This discussion should be read in conjunction withAytu BioPharma, Inc.'s Annual Report on Form 10-K for the year endedJune 30, 2021 , filed onSeptember 28, 2021 . The following discussion and analysis contain forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. For additional information regarding these risks and uncertainties, please see the risk factors included in Aytu's Form 10-K filed with theSecurities and Exchange Commission onSeptember 28, 2021 . Objective The purpose of the Management Discussion and Analysis (the "MD&A") is to present information that management believes is relevant to an assessment and understanding of our results of operations and cash flows for the three months endedSeptember 30, 2021 and our financial condition as ofSeptember 30, 2021 . The MD&A is provided as a supplement to, and should be read in conjunction with, our financial statements and notes. The MD&A is organized in the following
sections: ? Overview
? Significant Developments. We discuss (i) impact of COVID-19 on our operations
and (ii) material divestitures.
Liquidity and Capital Resources. We discuss (i) sources of our liquidity, (ii)
? cash flows, (iii) obligations due on our debt obligations and (iv) expected
payments under contractual obligations, commitments and contingencies.
Results of Operations. We discuss changes in our statements of operations line
? items, including the major drivers of these changes for three months ended
? Critical Accounting Estimates. We discuss the critical accounting policies and
estimates that require significant management judgment.
Overview
We are commercial-stage specialty pharmaceutical company focused on commercializing novel therapeutics and consumer healthcare products. We operate through two business segments:Aytu BioPharma segment, consisting of various prescription pharmaceutical products sold through third party wholesalers, and Aytu Consumer health segment, which consists of various consumer health products sold directly to consumers. We generate revenue by selling our products through third party intermediaries in our marketing channels as well as directly to our customers. We develop and manufacture our ADHD products at our manufacturing facilities and use third party manufacturers for our other prescription and consumer health products. We have incurred significant losses in each year since inception. Our net losses were$27.9 million and$4.3 million for the three months endedSeptember 30, 2021 and 2020, respectively. As ofSeptember 30, 2021 andJune 30, 2021 , we had an accumulated deficit of approximately$206.2 million and$178.3 million , respectively. We expect to continue to incur significant expenses in connection with our ongoing activities, including the successful integration of our acquisitions.
Significant Developments
Below are significant developments in our business and other factors affecting
our business during the three months ended
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COVID-19
The ongoing COVID-19 pandemic continues to impact the global economy and create
economic uncertainties during fiscal years 2020 and 2021. The federal government
and states-imposed restrictions on travel and business operations and placed
limitations on the size of public and private gatherings. However, beginning the
third quarter of fiscal 2021, with the introduction of vaccines under emergency
use authorizations, these restrictions began to wind down and business operating
environments have improved.
We believe COVID-19 has negatively impacted the overall market for prescription
products. The extent to which COVID-19 continues to negatively impact our
business in the future will depend on future developments, which are highly
uncertain and cannot be predicted with confidence, including the duration of the
outbreak, new information that may emerge concerning the severity of the new
variants of coronavirus, the actions taken to contain the coronavirus or treat
its impact, and the continued impact of each of these items on the economies and
financial markets in the United States and abroad. While states and
jurisdictions have rolled back stay-at-home and quarantine orders and reopened
in phases, it is difficult to predict what the lasting impact of the pandemic
will be, and if we or any of the third parties with whom we engage were to
experience additional shutdowns or other prolonged business disruptions, our
ability to conduct our business in the manner and on the timelines presently
planned could have a material adverse impact on our business, results of
operation and financial condition. In addition, a recurrence or impact from new
strains of COVID-19 cases could cause other widespread or more severe impacts
depending on where infection rates are highest. We will continue to monitor
developments as we deal with the disruptions and uncertainties relating to
