**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**FORM 10-Q**

 

**(Markone)**
| **ý**                                                                                                                                                                                        | ** ** | **QUARTERLY REPORT PURSUANT TO SECTION 13  OR 15(d)  OF THE SECURITIES EXCHANGE ACT OF 1934**  | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------|------------|
|                                                                                                                                                                                              |       |                                                                                                |
| **For the quarterly period ended September 30,  2005**                                                                                                                                       |
|                                                                                                                                                                                              |       |                                                                                                |
| **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**                                                                                                                                                                |
|                                                                                                                                                                                              |       |                                                                                                |
| **LANCER CORPORATION**                                                                                                                                                                            |
| (Exact name of registrant as specified in its  charter)                                                                                                                                           |

 
| **Texas**                       | ** ** | **74-1591073**                       |
|---------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of |       | (I.R.S. Employer Identification No.) |
| incorporation or organization)  |       |                                 |

 

**6655 LANCER BLVD.SAN ANTONIO, TEXAS**

 (Address of principal executiveoffices)

 

**(210) 310-7000**

(Registrant’s telephone number, including area code)

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Exchange Act during the past 12 months (or for suchshorter period that the registrant was required to file such reports), and (2) hasbeen subject to such filing requirements for the past 90 days.  Yes ý   No o

 

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

 

Indicate by check mark whether the registrant is a shell company (asdefined in Rule 12b-2 of the Exchange Act). Yes o   No ý

 

The number of shares of registrant’s common stock outstanding as of November 1,2005 was 9,509,028.

 

 

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**PART I**

**FINANCIAL INFORMATION**

 

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

 

**LANCER CORPORATION**

**CONSOLIDATED BALANCE SHEETS**

 

(Amounts in thousands, except share data)

 

ASSETS

 
| ** **                                                            | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                            | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **                                                            | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
|                                                                  |       |                   |       |                  |       |
| Current assets:                                                       |       |                   |       |                  |       |
| Cash                                                                  |       | $                      | 5,870      |                  | $          | 5,196 |   |
| Receivables:                                                          |       |                   |       |                  |       |
| Trade accounts and notes                                              |       | 17,110                 |       | 16,733                |       |
| Other                                                                 |       | 1,353                  |       | 801                   |       |
|                                                                  |       | 18,463                 |       | 17,534                |       |
| Less allowance for doubtful accounts                                  |       | (303                   | )          | (420                  | )          |
|                                                                  |       |                   |       |                  |       |
| Net receivables                                                       |       | 18,160                 |       | 17,114                |       |
|                                                                  |       |                   |       |                  |       |
| Inventories, net                                                      |       | 28,666                 |       | 24,495                |       |
| Prepaid expenses                                                      |       | 761                    |       | 406                   |       |
| Deferred tax asset                                                    |       | 824                    |       | 824                   |       |
|                                                                  |       |                   |       |                  |       |
| Total current assets                                                  |       | 54,281                 |       | 48,035                |       |
|                                                                  |       |                   |       |                  |       |
| Net property,  plant and equipment                                    |       | 30,675                 |       | 29,999                |       |
| Investment in  joint ventures                                         |       | 3,238                  |       | 2,388                 |       |
| Goodwill                                                              |       | 1,879                  |       | 1,879                 |       |
| Intangibles and  other assets, at cost, less accumulated amortization |       | 3,583                  |       | 3,186                 |       |
|                                                                  |       |                   |       |                  |       |
|                                                                  |       | $                      | 93,656     |                  | $          | 85,487 |   |

 

See accompanying notes to consolidated financial statements.

 

2

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LIABILITIES AND SHAREHOLDERS’ EQUITY

 
| ** **                                                                                                                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                 | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| ** **                                                                                                                                 | ** ** | **(Unaudited)**        | ** ** | ** **            | ** ** |
|                                                                                                                                       |       |                   |       |                  |       |
| Current  liabilities:                                                                                                                      |       |                   |       |                  |       |
| Accounts payable                                                                                                                           |       | $                      | 7,853      |                  | $          | 7,555 |   |
| Current maturities of long-term debt                                                                                                       |       | 1,353                  |       | 1,345                 |       |
| Deferred licensing and maintenance fees                                                                                                    |       | 271                    |       | 451                   |       |
| Progress billings                                                                                                                          |       | 153                    |       | —                |       |
| Accrued expenses and other liabilities                                                                                                     |       | 7,816                  |       | 8,029                 |       |
| Income taxes payable                                                                                                                       |       | 688                    |       | 286                   |       |
| Total current liabilities                                                                                                                  |       | 18,134                 |       | 17,666                |       |
|                                                                                                                                       |       |                   |       |                  |       |
| Deferred tax  liability                                                                                                                    |       | 3,412                  |       | 3,401                 |       |
| Long-term debt,  excluding current maturities                                                                                              |       | 13                     |       | 132                   |       |
| Deferred  licensing and maintenance fees                                                                                                   |       | 1,421                  |       | 1,273                 |       |
|                                                                                                                                       |       |                   |       |                  |       |
| Total liabilities                                                                                                                          |       | 22,980                 |       | 22,472                |       |
|                                                                                                                                       |       |                   |       |                  |       |
| 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; 9,573,254 issued and  9,509,028 outstanding in 2005, and 9,522,054 issued and 9,457,828 outstanding  in 2004 |       | 96                     |       | 95                    |       |
|                                                                                                                                       |       |                   |       |                  |       |
| Additional paid-in capital                                                                                                                 |       | 13,484                 |       | 13,208                |       |
|                                                                                                                                       |       |                   |       |                  |       |
| Accumulated other cumulative income (loss)                                                                                                 |       | (100                   | )          | 523                   |       |
|                                                                                                                                       |       |                   |       |                  |       |
| Deferred compensation                                                                                                                      |       | —                 |       | (18                   | )          |
|                                                                                                                                       |       |                   |       |                  |       |
| Retained earnings                                                                                                                          |       | 57,556                 |       | 49,567                |       |
|                                                                                                                                       |       |                   |       |                  |       |
| Less common stock in treasury, at cost; 64,226  shares in 2005 and 2004                                                                    |       | (360                   | )          | (360                  | )          |
|                                                                                                                                       |       |                   |       |                  |       |
| Total shareholders’ equity                                                                                                            |       | 70,676                 |       | 63,015                |       |
|                                                                                                                                       |       |                   |       |                  |       |
|                                                                                                                                       |       | $                      | 93,656     |                  | $          | 85,487 |   |

 

See accompanying notes to consolidated financial statements.

 

3

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**LANCER CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

(Unaudited)

 

(Amounts in thousands, except share data)

 
| ** **                                    | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|-----------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                    | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                    | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|                                          |       |                   |       |                   |       |   |   |   |   |
| Net sales                                     |       | $                      | 32,460     |                   | $          | 31,264 |   | $ | 99,445 |   | $ | 92,467 |   |
| Cost of sales                                 |       | 21,535                 |       | 22,368                 |       | 66,840 |   | 64,772 |   |
| Gross profit                                  |       | 10,925                 |       | 8,896                  |       | 32,605 |   | 27,695 |   |
|                                          |       |                   |       |                   |       |   |   |   |   |
| Selling, general  and administrative expenses |       | 7,351                  |       | 6,940                  |       | 21,550 |   | 22,332 |   |
|                                          |       |                   |       |                   |       |   |   |   |   |
| Other operating  expense (income)             |       | 57                     |       | 339                    |       | (119 | ) | 12 |   |
| Operating income                              |       | 3,517                  |       | 1,617                  |       | 11,174 |   | 5,351 |   |
|                                          |       |                   |       |                   |       |   |   |   |   |
| Other income  (expense):                      |       |                   |       |                   |       |   |   |   |   |
| Interest expense                              |       | (31                    | )          | (204                   | )          | (91 | ) | (457 | ) |
| Income from joint ventures                    |       | 305                    |       | 571                    |       | 964 |   | 824 |   |
| Settlement of development project             |       | —                 |       | 7,000                  |       | — |   | 7,000 |   |
| Other income (expense), net                   |       | (57                    | )          | (93                    | )          | 188 |   | (102 | ) |
|                                          |       | 217                    |       | 7,274                  |       | 1,061 |   | 7,265 |   |
| Income before income taxes                    |       | 3,734                  |       | 8,891                  |       | 12,235 |   | 12,616 |   |
|                                          |       |                   |       |                   |       |   |   |   |   |
| Income tax  expense (benefit):                |       |                   |       |                   |       |   |   |   |   |
| Current                                       |       | 1,018                  |       | 3,189                  |       | 4,232 |   | 4,747 |   |
| Deferred                                      |       | 297                    |       | (124                   | )          | 11 |   | (323 | ) |
|                                          |       | 1,315                  |       | 3,065                  |       | 4,243 |   | 4,424 |   |
|                                          |       |                   |       |                   |       |   |   |   |   |
| Net income                                    |       | $                      | 2,419      |                   | $          | 5,826 |   | $ | 7,992 |   | $ | 8,192 |   |
|                                          |       |                   |       |                   |       |   |   |   |   |
| Common Shares  Outstanding:                   |       |                   |       |                   |       |   |   |   |   |
| Basic                                         |       | 9,504,473              |       | 9,380,558              |       | 9,486,463 |   | 9,371,993 |   |
| Diluted                                       |       | 9,729,404              |       | 9,506,649              |       | 9,695,813 |   | 9,480,633 |   |
|                                          |       |                   |       |                   |       |   |   |   |   |
| Earnings Per  Share:                          |       |                   |       |                   |       |   |   |   |   |
| Basic earnings                                |       | $                      | 0.25       |                   | $          | 0.62 |   | $ | 0.84 |   | $ | 0.87 |   |
| Diluted earnings                              |       | $                      | 0.25       |                   | $          | 0.61 |   | $ | 0.82 |   | $ | 0.86 |   |

 

See accompanying notes to consolidated financial statements.

