Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
1 - Organization and Summary of Significant Accounting Policies
Business
Activities and Organization
Company
Overview
Processa
Pharmaceuticals, Inc. (the “Company” and formerly known as “Heatwurx” ) and its wholly-owned subsidiary,
Processa Therapeutics LLC (“Processa”), a Delaware limited liability company, acquired all the net assets of a private
company, including the rights to the CoNCERT Agreement mentioned below, Promet Therapeutics, LLC (“Promet”), a Delaware
limited liability company on October 4, 2017 in exchange for 31,745,242 shares of the common stock of the Company which, at the
closing, constituted approximately 90% of the Company’s issued and outstanding common stock on a fully diluted basis. Immediately
following the closing, there were 35,272,626 shares of common stock issued and outstanding. At the closing, Processa was assigned
all of the assets and operations of Promet that constituted the operating business of Promet, while Promet, which continues as
an active company, received the Processa shares mentioned above and agreed to provide the Processa shares needed if the option
in the CoNCERT Agreement (see below) was exercised. Upon closing on October 4, 2017, there was a change in control of the Company
to Promet. The Company abandoned its prior business plan and adopted Promet’s business plan focused on developing drugs
to treat patients that have a high unmet medical need. Subsequent to closing and effective October 10, 2017, the Company changed
its trading symbol to “PCSA” on the OTC Pink Marketplace (“OTCQB”). The Company effected a one-for-seven
reverse split of its shares in December 2017. As a result, the 2017 condensed consolidated financial statements have been retrospectively
adjusted to reflect shares outstanding after the one-for-seven reverse split.
The
net asset acquisition transaction was accounted for as a reverse acquisition. Prior to the acquisition, Heatwurx (subsequently
renamed Processa Pharmaceuticals, Inc.) had nominal net liabilities and operations. It was considered a non-operating public shell
corporation. Therefore, Promet was considered the accounting acquirer (and legal wholly-owned subsidiary of Heatwurx, now called
Processa Pharmaceuticals, Inc.) and Heatwurx was considered the accounting acquiree (and legal acquirer). As a result, the consolidated
financial statements of the Company reflect the financial condition, results of operations and cash flows of Promet for all periods
presented prior to October 4, 2017 and Processa for the periods subsequent to October 4, 2017. The legal capital stock (number
and type of equity interests issued) is that of Processa Pharmaceuticals, Inc., the legal parent, in accordance with guidance
on reverse acquisitions accounted for as a capital transaction instead of a business combination (See Note 2 – Basis of
Presentation and Earnings Per Share and Note 3 – Reverse Acquisition in Item 8 of the Company’s Annual Report on Form
10-K filed with the SEC on April 17, 2018).
All
references to the “Company” and Processa Pharmaceuticals, Inc. refer to Heatwurx, Inc., Processa Therapeutics, LLC,
and the net assets acquired from Promet Therapeutics, LLC, which were assigned at acquisition to Processa Therapeutics, LLC and
Promet’s operations prior to October 4, 2017.
On
March 19, 2018, Promet, Processa and CoNCERT Pharmaceuticals Inc. (“CoNCERT”) amended the Option and License Agreement
(the “Agreement”) executed in October 2017. The Agreement was assigned to Processa and Processa exercised the exclusive
option for the PCS-499 compound. The option was exercised in exchange for CoNCERT receiving (i) $8 million of common stock of
Company that was owned by Promet (or 2,090,301 shares representing 6.58% of Promet’s common stock holding or 5.93% of total
the Company’s common stock issued and outstanding), and (ii) 15% of any sublicense revenue earned by the Company for a period
equivalent to the royalty term (as defined in the Agreement) until the earliest of (a) Processa raising $8 million of gross proceeds;
and (b) CoNCERT can sell its shares of Processa common stock without restrictions pursuant to the terms of the amended Agreement.
All other terms of the Agreement remain unchanged. As a result, the Company recognized an intangible asset and additional paid-in
capital in the amount of $8 million resulting from Promet satisfying Processa’s liability to CoNCERT (see Note 2 Intangible
Asset for the income tax effect of this transaction). There was no change in the total shares issued and outstanding, however,
Promet’s controlling interest in Processa was reduced from 90% to 84%.
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Description
of Business
Processa
is an emerging pharmaceutical company focused on the clinical development of drug products that are intended to improve the survival
and/or quality of life for patients who have a high unmet medical need or who have no alternative treatment. Within this group
of pharmaceutical products, we currently are developing one product for two indications (i.e., the use of a drug to treat a particular
disease) and searching for additional products for our portfolio.
Processa’s
lead product, PCS-499 is an oral tablet that is an analog of an active metabolite of an already approved FDA drug. The advantage
of PCS-499 is that it potentially may work in many conditions because it has multiple pharmacological targets it affects that
are important in the treatment of these conditions. Based on its pharmacological activity, Processa has identified multiple unmet
medical need conditions where the use of PCS-499 may result in clinical efficacy. The lead indication currently under development
for PCS-499 is Necrobiosis Lipoidica (NL). Processa has met with the FDA on the NL condition and has developed a strategy for
moving the program for NL forward starting with a Phase 2 clinical trial in NL patients in late 2018 (see Note 4 for clinical
trial funding). Processa will continue to evaluate other unmet need conditions for PCS-499 as well as other potential assets and
develop strategies including the regulatory pathway and commercialization plans for the product(s) for these unmet need conditions
over the next year.
