Theravance Biopharma, Inc.

Effective January 1, 2019, the Company adopted ASU 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 provided 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 adoption of ASU 2017-09 did not have a material impact upon the Company’s condensed consolidated financial statements and related disclosures as of January 1, 2019.

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13"). This guidance requires that financial assets measured at amortized cost be presented at the net amount expected to be collected. The measurement of expected credit losses is based on historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability. ASU 2016-13 also eliminates the concept of “other-than-temporary” impairment when evaluating available-for-sale debt securities and instead focuses on determining whether any impairment is a result of a credit loss or other factors. An entity will recognize an allowance for credit losses on available-for-sale debt securities rather than an other-than-temporary impairment that reduces the cost basis of the investment. ASU 2016-13 is effective for annual reporting periods and interim periods within those years beginning after December 15, 2019. The Company does not currently expect ASU 2016-13 to have a material impact on its consolidated financial statements and related disclosures based on the historical high credit quality of the Company’s financial instruments.

Our special purpose subsidiary Triple Royalty Sub LLC (the “Issuer”) issued the Non-Recourse 2033 Notes in November 2018, which are secured by all of the Issuer’s rights, title and interest as a holder of certain membership interests (the “Issuer Class C Units”) in TRC. The Issuer Class C Units entitle the Issuer to receive 63.75% of the economic interest that TRC receives in any future payments made by GSK under the agreements described above, or 75% of the income from our ownership interest in TRC. The primary source of funds to make payments on the Non-Recourse 2033 Notes will be 75% of the income from our ownership interest in TRC, as evidenced by the Issuer Class C Units. Since the principal and interest payments on the Non-Recourse 2033 Notes are ultimately based on royalties from TRELEGY ELLIPTA product sales, which will vary from quarter to quarter, the Non-Recourse 2033 Notes may be repaid prior to the final maturity date in 2033.  In order to comply with Regulation RR – Credit Risk Retention (17 C.F.R. Part 246), 5.0% of the original principal amount (equal to $12.5 million) of the Non-Recourse 2033 Notes were retained by Theravance Biopharma R&D, Inc., our wholly-owned subsidiary, and is eliminated in our condensed consolidated financial statements.

We have initiated an arbitration against Innoviva and TRC because Innoviva has caused TRC not to make any distributions to us with respect to our 85% economic interest in TRC for the quarter ended December 31, 2018, which distributions were due March 31, 2019, and Innoviva’s statement to us that it intends to cause TRC to withhold making further cash distributions through calendar year 2019. We believe that these actions by Innoviva and TRC constitute a material breach of their obligations to disburse to us 85% of the royalties paid to TRC by GSK as a result of GSK’s net sales of TRELEGY ELLIPTA (net of TRC expenses paid and the amount of cash, if any, expected to be used by TRC pursuant to the Agreement over the next four fiscal quarters). The TRC LLC Agreement imposes express fiduciary duties on Innoviva as manager. To ensure that Innoviva causes TRC to fulfill its contractual duties to distribute royalties, and to discharge its own fiduciary duties, the TRC LLC Agreement imposes significant limitations on Innoviva’s authority as manager, including requiring Theravance Biopharma’s consent before taking actions or omitting to take actions that would reasonably be expected to have a direct or indirect material and adverse effect on the Theravance Biopharma’s economic interest in TRC or its rights, preferences, privileges or obligations.

Satisfying the obligations of these Notes could adversely affect the amount or timing of any distributions to our shareholders. We may choose to satisfy, repurchase, or refinance these Notes through public or private equity or debt financings if we deem such financings are available on favorable terms. If any or all of the Convertible Senior 2023 Notes are not converted into our ordinary shares before the maturity date, we will have to pay the holders the full aggregate principal amount of the Convertible Senior 2023 Notes then outstanding. If the Non-Recourse 2033 Notes are not refinanced or paid in full, the holders of the Non-Recourse 2033 Notes will have the right to foreclose on the Issuer Class C Units that represent a 63.75% economic interest in future royalties due on net sales of Trelegy Ellipta and related assets. If the Issuer Class C Units are foreclosed upon, we will lose any right to receive 75% of the future royalty payments made by GSK in connection with the net sales of Trelegy Ellipta and related assets. Any of the above payments could have a material adverse effect on our cash position. Our failure to satisfy these obligations may result in a default under the applicable indenture governing these Notes, which could result in a default under certain of our other debt instruments, if any. Any such default would harm our business and the price of our securities could fall.