AYTU BIOPHARMA, INC - Quarter Report: 2018 December (Form 10-Q)

 UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended: December 31, 2018

 

or

 

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                      to                     

 

Commission File No. 001-38247

 

AYTU BIOSCIENCE, INC.

(Exact name of registrant as specified in its charter)

 

Delaware		47-0883144
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

 

373 Inverness Parkway, Suite 206

Englewood, Colorado 80112

(Address of principal executive offices, including zip code)

 

(720) 437-6580

(Registrant’s telephone number, including area code)

 

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

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer	☐	Accelerated filer	☐
Non-accelerated filer	☒	Smaller reporting company	☒
		Emerging growth company	☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

As of February 6, 2019, there were 12,390,435 shares of Common Stock outstanding.

 

 

FOR THE QUARTER ENDED DECEMBER 31, 2018

 

INDEX

 

		Page
	PART I—FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements	1
	Consolidated Balance Sheets as of December 31, 2018 (unaudited) and June 30, 2018	1
	Consolidated Statements of Operations for the three and six months ended December 31, 2018 (unaudited) and the three and six months ended December 31, 2017 (unaudited)	2
	Consolidated Statement of Stockholders’ Equity (unaudited)	3
	Consolidated Statements of Cash Flows for the six months ended December 31, 2018 (unaudited) and the six months ended December 31, 2017 (unaudited)	4
	Notes to Consolidated Financial Statements (unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	20
Item 4.	Controls and Procedures	20
	PART II—OTHER INFORMATION
Item 1.	Legal Proceeding	21
Item 1A.	Risk Factors	21
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	21
Item 3.	Defaults Upon Senior Securities	21
Item 4.	Mine Safety Disclosures	21
Item 5.	Other Information	21
Item 6.	Exhibits	21
SIGNATURES		26

 

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act. All statements other than statements of historical facts contained in this Quarterly Report, including statements regarding our anticipated future clinical and regulatory events, future financial position, business strategy and plans and objectives of management for future operations, are forward-looking statements. Forward looking statements are generally written in the future tense and/or are preceded by words such as “may,” “will,” “should,” “forecast,” “could,” “expect,” “suggest,” “believe,” “estimate,” “continue,” “anticipate,” “intend,” “plan,” or similar words, or the negatives of such terms or other variations on such terms or comparable terminology. Such forward-looking statements include, without limitation: the planned expanded commercialization of our products and the potential future commercialization of our product candidates, our anticipated future cash position; our plan to acquire additional assets; our anticipated future growth rates; anticipated sales increases; anticipated net revenue increases; the anticipated arrival dates of certain supply orders; the expected recognition and amounts of certain future expenses and costs of goods sold; anticipated increases to operating expenses, research and development expenses, and selling , general, and administrative expenses; director appointment to fill a current board of director vacancy; and future events under our current and potential future collaborations. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including without limitation the risks described in “Risk Factors” in Part I, Item 1A of our most recent Annual Report on Form 10-K, and in the reports we file with the Securities and Exchange Commission. These risks are not exhaustive. Moreover, we operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time and it is not possible for our management to predict all risk factors, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Forward-looking statements should not be relied upon as predictions of future events. We can provide no assurance that the events and circumstances reflected in the forward-looking statements will be achieved or occur and actual results could differ materially from those projected in the forward-looking statements. We assume no obligation to update or supplement forward-looking statements, except as may be required under applicable law.

 

This Quarterly Report on Form 10-Q includes trademarks, such as Aytu, Natesto, Tuzistra XR, ZolpiMist, ProstaScint, MiOXSYS, RedoxSYS, and Fiera, which are protected under applicable intellectual property laws and we own or have the rights to. Solely for convenience, our trademarks and trade names referred to in this Quarterly Report on Form 10-Q may appear without the ® or TM symbols, but such references are not intended to indicate in any way that we will not assert, to the fullest extent under applicable law, our rights to these trademarks and trade names.  

 

 

 

 

 PART I—FINANCIAL INFORMATION

  

Item 1. Consolidated Financial Statements

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARY

Consolidated Balance Sheets

 

	December 31,	June 30,
	2018	2018
	(unaudited)
Assets
Current assets
Cash and cash equivalents	$17,804,887	$7,012,527
Restricted cash	100,225	100,000
Accounts receivable, net	1,482,490	578,782
Inventory, net	1,644,861	1,338,973
Prepaid expenses and other	944,766	440,009
Total current assets	21,977,229	9,470,291
Fixed assets, net	186,944	218,684
Licensed assets, net	19,999,550	11,120,086
Patents, net	233,278	245,944
Deposits	2,200	5,088
Total long-term assets	20,421,972	11,589,802
Total assets	$42,399,201	$21,060,093
Liabilities and Stockholders' Equity
Current liabilities
Accounts payable and other	$2,371,785	$2,119,672
Accrued liabilities	932,690	185,882
Accrued compensation	743,834	540,674
Current deferred revenue	13,990	-
Current deferred rent	-	1,450
Current contingent consideration	593,173	547,100
Total current liabilities	4,655,472	3,394,778
Long-term contingent consideration	12,783,710	4,146,829
Long-term debt	5,036,164	-
Warrant derivative liability	25,992	93,981
Total liabilities	22,501,338	7,635,588
Commitments and contingencies (Note 7)
Stockholders' equity
Preferred Stock, par value $.0001; 50,000,000 shares authorized; shares issued
and outstanding 4,532,664 and 0, respectively as of
December 31, 2018 and June 30, 2018	453	-
Common Stock, par value $.0001; 100,000,000 shares authorized; shares issued
and outstanding 10,504,769 and 1,794,762, respectively as of
December 31, 2018 and June 30, 2018	1,050	179
Additional paid-in capital	107,258,097	92,681,918
Accumulated deficit	(87,361,737)	(79,257,592)
Total stockholders' equity	19,897,863	13,424,505
Total liabilities and stockholders' equity	$42,399,201	$21,060,093

 

 

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

 

 

Consolidated Statements of Operations

(unaudited)

 

	Three Months Ended December 31,		Six Months Ended December 31,
	2018	2017	2018	2017
Product revenue, net	$1,795,011	$1,051,154	$3,226,820	$2,127,522
Operating expenses
Cost of sales	525,138	385,411	936,097	672,612
Research and development	149,029	(277,486)	304,907	(136,532)
Selling, general and administrative	5,046,174	4,553,366	8,622,754	9,171,769
Selling, general and administrative - related party (Note 11)	91,337	-	345,046	-
Amortization and impairment of intangible assets	534,063	383,811	986,020	769,652
Total operating expenses	6,345,741	5,045,102	11,194,824	10,477,501
Loss from operations	(4,550,730)	(3,993,948)	(7,968,004)	(8,349,979)
Other (expense) income
Other expense, net	(127,569)	(196,781)	(204,130)	(385,526)
Derivative income	20,637	518,051	67,989	817,785
Total other (expense) income	(106,932)	321,270	(136,141)	432,259
Net loss	$(4,657,662)	$(3,672,678)	$(8,104,145)	$(7,917,720)
Weighted average number of
common shares outstanding	6,477,004	205,663	4,183,591	124,056
Basic and diluted net loss
per common share	$(0.72)	$(17.86)	$(1.94)	$(63.82)

