LECTEC CORP /MN/ - 10-Q Quarterly Report

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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, 2003.

[ ] 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 August
12, 2003 was 3,966,395 shares.

LECTEC CORPORATION

FORM 10-Q FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003

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-12

Item 4. Controls and Procedures..................................................... 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-2

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

The accompanying notes are an integral part of these
condensed financial statements.

I-1

LECTEC CORPORATION
CONDENSED BALANCE SHEETS - CONTINUED

The accompanying notes are an integral part of these
condensed financial statements.

I-2

LECTEC CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)

The accompanying notes are an integral part of these
condensed financial statements.

I-3

LECTEC CORPORATION
STATEMENTS OF CASH FLOWS
(UNAUDITED)

The accompanying notes are an integral part of these
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 six month periods
ended June 30, 2003 and 2002. 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 the Company's
Annual Report on Form 10-K for the year ended December 31, 2002. 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.

Certain reclassifications have been made to the statements of
operations for the three and six month periods ended June 30, 2002, to conform
to the presentation used in 2003. Such reclassifications had no effect on the
previously reported net loss or stockholders' equity.

(2) LIQUIDITY AND GOING CONCERN

The accompanying financial statements have been prepared in conformity
with generally accepted accounting principles, which contemplate continuation of
the Company as a going concern. However, the Company has experienced recurring
negative cash flows from operations and net losses resulting in an accumulated
deficit of $11,255,577 as of June 30, 2003 and, as of that date, the Company's
current liabilities exceeded its current assets by $518,601.

In view of the matters described in the preceding paragraph,
recoverability of a major portion of the recorded asset amounts shown in the
accompanying balance sheet is dependent upon profitable operations of the
Company and access to working capital financing. The financial statements do not
include any adjustments relating to the recoverability and classification of
recorded asset amounts or amounts and classification of liabilities that might
be necessary should the Company be unable to continue in existence. Management
expects to continue to operate at a net loss and experience negative cash flow
from operating activities through the foreseeable future.

At June 30, 2003, the Company's cash resources and available borrowings
are insufficient to fund operations for the next 12 months without additional
borrowings or equity capital. These factors raise substantial doubt about its
ability to continue as a going concern.

Management currently is exploring available options for additional
capital including borrowings secured by otherwise unencumbered assets or private
issuances of common stock. However, there is no assurance that such funds will
be available on terms acceptable to the Company. If the Company is not
successful in obtaining additional funding it may not be able to continue as a
going concern.

(3) NET LOSS PER SHARE

The Company's basic net loss per share amounts have been computed by
dividing net loss by the weighted average number of outstanding common shares.
The Company's diluted net loss per share amounts have been computed by dividing
net loss by the weighted average number of outstanding common shares and common
share equivalents, when dilutive. Options and warrants to purchase 1,315,945 and
1,252,680 shares of common stock with a weighted average exercise price of $1.89
and $1.95 were outstanding during the three and six months ended June 30, 2003,
but were excluded from the calculation because they were antidilutive. Options
and warrants to purchase 1,205,229 and 1,231,893 shares of common stock with a
weighted average exercise price of $4.64 and $4.63 were outstanding during the
three and six months ended June 30, 2002, but were excluded from the calculation
because they were antidilutive.

I-5

(4) 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 three months ended March 31, 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 for the three and six month periods
ended June 30, 2003 and June 30, 2002 were as follows:

(5) LONG-TERM OBLIGATIONS AND SALE OF CORPORATE FACILITY

The Company had a mortgage note payable to a bank. The principal
balance of $820,000 was due in December 2002 and was extended until April 2003.
Monthly interest payments were computed at the prime rate plus 5.0% (effective
rate of 9.25% at December 31, 2002). The mortgage was collateralized by the
Company's real property. On February 25, 2003, the Company sold its corporate
facility in Minnetonka, Minnesota for an aggregate purchase price of $910,270,
repaid the mortgage note payable, and recorded a loss on sale of $52,375 during
the quarter ended March 31, 2003. In connection with the sale, the Company
entered into a lease of its corporate facility which grants the Company free
rent for the 12 months following the sale/leaseback transaction and thereafter
extends the lease at costs based on current market conditions. Also in
connection with the sale, the purchaser received a warrant to purchase 200,000
shares of common stock at $0.90 per share.

