UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004.
[ ] 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 small business issuer 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)
(952) 933-2291
---------------------------
(Issuer's telephone number)
- --------------------------------------------------------------------------------
(Former name, former address and former fiscal year, if changed from last
report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act 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 issuer's common stock as of May 12, 2004
was 4,017,327 shares.
Transitional Small Business Disclosure Format (Check one):
Yes [ ] No [X]
LECTEC CORPORATION
REPORT ON FORM 10-QSB FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
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 or Plan of Operation................................ I-10
Item 3. Controls and Procedures.................................................................. I-12
PART II - OTHER INFORMATION
Item 1. Legal Proceedings........................................................................ II-1
Item 2. Changes in Securities and Small Business Issuer Purchases of Equity Securities........... 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-1
Signature Page........................................................................... II-2
- ---------------------
FORWARD-LOOKING STATEMENTS
From time to time, in reports filed with the Securities and Exchange
Commission (including this Form 10-QSB), 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 which 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 Company's dependence on
major customers and the continuance of prepayment terms; competitive forces
including new products or pricing pressures; 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 and capital requirements for operating needs, expansion or
capital expenditures and the matters discussed on the "Cautionary Statements"
filed as Exhibit 99.01 to the Company's Report on Form 10-KSB for the year ended
December 31, 2003.
PART I - FINANCIAL INFORMATION
ITEM 1- CONDENSED FINANCIAL STATEMENTS AND NOTES TO CONDENSED
FINANCIAL STATEMENTS
LECTEC CORPORATION
CONDENSED BALANCE SHEETS
(Unaudited)
March 31, December 31,
2004 2003
------------- --------------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 733,506 $ 483,844
Trade and other receivables, net of allowances of $41,767
and $46,000 at March 31, 2004 and December 31, 2003 100,254 203,866
Inventories:
Raw materials 540,267 465,050
Work-in-process 15,087 41,354
Finished goods 222,504 587,065
------------ -------------
777,858 1,093,469
Prepaid expenses and other 222,255 220,813
------------ -------------
Total current assets 1,833,873 2,001,992
PROPERTY, PLANT AND EQUIPMENT - AT COST, NET 409,474 477,063
OTHER ASSETS:
Patents and trademarks, less accumulated amortization of
$1,328,434 and $1,305,180 at March 31, 2004 and
December 31, 2003 219,814 211,595
------------ -------------
$ 2,463,161 $ 2,690,650
============ =============
See notes to condensed financial statements.
I - 1
LECTEC CORPORATION
CONDENSED BALANCE SHEETS - CONTINUED
(Unaudited)
March 31, December 31,
2004 2003
------------- --------------
LIABILITIES AND SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES:
Current maturities of long-term obligations 231,826 232,564
Accounts payable 377,996 336,749
Accrued expenses 370,651 361,828
Reserve for sales returns and credits 208,626 140,557
Customer deposits 1,215,897 1,710,282
------------ -------------
Total current liabilities 2,404,996 2,781,980
LONG-TERM OBLIGATIONS, LESS CURRENT MATURITIES 60,442 62,438
COMMITMENTS AND CONTINGENCIES - -
SHAREHOLDERS' DEFICIT:
Common stock, $.01 par value: 15,000,000 shares authorized;
3,979,327 shares issued and outstanding at
March 31, 2004 and December 31, 2003 39,793 39,793
Additional paid-in capital 11,627,507 11,550,743
Accumulated deficit (11,669,577) (11,744,304)
------------ -------------
(2,277) (153,768)
------------ -------------
$ 2,463,161 $ 2,690,650
============ =============
See notes to condensed financial statements.
