PROTEO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2018 AND 2017
1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION/NATURE OF BUSINESS
Proteo, Inc. and Proteo Marketing, Inc.
("PMI"), a Nevada corporation, which began operations in November 2000, entered into a reorganization and stock exchange
agreement in December 2000 with Proteo Biotech AG ("PBAG"), a German corporation, incorporated in Kiel, Germany. Pursuant
to the terms of the agreement, all of the shareholders of PBAG exchanged their common stock for 2,500,000 shares of PMI common
stock. As a result, PBAG became a wholly owned subsidiary of PMI. Proteo Inc.'s common stock is quoted on the OTCQB under the symbol
"PTEO." Effective December 31, 2004, PMI merged into Proteo, Inc. PBAG and Proteo, Inc. are hereinafter collectively
referred to as the "Company."
The Company intends to develop, promote
and market pharmaceuticals and other biotech products. The Company is focused on the development of pharmaceuticals based on the
human protein Elafin. Elafin is a human protein that naturally occurs in human skin, lungs, and mammary glands. The Company believes
Elafin may be useful in the treatment of post-surgery damage to tissue, complications resulting from organ transplantation, pulmonary
hypertension, as well as other diseases.
Since its inception, the Company has primarily
been engaged in the research and development of its proprietary product Elafin. Once the research and development phase is complete,
the Company will seek to obtain the various governmental regulatory approvals for the marketing of Elafin. The Company has not
generated any significant revenues from product sales. The Company believes that none of its planned products will produce sufficient
revenues in the near future. There are no assurances that the Company will be able to obtain regulatory approvals for marketing
of Elafin, or if approved, that Elafin will be accepted in the marketplace.
RECLASSIFICATIONS
Certain reclassifications have been made
to the 2017 financial statements to conform to the 2018 presentation. On-hand amounts of the Company’s product Elafin approximating
$48,000 and $51,000 at December 31, 2018 and 2017, respectively, that is sold for research purposes and used for research and
other purposes by external entities, have been reclassified from research supplies to prepaid expenses and other current assets
on the accompanying consolidated balance sheets. Additionally, intercompany foreign exchange gains (losses) approximating $41,000
and ($104,000) for the years ended December 31, 2018 and 2017, respectively, have been reclassified from interest and other
income (expense), net to other comprehensive income.
CONCENTRATIONS
The Company maintains substantially all
of its cash in bank accounts at a private German commercial bank. The Company's bank accounts at this financial institution are
presently protected by the voluntary Deposit Protection Fund of The German Private Commercial Banks. As such, the Company's bank
is a member of this deposit protection fund. The Company has not experienced any losses in these bank accounts.
The Company's research and development
activities and most of its assets are located in Germany. The Company's operations are subject to various political, economic,
and other risks and uncertainties inherent in Germany and the European Union.
OTHER RISKS AND UNCERTAINTIES
The Company will require substantial additional
funding for continuing research and development, obtaining regulatory approval, and for the commercialization of its products.
Management plans to generate revenues from product sales, but there are no products currently approved and there are no purchase
commitments for any of the proposed products. Additionally, the Company may generate revenues from out-licensing activities. There
can be no assurance that further out-licensing may be achieved or whether such will generate significant profit. In the absence
of significant sales and profits, the Company will be required to seek to raise additional funds to meet its working capital requirements
through the additional placement of debt and/or equity securities. There is no assurance that the Company will be able to obtain
sufficient additional funds when needed, or that such funds, if available, will be obtainable on terms satisfactory to the Company.
If we are unable to receive additional financing when needed, we may choose to delay or reduce other spending including Elafin
research and development spending.
The Company has cash approximating
$89,000 as of December 31, 2018 to support current and future operations. This is a decrease of $25,000 over the December 31,
2017 cash balance of approximately $114,000. Such cash is held by the Subsidiary in Germany in Euros. The Company does not intend
to repatriate any amount of this cash to the United States as it will be used to fund the Subsidiary’s continued operations.
Given the Company's current cash on hand and collections under the Grant of the German State of Schleswig-Holstein, management
believes the Company will have sufficient cash resources to cover its operations through one year from the filing of this Form
10-K. As for periods beyond this filing, we expect to continue to direct the majority of our research and development expenses
towards the development of Elafin. It is extremely difficult for us to reasonably estimate all future research and development
costs associated with Elafin due to the number of unknowns and uncertainties associated with preclinical and clinical trial development.
