Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Note
1 - Organization and Summary of Significant Accounting Policies
Business
Activities and Organization
Company
Overview
Processa Pharmaceuticals, Inc. (the “Company”,
formerly known as “Heatwurx” ) and its wholly-owned subsidiary, Processa Therapeutics LLC (“Processa”),
a Delaware limited liability company, acquired all the net assets of Promet Therapeutics, LLC (“Promet”) a private
Delaware limited liability company, including the rights to the CoNCERT Agreement mentioned below, on October 4, 2017 in exchange
for 31,745,242 shares of the common stock of the Company which, at closing, constituted approximately 90% of the Company’s
issued and outstanding common stock on a fully diluted basis accounted for as a tax-free contribution under Internal Revenue Code
Section 351. Immediately following closing, there were 35,272,626 shares of common stock issued and outstanding. At closing, Processa
was assigned all the assets and operations of Promet that constituted the operating business of Promet, while Promet, which continues
as an active company, received the shares of Company common stock mentioned above, including those shares that Promet agreed
to hold for the benefit of, and transfer to, CoNCERT in respect of the Agreement (as defined below) which was expected, anticipated
and intended to occur at this time. Upon closing on October 4, 2017, there was a change in control of the Company to Promet.
The Company abandoned its prior business plan and adopted Promet’s business plan focused on developing drugs to treat patients
that have a high unmet medical need. Subsequent to closing and effective October 10, 2017, the Company changed its trading symbol
to “PCSA” on the OTC Pink Marketplace. The Company effected a one-for-seven reverse split of its shares in December
2017. As a result, the 2017 condensed consolidated financial statements have been retrospectively adjusted to reflect shares outstanding
after the one-for-seven reverse split.
The
net asset acquisition transaction was accounted for as a reverse acquisition. Prior to the acquisition, Heatwurx (subsequently
renamed Processa Pharmaceuticals, Inc.) had nominal net liabilities and operations. It was considered a non-operating public shell
corporation. Therefore, Promet was considered the accounting acquirer (and legal wholly-owned subsidiary of Heatwurx, now called
Processa Pharmaceuticals, Inc.) and Heatwurx was considered the accounting acquiree (and legal acquirer). As a result, the consolidated
financial statements of the Company reflect the financial condition, results of operations and cash flows of Promet for all periods
presented prior to October 4, 2017 and Processa for the periods subsequent to October 4, 2017. The legal capital stock (number
and type of equity interests issued) is that of Processa Pharmaceuticals, Inc., the legal parent, in accordance with guidance
on reverse acquisitions accounted for as a capital transaction instead of a business combination (See Note 2 – Basis of
Presentation and Earnings Per Share and Note 3 – Reverse Acquisition in Item 8 of the Company’s Annual Report on Form
10-K filed with the SEC on April 17, 2018).
All
references to the “Company” and Processa Pharmaceuticals, Inc. refer to Heatwurx, Inc., Processa Therapeutics, LLC,
and the net assets acquired from Promet, which were assigned at acquisition to Processa Therapeutics, LLC and Promet’s operations
prior to October 4, 2017.
On March 19, 2018, Promet, Processa and CoNCERT
Pharmaceuticals Inc. (“CoNCERT”) amended the Option and License Agreement (the “Agreement”) executed in
October 2017. The Agreement was assigned to Processa and Processa exercised the exclusive option for the PCS-499 compound. The
option was exercised in exchange for CoNCERT receiving (i) $8 million of Company common stock that was held by Promet for
the benefit of CoNCERT (2,090,301 shares representing 5.93% of total the Company’s common stock issued and outstanding),
and (ii) 15% of any sublicense revenue earned by the Company for a period equivalent to the royalty term (as defined in the Agreement)
until the earliest of (a) Processa raising $8 million of gross proceeds; and (b) CoNCERT being able to sell its shares of Company
common stock without restrictions pursuant to the terms of the amended Agreement. All other terms of the Agreement remain unchanged.
As a result, the Company recognized an intangible asset and additional paid-in capital in the amount of $8 million resulting from
Promet releasing the shares to CoNCERT in satisfaction of Processa’s obligation under the Agreement to CoNCERT
(see Note 2 Intangible Asset for the income tax effect of this transaction). There was no change in the total shares issued and
outstanding, however, after Promet released CoNCERT’s shares it held for CoNCERT, Promet’s percentage
interest held in Processa was reduced from 90% to 84%.
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Description
of Business
Processa
is an emerging pharmaceutical company focused on the clinical development of drug products that are intended to improve the survival
and/or quality of life for patients who have a high unmet medical need or who have no alternative treatment. Within this group
of pharmaceutical products, we currently are developing one product for two indications (i.e., the use of a drug to treat a particular
disease) and searching for additional products for our portfolio.
Processa’s
lead product, PCS-499 is an oral tablet that is an analog of an active metabolite of an already approved FDA drug. The advantage
of PCS-499 is that it potentially may work in many conditions because it has multiple pharmacological targets it affects that
are important in the treatment of these conditions. Based on its pharmacological activity, Processa has identified multiple unmet
medical need conditions where the use of PCS-499 may result in clinical efficacy. The lead indication currently under development
for PCS-499 is Necrobiosis Lipoidica (NL). Processa has met with the FDA on the NL condition and has developed a strategy for
moving the program for NL forward starting with a Phase 2 clinical trial in NL patients in late 2018. Processa will continue to
evaluate other unmet need conditions for PCS-499 as well as other potential assets and develop strategies including the regulatory
pathway and commercialization plans for the product(s) for these unmet need conditions over the next year.
Processa
is also looking to acquire additional drug candidates to help patients who have an unmet medical need.
Our
operations are performed in the state of Maryland and are still in the organizational and research and development phase of operations.
As a result, we have a limited operating history and only a preliminary business plan from which investors may evaluate our future
prospects. We have not had any sources of revenue from inception (August 31, 2015) through September 30, 2018 and have a history
of operating losses from operations. Our ability to generate meaningful revenue from any products in the United States depends
on obtaining FDA authorization. Even if our products are authorized and approved by the FDA, we must still meet the challenges
of successful marketing, distribution and consumer acceptance.
