Notes to Unaudited Condensed Consolidated Financial Statements
1. Business
Avalo Therapeutics, Inc. (the “Company” or “Avalo” or “we”) is a clinical stage biotechnology company focused on the treatment of immune dysregulation by developing therapies that target the LIGHT network.
LIGHT (Lymphotoxin-like, exhibits Inducible expression, and competes with HSV Glycoprotein D for Herpesvirus Entry Mediator (“HVEM”), a receptor expressed by T lymphocytes; also referred to as TNFSF14) is an immunoregulatory cytokine. LIGHT and its signaling receptors, HVEM (TNFRSF14), and lymphotoxin β receptor (TNFRSF3), form an immune regulatory network with two co-receptors of herpesvirus entry mediator, checkpoint inhibitor B and T Lymphocyte Attenuator (“BTLA”), and CD160 (collectively, the “LIGHT-signaling network” or the “LIGHT network”). Accumulating evidence points to the dysregulation of the LIGHT network as a disease-driving mechanism in autoimmune and inflammatory reactions in barrier organs. Therefore, we believe reducing LIGHT levels can moderate immune dysregulation in many acute and chronic inflammatory disorders.
Avalo was incorporated in Delaware and commenced operation in 2011 and completed its initial public offering in October 2015.
Liquidity
In order to meet its cash flow needs, the Company applies a disciplined decision-making methodology as it evaluates the optimal allocation of the Company’s resources between investing in the Company’s existing pipeline assets and acquisitions or in-licensing of new assets. As of March 31, 2023, Avalo had $16.7 million in cash and cash equivalents. For the three months ended March 31, 2023, Avalo generated a net loss of $10.0 million and negative cash flows from operations of $10.1 million. As of March 31, 2023, Avalo had an accumulated deficit of $313.8 million. As of March 31, 2023, the future principal payments under the Company’s Loan Agreement (as defined in Note 9) were $21.2 million, $5.9 million of which are due in 2023 (beginning in the third quarter).
On February 7, 2023, the Company closed an underwritten public offering of 3,770,000 shares of its common stock and warrants to purchase up to an aggregate 3,770,000 shares of common stock, resulting in net proceeds of approximately $13.7 million, after deducting the underwriting discounts and commissions and offering expenses paid by us. The warrants were immediately exercisable at an exercise price of $5.00 per share and are exercisable for one year from the issuance date.
The accompanying unaudited condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern; however, losses are expected to continue as the Company continues to invest in its research and development pipeline assets. The Company will require additional financing to fund its operations and to continue to execute its business strategy within one year after the date the unaudited condensed consolidated financial statements included herein were issued. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.
To mitigate these conditions and to meet the Company’s capital requirements, management plans to use its current cash on hand along with some combination of the following: (i) financings, (ii) out-licensing, strategic alliances/collaborations or sale of our pipeline assets, and (iii) federal and/or private grants. If the Company raises additional funds through collaborations, strategic alliances or licensing arrangements with third parties, the Company might have to relinquish valuable rights to its technologies, future revenue streams, research programs or product candidates. Subject to limited exceptions, the Loan Agreement (as defined in Note 9) prohibits the Company from incurring certain additional indebtedness, making certain asset dispositions, and entering into certain mergers, acquisitions or other business combination transactions without the prior consent of the lenders. Additionally, the Loan Agreement contains certain covenants and certain other specified events, including a material adverse change in the business, that could result in an event of default, which if not cured or waived, could result in the immediate acceleration of all or a substantial portion of the outstanding Notes. If the AVTX-002 PEAK trial, for which we expect topline data in the second quarter of 2023, does not have a positive data readout, it may result in a material adverse change in the business. As of the filing date of this Quarterly Report on Form 10-Q, the Company was not aware of any breach of covenants or occurrence of material adverse change, nor had it received any notice of event of default from the lenders (refer to Note 9 for more information).
If the Company requires but is unable to obtain additional funding, the Company may be forced to make reductions in spending, delay, suspend, reduce or eliminate some or all of its planned research and development programs, or liquidate assets where possible. Due to the uncertainty regarding future financing and other potential options to raise additional funds, management has concluded that substantial doubt exists with respect to the Company’s ability to continue as a going concern within one year after the date that the financial statements in this Quarterly Report on Form 10-Q were issued.
Over the long-term, the Company’s ultimate ability to achieve and maintain profitability will depend on, among other things, the development, regulatory approval, and commercialization of its pipeline assets, and the potential receipt and sale of any priority review vouchers it receives.
2. Basis of Presentation and Significant Accounting Policies
Basis of Presentation
The Company’s unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). Any reference in these notes to applicable guidance is meant to refer to the authoritative GAAP as found in the Accounting Standards Codification (“ASC”) and Accounting Standards Updates (“ASU”) of the Financial Accounting Standards Board (“FASB”).
In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring adjustments, which are necessary to present fairly the Company’s financial position, results of operations, and cash flows. The condensed consolidated balance sheet at December 31, 2022 has been derived from audited financial statements at that date. The interim results of operations are not necessarily indicative of the results that may occur for the full fiscal year. Certain information and footnote disclosure normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to instructions, rules, and regulations prescribed by the United States Securities and Exchange Commission (“SEC”).
The Company believes that the disclosures provided herein are adequate to make the information presented not misleading when these unaudited condensed consolidated financial statements are read in conjunction with the December 31, 2022 audited consolidated financial statements.
In the second quarter of 2022, the Company concluded that it would include sales and marketing expenses within the selling, general and administrative line in the Company’s condensed consolidated statement of operations. The Company reclassified $1.9 million from sales and marketing expense to selling, general and administrative expense for the three months ended March 31, 2022 to conform with the current period presentation.
On July 7, 2022, Avalo effected a 1-for-12 reverse stock split of the outstanding shares of the Company’s common stock. The Company retroactively applied the reverse stock split to common share and per share amounts for periods prior to July 7, 2022, including the unaudited condensed consolidated financial statements for the three months ended March 31, 2022. Additionally, pursuant to their terms, a proportionate adjustment was made to the per share exercise price and number of shares issuable under all of the Company’s outstanding options and warrants, and the number of shares authorized for issuance pursuant to the Company’s equity incentive plans have been reduced proportionately. Avalo retroactively applied such adjustments in the notes to the unaudited condensed consolidated financial statements for periods presented prior to July 7, 2022, including the three months ended March 31, 2022. The reverse stock split did not reduce the number of authorized shares of common and preferred stock and did not alter the par value.
Unless otherwise indicated, all amounts in the following tables are in thousands except share and per share amounts.