Processa
is looking to acquire additional drug candidates to help patients who have an unmet medical need.
Our
operations are performed in the state of Maryland and are still in the organizational and research and development phase of operations.
As a result, we have a limited operating history and only a preliminary business plan from which investors may evaluate our future
prospects. We have not had any sources of revenue from inception (August 31, 2015) through June 30, 2018 and have a history of
operating losses from operations. Our ability to generate meaningful revenue from any products in the United States depends on
obtaining FDA authorization. Even if our products are authorized and approved by the FDA, we must still meet the challenges of
successful marketing, distribution and consumer acceptance.
Basis
of Presentation
The
accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally
accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instruction of the Securities
and Exchange Commission (“SEC”) on Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly,
they do not include all of the information and disclosures required by U.S. GAAP for complete financial statements. All material
intercompany accounts and transactions have been eliminated in consolidation. In the opinion of management, the accompanying unaudited
consolidated financial statements include all adjustments necessary, which are of a normal and recurring nature, for the fair
presentation of the Company’s financial position and of the results of operations and cash flows for the periods presented.
These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto
included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the SEC on April
17, 2018. The results of operations for the interim period shown in this report are not necessarily indicative of the results
that may be expected for any other interim period or for the full year.
As
a result of the modification of the Agreement with CoNCERT and the acquisition of an exclusive license intangible asset used in
research and development activities described above, the Company adopted a new intangible asset policy and disclosure (see Intangible
Assets below and Note 2 – Intangible Asset) and recognized a deferred tax liability for the acquired temporary difference
between the financial reporting basis and the tax basis of the intangible asset (see Note 5 – Income Taxes).
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Going
Concern and Management’s Plan
The
Company’s consolidated financial statements are prepared using U.S. GAAP and are based on the assumption that the Company
will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course
of business. The Company faces certain risks and uncertainties that are present in many emerging growth companies regarding product
development and commercialization, limited working capital, recurring losses and negative cash flow from operations, future profitability,
ability to obtain future capital, protection of patents, technologies and property rights, competition, rapid technological change,
navigating the domestic and major foreign markets’ regulatory and clinical environment, recruiting and retaining key personnel,
dependence on third party manufacturing organizations, third party collaboration and licensing agreements, lack of sales and marketing
activities, and no customers or pharmaceutical products to sell or distribute. These risks and other factors raise substantial
doubt about our ability to continue as a going concern.
The
Company has relied exclusively on private placements with a small group of accredited investors to finance its business and operations.
We do not have any prospective arrangements or credit facilities as a source of future funds. The Company has had no revenue since
inception on August 31, 2015. The Company does not currently have any revenue under contract nor does it have any immediate sales
prospects. As of June 30, 2018, the Company had an accumulated deficit of approximately $6.2 million incurred since inception.
For the six months ended June 30, 2018, the Company incurred a net loss from continuing operations of approximately $2.3 million
and used approximately $2.2 million in net cash from operating activities from continuing operations. The Company had total cash
and cash equivalents and certificates of deposit of approximately $3.3 million as of June 30, 2018.
We
are looking at ways to add a revenue stream to offset some of our expenses. We will begin fundraising efforts in the first half
of 2019. In addition, we are seeking alternative options to add additional cash. However, no assurance can be given that we will
be successful in securing adequate funds that may be required. If we are unable to raise additional capital when required or on
acceptable terms, we may have to significantly delay, scale back or discontinue the development or commercialization of one or
more of our product candidates, restrict our operations or obtain funds by entering into agreements on unattractive terms, which
would likely have a material adverse effect on our business, stock price, and our relationships with third parties with whom we
have business relationships, at least until additional funding is obtained.
Uncertainty
concerning our ability to continue as a going concern may hinder our ability to obtain future financing, as well as adversely
affect our collaborative drug development relationships. Continued operations and our ability to continue as a going concern are
dependent on our ability to obtain additional funding in the near future and thereafter, and no assurances can be given that such
funding will be available at all or will be available in sufficient amounts or on reasonable terms. Without additional funds from
debt or equity financing, sales of assets, sales or out-licenses of intellectual property or technologies, or other transactions
yielding funds, we will rapidly exhaust our resources and will be unable to continue operations. Absent additional funding, we
believe that our cash and cash equivalents will not be sufficient to fund our operations for a period of one year or more after
the date that these consolidated financial statements are available to be issued based on the timing and amount of our projected
net loss from continuing operations and cash to be used in operating activities during that period of time.
As
a result, substantial doubt exists about the Company’s ability to continue as a going concern within one year after the
date that these consolidated financial statements are available to be issued. The accompanying consolidated financial statements
do not include any adjustments to reflect the possible future effects on the recoverability and classification of recorded assets,
or the amounts and classification of liabilities that might be different should the Company be unable to continue as a going concern
based on the outcome of these uncertainties described above.
