UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ----------------- FORM 10-K ----------------- (Mark One) /X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 2000. / / 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: (952) 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 Common Stock held by non-affiliates of the Registrant as of September 20, 2000 was $6,513,235 based upon the last reported sale price of the Common Stock at that date by the Nasdaq Stock Market. The number of shares outstanding of the Registrant's Common Stock as of September 20, 2000 was 3,904,465 shares. ----------------------------- DOCUMENTS INCORPORATED BY REFERENCE Part III of this Annual Report on Form 10-K incorporates by reference information from the Registrant's Proxy Statement for its Annual Meeting of Shareholders to be held November 16, 2000. PART I ITEM 1. BUSINESS GENERAL LecTec Corporation (the "Company") designs, manufactures and markets diagnostic electrocardiograph ("ECG") electrodes, conductive and non-conductive adhesive hydrogels, and patches for the topical application of over-the-counter ("OTC") drugs. The Company markets and sells its products to medical products distributors, consumers through retail outlets (food, chain drug and mass merchandise stores), consumer products companies and original equipment manufacturers ("OEM"s). All of the products manufactured by the Company are designed to be highly compatible with skin. The Company developed one of the first solid gel disposable ECG electrodes which did not require the use of aqueous conductive gels in order to maintain contact with the skin. The Company has since continued to develop, manufacture and market electrodes as well as hydrogels and OTC topical therapeutic patches. A hydrogel is a gel-like material having an affinity for water and similar compounds. These gels are ideal for electrical conductivity and skin compatibility. The Company holds multiple domestic and foreign patents. Effective January 14, 1999, the Company was certified as meeting the requirements of ISO 9001 and EN46001 quality system standards. Certification was granted by TUV Product Service GmbH. Meeting these standards, particularly EN46001, confirms that the Company has achieved the highest level of quality systems compliance demonstrated by world-class design and manufacturing firms. For medical devices, EN46001 is awarded only to those companies which satisfy the rigorous standards of ISO 9001 and comply with the European Union's Medical Device Directive. The Company, through its research and development efforts, is investigating new products for topical delivery of OTC drugs, and new conductive adhesive hydrogel polymers. In addition, existing technologies are being refined to focus on new consumer products targeting new retail customers and 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 (952) 933-2291. PRODUCTS The Company's core competency is skin interface technology. This competency results in products which are chemically compatible with human skin, thereby reducing skin irritation and reducing damage to the skin as well as the risk of infection. The electrical properties, adhesive characteristics, dimensions, drug stability, shelf life and manufacturability of the Company's products are highly consistent and reproducible from product to product. CONDUCTIVE PRODUCTS The Company's conductive products include diagnostic electrodes and electrically conductive adhesive hydrogels. The Company applies its patented conductive, skin compatible, adhesive hydrogel technology to cardiac diagnostic electrodes. The Company's patented natural and synthetic-based hydrogel polymers are self-adherent and are capable of being made electrically conductive. Using natural-based polymers, the Company developed the first solid gel disposable diagnostic ECG electrodes. The solid gel design of the Company's electrodes provides more consistent electrical performance and eliminates clean-up time for the clinician. Currently the Company has three different types of diagnostic electrodes: LecTec 1000 Series, a disposable electrode made of natural polymer solid gel with gentle adhesion; LecTec 3000 Series and LecTec 3009 Series, synthetic solid gel electrodes with higher levels of adhesion which meet all American Association for Medical Instrumentation ("AAMI") standards -1- including defibrillation recovery; and LecTec 4000 Series, a synthetic solid gel, silver substrate electrode which also meets all AAMI standards including defibrillation recovery. The Company pioneered hydrogel technology and manufactures synthetic and natural-based hydrogels. These hydrogels are resistant to dehydration, evaporation and changes in electrical and physical properties. Hydrogels are also used topically to deliver specific medications to the skin. Hydrogels are manufactured with various levels of conductivity, as well as with varying degrees of self-adhesive properties, for diagnostic electrodes, external defibrillation, pacing and monitoring electrodes, Transcutaneous Electronic Nerve Stimulation ("TENS") products and iontophoretic return electrodes. Sales of conductive products accounted for approximately 51%, 63% and 61% of the Company's total sales for fiscal years 2000, 1999 and 1998. MEDICAL TAPE PRODUCTS The Company adopted a plan at the end of fiscal 2000 to exit the low margin medical tape business for which sales had been declining for several years. The medical tape business was comprised of sales of individual slit roll widths of the standard paper, plastic and cloth products widely used in the health care industry and sales of large jumbo rolls which were converted by the customer into individual slit rolls widths for ultimate sale to consumers. Minimal sales are expected in fiscal 2001 as remaining medical tape inventories are liquidated. Sales of medical tapes accounted for approximately 13%, 22% and 32% of the Company's total sales for fiscal years 2000, 1999 and 1998. THERAPEUTIC CONSUMER PRODUCTS The Company manufactures and markets patches for the topical application of OTC drugs and other therapeutic compounds. Therapeutic patch products use a hydrogel coated, breathable cloth patch to deliver OTC drugs and other therapeutic compounds onto the skin. Products currently manufactured using the adhesive-based patch technology are analgesic patches for localized pain relief, cooling gel comfort patches, vapor cough suppressant patches, anti-itch patches, acne treatment patches, wart removers, and a corn and callus remover. These products are marketed as OTC products. The analgesic, cooling and anti-itch patches are marketed under the LecTec brand name TheraPatch(R). The acne treatment patches, wart removers and corn and callus removers are marketed by the customer under the brand of the customer. The vapor cough suppressant patches are marketed under the TheraPatch brand name as well as by the customer under the brand of the customer. Sales of therapeutic consumer products accounted for approximately 36%, 15% and 7% of the Company's total sales for fiscal years 2000, 1999 and 1998. MARKETING AND MARKETING STRATEGY The Company markets and sells its products to medical products distributors, consumers through retail outlets (food, chain drug and mass merchandise stores), consumer products companies and original equipment manufacturers. A major entry into the consumer products markets was supported by the hiring of a new retail sales executive late in fiscal 1998 and a retail sales team in fiscal 1999. In the consumer products markets, retail broker and manufacturer's representative contracts have been established. The TheraPatch brand is the umbrella brand for the Company's therapeutic patch products introduced to all markets. In addition to the retail sales team hired for entry into the retail consumer products markets, the Company has sales teams which address other markets into which it sells. These teams support sales to: o medical products distributors who sell to end-user organizations, o consumer products companies who sell directly to the consumer, and o OEMs which either include the Company's product with the product they sell (e.g., electrodes purchased from the Company may be included with electrocardiogram machines manufactured and sold by an OEM), or use the Company's jumbo rolls of hydrogels to -2- manufacture a finished product for sale to the end-user (e.g., hydrogel purchased from the Company may be used by an OEM to make electrodes). The Company has not experienced any significant seasonality in sales of its products. The Company sells its products in the U.S., Europe, Latin America, Asia, Canada and Middle East. Except for sales of the TheraPatch brand patch product into Canada, all of the Company's international sales are denominated in U.S. dollars, thus, most of the impact of the foreign currency transaction gains and losses are borne by the Company's customers. The Company does not believe the January 1, 1999 euro currency conversion has had, nor will have, a material impact on its financial statements. Export sales accounted for approximately 13%, 13% and 26% of total sales for 2000, 1999 and 1998. The Company's international sales are made by the Company's corporate sales force. The Company does not maintain a separate international marketing staff or operations. The following table sets forth export sales by geographic area: Years ended June 30 ----------------------------------------------------- 2000 1999 1998 ---- ---- ---- Europe $1,006,412 $1,216,199 $1,705,996 Latin America 547,904 371,654 371,854 Asia 46,279 31,935 62,027 Canada 298,884 7,011 199,082 Middle East 10,272 -- 912,240 Other 25,962 28,333 71,949 ---------- ---------- ---------- Total Export Sales $1,935,713 $1,655,132 $3,323,148 ========== ========== ========== CUSTOMERS Spacelabs Burdick Inc. accounted for 17%, 22% and 18% of the Company's total sales for the fiscal years 2000, 1999 and 1998. The Company sold its products to approximately 275, 240 and 190 active customers (excluding TheraPatch sales to individuals) during 2000, 1999 and 1998. The Company's backlog orders (purchase orders received from customers for future shipment) as of August 11, 2000 totaled $3,170,000 (all of which the Company expects to fill in fiscal 2001), compared with approximately $913,000 on August 12, 1999. The increase in the backlog as of August 11, 2000 was primarily the result of supply agreements for patch products signed with Johnson & Johnson Consumer Products Company and Novartis Consumer Health, Inc. towards the end of fiscal 2000. COMPETITION The markets for electrodes, hydrogels and topical OTC drug delivery patches are highly competitive. Firms in the medical and consumer industries compete on the basis of product performance, pricing, distribution and service. Many of the Company's major competitors have significantly greater financial, marketing and technological resources than the Company. However, the Company believes that it competes on the basis of proprietary technology, speed-to-market, flexibility, innovative "first-in-category" patches, customer focus and its ability to manufacture and market its products to targeted market segments. Over the past several years there have been a number of mergers within the electrode and hydrogel industries, resulting in fewer but larger competitors. The Company's primary competitor for electrode and hydrogel sales is Tyco International. The Company's OTC TheraPatch family of analgesic, anti-itch and cough suppressant patches competes with ointments, lotions and creams manufactured by various competitors including Mentholatum/Rohto Pharmaceuticals, Inc. -3- MANUFACTURING The Company manufactures its conductive and therapeutic membranes at the Company's Minnetonka, Minnesota facility. The Minnetonka facility also processes raw materials and manufactures the Company's therapeutic products. The Company's second manufacturing facility in Edina, Minnesota is the primary site for the manufacturing and packaging of diagnostic electrodes and the packaging of therapeutic products. 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. 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 and improved products and new technologies. The Company may develop products internally, jointly with corporations and/or with inventors from outside the Company. The Company may then market resulting products by sponsoring partners or through a marketing arrangement with an appropriate distributor. Research and development contract opportunities are evaluated on an individual basis. The Company, through its research and development efforts, is investigating new products for topical delivery of OTC drugs and new conductive adhesive hydrogel polymers. In addition, existing technologies are being refined to focus on new products targeting new customers and new markets. During fiscal 2000 the Company discontinued development of a cotinine-based smoking cessation product after unsuccessful efforts to secure the third party funding necessary for the next phases of research and development. During fiscal years 2000, 1999 and 1998, the Company spent approximately $1,095,000, $1,170,000 and $1,037,000 on research and development. GOVERNMENTAL AND ENVIRONMENTAL REGULATION The Company's Quality System includes design development planning, testing, manufacturing, packaging, labeling and distribution of the Company's products which are subject to federal and foreign regulations, and in some instances, state and local government regulations. UNITED STATES REGULATION The Company's electrodes sold in the United States are subject to federal Food and Drug Administration (the "FDA") policy and are marketed pursuant to Section 510(k) notification, which is a means of obtaining FDA clearance to market a medical device. The Company's finished goods electrodes sold in the United States are subject to the FDA's current Good Manufacturing Practices ("GMP") and quality system regulations. The Company's hydrogels sold domestically are also subject to GMP and quality system regulations as they are sold to OEMs and distributors for processing into finished commercial goods. The Company's topical OTC drug delivery patches are marketed under applicable federal FDA OTC monographs. FOREIGN REGULATION The Company's electrodes sold into the European Community (the "EC") are considered to be Class I, non-sterile and non-measuring medical devices. These products are "CE" marked and "self declared" as being compliant to the Medical Device Directive 93/42/EEC. An authorized representative for -4- the Company has been established in the EC as required by European law. Foreign sales of the Company's electrodes are made only into the EC. There are no foreign regulatory approvals required to sell the Company's hydrogels into foreign countries because these products are sold to OEM customers for processing into finished commercial goods. The Company's topical OTC drug delivery patches are marketed in Canada under applicable Canadian OTC monographs where appropriate, and are reviewed and approved prior to commercialization by the Health Protection branch of Health Canada. ENVIRONMENTAL REGULATION The Company does not use solvents that have an adverse effect on the environment in the manufacturing of its products. The Company does not anticipate any major expenditure for environmental controls during the next fiscal year. PATENTS AND TRADEMARKS The Company has U.S. and foreign patents on adhesive hydrogels, electrodes and transdermal and topical delivery systems. Twenty-two active U.S. patents and fourteen active international patents are currently assigned or licensed to the Company. Four U.S. patents were allowed during fiscal 2000 and are expected to be issued to the Company in fiscal 2001. Sixteen U.S. and foreign applications are pending including two which are on appeal. Foreign patent applications are pending in numerous European countries, Canada and Japan. The patents most pertinent to the Company's major products have a remaining duration ranging from four to twenty years. Three of these patents have a remaining duration of less than five years and the expiration of these patents is not expected to have a material effect on the Company's proprietary position. Four trademark registrations were received in fiscal 2000. One trademark registration is pending. The Company expects that its products will be subject to continuous modifications due to improvements in materials and technological advances for medical products. Therefore, the Company's continued success does not depend solely upon ownership of patents, but upon technical expertise, creative skills and the ability to forge these talents into the timely release of new products. The Company uses both patents and trade secrets 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. EMPLOYEES As of June 30, 2000, the Company employed 97 full-time employees. None of the Company's employees are represented by labor unions or other collective bargaining units. The Company believes relations with its employees are good. EXECUTIVE OFFICERS OF THE REGISTRANT Name Age Title - - --------------------- --- -------------------------------------------------- Rodney A. Young 45 Chairman, Chief Executive Officer and President Douglas J. Nesbit 48 Chief Financial Officer Timothy P. Fitzgerald 60 Vice President, Operations John D. LeGray 54 Vice President, Quality Assurance and Regulatory Affairs Daniel M. McWhorter 60 Vice President, Research and Development Jane M. Nichols 54 Vice President, Marketing and New Business Development Timothy R. J. Quinn 39 Vice President, Consumer Products -5- Rodney A. Young is Chairman, Chief Executive Officer and President. He joined the Company in August 1996. Prior to joining LecTec, Mr. Young had 23 years of health care industry experience including sales and marketing for Upjohn Company and 3M Company. Prior to joining the Company, he was Vice President and General Manager of the Specialized Distribution Division of Baxter International, Inc. Douglas J. Nesbit is Chief Financial Officer. He joined the Company in August 2000. Mr. Nesbit's 23-year professional background includes public accounting experience with the big five firm of KPMG LLP. Prior to joining LecTec he was the Chief Financial Officer at Total Solutions Group, Inc. and Treasurer at Secure Computing Corporation. Timothy P. Fitzgerald is Vice President, Operations. He joined the Company in February 2000. Mr. Fitzgerald's 40-year career includes technical and senior management positions at Bell & Howell Co., International Data Engineering, Inc. and Varitronic Systems, Inc. John D. LeGray is Vice President, Quality Assurance and Regulatory Affairs. He joined the Company in September 1997. Mr. LeGray's 33-year career includes technical and management positions at DiaSorin Inc., Bayer Corporation and Abbott Laboratories. Daniel M. McWhorter is Vice President, Research and Development. He joined the Company in January 1997. Mr. McWhorter has more than 28 years of experience in the