NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2016
Note A. OVERVIEW OF BUSINESS
D
escription
of the Business
Capstone Therapeutics Corp. (the “Company”, “we”,
“our” or “us”) is a biotechnology company committed to developing a pipeline of novel peptides and other
molecules aimed at helping patients with under-served medical conditions. Previously, we were focused on the development and commercialization
of two product platforms: AZX100 and Chrysalin (TP508). Since March 2012, we no longer have any interest in or rights to Chrysalin.
In 2012 we ceased clinical development of AZX100 in dermal scarring, formerly our principal drug candidate, and moved to a more
virtual operating model. In 2014, we terminated the License Agreement for AZX100 intellectual property and returned all interest
in and rights to the AZX100 intellectual property to the Licensor (AzTE).
On August 3, 2012, we entered into a joint venture, LipimetiX Development,
LLC, (now LipimetiX Development, Inc.), (the “JV”), to develop Apo E mimetic peptide molecule AEM-28 and its analogs.
The JV has a development plan to pursue regulatory approval of AEM-28, or an analog, as treatment for Homozygous Familial Hypercholesterolemia
(granted Orphan Drug Designation by FDA in 2012), Acute Hypertriglyceridemic Pancreatitis (“AP”), diabetic dyslipidemia,
and other hyperlipidemic indications. The initial development plan extended through Phase 1a and 1b/2a clinical trials and was
completed in the fourth quarter of 2014. The clinical trials had a safety primary endpoint and an efficacy endpoint targeting reduction
of cholesterol and triglycerides.
The JV received allowance from regulatory authorities in Australia
permitting the JV to proceed with the planned clinical trials. The Phase 1a clinical trial commenced in Australia in April 2014
and the Phase 1b/2a clinical trial commenced in Australia in June 2014. The clinical trials for AEM-28 were randomized, double-blinded,
placebo-controlled studies to evaluate the safety, tolerability, pharmacokinetics and pharmacodynamics of six escalating single
doses (Phase 1a in healthy patients with elevated cholesterol) and multiple ascending doses of the three highest doses from Phase
1a (Phase 1b/2a in patients with hypercholesterolemia and healthy volunteers with elevated cholesterol and high Body Mass Index).
The Phase 1a clinical trial consisted of 36 patients and the Phase 1b/2a consisted of 15 patients. Both clinical trials were completed
in 2014 and the Medical Safety Committee, reviewing all safety-related aspects of the clinical trials, observed a generally acceptable
safety profile. As first-in-man studies, the primary endpoint was safety; yet efficacy measurements analyzing pharmacodynamics
yielded statistical significance in the pooled dataset favoring AEM-28 versus placebo in multiple lipid biomarker endpoints.
Concurrent with the clinical development activities of AEM-28, the
JV has performed pre-clinical studies that have identified an analog of AEM-28, referred to as AEM-28-14, and a new formulation,
that has the potential of increased efficacy, higher human dose toleration and an extended composition of matter patent life (application
filed with the U.S. Patent and Trademark Office in 2015). The JV’s current intent is to prioritize the development of AEM-28-14.
The JV and the Company are exploring fundraising, partnering or licensing,
to obtain additional funding to continue development activities of AEM-28 and its analogs, including AEM-28-14, and operations.
The JV and the Company do not have sufficient funding at this time
to continue additional material development activities of AEM-28 and its analogs, including AEM-28-14. The JV may conduct future
clinical trials in Australia, the USA, and other regulatory jurisdictions if regulatory approvals, additional funding, and other
conditions permit.
The Company, funding permitting, intends to continue limiting its
internal operations to a virtual operating model while monitoring and participating in the management of JV’s AEM-28 and
analogs development activities.
Description of Current Peptide Drug Candidates.
