UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006.
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT
FOR THE TRANSITION PERIOD FROM _______________ to ______________
Commission file number: 0-16159
LECTEC CORPORATION
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(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.)
5610 Lincoln Drive, Edina, Minnesota 55436
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(Address of principal executive offices) (Zip Code)
(952) 933-2291
--------------------------
(Issuer's telephone number)
Not Applicable
----------------------------------------------------
(Former name, former address and former fiscal year,
if changed since 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 past 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 registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).
Yes [ ] No [X]
The number of shares outstanding of the issuer's common stock as of November 14,
2006 was 4,148,998 shares.
Transitional Small Business Disclosure Format (Check one):
Yes [ ] No [X]
LECTEC CORPORATION
REPORT ON FORM 10-QSB FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006
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-8
Item 3. Controls and Procedures.................................................................... I-10
PART II - OTHER INFORMATION
Item 1. Legal Proceedings.......................................................................... II-1
Item 2. Unregistered Sales of Equity 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................................................................................... 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," "wants," "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 royalty payments from Novartis Consumer Health, Inc. ("Novartis"),
which is not currently selling the Company's licensed product, the Company's
dependence on key personnel, the success or failure of any attempt by the
Company to protect or enforce its patents, the issuance of new accounting
pronouncements, the availability of opportunities for licensing agreements
related to patents that the Company holds, limitations on market expansion
opportunities, and other risks and uncertainties as described in the "Cautionary
Statements" filed as Exhibit 99.01 to Form 10-KSB for the year ended December
31, 2005.
PART 1 - FINANCIAL INFORMATION
ITEM 1 - CONDENSED FINANCIAL STATEMENTS AND NOTES TO CONDENSED
FINANCIAL STATEMENTS
LECTEC CORPORATION
CONDENSED BALANCE SHEETS
September 30, December 31,
2006 2005
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(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,361,840 $ 1,310,578
Royalty receivable - 214,906
Prepaid expenses and other 75,200 66,735
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Total current assets 1,437,040 1,592,219
OTHER ASSETS:
Patent costs 71,306 90,651
Prepaid insurance - director and officer 111,536 141,955
------------ ------------
182,842 232,606
------------ ------------
$ 1,619,882 $ 1,824,825
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 11,382 $ 10,495
Accrued expenses 65,745 52,015
Discontinued operations 98,350 98,350
------------ ------------
Total current liabilities 175,477 160,860
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COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value; 15,000,000 shares
authorized; 4,148,998 shares issued and
outstanding at September 30, 2006
and December 31, 2005 41,490 41,490
Additional contributed capital 11,847,536 11,847,536
Accumulated deficit (10,444,621) (10,225,061)
------------ ------------
1,444,405 1,663,965
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$ 1,619,882 $ 1,824,825
============ ============
The accompanying notes are an integral part of these condensed financial
statements.
I-1
LECTEC CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
------------ ------------ ------------ -----------
CONTINUING OPERATIONS:
Revenue - royalty and licensing income $ 34,383 $ 68,717 $ 126,660 $ 189,195
Operating expenses 96,308 87,850 346,220 653,292
----------- ----------- ----------- -----------
Loss from continuing operations (61,925) (19,133) (219,560) (464,097)
----------- ----------- ----------- -----------
DISCONTINUED OPERATIONS:
Earnings (loss) from discontinued
operations - 19,512 - (206,090)
----------- ----------- ----------- -----------
Net earnings (loss) $ (61,925) $ 379 $ (219,560) $ (670,187)
=========== =========== =========== ===========
Weighted average common shares outstanding:
Basic and diluted 4,148,998 4,148,998 4,148,998 4,129,262
=========== =========== =========== ===========
Earnings (loss) per common share:
Basic and diluted:
Continuing operations $ (0.01) $ (0.00) $ (0.05) $ (0.11)
Discontinued operations 0.00 0.00 0.00 (0.05)
----------- ----------- ----------- -----------
Total $ (0.01) $ 0.00 $ (0.05) $ (0.16)
=========== =========== =========== ===========
The accompanying notes are an integral part of these condensed financial
statements.
