UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended March 31, 2016.
 
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
0-50481
AEOLUS PHARMACEUTICALS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
 
56-1953785
(State or Other Jurisdiction of
Incorporation or Organization)
 
 
(I.R.S. Employer
Identification No.)
 
26361 Crown Valley Parkway, Suite 150
Mission Viejo, California
(Address of Principal Executive Offices)
 
 
92691
(Zip Code)
 
(Registrant's Telephone Number, Including Area Code)
949-481-9825
 
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 (§232.405 of this chapter) 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, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
Non-accelerated filer
(Do not check if a smaller reporting company)
 
Accelerated filer
 
Smaller reporting company
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  YES NO
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class
Common Stock, par value $.01 per share
 
 
 Outstanding as of
May 16, 2016
151,559,745 shares
 

 

 
AEOLUS PHARMACEUTICALS, INC.
FORM 10-Q
For the Quarter Ended March 31, 2016
Table of Contents
 
     Page
     
PART I.
FINANCIAL INFORMATION
3
 
Item 1.
Financial Statements
3
   
Condensed Consolidated Balance Sheets as of March 31, 2016 (unaudited) and September 30, 2015 (unaudited)
3
   
Condensed Consolidated Statements of Operations for the Three and Six Months ended March 31, 2016 and 2015 (unaudited)
4
   
Condensed Consolidated Statements of Cash Flows for the Six Months ended March 31, 2016 and 2015 (unaudited)
5
   
Notes to Condensed Consolidated Financial Statements (unaudited)
6
 
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
15
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
21
 
Item 4.
Controls and Procedures
21
PART II.
OTHER INFORMATION
21
 
Item 1A.
Risk Factors
21
 
Item 6.
Exhibits
22
 
SIGNATURES
23
 
 
2

PART I.FINANCIAL INFORMATION
Item 1. Financial Statements
AEOLUS PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share and per share data)
   
March 31,
2016
   
September 30,
2015
 
ASSETS
           
Current assets:
           
Cash and cash equivalents
 
$
4,509
   
$
94
 
Accounts receivable
   
1,366
     
1,585
 
Deferred subcontractor cost
   
197
     
21
 
Prepaid expenses and other current assets
   
156
     
45
 
Total current assets
   
6,228
     
1,745
 
 
Investment in CPEC LLC
   
32
     
32
 
Total assets
 
$
6,260
   
$
1,777
 
                 
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
               
Current liabilities:
               
Accounts payable and accrued expenses
 
$
1,031
   
$
1,598
 
Deferred revenue
   
205
     
22
 
Note payable to shareholders, net of debt discount of $273
   
     
727
 
Note payable to shareholders redemption liability
   
     
275
 
Total current liabilities
   
1,236
     
2,622
 
                 
Total liabilities
   
1,236
     
2,622
 
 
Commitments and Contingencies (Note H)
               
 
Stockholders' equity:
               
Preferred stock, $.01 par value per share, 10,000,000 shares authorized:
               
Series A nonredeemable convertible preferred stock, 1,250,000 shares authorized as of March 31, 2016 and September 30, 2015, respectively; no shares issued and outstanding as of March 31, 2016 and September 30, 2015, respectively
   
     
 
Series B nonredeemable convertible preferred stock, 1,600,000 and 1,600,000 shares authorized as of March 31, 2016 and September 30, 2015, respectively; 526,080 and 526,080 shares issued and outstanding as of March 31, 2016 and September 30, 2015, respectively
   
5
     
5
 
    Series C nonredeemable convertible preferred stock, 5,000 and zero shares authorized as
    of March 31, 2016 and September 30, 2015, respectively; 4,500 and zero shares issued
    and outstanding as of March 31, 2016 and September 30, 2015, respectively 
     
       
 
Common stock, $.01 par value per share, 200,000,000 shares authorized; 151,559,745 and 135,930,068 shares issued and outstanding as of March 31, 2016 and September 30, 2015, respectively
   
1,515
     
1,359
 
Additional paid-in capital
   
191,797
     
184,421
 
Accumulated deficit
   
(188,293
)
   
(186,630
)
Total stockholders' equity (deficit)
   
5,024
     
(845
)
Total liabilities and stockholders' equity (deficit)
 
$
6,260
   
$
1,777
 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
3

 
AEOLUS PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)

   
Three months Ended
March 31,
   
Six Months Ended
March 31,
 
   
2016
   
2015
   
2016
   
2015
 
Revenue:
                       
Contract revenue
 
$
565
   
$
1,189
   
$
870
   
$
2,114
 
 
Costs and expenses:
                               
Research and development
   
501
     
1,297
     
993
     
2,270
 
General and administrative
   
693
     
604
     
1,254
     
1,254
 
Total costs and expenses
   
1,194
     
1,901
     
2,247
     
3,524
 
Loss from operations
   
(629
)
   
(712
)
   
(1,377
)
   
(1,410
)
                                 
Interest expense
   
     
     
(285
)
   
 
Net loss
   
(629
)
     (712    
(1,662
)
   
(1,410
)
Deemed dividend on Series C preferred stock
   
1,906
     
     
2,486
     
 
Net loss attributable to common stockholders
 
$
(2,535
)
 
$
(712
)
 
$
(4,148
)
 
$
(1,410
)
 
Net loss per weighted share attributable to common stockholders:
                               
Basic (Note E)
 
$
(0.02
)
 
$
(0.01
)
 
$
(0.03
)
 
$
(0.01
)
Diluted (Note E)
 
$
(0.02
)
 
$
(0.01
)
 
$
(0.03
)
 
$
(0.01
)
 
Weighted average common shares outstanding:
                               
Basic
   
151,560
     
135,850
     
145,466
     
135,850
 
Diluted
   
151,560
     
135,850
     
145,466
     
135,850
 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
4

AEOLUS PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
   
Six Months Ended
March 31,
 
   
2016
   
2015
 
Cash flows from operating activities:
           
Net loss
 
$
(1,662
)
 
$
(1,410
)
Adjustments to reconcile net loss to net cash used in operating activities:
               
Amortization of discount on note payable to shareholders
   
273
     
 
Accrued interest
   
12
     
 
Non-cash compensation
   
74
     
259
 
Change in assets and liabilities:
               
Accounts receivable
   
219
     
(248
)
Deferred subcontractor cost
   
(176
)
   
375
 
Prepaid expenses and other current assets
   
(111
)
   
(64
)
Accounts payable and accrued expenses
   
(567
)
   
209
 
Deferred revenue
   
183
     
(390
)
Net cash used in operating activities
   
(1,755
)
   
(1,269
)
                 
Cash flows from financing activities:
               
Proceeds from issuance of common stock and common stock warrants, net
   
2,005
     
 
Proceeds from issuance of preferred stock and common stock warrants, net
   
4,165
     
 
Net cash provided by financing activities
   
6,170
     
 
Net increase (decrease) in cash and cash equivalents
   
4,415
     
(1,269
)
Cash and cash equivalents at beginning of period
   
94
     
1,517
 
Cash and cash equivalents at end of period
 
$
4,509
   
$
248
 
                 
Supplemental disclosure of non-cash financing activities:
               
Conversion of note payable to shareholders for common stock and warrants
 
$
1,000
   
$
 
Conversion of accrued interest on note payable to shareholders for common stock and warrants
 
