1. Organization and Summary of Significant Accounting Policies

Theravance Biopharma, Inc. (“Theravance Biopharma” or the “Company”) is a diversified biopharmaceutical company primarily focused on the discovery, development and commercialization of organ-selective medicines to improve the lives of patients suffering from serious illnesses.

Basis of Presentation

The Company’s consolidated financial statements have been prepared in conformity with US Generally Accepted Accounting Principles ("GAAP"), and the US Securities and Exchange (“SEC”) regulations for annual reporting.

Principles of Consolidation

The consolidated financial statements include the accounts of Theravance Biopharma and its wholly-owned subsidiaries, all of which are denominated in US dollars. All intercompany balances and transactions have been eliminated in consolidation.

Use of Management’s Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates. On an ongoing basis, management evaluates its significant accounting policies or estimates. Management based its estimates on historical experience and other relevant assumptions that it believes to be reasonable under the circumstances. These estimates also form the basis for making judgments about the carrying values of assets and liabilities when these values are not readily apparent from other sources.

Segment Reporting

The Company operates in a single segment, which is the discovery (research), development and commercialization of human therapeutics. The Company’s business offerings have similar economics and other characteristics, including the nature of products and manufacturing processes, types of customers, distribution methods and regulatory environment. The Company is comprehensively managed as one business segment by the Company’s Chief Executive Officer and the management team. Product sales are attributed to regions based on ship‑to location and revenue from collaborative arrangements, including royalty revenue, are attributed to regions based on the location of the collaboration partner. Revenue from profit sharing arrangements are attributed to the geographic market in which the products are sold. Capitalized property and equipment is predominantly located in the US.

Cash and Cash Equivalents

The Company considers all highly liquid investments purchased with a maturity of three months or less on the date of purchase to be cash equivalents. Cash equivalents are carried at fair value.

Restricted Cash

Under certain lease agreements and letters of credit, the Company has pledged cash and cash equivalents as collateral. As of December 31, 2018 and 2017, restricted cash related to such agreements was $0.8 million.

Investments in Marketable Securities

The Company invests in marketable securities, primarily corporate notes, government, government agency, and municipal bonds. The Company classifies its marketable securities as available‑for‑sale securities and reports them at fair value in cash equivalents or marketable securities on the consolidated balance sheets with related unrealized gains and losses included as a component of shareholders’ equity. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, which is included in interest income on the consolidated statements of operations. Realized gains and losses and declines in value judged to be other‑than‑temporary, if any, on available‑for‑sale securities are included in interest and other income (loss). The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available‑for‑sale are included in interest income.

The Company regularly reviews all of its investments for other‑than‑temporary declines in estimated fair value. The Company’s review includes the consideration of the cause of the impairment, including the creditworthiness of the security issuers, the number of securities in an unrealized loss position, the severity and duration of the unrealized losses, whether the Company has the intent to sell the securities and whether it is more likely than not that the Company will be required to sell the securities before the recovery of their amortized cost basis. When the Company determines that the decline in estimated fair value of an investment is below the amortized cost basis and the decline is other‑than‑temporary, the Company reduces the carrying value of the security and records a loss for the amount of such decline.

Fair Value of Financial Instruments

The Company defines 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.

The Company’s valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company’s market assumptions. The Company classifies 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, non-marketable securities, accounts receivable, accounts payable, accrued liabilities, and debt. The Company’s cash equivalents and marketable securities are carried at estimated fair value and remeasured on a recurring basis. The carrying value of 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.

Accounts Receivable

Trade accounts receivable are recorded net of allowances for wholesaler chargebacks related to government rebate programs, cash discounts for prompt payment, distribution fees, and sales discounts. Estimates for wholesaler chargebacks for government rebates and cash discounts are based on contractual terms, historical trends and the Company’s expectations regarding the utilization rates for these programs. When appropriate, the Company provides for an allowance for doubtful accounts by reserving for specifically identified doubtful accounts. For the periods presented, the Company did not have any material write‑offs of trade accounts receivable. The Company performs periodic credit evaluations of its customers and generally does not require collateral.

