Dividend Policy

We have not previously declared or paid any dividends on our common stock. The payment of dividends on our common stock in the future will depend on our profitability at the time, cash available for those dividends, and such other factors as our board of directors may consider appropriate. We do not anticipate paying dividends on our common stock in the foreseeable future.

Securities Authorized for Issuance under Equity Compensation Plans

The Heatwurx Board of Directors and stockholders approved the Amended and Restated Heatwurx, Inc. 2011 Equity Incentive Plan (the “Plan”) in October 2012. All prior awards made under the Plan were cancelled and are available for future issuances.

Eligibility.Employees, non-employee directors, advisors, and consultants of the Company and its affiliates are eligible to receive grants under the Plan.

Shares Available. 257,143 shares are reserved for issuance under the Plan after the one for seven reverse-split. There are currently no outstanding awards under the Plan. If unexercised options expire or are terminated, the underlying shares will again become available for grants under the Plan.

Grants under the Plan. The Plan provides for the grant of options to purchase shares of common stock of the Company. Options may be incentive stock options, designed to satisfy the requirements of Section 422 of the U.S. Internal Revenue Code, or non-statutory stock options, which do not meet those requirements.

Incentive stock options may only be granted to employees of the Company and its affiliates. Non-statutory stock options may be granted to employees, nonemployee directors, advisors, and consultants of Company and its affiliates.

Outstanding Options. As of December 31, 2017, and the date hereof, there were no outstanding option grants under the Plan.

Administration of the Plan. The Plan provides that it will be administered by the Board or a Committee designated by the Board. Our Board of Directors will administer the Plan until such time as the Board appoints a Compensation Committee. The Board or the Compensation Committee once appointed will have complete discretion to:

Terms of Options. The exercise price for non-statutory and incentive stock options granted under the equity compensation plan may not be less than 100% of the fair market value of the common stock on the option grant date or 110% in the case of incentive stock options granted to employees who own stock representing more than 10% of the voting power of all classes of common stock of the Company and its parent and subsidiaries (“10%-Stockholders”). The Board of Directors, until a Compensation Committee has been appointed, has the authority to establish the vesting, including the terms under which vesting may be accelerated, and other terms and conditions of the options granted. Options can have a term of no more than ten years from the grant date except for incentive stock options granted to 10%-stockholders which can have a term of no more than five years from the grant date.

The Plan authorizes the Board of Directors or the Compensation Committee once appointed to provide for accelerated vesting of options upon a “Change in Control”, as defined in the Plan. A Change in Control includes:

Amendment and Termination. The Board of Directors may amend or terminate the Plan and outstanding options at any time without the consent of option holders provided that such action does not adversely affect outstanding options. Amendments are subject to stockholder approval to the extent required by applicable laws and regulations. Unless terminated sooner, the Plan will automatically terminate on April 15, 2021, the tenth anniversary of April 15, 2011, the date the Plan was adopted by our Board of Directors and approved by our Stockholders.

The table below provides information as to the number of options outstanding and their weighted average exercise price at December 31, 2017.

Recent Sales of Unregistered Securities

On October 4, 2017 certain entities affiliated with current shareholders purchased $1.25 million of our senior secured convertible notes (“Senior Notes”) in a bridge financing undertaken by us to support our operations. On November 21, 2017, additional third party accredited investors contributed $1.33 million in financing proceeds. The Senior Notes were issues solely to investors who are “accredited investors” within the meaning of Rule 501(a) of Regulation D in reliance on the exemptions from registration under Regulation D and Securities Act Section 4(2).

Repurchases of Equity Securities

We repurchased no shares of our common stock during the fourth quarter of 2017.

Not applicable.

The following discussion and analysis should be read together with our financial statements and the related notes appearing elsewhere in this report. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. See “Special Note Regarding Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. Actual results and the timing of events could differ materially from those discussed in our forward-looking statements as a result of many factors, including those set forth under “Risk Factors” and elsewhere in this Annual Report on Form 10-K.

Background

On October 2, 2017 Heatwurx, Inc., “(Heatwurx”) and Processa Therapeutics, LLC (“Processa”), a Delaware limited liability company and a wholly-owned subsidiary of Heatwurx entered into an Asset Purchase Agreement (the “Acquisition Agreement”) with Promet Therapeutics, LLC, a Delaware limited liability company (“Promet”) pursuant to which, at the effective time on October 4, 2017, Heatwurx acquired all of the assets of Promet, in exchange for issuing to Promet approximately 222,217,000 shares of the common stock of Heatwurx (approximately 31,745,000 shares following our reverse stock split). Following the closing, Heatwurx changed its name to Process Pharmaceuticals, Inc. As used in this Form 10-K, unless the context suggests otherwise, “we,” “us,” “our,” “the Company” or “Processa” refer to Processa Pharmaceuticals, Inc., its wholly-owned subsidiaries and the acquired assets from Promet.

Following the acquisition, we have abandoned our prior business plan and we are now pursuing Promet’s historical business and proposed business, with a focus on developing drugs to treat patients that have a high unmet medical need. Prior to the acquisition, Heatwurx had nominal net liabilities and operations. It was considered a nonoperating public shell corporation. Therefore, because Promet is considered the accounting acquirer (and legal wholly-owned subsidiary of Heatwurx) and Heatwurx is considered the accounting acquiree (and legal acquirer), we have presented Promet’s information as that of the Company, including operations prior to the closing of the Acquisition Agreement.

Overview of the Company

Processa is an emerging pharmaceutical company focused on the clinical development of drug products that are intended to improve the survival and/or quality of life for patients who have a high unmet medical need. Within this group of pharmaceutical products, we currently are developing one product for two indications (i.e., the use of a drug to treat a particular disease) and searching for additional products for our portfolio.

Going Concern and Management’s Plan

The Company’s consolidated financial statements are prepared using U.S. GAAP and are based on the assumption that the Company will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The Company faces certain risks and uncertainties that are present in many emerging growth companies regarding product development and commercialization, limited working capital, recurring losses and negative cash flow from operations, future profitability, ability to obtain future capital, protection of patents, technologies and property rights, competition, rapid technological change, navigating the domestic and major foreign markets’ regulatory and clinical environment, recruiting and retaining key personnel, dependence on third party manufacturing organizations, third party collaboration and licensing agreements, lack of sales and marketing activities and no customers or pharmaceutical products to sell or distribute. These risks and other factors raise substantial doubt about our ability to continue as a going concern.

The Company has relied exclusively on private placements with a small group of accredited investors to finance its business and operations. We do not have any credit facilities as a source of future funds. The Company has had no revenue since inception on August 31, 2015. The Company does not currently have any revenue under contract nor does it have any immediate sales prospects. As of December 31, 2017, the Company had an accumulated deficit of approximately $3.859 million incurred since inception. For the year ended December 31, 2017, the Company incurred a net loss from continuing operations of approximately $1.856 million and used approximately $1.655 million in net cash from operating activities from continuing operations. The Company had total cash and cash equivalents of approximately $2.847 million as of December 31, 2017. We have raised proceeds of $2.58 million from the Senior Convertible Notes issued through December 31, 2017. No additional Senior Convertible Notes have been issued through the date this report was available to be issued. On March 19, 2018, we modified the Option and License Agreement with CoNCERT Pharmaceuticals, Inc. (“CoNCERT”) (see Notes 10 and 14 in the consolidated financial statements in Item 8 of Form 10-K) effective January 2018, which enabled us to exercise our option to license the CoNCERT patent rights and know-how to develop and commercialize compounds (CTP-499 and each metabolite thereof) and products, as defined in the agreement. Although we have other drugs being positioned into our pipeline, the loss of our rights to CTP-499 would have materially and adversely affected our planned growth and business plan. We expect our operating costs to be substantial as we incur costs related to the clinical trials for our product candidates and that we will operate at a loss for the foreseeable future.

We are in the process of raising additional funds by potentially selling additional Senior Convertible Notes, convertible loans or other securities. No assurance can be given that we will be successful in raising adequate funds needed. If we are unable to raise additional capital when required or on acceptable terms, we may have to significantly delay, scale back or discontinue the development or commercialization of one or more of our product candidates, restrict our operations or obtain funds by entering into agreements on unattractive terms, which would likely have a material adverse effect on our business, stock price and our relationships with third parties with whom we have business relationships, at least until additional funding is obtained.

Uncertainty concerning our ability to continue as a going concern may hinder our ability to obtain future financing, as well as adversely affect our collaborative drug development relationships. Continued operations and our ability to continue as a going concern are dependent on our ability to obtain additional funding in the near future and thereafter, and no assurances can be given that such funding will be available at all or will be available in sufficient amounts or on reasonable terms. Without additional funds from debt or equity financing, sales of assets, sales or out-licenses of intellectual property or technologies, or other transactions yielding funds, we will rapidly exhaust our resources and will be unable to continue operations. Absent additional funding, we believe that our cash and cash equivalents will not be sufficient to fund our operations for a period of one year or more after the date that the consolidated financial statements are available to be issued based on the timing and amount of our projected net loss from continuing operations and cash to be used in operating activities during that period of time.

As a result, substantial doubt exists about the Company’s ability to continue as a going concern within one year after the date that the consolidated financial statements are available to be issued. The consolidated financial statements included in Item 8 of Form 10-K do not include any adjustments to reflect the possible future effects on the recoverability and classification of recorded assets, or the amounts and classification of liabilities that might be different should the Company be unable to continue as a going concern based on the outcome of these uncertainties described above.

Recent Developments

Our first FDA meeting with the FDA was held on October 18, 2017. This was a pre-IND meeting to review the proposed development program of PCS-499 (formerly known as CTP-499) for the treatment of Necrobiosis Lipoidica with special emphasis on the clinical program. The IND for this indication is expected to be submitted to the FDA in Q3 2018, and the Phase 2 study will commence in Q4 2018.

On or about November 21, 2017, Processa received proceeds from the second tranche of a Senior Convertible Note for $1,330,000 (convertible to shares of Processa Pharmaceuticals, Inc.). This first tranche was for $1,250,000 from prior Heatwurx and Promet shareholders.

In January 2018 we incurred losses of approximately $144,000 due to fraud from a cybersecurity breach. While we are taking steps to prevent such event from reoccurring, we cannot provide assurance that similar issues will not reoccur. Failure of our internal control systems to prevent error or fraud could materially adversely impact us.

On March 21, 2018, Processa announced that it has been assigned the license for the clinical stage compound CTP-499 and plans to develop the drug in multiple unmet medical need conditions.

On March 19, 2018 Promet, Processa and CoNCERT Pharmaceuticals, Inc. (“CoNCERT”) executed an Amendment to the Option Licensing Agreement granting an exclusive license, including the right to assign the license, sublicense, develop, manufacture, use and commercialize CTP-499 worldwide. Upon exercising the option to license CTP-499, Promet transferred $8.0 million of its Processa shares, approximately 5.9% of all Processa outstanding shares, to CoNCERT with CoNCERT also being eligible to receive royalties on commercial sales. Promet with CoNCERT’s agreement has subsequently assigned the license to Processa after exercising the licensing option.

Promet, Processa and CoNCERT entered into this Agreement to permit Processa to exercise the Option exchange for 2,090,301 shares of Processa’s common stock upon the terms and subject to the conditions stated in this Agreement.

On June 26, 2017, Processa terminated the development and licensing agreement with Drexel for the cyclic peptide. Processa was investigating the effects of the cyclic peptide for a rare orphan condition known as Krabbe Disease. Certain pharmacological targets were proposed to be an important factor in the development of any efficacious treatment for this condition. Based on preliminary data available for the peptide, it appeared that the cyclic peptide might be a feasible option for use in the condition. Unfortunately, as the peptide was further evaluated, there were inconsistent results related to the pharmacological effects as well as issues with manufacturing a viable formulation for clinical studies. Although other conditions were considered for the development of the peptide, the long-term program was determined not to meet the requirements for Processa to continue with development of the peptide. As such, the development and licensing agreement was terminated. The costs incurred under this agreement were substantially completed at December 31, 2016. Insignificant costs were incurred in 2017 to finalize and terminate the agreement.

Processa also has evaluated over 50 potential assets for acquisition and are presently performing due diligence on a cancer drug and a drug used for a cardiovascular condition that has no approved treatment. If one or both of these assets are a good fit for our portfolio, we will try to acquire the asset through in-licensing or acquisition of the Company as long as the acquisition makes good business sense.

Critical Accounting Policies and Use of Estimates

The discussion and analysis of our financial condition and results of operations are based on our audited consolidated financial statements which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We believe the following accounting policies and estimates are most critical to aid in understanding and evaluating our financial results reported in our consolidated financial statements (see also Note 1, 2 and 3 to our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K).

Going Concern.As noted above in Going Concern and Management’s Plan, absent additional funding, we believe that our cash and cash equivalents will not be sufficient to fund our operations for a period of one year or more after the date that the consolidated financial statements included in Item 8 of the Form 10-K are available to be issued based on the timing and amount of our projected net loss from continuing operations and cash to be used in operating activities during that period of time.

As a result, substantial doubt exists about the Company’s ability to continue as a going concern within one year after the date that the consolidated financial statements are available to be issued. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of recorded assets, or the amounts and classification of liabilities that might be different should the Company be unable to continue as a going concern based on the outcome of these uncertainties described above.

