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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 SEPTEMBER 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act):
Yes [ ] No [X]
The number of shares outstanding of the registrant's common stock as of November
13, 2002 was 3,966,395 shares.
LECTEC CORPORATION
FORM 10-Q FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 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-9
Item 3. Quantitative and Qualitative Disclosures About Market Risk........................................... I-13
Item 4. Controls and Procedures.............................................................................. I-14
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
September 30, December 31,
2002 2001
------------------- -------------------
(Unaudited) (Audited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 536,983 $ 1,425,205
Trade receivables and other, net of allowances of $95,000
and $99,000 at September 30, 2002 and December 31, 2001 281,032 547,838
Inventories
Raw materials 835,670 1,159,685
Work-in-process 28,789 5,198
Finished goods 659,075 362,660
------------------- -------------------
1,523,534 1,527,543
Prepaid expenses and other 127,243 290,401
------------------- -------------------
Total current assets 2,468,792 3,790,987
PROPERTY, PLANT AND EQUIPMENT - AT COST, NET 1,879,394 2,262,094
OTHER ASSETS
Patents and trademarks, less accumulated amortization of $1,295,678
and $1,227,627 at September 30, 2002 and December 31, 2001 293,527 297,073
------------------- -------------------
$ 4,641,713 $ 6,350,154
=================== ===================
See accompanying notes to the condensed financial statements.
I-1
LECTEC CORPORATION
CONDENSED BALANCE SHEETS - CONTINUED
September 30, December 31,
2002 2001
------------ ------------
(Unaudited) (Audited)
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Current maturities of long-term obligations 938,227 938,800
Accounts payable 687,865 628,363
Accrued expenses 694,639 937,390
Customer deposits 438,942 75,000
Restructuring charges - 105,232
------------ ------------
Total current liabilities 2,759,673 2,684,785
LONG-TERM OBLIGATIONS, LESS CURRENT MATURITIES 257,505 125,170
COMMITMENTS AND CONTINGENCIES - -
SHAREHOLDERS' EQUITY
Common stock, $.01 par value: 15,000,000 shares authorized;
3,966,395 and 3,940,920 shares issued and outstanding at
September 30, 2002 and December 31, 2001 39,664 39,409
Additional paid-in capital 11,389,678 11,360,552
Accumulated deficit (9,804,807) (7,859,762)
------------ ------------
1,624,535 3,540,199
------------ ------------
$ 4,641,713 $ 6,350,154
============ ============
See accompanying notes to the condensed financial statements.
I-2
LECTEC CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three months ended Nine months ended
September 30, September 30,
------------------------------- ---------------------------------
2002 2001 2002 2001
------------- ------------- -------------- --------------
Net sales $ 2,013,949 $ 2,402,908 $ 5,111,451 $ 9,563,326
Cost of goods sold 1,419,673 1,784,580 3,560,784 7,038,237
------------- ------------- -------------- --------------
Gross profit 594,276 618,328 1,550,667 2,525,089
Operating expenses
Sales and marketing 311,133 942,449 1,274,781 2,502,423
General and administrative 509,939 653,395 1,715,240 2,150,585
Research and development 109,126 217,548 394,827 695,811
Restructuring charge - - - 303,759
------------- ------------- -------------- --------------
930,198 1,813,392 3,384,848 5,652,578
------------- ------------- -------------- --------------
Loss from operations (335,922) (1,195,064) (1,834,181) (3,127,489)
Other income (expenses)
Interest expense (37,855) (30,540) (114,686) (108,892)
Gain on disposition of assets - - - 4,662,210
Other, net 3,316 35,480 3,822 65,437
------------- ------------- -------------- --------------
Earnings (loss) before income taxes (370,461) (1,190,124) (1,945,045) 1,491,266
Income taxes - - - 48,000
------------- ------------- -------------- --------------
Net earnings (loss) $ (370,461) $ (1,190,124) $ (1,945,045) $ 1,443,266
============= ============= ============== ==============
Net earnings (loss) per share
Basic $ (0.09) $ (0.30) $ (0.49) $ 0.37
Diluted $ (0.09) $ (0.30) $ (0.49) $ 0.37
Weighted average shares outstanding
Basic 3,957,982 3,922,384 3,954,429 3,918,698
Diluted 3,957,982 3,922,384 3,954,429 3,919,432
See accompanying notes to the condensed financial statements.
