avtx-20230630

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 June 30, 2023
OR
☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

COMMISSION FILE NUMBER: 001-37590

AVALO THERAPEUTICS, INC.

(Exact name of registrant as specified in its charter)


Delaware (State of incorporation)			45-0705648 (I.R.S. Employer Identification No.)
540 Gaither Road, Suite 400 Rockville, Maryland 20850 (Address of principal executive offices)			(410) 522-8707 (Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:


Title of each class	Trading Symbol	Name of each exchange on which registered
Common Stock, $0.001 par value	AVTX	Nasdaq Capital Market

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 every Interactive Data File required to be submitted 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 such files). Yes ☑ No ☐

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


Large accelerated filer ☐						Accelerated filer ☐
Non-accelerated filer ☑						Smaller reporting company ☑
Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b‑2 of the Exchange Act). Yes ☐ No ☑

As of August 2, 2023, the registrant had 20,249,447 shares of common stock outstanding.

AVALO THERAPEUTICS, INC.

FORM 10-Q

For the Quarter Ended June 30, 2023

TABLE OF CONTENTS

Page

PART I.

FINANCIAL INFORMATION

Item 1.

Financial Statements

Condensed Consolidated Balance Sheets as of June 3 0 , 2023 (Unaudited) and December 31, 2022

Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited) for the Three a nd Six Months Ended June 3 0 , 2023 and 2022

Condensed Consolidated Statements of Changes in Stockholders’ (Deficit ) Equity (Unaudited) for the Three and Six Months Ended June 3 0 , 2023 and 2022

Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 3 0 , 2023 and 2022

Notes to Unaudited Condensed Consolidated Financial Statements

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Item 4.

Controls and Procedures

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

AVALO THERAPEUTICS, INC. and SUBSIDIARIES

Condensed Consolidated Balance Sheets

(In thousands, except share and per share data)


	June 30, 2023		December 31, 2022
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	6,307	$	13,172
Accounts receivable	38		—
Other receivables	6		1,919
Inventory, net	18		20
Prepaid expenses and other current assets	1,135		1,290
Restricted cash, current portion	15		15
Total current assets	7,519		16,416
Property and equipment, net	2,176		2,411
Goodwill	14,409		14,409
Restricted cash, net of current portion	131		131
Total assets	$	24,235	$	33,367
Liabilities and stockholders’ deficit
Current liabilities:
Accounts payable	$	751	$	2,882
Deferred revenue	—		88
Accrued expenses and other current liabilities	7,588		13,214
Notes payable, current	14,115		5,930
Total current liabilities	22,454		22,114
Notes payable, non-current	—		13,486
Royalty obligation	2,000		2,000
Deferred tax liability, net	156		141
Derivative liability	5,050		4,830
Other long-term liabilities	1,544		1,711
Total liabilities	31,204		44,282
Stockholders’ deficit:
Common stock—$0.001 par value; 200,000,000 shares authorized at June 30, 2023 and December 31, 2022; 14,036,940 and 9,430,535 shares issued and outstanding at June 30, 2023 and December 31, 2022, respectively	14		9

Additional paid-in capital	314,755		292,900
Accumulated deficit	(321,738)		(303,824)
Total stockholders’ deficit	(6,969)		(10,915)
Total liabilities and stockholders’ deficit	$	24,235	$	33,367

See accompanying notes to the unaudited condensed consolidated financial statements.

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AVALO THERAPEUTICS, INC. and SUBSIDIARIES

Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited)

(In thousands, except per share data)


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2023		2022		2023		2022
Revenues:
Product revenue, net	$	643	$	1,033	$	1,117	$	2,206

Total revenues, net	643		1,033		1,117		2,206

Operating expenses:
Cost of product sales	708		1,567		1,259		2,286
Research and development	4,658		8,510		10,667		18,094
Selling, general and administrative	2,427		2,784		5,134		14,468
Amortization expense	—		—		—		38
Total operating expenses	7,793		12,861		17,060		34,886
	(7,150)		(11,828)		(15,943)		(32,680)
Other expense:
Interest expense, net	(996)		(1,154)		(1,945)		(2,323)
Change in fair value of derivative liability	(40)		—		(220)		—
Other expense, net	—		—		(25)		(20)
Total other expense, net	(1,036)		(1,154)		(2,190)		(2,343)
Loss before taxes	(8,186)		(12,982)		(18,133)		(35,023)
Income tax expense	7		5		15		15
Net loss and comprehensive loss	$	(8,193)	$	(12,987)	$	(18,148)	$	(35,038)
Net loss per share of common stock, basic and diluted1	$	(0.59)	$	(1.38)	$	(1.41)	$	(3.73)

1 Amounts for prior periods presented have been retroactively adjusted to reflect the 1-for-12 reverse stock split effected on July 7, 2022. See Note 2 for details.

See accompanying notes to the unaudited condensed consolidated financial statements.

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AVALO THERAPEUTICS, INC. and SUBSIDIARIES

Condensed Consolidated Statements of Changes in Stockholders’ Deficit (Unaudited)

(In thousands, except share amounts)


	Common stock			Additional paid-in	Accumulated		Total stockholders’
	Shares	Amount			capital		deficit		deficit
Three Months Ended June 30, 2023
Balance, March 31, 2023	13,200,535	$	13		$	307,499	$	(313,779)	$	(6,267)
Issuance of common shares pursuant to ATM Program, net	2,044,672	2			6,529		—		6,531
Retirement of common shares in exchange for pre-funded warrants	(1,300,000)	(1)			(3,873)		234		(3,640)
Issuance of pre-funded warrants in exchange for retirement of common shares	—	—			3,640		—		3,640
Exercise of pre-funded warrants for common shares	72,110	—			—		—		—
Shares purchased through employee stock purchase plan	19,623	—			67		—		67
Stock-based compensation	—	—			893		—		893
Net loss	—	—			—		(8,193)		(8,193)
Balance, June 30, 2023	14,036,940	$	14		$	314,755	$	(321,738)	$	(6,969)

