Innoviva, Inc. - Quarter Report: 2018 March (Form 10-Q)

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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 March 31, 2018

 

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

 

INNOVIVA, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

2000 Sierra Point Parkway, Suite 500

Brisbane, CA 94005

(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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

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

 

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. o

 

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 April 30, 2018 was 101,470,190.

 

 

Table of Contents

 

TABLE OF CONTENTS

 

PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2018 and December 31, 2017	3
Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2018 and 2017	4
Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2018 and 2017	5
Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2018 and 2017	6
Notes to Condensed Consolidated Financial Statements	7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	15
Item 3. Quantitative and Qualitative Disclosures About Market Risk	21
Item 4. Controls and Procedures	21
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	22
Item 1A. Risk Factors	22
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	38
Item 6. Exhibits	39
Signatures	40
Exhibits

 

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PART I — FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

INNOVIVA, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

 

		March 31,			December 31,
		2018			2017
		(unaudited)			*
Assets
Current assets:
Cash and cash equivalents		$	27,138		$	73,336
Short-term marketable securities		29,322			55,739
Related party receivables from collaborative arrangements		55,835			70,540
Prepaid expenses and other current assets		950			754
Total current assets		113,245			200,369
Property and equipment, net		197			209
Capitalized fees paid to a related party, net		163,266			166,722
Other assets		37			37
Total assets		$	276,745		$	367,337
Liabilities and Stockholders’ Deficit
Current liabilities:
Accounts payable		$	66		$	601
Accrued personnel-related expenses		537			1,721
Accrued interest payable		2,545			5,920
Other accrued liabilities		918			1,500
Current portion of long-term debt		—			25,000
Total current liabilities		4,066			34,742
Long-term debt, net of current portion, discount and issuance costs		484,591			574,362
Other long-term liabilities		835			940
Commitments and contingencies
Stockholders’ deficit:
Preferred stock: $0.01 par value, 230 shares authorized, no shares issued and outstanding		—			—
Common stock: $0.01 par value, 200,000 shares authorized, 101,475 and 102,046 shares issued as of March 31, 2018 and December 31, 2017, respectively		1,014			1,019
Treasury stock: 150 shares as of March 31, 2018 and December 31, 2017		(3,263		)	(3,263		)
Additional paid-in capital		1,257,880			1,258,151
Accumulated other comprehensive loss		(22		)	(18		)
Accumulated deficit		(1,469,167		)	(1,498,748		)
Total Innoviva stockholders’ deficit		(213,558		)	(242,859		)
Noncontrolling interest		811			152
Total stockholders’ deficit		(212,747		)	(242,707		)
Total liabilities and stockholders’ deficit		$	276,745		$	367,337

 

See accompanying notes to condensed consolidated financial statements.

 

*Condensed consolidated balance sheet as of December 31, 2017 has been derived from audited consolidated financial statements.

 

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INNOVIVA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

		Three Months Ended
		March 31,
		2018			2017
Royalty revenue from a related party, net of amortization of capitalized fees paid to a related party of $3,456 in the three months ended March 31, 2018 and 2017		$	52,380		$	40,271
Revenue from collaborative arrangements from a related party		—			221
Total net revenue		52,380			40,492
Operating expenses:
Research and development		—			354
General and administrative		8,985			10,795
General and administrative - related party		2,700			—
Total operating expenses		11,685			11,149
Income from operations		40,695			29,343
Other (expense) income, net		(3,099		)	47
Interest income		391			236
Interest expense		(7,657		)	(12,781		)
Net income		30,330			16,845
Net income attributable to noncontrolling interest		749			—
Net income attributable to Innoviva stockholders		$	29,581		$	16,845
Basic net income per share attributable to Innoviva stockholders		$	0.29		$	0.16
Diluted net income per share attributable to Innoviva stockholders		$	0.27		$	0.15
Shares used to compute Innoviva basic and diluted net income per share:
Shares used to compute basic net income per share		100,604			107,487
Shares used to compute diluted net income per share		113,566			120,336

 

See accompanying notes to condensed consolidated financial statements.

 

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INNOVIVA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

 

		Three Months Ended March 31,
		2018			2017
Net income		$	30,330		$	16,845
Unrealized loss on marketable securities, net		(4		)	(2		)
Comprehensive income		30,326			16,843
Comprehensive income attributable to noncontrolling interest		749			—
Comprehensive income attributable to Innoviva stockholders		$	29,577		$	16,843

 

See accompanying notes to condensed consolidated financial statements.

 

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INNOVIVA, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

		Three Months Ended March 31,
		2018			2017
Cash flows from operating activities
Net income		$	30,330		$	16,845
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		3,468			3,496
Stock-based compensation		2,169			2,507
Amortization of debt discount and issuance costs		2,092			687
Loss on extinguishment of debt		3,137			—
Amortization of premium (discount) on short-term investments		(100		)	17
Amortization of lease guarantee		(81		)	(81		)
Changes in operating assets and liabilities:
Receivables from collaborative arrangements		14,705			3,120
Prepaid expenses and other current assets		(196		)	(114		)
Accounts payable		(535		)	2,176
Accrued personnel-related expenses and other accrued liabilities		(1,702		)	752
Accrued interest payable		(3,375		)	(1,428		)
Other long-term liabilities		2			5
Deferred revenue		—			(221		)
Net cash provided by operating activities		49,914			27,761
Cash flows from investing activities
Maturities of marketable securities		31,875			26,387
Purchases of marketable securities		(5,362		)	(3,992		)
Net cash provided by investing activities		26,513			22,395
Cash flows from financing activities
Repurchase of shares to satisfy tax withholding		(2,611		)	(553		)
Payments of principal on senior secured term loans		(120,000		)	—
Payments of cash dividends to stockholders		(38		)	(67		)
Proceeds from issuances of common stock, net		114			8
Payment of principal on non-recourse notes due 2029		—			(7,752		)
Distributions to noncontrolling interest		(90		)	—
Net cash used in financing activities		(122,625		)	(8,364		)
Net (decrease) increase in cash and cash equivalents		(46,198		)	41,792
Cash and cash equivalents at beginning of period		73,336			118,016
Cash and cash equivalents at end of period		$	27,138		$	159,808
Supplemental disclosure of cash flow information
Cash paid for interest		$	8,941		$	13,522

 

See accompanying notes to condensed consolidated financial statements.

