Item 1A. Risk Factors
ITEM
1A. RISK FACTORS
Except
for the additional risk factors addressed below, there were no material changes from the risk factors set forth under Part I, Item 1A.,
“Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020. You should carefully consider
these factors in addition to the other information set forth in this report which could materially affect our business, financial condition
or future results. The risks and uncertainties described in this report and in our Annual Report on Form 10-K for the year ended December 31,
2020, as well as other reports and statements that we file with the SEC, are not the only risks and uncertainties facing us. Additional
risks and uncertainties not currently known to us or that we currently deem to be immaterial may also have a material adverse effect
on our financial position, results of operations or cash flows.
Our
general development operations have continued during the COVID-19 pandemic and we have not had significant disruption. Currently we are
unable to accurately predict the future impact of COVID-19 due to the developing circumstances and uncertainty surrounding this current
pandemic, including the ultimate geographic spread of COVID-19, the severity of the disease, the duration of the outbreak, and effectiveness
of the actions that may be taken by governmental authorities. Our management has been closely monitoring the impact caused by COVID-19
and we will continue to operate our business as steadily and safely as we can.
General
Risk Factors
We
have entered into two third-party research agreements to advance our sponsored research programs. These arrangements may not ultimately
yield any promising product candidates for preclinical or clinical development. We may not be able to fully realize the benefits of any
intellectual property generated by these arrangements.
Part
of our strategy involves collaborative sponsored research to be performed by third-party research institutions. Avalon has entered into
various research agreements including an agreement with Massachusetts Institute of Technology (MIT) to research novel therapeutic and
diagnostic targets development utilizing QTY-code protein design technology including using the QTY code protein design technology for
development of a hemofiltration device to treat Cytokine Storm Strategic as well as a partnership with the University of Natural Resources
and Life Sciences (BOKU) in Vienna, Austria to develop an S-layer vaccine that can be administered by an intranasal or oral route against
SARS-CoV-2, the novel coronavirus that causes COVID-19 disease.
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Although
we seek to direct this research and advise on the design of these projects as well as critical development decisions, this research is
being performed by individuals who are not our employees and the timeline and quality of the research efforts are outside of our direct
control. Academic investigators and other researchers may have different priorities than we do as a CellTech bio-developer. The sponsored
research agreements we enter into for these programs generally provide that any inventions resulting from the research will be owned
by the research institution performing the research, and that we have an option to negotiate for a license to develop and exploit any
such inventions. Confidential information and new inventions derived from these research efforts may be disclosed through publications
or other means prior to our third-party research collaborators being able to protect such intellectual property through the filing of
patent applications. Our third-party research collaborators may not be able to obtain or maintain full ownership of inventions that are
derived from the research or associated rights, which may limit their ability to provide us with a license to all relevant intellectual
property on terms and conditions that are acceptable to us. Even if our collaborative research efforts yield promising results or new
technological advances, they may not ultimately result in our being able to protect, develop or exploit the resulting intellectual property.
Risks
Related to the VIE Structure and SenlangBio being a PRC Domestic Entity
There
are uncertainties regarding the interpretation and enforcement of PRC laws, rules, and regulations in general, as well as the actions
taken by PRC regulatory authorities.
SenlangBio’s
operations are conducted in the PRC, and are governed by PRC laws, rules, and regulations. The PRC legal system is a civil law system
based on written statutes. Unlike the common law system, prior court decisions may be cited for reference but have limited precedential
value. Recently enacted laws, rules and regulations may not sufficiently cover all aspects of economic activities in China or may be
subject to a significant degree of interpretation by PRC regulatory agencies and courts. Because these laws, rules and regulations are
relatively new, and because of the limited number of published decisions and the non-precedential nature of these decisions, and because
the laws, rules and regulations often give the relevant regulator significant discretion in how to enforce them, the interpretation and
enforcement of these laws, rules and regulations involve uncertainties and can be inconsistent and unpredictable. Therefore, if the applicable
regulations change or are interpreted differently, it is possible that SenlangBio’s existing operations or the contractual arrangements
constituting part of the VIE structure are not in full compliance with relevant laws and regulations. Avalon’s operating results
may be significantly impacted and its shares may decline in value or become worthless if Avalon is unable to assert its contractual control
rights over the assets of its PRC subsidiaries that conduct a significant portion of its operations. In addition, the PRC legal system
is based in part on government policies and internal rules, some of which are not published on a timely basis or at all, and which may
have a retroactive effect. As a result, SenlangBio or Avalon may not be aware of any violation of these policies and rules until after
the occurrence of the violation. Overall, the significant uncertainties in the regulatory environment in China imposes significant risks
on VIE and other contractual arrangements.