Accounting Pronouncements Adopted in 2023
In January 2017, the FASB issued ASU No. 2017-04 Intangibles - Goodwill and Other Topics (Topic 350): Simplifying the Test for Goodwill Impairment. This guidance eliminates the requirement to calculate the implied fair value of goodwill of a reporting unit to measure a goodwill impairment charge. Instead, a company will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value. This new standard was adopted effective January 1, 2023 and will be applied upon any recognition of any future goodwill impairment charge. This ASU has not had a material impact on our financial statements.
Significant Accounting Policies
During the three months ended March 31, 2023, there were no significant changes to the Company’s summary of significant accounting policies contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022, as filed with the SEC on March 29, 2023.
3. Revenue
Avalo generates its product revenue from sales of Millipred®, an oral prednisolone indicated across a wide variety of inflammatory conditions, which is considered a prescription drug. The Company sells its prescription drug in the United States primarily through wholesale distributors. Wholesale distributors account for substantially all of the Company’s net product revenues and trade receivables. For the three months ended March 31, 2023, the Company’s two largest customers accounted for approximately 53% and 47%, respectively, of the Company’s total net product revenues. Net revenue from sales of prescription drugs was $0.5 million and $1.2 million for the three months ended March 31, 2023 and 2022, respectively.
The Company has a license and supply agreement for the Millipred® product with a wholly owned subsidiary of Teva Pharmaceutical Industries Ltd. (“Teva”), which expires on September 30, 2023. Avalo is required to pay Teva fifty percent of the net profit of the Millipred® product following each calendar quarter, subject to a $0.5 million quarterly minimum payment, which commenced on July 1, 2021.
Aytu BioScience, Inc. (“Aytu”), to which the Company sold its rights, title, and interests in assets relating to certain commercialized products in 2019 (the “Aytu Transaction”), managed Millipred® commercial operations until August 31, 2021 pursuant to transition service agreements, which included managing the third-party logistics provider and providing accounting reporting services. Aytu collected cash on behalf of Avalo for revenue generated by sales of Millipred® from the second quarter of 2020 through the third quarter of 2021 and is obligated to transfer cash generated by such sales to Avalo. In the third quarter of 2021, Avalo finalized its trade and distribution channel to allow it to control the third-party distribution and began managing Millipred® commercial operations at that time. The transition services agreement allowed Aytu to withhold cash of $2.0 million until September 30, 2022, and allows withholding of $1.0 million until December 2024.
As of March 31, 2023, the total receivable balance, which represents revenue generated by sales of Millipred® during the time Aytu was managing its commercial operations partially offset by minimal operational liabilities Aytu paid on our behalf, was estimated to be approximately $1.4 million, $0.4 million of which was currently due pursuant to the transition services agreement. Avalo received $0.2 million in the second quarter of 2023. In the second quarter of 2022, Avalo fully reserved the $1.0 million due in December 2024 as a result of Aytu’s conclusion within its Quarterly Report on Form 10-Q for the quarter ended March 31, 2022, that substantial doubt existed with respect to its ability to continue as a going concern within one year after the date of financial statements were issued. This conclusion has remained unchanged within Aytu’s most recent publicly disclosed financial statements. We will continue to re-assess collectability each reporting period.
4. Net Loss Per Share
Basic and diluted EPS is provided below for common stock for the three months ended March 31, 2023 and March 31, 2022.
EPS for common stock is computed by dividing the sum of distributed earnings and undistributed earnings by the weighted average number of shares outstanding for the period. The weighted average number of common shares outstanding as of March 31, 2023 and 2022 include the weighted average effect of the pre-funded warrants issued in connection with the underwritten public offering that closed in January 2021, the exercise of which requires nominal consideration for the delivery of the shares of common stock.
Diluted net loss per share includes the potential dilutive effect of common stock equivalents as if such securities were converted or exercised during the period, when the effect is dilutive. Common stock equivalents include: (i) outstanding stock options and restricted stock units, which are included under the “treasury stock method” when dilutive; and (ii) common stock to be issued upon the exercise of outstanding warrants, which are included under the “treasury stock method” when dilutive. Because the impact of these items is generally anti-dilutive during periods of net loss, there is no difference between basic and diluted loss per common share for periods with net losses. In periods of net loss, losses are allocated to the participating security only if the security has not only the right to participate in earnings, but also a contractual obligation to share in the Company’s losses.
The following tables set forth the computation of basic and diluted net loss per share of common stock for the three months ended March 31, 2023 and March 31, 2022 (in thousands, except share and per share amounts):
| | | | | | | | | | |
| | Three Months Ended |
| | | March 31, 2023 |
| Net loss | | $ | (9,955) | | | |
| Weighted average shares | | 11,722,764 | | | |
| Basic and diluted net loss per share | | $ | (0.85) | | | |
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| | | | | | | | | | | | |
| | Three Months Ended |
| | | March 31, 2022 |
| Net loss | | $ | (22,051) | | | | | |
| Weighted average shares | | 9,399,518 | | | | | |
| Basic and diluted net loss per share | | $ | (2.35) | | | | | |
The following outstanding securities have been excluded from the computation of diluted weighted shares outstanding for the three months ended March 31, 2023 and 2022, as they could have been anti-dilutive:
| | | | | | | | | | | | | | |
| | | Three Months Ended |
| | March 31, |
| | | 2023 | | 2022 |
| Stock options | | 1,460,346 | | 1,424,004 |
Warrants on common stock1 | | 4,136,990 | | 367,187 |
| Restricted Stock Units | | — | | 938 |
1 The weighted average number of common shares outstanding as of March 31, 2023 and 2022 included the weighted average effect of the 114,007 pre-funded warrants outstanding because the exercise of such warrants requires only nominal consideration ($0.012 per share exercise price for each pre-funded warrant). Therefore, these pre-funded warrants are not included in the table above.
5. Fair Value Measurements
ASC No. 820, Fair Value Measurements and Disclosures (“ASC 820”), defines fair value as the price that would be received to sell an asset, or paid to transfer a liability, in the principal or most advantageous market in an orderly transaction between market participants on the measurement date. The fair value standard also establishes a three‑level hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability on the measurement date. The three levels are defined as follows:
•Level 1—inputs to the valuation methodology are quoted prices (unadjusted) for an identical asset or liability in an active market.
•Level 2—inputs to the valuation methodology include quoted prices for a similar asset or liability in an active market or model‑derived valuations in which all significant inputs are observable for substantially the full term of the asset or liability.
