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Summary of Significant Accounting Policies

12 Months Ended

Jun. 30, 2020

Summary of Significant Accounting Policies

Basis of Presentation. The audited consolidated financial statements include the operations of Aytu and its wholly-owned subsidiaries, Aytu Women’s Health, LLC, Aytu Therapeutics, LLC and Innovus Pharmaceuticals, Inc. 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”).

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 consists primarily of amounts held in certificate of deposit investments to maintain certain credit amounts for the Company's business credit cards. The Company’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, 2020, the Company has maintained balances in excess of federally insured limits.

Accounts Receivable. Accounts receivable are recorded at their estimated net realizable value. The Company evaluates collectability of accounts receivable on a quarterly basis and records a reserve, if any, accordingly. The Company recognized a reserve of $0.4 million and $0.0 million as of June 30, 2020 and 2019, respectively. The Company does not charge interest on its outstanding trade receivables as its standard trade practices. However the Company does reserve the right to such charges as circumstances arise.

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. Therefore, we currently have $1.3 million and $0 reserved for slow moving inventory as of June 30, 2020 and 2019, 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 are placed into service. Maintenance and repairs are expensed as incurred.

Fair Value of Financial Instruments.

Cash, cash equivalents, restricted cash, accounts receivable, and accounts payable. 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.

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

Liability and equity classified warrants. The Company accounts for liability classified 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 liability classified derivative financial instruments were calculated using a lattice valuation model. Equity classified financial instruments are valued using a Black-Scholes model. Changes in the fair value of liability classified derivative financial instruments in subsequent periods were recorded as derivative income or expense for the warrants and reported as a component of cash flows from operations. During the year ended June 30, 2020, such changes in the fair value of the Company’s liability classified derivative liabilities was less than $0.1 million.

Contingent value rights. The fair value of the contingent value rights was based on a model in which each individual payout was deemed either (a) more likely than not to be paid out or (b) less likely than not to be paid out. From there, each obligation was then discounted at a 30% discount rate to reflect the overall risk to the contingent future payouts pursuant to the CVRs. This value is then remeasured both for future expected payout at well as the increase fair value due to the time value of money. These gains or losses, if any, are included as a component of operating cash flows.

Fixed Payment Arrangements. Fixed payment arrangements are comprised of minimum product payment obligations relating to either make whole payments or fixed minimum royalties arising from the acquisition of the Pediatric Portfolio. These were recognized at their amortized cost basis using a market appropriate discount rate and are accreted up to their ultimate face value over time. These are one-time measurements and remeasurement at each reporting period is not recognized at as a component of earnings each reporting period. However, if the Company determines the circumstances have changed such that the fair value of these fixed payment obligations would have changed due to changes in company specific circumstances or interest rate environments, such changes would be reflected in the Company’s footnote disclosures..

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.

Aytu BioScience Segment (Note 19)

Product sales consist of sales of its prescription related products from both the (i) Pediatric Portfolio and (ii) Primary Care Portfolio principally to a limited number of wholesale distributors and pharmacies in the United States, which account for the largest portion of our total prescription products revenue. International sales are made primarily to specialty distributors, as well as to hospitals, laboratories, and clinics, some of which are government owned or supported (collectively, its “Customers”).

Products are generally shipped “free-on- board” destination when shipped domestically within the United States and if shipped internationally, products are shipped “free-on-board” shipping point, as those are the agreed-upon contractual terms.

Collectability of revenue is reasonably assured based on historical evidence of collectability 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.

Aytu Consumer Health Segment (Note 19)

The Company generates revenues from its Consumer Health Portfolio from product sales and the licensing of the rights to market and commercialize our products. Sales from the Company’s Aytu Consumer Health division are generally recognized ”free-on-board” shipping point, as those are the agreed-upon contractual terms. Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by us from a customer, are excluded from revenue. Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of sales.

Customer Contract Costs. The Company has elected to adopt the practical expedient on expensing the incremental costs to obtain a contract, given the expectation that any amounts attributable to obtaining such a contract would be satisfied within one year.

Customer Concentrations. The following customers contributed greater than 10% of the Company's gross revenue during the year ended June 30, 2020 and 2019, respectively. The customers, sometimes referred to as partners or customers, are large wholesale distributors that resell our products to retailers. As of June 30, 2020, three customers accounted for 46% of gross revenue. 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,
	2020			2019
Customer A		16	%		19	%
Customer B		16	%		20	%
Customer C		14	%		26	%
Customer D		−			22	%

The loss of one or more of the Company's significant partners or customers 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, 2020, four customers accounted for 61% of gross accounts receivable. As of June 30, 2019, four customers accounted for 88% of gross accounts receivable.

