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 MARCH 31,
1999.
[ ] 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 May 12,
1999 was 3,860,329 shares.
LECTEC CORPORATION
FORM 10-Q - QUARTERLY REPORT FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1999
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
Item 3. Quantitative and Qualitative Disclosures About Market Risk. . . . . . . . . . . . . . . . . . . I-13
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-1
Item 6. Exhibits and Reports on Form 8-K. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . II-1
Signature Page. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . II-2
PART I - FINANCIAL INFORMATION
ITEM 1- FINANCIAL STATEMENTS AND NOTES TO FINANCIAL STATEMENTS
LECTEC CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
March 31, June 30,
1999 1998
------------ ------------
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 867,497 $ 2,186,532
Receivables
Trade, net of allowances of $91,540 (unaudited) and $90,818
at March 31, 1999 and June 30, 1998 2,701,299 2,251,757
Refundable income taxes 7,544 59,544
Other 17,883 30,624
----------- -----------
2,726,726 2,341,925
Inventories
Raw materials 1,204,135 1,184,778
Work-in-process 17,265 15,055
Finished goods 671,411 518,178
----------- -----------
1,892,811 1,718,011
Prepaid expenses and other 192,956 103,063
Deferred income taxes 379,000 379,000
----------- -----------
Total current assets 6,058,990 6,728,531
PROPERTY, PLANT AND EQUIPMENT - AT COST
Building and improvements 1,921,252 1,816,277
Equipment 6,917,847 6,791,765
Furniture and fixtures 408,131 384,260
----------- -----------
9,247,230 8,992,302
Less accumulated depreciation 5,454,442 4,933,465
----------- -----------
3,792,788 4,058,837
Land 247,731 247,731
----------- -----------
4,040,519 4,306,568
OTHER ASSETS
Patents and trademarks, less accumulated amortization of $1,114,734
(unaudited) and $1,001,157 at March 31, 1999 and June 30, 1998 228,680 273,999
Long-term investments 8,676 8,676
----------- -----------
237,356 282,675
----------- -----------
$10,336,865 $11,317,774
=========== ===========
See accompanying notes to the consolidated financial statements.
I - 1
LECTEC CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS - CONTINUED
(Unaudited)
March 31, June 30,
1999 1998
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable $ 1,414,562 $ 809,147
Accrued expenses
Payroll related 508,489 384,135
Other 194,411 199,388
------------ ------------
Total current liabilities 2,117,462 1,392,670
DEFERRED INCOME TAXES 222,000 222,000
SHAREHOLDERS' EQUITY
Common stock, $.01 par value: 15,000,000 shares authorized; issued and
outstanding 3,860,300 shares (unaudited) at March 31, 1999 and
4,036,000 shares at June 30, 1998 38,603 40,360
Additional paid-in capital 11,227,411 11,769,053
Unrealized losses on securities available-for-sale (8,508) (8,508)
Deficit in retained earnings (3,260,103) (2,097,801)
------------ ------------
7,997,403 9,703,104
------------ ------------
$ 10,336,865 $ 11,317,774
============ ============
See accompanying notes to the consolidated financial statements.