 

4

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**LANCER CORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

(Unaudited)

 

(Amounts in thousands)

 
| ** **                                                                          | ** ** | **Nine Months Ended**  | ** ** |
|-------------------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                          | ** ** | **2005**               | ** ** | **2004** | ** ** |
| Cash flow from  operating activities:                                               |       |                   |       |   |   |
| Net income                                                                          |       | $                      | 7,992      |   | $ | 8,192 |   |
| Adjustments to reconcile net earnings to net cash  provided by operating activities |       |                   |       |   |   |
| Depreciation and amortization                                                       |       | 2,725                  |       | 3,609 |   |
| Deferred licensing and maintenance fees                                             |       | 150                    |       | (488 | ) |
| Deferred revenue                                                                    |       | 162                    |       | — |   |
| Inventory and receivable reserves                                                   |       | (265                   | )          | (829 | ) |
| Deferred income taxes                                                               |       | (1                     | )          | 829 |   |
| Gain on sale and disposal of assets                                                 |       | (119                   | )          | (622 | ) |
| Loss on impairment of assets                                                        |       | —                 |       | 405 |   |
| Income from joint ventures                                                          |       | (964                   | )          | (824 | ) |
| Stock-based compensation expense                                                    |       | 18                     |       | 52 |   |
| Changes in assets and liabilities:                                                  |       |                   |       |   |   |
| Receivables                                                                         |       | (1,519                 | )          | (3,628 | ) |
| Prepaid expenses                                                                    |       | (361                   | )          | (352 | ) |
| Income taxes receivable                                                             |       | (36                    | )          | 225 |   |
| Inventories                                                                         |       | (4,047                 | )          | 88 |   |
| Accounts payable                                                                    |       | 470                    |       | 1,382 |   |
| Accrued expenses and other liabilities                                              |       | (142                   | )          | 1,908 |   |
| Income taxes payable                                                                |       | 470                    |       | 2,694 |   |
| Net cash provided by operating activities                                           |       | 4,533                  |       | 12,641 |   |
| Cash flow from  (used in) investing activities:                                     |       |                   |       |   |   |
| Proceeds from sale of assets                                                        |       | 764                    |       | 525 |   |
| Acquisition of property, plant and equipment                                        |       | (4,435                 | )          | (1,488 | ) |
| Investment in joint ventures                                                        |       | (804                   | )          | (210 | ) |
| Distributions from joint ventures                                                   |       | 917                    |       | 315 |   |
| Investment in intangibles assets                                                    |       | (263                   | )          | (195 | ) |
| Net cash used in investing activities                                               |       | (3,821                 | )          | (1,053 | ) |
| Cash flow from  (used in) financing activities:                                     |       |                   |       |   |   |
| Borrowings under line of credit                                                     |       | —                 |       | 4,300 |   |
| Repayments under line of credit                                                     |       | —                 |       | (5,300 | ) |
| Retirement of long-term debt                                                        |       | (111                   | )          | (1,153 | ) |
| Net proceeds from exercise of stock options                                         |       | 276                    |       | 207 |   |
| Net cash provided by financing activities                                           |       | 165                    |       | (1,946 | ) |
| Effect of  exchange rate changes on cash                                            |       | (203                   | )          | (293 | ) |
| Net increase in  cash                                                               |       | 674                    |       | 9,349 |   |
| Cash at  beginning of period                                                        |       | 5,196                  |       | 1,129 |   |
| Cash at end of  period                                                              |       | $                      | 5,870      |   | $ | 10,478 |   |
|                                                                                |       |                   |       |   |   |
| Supplemental  cash flow informaton:                                                 |       |                   |       |   |   |
| Cash paid for  interest                                                             |       | $                      | 57         |   | $ | 402 |   |
| Cash paid for  income taxes                                                         |       | 2,739                  |       | — |   |

 

See accompanying notes to consolidated financial statements.

 

5

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LANCER CORPORATION

 

NOTES TO UNAUDITEDCONSOLIDATED FINANCIAL STATEMENTS

 

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

 

We design, engineer,manufacture and market fountain soft drink, beer and citrus beverage dispensingsystems, and other equipment for use in the food service and beverageindustry.  We also market frozen beverage dispensers manufactured byLancer FBD Partnership, Ltd., a partnership in which we own a 50% partnershipinterest.  Our products are sold by our personnel and through independentdistributors and agents principally to major soft drink companies (primarilyThe Coca-Cola Company), bottlers, equipment distributors, beer breweries,restaurants and convenience stores for use in various food and beverageoperations.  We are a vertically integrated manufacturer with tooling,production, assembly and testing capabilities that enable us to fabricate asubstantial portion of the components used in our products.  In addition,we are an innovator of new products in the beverage dispensing industry.  We have a large technical staff supported bystate-of-the-art engineering facilities to develop new products and to enhanceour existing product lines in response to changing industry requirements andspecific customer demands.

 

Our accompanying unaudited consolidated financial statements have beenprepared in conformity with accounting principles generally accepted in theUnited States of America for interim financial information and with theinstructions to 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 our opinion, these financial statements containall adjustments, consisting of normal recurring accruals unless otherwisedisclosed, necessary to present fairly the financial position, results ofoperations and cash flows for the periods indicated.  Our significant accounting policies weredisclosed in the notes to the consolidated financial statements included in ourAnnual Report on Form 10-K for the year ended December 31, 2004, andno material changes have occurred with respect to these policies.  The year-end consolidated balance sheet datawas derived from audited financial statements, but does not include alldisclosures required by accounting principles generally accepted in the UnitedStates.  The consolidated results ofoperations for the periods reported are not necessarily indicative of theresults to be experienced for the entire current year.

 

Certain amounts in theconsolidated financial statements for prior periods have been reclassified toconform to the current year’s presentation. Wehave revised our previously reported results of operations for the threeand nine months ended September 30, 2004 to reclassify one item fromnon-operating to operating expense.  Thisitem consists of a $110,000 loss on the sale and disposal of assets for thethree months ended September 30, 2004 and a $215,000 gain on the sale anddisposal of assets for the nine months ended September 30, 2004.  Previously, this item was presented asnon-operating expenses in “Other Income (Expense)”.  As noted in the following reconciliation, thereclassification increased the amount of our previously reported operatingincome for the nine months ended September 30, 2004, but did not affectour previously reported net earnings, earnings per share, financial position,or cash flows. 

 

| ** **                                | ** ** | **Three Months**       | ** ** | **Nine Months**        | ** ** |
|-------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| **(Amounts in 000s)**                     | ** ** | **2004**               | ** ** | **2004**               | ** ** |
|                                      |       |                   |       |                   |       |
| Operating income  as previously reported  |       | $                      | 1,728      |                   | $          | 5,135 |   |
| Gain on sale and  disposal of assets      |       | (111                   | )          | 216                    |       |
| Operating income  after reclassifications |       | $                      | 1,617      |                   | $          | 5,351 |   |

 

**2.****              NewAccounting Pronouncements.**

 

In November 2004,the Financial Accounting Standards Board (“FASB”) issued Statement of FinancialAccounting Standards (“SFAS”) No. 151, “Inventory Costs”, an amendment ofARB No. 43, Chapter 4. The amendments made by SFAS No. 151 clarifythat abnormal amounts of idle facility expense, freight, handling costs andwasted materials (spoilage) should be recognized as current-period charges andrequire the allocation of fixed production overheads to inventory based on thenormal capacity of the production facilities. The pronouncement is effectivefor inventory costs incurred during fiscal years beginning after June 15,2005.  Earlier application is permittedfor inventory costs incurred during fiscal years beginning after November 23,2004. We currently recognize as period costs any 

 

6

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abnormal amounts of idlefacility expense, freight, handling costs and wasted materials, and allocatefixed production overhead to inventory based on the normal capacity of theproduction facilities. We do not believe that the adoption of thispronouncement will have a significant impact on our results of operations orfinancial position. We will adopt this pronouncement beginning January 1,2006.

 

In December 2004,the FASB issued SFAS No. 123(R) –*Share-Based Payment,*which replaces SFAS No. 123 –*Accounting forStock-Based Compensation*, and supersedes APB Opinion No. 25 –*Accounting for Stock Issued to Employees*. In March 2005,the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 107– *Share-Based Payment,*which providesinterpretive guidance related to SFAS No. 123(R). SFAS No. 123(R)requires compensation costs related to share-based payment transactions to berecognized in the financial statements. With limited exceptions, the amount ofcompensation cost is measured based on the grant-date fair value of the equityor liability instruments issued. SFAS No. 123(R) requires liability awardsto be remeasured each reporting period and compensation costs to be recognizedover the period that an employee provides service in exchange for the award. InApril 2005, the SEC delayed the effective date of SFAS No. 123(R) tothe beginning of the annual reporting period that begins after June 15,2005. We are currently evaluating the effect that adoption of this statementwill have on our financial position and results of operations.

 

On December 21,2004, the FASB issued “Application of FASB Statement No. 109, **Accounting for Income Taxes,** to theTax Deduction on Qualified Production Activities Provided by the American JobsCreation Act of 2004”, a FASB Staff Position (FSP) that provides guidance onthe application of SFAS No. 109 to the tax deduction on qualifiedproduction activities provided by the American Jobs Creation Act of 2004. FSPFAS 109-1 states that the qualified production activities deduction should beaccounted for as a special deduction in accordance with SFAS No. 109,whereby the deduction is contingent upon the future performance of specificactivities, including wage levels. The FASB also concluded that the specialdeductions should be considered with measuring deferred taxes and assessing avaluation allowance. The impact on our results of operations or financialposition of FSP FAS 109-1 lowered our effective tax rate in the first ninemonths of 2005 to 34.4%, compared to 36.4% in the first nine months of 2004.

 

In May 2005, theFinancial Accounting Standards Board issued FASB Statement No. 154, “AccountingChanges and Error Corrections,” a replacement of APB Opinion No. 20 andFASB Statement No. 3.  The Statementprovides guidance on the accounting for and reporting of accounting changes anderror corrections.  It establishes,unless impracticable, retrospective application as the required method forreporting a change in accounting principle in the absence of explicittransition requirements specific to the newly adopted accountingprinciple.  This Statement is effectivefor accounting changes and corrections of errors made in fiscal years beginningafter December 15, 2005.

 

At the June 2005meeting, the Emerging Issues Task Force reached a consensus on EITF 05-6,”Determiningthe Amortization Period for Leasehold Improvements Purchased after LeaseInception or acquired in a Business Combination.”  The consensus reached is that the leaseholdimprovements, whether acquired in a business combination or placed in servicesignificantly after and not contemplated at or near the beginning of the leaseterm, should be amortized over the shorter of the useful life of the assets ora term that includes required lease periods and renewals that are deemed to bereasonably assured.  The consensus inthis issue, which is to be applied to leasehold improvements that are purchasedor acquired in reporting periods beginning after June 29, 2005, will nothave a material impact on our financial statements.

