AYTU BIOPHARMA, INC - Quarter Report: 2019 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, 2019

 

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.

(www.aytubio.com)

 

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   ☒

 

Title of each class		Trading Symbol(s)		Name of each exchange on which registered
Common Stock, par value $0.0001 per share		AYTU		The NASDAQ Stock Market LLC

 

As of February 1, 2019, there were 23,018,052 shares of Common Stock outstanding.

 

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARIES

FOR THE QUARTER ENDED DECEMBER 31, 2019

 

INDEX

 

		Page
	PART I—FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements	4
	Consolidated Balance Sheets as of December 31, 2019 (unaudited) and June 30, 2019	4
	Consolidated Statements of Operations for the three and six months ended December 31, 2019 (unaudited) and the three and six months ended December 31, 2018 (unaudited)	5
	Consolidated Statement of Stockholders’ Equity for the year-to-date interim periods ended December 31, 2019 (unaudited) and December 31, 2018 (unaudited)	6
	Consolidated Statements of Cash Flows for the six months ended December 31, 2019 (unaudited) and the six months ended December 31, 2018 (unaudited)	7
	Notes to Consolidated Financial Statements (unaudited)	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33
Item 4.	Controls and Procedures	33
	PART II—OTHER INFORMATION
Item 1.	Legal Proceeding	34
Item 1A.	Risk Factors	34
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	44
Item 3.	Defaults Upon Senior Securities	44
Item 4.	Mine Safety Disclosures	44
Item 5.	Other Information	44
Item 6.	Exhibits	44
SIGNATURES		45

 

  

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; 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; 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, ZolpiMist, MiOXSYS, AcipHex® Sprinkle™, Cefaclor for Oral Suspension, Karbinal® ER, Flexichamber™, Poly-Vi-Flor® and Tri-Vi-Flor™ 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

 

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

 

	December 31,	June 30,
	2019	2019
	(Unaudited)
Assets
Current assets
Cash and cash equivalents	$5,259,492	11,044,227
Restricted cash	251,396	250,000
Accounts receivable, net	5,197,151	1,740,787
Inventory, net	2,491,807	1,440,069
Prepaid expenses and other	2,361,249	957,781
Note receivable	1,350,000	–
Other current assets	1,426,617	–
Total current assets	18,337,712	15,432,864
Fixed assets, net	122,064	203,733
Licensed assets, net	17,724,416	18,861,983
Patents, net	207,944	220,611
Right-of-use asset	374,568	–
Product technology rights	22,321,667	–
Deposits	2,200	2,200
Goodwill	15,387,064	–
Total long-term assets	56,139,923	19,288,527
Total assets	$74,477,635	$34,721,391
Liabilities
Current liabilities
Accounts payable and other	$9,598,567	$2,297,270
Accrued liabilities	2,114,060	1,147,740
Accrued compensation	786,769	849,498
Current lease liability	82,755	–
Current contingent consideration	705,880	1,078,068
Current portion of fixed payment arrangements	2,661,456	–
Total current liabilities	15,949,487	5,372,576
Long-term contingent consideration	17,739,964	22,247,796
Long-term lease liability	291,813	–
Long-term fixed payment arrangements	23,394,761	–
Warrant derivative liability	11,371	13,201
Total liabilities	57,387,395	27,633,573
Commitments and contingencies (Note 12)
Stockholders' equity
Preferred Stock, par value $.0001; 50,000,000 shares authorized; shares issued and outstanding 10,215,845 and 3,594,981, respectively as of December 31, 2019 (unaudited) and June 30, 2019.	1,022	359
Common Stock, par value $.0001; 100,000,000 shares authorized; shares issued and outstanding 20,733,052 and 17,538,071, respectively as of December 31, 2019 (unaudited) and June 30, 2019.	2,073	1,754
Additional paid-in capital	128,619,922	113,475,205
Accumulated deficit	(111,532,777)	(106,389,500)
Total stockholders' equity	16,758,367	7,087,818
Total liabilities and stockholders' equity	$74,477,635	$34,721,391

 

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(unaudited)

 

	Three Months Ended December 31,		Six Months Ended December 31,
	2019	2018	2019	2018
Revenues
Product revenue, net	$3,175,236	$1,795,011	$4,615,062	$3,226,820
Operating expenses
Cost of sales	606,046	525,138	981,766	936,097
Research and development	66,675	149,029	144,695	304,907
Selling, general and administrative	6,516,160	5,046,174	11,662,603	8,622,754
Selling, general and administrative - related party	–	91,337	–	345,046
Amortization of intangible assets	953,450	534,063	1,528,567	986,020
Total operating expenses	8,142,331	6,345,741	14,317,631	11,194,824
Loss from operations	(4,967,095)	(4,550,730)	(9,702,569)	(7,968,004)
Other (expense) income
Other (expense), net	(446,958)	(127,569)	(642,344)	(204,130)
Gain from derecognition of contingent consideration liability	5,199,806	–	–	–
Gain from warrant derivative liability	–	20,637	1,830	67,989
Total other (expense) income	4,752,848	(106,932)	4,559,292	(136,141)
Net loss	$(214,247)	$(4,657,662)	$(5,143,277)	$(8,104,145)
Weighted average number of common shares outstanding	17,538,148	6,477,004	16,425,990	4,183,591
Basic and diluted net loss per common share	$(0.01)	$(0.72)	$(0.31)	$(1.94)

 

See the accompanying Notes to the Consolidated Financial Statements

 