Any
administrative and court proceedings in China may be protracted, resulting in substantial costs and the diversion of resources and management
attention. Since PRC administrative and court authorities have significant discretion in interpreting and implementing statutory and
contractual terms, it may be more difficult to evaluate the outcome of administrative and court proceedings. These uncertainties may
impede Avalon’s ability to enforce contracts, including the VIE Agreements, and could materially and adversely affect Avalon’s
business, financial condition, and results of operations. Moreover, since the PRC administrative authorities have significant discretion
in interpreting and implementing statutory and contractual terms, they may materially intervene with or influence Avalon’s or SenlangBio’s
operations at any time, which could result in a material change in the value of Avalon’s common stock.
In
addition, the PRC government has recently announced its plans to enhance its regulatory oversight of Chinese companies listing overseas.
The Opinions on Intensifying Crack Down on Illegal Securities Activities issued on July 6, 2021, called for extraterritorial application
of China’s securities laws. As the Opinions on Intensifying Crack Down on Illegal Securities Activities were recently issued, there
are great uncertainties with respect to the interpretation and implementation thereof. The Chinese government may promulgate relevant
laws, internal rules and regulations that may impose additional and significant obligations and liabilities on overseas listed Chinese
companies regarding data security, cross-border data flow, and compliance with China’s securities laws. These laws and regulations
can be complex and stringent, and many are subject to change and uncertain interpretation, which could result in claims, change to our
data and other business practices, regulatory investigations, penalties, increased cost of operations, or declines in user growth or
engagement, or otherwise affect our business. Currently, Avalon believes that it is unlikely to be directly subject to the above-mentioned
securities laws because Avalon is a U.S. domiciled and listed corporation. However, any action taken by PRC regulatory authorities under
such laws and regulations could change this and could cause the value of such securities to significantly decline or be worthless.
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The
business of SenlangBio may fall into the prohibited foreign investment category under currently effective PRC laws.
On
March 15, 2019, the National People’s Congress (“NPC”) promulgated the Foreign Investment Law, which took effect on
January 1, 2020, and replaced three existing laws regulating foreign investment in China, namely, the PRC Equity Joint Venture Law, the
PRC Cooperative Joint Venture Law and the Wholly Foreign-owned Enterprise Law, together with their implementation rules and ancillary
regulations. The Foreign Investment Law grants foreign invested entities the same treatment as PRC domestic entities, except for those
foreign invested entities that operate in industries deemed to be either “restricted” or “prohibited” in the
“negative list” published by the State Council. Sen Lang BVI is a BVI company, and the PRC Subsidiary is currently considered
to be a foreign invested entity.
The
latest version of the “negative list,” namely, the Special Management Measures (Negative List) for the Access of Foreign
Investment (2020), which became effective on July 23, 2020, provides that foreign investment is prohibited in the development and application
of human stem cells, genetic diagnosis, and treatment technology. However, the PRC laws do not clarify the meaning of “development
and application of human stem cells, genetic diagnosis and treatment technology” and do not explain whether transactions involving
a VIE Structure should be considered as “investment” in the context of the prohibition of foreign investment. SenlangBio’s
main business is conducting R&D and clinical transformation of immunotherapy cell therapy, which involves modifying the patient’s
T-Cells genetically. Despite the foregoing lack of clarity, the applicable rules could be interpreted in a way unfavorable to the business
of SenlangBio. In the context of law enforcement, if the competent PRC authorities and courts interpret “development and application
of human stem cells, genetic diagnosis and treatment technology” broadly, the modification of T-Cells genetically could be considered
as falling into the prohibited foreign investment category.
Although
Avalon believes that no approvals or permissions are required under current applicable PRC laws and regulations for Avalon to complete
the Acquisition, if SenlangBio’s CAR-T cell therapies or other technologies that are being researched and developed are deemed
by relevant PRC regulatory agencies as falling into the category of “human stem cells, genetic diagnosis and treatment technology,”
and if the VIE Structure is considered as “investment” in the context of the prohibition of foreign investment, SenlangBio
would be prohibited from engaging in the research or development of such technologies. In that event, Avalon and the Sen Lang BVI Beneficial
Shareholders would have to restructure Avalon’s control over SenlangBio. SenlangBio may also have to forfeit its income derived
from the research and development of such technologies. Any of these occurrences may harm Avalon’s and SenlangBio’s business,
prospects, financial condition, and results of operations significantly.
