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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------------------
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTER ENDED SEPTEMBER 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 001-15823
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VIRAGEN, INC.
(Exact name of registrant as specified in its charter)
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DELAWARE 59-2101668
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
865 SW 78TH AVENUE, SUITE 100, PLANTATION, FLORIDA 33324
(Address of principal executive offices)
(954) 233-8746
(Registrant's telephone number, including area code)
------------------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
As of November 12, 2002 there were 118,793,577 shares of the issuer's common
stock outstanding, par value $0.01.
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VIRAGEN, INC. AND SUBSIDIARIES
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
1.) Consolidated condensed statements of operations for the three
months ended September 30, 2002 and 2001
2.) Consolidated condensed balance sheets as of September 30, 2002
and June 30, 2002
3.) Consolidated condensed statements of cash flows for the three
months ended September 30, 2002 and 2001
4.) Notes to consolidated condensed financial statements
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATION OF CEO AND CFO
2
VIRAGEN, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(UNAUDITED)
THREE MONTHS ENDED
SEPTEMBER 30,
--------------------------------------
2002 2001
------------- ------------
Product sales $ 344,885 $ --
Costs and expenses
Cost of sales 318,173 --
Research and development 832,328 1,492,322
Selling, general and administrative 1,731,248 1,281,618
Amortization of intangible assets 57,017 --
Interest and other income (41,604) (85,386)
Interest expense 811,268 1,828
------------- ------------
Loss before income taxes and minority interest (3,363,545) (2,690,382)
Income tax benefit 19,386 73,314
Minority interest in loss of subsidiaries 329,475 98,268
------------- ------------
Net loss (3,014,684) (2,518,800)
Deduct required dividends on convertible preferred stock,
Series A 662 663
------------- ------------
Net loss attributable to common stock $ (3,015,346) $ (2,519,463)
============= ============
Basic and diluted net loss per share of common stock, after
deduction for required dividends on convertible
preferred stock $ (0.03) $ (0.03)
============= ============
Weighted average common shares - basic and diluted 106,868,182 99,605,684
============= ============
See notes to consolidated condensed financial statements
which are an integral part of these statements.
3
VIRAGEN, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
SEPTEMBER 30, JUNE 30,
2002 2002
------------ ------------
(Unaudited)
ASSETS
Current assets
Cash and cash equivalents $ 493,864 $ 765,861
Accounts receivable 294,951 349,965
Inventories 2,108,323 1,866,568
Prepaid expenses 394,369 399,626
Other current assets 616,174 1,033,287
------------ ------------
Total current assets 3,907,681 4,415,307
Property, plant and equipment
Land, building and improvements 3,288,439 3,254,701
Equipment and furniture 5,284,391 5,022,695
Construction in progress 429,511 375,373
------------ ------------
9,002,341 8,652,769
Less accumulated depreciation (2,924,646) (2,678,299)
------------ ------------
6,077,695 5,974,470
Goodwill 8,387,913 8,460,940
Developed technology, net 1,717,763 1,765,618
Other intangible assets, net 25,091 50,619
Deposits and other assets 241,560 129,650
------------ ------------
$ 20,357,703 $ 20,796,604
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities
Accounts payable $ 2,069,057 $ 1,583,333
Accrued expenses and other liabilities 712,887 1,081,079
Convertible debentures 513,164 711,982
Lines of credit and short term promissory notes 1,792,216 1,294,904
Current portion of long-term debt 41,946 72,374
Deferred tax liability, current 52,257 60,686
------------ ------------
Total current liabilities 5,181,527 4,804,358
Royalties payable 107,866 107,866
Long-term debt, less current portion 1,029,502 1,023,948
Minority interest in subsidiaries 2,501,853 2,845,616
Deferred tax liability 533,239 544,196
Commitments and Contingencies
Stockholders' equity
Convertible 10% Series A cumulative preferred stock, $1.00 par value
Authorized 375,000 shares; issued and outstanding 2,650 shares
Liquidation preference value: $10 per share, aggregating $26,500 2,650 2,650
Common stock, $.01 par value. Authorized 150,000,000 shares at September
30, 2002 and June 30, 2002; 116,374,964 issued and 115,529,687
outstanding at September 30, 2002; 104,831,855 issued and 103,986,578
outstanding at June 30, 2002 1,163,748 1,048,317
Capital in excess of par value 98,562,923 96,197,939
Treasury stock, 845,277 shares at September 30, 2002 and June 30, 2002, (1,277,613) (1,277,613)
at cost
Accumulated deficit (87,954,559) (84,939,213)
Accumulated other comprehensive income
608,279 656,237
Notes due from directors (101,712) (217,697)
------------ ------------
Total stockholders' equity 11,003,716 11,470,620
------------ ------------
$ 20,357,703 $ 20,796,604
============ ============
See notes to consolidated condensed financial statements
which are an integral part of these statements.
4
VIRAGEN, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(UNAUDITED)
THREE MONTHS ENDED
SEPTEMBER 30,
-----------------------------
2002 2001
----------- -----------
OPERATING ACTIVITIES
Net loss $(3,014,684) $(2,518,800)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization 211,448 154,504
Amortization of intangible assets 57,017 --
Compensation expense on stock options and warrants (64,751) 82,375
Minority interest in loss of subsidiaries (329,475) (98,268)
Amortization of discount on convertible debentures and promissory notes 643,734 --
Amortization of deferred financing costs 53,778 --
Income tax benefit (19,386) --
Increase (decrease) relating to operating activities from:
Accounts receivable 55,014 --
Inventories (241,755) --
Prepaid expenses 53,627 6,273
Other current assets 364,816 246,507
Deposit and other assets -- 20,779
Accounts payable 485,724 (121,144)
Accrued expenses and other liabilities (368,853) (159,332)
Notes due from directors 2,594 (2,125)
----------- -----------
Net cash used in operating activities (2,111,152) (2,389,231)
INVESTING ACTIVITIES
Additions to property, plant and equipment (256,073) (33,465)
Acquisition of ViraNative, net of cash acquired -- (30,695)
----------- -----------
Net cash used in investing activities (256,073) (64,160)
FINANCING ACTIVITIES
Net proceeds from private placements 2,498,310 332,199
Net borrowings on lines of credit and short term promissory notes 478,923 --
Payments on long-term debt (15,972) (10,297)
Payments on convertible debentures (833,334) --
Proceeds from exercise of options and warrants -- 117,282
----------- -----------
Net cash provided by financing activities 2,127,927 439,184
Effect of exchange rate fluctuations on cash (32,699) (52,232)
----------- -----------
Decrease in cash and cash equivalents (271,997) (2,066,439)
Cash and cash equivalents at beginning of period 765,861 7,659,153
----------- -----------
Cash and cash equivalents at end of period $ 493,864 $ 5,592,714
=========== ===========
See notes to consolidated condensed financial statements
which are an integral part of these statements.
5
VIRAGEN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
NOTE A - CONSOLIDATION AND BASIS OF PRESENTATION
Viragen, Inc. and its subsidiaries are engaged in the research,
development, manufacture and sale of certain immunological products for the
treatment of life-threatening illnesses. We are also in the business of
developing innovative technologies aimed at improving the manufacturing
processes used to produce certain medical therapies.
