UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

 

☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2018

 

OR

 

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                  to

 

Commission file number:  001-36033

 

THERAVANCE BIOPHARMA, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

(650) 808-6000

(Registrant’s Telephone Number, Including Area Code)

 

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post 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 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. (Check one):

 

 

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 July 31, 2018, the number of the registrant’s outstanding ordinary shares was 55,104,127.

 

 

 

THERAVANCE BIOPHARMA, INC.

TABLE OF CONTENTS

 

 

 

PART I. FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

 

THERAVANCE BIOPHARMA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

(In thousands, except per share data)

 

 

 

See accompanying notes to condensed consolidated financial statements.

THERAVANCE BIOPHARMA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Unaudited)

(In thousands, except per share data)

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

THERAVANCE BIOPHARMA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

 

 

See accompanying notes to condensed consolidated financial statements.

THERAVANCE BIOPHARMA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

1. Organization and Summary of Significant Accounting Policies

 

Theravance Biopharma, Inc. (“Theravance Biopharma”, the “Company”, or “we” and other similar pronouns) is a diversified biopharmaceutical company with the core purpose of creating medicines that help improve the lives of patients suffering from serious illness.

 

Basis of Presentation

 

Our condensed consolidated financial information as of June 30, 2018, and the three and six months ended June 30, 2018 and 2017 are unaudited but include all adjustments (consisting only of normal recurring adjustments), which we consider necessary for a fair presentation of the financial position at such date and of the operating results and cash flows for those periods, and have been prepared in accordance with US generally accepted accounting principles (“GAAP”) for interim financial information. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated December 31, 2017 financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission (“SEC”) on February 28, 2018.

 

Effective January 1, 2018, we adopted Accounting Standards Codification, Topic 606, Revenue from Contracts with Customers (“ASC 606”) using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018 and recognized the cumulative effect of ASC 606 at the date of initial application. This standard applies to all contracts with customers, except for contracts that are within the scope of other standards, such as leases, insurance, collaboration arrangements and financial instruments. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior period. We recorded a reduction to the opening balance of accumulated deficit of approximately $1.1 million and a corresponding reduction in deferred revenue as of January 1, 2018 due to ASC 606’s cumulative adoption impact on our collaborative arrangements. Our product sales revenue under ASC 606 would not have been materially different under the legacy Accounting Standards Codification, Topic 605, Revenue Recognition (“ASC 605”).

 

Effective January 1, 2018, we adopted Accounting Standards Update 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”) that changed the presentation of restricted cash and cash equivalents on the condensed consolidated statement of cash flows. Restricted cash balances are now included with cash and cash equivalents when reconciling the beginning of period and end of period total amounts shown on the condensed consolidated statements of cash flows. To conform to the presentation under ASU 2016-18, we revised the amounts previously reported on the condensed consolidated statements of cash flows for the comparable prior year period.

 

Significant Accounting Policies

 

Other than the policies below, there have been no material revisions in our significant accounting policies described in Note 1 to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

Revenue Recognition

 

Under ASC 606, an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, the entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation.

 

At contract inception, once the contract is determined to be within the scope of ASC 606, we identify the performance obligations in the contract by assessing whether the goods or services promised within each contract are distinct. We then recognize revenue for the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

 

Product Sales

 

We sell VIBATIV in the US market by making the drug product available through a limited number of distributors, who sell VIBATIV to healthcare providers. Title and risk of loss transfer upon receipt by these distributors. We recognize VIBATIV product sales and related cost of product sales when the distributors obtain control of the drug product, which is at the time title transfers to the distributors.

 

Product sales are recorded on a net sales basis which includes estimates of variable consideration. The variable consideration results from sales discounts, government‑mandated rebates and chargebacks, distribution fees, estimated product returns and other deductions. We reflect such reductions in revenue as either an allowance to the related account receivable from the distributor, or as an accrued liability, depending on the nature of the sales deduction. Sales deductions are based on management’s estimates that consider payor mix in target markets, industry benchmarks and experience to date. In general, these estimates take into consideration a range of possible outcomes which are probability-weighted in accordance with the expected value method in ASC 606. We monitor inventory levels in the distribution channel, as well as sales of VIBATIV by distributors to healthcare providers, using product‑specific data provided by the distributors. Product return allowances are based on amounts owed or to be claimed on related sales. These estimates take into consideration the terms of our agreements with customers, historical product returns of VIBATIV, rebates or discounts taken, estimated levels of inventory in the distribution channel, the shelf life of the product, and specific known market events, such as competitive pricing and new product introductions. We update our estimates and assumptions each quarter and if actual future results vary from our estimates, we may adjust these estimates, which could have an effect on product sales and earnings in the period of adjustment.

 

Sales Discounts: We offer cash discounts to certain customers as an incentive for prompt payment. We expect our customers to comply with the prompt payment terms to earn the cash discount. In addition, we offer contract discounts to certain direct customers. We estimate sales discounts based on contractual terms, historical utilization rates, as available, and our expectations regarding future utilization rates. We account for sales discounts by reducing accounts receivable by the expected discount and recognizing the discount as a reduction of revenue in the same period the related revenue is recognized.