On November 12, 2018, the Company completed the sale of its assets related to the manufacture, marketing and sale of the VIBATIV product to Cumberland Pharmaceuticals Inc. (“Cumberland”) pursuant to the Asset Purchase Agreement dated November 1, 2018. As a result, the remaining accounts receivable balance at December 31, 2018 related to product sales recognized prior to November 12, 2018.

Concentration of Credit Risks

The Company invests in a variety of financial instruments and, by its policy, limits the amount of credit exposure with any one issuer, industry or geographic area for investments other than instruments backed by the US federal government.

Inventories

Inventories consist of raw materials, work‑in‑process and finished goods related to the production of VIBATIV. Raw materials include VIBATIV active pharmaceutical ingredient (“API”) and other raw materials. Work‑in‑process and finished goods include third‑party manufacturing costs and labor and indirect costs the Company incurred in the production process. Included in inventories are raw materials and work‑in‑process that may be used as clinical products, which are charged to research and development (“R&D”) expense when consumed. In addition, under certain prior commercialization agreements, the Company sold VIBATIV packaged in unlabeled vials that were recorded in work‑in‑process. Inventories are stated at the lower of cost or net realizable value. The Company determines the cost of inventory using the average‑cost method for each manufacturing batch.

The Company assesses its inventory levels each reporting period and writes‑down inventory that is expected to be at risk for expiration, that has a cost basis in excess of its expected net realizable value and inventory quantities in excess of expected requirements. In evaluating the sufficiency of its inventory reserves or liabilities for firm purchase commitments, the Company also takes into consideration its firm purchase commitments for future inventory production. If the Company were to decide to cancel its manufacturing commitment, such cancellation would trigger the payment of a cancellation fee. If the Company projects to have excess inventories and that it would be more cost-efficient to pay the cancellation fee, it may accrue the cancellation fee as a liability. The Company’s assessment of excess inventories, including future firm purchase commitments, requires management to utilize judgement in formulating estimates and assumptions that it believes to be reasonable under the circumstances. Actual results may differ from those estimates and assumptions.

When the Company recognizes a loss on such inventory or firm purchase commitments, it establishes a new, lower cost basis for that inventory, and subsequent changes in facts and circumstances will not result in the restoration or increase in that newly established cost basis. If inventory with a lower cost basis is subsequently sold, it will result in higher gross margin for those sales. In 2017, the Company recognized a charge of $3.0 million arising from excess inventory of which $2.25 million was attributed to an expected purchase obligation at the time. In 2018, the Company reversed the expense related to the $2.25 million purchase obligation due to the waiver of its minimum purchase commitment by the third-party manufacturer.

As a result of the VIBATIV sale to Cumberland in November 2018, the Company did not have any inventory as of December 31, 2018.

Property and Equipment

Property, equipment and leasehold improvements are stated at cost, net of accumulated depreciation and depreciated using the straight‑line method as follows:


Leasehold improvements	Shorter of remaining lease terms or useful life
Equipment, furniture and fixtures	5 ‑ 7 years
Software and computer equipment	3 ‑ 5 years

Capitalized Software

The Company capitalizes certain costs related to direct material and service costs for software obtained for internal use. For the year ended December 31, 2017, the Company capitalized costs for the implementation of its new procurement software system of $0.5 million. Upon being placed in service, these costs and other future capitalizable costs related to the internal use software system integration will be depreciated over five years. There was no additional capitalized software costs recorded for the year ended December 31, 2018.

Impairment of Long‑Lived Assets

Long‑lived assets include property and equipment. The carrying value of long‑lived assets is reviewed for impairment whenever events or changes in circumstances indicate that the asset may not be recoverable. An impairment loss is recognized when the total of estimated future cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount.

Deferred Rent

Deferred rent consists of the difference between cash payments and the recognition of rent expense on a straight‑line basis for the buildings the Company occupies. Rent expense is recognized ratably over the life of the leases. Because the Company’s facility operating leases provide for rent increases over the terms of the leases, average annual rent expense during the initial years of the leases exceeded the Company’s actual cash rent payments. Also included in deferred rent are lease incentives which are being recognized ratably over the life of the leases.

Revenue Recognition

Prior to January 1, 2018, the Company recognized revenue under Accounting Standards Codification (“ASC”), Topic 605, Revenue Recognition (“ASC 605”). Under ASC 605, 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. Where the revenue recognition criteria was not met, the Company delayed the recognition of revenue by recording deferred revenue until such time that all criteria are met.