medical products industry including both technical and general management positions at The Kendall Company and Pharmacia Deltec and senior technical positions at Abbott Laboratories and Mentor Corporation. Jane M. Nichols is Vice President, Marketing and New Business Development. She joined the Company in April 1997. Ms. Nichols' 28-year career includes clinical, technical and management roles at Methodist Hospital and Park Nicollet Medical Centers, and senior marketing positions at 3M Company and Ecolab. Timothy R. J. Quinn is Vice President and General Manager, Consumer Products. He joined the Company in May 1998. He has 20 years of sales and marketing experience in the consumer products industry. Prior to joining LecTec, he was Vice President of Sales at Redmond Products. Prior to Redmond, Quinn served in a variety of sales and marketing management positions for Lederle Laboratories and General Foods Corporation. He received his Bachelor of Science Degree in business administration from Western Michigan University and completed Columbia University executive management courses. -6- 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 of manufacturing and warehouse space. The Edina building lease term extends through June 30, 2002. ITEM 3. LEGAL PROCEEDINGS None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The Company's common stock trades on the Nasdaq National Market tier of the Nasdaq Stock Market ("Nasdaq") under the symbol LECT. The following table sets forth the high and low daily trade price information for the Company's common stock for each quarter of fiscal 2000 and 1999. Such prices reflect interdealer prices, without retail mark-up, mark-down, or commission, and may not necessarily represent actual transactions. YEARS ENDED JUNE 30, 2000 1999 ------------------ ---------------- HIGH LOW HIGH LOW ---- --- ---- --- First Quarter $4.375 $2.688 $4.000 $2.250 Second Quarter 3.125 1.188 4.000 2.125 Third Quarter 5.000 1.375 3.000 1.250 Fourth Quarter 4.875 2.000 4.750 1.813 As of September 20, 2000 the Company had 3,904,465 shares of common stock outstanding, and 315 common shareholders of record which number does not include beneficial owners whose shares were held of record by nominees or broker dealers. 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. -7- ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA CONSOLIDATED STATEMENT OF OPERATIONS DATA
Years ended June 30, 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- Net sales $ 14,596,346 $ 12,279,075 $ 12,922,365 $ 12,256,327 $ 13,100,754 Gross profit 5,121,217* 4,093,561 3,715,032 4,324,180 4,969,659 Loss from operations (2,890,497)** (1,771,324) (474,935) (2,215,951)*** (724,074) Loss before equity in losses of unconsolidated subsidiary (2,859,276)** (1,683,257) (404,061) (2,140,660)*** (632,193) Equity in losses of unconsoli- dated subsidiary -- -- -- 126,067 -- Net loss (2,859,276)** (1,683,257) (404,061) (2,266,727)*** (632,193) Net loss per common and common equivalent share (BASIC AND DILUTED) (.74)** (.43) (.10) (.59)*** (.17)
CONSOLIDATED BALANCE SHEET DATA
At June 30, 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- Cash, cash equivalents and short-term investments $ 100,171 $ 1,022,025 $ 2,186,532 $ 1,242,777 $ 800,693 Current assets 5,236,110 5,904,111 6,728,531 6,873,696 5,624,682 Working capital 1,512,561 3,497,926 5,335,861 4,035,084 4,240,024 Property, plant and equipment, net 3,039,088 4,028,491 4,306,568 4,592,304 5,112,975 Long-term investments -- -- 8,676 8,013 574,806 Total assets 8,474,549 10,132,573 11,317,774 11,837,356 12,494,003 Long-term liabilities 31,184 217,868 222,000 211,000 174,000 Shareholders' equity 4,719,816 7,508,520 9,703,104 8,787,744 10,935,345
* Includes a charge of $85,000 related to the plan to exit the medical tape product line. ** Includes a charge of $730,000 or $.19 per share related to the plan to exit the medical tape product line. *** Includes a nonrecurring restructuring charge of $2,180,353 or $.57 per share. -8- ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS NET SALES Net sales were $14,596,346 in 2000, an increase of 18.9% from net sales of $12,279,075 in 1999. Net sales were $12,922,365 in 1998. The increase in 2000 net sales was primarily the result of increased therapeutic consumer product sales, partially offset by decreased medical tape and conductive product sales. The decrease in 1999 net sales was primarily the result of decreased medical tape sales, partially offset by increased therapeutic consumer product sales. Net sales of conductive products (medical electrodes and conductive hydrogels) decreased by 4.0% in 2000 to $7,450,755 from $7,758,286 in 1999. Conductive product net sales were $7,906,676 in 1998. These fluctuations in sales were primarily volume-related. The Company expects fiscal 2001 conductive sales to be comparable to fiscal 2000 sales. Net sales of medical tapes decreased by 29.0% in 2000 to $1,927,392 from $2,716,540 in 1999. Medical tape net sales were $4,157,199 in 1998. The decrease in 2000 was primarily the result of reduced sales to a low-margin slit roll tape customer and decreases in sales volume to several other low-margin medical tape customers. The decrease in 1999 was primarily the result of the absence of sales in 1999 to an international customer. The Company adopted a plan at the end of fiscal 2000 to exit the medical tape business and expects minimal medical tape sales in 2001 as remaining inventories are liquidated. Net sales of therapeutic consumer products increased 189.2% in 2000 to $5,218,199 from $1,804,249 in 1999. Net sales of therapeutic consumer products were $858,490 in fiscal 1998. The increase in 2000 was primarily the result of increased TheraPatch(R) product sales, which increased 127.1%, and sales in 2000 of the new acne product to Johnson & Johnson Consumer Products Worldwide. The increase in 1999 was primarily the result of increased TheraPatch sales to retailers, both as a result of increased volumes and increased unit selling price. The higher unit selling price in 1999 was the result of the Company selling directly to retailers rather than to CNS, Inc., the Company's exclusive distributor to retailers in the prior year. The agreement under which CNS distributed the TheraPatch product was terminated at the end of fiscal 1998 when the Company assumed responsibility for retail distribution of the product. Management believes that sales of the Company's therapeutic patch products will represent an increased percentage of total net sales during fiscal 2001 due to continued sales growth of the acne product, new sales of Triaminic(R) Vapor brand topical cough and cold patches and increased TheraPatch brand name recognition. Export sales, consisting primarily of electrodes, semi-finished conductive and medical tape products sold to overseas converters for final processing, packaging and marketing, as well as TheraPatch brand therapeutic consumer products, were 13%, 13% and 26% of total net sales in 2000, 1999 and 1998. All international sales are in U. S. dollars with the exception of TheraPatch brand products sold in Canada. Export sales increased by $280,581 in fiscal 2000 primarily as a result of the Canadian TheraPatch sales. The decrease in the percent for 1999 resulted primarily from the absence in 1999 of medical tape sales to an international customer as well as decreased conductive sales to another customer who began manufacturing product previously purchased from the Company. The Company expects fiscal 2001 international sales will be comparable to 2000. GROSS PROFIT The Company's gross profit was $5,121,217 in 2000, up from $4,093,561 in 1999. Gross profit was $3,715,032 in 1998. As a percentage of net sales, gross profit was 35.1% in 2000, 33.3% in 1999 and 28.8% in 1998. Gross profit in 2000 increased by 25.1% from the prior year and gross profit in 1999 increased by 10.2% from the prior year. The increase in gross profit in 2000 resulted primarily from a shift in the sales mix to higher margin therapeutic consumer products. The increase in gross profit in 1999 resulted primarily from a shift in the sales mix to higher margin therapeutic consumer products from lower margin medical tape products, as well as higher margins on therapeutic patch sales primarily as a result of sales made directly to retailers rather than to a distributor. -9- SALES AND MARKETING EXPENSES Sales and marketing expenses totaled $3,672,908 or 25.2% of net sales in 2000, compared to $2,187,710 or 17.8% of net sales in 1999, and $1,042,788 or 8.1% of net sales in 1998. The 2000 increase was primarily due to increased TheraPatch related advertising and promotional expenses and slotting fees. The increase in advertising was primarily the result of a TV ad campaign for TheraPatch Vapor for Kids. The increased slotting fees resulted from the placement of TheraPatch products in new stores as well as the placement of new TheraPatch products on the shelves in existing stores. The 1999 increase was primarily due to increased sales staff and advertising and slotting fees to establish new retail accounts. The Company anticipates sales and marketing expenses as a percent of sales in fiscal 2001 will be comparable to 2000. GENERAL AND ADMINISTRATIVE EXPENSES General and administrative expenses totaled $2,598,998 or 17.8% of net sales in 2000, compared to $2,507,432 or 20.4% of net sales in 1999, and $2,110,084 or 16.3% of net sales in 1998. The increase in 2000 was primarily the result of increased consulting expense which more