 

Chargebacks and Government Rebates: For VIBATIV sales in the US, we estimate reductions to product sales for qualifying federal and state government programs including discounted pricing offered to Public Health Service (“PHS”), as well as government‑managed Medicaid programs. Our reduction for PHS is based on actual chargebacks that distributors have claimed for reduced pricing offered to such healthcare providers and our expectation about future utilization rates. Our accrual for Medicaid is based upon statutorily‑defined discounts, estimated payor mix, expected sales to qualified healthcare providers, and our expectation about future utilization. The Medicaid accrual and government rebates that are invoiced directly to us are recorded in other accrued liabilities on the condensed consolidated balance sheets. For qualified programs that can purchase our products through distributors at a lower contractual government price, the distributors charge back to us the difference between their acquisition cost and the lower contractual government price, which we record as an allowance against accounts receivable.

 

Distribution Fees: We have contracts with our distributors in the US that include terms for distribution‑related fees. We determine distribution‑related fees based on a percentage of the product sales price, and we record the distribution fees as an allowance against accounts receivable.

 

Product Returns: We offer our distributors a right to return product purchased directly from us, which is principally based upon the product’s expiration date. Our policy is to accept product returns during the six months prior to and twelve months after the product expiration date on product that has been sold to our distributors. Product return allowances are based on amounts owed or to be claimed on related sales. These estimates take into consideration the terms of our agreements with customers, historical product returns of VIBATIV, rebates or discounts taken, estimated levels of inventory in the distribution

channel, the shelf life of the product, and specific known market events, such as competitive pricing and new product introductions. We record our product return reserves as accrued other liabilities.

 

Allowance for Doubtful Accounts: We record allowances for potentially doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. As of June 30, 2018, there was no allowance for doubtful accounts related to customer payments.

 

The following table summarizes activity in each of the product revenue allowance and reserve categories for the six months ended June 30, 2018.

 

 

We adopted ASC 606 on January 1, 2018 using the modified retrospective method. Our prior periods remain reported under ASC 605. Our revenue recognition policy under ASC 605 for the comparative 2017 periods is included in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

Collaborative Arrangements

 

We enter into collaborative arrangements with partners that fall under the scope of Accounting Standards Codification, Topic 808, Collaborative Arrangements (“ASC 808”). While these arrangements are in the scope of ASC 808, we may analogize to ASC 606 for some aspects of the arrangements. We analogize to ASC 606 for certain activities within the collaborative arrangement for the delivery of a good or service (i.e., a unit of account) that is part of our ongoing major or central operations. 

 

The terms of our collaborative arrangements typically include one or more of the following: (i) up-front fees; (ii) milestone payments related to the achievement of development, regulatory, or commercial goals; (iii) royalties on net sales of licensed products; (iv) reimbursements or cost sharing of R&D expenses; and (v) profit/loss sharing arising from co-promotion arrangements. Each of these payments results in collaboration revenues or an offset against R&D expenses. Where a portion of non‑refundable up-front fees or other payments received are allocated to continuing performance obligations under the terms of a collaborative arrangement, they are recorded as deferred revenue and recognized as collaboration revenue when (or as) the underlying performance obligation is satisfied. 

 

As part of the accounting for these arrangements, we must develop estimates and assumptions that require judgment to determine the underlying stand-alone selling price for each performance obligation which determines how the transaction price is allocated among the performance obligations. The estimation of the stand-alone selling price may include such estimates as, forecasted revenues or costs, development timelines, discount rates, and probabilities of technical and regulatory success. We evaluate each performance obligation to determine if they can be satisfied at a point in time or over time, and we measure the services delivered to our collaboration partner which are periodically reviewed based on the progress of the related program. The effect of any change made to an estimated input component and, therefore revenue or expense recognized, would be recorded as a change in estimate. In addition, variable consideration (e.g., milestone payments) must be evaluated to determine if it is constrained and, therefore, excluded from the transaction price.

 

Up-front Fees: If a license to our intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, we recognize collaboration revenues from the transaction price allocated to the license when the license is transferred to the licensee and the licensee is able to use and benefit from the license. For licenses that are bundled with other promises, we utilize judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing collaboration revenue from the allocated transaction price. For example, when we receive up-front fees for the performance of research and development services, or when

research and development services are not considered to be distinct from a license, we recognize collaboration revenue for those units of account over time using a measure of progress. We evaluate the measure of progress each at reporting period and, if necessary, adjust the measure of performance and related revenue or expense recognition as a change in estimate.

 

Milestone Payments: At the inception of each arrangement that includes milestone payments (variable consideration), we evaluate whether the milestones are considered probable of being reached and estimate the amount to be included in the transaction price using the most likely amount method. If it is probable that a significant revenue reversal would not occur, the associated milestone value is included in the transaction price. Milestone payments that are not within our or the collaboration partner’s control, such as non-operational developmental and regulatory approvals, are generally not considered probable of being achieved until those approvals are received. At the end of each reporting period, we re-evaluate the probability of achievement of milestones that are within our or the collaboration partner’s control, such as operational developmental milestones and any related constraint, and if necessary, adjust our estimate of the overall transaction price. Any such adjustments are recorded on a cumulative catch-up basis, which would affect collaboration revenues and earnings in the period of adjustment. Revisions to our estimate of the transaction price may also result in negative collaboration revenues and earnings in the period of adjustment.

 

Royalties: For arrangements that include sales-based royalties, including commercial milestone payments based on the level of sales, and the license is deemed to be the predominant item to which the royalties relate, we recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied). To date, we have not recognized any material royalty revenue resulting from any of our collaborative arrangements.

