U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2014

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ________ to ________

 

Commission File Number 000-51474

 

PROTEA BIOSCIENCES GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware	20-2903252
(State or other jurisdiction	(I.R.S. Employer Identification
of incorporation or organization)	No.)

 

955 Hartman Run Road, Morgantown, West Virginia 26505

(Address of principal executive offices) (Zip Code)

 

(304) 292-2226

(Registrant’s telephone number, including area code)

  

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files. Yes x No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated file. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	x
(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x 

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 66,263,600 shares of common stock, par value $0.0001 per share, outstanding as of August 5, 2014.

   

 

PROTEA BIOSCIENCES GROUP, INC.

 

- INDEX -

 

		Page
PART I – FINANCIAL INFORMATION:
Item 1.	Financial Statements:	1
	Consolidated Balance Sheets	2
	Consolidated Statements of Operations and Total Comprehensive Loss	3
	Consolidated Statements of Stockholders’ Equity (Deficit)	4
	Consolidated Statements of Cash Flows	5
	Notes to Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	29
Item 4.	Controls and Procedures	29
PART II – OTHER INFORMATION :
Item 1.	Legal Proceedings	30
Item 1A.	Risk Factors	30
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 3.	Defaults Upon Senior Securities	31
Item 4.	Mine Safety Disclosures	31
Item 5.	Other Information	31
Item 6.	Exhibits	31
Signatures		33

 

 

PART I – FINANCIAL INFORMATION

 

Item 1. Financial Statements.

 

The accompanying financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions for Form 10-Q. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.

 

In the opinion of management, the financial statements contain all material adjustments, consisting only of normal recurring adjustments necessary to present fairly the financial condition, results of operations, and cash flows of the Company for the interim periods presented.

 

The results for the period ended June 30, 2014 are not necessarily indicative of the results of operations for the full year. These financial statements and related footnotes should be read in conjunction with the financial statements and footnotes thereto included in the Company’s Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission on March 31, 2014.

 

 

PROTEA BIOSCIENCES GROUP, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

Consolidated Balance Sheets

See Accompanying Notes to Financial Statements

 

		June 30, 2014 (unaudited)				December 31, 2013
ASSETS
Current Assets:
Cash and cash equivalents		$	277,477			$	1,086,330
Trade accounts receivable			83,305				216,864
Other receivables			427,827				435,278
Inventory			505,549				465,334
Prepaid expenses			78,647				304,696
Total current assets			1,372,805				2,508,502
Property and equipment, net			3,180,096				2,886,176
Other noncurrent assets			23,096				23,249
Total Assets		$	4,575,997			$	5,417,927
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities on short and long-term debt		$	1,472,957			$	1,054,053
Accounts payable			2,622,848				759,021
Bank line of credit			3,000,000				2,725,000
Loans payable to stockholders, net of discount			2,287,978				465,883
Obligation related to the letter of credit, net of discount			-				151,981
Other payables and accrued expenses			790,037				1,069,167
Total current liabilities			10,173,820				6,225,105
Contingent Subsidiary Sale			600,000				-
Long-term debt - net of current portion			1,655,536				1,580,260
Derivative Liabilities			600,683				623,587
Noncurrent Liabilities			2,256,219				2,203,847
Commitments and contingencies			-				-
Stockholders' Equity:
Preferred stock ($.0001 par value; 10,000,000 shares
authorized; none issued or outstanding)			-				-
Common stock ($.0001 par value; 200,000,000 shares
authorized; 66,013,600 and 65,442,735 shares issued
and outstanding at June 30, 2014 and December 31, 2013)			6,602				6,545
Additional paid in capital			56,100,550				55,351,613
Deficit accumulated during development stage			(64,570,824	)			(58,392,348	)
Accumulated other comprehensive income (loss)			9,630				23,165
Total Stockholders' Equity (Deficit)			(8,454,042	)			(3,011,025	)
Total Liabilities and Stockholders' Equity		$	4,575,997			$	5,417,927

 

 

PROTEA BIOSCIENCES GROUP, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

Consolidated Statements of Comprehensive Loss (Unaudited)

See Accompanying Notes to Financial Statements

 

		For the Three Months Ended June 30,				For the Three Months Ended June 30,				For the Six Months Ended June 30,				For the Six Months Ended June 30,				Period from July 13, 2001(date
		2014				2013				2014				2013				of inception) to June 30, 2014
Gross revenue		$	346,561			$	277,991			$	814,661			$	759,606			$	5,531,008
Selling, general, administrative expenses			(2,746,090	)			(2,023,630	)			(5,099,531	)			(4,071,263	)			(36,582,945	)
Research and development expense			(804,030	)			(844,532	)			(1,525,983	)			(1,708,135	)			(30,060,708	)
Loss from operations			(3,203,559	)			(2,590,171	)			(5,810,853	)			(5,019,792	)			(61,112,645	)
Other income (expense):
Interest and exchange income (expense)			(133	)			8,602				32				6,424				56,079
Interest expense			(206,317	)			(174,563	)			(372,480	)			(332,818	)			(3,149,093	)
Debt conversion cost			-				-				-				-				(724,623	)
Gain on debt settlement			-				-				-				-				13,834
Loss on asset disposal			6,000				-				(18,768	)			(15,773	)			(57,955	)
Derivative income			(42,329	)			-				23,593				-				403,579
Total other income (expense)			(242,779	)			(165,961	)			(367,623	)			(342,167	)			(3,458,179	)
Loss before income taxes			(3,446,338	)			(2,756,132	)			(6,178,476	)			(5,361,959	)			(64,570,824	)
Income taxes			-				-				-				-				-
Net loss			(3,446,338	)			(2,756,132	)			(6,178,476	)			(5,361,959	)			(64,570,824	)
Foreign currency translation adjustment			(14,304	)			12,210				(13,535	)			690				9,630
Total comprehensive loss		$	(3,460,642	)		$	(2,743,922	)		$	(6,192,011	)		$	(5,361,269	)		$	(64,561,194	)
Net loss per share - basic and diluted		$	(0.05	)		$	(0.07	)		$	(0.09	)		$	(0.14	)		$	(4.15	)
Weighted average number of shares
outstanding - basic and diluted			65,655,378				40,866,191				65,556,136				37,709,434				15,550,598

 

 

PROTEA BIOSCIENCES GROUP, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

Consolidated Statements of Stockholders' Equity (Deficit) (Unaudited)

See Accompanying Notes to Financial Statements

 

														Deficit				Accumulated				Total
		Common Stock								Additional				Accumulated				Other				Stockholders'
		Par Value $.0001								Paid in Capital				During				Comprehensive				Equity
		Shares				Amount				Common Stock				Development Stage				Income (Loss)				(Deficit)
December 31, 2013			65,442,735			$	6,545			$	55,351,613			$	(58,392,348	)		$	23,165			$	(3,011,025	)
Issuance costs of $12,500							-				(12,500	)			-				-				(12,500	)
Issuance of stock for services			562,348				56				465,486				-				-				465,542
Stock warrants exercised			8,517				1				(1	)											-
Stock-based compensation expense			-				-				179,049				-				-				179,049
Stock warrants issued for services and debt			-				-				116,903				-				-				116,903
Net loss			-				-				-				(6,178,476	)			-				(6,178,476	)
Foreign currency translation adjustment			-				-				-				-				(13,535	)			(13,535	)
June 30, 2014			66,013,600			$	6,602			$	56,100,550			$	(64,570,824	)		$	9,630			$	(8,454,042	)

 

 

PROTEA BIOSCIENCES GROUP, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

Consolidated Statements of Cash Flows (Unaudited)

See Accompanying Notes to Financial Statements

 

		For the Six Months Ended June 30,				For the Six Months Ended June 30,				Period from July 13, 2001 (date
		2014				2013				of inception) to June 30, 2014
Cash flows from operating activities:
Net loss		$	(6,178,476	)		$	(5,361,959	)		$	(64,570,824	)
Adjustments to reconcile net loss to net
cash from operating activities:
Depreciation and amortization			430,771				412,184				5,674,153
Non-cash compensation			179,049				154,340				2,578,193
Issuance of common stock and warrants for services			515,463				100,000				1,390,279
Issuance of common stock for accrued interest			-				-				833,432
Accretion of convertible debenture discount			125,645				11,216				456,325
Debt conversion costs associated with inducement			-				-				724,623
Loss on disposal of fixed assets			18,768				16,009				57,955
Bad debt expense			1,200				-				35,232
(Income) Expense from change in value of derivative			(23,593	)			-				(403,579	)
Net change in assets and liabilities:
Decrease (increase)
Trade accounts receivable			132,359				(100,718	)			(118,537	)
Prepaid expenses			226,049				(27,702	)			(78,647	)
Other receivables			7,604				273,971				35,403
Inventory			(40,215	)			297,554				(505,549	)
Increase (decrease)
Trade accounts payable			1,596,754				(1,201,726	)			1,997,466
Other payables and accrued expenses			(279,128	)			362,984				790,038
Net cash used in operating activities			(3,287,750	)			(5,063,847	)			(51,104,037	)
Cash flows from investing activities:
Purchase of and deposits on equipment			(119,983	)			(196,061	)			(5,090,356	)
Proceeds from sale of equipment			6,000				-				54,450
Proceeds from contingent subsidiary sale			600,000				-				600,000
Net cash used in investing activities			486,017				(196,061	)			(4,435,906	)
Cash flows from financing activities:
Net advances on bank line of credit			275,000				-				3,000,000
Proceeds from sale of common stock, net			(12,500	)			4,680,775				35,108,347
Proceeds from short and long-term debt			283,500				-				13,908,000
Proceeds from shareholder debt			2,025,000				775,000				6,423,216
Repayment of long-term debt			(325,890	)			(359,469	)			(2,627,386	)
Proceeds from Obligation related to the Letter of Credit			-				600,000				600,000
Repayment of Obligation related to the Letter of Credit			(238,695	)			(156,060	)			(600,000	)
Financing costs			-				-				(4,387	)
Net cash provided by financing activities			2,006,415				5,540,246				55,807,790
Effect of exchange rate changes on cash			(13,535	)			690				9,630
Net increase (decrease) in cash			(808,853	)			281,028				277,477
Cash, beginning of period			1,086,330				27,604				-
Cash, end of period		$	277,477			$	308,632			$	277,477
Supplemental disclosure of cash flow information:
Cash paid during the period for interest		$	136,101			$	224,967			$	1,762,502
Supplemental disclosure of non-cash investing and financing activities:
Financed equipment		$	629,476			$	-			$	3,898,200
Debt converted to company stock		$	-			$	-			$	15,273,658

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE)

 

Notes to Consolidated Financial Statements – (Unaudited)

   

1.