$
12
   
$
 
Issuance of warrants for financing costs
 
$
266
   
$
 
Deemed dividend on Series C preferred stock
 
$
2,486
   
$
 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

5

AEOLUS PHARMACEUTICALS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
A.
Organization, Business and Summary of Significant Accounting Policies
Organization
The accompanying unaudited condensed consolidated financial statements include the accounts of Aeolus Pharmaceuticals, Inc. and its wholly-owned subsidiary, Aeolus Sciences, Inc. (collectively, "we," "us," "Company" or "Aeolus"). All significant intercompany accounts and transactions have been eliminated in consolidation.  Aeolus is a Delaware corporation. The Company's primary operations are located in Mission Viejo, California.
Business
Aeolus is developing a platform of novel compounds, known as metalloporphyrins, for use in biodefense, fibrosis, oncology, infectious disease and diseases of the central nervous system.    Its lead compound, AEOL 10150, is being developed as a medical countermeasure against the pulmonary effects of radiation exposure under a contract ("BARDA Contract") valued at up to $118.4 million with the Biomedical Advanced Research and Development Authority ("BARDA"), a division of the U.S. Department of Health and Human Services ("HHS").  Aeolus is in its fifth year under the BARDA Contract.  Aeolus also receives development support from the National Institutes of Health ("NIH") for development of the compound as a medical countermeasure against radiation and exposure to chemical and nerve agents.  Aeolus' strategy is to leverage the substantial investment in toxicology, manufacturing, and preclinical and clinical studies made by U.S. Government agencies in AEOL 10150 to develop the compound for the treatment of lung fibrosis, including idiopathic pulmonary fibrosis ("IPF") and as a treatment to reduce side effects caused by radiation toxicity and improve local tumor control in cancer therapy.  The Company is also developing AEOL 11114 as a treatment for Parkinson's disease and AEOL 20415 as a treatment for infection related to cystic fibrosis and diseases that have developed a resistance to existing antibiotic and anti-viral therapies.
Basis of Presentation
All significant intercompany activity has been eliminated in the preparation of the unaudited condensed consolidated financial statements. The unaudited condensed consolidated financial statements have been prepared in accordance with the requirements of Form 10-Q and Rule 10-01 of Regulation S-X. Some information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to those rules and regulations. In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the consolidated financial position, results of operations and cash flows of the Company. The condensed consolidated balance sheet at September 30, 2015 was derived from the Company's audited financial statements included in the Company's Annual Report on Form 10-K for the fiscal year ended September 30, 2015, filed with the Securities and Exchange Commission (the "SEC") on December 18, 2015.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
The Company invests available cash in short-term bank deposits. Cash and cash equivalents include investments with original maturities of three months or less at the date of purchase. The carrying value of cash and cash equivalents approximate their fair market value at March 31, 2016 and September 30, 2015 due to their short-term nature.
6

Significant customers and accounts receivable

          For the six months ended March 31, 2016, the Company's primary customer was BARDA, which comprised 100% of total revenues. As of March 31, 2016, the Company's receivable balances were comprised 100% from this customer. Unbilled accounts receivable, included in accounts receivable, totaling $311,000 and $589,000 as of March 31, 2016 and September 30, 2015, respectively, relate to work that has been performed, though invoicing has not yet occurred. All of the unbilled receivables are expected to be billed and collected within the next 12 months. Accounts receivable are stated at invoice amounts and consist primarily of amounts due from HHS. If necessary, the Company records a provision for doubtful receivables to allow for any amounts that may be unrecoverable. This provision is based upon an analysis of the Company's prior collection experience, customer creditworthiness and current economic trends. As of March 31, 2016 and September 30, 2015, an allowance for doubtful accounts was not recorded as the collection history from the Company's customer indicated that collection was probable.
Concentrations of credit risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and accounts receivable. The Company places its cash and cash equivalents with high quality financial institutions. Management believes that the financial risks associated with its cash and cash equivalents and investments are minimal. Because accounts receivable consist primarily of amounts due from the U.S. federal government agencies, management deems there to be minimal credit risk.
Revenue Recognition
Aeolus recognizes revenue in accordance with the authoritative guidance for revenue recognition.  Revenue is recognized when all of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery (or passage of title) has occurred or services have been rendered, (iii) the seller's price to the buyer is fixed or determinable, and (iv) collectability is reasonably assured. 
The BARDA Contract is classified as a "cost-plus-fixed-fee" contract. Aeolus recognizes government contract revenue in accordance with the authoritative guidance for revenue recognition including the authoritative guidance specific to federal government contracts. Reimbursable costs under the contract primarily include direct labor, subcontract costs, materials, equipment, travel, and indirect costs. In addition, we receive a fixed fee under the BARDA Contract, which is unconditionally earned as allowable costs are incurred and is not contingent on success factors. Reimbursable costs under the BARDA Contract, including the fixed fee, are recognized as revenue in the period the reimbursable costs are incurred and become billable.
Fair Value of Financial Instruments
The carrying amounts of Aeolus' short-term financial instruments, which include cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, debt and redemption liability, approximate their fair values due to their short maturities.
Fair Value Measurements
The Company applies Accounting Standards Codification ("ASC") Topic 820, Fair Value Measurements and Disclosures, for financial and non-financial assets and liabilities.
ASC Topic 820 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow) and the cost approach (cost to replace the service capacity of an asset or replacement cost). The statement utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:
· Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.
· Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
· Level 3: Unobservable inputs that reflect the reporting entity's own assumptions.
7

The redemption liability, discussed further at Note F - Debt, was measured at fair market value on a recurring basis and is summarized below (in thousands):

Fair value at March 31, 2016
 
Level 1
   
Level 2
   
Level 3
 
$
   
$
   
$
 

The following table summarizes, as of March 31, 2016, the redemption liability activity subject to Level 2 inputs which are measured on a recurring basis:
Fair value measurement of redemption
liability
 
Balance at September 30, 2015
 
$
275
 
Conversion of convertible promissory notes with redemption feature
   
(275
)
Change in fair value of redemption liability
   
 
Balance at March 31, 2016
 
$
 

Research and Development
Research and development costs are expensed in the period incurred.
Leases
The Company leases office space and office equipment under month to month operating lease agreements. For the six months ended March 31, 2016 and 2015, total rent expense was approximately $21,000 and $21,000, respectively.
Income Taxes
 The Company recognizes liabilities or assets for the deferred tax consequences of temporary differences between the tax bases of assets or liabilities and their reported amounts in the financial statements. These temporary differences will result in taxable or deductible amounts in future years when the reported amounts of the assets or liabilities are recovered or settled. A valuation allowance is established when management determines that is more likely than not that all or a portion of a deferred tax asset will not be realized. Management evaluates the Company's ability to realize its net deferred tax assets on a quarterly basis and valuation allowances are provided, as necessary. During this evaluation, management reviews its forecasts of income in conjunction with other positive and negative evidence surrounding the Company's ability to realize its deferred tax assets to determine if a valuation allowance is required. Adjustments to the valuation allowance will increase or decrease the Company's income tax provision or benefit. Management also applies the relevant guidance to determine the amount of income tax expense or benefit to be allocated among continuing operations, discontinued operations, and items charged or credited directly to stockholders' equity (deficit).
A tax position must meet a minimum probability threshold before a financial statement benefit is recognized. The minimum threshold is a tax position that is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation process, based on the technical merits of the position. The Company recognizes interest and penalties related to uncertain tax positions in income tax expense.
Net Income (Loss) Per Common Share
The Company computes net income attributable to common stockholders using the two-class method required for participating securities. Under the two-class method, securities that participate in dividends, such as the Company's outstanding preferred shares, preferred warrants, and most common stock warrants, are considered "participating securities." Our preferred shares, preferred warrants and common stock warrants are considered "participating securities" because they include non-forfeitable rights to dividends.
8

In applying the two-class method, (i) basic net income (loss) per share is computed by dividing net income (less any dividends paid on participating securities) by the weighted average number of shares of common stock and participating securities outstanding for the period and (ii) diluted earnings per share may include the additional effect of other securities, if dilutive, in which case the dilutive effect of such securities is calculated using the treasury stock method. The Company does have other securities with a dilutive effect outstanding, so the Company's basic net income (loss) per share uses the two-class method and diluted net income (loss) per share uses the treasury stock method.
Accounting for Stock-Based Compensation
The Company recognizes stock based compensation expense in the statement of operations based upon the fair value of the equity award amortized over the vesting period.
Segment Reporting
The Company currently operates in one segment.
B.
Liquidity
The Company completed a financing in December 2015, which is discussed further at Note C - Stockholders' Equity. The primary use of our cash from operations is to further develop our various drug compounds and depending on the results of that development we may need to raise additional capital in the future.
C.                 Stockholders' Equity