I-3
LECTEC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended September 30,
-------------------------------
2002 2001
----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $(1,945,045) $ 1,443,266
Adjustments to reconcile net income (loss) to net cash
used in operating activities:
Gain on disposition of assets - (4,662,210)
Depreciation and amortization 464,085 342,668
Common stock issued for consulting services 19,009 -
Changes in operating assets and liabilities, net of dispositions:
Trade and other receivables 486,806 (806,075)
Inventories 4,009 (74,483)
Prepaid expenses and other 163,158 47,755
Accounts payable 59,502 (1,252,022)
Accrued expenses (242,751) 460,907
Restructuring charge (105,232) 216,075
Customer deposits 363,942 (85,000)
----------- -----------
Net cash used in operating activities (732,517) (4,369,119)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (13,334) (238,043)
Investment in patents and trademarks (64,505) (94,434)
Net proceeds from disposition of assets - 6,666,988
----------- -----------
Net cash provided by (used in) investing activities (77,839) 6,334,511
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock 10,372 11,404
Net repayments on note payable - (343,325)
Proceeds from borrowing on long-term obligations - 47,703
Repayment of long-term obligations (88,238) (23,329)
----------- -----------
Net cash used in financing activities (77,866) (307,547)
----------- -----------
Net increase (decrease) in cash and cash equivalents (888,222) 1,657,845
Cash and cash equivalents at beginning of period 1,425,205 285,620
----------- -----------
Cash and cash equivalents at end of period $ 536,983 $ 1,943,465
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest expense $ 113,139 $ 119,976
Income taxes $ - $ 56,000
SUPPLEMENTAL DISCLOSURE OF NON-CASH FINANCING ACTIVITIES:
Sales credit obligation exchanged for a long-term note payable $ 220,000 $ -
See accompanying notes to the condensed financial statements.
I-4
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 nine month
periods ended September 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 1,199,885 and 1,177,085 shares of
common stock with a weighted average exercise price of $2.11 and $4.82 were
outstanding during the three months ended September 30, 2002 and 2001, but were
excluded from the calculation because they were antidilutive. Options and
warrants to purchase 1,194,557 and 1,094,074 shares of common stock with a
weighted average exercise price of $3.85 and $5.05 were outstanding during the
nine months ended September 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 and the Company
experienced returns of skin care products in the third 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 Nine months ended
September 30, September 30,
--------------------------- ---------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Therapeutic consumer products $1,964,940 $1,736,093 $4,112,856 $5,464,314
Skin care products (77,947) - 280,316 -
Conductive and medical tape products 126,956 666,815 718,279 4,099,012
---------- ---------- ---------- ----------
$2,013,949 $2,402,908 $5,111,451 $9,563,326
========== ========== ========== ==========
(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
I-5
November 1999. In August 2002 the Company and the bank mutually agreed to
terminate the line of credit financing arrangement due to the Company's default
of covenants relating to the minimum net worth and the maximum loss before
income taxes.
(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 September 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 September 30, 2002). The
mortgage is collateralized by the Company's real property. The balance at
September 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 September 30, 2002 the
Company had recorded deposits of $363,942 to this customer.
(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 continued to
manufacture and supply the buyer electrically conductive adhesive hydrogels, at
margins of approximately 30%, through September 2002. The Company anticipates no
additional sales to the buyer subsequent to 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
I-6
Report on Form 10-K for the six months ended December 31, 2001. Hereafter, the
fiscal year will correspond with the calendar year.
