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 September 30, ~~2022~~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 November ~~3, 2022,~~7, 2023, the registrant had ~~9,414,104~~192,382,419 shares of common stock outstanding.

AVALO THERAPEUTICS, INC.

FORM 10-Q

For the Quarter Ended September 30, ~~2022~~2023

TABLE OF CONTENTS

Page

PART I.

FINANCIAL INFORMATION

Item 1.

Financial Statements

Condensed Consolidated Balance Sheets ~~(Unaudited)~~ as of September 30, ~~2022~~2023 (Unaudited) and December 31, ~~2021~~2022

Condensed Consolidated Statements of Operations and Comprehensive (Loss ) Income (Unaudited) for the Three and Nine Months Ended ~~September~~ Se p tember 30, ~~2022~~2023 and ~~2021~~2022

d)c)

Condensed Consolidated Statements of Changes in Stockholders’ (D ~~eficit)~~ (Deficit) Equity (Unaudited) for the Three and Nine Months Ended September 30, ~~2022~~2023 and ~~2021~~2022

c)d)

Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, ~~2022~~2023 and ~~2021~~2022

Notes to Unaudited Condensed Consolidated Financial Statements

Item 2.

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

2527

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

3437

Item 4.

Controls and Procedures

~~Item 5.~~

~~Other Information~~

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements.

AVALO THERAPEUTICS, INC. and SUBSIDIARIES

Condensed Consolidated Balance Sheets ~~(Unaudited)~~

(In thousands, except share and per share data)

September 30, 2022 December 31, 2021
Assets
Current assets:
Cash and cash equivalents $ 16,943 $ 54,585
Accounts receivable, net — 1,060
Other receivables 1,314 3,739
Inventory, net 22 38
Prepaid expenses and other current assets 1,118 2,372
Restricted cash, current portion 53 51
Total current assets 19,450 61,845
Property and equipment, net 2,507 2,695
Other long-term asset — 1,000
Intangible assets, net — 38
Goodwill 14,409 14,409
Restricted cash, net of current portion 181 227
Total assets $ 36,547 $ 80,214
Liabilities and stockholders’ (deficit) equity
Current liabilities:
Accounts payable $ 1,447 $ 3,369
Deferred revenue 442 —
Accrued expenses and other current liabilities 13,696 16,519
Notes payable, current 2,564 —
Total current liabilities 18,149 19,888
Notes payable, non-current 16,502 32,833
Royalty obligation 2,000 2,000
Deferred tax liability, net 133 113
Other long-term liabilities 1,791 2,298
Total liabilities 38,575 57,132
Stockholders’ (deficit) equity:
Common stock—$0.001 par value; 200,000,000 shares authorized at September 30, 2022 and December 31, 2021; 9,414,104 and 9,399,517 shares issued and outstanding at September 30, 2022 and December 31, 2021, respectively1
9 9
Additional paid-in capital1
291,975 285,239
Accumulated deficit (294,012) (262,166)
Total stockholders’ (deficit) equity (2,028) 23,082
Total liabilities and stockholders’ (deficit) equity $ 36,547 $ 80,214

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 1 for details.~~


	September 30, 2023		December 31, 2022
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	10,180	$	13,172

Other receivables	1,538		1,919
Inventory, net	—		20
Prepaid expenses and other current assets	940		1,290
Restricted cash, current portion	1		15
Total current assets	12,659		16,416
Property and equipment, net	2,071		2,411
Goodwill	14,409		14,409
Restricted cash, net of current portion	131		131
Total assets	$	29,270	$	33,367
Liabilities and stockholders’ equity (deficit)
Current liabilities:
Accounts payable	$	789	$	2,882
Deferred revenue	—		88
Accrued expenses and other current liabilities	5,216		13,214
Notes payable, current	—		5,930
Total current liabilities	6,005		22,114
Notes payable, non-current	—		13,486
Royalty obligation	2,000		2,000
Deferred tax liability, net	164		141
Derivative liability	4,950		4,830
Other long-term liabilities	1,456		1,711
Total liabilities	14,575		44,282
Stockholders’ equity (deficit):
Common stock—$0.001 par value; 200,000,000 shares authorized at September 30, 2023 and December 31, 2022; 192,382,419 and 9,430,535 shares issued and outstanding at September 30, 2023 and December 31, 2022, respectively	192		9

Additional paid-in capital	341,469		292,900
Accumulated deficit	(326,966)		(303,824)
Total stockholders’ equity (deficit)	14,695		(10,915)
Total liabilities and stockholders’ equity (deficit)	$	29,270	$	33,367

See accompanying notes to the unaudited condensed consolidated financial statements.

Table of Contents

AVALO THERAPEUTICS, INC. and SUBSIDIARIES

Condensed Consolidated Statements of Operations and Comprehensive ~~Loss~~(Loss) Income (Unaudited)

(In thousands, except per share data)

Three Months Ended Nine Months Ended
September 30, September 30,
2022 2021 2022 2021
Revenues:
Product revenue, net $ 432 $ 1,350 $ 2,638 $ 4,554
License revenue 14,517 — 14,517 625
Total revenues, net 14,949 1,350 17,155 5,179
Operating expenses:
Cost of product sales 528 908 2,814 1,067
Research and development 7,042 10,551 25,136 48,325
Selling, general and administrative 3,284 5,926 17,752 18,677
Amortization expense — 428 38 1,281
Total operating expenses 10,854 17,813 45,740 69,350
4,095 (16,463) (28,585) (64,171)
Other expense:
Interest expense, net (898) (985) (3,221) (1,207)
Other expense, net — (15) (20) (20)
Total other expense, net from continuing operations (898) (1,000) (3,241) (1,227)
Income (loss) from continuing operations before taxes 3,197 (17,463) (31,826) (65,398)
Income tax expense (benefit) 5 8 20 (180)
Income (loss) from continuing operations $ 3,192 $ (17,471) $ (31,846) $ (65,218)
Income from discontinued operations — 76 — 38
Net income (loss) $ 3,192 $ (17,395) $ (31,846) $ (65,180)
Net income (loss) per share of common stock, basic and diluted1:
Continuing operations $ 0.34 $ (2.09) $ (3.39) $ (8.02)
Discontinued operations 0.00 0.01 0.00 0.00
Net income (loss) per share of common stock, basic and diluted $ 0.34 $ (2.08) $ (3.39) $ (8.02)
Net loss per share of preferred stock, basic and diluted1:
Continuing operations $ (3.34)
Discontinued operations 0.00
Net loss per share of preferred stock, basic and diluted $ (3.34)

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 1 for details.~~


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2023		2022		2023		2022
Revenues:
Product revenue, net	$	236	$	432	$	1,353	$	2,638
License revenue	—		14,517		—		14,517
Total revenues, net	236		14,949		1,353		17,155

Operating expenses:
Cost of product sales	247		528		1,505		2,814
Research and development	1,249		7,042		11,917		25,136
Selling, general and administrative	2,490		3,284		7,624		17,752
Amortization expense	—		—		—		38
Total operating expenses	3,986		10,854		21,046		45,740
	(3,750)		4,095		(19,693)		(28,585)
Other expense:
Interest expense, net	(1,553)		(898)		(3,498)		(3,221)
Change in fair value of derivative liability	100		—		(120)		—
Other expense, net	(17)		—		(42)		(20)
Total other expense, net	(1,470)		(898)		(3,660)		(3,241)
(Loss) income before taxes	(5,220)		3,197		(23,353)		(31,826)
Income tax expense	8		5		23		20
Net (loss) income and comprehensive loss	$	(5,228)	$	3,192	$	(23,376)	$	(31,846)
Net (loss) income per share of common stock, basic and diluted	$	(0.11)	$	0.34	$	(0.96)	$	(3.39)

See accompanying notes to the unaudited condensed consolidated financial statements.

Table of Contents

AVALO THERAPEUTICS, INC. and SUBSIDIARIES

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

(In thousands, except share amounts)

Common stock Additional paid-in Accumulated Total stockholders’

Shares1
Amount1
capital1
deficit deficit
Three Months Ended September 30, 2022
Balance, June 30, 2022 9,405,724 $ 9 $ 291,244 $ (297,204) $ (5,951)
Impact of reverse stock split fractional share round-up 8,380 — — — —
Stock-based compensation — — 731 — 731
Net income — — — 3,192 3,192
Balance, September 30, 2022 9,414,104 $ 9 $ 291,975 $ (294,012) $ (2,028)


	Common stock			Additional paid-in	Accumulated		Total stockholders’
	Shares	Amount			capital		deficit		(deficit) equity
Three Months Ended September 30, 2023
Balance, June 30, 2023	14,036,940	$	14		$	314,755	$	(321,738)	$	(6,969)
Issuance of common shares pursuant to ATM Program, net	177,013,776	177			25,762		—		25,939
Exercise of pre-funded warrants for common shares	1,331,703	1			(1)		—		—
Stock-based compensation	—	—			953		—		953
Net loss	—	—			—		(5,228)		(5,228)
Balance, September 30, 2023	192,382,419	$	192		$	341,469	$	(326,966)	$	14,695

Common stock Additional paid-in Accumulated Total stockholders’

Shares1
Amount1
capital1
deficit deficit
Nine Months Ended September 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
Impact of reverse stock split fractional share round-up 8,380 — — — —
Stock-based compensation — — 6,711 — 6,711
Net loss — — — (31,846) (31,846)
Balance, September 30, 2022 9,414,104 $ 9 $ 291,975 $ (294,012) $ (2,028)


	Common stock			Additional paid-in	Accumulated		Total stockholders’
	Shares	Amount			capital		deficit		(deficit) equity
Nine Months Ended September 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	179,058,448	179			32,291		—		32,470
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	1,403,813	1			(1)		—		—
Shares purchased through employee stock purchase plan	19,623	—			67		—		67
Stock-based compensation	—	—			2,701		—		2,701
Net loss	—	—			—		(23,376)		(23,376)
Balance, September 30, 2023	192,382,419	$	192		$	341,469	$	(326,966)	$	14,695

Table of Contents

Common stock Additional paid-in Accumulated Total stockholders’

Shares1
Amount1
capital1
deficit equity
Three Months Ended September 30, 2021
Balance, June 30, 2021 8,000,746 $ 8 $ 247,155 $ (225,575) $ 21,588
Issuance of common stock in underwritten public offering, net 1,192,407 1 29,045 — 29,046
Issuance of common stock pursuant to ATM Program, net 166,667 — 5,312 — 5,312
Stock-based compensation — — 1,758 — 1,758
Net loss — — — (17,395) (17,395)
Balance, September 30, 2021 9,359,820 $ 9 $ 283,270 $ (242,970) $ 40,309


	Common stock			Additional paid-in	Accumulated		Total stockholders’
	Shares	Amount			capital		deficit		deficit
Three Months Ended September 30, 2022
Balance, June 30, 2022	9,405,724	$	9		$	291,244	$	(297,204)	$	(5,951)
Impact of reverse stock split fractional share round-up	8,380	—			—		—		—
Stock-based compensation	—	—			731		—		731
Net loss	—	—			—		3,192		3,192
Balance, September 30, 2022	9,414,104	$	9		$	291,975	$	(294,012)	$	(2,028)

Common stock Preferred Stock Additional paid-in Accumulated Total stockholders’

Shares1
Amount1
Shares Amount
capital1
deficit equity
Nine Months Ended September 30, 2021
Balance, December 31, 2020 6,250,344 $ 6 1,257,143 $ 1 $ 202,345 $ (177,790) $ 24,562
Issuance of shares of common stock and pre-funded warrants in underwritten public offering, net 1,164,323 1 — — 37,652 — 37,653
Issuance of common stock in underwritten public offering, net 1,192,407 1 — — 29,045 — 29,046
Issuance of common stock pursuant to ATM Program, net 166,667 — — — 5,312 — 5,312
Issuance of equity classified warrants related to venture loan and security agreement — — — — 861 — 861
Exercise of stock options 48,385 — — — 1,568 — 1,568
Conversion of preferred stock to common stock 523,810 1 (1,257,143) (1) — — —
Shares purchased through employee stock purchase plan 7,391 — — — 207 — 207
Restricted stock units vested during period 6,493 — — — — — —
Stock-based compensation — — — — 6,280 — 6,280
Net loss — — — — — (65,180) (65,180)
Balance, September 30, 2021 9,359,820 $ 9 — $ — $ 283,270 $ (242,970) $ 40,309
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 1 for details.~~


	Common stock			Additional paid-in	Accumulated		Total stockholders’
	Shares	Amount			capital		deficit		(deficit) equity
Nine Months Ended September 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
Impact of reverse stock split fractional share round-up	8,380	—			—		—		—
Stock-based compensation	—	—			6,711		—		6,711
Net loss	—	—			—		(31,846)		(31,846)
Balance, September 30, 2022	9,414,104	$	9		$	291,975	$	(294,012)	$	(2,028)

See accompanying notes to the unaudited condensed consolidated financial statements.

