Financial Instruments and Fair Value Measurements

3 Months Ended

Mar. 31, 2020

Financial Instruments and Fair Value Measurements

Financial Instruments and Fair Value Measurements

4. Financial Instruments and Fair Value Measurements

Equity Investment in Armata

On January 27, 2020, we entered into a securities purchase agreement to acquire 8,710,800 shares of Armata’s common stock and warrants to purchase up to 8,710,800 additional shares of its common stock for $25.0 million in cash. Armata is a clinical stage biotechnology company focused on precisely targeted bacteriophage therapeutics for antibiotic-resistant infections. The investment is to support Armata’s ongoing advancement of its bacteriophage development programs including the expected first in human studies related to Armata's lead phage candidate, AP-PA02, targeting Pseudomonas aeruginosa, as well as AP-SA02, its phage candidate targeting Staphylococcus Aureus.

The investment was closed in two tranches on February 12, 2020 and March 27, 2020. Two of our board members joined Armata’s board. After the second closing, we own approximately 46.7% of Armata’s common stock.

The investment provides Innoviva the ability to have significant influence, but not control over Armata’s operations. Based on our evaluation, we determined that Armata is a VIE, but Innoviva is not the primary beneficiary of the VIE. We elected the fair value option under Accounting Standards Codification (“ASC”) Topic 825, Financial Instruments, to account for both Armata’s common stock and warrants at fair value. The fair value of Armata’s common stock is measured based on its closing market price. The warrants have an exercise price of $2.87 per share, are exercisable immediately within five years from the issuance date of the warrants, and include a cashless exercise option. We use the Black-Scholes-Merton pricing model to estimate the fair value of these warrants with the following input assumptions: Armata’s closing market price on the valuation date, the risk-free interest rate computed based on the U.S. Treasury yield, the remaining contractual term as the expected term, and the expected stock price volatility calculated based on the historical volatility of the common stock of Armata’s peer companies.

As of March 31, 2020, the fair values of Armata’s common stock and warrants were estimated at $27.0 million and $19.9 million, respectively. The total fair value of both financial instruments in the amount of $46.9 million was recorded as equity investments on the consolidated balance sheets. We recorded $21.9 million of unrealized gains and fair value changes in Armata’s investments as changes in fair values of equity investments, net on the consolidated statements of income for the three months ended March 31, 2020.

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, 2020
			Gross		Gross
			Unrealized		Unrealized		Estimated
(In thousands)	Amortized Cost		Gains		Losses		Fair Value
U.S. government securities	$	13,958	$	41	$	—	$	13,999
U.S. commercial paper		48,964		—		—		48,964
Money market funds		285,309		—		—		285,309
Total	$	348,231	$	41	$	—	$	348,272

	December 31, 2019
			Gross		Gross
			Unrealized		Unrealized		Estimated
(In thousands)	Amortized Cost		Gains		Losses		Fair Value
U.S. government securities	$	53,799	$	35	$	—	$	53,834
U.S. commercial paper		18,915		—		—		18,915
Money market funds		233,992		—		—		233,992
Total	$	306,706	$	35	$	—	$	306,741

As of March 31, 2020, all of the available-for-sale debt securities had contractual maturities within one year, and the average duration of debt securities was approximately one month. There was no credit loss of these securities as of March 31, 2020.

Fair Value Measurements

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

	Estimated Fair Value Measurements as of March 31, 2020 Using:
	Quoted Price in
	Active Markets		Significant Other		Significant
	for Identical		Observable		Unobservable
Types of Instruments	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Total
Assets
U.S. government securities	$	—	$	13,999	$	—	$	13,999
U.S. commercial paper		—		48,964		—		48,964
Money market funds		285,309		—		—		285,309
Equity investment - Armata Common Stock		27,003		—		—		27,003
Equity investment - Armata Warrants		—		19,912		—		19,912
Total assets measured at estimated fair value	$	312,312	$	82,875	$	—	$	395,187
Debt
2023 Notes	$	—	$	216,886	$	—	$	216,886
2025 Notes		—		191,538		—		191,538
Total fair value of debt	$	—	$	408,424	$	—	$	408,424

	Estimated Fair Value Measurements as of December 31, 2019 Using:
	Quoted Price in
	Active Markets		Significant Other		Significant
	for Identical		Observable		Unobservable
Types of Instruments	Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Total
Assets
U.S. government securities	$	—	$	53,834	$	—	$	53,834
U.S. commercial paper		—		18,915		—		18,915
Money market funds		233,992		—		—		233,992
Total assets measured at estimated fair value	$	233,992	$	72,749	$	—	$	306,741
Debt
2023 Notes	$	—	$	243,394	$	—	$	243,394
2025 Notes		—		208,976		—		208,976
Total fair value of debt	$	—	$	452,370	$	—	$	452,370

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 equity investment in Armata’s commons stock is based on Armata’s closing market price per share at the reporting date and is a Level 1 financial instrument. The fair value of our equity investment in Armata’s warrants is classified within Level 2 as the assumptions used in the valuation model are based on the observable inputs that include Armata’s closing market price, its comparable companies’ market data and U.S. Treasury yield.

The fair value of our 2023 Notes and of our 2025 Notes is based on recent trading prices of the instruments.