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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002.
[ ] 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: 0-16159
LECTEC CORPORATION
-------------------
(Exact name of Registrant as specified in its charter)
Minnesota 41-1301878
- --------------------------------- --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10701 Red Circle Drive, Minnetonka, Minnesota 55343
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (952) 933-2291
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No
The number of shares outstanding of the registrant's common stock as of August
13, 2002 was 3,957,395 shares.
LECTEC CORPORATION
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. Condensed Financial Statements and Notes to Condensed Financial Statements
(unaudited) .......................................................................................I-1
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations .........................................................................................I-8
Item 3. Quantitative and Qualitative Disclosures About Market Risk ........................................I-12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings ................................................................................ II-1
Item 2. Changes in Securities and Use of Proceeds ........................................................ II-1
Item 3. Defaults Upon Senior Securities ...................................................................II-1
Item 4. Submission of Matters to a Vote of Security Holders .............................................. II-1
Item 5. Other Information ............................................................................... II-1
Item 6. Exhibits and Reports on Form 8-K ..................................................................II-2
Signature Page ....................................................................................II-3
PART I -FINANCIAL INFORMATION
ITEM 1- CONDENSED FINANCIAL STATEMENTS AND NOTES TO CONDENSED
FINANCIAL STATEMENTS
LECTEC CORPORATION
CONDENSED BALANCE SHEETS
(UNAUDITED)
June 30, December 31,
2002 2001
---------- ----------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 672,248 $1,425,205
Trade receivables and other, net of allowances of $87,500
and $99,000 at June 30, 2002 and December 31, 2001 677,011 547,838
Inventories
Raw materials 733,791 1,159,685
Work-in-process 14,168 5,198
Finished goods 611,255 362,660
---------- ----------
1,359,214 1,527,543
Prepaid expenses and other 211,980 290,401
---------- ----------
Total current assets 2,920,453 3,790,987
PROPERTY, PLANT AND EQUIPMENT -- AT COST, NET 2,004,198 2,262,094
OTHER ASSETS
Patents and trademarks, less accumulated amortization of $1,271,908
and $1,227,627 at June 30, 2002 and December 31, 2001 293,495 297,073
---------- ----------
$5,218,146 $6,350,154
========== ==========
See accompanying notes to the condensed financial statements
I-1
LECTEC CORPORATION
CONDENSED BALANCE SHEETS - CONTINUED
(UNAUDITED)
June 30, December 31,
2002 2001
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term obligations 941,999 938,800
Accounts payable 488,921 628,363
Accrued expenses 864,187 937,390
Customer deposits 652,642 75,000
Restructuring charges -- 105,232
------------ ------------
Total current liabilities 2,947,749 2,684,785
LONG-TERM OBLIGATIONS, LESS CURRENT MATURITIES 283,501 125,170
COMMITMENTS AND CONTINGENCIES -- --
SHAREHOLDERS' EQUITY
Common stock, $.01 par value: 15,000,000 shares authorized;
3,957,395 and 3,940,920 shares issued and outstanding at
June 30, 2002 and December 31, 2001 39,574 39,409
Additional paid-in capital 11,381,668 11,360,552
Accumulated deficit (9,434,346) (7,859,762)
------------ ------------
1,986,896 3,540,199
------------ ------------
$ 5,218,146 $ 6,350,154
============ ============
See accompanying notes to the condensed financial statements.
