AYTU BIOPHARMA, INC - Quarter Report: 2019 March (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: March 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, every Interactive Data File required to be submitted 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 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 May 1, 2019, there were 16,660,395 shares of common stock outstanding.

 

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARY

FOR THE QUARTER ENDED MARCH 31, 2019

 

INDEX

 

		Page
	PART I—FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements	1
	Consolidated Balance Sheets as of March 31, 2019 (unaudited) and June 30, 2018	1
	Consolidated Statements of Operations for the three and nine-month periods ended March 31, 2019 (unaudited) and the three and nine-month periods ended March 31, 2018 (unaudited)	2
	Consolidated Statement of Stockholders’ Equity for the year-to-date interim periods ended March 31, 2019 (unaudited) and March 31, 2018 (unaudited)	3
	Consolidated Statements of Cash Flows for the nine months ended March 31, 2019 (unaudited) and the nine months ended March 31, 2018 (unaudited)	5
	Notes to Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	21
Item 4.	Controls and Procedures	21
	PART II—OTHER INFORMATION
Item 1.	Legal Proceeding	22
Item 1A.	Risk Factors	22
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	22
Item 3.	Defaults Upon Senior Securities	22
Item 4.	Mine Safety Disclosures	22
Item 5.	Other Information	22
Item 6.	Exhibits	23
SIGNATURES		24

 

i

 

 

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, and RedoxSYS, 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.  

 

 

ii

 

PART I—FINANCIAL INFORMATION

  

Item 1. Consolidated Financial Statements

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARY

Consolidated Balance Sheets

      

	March 31,	June 30,
	2019	2018
	(unaudited)
Assets
Current assets
Cash and cash equivalents	$14,647,402	$7,012,527
Restricted cash	100,296	100,000
Accounts receivable, net	1,376,358	578,782
Inventory, net	1,530,083	1,338,973
Prepaid expenses and other	804,840	440,009
Total current assets	18,458,979	9,470,291
Fixed assets, net	219,177	218,684
Licensed assets, net	19,430,767	11,120,086
Patents, net	226,944	245,944
Deposits	2,200	5,088
Total long-term assets	19,879,088	11,589,802
Total assets	$38,338,067	$21,060,093
Liabilities and Stockholders' Equity
Current liabilities
Accounts payable and other	$2,131,251	$2,119,672
Accrued liabilities	772,140	185,882
Accrued compensation	791,586	540,674
Current deferred rent	-	1,450
Current contingent consideration	808,779	547,100
Total current liabilities	4,503,756	3,394,778
Long-term contingent consideration	12,633,824	4,146,829
Long-term debt - related party (Note 11)	5,134,795	-
Warrant derivative liability	28,513	93,981
Total liabilities	22,300,888	7,635,588
Commitments and contingencies (Note 7)
Stockholders' equity
Preferred Stock, par value $.0001; 50,000,000 shares authorized; shares issued
and outstanding 2,335,665 and 0, respectively as of
March 31, 2019 and June 30, 2018	234	-
Common Stock, par value $.0001; 100,000,000 shares authorized; shares issued
and outstanding 12,848,499 and 1,794,762, respectively as of
March 31, 2019 and June 30, 2018	1,285	179
Additional paid-in capital	107,893,259	92,681,918
Accumulated deficit	(91,857,599)	(79,257,592)
Total stockholders' equity	16,037,179	13,424,505
Total liabilities and stockholders' equity	$38,338,067	$21,060,093

  

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

 

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARY

Consolidated Statements of Operations

(unaudited)

    

	Three Months Ended March 31,		Nine Months Ended March 31,
	2019	2018	2019	2018
Product revenue, net	$2,372,016	$607,473	$5,598,836	$2,734,995
License revenue, net	5,776	-	5,776	-
Total revenue	2,377,792	607,473	5,604,612	2,734,995
Operating expenses
Cost of sales	616,853	1,136,833	1,552,950	1,809,445
Research and development	108,901	114,141	413,808	(22,391)
Selling, general and administrative	5,368,762	4,637,495	13,991,516	13,809,264
Selling, general and administrative - related party (Note 11)	6,797	-	351,843	-
Impairment of intangible assets	-	1,856,020	-	1,856,020
Amortization of intangible assets	575,117	387,606	1,561,137	1,156,258
Total operating expenses	6,676,430	8,132,095	17,871,254	18,608,596
Loss from operations	(4,298,638)	(7,524,622)	(12,266,642)	(15,873,601)
Other (expense) income
Other expense, net	(194,703)	(186,629)	(398,833)	(572,155)
Derivative (expense) income	(2,521)	3,139,971	65,468	3,957,756
Other gain	-	1,753,568	-	1,753,568
Total other (expense) income	(197,224)	4,706,910	(333,365)	5,139,169
Net loss	$(4,495,862)	$(2,817,712)	$(12,600,007)	$(10,734,432)
Weighted average number of
common shares outstanding	9,061,023	592,771	5,785,669	250,478
Basic and diluted net loss
per common share	$(0.50)	$(4.75)	$(2.18)	$(42.86)