Reverse Acquisition.The asset acquisition of Promet by Heatwurx has been accounted for as a reverse acquisition in accordance with U.S. GAAP, Financial Accounting Standards Board (“FASB”), Accounting Standards Codification (“ASC”) 805-40-45,Business Combinations - Reverse Acquisitions. Under this method of accounting, Heatwurx, a nonoperating public shell corporation with nominal net liabilities, acquired all the assets of Promet, a private operating entity, through issuance of 90 percent of the issued and outstanding common stock of Heatwurx immediately after the asset acquisition. As a result of the change in control, Promet comprises the ongoing operations and assets of the combined entity and Promet senior management comprises the senior management of the Company and Promet is considered the accounting acquirer. Heatwurx has been treated as the “acquired” company for financial reporting purposes. The transaction is considered to be a capital transaction in substance. Accordingly, for accounting purposes, it is assumed that Promet issued shares to Heatwurx at fair value for Heatwurx’s net liabilities assumed by Promet at closing of the reverse acquisition. The fair value of the net liabilities assumed from Heatwurx, net of the par value of the assumed shares issued to Heatwurx is recognized as a reduction of additional paid-in capital.

As a result of the above, the operations prior to the asset purchase transaction are those of Promet. The assets and liabilities of Promet are recognized and measured at the historical carrying amounts. The accumulated deficit and other equity balances of Promet have been carried forward and adjusted to reflect the legal shares and par value of Heatwurx with the difference allocated to additional paid-in capital. Additional paid-in capital is also reduced by the fair value over the historical cost of the net liabilities assumed from Heatwurx, since the transaction is accounted for as a capital transaction, not a business combination.

Earnings per share (“EPS”) is calculated using the equity structure of Processa Pharmaceuticals, Inc., including the equity interests issued to Promet. Prior to the reverse acquisition, EPS is based on Promet’s net income and weighted average common shares outstanding that were received in the asset purchase transaction. Subsequent to the reverse acquisition, EPS is based on the actual number of common shares of Processa Pharmaceuticals, Inc. outstanding during that period.

The Company completed a reverse split or a one-for-seven exchange of its shares. As a result, the consolidated financial statements have been retrospectively adjusted to reflect the one-for-seven reverse split. See Note 2 and Note 3 of the consolidated financial statements included at Item 8 of the Form 10-K for more information.

At the closing of the asset purchase transaction on October 4, 2017, Heatwurx issued Promet 31,745,242 shares of the Company’s common stock or approximately 90% of the 35,272,626 total common shares issued and outstanding adjusted for the reverse split. As the accounting acquirer, Promet had assets of $1,168,609 and members’ equity of $1,017,342. Members’ equity consisted of members’ interest of $4,270,000 and accumulated deficit of $3,252,658. Promet acquired the fair value of net liabilities assumed from Heatwurx at acquisition of $37,750 consisting of $6,280 of cash and $44,030 of accounts payable and accrued expenses. The transaction was accounted for as a capital transaction. As a result, the fair value of the net liabilities assumed from Heatwurx of $37,750, net of the par value of the assumed shares issued to Heatwurx of $38,102 is recognized as a reduction of additional paid-in capital. Promet’s members’ interest was allocated to common stock at par value for $3,175 with the balance of $4,266,825 allocated to additional paid in capital. The loss from operations was $1,249,887 from January 1, 2017 through the acquisition date of October 4, 2017 and $606,428 from the acquisition date through December 31, 2017.

Stock-Based Compensation: The Company accounts for the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award, determined on the date of grant. Significant assumptions utilized in determining the fair value of our stock options include the volatility rate, estimated term of the options, risk-free interest rate and forfeiture rate. The term of the options will be based on the contractual term of the options as determined by the Board of Directors when the 2011 Equity Incentive Plan is amended or terminated and approved by the stockholders to the extent required by applicable laws and regulations. The expense is to be recognized over the period during which an employee is required to provide services in exchange for the award. The Company estimates forfeitures at the time of grant and makes revisions, if necessary, at each reporting period if actual forfeitures differ from those estimates. The Company has not estimated future unvested forfeitures since there were no option grants outstanding at December 31, 2017. Upon the issuance of 90% of Heatwurx’s common stock to Promet on October 4, 2017, there was a Change in Control event, as defined in the Plan. As of September 30, 2017, prior to the Change in Control event, all 269,500 unexercised options and all 40,000-unexercised performance options outstanding at December 31, 2016 were cancelled and are available for issuance.

Non-employee share-based compensation charges generally are immediately vested and have no future performance requirements by the non-employee and the total share-based compensation charge is recorded in the period of the measurement date.

We record equity instruments at their fair value on the measurement date by utilizing the Black-Scholes option-pricing model. Stock Compensation for all share-based payments, is recognized as an expense over the requisite service period.

Significant assumptions utilized in determining the fair value of our stock options include the volatility rate, estimated term of the options, risk-free interest rate and forfeiture rate. In order to estimate the volatility rate at each issuance date, given that the Company has not established a historical volatility rate as it has minimal trading volume since Processa began trading on October 4, 2017, management will review volatility rates for a number of companies with similar biopharmaceutical operations to arrive at an estimated volatility rate for each option grant. The term of the options will be based on the contractual term of the options as determined by the Board of Directors when the 2011 Equity Incentive Plan is amended or terminated and approved by the stockholders to the extent required by applicable laws and regulations. The risk-free interest rate is determined utilizing the treasury rate with a maturity equal to the estimated term of the option grant. Finally, management will make assumptions regarding a forfeiture rate once the 2011 Equity Incentive Plan is amended or terminated by the Board of Directors and approved by the stockholders to the extent required by applicable laws and regulations.

The Plan approved by the Heatwurx Board of Directors and stockholders in October 2012 has 257,143 shares of common stock after the reverse-split reserved for issuance under the Plan. The Plan is being reviewed by the Board of Directors and may be amended or terminated. Amendments are subject to stockholder approval to the extent required by applicable laws and regulations. Unless terminated sooner, the Plan will automatically terminate on April 15, 2021. There are currently no outstanding option grants under the Plan. If unexercised options expire or are terminated, the underlying shares will again become available for grants under the Plan.

During the year ended December 31, 2016, there were no options or performance options granted or exercised and 321,667 unexercised options with a weighted average exercise price of $1.69 were cancelled. At December 31, 2016, there were 269,500 unexercised options with a weighted average exercise price of $1.88 and a weighted average remaining life of 2.04 years and 40,000 unexercised performance options with a weighted average exercise price of $2.00. Upon the issuance of 90% of Heatwurx’s common stock to Promet on October 4, 2017, there was a Change in Control event, as defined in the Plan. As of September 30, 2017, prior to the Change in Control event, all 269,500 unexercised options and all 40,000-unexercised performance options outstanding at December 31, 2016 were cancelled. No stock-based compensation expense was recognized for the years ended December 31, 2017 and 2016.

Warrants.During the year ended December 31, 2016, there were no warrants granted, exercised or cancelled. At December 31, 2016, there were 2,000,304 warrants outstanding with a weighted average exercise price of $2.36 and a weighted average remaining life of 0.63 years. During the nine months ended September 30, 2017, 723,181 warrants with a weighted average exercise price of $2.99 were cancelled a result of non-exercise prior to their exercise date. At September 30, 2017, there were 1,277,123 warrants with a weighted average exercise price of $2.00 and a weighted average remaining life of 0.08 years.

Income Taxes. As a result of the transaction accounted for a reverse acquisition discussed above (also see Note 1 and Note 3 of the consolidated financial statements in Item 8 of Form 10-K), there was an ownership change as defined by Internal Revenue Code Section 382. Prior to the closing of the transaction, Promet was treated as a partnership for federal income tax purposes and thus was not subject to income taxes at the entity level. Therefore, no provision or liability for income taxes has been included in these financial statements through October 4, 2017. In addition, Promet determined that it was not required to record a liability related to uncertain tax positions as a result of the requirements of ASC 740-10-25 Income Taxes.

The net deferred tax assets of Heatwurx were principally federal and state net operating loss carry forwards which are not available to the Company following an ownership change as defined by Internal Revenue Code Section 382. The Heatwurx net deferred tax assets were fully reserved with a valuation allowance.

The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.

The provision for income taxes includes federal and state income taxes currently payable and deferred taxes resulting from temporary differences between the financial statement and tax basis of assets and liabilities at the enacted tax rates. Changes in deferred income tax assets and liabilities are included as a component of income tax expense. The effect on deferred income tax assets and liabilities attributable to changes in enacted tax rates are charged or credited to income tax expense in the period of enactment. Valuation allowances are recorded to reduce deferred tax assets when it is more-likely-than-not that a tax benefit will not be realized.

With respect to uncertain tax positions, the Company would recognize the tax benefit from an uncertain tax position only if it is more-likely-than-not that the tax position will be sustained upon examination by the taxing authorities, based on the technical merits of the position. Estimated interest and penalties related to uncertain tax positions are included as a component of interest expense and general and administrative expense, respectively. We had no accrual for interest or penalties on our consolidated balance sheets at December 31, 2017 and 2016. The Company had no unrecognized tax benefits or uncertain tax positions at December 31, 2017 or 2016.

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“TCJA”) was signed into law. In December 2017, the Securities and Exchange Commission issued Staff Accounting Bulletin 118 (“SAB 118”) to provide clarification in implementing the TCJA when registrants do not have the necessary information available to complete the accounting for an element of the TCJA in the period of its enactment. SAB 118 provides for tax amounts to be classified as provisional and subject to remeasurement for up to one year from the enactment date for such elements when the accounting effect is not complete but can be reasonably estimated. We consider our estimates of the tax effects of the TCJA on the components of our tax provision to be reasonable and no provisional estimates subject to remeasurement will be necessary to complete the accounting. For further information, see Note 7 to our consolidated financial statements included in Item 8 of Form 10-K.

We file U.S. federal income and Maryland state tax returns. There are currently no income tax examinations underway for these jurisdictions. However, tax years from and including 2014 remain open for examination by federal and state income tax authorities.

During the year ended December 31, 2017, we incurred operating losses of approximately $606,400. However, we recorded no income tax benefit for the approximately $347,500 ($95,632 net of tax) of general and administrative expenses treated as deferred start-up expenditures for tax purposes and approximately $258,600 ($71,155 net of tax) of tax losses resulting in tax loss carryforwards. The net operating loss carry forwards are available for application against future taxable income for 20 years expiring in 2037. Tax losses incurred after December 31, 2017 have an indefinite carry forward period. However, the tax loss incurred after December 31, 2017 and carried forward can only offset 80 percent of future taxable income. The benefit associated with the net operating loss carry forward will more-likely-than-not go unrealized unless future operations are successful. Since the success of future operations is indeterminable, the potential benefits resulting from these net operating losses have not been recorded in the consolidated financial statements. As of December 31, 2016, the Company had no net operating losses for federal and state income tax purposes since Promet’s members were taxed separately on their proportionate share of Promet’s income, deductions, losses and credits.

Convertible Debt. The $2.58 million of 8% Senior Convertible Notes are discussed in Note 6 to the consolidated financial statements in Item 8 of Form 10-K. Principal and interest under each Senior Note is due on the earlier of (i) the mandatory and automatic conversion of the Senior Note into the next Private Investment in Public Equity (“PIPE”) financing we undertake, provided the PIPE financing yields gross proceeds of at least $4 million at a conversion price per share equal to the lower of (a) $72 million pre-money valuation or (b) a 10% discount to the pre-money valuation (Qualified Financing) or (ii) the one-year anniversary of that Senior Note (Maturity Date). The Senior Notes bear interest at 8% per year and are payable in kind (in common stock). At the Maturity Date, the outstanding principal and accrued interest on the Senior Note will be automatically converted into shares of common stock of the Company equal to the lesser of (i) $72 million pre-money valuation or (ii) any adjusted price resulting from the application of down round pricing during the anti-dilution period through December 31, 2018. In such event, the anti-dilution period, as defined, will be extended for a further 12 months. The Senior Notes are secured by a security interest in the assets of the Company and contain negative covenants as defined in the note agreement.

Holders of Senior Notes (a) may elect to receive 110% of principal plus accrued interest in the event there is a change of control prior to conversion of the Senior Notes, (b) are entitled to full ratchet anti-dilution protection in event of any sale of securities at a net consideration per share that is less than the applicable conversion price per share to the holder, (c) are entitled to certain registration rights for the securities underlying the Senior Notes and (d) have been granted certain preemptive rights pro rata to their respective interests through December 31, 2018. The Senior Notes can be prepaid by the Company at any time following the date of issuance with seven days prior written notice to the note holder.

The Company retained Boustead Securities Ltd. (“Boustead”), a registered broker-dealer, as its exclusive financial adviser and has agreed to pay Boustead (i) six percent (6%) of gross proceeds received by the Company and (ii) warrants to purchase securities in the amount of three percent (3%) of the equity issued or issuable in connection with the Senior Notes bridge financing. These warrants will be issued upon achieving certain financing levels under the PIPE financing. No warrants are issuable, and none have been issued as of December 31, 2017.

No debt was issued and outstanding for 2016.

The Company recognizes debt issuance costs incurred on the Senior Convertible Notes as a reduction of the carrying amount of the Senior Convertible Notes on the face of the consolidated balance sheet. The debt issuance costs are amortized to interest expense using the interest method over the term of the Senior Convertible Notes.

The convertible debt is classified as a liability based on its terms and the guidance in ASC 480,Distinguishing Liabilities from Equity.The guidance provides that an unconditional obligation that the issuer must or may settle by issuing a variable number of its equity shares shall be classified as a liability if, at inception, the monetary value of the obligation is based solely or predominately on a fixed monetary amount known at inception.

Additionally, the conversion feature in the convertible debt was evaluated in accordance with ASC Topic 815-15,Derivatives and Hedging – Embedded Derivatives and ASC 815-10,Derivatives and Hedging to determine whether there is an Embedded Derivative that should be separately recognized and measured in the financial statements. Based on the terms of the convertible debt, the embedded written option would be considered indexed to the issuer’s own stock and a separate instrument with the same terms would be classified in stockholders’ equity in the statement of financial position, therefore, the written option is not considered a derivative instrument and should not be separated from the host contract.