I-2
LECTEC CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three months ended Six months ended
June 30, June 30,
------------------------------ ------------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Net sales $ 1,583,007 $ 3,411,859 $ 3,097,502 $ 7,160,418
Cost of goods sold 1,114,968 2,518,520 2,141,111 5,253,656
----------- ----------- ----------- -----------
Gross profit 468,039 893,339 956,391 1,906,762
Operating expenses
Sales and marketing 472,532 873,325 963,648 1,559,973
General and administrative 609,822 788,207 1,205,301 1,497,191
Research and development 115,676 259,027 285,701 478,263
Restructuring charge -- 303,759 -- 303,759
----------- ----------- ----------- -----------
1,198,030 2,224,318 2,454,650 3,839,186
----------- ----------- ----------- -----------
Loss from operations (729,991) (1,330,979) (1,498,259) (1,932,424)
Other income (expenses)
Interest expense (38,065) (33,421) (76,831) (78,353)
Gain on disposition of assets -- 4,558,586 -- 4,662,210
Other, net 453 30,985 506 29,957
----------- ----------- ----------- -----------
Earnings (loss) before income taxes (767,603) 3,225,171 (1,574,584) 2,681,390
Income taxes -- 48,000 -- 48,000
----------- ----------- ----------- -----------
Net earnings (loss) $ (767,603) $ 3,177,171 $(1,574,584) $ 2,633,390
=========== =========== =========== ===========
Net earnings (loss) per share
Basic $ (0.19) $ 0.81 $ (0.40) $ 0.67
Diluted $ (0.19) $ 0.81 $ (0.40) $ 0.67
Weighted average shares outstanding
Basic 3,954,877 3,917,961 3,952,622 3,916,825
Diluted 3,954,877 3,920,162 3,952,622 3,917,926
See accompanying to the condensed financial statements.
I-3
LECTEC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Six Months Ended June 30,
------------------------------
2002 2001
------------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(1,574,584) $ 2,633,390
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Gain on disposition of assets -- (4,662,210)
Depreciation and amortization 320,270 193,414
Common stock issued for consulting services 19,009 --
Changes in operating assets and liabilities, net of dispositions:
Trade and other receivables 90,827 (753,150)
Inventories 168,329 (132,033)
Prepaid expenses and other 78,421 110,324
Accounts payable (139,442) (988,336)
Accrued expenses and other (73,203) 373,529
Restructuring charge (105,232) 274,698
Customer deposits 577,642 (85,000)
----------- -----------
Net cash used in operating activities (637,963) (3,035,374)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (18,093) (188,255)
Investment in patents and trademarks (40,703) (55,426)
Net proceeds from disposition of assets -- 6,666,988
----------- -----------
Net cash provided by (used in) investing activities (58,796) 6,423,307
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 2,272 11,404
Net repayments on note payable -- (343,325)
Proceeds from borrowing on long-term obligations -- 47,703
Repayment of long-term obligations (58,470) (12,612)
----------- -----------
Net cash used in financing activities (56,198) (296,830)
----------- -----------
Net increase (decrease) in cash and cash equivalents (752,957) 3,091,103
Cash and cash equivalents at beginning of period 1,425,205 285,620
----------- -----------
Cash and cash equivalents at end of period $ 672,248 $ 3,376,723
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest expense $ 77,101 $ 93,116
Income taxes $ -- $ --
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
Sales credit obligation exchanged for a long-term note payable $ 220,000 $ --
See accompanying to the condensed financial statements.
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LECTEC CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
(1) GENERAL
The accompanying condensed financial statements include the
accounts of LecTec Corporation (the "Company") as of and for the three and six
month periods ended June 30, 2002 and 2001. The Company's condensed financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States of America and should be read in conjunction with
its Transition Report on Form 10-K for the transition period from July 1, 2001
to December 31, 2001. The interim condensed financial statements are unaudited
and in the opinion of management, reflect all adjustments necessary for a fair
presentation of results for the periods presented. Results for interim periods
are not necessarily indicative of results for the year.
(2) NET EARNINGS (LOSS) PER SHARE
The Company's basic net earnings (loss) per share amounts have
been computed by dividing net earnings (loss) by the weighted average number of
outstanding common shares. The Company's diluted net earnings (loss) per share
amounts have been computed by dividing net earnings (loss) by the weighted
average number of outstanding common shares and common share equivalents, when
dilutive. Options and warrants to purchase 1,205,229 and 1,067,568 shares of
common stock with a weighted average exercise price of $4.64 and $5.11 were
outstanding during the three months ended June 30, 2002 and 2001, but were
excluded from the calculation because they were antidilutive. Options and
warrants to purchase 1,231,893 and 1,052,569 shares of common stock with a
weighted average exercise price of $4.63 and $5.18 were outstanding during the
six months ended June 30, 2002 and 2001, but were excluded from the calculation
because they were antidilutive.