Description of Company and Nature of Business

 

Protea Biosciences Group, Inc. (referred to as “Protea”, “the Company”, “we”, “us” and “our”) is a development stage molecular information company incorporated in the state of Delaware on May 24, 2005. “Molecular information” is the identification and characterization of the proteins, metabolites and other biomolecules, which are the products of all living cells and life forms. The Company is applying its technology to the development of next generation “direct molecular imaging” service capabilities that it believes enable more rapid and comprehensive molecular profiling of living cells and biofluids. This provides better molecular information that helps to define normal and disease processes. We believe that our proprietary technology is useful to support medical research and pharmaceutical development. The Company’s technologies enable the direct molecular imaging of the proteins, metabolites and other biomolecules that regulate the biological functions of the human body and all other forms of life. Management believes this is a critical area of research, as pharmaceutical research is in need of direct molecular imaging to improve and accelerate the development of new therapeutics and diagnostic tests.

 

The consolidated balance sheet presented as of December 31, 2013, has been derived from the audited consolidated financial statements as of that date. The consolidated financial statements and notes included in this report should be read in conjunction with the financial statements and notes included in the Company’s 2013 year end audit.

 

The accompanying financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The loss from operations since inception had an accumulated deficit balance at June 30, 2014 of approximately $61 million and at December 31, 2013 of approximately $55 million. The Company has funded its activities to date almost exclusively from debt and equity financings. The Company will continue to require substantial funds to advance the research and development of its core technologies and to develop new products and services based upon its proprietary protein recovery and identification technologies.

 

Management intends to meet its operating cash flow requirements primarily from the sale of equity and debt securities. The Company seeks additional capital through sales of equity securities or convertible debt and, if appropriate, to pursue partnerships to advance various research and development activities. The Company may also consider the sale of certain assets, or entering into a transaction such as a merger with a business complimentary to theirs.

 

While the Company believes that it will be successful in obtaining the necessary financing to fund its operations, they have no committed sources of funding and are not assured that additional funding will be available to them. These factors raise substantial doubt about the Company’s ability to continue as a going-concern. The accompanying consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going-concern.

 

2.

Summary of Significant Accounting Policies

 

The accounting policies underlying the accompanying unaudited consolidated financial statements are those set forth in Note 2 to the consolidated financial statements included in the Company’s 10-K for the year ended December 31, 2013.

 

Revenue Recognition

 

We follow the provisions of FASB ASC 605, “Revenue Recognition”. We recognize revenue of products when persuasive evidence of a sale arrangement exists, the price to the buyer is fixed or determinable, delivery has occurred/title has passed, and collectability of the sales price is reasonably assured. The Company recognizes revenue from the sale of its ProteaPlot™ software when bundled with the LAESI platform, which facilitates operating the instrument and storage and display of datasets. The Company also recognizes revenue of standalone sales of ProteaPlot™, which generally consists of additional user licenses.

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE)

 

Notes to Consolidated Financial Statements (unaudited)

 

2.

Summary of Significant Accounting Policies (continued)

 

We account for shipping and handling costs in accordance with the provisions of FASB ASC 605-45-45, “Revenue Recognition – Principal Agent Considerations”, which requires all amounts charged to customers for shipping and handling to be classified as revenues. Shipping and handling costs charged to customers are recorded in the period the related product sales revenue is recognized.

 

Regarding short-term service contracts, the majority of these service contracts involve the processing of imaging and bioanalytical samples for pharmaceutical and academic/clinical research laboratories. These contracts generally provide for a fixed fee for each method developed or sample processed and revenue is recognized when the analysis is complete and a report is delivered.

 

For longer-term contracts involving multiple elements, the items included in the arrangement (deliverables) are evaluated to determine whether they represent separate units of accounting. We perform this evaluation at the inception of an arrangement and as each item in the arrangement is delivered. Generally, we account for a deliverable (or a group of deliverables) separately if: (i) the delivered item(s) have standalone value to the customer, and the delivery or performance of the service(s) is probable and substantially in our control. Revenue on multiple revenue arrangements is recognized using a proportional method for each separately identified element. All revenue from contracts determined not to have separate units of accounting is recognized based on consideration of the most substantive delivery factor of all the elements in the contract or, if there is no predominant deliverable, upon delivery of the final element of the arrangement.

 

Revenues from grants are based upon internal costs that are specifically covered by the grants, and where applicable, an additional facilities and administrative rate that provides funding for overhead expenses. These revenues are recognized when expenses have been incurred by the Company that is related to the grants.

 

The Company has revenue from four major components: molecular information services, LAESI instrument platform, research products, and grants and other collaboration revenues. Revenue by component was as follows:

 

		Three Months Ended								Six Months Ended
		June 30, 2014				June 30, 2013				June 30, 2014				June 30, 2013
Molecular Information Services		$	59,375			$	43,720			$	229,945			$	114,450
LAESI Instrument Platform			140,500				139,000				318,500				435,694
Research Products			120,361				95,271				215,703				209,462
Grants and Other Collaborations			26,325				-				50,513				-
Gross Revenue		$	346,561			$	277,991			$	814,661			$	759,606

 

Other Receivables

 

Other receivables, which reflect amounts due from non-trade activity, consist of the following at:

 

		June 30, 2014				December 31, 2013
French government R&D credit		$	396,859			$	400,379
French payroll taxes receivable			30,968				34,899
Other receivables – current		$	427,827			$	435,278
Deposits		$	23,096			$	23,249
Other receivables – noncurrent		$	23,096			$	23,249

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE)

 

Notes to Consolidated Financial Statements (unaudited)

 

2.

Summary of Significant Accounting Policies (continued)

 

Other Payables and Accrued Expenses

 

Other payables and accrued expenses, which reflect amounts due from non-trade activity, consist of the following at:

 

		June 30, 2014				December 31, 2013
Accrued expenses		$	165,147			$	653,047
Accrued interest			150,645				39,911
Accrued warranties			97,500				81,250
Accrued payroll and benefits			370,845				286,979
Unearned revenue			5,900				7,980
Other payables and accrued expenses		$	790,037			$	1,069,167

 

Derivative Liabilities

 

The Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks; however, the Company has certain financial instruments that are embedded derivatives associated with capital raises and common stock purchase warrants. The Company evaluates all its financial instruments to determine if those contracts or any potential embedded components of those contracts qualify as derivatives to be separately accounted for in accordance with FASB ASC 810-10-05-4 and 815-40. This accounting treatment requires that the carrying amount of any embedded derivatives be recorded at fair value at issuance and marked-to-market at each balance sheet date. In the event that the fair value is recorded as a liability, as is the case with the Company, the change in the fair value during the period is recorded as either income or expense. Upon conversion or exercise, the derivative liability is marked to fair value at the conversion date and then the related fair value is reclassified to equity.

 

Fair value of financial assets and liabilities – Derivative Instruments

 

We measure the fair value of financial assets and liabilities in accordance with GAAP, which defines fair value, establishes a framework for measuring fair value, and requires certain disclosures about fair value measurements.

 

GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. GAAP also establishes the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

 

The three levels of inputs used to measure fair value:

 

Level 1 – quoted prices in active markets for identical assets or liabilities.

Level 2 – quoted prices for similar assets and liabilities in active markets or inputs that are observable.

Level 3 – inputs that are unobservable (for example, the probability of a capital raise in a “binomial” methodology for valuation of a derivative liability directly related to the issuance of common stock warrants).

 

The Company has entered into certain financial instruments and contracts such as, equity financing arrangements for the issuance of common stock, which include anti-dilution arrangements and detachable stock warrants that are i) not afforded equity classification, ii) embody risks not clearly and closely related to host contracts, or iii) may be net-cash settled by the counterparty. These instruments are recorded as derivative liabilities at fair value at the issuance date. Subsequent changes in fair value are recorded through the Statement of Comprehensive Loss.

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE)

 

Notes to Consolidated Financial Statements (unaudited)

 

2.

Summary of Significant Accounting Policies (continued)

 

The Company’s derivative liabilities are related to common stock issuances, detachable common stock purchase warrants (“warrants”) issued in conjunction with debt and common stock, or warrants issued to placement agents for financial instrument issuances. We estimate fair values of the warrants that contain anti-dilution or “Down Round Protections” utilizing valuation models and techniques that have been developed and are widely accepted that take into account the additional value inherent in “Down Round Protection.” These widely accepted techniques include “Modified Binomial”, “Monte Carlo Simulation” and the “Lattice Model.” The “core” assumptions and inputs to the “Binomial” model are the same as for “Black-Scholes”, such as trading volatility, remaining term to maturity, market price, strike price, and risk free rates; all Level 2 inputs.  Fair value measurements are classified according to the lowest level input or value-driver that is significant to the valuation. A measurement may therefore be classified within Level 3 even though there may be significant inputs that are readily observable. However, a key input to a “Binomial” model (in our case, the “Monte Carlo Simulation”, for which we engaged an independent valuation firm to perform) is the probability of a future capital raise.  By definition, this input assumption does not meet the requirements for Level 1 or Level 2 outlined above; therefore, the entire fair value calculation is deemed to be Level 3 under accounting requirements due to this single Level 3 assumption. This input to the Monte Carlo Simulation model was developed with significant input from management based on its knowledge of the business, current financial position and the strategic business plan with its best efforts.

 

As discussed above, financial liabilities are considered Level 3 when their fair values are determined using pricing models or similar techniques and at least one significant model assumption or input is unobservable.  For the Company, the Level 3 financial liability is the derivative liability related to the common stock and warrants that include “Down Round Protection” and they were valued using the “Monte Carlo Simulation” technique.  This technique, while the majority of inputs are Level 2, necessarily incorporates a Capital Raise Assumption which is unobservable and, therefore, a Level 3 input.  A range of key quantitative assumptions related to the common stock and warrants that include “Down Round Protection” are as follows:

 

		June 30, 2014
		Expected Life (Years)		Risk Free Rate				Volatility				Probability of a Capital Raise
Derivative liabilities		<1 – 4.83			0.88	%			78.77	%			100	%

 

Financial Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The Company’s derivative liabilities are related to common stock issuances, detachable warrants issued in conjunction with debt and common stock, or warrants issued to the placement agents for financial instrument issuances. The derivative liabilities measured at fair value on a recurring basis are summarized below:

 

		Fair Value Measurements at June 30, 2014
		Carrying Value				Level 1				Level 2				Level 3
Derivative liabilities – common stock		$	528,553				-				-			$	528,553
Derivative liabilities – warrants			72,130				-				-				72,130
Total		$	600,683				-				-			$	600,683

 

		Fair Value Measurements at December 31, 2013
		Carrying Value				Level 1				Level 2				Level 3
Derivative liabilities – common stock		$	558,799				-				-			$	558,799
Derivative liabilities – warrants			64,788				-				-				64,788
Total		$	623,587				-				-			$	623,587

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

2.