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARIES

Consolidated Statement of Stockholders’ Equity

(unaudited unless indicated otherwise)

 

	Preferred Stock		Common Stock		Additional paid-in	Accumulated	Total Stockholders'
	Shares	Amount	Shares	Amount	capital	Deficit	Equity
BALANCE - June 30, 2019	3,594,981	$359	17,538,071	$1,754	$113,475,205	$(106,389,500)	$7,087,818
Stock-based compensation (unaudited)	–	–	–	–	165,171	–	165,171
Preferred stock converted in common stock (unaudited)	(443,833)	(44)	443,833	44	–	–	–
Net loss (unaudited)	–	–	–	–	–	(4,929,030)	(4,929,030)
BALANCE - September 30, 2019 (unaudited)	3,151,148	$315	17,981,904	$1,798	$113,640,376	$(111,318,530)	$2,323,959
Stock-based compensation (unaudited)	–	–	–	–	162,264	–	162,264
Issuance of Series F preferred stock from October 2019 private placement financing, net of $741,650 issuance costs (unaudited)	10,000	1	–	–	5,249,483	–	5,249,484
Warrants issued in connection with the private placement (unaudited)	–	–	–	–	4,008,866	–	4,008,866
Issuance of Series G preferred stock due to acquisition of the Cerecor portfolio of pediatrics therapeutics (unaudited)	9,805,845	981	–	–	5,558,933		5,559,914
Preferred stock converted in common stock (unaudited)	(2,751,148)	(275)	2,751,148	275	–	–	–
Net loss (unaudited)	–	–	–	–	–	(214,247)	(214,247)
BALANCE - December 31, 2019 (unaudited)	10,215,845	$1,022	20,733,052	$2,073	$128,619,922	$(111,532,777)	$17,090,240

  

	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)	–	–	–	–	152,114	–	152,114
Adjustment for rounding of shares due to stock split	–	–	6,649	1	(1)	–	–
Net loss (unaudited)	–	–	–	–	–	(3,446,483)	(3,446,483)
BALANCE - September 30, 2018 (unaudited)	–	$–	1,801,411	$180	$92,834,031	$(82,704,075)	$10,130,136
Stock-based compensation (unaudited)	–	–	2,707,022	270	193,792	–	194,062
Common 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 (unaudited)	–	–	–	–	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	–	–	–
Net loss (unaudited)	–	–	–	–	–	(4,657,662)	(4,657,662)
BALANCE - December 31, 2018 (unaudited)	4,532,664	$453	10,504,769	$1,050	$107,258,097	$(87,361,737)	$19,897,863

 

   See the accompanying Notes to the Consolidated Financial Statements

 

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

 

	Six Months Ended December 31,
	2019	2018
Operating Activities
Net loss	$(5,143,277)	$(8,104,145)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation, amortization and accretion	2,157,540	1,230,671
Stock-based compensation expense	327,435	346,176
Derecognition of contingent consideration	(5,199,806)	–
Issuance of common stock to employee	–	11,690
Derivative income	(1,830)	(67,989)
Changes in operating assets and liabilities:
(Increase) in accounts receivable	(3,456,364)	(903,708)
(Increase) in inventory	(132,199)	(305,888)
(Increase) in prepaid expenses and other	(171,430)	(504,757)
(Increase) in other current assets	(136,694)	–
Increase in accounts payable and other	2,806,973	252,113
Increase in accrued liabilities	145,467	760,798
(Decrease) Increase in accrued compensation	(62,729)	203,160
(Decrease) in fixed payment arrangements	(216,150)	–
Increase in interest payable	–	36,164
(Decrease) in deferred rent	(3,990)	(1,450)
Net cash used in operating activities	(9,087,054)	(7,047,165)
Investing Activities
Deposit	–	2,888
Purchases of fixed assets	–	(12,954)
Contingent consideration payment	(104,635)	(50,221)
Note receivable	(1,350,000)	–
Purchase of assets	(4,500,000)	(800,000)
Net cash used in investing activities	(5,954,635)	(860,287)
Financing Activities
Issuance of preferred, common stock and warrants	10,000,000	15,180,000
Issuance costs related to preferred, common stock and warrants	(741,650)	(1,479,963)
Issuance of debt	–	5,000,000
Net cash provided by financing activities	9,258,350	18,700,037
Net change in cash, restricted cash and cash equivalents	(5,783,339)	10,792,585
Cash, restricted cash and cash equivalents at beginning of period	11,294,227	7,112,527
Cash, restricted cash and cash equivalents at end of period	$5,510,888	$17,905,112
Supplemental disclosures of cash and non-cash investing and financing transactions
Cash paid for interest	$161,890	$–
Fair value of right-to-use asset and related lease liability	374,568	–
Issuance of Series G preferred stock due to acquisition of the Cerecor portfolio of pediatrics therapeutics (unaudited)	5,559,914	–
Inventory payment included in accounts payable	460,416	–
Contingent consideration included in accounts payable	16,014	–
Fixed payment arrangements included in accounts payable	291,666	–
Exchange of convertible preferred stock into common stock	319	–
Return deductions received by Cerecor	1,309,365	–
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 related to purchase of asset	$–	$8,833,219

  

See the accompanying Notes to the Consolidated Financial Statements

 

  

AYTU BIOSCIENCE, INC. AND SUBSIDIARIES

 

Notes to Consolidated Financial Statements

(unaudited)

 

 

Nature of 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 global commercialization of novel products addressing significant medical needs such as hypogonadism (low testosterone), cough and upper respiratory symptoms, insomnia, male infertility, various pediatric conditions and the Company plans to expand opportunistically into other therapeutic areas.