  

 

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

 

 

Consolidated Statement of Stockholders’ Equity

(unaudited)

 

	Preferred Stock		Common Stock		Additional paid-in	Accumulated	Total Stockholders'
	Shares	Amount	Shares	Amount	capital	Deficit	Equity
Balance - June 30, 2018	-	$-	1,794,762	$179	$92,681,918	$(79,257,592)	$13,424,505
Stock-based compensation (unaudited)	-	-	-	-	106,671	-	106,671
Issuance of restricted stock (unaudited)	-	-	2,707,022	271	239,234	-	239,505
Commen stock issued to employee (unaudited)	-	-	9,000	1	11,689	-	11,690
Issuance of preferred and common stock, net of $1,479,963 in cash issuance costs (unaudited)	8,342,993	834	1,777,007	178	11,810,373	-	11,811,385
Warrants issued in connection with the registered offering (uniaudited)	-	-	-	-	1,827,628	-	1,827,628
Warrants issued in connection with the registered offering to the placement agents, non-cash issuance costs (unaudited)	-	-	-	-	61,024	-	61,024
Preferred stocks issued in connection with the purchase of assets (unaudited)	400,000	40	-	-	519,560		519,600
Preferred stocks converted into common stock (unaudited)	(4,210,329)	(421)	4,210,329	421	-	-	-
Adjustment for rounding of shares due to stock split (unaudited)	-	-	6,649	-	-	-	-
Net loss (unaudited)	-	-	-	-	-	(8,104,145)	(8,104,145)
Balance - December 31, 2018 (unaudited)	4,532,664	$453	10,504,769	$1,050	$107,258,097	$(87,361,737)	$19,897,863

   

 

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

 

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

(unaudited)

 

	Six Months Ended December 31,
	2018	2017
Cash flows from operating activities
Net loss	$(8,104,145)	$(7,917,720)
Adjustments to reconcile net loss to cash used in operating activities
Stock-based compensation expense	106,671	275,688
Issuance of restricted stock	239,505	103,635
Depreciation, amortization and accretion	1,230,671	1,315,063
Issuance of common stock to employee	11,690	-
Derivative (income)	(67,989)	(817,785)
Changes in operating assets and liabilities:
(Increase) in accounts receivable	(903,708)	(849,397)
(Increase) in inventory	(305,888)	(67,585)
(Increase) in prepaid expenses and other	(504,757)	(454,595)
Increase in accounts payable and other	252,113	1,124,558
Increase (decrease) in accrued liabilities	746,808	(524,905)
Increase in accrued compensation	203,160	497,586
Increase in interest payable	36,164	-
Increase in deferred revenue	13,990	-
(Decrease) in deferred rent	(1,450)	(3,337)
Net cash used in operating activities	(7,047,165)	(7,318,794)
Cash flows used in investing activities
Deposit	2,888	-
Purchases of property and equipment	(12,954)	(12,195)
Contingent consideration payment	(50,221)	-
Purchase of assets	(800,000)	-
Net cash used in investing activities	(860,287)	(12,195)
Cash flows from financing activities
Issuance of preferred, common stock and warrants	15,180,000	11,839,995
Issuance costs related to preferred, common stock and warrants	(1,479,963)	(1,402,831)
Issuance of debt	5,000,000	-
Net cash provided by financing activities	18,700,037	10,437,164
Net change in cash, cash equivalents and restricted cash	10,792,585	3,106,175
Cash, cash equivalents and restricted cash at beginning of period	7,112,527	877,542
Cash, cash equivalents and restricted cash at end of period	$17,905,112	$3,983,717
Non-cash transactions:
Fair value of warrants issued to investors and underwriters	$1,888,652	$-
Issuance of preferred stock related to purchase of asset	$519,600	$-
Contingent consideration	$8,833,219	$-
Warrants issued to investors and underwriters (see Note 6)	$-	$4,117,997
Revenue share payment to Jazz included in accounts payable	$-	$7,385
Earn-out payment to Nuelle Shareholders in common stock	$-	$250,000
Fixed assets included in accounts payable	$-	$62,512

   

 

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

 

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

(unaudited)

 

Note 1 – Business, Basis of Presentation, License and Supply Agreements

 

Business

 

Aytu BioScience, Inc. (“Aytu”, the “Company” or “we”) was incorporated as Rosewind Corporation on August 9, 2002 in the State of Colorado. Aytu was re-incorporated in the state of Delaware on June 8, 2015. Aytu is a specialty pharmaceutical company focused on commercializing novel products that address significant patient needs like hypogonadism (low testosterone), severe cough and respiratory symptoms, insomnia, and male infertility and plans to expand into other therapeutic areas.

  

Basis of Presentation

 

These unaudited consolidated financial statements represent the financial statements of Aytu and its wholly-owned subsidiary, Aytu Women’s Health, LLC. These unaudited consolidated financial statements should be read in conjunction with Aytu’s Annual Report on Form 10-K for the year ended June 30, 2018, which included all disclosures required by generally accepted accounting principles in the United States (“GAAP”). In the opinion of management, these unaudited consolidated financial statements contain all adjustments necessary to present fairly the financial position of Aytu and the results of operations and cash flows for the interim periods presented. The results of operations for the period ended December 31, 2018 are not necessarily indicative of expected operating results for the full year. The information presented throughout this report, as of and for the period ended December 31, 2018, and 2017, is unaudited.

 

The accompanying consolidated financial statements of the Company have been prepared in accordance with GAAP. On August 10, 2018, Aytu effected a reverse stock split in which each common stockholder received one share of common stock for every 20 shares outstanding (herein referred to collectively as the “Reverse Stock Split”). All share and per share amounts in this report have been adjusted to reflect the effect of the Reverse Stock Split.

    

License and Supply Agreement—Natesto

  

In April 2016, Aytu entered into a license and supply agreement to acquire the exclusive U.S. rights to distribute Natesto® (testosterone) nasal gel from Acerus Pharmaceuticals Corporation, or Acerus. We acquired the rights effective upon the expiration of the former licensee’s rights, which occurred on June 30, 2016. The term of the license runs for the greater of eight years or until the expiry of the latest to expire patent including claims covering Natesto and until the entry on the market of at least one AB-rated generic product.

