Sale of Equity Interests in Theravance Respiratory Company, LLC and Discontinued Operations

9 Months Ended

Sep. 30, 2022

Sale of Equity Interests in Theravance Respiratory Company, LLC and Discontinued Operations

Sale of Equity Interests in Theravance Respiratory Company, LLC and Discontinued Operations

8. Sale of Equity Interests in Theravance Respiratory Company, LLC and Discontinued Operations

On July 20, 2022, the Company completed the sale of its 2,125 Class B Units and 6,375 Class C Units (collectively, the “Issuer II Units”) of Theravance Respiratory Company, LLC (“TRC”) to, and entered into a sale of future royalties from sales of ampreloxetine (see Note 9 below) with, Royalty Pharma Investments 2019 ICAV, an Irish collective asset-management vehicle (“Royalty Pharma”), pursuant to the Equity Purchase and Funding Agreement, dated as of July 13, 2022 (including the schedules and exhibits thereto, the “Purchase Agreement”), by and between the Company and Royalty Pharma (collectively with the other transactions contemplated by the Purchase Agreement, the “TRC Transaction”). The Issuer II Units represent the right to receive 85% of the royalty payments on worldwide net sales of Assigned Collaboration Products (as defined in the Purchase Agreement) pursuant to the terms of that certain Collaboration Agreement, dated as of November 14, 2002, by and between Innoviva, Inc. (formerly known as Theravance, Inc.), a Delaware corporation (“Innoviva”), and Glaxo Group Limited, a private company limited by shares registered under the laws of England and Wales (“GSK”) (as amended, the “Collaboration Agreement”). Assigned

Collaboration Products is primarily comprised of Trelegy ELLIPTA (“TRELEGY”). Total consideration payable by Royalty Pharma under the terms of the TRC Transaction included initial consideration of $1,326.6 million plus additional payments as further described below.

At the closing of the TRC Transaction (the “Closing”), the Company received approximately $1.1 billion in cash. From and after January 1, 2023, for any calendar year starting with the year ending December 31, 2023 and ending with the year December 31, 2026, upon certain milestone minimum royalty amounts for the Assigned Collaboration Products being met, Royalty Pharma is obligated to make certain cash payments to the Company (the “Milestone Payments”), which are not to exceed $250.0 million in aggregate. Additionally, the Company will receive from Royalty Pharma 85% of the royalty payments on the Assigned Collaboration Products payable (a) for sales or other activities occurring on and after January 1, 2031 related to the Assigned Collaboration Products in the US, and (b) for sales or other activities occurring on and after July 1, 2029 related to the Assigned Collaboration Products outside of the US.

The Purchase Agreement contained customary representations and warranties of the Company and Royalty Pharma, including with respect to organization, authorization, intellectual property matters and tax matters, and certain covenants with respect to confidentiality, taxes and actions and conduct relating to preservation of TRC prior to the Closing. The Company and Royalty Pharma will each indemnify the other against damages arising from breaches of representations, warranties and covenants under the Purchase Agreement.

Effective as of the Closing, the Company consented to certain amendments to the Collaboration Agreement and the Extension Agreement, dated as of March 3, 2014, by and between the Company and GSK, as well as the termination of the Master Agreement, dated as of March 3, 2014, by and between Innoviva, the Company and GSK, and further released Innoviva, Innoviva TRC Holdings LLC, a Delaware limited liability company, Royalty Pharma and TRC for claims relating to TRC or the ownership of TRC by the Company or Innoviva prior to the Closing.

The Company evaluated the TRC Transaction under ASC 860, Transfers and Servicing of Financial Assets, (“ASC 860”) and determined that the future potential Milestone Payments and royalty payments are considered a form of continuing involvement between the Company and Royalty Pharma. The Company further evaluated the TRC Transaction under ASC 860 and concluded that (i) the equity interests in TRC have been isolated from the Company (even in the event of bankruptcy or other receivership); (ii) Royalty Pharma has the right to pledge or exchange the TRC assets it received from the Company without constraint; and (iii) the Company had surrendered control over its equity interests in TRC to Royalty Pharma. Based on the Company’s evaluation under ASC 860, the TRC Transaction was treated as a sale, and the Company recognized a gain from the sale of its equity interests in TRC of $1,141.1 million based on the excess of the total net consideration allocated to the sale of the Company’s equity interests (based on relative fair value) of $1,301.6 million over the carrying value of the equity interests sold of $136.7 million, less transaction costs of $23.8 million. The total net consideration of $1,301.6 million included upfront cash of $1,107.4 million, plus an estimated $194.2 million representing the fair value of the future Milestone Payments and royalties (collectively, “Contingent Consideration”).