I-2
LECTEC CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
2006 2005
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Revised (1)
Cash flows from operating activities:
Net loss $ (219,560) $ (670,187)
Discontinued operations, net of tax - 206,090
----------- -----------
Loss from continuing operations, net of tax (219,560) (464,097)
Adjustments to reconcile loss from continuing operations to net cash
provided by (used in) operating activities:
Compensation expense related to stock options - 17,500
Amortization 19,345 13,106
Changes in operating assets and liabilities of continuing operations:
Royalty receivable 214,906 (69,611)
Prepaid expenses and other 21,954 93,212
Accounts payable 887 48,031
Accrued expenses 13,730 (166,740)
----------- -----------
Net cash provided by (used in) operating activities from
continuing operations 51,262 (528,599)
----------- -----------
Cash flows from investing activities from continuing operations:
Investment in patents - (60,000)
----------- -----------
Cash flows from financing activities from continuing operations:
Payment of cash dividend - (246,824)
Proceeds from exercises of stock options - 6,447
Repayment of long-term obligations - (2,525)
----------- -----------
Net cash used in financing activities from
continuing operations - (242,902)
----------- -----------
Discontinued operations:
Used in operating activities - (206,211)
Provided by investing activities - 69,402
Provided by financing activities - 83,780
----------- -----------
Net cash used in discontinued operations - (53,029)
----------- -----------
Net increase (decrease) in cash and cash equivalents 51,262 (884,530)
Cash and cash equivalents - beginning of period 1,310,578 2,239,318
----------- -----------
Cash and cash equivalents - end of period $ 1,361,840 $ 1,354,788
=========== ===========
(1) The Company revised the statement of cash flows for the nine months ended
September 30, 2005 to present cash flows from discontinued operations for
each of the operating, investing and financing activities. Previously, the
components were not broken out separately.
The accompanying notes are an integral part of these condensed financial
statements.
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LECTEC CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
SEPTEMBER 30, 2006 AND 2005
(UNAUDITED)
(1) GENERAL
The accompanying condensed financial statements include the accounts of
LecTec Corporation (the "Company") as of September 30, 2006 and December 31,
2005 and for the three and nine month periods ended September 30, 2006 and 2005.
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, 2005. 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 full year.
(2) BUSINESS SUMMARY AND CRITICAL ACCOUNTING POLICIES
BUSINESS SUMMARY
The Company is an intellectual property licensing and holding company. The
Company receives royalties and licensing fees from licensing agreements
pertaining to the Company's patents. The Company has one licensing agreement
("Novartis Agreement" or "Agreement") with Novartis, which pays royalties to the
Company from time to time (usually quarterly), based upon a percentage of
Novartis net sales of licensed products. Previously, the Company was a contract
manufacturer of hydrogel topical patches which were sold to major pharmaceutical
customers until the Company ceased its manufacturing operations in December
2004. See the discussion under "Novartis Licensing and Supply Agreement" in Note
5.
In June 2006, Novartis issued a nationwide recall of all of its
Triaminic(R) vapor patch products. The Company opted not to record any royalty
income for the second quarter ended June 30, 2006 because of the uncertainty of
the recall on licensed products sold by Novartis. During the third quarter ended
September 30, 2006, the Company subsequently received royalty income related to
sales of licensed product by Novartis related to the second quarter of 2006. See
"Novartis Product Recall" (Note 6).
CRITICAL ACCOUNTING POLICIES
Some of the Company's most critical accounting policies include:
Revenue Recognition. Royalty and licensing income is recognized when
earned under the terms of the agreements with customers and collection is
reasonably assured.
Patent Costs. The carrying value of patent costs is reviewed periodically
or when factors indicating impairment are present. Any impairment loss is
measured as the amount by which the carrying value of the assets exceeds the
fair value of the assets. The Company believes no impairment existed at
September 30, 2006.
