INVA - NASDAQ

Eric d'Esparbes - Chief Financial Officer Michael Aguiar - Chief Executive Officer

Tyler Van Buren - Cowen and Company Prakhar Verma - Stifel, Nicolaus & Co., Inc.

Ladies and gentlemen, good afternoon. At this time, I’d like to welcome everyone to the Innoviva Third Quarter 2017 Financial Results Webcast and Conference Call. During the presentation, all participants will be in a listen-only mode. A question-and-answer session will follow the Company’s follow remarks. [Operator Instructions] I’ll repeat these instructions after management completes their prepared remarks. Today's conference call is being recorded. And now, I would like to turn the call over to Eric d'Esparbes, Chief Financial Officer of Innoviva. Please go ahead, sir.

Good afternoon, everyone, and thank you for joining us. With me on the call today is Mike Aguiar, our Chief Executive Officer. On today's call, Mike will review the highlights from the third quarter of 2017 and I will review our financial results. Following our comments, we will open up the call for questions. I also want to take a moment to say that due to the ongoing litigation with Sarissa Capital Domestic Fund LP and certain of its affiliates related to Innoviva’s 2017 Annual Meeting of Stockholders, we are not able to comment further at this time on this topic and do not intend to address the matter on this call. Earlier today, Innoviva issued a press release announcing recent corporate developments and financial results for the third quarter of 2017. A copy of the press release can be found on our website. Before we get started, we would like to remind you that this conference call contains forward-looking statements regarding future events and the future performance of Innoviva. Forward-looking statements include anticipated results and other statements regarding Innoviva's goals, plans, objectives, expectations, strategies and beliefs. These statements are based upon information available to the Company today and Innoviva assumes no obligation to update these statements as circumstances change. Future events and actual results could differ materially from those projected in the Company's forward-looking statements. Additional information concerning factors that could cause results to differ materially from our forward-looking statements are described in greater detail in the Company’s press release and the Company’s filings with the SEC. Additionally, adjusted EBITDA and adjusted earnings per share, two non-GAAP financial measures, will be discussed on this conference call. A reconciliation to the most directly comparable GAAP financial measures can also be found in our press release. I would now like to turn the call over to our Chief Executive Officer, Mike Aguiar.

