PROTEO, INC. AND SUBSIDIARY
PROTEO, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2017 AND 2016
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.
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. Based on our current plan, we believe that our current resources will be sufficient to satisfy
our anticipated working capital requirements through April 2019.
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.
GRANTS
At times the Company has received grants
from the German government which are used to fund research and development activities and the acquisition of equipment. Grant receipts
for the reimbursement of 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. Grants related to the acquisition of tangible property,
if any, will be recorded as a reduction of such property's historical cost.
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, 2017 and 2016 due to their short-term nature. The Company did not have any assets or liabilities that are measured at fair
value on a recurring or non-recurring basis during the years ended December 31, 2017 and 2016.
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
loss and accumulated in a separate component of stockholders' deficit. Accumulated income (losses) approximated $74,000 and ($24,000)
at December 31, 2017 and 2016, 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, 2017 and 2016.
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 ($187,000) and $51,000 for the years ended December 31, 2017 and 2016,
respectively, which are included in interest and other income, net in the accompanying consolidated statements of operations and
comprehensive 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, 2017 and 2016.
REVENUE RECOGNITION
As more fully described in Note 5, 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.
INCOME TAXES
The Company accounts for income taxes using
the liability method in accordance with ASC 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 740-10 relating to accounting for uncertain tax positions. Under ASC 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 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, 2017 and 2016, 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.
LOSS PER COMMON SHARE
Basic loss per common share is computed
based on the weighted average number of shares outstanding for the period. Diluted loss per common share is computed by dividing
net 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, 2017 or 2016.
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 LOSS
Total comprehensive 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 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 operating revenues from inception. See Note 2 for information on long-lived assets located in Germany.
SIGNIFICANT RECENT ACCOUNTING PRONOUNCEMENTS
In May 2014, the FASB issued Accounting
Standards Update (“ASU”) 2014-09, Revenue from Contracts with customer (Topic 606), a new revenue recognition standard
which amends revenue recognition principles and provides a single, comprehensive set of criteria for revenue recognition within
and across all industries. The core principle of the guidance is that a company should recognize revenue to depict the transfer
of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled
in exchange for those goods or services. The guidance also requires improved disclosures on the nature, amount, timing, and uncertainty
of revenue that is recognized. In August 2015, the FASB issued an update to the guidance to defer the effective date by one year,
such that the new standard will be effective for annual reporting periods beginning after December 15, 2017 and interim periods
therein. The standard allows for adoption using a full retrospective method or a modified retrospective method. The Company will
apply the new guidance effective January 1, 2018 using the modified retrospective method to contracts that are not completed as
of January 1, 2018. The adoption of this guidance, including the cumulative effect of any adjustment to the opening balance of
retained earnings, is not estimated to have a material impact to its consolidated financial statements.
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 is currently evaluating the
impact of this standard on its consolidated financial statements and related disclosures.
In February 2018, the FASB issued Accounting
Standards Update (“ASU”) No. 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220)—Reclassification
of Certain Tax Effects from Accumulated Other Comprehensive Income. This update was issued to address the income tax accounting
treatment of the stranded tax effects within other comprehensive income due to the prohibition of backward tracing due to an income
tax rate change that was initially recorded in other comprehensive income. This issue came about from the enactment of the Tax
Cuts and Jobs Act on December 22, 2017, which changed the Company’s income tax rate from 35% to 21%. The ASU changed current
accounting whereby an entity may elect to reclassify the stranded tax effect from accumulated other comprehensive income to retained
earnings. The ASU is effective for periods beginning after December 15, 2018, although early adoption is permitted. The Company
does not anticipate that the adoption of this ASU will have a material impact on its consolidated financial statements.
2. PROPERTY AND EQUIPMENT
Property and equipment, all of which is located in Kiel, Germany,
consist of the following:
|
|
December 31,
|
|
|
|
2017
|
|
|
2016
|
|
Technical and laboratory equipment
|
|
$
|
220,511
|
|
|
$
|
193,653
|
|
Leasehold improvements
|
|
|
4,454
|
|
|
|
3,911
|
|
Office equipment
|
|
|
12,883
|
|
|
|
9,842
|
|
|
|
|
237,848
|
|
|
|
207,406
|
|
Less accumulated depreciation and amortization
|
|
|
(230,795
|
)
|
|
|
(201,246
|
)
|
Total
|
|
$
|
7,053
|
|
|
$
|
6,160
|
|
Depreciation and amortization expense included
in general and administrative expense in the consolidated statements of operations approximated $2,000 and $3,000 for the years
ended December 31, 2017 and 2016, 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. No common stock was issued during the years ended December 31, 2017
and 2016.