 

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INNOVIVA, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. Description of Operations and Summary of Significant Accounting Policies

 

Description of Operations

 

Innoviva, Inc. (referred to as “Innoviva”, the “Company”, or “we” and other similar pronouns) is focused on royalty management. Innoviva’s portfolio includes the respiratory assets partnered with Glaxo Group Limited (“GSK”), including RELVAR®/BREO®ELLIPTA® (fluticasone furoate/ vilanterol, “FF/VI”), ANORO® ELLIPTA®(umeclidinium bromide/ vilanterol, “UMEC/VI”) and TRELEGY® ELLIPTA® (the combination FF/UMEC/VI). Under the Long-Acting Beta2 Agonist (“LABA”) Collaboration Agreement, Innoviva is eligible to receive the associated royalty revenues from RELVAR®/BREO® ELLIPTA® and ANORO® ELLIPTA®. Innoviva is also entitled to 15% of royalty payments made by GSK under its agreements originally entered into with us, and since assigned to Theravance Respiratory Company, LLC (“TRC”), relating to TRELEGY® ELLIPTA® and any other product or combination of products that may be discovered and developed in the future under the LABA Collaboration Agreement and the Strategic Alliance Agreement with GSK (referred to herein as the “GSK Agreements”), which have been assigned to TRC other than RELVAR®/BREO® ELLIPTA® and ANORO® ELLIPTA®.

 

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. 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 income and cash flows. The interim results are not necessarily indicative of the results of operations to be expected for the year ending December 31, 2018 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 our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the Securities and Exchange Commission (“SEC”) on February 23, 2018.

 

Variable Interest Entity

 

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.

 

Accounting Pronouncement Adopted by the Company

 

In April 2016, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) 2016-10 to clarify the implementation guidance on licensing and the identification of performance obligations consideration included in ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which is also known as ASC 606, was issued in May 2014 and outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. In March 2016, the FASB issued ASU 2016-08 to provide amendments to clarify the implementation guidance on principal versus agent considerations. We implemented the standard on the effective date of January 1, 2018 on a modified retrospective basis to contracts which were not completed as of this date. Adoption of this standard did not have a material impact on our consolidated financial statements as we did not have any unrecognized transaction price, other than sales-based royalty revenue, or any remaining performance obligations under our collaboration agreements. We continue to recognize royalty revenue when it is earned.

 

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Recently Issued Accounting Pronouncement Not Yet Adopted

 

In February 2016, the FASB issued ASU 2016-02, Leases, which supersedes the lease recognition requirements in ASC Topic 840, Leases. The standard requires an entity to recognize right-of-use assets and lease liabilities arising from a lease for both financing and operating leases in the consolidated balance sheets but recognize the impact on the consolidated statement of operations and cash flows in a similar manner under current GAAP. The standard also requires additional qualitative and quantitative disclosures. The standard is effective for us at the beginning January 1, 2019 and requires transition under a modified retrospective method. The most significant impact of the update to us is that we will be required to recognize a “right-of-use” asset and lease liability for the operating lease agreement that was not previously included on the balance sheet under the existing lease guidance. We anticipate that the treatment of the lease on our consolidated statement of operations and cash flows will not materially be affected by the adoption of the new standard.

 

2. Net Income Per Share

 

Basic net income per share attributable to Innoviva stockholders is computed by dividing net income attributable to Innoviva stockholders by the weighted-average number of shares of common stock outstanding. Diluted net income per share attributable to Innoviva stockholders is computed by dividing net income attributable to Innoviva stockholders by the weighted-average number of shares of common stock and dilutive potential common stock equivalents then outstanding. Dilutive potential common stock equivalents include the assumed exercise, vesting and issuance of employee stock awards using the treasury stock method, as well as common stock issuable upon assumed conversion of our convertible subordinated notes due 2023 (the “2023 Notes”) using the if-converted method.

 

Our convertible senior notes due 2025 (the “2025 Notes”) are convertible, based on the applicable conversion rate, into cash, shares of our common stock or a combination thereof, at our election. Our current intent is to settle the principal amount of the 2025 Notes in cash upon conversion. The impact of the assumed conversion premium to diluted net income per share is computed using the treasury stock method. As the average market price per share of our common stock as reported on The Nasdaq Global Select Market was lower than the initial conversion price of $17.26 per share, there was no dilutive effect of the assumed conversion premium for the three months ended March 31, 2018.

 

The following table shows the computation of basic and diluted net income per share for the three months ended March 31, 2018 and 2017:

 

		Three Months Ended March 31,
(In thousands except per share data)		2018			2017
Numerator:
Net income attributable to Innoviva stockholders, basic		$	29,581		$	16,845
Add: interest expense on 2023 Notes		1,412			1,407
Net income attributable to Innoviva stockholders, diluted		$	30,993		$	18,252
Denominator:
Weighted-average shares used to compute basic net income per share attributable to Innoviva stockholders		100,604			107,487
Dilutive effect of 2023 Notes		12,189			12,189
Dilutive effect of options and awards granted under equity incentive plan and employee stock purchase plan		773			660
Weighted-average shares used to compute diluted net income per share attributable to Innoviva stockholders		113,566			120,336
Net income per share attributable to Innoviva stockholders
Basic		$	0.29		$	0.16
Diluted		$	0.27		$	0.15

 

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Anti-Dilutive Securities

 

The following common stock equivalents were not included in the computation of diluted net income per share because their effect was anti-dilutive:

 

		Three Months Ended March 31,
(In thousands)		2018		2017
Outstanding options and awards granted under equity incentive plan and employee stock purchase plan		1,492		3,062

 

3. Revenue Recognition and Collaborative Arrangements

 

In May 2014, the FASB issued a new comprehensive revenue recognition standard, ASC 606. We adopted this standard on January 1, 2018 on a modified prospective basis. Under the new guidance, revenue is recognized when our customer obtains control of promised goods or services, in an amount that reflects the consideration which we expect to receive in exchange for those goods or services. Revenue is recognized through a five-step process: (i) identify the contract with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price for the contract; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) a performance obligation is satisfied.

 

Adoption of this standard did not have an impact on the method in which we account for royalties, our main source of revenue. We continue to recognize the 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. Royalties are recognized net of amortization of capitalized fees associated with any approval and launch milestone payments made to GSK.