(10) INCOME TAXES
The provision for income taxes in the third quarter and first nine
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:
September 30, 2002 December 31, 2001
---------------------------------- ----------------------------------
Gross carrying Accumulated Gross carrying Accumulated
amount amortization amount amortization
-------------- -------------- -------------- --------------
Patents $1,555,442 $1,288,575 $1,494,003 $1,223,859
Trademarks 33,763 7,103 30,697 3,768
---------- ---------- ---------- ----------
$1,589,205 $1,295,678 $1,524,700 $1,227,627
========== ========== ========== ==========
Amortization expense of amortized intangible assets totaled $23,771 and $17,935
for the three months ended September 30, 2002 and 2001 and $68,051 and $52,843
for the nine months ended September 30, 2002 and 2001. Amortization expense for
the succeeding years is expected to be as follows:
Years ended December 31:
2002 $92,000
2003 90,000
2004 78,000
2005 59,000
2006 17,000
In June 2001, the Financial Accounting Standards Board (FASB) issued SFAS 143,
"Accounting for Asset Retirement Obligations." SFAS 143 applies to all entities
that have legal obligations associated with the retirement of a tangible
long-lived asset that result from acquisition, construction, or development and
(or) normal operations of the long-lived asset. For purposes of SFAS 143, a
liability for an asset retirement obligation should be recognized if the
obligation meets the definition of a liability in FASB Concepts Statement 6,
"Elements of Financial Statements," and if the amount of the liability can be
reasonably estimated. Consequently, an entity should recognize a liability for
an asset retirement obligation if (a) the entity has a duty or responsibility to
settle an asset retirement obligation, (b) the entity has little or no
discretion to avoid the future transfer or use of assets, and (c) the
transaction or other event obligating the entity has occurred.
I-7
In August 2001, the FASB issued SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS 144 retains the requirement from SFAS 121
to test a long-lived asset or asset group for impairment using a two-step
impairment test whenever a triggering event occurs. SFAS 144 provides an
additional triggering event, a current expectation that, more likely than not, a
long-lived asset or asset group will be sold or disposed of significantly before
the end of its previously estimated useful life would indicate the need to test
that asset or asset group for impairment. SFAS 144 is effective for fiscal years
beginning after December 15, 2001, and is generally to be applied prospectively.
SFAS 144 does not apply to goodwill and other intangible assets with indefinite
lives, long-term customer relationships of financial institutions, financial
instruments, deferred policy acquisition costs, deferred tax assets, and other
long-lived assets for which the accounting is prescribed in certain other FASB
Statements.
In June 2002, the FASB issued SFAS 146, "Accounting for Costs Associated with
Exit or Disposal Activities." SFAS 146 provides financial accounting and
reporting guidance for costs associated with exit or disposal activities,
including one-time termination benefits, contract termination costs other than
for a capital lease, and costs to consolidate facilities or relocate employees.
SFAS 146 is effective for exit or disposal activities that are initiated after
December 31, 2002. Management does not believe this pronouncement will have a
material effect on the Company's financial statements.
The adoption of SFAS 143, 144 and 146 should not have a material effect on the
Company's financial statements.
On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002
(the "Act"), which immediately impacts Securities and Exchange Commission
registrants, public accounting firms, lawyers and securities analysts. This
legislation is the most comprehensive since the passage of the Securities Acts
of 1933 and 1934. It has far reaching effects on the standards of integrity for
corporate management, board of directors, and executive management. Additional
disclosures, certifications and procedures will be required of the Company. We
do not expect any material adverse effect on the Company as a result of the
passage of this legislation; however, the full scope of the Act has not yet been
determined. The Act provides for additional regulations and requirements of
publicly traded companies, which have yet to be issued.
Refer to management's certifications contained elsewhere in this report
regarding the Company's compliance with Sections 302 and 906 of the
Sarbanes-Oxley Act of 2002.