Thank you, Eric, and good afternoon, everybody. Innoviva had a very successful third quarter of 2017 driven by record high TRx market share in the U.S. for RELVAR/BREO and ANORO, a successful refinancing our 9% royalty notes, and positive regulatory outcome in the U.S. and Europe for TRELEGY ELLIPTA. As a result, we remain confident that Innoviva is well-positioned to deliver value to shareholders through continuing profitability and further growth. Our partnership with GSK continues to make significant progress towards our goal of building BREO and ANORO into leading global medicines for the treatment of patients suffering from asthma and COPD. In the U.S, BREO and ANORO both continued to significantly outperform the market in prescription volume growth, resulting in new all-time high market share for both products. During Q3 2017, BREO script volume grew by 5.5% versus the second quarter, which compares favorably to the total LABA ICS market, which was down by 1.1% due to typically slow summer seasonality. We saw the same trends for ANORO, which had Q3 script growth volume of 10.3% compared to Q2, while the market was up 1.3%. I'm also pleased to note that BREO U.S. TRx volumes have broken through the 100,000 scripts per week level recently. According to most recent weekly data compiled by IMS, TRx market share for BREO is now at 18.4% and ANORO reached 15%. IMS data also show that BREO new to brand market share remained strong at 24.6% overall, and at more than 40% for pulmonologist. ANORO also significantly improved during the third quarter with higher market share in both TRx and NBRx. In the week ending October 19, ANORO new to brand market share was 22.1% overall and 24.9% for pulmonologists. As we mentioned on prior calls, improvements in various market share measures remain the primary metrics of our analytic efforts to assess progress toward the achievement of our commercial goals. In contrast, reported net sales by GSK experienced quarter-over-quarter volatility that is not related to underlying prescription trends. During the third quarter of 2017, in spite of continued strong TRx demand trends, GSK reported net sales for BREO that were down compared to Q2. According to GSK, the primary driver of this was a significant negative adjustment to returns and rebates accounting reserves related to prior periods. I would like to remind you that in Q2, net sales reported by GSK were favorably impacted by increases in U.S. wholesaler channel inventory, which did not continue during Q3. As a result of these two factors, the improvements in Q3 BREO product demand were offset from a net sales reporting perspective. RELVAR/BREO recorded total net sales during the third quarter of 2017 of $297.4 million, up 40% from Q3 last year. Net sales in the U.S. were $164.4 million, up 47%, while outside the U.S. net sales were $133 million, an increase of 32%. For ANORO, Q3 net sales were $111.9 million, a 57% increase from the third quarter of 2016. Overall in the U.S. market, BREO TRx in the third quarter of 2017 reached close to 1.3 million scripts, and approximately 73% increase compared to Q3 of 2016, while ANORO grew by approximately 69% during the same period. With strong underlying demand trends, favorable 2017 reimbursement status, and an effective collaboration with GSK, we remain optimistic about the potential for both products. In September, we received the positive regulatory news for TRELEGY ELLIPTA from the European Medicines Agency and the U.S. Food and Drug Administration. Importantly, both regulatory agencies noted the requirements for patients to step through ICS/LABA therapy before initiating on TRELEGY. In the U.S., BREO is required ICS/LABA under current labeling. We believe that these decisions highlight the importance of ICS containing therapies, such as BREO, in the treatment paradigm of COPD. This is another important milestone in our collaboration with GSK, as it completes the ELLIPTA portfolio and provides us with a strong respiratory portfolio position relative to other players in the respiratory market. Turning to our operations. We are very pleased with the refinancing of our 9% royalty notes. This is a significant event for the Company as interest cost is our single largest expense line in the P&L. Our new capital structure will allow the Company to reduce its cash interest spending by more than $18 million on an annual run rate basis, which is more than we spend in annual cash operating expenses. In addition, the special committee of the Company’s independent directors and the compensation committee completed its previously announced comprehensive review of the Company spending and executive and board compensation structures. During the course of the review, we began implementing certain changes in the second quarter and today, we announced completion of the review with a total identified savings of $2.2 million in 2017 versus our prior cash operating expense guidance representing a more than 10% reduction. In total, board and management actions during the third quarter have implemented cost savings actions including the refinancing of the 9% royalty notes that reduced our cash expenses by more than $20 million on an annual run rate basis. In addition to achieving material reductions in spending, we have also been focused on completing our 2017 capital return plan, and plan to launch an $80 million accelerated share repurchase program shortly. The completion of the ASR program will result in nearly $150 million of capital returns to investors for 2017 and reflects our positive outlook on the Company's future prospects. Now I’ll turn the call back to Eric to review our financial results. Eric?