than offset a decrease in legal expenses. Legal expense in the prior year included approximately $126,000 related to the re-negotiation and modification of the license agreement for the development and commercialization of cotinine as well as legal expenses associated with work on new and existing patents. The increase in 1999 was primarily the result of increased regulatory and quality assurance expenses associated with achieving and maintaining ISO 9001 and EN 46001 certification, expenses related to the re-negotiation and modification of the license agreement for the development and commercialization of cotinine, and legal expenses associated with work on new and existing patents. The Company anticipates general and administrative expenses in fiscal 2001 will be comparable to fiscal 2000. RESEARCH AND DEVELOPMENT EXPENSES Research and development expenses totaled $1,094,808 or 7.5% of net sales in 2000, compared to $1,169,743 or 9.5% of net sales in 1999, and $1,037,095 or 8.0% of net sales in 1998. The decrease in 2000 primarily reflects decreased test-run production costs and supplies which were partially offset by increased labor costs. The increase in 1999 reflects increased staffing levels and increased costs for testing of products under development. Management believes that research and development expenditures as a percent of sales will be comparable in fiscal 2001 to fiscal 2000. MEDICAL TAPE ASSET IMPAIRMENT AND EXIT PLAN In June of fiscal 2000, the Company adopted a plan to exit the medical tape business effective June 30, 2000. Adoption of this plan resulted in a charge for $645,000 related to the write-down of the medical tape equipment to its estimated fair market value, net of disposal costs, of $526,000. The Company also recorded a charge of $85,000 to reduce the carrying value of medical tape inventory to a net realizable value. The $85,000 charge was included in the cost of goods sold. The Company expects to sell the assets and dispose of the remaining inventory by December 31, 2000. OTHER INCOME AND EXPENSE Interest expense increased to $35,405 in 2000 from $1,173 in 1999 primarily due to interest expense associated with the line of credit. There was no interest expense in 1998. Other income decreased to $27,692 in 2000 from $89,240 in 1999 and $69,874 in 1998 primarily due to decreased interest income as a result of lower cash and cash equivalent balances. INCOME TAX BENEFIT The Company recorded an income tax benefit in 2000 of $38,934, no income tax expense or benefit in 1999 and an income tax benefit of $1,000 in 1998. The income tax benefit in 2000 resulted primarily from the refund of taxes previously paid by the Company's foreign sales corporation. The foreign sales corporation was dissolved during fiscal 2000. There was no income tax benefit recorded during 2000, 1999 and 1998 related to the loss before income taxes since the tax benefit may not be realizable by the Company. -10- OPERATIONS SUMMARY The net loss for 2000 resulted primarily from increased sales and marketing expenses and charges related to the plan to exit the medical tape business which more than offset an increase in gross profit. The increase in gross profit resulted from increased sales volume and a shift in the sales mix toward higher-margin therapeutic consumer products. The net loss for 1999 resulted primarily from increased sales and marketing expenses related to the Company's investment in the consumer products market and increased general and administrative expenses, primarily those expenses related to the modification of the cotinine license agreement and achievement of ISO 9001 and EN 46001 certification. The net loss for 1998 resulted primarily from a decrease in the gross profit percent due to a shift in the sales mix from higher margin conductive and therapeutic consumer products to lower margin medical tape products and increased material costs and material usage. 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 decreased by $921,854 to $100,171 at June 30, 2000 from $1,022,025 at June 30, 1999. This decrease was primarily due to the net loss for fiscal 2000 of $2,859,276. Accounts receivable increased by $294,165 to $2,645,710 primarily due to increased sales for June 2000 as compared to June 1999. Inventories increased by $251,162 to $2,247,686 primarily due to increased raw material and finished goods inventory related to therapeutic products which was partially offset by decreased finished goods inventory of medical tape. Working capital totaled $1,512,561 at June 30, 2000, compared to $3,497,926 at the end of fiscal 1999. The Company's current ratio was 1.4 at June 30, 2000 compared to 2.5 at June 30, 1999. Capital spending for plant improvements and equipment totaled $425,856 in 2000. There were no material commitments for capital expenditures at June 30, 2000. Net property, plant and equipment decreased by $989,403 to $3,039,088 at June 30, 2000 from $4,028,491 at June 30, 1999, reflecting the write-down of the medical tape equipment to its estimated fair market value of $526,000 and the excess of depreciation expense over capital spending. Accounts payable increased by $265,643 to $1,910,551 at June 30, 2000 from $1,644,908 at June 30, 1999 primarily due to increased payables related to increased manufacturing production as well as an increase in the average number of days outstanding before payment. The Company finalized a $2,000,000 asset-based line of credit in November, 1999 and borrowings outstanding on the line were $837,542 at June 30, 2000. The Company was in default at June 30, 2000 with covenants relating to the minimum book net worth and the maximum loss before taxes as a result of the charges totaling $730,000 related to the exit of the medical tape business. These defaults were waived by the bank in an amendment to the line of credit dated September 26, 2000. Shareholders' equity decreased by $2,788,704 to $4,719,816 as of June 30, 2000 from $7,508,520 as of June 30, 1999, primarily due to the net loss incurred during 2000. Management believes that existing cash and cash equivalents, internally-generated cash flow, the existing secured line of credit, an expected increase in the existing line of credit due to the addition of international receivables and inventory in the asset base, and expected additional fixed asset-based financing will be sufficient to support anticipated operating and capital spending requirements during fiscal 2001. Management is also evaluating additional sources of capital that may be appropriate for funding longer-term growth and expansion of the business. Maintaining adequate levels of working capital depends in part upon the success of the Company's products in the marketplace, the relative profitability of those products and the Company's ability to control operating expenses. Funding of the Company's operations in future periods may require additional investments in the Company in the form of equity or debt. There can be no assurance that the Company will achieve desired levels of sales or profitability, or that future capital infusions will be available. -11- FORWARD-LOOKING STATEMENTS From time to time, in reports filed with the Securities and Exchange Commission (including this Form 10-K), in press releases, and in other communications to shareholders or the investment community, the Company may provide forward-looking statements concerning possible or anticipated future results of operations or business developments which are typically preceded by the words "believes", "expects", "anticipates", "intends", "will", "may", "should" or similar expressions. Such forward-looking statements are subject to risks and uncertainties which could cause results or developments to differ materially from those indicated in the forward-looking statements. Such risks and uncertainties include, but are not limited to, the buying patterns of major customers; competitive forces including new products or pricing pressures; costs associated with and acceptance of the Company's TheraPatch brand strategy; impact of interruptions to production; dependence on key personnel; need for regulatory approvals; changes in governmental regulatory requirements or accounting pronouncements; and ability to satisfy funding requirements for operating needs, expansion or capital expenditures. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company has no history of, and does not anticipate in the future, investing in derivative financial instruments, derivative commodity instruments or other such financial instruments. Transactions with international customers are entered into in U. S. dollars with the exception of TheraPatch sales to Canadian customers, precluding the need for foreign currency hedges. These Canadian sales have not been material. Additionally, the Company invests in money market funds and short-term commercial paper, which experience minimal volatility. Thus, the exposure to market risk is not material. -12- 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 To the Shareholders and Board of Directors LecTec Corporation We have audited the accompanying consolidated balance sheets of LecTec Corporation and subsidiaries as of June 30, 2000 and 1999, and the related consolidated statements of operations, comprehensive loss, shareholders' equity, and cash flows for each of the three years in the period ended June 30, 2000. 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 auditing standards generally accepted in the United States of America. 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, 2000 and 1999, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended June 30, 2000, in conformity with accounting principles generally accepted in the United States of America. We have also audited Schedule II of LecTec Corporation and subsidiaries for each of the three years in the period ended June 30, 2000. In our opinion, this Schedule presents fairly, in all material respects, the information required to be set forth therein. /s/ GRANT THORNTON LLP Minneapolis, Minnesota August 18, 2000 (except for note B, as to which the date is September 26, 2000) -13- LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
