**UNITEDSTATES**

**SECURITIES AND EXCHANGECOMMISSION**

**Washington,D.C. 20549**

 

**FORM 10-Q**
| **(Mark  one)** | ** ** | ** **                                             | ** ** | ** ** |
|-----------------|------------|--------------------------------------------------------|------------|------------|
| ý          | ** ** | **QUARTERLY REPORT PURSUANT TO  SECTION 13 OR 15(d)**  |       |       |
|            | ** ** | **OF THE SECURITIES EXCHANGE ACT OF 1934**             |       |       |
|            |       |                                                   |       |       |
|            | ** ** | **For the quarterly period ended September 30, 2004**  |       |       |
|            |       |                                                   |       |       |
|            | ** ** | **OR**                                                 | ** ** | ** ** |
|            |       |                                                   |       |       |
| **o**           | ** ** | **TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d)** | ** ** | ** ** |
|            | ** ** | **OF THE SECURITIES EXCHANGE ACT OF 1934**             |       |       |

 

**For the transition period from_______ to _______**

** **

**Commission file number 0-13875**

 

**LANCERCORPORATION**

(Exact name of registrant as specified in its charter)

 

| **Texas**                                                         | ** ** | **74-1591073**                        |
|-------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of

incorporation or  organization) |       | (I.R.S. Employer  Identification No.) |

 

**6655 LANCER BLVD.**

**SAN ANTONIO, TEXAS**

 (Address of principal executiveoffices)

 

**(210) 310-7000**

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Act during the past12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.  Yes ý   No o

 

Indicate by checkmark whether the registrant is an accelerated filer (as defined in Exchange ActRule 12b-2).  Yes o   No ý

 

The number of shares ofregistrant’s common stock outstanding as of October 22, 2004 was 9,426,028.

 

 

----

 

**PART I**

**FINANCIAL INFORMATION**

 

**Item 1.** **Financial Statements.**

 

**LANCER CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

 

(Amounts in thousands,except share data)

 

ASSETS

** **
| ** **                                                            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                            | ** ** | **2004**          | ** ** | **2003**         | ** ** |
| ** **                                                            | ** ** | **(Unaudited)**   | ** ** | ** **       | ** ** |
| Current assets:                                                       |       |              |       |             |       |
| Cash                                                                  |       | $                 | 10,478     |             | $          | 1,129 |   |
| Receivables:                                                          |       |              |       |             |       |
| Trade accounts  and notes                                             |       | 17,656            |       | 14,226           |       |
| Other                                                                 |       | 832               |       | 1,268            |       |
|                                                                  |       | 18,488            |       | 15,494           |       |
| Less allowance  for doubtful accounts                                 |       | (518              | )          | (745             | )          |
|                                                                  |       |              |       |             |       |
| Net receivables                                                       |       | 17,970            |       | 14,749           |       |
|                                                                  |       |              |       |             |       |
| Inventories, net                                                      |       | 25,365            |       | 24,502           |       |
| Prepaid expenses                                                      |       | 826               |       | 474              |       |
| Tax refund  receivable                                                |       | —            |       | 225              |       |
| Deferred tax  asset                                                   |       | 547               |       | 568              |       |
|                                                                  |       |              |       |             |       |
| Total current  assets                                                 |       | 55,186            |       | 41,647           |       |
|                                                                  |       |              |       |             |       |
| Property, plant  and equipment, at cost:                              |       |              |       |             |       |
| Land                                                                  |       | 1,432             |       | 1,432            |       |
| Buildings                                                             |       | 22,261            |       | 22,211           |       |
| Machinery and  equipment                                              |       | 23,493            |       | 22,769           |       |
| Tools and dies                                                        |       | 10,933            |       | 12,709           |       |
| Leaseholds,  office equipment and vehicles                            |       | 10,605            |       | 10,796           |       |
| Assets in  progress                                                   |       | 1,518             |       | 2,597            |       |
|                                                                  |       | 70,242            |       | 72,514           |       |
| Less accumulated  depreciation and amortization                       |       | (39,862           | )          | (38,395          | )          |
|                                                                  |       |              |       |             |       |
| Net property,  plant and equipment                                    |       | 30,380            |       | 34,119           |       |
|                                                                  |       |              |       |             |       |
| Long-term  investments                                                |       | 2,505             |       | 1,786            |       |
| Intangibles and  other assets, at cost, less accumulated amortization |       | 4,730             |       | 4,726            |       |
|                                                                  |       |              |       |             |       |
|                                                                  |       | $                 | 92,801     |             | $          | 82,278 |   |

 

See accompanying notes toconsolidated financial statements.

 

 

2

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LIABILITIES ANDSHAREHOLDERS’ EQUITY

** **
| ** **                                                                                                                                                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                                                                                                                                                 | ** ** | **2004**          | ** ** | **2003**         | ** ** |
| ** **                                                                                                                                                                 | ** ** | **(Unaudited)**   | ** ** | ** **       | ** ** |
| Current  liabilities:                                                                                                                                                      |       |              |       |             |       |
| Accounts payable                                                                                                                                                           |       | $                 | 7,677      |             | $          | 6,609 |   |
| Current  installments of long-term debt                                                                                                                                    |       | 2,743             |       | 2,735            |       |
| Line of credit  with bank                                                                                                                                                  |       | —            |       | 1,000            |       |
| Deferred  licensing and maintenance fees                                                                                                                                   |       | 369               |       | 1,021            |       |
| Accrued expenses  and other liabilities                                                                                                                                    |       | 8,995             |       | 6,964            |       |
| Taxes payable                                                                                                                                                              |       | 2,695             |       | —           |       |
| Total current  liabilities                                                                                                                                                 |       | 22,479            |       | 18,329           |       |
|                                                                                                                                                                       |       |              |       |             |       |
| Deferred tax  liability                                                                                                                                                    |       | 1,992             |       | 1,175            |       |
| Long-term debt,  excluding current installments                                                                                                                            |       | 7,107             |       | 8,268            |       |
| Deferred  licensing and maintenance fees                                                                                                                                   |       | 1,108             |       | 2,396            |       |
| Other long-term  liabilities                                                                                                                                               |       | 36                |       | 147              |       |
|                                                                                                                                                                       |       |              |       |             |       |
| Total  liabilities                                                                                                                                                         |       | 32,722            |       | 30,315           |       |
|                                                                                                                                                                       |       |              |       |             |       |
| Commitments and  contingencies                                                                                                                                             |       |              |       |             |       |
|                                                                                                                                                                       |       |              |       |             |       |
| Shareholders’  equity:                                                                                                                                                |       |              |       |             |       |
| Preferred stock,  without par value   5,000,000 shares authorized; none issued                                                                                             |       | —            |       | —           |       |
|                                                                                                                                                                       |       |              |       |             |       |
| Common stock,  $.01 par value:   50,000,000 shares authorized; 9,480,254 issued and 9,416,028 outstanding in  2004, and 9,426,121 issued and 9,361,895 outstanding in 2003 |       | 94                |       | 94               |       |
|                                                                                                                                                                       |       |              |       |             |       |
| Additional  paid-in capital                                                                                                                                                |       | 13,054            |       | 12,848           |       |
|                                                                                                                                                                       |       |              |       |             |       |
| Accumulated  other comprehensive income (loss)                                                                                                                             |       | (329              | )          | 6                |       |
|                                                                                                                                                                       |       |              |       |             |       |
| Deferred  compensation                                                                                                                                                     |       | (40               | )          | (92              | )          |
|                                                                                                                                                                       |       |              |       |             |       |
| Retained  earnings                                                                                                                                                         |       | 47,660            |       | 39,467           |       |
|                                                                                                                                                                       |       |              |       |             |       |
| Less common  stock in treasury, at cost;   64,226 shares in 2004 and 2003                                                                                                  |       | (360              | )          | (360             | )          |
|                                                                                                                                                                       |       |              |       |             |       |
| Total  shareholders’ equity                                                                                                                                           |       | 60,079            |       | 51,963           |       |
|                                                                                                                                                                       |       |              |       |             |       |
|                                                                                                                                                                       |       | $                 | 92,801     |             | $          | 82,278 |   |

 

 

See accompanying notes toconsolidated financial statements.

 

 

3

----

 

**LANCER CORPORATION**

**CONSOLIDATED STATEMENTS OFOPERATIONS**

(Unaudited)

 

(Amounts in thousands,except share data)