Table of Contents

AVALO THERAPEUTICS, INC. and SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows (Unaudited)

(Amounts in thousands)


		Nine Months Ended September 30,					Nine Months Ended September 30,
		2022		2021			2023		2022
Operating activities	Operating activities					Operating activities
Net loss	Net loss	$	(31,846)	$	(65,180)	Net loss	$	(23,376)	$	(31,846)
Adjustments to reconcile net loss used in operating activities:	Adjustments to reconcile net loss used in operating activities:					Adjustments to reconcile net loss used in operating activities:
Depreciation and amortization	Depreciation and amortization	131		1,362		Depreciation and amortization	115		131
Stock-based compensation	Stock-based compensation	6,711		6,280		Stock-based compensation	2,701		6,711
Accretion of debt discount	Accretion of debt discount	1,040		445		Accretion of debt discount	1,828		1,040
Allowance for other long-term asset	Allowance for other long-term asset	1,000		—		Allowance for other long-term asset	—		1,000
Deferred taxes	Deferred taxes	20		40		Deferred taxes	23		20
Change in fair value of derivative liability						Change in fair value of derivative liability	120		—
Changes in assets and liabilities:	Changes in assets and liabilities:					Changes in assets and liabilities:
Accounts receivable, net	Accounts receivable, net	1,060		742		Accounts receivable, net	—		1,060
Other receivables	Other receivables	2,425		(269)		Other receivables	381		2,425
Other long-term asset		—		(2,000)

Inventory, net	Inventory, net	16		(13)		Inventory, net	20		16
Prepaid expenses and other assets	Prepaid expenses and other assets	1,254		1,252		Prepaid expenses and other assets	350		1,254

Lease incentive						Lease incentive	158		—
Accounts payable	Accounts payable	(1,922)		994		Accounts payable	(2,094)		(1,922)

Deferred revenue	Deferred revenue	442				Deferred revenue	—		442
Accrued expenses and other liabilities	Accrued expenses and other liabilities	(3,144)		2,604		Accrued expenses and other liabilities	(8,088)		(3,144)
Lease liability, net	Lease liability, net	2		(50)		Lease liability, net	(52)		2
Net cash used in operating activities	Net cash used in operating activities	(22,811)		(53,793)		Net cash used in operating activities	(27,914)		(22,811)
Investing activities	Investing activities					Investing activities
Leasehold improvements						Leasehold improvements	(158)		—
Disposal of property and equipment						Disposal of property and equipment	25		—
Purchase of property and equipment	Purchase of property and equipment	(95)		(102)		Purchase of property and equipment	—		(95)
Net cash used in investing activities	Net cash used in investing activities	(95)		(102)		Net cash used in investing activities	(133)		(95)
Financing activities	Financing activities					Financing activities
Proceeds from issuance of common stock and pre-funded warrants in underwritten public offering, net		—		37,653
Proceeds from Notes and warrants, net of debt issuance costs paid		—		32,900
Prepayment on Notes		(14,806)		—
Proceeds from issuance of common stock in underwritten public offering, net		—		29,046
Proceeds from common stock pursuant to ATM Program, net		—		5,312

Proceeds from exercise of stock options		—		1,568
Proceeds from sale of common stock pursuant to ATM Program, net						Proceeds from sale of common stock pursuant to ATM Program, net	32,470		—
Proceeds from issuance of common stock and warrants in underwritten public offering, net						Proceeds from issuance of common stock and warrants in underwritten public offering, net	13,748		—
Principal payments on Notes						Principal payments on Notes	(21,244)		(14,806)

Proceeds from issuance of common stock under employee stock purchase plan	Proceeds from issuance of common stock under employee stock purchase plan	25		207		Proceeds from issuance of common stock under employee stock purchase plan	67		25
Net cash (used in) provided by financing activities		(14,781)		106,686
(Decrease) increase in cash, cash equivalents and restricted cash		(37,687)		52,791
Net cash provided by (used in) financing activities						Net cash provided by (used in) financing activities	25,041		(14,781)
Decrease in cash, cash equivalents and restricted cash						Decrease in cash, cash equivalents and restricted cash	(3,006)		(37,687)
Cash, cash equivalents, and restricted cash at beginning of period	Cash, cash equivalents, and restricted cash at beginning of period	54,864		19,106		Cash, cash equivalents, and restricted cash at beginning of period	13,318		54,864
Cash, cash equivalents, and restricted cash at end of period	Cash, cash equivalents, and restricted cash at end of period	$	17,177	$	71,897	Cash, cash equivalents, and restricted cash at end of period	$	10,312	$	17,177
Supplemental disclosures of cash flow information	Supplemental disclosures of cash flow information					Supplemental disclosures of cash flow information
Cash paid for interest	Cash paid for interest	$	2,256	$	796	Cash paid for interest	$	1,925	$	2,256

Supplemental disclosures of non-cash activities						Supplemental disclosures of non-cash activities
Fair value of common stock retired in exchange for issuance of prefunded warrants						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):


		September 30,
		2022		2021			September 30,
							2023		2022
Cash and cash equivalents	Cash and cash equivalents	$	16,943	$	71,506	Cash and cash equivalents	$	10,180	$	16,943
Restricted cash, current	Restricted cash, current	53		164		Restricted cash, current	1		53
Restricted cash, non-current	Restricted cash, non-current	181		227		Restricted cash, non-current	131		181
Total cash, cash equivalents and restricted cash	Total cash, cash equivalents and restricted cash	$	17,177	71,897		Total cash, cash equivalents and restricted cash	$	10,312	17,177

See accompanying notes to the unaudited condensed consolidated financial statements.

Table of Contents

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 (L~~ymphotoxin-like,~~(Lymphotoxin-like, exhibits I~~nducible~~Inducible expression, and competes with HSV G~~lycoprotein~~Glycoprotein D for H~~erpesvirus~~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.

On July 7, 2022, Avalo effected a 1-for-12 reverse stock split. The Company retroactively applied the reverse stock split to share and per share amounts for periods prior to July 7, 2022, including the unaudited condensed consolidated financial statements for the nine months ended September 30, 2022, three and nine months ended September 30, 2021, and the year ended December 31, 2021. 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 nine months ended September 30, 2022, three and nine months ended September 30, 2021, and the year ended December 31, 2021. The reverse stock split did not reduce the number of authorized shares of common and preferred stock and did not alter the par value.

Liquidity

In order to meet its cash flow needs, the Company applies a disciplined decision-making methodology as it evaluates the optimal allocation of the Company’s resources between investing in the Company’s existing pipeline assets and acquisitions or in-licensing of new assets. As of September 30, 2022, Avalo had $16.9 million in cash and cash equivalents. For the nine months ended September 30, ~~2022,~~2023, Avalo generated a net loss of ~~$31.8~~$23.4 million and negative cash flows from operations of ~~$22.8~~$27.9 million. As of September 30, ~~2022,~~2023, Avalo had ~~an accumulated deficit of $294.0 million.~~

$10.2 million in cash and cash equivalents. In the ~~second quarter of 2022, as collectively agreed upon with the Lenders (as defined below),~~three months ended September 30, 2023, the Company ~~made a partial prepayment of $15.0 million ($14.8~~raised approximately $25.9 million of ~~which was applied to principal) on the notes (the “Notes) issued~~net proceeds under its ~~venture loan~~“at-the-market” (or “ATM”) program. On September 22, 2023, the Company and ~~security agreement~~its lenders entered into a Payoff Letter (the ~~“Loan Agreement”~~“Payoff Letter”) ~~with Horizon Technology Finance Corporation (“Horizon”) and Powerscourt Investments XXV, LP (“Powerscourt”~~, ~~and together with Horizon,~~pursuant to which the ~~“Lenders”). Avalo intends to consider additional prepayments prior to~~Company repaid all outstanding principal, ~~loan amounts coming due, if collectively agreed upon with the Lenders. As of September 30, 2022, the carrying value~~inclusive of the ~~Notes~~final payment fee, and interest under the Loan Agreement (as defined in Note 9) ~~was $19.1~~in the aggregate amount of $14.3 million. As a result of the payment, all obligations of the parties under the Loan Agreement were deemed satisfied and terminated.

The accompanying unaudited condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern; however, losses are expected to continue as the Company continues to invest in its research and development pipeline assets. The Company will require additional financing to fund its operations and to continue to execute its business strategy within one year after the date the unaudited condensed consolidated financial statements included herein were issued. We anticipate that the cash and cash equivalents as of September 30, 2022 will not be sufficient for us to fund our product candidates through their next anticipated milestones, which include topline data from the AVTX-002 Phase 2 PEAK trial and pivotal data from the AVTX-803 LADDER trial, both expected in the first half of 2023. We will need to raise additional capital to reach these milestones. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

To mitigate these conditions and to meet the Company’s capital requirements, management plans to use its current cash on hand along with some combination of the following: (i) ~~dilutive and/or non-dilutive~~ financings, (ii) out-licensing, or strategic alliances/collaborations ~~of its current pipeline assets, (iii) out-licensing~~ or sale of ~~its~~core and non-core ~~assets,~~programs, and ~~(iv) federal and/~~(iii) mergers and acquisitions. There can be no assurance that any financing or ~~private grants. If~~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. Raising capital would be more difficult if our common stock is delisted from Nasdaq. The Company is currently in the delisting hearings process with Nasdaq (for more information refer to the “Recent Developments” section under “Management’s Discussion and Analysis of Financial Condition and Results of Operations”). 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

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Lenders. Additionally, the Loan Agreement contains certain covenants and certain other specified events that could result in an event of default, which if not cured or waived, could result in the immediate acceleration of all or a substantial portion of the outstanding Notes. As of the filing date of this Quarterly Report on Form 10-Q, the Company was not aware of any breach of covenants or occurrence of material adverse change, nor had it received any notice of event of default from the Lenders (refer to Note 9 of the condensed unaudited consolidated financial statements for more information).

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 ~~additional~~ funds, management has concluded that substantial doubt exists with respect to the Company’s ability to continue as a going concern within one year after the date that the financial statements in this Quarterly Report on Form 10-Q were issued.

~~Over~~

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The accompanying unaudited condensed consolidated financial statements have been prepared assuming the ~~long term, the~~Company will continue as a going concern. The Company’s ~~ultimate~~ ability to ~~achieve and maintain profitability will depend on, among other things,~~continue as a going concern is dependent upon its ability to obtain additional capital as described above. The unaudited financial statements as of September 30, 2023 do not include any adjustments that might result from the ~~development, regulatory approval, and commercialization~~outcome of ~~its pipeline assets, and the potential receipt and sale of any priority review vouchers it receives.~~this uncertainty.

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, ~~2021~~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, ~~2021~~2022 audited consolidated financial statements.

In the second quarter of 2022, the Company concluded that it would include sales and marketing expenses within the selling, general and administrative line in the Company’s condensed consolidated statement of operations. The Company reclassified $0.7 million and $2.0 million from sales and marketing expense to selling, general and administrative expense for the three and nine months ended September 30, 2021, respectively, to conform with the current period presentation.

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 nine months ended September 30, ~~2022,~~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, ~~2021,~~2022, as filed with the SEC on March ~~2, 2022.~~29, 2023.

~~3. Revenue~~

~~In July 2022, Avalo entered into a license agreement with Apollo AP43 Limited, a wholly owned subsidiary of Apollo Therapeutics Group Limited (collectively, “Apollo”) pursuant to which the Company~~ granted Apollo a worldwide, exclusive license to research, develop, manufacture and commercialize AVTX-007, an anti-IL-18 monoclonal antibody (the “Apollo License Agreement”). Pursuant to the Apollo License Agreement, the Company received an upfront payment of $14.5 million, which was recognized as license revenue for the three and nine months ended ~~September 30, 2022~~.

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3. Revenue

~~The Company generates substantially all of~~

Avalo generated its product revenue from sales of Millipred®, an oral prednisolone indicated across a wide variety of inflammatory conditions, which is considered a prescription drug. Avalo’s license and supply agreement for Millipred® expired on September 30, 2023. The Company ~~sells~~sold its prescription drug in the United States primarily through wholesale distributors. Wholesale distributors ~~account~~accounted for substantially all of the Company’s net product revenues and trade receivables. For the three months ended September 30, ~~2022,~~2023, the Company’s two largest customers accounted for approximately ~~65%~~72% and ~~35%, respectively,~~28% of the Company’s total net product revenues. For the nine months ended September 30, ~~2022,~~2023, the Company’s two largest customers accounted for approximately ~~72%~~58% and ~~28%, respectively,~~42% of the Company’s total net product revenues. Net revenue from sales of prescription drugs was ~~$0.4~~$0.2 million and ~~$1.4~~$0.4 million for the three months ended September 30, ~~2022~~2023 and ~~2021,~~2022, respectively, and ~~$2.6~~$1.4 million and ~~$4.6~~$2.6 million for the nine months ended September 30, 2023 and 2022, ~~and 2021,~~ respectively. ~~As of September 30, 2022, deferred revenue was $0.4 million due to the receipt of payment from wholesale distributors related to product that had not yet been sold to the customer.~~

The Company ~~has a~~does not expect future gross revenue related to the Millipred® product given the product’s license and supply agreement expired on September 30, 2023. However, the Company will continue to monitor estimates for commercial liabilities, such as sales returns. As additional information becomes available, the Company could recognize expense (or a benefit) for differences between actuals or updated estimates to the reserves previously recognized.

Pursuant the Millipred® ~~product with a wholly owned subsidiary of Teva Pharmaceutical Industries Ltd. (“Teva”), which expires on September 30, 2023. Beginning July 1, 2021,~~license and supply agreement, Avalo was required to pay ~~Teva~~the supplier fifty percent of the net profit of the Millipred® product following each calendar quarter, subject to a $0.5 million quarterly minimum payment ~~unless total~~dependent on Avalo reaching certain net profit ~~is below a specified threshold. For~~amounts as stipulated in the ~~three~~agreement. The profit share commenced on July 1, 2021 and ~~nine months~~ ended on September 30, ~~2022,~~2023. Within twenty-five months of September 30, 2023, the ~~Company recognized $0.4 million~~net profit share is subject to a reconciliation process where estimated deductions to arrive at net profit will be trued up to actuals and ~~$1.4 million, respectively,~~could result in ~~cost of product sales related~~Avalo owing additional amounts to ~~the royalty. Dr. Sol Barer served as the Chairman of the Company’s board of directors until June 2021 and currently serves as the Chairman of Teva’s board of directors.~~Teva or vice versa.

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.~~provider. As a result, 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.~~2021. The ~~current~~ transition services agreement allows Aytu to withhold ~~cash of $2.0 million until September 30, 2022 and~~up to $1.0 million until December of 2024. ~~The Company received $2.2 million from Aytu in first~~In the second quarter of ~~2022. As~~2022, Avalo fully reserved the $1.0 million receivable as a result of ~~September 30, 2022, the total receivable balance was approximately $1.8 million. As disclosed in~~Aytu’s conclusion within its ~~Annual~~Quarterly Report on Form ~~10-K~~10-Q for the ~~year~~quarter ended June 30, 2022 ~~(filed September 27, 2022), Aytu concluded~~ that substantial doubt ~~exists~~existed with respect to ~~their~~its ability to continue as a going concern within one year after the date those financial statements were issued. As of September 30, 2023, the total receivable balance was approximately $0.9 million. The receivable remains fully reserved given Aytu’s conclusion in its most recent publicly disclosed financial statements that substantial doubt exists with respect to its ability to continue as a going concern within one year after the date of financial statements were issued, ~~or until September 2023. As such, the Company fully reserved for the $1.0 million due in~~which is prior to December ~~2024 and recognized the related expense in cost~~ of ~~product sales for the nine months ended September 30, 2022. The remaining $0.8 million is included within other receivables and is contractually owed in the fourth quarter of 2022.~~2024. We will continue to re-assess its collectability each reporting period.

