Vertex Pharmaceuticals
VERTEX PHARMACEUTICALS INC / MA (Form: 10-Q, Received: 10/30/2015 16:29:05)
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________________________________________________
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2015
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM                 TO               
Commission file number 000-19319
____________________________________________
Vertex Pharmaceuticals Incorporated
(Exact name of registrant as specified in its charter)
Massachusetts
04-3039129
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
50 Northern Avenue, Boston, Massachusetts
02210
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code (617) 341-6100
____________________________________________

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x No  o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x No  o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  x
Accelerated filer  o
Non-accelerated filer  o  
Smaller reporting company  o
 
                                       (Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o No  x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Common Stock, par value $0.01 per share
245,717,286
Class
Outstanding at October 23, 2015

 


Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2015

TABLE OF CONTENTS
 
 
Page
 
 
 
Condensed Consolidated Statements of Operations - Three and Nine Months Ended September 30, 2015 and 2014
 
Condensed Consolidated Statements of Comprehensive Loss - Three and Nine Months Ended September 30, 2015 and 2014
 
Condensed Consolidated Balance Sheets - September 30, 2015 and December 31, 2014
 
Condensed Consolidated Statements of Shareholders' Equity and Noncontrolling Interest - Nine Months Ended September 30, 2015 and 2014
 
Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2015 and 2014
 
 
 
“We,” “us,” “Vertex” and the “Company” as used in this Quarterly Report on Form 10-Q refer to Vertex Pharmaceuticals Incorporated, a Massachusetts corporation, and its subsidiaries.
“Vertex,” “KALYDECO ® ” and “ORKAMBI ® ” are registered trademarks of Vertex. Other brands, names and trademarks contained in this Quarterly Report on Form 10-Q are the property of their respective owners.



Table of Contents

Part I. Financial Information
Item 1.    Financial Statements
VERTEX PHARMACEUTICALS INCORPORATED
Condensed Consolidated Statements of Operations
(unaudited)
(in thousands, except per share amounts)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
Product revenues, net
$
302,511

 
$
137,099

 
$
593,774

 
$
362,879

Royalty revenues
5,759

 
8,386

 
17,628

 
32,134

Collaborative revenues
1,546

 
33,502

 
2,999

 
40,846

Total revenues
309,816

 
178,987

 
614,401

 
435,859

Costs and expenses:
 
 
 
 
 
 
 
Cost of product revenues
30,269

 
10,208

 
55,059

 
28,435

Royalty expenses
1,691

 
3,976

 
6,068

 
18,525

Research and development expenses
246,284

 
190,939

 
685,741

 
654,043

Sales, general and administrative expenses
99,772

 
75,224

 
280,026

 
226,882

Restructuring expenses, net
1,826

 
40,843

 
682

 
46,761

Total costs and expenses
379,842

 
321,190

 
1,027,576

 
974,646

Loss from operations
(70,026
)
 
(142,203
)
 
(413,175
)
 
(538,787
)
Interest expense, net
(21,134
)
 
(20,384
)
 
(63,552
)
 
(51,686
)
Other (expenses) income, net
(1,326
)
 
(3,990
)
 
(5,025
)
 
34,192

Loss from continuing operations before provision for income taxes
(92,486
)
 
(166,577
)
 
(481,752
)
 
(556,281
)
Provision for income taxes
1,330

 
3,419

 
31,760

 
4,915

Loss from continuing operations
(93,816
)
 
(169,996
)
 
(513,512
)
 
(561,196
)
Loss from discontinued operations, net of tax benefit of $0

 
(64
)
 

 
(703
)
Net loss
(93,816
)
 
(170,060
)
 
(513,512
)
 
(561,899
)
(Income) loss attributable to noncontrolling interest
(1,333
)
 

 
30,909

 

Net loss attributable to Vertex
$
(95,149
)
 
$
(170,060
)
 
$
(482,603
)
 
$
(561,899
)
 
 
 
 
 
 
 
 
Amounts attributable to Vertex:
 
 
 
 
 
 
 
Loss from continuing operations
(95,149
)
 
(169,996
)
 
(482,603
)
 
(561,196
)
Loss from discontinued operations

 
(64
)
 

 
(703
)
Net loss attributable to Vertex
(95,149
)
 
(170,060
)
 
(482,603
)
 
(561,899
)
 
 
 
 
 
 
 
 
Amounts per share attributable to Vertex common shareholders:
 
 
 
 
 
 
 
Net loss from continuing operations:
 
 
 
 
 
 
 
Basic
$
(0.39
)
 
$
(0.72
)
 
$
(2.00
)
 
$
(2.40
)
Diluted
$
(0.39
)
 
$
(0.72
)
 
$
(2.00
)
 
$
(2.40
)
Net loss from discontinued operations:
 
 
 
 
 
 
 
Basic
$

 
$

 
$

 
$

Diluted
$

 
$

 
$

 
$

Net loss:
 
 
 
 
 
 
 
Basic
$
(0.39
)
 
$
(0.72
)
 
$
(2.00
)
 
$
(2.40
)
Diluted
$
(0.39
)
 
$
(0.72
)
 
$
(2.00
)
 
$
(2.40
)
Shares used in per share calculations:
 
 
 
 
 
 
 
Basic
241,969

 
236,137

 
240,749

 
234,207

Diluted
241,969

 
236,137

 
240,749

 
234,207

The accompanying notes are an integral part of these condensed consolidated financial statements.


2

Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
Condensed Consolidated Statements of Comprehensive Loss
(unaudited)
(in thousands)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
Net loss
$
(93,816
)
 
$
(170,060
)
 
$
(513,512
)
 
$
(561,899
)
Changes in other comprehensive loss:
 
 
 
 
 
 
 
Unrealized holding gains (losses) on marketable securities
56

 
(30
)
 
186

 
25

Unrealized gains on foreign currency forward contracts
4,546

 
1,838

 
572

 
1,713

Foreign currency translation adjustment
(1,384
)
 
(624
)
 
(164
)
 
(271
)
Total changes in other comprehensive loss
3,218

 
1,184

 
594

 
1,467

Comprehensive loss
(90,598
)
 
(168,876
)
 
(512,918
)
 
(560,432
)
Comprehensive (income) loss attributable to noncontrolling interest
(1,333
)
 

 
30,909

 

Comprehensive loss attributable to Vertex
$
(91,931
)
 
$
(168,876
)
 
$
(482,009
)
 
$
(560,432
)
The accompanying notes are an integral part of these condensed consolidated financial statements.


3

Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
Condensed Consolidated Balance Sheets
(unaudited)
(in thousands, except share and per share amounts)
 
September 30,
 
December 31,
 
2015
 
2014
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
756,250

 
$
625,259

Marketable securities, available for sale
249,580

 
761,847

Restricted cash and cash equivalents (VIE)
75,765

 
8,418

Accounts receivable, net
165,272

 
75,964

Inventories
49,197

 
30,848

Prepaid expenses and other current assets
63,388

 
44,175

Total current assets
1,359,452

 
1,546,511

Property and equipment, net
706,670

 
715,812

Intangible assets
284,340

 
29,000

Goodwill
50,384

 
39,915

Restricted cash
22,086

 
176

Other assets
11,061

 
3,265

Total assets
$
2,433,993

 
$
2,334,679

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
78,899

 
$
71,194

Accrued expenses
249,698

 
209,676

Deferred revenues, current portion
14,000

 
17,468

Accrued restructuring expenses, current portion
8,682

 
33,107

Capital lease obligations, current portion
14,153

 
17,806

Senior secured term loan, current portion

 
14,206

Other liabilities, current portion
9,527

 
4,797

Total current liabilities
374,959

 
368,254

Deferred revenues, excluding current portion
17,501

 
27,808

Accrued restructuring expenses, excluding current portion
9,122

 
12,748

Capital lease obligations, excluding current portion
39,273

 
39,293

Deferred tax liability
113,860

 
15,044

Fan Pier lease obligation, excluding current portion
472,724

 
473,073

Senior secured term loan, excluding current portion
294,832

 
280,569

Other liabilities, excluding current portion
34,990

 
21,707

Total liabilities
1,357,261

 
1,238,496

Commitments and contingencies


 


Shareholders’ equity:
 
 
 
Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued and outstanding at September 30, 2015 and December 31, 2014

 

Common stock, $0.01 par value; 500,000,000 and 300,000,000 shares authorized at September 30, 2015 and December 31, 2014, respectively; 245,646,269 and 241,764,398 shares issued and outstanding at September 30, 2015 and December 31, 2014, respectively
2,419

 
2,385

Additional paid-in capital
6,106,270

 
5,777,154

Accumulated other comprehensive income
1,511

 
917

Accumulated deficit
(5,188,053
)
 
(4,705,450
)
Total Vertex shareholders' equity
922,147

 
1,075,006

Noncontrolling interest
154,585

 
21,177

Total shareholders’ equity
1,076,732

 
1,096,183

Total liabilities and shareholders’ equity
$
2,433,993

 
$
2,334,679

The accompanying notes are an integral part of these condensed consolidated financial statements.


