Note 10 – Equity Instruments

Options

Prior to the Merger, Aytu had two approved stock option plans (Luoxis 2013 Stock Option Plan and Vyrix 2013 Stock Option Plan), pursuant to which Aytu had reserved a total of 1,718,828 million shares of common stock, both of which were terminated on April 16, 2015 upon the closing of the Merger.

The Luoxis options that were in the money and all outstanding Vyrix options issued under the respective 2013 Option Plans were accelerated and cancelled in connection with the Merger. Option holders received a cash payment per option share equal to the difference between the consideration payable per share of common stock pursuant to the Merger and the exercise price of the option; if the consideration paid to holders of common stock was less than the exercise price of such options, no amount was paid to the option holder in connection with the cancellation. The cash payment during the period ended June 30, 2015 was $27,000. The Company recognized non-cash compensation expense of $422,000 and $189,000 related to the Luoxis and Vyrix options that had accelerated vesting as of the Merger date during the period ended June 30, 2015.

The Luoxis options that were not paid out were terminated pursuant to the terms of the 2013 Luoxis Option Plan. The Company treated these options as pre-vesting forfeitures and $433,000 of previously recognized non-cash compensation expense was reversed.

On June 1, 2015, Aytu’s stockholders approved the 2015 Stock Option and Incentive Plan (the “2015 Plan”), which provides for the award of stock options, stock appreciation rights, restricted stock and other equity awards for up to an aggregate of 10.0 million shares of common stock. The shares of common stock underlying any awards that are forfeited, canceled, reacquired by Aytu prior to vesting, satisfied without any issuance of stock, expire or are otherwise terminated (other than by exercise) under the 2015 Plan will be added back to the shares of common stock available for issuance under the 2015 Plan. The fair value of the options are calculated using the Black-Scholes option pricing model. In order to calculate the fair value of the options, certain assumptions are made regarding components of the model, including the estimated fair value of the underlying common stock, risk-free interest rate, volatility, expected dividend yield and expected option life. Changes to the assumptions could cause significant adjustments to valuation. Aytu estimates the expected term based on the average of the vesting term and the contractual term of the options. The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of the grant for treasury securities of similar maturity. Aytu has computed the fair value of all options granted during the nine months ended March 31, 2016 using the following assumptions:

Expected volatility	75.00	%
Risk free interest rate	1.21% - 1.90	%
Expected term (years)	3.75 - 6.25
Dividend yield	0	%

Stock option activity is as follows:

			Weighted		Weighted Average
	Number of		Average		Remaining Contractual
	Options		Exercise Price		Life in Years
Outstanding June 30, 2015		-	$	-
Granted		3,717,500	$	1.55
Exercised		-	$	-
Forfeited/Cancelled		(50,000)	$	1.51
Outstanding March 31, 2016		3,667,500	$	1.55	9.55
Exercisable at March 31, 2016		1,477,500	$	1.51	9.62
Available for grant at March 31, 2016		6,332,500

Stock-based compensation expense related to the fair value of stock options was included in the statements of operations as research and development expenses and selling, general and administrative expenses as set forth in the table below. Aytu determined the fair value as of the date of grant using the Black-Scholes option pricing model and expenses the fair value ratably over the vesting period. The following table summarizes stock-based compensation expense for the three and nine months ended March 31, 2016 and for the stock-based compensation expense related to the Luoxis and Vyrix options for the three and nine months ended March 31, 2015:

	Three Months Ended March 31,				Nine Months Ended March 31,
	2016		2015		2016		2015
Research and development expenses Stock options	$	38,000	$	115,000	$	63,000	$	323,000

Selling, general and administrative expenses Stock options		258,000		157,000		484,000		427,000
	$	296,000	$	272,000	$	547,000	$	750,000

Unrecognized expense at March 31, 2016	$	1,554,000

Weighted average remaining years to vest		2.90

Of the options that Aytu issued during the nine months ended March 31, 2016, 1,447,500 were to Ampio board members and employees. This was recorded as a return of capital to Ampio and Ampio will take a stock-based compensation expense equal to $1.3 million on their financial statements related to these option grants.

Warrants

Aytu issued warrants in conjunction with its 2013 private placement as well as to the placement agents in conjunction with the 2015 convertible promissory note financing that converted to common stock (see Note 8). The 2015 warrants were previously classified as a liability and upon conversion of the notes to common stock the associated warrants were assigned a value and moved to equity. A summary of these warrants is as follows:

				Weighted		Weighted Average
	Number of			Average		Remaining Contractual
		Warrants		Exercise Price		Life in Years

Outstanding June 30, 2015			102,613	$	4.53		2.92
Warrants issued to placement agents for convertible promissory notes			267,052	$	0.65
Outstanding March 31, 2016 (unaudited)			369,665	$	1.73		3.78

Significant assumptions in valuing the warrant liability related to the placement agent warrants issued during the March 31, 2016 quarter were as follows:

Expected volatility	75	%
Risk free interest rate	1.36% - 1.37	%
Contractual term (years)	4.6
Dividend yield	0	%

Warrant Obligation related to the Convertible Promissory Notes

Aytu has the obligation to issue warrants to the private placement agents for the 2015 convertible note financing as part of their fees for the financing. These warrants are classified as a derivative warrant liability due to the fact that the number of shares and exercise price have not been set as of March 31, 2016. The number of shares of Company stock that these warrants will convert into is equal to 8% of the gross number of shares of the Company stock issuable upon conversion of the Notes issued to investors introduced to the Company by the private placement agents pursuant to the private placement memorandum. The exercise price will be the conversion price per share at which the first outstanding Note converts into Company common stock. The warrants have a term of five years from August 31, 2015 due to the conversion setting the price of these warrants (see Note 8). During the quarter ended March 31, 2016, a portion of this warrant obligation converted into 267,052 warrants with an exercise price of $0.65 which were reclassified from liability based warrants to equity presentation (see Note 12). This conversion increased additional paid-in capital by $87,000. The warrants related to the convertible debt that did not convert are still classified as a liability until such time as the conversion price is set.