UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-QSB
[X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005.
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE ACT FOR THE
TRANSITION PERIOD FROM _______________ to______________
Commission file number: 0-16159
LECTEC CORPORATION
---------------------------
(Exact name of small business issuer as specified in its charter)
Minnesota 41-1301878
- ------------------------------------------ --------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5616 Lincoln Drive, Edina, Minnesota 55436
- ------------------------------------------ --------------------
(Address of principal executive offices) (Zip Code)
(952) 933-2291
---------------------------
(Issuer's telephone number)
Not Applicable
---------------------------
(Former name, former address and former fiscal year, if changed from last
report)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days:
Yes [X] No [ ]
The number of shares outstanding of the issuer's common stock as of May 13, 2005
was 4,153,998 shares.
Transitional Small Business Disclosure Format (Check one):
Yes [ ] No [X]
LECTEC CORPORATION
REPORT ON FORM 10-QSB FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2005
TABLE OF CONTENTS
PART I - FINANCIAL INFORMATION
Item 1. Condensed Financial Statements and Notes to Condensed Financial Statements (unaudited) I-1
Item 2. Management's Discussion and Analysis or Plan of Operation......................... I-8
Item 3. Controls and Procedures........................................................... I-11
PART II - OTHER INFORMATION
Item 1. Legal Proceedings................................................................. II-1
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds....................... II-1
Item 3. Defaults Upon Senior Securities................................................... II-1
Item 4. Submission of Matters to a Vote of Security Holders............................... II-1
Item 5. Other Information................................................................. II-1
Item 6. Exhibits.......................................................................... II-1
Signature Page.................................................................... II-2
FORWARD-LOOKING STATEMENTS
From time to time, in reports filed with the Securities and Exchange
Commission (including this Form 10-QSB), in press releases, and in other
communications to shareholders or the investment community, the Company may
provide forward-looking statements concerning possible or anticipated future
results of operations or business developments which are typically preceded by
the words "believes", "expects", "anticipates", "intends", "will", "may",
"should" or similar expressions. Such forward-looking statements are subject to
risks and uncertainties which could cause results or developments to differ
materially from those indicated in the forward-looking statements. Such risks
and uncertainties include, but are not limited to, the Company's dependence on
royalty payments from Novartis Consumer Health, Inc. ("Novartis") and on key
personnel, the success or failure of any attempt by the Company to protect or
enforce its patents, issuance of new accounting pronouncements; available
opportunities for licensing agreements related to patents that the Company
holds, and other risks and uncertainties as described in the "Cautionary
Statements" filed as Exhibit 99.01 to the Company's Report on Form 10-KSB for
the year ended December 31, 2004.
PART 1 - FINANCIAL INFORMATION
ITEM 1 - CONDENSED FINANCIAL STATEMENTS AND NOTES TO CONDENSED FINANCIAL
STATEMENTS
LECTEC CORPORATION
CONDENSED BALANCE SHEETS
March 31, December 31,
2005 2004
------------- ------------
(Unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,551,586 $ 2,239,318
Royalty income receivable 81,296 -
Prepaid expenses and other 97,188 137,981
Discontinued operations 1,224 192,629
------------- ------------
Total current assets 1,731,294 2,569,928
OTHER ASSETS:
Patents and trademarks 46,271 50,693
Prepaid insurance - director and officer 172,374 182,513
------------- ------------
218,645 233,206
------------- ------------
$ 1,949,939 $ 2,803,134
============= ============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term obligations $ 1,292 $ 2,525
Accounts payable 34,030 4,944
Accrued expenses 100,132 240,293
Discontinued operations 98,350 273,290
------------- ------------
Total current liabilities 233,804 521,052
------------- ------------
COMMITMENTS AND CONTINGENCIES - -
SHAREHOLDERS' EQUITY:
Common stock, $.01 par value; 15,000,000 shares
authorized; 4,147,998 and 4,030,330 shares
issued and outstanding at March 31, 2005 and
December 31, 2004, respectively 41,480 40,303
Additional contributed capital 11,957,351 11,689,404
Accumulated deficit (10,282,696) (9,447,625)
------------- ------------
1,716,135 2,282,082
------------- ------------
$ 1,949,939 $ 2,803,134
============= ============
The accompanying notes are an integral part of these condensed financial
statements.
