Aytu Biopharma, Inc: Form 10-Q for the period ended Dec 31, 2023

This discussion should be read in conjunction with the Company’s 2023 Form 10-K. The following discussion and analysis contain forward-looking statements that involve risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. For additional information regarding these risks and uncertainties, please see the risk factors included in the Company’s 2023 Form 10-K, and in Part II Item 1A of this Form 10-Q.

Objective

The purpose of the Management’s Discussion and Analysis (the “MD&A”) is to present information that management believes is relevant to an assessment and understanding of our results of operations and cash flows for the three and six months ended December 31, 2023, and our financial condition as of December 31, 2023. The MD&A is provided as a supplement to, and should be read in conjunction with, our Unaudited Consolidated Financial Statements and Notes to the Unaudited Consolidated Financial Statements.

Overview

We are a pharmaceutical company focused on commercializing novel therapeutics. We operate through two business segments (i) the Rx Segment, consisting of prescription pharmaceutical products sold primarily through third party wholesalers and (ii) the Consumer Health Segment, which consists of various consumer health products sold directly to consumers. We currently manufacture our products for the treatment of attention deficit hyperactivity disorder (“ADHD”) at our manufacturing facility and use third party manufacturers for our other prescription and consumer health products. We are in the process of moving production of our ADHD products to a third-party manufacturer to improve the profitability of these products.

We have incurred significant losses in each year since inception. Our net loss was $0.2 million and $8.3 million for the three and six months ended December 31, 2023, respectively. As of December 31, 2023, and June 30, 2023, we had accumulated deficits of $312.5 million and $304.1 million, respectively. As of December 31, 2023, and largely as a result of the January 2025 maturity of the Avenue Note, there is significant uncertainty about our ability to fund planned operations for the twelve months following the filing date of this Form 10-Q, which raises substantial doubt about our ability to continue as a going concern.

Company Strategy

In the first quarter of fiscal 2023, we announced that we will focus our efforts on accelerating the growth of our Rx business and achieving operating cash flows. To achieve these goals, we indefinitely suspended active development of our clinical development programs. The suspension of these programs is expected to save over $20 million in projected future study costs over the next three fiscal years. In addition, we announced that we would wind down our Consumer Health Segment in fiscal 2024, which has not generated cash flows since we acquired the business in February 2020, to allow us to focus our efforts on improving the performance of our Rx Segment.

Business Environment

We have continued to experience significant inflationary pressure and have experienced supply chain disruptions related to the sourcing of raw materials, energy, logistics and labor during fiscal 2023 and 2024. While we do not have sales or operations in Russia, Ukraine, or the Middle East, it is possible that the conflict or actions taken in response, could adversely affect some of our markets and suppliers, economic and financial markets, costs and availability of energy and materials, or cause further supply chain disruptions. We continue to closely monitor the impact of, and responses to, COVID-19 variants, including government-imposed lockdowns, on demand conditions and our supply chain. We expect that inflationary pressures and supply chain disruptions could continue to be significant across the business throughout fiscal 2024. The Company has not experienced stock outages for its ADHD products since the launch of those products, and the pediatric product supply has remained adequate to satisfy demand for the preceding three years.

Results of Operations

The results of operations for the three and six months ended December 31, 2023, compared to the three and six months ended December 31, 2022 is as follows:

(in thousands)

Product revenue, net

During the three and six months ended December 31, 2023, net product revenue decreased by $3.3 million, or 13% and decreased by $8.9 million, or 17%, compared to the same period ended December 31, 2022. The decrease during the three and six months ended December 31, 2023 was primarily due to the decrease in revenue from the Consumer Health Segment, with some of the decrease in revenue attributed to a decline in revenue from the Pediatric Portfolio in the Rx Segment. These declines were partially offset by an increase in revenue from the ADHD Portfolio in the Rx Segment.

Gross margin

During the three and six months ended December 31, 2023, gross profit decreased by 6% and by 12%, respectfully, compared to the same period ended December 31, 2022. Gross margin percentage was 71% and 69% for the three and six months ended December 31, 2023, respectfully, compared to 66% and 65% for the same period ended December 31, 2022. The improvements were primarily due to higher net revenues and cost saving efficiencies in the Pediatric Portfolio and a decline in the lower-margin Consumer Health Segment. Gross margin improvements in the ADHD Portfolio were due to efficiencies in production related to higher demand for Adzenys XR-ODT and Cotempla XR-ODT.

Advertising and direct marketing

During the three and six months ended December 31, 2023, advertising and direct marketing expense decreased $3.2 million, or 70% and $6.4 million or 70%, compared to the same periods ended December 31, 2022. Advertising and direct marketing expense include direct-to-consumer marketing, advertising, sales, and customer support and processing fees related to our Consumer Health Segment and have decreased as we continue to wind down our Consumer Health Segment.

Other selling and marketing

During the three and six months ended December 31, 2023, other selling and marketing expense decreased by $0.7 million, or 13% and $0.3 million, or 3%, compared to the same periods ended December 31, 2022. The decreases were primarily driven by commission expense based on prescriptions generated by our sale force and commercial marketing program fees that decrease as product sales decrease.

General and administrative

During the three and six months ended December 31, 2023, general and administrative expense decreased by $2.6 million, or 32% and $2.9 million, or 19% compared to the same periods ended December 31, 2022. The decrease is primarily a result of ongoing cost-cutting initiatives and operational improvements.

Research and development

During the three and six months ended December 31, 2023, research and development expense decreased by $1.2 million, or 69% and $1.6 million, or 59%, compared to the same periods ended December 31, 2022. Our research and development costs were primarily associated with AR101 and to a lesser extent, the development of Healight and support for our commercialized products. In October 2022, we announced the suspension of the development of AR101 and Healight to focus on our commercial operations. As a result, research and development spending has significantly declined. We expect our research and development expenses to decrease from historical levels as a result of our focus on commercial operations.

Amortization of intangible assets

In the three and six months ended December 31, 2023, amortization expense of intangible assets, excluding amounts included in cost of sales, were relatively consistent compared to the same periods ended December 31, 2022.

Impairment expense

In the three and six months ended December 31, 2023, no impairment expense was recorded.

Due to increased focus on our Rx business efforts, we ceased active development of our NT0502 product candidate. As a result, we returned the intellectual property and terminated the Exclusive License Agreement with NeuRx Pharmaceuticals entered in October 2018. In the three and six months ended December 31, 2022, we incurred an impairment charge of $2.6 million related to these decisions.

Other expense, net

In the three and six months ended December 31, 2023, other expense, net, decreased by $49.0 thousand, or 4% and $0.4 million, or 18% compared to the same periods ended December 31, 2022, primarily due to $0.5 million in other income from insurance proceeds for damage of inventory in the first quarter of fiscal 2024. Other expense, net, include interest expense, accretion from fixed payment arrangements, and other income.

(Loss) gain on derivative warrant liabilities

The fair value of derivative warrant liabilities is calculated using either the Black-Scholes option model or the Monte Carlo simulation model and is revalued at each reporting period. For the three and six months ended December 31, 2023, we recognized unrealized losses of $0.6 million and $6.5 million, respectively, from the fair value adjustments.

Income tax expense

For both the three and six months ended December 31, 2023, income tax expense was $0.8 million with an effective tax rate of 136.2% and negative 11.0% for the three and six months ended December 31, 2023, respectively. This income tax expense was primarily driven by the limitations on losses as a result of Section 382 of the Internal Revenue Code changes in ownership coupled with existing valuation allowances.

For both the six months ended December 31, 2023 and 2022, income tax expense was zero with an effective tax rate of zero percent for both the six months ended December 31, 2023 and 2022, reflecting the full valuation allowance and no impact of Section 382 of the Internal Revenue Code.

Liquidity and Capital Resources

Sources of Liquidity

We have obligations related to our loan agreements, and in the form of contingent consideration related to our acquisitions, milestone payments for licensed products, and manufacturing purchase commitments.

We finance our operations through a combination of sales of our common stock and warrants, borrowings under our line of credit facility, and from cash generated from operations.

Shelf Registrations

On September 28, 2021, we filed a shelf registration statement on Form S-3, which was declared effective by the SEC on October 7, 2021. This shelf registration statement covered the offering, issuance and sale by the Company of up to an aggregate of $100.0 million of its common stock, preferred stock, debt securities, warrants, rights and units (the “2021 Shelf”). As of December 31, 2023, approximately $82.4 million remains available under the 2021 Shelf. This availability is subject to SEC 1.B.6 limitations of Form S-3.

Eclipse Loan Agreement

The Eclipse Loan Agreement, as amended, provides us with up to $14.5 million, less a $3.5 million availability block, in Revolving Loans, against 85% of eligible accounts receivable. The Revolving Loans bore interest at LIBOR, plus 4.50% through April 2022. Beginning in May 2022 through maturity, the Revolving Loans bear interest at the Secured Overnight Financing Rate (“SOFR”) plus 4.50%. In addition, we are required to pay an unused line fee of 0.50% of the average unused portion of the maximum Revolving Loans amount during the immediately preceding month. Interest is payable monthly in arrears. The maturity date under the Eclipse Loan Agreement, as amended, is January 26, 2025.

Cash Flows

The following table shows cash flows for the six months ended December 31, 2023 and 2022:

(in thousands)

Net Cash Used in Operating Activities

Net cash used in operating activities during these periods primarily reflected our net losses, partially offset by changes in working capital and non-cash charges including impairment, stock-based compensation expense, gain or loss on derivative warrant liabilities, depreciation, amortization and accretion, and other charges.

During the six months ended December 31, 2023, net cash used in operating activities totaled $0.4 million. The use of cash was primarily the result of the decrease in accrued liabilities, partially offset by funds from the Employee Retention Credit program recorded in other operating liabilities (see Note 9 - Other Liabilities). Additionally, these were partially offset by positive cash earnings (net loss offset by non-cash depreciation, amortization and accretion, derivative warrant liabilities adjustment, and stock compensation expense).

During the six months ended December 31, 2022, net cash used in operating activities totaled $11.6 million. The use of cash was primarily the result of the decrease in inventory, prepaid expenses, and accrued liabilities. These were partially offset by positive cash earnings (net loss offset by non-cash depreciation, amortization and accretion, in addition to stock compensation expense and impairment charges).

Net Cash (Used in) Provided by Investing Activities

Net cash flows from investing activities were nominal during each of the six months ended December 31, 2023 and 2022.

Net Cash (Used in) Provided by Financing Activities

Net cash used in financing activities of $2.7 million during the six months ended December 31, 2023, was primarily from payments made to fixed payment arrangements.

Net cash provided by financing activities of $11.7 million during the six months ended December 31, 2022, was primarily from $9.1 million of proceeds from our August 2022 equity raise, $3.6 million of additional net borrowing made under our short-term line of credit, and $1.5 million from our sales under our ATM Sales Agreement.

Inflation

Inflation has resulted in increased costs for our suppliers and our customers. In addition, the U.S. Government has responded to inflation by raising interest rates, which has increased the cost of capital. We believe this has resulted in some of our customers making decisions to reduce their costs as well as increased costs of our operations, which has negatively impacted the results of our operations during the three and six months ended December 31, 2023. We maintain strategies to mitigate the impact of higher material, energy and commodity costs, including cost reduction, alternative sourcing strategies, and passing along cost increases to customers, which may offset only a portion of the adverse impact.

Contractual Obligations, Commitments and Contingencies

As a result of our acquisitions and licensing agreements, we are contractually and contingently obliged to pay, when due, various fixed and contingent milestone payments. See Note 13 – Commitments and Contingencies in the accompanying Notes to the Unaudited Consolidated Financial Statements for further information.

On May 12, 2022, we entered into an agreement with Tris Pharma Inc. (“Tris”) to terminate the Tuzistra License, Development, Manufacturing and Supply Agreement dated November 2, 2018 (the “Tuzistra License Agreement”). Pursuant to such termination, we agreed to pay Tris a total of $6 million to $9 million, which reduced our total liability for minimum payments by approximately $8 million from the original Tuzistra License Agreement. As of December 31, 2023, the total remaining liability for minimum payments was $6.0 million. Pursuant to the settlement agreement, if the Company does not make timely payments, it is required to pay interest on any outstanding balances at a rate equal to the greater of (i) 2.5% per month and (ii) the maximum interest rate permitted by applicable law.

Upon closing of the acquisition of a line of prescription pediatric products from Cerecor, Inc. in October 2019, we assumed payment obligations that require us to make fixed and product milestone payments based on sales. As of December 31, 2023, up to $3.0 million of fixed and product milestone payments based on net sales remain.

