edX - TXT1x Data
<SEC-DOCUMENT>0000897101-01-500638.txt : 200110091<SEC-HEADER>0000897101-01-500638.hdr.sgml : 200110092ACCESSION NUMBER: 0000897101-01-5006383CONFORMED SUBMISSION TYPE: 10-K4PUBLIC DOCUMENT COUNT: 35CONFORMED PERIOD OF REPORT: 200106306FILED AS OF DATE: 2001092878FILER:910COMPANY DATA:11COMPANY CONFORMED NAME: LECTEC CORP /MN/12CENTRAL INDEX KEY: 000080592813STANDARD INDUSTRIAL CLASSIFICATION: ELECTROMEDICAL & ELECTROTHERAPEUTIC APPARATUS [3845]14IRS NUMBER: 43130187815STATE OF INCORPORATION: MN16FISCAL YEAR END: 12311718FILING VALUES:19FORM TYPE: 10-K20SEC ACT: 1934 Act21SEC FILE NUMBER: 000-1615922FILM NUMBER: 17482482324BUSINESS ADDRESS:25STREET 1: 10701 RED CIRCLE DR26CITY: MINNETONKA27STATE: MN28ZIP: 5534329BUSINESS PHONE: 61293322913031MAIL ADDRESS:32STREET 1: 10701 RED CIRCLE DRIVE33STREET 2: 10701 RED CIRCLE DRIVE34CITY: MINNETONKA35STATE: MN36ZIP: 5534337</SEC-HEADER>38<DOCUMENT>39<TYPE>10-K40<SEQUENCE>141<FILENAME>lectec013788_10k.txt42<DESCRIPTION>LECTEC CORPORATION FORM 10K43<TEXT>44UNITED STATES SECURITIES AND EXCHANGE COMMISSION45WASHINGTON, D.C. 205494647--------------------4849FORM 10-K5051--------------------52(Mark One)5354/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES55EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED JUNE 30, 2001.5657/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES58EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______________59TO ______________.606162Commission File Number: 0-161596364LECTEC CORPORATION65(Exact name of registrant as specified in its charter)6667MINNESOTA 41-130187868(State or other jurisdiction of (I.R.S. Employer Identification No.)69incorporation or organization)707110701 RED CIRCLE DRIVE, MINNETONKA, MINNESOTA 5534372(Address of principal executive offices) (Zip Code)7374Registrant's telephone number, including area code: (952) 933-22917576--------------------7778Securities registered pursuant to Section 12(b) of the Act: None7980Securities registered pursuant to Section 12(g) of the Act: Common Stock, par81value $0.01 per share.8283--------------------8485Indicate by check mark whether the Registrant (1) has filed all reports86required to be filed by Section 13 or 15(d) of the Securities Exchange Act of871934 during the preceding 12 months (or for such shorter period that the88Registrant was required to file such reports), and (2) has been subject to such89filing requirements for the past 90 days. Yes [X] No [ ]9091Indicate by check mark if disclosure of delinquent filers pursuant to92Item 405 of Regulation S-K is not contained herein; and will not be contained,93to the best of the Registrant's knowledge, in the definitive proxy statement94incorporated by reference in Part III of this Form 10-K, or any amendment to95this Form 10-K. [ ]9697The aggregate market value of the Common Stock held by non-affiliates98of the Registrant as of September 20, 2001 was $4,470,945 based upon the last99reported sale price of the Common Stock at that date by the Nasdaq Stock Market.100101The number of shares outstanding of the Registrant's Common Stock as of102September 20, 2001 was 3,922,384 shares.103104---------------------------------105106107<PAGE>108109110PART I111112ITEM 1. BUSINESS113------- --------114115GENERAL116LecTec Corporation (the "Company") is a health care and consumer117products company that develops, manufactures and markets products based on its118advanced skin interface technologies. Primary products include a complete line119of over-the-counter ("OTC") therapeutic patches. The Company markets and sells120its products to consumers through retail outlets (food, chain drug and mass121merchandise stores), other consumer products companies, and direct via the122Internet. All of the products manufactured by the Company are designed to be123highly compatible with skin.124125The Company is an innovator in hydrogel-based topical delivery of126therapeutic OTC medications which provide alternatives to creams and ointments.127A hydrogel is a gel-like material having an affinity for water and similar128compounds. These gels are ideal for delivering medication on to the skin. The129Company holds multiple domestic and foreign patents.130131Effective January 14, 1999, the Company was certified as meeting the132requirements of ISO 9001 and EN46001 quality system standards. Certification was133granted by TUV Product Service GmbH. On September 21, 2001 the quality system134was re-audited and certification was expanded to include ISO 13485, as well as135recognition to be certified as a contract manufacturer for other consumer136products companies. Meeting these standards confirms that the Company has137achieved the highest level of quality systems compliance demonstrated by138world-class design and manufacturing firms.139140The Company, through its research and development efforts, is141investigating new products for topical delivery of OTC drugs. In addition,142existing technologies are being refined to focus on new skin care and comfort143care consumer products targeting new retail customers and new markets.144145The Company was organized in 1977 as a Minnesota corporation. Its146principal executive office is located at 10701 Red Circle Drive, Minnetonka,147Minnesota 55343, and its telephone number is (952) 933-2291.148149RECENT DEVELOPMENTS150151During fiscal 2001 the Company significantly restructured, transforming152from a technology-based company, to a consumer products company. Consistent with153its new strategic focus, the Company is concentrating all of its efforts on its154consumer products business, with its comparatively higher margins and current155growth in revenues, and has exited the medical tape business and the conductive156products business.157158During the third quarter of fiscal 2001, the Company sold its medical159tape manufacturing equipment and other related assets. The sale of the medical160tape equipment finalized the Company's plan, adopted at the end of fiscal year1612000, to exit the low margin medical tape business. The medical tape business162included sales of individual slit roll widths of the standard paper, plastic and163cloth products widely used in the health care industry and sales of large jumbo164rolls which were converted by the customer into individual slit roll widths for165ultimate sale to consumers. Sales of medical tapes accounted for approximately1661%, 13% and 22% of the Company's total sales for fiscal years 2001, 2000 and1671999 respectively. No sales are expected in fiscal 2002.168169During the fourth quarter of fiscal 2001, the Company sold its170diagnostic electrode and electrically conductive adhesive hydrogel business171assets which were used to produce the Company's conductive products. The172conductive products include diagnostic electrodes and electrically conductive173adhesive hydrogels. Under a manufacturing and supply agreement between the174Company and the buyer, the Company will continue to manufacture, and supply to175the buyer, certain conductive products for a portion1761771781179<PAGE>180181182of fiscal 2002. The Company will supply the products at its cost of production183through October 31, 2001, and at its cost of production plus ten percent184thereafter. Sales of conductive products accounted for approximately 41%, 51%185and 63% of the Company's total sales for fiscal years 2001, 2000 and 1999186respectively.187188PRODUCTS189190The Company's core competency is skin interface hydrogel technology.191This competency results in products which are compatible with human skin,192thereby reducing skin irritation and reducing damage to the skin as well as the193risk of infection. The products are convenient to use and less messy than creams194and lotions. The adhesive characteristics, dimensions, drug stability, shelf195life and manufacturability of the Company's products are highly consistent and196reproducible from product to product.197198The Company designs, manufactures and markets topical ointment-based199products for the application of OTC drugs. Therapeutic patch products use a200hydrogel coated, breathable cloth patch to deliver OTC drugs and other201therapeutic compounds onto the skin. Products currently manufactured using the202adhesive-based patch technology are analgesics for localized pain relief,203cooling gel comfort strips, vapor cough suppressants, anti-itch, cold sore and204acne treatment products, wart removers, and a corn and callus remover. The205analgesic, cooling, anti-itch and cold sore patches are marketed under the206LecTec brand name TheraPatch(R). The acne treatment patches are marketed by207Johnson & Johnson Consumer Products Company under the Neutrogena(R)208On-the-Spot(R) Acne Patch and CLEAN & CLEAR(R) brand names. The vapor cough209suppressant patches are marketed under the TheraPatch brand name as well as by210Novartis Consumer Health, Inc. under the Triaminic(R) brand name. The wart211removers and corn and callus removers are sold by LecTec to certain customers212who market them under their own brand name.213214Sales of therapeutic consumer products accounted for approximately 58%,21536% and 15% of the Company's total sales for fiscal years 2001, 2000 and 1999216respectively.217218MARKETING AND MARKETING STRATEGY219220The Company markets and sells its products to consumers through retail221outlets (food, chain drug and mass merchandise stores), consumer products222companies and via the Internet.223224A major entry into the consumer products markets was supported by the225hiring of a new retail sales executive late in fiscal 1998 and a retail sales226team in fiscal 1999. In the consumer products markets, retail broker and227manufacturer's representative contracts have been established. The TheraPatch228brand is the umbrella brand for the Company's therapeutic patch products229introduced to all markets.230231In addition to the retail sales team hired for entry into the retail232consumer products markets, the Company has sales teams which support sales to233consumer products companies who sell directly to the consumer. Approximately 71%234of the sales of the Company's consumer patch products during fiscal year 2001235were derived from contract manufacturing agreements with other companies that236act as resellers of our products. Under these agreements, the Company's products237are marketed and sold under another company's brand name and by another238company's sales force. The Company's success depends in part upon its ability to239enter into additional reseller agreements with new third parties while240maintaining existing reseller relationships. The Company believes its241relationships with existing third party resellers has been a significant factor242in the success to date of its therapeutic consumer products business, and any243deterioration or termination of these relationships would seriously harm244business.245246The Company experiences seasonality in the sales of three of its247therapeutic patch products. The vapor cough suppressant patches and cold sore248patches experience increased sales during the cough and cold season which249typically includes the winter months. The anti-itch patches experience increased250sales during the summer months when insects bites and itching associated with251poison oak/ivy/sumac are prevalent.2522532542255<PAGE>256257258The Company currently sells its products in the U.S. and Canada. In259prior years, the Company also sold its conductive products in Europe, Latin260America, Asia and the Middle East. Except for sales of the TheraPatch brand261patch product into Canada, all of the Company's international sales were262denominated in U.S. dollars, thus, most of the impact of the foreign currency263transaction gains and losses were borne by the Company's customers. The Company264does not believe the January 1, 1999 euro currency conversion has had a material265impact on its financial statements. Export sales accounted for approximately 8%,26613% and 13% of total sales for 2001, 2000 and 1999 respectively.267268The Company's international sales are made by the Company's corporate269sales force. The Company does not maintain a separate international marketing270staff or operations. The following table sets forth export sales by geographic271area:272273274Years ended June 30275--------------------------------------------------2762001 2000 1999277---------- ---------- ----------278Europe $815,796 $1,006,412 $1,216,199279Latin America 139,613 547,904 371,654280Asia 72,851 46,279 31,935281Canada 215,686 298,884 7,011282Other 7,950 36,234 28,333283---------- ---------- ----------284285Total Export Sales $1,251,896 $1,935,713 $1,655,132286========== ========= =========287288289CUSTOMERS290291Novartis Consumer Health, Inc. (Novartis) accounted for 20% of the292Company's total sales for the year ended June 30, 2001. Fiscal 2001 was the293first full year of sales to Novartis. The Company's reseller agreement with294Novartis provides that Novartis will purchase from the Company hydrogel patches295which emit vapors that, when inhaled, provide relief of cough and cold symptoms.296The agreement has an initial term that expires May 15, 2005. The Company's297principal duty under the agreement is to manufacture the patches ordered by298Novartis. The Company may not manufacture the patches or any other vapor patches299in the pediatric field of use and in the United States to any other reseller,300but may manufacture and sell competing patches under the Company's own brand301name. The agreement does not require Novartis to purchase a minimum quantity302each year. The Company's results of operations could be harmed if Novartis303decreased the purchases it makes under the agreement. In addition, if the304agreement were cancelled, which Novartis has the right to do upon six months305notice, the Company's results of operations would be harmed. If the Company is306unable to extend or renew the agreement upon its expiration, its results of307operations would be harmed.308309Johnson & Johnson Consumer Products Company (J&J) accounted for 10% of310the Company's total sales for the year ended June 30, 2001. Fiscal 2001 was the311first full year of sales to J&J. The reseller agreement with J&J provides that312J&J will purchase from the Company hydrogel patches for use in the treatment of313acne. The agreement has an initial term that expires May 24, 2002. The Company's314principal duty under the agreement is to manufacture and sell the patches315ordered by J&J. Under the terms of the agreement J&J is required to purchase a316minimum amount of patches in each year of the initial two-year term. During the317term of the agreement, J&J has the exclusive worldwide right to market, sell and318distribute the patches and the right of first negotiation as to any of the319Company's new acne products utilizing the same technology as the patches. The320Company's operations would be harmed if the reseller purchased only the minimum321requirement. In addition, if the agreement were cancelled due to the Company's322breach, the Company's results of operations would be harmed. If the Company is323unable to extend or renew the agreement upon its expiration, its results of324operations would be harmed.325326Spacelabs Burdick Inc. accounted for 12%, 17% and 22% of the Company's327total sales for the fiscal years 2001, 2000 and 1999. This conductive products328customer will no longer generate sales due to the sale of the assets of the329Company's conductive products division during the year.3303313323333<PAGE>334335336The Company sold its products to approximately 310, 275 and 240 active337customers (excluding TheraPatch sales to individual consumers) during 2001, 2000338and 1999. The Company's backlog orders (purchase orders received from customers339for future shipment) as of August 10, 2001 totaled $3,606,000 (all of which the340Company expects to fill in fiscal 2002), compared with approximately $3,170,000341on August 11, 2000.342343COMPETITION344345The market for OTC drug delivery patches is highly competitive. Firms346in the consumer and medical industries compete on the basis of product347performance, pricing, distribution and service. Competitors in the United States348and abroad are numerous and include, among others, major pharmaceutical and349consumer product companies who have significantly greater financial, marketing350and technological resources than the Company. However, the Company believes that351it competes on the basis of proprietary technology, speed-to-market,352flexibility, innovative "first-in-category" patches, customer focus and its353ability to manufacture and market its products to targeted market segments.354355The Company's OTC TheraPatch family of analgesic, cooling, vapor,356anti-itch and cold sore patches competes with ointments, lotions and creams357manufactured by various competitors including Mentholatum/Rohto Pharmaceuticals,358Inc.359360MANUFACTURING361362The Company manufactures its therapeutic membranes at the Company's363Minnetonka, Minnesota facility. The Minnetonka facility also processes raw364materials and manufactures the Company's therapeutic products. The Company's365second facility in Edina, Minnesota is the primary site for the packaging of366therapeutic products and the majority of the Company's warehouse capacity. The367Company believes that the raw materials used in manufacturing its products are368generally available from multiple suppliers.369370RESEARCH AND DEVELOPMENT371372The Company's research and development staff consists of