I-1
LECTEC CORPORATION
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended March 31,
2005 2004
------------ ------------
(Restated)
CONTINUING OPERATIONS:
Revenue - royalty and licensing fee income $ 81,296 $ -
Operating expenses 459,607 359,732
------------ ------------
Loss from continuing operations (378,311) (359,732)
------------ ------------
DISCONTINUED OPERATIONS:
Earnings (loss) from discontinued operations (209,936) 434,459
------------ ------------
Net earnings (loss) $ (588,247) $ 74,727
============ ============
Weighted average common shares outstanding:
Basic and diluted 4,089,399 3,979,327
Earnings (loss) per share:
Basic and diluted -
Continuing operations $ (0.09) $ (0.09)
Discontinued operations (0.05) 0.11
------------ ------------
Total $ (0.14) $ 0.02
============ ============
The accompanying notes are an integral part of these condensed financial
statements.
I-2
LECTEC CORPORATION
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Months ended March 31,
2005 2004
----------- -----------
(Restated)
Cash flows from operating activities:
Loss from continuing operations $ (378,311) $ (359,732)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Earnings (loss) from discontinued operations (209,936) 434,459
Depreciation and amortization 4,422 90,843
Compensation expense related to re-priced stock options 179,707 76,765
Changes in continuing operating assets and liabilities:
Royalty income receivable (81,296) -
Prepaid expenses and other 50,932 (20,291)
Accounts payable 29,086 8,794
Accrued expenses (140,161) 21,957
Change in net assets and liabilities of discontinued operations 16,465 31,074
----------- -----------
Net cash provided by (used in) operating activities (529,092) 283,869
Cash flows from investing activities:
Investment in patents and trademarks - (31,473)
----------- -----------
Cash flows from financing activities:
Cash dividends paid (246,824) -
Proceeds from exercises of stock options 89,417 -
Repayment of long-term obligations (1,233) (2,734)
----------- -----------
Net cash used in financing activities (158,640) (2,734)
----------- -----------
Net increase (decrease) in cash and cash equivalents (687,732) 249,662
Cash and cash equivalents - beginning of period 2,239,318 483,844
----------- -----------
Cash and cash equivalents - end of period $ 1,551,586 $ 733,506
=========== ===========
Supplemental disclosures of cash flow information:
Cash paid for interest $ 2,340 $ 1,455
The accompanying notes are an integral part of these condensed financial
statements.
I-3
LECTEC CORPORATION
NOTES TO CONDENSED FINANCIAL STATEMENTS
MARCH 31, 2005 AND 2004
(UNAUDITED)
(1) GENERAL
The accompanying condensed financial statements include the accounts of
LecTec Corporation (the "Company") as of March 31, 2005 and December 31, 2004
and for the three month periods ended March 31, 2005 and 2004. The Company's
condensed financial statements have been prepared in accordance with accounting
principles generally accepted in the United States of America and should be read
in conjunction with the Company's Annual Report on Form 10-KSB for the year
ended December 31, 2004. The interim condensed financial statements are
unaudited and in the opinion of management, reflect all adjustments necessary
for a fair presentation of results for the periods presented. Results for
interim periods are not necessarily indicative of results for the full year.