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 filed
a Certificate of Designation with the Secretary of State of the State of Nevada to designate 1,000,000 shares of its authorized
preferred stock as Series B-1 Preferred Stock ("Series B-1 Stock"). On September 9, 2016, the Company entered into a
Preferred Stock Purchase Agreement (the “Agreement”) with CFI Innovation GmbH Berlin Unternehmensberatung und Beteiligungen
("Investor"), a German corporation. Pursuant to the Agreement, the Company agreed to issue and sell to the Investor 1,000,000
shares of the Company’s Series B-1 Preferred Stock (the “Purchase Shares”) at the price of EUR 1.00 per share
(the “Purchase Price”), for an aggregate purchase price of EUR 1,000,000. The Investor agreed to purchase such shares
no later than March 31, 2017. However, the Investor failed to deliver the purchase price by that date. During 2017 and 2016, the
Company received 35,000 EUR ($41,000) and 15,000 EUR ($16,000), respectively, from the 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 and 2016. The Company is currently negotiating with the Investor to complete the transaction.
The rights, preferences, and privileges
of the Series B-1 Preferred Stock are as follows:
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·
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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.
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·
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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 an matter to be voted on by stockholders of the Company.
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·
|
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.
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|
·
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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.
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No shares of preferred stock were issued during the years ended
December 31, 2017 and 2016.
Subsequent to December 31, 2017, the
Company received an additional 30,000 Euros (approximately $36,000) from the Investor, however, the full committed purchase amount
was not received by March 31, 2018.
4. INCOME TAXES
There is no material income tax expense
or benefit recorded for the years ended December 31, 2017 or 2016 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.
Pursuant to the SEC Staff Accounting Bulletin
No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act, the Company has not finalized its accounting for the
income tax effects of the 2017 Tax Act. This includes a provisional amount related to the re-measurement of deferred tax assets
based on the rates at which they are expected to reverse in the future, which is generally 21%, with a corresponding change to
the valuation allowance as of December 31, 2017. The impact of the 2017 Tax Act may differ from this estimate during the one-year
measurement period due to, among other things, further refinement of the Company’s calculation, changes in interpretations
and assumptions the Company has made, additional guidance that may be issued and actions the Company may take as a result of the
2017 Tax Act.
Income tax expense (benefit) for the years
ended December 31, 2017 and 2016 differed from the amounts computed by applying the U.S. federal income tax rate of 34 percent
to the pretax loss for the following reasons:
|
|
2017
|
|
|
2016
|
|
Income tax benefit at U.S. federal statutory rates
|
|
$
|
(85,000
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)
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|
$
|
(11,000
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)
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Impact of 2017 Tax Act
|
|
|
377,000
|
|
|
|
–
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|
Foreign rate change impacts
|
|
|
(163,000
|
)
|
|
|
54,000
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|
Foreign rate differential
|
|
|
(7,000
|
)
|
|
|
(4,000
|
)
|
Change in valuation allowance
|
|
|
(101,000
|
)
|
|
|
(33,000
|
)
|
Other
|
|
|
(21,000
|
)
|
|
|
(6,000
|
)
|
|
|
$
|
–
|
|
|
$
|
–
|
|
The Company has a deferred tax asset and
an equal amount of valuation allowance of approximately $2,107,000 and $2,209,000 at December 31, 2017 and 2016, respectively,
relating primarily to tax net operating loss carryforwards, as discussed below, and temporary differences related to the recognition
of accrued licensing fees.
As of December 31, 2017, the Company
had tax net operating loss carryforwards ("NOLs") of approximately $2,239,000 and $5,995,000 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 Euros (approximately
$4 million). Through December 31, 2017, the Company received approximately 1.6 million Euros (including $6,000 accrued as a receivable
at December 31, 2017) of the 3.5 million Euro 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 Euro. As revenues to
be received also totaled 3.5 million Euros, 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 Euro 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, 2017
and 2016, the Company recognized approximately $199,000 and $243,000, respectively, of development income under the Development
Agreement, which is included in revenues in the accompanying consolidated statements of operations. Deferred revenues approximated
$83,000 and $174,000 at December 31, 2017 and 2016, respectively. Subsequent to year-end, the Company received 10,000 Euros (approximately
$12,000) 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, 2018. Research and development expenses for the years ended December 31, 2017 and 2016 were reduced
by approximately $191,000 and $220,000, respectively, for Grant funds received and accrued during those periods. Approximately
9,500 Euros ($11,000) and 45,000 Euros ($47,000) of eligible expense was submitted for reimbursement at December 31, 2017 and
2016, respectively, but payment was not received. These receivables are included in the accompanying consolidated balance sheets
as grant funds receivable.
7. 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 a director of the Company,
beneficially owned approximately 27% of the Company's outstanding common stock as of December 31, 2017.
At December 31, 2017, the Company has accrued
approximately $683,000 of licensing fees payable to Dr. Wiedow, which are included in long-term liabilities. This is an increase
over the respective accrual of approximately $600,000 at December 31, 2016, which was solely due to changes in foreign currency
exchange rates.
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 2017 or 2016. 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, 2017 and 2016 approximated
$31,000 and $29,000, respectively.