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	Common stock			Additional paid-in	Accumulated		Total stockholders’
	Shares	Amount			capital		deficit		deficit
Six Months Ended June 30, 2023
Balance, December 31, 2022	9,430,535	$	9		$	292,900	$	(303,824)	$	(10,915)
Issuance of shares of common stock and warrants in underwritten public offering, net	3,770,000	4			13,744		—		13,748
Issuance of common shares pursuant to ATM Program, net	2,044,672	2			6,529		—		6,531
Retirement of common shares in exchange for pre-funded warrants	(1,300,000)	(1)			(3,873)		234		(3,640)
Issuance of pre-funded warrants in exchange for retirement of common shares	—	—			3,640		—		3,640
Exercise of pre-funded warrants for common shares	72,110	—			—		—		—
Shares purchased through employee stock purchase plan	19,623	—			67		—		67
Stock-based compensation	—	—			1,748		—		1,748
Net loss	—	—			—		(18,148)		(18,148)
Balance, June 30, 2023	14,036,940	$	14		$	314,755	$	(321,738)	$	(6,969)


	Common stock			Additional paid-in	Accumulated		Total stockholders’
	Shares1	Amount1			capital1		deficit		equity (deficit)
Three Months Ended June 30, 2022
Balance, March 31, 2022	9,399,517	$	9		$	290,550	$	(284,217)	$	6,342
Restricted stock units vested during period	938	—			—		—		—
Shares purchased through employee stock purchase plan	5,269	—			25		—		25
Stock-based compensation	—	—			669		—		669
Net loss	—	—			—		(12,987)		(12,987)
Balance, June 30, 2022	9,405,724	$	9		$	291,244	$	(297,204)	$	(5,951)

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	Common stock			Additional paid-in	Accumulated		Total stockholders’
	Shares1	Amount1			capital1		deficit		equity (deficit)
Six Months Ended June 30, 2022
Balance, December 31, 2021	9,399,517	$	9		$	285,239	$	(262,166)	$	23,082
Restricted stock units vested during period	938	—			—		—		—
Shares purchased through employee stock purchase plan	5,269	—			25		—		25
Stock-based compensation	—	—			5,980		—		5,980
Net loss	—	—			—		(35,038)		(35,038)
Balance, June 30, 2022	9,405,724	$	9		$	291,244	$	(297,204)	$	(5,951)

1 Amounts for prior periods presented have been retroactively adjusted to reflect the 1-for-12 reverse stock split effected on July 7, 2022. See Note 2 for details.

See accompanying notes to the unaudited condensed consolidated financial statements.

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AVALO THERAPEUTICS, INC. and SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

(Amounts in thousands)


	Six Months Ended June 30,
	2023		2022
Operating activities
Net loss	$	(18,148)	$	(35,038)
Adjustments to reconcile net loss used in operating activities:
Depreciation and amortization	74		97
Stock-based compensation	1,748		5,980
Accretion of debt discount	699		686
Allowance for other long-term asset	—		1,000
Deferred taxes	15		15
Change in fair value of derivative liability	220		—
Changes in assets and liabilities:
Accounts receivable, net	(38)		516
Other receivables	1,913		2,433

Inventory, net	2		15
Prepaid expenses and other assets	155		487

Lease incentive	158
Accounts payable	(2,131)		(1,205)

Deferred revenue	(88)		—
Accrued expenses and other liabilities	(5,627)		(3,537)
Lease liability, net	(30)		14
Net cash used in operating activities	(21,078)		(28,537)
Investing activities
Leasehold improvements	(158)		—
Disposal of property and equipment	25		—
Purchase of property and equipment	—		(56)
Net cash used in investing activities	(133)		(56)
Financing activities


Prepayment on Notes	(6,000)		(14,806)
Proceeds from issuance of common stock and warrants in underwritten public offering, net	13,748		—
Proceeds from sale of common stock pursuant to ATM Program, net	6,531		—



Proceeds from issuance of common stock under employee stock purchase plan	67		25
Net cash provided by financing activities	14,346		(14,781)
Decrease in cash, cash equivalents and restricted cash	(6,865)		(43,374)
Cash, cash equivalents, and restricted cash at beginning of period	13,318		54,864
Cash, cash equivalents, and restricted cash at end of period	$	6,453	$	11,490
Supplemental disclosures of cash flow information
Cash paid for interest	$	1,439	$	1,657

Supplemental disclosures of non-cash activities
Fair value of common stock retired in exchange for issuance of prefunded warrants	$	3,640	$	—

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the condensed consolidated balance sheets that sum to the total of the same such amounts shown in the condensed consolidated statements of cash flows (in thousands):


	June 30,
	2023		2022
Cash and cash equivalents	$	6,307	$	11,249
Restricted cash, current	15		14
Restricted cash, non-current	131		227
Total cash, cash equivalents and restricted cash	$	6,453	11,490

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See accompanying notes to the unaudited condensed consolidated financial statements.

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AVALO THERAPEUTICS, INC. and SUBSIDIARIES

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

For the six months ended June 30, 2023, Avalo generated a net loss of $18.1 million and negative cash flows from operations of $21.1 million. As of June 30, 2023, Avalo had $6.3 million in cash and cash equivalents. The future principal payments inclusive of the final payment fee under the Company’s Loan Agreement (as defined in Note 9) were $15.2 million as of June 30, 2023, which gives effect of the $6.0 million partial prepayment in June of 2023, as collectively agreed upon with the Lenders (as defined in Note 9). On July 20, 2023, the Company entered into a forbearance agreement (the “Forbearance Agreement”) with the Lenders, pursuant to which the Company and the Lenders agreed that an event of default had occurred due to a material adverse change in the Company’s business (the “Existing Default”) and the Lenders agreed to forbear from enforcing its full remedies related to the Existing Default, including acceleration of the outstanding principal payments and final payment fees of $15.2 million, plus interest, fees, and other amounts accrued, until the earliest of (i) August 15, 2023, (ii) the occurrence of any default or event of default (other than the Existing Default) under the Loan Agreement, or (iii) the occurrence of a breach by the Company of any provision in the Forbearance Agreement. In exchange for the Lenders agreeing to enter the Forbearance Agreement, the Company agreed to maintain cash on deposit in deposit accounts subject to an Account Control Agreement (as defined in the Loan Agreement) in an amount not less than the sum of (a) $3.0 million plus (b) one-hundred percent (100%) of the aggregate cash proceeds received by the Company as a result of any future sale of the Company’s equity securities while the Forbearance Agreement is in effect. The Company closely monitors its cash and cash equivalents and intends to raise money through all means available to raise capital to meet its projected operating requirements, including but not limited to sale of equity securities under its “at-the-market” (or “ATM”) program or otherwise, out-licensing transactions, strategic alliances/collaborations, sale of its core and non-core programs, and/or mergers and acquisitions. If the Company is able to negotiate extensions to the Forbearance Agreement and absent future cash raises or modifications to the originally planned principal and interest payments, the Company has approximately 60 days of cash on hand as of the filing date of this Quarterly Report on Form 10-Q.

