Note 6 – Fair Value Considerations

Aytu’s financial instruments include cash, cash equivalents and restricted cash, accounts receivable, investments, accounts payable and accrued liabilities, contingent consideration and warrant derivative liability. The carrying amounts of cash, cash equivalents, restricted cash, accounts receivable, accounts payable and accrued liabilities approximate their fair value due to their short maturities. The valuation policies are determined by the Chief Financial Officer and approved by the Company’s Board of Directors.

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 assets and liabilities that were accounted for at fair value on a recurring basis, by level within the fair value hierarchy:

	Fair Value Measurements Using
	Level 1		Level 2		Level 3		Total
March 31, 2017
ASSETS
Investment in Acerus	$	-	$	-	$	-	$	-

LIABILITIES
Warrant derivative liability	$	-	$	-	$	-	$	-
Contingent consideration	$	-	$	-	$	4,080,000	$	4,080,000

June 30, 2016
ASSETS
Investment in Acerus	$	1,041,000	$	-	$	-	$	1,041,000

LIABILITIES
Warrant derivative liability	$	-	$	-	$	276,000	$	276,000
Contingent consideration	$	-	$	-	$	3,869,000	$	3,869,000

The estimated fair value of the Company’s investment in Acerus, which is classified as Level 1 (quoted price is available), was $1,041,000 as of June 30, 2016. This investment was sold during the three months ended March 31, 2017.

The warrant derivative liability was valued using the Black-Scholes valuation methodology because that model embodies all of the relevant assumptions that address the features underlying these instruments. The warrants related to the warrant derivative liability are not actively traded and therefore classified as Level 3. Significant assumptions in valuing the warrant derivative liability, based on estimates of the value of Aytu common stock and various factors regarding the warrants, were as follows as of February 28, 2017 and at June 30, 2016:

	February 28, 2017			June 30, 2016
Warrants:
Volatility		160.7	%		75.0	%
Equivalent term (years)		4.18			4.84
Risk-free interest rate		1.87	%		0.99	%
Dividend yield		0.00	%		0.00	%

The following table sets forth a reconciliation of changes in the fair value of the derivative financial liabilities classified as Level 3 in the fair value hierarchy:

	Derivative Instruments

Balance as of June 30, 2016	$	276,000
Warrant issuances		-
Change in fair value included in earnings (February 28, 2017)		(213,000)
Reclassification of warrant from liability to equity upon amendment		(63,000)
Balance as of March 31, 2017	$	-

We classify our contingent consideration liability in connection with the acquisition of ProstaScint and Natesto 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 our contingent consideration liability 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 model. There was no change in the fair value of the contingent consideration during the period ended March 31, 2017.