11. Facility financing agreement

The significant activity related to the facility financing agreement during the six months ended June 30, 2014 consist of the following (in thousands):


	June 30, 2014
Facility financing obligation
Carrying value at December 31, 2013	$	102,300
Principal converted to equity		(93,500	)
Accretion of debt discount and debt issuance expense		7,191
Adjustment to debt discount related to modification of the 2019 notes		2,921
Tranche B principal amount		20,000
Debt discount related to Tranche B purchase		(1,168	)

Net carrying value of facility financing obligation	$	37,744

Commitment Asset
Commitment asset fair value balance at December 31,2013	$	5,157
Tranche B commitment asset fair value		2,921
Less commitment asset portion associated with the receipt of Tranche B notes		(1,168	)

Commitment asset value included in other assets	$	6,910

Accretion of debt issuance cost and debt discount in connection with the facility financing agreement during the three and six months ended June 30, 2014 are as follows (in thousands):


	Three months ended June 30, 2014		Six months ended June 30, 2014
Accretion expense- debt issuance cost	$	27	$	309
Accretion expense- debt discount	$	516	$	6,883

On July 1, 2013, the Company entered into the Facility Agreement providing for the sale of up to $160.0 million of 2019 notes to Deerfield in four equal tranches of $40.0 million principal amount. The 2019 notes accrue interest at a rate of 9.75% per annum until maturity in 2019 or their earlier repayment, repurchase, or conversion. As of June 30, 2014, Deerfield had purchased the first three tranches of 2019 notes in the aggregate principal amount of $120.0 million. Deerfield’s obligation to purchase the fourth tranche of the 2019 notes was subject to (i) the Company’s receipt of marketing approval of AFREZZA from the FDA, which occurred on June 27, 2014, and (ii) the shares of the Company’s common stock issuable upon conversion of all previously sold 2019 notes being freely tradable pursuant to an effective registration statement filed with the SEC or pursuant to Rule 144 under the Securities Act. Subsequent to June 30, 2014, on July 18, 2014, Deerfield purchased the fourth tranche of 2019 notes in the aggregate principal amount of $40.0 million (See Note 14 — Subsequent Events).

On February 28, 2014, the Company entered into the Amendment, which modified the terms of the Facility Agreement to provide for the issuance of Tranche B notes to Deerfield. Pursuant to the terms of the Amendment and the subsequent occurrence of certain events specified in the Amendment, the Company may issue to Deerfield up to $90.0 million aggregate principal amount of Tranche B notes. The Tranche B notes bear interest at the rate of 9.75% per year, subject to reduction to 8.75% if the Company enters into a collaboration with a third party to commercialize AFREZZA, on the outstanding principal amount, payable in cash quarterly in arrears on the last business day of March, June, September and December of each year. The Company is required to repay 25% of the original principal amount of any Tranche B notes on the third, fourth, fifth and sixth anniversaries of the applicable issue dates of such notes, provided that the entire outstanding principal amount of all Tranche B notes will become due and payable no later than December 31, 2019. The Tranche B notes can be prepaid without penalty or premium commencing two years after issuance thereof. On May 6, 2014, Deerfield purchased an aggregate principal amount of $20.0 million in Tranche B notes in accordance with the provisions of the Facility Agreement, as amended.

In addition, pursuant to the Amendment, the outstanding first tranche of 2019 notes (the “Tranche 1 notes”) and third tranche of 2019 notes (the “Tranche 3 notes”) held by Deerfield were amended and restated to permit Deerfield to convert up to an additional $60.0 million principal amount under such 2019 notes into the Company’s common stock after the effective date of the Amendment. The Company also agreed to register for resale up to 12,000,000 shares of the Company’s common stock issuable upon conversion of the outstanding 2019 notes, as amended and restated, as of the date of the Amendment. In March 2014, Deerfield elected to convert the full $40.0 million of outstanding principal amount of the Tranche 3 notes and $12.5 million principal amount of the Tranche 1 notes. In April 2014, Deerfield elected to convert the remaining $7.5 million principal amount of the Tranche 1 notes.

On August 11, 2014 the Company entered into a second amendment to the Facility Agreement to permit for the Sanofi Loan Facility.

Milestone Rights

In connection with the execution of the Facility Agreement, on July 1, 2013, the Company issued Milestone Rights to the Milestone Purchasers. The Milestone Rights provide the Milestone Purchasers certain rights to receive payments of up to $90.0 million upon the occurrence of specified strategic and sales milestones, including the first commercial sale of an AFREZZA product and the achievement of specified net sales figures. The payments due under the Milestone Rights are subject to pro rata reduction in the event of certain funding failures by Deerfield under the Facility Agreement.

The Milestone Agreement includes customary representations and warranties and covenants by the Company, including restrictions on transfers of intellectual property related to AFREZZA. The Milestone Rights are subject to acceleration in the event the Company transfers its intellectual property related to AFREZZA in violation of the terms of the Milestone Agreement.