 
| ** **                                                 | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                 | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                 | ** ** | **2004**               | ** ** | **2003**              | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                       |       |                   |       |                  |       |   |   |   |   |
| Net sales                                                  |       | $                      | 31,264     |                  | $          | 30,237 |   | 92,467 |   | $ | 86,481 |   |
| Cost of sales                                              |       | 22,368                 |       | 21,855                |       | 64,772 |   | 64,615 |   |
| Gross profit                                               |       | 8,896                  |       | 8,382                 |       | 27,695 |   | 21,866 |   |
|                                                       |       |                   |       |                  |       |   |   |   |   |
| Selling, general  and administrative expenses              |       | 7,168                  |       | 7,722                 |       | 22,560 |   | 20,996 |   |
| Operating income                                           |       | 1,728                  |       | 660                   |       | 5,135 |   | 870 |   |
|                                                       |       |                   |       |                  |       |   |   |   |   |
| Other (income)  expense:                                   |       |                   |       |                  |       |   |   |   |   |
| Interest expense                                           |       | 204                    |       | 103                   |       | 457 |   | 427 |   |
| (Income) loss  from joint ventures                         |       | (571                   | )          | (427                  | )          | (824 | ) | 60 |   |
| Other (income)  expense, net                               |       | (6,796                 | )          | 20                    |       | (7,115 | ) | (206 | ) |
|                                                       |       | (7,163                 | )          | (304                  | )          | (7,482 | ) | 281 |   |
| Income from  continuing operations before income taxes     |       | 8,891                  |       | 964                   |       | 12,617 |   | 589 |   |
|                                                       |       |                   |       |                  |       |   |   |   |   |
| Income tax  expense (benefit):                             |       |                   |       |                  |       |   |   |   |   |
| Current                                                    |       | 3,189                  |       | 447                   |       | 4,747 |   | 1,328 |   |
| Deferred                                                   |       | (124                   | )          | (90                   | )          | (323 | ) | (616 | ) |
|                                                       |       | 3,065                  |       | 357                   |       | 4,424 |   | 712 |   |
|                                                       |       |                   |       |                  |       |   |   |   |   |
| Income (loss)  from continuing operations                  |       | 5,826                  |       | 607                   |       | 8,193 |   | (123 | ) |
|                                                       |       |                   |       |                  |       |   |   |   |   |
| Discontinued  operations:                                  |       |                   |       |                  |       |   |   |   |   |
| Loss from  operations of discontinued Brazilian subsidiary |       | —                 |       | 40                    |       | — |   | 160 |   |
| Income tax  benefit                                        |       | —                 |       | (7                    | )          | — |   | (770 | ) |
| (Income) loss  from discontinued operations                |       | —                 |       | 33                    |       | — |   | (610 | ) |
| Net earnings                                               |       | $                      | 5,826      |                  | $          | 574 |   | 8,193 |   | $ | 487 |   |
|                                                       |       |                   |       |                  |       |   |   |   |   |
| Common Shares  Outstanding:                                |       |                   |       |                  |       |   |   |   |   |
| Basic                                                      |       | 9,380,558              |       | 9,360,893             |       | 9,371,993 |   | 9,353,912 |   |
| Diluted                                                    |       | 9,506,649              |       | 9,431,772             |       | 9,480,633 |   | 9,460,611 |   |
|                                                       |       |                   |       |                  |       |   |   |   |   |
| Earnings Per  Share:                                       |       |                   |       |                  |       |   |   |   |   |
| Basic                                                      |       |                   |       |                  |       |   |   |   |   |
| Earnings (loss)  from continuing operations                |       | $                      | 0.62       |                  | $          | 0.07 |   | 0.87 |   | $ | (0.01 | ) |
| Earnings (loss)  from discontinued operations              |       | $                      | —     |                  | $          | (0.01 | ) | — |   | $ | 0.06 |   |
| Net earnings                                               |       | $                      | 0.62       |                  | $          | 0.06 |   | 0.87 |   | $ | 0.05 |   |
|                                                       |       |                   |       |                  |       |   |   |   |   |
| Diluted                                                    |       |                   |       |                  |       |   |   |   |   |
| Earnings (loss)  from continuing operations                |       | $                      | 0.61       |                  | $          | 0.07 |   | 0.86 |   | $ | (0.01 | ) |
| Earnings (loss)  from discontinued operations              |       | $                      | —     |                  | $          | (0.01 | ) | — |   | $ | 0.06 |   |
| Net earnings                                               |       | $                      | 0.61       |                  | $          | 0.06 |   | 0.86 |   | $ | 0.05 |   |
|                                                            |            |                        |            |                       |            |  |  |  |  |  |  |  |  |

 

See accompanyingnotes to consolidated financial statements.

 

 

4

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**LANCER CORPORATION**

**CONSOLIDATED STATEMENTS OF CASHFLOWS**

(Unaudited)

 

(Amounts in thousands)
| ** **                                                                                    | ** ** | **Nine Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                    | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** |
| ** **                                                                                    | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Cash flow from  operating activities:                                                         |       |                  |       |   |   |
| Net earnings                                                                                  |       | $                     | 8,193      |   | $ | 487 |   |
| Adjustments to  reconcile net earnings to net cash provided by (used in) operating activities |       |                  |       |   |   |
| Depreciation and  amortization                                                                |       | 3,609                 |       | 4,087 |   |
| Deferred  licensing and maintenance fees                                                      |       | (488                  | )          | (419 | ) |
| Deferred income  taxes                                                                        |       | 829                   |       | (776 | ) |
| Loss (gain) on  sale and disposal of assets                                                   |       | (622                  | )          | 55 |   |
| Loss on  impairment of Assets                                                                 |       | 405                   |       | — |   |
| Gain on sales of  long-term investment                                                        |       | —                |       | (220 | ) |
| (Income) loss from  joint ventures                                                            |       | (824                  | )          | 59 |   |
| Stock-based  compensation expense                                                             |       | 52                    |       | 56 |   |
| Changes in  assets and liabilities:                                                           |       |                  |       |   |   |
| Receivables                                                                                   |       | (3,401                | )          | 2,714 |   |
| Prepaid expenses                                                                              |       | (352                  | )          | (623 | ) |
| Income taxes  receivable                                                                      |       | 225                   |       | (2,505 | ) |
| Inventories                                                                                   |       | (968                  | )          | 2,806 |   |
| Other assets                                                                                  |       | (195                  | )          | (446 | ) |
| Accounts payable                                                                              |       | 1,382                 |       | (2,832 | ) |
| Accrued expenses                                                                              |       | 1,907                 |       | 267 |   |
| Income taxes  payable                                                                         |       | 2,694                 |       | (161 | ) |
|                                                                                          |       |                  |       |   |   |
| Net cash  provided by operating activities                                                    |       | 12,446                |       | 2,549 |   |
| Cash flow from  investing activities:                                                         |       |                  |       |   |   |
| Proceeds from  sale of assets                                                                 |       | 525                   |       | 28 |   |
| Acquisition of  property, plant and equipment                                                 |       | (1,488                | )          | (3,059 | ) |
| Proceeds from  sale of long-term investments                                                  |       | —                |       | 319 |   |
| Net  distributions from joint ventures                                                        |       | 105                   |       | — |   |
|                                                                                          |       |                  |       |   |   |
| Net cash used in  investing activities                                                        |       | (858                  | )          | (2,712 | ) |
| Cash flow from  financing activities:                                                         |       |                  |       |   |   |
| Net borrowings  under line of credit agreements                                               |       | (1,000                | )          | (300 | ) |
| Retirement of  long-term debt, net of proceeds                                                |       | (1,153                | )          | (1,147 | ) |
| Net proceeds  from exercise of stock options                                                  |       | 207                   |       | 135 |   |
|                                                                                          |       |                  |       |   |   |
| Net cash used in  financing activities                                                        |       | (1,946                | )          | (1,312 | ) |
|                                                                                          |       |                  |       |   |   |
| Effect of  exchange rate changes on cash                                                      |       | (293                  | )          | 209 |   |
| Net increase  (decrease) in cash                                                              |       | 9,349                 |       | (1,266 | ) |
| Cash at  beginning of period                                                                  |       | 1,129                 |       | 3,241 |   |
|                                                                                          |       |                  |       |   |   |
| Cash at end of  period                                                                        |       | $                     | 10,478     |   | $ | 1,975 |   |
|                                                                                          |       |                  |       |   |   |
| Supplemental  cash flow informaton:                                                           |       |                  |       |   |   |
| Cash paid for  interest                                                                       |       | $                     | 958        |   | $ | 427 |   |
| Cash paid  (refunded) for income taxes                                                        |       | —                |       | — |   |

 

See accompanying notes toconsolidated financial statements.

 

 

5

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LANCERCORPORATION

 

NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS

** **

**1. Organization and Basis of Presentation.**

 

Lancer Corporation (the “Company”) designs, engineers, manufactures andmarkets fountain soft drink and other beverage dispensing systems and relatedequipment for use in the food service and beverage industry. The Company sellsits products through Company personnel, and through independent distributorsand agents, principally to major soft drink companies (primarily The Coca-ColaCompany, which influences substantially more than half of the Company’s sales),bottlers, equipment distributors, beer breweries and food service chains foruse in various food and beverage operations. Lancer is a vertically integratedmanufacturer, fabricating a significant portion of the components used inCompany products.  Lancer wasincorporated in Texas in 1967.

 

The accompanyingunaudited consolidated financial statements of the Company have been preparedin conformity with accounting principles generally accepted in the UnitedStates of America for interim financial information and with the instructionsto Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of theinformation and footnotes required by accounting principles generally acceptedin the United States of America for complete financial statements.  In the opinion of management, these financialstatements contain all adjustments, consisting of normal recurring accrualsunless otherwise disclosed, necessary to present fairly the financial position,results of operations and cash flows for the periods indicated.  Significant accounting policies followed bythe Company were disclosed in the notes to the consolidated financialstatements included in the Company’s Annual Report on Form 10-K for the yearended December 31, 2003, and no material changes have occurred withrespect to these policies.  The year-endconsolidated balance sheet data was derived from audited financial statements,but does not include all disclosures required by accounting principlesgenerally accepted in the United States. The consolidated results of operations for the periods reported are notnecessarily indicative of the results to be experienced for the entire currentyear.

 

Certain amounts in the consolidated financial statements for priorperiods have been reclassified to conform with the current year’s presentation.

 

 

**2.****             ****New Accounting Pronouncements.**

 

In December 2003, the Financial Accounting Standards Board issued FASBInterpretation No. 46 (revised December 2003) (“Interpretation 46”), “Consolidationof Variable Interest Entities.” Application of this interpretation is required in our financialstatements for interests in variable interest entities that are considered tobe special-purpose entities for the year ended December 31, 2003.  The Company determined that it does not haveany arrangements or relationships with special-purpose entities.  Application of Interpretation 46 for allother types of variable entities is required for our Company effective March31, 2004.

 

SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments andHedging Activities,” issued in April 2003, amends and clarifies financialaccounting and reporting for derivative instruments, including certainderivative instruments embedded in other contracts (collectively referred to asderivatives) and for hedging activities under FASB Statement No. 133, “Accountingfor Derivative Instruments and Hedging Activities.”  SFAS No. 149 is generally effective forcontracts entered into or modified after June 30, 2003.  The adoption of SFAS No. 149 did not have amaterial impact on the Company’s financial statements.

 

SFAS No. 150, “Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity,” issued in May 2003, establishes standards for how an issuer classifiesand measures certain financial instruments with characteristics of bothliabilities and equity. It requires that an issuer classify a financialinstrument that is within its scope as a liability (or an asset in somecircumstances). Many of those instruments were previously classified asequity.  The Statement is effective forfinancial instruments entered into or modified after May 31, 2003, and otherwiseis effective at the beginning of the first interim period beginning after June15, 2003, except for mandatorily redeemable financial instruments of nonpublicentities.  The adoption of SFAS No. 150did not have a material impact on the Company’s financial statements.

 

 

6

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**3.  Discontinued Operations.**

 

During the quarter endedJune 30, 2002, the Company decided to close its Brazilian subsidiary.Accordingly, the Company has reported the results of operations of theBrazilian subsidiary as discontinued operations in the Consolidated Statementsof Operations.