The Company’s future success and ability to fund its operations within one year following the date on which this Quarterly Report on Form 10-Q is issued depend on its ability to obtain additional capital. There can be no assurance that any financing or business development initiatives can be realized by the Company, or if realized, what the terms may be, or that any amount that the Company is able to raise will be adequate. Further, 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 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. If the Company requires but is unable to obtain additional funding, the Company may be forced to make further 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 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.

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The accompanying unaudited condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company’s ability to continue as a going concern is dependent upon its ability to obtain additional capital as described above. The unaudited financial statements as of June 30, 2023 do not include any adjustments that might result from the outcome of this uncertainty. If the Company is unable to continue as a going concern, it may have to liquidate its assets and may receive less than the value at which those assets are carried on the financial statements and less than the amount of its outstanding debt, leaving no proceeds for stockholders.

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.

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 and six months ended June 30, 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 and six months ended June 30, 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 six months ended June 30, 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

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receivables. For the three months ended June 30, 2023, the Company’s two largest customers accounted for approximately 65% and 35% of the Company’s total net product revenues. For the six months ended June 30, 2023, the Company’s two largest customers accounted for approximately 63% and 37% of the Company’s total net product revenues. Net revenue from sales of prescription drugs was $0.6 million and $1.0 million for the three months ended June 30, 2023 and 2022, respectively, and $1.1 million and $2.2 million for the six months ended June 30, 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 June 30, 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 $1.0 million, all of which is due in December 2024. 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 June 30, 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 and six months ended June 30, 2023 and June 30, 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 June 30, 2023 and 2022 include the weighted average effect of pre-funded warrants, 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 and six months ended June 30, 2023 and June 30, 2022 (in thousands, except share and per share amounts):


	Three Months Ended June 30,
	2023		2022
Net loss	$	(8,193)	$	(12,987)
Weighted average shares	13,971,968		9,400,902
Basic and diluted net loss per share	$	(0.59)	$	(1.38)

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	Six Months Ended June 30,
	2023		2022
Net loss	$	(18,148)	$	(35,038)
Weighted average shares	12,853,579		9,400,214
Basic and diluted net loss per share	$	(1.41)	$	(3.73)

The following outstanding securities have been excluded from the computation of diluted weighted shares outstanding for the three and six months ended June 30, 2023 and 2022, as they could have been anti-dilutive:


	Three and Six Months Ended
	June 30,
	2023	2022
Stock options	1,849,229	1,379,570
Warrants on common stock1	4,136,990	366,990
Restricted Stock Units	—	—

1 The weighted average number of common shares outstanding includes the weighted average outstanding pre-funded warrants for the period because their exercise price is nominal. The weighted average shares outstanding for the three and six months ended June 30, 2023 include the weighted average effect of 525,909 and 321,096 pre-funded warrants, respectively. The weighted average shares outstanding for the three and six months ended June 30, 2022 included the weighted average effect of 114,007 pre-funded warrants.

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):


	June 30, 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*	$	5,042	$	—	$	—
Liabilities
Derivative liability	$	—	$	—	$	5,050

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	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 unaudited condensed consolidated balance sheets.

As of June 30, 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 debt. The carrying amounts reported in the accompanying unaudited 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 was approximately $10 million as of June 30, 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 six months ended June 30, 2023:


	Derivative liability
Balance at December 31, 2022	$	4,830
Change in fair value of derivative liability	220
Balance at June 30, 2023	$	5,050

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”). At the time of the transaction, Armistice was 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 June 30, 2023, the fair value of the derivative liability was $5.1 million, of which $3.7 million was attributable to the AVTX-501 Milestone and $1.3 million was

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attributable to the AVTX-007 Milestones and Royalties. For the six months ended June 30, 2023, the $0.2 million change in fair value was recognized in other expense, net in the accompanying unaudited 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 4.3 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 5.3 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 six months ended June 30, 2023 and 2022. No transfers of assets between Level 1 and Level 2 of the fair value measurement hierarchy occurred during the six months ended June 30, 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 June 30, 2023 was 5.1 years.

Supplemental balance sheet information related to the leased properties include (in thousands):


	As of
	June 30, 2023		December 31, 2022
Property and equipment, net	$	1,457	$	1,750

Accrued expenses and other current liabilities	$	535	$	532
Other long-term liabilities	1,544		1,711
Total operating lease liabilities	$	2,079	$	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 unaudited 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 and six months ended June 30, 2023 and 2022 were as follows (in thousands):

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	Three Months Ended June 30,				Six Months Ended June 30,
	2023		2022		2023		2022
Operating lease cost*	$	132	$	122	$	253	$	239

*Includes short-term leases, which are immaterial.

The following table shows a maturity analysis of the operating lease liabilities as of June 30, 2023 (in thousands):



	Undiscounted Cash Flows
July 1, 2023 through December 31, 2023	$	267
2024	537
2025	547
2026	557
2027	258
2028	201
Thereafter	224
Total lease payments	$	2,591
Less implied interest	(512)
Total	$	2,079

7. Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities as of June 30, 2023 and December 31, 2022 consisted of the following (in thousands):


	As of
	June 30, 2023		December 31, 2022
Research and development	$	3,339	$	6,293
Compensation and benefits	527		2,699
Selling, general and administrative	717		1,008
Commercial operations	1,863		1,694
Royalty payment	607		508
Lease liability, current	535		532
Other	—		480
Total accrued expenses and other current liabilities	$	7,588	$	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 six months ended June 30, 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.

