Protea Biosciences Group, Inc. - FORM 10-Q

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EXCEL - IDEA: XBRL DOCUMENT - Protea Biosciences Group, Inc.	Financial_Report.xls
EX-31.2 - EXHIBIT 31.2 - Protea Biosciences Group, Inc.	v325770_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Protea Biosciences Group, Inc.	v325770_ex31-1.htm
EX-32.2 - EXHIBIT 32.2 - Protea Biosciences Group, Inc.	v325770_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - Protea Biosciences Group, Inc.	v325770_ex32-1.htm

FORM 10-Q

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2012

¨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)		Number)

955 Hartman Run Road, Morgantown, West Virginia 26507

(Address of principal executive offices)

(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: 29,879,247 shares of common stock, par value $.0001 per share, outstanding as of November 9, 2012.

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

	Condensed 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	19

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	24

Item 4.	Controls and Procedures	24

PART II – OTHER INFORMATION :

Item 1.	Legal Proceedings	25

Item 1A.	Risk Factors	25

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25

Item 3.	Defaults Upon Senior Securities	27

Item 4.	Mine Safety Disclosures	27

Item 5.	Other Information	27

Item 6.	Exhibits	28

Signatures		29

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 September 30, 2012 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 filed with the Securities and Exchange Commission on March 29, 2012.

PROTEA BIOSCIENCES GROUP, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

Consolidated Balance Sheets

See Accompanying Notes to Financial Statements

	September 30, 2012 (Unaudited)			December 31, 2011
ASSETS
Current Assets:
Cash and cash equivalents	$	56,345		$	505,277
Restricted cash		-			49,979
Trade accounts receivable		61,335			76,650
Other receivables		40,789			315,555
Inventory		830,319			223,336
Prepaid expenses		122,621			141,425
Total current assets		1,111,409			1,312,222
Property and equipment, net		3,008,219			3,319,219
Other noncurrent assets		24,293			17,632
Total Assets	$	4,143,921		$	4,649,073
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities on short and long-term debt	$	1,253,280		$	398,383
Accounts payable		2,612,792			2,504,094
Bank line of credit		3,000,000			3,000,000
Loans payable to stockholders		2,108,216			750,000
Other payables and accrued expenses		492,906			310,924
Total current liabilities		9,467,194			6,963,401

Long-term debt - net of current portion		2,221,367			2,189,454
Commitments and contingencies (see Notes)		-			-
Stockholders' Equity:
Preferred stock ($.0001 par value; 10,000,000 shares authorized; none issued or outstanding)		-			-
Common stock ($.0001 par value; 100,000,000 shares authorized; 29,616,994 and 27,061,498 shares issued and outstanding at September 30, 2012 and December 31, 2011)		2,962			2,706
Additional paid in capital		37,659,046			32,922,112
Deficit accumulated during development stage		(45,201,523	)		(37,443,419	)
Accumulated other comprehensive income (loss)		(5,125	)		14,819
Total Stockholders' Equity (Deficit)		(7,544,640	)		(4,503,782	)
Total Liabilities and Stockholders' Equity	$	4,143,921		$	4,649,073

PROTEA BIOSCIENCES GROUP, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

Consolidated Statements of Operations and Total Comprehensive Loss (Unaudited)

See Accompanying Notes to Financial Statements

	For the Three Months Ended						For the Nine Months Ended						Period from July 13,
	September 30,						September 30,						2001 (date of inception)
	2012			2011			2012			2011			to September 30, 2012

Revenue	$	165,538		$	215,379		$	568,994		$	541,474		$	3,227,599
Selling, general, administrative expenses		(1,111,652	)		(1,457,330	)		(3,825,172	)		(4,023,947	)		(24,478,532	)
Research and development expense		(1,118,768	)		(1,195,618	)		(4,103,345	)		(4,349,896	)		(22,105,155	)
Loss from operations		(2,064,882	)		(2,437,569	)		(7,359,523	)		(7,832,369	)		(43,356,088	)

Other income (expense):
Interest and exchange income (expense)		(2,369	)		942			(6,169	)		6,979			45,406
Interest expense		(138,621	)		(414,455	)		(367,309	)		(658,455	)		(1,855,919	)
Gain on debt settlement		-			-			-			-			13,834
Loss on asset disposal		(25,103	)		-			(25,103	)		-			(48,756	)
Total other income (expense)		(166,093	)		(413,513	)		(398,581	)		(651,476	)		(1,845,435	)

Loss before income taxes		(2,230,975	)		(2,851,082	)		(7,758,104	)		(8,483,845	)		(45,201,523	)
Income taxes		-			-			-			-			-

Net loss		(2,230,975	)		(2,851,082	)		(7,758,104	)		(8,483,845	)		(45,201,523	)

Foreign currency translation adjustment		2,136			12,350			(19,944	)		(24,191	)		(5,125	)
Total comprehensive loss	$	(2,228,839	)	$	(2,838,732	)	$	(7,778,048	)	$	(8,508,036	)	$	(45,206,648	)

Net loss per share - basic and diluted	$	(0.08	)	$	(0.13	)	$	(0.27	)	$	(0.38	)	$	(4.35	)
Weighted average number of shares outstanding - basic and diluted		29,245,418			22,676,938			28,442,560			22,666,938			10,380,600

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, 2011		27,061,498	$	2,706	$	32,922,112		$	(37,443,419	)	$	14,819		$	(4,503,782	)

Issuance of stock for cash at $2.00 per share (net of issuance costs of $418,294)		2,380,000		238		4,341,468			-			-			4,341,706
Issuance of stock for placement agent		124,871		12		(12	)		-			-			-
Stock-based compensation expense		-		-		238,484			-			-			238,484
Stock warrants issued as part of convertible debentures		-		-		68,250			-			-			68,250
Stock options exercised at $1.50 per share		25,000		3		37,497			-			-			37,500
Stock warrants exercised at $2.00 per share		25,625		3		51,247			-			-			51,250
Net loss		-		-		-			(7,758,104	)		-			(7,758,104	)
Foreign currency translation adjustment		-		-		-			-			(19,944	)		(19,944	)
September 30, 2012		29,616,994	$	2,962	$	37,659,046		$	(45,201,523	)	$	(5,125	)	$	(7,544,640	)

PROTEA BIOSCIENCES GROUP, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

Consolidated Statements of Cash Flows (Unaudited)

See Accompanying Notes to Financial Statements

	For the Nine Months			For the Nine Months			Period from July 13, 2001
	Ended September 30,			Ended September 30,			(date of inception) to
	2012			2011			September 30, 2012
Cash flows from operating activities:
Net loss	$	(7,758,104	)	$	(8,483,845	)	$	(45,201,523	)
Adjustments to reconcile net loss to net cash from operating activities:
Depreciation and amortization		749,155			943,612			4,138,509
Non-cash compensation		238,484			252,903			1,503,032
Issuance of common stock and warrants for services		-			-			529,138
Issuance of common stock for accrued interest		-			258,181			461,200
Accretion of convertible debenture discount		47,686			132,689			187,520
Loss on disposal of fixed assets		25,103			-			48,756
Net change in assets and liabilities:
Decrease (increase)
Trade accounts receivable		15,315			(41,530	)		(61,335	)
Prepaid expenses		18,804			(39,814	)		(122,721	)
Other receivables		291,711			148,009			360,917
Inventory		(606,983	)		4,208			(830,319	)
Increase (decrease)
Trade accounts payable		108,698			(521,662	)		2,732,300
Other payables and accrued expenses		181,983			184,167			492,906
Net cash used in operating activities		(6,688,148	)		(7,163,082	)		(35,761,620	)

Cash flows from investing activities:
Movement in restricted cash		49,979			(54	)		-
Purchase of and deposits on equipment		(390,624	)		(636,652	)		(4,473,929	)
Proceeds from sale of equipment		-			-			47,450
Net cash used in investing activities		(340,645	)		(636,706	)		(4,426,479	)

Cash flows from financing activities:
Net advances on bank line of credit		-			-			3,000,000
Proceeds from sale of common stock		4,406,851			1,710,500			24,436,340
Proceeds from short and long-term debt		1,090,000			6,655,000			11,630,000
Proceeds from shareholder debt		1,358,216			-			2,608,216
Repayment of long-term debt		(255,262	)		(295,229	)		(1,420,600	)
Financing costs		-			-			(4,387	)
Net cash provided by financing activities		6,599,805			8,070,271			40,249,569