 

Reimbursement, cost-sharing and profit-sharing payments: Under certain collaborative arrangements, we have been reimbursed for a portion of our R&D expenses or participate in the cost sharing of such R&D expenses. Such reimbursements and cost sharing arrangements have been reflected as a reduction of R&D expense in our condensed consolidated statements of operations, as we do not consider performing research and development services for reimbursement to be a part of our ongoing major or central operations. Therefore, the reimbursement or cost sharing of research and development services are recorded as a reduction of R&D expense.

 

Under the terms of our collaboration agreement with Mylan Ireland Limited (“Mylan”) for revefenacin, including YUPELRITM inhalation solution, we are also entitled to a share of US profits and losses (65% Mylan/35% Theravance Biopharma) received in connection with commercialization of YUPELRI, and we are entitled to low double-digit royalties on ex-US net sales (excluding China). If and when YUPELRI is approved, we expect that Mylan will be the principal in the sales transaction and will record the product sales.  For the periods presented, our share of the losses under a co-promote arrangement are recorded within R&D expense and selling, general and administrative expense on our condensed consolidated statements of operations. See “Note 3. Collaborative Arrangements” for additional information about our collaboration agreement with Mylan.

 

Income Taxes

 

On January 1, 2018, we adopted ASU 2016-16, Income Taxes (Topic 740), Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”) using the modified retrospective approach. ASU 2016-16 requires immediate recognition of income tax consequences of intra-company asset transfers, other than inventory transfers. Legacy GAAP prohibited recognition of income tax consequences of intra-company asset transfers whereby the seller defers any net tax effect and the buyer is prohibited from recognizing a deferred tax asset on the difference between the newly created tax basis of the asset in its tax jurisdiction and its financial statement carrying amount as reported in the consolidated financial statements. An example of an inter-company asset transfers included in ASU 2016-16’s scope is intellectual property. The adoption of ASU 2016-16 did not have a material impact on our balance sheet or statement of operations as our deferred tax assets are fully offset by a valuation allowance. 

 

Recently Issued Accounting Pronouncements Not Yet Adopted

 

In February 2016, the FASB issued ASU 2016‑02, Leases (“ASU 2016‑02”). ASU 2016‑02 is aimed at making leasing activities more transparent and comparable, and requires substantially all leases be recognized by lessees on their balance sheet as a right‑of‑use asset and corresponding lease liability, including leases currently accounted for as operating

leases. ASU 2016‑02 is effective for all interim and annual reporting periods beginning after December 15, 2018 with early adoption permitted. Based on our initial assessment of ASU 2016-02, we believe that the largest impact to our balance sheet will be from recognizing a right-of-use asset and corresponding lease liability related to our property leases in South San Francisco and Dublin, Ireland. We expect to adopt ASU 2016-02 in the first quarter of 2019, and we are continuing to evaluate the full impact that the adoption of ASU 2016‑02 will have on our consolidated financial statements and related disclosures.

 

We have evaluated other recently issued accounting pronouncements and do not believe that any of these pronouncements will have a material impact on our consolidated financial statements and related disclosures.

 

2. Net Loss per Share

 

Basic net loss per share is computed by dividing net loss by the weighted-average number of shares of outstanding, less ordinary shares subject to forfeiture. Diluted net loss per share is computed by dividing net loss by the weighted-average number of shares outstanding, less ordinary shares subject to forfeiture, plus all additional ordinary shares that would have been outstanding, assuming dilutive potential ordinary shares had been issued for other dilutive securities.

 

For the three and six months ended June 30, 2018 and 2017, diluted and basic net loss per share was identical since potential ordinary shares were excluded from the calculation, as their effect was anti-dilutive.

 

Anti-dilutive Securities

 

The following ordinary equivalent shares were not included in the computation of diluted net loss per share because their effect was anti-dilutive:

 

 

In addition, there were 978,750 and 1,305,000 shares that are subject to performance‑based vesting criteria which have been excluded from the ordinary equivalent shares table above as of June 30, 2018 and 2017, respectively.

 

3. Collaborative Arrangements

 

Revenue from Collaborative Arrangements

 

We recognized revenues from our collaborative arrangements as follows:

 

 

The change from our legacy revenue policy, under ASC 605, had no material impact on our collaboration revenue for the three and six months ended June 30, 2018, which would have been $18.1 million and $22.8 million, respectively.

 

Changes in Deferred Revenue Balances

 

We recognized the following revenue from collaborative arrangements as a result of changes in our deferred revenue balance during the periods below:  

 

 

 

Mylan

 

Development and Commercialization Agreement

 

In January 2015, Mylan Ireland Limited (“Mylan”) and we established a strategic collaboration (the “Mylan Agreement”) for the development and, subject to regulatory approval, commercialization of revefenacin, our investigational LAMA in development under the proposed brand name YUPELRITM inhalation solution as a nebulized, once-daily single-agent for the treatment of COPD. We entered into this collaboration to expand the breadth of our revefenacin development program and extend our commercial reach beyond the acute care setting where we currently market VIBATIV.