 

Certain information withrespect to the discontinued Brazilian operation for the three months and ninemonths ended September 30, 2004 and 2003 is as follows (amounts in thousands):

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|---------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                  | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                  | ** ** | **2004**               | ** ** | **2003**              | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                        |       |                   |       |                  |       |   |   |   |   |
| Net sales                                   |       | $                      | —     |                  | $          | — |   | $ | — |   | $ | — |   |
|                                        |       |                   |       |                  |       |   |   |   |   |
| Pretax loss from  discontinued operations   |       | —                 |       | 40                    |       | — |   | 160 |   |
|                                        |       |                   |       |                  |       |   |   |   |   |
| Income tax  benefit                         |       | —                 |       | (7                    | )          | — |   | (770 | ) |
|                                        |       |                   |       |                  |       |   |   |   |   |
| (Income) loss  from discontinued operations |       | $                      | —     |                  | $          | 33 |   | $ | — |   | $ | (610 | ) |

 

During the first quarter of 2003, the IRS completed its audit of theCompany’s deduction of its investment in the Brazilian operations, and othermatters.  As a result, the Companyreversed certain tax accruals resulting in a tax benefit of  $0.7 million from discontinued operations forthe year ended December 31, 2003.  SeeNote 8 — Income Taxes, below.

 

Assets and liabilities of the discontinued operation are as follows(amounts in thousands):

 
| ** **                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **                                 | ** ** | **2004**          | ** ** | **2003**         | ** ** |
| Current assets                             |       | $                 | —     |             | $          | — |   |
| Property, plant  and equipment, net        |       | —            |       | —           |       |
| Current  liabilities                       |       | (1,227            | )          | (1,208           | )          |
|                                       |       |              |       |             |       |
| Net liabilities  of discontinued operation |       | $                 | (1,227     | )                | $          | (1,208 | ) |
|                                            |            |                   |            |                  |            |  |  |  |  |

 

Current liabilities include a $1.196 million principal amount of debtpayable in relation to the Company’s discontinued Brazilian operations that wasdue on December 31, 2001.  The Company hasnot repaid the debt, pending discussions with the payee relating to settlementof the debt, but has recorded the balance of the debt, plus interest accruedthrough September 30, 2004, in its financial statements.  During the second quarter of 2003, the payeedemanded payment of the debt.  TheCompany has not paid the debt, but has chosen to continue to discuss the statusof the debt in an attempt to reach a settlement.  The Company can make no assurance that itwill be successful in negotiating such a settlement of the debt.  The Company believes that it has theliquidity available to pay the debt if the circumstances so require, assumingthat the Company’s ability to access cash through its credit facility remainsunimpeded. Nonpayment of a material obligation is an event of default under theCompany’s Amended and Restated Credit Agreement (the “Current Credit Agreement”).  The Company’s Current Credit Agreementprovides, however, that non-payment of this debt shall not be an event ofdefault, unless additional collection actions are commenced and non-payment byLancer continues for more than twenty (20) business days after Lancer hasknowledge of the additional collection action.

 

 

#### **4.   InventoryComponents.**

 

Inventories are stated at the lower of cost (on a first-in, first-outbasis for finished goods and work in process, and an average cost basis for rawmaterials and supplies) or market. Inventory components are as follows (amountsin thousands):

 

 

7

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| ** **                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------|------------|-------------------|------------|------------------|------------|
| ** **                 | ** ** | **2004**          | ** ** | **2003**         | ** ** |
| Finished goods             |       | $                 | 8,594      |             | $          | 9,327 |   |
| Work in process            |       | 6,287             |       | 6,504            |       |
| Raw material and  supplies |       | 10,484            |       | 8,671            |       |
|                       |       | $                 | 25,365     |             | $          | 24,502 |   |
|                            |            |                   |            |                  |            |  |  |  |

 

 

**5.   NetEarnings Per Share.**

 

Basic earnings per share is calculated using the weighted averagenumber of common shares outstanding and diluted earnings per share iscalculated assuming the issuance of common shares for all potential dilutivecommon shares outstanding during the reporting period.  The dilutive effect of stock optionsapproximated 126,090 and 70,879 shares for the three months ended September 30,2004 and 2003, respectively.  Thedilutive effect of stock options approximated 108,640 and 106,699 for the ninemonths ended September 30, 2004 and 2003, respectively.

 

 

**6.   StockCompensation Plans.**

 

The Company utilizes theintrinsic value method required under provisions of APB Opinion No. 25 andrelated interpretations in measuring stock-based compensation for employees. Ifthe Company had elected to recognize compensation cost based on the fair valueof the options granted at grant date as prescribed by SFAS No. 123, netearnings and net earnings per share would have been adjusted to the pro formaamounts indicated in the table below (amounts in thousands, except share data):

 
| ** **                                                                                                           | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                           | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                                                           | ** ** | **2004**               | ** ** | **2003**              | ** ** | **2004** | ** ** | **2003** | ** ** |
| Net earnings -  as reported                                                                                          |       | $                      | 5,826      |                  | $          | 574 |   | $ | 8,193 |   | $ | 487 |   |
| Add: Total  stock-based compensation expense determined under the intrinsic value method,  net of tax                |       | 8                      |       | 10                    |       | 35 |   | 37 |   |
| Deduct: Total  stock-based compensation expense determined under fair value based method for  all awards, net of tax |       | (18                    | )     | (32                   | )     | (65 | )  | (89 | )  |
| Net earnings -  pro forma                                                                                            |       | $                      | 5,816      |                  | $          | 552 |   | $ | 8,163 |   | $ | 435 |   |
| Net earnings per  basic share-as reported                                                                            |       | $                      | 0.62       |                  | $          | 0.06 |   | $ | 0.87 |   | $ | 0.05 |   |
| Net earnings per  basic share-pro forma                                                                              |       | $                      | 0.62       |                  | $          | 0.06 |   | $ | 0.87 |   | $ | 0.05 |   |
|                                                                                                                 |       |                   |       |                  |       |   |   |   |   |
| Net earnings per  diluted share-as reported                                                                          |       | $                      | 0.61       |                  | $          | 0.06 |   | $ | 0.86 |   | $ | 0.05 |   |
| Net earnings per  diluted share-pro forma                                                                            |       | $                      | 0.61       |                  | $          | 0.06 |   | $ | 0.86 |   | $ | 0.05 |   |
|                                                                                                                 |       |                   |       |                  |       |   |   |   |   |
| Weighted-average  fair value of options, granted during the period                                                   |       | $                      | —     | (1)                   | $          | — | (2) | $ | — | (1) | $ | 4.16 |   |
|                                                                                                                      |            |                        |            |                       |            |  |  |  |  |  |  |  |  |  |  |

 

The fair value of each option granted in the three and nine monthsended September 30, 2004 and 2003, respectively, is estimated on the dateof grant using the Black-Scholes option-pricing model with thefollowing assumptions:

 

 

8

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| ** **             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **             | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **             | ** ** | **2004**               | ** ** | **2003**              | ** ** | **2004** | ** ** | **2003** | ** ** |
|                   |       |                   |       |                  |       |   |   |   |   |
| Expected life  (years) |       | —                 | (1)        | —                | (2)        | — | (1) | 7 |   |
| Interest rate          |       | —                 | (1)        | —                | (2)        | — | (1) | 3.3 | % |
| Volatility             |       | —                 | (1)        | —                | (2)        | — | (1) | 47.2 | % |
| Dividend yield         |       | None                   |       | None                  |       | None |   | None |   |

 

----

(1) No options were granted during the three and nine months endedSeptember 30, 2004.

(2) No options were granted during the three months ended September 30,2003.

 

 

**7.  Comprehensive Income.**

 

The following are the components of comprehensive income (amounts inthousands):

 
| ** **                                                     | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                     | ** ** | **September 30,**      | ** ** | **September 30,**     | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                     | ** ** | **2004**               | ** ** | **2003**              | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                           |       |                   |       |                  |       |   |   |   |   |
| Net earnings                                                   |       | $                      | 5,826      |                  | $          | 574 |   | $ | 8,193 |   | $ | 487 |   |
| Foreign currency  gain (loss) arising during the period        |       | 395                    |       | 66                    |       | (335 | )  | 1,467 |   |
| Unrealized gain  on investment, net of tax                     |       | —                 |       | —                |       | — |   | 40 |   |
| Reclassification  adjustment for gain included in other income |       | —                 |       | —                |       | — |   | (45 | )  |
| Comprehensive  income                                          |       | $                      | 6,221      |                  | $          | 640 |   | $ | 7,858 |   | $ | 1,949 |   |

 

The line item, “Accumulatedother comprehensive (income) loss” on the accompanying consolidated balancesheets includes foreign currency gains, unrealized gain (loss) on investmentand unrealized loss on derivative instruments.

 

 

**8.   Income Taxes.**

 

The actual tax benefit for the three and nine months ended September30, 2004 approximates the “expected” tax expense (computed by applying U.S.Federal corporate rate of 34% to earnings before income taxes). The actual taxbenefit for the three and nine months ended September 30, 2003 differs from the“expected” tax expense primarily as a result of the factors described below.

 

In accordance with SFAS No. 109, no federal income taxes had beenprovided for the accumulated undistributed earnings of the Company’s DomesticInternational Sales Corporation (the “DISC”) as of December 31, 1992.  On December 31, 1992, the accumulatedundistributed earnings of the DISC totaled $2.4 million. During the threemonths ended March 31, 2003, the Company decided to terminate the DISC electionand recorded $0.8 million in income tax expense for the taxes due prior toDecember 31, 1992.

 

During the first quarter of 2003, the IRS completed its audit of theCompany’s deduction of its investment in the Brazilian operations, and othermatters.  As a result, the Companyreversed certain tax accruals in the three months ended March 31, 2003,resulting in an income tax benefit of $1.1 million. Of this benefit, $0.7million related to the Brazilian operations was reclassified from tax benefitsof continuing operations to tax benefits of discontinued operations for thethree months ended March 31, 2003.  SeeNote 3 — Discontinued Operations, above.