Summary of Significant Accounting Policies (continued)

 

The table below provides a summary of the changes in fair value of the derivative liabilities measured at fair value on a recurring basis:

 

		Six Months Ended June 30, 2014
		Derivative Liabilities - Common Stock				Derivative Liabilities - Warrants				Total Fair Value Measurements Using Level 3 Inputs
Balance at January 1, 2014		$	558,799			$	64,788			$	623,587
Issuance of warrants			-				689				689
Unrealized (gain) loss on derivative liabilities			(30,246	)			6,653				(23,593	)
Recognition of derivative liabilities			-				-				-
Balance at June 30, 2014		$	528,553			$	72,130			$	600,683

 

		Year Ended December 31, 2013
		Derivative Liabilities - Common Stock				Derivative Liabilities - Warrants				Total Fair Value Measurements Using Level 3 Inputs
Beginning balance at January 1, 2013		$	-			$	-			$	-
Issuance of warrants			-				45,685				45,685
Unrealized (gain) loss on derivative liabilities			(257,846	)			(122,140	)			(379,986	)
Recognition of derivative liabilities			816,645				141,243				957,888
Balance at December 31, 2013		$	558,799			$	64,788			$	623,587

 

Net Loss per Share

 

Basic and diluted loss per common share is computed based on the weighted average number of common shares outstanding. Common share equivalents (which may consist of options, warrants and convertible debt) are excluded from the computation of diluted loss per share since the effect would be anti-dilutive. Common share equivalents which could potentially dilute basic earnings per share in the future, and which were excluded from the computation of diluted loss per share, totaled approximately 63,963,000 and 56,711,000 at June 30, 2014 and December 31, 2013, respectively.

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

2.

Summary of Significant Accounting Policies (continued)

 

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS:

 

In May 2014, the FASB issued a standard on revenue recognition that provides a single, comprehensive revenue recognition model for all contracts with customers.  The standard is principle-based and provides a five-step model to determine the measurement of revenue and timing of when it is recognized. The core principle is that a company will recognize revenue to reflect the transfer of goods or services to customers at an amount that the company expects to be entitled to in exchange for those goods or services. This standard is to be applied retrospectively and is effective for fiscal years beginning after December 15, 2016. The Company is evaluating the impact that this standard will have on its consolidated financial statements.

 

In June 2014, the FASB issued authoritative guidance which eliminates the concept of a development stage entity. The incremental reporting requirements for presenting the development stage operations and cash flows since inception will no longer apply to development stage entities. The amendments related to the elimination of inception-to-date information and the other remaining disclosure requirements of Topic 915 are to be applied retrospectively and are effective for fiscal years beginning after December 15, 2014. The Company is evaluating the impact that this standard will have on its consolidated financial statements.

 

In June 2014, the FASB issued authoritative guidance on stock compensation, which requires performance targets that affect vesting and can be achieved after the requisite service period, to be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If achievement of the performance target becomes probable before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. The amendments are effective for fiscal years beginning after December 15, 2015. The Company is evaluating the impact that this standard will have on its consolidated financial statements.

 

3.

Inventory

 

Inventory represents finished goods and work in progress. Finished goods and work in progress consist primarily of specifically identifiable items that are valued at the lower of cost or fair market value using the first-in, first-out (FIFO) method. Inventory consists of the following at:

 

Inventory:		June 30, 2014				December 31, 2013
Finished goods		$	72,360			$	360,607
Work in progress			433,189				104,727
Total Inventory		$	505,549			$	465,334

 

4.

Property and Equipment

 

Property and equipment and leasehold improvements are capitalized at cost and depreciated using the straight-line method (the Company used the double-declining balance method for property and equipment placed in service prior to January 2011) over estimated lives as follows:

 

Equipment		5 - 10 years
Vehicle		5 years
Leasehold improvements		3 years
Software		3 years

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

4.

Property and Equipment (continued)

 

Property and equipment consists of the following at:

 

		June 30, 2014				December 31, 2013
Lab equipment		$	7,283,806			$	6,620,662
Computer equipment			600,318				563,976
Office equipment and vehicle			248,490				248,490
Leasehold improvements			477,682				477,682
			8,610,296				7,910,810
Accumulated depreciation			(5,430,200	)			(5,024,634	)
Property and equipment, net		$	3,180,096			$	2,886,176

 

For the three and six months ended June 30, 2014, depreciation expense was $224,455 and $430,528, respectively compared to $207,432 and $412,184 for the three and six months ended June 30, 2013.

 

5.

Bank Line of Credit

 

The Company has a line of credit that is authorized to $3,000,000 and payable on demand. The interest rate is variable and is .75% plus prime with a minimum rate of 5.87%. The line of credit is subject to an annual review and certain covenants. At June 30, 2014, the balance was $3,000,000 compared to $2,725,000 at December 31, 2013 with interest payable at 5.87% and all covenants had been met. Borrowings under the line are secured by the personal guarantee of three board members and the estate of a former board member.

 

6.

Loans Payable to Stockholders

 

On August 6, 2013, the Company entered into the Note and Warrant Purchase Agreement (the “Summit Agreement”) with Summit Resources, Inc. (“Summit”), an affiliate of Steve Antoline, a director of the Company, pursuant to which Summit acquired (a) a promissory note (the “Summit Note”) bearing simple interest at a rate of 10% per annum, in an aggregate principal amount of $600,000 and (b) a five year warrant to purchase 1,000,000 shares of common stock at an exercise price of $1.10 per share. The fair value of these warrants was estimated to be $134,117, which was recorded as a discount to the promissory note, and will be accreted based on the repayment of the obligation. In accordance with the terms of the Summit Agreement, up to $150,000 of the gross proceeds received by the Company from the sale of each LAESI instrument shall be used to repay the principal amounts due under the Summit Note. The Company repaid $174,166 as of June 30, 2014. Accretion expense of $38,931 was recognized during the six months ended June 30, 2014, while no accretion expense was recorded in 2013. The outstanding balance, net of discount, was $330,648 as of June 30, 2014.

 

From March 26, 2014 through June 30, 2014, the Company received advances equal to an aggregate of $835,000 from Summit. On April 2, 2014, April 11, 2014, and May 30, 2014, in exchange for a portion of the advances received through June 30, 2014, the Company entered into Note and Warrant Purchase Agreements and issued (a) one-year promissory notes bearing simple interest at the rate of 10% per annum to Summit in an aggregate principal amount of $650,000 and (b) five-year warrants to purchase up to 650,000 shares of common stock at an exercise price of $0.80 per share. On June 3, 2014, the Board approved an increase in the total offering amount of the promissory notes issuable to $1,500,000 from $900,000. The fair value of these warrants was estimated to be $67,670, which was recorded as a discount to the promissory note, and will be accreted based on the repayment of the obligation. The outstanding balance, net of discount, was $767,330 as of June 30, 2014. Subsequent to June 30, 2014, the Company received an additional advance of $115,000 from Summit. On July 8, 2014, in exchange for the remaining balance of advances equal to an aggregate of $300,000, the Company issued a) one-year promissory notes to Summit in an aggregate principal amount of $300,000 and b) five-year warrants to purchase up to 300,000 shares of common stock at an exercise price of $0.80 per share. (See Note 18, Subsequent Events.)

 

From March 5, 2014 through June 30, 2014, the Company received advances equal to an aggregate of $95,000 from Stanley Hostler, a director of the Company. No terms of repayment have been specified on the aforementioned advances as of the filing date. In addition, the Company received advances equal to an aggregate of $20,000 from Steve Turner, a director and CEO of the Company. No terms of repayment have been specified on the aforementioned advances as of the filing date.

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

6.

Loans Payable to Stockholders (continued)

 

From March 13, 2014 through June 30, 2014, the Company received advances equal to an aggregate of $1,075,000 from El Coronado Holdings, LLC, (“El Coronado”), Scott Segal and Leo Harris. Josiah Austin is the managing member of El Coronado and a director of the Company. Scott Segal and Leo Harris are also directors of the Company. On April 2, 2014, the Board approved an offering of up to $300,000 in convertible one year promissory notes. On June 3, 2014, the Board approved an increase in the total offering amount of convertible notes issuable to $2,000,000 (the “Related Party Offering”). In exchange for each advance, the Company entered into a Note Purchase Agreement, and issued a convertible one-year promissory note bearing simple interest at a rate of 10% per annum to the director. Each $100,000 of outstanding principal and accrued unpaid interest underlying the note is automatically convertible into securities of the Company issued in a subsequent financing pursuant to which the Company raises at least $2,000,000 in gross proceeds (“Subsequent Financing”) at a conversion price that shall be equal to the purchase price payable for the securities issued in any such Subsequent Financing.

 

7.

Obligation Related to the Letter of Credit

 

On March 6, 2013, the Company entered into a Warrant Purchase and Reimbursement Agreement, (the “Reimbursement Agreement”) with Steve Antoline, a director of the Company, pursuant to which Mr. Antoline agreed to issue a letter of credit, dated February 25, 2013 (the "Letter of Credit") for the benefit of MPR Associates, Inc. ("MPR") for the purpose of guaranteeing an amount equal to $600,000 (the “Purchase Order Amount”) due by the Company to MPR in connection with the production of certain LAESI instruments in exchange for (a) the agreement by the Company to reimburse Mr. Antoline for any amounts paid by him on behalf of the Company pursuant to the Letter of Credit, up to the Purchase Order Amount and (b) a five-year warrant to purchase up to 1,100,000 shares of common stock, issued to an affiliate of Mr. Antoline. The fair value of these warrants was estimated to be $138,763, which was recorded as a discount to the Reimbursement Agreement balance of $600,000, and has been accreted based on the repayment of the obligation. Accretion expense of $55,204 was recognized during the six months ended June 30, 2014 while $83,559 was recognized in 2013. During the first quarter of 2013, MPR drew $600,000 against the Letter of Credit. On April 4, 2014, the Company repaid $90,835 to Mr. Antoline and the Letter of Credit was paid in full.

 

8.

Long-term Debt

 

1)

Note Payable to the West Virginia Development Office (“WVDO”)

In March 2007, the Company obtained an 8-year loan in the amount of $685,000 from the WVDO. The note bears interest at 3% providing for 96 monthly principal and interest payments of $8,035 through April 2015, at which time the note is due and payable. The note is secured by equipment costing $1,057,167. As of June 30, 2014, the Company was in arrears on the note. The repayment terms were modified, whereby the WVDO approved a deferral of principal and interest until August 29, 2014.

 

2)

Note Payable to the West Virginia Economic Development Authority (“WVEDA”)

In August 2009, the Company obtained a 10-year loan in the amount of $242,631 from the WVEDA. The note bears interest at 4% providing for 120 monthly principal and interest payments of $2,457 through August 2019, at which time the note is due and payable. The note is secured by 50% of equipment costing $569,812. As of June 30, 2014, the Company was in arrears on the note. The repayment terms were modified, whereby the WVEDA approved a deferral of principal and interest until August 31, 2014.

 

3)

Note Payable to the West Virginia Infrastructure and Jobs Development Council (“WVIJDC”)

In August 2009, the Company obtained a 10-year loan in the amount of $242,630 from the WVIJDC. The note bears interest at 3.25% providing for 120 monthly principal and interest payments of $2,371 through August 2019, at which time the note is due and payable. The note is secured by 50% of equipment costing $569,812. As of June 30, 2014, the Company was in arrears on the note. The repayment terms were modified, whereby the WVIJDC approved a deferral of principal and interest until August 29, 2014.

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

8.