 

Under the Mylan Agreement, Mylan paid us an up-front fee of $15.0 million for the delivery of the revefenacin license in 2015 and, in 2016, Mylan paid us a milestone payment $15.0 million for the achievement of 50% enrollment in the Phase 3 twelve-month safety study. Separately, pursuant to an ordinary share purchase agreement entered into on January 30, 2015, Mylan Inc., a subsidiary of Mylan N.V., made a $30.0 million equity investment in us, buying 1,585,790 ordinary shares from us in early February 2015 in a private placement transaction at a price of approximately $18.918 per share, which represented a 10% premium, equal to $4.2 million, over the volume weighted average price per share of our ordinary shares for the five trading days ending on January 30, 2015. 

 

As of June 30, 2018, we are eligible to receive from Mylan additional potential development, regulatory and sales milestone payments totaling up to $205.0 million in the aggregate, with $160.0 million associated with YUPELRI, which is a monotherapy, and $45.0 million for future potential combination products. Of the $160.0 million associated with monotherapy, $150.0 million relates to sales milestones based on achieving certain levels of net sales and $10.0 million relates to regulatory actions in the European Union (“EU”).

 

The Mylan Agreement is considered to be within the scope of ASC 808, as the parties are active participants and exposed to the risks and rewards of the collaborative activity. Under the terms of the Mylan Agreement, Mylan is responsible for reimbursement of our costs related to the registrational program up until the approval of the first new drug application. Performing R&D services for reimbursement is considered to be a collaborative activity under the scope of ASC 808. Reimbursable program costs are recognized proportionately with the performance of the underlying services and accounted for as reductions to R&D expense. For this unit of account, we do not recognize revenue or analogize to ASC 606 and, as such, the reimbursable program costs are excluded from the transaction price.

 

We analogized to ASC 606 for the accounting for two performance obligations: (1) delivery of the license to develop and commercialize revefenacin; and (2) joint steering committee participation. We determined the license to be distinct from the joint steering committee participation. We further determined that the transaction price under the arrangement was comprised of the following: (1) $15.0 million up-front license fee received in 2015; (2) $4.2 million

premium related to the ordinary share purchase agreement received in 2015; and (3) $15.0 million milestone for 50% enrollment in the Phase 3 twelve-month safety study received in 2016. The total transaction price of $34.2 million was allocated to the two performance obligations based on our best estimate of the relative stand-alone selling price. For the delivery of the license, we based the stand-alone selling price on a discounted cash flow approach and considered several factors including, but not limited to: discount rate, development timeline, regulatory risks, estimated market demand and future revenue potential. For the committee participation, we based the stand-alone selling price on the average compensation of our committee members estimated to be incurred over the performance period. We expect to recognize collaboration revenue from the committee participation ratably over the performance period of approximately seventeen years.

 

The future potential milestone amounts were not included in the transaction price, as they were all determined to be fully constrained following the concepts of ASC 606. As part of our evaluation of the development and regulatory milestones constraint, we determined that the achievement of such milestones are contingent upon success in future clinical trials and regulatory approvals which are not within our control and uncertain at this stage. We expect that the sales-based milestone payments and royalty arrangements will be recognized when the sales occur or the milestone is achieved. We will re-evaluate the transaction price each quarter and as uncertain events are resolved or other changes in circumstances occur.

 

We are also entitled to a share of US profits and losses (65% Mylan/35% Theravance Biopharma) received in connection with commercialization of YUPELRI, and we are entitled to low double-digit royalties on ex-US net sales (excluding China). We expect that Mylan will be the principal in the sales transaction and will record the product sales. Under a co-promote arrangement with Mylan, we record our 35% share of expenses based on collaboration activities to prepare for a potential product launch. Until YUPELRI is approved and we have recognized a profit under the agreement, collaboration expenses are recognized within R&D expense and selling, general and administrative expense on our condensed consolidated statements of operations. Our 35% share of profits related to the commercialization of YUPELRI will be recognized as collaboration revenue. For the cost-sharing and profit-sharing activities, we do not analogize to ASC 606. We consider these activities to be collaborative activities under the scope of ASC 808, and we will recognize the shared profits and losses in the periods that such profits and losses occur, following the implementation guidance in ASC 808. For the three and six months ended June 30, 2018, we recognized $1.3 million and $1.7 million, respectively, in collaboration loss under the YUPELRI co-promote arrangement with Mylan.

 

As of June 30, 2018, $0.3 million was recorded in deferred revenue on the condensed consolidated balance sheet under the Mylan Agreement. This amount reflects revenue allocated to joint steering committee participation and will be recognized as collaboration revenue over the course of the remaining performance period of approximately fourteen years. For the three and six months ended June 30, 2018, we recognized $6,000 and $12,000, respectively, in collaboration revenue from the recognition of previously deferred revenue under the Mylan collaborative arrangement.

 

Janssen Biotech

 

In February 2018, we entered into a global co-development and commercialization agreement with Janssen Biotech, Inc. (“Janssen”) for TD-1473 and related back-up compounds for inflammatory intestinal diseases, including ulcerative colitis and Crohn's disease (the “Janssen Agreement”). Under the terms of the Janssen Agreement, we received an upfront payment of $100.0 million.  In 2018, we plan to initiate a large, Phase 2b/3 adaptive design induction and maintenance study in ulcerative colitis with TD-1473, as well as a Phase 2 study in Crohn’s disease. Following completion of the Phase 2 Crohn’s study and the Phase 2b induction portion of the ulcerative colitis study, Janssen can elect to obtain an exclusive license to develop and commercialize TD-1473 and certain related compounds by paying us a fee of $200.0 million. Upon such election, we and Janssen will jointly develop and commercialize TD-1473 in inflammatory intestinal diseases and share profits in the US and expenses related to a potential Phase 3 program (67% to Janssen; 33% to Theravance Biopharma). We would receive royalties on ex-US sales at double-digit tiered percentage royalty rates, and we would be eligible to receive up to an additional $700.0 million in development and commercialization milestone payments from Janssen.

