Note 5 — Liability Related to Sale of Future Royalties

On February 24, 2012, we entered into a Purchase and Sale Agreement (the Purchase and Sale Agreement) with RPI Finance Trust (RPI), an affiliate of Royalty Pharma, pursuant to which we sold, and RPI purchased, our right to receive royalty payments (the Royalty Entitlement) arising from the worldwide net sales, from and after January 1, 2012, of (a) CIMZIA^®, under Nektar’s license, manufacturing and supply agreement with UCB Pharma (UCB), and (b) MIRCERA^®, under Nektar’s license, manufacturing and supply agreement with F. Hoffmann-La Roche Ltd and Hoffmann-La Roche Inc. (together referred to as Roche). We received an aggregate cash purchase price for the Royalty Entitlement of $124.0 million. As part of this sale, we incurred approximately $4.4 million in transaction costs, which will be amortized to interest expense over the estimated life of the Purchase and Sale Agreement. As a result of our ongoing manufacturing and supply obligations related to the generation of these royalties and as is further described below, although we sold all of our rights to receive royalties from the CIMZIA^® and MIRCERA^® products, we will continue to account for these royalties as revenue and recorded the $124.0 million in proceeds from this transaction as a liability.

The following table shows the activity within the liability account:


	Nine months ended September 30, 2012
Liability related to sale of future royalties—beginning balance	$	—
Proceeds from sale of future royalties		124,000
Non-cash interest expense		12,641
CIMZIA^® and MIRCERA^® royalties		(6,895	)

Total liability related to sale of future royalties		129,746
Less: current portion		(3,000	)

Liability related to sale of future royalties, non-current portion:	$	126,746

We determined that we have significant continuing involvement in the generation of the future royalty payments to be received by RPI related to CIMZIA^® and MIRCERA^® through our ongoing manufacturing and supply obligations related to these products. As a result, we recorded the $124.0 million as a long-term liability (Royalty Obligation) on our Condensed Consolidated Balance Sheet that will be amortized using the interest method over the estimated life of the Purchase and Sale Agreement. The discounted cash flow model used to estimate the fair value of the rights sold to RPI requires us to make estimates regarding, among other things, the assumptions market participants would make regarding the timing, probability and amount of future royalties, as well as the appropriate financial discount rates. We consider the assumptions and estimates used in this analysis to fall within Level 3 of the fair value hierarchy. We believe the carrying amount of the Royalty Obligation is consistent with its fair value at September 30, 2012.

As a result of this liability accounting, even though the royalties from UCB and Roche are remitted directly to RPI starting in the second quarter of 2012 for royalties arising from product sales in the first quarter of 2012, we will continue to record revenue for these royalties. We recognize royalties from net sales of CIMZIA^® and MIRCERA^® upon notification of the actual royalty amount, which occurs in the quarter after those sales are made. During the nine months ended September 30, 2012, we recognized $9.6 million in aggregate royalties from net sales of CIMZIA^® and MIRCERA^®, of which the $2.7 million recognized in the three months ended March 31, 2012 was retained by us as these amounts resulted from royalties on product sales in the fourth quarter of 2011 and the $6.9 million recognized in the six month period ended September 30, 2012 was remitted by UCB and Roche directly to RPI as these amounts resulted from product sales in the first and second quarters of 2012.

As royalties are remitted to RPI from Roche and UCB, the balance of the Royalty Obligation will be effectively repaid over the life of the agreement. In order to determine the amortization of the Royalty Obligation, we are required to estimate the total amount of future royalty payments to be received by RPI and payments we are required to make to RPI as noted below, if any, over the life of the agreement. The sum of these amounts less the $124.0 million proceeds we received will be recorded as interest expense over the life of the Royalty Obligation. Since inception, our estimate of this total interest expense resulted in an effective annual interest rate of approximately 17%. We will periodically assess the estimated royalty payments to RPI from UCB and Roche and to the extent such payments are greater or less than our initial estimates, or the timing of such payments is materially different than our original estimates, we will adjust the amortization of the Royalty Obligation. There are a number of factors that could materially affect the amount and timing of royalty payments from CIMZIA^® and MIRCERA^®, most of which are not within our control. Such factors include, but are not limited to, changing standards of care, the introduction of competing products, manufacturing or other delays, biosimilar competition, intellectual property matters, adverse events that result in governmental health authority imposed restrictions on the use of the drug products, and other events or circumstances that could result in reduced royalty payments from CIMZIA^® and MIRCERA^®, all of which would result in a reduction of non-cash royalty revenues and the non-cash interest expense over the life of the Royalty Obligation. Conversely, if sales of CIMZIA^® and MIRCERA^® are more than expected, the non-cash royalty revenues and the non-cash interest expense recorded by us would be greater over the term of the Royalty Obligation.

Pursuant to the Purchase and Sale Agreement, we are required to pay to RPI (a) $3.0 million if certain worldwide net sales thresholds of MIRCERA^® for the 12 month period ending on December 31, 2012 are not achieved and (b) up to an additional $7.0 million if certain worldwide net sales thresholds of MIRCERA^® for the 12 month period ending on December 31, 2013 are not achieved. The Purchase and Sale Agreement grants RPI the right to receive certain reports and other information relating to the Royalty Entitlement and contains other representations and warranties, covenants and indemnification obligations that are customary for a transaction of this nature. In particular, if we breach our obligations under the Purchase and Sale Agreement, we could be required to pay damages to RPI that are not limited to the purchase price we received in the sale transaction. As of September 30, 2012, we have concluded that it is probable that the minimum 2012 MIRCERA^® net sales threshold will not be met and, therefore, we expect to make the $3.0 million payment to RPI described above in early 2013. The liability for this expected $3.0 million payment is included in other current liabilities on our Condensed Consolidated Balance Sheet at September 30, 2012.