June 30, ---------------------------- ASSETS 2000 1999 ------------ ------------ CURRENT ASSETS Cash and cash equivalents $ 100,171 $ 1,022,025 Receivables Trade, net of allowance of $127,100 and $101,800 at June 30, 2000 and 1999 2,642,880 2,335,314 Other 2,830 16,231 Inventories 2,247,686 1,996,524 Prepaid expenses and other 220,514 174,674 Investments 22,029 5,343 Deferred income taxes -- 354,000 ------------ ------------ Total current assets 5,236,110 5,904,111 PROPERTY, PLANT AND EQUIPMENT - AT COST Land 247,731 247,731 Building and improvements 1,879,006 1,841,742 Equipment 5,080,180 7,157,016 Furniture and fixtures 414,857 413,013 ------------ ------------ 7,621,774 9,659,502 Less accumulated depreciation 4,582,686 5,631,011 ------------ ------------ 3,039,088 4,028,491 OTHER ASSETS Patents and trademarks, less accumulated amortization of $1,293,871 and $1,154,698 at June 30, 2000 and 1999 199,351 199,971 ------------ ------------ $ 8,474,549 $ 10,132,573 ============ ============
The accompanying notes are an integral part of these statements. -14- LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - CONTINUED
June 30, LIABILITIES AND ------------------------------ SHAREHOLDERS' EQUITY 2000 1999 ------------ ------------ CURRENT LIABILITIES Note payable to bank $ 837,542 $ -- Current maturities of long-term obligations 22,562 11,000 Accounts payable 1,910,551 1,644,908 Accrued expenses Payroll related 371,405 403,075 Retail support programs 421,489 165,472 Other -- 181,730 Customer deposits 160,000 -- ------------ ------------ Total current liabilities 3,723,549 2,406,185 LONG-TERM OBLIGATIONS, less current maturities 31,184 20,868 DEFERRED INCOME TAXES -- 197,000 COMMITMENTS AND CONTINGENCIES -- -- SHAREHOLDERS' EQUITY Common stock, $.01 par value; 15,000,000 shares authorized; 3,904,465 and 3,876,476 shares issued and outstanding at June 30, 2000 and 1999 39,045 38,765 Additional contributed capital 11,316,260 11,262,654 Accumulated other comprehensive gain (loss) 4,845 (11,841) Accumulated deficit (6,640,334) (3,781,058) ------------ ------------ 4,719,816 7,508,520 ------------ ------------ $ 8,474,549 $ 10,132,573 ============ ============
The accompanying notes are an intregral part of these statements. -15- LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended June 30, ------------------------------------------------ 2000 1999 1998 ------------ ------------ ------------ Net sales $ 14,596,346 $ 12,279,075 $ 12,922,365 Cost of goods sold 9,475,129 8,185,514 9,207,333 ------------ ------------ ------------ Gross profit 5,121,217 4,093,561 3,715,032 Operating expenses Sales and marketing 3,672,908 2,187,710 1,042,788 General and administrative 2,598,998 2,507,432 2,110,084 Research and development 1,094,808 1,169,743 1,037,095 Medical tape asset impairment 645,000 -- -- ------------ ------------ ------------ 8,011,714 5,864,885 4,189,967 ------------ ------------ ------------ Loss from operations (2,890,497) (1,771,324) (474,935) Other income (expenses) Interest expense (35,405) (1,173) -- Other, net 27,692 89,240 69,874 ------------ ------------ ------------ Loss before income taxes (2,898,210) (1,683,257) (405,061) Income tax benefit (38,934) -- (1,000) ------------ ------------ ------------ Net loss $ (2,859,276) $ (1,683,257) $ (404,061) ============ ============ ============ Net loss per share - basic and diluted $ (0.74) $ (0.43) $ (0.10) Weighted average shares outstanding - basic and diluted 3,885,911 3,906,694 4,005,455
The accompanying notes are an intregral part of these statements. -16- LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
Years ended June 30, ------------------------------------------------ 2000 1999 1998 ------------ ------------ ------------ Net loss $ (2,859,276) $ (1,683,257) $ (404,061) Other comprehensive income (loss) Unrealized gains (losses) on securities available-for-sale Unrealized holding gains (losses) arising during period 16,686 (3,333) 13,949 Reclassification adjustment for losses included in net loss -- -- 10,915 ------------ ------------ ------------ 16,686 (3,333) 24,864 ------------ ------------ ------------ Comprehensive loss $ (2,842,590) $ (1,686,590) $ (379,197) ============ ============ ============
The accompanying notes are an intregral part of these statements. -17- LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY YEARS ENDED JUNE 30, 2000, 1999 AND 1998
Accumulated Common stock Additional other Total ------------------------- contributed comprehensive Accumulated shareholders' Shares Amount capital gain (loss) deficit equity ----------- ----------- ----------- ------------- ----------- ------------- Balance at July 1, 1997 3,842,800 $ 38,428 $10,476,428 $ (33,372) $(1,693,740) $ 8,787,744 Net loss -- -- -- -- (404,061) (404,061) Cost of shares retired (10,863) (109) (40,627) -- -- (40,736) Common shares issued upon exercise of options 11,615 116 40,329 -- -- 40,445 Unrealized gain on securities available-for-sale -- -- -- 24,864 -- 24,864 Common shares issued to acquire minority shares of consolidated subsidiary 221,948 2,220 1,367,191 -- -- 1,369,411 Shares repurchased (29,500) (295) (124,268) -- -- (124,563) Warrants issued for services -- -- 50,000 -- -- 50,000 ----------- ----------- ----------- ----------- ----------- ----------- Balance at June 30, 1998 4,036,000 40,360 11,769,053 (8,508) (2,097,801) 9,703,104 Net loss -- -- -- -- (1,683,257) (1,683,257) Common shares issued upon exercise of options 1,000 10 2,390 -- -- 2,400 Unrealized loss on securities available-for-sale -- -- -- (3,333) -- (3,333) Common shares issued in connection with the employee stock purchase plan 15,126 151 32,855 -- -- 33,006 Shares repurchased (175,650) (1,756) (541,644) -- -- (543,400) ----------- ----------- ----------- ----------- ----------- ----------- Balance at June 30, 1999 3,876,476 38,765 11,262,654 (11,841) (3,781,058) 7,508,520 Net loss -- -- -- -- (2,859,276) (2,859,276) Common shares issued upon exercise of options 500 5 1,295 -- -- 1,300 Unrealized gain on securities available-for-sale -- -- -- 16,686 -- 16,686 Common shares issued in connection with the employee stock purchase plan 27,489 275 52,311 -- -- 52,586 ----------- ----------- ----------- ----------- ----------- ----------- Balance at June 30, 2000 3,904,465 $ 39,045 $11,316,260 $ 4,845 $(6,640,334) $ 4,719,816 =========== =========== =========== =========== =========== ===========
The accompanying notes are an intregral part of these statements. -18- LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended June 30, ------------------------------------------------ 2000 1999 1998 ------------ ------------ ------------ Cash flows from operating activities: Net loss $ (2,859,276) $ (1,683,257) $ (404,061) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Medical tape asset impairment and inventory write-down 730,000 -- -- Depreciation and amortization 908,024 851,087 844,594 Warrants issued for services -- -- 50,000 Loss on sales of investments -- -- 10,915 Deferred income taxes 157,000 -- (2,000) Changes in operating assets and liabilities, net of effect of medical tape asset charges: Trade and other receivables (294,165) (61,620) (80,617) Refundable income taxes -- 52,000 341,719 Inventories (336,162) (278,513) 859,010 Prepaid expenses and other (45,840) (71,611) (18,192) Accounts payable 265,643 835,761 29,448 Accrued expenses 42,917 167,154 (104,279) Customer deposits 160,000 -- -- ------------ ------------ ------------ Net cash provided by (used in) operating activities (1,271,859) (188,999) 1,526,537 Cash flows from investing activities: Purchase of property, plant and equipment (424,448) (419,469) (406,515) Investment in patents and trademarks (138,553) (79,513) (62,999) Sale of investments -- -- 590,873 ------------ ------------ ------------ Net cash provided by (used in) investing activities (563,001) (498,982) 121,359 Cash flows from financing activities: Issuance of common stock 53,586 35,006 38,745 Repurchases and retirement of common stock -- (543,400) (165,299) Net borrowings on note payable 837,542 -- -- Proceeds from long-term obligations 33,649 36,849 -- Repayment of long-term obligations (11,771) (4,981) -- ------------ ------------ ------------ Net cash provided by (used in) financing activities 913,006 (476,526) (126,554) ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents (921,854) (1,164,507) 1,521,342 Cash and cash equivalents at beginning of year 1,022,025 2,186,532 665,190 ------------ ------------ ------------ Cash and cash equivalents at end of year $ 100,171 $ 1,022,025 $ 2,186,532 ============ ============ ============
The accompanying notes are an intregral part of these statements. -19- LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
