Long-Term Related Party Payable

Long-term related party payable and related activity are reported at fair value and consist of the following at September 30, 2018 and December 31, 2017:



				Activity during the Nine Months Ended September 30, 2018
							Changes in Fair Value of Related Party Payable
Long-Term Related Party Payable:	Balance, December 31, 2017			Payments to Related Parties			Operating (Gain) Expense			Other (Income) Expense			Warrant Exercise			Disposal			Balance, September 30, 2018

Acquisition-related contingent consideration:
Warrants - Éclat Pharmaceuticals (a)	$	2,479		$	—		$	(312	)	$	—		$	(2,167	)	$	—		$	—
Earn-out payments - Éclat Pharmaceuticals (b)	67,744			(16,254		)	(16,966		)	—			—			—			34,524
Royalty agreement - FSC (c)	5,740			(645		)	242			—			—			(5,337		)	—
Financing-related:																			—
Royalty agreement - Deerfield (d)	5,392			(1,600		)	—			(970		)	—			—			2,822
Royalty agreement - Broadfin (e)	2,570			(762		)	—			(462		)	—			—			1,346
Long-term liability - FSC (f)	15,000			—			—			—			—			(15,000		)	—
Total related party payable	98,925			$	(19,261	)	$	(17,036	)	$	(1,432	)	$	(2,167	)	$	(20,337	)	38,692
Less: Current portion	(25,007		)																(10,979		)
Total long-term related party payable	$	73,918																	$	27,713

Long-term related party payable and related activity are reported at fair value and consist of the following at September 30, 2018 and June 30, 2018:



				Activity during the Three Months Ended September 30, 2018
							Changes in Fair Value of Related Party Payable
Long-Term Related Party Payable:	Balance, June 30, 2018			Payments to Related Parties			Operating Expense			Other Expense			Balance, September 30, 2018

Acquisition-related contingent consideration:
Earn-out payments - Éclat Pharmaceuticals (b)	$	46,780		$	(5,141	)	$	(7,115	)	$	—		$	34,524
Royalty agreement - FSC (c)	—			—			—			—			—
Financing-related:
Royalty agreement - Deerfield (d)	3,614			(504		)	—			(288		)	2,822
Royalty agreement - Broadfin (e)	1,723			(240		)	—			(137		)	1,346
Total related party payable	52,117			$	(5,885	)	$	(7,115	)	$	(425	)	38,692
Less: Current portion	(14,067		)										(10,979		)
Total long-term related party payable	$	38,050											$	27,713

(a)

As part of the consideration for the Company’s acquisition of Éclat on March 13, 2012, the Company issued two warrants to a related party with a six-year term which allow for the purchase of a combined total of 3,300 ordinary shares of Avadel. One warrant was exercisable for 2,200 shares at an exercise price of $7.44 per share, and the other warrant was exercisable for 1,100 shares at an exercise price of $11.00 per share. On February 23, 2018, the related party exercised in full the warrant to purchase 2,200 ordinary shares. These warrants were settled by delivering to the related party cash of $2,911 and approximately 603 ADS. On March 12, 2018, the remaining warrants to purchase 1,100 ordinary shares expired.

The fair value of the warrants is estimated on a quarterly basis using a Black-Scholes option pricing model with the following assumptions at December 31, 2017:



Assumptions for the Warrant Valuation:	December 31, 2017

Stock price	$	8.20
Weighted average exercise price per share	8.63
Expected term (years)	0.25
Expected volatility	37.90		%
Risk-free interest rate	1.39		%
Expected dividend yield	—

These Black-Scholes fair value measurements are based on significant inputs not observable in the market and thus represent a level 3 measurement as defined in ASC 820. The fair value of the warrant consideration was most sensitive to movement in the Company’s share price and expected volatility at the balance sheet date.

Expected term: The expected term of the options or warrants represents the period of time between the grant date and the time the options or warrants are either exercised or forfeited, including an estimate of future forfeitures for outstanding options or warrants. Given the limited historical data and the grant of stock options and warrants to a limited population, the simplified method has been used to calculate the expected life.

Expected volatility: The expected volatility is calculated based on an average of the historical volatility of the Company’s stock price for a period approximating the expected term.

Risk-free interest rate: The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant and a maturity that approximates the expected term.

Expected dividend yield: The Company has not distributed any dividends since its inception and has no plan to distribute dividends in the foreseeable future.

