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EX-32.2 - EXHIBIT 32.2 - Protea Biosciences Group, Inc.v391235_ex32-2.htm
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EX-32.1 - EXHIBIT 32.1 - Protea Biosciences Group, Inc.v391235_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - Protea Biosciences Group, Inc.v391235_ex31-1.htm
EXCEL - IDEA: XBRL DOCUMENT - Protea Biosciences Group, Inc.Financial_Report.xls

  

U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

SECURITIES EXCHANGE ACT OF 1934

 

 

For the quarterly period ended September 30, 2014

 

OR

 

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

SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ________ to ________

 

Commission File Number 000-51474

 

PROTEA BIOSCIENCES GROUP, INC.

(Exact name of registrant as specified in its charter)

 

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

 

955 Hartman Run Road, Morgantown, West Virginia 26505

(Address of principal executive offices) (Zip Code)

 

(304) 292-2226

(Registrant’s telephone number, including area code)

  

N/A

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

 

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

 

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

 

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

 

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

 

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

 

APPLICABLE ONLY TO CORPORATE ISSUERS

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 66,288,600 shares of common stock, par value $0.0001 per share, outstanding as of November 14, 2014.

   

 
 

  

PROTEA BIOSCIENCES GROUP, INC.

 

- INDEX -

 

  Page
PART I – FINANCIAL INFORMATION:  
     
Item 1. Financial Statements: 1
     
  Consolidated Balance Sheets 2
     
  Consolidated Statements of Operations and Total Comprehensive Loss 3
     
  Consolidated Statements of Stockholders’ Equity (Deficit) 4
     
  Consolidated Statements of Cash Flows 5
     
  Notes to Financial Statements 6
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 25
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 29
     
Item 4. Controls and Procedures 29
     
PART II – OTHER INFORMATION:  
     
Item 1. Legal Proceedings 30
     
Item 1A. Risk Factors 30
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 30
     
Item 3. Defaults Upon Senior Securities 31
     
Item 4. Mine Safety Disclosures 31
     
Item 5. Other Information 31
     
Item 6. Exhibits 31
     
Signatures 32

 

 
 

 

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

 

1
 

  

PROTEA BIOSCIENCES GROUP, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

Consolidated Balance Sheets

See Accompanying Notes to Financial Statements

 

   September 30, 2014
(unaudited)
   December 31, 2013 
         
ASSETS          
           
Current Assets:          
Cash and cash equivalents  $118,277   $1,086,330 
Trade accounts receivable, net   264,526    216,864 
Other receivables   33,557    435,278 
Inventory   262,219    465,334 
Prepaid expenses   68,995    304,696 
Total current assets   747,574    2,508,502 
           
Property and equipment, net   3,090,349    2,886,176 
           
Other noncurrent assets   21,887    23,249 
           
Total Assets  $3,859,810   $5,417,927 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
           
Current Liabilities:          
Current maturities on short and long-term debt  $1,780,139   $1,054,053 
Accounts payable   2,636,197    759,021 
Bank line of credit   3,000,000    2,725,000 
Loans payable to stockholders, net of discount   3,383,195    465,883 
Derivative Liabilities   2,703,611    623,587 
Obligation related to the letter of credit, net of discount   -    151,981 
Other payables and accrued expenses   1,101,371    1,069,167 
Total current liabilities   14,604,513    6,848,692 
           
Contingent Subsidiary Sale   589,528    - 
           
Long-term debt - net of current portion   1,568,669    1,580,260 
           
Stockholders' Equity (Deficit):          
Preferred stock ($.0001 par value; 10,000,000 shares authorized; none issued or outstanding)   -    - 
Common stock ($.0001 par value; 200,000,000 shares authorized; 66,288,600 and 65,442,735 shares issued and outstanding at September 30, 2014 and December 31, 2013)   6,629    6,545 
Additional paid in capital   56,333,356    55,351,613 
Deficit accumulated during development stage   (69,229,600)   (58,392,348)
Accumulated other comprehensive income (loss)   (13,285)   23,165 
Total Stockholders' Equity (Deficit)   (12,902,900)   (3,011,025)
           
Total Liabilities and Stockholders' Equity (Deficit)  $3,859,810   $5,417,927 

  

2
 

 

PROTEA BIOSCIENCES GROUP, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

Consolidated Statements of Comprehensive Loss (Unaudited)

See Accompanying Notes to Financial Statements

   

   For the Three Months
Ended September 30,
   For the Three Months
Ended September 30,
   For the Nine Months
Ended September 30,
   For the Nine Months
Ended September 30,
   Period from July 13, 2001 (date
of inception) to September 30,
 
   2014   2013   2014   2013   2014 
                     
Gross revenue  $517,569   $178,475   $1,332,230   $938,080   $6,048,577 
                          
Selling, general, administrative expenses   (2,280,876)   (1,943,814)   (7,380,407)   (6,015,077)   (38,863,821)
Research and development expense   (600,162)   (658,880)   (2,126,144)   (2,367,014)   (30,660,869)
Loss from operations   (2,363,469)   (2,424,219)   (8,174,321)   (7,444,011)   (63,476,113)
                          
Other income (expense):                         
Interest and exchange income (expense)   (624)   573    (593)   6,997    55,454 
Interest expense   (191,755)   (131,277)   (564,235)   (464,095)   (3,340,848)
Debt conversion cost   -         -    -    (724,623)
Gain on debt settlement   -    -    -    -    13,834 
Loss on asset disposal   -    -    (18,768)   (15,773)   (57,955)
Change in fair market value of derivative instruments   (2,102,928)        (2,079,335)   -    (1,699,349)
Total other income (expense)   (2,295,307)   (130,704)   (2,662,931)   (472,871)   (5,753,487)
                          
Loss before income taxes   (4,658,776)   (2,554,923)   (10,837,252)   (7,916,882)   (69,229,600)
Income taxes   -    -    -    -    - 
                          
Net loss   (4,658,776)   (2,554,923)   (10,837,252)   (7,916,882)   (69,229,600)
Foreign currency translation adjustment   (22,915)   5,797    (36,450)   6,487    (13,285)
Total comprehensive loss  $(4,681,691)  $(2,549,126)  $(10,873,702)  $(7,910,395)  $(69,242,885)
                          
Net loss per share - basic and diluted  $(0.07)  $(0.06)  $(0.17)  $(0.19)  $(4.19)
Weighted average number of shares outstanding - basic and diluted   66,228,546    43,952,003    65,782,735    41,122,424    16,516,192 

 

3
 

 

PROTEA BIOSCIENCES GROUP, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

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

See Accompanying Notes to Financial Statements

 

               Deficit   Accumulated   Total 
   Common Stock   Additional   Accumulated   Other   Stockholders' 
   Par Value $.0001   Paid in Capital   During   Comprehensive   Equity 
   Shares   Amount   Common Stock   Development Stage   Income (Loss)   (Deficit) 
December 31, 2013   65,442,735   $6,545  $55,351,613   $(58,392,348)  $23,165   $(3,011,025)
                               
Issuance costs of $105,168   -    -    (105,168)   -    -    (105,168)
Issuance of stock for services   812,348    81    685,460    -    -    685,541 
Stock options exercised   25,000    2    19,263    -    -    19,265 
Stock warrants exercised   8,517    1    (1)   -    -    - 
Stock-based compensation expense   -    -    231,779    -    -    231,779 
Stock warrants issued for services and debt   -    -    150,410    -    -    150,410 
Net loss   -    -    -    (10,837,252)   -    (10,837,252)
Foreign currency translation adjustment   -    -    -    -    (36,450)   (36,450)
September 30, 2014   66,288,600   $6,629  $56,333,356   $(69,229,600)  $(13,285)  $(12,902,900)

 

4
 

 

PROTEA BIOSCIENCES GROUP, INC.