4

Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
Condensed Consolidated Statements of Shareholders’ Equity and Noncontrolling Interest
(unaudited)
(in thousands)
 
Common Stock
 
Additional
Paid-in Capital
 
Accumulated
Other
Comprehensive Income (Loss)
 
Accumulated Deficit
 
Total Vertex
Shareholders’ Equity
 
Noncontrolling
Interest
 
Total
Shareholders’ Equity
 
Shares
 
Amount
 
 
 
 
 
 
Balance at December 31, 2013
233,789

 
$
2,320

 
$
5,321,286

 
$
(306
)
 
$
(3,966,895
)
 
$
1,356,405

 
$

 
$
1,356,405

Other comprehensive income, net of tax

 

 

 
1,467

 

 
1,467

 

 
1,467

Net loss

 

 

 

 
(561,899
)
 
(561,899
)
 

 
(561,899
)
Issuance of common stock under benefit plans
6,449

 
55

 
223,812

 

 

 
223,867

 

 
223,867

Stock-based compensation

 

 
136,065

 

 

 
136,065

 

 
136,065

Balance at September 30, 2014
240,238

 
$
2,375

 
$
5,681,163

 
$
1,161

 
$
(4,528,794
)
 
$
1,155,905

 
$

 
$
1,155,905

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2014
241,764

 
$
2,385

 
$
5,777,154

 
$
917

 
$
(4,705,450
)
 
$
1,075,006

 
$
21,177

 
$
1,096,183

Other comprehensive loss, net of tax

 

 

 
594

 

 
594

 

 
594

Net loss

 

 

 

 
(482,603
)
 
(482,603
)
 
(30,909
)
 
(513,512
)
Issuance of common stock under benefit plans
3,882

 
34

 
139,419

 

 

 
139,453

 

 
139,453

Stock-based compensation

 

 
189,697

 

 

 
189,697

 

 
189,697

Noncontrolling interest upon consolidation

 

 

 

 

 

 
164,317

 
164,317

Balance at September 30, 2015
245,646

 
$
2,419

 
$
6,106,270

 
$
1,511

 
$
(5,188,053
)
 
$
922,147

 
$
154,585

 
$
1,076,732

The accompanying notes are an integral part of these condensed consolidated financial statements.


5

Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
Condensed Consolidated Statements of Cash Flows
(unaudited)
(in thousands)
 
Nine Months Ended September 30,
 
2015
 
2014
Cash flows from operating activities:
 
 
 
Net loss
$
(513,512
)
 
$
(561,899
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization expense
46,596

 
46,921

Stock-based compensation expense
186,379

 
135,160

Deferred income taxes
7,793

 

Impairment of property and equipment
23

 
978

Other non-cash items, net
(2,899
)
 
7

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(88,735
)
 
(7,315
)
Inventories
(16,127
)
 
(4,901
)
Prepaid expenses and other assets
(23,737
)
 
(19,110
)
Accounts payable
6,283

 
(5,544
)
Accrued expenses and other liabilities
90,320

 
12,210

Accrued restructuring expense
(28,051
)
 
27,249

Deferred revenues
(13,751
)
 
(15,085
)
Net cash used in operating activities
(349,418
)
 
(391,329
)
Cash flows from investing activities:
 
 
 
Purchases of marketable securities
(292,135
)
 
(1,066,772
)
Maturities of marketable securities
804,588

 
1,203,400

Payment for acquisition of variable interest entity
(80,000
)
 

Expenditures for property and equipment
(32,775
)
 
(36,525
)
(Increase) decrease in restricted cash and cash equivalents
(21,980
)
 
9

Decrease in restricted cash and cash equivalents (VIE)
14,830

 

Decrease (increase) in other assets
(982
)
 
(92
)
Net cash provided by investing activities
391,546

 
100,020

Cash flows from financing activities:
 
 
 
Issuances of common stock under benefit plans
139,689

 
201,274

Payments on capital lease obligations
(16,515
)
 
(17,215
)
Proceeds from capital lease financing
13,386

 

Payments on Fan Pier lease obligation
(45,438
)
 
(45,438
)
Proceeds from senior secured term loan

 
294,383

Payments returned related to Fan Pier lease obligation

 
8,050

Net cash provided by financing activities
91,122

 
441,054

Effect of changes in exchange rates on cash
(2,259
)
 
(481
)
Net increase in cash and cash equivalents
130,991

 
149,264

Cash and cash equivalents—beginning of period
625,259

 
569,299

Cash and cash equivalents—end of period
$
756,250

 
$
718,563

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
19,074

 
$
2,817

Cash paid for income taxes
$
1,261

 
$
798

Capitalization of costs related to Fan Pier lease obligation
$

 
$
25,564

Assets acquired under capital lease
$

 
$
8,985

Issuances of common stock exercises from employee benefit plans receivable
$
(236
)
 
$
23,035

The accompanying notes are an integral part of these condensed consolidated financial statements.

6

Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)


A. Basis of Presentation and Accounting Policies
Basis of Presentation
The accompanying condensed consolidated financial statements are unaudited and have been prepared by Vertex Pharmaceuticals Incorporated ("Vertex" or the "Company") in accordance with accounting principles generally accepted in the United States of America ("GAAP").
The condensed consolidated financial statements reflect the operations of (i) the Company, (ii) its wholly-owned subsidiaries and (iii) consolidated variable interest entities (VIEs). All material intercompany balances and transactions have been eliminated. The Company operates in one segment, pharmaceuticals.

Certain information and footnote disclosures normally included in the Company's annual financial statements have been condensed or omitted. These interim financial statements, in the opinion of management, reflect all normal recurring adjustments necessary for a fair presentation of the financial position and results of operations for the interim periods ended September 30, 2015 and 2014 .
The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full fiscal year. These interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2014 , which are contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2014 that was filed with the Securities and Exchange Commission (the “SEC”) on February 13, 2015 (the "2014 Annual Report on Form 10-K").
Use of Estimates and Summary of Significant Accounting Policies
The preparation of condensed consolidated financial statements in accordance with GAAP requires management to make certain 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 amounts of revenues and expenses during the reported periods. Significant estimates in these condensed consolidated financial statements have been made in connection with the calculation of revenues, inventories, research and development expenses, stock-based compensation expense, restructuring expense, the fair value of intangible assets, goodwill, noncontrolling interest, the consolidation of VIEs, leases, the fair value of cash flow hedges and the provision for or benefit from income taxes. The Company bases its estimates on historical experience and various other assumptions, including in certain circumstances future projections that management believes to be reasonable under the circumstances. Actual results could differ from those estimates. Changes in estimates are reflected in reported results in the period in which they become known.
The Company's significant accounting policies are described in Note A, "Nature of Business and Accounting Policies," in the 2014 Annual Report on Form 10-K.
Recent Accounting Pronouncements
For a discussion of recent accounting pronouncements please refer to Note A, “Nature of Business and Accounting Policies—Recent Accounting Pronouncements,” in the 2014 Annual Report on Form 10-K. The Company did not adopt any new accounting pronouncements during the nine months ended September 30, 2015 that had a material effect on its condensed consolidated financial statements.
B.
Product Revenues, Net
The Company sells its products principally to a limited number of specialty pharmacy providers and selected regional wholesalers in North America as well as government-owned and supported customers in international markets (collectively, its “Customers”). The Company's Customers in North America subsequently resell the products to patients and health care providers. The Company recognizes net revenues from product sales upon delivery to the Customer as long as (i) there is persuasive evidence that an arrangement exists between the Company and the Customer, (ii) collectibility is reasonably assured and (iii) the price is fixed or determinable.