Long-term Debt (continued)

 

4)

Note Payable to the West Virginia Economic Development Authority (“WVEDA”)

In October 2010, the Company issued a 10-year note in the amount of $900,000 from the WVEDA. The note bears interest at 3.26% providing for 120 monthly principal and interest payments of $8,802 through October 2020, at which time the note is due and payable. The note is secured by equipment costing $997,248. As of June 30, 2014, the Company was in arrears on the note. The repayment terms were modified, whereby the WVEDA approved a deferral of principal and interest until August 31 2014.

 

5)

Note Payable to the West Virginia Infrastructure and Jobs Development Council (“WVIJDC”)

In December 2010, the Company issued a 10-year note in the amount of $900,000 from the WVIJDC. The note bears interest at 3.25% providing for 120 monthly principal and interest payments of $8,781 through December 2020, at which time the note is due and payable. The note is secured by equipment costing $1,098,249. As of June 30, 2014, the Company was in arrears on the note. The repayment terms were modified, whereby the WVIJDC approved a deferral of principal and interest until August 29, 2014.

 

6)

Convertible Promissory Note Payable to the West Virginia Jobs Investment Trust Board (“WVJITB”)

In March 2012, the Company issued an 18-month note in the amount of $290,000 from the WVJITB. The note bears interest at 6% providing for monthly interest-only payments starting April 2012 through August 2013, then final interest and principal payments due September 2013. The note has an adjustable conversion price, initially $2.00 per share, and includes a stock warrant for 72,500 shares (see Note 9, Stock Warrants). On December 13, 2013, the Company and the WVJITB entered into a Loan Modification Agreement whereby the maturity date changed from September 14, 2013 to $100,000 due on March 15, 2014 and the remaining $190,000 due on June 15, 2014. The WVJITB and the Company signed three addendums to the note extending the maturity date and deferring interest and principal payments until August 29, 2014. C. Andrew Zulauf, an executive member of the WVJITB, is a board member of the Company.

 

7)

Convertible Promissory Note Payable to the West Virginia Jobs Investment Trust Board (“WVJITB”)

In April 2012, the Company issued a 3-month note in the amount of $400,000 from the WVJITB. The note bears interest at 10% providing for monthly interest-only payments starting May 2012 through June 2012, then final interest and principal payments due July 2012. The note includes a stock warrant for 88,889 shares (see Note 9, Stock Warrants). The WVJITB and the Company have signed several addendums to the note extending the maturity date and reducing the price of converting into common shares to $0.50 per share. The WVJITB further extended the maturity date until November 29, 2013, with a $100,000 principal payment due on or before November 15, 2013. The Company repaid the $100,000 as agreed, which reduced the principal outstanding balance to $300,000. The WVJITB and the Company signed four addendums to the note extending the maturity date and deferring interest and principal payments until August 29, 2014. C. Andrew Zulauf, an executive member of the WVJITB, is a board member of the Company.

 

8)

Convertible Promissory Note Payable to the West Virginia High Technology Consortium Foundation (“WVHTCF”)

In May 2012, the Company issued a 30-month note in the amount of $200,000 from the WVHTCF. The note bears interest at 8% providing for 25 monthly principal and interest payments of $9,001 starting December 2012 through November 2014, then final interest and principal payments due December 2014. The note is secured by 50% of equipment costing $447,320. As of June 30, 2014, the Company was in arrears on the note. The repayment terms were modified, whereby the West Virginia High Technology Consortium Foundation approved a deferral of principal and interest until August 29, 2014.

 

9)

Note Payable to the West Virginia Economic Development Authority (“WVEDA”)

In June 2012, the Company issued a 10-year note in the amount of $200,000 from the WVEDA. The note bears interest at 2% providing for 120 monthly principal and interest payments of $1,840 through June 2022, at which time the note is due and payable. The note is secured by 50% of equipment costing $447,320. As of June 30, 2014, the Company was in arrears on the note. The repayment terms were modified, whereby the West Virginia Economic Development Authority approved a deferral of principal and interest until August 31, 2014.

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

8.

Long-term Debt (continued)

 

10)

Convertible Debentures

In addition to the related party convertible promissory notes, the Company also issued an aggregate of $183,500 under the Related Party Offering (see Note 6, Loans Payable to Stockholders.) In exchange for each advance, the Company entered into a Note Purchase Agreement, and issued a convertible one-year promissory note to the stockholders, in the aggregate principal amount of $183,500 to accrue simple interest at the rate of 10% per annum.

 

11)

Capital Leases

From time to time, in the normal course of business, the Company enters into capital leases to finance equipment. As of June 30, 2014, the Company had three capital lease obligations outstanding with imputed interest rates ranging from 6.0% to 7.74%. The leases require 36 monthly payments and begin to expire in April 2014 through May 2017. These leases are secured by equipment with an aggregate cost of $834,593. As of June 30, 2014, the Company was in arrears on two capital leases.

 

12)

Other Short Term Promissory Notes

On April 24, 2014, the Company issued a 3-month promissory note of $100,000 to BioPharma d’Azur, Inc. (the “Buyer”). The note bears interest at 6% per annum. On June 13, 2014, the note was cancelled by the Buyer pursuant to the contingent sale of Protea Europe to the Buyer and reduced from cash consideration paid to the Company. (See Note 17, Contingent Subsidiary Sale.)

 

Total debts outstanding are as follows:

 

		June 30, 2014				December 31, 2013
1)      Note Payable to the WVDO		$	123,744			$	123,744
2)      Note Payable to the WVEDA			147,306				147,306
3)      Note Payable to the WVIJDC			145,078				145,078
4)      Note Payable to the WVEDA			639,085				639,085
5)      Note Payable to the WVIJDC			651,913				651,913
6)      Note Payable to the WVJITB			290,000				290,000
7)      Note Payable to the WVJITB			300,000				300,000
8)      Note Payable to the WVHTCF			95,178				95,178
9)      Note Payable to the WVEDA			170,932				170,932
10)   Convertible Debentures			183,500				-
11)   Capital leases			381,757				71,077
Total			3,128,493				2,634,313
Less: current portion			(1,472,957	)			(1,054,053	)
Long-term portion		$	1,655,536			$	1,580,260

 

Future required minimum principal repayments over the next five years are as follows:

 

Year Ending December 31:		Future Required Minimum Principal Repayments
2014		$	1,257,313
2015			390,360
2016			360,217
2017			345,839
2018 & Thereafter			774,764
Total		$	3,128,493

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

9.

Common Stock

 

The Company is authorized to issue a total of 210,000,000 shares of stock, of which 200,000,000 shares are designated common stock and 10,000,000 shares designated preferred stock.

 

Common Stock – par value of $.0001 per share with one vote in respect of each share held. Holders of common stock do not have cumulative voting rights. The members of the Board of Directors are elected by the affirmative vote of the holders of a majority of the Company’s outstanding common stock. Common stock issued are as follows:

 

		# Shares Issued				Par Value				Price Per Share				Gross Proceeds				Value of Services Obtained				Par Value				Additional Paid in Capital (1)
Balance at December 31, 2013			65,442,735			$	.0001				Various			$	53,694,771			$	829,132			$	6,545			$	54,517,358
Issuance of stock (2)			562,348				.0001				Various				-				465,542				56				465,486
Stock warrants exercised (3)			8,517				.0001			$	1.77				-				-				1				(1	)
Balance at June 30, 2014			66,013,600											$	53,694,771			$	1,294,674			$	6,602			$	54,982,843

 

(1)

Activity does not include issuance costs, deferred financing, warrants portion of convertible debentures and stock options.

 

(2)

Shares issued for services performed and did not contain an anti-dilution provision

 

(3)

Shares issued under cashless stock warrant exercise and did not contain an anti-dilution provision

 

10.

Preferred Stock

 

The Company is authorized to issue preferred stock, par value $0.0001 per share, in one or more series and containing such rights, privileges and limitations, including voting rights, dividend rates, conversion privileges, redemption rights and terms, redemption prices and liquidation preferences, as the Board may, from time to time, determine. No shares of the Preferred Stock have been issued.

 

11.

Stock Options and Stock-based Compensation

 

In 2002, the Board adopted the 2002 Equity Incentive Plan (the “2002 Plan”) that governed equity awards to employees, directors and consultants of the Company. Under the 2002 Plan, 450,000 shares of common stock were reserved for issuance. From 2006 through 2012, the 2002 Plan was amended several times to increase the total number of shares authorized under the 2002 Plan to 4,150,000 shares. During the first quarter 2013, the Board adopted the 2013 Equity Incentive Plan (the “2013 Plan”) and together with the 2002 Plan (the “Plans”) governs the equity awards to employees, directors and consultants of the Company. Under the 2013 Plan, an additional 5,000,000 shares of common stock has been reserved for issuance. On June 18, 2013, the 2013 Plan was approved by holders of a majority of the issued and outstanding shares of common stock of the Company.

 

The types of awards permitted under the Plans include qualified incentive stock options (ISO), non-qualified stock options (NQO), and restricted stock. Each option shall be exercisable at such times and subject to such terms and conditions as the Board may specify. Stock options generally vest over four years and expire no later than ten years from the date of grant.

 

A summary of stock option activity is as follows:

 

		Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Life (in years)
Outstanding at December 31, 2013			5,082,750			$	1.11				7.02
Granted			2,347,000			$	0.55
Exercised			-				-
Cancelled or expired			(207,500	)		$	1.50
Outstanding at June 30, 2014			7,222,250			$	0.92				7.51
Exercisable at December 31, 2013			4,005,583			$	1.20				6.52
Exercisable at June 30, 2014			4,433,956			$	1.14				6.30

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

11.

Stock Options and Stock-based Compensation (continued)

 

The following table summarizes information about stock options at June 30, 2014:

 

Options Outstanding																Options Exercisable
Exercise Price				Outstanding				Weighted Average Remaining Contractual Life (in years)				Weighted Average Exercise Price				Exercisable				Weighted Average Exercise Price
$	0.50				159,000												121,250
$	0.55				4,040,000												1,369,956
$	0.80				320,000												320,000
$	1.25				310,000												310,000
$	1.50				2,178,500												2,098,000
$	2.00				214,750												214,750
	$0.50 - $2.00				7,222,250				7.51			$	0.92				4,433,956			$	1.14

 

At June 30, 2014 and December 31, 2013, the total aggregate intrinsic value for options currently exercisable and options outstanding was $0. These values represent the total pre-tax intrinsic value based on the estimated fair value of the Company’s stock price of $0.50 as of June 30, 2014 and December 31, 2013. In 2014 and 2013, no options were exercised.