(A DEVELOPMENT STAGE ENTERPRISE)

Consolidated Statements of Cash Flows (Unaudited)

See Accompanying Notes to Financial Statements

 

   For the Nine Months
Ended September 30,
   For the Nine Months
Ended September 30,
   Period from July 13, 2001 (date of
inception) to September 30,
 
   2014   2013   2014 
Cash flows from operating activities:               
Net loss  $(10,837,252)  $(7,916,882)  $(69,229,600)
Adjustments to reconcile net loss to net cash from operating activities:               
Depreciation and amortization   627,094    633,535    5,870,476 
Non-cash compensation   237,294    238,495    2,636,438 
Issuance of common stock and warrants for services   735,462    100,000    1,610,278 
Issuance of common stock for accrued interest   -    228,384    833,432 
Accretion of convertible debenture discount   159,118    17,208    489,798 
Debt conversion costs associated with inducement   -    -    724,623 
Loss on disposal of fixed assets   18,768    15,921    57,955 
Bad debt expense   3,200    5,000    37,232 
Change in fair market value of derivative instrument   2,079,335    -    1,699,349 
Net change in assets and liabilities:               
Decrease (increase)               
Trade accounts receivable   (50,862)   56,125    (301,758)
Prepaid expenses   123,552    (74,328)   (181,144)
Other receivables   403,084    280,870    430,883 
Inventory   203,115    313,782    (262,219)
Increase (decrease)               
Trade accounts payable   1,784,246    (813,738)   2,184,958 
Other payables and accrued expenses   32,205    (353,758)   1,101,371 
Net cash used in operating activities   (4,481,641)   (7,269,386)   (52,297,928)
                
Cash flows from investing activities:               
Purchase of and deposits on equipment   (391,692)   (42,715)   (5,362,065)
Proceeds from sale of equipment   6,000    -    54,450 
Proceeds from contingent subsidiary sale   600,000    -    600,000 
Net cash provided by (used in) investing activities   214,308    (42,715)   (4,707,615)
                
Cash flows from financing activities:               
Net advances on bank line of credit   275,000    -    3,000,000 
Proceeds from sale of common stock, net   1,250    4,830,775    35,122,097 
Proceeds from short and long-term debt   536,000    1,769,500    14,160,500 
Proceeds from shareholder debt   3,270,000    825,000    7,668,216 
Repayment of shareholder, short and long-term debt   (507,825)   (483,921)   (2,809,321)
Proceeds from Obligation related to the Letter of Credit   -    600,000    600,000 
Repayment of Obligation related to the Letter of Credit   (238,695)   (222,305)   (600,000)
Financing costs   -    -    (4,387)
Net cash provided by financing activities   3,335,730    7,319,049    57,137,105 
                
Effect of exchange rate changes on cash   (36,450)   6,487    (13,285)
                
Net (decrease) increase in cash   (968,053)   13,435    118,277 
Cash, beginning of period   1,086,330    27,604    - 
                
Cash, end of period  $118,277   $41,039   $118,277 
                
Supplemental disclosure of cash flow information:               
Cash paid during the period for interest  $193,942   $403,140   $1,820,343 
                
Supplemental disclosure of non-cash investing and financing activities:               
Financed equipment  $532,211   $205,381   $3,800,935 
Debt converted to company stock  $-   $3,331,600   $15,273,658 

 

5
 

  

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

 

Notes to Consolidated Financial Statements – (Unaudited)

   

1.Description of Company and Nature of Business

 

Protea Biosciences Group, Inc. (referred to as “Protea”, “the Company”, “we”, “us” and “our”) is a development stage molecular information company incorporated in the state of Delaware on May 24, 2005. “Molecular information” refers to the process of transforming large analytical data sets, obtained by applying the Company’s technology, expertise and infrastructure, towards the identification and characterization of the proteins, metabolites and other biomolecules such as lipids, which are the byproducts of all living cells and life forms.

 

The Company is applying its technology to the development of next generation “direct molecular imaging” technology and service capabilities that it believes enable more rapid and comprehensive molecular profile of diseases based on biomolecules derived from the end result of gene expression in living cells, i.e. proteins, lipids, and metabolites. We believe that our proprietary technology and its integration into pathology, which is the current standard of care for tissue based diagnosis, will allow more rapid and confident identification of highly specific biomarkers of disease. The molecular information and associated processes that the Company is developing will be critical in accelerating the discovery, development and commercialization of diagnostic markers or tests for challenging human biology problems such as cancer and neurodegenerative disease.

 

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

 

The accompanying financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities and commitments in the normal course of business. The Company’s loss from operations since inception had an accumulated deficit balance at September 30, 2014 of approximately $63 million and at December 31, 2013 of approximately $55 million. The Company has funded its activities to date almost exclusively from debt and equity financings. The Company will continue to require substantial funds to advance the research and development of its core technologies and to develop new products and services based upon its proprietary protein recovery and identification technologies.

 

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

 

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

 

2.Summary of Significant Accounting Policies

 

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

 

Revenue Recognition

 

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

 

6
 

 

 

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

 

Notes to Consolidated Financial Statements (unaudited)

 

2.Summary of Significant Accounting Policies (continued)

 

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

 

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

 

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

 

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

 

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

 

   Three Months Ended   Nine Months Ended 
   September 30,
2014
   September 30,
2013
   September 30,
2014
   September 30,
2013
 
Molecular Information Services  $104,600   $29,035   $334,545   $143,485 
LAESI Instrument Platform   274,750    66,390    593,250    502,084 
Research Products   108,053    83,050    323,755    292,511 
Grants and Other Collaborations   30,166    -    80,680    - 
Gross Revenue  $517,569   $178,475   $1,332,230   $938,080 

 

Other Receivables

 

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

 

   September 30, 2014   December 31, 2013 
French government R&D credit  $-   $400,379 
French payroll taxes receivable   33,557    34,899 
Other receivables – current  $33,557   $435,278 
           
Deposits  $21,887   $23,249 
Other receivables – noncurrent  $21,887   $23,249 

 

7
 

  

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

 

Notes to Consolidated Financial Statements (unaudited)

 

2.Summary of Significant Accounting Policies (continued)

 

Other Payables and Accrued Expenses

 

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

 

   September 30, 2014   December 31, 2013 
Accrued expenses  $445,812   $653,047 
Accrued interest   251,087    39,911 
Accrued warranties   81,250    81,250 
Accrued payroll and benefits   285,322    286,979 
Unearned revenue   37,900    7,980 
Other payables and accrued expenses  $1,101,371   $1,069,167 