 

 

9

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**9.   Segmentand Geographic Information.**

 

The Company is engaged inthe manufacture and distribution of beverage dispensing equipment and relatedparts and components.  The Companymanages its operations geographically. Sales are attributed to a region based on the ordering location of thecustomer.

 
| ** **                             | ** ** | **North**   | ** ** | **Latin**   | ** ** | **Asia/**   | ** ** | ** ** | ** ** | ** **    | ** ** | ** ** | ** ** |
|----------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|------------|------------|---------------|------------|------------|------------|
| **(Amounts in thousands)**             | ** ** | **America** | ** ** | **America** | ** ** | **Pacific** | ** ** | **Europe** | ** ** | **Corporate** | ** ** | **Total**  | ** ** |
| ** **                             | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** **    | ** ** | ** ** | ** ** |
| Three months  ended September 30, 2004 |       |        |       |        |       |        |       |       |       |          |       |       |       |
| Total revenues                         |       | $           | 20,338     |        | $          | 1,582       |       | $          | 6,970      |          | $          | 2,374      |       | $ | — |   | $ | 31,264 |   |
| Operating income  (loss)               |       | 4,223       |       | 170         |       | 804         |       | 220        |       | (3,689        | )     | 1,728      |       |
| ** **                             | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** **    | ** ** | ** ** | ** ** |
| Three months  ended September 30, 2003 |       |        |       |        |       |        |       |       |       |          |       |       |       |
| Total revenues                         |       | $           | 20,820     |        | $          | 2,172       |       | $          | 5,392      |          | $          | 1,853      |       | $ | — |   | $ | 30,237 |   |
| Operating income  (loss)               |       | 4,709       |       | (210        | )          | 228         |       | (156       | )          | (3,911        | )          | 660        |       |
|                                   |       |        |       |        |       |        |       |       |       |          |       |       |       |
| Nine months  ended September 30, 2004  |       |        |       |        |       |        |       |       |       |          |       |       |       |
| Total revenues                         |       | $           | 59,292     |        | $          | 4,057       |       | $          | 19,793     |          | $          | 9,325      |       | $ | — |   | $ | 92,467 |   |
| Operating income  (loss)               |       | 13,948      |       | (137        | )          | 1,946       |       | 1,235      |       | (11,857       | )     | 5,135      |       |
| ** **                             | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** **    | ** ** | ** ** | ** ** |
| Nine months  ended September 30, 2003  |       |        |       |        |       |        |       |       |       |          |       |       |       |
| Total revenues                         |       | $           | 60,032     |        | $          | 5,863       |       | $          | 15,086     |          | $          | 5,500      |       | $ | — |   | $ | 86,481 |   |
| Operating income  (loss)               |       | 10,009      |       | 236         |       | 832         |       | 98         |       | (10,305       | )     | 870        |       |

 

All intercompany revenues are eliminated in computing revenues andoperating income.  The corporatecomponent of operating income represents corporate general and administrativeexpenses.

 

 

**10.****      ****Product Warranties.**

 

The Company generally warrants its products against certainmanufacturing and other defects.  Theseproduct warranties are provided for specific periods of time from the date ofsale.  As of September 30, 2004 andDecember 31, 2003, the Company has accrued $1.2 million and $0.6 million,respectively, for estimated product warranty claims.  The accrued product warranty costs are basedprimarily on actual warranty claims as well as current information on repaircosts.  Warranty claims expense for thethree and nine months ended September 30, 2004 was $0.04 million and $0.29million, respectively.  Warranty claimsexpense for the three and nine months ended September 30, 2003 was $0.25million and $0.70 million, respectively.

 
| **(Amounts  in thousands)**                                  |   |   |   |
|--------------------------------------------------------------|--------|--------|--------|
| Accrued product  warranty costs as of January 1, 2004        |   | $      | 586    |   |
|                                                         |   |   |   |
| Liabilities  accrued for warranties issued during the period |   | 938    |   |
|                                                         |   |   |   |
| Warranty claims  paid during the period                      |   | (288   | )      |
|                                                         |   |   |   |
| Accrued product  warranty costs as of September 30, 2004     |   | $      | 1,236  |   |

 

 

**11.  OtherGuaranties.**

 

On January 31, 2003, Lancer FBD Partnership, Ltd., apartnership in which the Company owns a 50% partnership interest, obtained a$1.5 million revolving credit facility from a bank.  The Company entered into a ContinuingGuarantee Agreement with the lender pursuant to which it guaranteed therepayment of the partnership’s debt.  Inaccordance with FIN 45, the Company has recorded a liability of $22,500, whichrepresents the estimated value of the guaranty. As of September 30, 2004, there were no amounts outstanding under thecredit facility.

 

 

10

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On March 5, 2003, Moo Technologies, LLC, a limitedliability company in which the Company owns 50% of the outstanding equity,obtained a $0.75 million revolving credit facility from a bank.  The Company entered into a CommercialGuarantee with the lender pursuant to which it guaranteed the repayment of theMoo Technologies, LLC debt.  The Companyrecorded a liability of $11,250 in 2003, which represents the estimated valueof the guaranty.  As of September 30,2004, the balance of the credit facility was $0.75 million.  Moo Technologies, LLC is a developmentalstage company that reported no operating revenue in 2003 and the first ninemonths of 2004.  Moo Technologies, LLCincurred a net loss of $0.3 million in 2003, and a net loss of $0.4 million inthe first nine months of 2004.  TheCompany invested $0.2 million in Moo Technologies, LLC during the first ninemonths of 2004, bringing its net investment in the company to $0.3 million asof September 30, 2004.

 

 

**12.****      ****Other Matters.**

 

In June 2003, the AuditCommittee of the Company’s Board of Directors (the “Audit Committee”) beganconducting an internal investigation (the “Investigation”). The Investigationwas related to allegations raised by a lawsuit against The Coca-Cola Company bya former Coca-Cola employee, Matthew Whitley. Although the Company was not adefendant to the lawsuit, certain allegations contained in the lawsuitspecifically involved the Company. The Investigation was later expanded toinclude allegations raised in certain press articles.

 

The Company’s formerindependent auditor advised that, until the Investigation was complete, itwould not be able to complete its review of the Company’s consolidatedfinancial statements for the second and third quarters of 2003. Therefore, theCompany was unable to file its quarterly reports for the second and thirdquarters of 2003 with the Securities and Exchange Commission (the “SEC”). OnDecember 5, 2003, the Company provided financial information for the second andthird quarters of 2003 in exhibits to a Form 8-K, in order to provideinformation to the investing public while the Investigation continued.

 

The Company’s inabilityto file its quarterly report for the second quarter of 2003 with the SEC on atimely basis violated the American Stock Exchange (“AMEX”) continued listingstandards, specifically Section 1003(d) of the AMEX Company Guide. The Companysubmitted a formal action plan to regain compliance with AMEX on September 30,2003 and AMEX accepted the plan on October 8, 2003. After the initialacceptance, the Company revised the plan with the approval of AMEX in order toaccommodate new developments, including the Company’s inability to file itsannual report on Form 10-K for 2003 and its quarterly report on Form 10-Q forthe first quarter 2004.

 

In August 2003, theUnited States Attorney’s Office for the Northern District of Georgia (the “USAttorney’s Office”) informed the Company that it was conducting aninvestigation arising from allegations raised in a lawsuit against TheCoca-Cola Company by a former Coca-Cola employee, Matthew Whitley, andrequested certain information, which the Company supplied. In January 2004, theCompany received written notice that the SEC had issued a formal order ofinvestigation that appeared to concern matters which were the subject of theInvestigation. The Company has fully cooperated, and intends to continue tocooperate fully, with both the US Attorney’s Office and the SEC investigations.Although the Company is unable at this point to predict the scope or outcome ofthese investigations, it is possible that it could result in the institution ofadministrative, civil injunctive or criminal proceedings, the imposition offines and penalties, and/or other remedies and sanctions.  The conduct of these proceedings couldadversely affect the Company’s business. In addition, the Company expects tocontinue to incur expenses associated with responding to these agencies,regardless of the outcome, and the efforts and attention of the Company’smanagement team may be diverted from normal business operations. This couldadversely affect the business, financial condition, operating results, and cashflow of the Company.

 

On January 30, 2004, theCompany announced that the Investigation had concluded and the Audit Committeereleased a general summary of the Investigation findings. On February 2, 2004,our former auditor resigned from its position and subsequently withdrew itsaudit reports for the periods ended December 31, 2002, 2001 and 2000, advisingthe Company that the financial statements and related audit reports should nolonger be relied upon. The former auditors stated in a letter to the Companythat it had determined that likely “illegal acts”, which had been the subjectof the Investigation, had come to its attention and that these illegal actswould have a material effect on the Company’s financial statements.Additionally, our former auditor indicated that information had come to itsattention that caused it to conclude that the Company’s accounting for revenuerecognition in connection with sales of 

 

 

11

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equipment to Coca-ColaNorth America Fountain in the years ended December 31, 2001 and 2002 is “notcorrect” and had raised concerns that the accounting is not correct in each ofthe three quarters of fiscal year 2003. The Company has filed the letters fromits former auditors which outline these assertions and have responded to themin an 8-K, filed with the SEC on February 10, 2004, and two subsequentamendments to that Form 8-K, filed with the SEC on February 24, 2004 and March10, 2004.

 

On May 14, 2004, apurported class action, cause number 04-CV-427, naming as defendants theCompany, George F. Schroeder, David F. Green and The Coca-Cola Company wasfiled in the United States District Court for the Western District of Texas byTDH Partners. The action alleges that the defendants violated Sections 10(b) and20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgatedthereunder. No specific amount of damages was claimed and the action wasvoluntarily dismissed by the plaintiff, without prejudice, on July 15, 2004.See “*Part II — Other Information — Item 1 — LegalProceedings*.”

 

On March 1, 2004, theAudit Committee engaged BDO Seidman as the Company’s new independent auditor toaudit the Company’s financial information for 2003, as well as for priorperiods for which the former auditor had withdrawn its audit reports, and toreview financial information for prior quarterly periods. This process of auditand review was completed by BDO Seidman on June 16, 2004, which enabled Lancerto file all past due and current periodic reports with the SEC on July 1, 2004and to regain compliance with Section 1003(d) of the AMEX Company Guide. Thereaudit did not result in any adjustment to the Company’s previously disclosedfinancial statements for the prior periods.

 

Due to its inability todeliver audited financial statements for the year 2003 to its lenders and otherevents and circumstances, the Company was in default under the terms of theSeventh Amendment and Restated Credit Agreement, as amended (the “Former CreditAgreement”). Due mainly to certain “cross-default” provisions, the Company alsocame into default under certain of its guaranties and a capital lease.

 

Effective June 30, 2004, the Company and its lenders entered into theCurrent Credit Agreement.  The knowndefaults under the Company’s guarantees and capital lease have been waived asof June 30, 2004. For further discussion relating to the Former CreditAgreement and the Current Credit Agreement, see Part I — Financial Information —Item 2 — “*Management’s Discussion and Analysis of Financial Conditionand Results of Operations — Liquidity and Capital Resources — Debt.”*

 

On September 13, 2004, the Company entered into an agreement with TheCoca-Cola Company relating to the joint development of the iFountain line ofdispensers.  Pursuant to the agreement,The Coca-Cola Company paid Lancer a total of $7.0 million in consideration of(i) Lancer’s engineering, research and development and other costs incurred byLancer on the project,  (ii) Lancer’sinventory related to the project that could not be used as intended and did nothave feasible alternate uses, and (iii) certain covenants and releases relatingto the project.  Lancer had previouslywritten-off $1.2 million of inventory associated with the project during thefourth quarter of 2003.  The Companyrecorded the $7.0 million payment as other income when it received the paymentin the third quarter of 2004.

