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Fair Value Considerations

12 Months Ended

Jun. 30, 2020

Fair Value Disclosures [Abstract]

Fair Value Considerations

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 those inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’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.

The Company’s assets and liabilities which are measured at fair value on a recurring basis are classified in their entirety based on the lowest level of input that is significant to their fair value measurement. The Company 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 Company’s financial liabilities that were accounted for at fair value on a recurring basis as of June 30, 2020 and 2019, by level within the fair value hierarchy:

	Fair Value Measurements at June 30, 2020
		Total				Quoted Priced in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs(Level 3)
Recurring:
Warrant derivative liability		$	11,000				–				–			$	11,000
Contingent consideration			13,588,000				–				–				13,588,000
CVR liability			5,572,000				–				–				5,572,000
		$	19,171,000				–				–			$	19,171,000

	Fair Value Measurements at June 30, 2019
		Total				Quoted Priced in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Recurring:
Warrant derivative liability		$	13,000				–				–			$	13,000
Contingent consideration			23,326,000				–				–				23,326,000
		$	23,339,000				–				–			$	23,339,000

Warrant Derivative Liability. 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, 2020:

		As of June 30, 2020				As of June 30, 2019				At Issuance
Warrant Derivative Liability
Volatility			163.2	%			163.2	%			188.0	%
Equivalent term (years)			2.13				3.13				5.00
Risk-free interest rate			0.16	%			1.83	%			1.83	%
Dividend yield			0.00	%			0.00	%			0.00	%

The following table sets forth a reconciliation of changes in the warrant derivative liability for the period ended June 30, 2020:

		Liability Classified Warrants

Balance as of June 30, 2018		$	94,000
Change in fair value included in earnings			(81,000	)
Balance as of June 30, 2019		$	13,000
Change in fair value included in earnings			(2,000	)
Balance as of June 30, 2020		$	11,000

Contingent Consideration.

The Company classifies its contingent consideration liability in connection with the acquisition of Tuzistra, ZolpiMist and Innovus within Level 3 factors used to develop the estimated fair value are unobservable inputs that are not supported by market activity.

Natesto. On July 29, 2019, the Company and Acerus agreed to an Amended and Restated License and Supply Agreement (the “Acerus Amendment”), subject to certain conditions being satisfied prior to the Acerus Amendment becoming effective and enforceable. The Acerus Amendment eliminated the previously disclosed revenue-based milestone payments to Acerus that were expected to occur. The maximum aggregate milestones payable under the original agreement was $37.5 million. Upon the effectiveness of the Acerus Amendment on December 1, 2019, all royalty and milestone liabilities were eliminated. Upon the effectiveness of the Acerus Amendment, Acerus was granted the right to earn commissions on certain filled Natesto prescriptions. Additionally, Acerus assumed certain ongoing sales, marketing and regulatory obligations from the Company. This Acerus Amendment became effective December 1, 2019, resulting in a $5.2 million unrealized gain for the fiscal year 2020, due to the elimination of the revenue-based product milestones.

ZolpiMist. The contingent consideration, related to these royalty payments, was valued at $2.6 million using a Monte Carlo simulation, as of June 11, 2018. As of June 30, 2019, the contingent consideration was revalued at $2.3 million (Note 10). As of June 30, 2020, the contingent consideration was revalued at $0.2 million (Note 10). The contingent consideration accretion expense for fiscal 2020 and 2019 was $0.2 million and $0.3 million, respectively.

Tuzistra XR. At the November 2, 2018 acquisition date, the contingent consideration, related to this licensed asset, was initially valued at $8.8 million using a Monte Carlo simulation. The contingent consideration was revalued at $13.2 million and $16.0 million as of June 30, 2020 and 2019, respectively. The contingent consideration accretion expense for the year ended June 30, 2020 and 2019 was $0.4 million and $0.2 million, respectively.

Innovus. The Company recognized approximately $0.2 million in contingent consideration as a result of the February 14, 2020 Innovus Merger. The fair value was based on a discounted value of the future contingent payment using a 30% discount rate based on the estimates risk that the milestones are achieved. There was no material change in this valuation as of June 30, 2020.

The following table sets forth a summary of changes in the contingent consideration for the period ended June 30, 2020:

		Contingent Consideration

Balance as of June 30, 2018		$	4,694,000
Increase due to purchase of assets			8,833,000
Increase due to accretion			516,000
Decrease due to contractual payment			(548,000	)
Increase due to remeasurement			9,831,000
Balance as of June 30, 2019		$	23,326,000
Increase due to purchase of assets			183,000
Increase due to accretion			789,000
Decrease due to contractual payment			(180,000	)
Decrease due to amended license agreement			(5,200,000	)
Decrease due to remeasurement			(5,330,000	)
Balance as of June 30, 2020		$	13,588,000

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.

