ------------ ------------ $ 102,392 $ 103,054 ============ ============ See accompanying notes to consolidated financial statements. F-4 21 LANCER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS Years ended December 31, 2000, 1999 and 1998 (Amounts in thousands, except share data) 2000 1999 1998 ----------- ----------- ----------- Net sales $ 113,530 $ 129,840 $ 138,423 Cost of sales 87,663 108,154 105,016 ----------- ----------- ----------- Gross profit 25,867 21,686 33,407 Selling, general and administrative expenses 22,084 22,153 19,911 Write-down of Brazilian assets -- 5,956 -- ----------- ----------- ----------- Operating income (loss) 3,783 (6,423) 13,496 ----------- ----------- ----------- Other (income) expense: Interest expense 3,297 3,464 3,899 Loss (income) from joint venture 82 (1,677) (154) Gain on sale of investment -- (895) -- Minority interest (248) (124) -- Interest and other income, net (261) (123) (170) ----------- ----------- ----------- 2,870 645 3,575 ----------- ----------- ----------- Earnings (loss) before income taxes 913 (7,068) 9,921 ----------- ----------- ----------- Income tax expense (benefit): Current 1,059 (2,675) 2,772 Deferred (704) 174 1,306 ----------- ----------- ----------- 355 (2,501) 4,078 ----------- ----------- ----------- Net earnings (loss) $ 558 $ (4,567) $ 5,843 =========== =========== =========== Common Shares and Equivalents Outstanding: Basic 9,124,857 9,123,527 9,059,539 Diluted 9,290,003 9,123,527 9,305,796 Earnings (Loss) Per Share: Basic $ 0.06 $ (0.50) $ 0.64 Diluted $ 0.06 $ (0.50) $ 0.63 See accompanying notes to consolidated financial statements. F-5 22 LANCER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (LOSS) Years ended December 31, 2000, 1999 and 1998 (Amounts in thousands, except share data) Accumulated Additional and Other Total Common Paid-in Comprehensive Retained Shareholders' Stock Capital Income (Loss) Earnings Equity ------------ ------------ ------------- ------------ ------------ Balance December 31, 1997 $ 89 $ 11,607 $ (1,728) $ 32,992 $ 42,960 Comprehensive income: Net earnings -- -- -- 5,843 5,843 Cumulative translation adjustment -- -- (853) -- (853) ------------ Total comprehensive income: -- -- -- -- 4,990 ------------ Acquisition and retirement of 40,608 share of common stock -- (591) -- -- (591) Exercise of 259,906 stock options 2 897 -- -- 899 ------------ ------------ ------------ ------------ ------------ Balance December 31, 1998 91 11,913 (2,581) 38,835 48,258 Comprehensive loss: Net loss -- -- -- (4,567) (4,567) Cumulative translation adjustment -- -- 829 -- 829 Unrealized loss on investment, net of tax -- -- (64) -- (64) ------------ Total comprehensive loss: (3,802) ------------ Exercise of 3,375 stock options -- 20 -- -- 20 ------------ ------------ ------------ ------------ ------------ Balance December 31, 1999 91 11,933 (1,816) 34,268 44,476 Comprehensive loss: Net earnings -- -- -- 558 558 Cumulative translation adjustment -- -- (1,393) -- (1,393) Unrealized loss on investment, net of tax -- -- (108) -- (108) ------------ Total comprehensive loss: (943) ------------ ------------ ------------ ------------ ------------ Balance December 31, 2000 $ 91 $ 11,933 $ (3,317) $ 34,826 $ 43,533 ============ ============ ============ ============ ============ See accompanying notes to consolidated financial statements. F-6 23 LANCER CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 2000, 1999 and 1998 (Amounts in thousands) 2000 1999 1998 ------------ ------------ ------------ Cash flow from operating activities: Net earnings (loss) $ 558 $ (4,567) $ 5,843 Adjustments to reconcile net earnings to net cash (used in) provided by operating activities: Depreciation and amortization 4,205 3,990 2,888 Deferred licensing and maintenance fees (472) 2,521 494 Deferred income taxes (704) 174 1,321 Loss on sale and disposal of assets 10 22 16 Gain on sale of long-term investments -- (895) -- Minority interest (248) (124) -- Loss (earnings) from joint venture 82 (1,677) (154) Impairment of Brazilian assets -- 5,956 -- Change in assets and liabilities, net of effects from purchase of subsidiary: Receivables 635 3,041 1,401 Prepaid expenses (177) 95 (381) Income taxes receivable 3,505 (3,300) (212) Inventories (4,646) 9,431 (2,174) Other assets (365) (567) (439) Accounts payable 409 303 (3,098) Accrued expenses 1,098 (1,298) (930) Income taxes payable 584 (12) (193) ------------ ------------ ------------ Net cash provided by operating activities 4,474 13,093 4,382 ------------ ------------ ------------ Cash flow from investing activities: Proceeds from sale of assets 2 16 7 Acquisition of property, plant and equipment (5,166) (4,957) (5,216) Acquisition of subsidiary company -- (1,719) -- Proceeds (purchase) of long-term investments and affiliates 209 2,738 111 ------------ ------------ ------------ Net cash used in investing activities (4,955) (3,922) (5,098) ------------ ------------ ------------ Cash flow from financing activities: Net borrowings (repayments) under line of credit agreements 3,400 (4,700) 3,300 Proceeds from issuance of long-term debt -- 1,457 -- Retirement of long-term debt (3,075) (4,827) (3,647) Net proceeds from exercise of stock options -- 20 308 ------------ ------------ ------------ Net cash (used in) provided by financing activities 325 (8,050) (39) ------------ ------------ ------------ Effect of exchange rate changes on cash (300) (1,013) 23 Net (decrease) increase in cash (456) 108 (732) Cash at beginning of year 1,227 1,119 1,851 ------------ ------------ ------------ Cash at end of year $ 771 $ 1,227 $ 1,119 ============ ============ ============ See accompanying notes to consolidated financial statements F-7 24 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The Company designs, engineers, manufactures and markets fountain soft drink and other beverage dispensing systems and related equipment for use in the food service and beverage industry. The consolidated financial statements include the accounts of Lancer Corporation (the "Company") and its majority-owned subsidiaries, with intercompany balances and transactions eliminated in consolidation. Inventories Inventories are stated at the lower of cost or market on a first-in, first-out basis (average cost as to raw materials and supplies) or market (net realizable value). Certain items in inventory have become obsolete due to technological advances and discontinuation of products. The Company has taken these items into consideration in valuing its inventory. Property, Plant and Equipment Property, plant and equipment are stated at cost. Depreciation is calculated on a straight-line basis over estimated useful lives ranging from 5 to 39 years. Long-lived assets are evaluated annually for possible impairment adjustments which may be required. See note 2 for discussion of impairment of Brazilian assets in 1999. Maintenance, repair and purchases of small tools and dies are expensed as incurred. Intangibles and Other Assets Intangibles and other assets consist principally of patents and goodwill. Patents are amortized over the estimated useful lives of the respective assets using the straight-line method. Goodwill is being amortized using the straight-line method over twenty to thirty years. The Company continually evaluates the carrying value of goodwill as well as the amortization period to determine whether adjustments are required. See note 2 for discussion of impairment of Brazilian assets in 1999. Long-term Investments The Company owns a 50% interest in a joint venture, Lancer FBD Partnership, Ltd., which manufactures frozen beverage dispensing systems. The investment is accounted for under the