Royalty Receivable (Continuing Operations). The Company grants credit to
its only customer, Novartis, in the normal course of business and under the
terms contained in the Agreement. Pursuant to the Agreement, Novartis pays
royalty income within the terms defined in the Agreement. At September 30, 2006,
the Company did not have an outstanding royalty receivable with Novartis due to
a voluntary recall of licensed products of the Company by Novartis. The Company
believes it has earned and been paid all royalty income due to the Company up to
the point of the product recall.
Accounting for Discontinued Operations. The Company exited from
manufacturing operations of topical patches and sold off all of its
manufacturing assets related to the production of patches to its only remaining
customer, Novartis, as of December 31, 2004. The assets related to the Company's
manufacturing operations have been classified as discontinued operations due to
the sale of the manufacturing assets by December 31, 2004. The operations and
cash flows of the contract manufacturing operations have been eliminated from
the ongoing operations as a result of the sale transaction. The Company does not
have any significant involvement in the operations of the
I-4
previously sold manufacturing operations. It is therefore management's position
that the conditions for reporting the Company's balance sheets, statements of
operations, and cash flows under the requirements of Statement of Financial
Accounting Standard ("SFAS") No. 144 as discontinued operations are appropriate.
The Company used reasonable judgment combined with quantitative analysis
in determining the amounts of assets, liabilities, revenues, and expenses that
are allocated between continuing operations and discontinued operations.
Stock-Based Compensation. In January 2005, the Company extended the
exercise period for options held by two former executive officers of the Company
and one former employee by two years from the date of their respective
termination dates (but not longer than the normal expiration date of the
options, if earlier). There were 222,667 options with a weighted average
exercise price of $0.83 per share subject to this modification to the exercise
period. Normally these options would have expired 90 days from the employee's
termination date. Because of this modification to the exercise period of these
options for those former employees, the Company recorded a one-time compensation
expense of $99,957 during the first quarter ended March 31, 2005. The Company
does not have any back-dating issues relating to current outstanding stock
options.
Prior to January 1, 2006, the Company utilized 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
was reflected in the net earnings (loss) for the three and nine months ended
September 30, 2006 and 2005.
Had the Company applied the fair value recognition provisions of SFAS No.
123, "Accounting for Stock-Based Compensation," the net earnings (loss) and net
earnings (loss) per common share for the three and nine months ended September
30, 2005 would not be materially different.
In December 2004, the Financial Accounting Standards Board issued SFAS No.
123(R), "Share-Based Payment," which requires that compensation cost relating to
share-based payment transactions (including the cost of all employee stock
options) be recognized in the financial statements. That cost is measured based
on the estimated fair value of the equity or liability instruments issued. SFAS
No. 123(R) covers a wide range of share-based compensation arrangements
including share options, restricted share plans, performance-based awards, share
appreciation rights, and employee share purchase plans. SFAS No. 123(R) replaces
SFAS No. 123, "Accounting for Stock-Based Compensation," and supersedes
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees." The Company was required to apply SFAS No. 123(R) effective
January 1, 2006. Thus, the Company's financial statements reflect the cost for
(a) all share-based compensation arrangements granted after December 31, 2005
and for any such arrangements that are modified, cancelled, or repurchased after
that date, and (b) the portion of previous share-based awards for which the
requisite service had not been rendered as of that date, based on the grant date
estimated fair value.
All of the Company's options were fully vested as of December 31, 2005 and
there were no new grants, or modifications to existing grants, during the nine
months ended September 30, 2006. Therefore, the adoption of SFAS No, 123(R) had
no impact on the Company's financial statements.
(3) NET EARNINGS (LOSS) PER COMMON SHARE
Basic net earnings (loss) per common share are computed by dividing the
net earning (loss) by the weighted average number of common shares outstanding.
