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Fair Value Considerations
 12 Months Ended
Jun. 30, 2018
Fair Value Disclosures [Abstract]  
Fair Value Considerations

Note 4 – Fair Value Considerations

 

The carrying amounts of financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, accounts payable, and other current assets and other liabilities approximate their fair value due to their short maturities. The fair value of the warrant derivative liability was valued using the lattice valuation methodology. The fair value of acquisition-related contingent consideration is based on estimated discounted future cash flows and assessment of the probability of occurrence of potential future events. 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 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 liabilities that were accounted for at fair value on a recurring basis as of June 30, 2018 and 2017, by level within the fair value hierarchy:

 

   Fair Value Measurements Using 
   Level 1   Level 2   Level 3   Total 
June 30, 2018                    
LIABILITIES                    
Warrant derivative liability  $       -   $       -   $94,000   $94,000 
Contingent consideration  $-   $-   $4,694,000   $4,694,000 
                     
June 30, 2017                    
LIABILITIES                    
Warrant derivative liability  $-   $-   $-   $- 
Contingent consideration  $-   $-   $7,648,000   $7,648,000 

 

The warrant derivative liability was valued using the lattice valuation methodology because that model embodies the relevant assumptions that address the features underlying these instruments. The warrants related to the warrant derivative liability are not actively traded and are, therefore, classified as Level 3 liabilities. 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 issuance and as of June 30, 2018:

  

   June 30,
2018		   At Issuance 
Warrants:          
Volatility   173.4%   188.0%
Equivalent term (years)   4.13    5.00 
Risk-free interest rate   2.69%   1.83%
Dividend yield   0.00%   0.00%

 

The following table sets forth a reconciliation of changes in the warrant derivative liability for the period ended June 30, 2018

 

   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 June 30, 2017  $- 
Warrant issuances   4,118,000 
Warrant exercises   (40,000)
Change in fair value included in earnings   (3,984,000)
Balance as of June 30, 2018  $94,000 

 

We classify our contingent consideration liability in connection with the acquisition of ProstaScint, Natesto, ZolpiMist and the merger with Nuelle 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 contractual payment obligations, discount rates, probabilities of payment, and expected future performance. Contingent payment amounts are discounted back to the current period using a discounted cash flow methodology. The contingent consideration related to the AWH assets was prepaid up to the first $1.0 million in net revenue. Since we will not be able to manufacture more product (see Note 1), we will not generate any additional revenue. Therefore, we will not exceed $1.0 million and thus, we have adjusted the remaining contingent consideration balance to zero. This adjustment is reflected in Other Gain on the Consolidated Statement of Operations. We also reduced the contingent consideration for ProstaScint by $57,000 to reflect that product’s abandonment. As of June 30, 2018, the value for the contingent consideration was adjusted to $0 based upon the abandonment of ProstaScint in June 2018. Also, as of June 30, 2018, the contingent consideration related to Natesto was revalued at $1.8 million.

 

The following table sets forth a summary of changes in the contingent consideration for the period ended June 30, 2018:

 

   Contingent Consideration 
     
Balance as of June 30, 2016  $3,869,000 
Increase due to purchase of assets   1,927,000 
Increase due to accretion   306,000 
Increase due to remeasurement   2,256,000 
Decrease due to impairment   (710,000)
Balance as of June 30, 2017  $7,648,000 
Increase due to purchase of assets   2,846,000 
Increase due to accretion   801,000 
Decrease due to contractual payment   (266,000)
Decrease due to remeasurement   (6,335,000)
Balance as of June 30, 2018  $4,694,000 

 

The contingent consideration was valued using the Monte-Carlo valuation methodology because that model embodies all of the relevant assumptions that address the features underlying these instruments. Contingent consideration is not actively traded and therefore classified as Level 3.