Basis
of Presentation
The
accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles
generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions
of the Securities and Exchange Commission (“SEC”) on Form 10-Q and Rule 10-01 of Regulation S-X.
Accordingly,
they do not include all of the information and disclosures required by U.S. GAAP for complete financial statements. All material
intercompany accounts and transactions have been eliminated in consolidation. In the opinion of management, the accompanying unaudited
consolidated financial statements include all adjustments necessary, which are of a normal and recurring nature, for the fair
presentation of the Company’s financial position and of the results of operations and cash flows for the periods presented.
These consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto
included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the SEC on April
17, 2018. The results of operations for the interim periods shown in this report are not necessarily indicative of the results
that may be expected for any other interim period or for the full year.
As
a result of the modification of the Agreement with CoNCERT and the acquisition of an exclusive license intangible asset used in
research and development activities described above, the Company adopted a new intangible asset policy and disclosure (see Intangible
Assets below and Note 2 – Intangible Asset) and recognized a deferred tax liability for the acquired temporary difference
between the financial reporting basis and the tax basis of the intangible asset (see Note 5 – Income Taxes).
Processa
Pharmaceuticals, Inc.
Notes
to Condensed Consolidated Financial Statements
(Unaudited)
Going
Concern and Management’s Plan
The
Company’s condensed consolidated financial statements are prepared using U.S. GAAP and are based on the assumption that
the Company will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the
normal course of business. The Company faces certain risks and uncertainties that are present in many emerging growth companies
regarding product development and commercialization, limited working capital, recurring losses and negative cash flow from operations,
future profitability, ability to obtain future capital, protection of patents, technologies and property rights, competition,
rapid technological change, navigating the domestic and major foreign markets’ regulatory and clinical environment, recruiting
and retaining key personnel, dependence on third party manufacturing organizations, third party collaboration and licensing agreements,
lack of sales and marketing activities, and no customers or pharmaceutical products to sell or distribute. These risks and other
factors raise substantial doubt about our ability to continue as a going concern.
The
Company has relied exclusively on private placements with a small group of accredited investors to finance its business and operations.
We do not have any prospective arrangements or credit facilities as a source of future funds. The Company has not had any revenue
since its inception on August 31, 2015. We are looking at ways to add a revenue stream to offset some of our expenses. The Company
does not currently have any revenue under contract or any immediate sales prospects. As of September 30, 2018, the Company had
an accumulated deficit of approximately $7.0 million, incurred a net loss of approximately $3.2 million and used approximately
$3.2 million in net cash from operating activities from continuing operations for the nine months ended September 30, 2018. The
Company had total cash and cash equivalents of approximately $2.4 million as of September 30, 2018 and a Clinical Trial Funding
commitment from an investor (PoC Capital) of $1.8 million.
Based
on our current plan and our available resources (including the Clinical Trial Funding commitment of $1.8 million from PoC Capital),
we will need to raise additional capital before the end of the second quarter of 2019 in order to fund our future operations.
While we believe our current resources are adequate to complete our upcoming Phase 2a trial for NL, we do not currently have resources
to conduct other future trials without raising additional capital. As noted above, the timing and extent of our spending will
depend on the cost associated with, and the results of our upcoming Phase 2a trial for NL. Our anticipated spending and our cash
flow needs could change significantly as the trial progresses. There may be costs we incur during our trial that we do not currently
anticipate requiring us to need additional capital sooner than currently expected.
When
additional funding is required, it may not be available to us on acceptable terms, or at all. If we are unable to obtain adequate
financing when needed, we may have to delay, reduce the scope of or suspend one or more of our clinical trials, or research and
development programs. We may seek to raise any necessary additional capital through a combination of public or private equity
offerings, debt financings, collaborations, strategic alliances, licensing arrangements and other marketing and distribution arrangements.
To the extent that we raise additional capital through marketing and distribution arrangements or other collaborations, strategic
alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our product candidates, future
revenue streams, research programs or product candidates or to grant licenses on terms that may not be favorable to us. If we
do raise additional capital through public or private equity offerings, the ownership interest of our existing stockholders will
be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our stockholders’
rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability
to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends.
Uncertainty
concerning our ability to continue as a going concern may hinder our ability to obtain future financing. Continued operations
and our ability to continue as a going concern are dependent on our ability to obtain additional funding in the near future and
thereafter, and no assurances can be given that such funding will be available at all or will be available in sufficient amounts
or on reasonable terms. Without additional funds from debt or equity financing, sales of assets, sales or out-licenses of intellectual
property or technologies, or other transactions yielding funds, we will rapidly exhaust our resources and will be unable to continue
operations. Absent additional funding, we believe that our cash and cash equivalents will not be sufficient to fund our operations
for a period of one year or more after the date that these consolidated financial statements are available to be issued based
on the timing and amount of our projected net loss from continuing operations and cash to be used in operating activities during
that period of time.
Processa Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial
Statements
(Unaudited)
As
a result, substantial doubt exists about the Company’s ability to continue as a going concern within one year after the
date that these consolidated financial statements are available to be issued. The accompanying consolidated financial statements
do not include any adjustments to reflect the possible future effects on the recoverability and classification of recorded assets,
or the amounts and classification of liabilities that might be different should the Company be unable to continue as a going concern
based on the outcome of these uncertainties described above.
Use
of Estimates
The
preparation of the accompanying unaudited consolidated financial statements in conformity with U.S. GAAP requires management to
make estimates and assumptions that affect the reported amounts (including assets, liabilities, revenues and expenses) and related
disclosures, including contingent assets and liabilities. Estimates have been prepared on the basis of the most current and best
available information. However, actual results could differ materially from those estimates.
Cash
and Cash Equivalents
Cash
and cash equivalents include cash on hand and money market funds. The Company considers all highly liquid investments with a maturity
at the date of purchase of three months or less to be cash equivalents.
Intangible
Assets
Intangible
assets acquired individually or with a group of other assets from others (other than in a business combination) are recognized
at cost, including transaction costs, and allocated to the individual assets acquired based on relative fair values and no goodwill
is recognized. Cost is measured based on cash consideration paid. If consideration given is in the form of non-cash assets, liabilities
incurred, or equity interests issued, measurement of cost is based on either the fair value of the consideration given or the
fair value of the assets (or net assets) acquired, whichever is more clearly evident and more reliably measurable. Costs of internally
developing, maintaining or restoring intangible assets that are not specifically identifiable, have indeterminate lives or are
inherent in a continuing business are expensed as incurred.