Avalon intends to receive dividends and other
distributions from SenlangBio through the VIE Structure, and any limitation on the ability of SenlangBio or Sen Lang BVI or its subsidiaries
to make payments to Avalon could have an adverse effect on Avalon’s ability to conduct its business.
Avalon
intents to receive dividends and other distributions from SenlangBio through the VIE Structure. Current PRC regulations permit the PRC
Subsidiary (the counter-party to the VIE Agreements with SenlangBio) to pay dividends up to Sen Lang BVI, the entity that will be acquired
by Avalon in the Acquisition, only out of its accumulated after-tax profits upon satisfaction of relevant statutory conditions and procedures,
if any, determined in accordance with Chinese accounting standards and regulations. In addition, the PRC Subsidiary is required to set
aside at least 10% of its after-tax profits each year, if any, to fund certain reserve funds until the total amount set aside reaches
50% of its registered capital. Additionally, the PRC tax authorities may require the PRC Subsidiary to adjust its taxable income under
the contractual arrangements it currently has in place with SenlangBio in a manner that could materially and adversely affect the PRC
Subsidiary’s ability to pay dividends and other distributions up to Avalon.
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Sen
Lang BVI may not be able to obtain certain benefits under relevant tax treaty on dividends paid by PRC Subsidiary through Senlang HK.
Sen
Lang BVI is a holding company incorporated under the laws of the British Virgin Islands and as such intends to receive dividends and
other distributions from the PRC Subsidiary through Senlang HK. Pursuant to the PRC Enterprise Income Tax Law, a withholding tax rate
of 10% currently applies to dividends paid by a PRC resident enterprise to a foreign enterprise investor, unless any such foreign investor’s
jurisdiction of incorporation has a tax treaty with China that provides for preferential tax treatment. Pursuant to the Arrangement between
the Mainland China and the Hong Kong Special Administrative Region for the Avoidance of Double Taxation and Tax Evasion on Income, such
withholding tax rate may be lowered to 5% if a Hong Kong resident enterprise owns no less than 25% of the capital of a PRC enterprise
and is the beneficial owner of the dividend income. Furthermore, the Announcement of State Taxation Administration on Promulgation of
the Administrative Measures on Non-Resident Taxpayers Enjoying Treaty Benefits, issued on October 14, 2019 by the PRC State Taxation
Administration, which became effective from January 1, 2020, requires non-resident enterprises to determine whether they are qualified
to enjoy the preferential tax treatment under the tax treaties and make appropriate filings with the competent tax authorities. In addition,
based on the Notice on Issues concerning Beneficial Owner in Tax Treaties, or Circular 9, issued on February 3, 2018 by the PRC State
Taxation Administration, which became effective from April 1, 2018, when determining the applicant’s “beneficial owner”
status regarding tax treatments in connection with dividends, interests or royalties in the tax treaties, several factors, including,
without limitation, whether the applicant is obligated to pay more than 50% of the applicant’s income for twelve months to residents
in a third country or region, whether the business operated by the applicant constitutes the actual business activities, and whether
the counterparty country or region to the tax treaties does not levy any tax or grant tax exemption on relevant incomes or levy tax at
an extremely low rate, will be taken into account, and it will be analyzed according to the actual circumstances of the specific cases.
There are also other conditions for enjoying the reduced withholding tax rate according to other relevant tax rules and regulations.
Therefore, Avalon currently believes that the PRC Subsidiary’s distribution of dividends to Senlang HK, if any, shall be subject
to a withholding tax rate of 10%, unless the reduced rate of 5% under the tax treaty is applicable.
VIE
contractual arrangements may be subject to scrutiny by the PRC tax authorities and they may determine that Avalon or its subsidiaries
or SenlangBio owe additional taxes, which could negatively affect Avalon’s financial condition and the value of its stock.