 

 

## **Item 2 -Management’s Discussion And Analysis Of Financial Condition And Results OfOperations.**

 

This report containscertain “forward-looking statements” within the meaning of Section 27A of theSecurities Act of 1933, as amended, and Section 21E of the Securities ExchangeAct of 1934, as amended. The Company desires to take advantage of the “safeharbor” provisions of the Private Securities Litigation Reform Act of 1995 andis including this statement for the expressed purpose of availing itself of theprotection of the safe harbor with respect to all of such forward-lookingstatements. These forward-looking statements describe future plans orstrategies and include the Company’s expectations of future financial resultsand often include words such as “may,” “will,” “should,” “expect,” “intend,” “estimate,”“anticipate,” “believe,” “predict,” “plan,” “potential,” and “continue,” andthe negatives of these terms and variations of them or similar terminology. TheCompany’s ability to predict results or the effect of future plans orstrategies is inherently uncertain and the Company can give no assurance thatthose results or expectations will be attained. Factors that could affectactual results include but are not limited to:

 

 

12

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•                  general economic trends;

•                  ability to service its debt;

•                  availability of capital sources;

•                  currency fluctuations;

•                  fluctuations in operating costs;

•                  competitive practices in the industry in which itcompetes;

•                  changes in labor conditions;

•                  its capital expenditure requirements;

•                  technological changes and innovations;

•                  legislative or regulatory requirements;

•                  operating changes and product needs of its maincustomer, The Coca-Cola Company;

•                  losses from litigation; and

•                  all other factors described herein under “RiskFactors.”

 

These and other factorsshould be considered in evaluating the forward-looking statements, and unduereliance should not be placed on such statements.

 

The Company does notundertake and specifically disclaims any obligation to update anyforward-looking statements to reflect occurrence of anticipated orunanticipated events or circumstances after the date of such statements.

 

Thefollowing discussion should be read in connection with the Company’sConsolidated Financial Statements, related notes and other financialinformation included elsewhere in this document.

 

 

**Overview**

 

***General****.*  Lancer Corporation (“Lancer” or the “Company”)designs, engineers, manufactures and markets fountain soft drink, beer andcitrus beverage dispensing systems, and other equipment for use in the foodservice and beverage industry.  TheCompany also markets frozen beverage dispensers manufactured by Lancer FBDPartnership, Ltd. (“Lancer FBD”), a partnership in which the Company owns a 50%partnership interest.  The Company’sproducts are sold by Company personnel and through independent distributors andagents principally to major soft drink companies (primarily The Coca-ColaCompany, which influences substantially more than half of the Company’s sales),bottlers, equipment distributors, beer breweries, restaurants and conveniencestores for use in various food and beverage operations. The Company’s primarymanufacturing and administrative facility is located in San Antonio, Texas. TheCompany has sales employees, distributors, and/or licensees in Latin America,Europe, Africa and Asia. The Company manufactures products in Australia andMexico, and operates warehouses in Belgium, New Zealand, and the UnitedKingdom.

 

The Company is a vertically integrated manufacturer whose tooling,production, assembly and testing capabilities enable it to fabricate asubstantial portion of the components used in Company products.  In addition, the Company is an innovator ofnew products in the beverage dispensing industry and has a large technicalstaff supported by state-of-the-art engineering facilities to develop these newproducts and to enhance existing product lines in response to changing industryrequirements and specific customer demands.

 

 The Company’s products can bedivided into four major categories: (i) fountain soft drink, citrus, and frozenbeverage dispensers, which includes a broad range of mechanically cooled andice cooled soft drink and citrus dispensing systems; (ii) post-mix dispensingvalves, which mix syrup and carbonated water at a preset ratio; (iii) beerdispensing systems and related accessories; and (iv) other products andservices, which includes various dispensing systems and replacement parts inconnection with the remanufacturing process.

 

***Events****.* OnJanuary 30, 2004, the Company announced that the Audit Committee of its Boardof Directors (the “Audit Committee”) had concluded its internal investigation(the “Investigation”) and released a general summary of the Investigationfindings. On February 2, 2004, the Company’s former auditor resigned from itsposition and subsequently withdrew its audit reports for the periods endedDecember 31, 2002, 2001 and 2000, advising the Company that the financialstatements and related audit reports should no longer be relied upon.

 

 

13

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On March 1, 2004, the Audit Committee engaged BDO Seidman as theCompany’s new independent auditor to audit the Company’s financial informationfor 2003, as well as for prior periods for which the former auditor hadwithdrawn its audit reports, and to review financial information for prior quarterlyperiods. This process of audit and review was completed by BDO Seidman on June16, 2004. The reaudit did not result in any adjustment to the Company’spreviously disclosed financial statements for the prior periods.

 

On July 1, 2004, theCompany filed the following reports with the SEC: Form 10-K/A for the 2002fiscal year, Form 10-Q/A for the 2003 first quarter, Forms 10-Q for the 2003second and third quarters, Form 10-K for the fiscal year 2003 and Form 10-Q forthe 2004 first quarter. The filing of these reports enabled the Company tobecome current in its filing obligations with the SEC and to regain compliancewith Section 1003(d) of the AMEX Company Guide.

 

Effective June 30, 2004, the Company and its lenders entered into thenew Credit Facility, providing for, among other things a waiver for all pastdefaults under the prior Credit Facility. See Part I — Financial Information — Item 2 — “*Management’sDiscussion and Analysis of Financial Condition and Results of Operations —Liquidity and Capital Resources — Debt.”*

 

On September 13, 2004, the Company entered into an agreement (the “SettlementAgreement”) with The Coca-Cola Company relating to the joint development of theiFountain line of dispensers.  Pursuantto the Settlement Agreement, The Coca-Cola Company paid Lancer a total of $7.0million in consideration of (i) Lancer’s engineering, research and developmentand other costs incurred by Lancer on the project,  (ii) Lancer’s inventory related to theproject that could not be used as intended and did not have feasible alternateuses, and (iii) certain covenants and releases relating to the project.  Lancer had previously written-off $1.2million of inventory associated with the project during the fourth quarter of2003.  The Company recorded the $7.0million payment as other income when it received the payment in the thirdquarter of 2004.

 

***Accounting Policies****.*The Company has listed what it believes to be its mostimportant accounting policies below.  See “*Management’s Discussion and Analysis of FinancialCondition and Results of Operations — Critical Accounting Policies” and “*Note1 — Summary of Significant Accounting Policies in the Notes to ConsolidatedFinancial Statements” contained in the 2003 Annual Report on Form 10-K filedwith the SEC on July 1, 2004.

 

*Revenue Recognition.* Revenue is recognized in accordance with thefollowing methods:

 

(a)           At the time of shipment for allproducts except for those sold under agreements described in (b).  The Company requires a purchase order for allsales. At the time of the shipment, risk of ownership and title passes to thecustomer. The goods are completely assembled and packaged and the Company hasno further performance obligations.

 

(b)           As produced and attime of title transfer, for certain products manufactured and warehoused underproduction and warehousing agreements with certain customers.  The Company had no such arrangements afterMarch 31, 2002.

 

(c)           The Company has entered into anagreement with its major customer to receive partial reimbursement for designand development.  The reimbursement isoffset against cost on a percentage of completion basis.

 

(d)           The Company hasagreed to provide exclusive rights for use of certain tools to its majorcustomer.  These tools are included infixed assets and are depreciated over the life of the asset.  The corresponding license and maintenancefees are recorded as deferred income and recognized over the life of theagreement, which approximates the life of the corresponding asset.

 

*Reserve for Slow Moving and Obsolete Inventory.* The Companyprovides for slow moving inventory based on an analysis of the age and usage ofthe inventory. Additionally, management evaluates the inventory forobsolescence, and adds to the inventory reserve as appropriate.  The Company believes that the reserve as ofSeptember 30, 2004 is adequate to provide for expected losses.

 

 

14

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**Resultsof Operations**

 

***Comparison of the Three-Month Periods Ended September 30, 2004 and 2003***

 

Non-RecurringPayment:  During the third quarter of2004, the Company recorded other income of $7.0 million from the SettlementAgreement.

** **

Revenues by Geographic Segment

(Amounts in thousands)

 
| ** **    | ** ** | **Quarter Ended September 30,** | ** ** | **% Change**      | ** ** |
|---------------|------------|---------------------------------|------------|-------------------|------------|
| ** **    | ** ** | ** **                      | ** ** | **Third Quarter** | ** ** |
| ** **    | ** ** | **2004**                        | ** ** | **2003**          | ** ** | **2004 vs 2003** | ** ** |
| North America |       | $                               | 20,338     |              | $          | 20,820 |   | -2 | % |
| Latin America |       | 1,582                           |       | 2,172             |       | -27 | % |
| Asia/Pacific  |       | 6,970                           |       | 5,392             |       | 29 | % |
| Europe        |       | 2,374                           |       | 1,853             |       | 28 | % |
|          |       | $                               | 31,264     |              | $          | 30,237 |   | 3 | %  |

 

*Revenues*. Net sales for the three months ended September 30, 2004 were $31.3million, up 3% from sales in the third quarter of 2003.  Currency exchange rate fluctuations had apositive impact of 2% on 2004 third quarter sales.  In the North America region, quarterly salesdeclined 2% from 2003 levels, due mainly to a decline in the Company’s sales tosoft drink bottlers during the third quarter of 2004.  Sales fell 27% in the Latin America region,due mainly to a continued weakening demand for our products in the region.  Market conditions appear likely to remainweak in most of Latin America.  Salesrose 32% in the Asia/Pacific region, including the positive effect of 9% fromexchange rate fluctuations.  Most of theimprovement in the Asia/Pacific region came in Australia, where beer andfountain equipment sales were strong. Some of the strength in Australian fountain sales is attributable to alarge project for a single customer that is not expected to recur in 2005.  Sales in the Europe region increased 28%,including an 11% positive effect from currency fluctuations.  Valve sales increased in Europe, afterproduction issues with one of the Company’s valve products negatively impactedsales in the Europe region in the 2003 period. Incremental sales in the UnitedKingdom, where Lancer established an operation in 2003, also contributed to theimprovement in the Europe region.

