SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 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 incorporation or organization) Identification No.) 10701 Red Circle Drive, Minnetonka, Minnesota 55343 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (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 _______ The number of shares outstanding of the registrant's common stock as of February 1, 1997 was 3,835,989 shares. LECTEC CORPORATION FORM 10-Q - QUARTERLY REPORT FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 1996 Table of Contents Part I - Financial Information Item 1. Financial Statements and Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . . I-1 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations . . . . . I-8 Part II - Other Information Item 1. Legal Proceedings . . . . . . . . . . . . . . . . . . . II-1 Item 2. Changes in Securities . . . . . . . . . . . . . . . . . II-1 Item 3. Defaults Upon Senior Securities . . . . . . . . . . . . II-1 Item 4. Submission of Matters to a Vote of Security Holders. . . . . . . . . . . . . . . . II-1 Item 5. Other Information . . . . . . . . . . . . . . . . . . . II-2 Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . II-3 Signature Page. . . . . . . . . . . . . . . . . . . . . II-4
LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited) December 31, June 30, 1996 1996 ----------- ----------- ASSETS CURRENT ASSETS Cash and cash equivalents $ 590,432 $ 800,693 Receivables Trade, net of allowances of $34,185 (unaudited) and $74,208 at December 31, 1996 and June 30, 1996, respectively 2,179,318 1,847,736 Refundable income taxes 55,580 55,580 Other 43,277 182,247 ----------- ----------- 2,278,175 2,085,563 Inventories Raw materials 1,457,279 1,144,078 Work-in-process 532,059 229,974 Finished goods 363,909 637,275 ----------- ----------- Total inventories 2,353,247 2,011,327 Prepaid expenses and other 171,844 123,099 Deferred income taxes 429,000 429,000 ----------- ----------- Total current assets 5,822,698 5,449,682 PROPERTY, PLANT AND EQUIPMENT - AT COST Building and improvements 1,632,423 1,629,630 Equipment 6,480,038 6,414,132 Furniture and fixtures 369,398 354,985 ----------- ----------- 8,481,859 8,398,747 Less accumulated depreciation 3,881,429 3,533,503 ----------- ----------- 4,600,430 4,865,244 Construction in progress 18,632 - Land 247,731 247,731 ----------- ----------- 4,866,793 5,112,975 OTHER ASSETS Patents and trademarks, less accumulated amortization of $768,136 (unaudited) and $687,871 at December 31, 1996 and June 30, 1996, respectively 402,321 417,681 Goodwill, less accumulated amortization of $540,837 (unaudited) and $442,503 at December 31, 1996 and June 30, 1996, respectively 49,163 147,497 Long-term investments 591,159 574,806 Investment in limited liability company 522,924 606,167 Other 258 10,195 ----------- ----------- 1,565,825 1,756,346 ----------- ----------- $12,255,316 $12,319,003 =========== =========== See accompanying notes to the consolidated financial statements.
LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited) December 31, June 30, 1996 1996 ------------ ------------ LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Accounts payable $ 736,127 $ 894,846 Accrued expenses Payroll related 362,315 304,527 Other 173,393 10,285 ------------ ------------ Total current liabilities 1,271,835 1,209,658 DEFERRED INCOME TAXES 174,000 174,000 SHAREHOLDERS' EQUITY Common stock, $.01 par value: 15,000,000 shares authorized; issued and outstanding: 3,836,000 shares (unaudited) at December 31, 1996 and 3,835,800 shares at June 30, 1996 38,360 38,358 Additional paid-in capital 10,452,887 10,368,166 Unrealized losses on securities available-for-sale (27,813) (44,166) Retained earnings 346,047 572,987 ------------ ------------ 10,809,481 10,935,345 ------------ ------------ $ 12,255,316 $ 12,319,003 ============ ============ See accompanying notes to the consolidated financial statements.
LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (Unaudited) Three months ended Six months ended December 31, December 31, -------------------------- -------------------------- 1996 1995 1996 1995 ----------- ----------- ----------- ----------- Net sales $ 3,028,118 $ 3,255,110 $ 6,001,601 $ 6,717,561 Cost of goods sold 1,938,591 1,957,457 3,836,985 4,080,704 ----------- ----------- ----------- ----------- Gross profit 1,089,527 1,297,653 2,164,616 2,636,857 Operating expenses Selling, general and administrative 882,157 1,468,050 1,435,373 2,409,540 Research and development 411,726 503,518 911,928 1,014,551 ----------- ----------- ----------- ----------- 1,293,883 1,971,568 2,347,301 3,424,091 ----------- ----------- ----------- ----------- Loss from operations (204,356) (673,915) (182,685) (787,234) Other income (expense) Interest income (8,737) 5,782 8,018 15,605 Dividend income 10,117 10,937 19,549 20,068 Interest expense (33) (6,415) (1,263) (6,415) Other - - 15,000 - ----------- ----------- ----------- ----------- 1,347 10,304 41,304 29,258 ----------- ----------- ----------- ----------- Loss before income taxes and equity in losses of unconsolidated subsidiary (203,009) (663,611) (141,381) (757,976) Income tax expense 913 176 2,316 1,177 ----------- ----------- ----------- ----------- Loss before equity in losses of unconsolidated subsidiary (203,922) (663,787) (143,697) (759,153) Equity in losses of unconsolidated subsidiary 60,402 - 83,243 - ----------- ----------- ----------- ----------- Net loss $ (264,324) $ (663,787) $ (226,940) $ (759,153) =========== =========== =========== =========== Net loss per common share ($ 0.07) ($ 0.17) ($ 0.06) ($ 0.20) Weighted average number of common shares outstanding during the period 3,835,989 3,796,824 3,835,973 3,792,566 See accompanying notes to the consolidated financial statements.
LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Unaudited) Six months Six months Ended Ended December 31, December 31, 1996 1995 --------- --------- Cash flows from operating activities: Net loss $(226,940) $(759,153) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization 526,525 540,304 Gain on sale of equipment (15,000) - Equity in losses of unconsolidated subsidiary 83,243 - Changes in operating assets and liabilities: Trade and other receivables (192,612) 189,166 Inventories (341,920) (374,784) Prepaid expenses and other (38,808) (76,380) Accounts payable (75,124) 5,944 Accrued expenses 220,896 283,154 --------- --------- Net cash used in operating activities (59,740) (191,749) Cash flows from investing activities: Purchase of property, plant and equipment (101,744) (222,873) Proceeds from sale of equipmnent 15,000 - Investment in patents and trademarks (64,905) (67,488) --------- --------- Net cash used in investing activities (151,649) (290,361) Cash flows from financing activities: Issuance of common stock 1,128 50,206 Proceeds from notes payable - 83,595 --------- --------- Net cash provided by financing activities 1,128 133,801 --------- --------- Net decrease in cash and cash equivalents (210,261) (348,309) Cash and cash equivalents at beginning of period 800,693 839,942 --------- --------- Cash and cash equivalents at end of period $ 590,432 $ 491,633 ========= ========= See accompanying notes to the consolidated financial statements.
LECTEC CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited) (Unaudited) Six months Six months Ended Ended December 31, December 31, 1996 1995 ----------- --------- Supplemental Disclosures of Cash Flow Information: Cash paid during the period for: Interest expense $ 5,957 $ - Income taxes 6,000 20,725 Supplemental Schedule Of Noncash Activities: Conversion of subsidiary's notes payable to equity $ 83,595 $ - During fiscal 1996 the Company recorded the disposition of certain assets. The effect of the transaction during the six months ended December 31, 1995 was as follows: Reduction of accounts receivable $ 9,168 Reduction of inventories 420,988 Reduction of prepaid expenses and other 185,765 Reduction of property and equipment 156,160 Reduction of accumulated depreciation (69,215) --------- $ 702,866 ========= See accompanying notes to the consolidated financial statements.