Intangible
assets purchased from others for use in research and development activities and that have alternative future uses (in research
and development projects or otherwise) are capitalized in accordance with ASC Topic 350,
Intangibles – Goodwill and Other.
Those that have no alternative future uses (in research and development projects or otherwise) and therefore no separate economic
value are considered research and development costs and are expensed as incurred. Amortization of intangibles used in research
and development activities is a research and development cost.
Intangibles
with a finite useful life are amortized and those with an indefinite useful life are not amortized. The useful life is the best
estimate of the period over which the asset is expected to contribute directly or indirectly to the future cash flows of the Company.
The useful life is based on the duration of the expected use of the asset by the Company and the legal, regulatory or contractual
provisions that constrain the useful life and future cash flows of the asset, including regulatory acceptance and approval, obsolescence,
demand, competition and other economic factors. If an income approach is used to measure the fair value of an intangible asset,
the Company considers the period of expected cash flows used to measure the fair value of the intangible asset, adjusted as appropriate
for Company-specific factors discussed above, to determine the useful life for amortization purposes. If no regulatory, contractual,
competitive, economic or other factors limit the useful life of the intangible to the Company, the useful life is considered indefinite.
Intangibles
with a finite useful life are amortized on the straight-line method unless the pattern in which the economic benefits of the intangible
asset are consumed or used up are reliably determinable. The Company evaluates the remaining useful life of intangible assets
each reporting period to determine whether any revision to the remaining useful life is required. If the remaining useful life
is changed, the remaining carrying amount of the intangible asset will be amortized prospectively over the revised remaining useful
life.
Processa Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial
Statements
(Unaudited)
Intangibles
with an indefinite useful life are not amortized until its useful life is determined to be no longer indefinite. If the useful
life is determined to be finite, the intangible is tested for impairment and the carrying amount is amortized over the remaining
useful life in accordance with intangibles subject to amortization. Indefinite-lived intangibles are tested for impairment annually
and more frequently if events or circumstances indicate that it is more-likely-than-not that the asset is impaired.
Impairment
of Long-Lived Assets and Intangibles Other Than Goodwill
The
Company accounts for the impairment of long-lived assets in accordance with ASC 360
, Property, Plant and Equipment
and
ASC 350,
Intangibles – Goodwill and Other
which requires that long-lived assets and certain identifiable intangibles
be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to its
expected future undiscounted net cash flows generated by the asset. If such assets are considered to be impaired, the impairment
to be recognized is measured as the amount by which the carrying amounts of the assets exceed the fair value of the assets based
on the present value of the expected future cash flows associated with the use of the asset. Assets to be disposed of are reported
at the lower of the carrying amount or fair value less costs to sell. Based on management’s evaluation, there was no impairment
loss recorded for the three or nine-month periods ended September 30, 2018.
Fair
Value Measurements and Disclosure
The
Company applies ASC 820,
Fair Value Measurements and Disclosures
, which expands disclosures for assets and liabilities
that are measured and reported at fair value on a recurring basis. Fair value is defined as an exit price, representing the amount
that would be received upon the sale of an asset or payment to transfer a liability in an orderly transaction between market participants.
Fair
value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset
or liability. A three-tier fair value hierarchy is used to prioritize the inputs in measuring fair value as follows:
Level
1 – Quoted market prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has
the ability to access at the measurement date.
Level
2 – Quoted market prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets
or liabilities in markets that are not active, or other inputs that are observable, either directly or indirectly. Fair value
determined through the use of models or other valuation methodologies.
Level
3 – Significant unobservable inputs for assets or liabilities that cannot be corroborated by market data. Fair value is
determined by the reporting entity’s own assumptions utilizing the best information available and includes situations where
there is little market activity for the asset or liability.
The
asset’s or liability’s fair value measurement within the fair value hierarchy is based upon the lowest level of any
input that is significant to the fair value measurement. The Company’s policy is to recognize transfers between levels of
the fair value hierarchy in the period the event or change in circumstances that caused the transfer. There were no transfers
into or out of Level 1, 2, or 3 during the periods presented.
Stock-based
Compensation
Share-based
compensation expense is based on the grant-date fair value estimated in accordance with the provisions of ASC 718,
Compensation-Stock
Compensation
. The Company expenses stock-based compensation to employees over the requisite service period based on the estimated
grant-date fair value of the awards. Stock-based awards with graded-vesting schedules are recognized on a straight-line basis
over the requisite service period for each separately vesting portion of the award. The Company estimates the fair value of stock
option grants using the Black-Scholes option pricing model, and the assumptions used in calculating the fair value of stock-based
awards represent management’s best estimates and involve inherent uncertainties and the application of management’s
judgment. Stock-based compensation costs are recorded as general and administrative or research and development costs in the statements
of operations based upon the underlying individual’s role at the Company.
Processa Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial
Statements
(Unaudited)
Net
Income (Loss) per Share
The
Company computes basic and diluted earnings per share amounts pursuant to ASC 260-10-45. Basic earnings per share is computed
by dividing net income (loss) available to common shareholders, by the weighted average number of shares of common stock outstanding
during the period, excluding the effects of any potentially dilutive securities. Diluted earnings per share is computed by dividing
net income (loss) available to common shareholders by the diluted weighted average number of shares of common stock during the
period. Since the Company had a net loss for each of the periods presented, basic and diluted net loss per share are the same.
The computation of diluted net loss per share for the periods presented does not assume the impact of the conversion of the Senior
Convertible Notes or the exercise or contingent exercise of securities since that would have an anti-dilutive effect on loss per
share during the three and nine months ended September 30, 2018 and 2017.
Recent
Accounting Pronouncements
From
time to time, the Financial Accounting Standards Board (“FASB”) or other standard setting bodies issue new accounting
pronouncements. Updates to the FASB Accounting Standards Codification are communicated through issuance of an Accounting Standards
Update (“ASU”). The Company has implemented all new accounting pronouncements that are in effect and that may impact
its financial statements. We have evaluated recently issued accounting pronouncements and determined that there is no material
impact on our financial position or results of operations.