(2) BUSINESS SUMMARY AND CRITICAL ACCOUNTING POLICIES
BUSINESS SUMMARY
The Company is currently an intellectual property licensing and holding
company. The Company receives royalties and licensing fees from licensing
agreements pertaining to the Company's patents. The Company currently has one
licensing agreement ("Novartis Agreement" or "Agreement") with Novartis Consumer
Health, Inc. ("Novartis"), which pays royalties to the Company on a semi-annual
basis based upon a percentage of Novartis net sales. The Company was a contract
manufacturer of hydrogel topical patches sold to major pharmaceutical customers
until the Company ceased its manufacturing operations in December 2004. See the
discussion under "Licensing and Supply Agreement" in Note 5 of Part I, Item 1
for a description of the agreement with Novartis.
CRITICAL ACCOUNTING POLICIES
Some of the Company's most critical accounting policies include:
Revenue Recognition. Royalty and licensing income is recognized when
earned under the terms of the agreements with customers and collection is
reasonably assured. Revenue from sales from discontinued operations was
recognized when the product was shipped to the customer and collection was
probable.
Impairment of Long-Lived Assets. The carrying value of long-lived
assets is reviewed quarterly or when factors indicating impairment are present.
The amount of impairment loss is measured as the amount by which the carrying
value of the assets exceeds the fair value of the assets. The Company believes
no impairment exists at March 31, 2005.
Royalty Income Receivable. The Company currently has royalty income
receivable under the terms of the licensing and supply agreement with Novartis.
The Company granted credit to Novartis in the normal course of business and
management believes, based upon past experience, that all amounts outstanding
are fully collectible.
Accounting for Discontinued Operations. Under the provisions of
Statement of Financial Accounting Standard ("SFAS") No. 144, if a component of
an entity is either classified as held-for-sale or has been disposed of during
the period, the results of its operations are to be reported in discontinued
operations, provided that both of the following conditions are met:
- The operations and cash flows of the component have been or
will be removed from the ongoing operations of the entity as a
result of the disposal transaction, and
- The entity will have no significant continuing involvement in
the operations of the component after the disposal
transaction.
I-4
The Company exited from manufacturing operations of topical patches and
sold off all of its manufacturing assets related to the production of patches to
its only remaining customer, Novartis, as of December 31, 2004. The assets
related to the Company's manufacturing operations have been classified as
discontinued operations due to the sale of the manufacturing assets prior to
December 31, 2004. The operations and cash flows of the contract manufacturing
operations were eliminated from the ongoing operations as a result of the sale
transaction. The surviving entity (intellectual property licensing and holding
company) will not have any significant involvement in the operations of the
previously sold manufacturing operations. It is therefore management's position
that the conditions for reporting the Company's financial statements under the
requirements of SFAS 144 as discontinued operations has been satisfied. The
comparative 2004 condensed statements of operations and cash flows have been
restated to conform to the 2005 presentation.
The Company used reasonable judgment combined with quantitative
analysis in determining the amounts of assets, liabilities, revenues and
expenses that would be allocated between continuing operations and discontinued
operations.
Stock Based Compensation. In January 2005, the Company extended the
exercise period for options held by two former executive officers of the Company
and one former employee by two years from the date of their respective
termination dates (but not longer than the options normal expiration date, if
earlier). There were 222,667 options with a weighted average exercise price of
$0.83 per share subject to this modification to the exercise period. Normally
these options would expire ninety days from the employees termination date.
Because of this modification to the exercise period of these options for these
former employees, the Company recorded compensation expense of $99,957 for the
first quarter ended March 31, 2005.
In July 2002, 803,958 stock options with a weighted average exercise
price of $4.54 per share were re-priced to $0.81 per share. At March 31, 2005,
145,000 of these options were outstanding and were exercisable. No compensation
expense was recorded by the Company in connection with the re-pricing because
the exercise price exceeded the market price on the date of the re-pricing. On
March 31, 2005, the market price for the Company's common stock was above the
exercise price of the re-priced options. Accordingly, the Company recorded
additional compensation expense of $79,750 for the three months ended March 31,
2005. For the three months ended March 31, 2004, the Company recorded
compensation expense of $76,765 in connection with the re-pricing.