 

*GrossMargin*.  Gross margin was 28.5% in the third quarterof 2004, compared to 27.7% in the same period last year.  During the third quarter of 2004, the Companyincurred a charge of $0.6 million for the impairment of certain inventory.  Additionally, the Company experienced risingcosts for certain raw materials including stainless steel and plasticresin.  Those negative factors were morethan offset by the positive effects of manufacturing cost reductions, includinga reduction in the number of manufacturing employees, improved manufacturingefficiency, and a shift of some operations to a lower cost facility.

 

*OperatingExpenses*.  Selling, general and administrative expenseswere $7.2 million in the third quarter of 2004, compared to $7.7 million in thethird quarter of 2003.  During the 2004quarter, professional fees declined $1.1 million from 2003 levels.  The higher spending in 2003 related to theinvestigations conducted by the Securities and Exchange Commission, the UnitedStates Attorney’s Office, and the Audit Committee.  Compensation expense increased $0.7 millionin the three months ended September 30, 2004, due mainly to variablecompensation accruals based on the Company’s performance in 2004.

 

*Non-OperatingIncome/Expenses.*  The following information relates to certainof the Company’s non-operating income and expenses during the three-monthperiods ended September 30, 2004 and 2003:

 

•                  Other income included $7.0 million paid to Lancerpursuant to the Settlement Agreement. See Part I — Financial Information — Item 2 — *“Management’sDiscussion And Analysis Of Financial Condition And Results Of Operations —Overview — Events.”* Additionally, the Company wrote-off certain tooling and related deferredlicensing and maintenance fees, resulting in $0.4 million (net) of income.  The Company also wrote-off $0.4 million oftooling from another project, and $0.2 million of capitalized bank facilityclosing costs during the third quarter of 2004.

 

 

15

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•                  Interest expense was $0.2 million in the third quarterof 2004, up from $0.1 million in the third quarter last year.  The increase was caused by higher averageinterest rates on the Company’s borrowings.

•                  Income from joint ventures was $0.6 million in thethird quarter of 2004, compared to $0.4 million in the same period of2003.  The improvement in 2004 was drivenby the profitability of Lancer FBD.  MooTechnologies LLC is a developmental stage limited liability company in whichthe Company owns 50% of the outstanding equity. Lancer’s portion of Moo Technologies’ net loss was $0.1 million in thethird quarter of 2004 and 2003.  TheCompany expects Moo Technologies to be unprofitable for at least the next twoquarters.

•                  The effective tax rate in the third quarter of 2004was 34.5%, compared to 37.0% in the third quarter of 2003.  The Company’s lower level of profitability inthe third quarter of 2003 enhanced the impact of nondeductible expenses on thetax rate.

 

*NetEarnings/Loss*.  Net earnings were $5.8 million in the thirdquarter of 2004, compared to $0.6 million in the third quarter of 2003.  The $7.0 million ($4.6 million net of tax) ofother income relating to the Settlement Agreement caused most of theimprovement in profitability.

 

***Comparison of the Nine-Month Periods Ended September 30, 2004 and 2003***

 

Non-RecurringPayment:  During the nine months endedSeptember 30, 2004, the Company recorded other income of $7.0 million from theSettlement Agreement.

 

Revenues by Geographic Segment

(Amounts in thousands)

 
| ** **    | ** ** | **Nine Months Ended September 30,** | ** ** | **% Change**          | ** ** |
|---------------|------------|-------------------------------------|------------|-----------------------|------------|
| ** **    | ** ** | ** **                          | ** ** | **First Nine Months** | ** ** |
| ** **    | ** ** | **2004**                            | ** ** | **2003**              | ** ** | **2004 vs 2003** | ** ** |
| North America |       | $                                   | 59,292     |                  | $          | 60,032 |   | -1 | % |
| Latin America |       | 4,057                               |       | 5,863                 |       | -31 | % |
| Asia/Pacific  |       | 19,793                              |       | 15,086                |       | 31 | % |
| Europe        |       | 9,325                               |       | 5,500                 |       | 70 | % |
|          |       | $                                   | 92,467     |                  | $          | 86,481 |   | 7 | % |

 

*Revenues*. Net sales for the first nine months of 2004 were $92.5 million, up 7%from sales in the same period of 2003. Currency exchange rate fluctuations had a positive impact of 3% on netsales for the nine months ended September 30, 2004.  In the North America region, sales declined1% in the first three quarters of 2004, due to a decline in the Company’s salesto soft drink bottlers during the 2004 period. Sales fell 31% in the Latin America region, including the negativeimpact from currency exchange rate movements of 5%, due to continued weakeningof demand for our products in the region. Market conditions appear likely to remain weak in Latin America.  In the Asia/Pacific region, sales rose 31%,aided by a positive impact from currency exchange rates of 16%.  Most of the sales growth in the Asia/Pacificregion occurred in Australia, where beer and fountain equipment sales werestrong.  Some of the strength inAustralian fountain sales is attributable to a large project for a singlecustomer that is not expected to recur in 2005. Sales in the Europe region rose 70%, including a 16% positive effectfrom currency fluctuations.  Valve salesincreased in Europe, after production issues with one of the Company’s valveproducts negatively impacted sales in the Europe region in the 2003period.  Incremental sales in the UnitedKingdom, where Lancer established an operation in 2003, also contributed to theimprovement in the Europe region.

 

*GrossMargin*.  Gross margin was 30.0% in the first ninemonths of 2004, compared to 25.3% in the same period of 2003.  During the 2004 period, the Company incurreda charge of $0.6 million for the impairment of certain inventory.  Additionally, the Company experienced risingcosts for certain raw materials including stainless steel and plasticresin.  Those negative factors were morethan offset by manufacturing cost reductions, including a reduction in thenumber of manufacturing employees, improved manufacturing efficiency, and ashift of some operations to a lower cost facility.

 

 

16

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*OperatingExpenses*.  Selling, general and administrative expenseswere $22.6 million in the first nine months of 2004, compared to $21.0 millionin the same period of 2003.  During the2004 period, compensation expense rose $1.6 million, due mainly to variablecompensation accruals based on the Company’s performance in 2004.   Additionally, professional fees increased$0.5 million, as increased costs from the re-audit of the years 2000, 2001 and2002 were partially offset by a decline in legal fees.

 

*Non-OperatingIncome/Expenses. *The following information relates tocertain of the Company’s non-operating income and expenses during thenine-month periods ended September 30, 2004 and 2003:

 

•                  Other income includes $7.0 million paid to Lancerpursuant to the Settlement Agreement. See Part I — Financial Information — Item 2 — *“Management’sDiscussion And Analysis Of Financial Condition And Results Of Operations —Overview — Events.”* Additionally, the Company wrote-off certain tooling and related deferredlicensing and maintenance fees, resulting in $0.4 million (net) of income.  The Company also wrote-off $0.4 million oftooling from another project.  Finally,other income includes a $0.4 million gain relating to insurance proceeds from aclaim that occurred in 2003, partially offset by the write-off of $0.2 millionof capitalized bank facility closing costs during 2004.

•                  Interest expense was $0.5 million in the first threequarters of 2004, up from $0.4 million in the same period of 2003.  Higher average interest rates on the Company’sborrowings were only partially offset by lower average borrowings.

•                  Income from joint ventures was $0.8 million in thefirst nine months of 2004, compared to a loss of $0.1 million in the sameperiod last year.  The improvement in2004 was driven by the profitability of Lancer FBD.  During the first quarter of 2004, one ofLancer FBD’s customers agreed to reimburse it for $0.5 million of inventorythat had been impaired during 2003. Lancer’s portion of Moo Technologies’ netloss was $0.2 million in the nine-month periods ended September 30, 2004 and2003.  The Company expects MooTechnologies to be unprofitable for at least the next two quarters.

•                  The effective tax rate was 35.0% in the first ninemonths of 2004.  During the same periodof 2003, the Company recorded a $0.8 million charge to income tax expensestemming from the decision to terminate the DISC election for the Company’ssubsidiary that exports products from the United States. Additionally, theInternal Revenue Service completed its audit of the Company’s deduction of itsinvestment in Brazil, and other matters. As a result of the resolution, Lancerreversed certain tax accruals, resulting in an income tax benefit of$0.4 million.

 

*NetEarnings/Loss*.  Net earnings were $8.2 million in the firstthree quarters of 2004, compared to $0.5 million in the same period of 2003,due primarily to $7.0 million ($4.6 million net of tax) of other incomerelating to the Settlement Agreement. Higher sales and a higher gross margin also contributed to the improvedprofitability in the 2004 period.

 

**Outlook**

 

Duringthe first nine months of 2004, the Company incurred $1.1 million of expensesrelating to the Investigation, the investigations conducted by the SEC and theUS Attorney’s Office, and the negotiation of the Company’s amended and restatedcredit facility.  The Company expects tocontinue to incur expense from the investigations conducted by the SEC and theUS Attorney’s Office and related matters during 2004.  Additionally, the Company incurred $1.2million of expense in the first six months of 2004 from the audit of theCompany’s financial statements for fiscal years 2000, 2001, 2002 and 2003.  Audit expense approximated historical levelsduring the third quarter of 2004.  TheCompany expects audit expense to approximate historical levels for theremainder of 2004 as well.

 

 

**Liquidityand Capital Resources**

 

*General.*  The Company’s principal sources of liquidityare cash flows from operations and amounts available under the Company’s linesof 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 andborrowings under its credit facilities.

 

 

17

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*CashProvided by Operations and Capital Expenditures.*  Cash providedby operating activities was $12.4 million in the first nine months of 2004,compared to $2.5 million in the same period of 2003.  The improvement in 2004 was caused largely bythe Company’s profitability (which was driven by $7.0 million of other incomerelating to the Settlement Agreement), and by increases in accounts payable,accrued expenses, and income taxes payable. The Company made capital expenditures of $1.5 million during the firstnine months of 2004, primarily for equipment and tooling.  Capital expenditures were $3.1 million duringthe nine months ended September 30, 2003, and included spending for theexpansion of a production facility in Piedras Negras, Mexico, and for equipmentand tooling.  The Company currently hasno plans for major capital projects.