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 2.0% (effective
rate of 6% at June 30, 2003). The promissory note is collateralized by
substantially all of the Company's assets.

(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 this customer for future product orders. The Company is also
receiving advance product payments from other customers. At June 30, 2003, the
Company had recorded customer deposits of $1,187,375 from these customers.

(7) SALE OF CONDUCTIVE BUSINESS ASSETS

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.

I-6

The Company supplied the products at its cost of production through
October 2001, and at its cost of production plus ten percent from November 2001
through January 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
in 2003.

(8) STOCK BASED COMPENSATION

The Company utilizes the intrinsic value method of accounting for stock
based employee compensation plans. All options granted had an exercise price
equal to the market value of the underlying common stock on the date of grant
and no compensation cost is reflected in net loss, for the three and six months
ended June 30, 2003 and 2002. The following table illustrates the effect on net
loss if the Company had applied the fair value recognition provisions of FASB
Statement No. 123, Accounting for Stock-based Compensation:

The pro-forma information above should be read in conjunction with the
related historical information.

The weighted average fair value of options granted during the six
months ended June 30, 2003 and 2002 was $0.44 and $0.63. The fair value of each
option grant is estimated on the date of grant using the Black-Scholes option
valuation model with the following weighted-average assumptions used for all
grants during the six months ended June 30, 2003 and 2002, zero dividend yield,
expected volatility of 153% and 121%, risk-free interest rates of 2.85% and
3.13% and expected lives of 4.0 years.

Management believes the Black-Scholes option valuation model currently
provides the best estimate of fair value. However, the Black-Scholes option
valuation model was developed for use in estimating the fair value of traded
options which have no vesting restrictions and are fully transferable. In
addition, option valuation models require the input of several subjective
assumptions. The Company's employee and director stock options have
characteristics different from those of traded options, and changes in the
subjective input assumptions can materially affect the fair value estimate.

(9) INCOME TAXES

The provision for income tax benefits for the three and six months
ended June 30, 2003 and 2002 has been offset by a valuation allowance for
deferred taxes.

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(10) RECENT ACCOUNTING PRONOUNCEMENTS

In January 2003, the Financial Accounting Standards Board (FASB) issued
Financial Interpretations No. 46 (FIN 46), "Consolidation of Variable Interest
Entities." FIN 46 is an interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements," and addresses consolidation by business
enterprises of variable interest entities. FIN 46 applies immediately to
variable interest entities created or obtained after January 31, 2003 and
applies in the first fiscal year or interim period beginning after June 15,
2003, to variable interest entities in which an enterprise holds a variable
interest that it acquired before February 1, 2003. This interpretation is not
anticipated to have an impact on the Company's financial position or results of
operations.

In April 2003, the FASB issued Statement 149, Amendment of Statement 133 on
Derivative Instruments and Hedging Activities. Statement 149 clarifies
implementation issues and amends Statement 133, to include the conclusions
reached by the FASB on certain FASB Staff Implementation Issues that, while
inconsistent with Statement 133's conclusions, were considered by the Board to
be preferable, amends discussion of financial guarantee contracts and the
application of the shortcut method to an interest-rate swap agreement that
includes an embedded option, and amends other pronouncements. Statement 149 is
effective to contracts entered into or modified, and hedging arrangements
designated after June 30, 2003, with various exceptions as outlined in the
statement. Adoption of Statement 149 is not anticipated to have an impact on the
Company's consolidated financial position or results of operations.

In May 2003, the FASB issued Statement 150, Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity. Statement 150
changes the classification in the statement of financial position of certain
common financial instruments from either equity or mezzanine presentation to
liabilities and requires an issuer of those financial statements to recognize
changes in fair value or redemption amount, as applicable, in earnings. SFAS 150
is effective for financial instruments entered into or modified after May 31,
2003, and otherwise is effective at the beginning of the first interim period
beginning after June 15, 2003. Adoption of Statement 150 is not anticipated to
have an impact on the Company's financial position or results of operations.