The Company's line of future pharmaceutical
products being developed by its German subsidiary are considered drugs or biologics, and as such, are governed by the Federal Food
and Drug and Cosmetics Act and by the regulations of state agencies and various foreign government agencies. There can be no assurance
that the Company will obtain the regulatory approvals required to market its products. The pharmaceutical products under development
in Germany will be subject to more stringent regulatory requirements because they are recombinant proteins for use in humans. The
Company has no experience in obtaining regulatory approvals for these types of products. Therefore, the Company will be subject
to the risks of delays in obtaining or failing to obtain regulatory clearance and other uncertainties, including financial, operational,
technological, regulatory and other risks associated with an emerging business, including the potential risk of business failure.
As substantially all of the Company's operations
are in Germany, they are exposed to risks related to fluctuations in foreign currency exchange rates. The Company does not utilize
derivative instruments to hedge against such exposure.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements have
been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) and include
the accounts of Proteo, Inc. and PBAG, its wholly owned subsidiary. All significant intercompany accounts and transactions have
been eliminated in consolidation.
Furthermore, the Company classifies noncontrolling
interests (previously referred to as "minority interest") as part of consolidated net earnings and includes the accumulated
amount of noncontrolling interests as part of stockholders' deficit. Earnings (loss) per share reflects amounts attributable only
to the Company, excluding noncontrolling interests. Increases and decreases in the Company's controlling financial interests in
consolidated subsidiaries will be reported in equity similar to treasury stock transactions. If a change in ownership of a consolidated
subsidiary results in loss of control and deconsolidation, any retained ownership interests are remeasured with the gain or loss
reported in net earnings. The Company has a substantive contractual arrangement that specifies the attribution of net earnings
and loss not to exceed the noncontrolling interest.
USE OF ESTIMATES
The Company prepares its consolidated financial
statements in conformity with GAAP, which requires management to make estimates and assumptions that affect the reported amounts
of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported
amounts of revenues (if any) and expenses during the reporting period. Significant estimates made by management include, among
others, realizability of long-lived assets, revenue recognition estimates for the Development Agreement, and estimates for deferred
tax asset valuation allowances. Actual results could materially differ from such estimates.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Fair Value Measurements and Disclosures
Topic of the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”
or the “Codification”) requires disclosure of fair value information about financial instruments when it is practicable
to estimate that value. Management believes that the carrying amounts of the Company's financial instruments, consisting primarily
of cash and cash equivalents, receivables, and accounts payable and accrued liabilities approximate their fair value at December
31, 2018 and 2017 due to their short-term nature. The Company did not have any assets or liabilities that were measured at fair
value on a recurring or non-recurring basis as of December 31, 2018 or 2017.
FOREIGN CURRENCY
Assets and liabilities of the Company's
German operations are translated from Euros (the functional currency) into U.S. dollars (the reporting currency) at period-end
exchange rates. Expense and grant receipts are translated at weighted average exchange rates for the period. Net exchange gains
or losses resulting from such translation are excluded from the consolidated statements of operations and are included in comprehensive
income (loss) and accumulated in a separate component of stockholders' deficit. Accumulated other comprehensive loss approximated
$31,000 and $30,000 at December 31, 2018 and 2017, respectively.
The Company records quarterly payables
related to a certain licensing agreement (Note 7) which are denominated in Euros. For each reporting period, the Company translates
the quarterly amount to U.S. dollars at the exchange rate effective on that date. If the exchange rate changes between when the
liability is incurred and the time payment is made, a foreign exchange gain or loss results. The Company made no payments under
this licensing agreement during the years ended December 31, 2018 and 2017.
Additionally, the Company computes a foreign
exchange gain or loss at each balance sheet date on all recorded transactions denominated in foreign currencies that have not
been settled. The difference between the exchange rate that could have been used to settle the transaction on the date it occurred
and the exchange rate at the balance sheet date is the unrealized gain or loss that is currently recognized. The Company recorded
unrealized foreign currency transaction gains (losses) of approximately $30,000 and ($83,000) for the years ended December 31,
2018 and 2017, respectively, which are included in interest and other income, net in the accompanying consolidated statements
of operations and comprehensive income (loss).
