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EX-32.1 - EX-32.1 - VERU INC.veru-20180331xex32_1.htm
EX-31.2 - EX-31.2 - VERU INC.veru-20180331xex31_2.htm
EX-31.1 - EX-31.1 - VERU INC.veru-20180331xex31_1.htm
EX-10.9 - EX-10.9 - VERU INC.veru-20180331xex10_9.htm



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q





(Mark One)



 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



For the quarterly period ended March 31, 2018





 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934



For the transition period from              to             



Commission file number 1-13602





Veru Inc.

(Name of registrant as specified in its charter)





 

 

 

 

 

Wisconsin

 

39-1144397

(State of Incorporation)

 

(I.R.S. Employer Identification No.)

 

 

4400 Biscayne Boulevard, Suite 888

Miami, FL

 

33137

(Address of principal executive offices)

 

(Zip Code)



305-509-6897

(Registrant’s telephone number, including area code)



N/A

(Former Name or Former Address, if Changed Since Last Report)





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes       No  



Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes      No  



Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.





 

 

 

 

 

 

Large accelerated filer 

 

Accelerated filer 

Non-accelerated filer 

 

Smaller reporting company

(Do not check if smaller reporting company)

 

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.      



Indicate by check mark whether the registrant is a shell company (as determined by Rule 12b-2 of the Exchange Act).    Yes      No  



As of May 8, 2018, the registrant had 53,512,946 shares of $0.01 par value common stock outstanding.

 

 


 

VERU INC.

INDEX





 



 

                      

PAGE



 

Forward Looking Statements



 

PART I.          FINANCIAL INFORMATION

 



 

Item 1.  Financial Statements



 

Unaudited Condensed Consolidated Balance Sheets -

 

     March 31, 2018 and September 30, 2017 



 

Unaudited Condensed Consolidated Statements of Operations -

 

     Three and six months ended March 31, 2018 and 2017



 

Unaudited Condensed Consolidated Statement of Stockholders’ Equity -

 

     Six months ended March 31, 2018



 

Unaudited Condensed Consolidated Statements of Cash Flows -

 

     Six months ended March 31, 2018 and 2017



 

Notes to Unaudited Condensed Consolidated Financial Statements



 

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations

28 



 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

37 



 

Item 4.  Controls and Procedures

37 



 

PART II.          OTHER INFORMATION

 



 

Item 1.  Legal Proceedings

38 



 

Item 1A.  Risk Factors

38 



 

Item 6.  Exhibits

39 



 



 

2


 

FORWARD LOOKING STATEMENTS



Certain statements included in this quarterly report on Form 10-Q which are not statements of historical fact are intended to be, and are hereby identified as, "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, but are not limited to, statements about future financial and operating results, plans, objectives, expectations and intentions, costs and expenses, outcome of contingencies, financial condition, results of operations, liquidity, cost savings, objectives of management, business strategies, clinical trial timing and plans, the achievement of clinical and commercial milestones, the advancement of our technologies and our products and drug candidates, and other statements that are not historical facts.  Forward-looking statements can be identified by the use of forward-looking words or phrases such as "anticipate," "believe," "could," "expect, " "intend," "may," "opportunity," "plan," "predict," "potential," "estimate," "should, " "will," "would" or the negative of these terms or other words of similar meaning.  These statements are based upon the Company's current plans and strategies and reflect the Company's current assessment of the risks and uncertainties related to its business, and are made as of the date of this report.  The Company cautions readers that forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievement expressed or implied by such forward-looking statements. Such factors include, among others, the following:



·

potential delays in the timing of and results from clinical trials and studies and the risk that such results will not support marketing approval and commercialization;

·

potential delays in the timing of any submission to the U.S. Food and Drug Administration (the FDA) and in regulatory approval of products under development;

·

risks relating to the Company's ability to secure adequate financing on acceptable terms when needed to fund product development and the Company's operations;

·

risks related to the development of the Company's product portfolio, including clinical trials, regulatory approvals and time and cost to bring to market;

·

product demand and market acceptance;

·

some of the Company's products are in development and the Company may fail to successfully commercialize such products;

·

risks related to intellectual property, including the uncertainty of obtaining intellectual property protections and in enforcing them, the possibility of infringing a third party's intellectual property, and licensing risks;

·

competition from existing and new competitors including the potential for reduced sales, pressure on pricing and increased spending on marketing;

·

risks relating to compliance and regulatory matters, including costs and delays resulting from extensive government regulation and reimbursement and coverage under healthcare insurance and regulation;

·

risk inherent in doing business on an international level;

·

the disruption of production at the Company's manufacturing facilities due to raw material shortages, labor shortages and/or physical damage to the Company's facilities;

·

the Company’s reliance on its major customers and risks relating to delays in payment of accounts receivable by major customers;

·

the Company's growth strategy;

·

the costs and other effects of litigation, governmental investigations, legal and administrative cases and proceedings, settlements and investigations;

·

government contracting risks;

·

the Company’s ability to identify, successfully negotiate and complete suitable acquisitions or other strategic initiatives; and

·

the Company’s ability to successfully integrate acquired businesses, technologies or products.



Such uncertainties and other risks that may affect the Company's performance are discussed further in Part I, Item 1A, "Risk Factors," in the Company's Form 10-K for the year ended September 30, 2017 and Part II, Item 1A of this Form 10-Q.  The Company undertakes no obligation to make any revisions to the forward-looking statements contained in this report or to update them to reflect events or circumstances occurring after the date of this report.



3


 

Item 1.  Financial Statements

VERU INC.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS







 

 

 

 

 



 

 

 

 

 



March 31,
2018

 

September 30, 2017

ASSETS

 

 

 

 

 

Current Assets:

 

 

 

 

 

Cash

$

8,972,498 

 

$

3,277,602 

Accounts receivable, net

 

2,969,073 

 

 

3,555,350 

Inventory, net

 

3,589,057 

 

 

2,767,924 

Prepaid expenses and other current assets

 

629,527 

 

 

697,097 

TOTAL CURRENT ASSETS

 

16,160,155 

 

 

10,297,973 

LONG-TERM ASSETS

 

 

 

 

 

PLANT AND EQUIPMENT

 

 

 

 

 

Equipment, furniture and fixtures

 

4,069,810 

 

 

4,067,896 

Leasehold improvements

 

287,686 

 

 

287,686 

Less: accumulated depreciation and amortization

 

(3,888,281)

 

 

(3,800,043)

Plant and equipment, net

 

469,215 

 

 

555,539 

Other trade receivables  (Note 4)

 

 —

 

 

7,837,500 

Other assets

 

165,959 

 

 

156,431 

Deferred assets

 

424,921 

 

 

 —

Deferred income taxes

 

13,480,558 

 

 

8,827,000 

Intangible assets, net

 

20,615,360 

 

 

20,752,991 

Goodwill

 

6,878,932 

 

 

6,878,932 

TOTAL ASSETS

$

58,195,100 

 

$

55,306,366 



 

 

 

 

 

LIABILITIES AND STOCKHOLDERS' EQUITY

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

Accounts payable

$

3,539,667 

 

$

2,685,718 

Accrued expenses and other current liabilities

 

1,940,348 

 

 

1,441,359 

Credit agreement, short-term portion  (Note 7)

 

3,912,888 

 

 

 —

Unearned revenue

 

872,370 

 

 

1,014,517 

Accrued compensation

 

322,654 

 

 

345,987 

TOTAL CURRENT LIABILITIES

 

10,587,927 

 

 

5,487,581 



 

 

 

 

 

LONG-TERM LIABILITIES

 

 

 

 

 

Credit agreement, long-term portion  (Note 7)

 

5,822,693 

 

 

 —

Residual royalty agreement  (Note 7)

 

372,070 

 

 

 —

Other liabilities  (Note 4)

 

 —

 

 

1,233,750 

Deferred rent

 

81,192 

 

 

131,830 

TOTAL LIABILITIES

 

16,863,882 

 

 

6,853,161 



 

 

 

 

 

Commitments and contingencies  (Note 10)

 

 

 

 

 

STOCKHOLDERS' EQUITY

 

 

 

 

 

Preferred stock

 

 —

 

 

 —

Common stock

 

556,967 

 

 

553,922 

Additional paid-in-capital

 

91,514,007 

 

 

90,550,669 

Accumulated other comprehensive loss

 

(581,519)

 

 

(581,519)

Accumulated deficit

 

(42,351,632)

 

 

(34,263,262)

Treasury stock, at cost

 

(7,806,605)

 

 

(7,806,605)

TOTAL STOCKHOLDERS' EQUITY

 

41,331,218 

 

 

48,453,205 

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

$

58,195,100 

 

$

55,306,366 



 

 

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

 

 

 

 



 

4


 

VERU INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS









 

 

 

 

 

 

 

 

 

 

 



Three Months Ended

 

Six Months Ended



March 31,

 

March 31,



2018

 

2017

 

2018

 

2017



 

 

 

 

 

 

 

 

 

 

 

Net revenues

$

2,572,872 

 

$

2,405,519 

 

$

5,159,485 

 

$

5,649,118 

   

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

1,373,469 

 

 

1,127,864 

 

 

2,645,570 

 

 

2,719,179 

   

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

1,199,403 

 

 

1,277,655 

 

 

2,513,915 

 

 

2,929,939 

   

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

2,076,794 

 

 

1,207,561 

 

 

4,035,162 

 

 

1,374,959 

Selling, general and administrative

 

3,819,159 

 

 

2,541,312 

 

 

6,847,748 

 

 

5,074,518 

Loss on settlement of accounts receivable

 

 

 

 

 

3,764,137 

 

 

 —

Business acquisition

 