the COVID-19 pandemic. Divestiture of MiOXSYS OnJuly 1, 2021 we signed an Asset Purchase Agreement with UAB "Caerus Biotechnologies" ("UAB"). Pursuant to the terms and conditions of the agreement, UAB has acquired all existing intellectual property rights, technical information and know-how related to MiOXSYS as well as all existing inventory and all rights attached and related to the product and manufacturing thereof. As consideration, UAB agreed to pay us approximately$0.5 million and make royalty payments to us of five percent of global net revenue of the MiOXSYS product for five years from the closing date of the transactions contemplated in the Asset Purchase Agreement. 33 Table of Contents RESULTS OF OPERATIONS Three Months EndedSeptember 30, 2021 compared to the Three Months EndedSeptember 30, 2020 Three Months Ended September 30, 2021 2020 Change % In thousands) Product revenue, net$ 21,897 $ 13,520 $ 8,377 62 % Cost of sales 9,441 4,063 5,378 132 % Gross profit 12,456 9,457 2,999 32 % Operating expenses Research and development 2,096 183 1,913 1,045 %
Advertising and direct marketing 4,545 4,763
(218) (5) % Other selling and marketing 4,752 1,063 3,689 347 % General and administrative 8,216 5,420 2,796 52 % Impairment of goodwill 19,453 - 19,453 N/A %
Amortization of intangible assets 1,093 1,585
(492) (31) % Total operating expenses 40,155 13,014 27,141 209 % Loss from operations (27,699) (3,557) (24,142) 679 % Other (expense) income Other (expense), net (40) (751) 711 (95) %
Gain / (Loss) from contingent consideration (219) 2 (221) N/A % Total other (expense) income (259) (749) 490 (65) % Loss before income tax (27,958) (4,306) (23,652) 549 % Income tax expense (benefit) (107) -
(107) - Net loss$ (27,851) $ (4,306) $ (23,545) 547 % Product revenue. Total net product revenue was$21.9 million during the three months endedSeptember 30, 2021 , an increase of approximately$8.4 million , or 62%, compared to$13.5 million during the three months endedSeptember 30, 2020 . The increase was primarily driven by the revenue generated from the ADHD product portfolio of Neos, which was acquired onMarch 19, 2021 and an increase in year-over-year revenue of our consumer health products, offset by the decrease in revenue resulting from the divesture of our Natesto prescription product in the third fiscal quarter of 2021. Cost of sales. Total cost of sales was$9.4 million during the three months endedSeptember 30, 2021 , an increase of$5.3 million , or 132%, compared to$4.1 million during the three months endedSeptember 30, 2020 . The increase was primarily driven by the costs incurred for the production and sale of the ADHD product portfolio of Neos, which was acquired onMarch 19, 2021 . Neos manufactures the ADHD products at itsGrand Prairie, Texas facilities, and as such, allocates a significant portion of its intangible assets amortization and fixed assets depreciation into cost of sales. Research and development. Total research and development expense was$2.1 million during the three months endedSeptember 30, 2021 , an increase of$1.9 million , compared to$0.2 million during the three months endedSeptember 30, 2020 . The significant increase was due primarily to costs associated with our AR101 in-process R&D, Healight Platform license and initial research and development costs, as well as regulatory and medical monitoring costs associated with the acquisition of the ADHD product portfolio onMarch 19, 2021 . Advertising and direct marketing. Advertising and direct marketing expenses include direct-to-consumer marketing, advertising, sales and customer support and processing fees related to our consumer health segment. Total advertising and direct marketing expense were$4.5 million for the three months endedSeptember 30, 2021 , a decrease of$0.2 million , or 5%, compared to$4.8 million during the three months endedSeptember 30, 2020 . 34
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Other selling and marketing. Total other selling and marketing expense was$4.8 million during the three endedSeptember 30, 2021 , an increase of$3.7 million , or 347%, compared to$1.1 million during the three months endedSeptember 30, 2020 . The increase was primarily driven by costs associated with the commercialization of the ADHD product portfolio of Neos, which was acquired onMarch 19, 2021 . General and administrative. Total general and administrative expense was$8.2 million during the three months endedSeptember 30, 2021 , an increase of$2.8 million , or 52%, compared to$5.4 million during the three months endedSeptember 30, 2020 . The increase was primarily driven by the general and administrative expenses of Neos, including directors and officers insurance, which was acquired onMarch 19, 2021 . Impairment of goodwill. Since theJune 30, 2021 annual goodwill impairment assessment, our stock price has continued to decline. As ofSeptember 30, 2021 , our market capitalization was below the carrying value of our assets, which led Management to consider whether those assets should be revalued for impairment at an interim reporting date. Pursuant to the guidance under Topic ASC 350, Management conducted impairment testing at each reporting unit level to determine the recoverability of goodwill. Based on the