 

The Company is currently focused on commercialization of the following products (i) Natesto®, a testosterone replacement therapy, or TRT, (ii) Tuzistra® XR, a codeine–based antitussive, (iii) ZolpiMist™, a short-term insomnia treatment and (iv), MiOXSYS®, a novel in vitro diagnostic system for male infertility assessment. Additionally, the Company completed an Asset Purchase Agreement (the “Purchase Agreement”) with Cerecor, Inc (“Cerecor”) on November 1, 2019, acquiring six products, (i) AcipHex® Sprinkle™, (ii) Cefaclor for Oral Suspension, (iii) Karbinal® ER, (iv) Flexichamber™, (v) Poly-Vi-Flor® and Tri-Vi-Flor™ (the “Pediatric Portfolio”) (see below and Note 2). The Company immediately began to include the acquired Pediatric Portfolio in its commercialization efforts.

 

In the future the Company will seek to acquire additional commercial-stage or near-market products, including existing products the Company believes can offer distinct clinical advantages and patient benefits over other marketed products. The management team’s prior experience has involved identifying both clinical-stage and commercial-stage assets that can be launched or re-launched to increase value, with a focused commercial infrastructure specializing in novel, niche products.

 

Financial Condition. As of December 31, 2019, the Company had approximately $5.5 million of cash, cash equivalents and restricted cash. The Company’s operations have historically consumed cash and are expected to continue to require cash, but at a declining rate.

 

On November 1, 2019, the Company closed an asset acquisition with Cerecor, Inc. (“Cerecor”) whereby the Company acquired certain of Cerecor’s Portfolio of Pediatric Therapeutics (the “Pediatric Portfolio”) for $4.5 million in cash, approximately 9.8 million shares of Series G Convertible Preferred Stock, the assumption of Cerecor’s financial and royalty obligations, which includes not more than $3.5 million of Medicaid rebates and products returns as they come due, and other assumed liabilities associated with the Pediatric Portfolio (see Note 2).

 

In addition, the Company has assumed obligations in connection with the Pediatric Portfolio acquisition due to an investor including fixed and variable payments. The Company assumed fixed monthly payments equal to $0.1 million from November 2019 through January 2021 plus $15 million due in January 2021. Monthly variable payments due to the same investor are equal to 15% of net revenue generated from a subset of the Product Portfolio, subject to an aggregate monthly minimum of $0.1 million, except for January 2020, when a one-time payment of $0.2 million is due. The variable payment obligation continues until the earlier of: (i) aggregate variable payments of approximately $9.5 million have been made, or (ii) February 12, 2026.

 

The Company expects to require capital beyond operating need to complete and integrate the Pediatric Portfolio acquisition and the merger with Innovus Pharmaceuticals, Inc. (“Innovus”), approved by the shareholders of both companies on February 13, 2020, and expected to close February 14, 2020 (the “Merger”) (see below). Revenues for the three-months ended December 31, 2019 increased 77% compared to the three-months ended December 31, 2018, and revenues increased 100% and 14% for each of the years ended June 30, 2019 and 2018, respectively. Revenue is expected to continue to increase long-term, allowing the Company to rely less on our existing cash and cash equivalents, and proceeds from financing transactions. Cash used in operations during the six-months ended December 31, 2019 was $9.1 million compared to $7.0 million for the six-months ended December 31, 2018, due primarily to the Company’s acquisition and integration of the Pediatric Portfolio, which consumed additional cash resources.

 

On October 11, 2019, the Company entered into Securities Purchase Agreements (the “Purchase Agreement”) with two institutional investors (the “Investors”) providing for the issuance and sale by the Company (the “October 2019 Offering”) of $10.0 million of, (i) shares of the Company’s Series F Convertible Preferred Stock (the “Preferred Stock”) which are convertible into shares of common stock (the “Conversion Shares”) and (ii) warrants (the “Warrants”) which are exercisable for shares of common stock (the “Warrant Shares”), which expire January 10, 2025, for a stated value of $1,000 per unit. The closing of the October 2019 offering occurred on October 16, 2019. The Warrants had an exercise price equal to $1.25 and contain a cashless exercise provision. This provision was dependent on (i) performance of the Company’s stock price between October 11, 2019 and the date of exercise of all, or a portion of the Warrants, and (ii) subject to shareholder approval of the October 2019 Offering, which was approved January 24, 2020. On January 27, 2020, 2.0 million cashless warrants were exercised to acquire 2.0 million shares of the Company’s common stock.

 

The net proceeds that the Company received from the October 2019 Offering were approximately $9.3 million. The net proceeds received by the Company from the October 2019 Offering will be used for general corporate purposes, including working capital.

 

  

As of the date of this Report, the Company expects its commercial costs for its current operation to increase modestly as the Company integrates the acquisition of the Pediatrics Portfolio and continues to focus on revenue growth through increasing product sales. The Company’s total asset position totaling $74.5 million plus the proceeds expected from ongoing product sales will be used to fund operations. The Company will access the capital markets to fund operations when needed, and to the extent it is required. The timing and amount of capital that may be raised is dependent on market conditions and the terms and conditions upon which investors would require to provide such capital. There is no guarantee that capital will be available on terms favorable to the Company and its stockholders, or at all. However, the Company has been successful in accessing the capital markets in the past and is confident in its ability to access the capital markets again, if needed. Since the Company does not have sufficient cash and cash equivalents on-hand as of December 31, 2019 to cover potential net cash outflows for the twelve months following the filing date of this Quarterly Report, ASU 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40) requires the Company to report that there exists an indication of substantial doubt about its ability to continue as a going concern.