I - 2
LECTEC CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three months ended March 31,
-----------------------------
2004 2003
------------- -------------
Net sales $ 2,479,300 $ 1,645,690
Cost of goods sold 1,733,535 1,154,391
------------- -------------
Gross profit 745,765 491,299
Operating expenses:
Sales and marketing 67,948 198,077
General and administrative 450,901 482,365
Research and development 147,240 101,532
Loss on sale of building - 52,375
------------- -------------
666,089 834,349
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Income (loss) from operations 79,676 (343,050)
Other income (expense):
Interest expense (4,791) (18,932)
Other, net (158) 2,496
------------- -------------
Net income (loss) $ 74,727 $ (359,486)
============= =============
Net income (loss) per share:
Basic $ 0.02 $ (0.09)
============= =============
Diluted $ 0.02 $ (0.09)
============= =============
Weighted average shares outstanding:
Basic 3,979,327 3,966,395
============= =============
Diluted 4,140,735 3,966,395
============= =============
See notes to condensed financial statements.
I - 3
LECTEC CORPORATION
STATEMENTS OF CASH FLOWS
(Unaudited)
Three months ended March 31,
--------------------------------
2004 2003
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 74,727 $ (359,486)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Loss on sale of building - 52,375
Depreciation and amortization 90,843 138,285
Compensation expense related to repriced stock options 76,765 -
Changes in operating assets and liabilities:
Trade and other receivables 103,612 131,770
Inventories 315,611 (159,089)
Prepaid expenses and other (1,442) 8,584
Accounts payable 41,247 172,637
Accrued expenses and other 76,891 (179,888)
Customer deposits (494,385) (37,103)
------------ -------------
Net cash provided by (used in) operating activities 283,869 (231,915)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment - (5,927)
Proceeds from sale of property, plant and equipment - 845,000
Investment in patents and trademarks (31,473) (30,678)
------------ -------------
Net cash provided by (used in) investing activities (31,473) 808,395
CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of mortgage note payable - (820,000)
Repayment of long-term obligations (2,734) (30,877)
------------ -------------
Net cash used in financing activities (2,734) (850,877)
------------ -------------
Net increase (decrease) in cash and cash equivalents 249,662 (274,397)
Cash and cash equivalents at beginning of period 483,844 671,588
------------ -------------
Cash and cash equivalents at end of period $ 733,506 $ 397,191
============ =============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest expense $ 1,455 $ 17,168
SUPPLEMENTAL DISCLOSURES OF NON-CASH FINANCING ACTIVITIES:
Fair value of warrants issued in connection with the sale
of building $ - $ 158,000
Value of free rent received in connection with the sale
of building $ - $ 228,512
See notes to condensed financial statements.
I - 4
LECTEC CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
MARCH 31, 2004 AND 2003
(Unaudited)
(1) GENERAL
The accompanying condensed financial statements include the accounts of
LecTec Corporation (the "Company") as of and for the three month periods ended
March 31, 2004 and 2003. 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-KSB for the year ended December 31, 2003. 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) MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
BUSINESS SUMMARY
LecTec Corporation (the "Company") is a health care and consumer
products company that develops, manufactures, and markets products based on its
advanced skin interface technologies. Primary products include a complete line
of over-the-counter ("OTC") therapeutic patches and a line of skin care
products. The Company markets and sells its products to consumers through other
health care consumer products companies, retail outlets (food, chain drug, and
mass merchandise stores), and directly from the Internet. All of the products
manufactured by the Company are designed to be effective, safe, and highly
compatible with skin.
CRITICAL ACCOUNTING POLICIES
Some of the most critical accounting policies include:
Revenue Recognition
For domestic sales, revenue is recognized when the product has been
shipped to the customer and collection is probable. For international sales,
revenue is recognized when the product is received by the customer and
collection is probable.
Inventories
Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market.
LIQUIDITY, GOING CONCERN, AND WIND DOWN OF MANUFACTURING OPERATIONS
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 $11,669,577 as of March 31, 2004 and, as of that date, the Company's
current liabilities exceeded its current assets by $571,123. In addition, the
Company's two largest customers have indicated their intention to discontinue
their supply arrangements with the Company during 2004. It is management's
intent to wind down its manufacturing operations, sell off manufacturing assets,
renegotiate its facility leases and fund continuing operations with royalty
income from licensing agreements or from other income derived from protection of
rights pertaining to the Company's intellectual property.