equity method. The remaining 50% is owned by the developer of the technology utilized by the joint venture. The joint venture now owns the rights to that technology. (See note 3) Also included in long-term investments is an investment in the common stock of Packaged Ice, Inc., a company which sells ice bagger machines manufactured by the Company. Lancer owns less than 10% of the common stock of Packaged Ice, Inc. The investment, accounted for as an available-for-sale security, is recorded at fair value with net unrealized gains and losses reported, net of tax, in other comprehensive income. The fair value is determined by quoted market prices. Net Earnings per Share Basic earnings per share is calculated using the weighted average number of common shares outstanding and diluted earnings per share is calculated assuming the issuance of common shares for all dilutive potential common shares outstanding during the reporting period. The dilutive effect of stock options approximated 165,146, 0, and 246,257 shares in 2000, 1999 and 1998, respectively. Options to purchase approximately 293,875, 110,750 and 56,500 shares in 2000, 1999 and 1998, respectively, were outstanding but were not included in the computation because the exercise price is greater than the average market price of the common shares. F-8 25 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Revenue Recognition Revenue is recognized in accordance with the following methods: (a) At time of shipment for all products except for those sold under agreements described in (b); (b) As produced and at time of title transfer, for certain products manufactured and warehoused under production and warehousing agreements with certain customers. The Company has entered into an agreement with its major customer to receive partial reimbursement for design and development. The reimbursement is offset against cost on a percentage of completion basis. In addition, the Company has agreed to provide exclusive rights for use of certain tools to its major customer. These tools are included in fixed assets and are depreciated over the life of the asset. The corresponding license and maintenance fees are recorded as deferred income and recognized over the life of the agreement which approximates the life of the corresponding asset. Income Taxes Amounts in the financial statements related to income taxes are calculated using the principles of Statement of Financial Accounting Standards ("SFAS") No. 109, "Accounting for Income Taxes." Under SFAS No. 109, deferred taxes reflect the impact of temporary differences between the amounts of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes. These deferred taxes are measured by applying currently enacted tax rates. Provision for U.S. income taxes on the undistributed earnings of foreign subsidiaries is made only on those amounts in excess of the funds considered to be permanently reinvested. Research and Development Company-sponsored research and development costs are expensed as incurred and totaled approximately $3.8 million, $2.7 million and $2.2 million for the years ended December 31, 2000, 1999 and 1998, respectively. Foreign Currency Translation Assets and liabilities of non-U.S. subsidiaries that operate in a local currency environment are translated to U.S. dollars at year-end exchange rates. Income and expense items are translated at average rates of exchange prevailing during the year. Translation adjustments are accumulated in a separate component of shareholders' equity. Inventories, plant and equipment and other non-monetary assets and liabilities of non-U.S. subsidiaries that operate in U.S. dollars are translated at approximate exchange rates prevailing when acquired. All other assets and liabilities are translated at year-end exchange rates. Inventories charged to cost of sales and depreciation are translated at historical exchange rates. All other income and expense items are translated at average rates of exchange prevailing during the year. For those companies that operate in U.S. dollars, gains and losses that result from translation are included in earnings. Stock Compensation Plans The Company utilizes the intrinsic value method required under provisions of APB Opinion No. 25 and related interpretations in measuring stock-based compensation for employees. In addition, the required pro forma disclosures of net income and net income per share as if the fair value method of accounting for stock based compensation had been applied under SFAS No. 123 "Accounting for Stock-Based Compensation" are made in the notes to the consolidated financial statements. (See note 6) F-9 26 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Comprehensive Income The Company has adopted SFAS No. 130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards for reporting and presentation of comprehensive income and its components in a full set of financial statements. Comprehensive (loss) income consists of net earnings (loss), currency translation adjustment, and unrealized loss on investment and is presented in the consolidated statements of shareholders' equity and comprehensive income. The Statement requires additional disclosures in the consolidated financial statements but it does not affect the Company's financial position or results of operations. Segment Disclosures The Company has adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." SFAS No. 131 establishes standards for reporting information about operating segments and related disclosures about products and services, geographic areas and major customers. (See note 14) 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 contingent 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. Recent Accounting Pronouncement In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." The Statement provides guidance on accounting and financial reporting for derivative instruments and hedging activities. The Statement requires the recognition of all derivatives as either assets or liabilities in the consolidated balance sheet, and the periodic measurement of those instruments at fair value. The Company will adopt SFAS No. 133 effective January 1, 2001. Under the transition provisions of SFAS No. 133, on January 1, 2001 the Company will record an after-tax, cumulative-effect-type expense to net income of approximately $34,000 related to certain derivative instruments consisting principally of interest rate swap agreements. The Company has determined that hedge accounting will not be elected for derivatives existing at January 1, 2001. Future changes in the fair value of those derivatives will be recorded in income. 2. IMPAIRMENT OF BRAZILIAN ASSETS As a result of the continuing poor business conditions in much of Latin America, the Company has substantially reduced its manufacturing operations in Brazil. Accordingly, the Company's investment in Brazil has been written-down to net realizable value. The write-down resulted in a pre-tax charge of approximately $6.0 million during 1999. 3. INVESTMENT IN JOINT VENTURE Summarized financial data for investment in joint venture is as follows (amounts in thousands): Condensed Statement of Operations 2000 1999 1998 ------------ ------------ ------------ Net Sales $ 8,632 $ 22,991 $ 7,512 Gross profit 2,251 5,480 1,557 Net earnings 154 3,826 445 Condensed Balance Sheet Current assets $ 3,225 $ 3,529 Non-current assets 3,344 3,497 ------------ ------------ $ 6,569 $ 7,026 ============ ============ Current liabilities $ 1,008 $ 1,140 Non-current liabilities 9 16 Partners' capital 5,552 5,870 ------------ ------------ $ 6,569 $ 7,026 ============ ============ F-10 27 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Company's 50% share of net earnings, after elimination of profit in ending inventory, is included in other income. The Company purchases substantially all equipment manufactured by the joint venture as it is produced. 