Use
of Estimates
The
preparation of the accompanying unaudited consolidated financial statements in conformity with U.S. GAAP requires management to
make estimates and assumptions that affect the reported amounts (including assets, liabilities, revenues and expenses) and related
disclosures, including contingent assets and liabilities. Estimates have been prepared on the basis of the most current and best
available information. However, actual results could differ materially from those estimates.
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Cash
and Cash Equivalents
Cash
and cash equivalents include cash on hand and money market funds. The Company considers all highly liquid investments with a maturity
at the date of purchase of three months or less to be cash equivalents. Included in cash and cash equivalents were certificates
of deposit totaling $496,201 at June 30, 2018. The certificates of deposit will mature in late September 2018.
Intangible
Assets
Intangible
assets acquired individually or with a group of other assets from others (other than in a business combination) are recognized
at cost, including transaction costs, and allocated to the individual assets acquired based on relative fair values and no goodwill
is recognized. Cost is measured based on cash consideration paid. If consideration given is in the form of non-cash assets, liabilities
incurred, or equity interests issued, measurement of cost is based on either the fair value of the consideration given or the
fair value of the assets (or net assets) acquired, whichever is more clearly evident and more reliably measurable. Costs of internally
developing, maintaining or restoring intangible assets that are not specifically identifiable, have indeterminate lives or are
inherent in a continuing business are expensed as incurred.
Intangible
assets purchased from others for use in research and development activities and that have alternative future uses (in research
and development projects or otherwise) are capitalized in accordance with ASC Topic 350, Intangibles – Goodwill and Other
and those that have no alternative future uses (in research and development projects or otherwise) and therefore no separate economic
value are research and development costs expensed as incurred. Amortization of intangibles used in research and development activities
is a research and development cost.
Intangibles
with a finite useful life are amortized and those with an indefinite useful life are not amortized. The useful life is the best
estimate of the period over which the asset is expected to contribute directly or indirectly to the future cash flows of the Company.
The useful life is based on the duration of the expected use of the asset by the Company and the legal, regulatory or contractual
provisions that constrain the useful life and future cash flows of the asset, including regulatory acceptance and approval, obsolescence,
demand, competition and other economic factors. If an income approach is used to measure the fair value of an intangible asset,
the Company considers the period of expected cash flows used to measure the fair value of the intangible asset, adjusted as appropriate
for Company-specific factors discussed above, to determine the useful life for amortization purposes. If no regulatory, contractual,
competitive, economic or other factors limit the useful life of the intangible to the Company, the useful life is considered indefinite.
Intangibles
with a finite useful life are amortized on the straight-line method unless the pattern in which the economic benefits of the intangible
asset are consumed or used up are reliably determinable. The Company evaluates the remaining useful life of intangible assets
each reporting period to determine whether any revision to the remaining useful life is required. If the remaining useful life
is changed, the remaining carrying amount of the intangible asset will be amortized prospectively over the revised remaining useful
life.
Intangibles
with an indefinite useful life are not amortized until its useful life is determined to be no longer indefinite. If the useful
life is determined to be finite, the intangible is tested for impairment and the carrying amount is amortized over the remaining
useful life in accordance with intangibles subject to amortization. Indefinite-lived intangibles are tested for impairment annually
and more frequently if events or circumstances indicate that it is more-likely-than-not that the asset is impaired.
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Impairment
of Long-Lived Assets and Intangibles Other Than Goodwill
The
Company accounts for the impairment of long-lived assets in accordance with ASC 360, Property, Plant and Equipment and ASC 350,
Intangibles – Goodwill and Other which requires that long-lived assets and certain identifiable intangibles be reviewed
for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to expected future
undiscounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment
to be recognized is measured as the amount by which the carrying amounts of the assets exceed the fair value of the assets based
on the present value of the expected future cash flows associated with the use of the asset. Assets to be disposed of are reported
at the lower of the carrying amount or fair value less costs to sell. Based on management’s evaluation, there was no impairment
loss recorded for the three or six-month periods ended June 30, 2018 and 2017, respectively.
Fair
Value Measurements and Disclosure
The
Company applies ASC 820, “Fair Value Measurements and Disclosures,” which expands disclosures for assets and liabilities
that are measured and reported at fair value on a recurring basis. Fair value is defined as an exit price, representing the amount
that would be received upon the sale of an asset or payment to transfer a liability in an orderly transaction between market participants.
Fair
value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset
or liability. A three-tier fair value hierarchy is used to prioritize the inputs in measuring fair value as follows:
Level
1 – Quoted market prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has
the ability to access at the measurement date.
Level
2 – Quoted market prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets
or liabilities in markets that are not active, or other inputs that are observable, either directly or indirectly. Fair value
determined through the use of models or other valuation methodologies.
Level
3 – Significant unobservable inputs for assets or liabilities that cannot be corroborated by market data. Fair value is
determined by the reporting entity’s own assumptions utilizing the best information available and includes situations where
there is little market activity for the asset or liability.
The
asset’s or liability’s fair value measurement within the fair value hierarchy is based upon the lowest level of any
input that is significant to the fair value measurement. The Company’s policy is to recognize transfers between levels of
the fair value hierarchy in the period the event or change in circumstances that caused the transfer. There were no transfers
into or out of Level 1, 2, or 3 during the periods presented.