 

In addition to the previously disclosed upfront payments made to Acerus, we agreed to make one-time, non-refundable milestone payments to Acerus within 45 days of certain agreed upon occurrence of the milestones. The maximum aggregate amount payable under such milestone payments is $37.5 million.

 

The fair value of the net identifiable Natesto asset acquired was determined to be $10.5 million, which is being amortized over eight years. The aggregate amortization expense for each of the three-month periods ended December 31, 2018 and 2017 was $329,000. The aggregate amortization expense for each of the six-month periods ended December 31, 2018 and 2017 was $659,000.

 

The contingent consideration was initially valued at $3.2 million using a Monte Carlo simulation, as of June 30, 2016. As of June 30, 2018, the contingent consideration was revalued at $1.8 million using the same Monte Carlo simulation methodology, and based on current interest rates, expected sales potential, and Aytu stock trading variables. The contingent consideration accretion expense for each of the three-month periods ended December 31, 2018 and 2017 was $16,000, and $169,000, respectively. The contingent consideration accretion expense for each of the six-month periods ended December 31, 2018 and 2017 was $31,000, and $330,000, respectively. As of December 31, 2018, none of the milestones had been achieved, and therefore, no milestone payment was made.

 

License Agreement—ZolpiMist

 

In June 2018, Aytu signed an exclusive license agreement for ZolpiMist™ (zolpidem tartrate oral spray) from Magna Pharmaceuticals, Inc., (“Magna”). This agreement allows for Aytu’s exclusive commercialization of ZolpiMist in the U.S. and Canada.

 

Aytu made an upfront payment of $400,000 to Magna upon execution of the agreement. In July 2018, we paid an additional $300,000, of which, $297,000 was included in current contingent consideration at June 30, 2018.

 

 

 

We also agreed to make certain royalty payments to Magna which will be calculated as a percentage of our ZolpiMist net sales and is payable within 45 days of the end of the quarter during which the applicable net sales occur.

 

The contingent consideration, related to these royalty payments, was valued at $2.6 million using a Monte Carlo simulation, as of June 11, 2018. The contingent consideration accretion expense for the three months ended December 31, 2018 and 2017 was $61,000, and $0, respectively. The contingent consideration accretion expense for the six months ended December 31, 2018 and 2017 was $120,000, and $0, respectively.

 

License Development, Manufacturing and Supply Agreement—Tuzistra XR

 

On November 2, 2018, the Company entered into a License, Development, Manufacturing and Supply Agreement (the “Tris License Agreement”) with TRIS Pharma, Inc. (“TRIS”). Pursuant to the Tris License Agreement, TRIS granted the Company an exclusive license in the United States related to Tuzistra XR. In addition, TRIS has agreed to grant the Company an exclusive license in the United States related to a complementary antitussive referred to as “CCP-08” (together with Tuzistra XR, the “Products”) for which marketing approval has been sought by TRIS under a New Drug Application filed with the FDA. As consideration for the Product's license grant, the Company (i) made an upfront cash payment to TRIS; (ii) issued to TRIS shares of Series D Convertible Preferred Stock to TRIS; and (iii) will pay TRIS certain royalty fees through license term in accordance with the Tris License Agreement.

 

The Tris License Agreement was valued at $9.9 million and will be amortized over the life of the Tris License Agreement up to twenty years. The amortization expense for each of the three months ended December 31, 2018 and 2017 was $82,000 and $0, respectively. The amortization expense for each of the six months ended December 31, 2018 and 2017 was $82,000 and $0, respectively.

 

We also agreed to make certain quarterly royalty payments to TRIS which will be calculated as a percentage of our Tuzistra XR net sales, payable within 45 days of the end of the applicable quarter.

 

As of November 2, 2018, the contingent consideration, related to this asset, was valued at $8.8 million using a Monte Carlo simulation. The contingent consideration accretion expense for the three months ended December 31, 2018 and 2017 was $46,000, and $0, respectively. The contingent consideration accretion expense for the six months ended December 31, 2018 and 2017 was $46,000, and $0, respectively.

 

Liquidity Assessment

 

Accounting Standards Update (“ASU”) No. 2014-15, Presentation of Financial Statements - Going Concern, requires management to evaluate the company’s ability to continue as a going concern one year beyond the filing date of the given financial statements. This evaluation requires management to perform two steps. First, management must evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern. Second, if management concludes that substantial doubt is raised, management is required to consider whether it has plans in place to alleviate that doubt. Disclosures in the notes to the financial statements are required if management concludes that substantial doubt exists or that its plans alleviate the substantial doubt that was raised.

 

Prior to the date of this Report, we have financed operations through a combination of private and public debt and equity financings, funds from the sale of our products, and occasionally through divestures of non-strategic assets. Our financing transactions have included private placements of stock and convertible notes, and public offerings of the Company’s equity securities. Since the formation of Aytu in June 2015, the Company has raised approximately $70.1 million, inclusive of the $15.2 million we raised in October 2018, from the sale of its securities to investors and the exercise of warrants by investors and the $5.0 million debt we issued in November 2018. Although it is difficult to predict our liquidity requirements, based upon our current operating plan, as of the date of this Report, we believe we will have sufficient cash to meet our projected operating requirements for the next 12 months.

 

Recently Adopted Accounting Pronouncements

 

In May 2014, the FASB issued ASU 2014-09, Topic 606, Revenue from Contracts with Customers. The amendments in this ASU provide a single model for use in accounting for revenue arising from contracts with customers and supersedes current revenue recognition guidance, including industry-specific revenue guidance. The core principle of the new ASU is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. New disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers are also required. ASC 606 and ASC 340-40 also require the deferral of incremental costs of obtaining contracts with customers and subsequent amortization of those costs of the period of anticipated benefit. Collectively, we refer to this guidance as “ASC 606.”

 

 

   

We adopted the new standard through applying the following conclusions (resulting from a thorough analysis of all contract types): (1) The new guidance did not materially change our existing policy and practice for identifying contracts with customers, nor did it give rise to changes to our existing policy and practice or create new concern surrounding the collectability of our receivables from customers, (2) none of our contracts with customers contain multiple performance obligations that are not fulfilled at the same time, (3) the new guidance did not change our existing policy and practice regarding the recording of variable consideration, and (4) we did not identify any customer acquisition costs that are incremental and that are expected to be recovered at a future time.

 

As mentioned above, the modified retrospective method of transition did not result in a cumulative adjustment as of July 1, 2018. Additionally, no other line items in the statement of operations or the balance sheet reflect any changes due to the adoption of the new standard. Adoption of the standards related to revenue recognition had no impact to cash from or used in operating, financing, or investing on our consolidated cash flows statement.