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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 of 2023, the Company, as collectively agreed upon with the Lenders, prepaid $6.0 million of principal. Additionally, in the second quarter of 2022, the Company, as collectively agreed upon with the Lenders, prepaid $15.0 million, of which $14.8 million was applied to principal and the remainder applied to accrued interest. As of June 30, 2023, the outstanding notes payable balance was $15.2 million, inclusive of the final payment fee.

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 (see below), 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.

On July 20, 2023, the Company entered into a Forbearance Agreement with the Lenders, pursuant to which the Company and the Lenders agreed that an event of default had occurred due to a material adverse change in the Company’s business and the Lenders agreed to forbear from enforcing its full remedies related to the Existing Default, including acceleration of the outstanding principal payments and final payment fees of $15.2 million, plus interest, fees, other amounts accrued, until the earliest of (i) August 15, 2023, (ii) the occurrence of any default or event of default (other than the Existing Default) under the Loan Agreement, or (iii) the occurrence of a breach by the Company of any provision in the Forbearance Agreement. In exchange for the Lenders agreeing to enter the Forbearance Agreement, the Company agreed to maintain cash on deposit in deposit accounts subject to an Account Control Agreement (as defined in the Loan Agreement) in an amount not less than the sum of (a) $3.0 million plus (b) one-hundred percent (100%) of the aggregate cash proceeds received by Company as a result of the any future sale of the Company’s equity securities while the Forbearance Agreement is in effect. As of June 30, 2023, the carrying value of the notes payable was $14.1 million and is classified as a current liability.

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 on the date of issuance 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 17.1% as of June 30, 2023.

Balance sheet information related to the note payable for the Notes is as follows (in thousands):

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	As of
	June 30, 2023		December 31, 2022		Maturity
Initial Note	$	8,711	$	12,139	January 2025
Second Note	4,355		6,070		February 2025
Third Note	2,178		3,035		April 2025
Notes payable, gross1	$	15,244	$	21,244
Less: Unamortized debt discount and issuance costs	1,129		1,828
Carrying value of notes payable, current	$	14,115	$	19,416
Less: Current portion	14,115		5,930
Carrying value of notes payable, non-current	$	—	$	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 June 30, 2023, the contractual future principal payments, excluding the Lender’s right to accelerate the maturity of the obligations on the earliest of (i) August 15, 2023, (ii) the occurrence of any default or event of default (other than the Existing Default) under the Loan Agreement, or (iii) the occurrence of a breach by the Company of any provision in the Forbearance Agreement, were as follows (in thousands):


	As of June 30, 2023
2023	$	4,168
2024	9,463
2025	1,613
2026	—
Total principal payments1	$	15,244

1 Balance includes $1.1 million final payment fee, which represents 3% of the original principal loan amount.

If the Company is unable to reach an agreement with its Lenders to waive the Existing Default or extend the forbearance period prior to the expiration of the Forbearance Agreement on August 15, 2023, the Forbearance Agreement will terminate automatically and without further notice or action, the effect of which shall permit the Lenders to immediately exercise any and all rights and remedies available under the Loan Agreement, including acceleration of the outstanding principal payments and final payment fees, plus interest, fees, and other amounts accrued.

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 June 30, 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

Exchange Agreement

In May 2023, the Company entered into an exchange agreement (the “Exchange Agreement”) with entities affiliated with Venrock Healthcare Capital Partners (“Venrock”), pursuant to which the Company exchanged an aggregate of 1.3 million shares of the Company’s common stock, par value $0.001 per share, owned by Venrock for pre-funded warrants (the “Exchange Warrants”) to purchase an aggregate of 1.3 million shares of common stock (subject to adjustment in the event of stock splits, recapitlizations and other similar events affecting common stock), with an exercise price of $0.001 per share. The Exchange Warrants are exercisable at any time, except that the Exchange Warrants will not be exercisable by Venrock if, upon giving effect or immediately prior thereto, Venrock would beneficially own more than 9.99% of the total number of issued and outstanding common stock, which percentage may change at the holders’ election to any other number less than or equal to 19.99% upon 61 days’ notice to the Company. The holders of the Exchange Warrants will not have the right to vote on any matter except to the extend required by Delaware law. In accordance with ASC No. 505, Equity, the Company recorded the retirement of the common stock exchanged as a reduction of

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common shares outstanding and a corresponding impact to additional paid-in-capital and accumulated deficit at the fair value of the Exchange Warrants on the issuance date. The Exchange Warrants were classified as equity in accordance with ASC 480 and the fair value of the Exchange Warrants was recorded as a credit to additional paid-in-capital and is not subject to remeasurement. The Company determined that the fair value of the Exchange Warrants is substantially similar to the fair value of the retired shares on the issuance date due to the negligible exercise price for the Exchange Warrants. As of June 30, 2023, none of the Exchange Warrants have been exercised.

At-the-Market Offering Program

In May 2023, the Company entered into an “at-the-market” sales agreement with Oppenheimer & Co. Inc. (“Oppenheimer”), pursuant to which the Company may sell from time to time, shares of its common stock having an aggregate offering price of up to $9,032,567 through Oppenheimer. In the second quarter of 2023, the Company sold approximately 2.0 million shares under the ATM program for net proceeds of approximately $6.5 million.

Subsequent to June 30, 2023 and as of the filing date of this Quarterly Report on Form 10-Q, the Company sold an additional 6.2 million shares under the ATM program for gross proceeds of approximately $1.3 million.