Further, the mandatory conversion of the debt and accrued interest into common stock encompasses a residual interest in Processa, therefore, the conversion feature would possess principally equity characteristics related to Processa and would be considered clearly and closely related to the host contract. As a result, the conversion feature would not be required to be separately stated

Research and Development.Research and development costs are charged to expense as incurred. These costs include, but are not limited to, employee-related expenses, including salaries, benefits and travel as well as expenses related to contract research arrangements, costs of conducting pre-clinical and clinical trials and materials purchased for research and development activities.

Research and development activities are central to our business model. Product candidates in later clinical development generally have higher development costs than those in earlier stages of development, primarily due to the cost of the clinical trials and manufacturing. As we advance our product candidates, we expect the amount of external research and development will continue to increase for the foreseeable future.

Our clinical trial accruals are based on estimates of patient enrollment and related costs at clinical investigator sites as well as estimates for the services received and efforts expended pursuant to contracts with multiple research institutions and clinical research organizations that conduct and manage clinical trials on our behalf.

We estimate preclinical and clinical trial expenses based on the services performed, pursuant to contracts with research institutions and clinical research organizations that conduct and manage preclinical studies and clinical trials on its behalf. In accruing service fees, we estimate the time period over which services will be performed and the level of patient enrollment and activity expended in each period. If the actual timing of the performance of services or the level of effort varies from the estimate, we adjust the accrual accordingly. Payments made to third parties under these arrangements in advance of the receipt of the related series are recorded as prepaid expenses until the services are rendered.

It is difficult to determine with certainty the duration and completion costs of our current or future preclinical programs and clinical trials of our product candidates, or if, when or to what extent we will generate revenue from the commercialization and sale of any of our product candidates that obtain regulatory approval. We may never succeed in achieving regulatory approval for any of our product candidates. The duration, costs and timing of clinical trials and development of our product candidates will depend on a variety of factors, including the uncertainties of future clinical and preclinical studies, uncertainties in clinical trial enrollment rate and significant and changing government regulation. In addition, the probability of success for each product candidate will depend on numerous factors, including competition, manufacturing capability and commercial viability. We will determine which programs to pursue and how much to fund each program in response to the scientific and clinical success of each product candidate, as well as an assessment of each product candidate’s commercial potential.

Cash and Cash Equivalents.We consider all highly liquid investments with a maturity of three months or less to be cash equivalents. We will be putting cash into certificates of deposit that are purchased through an investment company and are held at multiple banks. The maturities of said certificates of deposit are typically six months or less.

Results of Operations

Our consolidated results of operations for the years ended December 31, 2017 and 2016 are as follows:

Year Ended December 31, 2017 and Year Ended December 31, 2016

Revenues. Processa had no revenues during the years ending December 31, 2017 and 2016, respectively.

Operating Expenses.

Research and Development Expenses. Our research and development costs are expensed as incurred. Research and development expenses primarily consist of (i) licensing of compounds for product testing and development, (ii) program and testing related expenses, (iii) internal research and development staff related payroll, taxes and employee benefits, external consulting and professional fees related to the product testing and development activities of the Company. Non-refundable advance payments for goods and services to be used in future research and development activities are recorded as prepaid expenses and expensed when the research and development activities are performed. Research and development expenses were approximately $926,000 and $1,537,000 for the years ended December 31, 2017 and 2016, respectively.

Research and development expenses decreased by approximately $611,000, or 39.7% to $926,000 in 2017 compared to $1,537,000 in 2016. The decrease in research and development expenses relate primarily to the substantial completion of the licensing, program and testing costs incurred under the Drexel agreement in 2016. The contract was officially terminated in June 2017 with insignificant costs incurred during 2017. However, the CoNCERT Pharmaceuticals, Inc. license and option agreement for the replacement compound CTP-499 was not executed until October 2017. As a result, research and development expenses were approximately $747,000 less in 2017 compared to 2016. This decline was partially offset by increased research and development staff related payroll, taxes and employee benefits of approximately $136,000 in 2017 compared to 2016.

Our clinical trial accruals are based on estimates of patient enrollment and related costs at clinical investigator sites as well as estimates for the services received and efforts expended pursuant to contracts with multiple research institutions and CROs that conduct and manage clinical trials on our behalf.

We estimate preclinical and clinical trial expenses based on the services performed, pursuant to contracts with research institutions and clinical research organizations that conduct and manage preclinical studies and clinical trials on our behalf. In accruing service fees, we estimate the time period over which services will be performed and the level of patient enrollment and activity expended in each period. If the actual timing of the performance of services or the level of effort varies from the estimate, we will adjust the accrual accordingly. Payments made to third parties under these arrangements in advance of the receipt of the related series are recorded as prepaid expenses until the services are rendered.

We expect research and development expenses to increase as we advance our lead candidates and pipeline product candidates. The funding necessary to bring a drug candidate to market is subject to numerous uncertainties. Once a drug candidate is identified, the further development of that drug candidate can be halted or abandoned at any time due to a number of factors. These factors include, but are not limited to, funding constraints, safety or a change in market demand. For each of our drug candidate programs, we periodically assess the scientific progress and merits of the programs to determine if continued research and development is economically viable. Certain of our programs may be terminated due to the lack of scientific progress and lack of prospects for ultimate commercialization.

General and Administrative Expenses. General and administrative expenses increased by approximately $492,000, or 127.9% to $876,000 in 2017 compared to $384,000 in 2016. The increase in general and administrative expenses relate primarily to professional fees for legal, accounting, advisory and consulting costs of approximately $234,000 related to Company operations and costs of being a public company; increased internal general and administrative staff related payroll, taxes and employee benefits of approximately $214,000 due to growth in Company operations and a full year of expense for 2016 hires; increase in office rent of approximately $55,000 as a result of being the primary obligor on the headquarters lease for a full year in 2017 compared to one-quarter in 2016 and sharing office rent costs with Corlyst, a related party of Promet and a shareholder of Processa, during the balance of 2016; and, one-time costs incurred in 2017 related to the reverse acquisition of Heatwurx by Promet, which closed on October 4, 2017, of approximately $59,000 and the impairment of software costs of approximately $15,000 related to obsolete software costs as a result of the reverse acquisition transaction and change in control of Processa Pharmaceuticals, Inc. These expense increases were partially offset by increased cost reimbursements (payroll, health care and office rent) by Corlyst of approximately $79,000 related to a full year of reimbursements in 2017 compared to one-quarter in 2016 and a net decrease in the other general and administrative expenses.

We expect the general and administrative expenses and consulting costs to increase as we add staff to support the growing research and development activities of the Company and the administration required to operate as a public company.

Other Income (Expense).

Interest Expense. Interest expense was approximately $59,000 and $0 for the years ended December 31, 2017 and 2016, respectively. Interest expense represents accrued interest of approximately $35,700 and the amortization of debt issuance costs of approximately $23,300 on the $2.58 million issuance of 8% Senior Convertible Notes issued on October 4, 2017 ($1,250,000) and November 21, 2017 ($1,330,000). The interest accrues monthly at 8% annually on the principal balance outstanding and is payable in kind through the issuance of common stock of the Company at maturity, which is not later than one-year from the date of issuance of the Senior Convertible Notes. The debt issuance costs are amortized over a one-year period on the effective interest method. The principal balance of the Senior Convertible Notes is also automatically and mandatorily convertible into the common stock of the Company at maturity, except for a change in control event or default. There was no debt in 2016.

Interest Income. Interest income was approximately $5,000 and $4,000 for the years ended December 31, 2017 and 2016, respectively. Interest income represents interest earned on money market funds and certificates of deposit which matured in 2017 and certificates of deposit in 2016.

Financial Condition

Total assets increased by approximately $618,000 at December 31, 2017 compared December 31, 2016. This increase is primarily attributable to the proceeds from issuance of $2.58 million of senior convertible notes reduced by the debt issuance costs of $154,800 which was used to fund the loss from operations of approximately $1.86 million included in the accumulated deficit at December 31, 2017. The senior convertible notes are due within one year of issuance or October and November of 2018. The repayment is through the automatic and mandatory conversion of the principal and fixed interest due into a variable number of common shares based on a valuation of the stock at that date. We expect to continue to require significant future financing to fund our operating activities and to use cash in operating activities for the foreseeable future as we continue our research and development activities to develop products that can be commercialized to generate revenue. Absent additional financing, substantial doubt exists about the Company’s ability to continue as a going concern as noted under Going Concern above.

Other significant changes in assets include the decrease in a vendor advance payment of approximately $228,000 related to the research and development activities paid in 2016 that was recognized as expense in 2017 with no recurring advance payment in 2017. Additionally, amounts due from Corlyst increased approximately $63,000 based on the timing of billing and collecting the third and fourth quarter administrative service reimbursements for 2017 with no similar receivable due for 2016.

Liabilities, excluding the senior convertible debt, increased approximately $63,500 at December 31, 2017 compared to 2016 related primarily to (i) Heatwurx accounts payable and accrued expenses at acquisition of approximately $44,000 that have not been paid at December 31, 2017 and it is reasonably possible that future payment may not occur for the disputed obligations; (ii) accrued interest of approximately $35,700 on the senior convertible notes that is not due until maturity in October and November 2018, but will be paid through issuance of a variable number of common shares based on a valuation of the stock at that date; and, (iii) accrued rent liability of approximately $13,300 related to the office lease of which $9,963 is noncurrent.

The changes in stockholders’ equity consist of the 2017 operating loss in accumulated deficit discussed above and the fair value of the net liabilities assumed from Heatwurx, net of the par value of the assumed shares issued to Heatwurx resulting in a reduction of additional paid-in capital of approximately $38,100.

Liquidity and Capital Resources

To date, we have funded our business and operations primarily through the private placement of equity securities and senior secured convertible notes. At December 31, 2017, we had $2.85 million in cash and cash equivalents compared to $2.09 million in cash and cash equivalents and certificates of deposit as of December 31, 2016 to be used to fund on-going operations. We do not believe we have sufficient cash resources to fund all necessary activities for the completion of the Phase 1 study for CTP-499 and the on-going general and administrative costs of the Company for a period of one year or more from the date the consolidated financial statements were issued. We do not have any credit facilities as a source of future funds, and there can be no assurance that we will be able to raise sufficient additional capital on acceptable terms, or at all. As a result, substantial doubt exists about the Company’s ability to continue as a going concern within one year after the date that these consolidated financial statements are issued.

We will seek additional capital through a combination of private and public equity offerings, debt financings and strategic collaborations. However, no assurance can be given that we will be successful in raising adequate funds needed. If we are unable to raise additional capital when required or on acceptable terms, we may have to significantly delay, scale back or discontinue the development or commercialization of one or more of our product candidates, restrict our operations or obtain funds by entering into agreements on unattractive terms, which would likely have a material adverse effect on our business, stock price and our relationships with third parties with whom we have business relationships, at least until additional funding is obtained.

We believe that our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs until October 2018. Further, our operating plan may change, and we may need additional funds to meet operational needs and capital requirements for product development sooner than planned. We currently have no credit facility or committed sources of capital. Because of the numerous risks and uncertainties associated with the development and commercialization of our product candidates and the extent to which we may enter into additional agreements with third parties to participate in their development and commercialization, we are unable to estimate the amounts of increased capital outlays and operating expenditures associated with our current and anticipated clinical trials. Our future capital requirements will depend on many factors, including:

We will need to raise additional capital to fund our operations in the near future. Funding may not be available to us on acceptable terms, or at all. If we are unable to obtain adequate financing when needed, we may have to delay, reduce the scope of or suspend one or more of our clinical trials, or research and development programs. We may seek to raise any necessary additional capital through a combination of public or private equity offerings, debt financings, collaborations, strategic alliances, licensing arrangements and other marketing and distribution arrangements. To the extent that we raise additional capital through marketing and distribution arrangements or other collaborations, strategic alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our product candidates, future revenue streams, research programs or product candidates or to grant licenses on terms that may not be favorable to us. If we do raise additional capital through public or private equity offerings, the ownership interest of our existing stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our stockholders’ rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends.

Cash Flows

The following table sets forth the primary sources and uses of cash and cash equivalents for each of the periods presented below.

Net cash used in operating activities

Net cash used in operating activities was $1.65 million and $2.15 million for the years ended December 31, 2017 and 2016, respectively. The reduction in costs used in operating activities is primarily related to the payment of vendor deposits in 2016 that were applied to obligations due for research and development activities in 2017. Additionally, the contract and licensing costs incurred under the Drexel agreement was substantially completed in 2016 and the contract was officially terminated in June 2017. However, the CoNCERT Pharmaceuticals, Inc. license and option agreement for the replacement compound CTP-499 was not executed until October 2017. As a result, research and development costs for program costs, testing and licensing declined in 2017 compared to 2016. This decline was partially offset by increased salaries and wages and payroll related costs from employee hiring in both the research and development and general and administrative functions, professional fees related to operating as a publically-traded company, office rental costs and one-time transaction costs related to the reverse acquisition of Heatwurx by Promet, which closed on October 4, 2017.

We anticipate our research and development efforts and on-going general and administrative costs will generate negative cash flows from operating activities for the foreseeable future. As the Company is still in the process of developing its products, we do not currently sell or distribute pharmaceutical products. We do not currently have sales or marketing capabilities.

Net cash provided by (used in) in investing activities

Net cash provided by investing activities was $1.00 million for the year ended December 31, 2017. This was due to proceeds from the maturity of the certificates of deposit purchased in 2016, partially offset by software acquisition costs. Net cash used in investing activities was $1.04 million for the year ended December 31, 2016. This was due primarily to the purchase of certificates of deposit and the purchase of property and equipment and software acquisition costs.