   

Recently Issued Accounting Pronouncements, Not Adopted as of December 31, 2018

  

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820) Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement.” The amendments in the standard apply to all entities that are required, under existing GAAP, to make disclosures about recurring or nonrecurring fair value measurements. ASU 2018-13 removes, modifies, and adds certain disclosure requirements in ASC 820, Fair Value Measurement. The standard is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019.

 

The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted upon issuance of ASU 2018-13. An entity is permitted to early adopt any removed or modified disclosures upon issuance of ASU 2018-13 and delay adoption of the additional disclosures until their effective date. The Company is currently assessing the impact that ASU 2018-13 will have on its financial statements.

 

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842)”. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. Lessees are required to use a modified retrospective transition approach for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. In July 2018, the FASB issued ASU 2018-10, “Codification Improvements to Topic 842, Leases,” to clarify how to apply certain aspects of the new lease standard. In July 2018, the FASB also issued ASU 2018-11, “Leases (Topic 842): Targeted Improvements,” to give entities another option for transition. The additional option for transition allows an entity to apply the new lease standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. The new standards are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact of its pending adoption of this standard on its financial statements. As of December 31, 2018, the Company has future operating lease payments of approximately $197,000 that are being evaluated. The Company is working on gathering all key lease data elements to meet the requirements of the new guidance. 

 

 

 

We generate all of our revenues from the sale of products. Revenue is recognized when control of these promised products is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those products.

 

The Company determines revenue recognition through the following five-step model:

 

(i) identification of the promised goods or services in the contract;

 

(ii) determination of whether the promised goods or services are performance obligations, including whether they are distinct in the context of the contract;

 

(iii) measurement of the transaction price, including the constraint on variable consideration;

 

(iv) allocation of the transaction price to the performance obligations; and

 

(v) recognition of revenue when, or as the Company satisfies each performance obligation.

   

Product Revenues, Net

 

The Company sells its products principally to a limited number of wholesale distributors and pharmacies in the United States, which account for the largest portion of our total revenues, and international sales are made primarily to specialty distributors, as well as hospitals, laboratories, and clinics many of which are government owned or supported (collectively, its “Customers”). The Company’s Customers in the United States subsequently resell the products to patients and health care providers. In accordance with ASC 606, the Company recognizes net revenues from product sales when the Customer obtains control of the Company’s product, which typically occurs upon delivery to the Customer. The Company’s payment terms are approximately 30 days in the United States and consistent with prevailing practice in international markets.

 

Revenues from product sales are recorded at the net sales price, or “transaction price,” which includes estimates of variable consideration that result from coupons, discounts, chargebacks and distributor fees, processing fees, as well as allowances for returns and government rebates. Provisions are established for the estimates of variable consideration based on the amounts earned or to be claimed on the related sale. Provision balances relating to estimated amounts payable to direct customers are netted against accounts receivable and balances relating to indirect customers are included in accounts payable and accrued liabilities. Where appropriate, the Company utilizes the expected value method to determine the appropriate amount for estimates of variable consideration based on factors such as the Company’s historical experience and specific known market events and trends. We constrain our estimates based on factors that could lead to a probable reversal of revenue.

 

Revenues by Geographic location

 

The following table reflects our product revenues by geographic location as determined by the billing address of our customers:

 

	Three Months Ended December 31,		Six Months Ended December 31,
	2018	2017	2018	2017
U.S	$1,730,000	$965,000	$3,001,000	$1,897,000
Rest-of-the-World	65,000	86,000	226,000	231,000
Total net revenue	$1,795,000	$1,051,000	$3,227,000	$2,128,000

 

Note 3 - Inventories

 

Inventories consist of raw materials, work in process and finished goods and are recorded at the lower of cost or net realizable value, with cost determined on a first-in, first-out basis. Aytu periodically reviews the composition of its inventories to identify obsolete, slow-moving or otherwise unsaleable items. If unsaleable items are observed and there are no alternate uses for the inventory, Aytu will record a write-down to net realizable value in the period that the impairment is first recognized. We currently have a reserve of $11,000 for slow moving inventory as of December 31, 2018 and $0 at June 30, 2018.

 

 

 

	December 31, 2018	June 30, 2018
Finished goods	$1,158,000	$239,000
Raw materials	498,000	1,100,000
Reserve	(11,000)	-
Total inventory	$1,645,000	$1,339,000

 

Note 4 – Fixed Assets

 

Fixed assets are recorded at cost and, once placed in service, are depreciated on a straight-line basis over the estimated useful lives. Leasehold improvements are amortized over the shorter of the estimated economic life or related lease term. Fixed assets consist of the following:

 

	Estimated	As of December 31,	As of June 30,
	Useful Lives in years	2018	2018
Manufacturing equipment	2 - 5	$36,000	$213,000
Leasehold improvements	3	112,000	112,000
Office equipment, furniture and other	2 - 5	315,000	344,000
Lab equipment	3 - 5	90,000	90,000
Less accumulated depreciation and amortization		(366,000)	(540,000)
Fixed assets, net		$187,000	$219,000

 

The depreciation and amortization expense was as follows:

  

	Three Months Ended December 31,		Six Months Ended December 31,
	2018	2017	2018	2017
Depreciation and amortization expense	$16,000	$81,000	$44,000	$161,000

 

Note 5 – Patents

The cost of the oxidation reduction potential (“ORP”) related patents for the RedoxSYS and MiOXSYS Systems was $380,000 when they were acquired and are being amortized over the remaining U.S. patent life of approximately 15 years as of the date, which expires in March 2028. Patents consist of the following:

  

	As of December 31,	As of June 30,
	2018	2018
Patents	$380,000	$380,000
Less accumulated amortization	(147,000)	(134,000)
Patents, net	$233,000	$246,000

 

 

 

	Three Months Ended December 31,		Six Months Ended December 31,
	2018	2017	2018	2017
Amortization expense	$7,000	$6,000	$13,000	$12,000

 

Note 6 – Fair Value Considerations

 

Aytu’s financial instruments include cash and cash equivalents, restricted cash, accounts receivable, accounts payable, accrued liabilities, warrant derivative liability, and contingent consideration. The carrying amounts of financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accounts payable, accrued liabilities, and debt approximate their fair value due to their short maturities. The fair value of the warrant derivative liability was valued using the lattice valuation methodology. The fair value of acquisition-related contingent consideration is based on a Monte Carlo methodology using estimated discounted future cash flows and periodic assessments of the probability of occurrence of potential future events. The valuation policies are determined by the Chief Financial Officer, and the Company’s Board of Directors is informed of any policy change.