 

Net Revenue from Collaborative Arrangements

 

Net revenue recognized under our GSK Agreements was as follows:

 

		Three Months Ended March 31,
(In thousands)		2018			2017
Royalties from a related party - RELVAR/BREO		$	46,160		$	38,689
Royalties from a related party - ANORO		8,724			5,038
Royalties from a related party - TRELEGY		952			—
Total royalties from a related party		55,836			43,727
Less: amortization of capitalized fees paid to a related party		(3,456		)	(3,456		)
Royalty revenue		52,380			40,271
Strategic alliance - MABA program license		—			221
Total net revenue from GSK		$	52,380		$	40,492

 

LABA Collaboration

 

As a result of the launch and approval of RELVAR®/BREO® ELLIPTA® and ANORO® ELLIPTA® in the U.S., Japan and Europe, we paid milestone fees to GSK totaling $220.0 million during the year ended December 31, 2014. Although we have no further milestone payment obligations to GSK pursuant to the LABA Collaboration Agreement, we continue to have ongoing participation as part of the collaboration, including joint steering and joint project committees that are expected to continue over the life of the agreement. The milestone fees paid to GSK were recognized as capitalized fees paid to a related party, which are being amortized over their estimated useful lives commencing upon the commercial launch of the product. The amortization expense is recorded as a reduction to the royalties from GSK.

 

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®, which royalties are upward tiering and range from 6.5% to 10%.

 

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We are also entitled to 15% of any future royalty payments made by GSK under its agreements originally entered into with us, and since assigned to TRC, including TRELEGY® ELLIPTA®, which royalties are upward tiering and range from 6.5% to 10%

 

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

 

Available-for-Sale Securities

 

The estimated fair value of available-for-sale 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:

 

		March 31, 2018
(In thousands)		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Estimated Fair Value
U.S. government securities		$	9,978		$	—		$	(3	)	$	9,975
U.S. corporate notes		11,884			—			(19		)	11,865
U.S. commercial paper		12,476			—			—			12,476
Money market funds		17,118			—			—			17,118
Total		$	51,456		$	—		$	(22	)	$	51,434

 

		December 31, 2017
(In thousands)		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Estimated Fair Value
U.S. government securities		$	9,943		$	—		$	(1	)	$	9,942
U.S. government agencies		9,987			—			(2		)	9,985
U.S. corporate notes		10,881			—			(15		)	10,866
U.S. commercial papers		29,945			—			—			29,945
Money market funds		61,971			—			—			61,971
Total		$	122,727		$	—		$	(18	)	$	122,709

 

As of March 31, 2018, all of the available-for-sale securities had contractual maturities within one year and the weighted average maturity of marketable securities was approximately two months.

 

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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:

 

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		Estimated Fair Value Measurements as of March 31, 2018 Using:
Types of Instruments		Quoted Price in Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
(In thousands)		Level 1			Level 2			Level 3			Total
Assets
U.S. government securities		$	—		$	9,975		$	—		$	9,975
U.S. corporate notes		—			11,865			—			11,865
U.S. commercial paper		—			12,476			—			12,476
Money market funds		17,118			—			—			17,118
Total assets measured at estimated fair value		$	17,118		$	34,316		$	—		$	51,434
Liabilities
Term B Loan		$	—		$	123,750		$	—		$	123,750
2023 Notes		—			259,058			—			259,058
2025 Notes		—			223,106			—			223,106
Total fair value of liabilities		$	—		$	605,914		$	—		$	605,914

 

		Estimated Fair Value Measurements as of December 31, 2017 Using:
Types of Instruments		Quoted Price in Active Markets for Identical Assets			Significant Other Observable Inputs			Significant Unobservable Inputs
(In thousands)		Level 1			Level 2			Level 3			Total
Assets
U.S. government securities		$	—		$	9,942		$	—		$	9,942
U.S. government agencies		—			9,985			—			9,985
U.S. corporate notes		—			10,866			—			10,866
U.S. commercial papers		—			29,945			—			29,945
Money market funds		61,971			—			—			61,971
Total assets measured at estimated fair value		$	61,971		$	60,738		$	—		$	122,709
Liabilities
Term B Loan		$	—		$	243,750		$	—		$	243,750
2023 Notes		—			241,259			—			241,259
2025 Notes		—			205,975			—			205,975
Total fair value of liabilities		$	—		$	690,984		$	—		$	690,984

 

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.

 

The fair value of our 2023 Notes and of our 2025 Notes is based on recent trading prices of the instruments. The carrying amount of our initial senior secured term loan (the “Term B Loan”) before deducting debt issuance costs approximates fair value as the loan carries a variable interest rate that is tied to the LIBOR rate plus an applicable spread.

 

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5. Stock-Based Compensation

 

Performance-Contingent RSAs and RSUs

 

Since 2011, the Compensation Committee of our Board of Directors (the “Compensation Committee”) have approved grants of performance-contingent RSAs and RSUs 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. Recognition of stock-based compensation expense begins when the performance goals are deemed probable of achievement.

 

Included in these performance-contingent RSAs was the remaining grant of 63,000 special long-term retention and incentive performance-contingent RSAs to senior management in 2011. The awards had dual triggers of vesting based upon the achievement of certain performance conditions over a six-year timeframe from 2011 through December 31, 2016 and required continued service to the Company. During the year ended December 31, 2016, we determined that the achievement of the requisite performance conditions was met. These awards were released in November 2017 upon vesting.

 

Market-Based RSAs and RSUs

 

2016 Market-Based RSAs and RSUs

 

On January 14, 2016, the Compensation Committee approved and granted 282,394 RSAs and 46,294 RSUs to senior management. These awards include a market condition based on Total Shareholder Return (“TSR”) and a service condition that requires continued employment, collectively the “Performance Measures I”. The vesting percentages of these awards are calculated based on the two-year TSR with a catch-up provision opportunity measured on January 13, 2019 for RSAs and on September 30, 2018 for RSUs. Two-thirds of amounts earned at the end of year two would vest and be distributed on February 20, 2018, while the final one-third earned after two years as well as the catch-up amount earned will vest and be distributed on February 20, 2019 for RSAs and November 20, 2018 for RSUs. The actual payout of shares may range from a minimum of zero shares to a maximum of 328,688 shares granted upon the actual performance against the Performance Measures I. The grant date fair value of these awards was determined using a Monte Carlo valuation model. The aggregate value of $2.0 million is recognized as compensation expense over the implied service period and will not be reversed if the market condition is not met, but with the exception of such person’s continued employment with the Company.

 

In February 2018, the Compensation Committee certified the maximum achievement of the TSR as of the first measurement date, January 12, 2018. 69,440 RSAs and 30,862 RSUs representing two-thirds of the amounts were released on February 20, 2018, and the remaining 34,720 RSAs and 15,432 RSUs will vest on February 20, 2019 subject to each eligible person’s continued employment with the Company. Additionally, in connection with certain members of senior management’s separation from the Company in early February 2018, the Board agreed to accelerate the vesting and distribution of an aggregate of 118,821 RSAs to these members of senior management. The remaining 59,411 RSAs for these members of senior management were forfeited. As a net result of the vesting acceleration of the RSAs and the forfeiture of those unvested RSAs, an additional $0.7 million compensation expense was recognized during the three months ended March 31, 2018.