(3) SEGMENTS
The Company operates its business in one reportable segment -- the
manufacture and sale of products based on advanced skin interface technologies.
Each of the Company's major product lines has similar economic characteristics,
technology, manufacturing processes, and regulatory environments. Customers and
distribution and marketing strategies vary within major product lines as well as
overlap between major product lines. The Company's executive decision makers
evaluate sales performance based on the total sales of each major product line
and profitability on a total company basis, due to shared infrastructures, to
make operating and strategic decisions. The Company's initial sales of skin care
products occurred during the first quarter of calendar year 2002. The Company
sold the conductive and medical tape product lines during the fiscal year ended
June 30, 2001. Net sales by major product line were as follows:
Three months ended Six months ended
June 30, June 30,
---------------------------- ---------------------------
2002 2001 2002 2001
---------- ----------- ---------- ----------
Therapeutic consumer products $1,250,709 $1,890,679 $2,147,916 $3,728,221
Skin care products 66,191 -- 358,263 --
Conductive and medical tape products 266,107 1,521,180 591,323 3,432,197
---------- ---------- ---------- ----------
$1,583,007 $3,411,859 $3,097,502 $7,160,418
========== ========== ========== ==========
(4) NOTE PAYABLE TO BANK
The Company finalized a two year extension of its $2,000,000 asset
based line of credit in November 2001 with terms similar to the terms of the
$2,000,000 line of credit as originally finalized in November 1999. There were
no borrowings outstanding on the line of credit at June 30, 2002. The
I-5
Company was in default of covenants relating to the minimum book net worth and
the maximum loss before income taxes at June 30, 2002. Until the Company cures
or receives a waiver for the covenant defaults, the line of credit is not
available for borrowings.
(5) LONG-TERM OBLIGATIONS
In May 2002, the Company entered into a $220,000 promissory note
with a major customer related to the costs incurred by the customer associated
with resolving a packaging issue that previously had been recorded as a sales
credit by the Company. The principal balance of the note is due in December
2003. Monthly payments of interest are computed at the prime rate plus two
percentage points (effective rate of 6.75% at June 30, 2002). The promissory
note is collateralized by substantially all of the Company's assets.
In December 2000, the Company entered into a mortgage agreement
with gross proceeds of $820,000. The principal balance of the mortgage is due in
December 2002. Monthly payments of interest are computed at the prime rate plus
five percentage points (effective rate of 9.75% at June 30, 2002). The mortgage
is collateralized by the Company's real property. The balance at June 30, 2002
of $820,000 is classified as current maturities of long-term debt.
(6) CUSTOMER DEPOSITS
In May 2002 the Company renegotiated its Supply Agreement with a
major customer. Pursuant to the revised agreement, the Company is receiving
advance payments from the customer for future product orders. At June 30, 2002
the Company had recorded deposits of $577,642.
(7) DISPOSITION OF MEDICAL TAPE ASSETS
In March 2001, the Company sold its medical tape manufacturing
equipment and other related assets. The sale of the medical tape equipment
finalized the Company's plan to exit the medical tape business that was adopted
at the end of the fiscal year ended June 30, 2000.
(8) SALE OF CONDUCTIVE BUSINESS ASSETS AND RESTRUCTURING
In April 2001, the Company sold its diagnostic electrode and
electrically conductive adhesive hydrogel business assets that were used to
produce the Company's conductive products. The conductive products included
diagnostic electrodes and electrically conductive adhesive hydrogels. Under a
manufacturing and supply agreement between the Company and the buyer, the
Company continued to manufacture, and supply to the buyer, certain conductive
products through January 2002. The Company supplied the products at its cost of
production through October 31, 2001, and at its cost of production plus ten
percent from November 1, 2001 through January 31, 2002. The Company is
continuing to manufacture and supply the buyer electrically conductive adhesive
hydrogels, at margins of approximately 30%, subsequent to expiration of the
manufacturing and supply agreement. The Company anticipates supplying the
product to the buyer on a limited basis through September 2002.