professionals373drawn from the business and academic communities with experience in the374biological, chemical, pharmaceutical and engineering sciences. The research and375development staff is responsible for the investigation, development and376implementation of new and improved products and new technologies.377378The Company may develop products internally, jointly with corporations379and/or with inventors from outside the Company. The Company may then market380resulting products by sponsoring partners or through a marketing arrangement381with appropriate health care companies. Research and development contract382opportunities are evaluated on an individual basis.383384The Company, through its research and development efforts, is385investigating new products for topical delivery of OTC drugs. In addition,386existing technologies are being refined to focus on new products targeting new387customers and new markets.388389During fiscal years 2001, 2000 and 1999, the Company spent390approximately $920,000, $1,095,000 and $1,170,000 on research and development391respectively.3923933944395<PAGE>396397398GOVERNMENTAL AND ENVIRONMENTAL REGULATION399400The Company's Quality System includes design development planning,401testing, manufacturing, packaging, labeling and distribution of the Company's402products which are subject to federal and foreign regulations, and in some403instances, state and local government regulations.404405UNITED STATES REGULATION406407The products manufactured by the Company's consumer products division408are classified as either non-drugs or over-the-counter, or OTC drugs, which are409either not regulated or regulated with published FDA OTC monographs, which are410used to regulate drugs that contain ingredients known to be safe and effective.411The monographs set out acceptable ingredients, combinations, concentrations and412specific labeling requirements.413414Until all finished good electrodes sold in the United States reach415their expiration date, the Company will continue to be subject to federal Food416and Drug Administration (the "FDA") policy including current Good Manufacturing417Practices ("GMP") and quality system regulations.418419The Company's hydrogels sold domestically also continue to be subject420to GMP and quality system regulations as they are sold to OEMs and distributors421for processing into finished commercial goods.422423FOREIGN REGULATION424425The Company's topical OTC drug delivery patches are marketed in Canada426under applicable Canadian OTC monographs where appropriate, and are reviewed and427approved prior to commercialization by the Health Protection branch of Health428Canada.429430The Company's electrodes previously sold into the European Community431(the "EC") were considered to be Class I, non-sterile and non-measuring medical432devices. These products were "CE" marked and "self declared" as being compliant433to the Medical Device Directive 93/42/EEC.434435ENVIRONMENTAL REGULATION436437The Company does not use solvents that have an adverse effect on the438environment in the manufacturing of its products. The Company does not439anticipate any major expenditure for environmental controls during the next440fiscal year.441442PATENTS AND TRADEMARKS443444The Company has U.S. and foreign patents on adhesive hydrogels,445electrodes and transdermal and topical delivery systems. Thirteen active U.S.446patents and four active international patents are currently assigned or licensed447to the Company. Twenty-two U.S. and foreign applications are pending including448two which are on appeal. Foreign patent applications are pending in numerous449European countries, Canada and Japan. The patents most pertinent to the450Company's major products have a remaining duration ranging from eight to twenty451years. Issued patents can later be held invalid by the patent office issuing the452patent or by a court. The Company cannot be certain that its patents will not be453challenged, invalidated or circumvented or that the rights granted thereunder454will provide a competitive advantage.455456One trademark registration was received in fiscal 2001. Two trademark457registrations are pending.458459The Company expects that its products will be subject to continuous460modifications due to improvements in materials and technological advances for461medical products. Therefore, the Company's4624634645465<PAGE>466467468continued success does not depend solely upon ownership of patents, but upon469technical expertise, creative skills and the ability to forge these talents into470the timely release of new products.471472The Company uses both patents and trade secrets to protect its473proprietary property and information. In addition, the Company monitors474competitive products and patent publications to be aware of potential475infringement of its rights. To the extent the Company relies on confidential476information to maintain competitive position, there can be no assurance that477other parties will not independently develop the same or similar information.478479EMPLOYEES480481As of June 30, 2001, the Company employed 94 full-time employees. None482of the Company's employees are represented by labor unions or other collective483bargaining units. The Company believes relations with its employees are good.484485EXECUTIVE OFFICERS OF THE REGISTRANT486<TABLE>487<CAPTION>488<S> <C> <C>489Name Age Title490--------------------- --- --------------------------------------------------------491Rodney A. Young 46 Chairman, Chief Executive Officer and President492Douglas J. Nesbit 49 Chief Financial Officer, Secretary and Treasurer493Timothy P. Fitzgerald 61 Vice President, Operations494John D. LeGray 55 Vice President, Quality Assurance and Regulatory Affairs495William J. Tourek 53 Vice President, Research and Development496Jane M. Nichols 55 Vice President, Marketing and New Business Development497Timothy R. J. Quinn 40 Vice President, Consumer Products498</TABLE>499500501Rodney A. Young, 46 years old, was appointed a Director, Chief502Executive Officer and President of LecTec in August 1996. In November 1996 he503was appointed as Chairman of the Board. Prior to assuming the leadership role504with LecTec, Mr. Young served Baxter International, Inc. for five years in505various management roles, most recently as Vice President and General Manager of506the Specialized Distribution Division. Mr. Young also serves as a Director of507Possis Medical, Inc., Delta Dental Plan of Minnesota, as well as Health Fitness508Corporation.509510Douglas J. Nesbit is Chief Financial Officer, Secretary and Treasurer.511He joined the Company in August 2000. Mr. Nesbit's 24-year professional512background includes public accounting experience with the big five firm of KPMG,513LLP. Prior to joining LecTec he was the Chief Financial Officer at Total514Solutions Group, Inc. and Corporate Treasurer at Secure Computing Corporation.515516Timothy P. Fitzgerald is Vice President, Operations. He joined the517Company in February 2000. Mr. Fitzgerald's 41-year career includes technical and518senior management positions at Bell & Howell Co., International Data519Engineering, Inc. and Varitronic Systems, Inc.520521John D. LeGray is Vice President, Quality Assurance and Regulatory522Affairs. He joined the Company in September 1997. Mr. LeGray's 34-year career523includes technical and management positions at DiaSorin Inc., Bayer Corporation524and Abbott Laboratories.525526William J. Tourek is Vice President, Research and Development. He527joined the Company in February 2001. Mr. Tourek's 26-year career includes528technical and management positions in pharmaceutical development at Upsher-Smith529Laboratories and Boehringer Ingelheim Corporation (Roxane Laboratories).5305315326533<PAGE>534535536Jane M. Nichols is Vice President, Marketing and New Business537Development. She joined the Company in April 1997. Ms. Nichols' 29-year career538includes clinical, technical and management roles at Methodist Hospital and Park539Nicollet Medical Centers, and senior marketing positions at 3M Company and540Ecolab.541542Timothy R. J. Quinn is Vice President and General Manager, Consumer543Products. He joined the Company in May 1998. He has 21 years of sales and544marketing experience in the consumer products industry. Prior to joining LecTec,545he was Vice President of Sales at Redmond Products. Prior to Redmond, Mr. Quinn546served in a variety of sales and marketing management positions for Lederle547Laboratories and General Foods Corporation.548549ITEM 2. PROPERTIES550------- ----------551552The Company owns a building located in Minnetonka, Minnesota,553containing 18,000 square feet of office and laboratory space and 12,000 square554feet of manufacturing and warehouse space. In addition, the Company leases a555building in Edina, Minnesota containing 29,000 square feet of manufacturing and556warehouse space. The Edina building lease term extends through June 30, 2002.557558559ITEM 3. LEGAL PROCEEDINGS560------- -----------------561562None563564565ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS566------- ---------------------------------------------------567568None569570571PART II572573ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS574------- ---------------------------------------------------------------------575576The Company's common stock trades on the Nasdaq National Market tier of577the Nasdaq Stock Market ("Nasdaq") under the symbol LECT.578579The following table sets forth the high and low daily trade price580information for the Company's common stock for each quarter of fiscal 2001 and5812000. Such prices reflect interdealer prices, without retail mark-up, mark-down,582or commission, and may not necessarily represent actual transactions.583584YEARS ENDED JUNE 30, 2001 2000585------------------ -------------------586HIGH LOW HIGH LOW587---- ---- ---- ----588First Quarter $4.22 $2.00 $4.38 $2.69589590Second Quarter 2.75 1.00 3.13 1.19591592Third Quarter 3.13 1.56 5.00 1.38593594Fourth Quarter 3.00 1.56 4.88 2.00595596As of September 20, 2001 the Company had 3,922,384 shares of common597stock outstanding, and 296 common shareholders of record which number does not598include beneficial owners whose shares were held of record by nominees or broker599dealers.6006016027603<PAGE>604605606The Company has not declared or paid cash dividends on its common stock607since its inception, and intends to retain all earnings for use in its business608for the foreseeable future.6096106116126138614<PAGE>615616617ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA618------- ------------------------------------619620Please see Item 1 of this report for information regarding the621disposition of significant business operations that affect the comparability of622the information set forth below.623624<TABLE>625<CAPTION>626CONSOLIDATED STATEMENT OF OPERATIONS DATA627628Year ended June 30,629-----------------------------------------------------------------------------------------6302001 2000 1999 1998 1997631---- ---- ---- ---- ----632<S> <C> <C> <C> <C> <C>633Net sales $ 15,928,832 $ 14,596,346 $ 12,279,075 $ 12,922,365 $ 12,256,327634Gross profit 5,422,601 5,121,217(3) 4,093,561 3,715,032 4,324,180635Loss from operations (3,315,622)(1) (2,890,497)(4) (1,771,324) (474,935) (2,215,951)(5)636Earnings (loss) before equity637in losses of unconsolidated638subsidiary 1,343,492(2) (2,859,276)(4) (1,683,257) (404,061) (2,140,660)(5)639Equity in losses of unconsoli-640dated subsidiary -- -- -- -- 126,067641642Net earnings (loss) 1,343,492(2) (2,859,276)(4) (1,683,257) (404,061) (2,266,727)(5)643Net earnings (loss) per share644Basic .34(2) (.74)(4) (.43) (.10) (.59)(5)645Diluted .34(2) (.74)(4) (.43) (.10) (.59)(5)646647<CAPTION>648CONSOLIDATED BALANCE SHEET DATA649650651June 30,652-----------------------------------------------------------------------------------------6532001 2000 1999 1998 1997654---- ---- ---- ---- ----655<S> <C> <C> <C> <C> <C>656Cash, cash equivalents and657short-term investments $ 3,376,723 $ 100,171 $ 1,022,025 $ 2,186,532 $ 1,242,777658Current assets 7,301,333 5,236,110 5,904,111 6,728,531 6,873,696659Working capital 4,279,728 1,512,561 3,497,926 5,335,861 4,035,084660Property, plant and equipment, net 2,422,494 3,039,088 4,028,491 4,306,568 4,592,304661Long-term investments -- -- -- 8,676 8,013662Total assets 9,967,776 8,474,549 10,132,573 11,317,774 11,837,356663Long-term liabilities 859,623 31,184 217,868 222,000 211,000664Shareholders' equity 6,086,548 4,719,816 7,508,520 9,703,104 8,787,744665</TABLE>666667668(1) Includes a nonrecurring restructuring charge of $303,759 related to the669sale of the conductive business assets.670671(2) Includes a nonrecurring restructuring charge of $303,759 related to the672sale of the conductive business assets and a gain on disposition of673assets of $4,662,210 related to the sale of the conductive business674assets and the disposition of the medical tape assets.675676(3) Includes a charge of $85,000 related to the impairment of inventory of677the medical tape product line.678679(4) Includes a charge of $730,000 or $.19 per share related to the plan to680exit the medical tape product line.681682(5) Includes a nonrecurring restructuring charge of $2,180,353 or $.57 per683share related to the elimination of the Pharmadyne subsidiary.6846856869687<PAGE>688689690ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS691------- -----------------------------------------------------------------------692OF OPERATIONS693-------------694695RESULTS OF OPERATIONS696697RECENT DEVELOPMENTS698699During the third quarter of fiscal 2001, the Company sold its medical700tape manufacturing equipment and other related assets. Net proceeds from the701sale were $630,000 consisting of the purchase price of $700,000 less transaction702costs of $70,000. The Company realized a gain on the sale of $103,624. The gain703resulted from achieving a higher sales price for the assets than originally704projected. The sale of the medical tape equipment finalized the Company's plan705to exit the medical tape business which was adopted at the end of the fiscal706year 2000. Adoption of this plan originally resulted in a charge of $645,000707during fiscal year 2000 related to the write-down of the medical tape equipment708to its estimated fair market value, net of disposal costs, of $525,000 at June70930, 2000.710711During the fourth quarter of fiscal 2001, the Company sold its712diagnostic electrode and electrically conductive adhesive hydrogel business713assets which were used to produce the Company's conductive products. Net714proceeds from the sale were $6,036,988 consisting of the purchase price of715$7,268,404 less transaction costs of $1,231,416. The net assets sold as part of716the transaction were carried at a cost of $1,478,402. The Company realized a717gain on the sale of $4,558,586. Under a manufacturing and supply agreement718between the Company and the buyer, the Company will continue to manufacture, and719supply to the buyer, certain conductive products for a portion of fiscal 2002.720The Company will supply the products at its cost of production through October72131, 2001, and at its cost of production plus ten percent thereafter.722723A non-recurring restructuring charge of $303,759 was incurred in the724fourth quarter of fiscal 2001 relating to the sale of the Company's conductive725business assets. The restructuring charge consists primarily of future rental726payments for a leased facility, separation costs, and other costs associated727with the wind-down of conductive business activity. The separation costs728includes the termination of production and administrative employees, of which729six were terminated on June 28, 2001. The total restructuring charge decreased730the 2001 net income per basic and diluted share by $.08. The Company expects to731complete the restructuring during fiscal 2002.732733On September 5, 2001, the Company's Board of Directors approved a734change in the Company's fiscal year end from June 30 to December 31. The change735is effective immediately. The Company will file a Transition Report on Form 10-K736for the six months ended December 31, 2001.737738NET SALES739740Net sales were $15,928,832 in fiscal 2001, an increase of 9.1% from net741sales of $14,596,346 in fiscal 2000. Net sales were $12,279,075 in fiscal 1999.742The increase in both fiscal 2001 and fiscal 2000 net sales was primarily the743result of increased therapeutic consumer product sales, partially offset by744decreased medical tape and conductive product sales.745746Net sales of therapeutic consumer products increased 77.0% in fiscal7472001 to $9,237,472 from $5,218,199 in fiscal 2000. Net sales of therapeutic748consumer products were $1,804,249 in fiscal 1999. The increase in fiscal 2001749was primarily the result of sales of the new vapor product to Novartis Consumer750Health, Inc as well as sales of the acne product to Johnson & Johnson Consumer751Products Worldwide. The increase in fiscal 2000 was primarily the result of752increased TheraPatch product sales, which increased 127.1%, and sales of the new753acne product to Johnson & Johnson Consumer Products Worldwide. Management754believes that sales of the Company's therapeutic patch products will represent755substantially all of total net sales during fiscal 2002 due to continued sales756growth of the vapor and acne products, increased TheraPatch brand name757recognition and the sale of the conductive business