 

2017 Market-Based RSAs and RSUs

 

On January 17, 2017, the Compensation Committee approved and granted 353,508 RSAs and 53,360 RSUs to senior management. These awards include a market condition based on the TSR of Innoviva’s common stock as compared to the TSR of NASDAQ Biotechnology Index (“Index”) and a service condition that requires continued employment, collectively the “Performance Measures II”. The vesting percentages of these awards are calculated based on the two-year performance period with a catch-up provision opportunity measured on December 31, 2019 for RSAs and on September 30, 2019 for RSUs. Two-thirds of amounts earned at the end of year two will vest and be distributed on February 20, 2019, while the final one-third earned after two years as well as the catch-up amount earned will vest and be distributed on February 20, 2020 for RSAs and November 20, 2019 for RSUs. The actual payout of shares may range from a minimum of zero shares to a maximum of 406,868 shares granted upon the actual performance against the Performance Measures II. The grant date fair value of these awards is determined using a Monte Carlo valuation model. The aggregate value of $3.2 million is recognized as compensation expense over the implied service period and will not be reversed if the market condition is not met, but with the exception of such person’s continued employment with the Company.

 

In connection with certain members of senior management’s separation from the Company mentioned above, an aggregate of 233,448 RSAs for these members of senior management were forfeited, and $0.8 million of previously recognized compensation expense was reversed during the three months ended March 31, 2018.

 

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2018 Market-Based RSAs and RSUs

 

On March 2, 2018, the Compensation Committee approved and granted 111,668 RSAs and 49,630 RSUs to senior management. These awards include a market condition based on the TSR of Innoviva’s common stock over a three-year performance period from the date of grant for the RSAs and from the date of grant until September 30, 2020 for RSUs, and a service condition that requires continued employment, collectively the “Performance Measures III”. The actual payout of shares may range from a minimum of zero shares to a maximum of 161,298 shares granted upon the actual performance against the Performance Measures III. The grant date fair value of these awards was determined using a Monte Carlo valuation model. The aggregate value of $1.7 million is recognized as compensation expense over the implied service period and will not be reversed if the market condition is not met, but with the exception of such person’s continued employment with the Company.

 

Stock-Based Compensation Expense

 

Stock-based compensation expense is included in the condensed consolidated statements of operations as follows:

 

		Three Months Ended March 31,
(In thousands)		2018			2017
Research and development		$	—		$	178
General and administrative		2,169			2,329
Total stock-based compensation expense		$	2,169		$	2,507

 

As of March 31, 2018, unrecognized stock-based compensation cost, including performance-contingent RSAs for which the performance milestones were determined to be probable of achievement, was as follows:

 

(In thousands)		Unrecognized Compensation Cost
Stock options		$	157
RSUs		1,657
RSAs		4,068
Market-based RSUs		728
Market-based RSAs		1,705
Total unrecognized compensation cost		$	8,315

 

6. Debt

 

Our debt consists of:

 

		March 31,			December 31,
(In thousands)		2018			2017
Senior secured term loans		$	123,750		$	243,750
Convertible subordinated notes due 2023		240,984			240,984
Convertible senior notes due 2025		192,500			192,500
Total debt		557,234			677,234
Unamortized debt discount and issuance costs		(72,643		)	(77,872		)
Current portion of senior secured term loan		—			(25,000		)
Net long-term debt		$	484,591		$	574,362

 

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Prepayment of Senior Secured Term Loans

 

On February 28, 2018, we paid down the principal balance of the Term B Loan by $120.0 million. With the prepayment, we incurred a loss on the extinguishment of debt of $3.1 million representing unamortized debt issuance costs. The loss on the extinguishment of debt is presented as part of other income (expense), net in our consolidated statements of operations. As of March 31, 2018, the outstanding principal balance of the Term B Loan was reduced to $123.8 million.

 

Convertible Senior Notes Due 2025

 

In accordance with accounting guidance for debt with conversion and other options, we separately account for the liability and equity components of the 2025 Notes by allocating the proceeds between the liability component and the embedded conversion option (“equity component”) due to our ability to settle the conversion obligation of the 2025 Notes in cash, common stock or a combination of cash and common stock, at our option. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature using the income approach. The allocation was performed in a manner that reflected our non-convertible debt borrowing rate for similar debt. The equity component of the 2025 Notes was recognized as a debt discount and represents the difference between the proceeds from the issuance of the 2025 Notes and the fair value of the liability of the 2025 Notes on the date of issuance. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) is amortized to interest expense using the effective interest method. The equity component is not re-measured as long as it continues to meet the conditions for equity classification.

 

Our outstanding 2025 Notes balances as March 31, 2018, consisted of the following:

 

(In thousands)
Liability component
Principal		$	192,500
Debt discount and issuance costs, net		(66,740		)
Net carrying amount		$	125,760
Equity component, net		$	65,361

 

In connection with the issuance of the 2025 Notes, we incurred approximately $5.4 million of debt issuance costs, which primarily consisted of placement, legal and other professional fees, and allocated these costs to the liability and equity components based on the allocation of the proceeds. Of the total $5.4 million of debt issuance costs, $1.9 million were allocated to the equity component and recorded as a reduction to additional paid-in capital and $3.5 million were allocated to the liability component and recorded as a reduction to the carrying amount of the liability component on the consolidated balance sheet. The portion allocated to the liability component is amortized to interest expense over the expected life of the 2025 Notes using the effective interest method.

 

The following table sets forth total interest expense recognized related to the 2025 Notes for the three months ended March 31, 2018:

 

(In thousands)
Contractual interest expense		$	1,190
Amortization of debt issuance costs		123
Amortization of debt discount		1,479
Total interest and amortization expense		$	2,792

 

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Debt Maturities

 

The aggregate scheduled maturities of our long-term debt as of March 31, 2018, are as follows:

 

(In thousands)
Years ending December 31:
2018 to 2021		$	—
2022		123,750
Thereafter		433,484
Total		$	557,234

 

7. Related Party Transaction

 

On February 12, 2018, the Company entered into an agreement with Sarissa Capital Management LP, and certain of its affiliates (collectively, the “Sarissa Group”) related to the Company’s 2018 Annual Meeting of Stockholders (the “2018 Annual Meeting”). The agreement provided for, among other things, the concurrent appointment of three designees of the Sarissa Group as members of the Company’s Board of Directors and an agreement to recommend and nominate a five-person slate of directors for election at the 2018 Annual Meeting composed of the three new directors and two current directors of the Company and partially reimburse the Sarissa Group $2.7 million for expenses, which reimbursement obligation relating to the 2018 Annual Meeting arose upon execution of the agreement. The Sarissa Group is considered to be a related party due to its representation on the Board of Directors.

