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Summary of Significant Accounting Policies

12 Months Ended

Jun. 30, 2019

Summary of Significant Accounting Policies

Principals of Consolidation. These consolidated financial statements include the accounts of Aytu and its wholly-owned subsidiary, Aytu Women’s Health. All material intercompany transactions and balances have been eliminated.

Basis of Presentation. The audited consolidated financial statements include the operations of Aytu and its wholly-owned subsidiary, Aytu Women’s Health, LLC. All significant inter-company balances and transactions have been eliminated in consolidation. The accompanying consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”).

Use of Estimates. The preparation of financial statements in accordance with Generally Accepted Accounting Principles in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosures of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Significant items subject to such estimates and assumptions include valuation allowances, stock-based compensation, warrant valuation, purchase price allocation, valuation of contingent consideration, sales returns and allowances, useful lives of fixed assets, collectability of accounts receivable, and assumptions in evaluating impairment of definite and indefinite lived assets. Actual results could differ from these estimates.

Cash, Cash Equivalents and Restricted Cash. Aytu considers all highly liquid instruments purchased with an original maturity of three months or less to be cash equivalents. Restricted cash consist primarily of amounts held in certificate of deposit investments to maintain certain credit amount for Aytu's business credit cards. Aytu’s investment policy is to preserve principal and maintain liquidity. The Company periodically monitors its positions with, and the credit quality of the financial institutions with which it invests. Periodically, throughout the year, and as of June 30, 2019, Aytu has maintained balances in excess of federally insured limits.

Accounts Receivable. Accounts receivable are recorded at their estimated net realizable value. Aytu evaluates collectability of accounts receivable on a quarterly basis and records a reserve, accordingly. The Company did not recognize a reserve as of June 30, 2019 and 2018, respectively.

Inventories. Inventories consist of raw materials, work in process and finished goods and are recorded at the lower of cost or net realizable value, with cost determined on a first-in, first-out basis. Aytu periodically reviews the composition of its inventories in order to identify obsolete, slow-moving or otherwise unsaleable items. If unsaleable items are observed and there are no alternate uses for the inventory, Aytu will record a write-down to net realizable value in the period that the impairment is first recognized. Inventory for our abandoned products was written down during fiscal 2018. Therefore, we currently have no reserve for slow moving inventory as of June 30, 2019 and 2018, respectively.

Fixed Assets. Fixed assets are recorded at cost, less accumulated depreciation and amortization. Depreciation is computed using the straight-line method over the assets’ estimated useful lives. Leasehold improvements are amortized over the term of the lease agreement or the service lives of the improvements, whichever is shorter. The Company begins depreciating assets when they placed into service. Maintenance and repairs are expenses as incurred.

Fair Value of Financial Instruments. The carrying amounts of financial instruments, including cash and cash equivalents, restricted cash, accounts receivable, and accounts payable approximate their fair value due to their short maturities. 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.

Aytu accounts for liability warrants by recording the fair value of each instrument in its entirety and recording the fair value of the warrant derivative liability. The fair value of the financial instruments was calculated using a lattice valuation model. Changes in the fair value in subsequent periods was recorded as derivative income or expense for the warrants. The fair value of the warrants issued to the placement agents in connection with the registered offering were valued using the lattice valuation methodology. Changes in the fair value in subsequent periods were recorded to derivative income.

Revenue Recognition. The Company generates revenue from product sales and license sales. The Company recognizes revenue when all of the following criteria are satisfied: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations, including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when, or as the Company satisfies each performance obligation.

Product sales consist of sales of the Company’s four products: (i) Natesto, (ii) Tuzistra XR, (iii) ZolpiMist, and (iv), MiOXSYS. Products are generally shipped “free-on-board” destination. Collectibility of revenue is reasonably assured based on historical evidence of collectibility between the Company and its customers, or for new customers, upon review of customer financial condition and credit history. Revenue from product sales is recorded at the net sales price, or “transaction price,” which includes estimates of variable consideration that result from coupons, discounts, chargebacks and distributor fees, processing fees, as well as allowances for returns and government rebates. The Company constrains revenue by giving consideration to factors that could otherwise lead to a probable reversal of revenue. Provision balances related to estimated amounts payable to direct customers are netted against accounts receivable from such customers. Balances related to indirect customers are included in accounts payable and accrued liabilities. Where appropriate, the Company utilizes the expected value method to determine the appropriate amount for estimates of variable consideration based on factors such as the Company’s historical experience and specific known market events and trends.

License sales consist of amounts generated from the Company’s sublicense agreement to a third-party for certain of its patented products. Revenue is recognized when earned, based on sales of products under the specified sub-license agreement.