assets.75875976010761<PAGE>762763764Net sales of conductive products (medical electrodes and conductive765hydrogels) decreased by 11.9% in fiscal 2001 to $6,563,924 from $7,450,755 in766fiscal 2000. Net conductive product sales were $7,758,286 in fiscal 1999. The767decrease in fiscal 2001 was primarily the result of the sale of the assets of768the conductive products division in the fourth quarter. The decrease in fiscal7692000 net sales was primarily due to a decrease in units sold. The Company770expects fiscal 2002 conductive sales to decrease significantly due to the sale771of the assets of the conductive products division. Under a manufacturing and772supply agreement between the Company and the buyer, the Company will continue to773manufacture, and supply to the buyer, certain conductive products for a portion774of fiscal 2002. The Company will supply the products at its cost of production775through October 31, 2001, and at its cost of production plus ten percent776thereafter.777778Net sales of medical tapes decreased by 93.4% in fiscal 2001 to779$127,436 from $1,927,392 in fiscal 1999. Net medical tape sales were $2,716,540780in fiscal 1999. The decrease in fiscal 2001 was primarily the result of exiting781the medical tape business. The decrease in fiscal 2000 was primarily the result782of reduced sales to low-margin slit roll tape customers. The Company expects no783medical tape sales in fiscal 2002 due to the sale of its medical tape784manufacturing equipment in the third quarter of fiscal 2001 which finalized the785Company's plan to exit the medical tape business.786787Export sales, consisting primarily of electrodes, semi-finished788conductive products sold to overseas converters for final processing, packaging789and marketing, as well as TheraPatch brand therapeutic consumer products, were7908%, 13% and 13% of total net sales in fiscal 2001, 2000 and 1999 respectively.791All international sales were in U. S. dollars with the exception of TheraPatch792brand products sold in Canada. Export sales decreased by $683,817 in fiscal 2001793primarily as a result of the exit from the medical tape business and the sale of794the assets of the conductive products division. The Company expects fiscal 2002795international sales to decrease significantly due to the sale of the assets of796the conductive products division.797798GROSS PROFIT799800The Company's gross profit was $5,422,601 in fiscal 2001, up from801$5,121,217 in fiscal 2000. Gross profit was $4,093,561 in fiscal 1999. As a802percentage of net sales, gross profit was 34.0 % in fiscal 2001, 35.1% in fiscal8032000 and 33.3% in fiscal 1999. Gross profit in fiscal 2001 increased by 5.9%804from the prior year and gross profit in fiscal 2000 increased by 25.1% from the805prior year. The increase in gross profit in fiscal 2001 resulted primarily from806increased sales. The slight decrease in gross profit percent in 2001 resulted807primarily from the Company entering into a manufacturing and supply agreement808with the buyer of the assets of the conductive products division to continue to809manufacture, and supply the buyer certain conductive products at the Company's810cost. The increase in gross profit in fiscal 2000 resulted primarily from a811shift in the sales mix to higher margin therapeutic consumer products.812813SALES AND MARKETING EXPENSES814815Sales and marketing expenses totaled $4,377,580 or 27.5% of net sales816in fiscal 2001, compared to $3,672,908 or 25.2% of net sales in fiscal 2000, and817$2,187,710 or 17.8.% of net sales in fiscal 1999. The fiscal 2001 increase was818primarily due to an increase of $697,000 in media advertising expense related to819a TV ad campaign for TheraPatch Anti-Itch for Kids. The fiscal 2000 increase was820primarily due to increases of $280,000 in TheraPatch related advertising,821$256,000 in cooperative marketing retail promotions and $607,000 in slotting822fees. The Company anticipates sales and marketing expenses as a percent of sales823in fiscal 2002 will be comparable to fiscal 2001.824825GENERAL AND ADMINISTRATIVE EXPENSES826827General and administrative expenses totaled $2,957,098 or 18.6% of net828sales in fiscal 2001, compared to $2,598,998 or 17.8% of net sales in fiscal8292000, and $2,507,432 or 20.4% of net sales in fiscal 1999. The increase in830fiscal 2001 was primarily due to an increase of $270,000 in payroll related831expenses, and employment fees related to the hiring of a new CFO. The increase832in fiscal 2000 was primarily the result of an increase of $154,000 in consulting833expense which more than offset a decrease in83483583611837<PAGE>838839840legal expenses. Legal expense in the prior year included approximately $126,000841related to the re-negotiation and modification of the license agreement for the842development and commercialization of cotinine as well as legal expenses843associated with work on new and existing patents. The Company anticipates844general and administrative expenses as a percent of sales in fiscal 2002 will be845comparable to fiscal 2001.846847RESEARCH AND DEVELOPMENT EXPENSES848849Research and development expenses totaled $919,786 or 5.8% of net sales850in fiscal 2001, compared to $1,094,808 or 7.5% of net sales in fiscal 2000, and851$1,169,743 or 9.5% of net sales in fiscal 1999. The decrease in fiscal 2001852primarily resulted from a decrease of $60,000 in test run production costs. The853decrease was primarily the result of decreased activity due to exiting the854conductive products and tape business segments. The decrease in fiscal 2000855primarily reflects a decrease of $60,000 in test-run production costs.856Management believes that research and development expenditures as a percent of857sales will be comparable in fiscal 2002 to fiscal 2001.858859OTHER INCOME AND EXPENSE860861Interest expense totaled $151,272 in fiscal 2001 compared to $35,405 in862fiscal 2000 and $1,173 in fiscal 1999. The increase in fiscal 2001 was primarily863due to interest expense associated with increased borrowings on the line of864credit and interest expense associated with the mortgage agreement. The increase865in fiscal 2000 was primarily due to interest expense associated with the line of866credit. Gain on disposition of assets totaled $4,622,210 in fiscal 2001 due to867the sale of the conductive business assets and the disposition of the medical868tape equipment. There was no gain on disposition of assets in fiscal 2000 and869fiscal 1999. Other income decreased to $16,176 in fiscal 2001 from $27,692 in870fiscal 2000 and $89,240 in fiscal 1999 primarily due to decreased interest871income as a result of lower cash and cash equivalent balances.872873INCOME TAXES874875The Company recorded an income tax expense in fiscal 2001 of $48,000,876an income tax benefit in fiscal 2000 of $38,934 and no income tax expense or877benefit in fiscal 1999. The income tax expense in fiscal 2001 resulted from an878alternative minimum tax liability after offsetting regular taxable income with879prior years net operating loss carry forwards. The income tax benefit in fiscal8802000 resulted primarily from the refund of taxes previously paid by the881Company's foreign sales corporation. The foreign sales corporation was dissolved882during fiscal 2000. There was no income tax benefit recorded during fiscal 2000883and fiscal 1999 related to the loss before income taxes since the tax benefit884may not be realizable by the Company.885886OPERATIONS SUMMARY887888The net earnings from fiscal 2001 resulted primarily from the gain on889the sale of the assets of the conductive products division, which was partially890offset by a non-recurring restructuring charge. Excluding the gain and891restructuring charge, the Company incurred a comparable net loss to fiscal 2000.892The net loss excluding the gain and restructuring charge for fiscal 2001893resulted primarily from an increase in advertising expenses associated with894retail sales of the Company's TheraPatch products which more than offset an895increase in gross profit. The increase in gross profit resulted from increased896sales volume. The net loss for fiscal 2000 resulted primarily from increased897sales and marketing expenses and charges related to the plan to exit the medical898tape business which more than offset an increase in gross profit. The increase899in gross profit resulted from increased sales volume and a shift in the sales900mix toward higher-margin therapeutic consumer products. The net loss for fiscal9011999 resulted primarily from increased sales and marketing expenses related to902the Company's investment in the consumer products market and increased general903and administrative expenses, primarily those expenses related to the904modification of the cotinine license agreement and achievement of ISO 9001 and905EN 46001 certification.90690790812909<PAGE>910911912EFFECT OF INFLATION913914Inflation has not had a significant impact on the Company's operations915or cash flow.916917LIQUIDITY AND CAPITAL RESOURCES918919Cash and cash equivalents increased by $3,276,552 to $3,376,723 at June92030, 2001 from $100,171 at June 30, 2000. This increase was primarily due to the921net proceeds from the disposition of assets in fiscal 2001 of $6,666,988 which922was partially offset by the net loss excluding the gain on disposition of assets923and non-recurring restructuring charge of $3,014,959. Accounts receivable924decreased by $1,067,475 to $1,578,235 primarily due to accounts receivable sold925as part of the sale of the assets of the conductive products division.926Inventories decreased by $195,748 to $2,051,938 primarily due to inventory sold927as part of the sale of the assets of the conductive products928929Working capital totaled $4,279,728 at June 30, 2001, compared to930$1,512,561 at the end of fiscal 2000. The Company's current ratio was 2.4 at931June 30, 2001 compared to 1.4 at June 30, 2000.932933Capital spending for plant improvements and equipment totaled $371,906934in fiscal 2001. The Company entered into a purchase commitment for production935machinery in the amount of $154,482 during fiscal 2001. This purchase commitment936will be fulfilled sometime in the first six months of fiscal 2002. Net property,937plant and equipment decreased by $616,594 to $2,422,494 at June 30, 2001 from938$3,039,088 at June 30, 2000, reflecting equipment sold as part of the sale of939the assets of the conductive products division and the excess of depreciation940expense over capital spending.941942Accounts payable decreased by $401,254 to $1,175,728 at June 30, 2001943from $1,576,982 at June 30, 2000 primarily due to accounts payable sold as part944of the sale of the assets of the conductive products division as well as a945decrease in the average number of days outstanding before payment.946947The Company finalized a $2,000,000 asset-based line of credit in948November, 1999. In September 2000, the line of credit was increased to allow949borrowing of up to $2,800,000. There were no borrowings outstanding on the line950of credit at June 30, 2001. Borrowings outstanding on the line of credit were951$837,542 at June 30, 2000. The Company was in compliance with all covenants at952June 30, 2001. During fiscal 2001, the Company entered into a mortgage agreement953with gross proceeds of $820,000. Shareholders' equity increased by $1,366,732 to954$6,086,548 as of June 30, 2001 from $4,719,816 as of June 30, 2000, primarily955due to the net earnings incurred during 2001.956957Management believes that existing cash and cash equivalents,958internally-generated cash flow, and the existing secured line of credit959including the line of credit increase will be sufficient to support anticipated960operating and capital spending requirements through June 30, 2002 and contribute961to the funding of longer-term growth and expansion of the business. Management962is also evaluating additional sources of capital that may be appropriate for963funding longer-term growth and expansion. Maintaining adequate levels of working964capital depends in part upon the success of the Company's products in the965marketplace, the relative profitability of those products and the Company's966ability to control operating expenses. Funding of the Company's operations in967future periods may require additional investments in the Company in the form of968equity or debt. There can be no assurance that the Company will achieve desired969levels of sales or profitability, or that future capital infusions will be970available.971972FORWARD-LOOKING STATEMENTS973974From time to time, in reports filed with the Securities and Exchange975Commission (including this Form 10-K), in press releases, and in other976communications to shareholders or the investment community, the Company may977provide forward-looking statements concerning possible or anticipated future978results of operations or business developments which are typically preceded by979the words "believes", "expects", "anticipates", "intends", "will", "may",980"should" or similar expressions. Such forward-looking statements are subject to981risks and uncertainties which could cause results or developments to differ982materially from those indicated in the forward-looking statements. Such risks983and uncertainties98498598613987<PAGE>988989990include, but are not limited to, the buying patterns of major customers;991competitive forces including new products or pricing pressures; costs associated992with and acceptance of the Company's TheraPatch brand strategy; impact of993interruptions to production; dependence on key personnel; need for regulatory994approvals; changes in governmental regulatory requirements or accounting995pronouncements; ability to satisfy funding requirements for operating needs,996expansion or capital expenditures and the matters discussed on our "Cautionary997Statements" filed as Exhibit 99.01 to this from 10-K for the year ended June 30,9982001.9991000ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK1001-------- ----------------------------------------------------------10021003The Company has no history of, and does not anticipate in the future,1004investing in derivative financial instruments, derivative commodity instruments1005or other such financial instruments. Transactions with international customers1006are entered into in U.S. dollars with the exception of TheraPatch sales to1007Canadian customers, precluding the need for foreign currency hedges. Canadian1008sales have not been material. Additionally, the Company invests in money market1009funds which experience minimal volatility. Thus, the exposure to market risk is1010not material.101110121013141014<PAGE>101510161017ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA1018------- -------------------------------------------10191020LecTec Corporation Financial Statements Furnished Pursuant to the Requirements1021of Form 10-K.102210231024REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS1025--------------------------------------------------102610271028To the Shareholders and1029Board of Directors1030LecTec Corporation10311032We have audited the accompanying balance sheets of LecTec1033Corporation as of June 30, 2001 and 2000, and the related statements of1034operations, comprehensive earnings (loss), shareholders' equity, and cash flows1035for each of the three years in the period ended June 30, 2000. These financial1036statements are the responsibility of the Company's management. Our1037responsibility is to express an opinion on these financial statements based on1038our audits.10391040We conducted our audits in accordance with auditing standards1041generally accepted in the United States of America. Those standards require that1042we plan and perform the audit to obtain reasonable assurance about whether the1043financial statements are free of material misstatement. An audit includes1044examining, on a test basis, evidence supporting the amounts and disclosures in1045the financial statements. An audit also includes assessing the accounting1046principles used and significant estimates made by management, as well as1047evaluating the overall financial statement presentation. We believe our audits1048provide a reasonable basis for our opinion.10491050In our opinion, the financial statements referred to above1051present fairly, in all material respects, the financial position of LecTec1052Corporation as of June 30, 2001 and 2000, and the results of their operations1053and their cash flows for each of the three years in the period ended June 30,10542001, in conformity with accounting principles generally accepted in the United1055States of America.10561057We have also audited Schedule II of LecTec Corporation for each1058of the three years in the period ended June 30, 2001. In our opinion, this1059Schedule presents fairly, in all material respects, the information required to1060be set forth therein.106110621063/s/ Grant Thornton LLP10641065Minneapolis, Minnesota1066August 7, 2001106710681069151070<PAGE>107110721073LECTEC CORPORATION10741075BALANCE SHEETS10761077<TABLE>1078<CAPTION>1079June 30,1080------------------------1081ASSETS 2001 20001082---------- ----------1083<S> <C> <C>1084CURRENT ASSETS1085Cash and cash equivalents $3,376,723 $ 100,1711086Receivables1087Trade, net of allowances of $108,500 and1088$127,100 at June 30, 2001 and 2000 1,519,232 2,642,8801089Other 59,003 2,8301090Inventories 2,051,938 2,247,6861091Prepaid expenses and other 294,437 220,5141092Investments -- 22,0291093---------- ----------10941095Total current assets 7,301,333 