UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
Date of Report (Date of earliest event reported): October 31, 2019
AYTU
BIOSCIENCE, INC.
(Exact name of registrant as specified in its charter)
| Delaware | 001-38247 | 47-0883144 | ||
| (State or other jurisdiction of incorporation) | (Commission File Number) | (IRS Employer Identification No.) |
373 Inverness Parkway, Suite 206
Englewood, CO 80112
(Address of principal executive offices, including Zip Code)
Registrant’s telephone number, including area code: (720) 437-6580
N/A
(Former name or former address, if changed since last report)
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:
| ☒ | Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425) |
| ☐ | Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12) |
| ☐ | Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b)) |
| ☐ | Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c)) |
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||
| Common Stock, par value $0.0001 per share | AYTU | The NASDAQ Stock Market LLC |
Indicate by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (§230.405 of this chapter) or Rule 12b-2 of the Securities Exchange Act of 1934 (§240.12b-2 of this chapter).
Emerging growth company ☐
If
an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for
complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Item 2.01 Completion of Acquisition of Disposition of Assets
On November 1, 2019, Aytu BioScience, Inc. (“Company”) and Cerecor, Inc. (“Seller”) closed the acquisition (the “Acquisition”) of the Pediatrics Product Portfolio (the “Cerecor transaction”) contemplated by the Purchase Agreement. Pursuant to the Purchase Agreement, Seller transferred certain assets and assigned certain liabilities to a newly formed subsidiary established by the Company to hold the assets which are the subject of the Purchase Agreement, Aytu Therapeutics, LLC (“Aytu Therapeutics”). In addition, the Seller transferred most of its existing commercial sales workforce to the Company.
The Company determined that this acquisition constitutes a business pursuant to Article 11 of Regulation S-X, and therefore is required pursuant to Rule 8-04 of Regulation S-X to provide within 71 days after the Acquisition close, historical, audited financial statements for a period consisting of the most recent fiscal year ended December 31, 2018 and the nine months ended September 30, 2019. In addition, pursuant to Article 11 of Regulation S-X, the Company is required to provide pro forma financial statements for the year-ended June 30, 2019 and three months ended September 30, 2019.
The exhibits to this amended Form 8-K satisfies these requirements.
Item 9.01 Financial Statements and Exhibits.
(a) Financial statements of businesses acquired
The (i) audited historical abbreviated financial statements for the Pediatrics Product Portfolio of Cerecor, Inc. (the “Cerecor Products”) as of September 30, 2019, and December 31, 2018 and for the Nine Months Ended September 30, 2019 and the Year Ended December 31, 2018, and (ii) unaudited historical abbreviated financial statements for the Cerecor Products. as of September 30, 2018 and for the Nine Months Ended September 30, 2018 is filed as Exhibit 99.1 and Exhibit 99.2, respectively, to this Current Report on Form 8-K/A.
Pursuant to a letter dated October 21, 2019 (the “Relief Letter”), the Company has obtained relief from the Staff of the Securities and Exchange Commission, pursuant to its authority under Rule 3-13 of Regulation S-X, from the requirements of Rule 8-04 of Regulation of S-X to provide certain historical financial statements that would otherwise be required in connection with its acquisition of the Cerecor Products and to provide corresponding pro forma financial information required under Article 11 of Regulation S-X. In accordance with the Relief Letter, the Company has substituted abbreviated audited historical financial statements for the full financial statements of Cerecor Products required by Rule 8-04 of Regulation S-X.
(d) The following exhibit is being filed herewith:
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
| AYTU BIOSCIENCE, INC. | ||||
| Date: | January 10, 2020 | By: | /s/ Joshua R. Disbrow | |
| Joshua R. Disbrow | ||||
| Chief Executive Officer | ||||
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Exhibit 23.1
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statements (Form S-1 Nos 333-207421, 333-205414, 333-209874, 333-212100, 333-213489, 333-220351, Form S-3 Nos 333-221735, 333-235548, and Form S-8 No. 333-205462) of Aytu Bioscience, Inc. of our report dated January 3, 2020, with respect to the abbreviated financial statements of the Pediatrics Product Portfolio of Cerecor Inc. as of September 30, 2019 and December 31, 2018 and for the nine months ended September 30, 2019 and for the year ended December 31, 2018, included in this Current Report on Form 8-K/A of Aytu Bioscience, Inc. dated January 10, 2020.
/s/ Ernst & Young LLP
Baltimore, Maryland
January 10, 2020
Exhibit 99.1
FINANCIAL STATEMENTS
Pediatrics Product Portfolio of Cerecor Inc.
As
of September 30, 2019, and December 31, 2018 and for the Nine Months Ended September 30, 2019
and the Year Ended December 31,
2018
Pediatrics Product Portfolio of Cerecor Inc.
Index to Abbreviated Financial Statements
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Report of Independent Auditors
To the Board of Directors of Cerecor Inc.
We have audited the accompanying abbreviated financial statements of the Pediatrics Product Portfolio of Cerecor Inc., which comprise the statements of assets acquired and liabilities assumed as of September 30, 2019 and December 31, 2018, and the related statements of net revenues and direct expenses for the nine months ended September 30, 2019 and the year ended December 31, 2018, and the related notes to the abbreviated financial statements.
Management’s Responsibility for the Abbreviated Financial Statements
Management is responsible for the preparation and fair presentation of these abbreviated financial statements in conformity with U.S. generally accepted accounting principles; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of abbreviated financial statements that are free of material misstatement, whether due to fraud or error.
Auditor’s Responsibility
Our responsibility is to express an opinion on these abbreviated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the abbreviated financial statements are free of material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the abbreviated financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the abbreviated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the abbreviated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the abbreviated financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the abbreviated financial statements referred to above present fairly, in all material respects, the assets acquired and liabilities assumed of the Pediatrics Product Portfolio of Cerecor Inc. at September 30, 2019 and December 31, 2018, and its net revenues and direct expenses for the nine months ended September 30, 2019 and the year ended December 31, 2018 in conformity with U.S. generally accepted accounting principles.
Emphasis of matter
The accompanying abbreviated financial statements were prepared in connection with Cerecor Inc.’s divestiture of the Pediatrics Product Portfolio of Cerecor Inc. and as described further in note 2 were prepared in accordance with an SEC waiver received by the buyer, for the purpose of the buyer complying with the rules and regulations of the Securities and Exchange Commission under Rule 8-04 of Regulation S-X and are not intended to be a complete presentation of the financial position, results of operations or cash flows of the Pediatrics Product Portfolio of Cerecor Inc. Our opinion is not modified with respect to this matter.
/s/ Ernst & Young LLP
Baltimore, Maryland
January 3, 2020
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The Pediatrics Product Portfolio of Cerecor Inc.
Statements of Assets Acquired and Liabilities Assumed
| September 30, 2019 | December 31, 2018 | |||||||
| Other receivables | $ | 208,204 | $ | 206,798 | ||||
| Inventory, net | 376,884 | 792,857 | ||||||
| Prepaid expenses and other current assets | 1,202,841 | 797,562 | ||||||
| Intangible assets, net | 23,834,232 | 27,474,214 | ||||||
| Total assets acquired | $ | 25,622,161 | $ | 29,271,431 | ||||
| Accrued liabilities | $ | 6,373,187 | $ | 5,402,494 | ||||
| Contingent consideration | 7,473,485 | 7,794,354 | ||||||
| Long-term debt | 15,304,856 | 15,377,882 | ||||||
| Total liabilities assumed | 29,151,528 | 28,574,730 | ||||||
| Total net (liabilities assumed) and assets acquired | $ | (3,529,367 | ) | $ | 696,701 | |||
See accompanying notes to the abbreviated financial statements.
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The Pediatrics Product Portfolio of Cerecor Inc.
Statements of Net Revenues and Direct Expenses
| Nine Months Ended | Year Ended | |||||||
| September 30, | December 31, | |||||||
| 2019 | 2018 | |||||||
| Product revenue, net | $ | 9,304,580 | $ | 11,298,423 | ||||
| Direct expenses: | ||||||||
| Cost of product sales | 3,852,878 | 4,217,594 | ||||||
| Sales and marketing | 7,864,075 | 8,142,917 | ||||||
| Amortization expense | 2,190,861 | 2,703,896 | ||||||
| Impairment of intangible assets | 1,449,121 | — | ||||||
| Change in fair value of contingent consideration | 247,042 | 169,289 | ||||||
| Total direct expenses | 15,603,977 | 15,233,696 | ||||||
| Net product revenues less direct expenses | $ | (6,299,397 | ) | $ | (3,935,273 | ) | ||
See accompanying notes to the abbreviated financial statements.
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The Pediatrics Product Portfolio of Cerecor Inc.
Notes to Abbreviated Financial Statements
1. Background
On October 10, 2019, Cerecor Inc, (the “Company”) entered into the Aytu Purchase Agreement with Aytu Bioscience, Inc. (“Aytu”) to sell the Company’s rights, title and interest in, assets relating to its Pediatric Portfolio, namely Aciphex® Sprinkle™ , Cefaclor for Oral Suspension, Karbinal™ ER, Flexichamber™, Poly-Vi-Flor® and Tri-Vi-Flor™ (the “Divested Assets” or “Pediatric Portfolio”) as well as the corresponding commercial infrastructure consisting of the right to offer employment to Cerecor’s sales force and the assignment of supporting commercial contracts (“The Pediatrics Product Portfolio”). Aytu provided consideration of cash and preferred stock totaling $17 million ($4.5 million in cash and $12.5 million in shares of Aytu preferred stock) and assumed certain of the Company’s liabilities, including the Company’s payment obligations payable to Deerfield CSF, LLC (“Deerfield Obligation”) of approximately $15.0 million and certain other liabilities in excess of approximately $11 million. In addition, Aytu assumed future contractual obligations under existing license agreements associated with the Divested Assets. The transaction closed on November 1, 2019. Armistice, a significant stockholder of the Company, is also a significant stockholder of Aytu.
On November 17, 2017, the Company acquired TRx Pharmaceuticals, LLC (“TRx”) and its wholly-owned subsidiaries. TRx acquisition included the purchase of the acquired product marketing rights to Metafolin (Poly-Vi-Flor® and Tri-Vi-Flor™).
On February 16, 2018, Cerecor acquired all rights to Avadel Pharmaceuticals PLC’s (“Avadel”) marketed pediatric products (the “Acquired Products”) for the assumption of certain of Avadel’s financial obligations which included assets and liabilities assumed as part of the Aytu Purchase Agreement.
2. Significant Accounting Policies
Basis of Presentation
The accompanying Statements of Assets Acquired and Liabilities Assumed as of September 30, 2019 and December 31, 2018 and the related Statements of Net Revenues and Direct Expenses for the period from January 1, 2019 through September 30, 2019 and the year ended December 31, 2018 (collectively, the “Abbreviated Financial Statements”) of the Pediatrics Product Portfolio have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for the purpose of Aytu’ s compliance with the rules and regulations of the Securities and Exchange Commission under Rule 8-04 of Regulation S-X. Aytu received a waiver from the SEC to present a Statement of Revenues and Direct Expenses and a Statement of Assets Acquired and Liabilities Assumed in lieu of complete financial statements for the Pediatrics Product Portfolio. Complete financial statements have not been prepared historically for the Pediatrics Product Portfolio as Cerecor did not maintain the Pediatrics Product Portfolio as a stand-alone business, division or subsidiary for the periods presented. The Statements of Assets Acquired and Liabilities Assumed and Net Revenues and Direct Expenses of the Pediatrics Product Portfolio have been derived from the operating activities attributed to the Pediatrics Product Portfolio from Cerecor’s books and records and reflect only those assets acquired in the transaction and related liabilities assumed and revenues and expenses directly related to the assets acquired and liabilities assumed. The Statements of Net Revenues and Direct Expenses do not purport to reflect all of the costs, expenses, and cash flows that would have been associated had the Pediatrics Product Portfolio been operated as a stand-alone, separate entity. In addition, the Statements of Net Revenues and Direct Expenses may not be indicative of the operating results going forward given the omission of certain corporate overhead described below and changes in the business that may be made by Aytu BioScience, Inc (See note 11). No additional or separate allocations have been made for certain general and administrative, interest or income tax expenses as Cerecor considered such items to be corporate expenses and not directly related to the Pediatrics Product Portfolio.
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As previously mentioned, Cerecor acquired all rights to the Acquired Products on February 16, 2018, certain of which are included in the assets acquired and liabilities assumed as of September 30, 2019 and December 31, 2018. The related net revenues and related direct expenses are included in the abbreviated financial statements only for the period that Cerecor owned the Acquired Products and not for the period between January 1, 2018 and February 15, 2018, as Cerecor does not have access to the books and records of the Acquired Products for that period.
Statements of cash flows are not presented as such data was not maintained by Cerecor for the Pediatric Product Portfolio as it did not operate as a separate business or a separate legal entity.
Use of Estimates
The preparation of Abbreviated Financial Statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures. On an ongoing basis, management evaluates its estimates, including estimates related to but not limited to, revenue recognition, cost of product sales, stock-based compensation, fair value measurements (including those relating to contingent consideration), and other intangible assets. The Company bases its estimates on historical experience and other market-specific or other relevant assumptions that it believes to be reasonable under the circumstances. Actual results may differ from those estimates or assumptions.
Inventory
Inventory consists primarily of finished goods stated at the lower of cost or net realizable value, with cost determined on a first-in, first-out basis. The Company reviews the composition of inventory at each reporting period in order to identify obsolete, slow-moving, quantities in excess of expected demand, or otherwise non-saleable items. If non-saleable items are observed and there are no alternate uses for the inventory, the Company will record a write-down to net realizable value in the period that the decline in value is first recognized. These valuation adjustments are recorded based upon various factors for the Company’s products, including the level of product manufactured by the Company, the level of product in the distribution channel, current and projected product demand, the expected shelf life of the product and firm inventory purchase commitments.
Intangible Assets
Intangible assets with definite useful lives are amortized straight-line over their estimated useful lives and reviewed for impairment if certain events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an intangible asset might not be recoverable. Impairment losses are measured and recognized to the extent the carrying value of such assets exceeds their fair value.