 —

 

 

108,015 

 

 

 —

 

 

934,385 

Total operating expenses

 

5,895,953 

 

 

3,856,888 

 

 

14,647,047 

 

 

7,383,862 

   

 

 

 

 

 

 

 

 

 

 

 

Operating loss

 

(4,696,550)

 

 

(2,579,233)

 

 

(12,133,132)

 

 

(4,453,923)

   

 

 

 

 

 

 

 

 

 

 

 

Non-operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

(350,595)

 

 

 —

 

 

(350,595)

 

 

 —

Other expense, net

 

(2,411)

 

 

(12,686)

 

 

(15,580)

 

 

(22,307)

Change in fair value of derivative liabilities

 

(21,000)

 

 

 —

 

 

(21,000)

 

 

 —

Foreign currency transaction loss

 

(63,077)

 

 

(8,756)

 

 

(116,532)

 

 

(20,695)

Total non-operating expenses

 

(437,083)

 

 

(21,442)

 

 

(503,707)

 

 

(43,002)

   

 

 

 

 

 

 

 

 

 

 

 

Loss before income taxes

 

(5,133,633)

 

 

(2,600,675)

 

 

(12,636,839)

 

 

(4,496,925)

   

 

 

 

 

 

 

 

 

 

 

 

Income tax benefit

 

(1,302,416)

 

 

(824,033)

 

 

(4,548,469)

 

 

(1,354,102)



 

 

 

 

 

 

 

 

 

 

 

Net loss

$

(3,831,217)

 

$

(1,776,642)

 

$

(8,088,370)

 

$

(3,142,823)

   

 

 

 

 

 

 

 

 

 

 

 

Net loss per basic and diluted common share outstanding

$

(0.07)

 

$

(0.06)

 

$

(0.15)

 

$

(0.10)

   

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted weighted average common shares outstanding

 

53,355,944 

 

 

30,982,497 

 

 

53,253,901 

 

 

30,979,283 

   

 

 

 

 

 

 

 

 

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



 



 

5


 



VERU INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

 

Additional

 

Other

 

 

 

 

Treasury

 

 

 

   

Preferred

 

Common Stock

 

Paid-in

 

Comprehensive

 

Accumulated

 

Stock,

 

 

 

   

Stock

 

Shares

 

Amount

 

Capital

 

Loss

 

Deficit

 

at Cost

 

Total

   

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at September 30, 2017

$

 —

 

55,392,193 

 

$

553,922 

 

$

90,550,669 

 

$

(581,519)

 

$

(34,263,262)

 

$

(7,806,605)

 

$

48,453,205 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Share-based compensation

 

 —

 

 —

 

 

 —

 

 

619,302 

 

 

 —

 

 

 —

 

 

 —

 

 

619,302 

Shares issued in connection with common stock purchase agreement

 

 —

 

304,457 

 

 

3,045 

 

 

344,036 

 

 

 —

 

 

 —

 

 

 —

 

 

347,081 

Net loss

 

 —

 

 —

 

 

 —

 

 

 —

 

 

 —

 

 

(8,088,370)

 

 

 —

 

 

(8,088,370)

Balance at March 31, 2018

$

 —

 

55,696,650 

 

$

556,967 

 

$

91,514,007 

 

$

(581,519)

 

$

(42,351,632)

 

$

(7,806,605)

 

$

41,331,218 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See notes to unaudited condensed consolidated financial statements.







 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 









 

6


 

VERU INC.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS







 

 

 

 

 



 

 

 

 

 



Six Months Ended



March 31,



2018

 

2017



 

 

 

 

 

OPERATING ACTIVITIES

 

 

 

 

 

Net loss

$

(8,088,370)

 

$

(3,142,823)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

Depreciation and amortization

 

88,239 

 

 

177,444 

Amortization of intangible assets

 

137,631 

 

 

66,822 

Noncash interest expense

 

350,595 

 

 

 —

Share-based compensation

 

619,302 

 

 

422,469 

Warrants issued

 

 —

 

 

542,930 

Deferred income taxes

 

(4,653,558)

 

 

(1,464,900)

Loss on settlement of accounts receivable

 

3,764,137 

 

 

 —

Change in fair value of derivative liabilities

 

21,000 

 

 

 —

Other

 

(1,942)

 

 

4,469 

Changes in current assets and liabilities, net of effects of acquisition of a business:

Decrease in accounts receivable

 

3,255,107 

 

 

3,471,625 

(Increase) decrease in inventory

 

(821,133)

 

 

95,419 

Decrease in prepaid expenses and other assets

 

58,042 

 

 

37,313 

Increase (decrease) in accounts payable

 

853,949 

 

 

(353,223)

Decrease in unearned revenue

 

(142,147)

 

 

 —

Increase (decrease) in accrued expenses and other current liabilities

 

375,957 

 

 

(917,542)

Net cash used in operating activities

 

(4,183,191)

 

 

(1,059,997)



 

 

 

 

 

INVESTING ACTIVITIES

 

 

 

 

 

Capital expenditures

 

(1,913)

 

 

(83,492)

Net cash used in investing activities

 

(1,913)

 

 

(83,492)



 

 

 

 

 

FINANCING ACTIVITIES

 

 

 

 

 

Proceeds from SWK credit agreement

 

10,000,000 

 

 

 —

Payment of debt issuance costs

 

(120,000)

 

 

 —

Net cash provided by financing activities

 

9,880,000 

 

 

 —



 

 

 

 

 

Net increase (decrease) in cash

 

5,694,896 

 

 

(1,143,489)

CASH AT BEGINNING OF PERIOD

 

3,277,602 

 

 

2,385,082 

CASH AT END OF PERIOD

$

8,972,498 

 

$

1,241,593 



 

 

 

 

 

Schedule of noncash investing and financing activities:

 

 

 

 

 

Issuance of common stock in connection with the APP Acquisition

$

 —

 

$

1,826,097 

Issuance of Series 4 Preferred Stock in connection with the APP Acquisition

$

 —

 

$

17,981,883 

Reduction of accrued expense upon issuance of shares

$

 —

 

$

22,176 

Fixed assets in accounts payable at period end

$

 —

 

$

7,937 

Shares issued in connection with common stock purchase agreement

$

347,081 

 

$

 —

Increase in deferred assets from accounts payable and accrued expenses

$

77,840 

 

$

 —

Debt issuance costs in accounts payable and accrued expenses

$

143,943 

 

$

 —



 

 

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

 

 

 

 



7


 

VERU INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



Note 1 - Basis of Presentation



The accompanying unaudited interim condensed consolidated financial statements for Veru Inc. (“we,” “our,” “us,” “Veru” or the “Company”) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for reporting of interim financial information. Pursuant to these rules and regulations, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) have been condensed or omitted, although the Company believes that the disclosures made are adequate to make the information not misleading. Accordingly, these statements do not include all the disclosures normally required by U.S. GAAP for annual financial statements and should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in this report and the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017. The accompanying condensed consolidated balance sheet as of September 30, 2017 has been derived from our audited financial statements. The unaudited condensed consolidated statements of operations for the three and six months ended March 31, 2018 and cash flows for the six months ended March 31, 2018 are not necessarily indicative of the results to be expected for any future period or for the year ending September 30, 2018.



The preparation of our unaudited interim condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.



In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements contain all adjustments (consisting of only normally recurring adjustments) necessary to present fairly the financial position and results of operations as of the dates and for the periods presented.



Principles of Consolidation and Nature of Operations

 

The consolidated financial statements include the accounts of Veru and its wholly owned subsidiaries, Aspen Park Pharmaceuticals, Inc. (“APP”) and The Female Health Company Limited, and The Female Health Company Limited’s wholly owned subsidiaries, The Female Health Company (UK) plc and The Female Health Company (M) SDN.BHD. All significant intercompany transactions and accounts have been eliminated in consolidation. Prior to the completion of the acquisition (the “APP Acquisition”) of APP through the merger of a wholly owned subsidiary of the Company into APP, the Company had been a single product company engaged in marketing, manufacturing and distributing a consumer health care product, the FC2 Female Condom® (“FC2”).  The completion of the APP Acquisition transitioned the Company into a biopharmaceutical company with multiple drug products under clinical development focused on urology and oncology.  Nearly all of the Company’s net revenues during the three and six months ended March 31, 2018 and 2017 were derived from sales of FC2.  The Female Health Company Limited is the holding company of The Female Health Company (UK) plc, which is located in London, England (collectively the “U.K. subsidiary”). The Female Health Company (M) SDN.BHD leases a manufacturing facility located in Selangor D.E., Malaysia (the “Malaysia subsidiary”).  The Company’s headquarters are located in Miami, Florida in a leased office facility.



FC2 has been distributed in either or both commercial (private sector) and public health sector markets in 144 countries.  It is marketed to consumers in 25 countries through distributors, public health programs, and/or retailers and in the U.S. by prescription.



Reclassifications: Certain prior period amounts in the accompanying unaudited interim condensed consolidated financial statements have been reclassified to conform with the current period presentation. These reclassifications had no effect on the results of operations or financial position for any period presented.



Cash concentration: The Company’s cash is maintained primarily in three financial institutions, located in Chicago, Illinois, London, England and Kuala Lumpur, Malaysia, respectively.



8


 

Restricted cash:  Restricted cash relates to security provided to one of the Company’s U.K. banks for performance bonds issued in favor of customers. The Company has a facility of $250,000 for such performance bonds.  Such security has been extended infrequently and only on occasions where it has been a contract term expressly stipulated as an absolute requirement by the customer or its provider of funds. The expiration of the bond is defined by the completion of the event such as, but not limited to, a period of time after the product has been distributed or expiration of the product shelf life.  Restricted cash was approximately $145,000 and $139,000 at March 31, 2018 and September 30, 2017, respectively, and is included in cash on the accompanying unaudited condensed consolidated balance sheets.  