I-5
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 cease operations or be unable to continue in
existence.
In connection with the pending cessation of manufacturing operations,
the Company has implemented employee reduction and retention programs to reduce
the number of employees needed to support the wind down of manufacturing
operations while retaining those employees who are critical to that process and
to managing the Company's ongoing licensing agreements and intellectual property
portfolio. The Company is exploring its alternatives with respect to the sale of
its manufacturing assets, the renegotiation or termination of its leases and
other contractual obligations, and other adjustments resulting directly from the
Company's exit from manufacturing operations. In addition, the Company will be
considering other possible fundamental changes in future periods that could
include, among other things, a sale of its remaining assets or of the business
as a whole.
At March 31, 2004, the Company's cash resources are insufficient to
fund operations for the foreseeable future without the continuation of
prepayment terms on future product orders with the Company's major customers or
obtaining additional outside capital or funding. Furthermore, the Company does
not have any other financing resources in place from which the it can borrow or
obtain additional working capital. These factors raise substantial doubt about
its ability to continue as a going concern.
There can be no assurance that sources of additional capital or funds
will be available on terms acceptable to the Company, if at all. If the Company
is not successful in obtaining additional funding, or in continuing prepayment
terms on future product orders with its major customers, it may not be able to
continue as a going concern.
(3) NET INCOME (LOSS) PER SHARE
The Company's basic net income (loss) per share amounts have been
computed by dividing net income (loss) by the weighted average number of
outstanding common shares. The Company's diluted net income (loss) per share
amounts have been computed by dividing net income (loss) by the weighted average
number of outstanding common shares and common share equivalents, when dilutive.
Options and warrants to purchase 302,861 and 1,189,415 shares of common stock
with weighted average exercise prices of $4.39 and $2.00 were outstanding during
the three-month periods ended March 31, 2004 and 2003, respectively, but were
excluded from the calculation because they were anti-dilutive.
(4) SEGMENTS
The Company operates its business in one reportable segment - the
manufacture and sale of products based on advanced skin interface technologies.
The Company also has only one major product line - therapeutic topical skin
patch products for the consumer market. The Company's products have similar
economic characteristics, technology, manufacturing processes, and regulatory
environments. Customers and distribution and marketing strategies vary within
individual products as well as overlap between products. The Company's executive
decision makers evaluate sales performance based on the total sales of each
product and profitability on a total company basis, due to shared
infrastructures, to make operating and strategic decisions. Net sales by product
line for the three-month periods ended March 31, 2004 and 2003 were as follows:
Three months ended
March 31,
--------------------------
2004 2003
---- ----
Therapeutic consumer products $2,476,426 $1,641,614
Skin care products 2,874 4,076
---------- ----------
$2,479,300 $1,645,690
========== ==========
I-6
(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 was originally due in December
2003 and is subject to ongoing negotiations regarding payment. Interest is
accrued at the prime rate plus 2.0% (effective rate of 6.0% at March 31, 2004).
The promissory note is collateralized by substantially all of the Company's
assets.
The Company has capital lease obligations related to its leased
corporate facility as well as leased computer and production equipment. Capital
lease obligations are due through June 2013 in various monthly installments up
to $879 and carry interest up to 19.1%. The obligations are generally
collateralized by equipment. At March 31, 2004, the principal balance remaining
on capital lease obligations was $72,268.
(6) CUSTOMER DEPOSITS
The Company receives advance payments from customers for future product
orders and records these amounts as liabilities. At March 31, 2004, the Company
had recorded customer deposits of $1,215,897.