5,236,11010961097PROPERTY, PLANT AND EQUIPMENT1098Land 247,731 247,7311099Building and improvements 1,971,031 1,963,3641100Equipment 4,439,139 4,995,8221101Furniture and fixtures 414,857 414,8571102---------- ----------11037,072,758 7,621,7741104Less accumulated depreciation 4,650,264 4,582,6861105---------- ----------11062,422,494 3,039,08811071108OTHER ASSETS1109Patents and trademarks, less accumulated amortization1110of $1,189,787 and $1,293,871 at June 30, 2001 and 2000 243,949 199,3511111---------- ----------11121113$9,967,776 $8,474,5491114========== ==========1115</TABLE>111611171118111911201121The accompanying notes are an integral part of these statements112211231124161125<PAGE>112611271128LIABILITIES AND1129SHAREHOLDERS' EQUITY11301131<TABLE>1132<CAPTION>1133June 30,1134-----------------------------11352001 20001136------------ ------------1137<S> <C> <C>1138CURRENT LIABILITIES1139Note payable to bank $ -- $ 837,5421140Current maturities of long-term obligations 38,311 22,5621141Accounts payable 1,175,728 1,576,9821142Accrued expenses1143Payroll related 366,467 371,4051144Retail support programs 595,509 421,4891145Other 495,892 333,5691146Customer deposits 75,000 160,0001147Restructuring charges 274,698 --1148------------ ------------11491150Total current liabilities 3,021,605 3,723,54911511152LONG-TERM OBLIGATIONS, less current maturities 859,623 31,18411531154COMMITMENTS AND CONTINGENCIES -- --11551156SHAREHOLDERS' EQUITY1157Common stock, $.01 par value; 15,000,000 shares1158authorized; 3,922,384 and 3,904,465 shares1159issued and outstanding at June 30, 2001 and 2000 39,224 39,0451160Additional contributed capital 11,344,166 11,316,2601161Accumulated other comprehensive gain -- 4,8451162Accumulated deficit (5,296,842) (6,640,334)1163------------ ------------11646,086,548 4,719,8161165------------ ------------11661167$ 9,967,776 $ 8,474,5491168============ ============1169</TABLE>117011711172171173<PAGE>117411751176LECTEC CORPORATION11771178STATEMENTS OF OPERATIONS11791180<TABLE>1181<CAPTION>1182Years ended June 30,1183----------------------------------------------11842001 2000 19991185------------ ------------ ------------1186<S> <C> <C> <C>1187Net sales $ 15,928,832 $ 14,596,346 $ 12,279,0751188Cost of goods sold 10,506,231 9,475,129 8,185,5141189------------ ------------ ------------11901191Gross profit 5,422,601 5,121,217 4,093,56111921193Operating expenses1194Sales and marketing 4,377,580 3,672,908 2,187,7101195General and administrative 2,957,098 2,598,998 2,507,4321196Research and development 919,786 1,094,808 1,169,7431197Restructuring charge 303,759 -- --1198Medical tape asset impairment -- 645,000 --1199------------ ------------ ------------12008,558,223 8,011,714 5,864,8851201------------ ------------ ------------12021203Loss from operations (3,315,622) (2,890,497) (1,771,324)12041205Other income (expenses)1206Interest expense (151,272) (35,405) (1,173)1207Gain on disposition of assets 4,662,210 -- --1208Other, net 16,176 27,692 89,2401209------------ ------------ ------------12101211Earnings (loss) before income taxes 1,391,492 (2,898,210) (1,683,257)12121213Income taxes 48,000 (38,934) --1214------------ ------------ ------------12151216Net earnings (loss) $ 1,343,492 $ (2,859,276) $ (1,683,257)1217============ ============ ============12181219Net earnings (loss) per share1220Basic $ 0.34 $ (0.74) $ (0.43)1221Diluted $ 0.34 $ (0.74) $ (0.43)12221223Weighted average shares outstanding1224Basic 3,911,577 3,885,911 3,906,6941225Diluted 3,925,851 3,885,911 3,906,6941226</TABLE>12271228122912301231The accompanying notes are an integral part of these statements.123212331234181235<PAGE>12361237123812391240LECTEC CORPORATION12411242STATEMENTS OF COMPREHENSIVE EARNINGS (LOSS)1243124412451246<TABLE>1247<CAPTION>1248Years ended June 30,1249------------------------------------------12502001 2000 19991251----------- ----------- -----------1252<S> <C> <C> <C>1253Net earnings (loss) $ 1,343,492 $(2,859,276) $(1,683,257)12541255Other comprehensive income (loss)12561257Unrealized holding gains (losses)1258arising during period on securities1259available for sale -- 16,686 (3,333)1260----------- ----------- -----------1261-- 16,686 (3,333)1262----------- ----------- -----------12631264Comprehensive earnings (loss) $ 1,343,492 $(2,842,590) $(1,686,590)1265=========== =========== ===========1266</TABLE>126712681269127012711272The accompanying notes are an integral part of these statements.127312741275191276<PAGE>127712781279LECTEC CORPORATION12801281STATEMENTS OF SHAREHOLDERS' EQUITY128212831284<TABLE>1285<CAPTION>1286Accumulated1287Common stock Additional other Total1288--------------------------- contributed comprehensive Accumulated shareholders'1289Shares Amount capital gain (loss) deficit equity1290------------ ------------ ------------ ------------ ------------ ------------1291<S> <C> <C> <C> <C> <C> <C>1292Balance at July 1, 1998 4,036,000 $ 40,360 $ 11,769,053 $ (8,508) $ (2,097,801) $ 9,703,1041293Net loss -- -- -- -- (1,683,257) (1,683,257)1294Common shares issued upon exercise1295of options 1,000 10 2,390 -- -- 2,4001296Unrealized loss on securities1297available-for-sale -- -- -- (3,333) -- (3,333)1298Common shares issued in connection1299with the employee stock purchase plan 15,126 151 32,855 -- -- 33,0061300Shares repurchased (175,650) (1,756) (541,644) -- -- (543,400)1301------------ ------------ ------------ ------------ ------------ ------------1302Balance at June 30, 1999 3,876,476 38,765 11,262,654 (11,841) (3,781,058) 7,508,5201303Net loss -- -- -- -- (2,859,276) (2,859,276)1304Common shares issued upon exercise of1305options 500 5 1,295 -- -- 1,3001306Unrealized gain on securities1307available-for-sale -- -- -- 16,686 -- 16,6861308Common shares issued in connection1309with the employee stock purchase plan 27,489 275 52,311 -- -- 52,5861310------------ ------------ ------------ ------------ ------------ ------------1311Balance at June 30, 2000 3,904,465 39,045 11,316,260 4,845 (6,640,334) 4,719,8161312Net earnings -- -- -- -- 1,343,492 1,343,4921313Realized loss on securities available1314for sale -- -- -- (4,845) -- (4,845)1315Common shares issued in connection1316with the employee stock purchase plan 17,919 179 27,906 -- -- 28,0851317------------ ------------ ------------ ------------ ------------ ------------1318Balance at June 30, 2001 3,922,384 $ 39,224 $ 11,344,166 $ -- $ (5,296,842) $ 6,086,5481319============ ============ ============ ============ ============ ============1320</TABLE>132113221323132413251326The accompanying notes are an integral part of these statements.132713281329201330<PAGE>133113321333LECTEC CORPORATION13341335STATEMENTS OF CASH FLOWS13361337<TABLE>1338<CAPTION>1339Years ended June 30,1340-------------------------------------------13412001 2000 19991342----------- ----------- -----------1343<S> <C> <C> <C>1344Cash flows from operating activities:1345Net earnings (loss) $ 1,343,492 $(2,859,276) $(1,683,257)1346Adjustments to reconcile net earnings (loss) to net1347cash provided by (used in) operating activities:1348Medical tape asset impairment and inventory write-down -- 730,000 --1349Gain on disposition of assets (4,662,210) -- --1350Restructuring charge 274,698 -- --1351Depreciation and amortization 521,276 908,024 851,0871352Deferred income taxes -- 157,000 --1353Changes in operating assets and liabilities, net of dispositions:1354Trade and other receivables (297,647) (294,165) (61,620)1355Refundable income taxes -- -- 52,0001356Inventories (177,646) (336,162) (278,513)1357Prepaid expenses and other (73,923) (45,840) (71,611)1358Accounts payable (103,675) 265,643 835,7611359Accrued expenses 337,513 42,917 167,1541360Customer deposits (85,000) 160,000 --1361----------- ----------- -----------13621363Net cash used in operating activities (2,923,122) (1,271,859) (188,999)13641365Cash flows from investing activities:1366Purchase of property, plant and equipment (371,906) (424,448) (419,469)1367Investment in patents and trademarks (141,215) (138,553) (79,513)1368Net proceeds from disposition of assets 6,666,988 -- --1369Proceeds from the sale of investments 11,076 -- --1370----------- ----------- -----------1371Net cash provided by (used in) investing activities 6,164,943 (563,001) (498,982)13721373Cash flows from financing activities:1374Issuance of common stock 28,085 53,586 35,0061375Repurchases and retirement of common stock -- -- (543,400)1376Net borrowings (repayments) on note payable (837,542) 837,542 --1377Proceeds from borrowing on long-term obligations 867,703 33,649 36,8491378Repayment of long-term obligations (23,515) (11,771) (4,981)1379----------- ----------- -----------13801381Net cash provided by (used in) financing activities 34,731 913,006 (476,526)1382----------- ----------- -----------13831384Net increase (decrease) in cash and cash1385equivalents 3,276,552 (921,854) (1,164,507)13861387Cash and cash equivalents at beginning of year 100,171 1,022,025 2,186,5321388----------- ----------- -----------13891390Cash and cash equivalents at end of year $ 3,376,723 $ 100,171 $ 1,022,0251391=========== =========== ===========1392</TABLE>139313941395211396<PAGE>13971398139914001401LECTEC CORPORATION14021403STATEMENTS OF CASH FLOWS - CONTINUED14041405140614071408Years ended June 30,1409------------------------------14102001 2000 19991411-------- -------- --------1412Supplemental disclosure of cash flow1413information:14141415Cash paid during the year for interest $161,664 $ 28,085 $ 79214161417Cash paid during the year for income taxes $ 2,000 $ -- $ 22,01014181419142014211422142314241425The accompanying notes are an integral part of these statements.142614271428221429<PAGE>143014311432LECTEC CORPORATION14331434NOTES TO FINANCIAL STATEMENTS14351436143714381439NOTE A - SUMMARY OF ACCOUNTING POLICIES14401441LecTec Corporation (the "Company") is primarily engaged in the research,1442design, manufacture and sale of therapeutic consumer products. The Company's1443customers are located throughout the United States as well as Canada.1444Subsequent to June 30, 2001, the Company changed its year end to December 31,1445from June 30. A summary of the Company's significant accounting policies1446consistently applied in the preparation of the accompanying financial1447statements follows:14481449Cash and Cash Equivalents1450-------------------------14511452The Company considers all highly liquid temporary investments purchased with1453original maturities of three months or less to be cash equivalents. At times1454cash and cash equivalents may be in excess of FDIC insurance limits.14551456Accounts Receivable1457-------------------14581459The Company grants credit to customers in the normal course of business, but1460generally does not require collateral or any other security to support1461amounts due. Management performs on-going credit evaluation of customers. The1462Company maintains allowances for potential credit losses which, when1463realized, have been within management expectations.14641465Investments1466-----------14671468The Company's investments are classified as available-for-sale and are1469reported at fair value. The Company utilizes the specific identification1470method in computing realized gains and losses.14711472Inventories1473-----------14741475Inventories are stated at the lower of cost (determined on a first-in,1476first-out basis) or market and consist of the following:14771478June 301479---------------------------14802001 20001481---------- ----------14821483Raw materials $1,517,167 $1,666,5441484Work in process 4,850 23,2021485Finished goods 529,921 557,9401486---------- ----------14871488$2,051,938 $2,247,6861489========== ==========1490149114921493231494<PAGE>149514961497NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued14981499Long-Lived Assets1500-----------------15011502Property, plant, and equipment is recorded at cost. Depreciation is provided1503in amounts sufficient to relate the cost of depreciable assets to operations1504over their estimated service lives. The straight-line method of depreciation1505is followed for financial reporting purposes, and accelerated methods are1506used for tax purposes. Estimated useful lives used in the calculation of1507depreciation for financial statement purposes are:15081509Buildings and improvements 5 - 40 years1510Equipment 4 - 15 years1511Furniture and fixtures 5 - 7 years15121513Patents and trademarks consist primarily of the cost of applying for patents1514and trademarks. Patents and trademarks are amortized on a straight-line basis1515over the estimated useful life of the asset, generally five years.15161517The carrying value of long-lived assets is reviewed periodically or when1518factors indicating impairment are present. Projected undiscounted cash flows1519are used when reviewing these assets.15201521Revenue Recognition1522-------------------15231524Revenue is recognized at the time of shipment.15251526Advertising1527-----------15281529The Company expenses the cost of advertising as incurred, except for the cost1530of television commercials which are expensed as the commercials are1531broadcast. Advertising expense totaled approximately $1,233,000, $536,000 and1532$271,000, for the years ended June 30, 2001, 2000 and 1999.15331534Research and Development1535------------------------15361537Research and development costs are expensed as incurred and are reported as a1538component of selling, general and administrative expenses.15391540154115421543241544<PAGE>154515461547NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued15481549Net Earnings (Loss) Per Share1550-----------------------------15511552Basic net earnings (loss) per share is computed by dividing net earnings1553(loss) by the weighted average number of common shares outstanding. Diluted1554net earnings (loss) per share is computed by dividing net earnings (loss) by1555the weighted average number of common shares outstanding and common share1556equivalents related to stock options and warrants when dilutive.15571558Common stock options and warrants to purchase 1,044,129, 1,048,205 and1559897,506 shares of common stock with a weighted average exercise price of1560$5.39, $6.07 and $7.54 were outstanding during the years ended June 30, 2001,15612000 and 1999, but were excluded because they were antidilutive.15621563Stock Based Compensation1564------------------------15651566The Company utilizes the intrinsic value method of accounting for its1567stock-based employee compensation plan. Pro-forma information related to the1568fair value based method of accounting is disclosed in Note H.15691570Fair Value of Financial Instruments1571-----------------------------------15721573Due to their short-term nature, the carrying value of current financial1574assets and liabilities approximates their fair values. The fair value of1575long-term obligations, if recalculated based on current interest rates, would1576not significantly differ from the recorded amounts.15771578Use of Estimates1579----------------15801581In preparing financial statements in conformity with accounting principles1582generally accepted in the United States of America, management is required to1583make estimates and assumptions that affect the reported amounts of assets and1584liabilities and the disclosure of contingent assets and liabilities at the1585date of the financial statements and the reported amounts of revenues and1586expenses during the reporting period. Actual results could differ from those1587estimates.1588158915901591251592<PAGE>159315941595NOTE A - SUMMARY OF ACCOUNTING POLICIES - Continued15961597Reclassifications1598-----------------15991600Certain reclassifications have been made to the 2000 and 1999 balances to1601conform to the presentation used in 2001.160216031604NOTE B - DISPOSITION OF MEDICAL TAPE ASSETS16051606During the third quarter of 2001, the Company sold its medical tape1607manufacturing equipment and other related assets. Net proceeds from the sale1608were $630,000 consisting of the purchase price of $700,000 less transaction1609costs of $70,000. The Company realized a gain on the sale of $103,624. The1610sale of the medical tape equipment finalized the Company's plan to exit the1611medical tape business which was adopted at the end of the fiscal year 2000.1612Adoption of this plan originally resulted in a charge of $645,000 during1613fiscal year 2000 related to the write-down of the medical tape equipment to1614its estimated fair market value of $525,375 at June 30, 2000.161516161617NOTE C - SALE OF CONDUCTIVE BUSINESS ASSETS AND RESTRUCTURING16181619During the fourth quarter of 2001, the Company sold its diagnostic electrode1620and electrically conductive adhesive hydrogel business assets which were used1621to produce the Company's conductive products. Net proceeds from the sale were1622$6,036,988 consisting of the purchase price of $7,268,404 less transaction1623costs of $1,231,416. The net assets sold as part of the transaction were1624carried at a cost of $1,478,402. The Company realized a gain on the sale of1625$4,558,586. Under a manufacturing and supply agreement between the Company1626and the buyer, the Company will continue to manufacture, and supply to the1627buyer, certain conductive products for a portion of fiscal 2002. The Company1628will supply the products at its cost of production through October 31, 20011629and at its cost of production plus 10% thereafter.163016311632163316341635261636<PAGE>163716381639NOTE C - SALE OF CONDUCTIVE BUSINESS ASSETS AND