 

*Debt.*  The Companyhas a $1.196 million principal amount of debt payable in relation to theCompany’s discontinued Brazilian operations that was due on December 31, 2001.  The Company has not repaid the debt, pendingdiscussions with the payee relating to settlement of the debt, but has recordedthe balance of the debt plus interest accrued through September 30, 2004 in itsfinancial statements.  During the secondquarter of 2003, the payee demanded payment of the debt.  The Company has not paid the debt, but haschosen to continue to discuss the status of the debt in an attempt to reach asettlement.  The Company can make noassurance that it will be successful in negotiating such a settlement of thedebt.  The Company believes that it hasthe liquidity available to pay the debt if the circumstances so require,assuming that the Company’s ability to access cash through its credit facilityremains unimpeded. Nonpayment of a material obligation is an event of defaultunder the Company’s Amended and Restated Credit Agreement (the “Current CreditAgreement”).  The Current CreditAgreement provides, however, that non-payment of this debt shall not be anevent of default, unless additional collection actions are commenced andnon-payment by Lancer continues for more than twenty (20) business days afterLancer has knowledge of the additional collection action.

 

Prior to June 30, 2004, the Company, along with certain of itssubsidiaries, was a party to the Seventh Amendment and Restated CreditAgreement (the “Former Credit Agreement”), which provided for a term loan inthe aggregate amount of $14.8 million, consisting of $12.9 million in Term Aloans and $1.9 million in Term B loans and a $25.0 million revolving loanamount (the “Former Credit Facility”) with The Frost National Bank as theAdministrative Agent and as a lender (“Frost”), Harris Trust and Savings Bank (“Harris”)and Whitney National Bank (“Whitney” and together with Frost and Harris, the “Lenders”).Due to the Company’s inability to deliver audited financial statements for theyear 2003 to its lenders and certain other events and circumstances, theCompany came into default under the terms of its Former Credit Agreement.

 

Effective June 30, 2004, the Company and the Lenders came to terms on anew credit facility (the “Credit Facility”) which replaced the Former CreditFacility and entered into the Current Credit Agreement, which provides for (i)aggregate term loans in the amount of $9.0 million, consisting of $8.2 millionin Term A loans and $0.8 million in Term B loans (the Term A and Term B loansare referred to herein as the “Term Loans”), and (ii) a $10.0 million revolvingloan amount (the “Line of Credit”). The Term Loan amounts were based on theexisting balances of the Former Credit Facility.

 

As of September 30, 2004, the outstanding balance on the Line of Creditwas zero, with unused availability of $10.0 million.  The Company had cash of $10.5 million. Theterm loans had a combined September 30, 2004 balance of $8.3 million.

 

Principal balances outstanding under the Credit Facility bear interestper annum at the sum of the base rate plus 2.0%.  The base rate is defined as the greater of(i) the variable rate per annum (as established by Frost from time to time asits corporate base rate for short-term commercial loans to corporate buyers)and (ii) the overnight cost of funds of Frost as determined solely by Frost,plus a margin of 0.5% per annum.  AtSeptember 30, 2004, the weighted average interest rate of borrowingsoutstanding under the Credit Facility was 6.75%.  Interest on base rate loans is payable on thelast day of each quarter.  The Companypays a quarterly fee on the average availability under the Line of Credit basedon an annual rate of 0.2%.

 

The Credit Facility requires quarterly payments of $275,000 on the TermA loans and $75,000 on the Term B loans beginning on June 30, 2004, providedthat the Term loans are paid in full on or before July 15, 2005.   TheLine of Credit expires on January 31, 2005.

 

 

18

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Subject to certain conditions, mandatory prepayments of the Term A loanare required to be made with portions of the proceeds from the issuance or saleof any indebtedness as defined in the Credit Agreement.  A mandatory payment on the outstanding amountunder the Line of Credit is required if such outstanding amount exceeds theConsolidated Borrowing Base (as defined in the Credit Agreement), which is determinedbased on certain percentages of accounts receivable and inventory.

 

The Credit Facility contains financial covenants which includelimitations on indebtedness and the maintenance of certain financial ratios, asdefined in the Credit Facility, and is collateralized by substantially all ofthe Company’s assets in the United States. At September 30, 2004, the Companywas in compliance with these covenants.

 

*Subsequent Events*.  In October2004, the Company and a new lender agreed upon general terms for a new creditfacility to replace the existing Credit Facility.  According to these general terms, thecontemplated new credit facility would consist of a $15.0 million revolvingfacility due in three years, the borrowings would be secured by certain domesticaccounts receivable, inventory, equipment, and real estate, and financialcovenants would require the Company to maintain a minimum current ratio and networth, and a maximum ratio of funded debt to EBITDA.  The Company believes it will enter into a definitivecredit facility in the fourth quarter of 2004, but it can make no assurancethat it will do so.  If it is unable toenter into a new credit facility, the Company will not have access to arevolving facility for liquidity after the existing revolving facility expireson January 31, 2005, which could affect the Company’s ability to finance itsgrowth.  Additionally, the Company mightnot have sufficient cash on hand to retire the Term loans when they expire onJuly 15, 2005.  Because it believes it willbe successful in entering into a new credit facility, the Company isclassifying its term debt as long term despite the fact that it expires in lessthan one year.

 

Also in October 2004, the Company used cash on hand to make unscheduledprincipal payments of $6.0 million on its long-term debt.

 

At September 30, 2004 and December 31, 2003, long-term obligationsconsisted of the following:

 
| ** **                    | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-------------------------------|------------|-------------------|------------|------------------|------------|
| **(Amounts in thousands)**    | ** ** | **2004**          | ** ** | **2003**         | ** ** |
|                          |       |              |       |             |       |
| Credit facility -  term loans |       | $                 | 8,337      |             | $          | 9,386 |   |
| Other                         |       | 1,513             |       | 1,617            |       |
| Total long-term  obligations  |       | 9,850             |       | 11,003           |       |
| Less: Current  maturities     |       | 2,743             |       | 2,735            |       |
| Long-term  obligations, net   |       | $                 | 7,107      |             | $          | 8,268 |   |

 

 

**Off-BalanceSheet Arrangements**

 

TheCompany owns 50% of Lancer FBD, a manufacturer of frozen beverage dispensingequipment.  The Company guaranteesrepayment of Lancer FBD’s $1.5 million facility with a bank.  Lancer’s portion of Lancer FBD’s net loss in2003 was $0.1 million, and its share of Lancer FBD’s net income in the ninemonths ended September 30, 2004 was $1.0 million.  As of September 30, 2004, there were noamounts outstanding under the credit facility.

 

TheCompany owns 50% of Moo Technologies, a company engaged in thecommercialization of milk products.  TheCompany has guaranteed repayment of Moo Technologies’ $0.75 million revolvingcredit facility with a bank. As of September 30, 2004, the balance of thecredit facility was $0.75 million. Lancer’s portion of Moo Technologies’ netloss was $0.2 million in 2003 and in the first nine months of 2004.  The Company invested $0.2 million in MooTechnologies, LLC during the first nine months of 2004, bringing its netinvestment in the company to $0.3 million as of September 30, 2004.  The Company expects Moo Technologies to be unprofitablefor at least the next two quarters.

 

 

19

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**RiskFactors**

 

***RelianceUpon The Coca-Cola Company***

 

Substantially more thanhalf of the Company’s sales are derived from or influenced by The Coca-Cola Company.Direct sales to The Coca-Cola Company, the Company’s largest customer,accounted for approximately 28%, 35% and 36% of the Company’s net sales for theyears ended December 31, 2003, 2002 and 2001, respectively. The Company doesnot have a long-term supply contract with The Coca Cola Company or its any ofits other customers. As a result, The Coca Cola Company has the ability toadversely affect, directly or indirectly, the volume and price of the productssold by the Company. While the Company does not anticipate the loss orreduction in this business or the imposition or significant price constraintsbased upon Lancer’s past experience and current relations with The Coca ColaCompany, any such occurrence would have a material adverse effect upon the Companyand its results of operation.

 

***Weare Subject to a Formal SEC Inquiry and an Investigation by the US Attorney.***

 

In August 2003, the USAttorney’s Office informed the Company that it was conducting an investigationarising from allegations raised in a lawsuit against The Coca-Cola Company by aformer Coca-Cola employee, Matthew Whitley, and requested certain information,which the Company supplied. In January 2004, the Company received writtennotice that the SEC had issued a formal order of investigation that appeared toconcern matters which were the subject of the Investigation. The Company hasfully cooperated, and intends to continue to fully cooperate, with both the USAttorney’s Office and the SEC investigations. Although the Company is unable atthis point to predict the scope or outcome of these investigations, it ispossible that it could result in the institution of administrative, civilinjunctive or criminal proceedings, the imposition of fines and penalties,and/or other remedies and sanctions.  Theconduct of these proceedings could adversely affect the Company’s business. TheCompany expects to continue to incur expenses associated with responding tothese agencies, regardless of the outcome, and the efforts and attention of theCompany’s management team may be diverted from normal business operations whichcould, in turn adversely affect the Company’s business, financial condition,operating results, and cash flow. The Company cannot predict when the SEC willconclude its inquiry, or the outcome and impact thereof.

 

In addition, under the terms of the Credit Facility, certaingovernmentally imposed fines or cease and desist orders are an event of defaultand could result in the termination of the loan commitments and acceleration ofthe outstanding debt thereunder. Such termination and acceleration of theCredit Facility could adversely affect the Company’s business, financialcondition, operating results and cash flow. See Part I — Financial Information —Item 2 — “*Management’s Discussion and Analysis of FinancialCondition and Results of Operations — Liquidity and Capital Resources — Debt*”**for more information relating to the Credit Facility.

 

Finally, the Company’sfuture success depends in large part on the support of its suppliers and customers,who may react adversely to the ongoing investigation by the SEC and USAttorney.  Negative publicity about theCompany may cause some of our potential customers to defer purchases of ourproducts. The Company’s vendors and suppliers may re-examine their willingnessto do business with the Company if they lose confidence in its ability tofulfill its commitments.

 

 

***The Company has been the Target of Securities Litigation and May AgainBe the Target of Further Actions, Which May Be Costly and Time Consuming toDefend.***

 

On May 14, 2004, a purported class action naming as defendants theCompany, George F. Schroeder, David F. Green and The Coca-Cola Company wasfiled in the United States District Court for the Western District of Texas. OnJuly 15, 2004, the plaintiff’s voluntarily dismissed the lawsuit, withoutprejudice. *See Part II — Other Information — Item 1 — LegalProceedings.* Although the lawsuit was dismissed, securities classaction litigation is often brought against a company following a decline in themarket price of its securities. The uncertainty of the currently pending SECand US Attorney investigations could lead to more volatility in our stockprice. The Company may in the future be the target of securities class actionclaims similar to those described above.