4. INCOME TAXES An analysis of income tax expense (benefit) follows (amounts in thousands): 2000 Current Deferred Total ---- ---------- ---------- ---------- Federal $ (297) $ (680) $ (977) State 24 -- 24 Foreign 1,332 (24) 1,308 ---------- ---------- ---------- Total $ 1,059 $ (704) $ 355 ========== ========== ========== 1999 ---- Federal $ (3,563) $ 158 $ (3,405) State 24 -- 24 Foreign 864 16 880 ---------- ---------- ---------- Total $ (2,675) $ 174 $ (2,501) ========== ========== ========== 1998 ---- Federal $ 1,844 $ 1,095 $ 2,939 State 52 -- 52 Foreign 876 211 1,087 ---------- ---------- ---------- Total $ 2,772 $ 1,306 $ 4,078 ========== ========== ========== F-11 28 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities that give rise to significant portions of the net deferred tax liability relate to the following (amounts in thousands): 2000 1999 ---------- ---------- Deferred tax assets: Accounts receivable $ 85 -- Inventory 382 -- Compensation and benefits 349 308 Net operating loss carryforward, expiring in 2020 579 -- Foreign creditable minimum taxes 323 441 Foreign deferred assets 108 101 Other 392 54 ---------- ---------- Total gross deferred tax assets 2,218 904 ---------- ---------- Deferred tax liabilities: Accounts receivable -- 85 Inventories -- 35 Property, plant and equipment 3,007 2,603 DISC income 1,386 1,149 ---------- ---------- Total deferred tax liability 4,393 3,872 ---------- ---------- Net deferred tax liability $ 2,175 $ 2,968 ========== ========== The Company elected to treat the Brazilian subsidiary as a partnership for U.S. tax purposes for the year ended December 31, 1999. This election has enabled the Company to recognize for U.S. income tax purposes a loss on its investment in the Brazilian operation. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. Based on the expectation of future taxable income and that the deductible temporary differences will offset existing taxable temporary differences, management believes it is more likely than not the Company will realize the benefits of these deductible differences at December 31, 2000. The actual tax expense (benefit) differs from the "expected" tax expense (benefit) (computed by applying U.S. Federal corporate rate of 34% to earnings before income taxes) as follows (amounts in thousands): 2000 1999 1998 ------------ ------------ ------------ Computed "expected" tax expense (benefit) $ 310 $ (2,403) $ 3,373 Increase (decrease) in taxes resulting from: Effect of foreign tax losses -- (256) 452 Effect of nondeductible expenses 99 167 106 State, net of Federal benefit 16 16 35 Effect of foreign tax rates 83 68 50 Other, net (153) (93) 62 ------------ ------------ ------------ $ 355 $ (2,501) $ 4,078 ============ ============ ============ F-12 29 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS In accordance with SFAS No. 109, no federal and state income taxes have been provided for the accumulated undistributed earnings of the DISC as of December 31, 1992. On December 31, 1992, the accumulated undistributed earnings of the DISC totaled $2.4 million. Should the DISC terminate in the future, SFAS No. 109 would require federal and state income taxes to be provided. Such a provision would result in a federal and state income tax charge to the financial statements, thereby increasing the Company's effective tax rate. Actual net income taxes (refunded) paid were approximately ($3.0) million, ($0.3) million and $3.2 million for 2000, 1999 and 1998, respectively. 5. LONG-TERM DEBT AND LINE OF CREDIT WITH BANKS (Amounts in thousands) 2000 1999 ------------ ------------ $14,824 notes payable to banks, due in quarterly installments plus interest based upon prime and LIBOR (weighted average rate of 9.46% at December 31, 2000) through July 15, 2002; secured by substantially all of the Company' assets in the United States $ 14,124 $ 15,974 Note payable to seller of Brazil subsidiary, due in annual installments plus interest based on LIBOR (weighted average interest rate of 7.37% at December 31, 2000) through December 31, 2001 1,594 2,392 Notes payable to bank, denominated in Australian dollars, due in monthly installments plus interest based on the Bank Bill Swap Reference Rate (weighted average interest rate of 7.81% at December 31, 1999) -- 639 Other 135 -- ------------ ------------ 15,853 19,005 Less current installments of long-term debt 3,129 5,083 ------------ ------------ $ 12,724 $ 13,922 ============ ============ The Company also has a $30.0 million revolving credit facility (the "Revolving Facility") from three banks. Borrowings under the Revolving Facility are based on certain percentages of accounts receivable and inventories. The Revolving Facility is collateralized by substantially all of the Company's assets in the United States. Amounts outstanding under the revolving facility were $21.0 million at December 31, 2000 and $17.6 million at December 31, 1999. There was $2.5 million available under the Revolving Facility on December 31, 2000. Interest accrues at a rate based upon either LIBOR or upon the Banks' prime rate. The weighted average interest rate was 9.66% as of December 31, 2000. The Revolving Facility expires July 15, 2002. The Company has a $0.3 million credit facility with an Australian bank. Availability under the credit facility is based on the original principal balance less scheduled monthly payments. There was $0.3 million available under the credit facility at December 31, 2000. F-13 30 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Annual maturities on long-term debt outstanding at December 31, 2000 are as follows (amounts in thousands): 2001 $ 3,129 2002 12,724 ----------- $ 15,853 =========== To manage its exposure to fluctuations in interest rates, the Company has entered into interest rate swap agreements (the "Swap Agreements") for a combined notional principal amount of $15 million. Interest rate swap agreements involve the exchange of interest obligations on fixed and floating rate debt without the exchange of the underlying principal amounts. The difference paid or received on the swap agreement is recognized as an adjustment to interest expense. The Company's Swap Agreements provide that the Company pay fixed interest rates ranging from 5.98% to 6.345%, while receiving a floating rate payment equal to the three month LIBOR rate determined on a quarterly basis with settlement occurring on specific dates. While the Company has credit risk associated with this financial instrument, no loss is anticipated due to nonperformance by the counterparties to these agreements because of the financial strength of the financial institution involved. The Credit Facilities and the Revolving Credit Facility require that the Company maintain certain financial ratios and other covenants. The Company is in compliance or has obtained waivers for all of these financial ratios and covenants as of December 31, 2000. Actual interest paid was approximately $3.2 million, $3.6 million and $4.0 million in 2000, 1999 and 1998, respectively. 