 

The following table summarizes the activity of the Company’s stock options that have not vested:

 

		Shares				Weighted Average Grant-date Fair Value
Nonvested at December 31, 2013			1,077,167			$	0.467
Granted			2,129,127			$	0.206
Forfeited			(81,250	)		$	1.026
Vested			(336,750	)		$	0.513
Nonvested at June 30, 2014			2,788,294			$	0.375

 

The fair value of non-vested options to be recognized in future periods is $612,213, which is expected to be recognized over a weighted average period of 2.4 years. The total fair value of options vested during the six months ended June 30, 2014 was $179,049 compared to $154,340 for the six months ended June 30, 2013. Stock-based compensation expense is as follows:

 

		Six Months Ended
		June 30, 2014				June 30, 2013
Selling, general, and administrative expense		$	163,541			$	142,532
Research and development expense			15,508				11,808
Total stock-based compensation expense		$	179,049			$	154,340

 

The weighted average grant-date fair value of options granted during the six months ended June 30, 2014 was $0.206 and for the six months ended June 30, 2013 was $0.112 per option. The fair value of the option grants was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:

 

		Six Months Ended
		June 30, 2014				June 30, 2013
Weighted average risk-free interest rate			1.91	%			0.15	%
Volatility factor			69.96	%			24 - 73	%
Weighted average expected life (in years)			7				7
Dividend rate			0.0	%			0.0	%

 

The Company utilizes a peer group to estimate its expected volatility assumptions used in the Black-Scholes option-pricing model. The Company completed an analysis and identified four similar companies considering their industry, stage of life cycle, size, and financial leverage. Given the Company’s limited history with stock options, the Company’s expected term is based on an average of the contractual term and the vesting period of the options (the SAB 110 “Simplified” method).

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

12.

Stock Warrants

 

From 2008 through 2014, the Company issued warrants to purchase shares of common stock. The warrants are exercisable for five years from date of issuance and are exercisable at exercise prices that range from $0.50 to $2.25 per share.

 

During 2013, the Company issued warrants mostly in connection with common stock issuances. The warrants are exercisable one or five years from date of issuance. The exercise price is $0.50 to $1.10 per share. The warrant allows the holder to purchase shares of common stock, and contains anti-dilution provisions that adjust the exercise price if certain equity instruments are issued (subject to certain exceptions) at a value below the then-existing exercise price of the warrants. The anti-dilutive provisions have an expiration term of either one or five years from date of issuance. The anti-dilutive provision on 7,592,400 warrants expired on December 31, 2013.

 

As of June 30, 2014, warrants to purchase 57,240,937 shares of common stock were outstanding and exercisable. The Company recognized a total of $125,645 in interest expense and $49,921 in consulting services during the six months ended June 30, 2014 and $537,137 in placement agent services as of December 31, 2013 as a result of issuing an aggregate of 3,720,323 warrants earned in 2014.

 

		Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Life (in years)
Outstanding at December 31, 2013			52,705,614			$	1.30				2.58
Granted			4,557,823			$	0.79				4.63
Exercised			(22,500	)			-
Cancelled or expired			-				-
Outstanding at June 30, 2014			57,240,937			$	1.27				2.77

 

The following table summarizes information about stock warrants at June 30, 2014:

 

Warrants Outstanding
Exercise Price				Outstanding				Weighted Average Remaining Contractual Life (in years)				Weighted Average Exercise Price
$	0.50				15,524,642
$	0.75				11,065,144
$	0.80				650,000
$	1.10				18,886,850
$	1.12				263,750
$	2.00				9,455,842
$	2.20				98,320
$	2.25				1,296,389
	$0.50 - $2.00				57,240,937				2.77			$	1.27

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

13.

Income Taxes

 

The provision for income taxes, if any, is comprised of current and deferred components. The current component, if any, presents the amount of federal and state income taxes that are currently reportable to the respective tax authorities and is measured by applying statutory rates to the Company’s taxable income as reported in its income tax returns. The Company has evaluated its income tax positions in accordance with FASB ASC 740. There were no changes to unrecognized tax benefits during 2013. The tax years 2009 through 2012 remain open to review by various taxing authorities.

 

ASC Topic 740, Income Taxes defines the confidence level that a tax position must meet in order to be recognized in the financial statements. Accordingly, we have assessed uncertain tax positions in each of the tax jurisdictions in which we have operations and account for the related financial statement implications. We 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 on a particular tax position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. The amount of unrecognized tax benefits is adjusted as appropriate for changes in facts and circumstances, such as significant amendments to existing tax law, new regulations or interpretations by the taxing authorities, new information obtained during a tax examination, or resolution of an examination. We recognize both accrued interest and penalties, where appropriate, related to unrecognized tax benefits in income tax expense.

 

Significant management judgment is required in determining the provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded in connection with the deferred tax assets.

 

Deferred income taxes are provided for the temporary differences between the carrying values of the Company’s assets and liabilities for financial reporting purposes and their corresponding income tax basis. These temporary differences are primarily attributable to a net operating loss, which, due to income tax laws and regulations, become taxable or deductible in different years than their corresponding treatment for financial reporting purposes. The temporary differences give rise to either a deferred tax asset or liability in the financial statements, which is computed by applying statutory tax rates to taxable or deductible temporary differences based upon the classification (i.e., current or noncurrent) of the asset or liability in the financial statements which relate to the particular temporary difference. Deferred taxes related to differences that are not attributable to a specific asset or liability are classified in accordance with the future period in which they are expected to reverse and be recognized for income tax purposes.

 

During the development stage of the Company when future benefit of the deferred tax asset is uncertain, the Company provides for a full valuation allowance against the deferred tax asset. Net operating loss carryforwards start to expire beginning 2021 for both federal and state purposes. The net operating tax loss carryforwards total approximately $54,800,000 and $50,000,000 at June 30, 2014 and December 31, 2013, respectively.

 

14.

Lease Commitments

 

The Company leases its USA facilities under operating leases beginning a) April 2012 through March 2017 and b) a month-to-month lease. Additionally, the Company leases its Europe facility on a three-year lease beginning January 2012 through January 2015. The Company also has three equipment operating leases with terms of three to five years.

 

Future required minimum principal repayments over the next five years are as follows:

 

Year ending December 31:		Future required minimum lease payments
2014 (payment in arrears)		$	156,931
2014		$	83,816
2015		$	167,628
2016		$	167,628
2017		$	41,907

 

Rent expense totals $94,220 for the three months ended and $189,048 for the six months ended June 30, 2014, compared to $108,036 for the three months ended and $217,534 for the six months ended June 30, 2013.

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

15.

Retirement Plan

 

The Company provides a 401(k) Profit Sharing Plan (“401(k) Plan”) for elective deferrals whereby participants can defer up to 85% of their wages not to exceed a maximum dollar amount determined by the Federal Government each year. The Company, at its discretion, can make matching contributions to the 401(k) Plan. The Company may also make qualified non-elective contributions to participants who are not highly compensated employees. All employees meeting age and hours of service requirements are eligible to participate in the 401(k) Plan immediately upon hire. Participants become vested in employer contributions on a graduated scale with full vesting after five years. No company contributions have yet been made.

 

16.

Commitments and Contingencies

 

Legal Proceedings

 

The Company currently is not a party to any material legal proceeding and has no knowledge of any material legal proceeding contemplated by any governmental authority or third party. The Company may be subject to a number of claims and legal proceedings which, in the opinion of our management, are incidental to normal business operations. In managements’ opinion, although final settlement of these claims and suits may impact the financial statements in a particular period, they will not, in the aggregate, have a material adverse effect on the Company’s financial position, cash flows or results of operations.

 

Indemnity of Directors and Officers

 

As permitted under Delaware law and required by corporate by-laws, the Company indemnifies and holds harmless its directors and officers for certain events or occurrences while the director or officer is or was serving in such capacity. The maximum potential amount of future payments that could be required under these indemnification obligations is unlimited; however, the Company maintains a Directors and Officers liability insurance policy that enables it to recover a portion of any future amounts paid with a limit of liability of $5,000,000.  The Company may incur an additional liability if indemnity for more than the limit of liability occurred, and such liability may have a material adverse effect on its financial position, cash flows and results of operations. As there were no known or pending claims, the Company has not accrued a liability for such claims as of June 30, 2014.

 

Warranty Costs

 

The Company provides for a one year warranty with the sale of its LAESI instrument. All other product warranties are 90 days from the date of delivery of the goods. As the Company does not currently have sufficient historical data on warranty claims, the Company's estimates of anticipated rates of warranty claims and costs are primarily based on comparable industry metrics. The Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its product. As of June 30, 2014, the Company recorded accrued warranty expense of $97,500 compared to $81,250 as of December 31, 2013.

 

Stock Options

 

The Company has an agreement with one board member for payment of services by stock options. The board member is to receive a stock option for 4,000 shares per month (awarded annually) with an exercise price equal to the current market price. The agreement is cancellable with 90 days’ notice. This agreement terminated on March 31, 2014.

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

16.

Commitments and Contingencies (continued)

 

University License Agreements

 

The Company has agreements with universities related to in-licensed technologies as follows:

 

AGREEMENT WITH WEST VIRGINIA UNIVERSITY (WVU)

The Company has entered into a License and Exclusive Option to License Agreement with the West Virginia University Research Corporation, a nonprofit West Virginia corporation (“WVURC”) acting for and on behalf of WVU. Under the terms of this Agreement, the WVURC has granted the Company an exclusive option to license technology from the laboratories of certain WVU principal investigators in the field of protein discovery, for therapeutic, diagnostic and all other commercial fields worldwide.

 

Under the terms of this Agreement, the Company pays expenses for the preparation, filing and prosecution of related patent applications, and the Company will pay royalties on the net revenue resulting from the sale of products and services that utilize the WVU subject technology.

 

AGREEMENT WITH GEORGE WASHINGTON UNIVERSITY (GWU)

In March 2009, the Company entered into an Exclusive License Agreement with George Washington University (Washington D.C.) for technology developed in the laboratory of Dr. Akos Vertes Ph.D., Professor of Chemistry, Professor of Biochemistry & Molecular Biology, Founder and Co-Director of the W.M. Keck Institute for Proteomics Technology and Applications, the Department of Chemistry, who is a science advisor to the Company. The technology field is LAESI - laser ablation electrospray ionization, a new method of bioanalytical analysis that enables high throughput biomolecule characterization.

 

Under the terms of the license agreement, the Company has the exclusive, worldwide rights to commercialize the technology. The Company is obligated to pay expenses for the preparation, filing and prosecution of related patent applications, and the Company will pay royalties on the net revenues resulting from the sale of products and services that utilize the GWU subject technology. As of June 30, 2014, the Company accrued approximately $54,795 to GWU for royalties compared to $32,600 as of December 31, 2013.

 

In November 2012, the Company entered into a Patent License Agreement with George Washington University (Washington D.C) for technology developed in the laboratory of Akos Vertes Ph.D. The technology field is Laser Desorption/Ionization and Peptide Sequencing on Laser-Induced Silicon Microcolumn Arrays (Matrix) and Nanophotonic Production, Modulation and Switching of Ions by Silicon Microcolumn Arrays.

 

Under the terms of the license agreement, the Company has an exclusive, worldwide license to make, have made, use, import, offer for sale and sell the licensed products. The Company is obligated to pay a license initiation fee of $25,000 and a minimum license diligence resources of $12,500 in year two and $20,000 each year thereafter to develop and commercialize the products, $30,000 milestone payment upon the first sale of a licensed product, and royalties will be 7% of the net sales of licensed products and 5% of the net sales of combination products for combined cumulative net sales up to $50 million. Thereafter, royalties reduce to 6% and 4%, respectively, after taking into account quarterly minimum royalties of $1,500 for the first four quarters after the first sale of a licensed product, $2,500 for the next four quarters, $3,000 for the next four quarters and $6,000 for each succeeding quarter.