 

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

         

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARY

(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)	-	-	-	-	65,563	-	65,563
Issuance of restricted stock (unaudited)	-	-	-	-	86,551	-	86,551
Adjustment for rounding of shares due to stock split (unaudited)	-	-	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)	-	-	-	-	41,108	-	41,108
Issuance of restricted stock (unaudited)	-	-	2,707,022	271	152,683	-	152,954
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	-	-	-
Net loss (unaudited)	-	-	-	-	-	(4,657,662)	(4,657,662)
Balance - December 31, 2018 (unaudited)	4,532,664	453	10,504,769	1,051	107,258,096	(87,361,737)	19,897,863
Stock-based compensation (unaudited)	-	-	-	-	15,308	-	15,308
Issuance of restricted stock (unaudited)	-	-	(25,600)	(2)	361,360	-	361,358
Preferred stocks converted into common stock (unaudited)	(2,196,999)	(219)	2,196,999	219	-	-	-
Warrant exercises (unaudited)	-	-	172,331	17	258,495	-	258,512
Net loss (unaudited)	-	-	-	-	-	(4,495,862)	(4,495,862)
Balance - March 31, 2019 (unaudited)	2,335,665	$234	12,848,499	$1,285	$107,893,259	$(91,857,599)	$16,037,179

 

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

 

 

AYTU BIOSCIENCE, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

(unaudited)

   

	Nine Months Ended March 31,
	2019	2018
Cash flows from operating activities
Net loss	$(12,600,007)	$(10,735,432)
Adjustments to reconcile net loss to cash used in operating activities
Depreciation, amortization and accretion	1,974,213	1,975,448
Stock-based compensation expense	121,979	288,010
Issuance of restricted stock	600,863	158,585
Issuance of common stock to employee	11,690	-
Derivative (income)	(65,468)	(3,957,756)
Impairment of intangible assets	-	1,856,020
Other gain	-	(1,753,568)
Issuance of warrants	-	179,287
Warrant amendment	-	4,633
Changes in operating assets and liabilities:
(Increase) in accounts receivable	(797,576)	(204,437)
(Increase) decrease in inventory	(191,110)	428,401
(Increase) in prepaid expenses and other	(364,831)	(586,139)
(Decrease) increase in accounts payable and other	(17,769)	967,641
Increase (decrease) in accrued liabilities	586,258	(571,121)
Increase in accrued compensation	250,912	558,451
Increase in interest payable - related party	134,795	-
(Decrease) in deferred rent	(1,450)	(5,005)
Net cash used in operating activities	(10,357,501)	(11,396,982)
Cash flows used in investing activities
Deposit	2,888	-
Purchases of property and equipment	(59,848)	(74,707)
Contingent consideration payment	(408,917)	(7,385)
Purchase of assets	(500,000)	-
Net cash used in investing activities	(965,877)	(82,092)
Cash flows from financing activities
Issuance of preferred, common stock and warrants	15,180,000	24,740,015
Issuance costs related to preferred, common stock and warrants	(1,479,963)	(2,697,066)
Warrant exercises	258,512	640,380
Issuance of debt - related party	5,000,000	-
Net cash provided by financing activities	18,958,549	22,683,329
Net change in cash, cash equivalents and restricted cash	7,635,171	11,204,255
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	$14,747,698	$12,081,797
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 (see Note 6)	$8,833,219	$-
Contingent consideration included in accounts payable	$29,348	$11,283
Warrants issued to investors and underwriters	$-	$4,117,997
Earn-out payment to Nuelle Shareholders in common stock	$-	$250,000
Warrant exercise of derivative warrants	$-	$40,096

 

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

  

Basis of Presentation

 

The unaudited consolidated financial statements contained in this report represent the financial statements of Aytu and its wholly-owned subsidiary, Aytu Women’s Health, 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, 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 March 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 periods ended March 31, 2019, and 2018, 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 held (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 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.

 

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 the occurrence of certain agreed upon 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 March 31, 2019 and 2018 was $330,000. The aggregate amortization expense for each of the nine-month periods ended March 31, 2019 and 2018 was $989,000.

 

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 March 31, 2019 and 2018 was $17,000, and $178,000, respectively. The contingent consideration accretion expense for each of the nine-month periods ended March 31, 2019 and 2018 was $48,000, and $508,000, respectively. As of March 31, 2019, no milestone payments have been 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.

 

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 March 31, 2019 and 2018 was $116,000 and $0, respectively. The amortization expense for each of the nine months ended March 31, 2019 and 2018 was $348,000 and $0, respectively.