The consolidated condensed financial statements include Viragen, Inc.,
Viragen International, Inc. and all subsidiaries, including those operating
outside the United States of America. All significant transactions among our
businesses have been eliminated. As of September 30, 2002 and June 30, 2002 our
ownership interest in Viragen International was approximately 70.2%. If
ViraNative, a wholly-owned subsidiary of Viragen International acquired in
September 2001, meets all of the milestones under the acquisition agreement, our
ownership interest in Viragen International would be reduced to approximately
56.1% assuming additional Viragen International shares are not issued for any
other purposes.
During fiscal 2002, 2001 and 2000, Viragen, Inc. incurred significant
losses of approximately $11,089,000, $11,008,000 and $12,311,000, respectively,
and has an accumulated deficit of approximately $87,955,000 as of September 30,
2002. Additionally, the Company had a cash balance of approximately $494,000 and
a working capital deficit of approximately $1,274,000 at September 30, 2002.
Management anticipates additional future losses as it commercializes its natural
human interferon product and conducts additional research activities and
clinical trials to obtain additional regulatory approvals. Accordingly, the
Company will require substantial additional funding. Management's plans include
obtaining additional capital through equity and debt financings. No assurance
can be given that additional capital will be available when required or upon
terms acceptable to the Company. These factors, among others, raise substantial
doubt about the Company's ability to continue as a going concern. The
accompanying consolidated condensed financial statements do not include any
adjustments relating to the recoverability and classification of asset carrying
amounts or the amount and classification of liabilities that might result from
the outcome of these uncertainties.
The accompanying unaudited interim consolidated condensed financial
statements for Viragen have been prepared in accordance with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States
have been condensed or omitted. The accompanying consolidated condensed
financial statements have been prepared in conformity with accounting principles
generally accepted in the United States, which contemplate continuation of the
Company as a going concern.
The balance sheet at June 30, 2002 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by accounting principles generally accepted in the United
States for complete financial statements. Certain amounts in prior year's
consolidated condensed financial statements have been reclassified to conform to
the current year's presentation. The reclassifications had no effect on
previously reported results of operations.
6
VIRAGEN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (CONTINUED)
NOTE B - INTERIM ADJUSTMENTS AND USE OF ESTIMATES
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported amounts of
income and expenses during the reporting period. Actual results could differ
from those estimates. In the opinion of management, all adjustments, including
normal recurring accruals, considered necessary for a fair presentation have
been included.
Operating results for the three month period ended September 30, 2002
are not necessarily indicative of the results that may be expected for the
fiscal year ended June 30, 2003.
The unaudited interim consolidated condensed financial statements
should be read in conjunction with Management's Discussion and Analysis of
Financial Condition and Results of Operations contained in this report and the
audited consolidated financial statements and accompanying notes included in the
Company's Annual Report on Form 10-K for the year ended June 30, 2002, filed
with the Securities and Exchange Commission.
NOTE C - ACQUISITION
On September 28, 2001, Viragen International, Inc. acquired all of the
outstanding shares of BioNative AB ("BioNative"), a privately held biotechnology
company located in Umea, Sweden. BioNative manufactured a human leukocyte
interferon (alpha) product called INTERFERON ALFANATIVE(R). Subsequent to the
acquisition, BioNative was renamed ViraNative and INTERFERON ALFANATIVE was
further developed into our new product, MULTIFERON(R).
The initial purchase consideration consisted of 2,933,190 shares of
Viragen International common stock, which was valued at approximately $2.2
million based on the market price of Viragen International common stock at the
date of the acquisition. In addition, Viragen International incurred
approximately $204,000 in acquisition related costs. In January 2002, ViraNative
received notification from the Medical Products Agency in Sweden that
ViraNative's Re-registration certificate was approved and as a second line
treatment for any indication where patients did not respond to recombinant
interferon. At that time, the former shareholders of ViraNative were issued an
additional 8,799,570 shares of Viragen International common stock, which
represented achievement of the first two milestones as defined in the
acquisition agreement. The additional shares of Viragen International common
stock were valued at approximately $6.6 million, based on the market price of
Viragen International common stock at the time the milestones were achieved, all
of which was allocated to goodwill.
In connection with the acquisition, the former shareholders of
ViraNative are entitled to additional shares of Viragen International common
stock contingent upon the attainment of certain milestones related to regulatory
approvals:
o 8,799,570 additional shares when and if the Mutual Recognition
Procedures application has received the approval of the requisite
national and EU regulatory authorities for the use, sale and
marketing of MULTIFERON in certain countries which must include
Germany; and
7
VIRAGEN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (CONTINUED)
NOTE C - ACQUISITION - (CONTINUED)
o 2,933,190 additional shares when and if MULTIFERON has been approved
by the requisite regulatory bodies in the EU for the treatment of
Melanoma or when MULTIFERON has been approved by the requisite
regulatory bodies for sale in the USA.
As each of these milestones is met, the additional shares of Viragen
International will be issued, which will result in the recognition of additional
intangible assets.
The acquisition, completed on September 28, 2001, was accounted for as
a purchase under Statement of Financial Accounting Standards No. 141 and,
accordingly, the results of ViraNative's operations are included in the
Company's consolidated results from the date of the acquisition.
NOTE D - GOODWILL AND OTHER INTANGIBLE ASSETS
The goodwill reported in our balance sheet as of September 30, 2002
arose from our acquisition of ViraNative in September 2001 and the subsequent
achievement of certain milestones by ViraNative in January 2002 as discussed in
Note C. In accordance with the provisions of SFAS No. 142, goodwill will not be
amortized but will be reviewed for impairment on an annual basis or sooner if
indicators of impairment arise. The following table reflects the changes in the
carrying amount of goodwill for the quarter ended September 30, 2002.
Balance as of June 30, 2002 $ 8,460,940
Goodwill acquired during the year --
Foreign exchange adjustment (73,027)
-----------
Balance as of September 30, 2002 $ 8,387,913
===========
The intangible assets reported in our balance sheet as of September 30,
2002 arose from our acquisition of ViraNative in September 2001. As of September
30, 2002, intangible assets consist of the following:
GROSS CARRYING ACCUMULATED
AMOUNT AMORTIZATION
-------------- --------------
Developed technology $1,848,226 $(130,463)
Customer contract 125,455 (100,364)
---------- ---------
Total intangible assets $1,973,681 $(230,827)
========== =========
The developed technology is being amortized over its estimated useful
life of approximately 14 years. The customer contract is being amortized over
the remaining term of the contract, which ends in December 2002.
8
VIRAGEN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (CONTINUED)
NOTE D - GOODWILL AND OTHER INTANGIBLE ASSETS - (CONTINUED)
The estimated aggregate amortization expense for the fiscal year ended June 30,
2003 and the four succeeding fiscal years is as follows:
2003 $ 179,000
2004 129,000
2005 129,000
2006 129,000
2007 129,000
NOTE E - INVENTORIES
Inventories are stated at the lower of cost or market (estimated net
realizable value). Raw materials and supplies cost is determined on a first-in,
first-out basis. Work in process and finished products costs consisting of
materials, labor and overhead are recorded at a standard cost (which
approximates actual cost). If the cost of the inventories exceeds their expected
market value, provisions are recorded currently for the difference between the
cost and the market value. These provisions are determined based on estimates.
Finished products consist of bulk and purified human leukocyte interferon.