	Year Ended June 30,
	2020			2019
Customer A		19	%		9	%
Customer B		16	%		20	%
Customer C		14	%		36	%
Customer E		0	%		23	%
Customer F		12	%		0	%

In addition, the Company is owed approximately $3.6 million as of June 30, 2020 by Cerecor that arose as a result of certain transition processes that caused customer payments on the Pediatric Portfolio products to continue to be deposited in Cerecor’s account. The Company and Cerecor are expected to finalize the settlement of these amounts in the first half of the fiscal year ended June 30, 2021.

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, 2020, and 2019, the Company accrued $1.3 million and $0.1 million, 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 Sales. Costs of sales 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 sales 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 and tradenames. 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 life of approximately 15 years, which expires in March 2028.

Patents and tradenames subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an intangible asset may not be recoverable. Impairment losses are measured and recognized to the extent the carrying value of such assets exceeds their fair value. In June 2020, the Company decided to write off the entire remaining balance of the Luoxis patents.

On February 14, 2020, upon completion of the Merger with Innovus, the Company recognized the fair value of the rental of the customer lists for $390,000 and amortizes the asset over a useful life of 1.5 years.

The Company recognized the fair value of trademarks, patents or a combination of both for 18 distinct products that Innovus markets, distributes and sells for $11,354,000 and amortizes the asset over a useful life of 5 years.

Advertising Costs. Advertising costs consist of the direct marketing activities related to the Company’s Aytu Consumer Health reportable segment that arose from the February 14, 2020 acquisition of Innovus Pharmaceuticals, Inc. The Company expenses all advertising costs as incurred. The Company incurred $4.7 million and $0 for the years ended June 30, 2020 and 2019, respectively.

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, (iii) patents and tradenames, net and (iv) Products technology rights. Circumstances which could trigger a review include, but are not limited to: (i) significant decreases in the market price of the asset; (ii) significant adverse changes in the business climate or legal or regulatory factors; (iii) 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, 2020 and 2019 respectively, and there was $0.2 million and $0 million of impairment recorded.

Income Taxes. Deferred taxes are provided on an asset and liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred taxes are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

The amount of income taxes and related income tax positions taken are subject to audits by federal and state tax authorities. The Company has adopted accounting guidance for uncertain tax positions which provides that in order to recognize an uncertain tax position, the taxpayer must be more likely than not of sustaining the position, and the measurement of the benefit is calculated as the largest amount that is more than 50% likely to be realized upon settlement with the taxing authority. The Company believes that it has no material uncertain tax positions. The Company's policy is to record a liability for the difference between the benefits that are both recognized and measured pursuant to FASB ASC 740-10. "Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement 109" (ASC 740-10) and tax position taken or expected to be taken on the tax return. Then, to the extent that the assessment of such tax positions changes, the change in estimate is recorded in the period in which the determination is made. The Company reports tax-related interest and penalties as a component of income tax expense. During the periods reported, management of the Company has concluded that no significant tax position requires recognition under ASC 740-10.

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. As the Company incurred losses in both 2020 and 2019, basic and diluted loss per share was the same and 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, 2020 and 2019 are anti-dilutive, and therefore excluded from the calculation of diluted earnings per share.

		Year Ended June 30,
		2020		2019
Warrants to purchase common stock - liability classified	(Note 15)		240,755		240,755
Warrant to purchase common stock - equity classified	(Note 15)		22,884,538		16,238,657
Employee stock options	(Note 14)		765,937		1,607
Employee unvested restricted stock	(Note 14)		4,186,056		2,551,024
Convertible preferred stock	(Note 13)		-		3,594,981
			28,077,286		22,627,024

Adoption of New Accounting Pronouncements

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 which resulted in no cumulative adjustment to retained earnings.

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. As a result of the adoption, on July 1, 2019, the Company recognized a lease liability of approximately $0.4 million, which represented the present value of the remaining minimum lease payments using an estimated incremental borrowing rate of 8%. As of July 1, 2019, the Company recognized a right-to-use asset of approximately $0.4 million. Lease expense did not change materially as a result of the adoption of ASU 2016-02.

In addition, in conjunction with the Innovus Merger, the Company recognized a lease liability of approximately $0.8 million relating to Innovus’ corporate offices and related warehouse as part of the purchase price allocation (see Note 2 and Note 22).