(7) SALE OF CORPORATE FACILITY
In February 2003, the Company sold its corporate facility in
Minnetonka, Minnesota for an aggregate purchase price of $910,270, repaid the
balance of the mortgage note payable of $820,000, 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 granted the
Company free rent for the twelve months following the sale/leaseback transaction
and thereafter extends the lease at costs based on current market conditions.
The lease has been extended to February 2005 at a base rent per month of
$10,853. Also in connection with the sale, the purchaser received a warrant to
purchase 200,000 shares of common stock at $0.90 per share.
I-7
(8) STOCK BASED COMPENSATION
In July 2002, 803,958 stock options with a weighted average exercise
price of $4.54 per share were re-priced to $0.81 per share. At March 31, 2004,
198,500 of these options were outstanding, 196,833 of which were exercisable. No
compensation expense was recorded by the Company in connection with the
re-pricing, as the exercise price exceeded the market price on the date of the
re-pricing. However, at March 31, 2004 the ending market price for the Company's
common stock exceeded the exercise price of the re-priced options. Accordingly,
compensation expense of $76,765 was recorded for the three months ended March
31, 2004.
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 related to stock option grants is reflected in net
income or loss for the three months ended March 31, 2004 and 2003. The following
table illustrates the effect on net income or loss if the Company had applied
the fair value recognition provisions of FASB Statement No. 123, Accounting for
Stock-based Compensation:
Three months ended
March 31,
------------------------
2004 2003
---- ----
Net income (loss), as reported $74,727 $(359,486)
Less: compensation expense
determined under the fair value
method (26,805) (49,954)
------- ---------
Pro-forma net income (loss) $47,922 $(409,440)
======= =========
Net income (loss) per share:
Basic, as reported $ 0.02 $ (0.09)
Basic, pro-forma 0.01 (0.10)
Diluted, as reported 0.02 (0.09)
Diluted, pro-forma 0.01 (0.10)
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 three
months ended March 31, 2004 and 2003 was $1.09 and $0.56. 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 three months ended March 31, 2004 and 2003; zero dividend
yield, expected volatility of 179% and 144%, risk-free interest rates of 2.72%
and 3.24% and expected lives of 3.0 and 4.0 years, respectively.
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
No federal or state income taxes were provided for the quarter ended
March 31, 2004, due to available tax credit and net operating loss carryforwards
to the current period. The provision for income tax benefits for the quarter
ended March 31, 2003 has been offset by a valuation allowance for deferred
taxes.
I-8
(10) RECENT ACCOUNTING PRONOUNCEMENTS
In November 2002, the Financial Accounting Standards Board (FASB)
issued Financial Interpretations No. 45 (FIN 45), "Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others". FIN 45 addresses the disclosure requirements of a
guarantor in its interim and annual financial statements about its obligations
under certain guarantees that it has issued. FIN 45 also requires a guarantor to
recognize, at the inception of a guarantee, a liability for the fair value of
the obligation undertaken in issuing the guarantee. The disclosure requirements
of FIN 45 were effective for the Company for the year ended December 31, 2002.
The liability recognition requirements are applicable prospectively to all
guarantees issued or modified after January 1, 2003. The Company currently does
not have guarantees within the scope of this pronouncement, and therefore this
interpretation is not anticipated to have an impact on the Company's
consolidated financial position or results of operations
In January 2003, the FASB issued 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 before 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 consolidated financial position
or results of operations.
I-9
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
THREE MONTHS ENDED MARCH 31, 2004 AND 2003
RESULTS OF OPERATIONS
Total net sales for the first quarter of 2004 were $2,479,300 compared
to net sales of $1,645,690 for the first quarter of 2003, an increase of 50.7%.
The increase was the result of higher therapeutic consumer contract
manufacturing sales due to product acceptance and a stronger cough/cold season.
Contract manufacturing net sales increased 74.6% to $2,328,771 for the
first quarter of 2004 from $1,333,538 for the same period in the prior year.
