Innoviva, Inc. - Quarter Report: 2014 September (Form 10-Q)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended September 30, 2014

 

OR

 

o                   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: 000-30319

 

THERAVANCE, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

951 Gateway Boulevard

South San Francisco, CA 94080

(Address of Principal Executive Offices)

 

(650) 238-9600

(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  x  No  o

 

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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x  No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x		Accelerated filer o
Non-accelerated filer o		Smaller reporting company o
(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o  No  x

 

The number of shares of registrant’s common stock outstanding on October 31, 2014 was 115,369,046.

 

 

 

TABLE OF CONTENTS

 

PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013		3
Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2014 and 2013		4
Condensed Consolidated Statements of Comprehensive Loss for the three and nine months ended September 30, 2014 and 2013		5
Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013		6
Notes to Condensed Consolidated Financial Statements		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		23
Item 3. Quantitative and Qualitative Disclosures About Market Risk		34
Item 4. Controls and Procedures		34
PART II. OTHER INFORMATION
Item 1A. Risk Factors		35
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		48
Item 3. Defaults Upon Senior Securities		48
Item 4. Mine Safety Disclosures		48
Item 5. Other Information		48
Item 6. Exhibits		49
Signatures		50

 

2

 

PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

THERAVANCE, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

 

		September 30, 2014			December 31, 2013
		(Unaudited)			*
Assets
Current assets:
Cash and cash equivalents		$	119,575		$	143,510
Restricted cash		5,600			—
Short-term marketable securities		143,536			321,615
Accounts receivable, net of allowances of $89 at December 31, 2013		—			199
Receivables from collaborative arrangements (including amounts from a related party of $4,012 and $2,247 at September 30, 2014 and December 31, 2013)		4,012			3,181
Prepaid expenses and other current assets		748			4,287
Inventories		—			10,406
Total current assets		273,471			483,198
Marketable securities		47,752			55,374
Restricted cash		833			833
Property and equipment, net		64			10,238
Intangible assets, net		211,646			124,257
Other assets		19,947			7,355
Total assets		$	553,713		$	681,255
Liabilities and stockholders’ (deficit) equity
Current liabilities:
Accounts payable		$	573		$	7,583
Payable to a related party		10,000			40,000
Accrued personnel-related expenses		1,203			10,881
Accrued clinical and development expenses		—			9,714
Accrued interest payable		19,467			2,800
Other accrued liabilities		3,773			4,137
Deferred revenue		1,082			9,289
Total current liabilities		36,098			84,404
Convertible subordinated notes		255,109			287,500
Non-recourse notes payable, due 2029		450,000			—
Deferred rent		54			4,774
Other long-term liabilities		1,530			—
Deferred revenue		4,058			5,455
Commitments and contingencies (Notes 3, 6 and 8)
Stockholders’ (deficit) equity:
Common stock, $0.01 par value; authorized: 200,000 shares; issued: 115,380 and 111,516 at September 30, 2014 and December 31, 2013		1,154			1,115
Treasury stock, 150 and 0 shares at September 30, 2014 and December 31, 2013		(3,263		)	—
Additional paid-in capital		1,466,911			1,803,048
Accumulated other comprehensive (loss) income		(197		)	162
Accumulated deficit		(1,657,741		)	(1,505,203		)
Total stockholders’ (deficit) equity		(193,136		)	299,122
Total liabilities and stockholders’ (deficit) equity		$	553,713		$	681,255

*                    Condensed consolidated balance sheet at December 31, 2013 has been derived from audited consolidated financial statements.

 

See accompanying notes to condensed consolidated financial statements.

 

3

 

THERAVANCE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 (Unaudited)

(In thousands, except per share data)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2014			2013			2014			2013
Royalty revenue from a related party, net of intangible assets amortization: three months—2014-$3,233; 2013-$0; nine months—2014-$7,611; 2013-$0 (Note 3) (1)		$	729		$	—		$	342		$	—
Net revenue from collaborative arrangements from a related party		270			415			811			3,059
Total net revenue		999			415			1,153			3,059
Operating expenses:
Research and development		1,909			2,104			6,721			6,555
General and administrative		8,632			6,018			28,491			17,882
Total operating expenses		10,541			8,122			35,212			24,437
Loss from operations		(9,542		)	(7,707		)	(34,059		)	(21,378		)
Other income (expense), net		255			(37		)	335			6,734
Interest income		93			192			446			567
Interest expense		(12,355		)	(1,902		)	(24,326		)	(7,662		)
Loss from continuing operations before income taxes		(21,549		)	(9,454		)	(57,604		)	(21,739		)
Income tax		278			—			—			—
Loss from continuing operations, net of tax		(21,271		)	(9,454		)	(57,604		)	(21,739		)
Loss from discontinued operations (Notes 10 and 11):		—			(37,531		)	(94,934		)	(99,033		)
Net loss		$	(21,271	)	$	(46,985	)	$	(152,538	)	$	(120,772	)
Basic and diluted net loss per share:
Continuing operations, net of tax		$	(0.19	)	$	(0.09	)	$	(0.52	)	$	(0.21	)
Discontinued operations		—			(0.35		)	(0.85		)	(0.99		)
Basic and diluted net loss per share		$	(0.19	)	$	(0.44	)	$	(1.37	)	$	(1.20	)
Cash dividends declared per common share		$	0.25		$	—		$	0.25		$	—
Shares used to compute basic and diluted net loss per share		113,100			106,295			111,306			100,321

 

(1) Gross royalty revenue from a related party for the three and nine months ended September 30, 2014 is $3,962 and $7,953, respectively.

 

See accompanying notes to condensed consolidated financial statements.

