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The following is an excerpt from a 10-Q SEC Filing, filed by NPS PHARMACEUTICALS INC on 5/17/2004.
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NPS PHARMACEUTICALS INC - 10-Q - 20040517 - NOTES_TO_FINANCIAL_STATEMENT

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

(1) Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements included herein have been prepared by NPS Pharmaceuticals, Inc. (NPS) in accordance with the rules and regulations of the Securities and Exchange Commission (SEC). The condensed consolidated financial statements are comprised of the financial statements of NPS and its subsidiaries, collectively referred to as the Company. The Company carries one investment in a non-public corporation at cost. In management’s opinion, the interim financial data presented includes all adjustments (consisting solely of normal recurring items) necessary for fair presentation. All intercompany accounts and transactions have been eliminated. All monetary amounts are reported in U.S. dollars unless specified otherwise. Through December 31, 2003, the Company had been considered a development stage enterprise. During the first quarter of 2004, the Company commenced its principle operations when Sensipar ® , the Company’s first commercial product, received marketing approval by the U.S. Food and Drug Administration for the treatment of secondary hyperparathyroidism in chronic kidney disease patients on dialysis and for the treatment of elevated calcium levels in patients with parathyroid carcinoma and is no longer considered a development stage enterprise. Certain information required by accounting principles generally accepted in the United States of America has been condensed or omitted in accordance with rules and regulations of the SEC. Operating results for the three months ended March 31, 2004 are not necessarily indicative of the results that may be expected for any future period or the year ending December 31, 2004.

 

This report should be read in conjunction with the Company’s audited consolidated financial statements and the notes thereto for the year ended December 31, 2003, included in the Company’s Annual Report on Form 10-K/A filed with the SEC.

 

The preparation of the condensed consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates. Certain prior period amounts have been reclassified to conform with the current period presentation.

 

The Company employs the footnote disclosure provisions of Statement of Financial Accounting Standard (SFAS) No. 123, Accounting for Stock - Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, an amendment of SFAS Statement No. 123. SFAS No. 123 encourages entities to adopt a fair-value based method of accounting for stock options or similar equity instruments. However, it also allows an entity to continue measuring compensation cost for stock-based compensation using the intrinsic-value method of accounting prescribed by APB Opinion No. 25, Accounting for Stock Issued to Employees (APB No. 25). The Company has elected to continue to apply the provisions APB No. 25, under which no compensation cost has been recognized when the exercise price of the option equals the market price of the stock on the date of grant. The Company generally uses the straight-line method of amortization for stock-based compensation. Had compensation cost for these plans been determined consistent with SFAS No. 123, the Company’s net loss and net loss per share for the three months ended March 31, 2004 and 2003 would have been increased to the following pro forma amounts (in thousands, except per share amounts):

 

    

Three months
ended

March 31,
2004


   

Three months
ended

March 31,
2003


 

Net loss:

                

As reported

   $ (35,651 )   $ (28,090 )

Add: Stock based employee compensation expense included in reported net loss

     500       31  

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards

     (3,820 )     (2,228 )
    


 


Pro forma

   $ (38,971 )   $ (30,287 )
    


 


Net loss per share as reported:

                

Basic and diluted

   $ (0.96 )   $ (0.80 )
    


 


Pro forma:

                

Basic and diluted

   $ (1.05 )   $ (0.86 )
    


 


 

Net loss, as reported, also included compensation cost of $23,000 and $5,000 for stock-based compensation awards for nonemployees for the three months ended March 31, 2004 and 2003, respectively.

 

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(2) Loss Per Common Share

 

Basic loss per common share is the amount of loss for the period applicable to each share of common stock outstanding during the reporting period. Diluted loss per common share is the amount of loss for the period applicable to each share of common stock outstanding during the reporting period and to each share that would have been outstanding assuming the issuance of common shares for all dilutive potential common shares outstanding during the period.

 

Potential common shares of approximately 9.1 million and 3.1 million during the three months ended March 31, 2004 and 2003, respectively, that could potentially dilute basic earnings per share in the future were not included in the computation of diluted loss per share because to do so would have been anti-dilutive for the periods presented. Potential dilutive common shares for the three months ended March 31, 2004 include approximately 5.2 million common shares related to convertible debentures and 3.9 million common shares related to stock options.

 

(3) Operating Segment

 

The Company is engaged in the discovery, development, and commercialization of pharmaceutical products and considers its operations to be a single reportable segment. Financial results of this reportable segment are presented in the accompanying condensed consolidated financial statements. The Company’s only non-United States revenue relates to the Company’s Canadian subsidiary. No revenue was recognized by this subsidiary for the three months ended March 31, 2004 and 2003, respectively.