Accounts receivable and concentration of credit risk:  Accounts receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a periodic basis. 



The Company's standard credit terms vary from 30 to 120 days, depending on the class of trade and customary terms within a territory, so accounts receivable is affected by the mix of purchasers within the period.  As is typical in the Company's business, extended credit terms may occasionally be offered as a sales promotion or for certain sales.  The Company has agreed to credit terms of up to 150 days with our distributor in the Republic of South Africa.  For the most recent order of 15 million units under the last Brazil tender, the Company has agreed to up to 360 days credit terms with our distributor in Brazil subject to earlier payment upon receipt of payment by the distributor from the Brazilian Government.  See discussion of receivables in Note 4.  For the past twelve months, the Company's average days’ sales outstanding was approximately 207 days. 



Inventory:  Inventories are valued at the lower of cost or net realizable value.  The cost is determined using the first-in, first-out (“FIFO”) method.  Inventories are also written down for management’s estimates of product which will not sell prior to its expiration date.  Write-downs of inventories establish a new cost basis which is not increased for future increases in the net realizable value of inventories or changes in estimated obsolescence.



Equipment, furniture and fixtures:  Depreciation and amortization are computed using primarily the straight-line method.  Depreciation and amortization are computed over the estimated useful lives of the respective assets which range as follows:







 



 

Manufacturing equipment

510 years

Office equipment

35 years

Furniture and fixtures

710 years



Depreciation on leased assets is computed over the lesser of the remaining lease term or the estimated useful lives of the assets.  Depreciation on leased assets is included with depreciation on owned assets.



Patents and trademarks:   The costs for patents and trademarks are expensed when incurred. 



Intangible assets:  Our intangible assets arose from the APP Acquisition on October 31, 2016.  These intangible assets are carried at cost less accumulated amortization. Intangible assets with finite lives are tested for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. In-process research and development (“IPR&D”) is required to be tested at least annually until the underlying projects are completed or abandoned.



9


 

Assets acquired and liabilities assumed in business combinations, licensing and other transactions are generally recognized at the date of acquisition at their respective fair values. Any excess of the purchase price over the estimated fair values of the net assets acquired is recognized as goodwill. We determined the fair value of intangible assets, including IPR&D, using the “income method.” This method starts with a forecast of net cash flows, risk adjusted for estimated probabilities of technical and regulatory success and adjusted to present value using an appropriate discount rate that reflects the risk associated with the cash flow streams. All assets are valued from a market participant view which might be different than our specific views. The valuation process is very complex and requires significant input and judgment using internal and external sources. Although a valuation is required to be finalized within a one-year period, it must consider all and only those facts and evidence which existed at the acquisition date. The most complex and judgmental matters applicable to the valuation process are summarized below:



·

Unit of account – Most intangible assets are valued as single global assets rather than multiple assets for each jurisdiction or indication after considering the development stage, expected levels of incremental costs to obtain additional approvals, risks associated with further development, amount and timing of benefits expected to be derived in the future, expected patent lives in various jurisdictions and the intention to promote the asset as a global brand.

·

Estimated useful life – The asset life expected to contribute meaningful cash flows is determined after considering all pertinent matters associated with the asset, including expected regulatory approval dates (if unapproved), exclusivity periods and other legal, regulatory or contractual provisions as well as the effects of any obsolescence, demand, competition, and other economic factors, including barriers to entry.

·

Probability of Technical and Regulatory Success (“PTRS”) Rate – PTRS rates are determined based upon industry averages considering the respective project’s development stage and disease indication and adjusted for specific information or data known at the acquisition date. Subsequent clinical results or other internal or external data obtained could alter the PTRS rate and materially impact the estimated fair value of the intangible asset in subsequent periods leading to impairment charges.

·

Projections – Future revenues are estimated after considering many factors such as initial market opportunity, pricing, sales trajectories to peak sales levels, competitive environment and product evolution. Future costs and expenses are estimated after considering historical market trends, market participant synergies and the timing and level of additional development costs to obtain the initial or additional regulatory approvals, maintain or further enhance the product. We generally assume initial positive cash flows to commence shortly after the receipt of expected regulatory approvals which typically may not occur for a number of years. Actual cash flows attributed to the project are likely to be different than those assumed since projections are subjected to multiple factors including trial results and regulatory matters which could materially change the ultimate commercial success of the asset as well as significantly alter the costs to develop the respective asset into commercially viable products.

·

Tax rates – The expected future income is tax effected using a market participant tax rate. In determining the tax rate, we consider the jurisdiction in which the intellectual property is held and location of research and manufacturing infrastructure. We also consider that any repatriation of earnings would likely have U.S. tax consequences.

·

Discount rate – Discount rates are selected after considering the risks inherent in the future cash flows; the assessment of the asset’s life cycle and the competitive trends impacting the asset, including consideration of any technical, legal, regulatory, or economic barriers to entry, as well as expected changes in standards of practice for indications addressed by the asset.



Intangible assets are highly vulnerable to impairment charges, particularly newly acquired assets for recently launched products. These assets are initially measured at fair value and therefore any reduction in expectations used in the valuations could potentially lead to impairment. Some of the more common potential risks leading to impairment include competition, earlier than expected loss of exclusivity, pricing pressures, adverse regulatory changes or clinical trial results, delay or failure to obtain regulatory approval and additional development costs, inability to achieve expected synergies, higher operating costs, changes in tax laws and other macro-economic changes. The complexity in estimating the fair value of intangible assets in connection with an impairment test is similar to the initial valuation. Considering the high-risk nature of research and development and the industry’s success rate of bringing developmental compounds to market, IPR&D impairment charges are likely to occur in future periods.

10


 

GoodwillGoodwill represents the difference between the purchase price and the estimated fair value of the net assets acquired in connection with the APP Acquisition.  All goodwill resides in the Company’s Research and Development reporting unit.



Goodwill is tested at least annually for impairment or when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable, by assessing qualitative factors or performing a quantitative analysis in determining whether it is more likely than not that its fair value exceeds the carrying value. Examples of qualitative factors include our share price, our financial performance compared to budgets, long-term financial plans, macroeconomic, industry and market conditions as well as the substantial excess of fair value over the carrying value of net assets from the annual impairment test previously performed.



The estimated fair value of a reporting unit is highly sensitive to changes in projections and assumptions; therefore, in some instances changes in these assumptions could potentially lead to impairment. We perform sensitivity analyses around our assumptions in order to assess the reasonableness of the assumptions and the results of our testing. Ultimately, future potential changes in these assumptions may impact the estimated fair value of a reporting unit and cause the fair value of the reporting unit to be below its carrying value. We believe that our estimates are consistent with assumptions that marketplace participants would use in their estimates of fair value; however, if actual results are not consistent with our estimates and assumptions, we may be exposed to an impairment charge that could be material.



Deferred Financing Costs: Costs incurred in connection with the common stock purchase agreement discussed in Note 8 have been included in deferred assets on the accompanying unaudited condensed consolidated balance sheet at March 31, 2018. When shares of the Company’s common stock are sold under the common stock purchase agreement, a pro-rata portion of the deferred costs will be recorded to additional paid-in-capital. Costs incurred in connection with the issuance of debt discussed in Note 7 are presented as a reduction of the debt on the accompanying unaudited condensed consolidated balance sheet at March 31, 2018. These issuance costs are being amortized using the effective interest method over the expected repayment period of the debt, which is currently estimated to occur in the first quarter of fiscal 2021. The amount of amortization was approximately $6,000 for the three and six months ended March 31, 2018.



Fair value measurements: Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820 – Fair Value Measurements and Disclosures, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. FASB ASC Topic 820 requires disclosures about the fair value of all financial instruments, whether or not recognized, for financial statement purposes. Disclosures about the fair value of financial instruments are based on pertinent information available to us as of the reporting dates. Accordingly, the estimates presented in the accompanying unaudited condensed consolidated financial statements are not necessarily indicative of the amounts that could be realized on disposition of the financial instruments. See Note 3 for a discussion of fair value measurements.



Unearned revenue:  FC2 is distributed in the U.S. prescription channel principally through large pharmaceutical distributors. These distributors then sell principally to retail pharmacies.  Unearned revenue as of March 31, 2018 and September 30, 2017 was approximately $872,000 and $1,015,000, respectively, and was comprised mainly of sales made to a large distributor. We lack the experiential data which would allow us to estimate returns for product sold to this distributor. Therefore, as of March 31, 2018 and September 30, 2017, we determined that we do not yet meet the criteria for the recognition of revenue at the time of shipment to this distributor as returns cannot be reasonably estimated. Accordingly, the Company deferred recognition of revenue on prescription product sold to this particular distributor until the right of return no longer exists, which occurs at the earlier of the time the prescription products were dispensed through patient prescriptions or expiration of the right of return.



Derivative instruments: The Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks. The Company reviews the terms of debt instruments it enters into to determine whether there are embedded derivative instruments, which are required to be bifurcated and accounted for separately as derivative financial instruments. Embedded derivatives that are not clearly and closely related to the host contract are bifurcated and are recognized at fair value with changes in fair value recognized as either a gain or loss in earnings.



11


 

Revenue recognition:  The Company recognizes revenue from product sales when each of the following conditions has been met: an arrangement exists, delivery has occurred, there is a fixed price, and collectability is reasonably assured. 