Effect of exchange rate changes on cash		(19,944	)		(24,191	)		(5,125	)

Net increase (decrease) in cash		(448,932	)		246,292			56,345
Cash, beginning of period		505,277			410,696			-

Cash, end of period	$	56,345		$	656,988		$	56,345

Supplemental disclosure of cash flow information:
Cash paid during the period for interest	$	315,235		$	267,584		$	1,185,594

Supplemental disclosure of non-cash investing and financing activities:
Equipment financed through finance company debt	$	72,635		$	365,870		$	2,790,907
Debt converted to company stock	$	-		$	9,425,791		$	9,628,710
Stock subscription	$	23,605		$	500,000		$	23,605

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

Notes to Consolidated Financial Statements – (Unaudited)

Description of Company and Nature of Business

Protea Biosciences Group, Inc. (“Protea” or the “Company”) was incorporated in the state of Delaware on May 24, 2005. Pursuant to an Agreement and Plan of Merger, dated September 2, 2011 (the “Merger Agreement”), by and among the Company, Protea Biosciences, Inc. (“PBI”), and SRKP 5 Acquisition Corp., a wholly-owned subsidiary of the Company (“MergerCo”), PBI was merged with and into MergerCo, with PBI continuing as the surviving entity (the “Merger”). Upon the closing of the Merger, the Company changed its name from “SRKP 5, Inc.” to “Protea Biosciences Group, Inc.” and became the parent company of PBI.

PBI is an emerging biotechnology company incorporated in Delaware in July 2001, and based in Morgantown, West Virginia. The Company is engaged in developing and commercializing proprietary life science technologies, products and services that are used to recover and identify proteins in biological samples. Through its wholly-owned French subsidiary, it has a joint development arrangement with Laboratoires Mayoly Spindler SAS to develop and market a recombinant biopharmaceutical product.

The interim consolidated financial statements presented herein have been prepared by the Company, are unaudited and, in the opinion of management, reflect all adjustments of a normal recurring nature necessary for a fair statement of the financial position at September 30, 2012, the results of operations for the three and nine month periods ended September 30, 2012 and September 30, 2011, and the cash flows for the nine month periods ended September 30, 2012 and September 30, 2011. Interim results are not necessarily indicative of results for a full year.

The consolidated balance sheet presented as of December 31, 2011, 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 2011 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 Company has experienced negative cash flows from operations since inception and had an accumulated deficit at September 30, 2012 of approximately $45 million and at December 31, 2011 of approximately $37 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, to develop new products and services based upon its proprietary protein recovery and identification technologies, and to continue clinical trials of its recombinant pharmaceutical compound.

Management intends to meet its operating cash flow requirements from the sale of equity or issuance of debt. The Company seeks additional capital through sales of equity securities or convertible debt and, if appropriate, to pursue partnerships to advance its drug and technology 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.

Summary of Significant Accounting Policies

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of Protea Biosciences Group, Inc. and all of its wholly-owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.

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

Notes to Consolidated Financial Statements (unaudited)

Summary of Significant Accounting Policies (continued)

Development Stage Enterprise

The Company is a development stage enterprise and devotes substantial efforts to establishing new business, raising capital, conducting research and development activities and developing markets. All losses accumulated since inception have been considered as part of the Company’s development stage activities.

Estimates and Assumptions

The presentation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Reclassification

Certain amounts have been reclassified in the presentation of the Consolidated Financial Statements for the year ended December 31, 2011 to be consistent with the presentation in the Consolidated Financial Statements for the nine months ended September 30, 2012. This reclassification had no impact on previously reported net income, cash flow from operations or changes in stockholder equity.

Other Receivables

Other receivables, which reflect amounts due from non-trade activity, consist of the following at September 30, 2012 and December 31, 2011:

	September 30, 2012		December 31, 2011
French government R&D credit	$	-	$	281,996
Employee loan – current		16,699		-
Stock subscription and other		24,090		33,559
Other receivables – current	$	40,789	$	315,555

Employee loan – noncurrent		8,096		17,632
Deposits		16,197		-
Other receivables – noncurrent	$	24,293	$	17,632

Total Comprehensive Loss

For the period from inception through September 30, 2012, the Company has a translation loss which represents other comprehensive loss and is included in the Statement of Operations and Total Comprehensive Loss in the financial statements.

Net Loss per Share

Basic and diluted loss per common share are 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 17,072,000 and 15,133,000 at September 30, 2012 and December 31, 2011, respectively.

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

Notes to Consolidated Financial Statements (unaudited)

Summary of Significant Accounting Policies (continued)

RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS:

FASB ASU 2011-05 – Presentation of Comprehensive Income

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income, updating ASC Topic 220, Comprehensive Income. Under the amended ASC Topic 220, an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance eliminates the current option to present other comprehensive income and its components in the Statement of Stockholders’ Equity. This guidance does not change the components that are recognized in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. In December 2011, the FASB issued ASU 2011-12, Deferral of the Effective Date for the Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, updating ASC Topic 220, Comprehensive Income. This guidance defers changes in ASU 2011-05 that relate to the presentation of reclassification adjustments. The guidance in ASU 2011-05 and ASU 2011-12 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011, and is to be applied retrospectively. Adoption of this guidance did not have an impact on the Company’s consolidated financial statements or on future operating results.

Bank Line of Credit

In August of 2009, the Company took out 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 September 30, 2012 and December 31, 2011, the balance was $3,000,000 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 (see Note 14, Subsequent Events).

Loans Payable to Stockholders

In December of 2011, the Company borrowed $750,000 in an aggregate principal amount from two board members. The notes accrue simple interest at a rate of 10% per annum and are due and payable 180 days from the date of issue. At the option of the holders, the notes, including the principal and accrued interest, are convertible into common stock of the Company at $2.00 per share. On June 15, 2012, the board members signed addendums to the notes agreeing to extend the maturity date by 90 days to September 15, 2012. On September 25, 2012, the board members signed addendums to the notes agreeing to extend the maturity date by an additional 90 days to December 14, 2012.

In April of 2012, the Company borrowed $640,000 in an aggregate principal amount from various board members and their spouses. The notes accrue simple interest at a rate of 10% per annum and are due and payable 90 days from the date of issue. At the option of the holders, the notes, including the principal and accrued interest, are convertible into common stock of the Company at $2.00 per share. In June and July of 2012, the note holders signed addendums to the notes agreeing to extend the maturity date by 90 days to October 13, 2012. Subsequent to the balance sheet date, the notes were extended to January 11, 2013.

In September of 2012, the Company borrowed $593,216 in an aggregate principal amount from various board members and their spouses. The notes accrue simple interest at a rate of 10% per annum and are due and payable 60 days from the date of issue. At the option of the holders, the notes, including the principal and accrued interest, are convertible into common stock of the Company at $2.00 per share.

In September of 2012, one board member and his spouse advanced the Company an additional $125,000.

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

Notes to Consolidated Financial Statements (unaudited)

Long-term Debt

Note Payable to the West Virginia Development Office

In March 2007, the Company obtained an 8-year loan in the amount of $685,000 from the West Virginia Development Office. 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. As of September 30, 2012, the Company was in arrears on the note. The repayment terms were modified, whereby the West Virginia Development Office approved a three month deferral of principal and interest. Therefore, the default has not triggered an acceleration of the entire balance plus accumulated interest.

Note Payable to Finance Company

In July 2007, the Company obtained a 5-year loan in the amount of $28,726 from a finance company. The note bears interest at 6.99% with monthly principal and interest payments of $569 through July 2012. The note is secured by a vehicle. The note was paid in full on July 11, 2012.

Note Payable to the West Virginia Economic Development Authority

In August 2009, the Company obtained a 10-year loan in the amount of $242,631 from the West Virginia Economic Development Authority. 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 September 30, 2012, the Company was in arrears on the note. The repayment terms were modified, whereby the West Virginia Economic Development Authority approved a three month deferral of principal and interest. Therefore, the default has not triggered an acceleration of the entire balance plus accumulated interest.