Thanks Mike. Our royalties earned in the third quarter of 2017 were $51.9 million, a 42% increase over the third quarter of 2016 offset by $3.5 million of net non-cash amortization expense. Royalty revenues earned in the third quarter of 2017 included $44.6 million for BREO and $7.3 million for ANORO. Total operating expenses in the third quarter of 2017 were $8.6 million. This includes $3.8 million of operating expenses, $2.5 million in proxy contest and related litigation costs, and $2.5 million in non-cash stock compensation expenses. Year-to-date total operating expenses were $30.5 million consisting of $12.1 million in operating expenses, $11 million in proxy contest and related litigation costs, and $7.4 million in non-cash stock-based compensation expenses. As Mike mentioned earlier, the result of our cost review combined with the successful refinancing of our 9% royalty notes, result in cash expense savings in excess of $20 million on a run rate basis. We are reducing our guidance for 2017 full-year operating expenses from a range of $18 million to $20 million to a range of between $16 million and $18 million, a reduction of $2 million. As a reminder, our expense guidance excludes proxy contests and related litigation costs and non-cash stock-based compensation accruals. We continued to generate strong cash flows from our operations in the third quarter of 2017. Income from operation was $40 million compared to $27.9 million in the third quarter of 2016. Adjusted EBITDA was $46.1 million in the third quarter of 2017, compared to $33.2 million in the third quarter of last year. In spite of incurring cost associated with the proxy contest litigations which reduced basic EPS by approximately $0.02 per share in the third quarter of 2017, our adjusted earnings per share was $0.31 per share, up 82% compared with adjusted earnings per share of $0.17 in the third quarter of 2016. As Mike mentioned earlier, we fully refinanced our 9% royalty notes in August. We successfully issued $192 million in 2.5% interest convertible notes due 2025 with the strike price of $17.26 per share and we included a net share settlement option, which allows the Company to repay the par value of the notes in cash if the notes ever get converted. We believe this as a shareholder friendly feature since it allows the Company to substantially reduce dilution to existing shareholders, normally associated with convertible notes. We also successfully closed a five-year, $250 million Term B loan, paying a coupon of LIBOR plus 450 basis point, which currently represents an interest rates of approximately 5.8% on an annual basis. The Company received ratings from Moody's and from Standard & Poor's of B3 and B plus for corporate, and Ba3 and double B4 first lien Term B loan both with stable outlook. As a result of this financing, we've been able to reduce the Company's weighted average cash interest costs to approximately 3.6% and maintain the Company’s flexibility to continue gradually reducing our debt balance. For modeling purposes, side from the right of unamortized debt issuance cost of $6.4 million associated with the full repayment of our 9% royalty notes, which was reflected in other expansion in our Q3 financial results. We will add to our reported interest expense going forward, additional amortization charges associated with the new 2025 convertible notes, and the Term B loan. The amortization associated with the 2025 convertible notes is associated with a net share settlement option fair value of $65.4 million, which were referred to as a discount and will be allocated to the equity component of our balance sheet, and it will be amortized over the eight-year term of the note. The additional amortization associated with the Term B loan relates to the original interest discount of 1% commonly called OID, that was part of the final transaction turns and will be amortized over the five-year terms of the loan. Over the last 12 months, we generated approximately $179 million in adjusted EBITDA and continue to reduce our debt level during the quarter with a total net debt balance of $515.3 million at the end of the third quarter of 2017, resulting in a leverage ratio of 2.9 times net debt to last 12 months at adjusted EBITDA. As we mentioned earlier, we plan to launch an $80 million accelerated share repurchase program, compared with the $50 million early redemption of our 9% royalty notes we did in May and $17.5 million stock buyback within August, alongside issuance of the 2025 convertible notes. The ASR program will complete our 2017 capital return program. Cash, cash equivalents, short-term investments and marketable securities totaled $168.2 million as of September 30, 2017 and we had $51.9 million of royalties’ receivable from GSK at the end of the third quarter. With a more optimized capital structure, substantially reduced cash interest cost and continued strong cash generating capacity, we believe we are in a good liquidity position for the rest of 2017. And now, I would like to turn the call over to Mike for some closing comments.

Thank you, Eric. In summary, we remain optimistic about our future prospects based upon ongoing gains in prescription volumes and market share for both products and a steadily improving financial profile of the business. Our primary focuses in 2017 remain the optimization of the commercial success and global rollout of BREO and ANORO and the continued implementation of our capital return program. There are many positive things happening here in Innoviva and we remain optimistic about the outlook of the Company. I'd now like to ask the conference facilitator to open the call for questions.

Thank you, sir. [Operator Instructions] We’ll have our first question from Tyler Van Buren of Cowen and Company. Your line is now open.

Hi, guys. Good afternoon, and thanks for taking the questions. So I guess I was really surprised by the magnitude of the move that we saw here today in the stock following Glaxo's call, and was hoping that you could clarify some of the commentary. I guess my first question is kind of related to the macro picture in the respiratory space. You spent a little bit more time this quarter talking about the fact that the respiratory environment is challenging, which in my opinion it has been for quite a long time and then they talked about pricing and said that was in line with their expectations, which was comforting in some respect. So first, I was just hoping that you guys could clarify that there's no major kind of structural changes to the respiratory environment and from a macro perspective that it's kind of as expected?