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid
temporary cash investments with original maturities of three months or less to be cash equivalents. Cash and cash equivalents consist
primarily of deposits with banks.
RESEARCH AND DEVELOPMENT ACTIVITIES
The Company capitalizes the cost of supplies
used in its research and development activities if such supplies are deemed to have alternative future uses, usually in other research
and development projects. Such costs are expensed as used to research and development expenses in the accompanying consolidated
statements of operations. All other research and development costs are expensed as incurred.
The costs of materials that are acquired
for a particular research and development project and that have no alternative future uses (in other research and development projects
or otherwise) and therefore no separate economic values are expensed as research and development costs at the time the costs are
incurred.
Nonrefundable advance payments for goods
or services that have the characteristics that will be used or rendered for future research and development activities are deferred
and capitalized as prepaid expenses. Such amounts are expensed to research and development as the related goods and services are
received.
The Company may receive grants from the
German government which are used to fund research and development activities (see Note 6). Grant funds to be received for the reimbursement
of qualified research and development expenses are offset against such expenses in the accompanying consolidated statements of
operations and comprehensive loss when the related expenses are incurred.
LONG-LIVED ASSETS
Property and equipment are recorded at
cost and depreciated using the straight-line method over their expected useful lives, which range from 3 to 14 years. Leasehold
improvements are amortized over the expected useful life of the improvement or the remaining lease term, whichever is shorter.
Expenditures for normal maintenance and repairs are charged to income, and significant improvements are capitalized. The cost and
related accumulated depreciation or amortization of assets are removed from the accounts upon retirement or other disposition;
any resulting gain or loss is reflected in the consolidated statements of operations and comprehensive loss.
GAAP requires that certain long-lived assets
be reviewed for impairment whenever events or changes in circumstances indicate that their carrying amounts may not be recoverable.
If the cost basis of a long-lived asset is greater than the projected future undiscounted net cash flows from such asset, an impairment
loss is recognized. Impairment losses are calculated as the difference between the cost basis of an asset and its estimated fair
value. Assets to be disposed are reported at the lower of the carrying amount or fair value less costs to sell. Management believes
that no indicators of impairment existed for property and equipment as of or during the years ended December 31, 2018 and 2017.
REVENUE RECOGNITION
On January 1, 2018, the Company adopted
ASC Topic 606, Revenue from Contracts with Customers (“Topic 606”) using the modified retrospective method applied
to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018
are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company’s
historic accounting under ASC Topic 605, Revenue Recognition (“Topic 605”).
Adoption of the new standard did not result
in any change to the Company’s opening retained earnings as of January 1, 2018 as product sale revenue is not significant.
As more fully described in Note 5, the
Company’s revenue primarily consist of the Development Agreement. Amounts received under the Development Agreement are initially
deferred and recognized as revenue over the projected performance period under the Development Agreement in direct relation to
development expenses incurred.
In determining the appropriate amount of
revenue to be recognized as it fulfills its performance obligations under its agreements, the Company performs the following steps:
(i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services
are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction
price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations
based on estimated selling prices; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation.
INCOME TAXES
The Company accounts for income taxes using
the liability method in accordance with ASC Topic 740-10, Income Taxes. Deferred tax assets and liabilities are recognized for
future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities
and their respective tax bases. A valuation allowance is provided for significant deferred tax assets when it is more likely than
not that such assets will not be recovered.
The Company also follows the provisions
of ASC Topic 740-10 relating to accounting for uncertain tax positions. Under ASC Topic 740-10, the Company must recognize the
tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination
by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements
from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate
resolution. The Company has not recognized any liabilities for uncertain tax positions as a result of ASC Topic 740-10. The Company
expects any resolution of unrecognized tax benefits, if created, would occur while the full valuation allowance of deferred tax
assets is maintained; therefore, the Company does not expect to have any unrecognized tax benefits that, if recognized, would affect
the effective tax rate.
The Company will recognize interest and
penalties related to any unrecognized tax benefits within the income tax expense line in the accompanying consolidated statements
of operations. As of December 31, 2018 and 2017, management believes the Company has no unrecognized tax benefits.