 

As of the date of this report, the Company has inadequate capital resources to complete its near-term operating and transaction objectives. In anticipation of the cash outlays related to the merger, the Pediatric Portfolio acquisition, and funding the Company’s operations, the Company has taken the following steps to address its post-closing cash needs, including, but not limited to (i) engaging a placement agent to refinance the fixed obligation, and (ii) engaging in discussions with lenders to establish a debt facility to provide the Company with capital while considering other funding strategies. The Company will also require the investors that participated in the October PIPE to waive the financing prohibition which expires in April 2020. There is no guarantee that capital will be available on terms that the Company considers to be favorable. However, the Company has been successful in accessing the capital markets in the past and the Company is confident in its ability to access the capital markets again, if needed.

 

If the Company is unable to raise adequate capital in the future when it is required, the Company can adjust its operating plans to reduce the magnitude of the capital need under its existing operating plan. Some of the adjustments that could be made include delays of and reductions to commercial programs, reductions in headcount, narrowing the scope of the Company’s commercial plans, or reductions to its research and development programs. Without sufficient operating capital, the Company could be required to relinquish rights to products or renegotiate to maintain such rights on less favorable terms than it would otherwise choose. This may lead to impairment or other charges, which could materially affect the Company’s balance sheet and operating results.

 

The Pending Merger. The Company entered into a definitive merger agreement (the “Merger Agreement”) between the Company and Innovus on September 12, 2019. The Merger was approved by the shareholders of both companies February 13, 2020 and is expected to close February 14, 2020.

 

Upon closing, the Merger will cause for the Company to retire all of the outstanding common stock of Innovus for an estimate of (i) up to approximately 3.7 million in shares of the Company’s common stock and, (ii) up to $16 million in milestone payments in the form of contingent value rights (CVRs) may be paid to Innovus shareholders in cash or stock over the next five years if certain revenue and profitability milestones are achieved. Innovus specializes in commercializing, licensing and developing safe and effective over-the-counter consumer health products and supplements. The Company anticipates that this transaction will formally close on February 14, 2020, subject to shareholder approval. The outstanding Innovus warrants with cash out rights will receive Aytu preferred stock and such warrants will be retired. The remaining outstanding Innovus warrants will retain the right to be exercised for merger consideration.

 

Nasdaq Listing Compliance. The Company’s common stock is listed on The Nasdaq Capital Market. In order to maintain compliance with Nasdaq listing standards, the Company must, amongst other requirements, maintain a stockholders’ equity balance of at least $2.5 million pursuant to Nasdaq Listing Rule 5550(b). In that regard, on September 30, 2019, the Company’s stockholders’ equity totaled approximately $2.3 million, thereby potentially resulting in a stockholders’ equity deficiency upon the filing of the September 30, 2019 Form 10-Q. However, subsequent to September 30, 2019, the Company completed (i) the Offering with the Investors, raising approximately $9.3 million, net in equity financing (see Note 1), and (ii) the “Asset Purchase Agreement” in which the Company issued approximately 9.8 million shares of Series G Convertible Preferred Stock worth approximately $5.6 million, resulting in an increase in stockholders’ equity of approximately $14.8 million in the aggregate. Accordingly, as of the filing of this Form 10-Q for the three and six months ended December 31, 2019, the Company’s stockholders’ equity balance exceeds the minimum $2.5 million threshold and, therefore, the Company believes it is currently in compliance with all applicable Nasdaq Listing Requirements. No formal communication has been received from the Nasdaq Capital Markets indicating anything to the contrary.   

 

Basis of Presentation. The unaudited consolidated financial statements contained in this report represent the financial statements of Aytu and its wholly-owned subsidiaries, Aytu Women’s Health, LLC, Aytu Acquisition Sub, LLC, and Aytu Therapeutics, LLC. The unaudited consolidated financial statements should be read in conjunction with Aytu’s Annual Report on Form 10-K for the year ended June 30, 2019, 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, 2019 are not necessarily indicative of expected operating results for the full year. The information presented throughout this report, as of and for the three- and six- month periods ended December 31, 2019, and 2018, is unaudited.

  

  

Adoption of New Accounting Pronouncements

 

Leases (“ASU 2016-02”). In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02 – Topic 842 Leases. ASU 2016-02 requires that most leases be recognized on the financial statements, specifically the recognition of right-to-use assets and related lease liabilities, and enhanced disclosures about leasing arrangements. The objective is to provide improved transparency and comparability among organizations. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The standard requires using the modified retrospective transition method and apply ASU 2016-02 either at (i) latter of the earliest comparative period presented in the financial statements or commencement date of the lease, or (ii) the beginning of the period of adoption. The Company has elected to apply the standard at the beginning period of adoption, July 1, 2019 which resulted in no cumulative adjustment to retained earnings.

 

The Company has elected to apply the short-term scope exception for leases with terms of 12 months or less at the inception of the lease and will continue to recognize rent expense on a straight-line basis. As a result of the adoption, on July 1, 2019, the Company recognized a lease liability of approximately $0.4 million, which represented the present value of the remaining minimum lease payments using an estimated incremental borrowing rate of 8%. As of December 31, 2019, the Company recognized a right-to-use asset of approximately $0.4 million. Lease expense did not change materially as a result of the adoption of ASU 2016-02.