Diluted net earnings (loss) per common share is computed by dividing the net
earnings (loss) by the weighted average number of common shares outstanding and
common share equivalents related to stock options and warrants when dilutive.
Common stock options and warrants to purchase 396,250 and 429,583 shares
of common stock with a weighted average exercise price of $2.03 and $2.02 were
outstanding during the three and nine months ended September 30, 2006,
respectively. Common stock options and warrants to purchase 250,200 and 601,417
shares of common stock with a weighted average exercise price of $3.48 and $1.98
were outstanding during the three and nine months ended September 30, 2005,
respectively. Because the Company had a loss from continuing operations during
the three and nine months ended September 30, 2006 and the nine month period
ended September 30, 2005, those options and warrants were excluded from the net
income (loss) per share computations because they were antidilutive.
I-5
(4) INCOME TAXES
The provision for income taxes for the three and nine months ended
September 30, 2006 and 2005, was offset principally by a valuation allowance for
deferred taxes. No federal or state income tax benefit was provided for the
three and nine months ended September 30, 2006 and 2005, as the realization of
such benefits is not reasonably assured.
(5) NOVARTIS LICENSING AND SUPPLY AGREEMENT
On July 19, 2004, the Company entered into the Novartis Agreement,
effective as of January 1, 2004. The Agreement replaced the Company's prior
licensing and supply agreement with Novartis dated May 8, 2002. The Agreement
required the Company to manufacture, sell, and deliver to Novartis vapor patches
for sale to the pediatric market in the United States, Canada, and Mexico. In
order to provide the Company with working capital funds necessary to enable it
to manufacture and deliver vapor patches to Novartis in accordance with the
Agreement, Novartis advanced up to $2,000,000 for use by the Company to pay
current accounts payable and expenses incurred exclusively for the manufacture
and delivery of vapor patches. In consideration of any advanced funds, the
Company executed and delivered to Novartis a promissory note of $2,000,000 and a
security agreement. Under the security agreement, the Company pledged
substantially all of its assets. The note was repaid by the Company by the
delivery to Novartis of vapor patches under the Agreement. All amounts owed were
repaid as of December 31, 2004. Under the Agreement, Novartis had the option
until March 31, 2005, to extend the use of vapor patches to the adult cough/cold
category in the United States, Canada, and Mexico at no additional cost and
under the same terms and conditions as set forth in the Agreement. On March 31,
2005, Novartis notified the Company of its intention to enter the adult market
pursuant to the Agreement. However, there can be no assurance that Novartis is
obligated or will enter the adult market under the terms of the Agreement.
Under the Agreement, the Company granted Novartis an exclusive license
(the "License") to all of the intellectual property of the Company to the extent
that it is used or useful in the production of the vapor patches being supplied
under the Agreement for a fee of $1,065,000, which was paid to the Company by
Novartis as follows: (1) release of $250,000 in promissory note debt as of the
date of the Agreement, (2) payment of $407,500 in cash in July 2004, and (3)
payment of $407,500 in cash in September 2004. The License began on July 19,
2004, and will continue for the duration of any patents included in the licensed
intellectual property and, with respect to all other elements of the licensed
intellectual property, for the maximum duration permitted under applicable law
(14 years). Upon the expiration of the patents included in the licensed
intellectual property, Novartis will have a non-revocable, perpetual, fully
paid-up license to the intellectual property used or useful in the production of
vapor patches for the pediatric market and the adult cough/cold market.
Commencing on January 1, 2005, Novartis was required by the Agreement to pay
royalties, at an agreed upon percentage, to the Company, based upon the net
semi-annual or quarterly sales of vapor patches by Novartis for each year the
License is in effect.