Preferred Stock

The Certificate of Incorporation of the Company authorizes the issuance of up to 10,000,000 shares of Preferred Stock, at a par value of $0.01 per share, of which 1,250,000 shares are designated Series A Convertible Preferred Stock, 1,600,000 shares are designated Series B Convertible Preferred Stock (the "Series B Stock") and 5,000 shares are designated Series C Convertible Preferred Stock (the "Series C Stock"). The Board of Directors has the authority to issue Preferred Stock in one or more series, to fix the designation and number of shares of each such series, and to determine or change the designation, relative rights, preferences, and limitations of any series of Preferred Stock, without any further vote or action by the stockholders of the Company.
As of March 31, 2016, 526,080 shares of Series B Stock and 4,500 shares of Series C Convertible Preferred Stock were outstanding. There are no shares of Series A Convertible Preferred Stock issued or outstanding.
With respect to dividend rights and rights upon liquidation, winding up and dissolution, the Series B Stock ranks pari passu with the common stock. Subject to any rights of senior stock, holders of Series B Stock are entitled to receive dividends or distributions as, when and if declared by the Board of Directors. In the event the Board of Directors declares a dividend or distribution with respect to the outstanding common stock, the holders of Series B Stock are entitled to receive the amount of dividends per share in the same form payable on the common stock based on the largest number of shares of common stock issuable upon conversion of the outstanding Series B Stock. In the event of a liquidation, winding up or dissolution of the Company, subject to any rights of senior stock, the holders of Series B Stock are entitled to receive, pari passu with the holders of the common stock, the assets of the Company based on the largest number of shares of common stock issuable upon conversion of the outstanding Series B Stock.
Each share of Series B Stock is convertible into one share of common stock. The Series B Stock can be converted into common stock at any time upon the election of the holders of the Series B Stock except to the extent such conversion would result in the holders of Series B Stock owning in the aggregate more than 9.99% of the outstanding common stock.
The Series B Stock is not entitled to vote on any matter submitted to the vote of holders of the common stock except that the Company must obtain the approval of a majority of the outstanding shares of Series B Stock to either amend the Company's Certificate of Incorporation in a manner that would adversely affect the Series B Stock (including by creating an additional class or series of stock with rights that are senior or pari passu to the Series B Stock) or change the rights of the holders of the Series B Stock in any other respect.
9

The Series C Stock is non-voting stock.  Each share of Series C Stock is convertible into 4,545 shares of our common stock except to the extent such conversion would result in such holder of Series C Stock, and its affiliates, owning in the aggregate more than 9.99% of the outstanding common stock.  Dividends on the Series C Stock are due whenever dividends are due on the Company's common stock on an as-if-converted basis, but shall be subordinate to any dividends due to holders of the Company's Series B Stock as a result of such common stock dividends. The Series C Stock shall also be junior to the Series B Stock in the event of liquidation of the Company.
On December 10, 2015, the Company entered into securities purchase agreements with certain accredited investors to sell and issue 4,500 preferred stock units issued to existing investors, Biotechnology Value Fund, L.P. and other affiliates of BVF Partners, L.P., for an aggregate purchase price of $4,500,000. The preferred units collectively consist of (i) 4,500 shares of Series C Stock of the Company that are collectively convertible into an aggregate of 20,454,546 shares of common stock and (ii) warrants to purchase an aggregate of 20,454,546 shares of common stock, in each case subject to adjustment.  The warrants have an initial exercise price of $0.22 per share.  The warrants may not be exercised until after 90 days following the date of issuance.  The Series C Stock and warrants contain provisions restricting the conversion or exercise of such securities in circumstances where such event would result in the holder and its affiliates to beneficially own in excess of 9.99% of the Company's outstanding common stock.
The fair value of the December 10, 2015 financing warrants issued was estimated to be $4,476,000 using the Black-Scholes option pricing model with the following assumptions: dividend yield of 0%, expected volatility of 109.74%, risk free interest rate of 1.67%, and an expected life equal to the five year contractual term. The proceeds from the December 10, 2015 financing were allocated based upon the relative fair values of the warrants and preferred shares issued in the transaction.
The allocation of the proceeds based on relative fair values of the instruments resulted in recognition of a discount on the Series C Preferred Stock of $2,486,000 from a beneficial conversion feature, which is being amortized from the date of issuance to the earliest redemption date of 90 days post issuance. For the quarter ended March 31, 2016 the Company recognized $1,906,000 of amortization of the discount on Series C Preferred Stock as deemed dividends charged to additional paid in capital. The value of the beneficial conversion feature is calculated as the difference between the effective conversion price of the Series C Preferred Stock and the fair market value of the common stock into which the Series C Preferred Stock are convertible at the commitment date.
Common Stock
On December 10, 2015, the Company entered into securities purchase agreements with certain accredited investors to sell and issue (i) an aggregate of 10,215,275 common units issued at a purchase price of $0.22 per unit.  Each common unit consists of one share of the Company's common stock and a five year warrant to purchase one share of the Company's common stock, subject to adjustment. The warrants may not be exercised until after 90 days following the date of issuance.  The warrants contain provisions restricting the conversion or exercise of such securities in circumstances where such event would result in the holder and its affiliates to beneficially own in excess of 9.99% of the Company's outstanding common stock.
On September 29, 2015, the Company received funding in the form of convertible promissory notes (the "BVF Notes") from Biotechnology Value Fund, L.P. and certain other affiliates of BVF Partners, L.P.  The BVF Notes had an aggregate principal balance of $1,000,000, accrue interest at a rate of 6% per annum and had a scheduled maturity date of September 28, 2016. The outstanding principal and accrued interest on the BVF Notes were automatically convertible into Company equity securities, provided a qualified financing of not less than $4,000,000 occurred.
On December 11, 2015, following the completion of a qualified financing (consisting of the common units and preferred units involving aggregate proceeds of $6,747,000 described above and under "Preferred Stock,") the principal and accrued interest amounts under the BVF Notes were converted into 5,414,402 shares of the Company's common stock and warrants to purchase an additional 5,414,402 shares of the Company's common stock at an exercise price per share of $0.22 subject to adjustment. As a result, the BVF Notes were no longer outstanding as of that date.
10

Net cash proceeds from the December 10, 2015 financing, after deducting for $577,000 of expenses, were approximately $6,170,000. The Company also incurred non-cash expenses in the form of 1,214,027 warrants issued to the placement agents with an estimated fair value of $266,000, at similar terms as the financing warrants, for services provided. These warrants were recorded to additional paid in capital as a direct cost of the financing. The Company issued a total of 37,298,250 warrants in connection with the December 10, 2015 financing.
The fair value of the December 10, 2015 financing warrants and December 11, 2015 warrants issued for conversion of the BVF notes was estimated to be $3,420,000 using the Black-Scholes option pricing model with the following assumptions: dividend yield of 0%, expected volatility of 109.74%, risk free interest rate of 1.67%, and an expected life equal to the five year contractual term. The proceeds from the December 10, 2015 financing and December 11, 2015 conversion of the BVF Notes were allocated based upon the relative fair values of the warrants and common shares issued in the transactions.
Dividends
The Company has never paid a cash dividend on its common stock and does not anticipate paying cash dividends on its common stock in the foreseeable future. If the Company pays a cash dividend on its common stock, it also must pay the same dividend on an as converted basis on its outstanding Series B and C Stock.
Warrants
As of March 31, 2016, warrants to purchase an aggregate of 53,247,877 shares of common stock were outstanding with a weighted average exercise price of $0.24 per share. Details of the warrants for common stock outstanding at March 31, 2016 are as follows:
 