The Company’s income tax returns
remain open for examination by taxing authorities for a statutory defined period of time. The Company is currently not under examination
by any taxing authorities.
EARNINGS (LOSS) PER COMMON SHARE
Basic earnings (loss) per common share
is computed based on the weighted average number of shares outstanding for the period. Diluted earnings (loss) per common share
is computed by dividing net income (loss) available to common stockholders by the weighted average shares outstanding assuming
all dilutive potential common shares were issued. There were no dilutive potential common shares outstanding at December 31, 2018
or 2017.
SUBSEQUENT EVENTS
Management has evaluated subsequent events
through the date the accompanying financial statements were filed with the SEC for transactions and other events which may require
adjustment of and/or disclosure in such financial statements.
COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss) represents
the net change in stockholders' deficit during a period from sources other than transactions with stockholders and as such, includes
net earnings or loss. For the Company, other comprehensive income (loss) represents the foreign currency translation adjustments,
which are recorded as components of stockholders' deficit.
SEGMENTS OF AN ENTERPRISE AND RELATED INFORMATION
The Company considers itself to operate
in one segment and has had no revenues from principal operations from inception. See Note 2 for information on long-lived assets
located in Germany.
SIGNIFICANT RECENT ACCOUNTING PRONOUNCEMENTS
In March 2018, the FASB issued ASU No.
2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin (“SAB”) No.
118 (SEC Update). This standard adds various SEC paragraphs pursuant to the issuance of SEC Staff Accounting Bulletin No. 118,
which clarifies the SEC Staff’s views on income tax accounting implications of the Tax Cuts and Jobs Act (the “Act”).
It requires reporting of provisional amounts for specific income tax effects of the Act for which the accounting under ASC Topic
740 will be incomplete, but a reasonable estimate can be determined. Provision amounts for income tax effects of the Act for which
a reasonable estimate cannot be determined, ASC Topic 740 should be applied based on provisions of the tax laws that were in effect
immediately prior to the Act being enacted. Provisional amounts for income tax effects for which a reasonable estimate cannot be
determined would be reported in the first reporting period in which a reasonable estimate can be determined. In accordance with
this standard and SAB 118, the Company reported provisional amounts for income tax effects from the Act as of December 31, 2017,
and amounts were finalized as of December 31, 2018 with no adjustments made to the amounts previously recorded.
In February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842)
, which will require, among other things, lessees to recognize for all leases (with the exception of short-term
leases) a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, and a right-of-use
asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease
term. ASU 2016-02 is effective for the Company for the year beginning January 1, 2019. The Company does not believe the impact
of adopting this standard will have a material effect on its consolidated financial statements and related disclosures.
2. PROPERTY AND EQUIPMENT
Property and equipment, all of which is located in Kiel, Germany,
consist of the following:
|
|
December 31,
|
|
|
|
2018
|
|
|
2017
|
|
Technical and laboratory equipment
|
|
$
|
210,669
|
|
|
$
|
220,511
|
|
Leasehold improvements
|
|
|
4,255
|
|
|
|
4,454
|
|
Office equipment
|
|
|
12,307
|
|
|
|
12,883
|
|
|
|
|
227,231
|
|
|
|
237,848
|
|
Less accumulated depreciation
|
|
|
(222,302
|
)
|
|
|
(230,795
|
)
|
Total
|
|
$
|
4,929
|
|
|
$
|
7,053
|
|
Depreciation expense is included in general
and administrative expense in the consolidated statements of operations and comprehensive income (loss) approximated $2,000 and
$2,000 for the years ended December 31, 2018 and 2017, respectively.
3. STOCKHOLDERS' DEFICIT
COMMON STOCK
The Company is authorized to issue 300,000,000
shares of $0.001 par value common stock. The holders of the Company's common stock are entitled to one vote for each share held
of record on all matters to be voted on by those stockholders.
