SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 1996. [ ] 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 Identification No.) incorporation or organization) 10701 Red Circle Drive, Minnetonka, Minnesota 55343 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (612) 933-2291 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $0.01 per share. 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein; and will not be contained, to the best of the registrant's knowledge, in the definitive proxy statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. The aggregate market value of the voting stock held by non-affiliates of the registrant as of September 16, 1996 was $34,523,901. The number of shares outstanding of the registrant's common stock as of September 16, 1996 was 3,835,989 shares. Documents Incorporated by Reference 10-K Parts Where Incorporated ----------------------------------- ----------------------------- 1. Definitive Proxy Statement for Annual Meeting of Shareholders of the Registrant to be held November 18, 1996. Part III PART I Item 1. BUSINESS GENERAL LecTec Corporation (the "Company") designs, manufactures and markets diagnostic and monitoring ECG electrodes, conductive and non-conductive adhesive hydrogels, medical tapes, drug delivery patches and therapeutic products. The Company markets its products to original equipment manufacturers, medical products distributors, clinic and hospital purchasing groups, individual clinics and hospitals as well as electronic retailing and direct selling groups. All of the products manufactured by the Company are designed to be highly compatible with skin, the largest organ of the human body. The Company developed one of the first solid gel disposable ECG electrodes, which did not require the use of messy liquid, aqueous conductive gels in order to maintain contact with the skin. The Company has since continued to develop, manufacture and market electrodes, hydrogels, medical tapes, drug delivery systems, patches and therapeutic products. The Company holds domestic and foreign patents on various products. The Company, through its research and development efforts, is developing new systems for drug delivery patches, new conductive-adhesive hydrogel polymers, medical tapes and therapeutic drugs, and refining existing technologies for new markets. The Company was organized in 1977 as a Minnesota corporation. Its principal executive office is located at 10701 Red Circle Drive, Minnetonka, Minnesota 55343, and its telephone number is (612) 933-2291. PRODUCTS The Company applies its patented conductive and non-conductive adhesive hydrogels technology to cardiac diagnostic and cardiac monitoring electrodes. The Company's patented natural and synthetic-based polymers are self-adhesive and can be made electrically conductive. Using natural-based polymers, the Company developed one of the first solid gel disposable ECG electrodes. All of the Company's electrodes are electrically and chemically stable. All of the Company's "skin-like" hydrogels are chemically compatible with human skin, thereby reducing or eliminating causative agents of skin irritation and reducing both damage to the skin and the risk of infection. The electrical and adhesive properties and the dimensions of the Company's products are highly consistent and reproducible from product to product because the conductive polymer is in a solid form, unlike some of the conductive gels used on competitive products. As a result of its proprietary technology the Company does not use toxic solvents in the manufacturing of its products. Solvents can cause dehydration of the skin, thereby causing damage to the skin as well as pain and discomfort to the patient. In addition, the use of this proprietary technology enables the Company to avoid certain environmental concerns associated with the use of harmful solvents in the manufacturing process. Conductive Products The Company's conductive products include diagnostic electrodes, monitoring electrodes, and electrically conductive and non-conductive adhesive hydrogels. The Company's "Tracets"(R) diagnostic electrodes are snapless, disposable electrodes designed to replace reusable suction cups (Welsh bulbs) and conductive gels applied during routine electrocardiographs. Because Tracets electrodes are disposable, they pose less risk of cross infection than reusable suction cups. The solid gel and snapless design of the Tracets electrodes provide more consistent electrical performance and offer shorter procedure and clean-up time than Welsh bulbs. Currently the Company has three different types of Tracets diagnostic electrodes: T1000 Plus, a snapless disposable tab electrode made of natural polymer solid gel with gentle adhesion; MP 3000, a synthetic solid gel electrode with aggressive adhesion which meets all AAMI standards including defibrillation recovery; and AG 4000, a synthetic solid gel, silver substrate electrode which meets all AAMI standards including defibrillation recovery. The Company's SynCor(R) monitoring electrodes are used for heart monitoring applications. These applications include surgical patients and hospitalized patients attached to bedside cardiac monitors. The SynCor product line consists of a specialized short term surgical electrode and a neo-natal product. The Company's short-term and neo-natal electrodes adhere without the use of tape. The Company introduced a new monitoring snap-type electrode in 1995, VitaTrace(TM) VT-10, composed of a synthetic solid state gel that meets all AAMI standards for adult use in bedside cardiac monitoring. The Company manufactures synthetic and naturally-based hydrogels. The Company pioneered hydrogel technology and developed alternatives to competitors' hydrogels that are resistant to dehydration and evaporation problems and changes in their electrical and physical properties. The Company regulates the adhesive qualities of its hydrogels so that they can be used for attaching devices to the body. The hydrogels can be developed to deliver specific medications to the skin for topical use, or into or through the skin for localized or systemic application. Also, the hydrogels can be manufactured to have various levels of conductivity, with or without self-adhesive properties, for diagnostic and monitoring electrodes, electrosurgical grounding pads, external pacing and defibrillation electrodes, ultra-sonic gel pads, TENS products and iontophoretic return electrodes. Sales of conductive products accounted for approximately 61%, 52% and 58% of the Company's sales during its fiscal years ended June 30, 1996, 1995 and 1994. Medical Tape Products The Company manufactures and markets medical tape products of various types and configurations for the world market. The Company's medical tape business includes the U.S. healthcare market (hospitals and alternate care), the U.S. consumer market and the international healthcare market. Medical tape products manufactured and marketed by the Company are configured in both self-wound finished rolls and semi-finished master rolls. The Company's medical tape product line is comprised of the standard paper, plastic and cloth products widely used in the medical industry. The Company's trademarked products include "Superpore(R)" Porous Paper Tape, "Isosilk(TM)" Cloth Tape and "Isoclear(TM)" Transparent Tape. All of the Company's tapes are hypoallergenic and utilize solvent-free adhesives. The Company offers private label and converter alliance (selling of semi-finished goods to a manufacturer who then converts the goods into a finished product) programs. These programs offer customers quality products to compete successfully against established brand names. Private labeling tape products allows major medical marketers to penetrate markets offering significant volume potential with their own custom brand of medical tapes. The Converter Alliance Program increases profitability and marketing opportunities for the Company's partners abroad. This program involves exporting semi-finished master rolls of medical tape to partners who convert the material into finished product, package the product and market it in a specific country. When product labeling and packaging is completed in the country where the product is sold, language and cultural barriers are reduced and packaging costs are often significantly lowered. Manufacturing partners benefit from using quality raw materials, market-oriented packaging, local labor content, established distribution channels, and connections with local Ministries of Health and other healthcare decision makers. Sales of medical tapes accounted for approximately 24%, 26% and 36% of the Company's sales in its fiscal years ended June 30, 1996, 1995 and 1994. Therapeutic Products The Company manufactures and markets drug delivery patches. The hydrogel-based patch products use a monolithic system that delivers drugs topically onto the skin. Products currently manufactured using the adhesive-based patch technology are wart removers, analgesic patches for localized pain relief and a corn and callus remover. These products are marketed as OTC (over-ther-counter) products. The Company, through its subsidiary, Pharmadyne Corporation (formerly Natus Corporation), markets the analgesic pain patches manufactured by the Company through a variety of distribution channels. Effective April 1, 1994, the Company consolidated Pharmadyne and its results of operations. Sales of therapeutic products accounted for approximately 15%, 22% and 6% of the Company's sales in each of the fiscal years ended June 30, 1996, 1995 and 1994. CUSTOMERS Burdick Corporation, ("Burdick") accounted for 17.0%, 14.6% and 17.4% of the Company's total sales during fiscal years 1996, 1995 and 1994, respectively. The