Research and development costs:  Research and development costs are expensed as they are incurred and include salaries and benefits, clinical trials costs and contract services. Nonrefundable advance payments made for goods or services to be used in research and development activities are deferred and capitalized until the goods have been delivered or the related services have been performed. If the goods are no longer expected to be delivered or the services are no longer expected to be performed, the Company would be required to expense the related capitalized advance payments. The Company had no capitalized nonrefundable advance payments as of March 31, 2018 or September 30, 2017.



The Company records estimated costs of research and development activities conducted by third-party service providers, which include the conduct of preclinical studies and clinical trials and contract manufacturing activities. These costs are a significant component of the Company’s research and development expenses. The Company accrues for these costs based on factors such as estimates of the work completed and in accordance with agreements established with its third-party service providers under the service agreements. The Company makes significant judgments and estimates in determining the accrued liabilities balance in each reporting period. As actual costs become known, the Company adjusts its accrued liabilities. The Company has not experienced any material differences between accrued costs and actual costs incurred. However, the status and timing of actual services performed, number of patients enrolled and the rate of patient enrollments may vary from the Company’s estimates, resulting in adjustments to expense in future periods. Changes in these estimates that result in material changes to the Company’s accruals could materially affect the Company’s results of operations.



Share-based compensation: The Company accounts for share-based compensation expense for equity awards exchanged for services over the vesting period based on the grant-date fair value. In many instances, the equity awards are issued upon the grant date subject to vesting periods. In certain instances, the equity awards provide for future issuance contingent on future continued employment or performance of services as of the issuance date.



Advertising:  The Company's policy is to expense advertising costs as incurred. Advertising costs were immaterial to the Company’s results of operations for the three and six months ended March 31, 2018 and 2017. 



Income taxes:  The Company files separate income tax returns for its foreign subsidiaries. FASB ASC Topic 740 requires recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns.  Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statements and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. Deferred tax assets are also provided for carryforwards for income tax purposes. In addition, the amount of any future tax benefits is reduced by a valuation allowance to the extent such benefits are not expected to be realized.

 

Foreign currency translation and operations: Effective October 1, 2009, the Company determined that there were significant changes in facts and circumstances, triggering an evaluation of its subsidiaries’ functional currency.  The evaluation indicated that the U.S. dollar is the currency with the most significant influence upon the subsidiaries.  Because all of the U.K. subsidiary's future sales and cash flows would be denominated in U.S. dollars following the October 2009 cessation of production of the Company’s first-generation product, FC1, the U.K. subsidiary adopted the U.S. dollar as its functional currency effective October 1, 2009. As the Malaysia subsidiary is a direct and integral component of the U.K. parent’s operations, it, too, adopted the U.S. dollar as its functional currency as of October 1, 2009. The consistent use of the U.S. dollar as the functional currency across the Company reduces its foreign currency risk and stabilizes its operating results. The cumulative foreign currency translation loss included in accumulated other comprehensive loss was $581,519 as of March 31, 2018 and September 30, 2017. Assets located outside of the U.S. totaled approximately $5,300,000 and $5,600,000 at March 31, 2018 and September 30, 2017, respectively.

   

Other comprehensive loss:  Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net loss.  Although certain changes in assets and liabilities, such as foreign currency translation adjustments, are reported as a separate component of the equity section of the accompanying condensed consolidated balance sheets, these items, along with net loss, are components of other comprehensive loss.



12


 

The U.S. parent company and its U.K. subsidiary routinely purchase inventory produced by its Malaysia subsidiary for sale to their respective customers. These intercompany trade accounts are eliminated in consolidation. The Company’s policy and intent is to settle the intercompany trade account on a current basis.  Since the U.K. and Malaysia subsidiaries adopted the U.S. dollar as their functional currencies effective October 1, 2009, no foreign currency gains or losses from intercompany trade are recognized.  In the three and six months ended March 31, 2018 and 2017, comprehensive loss is equivalent to the reported net loss.    



Recently Issued Accounting Pronouncements



In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09 Revenue from Contracts with Customers (Topic 606).  This new accounting guidance on revenue recognition provides for a single five-step model that includes identifying the contract with a customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations, and recognizing revenue when, or as, an entity satisfies a performance obligation. This new guidance is to be applied to all revenue contracts with customers.  The new standard also requires additional financial statement disclosures that will enable users to understand the nature, amount, timing and uncertainty of revenue and cash flows relating to customer contracts.  ASU 2014-09 will be effective for the Company beginning on October 1, 2018.  ASU 2014-09 allows for either full retrospective or modified retrospective adoption. We have not yet selected a transition method, and we are currently evaluating the effect that ASU 2014-09 will have on our consolidated financial statements and related disclosures.



In July 2015, the FASB issued ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory.  This new accounting guidance more clearly articulates the requirements for the measurement and disclosure of inventory.  Topic 330, Inventory, currently requires an entity to measure inventory at the lower of cost or market.  Market could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin.  This new accounting guidance requires the measurement of inventory at the lower of cost or net realizable value.  ASU 2015-11 was effective for the Company beginning on October 1, 2017, and the adoption did not have a material effect on our consolidated financial statements.



In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842).  The amendments in this Update increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements.  ASU 2016-02 will be effective for the Company beginning on October 1, 2019.  Early adoption is permitted. We are currently evaluating the effect of the new guidance on our consolidated financial statements and related disclosures.



In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.  The amendments in this Update simplify the income tax effects, minimum statutory tax withholding requirements and impact of forfeitures related to how share-based payments are accounted for and presented in the financial statements.  ASU 2016-09 was effective for the Company beginning on October 1, 2017, and the adoption did not have a material effect on our consolidated financial statements.



In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The purpose of ASU 2016-18 is to clarify guidance and presentation related to restricted cash in the statements of cash flows as well as increased disclosure requirements. It requires beginning-of-period and end-of-period total amounts shown on the statements of cash flows to include cash and cash equivalents as well as restricted cash and restricted cash equivalents. ASU 2016-18 will be effective for annual periods beginning after December 15, 2017, including interim reporting periods within those annual periods. Early adoption is permitted. We are in the process of determining the effect the adoption will have on our consolidated statements of cash flows.



In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other Topics (Topic 350): Simplifying the Test for Goodwill Impairment. The purpose of ASU 2017-04 is to reduce the cost and complexity of evaluating goodwill for impairment. It eliminates the need for entities to calculate the impaired fair value of goodwill by assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination. Under this amendment, an entity will perform its goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge is recognized for the amount by which the carrying value exceeds the reporting unit's fair value. ASU 2017-04 is effective for annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim

13


 

or annual goodwill impairment tests performed on testing dates after January 1, 2017. We do not expect Update No. 2017-04 to have a material effect on our financial position or results of operations.



In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The purpose of ASU 2017-01 is to change the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. Update No. 2017-01 will be effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted as of the beginning of an annual or interim period for which financial statements have not been issued or made available for issuance. The adoption of ASU 2017-01 is not expected to have a material effect on our financial position or results of operations.



In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. The purpose of ASU 2017-09 is to provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. ASU 2017-09 will be effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted as of the beginning of an annual or interim period for which financial statements have not been issued or made available for issuance. The adoption of ASU 2017-09 is not expected to have a material effect on our financial position or results of operations

 

Note 2 - APP Acquisition



On October 31, 2016, as part of the Company's strategy to diversify its product line to mitigate the risks of being a single product company, the Company completed the APP Acquisition through the merger of a wholly owned subsidiary of the Company into APP. The completion of the APP Acquisition transitioned the Company from a single product company selling only FC2 to a biopharmaceutical company with multiple drug products under clinical development focused on urology and oncology.



The Company incurred acquisition-related costs of approximately $100,000 and $900,000 in the three and six months ended March 31, 2017, respectively, which are presented on a separate line item in the accompanying unaudited condensed consolidated statements of operations. The Company did not incur acquisition-related costs in the three and six months ended March 31, 2018.



As of the date of the APP Acquisition, APP had developed technology consisting of PREBOOST® medicated wipes for prevention of premature ejaculation.  IPR&D represents incomplete research and development projects at APP as of the date of the APP Acquisition. The fair value of the developed technology and IPR&D were determined using the income approach, which was prepared based on forecasts by management.



Purchase price in excess of assets acquired and liabilities assumed was recorded as goodwill.  Goodwill from the APP Acquisition principally relates to intangible assets that do not qualify for separate recognition, our expectation to develop and market new products, and the deferred tax liability generated as a result of the transaction.  Goodwill is not tax deductible for income tax purposes and was assigned to the Research and Development reporting unit.



In connection with the APP Acquisition, a consolidated complaint has been filed against the Company and its directors alleging breach of fiduciary duty. The Company intends to vigorously defend this lawsuit.  See Note 10 for additional detail.

 

Note 3 – Fair Value Measurements



FASB ASC Topic 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect market assumptions. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement).



The three levels of the fair value hierarchy are as follows:



Level 1 – Quoted prices for identical instruments in active markets.

14


 



Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable. 



Level 3 – Instruments with primarily unobservable value drivers.



We review the fair value hierarchy classification on a quarterly basis. Changes in the ability to observe valuation inputs may result in a reclassification of levels of certain securities within the fair value hierarchy. There were no transfers between Level 1, Level 2 and Level 3 during the six months ended March 31, 2018.



As of March 31, 2018, the Company’s financial liabilities measured at fair value on a recurring basis, which consisted of embedded derivatives, were classified within Level 3 of the fair value hierarchy. The Company did not have any financial assets or liabilities measured at fair value on a recurring basis as of September 30, 2017.



