8. Financing Obligations

Teva Pharmaceuticals USA, Inc.

In May 2013, concurrent with our execution of a License and Collaboration Agreement with Teva, or the Teva Agreement (refer to Note 9 – License Agreements), we entered into a Convertible Promissory Note and Agreement to Lend with 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, 2015, 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. Under 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 was 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 was 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 was amortized to interest expense over the life of the borrowing. The right-to-borrow asset had been fully reclassified against the Teva Note in 2014.

In February 2016, we entered into the Amended Teva Note, which provided for (i) the issuance of 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) the contingent repayment of the remaining $20,000,000 outstanding balance of the Amended Teva Note in four annual consecutive payments of $5,000,000 on January 31 of the 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 assessed the note restructuring under ASC 470, Debt, and concluded that the transaction qualified as a troubled debt restructuring as defined by the accounting literature, as we are experiencing financial difficulty and the Amended Teva Note contained a concession through a reduction in the effective interest rate from 5.2 percent to zero percent. At the date of restructuring, the carrying amount of the Teva Note was $23,081,000. As the restructuring involved a partial settlement by us granting Teva an equity interest and a modification of the terms of the remaining Teva Note, we reduced the carrying amount of the Amended Teva Note by $575,000, which represents the fair value of the 2,172,886 shares of our common stock granted to Teva based on the $0.28 per share price as of the restructuring date, net of $33,000 in direct issuance costs. The remaining carrying amount of $22,506,000 was then written down to $20,000,000, which represents the total future undiscounted cash payments of the Amended Teva Note and consist entirely of the contingent repayments, resulting in a restructuring gain of $2,506,000, or $0.12 per share as reflected on our consolidated statements of loss and comprehensive loss. The remaining outstanding balance of $20,000,000 of the Amended Teva Note is classified as a non-current liability as of March 31, 2016.

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, or the Notes, issued by Atlas U.S. Royalty, LLC, a Delaware limited liability company and our wholly-owned subsidiary, or Atlas, 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, or the 2014 Warrants. The Notes bear interest at 12.25% per annum payable quarterly beginning June 15, 2014. All U.S. ADASUVE royalty and milestone payments, 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. 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 Atlas all of our rights to U.S. ADASUVE royalty and milestone payments. The Notes are secured by all of the assets of Atlas (including the right to receive royalty and milestone payments based on commercial sales of ADASUVE in the U.S.) and our equity ownership in Atlas. 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.

In connection with the execution of the Merger Agreement, the holders of the Notes each entered into a participation agreement with Atlas pursuant to which Atlas agreed to grant to the holders of the Notes contractual rights to receive payments from Atlas upon the receipt of certain payments and achievement of certain milestones in respect of the commercialization of ADASUVE within the Unites States.

We valued the 2014 Warrants 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 2014 Warrants, $1,721,000, was recognized as an increase to additional paid in capital and as a discount to the Notes. The discount on the Notes 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 $4,262,000, which includes the interest due and payable since September 15, 2015. In January 2016, we entered into a forbearance agreement with the holders of the Notes whereby such holders would generally forbear from delivering an acceleration notice and exercising other remedies under the Notes for thirty day renewing periods through June 15, 2016. In connection with the execution of the Merger Agreement, we entered into a Forbearance and Waiver Agreement, or the Second Forbearance Agreement, with Atlas, Purchaser and the holders of the 2014 Warrants and the Notes. Pursuant to the terms of the Second Forbearance Agreement, the holders of the Notes agreed (i) to forbear on exercising all rights and remedies under that certain Indenture by and between Atlas and U.S. Bank National Association, as the trustee, or the Indenture, and the other documentation relating to the Notes and Atlas through the earlier of November 9, 2016 (subject to extension under certain circumstances) and the termination of the Merger Agreement and (ii) to ratify certain amendments to the Teva Agreement. Pursuant to the terms of the Second Forbearance Agreement, the holders of the Notes also agreed to the cancellation of the Notes and the discharge of the Indenture in connection with the consummation of the Offer and to take any and all actions necessary to effect the foregoing. In addition, the holders of the 2014 Warrants agreed to the treatment of the 2014 Warrants in connection with the Offer as described in the Merger Agreement effective as of the Merger. Each of the holders of the Notes, the holders of the 2014 Warrants, Atlas and us also agreed to certain releases of claims effective upon the consummation of the Offer or, in the case of claims with respect to Purchaser and its affiliates, upon the execution of the Second Forbearance Agreement.

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 $1,021,000 related to the 2014 Warrants were reclassified from non-current liabilities to current liabilities since the fourth quarter of 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 March 31, 2016, consistent with the related debt.

Ferrer Promissory Note

In September 2015, we issued the Ferrer Note to Ferrer. The terms of the Ferrer Note provided that (i) Ferrer would 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) the third tranche of $1,000,000 was received by us on April 15, 2016, (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 became due and payable upon Ferrer’s demand on May 31, 2016, (vii) we could prepay the Ferrer Note at any time without premium or penalty, and (viii) we issue 125,000 shares of our common stock to Ferrer as partial consideration for the loan. The common stock was issued to Ferrer pursuant to a stock issuance agreement and was not registered at the time of issuance under the Securities Act of 1933, as amended.

On May 9, 2016, we amended and restated the Ferrer Note in order to, among other things (i) increase the maximum principal amount of the Ferrer Note to $6,300,000, (ii) extend the maturity date of the Ferrer Note to September 30, 2016 and (iii) provide for certain events of default under the Ferrer Note in connection with the Merger. As of May 11, 2016, the outstanding principal amount of the Ferrer Note was $6,300,000.

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 through March 31, 2016, 80% of the value of the common stock issued to Ferrer was proportionately recorded as a discount to the Ferrer Note and 20% was capitalized as a current asset on our consolidated Balance Sheet as of March 31, 2016. With the third tranche and the final tranche of the Ferrer Note drawn in April 2016 and May 2016, respectively, the remaining balance of the capitalized amount will be reclassified as a debt discount against the remaining tranches. The amount of $144,000 is being amortized over the life of the Ferrer Note. The effective interest rate of the Ferrer Note, including the value of the shares issued, is 10.5%.

Future Scheduled Payments

Future scheduled principal payments under our various debt obligations as of March 31, 2016 are as follows (in thousands):

	Total
2016 - remaining 9 months	$	4,000
2017		—
2018		—
2019		—
Thereafter		20,000
Total	$	24,000

The above table excludes the third tranche of $1,000,000 and the final tranche of $1,300,000 from the Ferrer Note that we received in April and May 2016, respectively, plus any payments pursuant to the Notes issued by Atlas, which have a legal maturity date in 2027. The principal payments by Atlas under the royalty securitization financing will be dependent upon the timing and amounts of royalties and milestone payments received from any future U.S. collaborator. 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 on January 31 of 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.