I-8
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
QUARTERS AND NINE MONTHS ENDED SEPTEMBER 30, 2002 AND 2001
RESULTS OF OPERATIONS
Net sales for the third quarter of calendar 2002 were $2,013,949
compared to net sales of $2,402,908 for the third quarter of calendar 2001, a
decrease of 16.2%. 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. Therapeutic consumer product sales increased by 13.2% from
$1,736,093 to $1,964,940 while conductive and medical tape product sales
decreased by 81.0% from $666,815 to $126,956. The therapeutic consumer product
sales increase was primarily the result of increased demand from consumer
contract therapeutic patch customers resulting from inventory buildup for the
upcoming cough/cold season. The Company previously sold the assets used to
produce the conductive products. As part of the sale of the assets of the
conductive products division 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 continued to manufacture and supply the buyer, on a
limited basis, electrically conductive adhesive hydrogels, at margins of
approximately 30%, through September 30, 2002. The Company expects no future
conductive product sales. 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. Net sales of skin care products totaled $(77,947) for
the third quarter of calendar 2002, a decrease from sales of $66,191 in the
second quarter of calendar 2002. The decrease was primarily the result of
product returns which the Company believes resulted from the Company's lack of a
national advertising program and the soft economy. The negative sales in the
third quarter are a result of returns in excess of the allowance for returns
that was recorded. There were no sales of skin care products during 2001.
Net sales for the first nine months of calendar 2002 were $5,111,451
compared to net sales of $9,563,326 for the first nine months of calendar 2001,
a decrease of 46.6%. 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 24.7% from $5,464,314
to $4,112,856 while conductive and medical tape product sales decreased by 82.5%
from $4,099,012 to $718,279. Sales of skin care products were $280,316 for the
first nine 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 the Company's
lack of a national advertising program.
Gross profit for the third quarter of calendar 2002 was $594,276,
compared to $618,328 for the third quarter of calendar 2001, a decrease of 3.9%.
Gross profit as a percent of net sales for the third quarter of calendar 2002
was 29.5% compared to 25.7% for the third 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 reduced level of low margin conductive product sales to the
buyer of the conductive business assets.
Gross profit for the first nine months of calendar 2002 was $1,550,667
compared to $2,525,089 for the first nine months of calendar 2001, a decrease of
38.6%. Gross profit as a percent of net sales for the first nine months of
calendar 2002 was 30.3% compared to 26.4% for the first nine months of calendar
2001. The decrease in gross profit for the nine 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 and the reduction of
lower margin conductive product sales to the buyer of the conductive business
assets.
I-9
Sales and marketing expenses were $311,133 and $942,449 during the
third quarters of calendar 2002 and 2001, and as a percentage of net sales, were
15.4% and 39.2% respectively. The decrease in sales and marketing expenses for
the quarter was primarily due to a decrease of $446,000 in product promotional
expenses and a decrease of $123,000 in compensation related expenses. These
decreases resulted from aggressive cost control/reduction programs implemented
by management.
Sales and marketing expenses were $1,274,781 and $2,502,423 during the
first nine months of calendar 2002 and 2001, and as a percentage of net sales,
were 24.9% and 26.2%. The decrease in sales and marketing expenses for the first
nine months was primarily due to a decrease of $787,000 in product promotional
expenses and a decrease of $234,000 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 nine months
of 2002 due to the planned implementation of additional cost control/reduction
programs by management.
General and administrative expenses were $509,939 and $653,395 during
the third quarters of calendar 2002 and 2001, and as a percentage of net sales,
were 25.3% and 27.2% respectively. The decrease in general and administrative
expenses for the quarter was primarily due to a decrease of $119,000 in
compensation related expenses and a decrease of $26,000 in travel and lodging
expenses.