I - 2
LECTEC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
Three months ended Nine months ended
March 31, March 31,
--------------------------- ----------------------------
1999 1998 1999 1998
----------- ----------- ----------- ------------
Net sales $ 3,196,311 $ 3,256,759 $ 9,202,645 $ 10,196,531
Cost of goods sold 2,027,130 2,521,775 6,090,473 7,306,118
----------- ----------- ----------- ------------
Gross profit 1,169,181 734,984 3,112,172 2,890,413
Operating expenses
Sales and marketing 651,926 192,875 1,531,397 698,099
General and administrative 586,442 574,155 1,954,533 1,575,848
Research and development 298,367 280,411 864,405 788,740
----------- ----------- ----------- ------------
1,536,735 1,047,441 4,350,335 3,062,687
----------- ----------- ----------- ------------
Loss from operations (367,554) (312,457) (1,238,163) (172,274)
Other income, net 19,788 21,205 78,576 42,622
----------- ----------- ----------- ------------
Loss before income taxes (347,766) (291,252) (1,159,587) (129,652)
Income tax expense (benefit) 1,103 (1,739) 2,715 6,261
----------- ----------- ----------- ------------
Net loss $ (348,869) $ (289,513) $(1,162,302) $ (135,913)
=========== =========== =========== ============
Net loss per share
Basic $ (0.09) $ (0.07) $ (0.30) $ (0.03)
=========== =========== =========== ============
Diluted $ (0.09) $ (0.07) $ (0.30) $ (0.03)
=========== =========== =========== ============
Weighted average shares outstanding
Basic 3,867,774 4,064,766 3,920,037 3,989,433
=========== =========== =========== ============
Diluted 3,867,774 4,064,766 3,920,037 3,989,433
=========== =========== =========== ============
See accompanying notes to the consolidated financial statements.
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LECTEC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended March 31,
----------------------------
1999 1998
----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss $(1,162,302) $ (135,913)
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
Depreciation and amortization 634,554 638,256
Warrants issued for services -- 33,401
Loss on sale of investments -- 10,915
Deferred income taxes -- 15,000
Changes in operating assets and liabilities:
Trade and other receivables (436,801) (1,088,591)
Refundable income taxes 52,000 309,653
Inventories (174,800) 837,285
Prepaid expenses and other (89,893) (77,311)
Accounts payable 605,415 273,050
Accrued expenses 119,377 (64,548)
----------- -----------
Net cash provided by (used in) operating activities (452,450) 751,197
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property, plant and equipment (254,928) (348,525)
Investment in patents and trademarks (68,258) (49,198)
Sale of investments -- 590,873
----------- -----------
Net cash provided by (used in) investing activities (323,186) 193,150
CASH FLOWS FROM FINANCING ACTIVITIES:
Retirement of common stock (543,399) --
----------- -----------
Net cash used in financing activities (543,399) --
----------- -----------
Net increase (decrease) in cash and cash equivalents (1,319,035) 944,347
Cash and cash equivalents at beginning of period 2,186,532 665,190
----------- -----------
Cash and cash equivalents at end of period $ 867,497 $ 1,609,537
=========== ===========
See accompanying notes to the consolidated financial statements.
I - 4
LECTEC CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(UNAUDITED)
Nine Months Ended March 31,
---------------------------
1999 1998
---------- ------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest expense $ -- $ 1,106
Income taxes 22,128 16,732
SUPPLEMENTAL SCHEDULE OF NONCASH ACTIVITIES:
Conversion of Pharmadyne minority shareholders' interest in the
Pharmadyne subsidiary into LecTec Corporation common stock $ -- $1,369,411
Warrants granted for future services $ -- $ 16,599
See accompanying notes to the consolidated financial statements.
I - 5
LECTEC CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
QUARTERS ENDED MARCH 31, 1999 AND 1998
(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
wholly-owned subsidiary which was merged into LecTec Corporation on December 31,
1997. All significant intercompany balances and transactions have been
eliminated in consolidation. The Company's financial statements for the three
months and nine months ended March 31, 1999 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, 1998. The interim 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 year.
The Company's basic net earnings (loss) per share amounts have
been computed by dividing net earnings (loss) by the weighted average number of
outstanding common shares. The Company's diluted net earnings (loss) per share
amounts have been computed by dividing net earnings (loss) by the weighted
average number of outstanding common shares and common share equivalents, when
dilutive. Options and warrants to purchase 888,822 and 852,310 shares of common
stock with a weighted average exercise price of $7.56 and $7.90 were outstanding
during the three months ended March 31, 1999 and 1998, but were excluded because
they were antidilutive. Options and warrants to purchase 876,489 and 775,076
shares of common stock with a weighted average exercise price of $7.64 and $8.18
were outstanding during the nine months ended March 31, 1999 and 1998, but were
excluded because they were antidilutive.