The Company determines the fair value of hybrid instruments based on available market data using appropriate valuation models, giving consideration to all of the rights and obligations of each instrument. The Company estimates the fair value of hybrid instruments using various techniques (and combinations thereof) that are considered to be consistent with the objective of measuring fair value. In selecting the appropriate technique, the Company considers, among other factors, the nature of the instrument, the market risks that it embodies and the expected means of settlement. Estimating the fair value of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. Increases in fair value during a given financial quarter result in the recognition of non-cash derivative expense. Conversely, decreases in fair value during a given financial quarter would result in the recognition of non-cash derivative income. 



The following table provides a reconciliation of the beginning and ending liability balance associated with embedded derivatives measured at fair value using significant unobservable inputs (Level 3) for the six months ended March 31, 2018:







 

 

Beginning balance at October 1, 2017

$

 —

Additions

 

3,319,000 

Change in fair value of derivative liabilities

 

21,000 

Ending balance at March 31, 2018

$

3,340,000 



 

 

The expense associated with the change in fair value of the embedded derivatives is included on a separate line item on our condensed consolidated statements of operations.



The liabilities associated with embedded derivatives represent the fair value of the change of control provisions in the SWK Credit Agreement and Residual Royalty Agreement. See Note 7 for additional information. There is no current observable market for these types of derivatives. The Company determined the fair value of the embedded derivatives using a Monte Carlo simulation model to value the financial liabilities at inception and on subsequent valuation dates. This valuation model incorporates transaction details such as the contractual terms, expected cash outflows, expected repayment dates, probability of a change of control, expected volatility, and risk-free interest rates. A significant acceleration of the estimated repayment date or a significant decrease in the probability of a change of control event prior to repayment of the SWK Credit Agreement, in isolation, would result in a significantly lower fair value measurement of the liabilities associated with the embedded derivatives.



15


 

The following table presents quantitative information about the inputs and valuation methodologies used to determine the fair value of the embedded derivatives classified in Level 3 of the fair value hierarchy as of March 31, 2018:





 

 

 

 



 

 

 

 

Valuation Methodology

 

Significant Unobservable Input

 

Weighted Average
(range, if applicable)



 

 

 

 

Monte Carlo Simulation

 

Estimated change of control dates

 

December 2018 to March 2020



 

Discount rate

 

10.5% to 12.5%



 

Probability of change of control

 

50% to 95%



Assets That Are Measured at Fair Value on a Nonrecurring Basis



Non-financial assets such as identified intangibles and goodwill that arose from the APP Acquisition are measured at fair value using Level 3 inputs, which include discounted cash flow methodologies, or similar techniques, when there is limited market activity and the determination of fair value requires significant judgment or estimation

 

Note 4 - Accounts Receivable and Concentration of Credit Risk



The components of accounts receivable consist of the following at March 31, 2018 and September 30, 2017:









 

 

 

 

 

 



 

March 31, 2018

 

September 30, 2017



 

 

 

 

 

 

Trade receivables

 

$

2,903,058 

 

$

11,330,814 

Other receivables

 

 

102,176 

 

 

100,139 

Accounts receivable, gross

 

 

3,005,234 

 

 

11,430,953 

Less: allowance for doubtful accounts

 

 

(36,161)

 

 

(38,103)

Accounts receivable, net

 

 

2,969,073 

 

 

11,392,850 

Less: long-term trade receivables

 

 

 —

 

 

(7,837,500)

Current accounts receivable, net

 

$

2,969,073 

 

$

3,555,350 



On December 27, 2017, we entered into a settlement agreement with Semina, our distributor in Brazil, pursuant to which Semina has made a payment of $2.25 million and was obligated to make a second payment of $1.5 million by February 28, 2018, to settle net amounts due to us totaling $7.5 million. Semina did not make its second payment of $1.5 million by February 28, 2018, and we currently expect it to make the payment during the third quarter of fiscal 2018. The amounts owed to us relate to outstanding accounts receivable for sales to Semina for the 2014 Brazil Tender totaling $8.9 million, $7.8 million of which was classified as a long-term trade receivable and $1.1 million as a current account receivable on the accompanying condensed consolidated balance sheet as of September 30, 2017. These receivables were net of payables owed to Semina by us totaling $1.4 million, $1.2 million of which was classified as a long-term liability and $0.2 million was classified as a current liability on the accompanying condensed consolidated balance sheet as of September 30, 2017. The settlement was not related to our belief in the ultimate collectability of the receivables or in the creditworthiness of Semina. The result of the settlement was a net loss of approximately $3.76 million, which is presented as a separate line item in the accompanying unaudited condensed consolidated statement of operations for the six months ended March 31, 2018.



At March 31, 2018 and September 30, 2017, Semina’s accounts receivable balance represented 9 percent and 11 percent of current assets, respectively. No other single customer’s accounts receivable balance accounted for more than 10 percent of current assets at those dates. At March 31, 2018, Semina’s accounts receivable balance represented 50 percent of the Company’s accounts receivable balance. At September 30, 2017, Semina’s accounts receivable and long-term other receivables balance represented 78 percent of the Company’s accounts receivable and long-term other receivables balance. For the three months ended March 31, 2018 and 2017, there was one customer who exceeded 10 percent of net revenues.  For the six months ended March 31, 2018 and 2017, there were two customers who each exceeded 10 percent of net revenues.



16


 

The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments on accounts receivable.  Management determines the allowance for doubtful accounts by identifying troubled accounts and by using historical experience applied to an aging of accounts.  Management also periodically evaluates individual customer receivables and considers a customer’s financial condition, credit history, and the current economic conditions.  Accounts receivable are written-off when deemed uncollectible.  The table below summarizes the change in the allowance for doubtful accounts for the six months ended March 31, 2018 and 2017:









 

 

 

 

 

 

 

 

 

 

 

Fiscal

Balance at

 

Charges

 

Write offs/

 

Balance at

Year

October 1

 

 to Expense

 

Recoveries

 

March 31

2017

$

38,103 

 

$

 —

 

$

 —

 

$

38,103 

2018

$

38,103 

 

$

3,058 

 

$

(5,000)

 

$

36,161 



Recoveries of accounts receivable previously written-off are recorded when received.  The Company’s customers are primarily large global agencies, non-government organizations, ministries of health and other governmental agencies which purchase and distribute the female condom for use in HIV/AIDS prevention and family planning programs. 

 

Note 5 - Inventory



Inventory at March 31, 2018 and September 30, 2017 consists of:







 

 

 

 

 



 

 

 

 

 



March 31, 2018

 

September 30, 2017

FC2

 

 

 

 

 

Raw material

$

641,155 

 

$

530,384 

Work in process

 

27,630 

 

 

90,164 

Finished goods

 

3,206,660 

 

 

2,427,386 

Inventory, gross

 

3,875,445 

 

 

3,047,934 

Less: inventory reserves

 

(286,388)

 

 

(312,997)

FC2, net

 

3,589,057 

 

 

2,734,937 

PREBOOST®

 

 

 

 

 

Finished goods

 

 —

 

 

32,987 

Inventory, net

$

3,589,057 

 

$

2,767,924 

 

Note 6 - Intangible Assets

Intangible assets acquired in the APP Acquisition included IPR&D, developed technology consisting of PREBOOST®  medicated wipes for prevention of premature ejaculation, and covenants not-to-compete.  

The gross carrying amounts and net book value of intangible assets are as follows at March 31, 2018:

 





 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 



Gross Carrying

 

Accumulated

 

Net Book



Amount

 

Amortization

 

Value

Intangible assets with finite lives:

 

 

 

 

 

 

 

 

Developed technology - PREBOOST®

$

2,400,000 

 

$

183,450 

 

$

2,216,550 

Covenants not-to-compete

 

500,000 

 

 

101,190 

 

 

398,810 

Total intangible assets with finite lives

 

2,900,000 

 

 

284,640 

 

 

2,615,360 

Acquired in-process research and development assets

 

18,000,000 

 

 

 —

 

 

18,000,000 

Total intangible assets

$

20,900,000 

 

$

284,640 

 

$

20,615,360 



17


 

The gross carrying amounts and net book value of intangible assets are as follows at September 30, 2017:







 

 

 

 

 

 

 

 



Gross Carrying

 

Accumulated

 

Net Book



Amount

 

Amortization

 

Value

Intangible assets with finite lives:

 

 

 

 

 

 

 

 

Developed technology - PREBOOST®

$

2,400,000 

 

$

81,533 

 

$

2,318,467 

Covenants not-to-compete

 

500,000 

 

 

65,476 

 

 

434,524 

Total intangible assets with finite lives

 

2,900,000 

 

 

147,009 

 

 

2,752,991 

Acquired in-process research and development assets

 

18,000,000 

 

 

 —

 

 

18,000,000 

Total intangible assets

$

20,900,000 

 

$

147,009 

 

$

20,752,991 



Amortization is recorded over the projected related revenue stream for the PREBOOST® developed technology over the next 10 years and on a straight-line basis over seven years for the covenants not-to-compete. The amortization expense is recorded in selling, general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations. The IPR&D assets will not be amortized until the underlying development projects are completed. If and when development is complete, which generally occurs when regulatory approval to market the product is obtained, the associated IPR&D assets would be accounted for as finite-lived intangible assets and amortized over the estimated period of economic benefit.  If a development project is abandoned, the associated IPR&D assets would be charged to expense.