Note Payable to the West Virginia Infrastructure and Jobs Development Council

In August 2009, the Company obtained a 10-year loan in the amount of $242,630 from the West Virginia Infrastructure and Jobs Development Council. 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 September 30, 2012, the Company was in arrears on the note. The repayment terms were modified, whereby the West Virginia Infrastructure and Jobs Development Council approved a three month deferral of principal and interest. Therefore, the default has not triggered an acceleration of the entire balance plus accumulated interest.

Note Payable to the West Virginia Economic Development Authority

In October 2010, the Company issued a 10-year note in the amount of $900,000 from the West Virginia Economic Development Authority. 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 September 30, 2012, the Company was in arrears on the note. The repayment terms were modified, whereby the West Virginia Economic Development Authority approved a three month deferral of principal and interest. Therefore, the default has not triggered an acceleration of the entire balance plus accumulated interest.

Note Payable to the West Virginia Infrastructure and Jobs Development Council

In December 2010, the Company issued a 10-year note in the amount of $900,000 from the West Virginia Infrastructure and Jobs Development Council. 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 September 30, 2012, the Company was in arrears on the note. The repayment terms were modified, whereby the West Virginia Infrastructure and Jobs Development Council approved a three month deferral of principal and interest. Therefore, the default has not triggered an acceleration of the entire balance plus accumulated interest.

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

Notes to Consolidated Financial Statements (unaudited)

Long-term Debt (continued)

Convertible Promissory Note Payable to the West Virginia Jobs Investment Trust Board

In March 2012, the Company issued an 18-month note in the amount of $290,000 from the West Virginia Jobs Investment Trust Board. 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 includes a stock warrant for 72,500 shares (see Note 9, Stock Warrants). As of September 30, 2012, the Company was in arrears on the note. The repayment terms were modified, whereby the West Virginia Jobs Investment Trust Board approved an extension of the Company’s interest payments until November 30, 2012. Therefore, the default has not triggered an acceleration of the entire balance plus accumulated interest. An executive member of the West Virginia Jobs Investment Trust Board is a board member of the Company.

Convertible Promissory Note Payable to the West Virginia Jobs Investment Trust Board

In April 2012, the Company issued a 3-month note in the amount of $400,000 from the West Virginia Jobs Investment Trust Board. 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). On June 18, 2012, the West Virginia Jobs Investment Trust Board signed an addendum to the note agreeing to extend the maturity date by 90 days to October 15, 2012. As of September 30, 2012, the Company was in arrears on the note. The repayment terms were modified, whereby the West Virginia Jobs Investment Trust Board approved an extension of the Company’s interest payments until November 30, 2012 and principal repayment until January 15, 2013. Therefore, the default has not triggered an acceleration of the entire balance plus accumulated interest. An executive member of the West Virginia Jobs Investment Trust Board is a board member of the Company.

Convertible Promissory Note Payable to the West Virginia High Technology Consortium Foundation

In May 2012, the Company issued a 30-month note in the amount of $200,000 from the West Virginia High Technology Consortium Foundation. 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.

10)

Note Payable to the West Virginia Economic Development Authority

In June 2012, the Company issued a 10-year note in the amount of $200,000 from the West Virginia Economic Development Authority. 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 September 30, 2012, the Company was in arrears on the note. The repayment terms were modified, whereby the West Virginia Economic Development Authority approved a three month deferral of principal and interest. Therefore, the default has not triggered an acceleration of the entire balance plus accumulated interest.

11)

Capital Leases

From time to time, in the normal course of business, the Company enters into capital leases to finance equipment. As of September 30, 2012, the Company had four capital lease obligations outstanding with imputed interest rates ranging from 2.9% to 8.0%. The leases require 36 monthly payments and begin to expire in March 2013 through May 2015. These leases are secured by equipment with an aggregate cost of $560,195. As of September 30, 2012, the Company was in arrears on all four capital leases.

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

Notes to Consolidated Financial Statements (unaudited)

Long-term Debt (continued)

Total debt outstanding as of September 30, 2012 and December 31, 2011 are as follows:

		September 30, 2012			December 31, 2011
1)	Note Payable to the WV Development Office	$	258,497		$	312,343
2)	Note Payable to Finance Company		-			3,343
3)	Note Payable to the WVEDA		179,728			192,559
4)	Note Payable to the WVIJDC		177,894			190,974
5)	Note Payable to the WVEDA		756,217			802,916
6)	Note Payable to the WVIJDC		768,259			814,652
7)	Note Payable to the WVJITB		269,437			-
8)	Note Payable to the WVJITB		400,000			-
9)	Note Payable to the WVHTCF		200,000			-
10)	Note Payable to the WVEDA		196,983			-
11)	Capital leases		267,632			271,050
	Total		3,474,647			2,587,837
	Less: current portion		(1,253,280	)		(398,383	)
	Long-term portion	$	2,221,367		$	2,189,454

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

Year ending December 31:	Future required minimum principal repayments
2012 (September to December)	$	568,438
2013	$	823,183
2014	$	504,915
2015	$	287,768
2016	$	253,577
2017 & Thereafter	$	1,036,766

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

Notes to Consolidated Financial Statements (unaudited)

Common Stock

The Company is authorized to issue a total of 110,000,000 shares of stock, of which 100,000,000 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 are elected by the affirmative vote of the holders of a majority of the Company’s outstanding Common Stock. Common Stock issues during 2012 are as follows:

	# Shares Issued		Par Value		Price Per Share		Gross Proceeds		Value of Services Obtained		Par Value		Additional Paid in Capital (2)
December 31, 2011 Balance		27,061,498	$	.0001		Various	$	31,226,645	$	529,138	$	2,706	$	31,753,077
Stock options exercised		25,000		.0001		1.50		37,500		-		3		37,497
Stock warrants exercised		25,625		.0001		2.00		51,250		-		3		51,247
Issuance of stock (includes stock warrants)		2,380,000		.0001		2.00		4,760,000		-		238		4,759,762
Issuance of stock (1)		124,871						-		-		12		(12	)
September 30, 2012 Balance		29,616,994					$	36,075,395	$	529,138	$	2,962	$	36,601,571

(1) Refer to Note 8 for details relating to shares issued as compensation to placement agent.

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

Preferred Stock

The Company is authorized to issue Preferred Stock 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.

Stock Options and Stock-based Compensation

The Company has an Equity Incentive Plan that governs equity awards to employees, directors and consultants of the Company. The Plan has been amended several times since adoption, and under the Plan, 4,150,000 shares of Common Stock are reserved for issuance.

The types of awards permitted under the Plan 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, 2011		4,046,750	$	1.40		4.21
Granted		61,000	$	2.00
Exercised		25,000	$	1.50
Cancelled or expired		145,000	$	1.50
Outstanding at September 30, 2012		3,937,750	$	1.40		4.04

Exercisable at December 31, 2011		2,518,854	$	1.33		3.79
Exercisable at September 30, 2012		2,967,855	$	1.37		3.64

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

Notes to Consolidated Financial Statements (unaudited)

Stock Options and Stock-based Compensation (continued)

The following table summarizes information about stock options at September 30, 2012:

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		80,000						80,000
$	0.80		320,000						320,000
$	1.25		510,000						510,000
$	1.50		2,936,000						1,966,105
$	2.00		91,750						91,750
$	0.50 - $2.00		3,937,750		4.04	$	1.40		2,967,855	$	1.37

At September 30, 2012, the total aggregate intrinsic value for options currently exercisable was $1,869,552 and options outstanding was $2,354,500. These values represent the total pre-tax intrinsic value based on the estimated fair value of the Company’s stock price of $2.00 as of September 30, 2012. This intrinsic value represents the value that would have been received by the option holders had option holders exercised all of their options as of that date. Intrinsic value for stock options is defined as the difference between the current market value and the exercise price. During the nine months ended September 30, 2012, 25,000 shares were exercised, whereas during the nine months ended September 30, 2011, no options were exercised.