(2) 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 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 quarter and nine months ended March 31, 1999, 10,000 and
175,650 shares were repurchased for $19,062 and $543,399. Through March 31, 1999
the Company has repurchased a total of 205,150 shares at a cost of $667,962.
During the period from April 1, 1999 through May 13, 1999 the Company did not
repurchase any additional shares.
(3) COMPREHENSIVE INCOME
As of July 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, Reporting Comprehensive Income, which establishes
new rules for the reporting and display of comprehensive income and it
components. SFAS 130 requires companies to report, in addition to net income,
other components of comprehensive income, including unrealized gains or losses
on securities available-for-sale. Total comprehensive loss for the third quarter
of fiscal 1999 and 1998 was $348,869 and $292,827. Total comprehensive loss for
the first nine months of fiscal 1999 and 1998 was $1,162,302 and $118,340.
Adoption of this disclosure standard had no effect on the Company's results of
operations or financial position as reported in the consolidated financial
statements.
I-6
LECTEC CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
QUARTERS ENDED MARCH 31, 1999 AND 1998
(CONTINUED)
(4) NEW ACCOUNTING PRONOUNCEMENTS
Additionally, the Company adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," effective July 1, 1998. SFAS
No. 131 requires the Company to disclose financial and other information about
its business segments, their products and services, geographic areas, sales,
profits, assets and other information. SFAS No. 131 is effective for financial
statements for periods beginning after December 15, 1997, however the statement
does not need to be applied to interim financial statements in the initial year
of application. Comparative information for the interim period in the initial
year of application will be reported in the Company's financial statements for
interim periods in fiscal 2000.
I-7
PART I - FINANCIAL INFORMATION
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THREE MONTHS AND NINE MONTHS ENDED MARCH 31, 1999 AND 1998
RESULTS OF OPERATIONS
NET SALES
Net sales for the third quarter of fiscal 1999 were $3,196,311 compared
to net sales of $3,256,759 for the third quarter of fiscal 1998, a decrease of
1.9%. The decrease was primarily the result of decreased medical tape product
sales which were partially offset by increased sales of therapeutic products and
conductive products. Conductive product sales, the Company's largest product
group, increased by 8.3% from the prior year while medical tape sales, the
Company's second largest product group, decreased by 48.6% from the prior year
and therapeutic product sales increased to $565,919 from $110,250 in the prior
year. The conductive product sales increase was primarily due to increased sales
to a specific OEM customer. Medical tape product sales decreased in fiscal 1999
primarily due to the absence of sales to a large international customer who
purchases intermittently. The therapeutic product sales increase was primarily
the result of sales of the Company's various TheraPatch(R) brand products
directly to retailers. During the third quarter of fiscal 1998, the Company had
no sales of therapeutic patch products to CNS, Inc., the former retail
distributor of the Company's analgesic patches. Effective July 1, 1998, the
Company assumed responsibility for managing the retail distribution of the
analgesic patch product that CNS, Inc. had previously handled, and in September
1998, the Company began the launch of its TheraPatch family of patch products.
The September 1998 product family launch included two patches for topical pain
relief and two patches for cough suppression. In March 1999 the Company added
two new anti-itch patches to the TheraPatch product family.
Net sales for the first nine months of fiscal 1999 were $9,202,645
compared to net sales of $10,196,531 for the first nine months of fiscal 1998, a
decrease of 9.7%. The decrease was primarily the result of decreased medical
tape product sales. Conductive product sales decreased by 0.6% from the prior
year, while medical tape product sales decreased by 39.6% and therapeutic
product sales increased by 67.2%. Conductive product sales decreased primarily
as a result of normal period-to-period fluctuations of sales to the Company's
customers. Medical tape product sales decreased primarily due to the absence of
sales to several large international customers who purchase intermittently and
due to the discontinuance of sales to several low-margin slit roll customers.