Company sold its products to approximately 150 active customers during the fiscal years 1996 and 1995, down from approximately 240 active customers during fiscal year 1994. The decrease in active customers was the result of a marketing strategy to consolidate low volume customers with higher volume dealers and distributors in an effort to reduce total costs associated with order processing and shipping. The Company's backlog orders (purchase orders received from customers for future shipment) as of August 12, 1996 totaled approximately $1,318,500 (all of which the Company expects to fill), compared with approximately $2,184,800 and $1,807,900 on August 12, 1995 and 1994. The decrease in backlog at August 12, 1996 was primarily the result of a change in customer ordering patterns from placing standing purchase orders for multiple periods to placing individual purchase orders as needed. GOVERNMENTAL REGULATION Clinical testing, manufacturing, packaging, labeling and distribution of the Company's products are subject to FDA (Food and Drug Administration) regulation. Comparable agencies in some states and certain foreign countries also regulate the Company's activities. The Company's electrodes under current FDA policy are marketed pursuant to Section 510(k) notifications, which are simplified means of obtaining FDA approval to market a medical device. The Company's topical drug products are marketed under OTC monographs. The Company's `new drug' and transdermal `new drug' developments, may be marketed only after approval of a New Drug Application (NDA) containing full reports of extensive laboratory and clinical investigations on animals and humans. The Company does not use toxic solvents in the manufacturing of its products and thus environmental concerns are reduced for the Company's manufacturing processes as compared with its competitors. The Company does not anticipate any major expenditures for environmental controls during the next year. COMPETITION The markets for electrodes, hydrogels, tapes, drug delivery patches and therapeutic products are highly competitive. Firms in the medical supply industry compete on the basis of product performance, pricing, distribution and service. Many of the Company's major competitors, including Minnesota Mining and Manufacturing Company (3M), have significantly greater financial, marketing and technological resources than the Company. Competitors of the Company most often rely on pricing, distribution or brand-name recognition to obtain sales. The Company believes that it competes successfully on the basis of product performance, cost savings in the use of patented technology and its ability to manufacture private label products for distributors and OEMs (Original Equipment Manufacturers). Over the past several years there has been a number of mergers within the electrode and hydrogel industries, resulting in fewer but larger competitors. The Company believes its proprietary technology and manufacturing capabilities position it competitively in this market. In recent years the Company has noted a reduction in the number of manufacturers of medical tapes. The Company believes this is due, in part, to the competitors' inability to satisfy increasingly stringent environmental requirements and market price pressures. This provides the Company an opportunity to increase its market share. The Company believes that it is one of the first medical tape companies manufacturing medical tapes without the use of harmful solvent-based adhesives or processing aids. Schering-Plough (Dr. Scholl's) is the major competitor of two of the Company's therapeutic products, an OTC corn and callous remover and an OTC wart remover. Dr. Scholl's holds in excess of 85% market share for both products. The Company's OTC analgesic patch competes with ointments, lotions and creams manufactured by various competitors. PATENTS AND TRADEMARKS The Company has U.S. and foreign patents on adhesive membranes, electrode designs, transdermal and dermal delivery systems and tape structures. In the last year the Company was allowed four new U.S. patents. The first covered cotinine's utility in aiding smoke cessation and the second covered cotinine for weight management purposes. The third patent allowance covered a new non-occlusive adhesive patch for applying medication. The fourth covered a solid multi-purpose ultrasonic biomedical gel for diagnostic use. Eighteen U.S. and foreign patent applications are pending; additionally the Company has exclusive license for eight other patents. The patents most pertinent to the Company's major products have been issued and have a remaining duration in excess of eight years. The Company expects that its products will be subject to continual modifications due to improvements in materials and rapid technological advances in the market for medical devices. Therefore, the Company's continued success does not depend only upon ownership of patents, but also upon technical expertise, creative skills and the ability to forge these talents into the timely release of new products into the marketplace. The Company uses its best efforts to protect its proprietary property and information. In addition, the Company monitors competitive products and patent publications to be aware of potential infringement of its rights. The Company has registered the following trademarks in the United States Patent and Trademark Office: LecPads, SPARE, Tracets, Superpore, Tree-Skin, ResTest II, VitaTrace, SME, LecTec and SynCor. The Company has filed for the registration of the tradenames UltraEase and Isoclear. The Company uses, but has not registered, the following tradenames: LecTrode, Isosilk, Isotex, Isopore, SME-5000, infiniti, Exten 238, DermaPhyl and "The Best ... Next to Skin.". The Company's subsidiary, Pharmadyne Corporation, has registered the following tradenames in the United States Patent and Trademark Office: TheraPatch, Thermal Patch, HydroGesic Patch and ThermoGesic Patch. RESEARCH AND DEVELOPMENT The Company's research and development staff consists of professionals drawn from the business and academic communities with experience in the biological, chemical, pharmaceutical and engineering sciences. The research and development staff is responsible for the investigation, development and implementation of new technologies. The Company may develop products jointly with corporations and/or with inventors from the academic world via research and development contracts or other forms of working alliances. Resulting products may then be marketed by the Company, by sponsoring partners or through a marketing arrangement with an appropriate distributor. R&D contract opportunities are evaluated on an individual basis. Pilot clinical studies performed in previous years demonstrated encouraging results for our cotinine drug product used in smoking cessation for which the Company has exclusive license. The Addiction Research Center of the National Institute of Health (NIH) completed a study to determine if cotinine is addictive. The data was presented in June, 1996 at the CPDD (College on Problems of Drug Dependence) National Meeting. This data lends support to the notion that cotinine is behaviorally active and could mediate certain of the behavorial effects attributed to nicotine dependence. Minimal abuse potential (addiction potential) was detected. The encouraging clinical data gathered to date and the Company's positive patent developments have propelled this project out of the research phase and into the development phase which begins with a corporate sponsored IND (Investigational New Drug) application. Work on this submission continued throughout fiscal 1996 and the Company expects to file the IND in October 1996. Research and development efforts are underway to complete the development of a new polymer-based reusable hydrogel. A 510(k) was awarded for the new UltraEase ultrasonic hydrogel couplant pad product. The Company has developed a new proprietary coating process for the manufacture of porous medical tape products. The recently acquired and developed pressure sensitive adhesive coating and slitting production equipment, for the manufacturing of medical tapes employs two patent pending processes. Each of these two patent pending processes are used to manufacture LecTec's medical tape products. R&D resources are also being used to fund development of new analgesic pain patch products, conductive products and specialized medical tapes. In the fiscal years ended June 30, 1996, 1995 and 1994, the Company spent, approximately, $1,975,000, $1,877,000 and $1,380,000, respectively, on research and development. MARKETING AND MARKETING STRATEGY The Company markets and sells its products to original equipment manufacturers (OEM), medical product distributors, clinic and hospital purchasing groups, individual clinics and hospitals as well as electronic retailing and direct selling groups. The Company has focused on OEM accounts to build strategic partnerships with medical equipment and disposable supply manufacturers. Additionally, joint venture and marketing contracts are used to promote the Company's growth in therapeutic markets. The Company has not experienced any significant seasonality in sales of its products. The Company sells its products in the U.S., Canada, Europe, Asia, and portions of Latin America. Export sales totaled $2,425,904 (19% of total sales) in the fiscal year ended June 30, 1996, $2,603,349 (18% of total sales) in the fiscal year ended June 30, 1995 and $2,349,007 (22% of total sales) in the fiscal year ended June 30, 1994. The Company intends to continue to market its products internationally and expects international sales to remain approximately the same as a percent of total