 

**3.   Supplemental Balance Sheet and IncomeStatement Information.**

 

*Balance Sheet Information*:

 

**Inventory:**  We state inventories at the lower of cost (ona first-in, first-out basis for finished goods and work in process, and anaverage cost basis for raw materials and supplies) or market.  Our inventory components consist of thefollowing items (amounts in thousands):

 

7

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| ** **                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2005**               | ** ** | **2004**              | ** ** |
| Finished goods             |       | $                      | 13,536     |                  | $          | 11,143 |   |
| Work in process            |       | 6,460                  |       | 5,593                 |       |
| Raw material and  supplies |       | 8,670                  |       | 7,759                 |       |
|                       |       | $                      | 28,666     |                  | $          | 24,495 |   |

 

**Property,Plant and Equipment:** Our net property, plant and equipment consist of the following items(amounts in thousands):  

 
| ** **                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2005**               | ** ** | **2004**              | ** ** |
|                                       |       |                   |       |                  |       |
| Land                                       |       | $                      | 1,082      |                  | $          | 1,082 |   |
| Buildings                                  |       | 22,090                 |       | 22,056                |       |
| Machinery and  equipment                   |       | 17,024                 |       | 19,633                |       |
| Tools and dies                             |       | 10,230                 |       | 10,775                |       |
| Leaseholds,  office equipment and vehicles |       | 8,771                  |       | 8,542                 |       |
| Assets in  progress                        |       | 3,620                  |       | 1,365                 |       |
| Assets available  for sale                 |       | —                 |       | 780                   |       |
|                                       |       | 62,817                 |       | 64,233                |       |
| Less accumulated  depreciation             |       | (32,142                | )          | (34,234               | )          |
| Net property,  plant and equipment         |       | $                      | 30,675     |                  | $          | 29,999 |   |

 

**Intangibles and Other Assets:**  Our netintangibles and other assets consist of the following items (amounts inthousands):

 
| ** **                           | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                           | ** ** | **2005**               | ** ** | **2004**              | ** ** |
|                                 |       |                   |       |                  |       |
| Patents                              |       | $                      | 4,380      |                  | $          | 3,848 |   |
| Accumulated amortization  of patents |       | (918                   | )          | (774                  | )          |
| Net intangibles                      |       | 3,462                  |       | 3,074                 |       |
| Deposits                             |       | 121                    |       | 112                   |       |
| Net intangibles  and other assets    |       | $                      | 3,583      |                  | $          | 3,186 |   |

 

**Accrued Expenses and OtherLiabilities:**  Our accrued expenses consist of the followingitems (amounts in thousands):

 
| ** **                             | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|----------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                             | ** ** | **2005**               | ** ** | **2004**              | ** ** |
|                                   |       |                   |       |                  |       |
| Payroll and  related expenses          |       | $                      | 4,036      |                  | $          | 4,159 |   |
| Commissions                            |       | 612                    |       | 328                   |       |
| Health and  workers’ compensation |       | 193                    |       | 303                   |       |
| Property taxes                         |       | 412                    |       | 226                   |       |
| Interest                               |       | 210                    |       | 189                   |       |
| Warranty                               |       | 839                    |       | 1,257                 |       |
| Other taxes                            |       | 562                    |       | 505                   |       |
| Other accrued  expenses                |       | 952                    |       | 1,062                 |       |
|                                   |       | $                      | 7,816      |                  | $          | 8,029 |   |

 

8

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*Income Statement Information.*

 

**Other Operating Income:**  Our otheroperating income consists of the following items (amounts in thousands):

 
| ** **                                  | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                  | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                  | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                  | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| (Gain) loss on  sale and disposal of assets |       | $                      | 57         |                   | $          | 110 |   | $ | (119 | ) | $ | (217 | ) |
| Impairment of  Patents                      |       | 0                      |       | 229                    |       | 0 |   | 229 |   |
|                                        |       | $                      | 57         |                   | $          | 339 |   | $ | (119 | ) | $ | 12 |   |

 

**Other Income (Expense):**  Our otherincome (expenses) consist of the following items (amounts in thousands):

 
| ** **                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                         | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                         | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                         | ** ** | ** **             | ** ** | ** **             | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                                    |       | $                      | 38         |                   | $          | 2 |   | $ | 100 |   | $ | 10 |   |
| Bank charges                                       |       | (44                    | )          | (212                   | )          | (127 | ) | (294 | ) |
| Royalties income  - net                            |       | 3                      |       | 26                     |       | 42 |   | 110 |   |
| Exchange gains  (losses)                           |       | (69                    | )          | 40                     |       | (13 | ) | 4 |   |
| Gain from sale  of non operating asset             |       | —                 |       | —                 |       | 72 |   | — |   |
| Extinguishment  of guarantee of joint venture debt |       | —                 |       | —                 |       | 34 |   | — |   |
| Miscellaneous                                      |       | 15                     |       | 51                     |       | 80 |   | 68 |   |
| Total                                              |       | $                      | (57        | )                      | $          | (93 | ) | $ | 188 |   | $ | (102 | ) |

 

**4.   Earnings Per Share.**

 

Basic earnings per shareis calculated using the weighted average number of common shares outstandingand diluted earnings per share is calculated assuming the issuance of commonshares for all potential dilutive common shares outstanding during thereporting period.  The dilutive effect ofstock options approximated 224,930 and 126,090 shares for the three monthsended September 30, 2005 and 2004, respectively.  The dilutive effect of stock optionsapproximated 209,351 and 108,640 for the nine months ended September 30,2005 and 2004, respectively.

 

9

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**5.   Stock Compensation Plans.**

 

We utilize the intrinsic value method, as permitted under provisions ofAPB Opinion No. 25 and related interpretations, in measuring stock-basedcompensation for employees.  If we hadelected to recognize compensation cost based on the fair value of the optionsgranted at grant date as prescribed by SFAS No. 123R, net earnings and netearnings per share would have been adjusted to the pro forma amounts indicatedin the table below (amounts in thousands, except share data):

 
| ** **                                                                                                          | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                                                          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                                                                                          | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
| Net earnings -  as reported                                                                                         |       | $                      | 2,419      |                   | $          | 5,826 |   | $ | 7,992 |   | $ | 8,193 |   |
| Add: Total stock-based compensation expense  determined under the intrinsic value method, net of tax                |       | —                 |       | 8                      |       | 12 |   | 35 |   |
| Deduct: Total stock-based compensation expense  determined under fair value based method for all awards, net of tax |       | (107                   | )          | (18                    | )          | (461 | ) | (65 | ) |
| Net earnings -  pro forma                                                                                           |       | $                      | 2,312      |                   | $          | 5,816 |   | $ | 7,543 |   | $ | 8,163 |   |
| Net earnings per  basic share-as reported                                                                           |       | $                      | 0.25       |                   | $          | 0.62 |   | $ | 0.84 |   | $ | 0.87 |   |
| Net earnings per  basic share-pro forma                                                                             |       | $                      | 0.24       |                   | $          | 0.62 |   | $ | 0.80 |   | $ | 0.87 |   |
|                                                                                                                |       |                   |       |                   |       |   |   |   |   |
| Net earnings per  diluted share-as reported                                                                         |       | $                      | 0.25       |                   | $          | 0.61 |   | $ | 0.82 |   | $ | 0.86 |   |
| Net earnings per  diluted share-pro forma                                                                           |       | $                      | 0.24       |                   | $          | 0.61 |   | $ | 0.78 |   | $ | 0.86 |   |
|                                                                                                                |       |                   |       |                   |       |   |   |   |   |
| Weighted-average fair value of options, granted  during the period                                                  |       | $                      | —     | (1)                    | $          | — | (1) | $ | 8.33 |   | $ | — | (1) |

 

The fair value of eachoption granted in the three and nine months ended September 30, 2005 and2004, respectively, is estimated on the date of grant using the Black-Scholesoption-pricing model with the following assumptions:

 
| ** **             | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|------------------------|------------|------------------------|------------|------------------------|------------|
| ** **             | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **             | ** ** | **2005**               | ** ** | **2004**               | ** ** | **2005** | ** ** | **2004** | ** ** |
|                   |       |                   |       |                   |       |   |   |   |   |
| Expected life  (years) |       | —                 | (1)        | —                 | (1)        | 7 |   | — | (1) |
| Interest rate          |       | —                 | (1)        | —                 | (1)        | 4.0 | % | — | (1) |
| Volatility             |       | —                 | (1)        | —                 | (1)        | 48.0 | % | — | (1) |
| Dividend yield         |       | None                   |       | None                   |       | None |   | None |   |

 

----

(1)  No options weregranted during the three months ended September 30, 2005.  No options were granted during the three andnine months ended September 30, 2004.

 

10

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**6.   Other Comprehensive Income.**

 

The line item, “Accumulatedother comprehensive income” on the accompanying consolidated balance sheetsincludes foreign currency gains and unrealized gain (loss) on investment.

 

The following are thecomponents of comprehensive income (amounts in thousands):

 
| ** **                          | ** ** | **Cumulative  Translation  Adjustment** | ** ** | **Unrealized Loss  on Investments** | ** ** | **Total** | ** ** |
|-------------------------------------|------------|-----------------------------------------|------------|-------------------------------------|------------|-----------|------------|
| Balance at December 31,  2003  |       | $                                       | —     |                                | $          | 6         |       | $ | 6 |   |
| Current period  change              |       | 523                                     |       | (6                                  | )          | 517       |       |
| Balance at December 31,  2004  |       | $                                       | 523        |                                | $          | —    |       | $ | 523 |   |
| Current period  change              |       | (623                                    | )          | —                              |       | (623      | )          |
| Balance at September 30,  2005 |       | $                                       | (100       | )                                   | $          | —    |       | $ | (100 | ) |

 

**Disclosure of related tax effectsallocated to each component of Accumulated Other Comprehensive Income**

 
| ** **                                     | ** ** | **Before-tax  amount** | ** ** | **Tax (expense)  benefit** | ** ** | **Net of tax  amount** | ** ** |
|------------------------------------------------|------------|------------------------|------------|----------------------------|------------|------------------------|------------|
| **2004**                                       |       |                   |       |                       |       |                   |       |
| Cumulative  translation adjustments            |       | $                      | 523        |                       | $          | —                 |       | $ | 523 |   |
| Reclassifiaction  adjustment for realized loss |       | (6                     | )          | —                     |       | (6                     | )          |
| Total Other  Comprehensive income              |       | $                      | 517        |                       | $          | —                 |       | $ | 517 |   |
|                                           |       |                   |       |                       |       |                   |       |
| **2005**                                       |       |                   |       |                       |       |                   |       |
| Cumulative  translation adjustments            |       | $                      | (623       | )                          | $          | —                 |       | $ | (623 | ) |
| Total Other  Comprehensive income              |       | $                      | (623       | )                          | $          | —                 |       | $ | (623 | ) |

 

**7.Investment in Joint Ventures.**

 

At September 30,2005 our long-term investments consisted of the following:

 
| ** **                                 | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|--------------------------------------------|------------|------------------------|------------|-----------------------|------------|
| ** **                                 | ** ** | **2005**               | ** ** | **2004**              | ** ** |
|                                       |       |                   |       |                  |       |
| Investment in  Lancer FBD Partnership Ltd. |       | $                      | 2,449      |                  | $          | 2,046 |   |
| Investment in  Moo Technologies, LLC       |       | 789                    |       | 342                   |       |
| Total long-term investments                |       | $                      | 3,238      |                  | $          | 2,388 |   |

 

Our 50% share of netearnings from both joint ventures, after elimination of profit in endinginventory, is included in other income.