RESTRUCTURING -1640Continued16411642Revenues and cost of goods sold for the medical tape business and conductive1643business are as follows for the years ended June 30:164416452001 2000 19991646---------- ---------- ----------16471648Net sales1649Conductive products $6,564,000 $7,451,000 $7,758,0001650Medical tape products 127,000 1,927,000 2,717,0001651----------- ---------- ----------16526,691,000 9,378,000 10,475,00016531654Cost of good sold1655Conductive products 4,940,000 5,230,000 4,780,0001656Medical tape products 178,000 2,048,000 2,685,0001657---------- ---------- ----------16585,118,000 7,278,000 7,465,0001659---------- ---------- ----------16601661Gross profit $1,573,000 $2,100,000 $3,010,0001662========== ========== ==========16631664A non-recurring restructuring charge of $303,759 was incurred in the fourth1665quarter of 2001 relating to the sale of the Company's conductive business1666assets. The restructuring charge consists primarily of future rental payments1667for a leased facility, separation costs, and other costs associated with the1668wind-down of conductive business activity. The separation costs includes the1669termination of 17 production and administrative employees, of which six were1670terminated on June 28, 2001. The total restructuring charge decreased the16712001 net income per basic and diluted share by $.08. The Company expects to1672complete the restructuring during fiscal 2002.16731674Selected information regarding the restructuring accrual as of June 30, 20011675is as follows:16761677Separation Facility Other1678costs costs costs Total1679------- -------- -------- --------16801681Accrual at April 1, 2001 $ -- $ -- $ -- $ --1682Restructuring accrual 111,637 122,702 69,420 303,7591683Payments (9,641) -- (19,420) (29,061)1684-------- -------- -------- --------16851686$101,996 $122,702 $ 50,000 $274,6981687======== ======== ======== ========16881689169016911692271693<PAGE>169416951696NOTE D - NOTE PAYABLE TO BANK16971698The Company entered into a secured line of credit on November 22, 1999, with1699a maximum borrowing of $2,000,000 as defined in the agreement. In September17002000, the line of credit was increased to allow borrowing of up to1701$2,800,000. The credit agreement expires November 22, 2001 and includes1702interest computed at the prime rate plus 3% (effective rate of 9.75% and170312.5% at June 30, 2001 and 2000). The agreement includes a minimum annual1704interest charge for each year of the agreement ($80,000 and $95,000 for each1705of the two years ended November 22, 2001). There were no borrowings1706outstanding on the line of credit at June 30, 2001. Borrowings under the1707credit agreement are collateralized by substantially all of the Company's1708assets. At June 30, 2001, the Company was in compliance with all covenants1709contained in the credit agreement.171017111712NOTE E - LONG-TERM OBLIGATIONS17131714In December 2000, the Company entered into a mortgage agreement which1715provided gross proceeds of $820,000. The principal balance of the mortgage is1716due in December 2002 with monthly interest payments due computed at the prime1717rate plus five percentage points (effective rate of 11.75% at June 30, 2001).1718The mortgage is collateralized by the Company's real property. The remainder1719of long-term obligations consists of capital lease obligations, due in1720various monthly installments up to $1,230 including interest up to 19.1%1721through June 2005, collateralized by equipment.17221723Maturities of long-term obligations are as follows:17241725Years ending June 30:17262002 $ 38,31117272003 850,81117282004 3,99017292005 4,8221730--------17311732$897,9341733========17341735173617371738281739<PAGE>174017411742NOTE F - COMMITMENTS AND CONTINGENCIES17431744Leases1745------17461747The Company conducts portions of its operations in a leased facility that1748expires June 30, 2002. The lease provides for payment of a portion of taxes1749and other operating expenses by the Company. Total rent expense for operating1750leases was $265,595, $260,481 and $250,641 for the years ended June 30, 2001,17512000 and 1999.17521753Future minimum lease commitments under all operating leases are as follows:17541755Years ending June 30:1756---------------------17572002 $257,00317582003 2,26917592004 2,26917602005 79217611762Employee Benefit Plan1763---------------------17641765The Company maintains a contributory 401(k) profit sharing benefit plan1766covering substantially all employees. The Company matches 50% of employee1767contributions up to 5% of a participant's compensation. The Company's1768contributions under this plan were $86,750, $81,474 and $71,006 for the years1769ended June 30, 2001, 2000 and 1999. The Company may also make a discretionary1770contribution. No discretionary contributions were made for each of the three1771years ended June 30, 2001.17721773Legal Proceedings1774-----------------17751776The Company is subject to various legal proceedings in the normal course of1777business. Management believes these proceedings will not have a material1778adverse effect on the Company's financial position or results of operations.1779178017811782291783<PAGE>178417851786NOTE G - INCOME TAXES17871788Income tax expense (benefit) consists of the following:17891790Years ended June 30,1791---------------------------------------------17922001 2000 19991793--------- --------- --------17941795Current $ 48,000 $(195,934) $ --1796Deferred -- 157,000 --1797--------- --------- --------17981799$ 48,000 $ (38,934) $ --1800========= ========= ========18011802Deferred tax assets and liabilities represent the tax effects of cumulative1803future deductible or taxable items that have been recognized in the financial1804statements as follows:18051806June 30,1807---------------------------18082001 20001809----------- -----------1810Current assets and liabilities:1811Inventories $ 150,500 $ 160,6001812Vacation pay 57,300 73,5001813Write-down of long-lived medical tape1814assets -- 232,2001815Restructuring accrual 109,400 --1816Other 227,800 115,6001817----------- -----------18181819Net current asset 545,000 581,90018201821Long-term assets and liabilities:1822Net operating loss carryforwards 1,640,000 2,312,0001823Tax credit carryforwards 287,600 253,6001824Tax depreciation in excess of book1825depreciation (210,100) (225,000)1826Charitable contribution carryforwards -- 19,2001827Other 70,200 69,8001828----------- -----------18291830Net long-term asset 1,787,000 2,429,6001831----------- -----------18321833Net deferred tax asset 2,332,700 3,011,5001834Less valuation allowance (2,332,700) (3,011,500)1835----------- -----------18361837Net deferred tax asset $ -- $ --1838=========== ===========183918401841301842<PAGE>184318441845NOTE G - INCOME TAXES - Continued18461847At June 30, 2001, the Company has available net operating loss carryforwards1848of approximately $4,800,000 which can be used to reduce future taxable1849income. The utilization of a portion of these net operating loss1850carryforwards is restricted under Section 382 of the Internal Revenue Code1851due to past ownership changes. These net operating loss carryforwards begin1852to expire in 2007. A valuation allowance has been recorded for these net1853operating loss carryforwards and all other deferred tax assets as they may1854not be realizable.18551856Differences between income tax expense (benefit) and the statutory federal1857income tax rate of 34% are as follows:18582001 2000 19991859------- ------- -------18601861Federal statutory income tax rate 34.0% (34.0)% (34.0)%1862State income taxes, net of federal effect .1 .1 --1863Change in valuation allowance (35.4) 33.6 34.41864Other 4.8 (1.0) (0.4)1865------- ------- -------186618673.5% (1.3)% --%1868======= ======= =======186918701871NOTE H - EQUITY TRANSACTIONS18721873Employee Stock Purchase Plan1874----------------------------18751876The Company's employee stock purchase plan, adopted November 19, 1998, allows1877eligible employees to purchase shares of the Company's common stock through1878payroll deductions. The purchase price is the lower of 85% of the fair market1879value of the stock on the first or last day of each six-month period during1880which an employee participated in the plan. The Company has reserved 200,0001881shares under the plan. The Company issued 17,919 and 27,489 shares in1882connection with purchases by employees for $28,085 and $52,586 for the years1883ended June 30, 2001 and 2000.1884188518861887311888<PAGE>188918901891NOTE H - EQUITY TRANSACTIONS - Continued189218931894Stock Options and Warrants1895--------------------------18961897The Company has stock option plans for the benefit of selected officers,1898employees and directors of the Company. A total of 1,673,049 shares of common1899stock are reserved for issuance under the plans. Options under the Company's1900plans are granted at fair market value and expire at five or ten years from1901the grant date. Options given to directors are exercisable at the date of1902grant. Options given to selected officers and employees are exercisable at1903such times as set forth in the individual option agreements, generally1904vesting 100% after three to four years.19051906A summary of the Company's stock option transactions for the years ended June190730, 2001, 2000 and 1999 is as follows:1908Weighted average1909Number of shares exercise price1910---------------- ----------------191119121913Outstanding at July1, 1998 847,620 $7.861914Granted 304,200 2.761915Exercised (1,000) 2.001916Canceled (16,994) 8.741917---------19181919Outstanding at June 30, 1999 1,133,826 6.481920Granted 115,000 3.041921Exercised (500) 2.001922Canceled (221,704) 8.441923---------19241925Outstanding at June 30, 2000 1,026,622 5.681926Granted 285,000 2.201927Exercised -- --1928Canceled (176,007) 5.231929--------- -----19301931Outstanding at June 30, 2001 1,135,615 $4.871932========= =====19331934A total of 716,667, 604,971 and 593,876 options were exercisable at June 30,19352001, 2000 and 1999, with a weighted average price of $5.93, $6.54 and $7.83.1936193719381939321940<PAGE>194119421943NOTE H - EQUITY TRANSACTIONS - Continued194419451946The following information applies to grants that are outstanding at June 30,19472001:19481949<TABLE>1950<CAPTION>1951Options outstanding Options exercisable1952--------------------------------------------- --------------------------1953Weighted Weighted Weighted1954average average average1955Range of Number remaining exercise Number exercise1956exercise prices outstanding contractual life price exercisable price1957--------------- ----------- ---------------- ------------ ----------- ---------1958<S> <C> <C> <C> <C> <C> <C> <C>1959$ 2.00 - $ 2.94 577,167 3.8 years $ 2.45 231,260 $ 2.511960$ 3.19 - $ 4.43 68,700 5.3 years 3.58 38,784 3.621961$ 5.00 - $ 7.50 262,250 6.0 years 5.99 239,625 6.071962$7.77 - $11.25 226,998 4.0 years 10.11 206,998 10.001963--------- -------19641,135,615 716,6671965========= =======1966</TABLE>19671968The weighted average fair value of the options granted during 2001, 2000 and19691999 were $1.52, $1.84, and $1.47. The fair value of each option grant is1970estimated on the date of grant using the Black-Scholes option valuation model1971with the following weighted-average assumptions used for all grants in 2001,19722000 and 1999: zero dividend yield, expected volatility of 96%, 74% and 62%,1973risk-free interest rate of 4.97%, 6.53% and 5.77% and expected lives of 4.00,19744.00 and 4.09 years.19751976Management believes the Black-Scholes option valuation model currently1977provides the best estimate of fair value. However, the Black-Scholes option1978valuation model was developed for use in estimating the fair value of traded1979options which have no vesting restrictions and are fully transferable. In1980addition, option valuation models require the input of several subjective1981assumptions. The Company's employee and director stock options have1982characteristics different from those of traded options, and changes in the1983subjective input assumptions can materially affect the fair value estimate.1984In management's opinion, the existing models do not necessarily provide a1985reliable single measure of the fair value of its employee and director stock1986options.1987198819891990331991<PAGE>199219931994NOTE H - EQUITY TRANSACTIONS - Continued199519961997The Company's net earnings (loss) and net earnings (loss) per share for 2001,19982000 and 1999 would have been changed to the pro forma amounts indicated1999below had the fair value method been used for options granted to employees2000and directors. These effects may not be representative of the future effects2001of applying this method.20022003<TABLE>2004<CAPTION>20052001 2000 19992006------------------------- ------------------------- -------------------------2007As reported Pro forma As reported Pro forma As reported Pro forma2008----------- ----------- ----------- ----------- ----------- -----------2009<S> <C> <C> <C> <C> <C> <C>2010Net earnings (loss) $ 1,343,492 $ 873,179 $(2,859,276) $(3,447,381) $(1,683,257) $(2,201,974)2011Net earnings (loss)2012per share - $ .34 $ .22 $ (.74) $ (.89) $ (.43) $ (.56)2013basic/diluted2014</TABLE>201520162017Stock Repurchase Program2018------------------------20192020In April 1998, the Company's Board of Directors authorized a stock repurchase2021program pursuant to which up to 500,000 shares, or approximately 12.4% of the2022Company's outstanding common stock, may be repurchased. The shares may be2023purchased from time to time through open market transactions, block2024purchases, tender offers, or in privately negotiated transactions. The total2025consideration for all shares repurchased under this program cannot exceed2026$2,000,000. During the year ended June 30, 1999, the Company repurchased2027175,650 shares for $543,400. There were no shares repurchased during the2028years ended June 30, 2001 and 2000.202920302031NOTE I - SEGMENT INFORMATION20322033The Company operates its business in one reportable segment - the manufacture2034and sale of products based on advanced skin interface technologies. Each of2035the Company's major product lines have similar economic characteristics,2036technology, manufacturing processes, and regulatory environments. Customers2037and distribution and marketing strategies vary within major product lines as2038well as overlap between major product lines. The Company's executive decision2039makers evaluate sales performance based on the total sales of each major2040product line and20412042204320442045342046<PAGE>204720482049NOTE I - SEGMENT INFORMATION - Continued20502051profitability on a total company basis, due to shared infrastructures, to2052make operating and strategic decisions. The Company sold the conductive and2053medical tape product lines during fiscal year 2001. Net sales by major2054product line were as follows:20552056Years ended June 30,2057-----------------------------------------20582001 2000 19992059----------- ----------- -----------20602061Conductive products $ 6,563,924 $ 7,450,755 $ 7,758,2862062Medical tape products 127,436 1,927,392 2,716,5402063Therapeutic consumer products 9,237,472 5,218,199 1,804,2492064----------- ----------- -----------20652066$15,928,832 $14,596,346 $12,279,0752067=========== =========== ===========20682069Export sales accounted for approximately 8%, 13% and 13% of total net sales2070during the years ended June 30, 2001, 2000, and 1999. Export sales are2071attributed to geographic region based upon the location of the customer. The2072conductive and medical tape product lines have been sold during fiscal 20012073and accounted for all the export sales other than to Canada. Export sales by2074geographic area were as follows:20752076Years ended June 30,2077-----------------------------------------20782001 2000 19992079----------- ----------- -----------20802081Europe $ 815,796 $ 1,006,412 $ 1,216,1992082Latin America 139,613 547,904 371,6542083Asia 72,851 46,279 31,9352084Canada 215,686 298,884 7,0112085Middle East -- 10,272 --2086Other 7,950 25,962 28,3332087----------- ----------- -----------20882089$ 1,251,896 $ 1,935,713 $ 1,655,1322090=========== =========== ===========20912092209320942095352096<PAGE>209720982099NOTE J - MAJOR CUSTOMERS21002101Two customers accounted for 30% of total sales for the year ended June 30,21022001. The accounts receivable from these customers represented 36% of trade2103receivables at June 30, 2001. Management believes that the loss of these two2104major customers could have a material adverse effect on the Company. Another2105customer accounted for 12%, 17% and 22% of total sales for each of the three2106years ended June 30, 2001. The accounts receivable from this customer2107represented 18% and 26% of trade receivables at June 30, 2000 and 1999. This2108conductive products customer will no longer generate sales due to the sale of2109the Company's conductive business assets during the year ended June 30, 2001.211021112112NOTE K - RECENT ACCOUNTING PRONOUNCEMENTS21132114On July 20, 2001, the Financial Accounting Standards Board (FASB) issued2115Statement of Financial Accounting Standards (SFAS) 141, BUSINESS2116COMBINATIONS, and SFAS 142, GOODWILL AND INTANGIBLE ASSETS. SFAS 141 is2117effective for all business combinations completed after June 30, 2001. SFAS2118142 is effective for fiscal years beginning after December 15, 2001; however,2119certain provisions of this Statement apply to goodwill and other intangible2120assets