The supply portion of the Agreement continued in effect until February 5,
2005, except that the provisions relating to the License will continue in effect
until the conclusion of the term of the License. The Company may not assign or
otherwise transfer the Agreement (other than to an affiliate) without the prior
written consent of Novartis, except that the Company may assign the Agreement in
connection with the transfer or sale of all or substantially all of its assets
or business or its merger or consolidation with another company, so long as (1)
such acquirer or successor in interest agrees in writing to be bound by all
conditions of the Agreement, and (2) the Company gives Novartis written notice
of any such assignment and 15 days to object. Novartis may object to an
assignment only if such acquirer or successor is a direct competitor of
Novartis.
(6) NOVARTIS PRODUCT RECALL
On June 21, 2006, the Company issued a press release noting that Novartis
had issued a nationwide recall of all of its Triaminic(R) Vapor Patch products.
Royalties received by the Company from Novartis based on sales of this patch
represented substantially all of the Company's revenues in fiscal year 2005 and
for the nine months ended September 30, 2006. As a result of this development,
unless and until Novartis reintroduces this patch product or the Company
develops another source of revenue, the Company will have no immediate source of
revenue.
I-6
In a press release issued by Novartis, Novartis explained that the recall
was "due to the serious adverse health effects that could result if the product
is ingested by the child removing the patch and chewing on it." At the same time
that Novartis announced this voluntary recall, the U. S. Food and Drug
Administration (FDA) issued a release warning consumers "not to use the
Triaminic Vapor Patch due to reports of serious adverse events associated with
accidental ingestion by children."
According to news reports, the recall was triggered by an adverse event
experienced by a child who suffered a seizure after chewing on a Triaminic Vapor
Patch. Novartis confirmed to the Company that the patch involved in this
incident was not manufactured by the Company. A representative of Novartis also
indicated that no decision had yet been made whether to reintroduce the product
in certain markets.
The Board of Directors and management of the Company are currently
assessing the Company's position and strategy in light of this development. The
Company has been proactive in assisting Novartis to resolve the FDA issues
surrounding the product recall and wants to assist in moving forward to revive
the Company's royalty income stream.
On November 9, 2006, the Company received an inquiry from Novartis
relating to product recall returns and asking about royalty overpayments. Based
upon the facts and circumstances of the product recall situation, and the terms
of the licensing agreement the Company has with Novartis, the Company does not
believe it has any financial obligation related to the product recall.
(7) DISCONTINUED OPERATIONS
There were no assets of discontinued operations at September 30, 2006 or
December 31, 2005. However, the Company has fully depreciated assets on hand
that may be sold from time to time. Liabilities of discontinued operations at
September 30, 2006 and December 31, 2005, consisted of a $98,350 reserve for
sales returns and credits related to previous sales to customers of products
that the Company produced before the Company ceased its manufacturing operations
in 2004. Included in the loss from discontinued operations for the three and
nine months ended September 30, 2005 was a gain of $2,050 and $69,402,
respectively, on the sale of fully depreciated property and equipment related to
discontinued operations.
I-7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
RESULTS OF OPERATIONS
In July 2004, management determined that the Company would wind down and
cease its contract manufacturing operations by December 31, 2004. Because of
this, the past and future financial results related to contract manufacturing
have been treated as discontinued operations for financial reporting purposes.
Continuing operations consist of operations related to the surviving
intellectual property licensing and holding company. The Company accounts for
its discontinued operations under the provisions of SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets." Accordingly, results of
operations and the related charges for discontinued operations have been
classified as "Earnings (loss) from discontinued operations" in the accompanying
Condensed Statements of Operations. Assets and liabilities of the discontinued
operations have been classified and reflected on the accompanying Balance Sheets
as "Discontinued operations."
COMPARISON OF THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
RESULTS OF CONTINUING OPERATIONS
The Company recorded royalty income of $34,383 and $126,660 during the
three and nine months ended September 30, 2006, respectively, compared to
royalty income of $68,717 and $189,195, respectively, for the comparable periods
in 2005, related to its licensing Agreement with Novartis. The decrease in
royalty income for the three and nine months ended September 30, 2006 from the
comparable periods of 2005 is attributable to Novartis' nationwide voluntary
recall of its Triaminic(R) Vapor Patch product during June 2006. The Company
chose not to record royalty income during the second quarter of 2006 due to the
uncertainty of the product recall but subsequently received payment during the
third quarter ended September 2006 of $34,383, which the Company believes is
royalty income earned up to the point of the product recall in June 2006 by
Novartis.