Number of Shares
 
Exercise Price
 
Expiration Date
 
 
               50,000
 
$
0.50
 
May 2016
   
50,000
 
$
0.50
 
July 2016
 
 
               50,000
 
$
1.00
 
July 2016
   
               50,000
 
$
1.50
 
July 2016
   
               50,000
 
$
2.00
 
July 2016
   
               50,000
 
$
2.50
 
July 2016
   
           1,337,627
 
$
          0.40
 
March 2017
   
           325,000
 
$
          0.40
 
April 2017
   
            300,000
 
$
          0.258
 
June 2017
   
50,000
 
$
0.26
 
June 2017
   
140,000
 
$
0.35
 
October 2017
   
12,205,000
 
$
0.25
 
February 2018
   
1,242,000
 
$
          0.25
 
March 2018
   
50,000
 
$
0.49
 
January 2020
   
37,298,250
 
$
0.22
 
December 2020
   
53,247,877
         

As of March 31, 2016, no warrants to purchase preferred stock were outstanding.  A warrant to purchase an aggregate of 896,037 shares of preferred stock at an exercise price of $0.01 per share expired in February 2016.
Below is a summary of warrant activity ("common and preferred") for the six months ended March 31, 2016:
11

         
Weighted Average
       
   
Number of
Shares
   
Exercise Price
   
Remaining
Contractual
Term (in
years)
   
Aggregate
Intrinsic Value
 
Outstanding at 9/30/2015
   
16,845,664
   
$
0.27
     
2.2
   
$
206,626
 
    Granted
   
37,298,250
   
$
0.22
     
4.7
   
$
1,864,913
 
    Exercised
   
-
   
$
-
     
-
   
$
-
 
    Expired or Canceled
   
(896,037
)  
$
0.01
     
-
   
$
156,000
 
    Forfeited
   
-
   
$
-
     
-
   
$
-
 
    Vested
   
-
   
$
-
     
-
   
$
-
 
Outstanding at 3/31/2016
   
53,247,877
   
$
0.24
     
3.8
   
$
-
 

As of March 31, 2016, no warrants to purchase preferred stock were outstanding.  A warrant to purchase an aggregate of 896,037 shares of preferred stock at an exercise price of $0.01 per share expired in February 2016.
Below is a summary of warrant activity ("common and preferred") for the six months ended March 31, 2015:
         
Weighted Average
       
   
Number of
Shares
   
Exercise Price
   
Remaining
Contractual
Term (in
years)
   
Aggregate
Intrinsic Value
 
Outstanding at 9/30/2014
   
16,925,664
   
$
0.27
     
3.1
   
$
206,089
 
    Granted
   
50,000
   
$
0.49
     
4.8
   
$
-
 
    Exercised
   
-
   
$
-
     
-
   
$
-
 
    Expired or Canceled
   
-
   
$
-
     
-
   
$
-
 
    Forfeited
   
-
   
$
-
     
-
   
$
-
 
    Vested
   
-
   
$
-
     
-
   
$
-
 
Outstanding at 3/31/2015
   
16,975,664
   
$
0.27
     
2.7
   
$
1,682,066
 

D.            Stock-Based Compensation

   Below is a summary of stock option activity for the six months ended March 31, 2016:
         
Weighted Average
       
   
Number of
Shares
   
Exercise Price
   
Remaining
Contractual
Term (in years)
   
Aggregate
Intrinsic Value
 
Outstanding at 9/30/2015
   
12,164,591
   
$
0.42
     
5.4
   
$
1
 
    Granted
   
700,000
   
$
0.23
     
-
   
$
-
 
    Exercised
   
-
   
$
-
     
-
   
$
-
 
    Expired or Canceled
   
(101,591
)
 
$
0.94
     
-
   
$
-
 
    Forfeited
   
-
   
$
-
     
-
   
$
-
 
Outstanding at 3/31/2016
   
12,763,000
   
$
0.40
     
5.2
   
$
-
 
For the six months ended March 31, 2016, all stock options were granted with an exercise price at or above the fair market value of the Company's common stock on the date of grant.
Below is a summary of stock option activity for the six months ended March 31, 2015:
12

         
Weighted Average
       
   
Number of
Shares
   
Exercise Price
   
Remaining
Contractual
Term (in years)
   
Aggregate
Intrinsic Value
 
Outstanding at 9/30/2014
   
11,671,591
   
$
0.43
     
6.1
   
$
675
 
    Granted
   
775,000
   
$
0.25
     
-
   
$
-
 
    Exercised
   
-
   
$
-
     
-
   
$
-
 
    Expired or Canceled
   
(23,000
)
 
$
0.95
     
-
   
$
-
 
    Forfeited
   
-
   
$
-
     
-
   
$
-
 
Outstanding at 3/31/2015
   
12,423,591
   
$
0.42
     
5.9
   
$
255,299
 
For the six months ended March 31, 2015, all stock options were granted with an exercise price at or above the fair market value of the Company's common stock on the date of grant.
The details of stock options for the six months ended March 31, 2016 were as follows:
     
Options Outstanding
   
Options Exercisable
 
                 
Weighted
               
Weighted
 
     
Number
 
Weighted
   
Average
   
Number
 
Weighted
   
Average
 
Range of
   
Outstanding
 
Average
   
Remaining
   
Exercisable
 
Average
   
Remaining
 
Exercise
   
at March
 
Exercise
   
Contractual
   
At March
 
Exercise
   
Contractual
 
Prices
     31, 2016  
Price
   
Life (in years)
    31, 2016  
Price
   
Life (in years)
 
$
0.19-$0.20
     
250,000
   
$
0.19
     
9.92
     
-
   
$
-
     
-
 
$
0.21-$0.30
     
3,537,500
   
$
0.27
     
6.33
     
3,274,998
   
$
0.27
     
6.07
 
$
0.31-$0.40
     
6,551,500
   
$
0.39
     
5.33
     
6,551,500
   
$
0.39
     
5.33
 
$
0.41-$0.50
     
502,000
   
$
0.45
     
5.75
     
502,000
   
$
0.45
     
5.75
 
$
0.51-$0.60
     
982,250
   
$
0.59
     
3.21
     
982,250
   
$
0.59
     
3.21
 
$
0.61-$0.70
     
60,000
   
$
0.68
     
0.53
     
60,000
   
$
0.68
     
0.53
 
$
0.71-$0.80
     
352,750
   
$
0.75
     
1.30
     
352,750
   
$
0.75
     
1.30
 
$
0.81-$0.90
     
525,000
   
$
0.87
     
0.84
     
525,000
   
$
0.87
     
0.84
 
$
0.91-$1.19
     
2,000
   
$
1.19
     
1.08
     
2,000
   
$
1.19
     
1.08
 

Stock-based compensation expense recognized in the statement of operations is as follows (in thousands):
   
For the three months ended
March 31,
   
For the six months ended
March 31,
 
   
2016
   
2015
   
2016
   
2015
 
Research and Development Expenses
 
$
   
$
   
$
   
$
 
General and Administrative Expenses
   
36
     
68
     
74
     
259
 
   
$
36
   
$
68
   
$
74
   
$
259
 
  The total deferred compenation expense for outstanding and unvested stock options for the six months ended March 31, 2016 was $78,000. The weighted average remaining recognition period for the total deferred compensation expense is approximately eight months. The fair value of the options associated with the above compensation expense was determined at the date of the grant using the Black-Scholes option pricing model withthe following weighted average assumptions:
13

    For the three months ended
March 31,
    For the six months ended
March 31,
 
    2016     2015     2016     2015  
Dividend yield
   
0
   
0
   
0
   
0
Pre-vest forfeiture rate
   
18.95
   
11.65
   
7.87
   
5.01
Expected volatility
   
111.31
   
125.49
   
117.14
   
138.09
Risk-free interest rate
   
1.42
   
1.64
   
1.42
   
1.71
Expected term
   
5.27 years
     
5.27 years
   
5.27 years
     
5.27 years
 

E.
Net Income (Loss) Per Common Share
The Company computes basic net income (loss) per weighted average share attributable to common stockholders using the weighted average number of shares of common stock outstanding during the period. The Company computes diluted net income (loss) per weighted average share attributable to common stockholders using the weighted average number of shares of common and dilutive potential common shares outstanding during the period. Potential common shares outstanding consist of stock options, convertible debt, warrants and convertible preferred stock using the treasury stock method and are excluded if their effect is anti-dilutive. Diluted weighted average common shares did not include any incremental shares for the six months ended March 31, 2016 and 2015 issuable upon the exercise or conversion of convertible debt, stock options to purchase common stock, convertible preferred stock and warrants to purchase common stock. Diluted weighted average common shares excluded incremental shares of approximately 86,992,000 and 29,399,000 for the six months ended March 31, 2016 and 2015, respectively, due to their anti-dilutive effect.
 