A non-recurring restructuring charge of $303,759 was incurred in
the quarter ended June 30, 2001 relating to the sale of the Company's conductive
business assets. The restructuring charge consisted primarily of future rental
payments for a leased facility, separation costs, and other costs associated
with the wind-down of conductive business activity. The Company completed the
restructuring in the second quarter of calendar 2002.
(9) CHANGE IN FISCAL YEAR END
On September 5, 2001, the Company elected to change its fiscal
year end from June 30 to December 31. Previously, the fiscal year ran from July
1 through June 30. The Company filed a Transition Report on Form 10-K for the
six months ended December 31, 2001. Hereafter, the fiscal year will correspond
with the calendar year.
I-6
(10) INCOME TAXES
The provision for income taxes in the second quarter and first six
months of calendar 2002 has been offset principally by a valuation allowance for
deferred taxes. The Company recorded an income tax expense in the second quarter
of calendar 2001 of $48,000 resulting from an alternative minimum tax liability
for the fiscal year ended June 30, 2001 after offsetting regular taxable income
with prior years net operating loss carryforwards.
(11) RECENT ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2002 the Company adopted Statement of
Financial Accounting Standards SFAS 142, "Goodwill and Intangible Assets."
SFAS 142 eliminates the amortization of goodwill and other
intangible assets with indefinite lives and requires that these assets be tested
for impairment annually or whenever an impairment indicator arises using the two
step impairment test outlined in SFAS 142. The adoption of SFAS 142 did not
affect the Company's financial position or results of operations.
Amortized intangible assets consist of the following:
June 30, 2002 December 31, 2001
------------------------------- ------------------------------
Gross carrying Accumulated Gross carrying Accumulated
amount amortization amount amortization
-------------- ------------ -------------- ------------
Patents $1,537,044 $1,265,965 $1,494,003 $1,223,859
Trademarks 28,359 5,943 30,697 3,768
---------- ---------- ---------- ----------
$1,565,403 $1,271,908 $1,524,700 $1,227,627
========== ========== ========== ==========
Amortization expense of amortized intangible assets totaled $22,667 and $17,100
for the three months ended June 30, 2002 and 2001 and $44,281 and $34,909 for
the six months ended June 30, 2002 and 2001. Amortization expense for the
succeeding years is expected to be as follows:
Years ended December 31:
2002 $89,000
2003 88,000
2004 76,000
2005 55,000
2006 14,000
I-7
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
QUARTERS AND SIX MONTHS ENDED JUNE 30, 2002 AND 2001
RESULTS OF OPERATIONS
Net sales for the second quarter of calendar 2002 were $1,583,007
compared to net sales of $3,411,859 for the second quarter of calendar 2001, a
decrease of 53.6%. The decrease was primarily the result of decreased conductive
product sales due to the sale of the assets of the conductive products division
in April 2001 and decreased sales of consumer contract therapeutic patch
products. Therapeutic consumer product sales decreased by 33.8% from $1,890,679
to $1,250,709 while conductive and medical tape product sales decreased by 82.5%
from $1,521,180 to $266,107. The therapeutic consumer product sales decrease was
primarily the result of decreased demand from consumer contract therapeutic
patch customers resulting from the slowing economy and a weaker than expected
cough/cold season. The Company expects decreased conductive product sales to
continue due to the sale of the assets used to produce the conductive products.
