Well, well, well... Another Lancer that may yet incur the newfound wrath of the SEC...
Perhaps it's something in the name Lancer, or maybe it's just something in the water... Who knows?
Lancer Corporation: AMEX: LAN
usatoday.com
Posted 8/19/2003 10:14PM - Updated 8/20/2003 2:07AM
Big problems bubble up for Coke's little partner Lancer
By Elliot Blair Smith, USA TODAY
SAN ANTONIO — Ruben Quintanilla, a former internal auditor for one of Coca-Cola's most important equipment suppliers, made a startling discovery one day in late 1999. He could not find more than $1 million in soft-drink fountains and parts his South Texas employer, Lancer, supposedly had tucked away in its warehouses and truck trailers.
Quintanilla was concerned that if Lancer had miscalculated its inventory, the manufacturer's financial statements were inaccurate and the small, cash-strapped company would be required to write down the value of its assets. That could be disastrous when Lancer was fighting to survive.
Quintanilla also feared the reaction of his bosses. Lancer Chairman Alfred "Jud" Schroeder and Chief Executive George Schroeder are strong-willed brothers who own 27% of the public company's stock and run it like a family fief.
Last week, Lancer disclosed it was the subject of a federal criminal investigation for another matter. Lancer allegedly submitted fraudulent invoices to Coke's fountain division in 2001 under a secret agreement to disguise the true cost of its dispensers, according to court documents and records filed with the Securities and Exchange Commission. But the mystery of the missing inventory in 1999 shows that Lancer's accounting problems began even earlier.
At the time, trouble was piling up at the little-known company. Lancer was on the verge of reporting a large loss and facing bankers' demands to pledge substantially all its assets to refinance its debt. Coke, facing its own problems, also was retrenching. Quintanilla says he feared for his job but pressed ahead. And when he confronted the Schroeders, he says, "They could not verify the equipment even existed."
Family-run Lancer offers shareholders a cautionary tale. It is a small company that hitched its fortunes to a Wall Street star in Coke but was slow to implement the standards and accountability that investors expect of blue-chip companies, and, by association, of their partners. The relationship, which dates to Lancer's founding in Jud Schroeder's garage in 1967, is so closely intertwined that business and personal ties sometimes are indistinguishable.
Former Coke managers serve on Lancer's board and among its top executives. Coke pays for some Lancer research and development. And the two companies' executives share dozens of technical patents as well as a legacy of hard-drinking socializing at a Lancer hunting lodge in South Texas.
Today, Lancer's Coke-emblazoned machines deliver bubbling drinks at thousands of fast-food restaurants and convenience stores. But serious problems underscore the relationship as well.
In June the SEC launched an informal probe of Lancer and Coke after a former Coke auditor alleged the companies had formed an illegal agreement to disguise the cost of dispensers Lancer made for Coke. A federal grand jury in Atlanta began investigating shortly thereafter, as disclosed first by Coke and last week by Lancer.
A USA TODAY investigation shows that Lancer has engaged in questionable accounting practices for years, during which time Schroeder family members enriched themselves at company expense, according to former Lancer executives, directors, company financial disclosures and court records.
Lancer and the Schroeder brothers repeatedly declined to be interviewed for this story. Treasurer Scott Adams said, "We decline to comment." Previously the company said it was cooperating with federal investigators and undertaking its own review. The SEC and Justice Department in Atlanta and San Antonio also would not comment.
USA TODAY found:
• The Schroeder brothers put Lancer employees and equipment to work on a 1,618-acre family cattle ranch they own in Bexar County, Texas, and at a 326-acre ranch they own in a partnership, both near the company hunting lodge, say several former Lancer executives, including former Lancer vice president Samuel Durham, who remains a partner with the Schroeders at Mesquite Ranch.
George Schroeder also employed a Lancer foreman and other employees in building his personal residence in the wooded hills outside of San Antonio last year, the former Lancer executives say. Former Lancer vice president Raymond Frerich says he was fired in March 2002 in part because he protested the Schroeders' use of company resources. "I told them I had to have my maintenance guys at the plant," he says.