For the three months
   
For the six months
 
   
ended March 31,
   
ended March 31,
 
   
2016
   
2015
   
2016
   
2015
 
   
(in thousands, except per share data)
 
Numerator:
                   
Net loss
 
$
(629
)
 
$
(712
)
 
$
(1,662
)
 
$
(1,410
)
Less deemed dividend on Series C preferred stock
   
(1,906
)
   
-
     
(2,486
)    
-
 
Net loss attributable to common stockholders – basic
 
$
(2,535
)
$
(712
)
$
(4,148
)
$
(1,410
)
                                 
Net loss attributable to common stockholders – diluted
 
$
(2,535
)
 
$
(712
)
 
$
(4,148
)
 
$
(1,410
)
                                 
Denominator:
                               
Weighted-average shares used in computing net loss per
                               
share attributable to common stockholders – basic
   
151,560
     
135,850
     
145,466
     
135,850
 
Effect of potentially dilutive securities:
                               
Common stock warrants
   
-
     
-
     
-
     
-
 
Convertible preferred warrants
   
-
     
-
     
-
     
-
 
Convertible preferred stock
   
-
     
-
     
-
     
-
 
Common stock options
   
-
     
-
     
-
     
-
 
Non-participating common stock warrants
   
-
     
-
     
-
     
-
 
Weighted-average shares used in computing net loss
                               
per share attributable to common stockholders - diluted
   
151,560
     
135,850
     
145,466
     
135,850
 
Basic net loss per common share
 
$
(0.02
)
 
$
(0.01
)
 
$
(0.03
)
 
$
(0.01
)
Diluted net loss per common share
 
$
(0.02
)
 
$
(0.01
)
 
$
(0.03
)
 
$
(0.01
)
14

F.          Debt

Convertible Promissory Notes
  On September 29, 2015, the Company received funding from existing investors, Biotechnology Value Fund, L.P. and other affiliates of BVF Partners, L.P., in exchange for issuance of convertible promissory notes (the "Notes").

  The Notes have an aggregate principal balance of $1,000,000, accrue interest at a rate of 6% per annum and have a scheduled maturity date of September 28, 2016 (the "Maturity Date").  The outstanding principal and accrued interest on the Notes shall automatically convert into Company equity securities issued in a Qualified Financing (as defined below) at a conversion rate carrying a 15% discount to the lowest price per share (or share equivalent) issued in a Qualified Financing (an "Automatic Conversion").  If, prior to the Maturity Date, the Company enters into an agreement pertaining to a Corporate Transaction (as defined below) and the Notes have not been previously converted pursuant to an Automatic Conversion, then, the outstanding principal balance and unpaid accrued interest of the Notes shall automatically convert in whole into the right of the holder to receive, in lieu of any other payment and in cancellation of the Notes, an amount in cash upon closing of the Corporate Transaction equal to two times the outstanding principal amount of the Notes.

  For purposes of the foregoing:  "Qualified Financing" means a bona fide new money equity securities financing on or before the Maturity Date with total proceeds to the Company of not less than four million dollars; and "Corporate Transaction" means a sale, lease or other disposition of all or substantially all of the Company's assets or a consolidation or merger of  the Company with or into any other corporation or other entity or person, or any other corporate reorganization, in which the stockholders of the Company immediately prior to such consolidation, merger or reorganization own less than fifty percent (50%) of the voting power of the surviving entity immediately after such consolidation, merger or reorganization.

  As of September 30, 2015, the $1,000,000 principal balance of the Notes was recorded in the financial statements at face value, net of a discount of $273,000, as a result of separating the fair value of the Qualified Financing redemption discount ("Redemption Feature") of 15% on the price per share in the Notes. The Redemption Feature qualifies as a derivative and is subject to fair value treatment. The Redemption Feature is amortized over the expected life of the derivative, and the amortization expense is presented with the interest expense from the Notes, yielding an effective interest rate of 40% that is different than the 6% stated in the Notes.

 On December 11, 2015, following the completion of a Qualified Financing described above, the principal and accrued interest amounts under the Notes were converted into 5,414,402 shares of the Company's common stock and warrants to purchase an additional 5,414,402 shares of the Company's common stock at an exercise price per share of $0.22 subject to adjustment. As a result, the Notes were no longer outstanding as of that date.
G. Recently Issued Accounting Pronouncements
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board ("FASB") that are adopted by us as of the specified effective date. Unless otherwise discussed, we believe that the impact of recently issued standards that are not yet effective will not have a material impact on our financial position or results of operations upon adoption.
In May 2014, the FASB issued Accounting Standards Update ("ASU") 2015-14 Revenue, which deferred the effective date of ASU 2014-09 Revenue from Contracts with Customers (ASC 606), which updates the principles for recognizing revenue. ASU 2014-09 also amends the required disclosures of the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. ASU 2014-09 is now effective for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The Company is evaluating the potential impacts of the new standard on its existing revenue recognition policies and procedures.
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern. ASU 2014-15 requires that an entity's management evaluate whether there are conditions or events that raise substantial doubt about the entity's ability to continue as a going concern within one year after the date that the financial statements are issued. ASU 2014-15 is effective for annual periods ending after December 15, 2016 and for interim periods thereafter. The Company is evaluating the potential impacts of this new standard on its quarterly reporting process.
H.             Commitments

         The Company acquires assets still in development and enters into research and development arrangements with third parties that often require milestone and royalty payments to the third party contingent upon the occurrence of certain future events linked to the success of the asset in development. Milestone payments may be required, contingent upon the successful achievement of an important point in the development life-cycle of the pharmaceutical product (e.g., approval of the product for marketing by a regulatory agency). If required by the arrangement, the Company may have to make royalty payments based upon a percentage of the sales of the pharmaceutical product in the event that regulatory approval for marketing is obtained. Because of the contingent nature of these payments, they are not included in the table of contractual obligations. No milestones have been met, nor have any payments been paid, as of March 31, 2016.

         We are also obligated to pay patent filing, prosecution, maintenance and defense costs, if any, for the intellectual property we have licensed from National Jewish Health, National Jewish Medical and Research Center, the University of Colorado and Duke University.
These arrangements may be material individually, and in the unlikely event that milestones for multiple products covered by these arrangements were reached in the same period, the aggregate charge to expense could be material to the results of operations in any one period. In addition, these arrangements often give Aeolus the discretion to unilaterally terminate development of the product, which would allow Aeolus to avoid making the contingent payments; however, Aeolus is unlikely to cease development if the compound successfully achieves clinical testing objectives.
                Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Introduction
Unless otherwise noted, the terms "we," "our" or "us" refer collectively to Aeolus Pharmaceuticals, Inc. and our wholly owned subsidiary, Aeolus Sciences, Inc.
This report contains, in addition to historical information, statements by us with respect to expectations about our business and future results which are "forward-looking" statements under the Private Securities Litigation Reform Act of 1995. These statements and other statements made elsewhere by us or by our representatives, which are identified or qualified by words such as "likely," "will," "suggests," "expects," "might," "believe," "could," "should," "may," "estimates," "potential," "predict," "continue," "would," "anticipates," "plans," or similar expressions, are based on a number of assumptions that are subject to risks and uncertainties. Such statements include, but are not limited to, those relating to our product candidates and funding options, as well as our proprietary technologies and uncertainties and other factors that may cause our actual results to be materially different from historical results or from any results expressed or implied by such forward-looking statements. Important factors that could cause results to differ include risks associated with uncertainties of progress and timing of clinical trials, scientific testing, obtaining regulatory approval, the need to obtain (and obtaining) funding for pre-clinical and clinical trials and operations, the scope and validity of intellectual property protection for our product candidates, proprietary technologies and their uses, new accounting and Securities and Exchange Commission ("SEC") requirements and competition from other biopharmaceutical companies. Certain of these factors and others are more fully described in our filings with the SEC, including, but not limited to, our Annual Report on Form 10-K for the fiscal year ended September 30, 2015, filed with the SEC on December 18, 2015. All forward-looking statements are based on information available as of the date hereof, and we do not assume any obligation to update such forward-looking statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.
15