4. Net ~~(Loss) Income~~Loss Per Share

The Company computes earnings per share (“EPS”) using the two-class method. The two-class method of computing EPS is an earnings allocation formula that determines EPS for common stock and any participating securities according to dividends declared and participation rights in undistributed earnings.

The Company had only common stock outstanding during the three and nine months ended September 30, 2022 and three months ended September 30, 2021. The Company had two classes of stock outstanding during the nine months ended September 30, 2021; common stock and preferred stock. The preferred stock outstanding during the prior period converted to shares of common stock on an approximately 1-for-0.42 ratio (ratio adjusted for the reverse stock split) and had the same rights, preferences and privileges as the Company’s common stock other than it held no voting rights. In April 2021, Armistice Capital, LLC (“Armistice”), which is a significant stockholder of the Company and whose chief investment officer, Steven Boyd, and managing director, Keith Maher, served on Avalo’s Board until August 8, 2022, converted the then outstanding 1,257,143 shares of convertible preferred stock into 523,810 shares of Avalo’s common stock. Under the two-class method, the convertible preferred stock was considered a separate class of stock until the time it was converted to common shares for EPS purposes. Therefore, basicBasic and diluted EPS is provided below for common stock for the three and nine months ended September 30, ~~2022~~2023 and ~~three months ended~~ September 30, ~~2021, and both common stock and preferred stock for the nine months ended September 30, 2021.~~2022.

EPS for common ~~stock and EPS for preferred~~ stock is computed by dividing the sum of distributed earnings and undistributed earnings ~~for each class of stock~~ by the weighted average number of shares outstanding for ~~each class of stock for~~ the period. In applying the two-class method, undistributed earnings are allocated to common stock and preferred stock based on the weighted average shares outstanding during the period, which assumed the convertible preferred stock had been converted to common stock. The weighted average number of common shares outstanding as of September 30, ~~2022~~2023 and ~~2021~~2022 include the weighted average effect of ~~the~~ pre-funded warrants, ~~issued in connection with the underwritten public offering that closed in January 2021,~~ the exercise of which requires nominal consideration for the delivery of the shares of common ~~stock (refer to Note 10 for more information).~~stock.

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Diluted net ~~(loss) income~~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) income per share of common stock for the three and nine months ended September 30, ~~2022~~2023 and ~~three months ended~~ September 30, ~~2021, and common stock and preferred stock for the nine months ended September 30, 2021~~2022 (in thousands, except share and per share amounts):

~~Three Months Ended~~

~~September 30, 2022~~

~~Common stock~~

~~Basic income per share:~~

~~Net income~~

~~3,192~~

~~Weighted average shares~~

~~9,413,466~~

~~Basic net income per share~~

~~0.34~~

~~Diluted income per share:~~

~~Net income~~

~~3,192~~

~~Weighted average shares - basic~~

~~9,413,466~~

~~Effect of dilutive securities:~~

~~Potentially dilutive shares~~

~~166~~

~~Weighted average shares - diluted~~

~~9,413,632~~

~~Diluted net income per share~~

~~0.34~~


	Three Months Ended September 30,
	2023		2022
Basic (loss) income per share:
Net (loss) income	$	(5,228)	$	3,192
Weighted average shares	46,764,117		9,413,466
Basic net (loss) income per share	$	(0.11)	$	0.34

Diluted (loss) income per share:
Net (loss) income	$	(5,228)	$	3,192
Weighted average shares - basic	46,764,117		9,413,466
Effect of dilutive securities:
Potentially dilutive shares	—		166
Weighted average shares - diluted	46,764,117		9,413,632
Diluted net (loss) income per share	$	(0.11)	$	0.34


	Nine Months Ended September 30,
	2023		2022
Basic and diluted loss per share:
Net loss	$	(23,376)	$	(31,846)
Weighted average shares	24,281,306		9,404,679
Basic and diluted net loss per share	$	(0.96)	$	(3.39)

~~Nine Months Ended~~

~~September 30, 2022~~

~~Common stock~~

~~Net loss~~

~~(31,846)~~

~~Weighted average shares~~

~~9,404,679~~

~~Basic and diluted net loss per share~~

~~(3.39)~~

Three Months Ended
September 30, 2021
Common stock
Continuing Operations Discontinued Operations
Allocation of undistributed net (loss) income $ (17,471) $ 76
Weighted average shares 8,374,200 8,374,200
Basic and diluted net (loss) income per share $ (2.09) $ 0.01

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Nine Months Ended
September 30, 2021
Common stock Preferred stock
Continuing Operations Discontinued Operations Continuing Operations Discontinued Operations
Allocation of undistributed net (loss) income $ (63,602) $ 37 $ (1,616) $ 1
Weighted average shares 7,927,152 7,927,152 483,517 483,517
Basic and diluted net (loss) income per share $ (8.02) $ 0.00 $ (3.34) $ 0.00

The following outstanding securities have been excluded from the computation of diluted weighted shares outstanding for the three and nine months ended September 30, ~~2022~~2023 and ~~2021,~~2022, as they could have been anti-dilutive:


		Three and Nine Months Ended			Three and Nine Months Ended
		September 30,			September 30,
		2022	2021		2023	2022
Stock options	Stock options	1,260,906	1,122,785	Stock options	1,849,229	1,260,906
Warrants on common stock1	Warrants on common stock1	366,990	367,186	Warrants on common stock1	4,136,990	366,990
Restricted Stock Units	Restricted Stock Units	—	6,493	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 was nominal. There were no pre-funded warrants outstanding as of September 30, 2021 included the weighted average effect of the 139,747 pre-funded warrants issued in connection with the underwritten public offering that closed in January 2021 because the exercise of such warrants requires only nominal consideration ($0.012 per share exercise price for each pre-funded warrant). During 2021, the holder exercised 25,740 of the pre-funded warrants. As of September 30, 2022, the weighted average number of common shares outstanding included the weighted average effect of the remaining 114,007 pre-funded warrants outstanding. These pre-funded warrants are not included in the table above.2023.

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):


	September 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*	$	9,324	$	—	$	—
Liabilities
Derivative liability	$	—	$	—	$	4,950

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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

(Level 1)

(Level 2)

(Level 3)

Assets

Investments in money market funds*

~~16,079~~12,133

—

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Liabilities

Derivative liability

~~December 31, 2021~~

~~Fair Value Measurements Using~~

~~Quoted prices in~~

~~Significant other~~

~~Significant~~

~~active markets for~~

~~observable~~

~~unobservable~~

~~identical assets~~

~~inputs~~

~~(Level 1)~~

~~(Level 2)~~

~~(Level 3)~~

~~Assets~~

Investments in money market funds*

~~54,010~~—

—

—4,830

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

As of September 30, ~~2022 and December 31, 2021,~~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 ~~long-term~~derivative liability. As of 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.

Level 3 Valuation

The ~~estimated~~table presented below is a summary of changes in the fair value of the Company’s ~~debt approximates~~Level 3 valuation for the derivative liability for the nine months ended September 30, 2023:


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

In the fourth quarter of 2022, Avalo sold its ~~carrying~~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.

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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 September 30, ~~2022~~2023, the fair value of the derivative liability was $5.0 million, of which $3.7 million was attributable to the AVTX-501 Milestone and $1.3 million was attributable to the AVTX-007 Milestones and Royalties. For the nine months ended September 30, 2023, the $0.1 million change in fair value was recognized in other expense, net in the accompanying unaudited condensed consolidated statements of operations and comprehensive (loss) income.

The fair value of the AVTX-501 Milestone was primarily driven by an approximate 23% probability of success to reach the milestone in approximately 4.1 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 5.1 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 ~~in Level Two~~the largest driver of the fair value ~~hierarchy (refer~~and therefore changes to ~~Note 9~~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 ~~more information).~~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 nine months ended September 30, ~~2022~~2023 and ~~2021.~~2022. No transfers of assets between Level 1 and Level 2 of the fair value measurement hierarchy occurred during the nine months ended September 30, ~~2022~~2023 and ~~2021.~~2022.

6. Leases

~~The Company~~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.

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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 ~~provided for a rent abatement period of three months following lease commencement. 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 September 30, ~~2022~~2023 was ~~5.8~~4.8 years.

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


		As of					As of
		September 30, 2022		December 31, 2021			September 30, 2023		December 31, 2022
Property and equipment, net	Property and equipment, net	$	1,813	$	2,001	Property and equipment, net	$	1,393	$	1,750

Accrued expenses and other current liabilities	Accrued expenses and other current liabilities	$	526	$	485	Accrued expenses and other current liabilities	$	536	$	532
Other long-term liabilities	Other long-term liabilities	1,791		2,018		Other long-term liabilities	1,456		1,711
Total operating lease liabilities	Total operating lease liabilities	$	2,317	$	2,503	Total operating lease liabilities	$	1,992	$	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 ~~9.2%~~9.1% to determine the present value of the lease payments.

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The components of lease expense for the three and nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 were as follows (in thousands):

Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
Operating lease cost* $ 134 $ 97 $ 373 $ 287


	Three Months Ended September 30,				Nine Months Ended September 30,
	2023		2022		2023		2022
Operating lease cost*	$	97	$	134	$	350	$	373

*Includes short-term leases, which are immaterial.

The following table shows a maturity analysis of the operating lease liabilities as of September 30, ~~2022~~2023 (in thousands):



		Undiscounted Cash Flows			Undiscounted Cash Flows
October 1, 2022 through December 31, 2022		$	130
2023		528
October 1, 2023 through December 31, 2023				October 1, 2023 through December 31, 2023	$	133
2024	2024	537		2024	537
2025	2025	547		2025	547
2026	2026	557		2026	557
2027	2027	258		2027	258
2028				2028	201
Thereafter	Thereafter	426		Thereafter	224
Total lease payments	Total lease payments	$	2,983	Total lease payments	$	2,457
Less implied interest	Less implied interest	(666)		Less implied interest	(465)
Total	Total	$	2,317	Total	$	1,992

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7. Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities as of September 30, ~~2022~~2023 and December 31, ~~2021~~2022 consisted of the following (in thousands):


		As of					As of
		September 30, 2022		December 31, 2021			September 30, 2023		December 31, 2022
Research and development	Research and development	$	7,094	$	8,221	Research and development	$	1,331	$	6,293
Compensation and benefits	Compensation and benefits	2,972		4,310		Compensation and benefits	449		2,699
Selling, general and administrative	Selling, general and administrative	903		1,386		Selling, general and administrative	530		1,008
Commercial operations	Commercial operations	1,798		1,733		Commercial operations	2,156		1,694
Royalty payment	Royalty payment	399		375		Royalty payment	214		508
Lease liability, current	Lease liability, current	526		485		Lease liability, current	536		532
Other	Other	4		9		Other	—		480
Total accrued expenses and other current liabilities	Total accrued expenses and other current liabilities	$	13,696	$	16,519	Total accrued expenses and other current liabilities	$	5,216	$	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”). ~~As part of the Plan, the Company announced plans to wind down internal development efforts of AVTX-006 and pause development efforts of AVTX-802. Accordingly, a~~A reduction in workforce plan was approved to reduce headcount and related expenses. The reduction in workforce plan ~~which~~ was considered a one-time termination benefit ~~was completed in the second quarter of 2022.~~

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.

~~Of the $1.5~~ $1.4 million ~~initial liability recognized~~of severance payments were paid in the ~~first quarter of~~year ended December 31, 2022 ~~$1.2~~and the remaining $0.1 million was paid in the nine months ended September 30, ~~2022. The remaining severance liability will be paid over the next~~ ~~two~~ ~~to six months as dictated in each separation~~

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~~agreement.~~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 ~~for~~during the ~~nine months ended September 30,~~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 in the first quarter of 2022.

9. Notes Payable

On June 4, 2021, the Company entered into ~~the~~a $35.0 million ~~Loan Agreement~~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”“Lenders”). OnBetween June and September ~~29,~~of 2021, ~~after achieving a second predetermined milestone,~~ the Company borrowed the ~~remaining $5.0~~full $35.0 million ~~which was evidenced by a third note payable~~ (the ~~“Third Note”, and collectively with~~“Note”) available under the ~~Initial and Second Notes,~~Loan Agreement. In the ~~“Notes”).~~

~~In June~~second quarter of 2022, the Company, as collectively agreed upon with the Lenders, prepaid $15.0 million toof principal and accrued interest. In June of 2023, the Company, as collectively agreed upon with the Lenders, prepaid $6.0 million of ~~which $14.8 million was applied to principal~~principal. On September 22, 2023, the Company and the ~~remainder applied~~Lenders entered into a Payoff Letter (the “Payoff Letter”), pursuant to ~~accrued interest. As of September 30, 2022,~~which the Company repaid all outstanding ~~notes payable balance was $21.2 million,~~principal, inclusive of the final payment ~~fee. Avalo intends to consider additional prepayments prior to principal loan amounts coming due, if collectively agreed upon with the Lenders.~~

~~Each advance~~fee, and interest 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~~aggregate amount 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~~$14.3 million. 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 prepaypayment, all obligations of the outstanding advances by paying the entire principal balance and all accrued and unpaid interest, subject to prepayment charges of up to 3% of the then outstanding principal balance. Upon the earlier of (i) payment in full of the principal balance, (ii) an event of default, or (iii) the maturity date, the Company will pay an additional final payment of 3% of the principal loan amount to the Lenders.

