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ANIXA BIOSCIENCES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

1.         BUSINESS AND FUNDING

Description of Business

As used herein, “we,” “us,” “our,” the “Company” or “Anixa” means Anixa Biosciences, Inc. and its consolidated subsidiaries. 

Our primary operations involve research and development of cancer therapeutics and diagnostics.  Our cancer therapeutics program consistsprograms consist of development of a vaccine against triple negative breast cancer (“TNBC”) and development of chimeric endocrine receptor T-cell (“CER-T”) technology, a novel form of CAR-T technology, initially focused on treating ovarian cancer.  Our cancer diagnostics program consists of development of the artificial intelligence (AI) driven Cchek™ liquid biopsy platform for early cancer detection. 

We hold an exclusive worldwide, royalty-bearing license to use certain intellectual property owned or controlled by The Cleveland Clinic Foundation (“Cleveland Clinic”) related to certain breast cancer vaccine technology developed at Cleveland Clinic.  We are working in collaboration with Cleveland Clinic to develop a method to vaccinate women against contracting breast cancer, focused specifically on TNBC, the most lethal form of the disease.  A specific protein, alpha-lactalbumin, has been identified that is only present during lactation in healthy women, but reappears in many forms of breast cancer, especially TNBC.  Animal studies have shown that vaccinating against this protein prevents breast cancer in mice.  We are working with researchers at Cleveland Clinic to advance this vaccine toward human clinical testing, and we anticipate filing an Investigational New Drug (“IND”) application with the U.S. Food and Drug Administration (“FDA”) by the end of the 2019 calendar year.

Our subsidiary, Certainty Therapeutics, Inc. (“Certainty”), is developing immuno-therapy drugs against cancer.  Certainty holds an exclusive worldwide, royalty-bearing license to use certain intellectual property owned or controlled by The Wistar Institute (“Wistar”) relating to Wistar’s CER-T technology.  We have initially focused on the development of a treatment for ovarian cancer, but we may also pursue applications of the technology for the development of treatments for additional solid tumors.  The license agreement requires Certainty to make certain cash and equity payments to Wistar.  With respect to Certainty’s equity obligations to Wistar, Certainty issued to Wistar shares of its common stock equal to five percent (5%) of the common stock of Certainty.

Certainty, in collaboration with the H. Lee Moffitt Cancer Center and Research Institute, Inc. (“Moffitt”), is advancing toward human clinical testing of its CER-T technology for treating ovarian cancer.  Certainty is working with researchers at Moffitt to complete studies necessary to submit an Investigational New Drug (“IND”)IND application with the U.S. Food and Drug Administration (“FDA”).FDA.  We anticipate filing the IND with the FDA inby the fallend of the 2019 calendar year, with human clinical trials commencing thereafter, by late 2019 or earlyin 2020.  The collaboration between Certainty and Moffitt was recently extended through November 2020, so the parties may continue research on Certainty’s CER-T technology.

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Our subsidiary, Anixa Diagnostics Corporation (“Anixa Diagnostics”), is developing Cchek™, an AI driven platform of non-invasive blood tests for the early detection of cancer which is based on the body’s immune response to the presence of a malignancy.  We have demonstrated the efficacy of Cchek™ with 20 different types of cancer, including:  breast, lung, colon, melanoma, ovarian, liver, thyroid, pancreatic, appendiceal, uterine, osteosarcoma, leiomyosarcoma, liposarcoma, vulvar, prostate, bladder, cervical, head and neck, gastric and testicular cancers.  Breast, lung, colon and prostate cancers represent the four largest categories of cancer worldwide.

We are currently developing tests for the detection of multiple types of cancer and are working with our development and commercialization partner, ResearchDx, a CLIA-certified laboratory, to launch Cchek™ Prostate Cancer Confirmation as a Laboratory Developed Test byduring the end of the thirdfourth calendar quarter of 2019. 

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Over the next several quarters, we expect the development of our breast cancer vaccine, Certainty’s CER-T technology and Anixa Diagnostic’s Cchek™ to be the primary focus of the Company.  As part of our legacy operations, the Company remains engaged in limited patent licensing activities in the area of encrypted audio/video conference calling.  We do not expect these activities to be a significant part of the Company’s ongoing operations nor do we expect these activities to require material financial resources or attention of senior management.