Inventories consisted of the following at September 30, 2002 and June
30, 2002:
SEPTEMBER 30, JUNE 30,
2002 2002
-------------- --------------
Finished products $ 260,065 $ 410,343
Work in process 1,691,611 1,293,851
Raw materials and supplies 156,647 162,374
---------- ----------
Total inventories $2,108,323 $1,866,568
========== ==========
NOTE F - DEBT
LINES OF CREDIT AND SHORT TERM BORROWINGS
On May 15, 2000, Viragen was approved for a $500,000 unsecured line of
credit with a bank located in Florida. Interest is payable at the greater of
7.25% or the Prime Rate, as quoted by The Wall Street Journal and is adjustable
daily. This unsecured line of credit was renewed on May 15, 2001, under the same
terms, and remained unused until May 2002. The facility was renewed on May 15,
2002, under the same terms, through November 15, 2002. Outstanding borrowings
under this credit facility totaled $300,000 as of September 30, 2002.
9
VIRAGEN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (CONTINUED)
NOTE F - DEBT - (CONTINUED)
Through Viragen International's Swedish subsidiary, ViraNative, we may
borrow up to $907,000 under an overdraft facility with a bank in Sweden.
Borrowings outstanding under this facility are at a floating rate of interest
which was approximately 7.5% at September 30, 2002 and the facility renews
annually in December. Outstanding borrowings under this agreement totaled
approximately $871,000 as of September 30, 2002. The overdraft facility is
secured by certain assets of ViraNative.
During August 2002, Viragen obtained a $500,000, 90 day loan from the
Isosceles Fund Limited. The loan bears interest at 8% and is secured by 2.5
million shares of Viragen common stock. In connection with this transaction, we
issued 53,868 Viragen common stock purchase warrants exercisable at $0.53 per
share for a period of three years. In November 2002, the loan was amended to
eliminate the fixed maturity date and make the loan payable within three
business days following demand. The loan was also amended to provide for
conversion of outstanding principal and interest into shares of Viragen common
stock at a price of $0.175 per share in lieu of cash at Isosceles' option.
During August 2002, Viragen obtained short term financing of
approximately $31,000 for the purchase of certain corporate insurance policies.
Outstanding borrowings under this arrangement bear interest at an effective rate
of approximately 6.45%. Principal and interest payments of approximately $3,200
are payable monthly. The outstanding balance on this short term borrowing was
approximately $28,000 as of September 30, 2002. The final payment on this short
term borrowing will be in June 2003.
LONG-TERM DEBT
During June 2002, Viragen obtained short term financing of
approximately $183,000 for the purchase of certain corporate insurance policies.
Outstanding borrowings under this arrangement bear interest at an effective rate
of approximately 5.53%. Principal and interest payments of approximately $21,000
are payable monthly. The outstanding balance on this short term borrowing was
approximately $103,000 as of September 30, 2002. The final payment on this short
term borrowing will be in March 2003.
As of September 30, 2002, our long-term debt totaling approximately
$1,071,000 consisted of a mortgage loan agreement with a Swedish bank, two other
loan agreements with Swedish governmental agencies and a loan agreement with a
Scottish bank. Outstanding borrowings under these agreements bear interest at
rates ranging from 5.6% to 11.5%.
Long-term debt includes a 25-year mortgage obtained to purchase one of
Viragen International's facilities in Sweden. The outstanding principal balance
on this loan was approximately $611,000 at September 30, 2002. This loan carries
a floating rate of interest which was approximately 5.6% at September 30, 2002.
We are required to make quarterly payments of principal and interest of
approximately $7,000 under this agreement. This loan is secured by the related
land and building with a carrying value of approximately $723,000 as of
September 30, 2002.
Under the terms of a credit facility with a Swedish agency that was
obtained for the purposes of conducting clinical trials, we are not required to
begin quarterly principal and interest payments of approximately $25,000 until
March 2003. This credit facility had an outstanding balance of approximately
$437,000 and carries a floating rate of interest at the Stockholm Interbank
Offered Rate (STIBOR) 90 plus 7%, which was approximately 11.5% as of September
30, 2002.
10
VIRAGEN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (CONTINUED)
NOTE G - CONVERTIBLE DEBENTURES
On January 15, 2002, Viragen entered into a securities purchase
agreement with Elliott International, L.P. and Elliott Associates, L.P.
("Elliott"). Under the terms of this agreement, we issued two convertible
debentures for a total principal amount of $2,500,000. The debentures bear
interest at a rate of 6% per annum. The principal and interest are payable
commencing April 1, 2002 over nine equal monthly installments. Viragen paid
$176,000 for placement fees and expenses on the transaction. Possible shares to
be issued and the warrants under this agreement are registered under the Form
S-3 registration statement (File No. 333-82452) filed with the Securities and
Exchange Commission, which was declared effective on February 26, 2002.
The debentures are payable monthly, in shares of common stock or in
cash (with a 5% premium) at our option, which must be communicated to Elliott at
the beginning of the previous month. The debentures are convertible into shares
of common stock at a price equal to the Conversion Price ($1.29465 per share)
or, with respect to certain unpaid monthly installments which we have elected to
pay in stock, the lesser of the Conversion Price or 90% of the arithmetic mean
of the ten lowest volume weighted average prices during the twenty days
preceding conversion, but not less than $0.75 per share. The agreement provides
that if we requested to make a monthly payment with stock valued at less than
$0.75 per share, Elliott could, at their option, waive the $0.75 per share
minimum. The $1.29465 Conversion Price is subject to adjustment in the event of
stock dividends, splits or the issuance of additional common stock at less then
the conversion price or fair market value on the date of issuance based on a
mathematical calculation. We have sold stock to institutional investors at
prices below the $1.29465 Conversion Price and below the fair value of our
common stock at those dates, thus the Conversion Price on the debentures has
been reduced to $1.20 based on the mathematical calculation. The debentures may
be prepaid at our discretion with a 15% premium on amounts then due.
Under the securities purchase agreement, Elliott also received warrants
to purchase a total of 405,515 shares of Viragen common stock. The warrants were
exercisable at $1.4796 per share through January 11, 2007. The warrants can be
exercised on a cashless basis whereby the holder may surrender a number of
warrants equal to the exercise price of the warrants being exercised. The
relative fair value of the warrants was calculated to be $230,000 using a
Black-Scholes valuation model. The value of the warrants was recorded as a
discount on the principal amount of the debentures. The exercise price of these
warrants is subject to adjustment in the event of stock dividends, mergers,
certain distributions of common stock or issuance of common stock at less than
the exercise price of the warrants on the date of issuance and less than the
fair value of common stock at date of issuance, based on a mathematical
calculation. We have sold stock to institutional investors at prices below the
$1.4796 exercise price of these warrants and below the fair value of our common
stock at that date, thus the exercise price on the warrants has been reduced to
$1.34 based on the mathematical calculation.
Under the securities purchase agreement, Elliott also has the option to
purchase an additional 1,363,636 shares at a Purchase Price of $1.10 per share
from May 11, 2002 through November 11, 2003, which may be exercised on a
cashless basis. The relative fair value of this option was calculated to be
$505,000 using a Black-Scholes valuation model. The value of the option was
recorded as a discount on the principal amount of the debentures. The Purchase
Price per share is subject to adjustment in the event of stock dividends,
mergers, certain distributions of common stock or issuance of common stock at
less than the Purchase Price of the option on the date of issuance and less than
the fair value of common
11
VIRAGEN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (CONTINUED)
NOTE G - CONVERTIBLE DEBENTURES - (CONTINUED)
stock at date of issuance, based on a mathematical calculation. We have sold
stock to institutional investors at prices below the $1.10 Purchase Price and
below the fair value of our common stock at that date, thus the Purchase Price
was reduced to $1.02 based on the mathematical calculation.
