8. NOTES PAYABLE

HealthCare Royalty Partners

In August 2012, the Company completed an agreement with an affiliate of HealthCare Royalty Partners, formerly Cowen Healthcare Partners (HC Royalty) entered into in December 2011, to refinance its existing loans with HC Royalty. As of the refinancing, the aggregate principal amount of the new loan was $80.5 million, consisting of a $21.7 million Tranche A Loan and a $58.8 million Tranche B Loan (collectively, the “Loan”). The Loan bears interest at a rate of 12% per annum, payable quarterly. The Loan will mature in August 2018, and can be repaid without penalty beginning in August 2015.

In connection with the Loan, the Company entered into a security agreement granting HC Royalty a security interest in the intellectual property related to the LFRP, and the revenues generated by the Company through the license of the intellectual property related to the LFRP. The security agreement does not apply to the Company's internal drug development or to any of the Company's co-development programs.

Under the terms of the Loan agreement, the Company is required to repay the Loan based on the annual net LFRP receipts. Until September 30, 2016, required payments are equal to the sum of 75% of the first $15.0 million in specified annual LFRP receipts and 25% of specified annual LFRP receipts over $15.0 million. After September 30, 2016, and until the maturity date or the complete repayment of the Loan, HC Royalty will receive 90% of all included LFRP receipts. If the HC Royalty portion of LFRP receipts for any quarter exceeds the interest for that quarter, then the principal balance will be reduced. Any unpaid principal will be due upon the maturity of the Loan. If the HC Royalty portion of LFRP revenues for any quarterly period is insufficient to cover the cash interest due for that period, the deficiency may be added to the outstanding principal or paid in cash by the Company. After five years from the dates of the Tranche A Loan and the Tranche B Loan, respectively, the Company must repay to HC Royalty all additional accumulated principal above the original loan amounts of $21.7 million and $58.8 million, respectively.

Tranche A Loan

In December 2011, the Company entered into an agreement with an affiliate of HC Royalty and received a loan of $20 million (Tranche A Loan) and a commitment to refinance the amounts outstanding under the Company’s March 2009 amended and restated loan agreement (the March 2009 loan agreement) at a reduced interest rate in August 2012. The Tranche A Loan was unsecured and accrued interest at an annual rate of 13% through August 2012, at which time the Tranche A Loan and its accrued interest was combined with 102% of the unpaid principal and accrued interest outstanding under the March 2009 loan agreement upon the closing of the Tranche B Loan.

Upon execution of the Tranche A Loan, the terms of the Original Loans (defined below) were determined to be modified under ASC 470. Accordingly, during the three and nine months ending September 30 2012, interest expense on the Loan is being recorded in the Company’s financial statements at an effective interest rate of 12.5%.

Upon modification of the debt arrangement, the note payable balance related to the Tranche A Loan was reduced by $193,000 to reflect payment of legal fees in conjunction with the loan; these fees are being accreted over the life of the Loan, through August 2018.

Tranche B Loan

In 2008 and 2009, the Company entered into loan agreements with an affiliate of HC Royalty that provided aggregate loan proceeds of $65.0 million (the Original Loans), which had an outstanding principal and accrued interest balance of $57.6 million at the time of their refinancing in August 2012 (Tranche B Loan). The Original Loans bore interest at an annual rate of 17.4%, payable quarterly, and were secured by the Company’s LFRP.

In connection with the Original Loans, the Company issued affiliates of HC Royalty warrants to purchase shares of the Company’s common stock. In August 2008, the Company issued warrants to purchase 250,000 shares of the Company’s common stock at an exercise price of $5.50 per share. This warrant expires in August 2016 and became exercisable in August 2009. The Company estimated the relative fair value of the warrant to be $853,000 on the date of issuance, using the Black-Scholes valuation model, assuming a volatility factor of 83.64%, risk-free interest rate of 4.07%, an eight-year expected term and an expected dividend yield of zero. In March 2009, the Company issued HC Royalty a second warrant to purchase 250,000 shares of the Company’s common stock at an exercise price of $2.87 per share. This warrant expires in August 2016 and became exercisable in March 2010. The Company estimated the relative fair value of the warrant to be $477,000 on the date of issuance, using the Black-Scholes valuation model, assuming a volatility factor of 85.98%, risk-free interest rate of 2.77%, a seven-year, four-month expected term and an expected dividend yield of zero. The relative fair values of the warrants as of the date of issuance are recorded in additional paid-in capital on the Company's consolidated balance sheets.

The cash proceeds from the Original Loans were recorded as a note payable on the Company's consolidated balance sheet. The note payable balance was reduced by $1.3 million for the fair value of the warrants issued, and by $580,000 for payment of HC Royalty’s legal fees in conjunction with the Tranche B Loan. Prior to the December 2011 issuance of the Tranche A Loan, each of these amounts was being accreted over the life of the note through August 2016. Subsequent to the modification of the debt arrangement in December 2011, the unamortized portion of these amounts is being accreted over the life of the Loan through August 2018.

The Loan principal balance at September 30, 2012 and December 31, 2011 was $80.5 million and $76.7 million, respectively. For financial reporting purposes, the Loan is adjusted for discounts associated with the debt issuance, including warrants and fees.

Activity under the Loan is presented for financial reporting purposes, as follows (in thousands):

	September 30, 2012			December 31, 2011
Beginning balance	$	75,372		$	56,406
Accretion of discount		149			246
Loans activity:
Net proceeds from Tranche A Loan		—			20,000
Discount on Tranche A Loan		(43	)		(150	)
Interest Expense		7,437			9,932
Payments applied to principal		(96	)		(1,129	)
Payments applied to interest		(5,628	)		(8,224	)
Accrued interest payable		—			(1,709	)
Ending balance	$	77,191		$	75,372

The estimated fair value of the note payable was $80.5 million at September 30, 2012 which was calculated based on level 3 inputs due to the limited availability of comparable data points. The note payable was valued using expected cash flows discounted at our estimate of the currently available market interest rate.

Equipment Loan

In June 2012, the Company entered into an equipment lease line of credit for up to $3 million with Silicon Valley Bank. When drawn, the note bears interest at a 6% annual rate. The Company drew down $1.4 million from this line, which will be financed over a 3-year term. The outstanding balance of this loan was $1.4 million as of September 30, 2012.