Yes. Thanks, Tyler. So I certainly won’t be able to comment on the movement of the stock price. As you know, we don't set the stock price over here. But we certainly – we’re of the conference that GSK made. I think I would echo your view that in the market we've had some pricing pressure here, if you look backwards a little bit certainly in 2013 and 2014, in that timeframe things were more challenging than they have been today. There was a lot of pressure. Since then there's been a few percentage points coming out kind of each year. So nothing really dramatic. Interesting if you were to sort of look at Q3 of this year and Q3 of last year, both quarters had true-ups that were made by GSK during this time period. And I would reiterate one thing, it's just not perfectly on point with what you're asking, but just it’s I think an important point to mention is, we do see if you look back over several years, volatility that happens in quarter-over-quarter revenues and it is frequently not associated with what's going on in the specifics of that demand side of the equation. There was a true-up taken last year in Q3, a true-up taken this year in Q3. This isn’t exactly right, but they were roughly of similar magnitude relative to the sales. This one is a little bit bigger than last year. But I would just say that we do expect to continue to see that kind of volatility back and forth. So the last thing I would offer is I think the pricing environment is generally in line with what we had been in communicating and expecting this year. And a last piece of offer is I would not focus on any one quarter in a row, I would tend to look at four quarters, the current plus the prior three that we are capturing an entire cycle in there as you're thinking about pricing and whether we’re in line or not in line with things in the last piece most importantly is script volume, so very long-winded answer to your question to say that things were generally in line with our expectations, nothing dramatic in results so far.

Yes. That's helpful. You kind of preempted my follow-up, which was on the rebate adjustment and the pattern that seems to be emerging on Q3. And clearly if you look at the prescription trends for what is seasonally weak quarter, but they appeared in line and you take kind of the average gross to net from Q1, it looks like most of that delta at least in the U.S. with respect to BREO sales was from that rebate, so maybe if you could confirm that qualitatively. And also in Q4 a lot of times you don't see another big rebate right, you usually see it kind of reverse quarter-over-quarter. Is that true?

Yes. Well, I would say if you just look back at last year that was a period when there was a significant rebate, and in this year, Q4 historically has seen a little bit of channel build. I can't guarantee that that will happen this year, but certainly if you think history repeats itself, you would say that's a high possibility. So I'm not aware of any new adjustments that are going to be taken next quarter, but I would say that we typically look at Q4 as being a pretty good quarter. Two things going on. Generally, overall category scripts are up generally, and frequently you'll see a slight increase in channel inventory as wholesalers are banking on a price increase the next year. So I think those are two things to think about. I'm going to jump slightly off topic, again, if you give me a little artistic license here just to talk about two other things. There was a comment GSK made in their call noting that they still remain on track to have 2020 respiratory sales in total that are bigger than their 2015 sales. So if you look at that that clearly gives you some sense that what we're seeing today is not dramatically outside of our prior expectations. So I think it's sort of another piece of evidence of things are generally in line with what we're expecting. Last thing I’m going to offer, and again, I will say this is certainly not on topic again is our guidance this year was for an unlikely scenario that the generic of Advair will get approved and fortunately so far we've been right, but we really had maintained our guidance that it's likely that something happens next year. And again, I think all of that is factored into GSK’s guidance. So again, another long-winded answer saying, generally we are comfortable with where we are in and underlying trends are not dramatically outside of our expectations.

Yes. That's helpful. And on TRELEGY, obviously you guys have a smaller economics that's smaller royalty stream and so there's been some concerns about them taking patients away from BREO and they reiterated that it is at most 15% of BREO patients, in TRELEGY, it looks like it's a 50% price increase, and they mentioned that they – there's a step-through from BREO to TRELEGY and that they're a little bit more cautious on the launch. So that would all seem to suggest that BREO still has room to run and clearly the 2020 guidance is going to be – it's going to be a significant contributor right. Was there anything about the TRELEGY commentary that was different from that or perhaps you could speak towards what they're saying in terms of contracting?

No. In fact, I think their commentary was very much in line with what we've been saying. If you think about – I'm going to talk about the market opportunity for TRELEGY or the likely market opportunity and then I'll talk about a potential expectation around slope. And both of these have been pretty consistently articulated by us. The first one is, as you think about the logical place for TRELEGY, we will find a home. It’s in the – what used to be called it GOLD D patients for a very big [rough around] numbers, something like 60% of LABA ICS business in the United States is in asthma and of course as plus or minus a little bit and the reciprocal of that is in COPD. So I'll just use 40% to keep the math simple. Of COPD patients, something like 40% of LABA ICS scripts are in combination with something else. So there was – we call the open triple. So if you just take 40% and 40% that gets you to 16%. There is the reasonable market opportunity for where TRELEGY today would fit in there ultimately, obviously if we plus or minus a little bit on that. And then the last thing as we've been very consistent saying if you look at every single respiratory product launch in recent history, you'll find it had a very slow ramp and I wouldn't intuitively expect anything different than that and I think GSK articulated a similar view here this morning. So again I think where we are today is largely in line with expectations. I would say we didn't initially expect this step through piece for both of the labels. But it's certainly in Innoviva’s mind gives a pretty good validation of the regulator is being very comfortable with ICS containing regimens and patient for COPD. So again, a short answer to say that generally the comments GSK made are pretty darn close to what we have been saying as well.