sales. The Company's international sales are made by the Company's corporate sales force and the Company does not maintain a separate international marketing staff or operations. The following table sets forth export sales by geographic area (See Note J to the Financial Statements): Export Sales Years ended June 30 ----------------------------------------- 1996 1995 1994 ---- ---- ---- Canada $ 80,746 $ 113,597 $ 122,208 Europe 1,652,941 1,171,910 943,250 Asia 466,777 1,122,179 1,114,928 Latin America 225,440 195,663 168,621 ------------ ----------- ----------- Total Export Sales $2,425,904 $ 2,603,349 $ 2,349,007 ============ =========== =========== MANUFACTURING The Company manufactures its conductive and therapeutic membranes at the Company's Minnetonka, Minnesota facility. The Minnetonka facility also manufactures and packages the Company's therapeutic products and conducts raw material processing operations. The Company's second manufacturing facility in Edina, Minnesota is the primary site for the manufacturing and packaging of medical tape and medical electrodes. The Edina location also provides the majority of the Company's warehouse capacity. The Company believes that the raw materials used in manufacturing its products are generally available from multiple suppliers. EMPLOYEES As of June 30, 1996, the Company employed 76 full-time employees. None of the Company's employees are represented by any labor unions or other collective bargaining units. The Company believes its relations with its employees are good. ACQUISITION OF PHARMADYNE CORPORATION (Formerly Natus Corporation) During 1993, the Company invested $175,000 in Pharmadyne Corporation, which represented a 19.5% ownership interest in Pharmadyne. This investment was recorded at cost. In addition to this equity investment, the Company made cash advances to Pharmadyne during fiscal 1993 and 1994. On April 1, 1994, the Company exercised an option to purchase 182,822 shares of Pharmadyne common stock at $1 per share increasing the ownership in Pharmadyne to 51%. This acquisition was accounted for as a stock purchase. The acquired goodwill of approximately $590,000 is being amortized on a straight-line basis over three years. Effective April 1, 1994, the Company consolidated Pharmadyne in its results of operations. During 1996 the Company made additional advances to Pharmadyne and received a warrant to purchase 227,959 additional shares of Pharmadyne at $1 per share. On September 5, 1996, the Company exercised the warrant and increased its ownership interest in Pharmadyne to 61%. DISPOSITION OF DIRECT MARKETING RELATED ASSETS On March 12, 1996, the Company contributed the direct marketing related assets of Pharmadyne to Natus L.L.C. (an Arizona limited liability company) in exchange for a 15% interest in Natus L.L.C. The direct marketing related assets contributed consisted of the following: Accounts receivable $ 32,791 Inventory 384,730 Prepaid expenses and other 135,708 Property and equipment, net 79,938 Other (27,000) -------- $606,167 ======== Item 2. PROPERTIES The Company owns a building located in Minnetonka, Minnesota, containing 18,000 square feet of office and laboratory space and 12,000 square feet of manufacturing and warehouse space. In addition, the Company leases a building in Edina, Minnesota containing 29,000 square feet. Item.3. LEGAL PROCEEDINGS None Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II Item 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS The Company has been listed on the NASDAQ since December 17, 1986 and on the National Market System since June 7, 1988 under the trading symbol LECT. The following table sets forth for the periods indicated the high and low prices of the Company's Common Stock. The figures reflect the high and low bid prices on the NASDAQ National Market System. Such prices reflect interdealer prices, without retail mark-up, mark-down, or commission, and may not necessarily represent actual transactions. Years ended June 30, 1996 1995 ----- ---- High Low High Low ---- --- ---- --- First Quarter $12.250 $8.500 $10.500 $7.000 Second Quarter 12.500 8.750 10.000 6.750 Third Quarter 12.000 9.875 11.000 7.250 Fourth Quarter 15.375 9.875 14.250 10.750 As of September 16, 1996 the Company had 3,835,989 shares of Common Stock outstanding and 399 shareholders of record. The Company has not declared or paid cash dividends on its Common Stock since its inception, and intends to retain all earnings for use in its business for the foreseeable future. Item 6. SELECTED CONSOLIDATED FINANCIAL DATA STATEMENT OF OPERATIONS DATA
Years ended June 30, 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- Net sales $13,100,754 $14,138,290 $10,715,490 $9,224,005 $8,101,954 Gross profit 4,969,659 5,697,562 4,041,853 3,434,128 3,290,005 Operating profit (loss) (724,074) 69,761 837,161 750,335 1,153,802 Earnings (loss) before equity in losses of unconsolidated subsidiary (632,193) 153,863 768,974 745,282 964,026 Equity in losses of unconsolidated subsidiary --- --- (133,639) (163,442) --- Net earnings (loss) (632,193) 153,863 635,335 581,840 964,026 Net earnings (loss) per share (.17) .04 .17 .15 .26 BALANCE SHEET DATA At June 30, 1996 1995 1994 1993 1992 ---- ---- ---- ---- ---- Cash, cash equivalents and short-term investments $ 800,693 $ 839,942 $ 2,182,570 $ 3,469,632 $2,736,361 Current assets 5,449,682 5,764,363 6,124,640 6,082,934 5,480,921 Working capital 4,240,024 4,490,796 4,737,567 5,471,894 5,013,766 Property, plant and equipment, net 5,112,975 5,559,807 4,705,602 3,016,761 2,961,711 Long-term investments 574,806 568,156 585,855 3,016,761 1,143,605 Total assets 12,319,003 12,646,745 12,363,075 10,876,068 9,885,809 Long-term obligations 174,000 167,000 139,000 64,000 --- Shareholders' equity 10,935,345 11,206,178 10,837,002 10,201,028 9,418,654
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Earnings Summary The Company reported a net loss of $632,000 or $.17 per share in fiscal 1996, a decrease from net earnings of $154,000 or $.04 per share in 1995 and down from net earnings of $635,000 or $.17 per share in 1994. The largest component of the net loss for 1996 was the losses associated with the direct marketing related operations of the Company's former Natus Corporation subsidiary. The 1996 net loss was also affected by increased R&D expenditures and decreased medical tape and therapeutic product sales which more than offset increased conductive product sales. Results Of Operations Sales Sales totaled $13,101,000 in fiscal 1996, a decrease of 7% from $14,138,000 in 1995 and up from $10,715,000 in 1994. The reduction in sales in 1996 was primarily attributable to decreased therapeutic product sales resulting from the disposition of the direct marketing related assets of the Pharmadyne subsidiary as well as decreased medical tape sales which more than offset increased conductive product sales. The increase in sales from 1994 to 1995 was primarily attributable to increases in volume of all products sold. Sales of conductive products (medical electrodes and conductive hydrogels) grew by 8% in fiscal 1996 to $7,940,000 from $7,334,000 in fiscal 1995. Conductive product sales were $6,015,000 in fiscal 1994. These increases were primarily attributable to unit volume increases. Sales of medical tapes decreased by 14% in fiscal 1996 to $3,180,000 from $3,688,000 in fiscal 1995. Medical tape sales were $3,790,000 in fiscal 1994. The 1996 decrease was primarily attributable to reduced volume to a major international customer as compared to the prior year which more than offset the increased sales volume associated with new product offerings. The 1995 decrease was primarily attributable to a temporary slowdown in the purchasing volume of domestic self-wound finished roll medical tape customers in anticipation of new product offerings introduced during fiscal 1996. Sales of therapeutic products decreased 36% in fiscal 1996 to $1,981,000 from $3,116,000 in fiscal 1995. Therapeutic product sales were $880,000 in fiscal 1994. The decrease in 1996 was primarily attributable to the decrease in the third quarter and the absence in the fourth quarter of the Pharmadyne Corporation (formerly Natus Corporation) direct marketing related sales due to the divestiture of the direct marketing related assets. The increase in 1995 was primarily attributable to increased sales of the over-the-counter analgesic patch products and the full year inclusion of Pharmadyne Corporation therapeutic product sales. Management believes the anticipated growth of the analgesic pain patch program will account for an increased proportion of the Company's sales mix during fiscal 1997. International sales, consisting primarily of semi-finished conductive and medical tape products sold to overseas converters for final processing, packaging and marketing, were 19% of total sales in fiscal 1996, 18% in 1995 and 22% in 1994. The Company intends to continue to market its products internationally and expects international sales to remain approximately the same as a percent of total sales. Gross Profit The Company's gross profit totaled $4,970,000 in fiscal 1996, down from $5,698,000 in 1995. Gross profit was $4,042,000 in 1994. As a percentage of sales, gross profit was 37.9% in fiscal 1996, 40.3% in 1995 and 37.7% in 1994. In 1996, the decrease in the gross profit percent was primarily attributable to decreased sales of higher margin therapeutic products and increased overhead costs. In 1995, the increased gross profit percent was primarily attributable to increased sales of higher-margin therapeutic products. The 1994 gross profit was affected by relatively high sales of lower-margin medical tape products. Selling, General and Administrative Expenses Selling, general and