 

4

 

THERAVANCE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(Unaudited)

(In thousands)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2014			2013			2014			2013
Net loss		$	(21,271	)	$	(46,985	)	$	(152,538	)	$	(120,772	)
Other comprehensive (loss) income:
Net unrealized (loss) gain on marketable securities		(3,903		)	217			(359		)	103
Comprehensive loss		$	(25,174	)	$	(46,768	)	$	(152,897	)	$	(120,669	)

 

See accompanying notes to condensed consolidated financial statements.

 

5

 

THERAVANCE, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Nine Months Ended September 30,
		2014			2013
Cash flows from operating activities
Net loss		$	(152,538	)	$	(120,772	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		8,720			1,959
Stock-based compensation		26,013			19,704
Amortization of premium on marketable securities		1,539			2,933
Change in fair value of capped-call derivative assets		—			1,422
Amortization of debt issuance costs		1,550			792
Other non-cash items		(2		)	17
Changes in operating assets and liabilities:
Account receivables		74			—
Receivables from collaborative arrangements		(833		)	(1,425		)
Prepaid expenses and other current assets		(52		)	(35		)
Inventories		(1,908		)	(2,912		)
Other assets		561			—
Accounts payable		(7,122		)	2,040
Payable to Theravance Biopharma, Inc., net		(16,166		)	—
Accrued personnel-related expenses, accrued clinical and development expenses, and other accrued liabilities		71			4,472
Accrued interest payable		16,667			(1,099		)
Deferred rent		224			(416		)
Deferred revenue		(2,911		)	3,692
Net cash used in operating activities		(126,113		)	(89,628		)
Cash flows from investing activities
Purchases of property and equipment		(556		)	(1,667		)
Purchases of marketable securities		(228,899		)	(354,583		)
Maturities of marketable securities		292,666			155,396
Sales of marketable securities		5,000			22,600
Payments for intangible assets		(125,000		)	(40,000		)
Payments received on notes receivable		140			100
Net cash used in investing activities		(56,649		)	(218,154		)
Cash flows from financing activities
Cash and cash equivalents contributed to Theravance Biopharma, Inc.		(277,541		)	—
Proceeds from issuances of common stock, net		35,629			140,003
Payments of cash dividends to stockholders		(28,338		)	—
Purchase of capped-call options		—			(36,800		)
Change in restricted cash		(5,600		)	—
Proceeds from issuances of notes payable, net of debt issuance costs		434,677			281,622
Net cash provided by financing activities		158,827			384,825
Net (decrease) increase in cash and cash equivalents		(23,935		)	77,043
Cash and cash equivalents at beginning of period		143,510			94,849
Cash and cash equivalents at end of period		$	119,575		$	171,892
Supplemental disclosures of noncash information
Contribution of net assets, excluding cash and cash equivalents to Theravance Biopharma, Inc.		$	125,337		$	—
Conversion of convertible subordinated notes into common stock		$	32,391		$	172,499

 

See accompanying notes to condensed consolidated financial statements.

 

6

 

THERAVANCE, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Description of Operations and Summary of Significant Accounting Policies

 

Description of Operations

 

Theravance, Inc. (“Theravance”, the “Company”, or “we” and other similar pronouns) is a royalty management company focused on maximizing the potential value of the respiratory assets partnered with Glaxo Group Limited (“GSK”), including RELVAR®/BREO® ELLIPTA® (fluticasone furoate/ vilanterol, “FF/VI”) and ANORO® ELLIPTA® (umeclidinium bromide/ vilanterol, “UMEC/VI”), with the intention of providing capital returns to stockholders. Under the Long-Acting Beta2 Agonist (“LABA”) Collaboration Agreement and the Strategic Alliance Agreement with GSK (referred to herein as the “GSK Agreements”), Theravance is eligible to receive the associated royalty revenues from RELVAR®/BREO® ELLIPTA® , ANORO® ELLIPTA® and if approved and commercialized, VI monotherapy. Theravance is also entitled to a 15% economic interest in any future payments made by GSK under its agreements originally entered into with us, and since assigned to Theravance Respiratory Company, LLC (“TRC”), relating to the combination of FF/UMEC/VI and the Bifunctional Muscarinic Antagonist-Beta2 Agonist (“MABA”) program, as monotherapy and in combination with other therapeutically active components, such as an inhaled corticosteroid, and any other product or combination of products that may be discovered and developed in the future under the LABA Collaboration Agreement (“LABA Collaboration”) with us, which has been assigned to TRC other than with respect to RELVAR®/BREO®ELLIPTA®, ANORO® ELLIPTA® and VI monotherapy.

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In our opinion, the unaudited condensed consolidated financial statements have been prepared on the same basis as audited consolidated financial statements and include all adjustments, consisting of only normal recurring adjustments, necessary for the fair presentation of our financial position, results of operations, comprehensive loss and cash flows. The interim results are not necessarily indicative of the results of operations to be expected for the year ending December 31, 2014 or any other period.

 

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission (“SEC”) on March 3, 2014.

 

Business Separation

 

On June 1, 2014, we separated our late-stage partnered respiratory assets from our biopharmaceutical research and drug development operations by transferring our research and drug development operations into a wholly-owned subsidiary. We contributed $393.0 million of cash, cash equivalents and marketable securities to Theravance Biopharma, Inc. (“Theravance Biopharma”) and all outstanding shares of Theravance Biopharma were then distributed to our stockholders as a pro-rata dividend distribution on June 2, 2014 by issuing one ordinary share of Theravance Biopharma for every 3.5 shares held of Theravance common stock to stockholders of record on May 15, 2014 (the “Spin-Off”). The Spin-Off resulted in Theravance Biopharma operating as an independent, publicly traded company.

 

The results of operations for our former research and drug development operations conducted by us and by Theravance Biopharma until June 1, 2014 are included as part of this report as discontinued operations. Refer to Notes 10 and 11, “Spin-Off of Theravance Biopharma, Inc.,” and “Discontinued Operations” for further information.

