AXE Compute Inc.: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis should be read together with our unaudited condensed consolidated financial statements and related notes thereto set forth in this Quarterly Report on Form 10-Q as well as our Annual Report on Form 10-K for the year ended December 31, 2022.

This Form 10-Q contains “forward-looking statements” that are subject to certain risks and uncertainties, many of which are beyond our control. Actual results could differ materially and adversely from those anticipated in such forward-looking statements as a result of certain factors, including those set forth below and elsewhere in this report. Important risk factors that may cause actual results to differ from forward-looking statements include:

• Our ability to be able to continue operating beyond twelve months without additional financing;
• Continued negative operating cash flows;
• Our capital needs to accomplish our goals, including any further financing, which may be highly dilutive and may include onerous terms;
• Risks related to recent and future acquisitions, including risks related to the benefits and costs of acquisition;
• Risks related to our partnerships with other companies, including the need to negotiate the definitive agreements; possible failure to realize anticipated benefits of these partnerships; and costs of providing funding to our partner companies, which may never be repaid or provide anticipated returns;
• Risks related to the initiation, formation, or success of our collaboration arrangements, commercialization activities and product sales levels by our collaboration partners and future payments that may come due to us under these arrangements,
• Risk that we will be unable to protect our intellectual property or claims that we are infringing on others’ intellectual property;
• The impact of competition;
• Acquisition and maintenance of any necessary regulatory clearances applicable to applications of our technology;
• Inability to attract or retain qualified senior management personnel, including sales and marketing personnel;
• Risk that we never become profitable if our product and services are not accepted by potential customers;
• Possible impact of government regulation and scrutiny;

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• Unexpected costs and operating deficits, and lower than expected sales and revenues, if any;
• Adverse results of any legal proceedings;
• The volatility of our operating results and financial condition;
• Management of growth;
• Risk that our business and operations will continue to be materially and adversely affected by disruptions caused by COVID-19 as well as general economic and geopolitical uncertainties; and
• Other specific risks that may be alluded to in this report.

All statements, other than statements of historical facts, included in this report regarding our growth strategy, future operations, financial position, estimated revenue or losses, projected costs, prospects and plans, and objectives of management are forward-looking statements. When used in this report, the words “will,” “may,” “believe,” “anticipate,” “intend,” “estimate,” “expect,” “project,” “plan,” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain such identifying words. All forward-looking statements speak only as of the date of this report. We do not undertake any obligation to update any forward-looking statements or other information contained herein. Potential investors should not place undue reliance on these forward-looking statements. Although we believe that our plans, intentions, and expectations reflected in or suggested by the forward-looking statements in this report are reasonable, we cannot assure potential investors that these plans, intentions or expectations will be achieved. We disclose important factors that could cause actual results to differ materially from expectations in the “Risk Factors” section and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2022 and in item 1A of Part II below. These cautionary statements qualify all forward-looking statements attributable to us or persons acting on our behalf.

Information regarding market and industry statistics contained in this report is included based on information available to us that we believe is accurate. It is generally based on academic and other publications that are not produced for purposes of securities offerings or economic analysis. We have not reviewed or included data from all sources, and we cannot assure potential investors of the accuracy or completeness of the data included in this report. Forecasts and other forward-looking information obtained from these sources are subject to the same qualifications and the additional uncertainties accompanying any estimates of future market size, revenue, and market acceptance of products and services. We have no obligation to update forward-looking information to reflect actual results or changes in assumptions or other factors that could affect those statements.

Overview

Predictive Oncology Inc. (“Predictive Oncology”) is a knowledge-driven company focused on applying artificial intelligence (“AI”) to support the development of optimal cancer therapies, which can ultimately lead to more effective treatments and improved patient outcomes. Through AI, Predictive Oncology uses a proprietary biobank of 150,000+ cancer tumor samples, categorized by patient type, against drug compounds to help the drug discovery process and increase the probability of success. The Company offers a suite of solutions for oncology drug development from early discovery to clinical trials.