As a result of the warrants, option to purchase additional shares and
the effective conversion price of the debentures, a beneficial conversion rate
was calculated, which resulted in additional discount on the debentures of
approximately $1.34 million. The total discount on the debentures at the date of
issuance was approximately $2.08 million and is composed of the value attributed
to the warrants, the additional purchase option and the beneficial conversion
feature on the convertible debentures. The discount will be amortized to
interest expense using the effective interest rate method over the term of the
debentures. In addition, deferred finance costs of $176,000, will be amortized
to interest expense using the effective interest rate method over the term of
the debentures. We recorded interest expense for the three months ended
September 30, 2002 of approximately $688,000 on these convertible debentures.
On April 1, 2002, we issued 388,007 shares of our common stock as
payment of the first monthly principal installment on the debentures plus
interest accrued to date. The number of shares was based on a conversion price
of approximately $0.80, which represented ninety percent of the average of the
ten lowest volume weighted average prices of our common stock during the twenty
trading days immediately preceding the conversion date. Subsequent to the April
1, 2002 installment, we have made six cash payments totaling approximately $1.5
million, which represented the May through October monthly principal
installments, plus interest accrued including a five percent premium.
The principal installment due November 1, 2002, plus accrued interest
was not made in cash. In November 2002, we issued 1,478,264 shares of our common
stock representing payment of the November installment due on the convertible
debentures. One final installment of approximately $279,000 is due on December
1, 2002.
NOTE H - CAPITAL STOCK
During the three months ended September 30, 2002, we sold 8,943,109
shares of our common stock to institutional investors at prices ranging from
$0.18 to $0.66 for an aggregate amount of approximately $2.5 million, net of
finders fees and related expenses. In connection with these transactions, we
also issued 224,429 stock purchase warrants with exercise prices ranging $0.20
to $0.76.
In October 2002, we sold 1,666,667 shares of our common stock to an
institutional investor at $0.15 per share for an aggregate amount of
approximately $237,000, net of finders fees and related expenses. In connection
with this transaction, we also issued 50,000 stock purchase warrants with an
exercise price of $0.1725.
12
NOTE I - COMPREHENSIVE LOSS
Comprehensive loss is comprised of the Company's net loss and other
comprehensive (loss) income. Other comprehensive (loss) income refers to
revenue, expenses, gains and losses that under accounting principles generally
accepted in the United States are included in comprehensive loss but are
excluded from net loss as these amounts are recorded directly as an adjustment
to stockholders' equity. Our other comprehensive (loss) income is composed of
foreign currency translation adjustments. The following table sets forth the
computation of comprehensive loss for the periods indicated:
THREE MONTHS ENDED
SEPTEMBER 30,
-----------------------------
2002 2001
----------- -----------
Net loss $(3,014,684) $(2,518,800)
Other comprehensive (loss) income:
Currency translation adjustment (47,958) 110,310
----------- -----------
Total comprehensive loss $(3,062,642) $(2,408,490)
=========== ===========
NOTE J - RECENT ACCOUNTING PRONOUNCEMENTS
Effective July 1, 2002 the Company adopted FASB issued SFAS No. 144,
ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. SFAS No. 144
supercedes SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND
FOR LONG-LIVED ASSETS TO BE DISPOSED OF. SFAS No. 144 applies to all long-lived
assets (including discontinued operations) and consequently amends APB Opinion
No. 30, REPORTING THE RESULTS OF OPERATIONS, REPORTING THE EFFECTS OF DISPOSAL
OF A SEGMENT OF A BUSINESS, AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY
OCCURRING EVENTS AND TRANSACTIONS. SFAS No. 144 develops one accounting model
for long-lived assets that are to be disposed of by sale. SFAS No. 144 requires
that long-lived assets that are to be disposed of by sale be measured at the
lower of book value or fair value less cost to sell. Additionally, SFAS No. 144
expands the scope of discontinued operations to include all components of an
entity with operations that (1) can be distinguished from the rest of the entity
and (2) will be eliminated from the ongoing operations of the entity in a
disposal transaction. The adoption of SFAS No. 144 did not have a material
impact on our financial position, results of operations or cash flows.
13
VIRAGEN, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS - (CONTINUED)
NOTE J - RECENT ACCOUNTING PRONOUNCEMENTS - (CONTINUED)
In April 2002, the FASB issued SFAS No. 145, RESCISSION OF FASB
STATEMENTS NOS. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL
CORRECTIONS. SFAS No. 145 eliminates SFAS No. 4, REPORTING GAINS AND LOSSES FROM
EXTINGUISHMENT OF DEBT, (and SFAS No. 64, EXTINGUISHMENTS OF DEBT MADE TO
SATISFY SINKING-FUND REQUIREMENTS, as it amends SFAS No. 4), which requires
gains and losses from extinguishments of debt to be aggregated and, if material,
classified as an extraordinary item, net of the related income tax effect. As a
result, the criteria in Accounting Principles Board ("APB") Opinion No. 30 will
now be used to classify those gains and losses. SFAS No. 145 amends SFAS No. 13,
ACCOUNTING FOR LEASES, to require that certain lease modifications that have
economic effects similar to sale-leaseback transactions are accounted for in the
same manner as sale-leaseback transactions. This amendment is consistent with
the FASB's goal of requiring similar accounting treatment for transactions that
have similar economic effects. In addition, SFAS No. 145 makes technical
corrections to existing pronouncements. While those corrections are not
substantive in nature, in some instances, they may change accounting practice.
The adoption of SFAS No. 145 did not have a material impact on our financial
position, results of operations or cash flows.
In June 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR EXIT OR
DISPOSAL ACTIVITIES, effective for exit or disposal activities that are
initiated after December 31, 2002, with early adoption encouraged. SFAS No. 146
addresses significant issues regarding the recognition, measurement, and
reporting of costs that are associated with exit and disposal activities,
including restructuring activities that are currently accounted for pursuant to
the guidance that the Emerging Issues Task Force ("EITF") has set forth in EITF
Issue No. 94-3, LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS
AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A
RESTRUCTURING). A fundamental conclusion reached by the Board in this Statement
is that an entity's commitment to a plan, by itself, does not create a present
obligation to others that meets the definition of a liability. Therefore, this
SFAS eliminates the definition and requirements for recognition of exit costs in
EITF Issue No. 94-3. This statement also establishes that fair value is the
objective for initial measurement of the liability. The scope of SFAS No. 146
also includes (1) costs related to terminating a contract that is not a capital
lease and (2) termination benefits that employees who are involuntarily
terminated receive under the terms of a one-time benefit arrangement or an
individual deferred-compensation contract. We do not expect the implementation
of this standard to have a material impact on our financial position, results of
operations or cash flows.
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS
This document and other documents we may file with the Securities and
Exchange Commission contain forward-looking statements. Also, our company
management may make forward-looking statements orally to investors, analysts the
media and others.