 

Pursuant to a three-way master agreement entered into by and among us, Theravance Biopharma and GSK in connection with the Spin-Off, we agreed to sell a certain number of Theravance Biopharma shares withheld from a taxable dividend of Theravance Biopharma shares to GSK. After such Theravance Biopharma shares were sent to the transfer agent, we agreed to purchase the Theravance Biopharma shares from the transfer agent, rather than have them sold on the open market, in order to satisfy tax withholdings.  GSK had an option to purchase these shares of Theravance Biopharma from us, but this option expired unexercised.  Accordingly, at September 30, 2014, we owned 436,802 ordinary shares of Theravance Biopharma, which are accounted for as marketable securities in the condensed consolidated balance sheet. These equity securities are discussed further in Note 4, “Available-for-Sale Securities and Fair Value Measurements”.

 

7

 

Fair Value of Financial Instruments

 

We define fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

 

Our valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our market assumptions. We classify these inputs into the following hierarchy:

 

Level 1—Quoted prices for identical instruments in active markets.

 

Level 2—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.

 

Level 3—Unobservable inputs and little, if any, market activity for the assets.

 

Financial instruments include cash equivalents, marketable securities, accounts receivable, receivables from collaborative arrangements, accounts payable, and accrued liabilities. Marketable securities are carried at estimated fair value. The carrying value of cash equivalents, accounts receivable, receivables from collaborative arrangements, accounts payable, and accrued liabilities approximate their estimated fair value due to the relatively short-term nature of these instruments.

 

Inventories

 

All inventories were related to our former research and drug development operations and, thus, were contributed to Theravance Biopharma in connection with the Spin-Off. Accordingly, we have no inventories as of September 30, 2014.

 

Prior to the Spin-Off of Theravance Biopharma, our inventories consisted of raw materials, work-in-process and finished goods related to the production of VIBATIV® (telavancin). Raw materials include VIBATIV® active pharmaceutical ingredient (API) and other raw materials. Work-in-process and finished goods included third party manufacturing costs and labor and indirect costs incurred in the production process. Included in inventories were raw materials and work-in-process that may be used as clinical products, which were charged to research and development expense when consumed. In addition, under certain commercialization agreements, we could sell VIBATIV® packaged in unlabeled vials that are recorded in work-in-process. Inventories were stated at the lower of cost or market value. We determined the cost of inventory using the average-cost method for validation batches. We analyzed our inventory levels quarterly and wrote down any inventory that was expected to become obsolete, that had a cost basis in excess of its expected net realizable value or for inventory quantities in excess of expected requirements.

 

Inventories were as follows:

 

		December 31,
(In thousands)		2013
Raw materials		$	5,138
Work-in-process		360
Finished goods		4,908
Total inventories		$	10,406

 

Revenue Recognition

 

Revenue is recognized when the four basic criteria of revenue recognition are met: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the nature of the fee charged for products or services delivered and the collectability of those fees. Where the revenue recognition criteria are not met, we defer the recognition of revenue by recording deferred revenue until such time that all criteria are met.

 

Collaborative Arrangements and Multiple-Element Arrangements

 

Revenue from nonrefundable, up-front license or technology access payments under license and collaborative arrangements that are not dependent on any future performance by us is recognized when such amounts are earned. If we have continuing obligations to perform under the arrangement, such fees are recognized over the estimated period of continuing performance obligation.

 

8

 

We account for multiple element arrangements, such as license and development agreements in which a customer may purchase several deliverables, in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Subtopic 605-25, “Multiple Element Arrangements.” For new or materially amended multiple element arrangements, we identify the deliverables at the inception of the arrangement and each deliverable within a multiple deliverable revenue arrangement is accounted for as a separate unit of accounting if both of the following criteria are met: (1) the delivered item or items have value to the customer on a standalone basis and (2) for an arrangement that includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in our control. We allocate revenue to each non-contingent element based on the relative selling price of each element. When applying the relative selling price method, we determine the selling price for each deliverable using vendor-specific objective evidence (“VSOE”) of selling price, if it exists, or third-party evidence (“TPE”) of selling price, if it exists. If neither VSOE nor TPE of selling price exist for a deliverable, we use the best estimated selling price for that deliverable. Revenue allocated to each element is then recognized based on when the basic four revenue recognition criteria are met for each element.

 

For multiple-element arrangements entered into prior to January 1, 2011, we determined the delivered items under our collaborative arrangements did not meet the criteria to be considered separate accounting units for the purposes of revenue recognition. As a result, we recognized revenue from non-refundable, upfront fees and development contingent payments in the same manner as the final deliverable, which is ratably over the expected term of our performance of research and development services under the agreements. These upfront or contingent payments received, pending recognition as revenue, are recorded as deferred revenue and are classified as a short-term or long-term liability on the consolidated balance sheets and recognized over the estimated period of performance. We periodically review the estimated performance periods of our contracts based on the progress of our programs.

 

Where a portion of non-refundable upfront 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 revenue, or as an accrued liability and recognized as a reduction of research and development expenses ratably over the term of our estimated performance period under the agreement. We determine the estimated performance periods, and they are periodically reviewed based on the progress of the related program. The effect of any change made to an estimated performance period and, therefore revenue recognized, would occur on a prospective basis in the period that the change was made.

 

Under certain collaborative arrangements, we have been reimbursed for a portion of our research and development expenses. These reimbursements have been reflected as a reduction of research and development expense in our consolidated statements of operations, as we do not consider performing research and development services to be a part of our ongoing and central operations. Therefore, the reimbursement of research and developmental services and any amounts allocated to our research and development services are recorded as a reduction of research and development expense.