Net cash provided by financing activities

Net cash provided by financing activities was $2.43 million for the year ended December 31, 2017 from the proceeds of the issuance of $2.58 million of 8% Senior Convertible Notes, partially offset by approximately $155,000 of debt issuance costs. Net cash provided by financing activities was $4.27 million for the year ended December 31, 2016 from the proceeds of the initial issuance of the private placement of equity for Promet.

We expect that we will continue to seek additional capital through a combination of private and public equity offerings, debt financings and strategic collaborations to fund future operations. However, no assurance can be given that we will be successful in raising adequate funds needed. Absent additional financing, substantial doubt exists about the Company’s ability to continue as a going concern as noted under Going Concern above.

Off Balance Sheet Arrangements

At December 31, 2017 and December 30, 2016, we did not have any off-balance sheet arrangements.

Contractual Obligations and Commitments

The following summarizes our contractual obligations and commitments as of December 31, 2017:

On October 4, 2017 certain entities affiliated with current shareholders purchased $1.25 million of our Senior Notes in a bridge financing undertaken by us to support our operations. On November 21, 2017, additional third party accredited investors contributed $1.33 million in financing proceeds. As of December 31, 2017, $2.58 million of Senior Notes were issued and outstanding. Principal and interest under each Senior Note is due on the earlier of (i) the mandatory and automatic conversion of the Senior Note into the next Private Investment in Public Equity (“PIPE”) financing we undertake, provided the PIPE financing yields gross proceeds of at least $4 million at a conversion price per share equal to the lower of (a) $72 million pre-money valuation or (b) a 10% discount to the pre-money valuation (Qualified Financing) or (ii) the one-year anniversary of that Senior Note (Maturity Date). The Senior Notes bear interest at 8% per year and are payable in kind (in common stock). At the Maturity Date, the outstanding principal and accrued interest on the Senior Note will be automatically converted into shares of common stock of the Company equal to the lesser of (i) $72 million pre-money valuation or (ii) any adjusted price resulting from the application of down round pricing during the anti-dilution period through December 31, 2018. In such event, the anti-dilution period, as defined, will be extended for a further 12 months. Upon a change in control event or an event of default the holder can be repaid in cash as defined in the agreement. The Company can prepay the Senior Notes at any time with 7 days’ notice to the holder.

The operating lease obligations consist of an office space lease and equipment lease from third parties under non-cancelable operating leases. The office lease commenced on October 1, 2016 and expires September 30, 2019 with monthly rent at inception of $5,535 that escalates $1,107 annually on each October plus reimbursement of common operating costs. We recognize rent expense on a straight-line basis over the term of the Lease.

The equipment lease commenced in June 2017 and expires in August 2020. Monthly rent of $586 over the 39-month lease term includes a monthly operating usage cost allowance of $125. Additional charges for excess usage, as defined in the agreement, are charged quarterly. The lessor charges monthly sales tax of 6 percent.

We enter into contracts in the normal course of business with contract research organizations and subcontractors to further develop our products. The contracts are cancellable, with varying provisions regarding termination. If a contract with a specific vendor were to be terminated, we would only be obligated for products or services that we had received as of the effective date of the termination and any applicable cancellation fees.

Recently Issued Accounting Pronouncements

From May 2014 through December 2017, the FASB issued several ASUs related to ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)”. These ASUs are intended to provide greater insight into both revenue that has been recognized and revenue that is expected to be recognized in the future from existing contracts. The new guidance is effective for interim and annual periods beginning after December 15, 2017, although entities may adopt one year earlier if they choose. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented and the cumulative effect of applying the standard would be recognized at the earliest period shown, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. The Company is currently in the pre-revenue stages of operations; therefore, we do not currently anticipate there would be any change to timing or method of recognizing revenue. As such, we do not believe this new standard will have a material impact on our results of operations, financial condition or cash flows.

In February 2016 through December 2017, the FASB issued several ASUs related to ASU-2016-02, “Leases (Topic 842).” The guidance requires that a lessee recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right of use asset representing its right to use the underlying asset for the lease term. For finance leases: the right-of-use asset and a lease liability will be initially measured at the present value of the lease payments, in the statement of financial position; interest on the lease liability will be recognized separately from amortization of the right-of-use asset in the statement of comprehensive income; and repayments of the principal portion of the lease liability will be classified within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows. For operating leases: the right-of-use asset and a lease liability will be initially measured at the present value of the lease payments, in the statement of financial position; a single lease cost will be recognized, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis; and all cash payments will be classified within operating activities in the statement of cash flows. Under Topic 842 the accounting applied by a lessor is largely unchanged from that applied under previous GAAP. The amendments in Topic 842 are effective for the Company beginning January 1, 2019. Management is currently evaluating the impact of adopting the new guidance on the Company’s financial statements.

Segment Information

We operate in one segment. Management uses one measurement of profitability and does not segregate its business for internal reporting. During 2017 and 2016, substantially all of our long-lived assets were located within the United States.

We are exposed to market risk in the ordinary course of our business. Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily a result of fluctuations in interest rates. As of December 31, 2017, we did not hold or issue financial instruments for trading purposes.

Interest rate fluctuation risk

The primary objective of our investment activities is to preserve our capital to fund our operations. We also seek to maximize income from our cash and cash equivalents without assuming significant risk. To achieve our objectives, we invest our cash and cash equivalents in money market funds and short-term certificates of deposit directly or through managed funds, with maturities of six months or less. As of December 31, 2017, we had cash and cash equivalents of $2,847,429 consisting of cash of $1,546,614 and investments of $1,300,815 in highly liquid U.S. money market funds. A portion of our investments may be subject to interest rate risk and could fall in value if market interest rates increase. However, because our investments are primarily short-term in duration, we believe that our exposure to interest rate risk is not significant and a 100-basis point movement in market interest rates would not have a significant impact on the total value of our portfolio. We actively monitor changes in interest rates.

Inflation risk

Inflation may affect us by increasing our cost of labor and study related costs. We do not believe that inflation has had a material effect on our business, financial condition or results of operations for any period presented herein.

INDEX TO FINANCIAL STATEMENTS

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Processa Pharmaceuticals, Inc. (formerly Heatwurx, Inc.)

Opinion on the Financial Statements

We have audited the accompanying consolidated balance sheets of Processa Pharmaceuticals, Inc. (formerly Heatwurx, Inc.) (the “Company”) as of December 31, 2017 and 2016, the related consolidated statements of operations, stockholders’ equity, and cash flows, for the years then ended, and the related notes (collectively referred to as the “financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2017 and 2016, and the consolidated results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.

The Company’s Ability to Continue as a Going Concern

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Notes 1 and 2 to the financial statements, the Company has suffered recurring losses from operations and has stated that substantial doubt exists about the Company’s ability to continue as a going concern. Management’s evaluation of the events and conditions and management’s plans regarding these matters are described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Change in Reporting Entity

On October 4, 2017, as described in Note 3, the Company entered into a reverse acquisition with Promet Therapeutics, LLC which resulted in a change in the historical reporting entity from Heatwurx, Inc. to Promet Therapeutics, LLC. Subsequently, the Company changed its name to Processa Pharmaceuticals, Inc.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

Owings Mills, MD

April 16, 2018

We have served as the Company’s auditor since 2017.

Processa Pharmaceuticals, Inc.

Consolidated Balance Sheets

December 31, 2017 and 2016

The accompanying notes are an integral part of these consolidated financial statements.

Processa Pharmaceuticals, Inc.

Consolidated Statements of Operations

Years Ended December 31, 2017 and 2016

The accompanying notes are an integral part of these consolidated financial statements.

Processa Pharmaceuticals, Inc.

Consolidated Statements of Changes in Stockholders’ Equity (Deficit)

Years Ended December 31, 2017 and 2016

The accompanying notes are an integral part of these consolidated financial statements.

Processa Pharmaceuticals, Inc.

Consolidated Statements of Cash Flows

Years Ended December 31, 2017 and 2016

The accompanying notes are an integral part of these consolidated financial statements.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

NOTE 1 – NATURE OF BUSINESS

Company Overview

Promet Therapeutics, LLC (“Promet”), a Delaware limited liability company, was a private company founded on August 31, 2015 (inception). On October 2, 2017, Heatwurx, Inc. (“Heatwurx”), a nonoperating public shell corporation, entered into an Asset Purchase Agreement with Promet and Heatwurx’s wholly-owned subsidiary, Processa Therapeutics LLC (“Processa”), a Delaware limited liability company, and closed on this agreement effective October 4, 2017. Under this agreement, Heatwurx acquired all of the assets and assumed all the liabilities of Promet, in exchange for 222,217,112 shares of the common stock of Heatwurx, which, at the closing, constituted 90% of the Company’s issued and outstanding common stock on a fully diluted basis. Immediately following the closing, there were 246,907,902 shares of common stock issued and outstanding, of which the prior Heatwurx shareholders own 24,690,790 shares after giving effect to 13,673,402 shares issued for Heatwurx’s Series D Preferred stock and existing debt that converted into common stock prior to closing of the asset purchase transaction. At the closing, Heatwurx assigned to Processa all of the assets and operations of Promet that constitutes the operating business of Promet. Authorized capital stock consists of 350,000,000 shares of $0.0001 par value common stock and 10,000,000 shares of $0.0001 par value preferred stock.

The closing of the Asset Purchase Agreement on October 4, 2017 resulted in a change in control of Heatwurx by Promet (see Note 3). The Heatwurx executive management, officers and directors resigned and Promet executive management, officers and directors were appointed. Following the closing, Heatwurx changed its trading symbol from “HUWX” to “PCSA” on the OTC Pink exchange effective as of October 10, 2017. Heatwurx changed its name to Processa Pharmaceuticals, Inc. (the “Company”) and authorized a one-for-seven exchange, or reverse split, of its shares effective October 23, 2017. On December 8, 2017, the Company received approval from the Financial Industry Regulatory Authority to implement the one-for-seven reverse split in trading markets. As a result, the consolidated financial statements have been retrospectively adjusted to reflect shares outstanding after the one-for-seven reverse split. Following the asset purchase transaction, the Company abandoned Heatwurx’s prior business plan and is now only pursuing Promet’s proposed business with a focus on developing drugs to treat patients that have a high unmet medical need.

As a result of the above, these consolidated financial statements represent Promet as the accounting acquirer (legal acquiree) and Processa Pharmaceuticals, Inc. from October 4, 2017 forward as the accounting acquiree (legal acquirer) and the legal capital stock (number and type of equity interests issued) is that of Heatwurx, which subsequently changed its name to Processa Pharmaceuticals, Inc., the legal parent, in accordance with guidance on reverse acquisitions accounted for as a capital transaction instead of a business combination (See Note 2 – Basis of Presentation and Earnings Per Share and Note 3 – Reverse Acquisition).

All references to the “Company” and Processa Pharmaceuticals, Inc. refer to Heatwurx, Inc., Processa Therapeutics, LLC, and Promet Therapeutics, LLC, which was assigned at acquisition to Processa Therapeutics, LLC.

Description of Business

We are an emerging clinical stage biopharmaceutical company focused on the development of drug products that are intended to provide treatment for and improve the survival and/or quality of life of patients who have a high unmet medical need condition or who have no alternative treatment. Within this group of pharmaceutical products, we currently are developing one product for two indications (i.e., the use of a drug to treat a particular disease) and searching for additional products for our portfolio. Our operations are performed in the state of Maryland and are still in the organizational and research and development phase of operations. As a result, we have a limited operating history and only a preliminary business plan from which investors may evaluate our future prospects. We have not had any sources of revenue from inception through December 31, 2017 and have a history of operating losses from operations.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

As of December 31, 2017, the Company had an accumulated deficit of approximately $3.859 million incurred over approximately 28 months of its existence. Our current capital is insufficient to fully fund our total business plan and the development of our planned product candidates. Our ability to achieve revenue-generating operations and, ultimately, achieve profitability will depend on whether we can obtain additional capital when we need it, complete the development of our technology, receive regulatory approval of our planned product candidates and find strategic collaborators that can incorporate our planned product candidates into new or existing drugs which can be successfully commercialized. There can be no assurance that we will ever generate revenues or achieve profitability.

Recent Developments

On or about October 4, 2017, the Company received $1.25 million from the first tranche of Senior Convertible Notes that are expected to convert into securities of the Company that are placed in the next placement round at a price that will not be greater than 90% of the offering price in that placement (See Note 6). This first tranche was from current Heatwurx and Promet shareholders. On November 21, 2017, an additional tranche of $1,330,000 of Senior Convertible Notes was issued to third party accredited investors. We are in the process of raising additional funds by potentially selling additional Senior Convertible Notes, convertible loans or other securities. No assurance however can be given that the Company will be successful in doing so.

On October 4, 2017, the Company and CoNCERT Pharmaceuticals Inc. (“CoNCERT”) entered into an exclusive option and license agreement for the CTP-499 compound. However, under the terms of this agreement, if the Company fails to meet the conditions set forth in the agreement, which include a requirement for us to have not less than $8 million in funding for the support of the drug as defined within the agreement, or if the Company elects not to exercise the option, then the product reverts back to ownership by CoNCERT. Since CPT-499 is currently our drug product lead candidate, should we lose our rights to CTP-499, our planned growth and business plan would be materially and adversely affected. On March 19, 2018, we modified the Option and License Agreement with CoNCERT effective January 2018 (see Notes 10 and 14), which enabled us to exercise our option to license the CoNCERT patent rights and know-how to develop and commercialize compounds (CTP-499 and each metabolite thereof) and products, as defined in the agreement.

Status as an Emerging Growth Company

We are an “emerging growth company” as that term is defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (i.e., those that have not had a registration statement declared effective under the Securities Act of 1933, as amended (the “Securities Act”), or do not have a class of securities registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are required to comply with such new or revised financial accounting standards.