Contract manufacturing net sales for the first quarter of 2004 includes sales of
$601,973, or 24.3% of total net sales, from two customers for which the Company
does not anticipate any future orders.
Therapeutic branded consumer product net sales decreased 71.8% in the
first quarter of 2004 to $88,076 from $312,152 for the same period in the prior
year. The branded consumer product sales decrease was attributable to a
reduction in the number of TheraPatch products available and the lack of retail
advertising and support programs.
Gross profit for the first quarter of 2004 was $745,765, compared to
$491,299 for the first quarter of 2003, an increase of 51.7%. Gross profit as a
percent of net sales for the first quarter of 2004 was 30.1% compared to 29.9%
for the first quarter of the prior year. The increase in gross profit dollars
for the first quarter of 2004 resulted primarily from the increased contract
manufacturing sales volume. The slight increase in gross profit as a percentage
of net sales for the first quarter of 2004 resulted primarily from lower
inventory obsolescence costs offset in part by first quarter 2004 accruals for
employee severance costs related to the manufacturing wind down (see "Wind Down
of Manufacturing Operations" below).
Sales and marketing expenses were $67,948 and $198,077 during the first
quarters of 2004 and 2003, and as a percentage of net sales, were 2.7% and
12.0%, respectively. The decrease in sales and marketing expenses was primarily
due to reductions in salaries and related benefits, travel expenditures, broker
commissions and other retail-related costs, and the elimination of advertising
expenses, as the Company retrenched to a position of pursuing contract
manufacturing opportunities that reduced the sales force and consolidated the
consumer and contract marketing efforts. Currently the Company has no employee
sales force and operates with a staff of two part time sales/customer service
employees.
General and administrative expenses were $450,901 and $482,365 during
the first quarters of 2004 and 2003, and as a percentage of net sales, were
18.2% and 29.3%, respectively. The decrease in general and administrative
expenses was primarily due to declines in headcount, consulting costs, corporate
legal fees, travel and entertainment expenses, building depreciation and bad
debt expense, offset in part by first quarter 2004 compensation expense related
to re-priced stock options outstanding (see Note 8 of Notes to Condensed
Financial Statements in Item 1 of this Report), accruals for employee severance
costs and rent expense related to the Company's sale and leaseback of its
corporate facility in Minnetonka, Minnesota (see Note 7 of Notes to Condensed
Financial Statements in Item 1 of this Report). The Company anticipates general
and administrative expenditures will continue to decrease during the
manufacturing wind down period (see "Wind Down of Manufacturing Operations"
below).
Research and development expenses for the first quarters of 2004 and
2003 were $147,240 and $101,532, and as a percentage of net sales, were 5.9% and
6.2%, respectively. The increase in research and development expenses resulted
primarily from an increase in first quarter 2004 patent-related legal costs,
accruals for employee severance costs and compensation expense related to
re-priced stock options outstanding (see Note 8 of Notes to Condensed Financial
Statements in Item 1 of this Report), offset in part by decreases in headcount
and compensation-related expenses due to staff turnover. The Company anticipates
research and development expenditures will decrease during the manufacturing
wind down period (see "Wind Down of Manufacturing Operations" below).
During the quarter ended March 31, 2003, the Company recorded a loss of
$52,375 on the February 2003 sale and leaseback of its Minnetonka, Minnesota
corporate facility. The Company also repaid an outstanding mortgage note payable
in connection with the building sale (see Note 7 of Notes to Condensed Financial
Statements in Item 1 of this Report).
I-10
Interest expense declined in the first quarter of 2004 to $4,791 from
$18,932 in the first quarter of 2003. The decline resulted primarily from the
absence of mortgage interest in connection with the sale of the Minnetonka,
Minnesota corporate facility in February 2003. Other expense for the first
quarter of 2004 was $158 compared to other income of $2,496 for the first
quarter of 2003. The decline was primarily the result of decreased interest
income on overnight investment of available operating cash.