Chimeric Apo E Mimetic Peptide Molecule – AEM-28 and its
analogs
Apolipoprotein E is a 299 amino acid protein that plays an important
role in lipoprotein metabolism. AEM-28 is a 28 amino acid mimetic of Apo E and AEM-28 and its analogs, including AEM-28-14 is a
28 amino acid mimetic of Apo E (with an aminohexanoic acid group and a phospholipid), and both contain a domain that anchors into
a lipoprotein surface while also providing the Apo E receptor binding domain, which allows clearance through the heparan sulfate
proteoglycan (HSPG) receptors (Syndecan-1) in the liver. AEM-28 and its analogs, including AEM-28-14, as Apo E mimetics, have the
potential to restore the ability of these atherogenic lipoproteins to be cleared from the plasma, completing the reverse cholesterol
transport pathway, and thereby reducing cardiovascular risk. This is an important mechanism of action for AEM-28 and its analogs,
including AEM-28-14. For patients that lack LDL receptors (Homozygous Familial Hypercholesterolemia-HoFH), have acute pancreatitis,
or have hypercholesterolemia, AEM-28 and its analogs may provide a therapeutic solution. Our joint venture has an Exclusive License
Agreement with the University of Alabama at Birmingham Research Foundation for AEM-28 and certain of its analogs.
Company History
Prior to November 26, 2003, we developed, manufactured and marketed
proprietary, technologically advanced orthopedic products designed to promote the healing of musculoskeletal bone and tissue, with
particular emphasis on fracture healing and spine repair. Our product lines, which included bone growth stimulation and fracture
fixation devices, are referred to as our “Bone Device Business.” In November 2003, we sold our Bone Device Business.
In August 2004, we purchased substantially all of the assets and
intellectual property of Chrysalis Biotechnology, Inc., including its exclusive worldwide license for Chrysalin, a peptide, for
all medical indications. Subsequently, our efforts were focused on research and development of Chrysalin with the goal of commercializing
our products in fresh fracture healing. (In March 2012, we returned all rights to the Chrysalin intellectual property and no longer
have any interest in, or rights to Chrysalin.)
In February 2006, we purchased certain assets and assumed certain
liabilities of AzERx, Inc. Under the terms of the transaction, we acquired an exclusive license for the core intellectual property
relating to AZX100, an anti-fibrotic peptide. In 2014, we terminated the License Agreement with AzTE (Licensor) for the core intellectual
property relating to AZX100 and returned all interest in and rights to the AZX100 intellectual property to the Licensor.
On August 3, 2012, we entered into a joint venture (see Note B below),
to develop Chimeric Apo E mimetic peptide molecule AEM-28 and its analogs.
Our development activities represent a single operating segment as
they shared the same product development path and utilized the same Company resources. As a result, we determined that it is appropriate
to reflect our operations as one reportable segment.
OrthoLogic Corp. commenced doing business under the trade name of
Capstone Therapeutics on October 1, 2008, and we formally changed our name from OrthoLogic Corp. to Capstone Therapeutics Corp.
on May 21, 2010.
In these notes, references to “we”, “our”,
“us”, the “Company”, “Capstone Therapeutics”, “Capstone”, and “OrthoLogic”
refer to Capstone Therapeutics Corp. References to our joint venture or “JV”, refer to LipimetiX Development, Inc.
(formerly LipimetiX Development, LLC).
Financial Statement Presentation and Management’s Plan
The accompanying financials statements have been prepared assuming
the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the
normal course of business.
The report from our Independent Registered Public Accounting Firm
on our consolidated financial statements for the year ended December 31, 2014 included in our Annual Report on Form 10-K expressed
substantial doubt about the Company’s ability to continue as a going concern. The Company did not engage an Independent Registered
Public Accounting Firm to audit and express an opinion on our consolidated financial statements for the year ended December 31,
2015.
Management has determined that the Company and our JV will require
additional capital above its current cash and working capital balances to further develop AEM-28 and its analogs or continue operations.
Accordingly, the Company has reduced its development activities. The Company’s corporate strategy is to raise funds by possibly
engaging in a strategic/merger transaction, or conducting a private or public offering of debt or equity securities for capital.
These financial statements do not include any adjustments that might result from the outcome of the uncertainty of the Company
successfully implementing its corporate strategy.