Effective January 1, 2018, the Company adopted ASC, Topic 606, Revenue from Contracts with Customers (“ASC 606”) using the modified retrospective method. Under ASC 606, an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, an entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation.

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

Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior period. The Company recorded a reduction to the opening balance of accumulated deficit of approximately $1.1 million and a corresponding reduction in deferred revenue as of January 1, 2018 due to ASC 606’s cumulative adoption impact on the Company’s collaborative arrangements. The Company’s revenue recognized in 2018 would not have been materially different under ASC 605 as compared to ASC 606.

Product Sales

On November 12, 2018, the Company completed the sale of its assets related to the manufacture, marketing and sale of the VIBATIV product to Cumberland pursuant to the Asset Purchase Agreement dated November 1, 2018. Up until that date, the Company sold VIBATIV in the US market by making the drug product available through a limited number of distributors, who sold VIBATIV to healthcare providers. Title and risk of loss transferred upon receipt by these distributors. The Company recognized VIBATIV product sales and related cost of product sales when the distributors obtained control of the drug product, which was at the time title transferred to the distributors.

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

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

Chargebacks and Government Rebates: The Company estimates 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. The Company’s reduction for PHS is based on actual chargebacks that distributors have claimed for reduced pricing offered to such healthcare providers and our expectation about future utilization rates. The Company’s accrual for Medicaid is based upon statutorily‑defined discounts, estimated payor mix, expected sales to qualified healthcare providers, and the Company’s expectation about future utilization. The Medicaid accrual and government rebates that are invoiced directly to the Company are recorded in other accrued liabilities on the consolidated balance sheets. For qualified programs that can purchase the Company’s products through distributors at a lower contractual government price, the distributors charge back to the Company the difference between their acquisition cost and the lower contractual government price, which the Company records as an allowance against accounts receivable.

Distribution Fees: The Company has contracts with its distributors in the US that include terms for distribution‑related fees. The Company determines distribution‑related fees based on a percentage of the product sales price, and it records the distribution fees as an allowance against accounts receivable.

Product Returns: The Company offers its distributors a right to return product purchased directly from the Company, which is principally based upon the product’s expiration date. The Company’s policy is to accept product returns during the six months prior to and twelve months after the product expiration date on product that has been sold to its distributors. Product return allowances are based on amounts owed or to be claimed on related sales. These estimates take into consideration the terms of our agreements with customers, historical product returns, 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. The Company records its product return reserves as other accrued liabilities.

Allowance for Doubtful Accounts: The Company records allowances for potentially doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. As of December 31, 2018, there was no allowance for doubtful accounts related to trade accounts receivable.

The following table summarizes activity in each of the product revenue allowance and reserve categories:


	Chargebacks,		Government
	Discounts and		and Other
(In thousands)	Fees		Rebates		Returns		Total
Balance at December 31, 2016	$	779	$	377	$	747	$	1,903
Provision related to current period sales		5,193		580		573		6,346
Adjustment related to prior period sales		(127)		75		561		509
Credit or payments made during the period		(4,853)		(680)		(935)		(6,468)
Balance at December 31, 2017	$	992	$	352	$	946	$	2,290
Provision related to current period sales		6,402		704		521		7,627
Adjustment related to prior period sales		(81)		168		(449)		(362)
Credit or payments made during the period		(6,938)		(932)		(157)		(8,027)
Balance at December 31, 2018	$	375	$	292	$	861	$	1,528

Collaborative Arrangements Under ASC 606 (Effective January 1, 2018)

The Company enters into collaborative arrangements with partners that fall under the scope of ASC, Topic 808, Collaborative Arrangements (“ASC 808”). While these arrangements are in the scope of ASC 808, the Company may analogize to ASC 606 for some aspects of the arrangements. The Company analogizes to ASC 606 for certain activities within the collaborative arrangement for the delivery of a good or service (i.e., a unit of account) that is part of its ongoing major or central operations. Revenue recognized by analogizing to ASC 606 is recorded as “collaboration revenue” whereas, revenue recognized in accordance with ASC 808, is recorded as “profit sharing revenue” in the consolidated statements of operations.