Under
applicable PRC laws and regulations, arrangements and transactions among related parties may be subject to audit or challenge by the
PRC tax authorities within ten years after the taxable year when the transactions are conducted. The PRC enterprise income tax law requires
every enterprise in China to submit its annual enterprise income tax return together with a report on transactions with its related parties
to the relevant tax authorities. The tax authorities may impose reasonable adjustments on taxation if they have identified any related
party transactions that are inconsistent with arm’s length principles. Avalon, its subsidiaries and SenlangBio may face material
and adverse tax consequences if the PRC tax authorities determine that the contractual arrangements were not entered into on an arm’s
length basis.
Governmental
control of currency conversion may limit Avalon’s ability to utilize its revenues effectively and affect the value of Investor’s
investment.
The
PRC government imposes controls on the convertibility of RMB into foreign currencies and, in certain cases, the remittance of currency
out of China. Under existing PRC foreign exchange regulations, payments of current account items, such as profit distributions and trade
and service-related foreign exchange transactions, can be made in foreign currencies without prior approval from the State Administration
of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, approval from or registration with appropriate
governmental authorities is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses
such as the repayment of loans denominated in foreign currencies. As a result, SAFE approval may need to be obtained to use cash generated
from the operations of the PRC Subsidiary. Any failure to comply with applicable foreign exchange regulations may subject Avalon to administrative
fines or, if serious, criminal penalties, which could materially and adversely affect the value of Avalon’s stock. Since 2016,
the PRC government has tightened its foreign exchange policies again and stepped up scrutiny of major outbound capital movement. More
restrictions and a substantial vetting process have been put in place by SAFE to regulate cross-border transactions falling under the
capital account. The PRC government may also restrict access in the future to foreign currencies for current account transactions, at
its discretion. Therefore, Avalon may not be able to obtain revenues effectively from SenlangBio through the VIE Structure under the
existing PRC foreign exchange control system.
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Substantial
uncertainties exist with respect to the interpretation and implementation of the PRC Foreign Investment Law, its implementing rules,
Foreign Investment Security Review Measures, other regulations and how they may impact the viability of the VIE structure, business,
financial condition, and results of operations.
Sen
Lang BVI, its PRC subsidiary, SenlangBio, and SenlangBio’s shareholders face uncertainty about potential future actions by the
PRC government that could affect the enforceability of the VIE contractual arrangements between Sen Lang BVI’s PRC Subsidiary,
SenlangBio and SenlangBio’s shareholders. The VIE structure has been adopted by many China-based companies to avoid restrictions
on or prohibitions for foreign investment in many industries in China. The Ministry of Commerce (“MOFCOM”) published a discussion
draft of the proposed Foreign Investment Law in January 2015, or the 2015 Draft Foreign Investment Law, according to which, variable
interest entities that are controlled via contractual arrangements would be deemed as foreign-invested enterprises if they are ultimately
“controlled” by foreign investors. Even though such language did not appear in the official Foreign Investment Law promulgated
by the PRC State Council in 2019, there can be no assurance that the concept of “control” as reflected in the 2015 Draft
of the Foreign Investment Law, will not be reintroduced, or that the VIE structure adopted by Sen Lang BVI will not be deemed as a method
of foreign investment by other laws, regulations, and rules. In addition, as the 2019 Foreign Investment Law has a catch-all provision
that broadly defines “foreign investments” as those made by foreign investors in China through methods as specified in laws,
administrative regulations, or as stipulated by the PRC State Council, relevant government authorities may promulgate additional rules
and regulations as to the interpretation and implementation of the 2019 Foreign Investment Law. Therefore, the use of a VIE Structure
could be considered a violation of the applicable PRC laws.
Accordingly,
there are substantial uncertainties as to whether the VIE Structure may be deemed as a method of foreign investment in a restricted industry
in the future. If the VIE Structure were to be deemed as a method of foreign investment under any future laws, regulations and rules,
and if any of SenlangBio’s business operations were to fall under the “negative list” for foreign investment, then
the VIE Structure may be found to be in violation of any existing or future PRC laws, rules or regulations, and the relevant PRC regulatory
authorities would have broad discretion to take action in dealing with these violations or failures, including revoking the business
and operating licenses of SenlangBio, requiring it to discontinue or restrict its operations, restricting its right to collect revenue,
requiring Avalon to restructure its operations as a whole or taking other regulatory or enforcement actions against Avalon and/or SenlangBio.