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, who was a significant stockholder of the Company at the time of the financing, 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 June 30, 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
41,701	$	0.012	—
33,656	$	31.20	June 2031
3,770,000	$	5.00	February 2024
1,300,000	$	0.001	—
5,478,691

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

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made available for issuance. As of June 30, 2023, there were 41,183 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 and second quarter of 2023, 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 and six months ended June 30, 2023 and 2022 was as follows (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2023		2022		2023		2022
Research and development	$	331	$	365	$	658	$	653
Selling, general and administrative	562		304		1,090		5,327
Total stock-based compensation	$	893	$	669	$	1,748	$	5,980

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 six months ended June 30, 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	760,272	$	2.72	$	2.06


Expired	(339,910)	$	42.99	$	27.13
Balance at June 30, 2023	1,765,894	$	14.42	$	8.98	8.6

Exercisable at June 30, 2023	563,963	$	31.73	$	18.54	7.1

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. In May 2023, the Company granted 0.3 million options with service-based vesting conditions to its employees that vest over one year.

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 June 30, 2023, the aggregate intrinsic value of options outstanding was zero. There were 0.2 million options that vested during the six months ended June 30, 2023 with a weighted average exercise price of $11.13 per share. The total grant date fair value of shares which vested during the six months ended June 30, 2023 was $1.7 million.

The Company recognized stock-based compensation expense of $0.9 million and $1.7 million related to stock options with service-based vesting conditions for the three and six months ended June 30, 2023, respectively. At June 30, 2023, there was $4.5 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 1.8 years.

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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 six months ended June 30, 2023:


Service-based options
Expected term of option (in years)						5 - 6.25
Expected stock price volatility						89.8% - 146.0%
Risk-free interest rate						3.43% - 4.13%
Expected annual dividend yield						0%

Stock options with market-based vesting conditions

As of June 30, 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 1.0 years. There were no stock options with market-based vesting conditions granted, exercised, or forfeited for the six months ended June 30, 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, (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 June 30, 2023, 192,079 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 $41 thousand and $0.1 million for the three and six months ended June 30, 2023, respectively.

12. Income Taxes

The Company recognized minimal income tax expense for the three and six months ended June 30, 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

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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.

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 six months ended June 30, 2023. There has been no cumulative expense recognized as of June 30, 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 six months ended June 30, 2023. There has been $0.5 million of cumulative expense recognized as of June 30, 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

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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 six months ended June 30, 2023. There has been no cumulative expense recognized as of June 30, 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 June 30, 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, who was a significant stockholder of the Company at the time of the financing and whose chief investment officer, Steven Boyd, and managing director, Keith Maher, served on Avalo’s Board until August 8, 2022. 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 June 30, 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.

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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 June 30, 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 June 30, 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 June 30, 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 June 30, 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 unaudited condensed consolidated balance sheet as of June 30, 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

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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.

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

This Quarterly Report on Form 10-Q and the information incorporated herein by reference contain forward-looking statements that involve a number of risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Forward-looking statements can be identified by the use of forward-looking words such as “projects,” “may,” “might,” “will,” “could,” “would,” “should,” “continue,” “seeks,” “aims,” “predicts,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “potential,” “pro forma” or other similar words (including their use in the negative), or by discussions of future matters such as: the future financial and operational outlook; the development of product candidates; and other statements that are not historical. Although our forward-looking statements reflect the good faith judgment of our management, these statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties, and actual results and outcomes may differ materially from results and outcomes discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those below and elsewhere in this Quarterly Report on Form 10-Q, particularly in Part II – Item 1A, “Risk Factors,” as well as in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 29, 2023, and in our other filings with the SEC. Statements made herein are as of the date of the filing of this Quarterly Report on Form 10-Q with the SEC and should not be relied upon as of any subsequent date. Unless otherwise required by applicable law, we do not undertake, and we specifically disclaim any obligation to update any forward-looking statements to reflect occurrences, developments, unanticipated events or circumstances after the date of such statement.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited financial statements and related notes that appear in Item 1 of this Quarterly Report on Form 10-Q and with our audited financial statements and related notes for the year ended December 31, 2022 appearing in our Annual Report on Form 10-K filed with the SEC on March 29, 2023.

Overview

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-signaling 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.

Management’s primary evaluation of the success of the Company is the ability to progress its pipeline assets forward towards commercialization or opportunistically out-licensing rights to indications or geographies. This success depends not only on the operational execution of the programs, but also the ability to secure sufficient funding to support the programs.

The following chart summarizes key information about our pipeline:

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Pipeline Chart (July 2023)_V2_803 LOI.jpg

Liquidity

For the six months ended June 30, 2023, Avalo generated a net loss of $18.1 million and negative cash flows from operations of $21.1 million. As of June 30, 2023, Avalo had $6.3 million in cash and cash equivalents. The future principal payments inclusive of the final payment fee under the Company’s Loan Agreement (as defined in Note 9 to the unaudited condensed consolidated financial statements) were $15.2 million as of June 30, 2023, which gives effect to the $6.0 million partial prepayment in June of 2023, as collectively agreed upon with the Lenders (as defined in Note 9 to the unaudited condensed consolidated financial statements). On July 20, 2023, the Company entered into a forbearance agreement (the “Forbearance Agreement”) with the Lenders, pursuant to which the Company and the Lenders agreed that an event of default had occurred due to a material adverse change in the Company’s business (the “Existing Default”) and the Lenders agreed to forbear from enforcing its full remedies related to the Existing Default, including acceleration of the outstanding principal payments and final payment fees of $15.2 million, plus interest, fees, and other amounts accrued, until the earliest of (i) August 15, 2023, (ii) the occurrence of any default or event of default (other than the Existing Default) under the Loan Agreement, or (iii) the occurrence of a breach by the Company of any provision in the Forbearance Agreement. In exchange for the Lenders agreeing to enter the Forbearance Agreement, the Company agreed to maintain cash on deposit in deposit accounts subject to an Account Control Agreement (as defined in the Loan Agreement) in an amount not less than the sum of (a) $3.0 million plus (b) one-hundred percent (100%) of the aggregate cash proceeds received by the Company as a result of any future sale of the Company’s equity securities while the Forbearance Agreement is in effect. The Company closely monitors its cash and cash equivalents and intends to raise money through all means available to raise capital to meet its projected operating requirements, including but not limited to sale of equity securities under its “at-the-market” (or “ATM”) program or otherwise, out-licensing transactions, strategic alliances/collaborations, sale of its core and non-core programs, and/or mergers and acquisitions. If the Company is able to negotiate extensions to the Forbearance Agreement and absent future cash raises or modifications to the originally planned principal and interest payments, the Company has approximately 60 days of cash on hand as of the filing date of this Quarterly Report on Form 10-Q.