 

Amounts deferred under a collaborative arrangement in which the performance obligations are terminated will result in an immediate recognition of any remaining deferred revenue and accrued liability in the period that termination occurred, provided that there are no remaining performance obligations.

 

We account for contingent payments in accordance with FASB Subtopic ASC 605-28 “Revenue Recognition—Milestone Method.” We recognize revenue from milestone payments when (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement and (ii) we do not have ongoing performance obligations related to the achievement of the milestone. Milestone payments are considered substantive if all of the following conditions are met: the milestone payment (a) is commensurate with either our performance to achieve the milestone or the enhancement of the value of the delivered item or items as a result of a specific outcome resulting from our performance to achieve the milestone, (b) relates solely to past performance, and (c) is reasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement.

 

Under our collaborative arrangements with GSK, and in accordance with FASB Subtopic ASC 808-10, “Collaborative Arrangements,” royalty revenue earned is reduced by amortization expense resulting from the fees paid to GSK, which were capitalized as finite-lived intangible assets. When amortization expense exceeds amounts recognized for royalty revenues from GSK, negative revenue would be reported in our consolidated statements of operations.

 

9

 

Royalties

 

We recognize royalty revenue on licensee net sales of products with respect to which we have contractual royalty rights in the period in which the royalties are earned and reported to us and collectability is reasonably assured.  Royalties are recognized net of amortization of intangible assets associated with any approval and launch milestone payments made to GSK.

 

Product Revenues

 

We currently have no product revenues following the Spin-Off of Theravance Biopharma.

 

Prior to the Spin-Off of Theravance Biopharma, we sold VIBATIV® in the U.S. through a limited number of distributors, and title and risk of loss transferred upon receipt of the product by these distributors. Healthcare providers ordered VIBATIV® through these distributors. Commencing in the first quarter of 2014, revenue on the sale of VIBATIV® was recorded on a sell-through basis, once the distributors sold the product to healthcare providers. As VIBATIV® is a product that is sold by Theravance Biopharma, the revenue from product sales are included within discontinued operations in the consolidated statements of operations for the nine months ended September 30, 2014. There was no revenue recognized from product sales for any period in 2013 as all amounts were deferred.

 

Product sales were recorded net of estimated government-mandated rebates and chargebacks, distribution fees, estimated product returns and other deductions. We reflected such reductions in revenue either as 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 were based on management’s estimates that considered payer mix in target markets, industry benchmarks and experience to date. We monitored 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 were based on amounts owed or to be claimed on related sales. These estimates took into consideration the terms of our agreements with customers, historical product returns of VIBATIV® experienced by our former collaborative partner, Astellas Pharma, Inc. (“Astellas”), 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.

 

Sales Discounts:  We offered cash discounts to our customers, generally 2% of the sales price, as an incentive for prompt payment. We expected our customers to comply with the prompt payment terms to earn the cash discount. We accounted for cash discounts by reducing accounts receivable by the full amount 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 U.S., we estimated 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 was based on actual chargebacks that distributors have claimed for reduced pricing offered to such health care providers. Our accrual for Medicaid was based upon statutorily-defined discounts, estimated payer mix, expected sales to qualified healthcare providers, and our expectation about future utilization. The Medicaid accrual and government rebates that were invoiced directly to us were recorded in other accrued liabilities on the consolidated balance sheet. For qualified programs that purchased our products through distributors at a lower contractual government price, the distributors charged back to us the difference between their acquisition cost and the lower contractual government price, which we recorded as an allowance against accounts receivable.

 

Distribution Fees and Product Returns:  We had written contracts with our distributors that include terms for distribution-related fees. We recorded distribution-related fees based on a percentage of the product sales price. We offered our distributors a right to return product purchased directly from us, which was principally based upon the product’s expiration date. Additionally, we had granted more expansive return rights to our distributors following our product launch of VIBATIV®. Our policy was to accept returns for expired product during the six months prior to and twelve months after the product expiration date on product that had been sold to our distributors. We developed estimates for VIBATIV® product returns based upon historical VIBATIV® sales from our former collaborative partner, Astellas. We recorded distribution fees and product returns as an allowance against accounts receivable.

 

Allowance for Doubtful Accounts:  We maintained a policy to record allowances for potentially doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. As of December 31, 2013, there were no allowances for doubtful accounts as we have not had any write-offs historically.

 

10

 

Variable Interest Entities

 

We evaluate our ownership, contractual and other interest in entities to determine if they are variable-interest entities (“VIE”), whether we have a variable interest in those entities and the nature and extent of those interests. Based on our evaluations, if we determine we are the primary beneficiary of such VIEs, we consolidate such entities into our financial statements. We consolidate the financial results of TRC, which we have determined to be a VIE, because we have the power to direct the economically significant activities of TRC and the obligation to absorb losses of, or the right to receive benefits from, TRC. The financial position and results of operations of TRC are not material as of and for the three and nine months ended September 30, 2014.

 

Intangible Assets

 

We capitalize fees paid to licensors related to agreements for approved products or commercialized products. We capitalize these fees as finite-lived intangible assets and amortize these intangible assets on a straight-line basis over their estimated useful lives upon the commercial launch of the product, which is expected to be shortly after regulatory approval of such product. The estimated useful lives of these intangible assets are based on a country-by-country and product-by-product basis, as the later of the expiration or termination of the last patent right covering the compound in such product in such country and 15 years from first commercial sale of such product in such country, unless the agreement is terminated earlier. Consistent with our policy for classification of costs under the research and development collaborative arrangements, the amortization of these intangible assets will be recognized as a reduction of royalty revenue. We review our intangible assets for impairment when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The recoverability of finite-lived intangible assets is measured by comparing the asset’s carrying amount to the expected undiscounted future cash flows that the asset is expected to generate. The determination of recoverability typically requires various estimates and assumptions, including estimating the useful life over which cash flows will occur, their amount, and the asset’s residual value, if any. We derive the required cash flow estimates from near-term forecasted product sales and long-term projected sales in the corresponding market.