The following table summarizes the activity of the Company’s stock options that have not vested for the nine months ended September 30, 2012:

	Shares		Weighted Average Grant-date Fair Value
Nonvested at December 31, 2011		1,527,896	$	0.437
Granted		-	$	-
Forfeited		145,000	$	0.425
Vested		413,001	$	0.459
Nonvested at September 30, 2012		969,895	$	0.435

The fair value of non-vested options to be recognized in future periods is $421,461, which is expected to be recognized over a weighted average period of 2 years.

The total fair value of options vested during the nine month period ended September 30, 2012 was $238,484 compared to $252,903 for the nine month period ended September 30, 2011. Stock-based compensation expense is as follows:

	Nine Months Ended
	September 30, 2012		September 30, 2011
Selling, general, and administrative expense	$	180,701	$	189,677
Research and development expense		57,783		63,226
Total stock-based compensation expense	$	238,484	$	252,903

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

Notes to Consolidated Financial Statements (unaudited)

Stock Options and Stock-based Compensation (continued)

The weighted average grant-date fair value of options granted during the nine month period ended September 30, 2012 was $0.568 and for the nine month period ended September 30, 2011 was $0.422 per option. The fair value of the option grants was estimated using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Nine months Ended
	September 30, 2012			September 30, 2011
Risk-free interest rate		1.04	%		1.43	%
Volatility factor		24.04	%		22.64	%
Weighted average expected life (in years)		7			7
Dividend rate		0.0	%		0.0	%

The Company based its estimate of expected stock price volatility on monthly price observations of the AMEX Biotech Index. 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).

In January 2012, the Company issued 499,482 shares of common stock to a placement agent (the “Shares”) in connection with a private placement offering of units consisting of common stock and warrants, which are subject to forfeiture under certain conditions. As of September 30, 2012, an aggregate of 124,871 Shares are no longer subject to forfeiture, and the balance of 374,611 Shares was forfeited.

Stock Warrants

Beginning in 2008, the Company began issuing stock warrants related to common stock issuances. The warrant is exercisable for five years from date of issuance. The warrant allows the holder the ability to purchase an additional share of common stock for every two shares purchased in connection with the warrant. Prior to the fourth quarter 2011, the exercise price was $2.00 per share. Commencing in the fourth quarter 2011 and continuing through the third quarter 2012, the exercise price is $2.25 per share.

In November 2009, the Company issued stock warrants to four board members in exchange for personal guarantees on a bank line of credit (see Note 3, Bank Line of Credit). The warrant is exercisable for five years from date of issuance. The warrant allows the four holders the ability to purchase an additional 375,000 shares of common stock. The exercise price is $2.00 per share.

In March 2012, the Company issued stock warrants in connection with the issuance of a Convertible Debenture to the West Virginia Jobs Investment Trust Board (see Note 5, Long-term Debt). The warrant is exercisable for five years from date of issuance. The warrant allows the holder the ability to purchase 72,500 shares of common stock. The exercise price is $2.25 per share.

In April 2012, the Company issued stock warrants in connection with the issuance of a Convertible Debenture to the West Virginia Jobs Investment Trust Board (see Note 5, Long-term Debt). The warrant is exercisable for five years from date of issuance. The warrant allows the holder the ability to purchase 88,889 shares of common stock. The exercise price is $2.25 per share.

As of September 30, 2012, warrants to purchase 13,115,569 shares of common stock were outstanding and exercisable.

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

Notes to Consolidated Financial Statements (unaudited)

10.

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 adopted ASC 740-10 effective January 1, 2007. The adoption of ASC 740-10 did not require an adjustment to the opening balance of retained earnings as of January 1, 2007. There were no changes to unrecognized tax benefits during 2011 or the first nine months of 2012. The tax years 2008 through 2011 remain open to review by various taxing authorities.

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 carryforward totals approximately $39,200,000 and $32,700,000 at September 30, 2012 and December 31, 2011, respectively.

11.

Lease Commitments

The Company leases its USA facilities under operating leases beginning a) February 2005 and extended through December 2012 and b) April 2012 through March 2017. 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
2012 (August to December)	$	208,670
2013	$	263,686
2014	$	257,304
2015	$	173,397
2016	$	167,628
2017	$	41,907

Rent expense totals $113,778 for the three month period ended September 30, 2012 and $300,754 for the nine month period ended September 30, 2012, compared to $76,764 for the three months ended September 30, 2011 and $189,095 for the nine month period ended September 30, 2011.

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

Notes to Consolidated Financial Statements (unaudited)

12.

Retirement Plan

The Company provides a 401(k) Profit Sharing Plan for elective deferrals whereby participants can defer up to 100% 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 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 Plan beginning their first full month of service. Participants become vested in employer contributions on a graduated scale with full vesting after five years. No company contributions have yet been made.

13.

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 September 30, 2012.

Warranty

In the ordinary course of business, the Company warrants to customers that its products will conform to published or agreed specifications. Generally, the applicable product warranty period is 90 days from the date of delivery of the goods. The Company provides for estimated warranty costs at the time of the product sale. As of September 30, 2012, management believes that no warranty allowance is necessary due to a limited sales history and that no goods have historically been returned.

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.

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

Notes to Consolidated Financial Statements (unaudited)

13.

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 JOHNS HOPKINS UNIVERSITY (JHU)

In June 2009, the Company entered into an Exclusive License Agreement with Johns Hopkins University for technology developed in the laboratory of Jennifer Van Eyk, Ph.D., Professor of Medicine, Division of Cardiology, Biological Chemistry and Biomedical Engineering. The technology field is albumin-bound protein complexes and their use in the diagnosis of cardiovascular disease. 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 JHU 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.

AGREEMENT WITH VIRGINIA TECH (VT)

In 2010, the Company entered into an agreement with VT for the exclusive option to license technology in development in the laboratory of Rafael Davalos, PhD., which is intended to enable the separation of specific cell populations, such as cancer cells, in blood and other fluids. It also has an exclusive license to the IRAK-1 compound as a regulator of diseases and disorders in the lab of Liwu Li, PhD. Per the licensing agreements, the Company may be required to pay milestone payments of $12,500 during 2012.

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

Notes to Consolidated Financial Statements (unaudited)

13.

Commitments and Contingencies (continued)

Joint Pharmaceutical Development Agreement

AGREEMENT WITH LABORATOIRE MAYOLY SPINDLER SAS (Mayoly)

In May 2009, the Company, and its wholly-owned subsidiary, Proteabio Europe SAS, entered into a Joint Research and Development Agreement with Mayoly, a European Pharmaceutical company with headquarters in France, for the joint development of a recombinant lipase biopharmaceutical. Under terms of the agreement, Protea receives the exclusive marketing rights for the therapeutic in the territory of North America; will be responsible for paying 40% of the development expenses (with Mayoly funding the remaining 60%); will pay royalties on net sales of the biopharmaceutical, and a milestone payment of 1 million Euros at the time the Company obtains the first FDA approval for the recombinant Lipase biotherapeutic. The Company also receives a sublicense to certain patents owned by Mayoly and licensed from the Government of France. As of September 30, 2012 and December 31, 2011, based on estimated expenditures by both companies and the anticipated sharing of expenditures, the Company estimates that it owed approximately $969,000 and $974,000 to Mayoly, which is reflected in Trade Accounts Payable on the Consolidated Balance Sheet.

Engineering and Design Services

The Company has approximately $191,000 in outstanding commitments with MPR Associates, Inc. for engineering and design services related to their LAESI (Laser Ablation Electrospray Ionization) technology. These amounts relate to production of instruments. At September 30, 2012, the Company recorded approximately $2,600 in accrued expenses owed to MPR.

14.

Evaluation of Subsequent Events

Common Stock

Subsequent to the balance sheet date, in connection with a private placement offering, the Company sold and issued 0.75 units consisting of an aggregate of 37,500 shares of Common Stock and 18,750 warrants at a per unit purchase price of $100,000. The warrants are exercisable for five years from the date of issuance at an exercise price of $2.25 per share.

In addition, the Company issued an aggregate of 224,753 shares of Common Stock in connection with the exercise of certain options and warrants as follows:

(1)

115,003 shares issued at an exercise price of $1.50 per share

(2)

100,000 shares issued at an exercise price of $1.25 per share

(3)

9,750 shares issued at an exercise price of $2.00 per share

Advances from Stockholders

Subsequent to the balance sheet date, the Company received advances equal to an aggregate of $790,000 from certain current directors and their related parties. No terms of repayment have been specified on the aforementioned advances as of the filing date.