 

Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815) (“ASU 2017-11”). In July 2017, the FASB issued ASU No. 2017-11 — Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815). Part I to ASU 2017-11 eliminates the requirement to consider “down round” features when determining whether certain equity-linked financial instruments or embedded features are indexed to an entity’s own stock. In addition, entities will have to make new disclosures for financial instruments with down round features and other terms that change conversion or exercise prices. Part I to ASU 2017-11 is effective for fiscal years beginning after December 31, 2018. The Company adopted this standard update as a result of the issuance of the Series F Preferred stock as a result of the October 2019 Offering.

 

Recently Accounting Pronouncements

 

Fair Value Measurements (“ASU 2018-03”). 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, with the impact mostly related to certain assets acquired or liabilities assumed that comprise Level 3 inputs.

 

Financial Instruments – Credit Losses (“ASU 2016-13”). In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses” to require the measurement of expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable forecasts. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The standard is effective for interim and annual reporting periods beginning after December 15, 2019. However, in October 2019, the FASB approved deferral of the adoption date for smaller reporting companies for fiscal periods beginning after December 15, 2022. Accordingly, the Company’s fiscal year of adoption will be the fiscal year ended June 30, 2024. Early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018, but the Company did not elect to early adopt. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements.  

 

  

This Quarterly Report on Form 10-Q does not discuss recent pronouncements that are not anticipated to have an impact on or are unrelated to its financial condition, results of operations, cash flows or disclosures.

 

2. Acquisitions

 

On October 10, 2019, the Company entered into the Purchase Agreement with Cerecor, Inc. (“Cerecor”) to purchase and acquire Cerecor’s Pediatric Portfolio, which closed on November 1, 2019. The Pediatric Portfolio consists of six prescription products consisting of (i) AcipHex® Sprinkle™, (ii) Cefaclor for Oral Suspension, (iii) Karbinal® ER, (iv) Flexichamber™, (v) Poly-Vi-Flor® and Tri-Vi-Flor™. Total consideration transferred to Cerecor consisted of $4.5 million cash and approximately 9.8 million shares of Series G Convertible Preferred Stock. The Company also assumed certain of Cerecor’s financial and royalty obligations, and not more than $3.5 million of Medicaid rebates and products returns. The Company also retained the majority of Cerecor’s workforce focused on commercial sales, commercial contracts and customer relationships.

 

In addition, the Company assumed Cerecor obligations due to an investor that include fixed and variable payments aggregating to $25.6 million. The Company assumed fixed monthly payments equal to $0.1 million from November 2019 through January 2021 plus $15 million due in January 2021. Monthly variable payments due to the same investor are equal to 15% of net revenue generated from a subset of the Product Portfolio, subject to an aggregate monthly minimum of $0.1 million, except for January 2020, when a one-time payment of $0.2 million is due to the investor. The variable payment obligation continues until the earlier of: (i) aggregate variable payments of approximately $9.5 million have been made, or (ii) February 12, 2026.

 

Further, certain of the products in the Product Portfolio require royalty payments ranging from 12% to 15% of net revenue. One of the products in the Product Portfolio requires the Company to generate minimum annual sales sufficient to represent annual royalties of approximately $1.8 million, in the event the minimum sales volume is not satisfied.

 

While no equity was acquired by the Company, the transaction was accounted for as a business combination under the acquisition method of accounting pursuant to Topic 805. Accordingly, the tangible and identifiable intangible assets acquired and liabilities assumed were recorded at fair value as of the date of acquisition, with the remaining purchase price recorded as goodwill. The goodwill recognized is attributable primarily to strategic opportunities related to an expanded commercial footprint and diversified pediatric product portfolio that is expected to provide revenue and cost synergies. Transaction costs of $0.3 million were included as general and administrative expense in the consolidated statements of operations for the three and six months ended December 31, 2019.

 

The following table summarized the preliminary fair value of assets acquired and liabilities assumed at the date of acquisition. These estimates are preliminary, pending final evaluation of certain assets, and therefore, are subject to revisions that may result in adjustments to the values presented below:

 

	As of
	November 1, 2019
Consideration
Cash and cash equivalents	$4,500,000
Fair value of Series G Convertible Preferred Stock
Total shares issued	9,805,845
Estimated fair value per share of Aytu common stock	$0.567
Estimated fair value of equity consideration transferred	$5,559,914
Total consideration transferred	$10,059,914
Recognized amounts of identifiable assets acquired and liabilities assumed
Inventory, net	$459,123
Prepaid assets	1,743,555
Other current assets	2,548,187
Intangible assets – product technology rights	22,700,000
Accrued product program liabilities	(6,320,853)
Assumed fixed payment obligations	(26,457,162)
Total identifiable net assets	(5,327,150)
Goodwill	$15,387,064

 

     

The fair values of intangible assets, including product technology rights were determined using variations of the income approach. Varying discount rates were also applied to the projected net cash flows. The Company believes the assumptions are representative of those a market participant would use in estimating fair value (see Note 10).

 

	As of November 1, 2019
Acquired product technology rights	$22,700,000

 

The fair value of the net identifiable asset acquired was determined to be $22.7 million, which is being amortized over ten years. The aggregate amortization expense was $0.4 and $0, for the three and six months ended December 31, 2019 and 2018 respectively.