General and administrative expenses were $1,715,240 and $2,150,585
during the first nine months of calendar 2002 and 2001, and as a percentage of
net sales, were 33.6% and 22.5% respectively. The decrease in general and
administrative expenses for the nine months was primarily due to a decrease of
$343,000 in compensation related expenses, a decrease of $41,000 in board of
directors expense and a decrease of $50,000 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 nine months
of 2002.
Research and development expenses for the third quarters of calendar
2002 and 2001 were $109,126 and $217,548, and as a percentage of net sales, were
5.4% and 9.1% respectively. The decrease in research and development expenses
for the current quarter was primarily due to a decrease of $94,000 in
compensation related expenses.
Research and development expenses were $394,827 and $695,811 during the
first nine months of calendar 2002 and 2001, and as a percentage of net sales,
were 7.7% and 7.3% respectively. The decrease in research and development
expenses for the nine months was primarily due to a decrease of $251,000 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 nine months of 2002.
Interest expense increased in the third quarter of calendar 2002 to
$37,855 from $30,540 in the third quarter of calendar 2001. The current year
increase resulted primarily from the payment of required minimum interest and
penalties associated with the line of credit and interest associated with the
promissory note with a major customer. In the prior year minimum interest
requirements associated with the line of credit were fulfilled. Interest expense
increased in the first nine months of calendar 2002 to $114,686 from $108,892 in
the first nine months of calendar 2001. The increase resulted primarily from
interest associated with the promissory note with a major customer. Gain on
disposition of assets totaled $4,662,210 in the first nine 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 third
quarter of calendar 2002 was $3,316 compared to other income of $35,480 for the
third quarter of calendar 2001. Other income for the first nine months of
calendar 2002 was $3,822 compared to other income of $65,437 for the first nine
months of calendar 2001. The current quarter and nine 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 $370,461 for the
third quarter of calendar 2002 compared to a loss before income taxes of
$1,190,124 for the third quarter of calendar 2001. The
I-10
Company recorded a loss before income taxes of $1,945,045 for the first nine
months of calendar 2002 compared to earnings before income taxes of $1,491,266
for the first nine months of calendar 2001. The earnings in the first nine
months of calendar 2001 resulted 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 $2,867,185 for the first nine
months of calendar 2001. 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. 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 nine months of calendar 2002 decreased compared to the loss before income
taxes for first nine months of calendar 2001. This decrease in loss was
primarily the result of a decrease in operating expenses which was partially
offset by a decrease in gross profit.
The provision for income taxes in the third quarter and first nine
months of calendar 2002 has been offset principally by a valuation allowance for
deferred taxes. The Company recorded an income tax expense in the first nine
months 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 $888,222 to $536,983 during the
first nine 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 decreased by $266,806 to $281,032 during the
first nine months of calendar 2002 primarily due to declining sales activity and
a prepayment program arranged with the company's largest customer. Inventories
decreased slightly by $4,009 to $1,523,534. Accounts payable of $687,865 at
September 30, 2002 increased by $59,502 during the first nine months of calendar
2002 due to the Company's increase in the number of days between vendor invoice
receipt and payment. Capital spending for manufacturing equipment and plant
improvements totaled $13,334 during the first nine months of calendar 2002.
There were no material commitments for capital expenditures at September 30,
2002.
The Company had a deficit in working capital of $290,881 and a current
ratio of 0.9 at September 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. In August
2002 the Company and the bank mutually agreed to terminate the line of credit
financing arrangement due to the Company's default of covenants relating to the
minimum net worth and the maximum loss before income taxes.
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 September 30, 2002). The
mortgage is collateralized by the Company's real property. The Company is
currently in the process of finalizing an agreement for the sale and leaseback
of the Company's real property located in Minnetonka, Minnesota. The proceeds
from the sale will be used to pay the principal balance of the mortgage due in
December 2002.