Amortization expense was approximately $69,000 and $40,000, for the three months ended March 31, 2018 and 2017, respectively. Amortization expense was approximately $138,000 and $67,000, for the six months ended March 31, 2018 and 2017, respectively. Based on finite-lived intangible assets recorded as of March 31, 2018, the estimated future amortization expense is as follows:







 

 



Estimated

Year Ending September 30,

Amortization Expense

2018

$

137,631 

2019

 

309,234 

2020

 

316,368 

2021

 

323,706 

2022

 

331,316 

Thereafter

 

1,197,105 

Total

$

2,615,360 

 

Note 7 – Debt



SWK Credit Agreement



On March 5, 2018, the Company entered into a Credit Agreement (the “Credit Agreement”) with the financial institutions party thereto from time to time (the “Lenders”) and SWK Funding LLC, as agent for the Lenders (the “Agent”), for a synthetic royalty financing transaction. On and subject to the terms of the Credit Agreement, the Lenders agreed to provide the Company with a multi-draw term loan of up to $12.0 million, with $10.0 million advanced to the Company on the date of the Credit Agreement. The Company may draw up to an additional $1.0 million if the Company enters into an agreement to distribute at least 47.5 million units of FC2 in Brazil upon the terms described in the Credit Agreement and up to an additional $1.0 million if the Company enters into an agreement to distribute at least 30 million units of FC2 in South Africa upon the terms described in the Credit Agreement.

The Lenders will be entitled to receive quarterly payments on the term loan based on the Company’s product revenue from net sales of FC2 as provided in the Credit Agreement until the Company has paid 175% of the aggregate amount advanced to the Company under the Credit Agreement. If product revenue from net sales of FC2 for the twelve-month period ended as of the last day of the respective quarterly payment period is less than $10.0 million, the quarterly payments will be 32.5% of product revenue from net sales of FC2 during the quarterly period. If product revenue from net sales of FC2 for the twelve month period ended as of the last day of the respective quarterly payment period is equal to or greater than $10.0 million, the quarterly payments are calculated as the sum of 25% of product revenue from net sales of FC2 up to and including $12.5 million in the Elapsed Period (as defined

18


 

in the Credit Agreement), plus 10% of product revenue from net sales of FC2 greater than $12.5 million in the Elapsed Period.  Upon the Credit Agreement’s termination date of March 5, 2025, the Company must pay 175% of the aggregate amount advanced to the Company under the Credit Agreement less the amounts previously paid by the Company from product revenue. Upon a change of control of the Company or sale of the FC2 business, the Company must pay off the loan by making a payment to the Lenders equal to (a) if the change of control or sale of the FC2 business occurs prior to September 5, 2018, an amount equal to 165% of the aggregate amount actually advanced to the Company under the Credit Agreement less the amounts previously paid by the Company from product revenue, or (b) if the change of control or sale of the FC2 business occurs on or after September 5, 2018, an amount equal to (i) 175% of the aggregate amount advanced to the Company under the Credit Agreement less the amounts previously paid by the Company from product revenue, plus (ii) the greater of (A) $2.0 million or (B) the product of (x) 5% of the product revenue from net sales of FC2 for the most recently completed 12-month period multiplied by (y) five. A “change of control” under the Credit Agreement includes (i) an acquisition by any person of direct or indirect ownership of more than 50% of the Company’s issued and outstanding voting equity, (ii) a change of control or similar event in the Company’s articles of incorporation or bylaws, (iii) certain Key Persons as defined in the Credit Agreement cease to serve in their current executive capacities unless replaced within 90 days by a person reasonably acceptable to the Agent, which acceptance not to be unreasonably withheld, or (iv) the sale of all or substantially all of the Company’s assets.

The Credit Agreement contains customary representations and warranties in favor of the Agent and the Lenders and certain covenants, including financial covenants addressing minimum quarterly marketing and distribution expenses for FC2 and a requirement to maintain minimum unencumbered liquid assets of $1.0 million. The recourse of the Lenders and the Agent for obligations under the Credit Agreement is limited to assets relating to FC2.

In connection with the Credit Agreement, the Company and the Agent also entered into a Residual Royalty Agreement, dated as of March 5, 2018 (the “Residual Royalty Agreement”), which provides for an ongoing royalty payment of 5% of product revenue from net sales of FC2 commencing upon the payment in full by the Company of the required amount pursuant to the Credit Agreement. The Residual Royalty Agreement will terminate upon (i) a change of control or sale of the FC2 business and the payment by the Company of the amount due in connection therewith pursuant to the Credit Agreement, or (ii) mutual agreement of the parties. If a change of control occurs prior to payment in full of the Credit Agreement, there will be no payment due with respect to the Residual Royalty Agreement.  If a change of control occurs after the payment in full of the Credit Agreement, the Agent will receive a payment that is the greater of (A) $2.0 million or (B) the product of (x) 5% of the product revenue from net sales of FC2 for the most recently completed 12-month period multiplied by (y) five.

Pursuant to a Guarantee and Collateral Agreement dated as of March 5, 2018 (the “Collateral Agreement”) and an Intellectual Property Security Agreement dated as of March 5, 2018 (the “IP Security Agreement”), the Company’s obligations under the Credit Agreement are secured by a lien against substantially all of the assets of the Company that relate to or arise from FC2. In addition, pursuant to a Pledge Agreement dated as of March 5, 2018 (the “Pledge Agreement”), the Company’s obligations under the Credit Agreement are secured by a pledge of up to 65% of the outstanding shares of The Female Health Company Limited, a wholly owned U.K. subsidiary.



After payment by the Company of certain fees and expenses of the Agent and the Lenders as required in the Credit Agreement, the Company received net proceeds of approximately $9.9 million from the initial $10.0 million advance under the Credit Agreement.



For accounting purposes, the initial $10.0 million advance under the Credit Agreement was allocated between the Credit Agreement and the Residual Royalty Agreement on a relative fair value basis.  A portion of the amount allocated to the Credit Agreement and a portion of the amount allocated to the Residual Royalty Agreement, in both cases equal to the fair value of the respective change of control provisions, was allocated to the embedded derivative liabilities. The derivative liabilities will be adjusted to fair market value at each subsequent reporting period.  For financial statement presentation, the embedded derivative liabilities have been included with their respective host instruments as noted in the following tables. The debt discounts are being amortized to interest expense over the expected term of the loan using the effective interest method. Additionally, the Company recorded deferred loan issuance costs of approximately $264,000 for legal fees incurred in connection with the Credit Agreement. The deferred loan issuance costs are presented as a reduction in the Credit Agreement obligation and are being amortized to interest expense over the expected term of the loan using the effective interest method.



19


 

At March 31, 2018, the Credit Agreement consisted of the following:







 

 



March 31, 2018



 

 

Aggregate repayment obligation

$

17,500,000 

Less: Unamortized discounts

 

(10,840,046)

Less: Unamortized deferred issuance costs

 

(258,373)

Credit agreement, net

 

6,401,581 

Add: Embedded derivative liability at fair value (see Note 3)

 

3,334,000 



 

9,735,581 

Credit agreement, short-term portion

 

(3,912,888)

Credit agreement, long-term portion

$

5,822,693 



 

 

The fair value of the Residual Royalty Agreement at inception of $346,000 was calculated using a Monte Carlo simulation model utilizing significant unobservable inputs including future revenue projections to determine when payments would commence under the Residual Royalty Agreement, the probability of a change of control event as defined in the Residual Royalty Agreement and an estimated discount rate commensurate with the risks of the expected cash flows attributable to the Residual Royalty Agreement.  The payment commencement dates varied between the simulated Credit Agreement payoff dates (which the earliest date was September 30, 2019 per the simulation) and the Credit Agreement termination date of March 5, 2025.  The change of control probabilities ranged from 50% to 95%.  The discount rates ranged from approximately 10% to approximately 12%.  Material changes in any of these inputs would have resulted in a significantly higher or lower fair value measurement and commensurate changes to this liability.



At March 31, 2018, the Residual Royalty Agreement liability consisted of the following:





 

 



March 31, 2018



 

 

Residual Royalty Agreement liability, fair value at inception

$

346,000 

Less: Unamortized discounts

 

(7,208)

Add: Accretion of liability using effective interest rate

 

27,278 

Residual Royalty Agreement liability, net

 

366,070 

Add: Embedded derivative liability at fair value (see Note 3)

 

6,000 

Residual Royalty Agreement liability

$

372,070 



 

 

Interest expense related to the Credit Agreement and the Residual Royalty Agreement consisted of amortization of the discounts, accretion of the liability for the Residual Royalty Agreement and amortization of the deferred issuance costs.  For the three and six months ended March 31, 2018, interest expense related to the Credit Agreement was as follows:







 

 



March 31, 2018



 

 

Amortization of Credit Agreement and Residual Royalty Agreement discounts

$

317,747 

Accretion of Residual Royalty Agreement liability

 

27,278 

Amortization of deferred issuance costs

 

5,570 



$

350,595 



 

 

Revolving Line of Credit



The Company’s Credit Agreement with BMO Harris Bank N.A. expired on December 29, 2017.   No amounts were outstanding under the Credit Agreement at September 30, 2017 or when it expired on December 29, 2017.

 

Note 8 - Stockholders’ Equity



Preferred Stock



The Company has 5,000,000 shares designated as Class A Preferred Stock with a par value of $.01 per share. There are 1,040,000 shares of Class A Preferred Stock - Series 1 authorized; 1,500,000 shares of Class A Preferred Stock-

20


 

Series 2 authorized; 700,000 shares of Class A Preferred Stock - Series 3 authorized; and 548,000 shares of Class A Preferred Stock- Series 4 (the “Series 4 Preferred Stock”) authorized. In connection with the completion of the APP Acquisition (see Note 2), a total of 546,756 shares of Series 4 Preferred Stock were issued to the former APP stockholders as of October 31, 2016, and all of the outstanding shares of Series 4 Preferred automatically converted into shares of the Company’s common stock effective July 31, 2017.  There were no shares of Class A Preferred Stock of any series issued and outstanding at March 31, 2018 or September 30, 2017.  The Company has 15,000 shares designated as Class B Preferred Stock with a par value of $0.50 per share. There were no shares of Class B Preferred Stock issued and outstanding at March 31, 2018 or September 30, 2017.



