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 our then 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 2,000,000 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, 2,000,000 shares of its common stock, are 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 six months ended December 31, 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:

			Weighted		Weighted Average
	Number of		Average		Remaining Contractual
	Options		Exercise Price		Life in Years
Outstanding June 30, 2016		322,302	$	18.01		9.33
Granted		441,999	$	3.23
Exercised		-	$	-
Forfeited/Cancelled		(17,646)	$	4.99
Outstanding December 31, 2016		746,655	$	3.52		9.21
Exercisable at December 31, 2016		323,755	$	3.40		9.10
Available for grant at December 31, 2016		1,253,345

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 six months ended December 31, 2016 and three and six months ended December 31, 2015:

	Three Months Ended December 31,				Six Months Ended December 31,
	2016		2015		2016		2015
Research and development expenses
Stock options	$	-	$	20,000	$	-	$	25,000
Selling, general and administrative expenses
Stock options		381,000	$	163,000		1,425,000		226,000
	$	381,000	$	183,000	$	1,425,000	$	251,000

Unrecognized expense at December 31, 2016	$	1,435,000

Weighted average remaining years to vest		2.26

Warrants

A summary of all warrants is as follows:

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

Issuance of settlement warrants to initial investors		88,032	$	4.00
Warrants issued to investors in connection with the registered offering		6,020,245	$	1.86
Warrants issued to placement agents for the registered offering		401,450	$	1.86

Outstanding December 31, 2016		8,711,354	$	2.98		4.51

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 December 31, 2016, these warrants had a fair value of $80,000.

During the six months ended December 31, 2016, Aytu issued warrants to purchase 88,032 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 generated a non-cash expense of $7,000 and $596,000 for the three and six month periods ended December 31, 2016, respectively, which is included in sales, general and administrative expense. These warrants are accounted for under equity treatment.

In connection with our November 2016 public offering, we issued warrants to purchase an aggregate of 401,450 shares of common stock at an exercise price of $1.86 and a term of five years to the underwriters of the public offering. These warrants are accounted for under equity treatment.

Also in connection with our November 2016 public offering, we issued to investors warrants to purchase an aggregate of 6,020,245 shares of common stock, which includes the over-allotment warrants, at an exercise price of $1.86 with a term of five years. These warrants are accounted for under equity treatment (see Note 9).

The warrants issued in connection with our November registered offering are all registered and tradable on the OTCQX under the ticker symbol “AYTUZ”.

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 selling 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. During the three months ended December 31, 2016, Aytu sold 5,735,000 units (each unit consisting of one share of common stock and one warrant with an exercise price of $1.86) which was sold at $1.50 per unit. The $1.50 was used as the selling price underlying the units to calculate the value attributable to the common stock and warrants. This resulted in a fair value of $0.77 for the common stock and $0.73 for the warrant. We used the value of $0.73 per in the valuation of all warrants issued in the December 31, 2016 quarter.

Significant assumptions in valuing the warrants issued during the December 31, 2016 quarter were as follows:

Expected volatility			186.7% - 229.8%
Risk free interest rate			1.02% - 1.33%
Contractual term (years)			4.68 - 5.0
Dividend yield			0%