6. EMPLOYEE BENEFIT PLANS Common Stock Options The Company has stock option plans under which incentive and non-qualified options may be granted. Options are granted at the market price per share at the grant date. Options generally become exercisable in 20% increments beginning on the grant date and expire five years from the grant date. A summary of transactions for all options follows: Stock Options Option Price ------------- ------------------------- Outstanding at December 31, 1997 798,638 $ 1.29 - 16.54 Granted 44,000 9.63 - 13.63 Canceled (27,869) 4.93 - 7.39 Exercised (259,906) 2.37 - 7.39 ---------- ---------- ---------- Outstanding at December 31, 1998 554,863 $ 1.29 - 16.54 Granted 82,000 7.81 - 10.06 Canceled (90,500) 7.22 - 13.83 Exercised (3,375) 4.96 - 7.22 ---------- ---------- ---------- Outstanding at December 31, 1999 542,988 $ 1.29 - 16.54 Granted 225,000 3.57 - 5.00 Canceled (22,950) 3.57 - 13.25 ---------- ---------- ---------- Outstanding at December 31, 2000 745,038 $ 1.29 - $ 16.54 ========== ========== ========== F-14 31 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS A summary of exercisable options follows: Number of Weighted Range of Exercisable Avg. of Prices Options Exercise Price ------------- ----------- -------------- 1998 $1.0 to 5.0 258,187 $ 1.33 $5.1 to 10.0 120,325 $ 7.49 $10.0 to 17.0 23,400 $ 14.23 ========== ========== 1999 $1.0 to 5.0 256,162 $ 1.30 $5.1 to 10.0 158,800 $ 7.61 $10.0 to 17.0 24,400 $ 14.94 ========== ========== 2000 $1.0 to 5.0 300,761 $ 1.66 $5.1 to 10.0 191,375 $ 7.67 $10.0 to 17.0 32,100 $ 14.97 ========== ========== The Company has adopted the disclosure-only provisions of SFAS No. 123. Accordingly, no compensation has been recognized for the stock option plans. If the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by SFAS No. 123, net earnings (loss) and net earnings (loss) per share would have been adjusted to the pro forma amounts indicated in the table below (amounts in thousands, except share data): 2000 1999 1998 ------------ ------------ ------------ Net earnings (loss)-as reported $ 558 $ (4,567) $ 5,843 Net earnings (loss)-pro forma 305 (4,893) 5,579 Net earnings (loss) per basic share-as reported 0.06 (0.50) 0.64 Net earnings (loss) per basic share-pro forma 0.03 (0.54) 0.62 Net earnings (loss) per diluted share-as reported 0.06 (0.50) 0.63 Net earnings (loss) per diluted share-pro forma 0.03 (0.54) 0.60 Weighted-average fair value of options, granted during the year 1.51 3.61 4.28 F-15 32 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The fair value of each option granted in 2000, 1999 and 1998 is estimated on the date of grant using the Black-Scholes option-pricing model with the following assumptions: 2000 1999 1998 -------- -------- -------- Expected life (years) 4 4 4 Interest rate 5.0% 6.5% 5.4% Volatility 43.4% 42.0% 40.4% Dividend yield None None None SELF-INSURED HOSPITALIZATION PLAN The Company maintains a self-insurance program for major medical and hospitalization coverage for employees and their dependents which is partially funded by payroll deductions. The Company has provided for both reported, and incurred but not reported, medical costs in the accompanying consolidated balance sheets. The Company has a maximum liability of $75,000 per employee / dependent per year. Amounts in excess of the stated maximum are covered under a separate policy provided by an insurance company. WORKERS' COMPENSATION COVERAGE The Company is self-insured for all workers' compensation claims submitted by employees for on-the-job injuries. The Company has provided for both reported, and incurred but not reported, costs of workers' compensation coverage in the accompanying consolidated balance sheets. In an effort to provide for catastrophic events, the Company carries an excess indemnity policy for workers' compensation claims. All claims paid under the policy are subject to a deductible to be paid by the Company. Based upon the Company's past experience, management believes that the Company has adequately provided for potential losses. However, multiple occurrences of serious injuries to employees could have a material adverse effect on the Company's financial position or its results of operations. EMPLOYEE PROFIT SHARING PLAN The Company has established an employee profit sharing and 401(k) plan, which covers substantially all United States employees who meet the eligibility requirements. Participants may elect to contribute up to 15% of their annual wages, subject to certain IRS limitations. The Company matches employee 401(k) contributions to the plan at a rate of 50% of the first 6% of the salary contributed to the plan through salary deferral. In addition, the Company, at the discretion of the Board of Directors, may make profit sharing contributions to the plan. The accompanying consolidated statements of income for the years ended December 31, 2000, 1999 and 1998 include Company contributions to the plan of approximately $0.5 million, $0.4 million and $0.6 million, respectively. The Company is also required to make contributions to a defined contribution plan for the employees of Lancer Pacific Pty. Ltd. Contributions during 2000, 1999 and 1998 totaled approximately $162,000, $80,000, and $47,000, respectively. 7. LEASES The Company rents a building, in which a portion of its manufacturing facilities are located, under an operating lease from a partnership controlled by certain shareholders. The month-to-month agreement provides for monthly rental payments of $7,400, and the payment of real estate taxes, insurance and maintenance expenses. F-16 33 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS At December 31, 2000, future minimum lease payments required under all noncancelable operating leases are as follows (amounts in thousands): 2001 891 2002 760 2003 304 2004 160 --------------- Total minimum lease payments $ 2,115 =============== Total rental expense was approximately $2.5 million, $2.8 million and $2.6 million in 2000, 1999 and 1998, respectively. The Company is party to agreements to provide warehousing space and services for certain of its customers. Rental income related to the warehousing agreements totaled approximately $1.2 million, $1.1 million and $0.8 million in 2000, 1999 and 1998, respectively. 8. LONG-TERM RECEIVABLES Long-term receivables are interest bearing and include approximately $0.5 million and $0.7 million due from officers as of December 31, 2000 and 1999, respectively. 9. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company is required to disclose estimated fair value of its financial instruments, including derivative financial instruments, for which it is practicable to estimate fair value. The following methods and assumptions were used to estimate the fair market value of each class of financial instrument for which it is practicable to estimate that value. Cash, Trade Receivables, and Trade Payables The carrying amounts of the Company's cash, trade receivables and trade payables approximate market value. Long-term Receivables The carrying amount of the Company's notes receivable approximates fair market value based on the actual interest rates paid on the interest bearing notes. Long-term Investments Long-term investments, excluding investment in joint venture, are stated at approximate market value based upon the current nature of the investments. Debt and Swap Agreements The carrying amount of the Company's long-term debt, short-term debt, and interest rate swap agreements approximate market value as the rates are variable or are fixed at current market rates. The fair market value of interest rate swap agreements was approximately $(0.1) million as of December 31, 2000. F-17 34 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 10. ACQUISITIONS During the second quarter of 1999, the Company acquired certain assets and liabilities of Allbar Manufacturing, an Australian company, for approximately $1.7 million. The Company funded the purchase with $1.5 million of bank borrowings denominated in Australian dollars, and with cash on hand. The acquisition has been accounted for by the purchase method, and accordingly, the results of operations of Allbar have been included in the Company's consolidated financial statements from the date of acquisition. The excess of the purchase price over the fair value of the identifiable assets acquired $0.5 million has been recorded as goodwill, and is being amortized over 20 years. The operating results of the Company would not have been significantly different had the acquisition occurred at the beginning of 1999. During the third quarter of 1999, the Company formed Lancer Ice Link, LLC. Lancer Ice Link is a joint venture formed to develop and commercialize ice transport technology. The Company's partner contributed intellectual property rights in return for a 40% ownership interest. The Company owns the remaining 60%, and has agreed to fund certain development costs incurred by the joint venture. Lancer Ice Link's financial statements are consolidated with those of the Company. 