 

Derivative Liabilities

 

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

 

Fair value of financial assets and liabilities – Derivative Instruments

 

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

 

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

 

The three levels of inputs used to measure fair value:

 

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

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

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

 

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

 

8
 

  

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

 

Notes to Consolidated Financial Statements (unaudited)

 

2.Summary of Significant Accounting Policies (continued)

 

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

 

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

 

   September 30, 2014
   Expected Life
(Years)
  Risk Free
Rate
   Volatility   Probability of a Capital
Raise
 
                   
Derivative liabilities  <1 – 4.58   1.07%   76.00%   100%

 

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

 

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

 

   Fair Value Measurements at September 30, 2014 
   Carrying Value   Level 1   Level 2   Level 3 
Derivative liabilities – common stock  $2,466,535    -    -   $2,466,535 
Derivative liabilities – warrants   237,076    -    -    237,076 
Total  $2,703,611    -    -   $2,703,611 

 

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

 

9
 

 

 

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

 

Notes to Consolidated Financial Statements (unaudited)

 

2.Summary of Significant Accounting Policies (continued)

 

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

 

   Nine Months Ended September 30, 2014 
   Derivative
Liabilities -
Common Stock
   Derivative
Liabilities -
Warrants
   Total Fair Value
Measurements
Using Level 3
Inputs
 
Balance at January 1, 2014  $558,799   $64,788   $623,587 
Issuance of warrants   -    689    689 
Unrealized (gain) loss on derivative liabilities   1,907,736    171,599    2,079,335 
Recognition of derivative liabilities   -    -    - 
Balance at September 30, 2014  $2,466,535   $237,076   $2,703,611 

 

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

 

Net Loss per Share

 

Basic and diluted loss per common share is computed based on the weighted average number of common shares outstanding. Common share equivalents (which may consist of options, warrants and convertible debt) are excluded from the computation of diluted loss per share since the effect would be anti-dilutive. Common share equivalents which could potentially dilute basic earnings per share in the future, and which were excluded from the computation of diluted loss per share, totaled approximately 66,168,000 and 56,711,000 at September 30, 2014 and December 31, 2013, respectively.

 

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS:

 

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

 

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

 

10
 

  

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

 

Notes to Consolidated Financial Statements (unaudited)

 

2.Summary of Significant Accounting Policies (continued)

 

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

 

In August 2014, the FASB issued authoritative guidance on going concern disclosures and financial statement presentation, which is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. Substantial doubt about an entity’s ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued (or available to be issued). This standard provides guidance to an organization’s management, with principles and definitions that are intended to reduce diversity in the timing and content of disclosures that are commonly provided by organizations in the financial statement footnotes. This standard is effective for annual reporting periods ending after December 15, 2016, and to annual and interim periods thereafter. Early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption of this standard on our consolidated financial statements and related disclosures.

 

In November, 2014, the FASB issued ASU 2014-16, "Derivatives and Hedging (Topic 815): Determining Whether the Host Contract in a Hybrid Financial Instrument Issued in the Form of a Share Is More Akin to Debt or to Equity (a consensus of the FASB Emerging Issues Task Force)." The ASU clarifies how current guidance should be interpreted in evaluating the economic characteristics and risks of a host contract in a hybrid financial instrument that is issued in the form of a share. Specifically, the amendments clarify that an entity should consider all relevant terms and features, including the embedded derivative feature being evaluated for bifurcation, in evaluating the nature of a host contract. The ASU is effective for fiscal years and interim periods beginning after December 15, 2015. The Company is currently in the process of evaluating the impact of adoption of this standard on our consolidated financial statements.

 

3.Inventory

 

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

 

Inventory:  September 30, 2014   December 31, 2013 
Finished goods  $31,138   $360,607 
Work in progress   231,081    104,727 
Total Inventory  $262,219   $465,334 

 

4.Property and Equipment

 

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

 

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

 

11
 

  

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

 

Notes to Consolidated Financial Statements (unaudited)

 

4.Property and Equipment (continued)

 

Property and equipment consists of the following at:

 

   September 30, 2014   December 31, 2013 
Lab equipment  $7,390,382   $6,620,662 
Computer equipment   600,318    563,976 
Office equipment   248,490    248,490 
Leasehold improvements   477,682    477,682 
    8,716,872    7,910,810 
Accumulated depreciation   (5,626,523)   (5,024,634)
Property and equipment, net  $3,090,349   $2,886,176 

 

For the three and nine months ended September 30, 2014, depreciation expense was $196,054 and $627,094, respectively compared to $221,351 and $633,535 for the three and nine months ended September 30, 2013.

 

5.Bank Line of Credit

 

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

 

6.Loans Payable to Stockholders

 

On August 6, 2013, the Company entered into the Note and Warrant Purchase Agreement (the “Summit Agreement”) with Summit Resources, Inc. (“Summit”), an affiliate of Steve Antoline, a director of the Company, pursuant to which Summit acquired (a) a promissory note (the “Summit Note”) bearing simple interest at a rate of 10% per annum, in an aggregate principal amount of $600,000 and (b) a five year warrant to purchase 1,000,000 shares of common stock at an exercise price of $1.10 per share. The fair value of these warrants was estimated to be $134,117, which was recorded as a discount to the promissory note, and will be accreted based on the repayment of the obligation. In accordance with the terms of the Summit Agreement, up to $150,000 of the gross proceeds received by the Company from the sale of each LAESI instrument shall be used to repay the principal amounts due under the Summit Note. The Company repaid $323,915 as of September 30, 2014. Accretion expense of $72,404 was recognized during the nine months ended September 30, 2014, while no accretion expense was recorded in 2013. The outstanding balance, net of discount, was $214,372 as of September 30, 2014. As of September 30, 2014, a total of $125,000 in accounts receivable has been pledged to Summit.

 

From March 26, 2014 through September 30, 2014, the Company received advances equal to an aggregate of $1,415,000 from Summit. During 2014, in exchange for a portion of the advances received through September 30, 2014, the Company entered into Note and Warrant Purchase Agreements and issued (a) one-year promissory notes bearing simple interest at the rate of 10% per annum to Summit in an aggregate principal amount of $1,415,000 and (b) five-year warrants to purchase up to 1,415,000 shares of common stock at an exercise price of $0.80 per share. On June 3, 2014, the Board approved an increase in the total offering amount of the promissory notes issuable to $1,500,000 from $900,000. The fair value of these warrants was estimated to be $101,777, which was recorded as a discount to the promissory note, and will be accreted based on the repayment of the obligation. The outstanding balance, net of discount, was $1,313,823 as of September 30, 2014. Subsequent to September 30, 2014, the Company repaid $75,000 to Summit.

 

From March 5, 2014 through September 30, 2014, the Company received advances equal to an aggregate of $195,000 from Stanley Hostler, a director of the Company. Subsequent to September 30, 2014, the Company repaid $100,000 to Stanley Hostler. No terms of repayment have been specified on the remaining aforementioned advances as of the filing date. In addition, the Company received advances equal to an aggregate of $20,000 from Steve Turner, a director and CEO of the Company. Subsequent to September 30, 2014, the Company repaid $20,000 to Steve Turner.