• Lancer provided the Schroeder brothers with loans up to $290,000 at interest rates below the adjustable IRS "gift" rate from 1994 to January 1997, company filings show. Lancer did not specify it was lending the money below the gift rate nor whether the deal was treated as compensation, as the IRS requires. In addition, the Schroeders repeatedly rolled over the company loans to them — passing multiple repayment deadlines — and borrowed more money up to $746,000 at the IRS gift rate in 1999 when Lancer confronted a cash-flow crisis and was renegotiating its own bank credit lines, company records show.
In April 2001 Lancer's board finally set the Schroeder loans at competitive rates and demanded repayment by the end of 2002, a director says.
"We decided they should pay a market rate of interest," says audit committee director Walter Biegler. But the brothers missed that deadline, too — owing $407,000 at year's end — before reducing the total outstanding to $41,000 by April.
• The Schroeders charged Lancer rent for warehouses the brothers own, even after the company no longer needed the space; and several family members, including George Schroeder Jr., a sculptor, used that space for personal storage and work areas, say former Lancer executives. Among the warehoused possessions, the former Lancer executives say: George Schroeder Sr.'s vintage automobiles, boats, Mexican tile and family purchases from a shopping expedition to South America.
Former vice president Frerich says, "I tried to get out of (the Schroeder) buildings ... several times because we had no use for them. They kept them open." Among other family perks, say the former executives: Lancer printed logos for the brothers' cattle ranch, wedding invitations for one of the CEO's daughters and T-shirts for a daughter's café, all at no charge. George Schroeder's cousin, Dolph Nesloney, adds that the CEO had his cars serviced at Nesloney's auto-repair shop and billed Lancer.
• George Schroeder borrowed $500,000 from a large bank in December under a home equity loan that valued his newly built residence at $1 million, county records show. But the Bexar County, Texas, Fair Appraisal District values the property at only $573,000, a recent assessment shows. And the loan, which requires the stated fair market value to be "accurate, true and correct in all respects," limits the loan-to-value ratio to 80%.
Bexar County Chief appraiser Michael Amezquita, who reviewed an aerial photo of Schroeder's property and the county's assessment, says, "I don't know where this guy came up with $1 million." The bank declined to comment.
At the time of the loan, Schroeder faced the December deadline to repay his $300,000 share of family debt to Lancer. He also confronted a $312,000 loss from a failed investment in a fraudulent car-lending business, according to a lawsuit he filed in state court.
Humble beginnings
Jud Schroeder, now 66, crafted his first invention in 1960 while attending St. Mary's University School of Law in San Antonio. Working by day as a salesman for American Photocopy Equipment, he invested $200 in the creation of a plastic photo "carrier" held together by tape. Brother George, now 63, who also attended St. Mary's and also graduated with a law degree, assembled the product.
The Schroeders' fortunes rose the next year when they began to produce Styrofoam coolers they affixed with Lone Star and Pearl beer decals. But their plant, in a World War I government warehouse, burned to the ground in 1965. "They didn't have any insurance," recounts cousin Nesloney, who grew up with the Schroeders. "So when they started over again they were flat broke."
Undeterred, Jud Schroeder turned to inventing a snap-fit valve that connected to a CO{-2} tank and dispensed soft-drink syrup. That became the cornerstone of Lancer.
"They kept growing and growing," Nesloney says. Lancer went public in 1985. And the Schroeders' fortunes soared: $100 invested in 1991 was worth $1,048 by the end of 1996. But several failed projects and revolving-door management took a toll, particularly in the Schroeders' disastrous foray into Brazil where some Lancer products never moved past a South American customs warehouse.
In late 1999, just as the Brazilian losses threatened the company's solvency, the chief financial officer, David Green, quit, becoming one of five CFOs to work at the company during the last nine years.
An internal management report that year complained of "organizational paralysis ... of accounting information within the company." The report, a copy of which was obtained by USA TODAY, says "there's no confidence ... when numbers have to be 'massaged' before they have meaning."
That was the backdrop for the internal auditor Quintanilla's presentation to the Schroeders that management appeared to have overstated inventory by more than $1 million.