•Level 3—inputs to the valuation methodology are unobservable and significant to the fair value measurement of the asset or liability.
The following table presents, for each of the fair value hierarchy levels required under ASC 820, the Company’s assets and liabilities that are measured at fair value on a recurring basis (in thousands):
| | | | | | | | | | | | | | | | | | | | |
| | | March 31, 2023 |
| | | Fair Value Measurements Using |
| | | Quoted prices in | | Significant other | | Significant |
| | | active markets for | | observable | | unobservable |
| | | identical assets | | inputs | | inputs |
| | | (Level 1) | | (Level 2) | | (Level 3) |
| Assets | | | | | | |
| Investments in money market funds* | | $ | 15,684 | | | $ | — | | | $ | — | |
| Liabilities | | | | | | |
| Derivative liability | | $ | — | | | $ | — | | | $ | 5,010 | |
| | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2022 |
| | | Fair Value Measurements Using |
| | | Quoted prices in | | Significant other | | Significant |
| | | active markets for | | observable | | unobservable |
| | | identical assets | | inputs | | inputs |
| | | (Level 1) | | (Level 2) | | (Level 3) |
| Assets | | | | | | |
| Investments in money market funds* | | $ | 12,133 | | | $ | — | | | $ | — | |
| Liabilities | | | | | | |
| Derivative liability | | $ | — | | | $ | — | | | $ | 4,830 | |
*Investments in money market funds are reflected in cash and cash equivalents on the accompanying condensed consolidated balance sheets.
As of March 31, 2023 and December 31, 2022, the Company’s financial instruments included cash and cash equivalents, restricted cash, accounts receivable, other receivables, prepaid and other current assets, accounts payable, accrued expenses and other current liabilities, derivative liability and long-term debt. The carrying amounts reported in the accompanying condensed consolidated financial statements for cash and cash equivalents, restricted cash, accounts receivable, other receivables, prepaid and other current assets, accounts payable, and accrued expenses and other current liabilities approximate their respective fair values because of the short-term nature of these accounts. The estimated fair value of the Company’s debt approximates its carrying value as of March 31, 2023 and is in Level Two of the fair value hierarchy (refer to Note 9 for more information).
Level 3 Valuation
The table presented below is a summary of changes in the fair value of the Company’s Level 3 valuation for the derivative liability for the three months ended March 31, 2023:
| | | | | | | | |
| | | Derivative liability |
| Balance at December 31, 2022 | | $ | 4,830 | |
| Change in fair value of derivative liability | | 180 | |
| Balance at March 31, 2023 | | $ | 5,010 | |
In the fourth quarter of 2022, Avalo sold its economic rights to future milestone and royalty payments for previously out-licensed assets AVTX-501, AVTX-007, and AVTX-611 to ES Therapeutics, LLC (“ES”), an affiliate of Armistice, in exchange for $5.0 million (the “ES Transaction”). Armistice is a significant stockholder of the Company and whose chief investment officer, Steven Boyd, and managing director, Keith Maher, served on Avalo’s Board until August 8, 2022. The ES Transaction was approved in accordance with Avalo’s related party transaction policy.
The economic rights sold include (a) rights to a milestone payment of $20.0 million upon the filing and acceptance of an NDA for AVTX-501 pursuant to an agreement with Janssen Pharmaceutics, Inc., (the “AVTX-501 Milestone”) and (b) rights to any future milestone payments and royalties relating to AVTX-007 under a license agreement with Apollo AP43 Limited, including up to $6.25 million of development milestones, up to $67.5 million in sales-based milestones, and royalty payments of a low single digit percentage of annual net sales (which percentage increases to another low single digit percentage if annual net sales exceed a specified threshold) (the “AVTX-007 Milestones and Royalties”). In addition, Avalo waived all its rights to AVTX-611 sales-based payments of up to $20.0 million that were payable by ES.
The exchange of the economic rights of the AVTX-501 Milestone and AVTX-007 Milestones and Royalties for cash meets the definition of a derivative instrument. The fair value of the derivative liability is determined using a combination of a scenario-based method and an option pricing method (implemented using a Monte Carlo simulation). The significant inputs including probabilities of success, expected timing, and forecasted sales as well as market-based inputs for volatility, risk-adjusted discount rates and allowance for counterparty credit risk are unobservable and based on the best information available to Avalo. Certain information used in the valuation is inherently limited in nature and could differ from Janssen and Apollo’s internal estimates.
The fair value of the derivative liability as of the transaction date was approximately $4.8 million, of which $3.5 million was attributable to the AVTX-501 Milestone and $1.3 million was attributable to the AVX-007 Milestones and Royalties.
Subsequent to the transaction date, at each reporting period, the derivative liability is remeasured at fair value. As of March 31, 2023, the fair value of the derivative liability was $5.0 million, of which $3.8 million was attributable to the AVTX-501 Milestone and $1.3 million was attributable to the AVTX-007 Milestones and Royalties. The $0.2 million change in fair value was recognized in other expense, net in the accompanying condensed consolidated statements of operations and comprehensive loss.
The fair value of the AVTX-501 Milestone was primarily driven by an approximate 23% probability of success to reach the milestone in approximately 4.6 years. The fair value of AVTX-007 Milestones and Royalties were primarily driven by an approximate 17% probability of success, time to commercialization of approximately 5.6 years, and sales forecasts with peak annual net sales reaching $300 million. As discussed above, these unobservable inputs were estimated by Avalo based on limited publicly available information and therefore could differ from Janssen and Apollo’s internal development plans. Any changes to these inputs may result in significant changes to the fair value measurement. Notably, the probability of success is the largest driver of the fair value and therefore changes to such input would likely result in significant changes to such fair value.
In the event that Janssen and/or Apollo are required to make payment(s) to ES Therapeutics pursuant to the underlying agreements, Avalo will recognize revenue under its existing contracts with those customers for that amount when it is no longer probable there would be a significant revenue reversal with any differences between the fair value of the derivative liability related to that payment immediately prior to the revenue recognition and revenue recognized to be recorded as other expense. However, given Avalo is no longer entitled to collect these payments, the potential ultimate settlement of the payments in the future from Janssen and/or Apollo to ES Therapeutics (and the future mark-to-market activity each reporting period) will not impact Avalo’s future cash flows.
No changes in valuation techniques or inputs occurred during the three months ended March 31, 2023 and 2022. No transfers of assets between Level 1 and Level 2 of the fair value measurement hierarchy occurred during the three months ended March 31, 2023 and 2022.