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
I-11
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 agreed to a proposal to factor its receivables and
continues to seek ways to reduce costs. In addition, management is exploring
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 will require additional investments in
the Company in the form of equity or debt either by outside investors or as part
of a business combination transaction. The Company is currently pursuing various
potential sources of capital and business combination transactions. There can be
no assurance that the Company will achieve desired levels of sales or
profitability, or that a future capital infusion or business combination
transaction will be available. If such desired levels of sales and profitability
are not reached, and infusions of capital or a business combination transaction
are not available, the company may be forced to cease operations in the near
future.
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.
I-12
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-13
PART I - FINANCIAL INFORMATION
ITEM 4 - CONTROLS AND PROCEDURES
The Company's Chief Executive Officer and Corporate Controller
(collectively, the "Certifying Officers") are responsible for establishing and
maintaining disclosure controls and procedures for the Company. Such officers
have concluded (based upon their evaluation of these controls and procedures as
of a date within 90 days of the filing of this report) that the Company's
disclosure controls and procedures are effective to ensure that information
required to be disclosed by the Company in this report is accumulated and
communicated to the Company's management, including its principal executive
officer as appropriate, to allow timely decisions regarding required disclosure.
The Certifying Officers also have indicated that there were no
significant changes in the Company's internal controls or other factors that
could significantly affect such controls subsequent to the date of their
evaluation, and there were no corrective actions with regard to significant
deficiencies and material weaknesses.
I-14
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
None.
Item 5. OTHER INFORMATION
On September 6, 2002 the Company received a Nasdaq Staff Determination
indicating that the Company fails to comply with the net tangible
assets and minimum bid price requirements for continued listing set
forth in Market Place Rules 4310(c)(2)(B) and 4310(c)(4), and that its
securities are, therefore, subject to removal from the Nasdaq SmallCap
Market. Based on its discussions with potential strategic investors,
strategic partners, and potential acquirers, the Company requested a
hearing before a Nasdaq Listing Qualifications Panel to review the
Staff Determination.
On September 18, 2002 the Company received a letter from The Nasdaq
Stock Market setting a hearing date of October 17, 2002 in connection
with its potential removal from The Nasdaq SmallCap Market. The hearing
was held before the Nasdaq Listing Qualifications Panel. The results of
the hearing were unknown as of the date of this filing. Although the
Company's securities currently remain listed on the Nasdaq SmallCap
Market, there can be no assurance that the Panel has granted the
Company's request for continued listing. In the event that the Company
is removed from the Nasdaq SmallCap Market, the Company anticipates
that its securities will qualify for quotation on Nasdaq's OTC Bulletin
Board.
II-1
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Item No. Item Method of Filing
-------- ---------------- ----------------
99.1 Chief Executive Officer Certification Pursuant to
18 U.S.C. ss.1350, as Adopted Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002. Filed herewith.
99.2 Corporate Controller Certification Pursuant to 18
U.S.C. ss.1350, as Adopted Pursuant to Section 906
of the Sarbanes-Oxley Act of 2002. Filed herewith.
(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 November 14, 2002 /s/ Rodney A. Young
----------------- ------------------------------------
Rodney A. Young, Chief Executive Officer &
President
Date November 14, 2002 /s/ Thomas D. Bartl
----------------- --------------------------------------
Thomas D. Bartl, Corporate Controller
(Principal Financial Officer and Chief
Accounting Officer)
II-3
CERTIFICATIONS
I, Rodney A. Young, certify that:
1. I have reviewed this quarterly report on Form 10-Q of LecTec Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which the quarterly report
is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002
By: /s/ Rodney A. Young
-------------------------------
Rodney A. Young
Chief Executive Officer & President
CERTIFICATIONS
I, Thomas D. Bartl, certify that:
1. I have reviewed this quarterly report on Form 10-Q of LecTec Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which the quarterly report
is being prepared;
(b) Evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
(c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
(a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
(b) Any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002
By: /s/ Thomas D. Bartl
-------------------------------
Thomas D. Bartl
Corporate Controller (Principal
Financial Officer and Chief
Accounting Officer)