Note 9 – Equity Instruments

Stock Option Repricing

In July 2016, our Board of Directors approved a common stock option repricing program whereby previously granted and unexercised options held by current employees, consultants and directors with exercise prices above $6.00 per share were repriced on a one-for-one basis to $3.23 per share which represented the per share fair value of our common stock as of the date of the repricing. There was no other modification to the vesting schedule of the previously issued options. As a result, 316,051 unexercised options originally granted to purchase common stock at prices ranging from $6.72 to $18.12 per share were repriced under this program.

We treated the repricing as a modification of the original awards and calculated additional compensation costs for the difference between the fair value of the modified award and the fair value of the original award on the modification date. The repricing resulted in incremental stock-based compensation expense of $318,000. Expense related to vested shares was expensed on the repricing date and expense related to unvested shares is being amortized over the remaining vesting period of such stock options.

Options

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 833,334 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.

Pursuant to the 2015 Stock Plan, 833,334 shares of its common stock, were reserved for issuance. The fair value of options granted was 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. The assumptions used for the three months ended September 30, 2016 are as follows:

Expected volatility		182% - 185%
Risk free interest rate		0.97% - 1.14%
Expected term (years)		5.0 - 6.5
Dividend yield		0%

Stock option activity is as follows:

	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life in Years
Outstanding June 30, 2016		322,302	$	18.01		9.33
Granted		441,999	$	3.23
Exercised		-	$	-
Forfeited/Cancelled		(2,084)	$	18.12
Outstanding September 30, 2016		762,217	$	3.52		9.48
Exercisable at September 30, 2016		254,131	$	3.44		9.42
Available for grant at September 30, 2016		71,117

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 months ended September 30, 2016 and the three months ended September 30, 2015:

	Three Months Ended September 30,
	2016		2015
Research and development expenses
Stock options	$	-	$	5,000
Selling, general and administrative expenses
Stock options		1,044,000		63,000
	$	1,044,000	$	68,000

Unrecognized expense at September 30, 2016	$	1,906,000

Weighted average remaining years to vest		2.48

Warrants

A summary of all warrants is as follows:

	Number of Warrants		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life in Years
Outstanding June 30, 2016		2,201,627	$	6.19		4.71

Issuance of settlement warrants to initial investors		84,918	$	4.00
Outstanding September 30, 2016		2,286,545	$	6.11		4.47

Included in the warrant balance at June 30, 2016 are warrants to purchase common stock of 109,375 issued to the underwriters of our May registered offering. These warrants are currently accounted for under liability accounting and are fair valued at each reporting period (see Note 5). At September 30, 2016, these warrants had a fair value of $347,000.

During the three months ended September 30, 2016, Aytu issued warrants to purchase 84,918 shares of common stock to initial investors of the Company at an exercise price of $4.00 and a term of five years from July 2016. These warrants are accounted for under equity treatment.

All warrants were valued using the Black-Scholes option pricing model. In order to calculate the fair value of the warrants, certain assumptions were made regarding components of the model, including the closing price of the underlying common stock, risk-free interest rate, volatility, expected dividend yield, and expected life. Changes to the assumptions could cause significant adjustments to valuation. The Company estimated a volatility factor utilizing a weighted average of comparable published volatilities of peer companies. 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.

Significant assumptions in valuing the warrants issued during the September 30, 2016 quarter were as follows:

Expected volatility		225.5% - 229.8%
Risk free interest rate		1.02% - 1.18%
Contractual term (years)		4.79 - 4.94
Dividend yield		0%