Even when the Schroeders were confronted with doubts about those Lancer assets, the brothers and other top executives negotiated how much of the missing inventory they would admit to in the company's financial statement, says another Lancer manager at the time. "It was clearly a negotiated number," says Robert Sanderford, Lancer's senior financial analyst who participated in the talks.
Several months later, in a filing with the SEC, the company discreetly cited "an unfavorable inventory adjustment" of $800,000 while offering no hint the accounting problems might be far worse.
Just before Christmas 2000, Quintanilla says, he reappeared before the Schroeders with another unfavorable report about how the company seemed to be improperly accounting for slow-moving and obsolete inventory that was piling up in company warehouses. The discussion quickly grew heated.
"We got an earful about the way we were approaching things," says Sanderford, who accompanied Quintanilla. Both men were fired, separately, several months later.
Lancer made no big accounting adjustment at the time. But as investor credulity waned, $100 invested in Lancer five years earlier fell to $36.81 by the end of 2001. And at the end of 2002, Lancer quietly increased its allowance for doubtful accounts by 136% to nearly $1 million from three years earlier and increased its reserves for slow-moving and obsolete inventory by 343% to $3.8 million.
A fateful deal with Coke
This time Lancer was saved by a strategy shift at Coke. The soft-drink marketer decided to consolidate its soda-fountain suppliers into a handful of companies. And Coke tapped Lancer to develop three new products: a Frozen Coke dispenser Burger King installed nationwide in 2000; a frozen coffee dispenser for Coke's Planet Java beverage installed at Wal-Mart and other stores in 2001 and 2002; and the computer-programmed iFountain, which Coke said would "transform the industry."
All three products failed. Lancer and Coke blame each other for the shortcomings.
Complicating the relationship, Lancer helped Coke launch iFountain under a now-suspect agreement to undercharge the soft-drink company for the new high-tech product and overcharge it for the traditional "legacy" dispensers it also makes, according to company e-mails, letters and memorandums filed as exhibits in the wrongful termination lawsuit of the former Coke internal auditor.
Coke persuaded Lancer to distort the internal cost accounting to make the new iFountain fraudulently appear more attractive, former Coke auditor Matthew Whitley alleges in his lawsuit filed in Atlanta. Coke needed retail clients to believe the new product was technically superior and a bargain relative to the older fountains, Whitley contends.
But the iFountain was plagued by technical problems. And the older "legacy" fountain continued to outsell it. As a result, Lancer ended up with $841,230 in overbillings it wanted to repay Coke, according to a January 2002 letter by Jud Schroeder's son, Lance Schroeder, to Coke executives.
At the same time, Lancer officials complained to Coke that their auditor, KPMG, was raising questions about the agreement and threatening to inform the SEC, according to handwritten notes of a conversation between Whitley and Lance Schroeder. Copies of the notes and letter are filed in court.
Lancer director Biegler denies that Lancer feared regulatory scrutiny. "As far as our auditor threatening to go to the SEC, that is absolutely false. We put these things on the table and asked the auditor if it's proper, and, if you need to ask the SEC, please do so," he says. KPMG declined to comment.
Coke tried to settle the controversy, according to a company letter in the court record, by telling Lancer to keep the money. It's unclear how Lancer accounted for this alleged "slush fund," as Whitley terms it. The windfall was equivalent to 60% of Lancer's net income in 2001. But in June, Coke's board acknowledged its fountain division had engaged in questionable "financial arrangements" with Lancer. Coke took related pretax write-downs of $9 million.
Lancer said it, too, would investigate through an outside law firm in Dallas that declined to comment.
A lawyer familiar with the federal investigation said Coke corporate now executives believe they were defrauded by fountain division managers and by Lancer executives. Another source familiar with both companies said Coke is considering distancing itself from Lancer as a result of the scandal.
Meanwhile, Lancer continues to operate much as it always has under the tight control of the Schroeder brothers, whose lives and wealth inextricably are tied to it, say people close to the company.
Former director E.T. Summers III, a retired president of Coca-Cola Bottling of the Southwest, notes he was asked to resign in 2001 after "Jud and I reached an agreement that I wasn't good for the board because I was too independent." Besides, Summers says, his advice was ignored. "I told them: 'You have to build shareholder value because you're the biggest shareholders. You're suffering more than anybody.'"
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