evaluation, during the three months endedSeptember 30, 2021 , we recognized an impairment loss of$19.5 million related to theAytu BioPharma segment. There was no such impairment expense during the three months endedSeptember 30, 2020 (see Note 8 -Goodwill and Other Intangible Assets). Amortization of intangible assets. Total amortization expense of intangible assets was$1.1 million during the three months endedSeptember 30, 2021 , a decrease of$0.5 million , or 31%, compared to$1.6 million for the three months endedSeptember 30, 2020 . The decrease was due primarily to licensed intangible assets that were being amortized during the three monthsSeptember 30, 2020 but which have subsequently been divested or written-off. Neos manufactures the ADHD products at itsGrand Prairie, Texas facilities, and as such, allocates a significant portion of its intangible assets amortization into cost of sales. Other (expense) income, net. Total other expense, net of other income during the three months endedSeptember 30, 2021 was approximately$40,000 , a decrease of$0.7 million , or 95%, compared to$0.7 million during the three months endedSeptember 30, 2020 . The decrease was primarily due to an increase in other income of$0.8 million from partial proceeds from the Natesto divestiture, partially offset by an increase in interest expense from the increase in debt as a result of the Neos Merger onMarch 19, 2021 . Gain (Loss) from contingent consideration. Net loss from contingent considerations during the three months endedSeptember 30, 2021 was$0.2 million , an increase of$0.2 million , compared to negligible amount of gain during the three months endedSeptember 30, 2020 . Of the$0.2 million net loss during the three months endedSeptember 30, 2021 ,$0.3 million loss was attributable to change in change in the fair value of the ZolpiMist and Tuzistra contingent consideration liabilities, partially offset by$47,000 gain from change in fair value of the contingent value rights ("CVR's") liability related to the Innovus Merger (see Note 10 - Fair Value Considerations). Income tax expense (benefit). The impairment of theAytu BioPharma segment book goodwill changed the net deferred tax liability of$0.2 million recorded as ofJune 30, 2021 fiscal year end into a net deferred tax liability of$0.1 million as ofSeptember 30, 2021 . As a result, we recognized an income tax benefit of$0.1 million during the three months endedSeptember 30, 2021 . There was no income tax expense or benefit during the three months endedSeptember 30, 2020 .
Liquidity and Capital Resources
Sources of Liquidity
We finance our operations through a combination of public offerings of our
common stock and warrants, borrowings under our line of credit facility and cash
generated from operations.
On
which was declared effective by the
registration statement covered the offering, issuance and sale by the Company
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of up to an aggregate of $100.0 million of its common stock, preferred stock,
debt securities, warrants, rights and units (the "2020 Shelf"). As of September
30, 2021 , approximately $48.0 million of the Company's common stock, preferred
stock, debt securities, warrants, rights and units remained available to be sold
pursuant to the 2020 Shelf.
On September 28, 2021 , the Company filed a shelf registration statement on Form
S-3, which was declared effective by the SEC on October 7, 2021 . This shelf
registration statement covered the offering, issuance and sale by the Company of
up to an aggregate of $100.0 million of its common stock, preferred stock, debt
securities, warrants, rights and units (the "2021 Shelf"). As of September 30,
2021 , $100.0 million of the Company's common stock, preferred stock, debt
securities, warrants, rights and units remained available to be sold pursuant to
the 2021 Shelf.
In June 2020 , we initiated an at-the-market offering program ("ATM"), which
allow us to sell and issue shares of our common stock from time-to-time. Since
initiated in June 2020 through September 30, 2021 , we issued a total of
3,155,039 shares of common stock for aggregate proceeds of $23.4 million before
estimated offering costs of $2.6 million . On June 2, 2021 , we terminated our
"at-the-market" sales agreement with Jefferies LLC . On June 4, 2021 , we entered
into a Controlled Equity OfferingSM Sales Agreement (the "Cantor Sales
Agreement") with Cantor Fitzgerald & Co. ("Cantor"), pursuant to which we agreed
to sell up to $30.0 million of our common stock from time to time in
"at-the-market" offerings. As of September 30, 2021 , approximately $17.0 million
of our common stock remained available to be sold pursuant to the Cantor ATM.
In December 2020 , we entered into an underwriting agreement with H.C. Wainwright
& Co., LLC ("Wainwright") (as amended and restated, the "Underwriting
Agreement"), pursuant to which the underwriter exercised its over-allotment
option in full and purchased 4,791,667 shares of our common stock for total
proceeds of $28.8 million before estimated offering costs of $2.6 million .