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

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

Up-front Fees: If a license to the Company’s intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, the Company recognizes collaboration revenues from the transaction price allocated to the license when the license is transferred to the licensee and the licensee is able to use and benefit from the license. For licenses that are bundled with other promises, the Company utilizes judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing collaboration revenue from the allocated transaction price. For example, when the Company receives up-front fees for the performance of research and development services, or when research and development services are not considered to be distinct from a license, the Company recognizes collaboration revenue for those units of account over time using a measure of progress. The Company evaluates the measure of progress each reporting period and, if necessary, adjusts the measure of performance and related revenue or expense recognition as a change in estimate.

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

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

Following the sale of VIBATIV to Cumberland in November 2018, VIBATIV royalties earned from Cumberland are included within “interest and other income, net” on the consolidated statements of operations. In addition, the Company’s income earned related to TRELEGY ELLIPTA sales is included within “income from our investment in TRC, LLC” on the consolidated statements of operations.

Reimbursement, cost-sharing and profit-sharing payments: Under certain collaborative arrangements, the Company has been reimbursed for a portion of its R&D expenses or participates in the cost-sharing of such R&D expenses. Such reimbursements and cost-sharing arrangements have been reflected as a reduction of R&D expense in the Company’s consolidated statements of operations, as the Company does not consider performing research and development services for reimbursement to be a part of its ongoing major or central operations.

Collaborative Arrangements under ASC 605 (Effective Prior to January 1, 2018)

Revenue from non‑refundable, up‑front license or technology access payments under license and collaborative arrangements that were not dependent on any future performance by the Company was recognized when such amounts were earned. If the Company had continuing obligations to perform under the arrangement, such fees were recognized over the estimated period of continuing performance obligation.

The Company accounted for multiple element arrangements, such as license and development agreements in which it may have provided several deliverables, in accordance with ASC, Subtopic 605‑25, Multiple Element Arrangements. For new or materially amended multiple element arrangements, the Company identified the deliverables at the inception of the arrangement and each deliverable within a multiple deliverable revenue arrangement was accounted for as a separate unit of accounting if both of the following criteria were met: (1) the delivered item or items had value to the customer on a standalone basis and (2) for an arrangement that included a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) was considered probable and substantially in the Company’s control. The Company allocated revenue to each non‑contingent element based on the relative selling price of each element. When applying the relative selling price method, the Company determined the selling price for each deliverable using vendor‑specific objective evidence (“VSOE”) of selling price, if it existed, or third‑party evidence (“TPE”) of selling price, if it existed. If neither VSOE nor TPE of selling price existed for a deliverable, the Company used the best estimated selling price for that deliverable. Revenue allocated to each element was then recognized based on when the basic four revenue recognition criteria were met for each element.

Where a portion of non‑refundable upfront fees or other payments received were allocated to continuing performance obligations under the terms of a collaborative arrangement, they were recorded as deferred revenue and recognized as revenue ratably over the term of the Company’s estimated performance period under the agreement. The Company determined the estimated performance periods, and they were 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, the Company was reimbursed for a portion of its R&D expenses. These reimbursements were reflected as a reduction of R&D expense in the Company’s consolidated statements of operations, as it did not consider performing research and development services to be a customer relationship in the context of those collaborative arrangements. Therefore, the reimbursement of research and development services were recorded as a reduction of R&D expense.

The Company recognized revenue from milestone payments when (i) the milestone event was substantive and its achievability was not reasonably assured at the inception of the agreement and (ii) the Company did not have ongoing performance obligations related to the achievement of the milestone. Milestone payments were considered substantive if all of the following conditions were met: the milestone payment (a) was commensurate with either the Company’s 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 the Company’s performance to achieve the milestone, (b) related solely to past performance, and (c) was reasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement.

Research and Development Expenses

Research and development expenses are recorded in the period that services are rendered or goods are received. Research and development expenses consist of salaries and benefits, laboratory supplies and facility costs, as well as fees paid to third parties that conduct certain research and development activities on behalf of the Company, net of certain external research and development expenses reimbursed under the Company’s collaborative arrangements.