We operate in three primary business areas: first, along the drug discovery continuum (i) the application of AI for optimized, high-confidence drug-response predictions within a large experimental space that enables a more informed selection of drug/tumor combinations to increase the probability of success during development and (ii) the creation and development of tumor-specific 3D cell culture models; second, contract services and research focused on solubility improvements, stability studies, and protein production, and; third, production of the United States Food and Drug Administration (“FDA”)-cleared STREAMWAY System for automated fluid waste management, direct-to-drain medical fluid disposal and associated products.

We have determined that we will focus our resources on applying AI to support the development of optimal cancer therapies, partnering with biopharma clients to help prioritize drugs for development and identify biomarker-informed indications. Our platform provides a more informed decision tool to select optimal drug/tumor combinations to increase the probability of success during drug development. As a result of this focused approach, we have consolidated our brand under the Predictive Oncology name. Going forward, we will operate under the Predictive Oncology tradename with laboratory operations in Pittsburgh, Pennsylvania and Birmingham, Alabama. As of January 1, 2023, we have changed in our reportable segments because of this focused approach.

We have three reportable segments that have been delineated by location and specialty: our Pittsburgh segment provides services that include the application of AI using its proprietary biobank of 150,000+ cancer tumor samples. Pittsburgh also utilizes 3D culture models in drug development. Our Birmingham segment provides services and research using a self-contained, automated system that conducts high-throughput, self-interaction chromatography screens, using additives and excipients commonly included in protein formulations resulting in soluble and physically stable formulations of biologics focused on solubility improvements, stability studies, and protein production. Our Eagan (Minnesota) segment consists of the production of the United States Food and Drug Administration (“FDA”)-cleared STREAMWAY System for automated fluid waste management, direct-to-drain medical fluid disposal, and associated products.

Capital Requirements

Since inception, we have been unprofitable. We incurred net losses of $10,508,620 and $17,821,524 for the nine months ended September 30, 2023, and September 30, 2022, respectively. As of September 30, 2023, and December 31, 2022, we had an accumulated deficit of $164,286,536 and $153,777,916, respectively.

We have never generated sufficient revenues to fund our capital requirements. Since 2017, we have diversified our business by investing in ventures, including making significant loans and investments in early-stage companies. These activities led to the acquisition of Helomics in April 2019, the purchase of the assets of three businesses in 2020 and the acquisition of zPREDICTA in November 2021, each of which have accelerated our capital needs. We have funded our operations through a variety of debt and equity instruments. See “Liquidity and Capital Resources – Liquidity and Plan of Financing; Going Concern Qualification” and “Liquidity and Capital Resources – Financing Transactions” below.

Our future cash requirements and the adequacy of available funds depend on our ability to generate revenues from our drug discovery businesses located in Pittsburgh and Birmingham; our ability to continue to sell our Skyline Medical products and services and to reach profitability in all our businesses; and the availability of future financing to fulfill our business plans. See “Liquidity and Capital Resources – Liquidity and Plan of Financing; Going Concern Qualification” below.

Our limited history of operations, especially in our drug discovery business, and our change in the emphasis of our business, starting in 2017, makes prediction of future operating results difficult. We believe that period-to-period comparisons of our operating results should not be relied on as predictive of our future results.

Results of Operations

Comparison of three and nine months ended September 30, 2023 and September 30, 2022

Revenue. We recorded revenue of $715,056 and $455,827 in the three months ended September 30, 2023 and 2022, respectively, and $1,445,061 and $1,141,986 in the nine months ended September 30, 2023 and 2022, respectively. Revenue in the three months ended September 30, 2023 was primarily derived from the Pittsburgh operating segment related to development of tumor-specific 3D cell culture models, while revenue in the three months ended September 30, 2022 was primarily derived from the Eagan operating segment. The Pittsburgh operating segment contributed revenues of $417,096 and $172,637 in the three months ended September 30, 2023 and September 30, 2022, respectively, while the Eagan operating segment contributed $259,530 and $253,751 in the three months ended September 30, 2023 and September 30, 2022, respectively. Revenue in the nine months ended September 30, 2023 and September 30, 2022 was primarily derived from the Eagan operating segment, which contributed $866,535 and $809,875 for the nine months ended September 30, 2023 and September 30, 2022, respectively.