Customer Concentrations. The following customers contributed greater than 10% of the Company's gross revenue during the year ended June 30, 2019 and 2018, respectively. The customers, sometimes referred to as partners or customers, are large wholesale distributors that resell our products to retailers. As of June 30, 2019, four customers accounted for 87% of gross revenue. The revenue from these customers as a percentage of gross revenue was as follows:

	Year Ended June 30,
	2019			2018
Customer A		19	%		32	%
Customer C		26	%		30	%
Customer B		20	%		24	%
Customer D		22	%		0	%

The loss of one or more of the Company's significant partners or collaborators could have a material adverse effect on its business, operating results or financial condition.

We are also subject to credit risk from our accounts receivable related to our product sales. Historically, we have not experienced significant credit losses on our accounts receivable and we do not expect to have write-offs or adjustments to accounts receivable which would have a material adverse effect on our financial position, liquidity or results of operations. As of June 30, 2019, four customers accounted for 88% of gross accounts receivable. As of June 30, 2018, four customers accounted for 93% of gross accounts receivable.

	Year Ended June 30,
	2019			2018
Customer A		9	%		27	%
Customer B		20	%		19	%
Customer C		36	%		35	%
Customer E		23	%		0	%
Other		0	%		12	%

Estimated Sales Returns and Allowances. Aytu records estimated reductions in revenue for potential returns of products by customers. As a result, the Company must make estimates of potential future product returns and other allowances related to current period product revenue. In making such estimates, the Company analyzes historical returns, current economic trends and changes in customer demand and acceptance of our products. If the Company were to make different judgments or utilize different estimates, material differences in the amount of the Company’s reported revenue could result. As of June 30, 2019 and 2018, the Company accrued $99,000 and $17,000, respectively, in our estimated returns allowance. Estimates of potential returns and allowances are recorded each quarter for the difference between estimates and actual results that become available.

Costs of Goods Sold. Costs of goods sold consists primarily of the direct costs of the Company’s products acquired from third-party manufacturers as well as certain royalties owed on certain of the Company’s products. Shipping and handling costs are also included in costs of goods sold for all periods presented.

Stock-Based Compensation. Aytu accounts for stock-based payments by recognizing compensation expense based upon the estimated fair value of the awards on the date of grant over the period of service. Stock option grants are valued on the grant date using the Black-Scholes option pricing model and recognizes compensation costs ratably over the period of service using the graded method. Restricted stock grants are valued based on the estimated grant date fair value of the Company’s common stock, and recognized ratable over the requisite service period. Forfeitures are adjusted for as they occur.

Research and Development. Research and development costs are expensed as incurred with expenses recorded in the respective period.

Patents. Costs of establishing patents, consisting of legal and filing fees paid to third parties, are expensed as incurred. The cost of the Luoxis patents; which relates to the RedoxSYS and MiOXSYS products; were $380,000 when they were acquired in connection with the 2013 formation of Luoxis and are being amortized over the remaining U.S. patent lives of approximately 15 years, which expires in March 2028.

Impairment of Long-lived Assets. The Company assesses impairment of its long-lived assets when events or changes in circumstances indicates that their carrying value amount may not be recoverable. The Company’s long-lived assets consist of (i) fixed assets, net, (ii) licensed assets, net, and (ii) patents, net. Circumstances which could trigger a review include, but are not limited to: (i) significant decreases in the market price of the asset; significant adverse changes in the business climate or legal or regulatory factors; or expectations that the asset will more likely than not be sold or disposed of significantly before the end of its estimated useful life.

The Company evaluated its long-lived assets for impairment as of June 30, 2019 and 2018 respectively, and there was $0 and $1.9 million of impairment recorded.

Income Taxes. Deferred tax assets and liabilities are recognized based on the difference between the carrying amounts of assets and liabilities in the financial statements and their respective tax bases. Deferred tax assets and liabilities are measured using currently enacted tax rates in effect in the years in which those temporary differences are expected to reverse. Deferred tax assets should be reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. At June 30, 2019 and 2018, respectively, the Company had recorded a valuation allowance against its deferred tax assets of $23.3 million $16.7 million, respectively.

Net Loss Per Common Share. Basic income (loss) per common share is calculated by dividing the net income (loss) available to the common shareholders by the weighted average number of common shares outstanding during that period. Diluted net loss per share reflects the potential of securities that could share in the net loss of Aytu. Basic and diluted loss per share was the same in 2019 and 2018, they were not included in the calculation of the diluted net loss per share because they would have been anti-dilutive.

The following table sets-forth securities that could be potentially dilutive, but as of the years ended June 30, 2019 and 2018 are anti-dilutive, and therefore excluded from the calculation of diluted earnings per share.