At the closing date of the 2012 Éclat acquisition and at December 31, 2017, it was uncertain whether the Company would ultimately fulfill its obligation under these warrants using ordinary shares or cash. Accordingly, pursuant to the guidance of ASC 480, the Company determined that these warrants should be classified as a liability. This classification as a liability was further supported by the Company’s determination, pursuant to the guidance of ASC 815-40-15-7(i), that these warrants could also not be considered as being indexed to the Company’s own ordinary shares, on the basis that the exercise price for the warrants is determined in U.S. dollars, although the functional currency of the Company at the closing date of the Éclat acquisition was the Euro.

(b)

In March 2012, the Company acquired all of the membership interests of Éclat from Breaking Stick Holdings, L.L.C. (“Breaking Stick”, formerly Éclat Holdings), an affiliate of Deerfield. Breaking Stick is majority owned by Deerfield, with a minority interest owned by the Company’s CEO, and certain other current and former employees. As part of the consideration, the Company committed to provide quarterly earn-out payments equal to 20% of any gross profit generated by certain Éclat products. These payments will continue in perpetuity, to the extent gross profit of the related products also continue in perpetuity.

(c)

In February 2016, the Company acquired all of the membership interests of FSC from Deerfield. The consideration for this transaction in part included a commitment to pay quarterly a 15% royalty on the net sales of certain FSC products, up to $12,500 for a period not exceeding ten years. This obligation was assumed by the buyer as part of the disposition of the pediatrics products on February 16, 2018. See Note 12: Divestiture of the Pediatric Assets.

(d)

As part of a February 2013 debt financing transaction conducted with Deerfield, the Company received cash of $2,600 in exchange for entering into a royalty agreement whereby the Company shall pay quarterly a 1.75% royalty on the net sales of certain Éclat products until December 31, 2024. In connection with such debt financing transaction, the Company granted Deerfield a security interest in the product registration rights of the Eclat products.


(e)	As part of a December 2013 debt financing transaction conducted with Broadfin Healthcare Master Fund, a related party and current shareholder, the Company received cash of $2,200 in exchange for entering into a royalty agreement whereby the Company shall pay quarterly a 0.834% royalty on the net sales of certain Éclat products until December 31, 2024.

(f)

In February 2016, the Company acquired all of the membership interests of FSC from Deerfield. The consideration for this transaction in part consists of payments totaling $1,050 annually for five years with a final payment in January 2021 of $15,000. Substantially all of FSC’s and its subsidiaries’ assets are pledged as collateral to Deerfield. This obligation was assumed by the buyer as part of the disposition of the pediatrics products on February 16, 2018. See Note 12: Divestiture of the Pediatric Assets.

At September 30, 2018, the fair value of each related party payable listed in (b), (d) and (e) above was estimated using a discounted cash flow model based on estimated and projected annual net revenues or gross profit, as appropriate, of each of the specified Éclat products using an appropriate risk-adjusted discount rate of 15%. These fair value measurements are based on significant inputs not observable in the market and thus represent a level 3 measurement as defined in ASC 820. Subsequent changes in the fair value of the acquisition-related related party payables, resulting primarily from management’s revision of key assumptions, will be recorded in the condensed consolidated statements of income (loss) in the line items entitled “Changes in fair value of related party contingent consideration” for items noted in (b) above and in “Other expense - changes in fair value of related party payable” for items (d) and (e) above. See Note 1: Summary of Significant Accounting Policies under the caption Acquisition-related Contingent Consideration and Financing-related Royalty Agreements in Part II, Item 8 of the Company’s 2017 Annual Report on Form 10-K for more information on key assumptions used to determine the fair value of these liabilities.

The Company has chosen to make a fair value election pursuant to ASC 825, “Financial Instruments” for its royalty agreements detailed in items (d) and (e) above. These financing-related liabilities are recorded at fair market value on the condensed consolidated balance sheets and the periodic change in fair market value is recorded as a component of “Other expense – change in fair value of related party payable” on the condensed consolidated statements of income (loss).

The following table summarizes changes to the related party payables, a recurring Level 3 measurement, for the nine-month periods ended September 30, 2018 and 2017, respectively:



Related Party Payable Rollforward:	Balance

Balance, December 31, 2016	$	169,347
Payments of related party payable	(29,135		)
Fair value adjustments ⁽¹⁾	(33,095		)
Balance, September 30, 2017	$	107,117

Balance, December 31, 2017	$	98,925
Payments of related party payable	(19,261		)
Fair value adjustments ⁽¹⁾	(18,468		)
Warrant exercise	(2,167		)
Disposition of the pediatrics products	(20,337		)
Balance, September 30, 2018	$	38,692

⁽¹⁾Fair value adjustments are reported as changes in fair value of related party contingent consideration and Other expense - changes in fair value of related party payable in the condensed consolidated statements of income (loss).