Each advance of the loan is secured by a lien on substantially all of the assets of the Company, other than Intellectual Property and Excluded Collateral (in each case as defined in the Loan Agreement), and contains customary covenants and representations, including a financial reporting covenant and limitations on dividends, indebtedness, collateral, investments, distributions, transfers, mergers or acquisitions, taxes, corporate changes, deposit accounts, and subsidiaries.

~~The events of default~~parties under the Loan Agreement include, but are not limited to, failing to make a payment, breach of covenant, or occurrence of a material adverse change. If an event of default occurs, the Lenders are entitled to accelerate the loan amounts due or take other enforcement actions. The accelerated payment obligations would include the outstanding principal balance (inclusive of the 3% final payment fee), a prepayment charge on the outstanding principal balance of up to 3%,were deemed satisfied and any accrued and unpaid interest. As of the filing date of this Quarterly Report on Form 10-Q, the Company was not aware of any breach of covenants, occurrence of a material adverse change, nor had it received any notice of event of default from the Lenders.terminated.

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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. ~~The Lenders may exercise~~Pursuant to the Payoff Letter, Avalo’s obligations under the Warrants ~~either by (a) cash or check or (b) through a net issuance conversion.~~shall survive pursuant to the original terms at issuance. The Warrants, which met equity classification, were recognized as a component of permanent stockholders’ equity within additional paid-in-capital and were recorded at the issuance date using a relative fair value allocation method.

The Company ~~valued~~recognized debt issuance costs and the ~~Warrants at issuance, which resulted in a discount on the debt, and allocated the proceeds from the loan proportionately to the Notes and to the Warrants, of which $0.9 million was~~amount allocated to the ~~Warrants.~~

In the second quarter of 2021, the Company incurred $2.1 million in debt issuance costs, including legal fees in connection with the Loan Agreement, fees paid directly to the Lenders, and other direct costs. All fees, warrants ~~and costs paid to the Lenders and all direct costs incurred by the Company are recognized~~ as a debt discount on the date of issuance and ~~are~~ amortized these costs to interest expense using the effective interest method over the original term of the loan. ~~The $1.1 million final payment fee is included~~As a result of the payoff in the ~~contractual cash flows and is accreted to~~third quarter of 2023, the Company accelerated the remaining $0.9 million amortization of the debt discount, which was recognized as interest expense ~~using~~for the ~~effective interest method over the term of the loan.~~three and nine months ended September 30, 2023.

~~The effective interest rate of the Notes, including the accretion of the final payment, was 18.7% as of September 30, 2022.~~

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

As of
September 30, 2022 December 31, 2021 Maturity
Initial Note 12,139 20,600 January 2025
Second Note 6,070 10,300 February 2025
Third Note 3,035 5,150 April 2025
Notes payable, gross1
21,244 36,050
Less: Unamortized debt discount and issuance costs 2,178 3,217
Carrying value of notes payable 19,066 32,833
Less: Current portion 2,564 —
Carrying value of notes payable, non-current 16,502 32,833


	As of
	September 30, 2023		December 31, 2022
Initial Note	$	—	$	12,139
Second Note	—		6,070
Third Note	—		3,035
Notes payable, gross1	$	—	$	21,244
Less: Unamortized debt discount and issuance costs	—		1,828
Carrying value of notes payable, current	$	—	$	19,416
Less: Current portion	—		5,930
Carrying value of notes payable, non-current	$	—	$	13,486

1 Balance as of December 31, 2022 includes $1.1 million final payment fee for the Notes, which represents 3% of the original principal loan amount.

As of September 30, ~~2022, the estimated~~2023, there were no remaining contractual future principal ~~payments due on the Notes were as follows (in thousands):~~

As of September 30, 2022
2022 $ —
2023 5,930
2024 13,463
2025 1,851
Total principal payments1
$ 21,244

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

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 September 30, ~~2022,~~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

~~2021 Financings~~At-the-Market Offering Program

~~Q3 2021~~On May 4, 2023, the Company entered into an “at-the-market” sales agreement (the “Sales Agreement”) with Oppenheimer & Co. Inc. (“Oppenheimer”), pursuant to which the Company could sell from time to time, shares of its common stock having an aggregate offering price of up to $9,032,567 through Oppenheimer. In August 2023, the Company and Oppenheimer entered into an amendment to the sales agreement (the “Amended Sales Agreement”) to increase the aggregate offering amount under the Sales Agreement to $50,000,000 inclusive of shares sold prior to the amendment. In the nine months ended September 30, 2023, the Company sold approximately 179.1 million shares under the ATM program for net proceeds of approximately $32.5 million.

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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, recapitalization and other similar events affecting common stock), with an exercise price of $0.001 per share.

The Exchange Warrants were exercisable at any time, except that the Exchange Warrants would 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 Avalo common stock, which percentage could change at the holders’ election to any amount less than or equal to 19.99% upon 61 days’ notice to the Company. Venrock exercised the Exchange Warrants in full in September of 2023.

In accordance with ASC No. 505, Equity, in the second quarter of 2023, the Company recorded the retirement of the common stock exchanged as a reduction of 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.

Q1 2023 Financing

On ~~September 17, 2021,~~February 7, 2023, the Company closed an underwritten public offering of ~~approximately 1.2 million~~3,770,000 shares of its common stock ~~for~~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 ~~$29.0 million.~~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 ~~approximately~~ 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 ~~(collectively, “Nantahala”)~~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.

~~At-the-Market Offering Program~~

~~In July 2021,~~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 ~~entered into an “at-the-market” sales agreement with Cantor Fitzgerald & Co. and RBC Capital Markets, LLC (together,~~to repurchase its shares, (iv) permit the ~~“Agents”), pursuant~~holders to ~~which the Company may sell from time to time, shares~~receive a fixed number of ~~its common stock having an aggregate offering price of up to $50.0 million through the Agents. In August 2021, the Company sold approximately 0.2 million~~ shares of common stock ~~under the ATM Program for net proceeds of approximately $5.2 million.~~

~~Q2 2021 Debt Financing Agreement~~

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~~As part of the Loan Agreement entered into in the second quarter of 2021, on June 4, 2021, the Company issued Warrants~~upon exercise, (v) are indexed to ~~Horizon and Powerscourt to purchase 33,656 shares of~~ the Company’s common stock ~~with an exercise price~~and (vi) meet the equity classification criteria. In addition, such warrants do not provide any guarantee of ~~$31.20 per share. The Warrants are exercisable for ten years from the date of issuance. Refer to Note 9 for additional information.~~

~~Q1 2021 Financing~~

In January 2021, the Company closed an underwritten public offering of approximately 1.2 million shares of its common stock and 139,747 pre-funded warrants for net proceeds of $37.7 million. Armistice participated in the offering by purchasing approximately 0.2 million shares of common stock, on the same terms as all other investors. Nantahala participated in the offering by purchasing approximately 0.1 million shares of common stock, on the same terms as all other investors.

Nantahala also purchased the pre-funded warrants to purchase up to an aggregate of 139,747 shares of common stock at a purchase price of $31.188, which represents the per share public offering price for the common stock less the $0.012 per share exercise price for each pre-funded warrant. During 2021, the holder exercised 25,740 of the pre-funded warrants. As of September 30, 2022, 114,007 pre-funded warrants were outstanding.value or return.

Common Stock Warrants

At September 30, ~~2022,~~2023, the following common stock warrants were outstanding:


Number of common shares	Number of common shares	Exercise price		Expiration	Number of common shares	Exercise price		Expiration
underlying warrants	underlying warrants	per share		date	underlying warrants	per share		date
333,334	333,334	$	150.00	June 2024	333,334	$	150.00	June 2024
114,007		$	0.012	—
33,656	33,656	$	31.20	June 2031	33,656	$	31.20	June 2031
480,997
3,770,000					3,770,000	$	5.00	February 2024
4,136,990					4,136,990

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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, ~~2022,~~2023, pursuant to the terms of the 2016 Third Amended ~~and Restated~~ Plan, an additional ~~375,981~~377,221 shares were made available for issuance. As of September 30, ~~2022,~~2023, there were ~~361,892~~51,284 shares available for future issuance under the 2016 Third Amended Plan. ~~In October 2022, the Company granted 225,000 options to its employees that vest on the first anniversary of the grant date.~~

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 ~~2022,~~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 ~~restricted stock units~~ and employee stock purchase plan shares. The amount of stock-based compensation expense recognized for the three and nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 was as follows (in thousands):

Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
Research and development $ 279 $ 480 $ 931 $ 1,244
Selling, general and administrative 452 1,278 5,780 5,036
Total stock-based compensation $ 731 $ 1,758 $ 6,711 $ 6,280

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	Three Months Ended September 30,				Nine Months Ended September 30,
	2023		2022		2023		2022
Research and development	$	371	$	279	$	1,028	$	931
Selling, general and administrative	582		452		1,673		5,780
Total stock-based compensation	$	953	$	731	$	2,701	$	6,711

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. ~~As a result, the~~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. ~~There was no additional expense related to the modifications in the three months ended September 30, 2022.~~

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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 nine months ended September 30, ~~2022~~2023 is as follows:


		Options Outstanding							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)		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, 2021		1,054,277	$	44.26	$	27.45	8.1
Balance at December 31, 2022								Balance at December 31, 2022	1,345,532	$	28.24	$	17.48	6.7
Granted	Granted	447,022	$	9.19	$	6.59		Granted	760,272	$	2.72	$	2.06

Forfeited	Forfeited	(262,852)	$	30.14	$	20.14		Forfeited	(10,101)	$	4.92	$	3.56
Expired	Expired	(60,876)	$	53.48	$	35.76		Expired	(339,910)	$	42.99	$	27.13
Balance at September 30, 2022		1,177,571	$	33.62	$	20.72	6.4
Balance at September 30, 2023								Balance at September 30, 2023	1,755,793	$	14.47	$	9.01	8.4

Exercisable at September 30, 2022		713,994	$	44.28	$	26.55	4.7
Exercisable at September 30, 2023								Exercisable at September 30, 2023	595,159	$	31.35	$	18.43	6.9

In ~~March 2022,~~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 ~~March 2022,~~May 2023, the Company granted ~~0.1~~0.3 million options with service-based vesting conditions to its employees that vest on the first anniversary of the grant date. As a result of the reduction of workforce plan, 0.1 million options were forfeited in the first quarter of 2022, and 0.2 million options were forfeited as a result of other terminations during the nine months ended September 30, 2022. In October 2022, the Company granted 0.2 million options to its employees that vest on the first anniversary of the grant date.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 September 30, ~~2022,~~2023, the aggregate intrinsic value of options outstanding was zero. There were ~~349,405~~0.3 million options that vested during the nine months ended September 30, ~~2022~~2023 with a weighted average exercise price of ~~$39.76~~$12.78 per ~~share, which included the acceleration of vesting of certain options in accordance with the separation agreements entered into in the first quarter of 2022.~~share. The total grant date fair value of shares which vested during the nine months ended September 30, ~~2022~~2023 was ~~$9.0~~$2.2 million.

The Company recognized stock-based compensation expense of ~~$0.7~~$0.9 million and ~~$6.6~~$2.6 million related to stock options with service-based vesting conditions for the three and nine months ended September 30, ~~2022,~~2023, respectively. At September 30, ~~2022,~~2023, there was ~~$4.8~~$3.6 million of total unrecognized compensation cost related to unvested service-based vesting condition awards. The unrecognized compensation cost is expected to be recognized over a weighted-average period of ~~2.2~~1.5 years.

Stock-based compensation assumptions

The following table shows the assumptions used to compute stock-based compensation expense for stock options with service-based vesting conditions granted under the Black-Scholes valuation model for the nine months ended September 30, ~~2022:~~2023:


Service-based options
Expected term of option (in years)						5 - 6.25
Expected stock price volatility						~~84.0%~~89.8% - ~~93.5%~~146.0%
Risk-free interest rate						~~1.50%~~3.43% - ~~4.06%~~4.13%
Expected annual dividend yield						0%

~~Stock options with market-based vesting conditions~~

1820

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Stock options with market-based vesting conditions

As of September 30, ~~2022,~~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 ~~1.7~~0.7 years. There were no stock options with market-based vesting conditions granted, exercised, or forfeited for the nine months ended September 30, ~~2022.~~

~~Restricted Stock Units~~

The Company measures the fair value of the restricted stock units using the stock price on the date of the grant. The restricted shares typically vest annually over a four-year period beginning on the first anniversary of the award. As of September 30, 2022, there were no unvested restricted stock units outstanding. During the nine months ended September 30, 2022, 937 restricted stock units vested and had a weighted average grant date fair value of $54.00 per unit.2023.

Employee Stock Purchase Plan

On April 5, 2016, the Company’s board of directors approved the 2016 Employee Stock Purchase Plan (the “ESPP”). The ESPP was approved by the Company’s stockholders and became effective on May 18, 2016 (the “ESPP Effective Date”).

Under the ESPP, eligible employees can purchase common stock through accumulated payroll deductions at such times as are established by the administrator. The ESPP is administered by the compensation committee of the Company’s board of directors. Under the ESPP, eligible employees may purchase stock at 85% of the lower of the fair market value of a share of the Company’s common stock (i) on the first day of an offering period or (ii) on the purchase date. Eligible employees may contribute up to 15% of their earnings during the offering period. The Company’s board of directors may establish a maximum number of shares of the Company’s common stock that may be purchased by any participant, or all participants in the aggregate, during each offering or offering period. Under the ESPP, a participant may not accrue rights to purchase more than $25,000 of the fair market value of the Company’s common stock for each calendar year in which such right is outstanding.

The Company initially reserved and authorized up to 41,667 shares of common stock for issuance under the ESPP. On January 1 of each calendar year, the aggregate number of shares that may be issued under the ESPP automatically increases by a number equal to the lesser of (i) 1% of the total number of shares of the Company’s capital stock outstanding on December 31 of the preceding calendar year, ~~and~~ (ii) 41,667 shares of the Company’s common stock, or (iii) a number of shares of the Company’s common stock as determined by the Company’s board of directors or compensation committee. The number of shares were increased by 41,667 on January 1, ~~2022.~~2023. As of September 30, ~~2022, 181,028~~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 ~~$33,000~~$48 thousand and ~~$117,000~~$0.1 million for the three and nine months ended September 30, ~~2022,~~2023, respectively.