 

Recently Issued Accounting Pronouncements Not Yet Adopted

 

In May 2014, the FASB issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which converges the FASB and the International Accounting Standards Board standards on revenue recognition. Areas of revenue recognition that will be affected include, but are not limited to, transfer of control, variable consideration, allocation of transfer pricing, licenses, time value of money, contract costs and disclosures. This guidance is effective for the fiscal years and interim reporting periods beginning after December 15, 2016, at which time we may adopt the new standard under the full retrospective method or the modified retrospective method. Early adoption is not permitted. We are currently evaluating the impact of adopting ASU 2014-09 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 common stock outstanding, less restricted stock awards (“RSAs”) subject to forfeiture. Diluted net loss per share is computed by dividing net loss by the weighted-average number of shares of common stock outstanding, less RSAs subject to forfeiture, plus all additional common shares that would have been outstanding, assuming dilutive potential common shares had been issued for other dilutive securities.

 

For the three months and nine months ended September 30, 2014 and 2013, diluted and basic net loss per share were identical since potential common shares were excluded from the calculation, as their effect was anti-dilutive.

 

The computations for basic and diluted net loss per share were as follows:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
(In thousands, except for per share amounts)		2014			2013			2014			2013
Numerator:
Loss from continuing operations, net of tax		$	(21,271	)	$	(9,454	)	$	(57,604	)	$	(21,739	)
Loss from discontinued operations		—			(37,531		)	(94,934		)	(99,033		)
Net loss		$	(21,271	)	$	(46,985	)	$	(152,538	)	$	(120,772	)
Denominator:
Weighted-average number of shares used to compute basic and diluted net loss per share		113,100			106,925			111,306			100,321
Basic and diluted net loss per share:
Continuing operations, net of tax		$	(0.19	)	$	(0.09	)	$	(0.52	)	$	(0.21	)
Discontinued operations		—			(0.35		)	(0.85		)	(0.99		)
Basic and diluted net loss per share		$	(0.19	)	$	(0.44	)	$	(1.37	)	$	(1.20	)

 

11

 

Anti-Dilutive Securities

 

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

 

		Three Months Ended September 30,				Nine Months Ended September 30,
(In thousands)		2014		2013		2014		2013
Shares issuable under equity incentive plans and ESPP		6,771		3,590		6,218		4,161
Unvested RSAs		1,782		2,418		1,782		2,418
Shares issuable upon the conversion of convertible subordinated notes		12,100		10,503		12,100		16,262
Total anti-dilutive securities		20,653		16,511		20,100		22,841

 

3. Collaborative Arrangements

 

Net Revenue from Collaborative Arrangements

 

Net revenue from collaborative arrangements from continuing operations relates to our arrangement with GSK. Net revenue from other collaborative arrangements was reflected as discontinued operations in the consolidated statements of operations. Refer to Notes 1, 10 and 11, “Description of Operations and Summary of Significant Accounting Policies,” “Spin-Off of Theravance Biopharma, Inc.” and “Discontinued Operations” for further information.

 

Net Royalty Revenue from GSK

 

Net revenue recognized under our GSK Agreements was as follows:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
(In thousands)		2014			2013			2014			2013
Royalty revenue		$	3,962		$	—		$	7,953		$	—
Amortization of intangible assets		(3,233		)	—			(7,611		)	—
Net royalty revenue		729			—			342			—
LABA collaboration		—			—			—			1,814
Strategic alliance—MABA program license		270			415			811			1,245
Total net revenue from GSK		$	999		$	415		$	1,153		$	3,059

 

LABA Collaboration

 

In November 2002, we entered into our LABA Collaboration Agreement with GSK to develop and commercialize once-daily LABA products for the treatment of chronic obstructive pulmonary disease (“COPD”) and asthma. For the treatment of COPD, the collaboration has developed two combination products: (1) RELVAR®/BREO® ELLIPTA® (FF/VI), a once-daily combination medicine consisting of a LABA, vilanterol (VI), and an inhaled corticosteroid (ICS), fluticasone furoate (FF) and (2) UMEC/VI, a once-daily medicine combining a long-acting muscarinic antagonist (“LAMA”), umeclidinium bromide (“UMEC”), with a LABA, VI. For the treatment of asthma, RELVAR® ELLIPTA® is approved in multiple regions outside of North America and the collaboration is further developing FF/VI for the U.S.

 

In the event that a product containing VI was successfully developed and commercialized, we were obligated to make milestone payments to GSK totaling $220.0 million if both a single-agent and a combination product or two different combination products were launched in multiple regions of the world. As of September 30, 2014, we have paid a total of $210.0 million of these milestones and have a payable of $10.0 million related to the launch and approval of BREO® ELLIPTA® and ANORO® ELLIPTA® in the U.S., Japan and Europe. The final milestone payment of $10.0 million was made in October 2014, which completed our obligation to GSK related to these milestone payments. These milestone fees paid or owed to GSK were capitalized as finite-lived intangible assets, which are being amortized over their estimated useful lives commencing upon the commercial launch of the product.

 

12

 

We are entitled to receive annual royalties from GSK on sales of RELVAR®/BREO® ELLIPTA® as follows: 15% on the first $3.0 billion of annual global net sales and 5% for all annual global net sales above $3.0 billion. Sales of single-agent LABA medicines and combination medicines would be combined for the purposes of this royalty calculation. For other products combined with a LABA from the LABA Collaboration, such as ANORO® ELLIPTA®, royalties are upward tiering and range from 6.5% to 10%.

 

Amortization expense resulting from the milestone fees paid to GSK, which are capitalized as finite-lived intangible assets, is a reduction to royalty revenue. When amortization expense exceeds amounts recognized for royalty revenue, negative revenue would be reported in our consolidated statements of operations.