Net
Income (Loss) per Share
The
Company computes basic and diluted earnings per share amounts pursuant to ASC 260-10-45. Basic earnings per share is computed
by dividing net income (loss) available to common shareholders, by the weighted average number of shares of common stock outstanding
during the period, excluding the effects of any potentially dilutive securities. Diluted earnings per share is computed by dividing
net income (loss) available to common shareholders by the diluted weighted average number of shares of common stock during the
period. Since the Company had a net loss for each of the periods presented, basic and diluted net loss per share are the same.
The computation of diluted net loss per share for the periods presented does not assume the impact of the conversion of the Senior
Convertible Notes or the exercise or contingent exercise of securities since that would have an anti-dilutive effect on loss per
share during the three and six months ended June 30, 2018 and 2017.
Recent
Accounting Pronouncements
From
time to time, the Financial Accounting Standards Board (“FASB”) or other standard setting bodies issue new accounting
pronouncements. Updates to the FASB Accounting Standards Codification are communicated through issuance of an Accounting Standards
Update (“ASU”). The Company has implemented all new accounting pronouncements that are in effect and that may impact
its financial statements. It has evaluated recently issued accounting pronouncements and determined that there was no material
impact on its financial position or results of operations.
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
From
May 2014 through June 30, 2018, the FASB issued several ASUs related to ASU 2014-09, “Revenue from Contracts with Customers
(Topic 606). The new guidance is effective for interim and annual periods beginning after December 15, 2017, although entities
may adopt one year earlier if they choose. The two permitted transition methods under the new standard are the full retrospective
method, in which case the standard would be applied to each prior reporting period presented and the cumulative effect of applying
the standard would be recognized at the earliest period shown, or the modified retrospective method, in which case the cumulative
effect of applying the standard would be recognized at the date of initial application. The Company is currently in the pre-revenue
stages of operations; therefore, we do not currently anticipate there would be any change to timing or method of recognizing revenue.
As such, the adoption of this standard did not have a material impact on our results of operations, financial condition or cash
flows.
In
February 2016 through June 30, 2018, the FASB issued several ASUs related to ASU-2016-02, “Leases (Topic 842).” The
guidance requires that a lessee recognize in the statement of financial position a liability to make lease payments (the lease
liability) and a right of use asset representing its right to use the underlying asset for the lease term. For operating leases:
the right-of-use asset and a lease liability will be initially measured at the present value of the lease payments, in the statement
of financial position; a single lease cost will be recognized, calculated so that the cost of the lease is allocated over the
lease term on a generally straight-line basis; and all cash payments will be classified within operating activities in the statement
of cash flows. The amendments in Topic 842 are effective for the Company beginning January 1, 2019. The Company’s office
lease expires September 30, 2019. Management is currently evaluating the impact of adopting the new guidance on the Company’s
consolidated financial statements.
In July 2017, the FASB issued Accounting
Standards Update 2017-11 (ASU 2017-11”), which allows companies to exclude a down round feature when determining whether
a financial instrument is considered indexed to the entity’s own stock. As a result, financial instruments with down round
features are no longer classified as liabilities and embedded conversion options with down round features are no longer bifurcated.
For equity-classified freestanding financial instruments, such as warrants, an entity will treat the value of the effect of the
down round, when triggered, as a dividend and a reduction of income available to common shareholders in computing basic earnings
per share. For convertible instruments with embedded conversion options that have down round features, an entity will recognize
the intrinsic value of the feature only when the feature becomes beneficial. The guidance in ASU 2017-11 is effective for fiscal
years beginning after December 15, 2018, and interim periods within those fiscal years. We early adopted ASU 2017-11 effective
January 1, 2018 without a material impact on our condensed consolidated financial statements.
Note
2 – Intangible Asset
Intangible
assets consist of the capitalized costs of $11,038,929, including transaction costs of $1,782, associated with the exercise of
the option to acquire the exclusive license from CoNCERT related to patent rights and know-how to develop and commercialize compounds
and products for PCS-499 and each metabolite thereof and the related income tax effects. The capitalized costs include $3,037,147
associated with the initial recognition of an offsetting deferred tax liability related to the acquired temporary difference for
an asset purchased that is not a business combination and has a tax basis of $1,782 in accordance with ASC 740-10-25-51
Income
Taxes
. In accordance with ASC Topic 730,
Research and Development
, the Company capitalized the costs of acquiring the
exclusive license rights to CTP-499 as the exclusive license rights represent intangible assets to be used in research and development
activities that have future alternative uses.
The
negotiation of the modification to the Agreement was finalized in mid-February 2018 and the legal documents were executed and
the option was exercised on March 19, 2018 in exchange for CoNCERT receiving (i) $8 million of common stock of Processa that was
owned by Promet (or 2,090,301 shares representing 6.58% of Promet’s common stock holding or 5.93% of total Processa common
stock issued and outstanding), and (ii) 15% of any sublicense revenue earned by Processa for a period equivalent to the royalty
term (as defined in the Agreement) until the earliest to occur of (a) Processa raising $8 million of gross proceeds; and (b) CoNCERT
can sell its shares of Processa common stock without restrictions pursuant to the terms of the amended Agreement. All other terms
of the Agreement remained unchanged. The license agreement was assigned to and deemed to have been exercised by the Company. As
a result of the transaction, the Company recognized an intangible asset for the fair value of the common stock consideration paid
of $8 million with an offsetting amount in additional paid-in capital resulting from Promet satisfying Processa’s liability
to CoNCERT.