The Milestone Rights were initially recorded as a short-term liability equal to $3.2 million included in Accrued expenses and other current liabilities in the accompanying condensed consolidated balance sheet and a long term liability equal to $13.1 million included in other liabilities. As of June 30, 2014, there have been no material changes to facts and circumstances that would impact the valuation or classification of the Milestone Rights.

Commitment Asset

In connection with the issuance of the Tranche 1 notes and the Milestone Rights, the Company recorded a commitment asset (the “Commitment Asset”), on July 1, 2013. As a result of the Amendment, the Company recorded an additional commitment asset with an estimated fair value equal to $2.9 million. The Commitment Asset remaining as of June 30, 2014 represented the right to receive $40.0 million funding under tranche 4 of the 2019 notes (the “Tranche 4 Notes”) and up to $70.0 million of funding remaining under the Facility Agreement, as amended, from the sale of the Tranche B notes. The Commitment Asset is derecognized and recorded as a debt discount on the 2019 notes and Tranche B notes when issued and amortized using the effective interest rate method over the life of the respective notes. Prior to derecognition occurring, the Company monitors the Commitment Asset on an ongoing basis to determine whether an impairment indicator is present that would result in a full or partial write down of the Commitment Asset as a result of events that may lead to the subsequent tranches of notes not being issued. Based on the monitoring procedures performed through June 30, 2014, the Company did not identify any indicators of impairment.

Amendment to the outstanding Tranche 1 notes and Tranche 3 notes

The amendment and restatement of the outstanding Tranche 1 notes and Tranche 3 notes, pursuant to the Amendment, did not represent a troubled debt restructuring of the 2019 notes because the Amendment did not result in Deerfield granting a concession to the Company. In addition, the Amendment did not result in a substantial modification to the terms of the Tranche 1 notes and Tranche 3 notes.

The impact of the Amendment to the Tranche 1 notes and Tranche 3 notes is being accounted for as a prospective yield adjustment. Specifically, the value of the Tranche B notes commitment asset (the “Tranche B Commitment Asset”) was considered a fee received from the creditor as consideration for the Amendment and is being amortized as an adjustment of interest expense over the remaining term of the Tranche 1 notes and Tranche 3 notes using the effective interest method. Further, the value of the Tranche B Commitment Asset, which decreased the amount of debt discount in the Tranche 1 notes and Tranche 3 notes, was allocated between the Tranche 1 notes and Tranche 3 notes in a manner which resulted in the Tranche 1 notes and Tranche 3 notes having a new effective interest rate of 11.63%.

Conversion Option

For accounting purposes, the Company evaluated the embedded conversion option in the 2019 notes as a redemption feature because the number of shares issuable upon conversion was based on the volume weighted average prices for specified periods prior to the conversion date (as opposed to being fixed). Accordingly, conversions by Deerfield were treated as redemptions of the 2019 notes and, the Company analyzed whether the conversion option required bifurcation as an embedded redemption feature.

As of December 31, 2013, Deerfield had converted $6.5 million principal amount of the second tranche of the 2019 notes (the “Tranche 2 notes”) for equity, resulting in an issuance of 1,293,224 shares of the Company’s common stock. Upon the conversion, the principal balance of the notes were recorded in equity and an expense was recognized in the Statement of Operations in the amount of $0.6 million for the difference between the principal amount of the notes converted and their carrying amount (which included unamortized discount and debt issuance costs).

During January 2014, Deerfield elected to convert the remaining $33.5 million of Tranche 2 notes, which resulted in the issuance of 6,559,251 shares of the Company’s common stock. During the six months ended June 30, 2014, the Company recorded an expense of $3.0 million for the difference between the principal amount of the notes converted and their carrying amount (which included unamortized discount and debt issuance costs).

In March 2014, following the Amendment, which allowed Deerfield to convert up to an additional $60.0 million principal amount under the outstanding Tranche 1 notes and Tranche 3 notes, Deerfield elected to convert the full $40.0 million of outstanding principal amount of the Tranche 3 notes and $12.5 million of principal amount of the Tranche 1 notes, pursuant to which the Company issued Deerfield 7,121,120 and 2,142,709 shares of the Company’s common stock, respectively. As a result of these conversions, the Company recorded the principal balance of the notes in equity and an expense of $3.0 million for the difference between the principal amount of the notes converted and their carrying amount (which included the unamortized discount and debt issuance costs) and the write-off of the derivative liability that was previously bifurcated from the Tranche 3 notes.

In April 2014, Deerfield elected to convert the remaining $7.5 million principal amount of the Tranche 1 notes, pursuant to which the Company issued Deerfield 1,500,000 shares of the Company’s common stock. As a result of this conversion, the Company recorded the principal amount being converted under the Tranche 1 notes in equity and an expense of $0.4 million for the difference between the principal amount of the notes converted and their carrying amount (which included the unamortized discount and debt issuance costs).

Further, upon Deerfield converting the remaining $7.5 million principal amount of the Tranche 1 notes, the full $60.0 million principal amount of the Tranche 1 notes and Tranche 3 notes that Deerfield was permitted to convert pursuant to the Amendment was converted. Therefore, as of June 30, 2014, no additional principal amount of the 2019 notes is convertible.