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

This discussion should be read in conjunction with Aytu BioPharma, Inc.’s Annual Report on Form 10-K for the year ended June 30, 2022, filed on September 27, 2022. 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 Aytu’s Form 10-K and Form 10-Q filed with the United Sates Securities and Exchange Commission (“SEC”) on September 27, 2022 and November 14, 2022, respectively.

Objective

The purpose of the Management 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, 2023, and our financial condition as of March 31, 2023. The MD&A is provided as a supplement to, and should be read in conjunction with, our condensed consolidated financial statements and notes.

Overview

We are a commercial-stage pharmaceutical company focused on commercializing novel therapeutics and consumer healthcare products. 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 have incurred significant losses in each year since inception. Our net losses were $7.2 million for the three months ended March 31, 2023, and $14.6 million for the nine months ended March 31, 2023. As of March 31, 2023, and June 30, 2022, we had accumulated deficits of $301.7 million and $287.1 million, respectively. We expect to continue to incur significant expenses in connection with our ongoing activities, including the integration of our acquisitions. As of March 31, 2023, we did not have sufficient working capital to cover our cash needs to fund planned operations for the twelve months following the filing date of this Quarterly Report on 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 commercial business and achieving operating cash flows. To achieve these goals, we have 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 April 2020 we entered into a licensing agreement with Cedars-Sinai Medical Center (“Cedars-Sinai”) to secure worldwide rights to various potential esophageal and nasopharyngeal uses of Healight. The agreement with Cedars-Sinai grants us a license to all patent and development related technology rights for the intra-corporeal therapeutic use of ultraviolet light in the field of endotracheal and nasopharyngeal applications. In April 2023, we ceased all development of Healight and are in the process of returning materials and intellectual property to Cedars-Sinai. We terminated the Healight license, effective May 9, 2023.

In October 2018, Neos entered into an Exclusive License Agreement (“NeuRx License”) with NeuRx Pharmaceuticals LLC (“NeuRx”), pursuant to which NeuRx granted Neos an exclusive, worldwide, royalty-bearing license to research, develop, manufacture, and commercialize certain pharmaceutical products containing NeuRx’s proprietary compound designated as NRX 101, referred to as NT0502. NT0502 is a new chemical entity that was being developed for the treatment of sialorrhea, which is excessive salivation or drooling. In April 2023, we returned the NT0502 rights to NeuRx in exchange for and receive a royalty and potential milestone payments on amounts received for future revenue generated by NeuRx (or a future licensee) on NT0502.

Our commercial business includes the Rx segment and the Consumer Health segment.

Business Environment

COVID-19 Pandemic

The ongoing COVID-19 pandemic continues to impact the global economy and create economic uncertainties. We believe COVID-19 has negatively impacted the market for prescription products and disrupted the reliability of the supply chain. The extent to which COVID-19 continues to negatively impact our business in the future will depend on future developments, which are highly uncertain and cannot be predicted with confidence, including the duration of the outbreak, new information that may emerge concerning the severity of the new variants of coronavirus, the actions taken to contain the coronavirus or treat its impact, and the continued impact of each of these items on the economies and financial markets in the United States and abroad. While the Biden administration has announced that the COVID-19 emergency declaration will end May 11, 2023 and states and jurisdictions have rolled back stay-at-home and quarantine orders, it is difficult to predict what the lasting impact of the pandemic will be, and if we or any of the third parties with whom we engage were to experience additional shutdowns or other prolonged business disruptions, our ability to conduct our business in the manner and on the timelines presently planned could have a material adverse impact on our business, results of operation and financial condition. In addition, a recurrence or impact from new strains of COVID-19 cases could cause other widespread or more severe impacts depending on where infection rates are highest. We will continue to monitor developments as we deal with the disruptions and uncertainties relating to the COVID-19 pandemic.

Inflationary pressure and supply chain disruptions

We have continued to experience significant inflationary pressure and supply chain disruptions related to the sourcing of raw materials, energy, logistics and labor during fiscal 2022 and 2023. While we do not have sales or operations in Russia or Ukraine, 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 our fiscal 2023 year.