As part of this asset sale, the Company entered into a Manufacturing and Supply
Agreement with the buyer. Under the terms of this Agreement, the Company
supplied the products at its cost of production through October 31, 2001, and at
its cost of production plus ten percent from November 1, 2001 through January
31, 2002. The Company is continuing to manufacture and supply the buyer, on a
limited basis, electrically conductive adhesive hydrogels, at margins of
approximately 30%, subsequent to expiration of the manufacturing and supply
agreement. The Company anticipates supplying the product to the buyer through
September 2002. In February 2002, the Company expanded into the skin care
cosmeceutical market by launching a line of skin care products under the
Company's brand name NeoSkin(R). These products include pre-formed face masks
and under eye gel patches. Sales of skin care products totaled $66,191 for the
second quarter of calendar 2002, a decrease from sales of $292,072 in the first
quarter of calendar 2002. The decrease was primarily the result of the soft
economy and the necessity for the Company to postpone national advertising
programs.
Net sales for the first six months of calendar 2002 were $3,097,502
compared to net sales of $7,160,418 for the first six months of calendar 2001, a
decrease of 56.7%. The decrease was primarily the result of decreased conductive
product sales due to the sale of the assets of the conductive products division
and decreased sales of consumer contract therapeutic patch products. Therapeutic
consumer product sales decreased by 42.4% from $3,728,221 to $2,147,916 while
conductive and medical tape product sales decreased by 82.8% from $3,432,197 to
$591,323. Sales of skin care products were $358,263 for the first six months of
calendar 2002. The therapeutic consumer product sales decrease was primarily the
result of decreased demand from consumer contract therapeutic patch customers
resulting from the slowing economy and a weaker than expected cough/cold season.
Gross profit for the second quarter of calendar 2002 was $468,039,
compared to $893,339 for the second quarter of calendar 2001, a decrease of
47.6%. Gross profit as a percent of net sales for the second quarter of calendar
2002 was 29.6% compared to 26.2% for the second quarter of calendar 2001. The
decrease in gross profit for the three months resulted primarily from decreased
sales. The increase in gross profit as a percent of net sales for the quarter
resulted primarily from a shift in the sales mix toward higher margin LecTec
branded therapeutic consumer and skin care products.
Gross profit for the first six months of calendar 2002 was $956,391
compared to $1,906,762 for the first six months of calendar 2001, a decrease of
49.8%. Gross profit as a percent of net sales for the first six months of
calendar 2002 was 30.9% compared to 26.6% for the first six months of calendar
2001. The decrease in gross profit for the six months resulted primarily from
decreased sales. The increase in gross profit as a percent of net sales for the
six months resulted primarily from a shift in the sales mix toward higher margin
LecTec branded therapeutic consumer and skin care products.
Sales and marketing expenses were $472,532 and $873,325 during the
second quarters of calendar 2002 and 2001, and as a percentage of net sales,
were 29.9% and 25.6% respectively. The decrease in sales and marketing expenses
for the quarter was primarily due to a decrease of $261,000 in
I-8
product promotional expenses and a decrease of $75,000 in compensation related
expenses. These decreases resulted from aggressive cost control/reduction
programs implemented by management
Sales and marketing expenses were $963,648 and $1,559,973 during the
first six months of calendar 2002 and 2001, and as a percentage of net sales,
were 31.1% and 21.8%. The decrease in sales and marketing expenses for the first
six months was primarily due to a decrease of $340,000 in product promotional
expenses and a decrease of $111,000 in compensation related expenses. The
Company anticipates that sales and marketing expenses as a percentage of net
sales for the remainder of 2002 will decrease compared to the first six months
of 2002 due to the planned implementation of additional cost control/reduction
programs by management.
General and administrative expenses were $609,822 and $788,207 during
the second quarters of calendar 2002 and 2001, and as a percentage of net sales,
were 38.5% and 23.1% respectively. The decrease in general and administrative
expenses for the quarter was primarily due to a decrease of $147,000 in
compensation related expenses.