acquired between July 1, 2001 and the effective date of SFAS 142. The2121company is currently reviewing the affect of these Statements on their2122financial statements.21232124The Securities and Exchange Commission issued Staff Accounting Bulletin No.2125101, "REVENUE RECOGNITION IN FINANCIAL STATEMENTS" ("SAB 101") in December21261999. SAB 101 summarizes certain aspects of the staff's views in applying2127generally accepted accounting principles to revenue recognition in financial2128statements. In 2000, the Securities and Exchange Commission issued SAB 101A2129and 101B, which extended the transition provision of SAB 101 to the Company's2130fiscal year 2001. SAB 101 has not had a material impact on the Company's2131financial statements.21322133Financial Accounting Standard Board Statement No. 133 "ACCOUNTING FOR2134DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("SFAS 133") was effective for2135the Company's 2001 fiscal year. SFAS 133 requires entities to recognize all2136derivatives in their financial statements as either assets or liabilities2137measured at fair value. The statement also specifies new methods of2138accounting for derivatives used in risk management strategies (hedging2139activities), prescribes the items and transactions that may be hedged, and2140specified detailed criteria required to qualify for hedge accounting. SFAS2141133 has not had a material impact on the Company's financial statements.214221432144214521462147362148<PAGE>214921502151NOTE K - RECENT ACCOUNTING PRONOUNCEMENTS - Continued21522153In March 2000, the Emerging Issues Task Force ("EITF") reached a consensus on2154EITF Issue No. 00-14, "Accounting for Certain Sales Incentives." This2155consensus provides guidance on the recognition, measurement and income2156statement classification of sales incentives which are offered voluntarily by2157a vendor without charge to customers that can be used in, or that are2158exercisable by a customer as a result of a single exchange transaction. EITF2159Issue No. 00-14 has not had a material impact on the Company's financial2160statements.21612162Financial Accounting Standards Board ("FASB") Interpretation 44,2163INTERPRETATION OF APB OPINION 25 (FIN 44) was issued in March 2000. FIN 442164provides an interpretation of APB Opinion 25 on accounting for employee stock2165compensation and describes its application to certain transactions. FIN 442166was effective as of the beginning of the Company's 2001 fiscal year. It2167primarily applies on a prospective basis to events occurring after that date,2168except for certain transactions involving options granted to non-employees,2169re-priced fixed options, and modifications to add reload option features. FIN217044 has not had a material impact on the Company's financial statements.217121722173NOTE L - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)21742175<TABLE>2176<CAPTION>2177Year ended June 30, 20002178---------------------------------------------------------------2179First Quarter Second Quarter Third Quarter Fourth Quarter*2180------------- -------------- ------------- ---------------2181<S> <C> <C> <C> <C>2182Net sales $ 4,188,894 $ 4,056,484 $ 4,171,778 $ 3,511,6762183Gross profit 1,634,031 1,358,773 1,436,641 993,1562184Net earnings (loss) (597,901) (691,996) (543,781) 3,177,1702185Net earnings (loss) per share2186Basic $ (0.15) $ (0.18) $ (0.14) $ 0.812187Diluted $ (0.15) $ (0.18) $ (0.14) $ 0.802188Weighted average common shares2189outstanding2190Basic 3,904,465 3,908,364 3,915,676 3,917,9612191Diluted 3,904,465 3,908,364 3,915,676 3,990,1702192</TABLE>219321942195* Includes a gain of $4,558,586 from the sale of the Conductive Business2196Assets and a related restructuring charge of $303,759.21972198219922002201372202<PAGE>220322042205NOTE L - QUARTERLY FINANCIAL INFORMATION (UNAUDITED) - Continued22062207<TABLE>2208<CAPTION>2209Year ended June 30, 20002210---------------------------------------------------------------2211First Quarter Second Quarter Third Quarter Fourth Quarter2212------------- -------------- ------------- --------------2213<S> <C> <C> <C> <C>22142215Net sales $ 3,008,752 $ 3,299,705 $ 3,934,825 $ 4,353,0642216Gross profit 939,281 1,063,014 1,511,661 1,607,2612217Net loss (603,282) (795,167) (643,328) (817,499)2218Net loss per share2219Basic $ (0.16) $ (0.20) $ (0.17) $ (0.21)2220Diluted $ (0.16) $ (0.20) $ (0.17) $ (0.21)22212222Weighted average common shares2223outstanding2224Basic 3,876,476 3,881,352 3,890,494 3,895,4792225Diluted 3,876,476 3,881,352 3,890,494 3,895,4792226</TABLE>22272228222922302231382232<PAGE>223322342235ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND2236------- ---------------------------------------------------------------2237FINANCIAL DISCLOSURE2238--------------------22392240None.224122422243PART III22442245ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT2246-------- --------------------------------------------------22472248The information required under this item with respect to executive2249officers has been previously included under the heading "Executive Officers of2250the Registrant" in Item 1 of this Form 10-K.22512252INFORMATION CONCERNING DIRECTORS22532254Lee M. Berlin, 79 years old, has been a Director since 1981 and served2255as Chairman of the Board from 1983 through May 1993. He served as LecTec's Chief2256Executive Officer from 1983 through January 1989. Prior to joining LecTec, Mr.2257Berlin served in a variety of foreign and domestic marketing, product2258development and general management positions with Minnesota Mining &2259Manufacturing Company ("3M"). Currently, Mr. Berlin manages personal business2260interests.22612262Alan C. Hymes, M.D., 69 years old, is a founder of LecTec, has been a2263Director since 1977 and acts as LecTec's medical consultant. He has been engaged2264in the private practice of surgery since 1968. He is a diplomat of the American2265Board of Surgery and the American Board of Thoracic and Cardiovascular Surgery.22662267Bert J. McKasy, 59 years old, has been a Director since 1997 and has2268been a partner with the law firm Lindquist & Vennum PLLP since 1994. He is also2269the current Comissioner of the Metropolitan Airports Commission and has owned2270McKasy Travel Service, Inc. since 1983. Prior to joining Lindquist & Vennum, Mr.2271McKasy was an attorney with Maun & Simon, Vice President of First Trust Company,2272Trust and Investment Administration (now U.S. Bank Trust) and Executive Vice2273President of Fritz Company.22742275Marilyn K. Speedie, Ph.D., 53 years old, has been a Director since 19972276and is the Dean of the College of Pharmacy and a professor at the University of2277Minnesota. Prior to her association with the University of Minnesota in 1996,2278Dr. Speedie held several professorship and departmental chairperson positions at2279the University of Maryland (1989-1995), the most recent being in the Department2280of Pharmaceutical Sciences. She has been the recipient of numerous honors, the2281most recent in October of 1996 which was as an inductee as Fellow of the2282American Association of Pharmaceutical Scientists, and has also co-authored a2283book published in 1996 entitled PHARMACOGNOSY AND PHARMACOBIOTECHNOLOGY.22842285Donald C. Wegmiller, 63 years old, has served as a Director since 1997.2286Since April 1993, Mr. Wegmiller has served as President and Chief Executive2287Officer of Clark/Bardes Consulting - Healthcare Group, a consulting firm2288specializing in compensation and benefits for health care executives and2289physicians. From May 1987 until April 1993, Mr. Wegmiller was President and CEO2290of Health One Corporation, Minneapolis, Minnesota. He currently serves as a2291Director of ALLETE (formerly known as Minnesota Power), Possis Medical, Inc. and2292JLJ Medical Devices International, LLC. From 1986 to 1988, Mr. Wegmiller served2293as Chairman of the Board of the American Hospital Association. From 1972 to 19762294and 1981 to 1988, Mr. Wegmiller served as a White House staff assistant to2295Presidents Nixon, Ford and Reagan.22962297Rodney A. Young, 46 years old, was appointed a Director, Chief2298Executive Officer and President of LecTec in August 1996. In November 1996 he2299was appointed as Chairman of the Board. Prior to assuming the leadership role2300with LecTec, Mr. Young served Baxter International, Inc. for five years in2301various management roles, most recently as Vice President and General Manager of2302the Specialized230323042305392306<PAGE>230723082309Distribution Division. Mr. Young also serves as a Director of Possis Medical,2310Inc., Delta Dental Plan of Minnesota, as well as Health Fitness Corporation.23112312SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE23132314Section 16(a) of the Securities Exchange Act of 1934 requires LecTec's2315executive officers and directors and persons who beneficially own more than 10%2316of LecTec's Common Stock to file initial reports of ownership and reports of2317changes in ownership with the Securities and Exchange Commission. Such executive2318officers, directors and greater than 10% beneficial owners are required by the2319regulations of the Commission to furnish LecTec with copies of all Section 16(a)2320reports they file.23212322Based solely on a review of the copies of such reports furnished to2323LecTec and written representations from the executive officers and directors,2324LecTec believes that all Section 16(a) filing requirements applicable to its2325executive officers and directors and greater than 10% beneficial owners have2326been met, except that an April 20, 2000 exercise of LecTec stock options by2327Marilyn Speedie was not reported on a timely filed April 2000 Form 4. A Form 52328for Ms. Speedie was filed on August 6, 2001 which correctly reported the2329transaction.23302331233223332334402335<PAGE>233623372338ITEM 11. EXECUTIVE COMPENSATION2339-------- ----------------------23402341SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION23422343The following table shows the cash and non-cash compensation for the2344fiscal years ended June 30, 2001, 2000 and 1999, awarded to or earned by Rodney2345A. Young, the Chairman of the Board and LecTec's President and Chief Executive2346Officer, and the other executive officers of LecTec.23472348SUMMARY COMPENSATION TABLE23492350<TABLE>2351<CAPTION>2352Long-Term2353Compensation2354Annual Compensation Awards2355---------------------- --------2356Fiscal Year Securities2357Ended Underlying All Other2358Name and Position June 30, Salary Bonus Options Compensation(1)2359----------------- -------- -------- -------- -------- --------2360<S> <C> <C> <C> <C> <C>2361Rodney A. Young 2001 $216,834 $ 80,000(2) 60,000 $ 3,4712362Chairman, President and 2000 200,000 -- -- 4,0392363Chief Executive Officer 1999 200,000 -- 95,000 2,35823642365Timothy R. J. Quinn 2001 124,859 35,640(2) 30,000 1,9012366Vice President and General 2000 118,800 35,640(3) -- 2,0092367Manager, Consumer Products 1999 99,000 -- 58,000 2,36523682369Douglas J. Nesbit 2001 104,870 11,600(2) 55,000 2,2672370Chief Financial Officer, 2000 -- -- -- --2371Secretary and Treasurer 1999 -- -- -- --23722373Jane M. Nichols 2001 123,282 35,190(2) 30,000 1,2332374Vice President, Marketing and 2000 117,300 -- -- 1,2182375New Business Development 1999 117,300 -- 22,500 1,17323762377John D. LeGray 2001 109,746 31,326(2) 30,000 2,7442378Vice President, Quality 2000 104,420 -- -- 2,7112379Assurance & Regulatory Affairs 1999 98,400 -- 22,500 2,46023802381Timothy P. Fitzgerald 2001 115,610 22,000(2) 30,000 2,8902382Vice President, Operations 2000 40,192 -- 25,000 --23831999 -- -- -- --23842385William J. Tourek 2001 46,154 -- -- 8082386Vice President, Research and 2000 -- -- -- --2387Development 1999 -- -- -- --2388------------------------2389</TABLE>23902391(1) Reflects matching contributions under LecTec's 401(k) and Profit2392Sharing Plan.2393(2) Executive officers at February 1, 2001 received a bonus outside the2394annual incentive program based on the work performed to complete the2395sale of the assets of the conductive products division.2396(3) Mr. Quinn received a bonus outside the annual incentive program based2397on the achievement of certain sales goals.2398239924002401412402<PAGE>240324042405OPTION GRANTS IN LAST FISCAL YEAR24062407The following table contains information concerning the grant of stock2408options under LecTec's 1998 Stock Option Plan during the fiscal year ended June240930, 2001, to each of the executive officers named in the Summary Compensation2410Table:24112412<TABLE>2413<CAPTION>2414INDIVIDUAL GRANTS(1) POTENTIAL2415------------------------------------------------------ REALIZABLE2416PERCENT VALUE AT2417OF TOTAL ASSUMED2418OPTIONS ANNUAL RATES OF2419NUMBER OF GRANTED STOCK PRICE2420SECURITIES TO EXERCISE APPRECIATION2421UNDERLYING EMPLOYEES PRICE FOR OPTION TERM(3)2422OPTIONS IN FISCAL PER EXPIRATION ------------------------2423NAME GRANTED YEAR(2) SHARE DATE 5% 10%2424--------------------------------- ------- -------- ----- ------------ ----------- -----------2425<S> <C> <C> <C> <C> <C> <C>2426Rodney A. Young 60,000 21.1% $2.22 Feb. 1, 2006 $37,971 $82,78124272428Timothy R. J. Quinn 30,000 10.5 2.22 Feb. 1, 2006 18,986 41,39124292430Douglas J. Nesbit 25,000 8.8 2.44 Aug. 21, 2005 17,828 38,459243130,000 0.5 2.22 Feb. 1, 2006 18,986 41,39124322433Jane M. Nichols 30,000 0.5 2.22 Feb. 1, 2006 18,986 41,39124342435John D. LeGray 30,000 0.5 2.22 Feb. 1, 2006 18,986 41,39124362437Timothy P. Fitzgerald 30,000 0.5 2.22 Feb. 1, 2006 18,986 41,39124382439William J. Tourek 0 0.0 -- -- -- --2440-------------------------2441</TABLE>24422443(1) Each option represents the right to purchase one share of LecTec common2444stock. The options shown in this column are all incentive stock options2445granted pursuant to LecTec's 1998 Stock Option Plan. The options vest2446in annual installments over a period of three years beginning one year2447after the date of grant. Each option grant allows the individual to2448acquire shares of the LecTec's common stock at a fixed price per share.2449The term of each option is five years.24502451(2) In the fiscal year ended June 30, 2001, LecTec granted employees2452options to purchase an aggregate of 285,000 shares of common stock.24532454(3) The 5% and 10% assumed annual rates of compounded stock price2455appreciation are mandated by rules of the Securities and Exchange2456Commission and do not represent LecTec's estimate or projection of2457LecTec's future common stock prices. These amounts represent certain2458assumed rates of appreciation only. Actual gains, if any, on stock2459option exercises are dependent on the future performance of the common2460stock and overall stock market conditions. The amounts reflected in the2461table may not necessarily be achieved.2462246324642465422466<PAGE>246724682469AGGREGATED OPTION EXERCISES IN THE LAST FISCAL YEAR AND FISCAL YEAR-END OPTION2470VALUES24712472The following table sets forth information concerning the exercise of2473options during the fiscal year ended June 30, 2001 and unexercised options held2474as of June 30, 2001, by each of the executive officers named in the Summary2475Compensation Table above.24762477<TABLE>2478<CAPTION>2479NUMBER OF SECURITIES VALUE OF UNEXERCISED2480UNDERLYING UNEXERCISED IN-THE-MONEY OPTIONS2481SHARES OPTIONS AT JUNE 30, 2001 AS OF JUNE 30, 2001 (1)2482ACQUIRED VALUE --------------------------- --------------------------2483NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE2484---- ----------- -------- ----------- ------------- ----------- -------------2485<S> <C> <C> <C> <C> <C> <C>2486Rodney A. Young 0 $ 0 218,750 141,250 $ 0 $ 1,8602487Timothy R. J. Quinn 0 0 29,000 59,000 0 9302488Douglas J. Nesbit 0 0 0 55,000 0 9302489Jane M. Nichols 0 0 66,250 46,250 0 9302490John D. LeGray 0 0 24,375 45,625 0 9302491Timothy P. Fitzgerald 0 0 8,334 46,666 0 9302492William J. Tourek 0 0 0 0 0 02493-------------------------2494</TABLE>24952496(1) "Value" has been determined based on the difference between the last2497sale price of LecTec's common stock as reported by the Nasdaq National2498Market System on June 29, 2001 ($2.25) and the per share option2499exercise price, multiplied by the number of shares subject to the2500in-the-money options.25012502DIRECTOR COMPENSATION25032504Directors who are not employees of LecTec are paid for their services2505at the rate of $6,000 per fiscal year plus $1,000 per regular board meeting plus2506reasonable meeting expenses. This compensation arrangement became effective2507during fiscal 2001. During the 2001 fiscal year, each of the outside directors2508received a five-year option under the LecTec 1998 Director's Stock Option Plan2509to purchase 10,000 shares of LecTec's common stock at a price of $2.00 which was2510the fair market value of the common stock at the date of grant.25112512CHANGE IN CONTROL PLANS25132514LecTec's Change in Control Termination Pay Plan provides for2515termination payments to executive officers if they are terminated within twelve2516months of a change in control. The plan provides for termination payments to the2517Chief Executive Officer equal to twenty times the monthly base salary and2518termination payments for all other executives equal to twelve times the monthly2519base salary.25202521In July 1999, LecTec adopted the Improved Shareholder Value Cash Bonus2522Plan which provides cash bonus payments to executive officers if LecTec is2523acquired by or merged with another company, and the valuation