 

12
 

 

 

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

 

Notes to Consolidated Financial Statements (unaudited)

 

6.Loans Payable to Stockholders (continued)

 

From March 13, 2014 through September 30, 2014, the Company received advances equal to an aggregate of $1,640,000 from El Coronado Holdings, LLC, (“El Coronado”), Scott Segal and Leo Harris. Josiah Austin is the managing member of El Coronado and a director of the Company. Scott Segal and Leo Harris are also directors of the Company. On April 2, 2014, the Board approved an offering of up to $300,000 in convertible one year promissory notes. On June 3, 2014, the Board approved an increase in the total offering amount of convertible notes issuable to $2,000,000 (the “Related Party Offering”). On September 25, 2014, the Board approved a subsequent increase in the total offering amount of convertible notes issuable to $3,000,000. In exchange for each advance, the Company entered into a Note Purchase Agreement, and issued a convertible one-year promissory note bearing simple interest at a rate of 10% per annum to the directors. Each $100,000 of outstanding principal and accrued unpaid interest underlying the note is automatically convertible into securities of the Company issued in a subsequent financing pursuant to which the Company raises at least $2,000,000 in gross proceeds (“Subsequent Financing”) at a conversion price that shall be equal to the purchase price payable for the securities issued in any such Subsequent Financing. Subsequent to September 30, 2014, the Company converted these notes into 849,697 shares of preferred stock and issued warrants to purchase common stock in an aggregate amount of 3,398,788 shares to El Coronado, Scott Segal, and Leo Harris. (See Note 18, Subsequent Events).

 

7.Obligation Related to the Letter of Credit

 

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

 

8.Long-term Debt

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

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

 

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

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

 

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

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

 

13
 

  

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

 

Notes to Consolidated Financial Statements (unaudited)

 

8.Long-term Debt (continued)

 

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

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

 

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

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

 

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

In March 2012, the Company issued an 18-month note in the amount of $290,000 from the WVJITB. The note bears interest at 6% providing for monthly interest-only payments starting April 2012 through August 2013, then final interest and principal payments due September 2013. The note has an adjustable conversion price, initially $2.00 per share, and includes a stock warrant for 72,500 shares (see Note 9, Stock Warrants). On December 13, 2013, the Company and the WVJITB entered into a Loan Modification Agreement whereby the maturity date changed from September 14, 2013 to $100,000 due on March 15, 2014 and the remaining $190,000 due on June 15, 2014. The WVJITB and the Company signed three addendums to the note extending the maturity date and deferring interest and principal payments until November 30, 2014. C. Andrew Zulauf, an executive member of the WVJITB, is a board member of the Company.

 

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

In April 2012, the Company issued a 3-month note in the amount of $400,000 from the WVJITB. The note bears interest at 10% providing for monthly interest-only payments starting May 2012 through June 2012, then final interest and principal payments due July 2012. The note includes a stock warrant for 88,889 shares (see Note 9, Stock Warrants). The WVJITB and the Company have signed several addendums to the note extending the maturity date and reducing the price of converting into common shares to $0.50 per share. The WVJITB further extended the maturity date until November 29, 2013, with a $100,000 principal payment due on or before November 15, 2013. The Company repaid the $100,000 as agreed, which reduced the principal outstanding balance to $300,000. The WVJITB and the Company signed four addendums to the note extending the maturity date and deferring interest and principal payments until November 30, 2014. C. Andrew Zulauf, an executive member of the WVJITB, is a board member of the Company.

 

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

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

 

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

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

 

14
 

  

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

 

Notes to Consolidated Financial Statements (unaudited)

 

8.Long-term Debt (continued)

 

10)Convertible Debentures

In addition to the related party convertible promissory notes, the Company also issued an aggregate of $436,000 under the Related Party Offering (see Note 6, Loans Payable to Stockholders.) In exchange for each advance, the Company entered into a Note Purchase Agreement, and issued a convertible one-year promissory note to the stockholders, in the aggregate principal amount of $436,000 to accrue simple interest at the rate of 10% per annum. Subsequent to September 30, 2014, the Company converted six of these notes converted into 93,828 shares of preferred stock and issued warrants to purchase common stock in an aggregate amount of 375,312 shares. The remaining notes will convert at the next subsequent closing. (See Note 18, Subsequent Events.)

 

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

 

12)Other Short Term Promissory Notes

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

 

Total debts outstanding are as follows:

 

   September 30, 2014   December 31, 2013 
1)   Note Payable to the WVDO  $123,744   $123,744 
2)   Note Payable to the WVEDA   147,306    147,306 
3)   Note Payable to the WVIJDC   145,078    145,078 
4)   Note Payable to the WVEDA   639,085    639,085 
5)   Note Payable to the WVIJDC   651,913    651,913 
6)   Note Payable to the WVJITB   290,000    290,000 
7)   Note Payable to the WVJITB   300,000    300,000 
8)   Note Payable to the WVHTCF   95,178    95,178 
9)   Note Payable to the WVEDA   170,932    170,932 
10) Convertible Debentures   436,000    - 
11) Capital leases   349,572    71,077 
Total   3,348,808    2,634,313 
Less: current portion   (1,780,139)   (1,054,053)
Long-term portion  $1,568,669   $1,580,260 

 

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

 

Year Ending December 31:  Future Required Minimum Principal Repayments 
2014  $1,477,628 
2015   390,360 
2016   360,217 
2017   345,839 
2018 & Thereafter   774,764 
Total  $3,348,808 

 

15
 

  

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

 

Notes to Consolidated Financial Statements (unaudited)

 

9.Common Stock

 

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

 

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

 

   # Shares
Issued
   Par
Value
   Price
Per
Share
   Gross
Proceeds
   Value of
Services
Obtained
   Par
Value
   Additional
Paid in
Capital (1)
 
Balance at December 31, 2013   65,442,735   $.0001    Various   $53,694,771   $829,132   $6,545   $54,517,358 
Issuance of stock (2)   812,348    .0001    Various    -    685,451    81    685,460 
Stock options exercised (3)   25,000    .0001   $0.55    13,750    -    2    13,748 
Stock warrants exercised (3)   8,517    .0001   $1.77    -    -    1    (1)
Balance at September 30, 2014   66,288,600             $53,708,521   $1,294,674   $6,629   $55,216,565 

(1)Activity does not include issuance costs, deferred financing, warrants portion of convertible debentures and stock options.
(2)Shares issued for services performed and does not contain an anti-dilution provision
(3)Shares issued for exercised stock options and does not contain an anti-dilution provision
(4)Shares issued under cashless stock warrant exercise and does not contain an anti-dilution provision

 

10.Preferred Stock

 

The Company is authorized to issue preferred stock, par value $0.0001 per share, in one or more series and contain 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. As of September 30, 2014, no shares of the preferred stock have been issued. Subsequent to September 30, 2014, the Company issued 2,213,263 shares of preferred stock. (See Note 18, Subsequent Events).