 

2004 Strategic Alliance

 

In March 2004, we entered into the Strategic Alliance Agreement with GSK where GSK received an option to license exclusive development and commercialization rights to product candidates from certain of our discovery programs on pre-determined terms and on an exclusive, worldwide basis. Upon GSK’s decision to license a program, GSK is responsible for funding all future development, manufacturing and commercialization activities for product candidates in that program. In addition, GSK is obligated to use diligent efforts to develop and commercialize product candidates from any program that it licenses. If the program is successfully advanced through development by GSK, we are entitled to receive clinical, regulatory and commercial milestone payments and royalties on any sales of medicines developed from the program. If GSK chooses not to license a program, we retain all rights to the program and may continue the program alone or with a third party. GSK has no further option rights on any of our research or development programs under the strategic alliance.

 

In 2005, GSK licensed our MABA program for the treatment of COPD, and in October 2011, we and GSK expanded the MABA program by adding six additional Theravance-discovered preclinical MABA compounds (the “Additional MABAs”). GSK’s development, commercialization, milestone and royalty obligations under the strategic alliance remain the same with respect to GSK961081 (‘081), the lead compound in the MABA program. GSK is obligated to use diligent efforts to develop and commercialize at least one MABA within the MABA program, but may terminate progression of any or all Additional MABAs at any time and return them to us, at which point we may develop and commercialize such Additional MABAs alone or with a third party. Both GSK and we have agreed not to conduct any MABA clinical studies outside of the strategic alliance so long as GSK is in possession of the Additional MABAs. If a single-agent MABA medicine containing ‘081 is successfully developed and commercialized, we are entitled to receive royalties from GSK of between 10% and 20% of annual global net sales up to $3.5 billion, and 7.5% for all annual global net sales above $3.5 billion. If a MABA medicine containing ‘081 is commercialized as a combination product, such as ‘081/FF, the royalty rate is 70% of the rate applicable to sales of the single-agent MABA medicine. For single-agent MABA medicines containing an Additional MABA, we are entitled to receive royalties from GSK of between 10% and 15% of annual global net sales up to $3.5 billion, and 10% for all annual global net sales above $3.5 billion. For combination products containing an Additional MABA, such as a MABA/ICS combination, the royalty rate is 50% of the rate applicable to sales of the single-agent MABA medicine. If an MABA medicine containing ‘081 is successfully developed and commercialized in multiple regions of the world, we could earn total contingent payments of up to $125.0 million for a single-agent medicine and up to $250.0 million for both a single-agent and a combination medicine. If an MABA medicine containing an Additional MABA is successfully developed and commercialized in multiple regions of the world, we could earn total contingent payments of up to $129.0 million.

 

Agreements Entered into with GSK in Connection with the Spin-Off

 

On March 3, 2014, in contemplation of the Spin-Off, we, Theravance Biopharma and GSK entered into a series of agreements clarifying how the companies would implement the Spin-Off and operate following the Spin-Off. We, Theravance Biopharma and GSK entered into a three-way master agreement providing for GSK’s consent to the Spin-Off provided certain conditions were met. In addition, we and GSK also entered into amendments of our GSK Agreements, and Theravance Biopharma and GSK entered into a governance agreement, a registration rights agreement and an extension agreement. The three-way master agreement was effective on June 1, 2014 when we transferred our research and drug development operations to Theravance Biopharma. Pursuant to a three-way master agreement entered into by and among us, Theravance Biopharma and GSK in connection with the Spin-Off, we agreed to sell a certain number of Theravance Biopharma shares withheld from a taxable dividend of Theravance Biopharma shares to GSK. After such Theravance Biopharma shares were sent to the transfer agent, we agreed to purchase the Theravance Biopharma shares from the transfer agent, rather than have them sold on the open market, in order to satisfy tax withholdings. GSK had an option to purchase these shares of Theravance Biopharma from us, but this option expired unexercised.  Accordingly, at September 30, 2014, we owned 436,802 ordinary shares of Theravance Biopharma, which are accounted for as marketable securities in the condensed consolidated balance sheets.

 

13

 

The amendments to the GSK Agreements do not change the economics or royalty rates under the GSK Agreements, though the assignment of the Strategic Alliance Agreement and portions of the LABA Collaboration to TRC do change how the economics are allocated between Theravance Biopharma and us. The amendments to the GSK Agreements do provide that GSK’s diligent efforts obligations regarding commercialization matters under both agreements will change upon regulatory approval in either the United States or the European Union of FF/UMEC/VI or a MABA in combination with FF. Upon such regulatory approval, GSK’s diligent efforts obligations as to commercialization matters under the GSK Agreements will have the objective of focusing on the best interests of patients and maximizing the net value of the overall portfolio of products under the GSK Agreements. Since GSK’s commercialization efforts following such regulatory approval will be guided by a portfolio approach across products in which we will retain our full interests upon the Spin-Off and also products in which we will have retained only a portion of our interests upon the planned Spin-Off transaction, GSK’s commercialization efforts may have the effect of reducing the overall value of our remaining interests in the GSK Agreements after the Spin-Off.

 

Purchases of Common Stock under the Company’s Governance Agreement and Common Stock Purchase Agreements with GSK

 

During the first nine months of 2014, GSK purchased 832,650 shares of our common stock pursuant to its periodic “top-up” rights under our Amended and Restated Governance Agreement, dated as of June 4, 2004, as amended, among us, GSK and certain GSK affiliates, for an aggregate purchase price of approximately $25.3 million.

 

GSK Contingent Payments and Revenue

 

The potential future contingent payments receivable related to the MABA program of $363.0 million are not deemed substantive milestones due to the fact that the achievement of the event underlying the payment predominantly relates to GSK’s performance of future development, manufacturing and commercialization activities for product candidates after licensing the program.