Product Revenues, net
The Company generates substantially all of its revenue from sales of the Pediatric to its customers and has identified a single product delivery performance obligation, which is the provision of prescription pharmaceutical products to its customers based upon master service agreements in place with wholesaler distributors, and purchase orders from retail pharmacies or other direct customers. The performance obligation is satisfied at a point in time, when control of the product has been transferred to the customer, either at the time the product has been received by the customer or to a lesser extent when the product is shipped. The Company determines the transaction price based on fixed consideration in its contractual agreements and the transaction price is allocated entirely to the performance obligation to provide pharmaceutical products. In determining the transaction price, a significant financing component does not exist because the timing from when the Company delivers product to when the customers pay for the product is less than one year and the customers do not pay for product in advance of the transfer of the product.
Revenues from sales of products are recorded net of any variable consideration for estimated allowances for returns, chargebacks, distributor fees, prompt payment discounts, government rebates, and other common gross-to-net revenue adjustments. The identified variable consideration is recorded as a reduction of revenue at the time revenues from product sales are recognized. The Company recognizes revenue only to the extent that it is probable that a significant revenue reversal will not occur in a future period.
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Provisions for returns and government rebates are included within accrued liabilities in the statement of assets acquired and liabilities assumed. Expenses for prompt payment discounts and distributor fees are included as a reduction to net revenue. Calculating these items involves estimates and judgments based on sales or invoice data, contractual terms, historical utilization rates, new information regarding changes in these programs’ regulations and guidelines that would impact the amount of the actual rebates, our expectations regarding future utilization rates for these programs, and channel inventory data. These estimates may differ from actual consideration amount received and the Company will re-assess these estimates and judgments each reporting period to adjust accordingly.
The following table presents net revenues disaggregated by type (in thousands):
| Nine Months Ended September 30, | Year Ended December 31, | |||||||
| 2019 | 2018 | |||||||
| Prescribed dietary supplements | $ | 5,949 | $ | 7,811 | ||||
| Prescription drugs | 3,356 | 3,487 | ||||||
| Total revenues, net | $ | 9,305 | $ | 11,298 | ||||
Concentration with Customer
The Company sells its products in the United States primarily through wholesale distributors. Wholesale distributors account for substantially all of the Company’s net product revenues. For the nine months ended September 30, 2019, the Company’s three largest customers accounted for approximately 36%, 26%, and 24%, respectively, of the Company’s total net product revenues from sale of prescription pharmaceutical products. For the year ended December 31, 2018, the Company’s three largest customers accounted for approximately 32%, 31% and 22%, respectively, of the Company’s total net product revenues from sale of prescription pharmaceutical products.
Returns and Allowances
Consistent with industry practice, the Company maintains a return policy that allows customers to return product within a specified period both prior to and, in certain cases, subsequent to the product’s expiration date. The Company’s return policy generally allows customers to receive credit for expired products within six months prior to expiration and within one year after expiration. The provision for returns and allowances consists of estimates for future product returns and pricing adjustments. The primary factors considered in estimating potential product returns include:
| ● | the shelf life or expiration date of each product; |
| ● | historical levels of expired product returns; |
| ● | external data with respect to inventory levels in the wholesale distribution channel; |
| ● | external data with respect to prescription demand for the Company’s products; and |
| ● | the estimated returns liability to be processed by year of sale based on analysis of lot information related to actual historical returns. |
The Company’s estimate for returns and allowances may be impacted by a number of factors, but the principal factor relates to the level of inventory in the distribution channel.
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Rebates
The Company is subject to rebates on sales made under governmental pricing programs. For example, Medicaid rebates are amounts owed based upon contractual agreements or legal requirements with public sector (Medicaid) benefit providers after the final dispensing of the product by a pharmacy to a benefit plan participant. Medicaid reserves are based on expected payments, which are driven by patient usage, contract performance and field inventory that will be subject to a Medicaid rebate. Medicaid rebates are typically billed up to 180 days after the product is shipped, however can be as much as 270 days after the quarter in which the product is dispensed to the Medicaid participant. In addition to the estimates mentioned above, the Company’s calculation also requires other estimates, such as estimates of sales mix, to determine which sales are subject to rebates and the amount of such rebates. Periodically, the Company adjusts the Medicaid rebate provision based on actual claims paid. Due to the delay in billing, adjustments to actual claims paid may incorporate revisions of this provision for several periods. Because Medicaid pricing programs involve particularly difficult interpretations of complex statutes and regulatory guidance, our estimates could differ from actual experience.
In determining estimates for these rebates, the Company considers the terms of the contracts, relevant statutes, historical relationships of rebates to revenues, past payment experience, estimated inventory levels and estimated future trends.
Cost of Product Sales
Cost of product sales is comprised of (i) costs to acquire products sold to customers, (ii) royalty, license payments and other agreements granting the Company rights to sell related products, (iii) distribution costs incurred in the sale of products; (iv) the value of any write-offs of obsolete or damaged inventory that cannot be sold, and (v) minimum sale obligations. The Company acquired the rights to sell certain of its commercial products through license and assignment agreements with the original developers or other parties with interests in these products. These agreements require the Company to make payments under varying payment structures based on its net revenue from related products.
Shipping, Handling, and Freight
The Company includes the cost of shipping, handling, and freight associated with product sales as part of cost of product sales.
Amortization Expense
Amortization expense includes the amortization of the Company’s acquired intangible assets. There is no amortization expense included in cost of product sales or sales and marketing expense as all amortization expense is included within its own standalone line in the statement of net revenues and direct expenses.
Estimated Fair Value and Change in Fair Value of Contingent Consideration
The Company may be obligated for the future payment of consideration that is contingent upon the achievement of operation and commercial milestones and royalty payments on future product sales. The fair value of contingent consideration was determined at the acquisition date utilizing unobservable inputs such as the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liability is remeasured at the current fair value with changes recorded in the statement of net revenues and direct expenses.
There is no change in fair value of contingent consideration included in cost of product sales or research and development costs as the change in fair value of contingent consideration is included within its own standalone line in operating expenses in the statement of net revenues and direct expenses.
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Sales and Marketing Expense
Sales and Marketing Expense includes salaries and benefits of the sales department, all contract costs related to servicing the commercial operations of the Pediatric Portfolio that are not included in gross to net deductions as well as product liability insurance.
Stock-based Compensation
The Company applies the provisions of ASC 718, Compensation-Stock Compensation (“ASC 718”), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees, which service the commercial operations of the Pediatrics Product Portfolio, including employee stock options, and has been included in the statements of net revenues and direct operating expenses.
For stock options issued to employees servicing the operations of the Pediatrics Product Portfolio, the Company estimates the grant date fair value of each option using the Black-Scholes option pricing model. The use of the Black-Scholes option pricing model requires management to make assumptions with respect to the expected term of the option, the expected volatility of the common stock consistent with the expected life of the option, risk-free interest rates and expected dividend yields of the common stock.
For awards subject to service-based vesting conditions, including those with a graded vesting schedule, the Company recognizes stock-based compensation expense equal to the grant date fair value of stock options on a straight-line basis over the requisite service period, which is generally the vesting term. Forfeitures are recorded as they are incurred as opposed to being estimated at the time of grant and revised.
Accounting Policy Elections Related to Adoption of New Revenue Recognition Standard
The Company elected the following practical expedients in applying Topic 606 to its identified revenue streams:
| ● | Portfolio approach - contracts within each revenue stream have similar characteristics and the Company believes this approach would not differ materially than if applying Topic 606 to each individual contract. |
| ● | Modified retrospective approach - the Company applied Topic 606 only to contracts with customers that were not completed at the date of initial application, January 1, 2018. |
| ● | Significant financing component - the Company does not adjust the promised amount of consideration for the effects of a significant financing component as the Company expects, at contract inception, that the period between when the Company transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less. |
| ● | Shipping and handling activities - the Company considers any shipping and handling costs that are incurred after the customer has obtained control of the product as a cost to fulfill a promise and will account for them as an expense. |
| ● | Contract costs - the Company recognizes the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that the Company otherwise would have recognized is one year or less. |
The Company does not incur costs to obtain a contract or costs to fulfill a contract that would result in the capitalization of contract costs. Specifically, internal sales commissions are costs to fulfill a contract and are expensed in the same period that revenue is recognized, which is typically within the same quarterly reporting period.
The Company has not made significant changes to the judgments made in applying ASU 2014-09, Revenue from Contracts with Customers (Topic 606) for the nine months ended September 30, 2019 and the year ended December 31, 2018.
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3. Fair Value Measurements
ASC No. 820, Fair Value Measurements and Disclosures (“ASC 820”), defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. The fair value standard also establishes a three-level hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability on the measurement date. The three levels are defined as follows:
| ● | Level 1—inputs to the valuation methodology are quoted prices (unadjusted) for an identical asset or liability in an active market. |
| ● | Level 2—inputs to the valuation methodology include quoted prices for a similar asset or liability in an active market or model-derived valuations in which all significant inputs are observable for substantially the full term of the asset or liability. |
| ● | Level 3—inputs to the valuation methodology are unobservable and significant to the fair value measurement of the asset or liability. |
For each of the fair value hierarchy levels required under ASC 820, the Company only has the Level 3 Liability, Contingent consideration, with a balance of $7,473,485 as of September 30, 2019 and $7,794,354 as of December 31, 2018 with amounts expected to be paid in the next twelve months of $1,237,401, and $1,097,137, respectively.
At September 30, 2019 and December 31, 2018, the Company’s financial instruments included accrued liabilities, short term and long-term debt, and contingent consideration. The carrying amounts reported in the accompanying abbreviated financial statements for, accrued liabilities approximate their respective fair values because of the short-term nature of these accounts. The estimated fair value of the Company’s long-term debt of $15.0 million as of September 30, 2019 and $14.9 million as of December 31, 2018 was based on current interest rates for similar types of borrowings and is in Level 2 of the fair value hierarchy.
Level 3 Valuation
The Company may be obligated for the future payment of consideration that is contingent upon the achievement of operation and royalty payments on future product sales. The fair value of contingent consideration was determined at the acquisition date utilizing unobservable inputs such as the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liabilities are remeasured at the current fair value with changes recorded in the statement of net revenues and direct expenses.
As part of the acquisition of Avadel’s pediatric products, the Company will pay a 15% annual royalty on net sales of the acquired Avadel pediatric products through February 2026 up to an aggregate amount of $12.5 million (“Deerfield Contingent Consideration”). The fair value of the future royalty is the expected future value of the contingent payments discounted to a present value. The estimated fair value of the royalty payments as of September 30, 2019 was $7.5 million. The significant assumptions used in estimating the fair value of the royalty payment as of September 30, 2019 include (i) the expected net sales of the acquired Avadel pediatric products for that are subject to the 15% royalty based on the Company’s net sales forecast and, (ii) the risk-adjusted discount rate of 7.86%, which is comprised of the risk-free interest rate of 1.60% and a counterparty risk of 6.26% utilized to discount the expected royalty payments. The estimated fair value of the royalty payments as of December 31, 2018 was $7.8 million. The significant assumptions used in estimating the fair value of the royalty payment as of December 31, 2018 include (i) the expected net sales of the acquired Avadel pediatric products that are subject to the 15% royalty based on the Company’s net sales forecast, and (ii) the risk-adjusted discount rate of 8.1%, which is comprised of the risk-free interest rate of 2.6% and a counter-party risk of 5.5%. The liability is reduced by periodic payments.
No other changes in valuation techniques or inputs occurred during the nine months ended September 30, 2019 and the year ended December 31, 2018.
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4. Inventory
Inventory consists of finished goods stated at the lower of cost or net realizable value with cost determined on a first-in, first-out basis. The Company reviews the composition of inventory at each reporting period in order to identify obsolete, slow-moving, quantities in excess of expected demand, or otherwise non-saleable items.
Inventory consisted of the following as of September 30, 2019 and December 31, 2018:
| September 30, | December 31, | |||||||
| 2019 | 2018 | |||||||
| Finished goods | $ | 558,937 | $ | 929,986 | ||||
| Inventory reserve | (182,053 | ) | (137,129 | ) | ||||
| Inventory, net | $ | 376,884 | $ | 792,857 | ||||
5. Intangible Assets
The changes in intangible assets for the nine months ended September 30, 2019 and the years ended December 31, 2018 were as follows:
| Balance at December 31, 2017 | $ | 10,377,792 | ||
| Additions | 16,453,000 | |||
| Purchase price allocation measurement period adjustments | 3,347,318 | |||
| Amortization | (2,703,896 | ) | ||
| Balance at December 31, 2018 | $ | 27,474,214 | ||
| Amortization | (2,190,861 | ) | ||
| Impairment | (1,449,121 | ) | ||
| Balance at September 30, 2019 | $ | 23,834,232 |
The following is a summary of intangible assets held by the Company at September 30, 2019 and December 31, 2018, respectively:
| September 30, 2019 | ||||||||||||||||||||
| Gross Carrying Amount | Accumulated Amortization | Impairment Loss | Net Carrying Amount | Weighted-Average Remaining Life | ||||||||||||||||
| (in years) | ||||||||||||||||||||
| Acquired Product Marketing Rights - Karbinal | $ | 6,200,000 | $ | (1,007,162 | ) | $ | — | $ | 5,192,838 | 8.375 | ||||||||||
| Acquired Product Marketing Rights - Cefaclor | 7,611,000 | (1,799,752 | ) | — | 5,811,248 | 5.245 | ||||||||||||||
| Acquired Product Marketing Rights - Aciphex | 2,803,000 | (461,486 | ) | 2,341,514 | 8.245 | |||||||||||||||
| Acquired Developed Technology - Flexichamber | 1,677,000 | (227,879 | ) | (1,449,121 | ) | — | — | |||||||||||||
| Acquired Product Marketing Rights - Metafolin | 11,987,000 | (1,498,368 | ) | 10,488,632 | 13.125 | |||||||||||||||
| Total Intangible Assets | $ | 30,278,000 | $ | (4,994,647 | ) | $ | (1,449,121 | ) | $ | 23,834,232 | ||||||||||
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| December 31, 2018 | ||||||||||||||||||||
| Gross Carrying Amount | Accumulated Amortization | Impairment Loss | Net Carrying Amount | Weighted-Average Remaining Life | ||||||||||||||||
| (in years) | ||||||||||||||||||||
| Acquired Product Marketing Rights - Karbinal | $ | 6,200,000 | $ | (542,161 | ) | $ | — | $ | 5,657,839 | 9.125 | ||||||||||
| Acquired Product Marketing Rights - Cefaclor | 7,611,000 | (969,096 | ) | — | 6,641,904 | 5.995 | ||||||||||||||
| Acquired Product Marketing Rights - Aciphex | 2,803,000 | (248,492 | ) | — | 2,554,508 | 8.995 | ||||||||||||||
| Acquired Developed Technology - Flexichamber | 1,677,000 | (145,014 | ) | — | 1,531,986 | 9.245 | ||||||||||||||
| Acquired Product Marketing Rights - Metafolin | 11,987,000 | (899,023 | ) | — | 11,087,977 | 13.88 | ||||||||||||||
| Total Intangible Assets | $ | 30,278,000 | $ | (2,803,786 | ) | $ | — | $ | 27,474,214 | |||||||||||
The Company recorded expense related to impairment of intangible assets of $1.4 million for the nine months ended September 30, 2019 due to the impairment of the Flexichamber intangible asset. During the second quarter of 2019, the Company made a strategic decision to eliminate sales force efforts related to selling Flexichamber. As a result of this decision, paired with significant deviations from forecasted sales, management identified an impairment indicator for Flexichamber during the second quarter of 2019. Accordingly, as a level 3 fair value hierarchy, the Company performed a test for recoverability and concluded that the sum of its estimated future undiscounted cash flows was less than its carrying value of $1.4 million. Management then measured the impairment loss by calculating the excess of the carrying amount of Flexichamber over its fair value. Management determined that due to the absence of future material cash flows that the fair value was $0. Accordingly, a full impairment was recognized in the amount of $1.4 million for the nine months ended September 30, 2019.