Significant assumptions in valuing the contingent consideration were as follows as of June 30, 2020 and 2019, respectively:

		As of June 30, 2020				As of June 30, 2019
Natesto
Relevered Beta			−				0.83
Market risk premium			−				5.50	%
Risk-free interest rate			−				3.50	%
Discount			−				5.20	%
Company specific discount			−				5.00	%

		As of June 30, 2020				As of June 30, 2019
ZolpiMist
Relevered Beta			1.17				1.16
Market risk premium			6.00	%			5.50	%
Risk-free interest rate			3.00	%			3.50	%
Discount			5.20	%			5.20	%
Company specific discount			5.00	%			5.00	%

		As of June 30, 2020				As of June 30, 2019
Tuzistra
Relevered Beta			0.36				1.19
Maket risk premium			6.00	%			5.50	%
Risk-free interest rate			3.00	%			3.50	%
Discount			5.20	%			5.20	%
Company specific discount			15.00	%			15.00	%

Contingent value rights

Contingent value rights (“CVRs”) represent contingent additional consideration of up to $16 million payable to satisfy future performance milestones related to the Innovus Merger. Consideration can be satisfied in up to 4.7 million shares of the Company’s common stock, or cash either upon the option of the Company or in the event there are insufficient shares available to satisfy such obligations. As of June 30, 2020, the Company paid out 1.2 million shares of the Company’s common stock to satisfy the first $2 million milestone, which relates to the Innovus achievement of $24.0 million in revenues during the 2019 calendar year. The Company has a remaining maximum of $14.0 million of additional contingent value rights to satisfy over the remaining four years. The contingent value rights accretion expense for fiscal 2020 and 2019 was $0.2 million and $0 million, respectively.

Non-Recurring Fair Value Measurements

The following table represents those asset and liabilities measured on a non-recurring basis for the fiscal year 2020 as a result of the (i) November 1, 2019 acquisition of the Pediatrics Portfolio and (ii) the February 14, 2020 Innovus Merger.

		Fair Value Measurements at June 30, 2020
		Fair Value at Measurement Date				Quoted Priced in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Non-recurring
MiOXSYS patent (Luoxis patents)		$	-			$	-			$	-			$	-
Debt			982,079				-				-				982,076

Pediatric Portfolio (November 1, 2019)
Product technology rights			22,700,000				–				–				22,700,000
Goodwill			19,453,135				–				–				19,453,135
Fixed payment arrangements			29,837,853				–				–				29,837,853

Innovus Merger (February 14, 2020)
Customer lists			390,000				–				–				390,000
Product distribution righs (trademarks and patents)			11,354,000				–				–				11,354,000
Goodwill			8,637,272				–				–				8,637,272
Notes payable			3,056,361				–				–				3,056,361

		$	96,410,697			$	–			$	–			$	96,410,697

Acquisition of the Pediatric Portfolio

Product technology rights. The Company recognized the product technology right intangible asset acquired as part of the November 1, 2019 acquisition of the Pediatric Portfolio. This intangible asset consists of the acquired product technology rights consisting of (i) Karbinal ER, (ii) Cefaclor, and (iii) Poly-Vi-Flor and Tri-Vi-Flor. The Company utilized a Multiple-Period Excess Earnings Method model.

		As of November 1, *2019 ()**
Product technology rights
Re-levered Beta			1.60
Market risk premium			6.00	%
Small stock risk premium			5.20	%
Risk-free interest rate			2.00	%
Company specific discount			25.00	%

(*) Valuation performed as of November 1, 2019. As a non-recurring fair value measurement, there is no remeasurement at each reporting period unless indications exist that the fair value of the asset has been impaired. There were no indicators as of June 30, 2020 that the fair value of the Product technology rights was impaired.

Goodwill. Goodwill represents the fair value of consideration transferred and liabilities assumed in excess of the fair value of assets acquired. Remeasurement of the fair value of goodwill only arises upon either (i) indicators that the fair value of goodwill has been impaired, or (ii) during the annual impairment test performed at June 30 of each fiscal year. There were no indicators observed or identified during and as of the period from November 1, 2019 through June 30, 2020.