 

Authoritative guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. The guidance establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of Aytu. Unobservable inputs are inputs that reflect Aytu’s assumptions of what market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on reliability of the inputs as follows:

 

Level 1:	Inputs that reflect unadjusted quoted prices in active markets that are accessible to Aytu for identical assets or liabilities;
Level 2:	Inputs that include quoted prices for similar assets and liabilities in active or inactive markets or that are observable for the asset or liability either directly or indirectly; and
Level 3:	Unobservable inputs that are supported by little or no market activity.

 

Aytu’s assets and liabilities which are measured at fair value are classified in their entirety based on the lowest level of input that is significant to their fair value measurement. Aytu’s policy is to recognize transfers in and/or out of fair value hierarchy as of the date in which the event or change in circumstances caused the transfer. Aytu has consistently applied the valuation techniques discussed below in all periods presented.

  

The following table presents Aytu’s financial liabilities that were accounted for at fair value on a recurring basis as of December 31, 2018 and June 30, 2018, by level within the fair value hierarchy.

  

	Fair Value Measurements Using
	Level 1	Level 2	Level 3	Total
December 31, 2018
LIABILITIES
Warrant derivative liability	$-	$-	$26,000	$26,000
Contingent consideration	$-	$-	$13,377,000	$13,377,000
June 30, 2018
LIABILITIES
Warrant derivative liability	$-	$-	$94,000	$94,000
Contingent consideration	$-	$-	$4,694,000	$4,694,000

 

 

  

	December 31, 2018	At Issuance
Warrants:
Volatility	166.2%	188.0%
Equivalent term (years)	3.63	5.00
Exercise premium	5%	20%
Risk-free interest rate	2.48%	1.83%
Dividend yield	0.00%	0.00%

  

The following table sets forth a reconciliation of changes in the fair value of the derivative financial liabilities classified as Level 3 in the fair value hierarchy:

  

	Derivative Instruments
Balance as of June 30, 2018	$94,000
Change in fair value included in earnings	(68,000)
Balance as of December 31, 2018	$26,000

   

We classify our contingent consideration liability in connection with the acquisition of Natesto, ZolpiMist and Tuzistra XR within Level 3 as factors used to develop the estimated fair value are unobservable inputs that are not supported by market activity. We estimate the fair value of our contingent consideration liability based on projected payment dates, discount rates, probabilities of payment, and projected revenues. Projected contingent payment amounts are discounted back to the current period using a discounted cash flow methodology.

 

The following table sets forth a summary of changes in the contingent consideration for the period ended December 31, 2018:

  

	Contingent Consideration
Balance as of June 30, 2018	$4,694,000
Increase due to purchase of assets	8,833,000
Increase due to accretion	200,000
Decrease due to contractual payment	(350,000)
Balance as of December 31, 2018	$13,377,000

 

Note 7 – Commitments and Contingencies

Commitments and contingencies are described below and summarized by the following as of December 31, 2018:

 

		Remaining
	Total	2019	2020	2021	2022	2023	Thereafter
Prescription database	$2,185,000	$630,000	$509,000	$534,000	$512,000	$-	$-
Milestone payments	5,500,000	-	-	-	3,000,000	2,500,000	-
Office lease	197,000	61,000	109,000	27,000	-	-	-
	$7,882,000	$691,000	$618,000	$561,000	$3,512,000	$2,500,000	$-

  

 

 

In May 2016, Aytu entered into an agreement with a vendor that will provide Aytu with prescription information. Aytu agreed to pay approximately $1.9 million over three years for access to the database of prescriptions written for Natesto. The payments have been broken down into quarterly payments. In December 2018, Aytu executed an amendment to the contract that added Tuzistra XR and extended the contract through May of 2022. The amendment added $1.7 million to the contract and as of December 31, 2018, Aytu has $2.2 million in payments remaining.

 

Milestone Payments

 

In connection with our intangible assets, Aytu has certain milestone payments that will be payable in the future based around sales performance totaling $5.5 million.

 

Office Lease

 

In June 2018, the Company entered into a 12-month operating lease, beginning on August 1, 2018, for a new office space in Raleigh, North Carolina. This lease has base rent of $1,100 a month, with total rent over the term of the lease of approximately $13,200. In September 2015, the Company entered into a 37-month operating lease in Englewood, Colorado. This lease had an initial base rent of $9,000 a month with a total base rent over the term of the lease of approximately $318,000. In October 2017, the Company signed an amendment to the 37-month operating lease in Englewood, Colorado, extending the lease for an additional 24 months beginning October 1, 2018. The base rent remained $9,000 a month. Rent expense for the respective periods was as follows: 

  

	Three Months Ended December 31,		Six Months Ended December 31,
	2018	2017	2018	2017
Rent expense	$31,000	$35,000	$63,000	$70,000

 

Note 8 -Debt

 

On November 29, 2018, Aytu issued a collateralized $5.0 million promissory note (the “Armistice Note”) to Armistice Capital (“Armistice”). The Armistice Note is collateralized by the future revenue stream from the products licensed to the Company under the Tris License Agreement between the Company and TRIS. The Armistice Note carries an annual interest rate of 8% and has a three-year term with principal and interest payable at that time. The Company has the right, in its sole discretion, to repay the Armistice Note without penalty at any time after December 29, 2018. For the quarter ended December 31, 2018, the Company has not exercised the early repayment option.

 

The interest expense for the three months ended December 31, 2018 and 2017 was $36,000 and $0, respectively. The interest expense for the six months ended December 31, 2018 and 2017 was $36,000 and $0, respectively.

 

Note 9 – Common Stock

  

At December 31, 2018 and June 30, 2018, Aytu had 10,504,769 and 1,794,762 common shares outstanding, respectively, and 4,532,664 and 0 preferred shares outstanding, respectively. The Company has 100 million shares of common stock authorized with a par value of $0.0001 per share and 50 million shares of preferred stock authorized with a par value of $0.0001 per share, of which 500 are designated Series A Convertible Preferred Stock, 161 are designated as Series B Convertible Preferred Stock, 8,342,993 are designated as Series C Convertible Preferred Stock, and 400,000 are designated as Series D Convertible Preferred Stock. Included in the common stock outstanding are 2,744,912 shares of restricted stock issued to executives, directors, employees and consultants.

 

On October 9, 2018, we closed an underwritten public offering, with total gross proceeds of $15.2 million which includes the full exercise of the underwriters’ over-allotment option to purchase additional shares and warrants, before deducting underwriting discounts, commissions and other offering expenses payable by the Company.