General and administrative expenses were $1,205,301 and $1,497,191
during the first six months of calendar 2002 and 2001, and as a percentage of
net sales, were 38.9% and 20.9% respectively. The decrease in general and
administrative expenses for the six months was primarily due to a decrease of
$224,000 in compensation related expenses, a decrease of $42,000 in board of
directors expense and a decrease of $24,000 in travel and lodging expenses. The
Company anticipates that general and administrative expenses as a percent of net
sales for the remainder of 2002 will decrease compared to the first six months
of 2002.
Research and development expenses for the second quarters of calendar
2002 and 2001 were $115,676 and $259,027, and as a percentage of net sales, were
7.3% and 7.6% respectively. The decrease in research and development expenses
for the current quarter was primarily due to a decrease of $112,000 in
compensation related expenses.
Research and development expenses were $285,701 and $478,263 during the
first six months of calendar 2002 and 2001, and as a percentage of net sales,
were 9.2% and 6.7% respectively. The decrease in research and development
expenses for the six months was primarily due to a decrease of $158,000 in
compensation related expenses. The Company anticipates that research and
development expenses as a percent of net sales for the remainder of 2002 will
decrease compared to the first six months of 2002.
Interest expense increased in the second quarter of calendar 2002 to
$38,065 from $33,421 in the second quarter of calendar 2001. The current year
increase resulted primarily from the payment of required minimum interest
associated with the line of credit. In the prior year minimum interest
requirements were fulfilled. Interest expense decreased in the first six months
of calendar 2002 to $76,831 from $78,353 in the first six months of calendar
2001. The decrease resulted primarily from the absence of borrowings under the
line of credit that was offset by interest expense associated with the mortgage.
Gain on disposition of assets totaled $4,558,586 in the second quarter of
calendar 2001 due to the sale of the Company's conductive business assets. Gain
on disposition of assets totaled $4,662,210 in the first six months of calendar
2001 due to the sale of the conductive business assets and the disposition of
the Company's medical tape manufacturing equipment. Other income for the second
quarter of calendar 2002 was $453 compared to other income of $30,985 for the
second quarter of calendar 2001. Other income for the first six months of
calendar 2002 was $506 compared to other income of $29,957 for the first six
months of calendar 2001. The current quarter and six month decreases were
primarily the result of decreased interest income due to lower cash and cash
equivalent balances.
The Company recorded a loss before income taxes of $767,603 for the
second quarter of calendar 2002 compared to earnings before income taxes of
$3,177,171 for the second quarter of calendar 2001. The Company recorded a loss
before income taxes of $1,574,584 for the first six months of calendar 2002
compared to earnings before income taxes of $2,633,390 for the first six months
of calendar 2001. The earnings in the second quarter and first six months of
calendar 2001 resulted
I-9
primarily from the gain on the sale of the assets of the conductive products
division, which was partially offset by a non-recurring restructuring charge.
Excluding the gain and restructuring charge, the Company had a loss before
income taxes of $1,029,656 for the second quarter of calendar 2001 and a loss
before income taxes of $1,677,061 for the first six months of calendar 2001.
Excluding the gain and restructuring charge, the decrease in loss before income
taxes in the current quarter was primarily the result of a decrease in operating
expenses resulting from aggressive cost control/reduction programs implemented
by management. This decrease was partially offset by decreased gross profit and
sales volume related to the sale of the assets of the conductive products
division and decreased demand from consumer contract therapeutic patch
customers. Excluding the gain and restructuring charge related to the sale of
the assets of the conductive products division, the Company's loss before income
taxes for the first six months of calendar 2002 was comparable to the loss
before income taxes for first six months of calendar 2001. A decrease in
operating expenses was offset entirely by a decrease in gross profit.
The provision for income taxes in the second quarter and first six
months of calendar 2002 has been offset principally by a valuation allowance for
deferred taxes. The Company recorded an income tax expense in the second quarter
of calendar 2001 of $48,000 resulting from an alternative minimum tax liability
for the fiscal year ended June 30, 2001 after offsetting regular taxable income
with prior years net operating loss carryforwards.