 

In January 2014, the Company became a subcontractor to George Washington University in a multi-year project with the Defense Advanced Research Projects Agency (DARPA) to develop new tools and methods to elucidate the mechanism of action of a threat agent, drug, biologic or chemical on living cells within 30 days of exposure.

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

16.

Commitments and Contingencies (continued)

 

AGREEMENT WITH OMICS2IMAGE

In 2014, the Company entered into an agreement with Omics2Image related to the “Next Generation Ambient Imaging Mass Spectrometry for (Bio)polymers and Smart Materials” (“COAST Project”). The Company has committed to fund 60,000 Euros or $82,000 related to the COAST Project over the next twelve month period. Omics2Image agrees to evenly share the value gained from the efforts outlined within the scope of the COAST Project, which may include new intellectual property and the development of a commercial, integrated instrument system.

 

Joint Pharmaceutical Development Agreement

 

In May 2009, the Company, and its wholly-owned subsidiary, Protea Europe, entered into a Joint Research and Development Agreement with Laboratories Mayoly Spindler SAS (Mayoly), a European Pharmaceutical company with headquarters in France, for the joint development of a recombinant lipase biopharmaceutical. Under the terms of the agreement, Protea received the exclusive marketing rights for the therapeutic in the territory of North America; was responsible for paying (a) 40% of the development expenses (with Mayoly funding the remaining 60%); (b) royalties on net sales of the biopharmaceutical, and (c) a milestone payment of 1m Euros at the time the Company obtains the first FDA approval for the recombinant Lipase biotherapeutic. The Company also received a sublicense to certain patents owned by Mayoly and licensed from the government of France. As of June 30, 2014 and December 31, 2013, the Company owed approximately $37,000 to Mayoly, which is reflected in Trade Accounts Payable on the Consolidated Balance Sheet. On June 13, 2014, the Company agreed to sell 100% of the issued and outstanding equity securities of Protea Europe and all of the Company’s rights and obligations under development agreement were transferred to the Buyer. (See Note 17, Contingent Subsidiary Sale.)

 

Engineering and Design Services

 

The Company has engaged Dynamic Manufacturing LLC, a contract manufacturer to produce ten LAESI units. As of June 30, 2014, the Company had received three LAESI units from Dynamic. As of June 30, 2014, the Company had $373,300 in outstanding commitments with Dynamic as well as approximately $269,400 in payables due to Dynamic.

 

The Company has approximately $113,100 in outstanding commitments with Bridger Photonics for lasers related to the LAESI technology. At June 30, 2014, the Company owed approximately $58,000 in payables due to Bridger.

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

17.

Contingent Subsidiary Sale

 

On June 13, 2014, the Company closed on an agreement for the sale of 100% of the issued and outstanding capital stock of Protea Europe to the Buyer pursuant to the terms of a Stock Purchase and Sale Agreement (the “SPA”), dated as of May 21, 2014. Under the terms of the SPA, the Company received the following consideration:

 

i.

an aggregate amount of $300,000 (the “Purchase Price”) including $200,000 in cash and $100,000 from the forgiveness of outstanding indebtedness of the Company owed to the Buyer;

ii.

100 shares of Series A Preferred Stock of the Buyer (the “Preferred Stock”) that is convertible into 33% of the issued and outstanding common stock of the Buyer; and

iii.

the right to receive certain other contingent consideration to be paid upon the satisfaction of certain events, including (a) a one-time milestone payment of $2,000,000 due within (10) days of receipt of the first approval by the FDA of a New Drug Application or Biologics License Application for a Business Product; (b) royalty payments equal to 2.5% of net sales of Business Product up to $100,000,000 and 1.5% of net sales of Business Product in excess of $100,000,000 and (c) ten percent (10%) of the Transaction Value received in connection with a sale or transfer of the pharmaceutical development business of Protea Europe.

 

In connection with the closing, the Company assigned (i) to Protea Europe all of its rights, assets, know-how and intellectual property rights in connection with program PR1101 and those granted under the Joint Research and Development Agreement with Laboratoires Mayoly Spindler SAS dated March 22, 2010 and (ii) to the Buyer all amounts, together with any right of reimbursement, due to the Company in connection with outstanding shareholder loans.

 

In the event the Buyer has not raised gross proceeds from an equity or equity-linked financing of at least $2 million on or before the date that is 6 months following the Closing Date (“Reversion Date”), all funds raised in such financing through the Reversion Date will revert to the Company and the Preferred Stock issued to the Company will be forfeited (the “Reversion”), and the Company will retain its ownership of Protea Europe. In the event of a Reversion, the Company will issue shares of its common stock to the Buyer equal to the total dollar amount raised by the Buyer through the Reversion Date plus the Purchase Price and the $300,000 option fee paid on March 27, 2014, at a per share price equal to the greater of $0.55 or the 20 day volume weighted average price of the Company’s common stock. The potential transaction is not included in the June 30, 2014 financial statements due to contingency of full consummation. Thijs Spoor, a director of the Company, is also the sole director of the Buyer’s board of directors.

 

18.

Evaluation of Subsequent Events

 

Common Stock

 

Subsequent to June 30, 2014, the Company issued 250,000 shares of common stock to numerous consultants for services rendered.

 

Stock Options

 

Subsequent to June 30, 2014, the Company granted options to purchase an aggregate of 57,500 shares of common stock to various employees in connection with the Company’s 2013 Equity Incentive Plan at an exercise price of $0.55 per share.

 

Issuance of Related Party Promissory Notes and Stock Warrants to Purchase Common Stock

 

Subsequent to June 30, 2014, the Company issued notes in an aggregate principal amount of $365,000 and warrants to purchase up to 365,000 shares of common stock to Summit, in connection with the July 8, 2014 and August 1, 2014 Promissory Notes.

 

Advances from Stockholders

 

Subsequent to June 30, 2014, the Company received advances equal to an aggregate of $75,000 from certain current directors and related parties. No terms of repayment have been specified on the aforementioned advances as of the filing date.

 

 

PROTEA BIOSCIENCES GROUP, INC. (A DEVELOPMENT STAGE ENTERPRISE) 

 

Notes to Consolidated Financial Statements (unaudited)

 

18.

Evaluation of Subsequent Events (continued)

 

Issuance of Convertible Debentures and Warrants to Purchase Common Stock

 

Subsequent to June 30, 2014, the Company issued an additional $202,500 in convertible promissory notes as part of the $2,000,000 offering. (See Note 6, Loans Payable to Stockholders). As of the filing date, the Company has issued an aggregate of $1,461,000 in convertible notes.

 

 

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Forward-Looking Statement Notice

 

Certain statements made in this Quarterly Report on Form 10-Q are “forward-looking statements” regarding the plans and objectives of management for future operations. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of Protea Biosciences Group, Inc. (“we”, “us”, “our”, “Protea” or the “Company”) to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. The Company's plans and objectives are based, in part, on assumptions involving the continued expansion of business. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond the control of the Company. Although the Company believes its assumptions underlying the forward-looking statements are reasonable, any of the assumptions could prove inaccurate and; therefore, there can be no assurance the forward-looking statements included in this Quarterly Report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the objectives and plans of the Company will be achieved.

 

Overview of Our Business

 

Protea Biosciences Group, Inc. (referred to as “Protea”, “the Company”, “we”, “us” and “our”) is a development stage molecular information company incorporated in the state of Delaware on May 24, 2005. “Molecular information” refers to the identification and characterization of the proteins, metabolites and other biomolecules, which are the products of all living cells and life forms. The Company is applying its technology to the development of next generation, “direct molecular imaging” technology and service capabilities that it believes enable more rapid and comprehensive molecular profiling of living cells and biofluids, thereby providing better molecular information that helps to define normal and disease processes. We believe that our proprietary technology is useful to support medical research and pharmaceutical development. The Company’s technologies enable the direct molecular imaging of the proteins, metabolites and other biomolecules that regulate the biological functions of the human body and all other forms of life. Management believes this is a critical area of research, as pharmaceutical research is in need of direct molecular imaging to improve and accelerate the development of new therapeutics and diagnostic tests.

 

Our Business Strategy and Products

 

The Company applies its core technologies and expertise to the development of products and services that improve the discovery and identification of proteins, metabolites and other biomolecules produced by living cells. Our products and services are purchased and used primarily by pharmaceutical and academic/clinical research laboratories, including analytical chemists, translational researchers, oncologists, pathologists and cell biologists.

 

Our commercial offering is organized as follows:

 

Molecular Information Technologies

 

In 2012, Protea completed the development of a novel bioanalytical instrument platform known as “LAESI” (laser ablation electrospray ionization) and commenced commercial availability of the DP-1000 instrument. This technology enables the direct identification of proteins, lipids and metabolites in tissue, cells and biofluids, such as serum and urine, without any sample preparation prior to analysis. By eliminating sample preparation, the biological sample can be analyzed without the possible contamination, bias or sample loss that occurs with the current techniques, which require the introduction of chemicals, or the destruction of the sample itself, in order to enable analysis by mass spectrometry. LAESI then can display the data obtained by mass spectrometry analysis combined with actual images of the tissue and cell samples. Thus, mass spectrometry data can be evaluated in the context of the biology of the sample; this allows the integration of mass spectrometry data with current pathology and microscopic imaging techniques. Data is available in seconds to minutes, allowing rapid time to results and the capacity to analyze thousands of samples in a single work period. As an example, a researcher testing a new drug’s effects on living cells can analyze changes in the cells’ metabolism across a specific time course, thereby almost immediately obtaining data as to the activity of the new drug. The Company believes that LAESI technology has the potential to significantly improve the availability of molecular information in pharmaceutical research, as well as many other fields, including agriculture, pathology, biomarker discovery, biodefense and forensics.

 

LAESI is intended to meet the broad need of the biologist for the direct, unbiased identification and characterization of biomolecules in biological samples, which can remain untouched prior to their analysis. By virtue of LAESI’s improved speed and the comprehensive datasets it generates, the Company is pursuing its vision of what it believes will be a new era of human molecular information where the molecular pathways of human disease will be more clearly elucidated, and datasets more rapidly available, thereby accelerating pharmaceutical and life science research.

 

 

The Company offers the LAESI DP-1000, its first generation LAESI instrument, as well as software packages developed by the Company (LAESI Desktop Software and ProteaPlot™). The Company believes that our software facilitates operating the instrument, and the storage and display of molecular information datasets, in a user friendly, intuitive software environment. The LAESI and ProteaPlot™ software generate “ion maps,” which are molecule-specific images that show the location and relative abundance of specific molecules in a sample helping researchers look for new, disease-specific biomarkers, and to elucidate disease-specific pathways.