 

The securities offered by the Company consist of (i) an aggregate of 457,007 shares of its Common Stock; (ii) an aggregate of 8,342,993 shares of its Series C Convertible Preferred Stock convertible into an aggregate of 8,342,993 shares of Common Stock at a conversion price of $1.50 per share; and (iii) Warrants to purchase an aggregate of 8,800,000 shares of Common Stock at an exercise price of $1.50 per share. The securities were issued at a public offering purchase price of $1.50 per fixed combination of (a) one share of Common Stock and one Warrant; or (b) one share of Series C Preferred Stock and one Warrant. The Common Stock issued had a relative fair value of $533,000 and a fair value of $594,000. The Series C Preferred Stock issued had a relative fair value of $9.7 million and a fair value of $10.8 million. The Warrants are exercisable upon issuance and will expire five years from the date of issuance. The Warrants have a relative fair value of $1.6 million, a fair value of $1.8 million, and gross proceeds of $88,000. The conversion price of the Series C Preferred Stock in the offering as well as the exercise price of the Warrants are fixed and do not contain any variable pricing features, or any price based anti-dilution features.

 

 

 

As of December 31, 2018, investors holding Aytu Series C Preferred shares exercised their right to convert 4,210,329 Aytu Series C Preferred shares into 4,210,329 shares of Aytu common stock.

 

In October 2018, Aytu issued 9,000 shares of common stock to a former employee.

 

On November 2, 2018, the Company issued 400,000 shares of Series D Convertible Preferred Stock as consideration for an asset purchase in a private placement.

 

Note 10 – Equity Instruments

 

Share-based Compensation Plans

  

On June 1, 2015, Aytu’s stockholders approved the Aytu BioScience 2015 Stock Option and Incentive Plan (the “2015 Plan”), which, as amended in July 2017, provides for the award of stock options, stock appreciation rights, restricted stock and other equity awards for up to an aggregate of 3.0 million shares of common stock. The shares of common stock underlying any awards that are forfeited, canceled, reacquired by Aytu prior to vesting, satisfied without any issuance of stock, expire or are otherwise terminated (other than by exercise) under the 2015 Plan will be added back to the shares of common stock available for issuance under the 2015 Plan. As of December 31, 2018, we have 179,841 shares that are available for grant under the 2015 Plan. 

 

Pursuant to the 2015 Stock Plan, 3.0 million shares of the Company’s common stock, are reserved for issuance. The fair value of options granted has been calculated using the Black-Scholes option pricing model. In order to calculate the fair value of the options, certain assumptions are made regarding components of the model, including the estimated fair value of the underlying common stock, the risk-free interest rate, volatility, expected dividend yield and the expected option life. Changes to the assumptions could cause significant adjustments to valuation. Aytu estimates the expected term of granted options based on the average of the vesting term and the contractual term of the options. The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of the grant for treasury securities of similar maturity. There were no issuances during the three months ended December 31, 2018, therefore, no assumptions are used for this quarter.

 

Stock option activity is as follows:

 

	Number of Options	Weighted Average Exercise Price	Weighted Average Remaining Contractual Life in Years
Outstanding June 30, 2018	1,798	$325.97	6.95
Granted	-	$-
Exercised	-	$-
Forfeited/Cancelled	(11)	$328.00
Outstanding December 31, 2018	1,787	$325.96	6.49
Exercisable at December 31, 2018	1,615	$325.74	6.39

  

As of December 31, 2018, there was $54,000 of total unrecognized option-based compensation expense related to non-vested stock options. The Company expects to recognize this expense over a weighted-average period of 0.65 years.

 

During the quarter ended December 31, 2018, Aytu issued 75,000 performance-based stock options out of the 2015 Plan to a consultant. These options vest based on meeting certain market criteria with exercise price of $1.00. Options that require specific events before they begin to vest are valued at grant date. During the quarter, we did not recognize any expense for these options as the specific events are not probable of occurring.

 

 

Restricted stock issued out of the 2015 Stock Plan is as follows:

	Number of Shares	Weighted Average Grant Date Fair Value	Weighted Average Remaining Contractual Life in Years
Unvested at June 30, 2018	37,200	$39.80	9.4
Vested	(850)	$40.40
Granted	2,707,022	$1.30
Cancelled	-	$-
Unvested at December 31, 2018	2,743,372	$1.81	9.6

 

In October 2018, Aytu issued 2,707,022 shares of restricted stock to executives, directors, employees pursuant to the 2015 Plan, which vest in October 2028. Expense will be recognized over the 10-year vesting period.

 

Under the 2015 Plan, there was $4,729,000 of total unrecognized share-based compensation expense related to the non-vested restricted stock as of December 31, 2018. The Company expects to recognize this expense over a weighted-average period of 9.56 years. During the three months ended December 31, 2018, the expense related to these awards was $103,000. During the six months ended December 31, 2018, the expense related to these awards was $139,000.

 

Aytu previously issued 1,540 shares of restricted stock outside the Aytu 2015 Plan, which vest in July 2026. The unrecognized expense related to these shares was $1,496,000 as of December 31, 2018 and will be recognized over the 10-year vesting period, of which 7.52 years remain. During the three months ended December 31, 2018, the expense related to these awards was $50,000. During the six months ended December 31, 2018, the expense related to these awards was $100,000.

 

Stock-based compensation expense related to the fair value of stock options and restricted stock was included in the statements of operations as selling, general and administrative expenses as set forth in the table below:

 

	Three Months Ended December 31,		Six Months Ended December 31,
Selling, general and administrative:	2018	2017	2018	2017
Stock options	$41,000	$81,000	$107,000	$276,000
Restricted stock	153,000	32,000	239,000	104,000
Total share-based compensation expense	$194,000	$113,000	$346,000	$380,000

 

 

 

A summary of all warrants is as follows:

 

	Number of Warrants	Weighted Average Exercise Price	Weighted Average Remaining Contractual Life in Years
Outstanding June 30, 2018	1,882,661	$25.94	4.61
Warrants issued in connection with the October 2018 offering	10,120,000	$1.50
Warrants issued to underwriters in connection with the October 2018 offering	303,600	$1.50
Outstanding December 31, 2018	12,306,261	$5.24	4.67

 

The warrants related to the August Financing issued in fiscal 2018 were valued using the lattice option pricing model. These warrants were accounted for as liability warrants (see assumptions used in Note 6).

 

In connection with our October 2018 public offering, we issued warrants to the investors and underwriters to purchase an aggregate of 10,423,600 shares of the Company's common stock at an exercise price of $1.50 and a term of five years. These warrants are accounted for under equity treatment. These warrants issued had a relative fair value of $1.8 million and a fair value of $2.0 million.

 

Note 11 – Related Party Transactions  

 

Executive Stock Purchases

 

Two Aytu executive officers, Joshua Disbrow and Jarrett Disbrow, participated in the August 2017 offering. Each officer purchased 4,167 units.