Years ended June 30, ---------------------------------------- 2000 1999 1998 ---------- ---------- ---------- Supplemental disclosure of cash flow information: Cash paid during the year for interest $ 28,085 $ 792 $ 1,106 Cash paid during the year for income taxes $ -- $ 22,010 $ 16,732
Supplemental disclosure of non-cash investing and financing activities: During fiscal 1998, the Company issued 221,948 shares of common stock in exchange for the minority interest in Pharmadyne, valued at $1,369,411. The accompanying notes are an intregral part of these statements. -20- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS JUNE 30, 2000, 1999 AND 1998 NOTE A - SUMMARY OF ACCOUNTING POLICIES LecTec Corporation (the "Company") is primarily engaged in the research, design, manufacture and sale of diagnostic electrodes, conductive hydrogels, medical tapes and therapeutic consumer products. The Company's customers are located throughout the United States as well as Europe, Latin America, Asia, Canada and the Middle East. A summary of the Company's significant accounting policies consistently applied in the preparation of the accompanying financial statements follows: Basis of Financial Statement Presentation The consolidated financial statements include the accounts of LecTec Corporation ("LecTec") and subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Cash and Cash Equivalents The Company considers all highly liquid temporary investments purchased with original maturities of three months or less to be cash equivalents. At times cash and cash equivalents may be in excess of FDIC insurance limits. Accounts Receivable The Company grants credit to customers in the normal course of business, but generally does not require collateral or any other security to support amounts due. Management performs on-going credit evaluation of customers. The Company maintains allowances for potential credit losses which, when realized, have been within management expectations. Investments The Company's investments are classified as available-for-sale and are reported at fair value. The Company utilizes the specific identification method in computing realized gains and losses. -21- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 2000, 1999 AND 1998 NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued 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 ------------------------- 2000 1999 ---------- ---------- Raw materials $1,666,544 $1,324,973 Work in process 23,202 69,324 Finished goods 557,940 602,227 ---------- ---------- $2,247,686 $1,996,524 ========== ========== 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 - 40 years Equipment 4 - 15 years Furniture and fixtures 5 - 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 five years. Revenue Recognition Revenue is recognized at the time of shipment. -22- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 2000, 1999 AND 1998 NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued Advertising The Company expenses the cost of advertising as incurred, except for the costs of television commercials. These costs are expensed as the commercials are broadcast. Advertising expense totaled approximately $536,000, $271,000, and $145,000 for the years ended June 30, 2000, 1999 and 1998. Research and Development Research and development costs are expensed as incurred and are reported as a component of selling, general and administrative expenses. Net Loss Per Share Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding. Diluted net loss per share is computed by dividing net 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 1,048,205, 897,506 and 795,997 shares of common stock with a weighted average exercise price of $6.07, $7.54 and $8.09 were outstanding during the years ended June 30, 2000, 1999 and 1998, but were excluded because they were antidilutive. Stock Based Compensation The Company utilizes the intrinsic value method of accounting for its stock-based employee compensation plan. Pro-forma information related to fair value based method of accounting is disclosed in Note F. -23- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 2000, 1999 AND 1998 NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued Fair Value of Financial Instruments Due to their short-term nature, the carrying value of current financial assets and liabilities approximates their fair values. The fair value of long-term obligations, if recalculated based on current interest rates, would not significantly differ from the recorded amounts. Use of Estimates In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, 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 the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Reclassifications Certain reclassifications have been made to the 1999 and 1998 balances to conform to the presentation used in 2000. NOTE B - NOTE PAYABLE TO BANK The Company entered into a secured line of credit on November 22, 1999, with a maximum borrowing of $2,000,000 as defined in the agreement. The credit agreement expires November 22, 2001 and includes interest computed at the prime rate plus 3% (effective rate of 12.5% at June 30, 2000). The agreement includes a minimum annual interest charge for each year of the agreement ($80,000 and $95,000 for each of the two years ended November 22, 2001). Borrowings outstanding on the line of credit were $837,542 at June 30, 2000. Borrowings under the credit agreement are collateralized by substantially all of the Company's assets. At June 30, 2000, the Company was in violation of certain covenants contained in the credit agreement. These covenant violations were waived by the bank on September 26, 2000 in connection with the establishment of revised financial covenants under the credit agreement. The Company expects to be in compliance with the revised covenants during fiscal 2001. -24- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 2000, 1999 AND 1998 NOTE C - LONG-TERM OBLIGATIONS Long-term obligations consists of capital leases, due in various monthly installments up to $1,230 including interest from 10.50% to 15.99% through May 2003, collateralized by equipment. Maturities of long-term obligations are as follows: Years ending June 30: --------------------- 2001 $22,562 2002 19,499 2003 11,685 ------- $53,746 ======= NOTE D - COMMITMENTS AND CONTINGENCIES Leases 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. Total rent expense for operating leases was $260,481, $250,641 and $248,931 for the years ended June 30, 2000, 1999 and 1998. Future minimum lease commitments under all operating leases are as follows: Years ending June 30: --------------------- 2001 $261,700 2002 256,100 -25- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 2000, 1999 AND 1998 NOTE D - COMMITMENTS AND CONTINGENCIES - Continued Employee Benefit Plan The Company maintains a contributory 401(k) profit sharing benefit plan covering substantially all employees. The Company matches 50% of employee contributions up to 5% of a participant's compensation. The Company's contributions under this plan were $81,474, $71,006 and $54,901 for the years ended June 30, 2000, 1999 and 1998. The Company may also make a discretionary contribution. No discretionary contributions were made for each of the three years ended June 30, 2000. Legal Proceedings 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. NOTE E - INCOME TAXES Income tax expense (benefit) consists of the following: Years ended June 30, --------------------------------------- 2000 1999 1998 --------- --------- --------- Current $(195,934) $ -- $ 1,000 Deferred 157,000 -- (2,000) --------- --------- --------- $ (38,934) $ -- $ (1,000) ========= ========= ========= -26- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 2000, 1999 AND 1998 NOTE E - INCOME TAXES - Continued Deferred tax assets and liabilities represent the tax effects of cumulative future deductible or taxable items that have been recognized in the financial statements as follows: June 30, -------------------------- 2000 1999 ----------- ----------- Current assets and liabilities: Inventories $ 160,600 $ 199,400 Vacation pay 73,500 67,100 Write-down of long-lived medical tape assets 232,200 -- Other 115,600 40,900 ----------- ----------- Net current asset 581,900 307,400 Long-term assets and liabilities: Net operating loss carryforwards 2,312,000 1,656,500 Tax credit carryforwards 253,600 253,600 Tax depreciation in excess of book depreciation (225,000) (273,400) Charitable contribution carryforwards 19,200 18,900 Other 69,800 57,500 ----------- ----------- Net long-term asset 2,429,600 1,713,100 ----------- ----------- Net deferred tax asset 3,011,500 2,020,500 Less valuation allowance (3,011,500) (1,863,500) ----------- ----------- Net deferred tax asset $ -- $ 157,000 =========== =========== At June 30, 2000, the Company has available net operating loss carryforwards of approximately $6,800,000 which can be used to reduce future taxable income. The utilization of a portion of these net operating loss carryforwards is restricted under Section 382 of the Internal Revenue Code due to past ownership changes. These net operating loss carryforwards begin to expire in 2007. A valuation allowance has been recorded for these net operating loss carryforwards as they may not be realizable. -27- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 2000, 1999 AND 1998 NOTE E - INCOME TAXES - Continued Differences between income tax benefit and the statutory federal income tax rate of 34% are as follows: 2000 1999 1998 ------ ------ ------ Federal statutory income tax rate (34.0)% (34.0)% (34.0)% State income taxes, net of federal effect .1 -- 0.3 Foreign sales corporation -- -- (11.1) Change in valuation allowance 33.6 34.4 58.0 Tax exempt investment income -- -- (1.7) Prior years' overaccruals -- -- (3.7) Other (1.0) (0.4) (8.0) ----- ----- ----- (1.3)% -- % (0.2)% ===== ===== ===== NOTE F - EQUITY TRANSACTIONS Employee Stock Purchase Plan The Company's employee stock purchase plan, adopted November 19, 1998, allows eligible employees to purchase shares of the Company's common stock through payroll deductions. The purchase price is the lower of 85% of the fair market value of the stock on the first or last day of each six-month period during which an employee participated in the plan. The Company has reserved 200,000 shares under the plan. The Company issued 27,489 and 15,126 shares in connection with purchases by employees for $52,586 and $33,006 for the years ended June 30, 2000 and 1999. -28- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 2000, 1999 AND 1998 NOTE F - EQUITY TRANSACTIONS - Continued Stock Options and Warrants The Company has stock option plans for the benefit of selected officers, employees and directors of the Company. A total of 1,673,049 shares of common stock are reserved for issuance under the plans. Options under the Company's plans are granted at fair market value and expire at five or ten years from the grant date. Options given to directors are exercisable at the date of grant. Options given to selected officers and employees are exercisable at such times as set forth in the individual option agreements, generally vesting 100% after three to four years. A summary of the Company's stock option transactions for the years ended June 30, 2000, 1999 and 1998 is as follows: Weighted average Number of shares exercise price ---------------- ---------------- Outstanding at July 1, 1997 722,833 $8.46 Granted 219,000 5.31 Exercised (11,615) 3.35 Canceled (82,598) 6.37 --------- Outstanding at June 30, 1998 847,620 7.86 Granted 304,200 2.76 Exercised (1,000) 2.00 Canceled (16,994) 8.74 --------- Outstanding at June 30, 1999 1,133,826 6.48 Granted 115,000 3.04 Exercised (500) 2.00 Canceled (221,704) 8.44 --------- ----- Outstanding at June 30, 2000 1,026,622 $5.68 ========= ===== A total of 604,971, 593,876 and 459,994 options were exercisable at June 30, 2000, 1999 and 1998, with a weighted average price of $6.54, $7.83 and $8.35. -29- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 2000, 1999 AND 1998 NOTE F - EQUITY TRANSACTIONS - Continued The following information applies to grants that are outstanding at June 30, 2000:
Options outstanding Options exercisable --------------------------- ----------------------- Weighted Weighted Weighted average average average Range of Number remaining exercise Number exercise exercise prices outstanding contractual life price exercisable price --------------- ----------- ---------------- -------- ----------- -------- $2.00- $2.99 341,000 3.7 years $ 2.71 117,750 $ 2.60 $3.00- $4.99 97,571 4.8 years 3.54 46,291 3.55 $5.00- $7.49 273,250 5.7 years 5.66 179,312 5.76 $7.50-$11.24 214,801 4.5 years 8.77 200,988 8.85 $11.25-$13.50 100,000 6.1 years 11.25 60,000 11.25 --------- ------- 1,026,622 604,971 ========= =======
The weighted average fair value of the options granted during 2000, 1999 and 1998 were $1.84, $1.47 and $2.77. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model with the following weighted-average assumptions used for all grants in 2000, 1999 and 1998: zero dividend yield, expected volatility of 74%, 62% and 52%, risk-free interest rate of 6.53%, 5.77% and 5.57% and expected lives of 4.00, 4.09 and 5.16 years. Management believes the Black-Scholes option valuation model currently provides the best estimate of fair value. However, the Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of several subjective assumptions. The Company's employee and director stock options have characteristics different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate. In management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee and director stock options. -30- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 2000, 1999 AND 1998 NOTE F - EQUITY TRANSACTIONS - Continued The Company's net loss and net loss per share for 2000, 1999 and 1998 would have been increased to the pro forma amounts indicated below had the fair value method been used for options granted to employees and directors. These effects may not be representative of the future effects of applying this method.
2000 1999 1998 -------------------------- -------------------------- -------------------------- As reported Pro forma As reported Pro forma As reported Pro forma ----------- ----------- ----------- ----------- ----------- ----------- Net loss $(2,859,276) $(3,447,381) $(1,683,257) $(2,201,974) $ (404,061) $ (897,365) Net loss per share - basic/diluted $(.74) $(.89) $(.43) $(.56) $(.10) $(.22)
During 1998, the Company issued a warrant to an outside consultant for the purchase of 12,953 shares of the Company's common stock at $6.25 per share, expiring November 20, 2004, in exchange for recruiting and placement services. The fair value of the warrant granted was calculated on the date of grant using the Black-Scholes option-pricing model. Stock Repurchase Program In April 1998, the Company's Board of Directors authorized a stock repurchase program pursuant to which up to 500,000 shares, or approximately 12.4% of the Company's outstanding common stock, may be repurchased. The shares may be purchased from time to time through open market transactions, block purchases, tender offers, or in privately negotiated transactions. The total consideration for all shares repurchased under this program cannot exceed $2,000,000. During the year ended June 30, 1999, the Company repurchased 175,650 shares for $543,400. There were no shares repurchased during the year ended June 30, 2000. -31- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 2000, 1999 AND 1998 NOTE G - MEDICAL TAPE ASSET IMPAIRMENT AND EXIT PLAN The Company announced that it was exiting the medical tape business effective June 30, 2000 and recorded a charge of $730,000. The Company analyzed all long-lived medical tape assets in connection with this exit and recorded a reduction of $645,000 to their estimated fair market value of $526,000. The Company also recorded a charge of $85,000 to reduce the current carrying value of medical tape inventory to a net realizable value which has been included with costs of goods sold. The Company expects to sell the assets by December 31, 2000. NOTE H - PHARMADYNE CORPORATION AND RESTRUCTURING In October 1997, the Company issued 221,948 new shares of its common stock to acquire the minority interests in Pharmadyne. In November 1997, the newly issued shares were registered with the Securities and Exchange Commission. On December 31, 1997, Pharmadyne Corporation was merged into LecTec Corporation. NOTE I - SEGMENT INFORMATION The Company operates its business in one reportable segment - the manufacture and sale of products based on advanced skin interface technologies. Each of the Company's major product lines have similar economic characteristics, technology, manufacturing processes, and regulatory environments. Customers and distribution and marketing strategies vary within major product lines as well as overlap between major product lines. The Company's executive decision makers evaluate sales performance based on the total sales of each major product line and profitability on a total company basis, due to shared infrastructures, to make operating and strategic decisions. Net sales by major product line were as follows: Years ended June 30, 2000 1999 1998 ----------- ----------- ----------- Conductive products $ 7,450,755 $ 7,758,286 $ 7,906,676 Medical tape products 1,927,392 2,716,540 4,157,199 Therapeutic consumer products 5,218,199 1,804,249 858,490 ----------- ----------- ----------- $14,596,346 $12,279,075 $12,922,365 =========== =========== =========== -32- LECTEC CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED JUNE 30, 2000, 1999 AND 1998 NOTE I - SEGMENT INFORMATION - Continued Export sales accounted for approximately 13%, 13% and 26% of total net sales during the years ended June 30, 2000, 1999, and 1998. Export sales are attributed to geographic region based upon the location of the customer. Export sales by geographic area were as follows: Years ended June 30, 2000 1999 1998 ---------- ---------- ---------- Europe $1,006,412 $1,216,199 $1,705,996 Latin America 547,904 371,654 371,854 Asia 46,279 31,935 62,027 Canada 298,884 7,011 199,082 Middle East 10,272 - 912,240 Other 25,962 28,333 71,949 ---------- ---------- ---------- $1,935,713 $1,655,132 $3,323,148 ========== ========== ========== NOTE J - MAJOR CUSTOMER One customer accounted for 17%, 22% and 18% of total sales for each of the three years ended June 30, 2000. The accounts receivable from this customer represented 18% and 26% of trade receivables at June 30, 2000 and 1999. Management believes that the loss of this customer could have a material adverse effect on the Company. -33- 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 16, 2000, and is incorporated herein by reference. The information required under this item with respect to executive officers is included under the heading "Executive Officers of the Registrant" of Item 1 of this Form 10-K. 