From
May 2014 through September 30, 2018, the FASB issued several ASUs related to ASU 2014-09,
Revenue from Contracts with Customers
.
The new guidance is effective for interim and annual periods beginning after December 15, 2017, although entities may adopt one
year earlier if they choose. The two permitted transition methods under the new standard are the full retrospective method, in
which case the standard would be applied to each prior reporting period presented and the cumulative effect of applying the standard
would be recognized at the earliest period shown, or the modified retrospective method, in which case the cumulative effect of
applying the standard would be recognized at the date of initial application. The Company is currently in the pre-revenue stages
of operations; therefore, we do not currently anticipate there would be any change to timing or method of recognizing revenue.
As such, the adoption of this standard did not have a material impact on our results of operations, financial condition or cash
flows.
In
February 2016 through September 30, 2018, the FASB issued several ASUs related to ASU-2016-02,
Leases
. The guidance requires
that a lessee recognize in the statement of financial position a liability to make lease payments (the lease liability) and a
right of use asset representing its right to use the underlying asset for the lease term. For operating leases: the right-of-use
asset and a lease liability will be initially measured at the present value of the lease payments, in the statement of financial
position; a single lease cost will be recognized, calculated so that the cost of the lease is allocated over the lease term on
a generally straight-line basis; and all cash payments will be classified within operating activities in the statement of cash
flows. The amendments in Topic 842 are effective for the Company beginning January 1, 2019. The Company’s office lease expires
September 30, 2019. Management is currently evaluating the impact of adopting the new guidance on the Company’s condensed
consolidated financial statements.
In
July 2017, the FASB issued Accounting Standards Update 2017-11 (ASU 2017-11), which allows companies to exclude a down round feature
when determining whether a financial instrument is considered indexed to the entity’s own stock. As a result, financial
instruments with down round features are no longer classified as liabilities and embedded conversion options with down round features
are no longer bifurcated. For equity-classified freestanding financial instruments, such as warrants, an entity will treat the
value of the effect of the down round, when triggered, as a dividend and a reduction of income available to common shareholders
in computing basic earnings per share. For convertible instruments with embedded conversion options that have down round features,
an entity will recognize the intrinsic value of the feature only when the feature becomes beneficial. The guidance in ASU 2017-11
is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. We early adopted
ASU 2017-11 effective January 1, 2018 without a material impact on our condensed consolidated financial statements.
Processa Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial
Statements
(Unaudited)
In
June 2018, the FASB issued ASU 2018-07,
Improvements to Nonemployee Share-Based Payment Accounting
, which simplifies the
accounting for share-based payments granted to nonemployees for goods and services. Under the ASU, most of the guidance on such
payment to nonemployees would be aligned with the requirements for share-based payment granted to employees. The changes take
effect for fiscal years starting after December 15, 2018, including interim periods within that fiscal year. We expect that the
adoption of this ASU would not have a material impact on our condensed consolidated financial statements.
Note
2 – Intangible Asset
Intangible
assets consist of the capitalized costs of $20,500 for a software license and $11,038,929 associated with our exercise of the
option to acquire the exclusive license from CoNCERT related to patent rights and know-how to develop and commercialize compounds
and products for PCS-499 and each metabolite thereof and the related income tax effects. The capitalized costs for the license
rights to PCS-499 include $1,782 in transaction costs and $3,037,147 associated with the initial recognition of an offsetting
deferred tax liability related to the acquired temporary difference for an asset purchased that is not a business combination
and has a tax basis of $1,782 in accordance with ASC 740-10-25-51
Income Taxes
. In accordance with ASC Topic 730,
Research
and Development
, the Company capitalized the costs of acquiring the exclusive license rights to PCS-499 as the exclusive license
rights represent intangible assets to be used in research and development activities that have future alternative uses.
The negotiation of the modification to the
Agreement was in process as of October 4, 2017 and was finalized in mid-February 2018 and the legal documents were thereafter
executed and the option exercised on March 19, 2018 in exchange for CoNCERT receiving (i) $8 million of Company common stock that
was held by Promet for the benefit of CoNCERT (2,090,301 shares representing 5.93% of total Company common stock
issued and outstanding), and (ii) 15% of any sublicense revenue earned by Processa for a period equivalent to the royalty term
(as defined in the Agreement) until the earliest to occur of (a) the Company raising $8 million of gross proceeds; and (b) CoNCERT
being able to sell its shares of Company common stock without restrictions pursuant to the terms of the amended Agreement. All
other terms of the Agreement remained unchanged. The license agreement was assigned to and exercised by the Company. As a result
of the transaction, the Company recognized an intangible asset for the fair value of the common stock consideration paid of $8
million with an offsetting amount in additional paid-in capital resulting from Promet releasing the shares to CoNCERT in satisfaction
of the Company’s obligation to CoNCERT under the Agreement.
The
Company estimated the fair value of the common stock issued based on the market approach and CoNCERT’s requirement to receive
shares valued at $8 million. The market approach was based on the final negotiated number of shares of stock determined on a volume
weighted average price of Company common stock quoted on the OTC Pink Marketplace over a 45 day period preceding the mid-February
2018 finalized negotiation of the modification to the option and license agreement with CoNCERT, an unrelated third party, for
the exclusive license rights to PCS-499. However, we have less than 300 shareholders, the volume of shares trading for our common
stock is not significant and the OTC Pink Marketplace is not a national exchange; therefore, the volume weighted average price
quotes for our common stock are from markets that are not active and consequently are Level 2 inputs. The total cost recognized
for the exclusive license acquired represents the allocated fair value related to the stock transferred to CoNCERT plus the recognition
of the deferred tax liability related to the acquired temporary difference and the transaction costs incurred to complete the
transaction as discussed above.