The JOBS Act also provides that an emerging growth company can elect to opt out of the extended transition period provided by Section 102(b)(1) of the JOBS Act and comply with the requirements that apply to nonemerging growth companies, but any such election to opt out is irrevocable. We may still take advantage of all of the other provisions of the JOBS Act, which include, but are not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, the reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and the exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

NOTE 2 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Earnings per Share

The accompanying consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”), and reflect all of our activities, including those of our wholly-owned subsidiary. All material intercompany accounts and transactions have been eliminated in consolidation. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. These adjustments consist of normal and recurring accruals, as well as non-recurring charges.

The acquisition of Promet by Heatwurx has been accounted for as a reverse acquisition in accordance with U.S. GAAP, Financial Accounting Standards Board (“FASB”), Accounting Standards Codification (“ASC”) 805-40-45,Business Combinations - Reverse Acquisitions. Under this method of accounting, Heatwurx, a nonoperating public shell corporation with nominal net liabilities, acquired all the assets of Promet, a private operating entity, through issuance of 90 percent of the issued and outstanding common stock of Heatwurx immediately after the asset acquisition. As a result of the change in control, Promet comprises the ongoing operations and assets of the combined entity and Promet senior management comprises the senior management of the Company and Promet is considered the accounting acquirer. Heatwurx has been treated as the “acquired” company for financial reporting purposes. The transaction is considered to be a capital transaction in substance. Accordingly, for accounting purposes, it is assumed that Promet issued shares to Heatwurx at fair value for Heatwurx’s net liabilities to be assumed by Promet at closing of the reverse acquisition. The fair value of the net liabilities assumed from Heatwurx, net of the par value of the assumed shares issued to Heatwurx is recognized as a reduction of additional paid-in capital.

As a result of the above, the operations prior to the asset purchase transaction are those of Promet. The assets and liabilities of Promet are recognized and measured at the historical carrying amounts. The accumulated deficit and other equity balances of Promet have been carried forward and adjusted to reflect the legal shares and par value of Heatwurx with the difference allocated to additional paid-in capital. Additional paid-in capital is also reduced by the fair value over the historical cost of the net liabilities assumed from Heatwurx, since the transaction is accounted for as a capital transaction, not a business combination.

Earnings per share (“EPS”) is calculated using the equity structure of Processa Pharmaceuticals, Inc., including the equity interests issued to Promet in the asset acquisition transaction (see Note 3). Prior to the reverse acquisition, EPS is based on Promet’s net income and weighted average common shares outstanding that were received in the asset purchase transaction. Subsequent to the reverse acquisition, EPS is based on the actual number of common shares of Processa Pharmaceuticals, Inc. outstanding during that period.

The Company completed a reverse split or a one-for-seven exchange of its shares. As a result, the consolidated financial statements have been retrospectively adjusted to reflect the one-for-seven reverse split.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

Segments

The Company operates in one segment. Management uses one measurement of profitability and does not segregate its business for internal reporting. During 2017 and 2016 all of the Company’s long-lived assets were located within the United States.

Going Concern and Management’s Plan

The Company’s consolidated financial statements are prepared using U.S. GAAP and are based on the assumption that the Company will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The Company faces certain risks and uncertainties that are present in many emerging growth companies regarding product development and commercialization, limited working capital, recurring losses and negative cash flow from operations, future profitability, ability to obtain future capital, protection of patents, technologies and property rights, competition, rapid technological change, navigating the domestic and major foreign markets’ regulatory and clinical environment, recruiting and retaining key personnel, dependence on third party manufacturing organizations, third party collaboration and licensing agreements, lack of sales and marketing activities and no customers or pharmaceutical products to sell or distribute. These risks and other factors raise substantial doubt about our ability to continue as a going concern.

The Company has relied exclusively on private placements with a small group of accredited investors to finance its business and operations. We do not have any prospective arrangements or credit facilities as a source of future funds. The Company has had no revenue since inception on August 31, 2015. The Company does not currently have any revenue under contract nor does it have any immediate sales prospects. As of December 31, 2017, the Company had an accumulated deficit of approximately $3.859 million incurred since inception. For the year ended December 31, 2017, the Company incurred a net loss from continuing operations of approximately $1.856 million and used approximately $1.655 million in net cash from operating activities from continuing operations. The Company had total cash and cash equivalents of approximately $2.847 million as of December 31, 2017. We have raised proceeds of $2.58 million from the Senior Convertible Notes issued through December 31, 2017.

No additional Senior Convertible Notes have been issued through the date this report was issued. On March 19, 2018, we modified the Option and License Agreement with CoNCERT Pharmaceuticals, Inc. effective January 2018 (see Notes 10 and 14), which enabled us to exercise our option to license the CoNCERT patent rights and know-how to develop and commercialize compounds (CTP-499 and each metabolite thereof) and products, as defined in the agreement. Although we have other drugs being positioned into our pipeline, the loss of our rights to CTP-499 would have materially and adversely affected our planned growth and business plan. We expect our operating costs to be substantial as we incur costs related to the clinical trials for our product candidates and that we will operate at a loss for the foreseeable future.

We are in the process of raising additional funds by potentially selling additional Senior Convertible Notes, convertible loans or other securities. However, no assurance can be given that we will be successful in raising adequate funds needed. If we are unable to raise additional capital when required or on acceptable terms, we may have to significantly delay, scale back or discontinue the development or commercialization of one or more of our product candidates, restrict our operations or obtain funds by entering into agreements on unattractive terms, which would likely have a material adverse effect on our business, stock price and our relationships with third parties with whom we have business relationships, at least until additional funding is obtained.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

Uncertainty concerning our ability to continue as a going concern may hinder our ability to obtain future financing, as well as adversely affect our collaborative drug development relationships. Continued operations and our ability to continue as a going concern are dependent on our ability to obtain additional funding in the near future and thereafter, and no assurances can be given that such funding will be available at all or will be available in sufficient amounts or on reasonable terms. Without additional funds from debt or equity financing, sales of assets, sales or out-licenses of intellectual property or technologies, or other transactions yielding funds, we will rapidly exhaust our resources and will be unable to continue operations. Absent additional funding, we believe that our cash and cash equivalents will not be sufficient to fund our operations for a period of one year or more after the date that these consolidated financial statements are available to be issued based on the timing and amount of our projected net loss from continuing operations and cash to be used in operating activities during that period of time.

As a result, substantial doubt exists about the Company’s ability to continue as a going concern within one year after the date that these consolidated financial statements are available to be issued. The accompanying consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of recorded assets, or the amounts and classification of liabilities that might be different should the Company be unable to continue as a going concern based on the outcome of these uncertainties described above.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires the use of estimates and assumptions by management that affect reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions are continuously evaluated and are based on management’s experience and knowledge of the relevant facts and circumstances. While management believes the estimates to be reasonable, actual results could differ materially from those estimates and could impact future results of operations and cash flows.

Cash and Cash Equivalents

Cash and cash equivalents includes cash on hand and money market funds. The Company considers all highly liquid investments with a maturity at the date of purchase of three months or less to be cash equivalents. Money market funds were $1,300,815 and $0 at December 31, 2017 and 2016, respectively.

Certificates of Deposit

The certificates of deposit were purchased through an investment company and were held at multiple banks. The maturities of the certificates of deposit are typically six months or less.

Fair Value Measurements and Disclosure

The Company applies ASC 820, “Fair Value Measurements and Disclosures,” which expands disclosures for assets and liabilities that are measured and reported at fair value on a recurring basis. Fair value is defined as an exit price, representing the amount that would be received upon the sale of an asset or payment to transfer a liability in an orderly transaction between market participants. Fair value is a market-based measurement that is determined based on assumptions that market participants would use in pricing an asset or liability. A three-tier fair value hierarchy is used to prioritize the inputs in measuring fair value as follows:

Level 1 – Quoted market prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

Level 2 – Quoted market prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable, either directly or indirectly. Fair value determined through the use of models or other valuation methodologies.

Level 3 – Significant unobservable inputs for assets or liabilities that cannot be corroborated by market data. Fair value is determined by the reporting entity’s own assumptions utilizing the best information available, and includes situations where there is little market activity for the asset or liability.

The asset’s or liability’s fair value measurement within the fair value hierarchy is based upon the lowest level of any input that is significant to the fair value measurement.

Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and the senior convertible notes approximate fair value because of the short-term maturity of these instruments, including the mandatory conversion of the senior convertible notes into the common stock of the Company upon the earlier of (i) meeting certain funding levels on the next Private Investment in Public Equity (“PIPE”) financing we undertake or (ii) the one-year anniversary of the issuance of the senior convertible note.

Due From/To Related Parties and Administrative Fees

Administrative fees are collected from a related party, Corlyst, LLC (“Corlyst”), for shared costs related to payroll, health care insurance and rent based on actual costs incurred and recognized as a reduction of the operating expense being reimbursed (see Note 4). Corlyst pays certain operating expenses on behalf of the Company and the Company reimburses Corlyst based on actual costs incurred and recognizes the appropriate expense. The amounts due from and due to Corlyst are billed monthly and are due on demand at the beginning of each month.

Property and Depreciation

Property is stated at cost, less accumulated depreciation. Depreciation is computed under the straight-line method over the estimated useful lives of the assets. Expenditures for maintenance and routine repairs are charged to expense as incurred; expenditures for improvements and major repairs that materially extend the useful lives of assets are capitalized. Depreciation expense for the years ended December 31, 2017 and 2016 was $1,865 and $1,381, respectively.

Following are the estimated useful lives for the various classifications of assets:

Impairment of Long-lived Assets

The Company periodically reviews its long-lived assets to determine potential impairment by comparing the carrying value of the long-lived assets with the estimated future net undiscounted cash flows expected to result from the use of the assets, including cash flows from disposition, at least annually or more frequently if events or changes in circumstances indicate a potential impairment may exist. Should the sum of the expected future net cash flows be less than the carrying value, the Company would recognize an impairment loss at that date. An impairment loss would be measured by comparing the amount by which the carrying value exceeds the fair value (estimated discounted future cash flows) of the long-lived assets. The Company performs its impairment analysis in October of each year. Based on management’s evaluation, $15,330 of carrying costs related to the software was impaired and an impairment loss recorded for the year ended December 31, 2017. No impairment of long-lived assets was recognized for the year ended December 31, 2016.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

Debt Issuance Costs

The Company recognizes debt issuance costs incurred on the Senior Convertible Notes as a reduction of the carrying amount of the Senior Convertible Notes on the face of the consolidated balance sheet. The debt issuance costs are amortized to interest expense using the interest method over the term of the Senior Convertible Notes. The amortization of the debt issuance costs was $23,370 for the year ended December 31, 2017 and zero for the year ended December 31, 2016.

Compensated Absences

For the years ended December 31, 2017 and 2016, the Company recorded a liability for paid time off earned by permanent employees but not taken, in accordance with human resource policies.

Advertising Costs

Advertising costs are recognized as expense in the year incurred. Total advertising and marketing expense for the years ended December 31, 2017 and 2016 was $135 and $3,850, respectively.

Research and development

Research and development costs are expensed as incurred and consist of direct and overhead-related expenses. Research and development costs totaled $926,117 and $1,536,996 for the years ended December 31, 2017 and 2016, respectively. Expenditures to acquire technologies, including licenses, which are utilized in research and development and that have no alternative future use are expensed when incurred. Technology the Company develops for use in its products is expensed as incurred until technological feasibility has been established after which it is capitalized and depreciated. No costs have been capitalized during the years ended December 31, 2017 and 2016.

Stock-Based Compensation

The Company accounts for the cost of employee services received in exchange for the award of equity instruments based on the fair value of the award, determined on the date of grant. Significant assumptions utilized in determining the fair value of our stock options include the volatility rate, estimated term of the options, risk-free interest rate and forfeiture rate. The term of the options will be based on the contractual term of the options as determined by the Board of Directors when the 2011 Equity Incentive Plan is amended or terminated and approved by the stockholders to the extent required by applicable laws and regulations. The expense is to be recognized over the period during which an employee is required to provide services in exchange for the award. The Company estimates forfeitures at the time of grant and makes revisions, if necessary, at each reporting period if actual forfeitures differ from those estimates. The Company has not estimated future unvested forfeitures since there were no option grants outstanding at December 31, 2017. Upon the issuance of 90% of Heatwurx’s common stock to Promet on October 4, 2017, there was a Change in Control event, as defined in the Amended and Restated Heatwurx, Inc. 2011 Equity Incentive Plan. As of September 30, 2017, prior to the Change in Control event, all 269,500 unexercised options and all 40,000-unexercised performance options outstanding at December 31, 2016 were cancelled.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

Non-employee share-based compensation charges generally are immediately vested and have no future performance requirements by the non-employee and the total share-based compensation charge is recorded in the period of the measurement date.

Income Taxes

As a result of the asset purchase transaction (see Note 1 Company Overview above and Note 3), there was a change in control of the Company. Prior to the closing of the asset purchase transaction, Promet was treated as a partnership for federal income tax purposes and thus was not subject to income tax at the entity level. Therefore, no provision or liability for income taxes has been included in these financial statements through the date of the asset purchase on October, 4, 2017. In addition, Promet determined that it was not required to record a liability related to uncertain tax positions as a result of the requirements of ASC 740-10-25 Income Taxes.

The net deferred tax assets of Heatwurx were principally federal and state net operating loss carry forwards. The Heatwurx net deferred tax assets were fully reserved with a valuation allowance.