12. Income Taxes

The Company recognized minimal income tax expense for the three and nine months ended September 30, ~~2022~~2023 and ~~the three months ended September 30, 2021~~2022 due to the significant valuation allowance against the Company’s deferred tax assets and the current and prior period losses. The Company recognized an income tax benefit of $0.2 million for the nine months ended September 30, 2021 due to the receipt of its refund claim related to the tax year 2017. The tax benefit recognized for the nine months ended September 30, 2020 was a result of a tax law change signed into law as part of the Coronavirus Aid, Relief and Economic Security Act (“CARES Act”), which allowed the Company to carry back certain losses for taxes paid in fiscal year 2017 and thus resulted in a refund claim. The 2021 income tax benefit was a result of the updated estimate of interest receivable and abatement of penalties on the refund claim, as the final refund payment was received from the Internal Revenue Service in the second quarter of 2021.

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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. Reserves are established in connection with such matters when a loss is probable and the amount of such loss can be reasonably estimated. 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.

~~Deerfield Guarantee~~Dispute Notice

~~As consideration~~On August 14, 2023, the Company received a notice from Apollo AP43 Limited alleging that the Company is in breach of the ~~sale~~License Agreement between them dated July 29, 2022 by virtue of owing $837,522 to a service provider under the ~~rights~~terms of that license. The notice formally initiates a dispute resolution process under the license, beginning with further negotiations between the companies’ executive officers. The possible loss to the ~~Company’s rights, title~~Company is between $0 and ~~interest in assets relating to certain commercialized products to Aytu in 2019, Aytu~~ ~~assumed our financial obligations to Deerfield CSF, LLC (“Deerfield”), which~~$837,522. The Company does not believe a loss is currently ~~includes the remaining~~probable and therefore has not recognized a contingent consideration of future royalties on the divested products. In conjunction with the closing of the transaction in 2019, the Company entered into an agreement, which guarantees the payment of the assumed liabilities to Deerfield (the “Guarantee”). ~~Aytu publicly reported that it had entered into a Waiver, Release and Consent in June 2021,~~ pursuant to which it paid a portion of the contingent consideration early and agreed to pay the remaining fixed obligations of $3.0 million in six equal quarterly payments of $0.5 million commencing September 30, 2021. As reported in Aytu’s Annual Report on Form 10-K for the year ended June 30, 2022, the fixed payment arrangement was $1.0 million.

Avalo is required to make a payment under the Guarantee upon demand by Deerfield if all or any part of the fixed payments are not paid by Aytu when due or upon breach of a covenant. In accordance with the Waiver, Release and Consent,liability as of September 30, ~~2022, the Company estimates Aytu has one quarterly payment of~~ ~~$0.5 million remaining, which represents~~ Avalo’s estimated maximum potential future payments under the Guarantee. The Company concluded that the expected credit loss of the Guarantee was de minimis as of September 30, 2022, based on considerations of Aytu’s ability to meet its current financial commitments including recent financings, cash position, operating cash flows and trends.

~~Karbinal Royalty Make-Whole Provision~~

In 2018, in connection with the acquisition of certain commercialized products, the Company entered into a supply and distribution agreement (the “Karbinal Agreement”) with TRIS Pharma Inc. (“TRIS”). As part of the Karbinal Agreement, the Company had an annual minimum sales commitment, which is based on a commercial year that spans from August 1 through July 31, of 70,000 units through 2025. The Company was required to pay TRIS a royalty make whole payment (“Make-Whole Payments”) of $30 for each unit under the 70,000 units annual minimum sales commitment through 2025.

As a part of the Aytu transaction, the Company assigned all 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.2023.

Possible Future Milestone Payments for In-Licensed Compounds

General

~~The Company~~Avalo is a party to license and development agreements with various third parties, which contain future payment obligations such as royalties and milestone ~~payments (discussed further below).~~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 ~~its own~~ 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 ~~equal to~~of $10.0 ~~million.~~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.

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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 nine months ended September 30, ~~2022. The Company recognized the upfront license fee of $10.0 million within research and development expenses in the nine months ended September 30, 2021.~~2023. There has been no cumulative expense recognized as of September 30, ~~2022~~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 nine months ended September 30, ~~2022.~~2023. There has been $0.5 million of cumulative expense recognized as of September 30, ~~2022~~2023 related to the milestones under this license agreement, which was recognized in ~~the nine months ended September 30,~~ 2021. The Company will continue to monitor the remaining milestones at each reporting period.

AVTX-008 Sanford Burnham Prebys License Agreement

On June 22, 2021, the Company entered into an Exclusive Patent License Agreement with Sanford Burnham Prebys Medical Discovery Institute (the “Sanford Burnham Prebys License Agreement”) under which the Company obtained an exclusive license to a portfolio of issued patents and patent applications covering an immune checkpoint program (AVTX-008).

Under the terms of the ~~agreement,~~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.~~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.

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No material expense related to the Sanford Burnham Prebys License Agreement was recognized in the nine months ended September 30, 2022. The Company recognized the upfront license fee of $0.4 million within research and development expenses and the upfront patent expense of $0.5 million within selling, general and administrative expenses in the nine months ended September 30, 2021.2023. There has been no cumulative expense recognized as of September 30, ~~2022~~2023 related to the milestones under ~~the Sanford Burnham Prebys License Agreement.~~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. ~~(“Merck”)~~ in 2013.

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Under the out-license agreement, the Company received a mid-six digit upfront payment from ~~Alto.~~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 ~~sale milestones (net of the payments due to Merck pursuant to the original license agreement, which Alto is responsible for).~~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.

~~Avalo recognized the upfront fee as license revenue in the nine months ended September 30, 2021.~~ The Company has not recognized any milestones as of September 30, ~~2022.~~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, ~~Therapeutics, LLC (“ES”), an affiliate~~a wholly owned subsidiary of ~~Armistice.~~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. ~~The Company initially in-licensed the compound from Merck in 2013.~~

Under the assignment agreement, the Company received a low-six digit upfront payment from ~~ES.~~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. ~~Avalo is no longer responsible for future milestones or royalties under the original license with Merck.~~

~~Avalo recognized the upfront fee as license revenue in the nine months ended September 30, 2021.~~ The Company has not recognized any milestones as of September 30, ~~2022.~~2023.

Acquisition Related and ~~Related Party~~Other Contingent Liabilities

Aevi Merger Possible Future Milestone Payments

In the first quarter of 2020, the Company consummated its merger with Aevi Genomic Medicine Inc. (“Aevi”), in which Avalo acquired the rights to AVTX-002, AVTX-006 and AVTX-007 (the “Merger” or the “Aevi Merger”). A portion of the consideration for the Aevi Merger included two future contingent development milestones worth up to an additional $6.5 million, payable in either shares of Avalo’s common stock or cash, at the election of Avalo.

The first milestone was the enrollment of a patient in a Phase 2 study related to AVTX-002 (for treatment of pediatric onset Crohn’s disease), AVTX-006 (for treatment of any indication) or AVTX-007 (for treatment of any indication) prior to February 3, 2022, which would have resulted in a milestone payment of $2.0 million. The Company did not meet the first milestone prior to February 3, 2022. Therefore, no contingent consideration related to this milestone was recognized as of September 30, ~~2022~~2023 and no future contingent consideration will be recognized.

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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 September 30, ~~2022.~~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 September 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 September 30, 2023. The Company will continue to monitor the third development milestone at each reporting period.

On October 27, 2023, the Company divested AVTX-801, AVTX-802 and AVTX-803 (see Note 14). Avalo remains responsible for the future milestone payment related to the protide molecule described above.

AVTX-006 Royalty Agreement with Certain Related Parties

In July 2019, Aevi entered into a royalty agreement, and liabilities thereunder were assumed by ~~the Company~~Avalo upon ~~closing~~close of the Aevi Merger in February 2020. The royalty agreement provided certain ~~Aevi~~ 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 the 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.

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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 September 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.

~~Ichorion Asset Acquisition Possible Future Milestone Payments~~Karbinal Royalty Make-Whole Provision

In ~~September~~ 2018, in connection with the acquisition of certain commercialized products, the Company ~~acquired Ichorion Therapeutics,~~entered into a supply and distribution agreement (the “Karbinal Agreement”) with TRIS Pharma Inc. ~~including acquiring three compounds~~(“TRIS”). As part of the Karbinal Agreement, the Company had an annual minimum sales commitment, which is based on a commercial year that spans from August 1 through July 31, of 70,000 units through 2025. The Company was required to pay TRIS a royalty make whole payment (“Make-Whole Payments”) of $30 for ~~inherited metabolic disorders known as CDGs (AVTX-801, AVTX-802 and AVTX-803) and one other preclinical compound. Consideration for~~each unit under 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, payable in either shares of Avalo’s common stock or cash, at the election of Avalo.70,000 units annual minimum sales commitment through 2025.

~~The first and second milestones were marketing approval~~As a part 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 September 30, 2022 and no future contingent consideration will be recognized.

~~The third milestone is the marketing approval of a protide molecule by the FDA on or prior to December 31, 2023. If this milestone is met,~~Aytu transaction, the Company ~~is required~~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 ~~a milestone payment~~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 $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 development milestone has been recognized as of September 30, 2022. The Company will continue to monitor the third development milestone at each reporting period.units sold.

14. Subsequent Events

On ~~November 4, 2022, Avalo entered into an~~October 27, 2023, the Company closed the transaction under the asset purchase agreement (the “Purchase Agreement”) to sell its ~~economic~~ rights, title and interest in, assets relating to ~~future payments for previously out-licensed assets including AVTX-007, AVTX-501,~~AVTX-801, AVTX-802 and ~~AVTX-611~~AVTX-803 (collectively, the “800 Series”) to ESAUG Therapeutics, LLC (“~~ES”), an affiliate of Armistice, in exchange for $5.0 million, payable upon closing (the “ES Transaction”~~AUG”). The ~~ES Transaction~~Purchase Agreement was entered into in on September 11, 2023.

AUG paid an upfront payment of $150,000, as well as, for each compound, make a contingent milestone payment of $15,000,000 (for a potential aggregate of $45.0 million) if the first FDA approval is ~~expected~~for an indication other than a Rare Pediatric Disease (as defined in the Purchase Agreement), or up to ~~close in November 2022. The ES Transaction was approved in accordance with Avalo’s related party transaction policy. The Company~~20% of certain payments, if any, granted to AUG upon any sale of any priority review voucher granted to AUG by the FDA, net of any selling costs. Additionally, AUG assumed up to $150,000 of certain liabilities incurred prior to the date of the Purchase Agreement and assume all costs relating to the 800 Series from the date of the Purchase Agreement. Avalo will evaluate the accounting impact of the transaction in the fourth quarter of ~~2022.~~2023.

Upon closing of the ES Transaction, the Company will no longer be entitled to receive the possible future milestones and royalties related to AVTX-007, AVTX-501 and AVTX-611, as discussed further below:

~~AVTX-007~~

On July 29, 2022, Avalo entered into a license agreement with Apollo pursuant to which the Company granted Apollo a worldwide, exclusive license to research, develop, manufacture and commercialize AVTX-007. Upon closing of the ES Transaction, the future economic rights to milestones and royalties for AVTX-007 under the Apollo License Agreement will be transferred to ES.

The program was originally licensed to Avalo from MedImmune Limited, a subsidiary of AstraZeneca plc (“MedImmune”), and such license was transferred to Apollo. Avalo is not responsible for future milestone or royalties under the original license with MedImmune.

~~AVTX-501~~

In 2017, Avalo sold its worldwide rights to AVTX-501 to Janssen Pharmaceuticals, Inc. Upon closing of the ES Transaction, the future economic rights to milestones for AVTX-501 will be transferred to ES.

~~The Company had initially in-licensed the compound from Eli Lilly Company (“Lilly”). Avalo is not responsible for future milestones or royalties under the original license with Lilly.~~

~~AVTX-611~~

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In 2019, Avalo assigned its rights, title, interest and obligations under an in-license covering its non-core asset, AVTX-611, to ES. Upon closing of the ES Transaction, Avalo will waive all rights, including payments due to the Company from ES, under the original license agreement.

~~Avalo initially in-licensed the compound from Lilly. Avalo is not responsible for future milestones or royalties under the original license with Lilly.~~

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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 ~~2, 2022,~~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, ~~2021~~2022 appearing in our Annual Report on Form 10-K filed with the SEC on March ~~2, 2022.~~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~~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. ~~We believe the ability~~The Company is pursuing funding for its programs, including financings and out-licensing, strategic alliances/collaborations or sale of its core and non-core programs, as well as evaluating new opportunities to achieve the anticipated milestones represents our most immediate evaluation points. The following chart summarizes key information about our clinical-stage pipeline and anticipated research & development milestones:further argument its immunology pipeline.

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Pipeline Summary

Quisovalimab (AVTX-002): Anti-LIGHT monoclonal antibody (“mAb”) targeting immune-inflammatory diseases.

•Quisovalimab has shown a rapid and sustained reduction of LIGHT levels, as well as a favorable safety and tolerability profile, in all indications studied including COVID-19 acute respiratory distress syndrome (“ARDS”), Crohn’s Disease and non-eosinophilic asthma (“NEA”).

•Quisovalimab was statistically significant in reducing respiratory failure and mortality in patients hospitalized with COVID-19 ARDS in a randomized placebo-controlled trial. Quisovalimab also demonstrated positive trends in an open-label study in Crohn’s Disease.

•A post-hoc analysis of the PEAK Trial showed a sub-population of NEA patients with baseline LIGHT levels over 125 pg/mL, which represented over 50% of patients, had an approximate 50% reduction in asthma-related events (“AREs”) for patients treated with quisovalimab compared to placebo.

•Avalo is pursuing funding for the program and is considering a randomized placebo-controlled trial in patients with ulcerative colitis or other inflammatory conditions.

AVTX-008: BTLA agonist fusion protein targeting immune dysregulation disorders.

•AVTX-008 is uniquely positioned as a fusion protein with high-binding affinity and serum stability. It utilizes the natural ligand thus it may avoid the potential problems with agonist mAbs.

