Note 10 – Equity Instruments

Stock Option Repricing

In March 2017, our Board of Directors approved a common stock option repricing program whereby all previously granted and unexercised options were repriced on a one-for-one basis to $0.82 per share which represented the closing price 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, 737, 279 unexercised options originally granted to purchase common stock at prices ranging from $3.23 to $55.56 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 an incremental stock-based compensation expense of $34,000. The full expense was recognized during the three months ended March 31, 2017.

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 an 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, as amended in November 2016, provides for the award of stock options, stock appreciation rights, restricted stock and other equity awards for up to an aggregate of 2.0 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, 2.0 million 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 nine months ended March 31, 2017 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	$	1.00	9.33
Granted		441,999	$	0.93
Exercised		-	$	-
Forfeited		(25,980)	$	4.42
Cancelled		(1,355)	$	3.23
Outstanding March 31, 2017		736,966	$	0.82	8.53
Exercisable at March 31, 2017		371,636	$	0.82	8.04
Available for grant at March 31, 2017		1,263,034

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. During the quarter ended March 31, 2017, one of the Company’s executive officers resigned and his options vested in full upon this event. This resulted in the Company recognizing the remainder of the expense of $520,000. The following table summarizes stock-based compensation expense for the stock option issuances for the three and nine months ended March 31, 2017 and three and nine months ended March 31, 2016:

	Three Months Ended March 31,				Nine Months Ended March 31,
	2017		2016		2017		2016
Research and development expenses
Stock options	$	-	$	38,000	$	-	$	63,000
Selling, general and administrative expenses
Stock options		817,000		258,000		2,242,000		484,000
	$	817,000	$	296,000	$	2,242,000	$	547,000

Unrecognized expense at March 31, 2017	$	1,022,000

Weighted average remaining years to vest		2.06

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		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	$	0.75
Warrants exercised		(2,991,041)	$	0.75

Outstanding March 31, 2017		5,720,313	$	2.51		4.48

Included in the warrant balance at June 30, 2016 are warrants to purchase of 109,375 shares of common stock issued to the underwriters of our May registered offering. These warrants were accounted for under liability accounting and were fair valued at each reporting period (see Note 6). On February 28, 2017, these warrants had a fair value of $63,000. Upon the amendment to these warrant agreements, in connection with the closing of our warrant tender offer, this value was reclassified from liability accounting to equity after we removed any provision in the amendment that could cause this to be paid in cash.

Included in the warrant balance at June 30, 2016 are warrants to purchase of 8,566 shares of common stock issued to the bankers that assisted us with our Notes (see Note 8). In March 2017, the Company reduced the exercise price of $7.80 to $0.75. This modification resulted in an expense of $1,500 which was recognized during the quarter ended March 31, 2017 in sales, general and administrative.

During the nine months ended March 31, 2017, 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 $596,000 for the nine month period ended March 31, 2017, 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 to the underwriters of the public offering 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. These warrants are accounted for under equity treatment. In February, we reduced the exercise price of these warrants to $0.75.

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.”

On February 28, 2017, the Company consummated its warrant tender offer to exercise, at a temporarily reduced exercise price of $0.75 per share, (i) outstanding warrants to purchase 1,733,322 shares of common stock with an exercise price of $6.00 per share, which were originally issued to investors in the Company’s May 2016 financing (the “May 2016 Warrants”), and (ii) outstanding warrants to purchase 6,020,245 shares of common stock with an exercise price of $1.86 per share, which were originally issued to investors in the Company’s October 2016 financing (the “October 2016 Warrants” and together with the May 2016 Warrants, the “Original Warrants”). Original Warrants to purchase an aggregate of 2,991,041 shares of common stock were tendered and exercised in the warrant tender offer, for aggregate gross proceeds to the Company of approximately $2.2 million. Original warrants that were not exercised remain in effect at the pre-tender offer exercise prices of $6.00 per share and $1.86 per share, respectively. The incremental fair value, which had no book impact, was $178,000.

The Company also reduced the exercise prices of an aggregate of 510,825 warrants to purchase shares of common stock, which were originally issued as underwriters’ compensation in the May 2016 and October 2016 financings, from $6.00 per share and $1.86 per share, respectively, to $0.75 per share. The amended warrants related to the May 2016 financing adjusted the accounting for these warrants from liability classification to equity. The incremental fair value of these warrant modifications, which had no book impact, was $23,000.

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 or fair market value 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 March 31, 2017, Aytu modified 3,510,432 warrants. We used the value of $0.76 per the valuation of our common stock issued in the March 31, 2017 quarter.

Significant assumptions in valuing the warrants modified during the March 31, 2017 quarter were as follows:

Expected volatility		156.64% - 169.22%
Risk free interest rate		1.63% - 1.87%
Contractual term (years)		3.46 - 4.67
Dividend yield		0%