 

11.Stock Options and Stock-based Compensation

 

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

 

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

 

   Shares   Weighted Average
Exercise
Price
   Weighted Average
Remaining Contractual Life
(in years)
 
Outstanding at December 31, 2013   5,082,750   $1.11    7.02 
Granted   2,404,500   $0.55      
Exercised   (25,000)  $0.55      
Cancelled or expired   (305,000)  $1.27      
Outstanding at September 30, 2014   7,157,250   $0.92    6.98 
                
Exercisable at December 31, 2013   4,005,583   $1.20    6.52 
Exercisable at September 30, 2014   4,474,032   $1.13    6.12 

 

16
 

  

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

 

Notes to Consolidated Financial Statements (unaudited)

 

11.Stock Options and Stock-based Compensation (continued)

 

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

 

Options Outstanding   Options Exercisable 
Exercise Price   Outstanding   Weighted Average
Remaining Contractual
Life (in years)
   Weighted
Average
Exercise
Price
   Exercisable   Weighted
Average
Exercise
Price
 
$0.50    159,000              127,438      
$0.55    3,997,500              1,402,282      
$0.80    320,000              320,000      
$1.25    310,000              310,000      
$1.50    2,156,000              2,099,562      
$2.00    214,750              214,750      
$0.50 - $2.00    7,157,250    6.98   $0.92    4,474,032   $1.13 

 

At September 30, 2014 and December 31, 2013, the total aggregate intrinsic value for options currently exercisable and options outstanding was $0. These values represent the total pre-tax intrinsic value based on the estimated fair value of the Company’s stock price of $0.50 as of September 30, 2014 and December 31, 2013. In 2014, 25,000 options were exercised whereas no options were exercised in 2013.

 

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

 

   Shares   Weighted Average Grant-date Fair Value 
Nonvested at December 31, 2013   1,077,167   $0.467 
Granted   2,105,843   $0.207 
Forfeited   (156,250)  $0.826 
Vested   (343,542)  $0.676 
Nonvested at September 30, 2014   2,683,218   $0.266 

 

The fair value of non-vested options to be recognized in future periods is $558,050, which is expected to be recognized over a weighted average period of 2.1 years. The total fair value of options vested during the nine months ended September 30, 2014 was $237,294 compared to $238,495 for the nine months ended September 30, 2013. Stock-based compensation expense is as follows:

 

   Nine Months Ended 
   September 30, 2014   September 30, 2013 
Selling, general, and administrative expense  $210,618   $220,840 
Research and development expense   26,676    17,655 
Total stock-based compensation expense  $237,294   $238,495 

 

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

 

   Nine Months Ended 
   September 30, 2014   September 30, 2013 
Weighted average risk-free interest rate   1.91%   0.35%
Volatility factor   70.90%   24 - 73%
Weighted average expected life (in years)   7    7 
Dividend rate   0.0%   0.0%

 

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

 

17
 

  

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

 

Notes to Consolidated Financial Statements (unaudited)

 

12.Stock Warrants

 

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

 

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

 

As of September 30, 2014, warrants to purchase 57,805,937 shares of common stock were outstanding and exercisable. The Company recognized a total of $159,118 in interest expense and $49,921 in consulting services during the nine months ended September 30, 2014 and $537,137 in placement agent services as of December 31, 2013 as a result of issuing an aggregate of 3,720,323 warrants earned in 2014.

 

   Shares   Weighted Average
Exercise
Price
   Weighted Average
Remaining
Contractual Life
(in years)
 
Outstanding at December 31, 2013   52,705,614   $1.30    2.58 
Granted   5,322,823   $0.79    3.87 
Exercised   (22,500)   -      
Cancelled or expired   (200,000)  $2.00      
Outstanding at September 30, 2014   57,805,937   $1.25    2.51 

 

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

 

Warrants Outstanding 
Exercise Price   Outstanding   Weighted Average
Remaining Contractual
Life (in years)
   Weighted
Average
Exercise
Price
 
$0.50    15,524,642           
$0.75    11,065,144           
$0.80    1,415,000           
$1.10    18,886,850           
$1.12    263,750           
$2.00    9,255,842           
$2.20    98,320           
$2.25    1,296,389           
$0.50 - $2.25    57,805,937    2.51   $1.25 

 

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

 

Notes to Consolidated Financial Statements (unaudited)

 

13.Income Taxes

 

The provision for income taxes, if any, is comprised of current and deferred components. The current component, if any, presents the amount of federal and state income taxes that are currently reportable to the respective tax authorities and is measured by applying statutory rates to the Company’s taxable income as reported in its income tax returns. The Company has evaluated its income tax positions in accordance with FASB ASC 740. There were no changes to unrecognized tax benefits during 2013. The tax years 2010 through 2013 remain open to review by various taxing authorities.

 

ASC Topic 740, Income Taxes defines the confidence level that a tax position must meet in order to be recognized in the financial statements. Accordingly, we have assessed uncertain tax positions in each of the tax jurisdictions in which we have operations and account for the related financial statement implications. We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized in the financial statements on a particular tax position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. The amount of unrecognized tax benefits is adjusted as appropriate for changes in facts and circumstances, such as significant amendments to existing tax law, new regulations or interpretations by the taxing authorities, new information obtained during a tax examination, or resolution of an examination. We recognize both accrued interest and penalties, where appropriate, related to unrecognized tax benefits in income tax expense.

 

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

 

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

 

During the development stage of the Company when future benefit of the deferred tax asset is uncertain, the Company provides for a full valuation allowance against the deferred tax asset. Net operating loss carryforwards start to expire beginning 2021 for both federal and state purposes. The net operating tax loss carryforwards total approximately $57,200,000 and $50,000,000 at September 30, 2014 and December 31, 2013, respectively.

 

14.Lease Commitments

 

The Company leases its USA facilities under operating leases beginning a) April 2012 through March 2017 and b) a month-to-month lease. Additionally, the Company leases its Europe facility on a three-year lease beginning January 2012 through January 2015. (See Note 17, Contingent Subsidiary Sale.) The Company also has three equipment operating leases with terms of three to five years.

 

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

 

Year ending December 31:  Future required minimum lease payments 
2014 (payment in arrears)  $198,764 
2014 (October – December)  $41,908 
2015  $167,628 
2016  $167,628 
2017  $41,907 

 

Rent expense totals $91,751 for the three months ended and $280,799 for the nine months ended September 30, 2014, compared to $108,446 for the three months ended and $325,980 for the nine months ended September 30, 2013.

 

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

 

Notes to Consolidated Financial Statements (unaudited)

 

15.Retirement Plan

 

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

 

16.Commitments and Contingencies

 

Legal Proceedings

 

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

 

Indemnity of Directors and Officers

 

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

 

Warranty Costs

 

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

 

Stock Options

 

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

 

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

 

Notes to Consolidated Financial Statements (unaudited)

 

16.Commitments and Contingencies (continued)

 

University License Agreements

 

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

 

AGREEMENT WITH WEST VIRGINIA UNIVERSITY (WVU)

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

 

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

 

AGREEMENT WITH GEORGE WASHINGTON UNIVERSITY (GWU)

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

 

Under the terms of the license agreement, the Company has the exclusive, worldwide rights to commercialize the technology. The Company is obligated to pay expenses for the preparation, filing and prosecution of related patent applications, and the Company will pay royalties on the net revenues resulting from the sale of products and services that utilize the GWU subject technology. As of September 30, 2014, the Company’s accounts payable balance includes approximately $70,927 to GWU for royalties compared to $32,600 as of December 31, 2013. All royalties were in arrears as of September 30, 2014.