Inflation has not had a significant impact on the Company's operations
or cash flow.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased by $752,957 to $672,248 during the
first six months of calendar 2002. The decrease in cash and cash equivalents was
primarily due to lower sales volume resulting in more cash used in operating
activities. Accounts receivable increased by $129,173 to $677,011 during the
first six months of calendar 2002 primarily due to the transfer of a sales
credit obligation to long-term debt. Inventories decreased by $168,329 to
$1,359,215 primarily due to lower inventory levels required for current
production levels. Accounts payable of $488,921 at June 30, 2002 decreased by
$139,442 during the first six months of calendar 2002 due to the decreased
manufacturing production. Capital spending for manufacturing equipment and plant
improvements totaled $18,093 during the first six months of calendar 2002. There
were no material commitments for capital expenditures at June 30, 2002.
The Company had a deficit in working capital of $27,296 and a current
ratio of 1.0 at June 30, 2002 compared to working capital of $1,106,202 and a
current ratio of 1.4 at December 31, 2001. The decreases resulted primarily from
lower cash and cash equivalent balances.
The Company finalized a two year extension of its $2,000,000 asset
based line of credit in November 2001 with terms similar to the terms of the
$2,000,000 line of credit as originally finalized in November 1999. There were
no borrowings outstanding on the line of credit as of June 30, 2002. The Company
was in default at June 30, 2002 with covenants relating to the minimum book net
worth and the maximum loss before income taxes. This was the result of financial
results not meeting expectations due to the continued soft economy. Until the
Company cures or receives a waiver for the covenant defaults, the line of credit
is not available for borrowings.
In December 2000, the Company entered into a mortgage agreement with
gross proceeds of $820,000. The principal balance of the mortgage is due in
December 2002. Monthly payments of interest are computed at the prime rate plus
five percentage points (effective rate of 9.75% at June 30, 2002). The mortgage
is collateralized by the Company's real property.
Management expects the Company to continue to operate at a net loss and
experience negative cash flow from operating activities for the foreseeable
future. In May 2002 the Company renegotiated its Supply Agreement with a major
customer. Pursuant to the revised agreement, the Company is receiving advance
payments from the customer for future product orders. The Company has also
received an offer to factor its receivables and continues to seek ways to reduce
costs. In addition, management is exploring
I-10
other options for additional capital. Management believes that the Company will
have sufficient cash, as well as the ability to factor accounts receivable, to
ensure the Company will continue operations through December 2002. Maintaining
adequate levels of working capital depends in part upon the success of the
Company's products in the marketplace, the relative profitability of those
products and the Company's ability to control operating expenses. Funding of the
Company's operations in future periods may require additional investments in the
Company in the form of equity or debt. There can be no assurance that the
Company will achieve desired levels of sales or profitability, or that future
capital infusion will be available. If such desired levels of sales and
profitability are not reached, and infusions of capital are not available, the
company may be forced to cease operations.
FORWARD-LOOKING STATEMENTS
From time to time, in reports filed with the Securities and Exchange
Commission (including this Form 10-Q), in press releases, and in other
communications to shareholders or the investment community, the Company may
provide forward-looking statements concerning possible or anticipated future
results of operations or business developments which are typically preceded by
the words "believes", "expects", "anticipates", "intends", "will", "may",
"should" or similar expressions. Such forward-looking statements are subject to
risks and uncertainties that could cause results or developments to differ
materially from those indicated in the forward-looking statements. Such risks
and uncertainties include, but are not limited to, the buying patterns of major
customers; competitive forces including new products or pricing pressures; costs
associated with and acceptance of the Company's TheraPatch brand strategy;
impact of interruptions to production; dependence on key personnel; need for
regulatory approvals; changes in governmental regulatory requirements or
accounting pronouncements; ability to satisfy funding requirements for operating
needs, expansion or capital expenditures; and the matters discussed on our
"Cautionary Statements" filed as Exhibit 99.1 to form 10-K for the transition
period from July 1, 2001 to December 31, 2001.