Debt and Equity financing

On March 24, 2023, the Company and certain of its subsidiaries entered into an Amendment No. 4 (the “Eclipse Amendment”) to the Loan and Security Agreement dated October 2, 2019 (as amended by Amendment No. 1, dated March 19, 2021, Amendment No. 2, dated January 26, 2022, Amendment No. 3, dated June 1, 2022, and the Eclipse Amendment, (the “Eclipse Agreement”). The Eclipse Amendment, among other things, provided for an aggregate increase of $2.0 million to the Eclipse Lender’s commitment to make revolving loans from time to time under the Eclipse Agreement and increased the maximum amount available under the revolving credit facility provided under the Eclipse Agreement to $14.5 million. The ability to make borrowings and obtain advances of revolving loans under the Eclipse Agreement remains subject to a borrowing base and reserve, and availability blockage requirements.

On October 25, 2022, we entered into an agreement with Avenue Venture Opportunities Fund, L.P (“Avenue”) to extend the interest-only period of our existing senior secure loan facility held with Avenue. The amendment to the original loan agreement, which was executed in January 2022, extends the interest-only period to January of 2024. In exchange for this extension of the interest-only period, we and Avenue agreed to reset the exercise price of the warrants issued in conjunction with the original loan agreement to $8.60, corresponding to the warrant exercise price associated with the Company’s latest equity financing. We expect to conserve cash of approximately $3.0 million related to principal payment in calendar year 2023. (See Note —11 Long-Term Debt and Note 16— Warrants).

On August 11, 2022, we closed on an underwritten public offering (“August 2022 Offering”), of (i) 1,075,290 shares of our common stock and, in lieu of common stock to certain investors, pre-funded warrants (“Pre-Funded Warrants”) to purchase 87,500 shares of our common stock, and (ii) accompanying warrants (the “Common Warrants”)

to purchase 1,265,547 shares of our common stock. We received gross proceeds of $10.0 million and net proceeds of approximately $9.1 million, after deducting underwriting discounts and commissions and estimated offering expenses.

During the nine months ended March 31, 2023, we issued 699,929 shares of common stock under the ATM Sales Agreement (as defined below) with total gross proceeds of approximately $3.0 million before deducting commissions of 3% and other offering expenses including legal and audit fees.

On January 6, 2023, we effected a 1-for-20 reverse stock split of our common stock. All share and per share amounts in this quarterly report have been adjusted to reflect the effect of the Reverse Stock Split. Aytu’s Board of Directors implemented the reverse stock split with the objective of regaining compliance with the $1.00 minimum bid price requirement of the Nasdaq Capital Market. On January 23, 2023, Nasdaq confirmed we regained compliance with this listing rule.

Aytu’s shares of common stock will continue to trade on the Nasdaq Capital Market under the symbol "AYTU." The new CUSIP number for the Company's common stock post-reverse stock split is 054754858.

A cash payment will be made to each stockholder in lieu of any fractional interest in a share to which each stockholder would otherwise be entitled as a result of the reverse stock split. The reverse stock split reduced the number of shares of outstanding common stock from approximately 68.8 million shares to approximately 3.4 million shares. As a result of the reverse stock split, proportional adjustments were also made to outstanding warrants and options, and to our 2015 equity incentive plan.

RESULTS OF OPERATIONS

Three and nine months ended March 31, 2023 compared to the three and nine months ended March 31, 2022.

(In thousands)

Product revenue, net

In the three and nine months ended March 31, 2023, net product revenue decreased by $1.5 million, or 6%, and increased by $7.4 million, or 11%, compared to the three and nine months ended March 31, 2022, respectively. The decrease during the three months ended March 31, 2023 was primarily due to the resetting of patient deductibles at the beginning of calendar year 2023, changes in Rx Segment payer mix, and the Consumer Health Segment transitioning from direct mail to e-commerce, reducing operating losses. The increase during the nine months ended March 31, 2023 was primarily driven by product growth of our Pediatric Portfolio and ADHD Portfolio. These increases were partially offset by a modest decrease in Consumer Health products due to a change of focus on e-commerce, and supply chain issues.

Gross margins

In the three and nine months ended March 31, 2023, gross profit increased by 0%, and 28%, compared to the three and nine months ended March 31, 2022, respectively. The increase during the nine months ended March 31, 2023 was primarily driven by net revenue increases as described above. Gross margin percentage was 56% and 63% for the three and nine months ended March 31, 2023, compared to 52% and 54% for the same periods ended March 31, 2022. The improvements were primarily due to higher net revenues and cost saving efficiencies in the Pediatric Portfolio. Gross margin improvements in the ADHD Portfolio were due to efficiencies in production related to higher demand for products.