 

8. Income Taxes

 

The effective tax rate for the three months ended March 31, 2018 was minimal, compared to 0.1% for the same period in 2017. Should we continue to generate taxable income in 2018, we expect that the taxable income will be substantially offset by the utilization of net operating losses or other deferred tax assets. The difference between the consolidated effective income tax rate and the U.S. federal statutory rate is primarily attributable to a change in valuation allowance against net deferred tax assets.

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Forward-Looking Statements

 

The information in this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements involve substantial risks, uncertainties and assumptions. All statements contained herein that are not of historical fact, including, without limitation, statements regarding our strategy, future operations, future financial position, future revenue, projected costs, prospects, plans, intentions, expectations, goals and objectives, may be forward-looking statements. The words “anticipates,” “believes,” “could,” “designed,” “estimates,” “expects,” “goal,” “intends,” “may,” “objective,” “plans,” “projects,” “pursue,” “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. 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. All written and verbal forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. Important factors that we believe could cause actual results or events to differ materially from our forward-looking statements include, but are not limited to, risks related to: lower than expected future royalty revenue from respiratory products partnered with GSK, the commercialization of RELVAR®/BREO® ELLIPTA®, ANORO® ELLIPTA® and TRELEGY® ELLIPTA® in the jurisdictions in which these products have been approved; the strategies, plans and objectives of the company (including the company’s growth strategy and corporate development initiatives beyond the existing respiratory portfolio); the timing, manner, amount and planned growth of anticipated potential capital returns to stockholders (including, without limitation, statements regarding the company’s expectations of future purchases under its future share repurchase authorizations and future cash dividends); the status and timing of clinical studies, data analysis and communication of results; the potential benefits and mechanisms of action of product candidates; expectations for product candidates through development and commercialization; the timing of regulatory approval of product candidates; projections of revenue, expenses and other financial items and risks discussed below in “Risk Factors” in Item 1A of Part II and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in this Item 2 of Part I. All forward-looking statements in this document are based on information available to us as of the date hereof and we assume no obligation to update any such forward-looking statements on account of new information, future events or otherwise, except as required by law.

 

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We encourage you to read our consolidated financial statements contained in this Quarterly Report on Form 10-Q. We also encourage you to read Item 1A of Part II of this Quarterly Report on Form 10-Q, entitled “Risk Factors,” which contains a more complete discussion of the risks and uncertainties associated with our business. In addition to the risks described above and in Item 1A of Part II of this report, other unknown or unpredictable factors also could affect our results. Therefore, the information in this report should be read together with other reports and documents that we file with the Securities and Exchange Commission (SEC) from time to time, including on Form 10-Q and Form 8-K, which may supplement, modify, supersede or update those risk factors. As a result of these factors, we cannot assure you that the forward-looking statements in this report will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all.

 

OVERVIEW

 

Executive Summary

 

Innoviva, Inc. (“Innoviva”, the “Company” or “we”) is focused on the management of royalty revenues from RELVAR®/BREO® ELLIPTA® (fluticasone furoate/ vilanterol, “FF/VI”), ANORO® ELLIPTA® (umeclidinium bromide/ vilanterol, “UMEC/VI”) and TRELEGY® ELLIPTA® (the combination FF/UMEC/VI). Under the Long-Acting Beta2 Agonist (“LABA”) Collaboration Agreement, we are entitled to receive 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. and royalties from the sales of ANORO® ELLIPTA® tier upward at a range from 6.5% to 10%. Innoviva is also entitled to 15% of royalty payments made by GSK under its agreements originally entered into with us, and since assigned to Theravance Respiratory Company, LLC (“TRC”), including TRELEGY® ELLIPTA® and any other product or combination of products that may be discovered or developed in the future under the LABA Collaboration Agreement and the Strategic Alliance Agreement with GSK (referred to herein as the “GSK Agreements”), which have been assigned to TRC other than RELVAR®/BREO® ELLIPTA® and ANORO® ELLIPTA®.

 

Our company structure and organization are tailored to our focused activities of managing our respiratory assets with GSK, the commercial and developmental obligations associated with the GSK Agreements, intellectual property, licensing operations, business development activities and providing for certain essential reporting and management functions of a public company. As of March 31, 2018, we had nine employees. Our revenues consist of royalties from our respiratory partnership agreements with GSK.

 

Recent Highlights

 

·                  GSK Net Sales:

 

·                  First quarter 2018 net sales of RELVAR®/BREO® ELLIPTA® by GSK were $307.7 million, up 19% from $257.9 million in the first quarter of 2017, with $137.0 million in net sales from the U.S. market and $170.7 million from non-U.S. markets.

 

·                  First quarter 2018 net sales of ANORO® ELLIPTA® by GSK were $134.2 million, up 73% from $77.5 million in the first quarter of 2017, with $83.5 million net sales from the U.S. market and $50.7 million from non-U.S. markets.

 

·                  First quarter 2018 net sales of TRELEGY® ELLIPTA® by GSK were $14.6 million.

 

·                  Product Updates:

 

·                  Announced in March 2018 the positive European Commission approval for labelling update to RELVAR® ELLIPTA® in patients with asthma.

 

Collaborative Arrangements with GSK

 

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. The collaboration has developed three combination products: (1) RELVAR®/BREO® ELLIPTA® (FF/VI) (BREO® ELLIPTA® is the proprietary name in the U.S. and Canada and RELVAR® ELLIPTA® is the proprietary name outside the U.S. and Canada), a once-daily combination medicine consisting of a LABA, vilanterol (VI), and an inhaled corticosteroid (ICS), fluticasone furoate (FF), (2) ANORO® ELLIPTA® (UMEC/VI), a once-daily medicine combining a long-acting muscarinic antagonist (“LAMA”), umeclidinium bromide (UMEC), with a LABA, VI and (3) TRELEGY® ELLIPTA®, fluticasone furoate/umeclidinium/vilanterol (FF/UMEC/VI), a once-daily combination medicine consisting of an ICS, LAMA and LABA.

 

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As a result of the launch and approval of RELVAR®/BREO® ELLIPTA® and ANORO® ELLIPTA® in the U.S., Japan and Europe, in accordance with the LABA Collaboration Agreement, we paid milestone fees to GSK totaling $220.0 million during the year ended December 31, 2014. Although we have no further milestone payment obligations to GSK pursuant to the LABA Collaboration Agreement, we continue to have ongoing commercialization activities under the LABA Collaboration Agreement including participation on the joint steering committee and joint project committee that are expected to continue over the life of the agreement. The milestone fees paid to GSK were recognized as capitalized fees paid to a related party, which are being amortized over their estimated useful lives commencing upon the commercial launch of the products.