The
Company estimated the fair value of the common stock issued based on the market approach and CoNCERT’s requirement to receive
shares valued at $8 million. The market approach was based on the final negotiated number of shares of stock determined on a volume
weighted average price of Processa common stock quoted on the OTCQB (principal market) over a 45 day period preceding the mid-February
2018 finalized negotiation of the modification to the option and license agreement with CoNCERT, an unrelated third party, for
the exclusive license rights to PCS-499 however, Processa has less than 300 shareholders, the volume of shares trading for Processa’s
common stock is not significant and the OTCQB is not a national exchange; therefore, the volume weighted average price quotes
for the Processa stock are from markets that are not active and consequently are Level 2 inputs. The total cost recognized for
the exclusive license acquired represents the allocated fair value related to the stock transferred to CoNCERT plus the recognition
of the deferred tax liability related to the acquired temporary difference and the transaction costs incurred to complete the
transaction as discussed above.
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Intangible
assets consist of the following:
|
|
June 30,
|
|
|
|
2018
|
|
Gross intangible assets
|
|
|
|
|
Exclusive license rights to CTP-499
|
|
$
|
11,038,929
|
|
Less: Accumulated amortization
|
|
|
(222,559
|
)
|
Total intangible assets, net
|
|
$
|
10,816,370
|
|
Amortization
expense was $197,124 and $222,559 for the three and six months ended June 30, 2018, respectively. The weighted average amortization
period for the intangible asset is 14 years based on the average remaining patent lives for PCS-499 and the estimated royalty
period for a fully paid-up license under the terms of the license agreement. Amortization expense is included within research
and development expense in the accompanying consolidated statements of operations. As of June 30, 2018, the estimated future amortization
expense each year for the next five years and annual periods thereafter until fully amortized amounts to $788,495 per year.
Note
3 – Senior Convertible Notes
The
balance of our Senior Convertible Notes (“Senior Notes”) and accrued interest at June 30, 2018 and December 31, 2017
was as follows:
|
|
|
|
|
Unamortized
|
|
|
|
|
|
|
|
|
|
Senior
|
|
|
Debt
|
|
|
Senior
|
|
|
|
|
|
|
Convertible
|
|
|
Issuance
|
|
|
Convertible
|
|
|
Accrued
|
|
|
|
Notes
|
|
|
Costs
|
|
|
Notes, Net
|
|
|
Interest
|
|
Balance, December 31, 2017
|
|
$
|
2,580,000
|
|
|
$
|
(131,430
|
)
|
|
$
|
2,448,570
|
|
|
$
|
35,693
|
|
Conversion of debt
|
|
$
|
(2,350,000
|
)
|
|
$
|
64,361
|
|
|
$
|
(2,285,639
|
)
|
|
$
|
(109,472
|
)
|
Accrued interest
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
84,922
|
|
Amortize debt issuance costs
|
|
|
-
|
|
|
|
61,132
|
|
|
|
61,132
|
|
|
|
-
|
|
Balance, June 30, 2018
|
|
|
230,000
|
|
|
|
(5,937
|
)
|
|
|
224,063
|
|
|
|
11,143
|
|
Current portion
|
|
|
(230,000
|
)
|
|
|
5,937
|
|
|
|
(224,063
|
)
|
|
|
(11,143
|
)
|
Long-term portion
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Interest
expense totaled $58,314 for the three months ended June 30, 2018, consisting of interest on the Senior Notes at 8% of $24,992
and the amortization of debt issuance costs of $33,322. Interest expense totaled $146,054 for the six months ended June 30, 2018
consisting of interest on the Senior Notes at 8% of $84,922 and the amortization of debt issuance costs of $61,132. The Senior
Notes and related accrued interest are classified as a current liability in our balance sheet.
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Issuance
of our Senior Convertible Notes
As of October 4, 2017, certain entities affiliated
with current shareholders had purchased $1.25 million of our Senior Notes in a bridge financing undertaken by us to support our
operations. On November 21, 2017, additional third-party accredited investors contributed $1.33 million in financing proceeds.
On May 25, 2018, $2,350,000 of Senior Notes was converted, as described below, leaving $230,000 of Senior Notes outstanding
at June 30, 2018.
Principal
and interest under each Senior Note is due on the earlier of (i) the mandatory and automatic conversion of the Senior Note into
the next Private Investment in Public Equity (“PIPE”) financing we undertake, provided the PIPE financing yields minimum
gross proceeds and a pre-money valuation as defined in the financing agreement or (ii) the one-year anniversary of that Senior
Note (Maturity Date). The Senior Notes bear interest at 8% per year and are payable in kind (in common stock).