 

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

 

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

 

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

 

21
 

  

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

 

Notes to Consolidated Financial Statements (unaudited)

 

16.Commitments and Contingencies (continued)

 

AGREEMENT WITH OMICS2IMAGE

In 2014, the Company entered into an agreement with Omics2Image related to the “Next Generation Ambient Imaging Mass Spectrometry for (Bio)polymers and Smart Materials” (“COAST Project”). The Company has committed to fund 60,000 Euros or $76,000 related to the COAST Project over the next twelve month period. Omics2Image agrees to evenly share the value gained from the efforts outlined within the scope of the COAST Project, which may include new intellectual property and the development of a commercial, integrated instrument system. As of September 30, 2014, the Company had not made any payments to Omics2Image.

 

Joint Pharmaceutical Development Agreement

 

In May 2009, the Company, and its wholly-owned subsidiary, Protea Europe, entered into a Joint Research and Development Agreement with Laboratories Mayoly Spindler SAS (Mayoly), a European Pharmaceutical company with headquarters in France, for the joint development of a recombinant lipase biopharmaceutical. Under the terms of the agreement, Protea received the exclusive marketing rights for the therapeutic in the territory of North America; was responsible for paying (a) 40% of the development expenses (with Mayoly funding the remaining 60%); (b) royalties on net sales of the biopharmaceutical, and (c) a milestone payment of 1m Euros at the time the Company obtains the first FDA approval for the recombinant Lipase biotherapeutic. The Company also received a sublicense to certain patents owned by Mayoly and licensed from the government of France. As of September 30, 2014 and December 31, 2013, the Company owed approximately $34,000 and $37,000, respectively, to Mayoly, which is reflected in Trade Accounts Payable on the Consolidated Balance Sheet. On June 13, 2014, the Company agreed to sell 100% of the issued and outstanding equity securities of Protea Europe and all of the Company’s rights and obligations under development agreement were transferred to the Buyer. (See Note 17, Contingent Subsidiary Sale.)

 

Engineering and Design Services

 

The Company has engaged Dynamic Manufacturing LLC, a contract manufacturer to produce ten LAESI units. As of September 30, 2014, the Company had received five LAESI units from Dynamic. As of September 30, 2014, the Company had $373,300 in outstanding commitments with Dynamic as well as approximately $249,000 in payables due to Dynamic.

 

The Company has approximately $115,600 in outstanding commitments with Bridger Photonics for lasers related to the LAESI technology. At September 30, 2014, the Company owed approximately $31,000 in payables due to Bridger.

 

22
 

  

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

 

Notes to Consolidated Financial Statements (unaudited)

 

17.Contingent Subsidiary Sale

 

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

 

  i.an aggregate amount of $300,000 (the “Purchase Price”) including $200,000 in cash and $100,000 from the forgiveness of outstanding indebtedness of the Company owed to the Buyer;
 ii.100 shares of Series A Preferred Stock of the Buyer (the “Preferred Stock”) that is convertible into 33% of the issued and outstanding common stock of the Buyer; and
iii.the right to receive certain other contingent consideration to be paid upon the satisfaction of certain events, including (a) a one-time milestone payment of $2,000,000 due within (10) days of receipt of the first approval by the FDA of a New Drug Application or Biologics License Application for a Business Product; (b) royalty payments equal to 2.5% of net sales of Business Product up to $100,000,000 and 1.5% of net sales of Business Product in excess of $100,000,000 and (c) ten percent (10%) of the Transaction Value received in connection with a sale or transfer of the pharmaceutical development business of Protea Europe.

 

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

 

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

 

18.Evaluation of Subsequent Events

 

Issuance of Preferred Stock

 

On October 31, 2014 (the “Initial Closing”), the Company received $2,539,475 in aggregate gross cash proceeds from 47 accredited investors in connection with the sale of approximately 25.4 units (each a “Unit” and collectively, the “Units”) pursuant to the terms and conditions of a Subscription Agreement (the “Subscription Agreement”) and Unit Purchase Agreement (the “Purchase Agreement”) by and among the Company and each of the purchasers (the “Purchasers”) thereto. Each Unit consists of (i) 50,000 shares of Series A convertible preferred stock, par value $0.0001 per share (the Preferred Stock”), (ii) and a 3 year warrant to purchase 200,000 shares of common stock, par value $0.0001 per share (the “Common Stock”) at an exercise price of $0.375 per share (the “Investor Warrants”) for an aggregate of 1,269,738 shares of the Company’s preferred stock and Investor Warrants to purchase an aggregate of 5,078,800 shares of the Company’s common stock issued at the Initial Closing in connection with the cash proceeds received.

 

Each share of preferred stock has a stated value equal to $2.00, subject to increase (the “Stated Value”). The preferred stock will automatically convert into shares of common stock determined by dividing the Stated Value by $0.25 per share on February 17, 2015. Under certain circumstances, the holders of the preferred stock have voluntary conversion rights, are entitled to receive dividends at the rate of 6.0% per annum and shall be entitled to certain anti-dilution protections.

 

In connection with the Initial Closing, the Company also paid to a FINRA registered broker dealer that acted as the placement agent (the “Placement Agent”) an aggregate of $465,278.08 in cash compensation, representing fees and an expense allowance. In addition, the Company agreed to issue a warrant (the “Placement Agent Warrant”) to purchase an aggregate of 1,489,171 shares of common stock to the Placement Agent (or its designees).

 

23
 

  

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

 

Notes to Consolidated Financial Statements (unaudited)

 

18.Evaluation of Subsequent Events (continued)

 

Conversion of Convertible Debentures

 

In addition, at the Initial Closing, the Company issued an aggregate of approximately 18.9 in additional Units or 943,525 shares of preferred stock and Investor Warrants to purchase up to 3,774,100 shares of common stock, to certain existing convertible promissory note holders, in connection with the conversion of $1,887,053.90 in outstanding principal and accrued unpaid interest in convertible promissory notes.

 

Advances from Stockholders

 

Subsequent to September 30, 2014, the Company received advances equal to an aggregate of $325,000 from certain current directors and related parties, which brought the outstanding balance to $540,000. The Company repaid an aggregate of $335,000 to certain related parties. No terms of repayment have been specified on the remaining $205,000 in aforementioned advances as of the filing date.

 

24
 

  

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

 

Forward-Looking Statement Notice

 

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

 

Overview of Our Business

 

Protea Biosciences Group, Inc. (referred to as “Protea”, “the Company”, “we”, “us” and “our”) is a development stage molecular information company incorporated in the state of Delaware on May 24, 2005. “Molecular information” refers to the process of transforming large analytical data sets, obtained by applying the Company’s technology, expertise and infrastructure, towards the identification and characterization of the proteins, metabolites and other biomolecules such as lipids, which are the byproducts of all living cells and life forms.