 

We are entitled to receive 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. 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%.

 

We are also entitled to 15% of royalty payments made by GSK under its agreements originally entered into with us, and since assigned to TRC, including TRELEGY® ELLIPTA®, which royalties are upward tiering and range from 6.5% to 10%.

 

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. 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 Innoviva-discovered preclinical MABA compounds (the “Additional MABAs”). The development program has been funded in full by GSK and is in Phase II clinical studies stage. GSK is in the process of determining next steps for the program. For a detailed discussion of our alliance with GSK, see Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC on February 23, 2018.

 

Critical Accounting Policies and Estimates

 

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements, as well as the reported revenue generated and expenses incurred during the reporting periods. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

In May 2014, the FASB issued a new comprehensive revenue recognition standard, ASC 606. We adopted this standard on January 1, 2018 on a modified prospective basis. Under the new guidance, revenue is recognized when our customer obtains control of promised goods or services, in an amount that reflects the consideration which we expect to receive in exchange for those goods or services. Revenue is recognized through a five-step process: (i) identify the contract with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price for the contract; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) a performance obligation is satisfied.

 

The adoption of ASC 606 did not have a material impact on our consolidated financial statements as we do not have any unrecognized transaction price, other than sales-based royalty revenue, or any remaining performance obligations under our collaboration agreements. We continue to recognize the 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. Royalties are recognized net of amortization of capitalized fees associated with any approval and launch milestone payments made to GSK.

 

There were no other significant changes to our critical accounting policies and estimates. Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2017 filed with the SEC on February 23, 2018 provides a more complete discussion of our critical accounting policies and estimates.

 

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Results of Operations

 

Net Revenue

 

Total net revenue, as compared to the prior year period, was as follows:

 

		Three Months Ended March 31,						Change
(In thousands)		2018			2017			$			%
Royalties from a related party - RELVAR/BREO		$	46,160		$	38,689		$	7,471		19	%
Royalties from a related party - ANORO		8,724			5,038			3,686			73	%
Royalties from a related party - TRELEGY		952			—			952			—
Total royalties from a related party		55,836			43,727			12,109			28	%
Less: amortization of capitalized fees paid to a related party		(3,456		)	(3,456		)	—			—
Royalty revenue		52,380			40,271			12,109			30	%
Strategic alliance - MABA program license		—			221			(221		)	—
Total net revenue from GSK		$	52,380		$	40,492		$	11,888		29	%

 

Total net revenue increased for the three months ended March 31, 2018, compared to the same period a year ago primarily due to the growth in prescriptions and market share quarter over quarter for both RELVAR®/BREO® ELLIPTA® and ANORO® ELLIPTA®, and initiation of sales by GSK of TRELEGY® ELLIPTA® in the fourth quarter of 2017.

 

Research & Development

 

We did not incur research and development expenses during the three months ended March 31, 2018. For the three months ended March 31, 2017, we incurred $0.4 million in research and development activities related to the late-stage partnered respiratory assets with GSK.

 

General & Administrative

 

General and administrative expenses, as compared to the prior year period, were as follows:

 

		Three Months Ended March 31,						Change
(In thousands)		2018			2017			$			%
General and administrative expenses		$	8,985		$	10,795		$	(1,810	)	(17	)%
General and administrative expenses - related party		2,700			—			2,700			—

 

General and administrative expenses for the three months ended March 31, 2018 included $3.2 million cash severance payments in connection with certain members of senior management’s separation from the Company and payment of $2.7 million to Sarissa to partially reimburse expenses pursuant to a settlement agreement in February 2018. General and administrative expenses for the three months ended March 31, 2017 included proxy contest and related legal costs of $4.2 million.

 

Other Income (Expense), net and Interest Income

 

Other income (expense), net and interest income, as compared to the prior year period, were as follows:

 

		Three Months Ended March 31,						Change
(In thousands)		2018			2017			$			%
Other (expense) income, net		$	(3,099	)	$	47		$	(3,146	)	*
Interest income		391			236			155			66	%

 

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*Not meaningful

 

Other income (expense), net for the three months ended March 31, 2018, mainly consists of the loss on the extinguishment of debt of $3.1 million in relation to the $120.0 million prepayment of our Term B Loan.

 

Interest income increased for the three months ended March 31, 2018, as compared to the same period a year ago primarily due to higher interest generated from our investments in marketable securities.

 

Interest Expense

 

Interest expense, as compared to the prior year period, was as follows:

 

		Three Months Ended March 31,						Change
(In thousands)		2018			2017			$			%
Interest expense		$	(7,657	)	$	(12,781	)	$	5,124		(40	)%

 

Interest expense decreased for the three months ended March 31, 2018, compared to the same period a year ago primarily due to the lower average outstanding debt balance. See “Liquidity” section below for further information.

 

Liquidity and Capital Resources

 

Liquidity

 

Since our inception, we have financed our operations primarily through private placements and public offerings of equity and debt securities and payments received under collaborative arrangements. Since the start of the commercialization of RELVAR®/ BREO® ELLIPTA® in the fourth quarter of 2013, ANORO® ELLIPTA® during 2014 and TRELEGY® ELLIPTA® in fourth quarter of 2017, we have complemented the source of financing with royalty revenues from the global net sales of these products by GSK. In the three months ended March 31, 2018, we generated gross royalty revenues from GSK of $55.8 million. Net cash and cash equivalents, short term investments and marketable securities totaled $56.5 million, and royalties receivable from GSK totaled $55.8 million as of March 31, 2018.

 

In April 2014, we entered into certain note purchase agreements relating to the private placement of $450.0 million aggregate principal amount of our 2029 Notes. In May 2017, we redeemed $50.0 million on the 2029 Notes. In August 2017, we used the net proceeds of the 2025 Notes and Term B Loan (both described below) to redeem the 2029 Notes in full.

 

On August 7, 2017, we completed a private placement of $192.5 million aggregate principal amount of our 2025 Notes. The proceeds include the 2025 Notes sold pursuant to the $17.5 million over-allotment option granted by us to the initial purchasers, which option was exercised in full. The 2025 Notes were sold in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”). The 2025 Notes will mature on August 15, 2025, unless repurchased or converted in accordance with their terms prior to such date. Concurrently with the pricing of the offering, we repurchased and retired 1,317,771 shares of our common stock for approximately $17.5 million of the net proceeds from the offering, in privately negotiated transactions effected through one of the initial purchasers or its affiliate, as our agent. The remaining net proceeds from the sale of the 2025 Notes in the offering were used to redeem a portion of the principal outstanding under the 2029 Notes on August 15, 2017.