In the opinion of management, the unaudited condensed interim financial
statements include all adjustments necessary for the fair presentation of our financial position, results of operations, and cash
flows, and all adjustments were of a normal recurring nature. The results of operations for the interim periods are not necessarily
indicative of the results to be expected for the complete fiscal year. The financial statements include the consolidated results
of Capstone Therapeutics Corp. and our 64% owned subsidiary, LipimetiX Development, Inc. Intercompany transactions have been eliminated.
Certain information and footnote disclosures normally included in
financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant
to Securities and Exchange Commission rules and regulations, although we believe that the disclosures herein are adequate to make
the information presented not misleading. These unaudited condensed financial statements should be read in conjunction with the
financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2015.
Use of Estimates
The preparation of financial statements in accordance with accounting
principles generally accepted in the United States requires that management make a number of assumptions and estimates that affect
the reported amounts of assets, liabilities, and expenses in our financial statements and accompanying notes. Management bases
its estimates on historical experience and various other assumptions believed to be reasonable. Although these estimates are based
on management’s assumptions regarding current events and actions that may impact us in the future, actual results may differ
from these estimates and assumptions.
Legal and Other Contingencies
The Company is subject to legal proceedings and claims that arise
in the ordinary course of business. The Company records a liability when it is probable that a loss has been incurred and the amount
is reasonably estimable. There is significant judgment required in both the probability determination and as to whether an exposure
can be reasonably estimated. In the opinion of management, there was not at least a reasonable possibility the Company may have
incurred a material loss with respect to loss contingencies.
Joint Venture Accounting
The Company entered into a joint venture in which it has contributed
$6,000,000, and the noncontrolling interests have contributed certain patent license rights. Neither the Company nor the noncontrolling
interests have an obligation to contribute additional funds to the joint venture or to assume any joint venture liabilities or
to provide a guarantee of either joint venture performance or any joint venture liability. The financial position and results of
operations of the joint venture are presented on a consolidated basis with the financial position and results of operations of
the Company. Intercompany transactions have been eliminated. Joint venture losses were recorded on the basis of common ownership
equity interests until common ownership equity was reduced to $0. Subsequent joint venture losses are being allocated to the preferred
ownership equity (100% Company). Subsequent to March 31, 2013, all joint venture losses are being allocated to the Company. The
Company has a revolving loan agreement with the joint venture to advance the joint venture funds for operations in an amount not
to exceed a net (net of expected tax credits or other funds obtained) of $1,500,000, with the net amount due December 31, 2016.
Losses incurred by the joint venture in excess of the capital accounts of the joint venture will be allocated to the Company to
the extent of net outstanding advances.
Cash and Cash Equivalents
At March 31, 2016, cash and cash equivalents included money market
accounts.
Recent Accounting Pronouncements
In August 2014, the Financial Accounting Standards Board issued
Accounting Standard Update (“ASU”) No. 2014-15,
Presentation of Financial Statements – Going Concern
(Subtopic 205-40)(“Update”): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern,
providing a requirement under U.S. GAAP for an entity’s management to evaluate whether there are conditions or events, considered
in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern within one year
after the date the financial statements are issued; and if those conditions exist, to disclose that fact, the conditions and the
potential effects on the entity’s ability to meet its obligations. The Update will be effective for an annual period ending
after December 15, 2016, with early application permitted
. We have not elected early application. However, if additional funds
are not obtained to continue the development of AEM-28 or its analogs, or operations, it will impair our ability to continue as
a going concern. If we do not continue as a going concern, the Company may incur additional losses, up to, and possibly exceeding
our net joint venture investment and revolving loan balance.
Note B. JOINT VENTURE FOR DEVELOPMENT OF APO E MIMETIC PEPTIDE MOLECULE AEM-28
AND ANALOGS
On August 3, 2012, we entered into a Contribution Agreement with
LipimetiX, LLC to form a joint venture, LipimetiX Development, LLC (“JV”), to develop Apo E mimetic molecules, including
AEM-28 and its analogs. In June 2015, the JV converted from a limited liability company to a corporation, LipimetiX Development,
Inc. The Company contributed $6 million, which included $1 million for 600,000 voting common ownership units (now common stock),
representing 60% ownership in the JV, and $5 million for 5,000,000 non-voting preferred ownership units (now preferred stock),
which have preferential distribution rights. On March 31, 2016, the Company converted 1,500,000 shares of its preferred stock into
120,000 shares of common stock, increasing its common stock ownership from 60% to 64%.