 

The Company is applying its technology to the development of next generation “direct molecular imaging” technology and service capabilities that it believes enable more rapid and comprehensive molecular profile of diseases based on biomolecules derived from the end result of gene expression in living cells, i.e. proteins, lipids, and metabolites. We believe that our proprietary technology and its integration into pathology, which is the current standard of care for tissue based diagnosis, will allow more rapid and confident identification of highly specific biomarkers of disease. The molecular information and associated processes that the Company is developing will be critical in accelerating the discovery, development and commercialization of diagnostic markers or tests for challenging human biology problems such as cancer and neurodegenerative disease.

 

Our Business Strategy and Products

 

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

 

Our commercial offering is organized as follows:

 

Molecular Information Technologies

 

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

 

25
 

  

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

 

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

 

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

 

Molecular Information Services

 

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

 

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

 

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

 

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

 

Molecular Data and Informatics Products

 

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

 

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Emerging Growth Company

 

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

 

Results of Operations

 

Three and Nine Months Ended September 30, 2014 Compared to Three and Nine Months Ended June 30, 2013

 

For the three months ended September 30, 2014 and September 30, 2013, we earned revenue of $517,569 and $178,475, respectively, an increase of $339,094, or approximately 190%. We earned revenue of $1,332,230 and $938,080 for the nine months ended September 30, 2014 and September 30, 2013, respectively, an increase of $394,150 or approximately 42%. During the nine months ended September 30, 2014, the Company realized service revenues of $334,545 compared to $143,485 for the nine months ended September 30, 2013. The Company sold four LAESI units for total revenue of $593,250 compared to four units in 2013 for total revenue of $502,084. In addition, the Company received grant revenues associated with the initiation of a DARPA grant totaling $80,680.

 

For the three months ended September 30, 2014 and September 30, 2013, selling, general and administrative expenses totaled $2,280,876 and $1,943,814, respectively. This represents an increase of $337,062 or 17% from prior year. Selling, general and administrative expenses totaled $7,380,407 for the nine months ended September 30, 2014 compared to $6,015,077 for the nine months ended September 30, 2013, an increase of $1,365,330 or approximately 23%. The increase in selling, general and administrative expenses relates largely to increased salary and personnel costs associated with hiring new staff as well as additional services rendered by outside vendors and consultants in 2014 which was partially offset by lower cost of goods sold year over year.

 

For the three months ended September 30, 2014 and September 30, 2013, research and development expense totaled $600,162 and $658,880, respectively. This represents a decrease of $58,718 or approximately 9%. Research and development expense totaled $2,126,144 for the nine months ended September 30, 2014, compared to research and development expense of $2,367,014 for the nine months ended September 30, 2013, a decrease of $240,870 or approximately 10%. Research and development expenses primarily include costs associated with the development of the LAESI technology. Research and development expenses have decreased as the Company continues to transition from development to production of its research products and service offerings.

 

For the three months ended September 30, 2014 and September 30, 2013, loss from operations totaled $2,363,469 and $2,424,219, respectively. This represents a decrease of $60,750 or 3% from prior period. Loss from operations totaled $8,174,321 for the nine months ended September 30, 2014, compared to a loss from operations of $7,444,011 for the nine months ended September 30, 2013, an increase of $730,310 or approximately 10%.

 

For the three months ended September 30, 2014 and September 30, 2013, total other expense was $2,295,307 and $130,704, respectively. This is an increase of $2,164,603 from the prior period. Other expense was $2,662,931 for the nine months ended September 30, 2014 compared to $472,871 for the nine months ended September 30, 2013. Other expense increased as a result of the change in fair market value on derivatives related to anti-dilution protection on certain securities and interest expense incurred on new debt originated in 2014.

 

After foreign currency translation adjustments of ($22,915) and $5,797, respectively, total comprehensive loss was $4,681,691, or ($0.07) per share, for the three months ended September 30, 2014 as compared to a total comprehensive loss of $2,549,126, or ($0.06) per share, for the three months ended September 30, 2013. After foreign currency translation adjustments of ($36,450) and $6,487, respectively, total comprehensive loss was $10,873,702, or ($0.17) per share, for the nine months ended September 30, 2014 as compared to a total comprehensive loss of $7,910,395, or ($0.19) per share, for the nine months ended September 30, 2013.

 

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Liquidity and Capital Resources

 

We have experienced negative cash flows from operations since inception. To date, our operations since inception have been funded primarily through proceeds received from the issuance of debt and sale of equity securities in private placement offerings. We have a credit facility of $3,000,000 with United Bank, Inc. with a balance of $3,000,000 outstanding as of September 30, 2014. Interest is payable monthly and the loan is due on demand. During the first nine months of 2014, the Company received $3,270,000 from related parties and another $536,000 from other non-related parties.

 

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

 

Based on our current spending levels and, in light of our Initial Closing in connection with the sale of preferred stock on October 31, 2014 (See Note 18, Subsequent Events), management estimates that, as of the date of this filing through the end of 2014, the Company will need approximately $1,250,000 to maintain current operations.

 

As of September 30, 2014, we had total current assets equal to $747,574, comprised of $118,277 in cash and cash equivalents, $264,526 in trade accounts receivable, $33,557 in other receivables, $262,219 in inventory and $68,995 in prepaid expenses. This compares with total current assets of $2,508,502 at December 31, 2013 comprised of $1,086,330 in cash and cash equivalents, $216,864 in trade accounts receivable, $435,278 in other receivables, $465,334 in inventory and $304,696 in prepaid expenses. The Company's total current liabilities as of September 30, 2014 were equal to $11,900,902, comprised of $1,780,139 in current maturities on long term debt, $2,636,197 in trade accounts payable, $3,000,000 in connection with the United Bank, Inc. line of credit, $3,383,195 in loans payable to stockholders, net of discount, and $1,101,371 in other payables and accrued expenses. The Company's total current liabilities as of December 31, 2013 were equal to $6,225,105, comprised of $1,054,053 in current maturities on long term debt, $759,021 in trade accounts payable, $2,725,000 in connection with the United Bank line of credit, $465,883 in loans payable to stockholders, net of discount, $151,981 in Obligations related to the Letter of Credit, net of discount and $1,069,167 in other payables and accrued expenses.

 

Our working capital deficit at September 30, 2014 was $11,153,328 as compared to a working capital deficit of $3,716,603 at December 31, 2013. The increase in working capital deficit was $7,436,725 from December 31, 2013 to September 30, 2014.

 

Operating Activities

 

Net cash used in operating activities for the nine month period ended September 30, 2014 decreased $2,787,745, or 38% from $7,269,386 for the nine month period ended September 30, 2013 to $4,481,641. Net cash used in operating activities during the nine month period ended September 30, 2014 was primarily the result of a net loss of $10,837,252. Net loss was adjusted for non-cash items such as depreciation and amortization of $627,094, non-cash compensation of $237,294, issuance of stock for services of $735,462, accretion of convertible debenture discount of $159,118, loss on disposal of fixed assets of $18,768, bad debt expense of $3,200, and expense from change in value of derivative of $2,079,335. We also had a decrease in prepaid expenses of $123,552, and other receivables of $403,084 and in inventory of $203,115. We also had an increase in trade accounts receivable of $50,862, in trade accounts payable of $1,784,246 and other payables and accrued expenses of $32,205.