The Company utilizes the intrinsic value method of accounting for stock
based employee compensation plans. All options granted had an exercise price
equal to the market value of the underlying common stock on the date of grant,
and no compensation cost related to stock option grants is reflected in net
income or loss for the three months ended March 31, 2005 and 2004. The following
table illustrates the effect on net earnings (loss) if the Company had applied
the fair value recognition provisions of SFAS No. 123, Accounting for
Stock-Based Compensation:
Three months ended March 31,
---------------------------
2005 2004
----------- ----------
Net earnings (loss), as reported $ (588,247) $ 74,727
Less compensation expense
determined under the fair value
method - (26,805)
---------- ---------
Pro-forma net earnings (loss) $ (588,247) $ 47,922
========== =========
Net earnings (loss) per share:
As reported -
Basic and diluted earnings (loss) per share
Continuing operations $ (0.09) $ (0.09)
Discontinued operations (0.05) 0.11
---------- ---------
Total $ (0.14) $ 0.02
========== =========
I-5
Pro forma -
Basic and diluted earnings (loss) per share
Continuing operations $ (0.09) $ (0.10)
Discontinued operations (0.05) 0.11
---------- ---------
Total $ (0.14) $ 0.01
========== =========
The pro-forma information above should be read in conjunction with the
related historical information.
There were no stock options granted during the three months ended March
31, 2005. The weighted average fair value of options granted during the three
months ended March 31, 2004 was $1.09. The fair value of each option grant is
estimated on the date of grant using the Black-Scholes option valuation model
with the following weighted-average assumptions used for all grants during the
three months ended March 31, 2004; zero dividend yield, expected volatility of
179%, risk-free interest rates of 2.72% and expected lives of 3.0 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.
(3) NET EARNINGS (LOSS) PER SHARE
Basic net earnings (loss) per share is computed by dividing net
earnings (loss) by the weighted average number of common shares outstanding.
Diluted net earnings (loss) per share is computed by dividing net earnings
(loss) by the weighted average number of common shares outstanding and common
share equivalents related to stock options and warrants when dilutive. Common
stock options and warrants to purchase 632,750 and 302,861 shares of common
stock with a weighted average exercise price of $2.00 and $4.39 were outstanding
as of March 31, 2005 and 2004, respectively. As the Company had a loss from
continuing operations during the three months ended March 31, 2005 and 2004,
those shares were excluded from the net earnings (loss) per share computations
because they were antidilutive.
(4) INCOME TAXES
The provision for income tax benefits for the three months ended March
31, 2005, was offset principally by a valuation allowance for deferred taxes. No
federal or state income taxes were provided for the three months ended March 31,
2004, due to available tax credit and net operating loss carryforwards.
(5) LICENSING AND SUPPLY AGREEMENT
On July 19, 2004, the Company entered into the Novartis Agreement,
effective as of January 1, 2004. The Agreement replaced the Company's prior
licensing and supply agreement with Novartis dated May 8, 2002. The Agreement
requires the Company to manufacture, sell and deliver to Novartis vapor patches
for sale to the pediatric market in the United States, Canada and Mexico. In
order to provide the Company with working capital funds necessary to enable it
to manufacture and deliver vapor patches to Novartis in accordance with the
Agreement, Novartis advanced up to $2,000,000 for use by the Company to pay
current accounts payable and expenses incurred exclusively for the manufacture
and delivery of vapor patches. In consideration of any advanced funds, the
Company executed and delivered to Novartis a promissory note of $2,000,000 and a
security agreement. Under the security agreement, the Company pledged
substantially all of its assets. The note was repaid by the Company by the
delivery to Novartis of vapor patches under the Agreement. All amounts owed were
repaid as of December 31, 2004. Under the Agreement, Novartis had the option
until March 31, 2005, to extend the use of vapor patches to the adult cough/cold
category in the United States, Canada and Mexico at no additional cost and under
the same terms and conditions as set forth in the Agreement. On March 31, 2005,
Novartis notified the Company of its intention to enter the adult market
pursuant to the Agreement.
