PROTEO, INC. AND SUBSIDIARY
FOR THE THREE-MONTH AND NINE-MONTH PERIODS
ENDED SEPTEMBER 30, 2019 AND 2018
PROTEO, INC. AND SUBSIDIARY
NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL
STATEMENTS
SEPTEMBER 30, 2019 (UNAUDITED)
1. NATURE OF BUSINESS AND BASIS OF PRESENTATION
BASIS OF PRESENTATION
The accompanying condensed consolidated
balance sheet as of December 31, 2018, which has been derived from audited financial statements, and the accompanying interim condensed
consolidated financial statements as of September 30, 2019 and for the three-month and nine-month periods ended September 30, 2019
and 2018, have been prepared by management pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC")
for interim financial reporting. These interim condensed consolidated financial statements are unaudited and, in the opinion of
management, include all adjustments (consisting only of normal recurring adjustments and accruals) necessary to present fairly
the financial condition, results of operations and cash flows of Proteo, Inc. and its wholly owned subsidiary (hereinafter collectively
referred to as the "Company") as of and for the periods presented in accordance with accounting principles generally
accepted in the United States of America ("GAAP"). Operating results for the three-month and nine-month periods ended
September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019, or
for any other interim period during such year. Certain information and footnote disclosures normally included in financial statements
prepared in accordance with GAAP have been omitted in accordance with the rules and regulations of the SEC, although the Company
believes that the disclosures made are adequate to make the information not misleading. The accompanying condensed consolidated
financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto contained
in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2018 filed with the SEC on April 15, 2019.
NATURE OF BUSINESS
The Company is a clinical stage drug development
company focusing on the development of anti-inflammatory treatments for rare diseases with significant unmet needs. The Company's
management deems its lead drug candidate Tiprelestat (also known as Elafin) for intravenous use to be one of the most prospective
treatments of acute postoperative inflammatory complications, in particular after esophageal cancer surgery. Elafin appears to
be also a promising compound for the treatment of pulmonary arterial hypertension. The clinical development is currently focused
in Europe with the intention to receive the primary approval in Europe.
The products that the Company is developing,
to the extent they are considered drugs or biologics, are governed by the Federal Food, Drug and Cosmetics Act (in the United States)
and the regulations of State and various foreign government agencies. The Company's proposed pharmaceutical products to be used
by humans are subject to certain clearance procedures administered by the above regulatory agencies.
From time to time, the Company enters into
collaborative arrangements for the research and development (R&D), manufacture and/or commercialization of products and product
candidates. These collaborations may provide for non-refundable, upfront license fees, R&D and commercial performance milestone
payments, cost sharing, royalty payments and/or profit sharing. The Company's collaboration agreements with third parties are generally
performed on a “best efforts” basis with no guarantee of either technological or commercial success.
Proteo, Inc.'s common stock is currently
quoted on the OTC Pink under the symbol "PTEO".
RECLASSIFICATIONS
Certain reclassifications have been made
to the unaudited September 30, 2018 financial statements to conform to the 2019 presentation. Intercompany foreign exchange gains
approximating $6,000 and $28,000 for the three-month and nine-month periods ended September 30, 2018, respectively were reclassified
from interest and other income (expense), net to other comprehensive loss.
CONCENTRATIONS
The Company maintains substantially all
of its cash in bank accounts at a German private commercial bank. The Company's bank accounts at this financial institution are
presently fully protected by the voluntary "Deposit Protection Fund of The German Private Commercial Banks". The Company
has not experienced any losses in these accounts.
The Company's operations, including 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.
LIQUIDITY
Management expects existing cash to be
sufficient to fund the Company’s operations for at least twelve months from the issuance date of these interim financial
statements.
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 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
may seek to raise additional funds to meet its working capital requirements through the additional placement of debt and/or equity
securities, entering into revenue sharing arrangements and obtaining government grants. 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.
OTHER RISKS AND UNCERTAINTIES
The Company's line of future pharmaceutical
products being developed by its German subsidiary, to the extent they may be considered drugs or biologics, are governed by the
Federal Food, Drug and Cosmetics Act (in the United States) and by the regulations of State agencies and various foreign government
agencies. There can be no assurances that the Company will obtain the regulatory approvals required to market its products. The
pharmaceutical products under development will be subject to more stringent regulatory requirements because they are recombinant
products for humans. The Company has no experience in obtaining regulatory clearance on 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.
The Company is exposed to risks related
to fluctuations in foreign currency exchange rates. Management does not utilize derivative instruments to hedge against such exposure.
PRINCIPLES OF CONSOLIDATION
The condensed consolidated financial statements
have been prepared in accordance with GAAP and include the accounts of Proteo, Inc. and Proteo Biotech AG (“PBAG”),
its wholly owned subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation.
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 condensed consolidated
statements of operations.