Pro Forma Impact of Business Combination

 

The following supplemental unaudited proforma financial information presents the Company’s results as if the acquisition of the Pediatric Portfolio, which was completed on November 1, 2019, had occurred on July 1, 2018. Due to limitations on information on revenues and expenses for certain gap periods within each fiscal year, this unaudited proforma financial information may not fully reflect how the acquisition would impact the Company had the acquisition occurred at the beginning of the earliest fiscal year presented in these financial statements.

 

	Three Months Ended December 31,		Six Months Ended December 31,
	2019	2018	2019	2018
	Unaudited (aa)	Pro forma Unaudited	Pro forma Unaudited	Pro forma Unaudited
Total revenues, net	$3,175,236	$8,016,356	$8,027,106	$14,207,635
Net income (loss)	306,314	(2,532,910)	(5,997,071)	(3,854,640)
Net income / (loss) per share (bb)	$0.01	$(0.39)	$(0.38)	$(0.92)

 

(aa)	Due to a lack of financial information covering the period from October 1, 2019 through November 1, 2019, the Company was not able to provide pro forma adjusted financial statements without making estimated extrapolations that the Company did not believe would be useful to users of the above pro forma information.
(bb)	Pro forma net loss per share calculations excluded the impact of the issuance of the Series G Convertible Preferred under the assumption those shares would continue to remain non-participatory until the July 1, 2020 effective registration.

  

  

3. Revenue Recognition

 

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 revenue. International sales are made primarily to specialty distributors, as well as to hospitals, laboratories, and clinics, some of which are government owned or supported (collectively, its “Customers”). The Company’s Customers in the United States subsequently resell the products to pharmacies and patients. Revenue from product sales is recorded at the established 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.

 

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 between 30 to 60 days in the United States and consistent with prevailing practice in international markets. 

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,
	2019	2018	2019	2018
U.S.	$3,047,000	$1,730,000	$4,309,000	3,001,000
International	128,000	65,000	306,000	226,000
Total net revenue	$3,175,000	$1,795,000	$4,615,000	3,227,000

 

4. Product Licenses and Acquisitions

The Company licensed three of its existing product offerings from third parties: (i) Natesto, (ii) ZolpiMist, and (iii) Tuzistra XR. Each of these license agreements are subject to terms and conditions specific to each agreement. The Company acquired an additional six pharmaceutical products upon the closing of the Asset Purchase Agreement with Cerecor. The Company recognized an intangible asset of approximately $22.7 million relating the Product technology rights acquired from the Pediatric Portfolio.

License and Supply Agreement—Natesto

  

In April 2016, Aytu entered into a license and supply agreement to acquire the exclusive U.S. rights to commercialize 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 or until the entry on the market of at least one AB-rated generic product.

 

On July 29, 2019, the Company and Acerus agreed-to an Amended and Restated License and Supply Agreement (the “Acerus Amendment”), subject to certain conditions being satisfied prior to the Acerus Amendment becoming effective and enforceable. The Acerus Amendment eliminated the previously disclosed revenue-based milestone payments expected to-be-made to Acerus.The maximum aggregate milestones payable under the original agreement was $37.5 million. Upon the effectiveness of the Acerus Amendment on December 1, 2019, all royalty and milestone liabilities were eliminated. Upon the effectiveness of the Acerus Amendment, Acerus was granted the right to earn commissions on certain filled Natesto prescriptions. Additionally, Acerus assumed certain ongoing sales, marketing and regulatory obligations from the Company. This Acerus Amendment became effective December 1, 2020, resulting in a $5.2 million unrealized gain for the three and six months ended December 31, 2019, due to the elimination of the revenue-based product milestones.

 

  

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, 2019 and 2018 was $0.3 million. The aggregate amortization expense for each of the six-month periods ended December 31, 2019 and 2018 was $0.7 million.

 

The contingent consideration, reflecting the risk-adjusted value of Natesto milestone liability, was initially valued at $3.2 million using a Monte Carlo simulation, as of June 30, 2016. As of June 30, 2019, the contingent consideration was revalued at $5.1 million using the same Monte Carlo simulation methodology, and based on current interest rates, expected sales potential, and Aytu stock trading variables. The Company reevaluates the contingent consideration on a quarterly basis for changes in the fair value recognized after the acquisition date, such as measurement period adjustments.

 

The contingent consideration accretion expense for each of the three-month periods ended December 31, 2019 and 2018 was $54,000, and $16,000, respectively. The contingent consideration accretion expense for each of the six-month periods ended December 31, 2019 and 2018 was $133,000, and $31,000, respectively. Upon the effective date of the Acerus Amendment, the contingent consideration liability of $5.2 million was removed from the balance sheet as a result. As of December 31, 2019, 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 $0.4 million to Magna upon execution of the agreement. In July 2018, the Company paid an additional $0.3 million, of which, $0.3 million was included in current contingent consideration at June 30, 2018.

 

The ZolpiMist license agreement was valued at $3.2 million and will be amortized over the life of the license agreement up to seven years. The amortization expense for each of the three months ended December 31, 2019 and 2018 was $116,000. The aggregate amortization expense for each of the six-month periods ended December 31, 2019 and 2018 was $232,000.

 

We also agreed to make certain royalty payments to Magna which will be calculated as a percentage of ZolpiMist net sales and are 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. As of June 30, 2019, the contingent consideration was revalued at $2.3 million using the same Monte Carlo simulation methodology, and based on current interest rates, expected sales potential, and Aytu stock trading variables. The Company reevaluates the contingent consideration on a quarterly basis for changes in the fair value recognized after the acquisition date, such as measurement period adjustments.