Operations Summary
Business
We are a biopharmaceutical company leveraging significant U.S. Government funding to develop a platform of novel compounds for use in biodefense, fibrosis, oncology, infectious disease and diseases of the central nervous system.  The platform consists of approximately 180 compounds licensed from the University of Colorado ("UC") Duke University ("Duke") and National Jewish Health ("NJH").
Our lead compound, AEOL 10150 ("10150"), is being developed under contract with the Biomedical Advanced Research and Development Authority ("BARDA" and the "BARDA Contract"), a division of the U.S. Department of Health and Human Services ("HHS"), as a medical countermeasure ("MCM") against the pulmonary sub-syndrome of acute radiation syndrome ("Pulmonary Acute Radiation Syndrome" or "Lung-ARS") and the delayed effects of acute radiation exposure ("DEARE"). Lung-ARS is caused by acute exposure to high levels of radiation due to a nuclear detonation or radiological event.
We are also developing 10150 for the treatment of lung fibrosis, including idiopathic pulmonary fibrosis ("IPF") and other fibrotic diseases.  This new development program was created based upon the data generated from animal studies in Lung-ARS and chemical gas exposure under the BARDA Contract and National Institutes of Health ("NIH") grants.  On March 17, 2015, we announced that 10150 was granted Orphan Drug Designation by the U.S. Food and Drug Administration ("FDA"). The Company plans to initiate a Phase 1 safety study in patients with IPF in 2016. After we have completed safety studies, we plan to initiate efficacy studies in patients with IPF.   AEOL 10150 has previously been tested in two Phase I human clinical trials with no drug-related serious adverse events reported.
We are also developing 10150 for use in combination with radiation therapy for cancer as a treatment to reduce side effects caused by radiation toxicity and improve local tumor control.  Pre-clinical studies at Duke, the University of Maryland and Loma Linda University have demonstrated that 10150 protects healthy, normal tissue, while not interfering with the benefit of radiation therapy or chemotherapy in prostate and lung cancer.  Additional studies have demonstrated that 10150 enhances the anti-tumor activity of chemotherapy and radiation. A significant portion of the development work funded by the BARDA contract is applicable to the development program for radiation oncology, including safety, toxicology, pharmacokinetics and Chemistry, Manufacturing and Controls ("CMC").  The Company intends to initiate safety studies in this indication in 2016. After we have completed safety studies, we plan to initiate studies to demonstrate efficacy in protecting against the toxic side effects related to radiation therapy and/or the improvement of local tumor control.
16

We are also developing 10150 as a MCM for exposure to chemical vesicants (e.g., chlorine gas, sulfur mustard gas and phosgene gas) and nerve agents (e.g., sarin gas and soman gas) with grant money from the NIH Countermeasures Against Chemical Threats ("NIH-CounterACT") program. 10150 has consistently demonstrated safety and efficacy in animal studies of chemical gas exposure and nerve gas exposure.
We are also developing a second compound, AEOL 11114B ("11114"), as a treatment for Parkinson's disease.  Research funded by the Michael J Fox Foundation for Parkinson's disease ("MJFF") demonstrated the neuro-protective activity of 11114 in mouse and rat models of Parkinson's disease. The compounds were invented by Aeolus in collaboration with Brian J. Day, PhD at National Jewish Health and Manisha Patel, PhD at the University of Colorado, Anschutz Medical Campus, Department of Pharmaceutical Sciences in collaboration with the Company.  We have obtained worldwide, exclusive licenses to develop the compounds from NJH and the UC.  We plan to complete the remaining work to file an Investigational New Drug ("IND") application with the FDA by 2017.
In April 2015, we announced the discovery of a new compound, AEOL 20415 ("20415"), which has demonstrated anti-inflammatory and anti-infective properties, and could be effective in treating cystic fibrosis and combatting anti-biotic resistant bacteria. The compound was developed under collaboration between Brian J. Day, PhD at National Jewish Health in Denver, Colorado and Aeolus Pharmaceuticals. We have obtained a worldwide, exclusive license to develop the rights to the compound from NJH. We plan to complete the remaining work to file an Investigational New Drug ("IND") application with the FDA by 2017.

 Finally, we have a pipeline of approximately 180 additional compounds. We expect that the development of additional compounds in our portfolio could be dependent on our finding non-dilutive capital sources to fund the work.
BARDA Contract
Our most extensive development program to date is the advanced development of 10150 for Lung-ARS and DEARE.  On February 11, 2011, we signed a cost-plus contract with BARDA for the development of 10150 as a MCM against Lung-ARS.  BARDA is the government agency responsible for the advanced development and purchase of medical countermeasures for chemical, biological, radiological and nuclear threats.  The contract contemplates the advanced development of 10150 through approval by the FDA under 21 CFR Part 314 Subpart I and Part 601 Subpart H (the "Animal Rule.")  The Animal Rule allows for approval of drugs using only animal studies when human clinical trials cannot be conducted ethically.  The ultimate goal of the BARDA Contract is to complete all of the work necessary to obtain FDA approval for 10150 as a MCM for Lung-ARS.  In addition, the BARDA Contract is designed to generate the data that would allow for acquisition of the drug by BARDA prior to FDA approval under a pre-Emergency Use Authorization.
Pursuant to the BARDA Contract we were awarded approximately $10.4 million for the base period of the contract (from February 2011 to April 2012). On April 16, 2012, we announced that BARDA had exercised two options under the BARDA Contract worth approximately $9.1 million. On September 17, 2013, we announced that BARDA had exercised $6.0 million in additional contract options. On May 07, 2014, we announced that BARDA had exercised a Contract Modification worth approximately $1.8 million.  The Contract Modification allowed Aeolus to reconcile actual costs incurred with billings under the original provisional indirect billing rate. It established a new provisional indirect billing rate and placed a cap on the current and future provisional indirect billing rates.   On June 26, 2015, we announced that BARDA had exercised $3.0 million in additional contract options under its advanced research and development contract for AEOL 10150. On February 8, 2016, BARDA exercised approximately $57,000 in additional contract options under its advanced research and development contract for AEOL 10150.  The February option exercise brings the total contract value exercised as of February 8, 2016 to approximately $30.4 million.  We may receive up to an additional $88.0 million in options exercisable over the remainder of the BARDA Contract.   Options are exercised based on the progress of the development program, including the completion of clinical trials or manufacturing tasks under previously exercised options.
The final goal of the contract is to achieve FDA approval for 10150 and the development of commercial manufacturing capability.  In order to achieve these goals, we believe it will be necessary to exercise the majority of the options in the contract. We also believe that BARDA is likely to continue to exercise options as long as 10150 continues to demonstrate efficacy and safety in animal testing for Lung-ARS.  In the event we begin sales to the U.S. government following the filing of a pre-EUA application, we believe that BARDA is likely to exercise the majority of the remaining options under the contract.  One of the requirements of an EUA is that the development program continue towards the goal of FDA approval. If all of the options are exercised by BARDA, the total value of the contract would be approximately $118.4 million.
17

We believe there are no existing treatments for Lung-ARS or DEARE and we are not aware of any compounds in development that have shown efficacy when administered after exposure to radiation.  10150 has demonstrated efficacy in two animal models (mouse and non-human primate) when administered after exposure to radiation.  The U.S. government's planning scenario for a radiation incident is a 10 kiloton detonation of a nuclear device in a major American city.  It is estimated that several hundred thousand civilians would be exposed to high doses of radiation in this scenario.
Following the events at the Fukushima nuclear plant in Japan in 2011, we performed radiation exposure studies in mice at the request of Japanese researchers to determine how the administration of AEOL 10150 would impact the use of leukocyte growth factors ("LGF") used to treat the hematopoietic or bone marrow syndrome of ARS ("H-ARS").  Data showed that 10150 does not interfere with the efficacy of LGF (in this case Amgen's Neupogen®).  Additionally, the study demonstrated that administration of Neupogen®, the current standard of care for H-ARS, increased damage to the lungs.  When 10150 was administered with Neupogen® this damage was significantly reduced.  We believe that this finding may have important implications for the potential procurement of 10150 for the SNS.  In September 2013, BARDA announced that it had entered into a procurement and inventory management agreement with Amgen to provide Neupogen® for the SNS. On March 30, 2015, the FDA approved Neupogen® for the treatment of H-ARS.

