Note 7 - Liability Related to Sale of Future Royalties

9 Months Ended

Sep. 30, 2020

7. Liability Related to Sale of Future Royalties

In September 2015, the Company entered into the Royalty Monetization with PDL for which it received gross proceeds of $65.0 million. Under the Royalty Monetization, PDL will receive 75% of the European royalties under the Amended License Agreement with Grünenthal, as well as 80% of the first four commercial milestones worth $35.6 million (or 80% of $44.5 million), up to a capped amount of $195.0 million over the life of the arrangement.

The Company periodically assesses the expected royalty and milestone payments using a combination of historical results, internal projections and forecasts from external sources. To the extent such payments are greater or less than the Company’s initial estimates or the timing of such payments is materially different than its original estimates, the Company will prospectively adjust the amortization of the liability and the effective interest rate. During the three months ended June 30, 2019, the Company made a material revision to its estimates which resulted in an interest income rate on the Royalty Monetization liability balance at a prospective average rate of approximately 4.2%, which will be applied over the remaining term of the agreement. The change in estimate of future payments to PDL was a result of lower projected European royalties and milestones from sales of Zalviso over the life of the liability. The change in estimate results in interest income being recognized prospectively, over the remaining term of the agreement, as the estimated expected payments are less than the $65.0 million in gross proceeds received. During the three months ended June 30, 2020, Grünenthal notified the Company that it was terminating the Amended License Agreement, effective November 13, 2020. There is a continuing obligation on the Company’s part, through the term of the Royalty Monetization, to use commercially reasonable efforts to negotiate a replacement license agreement, or New Arrangement. However, without a New Arrangement to commercialize Zalviso in the Territory, the Company is currently unable to estimate the future payments to PDL over the remaining life of the Royalty Monetization. If the Company is unable to find a New Arrangement, a contingent gain of up to approximately $65 million may be recognized when it is realized upon expiration of the liability at the end of the Royalty Monetization term. Due to the significant judgments and factors related to the estimates of future payments under the Royalty Monetization, there are significant uncertainties surrounding the amount and timing of future payments and the probability of realization of the estimated contingent gain.

The change in estimate reduced the effective interest rate over the life of the liability to 0% by recording interest income over the remaining term of the arrangement as an offset to the interest expense that was recognized in prior periods. The effective interest income rates for both the three and nine months ended September 30, 2020 was approximately 3.6%. The change in estimate resulted in a decrease of $2.7 million to the net loss, or $0.03 per share of common stock, basic and diluted, for the three months ended September 30, 2019, and a decrease of $5.4 million to the net loss, or $0.07 per share of common stock, basic and diluted, for the nine months ended September 30, 2019. The effective interest income rate for the three months ended September 30, 2019 was approximately 4.2%. The effective interest income rate for the nine months ended September 30, 2019 was 0.5%.

The following table shows the activity within the liability account for the nine months ended and the period from inception to September 30, 2020 (in thousands):

	Nine months ended September 30, 2020			Period from inception to September 30, 2020
Liability related to sale of future royalties — beginning balance	$	92,035		$	—
Proceeds from sale of future royalties		—			61,184
Non-cash royalty revenue		(194	)		(878	)
Non-cash interest (income) expense recognized		(2,502	)		29,033
Liability related to sale of future royalties as of September 30, 2020		89,339			89,339
Less: current portion		(225	)		(225	)
Liability related to sale of future royalties — net of current portion	$	89,114		$	89,114

As royalties are remitted to PDL from ARPI LLC, as described in Note 1 “Organization and Summary of Significant Accounting Policies - Non-Cash Interest Income (Expense) on Liability Related to Sale of Future Royalties” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, the balance of the liability will be effectively repaid over the life of the agreement. The Company will record non-cash royalty revenues and non-cash interest expense within its Condensed Consolidated Statements of Comprehensive Loss over the term of the Royalty Monetization. On August 31, 2020, PDL announced it sold its royalty interest for Zalviso to SWK Funding, LLC.