Subsequent to the closing of the asset purchase, Processa Pharmaceuticals, Inc. will file a consolidated federal income tax return in the United States, which includes eligible subsidiaries. In addition, we file income tax returns in state and local jurisdictions as applicable. The Company accounts for income taxes under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.

The provision for income taxes includes federal and state income taxes currently payable and deferred taxes resulting from temporary differences between the financial statement and tax basis of assets and liabilities at the enacted tax rates. Changes in deferred income tax assets and liabilities are included as a component of income tax expense. The effect on deferred income tax assets and liabilities attributable to changes in enacted tax rates are charged or credited to income tax expense in the period of enactment. Valuation allowances are recorded to reduce deferred tax assets when it is more-likely-than-not that a tax benefit will not be realized. A full valuation allowance was recorded against the Company’s deferred tax assets at December 31, 2017. The Company had no deferred tax assets and no valuation allowance at December 31, 2016.

With respect to uncertain tax positions, the Company would recognize the tax benefit from an uncertain tax position only if it is more-likely-than-not that the tax position will be sustained upon examination by the taxing authorities, based on the technical merits of the position. Estimated interest and penalties related to uncertain tax positions are included as a component of interest expense and general and administrative expense, respectively. The Company had no unrecognized tax benefits or uncertain tax positions at December 31, 2017 or 2016.

Net Income (Loss) per Share

The Company computes basic and diluted earnings per share amounts pursuant to ASC 260-10-45. Basic earnings per share is computed by dividing net income (loss) available to common shareholders, by the weighted average number of shares of common stock outstanding during the period, as retrospectively restated for the one-for-seven reverse stock split, excluding the effects of any potentially dilutive securities. Diluted earnings per share is computed by dividing net income (loss) available to common shareholders by the diluted weighted average number of shares of common stock during the period. The diluted weighted average number of common shares outstanding is the basic weighted number of shares adjusted for any potentially diluted debt or equity. The computation does not assume conversion, exercise or contingent exercise of securities since that would have an anti-dilutive effect on earnings (loss) during the years ended December 31, 2017 and 2016.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

Equity

The asset purchase of Promet by Heatwurx is accounted for as a reverse acquisition. As a result, these consolidated financial statements represent Promet as the accounting acquirer (legal acquiree) and Heatwurx from October 4, 2017 forward as the accounting acquiree (legal acquirer). However, the legal capital stock (number and type of equity interests issued) is that of Heatwurx, which subsequently changed its name to Processa Pharmaceuticals, Inc., the legal parent, in accordance with guidance on reverse acquisitions accounted for as a capital transaction (See Note 2 – Basis of Presentation and Earnings per Share and Note 3 – Reverse Acquisition).

The accumulated deficit and other equity balances of Promet have been carried forward and adjusted to reflect the legal capital shares and par value of Heatwurx, including the shares issued to Promet in the reverse acquisition transaction with the difference allocated to additional paid-in capital. Additional paid-in capital is also reduced by the fair value/ historical cost of the net liabilities assumed from Heatwurx since the transaction is accounted for as a capital transaction, not a business combination.

Subsequent events

The Company has evaluated subsequent events and transactions for potential recognition or disclosure through April 16, 2018, the date the financial statements were issued, in accordance with ASC 855-10-50. Refer to Note 14 below for further information.

Recent Accounting Pronouncements

From time to time, the Financial Accounting Standards Board (“FASB”) or other standard setting bodies issue new accounting pronouncements. Updates to the FASB Accounting Standards Codification are communicated through issuance of an Accounting Standards Update (“ASU”). The Company has implemented all new accounting pronouncements that are in effect and that may impact its financial statements. It has evaluated recently issued accounting pronouncements and determined that there was no material impact on its financial position or results of operations.

From May 2014 through December 2017, the FASB issued several ASUs related to ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)”. These ASUs are intended to provide greater insight into both revenue that has been recognized and revenue that is expected to be recognized in the future from existing contracts. The new guidance is effective for interim and annual periods beginning after December 15, 2017, although entities may adopt one year earlier if they choose. The two permitted transition methods under the new standard are the full retrospective method, in which case the standard would be applied to each prior reporting period presented and the cumulative effect of applying the standard would be recognized at the earliest period shown, or the modified retrospective method, in which case the cumulative effect of applying the standard would be recognized at the date of initial application. The Company is currently in the pre-revenue stages of operations; therefore, we do not currently anticipate there would be any change to timing or method of recognizing revenue. As such, we do not believe this new standard will have a material impact on our results of operations, financial condition or cash flows.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

In February 2016 through December 2017, the FASB issued several ASUs related to ASU-2016-02, “Leases (Topic 842).” The guidance requires that a lessee recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right of use asset representing its right to use the underlying asset for the lease term. For finance leases: the right-of-use asset and a lease liability will be initially measured at the present value of the lease payments, in the statement of financial position; interest on the lease liability will be recognized separately from amortization of the right-of-use asset in the statement of comprehensive income; and repayments of the principal portion of the lease liability will be classified within financing activities and payments of interest on the lease liability and variable lease payments within operating activities in the statement of cash flows. For operating leases: the right-of-use asset and a lease liability will be initially measured at the present value of the lease payments, in the statement of financial position; a single lease cost will be recognized, calculated so that the cost of the lease is allocated over the lease term on a generally straight-line basis; and all cash payments will be classified within operating activities in the statement of cash flows. Under Topic 842 the accounting applied by a lessor is largely unchanged from that applied under previous GAAP. The amendments in Topic 842 are effective for the Company beginning January 1, 2019. Management is currently evaluating the impact of adopting the new guidance on the Company’s financial statements.

NOTE 3 – REVERSE ACQUISITION

On October 4, 2017, Heatwurx acquired Promet’s net assets of $1,017,342 at historical cost in exchange for approximately 90 percent or 222,217,112 shares of common stock issued by the Company (or 31,745,242 shares post reverse split). Immediately following the transaction, total shares issued and outstanding were 246,907,902 (or 35,272,626 shares post reverse split), representing the total legal capital of the Company. The transaction has been accounted for as a reverse acquisition in accordance with ASC 805-40-45,Business Combinations - Reverse Acquisitions. As a result, Heatwurx is considered the acquired company. The consolidated financial statements are under the name of Processa Pharmaceuticals, Inc., the legal parent (accounting acquiree) but represent Promet, the legal subsidiary (accounting acquirer) with an adjustment, to retrospectively adjust Promet’s legal capital to reflect the legal capital (number and type of shares) of Processa Pharmaceuticals, Inc. and Heatwurx from October 4, 2017 forward as the accounting acquiree (legal acquirer).

Promet’s assets and liabilities are recognized and measured at their precombination carrying amounts. Heatwurx, which subsequently changed its name to Processa Pharmaceuticals, Inc., recognized and measured its assets and liabilities at October 4, 2017 in accordance with guidance applicable to business combinations. The net liabilities were all short term in nature and were recognized at their precombination carrying amounts. The accumulated deficit reflects Promet balances before the reverse acquisition. See Note 2 – Basis of Presentation and Earnings per Share and Note 2 – Equity for the recognition and measurement of common stock and additional paid-in capital.

Promet incurred acquisition-related transaction costs of $58,763, which are included in general and administrative expense, a component of operating expenses in the consolidated statements of operations. The operating results for Heatwurx are included in the accompanying consolidated financial statements from October 4, 2017 forward.

Heatwurx’s assets acquired and liabilities assumed (see below) and the par value of the common stock allocated to Heatwurx stockholders is recognized as a reduction of additional paid-in capital at the acquisition date.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

NOTE 4 – RELATED PARTY TRANSACTIONS

A shareholder, Corlyst, LLC, pays the Company for administrative services performed by the Company. These administrative fees are included as a reduction of the related general and administrative expenses in the Company’s statement of operations. These fees were charged beginning in October 2016 and totaled $111,799 and $32,327 for the years ended December 31, 2017 and 2016, respectively. The receivable balances due from Corlyst at December 31, 2017 and 2016 were $62,709 and $0, respectively.

During 2016 and 2017, Corlyst paid certain operating expenses on behalf of the Company and the Company reimbursed Corlyst based on actual costs incurred at later dates. The accounts payable amounts due to Corlyst at December 31, 2017 and 2016 were $336 and $95, respectively. In addition, there was $100 due to an officer included in due to related parties as of December 31, 2017.

A director of the Company is the manager of the JMW Fund, LLC, the San Gabriel Fund, LLC, and the Richland Fund, LLC, collectively known as the “Funds”. These Funds own 14,180,543 shares of common stock in the aggregate at December 31, 2017 or 2,025,792 shares of common stock restated for the reverse stock split. In addition, the Funds own $1 million in Senior Convertible Notes at December 31, 2017.

Entities affiliated with the Chairman of the Board of Directors, Chief Executive Officer and Interim Chief Financial Officer of the Company own $250,000 in Senior Convertible Notes at December 31, 2017.

Heatwurx had secured notes payable with the Funds in the aggregate amount of $1,289,361; on September 29, 2017, prior to the asset purchase closing, Heatwurx converted the principal and accrued interest of $412,716 into 8,510,386 shares of common stock or 1,215,813 shares of common stock restated for the reverse stock split. The Funds also had an aggregate principal balance of $138,000 and accrued interest of $50,887 on the Heatwurx revolving line of credit converted into 944,436 shares of common stock on September 29, 2017 or 134,924 shares of common stock restated for the reverse stock split. 

NOTE 5– NOTES PAYABLE

On September 29, 2017, prior to the Asset Purchase closing, principal of all existing Heatwurx notes payable in the amount of $1,939,341 and related accrued interest in the amount of $613,114 were converted to 12,953,902 shares of common stock or 1,850,625 shares of common stock restated for the reverse stock split. As of December 31, 2017, there were no Heatwurx notes payable outstanding.

NOTE 6 – SENIOR CONVERTIBLE NOTES

As of October 4, 2017, certain entities affiliated with current shareholders (see Note 4) had purchased $1.25 million of our senior secured convertible notes (“Senior Notes”) in a bridge financing undertaken by us to support the Processa operations. On November 21, 2017, additional third party accredited investors contributed $1.33 million in financing proceeds. As of December 31, 2017, $2.58 million of Senior Notes were issued and outstanding.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

Principal and interest under each Senior Note is due on the earlier of (i) the mandatory and automatic conversion of the Senior Note into the next Private Investment in Public Equity (“PIPE”) financing we undertake, provided the PIPE financing yields gross proceeds of at least $4 million at a conversion price per share equal to the lower of (a) $72 million pre-money valuation or (b) a 10% discount to the pre-money valuation (Qualified Financing) or (ii) the one-year anniversary of that Senior Note (Maturity Date). The Senior Notes bear interest at 8% per year, and are payable in kind (in common stock). At the Maturity Date, the outstanding principal and accrued interest on the Senior Note will be automatically converted into shares of common stock of the Company equal to the lesser of (i) $72 million pre-money valuation or (ii) any adjusted price resulting from the application of down round pricing during the anti-dilution period through December 31, 2018. In such event, the anti-dilution period, as defined, will be extended for a further 12 months. There can be no assurance that we will be successful in achieving the financing levels targeted under the Senior Convertible Notes or the PIPE financing.

Holders of Senior Notes (a) may elect to receive 110% of principal plus accrued interest in the event there is a change of control prior to conversion of the Senior Notes, (b) are entitled to full ratchet anti-dilution protection in event of any sale of securities at a net consideration per share that is less than the applicable conversion price per share to the holder, (c) are entitled to certain registration rights for the securities underlying the Senior Notes and (d) have been granted certain preemptive rights pro rata to their respective interests through December 31, 2018. The Senior Notes can be prepaid by the Company at any time following the date of issuance with seven days prior written notice to the note holder.

The Senior Notes are secured by a security interest in the assets of the Company and contain negative covenants that do not permit the Company to incur additional indebtedness or liens on property or assets owned, repurchase common stock, pay dividends, or enter into any transaction with affiliates of the Company that would require disclosure in a public filing with the Securities and Exchange Commission. Upon an event of default, the outstanding principal amount of the Senior Notes, plus accrued but unpaid interest and other amounts owing in respect thereof through the date of acceleration, shall become immediately due and payable in cash at the holder’s election, if not cured within the cure period.

The Company retained Boustead Securities Ltd. (“Boustead”), a registered broker-dealer, as its exclusive financial adviser and has agreed to pay Boustead (i) six percent (6%) of gross proceeds received by the Company and (ii) warrants to purchase securities in the amount of three percent (3%) of the equity issued or issuable in connection with the Senior Notes bridge financing. These warrants will be issued upon achieving certain financing levels under the next PIPE financing we undertake. No warrants are issuable, and none have been issued as of December 31, 2017. To the extent that the Company raises more than $8 million (the “Excess Investment”) then as to that portion of the Excess Investment that is attributable to funds provided by existing holders of Company equity or by shareholders of the Company, including their respective affiliated holders (the “Affiliated Excess Investment”), the Company shall pay Boustead a cash fee equal to two percent (2%) of the Excess Investment and six percent (6%) of the balance of the Excess Investment, if any. Boustead may allow a portion of its fees payable hereunder to be shared with another registered broker-dealer assisting in the private capital raise.

Senior Notes and the underlying common stock that the Senior Notes will convert into have not been registered under the United States Securities Act of 1933, as amended (the “Act”). The Senior Notes and the underlying common stock that the Senior Notes will convert into shall be issued solely to investors who are “accredited investors” within the meaning of Rule 501(a) of Regulation D promulgated under the Act. There is no public market for the Senior Notes and there is no public market for the securities of the Company (or shares of common stock of the Company issued to Promet at the closing of the Asset Purchase Agreement discussed in Note 1) upon conversion of the Senior Notes.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

Debt and accrued interest at December 31, 2017 and interest expense for the year ended December 31, 2017 are as follows:

The Company incurred $154,800 in debt issuance costs on the Senior Notes with Boustead, which were offset against the debt balance. All debt issuance costs are being amortized over the term of the Senior Notes using the effective interest method. The face interest rate of the Senior Notes is 8 percent. The effective interest rate on the Senior Notes was 7.72 percent before debt issuance costs since no payments of interest are due until maturity and 13.96 percent including the debt issuance costs based on the repayment terms of the Senior Notes.