As part of the process of preparing financial statements, the Company is required to estimate and accrue certain research and development expenses. This process involves the following:

•identifying services that have been performed on the Company’s behalf and estimating the level of service performed and the associated cost incurred for the service when the Company has not yet been invoiced or otherwise notified of actual cost;

•estimating and accruing expenses in the Company’s financial statements as of each balance sheet date based on facts and circumstances known to it at the time; and

•periodically confirming the accuracy of the Company’s estimates with selected service providers and making adjustments, if necessary.

Examples of estimated research and development expenses that the Company accrues include:

•fees paid to clinical research organizations (“CROs”) in connection with preclinical and toxicology studies and clinical studies;

•fees paid to investigative sites in connection with clinical studies;

•fees paid to contract manufacturing organizations (“CMOs”) in connection with the production of product and clinical study materials; and

•professional service fees for consulting and related services.

The Company bases its expense accruals related to clinical studies on its estimates of the services received and efforts expended pursuant to contracts with multiple research institutions and CROs that conduct and manage clinical studies on the Company’s behalf. The financial terms of these agreements vary from contract to contract and may result in uneven payment flows. Payments under some of these contracts depend on factors, such as the successful enrollment of patients and the completion of clinical study milestones. The Company’s service providers invoice it monthly in arrears for services performed. In accruing service fees, the Company estimates the time period over which services will be performed and the level of effort to be expended in each period. If the Company does not identify costs that it has begun to incur or if it underestimates or overestimates the level of services performed or the costs of these services, the Company’s actual expenses could differ from its estimates.

To date, the Company has not experienced significant changes in its estimates of accrued research and development expenses after a reporting period. Such changes in estimates recorded after a reporting period have been less than 1% of the Company’s annual research and development expenses and have not been material. However, due to the nature of estimates, there is no assurance that the Company will not make changes to its estimates in the future as it becomes aware of additional information about the status or conduct of its clinical studies and other research activities. Such changes in estimates will be recognized as research and development expenses in the period that the change in estimate occurs.

Advertising Expenses

The Company expenses the costs of advertising, including promotional expenses, as incurred. Advertising expenses were $1.9 million, $3.2 million and $2.5 million for the years ended December 31, 2018, 2017 and 2016, respectively.

Fair Value of Share‑Based Compensation Awards

The Company uses the Black‑Scholes‑Merton option pricing model to estimate the fair value of options granted under its equity incentive plans and rights to acquire shares granted under its employee share purchase plan (“ESPP”). The Black‑Scholes‑Merton option valuation model requires the use of assumptions, including the expected term of the award and the expected share price volatility. The Company uses the “simplified” method as described in Staff Accounting Bulletin No. 107, Share‑Based Payment, to estimate the expected option term.

Share‑based compensation expense is calculated based on awards ultimately expected to vest and is reduced for actual forfeitures as they occur, as allowed under Accounting Standards Update (“ASU”) 2016-09, Compensation—Stock Compensation (Topic 718) (“ASU 2016‑09”). Prior to the adoption of ASU 2016-09 on January 1, 2017, forfeitures were estimated at the time of grant and revised, if necessary, in subsequent periods if the actual forfeitures differed from those estimates.

Compensation expense for purchases under the ESPP is recognized based on the fair value of the award on the date of offering.

Amortization of Debt Issuance Costs

Debt issuance costs are amortized to interest expense over the estimated life of the related debt based on the effective interest method.

Theravance Respiratory Company, LLC (“TRC”)

Through its equity ownership of TRC, the Company is entitled to receive an 85% economic interest in any future payments that may be made by Glaxo Group or one of its affiliates (“GSK”) relating to the GSK-Partnered Respiratory Programs (net of TRC expenses paid and the amount of cash, if any, expected to be used by TRC pursuant to the TRC LLC Agreement over the next four fiscal quarters). The GSK-Partnered Respiratory Programs consist primarily of the Trelegy Ellipta program and the inhaled Bifunctional Muscarinic Antagonist-Beta2 Agonist (“MABA”) program.