administrative expenses totaled $3,718,000 or 28.4% of sales in fiscal 1996, compared to $3,751,000 or 26.5% in 1995, and $1,825,000 or 17.0% in 1994. The 1996 decrease in expense was primarily the result of the absence of costs in the fourth quarter from the Pharmadyne Corporation direct marketing related operations which was partially offset by increases in other selling, general and administrative expenses. The 1995 increase was due primarily to the full year impact of the consolidation of Pharmadyne with the Company for fiscal 1995; the higher selling costs associated with the Pharmadyne direct selling organization; and the inclusion of goodwill amortization related to the acquisition of Pharmadyne. Research and Product Development Expenses (R&D) Research and product development expenses totaled $1,975,000 or 15.1% of sales in fiscal 1996, compared to $1,877,000 or 13.3% in 1995, and $1,380,000 or 12.9% in 1994. The high levels of R&D expenditures over this three-year period reflect the utilization of internally-generated funds to develop therapeutic products. Substantially all of the dollar increase in R&D during fiscal 1996 was associated with the clinical studies for the non-nicotine smoking cessation product. R&D resources are also being used to fund development of new analgesic pain patch products, conductive products and specialized medical tapes. Management believes that R&D expenditures, as a percentage of net sales, will remain in the range of 10% to 15% for the immediate future. Other Income (Expense) Other income totaled $54,000 in fiscal 1996, down from $73,000 in 1995 and $109,000 in 1994. In 1996 the decline resulted primarily from a reduction of interest income due to the prior year liquidation of short-term investments. In 1995 the decline resulted from the liquidation of short-term investments to finance research and product development efforts, the acquisition of a new therapeutic products production line plus increases in receivables and inventory necessary to support the growing business. Income Tax Expense The Company had income tax benefits of $38,000 in fiscal 1996 and $11,000 in 1995, compared to income tax expense of $177,000 in 1994. The tax benefit in 1996 resulted from losses incurred in the current year reduced by the effect of the subsidiary losses which cannot be utilized by the Company at this time and the effect of goodwill amortization. The tax benefit in 1995 was primarily attributable to R&D tax credits and alternative minimum tax credits. Equity in Losses of Unconsolidated Subsidiary On April 1, 1994, the Company acquired an additional 31.5% interest in Pharmadyne Corporation (formerly known as Natus Corporation) and began consolidating Pharmadyne's results of operations on that date. During the first nine months of fiscal 1994, the Company's pro-rata share of Pharmadyne's net loss (based on a 19.5% equity ownership position through March 31, 1994), together with goodwill amortization during the first nine months of the fiscal year, totaled $134,000. Effect of Inflation Inflation has not had a significant impact on the Company as it has generally been able to adjust its selling prices as the costs of materials and other expenses have changed Liquidity and Capital Resources Cash and cash equivalents decreased by $39,000 to $801,000 at June 30, 1996. Long-term investments increased by $7,000 to $575,000 at June 30, 1996. Capital spending for various equipment totaled $431,000 in 1996. There were no material commitments for capital expenditures at June 30, 1996. Working capital totaled $4,240,000 at June 30, 1996, compared to $4,491,000 at the end of fiscal 1995. The Company's current ratio stood at 4.5 at the end of both fiscal 1996 and 1995. Net property, plant and equipment decreased by $447,000 to $5,113,000 at June 30, 1996, reflecting the excess of depreciation expense over additions. Of this decrease, $80,000 was related to the disposition of the direct marketing related assets of Pharmadyne Corporation. The Company is free of long-term debt, and has a $1,000,000 annually renewable revolving line of credit for meeting current operating requirements. There were no outstanding amounts on this short-term facility at the end of fiscal 1996. Shareholders' equity decreased by $271,000 to $10,935,000 at June 30, 1996. Management believes that internally-generated cash and the existing short-term credit line will be sufficient for supporting anticipated growth and capital spending requirements in fiscal 1997. Statements about the fiscal 1997 outlook are forward-looking and, therefore, involve certain risks and uncertainties, including but not limited to: buying patterns of customers, competitive forces and other factors detailed from time to time in filings with the Securities and Exchange Commission. Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA LecTec Corporation and Subsidiaries Financial Statements Furnished Pursuant to the Requirements of Form 10-K REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Shareholders and Board of Directors LecTec Corporation We have audited the accompanying consolidated balance sheets of LecTec Corporation and subsidiaries as of June 30, 1996 and 1995, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended June 30, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of LecTec Corporation and subsidiaries as of June 30, 1996 and 1995, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended June 30, 1996, in conformity with generally accepted accounting principles. Grant Thornton LLP Minneapolis, Minnesota August 26, 1996
LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS JUNE 30, ASSETS 1996 1995 ---- ---- CURRENT ASSETS Cash and cash equivalents (note A) $ 800,693 $ 839,942 Receivables Trade, net of allowances of $74,208 in 1996 and $90,401 in 1995 1,847,736 1,955,584 Refundable income taxes 55,580 119,540 Other 182,247 268,247 ----------- ----------- 2,085,563 2,343,371 Inventories (note A) 2,011,327 2,097,254 Prepaid expenses and other 123,099 229,796 Deferred income taxes (note E) 429,000 254,000 ----------- ----------- Total current assets 5,449,682 5,764,363 PROPERTY, PLANT AND EQUIPMENT -- AT COST (note A) Building and improvements 1,629,630 1,603,447 Equipment 6,414,132 5,517,101 Furniture and fixtures 354,985 422,265 ----------- ----------- 8,398,747 7,542,813 Less accumulated depreciation 3,533,503 2,813,760 ----------- ----------- 4,865,244 4,729,053 Construction in progress -- 583,023 Land 247,731 247,731 ----------- ----------- 5,112,975 5,559,807 OTHER ASSETS Patents and trademarks, less accumulated amortization of $687,871 in 1996 and $554,286 in 1995 (note A) 417,681 386,470 Goodwill, less accumulated amortization of $442,503 in 1996 and $245,835 in 1995 (notes A and H) 147,497 344,165 Long-term investments (note B) 574,806 568,156 Investment in limited liability company (note I) 606,167 -- Other 10,195 23,784 ----------- ----------- 1,756,346 1,322,575 ----------- ----------- $12,319,003 $12,646,745 =========== =========== The accompanying notes are an integral part of these statements.
LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - CONTINUED JUNE 30, LIABILITIES AND SHAREHOLDERS' EQUITY 1996 1995 ---- ---- CURRENT LIABILITIES Accounts payable $ 894,846 $ 771,471 Accrued expenses Payroll related 304,527 375,282 Distributor bonuses -- 71,384 Other 10,285 55,430 ------------ ------------ Total current liabilities 1,209,658 1,273,567 DEFERRED INCOME TAXES (note E) 174,000 167,000 COMMITMENTS AND CONTINGENCIES (notes D, F and G) -- -- SHAREHOLDERS' EQUITY (note G) Common stock, $.01 par value; 15,000,000 shares authorized; issued and outstanding: 3,835,800 shares in 1996 and 3,786,500 shares in 1995 38,358 37,865 Additional paid-in capital 10,368,166 10,013,949 Unrealized losses on securities available-for- sale (note B) (44,166) (50,816) Retained earnings 572,987 1,205,180 ------------ ------------ 10,935,345 11,206,178 ------------ ------------ $ 12,319,003 $ 12,646,745 ============ ============ The accompanying notes are an integral part of these statements.
LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED JUNE 30, 1996 1995 1994 ---- ---- ---- Net sales (notes A and J) $ 13,100,754 $ 14,138,290 $ 10,715,490 Cost of goods sold 8,131,095 8,440,728 6,673,637 ------------ ------------ ------------ Gross profit 4,969,659 5,697,562 4,041,853 Operating expenses Selling, general and administrative 3,718,496 3,751,194 1,825,121 Research and development 1,975,237 1,876,607 1,379,571 ------------ ------------ ------------ 5,693,733 5,627,801 3,204,692 ------------ ------------ ------------ Earnings (loss) from operations (724,074) 69,761 837,161 Other income (expense) Interest income 26,554 35,846 89,498 Dividend income 38,029 38,487 60,433 Other (10,702) (1,231) (41,118) ------------ ------------ ------------ 53,881 73,102 108,813 ------------ ------------ ------------ Earnings (loss) before income taxes and equity in losses of unconsolidated subsidiary (670,193) 142,863 945,974 Income tax expense (benefit) (note E) (38,000) (11,000) 177,000 ------------ ------------ ------------ Earnings (loss) before equity in losses of unconsolidated subsidiary (632,193) 153,863 768,974 Equity in losses of unconsolidated subsidiary (note H) -- -- (133,639) ------------ ------------ ------------ Net earnings (loss) $ (632,193) $ 153,863 $ 635,335 ============ ============ ============ Net earnings (loss) per common and common equivalent share (note A) $ (.17) $ .04 $ .17 ============ ============ ============ Weighted average number of common and common equivalent shares outstanding during the year 3,801,155 3,826,905 3,803,439 ============ ============ ============ The accompanying notes are an integral part of these statements.
LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED JUNE 30, 1996, 1995 AND 1994 Additional Common stock paid-in Shares Amount capital ------ ------ ---------- Balance, July 1, 1993 3,563,845 $ 35,638 $ 7,867,675 Net earnings -- -- -- Cost of shares retired (3,883) (39) (43,874) Common stock issued upon exercise of options (note G) 18,366 184 68,768 Net unrealized loss on long-term marketable securities -- -- -- (note B) Stock dividend 178,721 1,787 1,871,042 Tax benefit from exercise of stock options -- -- 45,468 Other (49) -- -- ------------ ------------ ------------ Balance, June 30, 1994 3,757,000 37,570 9,809,079 Net earnings -- -- -- Cost of shares retired (2,102) (21) (17,330) Common stock issued upon exercise of options (note G) 31,602 316 162,200 Unrealized gain on securities available-for-sale -- -- -- (note B) Tax benefit from exercise of stock options -- -- 60,000 ------------ ------------ ------------ Balance, June 30, 1995 3,786,500 37,865 10,013,949 Net loss -- -- -- Cost of shares retired (16,281) (163) (184,319) Common stock issued upon exercise of options (note G) 65,581 656 450,536 Unrealized gain on securities available-for-sale -- -- -- (note B) Tax benefit from exercise of stock options -- -- 88,000 ------------ ------------ ------------ Balance, June 30, 1996 3,835,800 $ 38,358 $ 10,368,166 ============ ============ ============ [WIDE TABLE CONTINUED FROM ABOVE] Unrealized losses on securities Total available- Retained shareholders' for-sale earnings equity ------------ ------------ ------------ Balance, July 1, 1993 $ (58,745) $ 2,356,460 $ 10,201,028 Net earnings -- 635,335 635,335 Cost of shares retired -- -- (43,913) Common stock issued upon exercise of options (note G) -- -- 68,952 Net unrealized loss on long-term marketable securities (2,219) -- (2,219) (note B) Stock dividend -- (1,872,829) -- Tax benefit from exercise of stock options -- -- 45,468 Other -- (67,649) (67,649) ------------ ------------ ------------ Balance, June 30, 1994 (60,964) 1,051,317 10,837,002 Net earnings -- 153,863 153,863 Cost of shares retired -- -- (17,351) Common stock issued upon exercise of options (note G) -- -- 162,516 Unrealized gain on securities available-for-sale 10,148 -- 10,148 (note B) Tax benefit from exercise of stock options -- -- 60,000 ------------ ------------ ------------ Balance, June 30, 1995 (50,816) 1,205,180 11,206,178 Net loss -- (632,193) (632,193) Cost of shares retired -- -- (184,482) Common stock issued upon exercise of options (note G) -- -- 451,192 Unrealized gain on securities available-for-sale 6,650 -- 6,650 (note B) Tax benefit from exercise of stock options -- -- 88,000 ------------ ------------ ------------ Balance, June 30, 1996 $ (44,166) $ 572,987 $ 10,935,345 ============ ============ ============ The accompanying notes are an integral part of these statements.
LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED JUNE 30, 1996 1995 1994 ---- ---- ---- Cash flows from operating activities: Net earnings (loss) $ (632,193) $ 153,863 $ 635,335 Adjustments to reconcile net earnings (loss) to net cash provided by operating activities: Depreciation and amortization 1,128,103 932,051 584,362 Deferred income taxes (80,000) (149,000) 76,000 Equity in losses of unconsolidated subsidiary -- -- 133,639 Changes in operating assets and liabilities: Trade and other receivables 161,057 (410,006) (297,085) Refundable income taxes 63,960 109,714 (101,762) Inventories (298,803) (325,219) (811,246) Prepaid expenses and other (29,011) (128,059) (33,149) Accounts payable 123,375 (189,057) 185,234 Accrued expenses (187,284) 83,770 (19,109) ----------- ----------- ----------- Net cash provided by operating activities 249,204 78,057 352,219 Cash flows from investing activities: Purchase of property, plant and equipment (430,956) (1,471,427) (2,091,228) Investment in patents and trademarks (164,796) (141,665) (119,325) Purchase of investments -- (249,603) (3,003,396) Sale of investments -- 1,674,250 5,285,873 Acquisition of business, net of cash acquired -- -- (182,822) Other 40,589 19,395 85,656 ----------- ----------- ----------- Net cash used in investing activities (555,163) (169,050) (25,242) Cash flows from financing activities: Issuance of common stock 451,192 162,516 68,952 Retirement of common stock (184,482) (17,351) (43,913) ----------- ----------- ----------- Net cash provided by financing activities 266,710 145,165 25,039 ----------- ----------- ----------- Net increase (decrease) in cash and cash equivalents (39,249) 54,172 352,016 Cash and cash equivalents at beginning of year 839,942 785,770 433,754 ----------- ----------- ----------- Cash and cash equivalents at end of year $ 800,693 $ 839,942 $ 785,770 =========== =========== =========== Cash paid during the year for income taxes $ 33,199 $ 137,922 $ 178,316 =========== =========== =========== The accompanying notes are an integral part of these statements
LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 1996, 1995 AND 1994 NOTE A - SUMMARY OF ACCOUNTING POLICIES LecTec Corporation (the Company) is primarily engaged in the research, design, manufacture and sale of diagnostic and monitoring electrodes, membranes, medical tapes and therapeutic products. The Company sells and extends credit without collateral to customers located throughout the United States as well as Canada, Europe, Asia and Latin America. A summary of the Company's significant accounting policies consistently applied in the preparation of the accompanying financial statements follows: 1. Basis of Financial Statement Presentation The consolidated financial statements include the accounts of LecTec Corporation ("LecTec"), LecTec International Corporation, a wholly-owned subsidiary, and Pharmadyne Corporation ("Pharmadyne," formerly known as Natus Corporation), a fifty-one percent owned subsidiary (note H). The Company has consolidated Pharmadyne's results of operations since April 1, 1994. All material intercompany accounts and transactions have been eliminated. 2. Cash and Cash Equivalents The Company considers all highly liquid temporary investments with an original maturity of three months or less to be cash equivalents. Cash equivalents consist primarily of money market accounts. 3. Inventories Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market and consist of the following: June 30, -------------------------- 1996 1995 ---------- --------- Raw materials $1,144,078 $1,162,559 Work in process 229,974 218,351 Finished goods 637,275 716,344 ---------- ---------- $2,011,327 $2,097,254 ========== ========== 4. Depreciation and Amortization Depreciation is provided in amounts sufficient to relate the cost of depreciable assets to operations over their estimated service lives. The straight-line method of depreciation is followed for financial reporting purposes, and accelerated methods are used for tax purposes. Estimated useful lives used in the calculation of depreciation for financial statement purposes are: Buildings and improvements 5 - 39 years Equipment 5 - 15 years Furniture and fixtures 7 years The investment in patents and trademarks consists primarily of the cost of applying for patents and trademarks. Patents and trademarks are amortized on a straight-line basis over the estimated useful life of the asset, generally three to five years. Goodwill represents the excess of cost over the fair value of net assets acquired and is amortized on a straight-line basis over three years. 5. Revenue Recognition Sales are recognized at the time of shipment of product against a confirmed sales order. 6. Net Earnings (Loss) Per Common and Common Equivalent Share Net earnings (loss) per common and common equivalent share have been computed by dividing net earnings (loss) by the weighted average number of common and common equivalent shares outstanding during the years. Common equivalent shares included in the computation represent shares issuable upon the assumed exercise of stock options, when dilutive. 7. Use of Estimates In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Actual results could differ from those estimates. 8. Reclassifications Certain 1995 and 1994 amounts have been reclassified to conform with the financial statement presentation used in 1996. 