Cost of goods sold. Cost of sales was $106,940 and $386,840 in the three and nine months ended September 30, 2023 compared to $108,151 and $351,669 in the three and nine months ended September 30, 2022. The gross profit margin was approximately 85% and 73% in the three and nine months ended September 30, 2023 compared to 76% and 69% in the three and nine months ended September 30, 2022. The improvement in gross profit margins for both periods was primarily due to a change in sales mix to higher margin contracted services primarily provided by our Pittsburgh and Birmingham operating segments.

General and administrative expense. General and administrative (“G&A”) expense primarily consists of management salaries, professional fees, consulting fees, travel expense, administrative fees, and general office expenses. G&A expense decreased by $704,344 to $2,583,574 in the three months ended September 30, 2023 compared to $3,287,918 in the comparable period in 2022. G&A expense decreased by $439,180 to $7,624,085 in the nine months ended September 30, 2023 compared to $8,063,265 in the comparable period in 2022. The decreases in both periods were primarily due to decreased severance to former employees as well as decreased depreciation and amortization expenses due to fully depreciated assets and prior period impairments, offset by increased fees for investor relations and advisory boards as well as rent and other general and administrative expenses.

Operations expense. Operations expense primarily consists of expenses related to product development and prototyping and testing. Operations expense decreased by $14,551 to $842,579 in the three months ended September 30, 2023 compared to $857,130 in the comparable period in 2022. The decrease was primarily due to decreased consultant fees and decreased spending on tools, calibration, and testing in Eagan.

Operations expense increased by $56,825 to $2,714,139 in the nine months ended September 30, 2023 compared to $2,657,314 in the comparable period in 2022. The increase in the nine-month period was driven primarily by higher cloud computing expenses related to our Pittsburgh operating segment, which were offset by decreases in expenses related to the closure of the offices of the Company’s former wholly-owned subsidiaries.

Sales and marketing expense. Sales and marketing expense consists of expenses required to sell products through attendance at trade shows, product literature and other sales and marketing activities. Sales and marketing expense increased by $2,666 to $336,043 in the three months ended September 30, 2023 compared to $333,377 in the comparable period in 2022. Sales and marketing expense increased by $226,516 to $1,135,383 in the nine months ended September 30, 2023 compared to $908,867 in the comparable period in 2022. The increases in both periods were primarily due to the increase in marketing and business development staff hired after September 30, 2022.

Loss on impairment of property and equipment. We recorded a loss on impairment of property and equipment of $162,905 during the nine months ended September 30, 2023. We prepared an undiscounted cash flow for our Birmingham asset group as of June 30, 2023 to evaluate long-lived assets, then completed a fair value assessment which resulted in the impairment and allocated the impairment to the assets of the affected asset group. Please see Note 4 – Property and Equipment to our unaudited condensed consolidated financial statements for further information.

Other income. We earned other income of $47,838 in the three months ended September 30, 2023 compared to $63,047 in the comparable period in 2022 and earned other income of $118,617 in the nine months ended September 30, 2023 compared to $146,524 in the comparable period in 2022. Other income is primarily interest income.

Other expense. We incurred other expense of $60,671 in the three and nine months ended September 30, 2023 compared to $2,001 in the three months ended September 30, 2022 and $5,207 in the nine months ended September 30, 2022. The increase was primarily due to the write off of a note receivable deemed uncollectible.

Gain on derivative instruments. We recorded a gain of $3,463 in the three months ended September 30, 2023 compared to $10,219 in the comparable period in 2022 and recorded a gain of $11,724 in the nine months ended September 30, 2023 compared to $107,381 in the comparable period in 2022 related to the change in fair value of the derivative.

Liquidity and Capital Resources

Cash Flows

Net cash used in operating activities was $10,107,030 and $9,135,812 for the nine months ended September 30, 2023 and September 30, 2022, respectively. Cash used in operating activities increased in the 2023 period primarily because of the increase in operating expenses and changes in working capital.