Over the past several quarters, our revenue was derived from technology licensing and the sale of patented technologies, including revenue from the settlement of litigation.  We have not generated any revenue to date from our cancer therapeutics and diagnostics programs. In addition, to Certaintywhile we pursue our cancer therapeutics and Anixa Diagnostics, the Companydiagnostics programs, we may also make investments in and form new companies to develop additional emerging technologies.

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Funding and Management’s Plans

Based on currently available information as of June 11,September 5, 2019, we believe that our existing cash, cash equivalents, short-term investments and expected cash flows will be sufficient to fund our activities for the next twelve months.  However, our projections of future cash needs and cash flows may differ from actual results.  If current cash on hand, cash equivalents, short term investments and cash that may be generated from our business operations are insufficient to continue to operate our business, (including for the defense of a putative shareholder derivative complaint filed in the Court of Chancery of the State of Delaware, captioned Howland v. Kumar et al.), or if we elect to invest in or acquire a company or companies or new technology or technologies that are synergistic with or complimentarycomplementary to our technologies, we may be required to obtain more working capital.  During the sixnine months ended April 30,July 31, 2019, we raised approximately $4,358,000$4,900,000 through our at-the-market equity offering of 1,061,0321,208,808 shares of common stock which is currently effective (we can sell an additional 415,078267,302 shares under our current at-the-market equity program) and may remain available for us to use in the future.  Further, we have an additional at-the-market equity offering under which we may issue up to $50 million of common stock, which is currently effective and may remain available to us in the future.  We may seek to obtain working capital during our fiscal year 2019 or thereafter through sales of our equity securities (including through the commencement of another at-the-market offering) or through bank credit facilities or public or private debt from various financial institutions where possible.  We cannot be certain that additional funding will be available on acceptable terms, or at all.  If we do identify sources for additional funding, the sale of additional equity securities or convertible debt could result in dilution to our stockholders.  Additionally, the sale of equity securities or issuance of debt securities may be subject to certain security holder approvals or may result in the downward adjustment of the exercise or conversion price of our outstanding securities.  We can give no assurance that we will generate sufficient cash flows in the future to satisfy our liquidity requirements or sustain future operations, or that other sources of funding, such as sales of equity or debt, would be available or would be approved by our security holders, if needed, on favorable terms or at all.  If we fail to obtain additional working capital as and when needed, such failure could have a material adverse impact on our business, results of operations and financial condition.  Furthermore, such lack of funds may inhibit our ability to respond to competitive pressures or unanticipated capital needs, or may force us to reduce operating expenses, which would significantly harm the business and development of operations.

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Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X.  Accordingly, certain information and disclosures required by generally accepted accounting principles in annual financial statements have been omitted or condensed.  These interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related disclosures included in our Annual Report on Form 10-K for the year ended October 31, 2018.  The accompanying October 31, 2018 consolidated balance sheet data was derived from the audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America (“US GAAP”).  The condensed consolidated financial statements include all adjustments of a normal recurring nature which, in the opinion of management, are necessary for a fair statement of our financial position as of April 30,July 31, 2019, and results of operations and cash flows for the interim periods represented.  The results of operations for the sixnine months ended April 30,July 31, 2019 are not necessarily indicative of the results to be expected for the entire year.

Noncontrolling Interest

Noncontrolling interest represents Wistar’s equity ownership in Certainty and is presented as a component of equity.  The following table sets forth the changes in noncontrolling interest for the sixnine months ended April 30,July 31, 2019:

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Revenue Recognition

Since fiscal 2016 our revenue has been derived solely from technology licensing and the sale of patented technologies.  Revenue is recognized upon transfer of control of intellectual property rights and satisfaction of other contractual performance obligations to licensees in an amount that reflects the consideration we expect to receive. 