Amortization of intangible assets for the next five years and thereafter is expected to be as follows:
| Estimated | ||||
| Amortization | ||||
| For the Years Ended December 31, | Expense | |||
| 2019 (Three months remaining) | $ | 703,008 | ||
| 2020 | 2,810,664 | |||
| 2021 | 2,810,664 | |||
| 2022 | 2,810,664 | |||
| 2023 | 2,810,664 | |||
| Thereafter | 11,888,568 | |||
| Total future amortization expense | $ | 23,834,232 | ||
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6. Accrued Liabilities
Accrued liabilities as of September 30, 2019 and December 31, 2018 consisted of the following:
| September 30, 2019 | December 31, 2018 | |||||||
| Sales returns and allowances | $ | 3,623,486 | $ | 2,507,091 | ||||
| Medicaid rebates | 2,478,781 | 2,187,023 | ||||||
| Make whole provision | 270,920 | 708,380 | ||||||
| Total accrued liabilities | $ | 6,373,187 | $ | 5,402,494 | ||||
As part of the Aytu transaction, Aytu assumed certain of the Company’s existing liabilities including certain accrued liabilities primarily related to Medicaid rebates and sales returns. Aytu assumed the liability for Medicaid rebates arising out of the Pediatrics Product Portfolio sold prior to the closing date of November 1, 2019 up to $2.7 million. Additionally, Aytu assumed sales returns made related to the Pediatrics Product Portfolio after the closing date of November 1, 2019 only to the extent such post-Closing sales returns exceed $2.0 million and are less than $2.8 million (in other words, this amount will in no event be greater than $0.8 million). While Aytu will only assume a portion of the Sales return and allowance the full balance related to the Pediatrics Product Portfolio is presented herein. Aytu will assume liabilities associated with the minimum unit sales commitments specified in the Karbinal Agreement (see note 7) for $0.3 million.
7. Agreements
Poly-Vi-Flor and Tri-Vi-Flor Related Contracts
Supply and License Agreement, effective December 1, 2014, by and between TRx (wholly-owned subsidiary of the Company) and Merck & Co. (“Merck”)
On December 1, 2014 TRx entered into a Supply and License Agreement with Merck. The initial term of the agreement expires on December 31, 2020, and the agreement will automatically continue for subsequent one-year terms thereafter until terminated in accordance with its terms. Pursuant to the agreement, Merck agrees to supply a specific compound called Metafolin® to TRx for use in dietary supplements within a defined market, and TRx agrees to purchase 100% of its Metafolin requirements from Merck. Under the agreement, TRx has an exclusive license under a number of U.S. and international patents, as well as related trade secrets, know-how and trademark rights, to make and sell TRx products positioned in the pediatric market (i.e., targeted for children 0-3 years of age) in the U.S. Under the agreement, TRx also has a non-exclusive license under the same intellectual property rights to make and sell TRx dietary supplement products within the U.S. outside of certain specified fields, including products containing Metafolin in combination with folic acid or any other folate, products positioned for type II diabetes, pharmaceutical drugs, and medical, fortified, and special dietary foods. TRx must pay Merck a royalty of two-percent (2%) of net sales from TRx products in the pediatric field that contain Metafolin. The royalty payment does not apply to net sales of TRx products marketed as pre-or postnatal vitamins. The royalty payment will continue to apply throughout the initial term and any automatic renewal periods. The minimum annual order quantity for the compound is 1kg. Payments of royalties are made by TRx within 45 days following the end of each calendar quarter.
Settlement and License Agreement, dated February 28, 2011, by and between TRx and Mead Johnson and Company LLC, as amended
TRx entered into a Settlement and License Agreement with Mead Johnson and Company LLC, and the parties subsequently entered into an amendment to such agreement on October 6, 2011. Pursuant to the agreement, Mead Johnson granted TRx an exclusive license to the “Poly-Vi-Flor” and “Tri-Vi-Flor” trademarks and agreed not to oppose TRx’s seeking the marks Poly-Vi-Flor and Tri-Vi-Flor in the United States and in any other countries where Mead Johnson does not have an active registration for such marks. As consideration for such licenses, TRx agreed to pay a royalty to Mead Johnson in the amount of 10% of net revenues received by TRx with respect to products sold under the Poly-Vi-Flor and Tri-Vi-Flor trademarks during the term of the agreement. The term of the agreement is indefinite and will continue unless terminated pursuant to the provisions of the agreement. Payments are made by TRx in arrears on a quarterly basis within 45 days after the end of a given calendar quarter.
14
Redemption Agreement with Additional Poly-Vi-Flor Royalty Obligation
TRx and the Selling Members entered into an Agreement to Redeem Membership Interest on May 31, 2011 with a former Member, Presmar Associates, Inc. Pursuant to the agreement, TRx and the Selling Members agreed to pay to Presmar Associates a royalty payment of 5% of gross sales for Poly-Vi-Flor branded or authorized generic product and, upon the sale of the Poly-Vi-Flor trademark to a third party, to pay to Presmar Associates 5% of the cash proceeds from such sale transaction. Any future sale of the Poly-Vi-Flor trademark to a third party would require that 5% of the sale proceeds be paid to Presmar Associates. Payments are made by TRx in arrears on a quarterly basis within 45 days after the end of a given calendar quarter.
Commercial, Supply, and Distribution Agreements
Acquired Product Marketing Rights - Karbinal
On February 16, 2018, in connection with the acquisition of Avadel’s pediatric products, the Company entered into a supply and distribution agreement with TRIS Pharma (the “Karbinal Agreement”), under which the Company is granted the exclusive right to distribute and sell the product in the United States. The initial term of the Karbinal Agreement is 20 years. The Company will pay TRIS a royalty equal to 23.5% of net sales. Avadel has agreed to offset the 23.5% royalty payable by 8.5%, for a net royalty equal to 15%, in fiscal year 2018 and 2019 for net sales of Karbinal. The make-whole payment is capped at $750,000 each year. The Karbinal Agreement also contains minimum unit sales commitments, which is based on a commercial year that spans from August 1 through July 31, of 70,000 units through 2033. The Company is required to pay TRIS a royalty make whole payment of $30 for each unit under the 70,000 units annual minimum sales commitment through 2033. The annual payment is due in August of each year. The Karbinal Agreement also has multiple commercial milestone obligations that aggregate up to $3.0 million based on cumulative net sales, the first of which is triggered at $40.0 million.
Acquired Product Marketing Rights - AcipHex
On February 16, 2018, in connection with the acquisition of Avadel’s pediatric products, the Company assumed the License and Assignment Agreement for AcipHex (“AcipHex Agreement”) between Eisai, Inc. and FSC Therapeutics, LLC dated June 2014 and the Supply Agreement between Eisai, Inc. and FSC Laboratories, Inc. dated June 2014. Per the AcipHex Agreement, the Company is granted the exclusive license to exploit the products in the territory (U.S.) and an exclusive license to use Eisai trademarks to sell the products. Eisai will manufacture and supply the requirements for supply of the products. The term of the AcipHex Agreement is perpetual unless terminated per the agreement. Eisai will receive (a) a royalty with respect to the sales of AcipHex equal to 15.0% of Net Sales. The royalties are payable until the first commercial sale of an unauthorized generic product in the territory or the date that is five years from the effective date of the agreement. A maximum $8.0 million of sales-based milestone payments is possible should AcipHex accumulated net sales exceed $50.0 million in any twelve-month period
Acquired Product Marketing Rights- Cefaclor
On February 16, 2018, in connection with the acquisition of Avadel’s pediatric products, the Company assumed the License, Supply and Distribution Agreement for Cefaclor between Yung Shin Pharm. Ind, Co., Ltd. and FSC Therapeutics, LLC dated March 2015 (“Cefaclor Agreement”). The initial term of the Cefaclor Agreement runs through December 31, 2024 and will automatically renew for additional, successive twelve-month periods unless terminated by either party. Yung Shin will receive a royalty equal to 15.0% of Net Sales of Cefaclor. A maximum $6.5 million of sales-based milestone payments is possible should Cefaclor accumulated net sales exceed $40.0 million in any twelve-month period.
8. Long Term Debt
The Company has an obligation to Deerfield (the “Deerfield Obligation”). Beginning in July 2018 through October 2020, the Company will pay a quarterly payment of $262,500 to Deerfield CSF, LLC. In January 2021, a balloon payment of $15,250,000 is due. Interest expense for the nine months ended September 30, 2019 and the year ended December 31, 2018 was $0.7 million and $0.8 million, respectively, and is excluded from the statement of net revenues and direct expenses as further explained in Note 2. As part of the sale of the Pediatric Product Portfolio, the Deerfield Obligation was assumed by Aytu. The Deerfield Obligation was $15.3 million as of September 30, 2019, of which $1.1 million is payable within the next twelve months. The Deerfield Obligation was $15.4 million as of December 31, 2018, of which $1.1 million was payable within the next twelve months.
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9. Stock-Based Compensation
2016 Equity Incentive Plan
On April 5, 2016, the Company’s board of directors adopted the 2016 Equity Incentive Plan (the “2016 Plan”) as the successor to the 2015 Omnibus Plan (the “2015 Plan”). The 2016 Plan was approved by the Company’s stockholders and became effective on May 18, 2016 (the “2016 Plan Effective Date”).
As of the 2016 Plan Effective Date, no additional grants will be made under the 2015 Plan or the 2011 Stock Incentive Plan (the “2011 Plan”), which was previously succeeded by the 2015 Plan effective October 13, 2015. Outstanding grants under the 2015 Plan and 2011 Plan will continue according to their terms as in effect under the applicable plan.
Upon the 2016 Plan Effective Date, the 2016 Plan reserved and authorized up to 600,000 additional shares of common stock for issuance, as well as 464,476 unallocated shares remaining available for grant of new awards under the 2015 Plan. An Amended and Restated 2016 Equity Incentive Plan (the “2016 Amended Plan”) was approved by the Company’s stockholders in May 2018, which increased the share reserve by an additional 1.4 million shares. During the term of the 2016 Amended Plan, the share reserve will automatically increase on the first trading day in January of each calendar year, by an amount equal to 4% of the total number of outstanding shares of common stock of the Company on the last trading day in December of the prior calendar year. As of December 31, 2018, there were 602,657 shares available for future issuance under the 2016 Plan. On January 1, 2019, on the terms of the 2016 Amended Plan an additional 1,632,167 shares were made available for issuance for a total of 2,234,824 shares available for issuance.
Option grants expire after ten years. Employee options typically vest over four years. For stock options granted to employees the estimated grant date fair market value of the Company’s stock-based awards is amortized ratably over the individuals’ service periods, which is the period in which the awards vest. Stock-based compensation expense includes expense related to stock options, and ESPP shares. The amount of stock-based compensation expense recognized was $313,790 and $137,082 for the nine months ended September 30, 2019 and the years ended December 31, 2018 respectively for employees directly related to the Pediatrics Product Portfolio.
Stock options with service-based vesting conditions
The Company has granted to employees that are directly related to the Pediatrics Product Portfolio awards that contain service-based vesting conditions. The compensation cost for these options is recognized on a straight-line basis over the vesting periods. A summary of option activity with service-based vesting conditions for the nine months ended September 30, 2019 and year ended December 31, 2018 is as follows:
| Options Outstanding | ||||||||||||||
| Number of shares | Weighted average exercise price | Grant date fair value of options | Weighted average remaining contractual term (in years) | |||||||||||
| Balance at December 31, 2018 | 418,750 | $ | 2.70 | 9.19 | ||||||||||
| Granted | 557,500 | $ | 5.94 | $ | 1,800,725 | |||||||||
| Exercised | (1,390 | ) | ||||||||||||
| Forfeited | (148,264 | ) | $ | 5.45 | $ | 443,309 | ||||||||
| Balance at September 30, 2019 | 826,596 | $ | 4.39 | 9.03 | ||||||||||
| Exercisable at September 30, 2019 | 138,233 | $ | 2.43 | 8.24 | ||||||||||
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| Options Outstanding | ||||||||||||||
| Number of shares | Weighted average exercise price | Grant date fair value of options | Weighted average remaining contractual term (in years) | |||||||||||
| Balance at December 31, 2017 | 180,500 | $ | 1.13 | 9.88 | ||||||||||
| Granted | 297,000 | $ | 3.42 | $ | 585,090 | |||||||||
| Exercised | (0 | ) | ||||||||||||
| Forfeited | (58,750 | ) | $ | 1.54 | $ | 55,225 | ||||||||
| Balance at December 31, 2018 | 418,750 | $ | 2.70 | 9.19 | ||||||||||
| Exercisable at December 31, 2018 | 35,007 | $ | 1.13 | 8.88 | ||||||||||
The aggregate intrinsic value of stock options is calculated as the difference between the exercise price of the stock options and the fair value of the Company’s common stock for those stock options that had exercise prices lower than the fair value of the Company’s common stock.