6. Leases
Avalo currently occupies two leased properties, both of which serve as administrative office space. The Company determined that both of these leases are operating leases based on the lease classification test performed at lease commencement.
The annual base rent for the Company’s office located in Rockville, Maryland is $0.2 million, subject to annual 2.5% increases over the term of the lease. The applicable lease provided for a rent abatement for a period of 12 months following the Company’s date of occupancy. The lease has an initial term of 10 years from the date the Company made its first annual fixed rent payment, which occurred in January 2020. The Company has the option to extend the lease two times, each for a period of five years, and may terminate the lease as of the sixth anniversary of the first annual fixed rent payment, upon the payment of a termination fee.
The initial annual base rent for the Company’s office located in Chesterbrook, Pennsylvania is $0.2 million and the annual operating expenses are approximately $0.1 million. The annual base rent is subject to periodic increases of approximately 2.4% over the term of the lease. The lease has an initial term of 5.25 years from the lease commencement on December 1, 2021.
The weighted average remaining term of the operating leases at March 31, 2023 was 5.3 years.
Supplemental balance sheet information related to the leased properties include (in thousands):
| | | | | | | | | | | | | | |
| | | As of |
| | | March 31, 2023 | | December 31, 2022 |
| Property and equipment, net | | $ | 1,682 | | | $ | 1,750 | |
| | | | |
| Accrued expenses and other current liabilities | | $ | 533 | | | $ | 532 | |
| Other long-term liabilities | | 1,629 | | | 1,711 | |
| Total operating lease liabilities | | $ | 2,162 | | | $ | 2,243 | |
The operating lease right-of-use (ROU) assets are included in property and equipment, net and the lease liabilities are included in accrued expenses and other current liabilities and other long-term liabilities in our condensed consolidated balance sheets. The Company utilized a weighted average discount rate of 9.1% to determine the present value of the lease payments.
The components of lease expense for the three months ended March 31, 2023 and 2022 were as follows (in thousands):
| | | | | | | | | | | | | | | | | | |
| | | Three Months Ended March 31, | | |
| | 2023 | | 2022 | | | | |
| Operating lease cost* | | $ | 120 | | | $ | 116 | | | | | |
*Includes short-term leases, which are immaterial.
The following table shows a maturity analysis of the operating lease liabilities as of March 31, 2023 (in thousands):
| | | | | | | | |
| | | |
| | | Undiscounted Cash Flows |
| April 1, 2023 through December 31, 2023 | | $ | 400 | |
| 2024 | | 537 | |
| 2025 | | 547 | |
| 2026 | | 557 | |
| 2027 | | 258 | |
| 2028 | | 201 | |
| Thereafter | | 224 | |
| Total lease payments | | $ | 2,724 | |
| Less implied interest | | (562) | |
| Total | | $ | 2,162 | |
7. Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities as of March 31, 2023 and December 31, 2022 consisted of the following (in thousands):
| | | | | | | | | | | | | | |
| | | As of |
| | | March 31, 2023 | | December 31, 2022 |
| Research and development | | $ | 2,643 | | | $ | 6,293 | |
| Compensation and benefits | | 2,126 | | | 2,699 | |
| Selling, general and administrative | | 725 | | | 1,008 | |
| Commercial operations | | 1,788 | | | 1,694 | |
| Royalty payment | | 445 | | | 508 | |
| Lease liability, current | | 533 | | | 532 | |
| Other | | 13 | | | 480 | |
| Total accrued expenses and other current liabilities | | $ | 8,273 | | | $ | 13,214 | |
8. Cost Reduction Plan
In the first quarter of 2022, the Board approved a cost reduction plan to enable the Company to execute its strategy of prioritizing the development of its most promising programs (the “Plan”). A reduction in workforce plan was approved to reduce headcount and related expenses. The reduction in workforce plan was considered a one-time termination benefit as defined by ASC No. 420, Exit or Disposal Cost Obligations. The one-time termination benefits mainly relate to severance payments to separated employees. As a result, the Company recognized $1.5 million of expense during the first quarter of 2022, of which $0.7 million was recognized in research and development expense, and $0.8 million was recognized in selling, general and administrative expense. $1.4 million of severance payments were paid in the year ended December 31, 2022 and the remaining $0.1 million was paid in the three months ended March 31, 2023. Additionally, $0.4 million of stock-based compensation expense was recognized in the first quarter of 2022 related to the Plan, which was mainly related to accelerated vesting of certain separated employees’ stock options.
In addition, previously and separately, during the first quarter of 2022, the Company separated certain section 16 executive officers. Each of the former executives are entitled to the benefits provided in their respective separation agreements, which include severance payments to be paid over twelve to eighteen months. As a result, the Company recognized $1.7 million expense during the first quarter of 2022 within selling, general and administrative expenses. Additionally, the Company accelerated the vesting of certain outstanding stock options and extended the exercisability periods, which resulted in $3.9 million of compensation cost recognized in first quarter of 2022. Refer to Note 11 for information regarding stock compensation expense related to separations entered into the first quarter of 2022.
9. Notes Payable
On June 4, 2021, the Company entered into a $35.0 million venture loan and security agreement (the “Loan Agreement”) with Horizon Technology Finance Corporation (“Horizon”) and Powerscourt Investments XXV, LP (“Powerscourt”, and together with Horizon, the “Lenders”). In accordance with the Loan Agreement, $20.0 million was funded on the closing date (the “Initial Note”), with the remaining $15.0 million fundable upon the Company achieving certain predetermined milestones, which the Company met in the third quarter of 2021. On July 30, 2021, after achieving a predetermined milestone, the Company borrowed an additional $10.0 million, which was evidenced by a second note payable (the “Second Note”). On September 29, 2021, after achieving a second predetermined milestone, the Company borrowed the remaining $5.0 million, which was evidenced by a third note payable (the “Third Note”, and collectively with the Initial and Second Notes, the “Notes”).
In June 2022, the Company, as collectively agreed upon with the Lenders, prepaid $15.0 million to the Lenders, of which $14.8 million was applied to principal and the remainder applied to accrued interest. As of March 31, 2023, the outstanding notes payable balance was $21.2 million, inclusive of the final payment fee. Avalo might consider additional prepayments prior to principal loan amounts coming due, if collectively agreed upon with the Lenders.