Future maturities of debt and accrued interest, contractual interest expense to be incurred and amortization of debt issuance costs as of December 31, 2017 are $2,580,000, $206,400, $170,707 and $131,430, respectively, for the year ended December 31, 2018.

NOTE 7 – INCOME TAXES

The Company files income tax returns in the U.S. federal jurisdiction and in the state of Maryland. There are currently no income tax examinations underway for these jurisdictions.

The Company provides deferred income taxes for differences between the tax reporting bases and the financial reporting bases of assets and liabilities at the enacted tax rates. The Company determined that it was not required to record a liability related to uncertain tax positions as a result of implementing the requirements of ASC 740-10-25 Income Taxes. Should the Company incur interest and penalties relating to tax uncertainties, such amounts would be classified as a component of interest expense and general and administrative expense, respectively. The liability related to uncertain tax positions is not expected to increase or decrease within the next twelve months.

As of December 31, 2017, the Company’s tax year for 2016, 2015 and 2014 are subject to examination by the Internal Revenue Service and the state taxing authorities of Maryland, Colorado, Utah, North Dakota and California.

As discussed in Note 2 – Income Taxes, the historical information presented in the financial statements is that of Promet. Prior to the closing of the asset purchase transaction on October 4, 2017, Promet was treated as a partnership for federal income tax purposes and thus the partners were taxed separately on their proportionate share of Promet’s income, deductions, losses and credits. Therefore, no provision or liability for income taxes has been included in these financial statements through the date of the asset purchase on October 4, 2017.

In addition, as a result of the asset purchase transaction, Promet was issued 90 percent of the total issued and outstanding common stock of Heatwurx, including the shares issued to Promet. The transaction resulted in an ownership change as defined by Internal Revenue Code Section 382. The net deferred tax assets of Heatwurx, prior to the asset purchase transaction, were principally federal and state net operating loss carry forwards. The Heatwurx net deferred tax assets were fully reserved with a valuation allowance.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

The Company has no current federal or state tax provision recognized in the consolidated financial statements. Since the asset purchase transaction, the Company has incurred operating losses of approximately $606,400. The total deferred tax asset as of December 31, 2017 includes approximately $347,500 ($95,632 net of tax) of general and administrative expenses treated as deferred start-up expenditures for tax purposes and approximately $258,600 ($71,155 net of tax) of tax losses resulting in tax loss carryforwards. The Company has had no revenues and recognized cumulative loses since inception. Due to the uncertainty regarding future profitability and recognition of taxable income to utilize the amortization of deferred start-up expenditures and the tax loss carryforwards, a full valuation allowance against any potential deferred tax assets has been recognized for the year ended December 31, 2017 as discussed below.

As of December 31, 2017, the Company is evaluating its qualified research expenditures for application to federal and state research and development tax credits to offset potential future tax liabilities. The federal research and development tax credits have a 20-year carryforward period. The Maryland research and development tax credits have a 7-year carryforward period. There is no recognition of a deferred tax asset for research and development tax credits as of December 31, 2017.

The Company is subject to U.S. Federal and state income taxes. The provision (benefit) for income taxes for the tax years ended December 31, 2017 and 2016 are as follows:

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (“TCJA”) was signed into law. Among its provisions, the TCJA reduces the statutory U.S. Corporate income tax rate from 34% to 21% effective January 1, 2018. The TCJA includes provisions that, in certain instances, impose U.S. income tax liabilities on future earnings of foreign subsidiaries and limit the deductibility of future interest expenses. The TCJA also provides for accelerated deductions of certain capital expenditures made after September 27, 2017 through bonus depreciation and an indefinite tax loss carryforward period for losses incurred after December 31, 2017. However, these tax loss carry forwards can only offset 80 percent of future taxable income. Losses incurred prior to January 1, 2018 continue to carry forward for twenty years. The application of the TCJA may change due to regulations subsequently issued by the U.S. Treasury Department.

Upon the enactment of the TCJA, we recorded a reduction in our deferred income tax assets of approximately $72,300 for the effect of the aforementioned change in the U.S. statutory income tax rate with an offsetting decrease in the valuation allowance established against the deferred tax assets. As a result, there was no change or recognition of an income tax provision or benefit in the consolidated statement of operations for the year ended December 31, 2017.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

In December 2017, the Securities and Exchange Commission issued Staff Accounting Bulletin 118 (“SAB 118”) to provide clarification in implementing the TCJA when registrants do not have the necessary information available to complete the accounting for an element of the TCJA in the period of its enactment. SAB 118 provides for tax amounts to be classified as provisional and subject to remeasurement for up to one year from the enactment date for such elements when the accounting effect is not complete, but can be reasonably estimated. We consider our estimates of the tax effects of the TCJA on the components of our tax provision to be reasonable and no provisional estimates subject to remeasurement will be necessary to complete the accounting.

Deferred Income Taxes - The Company does not recognize the deferred income tax asset at this time because the realization of the asset is not more-likely-than-not. As of December 31, 2017, the Company had deferred start-up expenditures and net operating losses for both federal and state income tax purposes of approximately $166,787 as described above. As of December 31, 2016, the Company had no net operating losses for federal and state income tax purposes since Promet’s partners were taxed separately on their proportionate share of Promet’s income, deductions, losses and credits.

The net operating losses are available for application against future taxable income for 20 years, expiring in 2037. The benefit associated with the amortization of the deferred start-up expenditures and the net operating loss carry forward will more-likely-than-not go unrealized unless future operations are successful. Since the success of future operations is indeterminable, the potential benefits resulting from these deferred tax assets have not been recorded in the financial statements.

The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, the projected future taxable income and tax planning strategies in making this assessment. Based on management’s analysis, a full reserve has been established against this asset. The change in the valuation allowance in 2017 and 2016 was $166,787 and $0, respectively.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

A reconciliation of the Company’s effective income tax rate and statutory income tax rate at December 31, 2017 and 2016 is as follows:

NOTE 8 –STOCKHOLDERS’ EQUITY

On December 8, 2017, we completed a one-for-seven reverse split in trading markets. As a result, the consolidated financial statements have been retrospectively adjusted to reflect shares outstanding after the one-for-seven reverse split.

Common Stock– As of December 31, 2017 and 2016, the Company had authorized 350,000,000 and 43,261,049 shares of common stock with a $0.0001 par value. At December 31, 2017 and 2016 there were 35,272,626 and 31,745,242 common shares issued and outstanding, respectively. Common shares attributable to Promet’s controlling interest were 31,745,242 at December 31, 2017 and 2016. Common shares attributable to the minority shareholders’ interest were 3,527,384 and zero at December 31, 2017 and 2016, respectively.

Preferred Stock - As of December 31, 2017, the Company has authorized 10,000,000 shares of Preferred Stock with a $0.0001 par value. No shares were issued and outstanding.

On September 29, 2017, prior to the asset purchase closing, Heatwurx converted 178,924 shares of Series D Preferred Stock and all accrued dividends in the amount of $118,658 into 719,500 shares of common stock or 102,789 shares of common stock restated for the reverse stock split.

Stock and Performance Options - The Amended and Restated Heatwurx, Inc. 2011 Equity Incentive Plan (the “Plan”) approved by the Heatwurx Board of Directors and stockholders in October 2012 has 1,800,000 shares of common stock or 257,143 shares of common stock after the reverse-split reserved for issuance under the Plan. The Plan is being reviewed by the new Promet appointed Board of Directors and may be amended or terminated. Amendments are subject to stockholder approval to the extent required by applicable laws and regulations. Unless terminated sooner, the Plan will automatically terminate on April 15, 2021. There are currently no outstanding option grants to officers, directors, employees and consultants under the Plan. If unexercised options expire or are terminated, the underlying shares will again become available for grants under the Plan.

During the year ended December 31, 2016, there were no options or performance options granted or exercised and 321,667 unexercised options with a weighted average exercise price of $1.69 were cancelled. At December 31, 2016, there were 269,500 unexercised options with a weighted average exercise price of $1.88 and a weighted average remaining life of 2.04 years and 40,000 unexercised performance options with a weighted average exercise price of $2.00. Upon the issuance of 90% of Heatwurx’s common stock to Promet on October 4, 2017, there was a Change in Control event, as defined in the Plan. As of September 30, 2017, prior to the Change in Control event, all 269,500 unexercised options and all 40,000-unexercised performance options outstanding at December 31, 2016 were cancelled. No stock-based compensation expense was recognized for the years ended December 31, 2017 and 2016.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

Warrants- During the year ended December 31, 2016, there were no warrants granted, exercised or cancelled. At December 31, 2016, there were 2,000,304 warrants outstanding with a weighted average exercise price of $2.36 and a weighted average remaining life of 0.63 years. During the nine months ended September 30, 2017, 723,181 warrants with a weighted average exercise price of $2.99 were cancelled a result of non-exercise prior to their exercise date. At September 30, 2017, there were 1,277,123 warrants with a weighted average exercise price of $2.00 and a weighted average remaining life of 0.08 years that were cancelled in October 2017 as a result of non-exercise prior to their exercise date. As a result, there were no warrants issued, issuable or outstanding at December 31, 2017. See Note 6 for discussion of warrants.

NOTE 9 – NET LOSS PER COMMON SHARE

The Company computes loss per share of common stock using the two-class method required for participating securities. The Company’s participating securities include all series of its convertible preferred stock. Undistributed earnings allocated to these participating securities are added to net loss in determining net loss applicable to common stockholders. The Company has preferred stock authorized but no preferred stock issued and outstanding at December 31, 2017 and 2016.

The dilutive effect of convertible securities, including the preferred stock, if issued, and the Senior Convertible Notes, are reflected in diluted earnings per share using the if-converted method. As a result, (i) the preferred dividends applicable to the convertible preferred stock are deducted from income from continuing operations and net income in computing income available to common stockholders and, (ii) the interest expense and nondiscretionary adjustments on income that would have been calculated differently had the interest on the Senior Convertible Notes never been recognized, both net of income tax, are added back to the numerator. The convertible preferred stock and the Senior Convertible Notes assume the conversion to common stock at the beginning of the period or the date of issuance, if later, resulting in common shares being included in the denominator.

Other convertible securities that may be dilutive on their own but antidilutive when included with other potential common shares in computing diluted earnings per share include options and warrants since the treasury stock method applied to options and warrants has no effect on the numerator in the calculation. However, including potential common shares in the denominator (including convertible preferred stock and Senior Convertible Notes) of a diluted per share computation for continuing operations will always result in an antidilutive per share amount when the Company reports a loss from continuing operations or a loss from continuing operations available to common stockholders (after any preferred dividend deductions).

No potential common shares shall be included in the computation of any diluted per share amount when a loss from continuing operations or a loss from continuing operations available to common stockholders (after preferred dividend deduction) exists, even if the entity reports net income (as a result of discontinued operations) since it would be antidilutive. As a result, if there is a loss from continuing operations or a loss from continuing operations available to common stockholders, diluted earnings per share would be computed in the same manner as basic loss per share.

There were no outstanding options or warrants issued for the period from August 31, 2015 (inception) through December 31, 2017. See Notes 6 and 8 for further discussion of warrants related to the Senior Convertible Notes and the PIPE financing.

The Company has reported a loss from continuing operations and a loss from continuing operations available to common stockholders for all periods presented. As a result, there is no assumed conversion, exercise or contingent exercise of potential common shares included in the computation of the diluted per share amounts since it would have an antidilutive effect, therefore, basic and diluted loss per share are computed by dividing net loss applicable to common stockholders by the weighted-average number of shares of common stock outstanding.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

The calculation of the numerator and denominator for basic and diluted net loss per common share is shown in the table below. The weighted-average shares of common stock used in calculating basic earnings per share for the 2017 calculation uses the number of shares issued to Promet in the asset purchase transaction from January 1, 2017 through the acquisition date of October 4, 2017 plus all the legal capital issued and outstanding of Heatwurx, including Promet’s shares, from the closing date through December 31, 2017. All shares were restated for the one-for-seven reverse split.

The 2016 calculation uses the common shares issued to Promet in the asset purchase transaction, restated for the one-for-seven reverse split and weighted for the issuance dates of Promet’s member interests.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

NOTE 10 – COMMITMENTS AND CONTINGENCIES

Operating Lease Obligations

The Promet leases office space and equipment from third parties under non-cancelable operating leases. The office lease commenced on October 1, 2016 and expires September 30, 2019 with monthly rent at inception of $5,535 that escalates $1,107 annually on each October. Rent expense under the current office lease for the years ended December 31, 2017 and 2016 was $105,954 and $50,997, respectively. Rent expense for the year ended December 31, 2017 includes straight-line rent expense of $13,284 and $22,929 of common area maintenance and real estate tax reimbursements. At December 31, 2017, the accrued rent liability was $13,284, of which $3,321 was a current liability and $9,963 was a non-current liability.

The equipment lease commenced in June 2017 and expires in August 2020. Monthly rent of $586 over the 39-month lease term includes a monthly operating usage cost allowance of $125. Additional charges for excess usage, as defined in the agreement, are charged quarterly. The lessor charges monthly sales tax of 6 percent. Rent expense under the equipment lease for the years ended December 31, 2017 and 2016 was $6,626 and $5,362, respectively.