 

We own 50% of Lancer FBDPartnership, Ltd., a manufacturer of frozen beverage equipment.  Lancer FBD pays us a commission on sales ofLancer FBD products that we generate through our sales force.  Lancer FBD paid us sales commissions of $0.2million and $0.1 million for the three-month periods ended September 30,2005 and 2004, and 

 

11

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$0.4 million and $0.3million for the nine months ended September 30, 2005 and 2004,respectively.  Our portion of Lancer FBD’s income was $0.5 million and$0.6 million for the three months ended September 30, 2005 and 2004, and$1.3 million and $1.0 million for the nine months ended September 30, 2005and 2004, respectively.  Lancer FBD’spurchases from us were $0.4 million for both of the three months ended September 30,2005 and 2004, and $1.0 million and $0.9 million for the nine months ended September 30,2005 and 2004, respectively.  Lancer FBDhad a balance due to us of $0.3 million on September 30, 2005, and $0.2million on December 31, 2004.

 

We own 50% of MooTechnologies, LLC, a developmental stage limited liability company engaged inthe commercialization of concentrated shelf-stable milk products. Our portionof Moo Technology’s loss was $0.2 million and $0.1 million for the three monthsended September 30, 2005 and 2004, respectively, and $0.4 million and $0.2million for the nine months ended September 30, 2005 and 2004,respectively.  We have invested $1.6million in Moo Technologies since its inception, including $0.8 million duringthe first nine months of 2005, bringing our investment net of losses in thecompany to $0.8 million as of September 30, 2005.  We expect Moo Technologies to continue toincur losses through at least 2005, and we expect to continue to fund MooTechnologies in a manner consistent with our past funding practices.

 

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**8.   Segment and Geographic Information.**

 

We are engaged in the manufacture and distribution ofbeverage dispensing equipment and related parts and components.  We manage our business by geographic regionand have four main geographical region segments.  Sales are attributed to a region based on theordering location of the customer.

 
| ** **                                 | ** ** | **North**   | ** ** | **Latin**   | ** ** | **Asia/**   | ** ** | ** ** | ** ** | ** **    | ** ** | ** ** | ** ** |
|--------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|------------|------------|---------------|------------|------------|------------|
| **(amounts in thousands)**                 | ** ** | **America** | ** ** | **America** | ** ** | **Pacific** | ** ** | **Europe** | ** ** | **Corporate** | ** ** | **Total**  | ** ** |
| ** **                                 | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** **    | ** ** | ** ** | ** ** |
| Three months ended September 30, 2005 |       |        |       |        |       |        |       |       |       |          |       |       |       |
| Total revenues                             |       | $           | 20,618     |        | $          | 1,989       |       | $          | 6,926      |          | $          | 2,927      |       | $ | — |   | $ | 32,460 |   |
| Depreciation and amortization              |       | 721         |       | 55          |       | 105         |       | 10         |       | —        |       | 891        |       |
| Operating income (loss)                    |       | 6,025       |       | 317         |       | 676         |       | 190        |       | (3,691        | )          | 3,517      |       |
| Long-lived assets                          |       | 28,592      |       | 3,369       |       | 1,910       |       | 163        |       | —        |       | 34,034     |       |
| Goodwill, net                              |       | —      |       | —      |       | 1,879       |       | —     |       | —        |       | 1,879      |       |
| Capital expenditures                       |       | 1,113       |       | —      |       | 324         |       | 2          |       | —        |       | 1,439      |       |
| ** **                                 | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** **    | ** ** | ** ** | ** ** |
| Three months ended September 30, 2004 |       |        |       |        |       |        |       |       |       |          |       |       |       |
| Total revenues                             |       | $           | 20,337     |        | $          | 1,582       |       | $          | 6,970      |          | $          | 2,375      |       | $ | — |   | $ | 31,264 |   |
| Depreciation and amortization              |       | 1,085       |       | 43          |       | 99          |       | 11         |       | —        |       | 1,238      |       |
| Operating income (loss)                    |       | 4,139       |       | 167         |       | 782         |       | 221        |       | (3,692        | )          | 1,617      |       |
| Long-lived assets                          |       | 27,215      |       | 3,968       |       | 1,657       |       | 155        |       | —        |       | 32,995     |       |
| Goodwill, net                              |       | —      |       | 50          |       | 1,879       |       | —     |       | —        |       | 1,929      |       |
| Capital expenditures                       |       | 256         |       | 9           |       | 62          |       | 38         |       | —        |       | 365        |       |
|                                       |       |        |       |        |       |        |       |       |       |          |       |       |       |
| Nine months ended September 30, 2005  |       |        |       |        |       |        |       |       |       |          |       |       |       |
| Total revenues                             |       | $           | 63,915     |        | $          | 6,040       |       | $          | 19,257     |          | $          | 10,233     |       | $ | — |   | $ | 99,445 |   |
| Depreciation and amortization              |       | 2,206       |       | 166         |       | 322         |       | 31         |       | —        |       | 2,725      |       |
| Operating income (loss)                    |       | 18,107      |       | 1,183       |       | 1,250       |       | 1,314      |       | (10,680       | )          | 11,174     |       |
| Long-lived assets                          |       | 28,592      |       | 3,369       |       | 1,910       |       | 163        |       | —        |       | 34,034     |       |
| Goodwill, net                              |       | —      |       | —      |       | 1,879       |       | —     |       | —        |       | 1,879      |       |
| Capital expenditures                       |       | 3,803       |       | —      |       | 579         |       | 53         |       | —        |       | 4,435      |       |
|                                       |       |        |       |        |       |        |       |       |       |          |       |       |       |
| Nine months ended September 30, 2004  |       |        |       |        |       |        |       |       |       |          |       |       |       |
| Total revenues                             |       | $           | 59,291     |        | $          | 4,057       |       | $          | 19,793     |          | $          | 9,326      |       | $ | — |   | $ | 92,467 |   |
| Depreciation and amortization              |       | 3,114       |       | 158         |       | 306         |       | 31         |       | —        |       | 3,609      |       |
| Operating income (loss)                    |       | 13,734      |       | (6          | )          | 1,921       |       | 1,257      |       | (11,555       | )          | 5,351      |       |
| Long-lived assets                          |       | 27,215      |       | 3,968       |       | 1,657       |       | 155        |       | —        |       | 32,995     |       |
| Goodwill, net                              |       | —      |       | 50          |       | 1,879       |       | —     |       | —        |       | 1,929      |       |
| Capital expenditures                       |       | 967         |       | 215         |       | 260         |       | 46         |       | —        |       | 1,488      |       |

 

All intercompany revenuesare eliminated in computing revenues and operating income.  Corporate administration and engineeringexpenses are included in a Corporate segment rather than allocated among ourgeographic region segments.

 

**9.****              ProductWarranties.**

 

We generally warrant ourproducts against certain manufacturing and other defects.  These product warranties are provided forspecific periods of time from the date of sale. As of September 30, 2005 and December 31, 2004, we had accrued$0.8 million and $1.3 million, respectively, for estimated product warrantyclaims.  The accrued product warrantycosts are based primarily on actual warranty claims as well as currentinformation on repair costs.  Warrantyclaims expense was $0.05 million and $0.1 million for the three months ended September 30,2005 and 2004, respectively.  Warrantyclaims expense was $0.3 million and $0.4 million for the nine months ended September 30,2005 and 2004, respectively.

 

13

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The following chart sets forth our product warrantycosts for the periods ending September 30, 2005 and 2004

 
| **(amounts in thousands):**                                  | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------|------------|------------|------------|------------|------------|
| ** **                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Accrued product  warranty costs as of January 1         |       | $          | 1,257      |       | $          | 586 |   |
| Liabilities  accrued for warranties issued during the period |       | (70        | )          | 654        |       |
| Warranty claims  paid during the period                      |       | (348       | )          | (246       | )          |
| Accrued product  warranty costs as of September 30      |       | $          | 839        |       | $          | 994 |   |

 

**10.  Other Guaranties.**

 

During2003, Lancer FBD obtained a $1.5 million revolving credit facility from abank.  We entered into a Continuing Guarantee Agreement with the lenderpursuant to which we guaranteed the repayment of the partnership’s debt, whichexpired annually.  In accordance with FASB Interpretation No. 45, werecorded a liability of $22,500, which represents the estimated value of the guaranty. See “Item 2, Management’s Discussion and Analysis of Financial Condition andResults of Operations – Critical Accounting Policies – Guaranties”.  The Lancer FBD credit facility, by its terms,expired during the first quarter of 2005 and was not renewed, and the lenderreleased us from our guaranty of the Lancer FBD credit facility.  We reversed the liability associated with theguaranty, resulting in income of $22,500 during the first quarter of 2005.

 

On March 5, 2003,Moo Technologies obtained a $0.75 million revolving credit facility from abank.  We entered into a CommercialGuarantee with the lender pursuant to which we guaranteed the repayment of theMoo Technologies debt.  We recorded aliability of $11,250 in 2003, which represents the estimated value of theguaranty.  See “Item 2, Management’sDiscussion and Analysis of Financial Condition and Results of Operations –Critical Accounting Policies – Guaranties”. During the first quarter of 2005, Moo Technologies repaid all amountsdue under its revolving credit facility and terminated the facility, and thelender released us from our guaranty of the facility.  We reversed the liability associated with theguaranty, resulting in income of $11,250 during the first quarter of 2005.

 

**11.****       Other Matters.**

 

*Audit Committee Investigation*.  In June 2003, our Audit Committee beganconducting an internal investigation. The investigation was related toallegations raised by a lawsuit against The Coca-Cola Company by a formerCoca-Cola employee, Matthew Whitley. Although we were not a defendant to thelawsuit, certain allegations contained in the lawsuit specifically involved us.The investigation was later expanded to include allegations raised in certainpress articles.

 

During the investigation, we were unable to file our quarterly reportsfor the second and third quarters of 2003 with the Securities and ExchangeCommission.  On December 5, 2003, weprovided financial information for the second and third quarters of 2003 inexhibits to a Form 8-K, in order to provide information to the investingpublic while the investigation continued.

 

Our inability to file our quarterly report for the second quarter of2003 with the SEC on a timely basis violated the American Stock Exchange (AMEX)continued listing standards, specifically Section 1003(d) of the AMEXCompany Guide. We submitted a formal action plan to regain compliance with AMEXon September 30, 2003 and AMEX accepted the plan on October 8, 2003.After the initial acceptance, we revised the plan with the approval of AMEX inorder to accommodate new developments, including our inability to file ourannual report on Form 10-K for 2003 and our quarterly report on Form 10-Qfor the first quarter 2004.

 

On January 30, 2004, we announced that the Audit Committeeinvestigation had concluded and the Audit Committee had released a generalsummary of the investigation findings. On July 1, 2004, we filed all pastdue and current periodic reports with the Securities and Exchange Commissionand regained compliance with the AMEX listing standards.

 

14

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*US Attorney and Securities and Exchange CommissionInvestigations*. In August 2003, the US Attorney’s Officeinformed us that it was conducting an investigation arising from allegationsraised in a lawsuit against The Coca-Cola Company by a former Coca-Colaemployee, Matthew Whitley, and requested certain information, which wesupplied. On January 13, 2004, we received written notice that theSecurities and Exchange Commission had issued a formal order of investigation,dated December 2, 2003, that appeared to concern matters which were thesubject of our prior Audit Committee investigation (which concluded in January 2004)including certain allegations relating to us that were contained in the Whitleylawsuit against The Coca-Cola Company.