9. New Accounting Pronouncements The Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standard (SFAS) 123, "Accounting for Stock-Based Compensation," which establishes financial accounting and reporting standards for stock-based employee compensation plans. This Statement defines and encourages the use of a fair value based method of accounting for an employee stock option or similar equity instrument. The Statement allows the use of the intrinsic value based method of accounting as prescribed by current existing accounting standards for options issued to employees; however, there is a requirement to disclose the pro forma net income as if the fair value based method had been used. SFAS 123 is effective for fiscal years beginning after December 15, 1995. Management believes the adoption of SFAS 123 will not have a material effect on the Company's financial position or results of operations. The FASB also issued SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," which establishes guidance for when to recognize and how to measure impairment losses of long-lived assets and certain identifiable intangibles, and how to value long-lived assets to be disposed of. SFAS 121 is effective for fiscal years beginning after December 15, 1995. Management believes the adoption of SFAS 121 will not have a material effect on the Company's financial position or results of operations. LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 1996, 1995 AND 1994 NOTE B - INVESTMENTS The Company's long-term investments are classified as available-for-sale and consist primarily of a preferred stock fund at June 30, 1996 and 1995. These investments are reported at fair value, with the net unrealized loss of $44,166 and $50,816 included in shareholders' equity at June 30, 1996 and 1995. The Company utilizes the specific identification method in computing realized gains and losses. NOTE C - LINE OF CREDIT The Company has an unsecured $1,000,000 working capital line of credit through January 1, 1997 with interest at the bank's reference rate (effective rates of 8.25% and 9.0% at June 30, 1996 and 1995). There were no borrowings outstanding on the line at June 30, 1996 or 1995. The credit agreement contains certain restrictive covenants which require the Company to maintain, among other things, specified levels of working capital and net worth and certain financial ratios. At June 30, 1996, the Company was in compliance with these covenants. Management believes the Company will be able to renew its line of credit under similar terms and conditions. NOTE D - COMMITMENTS AND CONTINGENCIES The Company conducts portions of its operations in a leased facility. The lease provides for payment of a portion of taxes and other operating expenses by the Company. This lease expires in 1997; however, management believes the Company will be able to renew this lease under similar terms and conditions. The minimum rental commitments under all operating leases are as follows for the years ending June 30: 1997 $210,408 1998 7,910 -------- $218,318 ======== Total rent expense for operating leases was $219,095, $223,147 and $218,375 for the years ended June 30, 1996, 1995 and 1994. The Company is subject to various legal proceedings in the normal course of business. Management believes these proceedings will not have a material adverse effect on the Company's financial position or results of operations. LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 1996, 1995 AND 1994 NOTE E - INCOME TAXES Deferred tax assets and liabilities represent the tax effects, based upon current tax law, of future deductible or taxable items that have been recognized in the financial statements. The provision for income tax expense (benefit) consists of the following: Years ended June 30, ------------------------------------------ 1996 1995 1994 ---- ---- ---- Current Federal $ 40,000 $ 136,000 $ 99,000 State 2,000 2,000 2,000 -------- --------- -------- 42,000 138,000 101,000 Deferred Federal (80,000) (149,000) 76,000 State - - - -------- --------- ------- (80,000) (149,000) 76,000 -------- --------- -------- $(38,000) $ (11,000) $177,000 ======== ========= ======== Deferred tax assets (liabilities) represent the tax effects of cumulative temporary differences as follows at June 30: 1996 1995 ---- ---- Deferred current assets and liabilities: Net operating loss carryforwards $ 538,200 $ 309,000 Tax credit carryforwards 161,100 141,100 Stock option exercise 88,000 - Inventory capitalization and reserve 79,200 78,700 Vacation pay accrual 36,100 28,200 Other 7,400 6,000 --------- --------- 910,000 563,000 Valuation allowance (481,000) (309,000) --------- --------- Net current asset $ 429,000 $ 254,000 ========= ========= Deferred long-term assets and liabilities: 1996 1995 ---- ---- Tax depreciation in excess of book depreciation $(278,300) $(256,900) Charitable contribution carryforwards 57,100 51,700 Other 47,200 38,200 --------- --------- Net long-term liability $(174,000) $(167,000) ========= ========= At June 30, 1996, Pharmadyne has available net operating loss carryforwards of approximately $1,400,000 which can be used to reduce future taxable income. These carryforwards begin to expire in 2009 and cannot be utilized to offset taxable income of LecTec. The utilization of these net operating loss carryforwards by Pharmadyne is restricted under Section 382 of the Internal Revenue Code due to past ownership changes. A valuation allowance has been recorded for these net operating loss carryforwards as they may not be realizable. At June 30, 1996, LecTec has available tax credit carryforwards of approximately $161,000 which can be used to reduce future tax liabilities. These carryforwards begin to expire in 2010. LecTec also has available a net operating loss carryforward of approximately $168,000, which can be used to reduce future taxable income of LecTec. This carryforward expires in 2011. Differences between income tax expense (benefit) and the statutory federal income tax rate of 34% are as follows: 1996 1995 1994 ---- ---- ---- Federal statutory income tax rate (34.0)% 34.0% 34.0% State income taxes, net of federal benefit 0.2 0.1 0.1 Tax credit carryforwards - (74.7) (4.0) Foreign sales corporation (5.5) (24.9) (3.9) Subsidiary loss producing no benefit 25.7 29.9 - Tax exempt investment income (0.8) (14.7) (5.1) Goodwill amortization 10.0 46.8 1.8 Prior years' overaccruals - (4.8) - Other (1.3) .6 (4.2) ----- ---- ---- (5.7)% (7.7)% 18.7% ===== ===== ==== During the fourth quarter of the year ended June 30, 1995, the Company recorded a $131,000 reduction of income tax expense to adjust to the Company's annual effective tax rate. The effect of this adjustment was to increase net earnings per share by $.03 for the year. NOTE F - EMPLOYEE BENEFIT PLANS The Company has a profit sharing benefit plan covering substantially all employees who have completed one year of service. The Company's contributions are discretionary as determined by the Board of Directors, subject to certain limitations under the Internal Revenue Code. Pension expense under this plan was $55,585 and $46,918 for the years ended June 30, 1995 and 1994. No contributions were made to the plan during 1996. The Company has a profit sharing bonus plan covering substantially all employees who have completed two calendar quarters of employment. The quarterly bonuses are paid from a pool equal to a maximum of 9% of pretax income net of certain reductions, including the profit sharing distribution, and a reserve based on the preceding quarter's net earnings. Profit sharing bonus expense under this plan was $2,820, $18,534 and $56,978 for the years ended June 30, 1996, 1995 and 1994. The Company maintains a contributory 401(k) profit sharing benefit plan covering substantially all employees who have completed one year of service. The Company matches 50 percent of voluntary employee contributions to the plan not to exceed 50% of a maximum 5% of a participant's compensation. The Company's contributions under this plan were $44,549, $37,230 and $36,785 for the years ended June 30, 1996, 1995 and 1994. NOTE G - STOCK OPTIONS The Company's 1989 Stock Option Plan (the "Plan") provides for the grant of options to officers and other key employees of the Company. A total of 557,287 shares of common stock are reserved for issuance under the Plan. The ten-year options are exercisable at such times as set forth in the individual option agreements, generally vesting 100% after four years. The exercise price of the options granted is the fair market value of the Company's common stock at the date of grant. Option transactions under the Plan during the three years ended June 30, 1996 are summarized as follows: Number of shares Option price of share ---------------- --------------------- Outstanding at July 1, 1993 289,015 $3.34 - $ 9.07 Granted 132,914 8.62 - 9.52 Exercised (16,391) 3.34 - 7.77 Canceled (10,438) 3.34 - 9.52 ------- ---------------- Outstanding at June 30, 1994 395,100 3.34 - 9.52 Granted 107,000 9.00 - 13.00 Exercised (31,492) 3.34 - 9.52 Canceled (33,316) 3.34 - 9.52 ------- ---------------- Outstanding at June 30, 1995 437,292 3.34 - 13.00 Granted 121,500 9.00 - 13.50 Exercised (65,663) 3.34 - 9.52 Canceled (20,938) 3.34 - 9.52 ------- ---------------- Outstanding at June 30, 1996 472,191 $3.34 - $13.50 ======= ================ Under the Plan, options to purchase an aggregate of 212,441 shares were exercisable at June 30, 1996. The Company's 1991 Directors' Stock Option Plan (the "Directors' Plan") provides for the grant of options to members of the Board of Directors of the Company. A total of 115,762 shares of common stock are reserved for issuance under the Directors' Plan. The ten-year options are exercisable at the date of the grant. The exercise price of the options granted is the fair market value of the Company's common stock at the date of grant. Option transactions under the Directors' Plan during the three years ended June 30, 1996 are summarized as follows: Number of shares Option price of share ---------------- --------------------- Outstanding at July 1, 1993 25,634 $3.34 - $9.06 Granted 7,875 9.52 Exercised (2,895) 3.34 ------ -------------- Outstanding at June 30, 1994 30,614 3.34 - 9.52 Granted 10,000 9.00 Exercised (110) 7.77 ------ -------------- Outstanding at June 30, 1995 40,504 3.34 - 9.52 Granted 12,000 9.00 ------ -------------- Outstanding at June 30, 1996 52,504 $3.34 - $9.52 ====== ============== During the year ended June 30, 1996, the Company earned a tax benefit of $88,000 related to the exercise of stock options. As the benefit was not able to be utilized currently, the Company recorded a deferred tax asset and