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Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

In order to conclude that the price is fixed or determinable, the Company must be able to (i) calculate its gross product revenues from sales to Customers and (ii) reasonably estimate its net product revenues upon delivery to its Customer's locations. The Company calculates gross product revenues based on the price that the Company charges its Customers. The Company estimates its net product revenues by deducting from its gross product revenues (a) trade allowances, such as invoice discounts for prompt payment and Customer fees, (b) estimated government and private payor rebates, chargebacks and discounts, (c) estimated reserves for expected product returns and (d) estimated cost of co-pay assistance programs for patients, as well as other incentives for certain indirect customers. The Company makes significant estimates and judgments that materially affect the Company's recognition of net product revenues. In certain instances, the Company may be unable to reasonably conclude that the price is fixed or determinable at the time of delivery, in which case it defers the recognition of revenues. Once the Company is able to determine that the price is fixed or determinable, it recognizes the revenues associated with the units in which revenue recognition was deferred.
The following table summarizes activity in each of the product revenue allowance and reserve categories for the nine months ended September 30, 2015 :
 
Trade
Allowances
 
Rebates,
Chargebacks
and Discounts
 
Product
Returns
 
Other
Incentives
 
Total
 
(in thousands)
Balance at December 31, 2014
$
1,463

 
$
29,102

 
$
4,713

 
$
745

 
$
36,023

Provision related to current period sales
6,120

 
39,533

 
429

 
2,402

 
48,484

Adjustments related to prior period sales
(143
)
 
(12,342
)
 
(993
)
 
(235
)
 
(13,713
)
Credits/payments made
(5,115
)
 
(22,465
)
 
(3,254
)
 
(1,652
)
 
(32,486
)
Balance at September 30, 2015
$
2,325

 
$
33,828

 
$
895

 
$
1,260

 
$
38,308

C.
Collaborative Arrangements
Cystic Fibrosis Foundation Therapeutics Incorporated
In April 2011, the Company entered into an amendment (the “April 2011 Amendment”) to its existing collaboration agreement with Cystic Fibrosis Foundation Therapeutics Incorporated (“CFFT”) pursuant to which CFFT agreed to provide financial support for (i) development activities for VX-661, a compound that targets the processing and trafficking defect of the F508del CFTR proteins discovered under the collaboration, and (ii) additional research and development activities directed at discovering new compounds targeting the processing and trafficking defect of the F508del protein.
Under the April 2011 Amendment, CFFT agreed to provide the Company with up to $75.0 million in funding over approximately five years for research and development activities. The Company retains the right to develop and commercialize KALYDECO (ivacaftor), ORKAMBI (lumacaftor in combination with ivacaftor), lumacaftor, VX-661 and any other compounds discovered during the course of the research collaboration with CFFT. The Company recognized no collaborative revenues from this collaboration during the three and nine months ended September 30, 2015 and $2.0 million and $6.5 million of collaborative revenues from this collaboration during the three and nine months ended September 30, 2014 , respectively.
In the original agreement, as amended prior to the April 2011 Amendment, the Company agreed to pay CFFT tiered royalties calculated as a percentage, ranging from single digits to sub-teens, of annual net sales of any approved drugs discovered during the research term that ended in 2008, including KALYDECO, ORKAMBI, lumacaftor and VX-661. The April 2011 Amendment provides for a tiered royalty in the same range on net sales of compounds targeting the processing and trafficking defect of F508del CFTR proteins discovered during the research term that began in 2011 and ended in February 2014. In each of the third quarter of 2012 and the first quarter of 2013, CFFT earned a commercial milestone payment of $9.3 million from the Company upon achievement of certain sales levels for KALYDECO. These milestones were reflected in the Company's cost of product revenues. There are no additional commercial milestone payments payable by the Company to CFFT related to sales levels for KALYDECO. The Company also is obligated to make up to two one-time commercial milestone payments to CFFT upon achievement of certain sales levels for ORKAMBI.


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VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

The Company began marketing KALYDECO in the United States and certain countries in the European Union in 2012 and began marketing ORKAMBI in the United States in July 2015. The Company has royalty obligations to CFFT for each compound commercialized pursuant to this collaboration until the expiration of patents covering that compound. The Company has patents in the United States and European Union covering the composition-of-matter of ivacaftor that expire in 2027 and 2025, respectively, subject to potential patent life extensions. The Company has patents in the United States and European Union covering the composition-of-matter of lumacaftor that expire in 2030 and 2026, respectively, subject to potential patent life extensions. CFFT may terminate its funding obligations under the collaboration, as amended, in certain circumstances, in which case there will be a proportional adjustment to the royalty rates and commercial milestone payments for certain compounds. The collaboration also may be terminated by either party for a material breach by the other, subject to notice and cure provisions.
Janssen Pharmaceutica NV
The Company has a collaboration agreement (the “Janssen HCV Agreement”) with Janssen Pharmaceutica NV (“Janssen NV”) for the development, manufacture and commercialization of telaprevir, which Janssen NV began marketing under the brand name INCIVO in certain of its territories in September 2011. Pursuant to the Janssen HCV Agreement, as amended, Janssen NV has a fully-paid license to manufacture and commercialize INCIVO in its territories including Europe, South America, the Middle East, Africa and Australia, subject to the payment of third-party royalties on net sales of INCIVO. In addition to the collaborative revenues, the Company recorded royalty revenues and corresponding royalty expenses related to third-party royalties that Janssen NV remains responsible for based on INCIVO net sales.
During the three and nine months ended September 30, 2015 and 2014 , the Company recognized the following revenues attributable to the Janssen NV collaboration:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Royalty revenues (INCIVO)
$
158

 
$
2,284

 
$
1,742

 
$
12,917

Collaborative revenues (telaprevir)
441

 
1,390

 
1,620

 
4,262

  Total revenues attributable to the Janssen NV collaboration
$
599

 
$
3,674

 
$
3,362

 
$
17,179

CRISPR Therapeutics AG
On October 26, 2015, the Company entered into a strategic collaboration, option and license agreement (the "CRISPR Agreement") with CRISPR Therapeutics AG and its affiliates ("CRISPR") to collaborate on the discovery and development of potential new treatments aimed at the underlying genetic causes of human diseases using CRISPR-Cas9 gene editing technology. The Company has the exclusive right to license up to six CRISPR-Cas9-based targets. In connection with the CRISPR Agreement, the Company made an upfront payment to CRISPR of $75.0 million and will make a $30.0 million investment in CRISPR pursuant to a convertible loan agreement.
The Company will fund all of the discovery activities conducted pursuant to the CRISPR Agreement. For potential hemoglobinapathy treatments, including treatments for sickle cell disease, the Company and CRISPR will share equally all research and development costs and worldwide revenues. For other targets that the Company elects to license, the Company would lead all development and global commercialization activities. For each of up to six targets that the Company elects to license, other than hemoglobinapathy targets, CRISPR has the potential to receive up to $420.0 million in development, regulatory and commercial milestones and royalties on net sales.
The Company may terminate the CRISPR Agreement upon 90 days’ notice to CRISPR prior to any product receiving marketing approval or upon 270 days’ notice after such point. The CRISPR Agreement also may be terminated by either party for a material breach by the other, subject to notice and cure provisions. Unless earlier terminated, the CRISPR Agreement will continue in effect until the expiration of the Company's payment obligations under the CRISPR Agreement.