40% of the losses of Lancer Ice Link have been recorded as income from minority interest in the Company's Consolidated Statements of Operations. 11. SUPPLEMENTAL BALANCE SHEET AND INCOME STATEMENT INFORMATION Inventory components are as follows (amounts in thousands): 2000 1999 ---------- ---------- Finished goods $ 16,407 $ 14,662 Work in process 11,043 10,828 Raw material and supplies 12,774 10,676 ---------- ---------- $ 40,224 $ 36,166 ========== ========== Accrued expenses consist of the following (amounts in thousands): As of December 31, ----------------------- 2000 1999 --------- --------- Payroll and related expenses $ 1,832 $ 1,706 Commissions 556 170 Health and workers' compensation 604 481 Property taxes 319 330 Interest 434 344 Other 1,326 1,060 --------- --------- $ 5,071 $ 4,091 ========= ========= 12. CONTINGENCIES The Company is a party to various lawsuits and claims generally incidental to its business. The ultimate disposition of these matters is not expected to have a significant adverse effect on the Company's financial position or results of operations. F-18 35 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) In the third quarter of 1999, the Company wrote-off approximately $6.0 million of its investment in Brazil as a result of continuing poor economic conditions in that country. The fourth quarter of 1999 included an unfavorable inventory adjustment of $0.8 million resulting from a physical inventory count. The following table reflects the quarterly results for 2000 and 1999 (in thousands except for share data): Three Months Ended -------------------------------------------------- 2000 March June September December 31 30 30 31 ---------- ---------- ---------- ---------- Net sales $ 27,729 $ 31,551 $ 29,641 $ 24,609 Gross profit 6,237 8,156 6,709 4,765 Net earnings (loss) 315 806 549 (1,112) Earnings (loss) per share: Basic $ 0.03 $ 0.09 $ 0.06 $ (0.12) Diluted $ 0.03 $ 0.09 $ 0.06 $ (0.12) Three Months Ended -------------------------------------------------- 1999 March June September December 31 30 30 31 ---------- ---------- ---------- ---------- Net sales $ 36,228 $ 38,072 $ 29,183 $ 26,357 Gross profit 8,068 7,575 854 5,189 Net earnings (loss) 1,451 1,449 (7,082) (385) Earnings (loss) per share: Basic $ 0.16 $ 0.16 $ (0.78) $ (0.04) Diluted $ 0.16 $ 0.16 $ (0.78) $ (0.04) F-19 36 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. SEGMENT AND GEOGRAPHIC INFORMATION The Company and its subsidiaries are engaged in the manufacture and distribution of beverage dispensing equipment and related parts and components. The Company manages its operations geographically. Sales are attributed to a region based on the ordering location of the customer. North Latin Amounts in thousands America America Pacific Brazil Europe Asia Corporate Total --------- --------- --------- -------- --------- --------- ---------- --------- Year ended December 31, 2000 Total revenues $ 73,618 7,882 16,639 1,538 10,897 2,956 -- $ 113,530 Depreciation and amortization 3,583 156 342 60 64 -- -- 4,205 Operating income (loss) 11,272 1,219 2,196 10 1,113 973 (13,000) 3,783 Identifiable assets at December 31, 2000 76,885 9,348 9,522 1,915 4,722 -- -- 102,392 Capital expenditures 3,916 290 471 368 121 -- -- 5,166 Year ended December 31, 1999 Total revenues $ 85,889 11,225 15,407 2,065 9,471 5,783 -- $ 129,840 Depreciation and amortization 3,250 151 429 139 21 -- -- 3,990 Operating income (loss) 8,451 528 1,535 (6,819) 1,023 845 (11,986) (6,423) Identifiable assets at December 31, 1999 78,766 7,742 12,128 1,297 3,121 -- -- 103,054 Capital expenditures 4,819 4 55 63 16 -- -- 4,957 Year ended December 31, 1998 Total revenues $ 72,372 21,624 15,459 6,142 11,446 11,380 -- $ 138,423 Depreciation and amortization 2,317 21 245 284 21 -- -- 2,888 Operating income (loss) 15,691 3,282 2,199 (1,743) 2,273 2,153 (10,359) 13,496 Identifiable assets at December 31, 1998 88,274 4,496 9,233 6,319 4,518 -- -- 112,840 Capital expenditures 4,697 5 78 392 44 -- -- 5,216 All intercompany revenues are eliminated in computing revenues and operating income. The corporate component of operating income represents corporate general and administrative expenses. Identifiable assets are those assets identified with the operations in each geographic area. Substantially all revenues result from the sales of products and services associated with beverage dispensing. The products can be divided into four major categories: (i) fountain soft drink and citrus dispensers; (ii) post-mix dispensing valves; (iii) beer dispensing systems; and (iv) other products and services as follows (Amounts in thousands): 2000 1999 1998 ---------- ---------- ---------- Soft drink, citrus and frozen beverage dispensers $ 43,337 $ 62,886 $ 69,446 Post mix dispensing valves 13,359 15,222 18,702 Beer dispensing systems 8,472 9,641 8,768 Other 48,362 42,091 41,507 ---------- ---------- ---------- Total revenue $ 113,530 $ 129,840 $ 138,423 ========== ========== ========== F-20 37 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The following provides information regarding net sales to major customers, domestically and internationally (amounts in thousands): Percent of Percent of Percent of 2000 Net Sales 1999 Net Sales 1998 Net Sales ---------- ---------- ---------- ---------- ---------- ---------- United States: The Coca-Cola Company $ 29,649 26% $ 32,394 25% $ 31,816 23% Other 38,921 34 51,838 40 40,556 29 ---------- ---------- ---------- ---------- ---------- ---------- 68,570 60 84,232 65 72,372 52 ---------- ---------- ---------- ---------- ---------- ---------- Outside of United States: The Coca-Cola Company -- -- 12 -- 34 -- Panamerican Beverages, Inc. 1,615 2 1,818 1 14,861 11 Other 43,345 38 43,778 34 51,156 37 ---------- ---------- ---------- ---------- ---------- ---------- 44,960 40 45,608 35 66,051 48 ---------- ---------- ---------- ---------- ---------- ---------- $ 113,530 100% $ 129,840 100% $ 138,423 100% ========== ========== ========== ========== ========== ========== In addition to sales made directly to The Coca-Cola Company, substantially all sales to other entities are significantly influenced by The Coca-Cola Company. Any disruption or change in the relationship with The Coca-Cola Company could have a material adverse effect on the results of operations of the Company. F-21 38 LANCER CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SCHEDULE II RESERVE ACCOUNT Additions Balance at Charged to Deductions from Balance at Description Beginning of Year Expense Account End of Year ----------- ----------------- ---------- ---------------- ----------- Allowance for doubtful accounts (amounts in thousands): December 