The Company recorded net income of $74,727 for the first quarter of
2004 compared to a net loss of $359,486 for the first quarter of 2003. The
improvement in income (loss) was primarily the result of higher contract
manufacturing sales coupled with lower operating expenses resulting from the
shift in focus to contract manufacturing and the related cost reduction efforts.
No federal or state income taxes were provided for the first quarter of
2004, due to available tax credit and net operating loss carryforwards to the
current period. The provision for income tax benefits for the first quarter of
fiscal 2003 has been offset principally by a valuation allowance for deferred
taxes.
Inflation has not had a significant impact on the Company's operations
or cash flow.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased by $249,662 during the quarter
ended March 31, 2004 to $733,506 at quarter-end. The increase in cash and cash
equivalents during the first quarter of 2004 was due to cash provided by
operating activities of $283,869. Trade and other receivables decreased $103,612
during the first quarter of 2004 to $100,254 at March 31, 2004, primarily due to
lower branded consumer products sales. Inventories decreased by $315,611 during
the first quarter of 2004 to $777,858 at March 31, 2004, from $1,093,469 at
December 31, 2003, due primarily to the shipment of several lots of contract
manufacturing finished goods in January and February 2004 which were produced in
the fourth quarter of 2003. Accounts payable increased $41,247 during the first
quarter of 2004 to $377,996 at March 31, 2004, from $336,749 at December 31,
2003, primarily due to the timing of inventory purchases and raw material
receipts.
There was no capital spending for the first quarter of 2004 and there
were no material commitments for capital expenditures at March 31, 2004.
Investments in patents and intellectual property was $31,473 for the quarter
ended March 31, 2004. Cash used in financing activities totaled $2,734 for the
quarter ended March 31, 2004, due to the repayment of long-term capital lease
obligations.
The Company had a working capital deficit of $571,123 and a current
ratio of 0.76 at March 31, 2004 compared to a working capital deficit of
$779,988 and a current ratio of 0.72 at December 31, 2003. The improvement in
the working capital deficit and current ratio during the quarter ended March 31,
2004 is primarily due to first quarter 2004 shipments against product
prepayments received in 2003.
In May 2002, the Company and Novartis Consumer Health, Inc.
("Novartis"), the Company's largest customer, amended and restated its Supply
Agreements, incorporating a number of changes that included a vehicle for
prepayment against future orders. Since that time the Company has been receiving
advance payments on future production orders from Novartis. At March 31, 2004,
the amount owed to Novartis under product prepayment deposits was approximately
$1,070,000. In exchange for this product prepayment program, the Company agreed
to a conversion of a payable of $220,000 to a note payable, the execution of a
non-exclusive license agreement that would survive the Company in the event of
default on the Supply Agreements and the grant of a security interest in most of
the Company's assets. The Company has also been receiving advance product
payments from other customers. Maintaining adequate levels of working capital to
support the Company's manufacturing operations has been and will be dependent
upon the continuation of these advance product payments.
WIND DOWN OF MANUFACTURING OPERATIONS
In September 2003, the Company learned that, as a result of a change in
its internal supplier selection criteria, Novartis intends to stop using LecTec
as a contract manufacturer for its topical patches during 2004. In addition,
Johnson & Johnson Consumer Products Company, the Company's second largest
customer, has indicated that it also intends to stop using the Company as a
contract manufacturer in 2004.
I-11
Novartis and Johnson & Johnson accounted for approximately 55% and 16%
of the Company's net sales for the year ended December 31, 2003. Based on these
anticipated changes, the Board of Directors has determined that the Company will
cease manufacturing operations prior to the end of the third quarter of 2004.