 

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(4) Comprehensive Loss

 

The components of the Company’s comprehensive loss are as follows, in thousands:

 

    

Three months
ended

March 31,
2004


   

Three months
ended

March 31,
2003


 

Other comprehensive loss:

                

Gross unrealized loss on marketable investment securities

   $ (62 )   $ (118 )

Reclassification for realized gain on marketable investment securities

     (72 )     (205 )
    


 


Net unrealized loss on marketable investment securities

     (134 )     (323 )

Foreign currency translation gain (loss)

     (385 )     353  

Net loss

     (35,651 )     (28,090 )
    


 


Comprehensive loss

   $ (36,170 )   $ (28,060 )
    


 


 

(5) Convertible Notes Payable

 

In July 2003, the Company completed a private placement of $192.0 million of its 3.0% Convertible Notes due June 15, 2008 (Notes). The Company received net proceeds from this private placement of approximately $185.9 million, after deducting costs associated with the offering. The Notes bear interest at an annual rate of 3.0%. Interest is payable semiannually in arrears on June 15 and December 15 of each year. Accrued interest on the Notes was approximately $1.7 million as of March 31, 2004. The holders may convert all or a portion of the Notes into common stock at any time on or before June 15, 2008. The Notes are convertible into common stock at a conversion rate equal to approximately $36.59 per share, subject to adjustment in certain events. The Notes are unsecured senior debt obligations and rank equally in right of payment with all existing and future unsecured senior indebtedness. On or after June 20, 2006, the Company may redeem any or all of the Notes at redemption prices of 100% of their principal amount, plus accrued and unpaid interest to the day preceding the redemption date. Upon the occurrence of a “fundamental change,” as defined in the indenture governing the Notes, holders of the Notes may require the Company to redeem all or a part of the Notes at a price equal to 100% of the principal amount, plus accrued and unpaid interest and liquidated damages, if any. The Company has filed a registration statement with the United States Securities and Exchange Commission covering the resale of the Notes and common stock issuable upon conversion of the Notes. The Company incurred debt issuance costs of $6.1 million, which are being amortized over a five-year period. The effective interest rate on the Notes, including debt issuance costs, is 3.6%.

 

(6) Income Tax

 

The Company has recorded income tax expense of $81,000 and zero for the three months ended March 31, 2004 and 2003, respectively. The income tax expense is the net effect of an income tax payment to a foreign jurisdiction upon receipt of certain milestone payments offset by the Company’s estimate of refundable income tax credits from the Canadian province of Quebec relating to research and development activities performed. Estimated income tax expense (benefit) recorded during interim periods may be periodically revised, if necessary, to reflect current estimates.

 

(7) Contingencies

 

The Company has agreed to indemnify, under certain circumstances, certain manufacturers and service providers from and against any and all losses, claims, damages or liabilities incurred by them that arise from services provided by such manufacturers and service providers or from any use, including in clinical trials, or sale by the Company or any Company agent of any product supplied by the manufacturers.

 

(8) Legal Proceedings

 

The Company is presently engaged in legal proceedings with two contract research organizations, PharmData Inc. and Data Capture International, Inc. (DCI). PharmData has been engaged in the compilation and

 

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analysis of data from certain NPS clinical trials including some Phase I clinical pharmacokinetic studies with the Company’s osteoporosis drug candidate, PREOS. DCI has provided electronic data capture services to the Company in connection with certain Phase I clinical studies with PREOS. Neither PharmData or DCI have been involved in the compilation or analysis of data from the Company’s pivotal Phase III clinical study.

 