Intangible
assets consist of the following:
|
|
License Rights
|
|
|
Software
|
|
|
September 30,
|
|
|
|
to PCS-499
|
|
|
License
|
|
|
2018
|
|
Gross intangible assets
|
|
$
|
11,038,929
|
|
|
$
|
20,500
|
|
|
$
|
11,059,429
|
|
Less: Accumulated amortization
|
|
|
(419,682
|
)
|
|
|
(3,132
|
)
|
|
|
(422,814
|
)
|
Total intangible assets, net
|
|
$
|
10,619,247
|
|
|
$
|
17,368
|
|
|
$
|
10,636,615
|
)
|
Processa Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial
Statements
(Unaudited)
Amortization
expense was $200,256 and $422,814 for the three and nine months ended September 30, 2018, respectively. Amortization expense is
included within research and development expense in the accompanying consolidated statements of operations. As of September 30,
2018, the estimated amortization expense for the next two years amounts to approximately $795,000 per year. The estimated amortization
expense for the annual periods thereafter amounts to approximately $788,000 per year for the license rights to PCS-499.
Note
3 – Senior Convertible Notes
The
balance of our Senior Convertible Notes (“Senior Notes”) and accrued interest at September 30, 2018 and December 31,
2017 was as follows:
|
|
|
|
|
Unamortized
|
|
|
|
|
|
|
|
|
|
Senior
|
|
|
Debt
|
|
|
Senior
|
|
|
|
|
|
|
Convertible
|
|
|
Issuance
|
|
|
Convertible
|
|
|
Accrued
|
|
|
|
Notes
|
|
|
Costs
|
|
|
Notes, Net
|
|
|
Interest
|
|
Balance, December 31, 2017
|
|
$
|
2,580,000
|
|
|
$
|
(131,430
|
)
|
|
$
|
2,448,570
|
|
|
$
|
35,693
|
|
Conversion of debt
|
|
$
|
(2,350,000
|
)
|
|
$
|
64,361
|
|
|
$
|
(2,285,639
|
)
|
|
$
|
(109,472
|
)
|
Accrued interest
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
89,522
|
|
Amortize debt issuance costs
|
|
|
-
|
|
|
|
64,841
|
|
|
|
64,841
|
|
|
|
-
|
|
Balance, September 30, 2018
|
|
|
230,000
|
|
|
|
(2,228
|
)
|
|
|
227,772
|
|
|
|
15,743
|
|
Current portion
|
|
|
(230,000
|
)
|
|
|
2,228
|
|
|
|
(227,772
|
)
|
|
|
(15,743
|
)
|
Long-term portion
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Interest expense totaled $8,323 for
the three months ended September 30, 2018, consisting of interest on the Senior Notes at 8% of $4,600 and the amortization of
debt issuance costs of $3,723. Interest expense totaled $154,377 for the nine months ended September 30, 2018 consisting
of interest on the Senior Notes at 8% of $89,536 and the amortization of debt issuance costs of $64,841. The Senior Notes and
related accrued interest are classified as current liabilities in our consolidated balance sheets.
Issuance
of Senior Convertible Notes
As
of October 4, 2017, certain entities affiliated with current shareholders purchased $1.25 million of our Senior Notes in a bridge
financing undertaken by us to support our operations. On November 21, 2017, additional third-party accredited investors contributed
$1.33 million in financing proceeds. On May 25, 2018, $2,350,000 of Senior Notes were converted, as described below, leaving $230,000
of Senior Notes outstanding at September 30, 2018.
Principal
and interest under each Senior Note is due on the earlier of (i) the mandatory and automatic conversion of the Senior Note into
the next Private Investment in Public Equity (“PIPE”) financing we undertake, provided the PIPE financing yields minimum
gross proceeds and a pre-money valuation as defined in the financing agreement or (ii) the one-year anniversary of that Senior
Note (Maturity Date). The Senior Notes bear interest at 8% per year and are payable in kind (in common stock).
Holders
of Senior Notes (a) may elect to receive 110% of principal plus accrued interest in the event there is a change of control prior
to conversation of the Senior Notes, (b) are entitled to full ratchet anti-dilution protection in event of any sale of securities
at a net consideration per share that is less than the applicable conversion price per share to the holder, (c) are entitled to
certain registration rights for the securities underlying the Senior Notes and (d) have been granted certain preemptive rights
pro rata to their respective interests through December 31, 2018. The Senior Notes can be prepaid by the Company at any time following
the date of issuance with seven days prior written notice to the note holder.
Processa Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial
Statements
(Unaudited)
The
Senior Notes are secured by a security interest in the assets of the Company and contain negative covenants that do not permit
the Company to incur additional indebtedness or liens on property or assets owned, repurchase common stock, pay dividends, or
enter into any transaction with affiliates of the Company that would require disclosure in a public filing with the Securities
and Exchange Commission. Upon an event of default, the outstanding principal amount of the Senior Notes, plus accrued but unpaid
interest and other amounts owing in respect thereof through the date of acceleration, shall become immediately due and payable
in cash at the holder’s election, if not cured within the cure period.
The
Company retained a placement agent and agreed to pay the placement agent (i) six percent (6%) of gross proceeds received by the
Company and (ii) warrants to purchase securities in the amount of three percent (3%) of the equity issued or issuable in connection
with the Senior Notes bridge financing upon their conversion. As a result of the Senior Notes conversion, warrants to purchase
a total of 72,375 shares of common stock were issued, with a three-year term, at an exercise price equal to $2.452.
The
Company incurred $154,800 in debt issuance costs on the Senior Notes in connection with a payment to the placement agent, which
was reported as a reduction of the carrying amount of the Senior Convertible Notes on the face of the consolidated balance sheets.
The debt issuance costs are amortized to interest expense using the effective interest rate method over the term of the Senior
Convertible Notes. The effective interest rate on the Senior Notes was 7.72% before debt issuance costs, since no payments of
interest are due until maturity and 13.96% including the debt issuance costs based on the repayment terms of the Senior Notes.
Conversion
of Our Senior Convertible Notes
On
May 25, 2018, pursuant to the mandatory and automatic conversion provisions of the Senior Notes, we converted $2,350,000 of the
$2,580,000 outstanding Senior Notes, along with any accrued interest into 1,206,245 shares of common stock (at a conversion price
of $2.043 per share) and a warrant to purchase one share of common stock for three years, at an exercise price of $2.452.