an increase in additional paid-in capital. NOTE H - ACQUISITION OF PHARMADYNE CORPORATION On June 30, 1992, the Company entered into a Research, Development and Marketing Agreement with Pharmadyne and contract research revenues of $125,000 and $75,000 were recognized in 1993 and 1992. During 1993, the Company invested $175,000 in Pharmadyne, which represented a 19.5% ownership interest in Pharmadyne. This investment was recorded at cost. In addition to this equity investment, during 1993, the Company also made an advance of $50,000 to Pharmadyne. Effective March 28, 1994, the Company entered into a stock option agreement with Pharmadyne which provided the Company the right and option to purchase a number of shares of common stock of Pharmadyne that, when combined with the common stock already owned, would equal, at the date of exercise, 51% of the issued, outstanding and potentially issuable shares of common stock. On April 1, 1994, the Company exercised their option to purchase 182,822 shares of Pharmadyne common stock at $1 per share. The Company paid cash of $132,525 and reduced their note receivable from Pharmadyne by $50,000 and interest receivable by $297 to acquire the shares. This acquisition was accounted for as a purchase. The acquired goodwill of approximately $590,000 is being amortized on a straight-line basis over 3 years. The following unaudited pro forma consolidated results of operations for the year ended June 30, 1994 give effect to the acquisition of Pharmadyne as though it had occurred on July 1, 1993: 1994 ---- Net sales $11,501,000 Earnings before income taxes 347,000 Net earnings 178,000 Net earnings per common and common equivalent share .05 During 1996 the Company made additional advances to Pharmadyne and received a warrant to purchase 227,959 additional shares of Pharmadyne at $1 per share. On September 5, 1996 the Company exercised the warrant and increased its ownership interest in Pharmadyne to 61%. NOTE I - DISPOSITION OF DIRECT MARKETING RELATED ASSETS On March 12, 1996, the Company contributed the direct marketing related assets of Pharmadyne to Natus L.L.C. (an Arizona limited liability company) in exchange for a 15% interest in Natus L.L.C. The direct marketing related assets contributed consisted of the following: Accounts receivable $ 32,791 Inventory 384,730 Prepaid expenses and other 135,708 Property and equipment, net 79,938 Other (27,000) -------- $606,167 ======== NOTE J - MAJOR CUSTOMERS AND EXPORT SALES One customer accounted for 17.0%, 14.6% and 17.4% of total sales for the years ended June 30, 1996, 1995 and 1994. The accounts receivable from this customer represented 24% of trade receivables at June 30, 1996. The accounts receivable from one other customer represented 15% of trade receivables at June 30, 1996. One additional customer accounted for 10.1% of total sales during the year ended June 30, 1994. Export sales accounted for approximately 19%, 18% and 22% of total sales during the years ended June 30, 1996, 1995 and 1994. Export sales by geographic area were as follows: Years ended June 30, --------------------------------------------- 1996 1995 1994 ---- ---- ---- Canada $ 80,746 $ 113,597 $ 122,208 Europe 1,652,941 1,171,910 943,250 Asia 466,777 1,122,179 1,114,928 Latin America 225,440 195,663 168,621 ---------- ---------- ---------- $2,425,904 $2,603,349 $2,349,007 ========== ========== ========== Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None PART III Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required under this item with respect to directors will be included under the heading "Election of Directors" in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held November 18, 1996, and is incorporated herein by reference. NON DIRECTOR, EXECUTIVE OFFICERS OF THE REGISTRANT Name Age Title - ---- --- ----- Erwin W. Templin II 43 Executive Vice President, Chief Financial Officer, Secretary and Treasurer David A. Montecalvo 31 Vice President, Operations Erwin W. Templin II is Executive Vice President, Chief Financial Officer, Secretary and Treasurer. Mr. Templin joined the Company in July, 1993 as a Vice President of the Company and served as a director from 1990 to 1995. From 1991 to 1993, he was Senior Vice President and Chief Financial Officer of Aviation Services Holdings, Inc., a privately held general aviation investment company. From 1988 to 1990, Mr. Templin was Senior Vice President and Chief Financial Officer of Van Dusen Airport Services Company. Prior to 1988, he served in various financial management positions with H.B. Fuller Company and Jostens, Inc. David A. Montecalvo is Vice President, Operations. Mr. Montecalvo joined the Company in 1986 and held the position of Director, Corporate Science and Technology prior to July 1995, when he became the Vice President, Operations. Item 11. EXECUTIVE COMPENSATION The information required under this item will be included under the heading "Executive Compensation" in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held November 18, 1996, and is incorporated herein by reference. Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required under this item will be included under the heading "Security Ownership of Certain Beneficial Owners and Management" in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held November 18, 1996, and is incorporated herein by reference. Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required under this item with respect to certain relationships and related transactions will be included under the heading "Certain Relationships and Related Transactions" in the Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on November 18, 1996, and is incorporated herein by reference. PART IV Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) Financial Statements, Schedules and Exhibits 1. Financial Statements The following consolidated financial statements of the Company and its subsidiaries are filed as a part of this Form 10-K in Part II, Item 8: (i) Report of Independent Certified Public Accountants (ii) Consolidated Balance Sheets at June 30, 1996 and 1995 (iii) Consolidated Statements of Operations for the years ended June 30, 1996, 1995 and 1994 (iv) Consolidated Statements of Shareholders' Equity for the years ended June 30, 1996, 1995 and 1994 (v) Consolidated Statements of Cash Flows for the years ended June 30, 1996, 1995 and 1994 (vi) Notes to the Consoldiated Financial Statements 2. Financial Statement Schedules : All schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the financial statements or the notes thereto.
3. Exhibits Method of Filing -------- ---------------- 3.01 Articles of Incorporation of Registrant, as amended (1) 3.02 By-laws of Registrant (1) 10.01 Service Agreement dated July 1, 1986, between LecTec (1) International, Inc., a U.S. Virgin Islands corporation, and LecTec Corporation, relating to the sale, lease or rental of certain property outside the United States. 10.02 Distribution and Commission Agreement dated July 1, (1) 1986, between LecTec International, Inc., a U.S. Virgin Islands corporation, and LecTec Corporation, relating to the sale, lease or rental of certain property outside the United States. 10.03 1986 Incentive Stock Option Plan (1) 10.04 Agreement dated June 1, 1983, between LecTec (1) Corporation and George Ingebrand, relating to the grant of stock-equivalent units. 10.05 Certificate of Secretary pertaining to Resolution of (1) Board of Directors of LecTec Corporation, dated October 30, 1986, implementing a Profit Sharing Bonus Plan. 10.06 Research Agreement dated December 31, 1991, between (2) LecTec Corporation and the University of Minnesota, whereby LecTec Corporation received exclusive rights to market and sell a non-nicotine compound to be mutually developed for smoking cessation. 10.07 Assignment and Mutual Release Agreement dated March (2) 9, 1993 between Pharmaco Behavioral Associates, Inc., Robert M. Keenan, Ph.D., M.D. and the University of Minnesota, whereby the University assigned title, royalty and patent rights associated with the technology to alleviate symptoms of tobacco withdrawal to Pharmaco Behavioral Associates, Inc. and Dr. Keenan. Also included is a mutual release of all parties on all past title, royalty and patent rights. 10.08 License Agreement dated March 9, 1993 between (2) Pharmaco Behavioral Associates, Inc. and LecTec Corporation, whereby the Company received an exclusive, worldwide license to market, make and sublicense product associated with the technology to alleviate symptoms of tobacco withdrawal. 10.09 Consultant Contract and Invention Assignment dated (2) March 9, 1993 between Robert Keenan, Ph.D., M.D. and LecTec Corporation, whereby the Company received assignment of patent and invention rights associated with the technology to alleviate symptoms of tobacco withdrawal including provisions that the Company enter into a consulting agreement with Dr. Keenan. 10.10 Research Agreement dated June 30, 1992, between (2) LecTec Corporation and Natus Corporation, whereby Natus will fund the the development of an analgesic patch for exclusive rights to sell the the product. 10.11 Stock Investment and Repurchase Agreement dated July (2) 1, 1992, between LecTec Corporation and Natus Corporation, whereby LecTec purchased Common Stock of Natus Corporation. 10.12 Amendments dated March 18, 1993 to the original (2) Research Agreement dated June 30, 1992, between LecTec Corporation and Natus Corporation. 