 

The contingent consideration accretion expense for the three months ended December 31, 2019 and 2018 was $56,000 and $61,000, respectively. The contingent consideration accretion expense for each of the six-month periods ended December 31, 2019 and 2018 was $110,000, and $120,000, respectively. As of December 31, 2019, none of the milestones had been achieved, and therefore, no milestone payment was made.

 

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 to commercialize Tuzistra XR. In addition, TRIS granted the Company an exclusive license in the United States to commercialize 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 Food and Drug Administration (“FDA”). As consideration for the Products license, the Company: (i) made an upfront cash payment to TRIS; (ii) issued shares of Series D Convertible preferred stock to TRIS; and (iii) will pay certain royalties to TRIS throughout the 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-month periods ended December 31, 2019 and 2018 was $123,000 and $82,000, respectively. The aggregate amortization expense for each of the six-month periods ended December 31, 2019 and 2018 was $246,000 and $82,000.

 

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. As of June 30, 2019, the contingent consideration was revalued at $16.0 million using the same Monte Carlo simulation methodology, and based on current interest rates, expected sales potential, and Aytu stock trading variables. The Company reevaluates the contingent consideration on a quarterly basis for changes in the fair value recognized after the acquisition date, such as measurement period adjustments.

 

The contingent consideration accretion expense for the three months ended December 31, 2019 and 2018 was $101,000, and $46,000, respectively. The contingent consideration accretion expense for each of the six-month periods ended December 31, 2019 and 2018 was $197,000, and $46,000, respectively. As of December 31, 2019, none of the milestones had been achieved, and therefore, no milestone payment was made.

   

Asset Purchase Agreement—Cerecor Products

 

In November 2019, Aytu Therapeutics, LLC., a wholly-owned subsidiary of Aytu, acquired the portfolio of pediatric therapeutic commercial products from Cerecor, Inc. This transaction expanded our product portfolio with the addition of six pharmaceutical and other prescription products, (i) AcipHex® Sprinkle™, (ii) Cefaclor for Oral Suspension, (iii) Karbinal® ER, (iv) Flexichamber™, (v) Poly-Vi-Flor® and Tri-Vi-Flor™.

 

Aytu paid $4.5 million in cash, issued approximately 9.8 million shares of Series G Convertible Preferred Stock and assume certain of Seller’s financial and royalty obligations, and not more than $3.5 million of Medicaid rebates and products returns.

 

In addition, the Company has assumed obligations due to an investor including fixed and variable payments. The Company assumed fixed monthly payments equal to $0.1 million from November 2019 through January 2021 plus $15 million due in January 2021. Monthly variable payments due to the same investor are equal to 15% of net revenue generated from a subset of the Product Portfolio, subject to an aggregate monthly minimum of $0.1 million, except for January 2020, when a one-time payment of $0.2 million is due. The variable payment obligation continues until the earlier of: (i) aggregate variable payments of approximately $9.5 million have been made, or (ii) February 12, 2026.

 

 

Supply and Distribution Agreement, As Amended – Karbinal® ER

 

The Company acquired and assumed all rights and obligations pursuant to the Supply and Distribution Agreement, as Amended, with TRIS for the exclusive rights to commercialize Karbinal® ER in the United States (the “TRIS Karbinal Agreement”). The TRIS Karbinal Agreement’s initial term terminates in August of 2033, with an optional initial 20-year extension.

 

The Company owes royalties on sales of Karbinal of 23.5% of net revenues on a quarterly basis. As part of the agreement, the Company has agreed to pay TRIS a product make-whole payment of approximately $1.8 million per year through July 2023, totaling a minimum of $6.6 million (see Note 12).

 

Supply and License Agreement – Poly-vi-Flor & Tri-vi-Flor

 

The Company acquired and assumed all rights and obligations pursuant to a Supply and License Agreement and various assignment and release agreements, including a previously agreed to Settlement and License Agreements (the “Poly-Tri Agreements”) for the exclusive rights to commercialize Poly-vi-Flor and Tri-vi-Flor in the United States.

 

  

The Company owes royalties to multiple parties totaling approximately 29.0% of net revenues on a quarterly basis. There are no milestones, make-whole payments other otherwise any contingencies related to these agreements.

 

License and Assignment Agreement – AcipHex Sprinkle

 

The Company acquired and assumed all rights and obligations pursuant to the License and Assignment Agreement with Eisai, Inc. for exclusive rights to commercialized AcipHex Sprinkle in the United States (the “Eisai AcipHex Agreement”).

 

The Eisai AcipHex Agreement includes quarterly royalties totaling 15% of net revenues, but offset by amounts paid for certain regulatory costs otherwise the responsibility of Eisai Co., Ltd. In addition, there are certain milestone provisions triggering potential payments of between $3.0 - $5.0 million, for which the Company has preliminarily estimated to have a value of $0.00.

 

License, Supply and Distribution Agreement – Cefaclor

 

The Company acquired and assumed all rights and obligations pursuant to the License, Supply and Distribution Agreement involving multiple counterparties to commercialize Cefaclor in the United States. (the “Cefaclor Agreement”).

 

The Cefaclor Agreement includes quarterly royalties totaling approximately 15% of net products sales. In addition, there are certain milestone provisions triggering potential payments of between $0.5 - $2.5 million, for which the Company has preliminarily estimated to have a value of $0.00.