The therapeutic product sales increase resulted primarily from increased
TheraPatch product 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.
GROSS PROFIT
Gross profit for the third quarter of fiscal 1999 was $1,169,181
compared to $734,984 for the third quarter of fiscal 1998, an increase of 59.1%.
Gross profit as a percent of net sales for the third quarter of fiscal 1999 was
36.6% compared to 22.6% for the third quarter of fiscal 1998. The increase in
the gross profit percent for the quarter resulted primarily from a shift in the
sales mix from lower margin medical tapes toward higher margin patch products.
Gross profit for the first nine months of fiscal 1999 was $3,112,172
compared to $2,890,413 for the first nine months of fiscal 1998, an increase of
7.7%. Gross profit as a percent of net sales for the first nine months of fiscal
1999 was 33.8% compared to 28.3% for the first nine months of fiscal 1998. The
increase in the gross profit percent for the first nine months resulted
primarily from a shift in the sales mix from lower margin medical tapes toward
higher margin patch products, as well as higher margins on patch sales,
primarily as a result of sales directly to retailers rather than to a
distributor. These factors were partially offset
I-8
by higher scrap and material usage costs, due primarily to the start-up of
production on retail TheraPatch products.
SALES AND MARKETING EXPENSES
Sales and marketing expenses were $651,926 and $192,875 during the
third quarters of fiscal 1999 and 1998, and as a percentage of net sales, were
20.4% and 5.9%. The increase in sales and marketing expenses for the quarter was
primarily the result of expenses associated with the Company's new Consumer
Products Division. The new division is responsible for the management of the
Company's retail distribution network, and the sales and marketing activities
related to the TheraPatch family of products. The increase in expenses was
primarily due to increases in advertising, sales staff and slotting fees to
establish new retail accounts. These expenses were not present in the prior
year. The Company anticipates that sales and marketing expenses, as a percentage
of sales, will decrease as the sales volume of patch products increases.
Sales and marketing expenses were $1,531,397 and $698,099 during the
first nine months of fiscal 1999 and 1998, and as a percentage of net sales,
were 16.6% and 6.8%. The increase in expenses was primarily due to increases in
sales staff, advertising and slotting fees to establish new retail accounts.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses were $586,442 and $574,155 during
the third quarters of fiscal 1999 and 1998, and as a percentage of net sales,
were 18.3% and 17.6%. The Company anticipates that general and administrative
expenses, as a percentage of sales, will be approximately 20% of net sales for
the remainder of fiscal 1999.
General and administrative expenses were $1,954,533 and $1,575,848
during the first nine months of fiscal 1999 and 1998, and as a percentage of net
sales, were 21.2% and 15.5%. The increase in general and administrative expenses
for the nine months 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.
RESEARCH AND DEVELOPMENT EXPENSES
Research and development expenses for the third quarters of fiscal 1999
and 1998 were $298,367 and $280,411, and as a percentage of net sales, were 9.3%
and 8.6%.
Research and development expenses for the first nine months of fiscal
1999 and 1998 were $864,405 and $788,740, and as a percentage of net sales, were
9.4% and 7.7%. The increase in research and development expenses for the first
nine months reflects increased staffing levels and increased costs for testing
and test runs of products under development.
OTHER INCOME, NET
Other income decreased in the third quarter of fiscal 1999 to $19,788
from $21,205 in the third quarter of 1998. Other income increased in the first
nine months of fiscal 1999 to $78,576 from $42,622 in the first nine months of
1998. Other income was higher in the first nine months of fiscal 1999 due to
increased investment income as a result of higher cash and cash equivalent
balances in fiscal 1999 compared to 1998, and a loss on the sale of investments
incurred during fiscal 1998.