 

Three Aytu executive officers, Joshua Disbrow, Jarrett Disbrow and David Green, participated in the March 2018 offering. Joshua Disbrow and Jarrett Disbrow each purchased 11,306 units. Mr. Green purchased 3,330 units.

  

Co-Pay Support

 

In June 2018, the Company entered into a master services agreement with TrialCard Incorporated (“TCI”), a vendor selected to support the Company sponsored co-pay program. In supporting the program, Aytu will prefund certain amounts from which TCI will make disbursements to qualified patients presenting valid prescriptions for Natesto and ZolpiMist on behalf of Aytu. Disbursements will be based upon business rules determined by Aytu. The Company agreed to pay fees monthly to TCI for account management, data analytics, implementation, and technology and to reimburse TCI for certain direct costs incurred by TCI to support the Company’s program. One of the Aytu directors, Mr. Donofrio, is an executive officer of TCI and has no direct interest in the arrangement. 

 

Note 12 – Subsequent Events

 

On November 29, 2018, the Company issued a promissory note to Armistice Capital Master Fund Ltd. (“Armistice”) in the principal amount of $5,000,000 (the “Note”). In order to reduce its long-term debt, the Company and Armistice have enter into an Exchange Agreement dated February 5, 2019, pursuant to which Armistice has agreed, subject to shareholder approval, to exchange the Note for: (i) 3,120,064 shares of Common Stock of the Company, resulting in Armistice owning no more than 33.3% of the outstanding Common Stock of the Company; (ii) 2,751,148 shares of Series E Convertible Preferred Stock of the Company; and (iii) a Common Stock Purchase Warrant exercisable for 4,403,409 shares of Common Stock of the Company (the “Exchange Securities”). Upon issuance of the Exchange Securities, Armistice will cancel the Note and all principal and interest owed thereunder. The Exchange Agreement will also include the forms of: (i) a Certificate of Designation of Preferences, Rights and Limitations of Series E Convertible Preferred Stock; and (ii) the Common Stock Purchase Warrant to be issued to Armistice.

On February 5, we received a conversion notice for 1,900,000 shares of our preferred series C into common stock.

 

 

This discussion should be read in conjunction with Aytu BioScience, Inc.’s Annual Report on Form 10-K for the year ended June 30, 2018, filed on September 6, 2018. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. For additional information regarding these risks and uncertainties, please see the risk factors included in Aytu’s Form 10-K filed with the Securities and Exchange Commission on September 6, 2018.

 

Overview, Liquidity and Capital Resources

 

Aytu is a specialty pharmaceutical company focused on commercializing novel products that address significant patient needs like hypogonadism (low testosterone), severe cough and respiratory symptoms, insomnia, and male infertility and plans to expand into other therapeutic areas as the Company continues to execute on its growth plans.

 

On October 9, 2018, we closed an underwritten public offering, with total gross proceeds of $15.2 million which includes the full exercise of the underwriters’ over-allotment option to purchase additional shares and warrants, before deducting underwriting discounts, commissions and other offering expenses payable by the Company.

 

The securities offered by the Company consist of (i) an aggregate of 457,007 shares of its Common Stock, (ii) an aggregate of 8,342,993 shares of its Series C Convertible Preferred Stock convertible into an aggregate of 8,342,993 shares of Common Stock at a conversion price of $1.50 per share, and (iii) Warrants to purchase an aggregate of 8,800,000 shares of Common Stock at an exercise price of $1.50 per share. The securities were issued at a public offering purchase price of $1.50 per fixed combination of (a) one share of Common Stock and one Warrant or (b) one share of Series C Preferred Stock and one Warrant. The Warrants are exercisable upon issuance and will expire five years from the date of issuance. The conversion price of the Series C Preferred Stock in the offering as well as the exercise price of the Warrants are fixed and do not contain any variable pricing features, or any price based anti-dilution features.

 

In connection with this offering, the underwriters exercised their over-allotment option in full and purchased an additional 1,320,000 shares of Common Stock and 1,320,000 Warrants.

 

On November 30, 2018 the Board of Directors of Aytu expanded the size of the Board of Directors by two seats and elected Ketan B. Mehta as a director. We anticipate that the Board of Directors will elect Steven J. Boyd to fill the remaining vacancy in the third quarter of fiscal 2019.

 

Prior to the date of this Report, we have financed operations through a combination of private and public debt and equity financings, funds from the sale of our products, and occasionally through divestures of non-strategic assets. Our financing transactions have included private placements of stock and convertible notes, and public offerings of the Company’s equity securities. Since the formation of Aytu in June 2015, we have raised approximately $70.1 million from the sale of its securities to investors and the exercise of warrants by investors. Although it is difficult to predict our liquidity requirements, based upon our current operating plan, as of the date of this Report, we believe we will have sufficient cash to meet our projected operating requirements for fiscal 2019 and through February 2020.

 

We have incurred accumulated net losses since inception, and at December 31, 2018, we had an accumulated deficit of $87.4 million. Our net loss was $4.7 million for the three months ended December 31, 2018 and we used $7.0 million in cash from operating activities during the six months ended December 31, 2018. As of December 31, 2018, we had cash, cash equivalents and restricted cash totaling $17.9 million and other current assets with an aggregate balance of $4.1 million available to fund our operations, offset by an aggregate of $3.3 million in accounts payable and others and accrued liabilities. In October 2018, we raised gross proceeds of $15.2 million in a public offering, and in November 2018, we raised $5.0 million of debt which requires no cash payment until maturity in November 2022.

 

We are a relatively young company with substantial revenue growth expectations as demonstrated by the nearly 25% quarter-over-quarter net revenue growth for the three months ended December 31, 2018, and 108% growth in net revenue for the first six months of fiscal 2019 over prior six months period ended June 30, 2018. Our primary activities are focused on commercializing our approved product portfolio, including Natesto, Tuzistra XR, and ZolpiMist, building our commercial infrastructure, improving patient access, and improving the effectiveness and reach of our sales force.

 

 

 

ACCOUNTING POLICIES

 

Significant Accounting Policies and Estimates

 

Our consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the consolidated financial statements, and the reported amounts of expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to recoverability and useful lives of long-lived assets, stock compensation, valuation of derivative instruments, allowances, contingencies and going concern. Management bases its estimates and judgments on historical experience and on various other factors that the Company believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The methods, estimates, and judgments used by us in applying these critical accounting policies have a significant impact on the results we report in our consolidated financial statements. Our significant accounting policies and estimates are included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2018, filed with the SEC on September 6, 2018.

  

Information regarding our accounting policies and estimates can be found in the Notes to the consolidated Financial Statements. 

 

Newly Issued Accounting Pronouncements

 

Information regarding the recently issued accounting standards (adopted and pending adoption as of December 31, 2018) is combined in Note 1 to the consolidated financial statements.