Stock-based compensation assumptions
The following table shows the assumptions used to compute stock-based compensation expense for stock options granted to employees and members of the board of directors under the Black-Scholes valuation model for the nine months ended September 30, 2019 and the year ended December 31, 2018:
| Nine Months Ended September 30, | Year Ended December 31, | |||||||||||||||||||||||
| Service-based options | 2019 | 2018 | ||||||||||||||||||||||
| Risk-free interest rate | 1.47 | % | — | 2.59 | % | 2.51 | % | — | 3.01 | % | ||||||||||||||
| Expected term of options (in years) | 5.0 | — | 6.25 | 5.0 | — | 6.25 | ||||||||||||||||||
| Expected stock price volatility | 55 | % | 55 | % | — | 65 | % | |||||||||||||||||
| Expected annual dividend yield | 0 | % | — | 0 | % | 0 | % | — | 0 | % | ||||||||||||||
The valuation assumptions were determined as follows:
| ● | Risk-free interest rate: The Company bases the risk-free interest rate on the interest rate payable on U.S. Treasury securities in effect at the time of grant for a period that is commensurate with the assumed expected option term. |
| ● | Expected term of options: Due to lack of sufficient historical data, the Company estimates the expected life of its stock options with service-based vesting granted to employees as the arithmetic average of the vesting term and the original contractual term of the option for service-based options. |
| ● | Expected stock price volatility: The Company estimated the expected volatility based on actual historical volatility of the stock price of other publicly-traded biotechnology companies engaged in lines of business that are the same or similar to the Company’s. The Company calculated the historical volatility of the selected companies by using daily closing prices over a period of the expected term of the associated award. The companies were selected based on their enterprise value, risk profiles, position within the industry, and with historical share price information sufficient to meet the expected term of the associated award. A decrease in the selected volatility would decrease the fair value of the underlying instrument. |
| ● | Expected annual dividend yield: The Company estimated the expected dividend yield based on consideration of its historical dividend experience and future dividend expectations. The Company has not historically declared or paid dividends to stockholders. Moreover, it does not intend to pay dividends in the future, but instead expects to retain any earnings to invest in the continued growth of the business. Accordingly, the Company assumed and expected dividend yield of 0.0%. |
17
Employee Stock Purchase Plan
On April 5, 2016, the Company’s board of directors approved the 2016 Employee Stock Purchase Plan (the “ESPP”). The ESPP was approved by the Company’s stockholders and became effective on May 18, 2016 (the “ESPP Effective Date”).
Under the ESPP, eligible employees can purchase common stock through accumulated payroll deductions at such times as are established by the administrator. The ESPP is administered by the compensation committee of the Company’s board of directors. Under the ESPP, eligible employees may purchase stock at 85% of the lower of the fair market value of a share of the Company’s common stock (i) on the first day of an offering period or (ii) on the purchase date. Eligible employees may contribute up to 15% of their earnings during the offering period. The Company’s board of directors may establish a maximum number of shares of the Company’s common stock that may be purchased by any participant, or all participants in the aggregate, during each offering or offering period. Under the ESPP, a participant may not accrue rights to purchase more than $25,000 of the fair market value of the Company’s common stock for each calendar year in which such right is outstanding.
Upon the ESPP Effective Date, the Company reserved and authorized up to 500,000 shares of common stock for issuance under the ESPP. On January 1 of each calendar year, the aggregate number of shares that may be issued under the ESPP shall automatically increase by a number equal to the lesser of (i) 1% of the total number of shares of the Company’s capital stock outstanding on December 31 of the preceding calendar year, and (ii) 500,000 shares of the Company’s common stock, or (iii) a number of shares of the Company’s common stock as determined by the Company’s board of directors or compensation committee. As of December 31, 2018, 783,983 shares remained available for issuance.
In accordance with the guidance in ASC 718-50, the ability to purchase shares of the Company’s common stock at the lower of the offering date price or the purchase date price represents an option and, therefore, the ESPP is a compensatory plan under this guidance. Accordingly, stock-based compensation expense is determined based on the option’s grant-date fair value and is recognized over the requisite service period of the option. The Company used the Black-Scholes valuation model and recognized stock-based compensation expense of $33,605 and $20,814 for the nine months ended September 30, 2019 and the year ended December 31, 2018, respectively, for the employees directly related to the Pediatrics Product Portfolio.
10. Commitments and Contingencies
Purchase Obligations
Karbinal Royalty Make-Whole Provision
On February 16, 2018, in connection with the acquisition of Avadel’s pediatric products, the Company entered into a supply and distribution agreement with TRIS Pharma (the “Karbinal Agreement”). As part of this agreement, the Company has an annual minimum sales commitment, which is based on a commercial year that spans from August 1 through July 31, of 70,000 units through 2033. The Company is required to pay TRIS a royalty make whole payment of $30 for each unit under the 70,000 units annual minimum sales commitment through 2033. The annual payment is due in August of each year.
The Company paid $0.9 million in August 2018 and $1.7 million in August 2019 to TRIS related to the make whole payment for the commercial year ended July 31, 2018 and 2019. For the nine-months ended September 30, 2019, the Company has accrued $0.3 million in accrued liabilities related to the Karbinal royalty make whole for the commercial year ending July 31, 2020. Make whole provision of $1.3 million has been recorded in cost of product sales for the nine months ended September 30, 2019. For the year ended December 31, 2018, the Company has accrued $0.7 million in accrued liabilities related to the Karbinal royalty make whole for the commercial year ending July 31, 2019. Make whole provision of $1.3 million has been recorded in cost of product sales for the year ended December 31, 2018. The future royalty make whole payments is unknown as the amount owed to TRIS is dependent on the number of units sold.
18
As a part of the sale of the Pediatric Portfolio to Aytu, the Company assigned all payment obligations, including the Make-Whole Payments, under the Karbinal Agreement (collectively, the “TRIS Obligations”) to Aytu.
11. Subsequent Events
The Company has evaluated subsequent events through the date the Pediatrics Product Portfolio abbreviated financial statements were available to be issued or January 3, 2020. In addition to Purchase Agreement with Atyu the following subsequent events were identified.
On November 1, 2019, the Deerfield Contingent Consideration (see note 3) and Obligation (see note 8) was amended as part of the executed Consent and Limited Waiver Agreement. The agreement now requires a minimum monthly payment (Deerfield Contingent Consideration) that is the higher of $100,000 or 15% of net sales as opposed to previously only 15% of net sales, until the royalty payments reach the originally established maximum payout of $12.5 million. Furthermore, the Deerfield Obligation now requires monthly payments of $87,000 as opposed to quarterly payments of $263,000 through January 31, 2021. As part of the Aytu Purchase Agreement, Aytu assumed both the Deerfield Obligation and the Deerfield Contingent Consideration.
Amendment No.3 to Supply and Distribution Agreement for TRIS was executed on October 29, 2019. The amendment requires the purchase and transfer of the NDA for Karbinal™ ER for $250,000 to Cerecor. The $250,000 payment to Tris is to be split evenly between the Company and Aytu. As part of the Aytu Purchase Agreement, Aytu assumed the TRIS contract and AYTU will assume the Karbinal NDA upon transfer.
There were no other events in addition to those previously disclosed within the Notes above that require adjustments to or disclosure in the Company’s financial statements for the nine months ended September 30, 2019 and the year ended December 31, 2018.
19
Exhibit 99.2
FINANCIAL STATEMENTS
Pediatrics Product Portfolio of Cerecor Inc.
As of September 30, 2018, and for the Nine Months Ended September 30, 2018 (Unaudited)
Pediatrics Product Portfolio of Cerecor Inc.
Index to Abbreviated Financial Statements
2
The Pediatrics Product Portfolio of Cerecor Inc.
Statement of Assets Acquired and Liabilities Assumed (Unaudited)
| September 30, 2018 | ||||
| Other receivables | $ | 118,550 | ||
| Inventory, net | 694,762 | |||
| Prepaid expenses and other current assets | 891,311 | |||
| Intangible assets, net | 28,356,072 | |||
| Total assets acquired | $ | 30,060,695 | ||
| Accrued liabilities | $ | 4,744,148 | ||
| Long-term debt | 15,402,224 | |||
| Contingent consideration | 8,249,916 | |||
| Total liabilities assumed | 28,396,288 | |||
| Total net (liabilities assumed) and assets acquired | $ | 1,664,407 | ||
See accompanying notes to the unaudited abbreviated financial statements.
3
The Pediatrics Product Portfolio of Cerecor Inc.
Statements of Net Revenues and Direct Expenses (Unaudited)
| Nine Months Ended | ||||
| September 30, | ||||
| 2018 | ||||
| Product revenue, net | $ | 7,862,543 | ||
| Direct expenses: | ||||
| Cost of product sales | 2,890,459 | |||
| Sales and marketing | 5,741,219 | |||
| Amortization expense | 1,822,038 | |||
| Change in fair value of contingent consideration | 466,924 | |||
| Total direct expenses | 10,920,640 | |||
| Net product revenues less direct expenses | $ | (3,058,097 | ) | |
See accompanying notes to the unaudited abbreviated financial statements.
4
The Pediatrics Product Portfolio of Cerecor Inc.
Notes to Abbreviated Financial Statements
1. Background
On October 10, 2019, Cerecor Inc, (the “Company”) entered into the Aytu Purchase Agreement with Aytu Bioscience, Inc. (“Aytu”) to sell the Company’s rights, title and interest in, assets relating to its Pediatric Portfolio, namely Aciphex® Sprinkle™ , Cefaclor for Oral Suspension, Karbinal™ ER, Flexichamber™ , Poly-Vi-Flor® and Tri-Vi-Flor™ (the “Divested Assets” or “Pediatric Portfolio”) as well as the corresponding commercial infrastructure consisting of the right to offer employment to Cerecor’s sales force and the assignment of supporting commercial contracts (“The Pediatrics Product Portfolio”). Aytu provided consideration of cash and preferred stock totaling $17 million ($4.5 million in cash and $12.5 million in shares of Aytu preferred stock) and assumed certain of the Company’s liabilities, including the Company’s payment obligations payable to Deerfield CSF, LLC (“Deerfield Obligation”) of approximately $15.0 million and certain other liabilities in excess of approximately $11 million. In addition, Aytu assumed future contractual obligations under existing license agreements associated with the Divested Assets. The transaction closed on November 1, 2019. Armistice, a significant stockholder of the Company, is also a significant stockholder of Aytu.
On November 17, 2017, the Company acquired TRx Pharmaceuticals, LLC (“TRx”) and its wholly-owned subsidiaries. TRx acquisition included the purchase of the acquired product marketing rights to Metafolin (Poly-Vi-Flor® and Tri-Vi-Flor™).
On February 16, 2018, Cerecor acquired all rights to Avadel Pharmaceuticals PLC’s (“Avadel”) marketed pediatric products (the “Acquired Products”) for the assumption of certain of Avadel’s financial obligations which included assets and liabilities assumed as part of the Aytu Purchase Agreement.
2. Significant Accounting Policies
Basis of Presentation
The accompanying Statements of Assets Acquired and Liabilities Assumed as of September 30, 2018 and the related Statements of Net Revenues and Direct Expenses for the period from January 1, 2018 through September 30, 2018 (collectively, the “Abbreviated Financial Statements”) of the Pediatrics Product Portfolio have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for the purpose of Aytu’ s compliance with the rules and regulations of the Securities and Exchange Commission under Rule 8-04 of Regulation S-X. Aytu received a waiver from the SEC to present a Statement of Revenues and Direct Expenses and a Statement of Assets Acquired and Liabilities Assumed in lieu of complete financial statements for the Pediatrics Product Portfolio. Complete financial statements have not been prepared historically for the Pediatrics Product Portfolio as Cerecor did not maintain the Pediatrics Product Portfolio as a stand-alone business, division or subsidiary for the periods presented. The Statements of Assets Acquired and Liabilities Assumed and Net Revenues and Direct Expenses of the Pediatrics Product Portfolio have been derived from the operating activities attributed to the Pediatrics Product Portfolio from Cerecor’s books and records and reflect only those assets acquired in the transaction and related liabilities assumed and revenues and expenses directly related to the assets acquired and liabilities assumed. The Statements of Net Revenues and Direct Expenses do not purport to reflect all of the costs, expenses, and cash flows that would have been associated had the Pediatrics Product Portfolio been operated as a stand-alone, separate entity. In addition, the Statements of Net Revenues and Direct Expenses may not be indicative of the operating results going forward given the omission of certain corporate overhead described below and changes in the business that may be made by Aytu BioScience, Inc (See note 11). No additional or separate allocations have been made for certain general and administrative, interest or income tax expenses as Cerecor considered such items to be corporate expenses and not directly related to the Pediatrics Product Portfolio.
5
As previously mentioned, Cerecor acquired all rights to the Acquired Products on February 16, 2018, certain of which are included in the assets acquired and liabilities assumed as of September 30, 2018. The related net revenues and related direct expenses are included in the abbreviated financial statements only for the period that Cerecor owned the Acquired Products and not for the period between January 1, 2018 and February 15, 2018, as Cerecor does not have access to the books and records of the Acquired Products for that period.
Statements of cash flows are not presented as such data was not maintained by Cerecor for the Pediatric Product Portfolio as it did not operate as a separate business or a separate legal entity.
Use of Estimates
The preparation of Abbreviated Financial Statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses, and related disclosures. On an ongoing basis, management evaluates its estimates, including estimates related to but not limited to, revenue recognition, cost of product sales, stock-based compensation, fair value measurements (including those relating to contingent consideration), and other intangible assets. The Company bases its estimates on historical experience and other market-specific or other relevant assumptions that it believes to be reasonable under the circumstances. Actual results may differ from those estimates or assumptions.
Inventory
Inventory consists primarily of finished goods stated at the lower of cost or net realizable value, with cost determined on a first-in, first-out basis. The Company reviews the composition of inventory at each reporting period in order to identify obsolete, slow-moving, quantities in excess of expected demand, or otherwise non-saleable items. If non-saleable items are observed and there are no alternate uses for the inventory, the Company will record a write-down to net realizable value in the period that the decline in value is first recognized. These valuation adjustments are recorded based upon various factors for the Company’s products, including the level of product manufactured by the Company, the level of product in the distribution channel, current and projected product demand, the expected shelf life of the product and firm inventory purchase commitments.
Intangible Assets
Intangible assets with definite useful lives are amortized straight-line over their estimated useful lives and reviewed for impairment if certain events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an intangible asset might not be recoverable. Impairment losses are measured and recognized to the extent the carrying value of such assets exceeds their fair value.