 

The Janssen Agreement is considered to be within the scope of ASC 808, as the parties are active participants and exposed to the risks and rewards of the collaborative activity. We evaluated the terms of the Janssen Agreement and have analogized to ASC 606 for the research and development activities to be performed through the initial Phase 2 development period of the collaborative arrangement that are considered to be part of our ongoing major or central operations. Using the concepts of ASC 606, we have identified research and development activities as our only performance obligation. We further

determined that the transaction price under the arrangement was the $100.0 million upfront payment which was allocated to the single performance obligation.

 

The $900.0 million in future potential payments is considered variable consideration if Janssen elects to remain in the collaboration arrangement following completion of certain Phase 2 activities, as described above and, as such, was not included in the transaction price, as the potential payments were all determined to be fully constrained under ASC 606. As part of our evaluation of this variable consideration constraint, we determined that the potential payments are contingent upon developmental and regulatory milestones that are uncertain and are highly susceptible to factors outside of our control. We expect that any consideration related to royalties and sales-based milestones will be recognized when the subsequent sales occur.

 

For the three and six months ended June 30, 2018, we recognized $7.6 million and $12.2 million, respectively, as revenue from collaboration agreements related to the Janssen Agreement. The remaining transaction price of $87.8 million was recorded in deferred revenue on the condensed consolidated balance sheet and is expected to be recognized as collaboration revenue as the research and development services are delivered over the Phase 2 period. Collaboration revenue is recognized for the research and development services based on a measure of our efforts toward satisfying a performance obligation relative to the total expected efforts or inputs to satisfy the performance obligation (e.g., costs incurred compared to total budget). In future reporting periods, we will reevaluate our estimates related to our efforts towards satisfying the performance obligation and may record a change in estimate if deemed necessary.

 

Alfasigma

 

Development and Collaboration Agreement

 

Under an October 2012 development and collaboration agreement for velusetrag, we and Alfasigma S.p.A (“Alfasigma”) agreed to collaborate in the execution of a two-part Phase 2 program to test the efficacy, safety and tolerability of velusetrag in the treatment of patients with gastroparesis (a medical condition consisting of a paresis (partial paralysis) of the stomach, resulting in food remaining in the stomach for a longer time than normal) (the “Alfasigma Agreement”). As part of the Alfasigma Agreement, Alfasigma funded the majority of the costs associated with the Phase 2 gastroparesis program, which consisted of a Phase 2 study focused on gastric emptying and a Phase 2 study focused on symptoms. Alfasigma had an exclusive option to develop and commercialize velusetrag in the EU, Russia, China, Mexico and certain other countries, while we retained full rights to velusetrag in the US, Canada, Japan and certain other countries.

 

In April 2018, Alfasigma exercised its exclusive option to develop and commercialize velusetrag, and we elected not to pursue further development of velusetrag. As a result, we will transfer global rights for velusetrag to Alfasigma under the terms of the existing collaboration agreement. We received a $10.0 million option exercise fee from Alfasigma, and we are eligible to receive future potential development, regulatory and sales milestone payments of up to $26.8 million, and tiered royalties on global net sales ranging from high single digits to the mid-teens.

 

The Alfasigma Agreement is considered to be within the scope of ASC 808, as the parties are active participants and exposed to the risks and rewards of the collaborative activity. We have historically received reimbursements related to R&D services performed under the Alfasigma Agreement. Performing R&D services for reimbursement is considered to be a collaborative activity under the scope of ASC 808. Reimbursable program costs are accounted for as reductions to R&D expense. For this unit of account, we do not recognize revenue or analogize to ASC 606 and, as such, the reimbursable program costs are excluded from the transaction price.

 

In April 2018, Alfasigma exercised its exclusive option to develop and commercialize velusetrag and paid us a total of $11.0 million, comprised of the $10.0 option exercise fee and a $1.0 million non-refundable reimbursement. We analogized to ASC 606 for the delivery of the following identified performance obligations: (i) delivery of the velusetrag license; (ii) transfer of technical know-how; (iii) delivery of clinical study reports (“CSRs”); (iv) delivery of registration batches, including drug substances; and (v) joint steering committee participation. We determined that all of the five performance obligations were distinct, and we allocated the transaction price based on the estimated stand-alone selling prices of each of the performance obligations. The stand-alone selling price of the license was based on a discounted cash flow approach and considered several factors including, but not limited to: discount rate, development timeline, regulatory risks, estimated market demand and future revenue potential.

 

We determined that as any potential development or regulatory milestones were determined to be fully constrained as prescribed under ASC 606. As part of our evaluation of this variable consideration constraint, we determined that the potential payments are contingent upon development and regulatory milestones that are uncertain and are highly susceptible to factors outside of our control. In addition, we expect that any consideration related to sales-based milestones would be recognized when the subsequent sales occur.

 

For the three and six months ended June 30, 2018, we recognized $10.5 million as revenue from collaboration agreements related to the Alfasigma collaborative arrangement. The remaining transaction price of $0.5 million was recorded in deferred revenue on the condensed consolidated balance sheet and is expected to be recognized as collaboration revenue over approximately the next four years.