LipimetiX, LLC contributed all intellectual property rights for Apo
E mimetic molecules it owned and assigned its Exclusive License Agreement between The University of Alabama at Birmingham Research
Foundation (“UABRF”) and LipimetiX, LLC, for the UABRF intellectual property related to Apo E mimetic molecules AEM-28
and its analogs to the JV, in return for 400,000 voting common ownership units (now common stock) representing 40% ownership in
JV, and $378,000 in cash (for certain initial patent-related costs and legal expenses).
LipimetiX, LLC was formed by the principals of Benu BioPharma, Inc.
(“Benu”) and UABRF to commercialize UABRF’s intellectual property related to Apo E mimetic molecules, including
AEM-28 and analogs. Benu is composed of Dennis I. Goldberg, Ph.D., Phillip M. Friden, Ph.D. and Eric M. Morrel, Ph.D. The Exclusive
License Agreement, as amended, calls for payment of patent filing, maintenance and other related patent fees, as well as a royalty
of 3% on Net Sales of Licensed Products during the Term of the Agreement. The Agreement terminates upon the expiration of all Valid
Patent Claims within the Licensed Patents, which are currently estimated to expire between 2019 and 2035. The Agreement, as amended,
also calls for annual maintenance payments of $25,000, various milestone payments of $50,000 to $500,000 and minimum royalty payments
of $500,000 to $1,000,000 per year commencing on January 1 of the first calendar year following the year in which the First Commercial
Sale occurs. UABRF will also be paid 5% of Non Royalty Income received.
Concurrent with entering into the Contribution Agreement and the
First Amendment and Consent to Assignment of Exclusive License Agreement between LipimetiX, LLC, UABRF and the Company, the Company
and LipimetiX, LLC entered into a Limited Liability Company Agreement for JV which established a Joint Development Committee (“JDC”)
to manage JV development activities. Upon conversion by the JV from a limited liability company to a corporation, the parties entered
into a Stockholders Agreement for the JV, and the JDC was replaced by a Board of Directors (JV Board). The JV Board is composed
of three members appointed by the non-Company ownership group and two members appointed by the Company. Non-development JV decisions,
including the issuance of new equity, incurrence of debt, entry into strategic transactions, licenses or development agreements,
sales of assets and liquidation, and approval of annual budgets, will be decided by a majority vote of the common stockholders.
The JV, on August 3, 2012, entered into a Management Agreement with
Benu to manage JV development activities for a monthly fee of approximately $63,000 during the twenty-seven month development period,
and an Accounting Services Agreement with the Company to manage JV accounting and administrative functions. The current accounting
services fee is $1,000 a month. Commencing in November 2014, and ending in March 2015, Benu received a reduced monthly management
fee in the amount of $35,000. Subsequent to March 2015, a management fee of $150,000 was paid to Benu for their services. No management
fee is owed as of March 31, 2016.
The joint venture formation was as follows ($000’s):
Patent license rights
|
|
$
|
1,045
|
|
Noncontrolling interests
|
|
|
(667
|
)
|
Cash paid at formation
|
|
$
|
378
|
|
Patent license rights were recorded at their estimated fair value
and are being amortized on a straight-line basis over the key patent life of eighty months.
The financial position and results of operations of the joint venture
are presented on a consolidated basis with the financial position and results of operations of the Company. Intercompany transactions
have been eliminated. The joint venture agreement requires profits and losses to be allocated on the basis of common ownership
equity interests (60% Company / 40% noncontrolling interests originally, now 64% Company / 36% noncontrolling interests). However,
for the Company’s consolidated financial statement, joint venture losses were recorded on the basis of common ownership equity
interests until common ownership equity was reduced to $0. Subsequent joint venture losses have been allocated to the preferred
ownership equity (100% Company). Subsequent to March 31, 2013, all joint venture losses have been allocated to the Company. The
Company has a revolving loan agreement with the joint venture to advance the joint venture funds for operations in an amount not
to exceed a net (net of expected tax credits or other funds obtained) of $1,500,000, with the net amount due December 31, 2016.