•Avalo previously identified a lead molecule, is evaluating several immune dysregulation disorders to pursue and plans to rapidly progress the asset to IND, subject to funding.

Recent Developments

InThe Company raised approximately $25.9 million of net proceeds under its “at-the-market” (or “ATM”) program in the third quarter of ~~2022, we were focused on progressing our pipeline programs forward to meaningful data readouts, notably AVTX-002 for~~2023. Further, in September of 2023, the ~~treatment~~Company announced that it paid off the remainder of ~~non-eosinophilic asthma (“NEA”). We remain on track to deliver topline data~~its debt in the ~~first half~~aggregate amount of ~~2023 from our Phase 2 PEAK (A Phase 2, Randomized, Double-Blind, Placebo-Controlled, Parallel Group Study to Evaluate the Safety~~$14.3 million and ~~Efficacy of AVTX-002 for the treatment of Poorly Controlled Non-Eosinophilic Asthma K) trial.~~

In August 2022, we narrowed our focus to dysregulated inflammation specifically as it relates to the LIGHT-signaling network. LIGHT (TNFSF14) has emerged as an important modulator of critical innate and adaptive immune responses. LIGHT and its signaling receptors, herpesvirus entry mediator (TNFRSF14), and lymphotoxin β receptor, form an immune regulatory network with two co-receptors of herpesvirus entry mediator, checkpoint inhibitor BTLA, and CD160. There is increasing evidence that the dysregulation of the LIGHT-signaling network is a disease-driving mechanism in autoimmune and inflammatory reactions in barrier organs, including COVID-19 acute respiratory distress syndrome and inflammatory bowel diseases. We have two drug candidates that modulate the LIGHT-signaling network, AVTX-002, an anti-LIGHT monoclonal antibody (“mAb”) in Phase 2, and AVTX-008, a BTLA agonist fusion protein in lead optimization.

In August 2022, we announced that AVTX-008, which we in-licensed in 2021 from Sanford Burnham Prebys Medical Discovery Institute as a portfolio of patents covering an immune checkpoint program, is a BTLA agonist fusion protein. We also announced that AVTX-008 has now entered IND-enabling studies. We added AVTX-008 to our product development pipeline milestone chart as a result ~~of reaching the IND-enabling phase~~all payments and ~~our recent change in focus to the LIGHT-signaling network. We are targeting IND submission in 2024.~~

~~We are proceeding with the AVTX-803 LADDER (A Phase 3, Randomized, Double-Blind, Two-Period, Crossover, Withdrawal Study to Assess the Efficacy~~obligations under that debt were deemed satisfied and Safety of AVTX-803 in Subjects with Leukocyte Adhesion Deficiency Type II (LADD) (ER)) trial and remain on track to deliver pivotal data in the first half of 2023. We will continue to consider strategic alternatives for AVTX-803, as well as AVTX-801 and AVTX-802.terminated.

On ~~November 4, 2022, Avalo entered into an agreement~~October 27, 2023, the Company divested its rights, title and interest in, assets relating to ~~sell its economic rights~~AVTX-801, AVTX-802 and AVTX-803 to ~~future payments for previously out-licensed assets including AVTX-007, AVTX-501, and AVTX-611 to ES~~AUG Therapeutics, LLC ~~(“ES”),~~for an ~~affiliate~~upfront payment of ~~Armistice, in exchange~~$150,000 and contingent milestone payments of up to an aggregate of $45.0 million.

As previously reported on Form 8-K filed on August 8, 2023, on August 8, 2023, Nasdaq Stock Market LLC (“Nasdaq”) notified the Company that for ~~$5.0~~the last 30 consecutive business days, the bid price for the Company’s common stock had closed below the minimum $1.00 per share requirement for continued inclusion on the Nasdaq Capital Market pursuant to Nasdaq Listing Rule 5550(a)(2) (the “Bid Price Rule”) and that for the last 30 consecutive business days, the Company’s minimum Market Value of Listed Securities (“MVLS”) was below the minimum of $35 million ~~payable upon closing~~required for continued inclusion on the Nasdaq Capital Market pursuant to Nasdaq Listing Rule 5550(b)(2) (the ~~“ES Transaction”~~“MVLS Rule”). ~~The ES Transaction is expected to close in November 2022. The ES Transaction was approved~~Therefore, in accordance with ~~Avalo’s related party transaction policy. Refer~~Listing Rules 5810(c)(3)(A) and 5810(c)(3)(C), the Company was provided 180 calendar days, or until February 5, 2024, to ~~Note 14~~regain compliance with both the Bid Price Rule and the MVLS Rule. Also as previously reported on Form 8-K filed on September 13, 2023, on September 12, 2023, the Company received notice from Nasdaq as of September 11, 2023, the Company’s securities had a closing bid price of $0.10 or less for ten consecutive trading days triggering application of Listing Rule 5810(c)(3)(A)(iii) which states in part: if during any compliance period specified in Rule 5810(c)(3)(A), a company’s security has a closing bid price of $0.10 or less for ten consecutive trading days, the Listing Qualifications Department shall issue a Staff Delisting Determination under Rule 5810 with respect to that security. As a result, the Staff determined to delist the Company’s securities from Nasdaq, unless the Company timely requests an appeal of the Staff’s determination to a Hearings Panel (the “Panel”). The Company timely requested an appeal of the Staff’s determination to the Panel and the hearing took place on November 2, 2023. The Panel will issue a written decision, generally within 30 days of the hearing, that will determine whether the shares of the Company’s common stock will remain listed on Nasdaq. The Company will timely report the decision of the Panel on Form 8-K upon receiving the written decision.

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Liquidity

For the nine months ended September 30, 2023, Avalo generated a net loss of $23.4 million and negative cash flows from operations of $27.9 million. As of September 30, 2023, Avalo had $10.2 million in cash and cash equivalents. In the three months ended September 30, 2023, the Company raised approximately $25.9 million of net proceeds under its “at-the-market” (or “ATM”) program. On September 22, 2023, the Company and its lenders entered into a Payoff Letter (the “Payoff Letter”), pursuant to which the Company repaid all outstanding principal, inclusive of the final payment fee, and interest under the Loan Agreement (as defined in Note 9 of the unaudited condensed consolidated financial statements) in the aggregate amount of $14.3 million. As a result of the payment, all obligations of the parties under the Loan Agreement were deemed satisfied and terminated.

The Company will require additional financing to fund its operations and to continue to execute its business strategy within one year after the date the unaudited condensed consolidated financial statements ~~for~~included herein were issued. To mitigate these conditions and to meet the Company’s capital requirements, management plans to use its current cash on hand along with some combination of the following: (i) financings, (ii) out-licensing, strategic alliances/collaborations or sale of core and non-core programs, and (iii) mergers and acquisitions. 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. Raising capital would be more difficult if our common stock is delisted from Nasdaq. The Company is currently in the delisting hearings process with Nasdaq (for more information refer to the “Recent Developments” section above). Further, if the Company raises additional ~~information.~~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. 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.

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 September 30, 2023 do not include any adjustments that might result from the outcome of this uncertainty.

Our Strategy

Our strategy for increasing stockholder value includes:

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

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•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 near term in order to continue as a going concern and be able to execute on this strategy.

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Results of Operations

Comparison of the Three Months Ended September 30, ~~2022~~2023 and ~~2021~~2022

Product Revenue, Net

Net product revenue was $0.2 million for the three months ended September 30, 2023, compared to $0.4 million for the three months ended September 30, ~~2022, compared to $1.4 million for the three months ended September 30, 2021.~~2022. The decrease was mainly attributable to a decrease in units sold, which may have been caused by disruptions to the sales channel as a result of the transition of commercial operations from Aytu BioScience, Inc. (“Aytu”) to Avalo in the second half of 2021. The Company is uncertain whether these potential disruptions will be temporary or have a permanent impact on future sales.sold.

~~License Revenue~~

~~In the third quarter of 2022, Avalo granted a worldwide, exclusive~~Avalo’s license ~~to Apollo Therapeutics Group Limited (“Apollo”) to research, develop, manufacture~~ and ~~commercialize AVTX-007, Avalo’s anti-IL-18 mAb. The Company recognized $14.5 million of license revenue~~supply agreement for ~~the three months ended~~its only commercial pharmaceutical product, Millipred®, which we consider non-core, expired on September 30, ~~2022 related~~2023. Therefore, we do not expect gross product revenue going forward. However, the Company will continue to monitor estimates for commercial liabilities, such as sales returns. As additional information becomes available, the Company could recognize expense (or a benefit) for differences between actuals or updated estimates to the ~~receipt of upfront fees pursuant to the license.~~reserves previously recognized.

Cost of Product Sales

Cost of product sales were ~~$0.5~~$0.2 million for the three months ended September 30, ~~2022,~~2023, compared to ~~$0.9~~$0.5 million for the same period in ~~2021.~~2022. The decrease was mainly attributable to a decrease in units sold, as discussed above.

Avalo’s license and supply agreement for Millipred® expired on September 30, 2023. Therefore, we do not expect material cost of product sales going forward.

Research and Development Expenses

The following table summarizes our research and development expenses for the three months ended September 30, ~~2022~~2023 and ~~2021~~2022 (in thousands):


		Three Months Ended September 30,					Three Months Ended September 30,
		2022		2021			2023		2022
Preclinical expenses	Preclinical expenses	$	479	$	1,485	Preclinical expenses	$	269	$	479
Clinical expenses	Clinical expenses	3,003		2,658		Clinical expenses	915		3,003
CMC expenses	CMC expenses	1,687		3,366		CMC expenses	(1,191)		1,687

Internal expenses:	Internal expenses:					Internal expenses:
Salaries, benefits and related costs	Salaries, benefits and related costs	1,533		2,499		Salaries, benefits and related costs	826		1,533
Stock-based compensation expense	Stock-based compensation expense	279		480		Stock-based compensation expense	371		279
Other	Other	61		63		Other	59		61
		$	7,042	$	10,551		$	1,249	$	7,042

Research and development expenses decreased ~~$3.5~~$5.8 million for the three months ended September 30, ~~2022, compared to the same period~~2023. This decrease was mainly driven by a $2.9 million decrease in ~~2021.~~

~~Notably,~~ chemistry, manufacturing, and controls (“CMC”) expenses and ~~preclinical expenses decreased $1.7~~$2.1 million ~~and $1.0 million, respectively.~~decrease in clinical expenses. CMC expenses decreased ~~largely~~ due to the ~~increased~~timing of manufacturing ~~activities to support clinical development~~runs. Further, in the second quarter of 2023, the Company canceled its next manufacturing run for AVTX-002 and as a result incurred a cancelation fee of approximately $1.0 million. In the third quarter of ~~2021 that did not repeat~~2023, the Company and manufacurer agreed to a reduced cancelation fee, which resulted in a reversal of the ~~third quarter of 2022. Preclinical~~expense. Clinical expenses decreased due to ~~non-clinical~~decreased activities and biomarker studies in the third quarter of 2021 that did not repeat in the third quarter of 2022. Clinical expenses increased $0.3 million, which was driven by increased clinical trial activities for the AVTX-002 PEAK study partially offset by fewer clinical trials overall in the current period as a result of the ~~out-license~~AVTX-002 PEAK trial concluding in June of ~~AVTX-007 and de-prioritization of certain programs in 2022.~~

2023. Additionally, salaries, benefits and related costs decreased ~~$1.0~~$0.7 million primarily due to ~~the reduction in~~reduced headcount ~~implemented in the first quarter of 2022~~ and ~~cost savings initiatives.~~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.

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Selling, General and Administrative Expenses

The following table summarizes our selling, general and administrative expenses for the three months ended September 30, ~~2022~~2023 and ~~2021~~2022 (in thousands):


		Three Months Ended September 30,					Three Months Ended September 30,
		2022		2021			2023		2022

Salaries, benefits and related costs	Salaries, benefits and related costs	$	839	$	1,434	Salaries, benefits and related costs	$	582	$	839
Legal, consulting and other professional expenses	Legal, consulting and other professional expenses	1,687		2,425		Legal, consulting and other professional expenses	1,146		1,687
Stock-based compensation expense	Stock-based compensation expense	452		1,279		Stock-based compensation expense	582		452
Advertising and marketing expense	Advertising and marketing expense	6		482		Advertising and marketing expense	7		6
Other	Other	300		306		Other	173		300
		$	3,284	$	5,926		$	2,490	$	3,284

Selling, general and administrative expenses decreased ~~$2.6~~$0.8 million for the three months ended September 30, ~~2022~~2023 compared to the ~~same period in 2021 due to decreased headcount and~~prior period. The decrease was driven by the impact of cost savings initiatives. Notably, non-cash stock-based compensation expense and salaries, benefits, and related costs decreased $0.8 million and $0.6 million, respectively, as a result of decreased headcount. Legal,initiatives across legal, consulting and other professional expenses ~~decreased $0.7 million due~~and salaries, benefits, as well as reduced headcount and reduced salary related costs. The decrease was partially offset by increased stock-based compensation expense during the period related to ~~reduced recruiting, information technology services~~the options granted to employees in the second half of 2022 and ~~legal expenses as a result~~first half of ~~cost savings initiatives.~~2023.

~~We expect~~Future selling, general and administrative expenses are difficult to ~~continue~~predict given they are highly dependent on the Company’s ability to ~~decrease as compared~~obtain additional capital to ~~historical periods prior~~fund its programs and operations, including but not limited to ~~the reduction in headcount~~financings and/or out-licensing, strategic alliance/collaborations or sale of its core and ~~other cost savings initiatives implemented in the first quarter of 2022.~~

~~Amortization Expense~~

~~The following table summarizes our amortization expense for the three months ended September 30, 2022 and 2021 (in thousands):~~

Three Months Ended September 30,
2022 2021
Amortization of intangible assets $ — $ 428

Avalo’s acquired assembled workforce and acquired product marketing rights were fully amortized in the first quarter of 2022 and fourth quarter of 2021, respectively, thus driving the $0.4 million decrease as compared to the prior period. We expect amortization expense to decrease as compared to historical prior periods given the intangible assets are fully amortized.non-core programs.