 

On April 18, 2005, The Coca-Cola Company announced that theJustice Department had closed its investigation of allegations raised in theMatthew Whitley lawsuit and that they had reached a settlement with theSecurities and Exchange Commission regarding their investigation relating tocertain allegations set forth in the Matthew Whitley lawsuit. The settlementbetween The Coca-Cola Company and the Securities and Exchange Commission, asdescribed in the Security and Exchange Commission’s Order InstitutingCease-and-Desist Proceedings, Making Findings and Imposing a Cease-and-DesistOrder Pursuant to Section 8A of the Securities Act of 1933 and Section 21Cof the Securities Exchange Act of 1934, In the Matter of The Coca-Cola Company,dated April 18, 2005, did not relate to the business dealings betweenLancer and The Coca-Cola Company or any of the allegations from the MatthewWhitley lawsuit that involved Lancer. Therefore, in August 2005, we made adirect inquiry into the status of the investigations and were informallyadvised by both the Securities and Exchange Commission and the US Attorney’sOffice that the investigations into Lancer had concluded.

 

**12.****       Subsequent Event – MergerAgreement**

 

We entered into anAgreement and Plan of Merger, dated as of October 18, 2005, with HoshizakiAmerica, Inc.  The Agreement andPlan of Merger contemplates that a designee of Hoshizaki to be formed as acorporation under the laws of the State of Texas will be merged with and intoLancer, and each outstanding share of Lancer common stock will be converted inthe merger into the right to receive $22.00 per share in cash, withoutinterest.  Our board of directorsapproved the Agreement and Plan of Merger after receiving a fairness opinionthat the transaction is fair to our stockholders from a financial point ofview.

 

We have made customary representations and warrantiesand covenants in the Agreement and Plan of Merger, including among others (i) notto (A) solicit proposals relating to alternative business combinationtransactions or (B) subject to certain limited exceptions to permit theboard of directors to comply with their fiduciary duties, enter intodiscussions concerning or provide confidential information in connection withalternative business combination transactions, and (ii) subject to certainlimited exceptions to permit the board of directors to comply with theirfiduciary duties, for our board of directors to recommend that our stockholdersadopt the Agreement and Plan of Merger and thereby approve the merger.  The operating covenants in the Agreement andPlan of Merger also provide, among other things and subject to certainexceptions, that without Hoshizaki’s prior consent (i) we may not declare orpay any dividends and (ii) we may not enter into a material contractexcept in the ordinary course of business.

 

Consummation of the merger is subject to variouscustomary conditions, including adoption of the Agreement and Plan of Merger byour stockholders, the absence of certain legal impediments to consummation ofthe merger or any material adverse change in our business, no more than 5% ofour stockholders shall have perfected appraisal rights and the receipt ofcertain regulatory approvals.  Proceedsfrom existing Hoshizaki credit lines, together with available cash ofHoshizaki, will be sufficient for Hoshizaki to pay the aggregate mergerconsideration and all related fees and expenses.  The closing of the merger is not conditionedon the receipt of any debt financing by Hoshizaki.

 

The Agreement and Plan of Merger contains certaintermination rights and provides that, upon the termination of the Agreement andPlan of Merger under specified circumstances, we may be required to payHoshizaki a termination fee equal to $6,600,000.  In addition, in the event the Agreement andPlan of Merger is terminated because either (i) our stockholders fail toadopt the Agreement and Plan of Merger at the stockholders meeting called forthat purpose or (ii) our representations and warranties when considered intheir entirety are materially inaccurate as of the date made or as of theclosing date, except for any representations and warranties made as of aspecific date, we are required to reimburse Hoshizaki for expenses incurred inconnection with the Agreement and Plan of Merger.

 

15

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In connection with the execution of the Agreement and Plan of Merger,members of our board of directors holding approximately 38% of our outstandingcommon shares, in their capacities as stockholders, entered into the Voting andSupport Agreement, dated as of October 18, 2005, with Hoshizaki pursuantto which, among other things, such stockholders agreed to vote in favor of themerger, subject to certain limited exceptions to permit the board of directorsto comply with their fiduciary duties. The Voting and Support Agreement will terminate upon the earliest of (i) thetermination of the Agreement and Plan of Merger or (ii) the effective timeof the merger.

 

**Item 2 -Management’s Discussion and Analysis of Financial Condition and Results ofOperations.**

 

This report contains certain “forward-looking statements” within themeaning of Section 27A of the Securities Act of 1933, as amended, and Section 21Eof the Securities Exchange Act of 1934, as amended. We desire to take advantageof the “safe harbor” provisions of the Private Securities Litigation Reform Actof 1995 and we are including this statement for the expressed purpose ofavailing ourselves of the protection of the safe harbor with respect to all ofsuch forward-looking statements. These forward-looking statements describefuture plans or strategies and include our expectations of future financialresults and often include words such as “may,” “will,” “should,” “expect,” “intend,”“estimate,” “anticipate,” “believe,” “predict,” “plan,” “potential,” and “continue,”and the negatives of these terms and variations of them or similar terminology.These forward-looking statements involve known and unknown risks, uncertaintiesand other factors that may cause our actual results, performance orachievements to be materially different from results expressed or implied bythe forward-looking statements.  Factorsthat could affect actual results include but are not limited to:

 

•                  general economictrends;

•                  ability toservice our debt;

•                  availability ofcapital sources;

•                  currencyfluctuations;

•                  fluctuations inour operating costs;

•                  competitivepractices in the industry in which we compete;

•                  changes in ourlabor conditions;

•                  our capitalexpenditure requirements;

•                  technologicalchanges and innovations;

•                  legislative orregulatory requirements;

•                  operatingchanges and product needs of our main customer, The Coca-Cola Company;

•                  losses fromlitigation;

•                  satisfaction orwaiver of all conditions to consummate the Agreement and plan of Merger withHoshizaki America, Inc.; and

•                  all otherfactors described herein under “Risk Factors.”

 

These and other factors should be considered in evaluating the forward-lookingstatements, and undue reliance should not be placed on such statements.

 

We do not undertake and specifically disclaim any obligation to updateany forward-looking statements to reflect occurrence of anticipated orunanticipated events or circumstances after the date of such statements.

 

The following discussion should be read inconnection with our Consolidated Financial Statements, related notes and otherfinancial information included elsewhere in this document.

 

#### **Events**

#### ** **

On October 18, 2005,we entered into a definitive Agreement and Plan of Merger with HoshizakiAmerica, Inc.  Under the terms ofthe Agreement and Plan of Merger, Hoshizaki will acquire all of our outstandingcapital stock for $22.00 per share in cash, without interest.  See “Note 12 – Subsequent Event – MergerAgreement” in the Notes to Consolidated Financial Statements.  For a complete copy of the Agreement and Planof Merger, see Exhibit 99.1 to our Current Report on Form 8-K, dated October 19,2005.

 

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**Overview**

 

***General****.*  We design,engineer, manufacture and market fountain soft drink, beer and citrus beveragedispensing systems, and other equipment for use in the food service andbeverage industry.  We also market frozenbeverage dispensers manufactured by Lancer FBD, a partnership in which we own a50% partnership interest.  Our productsare sold by our employees and through independent distributors and agentspredominantly to major soft drink companies (primarily The Coca-Cola Company,which influences substantially more than half of our sales), bottlers,equipment distributors, beer breweries, restaurants and convenience stores foruse in various food and beverage operations. We are a vertically integrated manufacturer with tooling, production,assembly and testing capabilities that enable us to fabricate a substantialportion of the components used in our products.  Our primary manufacturingand administrative facility is located in San Antonio, Texas. We have salesemployees, distributors, and/or licensees in Latin America, Europe, Africa andAsia. We manufacture products in Australia and Piedras Negras, Mexico, andoperate warehouses in Australia, Belgium, Mexico, New Zealand, and the UnitedKingdom.

 

 Our products can be divided intofour 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-mixdispensing valves, 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.

 

**Critical Accounting Policies**

 

The Consolidated Financial Statements and Notes to ConsolidatedFinancial Statements contain information that is important to management’sdiscussion and analysis.  The preparation of financial statements inconformity with generally accepted accounting principles in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities.

 

Critical accounting policies are those that reflect significantjudgments and uncertainties and may result in materially different resultsunder different assumptions and conditions.  We believe that our criticalaccounting policies are limited to those described below.  For a detaileddiscussion on the application of these and other accounting policies, see “Note1 - Summary of Significant Accounting Policies” in the Notes to ConsolidatedFinancial Statements.

 

*Revenue Recognition*

 

We recognize revenue in accordance with the following methods:

 

### **(a)**          At the time of shipment for allproducts except for those sold under agreements described in (b). We require apurchase order for all sales. At the time of the shipment, risk of ownershipand title passes to our customer. The goods are completely assembled and packagedand we have no further performance obligations.

### ** **

### **(b)**         On a percentage of completion basisfor installation contracts exceeding 90 days in length.

### ** **

### **(c)**          We have entered into an agreementwith The Coca-Cola Company to receive partial reimbursement for design anddevelopment.  The reimbursement is offset against cost on a percentage ofcompletion basis.

### ** **

### **(d)**         Prior to 2003, we had agreed toprovide exclusive rights for use of certain tools to The Coca-ColaCompany.  These tools are included in fixed assets and are depreciatedover 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. After 2002,the Company has agreed to maintain certain tools that are the property of TheCoca-Cola Company. The corresponding maintenance fees are recorded as deferredlicensing and maintenance fees and recognized over the life of thecorresponding tool.

 

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*Reserve for Slow Moving and ObsoleteInventory*

 

We provide for slow moving inventory based on an analysis of the agingand utility of the inventory. Obsolete inventory is 100% reserved at the timethe product is deemed obsolete due to technological advances anddiscontinuation of products. In addition, management’s evaluation of thespecific items also influences the reserve.  We believe that the reserveas of September 30, 2005 is adequate to provide for expected losses.

 

*Medical Costs and Worker’s CompensationAccrual*

 

We maintain a self-insurance program for major medical andhospitalization coverage for employees in the United States and theirdependents, which is partially funded by payroll deductions.  The estimateof the accrual necessary for claims is based on our estimate of claims incurredas of the end of the quarter. We use detail lag reports provided by theinsurance administrator to determine an appropriate reserve balance at yearend. In addition to detail lag reports provided by the insurance administrator,we use an outside actuary report on an annual basis at year-end in determiningan appropriate accrual balance. We have provided for both reported medicalcosts and incurred but not reported medical costs in the accompanyingconsolidated financial statements.  We have a maximum liability of$100,000 per participant per policy year.  Amounts in excess of the statedmaximum are covered under a separate policy provided by an insurance company.