I-9
LOSS BEFORE INCOME TAXES
The Company recorded a loss before income taxes of $347,766 in the
third quarter of fiscal 1999 compared to a loss before income taxes of $291,252
in fiscal 1998. For the first nine months of fiscal 1999, the Company recorded a
loss before income taxes of $1,159,587 compared to a loss before income taxes of
$129,652 for the first nine months of fiscal 1998. The loss for the third
quarter and first nine months of fiscal 1999 was primarily the result of
increased sales and marketing expenses related to the Company's new Consumer
Products Division 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.
INCOME TAX EXPENSE (BENEFIT)
The Company recorded income tax expense of $1,103 in the third quarter
of fiscal 1999 compared to an income tax benefit of $1,739 in the third quarter
of fiscal 1998. For the first nine months of fiscal 1999 the Company recorded
income tax expense of $2,715 as compared to income tax expense of $6,261 in the
first nine months of fiscal 1998. Income tax expense for both the third quarter
and first nine months of fiscal 1999 reflect minimal tax expense associated with
the Company's foreign sales corporation subsidiary and does not include any loss
benefit as it may not be realizable. The income tax benefit recorded during the
third quarter of fiscal 1998 reflects the adjustment of the income tax expense
for the first nine months of fiscal 1998 to reflect minimal income tax expense
due to the utilization of NOL carryforwards.
IMPACT 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 $1,319,035 to $867,497 during
the first nine months of fiscal 1999. Receivables increased by $384,801 to
$2,726,726 during the same period primarily as a result of higher sales in March
of 1999 as compared to sales in June of 1998. Inventories increased by $174,800
during the nine months ended March 31, 1999 to $1,892,811 primarily due to
increased finished goods inventory of TheraPatch products necessary for the
timely fulfillment of retail orders. Accounts payable increased by $605,415 to
$1,414,562 during the first nine months of fiscal 1999 primarily due to
increased raw material, advertising and promotional payables related to the
TheraPatch product family. Capital spending totaled $254,928 during the first
nine months of fiscal 1999. There were no material commitments for capital
expenditures at March 31, 1999.
Working capital decreased to $3,941,528 at the end of the first nine
months of fiscal 1999 from $5,335,861 at the end of fiscal 1998. The Company had
a current ratio as of March 31, 1999 of 2.9 as compared to 4.8 as of June 30,
1998.
The Company had no short or long-term debt as of March 31, 1999. During
August 1997 the Company obtained an unsecured $1,000,000 working capital line of
credit which expired in September 1998. There were no borrowings outstanding on
the line of credit during fiscal 1998 or fiscal 1999. Shareholders' equity
decreased by $1,705,701 to $7,997,403 during the first nine months of fiscal
1999. Of this decrease, $543,399 was due to the repurchase of common stock under
the share repurchase program announced in April of 1998 authorizing the
repurchase of up to 500,000 shares. As of May 13, 1999 the Company has
repurchased a total of 205,150 shares at a cost of $667,962 under the share
repurchase program.
Management believes that existing cash and cash equivalents,
internally-generated cash-flow and a new secured line of credit, expected to be
in place by June 30, 1999, will be sufficient to support anticipated operating
and capital spending requirements over the next twelve months. Management is
currently
I-10
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 on 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.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 ("Y2K") issue is the result of computer systems using a
two-digit format, as opposed to four digits, to indicate the year. Such computer
systems may be unable to interpret dates beyond the year 1999, which could cause
a system failure or other computer errors, leading to disruptions in operations.
A number of other date issues (i.e. incorrect handling of leap years) may also
cause problems. All of these issues are collectively referred to as Y2K. In
fiscal 1998, the Company developed a comprehensive program for Y2K compliance
consisting of two parts: internal systems compliance and third party compliance.
The internal systems compliance program includes informational,
manufacturing, financial and communication systems. A committee consisting of
representatives from all key areas of the Company developed the program. The
internal systems compliance program consists of four-phases. Phase I is the
identification of all internal computer systems in the Company, including
embedded microprocessor or similar circuitry. Phase II is the determination of
Y2K compliance for these systems. Phase III is development and implementation of
action plans to achieve compliance where needed, and is followed by the testing
in Phase IV of these systems after action plans have been completed.