The Contingent Consideration was initially measured at fair value utilizing a Monte Carlo simulation model to calculate the present value of the risk-adjusted cash flows estimated to be received from the Contingent Consideration. The discount rate utilized in the valuation model was 7.83%. The fair value model involved significant unobservable inputs derived using management’s estimates. Management’s estimates were based in part on external data, and reflected management’s judgements and forecasts. The significant unobservable inputs included estimates of the forecasted TRELEGY net revenues, the expected volume and term of the royalty stream, and the royalty rate. These estimates are considered Level 3 fair value inputs. The Company will reassess the carrying value of the Contingent Consideration when indicators of impairment are identified and will recognize any increases in the carrying value of the asset when such contingent gains are realized. As of September 30, 2022, there were no changes in the carrying value of the Contingent Consideration since its initial measurement date.

The Contingent Consideration is subject to counterparty credit risk, and the carrying value of the Contingent Consideration represents the maximum amount of potential loss due to credit risk. To date, the Company has not recorded any credit losses related to the Contingent Consideration. The Contingent Consideration is presented on the condensed consolidated balance sheets as future contingent milestone and royalty assets.

Discontinued Operations

On July 20, 2022, the Company completed a monetization of its ownership in a significant equity method investment that had a major effect on the Company’s financial results (see Note 8 for more information). In accordance with GAAP, the sale was accounted for as an asset disposal.

The TRC Transaction represented a monetization of a significant equity method investment that had a major effect on the Company’s financial results. In accordance with GAAP, the TRC Transaction was accounted for as a sale of a financial asset. For all periods presented, balances and the results related to TRC have been classified as discontinued operations on the Company’s condensed consolidated financial statements.

The results of discontinued operations consisted of the following:

	Three Months Ended September 30,				Nine Months Ended September 30,
(In thousands)	2022		2021		2022		2021
Income from investments in TRC, LLC	$	—	$	30,208	$	53,237	$	68,681
Transaction-related legal expenses (prior to July 20, 2022)		—		—		(5,057)		—
Interest expense on 9.5% Non-recourse notes due 2035		(2,046)		(9,606)		(21,312)		(28,817)
Loss on extinguishment of debt		(24,022)		—		(24,022)		—
Net gain from sale of equity interests in TRC, LLC		1,141,084		—		1,141,084		—
Provision for income tax expense		(182,362)		—		(182,868)		—
Net income from discontinued operations	$	932,654	$	20,602	$	961,062	$	39,864

TRC Summary Financial Information

Prior to the TRC Transaction, the Company analyzed its ownership, contractual and other interests in TRC to determine if it was a variable-interest entity (“VIE”), whether the Company had a variable interest in TRC and the nature and extent of that interest. The Company determined that TRC was 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 it was the primary beneficiary of TRC based on the power to direct TRC’s activities that most significantly impact TRC’s economic performance and its obligation to absorb TRC’s losses or the right to receive benefits from TRC that could potentially be significant to TRC. Based on the Company’s assessment, the Company determined that it was not the primary beneficiary of TRC, and, as a result, the Company did not consolidate TRC in its condensed consolidated financial statements. The Company’s maximum exposure to loss, as a result of its involvement with TRC, were the amounts recorded in the condensed consolidated balance sheets within “Equity in net assets of TRC, LLC”. TRC was recognized in the Company’s condensed consolidated financial statements under the equity method of accounting.

Rule 3-09 of Regulation S-X requires that a company include summary financial information for equity method investees when such investees are individually significant for a company. For the prior year comparable periods and the current year period through the TRC disposal date, the income from the Company’s investment in TRC was determined to be significant. As a result, TRC’s summary financial information, including the portion of equity interest that the Company did not own, was as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
(In thousands)	2022		2021		2022		2021
Royalty revenue and gross profit	$	—	$	35,585	$	72,029	$	84,055
Income from continuing operations		—		35,391		71,693		80,244
Net income		—		35,539		62,632		79,655