LECTEC CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements Quarters Ended December 31, 1996 and 1995 (1) General The accompanying consolidated financial statements include the accounts of LecTec Corporation (the "Company"), LecTec International Corporation, a wholly-owned subsidiary, and Pharmadyne Corporation, a sixty-one percent owned subsidiary. All significant intercompany balances and transactions have been eliminated in consolidation. The Company's financial statements for the three and six months ended December 31, 1996 should be read in conjunction with its Annual Report on Form 10-K and its Annual Report to Shareholders for the fiscal year ended June 30, 1996. The interim financial statements are unaudited and in the opinion of management, reflect all adjustments (which consist only of adjustments of a normal recurring nature) necessary for a fair presentation of results for the periods presented. Results for interim periods are not necessarily indicative of results for the year. (2) Increase in Ownership Interest in Pharmadyne Corporation On September 5, 1996 the Company exercised a warrant to purchase 227,959 additional shares of Pharmadyne Corporation at $1 per share by converting a portion of an outstanding note receivable with Pharmadyne. This increased the Company's ownership interest in Pharmadyne Corporation from 51% to 61%. (3) Recently Adopted Accounting Standards The Company implemented Statement of Financial Accounting Standards (SFAS) 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," effective July 1, 1996. SFAS 121 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. The adoption of this Standard did not have a material effect on the Company's financial position. Additionally, the Company implemented SFAS 123 "Accounting for Stock-Based Compensation," which established 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. The Company adopted this Standard effective July 1, 1996, and management has elected to utilize the intrinsic value based method of accounting for stock-based compensation. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Three and Six Months Ended December 31, 1996 and 1995 Results of Operations Net sales for the second quarter of fiscal 1997 were $3,028,118 as compared with $3,255,110 for the second quarter of fiscal 1996, a decrease of 7.0%. The decrease was primarily the result of the absence of Pharmadyne Corporation direct marketing related sales due to the divestiture of the direct marketing related assets in the third quarter of fiscal 1996. Conductive product sales, the Company's largest product group, decreased by 0.7% from the prior year while medical tape sales increased by 42.4% and therapeutic product sales decreased by 70.5%. Medical tape sales increased primarily due to volume increases and sales to several new customers. The therapeutic product sales decrease was primarily the result of the absence of direct marketing related sales as discussed above. Net sales for the first six months of fiscal 1997 were $6,001,601 as compared with $6,717,561 for the first six months of fiscal 1996, a decline of 10.7%. The decrease was also due primarily to the absence of Pharmadyne Corporation direct marketing related sales due to the divestiture of the direct marketing related assets in the third quarter of fiscal 1996. Conductive sales increased by 5.3% from the prior year primarily as a result of volume increases and the timing of orders from major customers. Medical tape sales decreased by 1.5% from the prior year. Therapeutic product sales decreased 66.1% from the prior year primarily as a result of the absence of Pharmadyne direct marketing related sales as discussed above. Gross profit for the second quarter of fiscal 1997 was $1,089,527 as compared with $1,297,653 for the second quarter of fiscal 1996. Gross profit as a percent of net sales for the second quarter of fiscal 1997 was 36.0% as compared to 39.9% for the second quarter of fiscal 1996. The decrease in gross profit percent for the quarter was primarily the result of the absence of higher margin Pharmadyne direct marketing related sales. Gross profit for the first six months of fiscal 1997 was $2,164,616 as compared with $2,636,857 for the first six months of fiscal 1996. Gross profit as a percent of net sales for the first six months of fiscal 1997 was 36.1% as compared to 39.3% for the first six months of fiscal 1996. The decrease in gross profit percent for the first six months was also primarily the result of the absence of higher margin Pharmadyne direct marketing related sales. Selling, general and administrative expenses were $882,157 and $1,468,050 during the second quarters of fiscal 1997 and fiscal 1996, respectively, and as a percentage of net sales, were 29.1% and 45.1%, respectively. Selling, general and administrative expenses were $1,435,373 and $2,409,540 during the first six months of fiscal 1997 and fiscal 1996, respectively, and as a percentage of net sales were 23.9% and 35.9%, respectively. The decrease in selling, general and administrative expenses for both the quarter and first six months was primarily due to the absence in fiscal 1997 of expenses associated with the direct marketing operations of the Pharmadyne subsidiary. These decreases were partially offset by an increase in administrative expenses associated with hiring a new executive staff, separation costs associated with several former executives and expanding the sales and marketing department. Research and development expenses for the second quarters of fiscal 1997 and 1996 were $411,726 and $503,518, respectively, and as a percentage of net sales, were 13.6% and 15.5%, respectively. Research and development expenses for the first six months of fiscal 1997 decreased to $911,928 from $1,014,551 in the first six months of fiscal 1996. Research and development expenses for the first six months, as a percentage of net sales, were 