 

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. The contingent consideration accretion expense for the three months ended March 31, 2019 and 2018 was $64,000, and $0, respectively. The contingent consideration accretion expense for the nine months ended March 31, 2019 and 2018 was $184,000, 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 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 March 31, 2019 and 2018 was $123,000 and $0, respectively. The amortization expense for each of the nine-month periods ended March 31, 2019 and 2018 was $205,000 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 March 31, 2019 and 2018 was $73,000, and $0, respectively. The contingent consideration accretion expense for the nine months ended March 31, 2019 and 2018 was $119,000, 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 financial statements contained herein. 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, receipts 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 $70.3 million, inclusive of the $15.2 million we raised in October 2018, from the sale of securities to investors, the exercise of warrants by investors and the $5.0 million of debt 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 prior 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. 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.”

   

Effective July 1, 2018, the Company adopted Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”). Adoption of this ASU was done through the modified retrospective method and did not result in a cumulative adjustment to retained earnings or accumulated deficit as of the adoption date. This is due to the fact that the impact of adopting the new standard is not significant as it relates to historical revenues, future revenues, or accounting for incremental costs of obtaining contracts with our customers.

   

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 March 31, 2019

  

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 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. Early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements but does not anticipate there to be a material impact.

 

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 reporting 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. In March 2019, the FASB issued ASU 2019-01, “Leases (Topic 842): Codification Improvements,” which clarified that reporting entities are exempt from the interim period transition disclosure requirements in paragraph 250-10-50-3 of the guidance when adopting ASC 842.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 March 31, 2019, the Company has future operating lease payments of approximately $166,000 that are being evaluated. The Company is gathering and evaluating all key lease data elements to meet the requirements of the new guidance. 

 

Note 2 – Revenue Recognition

 

We generate revenues from the sale of products. Revenue is recognized when control of 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 revenue. International sales are made primarily to specialty distributors, as well as 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 patients and pharmacies. 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.

 

Revenue from product sales is 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 related to estimated amounts payable to direct customers are netted against accounts receivable from such customers. Balances related 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 by giving consideration to factors that could otherwise 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 March 31,		Nine Months Ended March 31,
	2019	2018	2019	2018
U.S	$2,024,000	$483,000	$5,025,000	$2,380,000
Rest-of-the-World	348,000	124,000	574,000	355,000
Total net revenue	$2,372,000	$607,000	$5,599,000	$2,735,000

  

License Revenue, Net

 

The license revenue of $6,000 and $0 recognized in the three and nine months ended March 31, 2019 and 2018, respectively, represent the payment received from the Company’s ZolpiMist sublicensing agreement with SUDA Pharmaceuticals. In connection with the ZolpiMist License Agreement, Aytu assumed the SUDA Pharmaceuticals sublicensing agreement for ZolpiMist outside of the United States and Canada. This licensing agreement calls for SUDA to lead commercial development and sublicensing efforts for ZolpiMist in major territories outside the United States and Canada, including Europe, Asia, and Latin America. SUDA has already entered into sublicensing agreements in key markets with large, multi-national pharmaceutical companies and has agreements in place in China, Chile, Brazil, and throughout Southeast Asia.

   

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 $10,000 for slow moving inventory as of March 31, 2019 and $0 at June 30, 2018.

 

Inventory balances consist of the following:

 

	March 31, 2019	June 30, 2018
Finished goods, net	$984,000	$1,100,000
Raw materials	546,000	239,000
Total inventory	$1,530,000	$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 Useful Lives in years	As of March 31, 2019	As of June 30, 2018
Manufacturing equipment	2 - 5	$83,000	$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		(381,000)	(540,000)
Fixed assets, net		$219,000	$219,000

 

 Depreciation and amortization expense was as follows:

  

	Three Months Ended March 31,		Nine Months Ended March 31,
	2019	2018	2019	2018
Depreciation and amortization expense	$15,000	$91,000	$59,000	$252,000

 

     

Note 5 – Patents

 

The cost of the oxidation-reduction potential (“ORP”) technology 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 March 31,	As of June 30,
	2019	2018
Patents	$380,000	$380,000
Less accumulated amortization	(153,000)	(134,000)
Patents, net	$227,000	$246,000

 

The amortization expense was as follows:

  

	Three Months Ended March 31,		Nine Months Ended March 31,
	2019	2018	2019	2018
Amortization expense	$6,000	$6,000	$19,000	$19,000

 

Note 6 – Fair Value Considerations

 

Aytu’s financial instruments include cash and cash equivalents, restricted cash, accounts receivable, accounts payable, accrued liabilities, debt, 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. The carrying amount of debt approximates its fair value. 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 March 31, 2019 and June 30, 2018, by level within the fair value hierarchy.

  

	Fair Value Measurements Using
	Level 1	Level 2	Level 3	Total
March 31, 2019
LIABILITIES
Warrant derivative liability	$-	$-	$29,000	$29,000
Contingent consideration	$-	$-	$13,443,000	$13,443,000
June 30, 2018
LIABILITIES
Warrant derivative liability	$-	$-	$94,000	$94,000
Contingent consideration	$-	$-	$4,694,000	$4,694,000