Each advance under the Loan Agreement will mature 42 months from the first day of the month following the funding of the advance. Each advance accrues interest at a per annum rate of interest equal to 6.25% plus the prime rate, as reported in the Wall Street Journal (subject to a floor of 3.25%). The Loan Agreement provides for interest-only payments for each advance for the first 18 months, however the interest-only period was extended to 24 months as a result of the Company satisfying the Interest Only Extension Milestone (as defined in the Loan Agreement) in the third quarter of 2021. Thereafter, amortization payments will be payable in monthly installments of principal and interest through each advance’s maturity date. Upon ten business days’ prior written notice, the Company may prepay all of the outstanding advances by paying the entire principal balance and all accrued and unpaid interest, subject to prepayment charges of up to 3% of the then outstanding principal balance. Upon the earlier of (i) payment in full of the principal balance, (ii) an event of default, or (iii) the maturity date, the Company will pay an additional final payment of 3% of the principal loan amount to the Lenders.
Each advance of the loan is secured by a lien on substantially all of the assets of the Company, other than Intellectual Property and Excluded Collateral (in each case as defined in the Loan Agreement), and contains customary covenants and representations, including a financial reporting covenant and limitations on dividends, indebtedness, collateral, investments, distributions, transfers, mergers or acquisitions, taxes, corporate changes, deposit accounts, and subsidiaries.
The events of default under the Loan Agreement include, but are not limited to, failing to make a payment, breach of covenant, or occurrence of a material adverse change. If an event of default occurs, the Lenders are entitled to accelerate the loan amounts due or take other enforcement actions. The accelerated payment obligations would include the outstanding principal balance (inclusive of the 3% final payment fee), a prepayment charge on the outstanding principal balance of up to 3%, and any accrued and unpaid interest. As of the filing date of this Quarterly Report on Form 10-Q, the Company was not aware of any breach of covenants, occurrence of a material adverse change, nor had it received any notice of event of default from the Lenders.
On June 4, 2021, pursuant to the Loan Agreement, the Company issued warrants to the Lenders to purchase 33,656 shares of the Company’s common stock with an exercise price of $31.20 per share (the “Warrants”). The Warrants are exercisable for ten years from the date of issuance.
Debt issuance costs and the amount allocated to the warrants were recognized as a debt discount and are amortized to interest expense using the effective interest method over the term of the loan. The $1.1 million final payment fee is included in the contractual cash flows and is accreted to interest expense using the effective interest method over the term of the loan.
The effective interest rate of the Notes was 21.2% as of March 31, 2023.
Balance sheet information related to the note payable for the Notes is as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | |
| | As of | | |
| | | March 31, 2023 | | December 31, 2022 | | Maturity |
| Initial Note | | 12,139 | | | 12,139 | | | January 2025 |
| Second Note | | 6,070 | | | 6,070 | | | February 2025 |
| Third Note | | 3,035 | | | 3,035 | | | April 2025 |
Notes payable, gross1 | | 21,244 | | | 21,244 | | | |
| Less: Unamortized debt discount and issuance costs | | 1,478 | | | 1,828 | | | |
| Carrying value of notes payable | | 19,766 | | | 19,416 | | | |
| Less: Current portion | | 9,296 | | | 5,930 | | | |
| Carrying value of notes payable, non-current | | 10,470 | | | 13,486 | | | |
| | | | | | |
| | | | | | |
1 Balance includes $1.1 million final payment fee for the Notes, which represents 3% of the original principal loan amount.
As of March 31, 2023, the contractual future principal payments were as follows (in thousands):
| | | | | | | | | | | | | | | | | | | | |
| | | As of March 31, 2023 |
| 2023 | | $ | 5,930 | |
| 2024 | | 13,463 | |
| 2025 | | 1,851 | |
| 2026 | | — | |
Total principal payments1 | | $ | 21,244 | |
1 Balance includes $1.1 million final payment fee, which represents 3% of the original principal loan amount.
10. Capital Structure
Pursuant to the Company’s amended and restated certificate of incorporation, the Company is authorized to issue two classes of stock, common stock and preferred stock. At March 31, 2023, the total number of shares of capital stock the Company was authorized to issue was 205,000,000, of which 200,000,000 was common stock and 5,000,000 was preferred stock. All shares of common and preferred stock have a par value of $0.001 per share.
Common Stock
Q1 2023 Financing
On February 7, 2023, the Company closed an underwritten public offering of 3,770,000 shares of its common stock and warrants to purchase up to 3,770,000 shares of common stock, at a combined price to the public of $3.98 per share and warrant, resulting in net proceeds of approximately $13.7 million, after deducting the underwriting discounts and commissions and offering expenses paid by us. The warrants were immediately exercisable at an exercise price of $5.00 per share and are exercisable for one year from the issuance date. Armistice participated in the offering by purchasing 0.5 million shares of common stock and 0.5 million warrants, on the same terms as all other investors. Certain affiliates of Nantahala Capital Management LLC and Point72 Asset Management, L.P., which each beneficially owned greater than 5% of the Company’s outstanding common stock at the time of the offering, participated in the offering on the same terms as all other investors.
The warrants were classified as a component of permanent stockholders’ deficit within additional paid-in capital. The warrants are equity classified because they (i) are freestanding financial instruments that are legally detachable and separately exercisable from the equity instruments, (ii) are immediately exercisable, (iii) do not embody an obligation for the Company to repurchase its shares, (iv) permit the holders to receive a fixed number of shares of common stock upon exercise, (v) are indexed to the Company’s common stock and (vi) meet the equity classification criteria. In addition, such warrants do not provide any guarantee of value or return.
Common Stock Warrants
At March 31, 2023, the following common stock warrants were outstanding:
| | | | | | | | | | | | | | |
| Number of common shares | | Exercise price | | Expiration |
| underlying warrants | | per share | | date |
| 333,334 | | $ | 150.00 | | | June 2024 |
| 114,007 | | $ | 0.012 | | | — |
| 33,656 | | $ | 31.20 | | | June 2031 |
| 3,770,000 | | $ | 5.00 | | | February 2024 |
| 4,250,997 | | | | |
11. Stock-Based Compensation
2016 Equity Incentive Plan
In April 2016, our board of directors adopted the 2016 Equity Incentive Plan, which was approved by our stockholders in May 2016 and which was subsequently amended and restated in May 2018 and August 2019 with the approval of our board of directors and our stockholders (the “2016 Third Amended Plan”). During the term of the 2016 Third Amended Plan, the share reserve will automatically increase on the first trading day in January of each calendar year ending on (and including) January 1, 2026, by an amount equal to 4% of the total number of outstanding shares of common stock of the Company on the last trading day in December of the prior calendar year. On January 1, 2023, pursuant to the terms of the 2016 Third Amended and Restated Plan, an additional 377,221 shares were made available for issuance. As of March 31, 2023, there were 430,066 shares available for future issuance under the 2016 Third Amended Plan.