I-8

PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

QUARTER AND SIX MONTHS ENDED JUNE 30, 2003 AND 2002

RESULTS OF OPERATIONS

Net sales for the second quarter ended June 30, 2003 were $1,624,416
compared to net sales of $1,583,007 for the comparable quarter of 2002, an
increase of 2.6%. The increase was the result of higher therapeutic consumer
contract manufacturing sales as the Company rebounded from soft contract
manufacturing sales in the prior year and also a shift in the Company's
strategic focus from retail consumer products to contract manufacturing.
Contract manufacturing net sales increased 53.1% to $1,492,001 for the second
quarter of 2003 from $974,744 for the same period in the prior year. Therapeutic
retail consumer product sales declined 51.7% in the second quarter of 2003 to
$133,339 from $275,965 for the same period in the prior year. The retail
consumer product sales decrease was primarily the result of a planned reduction
in the number of products offered and the discontinued active promotion of the
NeoSkin(R) line of skin care products due to the inability to fund national
advertising programs. The Neoskin product line was launched in the second
quarter of 2002 and includes pre-formed face masks and under eye gel patches.
Net sales of skin care products totaled ($924) in the second quarter of 2003
compared to net sales of $66,191 for the second quarter of 2002. Also offsetting
the contract manufacturing sales increase was the absence of conductive product
sales in the second quarter of 2003. The Company supplied conductive products to
the purchaser under the terms of the asset sale agreement through September
2002. The Company expects no future conductive product sales.

Net sales for the first six months of 2003 were $3,270,106 compared to
net sales of $3,097,502 for the first six months of 2002, an increase of 5.6%.
The increase was primarily due to an increase in sales of consumer contract
therapeutic patch products. Contract manufacturing net sales increased 113.2% to
$2,825,539 from $1,325,416 for the first six months of 2003 compared to the same
period of 2002. Offsetting the contract manufacturing sales increase was a
decline in therapeutic retail consumer brand product sales, which decreased
46.3% to $441,415 for the six month period ended June 30, 2003, from $822,500
for the comparable six months of the prior year. The decline was attributable to
a planned reduction in the number of products the Company offers to the retail
market and the discontinued active promotion of the NeoSkin(R) line of skin care
products due to the inability to fund national advertising programs. Net sales
of skin care products totaled $3,152 for the six months ended June 30, 2003,
compared to net sales of $358,263 for the same period in 2002. There were no
sales of conductive products during the six months ended June 30, 2003, compared
to net sales of $591,323 for the six months ended June 30, 2002. The decline was
due to the reasons stated above.

Gross profit for the second quarter of 2003 was $391,007, compared to
$456,248 for the second quarter of 2002, a decrease of 14.3%. Gross profit as a
percent of net sales for the second quarter of 2003 was 24.1% compared to 28.8%
for the second quarter of the prior year. The decrease in gross profit dollars
and gross profit as a percentage of net sales for the second quarter of 2003
compared to the same quarter of 2002 resulted primarily from the shift in sales
mix to lower margin consumer contract manufacturing products and to higher
inventory obsolescence costs related to the product discontinuations discussed
above.

Gross profit for the first six months of 2003 was $882,306 compared to
$921,107 for the first six months of 2002, a decrease of 4.2%. Gross profit as a
percent of net sales for the first six months of 2003 was 27.0% compared to
29.7% for the first six months of 2002. The decrease in gross profit dollars and
gross profit as a percentage of net sales for the first six months of 2003
compared to the same period of 2002 resulted primarily from the shift in sales
mix to lower margin consumer contract manufacturing products and to higher
inventory obsolescence costs related to the product discontinuations discussed
above.

Sales and marketing expenses were $165,598 and $461,283 during the
second quarters ended June 30, 2003 and 2002, and as a percentage of net sales
were 10.2% and 29.1%, respectively. The decrease in sales and marketing expenses
for the second quarter of 2003 was primarily due to a decrease of $123,067 in
product promotional expenses and a decrease of $122,084 in compensation

I-9

related expenses. These decreases resulted from aggressive cost control/
reduction programs implemented by management.

Sales and marketing expenses were $363,675 and $929,860 during the
first six months of 2003 and 2002, and as a percentage of net sales, were 11.1%
and 30.0%, respectively. The decrease in sales and marketing expenses for the
first six months of 2003 as compared with the same period of 2002 was primarily
due to a decrease of $191,880 in product promotional expenses and a decrease of
$274,186 in compensation related expenses. The Company anticipates that sales
and marketing expenses as a percentage of net sales will continue to decrease in
2003 due to the implementation of additional cost control/reduction programs by
management.