Research and development

In the three and nine months ended March 31, 2023, research and development expense decreased by $2.4 million, or 74%, and $5.8 million, or 61%, compared to the same periods ended March 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 significantly declined. We expect our research and development expenses to decrease from current levels as a result of our focus on commercial operations.

Advertising and direct marketing

In the three and nine months ended March 31, 2023, advertising and direct marketing expense was consistent with the three and nine months ended March 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. Advertising and direct marketing can fluctuate materially between periods based on the timing of marketing campaigns.

Other selling and marketing

In the three and nine months ended March 31, 2023, other selling and marketing expense increased by $3.2 million, or 68%, and $5.3 million, or 38%, compared to the same periods ended March 31, 2022. The increases were primarily driven by commission expense based on subscriptions generated by our sale force and commercial marketing program fees.

General and administrative

In the nine months ended March 31, 2023, general and administrative expense decreased by $1.3 million, or 5% compared to the same period ended March 31, 2022. The decrease is primarily a result of ongoing cost-cutting initiatives associated with our acquisition of Neos.

Gain or loss from contingent consideration

We fair value our acquisition-related contingent consideration based on our projected results, any changes are reflected through income or expense.

Impairment expense

Due to increased focus on our commercial efforts, we ceased active development of our NT0502 product candidate. As a result, we are returning the intellectual property and terminating the Exclusive License Agreement with NeuRx entered into in October 2018. In the nine months ended March 31, 2023, we incurred an impairment charge of $2.6 million related to these decisions.

In the three months ended March 31, 2022, we recognized total impairment expense of $45.2 million, consisting of (i) $37.7 million in goodwill impairment, (ii) $4.9 million intangible assets write-down, (iii) $2.0 million inventory write-down, (iv) $0.4 million other assets write-down and (v) $0.2 million property and equipment write-down. In the nine months ended March 31, 2022, we recognized total impairment expense of $64.6 million, consisting of (i) $57.2 million in goodwill impairment, (ii) $4.9 million intangible assets write-down, (iii) $2.0 million inventory write-down, (iv) $0.4 million other assets write-down and (v) $0.2 million property and equipment write-down. The impairment expense related to write-down of assets was due to the discontinuation of commercializing certain products in our BioPharma Segment. See Note 7 – Goodwill and Other Intangible Assets in the accompanying unaudited consolidated financial statements for further information.

Amortization of intangible assets

In the three and nine months ended March 31, 2023, amortization expense of intangible assets, excluding amounts included in cost of sales, decreased by $0.3 million, or 20%, and $1.0 million, or 21%, compared to the same periods ended March 31, 2022. The decreases were primarily related to the smaller intangible asset base due to the impairments of certain intangible assets during the fiscal 2022 year.

Unrealized gain or loss from derivative warrant liabilities

We calculate the fair value of derivative warrant liabilities using either the Black-Scholes option model or the Monte Carlo simulation model and are revalued at each reporting period, changes are reflected through income or expense.

Other (expense) income, net

In the three and nine months ended March 31, 2023, other (expense) income, net, increased by $1.2 million and $3.5 million, compared to the same periods ended March 31, 2022. Other (expense) income, net, includes interest expense, accretion from fixed payment arrangements, and other income. In the three months ended March 31, 2022, we received payments related to the divestiture of Natesto, which was recorded as other income. In the three months ended March 31, 2023, we did not receive such payments.

Liquidity and Capital Resources

Sources of Liquidity

We have obligations related to our loan agreements, 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 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, 2023, approximately $82.4 million remains available under the 2021 Shelf. This availability is subject to SEC 1.B.6 1limitations of Form S-3.

On June 8, 2020, we filed a shelf registration statement on Form S-3, which was declared effective by the SEC on June 17, 2020. 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 “2020 Shelf”). As of March 31, 2023, approximately $40.4 million remains available under the 2020 Shelf. This availability is subject to SEC 1.B.6 1limitations of Form S-3.

On June 4, 2021, we entered into a sales agreement with a sales agent, to provide for the offering, issuance and sale by us of up to $30.0 million of our common stock from time to time in “at-the-market” offerings under the 2020 Shelf (the “ATM Sales Agreement”). During the nine months ended March 31, 2023, we issued 699,929 shares of common stock under the ATM Sales Agreement, with total net proceeds of approximately $2.9 million. As of March 31, 2023, we had approximately $2.0 million of capacity under the ATM Sales Agreement due to baby self-limitations. As our market capitalization increases, these limitations will be adjusted and we will be able to issue additional ATM sales.