 

RESULTS OF OPERATIONS

 

Results of Operations – Three and six months ended December 31, 2018 compared to December 31, 2017

 

Results of operations for the three months ended December 31, 2018 and the three months ended December 31, 2017 reflected losses of approximately $4.7 million and $3.7 million, respectively. These losses include, in part, non-cash charges related to stock-based compensation, depreciation, amortization and accretion, issuance of restricted stock, and derivative income in the amount of $859,000 for the three months ended December 31, 2018 and $256,000 for the three months ended December 31, 2017, respectively. The non-cash charges increased in the three months ended December 31, 2018 primarily due to an increase in depreciation, amortization and accretion, and the issuance of restricted stock.

 

Results of operations for the six months ended December 31, 2018 and the six months ended December 31, 2017 reflected losses of approximately $8.1 million and $7.9 million, respectively. These losses include, in part, non-cash charges related to stock-based compensation, depreciation, amortization and accretion, issuance of restricted stock, and derivative income in the amount of $1.5 million for the six months ended December 31, 2018 and $877,000 million for the six months ended December 31, 2017, respectively. The non-cash charges increased in the six months ended December 31, 2018 primarily due to the reduction in warrant derivative income.

 

 

 

Product revenue

 

We recognized net revenue from product sales of $1.8 million and $1.1 million for the three months ended December 31, 2018 and 2017, respectively. We recognized net revenue from product sales of $3.2 million and $2.1 million for the six months ended December 31, 2018 and 2017, respectively. Our product portfolio includes Natesto, Tuzistra XR, ZolpiMist, and the MiOXSYS and RedoxSYS Systems, but the majority of our revenue currently comes from Natesto sales.

  

As is customary in the pharmaceutical industry, our gross product sales are subject to a variety of deductions in arriving at reported net product sales. Provisions for these deductions are recorded concurrently with the recognition of gross product revenue and include coupons, discounts, chargebacks, distributor fees, processing fees, as well as allowances for returns and government rebates. Provision deductions relating to estimated amounts payable to direct customers are netted against accounts receivable and balances relating to indirect customers are included in accounts payable and accrued liabilities. The provisions recorded to reduce gross product sales to net product sales are as follows:

 

	Three Months Ended December 31,		Six Months Ended December 31,
	2018	2017	2018	2017
Gross product revenue	$3,368,000	$2,028,000	$5,688,000	$4,272,000
Provisions to reduce gross product sales to net product sales	(1,573,000)	(977,000)	(2,461,000)	(2,144,000)
Net product revenue	$1,795,000	$1,051,000	$3,227,000	$2,128,000
Percentage of gross sales to net sales	53.3%	51.8%	56.7%	49.8%

 

Expenses

 

Cost of Sales

 

The cost of sales of $525,000 and $385,000 recognized for the three months ended December 31, 2018 and 2017, respectively, and $936,000 and $673,000 recognized for the six months ended December 31, 2018 and 2017, respectively, are related to Natesto, Tuzistra XR, ZolpiMist, and the MiOXSYS and RedoxSYS Systems. We expect cost of sales to increase in the future due to and in line with growth in revenue from product sales.

 

Research and Development

 

Research and development costs consist of clinical trials and sponsored research which includes manufacturing development, and consultants and other. These costs relate solely to research and development without an allocation of general and administrative expenses and are summarized as follows:

 

	Three Months Ended December 31,		Six Months Ended December 31,
	2018	2017	2018	2017
Clinical trials and sponsored research	$116,000	$(278,000)	$236,000	$(139,000)
Consultants and other	33,000	1,000	69,000	2,000
	$149,000	$(277,000)	$305,000	$(137,000)

 

Comparison of Three and Six Months Ended December 31, 2018 and 2017

 

Research and development expenses increased $426,000, or 153.8%, for the three months ended December 31, 2018 compared to the three months ended December 31, 2017. Research and development expenses increased $442,000, or 322.6%, for the six months ended December 31, 2018 compared to the six months ended December 31, 2017.The increase was due primarily to the absence of a reversal of a previously accrued liability, which we had present in December of 2017. We anticipate research and development expense to increase in fiscal 2019 as we anticipate funding a study to further support the clinical application of our MiOXSYS System, and to fund further clinical studies for Natesto to potentially support new claims and/or to comply with FDA post-marketing study requirements.

 

 

 

Selling, general and administrative expenses consist of labor costs, including personnel costs for employees in executive, commercial, business development and administrative functions; stock-based compensation; patents and intellectual property; professional fees including legal, auditing, accounting, investor relations, shareholder expense and printing and filing of SEC reports; occupancy, travel and other expenses including rent, governmental and regulatory compliance, insurance, and professional subscriptions; directors fees; and sales & marketing – related party, which includes payments to TCI for the Company sponsored co-pay program. These costs are summarized as follows:

 

	Three Months Ended December 31,		Six Months Ended December 31,
	2018	2017	2018	2017
Labor	$2,376,000	$2,371,000	$4,657,000	$4,772,000
Stock-based compensation	194,000	112,000	346,000	379,000
Patent costs	55,000	107,000	108,000	235,000
Professional fees	274,000	312,000	416,000	731,000
Occupancy, travel and other	2,106,000	1,611,000	3,014,000	2,975,000
Directors fees	42,000	40,000	82,000	80,000
Sales & marketing - related party	91,000	-	345,000	-
	$5,138,000	$4,553,000	$8,968,000	$9,172,000

 

Comparison of Three and Six Months Ended December 31, 2018 and 2017

 

Selling, general and administrative costs increased $585,000, or 12.8%, for the three months ended December 31, 2018, compared to the three months ended December 31, 2017. The primary increase was due to occupancy, travel and other, which included expenses related to our annual National Sales Meeting, sales & marketing – related party, which included payments to TCI for the Company sponsored co-pay program, and stock-based compensation. Selling, general and administrative costs decreased $204,000, or 2.2%, for the six months ended December 31, 2018, compared to the six months ended December 31, 2017. The primary decrease was due to professional fees and patent costs decreasing. Professional fees decreased because we used outside accounting firms less, and patent fees decreased as we abandoned ProstaScint and Fiera related patents. We expect selling, general and administrative expenses to increase slightly in the remainder of fiscal 2019 due to expanding our sales team and launching Tuzistra XR.

 

Amortization of Intangible Assets

 

Amortization of intangible assets was $534,000 for the three months ended December 31, 2018, and $384,000 for the three months ended December 31, 2017. Amortization of intangible assets was $986,000 for the six months ended December 31, 2018, and $770,000 for the six months ended December 31, 2017. This expense increased due to amortization of the related finite-lived intangible assets. We expect this expense to remain flat for the remainder of 2019.

 

Net Cash Used in Operating Activities