Product Revenues, net
The Company generates substantially all of its revenue from sales of the Pediatric to its customers and has identified a single product delivery performance obligation, which is the provision of prescription pharmaceutical products to its customers based upon master service agreements in place with wholesaler distributors, and purchase orders from retail pharmacies or other direct customers. The performance obligation is satisfied at a point in time, when control of the product has been transferred to the customer, either at the time the product has been received by the customer or to a lesser extent when the product is shipped. The Company determines the transaction price based on fixed consideration in its contractual agreements and the transaction price is allocated entirely to the performance obligation to provide pharmaceutical products. In determining the transaction price, a significant financing component does not exist because the timing from when the Company delivers product to when the customers pay for the product is less than one year and the customers do not pay for product in advance of the transfer of the product.
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Revenues from sales of products are recorded net of any variable consideration for estimated allowances for returns, chargebacks, distributor fees, prompt payment discounts, government rebates, and other common gross-to-net revenue adjustments. The identified variable consideration is recorded as a reduction of revenue at the time revenues from product sales are recognized. The Company recognizes revenue only to the extent that it is probable that a significant revenue reversal will not occur in a future period.
Provisions for returns and government rebates are included within accrued liabilities in the statement of assets acquired and liabilities assumed. Expenses for prompt payment discounts and distributor fees are included as a reduction to net revenue. Calculating these items involves estimates and judgments based on sales or invoice data, contractual terms, historical utilization rates, new information regarding changes in these programs’ regulations and guidelines that would impact the amount of the actual rebates, our expectations regarding future utilization rates for these programs, and channel inventory data. These estimates may differ from actual consideration amount received and the Company will re-assess these estimates and judgments each reporting period to adjust accordingly.
The following table presents net revenues disaggregated by type (in thousands):
Nine Months Ended September 30, | ||||
| 2018 | ||||
| Prescribed dietary supplements | $ | 5,900 | ||
| Prescription drugs | 1,963 | |||
| Total revenues, net | $ | 7,863 | ||
Concentration with Customer
The Company sells its products in the United States primarily through wholesale distributors. Wholesale distributors account for substantially all of the Company’s net product revenues. For the nine months ended September 30, 2018, the Company’s three largest customers accounted for approximately 32%, 30%, and 22%, respectively, of the Company’s total net product revenues from sale of prescription pharmaceutical products.
Returns and Allowances
Consistent with industry practice, the Company maintains a return policy that allows customers to return product within a specified period both prior to and, in certain cases, subsequent to the product’s expiration date. The Company’s return policy generally allows customers to receive credit for expired products within six months prior to expiration and within one year after expiration. The provision for returns and allowances consists of estimates for future product returns and pricing adjustments. The primary factors considered in estimating potential product returns include:
| ● | the shelf life or expiration date of each product; |
| ● | historical levels of expired product returns; |
| ● | external data with respect to inventory levels in the wholesale distribution channel; |
| ● | external data with respect to prescription demand for the Company’s products; and |
| ● | the estimated returns liability to be processed by year of sale based on analysis of lot information related to actual historical returns. |
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The Company’s estimate for returns and allowances may be impacted by a number of factors, but the principal factor relates to the level of inventory in the distribution channel.
Rebates
The Company is subject to rebates on sales made under governmental pricing programs. For example, Medicaid rebates are amounts owed based upon contractual agreements or legal requirements with public sector (Medicaid) benefit providers after the final dispensing of the product by a pharmacy to a benefit plan participant. Medicaid reserves are based on expected payments, which are driven by patient usage, contract performance and field inventory that will be subject to a Medicaid rebate. Medicaid rebates are typically billed up to 180 days after the product is shipped, however can be as much as 270 days after the quarter in which the product is dispensed to the Medicaid participant. In addition to the estimates mentioned above, the Company’s calculation also requires other estimates, such as estimates of sales mix, to determine which sales are subject to rebates and the amount of such rebates. Periodically, the Company adjusts the Medicaid rebate provision based on actual claims paid. Due to the delay in billing, adjustments to actual claims paid may incorporate revisions of this provision for several periods. Because Medicaid pricing programs involve particularly difficult interpretations of complex statutes and regulatory guidance, our estimates could differ from actual experience.
In determining estimates for these rebates, the Company considers the terms of the contracts, relevant statutes, historical relationships of rebates to revenues, past payment experience, estimated inventory levels and estimated future trends.
Cost of Product Sales
Cost of product sales is comprised of (i) costs to acquire products sold to customers, (ii) royalty, license payments and other agreements granting the Company rights to sell related products, (iii) distribution costs incurred in the sale of products; (iv) the value of any write-offs of obsolete or damaged inventory that cannot be sold, and (v) minimum sale obligations. The Company acquired the rights to sell certain of its commercial products through license and assignment agreements with the original developers or other parties with interests in these products. These agreements require the Company to make payments under varying payment structures based on its net revenue from related products.
Shipping, Handling, and Freight
The Company includes the cost of shipping, handling, and freight associated with product sales as part of cost of product sales.
Amortization Expense
Amortization expense includes the amortization of the Company’s acquired intangible assets. There is no amortization expense included in cost of product sales or sales and marketing expense as all amortization expense is included within its own standalone line in the statement of net revenues and direct expenses.
Estimated Fair Value and Change in Fair Value of Contingent Consideration
The Company may be obligated for the future payment of consideration that is contingent upon the achievement of operation and commercial milestones and royalty payments on future product sales. The fair value of contingent consideration was determined at the acquisition date utilizing unobservable inputs such as the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liability is remeasured at the current fair value with changes recorded in the statement of net revenues and direct expenses.
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There is no change in fair value of contingent consideration included in cost of product sales or research and development costs as the change in fair value of contingent consideration is included within its own standalone line in operating expenses in the statement of net revenues and direct expenses.
Sales and Marketing Expense
Sales and Marketing Expense includes salaries and benefits of the sales department, all contract costs related to servicing the commercial operations of the Pediatric Portfolio that are not included in gross to net deductions as well as product liability insurance.
Stock-based Compensation
The Company applies the provisions of ASC 718, Compensation-Stock Compensation (“ASC 718”), which requires the measurement and recognition of compensation expense for all stock-based awards made to employees, which service the commercial operations of the Pediatrics Product Portfolio, including employee stock options, and has been included in the statements of net revenues and direct operating expenses.
For stock options issued to employees servicing the operations of the Pediatrics Product Portfolio, the Company estimates the grant date fair value of each option using the Black-Scholes option pricing model. The use of the Black-Scholes option pricing model requires management to make assumptions with respect to the expected term of the option, the expected volatility of the common stock consistent with the expected life of the option, risk-free interest rates and expected dividend yields of the common stock.
For awards subject to service-based vesting conditions, including those with a graded vesting schedule, the Company recognizes stock-based compensation expense equal to the grant date fair value of stock options on a straight-line basis over the requisite service period, which is generally the vesting term. Forfeitures are recorded as they are incurred as opposed to being estimated at the time of grant and revised.
Accounting Policy Elections Related to Adoption of New Revenue Recognition Standard
The Company elected the following practical expedients in applying Topic 606 to its identified revenue streams:
| ● | Portfolio approach - contracts within each revenue stream have similar characteristics and the Company believes this approach would not differ materially than if applying Topic 606 to each individual contract. |
| ● | Modified retrospective approach - the Company applied Topic 606 only to contracts with customers that were not completed at the date of initial application, January 1, 2018. |
| ● | Significant financing component - the Company does not adjust the promised amount of consideration for the effects of a significant financing component as the Company expects, at contract inception, that the period between when the Company transfers a promised good or service to a customer and when the customer pays for that good or service will be one year or less. |
| ● | Shipping and handling activities - the Company considers any shipping and handling costs that are incurred after the customer has obtained control of the product as a cost to fulfill a promise and will account for them as an expense. |
| ● | Contract costs - the Company recognizes the incremental costs of obtaining a contract as an expense when incurred if the amortization period of the asset that the Company otherwise would have recognized is one year or less. |
The Company does not incur costs to obtain a contract or costs to fulfill a contract that would result in the capitalization of contract costs. Specifically, internal sales commissions are costs to fulfill a contract and are expensed in the same period that revenue is recognized, which is typically within the same quarterly reporting period.
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The Company has not made significant changes to the judgments made in applying ASU 2014-09, Revenue from Contracts with Customers (Topic 606) for the nine months ended September 30, 2018.
3. Fair Value Measurements
ASC No. 820, Fair Value Measurements and Disclosures (“ASC 820”), defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. The fair value standard also establishes a three-level hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability on the measurement date. The three levels are defined as follows:
| ● | Level 1—inputs to the valuation methodology are quoted prices (unadjusted) for an identical asset or liability in an active market. |
| ● | Level 2—inputs to the valuation methodology include quoted prices for a similar asset or liability in an active market or model-derived valuations in which all significant inputs are observable for substantially the full term of the asset or liability. |
| ● | Level 3—inputs to the valuation methodology are unobservable and significant to the fair value measurement of the asset or liability. |
For each of the fair value hierarchy levels required under ASC 820, the Company only has the Level 3 Liability, Contingent consideration, with a balance of $8,249,916 as of September 30, 2018, with amounts expected to be paid in the next twelve months of $1,099,848.
At September 30, 2018, the Company’s financial instruments included accrued liabilities, short term and long-term debt, and contingent consideration. The carrying amounts reported in the accompanying abbreviated financial statements for, accrued liabilities approximate their respective fair values because of the short-term nature of these accounts. The estimated fair value of the Company’s long-term debt of $15.4 million as of September 30, 2018 was based on current interest rates for similar types of borrowings and is in Level 2 of the fair value hierarchy.
Level 3 Valuation
The Company may be obligated for the future payment of consideration that is contingent upon the achievement of operation and royalty payments on future product sales. The fair value of contingent consideration was determined at the acquisition date utilizing unobservable inputs such as the estimated amount and timing of projected cash flows, the probability of success (achievement of the contingent event) and the risk-adjusted discount rate used to present value the probability-weighted cash flows. Subsequent to the acquisition date, at each reporting period, the contingent consideration liabilities are remeasured at the current fair value with changes recorded in the statement of net revenues and direct expenses.
As part of the acquisition of Avadel’s pediatric products, the Company will pay a 15% annual royalty on net sales of the acquired Avadel pediatric products through February 2026 up to an aggregate amount of $12.5 million. The fair value of the future royalty is the expected future value of the contingent payments discounted to a present value. The estimated fair value of the royalty payments as of September 30, 2018 was $8.2 million. The significant assumptions used in estimating the fair value of the royalty payment as of September 30, 2018 include (i) the expected net sales of the acquired Avadel pediatric products that are subject to the 15% royalty based on the Company’s net sales forecast, and (ii) the risk-adjusted discount rate of 6.3%, which is comprised of the risk-free interest rate of 3.0% and a counter-party risk of 3.3%. The liability is reduced by periodic payments.
No other changes in valuation techniques or inputs occurred during the nine months ended September 30, 2018.
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4. Inventory
Inventory consists of finished goods stated at the lower of cost or net realizable value with cost determined on a first-in, first-out basis. The Company reviews the composition of inventory at each reporting period in order to identify obsolete, slow-moving, quantities in excess of expected demand, or otherwise non-saleable items.
Inventory consisted of the following as of September 30, 2018:
| September 30, | ||||
| 2018 | ||||
| Finished goods | $ | 827,313 | ||
| Inventory reserve | (132,551 | ) | ||
| Inventory, net | $ | 694,762 | ||
5. Intangible Assets
The changes in intangible assets for the nine months ended September 30, 2018 were as follows:
| Balance at December 31, 2017 | $ | 10,377,792 | ||
| Additions | 16,453,000 | |||
| Purchase price allocation measurement period adjustments | 3,347,318 | |||
| Amortization | (1,822,038 | ) | ||
| Balance at September 30, 2018 | $ | 28,356,072 |
The following is a summary of intangible assets held by the Company at September 30, 2018:
| September 30, 2018 | ||||||||||||||||||||
| Gross Carrying Amount | Accumulated Amortization | Impairment Loss | Net Carrying Amount | Weighted-Average Remaining Life | ||||||||||||||||
| (in years) | ||||||||||||||||||||
| Acquired Product Marketing Rights - Karbinal | $ | 6,200,000 | $ | (249,401 | ) | $ | — | $ | 5,950,599 | 9.375 | ||||||||||
| Acquired Product Marketing Rights - Cefaclor | 7,611,000 | (692,211 | ) | — | 6,918,789 | 6.245 | ||||||||||||||
| Acquired Product Marketing Rights - Aciphex | 2,803,000 | (177,494 | ) | — | 2,625,506 | 9.245 | ||||||||||||||
| Acquired Developed Technology - Flexichamber | 1,677,000 | (103,580 | ) | — | 1,573,420 | 9.49 | ||||||||||||||
| Acquired Product Marketing Rights - Metafolin | 11,987,000 | (699,242 | ) | 11,287,758 | 14.125 | |||||||||||||||
| Total Intangible Assets | $ | 30,278,000 | $ | (1,921,928 | ) | $ | — | $ | 28,356,072 | |||||||||||
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6. Accrued Liabilities
Accrued liabilities as of September 30, 2018 consisted of the following:
| September 30, 2018 | ||||
| Sales returns and allowances | $ | 1,876,641 | ||
| Medicaid rebates | 2,561,517 | |||
| Make whole provision | 305,990 | |||
| Total accrued liabilities | $ | 4,744,148 | ||
As part of the Aytu transaction, Aytu assumed certain of the Company’s existing liabilities including certain accrued liabilities primarily related to Medicaid rebates and sales returns. Aytu assumed the liability for Medicaid rebates arising out of the Pediatrics Product Portfolio sold prior to the closing date of November 1, 2019 up to $2.7 million. Additionally, Aytu assumed sales returns made related to the Pediatrics Product Portfolio after the closing date of November 1, 2019 only to the extent such post-Closing sales returns exceed $2.0 million and are less than $2.8 million (in other words, this amount will in no event be greater than $0.8 million). While Aytu will only assume a portion of the Sales return and allowance the full balance related to the Pediatrics Product Portfolio is presented herein. Aytu will assume liabilities associated with the minimum unit sales commitments specified in the Karbinal Agreement (see note 7) for $0.3 million.