The third party compliance program consists of three phases with Phase
I being the identification of major and/or critical third party vendors and
customers. Phase II consists of contacting these third parties and determining
their Y2K compliance. Phase III involves establishing risk and developing
contingency plans where necessary (i.e. third party compliance can not be
established or the risks associated with noncompliance are significant).
The Company has completed Phases I and II of the internal systems
compliance program and found the majority of its systems and all of its core
systems to be Y2K compliant. The Y2K compliant status of the core systems
benefited from upgrades undertaken during the past several years to make these
systems adequate for the business needs of the Company. Plans to achieve Y2K
compliance for the non-core systems were developed and completed by the end of
calendar 1998 (Phase III). Phase IV of the program, testing of systems after
implementation of changes, was completed by March 31, 1999 with the exception of
the testing of point of sale and sales order systems. Testing of these systems
is expected to be completed by June 30, 1999, and the Company considers the risk
that compliance will not be achieved to be minimal.
The Company has completed Phase I and II of the third party compliance
program for current vendors and customers and is contacting new vendors and
customers to determine their Y2K compliance as necessary. The Company is
approximately 75% complete with Phase III, the evaluation of responses,
establishment of risk and the development of contingency plans. Because of the
diversity of sources available for the Company's raw material, packaging
material and supplies, the Company believes that third party Y2K compliance
issues for these third parties will not have a material adverse effect on the
Company's financial position, operations or cash flow. There can, however, be no
assurance that this will be the case. If certain critical third party providers,
such as those providers supplying electricity, water or telephone service,
experience difficulties resulting in disruption of service to the Company, a
shutdown of the Company's operations at individual facilities could occur for
the duration of the disruption. The Company expects to have substantially
completed all phases of the third party compliance program by June 30, 1999.
All costs for Y2K compliance have been expensed in the period incurred
and have been paid from operating funds. The Company does not specifically track
internal staff time spent on the Y2K issue, however, it has included an estimate
of the cost of this time in the estimated total costs. The Company estimates the
total costs for both the internal systems compliance program and the third party
compliance
I-11
program through March 31, 1999 to be approximately $22,000, while total costs
for Y2K compliance are estimated to be less than $50,000.
The Company's ability to successfully identify and address Y2K issues
involves inherent risks and uncertainties, and depends upon a number of factors
including, but not limited to, the availability of key Y2K personnel, the
Company's ability to locate and correct all relevant computer codes, the
readiness of third parties, and the Company's ability to respond to unforeseen
Y2K complications. Depending upon such factors, the Y2K issues faced by the
Company could result in, among other things, business disruption, operation
problems, financial loss, legal liability and similar adverse consequences.
FORWARD-LOOKING STATEMENTS
From time to time, in reports filed with the Securities and Exchange
Commission, 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 new brand strategy; impact of interruptions to production; dependence
on key personnel; need for regulatory approvals; changes in governmental
regulatory requirements or accounting pronouncements, unforeseen Y2K
complications and third party disruptions; and ability to satisfy funding
requirements for operating needs, expansion or capital expenditures.
I-12
PART I - FINANCIAL INFORMATION
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
I-13
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
None.
Item 5. OTHER INFORMATION
None.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Item No. Item Method of Filing
-------- ---- ----------------
27.01 Financial data schedule . . . . . . . . . . . Filed herewith.
(b) REPORTS ON FORM 8-K
None.
II-1
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 May 14, 1999 /s/ Rodney A. Young
----------------------------- -----------------------------------------------------------------------
Rodney A. Young, Chief Executive Officer & President
Date May 14, 1999 /s/ Deborah L. Moore
----------------------------- -----------------------------------------------------------------------
Deborah L. Moore, Chief Financial Officer
II-2