On December 12, 2018, Proteo, Inc., entered
into a Common Stock Purchase Agreement (the “Agreement”) with Jork von Reden (the “Investor”), who is also
a member of the Company’s board of directors. Pursuant to the Agreement, the Company agreed to issue and sell to the Investor
1,000,000 shares of the Company’s Common Stock (the “Purchase Shares”) at the price of $0.08 per share (the “Purchase
Price”), for an aggregate purchase price of USD $80,000. The Purchase Price was equal to the closing price of the Registrant’s
common stock as quoted on the OTCQB on December 6, 2018. The initial closing of 500,000 of the Purchase Shares occurred upon the
Company’s receipt of the initial payment of $40,000 of the Purchase Price. A second closing of the remaining 500,000 Purchase
Shares will occur in January 2019 (the “Second Closing Date”). The Investor paid the remaining $40,000 Purchase Price
with respect to the remaining Purchase Shares on January 14, 2019.
PREFERRED STOCK
The Company is authorized to issue 10,000,000
shares of preferred stock, $0.001 par value per share. Except as described below, the Board of Directors has not designated any
liquidation value, dividend rates or other rights or preferences with respect to any shares of preferred stock.
The Board of Directors has designated 750,000
preferred shares as non-voting Series A Preferred Stock. Holders of Series A Preferred Stock are entitled to receive preferential
dividends, if and when declared, at the per share rate of twice the per share amount of any cash or non-cash dividend distributed
to holders of the Company's common stock.
On September 7, 2016, the Company designated
1,000,000 shares of its authorized preferred stock as Series B-1 Preferred Stock ("Series B-1 Stock").
The rights, preferences, and privileges
of the Series B-1 Preferred Stock are as follows:
|
·
|
Holders of shares of Series B-1 Preferred Stock are entitled to receive, when, as and if declared by the Board of Directors preferential dividends at the per share rate of 1.5 times the per share amount of each and any cash and non-cash dividend distributed to the holders of the Registrants common stock.
|
|
·
|
Except as otherwise required by law, the Series B-1 Preferred Stock shall have no voting rights and not be entitled to vote as a separate class on a matter to be voted on by stockholders of the Company.
|
|
·
|
Upon any liquidation, voluntary or otherwise, dissolution or winding up of the Registrant, holders of Series B-1 Preferred Stock will be entitled to receive per share distributions equal to 1.5 times the rate of per share distributions to be made to the holders of the Registrant’s common stock.
|
|
·
|
In the event the Registrant enters into any consolidation, merger, combination or other transaction in which the shares of common stock of the Registrant are exchanged into other stock or securities, cash and/or any other property, then in any such case each share of Series B-1 Preferred Stock shall automatically be simultaneously exchanged for or converted into the same stock or securities, cash and/or other property at a rate per share equal to 1.5 times the rate per share that the common stock is being exchanged or converted.
|
On September 9, 2016, the Company entered
into a Preferred Stock Purchase Agreement (the “B-1 Stock Agreement”) with a German corporation (the "B-1 Stock
Investor"). Pursuant to the Agreement, the Company agreed to issue and sell to the B-1 Stock Investor 1,000,000 shares of
the Company’s Series B-1 Stock (the “Purchase Shares”) at the price of €1.00 per share (the “Purchase
Price”), for an aggregate purchase price of €1,000,000. The B-1 Stock Investor agreed to purchase such shares no later
than March 31, 2017. However, the B-1 Stock Investor failed to deliver the purchase price by that date. During 2017 and 2016, the
Company received €50,000 ($57,000) from the B-1 Stock Investor as a refundable deposit for the Initial Closing Date. Such
amount is included in accounts payable and accrued liabilities in the accompanying consolidated balance sheet at December 31, 2017.
During 2018, the Company received an additional €50,000 (approximately $60,000) from the B-1 Stock Investor, and on September
27, 2018, the Company issued 100,000 shares of Series B-1 Stock pursuant to the terms of the B-1 Stock Agreement. The transaction
was exempt from the registration requirements of the Securities Act of 1933, as amended, by virtue of the exemptions available
under Regulation S and the rules promulgated thereunder.
On April 8, 2019, the Company designated
1,000,000 shares of its authorized preferred stock as Series B-2 Preferred Stock ("Series B-2 Stock").