The Company anticipates that it will enter into a licensing agreement with
Novartis and possibly other contract manufacturing customers to enable them to
use the Company's proprietary patch technology in producing topical patch
products in the future. However, there can be no assurance that the Company will
be successful in entering into these licensing agreements. The Company currently
believes that it will be able to wind down and exit its manufacturing operations
and facility lease obligations without defaulting on its contractual obligations
to any contract manufacturing customer. However, there can be no assurance that
the Company will be able to exit manufacturing or its facility lease without
defaulting on contractual obligations or other debts which become due and
payable.
It is management's intent to wind down its manufacturing operations,
sell off manufacturing assets, renegotiate its facility leases and fund
continuing operations with royalty income from licensing agreements or from
other income derived from protection of rights pertaining to the Company's
intellectual property. However, there can be no assurance that the Company will
be successful in the wind down of manufacturing operations, selling off the
manufacturing assets, renegotiating its manufacturing facility lease,
negotiation of license agreements, or in the protection of the Company's rights
related to intellectual property.
In connection with the pending cessation of manufacturing operations,
the Company has implemented employee reduction and retention programs to reduce
the number of employees needed to support the wind down of manufacturing
operations while retaining those employees who are critical to that process and
to managing the Company's ongoing licensing agreements and intellectual property
portfolio. The Company is exploring its alternatives with respect to the sale of
its manufacturing assets, the renegotiation or termination of its leases and
other contractual obligations, and other adjustments resulting directly from its
exit from manufacturing operations. In addition, the Company will be considering
other possible fundamental changes in future periods that could include, among
other things, a sale of its remaining assets or of the business as a whole.
The Company believes its existing cash and cash equivalents will not be
sufficient to fund operations through 2004. The Company currently does not have
any new or additional committed sources of capital or financing identified, and
there can be no assurance that additional funding will be available in a timely
manner, on acceptable terms, or at all. In addition, the Company may not be
successful in winding down its manufacturing operations without defaulting on
its existing contractual obligations, and may require additional funds for its
ongoing operations during the wind down period. If adequate funds are not
available, the Company may be forced to further scale-back, eliminate certain
aspects of or cease operations entirely in the near future, or attempt to obtain
funds through unfavorable arrangements with partners or others that may require
the Company to relinquish rights to certain technologies or potential markets or
which otherwise may be materially unfavorable to the Company. The survivability
of the Company is also dependant upon the Company continuing to receive cash
under the prepayment agreement it has with Novartis, its largest customer. All
these factors, among others, raise substantial doubt about the Company's ability
to continue as a going concern. The Company's continuation as a going concern is
dependent upon its ability to generate sufficient cash flow to meet its
obligations on a timely basis, to obtain additional financing as may be
required, and ultimately to attain successful operations.
ITEM 3 - CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
have evaluated the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934 (the "Exchange Act")). Based upon this
evaluation, the principal executive officer and principal financial officer have
concluded that, as of the end of the period covered by this report, our
disclosure controls and procedures were effective in timely alerting them to the
material information relating to the Company required to be included in the
reports we file or submit under the Exchange Act.
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During the quarter ended March 31, 2004, there were no changes in the
Company's internal controls over financial reporting (as defined in Rule
13a-15(f) under the Exchange Act) that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
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PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
None.
ITEM 2 - CHANGES IN SECURITIES AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY
SECURITIES
None.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5 - OTHER INFORMATION
None.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Item No. Item
- -------- -----------------------------------------------------------------------------------------
31.01 Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002, filed herewith.
31.02 Certification of Acting Chief Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002, filed herewith.
32.01 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.
99.01 Cautionary Statements (incorporated herein by reference to Exhibit 99.01 to the Company's
Report on Form 10-KSB for the fiscal year ended December 31, 2003).
(b) REPORTS ON FORM 8-K
No Reports on Form 8-K were filed during the quarter covered by
this Report.
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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LECTEC CORPORATION
Date May 12, 2004 By /s/ Timothy P. Fitzgerald
-------------------------
Timothy P. Fitzgerald
Chief Executive Officer & President
(principal financial officer)
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