Forward-looking statements express our expectations or predictions of
future events or results. They are not guarantees and are subject to many risks
and uncertainties. There are a number of factors--many beyond our control--they
could cause actual events or results to be significantly different from those
described in the forward-looking statement. Any or all of our forward-looking
statements in this report or in any other public statements we make may turn out
to be wrong.
Forward-looking statements might include one or more of the following:
o projections of future revenue;
o anticipated clinical trial commencement dates, completion timelines
or results;
o descriptions of plans or objectives of management for future
operations, products or services;
o forecasts of future economic performance; and
o descriptions or assumptions underlying or relating to any of the
above items.
Forward-looking statements can be identified by the fact that they do
not relate strictly to historical or current facts. They use words such as
"anticipate", "estimate", "expect", "project", "intend", "plan", "believe" or
words of similar meaning. They may also use words such as "will", "would",
"should", "could" or "may".
Factors that may cause actual results to differ materially include the
risks discussed below, as well as in the "Risk Factors" section included in our
registration statement on Form S-3 (File No. 333-82452) as filed with the
Securities and Exchange Commission on February 11, 2002. We are incorporating
these "Risk Factors" by reference. You should read them. You should also read
the risk factors listed from time to time in our reports on Form 10-Q, S-1, S-3
or 10-K and amendments, if any, to these reports. Viragen will provide you with
any copy of any or all of these reports at no charge.
Among the uncertainties that may cause our results to differ materially
from our projections are:
o whether the efficacy, price and timing of our human leukocyte
interferon will enable us to compete with other well established,
highly capitalized, biopharmaceutical companies;
o whether our patent applications result in the issuance of patents,
or whether patents and other intellectual property rights provide
adequate protections in the event of misappropriation or
infringement by third parties;
o whether clinical testing confirms the efficacy of our product, and
results in the receipt of regulatory approvals;
o whether we are able to secure sufficient funding to complete product
development, including clinical trials, and successfully market our
product;
o whether our stock price will enable us to conduct future financings
without substantial dilution to our existing stockholders;
15
o whether we can generate revenue sufficient to offset our historical
losses, or achieve profitability;
o whether we can continue to integrate ViraNative's operations
successfully; and
o whether, despite receipt of regulatory approvals, our products are
accepted as a treatment superior to that of our competitors.
Our natural human alpha interferon product, MULTIFERON, was developed
and is being manufactured overseas. Our dependence on foreign manufacturing and
expected international sales exposes us to a number of risks, including:
o Transportation delays and interruptions;
o Unexpected changes in regulatory requirements;
o Currency exchange risks;
o Tariffs and other trade barriers, including import and export
restrictions;
o Political or economic instability;
o Compliance with foreign laws;
o Difficulties in protecting intellectual property rights in foreign
countries; and
o Exchange controls.
Viragen has incurred operational losses and operated with negative cash
flows since its inception in December 1980. Net losses have totaled $11,088,832,
$11,007,809, and $12,310,895 for the fiscal years ended June 30, 2002, 2001 and
2000, respectively.
RECENT DEVELOPMENTS
In October 2002, we entered into an exclusive distribution agreement
with CJ Pharma, a U.S. Pharmaceutical Division of Cheil Jedang, to distribute
MULTIFERON in designated Latin American countries. The agreement provides that
CJ Pharma shall take all measures necessary to obtain and maintain the
appropriate regulatory approvals for MULTIFERON in specified Latin American
territories. These exclusive territories include: Brazil, Chile, Uruguay, Peru,
Costa Rica, Honduras, Nicaragua, Guatemala and Panama. CJ Pharma is responsible
for all costs associated with the regulatory approval process, including
clinical trials if required, in each of the respective countries.
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of
operations is based upon our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States.
The preparation of these financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenue and expenses. On an on-going basis, the Company evaluates
its estimates, including those related to inventories, depreciation,
amortization, asset valuation allowances, contingencies and litigation. The
Company bases its estimates on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
16
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions. We believe that the following critical accounting policies affect
our more significant judgments and estimates used in the preparation of our
financial statements.
o CONSOLIDATION. Our consolidated financial statements include the
results of Viragen International and all of its subsidiaries,
including those operating outside the United States. All significant
transactions among our businesses have been eliminated. Assets and
liabilities are translated into United States dollars using foreign
exchange rates as of the balance sheet date. We translate the
revenue and expenses of our foreign subsidiaries using average
semi-monthly foreign exchange rates. Translation adjustments are
included in the balance sheet under accumulated other comprehensive
loss, a separate component of stockholders' equity.
o INVENTORIES. Inventories consist of raw materials and supplies, work
in process and finished products. Finished products consist of bulk
and purified leukocyte interferon. Our inventories are stated at the
lower of cost or market (estimated net realizable value). Raw
materials and supplies cost is determined on a first-in, first-out
basis. Work in process and finished goods costs consisting of
materials, labor and overhead are recorded at a standard cost (which
approximates actual cost). If the cost of the inventories exceeds
their expected market value, provisions are recorded currently for
the difference between the cost and the market value. These
provisions are determined based on estimates.
o LONG-LIVED ASSETS. We review our long-lived assets, including
intangible assets, for impairment whenever events or changes in
circumstances indicate that the carrying amount of these assets may
not be fully recoverable. The assessment of possible impairment is
based on our ability to recover the carrying value of our asset
based on our estimate of its undiscounted future cash flows. If
these estimated future cash flows are less than the carrying value
of the asset, an impairment charge is recognized for the difference
between the asset's estimated fair value and its carrying value. As
of the date of these financial statements, we are not aware of any
items or events that would cause us to adjust the recorded value of
our long-lived assets, including intangible assets, for impairment.
o GOODWILL. In accordance with SFAS No. 142, GOODWILL AND OTHER
INTANGIBLE ASSETS, goodwill is not amortized. Goodwill will be
reviewed for impairment on an annual basis or sooner if indicators
of impairment arise. All of our goodwill arose from the acquisition
of ViraNative in September 2001 and the subsequent achievement of
certain milestones defined in the acquisition agreement. We
periodically evaluate that acquired business for potential
impairment indicators. Our judgments regarding the existence of
impairment indicators are based on legal factors, market conditions,
and operational performance of our acquired business. Future events
could cause us to conclude that impairment indicators exist and that
goodwill and other intangibles associated with our acquired business
is impaired. We have approximately $8.4 million (or 41% of total
assets) of goodwill recorded on our balance sheet as of September
30, 2002. Any resulting impairment loss could have a material
adverse impact on our financial condition and results of operations.
