Financial Instruments and Fair Value Measurements

9 Months Ended

Sep. 30, 2020

Financial Instruments and Fair Value Measurements

Financial Instruments and Fair Value Measurements

5. 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 owned 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 to account for both Armata’s common stock and warrants. 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 and its peer companies.

As of September 30, 2020, the fair values of Armata’s common stock and warrants were estimated at $27.8 million and $20.2 million, respectively. The total fair value of both financial instruments in the amount of $48.0 million was recorded as equity investments on the consolidated balance sheets as of September 30, 2020. We recorded $12.4 million in unrealized loss and $23.0 million in unrealized gain from 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 and nine months ended September 30, 2020, respectively.

Equity Investment in Entasis

On April 12, 2020, we entered into a securities purchase agreement with Entasis (“April 2020 Entasis Agreement”) to purchase 14,000,000 shares of Entasis common stock as well as warrants to purchase 14,000,000 additional shares of its common stock for approximately $35.0 million in cash. Entasis is a clinical-stage biotechnology company focused on the discovery and development of novel antibacterial products. The investment is to support Entasis's ongoing advancement of its pathogen-targeted antibacterial product candidates, which include their global Phase 3 registration trial evaluating a fixed-dose combination of sulbactam and durlobactam (SUL-DUR) against Acinetobacter baumanii infections.

The investment was closed in two tranches on April 22, 2020 and June 11, 2020. Innoviva has a right to designate two members to Entasis's board. After the second closing, we owned approximately 51.3% of Entasis's common stock.

On August 27, 2020, we entered into another securities purchase agreement with Entasis ("August 2020 Entasis Agreement") to purchase 4,672,897 shares of Entasis common stock as well as warrants to purchase 4,672,897 additional shares of its common stock for approximately $12.5 million in cash. On September 1, 2020, we completed the purchase and increased our ownership in Entasis's common stock to 52.6%.

The investment provides Innoviva the ability to have significant influence, but not control, over Entasis's operations. Based on our evaluation, we determined that Entasis is a VIE, but Innoviva is not the primary beneficiary of the VIE. We elected the fair value option to account for both Entasis's common stock and warrants at fair value. The fair value of Entasis's common stock is measured based on its closing market price at each balance sheet date. The warrants have an exercise price of $2.50 per share under the April 2020 Entasis Agreement and an exercise price of $2.675 under the August 2020 Entasis Agreement. The warrants 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: Entasis'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 Entasis and its peer companies.

As of September 30, 2020, the fair values of Entasis's common stock and warrants were estimated at $38.1 million and $25.7 million, respectively. The total fair value of both financial instruments in the amount of $63.8 million was recorded as equity investments on the consolidated balance sheets. We recorded $17.0 million in unrealized loss and $16.3 million in unrealized gain from fair value changes in Entasis's investments as changes in fair values of equity investments, net on the consolidated statements of income for the three and nine months ended September 30, 2020, respectively.

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:

	September 30, 2020
			Gross		Gross
			Unrealized		Unrealized		Estimated
(In thousands)	Amortized Cost		Gains		Losses		Fair Value
Money market funds	$	430,144	$	—	$	—	$	430,144
Total	$	430,144	$	—	$	—	$	430,144

	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 September 30, 2020, all investments were money market funds. There was no credit loss as of September 30, 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 September 30, 2020 Using:
	Quoted Price		Significant
	in Active		Other		Significant
	Markets for		Observable		Unobservable
Types of Instruments	Identical Assets		Inputs		Inputs
(In thousands)	Level 1		Level 2		Level 3		Total
Assets
Money market funds	$	430,144	$	—	$	—	$	430,144
Equity investment - Armata Common Stock		27,787		—		—		27,787
Equity investment - Armata Warrants		—		20,167		—		20,167
Equity investment - Entasis Common Stock		38,093		—		—		38,093
Equity investment - Entasis Warrants		—		25,698		—		25,698
Total assets measured at estimated fair value	$	496,024	$	45,865	$	—	$	541,889
Debt
2023 Notes	$	—	$	230,494	$	—	$	230,494
2025 Notes		—		191,491		—		191,491
Total fair value of debt	$	—	$	421,985	$	—	$	421,985

	Estimated Fair Value Measurements as of December 31, 2019 Using:
	Quoted Price		Significant
	in Active		Other		Significant
	Markets for		Observable		Unobservable
Types of Instruments	Identical 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 values of our equity investments in Armata and Entasis's common stock are based on their respective closing market prices per share at the reporting date and are classified as Level 1 financial instruments. The fair values of our equity investments in Armata and Entasis's warrants are included within Level 2 as the assumptions used in the valuation model are based on the observable inputs that include their respective closing market prices per share, their respective comparable companies’ market data and the 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.