The rights, preferences, and privileges
of the Series B-2 Preferred Stock are as follows:
|
·
|
Holders of shares of Series B-2 Preferred Stock are entitled to receive, when, as and if declared by the Board of Directors preferential dividends at the per share rate of 1.5 times the per share amount of each and any cash and non-cash dividend distributed to the holders of the Registrants common stock.
|
|
·
|
Except as otherwise required by law, the Series B-2 Preferred Stock shall have no voting rights and not be entitled to vote as a separate class on a matter to be voted on by stockholders of the Company.
|
|
·
|
Upon any liquidation, voluntary or otherwise, dissolution or winding up of the Registrant, holders of Series B-2 Preferred Stock will be entitled to receive per share distributions equal to 1.5 times the rate of per share distributions to be made to the holders of the Registrant’s common stock.
|
|
·
|
In the event the Registrant enters into any consolidation, merger, combination or other transaction in which the shares of common stock of the Registrant are exchanged into other stock or securities, cash and/or any other property, then in any such case each share of Series B-2 Preferred Stock shall automatically be simultaneously exchanged for or converted into the same stock or securities, cash and/or other property at a rate per share equal to 1.5 times the rate per share that the common stock is being exchanged or converted.
|
On April 10, 2019, the Company entered
into a Preferred Stock Purchase Agreement (the “B-2 Stock Agreement”) with a Swiss corporation (the "B-2 Stock
Investor"). Pursuant to the B-2 Stock Agreement, the Company agreed to issue and sell to the B-2 Stock Investor 1,000,000
shares of the Company’s Series B-2 Stock (the “Purchase Shares”) at the price of €1.00 per share (the “Purchase
Price”), for an aggregate purchase price of €1,000,000. An initial closing of 100,000 of the Purchase Shares will occur
on June 30, 2019 or on such earlier date as the B-2 Stock Investor and Registrant may agree (the “Initial Closing Date”).
The B-2 Stock Investor agreed to deliver €100,000, which is the Purchase Price with respect to such Purchase Shares, on or
before the Initial Closing Date. Subsequent closings of the remaining Purchase Shares will occur on the fifth (5th) business day
after such date or dates that the B-2 Stock Investor delivers all or a portion of the Purchase Price with respect to such Purchase
Shares; provided, however, that B-2 Stock Investor shall deliver the Purchase Price for all remaining Purchase Shares on or before
June 30, 2020. The transaction was exempt from the registration requirements of the Securities Act of 1933, as amended, by virtue
of the exemptions available under Regulation S and the rules promulgated thereunder.
NONCONTROLLING INTEREST
On September 28, 2006, a shareholder of
the Company entered into an agreement and contributed 50,000 Euros (approximately $63,000 at such time) to PBAG for a 15%
non-voting interest in PBAG, in accordance with certain provisions of the German Commercial Code. The party will receive
15% of PBAG profits, as determined under the agreement, not to exceed in any given year 30% of the capital contributed. Additionally, the
party will be allocated 15% of losses, as determined under the agreement, not to exceed the capital contributed. The party
is under no obligation to provide additional capital contributions to the Company or absorb losses beyond his ownership
interest. Prior to 2008, allocated losses reduced the minority stockholder's capital account to $0. During the year ended December
31, 2018, approximately $3,000 of income was attributed to the noncontrolling interest, which has been reported as net income
attributable to noncontrolling interest in the accompanying consolidated financial statements.
4. INCOME TAXES
There is no material income tax expense
or benefit recorded for the years ended December 31, 2018 or 2017 due to the Company's net losses and related deferred tax asset
full valuation allowance.
On December 22, 2017, the Tax Cuts and
Jobs Act (2017 Tax Act) was enacted. The 2017 Tax Act includes a number of changes to existing U.S. tax laws that impact the Company,
most notably a reduction of the U.S. corporate tax rate from 34% to 21%, for tax years beginning after December 31, 2017. The 2017
Tax Act also provides for the implementation of a territorial tax system, a one-time transition tax on certain foreign earnings,
the acceleration of depreciation for certain assets placed into service after September 27, 2017 and other prospective changes
beginning in 2018, including repeal of the domestic manufacturing deduction, acceleration of tax revenue recognition, capitalization
of research and development expenditures, additional limitations on executive compensation and limitations on the deductibility
of interest.