 

We are self-insured for all workers’ compensation claims submitted byTexas employees for on-the-job injuries. The estimate of the accrual necessaryfor claims is based on our estimate of claims incurred as of September 30,2005. In addition to detail lag reports provided by the insuranceadministrator, we use an injury report to determine an appropriate reservebalance. We have provided for both reported costs and incurred but not reportedcosts of workers’ compensation coverage in the consolidated financialstatements.  In an effort to provide for catastrophic events, we carry anexcess indemnity policy for workers’ compensation claims.  All claims paidunder the policy are subject to an annual deductible of $500,000 per claim tobe paid by us.  Based upon our past experience, management believes thatwe have adequately provided for potential losses.  However, multipleoccurrences of serious injuries to our employees could have a material adverseeffect on our financial position or our results of operations.

 

###### *Classificationof Costs*

 

Cost of sales generally includes costs relating to the procurement,manufacture, and handling of inventory to the point of sale.  Cost of sales includes inbound freightcharges, purchasing and receiving costs, inspection costs, warehousing costs, internaltransfer costs, and other costs of distributing product to our customers,internal or external. Gross margins may not be comparable to those of otherentities, since some entities include all of the costs related to theirdistribution network in cost of sales. We include compensation, warehousingexpenses, office expenses, and other costs relating to maintaining ourdistribution subsidiaries in selling, general and administrative expenses.  These expenses from distributor subsidiariesincluded in selling, general and administrative expenses were $1.3 million and$1.9 million in the three-month periods ended September 30, 2005 and 2004,respectively and $3.8 million and $4.1 million in the nine month periods ended September 30,2005 and 2004, respectively.  Corporateexpenses relating to product development, accounting, human resources, andinformation technology are included in selling, general and administrativeexpenses.

 

*Goodwill*

 

We account for goodwill and other intangible assets in accordance withStatement of Financial Accounting Standards SFAS No. 142, “Goodwill andOther Intangible Assets,” which requires that goodwill and certainindefinite-lived assets no longer be amortized, but instead be evaluated atleast annually for impairment.  We adopted the provisions of SFAS 142 on January 1,2002.

 

The determination of the value of goodwill and other intangiblesrequires us to make estimates and assumptions about future business trends andgrowth.  If an event occurs which would cause us to revise our estimatesand assumptions used in analyzing the value of our goodwill or otherintangibles, such revision could result in an impairment charge that could havea material adverse impact on our results of operations for the period in whichthe impairment is recognized.

 

Goodwill is tested for impairment annually as of September 30 orwhenever an event occurs or circumstances change that may reduce the fair valueof the reporting unit below its book value.  The impairment test isconducted for each reporting unit in which goodwill is recorded by comparingthe fair value of the reporting unit with its carrying value.  

 

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Fair value is determined primarily by computing the future discountedcash flows expected to be generated by the reporting unit.  If thecarrying value exceeds the fair value, goodwill may be impaired. If thisoccurs, the fair value of the reporting unit is then allocated to its assetsand liabilities in a manner similar to a purchase price allocation in order todetermine the implied fair value of the goodwill of the reporting unit. The implied fair value is then compared with the carrying amount of thegoodwill of the reporting unit, and, if it is less, we would then recognize animpairment loss.

 

Other intangible assets with definite useful lives are recorded on thebasis of cost in accordance with SFAS No. 142 and are amortized on astraight-line basis over their estimated useful lives, which range fromeighteen months to fifteen years.  Inaccordance with SFAS No. 142, we subjected these assets to tests ofimpairment and we determined that certain patents we hold no longer have valuedue to technological changes and obsolescence.

 

*Allowance for Doubtful Accounts*

 

We maintain our allowance for doubtful accounts at a balance adequateto reduce accounts receivable to the amount of cash expected to be realized oncollection. The methodology used to determine the allowance is based on ourprior collection experience. Specific customers’ financial strength andcircumstance also influence the balance of our allowance for doubtful accounts.Accounts that are determined to be uncollectible are written-off in the periodin which they are determined to be uncollectible.

 

*Guaranties*

 

We have guaranteed the debt of certain of ourjoint venture investments in the past and may do so in the future.  At the time we enter into the guaranty, werecord a liability in the amount of the estimated value of the guaranty.  The guaranty value is assumed to equal the costof obtaining a standby letter of credit in favor of the lender.  We reverse the liability when the guaranty iscancelled.

 

***Segments. ***We manage our business by geographicregion, and have four main geographical region segments:  North America, Latin America, Asia/Pacific,and Europe. Corporate administrative and engineering expenses are included inthe Corporate segment, rather than allocated among our geographic regionsegments.  Each of the geographic regionscontains sales and distribution related operations.  Additionally, the North America andAsia/Pacific regions include manufacturing operations.  (We consider our maquiladora in PiedrasNegras, Mexico to be part of our North America operations, although our salesand distribution related operations in Mexico are included in our Latin Americaregion.)  A large portion of the costsassociated with the manufacturing operations are fixed, making gross margin inNorth America and Asia/Pacific sensitive to changes in sales volume.  Because most costs in our other regions arevariable, gross margin in those regions is not as sensitive to changes in salesvolume. Most of our sales and manufacturing activity occurs in the NorthAmerica region.  Additionally, ourcorporate headquarters are physically located in North America, thoughcorporate expenses are included in the Corporate segment.

 

**Results of Operations**

 

***Comparison of the Three-Month Periods Ended September 30,2005 and 2004***

 

*Revenues.*

 

Revenues by Geographic Segment

(Amounts in thousands)

 
| ** **           | ** ** | ** **                           | ** ** | ** **        | ** ** | **% Change**     | ** ** |
|----------------------|------------|--------------------------------------|------------|-------------------|------------|------------------|------------|
| ** **           | ** ** | **Quarter Ended September 30,** | ** ** | **Third Quarter** | ** ** |
| ** **           | ** ** | **2005**                             | ** ** | **2004**          | ** ** | **2005 vs 2004** | ** ** |
| North America region |       | $                                    | 20,618     |              | $          | 20,337           |       | 1 | % |
| Latin America region |       | 1,989                                |       | 1,582             |       | 26               | %          |
| Asia/Pacific region  |       | 6,926                                |       | 6,970             |       | -1               | %          |
| Europe region        |       | 2,927                                |       | 2,375             |       | 23               | %          |
|                 |       | $                                    | 32,460     |              | $          | 31,264           |       | 4 | % |

 

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Net sales for the three months ended September 30,2005 were $32.5 million, up 4% from $31.3 million in the same period of2004.  Currency exchange ratefluctuations had a positive impact of 1% on third quarter sales in 2005.  Quarterly sales rose 26% in the Latin Americaregion, primarily because of increased purchases by our customers inMexico.  Sales declined 1% in theAsia/Pacific region, despite the positive effect of 6% from exchange ratefluctuations.  The 2004 results in theAsia/Pacific region included a large, non-recurring sale to a singlecustomer.  Sales increased 23% in theEurope region.  Approximately half of theincrease came from improved sales at our subsidiary in the United Kingdom,while the remainder was attributable to stronger sales of fountain equipment inother parts of the region.

 

*Gross Margin*.

 

(Amounts in thousands)

 
| ** **           | ** ** | **Quarter Ended September 30,** | ** ** |
|----------------------|------------|--------------------------------------|------------|
| ** **           | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| North America region |       | 36.2                                 | %          | 27.4 | % |
| Latin America region |       | 27.6                                 | %          | 27.6 | % |
| Asia/Pacific region  |       | 29.9                                 | %          | 30.2 | % |
| Europe region        |       | 29.0                                 | %          | 32.9 | % |
|                 |       | 33.7                                 | %          | 28.5 | % |

 

Gross margin was 33.7% in the third quarter of2005, compared to 28.5% in the third quarter of 2004.  Margin improved in the North America region,where higher factory output to support increased sales levels aided grossmargin.  Higher manufacturing volumetends to have a positive impact on gross margin because a significant portionof our manufacturing costs is fixed.  Inthe Europe region, gross margin declined to 29.0% in the third quarter of 2005from 32.9% in the same period of 2004, due primarily to lower marginsassociated with the mix of products sold in the region in 2005.

 

*Operating Expenses*.  

 

Selling, General and Administrative Expensesby Segment

(Amounts in thousands)

 
| ** **           | ** ** | **Quarter Ended September 30,** | ** ** |
|----------------------|------------|--------------------------------------|------------|
| ** **           | ** ** | **2005**                             | ** ** | **2004** | ** ** |
| North America region |       | $                                    | 1,390      |   | $ | 1,348 |   |
| Latin America region |       | 229                                  |       | 266 |   |
| Asia/Pacific region  |       | 1,382                                |       | 1,302 |   |
| Europe region        |       | 659                                  |       | 561 |   |
| Corporate            |       | 3,691                                |       | 3,463 |   |
|                 |       | $                                    | 7,351      |   | $ | 6,940 |   |

 

Selling, general and administrative expenses were$7.4 million in the third quarter of 2005, compared to $6.9 million in the sameperiod of 2004.  Spending declined in theLatin America region due to a consolidation involving the closure of four salesoffices and a reduction in employment. Engineering and product development costs caused most of the $0.1million spending increase in the Europe region. In the Corporate segment, compliance costs associated with the requirementsof Section 404 of the Sarbanes-Oxley Act of 2002 were $0.3 million in thethird 

 

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quarter of 2005. Although we are unable to predict with any certainty the exact cost ofcontinuing compliance with the Sarbanes-Oxley Act, we currently expect to spendan additional $0.4 million during the remainder of 2005.

 

Other operating loss of $0.1 million in the thirdquarter of 2005 consisted primarily of loss on the disposal of assets.  In the third quarter last year, otheroperating loss of $0.3 million consisted of patent impairments of $0.2 millionand loss on the disposal of assets of $0.1 million.

 

*Non-Operating Income/Expenses.*  Thefollowing information relates to certain of our non-operating income and expensesduring the three-month periods ended September 30, 2005 and 2004:

 

•                  Incomefrom joint ventures was $0.3 million in the third quarter of 2005, compared to$0.6 million in the same period of 2004. The decline in the 2005 quarter reflects the lower profitability ofLancer FBD and increased losses from Moo Technologies.  Moo Technologies is a developmental stagelimited liability company in which we own 50% of the outstanding equity.  Our portion of Moo Technologies’ net loss was$0.2 million in the third quarter of 2005, and $0.1 million in the same periodof 2004.  We expect Moo Technologies tocontinue to incur losses for the remainder of 2005.

 

•                  Duringthe third quarter of 2004, we recorded other income of $7.0 million from asettlement with The Coca-Cola Company relating to the termination of a project.

 

*Net Earnings/Loss*.  Netearnings were $2.4 million in the third quarter of 2005, compared to $5.8million in the third quarter of 2004. The $7.0 million settlement with The Coca-Cola Company had a significantpositive impact on profitability in the third quarter of 2004.