Net cash used in investing activities was $309,666 and $412,096 for the nine months ended September 30, 2023 and September 30, 2022, respectively. Cash used in investing activities decreased in the 2023 period primarily due to a decrease in the acquisition of fixed assets.

Net cash provided by financing activities was $260,221 and $6,739,031 for the nine months ended September 30, 2023 and September 30, 2022, respectively. The cash provided in the nine months ended September 30, 2022 was primarily due to proceeds from the issuance of common stock and warrants while the cash provided in the nine months ended September 30, 2023 primarily related to proceeds from financing insurance premiums over the insured period with a short-term note payable.

Liquidity and Plan of Financing; Going Concern

We have incurred significant and recurring losses from operations for the past several years and had an accumulated deficit of $164,286,536 as of September 30, 2023. We had cash and cash equivalents of $11,915,048 as of September 30, 2023 and need to raise significant additional capital to meet our operating needs. Our short-term obligations as of September 30, 2023 were $4,171,891, consisting primarily of aggregate accounts payable and accrued expenses of $2,979,064 and operating lease obligations of $555,541. As of September 30, 2023, we also had a short-term note payable of $260,220 that bears interest at an annual percentage rate of 9.25% and long-term operating lease obligations of $2,343,622 with a weighted average remaining lease term of 4.23 years. We do not expect to generate sufficient operating revenue to sustain our operations in the near term. Year-to-date, we incurred negative cash flows from operations of $10,107,030. Although we have attempted to improve our operating margin by bolstering revenues and curtailing expenses, and continue to seek ways to generate revenue through business development activities, there is no guarantee that we will be able to improve our operating margin sufficiently or achieve profitability in the near term. These conditions raise substantial doubt about our ability to continue as a going concern. We are evaluating alternatives to obtain the required additional funding to maintain future operations. These alternatives may include, but are not limited to, equity financing, issuing debt, entering into other financing arrangements, or monetizing operating businesses or assets. Despite these potential sources of funding, we may be unable to access financing or obtain additional liquidity when needed or under acceptable terms, if at all. Therefore, there is substantial doubt about our ability to continue as a going concern for one year after the date that the financial statements are issued. The condensed consolidated financial statements included in this report have been prepared assuming we will continue as a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business, and do not include any adjustments that might result from the outcome of this uncertainty.

Financing Transactions

We have funded our operations through a combination of debt and equity instruments including short-term borrowings, and a variety of debt and equity offerings.

Accounting Standards and Recent Accounting Developments

See Note 1 - Summary of Significant Accounting Policies to the unaudited, Condensed Consolidated Financial Statements of this Quarterly Report on Form 10-Q for a discussion of recent accounting developments.

Evaluation of Disclosure Controls and Procedures

Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act), defines the term “disclosure controls and procedures” as those 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 recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.

Based on their evaluation as of September 30, 2023, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were not effective as of September 30, 2023 due to the material weaknesses in internal control over financial reporting described below.

Material Weaknesses in Internal Controls. In connection with the evaluation of the Company’s internal control over financial reporting as described above, management has identified the following deficiencies in our control environment in the current period that constitute material weaknesses in the Company’s internal control over financial reporting. Therefore, there was a risk that a potential material misstatement of the consolidated financial statements could occur without being prevented or detected on a timely basis.

Management did not maintain effective information technology general controls in the areas of user access management, administrative user access, and segregation of duties within its financial information systems and other financial reporting controls that are relevant to the Company’s preparation of financial statements. As a result of those segregation of duties deficiencies, the related manual business process controls were determined to be ineffective.

The material weakness first reported in our Quarterly Report on Form 10-Q for the quarter ended September 30, 2022 continued to exist as of September 30, 2023. Management determined that we have not maintained adequate accounting resources with a sufficient understanding of accounting principles generally accepted in the United States of America (“U.S. GAAP”) to allow us to properly identify and account for new complex transactions.