Income tax expense (benefit) for
the years ended December 31, 2018 and 2017 differed from the amounts computed by applying the U.S. federal income tax rates of
21 percent and 34 percent, respectively, to the pretax income (loss) for the following reasons:
|
|
2018
|
|
|
2017
|
|
Income tax expense (benefit) at U.S. federal statutory rates
|
|
$
|
16,000
|
|
|
$
|
(85,000
|
)
|
Impact of 2017 Tax Act
|
|
|
–
|
|
|
|
377,000
|
|
Foreign rate change impacts
|
|
|
70,000
|
|
|
|
(163,000
|
)
|
Foreign rate differential
|
|
|
–
|
|
|
|
(7,000
|
)
|
Change in valuation allowance
|
|
|
(88,000
|
)
|
|
|
(101,000
|
)
|
Other
|
|
|
2,000
|
|
|
|
(21,000
|
)
|
|
|
$
|
–
|
|
|
$
|
–
|
|
The Company has a deferred tax asset and
an equal amount of valuation allowance of approximately $2,020,000 and $2,107,000 at December 31, 2018 and 2017, respectively,
relating primarily to tax net operating loss carryforwards approximating $1,900,000, as discussed below, and temporary differences
related to the recognition of accrued licensing fees approximating $120,000.
As of December 31, 2018, the Company had
tax net operating loss carryforwards ("NOLs") of approximately $2,382,000 and $5,584,000 available to offset future taxable
Federal and foreign income, respectively. The Federal NOL begins to expire in 2025 over varying years. The foreign net operating
loss relates to Germany and does not have an expiration date.
In the event the Company were to experience
a greater than 50% change in ownership, as defined in Section 382 of the Internal Revenue Code, the utilization of the Company's
Federal tax NOLs could be restricted.
5. DEVELOPMENT AGREEMENT
On May 16, 2014, the Company entered into
a funding and revenue sharing agreement (the “Development Agreement”) with an unrelated third party. The third party
will fund operational expenses of the Company as well as the development costs related to the clinical development program aimed
at receiving regulatory approval for the use of Elafin for the intravenous treatment of patients undergoing esophageal cancer surgery
in the European Union. Total payments by the third party to the Company shall not exceed €3.5 million (approximately $4 million).
Through December 31, 2018, the Company received approximately €1.6 million of the €3.5 million maximum. Revenue participation
right payments will be made to the party when and if Elafin is commercialized within the European Union for the intravenous treatment
of patients undergoing esophageal cancer surgery.
The Development Agreement will terminate
after the earlier of 15 years or 10 complete and consecutive years after the first regulatory approval of Elafin for this indication.
Under no circumstances are the payments refundable, even if the drug is never commercialized. As no revenue sharing payments will
be made unless Elafin is commercialized, the payments received are being accounted for as payments for the Company to use reasonable
efforts to complete development, obtain regulatory approvals, and to commercialize Elafin (i.e. the performance period). Therefore,
amounts received from the party will be deferred and recognized as revenue over the projected performance period under the Development
Agreement in relation to expenses incurred.
From inception of the Development Agreement
through September 30, 2015, management estimated total Elafin related development expenses at €3.5 million. As revenues to
be received also totaled €3.5 million, revenue was recognized at 100% of the related expenses incurred. Beginning October
1, 2015, management increased their estimate of remaining development expenses by €3.5 million and began recognizing revenues
at 43% of related expenses. The increase in expenses was due to additional clinical indicators that will be explored by the Company.
For the years ended December 31, 2018
and 2017, the Company recognized approximately $99,000 and $199,000, respectively, of development income under the
Development Agreement, which is included in revenues in the accompanying consolidated statements of operations and
comprehensive income (loss). Deferred revenues approximated $0 and $83,000 at December 31, 2018 and 2017, respectively. At
this time, we believe it is unlikely that the Company will receive any future amounts under the Development Agreement.
6. GRANTS
In June 2016, the German State of Schleswig-Holstein
granted PBAG approximately 874,000 Euros (approximately $1,047,000) for further research and development of the Company's pharmaceutical
product Elafin (the “Grant”). The Grant covers 50% of eligible research and development costs incurred from December
1, 2015 through November 30, 2019. Research and development expenses for the years ended December 31, 2018 and 2017 were reduced
by approximately $306,000 and $191,000, respectively, for Grant funds received and accrued during those periods. Approximately
€32,800 ($38,000) and €9,500 ($11,000) of additional eligible expenses were incurred during the years ended December
31, 2018 and 2017, respectively, that were not reimbursed by the respective year end. These receivables are included in the accompanying
consolidated balance sheets as grant funds receivable.