 

Reimbursement of R&D Expense

 

Under certain collaborative arrangements, we are entitled to reimbursement of certain R&D expense. Activities under collaborative arrangements for which we are entitled to reimbursement are considered to be collaborative activities under the scope of ASC 808.  For these units of account, we do not analogize to ASC 606 or recognize revenue.  We record reimbursement payments received from our collaboration partners as reductions to R&D expense.

 

The following table summarizes the reductions to R&D expenses related to the reimbursement payments:

 

 

 

4. Cash, Cash Equivalents, and Restricted Cash

 

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 amount shown on the condensed consolidated statements of cash flows.

 

 

Restricted cash pertained to certain lease agreements and letters of credit where we have pledged cash and cash equivalents as collateral. The cash-related amounts reported in the table above exclude our investments in short and long-term marketable securities that are reported separately on the condensed consolidated balance sheets.

 

5. Investments and Fair Value Measurements

 

Available‑for‑Sale Securities

 

The estimated fair value of marketable securities is based on quoted market prices for these or similar investments that were based on prices obtained from a commercial pricing service. The fair value of our marketable securities classified within Level 2 is based upon observable inputs that may include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two‑sided markets, benchmark securities, bids, offers and reference data including market research publications.

 

 

 

Available‑for‑sale securities are summarized below:

 

 

 

As of June 30, 2018, all of the marketable securities had contractual maturities within two years and the weighted average maturity of the marketable securities was approximately five months. There were no transfers between Level 1 and Level 2 during the periods presented and there have been no changes to our valuation techniques during the three and six months ended June 30, 2018.

 

In general, we invest in debt securities with the intent to hold such securities until maturity at par value. We do not intend to sell the investments that are currently in an unrealized loss position, and it is unlikely that we will be required to sell the investments before recovery of their amortized cost basis, which may be maturity. We have determined that the gross unrealized losses on our marketable securities, as of June 30, 2018, were temporary in nature and primarily due to increases in short-term borrowing rates in the capital markets. There were no material unrealized losses on investments which have been in a loss position for more than twelve months as of June 30, 2018.

 

As of June 30, 2018, our accumulated other comprehensive loss on our condensed consolidated balance sheets consisted of net unrealized losses on available-for-sale investments. During the three and six months ended June 30, 2018, we did not sell any of our marketable securities.

 

Long-term Debt Fair Value

 

We have $230.0 million of 3.250% convertible senior notes (“Notes”) outstanding as of June 30, 2018 with an estimated fair value of $225.8 million. The estimated fair value was primarily based upon the underlying price of Theravance Biopharma’s publicly traded shares and other observable inputs as of June 30, 2018. The inputs to determine fair value of the Notes are categorized as Level 2 inputs. Level 2 inputs include quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

 

6. Theravance Respiratory Company, LLC

 

Prior to the spin-off from Innoviva (the “Spin-Off”), our former parent company, Innoviva, assigned to Theravance Respiratory Company, LLC (“TRC”), a Delaware limited liability company formed by Innoviva, its strategic alliance agreement with GSK and all of its rights and obligations under its collaboration agreement with GSK other than with respect to RELVAR® ELLIPTA®/BREO® ELLIPTA®, ANORO® ELLIPTA® and vilanterol monotherapy. Through our 85% equity

interests in TRC, we are entitled to receive an 85% economic interest in any future payments made by GSK under the strategic alliance agreement and under the portion of the collaboration agreement assigned to TRC. The drug programs assigned to TRC include Trelegy Ellipta and the MABA program, as monotherapy and in combination with other therapeutically active components, such as an inhaled corticosteroid (“ICS”), and any other product or combination of products that may be discovered and developed in the future under the GSK agreements.

 

On May 31, 2014, we entered into the TRC LLC Agreement with Innoviva that governs the operation of TRC. Under the TRC LLC Agreement, Innoviva is the manager of TRC, and the business and affairs of TRC are managed exclusively by the manager, including (i) day to day management of the drug programs in accordance with the existing GSK agreements, (ii) preparing an annual operating plan for TRC and (iii) taking all actions necessary to ensure that the formation, structure and operation of TRC complies with applicable law and partner agreements. We are responsible for our proportionate share of TRC’s administrative expenses incurred by Innoviva.

 

We analyzed our ownership, contractual and other interests in TRC to determine if it is a variable‑interest entity (“VIE”), whether we have a variable interest in TRC and the nature and extent of that interest. We determined that TRC is a VIE. The party with the controlling financial interest, the primary beneficiary, is required to consolidate the entity determined to be a VIE. Therefore, we also assessed whether we are the primary beneficiary of TRC based on the power to direct its activities that most significantly impact its economic performance and our obligation to absorb its losses or the right to receive benefits from it that could potentially be significant to TRC. Based on our assessment, we determined that we are not the primary beneficiary of TRC, and, as a result, we do not consolidate TRC in our consolidated financial statements. TRC is recognized in our consolidated financial statements under the equity method of accounting, and the value of our equity investment in TRC was not material for the periods presented.

 

For the three and six months ended June 30, 2018, we recognized $1.9 million and $2.6 million, respectively, in income from our investment in TRC which was generated by royalty payments from GSK to TRC arising from the net sales of Trelegy Ellipta. There was no income from TRC in the comparable prior year period.