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 16, 2000, 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 16, 2000, 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 16, 2000, and is incorporated herein by reference. -34- 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, 2000 and 1999 (iii) Consolidated Statements of Operations for the years ended June 30, 2000, 1999 and 1998 (iv) Consolidated Statements of Comprehensive Loss for the years ended June 30, 2000, 1999 and 1998 (v) Consolidated Statements of Shareholders' Equity for the years ended June 30, 2000, 1999 and 1998 (vi) Consolidated Statements of Cash Flows for the years ended June 30, 2000, 1999 and 1998 (vii) Notes to the Consolidated Financial Statements 2. Financial Statement Schedules (i) Schedule II - Valuation and Qualifying Accounts, for each of the three years in the period ended June 30, 2000 Page 38 (ii) Other Schedules - All other schedules have been omitted because of the absence of the conditions under which they are required or because the required information 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 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. (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. (1) -35- 10.03 Certificate of Secretary pertaining to Resolution of Board of Directors of LecTec Corporation, dated October 30, 1986, implementing a Profit Sharing Bonus Plan. (1) **10.04 LecTec Corporation 1989 Stock Option Plan (2) **10.05 LecTec Corporation 1991 Directors' Stock Option Plan (2) 10.06 Building lease dated May 24, 1991 between LecTec Corporation and Sierra Development Co. for the lease of the manufacturing and warehouse facility located in Edina, Minnesota (2) 10.07 First amendment dated May 5, 1997 between LecTec Corporation and Rushmore Plaza Partners Limited Partnership for the extension of the previous lease of the manufacturing and warehouse facility located in Edina, Minnesota (2) 10.08 Articles of Merger of Pharmadyne Corporation into LecTec Corporation dated December 31, 1997, whereby Pharmadyne, a wholly-owned subsidiary, is merged into LecTec Corporation (3) **10.09 Change In Control Termination Pay Plan adopted May 27, 1998, for the benefit of certain employees of LecTec Corporation in the event of a Change in Control (3) **10.10 LecTec Corporation Employee Stock Purchase Plan (4) **10.11 LecTec Corporation 1998 Stock Option Plan (5) 10.12 LecTec Corporation 1998 Directors' Stock Option Plan (5) 10.13 Letter of Intent dated April 19, 1999 between LecTec Corporation and Johnson & Johnson Consumer Companies, Inc., whereby the parties agree to certain milestones leading to the development of a skin care product (6) 10.14 Credit and Security Agreement by and between LecTec Corporation and Wells Fargo business Credit, Inc. dated November 22, 1999 and First Amendment To Credit and Security Agreement and Waiver of Defaults dated February 9, 2000, whereby the parties agree to the terms and amended terms regarding a line of credit (7) *10.15 Supply Agreement dated as of May 15, 2000 by and between LecTec Corporation and Novartis Consumer Health, Inc., whereby the parties agree to terms for the sale of product from LecTec Corporation to Novartis Consumer Health, Inc. (8) -36- 21.01 Subsidiaries of the Company (8) 23.01 Consent of Grant Thornton LLP (8) 27.01 Financial Data Schedule (8) - - --------------------------------------------------- * Confidential treatment has been 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 United States Securities and Exchange Commission together with a confidential treatment request. ** Management contract or compensatory plan or arrangment required to be filed as an exhibit to this Form 10-K. (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, 1997. (3) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended June 30, 1998. (4) Incorporated herein by reference to the Company's Registration Statement on Form S-8 (file number 333-72571) filed on February 18, 1999. (5) Incorporated herein by reference to the Company's Registration Statement on Form S-8 (file number 333-72569) filed on February 18, 1999. (6) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended June 30, 1999. (7) Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1999. (8) Filed herewith. (b) 1. Reports on Form 8-K. None. -37- LecTec Corporation and Subsidiaries Schedule II Valuation and Qualifying Accounts Three Years Ended June 30, 2000
Balance at Charged to Charge to Balance Beginning of costs and other Deductions at end Description Period expenses accounts (a) of period - - ------------------------------- ------------ ---------- --------- ---------- --------- Allowance for doubtful accounts Year ended June 30, 1998 48,529 48,000 -- 5,711 90,818 Year ended June 30, 1999 90,818 48,000 -- 37,067 101,751 Year ended June 30, 2000 101,751 48,000 -- 22,626 127,125 Allowance for sales returns and credits Year ended June 30, 1998 17,598 71,070 -- -- 88,668 Year ended June 30, 1999 88,668 61,876 -- 93,787 56,757 Year ended June 30, 2000 56,757 345,855 -- 160,206 242,406 Allowance for inventory obsolescence Year ended June 30, 1998 143,438 300,000 -- 233,216 210,222 Year ended June 30, 1999 210,222 243,198 -- 168,811 284,609 Year ended June 30, 2000 284,609 267,911 -- 406,545 145,975
-38- 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, 2000. LECTEC CORPORATION /s/Rodney A. Young ----------------------- Rodney A. Young Chairman, Chief Executive Officer and President (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, 2000 - - ---------------------------------------------------- ------------------ Rodney A. Young Chairman, Chief Executive Officer and President (Principal Executive Officer) /s/Douglas J. Nesbit September 27, 2000 - - ---------------------------------------------------- ------------------ Douglas J. Nesbit Chief Financial Officer (Principal Financial Officer and Accounting Officer) /s/Lee M. Berlin September 27, 2000 - - ---------------------------------------------------- ------------------ Lee M. Berlin Director /s/Bert J. McKasy September 27, 2000 - - ---------------------------------------------------- ------------------ Bert J. McKasy Director /s/Marilyn K. Speedie September 27, 2000 - - ---------------------------------------------------- ------------------ Marilyn K. Speedie /s/Donald C. Wegmiller September 27, 2000 - - ---------------------------------------------------- ------------------ Donald C. Wegmiller Director -39- EXHIBIT INDEX Exhibits - - -------- 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 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). **10.04 LecTec Corporation 1989 Stock Option Plan (Note 2). **10.05 LecTec Corporation 1991 Directors' Stock Option Plan (Note 2). 10.06 Building lease dated May 24, 1991 between LecTec Corporation and Sierra Development Co. for the lease of the manufacturing and warehouse facility located in Edina, Minnesota (Note 2). 10.07 First amendment dated May 5, 1997 between LecTec Corporation and Rushmore Plaza Partners Limited Partnership for the extension of the previous lease of the manufacturing and warehouse facility located in Edina, Minnesota (Note 2). 10.08 Articles of Merger of Pharmadyne Corporation into LecTec Corporation dated December 31, 1997, whereby Pharmadyne, a wholly-owned subsidiary, is merged into LecTec Corporation (Note 3). **10.09 Change In Control Termination Pay Plan adopted May 27, 1998, for the benefit of certain employees of LecTec Corporation in the event of a Change in Control (Note 3). **10.10 LecTec Corporation Employee Stock Purchase Plan (Note 4). **10.11 LecTec Corporation 1998 Stock Option Plan (Note 5). **10.12 LecTec Corporation 1998 Directors' Stock Option Plan (Note 5). 10.13 Letter of Intent dated April 19, 1999 between LecTec Corporation and Johnson & Johnson Consumer Companies, Inc., whereby the parties agree to certain milestones leading to the development of a skin care product (Note 6). 10.14 Credit and Security Agreement by and between LecTec Corporation and Wells Fargo business Credit, Inc. dated November 22, 1999 and First Amendment To Credit and Security Agreement and Waiver of Defaults dated February 9, 2000, whereby the parties agree to the terms and amended terms regarding a line of credit (Note 7). -40- *10.15 Supply Agreement dated as of May 15, 2000 by and between LecTec Corporation and Novartis Consumer Health, Inc., whereby the parties agree to terms for the sale of product from LecTec Corporation to Novartis Consumer Health, Inc...................................... 21.01 Subsidiaries of the Company........................................ 23.01 Consent of Grant Thornton LLP...................................... 27.01 Financial Data Schedule............................................ NOTES: * Confidential treatment has been 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 United States Securities and Exchange Commission together with a confidential treatment request. ** Management contract or compensatory plan or arrangment required to be filed as an exhibit to this Form 10-K. (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, 1997. (3) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended June 30, 1998. (4) Incorporated herein by reference to the Company's Registration Statement on Form S-8 (file number 333-72571) filed on February 18, 1999. (5) Incorporated herein by reference to the Company's Registration Statement on Form S-8 (file number 333-72569) filed on February 18, 1999. (6) Incorporated herein by reference to the Company's Annual Report on Form 10-K for the year ended June 30, 1999. (7) Incorporated herein by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 1999. -41-