9

Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

Variable Interest Entities
The Company has entered into several agreements pursuant to which it has licensed rights to certain drug candidates from third-party collaborators, which has resulted in the consolidation of the third parties' financial statements into the Company's condensed consolidated financial statements as VIEs. In order to account for the fair value of the contingent milestone and royalty payments related to these collaborations under GAAP, the Company uses present-value models based on assumptions regarding the probability of achieving the relevant milestones, estimates regarding the time to develop the drug candidates, estimates of future product sales and the appropriate discount rates. The Company bases its estimate of the probability of achieving the relevant milestones on industry data for similar assets and its own experience. The discount rates used in the valuation model represent a measure of credit risk and market risk associated with settling the liabilities. Significant judgment is used in determining the appropriateness of these assumptions at each reporting period. Changes in these assumptions could have a material effect on the fair value of the contingent milestone and royalty payments. The following collaborations are, or were previously, reflected in the Company's financial statements for being consolidated as VIEs:
Parion Sciences, Inc.
License and Collaboration Agreement

On June 4, 2015, the Company entered into a strategic collaboration and license agreement (the "Parion Agreement") with Parion Sciences, Inc. (“Parion”).  Pursuant to the agreement, the Company is collaborating with Parion to develop investigational epithelial sodium channel (“ENaC”) inhibitors, including VX-371 (formerly P-1037) and P-1055, for the potential treatment of cystic fibrosis, or CF, and other pulmonary diseases.  The Company is leading development activities for VX-371 and P-1055 in CF and other pulmonary diseases and is responsible for all costs, subject to certain exceptions, related to development and commercialization of the compounds.

Pursuant to the Parion Agreement, the Company has worldwide development and commercial rights to Parion’s lead investigational ENaC inhibitors, VX-371 and P-1055, for the potential treatment of CF and all other pulmonary diseases and has the option to select additional compounds discovered in Parion’s research program.  Parion received an $80.0 million up-front payment and has the potential to receive up to an additional (i) $490.0 million in development and regulatory milestone payments for development of ENaC inhibitors in CF, including $360.0 million related to global filing and approval milestones, (ii) $370.0 million in development and regulatory milestones for VX-371 and P-1055 in non-CF pulmonary indications and (iii)  $230.0 million in development and regulatory milestones should the Company elect to develop an additional ENaC inhibitor from Parion’s research program. The Company has agreed to pay Parion tiered royalties that range from the low double digits to mid-teens as a percentage of potential sales of licensed products.

The Company may terminate the Parion Agreement upon 90 days’ notice to Parion prior to any licensed product receiving marketing approval or upon 180 days’ notice after such point. If the Company experiences a change of control prior to the initiation of the first Phase 3 clinical trial for a licensed product, Parion may terminate the Parion Agreement upon 30 days’ notice, subject to the Company's right to receive specified royalties on any subsequent commercialization of licensed products. The Parion Agreement also may be terminated by either party for a material breach by the other, subject to notice and cure provisions. Unless earlier terminated, the agreement will continue in effect until the expiration of the Company's royalty obligations, which expire on a country-by-country basis on the later of (i) the date the last-to-expire patent covering a licensed product expires or (ii)  ten years after the first commercial sale in the country.

The Company determined that Parion is a VIE based on, among other factors, the significance to Parion of the ENaC inhibitors licensed to the Company pursuant to the Parion Agreement and on the Company's power to direct the activities that most significantly impact the economic performance of Parion.  Accordingly, the Company consolidated Parion's financial statements beginning on June 4, 2015. However, the Company's interests in Parion are limited to those accorded to the Company in the Parion Agreement. In particular, the Company did not acquire any equity interest in Parion, any interest in Parion's cash and cash equivalents or any control over Parion's activities that do not relate to the Parion Agreement.


10

Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

Consideration for the Parion Agreement

The Company determined that the fair value of the consideration from the Company to Parion was $255.3 million as of June 4, 2015, which consisted of (i) an $80.0 million up-front payment, (ii) the estimated fair value of the contingent research and development milestones potentially payable by the Company to Parion and (iii) the estimated fair value of potential royalty payments payable by the Company to Parion. The Company valued the contingent milestone and royalty payments using (a) discount rates ranging from 4.1% to 5.9% for the development milestones and (b) a discount rate of 6.6% for royalties. The consideration paid and the preliminary fair value of the contingent milestone and royalty payments payable by the Company pursuant to the agreement are set forth in the table below:
 
June 4, 2015
 
(in thousands)
Up-front payment
$
80,000

Fair value of contingent milestone and royalty payments
175,340

Total
$
255,340

Preliminary Allocation of Assets and Liabilities

For the purposes of the condensed consolidated balance sheets at June 4, 2015 and September 30, 2015 , the Company preliminarily allocated the total consideration, which is comprised of the up-front payment and the fair value of the contingent milestone and royalty payments, intangible assets, goodwill, deferred tax liability, net and net other assets and liabilities.

The Company recorded $255.3 million of intangible assets on the Company's condensed consolidated balance sheet for Parion's in-process research and development assets. These in-process research and development assets relate to Parion's pulmonary ENaC platform, including the intellectual property related to VX-371 and P-1055, that are licensed by Parion to the Company. The difference between the preliminary fair value of the consideration and the fair value of Parion's assets (including the fair value of intangible assets) and liabilities was allocated to goodwill.

The following table summarizes the preliminary fair values of the assets and liabilities recorded on the effective date of the agreement:
 
June 4, 2015
 
(in thousands)
Intangible assets
$
255,340

Goodwill
10,468

Deferred tax liability
(91,023
)
Net other assets (liabilities)
(10,468
)
Net assets attributable to noncontrolling interests
$
164,317

BioAxone Biosciences, Inc.
In October 2014, the Company entered into a license and collaboration agreement (the “BioAxone Agreement”) with BioAxone Biosciences, Inc. (“BioAxone”), a privately-held biotechnology company, which resulted in the consolidation of BioAxone as a VIE beginning on October 1, 2014. The Company paid BioAxone initial payments of $10.0 million in the fourth quarter of 2014.
BioAxone has the potential to receive up to $90.0 million in milestones and fees, including development, regulatory and milestone payments and a license continuation fee. In addition, BioAxone would receive royalties and commercial milestones on future net product sales of VX-210, if any. The Company holds an option to purchase BioAxone at a predetermined price. The option expires on the earliest of (a) the day the FDA accepts the Biologics License Application submission for VX-210, (b) the day the Company elects to continue the license instead of exercising the option to purchase BioAxone and (c) March 15, 2018, subject to the Company’s option to extend this date by one year.


11

Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

Alios BioPharma, Inc.
In 2011, the Company entered into a license and collaboration agreement (the “Alios Agreement”) with Alios BioPharma, Inc. (“Alios”), which was a privately-held biotechnology company, which resulted in the consolidation of Alios as a VIE through December 31, 2013. Pursuant to the Alios Agreement, the Company and Alios collaborated on the research, development and commercialization of HCV nucleotide analogues discovered by Alios through April 2014. In December 2014, the Alios Agreement terminated in accordance with its terms pursuant to a termination notice delivered by the Company in October 2014. As of September 30, 2014, the Company concluded that it no longer had significant continuing involvement with Alios due to its intent and ability to terminate the Alios Agreement, among other factors; therefore, the operations of Alios are presented as discontinued operations in these condensed consolidated financial statements .
Aggregate VIE Financial Information

The Company did not have any consolidated VIEs for the three and nine months ended September 30, 2014 . An aggregate summary of net loss attributable to noncontrolling interest related to the Company's VIEs for the three and nine months ended September 30, 2015 is as follows:
 
Three Months Ended September 30, 2015
 
Nine Months Ended September 30, 2015
 
(in thousands)
Loss attributable to noncontrolling interest before provision for income taxes
$
(1,743
)
 
$
(3,322
)
Provision for income taxes
(777
)
 
(30,367
)
Increase in fair value of contingent milestone and royalty payments
3,853

 
2,780

Net (income) loss attributable to noncontrolling interest
$
1,333

 
$
(30,909
)

During the three and nine months ended September 30, 2015 , the fair value of the contingent milestone and royalty payments related to the BioAxone collaboration decreased by $0.6 million and $0.1 million , respectively. During the three and nine months ended September 30, 2015 , the fair value of the contingent milestone and royalty payments related to the Parion collaboration increased by $4.5 million and $2.9 million , respectively. The changes in the fair value of the contingent milestone and royalty payments were primarily due to the changes in market interest rates and the time value of money. As of September 30, 2015 , the fair value of the contingent milestone and royalty payments related to the BioAxone collaboration and the Parion collaboration was $27.0 million and $178.2 million , respectively.