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 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.
The Company may receive grants from the
German government which are used to fund research and development activities (see Note 7). Grant funds received or to be received
for the reimbursement of qualified research and development expenses are offset against such expenses in the accompanying condensed
consolidated statements of operations and comprehensive income (loss) when the related expenses are incurred.
FAIR VALUE MEASUREMENTS
The Fair Value Measurements and Disclosures
Topic of the Financial Accounting Standard Board’s (“FASB”) Accounting Standards Codification (“ASC”
or “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, accounts payable and accrued expenses, approximate their fair value at September 30, 2019 due to their short-term nature.
The Company does not have any assets or liabilities that are measured at fair value on a recurring basis and, during the nine-month
periods ended September 30, 2019 and 2018, did not have any assets or liabilities that were measured at fair value on a non-recurring
basis.
REVENUE RECOGNITION
On January 1, 2018, the Company adopted
Topic 606 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018.
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.
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.
As more fully described in Note 5, amounts
received under the Development Agreement (as defined below) are initially deferred and recognized as revenue over the projected
performance period under the Development Agreement in relation to development expenses incurred.
SIGNIFICANT RECENT ACCOUNTING PRONOUNCEMENTS
In February 2016, the FASB issued ASU 2016-02,
Leases (Topic 842), which requires, 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 adoption of this standard did not have
a material effect on the Company’s condensed consolidated financial statements and related disclosures due to the short-term
nature of its leases. For these short-term leases, the Company has elected to not recognize lease assets and lease liabilities.
Lease expense for such leases are recognized on a straight-line basis over the lease term.
During the nine-months ended September
30, 2019, there have been no other changes to the Company’s significant accounting policies as described in the Annual Report
on Form 10-K for the fiscal year ended December 31, 2018.
2. 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) by the weighted average shares outstanding assuming all dilutive potential common shares
were issued. There were no dilutive potential common shares outstanding at September 30, 2019 and 2018. As such, basic and diluted
earnings (loss) per common share equals net income (loss), as reported, divided by the weighted average number of common shares
outstanding for the respective periods.
3. FOREIGN CURRENCY TRANSLATION
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; equity transactions are translated at historical rates; and income and expenses are translated at weighted average
exchange rates for the period. Net foreign currency exchange gains or losses resulting from such translations are excluded from
the results of operations but are included in other comprehensive loss and accumulated in a separate component of stockholders'
deficit. Accumulated other comprehensive loss approximated ($36,000) and ($31,000) at September 30, 2019 and December 31, 2018,
respectively.
4. FOREIGN CURRENCY TRANSACTIONS
The Company records payables related to
a certain licensing agreement (see Note 6) in accordance with the Foreign Currency Matters Topic of the Codification. Quarterly
commitments under such agreement 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.
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 gain or loss that is currently recognized. The Company recorded foreign currency
transaction gains of approximately $26,000 and $4,000 for the three-month periods ended September 30, 2019 and 2018, respectively,
and $30,000 and $21,000 for the nine-month periods ended September 30, 2019 and 2018, respectively, which are included in interest
and other income (expense), net in the accompanying condensed consolidated statements of operations and comprehensive income (loss).
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 (disclosed in the
Company’s Current Report on 8-K filed with the SEC on May 22, 2014). The third party agreed to 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. 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. Total payments by the third party to the Company were to not exceed
3.5 million Euros (approximately $4.1 million). Through September 30, 2019, the Company received approximately 1,633,000 Euros
($1,989,000) of the 3.5 million Euros maximum.
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 third party will be deferred and recognized as revenue over the projected performance period under the
Development Agreement in relation to expenses incurred.
For the three-month and nine-month periods
ended September 30, 2019 and 2018, the Company recognized approximately $0 and $23,000, and $0 and $100,000, respectively, of
development income under the Development Agreement, which is included in revenues in the accompanying condensed consolidated statements
of operations. There were no deferred revenues at September 30, 2019 and December 31, 2018. At this time, the Company believes
it is unlikely that they will receive any future amounts under the Development Agreement.
6. COMMITMENTS AND CONTINGENCIES
ACCRUED LICENSING FEES - RELATED PARTY
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, April 2017, June 2019 and again in November 2019, 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 Euros. As a result, the outstanding
balance of 570,000 Euros is due on November 15, 2021. While the total amount owed does not currently bear interest, any late payment
is 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 a director
of the Company, beneficially owned approximately 26% of the Company's outstanding common stock as of September 30, 2019.
At September 30, 2019, the Company has
accrued approximately $622,000 of licensing fees payable to Dr. Wiedow, which are included in long-term liabilities. This is a
decrease over the respective accrual of approximately $652,000 at December 31, 2018, which was solely due to changes in foreign
currency exchange rates.