Senior
Notes totaling $230,000 held by Canadian individuals cannot be converted until the Company completes certain regulatory matters
and filings in Canada. Once these regulatory matters and filings have been met, the Senior Notes held by these individuals will
automatically convert on the same terms as the other noteholders, which includes additional accrued interest until conversion.
The
Company completed an evaluation of the warrants issued in this transaction and determined the warrants should be classified as
equity.
Note
4 – Stockholders’ Equity
2018
Private Placement Transactions
Between
May 15, 2018 and June 29, 2018, the Company sold an aggregate of 1,402,442 units in a private placement transaction at a purchase
price equal to $2.27 per unit for gross proceeds of approximately $3.2 million. Each unit consisted of one share of our common
stock and a warrant to purchase one share of our common stock for $2.724, subject to adjustment thereunder for a period of three
years. The Company paid $167,526 to its placement agent and issued placement agent warrants to purchase up to 84,146 shares of
common stock, with a three-year term, at an exercise price equal to $2.724. The issuance costs were charged against additional
paid in capital.
On
May 25, 2018, we entered into an Agreement with PoC Capital, LLC (“PoC”), where PoC has agreed to finance $1,800,000
in study costs associated with certain clinical studies, including our Phase 2a study to evaluate the safety, tolerability, efficacy
and pharmacodynamics of PCS 499 in patients with Necrosis Lipoidica in exchange for 792,952 shares of our common stock and a warrant
for the purchase of 792,952 shares of common stock with an exercise price of $2.724, expiring on July 29, 2021. Any study costs
in excess of that amount will be our responsibility. PoC will not make payments to us, but directly to the contract research organization
based on their invoices. We paid $108,000 to our placement agent and issued our placement agent warrants to purchase 47,578 shares
of common stock, with a three-year term, at an exercise price equal to $2.724. The issuance costs were charged against additional
paid in capital.
Processa Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial
Statements
(Unaudited)
The
Company also entered into a pledge agreement with PoC, under which the Company received a security interest for 396,476 shares,
or half the shares we issued to them and we are holding these shares as collateral. These shares will be released in two tranches
of 198,238 shares each, with each tranche released upon PoC making payments totaling $720,000. During the nine months ended September
30, 2018, we have made payments to our CRO of $239,129, including the prepayment of certain amounts, all of which will be repaid
to us by PoC.
The
common stock, but not the warrants, issued for the 2018 Private Placement Transactions and the conversion of the Senior Convertible
Notes have, subject to certain customary exceptions, full ratchet anti-dilution protection. Until the Company has issued equity
securities or securities convertible into equity securities for a total of an additional $20.0 million in cash or assets, including
the proceeds from the exercise of the warrants issued above, in the event we issue additional equity securities or securities
convertible into equity securities at a purchase price less than $2.27 per share of common stock, the above purchase prices shall
be adjusted and new shares of common stock issued as if the purchase price was such lower amount (or, if such additional securities
are issued without consideration, to a price equal to $0.01 per share).
The
Company completed an evaluation of the warrants issued in the 2018 Private Placement Transactions and determined the warrants
should be classified as equity.
Purchase
of the CoNCERT License
On
March 19, 2018, Promet, Processa and CoNCERT amended the Agreement executed in October 2017. The Agreement was assigned to Processa
and Processa exercised the exclusive option for the PCS-499 compound in exchange for CoNCERT receiving, in part, $8 million of
common stock of the Company that was owned directly by Promet (2,090,301 shares at $3.83 per share) in satisfaction of the obligation
due for the exclusive license for PCS-499 acquired by Processa. There was no change in the total shares issued and outstanding
of 35,272,626, however, Promet’s controlling interest was reduced from 90% to 84%. Promet contributed the payment of the
obligation due for the exclusive license to the Company without consideration paid to them. As a result of the transaction, the
Company recognized an exclusive license intangible asset with a fair value of $8 million and an offsetting increase in additional
paid-in capital resulting from Promet satisfying Processa’s liability to CoNCERT (see Note 2 Intangible Asset for the income
tax effect of this transaction).
Note
5 – Income Taxes
The
Company accounts for income taxes in accordance with ASC Topic 740,
Income Taxes.
Deferred income taxes are recorded for
the expected tax consequences of temporary differences between the tax basis of assets and liabilities for financial reporting
purposes and amounts recognized for income tax purposes. The Company records a valuation allowance to reduce the Company’s
deferred tax assets to the amount of future tax benefit that is more likely than not to be realized.
As
of September 30, 2018, and December 31, 2017, the Company recorded a valuation allowance equal to the full recorded amount of
the Company’s net deferred tax assets related to intangible start-up costs since it is more-likely-than-not that such benefits
will not be realized. The valuation allowance is reviewed quarterly and is maintained until sufficient positive evidence exists
to support its reversal.
As
described more fully in Note 1, Promet and Processa entered into an Asset Purchase Agreement pursuant to which Processa acquired,
in an IRC Section 351 tax-free contribution of assets solely for over 80% of the voting stock of Processa (the “Section
351 Transaction”) by Promet, for properties, rights and assets, including liabilities and commitments, owned by Promet.
(the “Contributed Assets”). Contemplated in the Contributed Assets were rights, title and interest under a certain
option and license agreement with CoNCERT with respect to certain know-how, patent rights and compounds developed or obtained
by CoNCERT (the “CoNCERT Assets”) for which voting securities of Processa were expressly contemplated to be issued
as part and parcel with, and integrated into, the Section 351 Transaction to CoNCERT because all Contributed Assets including
the CoNCERT Assets were contemplated to be integral to each other and were considered to be an integrated undertaking as the primary
target, purpose and reason for the overall transaction itself.