 

In addition, the Company offers an expanding line of research products that are used in bioanalytical mass spectrometry, including a family of proprietary reagents. These include Progenta™ surfactants, that can rapidly remove proteins out of biological samples and into liquid phase, preparing them for analysis by mass spectrometry; single use products, including pipette tips and 96 well plates, that employ a novel chemistry technique, known as monolith chemistry, which enables recovery of proteins from solutions, as well as removal of salts, thereby improving the quality of analysis of the proteins by mass spectrometry; and, an extensive line of protein mass spectrometry standards, which provide defined and characterized proteins representing different protein structures and classes in order to improve the reproducibility of a researcher’s bioanalytical mass spectrometry results.

 

Molecular Information Services

 

Protea offers proprietary molecular information services for the discovery and identification of both small molecules (e.g. lipids and metabolites) and large molecules (e.g. proteins). Our services unit is operated under “Good Laboratory Practices” (GLP), which are necessary for regulatory submissions and to meet the internal research and development standards of pharmaceutical research clients.

 

The Company provides LAESI mass spectrometry imaging (“LAESI-MSI”) services with the unique capabilities of our proprietary LAESI technology platform, which can directly image and display the presence of specific biomolecules in cell and tissue samples, without sample preparation. The LAESI platform technology is highly disruptive for biological investigation of tissues and living cell cultures and bacterial colonies. LAESI-MSI provides new information based on direct analysis, without the need for labeling, radioisotopes, or complex sample preparation protocols. Datasets are automatically generated, and are available in minutes, depending on the complexity of the analysis.

 

In LAESI-MSI, the chemical identity of biomarkers or other biomolecules present, for example, in a tissue, is investigated as a function of spatial distribution. This breakthrough paradigm allows accurate distribution profiling of chemical species that help to elucidate pathologies or metabolic processes underway in the specimen. The Company believes that the LAESI-MSI has the potential to significantly improve biological investigation using objective chemical data by directly visualizing the distribution of specific molecules within a cell’s structure.

 

LAESI-MSI eliminates the need for sample preparation and allows the researcher to study the biochemical landscape of a sample as it exists in nature, thereby providing native, unbiased molecular information. LAESI-MSI services are available for both 2D and 3D tissue molecular profiling, high throughput biofluid analysis, and time course studies of live cell colonies.

 

Molecular Data and Informatics Products

 

We are applying LAESI-MSI to create comprehensive, cell-based molecular information databases that will be specific to disease states and allow the integration of LAESI biomolecular datasets with the sample-related pathology, gene expression and demographic data. LAESI-MSI generates large bioinformatics datasets for improved disease state assessment and management. Our initial focus is the development of database products for oncology and neurodegenerative disease.

 

Emerging Growth Company

 

The Company is an “emerging growth company”, as defined in the Jumpstart Our Business Startups Act of 2012 (“JOBS Act”), and may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of section 404(b) of the Sarbanes-Oxley Act, and exemptions from the requirements of Sections 14A(a) and (b) of the Securities Exchange Act of 1934 to hold a nonbinding advisory vote of stockholders on executive compensation and any golden parachute payments not previously approved.

 

 

Results of Operations

 

Three and Six Months Ended June 30, 2014 Compared to Three and Six Months Ended June 30, 2013

 

For the three months ended June 30, 2014 and June 30, 2013, we earned revenue of $346,561 and $277,991, respectively, an increase of $68,570, or approximately 25%. We earned revenue of $814,661 and $759,606 for the six months ended June 30, 2014 and June 30, 2013, respectively, an increase of $55,055 or approximately 7%. During the first half of 2014, the Company realized service revenues of $229,945 compared to $114,450 for the six months ended June 30, 2013. The Company sold two LAESI units compared to three units in 2013. This decrease was offset by additional service revenue and the initiation of DARPA grant revenues in 2014.

 

For the three months ended June 30, 2014 and June 30, 2013, selling, general and administrative expenses totaled $2,746,090 and $2,023,630, respectively. This represents an increase of $722,460 or 36% from prior year. Selling, general and administrative expenses totaled $5,099,531 for the six months ended June 30, 2014 compared to $4,071,263 for the six months ended June 30, 2013, an increase of $1,028,268 or approximately 25%. The increase in selling, general and administrative expenses relates largely to increased salary and personnel costs associated with hiring new staff as well as additional services rendered by outside vendors and consultants in 2014 which was partially offset by lower cost of goods sold year over year.

 

For the three months ended June 30, 2014 and June 30, 2013, research and development expense totaled $804,030 and $844,532, respectively. This represents a decrease of $40,502 or approximately 5%. Research and development expense totaled $1,525,983 for the six months ended June 30, 2014, compared to research and development expense of $1,708,135 for the six months ended June 30, 2013, a decrease of $182,152 or approximately 11%. Research and development expenses primarily include costs associated with the development of the LAESI technology. Research and development expenses have decreased as the Company continues to transition from development to production of its research products and service offerings.

 

For the three months ended June 30, 2014 and June 30, 2013, loss from operations totaled $3,203,559 and $2,590,171, respectively. This represents an increase of $613,388 or 24% from prior period. Loss from operations totaled $5,810,853 for the six months ended June 30, 2014, compared to a loss from operations of $5,019,792 for the six months ended June 30, 2013, an increase of $791,061 or approximately 16%.

 

For the three months ended June 30, 2014 and June 30, 2013, other expense was $242,779 and $165,961, respectively. This is an increase of $76,818 or 46% from the prior period. Other expense was $367,623 for the six months ended June 30, 2014 compared to $342,167 for the six months ended June 30, 2013. Other expense increased as a result of interest expense incurred on new debt originated in 2014.

 

After foreign currency translation adjustments of ($14,304) and $12,210, respectively, total comprehensive loss was $3,460,642, or ($0.05) per share, for the three months ended June 30, 2014 as compared to a total comprehensive loss of $2,743,922, or ($0.07) per share, for the three months ended June 30, 2013. After foreign currency translation adjustments of ($13,535) and $690, respectively, total comprehensive loss was $6,192,011, or ($0.09) per share, for the six months ended June 30, 2014 as compared to a total comprehensive loss of $5,361,269, or ($0.14) per share, for the six months ended June 30, 2013.

 

Liquidity and Capital Resources

 

We have experienced negative cash flows from operations since inception. To date, our operations since inception have been funded primarily through proceeds received from the issuance of debt and sale of equity securities in private placement offerings. We have a credit facility of $3,000,000 with United Bank, Inc. with a balance of $3,000,000 outstanding as of June 30, 2014. Interest is payable monthly and the loan is due on demand. During the first half of 2014, the Company received $2,025,000 from related parties and another $183,500 from other non-related parties.

 

We will continue to require substantial funds to advance our research products and services. We intend to continue to meet our operating cash flow requirements by raising additional funds from the sale of equity or debt securities and possibly, developing corporate development partnerships to advance our molecular information technology development activities for sharing the costs of development and commercialization.  We may also consider the sale of certain assets, or entering into a transaction such as a merger with a business complimentary to ours. While we have been successful in raising funds to fund our operations since inception and we believe that we will be successful in obtaining the necessary financing to fund our operations going forward, there are no assurances that we will be able to secure additional funding. These factors raise substantial doubt about our ability to continue as a going-concern.

 

Based on our current spending levels, management estimates that, for the latter six months of 2014, the Company will need approximately $4,500,000 to maintain current operations.

 

 

As of June 30, 2014, we had total current assets equal to $1,372,805, comprised of $277,477 in cash and cash equivalents, $83,305 in trade accounts receivable, $427,827 in other receivables, $505,549 in inventory and $78,647 in prepaid expenses. This compares with total current assets of $2,508,502 at December 31, 2013 comprised of $1,086,330 in cash and cash equivalents, $216,864 in trade accounts receivable, $435,278 in other receivables, $465,334 in inventory and $304,696 in prepaid expenses.  The Company's total current liabilities as of June 30, 2014 were equal to $10,173,820, comprised of $1,472,957 in current maturities on long term debt, $2,622,848 in trade accounts payable, $3,000,000 in connection with the United Bank, Inc. line of credit, $2,287,978 in loans payable to stockholders, net of discount, and $790,037 in other payables and accrued expenses. The Company's total current liabilities as of December 31, 2013 were equal to $6,225,105, comprised of $1,054,053 in current maturities on long term debt, $759,021 in trade accounts payable, $2,725,000 in connection with the United Bank line of credit, $465,883 in loans payable to stockholders, net of discount, $151,981 in Obligations related to the Letter of Credit, net of discount and $1,069,167 in other payables and accrued expenses.

 

Our working capital deficit at June 30, 2014 was $8,801,015 as compared to a working capital deficit of $3,716,603 at December 31, 2013.  The increase in working capital deficit was $5,084,412 from December 31, 2013 to June 30, 2014.

 

Operating Activities

 

Net cash used in operating activities for the six month period ended June 30, 2014 decreased $1,776,097, or 35% from $5,063,847 for the six month period ended June 30, 2013 to $3,287,750. Net cash used in operating activities during the six month period ended June 30, 2014 was primarily the result of a net loss of $6,178,476. Net loss was adjusted for non-cash items such as depreciation and amortization of $430,771, non-cash compensation of $179,049, issuance of stock for services of $515,463, accretion of convertible debenture discount of $125,645, loss on disposal of fixed assets of $18,768, bad debt expense of $1,200, and income from change in value of derivative of $23,593. We also had a decrease in trade accounts receivable of $132,359, prepaid expenses of $226,049, and other receivables of $7,604 and in other payables and accrued expenses of $279,128. We also had an increase in inventory of $40,215 and trade accounts payable of $1,596,754.

  

Investing Activities

 

Net cash provided by investing activities during the six month period ended June 30, 2014 was $486,017, which was the result of proceeds of $600,000 received from the contingent sale of Protea Europe offset by equipment purchases. As the development of the Lipase product was costing the Company over $1m of expense each year, management determined it was in the Company’s interest to focus those resources going forward on their core products and services. The sale includes success fees and royalties to the Company in the future if the product is subsequently approved by the FDA.

 

In addition, we expect to continue to purchase property and equipment in the normal course of our business. The amount and timing of these purchases and the related cash outflows in future periods is difficult to predict and is dependent on a number of factors including, but not limited to, any increase in the number of our employees and changes related to our development programs. Net cash used in investing activities during the six month period ended June 30, 2013 was $196,061 and was also used for equipment purchases.

 

Financing Activities

 

Cash provided by financing activities during the six month period ended June 30, 2014 was $2,006,415, which was the result of net proceeds of ($12,500) from the sale of our common stock, proceeds of $2,025,000 from advances recorded as related party debt, and proceeds of $283,500 from short term debt. This was offset by $325,890 used in the repayment of long-term debt and $238,695 used in the repayment of the obligation related to the letter of credit. Cash provided by financing activities during the six month period ended June 30, 2013 was $5,540,246, which was the result of net proceeds of $4,680,775 from the sale of our common stock, proceeds of $775,000 from the issuance of related party debt, and proceeds of $600,000 from the issuance of the obligation related to the letter of credit. This was offset by $359,469 used in the repayment of long-term debt and $156,060 used in the repayment of the obligation related to the letter of credit. 