Common Stock Purchase Warrants



In connection with the closing of the APP Acquisition, the Company issued a warrant to purchase up to 2,585,379 shares of the Company's common stock to Torreya Capital, the Company's financial advisor (the “Financial Advisor Warrant”).  The Financial Advisor Warrant has a five-year term, a cashless exercise feature and a strike price equal to $1.93 per share, the average price of the Company's common stock for the ten-day period preceding the original announcement of the APP Acquisition on April 6, 2016. The fair value of the Financial Advisor Warrant of $542,930 was estimated at the October 31, 2016 date of grant using the Black-Scholes option pricing model assuming expected volatility of 47.2 percent, a risk-free interest rate of 1.31 percent, an expected life of five years, no dividend yield, and the closing price of the Company's common stock on October 31, 2016 of $0.95. The Financial Advisor Warrant vested upon issuance. Half of the shares subject to the Financial Advisor Warrant, or 1,292,690 shares, were locked-up for a period of 18 months from the issuance date. The Financial Advisor Warrant was recorded as a component of additional paid-in-capital and the related expense is included in business acquisition expenses in the accompanying unaudited condensed consolidated statement of operations for the six months ended March 31, 2017.



Aspire Capital Purchase Agreement    



On December 29, 2017, the Company entered into a common stock purchase agreement (the “Purchase Agreement”) with Aspire Capital which provides that, upon the terms and subject to the conditions and limitations set forth therein, the Company has the right, from time to time in its sole discretion during the 36-month term of the Purchase Agreement, to direct Aspire Capital to purchase up to $15.0 million of the Company’s common stock in the aggregate.  Concurrently with entering into the Purchase Agreement, the Company also entered into a registration rights agreement with Aspire Capital (the “Registration Rights Agreement”), in which the Company agreed to prepare and file under the Securities Act of 1933 and under its current registration statement on Form S-3 (File No. 333-221120), a prospectus supplement for the sale or potential sale of the shares of the Company’s common stock that have been and may be issued to Aspire Capital under the Purchase Agreement.



Under the Purchase Agreement, on any trading day selected by the Company, the Company has the right, in its sole discretion, to present Aspire Capital with a purchase notice (each, a “Purchase Notice”), directing Aspire Capital (as principal) to purchase up to 200,000 shares of the Company’s common stock per business day, up to $15.0 million of the Company’s common stock in the aggregate at a per share price (the "Purchase Price") equal to the lesser of the lowest sale price of the Company’s common stock on the purchase date or the average of the three lowest closing sale prices for the Company’s common stock during the ten consecutive trading days ending on the trading day immediately preceding the purchase date.



In addition, on any date on which the Company submits a Purchase Notice to Aspire Capital in an amount equal to 200,000 shares and the closing sale price of our common stock is equal to or greater than $0.50 per share, the Company also has the right, in its sole discretion, to present Aspire Capital with a volume-weighted average price purchase notice (each, a “VWAP Purchase Notice”) directing Aspire Capital to purchase an amount of common stock equal to up to 30% of the aggregate shares of the common stock traded on its principal market on the next trading day (the VWAP Purchase Date), subject to a maximum number of shares the Company may determine.  The purchase price per share pursuant to such VWAP Purchase Notice is generally 97% of the volume-weighted average price for the Company’s common stock traded on its principal market on the VWAP Purchase Date.



In consideration for entering into the Purchase Agreement, concurrently with the execution of the Purchase Agreement, the Company issued to Aspire Capital 304,457 shares of the Company’s common stock. The shares of common stock issued as consideration were valued at approximately $347,000. This amount and related expenses of approximately $78,000, which total approximately $425,000, have been included in deferred assets on the

21


 

accompanying unaudited condensed consolidated balance sheet at March 31, 2018. As of the date of filing this Quarterly Report with the SEC, no shares of the Company’s common stock have been sold to Aspire Capital under the Purchase Agreement.

 

Note 9 – Share-based Compensation



We allocate share-based compensation expense to cost of sales, selling, general and administrative expense and research and development expense based on the award holder’s employment function. For the three and six months ended March 31, 2018 and 2017, we recorded share-based compensation expenses as follows:





 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Six Months Ended



 

March 31,

 

March 31,



 

2018

 

2017

 

2018

 

2017



 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales

 

$

330 

 

$

 

$

2,703 

 

$

Selling, general and administrative

 

 

363,475 

 

 

105,158 

 

 

539,702 

 

 

402,437 

Research and development

 

 

48,045 

 

 

 

 

76,897 

 

 



 

$

411,850 

 

$

105,158 

 

$

619,302 

 

$

402,437 



Equity Plans



In March 2018, the Company’s stockholders approved the Company's 2018 Equity Incentive Plan.  A total of 2.0 million shares are available for issuance under the 2018 Equity Incentive Plan. As of March 31, 2018, no shares had been granted under the 2018 Equity Incentive Plan.



In July 2017, the Company’s stockholders approved the Company's 2017 Equity Incentive Plan.  A total of 4.7 million shares are available for issuance under the 2017 Equity Incentive Plan. As of March 31, 2018, a total of 4,622,135 shares had been granted under the 2017 Equity Incentive Plan and not forfeited or are subject to outstanding commitments to issue shares under the 2017 Equity Incentive Plan, of which 4,242,135 shares were in the form of stock options, 190,000 shares were in the form of stock appreciation rights and 190,000 shares were in the form of restricted stock units.  The 2017 Equity Incentive Plan replaced the Company's 2008 Stock Incentive Plan, and no further awards will be made under the 2008 Stock Incentive Plan.



Stock Options



Each option grants the holder the right to purchase from us one share of our common stock at a specified price, which is generally the quoted market price of our common stock on the date the option is issued. Options generally vest on a pro-rata basis on each anniversary of the issuance date within three years of the date the option is issued. Options may be exercised after they have vested and prior to the specified expiry date provided applicable exercise conditions are met, if any. The expiry date can be for periods of up to ten years from the date the option is issued. The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model based on the assumptions established at that time. The Company accounts for forfeitures as they occur and does not estimate forfeitures as of the option grant date.



The following table outlines the weighted average assumptions for options granted during the three and six months ended March 31, 2018 and 2017:





 

 

 

 

 

 

 

 

 

 

 

 



 

Three Months Ended

 

Six Months Ended



 

March 31,

 

March 31,

Weighted Average Assumptions:

 

 

2018

 

 

2017

 

 

2018

 

 

2017

Expected Volatility

 

 

62.34% 

 

 

43.76% 

 

 

61.38% 

 

 

43.76% 

Expected Dividend Yield

 

 

0.00% 

 

 

0.00% 

 

 

0.00% 

 

 

0.00% 

Risk-free Interest Rate

 

 

2.76% 

 

 

1.62% 

 

 

2.47% 

 

 

1.62% 

Expected Term (in years)

 

 

6.0 

 

 

6.0 

 

 

5.8 

 

 

6.0 

Fair Value of Options Granted

 

$

1.28 

 

$

0.41 

 

$

0.93 

 

$

0.41 



During the three and six months ended March 31, 2018 and 2017, the Company used historical volatility of our common stock over a period equal to the expected life of the options to estimate their fair value.  The dividend yield

22


 

assumption is based on the Company’s history and expectation of future dividend payouts on the common stock.  The risk-free interest rate is based on the implied yield available on U.S. treasury zero-coupon issues with an equivalent remaining term.



The following table summarizes the stock options outstanding and exercisable at March 31, 2018: 





 

 

 

 

 

 

 

 

 



 

 

Weighted Average

 

 

 



 

 

 

 

 

Remaining

 

Aggregate



Number of

 

Exercise Price

 

Contractual Term

 

Intrinsic



Shares

 

Per Share

 

(years)

 

Value

Outstanding at September 30, 2017

2,830,805 

 

$

1.27 

 

 

 

 

 

Granted

2,058,051 

 

 

1.61 

 

 

 

 

 

Exercised

 

 

 

 

 

 

 

Forfeited

(349,221)

 

 

1.19 

 

 

 

 

 

Outstanding at March 31, 2018

4,539,635 

 

$

1.42 

 

8.93 

 

$

2,266,873 

Exercisable at March 31, 2018

510,417 

 

$

1.60 

 

3.91 

 

$

298,617 



The aggregate intrinsic value in the table above is before income taxes, based on the Company’s closing stock price of $1.81 on the last day of business for the six months ended March 31, 2018.  As of March 31, 2018, the Company had unrecognized compensation expense of approximately $2.6 million related to unvested stock options. This expense is expected to be recognized over approximately 3 years.



Restricted Stock



The Company has issued restricted stock to employees, directors and consultants. Such issuances may have vesting periods that range from one to three years. All such shares of restricted stock vest and all such shares must be issued pursuant to the vesting period noted, provided the grantee has not voluntarily terminated service or been terminated for cause prior to the vesting date.



A summary of the non-vested stock activity for the six months ended March 31, 2018 is presented in the table below:





 

 

 

 

 

 



 

 

 

 

 

 



 

 

Weighted Average

 

 



 

 

Grant Date

 

 



Shares

 

Fair Value

 

Vesting Period

Outstanding at September 30, 2017

198,750 

 

$

0.99 

 

 

Granted

 

 

 

 

 

Vested

(190,000)

 

 

 

 

 

Forfeited

 

 

 

 

 

Outstanding at March 31, 2018

8,750 

 

$

1.82 

 

April 2018



As of March 31, 2018, there was less than $1,000 of total unrecognized compensation cost related to non-vested restricted stock, which will be recognized in the third quarter of fiscal 2018.