On November 1, 2018 we adopted Accounting Standards Update 2014-09 (“ASU 2014-09”), Revenue from Contracts with Customers.  Upon adoption of ASU 2014-09 we are required to make certain judgments and estimates in connection with the accounting for revenue.  Such areas may include determining the existence of a contract and identifying each party’s rights and obligations to transfer goods and services, identifying the performance obligations in the contract, determining the transaction price and allocating the transaction price to separate performance obligations, estimating the timing of satisfaction of performance obligations, determining whether a promise to grant a license is distinct from other promised goods or services and evaluating whether a license transfers to a customer at a point in time or over time.

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Our revenue arrangements provide for the payment of contractually determined, one-time, paid-up license fees in settlement of litigation and in consideration for the grant of certain intellectual property rights for patented technologies owned or controlled by the Company.  These arrangements typically include some combination of the following: (i) the grant of a non-exclusive, retroactive and future license to manufacture and/or sell products covered by patented technologies owned or controlled by the Company, (ii) a covenant-not-to-sue, (iii) the release of the licensee from certain claims, and (iv) the dismissal of any pending litigation.  In such instances, the intellectual property rights granted have been perpetual in nature, extending until the expiration of the related patents.  Pursuant to the terms of these agreements, we have no further obligations with respect to the granted intellectual property rights, including no obligation to maintain or upgrade the technology, or provide future support or services.  Licensees obtained control of the intellectual property rights they have acquired upon execution of the agreement.  As such, the earnings process is complete and revenue is recognized upon the execution of the agreement, when collectability is probable and all other revenue recognition criteria have been met.

Cost of Revenues

Cost of revenues include the costs and expenses incurred in connection with our patent licensing and enforcement activities, including inventor royalties paid to original patent owners, contingent legal fees paid to external counsel, other patent-related legal expenses paid to external counsel, licensing and enforcement related research, consulting and other expenses paid to third-parties and the amortization of patent-related investment costs.  These costs are included under the caption “Operating costs and expenses” in the accompanying condensed consolidated statements of operations.

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Patents

Our only identifiable intangible assets are patents and patent rights.rights related to our legacy patent licensing operations.  We capitalize patent and patent rights acquisition costs and amortize the cost over the estimated economic useful life.  No patent acquisition costs were capitalized during the sixnine months ended April 30,July 31, 2019 and 2018.  We recorded patent amortization expense of approximately $377,000$419,000 and $163,000$244,000 during the six-monthnine-month periods ended April 30,July 31, 2019 and 2018, respectively.  In evaluating the carrying amount of capitalized patents at January 31, 2019, we determined that based on estimated undiscounted future cash flows a write-down of the carrying amount of approximately $419,000, to a carrying value of approximately $168,000, should be recorded as of January 31, 2019. The carrying value of capitalized patents has been amortized to $-0- as of July 31, 2019. Our estimates of future cash flows arewere based on our most recent assessment of the market for potential licensees, as well as the status of ongoing negotiations with potential licensees. While we may be able to generate future cash flows from this patent portfolio, as of July 31, 2019, we cannot reasonably determine an estimate of any such future cash flows.

2.SUBSEQUENT EVENT

            On August 21, 2019, the Company entered into a settlement agreement in connection with a putative shareholder derivative complaint filed in the Court of Chancery of the State of Delaware on November 5, 2018. See Note 9 to these condensed consolidation financial statements for additional information.  Management reviewed for subsequent events through the date of filing of this Quarterly Report on Form 10-Q and noted no other items requiring disclosure.

3.         STOCK BASED COMPENSATION AND WARRANTS

The Company maintains stock equity incentive plans under which the Company grants incentive stock options, non-qualified stock options, stock appreciation rights, stock awards, performance awards, or stock units to employees, directors and consultants.

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Stock Option Compensation Expense

The compensation cost for service-based stock options granted to employees and directors is measured at the grant date, based on the fair value of the award using the Black-Scholes pricing model, and is expensed on a straight-line basis over the requisite service period (the vesting period of the stock option).  We recorded stock-based compensation expense related to service-based stock options granted to employees and directors of approximately $1,649,000$2,433,000 and $473,000$1,153,000 during the sixnine months ended April 30,July 31, 2019 and 2018, respectively, and approximately $805,000$784,000 and $258,000$702,000 during the three months ended April 30,July 31, 2019 and 2018, respectively.