Effective June 2, 2021 , we terminated the Underwriting Agreement with
Wainwright, and pursuant to such termination, there will be no future sales of
our common stock under the agreement.
In October 2019 , our Neos subsidiary entered into a senior secured credit
agreement with Encina Business Credit, LLC ("Encina") as agent for the lenders
(the "Loan Agreement"). Under the Loan Agreement, Encina will extend up to $25.0
million in secured revolving loans to us (the "Revolving Loans"), of which up to
$2.5 million may be available for short-term swingline loans, against 85% of
eligible accounts receivable (see Note 16).
The following table shows cash flows for the three months ended September 30,
2021 and 2020:
Three Months Ended September 30, Increase
2021 2020 (Decrease)
(In thousands)
Net cash used in operating activities$ (3,791) $ (7,975) $ 4,184 Net cash used in investing activities $ (86) $ (17)$ (69)
Net cash (used in) provided by financing activities
$ 2,179$ (7,643)
Net cash used in operating activities during these periods primarily reflected our net losses, partially offset by changes in working capital and non-cash charges including inventory write-down, changes in fair values of various liabilities, stock-based compensation expense, depreciation, amortization and accretion and other charges. During the three months endedSeptember 30, 2021 , net operating cash outflows totaled$3.8 million . The use of cash was approximately$24.1 million less than the net loss due primarily to non-cash charges of goodwill impairment, depreciation, amortization and accretion, stock-based compensation, inventory write-down and loss from change in fair values of contingent consideration. These charges were partially offset by amortization of debt premium and gains from change in fair values of contingent value rights and amortization of debt premium. In addition, our use of cash decreased due to changes in working capital including decreases in accounts receivable and prepaid expense and other current assets, increase in accrued liabilities, offset by a decrease in accounts payable. 36 Table of Contents
During the three months endedSeptember 30, 2020 , our operating activities used$8.0 million in cash, which was greater than the net loss of$4.3 million , primarily due to increases in working capital including increases in accounts receivable, inventory, prepaid and other assets. These charges were offset by depreciation, amortization and accretion and an increase in accrued liabilities and accrued compensation.
Net cash used in investing activities of
ended
considerations and capital expenditure.
Net cash used in investing activities of approximately
months ended
consideration.
Net cash used in financing activities of$5.5 million during the three months endedSeptember 30, 2021 was primarily from$3.4 million paydown on the revolving loan and$2.3 million in payments of fixed payment arrangements. These decreases were partially offset by a$0.3 million net proceeds from issuance of our common stock under the ATM. Net cash used in financing activities of$2.2 million during the three months endedSeptember 30, 2020 . This was primarily related to the offering cost of$1.6 million which was paid in cash and payments of$0.6 million in note payables and fixed payment arrangements.
Capital Resources
We have obligations related to our loan and credit facilities, contingent
considerations related to our acquisitions, milestone payments and purchase
commitments.
Loan and Credit
Upon closing of the Neos Merger, we indirectly assumed$15.6 million principal and approximately$1.0 million in exit fee obligation under Neos' credit facility with Deerfield. As ofSeptember 30, 2021 ,$16.0 million was outstanding under the Deerfield facility, including the exit fee. Interest is due quarterly at a rate of 12.95% per year. Payment on the Deerfield facility, including the exit fee and any unpaid interest, is due onMay 11, 2022 . If all or any of the principal is prepaid or required to be prepaid prior toDecember 31, 2021 , then we shall pay, in addition to such prepayment and accrued interest thereon, a prepayment premium equal to 6.25% of the amount of principal prepaid. Our Neos subsidiary's Loan Agreement with Encina, provide us with up to$25.0 million in Revolving Loans, of which up to$2.5 million may be available for short-term swingline loans, against 85% of eligible accounts receivable. The Revolving Loans bear variable interest through maturity at the one-monthLondon Interbank Offered Rate, plus an applicable margin of 4.50%. In addition, we are required to pay an unused line fee of 0.50% of the average unused portion of the maximum revolving facility amount during the immediately preceding month. Interest is payable monthly in arrears, upon a prepayment of a loan and on the maturity date. The maturity date under the Loan Agreement isMay 11, 2022 . We may permanently terminate the Loan Agreement by prepaying all outstanding principal amounts and accrued interest at any time, subject to at least five (5) business days prior notice to the lender and the payment of a prepayment fee equal to (i) 1.0% of the aggregate principal amount prepaid if such prepayment occurs afterOctober 2, 2020 but on or beforeOctober 2, 2021 , and (ii) 0.5% of the aggregate principal amount prepaid if such prepayment occurs afterOctober 2, 2021 but beforeMay 11, 2022 . 37
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Contractual Obligations, Commitments and Contingencies