Bank Line of Credit

Subsequent to the balance sheet date, the Company used proceeds from their Common Stock sales noted above to make a principal payment of $275,000 to the Bank Line of Credit.

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

We were originally incorporated in the State of Delaware on May 24, 2005 under the name "SRKP 5, Inc." as a “blank check” shell company to investigate and acquire a target company or business seeking the perceived advantages of being a publicly-held corporation. On September 2, 2011, we completed a merger in accordance with the terms and conditions of an Agreement and Plan of Merger by and among the Company, Protea Biosciences, Inc., a Delaware corporation ("PBI") and SRKP 5 Acquisition Corp., a Delaware corporation and our wholly-owned subsidiary ("Merger Co"), pursuant to which Merger Co merged with and into PBI (the "Merger"). As a result of the Merger, we (i) became the 100% parent of PBI, (ii) assumed the operations of PBI and (iii) changed our name to "Protea Biosciences Group, Inc."

Protea operates in the field of bioanalytics. Bioanalytics is the identification and characterization of proteins and other biomolecules, which are the products of all living cells and life forms. The Company is applying its technology to the development of a new generation of products and services that enable comprehensive, real-time analysis of living cells, thereby providing data that helps to define normal and disease processes. We believe this will, in turn, support the next generation of medical research and pharmaceutical development. Protea’s technologies seek to enable the discovery and analysis of the proteins and other biomolecules that regulate the biological functions of the human body and all other forms of life. This is a critical area of research, because most biological functions are carried out by proteins, and the discovery of proteins that are associated with specific diseases can lead to the development of new pharmaceuticals, designed to block the proteins’ aberrant biological activities.

Our Business Strategy and Products

The Company applies its core technologies and expertise to the development of products, instruments and services that seek to provide improved capability to the discovery of new proteins and other biomolecules. The Company also seeks to improve the analysis of known biomolecules. To accomplish its commercial objectives, the Company’s operations are organized into two units as follows:

Bioanalytical Product Systems - This unit is responsible for research and development, product manufacturing and quality assurance, including the LAESI technology platform described below.

Bioanalytical Services - This unit is organized as a bioanalytics services business, and offers mass spectrometry-based bioanalytical services for the identification of proteins, metabolites, and other biomolecules to pharmaceutical, industrial and academic research laboratories.

Bioanalytical Product Systems

The Company’s products are purchased and used primarily by pharmaceutical and academic research laboratories. Our product groups are divided as follows:

Protein Sample Preparation

This product group encompasses consumable products for the recovery and preparation of protein samples for analysis by mass spectrometry. The product group includes the following:

· A family of proprietary reagents, known as surfactants, that can rapidly remove proteins out of biological samples and into liquid phase, preparing them for analysis by mass spectrometry. Our surfactants do not interfere with mass spectrometry analysis, as is the case with currently-available surfactants. Marketed as Progenta™ surfactants, they allow recovery of proteins from cells and other sample types, eliminating sample handling and purification steps that lead to reduced protein yield and poorer quality results by mass spectrometry. Our surfactants are available in a variety of forms to accommodate most classes of proteins.

· Single use products for capturing albumin protein in serum. More than 80% of all protein circulating in our bloodstream is human serum albumin (HSA). Our products allow the capture of intact HSA with >99% recovery, in a simple 20- minute disposable spin tip. The analysis of human serum albumin has been found to be a new source of new biomarkers for disease diagnosis (see discussion below). These products have been tested at Johns Hopkins University School of Medicine, and found to be effective for the recovery of serum albumin.

· Single use products, including pipette tips and 96-well plates, which 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. Monolith chemistry improves the quantity of protein recovered, as well as the reproducibility of its subsequent analysis.

Gel Protein Separation and Recovery

The Company developed and markets the GPR-800, a benchtop instrument system that employs proprietary, single-use plastic microfluidic chips and reagent kits to simultaneously recover eight protein samples in 20 minutes, compared to 3-6 hours per sample required by current methods. The GPR-800 improves the quality, reproducibility and throughput of intact protein analysis, while minimizing the possibility of sample loss or contamination.

Mass Spectrometry Standards

The Company has developed and markets an extensive line of protein mass spectrometry standards, which provide defined and characterized proteins representing different protein structures and classes. As the field of proteomics has progressed, there is increased interest in knowing the precise status of a protein, particularly in the identification of “post-translational modifications” (chemical modifications of the protein that occurs after its production via RNA translation), such as phosphorylation, a change that relates to the protein’s biological status. The Company’s mass spectrometry standards are intended to improve the reproducibility of a researcher’s mass spectrometry results.

LAESI Technology

In 2011, we completed the development of a novel bioanalytical instrument platform, known as “LAESI” (laser ablation electrospray ionization). 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. LAESI’s rapid time to results enables analysis of cell samples in real time. As an example, a researcher testing a new drug’s effects on living cells can analyze changes in the cells’ metabolism in real time and across a specific time course, thereby almost immediately obtaining precise data as to the effects of the new drug. The Company believes that LAESI has the potential to revolutionize bioanalytics in pharmaceutical research, as well as many other fields, including agriculture, pathology, biomarker discovery, biodefense and forensics.

We presently have three fully functional LAESI production units in-house with software packages developed by the Company (LAESI desktop software and ProteaPlot™). Instrument production has started and approximately eight units are in various stages of production. We have shipped a unit to the FOM Institute AMOLF in Amsterdam, the Netherlands in August 2012. A second unit was shipped to Waters Corporation in Manchester, England in October 2012.

Bioanalytical Services

Protea offers bioanalytical services for the analysis and identification of both small molecules (e.g. lipids and metabolites) and large molecules (e.g. proteins). The services unit is operated under GLP (Good Laboratory Practices, which are necessary for regulatory submissions and to meet the internal research and development standards of pharmaceutical research clients). The Company believes that it is the first laboratory to offer quantitative protein mass spectrometry services in a GLP regulatory environment.

The Company offers advanced techniques for the analysis of therapeutic proteins (known as biopharmaceuticals) by mass spectrometry, in particular the analysis of modifications to therapeutic proteins that occur in the course of their production by living cells. These modifications include phosphorylation (can activate or deactivate a protein), glycosylation (needed for proper protein folding), and many others. Knowledge of these subtleties of a protein’s structure improves the understanding of the relationship between a protein’s structure and its biological activity. This improved insight can lead to improvements in production methods for therapeutic proteins and improved safety and efficacy for the therapeutic protein.

Antibody-based detection techniques have traditionally been the means to identify proteins. However, antibody methods present challenges of non-specificity, poor reproducibility and in particular the inability to identify subtle changes in protein structure such as phosphorylation status. Protein analysis by mass spectrometry offers improved specificity, sensitivity, and reproducibility.

The Company offers advanced bioanalytical services employing its proprietary LAESI technology platform.

The Company recently opened a dedicated Mass Spectrometry Imaging Center (MSIC) at their facility in Morgantown, WV. This MSIC offers access to the most advanced bimolecular imaging capabilities, including ultra-high resolution mass spectrometry coupled with Protea’s revolutionary LAESI platform.

The Company believes that its advanced protein mass spectrometric methods are an important strategic asset, and will be a key component of its future corporate growth.

Since inception, we have relied primarily on sales of our securities to fund our operations. We have never been profitable and we cannot assure you that we will be profitable in the future. From inception through September 30, 2012, our loss from operations totaled $43,356,088 and our net loss for the nine month period ending September 30, 2012 totaled $7,359,523. We expect to require substantial funds to advance the research and development of our core technologies, to develop new products and services based on our proprietary protein recovery and identification technologies, and to continue clinical trials of our recombinant pharmaceutical compound. We intend to meet our operating cash flow requirements by raising additional funds from the sale of our securities and, whenever possible, by entering into additional partnerships, like our partnership with Laboratoires Mayoly Spindler SAS, to assist us with our drug and technology development activities. We do not have any committed sources of funding and there are no assurances that we will be able to secure additional funding.