Option grants expire after ten years. Employee options typically vest over four years. Employees typically receive a new hire option grant, as well as an annual grant in the first or second quarter of each year. In addition, in the first and fourth quarters of 2022, employees were also granted options that vest on the first anniversary of the grant date. Options granted to directors typically vest either immediately or over a period of one or three years. Directors may elect to receive stock options in lieu of board compensation, which vest immediately. For stock options granted to employees and non-employee directors, the estimated grant date fair market value of the Company’s stock-based awards is amortized ratably over the individuals’ service periods, which is the period in which the awards vest. Stock-based compensation expense includes expense related to stock options and employee stock purchase plan shares. The amount of stock-based compensation expense recognized for the three months ended March 31, 2023 and 2022 was as follows (in thousands):
| | | | | | | | | | | | | | | | | | |
| | | Three Months Ended March 31, | | |
| | | 2023 | | 2022 | | | | |
| Research and development | | $ | 326 | | | $ | 287 | | | | | |
| Selling, general and administrative | | 529 | | | 5,025 | | | | | |
| Total stock-based compensation | | $ | 855 | | | $ | 5,312 | | | | | |
As a result of separation agreements that the Company entered into in the first quarter of 2022 and in accordance with the terms of the pre-existing employment agreements, the Company accelerated the vesting of certain separated employees’ stock options and modified certain awards to extend the exercisability periods. The Company recognized $4.3 million of compensation cost in the first quarter of 2022, all of which was recognized in selling, general and administrative expense.
Stock options with service-based vesting conditions
The Company has granted options that contain service-based vesting conditions. The compensation cost for these options is recognized on a straight-line basis over the vesting periods. A summary of option activity for the three months ended March 31, 2023 is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Options Outstanding |
| | | Number of shares | | Weighted average exercise price per share | | Weighted average grant date fair value per share | | Weighted average remaining contractual term (in years) |
| Balance at December 31, 2022 | | 1,345,532 | | | $ | 28.24 | | | $ | 17.48 | | | 6.7 |
| Granted | | 371,389 | | | $ | 2.87 | | | $ | 2.21 | | | |
| | | | | | | | |
| | | | | | | | |
| Expired | | (339,910) | | | $ | 42.99 | | | $ | 27.13 | | | |
| Balance at March 31, 2023 | | 1,377,011 | | | $ | 17.76 | | | $ | 10.98 | | | 8.5 |
| | | | | | | | |
| Exercisable at March 31, 2023 | | 487,694 | | | $ | 35.04 | | | $ | 20.32 | | | 7.0 |
In February 2023, the Company granted 0.3 million options with service-based vesting conditions to its employees as part of its annual stock option award that vest over four years.
The aggregate intrinsic value of stock options is calculated as the difference between the exercise price of the stock options and the fair value of the Company’s common stock for those stock options that had exercise prices lower than the fair value of the Company’s common stock. As of March 31, 2023, the aggregate intrinsic value of options outstanding was zero. There were 0.1 million options
that vested during the three months ended March 31, 2023 with a weighted average exercise price of $11.41 per share. The total grant date fair value of shares which vested during the three months ended March 31, 2023 was $1.1 million.
The Company recognized stock-based compensation expense of $0.8 million related to stock options with service-based vesting conditions for the three months ended March 31, 2023. At March 31, 2023, there was $4.6 million of total unrecognized compensation cost related to unvested service-based vesting condition awards. The unrecognized compensation cost is expected to be recognized over a weighted-average period of 2.1 years.
Stock-based compensation assumptions
The following table shows the assumptions used to compute stock-based compensation expense for stock options with service-based vesting conditions granted under the Black-Scholes valuation model for the three months ended March 31, 2023:
| | | | | | | | |
| Service-based options | | |
| Expected term of option (in years) | | 5 - 6.25 |
| Expected stock price volatility | | 89.8% - 91.8% |
| Risk-free interest rate | | 3.60% - 3.87% |
| Expected annual dividend yield | | 0% |
| |
Stock options with market-based vesting conditions
As of March 31, 2023, there were 0.1 million exercisable stock options that contained market-based vesting conditions (that had been previously satisfied). The options have a weighted average share price per share of $39.53 and a weighted average remaining contractual term of 1.2 years. There were no stock options with market-based vesting conditions granted, exercised, or forfeited for the three months ended March 31, 2023.
Employee Stock Purchase Plan
On April 5, 2016, the Company’s board of directors approved the 2016 Employee Stock Purchase Plan (the “ESPP”). The ESPP was approved by the Company’s stockholders and became effective on May 18, 2016 (the “ESPP Effective Date”).
Under the ESPP, eligible employees can purchase common stock through accumulated payroll deductions at such times as are established by the administrator. The ESPP is administered by the compensation committee of the Company’s board of directors. Under the ESPP, eligible employees may purchase stock at 85% of the lower of the fair market value of a share of the Company’s common stock (i) on the first day of an offering period or (ii) on the purchase date. Eligible employees may contribute up to 15% of their earnings during the offering period. The Company’s board of directors may establish a maximum number of shares of the Company’s common stock that may be purchased by any participant, or all participants in the aggregate, during each offering or offering period. Under the ESPP, a participant may not accrue rights to purchase more than $25,000 of the fair market value of the Company’s common stock for each calendar year in which such right is outstanding.
The Company initially reserved and authorized up to 41,667 shares of common stock for issuance under the ESPP. On January 1 of each calendar year, the aggregate number of shares that may be issued under the ESPP automatically increases by a number equal to the lesser of (i) 1% of the total number of shares of the Company’s capital stock outstanding on December 31 of the preceding calendar year, and (ii) 41,667 shares of the Company’s common stock, or (iii) a number of shares of the Company’s common stock as determined by the Company’s board of directors or compensation committee. The number of shares were increased by 41,667 on January 1, 2023. As of March 31, 2023, 211,702 shares remained available for issuance.
In accordance with the guidance in ASC 718-50, Employee Share Purchase Plans, the ability to purchase shares of the Company’s common stock at the lower of the offering date price or the purchase date price represents an option and, therefore, the ESPP is a compensatory plan under this guidance. Accordingly, stock-based compensation expense is determined based on the option’s grant-date fair value and is recognized over the requisite service period of the option. The Company used the Black-Scholes valuation model and recognized stock-based compensation expense of $37,510 for the three months ended March 31, 2023.
12. Income Taxes
The Company recognized minimal income tax expense for the three months ended March 31, 2023 and 2022 due to the significant valuation allowance against the Company’s deferred tax assets and the current and prior period losses.