15.2% and 15.1% for fiscal 1997 and 1996, respectively. The decrease in R&D expense for both the quarter and first six months reflects reductions in research costs associated with the further development of the cotinine-based smoking cessation product. Other income decreased in the second quarter of fiscal 1997 to $1,347 from $10,304 in the second quarter of fiscal 1996. Other income increased in the first six months of fiscal 1997 to $41,304 from $29,258 in the first six months of fiscal 1996. The decline in the second quarter resulted primarily from a reduction of interest income. The increase in the first six months resulted primarily from a gain on the sale of equipment recorded in the first quarter of fiscal 1997. The Company had a loss before income taxes and equity in losses of an unconsolidated subsidiary of $203,009 for the second quarter of fiscal 1997 compared to a loss of $663,611 for the second quarter of fiscal 1996. The Company had a loss before income taxes and equity in losses of an unconsolidated subsidiary of $141,381 for the first six months of fiscal 1997 compared to a loss of $757,976 for the first six months of fiscal 1996. The decrease in the loss for both the three and six month periods compared to the prior year was primarily the result of the absence in fiscal 1997 of the losses from the direct marketing operations of the Pharmadyne subsidiary. The Company did not record a tax benefit in connection with losses generated for the three and six month periods ended December 31, 1996 and 1995 due to the uncertainty of the future realization of such tax benefits. On March 12, 1996, the Company contributed the direct marketing related assets of Pharmadyne Corporation to Natus L.L.C. (an Arizona limited liability company) in exchange for a 15% interest in Natus L.L.C. During the second quarter and first six months of fiscal 1997, the Company's pro-rata share of Natus L.L.C.'s net loss (based on a 15% equity ownership position) totaled $60,402 and $83,243, respectively. 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 $210,261 to $590,432 during the first six months of fiscal 1997. Long-term investments increased by $16,353 to $591,159 during the first six months of fiscal 1997 due to investment value appreciation. Capital spending for various equipment totaled $101,744 during the first six months of fiscal 1997. There were no material commitments for capital expenditures at December 31, 1996. Working capital, at the end of the first six months of fiscal 1997, increased to $4,550,863 from $4,240,024 at the end of fiscal 1996. The Company has a current ratio at the end of the first six months of fiscal 1997 of 4.58 as compared to 4.51 at the end of fiscal 1996. The Company has no outstanding short or long-term debt at December 31, 1996, and is currently negotiating a short-term revolving line of credit in the event it is needed to meet current operating requirements. Shareholders' equity decreased by $125,864 to $10,809,481 during the first six months of fiscal 1997. Management believes that internally-generated cash, existing cash and investment assets and the anticipated short-term credit line will be sufficient for supporting anticipated growth and capital spending requirements for the remainder of fiscal 1997. Statements about the remaining 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. PART II OTHER INFORMATION Item 1. Legal Proceedings None. Item 2. Changes in Securities There have been no changes in the rights of security holders. Item 3. Defaults Upon Senior Securities Not applicable. Item 4. Submission of Matters to a Vote of Security Holders The Regular Annual Meeting of Shareholders of the Company was held on November 18, 1996. The following matters were voted on by Shareholders: 1. The election of five directors to serve on the Board of Directors for a term of one year and until their successor is duly elected and qualified. 2. The ratification of the appointment of Grant Thornton, LLP as the Company's independent auditor for the Company's current fiscal year. 3. The approval of an amendment to increase the shares reserved for the 1989 Stock Option Plan from 500,000 shares to 800,000 shares. 4. The approval of an amendment to the 1989 Stock Option Plan to allow for gifting of fully vested and exercisable options. 5. The approval of an amendment to the 1991 Directors' Stock Option Plan to allow for gifting of fully vested and exercisable options. The results of the voting on these matters were as follows: 1. Board of Directors: For Against/Abstain Total --- --------------- ----- Lee M. Berlin 3,256,935 237,548 3,494,483 Alan C. Hymes 3,252,212 242,271 3,494,483 Paul O. Johnson 2,958,643 535,840 3,494,483 Alan J. Wilensky 3,185,679 308,804 3,494,483 Rodney A. Young 3,428,122 66,361 3,494,483 Write in votes: Thomas E. Brunelle 3,003 2. Appointment of Grant Thornton, LLP as independent auditor for the Company: For Against Abstain Total --- ------- ------- ----- 3,414,009 42,590 37,884 3,494,483 3. Increase shares reserved for the 1989 Stock Option Plan: For Against Abstain Total --- ------- ------- ----- 3,267,067 177,743 49,673 3,494,483 4. Allow for gifting of fully vested and exercisable options - 1989 Stock Option Plan: For Against Abstain Total --- ------- ------- ----- 2,934,032 484,885 75,566 3,494,483 5. Allow for gifting of fully vested and exercisable options - 1991 Directors' Stock Option Plan: For Against Abstain Total --- ------- ------- ----- 2,929,940 493,067 71,476 3,494,483 Item 5. Other Information The registrant is not aware of any other information of material importance to be included in this report. Item 6. Exhibits and Reports on Form 8-K (a) Exhibits None. (b) Reports on Form 8-K None. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. LECTEC CORPORATION Date February 14, 1997 /s/ Rodney A. Young ------------------- ---------------------------------- Rodney A. Young, CEO & Pres.