Results of Operations

Three and Nine Month Periods Ended September 30, 2012 Compared to Three and Nine Month Periods Ended September 30, 2011

For the three month periods ended September 30, 2012 and September 30, 2011, we earned revenue of $165,538 and $215,379, respectively. This represents a decrease of $49,841 or 23% from the prior period. Excluding grant revenue of $104,687 earned in 2011, revenues increased 50% over the prior period as a result of growth in our Bioanalytical Services area. For the nine month periods ended September 30, 2012 and September 30, 2011, we earned revenue of $568,994 and $541,474, respectively. This represents an increase of $27,520, or approximately 5%. Excluding grant revenue earned in 2011, revenues increased 30% over the prior period.

For the three month periods ended September 30, 2012 and September 30, 2011, selling, general and administrative expenses totaled $1,111,652 and $1,457,330, respectively. This represents a decrease of $345,678, or 24% over the prior period. For the nine month periods ended September 30, 2012 and September 30, 2011, selling, general and administrative expenses totaled $3,825,172 and $4,023,947, respectively. This represents a decrease of $198,775 or approximately 5% resulting mostly from a decrease in legal and consulting expenses.

For the three month periods ended September 30, 2012 and September 30, 2011, research and development expense totaled $1,118,768 and $1,195,618, respectively. This represents a decrease of $76,850, or 6%, resulting from a reduction in LAESI development expenses offset by higher personnel costs. For the nine month periods ended September 30, 2012 and September 30, 2011, research and development expense totaled $4,103,345 and $4,349,896, respectively. This represents a decrease of $246,551 or approximately 6% from the prior period resulting from a reduction in LAESI development and Lipase trial expenses offset by higher personnel costs.

For the three month periods ended September 30, 2012 and September 30, 2011, our loss from operations was $2,064,882 and $2,437,569, respectively. This represents a decrease of $372,687, or approximately 15%. For the nine month periods ended September 30, 2012 and September 30, 2011, our loss from operations was $7,359,523 and $7,832,369, respectively. This is a decrease of $472,846, or approximately 6%.

For the three month periods ended September 30, 2012 and September 30, 2011, other expense was $166,093 and $413,513, respectively. This represents a decrease of $247,420, or approximately 60% as a result of the conversion of $8,455,000 of convertible debentures in September of 2011. For the nine month periods ended September 30, 2012 and September 30, 2011, other expense was $398,581 and $651,476, respectively. This is a decrease of $252,895, or approximately 39%. This decrease reflects the conversion of convertible debentures during the prior year as noted above.

After foreign currency translation adjustments of $2,136 and $12,350, respectively, we had a total comprehensive loss of $2,228,839 and $2,838,732 for the three month periods ended September 30, 2012 and September 30, 2011. After foreign currency translation adjustments of $(19,944) and $(24,191), respectively, we had a total comprehensive loss of $7,778,048 and $8,508,036 for the nine month periods ended September 30, 2012 and September 30, 2011.

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. Prior to the Merger, we had $8,455,000 in principal amount of 6% Series A Convertible Debentures outstanding. Immediately prior to the closing of the Merger, the debentures were automatically converted into shares of common stock of the Company pursuant to their terms. We have a credit facility of $3,000,000 with United Bank, Inc. with a balance of $3,000,000 outstanding as of September 30, 2012. Interest is payable monthly and the loan is due on demand. In 2009 and 2010, we borrowed a total of $2,285,261 for the purchase of equipment from the West Virginia Economic Development Authority (WVEDA) and the West Virginia Water Development Authority. These loans have 10 year terms and interest rates ranging from 3.25% to 4%. In 2012, we borrowed a total of $400,000 for the purchase of equipment from the WVEDA and the West Virginia High Technology Consortium Foundation (WVHTC Foundation). The WVEDA loan has a 10 year term and an interest rate of 2%. The WVHTC Foundation loan has a 30-month term and an interest rate of 8%. In 2011 and 2012, we borrowed $2,108,216 from various board members and spouses. The notes have various terms and accrue simple interest at a rate of 10% per annum.

We will continue to require substantial funds to advance the research and development of our core technologies, to develop new products and services based upon our proprietary protein recovery and identification technologies and to continue clinical trials of our recombinant pharmaceutical compound. We intend to meet our operating cash flow requirements by raising additional funds from the sale of equity or issuance of debt and, possibly, pursuing partnerships to advance our drug and technology development activities. 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, we do not have any committed sources of funding and there are no assurances that we will be able to secure additional funding.

As of September 30, 2012, we had total current assets equal to $1,111,409, comprised of $56,345 in cash and cash equivalents, $102,124 in trade accounts receivable and other receivables, $830,319 in inventory and $122,621 in prepaid expenses. This compares with total current assets at December 31, 2011 equal to $1,312,222 comprised of $505,277 in cash and cash equivalents, $49,979 in restricted cash, $392,205 in trade accounts receivable and other receivables, $223,336 in inventory and $141,425 in prepaid expenses. The Company's total current liabilities as of September 30, 2012 were equal to $9,467,194, comprised of $1,253,280 in current maturities on long term debt, $2,612,792 in trade accounts payable, $3,000,000 in connection with the United Bank, Inc. line of credit, $2,108,216 in loans payable to shareholders and $492,906 in other payables and accrued expenses. The Company's total current liabilities as of December 31, 2011 were equal to $6,963,401, comprised of $398,383 in current maturities on long term debt, $2,504,094 in trade accounts payable, $3,000,000 in connection with United Bank, Inc. line of credit, $750,000 in loans payable to shareholders and $310,924 in other payables and accrued expenses.

Operating Activities

Net cash used in operating activities for the nine month period ended September 30, 2012 decreased $474,934, or 7% from $7,163,082 for the nine month period ended September 30, 2011 to $6,688,148. Net cash used in operating activities during the nine month period ended September 30, 2012 was primarily the result of a net loss of $7,758,104. Net loss was adjusted for non-cash items such as depreciation and amortization of $749,155, non-cash compensation of $238,484, accretion of convertible debenture discount of $47,686 and loss on disposal of fixed assets of $25,103. We also had a decrease in trade accounts receivable of $15,315, in prepaids of $18,804 and other receivables of $291,711. We also had an increase in inventory of $606,983, in trade accounts payable of $108,698 and in other payables and accrued expenses of $181,983.

Our working capital deficit at September 30, 2012 was $8,355,785 as compared to a working capital deficit of $5,651,179 at December 31, 2011. The increase in working capital deficit was $2,704,606 from December 31, 2011 to September 30, 2012.

Investing Activities

Net cash used in investing activities during the nine month period ended September 30, 2012 was $340,645, which was primarily used for equipment purchases. 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 nine month period ended September 30, 2011 was $636,706 and was also used for equipment purchases.

Financing Activities

Cash provided by financing activities during the nine month period ended September 30, 2012 was $6,599,805, which was the result of net proceeds of $4,406,851 from the sale of our common stock and proceeds of $2,448,216 from the issuance of short- and long-term debt. This was offset by $255,262 used in the repayment of long-term debt. Cash provided by financing activities during the nine month period ended September 30, 2011 was $8,070,271, which was the result of the net proceeds of $1,710,500 from the sale of our common stock and proceeds of $6,655,000 from the issuance of long-term debt. This was offset by $295,229 used in the repayment of long-term debt.

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. The following represents a summary of our critical accounting policies, defined as those policies that we believe are the most important to the portrayal of our financial condition and results of operations and that require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effects of matters that are inherently uncertain.

Revenue Recognition

We derive our revenue from the sale of products and services. Revenue is recognized when all four of the following criteria are met: (1) we have persuasive evidence that an arrangement exists, (2) the price is fixed and determinable, (3) title has passed, and (4) collection is reasonably assured. Product revenue is recognized upon shipment of the product, which is typically when title passes. Service revenue is recognized as the service is performed, generally through short-term contracts. However, where applicable, contract service revenue is earned and recognized according to the provisions of each agreement. As of September 30, 2012 and 2011, we had no deferred revenue that related to future periods.

Shipping and handling costs are included in cost of sales. Shipping and handling costs charged to customers are recorded as revenue in the period the related product sales revenue is recognized.

