Vertex Pharmaceuticals
VERTEX PHARMACEUTICALS INC / MA (Form: 10-Q, Received: 10/31/2016 16:51:16)
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, 2016
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
248,033,389
Class
Outstanding at October 21, 2016

 


Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2016

TABLE OF CONTENTS
 
 
Page
 
 
 
Condensed Consolidated Statements of Operations - Three and Nine Months Ended September 30, 2016 and 2015
 
Condensed Consolidated Statements of Comprehensive Loss - Three and Nine Months Ended September 30, 2016 and 2015
 
Condensed Consolidated Balance Sheets - September 30, 2016 and December 31, 2015
 
Condensed Consolidated Statements of Shareholders' Equity and Noncontrolling Interest - Nine Months Ended September 30, 2016 and 2015
 
Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2016 and 2015
 
 
 
“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,
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
Product revenues, net
$
409,689

 
$
302,511

 
$
1,229,750

 
$
593,774

Royalty revenues
3,835

 
5,759

 
12,713

 
17,628

Collaborative revenues
259

 
1,546

 
1,008

 
2,999

Total revenues
413,783

 
309,816

 
1,243,471

 
614,401

Costs and expenses:
 
 
 
 
 
 
 
Cost of product revenues
53,222

 
30,269

 
147,165

 
55,059

Royalty expenses
855

 
1,691

 
2,813

 
6,068

Research and development expenses
272,370

 
246,284

 
799,238

 
685,741

Sales, general and administrative expenses
106,055

 
99,772

 
322,921

 
280,026

Restructuring expenses, net
8

 
1,826

 
1,038

 
682

Total costs and expenses
432,510

 
379,842

 
1,273,175

 
1,027,576

Loss from operations
(18,727
)
 
(70,026
)
 
(29,704
)
 
(413,175
)
Interest expense, net
(20,140
)
 
(21,134
)
 
(60,993
)
 
(63,552
)
Other (expenses) income, net
(167
)
 
(1,326
)
 
3,025

 
(5,025
)
Loss before provision for income taxes
(39,034
)
 
(92,486
)
 
(87,672
)
 
(481,752
)
Provision for income taxes
503

 
1,330

 
24,118

 
31,760

Net loss
(39,537
)
 
(93,816
)
 
(111,790
)
 
(513,512
)
Loss (Income) attributable to noncontrolling interest
696

 
(1,333
)
 
(33,207
)
 
30,909

Net loss attributable to Vertex
$
(38,841
)
 
$
(95,149
)
 
$
(144,997
)
 
$
(482,603
)
 
 
 
 
 
 
 
 
Amounts per share attributable to Vertex common shareholders:
 
 
 
 
 
 
 
Net loss:
 
 
 
 
 
 
 
Basic
$
(0.16
)
 
$
(0.39
)
 
$
(0.59
)
 
$
(2.00
)
Diluted
$
(0.16
)
 
$
(0.39
)
 
$
(0.59
)
 
$
(2.00
)
Shares used in per share calculations:
 
 
 
 
 
 
 
Basic
244,920

 
241,969

 
244,529

 
240,749

Diluted
244,920

 
241,969

 
244,529

 
240,749

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,
 
2016
 
2015
 
2016
 
2015
Net loss
$
(39,537
)
 
$
(93,816
)
 
$
(111,790
)
 
$
(513,512
)
Changes in other comprehensive loss:
 
 
 
 
 
 
 
Unrealized holding gains (losses) on marketable securities
(96
)
 
56

 
104

 
186

Unrealized gains (losses) on foreign currency forward contracts, net of tax
2,149

 
4,546

 
1,936

 
572

Foreign currency translation adjustment
(2,508
)
 
(1,384
)
 
(7,709
)
 
(164
)
Total changes in other comprehensive loss
(455
)
 
3,218

 
(5,669
)
 
594

Comprehensive loss
(39,992
)
 
(90,598
)
 
(117,459
)
 
(512,918
)
Comprehensive (income) loss attributable to noncontrolling interest
696

 
(1,333
)
 
(33,207
)
 
30,909

Comprehensive loss attributable to Vertex
$
(39,296
)
 
$
(91,931
)
 
$
(150,666
)
 