Notwithstanding the material weaknesses in our internal control over financial reporting, we have concluded that the condensed consolidated financial statements and other financial information included in our annual and quarterly filings fairly present in all material respects our financial condition, results of operations and cash flows as of, and for, the periods presented.

Material Weakness Remediation Activities. In response to the material weakness, management, with oversight of the Audit Committee of the Company’s Board of Directors, has begun the process of, and is committed to, designing and implementing effective measures to strengthen our internal controls over financial reporting and remediate the material weakness. Our planned internal control remediation efforts include:

• Management is evaluating logical access, including administrative user access, and eliminating known segregation of duties conflicts.
• Management has designed and is in the process of implementing periodic logical access review controls to monitor user access and proper segregation of duties.
• Management has reevaluated our overall staffing levels within the accounting department and during the second quarter of 2023 we hired additional resources with qualifications that include a high level of experience with complex technical accounting transactions and application of U.S. GAAP.

Once the above actions and processes have been in operation for a sufficient period of time for our management to conclude that the material weakness has been fully remediated and our internal controls over financial reporting are effective, we will consider this material weakness fully addressed. We are committed to the continuous improvement of our internal control over financial reporting and will continue to diligently review our internal control over financial reporting.

Changes in Internal Control Over Financial Reporting

Except for the changes described above, there were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the three months ended September 30, 2023 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

As of the date of this Quarterly Report on Form 10-Q, there have been no material changes to our risk factors from those disclosed under “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on March 21, 2023, except as described below.

There is substantial doubt about our ability to continue as a going concern. We will require additional financing to fund operating expenses and fulfill our business plan. Such financing, if available, may be dilutive.

We have incurred significant and recurring losses from operations for the past several years and had an accumulated deficit of $164,286,536 as of September 30, 2023. We had cash and cash equivalents of $11,915,048 as of September 30, 2023 and need to raise significant additional capital to meet our operating needs. Our short-term obligations as of September 30, 2023 were $4,171,891, consisting primarily of aggregate accounts payable and accrued expenses of $2,979,064 and operating lease obligations of $555,541. As of September 30, 2023, we also had a short-term note payable of $260,220 that bears interest at an annual percentage rate of 9.25% and long-term operating lease obligations of $2,343,622 with a weighted average remaining lease term of 4.23 years. We do not expect to generate sufficient operating revenue to sustain our operations in the near term. Year-to-date, we incurred negative cash flows from operations of $10,107,030. Although we have attempted to improve our operating margin by bolstering revenues and curtailing expenses, and continue to seek ways to generate revenue through business development activities, there is no guarantee that we will be able to improve our operating margin sufficiently or achieve profitability in the near term. These conditions raise substantial doubt about our ability to continue as a going concern. We are evaluating alternatives to obtain the required additional funding to maintain future operations. These alternatives may include, but are not limited to, equity financing, issuing debt, entering into other financing arrangements, or monetizing operating businesses or assets. Despite these potential sources of funding, we may be unable to access financing or obtain additional liquidity when needed or under acceptable terms, if at all. Therefore, there is substantial doubt about our ability to continue as a going concern for one year after the date that the financial statements are issued. The condensed consolidated financial statements for the quarter ended September 30, 2023 have been prepared assuming we will continue as a going concern and do not include any adjustments that might result from the outcome of this uncertainty.

The use of AI in our business is subject to risks associated with new and rapidly evolving technologies and industries, may result in reputational harm or liability, and may not result in the development of commercially viable therapies, drugs or treatments.

Our business model relies on the use of AI to support the development of optimal cancer therapies. Through AI, we use a proprietary biobank of 150,000+ cancer tumor samples, categorized by patient type, and make optimized, high-confidence drug-response predictions against drug compounds to enable a more informed selection of drug/tumor combinations. While we believe that AI may potentially enable more efficient drug research and clinical development than the conventional model, our approach is novel and has not yet been widely studied. Our use of AI is subject to risks and challenges associated with new, disruptive, and rapidly evolving technologies and industries, which may affect its adoption and the success of our business. The algorithms we use may be flawed, our datasets may be insufficient or contain biased information, and inappropriate or controversial data practices by us or others could impair the acceptance of AI solutions. These deficiencies could undermine the predictions or analysis that AI applications produce, subjecting us to competitive harm, legal liability, and brand or reputational harm. Additionally, changes in laws and regulations could impact the usefulness of our solution and could necessitate modifications in our business to accommodate such changes. The regulatory landscape for AI is continually evolving, and both the FDA and the European Union are in the process of issuing comprehensive guidance on AI software which may change how our product is regulated.