The following table summarizes items related to the Company's VIEs included in the Company's condensed consolidated balance sheets as of the dates set forth in the table:
 
September 30, 2015
 
December 31, 2014
 
(in thousands)
Restricted cash and cash equivalents (VIE)
$
75,765

 
$
8,418

Prepaid expenses and other current assets
3,057

 
268

Intangible assets
284,340

 
29,000

Goodwill
19,391

 
8,923

Other assets
461

 
42

Accounts payable
1,115

 
189

Accrued expenses and other current liabilities
32,519

 
3,891

Deferred tax liability, net
110,360

 
11,544

Other liabilities
300

 
300

Noncontrolling interest
154,585

 
21,177


The Company has recorded the VIEs' cash and cash equivalents as restricted cash and cash equivalents (VIE) because (i) the Company does not have any interest in or control over the VIEs' cash and cash equivalents and (ii) the Company's agreements with each VIE do not provide for the VIEs' cash and cash equivalents to be used for the development of the assets


12

Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

that the Company licensed from the applicable VIE. Assets recorded as a result of consolidating our VIEs' financial condition into the Company's balance sheet do not represent additional assets that could be used to satisfy claims against the Company's general assets.
Outlicense Arrangements
In the ordinary course of the Company's business, the Company has entered into various agreements pursuant to which it has outlicensed rights to certain drug candidates to third-party collaborators. Although the Company does not consider any of these outlicense arrangements to be material, the most notable of these outlicense arrangements is described below. Pursuant to these outlicense arrangements, our collaborators are responsible for all costs related to the continued development of such drug candidates. Depending on the terms of the arrangements, the Company's collaborators may be required to make upfront payments, milestone payments upon the achievement of certain product research and development objectives and/or pay royalties on future sales, if any, of commercial products resulting from the collaboration.

Janssen Pharmaceuticals, Inc.
In June 2014, the Company entered into an agreement (the “Janssen Influenza Agreement”) with Janssen Pharmaceuticals, Inc. (“Janssen Inc.”), which was amended in October 2014 to clarify certain roles and responsibilities of the parties.

Pursuant to the Janssen Influenza Agreement, Janssen Inc. has an exclusive worldwide license to develop and commercialize certain drug candidates for the treatment of influenza, including VX-787. The Company received non-refundable payments of $35.0 million from Janssen Inc. in 2014, which were recorded as collaborative revenue. The Company has the potential to receive development, regulatory and commercial milestone payments as well as royalties on future product sales, if any.
Janssen Inc. is responsible for costs related to the development and commercialization of the compounds. During the three and nine months ended September 30, 2015 , the Company recorded reimbursement for these development activities of $4.0 million and $18.7 million , respectively. During the three and nine months ended September 30, 2014 , the Company recorded reimbursement for these development activities of $4.3 million . The reimbursements are recorded as a reduction to development expense in the Company's condensed consolidated statements of operations primarily due to the fact that Janssen Inc. directs the activities and selects the suppliers associated with these activities. Janssen Inc. may terminate the Janssen Influenza Agreement, subject to certain exceptions, upon six months' notice.
D.
Earnings Per Share
Basic net loss per share attributable to Vertex common shareholders is based upon the weighted-average number of common shares outstanding during the period, excluding restricted stock and restricted stock units that have been issued but are not yet vested. Diluted net loss per share attributable to Vertex common shareholders is based upon the weighted-average number of common shares outstanding during the period plus additional weighted-average common equivalent shares outstanding during the period when the effect is dilutive.
The Company did not include the securities described in the following table in the computation of the net loss from continuing operations per share attributable to Vertex common shareholder calculations because the effect would have been anti-dilutive during each period:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Stock options
12,025

 
13,097

 
12,025

 
13,097

Unvested restricted stock and restricted stock units
3,367

 
2,672

 
3,367

 
2,672

E.
Fair Value Measurements
The fair value of the Company’s financial assets and liabilities reflects the Company’s estimate of amounts that it would have received in connection with the sale of the assets or paid in connection with the transfer of the liabilities in an orderly transaction between market participants at the measurement date. In connection with measuring the fair value of its assets and liabilities, the Company seeks to maximize the use of observable inputs (market data obtained from sources independent from the Company) and to minimize the use of unobservable inputs (the Company’s assumptions about how market participants would price assets and liabilities). The following fair value hierarchy is used to classify assets and liabilities based on the observable inputs and unobservable inputs used in order to value the assets and liabilities:
Level 1:
Quoted prices in active markets for identical assets or liabilities. An active market for an asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2:
Observable inputs other than Level 1 inputs. Examples of Level 2 inputs include quoted prices in active markets for similar assets or liabilities and quoted prices for identical assets or liabilities in markets that are not active.
Level 3:
Unobservable inputs based on the Company’s assessment of the assumptions that market participants would use in pricing the asset or liability.
The Company’s investment strategy is focused on capital preservation. The Company invests in instruments that meet the credit quality standards outlined in the Company’s investment policy. This policy also limits the amount of credit exposure to any one issue or type of instrument. As of September 30, 2015 , the Company’s investments were in money market funds, corporate debt securities and commercial paper.
As of September 30, 2015 , all of the Company’s financial assets that were subject to fair value measurements were valued using observable inputs. The Company’s financial assets valued based on Level 1 inputs consisted of money market funds. The Company’s financial assets valued based on Level 2 inputs consisted of corporate debt securities and commercial paper, which consist of investments in highly-rated investment-grade corporations.


13

Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

The following table sets forth the Company’s financial assets and liabilities subject to fair value measurements:
 
Fair Value Measurements as of September 30, 2015
 
 
 
Fair Value Hierarchy
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(in thousands)
Financial assets carried at fair value:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
340,573

 
$
340,573

 
$

 
$

Corporate debt securities
25,109

 

 
25,109

 

Commercial paper
24,000

 

 
24,000

 

Marketable securities:
 
 
 
 
 
 
 
Corporate debt securities
109,335

 

 
109,335

 

Commercial paper
140,245

 

 
140,245

 

Prepaid and other current assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
3,508

 

 
3,508

 

Other assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
651

 

 
651

 

Total financial assets
$
643,421


$
340,573

 
$
302,848

 
$

Financial liabilities carried at fair value:
 
 
 
 
 
 
 
Other liabilities, current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
$
(1,552
)
 
$

 
$
(1,552
)
 
$

Other liabilities, excluding current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
(24
)
 

 
(24
)
 

Total financial liabilities
$
(1,576
)
 
$

 
$
(1,576
)
 
$

The Company's VIEs invested in cash equivalents consisting of money market funds of $75.4 million as of September 30, 2015 , which are valued based on Level 1 inputs. These cash equivalents are not included in the table above. The Company’s noncontrolling interest related to VIEs includes the fair value of the contingent milestone and royalty payments , which are valued based on Level 3 inputs. Please refer to Note C, “Collaborative Arrangements,” for further information.
As of September 30, 2015 , the fair value and carrying value of the Company's Term Loan was $294.8 million . The fair value of the Company's Term Loan was estimated based on Level 3 inputs computed using the effective interest rate of the Term Loan. The effective interest rate considers the timing and amount of estimated future interest payments as well as current markets rates. Please refer to Note K, "Long-term Obligations" for further information regarding the Company's Term Loan.


14

Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

F.
Marketable Securities
A summary of the Company’s cash, cash equivalents and marketable securities is shown below:
 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(in thousands)
As of September 30, 2015
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash and money market funds
$
707,141

 
$

 
$

 
$
707,141

Commercial paper
$
25,109

 
$

 
$

 
$
25,109

Corporate debt securities
$
24,000

 
$

 
$

 
$
24,000

Total cash and cash equivalents
$
756,250

 
$

 
$

 
$
756,250

Marketable securities:
 
 
 
 
 
 
 
Commercial paper (due within 1 year)
$
140,131

 
$
114

 
$

 
$
140,245

Corporate debt securities (due within 1 year)
109,386

 
28

 
(79
)
 
109,335

Total marketable securities
$
249,517

 
$
142

 
$
(79
)
 
$
249,580

Total cash, cash equivalents and marketable securities
$
1,005,767

 
$
142

 
$
(79
)
 
$
1,005,830

 
 
 
 
 
 
 
 
As of December 31, 2014
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash and money market funds
$
625,259

 
$

 
$

 
$
625,259

Total cash and cash equivalents
$
625,259

 
$

 
$

 
$
625,259

Marketable securities:
 
 
 
 
 
 
 
Government-sponsored enterprise securities (due within 1 year)
$
463,788

 
$
14

 
$
(52
)
 
$
463,750

Commercial paper (due within 1 year)
51,674

 
72

 

 
51,746

Corporate debt securities (due within 1 year)
196,065

 
2

 
(66
)
 
196,001

Corporate debt securities (due after 1 year through 5 years)
50,443

 

 
(93
)
 
50,350

Total marketable securities
$
761,970

 
$
88

 
$
(211
)
 
$
761,847

Total cash, cash equivalents and marketable securities
$
1,387,229

 
$
88

 
$
(211
)
 
$
1,387,106

The Company has a limited number of marketable securities in insignificant loss positions as of September 30, 2015 , which the Company does not intend to sell and has concluded it will not be required to sell before recovery of the amortized costs for the investment at maturity. There were no charges recorded for other-than-temporary declines in fair value of marketable securities nor gross realized gains or losses recognized in the three and nine months ended September 30, 2015 and 2014 .