I-6
Under the Agreement, the Company granted Novartis an exclusive license
(the "License") to all of the intellectual property of the Company to the extent
that it is used or useful in the production of the vapor patches being supplied
under the Agreement for a fee of $1,065,000, which was paid to the Company by
Novartis as follows: (1) release of $250,000 in promissory note debt as of the
date of the Agreement, (2) payment of $407,500 in cash in July 2004, and (3)
payment of $407,500 in cash in September 2004. The License began on July 19,
2004, and will continue for the duration of any patents included in the licensed
intellectual property and, with respect to all other elements of the licensed
intellectual property, for the maximum duration permitted under applicable law
(fourteen years). Upon the expiration of the patents included in the licensed
intellectual property, Novartis will have a non-revocable, perpetual, fully
paid-up license to the intellectual property used or useful in the production of
vapor patches for the pediatric market and the adult cough/cold market.
Commencing on January 1, 2005, Novartis is required by the Agreement to pay
royalties, at an agreed upon percentage, to the Company, based upon the net
semi-annual sales of vapor patches by Novartis for each year the License is in
effect.
The supply portion of the Agreement continued in effect until February
5, 2005, except that the provisions relating to the License will continue in
effect until the conclusion of the term of the License. The Company may not
assign or otherwise transfer the Agreement (other than to an affiliate) without
the prior written consent of Novartis, except that the Company may assign the
Agreement in connection with the transfer or sale of all or substantially all of
its assets or business or its merger or consolidation with another company, so
long as (1) such acquirer or successor in interest agrees in writing to be bound
by all conditions of the Agreement, and (2) the Company gives Novartis written
notice of any such assignment and 15 days to object. Novartis may object to an
assignment only if such acquirer or successor is a direct competitor of
Novartis.
In conjunction with the signing of the Agreement, Novartis purchased
certain manufacturing equipment from the Company for approximately $900,000
during the second half of 2004.
(6) DISCONTINUED OPERATIONS
Discontinued operations assets and liabilities and revenues includes the
following:
(Unaudited)
March 31, December 31,
2005 2004
----------- ------------
DISCONTINUED OPERATIONS - ASSETS
Accounts receivable, net $ - $ 176,207
Prepaid expenses and other 1,224 16,422
----------- -----------
Total discontinued operations - assets $ 1,224 $ 192,629
=========== ==========
DISCONTINUED OPERATIONS - LIABILITIES
Accounts payable $ - $ 21,267
Accrued expenses - 152,023
Reserve for sales returns and credits 98,350 100,000
----------- -----------
Total discontinued operations - liabilities $ 98,350 $ 273,290
=========== ==========
Revenues for the three months ended March 31, 2005 and 2004 $ - $2,479,300
=========== ==========
I-7
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
RESULTS OF OPERATIONS
In July 2004, management determined that the Company would wind down
and cease its contract manufacturing operations by December 31, 2004. Because of
this, the past and future financial results related to contract manufacturing
have been treated as discontinued operations for financial reporting purposes.
Continuing operations consist of operations related to the surviving
intellectual property licensing and holding company. The Company accounts for
its discontinued operations under the provisions of SFAS No. 144, "Accounting
for the Impairment or Disposal of Long-Lived Assets ". Accordingly, results of
operations and the related charges for discontinued operations have been
classified as "Earnings (loss) from discontinued operations" in the accompanying
Condensed Statements of Operations. Assets and liabilities of the discontinued
operations have been reclassified and reflected on the accompanying Balance
Sheets as "Discontinued operations". For comparative purposes, all prior periods
presented were restated to reflect the reclassifications on a consistent basis.
COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2005 AND 2004
RESULTS OF CONTINUING OPERATIONS
The Company recorded royalty income of $81,296 during the first quarter
ended March 31, 2005. The Company had no sales or revenue from continuing
operations for the three month period ended March 31, 2004.