Other Expense, Net

The following table summarizes our other expense, net for the three months ended September 30, ~~2022~~2023 and ~~2021~~2022 (in thousands):


		Three Months Ended September 30,					Three Months Ended September 30,
		2022		2021			2023		2022

Interest expense, net						Interest expense, net	(1,553)		(898)
Change in fair value of derivative liability						Change in fair value of derivative liability	100		—
Other expense, net	Other expense, net	—		(15)		Other expense, net	(17)		—
Interest expense, net		(898)		(985)
		$	(898)	$	(1,000)		$	(1,470)	$	(898)

Other expense, net was mainly comprised of interest expense related to the ~~venture loan and security agreement~~Loan Agreement for the three months ended September 30, 2023 and 2022. ~~In June 2022,~~On September 22, 2023, the Company ~~made~~and its lenders entered into a ~~partial prepayment~~Payoff Letter, pursuant to which the Company repaid all outstanding principal, inclusive of ~~$15.0 million~~the final payment fee, and interest under the ~~venture loan and security agreement, of which $14.8 million was applied to principal, which drove the $0.1 million decrease in interest expense compared to the prior period.~~Loan Agreement.

~~We expect interest~~Interest expense, net increased $0.6 million mainly due to ~~decrease as compared to prior periods~~the acceleration of the remaining $0.9 million amortization of the debt discount recognized as a result of the Company’s payoff of the debt in September of 2023. Prior to the payoff, the Company incurred lower ~~outstanding~~interest expense as compared to the prior period due to a lower principal ~~balance.~~balance from previous prepayments.

~~Income Tax Expense~~As a result of the full payoff of the loan, we do not expect to recognize interest expense in the fourth quarter of 2023 or beyond.

~~The following table summarizes our income tax expense for the three months ended September 30, 2022 and 2021 (in thousands):~~

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Three Months Ended September 30,
2022 2021
Income tax expense $ 5 $ 8
Income Tax Expense

The Company recognized minimal income tax expense for both the three months ended September 30, ~~2022~~2023 and ~~2021.~~2022.

Comparison of the Nine Months Ended September 30, ~~2022~~2023 and ~~2021~~2022

Product Revenue, Net

Net product revenue was $1.4 million for the nine months ended September 30, 2023, compared to $2.6 million for the nine months ended September 30, ~~2022, compared to $4.6 million for the nine months ended September 30, 2021.~~2022. The decrease was mainly attributable to a decrease in units sold, which may have been caused by disruptions to the sales channel as a result of the transition of commercial operations from Aytu to Avalo in the second half of 2021. The Company is uncertain whether these potential disruptions will be temporary or have a permanent impact on future sales.sold.

~~License Revenue~~

~~Avalo recognized $14.5 million of~~Avalo’s license ~~revenue~~and supply agreement for ~~the nine months ended~~our only commercial pharmaceutical product, Millipred®, which we consider non-core, expired on September 30, ~~2022 compared~~2023. Therefore, we do not expect product revenue going forward. However, the Company will continue to ~~$0.6 million of license revenue~~monitor estimates for commercial liabilities, such as sales returns. As additional information becomes available, the ~~prior period. The license revenue recognized in the current period related to receipt of upfront fees pursuant~~Company could recognize expense (or a benefit) for differences between actuals or updated estimates to the out-license of AVTX-007 to Apollo. The license revenue in the prior period related to upfront fees received pursuant to the out-license and assignment of the rights to its non-core neurology pipeline assets, AVTX-301 and AVTX-406, respectively.reserves previously recognized.

Cost of Product Sales

Cost of product sales were ~~$2.8~~$1.5 million for the nine months ended September 30, ~~2022,~~2023, compared to ~~$1.1~~$2.8 million for the same period in ~~2021. In the second quarter of 2022, we fully reserved~~2022. The decrease was mainly attributable to a decrease in units sold, as discussed above, paired with the $1.0 million reserve of the receivable due from Aytu in December 2024 ~~pursuant to the transition service agreement, given Aytu disclosed~~that was recognized in their Quarterly Report on Form 10-Q for the quarter ended March 31, 2022 that substantial doubt existed with respect to their ability to continue as a going concern within one year after the date the financial statements were issued, or May 2023. We recognized the expense in the cost of product sales for the nine months ended September 30, 2022. Aytu most recently disclosed in their Annual Report on Form 10-K for the year ended June 30, 2022, that it does not have sufficient cash to cover its cash needs for the following twelve months following the filing of its Annual Report on Form 10-K, or until September 2023.

~~The remainder~~Avalo’s license and supply agreement for Millipred® expired on September 30, 2023. Therefore, we do not expect material cost of ~~the increase from the prior period was mainly driven by the fifty percent net profit share with the supplier, which began on July 1, 2021.~~product sales going forward.

Research and Development Expenses

The following table summarizes our research and development expenses for the nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 (in thousands):


		Nine Months Ended September 30,					Nine Months Ended September 30,
		2022		2021			2023		2022
Preclinical expenses	Preclinical expenses	$	2,047	$	5,829	Preclinical expenses	$	844	$	2,047
Clinical expenses	Clinical expenses	9,037		10,558		Clinical expenses	5,388		9,037
CMC expenses	CMC expenses	6,800		13,005		CMC expenses	1,787		6,800
License and milestone expenses		—		10,900

Internal expenses:	Internal expenses:					Internal expenses:
Salaries, benefits and related costs	Salaries, benefits and related costs	6,093		6,595		Salaries, benefits and related costs	2,699		6,093
Stock-based compensation expense	Stock-based compensation expense	931		1,244		Stock-based compensation expense	1,028		931
Other	Other	228		194		Other	171		228
		$	25,136	$	48,325		$	11,917	$	25,136

Research and development expenses decreased ~~$23.2~~$13.2 million for the nine months ended September 30, ~~2022~~2023 as compared to the ~~same period in 2021. In the first quarter~~prior period. Notably, CMC and clinical expenses decreased $5.0 million and $3.6 million, respectively, as a result of ~~2021, the Company recognized a $10.0 million upfront license fee related to the expanded indication license agreement~~reduced manufacturing and clinical trial activities for AVTX-002 driven by timing of study completion in June of 2023, paired with ~~Kyowa Kirin Co., Ltd. (“KKC”), which did not repeat~~decreased expenses as a result of the out-license of AVTX-007 in ~~the current period.~~July of 2022 and decreased spend on non-core programs in 2023.

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The remaining $13.2 million decrease was primarily driven by a decrease in CMC, preclinical and clinical expenses. CMC expenses decreased $6.2 million due to the timing of raw material purchases and increased manufacturing activities in the prior period that did not repeat in the nine months ended September 30, 2022. Preclinical expenses decreased $3.8 million primarily due to non-clinical activities and biomarker studies in the in the prior period that did not repeat in the nine months ended September 30, 2022. Clinical expenses decreased $1.5 million due to fewer clinical trials ongoing in the current period as a result of certain programs being paused or wound down in 2022 and the out-license of AVTX-007. However, these decreases were partially offset by increased clinical activities related to the AVTX-002 PEAK study.

~~Salaries,~~Additionally, salaries, benefits and related costs decreased ~~$0.5~~$3.4 million ~~compared~~due to severance expense recognized in the ~~same period~~first quarter of 2022 from headcount reductions that did not repeat, paired with lower salary costs in ~~2021. The decrease was primarily~~2023 driven by ~~decreased headcount~~the reduced headcount.

Future research and ~~cost savings initiatives implemented in 2022.~~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 nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 (in thousands):


		Nine Months Ended September 30,
		2022		2021			Nine Months Ended September 30,
							2023		2022
Salaries, benefits and related costs	Salaries, benefits and related costs	$	5,435	$	3,842	Salaries, benefits and related costs	$	1,768	$	5,435
Legal, consulting and other professional expenses	Legal, consulting and other professional expenses	5,484		7,703		Legal, consulting and other professional expenses	3,399		5,484
Stock-based compensation expense	Stock-based compensation expense	5,780		5,036		Stock-based compensation expense	1,673		5,780
Advertising and marketing expense	Advertising and marketing expense	64		1,044		Advertising and marketing expense	26		64
Other	Other	989		1,052		Other	758		989
		$	17,752	$	18,677		$	7,624	$	17,752

Selling, general and administrative expenses decreased ~~$0.9~~$10.1 million for the nine months ended September 30, 2023 due to severance and stock-based compensation recognized in the first quarter of 2022 ~~compared~~from headcount reductions, paired with decreased headcount and cost savings initiatives realized in 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 $3.7 million due to $2.4 million of severance expense recognized in the ~~same period~~first half of 2022 from headcount reductions that did not repeat, paired with lower salary costs in ~~2021. The decrease was primarily~~the first half of 2023 driven by ~~a $2.2 million decrease in legal,~~the reduced headcount. Legal, consulting and other professional expenses ~~and a $1.0~~decreased $2.1 million ~~decrease in advertising and marketing expenses. These decreases were driven by reduced recruiting, information technology services, legal and consulting expenses as a result of~~due to cost savings initiatives.

Salaries, benefits and related costs and stock-based compensation expense increased $1.6 million and $0.7 million, respectively, as a result of severance expense and modifications of separated employee’s stock options recognized in the nine months ended September 30, 2022. Such increases were partially offset by overall decreased headcount in the current period.

Amortization Expense

The following table summarizes our amortization expense for the nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 (in thousands):

Nine Months Ended September 30,
2022 2021
Amortization of intangible assets $ 38 $ 1,281


	Nine Months Ended September 30,
	2023		2022

Amortization of intangible assets	$	—	$	38

~~Avalo’s~~The acquired assembled workforce ~~and acquired product marketing rights were~~was fully amortized in the first quarter of 2022, ~~and fourth quarter of 2021, respectively,~~ thus driving the ~~$1.2 million~~ decrease as compared to the prior period. ~~We expect amortization expense to decrease as compared to historical periods given the intangible assets are fully amortized.~~

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Other Expense, Net

The following table summarizes our other expense, net for the nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 (in thousands):

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		Nine Months Ended September 30,					Nine Months Ended September 30,
		2022		2021			2023		2022

Interest expense, net						Interest expense, net	(3,498)		(3,221)
Change in fair value of derivative liability						Change in fair value of derivative liability	(120)		—
Other expense, net	Other expense, net	(20)		(20)		Other expense, net	(42)		(20)
Interest expense, net		(3,221)		(1,207)
		$	(3,241)	$	(1,227)		$	(3,660)	$	(3,241)

Other expense, net was mainly comprised of interest expense related to the ~~venture loan and security agreement~~Loan Agreement for the nine months ended September 30, ~~2022~~2023 and ~~2021. Avalo~~2022. On September 22, 2023, the Company and its lenders entered into a Payoff Letter, pursuant to which the Company repaid all outstanding principal, inclusive of the final payment fee, and interest under the Loan Agreement.

Interest expense, net increased $0.3 million mainly due to the acceleration of the remaining $0.9 million amortization of the debt discount recognized as a result of the Company’s payoff of the debt in September of 2023. This increase was partially offset by lower interest expense incurred prior to the final payoff due to a lower principal balance from previous prepayments.

As a result of the full payoff of the loan, ~~agreement in June 2021 and therefore only recognized a partial period of~~we do not expect to recognize interest expense in the ~~prior period, which drove the increase for the nine months ended September 30, 2022.~~

~~In June 2022, the Company made a partial prepayment~~fourth quarter of ~~$15.0 million under the venture loan and security agreement, of which $14.8 million was applied to principal. Therefore, we expect interest expense to decrease as compared to prior periods.~~2023 or beyond.

Income Tax Expense ~~(Benefit)~~

~~The following table summarizes our income tax expense for the nine months ended September 30, 2022 and 2021 (in thousands):~~

Nine Months Ended September 30,
2022 2021
Income tax expense (benefit) $ 20 $ (180)

The Company recognized minimal income tax expense for both the nine months ended September 30, 2022 compared to an income tax benefit of $0.2 million for the nine months ended September 30, 2021. The income tax benefit in the prior period was a result of the updated estimate of interest receivable2023 and ~~abatement of penalties on the refund claim, as the final refund payment was received from the Internal Revenue Service in the second quarter of 2021.~~2022.

Liquidity and Capital Resources

In order to meet its cash flow needs, the Company applies a disciplined decision-making methodology as it evaluates the optimal allocation of the Company’s resources between investing in the Company’s existing pipeline assets and acquisitions or in-licensing of new assets. As of September 30, 2022, Avalo had $16.9 million in cash and cash equivalents. For the nine months ended September 30, 2022, Avalo generated a net loss of $31.8 million and negative cash flows from operations of $22.8 million. As of September 30, 2022, Avalo had an accumulated deficit of $294.0 million.

In the second quarter of 2022, as collectively agreed upon with the Lenders (as defined below), the Company made a partial prepayment of $15.0 million ($14.8 million of which was applied to principal) on notes (the “Notes”) issued under its 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”). Avalo intends to consider additional prepayments prior to principal loan amounts coming due, if collectively agreed upon with the Lenders. As of September 30, 2022, the carrying value of the Notes (as defined in Note 9) was $19.1 million.

To mitigate these conditions and to meet the Company’s capital requirements, management plans to use its current cash on hand along with some combination of the following: (i) dilutive and/or non-dilutive financings, (ii) out-licensing or strategic alliances/collaborations of its current pipeline assets, (iii) out-licensing or sale of its non-core assets, and (iv) federal and/or private grants. If the Company raises additional funds through collaborations, strategic alliances or licensing arrangements with third parties, the Company might have to relinquish valuable rights to its technologies, future revenue streams, research programs or product candidates. Subject to limited exceptions, the Loan Agreement prohibits the Company from incurring certain additional indebtedness, making certain asset dispositions, and entering into certain mergers, acquisitions or other business combination transactions without the prior consent of the Lenders. Additionally, the Loan Agreement contains certain covenants and certain

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other specified events that could result in an event of default, which if not cured or waived, could result in the immediate acceleration of all or a substantial portion of the outstanding Notes. As of the filing date of this Quarterly Report on Form 10-Q, the Company was not aware of any breach of covenants or occurrence of material adverse change, nor had it received any notice of event of default from the Lenders (refer to Note 9 of the condensed unaudited consolidated financial statements for more information).