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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. If the Company requires but is unable to obtain additional funding, the Company may be forced to make further 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 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.

Recent Developments

On June 26, 2023, the Company announced the topline data results from its Phase 2 randomized, double-blind, placebo-controlled parallel group trial (the “PEAK Trial”) evaluating AVTX-002 in poorly controlled non-eosinophilic asthma. The trial did not meet its primary endpoint, measured by the reduction in asthma-related events. AVTX-002 demonstrated a favorable safety and tolerability profile. AVTX-002 significantly reduced LIGHT levels for the study duration indicating target engagement. Additionally, an exploratory analysis revealed a positive trend in reduction of asthma-related events in patients treated with AVTX-002 as compared to placebo within a substantial sub-population of patients with elevated baseline LIGHT levels.

Our Strategy

Our strategy for increasing stockholder value includes:

•Advancing our pipeline of compounds through development and to regulatory approval;

•Developing the go-to-market strategy to quickly and effectively market, launch, and distribute each of our compounds that receive regulatory approval;

•Opportunistically out-licensing rights to indications or geographies; and

•Acquiring or licensing rights to targeted, complementary differentiated preclinical and clinical stage compounds.

As noted above under “Liquidity”, we need to raise money in the very near term in order to continue as a going concern and be able to execute on this strategy.

Results of Operations

Comparison of the Three Months Ended June 30, 2023 and 2022

Product Revenue, Net

Net product revenue was $0.6 million for the three months ended June 30, 2023, compared to $1.0 million for the three months ended June 30, 2022. The decrease was mainly attributable to a decrease in units sold.

We currently have rights to only one commercial pharmaceutical product, Millipred®, which we consider non-core. Avalo’s license and supply agreement for Millipred® expires on September 30, 2023. Therefore, we expect product revenue to decrease for the year ending December 31, 2023.

Cost of Product Sales

Cost of product sales were $0.7 million for the three months ended June 30, 2023, compared to $1.6 million for the same period in 2022. The decrease was mainly attributable to a decrease in units sold, as discussed above.

Avalo’s license and supply agreement for Millipred® expires on September 30, 2023. Therefore, we expect cost of product sales to decrease for the year ending December 31, 2023.

Research and Development Expenses

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The following table summarizes our research and development expenses for the three months ended June 30, 2023 and 2022 (in thousands):


	Three Months Ended June 30,
	2023		2022
Preclinical expenses	$	211	$	569
Clinical expenses	1,697		3,248
CMC expenses	1,685		2,967

Internal expenses:
Salaries, benefits and related costs	679		1,291
Stock-based compensation expense	331		365
Other	55		70
	$	4,658	$	8,510

Research and development expenses decreased $3.9 million for the three months ended June 30, 2023. This decrease was mainly driven by a $1.6 million decrease in clinical expenses and a $1.3 million decrease in chemistry, manufacturing, and controls (“CMC”) expenses. The decrease in clinical expenses was primarily due to decreased spend on non-core programs in the current period and the decrease in CMC was primarily due to the timing of manufacturing runs, decreased activities for the AVTX-002 PEAK trial as it approached study completion and topline data readout in June 2023, and limited spend for AVTX-007 in the current period as a result of the out-license of the compound in July 2022.

Additionally, salaries, benefits and related costs decreased $0.6 million primarily due to reduced headcount and reduced salary related costs.

Future research and development expenses are difficult to predict given they are highly dependent on the Company’s ability to obtain additional capital to fund its programs and operations, including but not limited to financings and/or out-licensing, strategic alliance/collaborations or sale of its core and non-core programs.

Selling, General and Administrative Expenses

The following table summarizes our selling, general and administrative expenses for the three months ended June 30, 2023 and 2022 (in thousands):


	Three Months Ended June 30,
	2023		2022

Salaries, benefits and related costs	$	431	$	496
Legal, consulting and other professional expenses	1,071		1,554
Stock-based compensation expense	562		304
Advertising and marketing expense	7		14
Other	356		416
	$	2,427	$	2,784

Selling, general and administrative expenses decreased $0.4 million for the three months ended June 30, 2023 compared to the prior period. The decrease was driven by the impact of cost savings initiatives across legal, consulting and other professional expenses. The decrease was partially offset by increased stock-based compensation expense during the period related to the options granted to employees in the second half of 2022 and first half of 2023.

Future selling, general and administrative expenses are difficult to predict given they are highly dependent on the Company’s ability to obtain additional capital to fund its programs and operations, including but not limited to financings and/or out-licensing, strategic alliance/collaborations or sale of its core and non-core programs.

Other Expense, Net

The following table summarizes our other expense, net for the three months ended June 30, 2023 and 2022 (in thousands):

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	Three Months Ended June 30,
	2023		2022

Interest expense, net	(996)		(1,154)
Change in fair value of derivative liability	(40)		—
Other expense, net	—		—
	$	(1,036)	$	(1,154)

Other expense, net was mainly comprised of interest expense related to the Loan Agreement (as defined in Note 9 to the unaudited condensed consolidated financial statements) for the three months ended June 30, 2023 and 2022. In June of 2022, the Company made a partial prepayment of $15.0 million under the venture loan and security agreement which drove the $0.2 million decrease in interest expense compared to the prior period. In June of 2023, the Company prepaid an additional $6.0 million of principal under the venture loan and security agreement.

We expect interest expense to decrease in the second half of 2023 as a result of the prepayment in June of 2023, paired with contractual principal payments beginning in the third quarter of 2023. The extent of the decrease is unknown given the contractual interest rate is tied to the prime rate.

Income Tax Expense

The Company recognized minimal income tax expense for both the three months ended June 30, 2023 and 2022.

Comparison of the Six Months Ended June 30, 2023 and 2022

Product Revenue, Net

Net product revenue was $1.1 million for the six months ended June 30, 2023, compared to $2.2 million for the six months ended June 30, 2022. The decrease was mainly attributable to a decrease in units sold.