Underwriting Agreements

On August 11, 2022, we closed on an underwritten public offering (“August 2022 Offering”), of (i) 1,075,290 shares of our common stock and, in lieu of common stock to certain investors, pre-funded warrants (“Pre-Funded Warrants”) to purchase 87,500 shares of our common stock, and (ii) accompanying warrants (the “Common Warrants”) to purchase 1,265,547 shares of our common stock. We received gross proceeds of $10.0 million and net proceeds of approximately $9.1 million, after deducting underwriting discounts and commissions and estimated offering expenses.

Eclipse Loan Agreement

The Eclipse Loan Agreement, as amended, provides us with up to $14.5 million in Revolving Loans, of which up to $2.5 million may be available for short-term swingline 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 nine months ended March 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 nine months ended March 31, 2023, net cash used in operating activities totaled $14.6 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.

During the nine months ended March 31, 2022, net cash used in operating activities totaled $21.7 million. The use of cash was approximately $70.7 million less than the net loss, primarily due to non-cash charges of goodwill and long-lived asset impairment, depreciation, amortization and accretion, stock-based compensation, inventory write-down and loss from change in fair values of contingent consideration. These non-cash charges were partially offset by non-cash credits of amortization of debt premium, and gain from change in fair values of contingent value rights. In addition, our use of cash decreased due to changes in working capital, including decreases in accounts receivable and prepaid expense and other current assets, increase in accrued liabilities, offset by a decrease in accounts payable.

Net Cash Provided by (Used in) Investing Activities

Net cash flows provided by investing activities were nominal in the nine months ended March 31, 2023.

Net cash used in investing activities of $3.2 million during the nine months ended March 31, 2022 was primarily due to $3.1 million payment of contingent consideration to Tris.

Net Cash Provided by Financing Activities

Net cash provided by financing activities of $14.4 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.

Net cash provided by financing activities of $2.6 million during the nine months ended March 31,2022 was primarily from $15.0 million proceeds from long-term debt and $11.9 million net proceeds from issuance of our common stock, partially offset by $16.1 million full repayment of long-term debt, $4.5 million net reduction in our revolving loan, $3.2 million in payments of fixed payment arrangements, and $0.4 million payment of debt issuance costs.

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 condensed consolidated financial statements for further information.

On May 12, 2022, we entered into an agreement with Tris Pharma Inc. (“Tris”) to terminate the License, Development, Manufacturing and Supply Agreement dated November 2, 2018 (the “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 License Agreement. As of March 31, 2023, the balance was $6.4 million on the condensed consolidated balance sheet. 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 driven on sales. As of March 31, 2023, up to $4.2 million of fixed and product milestone payments based on net sales remain.

In connection with the February 2020 acquisition of Innovus Pharmaceuticals, Inc. (“Innovus”), all of Innovus’ shares were converted to our common stock and CVRs, which represents contingent additional consideration of up to $16.0 million payable to satisfy future performance milestones. As of March 31, 2023, up to $5.0 million of potential CVR milestone payments remain.

In connection with our acquisition of the assets from Rumpus VEDS, LLC, Rumpus Therapeutics, LLC, Rumpus Vascular, LLC (collectively, “Rumpus”), upon satisfaction of milestones, we may be required to pay up to $67.5 million in regulatory and commercial-based earn-out payments to Rumpus. 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.

Critical Accounting Estimates

The preparation of financial statements in conformity with GAAP affect the amounts and disclosures in the financial statements and accompanying notes. Actual results could differ from those estimates. There have been no material changes to our Critical Accounting Policies and Estimates disclosed in our Annual Report on Form 10-K for the year ended June 30, 2022.

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 March 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, specifically, with regards to warrants. As a result, we performed additional analysis as deemed necessary to ensure that our financial statements were prepared in accordance with U.S. generally accepted accounting principles. Accordingly, management believes that the financial statements included in this Amendment 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

As disclosed in our September 30, 2022 Form 10Q/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.

Remediation Plan

Our Audit Committee is conducting an internal investigation to identify and determine a plan to remediate the material weakness described above and to enhance our overall control environment. We will not consider the material weakness remediated until our enhanced control is 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.

Changes in Internal Control Over Financial Reporting

Except for the material weakness noted above, there have been no changes in the Company’s internal control over financial reporting that occurred during the three months ended March 31, 2023 that have 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 fiscal year 2022 Annual Report on Form 10-K filed on September 27, 2022.