 

7. Inventories

 

Inventory consists of the following:

 

 

We assess our inventory levels each reporting period in consideration of the risk of product expiration. In evaluating the sufficiency of our inventory reserves or liabilities for firm purchase commitments, we also take into consideration our firm purchase commitments for future inventory production. In the fourth quarter of 2017, we accrued a $2.3 million liability related to excess inventory purchase commitments based on our expected purchase obligations at the time. For the three months ended June 30, 2018, we reversed the expense related to the $2.3 million purchase commitment liability due to the waiver of our minimum purchase commitment by our third-party manufacturer, and the $2.3 million adjustment is included within costs of goods sold on the condensed consolidated statements of operations.

 

 

 

8.  Share-Based Compensation

 

Share-Based Compensation Expense Allocation

 

The allocation of share-based compensation expense included in the condensed consolidated statements of operations was as follows:

 

 

Performance-Contingent Awards

 

In the first quarter of 2016, the Compensation Committee of our Board of Directors (“Compensation Committee”) approved the grant of 1,575,000 performance-contingent restricted share awards (“RSAs”) and 135,000 performance-contingent restricted share units (“RSUs”) to senior management. The vesting of such awards is dependent on the Company meeting its critical operating goals and objectives during a five-year period from 2016 to December 31, 2020. The goals that must be met in order for the performance-contingent RSAs and RSUs to vest are strategically important for the Company, and the Compensation Committee believes the goals, if achieved, will increase shareholder value. The awards have dual triggers of vesting based upon the achievement of these goals and continued employment. As of June 30, 2018, there were 978,750 performance-contingent RSAs and 101,250 performance-contingent RSUs outstanding. As of June 30, 2017, there were 1,305,000 performance-contingent RSAs and 135,000 performance-contingent RSUs outstanding.

 

Expense associated with these awards is broken into three separate tranches and may be recognized during the years 2016 to 2020 depending on the probability of meeting the performance conditions. Compensation expense relating to awards subject to performance conditions is recognized if it is considered probable that the performance goals will be achieved. The probability of achievement is reassessed at each quarter-end reporting period.

 

As of June 30, 2018, the performance conditions associated with the first tranche of these awards were completed, and, as a result, we recognized $0.6 million and $1.8 million of share-based compensation expense for the three and six months ended June 30, 2018, respectively, associated with these awards. For the three and six month ended June 30, 2017, we recognized $0.5 million and $0.9 million, respectively, of share-based compensation expense related to the first tranche of these awards.

 

For the three and six months ended June 30, 2018, we recognized $0.9 million and $1.7 million, respectively, of share-based compensation expense related to our assessment of the probability that the performance conditions associated with the second tranche of these awards was considered to be probable of vesting. As of June 30, 2017, the second tranche was not considered probable of vesting, and as of June 30, 2018 and 2017, we determined that the remaining third tranche was not probable of vesting and, as a result, no compensation expense related to the third tranche has been recognized to date.

 

The maximum potential expense associated with the remaining second and third tranches could be up to $21.4 million (allocated as $8.0 million for research and development expense and $13.4 million for selling, general and administrative expense) if the performance conditions for the second and third tranches are achieved.

 

In the third quarter of 2017, the Compensation Committee approved the grant of 50,000 performance contingent RSUs to a newly appointed member of senior management. The RSUs have dual triggers of vesting based upon the achievement of certain corporate operating milestones in specified timelines, as well as a requirement for continued employment. Share-based compensation expense related to this grant is broken into two separate tranches and recognized when the associated performance goals are deemed to be probable of achievement. The maximum expense associated with the first tranche is $0.8 million. In 2017, we recognized $0.4 million in share-based compensation expense as we determined that the performance conditions associated with the first tranche was probable of vesting, and during the three months ended March 31, 2018, we recognized the remaining $0.4 million of share-based compensation expense as the performance conditions associated with the first tranche of this award were met.  We have determined that the second tranche was not probable of vesting as of June 30, 2018 and, as a result, no compensation expense related to the second tranche has been recognized to date.

 

9. Income Taxes

 

The income tax provision was a $6.8 million benefit and $6.6 million benefit for the three and six months ended June 30, 2018, respectively. The benefit recorded in the income tax provision was primarily due to recording contingent tax liabilities pertaining primarily to uncertain tax positions taken with respect to transfer pricing and tax credits, offset by a tax benefit arising from an updated estimate of a tax filing position to be reported in our tax returns filed in 2018. No provision for income taxes has been recognized on undistributed earnings of our foreign subsidiaries because we consider such earnings to be indefinitely reinvested.

 

We follow the accounting guidance related to accounting for income taxes which requires that a company reduce its deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of its deferred tax assets will not be realized. As of June 30, 2018, our deferred tax assets were offset in full by a valuation allowance.

 

We record liabilities related to uncertain tax positions in accordance with the income tax guidance which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements by prescribing a minimum recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Resolution of one or more of these uncertain tax positions in any period may have a material impact on the results of operations for that period. We include any applicable interest and penalties within the provision for income taxes in the condensed consolidated statements of operations.

 

The difference between the Irish statutory rate and our effective tax rate was primarily due to the valuation allowance on deferred tax assets and the liabilities recorded for the uncertain tax position related to transfer pricing and tax credits.