Cost of Product Sales

Cost of product sales were $1.3 million for the six months ended June 30, 2023, compared to $2.3 million for the same period in 2022. The decrease was mainly attributable to a decrease in units sold, as discussed above.

Avalo’s license and supply agreement for Millipred® expires on September 30, 2023. Therefore, we expect cost of product sales to decrease for the year ending December 31, 2023.

Research and Development Expenses

The following table summarizes our research and development expenses for the six months ended June 30, 2023 and 2022 (in thousands):


	Six Months Ended June 30,
	2023		2022
Preclinical expenses	$	575	$	1,568
Clinical expenses	4,472		6,034
CMC expenses	2,978		5,113

Internal expenses:
Salaries, benefits and related costs	1,873		4,559
Stock-based compensation expense	658		653
Other	111		167
	$	10,667	$	18,094

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Research and development expenses decreased $7.4 million for the six months ended June 30, 2023 as compared to the prior period. This decrease was mainly driven by a $2.7 million decrease of salaries, benefits and related costs due to severance expense recognized in the first quarter of 2022 from headcount reductions that did not repeat, paired with lower salary costs in the first half of 2023 driven by the reduced headcount.

Additionally, CMC and clinical expenses decreased $2.1 million and $1.6 million, respectively. CMC and clinical expenses decreased due to the out-license of AVTX-007 in July of 2022, paired with decreased spend on non-core programs in 2023. The decrease in clinical expenses was partially offset by increased expenses for the AVTX-002 PEAK Trial as a result of the progression of trial as it approached completion and topline data readout in June of 2023.

Selling, General and Administrative Expenses

The following table summarizes our selling, general and administrative expenses for the six months ended June 30, 2023 and 2022 (in thousands):


	Six Months Ended June 30,
	2023		2022
Salaries, benefits and related costs	$	1,186	$	4,597
Legal, consulting and other professional expenses	2,253		3,797
Stock-based compensation expense	1,090		5,327
Advertising and marketing expense	20		57
Other	585		690
	$	5,134	$	14,468

Selling, general and administrative expenses decreased $9.3 million for the six months ended June 30, 2023 due to severance and stock-based compensation recognized in the first quarter of 2022 from headcount reductions, paired with decreased headcount and cost savings initiatives in the first half of 2023. Notably, we recognized $4.3 million of stock-based compensation in the first half of 2022 as a result of the acceleration and modification of certain separated employees’ stock options that did not repeat. Additionally, salaries, benefits and related costs decreased $3.4 million due to $2.4 million of severance expense recognized in the first half of 2022 from headcount reductions that did not repeat, paired with lower salary costs in the first half of 2023 driven by the reduced headcount. Legal, consulting and other professional expenses decreased $1.5 million due to cost savings initiatives.

Amortization Expense

The following table summarizes our amortization expense for the six months ended June 30, 2023 and 2022 (in thousands):


	Six Months Ended June 30,
	2023		2022

Amortization of intangible assets	$	—	$	38

Avalo’s acquired assembled workforce was fully amortized in the first quarter of 2022, thus driving the decrease as compared to the prior period.

Other Expense, Net

The following table summarizes our other expense, net for the six months ended June 30, 2023 and 2022 (in thousands):

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	Six Months Ended June 30,
	2023		2022

Interest expense, net	(1,945)		(2,323)
Change in fair value of derivative liability	(220)		—
Other expense, net	(25)		(20)
	$	(2,190)	$	(2,343)

Other expense, net was mainly comprised of interest expense related to the Loan Agreement (as defined in Note 9 to the unaudited condensed consolidated financial statements) for the six months ended June 30, 2023 and 2022. In June 2022, the Company made a partial prepayment of $15.0 million under the venture loan and security agreement which drove the decrease in interest expense compared to the prior period. In June of 2023, the Company prepaid an additional $6.0 million of principal under the venture loan and security agreement.

Income Tax Expense

The Company recognized minimal income tax expense for both the six months ended June 30, 2023 and 2022.

Liquidity and Capital Resources

Uses of Liquidity

The Company uses cash to primarily fund the ongoing development of our research and development pipeline assets and costs associated with its organizational infrastructure. Future operating cash flows are difficult to predict given they are highly dependent on the Company’s ability to obtain additional capital to fund its programs and operations, including but not limited to financings and/or out-licensing, strategic alliance/collaborations or sale of its core and non-core programs.

Cash Flows

The following table summarizes our cash flows for the six months ended June 30, 2023 and 2022 (in thousands):


	Six Months Ended June 30,
	2023		2022

Net cash (used in) provided by:
Operating activities	$	(21,078)	$	(28,537)
Investing activities	(133)		(56)
Financing activities	14,346		(14,781)
Net decrease in cash and cash equivalents	$	(6,865)	$	(43,374)

Net cash used in operating activities

Net cash used in operating activities was $21.1 million for the six months ended June 30, 2023 and consisted primarily of a net loss of $18.1 million and non-cash adjustments to reconcile net loss to net cash used in operating activities including stock-based compensation of $1.7 million. Additionally, changes in net liabilities decreased $5.8 million driven by decreases in accrued expenses and other liabilities and accounts payable of $5.6 million and $2.1 million, respectively, partially offset by a $1.9 million decrease in other receivables.

Net cash used in operating activities was $28.5 million for the six months ended June 30, 2022, and consisted primarily of a net loss of $35.0 million and non-cash adjustments to reconcile net loss to net cash used in operating activities including stock-based compensation of $6.0 million and a $1.3 million decrease in changes in net liabilities.

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Future operating cash flows are difficult to predict given they are highly dependent on the Company’s ability to obtain additional capital to fund its programs and operations, including but not limited to financings and/or out-licensing, strategic alliance/collaborations or sale of its core and non-core programs.

Net cash used in investing activities

Net cash used in investing activities was minimal for the six months ended June 30, 2023 and six months ended June 30, 2022.