Losses incurred by the joint venture in excess of the capital accounts of the joint venture will be allocated to the Company to
the extent of net outstanding advances. At March 31, 2016, outstanding advances on the revolving loan agreement totaled $1,529,000.
The joint venture incurred net operating expenses, prior to the elimination
of intercompany transactions, of $126,000 in the three month period ended March 31, 2016 and $7,517,000 for the period from August
3, 2012 (inception) to March 31, 2016, of which $126,000 and $6,850,000, respectively, have been recorded by the Company. The joint
venture operating expenses are included in research and development expenses in the condensed consolidated statements of operations.
Neither the Company nor the noncontrolling interests have an obligation
to contribute additional funds to the joint venture or to assume any joint venture liabilities or to provide a guarantee of either
joint venture performance or any joint venture liability. Losses allocated to the noncontrolling interests represent an additional
potential loss for the Company as the noncontrolling interests are not obligated to contribute assets to the joint venture to the
extent they have a negative capital account, and depending on the ultimate outcome of the joint venture, the Company could potentially
absorb all losses associated with the joint venture. From formation of the joint venture, August 3, 2012, through March 31, 2016,
losses totaling $667,000 have been allocated to the noncontrolling interests. If the joint venture or Company is unable to obtain
additional funding, the ability of the joint venture to continue development of AEM-28 and its analogs, including AEM-28-14, would
be impaired as would the joint venture’s ability to continue operations. If the joint venture does not continue as a going
concern, at March 31, 2016 the Company would incur an additional loss of $667,000 for the joint venture losses allocated to the
noncontrolling interests.
Note C. NOTE PAYABLE – FUNDRAISING ACTIVITIES
As disclosed above, management has determined that the Company will
require additional capital above its current cash and working capital balances to further develop AEM-28 and its analogs and to
continue operations. Accordingly, the Company has reduced its development activities. The Company’s corporate
strategy is to raise funds either by the Company, or directly in its joint venture, by possibly engaging in a strategic/merger
transaction, or conducting a private or public offering of debt or equity securities for capital. In connection
with these efforts, we filed a Registration Statement on Form S-1 with the Securities and Exchange Commission on June 26, 2015,
as amended, in connection with our contemplated public offering of shares of our Common Stock. The Registration Statement was not
effective as of December 31, 2015 and was withdrawn in January 2016. All costs relating to these fundraising activities were expensed
in 2015.
On December 11, 2015, we entered into a Securities Purchase Agreement
(the “Agreement”) with Biotechnology Value Fund affiliated entities Biotechnology Value Fund, L.P., Biotechnology Value
Fund II, L.P., Biotechnology Value Trading Fund OS, L.P., Investment 10, LLC, and MSI BVF SPV, LLC (the "Lenders"), to
provide short-term funding for our operations. A portion of the funds have been advanced to JV, to initiate preclinical development
activities for our lead commercial drug candidate, AEM-28-14. The Lenders, at March 31, 2016 and December 31, 2015, owned in the
aggregate, approximately 19% of our outstanding Common Stock.
Pursuant to the Agreement, the Lenders funded an aggregate of $1,000,000
of loans to us, evidenced by Convertible Promissory Notes (the “Notes”) dated December 11, 2015 and due April 30, 2017.
The Notes bear interest at 5% per annum and are secured by a security interest in all of our assets.
The unpaid principal amount of the Notes will convert automatically
upon the closing of a Qualified Equity Financing, which is defined in the Agreement as an offering of equity securities with aggregate
gross proceeds of at least $5,000,000 including the principal of any converted Notes. Such conversion will be into the same securities
and on the same terms as provided for the other investors in the Qualified Equity Financing.