31, 2000 $ 414 $ 66 $ 101 $ 379 December 31, 1999 $ 326 $ 154 $ 66 $ 414 December 31, 1998 $ 363 $ 61 $ 98 $ 326 F-22 39 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Lancer Frank Corporation, General Partner, Lancer Investment Corporation, Limited Partner, Jimmy I. Frank, Limited Partner, and Nita T. Frank, Limited Partner, the Partners of Lancer FBD Partnership, Ltd.: We have audited the accompanying balance sheets of Lancer FBD Partnership, Ltd. (the Company), as of December 31, 2000 and 1999, and the related statements of income, partners' capital and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Lancer FBD Partnership, Ltd., as of December 31, 2000 and 1999, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. Arthur Andersen LLP San Antonio, Texas February 23, 2001 F-23 40 LANCER FBD PARTNERSHIP, LTD. BALANCE SHEETS -- DECEMBER 31, 2000 AND 1999 ASSETS 2000 1999 ------ ------------ ------------ CURRENT ASSETS: Cash $ 648,342 $ 667,192 Trade accounts receivable- Third-party customers 344,280 72,254 Lancer Corporation 88,137 43,829 Inventories- Raw materials and subassemblies 1,305,835 2,055,021 Finished goods 816,633 679,444 Other current assets 21,361 11,414 ------------ ------------ Total current assets 3,224,588 3,529,154 ------------ ------------ FURNITURE AND EQUIPMENT: Leasehold improvements 60,362 60,362 Furniture and fixtures 246,721 165,231 Equipment 543,057 472,417 ------------ ------------ 850,140 698,010 Less-Accumulated depreciation (260,651) (153,028) ------------ ------------ Total furniture and equipment 589,489 544,982 ------------ ------------ PATENT, net 2,739,115 2,938,479 ------------ ------------ OTHER ASSETS 15,471 13,346 ------------ ------------ Total assets $ 6,568,663 $ 7,025,961 ============ ============ The accompanying notes are an integral part of these financial statements. F-24 41 LANCER FBD PARTNERSHIP, LTD. BALANCE SHEETS (Continued) - - DECEMBER 31, 2000 AND 1999 LIABILITIES AND PARTNERS' CAPITAL 2000 1999 --------------------------------- ------------ ------------ CURRENT LIABILITIES: Trade accounts payable-- Lancer Corporation $ 50,483 $ 30,446 Gagemaker, Inc. 67,901 35,919 Third-party suppliers 200,433 247,457 Bank overdraft 203,470 -- Accrued expenses-- Lancer Corporation 54,304 147,640 Gagemaker, Inc. 83,492 7,622 Other accrued 171,737 391,031 Warranty reserve 169,268 274,186 Current portion of note payable 6,443 5,770 ------------ ------------ Total current liabilities 1,007,531 1,140,071 ------------ ------------ LONG-TERM LIABILITIES: Note payable 9,392 15,835 ------------ ------------ CONTINGENCIES PARTNERS' CAPITAL: Lancer Frank Corporation, General Partner 55,518 54,741 Lancer Investment Corporation, Limited Partner 2,748,112 2,907,658 Jimmy I. Frank, Limited Partner 1,374,055 1,453,828 Nita T. Frank, Limited Partner 1,374,055 1,453,828 ------------ ------------ Total partners' capital 5,551,740 5,870,055 ------------ ------------ Total liabilities and partners' capital $ 6,568,663 $ 7,025,961 ============ ============ The accompanying notes are an integral part of these financial statements. F-25 42 LANCER FBD PARTNERSHIP, LTD. STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999 2000 1999 ------------ ------------ SALES, net of discounts of $115,399 and $453,981, respectively $ 8,631,923 $ 22,991,007 COST OF GOODS SOLD 6,380,757 17,511,299 ------------ ------------ GROSS PROFIT 2,251,166 5,479,708 SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 804,502 906,340 RESEARCH AND DEVELOPMENT 1,316,126 598,184 ------------ ------------ OPERATING INCOME 130,538 3,975,184 ------------ ------------ OTHER EXPENSES (INCOME): Interest, net (38,453) (52,681) Amortization of patent 212,412 212,412 Other, net (197,346) (10,419) ------------ ------------ Total other expenses (income) (23,387) 149,312 ------------ ------------ NET INCOME $ 153,925 $ 3,825,872 ============ ============ The accompanying notes are an integral part of these financial statements. F-26 43 LANCER FBD PARTNERSHIP, LTD. STATEMENTS OF PARTNERS' CAPITAL FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999 Partners' Partners' Capital, Partner Capital Net Capital, January 1 Distributions Contributions Income December 31 -------------- -------------- -------------- -------------- -------------- 2000 GENERAL PARTNER: Lancer Frank Corporation $ 54,741 $ (6,782) $ 6,020 $ 1,539 $ 55,518 LIMITED PARTNERS: Lancer Investment Corporation 2,907,658 (335,740) 100,000 76,194 2,748,112 Jimmy I. Frank 1,453,828 (167,869) 50,000 38,096 1,374,055 Nita T. Frank 1,453,828 (167,869) 50,000 38,096 1,374,055 -------------- -------------- -------------- -------------- -------------- $ 5,870,055 $ (678,260) $ 206,020 $ 153,925 $ 5,551,740 ============== ============== ============== ============== ============== 1999 GENERAL PARTNER: Lancer Frank Corporation $ 48,705 $ (32,223) $ -- $ 38,259 $ 54,741 LIMITED PARTNERS: Lancer Investment Corporation 2,608,888 (1,595,037) -- 1,893,807 2,907,658 Jimmy I. Frank 1,304,444 (797,519) -- 946,903 1,453,828 Nita T. Frank 1,304,444 (797,519) -- 946,903 1,453,828 -------------- -------------- -------------- -------------- -------------- $ 5,266,481 $ (3,222,298) $ -- $ 3,825,872 $ 5,870,055 ============== ============== ============== ============== ============== The accompanying notes are an integral part of these financial statements. F-27 44 LANCER FBD PARTNERSHIP, LTD. STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 2000 AND 1999 2000 1999 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 153,925 $ 3,825,872 Adjustments to reconcile net income to net cash used in operating activities-- Depreciation of furniture and equipment 107,623 82,004 Amortization of patent 212,412 212,412 (Increase) decrease in operating assets-- Accounts receivable, third-party customers (272,026) (72,254) Accounts receivable, Lancer Corporation (44,308) 340,718 Inventory 611,997 (956,423) Other assets (12,072) (9,279) Increase (decrease) in operating liabilities-- Trade accounts payable, third-party suppliers (47,024) (275,561) Trade accounts payable, Lancer Corporation 20,037 23,996 Accounts payable, Gagemaker, Inc. 31,982 (201,594) Bank overdraft 203,470 -- Accrued expenses, Lancer Corporation (93,336) 123,379 Accrued expenses, Gagemaker, Inc. 75,870 (8,841) Accrued expenses, other (219,294) 80,663 Warranty reserve (104,918) 203,649 ------------ ------------ Net cash provided by operating activities 624,338 3,368,741 ------------ ------------ CASH FLOWS USED IN INVESTING ACTIVITIES: Purchase of furniture and equipment (152,130) (197,644) Payments on note payable (5,770) (5,180) Patent costs incurred (13,048) -- ------------ ------------ Net cash used in investing activities (170,948) (202,824) ------------ ------------ CASH FLOWS USED IN FINANCING ACTIVITIES: Partner distributions (678,260) (3,222,298) Capital contributions 206,020 -- ------------ ------------ Net cash used in financing activities (472,240) (3,222,298) ------------ ------------ DECREASE IN CASH (18,850) (56,381) CASH, beginning of year 667,192 723,573 ------------ ------------ CASH, end of year $ 648,342 $ 667,192 ============ ============ INTEREST PAID $ 2,110 $ 2,647 ============ ============ The accompanying notes are an integral part of these financial statements. F-28 45 LANCER FBD PARTNERSHIP, LTD. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000 AND 1999 1. ORGANIZATION: Lancer FBD Partnership, Ltd. (the Company), a Texas limited partnership, was formed on October 7, 1996, and is engaged in the production and sale of frozen beverage dispensers and related products. The ownership structure of the Company consists of a general partner, Lancer Frank Corporation (1 percent), and three limited partners, Lancer Investment Corporation (49.5 percent), Jimmy I. Frank (24.75 percent) and Nita T. Frank (24.75 percent). Lancer Frank Corporation is owned by Lancer Corporation (50 percent) and Jimmy I. Frank and Nita Frank (50 percent). Lancer Corporation (a public company) owns 100 percent of Lancer Investment Corporation. The Company commenced operations in October 1996. The Company receives administrative support from Gagemaker, Inc. (Gagemaker), and Lancer Corporation (Lancer), both related entities. The Company also has a supply and sole distributor agreement with Gagemaker and Lancer, respectively (refer to Note 6). The Company is economically dependent upon its relationship with these related entities. 2. SIGNIFICANT ACCOUNTING POLICIES: Cash As of December 31, 2000, the Company had an overdraft balance in one of their bank accounts. The resulting bank overdraft is being presented as a payable on the balance sheet. Trade Accounts Receivable Management of the Company believes no allowance for doubtful accounts is required at December 31, 2000 and 1999. Concentration of Credit Risk Trade accounts receivable from Lancer represent approximately 20 percent and 38 percent of the total trade accounts receivable as of December 31, 2000 and 1999, respectively. The maximum loss that would be incurred by the Company if the related party failed to perform would be $88,137 and $43,829, respectively. Inventory Inventories are stated at the lower of cost (first-in, first-out) or market. The Company capitalizes overhead related to inventory by calculating the total of direct and indirect overhead allocable to inventory as a percentage of inventory purchases for the year multiplying this percentage by ending inventory to calculate capitalized overhead. Furniture and Equipment Furniture and equipment are stated at the lower of cost or fair market value as of the time the assets are placed in service. The Company periodically assesses the value of their long-lived assets to assure events or changes in circumstances have not adversely affected the carrying amounts of the assets. The equipment is depreciated over the estimated useful lives using a tax-based method which approximates straight-line. Estimated useful lives for depreciation purposes are as follows: F-29 46 LANCER FBD PARTNERSHIP, LTD. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000 AND 1999 Leasehold improvements 2 to 5 years Furniture and fixtures 3 to 10 years Equipment 10 years Revenue Recognition The Company sells products directly to Lancer, a related party, recognizing revenue at the time the products are shipped. During 2000, the Company began selling products directly to the Coca-Cola Company. All shipments have terms of FOB shipping point. Returns and Allowances The Company has not had a history of significant sales returns and, as such, no sales allowance has been established. The Company's payment terms are net 30 days, with a 2 percent discount granted to Lancer if payment is received within 10 days. Warranty Costs The Company warrants the refrigeration component of its products for a period of five years. The Company also provides a one-year warranty covering parts. Warranty costs are accrued based on estimated future warranty claims. During 1999, the Company occasionally performed warranty work on dispensers produced by FCB Engineering, Inc. (FCB), a company owned by Jimmy I. Frank prior to the Company's formation. For the year ended December 31, 2000 and 1999, these costs were approximately $855 and $15,733, respectively. Patent Patents, including legal costs incurred to acquire patents, are being amortized on a straight-line basis over 17 years. The Company periodically evaluates the recoverability of their patents by assessing whether the unamortized balance can be recovered over its remaining life through cash flows generated by the underlying assets. Patent amortization expense was $212,412 for each of the years ended December 31, 2000 and 1999. Accumulated amortization was $884,943 and $672,531 at December 31, 2000 and 1999, respectively. Research and Development Research and development costs are charged to expense as incurred. Research and development costs consist of all costs related to the Company's research and development program, including payroll, general and administrative and prototype manufacturing costs. Research and development expense was $1,316,126 and $598,184 for the years ended December 31, 2000 and 1999, respectively. Coca-Cola Company reimbursed the Company approximately $194,170 of research and development costs incurred during 2000 which has been reflected as other income on the income statement. Income Taxes The Company is taxed as a partnership under the Internal Revenue Code. Income or loss is reported for federal income tax purposes by the respective partners. F-30 47 LANCER FBD PARTNERSHIP, LTD. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000 AND 1999 Use of Estimates The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. 3. NEW ACCOUNTING PRONOUNCEMENTS: In December 1999, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin (SAB) No. 101, "Revenue Recognition in Financial Statements," which provides the SEC's views in applying accounting principles generally accepted in the United States to selected revenue recognition issues. We have reviewed the guidance of this SAB and believe that our accounting policies and the disclosures in the financial statements are appropriate and adequately address the requirements of this SAB. In June 2000, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities," an amendment of SFAS 133. SFAS 133 established accounting and reporting standards for derivative instruments, including certain derivative instruments imbedded in other contracts, and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. SFAS 138 amends the accounting and reporting standards of SFAS 133. The adoption of this statement has not had a material effect on the financial condition or results of operations of the Company. 4. LONG-TERM DEBT: In May 1998, the Company entered into a note payable with a company, for working capital purposes, in the amount of $30,000. The note calls for payments of $652 per month. Interest accrues monthly at an interest rate of 11 percent. The note is expected to be paid off in 2003. 5. LEASES: The Company leases office space under operating leases. Future minimum payments on operating leases are as follows: Year ending December 31- 2001 $ 134,016 2002 117,518 2003 27,756 2004 10,297 2005 and thereafter -- -------------- Total $ 289,587 ============== Rent expense for the years ended December 31, 2000 and 1999, was $139,989 and $131,430, respectively. F-31 48 LANCER FBD PARTNERSHIP, LTD. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000 AND 1999 6. RELATED-PARTY TRANSACTIONS: The Company entered into a supply agreement (the Supply Agreement) with Gagemaker on October 9, 1996. Under the Supply Agreement, the Company agreed to purchase a key component of its product from Gagemaker. The Supply Agreement remains effective for as long as the Company manufactures frozen beverage dispensers that require the key component provided by Gagemaker. Gagemaker must comply with certain conditions under the Supply Agreement, such as competitive pricing, quality products and ability to meet the demand of the Company. The Company entered into a distributor agreement (the Distributor Agreement) with Lancer on October 9, 1996. Under the Distributor Agreement, the Company agreed to grant Lancer exclusive distributor rights worldwide for all frozen beverage dispensers manufactured by the Company. The Distributor Agreement remains in effect as long as the Company's partnership remains intact or until one of the parties is adjudicated bankrupt, voluntarily or involuntarily. During 2000, the Company, with the approval of Lancer, began directly distributing and billing to the Coca-Cola Company for frozen beverage dispensers. Gagemaker and Lancer provide certain administrative and purchasing functions on behalf of the Company. The Company is allocated a portion of the salaries and associated expenses relating to these services. The costs charged to the Company during 2000 and 1999 were approximately $136,931 and $284,198, respectively. The Company purchases certain raw materials from Gagemaker under the Supply Agreement. Purchases from Gagemaker during 2000 and 1999 totaled approximately $1,639,659 and $5,492,657, respectively. The Company sells to Lancer under the Distributor Agreement. Sales to Lancer, net of discounts, were approximately $7,972,555 and $22,450,856 during 2000 and 1999, respectively. The Company also purchases certain raw materials from Lancer. Total purchases during 2000 and 1999 from Lancer were approximately $600,733 and $840,137, respectively. The Company pays certain premiums for insurance coverage for the operations of the Company. These insurance policies are held by Lancer, with the Company being defined as an insured party under the respective policies. The total amount of premiums paid by the Company under these insurance arrangements was $22,847 and $19,071 for the years ended December 31, 2000 and 1999, respectively. In December 1999, the Company purchased frozen beverage dispensers from Lancer. These dispensers were produced by FCB prior to formation of the Company. The Company incurred costs to upgrade and refurbish the dispensers and, subsequently, sold the dispensers to Lancer for an amount equal to the purchase price. The loss related to this transaction that was reflected in the December 31, 1999, income statement was $106,641. In August 1999, the Company began a research and development operation in San Antonio. This operation is housed in a warehouse facility leased by Lancer. The Company occupies approximately 1 percent of Lancer's leased facility and pays no rent to Lancer. The Company also utilizes a separate Lancer warehouse for storage and pays no rent to Lancer. The Company paid contractor wages to several related parties including Jim Frank and Nita Frank, limited partners, and George Schroeder and Alfred Schroeder, president and vice president, respectively, of Lancer, in the amount of $30,000 each for the year ended December 31, 2000, and $17,500 each for the year ended December 31, 1999. All related-party receivables and payables are presented gross on the balance sheet. F-32 49 LANCER FBD PARTNERSHIP, LTD. NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 2000 AND 1999 7. CONTINGENCIES: During 1999, under an oral agreement and at Lancer's request, the Company purchased and reworked certain frozen beverage dispensers that were produced by FCB prior to formation of the Company at a loss to the Company (see Note 6). While no written agreement exists, Lancer may from time to time request the Company to incur losses under similar oral arrangements. F-33 50 INDEX TO EXHIBITS EXHIBIT NUMBER DESCRIPTION ------- ----------- 3.1* Registrants Articles of Incorporation and amendments thereto 3.2* Bylaws of the Registrant 4.1* Specimen Common Stock Certificate, $0.01 par value, of Registrant 10.1* Lancer Corporation Profit Sharing Plan 10.2* 1992 Non-Statutory Stock Option Plan 10.3* 1987 Incentive Stock Option Plan 10.4* Master Development Agreement, dated January 12, 1984, between Lancer Corporation and The Coca-Cola Company 10.5* Net Lease Agreement, dated July 1, 1974, between Lancer Corporation and Lancer Properties dated as of June 3, 1977 10.13* Development and Manufacturing Agreement, dated April 13, 1993, between Lancer Corporation and Packaged Ice, Inc. 10.14* Manufacturer's Representation Agreement, dated June 1993, between Lancer Corporation and Middleby Marshall Inc., doing business as Victory - A Middleby Company 10.15* Form of Notice of Grant of Stock Option under the 1987 Incentive Stock Option Plan 10.16* Form of Nonstatutory Stock Option Agreement under the 1992 Non-Statutory Stock Option Plan 10.27++ Credit Agreement, dated July 15,1996, between Lancer Corporation and The Frost National Bank and The Boatmen's National Bank of St. Louis 10.28++ Term A Note, dated July 15,1996, between Lancer Corporation and The Frost National Bank and The Boatmen's National Bank of St. Louis 10.29++ Term B Note, dated July 15,1996, between Lancer Corporation and The Frost National Bank and The Boatmen's National Bank of St. Louis 10.30++ Revolving Note, dated July 15,1996, between Lancer Corporation and The Frost National Bank and The Boatmen's National Bank of St. Louis 51 10.31++ Acquisition Note, dated July 15,1996, between Lancer Corporation and The Frost National Bank and The Boatmen's National Bank of St. Louis 10.32++ Stock Pledge, dated July 15,1996, between Lancer Corporation and The Frost National Bank 10.33++ Parent and Affiliate Guaranties, dated July 15,1996, between Lancer Corporation or its subsidiaries and The Frost National Bank 10.34# Lancer Corporation Stock Incentive Plan, Effective Date March 1, 1996 10.35+++ Master Lease Agreement dated September 4, 1996 between Lancer Partnership, Ltd. and CCA Financial, Inc. 10.36## First Amendment to Credit Agreement dated May 12, 1997 between Lancer Partnership, Ltd. and The Frost National Bank and NationsBank, N.A. 10.37## Second Amendment to Credit Agreement dated December 31, 1997 between Lancer Partnership, Ltd. and The Frost National Bank and NationsBank, N.A. 10.38### Third Amendment to Credit Agreement dated July 15, 1998 between Lancer Corporation and The Frost National Bank and NationsBank, N.A. 10.39** Fourth Amendment to Credit Agreement dated March 15, 1999 between Lancer Corporation and The Frost National Bank and NationsBank, N.A. 10.40*** Seventh Amendment and Restated Credit Agreement dated October 26, 2000 between Lancer Corporation and The Frost National Bank, Harris Trust and Savings Bank, and Whitney National Bank. 10.41*** Security Agreement between Lancer Corporation and The Frost National Bank, Harris Trust and Savings Bank, and Whitney National Bank. 21.1 List of Significant Subsidiaries of the Registrant 23.1 Consent of KPMG LLP 23.2 Consent of Arthur Andersen LLP * These exhibits are incorporated by reference to the same Exhibit to the Registrant's Registration Statement No. 33-82434 filed on Form S-1 with the Securities and Exchange Commission (the "Commission") on August 5, 1994, as amended by Amendment No. 1 to Form S-1 Registration Statement with the Commission on August 23, 1994. ++ These exhibits are incorporated by reference to the Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 1995. +++ This exhibit is incorporated by reference to the Exhibit to the Registrant's Form 10-K for the year ended December 31, 1996. # This exhibit is incorporated by reference to the Exhibit to the Registrant's Proxy dated April 22, 1996. ## These exhibits are incorporated by reference to the Exhibit to the Registrant's Form 10-K for the year ended December 31, 1997. ### This exhibit is incorporated by reference to the Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 1998. ** This exhibit is incorporated by reference to the Exhibit to the Registrant's Form 10-Q for the quarter ended June 30, 1999. *** This exhibit is incorporated by reference to the Exhibit to the Registrant's Form 10-Q for the quarter ended September 30, 2000.