On April 27, 2004, PharmData filed a complaint in the Superior Court of Cobb County in the state of Georgia. The Company was formally served with a copy of the complaint on April 29, 2004. The Company has not yet filed an answer with the court. The complaint alleges that NPS and PharmData entered into a contract, dated October 31, 2003, whereunder PharmData agreed to reserve its service capacity and/or provide services to the Company in exchange for specified monthly payment amounts to be paid by the Company. The contract provides for total future payments as of March 31, 2004 of $62.8 million to be paid to PharmData over a five-year period. PharmData alleges that the Company has not met the specified monthly payment amounts as required by the agreement. As such, PharmData asserts that the Company is in breach of the agreement and that as a result of certain communications between NPS and PharmData, the Company anticipatorily breached the agreement. PharmData is seeking judgment against the Company in an amount that will compensate PharmData for the Company’s alleged breach of contract, reimbursement for costs incurred by PharmData in the legal proceeding and legal fees. The Company believes that PharmData procured the contract on the basis of illegal payments to an NPS employee who is no longer employed by the Company. The Company has advised PharmData that the Company has repudiated the October 31, 2003 agreement. The Company intends to vigorously contest the legal proceeding brought by PharmData and is evaluating its legal options including suit against PharmData and other defendants. As a result of the dispute with PharmData, the Company will likely have to retain the services of another contract research organization to complete the work PharmData had been engaged to provide. This may result in a delay in filing the NDA for PREOS of several weeks to months. As of March 31, 2004, the Company accrued approximately $1.5 million related to payments due under the PharmData contract and as of May 11, 2004, the Company notified PharmData of its intention to no longer use the services of PharmData as provided for under the terms of the contract.

 

On February 24, 2004, DCI filed a complaint in the Superior Court of Cobb County in the state of Georgia. DCI has not yet formally served the Company with a copy of the complaint. As a result, the Company has not filed a formal answer to the complaint. The complaint alleges that NPS and DCI entered into a contract whereunder DCI agreed to reserve its service capacity and/or provide services to the Company in exchange for specified monthly payment amounts to be paid by the Company. The contract provides for total future payments as of March 31, 2004 of $14.7 million to be paid to DCI over a five-year period. DCI alleges that the Company has not met the specified monthly payment amount as required by the agreement. As such, DCI asserts that the Company is in breach of the agreement and that as a result of certain communications between NPS and DCI, the Company has anticipatorily breached the agreement. DCI is seeking judgment against the Company in an amount deemed just and proper by the court, reimbursement for costs incurred by DCI in the legal proceeding and legal fees. The Company believes that DCI procured the contract on the basis of illegal payments to an NPS employee who is no longer employed by the Company. The Company intends to vigorously contest the proceedings and is evaluating its legal options including suit against DCI and other defendants. During the first quarter, the Company notified DCI of its intention to no longer use the services of DCI as provided for under the terms of the contract. As of March 31, 2004, the Company estimated that the fair value of the liability required to exit the DCI contract was not greater than $850,000, and the Company has accrued such amount.

 

On May 3, 2004, the Audit Committee of the Company’s Board of Directors retained independent counsel to conduct a thorough investigation into the circumstances involving the PharmData and DCI contracts. The Company believes that PharmData and DCI procured the contracts through improper payments to a Company employee, who has been subsequently terminated. As part of the investigation, numerous current and former employees and third parties have been interviewed and numerous documents and electronic data have been reviewed. Based on the results to date, it appears that PharmData and DCI paid commissions to the former employee, who was not part of the Company’s senior management. Although the investigation has progressed substantially, it is not yet fully complete. There is no evidence at this time to indicate that any other employee was involved. However, due to certain time constraints surrounding the retrieval and restoration of electronic data, some emails remain to be reviewed. The Company intends to disclose the final results of the investigation following its completion, which is expected to be in the near future.

 

It appears that Company contract approval procedures were not followed in the review and execution of these contracts and in any event may have not been wholly sufficient. The Company has since adopted more extensive procedures for contract approval.

 

(9) Subsequent Events

 

In April 2004, the Company signed a long-term operating lease agreement with MaRs Discovery District in downtown Toronto, Ontario, concerning the lease of approximately 60,000 square feet of laboratory, support and administrative space. The term of the lease is ten years and eight months with a commencement date of November 1, 2004. No payments are required during the first eight months of the lease term followed by an annual base rent commitment of approximately $1.0 million a year through June 30, 2015. Two of the Company’s outside board of directors serve as directors of the MaRs Discovery District, a not-for-profit corporation. These directors receive no financial remuneration for serving as directors of the MaRs Discovery District.

 

In April 2004, the Company signed a distribution and license agreement with Nycomed Danmark ApS (Nycomed) in which the Company granted rights to develop and market PREOS in Europe. Nycomed has agreed to make an equity investment in the Company of $40.0 million through the purchase of 1.33 million shares of the Company’s common stock. The agreement also requires Nycomed to pay the Company up to $25.0 million in milestone payments upon regulatory approvals and achievement of certain sales targets and pay the company royalties on product sales. Nycomed has also committed to participate in 50% of the costs incurred in the conduct of certain Phase IIIb clinical trials up to a maximum contribution of $12.5 million and to expend at least $12.5 million in the conduct of certain Phase IV clinical studies.

 

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