If a Qualified Equity Financing is not consummated by March 31, 2016,
the unpaid principal amount of the Notes may be converted at the election of the Lenders into shares of Common Stock, at a conversion
price (the "Optional Conversion Price") equal to the trailing 10-day weighted average trading price of the Common Stock,
but not be less than $.135 or more than $.18 per share. Upon a change in control of the Company, the Lenders may elect to accelerate
the Notes or convert them into Common Stock at a conversion price equal to the Optional Conversion Price.
Under the Agreement, the Lenders have the right to elect to acquire,
upon conversion of the Notes, convertible preferred stock rather than Common Stock, such preferred stock to vote with the Common
Stock and to be convertible into the equivalent number of shares of Common Stock as would have been originally issued if the Notes
conversion had been into Common Stock. Such preferred shares would have no preferential liquidation or distribution rights and
would not have any dividend or preferred return rights.
The Agreement grants Lenders an Exclusive Period, initially ending
January 31, 2016, to propose terms of an additional investment of at least $7,500,000, but not to exceed $10,000,000, in the Company
(the “Proposed Investment”). The Agreement provides that it is expected that the Proposed Investment will involve the
issuance of units at a price of $.18 per unit, with each unit composed of one share of Common Stock and a five-year warrant to
purchase one-half of a share of Common Stock at an exercise price equal to 125% of the unit price, and that the investors would
be entitled to nominate a majority slate of directors. However, neither the Lenders nor we are obligated under the Agreement to
proceed with a Proposed Investment, or to proceed with a Proposed Investment on these terms. The Lenders had the right to extend
the Exclusive Period to March 31, 2016 by funding an additional $1,000,000 aggregate of bridge loans on the same terms as the initial
advance pursuant to the Notes. We agreed that during the Exclusive Period, we would not consummate the offering originally contemplated
in our Form S-1 registration statement initially filed with the Securities and Exchange Commission on June 26, 2015. On January
29, 2016, the Lenders informed the Company that they would not exercise their right to extend the Exclusive Period or to proceed
with a Proposed Investment.
Note D.
Australian Refundable Research &
Development Credit
In March 2014, LipimetiX Development LLC, (see Note B) formed a wholly-owned
Australian subsidiary, Lipimetix Australia Pty Ltd, to conduct Phase 1a and Phase1b/2a clinical trials in Australia. Currently
Australian tax regulations provide for a refundable research and development tax credit equal to 45% of qualified expenditures.
Subsequent to the end of its Australian tax years, Lipimetix Australia Pty, Ltd intends to submit claims for a refundable research
and development tax credit. The transitional Australian tax periods/years granted for Lipimetix Australia Pty, Ltd end on June
30, 2014, December 31, 2014 and thereafter December 31 of each succeeding year. For the tax year ended June 30, 2014, Lipimetix
Australia Pty, Ltd received a refundable research and development tax credit of AUD$227,000. For the tax year ended December 31,
2014 Lipimetix Australia Pty, Ltd, received a refundable research and development tax credit of AUD$301,000. At December 31, 2015,
a refundable research and development tax credit of AUD$189,000 was recorded. At March 31, 2016, an additional AUD$19,000 was recorded
and at March 31, 2016, refundable research and development tax credits totaled AUD$208,000 (USA $ 159,000) and are included in
other current assets.
Note E:
Contingency
– Non-Compliance with Securities and Exchange Commission Reporting Requirements and OTCQB Market Requirements
Our current level of funds available for operation has led to additional
cost cutting, which included the decision to not engage an independent public accountant to audit and express an opinion on our
December 31, 2015 financial statements included in our Annual Report on Form 10-K filed with the SEC on March 30, 2016, or to review
this Current Report on Form 10-Q, as required by current SEC rules and regulations, and as required to be listed on the OTCQB Market.
We cannot currently predict the response to these actions by the SEC or the OTCQB Market, nor the effects of their actions, including
the possible effect on the trading of our common stock. The decision to not engage an independent public accountant to audit and
express an opinion on our December 31, 2015 financial statements or review this Current Report on form 10-Q could have a material
adverse effect on the Company and its Stockholders.