$
(482,009
)
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,
 
2016
 
2015
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
719,692

 
$
714,768

Marketable securities, available for sale
408,749

 
327,694

Restricted cash and cash equivalents (VIE)
58,420

 
78,910

Accounts receivable, net
182,229

 
173,838

Inventories
71,799

 
57,207

Prepaid expenses and other current assets
61,012

 
54,736

Total current assets
1,501,901

 
1,407,153

Property and equipment, net
687,613

 
697,715

Intangible assets
284,340

 
284,340

Goodwill
50,384

 
50,384

Cost method investments
53,314

 

Notes receivable

 
30,000

Restricted cash
22,087

 
22,083

Other assets
10,002

 
6,912

Total assets
$
2,609,641

 
$
2,498,587

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
50,914

 
$
74,942

Accrued expenses
292,015

 
305,820

Deferred revenues, current portion
9,247

 
16,296

Accrued restructuring expenses, current portion
3,923

 
7,894

Capital lease obligations, current portion
17,772

 
15,545

Senior secured term loan, current portion
297,751

 
71,296

Other liabilities, current portion
51,219

 
14,374

Total current liabilities
722,841

 
506,167

Deferred revenues, excluding current portion
6,559

 
9,714

Accrued restructuring expenses, excluding current portion
3,314

 
7,464

Capital lease obligations, excluding current portion
31,719

 
42,923

Deferred tax liability
133,270

 
110,439

Construction financing lease obligation, excluding current portion
473,073

 
472,611

Senior secured term loan, net of current portion and discount

 
223,863

Other liabilities, excluding current portion
30,524

 
31,778

Total liabilities
1,401,300

 
1,404,959

Commitments and contingencies


 


Shareholders’ equity:
 
 
 
Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued and outstanding at September 30, 2016 and December 31, 2015

 

Common stock, $0.01 par value; 500,000,000 and 500,000,000 shares authorized at September 30, 2016 and December 31, 2015, respectively; 248,028,962 and 246,306,818 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively
2,446

 
2,427

Additional paid-in capital
6,429,726

 
6,197,500

Accumulated other comprehensive (loss) income
(3,845
)
 
1,824

Accumulated deficit
(5,406,781
)
 
(5,261,784
)
Total Vertex shareholders' equity
1,021,546

 
939,967

Noncontrolling interest
186,795

 
153,661

Total shareholders’ equity
1,208,341

 
1,093,628

Total liabilities and shareholders’ equity
$
2,609,641

 
$
2,498,587

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 (Loss) Income
 
Accumulated Deficit
 
Total Vertex
Shareholders’ Equity
 
Noncontrolling
Interest
 
Total
Shareholders’ Equity
 
Shares
 
Amount
 
 
 
 
 
 
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 expense

 

 
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

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
246,307

 
$
2,427

 
$
6,197,500

 
$
1,824

 
$
(5,261,784
)
 
$
939,967

 
$
153,661

 
$
1,093,628

Other comprehensive loss, net of tax

 

 

 
(5,669
)
 

 
(5,669
)
 

 
(5,669
)
Net (loss) income

 

 

 

 
(144,997
)
 
(144,997
)
 
33,207

 
(111,790
)
Issuance of common stock under benefit plans
1,722

 
19

 
50,875

 

 

 
50,894

 

 
50,894

Stock-based compensation expense

 

 
181,351

 

 

 
181,351

 
(73
)
 
181,278

Balance at September 30, 2016
248,029

 
$
2,446

 
$
6,429,726

 
$
(3,845
)
 
$
(5,406,781
)
 
$
1,021,546

 
$
186,795

 
$
1,208,341

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,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net loss
$
(111,790
)
 
$
(513,512
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Stock-based compensation expense
178,623

 
186,379

Depreciation and amortization expense
45,947

 
46,596

Deferred income taxes
23,544

 
7,793

Other non-cash items, net
(904
)
 
(2,876
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(9,760
)
 
(88,735
)
Inventories
(11,536
)
 
(16,127
)
Prepaid expenses and other assets
(8,979
)
 
(23,737
)
Accounts payable
(21,532
)
 
6,283

Accrued expenses and other liabilities
26,121

 
45,163

Accrued restructuring expense
(8,151
)
 