15

Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

G.
Accumulated Other Comprehensive (Loss) Income
A summary of the Company's changes in accumulated other comprehensive (loss) income by component is shown below:
 
Foreign Currency Translation Adjustment
 
Unrealized Holding Gains (Losses) on Marketable Securities
 
Unrealized Gains (Losses) on Foreign Currency Forward Contracts
 
Total
 
(in thousands)
Balance at December 31, 2014
$
(971
)
 
$
(123
)
 
$
2,011

 
$
917

Other comprehensive (loss) income before reclassifications
(164
)
 
186

 
4,072

 
4,094

Amounts reclassified from accumulated other comprehensive loss

 

 
(3,500
)
 
(3,500
)
Net current period other comprehensive (loss) income
$
(164
)
 
$
186

 
$
572

 
$
594

Balance at September 30, 2015
$
(1,135
)
 
$
63

 
$
2,583

 
$
1,511

 
Foreign Currency Translation Adjustment
 
Unrealized Holding Gains on Marketable Securities
 
Unrealized (Losses) Gains on Foreign Currency Forward Contracts
 
Total
 
(in thousands)
Balance at December 31, 2013
$
(325
)
 
$
42

 
$
(23
)
 
$
(306
)
Other comprehensive (loss) income before reclassifications
(271
)
 
25

 
2,140

 
1,894

Amounts reclassified from accumulated other comprehensive loss

 

 
(427
)
 
(427
)
Net current period other comprehensive (loss) income
$
(271
)
 
$
25

 
$
1,713

 
$
1,467

Balance at September 30, 2014
$
(596
)
 
$
67

 
$
1,690

 
$
1,161

H.
Hedging
The Company maintains a hedging program intended to mitigate the effect of changes in foreign exchange rates for a portion of the Company’s forecasted product revenues denominated in certain foreign currencies. The program includes foreign currency forward contracts that are designated as cash flow hedges under GAAP having contractual durations from one to eighteen months. To date, the existence of operational sites in countries outside the United States has limited the degree to which the Company has sought to hedge its revenues in certain foreign currencies.
The Company formally documents the relationship between foreign currency forward contracts (hedging instruments) and forecasted product revenues (hedged items), as well as the Company's risk management objective and strategy for undertaking various hedging activities, which includes matching all foreign currency forward contracts that are designated as cash flow hedges to forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the foreign currency forward contracts are highly effective in offsetting changes in cash flows of hedged items on a prospective and retrospective basis. If the Company determines that a (i) foreign currency forward contract is not highly effective as a cash flow hedge, (ii) foreign currency forward contract has ceased to be a highly effective hedge or (iii) forecasted transaction is no longer probable of occurring, the Company would discontinue hedge accounting treatment prospectively. The Company measures effectiveness based on the change in fair value of the forward contracts and the fair value of the hypothetical foreign currency forward contracts with terms that match the critical terms of the risk being hedged. As of September 30, 2015 , all hedges were determined to be highly effective and the Company has not recorded any ineffectiveness related to the hedging program.
The following table summarizes the notional amount of the Company’s outstanding foreign currency forward contracts designated as cash flow hedges:
 
As of September 30, 2015
 
As of December 31, 2014
Foreign Currency
(in thousands)
Euro
$
106,620

 
$
20,209

British pound sterling
78,861

 
13,515

Australian dollar
25,414

 

Total foreign currency forward contracts
$
210,895

 
$
33,724

The following table summarizes the fair value of the Company's outstanding foreign currency forward contracts designated as cash flow hedges under GAAP included on the Company's condensed consolidated balance sheets:
As of September 30, 2015
Assets
 
Liabilities
Classification
 
Fair Value
 
Classification
 
Fair Value
(in thousands)
Prepaid and other current assets
 
$
3,508

 
Other liabilities, current portion
 
$
(1,552
)
Other assets
 
651

 
Other liabilities, excluding current portion
 
(24
)
Total assets
 
$
4,159

 
Total liabilities
 
$
(1,576
)
As of December 31, 2014
Assets
 
Liabilities
Classification
 
Fair Value
 
Classification
 
Fair Value
(in thousands)
Prepaid and other current assets
 
$
2,011

 
Other liabilities, current portion
 
$

Total assets
 
$
2,011

 
Total liabilities
 
$

The following table summarizes the potential effect of offsetting derivatives by type of financial instrument on the Company's condensed consolidated balance sheets:


16

Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

 
As of September 30, 2015
 
Gross Amounts Recognized
 
Gross Amounts Offset
 
Gross Amount Presented
 
Gross Amount Not Offset
 
Legal Offset
Foreign currency forward contracts
(in thousands)
Total assets
$
4,159

 
$

 
$
4,159

 
$
(1,576
)
 
$
2,583

Total liabilities
$
(1,576
)
 
$

 
$
(1,576
)
 
$
1,576

 
$

 
As of December 31, 2014
 
Gross Amounts Recognized
 
Gross Amounts Offset
 
Gross Amount Presented
 
Gross Amount Not Offset
 
Legal Offset
Foreign currency forward contracts
(in thousands)
Total assets
$
2,011

 
$

 
$
2,011

 
$

 
$
2,011

I. Inventories
Inventories consisted of the following:
 
As of September 30, 2015
 
As of December 31, 2014
 
(in thousands)
Raw materials
$
8,669

 
$
8,506

Work-in-process
34,115

 
20,508

Finished goods
6,413

 
1,834

Total
$
49,197

 
$
30,848

J. Intangible Assets and Goodwill
Intangible Assets
As of September 30, 2015 , in-process research and development intangible assets of $284.3 million were recorded on the Company's condensed consolidated balance sheet. The increase of $255.3 million as compared to the $29.0 million recorded as of December 31, 2014 is due to the Company's collaboration with Parion.
In June 2015, in connection with entering into the Parion Agreement, the Company recorded an in-process research and development intangible asset of $255.3 million based on the Company’s estimate of the fair value of Parion’s lead investigational ENaC inhibitors, including VX-371 and P-1055, that were licensed by the Company from Parion. The Company aggregated the fair value of the ENaC inhibitors into a single intangible asset because the phase, nature and risks of development as well as the amount and timing of benefits associated with the assets were similar. In October 2014, the Company recorded an in-process research and development intangible asset of $29.0 million based on the Company’s estimate of the fair value of VX-210, a drug candidate for patients with spinal cord injuries that was licensed by the Company from BioAxone. The Company used discount rates of 7.1% and 7.5% in the present-value models to estimate the fair values of the ENaC inhibitors and VX-210 intangible assets, respectively.
The Company also conducted an evaluation of Parion and BioAxone's other programs at the effective date of the Parion Agreement and BioAxone Agreement, respectively, and determined that market participants would not have ascribed value to those programs because of the stage of development of the assets in each program and uncertainties related to the potential clinical development and commercialization of the programs.
Goodwill
As of September 30, 2015 , goodwill of $50.4 million was recorded on the Company's condensed consolidated balance sheet. The Company allocated $10.5 million to goodwill related to the Parion Agreement during the nine months ended September 30, 2015 . This goodwill relates to the potential synergies between licensed drug candidates and the Company's CF drugs and drug candidates.  None of the goodwill related to the Parion Agreement is expected to be deductible for income tax purposes. As of December 31, 2014 , $39.9 million of goodwill was recorded on the Company’s consolidated balance sheet.
K. Long-term Obligations
Fan Pier Leases
In 2011, the Company entered into two lease agreements, pursuant to which the Company leases approximately 1.1 million square feet of office and laboratory space in two buildings (the “Buildings”) at Fan Pier in Boston, Massachusetts (the “Fan Pier Leases”). The Company commenced lease payments in December 2013, and will make lease payments pursuant to the Fan Pier Leases through December 2028. The Company has an option to extend the term of the Fan Pier Leases for an additional ten years .
Because the Company was involved in the construction project and determined that the Fan Pier Leases did not meet the criteria for “sale-leaseback” treatment upon completion of the Buildings, the Company recorded project construction costs