If the Company requires but is unable to obtain additional funding, the Company may be forced to make reductions in spending, delay, suspend, reduce or eliminate some or all of its planned research and development programs, or liquidate assets where possible. Due to the uncertainty regarding future financing and other potential options to raise additional funds, management has concluded that substantial doubt exists with respect to the Company’s ability to continue as a going concern within one year after the date that the financial statements in this Quarterly Report on Form 10-Q were issued.

Over the long term, the Company’s ultimate ability to achieve and maintain profitability will depend on, among other things, the development, regulatory approval, and commercialization of its pipeline assets, and the potential receipt and sale of any priority review vouchers it receives.

Uses of Liquidity

The Company uses cash to primarily fund the ongoing development of ~~our~~its 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.

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Cash Flows

The following table summarizes our cash flows for the nine months ended September 30, ~~2022~~2023 and ~~2021~~2022 (in thousands):


		Nine Months Ended September 30,					Nine Months Ended September 30,
		2022		2021			2023		2022

Net cash (used in) provided by:	Net cash (used in) provided by:					Net cash (used in) provided by:
Operating activities	Operating activities	$	(22,811)	$	(53,793)	Operating activities	$	(27,914)	$	(22,811)
Investing activities	Investing activities	(95)		(102)		Investing activities	(133)		(95)
Financing activities	Financing activities	(14,781)		106,686		Financing activities	25,041		(14,781)
Net (decrease) increase in cash and cash equivalents		$	(37,687)	$	52,791
Net decrease in cash and cash equivalents						Net decrease in cash and cash equivalents	$	(3,006)	$	(37,687)

Net cash used in operating activities

Net cash used in operating activities was $27.9 million for the nine months ended September 30, 2023 and consisted primarily of a net loss of $23.4 million and non-cash adjustments to reconcile net loss to net cash used in operating activities including stock-based compensation of $2.7 million and accretion of the debt discount of $1.8 million. Accrued expenses and other current liabilities and accounts payable decreased $8.1 million and $2.1 million, respectively, from December 31, 2022.

Net cash used in operating activities was $22.8 million for the nine months ended September 30, 2022, and consisted primarily of a net loss of $31.8 million and non-cash adjustments to reconcile net loss to net cash used in operating activities including stock-based compensation of $6.7 million and the full $1.0 million reserve on the Aytu receivable due December 2024. ~~Additionally, changes in net assets increased by $0.1 million.~~

~~Net~~Future operating cash ~~used in operating activities was $53.8 million for~~flows are difficult to predict given they are highly dependent on the ~~nine months ended September 30, 2021, consisting~~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 a net loss of $65.2 million. The decrease was partially offset by non-cash stock-based compensation of $6.3 million. Additionally, changes in net liabilities increased $3.5 million, mainly driven by a $2.6 million increase in accrued expenses. In April 2021, the Company paid the $10.0 million upfront license fee related to the expanded indication license agreement for AVTX-002 with KKC.its core and non-core programs.

Net cash used in investing activities

Net cash used in investing activities ~~which primarily consisted of purchases of property and equipment,~~ was minimal for the nine months ended September 30, ~~2022~~2023 and nine months ended September 30, ~~2021.~~2022.

Net cash ~~used in~~provided by (used in) financing activities

Net cash used in financing activities for the nine months ended September 30, 2022 consisted of the principal portion of the $15.0 million partial prepayment the Company made in the second quarter of 2022 under its the Loan Agreement.

Net cash provided by financing activities ~~was $106.7 million~~ for the nine months ended September 30, ~~2021 and~~2023 consisted ~~primarily~~ of net proceeds of ~~$104.9~~$32.5 million from ~~equity~~the sale of common stock pursuant to the Company’s at-the-market program and net proceeds of $13.7 million from an underwritten public offering that closed in February 2023, partially offset by debt ~~financings. Specifically,~~principal payments of $21.2 million. In September of 2023, the Company ~~received net proceeds~~repaid all outstanding principal, inclusive of the final payment fee, and interest under its loan agreement and therefore we do not expect any future principal payment outflows.

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$37.7 million from an underwritten public offering closed in January 2021, net proceeds of $32.9 million as part of the Loan Agreement entered into in the second quarter of 2021, and net proceeds of $29.0 million from an underwritten public offering that closed in September 2021.

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 other intangible assets~~ 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, ~~2021~~2022 filed with the SEC on March ~~2, 2022.~~29, 2023. There have been no material changes to our critical accounting policies during the nine months ended September 30, ~~2022.~~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.

~~Interest Rate 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.~~The information set forth in Note 13, Commitments and Contingencies, under the heading “Litigation” to our Unaudited Condensed Financial Statements, included in Part I, Item 1 of this Quarterly Report on Form 10-Q, is incorporated herein by reference.

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, ~~2021,~~2022, filed with the SEC on March ~~2, 2022,~~29, 2023(the “2022 10-K”), as updated by our Quarterly Report on Form 10-Q filed with the SEC on August 3, 2023 (the “2023 Q2 10-Q”), which could materially affect our business, financial condition, or future results. ~~Our risk factors as of the date of~~The risks described in this Quarterly Report on ~~Form~~ 10-Q ~~have not changed materially from those described in~~and the ~~Form~~2022 10-K ~~referenced above. The risks described in the Form 10-K referenced above~~and 2023 Q2 10-Q 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 ~~may~~ materially adversely affect our business, financial condition, or future results of operations and the trading price of our common stock.

~~Item 5. Other Information.~~Except for such additional information and the updated risk factor set forth below, we believe there have been no other material changes in our risk factors from those disclosed in our 2022 10-K and 2023 Q2 10-Q.

~~On November 4, 2022, the Company entered into a Purchase Agreement (the “Purchase Agreement”) with ES Therapeutics, LLC (“ES”), pursuant~~Risks Related to ~~which the Company will (i) sell to ES all of the Company’s (a) rights to any milestone payments, under the Asset Purchase Agreement, dated August 14, 2017, by~~Our Financial Position and between the Company and Janssen Pharmaceuticals, Inc. (relating to AVTX-501), and (b) any future milestone and royalty payments under the License Agreement, dated July 29, 2022, by and between Apollo AP43 Limited and the Company (relating to AVTX-007), and (ii) waive all rights, including all payments due to the Company from ES, under the Assignment of License Agreement, dated August 8, 2019 (relating to AVTX-611), by and among the Company, ES and Armistice Capital ~~Master Fund Ltd (“Armistice”). ES is required to pay the Company $5.0 million for all such rights and the waiver upon closing of the transaction. The sale is expected to close in November 2022.~~Needs

The ~~Purchase Agreement contains customary representations~~Company has a limited number of unissued and ~~warranties~~unreserved shares available for future issuance, which might impair its ability to conduct future financing and ~~covenants of the Company and ES, including indemnification of ES by the Company up to the amount of the purchase price.~~

ES is an affiliate of Armistice. Armistice is a significant stockholder of the Company and whose chief investment officer, Steven Boyd, and managing director, Keith Maher, served on the Company’s board of directors until August 8, 2022. The Company’s board of directors approved the transaction in accordance with its related party transaction policy.other transactions.

The ~~foregoing description~~Company’s amended and restated certificate of incorporation, as amended, currently authorizes the ~~Purchase Agreement does not purport~~Company to issue up to 200,000,000 shares of common stock and 5,000,000 shares of preferred stock. As of November 7, 2023, there was a total of 7,617,581 shares of common stock that were authorized but unissued, and the Company has currently reserved a significant number of these shares for future issuance pursuant to its outstanding warrants, equity awards and equity plans. As a result, the Company’s ability to issue shares of common stock other than pursuant to existing arrangements will be limited until such time, if ever, that it is able to amend its amended and restated certificate of incorporation, as amended, to increase the amount of authorized but unissued shares of common stock. As described in the Company’s definitive proxy statement filed with the SEC on October 19, 2023, the Company is presenting a proposal for stockholder vote at the annual meeting of stockholders to be held on December 5, 2023 to approve an amendment to its amended and restated certificate of incorporation, as amended, to effect a reverse stock split of its common stock at a ratio of between 1-for-5 and 1-for-250 as determined by its board. This proposal would provide the Company sufficient flexibility in regards to having enough shares of common stock available for future needs. There is no guarantee that this proposal will be approved by the Company’s stockholders.

If the Company is unable to effect a reverse stock split, its ability to complete equity-based financings or other transactions that involve the potential issuance of its common stock or securities convertible or exercisable into its common stock, will be limited. In lieu of issuing common stock or securities convertible into the Company’s common stock in any future equity financing transactions, the Company might need to issue some or all of our authorized but unissued shares of preferred stock, which would likely have superior rights, preferences and privileges to those of its common stock. If the Company is ~~qualified in~~unable to issue additional shares of common stock or securities convertible or exercisable into its ~~entirety by reference~~common stock, its ability to enter into strategic transactions such as acquisitions of companies or intellectual property, might also be limited. If the ~~full text~~Company is unable to complete financing, strategic or other transactions due to its inability to issue additional shares of common stock or securities convertible or exercisable into its common stock, the ~~Purchase Agreement, a copy of which is filed as Exhibit 10.3 to this Quarterly Report.~~Company’s financial condition and business prospects may be materially harmed.

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Item 6. Exhibits.


Exhibit Number						Description of Exhibit

~~10.1*+~~1.1						~~License~~Amendment No. 1 to the Sales Agreement, dated ~~July 29, 2022,~~as of August 7, 2023, between Avalo Therapeutics, Inc. and Oppenheimer & Co. Inc. (incorporated by reference to Exhibit 1.1 to the Form 8-K filed on August 7, 2023.

2.1*#						Purchase Agreement, dated September 11, 2023, by and between ~~Apollo AP43 Limited~~AUG Therapeutics, LLC and Avalo Therapeutics, Inc. (incorporated by reference to Exhibit 2.1 to the Form 8-K filed on September 12, 2023).

3.1						Fourth Amended and Restated Bylaws of Avalo Therapeutics, Inc. (incorporated by reference to Exhibit 3.1 to the Form 8-K filed on October 17, 2023).

10.1						Second Forbearance Agreement, dated as of August 14, 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 Exhibit 10.1 to the Form 8-K filed on August 14, 2023).

10.2						W ~~aive~~r,Third Forbearance Agreement, dated ~~August 11, 2022~~as of September 13, 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 Exhibit 10.1 to the Form 8-K filed on ~~August 11, 2022)~~September 13, 2023).

~~10.3*+~~10.3						~~Purchase~~First Amendment to Loan Agreement, dated ~~November 4, 2022, by and~~as of September 13, 2023, between ~~ES Therapeutics, LLC and~~ 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 Exhibit 10.2 to the Form 8-K filed on September 13, 2023).

10.4						Payoff Letter, dated as of September 22, 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 Exhibit 10.1 to the Form 8-K filed on September 26, 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 ~~(Unaudited)~~ as of September 30, ~~2022~~2023 (Unaudited) and December 31, ~~2021;~~2022; (ii) Condensed Consolidated Statements of Operations (Unaudited) for the Three and Nine Months Ended September 30, ~~2022~~2023 and ~~2021;~~2022; (iii) Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, ~~2022~~2023 and ~~2021;~~2022; (iv) Condensed Consolidated Statements of Changes in Stockholders’ (Deficit) Equity (Unaudited) for the Three and Nine Months Ended September 30, ~~2022~~2023 and ~~2021;~~2022; and (v) Notes to Unaudited Financial Statements.

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

*Certain exhibits and schedules to this exhibit have been omitted pursuant to Item 601(a)(5) of Regulation S-K. The Company hereby undertakes to furnish supplemental copies of any of the omitted exhibits or schedules upon request by the U.S. Securities and Exchange Commission.

# Certain confidential portions ~~and/or the schedules and attachments~~ to this exhibit have been omitted from this filing pursuant to Item ~~601(a)(5) or~~ 601(b)~~(10), as applicable,~~(2) of Regulation S-K. The Company will furnish copies of the unredacted exhibit to the SEC upon request.

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+ 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: November ~~7, 2022~~9, 2023									/s/ Christopher Sullivan
									Christopher Sullivan
									Chief Financial Officer
									(on behalf of the registrant and as the registrant’s principal financial officer)

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	Common stock			Preferred Stock			Additional paid-in		Accumulated		Total stockholders’
	Shares1	Amount1		Shares	Amount		capital1		deficit		equity
Nine Months Ended September 30, 2021
Balance, December 31, 2020	6,250,344	$	6	1,257,143	$	1	$	202,345	$	(177,790)	$	24,562
Issuance of shares of common stock and pre-funded warrants in underwritten public offering, net	1,164,323	1		—	—		37,652		—		37,653
Issuance of common stock in underwritten public offering, net	1,192,407	1		—	—		29,045		—		29,046
Issuance of common stock pursuant to ATM Program, net	166,667	—		—	—		5,312		—		5,312
Issuance of equity classified warrants related to venture loan and security agreement	—	—		—	—		861		—		861
Exercise of stock options	48,385	—		—	—		1,568		—		1,568
Conversion of preferred stock to common stock	523,810	1		(1,257,143)	(1)		—		—		—
Shares purchased through employee stock purchase plan	7,391	—		—	—		207		—		207
Restricted stock units vested during period	6,493	—		—	—		—		—		—
Stock-based compensation	—	—		—	—		6,280		—		6,280
Net loss	—	—		—	—		—		(65,180)		(65,180)
Balance, September 30, 2021	9,359,820	$	9	—	$	—	$	283,270	$	(242,970)	$	40,309


	Three Months Ended
	September 30, 2021
	Common stock
	Continuing Operations		Discontinued Operations

Allocation of undistributed net (loss) income	$	(17,471)	$	76

Weighted average shares	8,374,200		8,374,200
Basic and diluted net (loss) income per share	$	(2.09)	$	0.01


	As of September 30, 2022
2022	$	—
2023	5,930
2024	13,463
2025	1,851
Total principal payments1	$	21,244