As a result of our acquisitions and licensing agreements, we are contractually and contingently obliged to pay, when due, various fixed and milestone payments (see Note 11 - Commitments and Contingencies for additional information). Upon closing of the Pediatric Portfolio acquisition inOctober 2019 , we assumed fixed payment obligations that required us to make a payment of$3.1 million during the remainder of fiscal year 2022,$3.1 million in fiscal year 2023 and$2.1 million in each of the fiscal years 2024 and 2025. In addition, in fiscal year 2022, upon occurrence of certain events, we may be required to pay approximately$3.0 million in milestone payments. InFebruary 2020 , upon closing of our Innovus Merger, all of Innovus shares were converted to our common stock and CVRs, which represents contingent additional consideration of up to$16.0 million payable to satisfy future performance milestones. Depending on satisfaction of these conditions, we may be required to pay$2.0 million during the remainder of fiscal year 2022 and additional$5.0 million in each of the fiscal years 2023 and 2024. Our Innovus subsidiary is also contractually obligated for inventory purchase commitments, for which we are expected to pay approximately$0.7 million during the remainder of fiscal year 2022. InFebruary 2015 , Innovus acquired Novalere, which included the rights associated with distributing FlutiCare. As part of the Novalere acquisition, Innovus is obligated to make five payments of$0.5 million , between fiscal year 2026 through fiscal year 2033, when certain levels of FlutiCare sales are achieved.
In connection with our acquisition of the Rumpus assets, as discussed above
under the section “Acquisitions and Divestitures”, we are required to make a
payment of
Critical Accounting Estimates
Our management's discussion and analysis of financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted inthe United States ("U.S. GAAP"). The preparation of our financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and the disclosure of any contingent assets and liabilities at the date of the financial statements, as well as reported revenue and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments. We base our estimates on our historical experience and on various other assumptions that we believe to be reasonable under the circumstances. These estimates and assumptions form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our actual results may differ materially from these estimates under different assumptions or conditions. While our significant accounting policies are described in more detail in Note 2 to the notes to our audited financial statements included elsewhere in this Annual Report on Form 10-K, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our consolidated financial statements.
Revenue recognition
We generate revenue from product sales through ourAytu BioPharma segment and Aytu Consumer Health Segment. We recognize revenue when all of the following criteria are satisfied: (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) as each performance obligation is individually satisfied. Revenue from ourAytu BioPharma segment involves significant judgment and estimates of the net sales price, including estimates of variable consideration (e.g., savings offers, prompt payment discounts, product returns, wholesaler (distributor) fees, wholesaler chargebacks and estimated rebates) to be incurred on the respective product 38 Table of Contents
sales, and we recognize the estimated amount as revenue when control of the product is transferred to our customers (e.g., upon delivery). Variable consideration is determined using either an expected value or a most likely amount method. The estimate of variable consideration is also subject to a constraint such that some or all of the estimated amount of variable consideration will only be included in the transaction price to the extent that it is probable that a significant reversal of revenue (in the context of the contract) will not occur when the uncertainty associated with the variable consideration is subsequently resolved. Estimating variable consideration and the related constraint requires the use of significant management judgment and other market data. We provide for prompt payment discounts, wholesaler fees and wholesaler chargebacks based on customer contractual stipulations. We analyze recent product return history to determine a reliable return rate. Additionally, management analyzes historical savings offers and rebate payments based on patient prescriptions and information obtained from third party providers to determine these respective variable considerations.
Savings offers
We offer savings programs for our patients covered under commercial payor plans in which the cost of a prescription to such patients is discounted. The amount of redeemed savings offers is recorded based on information from third-party providers against the estimated discount recorded as accrued expenses. The estimated discount is recorded as a gross to net sales adjustment at the time revenue is recognized. Historical trends of savings offers will be regularly monitored, which may result in adjustments to such estimates in the future.
Prompt payment discounts
Prompt payment discounts are based on standard programs with wholesalers and are recorded as a discount allowance against accounts receivable and as a gross to net sales adjustment at the time revenue is recognized.