 

On August 18, 2017, we entered into a Credit Agreement and completed a financing of $250.0 million Term B Loan, the proceeds of which were used to repay the remaining balance of the 2029 Notes. The Term B Loan will mature on August 18, 2022. Two and a half percent (2.5%) of the initial principal amount was originally due quarterly beginning December 31, 2017. The remaining outstanding balance is due at maturity. Prepayments, in whole or in part, can be made at any time without a penalty. The Credit Agreement also provides us the ability to request one or more additional tranches of term loans (or increase an existing term loan) at any time prior to maturity. On February 28, 2018, we paid down the principal balance of the Term B Loan by $120.0 million. The outstanding principal balance of the Term B Loan as of March 31, 2018 was $123.8 million.

 

Adequacy of Cash Resources to Meet Future Needs

 

We believe that cash from projected future royalty revenues and our cash, cash equivalents and marketable securities will be sufficient to meet our anticipated debt service and operating needs for at least the next twelve months based upon current operating

 

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plans and financial forecasts. If our current operating plans and financial forecasts change, we may require additional funding sooner in the form of public or private equity offerings or debt financings. Furthermore, if in our view favorable financing opportunities arise, we may seek additional funding at any time. However, future financing may not be available in amounts or on terms acceptable to us, if at all. This could leave us without adequate financial resources to fund our operations as currently planned. In addition, from time to time we may restructure or reduce our debt, including through tender offers, redemptions, amendments, repurchases or otherwise, all consistent with the terms of our debt agreements.

 

Cash Flows

 

Cash flows, as compared to the prior year period, were as follows:

 

		Three Months Ended March 31,
(In thousands)		2018			2017			Change
Net cash provided by operating activities		$	49,914		$	27,761		$	22,153
Net cash provided by investing activities		26,513			22,395			4,118
Net cash used in financing activities		(122,625		)	(8,364		)	(114,261		)

 

Cash Flows from Operating Activities

 

Cash provided by operating activities for the three months ended March 31, 2018 was $49.9 million, consisting primarily of our net income of $30.3 million, adjusted for non-cash items such as $3.5 million of depreciation and amortization, $3.1 million of loss on extinguishment of debt and $2.2 million of stock-based compensation expense, as well as changes in operating assets and liabilities, including a decrease in receivables from collaborative arrangements of $14.7 million, partially offset by a reduction in accrued interest payable of $3.4 million.

 

Cash provided by operating activities for the three months ended March 31, 2017 was $27.8 million, consisting primarily of our net income of $16.9 million, adjusted for non-cash items such as $3.5 million of depreciation and amortization and $2.5 million for stock-based compensation expense, offset by changes in operating assets and liabilities, including $46.8 million provided by receipt of royalties from a related party and revenue from collaborative arrangements, after adjusting for a $3.1 million decrease in receivables from collaborative arrangements, and $13.5 million used for interest payments on 2023 Notes and 2029 Notes.

 

Cash Flows from Investing Activities

 

Net cash flows from investing activities for the three months ended March 31, 2018 of $26.5 million was primarily due to $31.9 million proceeds received from maturities of marketable securities, partially offset by $5.4 million in purchases of marketable securities.

 

Net cash flows from investing activities for the three months ended March 31, 2017 of $22.4 million was primarily due to $26.4 million proceeds received from maturities of marketable securities, partially offset by $4.0 million in purchases of marketable securities.

 

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Cash Flows from Financing Activities

 

Net cash used in financing activities for the three months ended March 31, 2018 of $122.6 million was primarily due to $120.0 million prepayment on our Term B Loan and $2.6 million paid for the repurchase of shares to satisfy tax withholding.

 

Net cash used in financing activities for the three months ended March 31, 2017 of $8.4 million was primarily due to $7.8 million partial payment on the principal of the 2029 Notes and $0.6 million paid for the repurchase of shares to satisfy tax withholding.

 

Off-Balance Sheet Arrangements

 

In June 2014, our facility leases in South San Francisco, California were assigned to Theravance Biopharma, Inc. (“Theravance Biopharma”). However, if Theravance Biopharma were to default on its lease obligations, we would be held liable by the landlord and thus, we have in substance guaranteed the lease payments for these facilities. We would also be responsible for lease-related payments including utilities, property taxes, and common area maintenance, which may be as much as the actual lease payments. As of March 31, 2018, the total remaining lease payments for the duration of the lease, which runs through May 2020, were $14.0 million. The carrying value of this lease guarantee was $0.7 million as of March 31, 2018 and is reflected in other long-term liabilities in our condensed consolidated balance sheet.

 

Contractual Obligations and Commercial Commitments

 

In the table below, we set forth our significant enforceable and legally binding obligations and future commitments as of March 31, 2018.

 

					Payment Due by Period
(In thousands)		Total			Less Than 1 Year			1 - 3 Years			3 - 5 Years			More Than 5 Years
2023 Notes		$	266,589		$	5,121		$	10,242		$	251,226		$	—
2025 Notes		228,594			4,813			9,625			9,625			204,531
Term B Loan		123,750			—			—			123,750			—
Facility leases		2,185			395			825			875			90
Total		$	621,118		$	10,329		$	20,692		$	385,476		$	204,621

 

The Term B Loan balances reflect the principal repayment obligations and do not include the interest payments as the loan bears interest at a varying rate of three-month LIBOR plus 4.5% margin.

 

Item 3. Quantitative and Qualitative Disclosure about Market Risk

 

There have been no significant changes in our market risk or how our market risk is managed compared to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

Item 4. Controls and Procedures

 

Evaluation of Disclosure Controls and Procedures.

 

We conducted an evaluation as of March 31, 2018, under the supervision and with the participation of our management, of the effectiveness of the design and operation of our disclosure controls and procedures, which are defined under SEC rules as controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files under the Securities Exchange Act of 1934 (“Exchange Act”) is recorded, processed, summarized and reported within required time periods. Based upon that evaluation, our Interim Principal Executive Officer, who is also our Principal Financial Officer and Chief Financial Officer, concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance levels.