The Company recorded a net loss from continuing operations of
$(378,311), or $(0.09) per basic and diluted share, for the first quarter of
2005 compared to a net loss from continuing operations of $(359,732), or $(0.09)
per basic and diluted share, for the first quarter of 2004. The slight increase
in net loss from continuing operations for the first quarter of 2005 compared to
the prior year quarter was primarily due to the recognition of royalty income
during the first quarter of 2005, partially offset by costs incurred during the
first quarter of 2005 associated with the Company's move from its Minnetonka,
Minnesota facility to its leased facility in Edina, Minnesota, office equipment
lease buyout costs, higher legal, audit and tax fees, and higher board of
director's fees and expenses.
RESULTS OF DISCONTINUED OPERATIONS
The loss from discontinued operations for the quarter ended March 31,
2005 was $(209,936), or $(0.05) per basic and diluted share, compared to
earnings from discontinued operations of $434,459 or $0.11 per basic and diluted
share for the same period in 2004. There were no net sales from discontinued
operations for the first quarter of 2005. For the first quarter of 2004, sales
to the Company's largest customer, Novartis, were $1,507,034. The decline in the
earnings from discontinued operations for the first quarter of 2005 over the
same period in 2004 is attributable to the completion of the wind down of
contract manufacturing operations coupled with higher stock compensation
expense.
NET RESULTS OF OPERATIONS
The net loss for the three months ended March 31, 2005 was $(588,247),
or $(0.14) per basic and diluted share, compared to net earnings of $74,727, or
$0.02 per basic and diluted share for the three months ended March 31, 2004. The
overall decline in results of operations for the quarter ended March 31, 2005
over the same period in the prior year is primarily due to the absence of net
sales and gross profit from discontinued operations related to the wind down of
contract manufacturing operations and the reasons stated above.
INCOME TAXES
The provision for income tax benefits for the first quarter of 2005 was offset
principally by a valuation allowance for deferred taxes. No federal or state
income taxes were provided for the first quarter of 2004, due to available tax
credit and net operating loss carryforwards for that period.
EFFECT OF INFLATION
Inflation has not had a significant impact on the Company's operations or cash
flow.
I-8
WIND DOWN OF MANUFACTURING OPERATIONS
In September 2003, the Company learned that, as a result of a change in
its internal supplier selection criteria, Novartis, the Company's largest
customer, intended to stop using the Company as a contract manufacturer for its
topical patches by the end of 2004. In addition, Johnson & Johnson Consumer
Products Company, the Company's second largest customer, also indicated that it
intended to stop using the Company as a contract manufacturer during 2004. Based
on this situation and without any other manufacturing prospects, in July 2004,
the Board of Directors determined that the Company would cease manufacturing
operations by December 31, 2004 and become an intellectual property licensing
and holding company.