 

5. 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. There was no inventory write-down during the three and six months ended December 31, 2019 or 2018, respectively.

 

Inventory balances consist of the following:

 

	As of	As of
	December 31,	June 30,
	2019	2019
Raw materials	$182,000	$117,000
Finished goods	2,310,000	1,323,000
	$2,492,000	$1,440,000

 

  

6. 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 Useful Lives in	As of December 31,	As of June 30,
	years	2019	2019
Manufacturing equipment	2 - 5	$83,000	$83,000
Leasehold improvements	3	112,000	112,000
Office equipment, furniture and other	2 - 5	265,000	315,000
Lab equipment	3 - 5	90,000	90,000
Less accumulated depreciation and amortization		(428,000)	(396,000)
Fixed assets, net		$122,000	$204,000

 

Depreciation and amortization expense totaled $16,000 for each of the three-months ended December 31, 2019 and 2018, respectively, and $32,000 and $44,000 for the six months ended December 31, 2019 and 2018.

 

7. Leases, Right-to-Use Assets and Related Liabilities

 

In September 2015, the Company entered into a 37-month operating lease in Englewood, Colorado. This lease had an initial base rent of approximately $9 thousand 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 approximately $9 thousand per month. In April 2019, the Company extended the lease for an additional 36 months beginning October 1, 2020.

 

In June 2018, the Company entered into a 12-month operating lease, beginning on August 1, 2018, for office space in Raleigh, North Carolina. This lease has base rent of approximately $1 thousand a month, with total rent over the term of the lease of approximately $13 thousand.

 

As discussed within Note 1, the Company adopted the FASB issued ASU 2016-02, “Leases (Topic 842)” as of July 1, 2019. With the adoption of ASU 2016-02, the Company recorded an operating right-of-use asset and an operating lease liability on its balance sheet associated with its lease of its corporate headquarters. The right-of-use asset represents the Company’s right to use the underlying asset for the lease term and the lease obligation represents the Company’s commitment to make the lease payments arising from the lease. Right-of-use lease assets and obligations are recognized at the later of the commencement date or July 1, 2019; the date of adoption of Topic 842; based on the present value of remaining lease payments over the lease term. As the Company’s lease does not provide an implicit rate, the Company used an estimated incremental borrowing rate based on the information available at the commencement date in determining the present value of the lease payments. Rent expense is recognized on a straight-line basis over the lease term, subject to any changes in the lease or expectations regarding the terms. The lease liability is classified as current or long-term on the balance sheet.

  

  

	Total	2020	2021	2022	2023	2024	Thereafter
Remaining Office leases	$445,000	$54,000	$113,000	$117,000	$121,000	$40,000	−
Less: Discount Adjustment	(70,000)
Total lease liability	375,000
Lease liability - current portion	83,000
Long-term lease liability	$292,000

 

Rent expense for the three months ended December 31, 2019 and 2018 totaled $30 thousand and $31 thousand, respectively. Rent expense for the six months ended December 31, 2019 and 2018 totaled $63 thousand and $63 thousand, respectively

 

8. Patents

 

The cost of the oxidation-reduction potential (“ORP”) technology related patents for the 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	As of
	December 31,	June 30,
	2019	2019
Patents	$380,000	$380,000
Less accumulated amortization	(172,000)	(159,000)
Patents, net	$208,000	$221,000

 

The amortization expense was $7 thousand for the three months ended December 31, 2019 and 2018, respectively, and $13 thousand for the six months ended December 31, 2019 and 2018 respectively.

 

9. Accrued liabilities

 

Accrued liabilities consist of the following:

 

	As of	As of
	December 31	June 30,
	2019	2019
Accrued accounting fee	$63,000	$85,000
Accrued program liabilities	1,087,000	736,000
Accrued product-related fees	601,000	295,000
Other accrued liabilities*	100,000	32,000
Accrued note payable	263,000	–
Total accrued liabilities	$2,114,000	$1,148,000

 

* Other accrued liabilities consist of franchise tax, samples and consultants, none of which individually represent greater than five percent of total current liabilities.

 

   

10. Fair Value Considerations

 

The Company’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, and accrued liabilities approximate their fair value due to their short maturities, including those acquired or assumed on November 1, 2019 as a result of the acquisition of the Cerecor Portfolio of Pediatrics Therapeutics. 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 management, 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 the Company. Unobservable inputs are inputs that reflect the Company’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.

 

The Company’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. The Company’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.

 

Recurring Fair Value Measurements

 

The following table presents the Company’s financial liabilities that were accounted for at fair value on a recurring basis as of December 31, 2019 and June 30, 2019, by level within the fair value hierarchy.

 

		Fair Value Measurements at December 31, 2019
	Fair Value at December 31, 2019	Quoted Priced in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Recurring:
Warrant derivative liability	$11,000	–	–	$11,000
Contingent consideration	18,446,000	–	–	18,446,000
	$18,457,000	–	–	$18,457,000

 

  

		Fair Value Measurements at June 30, 2019
	Fair Value at June 30, 2019	Quoted Priced in Active Markets for Identical Assets (Level 1)	Significant Other Observable Inputs (Level 2)	Significant Unobservable Inputs (Level 3)
Recurring:
Warrant derivative liability	$13,000	–	–	$13,000
Contingent consideration	23,326,000	–	–	23,326,000
	$23,339,000	–	–	$23,339,000