Future minimum rental payments under the leases as of December 31, 2017, are as follows:

Option and License Agreement with CoNCERT Pharmaceuticals

On October 4, 2017, Promet entered into an option and license agreement with CoNCERT Pharmaceuticals, Inc. (“CoNCERT”). The agreement provides the Company with an option to license the CoNCERT patent rights and know-how to develop and commercialize compounds (CTP-499 and each metabolite thereof) and products, as defined in the agreement. The option period ends, and the agreement terminates nine months from the date of the agreement if not exercised. Promet has the right to exercise the option during the option period; provided Promet (i) has raised gross proceeds of at least $8 million in one or more equity or other financings after the date of the agreement, and (ii) has a post-money valuation, following its then most recent equity financing, of at least $40.5 million.

Upon exercise of the option, Promet will have an exclusive, royalty-bearing right and license, including a right to sublicense, under CoNCERT intellectual property and joint intellectual property, to develop, manufacture, use and commercialize, including filing for, obtaining and maintaining regulatory approval for, products in all medical fields on a global basis. Promet shall control and be solely responsible for the commercialization of products in all medical fields on a global basis, including all costs and expenses. On March 19, 2018, we modified the Option and License Agreement with CoNCERT effective March 2018 (see Note 14), which enabled us to exercise our option to license the CoNCERT patent rights and know-how to develop and commercialize compounds (CTP-499 and each metabolite thereof) and products, as defined in the agreement.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

In addition, Promet will have the right and license, including a right to sublicense, under CoNCERT intellectual property and joint intellectual property, to develop compounds and products in all medical fields on a global basis. Promet shall control and be solely responsible for the development of and regulatory activities with respect to compounds and products in all medical fields on a global basis, including all costs and expenses.

Promet shall use commercially reasonable efforts to develop and obtain regulatory approval for one product in the U.S. and at least one other major market and subject to obtaining regulatory approval in the applicable major market, commercialize one product in the U.S. and at least one other major market. Failure to comply with the diligence obligation under the license agreement may result in the termination of the license agreement by CoNCERT in accordance with the relevant terms of the agreement.

In partial consideration for the rights granted to Promet , if the option is exercised, pursuant to the terms of a customary stock purchase agreement on mutually acceptable terms based on shares issued that enabled Promet to exercise the option under the license agreement discussed above, Promet shall issue to CoNCERT, for no additional consideration, shares representing the lesser of (a) the number of shares determined by dividing $8 million by the price per share paid by other investors in the financing round that enabled Promet to exercise the option under the license agreement discussed above or (b) the number of shares rounded down to the nearest whole share equal to 19.9 percent of the issued and outstanding shares of Promet immediately following the issuance of shares to CoNCERT. Following the execution of the stock purchase agreement, CoNCERT shall also be entitled to the same right to participate in future financing rounds of Promet (and subject to the same exceptions) as applicable to any investor in the financing round that enabled Promet to exercise the option under the license agreement.

Promet will incur royalty obligations to CoNCERT on a country-by-country and product-by-product basis that commence on the date of this agreement and expire on a country-by-country and product-by-product basis on the later of (i) expiration or invalidation of the last valid claim covering such product in such country or (ii) the tenth anniversary of the date of the first commercial sale to a non-sublicensee third party of such product in such country. Promet shall pay to CoNCERT royalties, on a product-by-product basis, on worldwide net sales of products during each year as follows: (a) four percent (4%) of sales less than or equal to $100 million; (b) five percent (5%) of sales greater than $100 million and less than or equal to $500 million; (c) six percent (6%) of sales greater than $500 million and less than or equal to $1 billion; and, (d) for that portion greater than $1 billion, (i) with respect to net sales made by Promet or any of its affiliates, ten percent (10%) of net sales, and (ii) with respect to net sales made by any sub-licensee, the greater of (1) 6% of such net sales or (2) 50% of all payments received by Promet or any of its affiliates with respect to such net sales. Royalties are subject to adjustment as provided in the terms of the agreement.

CoNCERT shall have one Board observer to attend all Board meetings of the Company in a nonvoting observer capacity subject to the Company’s right to exclude the CoNCERT observer for confidentiality and other reasons as defined in the agreement. CoNCERT’s Board Observer right will expire when CoNCERT’s ownership interest in Promet decreases below ten percent of the outstanding voting stock of Promet.

The term of the agreement commences on the date of the agreement and shall continue in full force and effect until the expiration of the last royalty term. On a country-by-country and product-by-product basis, upon the expiration of the royalty term in such country with respect to such product, Promet shall have a fully paid-up, perpetual, irrevocable license under the CoNCERT intellectual property and CoNCERT’s interest in the joint intellectual property with respect to such product in such country.

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

Purchase Obligations

The Company enters into contracts in the normal course of business with contract research organizations and subcontractors to further develop its products. The contracts are cancellable, with varying provisions regarding termination. If a contract with a specific vendor were to be terminated, the Company would only be obligated for products or services that it received as of the effective date of the termination and any applicable cancellation fees. The Company had purchase obligations of $895,740 and $0 at December 31, 2017 and 2016, respectively.

NOTE 11 – CONCENTRATION OF CREDIT RISK

The Company maintains its operating cash in two commercial banks. Balances on deposit are insured by the Federal Deposit Insurance Corporation (FDIC) up to specified limits. Total cash held by one bank was $2,900,393 and the second bank held a cash balance of $2,184 at December 31, 2017.

NOTE 12 – SUPPLEMENTAL CASH FLOW INFORMATION

Processa Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

NOTE 13 – QUARTERLY DATA

A summary of revenues, operating expenses, other income and net loss attributable to common stockholders for each of the last two years follows (this information is unaudited):

NOTE 14 – SUBSEQUENT EVENTS

Amendment of Option and License Agreement between Promet Therapeutics, LLC and CoNCERT Pharmaceuticals, Inc.

Promet Therapeutics, LLC (“Promet”) and CoNCERT Pharmaceuticals Inc. (“CoNCERT”) entered into an exclusive option and license agreement for the CTP-499 compound (the “Agreement”) in October 2017 (see Note 10). On March 19, 2018, Promet and CoNCERT amended the Agreement and Promet exercised the exclusive option for the CTP-499 compound and assigned the Agreement to Processa. The option was exercised in March 2018 in exchange for CoNCERT receiving (i) $8 million of common stock of Processa that was owned by Promet or approximately 2,090,300 shares representing 6.58% of Promet’s common stock holding or 5.93% of total Processa common stock issued and outstanding, and (ii) 15% of any sublicense revenue earned by Processa for a period equivalent to the royalty term (as defined in the Agreement) until (a) Processa raises $8 million of gross proceed; after the $8M is raised CoNCERT receives 0% sublicense revenue and (b) CoNCERT can sell its shares of Processa common stock without restrictions pursuant to the terms of the amended Agreement. All other terms of the Agreement remain unchanged.

Cybersecurity Fraud

In January 2018, we incurred a loss of $144,200 due to fraud from a cybersecurity breach. As a result, we have implemented certain review and approval procedures internally and with our banks; our technology consultants have implemented system changes; and, we reported the fraud to our banks and to a national law enforcement agency. We do not have insurance coverage against the type of fraud that occurred, therefore, recovery of the loss is remote. While we are taking steps to prevent such an event from reoccurring, we cannot provide assurance that similar issues will not reoccur. Failure of our control systems to prevent or detect and correct errors or fraud could have a material and adverse effect on our financial condition.

None.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Principal Executive Officer and Principal Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s (SEC) rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of December 31, 2017 to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP.

Management’s Annual Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act). Management conducted an assessment of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on this assessment, management has concluded that its internal control over financial reporting was not effective as of December 31, 2017.

Our independent registered public accounting firm, BD & Company, Inc., is not required to and has not issued an attestation report as of December 31, 2017 due to a transition period established by the rules of the SEC for newly public companies that have not lost their “emerging growth company” status as defined in the JOBS Act and our status as a smaller reporting company.

Changes in Internal Control Over Financial Reporting

Evaluation of disclosure controls and procedures

Our management, with the participation of our Chief Executive Officer, who also serves as our Chief Financial Officer, has concluded, based on evaluation, as of the end of the period covered by this report, that our disclosure controls and procedures (as defined in Rule 15d-15(e) under the Exchange Act) are (1) not effective to ensure that material information required to be disclosed by us in reports filed or submitted by us under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission due to the material weakness noted below, and (2) lacking design to ensure that material information required to be disclosed by us in such reports is accumulated, organized and communicated to our management, including our principal executive officer and principal financial officer, as appropriated, to allow timely decisions regarding required disclosure.

Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of our company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of our management and director; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed our internal control over financial reporting as of December 31, 2017, the end of our fiscal year. Management based its assessment on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Management’s assessment included evaluation of such elements as the design and operating effectiveness of key financial reporting controls, process documentation, accounting policies, and our overall control environment.

Based on our assessment, management has concluded that our internal control over financial reporting was not effective, as of the end of the fiscal year, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with generally accepted accounting principles.

In light of the material weaknesses described below, we performed additional analysis and other post-closing procedures to ensure that our financial statements were prepared in accordance with generally accepted accounting principles. Accordingly, we believe that the financial statements included in this report fairly present, in all material respects, our financial condition, results of operations and cash flows for the periods presented.

Material Weaknesses and Related Remediation Initiatives

Our management concluded that as of December 31, 2017, the following material weaknesses existed:

Due to the Company’s budget constraints, the Company’s accounting department does not maintain the number of accounting personnel (either in-house or external) necessary to ensure more complete and effective financial reporting and disclosure controls. Through the efforts of management and external consultants, we have developed a specific action plan to remediate the material weaknesses. Due to the limited number of employees and limited financial resources to hire required accounting and finance staff to implement the controls and procedures, the Company was unable to remediate the material weakness during 2017.

In January, we incurred a loss of approximately $144,000 due to fraud from a cybersecurity breach. We notified our banks and reported the fraud to the Federal Bureau of Investigation Cyber Crimes Unit. As a result, we have implemented certain review and approval procedures internally and with our banks as a preventative control and procedure. Our technology consultants have implemented system changes to enhance system access controls and limit the ability of hackers to gain access to internal systems to provide preventative measures to safeguard Company assets. We do not have insurance coverage against this type of fraud, therefore, the probability of recovery of the loss is remote.

While we are taking steps to prevent these control weaknesses from reoccurring, we cannot provide assurance that we will be successful. We are in the early stages of operations and fund raising so we currently lack the financial resources necessary to implement an effective internal control system to prevent and/or detect and correct material misstatements due to fraud or error. Our inability to implement an effective internal control system in the future to prevent and/or detect and correct material misstatements could have a material and adverse effect on our financial condition.

We have fewer than 300 stockholders on record and are not a mandatory filer of reports under Section 13 or 15(d) of the Exchange Act. As a voluntary filer, we may choose to cease filing Exchange Act reports at any time.

Changes in internal control over financial reporting

Except as described above, there has been no change in our internal control over financial reporting, as defined in Rules 13a-15(f) of the Exchange Act, for the year ended December 31, 2017, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Inherent Limitations on Effectiveness of Controls

Management recognizes that a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud or error, if any, have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Not applicable.

Part III

MANAGEMENT

The following table sets forth the names and ages of the members of our executive officers and the positions held by each as of March 31, 2018.

The following is a brief account of the education and business experience during at least the past five years of each director, executive officer and key employee of our company, indicating the person’s principal occupation during that period, and the name and principal business of the organization in which such occupation and employment were carried out.

Executive Officers

David Young, Pharm.D., Ph.D.

– Dr. Young has served as our Chairman and Chief Executive Officer Interim Chief Financial Officersince October 4, 2017 and Founder

Dr. Young has over 30 years of pharmaceutical research, drug development, and corporate experience. He was a Founder and CEOChief Executive Officer (CEO) of Promet Therapeutics, LLC (“Promet”) since its formation in August 2015. Dr. Young was Chief Scientific Officer of Questcor PharmaceuticalsHe served as our interim CFO from 2009-2014 and was responsible for working with the FDA on modernizing the Acthar Gel label and in obtaining FDA approval in Infantile Spasms.October 4, 2017 to September 1, 2018. From 2006-20092006 to 2009, prior to joining the Questcor executive management team, Dr. Young served as an independent Director on the Questcor Board of Directors. As an independent director, Dr. Young, representing Questcor, worked with the FDA in developing a process to obtain approval for Acthar (the only commercial product owned by Questcor) in Infantile Spasms (IS), a deadly and debilitating very rare orphan indication. In 2009, Dr. Young joined the Questcor executive management team as Chief Scientific Officer (CSO) in order to obtain IS FDA approval and market exclusivity by completing the New Drug Application (NDA) process, working with FDA on modernizing the label, and leading all aspects of approval including the Advisory Committee Meeting that voted to approve the NDA for IS. During the eight years that Dr. Young was involved with Questcor as an independent director and as its CSO, Questcor transitioned to an orphan drug specialty pharmaceutical company, moving from an outdated Acthar label and near bankruptcy in 2007 to a valuationmodernized Acthar label that helped it to achieve sales greater than $750 million per year and the ultimate sale of the company for approximately $5.6 billion in 2014. While serving on Questcor’s Board of Directors, Dr. Young was Executive Director & President, U.S. Operations of AGI Therapeutics Plc.plc. Dr. Young has also served as the Executive Vice President of the Strategic Drug Development Division of ICON plc, an international CRO, and was the Founder and CEO of GloboMax LLC, a CRO specializing in FDA drug development, purchased by ICON plc in 2003. Prior to forming GloboMax, Dr. Young was a Tenured Associate Professor at the School of Pharmacy, University of Maryland.Maryland at Baltimore (UMAB), where he led a group of 30 faculty, scientists, postdocs, graduate students and technicians in evaluating the biological properties of drugs and drug delivery systems in animals and humans.