Holders
of Senior Notes (a) may elect to receive 110% of principal plus accrued interest in the event there is a change of control prior
to conversation of the Senior Notes, (b) are entitled to full ratchet anti-dilution protection in event of any sale of securities
at a net consideration per share that is less than the applicable conversion price per share to the holder, (c) are entitled to
certain registration rights for the securities underlying the Senior Notes and (d) have been granted certain preemptive rights
pro rata to their respective interests through December 31, 2018. The Senior Notes can be prepaid by the Company at any time following
the date of issuance with seven days prior written notice to the note holder.
The
Senior Notes are secured by a security interest in the assets of the Company and contain negative covenants that do not permit
the Company to incur additional indebtedness or liens on property or assets owned, repurchase common stock, pay dividends, or
enter into any transaction with affiliates of the Company that would require disclosure in a public filing with the Securities
and Exchange Commission. Upon an event of default, the outstanding principal amount of the Senior Notes, plus accrued but unpaid
interest and other amounts owing in respect thereof through the date of acceleration, shall become immediately due and payable
in cash at the holder’s election, if not cured within the cure period.
The
Company retained a placement agent and agreed to pay the placement agent (i) six percent (6%) of gross proceeds received by the
Company and (ii) warrants to purchase securities in the amount of three percent (3%) of the equity issued or issuable in connection
with the Senior Notes bridge financing. These warrants will be issued upon achieving certain financing levels under the next PIPE
financing we undertake. Additional financing was received in May and June 2018. As a result, warrants to purchase a total of 79,423
shares of common stock were issued, with a three-year term, at an exercise price equal to $2.452.
The
Company incurred $154,800 in debt issuance costs on the Senior Notes in connection with a payment to the placement agent, which
was reported as a reduction of the carrying amount of the Senior Convertible Notes on the face of the consolidated balance sheets.
The debt issuance costs are amortized to interest expense using the interest method over the term of the Senior Convertible Notes.
The effective interest rate on the Senior Notes was 7.72% before debt issuance costs since no payments of interest are due until
maturity and 13.96% including the debt issuance costs based on the repayment terms of the Senior Notes.
Conversion
of Our Senior Convertible Notes
On
May 25, 2018, pursuant to the mandatory and automatic conversion provisions of the Senior Notes, we converted $2,350,000 of the
$2,580,000 outstanding Senior Notes, along with any accrued interest into 1,206,245 shares of common stock (at a conversion price
of $2.043 per share) and a warrant to purchase one share of common stock for three years, at an exercise price of $2.452.
Senior
Notes totaling $230,000 held by Canadian individuals cannot be converted until the Company completes certain regulatory matters
and filings in Canada. Once these regulatory matters and filings have been met, the Senior Notes held by these individuals will
automatically convert on the same terms as the other noteholders.
The
Company completed an evaluation of the warrants issued in this transaction and determined the warrants should be classified as
equity.
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
4 – Stockholders’ Equity
2018
Private Placement Transactions
Between
May 15, 2018 and June 29, 2018, the Company sold an aggregate of 1,402,442 units in a private placement transaction at a purchase
price equal to $2.27 per unit for gross proceeds of approximately $3.2 million. Each unit consisted of one share of our common
stock and a warrant to purchase one share of our common stock for $2.724, subject to adjustment thereunder for a period of three
years. The Company paid $167,526 to their placement agent and issued placement agent warrants to purchase up to 84,146 shares
of common stock, with a three-year term, at an exercise price equal to $2.724. The issuance costs were charged against additional
paid in capital. The Company also recorded a note receivable of $107,490, which represented proceeds from one non-affiliated investor
in the June 29, 2018 transaction that was not received until July 6, 2018.
On
May 25, 2018, we entered into an Agreement with PoC Capital, LLC (“PoC”), where PoC has agreed to finance $1,800,000
in study costs associated with certain clinical studies, including our Phase 2a study to evaluate the safety, tolerability, efficacy
and pharmacodynamics of PCS 499 in patients with Necrosis Lipoidica in exchange for 792,952 shares of our common stock and a warrant
for the purchase of 792,952 shares of common stock with an exercise price of $2.724, expiring on July 29, 2021. Any study costs
in excess of that amount will be our responsibility. PoC will not make payments to us, but directly to the contract research organization
based on their invoices. We paid $108,000 to our placement agent and issued our placement agent warrants to purchase 47,578 shares
of common stock, with a three-year term, at an exercise price equal to $2.724. The issuance costs were charged against additional
paid in capital.
The
Company also entered into a pledge agreement with PoC, under which the Company received a security interest in 396,476 shares,
or half the shares we issued to them. These shares will be released in two tranches of 198,238 shares each, with each tranche
released upon PoC making payments totaling $720,000. As of June 30, 2018, no proceeds have been paid by PoC and the Company holds
396,476 shares as collateral.
The
common stock, but not the warrants, issued for the 2018 Private Placement Transactions and the conversion of the Senior Convertible
Notes have, subject to certain customary exceptions, full ratchet anti-dilution protection. Until the Company has issued equity
securities or securities convertible into equity securities for a total of an additional $20.0 million in cash or assets, including
the proceeds from the exercise of the warrants issued above, in the event we issue additional equity securities or securities
convertible into equity securities at a purchase price less than $2.27 per share of common stock, the above purchase price shall
be adjusted and new shares of common stock issued as if the purchase price was such lower amount (or, if such additional securities
are issued without consideration, to a price equal to $0.01 per share).