The Company analyzed its ownership, contractual and other interests in TRC to determine if TRC is a variable‑interest entity (“VIE”), whether the Company has a variable interest in TRC and the nature and extent of that interest. The Company determined that TRC is a VIE. The party with the controlling financial interest, the primary beneficiary, is required to consolidate the entity determined to be a VIE. Therefore, the Company also assessed whether the Company is the primary beneficiary of TRC based on the power to direct its activities that most significantly impact its economic performance and the Company’s obligation to absorb its losses or the right to receive benefits from it that could potentially be significant to TRC. Based on the Company’s assessment, it determined that it is not the primary beneficiary of TRC, and, as a result, the Company does not consolidate TRC in its consolidated financial statements. TRC is recognized in the Company’s consolidated financial statements under the equity method of accounting. Income related to the Company’s equity ownership of TRC is reflected in its consolidated statement of operations as non-operating income.

Income Taxes

The Company utilizes the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using enacted tax rates and laws that are anticipated to be in effect when the differences are expected to reverse. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized.

The Company’s total unrecognized tax benefits of $52.4 million and $41.8 million, as of December 31, 2018 and December 31, 2017, respectively, may reduce the effective tax rate in the period of recognition. As of December 31, 2018, the Company does not believe that it is reasonably possible that its unrecognized tax benefit will significantly decrease in the next twelve months. The Company currently has a full valuation allowance against its deferred tax assets, which would impact the timing of the effective tax rate benefit should any of these uncertain positions be favorably settled in the future.

The Company assesses all material positions, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by relevant taxing authorities. Assessing an uncertain tax position begins with the initial determination of the position’s sustainability and is measured at the largest amount of benefit that is greater than 50% likely to be realized upon ultimate settlement. As of each balance sheet date, unresolved uncertain tax positions must be reassessed, and the Company will determine whether the factors underlying the sustainability assertion have changed and whether the amount of the recognized tax benefit is still appropriate.

The recognition and measurement of tax benefits requires significant judgment. The Company has taken certain positions where it believes that its position is greater than 50% likely to be realized upon ultimate settlement and for which no reserve for uncertain tax positions has been recorded. If the Company does not ultimately realize the expected benefit of these positions, it will record additional income tax expenses in future periods. Judgments concerning the recognition and measurement of a tax benefit might change as new information becomes available.

Net Loss per Share

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

For the years ended December 31, 2018, 2017 and 2016, diluted and basic net loss per share was identical since potential ordinary shares were excluded from the calculation, as their effect was anti‑dilutive.

Anti‑dilutive Securities

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


	Year Ended December 31,
(In thousands)	2018	2017	2016
Share issuances under equity incentive plans and ESPP	3,492	3,369	3,709
Restricted shares	2	6	33
Share issuances upon the conversion of convertible senior notes	6,676	6,676	6,676
Total	10,170	10,051	10,418

In addition, there were 978,750 and 1,305,000 shares that are subject to performance‑based vesting criteria which have been excluded from the ordinary equivalent shares table above for the years ended December 31, 2018 and 2017, respectively.

Comprehensive Loss

Comprehensive loss is comprised of net loss and changes in unrealized gains and losses on the Company’s available-for-sale investments.

Related Parties

GSK owned 17.3% of the Company’s ordinary shares outstanding as of December 31, 2018. On March 17, 2016, GSK purchased from the Company 1,301,015 of its ordinary shares for an aggregate purchase price of approximately $23.0 million pursuant to a Share Purchase Agreement between GSK and the Company dated March 14, 2016. The Share Purchase Agreement was entered into pursuant to Section 2.1(d)(ii) of the Governance Agreement between GSK and the Company dated March 3, 2014 (the “Governance Agreement”), which until December 31, 2017 afforded GSK, on a quarterly basis, the opportunity to purchase from the Company ordinary shares sufficient to maintain GSK’s Percentage Interest (as defined in the Governance Agreement) at the same level as prior to any exercise of share options and vesting of restricted shares that occurred during the prior quarter, and pursuant to the Company’s approval to GSK to make additional purchases, which approval was required by Section 2.1(a) of the Governance Agreement. The Governance Agreement expired on December 31, 2017.

Robert V. Gunderson, Jr. is a member of the Company’s board of directors. The Company has engaged Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, LLP, of which Mr. Gunderson is a partner, as its primary legal counsel. Fees incurred were $0.5 million, $0.3 million, and $1.1 million for the years ended December 31, 2018, 2017, and 2016, respectively.