 

***Comparison of the Nine-Month Periods Ended September 30,2005 and 2004***

 

*Revenues.*

 

Revenues by Geographic Segment

(Amounts in thousands)

 
| ** **           | ** ** | ** **                               | ** ** | ** **            | ** ** | **% Change**     | ** ** |
|----------------------|------------|------------------------------------------|------------|-----------------------|------------|------------------|------------|
| ** **           | ** ** | **Nine Months Ended September 30,** | ** ** | **First Nine Months** | ** ** |
| ** **           | ** ** | **2005**                                 | ** ** | **2004**              | ** ** | **2005 vs 2004** | ** ** |
| North America region |       | $                                        | 63,915     |                  | $          | 59,291           |       | 8 | % |
| Latin America region |       | 6,040                                    |       | 4,057                 |       | 49               | %          |
| Asia/Pacific region  |       | 19,257                                   |       | 19,793                |       | -3               | %          |
| Europe region        |       | 10,233                                   |       | 9,326                 |       | 10               | %          |
|                 |       | $                                        | 99,445     |                  | $          | 92,467           |       | 8 | % |

 

Net sales for the nine months ended September 30,2005 were $99.4 million, up 8% from $92.5 million in the same period of2004.  Currency exchange ratefluctuations had a positive impact of 1% on sales in the 2005 period.  Sales rose 8% in the North America region,largely because of improved sales of recently developed products to chainaccount customers.  Sales rose 49% in theLatin America region. The improvement in Latin America was centered in Mexico,and included $0.4 million from the sale of equipment that we had previouslyrented to our customers.  Sales declined3% in the Asia/Pacific region, despite the positive effect of 5% from exchangerate fluctuations.  The 2004 results inthe Asia/Pacific region included a large, non-recurring sale to a singlecustomer.  A 10% sales increase in theEurope region included the 3% positive impact from currency exchange ratefluctuations.  Additionally, sales at oursubsidiary in the United Kingdom increased by $0.3 million in 2005.

 

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*Gross Margin*.

 

Gross Margin by Geographic Segment

(Amounts in thousands)

 
| ** **           | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------|------------|------------------------------------------|------------|
| ** **           | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| North America region |       | 35.1                                     | %          | 30.0 | % |
| Latin America region |       | 28.7                                     | %          | 26.5 | % |
| Asia/Pacific region  |       | 26.7                                     | %          | 29.3 | % |
| Europe region        |       | 32.0                                     | %          | 32.7 | % |
|                 |       | 32.8                                     | %          | 30.0 | % |

 

Gross margin was 32.8% in the first nine months of2005, compared to 30.0% in the same period of 2004.  Much of the improvement came in the NorthAmerica region, where higher factory output to support increased sales levelsaided gross margin.  Higher manufacturingvolume tends to have a positive impact on gross margin because a significantportion of our manufacturing costs is fixed. Gross margin increased in the Latin America region due largely to marginassociated with the sale of equipment that we had previously rented to ourcustomers.  In the Asia/Pacific region,gross margin declined in the first nine months of 2005 because of lower factoryoutput at our manufacturing facility in Australia, and $0.2 million of factoryrelocation expense.

 

*Operating Expenses*.  

 

Selling, General and Administrative Expensesby Segment

(Amounts in thousands)

 
| ** **           | ** ** | **Nine Months Ended September 30,** | ** ** |
|----------------------|------------|------------------------------------------|------------|
| ** **           | ** ** | **2005**                                 | ** ** | **2004** | ** ** |
| North America region |       | $                                        | 4,318      |   | $ | 4,292 |   |
| Latin America region |       | 547                                      |       | 1,077 |   |
| Asia/Pacific region  |       | 3,792                                    |       | 3,843 |   |
| Europe region        |       | 1,956                                    |       | 1,794 |   |
| Corporate            |       | 10,937                                   |       | 11,326 |   |
|                 |       | $                                        | 21,550     |   | $ | 22,332 |   |

 

Selling, general and administrative expenses were$21.6 million in the first nine months of 2005, compared to $22.3 million inthe same period of 2004.  Spendingdeclined in the Latin America region due to a consolidation involving theclosure of four sales offices and a reduction in employment.  Additionally, improved credit quality of ouraccounts receivable in the Latin America region allowed us to reverse $0.1million of bad debt reserve in the first nine months of 2005, while we incurred$0.1 million of bad debt expense in the region in the 2004 period.  In the Corporate segment, compliance costsassociated with the requirements of Section 404 of the Sarbanes-Oxley Actof 2002 were $0.9 million in the nine months ended September 30,2005.  Although we are unable to predictwith any certainty the exact cost of continuing compliance with theSarbanes-Oxley Act, we currently expect to spend an additional $0.4 millionduring the remainder of 2005.  During thefirst nine months of 2004, we incurred $2.3 million of audit-related expensesand costs associated with the investigations conducted by our Audit Committee,the Securities and Exchange Commission and the US Attorney’s Office.  We incurred $0.4 million of audit expense inthe first nine months of 2005.  Also inthe first nine months of 2005, we incurred $0.3 million of expense relating toour proposed merger plan.

 

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Other operating income in the first nine months of2005 consisted primarily of a $0.3 million gain on the sale of land andimprovements located in Bee County, Texas. See “Liquidity and Capital Resources – Cash Provided by Operations andCapital Expenditures” below.  This gainwas partially offset by loss on the disposal of assets of approximately $0.1million.  In the 2004 period, otheroperating income included a $0.4 million gain relating to insurance proceedsfrom a claim of damages from a fire that occurred in 2003.  The gain was offset by a patent impairment of$0.2 million and loss on the disposal of assets of $0.2 million.

 

*Non-Operating Income/Expenses.*  Thefollowing information relates to certain of our non-operating income andexpenses during the nine-month periods ended September 30, 2005 and 2004:

 

•                  Incomefrom joint ventures was $1.0 million in the first nine months of 2005, comparedto $0.8 million in the same period of 2004. The improvement in 2005 was driven by the profitability of LancerFBD.  Moo Technologies is a developmentalstage limited liability company in which we own 50% of the outstandingequity.  Our portion of Moo Technologies’net loss was $0.4 million in the first nine months of 2005, and $0.2 million inthe same period of 2004.  We expect MooTechnologies to continue to incur losses for the remainder of 2005.

 

•                  Duringthe third quarter of 2004, we recorded other income of $7.0 million from asettlement with The Coca-Cola Company relating to the termination of a project.

 

*Net Earnings/Loss*.  Netearnings were $8.0 million in the first nine months of 2005, compared to $8.2million in the same period of 2004.  The$7.0 million settlement with The Coca-Cola Company had a significant positiveimpact on profitability in the first nine months of 2004.

 

**Liquidity and Capital Resources**

 

*General.*  Our principal sources of liquidity are cashflows from operations and amounts available under our lines of credit. We havemet, and currently expect that we will continue to meet, substantially all ofour working capital and capital expenditure requirements, as well as our debtservice requirements, with funds provided by operations and borrowings underour credit facility.

 

*Cash Provided by Operations andCapital Expenditures.*

 

Cash provided by operating activities was $4.5million in the first nine months of 2005, down from $12.6 million in the sameperiod of 2004.  During the 2005 period,inventory growth, lower accrued expenses, and higher tax payments caused mostof the negative comparison to the prior year. We made capital expenditures of $4.4 million and $1.5 million during thefirst nine months of 2005 and 2004, respectively.  Most of the capital spending in both periodswas for production equipment and tooling.

 

During the first quarter of 2005, we completed the sale of 546.65 acresof land and improvements, located in Bee and Karnes Counties, Texas, toSchroeder Land and Cattle Company, Incorporated (SLCC). The purchase price of$0.7 million approximates the average of two independent third party appraisalson the property.  SLCC is owned by thechildren of Alfred A. Schroeder and George F. Schroeder.  Both Alfred A. Schroeder and George F.Schroeder are our employees, members of our Board, and significant shareholdersof our stock.  Lance M. Schroeder, son ofAlfred A. Schroeder, is our Vice President of Corporate Development and is a25% owner of SLCC.  We had previouslyused the property, commonly known as the Monteola Ranch, for entertainingcustomers and other business associates. We realized a gain of $257 thousand on the transaction in the firstquarter of 2005.

 

*Credit Facility.*  As of September 30, 2005, there were noamounts outstanding under our $15.0 million revolving credit facility, and$15.0 million was available for borrowing.  Also as of September 30,2005, we were in compliance with all of the covenants of the credit facility.

 

*Disputed Debt*.  We have a $1.196 million principal amount ofdisputed debt payable in relation to our discontinued Brazilian operations thatwas due on December 31, 2001.  Wehave recorded the balance of the disputed debt plus interest in the amount of$0.17 million accrued through September 30, 2005 in our financialstatements. During the 

 

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second quarter of 2003, the payee demanded payment of the debt, and wemade a settlement offer. We have had no discussions with the payee since 2003.We may not be successful in negotiating a settlement of this disputed debt, inwhich case the total amount would remain due and payable.  If that were to occur, we would have todetermine what other options are available to us, including litigation. If wedetermined that the debt should simply be paid at that time, we believe that wewould likely have sufficient funding available, through our cash reservesand/or our available capacity under our credit facility, to pay the disputeddebt.

 

At September 30, 2005 and December 31,2004, long-term obligations consisted of the following:

 
| ** **                  | ** ** | **September 30,** | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|------------------------|------------|-----------------------|------------|
| **(amounts in thousands)**  | ** ** | **2005**               | ** ** | **2004**              | ** ** |
|                        |       |                   |       |                  |       |
| Credit facility             |       | $                      | —     |                  | $          | — |   |
| Disputed debt               |       | 1,196                  |       | 1,196                 |       |
| Capital lease obligation    |       | 170                    |       | 281                   |       |
| Total long-term obligations |       | 1,366                  |       | 1,477                 |       |
| Less: Current maturities    |       | 1,353                  |       | 1,345                 |       |
| Long-term obligations, net  |       | $                      | 13         |                  | $          | 132 |   |

 

**Off-Balance Sheet Arrangements**

 

We own 50% of Lancer FBD, a manufacturer of frozenbeverage dispensing equipment. We guaranteed repayment of Lancer FBD’s $1.5million credit facility with a bank until the facility’s expiration on March 3,2005.  After the expiration of thefacility, the bank released our guarantee. Accordingly, we reversed an accrual for the value of the guaranty,resulting in income of $22,500 during the first quarter of 2005.  Lancer’s portion of Lancer FBD’s net incomein 2004 was $1.4 million, and its share of Lancer FBD’s net income in the ninemonths ended September 30, 2005 was $1.3 million.