 

Investing Activities

 

Net cash provided by investing activities during the nine month period ended September 30, 2014 was $214,308, which was the result of proceeds of $600,000 received from the contingent sale of Protea Europe offset by equipment purchases of $391,692. As the development of the Lipase product was costing the Company over $1m of expense each year, management determined it was in the Company’s interest to focus those resources going forward on their core products and services. The sale includes success fees and royalties to the Company in the future if the product is subsequently approved by the FDA.

 

In addition, we expect to continue to purchase property and equipment in the normal course of our business. The amount and timing of these purchases and the related cash outflows in future periods is difficult to predict and is dependent on a number of factors including, but not limited to, any increase in the number of our employees and changes related to our development programs. Net cash used in investing activities during the nine month period ended September 30, 2013 was $42,715 and was also used for equipment purchases.

 

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Financing Activities

 

Cash provided by financing activities during the nine month period ended September 30, 2014 was $3,335,730, which was the result of net proceeds of $1,250 from the net sale of our common stock, proceeds of $3,270,000 from advances recorded as related party debt, and proceeds of $536,000 from short term debt. This was offset by $507,825 used in the repayment of shareholder, short and long-term debt and $238,695 used in the repayment of the obligation related to the letter of credit. Cash provided by financing activities during the nine month period ended September 30, 2013 was $7,319,049, which was the result of net proceeds of $4,830,775 from the sale of our common stock, proceeds of $825,000 from the issuance of related party debt, proceeds of short term debt of $1,769,500, and proceeds of $600,000 from the Obligation related to the Letter of Credit. This was offset by $483,921 used in the repayment of long-term debt and $222,305 used in repayment of the Obligation related to Letter of Credit.

 

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

 

Off-Balance Sheet Arrangements

 

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

 

Critical Accounting Policies

 

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

 

Recently Issued Accounting Pronouncements

 

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

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

 

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

 

Item 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

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

 

As of September 30, 2014, we carried out an evaluation, under the supervision and with the participation of our principal executive officer and our principal financial officer of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our principal executive officer and our principal financial officer had concluded that as of September 30, 2014, our disclosure controls and procedures were ineffective due to inadequate controls over information technology due to the departure of our IT/Network Administrator earlier in the year, which left insufficient resources in the IT department We have concluded that the Company’s controls were ineffective in this area, and our management team is taking immediate action and has been actively engaged in the planning for, and implementation of, remediation efforts since material weaknesses were discovered.

 

Since the material weakness was discovered in June 2014, we have contracted with an independent information technology firm (‘The firm’) to assist with managing information technology (‘IT’) services; such as 24/7 monitoring of the IT infrastructure, database management, backup processes, logical access and other key IT controls while employing sound change management practices. The firm is also assisting with stabilizing the current IT environment in a three phase approach to better utilize existing IT infrastructure and resources. Finally, the firm will also serve as a major contributor to the Company’s internal IT help desk function. We believe that the aforementioned will improve and remediate the material weakness in our financial reporting related to information technology.

 

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

 

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

 

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

 

Changes in Internal Control over Financial Reporting

 

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

 

PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings.

 

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

 

Item 1A. Risk Factors.

 

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

 

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

 

Common Stock

 

During the quarter ended September 30, 2014, the Company issued 250,000 shares of common stock having a value of $220,000 to three consultants for services rendered.

 

Warrants to Purchase Common Stock

 

During the quarter ended September 30, 2014, the Company issued warrants to purchase 765,000 shares of common stock to Summit Resources, Inc., an affiliate of Steve Antoline, a director of the Company, in connection with up to an aggregate of $765,000 in promissory notes issued during the quarter. The warrants are exercisable for five years from date of issuance at an exercise price of $0.80 per share.

 

Options

 

During the quarter ended September 30, 2014, the Company granted options to purchase an aggregate of 57,500 shares of common stock in connection with the Company’s 2013 Equity Incentive Plan at an exercise price of $0.55 per share to various employees. The options expire ten years from date of issuance. In addition, 25,000 options were exercised at $0.55 per share during the quarter. 

 

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Convertible Notes and Warrants

 

From July 1, 2014 until September 30, 2014, the Company entered into a Note Purchase Agreement, and issued convertible one-year promissory notes (the “Notes”) to ten related parties in the aggregate principal amount of $817,500. The Notes are convertible into units (the “Units”) consisting of 181,818 shares of the Company’s common stock and a warrant to purchase 109,091 shares of Common Stock, exercisable at $0.80 per share. Each $100,000 of outstanding principal and accrued unpaid interest underlying the Note is automatically convertible into securities of the Company issued in a subsequent financing pursuant to which the Company raises at least $2,000,000 in gross proceeds (“Subsequent Financing”).

  

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

 

Item 3.  Defaults Upon Senior Securities.

 

Not applicable

 

Item 4.  Mine Safety Disclosure.

 

Not applicable.

 

Item 5.  Other Information.

 

Not applicable.

 

Item 6.  Exhibits.

 

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

 

Exhibit No.    Description
3.1   Certificate of Incorporation (incorporated by reference from Exhibit 3.1 to the registrant’s Form 10-SB filed with the Securities and Exchange Commission on August 3, 2005).
3.2   Bylaws (incorporated by reference from Exhibit 3.2 to the registrant’s Form 10-SB filed with the Securities and Exchange Commission on August 3, 2005).
3.3   Certificate of Ownership and Merger filed with the Office of Secretary of State of Delaware on September 2, 2011 (incorporated by reference to the registrant's Form 8-K filed with the Securities and Exchange Commission on September 9, 2011).
4.1   Form of Promissory Note for $1,500,000 Offering (incorporated by reference from Exhibit 4.1 to the registrant’s Form 10-Q filed with the Securities and Exchange Commission on August 5, 2014).
4.2   Form of Warrant for $1,500,000 Offering (incorporated by reference from Exhibit 4.2 to the registrant’s Form 10-Q filed with the Securities and Exchange Commission on August 5, 2014).
4.3   Form of Convertible Promissory Note for $3,000,000 Offering (incorporated by reference from Exhibit 4.3 to the registrant’s Form 10-Q filed with the Securities and Exchange Commission on August 5, 2014).
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, 2014.
31.2   Certification of the Company’s Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, with respect to the registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014.
32.1   Certification of the Company’s Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2   Certification of the Company’s Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
EX-101.INS   XBRL Instance Document
EX-101.SCH   XBRL Taxonomy Extension Schema
EX-101.CAL   XBRL Taxonomy Extension Calculation Linkbase
EX-101.DEF   XBRL Taxonomy Extension Definition Linkbase
EX-101.LAB   XBRL Taxonomy Extension Label Linkbase
EX-101.PRE   XBRL Taxonomy Extension Presentation Linkbase

 

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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 14, 2014 By: /s/  Stephen Turner
    Stephen Turner
    President and Director
    Principal Executive Officer
     
  By: /s/  Edward Hughes
    Edward Hughes
    Chief Financial Officer
    Principal Financial Officer

 

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