8. Financing Obligations

Autoliv ASP, Inc.

In June 2010, in return for transfer to us of all right, title and interest in a production line for the commercial manufacture of Chemical Heat Packages completed or to be completed by Autoliv on our behalf, we paid Autoliv $4,000,000 in cash and issued Autoliv a $4,000,000 unsecured promissory note. In February 2011, we entered into an agreement to amend the terms of the unsecured promissory note, or the Autoliv Note. Under the terms of the Autoliv Note, the original $4,000,000 note was cancelled and the Autoliv Note was issued with a reduced principal amount of $2,800,000.

The Autoliv Note bore interest beginning on January 1, 2011 at 8% per annum and was paid in 48 consecutive and equal monthly installments of approximately $68,000. The Autoliv Note was paid in full in 2014.

Teva Pharmaceuticals USA, Inc.

In May 2013, concurrent with the Teva Agreement (refer to Note 9 – License Agreements), we entered into a Convertible Promissory Note and Agreement to Lend, dated as of May 7, 2013, between us and Teva, or the Teva Note. Under the terms of the Teva Note, we had the ability, upon written notice to Teva, to draw upon the Teva Note to fund agreed operating budgets related to ADASUVE. As of December 31, 2014, the aggregate drawdowns totaled $25,000,000 and are due and payable, together with all interest, on the fifth anniversary of the signing of the Teva Note. At any time prior to five days before the maturity date, Teva has the right to convert the then outstanding amounts into shares of our common stock at a conversion price of $4.4833 per share. The Teva Note bears simple interest of 4% per year.

At the time of the drawdowns, the contractual conversion price was less than the value of our common stock. As a result, at each draw down date, we calculated the value of the beneficial conversion feature of the convertible note and recorded an increase to additional paid-in-capital and a discount on the Teva Note which is being amortized to interest expense over the life of the borrowing. Additionally, at each draw, we reclassified the relative portion of the unamortized right-to-borrow asset, classified as an Other Asset, against the Teva Note, which is also being amortized to interest expense over the life of the borrowing.

As we drew on the Teva Note, the relative portion of the unamortized right-to-borrow was accounted for as a discount on the borrowing and is being amortized to interest expense over the life of the borrowing. The following table shows the effective interest rate for each drawdown after taking into consideration the beneficial ownership features and the right-to-borrow asset discount.

					Reclassified
			Beneficial		Unamortized		Effective
	Draw		Conversion		Right-to-		Interest
	Amount		Feature		Borrow		Rate
September 2013	$	10,000,000	$	2,455,000	$	900,000		14.20	%
December 2013		5,000,000		657,000		393,000		10.20	%
March 2014		5,000,000		883,000		318,000		11.60	%
June 2014		5,000,000		148,000		252,000		6.60	%

We recognized $216,000 and $752,000 of interest expense related to amortization of the right-to-borrow asset during the fiscal years ended December 31, 2014 and 2013, respectively. As of December 31, 2014, all of the right-to-borrow asset had been reclassified against the Teva Note.

In February 2016, we entered into an amendment to the Teva Note, or the Amended Teva Note, which provides that (i) we issue 2,172,886 shares of our common stock to Teva pursuant to a stock issuance agreement as consideration for a reduction in the outstanding balance of the Amended Teva Note by $5,000,000 and forgiveness of all accrued and unpaid interest under the Amended Teva Note; (ii) we are obligated to repay the remaining $20,000,000 outstanding balance of the Amended Teva Note in four annual consecutive payments of $5,000,000 beginning in the first calendar year following the calendar year in which the aggregate annual net sales of ADASUVE and any other Staccato enabled products first reach $50,000,000 in the United States; and (iii) we may prepay the outstanding balance of the Amended Teva Note. We are further evaluating the impact of these potential changes on our consolidated financial position, results of operations and cash flows.

Royalty Securitization Financing

In March 2014, we completed a royalty securitization financing, or the royalty securitization financing, which consisted of a private placement to qualified institutional investors of $45,000,000 of non-recourse notes issued by our wholly-owned subsidiary, or the Notes, and warrants to purchase 345,661 shares of our common stock at a price of $0.01 per share exercisable for five years from the date of issuance. The Notes bear interest at 12.25% per annum payable quarterly beginning June 15, 2014. All U.S. ADASUVE royalty and milestone payments under the Teva Agreement, after paying interest, administrative fees, and any applicable taxes, will be applied to principal and interest payments on the Notes until the Notes have been paid in full.