The
Company completed an evaluation of the warrants issued in the 2018 Private Placement Transactions and the conversion of the Senior
Convertible Notes and determined the warrants should be classified as equity.
Purchase
of the CoNCERT License
On
March 19, 2018, Promet, Processa and CoNCERT amended the Agreement executed in October 2017. The Agreement was assigned to Processa
and Processa exercised the exclusive option for the PCS-499 compound (see Note 1 – Company Overview and Note 2 – Intangible
Asset) in exchange for CoNCERT receiving, in part, $8 million of common stock of the Company that was owned directly by Promet
(or 2,090,301 shares at $3.83 per share representing 6.58% of Promet’s common stock holding or 5.93% of the Company’s
total common stock issued and outstanding) in satisfaction of the obligation due for the exclusive license for CTP-499 acquired
by Processa. There was no change in the total shares issued and outstanding of 35,272,626, however, Promet’s controlling
interest was reduced from 90% to 84%. Promet contributed the payment of the obligation due for the exclusive license to the Company
without consideration paid to them. As a result of the transaction, the Company recognized an exclusive license intangible asset
with a fair value of $8 million and an offsetting increase in additional paid-in capital resulting from Promet satisfying Processa’s
liability to CoNCERT (see Note 2 Intangible Asset for the income tax effect of this transaction).
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
5 – Income Taxes
The
Company accounts for income taxes in accordance with ASC Topic 740,
Income Taxes.
Deferred income taxes are recorded for
the expected tax consequences of temporary differences between the tax basis of assets and liabilities for financial reporting
purposes and amounts recognized for income tax purposes. The Company records a valuation allowance to reduce the Company’s
deferred tax assets to the amount of future tax benefit that is more likely than not to be realized.
As of June 30, 2018, and December 31, 2017,
the Company recorded a valuation allowance equal to the full recorded amount of the Company’s net deferred tax assets related
to intangible start-up costs since it is more-likely-than-not that such benefits will not be realized. The valuation allowance
is reviewed quarterly and is maintained until sufficient positive evidence exists to support its reversal.
A
deferred tax liability was recorded when CoNCERT sold its license and “Know-How” to Processa for stock in an Internal
Revenue Code Section 351 transaction on March 19, 2018 (see Note 1 – Company Overview and Note 2 – Intangible Asset).
A Section 351 transaction treats the acquisition of the license and Know-How for stock as a tax-free exchange. As a result, under
ASC 740-10-25-51
Income Taxes
, Processa recorded a deferred tax liability of $3,037,147 for the acquired temporary difference
between the financial reporting basis of approximately $11,038,929 and the tax basis of approximately $1,782. The deferred tax
liability may be offset by the deferred tax assets resulting from 2017 and 2018 net operating losses. Under ACS 740-270
Income
Taxes – Interim Reporting
, the Company is required to project its 2018 federal and state effective income tax rate and
apply it to the June 30, 2018 operating loss before income taxes. Based on the projection, the Company expects to recognize the
tax benefit from the 2017 net operating loss carryover and the projected 2018 loss, which resulted in the recognition of a deferred
tax benefit shown in the consolidated statements of operations for 2018.
As required under ASC 740-270,
Interim
Financial Reporting
, the Company has estimated its annual effective tax rate for the full fiscal year and applied that rate
to its year-to-date consolidated pre-tax ordinary loss before income taxes in determining its benefit for income taxes. The Company
recorded a benefit for income taxes of approximately $278,000 and $0 for the three months ended June 30, 2018 and 2017,
respectively, and $559,000 and $0 for the six months ended June 30, 2018 and 2017, respectively.
As
discussed in Note 2 – Income Taxes in the consolidated financial statements included in Item 8 of the 2017 Form 10-K filed
with the SEC on April 17, 2018, the historical information presented in the consolidated financial statements prior to October
4, 2017 is that of Promet in accordance with Accounting Standards Codification (“ASC”) 805-40-45,
Business Combinations
– Reverse Acquisitions
. Prior to the closing of the asset purchase transaction on October 4, 2017, Promet was treated
as a partnership for federal income tax purposes and thus was not subject to income tax at the entity level. Therefore, no provision
or liability for income taxes has been included in these consolidated financial statements through the date of the asset purchase
on October 4, 2017.
The
Company expects to be in an overall taxable loss position for 2018. However, the Company expects to recognize a deferred tax benefit
in 2018 to the extent the 2017 net operating loss carryover and the 2018 net operating losses can be used to offset the deferred
tax liability related to the intangible asset. No current income tax expense is expected for the foreseeable future as the Company
expects to generate taxable net operating losses.
Note
6 – Net Loss per Share of Common Stock
Basic
net loss per share is computed by dividing net loss by the weighted average common shares outstanding. Diluted net loss per share
is computed by dividing net loss by the weighted average common shares outstanding without the impact of potential dilutive common
shares outstanding because they would have an anti-dilutive impact on diluted net loss per share. The treasury-stock method is
used to determine the dilutive effect of the Company’s stock warrants grants, and the if-converted method is used to determine
the dilutive effect of the Company’s Senior Convertible Notes.