Processa Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial
Statements
(Unaudited)
A deferred tax liability was recorded when
Processa received CoNCERT’s license and “Know-How” in exchange for Processa stock that had been issued
in the Internal Revenue Code Section 351 Transaction on March 19, 2018. The Section 351 Transaction treats the acquisition
of the license and Know-How for stock as a tax-free exchange. As a result, under ASC 740-10-25-51
Income Taxes
, Processa
recorded a deferred tax liability of $3,037,147 for the acquired temporary difference between the financial reporting basis of
approximately $11,038,929 and the tax basis of approximately $1,782. The deferred tax liability may be offset by the deferred
tax assets resulting from 2017 and 2018 net operating losses. Under ACS 740-270
Income Taxes – Interim Reporting
,
the Company is required to project its 2018 federal and state effective income tax rate and apply it to the September 30, 2018
operating loss before income taxes. Based on the projection, the Company expects to recognize the tax benefit from the 2017 net
operating loss carryover and the projected 2018 loss, which resulted in the recognition of a deferred tax benefit shown in the
consolidated statements of operations for 2018.
As
required under ASC 740-270,
Interim Financial Reporting
, the Company has estimated its annual effective tax rate for the
full fiscal year and applied that rate to its year-to-date consolidated pre-tax ordinary loss before income taxes in determining
its benefit for income taxes. The Company recorded a benefit for income taxes of approximately $212,000 and $0 for the three months
ended September 30, 2018 and 2017, respectively, and $771,000 and $0 for the nine months ended September 30, 2018 and 2017, respectively.
As
discussed in Note 2 – Income Taxes in the consolidated financial statements included in Item 8 of the 2017 Form 10-K filed
with the SEC on April 17, 2018, the historical information presented in the consolidated financial statements prior to October
4, 2017 is that of Promet in accordance with Accounting Standards Codification (“ASC”) 805-40-45,
Business Combinations
– Reverse Acquisitions
. Prior to the closing of the asset purchase transaction on October 4, 2017, Promet was treated
as a partnership for federal income tax purposes and thus was not subject to income tax at the entity level. Therefore, no provision
or liability for income taxes has been included in these consolidated financial statements through the date of the asset purchase
on October 4, 2017.
The
Company expects to be in an overall taxable loss position for 2018. However, the Company expects to recognize a deferred tax benefit
in 2018 to the extent the 2017 net operating loss carryover and the 2018 net operating losses can be used to offset the deferred
tax liability related to the intangible asset. No current income tax expense is expected for the foreseeable future as the Company
expects to generate taxable net operating losses.
Note
6 - Stock-based Compensation
The
amended and restated Heatwurx, Inc. 2011 Equity Incentive Plan (the “Plan”) was adopted on April 15, 2011 by the board
of directors and approved by the shareholders on October 15, 2012. Under this Plan, employees, non-employee directors, advisors,
and consultants of the Company and its affiliates are eligible to receive grants under the Plan. The Plan authorizes the issuance
of up to 257,143 shares of common stock. If unexercised options expire or are terminated, the underlying shares will again become
available for future grants under the Plan. At September 30, 2018, there were no outstanding awards that had been granted under
this Plan.
The
Plan provides for the grant of options to purchase shares of common stock of the Company. Options may be incentive stock options,
designed to satisfy the requirements of Section 422 of the U.S. Internal Revenue Code, or non-statutory stock options, which do
not meet those requirements. Incentive stock options may only be granted to employees of the Company and its affiliates. Non-statutory
stock options may be granted to employees, nonemployee directors, advisors, and consultants of Company and its affiliates.
The
exercise price for non-statutory and incentive stock options granted under the equity compensation plan may not be less than 100%
of the fair market value of the common stock on the option grant date or 110% in the case of incentive stock options granted to
employees who own stock representing more than 10% of the voting power of all classes of common stock of the Company. The Board
of Directors, until a Compensation Committee has been appointed, has the authority to establish the vesting, including the terms
under which vesting may be accelerated, and other terms and conditions of the options granted. Options can have a term of no more
than ten years from the grant date except for incentive stock options granted to 10% stockholders which can have a term of no
more than five years from the grant date.
Processa Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial
Statements
(Unaudited)
The
Board of Directors may amend or terminate the Plan and outstanding options at any time without the consent of option holders provided
that such action does not adversely affect outstanding options. Amendments are subject to stockholder approval to the extent required
by applicable laws and regulations. Unless terminated sooner, the Plan will automatically terminate on April 15, 2021, the tenth
anniversary of April 15, 2011.
During
the nine months ended September 30, 2018, the Company granted non-qualified stock options outside of the Plan for a total of 334,400
shares of common stock. An option for the purchase of 316,400 shares of common stock vests over a four-year term and an option
for the purchase of 18,000 shares of common stock vests over one-year term. Both stock option grants have a maximum contractual
term of ten years. Vesting is subject to the holder’s continuous service with the Company.
The
fair value of each stock option grants was estimated using the Black-Scholes option-pricing model at the date of grant. The Company
recently completed a reverse merger, as described in Note 1, and as such, lacks company-specific historical and implied volatility
information. Therefore, it determined its expected stock volatility based on the historical volatility of a publicly traded set
of peer companies, and expects to continue to do so until such time as it has adequate historical data regarding the volatility
of its own traded stock price. Due to the lack of historical exercise history, the expected term of the Company’s stock
options was determined utilizing the “simplified” method for awards that qualify as “plain-vanilla” options.
The risk-free interest rate was determined by reference to the U.S. Treasury yield curve in effect at the time of grant of the
award for time periods approximately equal to the expected term of the award. Expected dividend yield is based on the fact that
the Company has never paid cash dividends and does not expect to pay any cash dividends in the foreseeable future.
The
fair value of the Company’s option awards granted during the nine-month period ended September 30, 2018 was estimated using
the following assumptions:
Exercise price
|
|
$
|
2.84
|
|
Risk-free rate of interest
|
|
|
3.09
|
%
|
Expected term (years)
|
|
|
5.0 to 6.25
|
|
Expected stock price volatility
|
|
|
85.31
|
%
|
Dividend yield
|
|
|
0
|
%
|
The
following table summarizes the Company’s stock option activity for the nine months ended September 30, 2018:
|
|
Total options
Outstanding
|
|
|
Weighted average
exercise price
|
|
|
Weighted
average remaining contractual life
(in years)
|
|
Outstanding as of January 1, 2018
|
|
|
-
|
|
|
$
|
-
|
|
|
|
-
|
|
Options granted
|
|
|
334,400
|
|
|
|
2.84
|
|
|
|
9.9
|
|
Exercised
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Forfeited
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Outstanding as of September 30, 2018
|
|
|
334,400
|
|
|
$
|
2.84
|
|
|
|
9.9
|
|
No options were vested or exercisable as of
September 30, 2018. The weighted average grant date fair value per share of options granted during the nine months ended September
30, 2018 was between $2.00 and $2.10. No forfeiture rate was applied to these stock options.