As of the date of these financial statements, we are not aware of
any items or events that would cause us to adjust the recorded value
of our goodwill for impairment.
o STOCK-BASED COMPENSATION. Our employee stock option plans are
accounted for under Accounting Principles Board Opinion No. 25 ("APB
25"), "Accounting for Stock Issued to Employees." We grant stock
options for a fixed number of shares to employees with an exercise
price equal to the fair market value of the shares at the date of
grant. In accordance with APB 25, we recognize no compensation
expense for these stock option grants. We account for our
stock-based compensation arrangements with non-employees in
accordance with Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation" and related
guidance, including Emerging Issues Task Force (EITF) No. 96-18,
"Accounting for Equity Instruments That Are Issued to Other Than
17
Employees for Acquiring, or in Conjunction with Selling, Goods or
Services." Accordingly, we recognize as expense the estimated fair
value of such instruments as calculated using the Black-Scholes
valuation model. The estimated fair value is re-determined each
quarter using the methodologies allowable by SFAS No. 123 and EITF
No. 96-18 and the expense is amortized over the vesting period of
each option or the recipient's contractual arrangement, if shorter.
o REVENUE RECOGNITION. We recognize revenue from product sales when
title and risk of loss has been transferred, which is generally upon
shipment. Moreover, recognition requires persuasive evidence that an
arrangement exists, the price is fixed and determinable, and
collectibility is reasonably assured.
o RESEARCH AND DEVELOPMENT COSTS. Research and development expenses
include scientific salaries and support fees, laboratory supplies,
consulting fees, research related travel, equipment rentals and
repairs and maintenance, and utilities. All such costs are charged
to research and development expense as incurred.
o LITIGATION AND OTHER CONTINGENCIES. We monitor the status of our
litigation, if any, and other contingencies for purposes of loss
accrual. If we believed a loss to be probable and reasonably
estimated, as required by SFAS No. 5, "Accounting for
Contingencies", we would establish an appropriate accrual. We would
base our accruals on information available at the time of such
determination. Information may become available to us after that
time, for which additional accruals may be required.
LIQUIDITY AND CAPITAL RESOURCES
The Company believes that its cash and cash equivalents and working
capital are not sufficient to meet its operating requirements through the end of
fiscal 2003. The Company's operating losses and working capital requirements
continue to adversely affect cash flow. We intend to continue financing our
operations for the foreseeable future from cash on hand, additional private
investment placements and debt financing. In the event of our inability to raise
capital, or a lack of expanded revenue from the sale of our natural human
interferon product, the Company will likely be unable to meet its operating
requirements through the end of fiscal 2003. In this event we would be required
to significantly curtail or suspend our operations.
As of September 30, 2002, Viragen had on-hand approximately $494,000 in
cash. As of September 30, 2002, we had a working capital deficit of
approximately $1,274,000 compared to a working capital deficit of approximately
$389,000 as of June 30, 2002. The decrease in working capital of approximately
$885,000 compared to the previous fiscal year end balance was due primarily to
the use of cash to fund operating activities totaling approximately $2,111,000,
capital expenditures totaling approximately $256,000 and the repayment of
convertible debentures and short term borrowings of approximately $870,000.
These amounts were partially offset by approximately $2,998,000 raised through
private equity placements and short term borrowings.
18
During the three months ended September 30, 2002, we sold 8,943,109
shares of our common stock to institutional investors at prices ranging from
$0.18 to $0.66 for an aggregate amount of approximately $2.5 million, net of
finders fees and related expenses. In connection with these transactions, we
also issued 224,429 stock purchase warrants with exercise prices ranging $0.20
to $0.76.
During August 2002, Viragen obtained a $500,000, 90 day loan from the
Isosceles Fund Limited. The loan bears interest at 8% and is secured by 2.5
million shares of Viragen common stock. In connection with this transaction, we
issued 53,868 Viragen common stock purchase warrants exercisable at $0.53 per
share for a period of three years. In November 2002, the loan was amended to
eliminate the fixed maturity date and make the loan payable within three
business days following demand. The loan was also amended to provide for
conversion of outstanding principal and interest into shares of Viragen common
stock at a price of $0.175 per share in lieu of cash at Isosceles' option.
In October 2002, we sold 1,666,667 shares of our common stock to an
institutional investor at $0.15 per share for an aggregate amount of
approximately $237,000, net of finders fees and related expenses. In connection
with this transaction, we also issued 50,000 stock purchase warrants with an
exercise price of $0.1725.
In October 2002, we made cash payments on our convertible debentures
totaling approximately $296,000 representing the October monthly principal
installment, plus interest accrued including five percent premium. In November
2002, we issued 1,478,264 shares of our common stock representing payment of the
November installment due on the convertible debentures. One final installment of
approximately $279,000 is due on December 1, 2002.
Our future capital requirements are dependent upon many factors,
including: revenue generated from the sale of our natural human interferon
product, progress with future and ongoing clinical trials; the costs associated
with obtaining regulatory approvals; the costs involved in patent applications;
competing technologies and market developments; and our ability to establish
collaborative arrangements and effective commercialization activities.
We intend to significantly expand our productive capacity of MULTIFERON
in Sweden through the renovation of a 21,500 square foot facility purchased by
ViraNative prior to our acquisition. ViraNative has commenced the initial
expansion phase with an estimated total cost of $1.1 million, which is expected
to be completed by March 2003. Based on MULTIFERON product demand and available
financing, the new facility could be further expanded and equipped. Such an
expansion, if warranted, could cost up to an additional $12 million. The
facility carries a 25 year mortgage for approximately $611,000.
We believe that our MULTIFERON product can be manufactured in
sufficient quantity and be priced at a level to offer patients an attractive
alternative treatment to the synthetic interferons currently being marketed.
However, we can not assure you of approval of these projects. Required
regulatory approvals are subject to the successful completion of lengthy and
costly clinical trials. The successful completion of any clinical trial project
also depends on our ability to raise significant additional investment capital.
We estimate that we will require additional funding of approximately
$25 million, over the next two years. These funds would be used to fund
operations including clinical trials. We will also use planned future funding
for continued product development, general working capital purposes, including
administrative support functions, and possible equity investments in businesses
complementary to our operations.
19
RESULTS OF OPERATIONS
As a result of our acquisition of ViraNative in September 2001, the
Company began recognizing revenue through the sale of human leukocyte
interferon. Since the date of the acquisition, a significant portion of our
product sales and related costs were for the sale of bulk product
(semi-purified) to a customer in Italy, Alfa Wasserman, under a contractual
arrangement. The loss of this customer prior to significant revenues from the
sale of our highly purified product would have a material effect on our results
of operations. We believe the gross profit margin reflected on sales of bulk
product is not necessarily indicative of the margins we anticipate on the sale
of our finished interferon product, MULTIFERON. We expect the margins on
finished product to be higher as the anticipated increase in selling price for
highly purified product will exceed the incremental costs of the additional
processing. We expect our product mix to shift significantly from the sale of
semi-purified material to highly purified over the next year.
RESEARCH AND DEVELOPMENT COSTS
Research and development costs are comprised of scientific salaries and
support fees, laboratory supplies, consulting fees, equipment rentals, repairs
and maintenance, utilities and research related travel. Research and development
costs for the three months ended September 30, 2002 totaled approximately
$832,000, a decrease of approximately $660,000 when compared to the same quarter
of the preceding year. This decrease was primarily attributed to cost reductions
in our Scottish facility related to the termination of our development efforts
on our Omniferon product totaling approximately $425,000. Also contributing to
the decrease in research and development costs are savings totaling
approximately $442,000 in our Florida central office composed of decreases of
approximately $74,000 and $368,000 related to compensation on options and
warrants and consulting fees, respectively. These reductions in research and
development costs were offset in part by research and development costs incurred
by our Swedish operations, acquired in September 2001, totaling approximately
$129,000 for the quarter ended September 30, 2002.