 

We own 50% of Moo Technologies, a developmental stage limited liabilitycompany engaged in the commercialization of concentrated shelf-stable milkproducts.  Until recently, we guaranteedMoo Technologies’ $0.75 million revolving credit facility with a bank.  During the first quarter of 2005, MooTechnologies repaid all amounts outstanding under the revolving credit facilityand terminated the facility, and the lender released us from our guaranty.  Our portion of Moo Technologies’ loss was$0.3 million in 2004, and $0.4 million during the first nine months of 2005.  We have invested $1.6 million in MooTechnologies since its inception, including $0.8 million during the first ninemonths of 2005, bringing our net investment in the company to $0.8 million asof September 30, 2005.  We expectMoo Technologies to be unprofitable through at least 2005, and we expect tocontinue to fund Moo Technologies in a manner consistent with what we have donein the past.

 

**Risk Factors**

 

**Risks Relating to Our Business**

 

***Our success is reliant upon our relationship with The Coca-Cola Company.***

 

Substantially more than half of our sales are derived from, orinfluenced by, The Coca-Cola Company. Direct sales to The Coca-Cola Company,our largest customer, accounted for approximately 23%, 28% and 35% of our netsales for the years ended December 31, 2004, 2003 and 2002, respectively.We do not have a long-term supply contract with The Coca-Cola Company or any ofour 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 us. While we do not anticipate the loss or reduction in this businessor the imposition of significant price constraints based upon our pastexperience and current relations with The Coca Cola Company, any suchoccurrence would have a material adverse effect on us and our results ofoperation.

 

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***Our business is subject to rapidly changing technologies and is highlycompetitive.***

 

The business of manufacturing and marketing beverage dispensing systemsand other related equipment is characterized by rapidly changing technology andis highly competitive. In addition, we frequently compete with companies havingsubstantially greater financial resources than ours. Although we have been ableto compete successfully in the past, if we were to lose any or all of ourcompetitive advantages or if our competitors were able to provide productsuitability and reliability, price, product warranty, technical expertise anddelivery time, in a manner superior to ours, we would likely lose our marketshare and demand for our products would decline. In addition, if our existinglong standing relationships with certain of our customers, including TheCoca-Cola Company, were to be disrupted or become unfriendly, our competitorsmay be afforded an opportunity to provide their products to our customers andbegin to develop their own strong relationships with our customers. Since theserelationships have become so important in our industry, these events would makeour ability to continue to provide our products much more difficult and inturn, the newly formed relationships would become more difficult barriers toovercome as time progressed.

 

***We have been the target of securitieslitigation and may again be the target of further actions, which may be costlyand time consuming to defend.***

 

We have been the target of securities class action litigation in thepast. Securities class action litigation is often brought against a companyfollowing a decline in the market price of its securities. Certain factors,including the uncertainty of the Securities and Exchange Commission and USAttorney’s Office investigations could lead to more volatility in our stockprice, which could in turn cause us to be the target of future securities classaction claims. If we were to become a target of future class action claims, itwould likely require significant commitment of our financial and managementresources and time, subverting resources and time away from our other business needs,which may materially and adversely affect our business, financial condition andresults of operations.

 

***Our directors and executive officers have substantial voting power,giving them the ability to influence corporate actions.***

 

Our directors and executive officers beneficially own approximately 40%of the outstanding shares of our common stock. As a result, our directors andexecutive officers will have the ability to affect the vote of our shareholderson significant corporate actions requiring shareholder approval, includingmergers, share exchanges and sales of all or substantially all of our assets.With such voting power, our directors and executive officers may also have theability to delay or prevent a change in control of our company.

 

***Our investment in Moo Technologies may not provide us with anyinvestment return or could result in a total loss of the investment.***

 

We own a 50% interest in Moo Technologies, a developmental stagelimited liability company engaged in the commercialization of milkproducts.  Our net investment was $0.8million at September 30, 2005, including $0.8 million that we invested inthe first nine months of 2005.  MooTechnologies’ inability to generate material revenues and/or profits in thefuture could lead to the impairment of some or all of our investment and suchinvestment could be permanently lost.

 

***Doing business in foreign countries creates certain risks not found indoing business in the United States.***

 

Doing business in foreign countries carries with it certain risks thatare not found in doing business in the United States. We currently derive aportion of our revenues from international sales of our products and servicesand intend to look for ways to expand our international operations. The risksof doing business in foreign countries that could result in losses againstwhich we are not insured include:

 

  •   exposure to local economic conditions;

  •   potential adverse changes in the diplomaticrelations of foreign countries with the United States;

  •   hostility from local populations;

  •   the adverse effect of currency exchangecontrols;

  •   restrictions on the withdrawal of foreigninvestment and earnings;

 

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  •   government policies against businesses ownedby foreigners;

  •   investment restrictions or requirements;

  •   expropriations of property;

  •   the potential instability of foreigngovernments;

  •   the risk of insurrections;

  •   foreign exchange restrictions;

  •   withholding and other taxes on remittancesand other payments by subsidiaries; and

  •   changes in taxation structure.

 

***Foreign exchange rates may cause future losses in our internationaloperations.***

 

Because we own assets overseas and derive revenues from our internationaloperations, we may incur currency translation losses due to changes in thevalues of foreign currencies and in the value of the U.S. dollar. We cannotpredict the effect of exchange rate fluctuations upon future operating results.

 

***Provisions in our Certificate ofIncorporation and Bylaws and Texas law could delay or discourage a takeover,which could adversely affect the price of our common stock.***

 

Our Board has the authority to issue up to 5 million shares ofpreferred stock and to determine the price, rights, preferences, privileges,and restrictions, including voting rights, of those shares without any furthervote or action by holders of our common stock. If preferred stock is issued, the voting and other rights of the holdersof our 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 that could have been at a premium price to ourstockholders.

 

Certain provisions of our certificate of incorporation and bylaws coulddiscourage potential takeover attempts and make attempts to change managementby stockholders difficult.  Our Board hasthe authority to impose various procedural and other requirements that couldmake it more difficult for our stockholders to effect certain corporateactions. Any vacancy on our Board may be filled by a vote of the majority ofdirectors then in office.

 

In addition, certain provisions of Texas law could have the effect ofdelaying or preventing a change in control of our company.  Section 13.03 of the Texas BusinessCorporation Act, for example, prohibits a Texas corporation from engaging inany business combination with any affiliated shareholder for a period of threeyears from the date the person became an affiliated shareholder unless certainconditions are met.

 

**Risks Relating to Our Common Stock**

 

***The trading price of our common stock has been, and is expected tocontinue to be, volatile.***

 

The American Stock Exchange, where our stock trades, and stock marketsin general, have historically experienced extreme price and volume fluctuationsthat have affected companies unrelated to their individual operatingperformance. The trading price of our common stock has been and is likely tocontinue to be volatile due to such factors as:

 

•                  variations inquarterly results of our operations;

•                  announcements ofnew products or acquisitions by our competitors;

•                  governmentalregulatory action;

•                  resolution ofpending or unasserted litigation; and

•                  general trendsin our industry and overall market conditions.

 

Movements in prices of equity securities in general may also affect themarket price of our common stock.

 

***We have no history of paying dividends on our common stock.***

 

Since our inception, we have not paid, and we haveno current plan to pay, cash dividends on our common stock. We currently intendto retain all earnings to support our operations and future growth. The paymentof any future

 

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dividends will be determined by the Board basedupon our earnings, financial condition and cash requirements, restrictions infinancing agreements, business conditions and other factors the Board may deemrelevant.

 

**Risks Relating to the Sale of Our Business**

 

On October 19, 2005, our Board approved a definitive agreement tosell Lancer Corporation to Hoshizaki America, Inc.  Under the terms of the agreement, HoshizakiAmerica, Inc. will acquire all of our outstanding shares for $22.00 pershare in cash, without interest, representing a transaction value ofapproximately $215.0 million.  Althoughwe expect to complete this transaction sometime in February 2006, it ispossible that we will not be able toconsummate the merger in that timeframe or at all because the completionof the transaction is contingent upon regulatory review, approval by ourstockholders, and other customary closing conditions.

 

# **Item 3 - Quantitative andQualitative Disclosures About Market Risk**

# ** **

There have been no significant changes in the Company’s market riskfactors since December 31, 2004.

 

**Item 4 – Controls and Procedures**

 

The Company’s principal executive and financialofficers have concluded, based on their evaluation as of the end of the periodcovered by this Form 10-Q, that Lancer’s disclosure controls andprocedures, 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 includecontrols and procedures designed to ensure that information we are required todisclose in such reports is accumulated and communicated to management,including our principal executive and financial officers, as appropriate, toallow timely decisions regarding required disclosure.

 

There has been no change in the Company’s internal control over financialreporting (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**

**OTHERINFORMATION**

 

**Item 1 - Legal Proceedings**

 

In August 2003, the US Attorney’s Office informed us that it wasconducting an investigation arising from allegations raised in a lawsuitagainst The Coca-Cola Company by a former Coca-Cola employee, Matthew Whitley,and requested certain information, which we supplied. On January 13, 2004,we received written notice that the Securities and Exchange Commission hadissued a formal order of investigation, dated December 2, 2003, thatappeared to concern matters which were the subject of our prior Audit Committeeinvestigation (which concluded in January 2004) including certainallegations relating to us that were contained in the Whitley lawsuit againstThe Coca-Cola Company.

 

On April 18, 2005, The Coca-Cola Company announced that theJustice Department had closed its investigation of allegations raised in theMatthew Whitley lawsuit and that they had reached a settlement with theSecurities and Exchange Commission regarding their investigation relating tocertain allegations set forth in the Matthew Whitley lawsuit. The settlementbetween The Coca-Cola Company and the Securities and Exchange Commission, asdescribed in the Security and Exchange Commission’s Order InstitutingCease-and-Desist Proceedings, Making Findings and Imposing a Cease-and-DesistOrder Pursuant to Section 8A of the Securities Act of 1933 and Section 21Cof the Securities Exchange Act of 1934, In the Matter of The Coca-Cola Company,dated April 18, 2005, did not relate to the business dealings betweenLancer and The Coca-Cola Company or any of the allegations from the MatthewWhitley lawsuit that involved Lancer. Therefore, in August 2005, we made adirect inquiry into the status 

 

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of the investigations and were informally advised by both theSecurities and Exchange Commission and the US Attorney’s Office that theinvestigations into Lancer had concluded.

 

 **Item 2.  Unregistered Sales ofEquity 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**

 

Not Applicable

 

**Item 5. Other Information**

 

Not Applicable

 

**Item 6. Exhibits**

 

Exhibits:  See Exhibit Indexon Page 30.

 

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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 14, 2005 | By:                                  |  /s/ CHRISTOPHER D. HUGHES | ** ** |
|                   |                                 |  Christopher D. Hughes   Chief Executive Officer |
|                   |                                 |
| November 14, 2005 | By:                                  |  /s/ MARK L. FREITAS |   |
|                   |                                 |  Mark L. Freitas   Chief Financial Officer |

 

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**INDEX TOEXHIBITS**

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                     |
|-------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                |
| 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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