On July 19, 2004, the Company entered into the Novartis Agreement,
effective as of January 1, 2004. The Agreement replaced the Company's prior
licensing and supply agreement with Novartis dated May 8, 2002. The Agreement
requires the Company to manufacture, sell and deliver to Novartis vapor patches
for sale to the pediatric market in the United States, Canada and Mexico. In
order to provide the Company with working capital funds necessary to enable it
to manufacture and deliver vapor patches to Novartis in accordance with the
Agreement, Novartis advanced up to $2,000,000 for use by the Company to pay
current accounts payable and expenses incurred exclusively for the manufacture
and delivery of vapor patches. In consideration of any advanced funds, the
Company executed and delivered to Novartis a promissory note of $2,000,000 and a
security agreement. Under the security agreement, the Company pledged
substantially all of its assets. The note was repaid by the Company by the
delivery to Novartis of vapor patches under the Agreement. All amounts owed were
repaid as of December 31, 2004. Under the Agreement, Novartis had the option
until March 31, 2005 (which Novartis exercised), to extend the use of vapor
patches to the adult cough/cold category in the United States, Canada and Mexico
at no additional cost and under the same terms and conditions as set forth in
the Agreement. On March 31, 2005, Novartis notified the Company of its intention
to enter the adult market pursuant to the Agreement
Under the Agreement, the Company granted Novartis an exclusive license
(the "License") to all of the intellectual property of the Company to the extent
that it is used or useful in the production of the vapor patches being supplied
under the Agreement for a fee of $1,065,000, which was paid to the Company by
Novartis as follows: (1) release of $250,000 in promissory note debt as of the
date of the Agreement, (2) payment of $407,500 in cash in July 2004, and (3)
payment of $407,500 in cash in September 2004. The License began on July 19,
2004, and will continue for the duration of any patents included in the licensed
intellectual property and, with respect to all other elements of the licensed
intellectual property, for the maximum duration permitted under applicable law
(maximum fourteen years). Upon the expiration of the patents included in the
licensed intellectual property, Novartis will have a non-revocable, perpetual,
fully paid-up license to the intellectual property used or useful in the
production of vapor patches for the pediatric market and the adult cough/cold
market. Commencing on January 1, 2005, Novartis is required by the Agreement to
pay royalties, at an agreed upon percentage, to the Company, based upon the net
semi-annual sales of vapor patches by Novartis for each year the License is in
effect.
In August 2004, Novartis purchased a cartoning machine from the Company
for a purchase price of $162,000. On December 7, 2004, the Company entered into
a capital equipment purchase agreement (the "Purchase Agreement") with Novartis.
Under the Purchase Agreement, Novartis paid the Company the contract price of
$733,100 in exchange for the Company's hydrogel coating and therapeutic
converting machinery and equipment. The contract price was based upon Novartis
taking delivery of the equipment at the Company's facility. Upon closing of this
disposition of assets to Novartis on December 29, 2004, the Company's
transformation from a manufacturing operation to an intellectual property
licensing and holding company was complete.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased by $687,732 during the first three
months of 2005 to $1,551,586 at March 31, 2005. The decrease in cash and cash
equivalents during the first three months of 2005 was due to cash used in
operating activities of $529,092 consisting primarily of cash used for
continuing operations as well as for severance and other manufacturing wind down
costs, and to the payment of a cash dividend of $246,824 in March 2005. The
Company's Board of Directors approved and declared a cash dividend of $0.06 per
share on January 20, 2005, payable on March 11, 2005 to shareholders of record
on February 25, 2005. The Company had 4,113,739 shares outstanding on the record
date.
I-9
During the first three months of 2005, the Company received $176,282
from Novartis under accounts receivable related to discontinued operations and
received proceeds of $89,417 related to exercises of stock options. The Company
also received proceeds of $64,652 from the sale of miscellaneous equipment and
office furniture having no book value during the first three months of 2005.
There were no future material commitments for capital expenditures at March 31,
2005.
The Company had working capital of $1,497,490 and a current ratio of
7.40 at March 31, 2005 compared to working capital of $2,048,876 and a current
ratio of 4.93 at December 31, 2004. The decrease in working capital during the
first three months of 2005 is primarily attributable to lower payables and
accrued expenses as the Company paid the majority of its severance and
manufacturing wind down obligations, the payment of a cash dividend, and a
reduction in accounts receivable partially offset with an increase in royalty
and licensing fee income receivable.
Shareholders' equity decreased to $1,716,135 at March 31, 2005 from
$2,282,082 at December 31, 2004, primarily due to the net loss for three months
ended March 31, 2005 and the cash dividend paid in March 2005, all of which have
been discussed above.
The Company believes its existing cash and cash equivalents will be
sufficient to fund continuing operations through 2005. However, cash and cash
equivalents may not be sufficient to fund continuing operations beyond 2005. The
Company's working capital requirements are dependent upon adequate levels of
royalty and licensing income to fund continuing operations. Royalty income is
uncertain because it is subject to factors that the Company cannot control. Such
factors include, but are not limited to, seasonality of the product, marketing
efforts by Novartis, markets Novartis enters the product into, and other factors
which can cause fluctuations in the amount of royalty income the Company earns.