We will continue incurring research and development costs for
additional clinical trial projects associated with MULTIFERON as well as other
projects to more fully develop potential commercial applications of our
interferon product, as well as broaden our potential product lines in the areas
of avian transgenics and oncology. Our ability to successfully conclude
additional clinical trials, a prerequisite for expanded commercialization of any
product, is dependent upon our ability to raise significant additional
investment capital.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative expenses are comprised of
administrative personnel salaries and related expenses, lease expenses,
utilities, repairs and maintenance, insurance, legal and accounting professional
fees and depreciation. Selling, general and administrative expenses totaled
approximately $1,731,000 for the three months ended September 30, 2002 compared
to $1,282,000 in the same period of to the previous fiscal year. This increase
of approximately $449,000 is primarily attributed to administrative expenses
incurred by our Swedish subsidiary of approximately $219,000, which was acquired
in September 2001. Also contributing to the increase in selling general and
administrative were increases in legal and consulting fees at our Scottish
facility totaling approximately $65,000 and $38,000, respectively.
20
We expect our overall selling, general and administrative expenses to
increase in the foreseeable future as a result of the increase in the number of
administrative employees and related expenses associated with the expansion of
our Swedish operations as well as additional management time spent on the
commercialization of MULTIFERON. Our ability to successfully commercialize
MULTIFERON will require additional marketing and promotional activities and is
dependent upon our ability to raise significant additional investment capital.
AMORTIZATION OF INTANGIBLE ASSETS
Amortization of intangible assets includes the amortization of the
purchase price allocated to separately identifiable intangible assets obtained
in the acquisition of ViraNative in September 2001. The separately identified
intangible assets acquired consist of developed technology and a customer
contract. The developed technology is being amortized over its estimated useful
life of approximately 14 years. The customer contract is being amortized over
the remaining term of the contract, which ends in December 2002. For the three
months ended September 30, 2002, amortization of intangible assets totaled
approximately $57,000.
INTEREST AND OTHER INCOME
The primary components of interest and other income are interest earned
on cash and cash equivalents, grant income from a government agency in Scotland,
sublease income on certain office space in our Scottish facility and gains or
losses on foreign exchange. The decrease in interest and other income of
approximately $44,000 during the three months ended September 30, 2002 is
attributed to the decrease in principal invested between the periods and lower
interest rates.
INTEREST EXPENSE
The significant increase in interest expense totaling approximately
$809,000 for the three months ended September 30, 2002, is primarily
attributable to approximately $750,000 of non-cash interest expense on the
convertible debentures which were issued in January 2002. Interest expense for
the three months ended September 30, 2002, includes interest accrued on the
debentures, amortization of deferred financing costs and amortization of the
discount on the debentures resulting from the detachable warrants, additional
purchase option and the debentures' beneficial conversion feature.
INCOME TAX BENEFIT
For the three months ended September 30, 2002, income tax benefit
totaled approximately $19,000. This amount is due to amortization expense on
certain intangible assets related to the ViraNative acquisition. Due to the
treatment of the identifiable intangible assets under Statement of Financial
Accounting Standard No. 109, ACCOUNTING FOR INCOME TAXES, our balance sheet
reflects a deferred tax liability of approximately $585,000. Based on our
accumulated losses, a full valuation allowance is provided to reduce deferred
tax assets to the amount that will more likely than not be realized. As of June
30, 2002, we had a net operating loss carry forward of approximately $44 million
for U.S. federal income tax purposes.
21
RECENT ACCOUNTING PRONOUNCEMENTS
Effective July 1, 2002 the Company adopted FASB issued SFAS No. 144,
ACCOUNTING FOR THE IMPAIRMENT OR DISPOSAL OF LONG-LIVED ASSETS. SFAS No. 144
supercedes SFAS No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS AND
FOR LONG-LIVED ASSETS TO BE DISPOSED OF. SFAS No. 144 applies to all long-lived
assets (including discontinued operations) and consequently amends APB Opinion
No. 30, REPORTING THE RESULTS OF OPERATIONS, REPORTING THE EFFECTS OF DISPOSAL
OF A SEGMENT OF A BUSINESS, AND EXTRAORDINARY, UNUSUAL AND INFREQUENTLY
OCCURRING EVENTS AND TRANSACTIONS. SFAS No. 144 develops one accounting model
for long-lived assets that are to be disposed of by sale. SFAS No. 144 requires
that long-lived assets that are to be disposed of by sale be measured at the
lower of book value or fair value less cost to sell. Additionally, SFAS No. 144
expands the scope of discontinued operations to include all components of an
entity with operations that (1) can be distinguished from the rest of the entity
and (2) will be eliminated from the ongoing operations of the entity in a
disposal transaction. The adoption of SFAS No. 144 did not have a material
impact on our financial position, results of operations or cash flows.
In April 2002, the FASB issued SFAS No. 145, RESCISSION OF FASB
STATEMENTS NOS. 4, 44, AND 64, AMENDMENT OF FASB STATEMENT NO. 13, AND TECHNICAL
CORRECTIONS. SFAS No. 145 eliminates SFAS No. 4, REPORTING GAINS AND LOSSES FROM
EXTINGUISHMENT OF DEBT, (and SFAS No. 64, EXTINGUISHMENTS OF DEBT MADE TO
SATISFY SINKING-FUND REQUIREMENTS, as it amends SFAS No. 4), which requires
gains and losses from extinguishments of debt to be aggregated and, if material,
classified as an extraordinary item, net of the related income tax effect. As a
result, the criteria in Accounting Principles Board ("APB") Opinion No. 30 will
now be used to classify those gains and losses. SFAS No. 145 amends SFAS No. 13,
ACCOUNTING FOR LEASES, to require that certain lease modifications that have
economic effects similar to sale-leaseback transactions are accounted for in the
same manner as sale-leaseback transactions. This amendment is consistent with
the FASB's goal of requiring similar accounting treatment for transactions that
have similar economic effects. In addition, SFAS No. 145 makes technical
corrections to existing pronouncements. While those corrections are not
substantive in nature, in some instances, they may change accounting practice.
The adoption of SFAS No. 145 did not have a material impact on our financial
position, results of operations or cash flows.
In June 2002, the FASB issued SFAS No. 146, ACCOUNTING FOR EXIT OR
DISPOSAL ACTIVITIES, effective for exit or disposal activities that are
initiated after December 31, 2002, with early adoption encouraged. SFAS No. 146
addresses significant issues regarding the recognition, measurement, and
reporting of costs that are associated with exit and disposal activities,
including restructuring activities that are currently accounted for pursuant to
the guidance that the Emerging Issues Task Force ("EITF") has set forth in EITF
Issue No. 94-3, LIABILITY RECOGNITION FOR CERTAIN EMPLOYEE TERMINATION BENEFITS
AND OTHER COSTS TO EXIT AN ACTIVITY (INCLUDING CERTAIN COSTS INCURRED IN A
RESTRUCTURING). A fundamental conclusion reached by the Board in this Statement
is that an entity's commitment to a plan, by itself, does not create a present
obligation to others that meets the definition of a liability. Therefore, this
SFAS eliminates the definition and requirements for recognition of exit costs in
EITF Issue No. 94-3. This statement also establishes that fair value is the
objective for initial measurement of the liability. The scope of SFAS No. 146
also includes (1) costs related to terminating a contract that is not a capital
lease and (2) termination benefits that employees who are involuntarily
terminated receive under the terms of a one-time benefit arrangement or an
individual deferred-compensation contract. We do not expect the implementation
of this standard to have a material impact on our financial position, results of
operations or cash flows.
22
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk generally represents the risk of loss that may result from the
potential change in value of a financial instrument as a result of fluctuations
in interest rates and market prices. We have not traded or otherwise transacted
in derivatives nor do we expect to do so in the future. We have established
policies and internal processes related to the management of market risks which
we use in the normal course of our business operations.