 

Reimbursement of Research and Development Costs

 

Reimbursement of research and development costs from continuing operations is solely related to the GSK Agreements.  Under the GSK Agreements, we are entitled to reimbursement of certain research and development costs. For the three months and nine months ended September 30, 2014, research and development costs reimbursed from GSK were not material. For the three and nine months ended September 30, 2013, research and development costs reimbursed from GSK was $0.2 million and $0.5 million. Reimbursement of research and development costs from other collaborative arrangements has been reflected as discontinued operations in the condensed consolidated statements of operations. Refer to Notes 1, 10 and 11, “Description of Operations and Summary of Significant Accounting Policies,” “Spin-Off of Theravance Biopharma, Inc.” and “Discontinued Operations” for further information.

 

4. Available-for-Sale Securities and Fair Value Measurements

 

Available-for Sale Securities

 

The classification of available-for-sale securities in the consolidated balance sheets is as follows:

 

(In thousands)		September 30, 2014			December 31, 2013
Cash and cash equivalents		$	119,022		$	125,009
Short-term marketable securities		143,536			321,615
Marketable securities		47,752			55,374
Restricted cash		6,433			833
Total		$	316,743		$	502,831

 

The estimated fair value of available-for-sales securities is based on quoted market prices for these or similar investments that were based on prices obtained from a commercial pricing service. Available-for-sale securities are summarized below:

 

		September 30, 2014
(In thousands)		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Estimated Fair Value
U.S. government securities		$	33,526		$	39		$	(1	)	$	33,564
U.S. government agencies		43,611			9			(6		)	43,614
U.S. corporate notes		59,644			9			(46		)	59,607
U.S. commercial paper		44,434			—			—			44,434
Equity securities		10,269			—			(201		)	10,068
Money market funds		125,456			—			—			125,456
Total		$	316,940		$	57		$	(254	)	$	316,743

 

14

 

		December 31, 2013
(In thousands)		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Estimated Fair Value
U.S. government securities		$	42,104		$	55		$	(1	)	$	42,158
U.S. government agencies		141,278			61			(8		)	141,331
U.S. corporate notes		94,923			54			—			94,977
U.S. commercial paper		102,021			2			(1		)	102,022
Money market funds		122,343			—			—			122,343
Total		$	502,669		$	172		$	(10	)	$	502,831

 

Equity securities consist of ordinary shares of Theravance Biopharma owned by us as of September 30, 2014. These equity securities are restricted securities and can only be resold pursuant to a registration statement or an exemption from registration under the Securities Act of 1933, as amended (the “Securities Act”).  We expect to be able to sell these shares pursuant to Rule 144 promulgated under the Securities Act after the satisfaction of a six-month holding period and, therefore, have classified them as available-for-sale marketable securities.

 

At September 30, 2014, all of the available-for-sale securities had contractual maturities within two years and the average duration of debt securities was approximately eight months. We do not intend to sell the investments that are 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 at September 30, 2014 were temporary in nature. All marketable securities with unrealized losses at September 30, 2014 have been in a loss position for less than twelve months.

 

During the nine months ended September 30, 2014 and 2013, we sold marketable securities totaling $5.0 million and $22.6 million, and the related realized gains and losses were not significant in any of these periods.

 

Fair Value Measurements

 

Our available-for-sale securities are measured at fair value on a recurring basis and our debt is carried at the amortized cost basis. The estimated fair values were as follows:

 

		Estimated Fair Value Measurements at Reporting Date Using:
Types of Instruments		Quoted Prices in Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
(In thousands)		Level 1			Level 2			Level 3			Total
Assets at September 30, 2014:
U.S. government securities		$	33,564		$	—		$	—		$	33,564
U.S. government agency securities		—			43,614			—			43,614
U.S. corporate notes		—			59,607			—			59,607
U.S. commercial paper		—			44,434			—			44,434
Equity securities		10,068			—			—			10,068
Money market funds		125,456			—			—			125,456
Total assets measured at estimated fair value		$	169,088		$	147,655		$	—		$	316,743
Liabilities at September 30, 2014:
Convertible subordinated notes due 2023		$	—		$	239,339		$	—		$	239,339
Non-recourse notes due 2029		—			454,500			—			454,500
Total fair value of liabilities		$	—		$	693,839		$	—		$	693,839

 

15

 

		Estimated Fair Value Measurements at Reporting Date Using
Types of Instruments		Quoted Prices in Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
(In thousands)		Level 1			Level 2			Level 3			Total
Assets at December 31, 2013:
U.S. government securities		$	42,158		$	—		$	—		$	42,158
U.S. government agency securities		98,236			43,095			—			141,331
U.S. corporate notes		61,591			33,386			—			94,977
U.S. commercial paper		3,499			98,523			—			102,022
Money market funds		122,343			—			—			122,343
Total assets measured at estimated fair value		$	327,827		$	175,004		$	—		$	502,831
Liabilities at December 31, 2013:
Convertible subordinated notes due 2023		$	—		$	408,250		$	—		$	408,250

 

At September 30, 2014, securities with a total fair value of $5.4 million were measured using Level 2 inputs in comparison to December 31, 2013, at which time the securities had a fair value of $5.4 million and were measured using Level 1 inputs.