Leases (“ASU 2018-11”). On July 30, 2018, the FASB issued ASU 2018-11 to provide entities with relief from the costs of implementing certain aspects of the new leasing standard, ASU 2016-02 (codified as ASC 842). Specifically, under the amendments in ASU 2018-11: (i) Entities may elect not to recast the comparative periods presented when transitioning to ASC 842 (Issue 1), and (ii) Lessors may elect not to separate lease and nonlease components when certain conditions are met (Issue 2). The Company adopted this standard and elected not to recast prior comparative periods when presented, including the year ended June 30, 2019, which is included in this Form 10-K.

Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815) (“ASU 2017- 11”). In July 2017, the FASB issued ASU No. 2017-11 — Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815). Part I to ASU 2017-11 eliminates the requirement to consider “down round” features when determining whether certain equity-linked financial instruments or embedded features are indexed to an entity’s own stock. In addition, entities will have to make new disclosures for financial instruments with down round features and other terms that change conversion or exercise prices. Part I to ASU 2017-11 is effective for fiscal years beginning after December 31, 2018. The Company adopted this standard update as a result of the issuance of the Series F Preferred stock as a result of the October 2019 Offering. There were no “down-round” features present in the financial instruments issued in conjunction with the March 2020 Offerings.

Compensation – Stock Compensation (Topic 718) (“ASU 2018-07). On June 20, 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting, as part of its ongoing Simplification Initiative. Currently, share-based payments to nonemployees are accounted for under Subtopic 505-50 which significantly differs from the guidance for share-based payments to employees under Topic 718. This ASU supersedes Subtopic 505-50 by expanding the scope of Topic 718 to include nonemployee awards and generally aligning the accounting for nonemployee awards with the accounting for employee awards (with limited exceptions). The Company issued stock to certain former Innovus Directors to compensate them for consulting services. Those grants were fully vested at the time of grant and an approximately $0.2 million charge was recognized as a current period expense.

Business Combinations (Topic 805) — Clarifying the Definition of a Business (“ASU 2017-01”). In January 2017, the FASB issued ASU 2017-01, which sets out a new framework for classifying transactions as acquisitions (disposals) of assets versus businesses. The new guidance provides a framework to evaluate when an input and a substantive process are present as well as provide more stringent criteria for sets without outputs to be considered businesses. As a result, fewer transactions are expected to involve acquiring (or selling) a business. ASU 2017-01 is effective for public companies with fiscal years beginning after December 15, 2018. This standard is expected to reduce the number of acquisitions which are considered business combinations upon adoption, especially in both real estate and life science industries.

During the fiscal year ended June 30, 2020, the Company acquired both the Pediatric Portfolio from Cerecor and Consumer Health Portfolio from Innovus. The Company adopted this standard as a result of the acquisitions, and while ASU 2017-01 is expected to result in more asset acquisitions in life science industries, the Company came to the conclusion that both of the acquisitions qualified as business combinations.

Statement of Cash Flows (Topic 230) — Classification of Certain Cash Receipts and Cash Payments (“ASU 2016-15”). On August 26, 2016, the FASB issued ASU 2016-15, which amends Topic 230 to add or clarify guidance on the classification of certain cash receipts and payments in the statement of cash flows. One of the items ASU 2016-15 clarified was the treatment of cash payments on zero coupon debt or debt-like instrument. Under ASU 2016-15, cash paid on zero coupon bonds should be allocated between the interest and principal portion of the obligation at the time of payment, with the interest portion classified as operating in the Statement of Cash Flows and the principal portion classified as a financing cash outflow in the Statement of Cash Flows.T

The Company has numerous obligations in which there is no stipulated interest rate, and the obligation is recognized at a discount from the ultimate obligation. These include certain notes and fixed payment arrangements. The Company adopted this standard in the year ended June 30, 2020 and classified cash payments, if any, in accordance with this standard.

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 2016-13”). 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 was originally effective for interim and annual reporting periods beginning after December 15, 2019 and early adoption is permitted for interim and annual reporting periods beginning after December 15, 2018. However, in November 2019, the Financial Accounting Standard Board (FASB) issued ASU 2019-10, Financial Instruments—Credit Losses, (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842) — Effective Dates (“ASU 2019-10”). ASU 2019-10 deferred the adoption date for (i) public business entities that meet the definition of an SEC filer, excluding entities eligible to be “smaller reporting companies” as defined by the SEC, for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, and (2) all other entities for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. As of June 30, 2020, the Company qualified as a smaller reporting companies as defined by the SEC. 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.