General and administrative expenses were $555,430 and $609,571 during
the second quarters of 2003 and 2002, and as a percentage of net sales, were
34.2% and 38.5%, respectively. The decrease in general and administrative
expenses was primarily due to decreases in headcount and compensation related
expenses of $73,974 and a reduction in professional fees and services of
$39,261, which reductions were offset by an increase in rent expense of $57,128
due to the sale and leaseback of the Company's Minnetonka, Minnesota corporate
facility during the first quarter of 2003.

General and administrative expenses were $1,037,795 and $1,204,983
during the first six months of 2003 and 2002, and as a percentage of net sales,
were 31.7% and 38.9%, respectively. The decrease in general and administrative
expenses for the six months ended June 30, 2003 from the six months ended June
30, 2002 was primarily due to a decrease of $186,136 in compensation related
expenses and a decrease of $41,537 in professional fees and services which
reductions were offset by an increase in rent expense of $76,171 discussed
above. The Company anticipates that general and administrative expenses as a
percent of net sales for the remainder of 2003 will continue to decrease.

Research and development expenses for the second quarters of 2003 and
2002 were $97,249 and $115,676, respectively, and as a percentage of net sales,
were 6.0% and 7.3%, respectively. The decrease in research and development
expenses was primarily due to decreases in headcount and compensation related
expenses of $15,185.

Research and development expenses were $198,781 and $284,523 during the
first six months of 2003 and 2002, and as a percentage of net sales, were 6.1%
and 9.2%, respectively. The decrease in research and development expenses for
the six months ended June 30, 2003 from the six months ended June 30, 2002 was
primarily due to a decrease of $76,759 in compensation related expenses. The
Company anticipates that research and development expenses as a percent of net
sales for the remainder of 2003 will continue to decrease.

Interest expense declined in the second quarter of 2003 to $5,721 from
$38,065 in the second quarter of 2002. The decline resulted primarily from the
interest reduction related to the sale of the Minnetonka, Minnesota corporate
facility and related payoff of debt in February 2003. Interest expense decreased
in the first six months of 2003 to $24,653 from $76,831 in the first six months
of 2002. The decrease resulted primarily from the absence of a line of credit in
existence during a portion of 2002 and from the absence of interest expense
associated with the mortgage on the corporate facility.

The Company recorded a net loss of $433,548, or $0.11 per basic and
fully diluted share, compared to a net loss of $767,603, or $0.19 per basic and
fully diluted share for the second quarters ended June 30, 2003 and 2002,
respectively. For the six months ended June 30, 2003 and 2002 the Company
recorded a net loss of $793,034, or $0.20 per basic and fully diluted share,
compared to a net loss of $1,574,584, or $0.40 per basic and fully diluted
share. The reduction in the net loss for the three and six months ended June 30,
2003 from the comparable periods in 2002 is due primarily to the reasons stated
above including headcount reductions, a shift in strategic focus from retail
consumer products to contract manufacturing and aggressive reductions of
operating expenses.

The provision for income tax benefits for the second quarter of fiscal
2003 and 2002 and the six months ended June 30, 2003 and 2002 has been offset by
a valuation allowance for deferred taxes.

Inflation has not had a significant impact on the Company's operations
or cash flow.

I-10

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents decreased by $260,304 to $411,284 during the
first six months of calendar 2003 compared to the cash and cash equivalent
balance at December 31, 2002. The decrease in cash and cash equivalents during
the period was primarily due to cash used in operating activities. Trade
receivables decreased $137,525 during the six months ended June 30, 2003 to
$181,371 from $318,896 at December 31, 2002, primarily due to increased
collections from retail sales customers. Inventories increased during the six
months ended June 30, 2003 from December 31, 2002 by $333,878, due primarily to
increases in raw material purchases to meet future consumer contract
manufacturing customer requirements. Accounts payable increased $145,507 during
the six months ended June 30, 2003 to $733,157 from $587,650 at December 31,
2002, primarily due to increased payables related to inventory purchases to meet
ramped up customer requirements. Capital spending for manufacturing equipment
and plant improvements totaled $11,005 and investments in patents and trademarks
totaled $43,993 for the six months ended June 30, 2003. There were no material
commitments for capital expenditures at June 30, 2003. Net cash used in
financing activities totaled $36,674 for the six months ended June 30, 2003,
resulting primarily from the repayment of long-term capital lease obligations.

