4. Debt

On June 29, 2012, the Company and its domestic subsidiaries, as co-borrowers, entered into a Loan and Security Agreement that allowed the Company to borrow up $20.0 million in $10.0 million increments (“Loan Agreement”). The Company borrowed the first and second $10.0 million increments by signing two Secured Promissory Notes (“Note A” and “Note B” and collectively, the “Notes”) on June 29, 2012 and December 27, 2012, respectively. Notes A and B bear interest at 9.25%. Note A was originally scheduled to be repaid over a 42-month period with the first twelve monthly payments representing interest only followed by thirty monthly equal payments of principal and interest. Note B was originally scheduled to be repaid over a 36-month period with the first six monthly payments representing interest only followed by thirty monthly equal payments of principal and interest. The Loan Agreement provided that in certain circumstances the Company could delay the first principal payment by five months. In July 2013, subsequent to the completion of certain ARIKACE-related development milestones, the Company elected to extend the interest only period under the Notes from July 31, 2013 to December 31, 2013 and delay the first monthly principal repayments for Notes A and B from August 1, 2013 to January 1, 2014. The election did not change the maturity date for Notes A and B, which is January 1, 2016. The “Current portion of long-term debt” and “Debt, long-term” balances included in the consolidated Balance Sheet as of September 30, 2013 and the future principal repayments summarized in the table below reflect this extension of the interest-only period.

In connection with entering into the Loan Agreement, the Company granted the lender a first position lien on all of the Company’s assets, excluding intellectual property. Prepayment of the loans made pursuant to the Loan Agreement is subject to a prepayment penalty. The Company will be required to pay an “end of term” charge of approximately $0.4 million upon termination of the Loan Agreement, which is being charged to interest expense (and accreted to the debt) using the effective interest method over the term of the Notes. Debt issuance costs paid to the lender were recorded as a discount on the debt and are being amortized to interest expense using the effective interest method over the life of the Loan Agreement. Debt issuance costs paid to third parties were capitalized and are being amortized to interest expense using the effective interest method over the term of the Notes.

The Loan Agreement also contains representations and warranties by the Company and the lender, indemnification provisions in favor of the lender, customary covenants (including limitations on other indebtedness, liens, acquisitions, investments and dividends, but no financial covenants), and events of default (including with respect to payment defaults, breaches of covenants following any applicable cure period, a material impairment in the perfection or priority of the lender’s security interest or in the collateral, and events relating to bankruptcy or insolvency). Upon the occurrence of an event of default, a default interest rate of the base rate plus an additional 5% may accrue on the outstanding loan balances, and the lender may terminate its lending commitment, declare all outstanding obligations immediately due and payable, and take such other actions as set forth in the Loan Agreement. In addition, pursuant to the Loan Agreement, the lender has the right to participate, in an amount of up to $1.0 million, in certain future private equity financing(s) by the Company.

In conjunction with entering into the Loan Agreement, the Company granted a warrant to the lender to purchase shares of the Company’s common stock. Since the warrant was granted in conjunction with entering into the Loan Agreement, the relative fair value of the warrant was recorded as equity and debt discount. The portion of the fair value allocated to debt discount is being amortized to interest expense over the term of the related debt using the effective interest method.

The following table presents the components of the Company’s debt balance as of September 30, 2013.

	September 30, 2013
	(in thousands)
Debt:
Notes payable	$	20,000
Add:
Accreted end of term charge	170
Less:
Unamortized debt issuance fees paid to lender	(140		)
Unamortized discount from warrant	(437		)
Current portion of long-term debt	(7,055		)
Long-term debt	$	12,538

Future principal repayments of the Notes are as follows (in thousands):

Year Ending December 31:
2014	9,519
2015	10,451
2016	30
Total	$	20,000

The estimated fair value of the debt (categorized as a Level 2 liability for fair value measurement purposes) is determined using current market factors and the ability of the Company to obtain debt at comparable terms to those that are currently in place. We believe the estimated fair value at September 30, 2013 approximates the gross carrying amount.