 

Limitations on the Effectiveness of Controls

 

Our management does not expect that our disclosure controls and procedures or our internal control over financial reporting will prevent all errors and all frauds. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefit of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Innoviva have been detected. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

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Changes in Internal Control over Financial Reporting

 

There were no material changes in our internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) that occurred during the quarter ended March 31, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

On February 6, 2018, our Chief Executive Officer resigned and our Chief Financial Officer assumed the position of interim Principal Executive Officer in addition to his position of Chief Financial Officer, pending a search for a new Chief Executive Officer. As a result, there was a lack of segregation of duties between the position of principal executive officer and principal financial officer over the period subsequent to February 6, 2018. To address this lack of segregation of duties, management ensured that additional oversight procedures were performed to ensure the financial statements included herein fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented. Accordingly, we believe the financial statements included in this report present fairly, in all material respects, our financial condition, results of operations and cash flows for the periods presented. Management will continue to evaluate this segregation of duties for future periods.

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

From time to time, we may be involved in legal proceedings in the ordinary course of business.

 

Item 1A. Risk Factors

 

Risks Related to our Business

 

For the foreseeable future we will derive all of our royalty revenues from GSK and our future success depends on GSK’s ability to successfully develop and commercialize the products in the respiratory programs partnered with GSK.

 

Pursuant to the GSK Agreements, GSK is responsible for the development and commercialization of products in the partnered respiratory programs. Royalty revenues from RELVAR®/BREO® ELLIPTA® and ANORO® ELLIPTA® are expected to represent the majority of our foreseeable future revenues from GSK. The amount and timing of revenue from such royalties are unknown and highly uncertain. Our future success depends upon the performance by GSK of its commercial obligations under the GSK Agreements and the commercial success of RELVAR®/BREO® ELLIPTA®, ANORO® ELLIPTA® and TRELEGY® ELLIPTA®. We have no control over GSK’s marketing and sales efforts, and GSK might not be successful, which would harm our business and cause the price of our securities to fall.

 

Our quarterly royalty revenues may fluctuate due to a variety of factors, many of which are outside of our control. The amount of royalties we receive will depend on many factors, including the following:

 

·                  the extent and effectiveness of the sales and marketing and distribution support GSK provides to our partnered products;

 

·                  market acceptance and demand for our partnered products;

 

·                  changes in the treatment paradigm or standard of care for COPD or asthma, for instance through changes to the GOLD (Global Initiative for Chronic Obstructive Lung Disease) guidelines;

 

·                  the competitive landscape of generic and branded products and developing therapies that compete with our partnered products, including TRELEGY® ELLIPTA® or products owned by GSK (such as Advair®) but which are not partnered with us and pricing pressure in the respiratory markets targeted by our partnered products;

 

·                  the size of the market for our partnered products;

 

·                  the mix of sales of our partnered products;

 

·                  decisions as to the timing of product launches, pricing and discounts;

 

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·                  GSK reprioritizing its commercial efforts on other products, including TRELEGY® ELLIPTA® or products owned by GSK (such as Advair®) but which are not partnered with us;

 

·                  GSK’s ability to expand the indications for which our partnered products can be marketed;

 

·                  a satisfactory efficacy and safety profile as demonstrated in a broad patient population;

 

·                  acceptance of, and ongoing satisfaction with, our partnered products by the medical community, patients receiving therapy and third party payors;

 

·                  timing and amounts of payor rebate adjustments;

 

·                  seasonal fluctuations of demand;

 

·                  the ability of patients to be able to afford our partnered products or obtain health care coverage that covers our partnered products;

 

·                  safety concerns in the marketplace for respiratory therapies in general and with our partnered products in particular;

 

·                  regulatory developments relating to the manufacture or continued use of our partnered products;

 

·                  the requirement to conduct additional post-approval studies or trials for our partnered products;

 

·                  decisions by GSK with respect to the MABA program;

 

·                  GSK’s ability to obtain regulatory approval of our partnered products in additional countries;

 

·                  the unfavorable outcome of any potential litigation relating to our partnered products;

 

·                  general economic conditions in the jurisdictions where our partnered products are sold, including microeconomic disruptions or slowdowns; or

 

·                  if our royalty revenue or operating results fall below the expectations of investors or securities analysts or below any guidance we may provide to the market, the price of our common stock could decline substantially.

 

If the FDA or other applicable regulatory authorities approve generic products, including but not limited to generic forms of Advair®, that compete with RELVAR®/BREO® ELLIPTA® and ANORO® ELLIPTA®, or generic form of RELVAR®/BREO® ELLIPTA®, the royalties payable to us pursuant to the LABA Collaboration Agreement will be less than anticipated, which in turn would harm our business and the price of our securities could fall.

 

Once an NDA or marketing authorization application outside the United States is approved, the product covered thereby becomes a “listed drug” that can, in turn, be cited by potential competitors in support of approval of an Abbreviated New Drug Application (“ANDA”) in the United States. Agency regulations and other applicable regulations and policies provide incentives to manufacturers to create modified, non-infringing versions of a drug to facilitate the approval of an ANDA or other application for generic substitutes in the United States and in nearly every pharmaceutical market around the world. Numerous companies like Mylan N.V., Hikma Pharmaceuticals PLC (Hikma), Novartis’ Sandoz division and Teva Pharmaceuticals Industries Ltd. (Teva) have publicly stated their intentions to bring generic forms of the ICS/LABA drug Advair®, when certain patents covering the Advair® delivery device expired in 2016. In March 2017, Mylan N.V. received a complete response letter from the FDA relating to its ANDA for fluticasone propionate 100, 250, 500 mcg and salmeterol 50 mcg inhalation powder, and is expecting a final decision by the FDA in June 2018. In May 2017, Hikma announced that it received a complete response letter form the FDA relating to its ANDA for fluticasone propionate and salmeterol inhalation powder, and in February 2018, Novartis announced that its generic division Sandoz, had received a complete response letter from FDA in response to its ANDA for a third fluticasone proprionate and salmeterol product. Lastly, Teva announced that the FDA approved two of their products for adolescent and adult patients with asthma, one of which is AirDuoTM RespiClick® (fluticasone propionate and salmeterol inhalation powder) a non-AB substitutable generic versions of Advair®. In general, these manufactures are required to conduct a restricted number of clinical efficacy, pharmacokinetic and device studies to demonstrate equivalence to Advair, per FDA’s September 2013 Draft Guidance document. These studies are designed to demonstrate that the generic product has the same active ingredient(s), dosage form, strength, exposure and clinical efficacy as the branded product. These generic equivalents, which must meet the same exacting quality standards as branded products, may be significantly less costly to bring to market, and companies that produce generic equivalents are generally able to offer their products at lower prices. Thus, after the introduction of a generic competitor, a significant percentage of the sales of any branded product and products that may compete with such branded product is typically lost to the generic product. In addition, in April 2016, the FDA

 

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