 The BARDA contract is designed to complete the work necessary for 10150 to be purchased for the SNS. BARDA currently acquires drugs for the SNS through a Special Reserve Fund (the "SRF") created under Project BioShield and reauthorized under the Pandemic All-Hazards Preparedness Reauthorization Act of 2013. Although the final goal of the contract is full FDA approval under the Animal Rule, BARDA, based on historical purchases from other suppliers, may purchase product prior to FDA approval following the filing of a pre-EUA application. Procurements from BARDA following a pre-EUA application could result in a significant increase in revenues for Aeolus and potential profitability.

 Activities under the contract to date include animal efficacy studies, animal model development with radiation survival curve studies, dosing studies, bulk drug manufacturing, bulk drug and final drug product manufacturing, validation testing, compliance studies, stability studies, absorption, distribution, metabolism and excretion ("ADME") studies, metabolic studies, genotoxicity studies and the filing of an orphan drug status application and a fast track designation application with the FDA.  CMC work has been completed, pilot lots have been prepared and production is being scaled up under the BARDA Contract.
In August 2014, we filed an Investigational New Drug ("IND") application with the Division of Medical Imaging Products of the U.S. Food & Drug Administration ("FDA") for 10150 as a treatment for Lung-ARS.  On September 4, 2014, the Company announced positive results from a study in non-human primates exposed to lethal radiation and treated with 10150. The study demonstrated that administration of 10150 24 hours after exposure to lethal radiation impacted survival at six months post-exposure as follows: survival in the 60 day treatment group was 50%, compared to 25% survival in the radiation only untreated control group. The data from this study, combined with development work completed in manufacturing and human safety data, will form the basis for a pre-EUA application.
On September 22, 2014, we received a letter from the FDA placing our proposed Phase I study in healthy normal volunteers for 10150 as a treatment for Lung-ARS on clinical hold. The FDA provided the Company with specific concerns that need to be addressed in order to allow for the initiation of studies in healthy normal volunteers.  In consultation with BARDA, the Company submitted a mitigation strategy to the FDA in January of 2015 and met with the FDA in March 2015 and received feedback from the FDA on specific steps to address the clinical hold.  After completing the work requested by the FDA, the Company filed a complete response to the FDA's question on January 20, 2016, and we would expect the FDA to review and respond to that submission within 30 days of the submission. On February 22, 2016 we received notice that the FDA had removed the clinical hold on the Company's IND for 10150 as a treatment for Lung-ARS. The lifting of the clinical hold allows the Company to initiate its planned human safety study in healthy normal volunteers.
As of March 31, 2016, the total contract value exercised by BARDA under the BARDA Contract is $30.4 million. From inception of the BARDA Contract, we have billed BARDA approximately $29.5 million.
Substantially all of the costs for the Lung-ARS program have been funded by the BARDA Contract.
10150 has been tested in two human Phase I safety studies where it was well-tolerated and no adverse events were observed.  Efficacy has been demonstrated in animal models for Lung-ARS, chlorine gas exposure, phosgene gas exposure, sulfur mustard gas exposure (lungs and skin) and nerve gas exposure. In both mouse and non-human primate ("NHP") studies for Lung-ARS, 10150 treated groups showed significantly reduced weight loss, inflammation, oxidative stress, lung damage, and most importantly, mortality. Therapeutic efficacy has been demonstrated when 10150 is administered 24 hours after exposure to radiation, a requirement for consideration as a radiation MCM for the SNS.
We have also benefitted from research funded by grants for a variety of other programs involving 10150 and programs other than 10150.  These grants, as well as the particular areas where we have identified commercialization and development opportunities are described in greater detail in our Annual Report on Form 10-K for the fiscal year ended September 30, 2015, filed with the SEC on December 18, 2015.  This report on Form 10-Q focuses on our material developments, results and trends with respect to the period covered hereby.
Results of Operations
Three months ended March 31, 2016 versus three months ended March 31, 2015
We had net loss of $629,000 and net loss of $712,000 and cash outflows from operations of $935,000 and $199,000 for the three months ended March 31, 2016 and March 31, 2015, respectively.
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Revenue for the three months ended March 31, 2016 was $565,000, which compares to $1,189,000 for the three months ended March 31, 2015. The revenue is from the BARDA contract.  Under the BARDA Contract, we generate contract revenue from a cost-plus fee arrangement. Revenues on reimbursable contracts are recognized as costs are incurred, which is based on allowable costs incurred during the period, plus any recognizable earned fee. We consider fixed fees under cost-plus fee contracts to be earned in proportion to the allowable costs incurred in performance of the contract.
Research and Development ("R&D") expenses decreased $796,000, or 61%, to $501,000 for the three months ended March 31, 2016 from $1,297,000 for the three months ended March 31, 2015. The decrease is primarily attributable to work related to the BARDA Contract.
General and administrative ("G&A") expenses increased $89,000, or 15%, to $693,000 for the three months ended March 31, 2016 from $604,000 for the three months ended March 31, 2015. Legal fees increased by $74,000 due to increased SEC filing requirements in the current period.
Six months ended March 31, 2016 versus six months ended March 31, 2015
We had net losses of $1,662,000 and $1,410,000 and cash outflows from operations of $1,755,000 and $1,269,000 for the six months ended March 31, 2016 and March 31, 2015, respectively.
Revenue for the six months ended March 31, 2016 was $870,000, which compares to $2,114,000 for the six months ended March 31, 2015. The revenue is from the BARDA Contract.  Since being awarded the BARDA Contract, we generate contract revenue from a cost-plus fee arrangement. Revenues on reimbursable contracts are recognized as costs are incurred, generally based on allowable costs incurred during the period, plus any recognizable earned fee. We consider fixed fees under cost-plus fee contracts to be earned in proportion to the allowable costs incurred in performance of the contract.
Research and Development ("R&D") expenses decreased $1,277,000, or 56%, to $993,000 for the six months ended March 31, 2016 from $2,270,000 for the six months ended March 31, 2015. The decrease is primarily attributable to work related to the BARDA Contract.
General and administrative ("G&A") expenses remained constant at $1,254,000 for the six months ended March 31, 2016 and 2015 due to decreases in stock based compensation offset by increases in legal and accounting fees.
Liquidity and Capital Resources
We had cash and cash equivalents of $4,509,000 on March 31, 2016, and $94,000 on September 30, 2015. The increase in cash was primarily due to cash received in the December 2015 financing.
We had net loss of $1,662,000 for the six months ended March 31, 2016. We had cash outflows from operations of $1,755,000. We expect to incur additional losses and negative cash flow from operations during the remainder of fiscal year 2016 and possibly for several more years.
On December 10, 2015, the Company received $4,500,000 in gross proceeds in exchange for the issuance of an aggregate of 4,500 shares of Series C preferred stock and 20,454,546 warrants.
On December 10, 2015, the Company received approximately $2,247,000 in gross proceeds in exchange for the issuance of an aggregate of 10,215,275 shares of common stock and 10,215,275 warrants.
Net cash proceeds from the December 10, 2015 financing, after deducting for expenses, were approximately $6,170,000. The Company also incurred non-cash expenses in the form of 1,214,027 warrants issued to the placement agents, at similar terms as the financing warrants, for services provided.
On February 11, 2011, we were awarded the BARDA Contract to fund the development of AEOL 10150 as a medical countermeasure for Lung-ARS from its current status to FDA approval in response to Special Instructions Amendment 4 to a Broad Agency Announcement (BAA-BARDA-09-34) for advanced research and development of medical countermeasures for chemical, biological, radiological and nuclear threats.  The contract value could be up to $118.4 million depending on options exercised by BARDA and the requirements for approval by the FDA.  Under the BARDA Contract, substantially all of the costs of the development of AEOL 10150 as a medical countermeasure for pulmonary injuries resulting from an acute exposure to radiation from a radiological/nuclear accident or attack, particularly injuries associated with ARS or Delayed Effects of Acute Radiation Exposure would be paid for by the U.S. government through BARDA funding.  We recognized $565,000 in revenue during the quarter ended March 31, 2016 related to the BARDA Contract. The BARDA Contract includes provisions to cover some, but not all, general corporate overhead as well as a small provision for profit. The net impact of the BARDA Contract on our liquidity is that our projected cash burn has been reduced. Certain costs, typically those of being a public company, like legal costs associated with being a public company, Investor Relations/Public Relations costs and patent-related costs, are not included in overhead reimbursement in the BARDA Contract.  In order to fund on-going operating cash requirements or to accelerate or expand our oncology and other programs we may need to raise significant additional funds.
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We do not have any revenues from product sales and, therefore, we rely on investors, grants, collaborations and licensing of our compounds to finance our operations. We generate limited revenue from reimbursable, cost-plus R&D contracts and grants. Revenues on reimbursable contracts are recognized as costs are incurred, generally based on allowable costs incurred during the period, plus any recognizable earned fee. We consider fixed fees under cost-plus fee contracts to be earned in proportion to the allowable costs incurred in performance of the contract.
We have incurred significant losses from operations to date. Our ongoing future cash requirements will depend on numerous factors, particularly the progress of our catalytic antioxidant program, potential government procurements for the national stockpile, clinical trials and/or ability to negotiate and complete collaborative agreements or out-licensing arrangements. In addition, we might sell additional shares of our stock and/or debt and explore other strategic and financial alternatives, including a merger or joint venture with another company, the sale of stock and/or debt, the establishment of new collaborations for current research programs, that include initial cash payments and ongoing research support and the out-licensing of our compounds for development by a third party.
There are significant uncertainties as to our ability to access potential sources of capital. We may not be able to enter into any collaboration on terms acceptable to us, or at all, due to conditions in the pharmaceutical industry or in the economy in general or based on the prospects of our catalytic antioxidant program. Even if we are successful in obtaining collaboration for our antioxidant program, we may have to relinquish rights to technologies, product candidates or markets that we might otherwise develop ourselves. These same risks apply to any attempt to out-license our compounds.
Similarly, due to market conditions, the illiquid nature of our stock and other possible limitations on equity offerings, we may not be able to sell additional securities or raise other funds on terms acceptable to us, if at all. Any additional equity financing, if available, would likely result in substantial dilution to existing stockholders.
Our forecast of the period of time through which our financial resources will be adequate to support our operations is forward-looking information, and actual results could vary.

Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Critical Accounting Policies and Estimates
Revenue Recognition
We do not currently generate revenue from product sales, but do generate revenue from the BARDA Contract.  We recognize revenue from the BARDA Contract in accordance with the authoritative guidance for revenue recognition.  Revenue is recognized when all of the following criteria are met: (i) persuasive evidence of an arrangement exists, (ii) delivery (or passage of title) has occurred or services have been rendered, (iii) the seller's price to the buyer is fixed or determinable, and (iv) collectability is reasonably assured.  We also comply with the authoritative guidance for revenue recognition regarding arrangements with multiple deliverables.
The BARDA Contract is classified as a "cost-plus-fixed-fee" contract. We recognize government contract revenue in accordance with the authoritative guidance for revenue recognition, including the authoritative guidance specific to federal government contracts. Reimbursable costs under the BARDA Contract primarily include direct labor, subcontract costs, materials, equipment, travel and indirect costs. In addition, we receive a fixed fee under the BARDA Contract, which is unconditionally earned as allowable costs are incurred and is not contingent on success factors. Reimbursable costs under this BARDA Contract, including the fixed fee, are generally recognized as revenue in the period the reimbursable costs are incurred and become billable.
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               Item 3. Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market risk is presently limited to the interest rate sensitivity of our cash and cash equivalents, which is affected by changes in the general level of U.S. interest rates. However, we believe that we are not subject to any material market risk exposure and do not expect that changes in interest rates would have a material effect upon our financial position. A hypothetical 10% change in interest rates would not have a material effect on our Statements of Operations or Cash Flows for the three months ended March 31, 2016. We do not have any foreign currency or other derivative financial instruments.
               Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain "disclosure controls and procedures," as such term is defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). In designing and evaluating our disclosure controls and procedures, our management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, our management was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
As of March 31, 2016, we carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer (our Principal Executive Officer) and Chief Financial Officer (our Principal Financial and Accounting Officer), of the effectiveness of our disclosure controls and procedures required by Rule 13a- 15 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based upon that evaluation, our Principal Executive Officer and Principal Financial and Accounting Officer have concluded that our disclosure controls and procedures were not effective as of March 31, 2016  to provide reasonable assurance that certain information (described below) required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.
In connection with the preparation of the Annual Report on Form 10-K for the fiscal year 2015 and the Quarterly Report on Form 10-Q for the period ended March 31, 2016, we determined that a material weakness existed regarding a lack of resources to provide technical accounting oversight and review over financial reporting for complex debt and equity transactions.
A material weakness is a significant deficiency, or combination of deficiencies, in internal control over financial reporting that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. As a result of the determination that there was a lack of resources to provide technical accounting oversight and review over financial reporting for complex debt and equity transactions for the quarter ended December 31, 2015, management has determined that a material weakness existed as of March 31, 2016.
As a result of the material weakness, management is evaluating mitigating controls to minimize errors related to financial reporting for complex transactions.
Changes in Internal Control over Financial Reporting
We have instituted new procedures for internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended March 31, 2016. These procedures consist of the use of external specialists for complex accounting issues. We will continue to monitor the effectiveness of these new control procedures over the remaining quarters of the current fiscal year.
                     PART II.  OTHER INFORMATION
Item 1A.     Risk Factors
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As of March 31, 2016, there have not been any material changes from the risk factors previously disclosed in Part 1, Item 1A of our Annual Report on Form 10-K for the fiscal year ended September 30, 2015, which was filed with the SEC on December 18, 2015.
Item 6. Exhibits
The following exhibits relate to agreements, arrangements or obligations that have arisen, been entered into or became effective or amended during the reporting period covered by the Form 10-Q:

Exhibit #
 
Description
31.1
 
 
Certification of the Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a).
 
31.2
 
 
Certification of the Interim Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a).
 
32.1
 
 
Certification by the Chief Executive Officer and Interim Chief Financial Officer pursuant to 18 U.S.C. §1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
101.INS
 
+
 
XBRL Instance Document
 
101.SCH
 
+
 
XBRL Taxonomy Extension Schema Document
 
101.CAL
 
+
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
101.DEF
 
+
 
XBRL Taxonomy Extension Definition Linkbase Document
 
101.LAB
 
+
 
XBRL Taxonomy Extension Label Linkbase Document
 
101.PRE
 
+
 
XBRL Taxonomy Extension Presentation Linkbase Document
 

+ Attached as Exhibit 101 to this report are documents formatted in XBRL (Extensible Business Reporting Language).
 
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
AEOLUS PHARMACEUTICALS, INC.
 
 
 
 
 
 
Date: May 16, 2016
By 
                                                                                                                     
 
 
John L. McManus
 
 
President and Chief Executive Officer
 
 
(Principal Executive Officer)
 
 
 
   By                                                                                                                       
    David Cavalier
    Chairman, Chief Financial Officer and Secretary
    (Principal Financial and Accounting Officer)



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