7. Agreements
Poly-Vi-Flor and Tri-Vi-Flor Related Contracts
Supply and License Agreement, effective December 1, 2014, by and between TRx (wholly-owned subsidiary of the Company) and Merck & Co. (“Merck”)
On December 1, 2014 TRx entered into a Supply and License Agreement with Merck. The initial term of the agreement expires on December 31, 2020, and the agreement will automatically continue for subsequent one-year terms thereafter until terminated in accordance with its terms. Pursuant to the agreement, Merck agrees to supply a specific compound called Metafolin® to TRx for use in dietary supplements within a defined market, and TRx agrees to purchase 100% of its Metafolin requirements from Merck. Under the agreement, TRx has an exclusive license under a number of U.S. and international patents, as well as related trade secrets, know-how and trademark rights, to make and sell TRx products positioned in the pediatric market (i.e., targeted for children 0-3 years of age) in the U.S. Under the agreement, TRx also has a non-exclusive license under the same intellectual property rights to make and sell TRx dietary supplement products within the U.S. outside of certain specified fields, including products containing Metafolin in combination with folic acid or any other folate, products positioned for type II diabetes, pharmaceutical drugs, and medical, fortified, and special dietary foods. TRx must pay Merck a royalty of two-percent (2%) of net sales from TRx products in the pediatric field that contain Metafolin. The royalty payment does not apply to net sales of TRx products marketed as pre-or postnatal vitamins. The royalty payment will continue to apply throughout the initial term and any automatic renewal periods. The minimum annual order quantity for the compound is 1kg. Payments of royalties are made by TRx within 45 days following the end of each calendar quarter.
Settlement and License Agreement, dated February 28, 2011, by and between TRx and Mead Johnson and Company LLC, as amended
TRx entered into a Settlement and License Agreement with Mead Johnson and Company LLC, and the parties subsequently entered into an amendment to such agreement on October 6, 2011. Pursuant to the agreement, Mead Johnson granted TRx an exclusive license to the “Poly-Vi-Flor” and “Tri-Vi-Flor” trademarks and agreed not to oppose TRx’s seeking the marks Poly-Vi-Flor and Tri-Vi-Flor in the United States and in any other countries where Mead Johnson does not have an active registration for such marks. As consideration for such licenses, TRx agreed to pay a royalty to Mead Johnson in the amount of 10% of net revenues received by TRx with respect to products sold under the Poly-Vi-Flor and Tri-Vi-Flor trademarks during the term of the agreement. The term of the agreement is indefinite and will continue unless terminated pursuant to the provisions of the agreement. Payments are made by TRx in arrears on a quarterly basis within 45 days after the end of a given calendar quarter.
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Redemption Agreement with Additional Poly-Vi-Flor Royalty Obligation
TRx and the Selling Members entered into an Agreement to Redeem Membership Interest on May 31, 2011 with a former Member, Presmar Associates, Inc. Pursuant to the agreement, TRx and the Selling Members agreed to pay to Presmar Associates a royalty payment of 5% of gross sales for Poly-Vi-Flor branded or authorized generic product and, upon the sale of the Poly-Vi-Flor trademark to a third party, to pay to Presmar Associates 5% of the cash proceeds from such sale transaction. Any future sale of the Poly-Vi-Flor trademark to a third party would require that 5% of the sale proceeds be paid to Presmar Associates. Payments are made by TRx in arrears on a quarterly basis within 45 days after the end of a given calendar quarter.
Commercial, Supply, and Distribution Agreements
Acquired Product Marketing Rights - Karbinal
On February 16, 2018, in connection with the acquisition of Avadel’s pediatric products, the Company entered into a supply and distribution agreement with TRIS Pharma (the “Karbinal Agreement”), under which the Company is granted the exclusive right to distribute and sell the product in the United States. The initial term of the Karbinal Agreement is 20 years. The Company will pay TRIS a royalty equal to 23.5% of net sales. Avadel has agreed to offset the 23.5% royalty payable by 8.5%, for a net royalty equal to 15%, in fiscal year 2018 and 2019 for net sales of Karbinal. The make-whole payment is capped at $750,000 each year. The Karbinal Agreement also contains minimum unit sales commitments, which is based on a commercial year that spans from August 1 through July 31, of 70,000 units through 2033. The Company is required to pay TRIS a royalty make whole payment of $30 for each unit under the 70,000 units annual minimum sales commitment through 2033. The annual payment is due in August of each year. The Karbinal Agreement also has multiple commercial milestone obligations that aggregate up to $3.0 million based on cumulative net sales, the first of which is triggered at $40.0 million.
Acquired Product Marketing Rights - AcipHex
On February 16, 2018, in connection with the acquisition of Avadel’s pediatric products, the Company assumed the License and Assignment Agreement for AcipHex (“AcipHex Agreement”) between Eisai, Inc. and FSC Therapeutics, LLC dated June 2014 and the Supply Agreement between Eisai, Inc. and FSC Laboratories, Inc. dated June 2014. Per the AcipHex Agreement, the Company is granted the exclusive license to exploit the products in the territory (U.S.) and an exclusive license to use Eisai trademarks to sell the products. Eisai will manufacture and supply the requirements for supply of the products. The term of the AcipHex Agreement is perpetual unless terminated per the agreement. Eisai will receive (a) a royalty with respect to the sales of AcipHex equal to 15.0% of Net Sales. The royalties are payable until the first commercial sale of an unauthorized generic product in the territory or the date that is five years from the effective date of the agreement. A maximum $8.0 million of sales-based milestone payments is possible should AcipHex accumulated net sales exceed $50.0 million in any twelve-month period
Acquired Product Marketing Rights- Cefaclor
On February 16, 2018, in connection with the acquisition of Avadel’s pediatric products, the Company assumed the License, Supply and Distribution Agreement for Cefaclor between Yung Shin Pharm. Ind, Co., Ltd. and FSC Therapeutics, LLC dated March 2015 (“Cefaclor Agreement”). The initial term of the Cefaclor Agreement runs through December 31, 2024 and will automatically renew for additional, successive twelve-month periods unless terminated by either party. Yung Shin will receive a royalty equal to 15.0% of Net Sales of Cefaclor. A maximum $6.5 million of sales-based milestone payments is possible should Cefaclor accumulated net sales exceed $40.0 million in any twelve-month period.
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8. Long Term Debt
The Company has an obligation to Deerfield (the “Deerfield Obligation”). Beginning in July 2018 through October 2020, the Company will pay a quarterly payment of $262,500 to Deerfield CSF, LLC. In January 2021, a balloon payment of $15,250,000 is due. As part of the sale of the Pediatrics Product Portfolio, the Deerfield Obligation was assumed by Aytu. The Deerfield Obligation was $15.4 million as of September 30, 2018, of which $1.1 million was payable within the next twelve months.
9. Stock-Based Compensation
2016 Equity Incentive Plan
On April 5, 2016, the Company’s board of directors adopted the 2016 Equity Incentive Plan (the “2016 Plan”) as the successor to the 2015 Omnibus Plan (the “2015 Plan”). The 2016 Plan was approved by the Company’s stockholders and became effective on May 18, 2016 (the “2016 Plan Effective Date”).
As of the 2016 Plan Effective Date, no additional grants will be made under the 2015 Plan or the 2011 Stock Incentive Plan (the “2011 Plan”), which was previously succeeded by the 2015 Plan effective October 13, 2015. Outstanding grants under the 2015 Plan and 2011 Plan will continue according to their terms as in effect under the applicable plan.
Upon the 2016 Plan Effective Date, the 2016 Plan reserved and authorized up to 600,000 additional shares of common stock for issuance, as well as 464,476 unallocated shares remaining available for grant of new awards under the 2015 Plan. An Amended and Restated 2016 Equity Incentive Plan (the “2016 Amended Plan”) was approved by the Company’s stockholders in May 2018, which increased the share reserve by an additional 1.4 million shares. During the term of the 2016 Amended Plan, the share reserve will automatically increase on the first trading day in January of each calendar year, by an amount equal to 4% of the total number of outstanding shares of common stock of the Company on the last trading day in December of the prior calendar year. As of September 30, 2018, there were 730,067 shares available for future issuance under the 2016 Plan.
Option grants expire after ten years. Employee options typically vest over four years. For stock options granted to employees the estimated grant date fair market value of the Company’s stock-based awards is amortized ratably over the individuals’ service periods, which is the period in which the awards vest. Stock-based compensation expense includes expense related to stock options, and ESPP shares. The amount of stock-based compensation expense recognized was $97,328 for the nine months ended September 30, 2018 for employees directly related to the Pediatrics Product Portfolio.
Stock-based compensation assumptions
The following table shows the assumptions used to compute stock-based compensation expense for stock options granted to employees and members of the board of directors under the Black-Scholes valuation model for the nine months ended September 30, 2018:
| Nine Months Ended September 30, | ||||||||||||
| Service-based options | 2018 | |||||||||||
| Risk-free interest rate | 2.53 | % | — | 2.94 | % | |||||||
| Expected term of options (in years) | 5.0 | — | 6.25 | |||||||||
| Expected stock price volatility | 55 | % | — | 65 | % | |||||||
| Expected annual dividend yield | 0 | % | — | 0 | % | |||||||
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The valuation assumptions were determined as follows:
| ● | Risk-free interest rate: The Company bases the risk-free interest rate on the interest rate payable on U.S. Treasury securities in effect at the time of grant for a period that is commensurate with the assumed expected option term. |
| ● | Expected term of options: Due to lack of sufficient historical data, the Company estimates the expected life of its stock options with service-based vesting granted to employees as the arithmetic average of the vesting term and the original contractual term of the option for service-based options. |
| ● | Expected stock price volatility: The Company estimated the expected volatility based on actual historical volatility of the stock price of other publicly-traded biotechnology companies engaged in lines of business that are the same or similar to the Company’s. The Company calculated the historical volatility of the selected companies by using daily closing prices over a period of the expected term of the associated award. The companies were selected based on their enterprise value, risk profiles, position within the industry, and with historical share price information sufficient to meet the expected term of the associated award. A decrease in the selected volatility would decrease the fair value of the underlying instrument. |
| ● | Expected annual dividend yield: The Company estimated the expected dividend yield based on consideration of its historical dividend experience and future dividend expectations. The Company has not historically declared or paid dividends to stockholders. Moreover, it does not intend to pay dividends in the future, but instead expects to retain any earnings to invest in the continued growth of the business. Accordingly, the Company assumed and expected dividend yield of 0.0%. |
Employee Stock Purchase Plan
On April 5, 2016, the Company’s board of directors approved the 2016 Employee Stock Purchase Plan (the “ESPP”). The ESPP was approved by the Company’s stockholders and became effective on May 18, 2016 (the “ESPP Effective Date”).
Under the ESPP, eligible employees can purchase common stock through accumulated payroll deductions at such times as are established by the administrator. The ESPP is administered by the compensation committee of the Company’s board of directors. Under the ESPP, eligible employees may purchase stock at 85% of the lower of the fair market value of a share of the Company’s common stock (i) on the first day of an offering period or (ii) on the purchase date. Eligible employees may contribute up to 15% of their earnings during the offering period. The Company’s board of directors may establish a maximum number of shares of the Company’s common stock that may be purchased by any participant, or all participants in the aggregate, during each offering or offering period. Under the ESPP, a participant may not accrue rights to purchase more than $25,000 of the fair market value of the Company’s common stock for each calendar year in which such right is outstanding.
Upon the ESPP Effective Date, the Company reserved and authorized up to 500,000 shares of common stock for issuance under the ESPP. On January 1 of each calendar year, the aggregate number of shares that may be issued under the ESPP shall automatically increase by a number equal to the lesser of (i) 1% of the total number of shares of the Company’s capital stock outstanding on December 31 of the preceding calendar year, and (ii) 500,000 shares of the Company’s common stock, or (iii) a number of shares of the Company’s common stock as determined by the Company’s board of directors or compensation committee. As of December 31, 2018, 783,983 shares remained available for issuance.
In accordance with the guidance in ASC 718-50, the ability to purchase shares of the Company’s common stock at the lower of the offering date price or the purchase date price represents an option and, therefore, the ESPP is a compensatory plan under this guidance. Accordingly, stock-based compensation expense is determined based on the option’s grant-date fair value and is recognized over the requisite service period of the option. The Company used the Black-Scholes valuation model and recognized stock-based compensation expense of $11,247 for the nine months ended September 30, 2018, for the Pediatrics Product Portfolio.
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10. Commitments and Contingencies
Purchase Obligations
Karbinal Royalty Make-Whole Provision
On February 16, 2018, in connection with the acquisition of Avadel’s pediatric products, the Company entered into a supply and distribution agreement with TRIS Pharma (the “Karbinal Agreement”). As part of this agreement, the Company has an annual minimum sales commitment, which is based on a commercial year that spans from August 1 through July 31, of 70,000 units through 2033. The Company is required to pay TRIS a royalty make whole payment of $30 for each unit under the 70,000 units annual minimum sales commitment through 2033. The annual payment is due in August of each year.
The Company paid $0.9 million in August 2018 to TRIS related to the make whole payment for the commercial year ended July 31, 2018. For the nine months ended September 30, 2018, the Company has accrued $0.3 million in accrued liabilities related to the Karbinal royalty make whole for the commercial year ending July 31, 2019. Make whole provision of $0.9 million has been recorded in cost of product sales for the nine months ended September 30, 2018. The future royalty make whole payments are unknown as the amount owed to TRIS is dependent on the number of units sold.
As a part of the sale of the Pediatric Portfolio to Aytu, the Company assigned all payment obligations, including the Make-Whole Payments, under the Karbinal Agreement (collectively, the “TRIS Obligations”) to Aytu.
11. Subsequent Events
The Company has evaluated subsequent events through the date the Pediatrics Product Portfolio abbreviated financial statements were available to be issued or January 3, 2020. In addition to Purchase Agreement with Atyu the following subsequent events were identified.
On November 1, 2019, the Deerfield Contingent Consideration (see note 3) and Obligation (see note 8) was amended as part of the executed Consent and Limited Waiver Agreement. The agreement now requires a minimum monthly payment (Deerfield Contingent Consideration) that is the higher of $100,000 or 15% of net sales as opposed to previously only 15% of net sales, until the royalty payments reach the originally established maximum payout of $12.5 million. Furthermore, the Deerfield Obligation now requires monthly payments of $87,000 as opposed to quarterly payments of $263,000 through January 31, 2021. As part of the Aytu Purchase Agreement, Aytu assumed both the Deerfield Obligation and the Deerfield Contingent Consideration.