Wholesale distribution fees
Wholesale distribution fees are based on definitive contractual agreements for
the management of our products by wholesalers and are recorded as accrued
expenses and as a gross to net sales adjustment at the time revenue is
recognized.
Rebates
The Rx Portfolio products are subject to commercial managed care and government managed Medicare and Medicaid programs whereby discounts and rebates are provided to participating managed care organizations and federal and/or state governments. Calculations related to rebate accruals are estimated based on information from third-party providers. Estimated rebates are recorded as accrued expenses and as a gross to net sales adjustment at the time revenue is recognized. Historical trends of estimated rebates will be regularly monitored, which may result in adjustments to such estimates in the future.
Returns
Wholesalers' contractual return rights are limited to defective product, product that was shipped in error, product ordered by customer in error, product returned due to overstock, product returned due to dating or product returned due to recall or other changes in regulatory guidelines. The return policy for expired product allows the wholesaler to return such product starting six months prior to expiry date to twelve months post expiry date. Estimated returns are recorded as accrued expenses and as a gross to net sales adjustments at the time revenue is recognized. We analyzed return data available from sales since inception date to determine a reliable return rate.
Wholesaler chargebacks
The Rx Portfolio products are subject to certain programs with wholesalers
whereby pricing on products is discounted below wholesaler list price to
participating entities. These entities purchase products through wholesalers at
the discounted price, and the wholesalers charge the difference between their
acquisition cost and the discounted price
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back to us. Estimated chargebacks are recorded as a discount allowance against accounts receivable and as a gross to net sales adjustment at the time revenue is recognized based on information provided by third parties.
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. Until objective and persuasive evidence exists that regulatory approval has been received and future economic benefit is probable, pre-launch inventories are expensed into research and development. Post-FDA approval, manufacturing costs for the production of our products are being capitalized into inventory. We periodically review the composition of our inventories in order to identify obsolete, slow-moving, excess or otherwise unsaleable items. Unsaleable items will be written down to net realizable value in the period identified.
Stock-based compensation expense
Stock-based compensation awards, including grants of stock options, restricted stock and restricted stock units, and modifications to existing awards, are recognized in the statement of operations based on their fair values on the date of grant. Stock option grants are valued on the grant date using the Black-Scholes option pricing model and compensation costs are recognized ratably over the period of service using the graded method. Restricted stock and restricted stock unit grants are valued based on the estimated grant date fair value of the Company's common stock and recognized ratably over the requisite service period. Forfeitures are adjusted for as they occur. We calculated the fair value of options using the Black Scholes option pricing model. Restricted stock and restricted stock unit grants are valued based on the estimated grant date fair value of our common stock. The Black Scholes option pricing model requires the input of subjective assumptions, including stock price volatility and the expected life of stock options. The application of this valuation model involves assumptions that are highly subjective, judgmental and sensitive in the determination of compensation cost. We have not paid and do not anticipate paying cash dividends. Therefore, the expected dividend rate is assumed to be 0%. The expected stock price volatility for stock option awards is based on our stock price volatility in the valuation model. The risk-free rate was based on theU.S. Treasury yield curve in effect commensurate with the expected life assumption. The average expected life of stock options was determined according to the "simplified method" as described in SAB Topic 110, which is the midpoint between the vesting date and the end of the contractual term. The risk-free interest rate was determined by reference to implied yields available fromU.S. Treasury securities with a remaining term equal to the expected life assumed at the date of grant. Forfeitures are adjusted for as they occur. There is a high degree of subjectivity involved when using option pricing models to estimate stock-based compensation. There is currently no market-based mechanism or other practical application to verify the reliability and accuracy of the estimates stemming from these valuation models, nor is there a means to compare and adjust the estimates to actual values. Although the fair value of employee stock-based awards is determined using an option pricing model, such a model value may not be indicative of the fair value that would be observed in a market transaction between a willing buyer and willing seller. If factors change and we employ different assumptions when valuing our options, the compensation expense that we record in the future may differ significantly from what we have historically reported.
Impairment of Long-lived Assets
We assess impairment of long-lived assets when events or changes in
circumstances indicates that their carrying value amount may not be recoverable.