The imposition of any of these measures could result in a material adverse effect on SenlangBio’s ability to conduct all or any
portion of its business operations. In addition, it is unclear what impact the PRC government actions would have on Avalon and on its
ability to consolidate the financial results of SenlangBio in Avalon’s consolidated financial statements, if the PRC government
authorities were to find Avalon’s legal structure and contractual arrangements to be in violation of PRC laws, rules, and regulations.
If the imposition of any of these government actions causes Avalon to lose its right to direct the activities of SenlangBio or otherwise
separate from SenlangBio, and if Avalon is not able to restructure its ownership and operations structure in a satisfactory manner, Avalon
would no longer be able to consolidate the financial results of SenlangBio in its consolidated financial statements. Any of these events
would have a material adverse effect on Avalon’s business, financial condition, and results of operations.
Furthermore,
on December 19, 2020, the National Development and Reform Commission and MOFCOM promulgated the Foreign Investment Security Review Measures,
which took effect on January 18, 2021. There are great uncertainties with respect to its interpretation and implementation. Under the
Foreign Investment Security Review Measures, investments in military, national defense-related areas or in locations in proximity to
military facilities, or investments that would result in acquiring the actual control of assets in certain key sectors, such as critical
agricultural products, energy and resources, equipment manufacturing, infrastructure, transport, cultural products and services, IT,
Internet products and services, financial services and technology sectors, are required to be approved by designated governmental authorities
in advance. Since SenlangBio’s main business is conducting R&D and clinical transformation of immunotherapy cell therapy, Avalon
cannot rule out the possibility that investment in SenlangBio may be regarded as “investment in technology sectors,” which
would require approval from governmental authorities. Moreover, because the term “investment through other means” is not
clearly defined under the Foreign Investment Security Review Measures, Avalon cannot rule out the possibility that control through contractual
arrangement may be regarded as a form of actual control and therefore require approval from the competent governmental authority.
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The
filing or change of the medical institution practice license of SenlangBio Clinical Laboratory may be affected by the VIE Structure.
As
SenlangBio Clinical Laboratory is a medical institution under the PRC laws, its operation is subject to the PRC regulation of foreign
investment in medical institution, which provides that a foreign investor can acquire 70% (to the highest extent) of the equity interests
in a PRC medical institution. The relevant PRC laws also provide that the related government authority shall not approve any application
of licenses/permits if the application is related to a company failing to comply with PRC foreign investment regulation. Therefore, if
the competent PRC authority responsible for the registration of the medical institution practice license of SenlangBio Clinical Laboratory
adopts a broad understanding of foreign investment rules that controlling via agreements can be deemed as a way of investment, the authority
may disapprove SenlangBio Clinical Laboratory’s application in relation to its medical institution practice license, including
any extension of such license. In the worst case, theoretically, the competent authorities may deem the VIE Agreements unenforceable
because they are in violation of the PRC laws. In that event, SenlangBio Clinical Laboratory would not be qualified to conduct any business
of testing of immunology, serology and molecular genetics specialties for patients, including hematology-tumor diagnostics and testing
prior to clinical trials for cell therapy, which would result in the loss of the license and thereby the loss of income to SenlangBio
from this business.
It
may be difficult for overseas shareholders and/or regulators to conduct investigation or collect evidence within China.
Stockholder
claims or regulatory investigation that are common in the United States generally are difficult to pursue as a matter of law or practicality
in China. The SEC, U.S. Department of Justice, PCAOB and other authorities often have substantial difficulties in bringing and enforcing
actions against non-U.S. companies and non-U.S. persons, including company directors and officers, in China. For example, in China, there
are significant legal and other obstacles to providing information needed for regulatory investigations or litigation initiated outside
China. Although the authorities in China may establish a regulatory cooperation mechanism with the securities regulatory authorities
of another country or region to implement cross-border supervision and administration, such cooperation with the securities regulatory
authorities in the Unities States may not be efficient in the absence of mutual and practical cooperation mechanism. Furthermore, according
to Article 177 of the PRC Securities Law, or Article 177, which became effective in March 2020, no overseas securities regulator is allowed
to directly conduct investigation or evidence collection activities within the territory of the PRC without first receiving approval
from the China Securities Regulatory Commission, or the CSRC. While detailed interpretation of or implementation rules under Article
177 have yet to be promulgated, the inability for an overseas securities regulator to directly conduct investigation or evidence collection
activities within China may further increase difficulties faced by Avalon’s stockholders in protecting their interests.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.