 

5. Intangible Assets

 

Intangible assets, which consist of registrational and launch-related milestone fees paid or owed to GSK, were as follows:

 

		September 30, 2014
(In thousands)		Weighted Average Remaining Amortization Period (Years)		Gross Carrying Value			Accumulated Amortization			Net Carrying Value
FDA approval and launch of BREO® ELLIPTA® in the U.S.		16.0		$	60,000		$	(3,411	)	$	56,589
Minister of Health, Labor and Welfare (“MHLW”) approval and launch of RELVAR® ELLIPTA® in Japan		14.2		20,000			(1,111		)	18,889
European Commission approval and launch of RELVAR® ELLIPTA®		14.3		30,000			(1,500		)	28,500
FDA approval and launch of ANORO® ELLIPTA® in the U.S.		16.0		60,000			(1,565		)	58,435
European Commission approval and launch of ANORO® ELLIPTA®		14.9		30,000			(656		)	29,344
MHLW approval and launch of ANORO® ELLIPTA® in Japan		15.0		20,000			(111		)	19,889
Total intangible assets				$	220,000		$	(8,354	)	$	211,646

 

		December 31, 2013
(In thousands)		Weighted Average Remaining Amortization Period (Years)		Gross Carrying Value			Accumulated Amortization			Net Carrying Value
FDA approval and launch of BREO® ELLIPTA® in the U.S.		15.7		$	60,000		$	(632	)	$	59,368
MHLW approval and launch of RELVAR® ELLIPTA® in Japan		14.9		20,000			(111		)	19,889
European Commission approval of RELVAR® ELLIPTA®		15.0		15,000			—			15,000
FDA approval of ANORO® ELLIPTA® in the U.S.		15.2		30,000			—			30,000
Total intangible assets				$	125,000		$	(743	)	$	124,257

 

These milestone fees are being amortized over their estimated useful lives commencing upon the commercial launch of the product in their respective regions with the amortization expense recorded as a reduction in revenue from collaborative arrangements. Additional information regarding these milestone fees is included in Note 3, “Collaborative Arrangements.” Amortization expense for the three months and nine months ended September 30, 2014 was $3.2 million and $7.6 million. The amortization expense for the same periods in 2013 is zero. The remaining estimated amortization expense of intangible assets is $3.5 million for 2014, $13.8 million for each of the years from 2015 to 2018 and $152.9 million thereafter.

 

16

 

6. Stock-Based Compensation

 

Equity Incentive Plan

 

The 2012 Equity Incentive Plan (“2012 Plan”) provides for the grant of stock options, time-based and performance-contingent restricted stock units (“RSUs”), time-based and performance-contingent RSAs, and stock appreciation rights to employees, non-employee directors and consultants. As of September 30, 2014, total shares remaining available for issuance under the 2012 Plan were 2,961,225.

 

Performance-Contingent RSAs

 

Over the past three years, the Compensation Committee of our Board of Directors (the “Compensation Committee”) has approved grants of performance-contingent RSAs to senior management and a non-executive officer. Generally, these awards have dual triggers of vesting based upon the achievement of certain performance goals by a pre-specified date, as well as a requirement for continued employment. When the performance goals are probable of achievement for these types of awards, time-based vesting and, as a result, recognition of stock-based compensation expense commence. Included in these performance-contingent RSAs is the grant of 1,290,000 special long-term retention and incentive performance-contingent RSAs to senior management in 2011. The awards have dual triggers of vesting based upon the achievement of certain performance conditions over a six-year timeframe from 2011 through December 31, 2016 and require continued employment.

 

As of March 31, 2014, we determined that the achievement of the requisite performance conditions for vesting of the first tranche of these awards was probable and, as a result, $6.8 million of the total stock-based compensation expense was recognized in the first quarter of 2014. The total stock-based compensation expense of $7.0 million for the first tranche was recognized through May 2014.

 

In May 2014, our Compensation Committee approved the modification of the remaining tranches related to these awards contingent upon the Spin-Off as the performance conditions associated with these awards were unlikely to be consistent with the new strategies of each company following the separation. The modification acknowledged the Spin-Off and permitted recognition of achievement of the original performance conditions that were met prior to the Spin-Off, triggering service-based vesting for a portion of the equity awards, for which $3.8 million is expected to be recognized by us during the twelve-month period that commenced in June 2014. The remaining 63,000 RSAs outstanding under this equity award remain subject to performance and service conditions.  In addition, the remaining RSAs outstanding under these awards are entitled to the pro rata dividend distribution made by Theravance on June 2, 2014 of one ordinary share of Theravance Biopharma for every three and one half shares of Theravance common stock, which will also be subject to the same performance and service conditions as the RSAs.

 

Stock-Based Compensation Expense

 

In connection with the Spin-Off of Theravance Biopharma, all outstanding shares of Theravance Biopharma were distributed to our stockholders as a pro-rata dividend distribution on June 2, 2014 by issuing one share of Theravance Biopharma common stock for every 3.5 shares held of Theravance common stock to stockholders of record on May 15, 2014. Outstanding stock options and RSUs that were not eligible for the dividend distribution were adjusted for the Spin-Off of Theravance Biopharma. The number of shares and exercise price for all outstanding stock options were adjusted and the number of shares for all outstanding RSUs was adjusted. All other terms of these grants remain the same; provided, however, that the vesting and expiration of these grants are based on the holder’s continuing employment or service with us or Theravance Biopharma, as applicable.

 

Although the anti-dilution adjustments were required pursuant to the terms of each stock plan, the anti-dilution adjustments were calculated using a volume-weighted average stock price, rather than the stock price as of the date of the dividend distribution, which resulted in incremental compensation expense. The accounting impact of the adjustment to the outstanding stock options and RSUs that occurred in connection with the Spin-Off of Theravance Biopharma was measured by comparing of the fair values of the modified stock options and RSUs to our employees and directors immediately before and after the adjustment. As a result, we recognized incremental stock-based compensation expense of $1.2 million in the second quarter of 2014, of which $0.9 million is included in discontinued operations. All remaining unrecognized stock-based compensation expense associated with this adjustment will be recognized by Theravance Biopharma as it pertains to stock options and RSUs held by individuals now employed by Theravance Biopharma or one if its affiliates.

 

17