For the third quarter ended September 30, 2006, the Company recorded a net
loss from continuing operations of $(61,925), or $(0.01) per basic and diluted
share, compared to a net loss from continuing operations of $(19,133), or $ -
per basic and diluted share, for the same quarter in 2005. For the nine months
ended September 30, 2006, the Company recorded a net loss from continuing
operations of $(219,560), or $(0.05) per basic and diluted share, compared to a
net loss from continuing operations of $(464,097), or $(0.11) per basic and
diluted share, for the same period in 2005. The increase in net loss from
continuing operations for the three month period ended September 30, 2006 from
the comparable period in 2005 is due to the reduction in royalty income during
the third quarter of 2006 as a result of the Novartis product recall. The
decrease in net loss from continuing operations for the nine months ended
September 30, 2006 from the comparable period in 2005 is due primarily to
reductions in general operating expenses for 2006, coupled with a reduction in
royalty income primarily related to the Novartis product recall in June 2006.
RESULTS OF DISCONTINUED OPERATIONS
There were no earnings or losses from discontinued operations for the
three and nine month periods ended September 30, 2006. The earnings from
discontinued operations for the third quarter ended September 30, 2005 were
$19,512, or $ - per basic and diluted share, primarily related to sales of fully
depreciated assets. For the nine months ended September 30, 2005, the loss from
discontinued operations was $(206,090), or $(0.05) per basic and diluted share.
The loss from discontinued operations for the three and nine month periods ended
September 30, 2005, was attributable to the wind down of the Company's
manufacturing operations.
NET RESULTS OF OPERATIONS
The net loss for the third quarter ended September 30, 2006 was $(61,925),
or $(0.01) per basic and diluted share, compared to net income of $379, or $ -
per basic and diluted share for the same period in 2005. The decrease in net
income is primarily attributable to a reduction in net income related to the
Novartis product recall coupled with increases in patent related costs. For the
nine months ended September 30, 2006, the net loss was $(219,560), or $(0.05)
per basic and diluted share, compared to a net loss of $(670,187), or $(0.16)
per basic and diluted share for the same period in 2005. The improvement in net
loss for the nine month period ended September 30, 2006 from the same
I-8
period in the prior year is primarily due to the reasons stated above, coupled
with an overall reduction in general operating expenses.
INCOME TAXES
The provision for income tax benefits for the three and nine months ended
September 30, 2006 and 2005 was offset by a valuation allowance for deferred
taxes as the realization of such benefit is not reasonably assured.
EFFECT OF INFLATION
Inflation has not had a significant impact on the Company's operations or
cash flow.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents increased $51,262 during the first nine months
of 2006 to $1,361,840 at September 30, 2006 from $1,310,578 at December 31,
2005. The increase in cash and cash equivalents during the nine months ended
September 30, 2006 from the end of 2005, was due to cash generated from
continuing operations, primarily related to cash received under the Novartis
Agreement (royalty income), coupled with a general reduction in operating
expenses related to continuing operations.
During the first nine months of 2006, the Company collected $341,566 in
royalty income (cash) under the Novartis Agreement, compared to royalty income
collected of $119,584 during the comparable period of 2005. There were no
material commitments for capital expenditures at September 30, 2006.
The Company had working capital of $1,261,563 and a current ratio of 8.19
at September 30, 2006 compared to working capital of $1,431,359 and a current
ratio of 9.90 at December 31, 2005. The decrease in working capital of $169,796
during the nine months of 2006 was primarily due to the net loss of the Company
during the nine months ended September 30, 2006.