		Year Ended June 30,
		2019		2018
Warrants to purchase common stock - liability classified	(Note 13)		240,755		240,755
Warrant to purchase common stock - equity classified	(Note 13)		16,218,908		1,641,906
Employee stock options	(Note 12)		1,607		1,798
Employee unvested restricted stock	(Note 12)		2,347,754		38,740
Convertible preferred stock	(Note 11)		3,594,981		–
			22,404,005		1,923,199

Adoption of New Accounting Pronouncements

Revenue from Contracts with Customers (“ASU 2014-09”). In May 2014, the FASB issued ASU 2014-09, Topic 606, Revenue from Contracts with Customers ("ASC 606"). The amendments in this ASU provide a single model for use in accounting for revenue arising from contracts with customers and supersedes prior revenue recognition guidance, including industry-specific revenue guidance. The core principle of the new ASU is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. Disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers are also required. ASC 606 and Topic 340-40 Contracts with Customers, also require the deferral of incremental costs of obtaining contracts with customers and subsequent amortization of those costs of the period of anticipated benefit.

Effective July 1, 2018, the Company adopted ASC 606 through the modified retrospective method and did not result in a cumulative adjustment to retained earnings or accumulated deficit as of the adoption date. This is due to the fact that the impact of adopting the new standard is not significant as it relates to historical revenues, future revenues, or accounting for incremental costs of obtaining contracts with our customers.

We adopted the new standard through applying the following conclusions (resulting from a thorough analysis of all contract types): (1) The new guidance did not materially change our existing policy and practice for identifying contracts with customers, nor did it give rise to changes to our existing policy and practice or create new concern surrounding the collectability of our receivables from customers, (2) none of our contracts with customers contain multiple performance obligations that are not fulfilled at the same time, (3) the new guidance did not change our existing policy and practice regarding the recording of variable consideration, and (4) we did not identify any customer acquisition costs that are incremental and that are expected to be recovered at a future time.

As mentioned above, the modified retrospective method of transition did not result in a cumulative adjustment as of July 1, 2018. The Company did not utilize either the (i) significant financing component practical expedient, or the (ii) contract cost practical expedient, as these did not apply to the Company's contracts, and there was no impact to the financial statements. Additionally, no other line items in the statement of operations or the balance sheet reflect any changes due to the adoption of the new standard. Adoption of the standards related to revenue recognition had no impact to cash from or used in operating, financing, or investing on our consolidated cash flows statement.

Recent Accounting Pronouncements

Fair Value Measurements (“ASU 2018-03”). In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820) Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement.” The amendments in the standard apply to all entities that are required, under existing GAAP, to make disclosures about recurring or nonrecurring fair value measurements. ASU 2018-13 removes, modifies, and adds certain disclosure requirements in ASC 820, Fair Value Measurement. The standard is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019.

The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted upon issuance of ASU 2018-13. An entity is permitted to early adopt any removed or modified disclosures upon issuance of ASU 2018-13 and delay adoption of the additional disclosures until their effective date. The Company is currently assessing the impact that ASU 2018-13 will have on its financial statements.

Financial Instruments – Credit Losses (“ASU 2016-03”). In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses” to require the measurement of expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable forecasts. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. The standard is effective for interim and annual reporting periods beginning after December 15, 2019. Early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements but does not anticipate there to be a material impact.

Leases (“ASU 2016-02”). In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-02 – Topic 842 Leases. ASU 2016-02 requires that most leases be recognized on the financial statements, specifically the recognition of right-to-use assets and related lease liabilities, and enhanced disclosures about leasing arrangements. The objective is to provide improved transparency and comparability among organizations. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The standard requires using the modified retrospective transition method and apply ASU 2016-02 either at (i) latter of the earliest comparative period presented in the financial statements or commencement date of the lease, or (ii) the beginning of the period of adoption. The Company has elected to apply the standard at the beginning period of adoption, July 1, 2019 with a cumulative adjustment to retained earnings, if any, as opposed to retrospectively adjusting prior periods presented in the financial statements.

Future minimum lease obligations for leases accounted for as operating leases at June 30, 2019 totaled approximately $0.3 million. While the Company has not yet completed its evaluation, it anticipates that the adoption of ASU 2016-02 will require the Company to recognize approximately $0.4 - $0.5 million of right-to-use assets and related lease liabilities related to the Company’s corporate office leases. The Company has not yet completed its determination whether leases qualify as (i) operating or (ii) financing under the new standard. The Company has elected to apply the short-term scope exception for leases with terms of 12 months or less at the inception of the lease, and will continue to recognize rent expense on a straight-line basis. The impact from electing this scope exception is expected to be less than $0.1 million.