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VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

incurred by the landlord as an asset and a related financing obligation during the construction period and began depreciating the asset and incurring interest expense related to the financing obligation in 2013. The Company bifurcates its lease payments pursuant to the Fan Pier Leases into (i) a portion that is allocated to the Buildings and (ii) a portion that is allocated to the land on which the Buildings were constructed. The portion of the lease obligations allocated to the land is treated as an operating lease that commenced in 2011.
Property and equipment, net, included $505.6 million and $515.0 million as of September 30, 2015 and December 31, 2014 , respectively, related to construction costs for the Buildings. The carrying value of the Company's lease agreement liability for the Buildings was $473.1 million and $473.4 million as of September 30, 2015 and December 31, 2014 , respectively.
Term Loan
In July 2014, the Company entered into a credit agreement with the lenders party thereto, and Macquarie US Trading LLC ("Macquarie"), as administrative agent. The credit agreement provides for a $300.0 million senior secured term loan ("Term Loan"). The credit agreement also provides that, subject to satisfaction of certain conditions, the Company may request that the lenders establish an incremental senior secured term loan facility in an aggregate amount not to exceed $200.0 million . The Term Loan initially bore interest at a rate of 7.2% per annum, which will be reduced to 6.2% per annum based on the FDA's approval of ORKAMBI. The Term Loan will bear interest at a rate of LIBOR plus 5.0% per annum during the third year of the term.
The maturity date of all loans under the facilities is July 9, 2017. Interest is payable quarterly and on the maturity date. In October 2015, the Company amended the terms of the credit agreement to provide for, among other things, a modification to the repayment schedule of the loan. As amended, the Company is required to repay principal on the Term Loan in quarterly installments of $75 million from October 1, 2016 through the maturity date. The Company may prepay the Term Loan, in whole or in part, at any time; provided that prepayments prior to the July 9, 2016 are subject to a make-whole premium to ensure Macquarie receives approximately the present value of two years of interest payments over the life of the loan. The Company expects that amending the credit agreement will be accounted for as a debt modification, as opposed to an extinguishment of debt, based on an insignificant change to the present value of the future cash flows relating to the credit agreement.
The Company's obligations under the facilities are unconditionally guaranteed by certain of its domestic subsidiaries. All obligations under the facilities, and the guarantees of those obligations, are secured, subject to certain exceptions, by substantially all of the Company's assets and the assets of all guarantors, including the pledge of all or a portion of the equity interests of certain of its subsidiaries.
The credit agreement requires that the Company maintain, on a quarterly basis, a minimum level of KALYDECO net revenues. Further, the credit agreement includes negative covenants, subject to exceptions, restricting or limiting the Company's ability and the ability of its subsidiaries to, among other things, incur additional indebtedness, grant liens, engage in certain investment, acquisition and disposition transactions, pay dividends, repurchase capital stock and enter into transactions with affiliates. The credit agreement also contains customary representations and warranties, affirmative covenants and events of default, including payment defaults, breach of representations and warranties, covenant defaults and cross defaults. If an event of default occurs, the administrative agent would be entitled to take various actions, including the acceleration of amounts due under outstanding loans. There have been no events of default as of or during the period ended September 30, 2015 .
Based on the Company's evaluation of the Term Loan, the Company determined that the Term Loan contains several embedded derivatives. These embedded derivatives are clearly and closely related to the host instrument because they relate to the Company's credit risk; therefore, they do not require bifurcation from the host instrument, the Term Loan.
The Company incurred $5.3 million in fees paid to Macquarie that were recorded as a discount on the Term Loan and are being recorded as interest expense using the effective interest method over the term of the loan in the Company’s condensed consolidated statements of operations . As of September 30, 2015 , the unamortized discount associated with the Term Loan that was embedded in the senior secured term loan caption on the Company’s condensed consolidated balance sheet was $5.2 million .


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VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

L. Stock-based Compensation Expense
The Company issues stock options, restricted stock and restricted stock units with service conditions, which are generally the vesting periods of the awards. The Company also has issued, to certain members of senior management, restricted stock and restricted stock units that vest upon the earlier of the satisfaction of (i) a performance condition or (ii) a service condition and stock options that vest upon the earlier of the satisfaction of (a) performance conditions or (b) a service condition. In addition, the Company issued pursuant to a retention program restricted stock awards to certain members of senior management that will vest upon the satisfaction of both (i) a performance condition and (ii) a service condition. The Company also issues shares pursuant to an employee stock purchase plan ("ESPP").
In the second quarter of 2015, the Company’s shareholders approved an amendment and restatement of the 2013 Stock and Option Plan that, among other things, increased the number of shares of common stock available for issuance under the plan by 7,800,000 shares, plus the number of shares that remained available for issuance under our 2006 Stock and Option Plan, which rolled-over into the 2013 Stock and Option Plan.
During the three and nine months ended September 30, 2015 and 2014 , the Company recognized the following stock-based compensation expense included in loss from continuing operations:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Stock-based compensation expense by type of award:
 
 
 
 
 
 
 
Stock options
$
39,074

 
$
26,291

 
$
105,720

 
$
78,403

Restricted stock and restricted stock units
26,203

 
18,418

 
78,274

 
51,431

ESPP share issuances
1,738

 
1,883

 
5,703

 
6,231

Less stock-based compensation expense capitalized to inventories
(1,281
)
 
(456
)
 
(3,318
)
 
(905
)
Total stock-based compensation included in costs and expenses
$
65,734

 
$
46,136

 
$
186,379

 
$
135,160

 
 
 
 
 
 
 


Stock-based compensation expense by line item:
 
 
 
 
 
 
 
Research and development expenses
$
44,701

 
$
31,131

 
$
124,550

 
$
91,284

Sales, general and administrative expenses
21,033

 
15,005

 
61,829

 
43,876

Total stock-based compensation included in costs and expenses
$
65,734

 
$
46,136

 
$
186,379

 
$
135,160

The following table sets forth the Company's unrecognized stock-based compensation expense, net of estimated forfeitures, by type of award and the weighted-average period over which that expense is expected to be recognized:
 
As of September 30, 2015
 
Unrecognized Expense,
Net of
Estimated Forfeitures
 
Weighted-average
Recognition
Period
 
(in thousands)
 
(in years)
Type of award:
 
 
 
Stock options
$
197,031

 
2.30
Restricted stock and restricted stock units
$
190,786

 
2.73
ESPP share issuances
$
1,885

 
0.44


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VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

The following table summarizes information about stock options outstanding and exercisable at September 30, 2015 :
 
 
Options Outstanding
 
Options Exercisable
Range of Exercise Prices
 
Number
Outstanding
 
Weighted-average
Remaining
Contractual Life
 
Weighted-average
Exercise Price
 
Number
Exercisable
 
Weighted-average
Exercise Price
 
 
(in thousands)
 
(in years)
 
(per share)
 
(in thousands)
 