of LecTec for2524purposes of the acquisition or merger equals or exceeds the minimum level2525defined by the plan. Cash bonus payments to executives increase as the total2526valuation of LecTec for purposes of the sale or merger increases, thus aligning2527the interests of the executives with the interests of the shareholders and2528providing an incentive to the executives to maximize shareholder value.25292530COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION IN COMPENSATION2531DECISIONS25322533The Compensation Committee consists of three non-employee directors,2534Lee M. Berlin, Alan C. Hymes, M.D. and Donald C. Wegmiller. All three directors2535served on the Committee for the entire fiscal year ended June 30, 2001.253625372538432539<PAGE>254025412542Mr. Berlin was formerly an officer of LecTec, having served as both2543Chairman of the Board and Chief Executive Officer of LecTec. There were no other2544Compensation Committee "interlocks" within the meaning of the SEC rules.254525462547ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT2548-------- --------------------------------------------------------------25492550The following table sets forth certain information with respect to the2551beneficial ownership of our common stock as of September 20, 2001, by each2552person, or group of affiliated persons, who is known by us to own beneficially2553more than 5% of our common stock, each of our directors, each of our executive2554officers named in the Summary Compensation Table above and all of our directors2555and executive officers as a group.25562557Beneficial ownership is determined in accordance with the rules of the2558SEC. In computing the number of shares beneficially owned by a person and the2559percentage ownership of that person, shares of common stock under options held2560by that person that are currently exercisable or exercisable within 60 days of2561September 20, 2001 are considered outstanding. The column entitled "Number of2562Shares Beneficially Owned" includes the number of shares of common stock subject2563to options held by that person that are currently exercisable or that will2564become exercisable within 60 days of September 20, 2001. The number of shares2565subject to options that each beneficial owner has the right to acquire within 602566days of September 20, 2001 are listed separately under the column entitled2567"Number of Shares Underlying Options Beneficially Owned."25682569Except as indicated in the footnotes to this table, each shareholder named in2570the table has sole voting and investment power for the shares shown as2571beneficially owned by them. Percentage of ownership is based on 3,922,384 shares2572of common stock outstanding on September 20, 2001.25732574257525762577442578<PAGE>257925802581<TABLE>2582<CAPTION>25832584NUMBER OF SHARES2585UNDERLYING2586NUMBER OF SHARES OPTIONS PERCENT OF2587BENEFICIALLY BENEFICIALLY SHARES2588NAME OWNED OWNED OUTSTANDING2589---- ----------- ----------- -----------2590<S> <C> <C> <C>2591Lee M. Berlin(1)(2) 577,029 34,125 14.6%2592Alan C. Hymes, M.D.(2) 437,128 39,755 11.02593Rodney A. Young(2) 253,250 238,750 6.12594Jane M. Nichols 72,529 66,250 1.82595Timothy R. J. Quinn 38,300 34,500 *2596John D. LeGray 37,410 28,750 *2597Bert J. McKasy 27,778 23,000 *2598Donald C. Wegmiller 27,000 26,000 *2599Marilyn K. Speedie, Ph.D. 23,000 21,500 *2600Timothy P. Fitzgerald 10,413 8,334 *2601Douglas J. Nesbit 9,834 8,334 *2602William J. Tourek 0 0 *2603All directors and executive2604officers as a group (12 persons) 1,513,671 529,298 34.02605----------------------------------2606</TABLE>26072608*Less than 1%26092610(1) Includes 75,605 shares owned by Mr. Berlin's wife and 137,145 shares2611owned by Mr. Berlin's son. Mr. Berlin disclaims beneficial ownership of2612these shares.26132614(2) The address is: LecTec Corporation, 10701 Red Circle Drive, Minnetonka,2615Minnesota 55343.261626172618ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS2619-------- ----------------------------------------------26202621None.2622262326242625452626<PAGE>262726282629PART IV26302631ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K2632-------- ----------------------------------------------------------------26332634(a) Financial Statements, Schedules and Exhibits2635--------------------------------------------263626371. Financial Statements2638--------------------26392640The following financial statements of the Company are filed as2641a part of this Form 10-K in Part II, Item 8:26422643(i) Report of Independent Certified Public Accountants26442645(ii) Balance Sheets at June 30, 2001 and 200026462647(iii) Statements of Operations for the years ended June 30,26482001, 2000 and 199926492650(iv) Statements of Comprehensive Loss for the years ended2651June 30, 2001, 2000 and 199926522653(v) Statements of Shareholders' Equity for the years2654ended June 30, 2001, 2000 and 199926552656(vi) Statements of Cash Flows for the years ended June 30,26572001, 2000 and 199926582659(vii) Notes to the Consolidated Financial Statements266026612. Financial Statement Schedules2662-----------------------------26632664(i) Schedule II - Valuation and Qualifying Accounts, for2665each of the three years in the period ended June 30,2666200126672668(ii) Other Schedules - All other schedules have been2669omitted because of the absence of the conditions2670under which they are required or because the required2671information is included in the financial statements2672or the notes thereto.267326743. Exhibits Method of2675-------- Filing2676---------26773.01 Articles of Incorporation of LecTec2678Corporation, as amended (1)267926803.02 By laws of LecTec Corporation (1)2681268210.01 Certificate of Secretary pertaining to2683Resolution of Board of Directors of2684LecTec Corporation, dated October 30,26851986, implementing a Profit Sharing2686Bonus Plan (1)26872688**10.02 LecTec Corporation 1989 Stock Option2689Plan (2)26902691**10.03 LecTec Corporation 1991 Directors' Stock2692Option Plan (2)2693269410.04 Building lease dated May 24, 1991 between2695LecTec Corporation and Sierra Development Co. (2)2696269710.05 First amendment dated May 5, 1997 between2698LecTec Corporation and Rushmore Plaza2699Partners Limited Partnership (2)270027012702462703<PAGE>27042705270610.06 Articles of Merger of Pharmadyne2707Corporation into LecTec Corporation dated2708December 31, 1997 (3)27092710**10.07 Change In Control Termination Pay Plan2711adopted May 27, 1998 (3)27122713**10.08 LecTec Corporation Employee Stock2714Purchase Plan (4)27152716**10.09 LecTec Corporation 1998 Stock Option Plan (5)27172718**10.10 LecTec Corporation 1998 Directors' Stock2719Option Plan (5)2720272110.11 Credit and Security Agreement by and2722between LecTec Corporation and Wells2723Fargo business Credit, Inc. dated2724November 22, 1999 (6)2725272610.12 First Amendment To Credit and Security2727Agreement and Waiver of Defaults by and2728Between LecTec Corporation and Wells Fargo2729Business Credit, dated February 9, 2000 (6)2730273110.13 Second Amendment to Credit and Security2732Agreement and Waiver of Defaults by and2733between LecTec Corporation and Wells2734Fargo Business Credit, Inc. dated2735September 26, 2000. (8)27362737*10.14 Supply Agreement dated as of March 21,27382000 by and between LecTec Corporation and2739Johnson & Johnson Consumer Companies, Inc.2740and Neutrogena Corporation (7)27412742*10.15 Supply Agreement dated as of May 15, 20002743by and between LecTec Corporation and2744Novartis Consumer Health, Inc. (7)2745274610.16 Credit and Security Agreement By and2747Between LecTec Corporation and Wells2748Fargo Bank Minnesota, National Association2749dated September 28, 2000 (8)2750275110.17 Loan Agreement and Promissory Note By and2752Between LecTec Corporation and Equity2753Holdings II dated December 21, 2000 (9)2754275510.18 Asset Purchase Agreement dated November275617, 2000 by and among The Ludlow Company2757LP, Sherwood Services AG and LecTec2758Corporation (10)2759276010.19 Asset Purchase Agreement dated March 13,27612001 by and among The National Medical2762Products Co. Ltd. and LecTec Corporation (11)27632764**10.20 LecTec Corporation 2001 Stock Option Plan (12)2765276623.01 Consent of Grant Thornton LLP (13)2767276899.01 Cautionary Statements (13)27692770--------------------------------27712772* Confidential treatment has been granted for portions of this2773Exhibit pursuant to Rule 24b-2 under the Securities Exchange2774Act of 1934 as amended. The277527762777472778<PAGE>277927802781confidential portions have been deleted and filed separately2782with the United States Securities and Exchange Commission.27832784** Management contract or compensatory plan or arrangement2785required to be filed as an exhibit to this Form 10-K.278627872788(1) Incorporated herein by reference to the Company's Form S-182789Registration Statement (file number 33-9774C) filed on October279031, 1986 and amended on December 12, 1986.27912792(2) Incorporated herein by reference to the Company's Annual2793Report on Form 10-K for the year ended June 30, 1997.27942795(3) Incorporated herein by reference to the Company's Annual2796Report on Form 10-K for the year ended June 30, 1998.27972798(4) Incorporated herein by reference to the Company's Registration2799Statement on Form S-8 (file number 333-72571) filed on2800February 18, 1999.28012802(5) Incorporated herein by reference to the Company's Registration2803Statement on Form S-8 (file number 333-72569) filed on2804February 18, 1999.28052806(6) Incorporated herein by reference to the Company's Quarterly2807Report on Form 10-Q for the quarter ended December 31, 1999.28082809(7) Incorporated herein by reference to the Company's Annual2810Report on Form 10-K for the year ended June 30, 2000, as2811amended.28122813(8) Incorporated herein by reference to the Company's Quarterly2814Report on Form 10-Q for the quarter ended September 30, 2000.28152816(9) Incorporated herein by reference to the Company's Quarterly2817Report on Form 10-Q for the quarter ended December 31, 2000.28182819(10) Incorporated herein by reference to the Company's Definitive2820Proxy Statement on Schedule 14A filed with the Commission on2821March 15, 200128222823(11) Incorporated herein by reference to the Company's Quarterly2824Report on Form 10-Q for the quarter ended March 31, 2001.28252826(12) Incorporated herein by reference to the Company's Registration2827Statement on Form S-8 (file number 333-68920) filed on2828September 4, 2001.28292830(13) Filed herewith.283128322833(b) Reports on Form 8-K2834-------------------28352836On May 1, 2001 the Company filed a report on Form 8-K in connection2837with the closing of the transactions contemplated by an asset purchase2838agreement dated November 17, 2000 with the Ludlow Company LP and2839Sherwood Services AG, both of which are wholly owned subsidiaries of2840Tyco International Ltd.284128422843482844<PAGE>284528462847LecTec Corporation2848Schedule II2849Valuation and Qualifying Accounts2850Three Years Ended June 30, 2001285128522853<TABLE>2854<CAPTION>2855Balance at Charged to Charge to Balance2856beginning of costs and other at end2857Description period expenses accounts Deductions of period2858---------------------------------- -------- ---------- --------- ---------- ----------28592860Allowance for doubtful accounts2861<S> <C> <C> <C> <C>2862Year ended June 30, 1999 90,818 48,000 -- 37,067 101,75128632864Year ended June 30, 2000 101,751 48,000 -- 22,626 127,12528652866Year ended June 30, 2001 127,125 24,000 -- 42,672 108,453286728682869Allowance for sales returns and credits28702871Year ended June 30, 1999 88,668 61,876 -- 93,787 56,75728722873Year ended June 30, 2000 56,757 345,855 -- 160,206 242,40628742875Year ended June 30, 2001 242,406 710,646 -- 382,254 570,7982876287728782879Allowance for inventory obsolescence28802881Year ended June 30, 1999 210,222 243,198 -- 168,811 284,60928822883Year ended June 30, 2000 284,609 267,911 -- 406,545 145,97528842885Year ended June 30, 2001 145,975 326,257 -- 343,442 128,7902886</TABLE>288728882889289028912892492893<PAGE>289428952896SIGNATURES28972898Pursuant to the requirements of Section 13 or 15(d) of the Securities2899Exchange Act of 1934, the registrant has duly caused this report to be signed on2900its behalf by the undersigned, thereunto duly authorized, on the 28th day of2901September, 2001.29022903LECTEC CORPORATION29042905/s/Rodney A. Young2906----------------------2907Rodney A. Young2908Chairman, Chief Executive Officer and President2909(Principal Executive Officer)29102911Pursuant to the requirements of the Securities Exchange Act of 1934,2912this report has been signed below by the following persons on behalf of the2913Registrant and in the capacities and on the date indicated.291429152916/s/Rodney A. Young September 28, 20012917-------------------------2918Rodney A. Young2919Chairman, Chief Executive Officer and President2920(Principal Executive Officer)292129222923/s/Douglas J. Nesbit September 28, 20012924-------------------------2925Douglas J. Nesbit2926Chief Financial Officer2927(Principal Financial Officer and Accounting Officer)292829292930/s/Lee M. Berlin September 28, 20012931-------------------------2932Lee M. Berlin2933Director293429352936/s/Bert J. McKasy September 28, 20012937-------------------------2938Bert J. McKasy2939Director294029412942/s/Marilyn K. Speedie September 28, 20012943-------------------------2944Marilyn K. Speedie2945Director294629472948/s/Donald C. Wegmiller September 28, 20012949-------------------------2950Donald C. Wegmiller2951Director29522953295429552956502957<PAGE>295829592960EXHIBIT INDEX2961-------------2962Exhibits2963--------296429653.01 Articles of Incorporation of Registrant, as amended (Note 1).296629673.02 By-laws of Registrant (Note 1).2968296910.01 Certificate of Secretary pertaining to Resolution of Board of2970Directors of LecTec Corporation, dated October 30, 1986,2971implementing a Profit Sharing Bonus Plan (Note 1).29722973**10.02 LecTec Corporation 1989 Stock Option Plan (Note 2).29742975**10.03 LecTec Corporation 1991 Directors' Stock Option Plan (Note 2).2976297710.04 Building lease dated May 24, 1991 between LecTec Corporation2978and Sierra Development Co (Note 2).2979298010.05 First amendment dated May 5, 1997 between LecTec Corporation2981and Rushmore Plaza Partners Limited Partnership (Note 2).2982298310.06 Articles of Merger of Pharmadyne Corporation into LecTec2984Corporation dated December 31, 1997 (Note 3).29852986**10.07 Change In Control Termination Pay Plan adopted May 27, 19982987(Note 3).29882989**10.08 LecTec Corporation Employee Stock Purchase Plan (Note 4).29902991**10.09 LecTec Corporation 1998 Stock Option Plan (Note 5).29922993**10.10 LecTec Corporation 1998 Directors' Stock Option Plan (Note 5).2994299510.11 Credit and Security Agreement by and between LecTec2996Corporation and Wells Fargo business Credit, Inc. dated2997November 22, 1999 (Note 6).2998299910.12 First Amendment to Credit and Security Agreement and Waiver of3000Defaults by and Between LecTec Corporation and Wells Fargo3001Business Credit, dated February 9, 2000 (Note 6).3002300310.13 Second Amendment to Credit and Security Agreement and Waiver3004of Defaults by and Between LecTec Corporation and Wells Fargo3005Business Credit, Inc. dated September 26, 2000 (Note 8).30063007*10.14 Supply Agreement dated as of March 21, 2000 by and between3008LecTec Corporation and Johnson & Johnson Consumer Companies,3009Inc. and Neutrogena Corporation (Note 7).30103011*10.15 Supply Agreement dated as of May 15, 2000 by and between3012LecTec Corporation and Novartis Consumer Health, Inc (Note 7).3013301410.16 Credit and Security Agreement By and Between LecTec3015Corporation and Wells Fargo Bank Minnesota, National3016Association dated September 28, 2000 (Note 8).301730183019513020<PAGE>30213022302310.17 Loan Agreement and Promissory Note By and Between LecTec3024Corporation and Equity Holdings II dated December 21, 20003025(Note 9).3026302710.18 Asset Purchase Agreement dated November 17, 2000 by and among3028The Ludlow Company LP, Sherwood Services AG and LecTec3029Corporation (Note 10).3030303110.19 Asset Purchase Agreement dated March 13, 2001 by and among The3032National Medical Products Co. Ltd. and LecTec Corporation3033(Note 11).30343035**10.20 LecTec Corporation 2001 Stock Option Plan (Note 12).3036303723.01 Consent of Grant Thornton LLP.3038303999.01 Cautionary Statements.304030413042NOTES:30433044* Confidential treatment has been granted for portions of this3045Exhibit pursuant to Rule 24b-2 under the Securities Exchange3046Act of 1934 as amended. The confidential portions have been3047deleted and filed separately with the United States Securities3048and Exchange Commission.30493050** Management contract or compensatory plan or arrangement3051required to be filed as an exhibit to this Form 10-K.30523053(1) Incorporated herein by reference to the Company's Form S-183054Registration Statement (file number 33-9774C) filed on October305531, 1986 and amended on December 12, 1986.30563057(2) Incorporated herein by reference to the Company's Annual3058Report on Form 10-K for the year ended June 30, 1997.30593060(3) Incorporated herein by reference to the Company's Annual3061Report on Form 10-K for the year ended June 30, 1998.30623063(4) Incorporated herein by reference to the Company's Registration3064Statement on Form S-8 (file number 333-72571) filed on3065February 18, 1999.30663067(5) Incorporated herein by reference to the