For stock options granted to employees and directors that vest based on market conditions, such as the trading price of the Company’s common stock exceeding certain price targets, we use a Monte Carlo Simulation in estimating the fair value at grant date and recognize compensation cost over the implied service period (median time to vest).  On May 8, 2018, we issued market condition options to purchase 1,500,000 shares of common stock, to our Chairman, President and Chief Executive Officer,vesting at target trading prices of $5.00 to $8.00 per share before May 31, 2021, with implied service periods of three to seven months.  In October 2018, the first tranche of 500,000 shares of market condition options became exercisable upon achieving an average closing price above $5.00 per share for twenty consecutive trading days.  We recorded stock-based compensation expense related to market condition stock options granted to employees of approximately $376,000 and $2,446,000 during both the sixnine months ended July 31, 2019 and 2018, respectively, and approximately $-0- and $2,446,000 during the three months ended April 30, 2019.   We did not have any market condition stock options during the six months ended April 30, 2018.July 31, 2019 and 2018, respectively.  

On November 1, 2018 we adopted Accounting Standards Update 2018-07 (“ASU 2018-07”) for stock options granted to consultants.  Upon adoption of ASU 2018-07 we estimated the fair value of unvested service-based and performance-based stock options at the date of adoption, using the Black-Scholes pricing model.  Subsequent to adoption of ASU 2018-07, future grants to consultants are measured at the grant date, based on the fair value of the award using the Black-Scholes pricing model, consistent with our policy for grants to employees and directors.  In prior periods, in accordance with US GAAP, we estimated the fair value of service-based and performance-based stock options granted to consultants at each reporting period using the Black-Scholes pricing model.  We recognize the fair value of stock options granted to consultants as consulting expense over the requisite or implied service period of the grant.  We recorded stock-based consulting expense related to stock options granted to consultants of approximately $50,000$75,000 and $148,000$197,000 during the sixnine months ended April 30,July 31, 2019 and 2018, respectively, and approximately $25,000 and $96,000$49,000 during the three months ended April 30,July 31, 2019 and 2018, respectively.

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Stock Option Activity

During the sixnine months ended April 30,July 31, 2019 and 2018, we granted options to purchase 497,00010,000 shares and 3,897,000 shares of common stock, respectively,  to employees, directors and consultants, with exercise prices ranging from $2.30 to $3.84 per share, pursuant to the Anixa Biosciences, Inc. 2010 Share Incentive Plan (the "2010 Share Plan”) and the Anixa Biosciences, Inc. 2018 Share Plan (the “2018 Share Plan”).    We did not grant any options duringDuring the sixnine months ended April 30, 2019.  During the six months ended April 30,July 31, 2019 and 2018, stock options to purchase 30,00040,000 and 48,600 shares of common stock, respectively, were exercised with aggregate proceeds of approximately $80,000$103,000 and $-0-, respectively.  Under certain circumstances, stock options may be exercised on a cashless basis.  During the sixnine months ended April 30,July 31, 2019 and 2018, -0- and 8,784 shares of common stock, respectively, were withheld in connection with cashless exercises of stock options.

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Stock Option Plans

As of April 30,July 31, 2019, we have three stock option plans:  the Anixa Biosciences, Inc. 2003 Share Incentive Plan (the "2003 Share Plan"), the 2010 Share Plan and the 2018 Share Plan, which were adopted by our Board of Directors on April 21, 2003, July 14, 2010 and January 25, 2018, respectively.  The 2018 Share Plan was approved by our shareholders on March 29, 2018.

2003 Plan

The 2003 Share Plan provided for the grant of nonqualified stock options, stock appreciation rights, stock awards, performance awards and stock units to employees, directors and consultants.  In accordance with the provisions of the 2003 Share Plan, the plan terminated with respect to the ability to grant future options on April 21, 2013.  Information regarding the 2003 Share Plan for the sixnine months ended April 30,July 31, 2019 is as follows: