Aytu Biopharma, Inc: Form 10-Q for the period ended Mar 31, 2024

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 nine months ended March 31, 2024, and our financial condition as of March 31, 2024. 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 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 $2.9 million and $11.2 million for the three and nine months ended March 31, 2024, respectively. As of March 31, 2024, and June 30, 2023, we had accumulated deficits of $315.4 million and $304.1 million, respectively. As of March 31, 2024, 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 second 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. 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, most notably affecting the Consumer Health Segment. While we do not have sales or operations in Russia or Ukraine and we do not have material sales or operations in 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 nine months ended March 31, 2024, compared to the three and nine months ended March 31, 2023, is as follows:

(in thousands)

Net revenue

During the three and nine months ended March 31, 2024, net revenue decreased by $4.7 million, or 21% and decreased by $13.6 million, or 18%, compared to the same periods ended March 31, 2023. The decrease during the three and nine months ended March 31, 2024 was primarily due to the decrease in net revenue from the Consumer Health Segment as we continue to wind down our Consumer Health Segment, with some of the decrease in net revenue attributed to a decline in net revenue from the Pediatric Portfolio in the Rx Segment. These declines were partially offset by an increase in net revenue from the ADHD Portfolio of $4.1 million, or 49% and $13.0 million, or 42% for the three and nine months ended March 31, 2024, compared to the same periods ended March 31, 2023.

Gross margin

During the three and nine months ended March 31, 2024, gross profit decreased by 8% and by 11%, respectively, compared to the same periods ended March 31, 2023. Gross margin percentage was 65% and 68% for the three and nine months ended March 31, 2024, respectively, compared to 56% and 63% for the same periods ended March 31, 2023. The improvements were primarily due to a decline in the lower-margin Consumer Health Segment net revenue as we continue to wind down our Consumer Health Segment and improvements in the ADHD Portfolio were primarily 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 nine months ended March 31, 2024, advertising and direct marketing expense decreased $3.8 million, or 76% and $10.2 million or 72%, compared to the same periods ended March 31, 2023. 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 nine months ended March 31, 2024, other selling and marketing expense decreased by $2.4 million, or 31% and $2.7 million, or 14%, compared to the same periods ended March 31, 2023. 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 nine months ended March 31, 2024, general and administrative expense decreased by $1.7 million, or 24% and $4.7 million, or 21% compared to the same periods ended March 31, 2023. The decrease is primarily a result of ongoing cost-cutting initiatives and operational improvements.

Research and development

During the three and nine months ended March 31, 2024, research and development expense decreased by $0.2 million, or 28% and $1.9 million, or 52%, compared to the same periods ended March 31, 2023. 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

During the three and nine months ended March 31, 2024, amortization expense of intangible assets, excluding amounts included in cost of sales, were relatively consistent compared to the same periods ended March 31, 2023.

Restructuring costs

During the three and nine months ended March 31, 2024, the Company incurred $0.2 million of restructuring costs related to our previously announced operational realignment and related costs. During the three and nine months ended March 31, 2023, no restructuring costs were incurred.

Impairment expense

During the three and nine months ended March 31, 2024, 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. We incurred an impairment charge of $2.6 million during the second quarter of fiscal 2023 related to these decisions.

Other expense, net

During the three and nine months ended March 31, 2024, other expense, net, decreased by $20.0 thousand, or 2% and $444.0 thousand, or 13% compared to the same periods ended March 31, 2023, 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.

Gain (loss) 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 nine months ended March 31, 2024, we recognized an unrealized gain of $1.0 million and an unrealized loss of $5.5 million, respectively, from the fair value adjustments.

Income tax expense

Income tax expense was $0.2 million and $1.1 million for the three and nine months ended March 31, 2024, respectfully, which was an effective tax rate of (9.3)% and (10.6)% for those same periods. 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 three and nine months ended March 31, 2023, income tax expense was zero with an effective tax rate of zero percent for those same periods, 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, 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 March 31, 2024, 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 the London Interbank Offered Rate (“LIBOR”), plus 4.50% through April 2022. Beginning in May 2022 through maturity, the Revolving Loans bear interest at the 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 nine months ended March 31, 2024, and 2023:

(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 nine months ended March 31, 2024, net cash used in operating activities totaled $0.6 million. The use of cash was primarily the result of the decrease in accounts payable and accrued liabilities, partially offset by positive cash earnings (net loss offset by non-cash depreciation, amortization and accretion, derivative warrant liabilities adjustment, and stock compensation expense). Additionally, these were partially offset by funds from the Employee Retention Credit program recorded in other operating liabilities (see Note 9 – Other Liabilities) and a decrease in accounts receivable, net and inventories.

During the nine months ended March 31, 2023, net cash used in operating activities totaled $14.5 million. The use of cash was primarily the result of the increase in accounts receivable, inventory, and prepaid expenses, offsetting these increases was an increase in accounts payable and accrued expenses.

Net Cash (Used in) Provided by Investing Activities

Net cash flows from investing activities were nominal during each of the nine months ended March 31, 2024, and 2023.

Net Cash (Used in) Provided by Financing Activities

Net cash used in financing activities of $2.3 million during the nine months ended March 31, 2024, was primarily from payments made to fixed payment arrangements.

Net cash provided by financing activities of $14.3 million during the nine months ended March 31, 2023, was primarily from $9.1 million of proceeds from our August 2022 equity raise, $6.6 million of additional net borrowing made under our short-term line of credit, and $2.9 million net proceeds from our sales under the ATM Sales Agreement; partially offset by fixed payment arrangements totaling $4.1 million and stock issuance costs of $1.0 million.

Inflation

Inflation has resulted in increased costs for our suppliers and our customers. In addition, the United States 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 nine months ended March 31, 2024. 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 March 31, 2024, 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 or (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 March 31, 2024, up to $3.0 million of fixed and product milestone payments based on net revenue from the product 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 and gain regulatory clearances to commercialize the product in multiple markets around the world, 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 revenue from the product, 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, revenue 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, revenue 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.

Evaluation of Disclosure Controls and Procedures

As required by Rules 13a-15(e) and 15d-15(e) under the Exchange Act, our management, with the participation of 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 the end of the period covered by this Form 10-Q. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of March 31, 2024, at reasonable assurance levels, in ensuring that information required to be disclosed by us in reports that we file or submit under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (ii) is accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Accordingly, we believe that the financial statements presented in this Form 10-Q present fairly, in all material respects, our financial position, results of operations and cash flows for the periods presented herein.

Remediation of Previously Identified Material Weakness

Warrants

As previously disclosed in our September 30, 2022 Form 10-Q/A, we identified a material weakness in internal control over financial reporting related to our 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

As previously disclosed in our 2023 Form 10-K, we identified a material weakness in internal control over financial reporting related to our analysis for the accounting for valuation of our inventory. As of June 30, 2023, it was determined that the analysis of over or under absorbed manufacturing costs was not performed, which could have led to material misstatement of our financial statement.

Remediation Efforts

As previously reported in our public reports referred to above, our Audit Committee conducted an internal investigation to identify and determine a plan to remediate the material weaknesses described above and to enhance our overall control environment. We undertook to remediate these deficiencies and strengthen our internal control over financial reporting by enhancing existing controls and establishing additional review and procedure controls over the process of reviewing significant and complex contracts and agreements, and the valuation of inventory, which include the following:

• Identified specific clauses and relevant guidance that could result in liability classification of issued warrants;
• Identified and engaged a firm that specializes in the analysis and technical accounting for the classification of warrants and utilized this firm to assist with the technical accounting analysis for our warrants issued on June 8, 2023, including arriving at the correct conclusion that these warrants should be classified as liabilities and marked to market each reporting period;
• Identified and engaged a firm that specializes in the valuation analysis regarding the fair value of our liability classified warrants to assist us with calculating the necessary mark to market adjustment each reporting period;
• Implemented a new quarterly control and related processes effective for the fourth quarter of fiscal 2023, and operating every quarter thereafter, to perform a detailed analysis of over or under absorbed manufacturing costs, quantify any over or under absorbed manufacturing costs, and have the appropriate level of management review and evaluate the analysis and approve the recording of any adjusting journal entries as necessary;
• Successfully hired additional personnel with the expertise necessary to improve the technical accounting and financial reporting functions; and
• Provided additional guidance, education and training to employees relating to our accounting procedures with a continued focus on warrant classification and inventory valuation;

Given these remediation efforts above and that a sufficient period of time has passed with successful testing performed, management has concluded that the material weaknesses set forth above were remediated as of March 31, 2024.

Inherent Limitations on Effectiveness of Internal Controls over Financial Reporting

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

There have been no changes in the Company’s internal control over financial reporting that occurred during the period covered by this Form 10-Q, that have a material effect, or are reasonably likely to have a material effect, on the Company’s internal control over financial reporting, other than those noted above.

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.