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PART I - FINANCIAL INFORMATION
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has no history of, and does not anticipate in the future,
investing in derivative financial instruments, derivative commodity instruments
or other such financial instruments. Transactions with international customers
are entered into in U.S. dollars with the exception of TheraPatch sales to
Canadian customers, precluding the need for foreign currency hedges. Canadian
sales have not been material. Additionally, the Company invests in money market
funds that experience minimal volatility. Thus, the exposure to market risk is
not material.
I-12
PART II
OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
None.
Item 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None.
Item 3. DEFAULTS UPON SENIOR SECURITIES
None.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Regular Annual Meeting of Shareholders of the Company was
held on June 26, 2002. The following matters were voted on by
Shareholders:
1. The election of six directors to serve on the Board of
Directors for a term of one year and until their successors
are duly elected and qualified.
2. The ratification of the appointment of Grant Thornton LLP as
the Company's independent auditor for the Company's current
fiscal year.
The results of the voting on these matters were as follows:
1. Board of Directors:
Withhold
For Authority Total
--------- -------- -----
Lee M. Berlin 3,456,219 90,981 3,547,200
Alan C. Hymes, M.D. 3,456,832 90,368 3,547,200
Bert J. McKasy 3,469,107 78,093 3,547,200
Marilyn K. Speedie, Ph.D. 3,469,107 78,093 3,547,200
Donald C. Wegmiller 3,466,107 81,093 3,547,200
Rodney A. Young 3,469,086 78,114 3,547,200
2. Appointment of Grant Thornton LLP as independent auditor for
the Company:
For Against Abstain Non-Vote Total
-------- ------- ------- -------- ---------
3,474,861 23,440 48,899 - 3,547,200
Item 5. OTHER INFORMATION
On July 11, 2002, the Company received a warning from Nasdaq that
the Company may be delisted from the Nasdaq Small Cap Market. The
letter states, "For the last 30 consecutive trading days, the
price of the Company's common stock has closed below the minimum
$1.00 per share requirement for continued inclusion under
Marketplace
II-1
Rule 4310(c)(4)." The Company has 180 calendar days, or until
January 7, 2003 to regain compliance. Otherwise, Nasdaq will
provide notification to the Company that the Company will be
delisted. The Company is currently reviewing its options.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Item No. Item Method of Filing
-------- ---- ----------------
*10.1 Supply and Non-Exclusive License Agreement By and Between LecTec
Corporation and Novartis Consumer Health, Inc. dated May 8, 2002. Filed herewith.
10.2 Promissory Note By and Between LecTec Corporation and Novartis
Consumer Health, Inc. dated May 8, 2002. Filed herewith.
10.3 Promissory Note By and Between LecTec Corporation and Novartis
Consumer Health, Inc. dated May 8, 2002. Filed herewith.
10.4 Security Agreement By and Between LecTec Corporation and Novartis
Consumer Health, Inc. dated May 8, 2002. Filed herewith.
99.1 Chief Executive Officer Certification Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. Filed herewith.
99.2 Chief Financial Officer Certification Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002. Filed herewith.
* Confidential treatment has been requested for
portions of this Exhibit pursuant to Rule 24b-2 under
the Securities Exchange Act of 1934 as amended. The
confidential portions have been deleted and filed
separately with the United States Securities and
Exchange Commission together with a confidential
treatment request.
(b) REPORTS ON FORM 8-K
None.
II-2
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 the
undersigned thereunto duly authorized.
LECTEC CORPORATION
Date August 14, 2002 /s/ Rodney A. Young
--------------- ------------------------------------
Rodney A. Young, Chief Executive Officer & President
Date August 14, 2002 /s/ Douglas J. Nesbit
--------------- --------------------------------------
Douglas J. Nesbit, Chief Financial Officer & Secretary
(Principal Financial Officer and
Chief Accounting Officer)
II-3