Avalo Therapeutics, Inc. annual report, FY2017

Business context and reporting period

This is Cerecor Inc.’s Form 10-K for the fiscal year ended December 31, 2017, filed April 2, 2018—not a filing under the name Avalo Therapeutics. Cerecor was shifting from a development-stage biotech toward a pediatric specialty pharmaceutical company. It acquired TRx Pharmaceuticals in November 2017; its acquisition of Avadel’s pediatric products occurred in February 2018, after year-end.

The portfolio included marketed pediatric products and development candidates CERC-301 (planned Phase 1 safety study for neurogenic orthostatic hypotension), CERC-611, CERC-406 and CERC-425 (preclinical). Cerecor sold CERC-501 rights to Janssen in August 2017.

Key financial metrics

2017 operating expenses were $13.9 million, including $4.4 million of research and development, $7.9 million of general and administrative, and $1.0 million of sales and marketing costs. Cash operating flows benefited substantially from the $25 million Janssen transaction; $3.75 million was held in escrow and reported as a receivable. The filing gives no meaningful consolidated product gross margin because the year’s revenue included the large license transaction.

At December 31, 2017, current assets were $11.0 million and current liabilities were $11.4 million, for negative working capital of about $0.4 million. The company reported an accumulated deficit of $58.2 million. The prior secured term loan was repaid in August 2017.

Material changes versus the prior comparable period

• Revenue and reported profitability increased sharply, chiefly because Cerecor recognized $25 million from selling CERC-501 rights to Janssen. This was a transaction-driven result, not evidence of recurring operating profitability.
• Product revenue of $1.9 million and sales-force revenue of $0.3 million arose after the November TRx acquisition; 2017 therefore includes only a short post-acquisition period, while 2016 had no product revenue.
• R&D expense fell to $4.4 million from $10.1 million, reflecting completion or transfer of studies, reduced CERC-501 activity and the sale of that program. G&A rose to $7.9 million from $7.1 million, including acquisition diligence and compliance infrastructure costs.
• Cash declined by $2.7 million during 2017 despite positive operating cash flow, principally reflecting the $18.9 million cash payment for TRx. Financing activities provided $3.7 million.
• TRx added $18.1 million of identifiable intangible assets and $14.3 million of goodwill. The company reported Q4 2017 net loss of $3.1 million, compared with a $1.6 million loss in Q4 2016.

Outlook, risks, contingencies and unusual items

• Management expected available cash and anticipated operating cash flows to fund expenses through at least April 2, 2019; elsewhere it described funding through March 2019. Management cautioned that additional financing might be needed. This is not formal revenue or earnings guidance.
• In February 2018, Cerecor acquired Avadel’s pediatric products for nominal cash consideration while assuming a $15 million loan due January 2021 and royalties of 15% of acquired-product net sales through February 2026. The acquired products had approximately $8 million in trailing twelve-month net sales. The filing does not provide 2018 earnings guidance for this transaction.
• TRx sellers could receive up to $7 million in contingent payments. The TRx acquisition also involved 2,349,968 shares subject to stockholder approval. Acquisition-related estimates and purchase-price allocation were preliminary.
• A material weakness in internal control over financial reporting was identified: controls did not adequately prevent or timely detect unauthorized cash disbursements. Management reported steps to strengthen controls and expected remediation in Q1 2018; the weakness did not result in a material financial-statement misstatement. TRx was excluded from the 2017 internal-control assessment.
• A dispute and arbitration concerned whether competition from Sklice constituted a “Market Change” under the related-party Ulesfia agreement. The outcome affects potential minimum purchases and royalties, including a stated $3 million annual minimum absent a qualifying Market Change. Cerecor reported no payments to Lachlan in 2017 after the acquisition date.
• Liquidity, commercial execution and dependence on acquired products are key risks. Other risks include clinical and regulatory failure, competition and generic entry, third-party manufacturing dependence, product reimbursement, potential dilution, and the company’s substantial financing needs.
• 2017 Q4 net loss was $3.1 million; reported Q4 revenue was approximately $2.2 million, comprising product, sales-force and grant revenue. The filing reports no product revenue for Q4 2016.

Most important facts for investors to verify

1. How much of 2017’s $11.9 million net income and $12.5 million operating cash flow reflects the one-time Janssen payment, and when the $3.75 million escrow is released or retained.
2. Current cash, burn rate and funding runway after the Avadel acquisition, including the $15 million loan, interest and royalty burden.
3. Post-acquisition sales, margins, product-level performance and integration results for TRx and Avadel products; 2017 includes only a limited period of TRx operations.
4. Resolution and financial exposure from the Ulesfia “Market Change” arbitration and related-party arrangements.
5. Progress on remediation of the cash-disbursement control weakness and inclusion of TRx in subsequent internal-control assessments.
6. Whether the planned CERC-301 study and preclinical programs advance as intended, and what financing is available to support them.