In connection with our acquisition of the assets from Rumpus VEDS, LLC, Rumpus Therapeutics, LLC, Rumpus Vascular, LLC (collectively, “Rumpus”), and only if we resume and ultimately complete clinical development of AR101, we may be required to pay up to $67.5 million in regulatory and commercial-based earn-out payments to Rumpus, which are primarily paid against commercial milestone achievements. Under the licensing agreement with Denovo Biopharma LLC (“Denovo”), we made a payment of $0.6 million for a license fee in April 2022. In addition, upon the achievement of regulatory and commercial milestones, we may be required to pay up to $101.7 million. Under the licensing agreement with Johns Hopkins University (“JHU”), upon achievement of regulatory and commercial milestone, we may be required to pay up to $1.6 million to JHU. In fiscal 2022, two milestones payable to Rumpus were achieved totaling $4.0 million, which were paid in 109,447 shares of common stock and $2.6 million in cash. The Company also assumed the responsibility for royalties of 3.0% of net product sales, with a minimum of $20,000 per year, and upon the achievement of certain regulatory and commercial milestones, up to $1.6 million. With clinical development currently suspended, only if we resume and ultimately complete clinical development of AR101, are substantially all milestones payable to these parties.

Critical Accounting Estimates

The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. For a detailed discussion about the Company’s significant accounting policies, refer to our 2023 Form 10-K.

Off-Balance Sheet Arrangements

We have not entered into any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources and would be considered material to investors.

We are a smaller reporting company as defined by Rule 12b-2 of the Exchange Act and are not required to provide information under this item.

As required by Rules 13a-15 and 15d-15 under the Exchange Act, our Chief Executive Officer and Chief Financial Officer carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2023. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were not effective, due to the material weakness in our internal control over financial reporting related to the Company’s accounting for complex financial instruments with regards to warrants, and the valuation of inventory. As a result, we performed additional analysis as described below to ensure that our financial statements were prepared in accordance with U.S. GAAP. Accordingly, management believes that the financial statements present fairly in all material respects our financial position, results of operations and cash flows for the period presented.

Changes in Internal Control over Financial Reporting

Previous Disclosure of Material Weakness in Internal Controls Over Financial Reporting

Warrants. As disclosed in our September 30, 2022 Form 10-Q/A, we identified a material weakness in controls over the accounting for complex warrant issuances and the classification of these issued warrants. This material weakness resulted in the failure to prevent material adjustments in accounting for the warrants as equity classification when the warrants should have been classified as liabilities and marked to market each reporting period. While we have processes to properly identify and evaluate the appropriate accounting technical pronouncements, other literature, and consultation with third-party experts, we did not classify the warrants correctly.

Inventory. In connection with the preparation of our financial statements for the period ended June 30, 2023 in our 2023 Form 10-K, we concluded that we had a material weakness in internal control over financial reporting related to our analysis for the accounting for valuation of our inventory. At fiscal year end, it was determined that the analysis of over/under absorbed manufacturing costs was not performed, which could have led to material misstatement of our financial statement. If not addressed, the deficiency could result in a material misstatement in the future. In response, we have incorporated the process for quantifying any over or under absorbed manufacturing costs, and having the appropriate level of management evaluate the analysis and materiality of any over or under absorption.

Remediation Plan

Our Audit Committee is conducting an internal investigation to identify and determine a plan to remediate the material weaknesses described above and to enhance our overall control environment. We will not consider the material weakness remediated until our enhanced controls are operational for a sufficient period of time and tested, enabling management to conclude that the enhanced controls are operating effectively. Our remediation plan includes the implementation of controls over the process of reviewing significant and complex contracts and agreements, and the valuation of inventory.

Inherent Limitations

Our management team, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdown can occur because of simple errors or mistakes. In particular, many of our current processes rely upon manual reviews and processes to ensure that neither human error nor system weakness has resulted in erroneous reporting of financial data.

Changes in Internal Control Over Financial Reporting

Except for the material weaknesses noted above, there have been no changes in the Company’s internal control over financial reporting that occurred during the three months ended December 31, 2023 that have a material effect, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Our business faces significant risks and uncertainties. Certain important factors may have a material adverse effect on our business prospects, financial condition, and results of operations, and you should carefully consider them. There have not been any material changes to our risk factors from those reported in our 2023 Form 10-K.