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Theravance Respiratory Company, LLC

6 Months Ended

Jun. 30, 2021

7. Theravance Respiratory Company, LLC

Through the Company’s 85% equity interest in TRC, the Company is entitled to receive an 85% economic interest in any future payments made by GSK under the strategic alliance agreement and under the portion of the collaboration agreement assigned to TRC (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 primary drug program assigned to TRC is Trelegy.

In May 2014, the Company entered into the TRC LLC Agreement with Innoviva, Inc. (“Innoviva”) that governs the operation of TRC. Under the TRC LLC Agreement, Innoviva is the manager of TRC, and the business and affairs of TRC are managed exclusively by the manager, including (i) day to day management of the drug programs in accordance with the existing GSK agreements; (ii) preparing an annual operating plan for TRC; and (iii) taking all actions necessary to ensure that the formation, structure and operation of TRC complies with applicable law and partner agreements. The Company is responsible for its proportionate share of TRC’s administrative expenses incurred, and communicated to the Company, by Innoviva.

The Company analyzed its ownership, contractual and other interests in TRC to determine if it 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 it is 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 is not the primary beneficiary of TRC, and, as a result, the Company does not consolidate TRC in its condensed consolidated financial statements. TRC is recognized in the Company’s condensed consolidated financial statements under the equity method of accounting.

For the three and six months ended June 30, 2021, the Company recognized net royalty income of $21.9 million and $38.5 million, respectively, in the condensed consolidated statements of operations within “Income from investment in TRC, LLC”. These amounts were recorded net of the Company’s share of TRC’s expenses of $0.3 million and $3.1 million for the three and six months ended June 30, 2021, respectively. The share of TRC expenses for the three and six months ended June 30, 2021 was primarily comprised of TRC legal and related fees associated with the most recent arbitration between Innoviva, as the manager of TRC, and TRC and the Company (see below for more information regarding the arbitration).

For the three and six months ended June 30, 2020, the Company recognized net royalty income of $21.4 million and $34.9 million, respectively. These amounts were recorded net of the Company’s share of TRC’s expenses of $0.4 million and $0.6 million for the three and six months ended June 30, 2020, respectively.

For the three and six months ended June 30, 2021, the Company also recognized a net unrealized loss of $0.2 million and a net unrealized gain of $0.3 million, respectively, associated with the estimated fair market value of certain equity investments made by TRC.

As of June 30, 2021, the amounts due from TRC of $27.7 million were recorded as a current asset in the condensed consolidated balance sheets within “Amounts due from TRC, LLC”. In addition, the Company has recorded $35.8 million as a long-term asset within “Equity in net assets of TRC, LLC” in the condensed consolidated balance sheets which represented its share of TRC’s net assets including funds withheld by TRC for future investments.

TRC’s summarized income statement information is presented below:


	Three Months Ended June 30,				Six Months Ended June 30,
(In thousands)	2021		2020		2021		2020
Royalty revenue and gross profit	$	26,386	$	25,633	$	48,470	$	41,768
Income from continuing operations		26,050		25,153		44,853		41,017
Net income	$	25,796	$	25,154	$	44,116	$	41,054

On June 10, 2020, the Company disclosed in a Form 8-K that it had formally objected to TRC and Innoviva, regarding their proposed plan to use TRELEGY royalties to invest in certain privately-held companies, funds that would otherwise be available for distribution to the Company under the terms of the TRC LLC Agreement. In this regard, the Company initiated an arbitration proceeding in October 2020 against Innoviva and TRC, challenging the authority of Innoviva and TRC to pursue such a business plan rather than distribute such funds to the Company in a manner that it believes is consistent with the TRC LLC Agreement and its 85% economic interest in TRC. The arbitration hearing was held during the week of February 16, 2021, with post-hearing briefing and arguments taking place over the following few weeks.

On March 30, 2021, the arbitrator ruled that, at its current levels of investment, Innoviva and TRC had not breached the TRC LLC Agreement. The arbitrator further ruled that Innoviva and TRC had not breached the implied covenant of good faith and fair dealing; or their fiduciary duties. The arbitrator also ruled that (i) Innoviva is entitled to indemnification from TRC for all legal fees and expenses reasonably incurred in the arbitration and (ii) the Company is entitled to indemnification from TRC for legal fees and costs incurred in defending an action Innoviva brought against it in the Delaware Court of Chancery. The arbitrator noted in the ruling that although the Company failed to show that Innoviva’s investment activities, at the current levels of investment, have or will have a material and adverse effect on its economic interest in TRC, this does not mean that any future investments or actions will not require the Company’s consent. The arbitrator noted in the ruling that the Company may, in the future, have a consent right over the decision to continue this investment strategy or whether to make a particular investment if, for example, Innoviva develops a track record of poor investments, over allocates royalties to these investment activities, or fails to distribute sufficient investment returns, and such facts cause the strategy or investment to have a material adverse effect on the Company’s economic interest in TRC.

Pursuant to the terms of the TRC LLC Agreement, Innoviva is required to deliver to the Company a draft quarterly financial plan 30 days prior to the end of each fiscal quarter covering the next fiscal quarter. As previously disclosed, on June 2, 2021, the Company received from Innoviva the draft TRC quarterly financial plan for the quarter ending September 30, 2021. The draft financial plan noted that Innoviva intends to invest TRC funds into two private companies and incur significant fees and costs associated with these possible investments. The Company provided comments to TRC regarding these proposed actions by TRC with Innoviva, and objected to the withholding of funds by TRC for these and similar investments. While the LLC Agreement provides that Innoviva must consider in good faith any comments the Company provides, the financial plan became effective 30 days after the draft plan was provided to the Company. If, as reflected in the draft plan, TRC makes these contemplated investments and incurs the associated fees and costs as well as the other costs identified in the plan, distributions by TRC to its members in the third quarter of 2021 will be reduced substantially.

The Company’s objections with regard to the TRC quarterly plan or other actions by TRC could result in additional legal proceedings between the Company, TRC and Innoviva, as was the case when the Company initiated arbitration proceedings against Innoviva and TRC in May 2019 and again in October 2020. Any such legal proceedings could divert the attention of management and cause the Company to incur significant costs, regardless of the outcome, which the Company cannot predict. If such proceedings were pursued, there can be no assurance that they would result in the Company receiving additional distributions from TRC. An adverse result could materially and adversely affect the funds that the Company would otherwise expect to receive from TRC in the future.