The Company had a working capital deficit of $518,601 and a current
ratio of 0.81 at June 30, 2003 compared to a working capital deficit of
$1,058,534 and a current ratio of 0.67 at December 31, 2002. The improvement in
current ratio and working capital deficit during the six month period ended June
30, 2003 is attributable to the payoff of the $820,000 mortgage payable related
to the sale and leaseback of the Company's Minnetonka, Minnesota corporate
facility in the first quarter of 2003, offset in part by the decline in cash and
cash equivalents and trade receivables. See Note 5 of Notes to Condensed
Financial Statements on page I-6 of this report for additional information on
the corporate facility sale.

In August 2002, the Company and its bank mutually agreed to terminate a
two-year, $2,000,000 asset-based 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.

Management expects the Company to continue to operate at a net loss and
experience negative cash flow from operating activities for the foreseeable
future. Management is exploring other options for additional capital to fund the
Company's operations. In 2002, the Company renegotiated its Supply Agreement
with a major customer and is receiving advance payments from the customer for
future product orders. The Company is also receiving advance product payments
from other customers. 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, the continuation of advance product payments
and the Company's ability to control operating expenses. Funding of the
Company's operations for the balance of 2003 and in future years 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.

I-11

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-Q for the quarter ended
March 31, 2003.

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.

ITEM 4 - CONTROLS AND PROCEDURES

Under the supervision and with the participation of our management,
including our principal executive and financial officer, we have evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as defined in Rule 13a-15 under the Securities Exchange Act of 1934)
as of the last day of the period covered by this quarterly report. Based upon
this evaluation, the principal executive and financial officer has concluded
that, as of such date, our disclosure controls and procedures were effective in
making him aware on a timely basis of the material information relating to the
Company required to be included in our periodic filings with the Securities and
Exchange Commission.

There were no significant changes made in our internal controls over
financial reporting (as defined in Rule 13(a)-15(f) under the Securities
Exchange Act of 1934 during the period covered by this report that materially
affected or are reasonable likely to materially affect our internal control over
financial reporting.

I-12

PART II - OTHER INFORMATION

ITEM 1 - LEGAL PROCEEDINGS

None.

ITEM 2(c) - 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
May 22, 2003. The following matters were voted on by Shareholders:

1. The election of five 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:

2. Appointment of Grant Thornton LLP as independent auditor for
the Company:

II-1

ITEM 5 - OTHER INFORMATION

In May 2003, the Company entered into a new operating lease for 14,376
square feet of warehouse and office space in Edina, MN. In July 2003,
the Company vacated approximately 29,000 square feet of warehouse and
office space, also in Edina, MN, which lease had expired under an
operating lease.

On August 1, 2003, the Company announced that Rodney A. Young,
Chairman, Chief Executive Officer and President, had resigned effective
as of July 30, 2003, to pursue other opportunities. Dr. Alan C. Hymes,
a co-founder and director of LecTec, has been appointed Chairman of the
Board of Directors and interim Chief Executive Officer and President of
the Company. Dr. Hymes will work in conjunction with other Board
members to identify and recruit a new chief executive officer for the
Company. The Company also announced that Board members Dr. Marilyn K.
Speedie and Donald C. Wegmiller have tendered their resignations from
the Board effective July 25, 2003. At a meeting of the Board held on
July 30, 2003, Lee Berlin, a former director and Chief Executive
Officer of LecTec, was reappointed to the Board. The Board of Directors
now consists of Dr. Hymes, Lee Berlin and Judd Berlin, son of Lee
Berlin.

ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS

(b) REPORTS ON FORM 8-K

The Company filed one Current Report on Form 8-K during the quarter
ended June 30, 2003. The Report on Form 8-K was dated May 7, 2003, and
disclosed the Company's financial results for the first quarter ended
March 31, 2003.

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 12, 2003 By /s/ Alan C. Hymes, M.D.
--------------- ---------------------------------------------
Alan C. Hymes
Chairman of the Board,
Interim Chief Executive Officer & President
(principal financial officer)

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