13. Commitments and Contingencies
Litigation
Litigation - General
The Company may become party to various contractual disputes, litigation, and potential claims arising in the ordinary course of business. The Company currently does not believe that the resolution of such matters will have a material adverse effect on its financial position or results of operations except as otherwise disclosed in this report.
Employee Incentive Bonus
In October 2022, the Compensation Committee of the Board of Directors approved a cash incentive bonus for its employees contingent on positive data of its AVTX-002 PEAK Trial for non-eosinophilic asthma and other specific criteria relating to the Company’s market capitalization and liquidity. The contingent bonus is payable at 25% of each employee’s base compensation, which the Company currently estimates to be approximately $1.3 million. The Company has not recognized a liability within its accompanying consolidated balance sheet as of March 31, 2023 because it does not believe it is probable that the contingent bonus will be earned in context of ASC No. 450, Contingencies. The Company evaluates the contingent bonus in regards to recognizing such liability each reporting period.
Possible Future Milestone Payments for In-Licensed Compounds
General
Avalo is a party to license and development agreements with various third parties, which contain future payment obligations such as royalties and milestone payments. The Company recognizes a liability (and related expense) for each milestone if and when such milestone is probable and can be reasonably estimated. As typical in the biotechnology industry, each milestone has unique risks that the Company evaluates when determining the probability of achieving each milestone and the probability of success evolves over time as the programs progress and additional information is obtained. The Company considers numerous factors when evaluating whether a given milestone is probable including (but not limited to) the regulatory pathway, development plan, ability to dedicate sufficient funding to reach a given milestone and the probability of success.
AVTX-002 KKC License Agreement
On March 25, 2021, the Company entered into a license agreement with Kyowa Kirin Co., Ltd. (“KKC”) for exclusive worldwide rights to develop, manufacture and commercialize AVTX-002, KKC’s first-in-class fully human anti-LIGHT (TNFSF14) monoclonal antibody for all indications (the “KKC License Agreement”). The KKC License Agreement replaced the Amended and Restated Clinical Development and Option Agreement between the Company and KKC dated May 28, 2020.
Under the KKC License Agreement, the Company paid KKC an upfront license fee of $10.0 million, which we recognized within research and development expenses in 2021. The Company is also required to pay KKC up to an aggregate of $112.5 million based on the achievement of specified development and regulatory milestones. Upon commercialization, the Company is required to pay KKC sales-based milestones aggregating up to $75.0 million tied to the achievement of annual net sales targets.
Additionally, the Company is required to pay KKC royalties during a country-by-country royalty term equal to a mid-teen percentage of annual net sales. The Company is required to pay KKC a double-digit percentage (less than 30%) of the payments that the Company receives from any sublicensing of its rights under the KKC License Agreement, subject to certain exclusions. Avalo is responsible for the development and commercialization of AVTX-002 in all indications worldwide (other than the option in the KKC License Agreement that, upon exercise by KKC, allows KKC to develop, manufacture and commercialize AVTX-002 in Japan). In addition to the KKC License Agreement, Avalo is subject to additional royalties upon commercialization of up to an amount of less than 10% of net sales.
No expense related to the KKC License Agreement was recognized in the three months ended March 31, 2023. There has been no cumulative expense recognized as of March 31, 2023 related to the milestones under this license agreement. The Company will continue to monitor the milestones at each reporting period.
AVTX-006 Astellas License Agreement
The Company has an exclusive license agreement with OSI Pharmaceuticals, LLC, an indirect wholly owned subsidiary of Astellas Pharma, Inc. (“Astellas”), for the worldwide development and commercialization of the novel, second generation mTORC1/2 inhibitor (AVTX-006). Under the terms of the license agreement, there was an upfront license fee of $0.5 million. The Company is required to pay Astellas up to an aggregate of $5.5 million based on the achievement of specified development and regulatory milestones. The Company is also required to pay Astellas a tiered mid-to-high single digit percentage of the payments that Avalo receives from any sublicensing of its rights under the Astellas license agreement, subject to certain exclusions. Upon commercialization, the Company is required to pay Astellas royalties during a country-by-country royalty term equal to a tiered mid-to-high single digit percentage of annual net sales. Avalo is fully responsible for the development and commercialization of the program.
No expense related to this license agreement was recognized in the three months ended March 31, 2023. There has been $0.5 million of cumulative expense recognized as of March 31, 2023 related to the milestones under this license agreement, which was recognized in 2021. The Company will continue to monitor the remaining milestones at each reporting period.
AVTX-008 Sanford Burnham Prebys License Agreement
On June 22, 2021, the Company entered into an Exclusive Patent License Agreement with Sanford Burnham Prebys Medical Discovery Institute (the “Sanford Burnham Prebys License Agreement”) under which the Company obtained an exclusive license to a portfolio of issued patents and patent applications covering an immune checkpoint program (AVTX-008).
Under the terms of the Sanford Burnham Prebys License Agreement, the Company incurred an upfront license fee of $0.4 million, as well as patent costs of $0.5 million, which we recognized within research and development expenses and within selling, general and administrative expenses, respectively, in 2021. The Company is required to pay Sanford Burnham Prebys up to an aggregate of $24.2 million based on achievement of specified development and regulatory milestones. Upon commercialization, the Company is required to pay Sanford Burnham Prebys sales-based milestone payments aggregating up to $50.0 million tied to annual net sales targets. Additionally, the Company is required to pay Sanford Burnham Prebys royalties during a country-by-country royalty term equal to a low-to-mid single digit percentage of annual net sales. The Company is also required to pay Sanford Burnham Prebys a tiered low-double digit percentage of the payments that Avalo receives from sublicensing of its rights under the Sanford Burnham Prebys License Agreement, subject to certain exclusions. Avalo is fully responsible for the development and commercialization of the program.
No expense related to the Sanford Burnham Prebys License Agreement was recognized in the three months ended March 31, 2023. There has been no cumulative expense recognized as of March 31, 2023 related to the milestones under this license agreement. The Company will continue to monitor the milestones at each reporting period.
Possible Future Milestone Proceeds for Out-Licensed Compounds
AVTX-301 Out-License
On May 28, 2021, the Company out-licensed its rights in respect of its non-core asset, AVTX-301, to Alto Neuroscience, Inc. (“Alto”). The Company initially in-licensed the compound from an affiliate of Merck & Co., Inc. in 2013.