Fixed payment arrangements. The Company assumed obligations due to an investor including fixed and variable payments. The Company assumed fixed monthly payments equal to $0.1 million from November 2019 through January 2021 plus $15.0 million due in January 2021, of which $15.0 million was paid down early in June 2020. Monthly variable payments due to the same investor are equal to 15% of net revenue generated from a subset of the Pediatric Portfolio, subject to an aggregate monthly minimum of $0.1 million, except for January 2020, when a one-time payment of $0.2 million was due and paid. The variable payment obligation continues until the earlier of: (i) aggregate variable payments of approximately $9.3 million have been made, or (ii) February 12, 2026. In addition, the Company assumed fixed, product minimums royalties of approximately $2.1 million per annum through February 2023.

As of November 1,

2019 (≠)

Fixed payment obligations

Discount rate

1.8% to 12.4%

(≠) Valuation performed as of November 1, 2019. As a non-recurring fair value measurement, there is no remeasurement at each reporting period unless indicates that the circumstances that existed as of the November 1, 2019 measurement date indicate that the carrying value is no longer indicative of fair value.

Innovus Merger

Customer lists. The Company recognized the fair value of the customer lists that existed as of the Valuation Date to be $0.4 million. The Company utilized an income method approach.

Trademarks and patents. The Company recognized the fair value of trademarks, patents or a combination of both for 18 distinct products that the Company markets, distributes and sells. An Income Approach known as the Relief-From-Royalty Method was utilized to value the product distribution rights associated with each of the 18 products associated with trademarks and patents. A royalty rate of 15% was used based on upon a range of observable royalties between the range of 7.5% and 34.5%.

		As of February 14, 2020
Trademarks and patents
Re-levered Beta			0.84	%
Market risk premium			6.17	%
Small stock risk premium			4.99	%
Risk-free interest rate			1.89	%
Company specific discount			20.00	%

Goodwill. Goodwill represents the fair value of consideration transferred and liabilities assumed in excess of the fair value of assets acquired. Remeasurement of the fair value of goodwill only arises upon either (i) indicators that the fair value of goodwill has been impaired, or (ii) during the annual impairment test performed at June 30 of each fiscal year. There were no indicators observed or identified during and as of the period from February 14, 2020 through June 30, 2020.

Innovus Notes Payable. The Innovus Notes Payable represent twelve financial obligations assumed as part of the Innovus Merger. These notes are comprised of ten uncollateralized obligations with a face value of approximately $3.6 million and two notes secured by inventory held fulfillment centers with Amazon, Inc. and a face value of approximately $0.4 million (the “Innovus Notes”). The Innovus Notes were revalued using the estimated cost of capital at the valuation date for a total estimated fair value of approximately $3.1 million.

The ten unsecured Innovus Notes consist of ten separate loans with implied effective interest rates ranging between 14.1% and 73.4%. The weighted average interest rate for these notes was 39.5%, while the weighted average interest rate for the most recent loan (January 9, 2020) was 41.4%. All ten of the notes are unsecured, and as of the valuation date there was significant risk associated with their repayment. Accordingly, the Company has revalued the notes using an effective rate of 40% and concluded that the fair value at the February 14, 2020 Innovus Merger date was approximately $2.7 million.

The secured Innovus Notes due to Amazon had maturities of less than one year and stated rates of 17.2% and 14.7% respectively. Due to the fact that the most recent loan had a stated rate of 14.7% and that the weighted average rate for these two loans was 15.6%, the Company has estimated the current value of the loans using an effective rate of 15% and concluded that the fair value of the secured Innovus Notes totaled approximately $0.4 million.

Summary of Level 3 Input Changes

The following table sets forth a summary of changes to those fair value measures using Level 3 inputs for the year ended June 30, 2020:

Product Technology Rights

Innovus Assets

Goodwill

Liability Classified Warrants

CVR Liability

Contingent Consideration

Fixed Payment Arrangements

Balance as of June 30, 2019

$

–

$

–

$

–

$

13,000

$

–

$

23,326,000

$

–

Transfers into Level 3

–

–

–

–

–

–

–

Transfer out of Level 3

–

–

–

–

–

–

–

Total gains, losses, amortization or accretion in period

–

–

–

–

–

–

–

Included in earnings

(1,513,000

)

(663,000

)

–

(2,000

)

523,000

(9,741,000

)

1,452,000

Included in other comprehensive income

–

–

–

–

–

Purchases, issues, sales and settlements

–

Purchases

22,700,000

11,744,000

28,090,000

–

7,049,000

183,000

–

Issues

–

–

–

–

–

–

29,838,000

Sales

–

–

–

–

–

–

–

Settlements

–

–

–

–

(2,000,000

)

(180,000

)

(17,778,000

)

Balance as of June 30, 2020

$

21,187,000

$

11,081,000

$

28,090,000

$

11,000

$

5,572,000

$

13,588,000

$

13,512,000

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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