Company's Registration3068Statement on Form S-8 (file number 333-72569) filed on3069February 18, 1999.30703071(6) Incorporated herein by reference to the Company's Quarterly3072Report on Form 10-Q for the quarter ended December 31, 1999.30733074(7) Incorporated herein by reference to the Company's Annual3075Report on Form 10-K for the year ended June 30, 2000, as3076amended.30773078(8) Incorporated herein by reference to the Company's Quarterly3079Report on Form 10-Q for the quarter ended September 30, 2000.30803081(9) Incorporated herein by reference to the Company's Quarterly3082Report on Form 10-Q for the quarter ended December 31, 2000.30833084(10) Incorporated herein by reference to the Company's Definitive3085Proxy Statement on Schedule 14A filed with the Commission on3086March 15, 2001.308730883089523090<PAGE>309130923093(11) Incorporated herein by reference to the Company's Quarterly3094Report on Form 10-Q for the quarter ended March 31, 2001.30953096(12) Incorporated herein by reference to the Company's Registration3097Statement on Form S-8 (file number 333-68920) filed on3098September 4, 2001.30993100310131023103310431055331063107</TEXT>3108</DOCUMENT>3109<DOCUMENT>3110<TYPE>EX-233111<SEQUENCE>33112<FILENAME>lectec013788_ex23-01.txt3113<DESCRIPTION>EXHIBIT 23.01 CONSENT OF INDEPENDENT CPA3114<TEXT>3115EXHIBIT 23.01311631173118311931203121312231233124CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS31253126We have issued our report dated August 7, 2001 accompanying the3127financial statements included in the Annual Report of LecTec Corporation on Form312810-K for the year ended June 30, 2001. We hereby consent to the incorporation by3129reference of said report in the Registration Statements of LecTec Corporation on3130Form S-3 (File No. 333-40183, effective November 17, 1997) and Forms S-8 (File3131No. 33-121780, effective April 21, 1987, File No. 33-45931, effective February313221, 1992, File No. 333-46283, effective February 13, 1998, File No. 333-46289,3133effective February 13, 1998, File No. 333-72569, effective February 18, 1999,3134File No. 333-72571, effective February 18, 1999 and File No. 333-68920,3135effective September 4, 2001).3136313731383139/s/ GRANT THORNTON LLP31403141Minneapolis, Minnesota3142September 28, 200131433144</TEXT>3145</DOCUMENT>3146<DOCUMENT>3147<TYPE>EX-993148<SEQUENCE>43149<FILENAME>lectec013788_ex99-01.txt3150<DESCRIPTION>EXHIBIT 99.01 CAUTIONARY STATEMENTS3151<TEXT>3152EXHIBIT 99.01315331543155CAUTIONARY STATEMENTS FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE3156PRIVATE SECURITIES LITIGATION REFORM ACT OF 199531573158The Private Securities Litigation Reform Act of 1995 provides public3159companies with a "safe harbor" from liability for forward-looking statements if3160those statements are accompanied by meaningful cautionary statements identifying3161important factors that could cause actual results to differ materially from3162those contained in the forward-looking statements. The Company hereby identifies3163the following important factors which could cause the Company's actual results3164to differ materially from those contained in any forward-looking statement made3165by the Company from time to time in any report, proxy statement, registration3166statement or other written communication or in oral forward-looking statements3167made from time to time by the Company's offices or agents.31683169WE HAVE A HISTORY OF LOSSES AND WE EXPECT LOSSES TO CONTINUE FORTHE3170FORESEEABLE FUTURE31713172Although we have generated differing levels of revenue over the last3173several years, we have not had profitable operations. We expect to continue to3174incur losses for the foreseeable future. We have expended a substantial amount3175of our resources in sales and marketing efforts and researching and developing3176technology relating to our products.31773178We plan to increase our operating expenses as we continue to devote3179significant resources to developing our therapeutic consumer products business.3180We expect to incur substantial operating losses in the foreseeable future as we3181invest in our therapeutic consumer products business. Our losses may increase in3182the future, and even if we achieve our revenue targets, we may not be able to3183sustain or increase profitability on a quarterly or annual basis. The amount of3184future net losses, and the time required to reach profitability, are both highly3185uncertain. We cannot assure you that we will ever be able to achieve or sustain3186profitability.31873188OUR SUCCESS DEPENDS ON A SINGLE FAMILY OF PRODUCTS31893190We have adopted a strategy of focusing our efforts on our therapeutic3191consumer products business. As a result, our revenue and profitability depend on3192sales of our topical ointment-based products for the application of3193over-the-counter drugs. A reduction in demand for these products would have a3194material adverse effect on our business. We have relatively limited experience3195selling our therapeutic consumer products. Accordingly, we can not assure you3196that sales of our therapeutic consumer products represent long-term consumer3197acceptance of these products, or that the recent increase in therapeutic3198consumer products sales is indicative of future growth rates for sales of these3199products. The sustainability of current levels of therapeutic consumer products3200sales and the future growth of such sales, if any, will depend on, among other3201factors:32023203* continued consumer trial of our products;32043205* generation of repeat consumer sales;32063207* further development and sales of our TheraPatch brand name3208products;32093210* development of further relationships with resellers of our3211products;32123213* competition from substitute products;32143215* effective consumer advertising.32163217We can not assure you that we will maintain or increase our current3218level of therapeutic consumer products sales or profits in future periods.321932203221<PAGE>322232233224OUR SUCCESS DEPENDS ON OUR RELATIONSHIPS WITH RESELLERS OF OUR PRODUCTS32253226A significant portion of the sales of our therapeutic consumer products3227are derived from agreements with other companies that act as resellers of our3228products. Under these agreements, our products are marketed and sold under3229another company's brand name and by another company's sales force. Our success3230depends in part upon our ability to enter into additional reseller agreements3231with new third parties while maintaining our existing reseller relationships. We3232believe our relationships with our existing third party resellers have been a3233significant factor in the success to date of our therapeutic consumer products3234business, and any deterioration or termination of these relationships would3235seriously harm our business.32363237OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO MANAGE ANY GROWTH IN OUR3238THERAPEUTIC CONSUMER PRODUCTS BUSINESS32393240If we are successful in increasing the sales of our therapeutic3241consumer products we may be required to expand our operations, particularly in3242the areas of research and development, sales and marketing, and manufacturing.3243If we are required to expand our operations in these areas, those expansions3244will likely result in new and increased responsibilities for management3245personnel and place significant strain on our management, operating and3246financial systems and other resources. To accommodate any such growth and3247compete effectively, we will be required to implement improved information3248systems, procedures and controls, and to expand, train, motivate and manage our3249work force. Our future success will depend to a significant extent on the3250ability of our current and future management personnel to operate effectively3251both independently and as a group. We can not assure you that our personnel,3252systems, procedures and controls will be adequate to support our future3253operations.32543255We manufacture our therapeutic consumer products in quantities3256sufficient to satisfy our current level of sales. To meet any increases in3257sales, we may need to increase our production significantly beyond our present3258manufacturing capacity. Accordingly, we may be required to increase our3259manufacturing capacities. We can not assure you that increasing our capacity can3260be accomplished on a profitable basis.32613262THE MARKET FOR OUR PRODUCTS IS COMPETITIVE AND WE MAY NOT HAVE THE3263RESOURCES REQUIRED TO COMPETE EFFECTIVELY32643265The markets for the therapeutic consumer products we sell are3266relatively new and therefore subject to rapid and significant change. We face3267significant competition in the development and marketing of these products. We3268can not assure you that we will be able to compete effectively in the sale of3269our products. Competitors in the United States and abroad are numerous and3270include, among others, major pharmaceutical and consumer product companies. Our3271competitors may succeed in developing technologies and products that are more3272effective than those we are developing and could render our therapeutic consumer3273products obsolete and noncompetitive. Many of our competitors have substantially3274greater financial and technical resources, marketing capabilities and regulatory3275experience. In addition, these companies compete with us in recruiting and3276retaining highly qualified personnel. As a result, we cannot assure you that we3277will be able to compete successfully with these organizations.32783279PATENTS AND OTHER PROPRIETARY RIGHTS PROVIDE UNCERTAIN PROTECTION OF3280OUR PROPRIETARY INFORMATION AND OUR INABILITY TO PROTECT A PATENT OR OTHER3281PROPRIETARY RIGHT MAY HARM OUR BUSINESS32823283The patent position of companies engaged in the sale of products such3284as ours is uncertain and involves complex legal and factual questions. Issued3285patents can later be held invalid by the patent office issuing the patent or by3286a court. We can not assure you that our patents will not be challenged,3287invalidated or circumvented or that the rights granted thereunder will provide3288us a competitive advantage. In addition, many other organizations are engaged in3289research and development of products similar to our therapeutic consumer3290products. Such organizations may currently have, or may obtain in the future,3291legally blocking proprietary rights, including patent rights, in one or more3292products or methods under329332943295<PAGE>329632973298development or consideration by us. These rights may prevent us from3299commercializing new technology, or may require us to obtain a license from the3300organizations to use their technology.33013302We also rely on trade secrets and other unpatented proprietary3303information in the manufacturing of our therapeutic consumer products. To the3304extent we rely on confidential information to maintain our competitive position,3305there can be no assurance that other parties will not independently develop the3306same or similar information.33073308There has been substantial litigation regarding patent and other3309intellectual property rights in the consumer products industry. Litigation could3310result in substantial costs and a diversion of our effort, but may be necessary3311to enforce any patents issued to us, protect our trade secrets or know-how,3312defend against claimed infringement of the rights of others or determine the3313scope and validity of the proprietary rights of others. We can not assure you3314that third parties will not pursue litigation that could be costly to us. An3315adverse determination in any litigation could subject us to significant3316liabilities to third parties, require us to seek licenses from or pay royalties3317to third parties or prevent us from manufacturing or selling our products, any3318of which could have a material adverse effect on our business.33193320WE ARE SUBJECT TO REGULATION BY REGULATORY AUTHORITIES INCLUDING THE3321FDA WHICH MAY AFFECT THE MARKETING OF OUR PRODUCTS33223323The research, development, manufacture, labeling, distribution,3324marketing and advertising of our products, and our ongoing research and3325development activities, are subject to extensive regulation by governmental3326regulatory authorities in the United States and other countries. Failure to3327comply with regulatory requirements for marketing our products could subject us3328to regulatory or judicial enforcement actions, including, but not limited to,3329product recalls or seizures, injunctions, civil penalties, criminal prosecution,3330refusals to approve new products and suspensions and withdrawals of existing3331approvals. Currently, the majority of our therapeutic consumer products are3332regulated as over-the-counter products. We can not assure you that the FDA will3333continue to regulate these products as over-the-counter products. If the FDA3334changed its approach to regulating our products, we would be faced with3335significant additional costs and may be unable to sell some or all of our3336products. Any such change would have a material adverse effect on our business.3337Delays in obtaining regulatory approvals for any new products could have a3338material adverse effect on our business. Even if regulatory approval of a new3339product is granted, such approval may include significant limitations on the3340indicated uses of the product or the manner in which or conditions under which3341the product may be marketed.33423343WE MAY BE REQUIRED TO REDUCE OR ELIMINATE SOME OR ALL OF OUR SALES AND3344MARKETING EFFORTS OR RESEARCH AND DEVELOPMENT ACTIVITIES IF WE FAIL TO OBTAIN3345ADDITIONAL FUNDING THAT MAY BE REQUIRED TO SATISFY OUR FUTURE CAPITAL3346EXPENDITURE NEEDS33473348We plan to continue to spend substantial funds to expand our sales and3349marketing efforts and our research and development activities related to our3350therapeutic consumer products. Our future liquidity and capital requirements3351will depend upon numerous factors, including the costs and timing of sales and3352marketing, manufacturing and research and development activities, the extent to3353which our therapeutic consumer products gain market acceptance and competitive3354developments. Any additional required financing may not be available on3355satisfactory terms, if at all. If we are unable to obtain financing, we may be3356required to reduce or eliminate some or all of our sales and marketing efforts3357or research and development activities.33583359WE HAVE LIMITED STAFFING AND WILL CONTINUE TO BE DEPENDENT UPON KEY3360EMPLOYEES33613362Our success is dependent upon the efforts and abilities of our key3363employees. If key individuals leave, we could be adversely affected if suitable3364replacement personnel are not quickly recruited. Our future success depends upon3365our ability to continue to attract and retain qualified scientific, marketing3366and technical personnel. There is intense competition for qualified personnel in3367all functional areas and competition will make it difficult to attract and3368retain the qualified personnel necessary for the development and growth of our3369business.337033713372<PAGE>337333743375THE PRICE OF OUR COMMON STOCK COULD BE HIGHLY VOLATILE DUE TO A NUMBER3376OF FACTORS33773378The trading price of our common stock may fluctuate widely as a result3379of a number of factors, including:33803381* performance of our therapeutic consumer products in the3382market;33833384* regulatory developments in both the United States and foreign3385countries;33863387* market perception and customer acceptance of our therapeutic3388consumer products;33893390* increased competition;33913392* relationships with resellers of our products;33933394* economic and other external factors; and33953396* period-to-period fluctuations in financial results.33973398In addition, the price of our common stock has from time to time3399experienced significant price and volume fluctuations that may be unrelated to3400our operating performance.34013402WE MAY NOT CONTINUE TO MEET THE REQUIREMENTS FOR CONTINUED LISTING ON3403NASDAQ34043405The National Association of Securities Dealers, Inc. which administers3406Nasdaq, has adopted certain criteria for continued eligibility on Nasdaq. In3407order to continue to be included on Nasdaq, we must maintain $4 million in net3408tangible assets, a public float of 750,000 shares and a $5 million market value3409of our public float. In addition, continued inclusion requires two3410market-makers, at least 400 holders of our common stock and a minimum bid price3411of our common stock of $1 per share. Our failure in the future to meet these3412maintenance criteria, as now in effect or as may be later amended, may result in3413the delisting of our common stock from Nasdaq. In such event, trading, if any,3414in our common stock may then continue to be conducted in the non-Nasdaq3415over-the-counter market in less orderly markets commonly referred to as the3416electronic bulletin board and the "pink sheets." As a result, an investor may3417find it more difficult to dispose of or to obtain accurate quotations as to the3418market value of our common stock. If Nasdaq were to begin delisting proceedings3419against us, it could reduce the level of liquidity currently available to our3420shareholders. If our common stock were delisted, the price of our common stock3421would, in all likelihood, decline.34223423</TEXT>3424</DOCUMENT>3425</SEC-DOCUMENT>342634273428