Further, the cost and time needed to discover drug candidates is difficult to predict, and our efforts may not result in the discovery and development of commercially viable therapies, drugs, or clinical treatments. Our estimates of our defined patient populations available for study and treatment may be lower than expected, which could adversely affect our or our partners’ ability to conduct clinical trials and may also adversely affect the size of any market for therapies, drugs or treatments we may license for commercialization. Our approach may not result in time savings, higher success rates or reduced costs as we expect it to, and if not, we may not attract collaborators or develop new drugs as quickly or cost effectively as expected and therefore we may not be able to commercialize our approach as expected at this time.

We have entered into, and may enter into additional collaborations, in-licensing arrangements, joint ventures, strategic alliances or partnerships with third parties that may not result in the development of commercially viable products or the generation of significant future revenues.

We may enter into collaborations, in-licensing arrangements, joint ventures, strategic alliances, partnerships or other arrangements to develop products and to pursue new markets. Proposing, negotiating and implementing collaborations, in-licensing arrangements, joint ventures, strategic alliances or partnerships may be a lengthy and complex process. Other companies, including those with substantially greater financial, marketing, sales, technology or other business resources, may compete with us for these opportunities or arrangements. We may not identify, secure, or complete any such transactions or arrangements in a timely manner, on a cost-effective basis, on acceptable terms or at all. We have limited institutional knowledge and experience with respect to these business development activities, and we may also not realize the anticipated benefits of any such transaction or arrangement. In particular, these collaborations may not result in the development of products that achieve commercial success or result in significant revenues and could be terminated prior to developing any products. Our ability to generate revenues from these arrangements will depend in part on our collaborators’ abilities to successfully perform the functions assigned to them in these arrangements.

Additionally, we may not be in a position to exercise sole decision-making authority regarding the transaction or arrangement, which could create the potential risk of creating impasses on decisions, and our future collaborators may have economic or business interests or goals that are, or that may become, inconsistent with our business interests or goals. It is possible that conflicts may arise with our collaborators, such as conflicts concerning the achievement of performance milestones, or the interpretation of significant terms under any agreement, such as those related to financial obligations or the ownership or control of intellectual property developed during the collaboration. If any conflicts arise with any future collaborators, they may act in their self-interest, which may be adverse to our best interest, and they may breach their obligations to us. In addition, we may have limited control over the amount and timing of resources that any future collaborators devote to our or their future products. Disputes between us and our collaborators may result in litigation or arbitration which would increase our expenses and divert the attention of our management. Further, these transactions and arrangements will be contractual in nature and will generally be terminable under the terms of the applicable agreements and, in such event, we may not continue to have rights to the products relating to such transaction or arrangement or may need to purchase such rights at a premium.

If we enter into in-bound intellectual property license agreements, we may not be able to fully protect the licensed intellectual property rights or maintain those licenses. Future licensors could retain the right to prosecute and defend the intellectual property rights licensed to us, in which case we would depend on the ability of our licensors to obtain, maintain and enforce intellectual property protection for the licensed intellectual property. These licensors may determine not to pursue litigation against other companies or may pursue such litigation less aggressively than we would. Further, entering into such license agreements could impose various diligence, commercialization, royalty or other obligations on us. Future licensors may allege that we have breached our license agreement with them, and accordingly seek to terminate our license, which could adversely affect our competitive business position and harm our business prospects.

In addition to the foregoing risks, and the other information set forth in this Quarterly Report on Form 10-Q, the reader should carefully consider the risks included in Item 1A of Part I of our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 before making an investment decision. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks, and you may lose all or part of your investment. The reader should also carefully consider these risk factors.