Comprehensive Loss

The financial statements of our international subsidiary are translated into U.S. dollars using the exchange rate at each balance sheet date for assets and liabilities, the historical exchange rate for shareholders’ equity and an average exchange rate for each period of revenues, expenses, and gains and losses. The functional currency of our non-U.S. subsidiary is the local currency. Adjustments resulting from the translation of financial statements are reflected in accumulated other comprehensive income. Transactional gains and losses are recorded within operating results.

Research and Development

We follow the policy of charging the costs of research and development to expense as incurred. Research and development expense is $4,103,345 and $4,349,896, respectively, for the nine month periods ended September 30, 2012 and September 30, 2011.

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 17,072,000 and 15,133,000 for the nine month period ended September 30, 2012 and year ended December 31, 2011, respectively.

Stock Based Compensation

We follow the provisions of FASB ASC 718, “Stock Based Compensation.” Stock-based compensation expense is estimated as of the grant date based on the fair value of the award and is recognized as expense over the requisite service period, which generally represents the vesting period. Fair value of stock options issued by the Company is estimated using the Black-Scholes option-pricing model. The associated compensation expense is recognized on a straight-line basis over the requisite service period, net of estimated forfeitures.

Estimating the fair value for stock options for each grant requires judgment, including estimating stock-price volatility, expected term, expected dividends and risk-free interest rates. The expected volatility rates are estimated based on the volatility of similar entities whose share information is publicly available. The expected term represents the average time that options are expected to be outstanding and is estimated based on the average of the contractual term and the vesting period of the options as provided in SEC Staff Accounting Bulletin 110 as the “simplified” method. The risk-free interest rate for periods approximating the expected term of the options is based on the U.S. Treasury yield curve in effect at the time of grant. Expected dividends are zero as we have no plans to issue dividends.

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 September 30, 2012, 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 have concluded that as of September 30, 2012, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal controls over financial reporting during the quarter ended September 30, 2012 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

On July 3, 2012, the Company issued units consisting of an aggregate of 175,000 shares of common stock and warrants to purchase 87,500 shares of common stock to accredited investors at a per unit purchase price equal to $100,000 for an aggregate purchase price equal to $350,000. The warrants are exercisable at an exercise price of $2.25 per share any time after the date of issuance until the earlier of (i) the closing of a firm commitment underwritten offering pursuant to an effective registration statement under the Securities Act covering the offer and sale of Common Stock for the account of the Company in which the net cash proceeds to the Company (after deduction of underwriting discounts and commissions) are at least $15,000,000 or (ii) 5:00 p.m. Eastern time on the fifth anniversary of the warrant issue date hereof.

On July 27, 2012, the Company issued units consisting of an aggregate of 100,000 shares of common stock and warrants to purchase 50,000 shares of common stock to accredited investors at a per unit purchase price equal to $100,000 for an aggregate purchase price equal to $200,000. The warrants are exercisable at an exercise price of $2.25 per share any time after the date of issuance until the earlier of (i) the closing of a firm commitment underwritten offering pursuant to an effective registration statement under the Securities Act covering the offer and sale of Common Stock for the account of the Company in which the net cash proceeds to the Company (after deduction of underwriting discounts and commissions) are at least $15,000,000 or (ii) 5:00 p.m. Eastern time on the fifth anniversary of the warrant issue date hereof.

On August 13, 2012, the Company issued units consisting of an aggregate of 12,500 shares of common stock and warrants to purchase 6,250 shares of common stock to accredited investors at a per unit purchase price equal to $100,000 for an aggregate purchase price equal to $25,000. The warrants are exercisable at an exercise price of $2.25 per share any time after the date of issuance until the earlier of (i) the closing of a firm commitment underwritten offering pursuant to an effective registration statement under the Securities Act covering the offer and sale of Common Stock for the account of the Company in which the net cash proceeds to the Company (after deduction of underwriting discounts and commissions) are at least $15,000,000 or (ii) 5:00 p.m. Eastern time on the fifth anniversary of the warrant issue date hereof.

On August 31, 2012, the Company issued units consisting of an aggregate of 62,500 shares of common stock and warrants to purchase 31,250 shares of common stock to accredited investors at a per unit purchase price equal to $100,000 for an aggregate purchase price equal to $125,000. The warrants are exercisable at an exercise price of $2.25 per share any time after the date of issuance until the earlier of (i) the closing of a firm commitment underwritten offering pursuant to an effective registration statement under the Securities Act covering the offer and sale of Common Stock for the account of the Company in which the net cash proceeds to the Company (after deduction of underwriting discounts and commissions) are at least $15,000,000 or (ii) 5:00 p.m. Eastern time on the fifth anniversary of the warrant issue date hereof.

All of the units, and securities underlying the units issued on July 3, 2012, July 27, 2012, August 13, 2012 and August 31, 2012 described above were issued to accredited investors in accordance with the exemption from registration provided by Section 4(2) of the Securities action in that the securities were offered and sold to accredited investors and the Company did not engage in any general advertisement or general solicitation in connection with the offering of the units.

On August 22, 2012, in connection with the terms of a private placement offering (the “Offering”) of up to $6,000,000 of units (the “Units”), each Unit consisting of 50,000 shares of common stock and warrants to purchase 25,000 shares of Common Stock (the “Warrants”), the Company issued an aggregate of 75,000 shares of Common Stock and Warrants to purchase an aggregate of 37,500 shares of Common Stock at a per Unit purchase price of $100,000 for aggregate gross proceeds equal to $150,000. The Warrants are exercisable at an exercise price of $2.25 per share any time after the date of issuance until the earlier of (i) the closing of a firm commitment underwritten offering pursuant to an effective registration statement under the Securities Act covering the offer and sale of Common Stock for the account of the Company in which the net cash proceeds to the Company (after deduction of underwriting discounts and commissions) are at least $15,000,000 or (ii) 5:00 p.m. Eastern time on the fifth anniversary of the warrant issue date hereof.

On August 31, 2012, in connection with a closing of the Offering the Company issued Units to accredited investors consisting of an aggregate of 150,000 shares of Common Stock and Warrants to purchase 75,000 shares of Common Stock for aggregate gross proceeds of $300,000.

On September 13, 2012, in connection with a closing of the Offering the Company issued Units to accredited investors consisting of an aggregate of 50,000 shares of Common Stock and Warrants to purchase 25,000 shares of Common Stock for aggregate gross proceeds of $100,000.

On September 14, 2012, in connection with a closing of the Offering the Company issued Units to accredited investors consisting of an aggregate of 75,000 shares of Common Stock and Warrants to purchase 37,500 shares of Common Stock for aggregate gross proceeds of $150,000.

On September 21, 2012, in connection with a closing of the Offering the Company issued Units to accredited investors consisting of an aggregate of 50,000 shares of Common Stock and Warrants to purchase 25,000 shares of Common Stock for aggregate gross proceeds of $100,000.

On September 28, 2012, in connection with a closing of the Offering the Company issued Units to accredited investors consisting of an aggregate of 15,000 shares of Common Stock and Warrants to purchase 7,500 shares of Common Stock for aggregate gross proceeds of $30,000.

On October 9, 2012, in connection with a closing of the Offering the Company issued Units to accredited investors consisting of an aggregate of 25,000 shares of Common Stock and Warrants to purchase 12,500 shares of Common Stock for aggregate gross proceeds of $50,000.

On October 17, 2012, in connection with a closing of the Offering the Company issued Units to accredited investors consisting of an aggregate of 12,500 shares of Common Stock and Warrants to purchase 6,250 shares of Common Stock for aggregate gross proceeds of $25,000.

All of the Units, and securities underlying the Units issued in the Offering were issued to accredited investors in accordance with Rule 506 of Regulation D under the Securities Act. The Company did not engage in any general advertisement or general solicitation in connection with the offering of the Units. Through the date of this filing the placement agent in the Offering has received total cash compensation equal to $56,400.