Shareholders' equity decreased $219,560 to $1,444,405 at September 30,
2006 from $1,663,965 at December 31, 2005, due to the net loss for nine months
ended September 30, 2006.
The Company believes its existing cash and cash equivalents will be
sufficient to fund continuing operations through 2006 and beyond. However, cash
and cash equivalents may not be sufficient to fund continuing operations in the
future depending upon how successful the Company is in negotiating future
licensing opportunities, incurrence of patent protection costs, revival of
royalty income stream, and success in entering other markets for which the
Company has patent coverage. The Company's working capital requirements are
dependent upon adequate levels of royalty and licensing income to fund
continuing operations. Royalty income is uncertain because it is subject to
factors that the Company cannot control. Such factors include, but are not
limited to, seasonality of the product, marketing efforts by Novartis, markets
Novartis enters the product into, product recalls and other factors which can
cause fluctuations in the amount of royalty income the Company earns and
collects. There can be no assurance because of these uncertainties that future
royalty income will be earned or sufficient to fund continuing operations. The
Company has been proactive in assisting Novartis to resolve the FDA issues
surrounding the product recall and wants to move forward to revive the Company's
royalty income stream. The Board of Directors of the Company is committed to
actions that serve the best interests of its shareholders. The royalty income of
$126,660 recorded during the nine months ended September 30, 2006 was based upon
information provided by Novartis. The Company believes that Novartis has paid
all royalty obligations up to the point of the product recall. There can be no
assurance current results will be indicative of results for the full year.
Furthermore, future royalties and licensing income the Company anticipates
earning is dependent on the success of the product in the marketplace by
Novartis and other firms or individuals with whom the Company may enter into
licensing agreements. Additionally, the Company does not presently have any
other financing resources in place from which it can borrow or obtain additional
working capital.
CRITICAL ACCOUNTING POLICIES
The Company has not adopted any new critical accounting policies, or
changed its existing policies. The critical accounting policies appear in Note 2
of Notes to Condensed Financial Statements in this Form 10-QSB.
I-9
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 has
concluded that, as of the end of the period covered by this report, our
disclosure controls and procedures were effective.
During the three months ended September 30, 2006, there were no changes in
the Company's internal control over financial reporting (as defined in Rule
13a-15(f) and 15d-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.
I-10
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
None.
ITEM 2 - UNREGISTERED SALES OF EQUITY 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
None.
ITEM 6 - EXHIBITS
Exhibit No. Description
- ---------- -------------------------------------------------------------------------------------------------------------
3.01 Articles of Incorporation of LecTec Corporation, as amended (Incorporated herein by reference to
the Company's Form S-1 Registration Statement (file number 33-9774C) filed on October 31, 1986
and amended on December 12, 1986).
3.02 Bylaws of LecTec Corporation (Incorporated herein by reference to the Company's Form S-1 Registration
Statement (file number 33-9774C) filed on October 31, 1986 and amended on December 12, 1986).
31.01 Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed
herewith.
31.02 Certification of Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, filed
herewith.
32.01 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, 2005).
II-1
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.
LECTEC CORPORATION
Date November 14, 2006 By /s/ Alan C. Hymes, M.D.
-------------------------------------------
Alan C. Hymes, M.D.
Chief Executive Officer, Chief Financial
Officer, and Director (principal executive and
financial officer and duly authorized officer)
II-2
EXHIBIT INDEX
Exhibit No. Description
- ----------- ------------------------------------------------------------------------------------------
3.01 Articles of Incorporation of LecTec Corporation, as amended (Incorporated herein by
reference to the Company's Form S-1 Registration Statement (file number 33-9774C)
filed on October 31, 1986 and amended on December 12, 1986).
3.02 Bylaws of LecTec Corporation (Incorporated herein by reference to the Company's Form
S-1 Registration Statement (file number 33-9774C) filed on October 31, 1986 and amended
on December 12, 1986).
31.01 Certification of Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002, filed herewith.
31.02 Certification of Principle Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002, filed herewith.
32.01 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, 2005).