(per share)
$18.93–$20.00
 
138

 
2.35
 
$
18.93

 
138

 
$
18.93

$20.01–$40.00
 
2,499

 
3.81
 
$
34.56

 
2,284

 
$
34.36

$40.01–$60.00
 
2,593

 
6.80
 
$
48.27

 
1,458

 
$
49.52

$60.01–$80.00
 
1,567

 
8.31
 
$
75.94

 
551

 
$
74.95

$80.01–$100.00
 
1,932

 
8.28
 
$
90.27

 
638

 
$
87.16

$100.01–$120.00
 
1,791

 
9.32
 
$
109.24

 
201

 
$
109.22

$120.01–$134.69
 
1,505

 
9.78
 
$
131.21

 
168

 
$
127.52

Total
 
12,025

 
7.31
 
$
74.90

 
5,438

 
$
53.98

M. Other Arrangements
Sale of HIV Protease Inhibitor Royalty Stream
In 2008, the Company sold to a third party its rights to receive royalty payments from GlaxoSmithKline plc, net of royalty amounts to be earned by and due to a third party, for a one-time cash payment of $160.0 million . These royalty payments relate to net sales of HIV protease inhibitors, which had been developed pursuant to a collaboration agreement between the Company and GlaxoSmithKline plc. As of September 30, 2015 , the Company had $31.2 million in deferred revenues related to the one-time cash payment, which it is recognizing over the life of the collaboration agreement with GlaxoSmithKline plc based on the units-of-revenue method. In addition, the Company continues to recognize royalty revenues equal to the amount of the third-party subroyalty and an offsetting royalty expense for the third-party subroyalty payment.
Other income (expense), net
In April 2014, the Company received a one-time cash payment of $36.7 million from its landlord pursuant to the Fan Pier Leases.  This payment related to bonds issued pursuant to an Infrastructure Development Assistance Agreement between The Commonwealth of Massachusetts and the Company’s landlord.  The bonds were issued in connection with the landlord’s contribution to infrastructure improvements and also were dependent upon employment levels at the Company through the bond issuance date.  The Company accounted for the cash payment as a government grant as it was provided in part related to the Company’s employment level in Massachusetts. Such grants are recognized as income in the period in which the conditions of the grant are met and there is reasonable assurance that the grant will be received, provided it is not subject to refund. In the second quarter of 2014, the Company recorded $36.7 million as a credit to other income (expense), net in its consolidated statements of operations because the Company’s employment obligations related to these funds were satisfied as of the date of issuance of the bonds and the payment received was not subject to refund.
N. Income Taxes
The Company is subject to U.S. federal, state, and foreign income taxes. For the three and nine months ended September 30, 2015 , the Company recorded a provision for income taxes of $1.3 million and $31.8 million , respectively. The provision for income taxes recorded in the three and nine months ended September 30, 2015 included $0.8 million and $30.4 million , respectively, related to the Company's VIE's income tax provision. The VIE's income tax provision for the nine months ended September 30, 2015 primarily related to the income tax effect on the $80.0 million up-front payment received by Parion from the Company in June 2015. The Company has no liability for taxes payable by Parion and the income tax provision and related liability have been allocated to noncontrolling interest (VIE). For the three and nine months ended September 30,


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VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

2014 , the Company recorded a provision for income taxes of $3.4 million and $4.9 million , respectively, related to state income taxes and income earned in various foreign jurisdictions.
As of September 30, 2015 and December 31, 2014 , the Company had unrecognized tax benefits of $0.9 million . The Company recognizes interest and penalties related to income taxes as a component of income tax expense. As of September 30, 2015 , no interest and penalties have been accrued. The Company does not expect that its unrecognized tax benefits will materially increase within the next twelve months. The Company did not recognize any material interest or penalties related to uncertain tax positions as of September 30, 2015 and December 31, 2014 . In 2015, it is reasonably possible that the Company will reduce the balance of its unrecognized tax benefits by approximately $0.5 million due to the application of statute of limitations and settlements with taxing authorities, all of which would reduce the Company’s effective tax rate.
The Company continues to maintain a valuation allowance against certain deferred tax assets where it is more likely than not that the deferred tax asset will not be realized because of its extended history of annual losses.
The Company files U.S. federal income tax returns and income tax returns in various state, local and foreign jurisdictions. The Company is no longer subject to any tax assessment from an income tax examination in the United States before 2011 or any other major taxing jurisdiction for years before 2009, except where the Company has net operating losses or tax credit carryforwards that originated before 2009. The Company currently is under examination by the Internal Revenue Service for the year ended December 31, 2011 and in Canada, Pennsylvania, Delaware, New York and Texas for varying periods including the years ended December 31, 2011 through 2013. No adjustments have been reported. The Company is not under examination by any other jurisdictions for any tax year. The Company concluded audits with Massachusetts and Revenue Quebec during 2015 and the Canada Revenue Agency and Revenue Quebec during 2014 with no material adjustments.
The Company currently intends to reinvest the total amount of its unremitted earnings. At September 30, 2015 , foreign earnings, which were not significant, have been retained indefinitely by foreign subsidiary companies for reinvestment; therefore, no provision has been made for income taxes that would be payable upon the distribution of such earnings, and it would not be practicable to determine the amount of the related unrecognized deferred income tax liability. Upon repatriation of those earnings, in the form of dividends or otherwise, the Company would be subject to U.S. federal income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries.
O. Restructuring Liabilities
2003 Kendall Restructuring
In 2003, the Company adopted a plan to restructure its operations to coincide with its increasing internal emphasis on advancing drug candidates through clinical development to commercialization. The restructuring liability relates to specialized laboratory and office space that is leased to the Company pursuant to a 15 -year lease that terminates in 2018. The Company has not used more than 50% of this space since it adopted the plan to restructure its operations in 2003. This unused laboratory and office space currently is subleased to third parties.
The activities related to the restructuring liability for the three and nine months ended September 30, 2015 and 2014 were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Liability, beginning of the period
$
9,924

 
$
14,936

 
$
11,596

 
$
19,115

Cash payments
(3,975
)
 
(4,249
)
 
(10,544
)
 
(12,071
)
Cash received from subleases
2,919

 
2,689

 
8,194

 
8,067

Restructuring expense (income)
146

 
(464
)
 
(232
)
 
(2,199
)
Liability, end of the period
$
9,014

 
$
12,912

 
$
9,014

 
$
12,912



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VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)


Fan Pier Move Restructuring
In connection with the relocation of its Massachusetts operations to Fan Pier in Boston, Massachusetts, which commenced in 2013, the Company is incurring restructuring charges related to its remaining lease obligations at its facilities in Cambridge, Massachusetts. The majority of these restructuring charges were recorded in the third quarter of 2014 upon decommissioning three facilities in Cambridge. During the first quarter of 2015, the Company terminated two of these lease agreements resulting in a credit to restructuring expense equal to the difference between the Company’s estimated future cash flows related to its lease obligations for these facilities and the termination payment paid to the Company’s landlord on the effective date of the termination. The third major facility included in this restructuring activity is 120,000 square feet of the Kendall Square Facility that the Company continued to use for its operations following its 2003 Kendall Restructuring . The rentable square footage in this portion of the Kendall Square Facility was subleased to a third party in February 2015. The Company will continue to incur charges through April 2018 related to the difference between the Company’s estimated future cash flows related to this portion of the Kendall Square Facility , which include an estimate for sublease income to be received from the Company's sublessee and its actual cash flows. The Company discounted the estimated cash flows related to this restructuring activity at a discount rate of 9% .
The activities related to the restructuring liability for the three and nine months ended September 30, 2015 and 2014 were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(in thousands)
Liability, beginning of the period
$
9,017

 
$
3,256

 
$
33,390

 
$
797

Cash payments
(3,070
)
 
(2,266
)
 
(25,421
)
 
(6,643
)
Cash received from subleases
1,820

 

 
1,820

 

Restructuring expense (income)
51

 
39,752

 
(1,971
)
 
46,588

Liability, end of the period
$
7,818

 
$
40,742

 
$
7,818

 
$
40,742

Other Restructuring Activities
The Company has incurred several other restructuring activities that are unrelated to its 2003 Kendall Restructuring and the Fan Pier Move Restructuring . In October 2013, the Company adopted a restructuring plan that included (i) a workforce reduction primarily related to the commercial support of INCIVEK following the continued and rapid decline in the number of patients being treated with INCIVEK as new medicines for the treatment of HCV infection neared approval and (ii) the write-off of certain assets. This action resulted from the Company's decision to focus its investment on future opportunities in cystic fibrosis and other research and development programs.
The activities related to the Company's other restructuring liabilities for the three and nine months ended September 30, 2015 and 2014 were as follows:
 
Three Months Ended September 30,