Quarterly report pursuant to Section 13 or 15(d)

Fair Value Measurements

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Fair Value Measurements
 9 Months Ended
Sep. 30, 2024
Fair Value Disclosures [Abstract]  
Fair Value Measurements Fair Value Measurements
 
ASC 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): 
  September 30, 2024
  Fair Value Measurements Using
  Quoted prices in active markets for identical assets Significant other observable inputs Significant unobservable inputs
  (Level 1) (Level 2) (Level 3)
Assets               
Investments in money market funds* $ 80,935  $ —  $ — 
Liabilities
Warrant liability $ —  $ —  $ 46,830 
Derivative liability $ —  $ —  $ 11,810 

  December 31, 2023
  Fair Value Measurements Using
  Quoted prices in active markets for identical assets Significant other observable inputs Significant unobservable inputs
  (Level 1) (Level 2) (Level 3)
Assets               
Investments in money market funds* $ 7,077  $ —  $ — 
Liabilities
Derivative liability $ —  $ —  $ 5,550 

*Investments in money market funds are reflected in cash and cash equivalents on the accompanying unaudited condensed consolidated balance sheets.

As of September 30, 2024, the Company’s financial instruments included cash and cash equivalents, restricted cash, other receivables, prepaid and other current assets, accounts payable, accrued expenses and other current liabilities, derivative liability, and warrant liability. As of December 31, 2023, 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, and derivative liability.

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.

Level 3 Valuation

The table presented below is a summary of changes in the fair value of the Company’s Level 3 valuations for the warrant liability and derivative liability for the three and nine months ended September 30, 2024 and September 30, 2023:

  Warrant liability Derivative liability Total
Balance at June 30, 2024 $ 82,855  $ 10,710  $ 93,565 
Change in fair value (36,025) 1,100  (34,925)
Balance at September 30, 2024 $ 46,830  $ 11,810  $ 58,640 
  Warrant liability Derivative liability Total
Balance at December 31, 2023 $ —  $ 5,550  $ 5,550 
Initial valuation of warrant liability 194,901  —  194,901 
Change in fair value (148,071) 6,260  (141,811)
Balance at September 30, 2024 $ 46,830  $ 11,810  $ 58,640 

  Derivative liability Total
Balance at June 30, 2023 $ 5,050  $ 5,050 
Change in fair value (100) (100)
Balance at September 30, 2023 $ 4,950  $ 4,950 

  Derivative liability Total
Balance at December 31, 2022 $ 4,830  $ 4,830 
Change in fair value 120  120 
Balance at September 30, 2023 $ 4,950  $ 4,950 

Warrant liability

On March 28, 2024, the Company closed a private placement investment with institutional investors in which the investors received (i) 19,946 shares of Series C Preferred Stock and (ii) warrants to purchase up to an aggregate of 11,967,526 shares of Avalo’s common stock (or a number of shares of Series C Preferred Stock convertible into the number of shares of common stock the warrant is then exercisable into). Refer to Note 10 - Capital Structure and sub-header “March 2024 Financing” for more information.

The Company determined that the warrants do not satisfy the conditions to be accounted for as equity instruments. As the warrants do not meet the equity contract scope exception, the Company classified the warrants as a derivative liability upon issuance.

The Company’s warrant liability was measured at fair value on the issuance date and is measured at fair value each reporting period thereafter until the warrants are either exercised or expire. As of September 30, 2024, there were 11,967,526 warrants outstanding. Subsequent to September 30, 2024 and through November 6, 2024, 10,026,847 warrants were exercised for gross proceeds of $58.1 million. The warrants expire on November 8, 2024, which is the thirty-first day following the public announcement of the first patient dosed in a Phase 2 trial of AVTX-009 in hidradenitis suppurativa (the “Dosing Date”). Avalo expects no warrant liability as of December 31, 2024 given the expiration on November 8, 2024. Avalo will evaluate the impact of the warrant exercises and/or expirations in the fourth quarter of 2024.

The Company utilizes the Black-Scholes option pricing model to measure fair value of the warrants, which requires assumptions including the value of the stock on the measurement date, exercise price, expected term, expected volatility, and the risk-free interest rate. Certain assumptions, including the expected term and expected volatility, are subjective and require judgment to develop. As a result, if factors or expected outcomes change and we use significantly different assumptions or estimates, our warrant liability could be materially different. The warrant liability was classified as a Level 3 instrument as its value was based on unobservable market inputs. The inputs utilized in the valuation as of September 30, 2024 include the following:
As of September 30, 2024
Common stock price $ 9.50 
Term (in years) 0.1 
Expected volatility 127  %
Risk-free rate 4.93  %
Exercise price $ 5.796933 
Dividend yield rate —  %

The common stock price utilized is the closing stock price of Avalo’s common stock on the last trading day of the reporting period. This input is the main driver of the fair value of the warrant liability as of September 30, 2024. The closing stock price on the last day of the third quarter of 2024 was $9.50 per share compared to the closing stock price on the last day of the second quarter and first quarter of 2024 of $12.47 per share and $21.75 per share, respectively.

The term utilized as of September 30, 2024 represents the contractual expiration date of November 8, 2024, which is the thirty-first day following the Dosing Date.

The other inputs include expected volatility, which, given the short-term of the warrants, is the Company’s historical volatility, and the risk-free interest rate, which is based on the implied yield available on U.S. treasury securities with a maturity equivalent to the term.

Derivative liability

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 Capital LLC (“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 (“Apollo”), including up to $6.25 million of development milestones, up to $67.5 million in sales-based milestones, and royalty payments over a ten year period 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 met 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 AVTX-007 Milestones and Royalties. Subsequent to the transaction date, at each reporting period, the derivative liability is remeasured at fair value. As of September 30, 2024, the fair value of the derivative liability was $11.8 million, of which $7.8 million was attributable to the AVTX-007 Milestones and Royalties and $4.0 million was attributable to the AVTX-501 Milestone. For the nine months ended September 30, 2024, the $6.3 million change in fair value was recognized in other income (expense), net in the accompanying unaudited condensed consolidated statements of operations and comprehensive income (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 3.1 years. The fair value of AVTX-007 Milestones and Royalties was primarily driven by sales forecasts with peak annual net sales reaching $1.8 billion in atopic dermatitis, which is a much larger market opportunity than adult-onset Still’s disease, the previous indication being pursued that was contemplated in valuations through the first quarter of 2024, an approximate 17% probability of success, as well as time to commercialization of approximately 6.3 years. 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 peak annual net sales forecast (for the AVTX-007 Milestones and Royalties) and probability of successes (for both the AVTX-501 Milestone and the AVTX-007 Milestone and Royalties) are the largest drivers of the fair value and therefore changes to such inputs 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 occurred during the nine months ended September 30, 2024 and 2023. No transfers of assets between Level 1 and Level 2 of the fair value measurement hierarchy occurred during the nine months ended September 30, 2024 and 2023.