Amendment No.3 to Supply and Distribution Agreement for TRIS was executed on October 29, 2019. The amendment requires the purchase and transfer of the NDA for Karbinal™ ER for $250,000 to Cerecor. The $250,000 payment to Tris is to be split evenly between the Company and Aytu. As part of the Aytu Purchase Agreement, Aytu assumed the TRIS contract and AYTU will assume the Karbinal NDA upon transfer.
There were no other events in addition to those previously disclosed within the Notes above that require adjustments to or disclosure in the Company’s financial statements for the nine months ended September 30, 2019 and the year ended December 31, 2018.
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Exhibit 99.3
CERTAIN UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS
The following unaudited pro forma condensed combined financial information is presented to illustrate the estimated effects of the merger.
The unaudited pro forma condensed combined balance sheets and the unaudited pro forma condensed combined statements of operations for the fiscal year ended June 30, 2019 and three months ended September 30, 2019 (the “Pro Forma Financials”) have been derived from the following sources:
Aytu BioScience, Inc.
| ● | Unaudited consolidated balance sheet and statement of operations as of and for the three months ended September 30, 2019; and |
| ● | Audited consolidated statement of operations for the year ended June 30, 2019. |
Pediatric Product Portfolio of Cerecor, Inc. (a/k/a “Cerecor Transaction”)
| ● | Audited abbreviated statement of net assets acquired and liabilities assumed of the Pediatric Product Portfolio of Cerecor, Inc. as of September 30, 2019; and |
| ● | Unaudited abbreviated statements of net revenues and direct expenses for the acquired Pediatric Product Portfolio of Cerecor, Inc. for the three months ended September 30, 2019 and year ended June 30, 2019. |
Innovus Pharmaceuticals, Inc.
| ● | Unaudited condensed combined balance sheet and statement of operations as of and for the three months ended September 30, 2019; and |
| ● | Unaudited condensed combined statement of operations for the year ended June 30, 2019. |
The preliminary unaudited pro forma condensed combined statements of operations for the three months ended September 30, 2019 and year ended June 30, 2019 give effect to these transactions as if they had occurred as of July 1, 2018. The preliminary unaudited pro forma condensed combined balance sheet as of September 30, 2019 give effect to these transactions as if they had occurred on September 30, 2019.
Unaudited Pro Forma Condensed Combined Balance Sheet (In thousands)
| As of September 30, 2019 (In thousands, except share amounts) | ||||||||||||||||||||||||||||||||
| Aytu BioScience, Inc. | Cerecor Transaction | Pro Forma Adj. (Cerecor) | Combined Aytu BioScience & Cerecor Transaction | Innovus Pharma, Inc. | Pro Forma Adj. (Innovus) | Pro Forma Combined | ||||||||||||||||||||||||||
| Assets | ||||||||||||||||||||||||||||||||
| Current assets | ||||||||||||||||||||||||||||||||
| Cash and cash equivalents | $ | 7,014 | – | $ | (4,500 | ) | (a) | $ | 2,514 | $ | 955 | $ | (500 | ) | (f) | $ | 2,969 | |||||||||||||||
| Restricted cash | 250 | – | – | 250 | – | – | 250 | |||||||||||||||||||||||||
| Other current assets | 4,718 | 1,788 | 1,236 | (b) | 7,742 | 3,398 | (1,000 | ) | (g) | 10,140 | ||||||||||||||||||||||
| Total current assets | 11,982 | 1,788 | (3,264 | ) | 10,506 | 4,353 | (1,500 | ) | 13,359 | |||||||||||||||||||||||
| Intangible asset, net | 18,293 | 23,834 | – | (c) | 42,127 | 3,378 | – | 45,505 | ||||||||||||||||||||||||
| Goodwill | – | – | 7,216 | (d) | 7,216 | 953 | 21,007 | (h) | 29,176 | |||||||||||||||||||||||
| Other non-current assets | 749 | – | – | 749 | 830 | – | 1,579 | |||||||||||||||||||||||||
| Total long-term assets | 19,042 | 23,834 | 7,216 | 50,092 | 5,161 | 21,007 | 76,260 | |||||||||||||||||||||||||
| Total assets | $ | 31,024 | $ | 25,622 | $ | 3,952 | $ | 60,598 | $ | 9,514 | $ | 19,507 | $ | 89,619 | ||||||||||||||||||
| Liabilities | ||||||||||||||||||||||||||||||||
| Current liabilities | ||||||||||||||||||||||||||||||||
| Accounts payable and accrued liabilities | $ | 3,863 | 6,373 | – | 10,236 | $ | 4,080 | – | $ | 14,316 | ||||||||||||||||||||||
| Accrued compensation | 1,002 | – | – | 1,002 | 1,341 | – | 2,343 | |||||||||||||||||||||||||
| Notes, loans payable and current portion of long-term debt | – | 1,050 | – | (c) | 1,050 | 3,315 | (1,000 | ) | (i) | 3,365 | ||||||||||||||||||||||
| Current contingent consideration | 1,237 | 1,237 | – | (c) | 2,474 | – | 1,730 | (j) | 4,204 | |||||||||||||||||||||||
| Total current liabilities | 6,102 | 8,660 | 14,762 | 8,736 | 730 | 24,228 | ||||||||||||||||||||||||||
| Long-term contingent consideration | 22,272 | 6,236 | – | 28,508 | 1,248 | – | 29,756 | |||||||||||||||||||||||||
| Long-term debt | – | 14,255 | – | 14,255 | – | – | 14,255 | |||||||||||||||||||||||||
| Other long-term liabilities | 326 | – | – | 326 | 1,526 | – | 1,852 | |||||||||||||||||||||||||
| Total liabilities | 28,700 | 29,151 | – | 57,851 | 11,510 | 730 | 70,091 | |||||||||||||||||||||||||
| Commitments and contingencies | ||||||||||||||||||||||||||||||||
| Total stockholders’ equity | 2,324 | (3,529 | ) | 3,952 | 2,747 | (1,996 | ) | 18,777 | 19,528 | |||||||||||||||||||||||
| Total liabilities and stockholders’ equity | $ | 31,024 | $ | 25,622 | $ | 3,952 | $ | 60,598 | $ | 9,514 | $ | 19,507 | $ | 89,619 | ||||||||||||||||||
See accompanying Notes to the Pro Forma Condensed Combined Financial Statements
2
Unaudited Pro Forma Condensed Combined Statement of Operations
Three Months Ended September 30, 2019
(In thousands, except per share data)
| Three Months Ended September 30, 2019 | |||||||||||||||||||||||||||||||
| Aytu BioScience, Inc. | Cerecor Transaction | Pro Forma Adjustments | Combined Aytu BioScience & Cerecor Transaction | Innovus Pharma, Inc. | Pro Forma Adjustments | Pro Forma Combined | |||||||||||||||||||||||||
| Revenues | |||||||||||||||||||||||||||||||
| Product revenue, net | $ | 1,440 | 3,412 | – | $ | 4,852 | $ | 5,648 | $ | - | $ | 10,500 | |||||||||||||||||||
| Service revenue, net | – | – | – | - | 107 | - | 107 | ||||||||||||||||||||||||
| Total product revenue | 1,440 | 3,412 | – | 4,852 | 5,755 | - | 10,607 | ||||||||||||||||||||||||
| Operating expenses | |||||||||||||||||||||||||||||||
| Cost of sales | 376 | 1,303 | – | 1,679 | 2,215 | – | 3,894 | ||||||||||||||||||||||||
| Research and development | 78 | – | – | 78 | 86 | – | 164 | ||||||||||||||||||||||||
| Selling, general and administrative | 5,146 | 2,458 | – | 7,604 | 5,152 | (400 | ) | (k) | 12,356 | ||||||||||||||||||||||
| Amortization of intangible assets | 575 | 703 | – | (c) | 1,278 | – | – | 1,278 | |||||||||||||||||||||||
| Total operating expenses | 6,175 | 4,464 | – | 10,639 | 7,453 | (400 | ) | 17,692 | |||||||||||||||||||||||
| Loss from operations | (4,735 | ) | (1,052 | ) | – | (5,787 | ) | (1,698 | ) | 400 | (7,085 | ) | |||||||||||||||||||
| Other (expense) income | - | ||||||||||||||||||||||||||||||
| Other (expense), net | (195 | ) | – | – | (c) | (195 | ) | (538 | ) | – | (733 | ) | |||||||||||||||||||
| Gain from warrant derivative liability | 2 | – | – | 2 | – | – | 2 | ||||||||||||||||||||||||
| Total other (expense) income | (193 | ) | – | – | (193 | ) | (538 | ) | - | (731 | ) | ||||||||||||||||||||
| Net loss | $ | (4,928 | ) | (1,052 | ) | – | $ | (5,980 | ) | $ | (2,236 | ) | $ | 400 | $ | (7,816 | ) | ||||||||||||||
| Weighted average number of common shares outstanding | 15,325,921 | – | – | 15,325,921 | 2,759,117 | 1,175,794 | (l) | 19,260,832 | |||||||||||||||||||||||
| Basic and diluted net loss per common share | $ | (0.32 | ) | $ | (0.39 | ) | $ | (0.81 | ) | $ | (0.41 | ) | |||||||||||||||||||
See accompanying Notes to the Pro Forma Condensed Combined Financial Statements
3
Unaudited Pro Forma Condensed COMBINED Statement of Operations
Year Ended June 30, 2019
(in thousands, except per share data)
| Year Ended June 30, 2019 | ||||||||||||||||||||||||||||||
| Aytu BioScience, Inc. | Cerecor Transaction | Pro Forma Adjustments | Combined Aytu BioScience & Cerecor Transaction | Innovus Pharma, Inc. | Pro Forma Adjustments | Pro Forma Combined | ||||||||||||||||||||||||
| Revenues | ||||||||||||||||||||||||||||||
| Product revenue, net | $ | 7,315 | 12,434 | – | $ | 19,749 | $ | 23,150 | – | $ | 42,899 | |||||||||||||||||||
| Cooperative marketing revenue, net | – | – | - | 519 | – | 519 | ||||||||||||||||||||||||
| Service revenue, net | 6 | – | – | 6 | 675 | – | 681 | |||||||||||||||||||||||
| Total product revenue | 7,321 | 12,434 | – | 19,755 | 24,344 | – | 44,099 | |||||||||||||||||||||||
| Operating expenses | ||||||||||||||||||||||||||||||
| Cost of sales | 2,202 | 4,899 | – | 7,101 | 6,256 | – | 13,357 | |||||||||||||||||||||||
| Research and development | 589 | – | – | 589 | 274 | – | 863 | |||||||||||||||||||||||
| Selling, general and administrative | 18,888 | 10,034 | – | 28,922 | 23,362 | (2,000 | ) | (k) | 50,284 | |||||||||||||||||||||
| Selling, general and administrative - related party | 352 | – | 352 | – | – | 352 | ||||||||||||||||||||||||
| Amortization of intangible assets | 2,136 | 3,126 | – | (c) | 5,262 | – | – | 5,262 | ||||||||||||||||||||||
| Impairment of intangible assets | – | 1,449 | (1,449 | ) | (e) | – | – | – | – | |||||||||||||||||||||
| Total operating expenses | 24,167 | 19,508 | (1,449 | ) | 42,226 | 29,892 | (2,000 | ) | 70,118 | |||||||||||||||||||||
| Loss from operations | (16,846 | ) | (7,074 | ) | 1,449 | (22,471 | ) | (5,548 | ) | 2,000 | (26,019 | ) | ||||||||||||||||||
| Other (expense) income | ||||||||||||||||||||||||||||||
| Other (expense), net | (536 | ) | – | – | (536 | ) | (1,838 | ) | – | (2,374 | ) | |||||||||||||||||||
| (Loss) / gain from change in fair value of contingent consideration | (9,831 | ) | (494 | ) | – | (10,325 | ) | 191 | – | (10,134 | ) | |||||||||||||||||||
| (Loss) on extinguishment of debt | – | – | – | – | (1,163 | ) | – | (1,163 | ) | |||||||||||||||||||||
| Gain from warrant derivative liability | 81 | 81 | – | – | 81 | |||||||||||||||||||||||||
| Total other (expense) income | (10,286 | ) | (494 | ) | – | $ | (10,780 | ) | (2,810 | ) | – | (13,590 | ) | |||||||||||||||||
| Net loss | $ | (27,132 | ) | $ | (7,568 | ) | $ | 1,449 | $ | (33,251 | ) | $ | (8,358 | ) | $ | 2,000 | $ | (39,609 | ) | |||||||||||
| Weighted average number of common shares outstanding | 7,794,489 | – | – | 7,794,489 | 2,700,000 | 1,234,911 | (l) | 11,729,400 | ||||||||||||||||||||||
| Basic and diluted net loss per common share | $ | (3.48 | ) | $ | (4.27 | ) | $ | (3.10 | ) | $ | (3.38 | ) | ||||||||||||||||||
See accompanying Notes to the Pro Forma Condensed Combined Financial Statements
4
NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION
(In thousands, except per share information)
Note 1. Basis of Presentation
The historical consolidated financial statements of Aytu BioScience, Inc. (the “Company”) have been adjusted in the pro forma condensed combined financial statements to give effect to pro forma events that are (i) directly attributable to the business combination, (ii) factually supportable and (iii) with respect to the pro forma condensed combined statements of operations, expected to have a continuing impact on the combined results following the business combinations.
While Aytu will account for the business combinations under the acquisition method of accounting in accordance with ASC Topic 805 Business Combinations (“Topic 805”), Aytu has not completed the estimation of the fair value of assets acquired or liabilities assumed (the “Cerecor Transaction”) and the merger with Innovus (the “Innovus Merger”) subject to shareholder approval. Accordingly, the preliminary pro forma condensed combined balance sheet as presented currently has not been fully adjusted in accordance with Topic 805. Any adjustments reflect information currently available to Aytu today, such as certain loans between Aytu and Innovus, estimates of certain fixed minimum future payments or the estimated modifications to goodwill, which exclude the current estimated and expected adjustments upon applying purchase accounting in accordance with Topic 805.
The combined preliminary pro forma condensed combined financial information does not reflect the realization of any expected cost savings or other synergies from the acquisition of both the (i) Cerecor Transaction and the (ii) Innovus Merger as a result of restructuring activities and other planned cost savings initiatives following the completion and integration of the business combinations.