Long-lived assets consist of property and equipment, net and goodwill and other
intangible assets, net. Circumstances which could trigger a review include but
are not limited to: (i) significant decreases in the market price of the asset;
(ii) significant adverse changes in the business climate or legal or regulatory
factors; (iii) or expectations that the asset will more likely than not be sold
or disposed of significantly before the end of its estimated useful life. If the
estimated future undiscounted cash flows, excluding interest charges, from the
use of an asset are less than the carrying value, a write-down would be recorded
to reduce the related asset to its estimated fair value.
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Goodwill
Goodwill is recorded as the difference between the fair value of the purchase
consideration and the fair value of the net identifiable tangible and intangible
assets acquired. Goodwill is reviewed for impairment at least annually or
whenever events or changes in circumstances indicate that the carrying amount of
an intangible asset may not be recoverable. We typically complete our annual
impairment test for goodwill using an assessment date in the fourth quarter of
each fiscal year. Pursuant to the guidance under ASC350, we first assess
qualitative factors to determine whether the existence of events or
circumstances leads to a determination that it is more likely than not that the
fair value of one or more of our reporting units is greater than its carrying
amount. If, after assessing events or circumstances, we determine it is more
likely than not that the fair value of a reporting unit is greater than its
carrying amount, there is no need to perform any further testing. However, if we
conclude otherwise, then we perform a quantitative impairment test by comparing
the fair value of the reporting unit with the carrying value. We also have the
option to bypass the qualitative assessment for any reporting unit in any period
and proceed directly to performing the quantitative goodwill impairment test.
The fair value of the reporting unit is determined using a combination of a
market multiple and a discounted cash flow approach. Determining the fair value
of a reporting unit requires the use of estimates, assumptions and judgment. The
principal estimates and assumptions that we use include prospective financial
information (revenue growth, operating margins and capital expenditures), future
market conditions, weighted average costs of capital, a terminal growth rate,
comparable multiples of publicly traded companies in our industry, and the
earnings metrics and multiples utilized. We believe that the estimates and
assumptions used in impairment assessments are reasonable. If the fair value of
the reporting unit is less than the carrying amount, an impairment charge is
recorded in the amount of the difference. Due to the decline in stock price this
was an indicator of increased risk primarily increasing the discount rates in
the valuation models. The Company determined the fair value of its the reporting
segments utilizing the discounted cash flow model. As a result of the continued
decline in its stock price, we risk adjusted our cost of equity, which increased
the over-all discount rate. As of September 30, 2021 , utilizing the risk
adjusted weighted-average discount rate, the fair value of Aytu BioPharma
segment is less than its carrying value. As a result, we recognized an
impairment loss of $19.5 million related to the Aytu BioPharma segment.
Furthermore, the quantitative test indicated there was no impairment at Aytu
Consumer Health segment as it resulted in an implied fair value greater than the
carrying value as of September 30, 2021 . There was no such impairment loss
during the three months ended September 30, 2020 .
Contingent considerations
We classify contingent consideration liabilities related to business acquisitions within Level 3 as factors used to develop the estimated fair value are unobservable inputs that are not supported by market activity. We estimate the fair value of contingent consideration liabilities based on projected payment dates, discount rates, probabilities of payment, and projected revenues. Projected contingent payment amounts are discounted back to the current period using a discounted cash flow methodology. The fair value of the contingent value rights was based on a model in which each individual payout was deemed either (a) more likely than not to be paid out or (b) less likely than not to be paid out. From there, each obligation was then discounted at a 30% discount rate to reflect the overall risk to the contingent future payouts pursuant to the CVRs. This value is then remeasured for future expected payout as well as the increase in fair value due to the time value of money. These gains or losses, if any, are included as a component of operating cash flows. Fixed payment arrangements are comprised of minimum product payment obligations relating to either make whole payments or fixed minimum royalties arising from a business acquisition. The fixed payment arrangements were recognized at their amortized cost basis using a market appropriate discount rate and are accreted up to their ultimate face value over time. The liabilities related to fixed payment arrangements are not remeasured at each reporting period, unless we determine the circumstances have changed such that the fair value of these fixed payment obligations would have changed due to changes in company specific circumstances or interest rate environments.
Warrants
We account for liability classified warrants by recording the fair value of each
instrument in its entirety and recording the fair value of the warrant
derivative liability. The fair value of liability classified derivative
financial
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instruments were calculated using a lattice valuation model. Equity classified
warrants are valued using a Black-Scholes model. Changes in the fair value of
liability classified derivative financial instruments in subsequent periods were
recorded as derivative income or expense for the warrants and reported as a
component of cash flows from operations.
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