Promissory Notes

On September 25, 2012 (the "Issue Date"), the Company issued convertible promissory notes (the "Notes") in an aggregate principal amount equal to $593,216 (the "Principal Amount") to Stanley Hostler, Scott Segal, Leonard Harris, Ed Roberson, each a director of the Company, Summit Resources, Inc., an affiliate of Steve Antoline, a director of the Company, Steven Turner, the Chief Executive Officer and a director of the Company, and his wife Nancy Turner and Virginia Child, the wife of Stanley Hostler (each a "Holder" and collectively, the "Holders") in consideration for certain advances to the Company equal to the Principal Amount. The Notes accrue simple interest at a rate of 10% per annum and are due and payable on the earlier to occur of (i) the date that is 60 days from the Issue Date, or (ii) when declared due and payable by the holder upon the occurrence of an event of default.

The occurrence of any one of the following events will be deemed an event of default: (i) the failure of the Company to pay the principal balance or accrued interest on the Note when due; (ii) the consent or institution by or against the Company of bankruptcy or insolvency proceedings or the filing, or consent by the Company for the filing of a petition or answer or consent seeking reorganization or release under the federal Bankruptcy Act, or any other applicable federal or state law, or the appointment of a receiver, liquidator, assignee, trustee or other similar official of the Company, or of any substantial part of its property, or the making by it of an assignment for the benefit of creditors, or the taking of corporate action by the Company in furtherance of any such action; or (iii) if the commencement of an action against the Company seeking any bankruptcy, insolvency, reorganization, liquidation, dissolution or similar relief has not been resolved in favor of the Company or the consent or acquiescence of the Company of any trustee, receiver or liquidator of the Company or of all or any substantial part of the properties of the Company, shall not have been vacated within 60 days.

At the option of the Holder, each $2.00 of outstanding principal and accrued unpaid interest is convertible into one share of common stock of the Company, at any time after the Issue Date.

Item 3. Defaults Upon Senior Securities.

As of the date of this quarterly report on Form 10-Q for the period ended September 30, 2012, we are in default under a certain secured note payable to the West Virginia Development Office in the total amount of approximately $259,000. The arrearage as of such date was $258,497, plus interest. The repayment terms were modified, whereby the West Virginia Development Office approved a three month deferral of principal and interest. Therefore, the default has not triggered an acceleration of the entire balance plus accumulated interest.

As of the date of this quarterly report on Form 10-Q for the period ended September 30, 2012, we are in default under three secured notes payable to the West Virginia Economic Development Authority in the total amount of approximately $1,136,000. The arrearage as of such date was $1,132,928, plus interest. The repayment terms were modified, whereby the West Virginia Economic Development Authority approved a three month deferral of principal and interest. Therefore, the default has not triggered an acceleration of the entire balance plus accumulated interest.

As of the date of this quarterly report on Form 10-Q for the period ended September 30, 2012, we are in default under two secured notes payable to the West Virginia Infrastructure and Jobs Development Council in the total amount of approximately $949,000. The arrearage as of such date was $946,153, plus interest. The repayment terms were modified, whereby the West Virginia Infrastructure and Jobs Development Council approved a three month deferral of principal and interest. Therefore, the default has not triggered an acceleration of the entire balance plus accumulated interest.

As of the date of this quarterly report on Form 10-Q for the period ended September 30, 2012, we are in default under two convertible promissory notes payable to the West Virginia Jobs Investment Trust Board in the total amount of approximately $674,000. The arrearage as of such date was $669,437, plus interest. The repayment terms were modified, whereby the West Virginia Jobs Investment Trust Board approved an extension of the company’s interest payments until November 30, 2012. Therefore, the default has not triggered an acceleration of the entire balance plus accumulated interest.

Item 4. Mine Safety Disclosure.

Not applicable.

Item 5. Other Information.

Extension of Maturity Date of Convertible Promissory Notes Dated December 20, 2011

On December 20, 2011 (the "December Issue Date"), the Company issued certain convertible promissory notes (the "December Notes") to Stanley Hostler, a director of the Company, and Summit Resources, Inc., an affiliate of Steve Antoline, a director of the Company (collectively, the "December Note Holders"), in an aggregate principal amount equal to $750,000 (the "December Principal Amount"). The Notes accrue simple interest at a rate of 10% per annum and were due and payable on the earlier to occur of (i) the date that is 180 days from the December Issue Date, or (ii) when declared due and payable by the December Note Holder upon the occurrence of an event of default (the "Maturity Date"). At the option of the December Note Holders, each $2.00 of outstanding December Principal Amount and accrued unpaid interest is convertible into one share of common stock of the Company. On June 15, 2012, pursuant to an addendum to the December Notes (the "December Note Addendum No. 1"), the Holders agreed to extend the Maturity Date of the December Notes by 90 days from June 17, 2012 to September 15, 2012, followed by a second addendum dated September 25, 2012 (the "December Note Addendum No. 2"), pursuant to which the Maturity Date was extended an additional 90 days to December 14, 2012.

The above descriptions of the December Notes and the December Note Addendum No. 2 are qualified in their entirety by the terms of the form of December Notes filed as Exhibit 10.1 to the Company's Form 8-K filed on December 28, 2011 and the December Note Addendum No. 1 filed as Exhibit 10.1 and 10.2 to the Company's Form 8-K filed on July 16, 2012. The description above of the December Note Addendum No. 2 is qualified in its entirety by the terms and conditions of the December Note Addendum No. 2 for each of the Stanley Hostler and Summit Resources, Inc. attached hereto as Exhibits 10.2 and 10.3.

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).
10.1		Form of Convertible Promissory Notes, dated as of September 25, 2012, issued to directors and certain related parties (incorporated by reference to Exhibit 10.1 to the registrant’s Form 8-K filed on October 4, 2012).
10.2		Convertible Promissory Note Addendum, dated as of September 25, 2012, executed by Stanley Hostler with respect to the December Note by and between the Company and Stanley Hostler (incorporated by reference to Exhibit 10.2 to the registrant’s Form 8-K filed on October 4, 2012).
10.3		Convertible Promissory Note Addendum, dated as of September 25, 2012, executed by Summit Resources, Inc. with respect to the December Note by and between the Company and Summit Resources, Inc. (incorporated by reference to Exhibit 10.3 to the registrant’s Form 8-K filed on October 4, 2012).
10.4		Convertible Promissory Note Addendum, dated as of October 31, 2012, executed by Summit Resources, Inc. with respect to the April Note by and between the Company and Summit Resources, Inc. (incorporated by reference to Exhibit 10.1 to the registrant’s Form 8-K filed on November 7, 2012).
10.5		Convertible Promissory Note Addendum, dated as of October 31, 2012, executed by Scott S. Segal with respect to the April Note by and between the Company and Scott S. Segal (incorporated by reference to Exhibit 10.2 to the registrant’s Form 8-K filed on November 7, 2012).
10.6		Convertible Promissory Note Addendum, dated as of October 31, 2012, executed by Stanley M. Hostler with respect to the April Note by and between the Company and Stanley M. Hostler (incorporated by reference to Exhibit 10.3 to the registrant’s Form 8-K filed on November 7, 2012).
10.7		Convertible Promissory Note Addendum, dated as of October 31, 2012, executed by Virginia E. Child with respect to the April Note by and between the Company and Virginia E. Child (incorporated by reference to Exhibit 10.4 to the registrant’s Form 8-K filed on November 7, 2012).
10.8		Convertible Promissory Note Addendum, dated as of October 31, 2012, executed by Nancy Turner with respect to the April Note by and between the Company and Nancy Turner (incorporated by reference to Exhibit 10.5 to the registrant’s Form 8-K filed on November 7, 2012).
10.9		Convertible Promissory Note Addendum, dated as of October 31, 2012, executed by Leonard P. Harris with respect to the April Note by and between the Company and Leonard P. Harris (incorporated by reference to Exhibit 10.6 to the registrant’s Form 8-K filed on November 7, 2012).
10.10		Letter Agreement, dated as of October 31, 2012, executed by the Company and WVJITB (incorporated by reference to Exhibit 10.7 to the registrant’s Form 8-K filed on November 7, 2012).
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 September 30, 2012.
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 September 30, 2012.
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

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: November 13, 2012	By:	/s/ Stephen Turner
		Stephen Turner
		President and Director
		Principal Executive Officer

	By:	/s/ Edward Hughes
		Edward Hughes
		Chief Financial Officer
		Principal Financial Officer

Protea Biosciences Group, Inc. - FORM 10-Q - November 13, 2012

Attached files

Protea Biosciences Group, Inc. Reports