 

Other than as discussed above, we know of no trends, events or uncertainties that are reasonably likely to impact our future liquidity.

 

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet guarantees, interest rate swap transactions or foreign currency contracts. We do not engage in trading activities involving non-exchange traded contracts.

 

Critical Accounting Policies

 

The discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses for each period. For further discussion of critical accounting policies, please see Note 2 to our financial statements, which are included in this report in Item 1.

 

Recently Issued Accounting Pronouncements

 

For a discussion of recently issued accounting pronouncements, please see Note 2 to our financial statements, which are included in this report in Item 1.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide information required by this Item.

 

Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed pursuant to the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules, regulations and related forms, and that such information is accumulated and communicated to our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

 

As of June 30, 2014, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and our principal financial officer of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our principal executive officer and our principal financial officer had concluded that as of June 30, 2014, our disclosure controls and procedures were ineffective due to inadequate controls over information technology. Our management team is taking immediate action and has been actively engaged in the planning for, and implementation of, remediation efforts since material weaknesses were discovered as a result of the loss of key personnel.

 

As of June 30, 2014, we commenced a search to employ additional resources which we believe will continue to improve and remediate the material weakness in our financial reporting related to information technology. Due to the departure of our Information Technology/Network Administrator earlier in the year, which left insufficient resources in the information technology department, we conclude that the Company’s controls were ineffective in this area.

 

To date, the Company is addressing the material weakness disclosed above by interviewing third party information technology firms to evaluate and provide recommendations to improve the existing information technology controls and procedures.

 

In addition, in connection with our annual audit for the year ended December 31, 2013, it came to management’s attention that certain equity and embedded derivative instruments were not properly recorded during 2013. The derivative liability related to common stock issuances, detachable common stock purchase warrants (“warrants”) issued in conjunction with debt and common stock, warrants issued to the placement agents for financial instrument issuances, and the expense associated with certain equity transactions which were not properly recorded due to their complexity.

 

Our management team took immediate action and remediated this material weakness by engaging an independent valuation firm to assist in valuing our derivative liabilities. In addition, the Company invested in a web-based accounting research solution, which provides access to research, analysis, discussion, financial interpretation and regulations drawing on various governing bodies, such as the SEC, FASB, IASB, etc.

 

 

Despite the existence of the material weakness above, we believe that our consolidated financial statements contained in this Form 10-Q fairly present our financial position, results of operations and cash flows as of and for the periods presented in all material respects.

 

Changes in Internal Control over Financial Reporting

 

Except as discussed above, there have been no changes in our internal controls over financial reporting during the quarter ended June 30, 2014 that have materially affected or are reasonably likely to materially affect our internal controls.

 

PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

There are presently no pending legal proceedings to which the Company or any of its subsidiaries is a party or to which any of their property is subject and no such proceedings are known to the Company to be threatened or contemplated against it.

 

Item 1A. Risk Factors.

 

As a “smaller reporting company” as defined by Item 10 of Regulation S-K, the Company is not required to provide information required by this Item.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

Common Stock and Warrants

 

During the quarter ended June 30, 2014, the Company issued 537,348 shares of common stock for services rendered by attorneys and two consultants.

 

During the quarter ended June 30, 2014, the Company issued warrants to purchase 650,000 shares of common stock to Summit Resources, Inc., an affiliate of Steve Antoline, a director of the Company, in connection with up to an aggregate of $650,000 in promissory notes issued during the quarter. The warrants are exercisable for five years from date of issuance at an exercise price of $0.80 per share.

 

On April 30, 2014, the Company issued warrants to purchase 187,500 shares of common stock in connection with services rendered pursuant to the terms of a Consulting Agreement by and between the Company and a consultant, dated October 17, 2013. The warrants contain an exercise price of $1.10 per share and are exercisable for five years from date of issuance.

 

Options

 

During the quarter ended June 30, 2014, the Company granted options to purchase an aggregate of 1,042,500 shares of common stock in connection with the Company’s 2013 Equity Incentive Plan at an exercise price of $0.55 per share to the Chief Scientific Officer, Vice President, Corporate Finance & Development and various employees. The options expire five years from date of issuance.

 

Convertible Notes and Warrants

 

From April 2, 2014 until June 30, 2014, the Company entered into a Note Purchase Agreement, and issued convertible one-year promissory notes (the “Notes”) to eight related parties in the aggregate principal amount of $1,378,500. The Notes are convertible into units (the “Units”) consisting of 181,818 shares of the Company’s common stock and a warrant to purchase 109,091 shares of Common Stock, exercisable at $0.80 per share. Each $100,000 of outstanding principal and accrued unpaid interest underlying the Note is automatically convertible into securities of the Company issued in a subsequent financing pursuant to which the Company raises at least $2,000,000 in gross proceeds (“Subsequent Financing”).

 

Sale of European Subsidiary

 

On June 13, 2014 (the “Closing Date”), the Company completed the sale of 100% of the issued and outstanding capital stock of ProteaBio Europe SAS (“Protea Europe”), a wholly-owned subsidiary of Protea Biosciences, Inc., to AzurRx BioPharma, Inc. (the “Buyer”) pursuant to the terms and conditions of a Stock Purchase and Sale Agreement (the “SPA”), dated as of May 21, 2014 (such transaction, the “Sale”). Effective upon the closing of the Sale, Thijs Spoor, a director of the Company, was appointed to serve as a director of the Buyer. The information disclosed in the Company’s Form 8-K filed with the Securities and Exchange Commission on June 19, 2014 (the “Form 8-K”) in connection with the issuance of shares of the Company’s common stock upon a Reversion (as such term is defined in the Form 8-K) is incorporated herein by reference.

 

The securities described above were issued pursuant to the exemption from registration provided by Rule 506 of Regulation D or Section 4(a)(2) of the Securities Act of 1933, as amended. In determining that the issuance of the securities qualified for an exemption under Section 4(a)(2) of the Securities Act, the Company relied on the following facts:(i) the recipients were either accredited investors or sophisticated investors as defined in Rule 501 promulgated under the Securities Act who had access to information about the Company that was generally the same as information required to be delivered in a registered offering; and (ii) the Company did not use any form of general solicitation or advertising to offer the securities issued. 

 

 

Item 3.  Defaults Upon Senior Securities.

 

Not applicable

 

Item 4.  Mine Safety Disclosure.

 

Not applicable.

 

Item 5.  Other Information.

 

Steven O’Loughlin, age 29, is Protea’s Vice President, Corporate Finance & Development effective as of August 4, 2014. He joined Protea in August 2012 as Director of Corporate Development. Prior to joining Protea, he served as Regional Manager for Caliber I.D. (OTCQB:LCDX) (formerly Lucid, Inc.), a cellular imaging and diagnostics company based in Rochester, New York from June 2010 through July 2012.  At Caliber I.D., he was responsible for the commercialization of the company’s FDA 510(K) cleared diagnostic product, the VivaScope 1500^®as well as in assisting the company in the development of its corporate finance activities and reimbursement strategy. Mr. O’Loughlin was Assistant Vice President of Healthcare Investment Banking with Forge Financial from September 2009 until June 2010 and Jesup & Lamont from February 2008 until August 2009, where he helped advise public and private life sciences companies on capital raising, merger & acquisition and corporate growth strategies.  Mr. O’Loughlin holds a Bachelor of Science degree in business administration with a concentration in finance from the Ramapo College of New Jersey. 

 

Family Relationships

 

There are no family relationships between Mr. O’Loughlin and any previous officers or directors of the Company.

 

Related Party Transactions

 

Except as disclosed below, since January 1, 2012, there are no related party transactions reportable under Item 5.02 of Form 8-K or Item 404(a) of Regulation S-K.

 

On May 6, 2013 and April 1, 2014, the Company granted Mr. O’Loughlin 100,000 and 80,000 stock options, respectively. The stock options have an exercise price of $0.55 per share and vest in 25% equal increments over a four year period and expire ten years from the grant date.

 

Employment Agreements

 

Mr. O’Loughlin receives a salary of $140,000 per year and will be eligible to receive equity compensation under the Company’s 2013 Equity Incentive Plan, subject to approval by the Company’s Compensation Committee.

 

Item 6.  Exhibits.

 

(a) Exhibits required by Item 601 of Regulation S-K.

 

Exhibit No.		Description
3.1		Certificate of Incorporation (incorporated by reference from Exhibit 3.1 to the registrant’s Form 10-SB filed with the Securities and Exchange Commission on August 3, 2005).
3.2		Bylaws (incorporated by reference from Exhibit 3.2 to the registrant’s Form 10-SB filed with the Securities and Exchange Commission on August 3, 2005).
3.3		Certificate of Ownership and Merger filed with the Office of Secretary of State of Delaware on September 2, 2011 (incorporated by reference to the registrant's Form 8-K filed with the Securities and Exchange Commission on September 9, 2011).
4.1*		Form of Promissory Note for $1,500,000 Offering.
4.2*		Form of Warrant for $1,500,000 Offering.**
4.3*		Form of Convertible Promissory Note for $2,000,000 Offering.
10.1		Memorandum of Understanding by and between the Company and AzurRx BioPharma, Inc. f/k/a BioPharma d’Azur, Inc. (incorporated by reference from Exhibit10.1 to the registrant’s Form 10-Q filed with the Securities and Exchange Commission on May 9, 2014).
10.2		Option Agreement by and among the Company, ProteaBio Europe SAS and AzurRx BioPharma, Inc. f/k/a BioPharma d’Azur, Inc. (incorporated by reference from Exhibit10.2 to the registrant’s Form 10-Q filed with the Securities and Exchange Commission on May 9, 2014) .
10.3*		Stock Purchase and Sale Agreement by and among the Company, Protea Biosciences, Inc., ProteaBio Europe SAS, and AzurRx BioPharma, Inc.**
31.1		Certification of the Company’s Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, with respect to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014.
31.2		Certification of the Company’s Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, with respect to the registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014.

 

 

32.1		Certification of the Company’s Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of the Company’s Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

EX-101.INS	XBRL Instance Document
EX-101.SCH	XBRL Taxonomy Extension Schema
EX-101.CAL	XBRL Taxonomy Extension Calculation Linkbase
EX-101.DEF	XBRL Taxonomy Extension Definition Linkbase
EX-101.LAB	XBRL Taxonomy Extension Label Linkbase
EX-101.PRE	XBRL Taxonomy Extension Presentation Linkbase
* Filed herewith

**

Schedules and exhibits have been omitted pursuant to Section 601(b)(2) of Regulation S-K. The Company will furnish supplemental copies of any omitted schedules as exhibits to the SEC upon request.

  

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

	PROTEA BIOSCIENCES GROUP, INC.
Dated: August 5, 2014	By:	/s/  Stephen Turner
		Stephen Turner
		President and Director
		Principal Executive Officer
	By:	/s/  Edward Hughes
		Edward Hughes
		Chief Financial Officer
		Principal Financial Officer