 

 

20

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If the Company became a target of future class action claims, it wouldlikely require significant commitment of the Company’s financial and managementresources and time, which may seriously harm the business, financial conditionand results of operations of the Company.

 

***Provisionsin the Company’s Certificate of Incorporation and Bylaws and Texas Law CouldDelay or Discourage a Takeover which Could Adversely Affect the Price of theCompany’s Common Stock.***

 

The Company’s board ofdirectors has the authority to issue up to 5 million shares of preferred stockand to determine the price, rights, preferences, privileges, and restrictions,including voting rights, of those shares without any further vote or action byholders of our common stock.  Ifpreferred stock is issued, the voting and other rights of the holders of theCompany’s common stock may be subject to, and may be adversely affected by, therights of the holders of our preferred stock. The issuance of preferred stock may have the effect of delaying orpreventing a change of control of the Company that could have been at a premiumprice to the Company’s stockholders.

 

Certain provisions of theCompany’s certificate of incorporation and bylaws could discourage potentialtakeover attempts and make attempts to change management by stockholdersdifficult.  The Company’s board ofdirectors has the authority to impose various procedural and other requirementsthat could make it more difficult for the Company’s stockholders to effectcertain corporate actions.  Any vacancyon the Company’s board of directors may be filled by a vote of the majority ofdirectors then in office.

 

In addition, certainprovisions of Texas law could have the effect of delaying or preventing achange in control of the Company. Section 13.03 of the Texas Business Corporation Act, for example,prohibits a Texas corporation from engaging in any business combination withany affiliated shareholder for a period of three years from the date the personbecame an affiliated shareholder unless certain conditions are met.

 

***TheTrading Price of the Company’s Common Stock Has Been, and Is Expected toContinue to Be, Volatile.***

 

The American StockExchange, where our stock trades, and stock markets in general, havehistorically experienced extreme price and volume fluctuations that haveaffected companies unrelated to their individual operating performance. Thetrading price of our common stock has been and is likely to continue to bevolatile due to such factors as:

 

•                  variations in quarterly results of operations;

•                  announcements of new products or acquisitions by theCompany’s competitors;

•                  governmental regulatory action;

•                  resolution of pending or unasserted litigation,including the existing purported class action;

•                  resolution of the Company’s SEC or US Attorneyinvestigations; and

•                  general trends in the Company’s industry and overallmarket conditions.

 

Movements in prices ofequity securities in general may also affect the market price of the Company’scommon stock.

 

***Competition***

 

The business ofmanufacturing and marketing beverage dispensing systems and other relatedequipment is characterized by rapidly changing technology and is highlycompetitive, with competition based primarily upon product suitability andreliability, price, product warranty, technical expertise and delivery time. Inaddition, the Company frequently competes with companies having substantiallygreater financial resources than the Company. Although the Company believes ithas been able to compete successfully in the past, there can be no assurancethat it will be able to do so in the future.

 

***Dividends***

 

Since its inception, theCompany has not paid, and it has no current plans to pay, cash dividends on theCommon Stock. The Company currently intends to retain all earnings to supportthe Company’s operations and future growth. 

 

 

21

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The payment of any futuredividends will be determined by the Board of Directors based upon the Company’searnings, financial condition and cash requirements, restrictions in financingagreements, business conditions and other factors the Board of Directors maydeem relevant. The Company’s debt financing agreements prohibit the payment ofdividends without lender approval.

 

*** Voting Power***

 

The directors andexecutive officers of the Company beneficially own approximately 40% of theoutstanding shares of the Common Stock. As a result, the directors andexecutive officers of the Company will have the ability to affect the vote ofthe Company’s shareholders on significant corporate actions requiringshareholder approval, including mergers, share exchanges and sales of all orsubstantially all of the Company’s assets. With such voting power, thedirectors and executive offers of the Company may also have the ability todelay or prevent a change in control of the Company.

 

 

# **Item 3 -Quantitative and Qualitative Disclosures About Market Risk**

 

There have been no significant changes in the Company’s market riskfactors since December 31, 2003.

 

 

**Item 4 - Controls and Procedures**

 

The Company’s principalexecutive and financial officers have concluded, based on their evaluation asof the end of the period covered by this Form 10-Q, that Lancer’s disclosurecontrols and procedures, as defined under Rules 13a-15(e) and 15d-15(e) ofthe Securities Exchange Act of 1934, are effective to ensure that informationthe Company is required to disclose in the reports that it files or submitsunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the SEC’s rules and forms, and include controlsand procedures designed to ensure that information we are required to disclosein such reports is accumulated and communicated to management, including ourprincipal executive and financial officers, as appropriate, to allow timelydecisions regarding required disclosure.

 

There has been no change in the Company’s internal control overfinancial reporting (as defined in Rule 13a-15(f) under the Exchange Act) thatoccurred during Lancer’s last fiscal quarter that has materially affected, oris reasonably likely to materially affect, Lancer’s internal control overfinancial reporting.

 

 

 

**PART II**

**OTHER INFORMATION**

 

 

**Item 1 - Legal Proceedings**

 

In August 2003, the USAttorney’s Office informed the Company that it was conducting an investigationarising from allegations raised in a lawsuit against The Coca-Cola Company by aformer Coca-Cola employee, Matthew Whitley and requested certain information,which the Company supplied. On January 13, 2004, the Company received writtennotice that the SEC had issued a formal order of investigation, dated December2, 2003, that appears to concern matters which were the subject of the AuditCommittee investigation, including allegations contained in the Matthew Whitleylawsuit against The Coca-Cola Company. The Company is unable at this point topredict the scope or outcome of these investigations. The Company hascooperated, and intends to continue to cooperate, with both the US Attorney’sOffice and the SEC investigations.

 

On May14, 2004, a purported class action, cause number 04-CV-427, naming asdefendants the Company, George F. Schroeder, David F. Green and The Coca-Cola Companywas filed in the United States District Court for the 

 

 

22

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WesternDistrict of Texas by TDH Partners.  Theaction alleged that the defendants violated Sections 10(b) and 20(a) of theSecurities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder.  No specific amount of damages was everclaimed, and neither the Company nor George F. Schroeder was ever served withthe lawsuit.   On July 15, 2004, theplaintiffs voluntarily dismissed the lawsuit, without prejudice.

 

**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.**

 

Not Applicable

 

**Item 3. Defaults Upon Senior Securities.**

 

Not Applicable

 

**Item 4 - Submission of Matters to a Vote ofSecurity Holders**

 

At the annual meeting ofshareholders of the Company held on August 24, 2004, the shareholders electedeight members of the Board of Directors of the Company to serve until the nextannual meeting of shareholders, or until their successors are duly elected andqualified.

                

The vote fornominated directors was as follows:

 

 
| ** **              | ** ** | ** ** | ** ** | **Authority** | ** ** |
|-------------------------|------------|------------|------------|---------------|------------|
| **Nominee**             | ** ** | **For**    | ** ** | **Withheld**  | ** ** |
| Norborne P.  Cole, Jr.  |       | 7,037,867  |       | 1,908,869     |       |
| Brian C. Flynn,  Jr.    |       | 8,930,726  |       | 16,010        |       |
| James F.  Gallivan, Jr. |       | 8,930,749  |       | 15,987        |       |
| Olivia F.  Kirtley      |       | 6,899,863  |       | 2,046,873     |       |
| Richard C.  Osborne     |       | 7,074,209  |       | 1,872,527     |       |
| Harold R.  Schmitz      |       | 8,844,351  |       | 102,385       |       |
| Alfred A.  Schroeder    |       | 8,909,620  |       | 37,116        |       |
| George F.  Schroeder    |       | 8,664,920  |       | 281,816       |       |

 

 

**Item 5. Other Information**

 

Not Applicable

 

**Item 6. Exhibits**

 

Exhibits:  See Exhibit Index onPage 25.

 

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities Exchange Act of 1934,the registrant has duly caused this report to be signed on its behalf by theundersigned thereunto duly authorized.

 

** **
| **Date:**         | **LANCER CORPORATION** |
|-------------------|------------------------|
| ** **        | **(Registrant)**       |
| ** **        | ** **             | ** ** |
| November 12, 2004 | By:                    | /s/ CHRISTOPHER D. HUGHES |
|              |                   | Christopher D. Hughes |
|              |                   | Chief Executive Officer |
|              |                   |   |
| November 12, 2004 | By:                    | /s/ MARK L. FREITAS |
|              |                   | Mark L. Freitas |
|              |                   | Chief Financial Officer |

 

 

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**INDEX TO EXHIBITS**

 

 

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                           |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                      |
| 10.1        |       | Form of Indemnification Agreement (incorporated by  reference to the exhibits of the Company’s Current Report on Form 8-K, filed  with the SEC on September 7, 2004).                                                                |
|        |       |                                                                                                                                                                                                                                      |
| 10.2        |       | Letter Agreement between Lancer Corporation and The  Coca-Cola Company, dated September 2, 2004 (incorporated by reference to the  exhibits of the Company’s Current Report on Form 8-K, filed with the SEC on  September 13, 2004). |
|        |       |                                                                                                                                                                                                                                      |
| 10.3        |       | Agreement by and between Lancer Corporation and  Christopher D. Hughes (incorporated by reference to the exhibits of the  Company’s Current Report on Form 8-K, filed with the SEC on September 17,  2004).                          |
|        |       |                                                                                                                                                                                                                                      |
| 10.4        |       | Agreement by and between Lancer Corporation and Mark  L. Freitas (incorporated by reference to the exhibits of the Company’s  Current Report on Form 8-K, filed with the SEC on September 17, 2004).                                 |
|        |       |                                                                                                                                                                                                                                      |
| 31.1        |       | Certification of Chief Executive Officer of Lancer  Corporation pursuant to Rule 13a-14(a) under the Securities Exchange Act of  1934, as amended.                                                                                        |
|        |       |                                                                                                                                                                                                                                      |
| 31.2        |       | Certification of Chief Financial Officer of Lancer  Corporation pursuant to Rule 13a-14(a) under the Securities Exchange Act of  1934, as amended.                                                                                        |
|        |       |                                                                                                                                                                                                                                      |
| 32.1        |       | Certification of Chief Executive Officer of Lancer  Corporation Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section  906 of the Sarbanes-Oxley Act of 2002.                                                                 |
|        |       |                                                                                                                                                                                                                                      |
| 32.2        |       | Certification of Chief Financial Officer of Lancer  Corporation Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section  906 of the Sarbanes-Oxley Act of 2002.                                                                 |

 

 

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