Under the out-license agreement, the Company received a mid-six digit upfront payment from Alto, which we recognized as license revenue in 2021. The Company is also eligible to receive up to an aggregate of $18.6 million based on the achievement of specified development, regulatory and commercial sales milestones. Additionally, the Company is entitled to a less than single digit percentage royalty based on annual net sales. Alto is fully responsible for the development and commercialization of the program.
The Company has not recognized any milestones as of March 31, 2023.
AVTX-406 License Assignment
On June 9, 2021, the Company assigned its rights, title, interest, and obligations under an in-license covering its non-core asset, AVTX-406, to ES, a wholly owned subsidiary of Armistice. The transaction with ES was approved in accordance with Avalo’s related party transaction policy.
Under the assignment agreement, the Company received a low-six digit upfront payment from ES, which we recognized as license revenue in 2021. The Company is also eligible to receive up to an aggregate of $6.0 million based on the achievement of specified
development and regulatory milestones. Upon commercialization, the Company is eligible to receive sales-based milestone payments aggregating up to $20.0 million tied to annual net sales targets. ES is fully responsible for the development and commercialization of the program.
The Company has not recognized any milestones as of March 31, 2023.
Acquisition Related and Other Contingent Liabilities
Aevi Merger Possible Future Milestone Payments
In the first quarter of 2020, the Company consummated its merger with Aevi Genomic Medicine Inc. (“Aevi”), in which Avalo acquired the rights to AVTX-002, AVTX-006 and AVTX-007 (the “Merger” or the “Aevi Merger”). A portion of the consideration for the Aevi Merger included two future contingent development milestones worth up to an additional $6.5 million, payable in either shares of Avalo’s common stock or cash, at the election of Avalo.
The first milestone was the enrollment of a patient in a Phase 2 study related to AVTX-002 (for treatment of pediatric onset Crohn’s disease), AVTX-006 (for treatment of any indication) or AVTX-007 (for treatment of any indication) prior to February 3, 2022, which would have resulted in a milestone payment of $2.0 million. The Company did not meet the first milestone prior to February 3, 2022. Therefore, no contingent consideration related to this milestone was recognized as of March 31, 2023 and no future contingent consideration will be recognized.
The second milestone is the receipt of an NDA approval for either AVTX-006 or AVTX-007 from the FDA on or prior to February 3, 2025. If this milestone is met, the Company is required to make a milestone payment of $4.5 million. The contingent consideration related to the second development milestone will be recognized if and when such milestone is probable and can be reasonably estimated. No contingent consideration related to the second development milestone has been recognized as of March 31, 2023. The Company will continue to monitor the second milestone at each reporting period.
Ichorion Asset Acquisition Possible Future Milestone Payments
In September 2018, the Company acquired Ichorion Therapeutics, Inc., including acquiring three compounds for inherited metabolic disorders known as CDGs (AVTX-801, AVTX-802 and AVTX-803) and one other preclinical compound. Consideration for the transaction included shares of Avalo common stock and three future contingent development milestones for the acquired compounds worth up to an additional $15.0 million. All milestones are payable in either shares of the Company’s common stock or cash, at the election of Avalo.
The first and second milestones were marketing approval of the first and second product, respectively, by the FDA on or prior to December 31, 2021, which would have resulted in milestone payments of $6.0 million and $5.0 million, respectively. The Company did not meet the first or second milestone as of December 31, 2021. As a result, no contingent consideration related to these milestones was recognized as of March 31, 2023 and no future contingent consideration will be recognized.
The third milestone is marketing approval of a protide molecule by the FDA on or prior to December 31, 2023. If this milestone is met, the Company is required to make a milestone payment of $4.0 million. The contingent consideration related to the third development milestone will be recognized if and when such milestone is probable and can be reasonably estimated. No contingent consideration related to the third milestone has been recognized as of March 31, 2023. The Company will continue to monitor the third development milestone at each reporting period.
AVTX-006 Royalty Agreement with Certain Related Parties
In July 2019, Aevi entered into a royalty agreement, and liabilities thereunder were assumed by Avalo upon close of the Aevi Merger in February 2020. The royalty agreement provided certain investors, including LeoGroup Private Investment Access, LLC on behalf of Garry Neil, the Company’s Chief Executive Officer and Chairman of the Board, and Mike Cola, the Company’s former Chief Executive Officer (collectively, the “Investors”), a royalty stream, in exchange for a one-time aggregate payment of $2.0 million (the “Royalty Agreement”). Pursuant to the Royalty Agreement, the Investors will be entitled collectively to an aggregate amount equal to a low-single digit percentage of the aggregate net sales of the Company’s second generation mTORC1/2 inhibitor, AVTX-006. At any time beginning three years after the date of the first public launch of AVTX-006, Avalo may exercise, at its sole discretion, a buyout option that terminates any further obligations under the Royalty Agreement in exchange for a payment to Investors of an aggregate of 75% of the net present value of the royalty payments. A majority of the independent members of the board of directors and the audit committee of Aevi approved the Royalty Agreement.
Avalo assumed this Royalty Agreement upon closing of the Aevi Merger and it is recorded as a royalty obligation within the Company's accompanying condensed consolidated balance sheet as of March 31, 2023 and December 31, 2022. Because there is a significant related party relationship between the Company and the Investors, the Company has treated its obligation to make royalty payments under the Royalty Agreement as an implicit obligation to repay the funds advanced by the Investors. As the Company makes royalty payments in accordance with the Royalty Agreement, it will reduce the liability balance. At the time that such royalty payments become probable and estimable, and if such amounts exceed the liability balance, the Company will impute interest accordingly on a prospective basis based on such estimates, which will result in a corresponding increase in the liability balance.
Karbinal Royalty Make-Whole Provision
In 2018, in connection with the acquisition of certain commercialized products, the Company entered into a supply and distribution agreement (the “Karbinal Agreement”) with TRIS Pharma Inc. (“TRIS”). As part of the Karbinal Agreement, the Company had an annual minimum sales commitment, which is based on a commercial year that spans from August 1 through July 31, of 70,000 units through 2025. The Company was required to pay TRIS a royalty make whole payment (“Make-Whole Payments”) of $30 for each unit under the 70,000 units annual minimum sales commitment through 2025.
As a part of the Aytu transaction, the Company assigned all its payment obligations, including the Make-Whole Payments, under the Karbinal Agreement (collectively, the “TRIS Obligations”) to Aytu. However, under the original license agreement, the Company could ultimately be liable for the TRIS Obligations to the extent Aytu fails to make the required payments. The future Make-Whole Payments to be made by Aytu are unknown as the amount owed to TRIS is dependent on the number of units sold.