OTHER LIABILITIES
Other liabilities at September 30, 2019
and December 31, 2018 consist of employee compensation that was incurred in 2015 to 2017, but for which payment was agreed to be
deferred until November 2021.
7. GRANTS
In June 2016, the German State of Schleswig-Holstein
granted PBAG approximately 874,000 Euro (approximately $1,021,000) for further research and development of the Company's pharmaceutical
product Elafin (the “Grant”). The Grant, as amended, covers 50% of eligible research and development costs incurred
from December 1, 2015 through November 30, 2019.
Research and development expenses for the
three-month periods ended September 30, 2019 and 2018 were reduced by approximately $32,000 and $37,000, respectively, for Grant
funds received and accrued during those periods. For the nine-month periods ended September 30, 2019 and 2018, research and development
expenses were reduced by Grant funds of approximately $94,000 and $270,000, respectively. Approximately €19,000 ($20,000)
and €33,000 ($38,000) of additional eligible expenses that were not previously reimbursed at September 30, 2019 and December
31, 2018, respectively, are included in the accompanying condensed consolidated balance sheets as grant funds receivable.
During the nine months ended September
30, 2018, the company received approval from the government to submit certain expenses for reimbursement that had been previously
expensed under GAAP. These expenses amounted to $177,000 and resulted in grant revenue exceeding grant expenses for the period.
This has resulted in the presentation of net Grant revenue for the nine months ended September 30, 2018, totaling $113,000.
8. RELATED PARTY LOAN
In March 2018, the Company’s president
provided a short-term loan of 50,000 Euros ($61,000) to the Company. During July 2018, the Company repaid such loan.
9. INCOME TAXES
The Company accounts for income taxes under
the asset and liability method, whereby deferred tax assets and liabilities are recognized for the future tax consequences attributable
to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates
is recognized in income in the period that includes the enactment date. Management evaluates the need to establish a valuation
allowance for deferred tax assets based upon the amount of existing temporary differences, the period in which they are expected
to be recovered and expected levels of taxable income. A valuation allowance to reduce deferred tax assets is established when
it is “more likely than not” that some or all of the deferred tax assets will not be realized. Management has determined
that a full valuation allowance against the Company’s net deferred tax assets is appropriate at September 30, 2019 and December
31, 2018.
There is no material income tax expense
recorded for the nine-month periods ended September 30, 2019 and 2018, due to the Company's history of net losses and related changes
to the full valuation allowance for deferred tax assets.
Based on management’s evaluation
of uncertainty in income taxes, the Company concluded that there were no significant uncertain tax positions requiring recognition
in its financial statements or related disclosures. Accordingly, no adjustments to recorded tax liabilities or accumulated deficit
were required. As of September 30, 2019, there were no increases or decreases to liability for income taxes associated with uncertain
tax positions.
10. CAPITAL EQUITY TRANSACTIONS
COMMON STOCK
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 $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 in December 2018. A second closing of the remaining
500,000 Purchase Shares occurred in January 2019 (the “Second Closing Date”), at which time the Investor paid the remaining
$40,000 Purchase Price.
PREFERRED STOCK
On September 9, 2016, the Company entered
into a Preferred Stock Purchase Agreement (the “B-1 Stock Agreement”) with a third-party (“B-1 Stock Investor”).
Pursuant to the B-1 Stock 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 Preferred Stock at the price of 1.00 Euro per share, for an aggregate purchase price of 1,000,000 Euros. Further details
are described in the Company's Current Report on Form 8-K filed with the SEC on September 13, 2016. The Company received deposits
totaling 100,000 Euros ($117,000) through September 30, 2018, including 20,000 Euros ($25,000) received during the three-months
ended March 31, 2018. As conditions for the initial closing were met, 100,000 shares of Series B-1 Preferred Stock were issued
during September 2018. During November 2019, an additional 10,000 shares of Series B-1 Preferred Stock were issued under this agreement.
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 Preferred 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 occurred on June 30, 2019 (the “Initial Closing Date”). Subsequent closings of the remaining Purchase Shares
will occur on the fifth 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. During
the nine months period ended September 30, 2019, the Company received €159,800 ($179,600) pursuant to the B-2 Stock Agreement.
During the nine months period ended September 30, 2019, 159,800 shares of Series B-2 Preferred Stock were issued. In September
2019 the B-2 Stock Investor requested the Company to renegotiate the Preferred Stock Purchase Agreement. Currently, Management
believes that an agreement cannot be reached and that the Company will not receive any further payments under the B-2 Stock Agreement.
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. During the nine-months ended September
30, 2019 (primarily during the first six months), approximately $3,000 of losses was attributed to the noncontrolling interest,
which has been reported as net loss attributable to noncontrolling interest in the accompanying consolidated financial
statements. The noncontrolling interest approximated $0 and $3,000 at September 30, 2019 and December, 31, 2018, respectively.