The
Company recorded $50,528 of stock-based compensation expense for the three and nine months ended September 30, 2018 for awards
issued under the above-mentioned plan as general and administrative expense.
No
tax benefits were attributed to the stock-based compensation expense because a valuation allowance was maintained for all net
deferred tax assets.
As of September 30, 2018, there was approximately
$649,913 of total unrecognized compensation expense, related to the unvested stock options which are expected to be recognized
over a weighted average period of 3.9 years.
Processa Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial
Statements
(Unaudited)
Note
7 – Net Loss per Share of Common Stock
Basic
net loss per share is computed by dividing net loss by the weighted average common shares outstanding. Diluted net loss per share
is computed by dividing net loss by the weighted average common shares outstanding without the impact of potential dilutive common
shares outstanding because they would have an anti-dilutive impact on diluted net loss per share. The treasury-stock method is
used to determine the dilutive effect of the Company’s stock options and warrants grants, and the if-converted method is
used to determine the dilutive effect of the Company’s Senior Convertible Notes.
The
computation of net loss per share for the three and nine months ended September 30, 2018 and 2017 is shown below.
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Basic and diluted net loss per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss
|
|
$
|
(852,822
|
)
|
|
$
|
(711,567
|
)
|
|
$
|
(3,155,874
|
)
|
|
$
|
(1,222,453
|
)
|
Weighted-average number of common shares-basic and diluted
|
|
|
38,674,265
|
|
|
|
31,745,242
|
|
|
|
36,869,323
|
|
|
|
31,745,242
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic and diluted net loss per share
|
|
$
|
(0.02
|
)
|
|
$
|
(0.02
|
)
|
|
$
|
(0.09
|
)
|
|
$
|
(0.04
|
)
|
The
outstanding options and warrants to purchase common stock and the shares issuable under the Senior Convertible Note were excluded
from the computation of diluted net income per share as their effect would have been anti-dilutive for the periods presented below:
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2018
|
|
|
2017
|
|
|
2018
|
|
|
2017
|
|
Stock options and purchase warrants
|
|
|
3,947,186
|
|
|
|
-
|
|
|
|
3,947,186
|
|
|
|
-
|
|
Senior convertible notes
|
|
|
119,195
|
|
|
|
-
|
|
|
|
119,195
|
|
|
|
-
|
|
Note
8 – Related Party Transactions
A
shareholder, CorLyst, LLC, reimburses the Company for shared costs related to payroll, health care insurance and rent based on
actual costs incurred and recognized as a reduction of the general and administrative operating expenses being reimbursed in the
Company’s condensed consolidated statement of operations. The reimbursed amounts totaled $1,025 and $0 for the three months
ended September 30, 2018 and 2017, respectively, and $28,505 and $49,089 for the nine months ended September 30, 2018 and 2017,
respectively. Amounts due from CorLyst at September 30, 2018 and December 31, 2017 were $79,422 and $62,709, respectively. CorLyst
also purchased 132,159 shares of our common stock for $300,001 in a private placement transaction.
A
Director of the Company is the manager of the JMW Fund, LLC, San Gabriel Fund, LLC, and Richland Fund, LLC, collectively known
as the “Funds”. The Funds received 515,583 shares of our common stock and warrants to purchase 515,583 shares of our
common stock upon the conversion of $1 million of Senior Convertible Notes held by the Funds purchased on October 4, 2017. At
September 30, 2018, the Funds owned a total of 2,566,639 shares of common stock and warrants to purchase 515,583 shares of common
stock.
Processa Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial
Statements
(Unaudited)
Entities
affiliated with our Chairman of the Board of Directors and Chief Executive Officer (CEO) received 103,117 shares of our common
stock and warrants to purchase 103,117 shares of our common stock upon the conversion of $200,000 in Senior Convertible Notes
purchased on October 4, 2017. Our CEO and entities affiliated with our CEO also purchased a total of 132,160 shares of common
stock and warrants to purchase 132,160 shares of common stock in private placement transactions.
Note
9 – Commitments and Contingencies
Purchase
Obligations
The
Company enters into contracts in the normal course of business with contract research organizations and subcontractors to further
develop its products. The contracts are cancellable, with varying provisions regarding termination. If a contract with a specific
vendor were to be terminated, the Company would only be obligated for products or services that it received as of the effective
date of the termination and any applicable cancellation fees. The Company had purchase obligations of approximately $41,000 and
$896,000 at September 30, 2018 and December 31, 2017, respectively.
Due to the contingent nature of the
amounts and timing of the payments, we have excluded our agreement with the CRO with whom we have contracted to conduct
our Phase 2a NL clinical trial. We were contractually obligated for up to approximately $1.8 million of future services
under the agreement, but our actual contractual obligations will vary depending on the progress and results of the clinical trial.
Cybersecurity
Fraud
In
January 2018, the Company incurred a loss of $144,200 due to fraud from a cybersecurity breach. As a result, we have implemented
certain review and approval procedures internally and with our banks; our technology consultants have implemented system changes;
and, we reported the fraud to our banks and the Federal Bureau of Investigation Cyber Crimes Unit. The Company does not have insurance
coverage against the type of fraud that occurred, therefore, recovery of the loss is remote. While we are taking steps to prevent
such an event from reoccurring, we cannot provide assurance that similar issues will not reoccur. The loss is included in general
and administrative expenses in the consolidated statement of operations for the nine months ended September 30, 2018.
Note
10 - Subsequent Events
The
Company has evaluated all subsequent events through the date of filing of this Quarterly Report on Form 10-Q with the SEC, to
ensure that this filing includes appropriate disclosure of events both recognized in the financial statements as of September
30, 2018, and events which occurred subsequent to September 30, 2018, but which were not recognized in the financial statements.
The Company has determined that there were no subsequent events which required recognition, adjustment to or disclosure in the
financial statements.