Great and just last question, on the $80 million buyback clearly bringing down the blended interest rate on the debt, makes the buyback even, even more attractive. But I guess is that debt guaranty to be executed by year-end and how do you think about paying back debt versus buyback kind of moving forward after the year in terms of creating value for shareholders?

Yes, thanks, Tyler. So for obvious reasons similar to what we've previously said about buyback programs, but probably not going to go into the detail of how we kind of executing this, that would be kind of giving the market information that would impede our ability to trade on behalf of our shareholders. So the plan is under ASR, you're committed to the amount, the timing and mechanism of doing the implementation is the part that will keep for our self right now, but you can consider that's a full commitment of the purchase. With regard to debt repayment, as part of the Term B turns we have minimal principal repayment every quarter so it's 10% annually, so 2.5% every quarter. So that will be done. We have the ability to do additional early prepayment on a Term B and the decision on making that decision will be predicated on their capital allocation plan that we are in the process of reviewing with our board and we'll have future communications on the plan for next year.

And just one final comment back to the share price on that – I was throw when the stock price goes down, but certainly since we have a plan in place now. I'm happy to pick up share at a lower price and create more value for shareholders. So we're going to have the good fortune of capitalizing on that.

That's great. Thanks for taking the several questions.

Thanks, Tyler. I appreciate it.

Thank you. [Operator Instructions] Our next question comes from the line of Stephen Willey of Stifel. Your line is now open.

Great, thank you. This is Prakhar Verma on for Steve. So quick question on the formulated positions for both BREO and ANORO for 2018, can you comment on what they are with the respected 2007 TRIs and other details?

Yes, we don’t have a lot of direct commentary on that. I would just say we have as good of coverage as anybody in the space. I mean certainly would not be the case on every single payer on a payer by payer basis, some were a little better, some were a little worse. But if you look across the Board, we are very, very well-positioned from a payer perspective. I haven't heard of any significant changes one way or another in 2018. I will give GSK credit. They've done a very nice job on the payer side. So I'm not expecting any data, any big drama around that one at all. I suspect we're going to be as well-positioned as anybody in 2018. Last thing is with the triple, we’ve articulated our view quite frequently that it will be helpful in terms of coverage for us. So I think this is very much a marginal benefit, but with that full portfolio, we will be the only record of portfolio that has the ability to treat some sort of first to last visit for many of these patients. So I think we're going to be very well-positioned, no updates, but I would just assume we're going to continue to be very, very well covered from a payer perspective.

And just last question on the impact trial data. What do you think the impact would be when the data finally is published or presented or also added to the label on the uptick with the triple?

Well, we'll have to see what the ultimate label looks like when the impact is incorporated. We know what it is today obviously, but we’ll have to see what the agencies view that the data has or kind of take a jump from there and say, our view of the impact data was very good. We expected the triple to win and it did. We've held a longstanding view here that LABA/ICS therapy provided a better control of exacerbations and just a bronchodilator alone and that's what you saw in this study as well. So we were pleased with that data. I think, I would probably just hold off on where regulatory agencies may take that until we actually see what happens. Now the last piece is what does that mean on uptick, again, the best example I can give you is history. I can't guarantee this is a perfect analog, but I'll try. When we launched ANORO, ANORO has data that said it was better than single agent LAMAs, so BREO at that time. And even with data, within the label that said it was better than it was out there, you saw a very flat slope. And I think that is just a more common rather than a less common launch trajectory for respiratory products. So based on that my suspicion is that our prior guidance of a relatively shallow launch GSK’s view was articulated today on the same thing in history are probably the best guide on how things will potentially look with the triple.

Okay. Thanks for taking my question.

Thank you so much for your question. End of Q&A

Thank you. It appears we have no further questions on the phone. I would now like to turn the conference back to Mr. d’Esparbes. Please go ahead, sir.

All right. Thank you very much operator. And thanks everyone for joining the call. Have a good day.