7. RELATED PARTY LOAN
In March 2018, the Company’s president provided a short-term
loan of 50,000 Euro ($62,000) to the Company. If repayment was made by July 15, 2018, no interest would be charged. During July
2018, the Company repaid the short-term loan.
8. COMMITMENTS AND CONTINGENCIES
ACCRUED LICENSING FEES
On December 30, 2000, the Company entered
into a thirty-year license agreement, beginning January 1, 2001 (the "License Agreement"), with Dr. Oliver Wiedow, MD,
the owner and inventor of several patents, patent rights and technologies related to Elafin. Pursuant to the License Agreement,
the Company agreed to pay Dr. Wiedow an annual license fee of 110,000 Euros for a period of six years. The License Agreement was
amended in December 2008 to waive non-payment defaults and to defer the due dates of each payment. In July 2011, February 2012,
February 2013, June 2014, and again in April 2017, Dr. Wiedow agreed in writing to waive the non-payment defaults and agreed to
defer the due dates of the payments for the outstanding balance of 570,000 Euro. As a result, the outstanding balance of 570,000
Euros is due on June 30, 2020. While the total amount owed does not currently bear interest, the Amendment provides that any late
payment shall be subject to interest at an annual rate equal to the German Base Interest Rate plus six percent. In the event that
the Company's financial condition improves, the parties can agree to increase and/or accelerate the payments.
Dr. Wiedow, who is an officer and director
of the Company, beneficially owned approximately 26% of the Company's outstanding common stock as of December 31, 2018.
At December 31, 2018, the Company has
accrued approximately $652,000 of licensing fees payable to Dr. Wiedow, which are included in long-term liabilities. This is a
decrease over the respective accrual of approximately $683,000 at December 31, 2017, which was solely due to changes in foreign
currency exchange rates that are included in interest and other income (expense), net in the accompanying consolidated statements
of operations and comprehensive income (loss).
Pursuant to the License Agreement, as amended,
Dr. Wiedow may terminate the License Agreement in the event of a breach which is not cured within 90 days following written notice
of such breach. In addition, Dr. Wiedow may terminate the License Agreement immediately in the event of the Company’s bankruptcy,
insolvency, assignment for the benefit of creditors, insolvency, liquidation, assignment of all or substantially all of its assets,
failure to continue to develop Elafin. After any termination, to the extent permitted by applicable law, the Company will return
all documents, information and data received by Dr. Wiedow and will immediately cease to develop, manufacture or sell Elafin.
ARTES BIOTECHNOLOGY LICENSE AGREEMENT
On November 15, 2004, the Company entered
into an exclusive worldwide license and collaboration agreement with ARTES Biotechnology GmbH ("ARTES"). This agreement
enables the Company to economically produce Elafin on a large scale by using the sublicensed yeast HANSENULA POLYMORPHA as a high
performance expression system. Rhein Biotech GmbH ("Rhein") has licensed the yeast to ARTES, who in-turn sublicensed
it to the Company. The agreement has a term of fifteen years with an annual license fee equal to the greater of 10,000 Euros or
2.5% royalties on the future sales of Elafin. Should the license agreement between Rhein and ARTES terminate, Rhein will assume
the sublicense agreement with the Company under similar terms.
RHEIN MINAPHARM AGREEMENT
In August 2007, the Company's subsidiary
entered into an agreement with Rhein Minapharm ("Minapharm") for clinical development, production and marketing of Elafin.
The Company has granted Minapharm the nonexclusive right to market Elafin in Egypt and certain Middle Eastern and African countries.
The Company may receive milestone-payments upon Minapharm's attainment of certain clinical milestones as well as royalties on any
future net product sales. No payments under this agreement were received in 2018 or 2017. The Minapharm agreement terminates 15
years after the first commercial sales of licensed products.
LEASES
The Company has entered into short-term
leases for office and laboratory facilities in Germany. The Company also leases office space in Irvine, California on a month-to-month
basis. Total rental expense (including additional expenses) for all facilities for the years ended December 31, 2018 and 2017 approximated
$36,000 and $31,000, respectively.