Dr. Smaldone Alsup is a member of the Company’s board of directors and is also the Chief Operating Officer and Chief Scientific Officer of NDA Group. The Company engaged NDA Group in 2017 to perform consulting services related to the regulatory plans for one of the Company’s drug candidates. There were no fees incurred for the year ended December 31, 2018 and $0.1 million in fees incurred for the year ended December 31, 2017.

Recently Adopted Accounting Pronouncements

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

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

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

Recently Issued Accounting Pronouncements Not Yet Adopted

In February 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016‑02, Leases (Topic 842) (“ASU 2016‑02”). ASU 2016‑02 is aimed at making leasing activities more transparent and comparable, and requires leases with terms greater than one year to be recognized by lessees on their balance sheet as a right‑of‑use asset and corresponding lease liability. ASU 2016‑02 is effective for all interim and annual reporting periods beginning after December 15, 2018, with early adoption permitted, and is required to be adopted using a modified retrospective approach. In July 2018, the FASB issued supplemental adoption guidance that allows for an optional transition method to initially account for the impact of the adoption with a cumulative adjustment to accumulated deficit on the effective date of ASU 2016-02, January 1, 2019, rather than applying the transition provisions in the earliest period presented.

Based on the Company’s assessment of ASU 2016-02, it elected the optional transition method described above and a package of practical expedients that allows entities to not (i) reassess whether any expired or existing contracts are considered or contain leases; (ii) reassess the lease classification for any expired or existing leases; and (iii) reassess initial direct costs for any existing leases. In addition, the Company elected other practical expedients that allow entities to (iv) use hindsight in determining the term of a lease when the lease includes an option to extend the lease term; (v) exclude all leases, on a go forward basis, that have a lease term of 12-month or less; and (vi) combine lease and non-lease components (e.g., office common area maintenance expenses) when recognizing a lease on an entity’s balance sheet on a go forward basis.

The Company will adopt ASU 2016-02 in January 2019, and the Company has substantially completed the evaluation of its existing lease arrangements in order to determine the full impact that the adoption of ASU 2016‑02 will have on its balance sheet, financial statement disclosures, and related internal controls. The most significant impact to the Company’s balance sheet upon adoption will be from recognizing a right-of-use asset and corresponding lease liability related to its office leases in South San Francisco and Dublin, Ireland. The Company currently anticipates that it will record a right-to-use asset and corresponding lease liability ranging between appropriately $47 million to $50 million. Based on the review of the Company’s existing lease arrangements, ASU 2016-02 will not have a material impact on the Company’s results of operations or cash flows.

In May 2017, the FASB issued ASU No. 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting (“ASU 2017-09”). ASU 2017-09 was issued to provide clarity and reduce both (1) diversity in practice and (2) cost and complexity when applying the guidance in Topic 718, Compensation—Stock Compensation, to a change to the terms or conditions of a share-based payment award. The amendments in ASU 2017-09 provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. Essentially, an entity will not have to account for the effects of a modification if: (1) the fair value of the modified award is the same immediately before and after the modification; (2) the vesting conditions of the modified award are the same immediately before and after the modification; and (3) the classification of the modified award as either an equity instrument or liability instrument is the same immediately before and after the modification. The amendments in ASU 2017-09 will become effective for the Company as of January 1, 2019. Early adoption is permitted, including adoption in any interim period. The adoption of this guidance is not expected to have a material impact upon the Company’s consolidated financial statements and related disclosures.

In August 2018, the SEC adopted the final rule under SEC Release No. 33-10532, Disclosure Update and Simplification, amending certain disclosure requirements that were redundant, duplicative, overlapping, outdated or superseded. In addition, the amendments expanded the disclosure requirements on the analysis of stockholders’ equity for interim financial statements. Under the amendments, an analysis of changes in each caption of stockholders’ equity presented in the balance sheet must be provided in a note or separate statement. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a statement of comprehensive income is required to be filed. The Company anticipates its first presentation of changes in stockholders’ equity as required under the new SEC guidance will be included in its Form 10-Q for the three month period ending March 31, 2019.

The Company has evaluated other recently issued accounting pronouncements and does not believe that any of these pronouncements will have a material impact on its consolidated financial statements and related disclosures.