Note 7 — 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 aggregate cash proceeds 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. Although we sold all of our rights to receive royalties from the CIMZIA^® and MIRCERA^® products, as a result of our ongoing manufacturing and supply obligations related to the generation of these royalties, we will continue to account for these royalties as revenue and recorded the $124.0 million in proceeds from this transaction as a liability (Royalty Obligation) that will be amortized using the interest method over the estimated life of the Purchase and Sale Agreement.

The following table shows the activity within the liability account during the year ended December 31, 2013 and for the period from the inception of the royalty transaction on February 24, 2012 (inception) to December 31, 2013 (in thousands):


	Year ended December 31, 2013			Period from inception to December 31, 2013
Liability related to sale of future royalties—beginning balance	$	131,266		$	—
Proceeds from sale of future royalties		—			124,000
Non-cash interest expense recognized		22,309			40,366
Non-cash CIMZIA^® and MIRCERA^® royalty revenue		(22,055	)		(32,846	)
Payments from Nektar to RPI		(3,000	)		(3,000	)

Total liability related to sale of future royalties as of December 31, 2013		128,520			128,520
Less: current portion		(7,000	)		(7,000	)

Liability related to sale of future royalties, less current portion	$	121,520		$	121,520

As a result of this liability accounting, even though the royalties from UCB and Roche are remitted directly to RPI starting with royalties arising from product sales in the first quarter of 2012, we will continue to recognize revenue for these royalties. During the year ended December 31, 2012, we recognized royalties from net sales of CIMZIA^® and MIRCERA^® upon notification of the actual royalty amount, which occurs in the quarter after such sales are made. During the year ended December 31, 2013, we began to recognize royalties based on estimates of the net sales made in each period, which resulted in an increase in non-cash royalty revenue of $4.6 million in the year ended December 31, 2013. During the years ended December 31, 2013 and 2012, we recognized $22.1 and $10.8 million, respectively, in non-cash royalties from net sales of CIMZIA^® and MIRCERA^®.

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 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 prospectively 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, in March 2013, we were required to pay RPI $3.0 million because worldwide net sales of MIRCERA^® for the 12 month period ended December 31, 2012 did not reach a required threshold. Furthermore, we are required to make an additional payment of up to $7.0 million if the specified worldwide net sales threshold of MIRCERA^® for the 12 month period ended December 31, 2013 is not achieved. We have concluded that it is probable that the minimum 2013 MIRCERA^® net sales threshold will not be met and, therefore, we expect to make the $7.0 million payment to RPI described above in early 2014. The liability for this expected $7.0 million payment is included in current liabilities on our Consolidated Balance Sheet at December 31, 2013.

In addition, 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.