As the Pediatrics Product Portfolio of Cerecor, Inc. (the “Product Portfolio”) reported on a December 31 year end, in preparing the Unaudited Pro Forma Condensed Combined Statement of Operations for the year ended June 30, 2019, the Company updated the annual income statement of the Product Portfolio to reflect a twelve-month period ended June 30, 2019.
These were obtained by taking the (i) audited abbreviated statements of net revenues and direct expenses for the acquired Product Portfolio for the nine months ended September 30, 2019, less the net revenues and direct expenses for Product Portfolio for the three month period ended September 30, 2019, and adding these amounts to the (ii) audited abbreviated statements of net revenues and direct expenses for the acquired Product Portfolio for the year ended December 31, 2018, less the net revenues and direct expenses for the acquired Product Portfolio for the abbreviated period prior to July 1, 2018.
Note 2. Financing Transactions
Cerecor Transaction
On November 1, 2019, the Company completed the Cerecor Transaction, acquiring a portfolio of pediatric products from Cerecor, Inc. for (i) $4.5 million in cash and (ii) $12.5 million in Series G Preferred Stock.
Innovus Merger
On September 12, 2019, the Company entered into an Agreement and Plan of Merger with Innovus Pharmaceuticals, Inc. (“Innovus Merger”). The Company currently estimates the pending Innovus Merger to constitute (i) approximately 3.9 million shares of Aytu common stock at close, (ii) $16 million of contingent value rights (“CVRs”) with the potential settlement from the issuance of up to a maximum of 4.7 million shares of Aytu common stock underlying the CVRs or cash at the option of the Company, and an estimated 1.3 million shares of Aytu common stock underlying Innovus warrants or Series H preferred stock.
Note 3. Estimated Purchase Price Consideration
Generally accepted accounting principles in the United States (“GAAP”) requires that Company’s assess whether the Company’s common stock, even if traded on a nationally listed exchange, is indicative of fair value. After careful analysis, due relatively thin daily trading volumes, the Company determined that the best indicator of fair value is the most recent offering price. The fair value of the Company’s common stock is determined based upon the estimated transaction price as a result of the Company’s most recently completed private placement offering on October 11, 2019, which was valued at $0.567 per share.
5
Cerecor Transaction
The following table provides the value of consideration transferred upon the November 1, 2019 closing of the Cerecor transaction:
| Estimated Consideration at Close | ||||
| Closing Shares Estimated Value | ||||
| Total shares of Aytu Series G Preferred Stock issued on November 1, 2019 | 9,805,845 | |||
| Estimated fair value per share of Aytu Series G Preferred Stock (see Note 3) | $ | 0.567 | ||
| Estimated value of Aytu Series G Preferred Stock issued at November 1, 2019 | $ | 5,559,914 | ||
| Cash Consideration | ||||
| Total cash consideration transferred at November 1, 2019 | 4,500,000 | |||
| Estimated Value of Consideration Transferred | $ | 10,059,914 | ||
Innovus Merger
The preliminary estimated purchase price is estimated as if the transaction had closed on January 6, 2019 and includes estimates as to the final total number of shares of Aytu common stock expected to either be issued at close, or registered to satisfy future potential issuances post-close. Accordingly, the amounts presented in the table below are likely to change upon the closing of the merger.
| Estimated Consideration at Close | ||||
| Closing Shares Estimated Value | ||||
| Estimated shares to be issued at Close | 3,934,911 | |||
| Estimated fair value of Aytu common stock (see Note 3) | $ | 0.567 | ||
| Estimated value of Aytu common stock issued at close | $ | 2,231,095 | ||
| Value of CVRs (Assuming 100% Milestone Achievement) (f) | ||||
| Minimum CVR Value (Assuming 100% Milestone Achievement) | $ | 16,000,000 | ||
| Other Shares of Aytu Common Stock Related to the Merger (҂) | ||||
| Estimated potential number of shares of Aytu Common stock | 1,293,003 | |||
| Estimated fair value of Aytu common stock | $ | 0.567 | ||
| Estimated value of other shares issued at close related to the merger | $ | 733,133 | ||
| Estimated Value of Consideration Transferred | $ | 18,964,227 | ||
(f) – Assumes 100% achievement for all Contingent Value Rights (“CVRs”) pursuant to the Contingent Value Rights Agreement (Exhibit B to the “Agreement and Plan of Merger” dated September 12, 2019). There is no guarantee that such CVRs will be achieved.
(҂) – Such estimate is subject to change due to the multiple variables involved in ultimately calculating the number of shares to be issued, including (a) the Company’s stock price; (b) the fair value of CVRs and their impact on valuations which determine certain shares to be issued to satisfy certain outstanding warrants, and (c) other inputs to certain warrant valuations that will not be determined until the date the Innovus Merger closes.
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Note 4. Preliminary purchase price allocation
The Company has performed a preliminary acquisition analysis which has not yet been adjusted to reflect Topic 805 adjustments either due to the fact that (i) the Company has commenced the valuation of the assets acquired and liabilities assumed relating to the Cerecor transaction, but has not been completed, and (ii) the Innovus merger is pending approval by both shareholders of Aytu and Innovus before the transaction can close.
Cerecor Transaction
The following table provides the estimated, preliminary pro forma purchase price allocation, which is subject to change upon a completed valuation of the assets acquired and liabilities assumed at the November 1, 2019 closing date. The Company anticipates a final valuation report near the beginning of the third quarter of the Company’s fiscal year ended June 30, 2020.
| Purchase Price Allocation | Estimated Purchase Price Allocation (in thousands) | |||
| Estimated consideration to be transferred | 10,060 | |||
| Total Assets Acquired | ||||
| Cash and cash equivalents | – | |||
| Other current assets (see Note 6) | 1,788 | |||
| Intangible assets (see Note 6) | 23,834 | |||
| Other non-current assets (see Note 6) | – | |||
| Total identifiable assets | 25,622 | |||
| Total liabilities assumed | ||||
| Current portion of long-term debt (see Note 6) | 1,050 | |||
| Current portion of contingent consideration (see Note 6) | 1,237 | |||
| Long-term contingent consideration (see Note 6) | 6,236 | |||
| Long-term debt (see Note 6) | 14,255 | |||
| Other long-term liabilities (see Note 6) | – | |||
| Total identifiable liabilities | 22,778 | |||
| Total pro forma goodwill | 7,216 | |||
7
Innovus Merger
The following table provides the estimated, preliminary pro forma purchase price allocation, which is subject to change upon a completed valuation of the assets to be acquired and liabilities to be assumed at the yet to be determined closing date, which is subject to shareholder approval.
| Purchase Price Allocation | Estimated Purchase Price Allocation (in thousands) | Notes | ||||
| Estimated consideration to be transferred | 18,964 | (1) | ||||
| Total Assets Acquired | ||||||
| Cash and cash equivalents | 955 | |||||
| Other current assets | 3,398 | |||||
| Intangible assets | 3,378 | |||||
| Other non-current assets | 1,783 | |||||
| Total identifiable assets | 9,514 | |||||
| Total liabilities assumed | ||||||
| Accounts payable and accrued liabilities | 4,080 | |||||
| Accrued compensation | 1,341 | |||||
| Notes payable | 2,315 | |||||
| Long-term contingent consideration | 3,248 | |||||
| Other long-term liabilities | 1,526 | |||||
| Total identifiable liabilities | 12,510 | |||||
| Total pro forma goodwill | 21,960 | |||||
| (1) | The estimated consideration transferred is an estimate both regarding the ultimate fair value of the Company’s common stock at the time of close, as well as the total number of shares of the Company’s common stock either issued at close or underlying other securities transferred at the time of close. |
Note 5. Pro Forma Adjustments
The preliminary pro forma adjustments are based on the Company’s estimates and assumptions that are subject to change. The following adjustments have been reflected in the unaudited pro forma condensed consolidated combined financial information:
Cerecor Transaction
| (a) | Represents the $4.5 million of cash consideration transferred as part of the Cerecor Transaction purchase price. |
| (b) | Represents adjustments to reflect preliminary estimated fair value of acquired inventory and prepaid expenses, as well as estimated amounts owed by Cerecor, Inc. to the Company for future product returns related to products sold prior to the November 1, 2019 closing date. Such amounts include estimates by the Company and are subject to potential future adjustments over the twelve-month measurement period. |
| (c) | As of the filing of this Form 8-K, the Company is still in the process of valuing the assets acquired and liabilities assumed at November 1, 2019. Until such time, adjustments to the pro forma balance sheet as of September 30, 2019 and related statements of operations for the year ended June 30, 2019 and three months ended September 30, 2019 are pending (see Note 6). |
| (d) | Represents the preliminary estimated goodwill, which represents the excess purchase price over the fair value of the Cerecor transaction (see Note 4). As noted, as of the filing of this Form 8-K, the Company is still in the process of valuing the assets acquired and liabilities assumed at November 1, 2019. Until such time, adjustments to the pro forma balance sheet as of September 30, 2019 cannot be determined (see Note 6). |
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| (e) | Impairment charges as reported by Cerecor, Inc. in the historical, audited abbreviated financial statements as filed in Exhibit 99.1 to this Current Report on Form 8-K/A are not specific to the identified assets acquired and to be ultimately valued by the Company (see Note 6), and therefore, the circumstances under which such impairment charges were recognized are not relevant. |
Innovus Merger
| (f) | Represents approximately $100,000 in cash consideration paid to certain key members of Innovus executive team and approximately $400,000 in severance to be paid to a parting executive of Innovus. |
| (g) | Represents the elimination of the $1.0 million note between Aytu and Innovus that the parties agreed to in August 2019 |
| (h) | Represents the preliminary estimated goodwill, which represents the excess purchase price over the fair value of the pending Innovus merger (see Note 4). |
| (i) | Represents the elimination of the $1.0 million note between Aytu and Innovus that was entered into in August 2019. |
| (j) | Represents the potential cash outflows related to the potential satisfaction of Contingent Value Rights relating to revenue targets established in the Agreement and Plan of Merger with Innovus Pharmaceuticals, Inc. on September 12, 2019. | |
| (k) | Represents the estimated expected cost savings and efficiencies to be realized within the first fiscal year post-close, due to the elimination or reduction in salaries or headcount, and elimination of various public company related activities such as accounting, legal or investor relations. |
| (l) | Represents the pro forma weighted average shares outstanding at the end of both the three months ended June 30, 2019 and three months ended September 30, 2019, excluding any future or potential transactions or offerings. |
Note 6. Pending Valuation of Cerecor Assets Acquired and Liabilities Assumed
The Company is in the process of completing the valuation for the identified assets acquired and liabilities assumed as part of the Cerecor Transaction, as of the date of this Form 8-K. Additionally, any amounts reported, are preliminary and subject to the twelve-month lookback period, and therefore, subject to potential adjustment, with any offsetting adjustment to goodwill. Due to the complexity involved in the valuation of acquired intangible assets and some assumed liabilities, the Company required the services of a third-party valuation specialist. The Company did not believe it would be useful to users of the financial statements to provide estimates for these assets prematurely, as they would have little relevance to the estimates to ultimately be provided by the third-party valuation specialist. The following are the preliminary identified assets acquired and liabilities assumed, and the current estimated value.
| Purchase Price Allocation | Estimated Purchase Price Allocation (in thousands) | ||||
| Identified Assets Acquired | |||||
| Inventory | 449 | (1) | |||
| Prepaid expenses | 575 | (2) | |||
| Other receivables – product programs | (i) | (3) | |||
| Intangible assets – product technology | (i) | (4) | |||
| Intangible assets – supplier agreements | (i) | (5) | |||
| Total liabilities assumed | |||||
| Other current liabilities - other | 388 | (6) | |||
| Other current liabilities – Product programs | (i) | (7) | |||
| Other long-term liabilities – fixed payments, product minimums, and certain contingent consideration arrangements | 27,883 | (8) | |||
| (i) | The Company hired a third party valuation specialist firm, which is currently working on the valuation of certain assets acquired and liabilities assumed. The valuation is not yet complete, and accordingly, a value cannot yet be attached to this asset or liability. |
| (1) | Current estimated maximum value of product inventory acquired at November 1, 2019, subject to change based on further analysis. |
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| (2) | Consists of certain prepaid regulatory and other fees. |
| (3) | Pursuant to the terms of the Product Purchase Agreement date October 10, 2019, Cerecor, Inc. agreed to reimburse the Company for certain obligations resulting from products sales occurring prior to the November 1, 2019 closing date. |
| (4) | The Company determined that for accounting purposes, the primary asset acquired was in the form of product technology, as opposed to trademark or patent rights. The reason for this distinction was because each acquired product license agreement which allows use of trademark or patent rights requires the Company to pay future periodic royalties to third parties for the rights to market, distribute and sell the acquired Cerecor Products. Under a relief-from-royalties model for valuing such acquired assets, there is no relief from royalties to value. Accordingly, the value is related to the multi-period excess earnings generated by each product over the earlier of the product lifecycle or license agreement term. The Company is still in the process of valuing these assets. |
| (5) | The Company does not produce its pharmaceutical products in-house and instead utilizes third party manufacturers to source production. Manufacturers of pharmaceutical products to be marketed, distributed and sold within the United States of America are required to comply with United States Food and Drug Administration (“FDA”) regulatory oversight, including obtaining FDA pre-approval before any manufactured pharmaceutical products can be distributed or sold within the United States of America. Complying with these regulations can require significant up-front costs, which the Company has avoided through acquiring products with previously approved suppliers. As of the filing of this Form 8-K, the Company has yet to complete the valuation of these assets. |
| (6) | Estimated costs owed to Cerecor Inc. to cover certain accounting and other payments as agreed to by both the Company and Cerecor Inc. as part of the Product Purchase Agreement dated October 10, 2019. |
| (7) | Pursuant to the terms of the Product Purchase Agreement date October 10, 2019, the Company assumed responsibility for certain obligations resulting from product sales occurring prior to the November 1, 2019 closing date, some of which, will be reimbursed by Cerecor Inc. |
| (8) | Other long-term liabilities consist of fixed payments tied to certain outstanding assumed debt obligations, product minimums or contingent consideration owed under certain of the Company’s licensing agreements. The Company’s estimated fair value is does not include a valuation of the contingent consideration, which is still pending. The valuation of fixed payment streams are discounted using an estimated Company specific discount rate of approximately 18.0%, which is consistent with historical discount rates used to value other contingent consideration obligations of the Company. A final discount rate will be updated based upon the work of the Company’s third-party valuation specialist. |
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