Net cash provided by (used in) financing activities

Net cash provided by financing activities for the six months ended June 30, 2023 consisted of net proceeds of $13.7 million from an underwritten public offering closed in February 2023 and net proceeds of $6.5 million from the sale of common stock pursuant to the Company’s at-the-market program in the second quarter of 2023, partially offset by the $6.0 million principal prepayment under the Loan Agreement (as defined in Note 9 to the unaudited condensed consolidated financial statements).

Net cash used in financing activities for the six months ended June 30, 2022 consisted of the $14.8 million partial prepayment applied to principal under the Loan Agreement (as defined in Note 9 to the unaudited condensed consolidated financial statements).

Critical Accounting Policies, Estimates, and Assumptions

This Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q, which have been prepared in accordance with GAAP. In preparing the financial statements in conformity with GAAP, the Company makes estimates and assumptions that have an impact on assets, liabilities, revenue and expenses reported. These estimates can also affect supplemental information disclosed by us, including information about contingencies, risk, and financial condition. In our unaudited condensed consolidated financial statements, estimates are used for, but not limited to, revenue recognition, cost of product sales, stock-based compensation, fair value measurements, the valuation of derivative liabilities, cash flows used in management’s going concern assessment, income taxes, goodwill, and clinical trial accruals. The Company believes, given current facts and circumstances, that our estimates and assumptions are reasonable, adhere to GAAP and are consistently applied. Inherent in the nature of an estimate or assumption is the fact that actual results may differ from estimates, and estimates may vary as new facts and circumstances arise. Our most critical accounting estimates and assumptions are included in our Annual Report on Form 10-K for the year ended December 31, 2022 filed with the SEC on March 29, 2023. There have been no material changes to our critical accounting policies during the six months ended June 30, 2023.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements, as defined by applicable SEC rules and regulations.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

As a smaller reporting company, we are not required to provide the information required by this Item.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

As required by Rule 13a-15(b) and Rule 15d-15(b) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, our management, including our principal executive officer and our principal financial officer, conducted an evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q of the effectiveness of the design and operation of our disclosure controls and procedures. In designing and evaluating our disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Based on that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of the end of the period covered by this Quarterly Report on Form 10-Q.

Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports we file or submit under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting identified in management’s evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the period covered by this Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings.

None.

Item 1A. Risk Factors.

In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on March 29, 2023, which could materially affect our business, financial condition, or future results. The risks described in this Quarterly Report on 10-Q and Form 10-K referenced above are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially adversely affect our business, financial condition, or future results of operations and the trading price of our common stock. Except for such additional information and the risk factor set forth below, we believe our risk factors as of the date of this Quarterly Report on Form 10-Q have not changed materially from those described in the Form 10-K referenced above.

Risks Related to Our Financial Position and Capital Needs

If the Company fails to reach an agreement with the Lender (as defined in Note 9 to the unaudited condensed consolidated financial statements) to waive defaults, extend its forbearance period or secure alternative financing, it may not be able to continue operating.

In connection with its entry into the Forbearance Agreement (as defined in Note 1 to the unaudited condensed consolidated financial statements), the Company is evaluating available financial alternatives, including but not limited to sale of equity securities under its “at-the-market” (or “ATM”) program or otherwise, out-licensing transactions, strategic alliances/collaborations, sale of its core and non-core programs, and/or mergers and acquisitions as well as seeking additional waivers, forbearances or amendments to the covenants or other provisions of the Company’s Loan Agreement (as defined in Note 9 to the unaudited condensed consolidated financial statements) to address any future defaults and has engaged financial advisors to assist the Company. If the Company is unable to reach an agreement with its lender to waive the defaults, extend the forbearance period or find alternative financing prior to the expiration of the forbearance period, the Lender of the Loan Agreement may choose to accelerate repayment. The Company cannot provide assurances that it will be successful in negotiating such a waiver or extension of the forbearance period, restructuring of existing debt obligations, obtaining capital or entering into a strategic alternative transaction which provides sufficient funding for the refinancing of its outstanding indebtedness prior to the expiration of the forbearance period or prior to the maturity date of its obligations under the Loan Agreement.

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Item 6. Exhibits.


Exhibit Number						Description of Exhibit

4.1						Form of Exchange Warrant to Purchase Shares of Common Stock of Avalo T herapeutics, I nc. issued to Venrock Healthcare Capital Partners EG, L.P., Venrock Healthcare Partners III, L.P. and VHCP Co-Invest ment Holdings, LLC. (incorporated by reference to Exhibit 4.1 to the Form 8-K filed on June 2, 2023).

10.1						Exchange Agreement, dated as of May 31, 2023, between Avalo Therapeutics, Inc. and Venrock Healthcare Capital Partners EG, L.P., Venrock Healthcare Partners III, L.P. and VHCP Co-Investement Holdings, LLC. (incorporated by reference to Exhibit 10.1 to the Form 8-K filed on June 2, 2023).

10.2						Forbearance Agreement, dated as of July 20, 2023, between Avalo Therapeutics, Inc. and Horizon Credit II LLC, Horizon Funding Trust 2019-1, Horizon Funding I, LLC, Powerscourt Investments XXV Trust and Horizon Technology Finance Corporation (incorporated by reference to the Exhibit 10.1 to Form 8-K filed on July 21, 2023 ).

31.1+						Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2+						Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1+†						Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101						Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of June 30, 2023 (Unaudited) and December 31, 2022; (ii) Condensed Consolidated Statements of Operations (Unaudited) for the Three and Six Months Ended June 30, 2023 and 2022; (iii) Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2023 and 2022; (iv) Condensed Consolidated Statements of Changes in Stockholders’ (Deficit) Equity (Unaudited) for the Three and Six Months Ended June 30, 2023 and 2022; and (v) Notes to Unaudited Financial Statements.

104						Cover Page Interactive Data File, formatted in XBRL (included in Exhibit 101).

+ Filed herewith.

† This certification is being furnished solely to accompany this Quarterly Report on Form 10-Q pursuant to 18 U.S.C. Section 1350, and is not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the registrant, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

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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.

									Avalo Therapeutics, Inc.

Date: August 3, 2023									/s/ Christopher Sullivan
									Christopher Sullivan
									Chief Financial Officer
									(on behalf of the registrant and as the registrant’s principal financial officer)