From the proceeds of the transaction, we established a $6,890,000 interest reserve account, which is classified as a noncurrent asset, to cover any potential shortfall in interest payments. At December 31, 2014, $2,757,000 remained in the interest reserve account. The interest reserve account was fully utilized in 2015 to pay for interest related to our royalty securitization financing.

In connection with our royalty securitization financing, we sold and contributed to our wholly-owned subsidiary all of our rights to U.S. ADASUVE royalty and milestone payments. The Notes are secured all of the assets of our subsidiary (including the right to receive royalty and milestone payments based on commercial sales of ADASUVE in the U.S.) and our equity ownership in the subsidiary. The Notes have no other recourse to us. The Notes may not be redeemed at our option until after March 18, 2016, and may be redeemed after that date subject to the achievement of certain milestones and the payment of a redemption premium for any redemption occurring prior to March 19, 2019. The Notes are not convertible into Alexza equity, nor have we guaranteed them.

We valued the warrants issued to the Note holders utilizing the Black-Scholes valuation model with an assumed volatility of 87%, an estimated life of 5 years, a 1.54% risk-free interest rate and a dividend rate of 0%. The total value of the warrants, $1,721,000, was recognized as an increase to additional paid in capital and as a discount to the Notes. The Note discount is being amortized into interest expense over five-years. We incurred total fees and expenses of $4,171,000, which we recorded as a noncurrent Other Asset, and are amortizing into interest expense over a five-year period.

In the fourth quarter of 2015, we did not make the quarterly interest payment due on December 15, 2015 for the Notes. As a result, we received a notice of event of default from the trustee. The aggregate interest payments that were in default were approximately $2,800,000, which includes the interest due and payable on September 15, 2015 and December 15, 2015. In January 2016, we entered into a forbearance agreement with the noteholders whereby the Noteholders would generally forbear from delivering an acceleration notice and exercising other remedies under the Notes for thirty day renewing periods through June 15, 2016. As a result of our default and the short forbearance time period, the principal balance of $45,000,000 and the amortization of the debt discounts of $74,000 related to the five-year warrants issued in connection with the royalty securitization financing were reclassified from non-current liabilities to current liabilities as of December 31, 2015. Additionally, the deferred interest charges associated with the royalty securitization financing that were being amortized over five years were reclassified from non-current assets to other current assets as of December 31, 2015, consistent with the related debt.

Ferrer Promissory Note

In September 2015, we issued the Ferrer Note to Ferrer. The terms of the Ferrer Note provide that (i) Ferrer will loan us up to $5,000,000 in tranches, ii) the initial tranche of $3,000,000 was received by us on September 28, 2015, (iii) another tranche of $1,000,000 was received by us on March 21, 2016, (iv) we have the option to borrow an additional tranche of $1,000,000 at any time, (v) interest accrues on the outstanding principal at the rate of 6% per annum, compounded monthly, through May 31, 2016, (vi) all outstanding principal and accrued interest under the Ferrer Note is due and payable upon Ferrer’s demand on May 31, 2016, (vii) we may prepay the Ferrer Note at any time without premium or penalty, and (viii) we issued 125,000 shares of our common stock to Ferrer as partial consideration for the loan. The common stock was issued to Ferrer pursuant to the Stock Issuance Agreement and was not registered at the time of issuance under the Securities Act of 1933, as amended. As of March 23, 2016, an aggregate of $4,000,000 of the principal amount of the Ferrer Note was outstanding.

We valued the common stock issued to Ferrer at approximately $144,000 using the closing price of our common stock on the date we issued the stock to Ferrer. Based on the percent of the maximum principal amount of the Ferrer Note drawdown to date, 60% of the value of the common stock issued to Ferrer was proportionately recorded as a discount to the Ferrer Note and 40% was capitalized as a current asset on our consolidated Balance Sheet. As we drawdown any additional tranches, the remaining balance of the capitalized amount will be reclassified as a debt discount against the additional tranche. The amount of $144,000 is being amortized over the life of the Ferrer Note. The effective interest rate of the note, including the value of the shares issued, is 10.5%.

Future scheduled principal payments under the debt obligations as of December 31, 2015 are as follows (in thousands):

	Total
2016	$	3,000
2017		—
2018		—
2019		—
Thereafter		25,000
Total	$	28,000

The above table excludes any payments pursuant to the $45,000,000 from the royalty securitization financing notes of our wholly-owned subsidiary, which have a legal maturity date in 2027. The principal payments by the subsidiary under the royalty securitization financing will be dependent upon the timing and amounts of royalties and milestone payments received under the Teva Agreement.