Restricted Stock Units



In connection with the closing of the APP Acquisition, the Company issued 50,000 and 140,000 restricted stock units to an employee and an outside director, respectively, that vest on October 31, 2018. The restricted stock units will be settled in common stock issued under the 2017 Equity Incentive Plan. As of March 31, 2018, there was approximately $71,000 of unrecognized compensation cost related to non-vested restricted stock units, which is expected to be recognized by October 31, 2018.



Stock Appreciation Rights



In connection with the closing of the APP Acquisition, the Company issued stock appreciation rights based on 50,000 and 140,000 shares of the Company’s common stock to an employee and an outside director, respectively, that vest on October 31, 2018. The stock appreciation rights have a ten-year term and an exercise price per share of

23


 

$0.95, which was the closing price of a share of the Company’s common stock as quoted on NASDAQ on the trading day immediately preceding the date of the completion of the APP Acquisition. The stock appreciation rights will be settled in common stock issued under the 2017 Equity Incentive Plan.  As of March 31, 2018, there was approximately $38,000 of unrecognized compensation cost related to non-vested stock appreciation rights, which is expected to be recognized by October 31, 2018.

 

Note 10 - Contingent Liabilities



The testing, manufacturing and marketing of consumer products by the Company entail an inherent risk that product liability claims will be asserted against the Company.  The Company maintains product liability insurance coverage for claims arising from the use of its products.  The coverage amount is currently $10.0 million.



Litigation



In connection with the APP Acquisition, two purported derivative and class action lawsuits were filed against the Company in the Circuit Court of Cook County, Illinois, which were captioned Glotzer v. The Female Health Company, et al., Case No. 2016-CH-13815, and Schartz v. Parrish, et al., Case No. 2016-CH-14488.  On January 9, 2017 these two lawsuits were consolidated.  On March 31, 2017, the plaintiffs filed a consolidated complaint.  The consolidated complaint named as defendants Veru, the members of our board of directors prior to the closing of the APP Acquisition and the members of our board of directors after the closing of the APP Acquisition.  The consolidated complaint alleges, among other things, that our directors breached their fiduciary duties, or aided and abetted such breaches, by consummating the APP Acquisition in violation of the Wisconsin Business Corporation Law and NASDAQ voting requirements and by causing us to issue the shares of our common stock and Series 4 Preferred Stock to the former stockholders of APP pursuant to the APP Acquisition in order to evade the voting requirements of the Wisconsin Business Corporation Law. The consolidated complaint also alleges that Mitchell S. Steiner, a director and the President and Chief Executive Officer of Veru and a co-founder of APP, and Harry Fisch, a director of Veru and a co-founder of APP, were unjustly enriched in receiving shares of our common stock and Series 4 Preferred Stock in the APP Acquisition.  Based on these allegations, the consolidated complaint seeks equitable relief, including rescission of the APP Acquisition, money damages, disgorgement of the shares of our common stock and Series 4 Preferred Stock issued to Dr. Steiner and Dr. Fisch, and costs and expenses of the litigation, including attorneys' fees.  On May 5, 2017, the defendants filed a motion to dismiss the consolidated complaint.  On August 15, 2017, the court entered an order dismissing without prejudice the claims that the post-acquisition directors aided and abetted the alleged breaches of fiduciary duties by the pre-acquisition directors and that Dr. Steiner and Dr. Fisch were unjustly enriched.  The court did not dismiss the claims that the pre-acquisition directors breached their fiduciary duties and the claims that Veru consummated the APP Acquisition in violation of the Wisconsin Business Corporation Law and NASDAQ voting requirements, and the action is continuing as to those claims.  The parties are currently engaged in discovery.    Veru believes that this action is without merit and is vigorously defending itself.  No amount has been accrued for possible losses relating to this litigation as any such losses are not both probable and reasonably estimable.



License and Purchase Agreements



From time to time, we license or purchase rights to technology or intellectual property from third parties. These licenses and purchase agreements require us to pay upfront payments as well as development or other payments upon successful completion of preclinical, clinical, regulatory or revenue milestones. In addition, these agreements may require us to pay royalties on sales of products arising from the licensed or acquired technology or intellectual property. Because the achievement of these milestones is not reasonably estimable, we have not recorded a liability in the accompanying unaudited condensed consolidated financial statements for any of these contingencies.



In connection with the Company's acquisition of intellectual property rights associated with Solifenacin DRG and Tadalafil/Finasteride combination capsules in December 2017, the Company was obligated to make upfront payments totaling $500,000 by March 2018, as well as future installment payments and milestone payments. The $500,000 is included in accounts payable on the accompanying condensed consolidated balance sheet as of March 31, 2018. The Company expects to pay this amount in the third quarter of fiscal 2018.



24


 

Note 11 - Income Taxes



The Company accounts for income taxes using the liability method, which requires the recognition of deferred tax assets or liabilities for the tax-effected temporary differences between the financial reporting and tax bases of its assets and liabilities, and for net operating loss and tax credit carryforwards.



On December 22, 2017, significant changes were enacted to the U.S. tax law pursuant to H.R.1. “An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018” (the “Tax Act”) (previously known as “The Tax Cuts and Jobs Act”).  The Tax Act included a permanent reduction to the U.S. federal corporate income tax rate from 35% to 21%, a one-time repatriation tax on deferred foreign income, deductions, credits and business-related exclusions.



On December 22, 2017, the SEC issued guidance under Staff Accounting Bulletin No.  118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (“SAB 118”), directing registrants to consider the impact of the Tax Act as “provisional” when it does not have the necessary information available, prepared or analyzed (including computations) in reasonable detail to complete its accounting for the change in tax law.



In accordance with SAB 118, the Company’s income tax provision as of March 31, 2018 reflects (i) the current year impacts of the Tax Act on the estimated annual effective tax rate and (ii) the following discreet items resulting directly from the enactment of the Tax Act based on the information available, prepared or analyzed (including computations) in reasonable detail.



(i)

The Tax Act reduces the federal corporate tax rate from 35% to 21%.  The impact from the permanent reduction to the U.S. federal corporate income tax rate from 35% to 21% is effective January 1, 2018 (the “Effective Date”).  When a U.S. federal tax rate change occurs during a fiscal year, tax payers are required to compute a weighted daily average rate for the fiscal year of enactment.  However, as the Company is in a net loss carry forward position, it is using the U.S. federal statutory income tax rate of 21% that will be in effect when the net loss is utilized. 

 

(ii)

The Company determined the impact of the U.S. federal corporate income tax rate change, net of the related state income tax impact on the U.S. deferred tax assets and liabilities, to be a benefit of $1,162,000 as of October 1, 2017.



The Tax Act imposes a one-time transition tax on earnings of certain foreign subsidiaries that were previously tax deferred and creates new taxes on certain foreign-sourced earnings.  The one-time transition tax is based on total post-1986 foreign earnings and profits (“E&P”) which a tax payer has previously deferred from U.S. income taxes.  The Company has no post-1986 foreign E&P which it has previously deferred. 



Within the calculation of the Company’s annual effective tax rate the Company has used assumptions and estimates that may change as a result of future guidance, interpretations, and rule-making from the Internal Revenue Service, the SEC, the FASB and/or various other taxing jurisdictions.  For example, the Company anticipates that state jurisdictions will continue to determine and announce their conformity to the Tax Act which would have an impact on the annual effective tax rate.



The Company completes a detailed analysis of its deferred income tax valuation allowances on an annual basis or more frequently if information comes to our attention that would indicate that a revision to our estimates is necessary.  In evaluating the Company’s ability to realize its deferred tax assets, management considers all available positive and negative evidence on a country-by-country basis, including past operating results, forecast of future taxable income, and the potential Section 382 limitation on the net operating loss carryforwards due to a change in control.  In determining future taxable income, management makes assumptions to forecast U.S. federal and state, U.K. and Malaysia operating income, the reversal of temporary differences, and the implementation of any feasible and prudent tax planning strategies.  These assumptions require significant judgment regarding the forecasts of the future taxable income in each tax jurisdiction and are consistent with the forecasts used to manage the Company’s business.  It should be noted that the Company realized significant losses through 2005 on a consolidated basis.  From fiscal year 2006 through fiscal year 2016, the Company has annually generated taxable income on a consolidated basis.  In management’s analysis to determine the amount of the deferred tax asset to recognize, management projected future taxable income for each tax jurisdiction.



25


 

As of March 31, 2018, the Company had U.S. federal and state net operating loss carryforwards of approximately $12,100,000 and $15,351,000, respectively, for income tax purposes expiring in years 2022 to 2037.  The Company’s U.K. subsidiary has U.K. net operating loss carryforwards of approximately $62,223,000 as of March 31, 2018, which can be carried forward indefinitely to be used to offset future U.K. taxable income.



A reconciliation of income tax expense and the amount computed by applying the statutory federal income tax rate to income before income taxes is as follows:













 

 

 

 

 

 

 

 

 

 

 



 

 

 

 

 

 

 

 

 

 

 



Three Months Ended

 

Six Months Ended



March 31,

 

March 31,



2018

 

2017

 

2018

 

2017

Income tax benefit at statutory rates

$

(1,077,736)

 

$

(884,000)

 

$

(3,628,736)

 

$

(1,529,000)

Effect of change in U.S. tax rate

 

 —

 

 

 —

 

 

(187,000)

 

 

 —

State income tax benefit, net of federal benefits

 

(385,395)

 

 

(133,000)

 

 

(948,395)

 

 

(229,000)

Non-deductible business acquisition expenses

 

 —

 

 

42,000