10.13 Subscription Agreement dated June 17, 1993 between (2) LecTec Corporation and Natus Corporation. 10.14 A Promissory Note dated June 17, 1993 between LecTec (2) Corporation and Natus Corporation. Included in the note is an option for LecTec to receive common stock of Natus in lieu of payment. 10.15 Amended and Restated Stock Option Agreement between (3) LecTec Corporation and Natus Corporation, whereby LecTec has obtained the option to acquire the additional shares required to equal 51% of the Common Stock of Natus. 10.16 Contribution Agreement dated March 12, 1996 between (4) Natus Corporation and ACM Investments, L.L.C. regarding the acquisition of an equity interest in Natus L.L.C *10.17 Distribution Agreement dated March 12, 1996 between (4) LecTec Corporation, Natus Corporation and Natus L.L.C. 10.18 Operating Agreement dated March 12, 1996 between (4) Natus L.L.C., ACM Investments, L.L.C., Natus Corporation and Natus Management, Inc. *10.19 Marketing and Distribution Agreement dated January (4) 11, 1996 between LecTec Corporation, Natus Corporation and CNS, Inc. regarding an analgesic pain patch 10.20 Credit Agreement dated May 1, 1996 between LecTec (4) Corporation and The First National Bank of Saint Paul, a national banking association, whereby LecTec Corporation has an unsecured $1 million working capital line of credit 10.21 Revolving Credit Note dated May 1, 1996 between (4) LecTec Corporation and The First National Bank of Saint Paul, a national banking association 10.22 Working Capital Loan Agreement dated September 5, (4) 1995 between LecTec Corporation and Natus Corporation relating to a loan from LecTec to Natus Corporation 10.23 Form of Working Capital Loan Agreement dated (4) September 5, 1995; between Natus Corporation and various shareholders relating to loans to Natus Corporation 21.01 Subsidiaries of the Company (3) 23.01 Consent of Grant Thornton LLP (4) 27.01 Financial Data Schedule (4) - -----------------------
* Confidential treatment requested for portions of this Exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of 1934 as amended, the confidential portions have been deleted and filed separately with the Securities and Exchange Commission together with a confidential treatment request (1) Incorporated herein by reference to the Company's Form S-18 Registration Statement (file number 33-9774C) filed on October 31, 1986 and amended on December 12, 1986. (2) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended June 30, 1993. (3) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended June 30, 1994. (4) Filed herewith. (b) 1. Reports on Form 8-K. None. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, on the 27th day of September, 1996. LECTEC CORPORATION /s/Rodney A. Young ------------------ Rodney A. Young Chief Executive Officer, President and Director (Principal Executive Officer) Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated. /s/Rodney A. Young September 27, 1996 - ------------------------------------------- Rodney A. Young Chief Executive Officer, President Director (Principal Executive Officer) /s/Erwin W. Templin II September 27, 1996 - ------------------------------------------- Erwin W. Templin II Executive Vice President, Chief Financial Officer, Secretary, Treasurer (Principal Financial Officer) /s/Justin W. Shireman September 27, 1996 - ------------------------------------------- Justin W. Shireman Controller (Principal Accounting Officer) /s/Thomas E. Brunelle September 27, 1996 - ------------------------------------------- Thomas E. Brunelle Chairman Director /s/Alan C. Hymes September 27, 1996 - ------------------------------------------- Alan C. Hymes Director /s/Lee M. Berlin September 27, 1996 - ------------------------------------------- Lee M. Berlin Director /s/Paul Johnson September 27, 1996 - ------------------------------------------- Paul Johnson Director /s/Alan J. Wilensky September 27, 1996 - ------------------------------------------- Alan J. Wilensky Director EXHIBIT INDEX ------------- Exhibits Page -------- ---- 3.01 Articles of Incorporation of Registrant, as amended (Note 1) 3.02 By-laws of Registrant (Note 1) 10.01 Service Agreement dated July 1, 1986, between LecTec International, Inc., a U.S. Virgin Islands corporation, and LecTec Corporation, relating to the sale, lease or rental of certain property outside the United States (Note 1). 10.02 Distribution and Commission Agreement dated July 1, 1986, between LecTec International, Inc., a U.S. Virgin Islands corporation, and LecTec Corporation, relating to the sale, lease or rental of certain property outside the United States (Note 1). 10.03 1986 Incentive Stock Option Plan (Note 1). 10.04 Agreement dated June 1, 1983, between LecTec Corporation and George Ingebrand, relating to the grant of stock-equivalent units (Note 1). 10.05 Certificate of Secretary pertaining to Resolution of Board of Directors of LecTec Corporation, dated October 30, 1986, implementing a Profit Sharing Bonus Plan (Note 1). 10.06 Research Agreement dated December 31, 1991, between LecTec Corporation and the University of Minnesota, whereby LecTec Corporation received exclusive rights to market and sell a non-nicotine compound to be mutually developed for smoking cessation (Note 2). 10.07 Assignment and Mutual Release Agreement dated March 9, 1993 between Pharmaco Behavioral Associates, Inc., Robert M. Keenan, Ph.D., M.D. and the University of Minnesota, whereby the University assigned title, royalty and patent rights associated with the technology to alleviate symptoms of tobacco withdrawal to Pharmaco Behavioral Associates, Inc. and Dr. Keenan. Also included is a mutual release of all parties on all past title, royalty and patent rights (Note 2). 10.08 License Agreement dated March 9, 1993 between Pharmaco Behavioral Associates, Inc. and LecTec Corporation, whereby the Company received an exclusive, worldwide license to market, make and sublicense product associated with the technology to alleviate symptoms of tobacco withdrawal (Note 2). 10.09 Consultant Contract and Invention Assignment dated March 9, 1993 between Robert Keenan, Ph.D., M.D. and LecTec Corporation, whereby the Company received assignment of patent and invention rights associated with the technology to alleviate symptoms of tobacco withdrawal, including provisions that the Company enter into a consulting agreement with Dr. Keenan. 10.10 Research Agreement dated June 30, 1992, between LecTec Corporation and Natus Corporation, whereby Natus will fund the the development of an analgesic patch for exclusive rights to sell the the product (Note 2). 10.11 Stock Investment and Repurchase Agreement dated July 1, 1992, between LecTec Corporation and Natus Corporation, whereby LecTec purchased Common Stock of Natus Corporation (Note 2). 10.12 Amendments dated March 18, 1993 to the original Research Agreement dated June 30, 1992 between LecTec Corporation and Natus Corporation (Note 2). 10.13 Subscription Agreement dated June 17, 1993 between LecTec Corporation and Natus Corporation (Note 2). 10.14 Promissory Note dated June 17, 1993 between LecTec Corporation and Natus Corporation. Included in the note is an option for LecTec to receive common stock of Natus in lieu of payment (Note 2). 10.15 Amended and Restated Stock Option Agreement between LecTec Corporation and Natus Corporation, whereby LecTec obtained the option to acquire the additional shares required to equal 51% of the Common Stock of Natus (Note 3). 10.16 Contribution Agreement dated March 12, 1996 between Natus Corporation and ACM Investments, L.L.C.regarding the acquisition of an equity interest in Natus L.L.C *10.17 Distribution Agreement dated March 12, 1996 between LecTec Corporation, Natus Corporation and Natus L.L.C 10.18 Operating Agreement dated March 12, 1996 between Natus L.L.C., ACM Investments, L.L.C., Natus Corporation and Natus Management, Inc. *10.19 Marketing and Distribution Agreement dated January 11, 1996 between LecTec Corporation, Natus Corporation and CNS, Inc. regarding an analgesic pain patch 10.20 Credit Agreement dated May 1, 1996 between LecTec Corporation and The First National Bank of Saint Paul, a national banking association, whereby LecTec Corporation has an unsecured $1 million working capital line of credit 10.21 Revolving Credit Note dated May 1, 1996 between LecTec Corporation and The First National Bank of Saint Paul, a national banking association 10.22 Working Capital Loan Agreement dated September 5, 1995 between LecTec Corporation and Natus Corporation relating to a loan from LecTec to Natus Corporation 10.23 Form of Working Capital Loan Agreement dated September 5, 1995; between Natus Corporation and various shareholders relating to loans to Natus Corporation 21.01 Subsidiaries of the Company (Note 3) 23.01 Consent of Grant Thornton LLP 27.01 Financial Data Schedule Notes: * Confidential treatment requested for portions of this Exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of 1934 as amended, the confidential portions have been deleted and filed separately with the Securities and Exchange Commission together with a confidential treatment request (1) Incorporated herein by reference to the Company's Form S-18 Registration Statement (file number 33-9774C) filed on October 31, 1986 and amended on December 12, 1986. (2) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended June 30, 1993. (3) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended June 30, 1994.