The
computation of net loss per share for the three and six months ended June 30, 2018 and 2017 is shown below.
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
|
|
Three Months Ended
June 30,
|
|
|
Six Months Ended
June 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Basic and diluted net loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(1,206,074
|
)
|
|
$
|
(278,445
|
)
|
|
$
|
(2,302,870
|
)
|
|
$
|
(500,536
|
)
|
Weighted-average number of common shares-basic and diluted
|
|
|
36,623,697
|
|
|
|
31,745,242
|
|
|
|
35,951,894
|
|
|
|
31,745,242
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net loss per share
|
|
$
|
(0.03
|
)
|
|
$
|
(0.01
|
)
|
|
$
|
(0.06
|
)
|
|
$
|
(0.02
|
)
|
The
outstanding warrants to purchase common stock and the shares issuable under the Senior Convertible Note were excluded from the
computation of diluted net income per share as their effect would have been anti-dilutive for the periods presented below:
|
|
Three
Months Ended
June
30,
|
|
|
Six
Months Ended
June
30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Stock purchase warrants
|
|
|
3,612,786
|
|
|
|
-
|
|
|
|
3,612,786
|
|
|
|
-
|
|
Senior Convertible Notes
|
|
|
115,128
|
|
|
|
-
|
|
|
|
115,128
|
|
|
|
-
|
|
Note
7 – Related Party Transactions
A
shareholder, Corlyst, LLC, reimburses the Company for shared costs related to payroll, health care insurance and rent based on
actual costs incurred and recognized as a reduction of the general and administrative operating expenses being reimbursed in the
Company’s condensed consolidated statement of operations. The reimbursed amounts totaled $0 and $19,660 for the three months
ended June 30, 2018 and 2017, respectively, and $27,480 and $49,089 for the six months ended June 30, 2018 and 2017, respectively.
Amounts due from Corlyst at June 30, 2018 and December 31, 2017 were $53,501 and $62,709, respectively.
During
2017 and 2018, Corlyst paid certain operating expenses on behalf of the Company and the Company reimbursed Corlyst based on actual
costs incurred at later dates. The accounts payable amounts due to Corlyst at June 30, 2018 and December 31, 2017 were $900 and
$0, respectively. In 2018, Promet paid CA state and FUTA payroll taxes on behalf of Processa. As a result, the accounts payable
amount due to Promet at June 30, 2018 and December 31, 2017 were $116 and $336, respectively. In addition, there was $100 due
to an officer included in due to related parties as of June 30, 2018 and December 31, 2017.
Corlyst
also purchased 132,159 shares of common stock in a private placement transaction.
A Director of the Company is the manager of
the JMW Fund, LLC, San Gabriel Fund, LLC, and Richland Fund, LLC, collectively known as the “Funds”. The Funds received
515,583 shares of our common stock and warrants to purchase 515,583 shares of our common stock upon the conversion of $1 million
of Senior Convertible Notes held by the Funds purchased on October 4, 2017. At June 30, 2018, the Funds owned a total of
2,065,789 shares of common stock and warrants to purchase 515,583 shares of common stock.
Entities affiliated with our Chairman of the
Board of Directors and Chief Executive Officer (CEO) received 103,117 shares of our common stock and warrants to purchase
103,117 shares of our common stock upon the conversion of $200,000 in Senior Convertible Notes purchased on October 4, 2017. Our
CEO and entities affiliated with our CEO also purchased a total of 132,160 shares of common stock and warrants to purchase
132,160 shares of common stock in private placement transactions.
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
8 – Commitments and Contingencies
Purchase
Obligations
The
Company enters into contracts in the normal course of business with contract research organizations and subcontractors to further
develop its products. The contracts are cancellable, with varying provisions regarding termination. If a contract with a specific
vendor were to be terminated, the Company would only be obligated for products or services that it received as of the effective
date of the termination and any applicable cancellation fees. The Company had purchase obligations of approximately $110,000 and
$896,000 at June 30, 2018 and December 31, 2017, respectively.
Cybersecurity
Fraud
In
January 2018, the Company incurred a loss of $144,200 due to fraud from a cybersecurity breach. As a result, we have implemented
certain review and approval procedures internally and with our banks; our technology consultants have implemented system changes;
and, we reported the fraud to our banks and the Federal Bureau of Investigation Cyber Crimes Unit. The Company does not have insurance
coverage against the type of fraud that occurred, therefore, recovery of the loss is remote. While we are taking steps to prevent
such an event from reoccurring, we cannot provide assurance that similar issues will not reoccur. The loss is included in general
and administrative expenses in the consolidated statement of operations for the six months ended June 30, 2018.
Note
9 - Subsequent Events
The
Company has evaluated all subsequent events through the date of filing of this Quarterly Report on Form 10-Q with the SEC, to
ensure that this filing includes appropriate disclosure of events both recognized in the financial statements as of June 30, 2018,
and events which occurred subsequent to June 30, 2018, but which were not recognized in the financial statements. The Company
has determined that there were no subsequent events which required recognition, adjustment to or disclosure in the financial statements.