 

Our future income tax expense may be affected by such factors as changes in tax laws, our business, regulations, tax rates, interpretation of existing laws or regulations, the impact of accounting for share-based compensation, the impact of accounting for business combinations, our international organization, shifts in the amount of income before tax earned in the US as compared with other regions in the world, and changes in overall levels of income before tax.

 

US Tax Reform

 

On December 22, 2017, the US government enacted the Tax Cuts and Jobs Acts (the "Tax Act"). The Tax Act significantly revises the US corporate income tax laws by, amongst other things, reducing the corporate income tax rate from 35% to 21% and implementing a modified territorial tax system that includes a one-time repatriation tax on accumulated undistributed foreign earnings.

 

Based on provisions of the Tax Act, we remeasured the deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is generally 21%. The estimated amount of the remeasurement of our federal deferred tax balance was $12.4 million. However, as we recognize a valuation allowance on deferred tax assets, if it is more likely than not that the assets will not be realized in future years, there is no impact to effective tax rate, as any change to deferred taxes would be offset by valuation allowances.

 

The changes included in the Tax Act are broad and complex. The final transition impact of the Tax Act may differ from the above estimate, possibly materially, due to, among other things, changes in interpretations of the Tax Act, any legislative action to address questions that arise because of the Tax Act, any changes in accounting standards for income taxes or related interpretations in response to the Tax Act, or any updates or changes to estimates the Company has utilized to calculate the transition impact, including impact from changes to current year earnings estimates and foreign exchange rates of foreign subsidiaries. For example, one area where we are waiting on further guidance before finalizing our conclusion as to the impact of the Tax Act on our deferred tax assets and liabilities is the transition rules with respect to the tax deductibility of executive compensation. The Securities Exchange Commission has issued rules that would allow for a measurement period of up to one year after the enactment date of the Tax Act to finalize the recording of the related tax impacts. For the three and six months ended June 30, 2018, we did not adjust or include any previously assessed Tax Act effect in our quarterly tax provision. We currently anticipate finalizing and recording any resulting adjustments by December 22, 2018.

ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Forward-Looking Statements

 

You should read the following discussion in conjunction with our condensed financial statements (unaudited) and related notes included elsewhere in this report. This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”), as amended, and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), as amended, that involve risks and uncertainties. All statements in this report, other than statements of historical facts, including statements regarding our strategy, future operations, future financial position, future revenues, projected costs, prospects, plans, intentions, expectations and objectives are forward-looking statements. The words “anticipate,” “assume,” “believe,” “contemplate,” “continue,” “could,” “designed,” “developed,” “drive,” “estimate,” “expect,” “forecast,” “goal,” “intend,” “may,” “mission,” “opportunities,” “plan,” “potential,” “predict,” “project,” “pursue,” “seek,” “should,” “target,” “will,” “would,” and similar expressions (including the negatives thereof) are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. These statements reflect our current views with respect to future events or our future financial performance, are based on assumptions, and involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. We may not actually achieve the plans, intentions, expectations or objectives disclosed in our forward-looking statements and the assumptions underlying our forward-looking statements may prove incorrect. Therefore, you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions, expectations and objectives disclosed in the forward-looking statements that we make. Factors that we believe could cause actual results or events to differ materially from our forward-looking statements include, but are not limited to, those discussed in “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report and in our Annual Report on Form 10-K for the year ended December 31, 2017. Our forward-looking statements in this report are based on current expectations and we do not assume any obligation to update any forward-looking statements for any reason, even if new information becomes available in the future.

 

Management Overview

 

Theravance Biopharma, Inc. (“Theravance Biopharma”) is a diversified biopharmaceutical company with the core purpose of creating medicines that help improve the lives of patients suffering from serious illness.

 

In our relentless pursuit of this objective, we strive to apply insight and innovation at each stage of our business, including research, development and commercialization, and utilize both internal capabilities and those of partners around the world. Our research efforts are focused in the areas of inflammation and immunology. Our research goal is to design localized medicines that target diseased tissues, without systemic exposure, in order to maximize patient benefit and minimize risk. These efforts leverage years of experience in developing localized medicines for the lungs to treat respiratory disease. The first potential medicine to emerge from our research focus on immunology and localized treatments is an oral, intestinally restricted pan-Janus kinase (JAK) inhibitor, currently in development to treat a range of inflammatory intestinal diseases. Our pipeline of internally discovered product candidates will continue to evolve with the goal of creating transformational medicines to address the significant needs of patients.

 

In addition, we have an economic interest in future payments that may be made by Glaxo Group or one of its affiliates (“GSK”) pursuant to its agreements with Innoviva, Inc. relating to certain programs, including Trelegy Ellipta.

 

Program Highlights

 

Intestinally Restricted Pan-Janus Kinase (JAK) Inhibitor Program (TD-1473)

 

JAK inhibitors function by inhibiting the activity of one or more of the Janus kinase family of enzymes (JAK1, JAK2, JAK3, TYK2) that play a key role in cytokine signaling. Inhibiting these JAK enzymes interferes with the JAK/STAT signaling pathway and, in turn, modulates the activity of a wide range of pro-inflammatory cytokines. JAK inhibitors are currently approved for the treatment of rheumatoid arthritis, myelofibrosis, and ulcerative colitis and have demonstrated therapeutic benefit for patients with Crohn’s disease. However, these products are known to have side effects based on their systemic exposure. Our goal is to develop an orally administered, intestinally restricted pan-JAK inhibitor specifically