There can be no assurance because of these uncertainties that future royalty
income will be sufficient to fund continuing operations. The royalty income of
$81,296 recorded during the first quarter ended March 31, 2005 was based upon
information provided by Novartis. There can be no assurance that this result
will be indicative of results for the full year. Furthermore, future royalties
and licensing income the Company anticipates earning is dependent on the success
of the product in the marketplace by Novartis and other firms or individuals
with whom the Company may enter into licensing agreements. Additionally, the
Company does not presently have any other financing resources in place from
which it can borrow or obtain additional working capital.
CRITICAL ACCOUNTING POLICIES
Management believes that the Company has not adopted any critical
accounting policies which, if changed, would result in a material change in
financial estimates, financial condition, results of operation or cash flows for
the three months ended March 31, 2005 and 2004. The critical accounting policies
appear in Note 2 of Part I, Item 1 of this Form 10-QSB.
I-10
ITEM 3 - CONTROLS AND PROCEDURES
Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
have evaluated the effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934 (the "Exchange Act")). Based upon this
evaluation, the principal executive officer and principal financial officer have
concluded that, as of the end of the period covered by this report, our
disclosure controls and procedures were effective.
During the three months ended March 31, 2005, there were no changes in
the Company's internal control over financial reporting (as defined in Rule
13a-15(f) under the Exchange Act) that has materially affected, or is reasonably
likely to materially affect, the Company's internal control over financial
reporting.
I-11
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
None.
ITEM 2 - UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
None.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5 - OTHER INFORMATION
None.
ITEM 6 - EXHIBITS
EXHIBITS
Exhibit No. Description
- ----------- -----------
3.01 Articles of Incorporation of LecTec Corporation, as amended
(Incorporated herein by reference to the Company's Form S-1
Registration Statement (file number 33-9774C) filed on October 31,
1986 and amended on December 12, 1986).
3.02 Bylaws of LecTec Corporation (Incorporated herein by reference to
the Company's Form S-1 Registration Statement (file number
33-9774C) filed on October 31, 1986 and amended on December 12,
1986).
31.01 Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002, filed herewith.
31.02 Certification of Acting Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
32.01 Chief Executive Officer and Acting Chief Financial Officer
Certification Pursuant to #18 U.S.C. Section.1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed
herewith.
99.01 Cautionary Statements (Incorporated herein by reference to Exhibit
99.01 to the Company's Report on Form 10-KSB for the fiscal year
ended December 31, 2004).
II-1
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned thereunto duly
authorized.
LECTEC CORPORATION
Date May 13, 2005 By /s/ Alan C. Hymes, M.D.
----------------------------------
Alan C. Hymes, M.D.
Chief Executive Officer & Director
(principal financial officer and
duly authorized officer)
II-2
EXHIBIT INDEX
Exhibit No. Description
- ----------- -----------
3.01 Articles of Incorporation of LecTec Corporation, as amended
(Incorporated herein by reference to the Company's Form S-1
Registration Statement (file number 33-9774C) filed on October 31,
1986 and amended on December 12, 1986).
3.02 Bylaws of LecTec Corporation (Incorporated herein by reference to
the Company's Form S-1 Registration Statement (file number
33-9774C) filed on October 31, 1986 and amended on December 12,
1986).
31.01 Certification of Chief Executive Officer Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002, filed herewith.
31.02 Certification of Acting Chief Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
32.01 Chief Executive Officer and Acting Chief Financial Officer
Certification Pursuant to #18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed
herewith.
99.01 Cautionary Statements (Incorporated herein by reference to Exhibit
99.01 to the Company's Report on Form 10-KSB for the fiscal year
ended December 31, 2004).