INTEREST RATE RISK
The fair value of long-term debt is subject to interest rate risk.
While changes in market interest rates may affect the fair value of our
fixed-rate long-term debt, we believe a change in interest rates would not have
a material impact on our financial condition, future results of operations or
cash flows.
FOREIGN CURRENCY EXCHANGE RISK
We conduct operations in several different countries. The balance sheet
accounts of our operations in Sweden and Scotland are translated to U.S. dollars
for financial reporting purposes and resulting adjustments are made to
stockholders' equity. The value of the respective local currency may strengthen
or weaken against the U.S. dollar, which would impact the value of stockholders'
investment in our common stock. Fluctuations in the value of the British Pound
and Swedish Krona against the U.S. dollar have occurred during our history,
which have resulted in unrealized foreign currency translation gains and losses,
which are included in accumulated other comprehensive loss and shown in the
equity section of our balance sheet.
While most of the transactions of our U.S. and European operations are
denominated in the respective local currency, some transactions are denominated
in other currencies. Since the accounting records of our foreign operations are
kept in the respective local currency, any transactions denominated in other
currencies are accounted for in the respective local currency at the time of the
transaction. Upon settlement of such a transaction, any foreign currency gain or
loss results in an adjustment to income.
Our operating results may be impacted by the fluctuating exchange rates
of foreign currencies, especially the British Pound and Swedish Krona, in
relation to the U.S. dollar. Most of the revenue and expense items of our
foreign subsidiaries are denominated in the respective local currency. In
Sweden, we believe this serves as a natural hedge against exchange rate
fluctuations because although an unfavorable change in the exchange rate of the
foreign currency against the U.S. dollar will result in lower revenue when
translated into U.S. dollars, operating expenses will also be lower in these
circumstances. A 10 percent adverse change in the British Pound or Swedish Krona
against the U.S. dollar would not have a material effect on our net loss.
We believe our foreign currency risk is not material. We do not
currently engage in hedging activities with respect to our foreign currency
exposure. However, we continually monitor our exposure to currency fluctuations.
We have not incurred significant realized losses on exchange transactions. If
realized losses on foreign transactions were to become significant, we would
evaluate appropriate strategies, including the possible use of foreign exchange
contracts, to reduce such losses.
We were not adversely impacted by the European Union's adoption of the
"Euro" currency. Our foreign operations to date have been located in Scotland
and Sweden which are not participating in the adoption of the Euro.
23
INTANGIBLE ASSET RISK
We have a substantial amount of intangible assets. Although at
September 30, 2002 we believe our intangible assets are recoverable, changes in
the economy, the business in which we operate and our own relative performance
could change the assumptions used to evaluate intangible asset recoverability.
We continue to monitor those assumptions and their consequent effect on the
estimated recoverability of our intangible assets.
ITEM 4. CONTROLS AND PROCEDURES
As of September 30, 2002, an evaluation was performed under the
supervision and with the participation of our management, including the Chief
Executive Officer and Chief Financial Officer, of the effectiveness of the
design and operation of our disclosure controls and procedures. Based on that
evaluation, our management, including the Chief Executive Officer and Chief
Financial Officer, believes that our disclosure controls and procedures are
adequately designed to ensure that the information that we are required to
disclose in this report has been accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding such required disclosure. There
have been no significant changes in our internal controls or other factors that
could significantly affect internal controls subsequent to September 30, 2002.
24
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In October 1997, Viragen, the company's president and Cytoferon Corp.,
a former affiliate of the president, were named as defendants in a civil action
brought in the United States District Court for the Southern District of Florida
(Walter L. Smith v Cytoferon Corp. et al; Case No: 97-3187-CIV-MARCUS). The
plaintiff is a former Viragen stockholder and investor in Cytoferon Corp. The
suit alleged the defendants violated federal and state securities laws, federal
and state RICO statutes, fraud, conspiracy, breach of fiduciary duties and
breach of contract. The plaintiff was seeking an unspecified monetary judgment
and the delivery of 441,368 shares of common stock. Viragen filed a motion to
dismiss denying the allegations and requesting reimbursement of its costs.
In November 1997, the plaintiff filed a notice of voluntary dismissal
with the federal court concurrently notifying Viragen of his intent to refile a
complaint in circuit court in the state of Florida. In December 1998, the U.S.
District Court awarded us reimbursement of attorneys' fees and expenses under
Rule 11 of the Federal Rules of Civil Procedure and the Private Securities
Litigation Reform Act. We recovered $31,000 during fiscal 2000.
In November 1997, the plaintiff filed a complaint in the Circuit Court
of the 11th Judicial Circuit for Miami-Dade County, Florida (Case No: 97-25587
CA30) naming the same defendants. The suit alleges breach of contract, fraud,
violation of Florida's RICO statute and breach of fiduciary duties. It sought an
unspecified monetary judgment and specific performance delivery of 441,368
shares of Viragen common stock. The plaintiff claimed that he was entitled to
additional shares of common stock under a consulting agreement. He also claimed
that Viragen's president breached his fiduciary duty to Cytoferon by not
achieving sufficient financing for Viragen, which would have entitled Cytoferon
to additional shares. He also claimed misrepresentations in connection with the
previous Cytoferon financings.
In March 1998, the Circuit Court granted Viragen's motion to dismiss
the complaint. Subsequently, the plaintiff filed an amended complaint alleging
breach of contract, fraud, violation of Florida's RICO Act and breach of
fiduciary duties and seeking an unspecified monetary judgment and specific
performance delivery of 441,368 shares of common stock. In April 1998, Viragen
filed a motion to dismiss plaintiff's amended complaint which was denied by the
court.
In August 2000, counsel for plaintiff indicated that they intended to
withdraw as counsel. In January 2001, the Circuit Court ruled in favor of
Viragen on all counts related to the Circuit Court Case (No.: 97-25587 CA30). No
further claims against Viragen are pending in this matter. Viragen has submitted
to the Circuit Court a request for reimbursement of related litigation costs. In
July 2002, the Circuit Court ruled in favor of Mr. Smith and Cytoferon and all
counts against these defendants were dismissed. We also intend to pursue
recovery of related litigation costs in these matters.
No accrual for loss had been recorded in this matter.
25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
99.1 Certification of Chief Executive Officer under Section 906 of
the Sarbanes-Oxley Act of 2002
99.2 Certification of Chief Financial Officer under Section 906 of
the Sarbanes-Oxley Act of 2002
(b) Reports on Form 8-K:
None
26
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Viragen, Inc.
By: /s/ DENNIS W. HEALEY
-------------------------------------
Dennis W. Healey
Executive Vice President and
Principal Financial Officer
By: /s/ NICHOLAS M. BURKE
-------------------------------------
Nicholas M. Burke
Controller and
Principal Accounting Officer
Date: November 14, 2002
27
CERTIFICATIONS
Date: November 14, 2002
I, Gerald Smith, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Viragen, Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls;
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002 By: /s/ Gerald Smith
----------------------------
Gerald Smith
President, Chairman and
Chief Executive Officer
28
CERTIFICATIONS
I, Dennis W. Healey, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Viragen, Inc.
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls;
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002 By: /s/ Dennis W. Healey
------------------------------------
Dennis W. Healey
Executive Vice President and
Chief Financial Officer
29