(28,051
)
Deferred revenues
(10,204
)
 
(13,751
)
Net cash provided by (used in) operating activities
91,379

 
(394,575
)
Cash flows from investing activities:
 
 
 
Purchases of marketable securities
(616,625
)
 
(292,135
)
Maturities of marketable securities
535,379

 
804,588

Expenditures for property and equipment
(41,775
)
 
(32,775
)
Decrease in restricted cash and cash equivalents (VIE)
20,490

 
14,830

Investments in other entities
(20,000
)
 

Investment in CRISPR Series B preferred stock
(3,075
)
 

(Increase) decrease in other assets
(90
)
 
(982
)
Increase in restricted cash and cash equivalents
(3
)
 
(21,980
)
Payment for acquisition of variable interest entity

 
(80,000
)
Net cash (used in) provided by investing activities
(125,699
)
 
391,546

Cash flows from financing activities:
 
 
 
Issuances of common stock under benefit plans
51,165

 
139,689

Payments on capital lease obligations
(13,330
)
 
(16,515
)
Payments on construction financing lease obligation
(356
)
 
(281
)
Proceeds from capital lease financing
2,030

 
13,386

Net cash provided by financing activities
39,509

 
136,279

Effect of changes in exchange rates on cash
(265
)
 
(2,259
)
Net increase in cash and cash equivalents
4,924

 
130,991

Cash and cash equivalents—beginning of period
714,768

 
625,259

Cash and cash equivalents—end of period
$
719,692

 
$
756,250

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
64,662

 
$
64,231

Cash received from (paid for) income taxes
$
1,617

 
$
(1,261
)
Capitalization of costs related to construction financing lease obligation
$
824

 
$

Issuances of common stock exercises from employee benefit plans receivable
$
19

 
$
(236
)
The Company has reclassified certain amounts in the period ending September 30, 2015 between operating, investing, and financing to correct improper classifications. 

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, 2016 and 2015 .
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, 2015 , which are contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2015 that was filed with the Securities and Exchange Commission (the “SEC”) on February 16, 2016 (the " 2015 Annual Report on Form 10-K"). The Company has reclassified certain amounts in the condensed consolidated balance sheets for the period ended December 31, 2015 between Accounts receivables, net and Prepaid expenses and other current assets to conform to the current year presentation. 
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, contingent consideration, 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 2015 Annual Report on Form 10-K.
Recent Accounting Pronouncements
In 2014, the Financial Accounting Standards Board (“FASB”) issued amended guidance applicable to revenue recognition that will be effective for the year ending December 31, 2018. Early adoption is permitted for the year-ending December 31, 2017. The new guidance applies a more principle based approach to recognizing revenue. The new guidance must be adopted using either a full retrospective approach for all periods presented or a modified retrospective approach. The Company is in the process of evaluating the new guidance and determining the expected effect on its consolidated financial statements.
In 2016, the FASB issued amended guidance applicable to leases that will be effective for the year ending December 31, 2019. Early adoption is permitted. This update requires an entity to recognize assets and liabilities for leases with lease terms of more than 12 months on the balance sheet. The Company is in the process of evaluating the new guidance and determining the expected effect on its consolidated financial statements.



7

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

In 2016, the FASB issued amended guidance applicable to share-based compensation to employees that will be effective for the year ending December 31, 2017. Early adoption is permitted. This update simplifies the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The Company is in the process of evaluating the new guidance and determining the expected effect on its consolidated financial statements.

In 2016, the FASB issued amended guidance for the classification of certain cash receipts and cash payments on the statement of cash flows to reduce existing diversity in practice. The new accounting guidance is effective for the year ending December 31, 2017. Early adoption is permitted. The Company is in the process of evaluating the new guidance and determining the expected effect on its consolidated financial statements.


For a discussion of other recent accounting pronouncements please refer to Note A, “Nature of Business and Accounting Policies—Recent Accounting Pronouncements,” in the 2015 Annual Report on Form 10-K. The Company did not adopt any new accounting pronouncements during the nine months ended September 30, 2016 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.
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 Customers' 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 costs 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, 2016 :
 
Trade
Allowances
 
Rebates,
Chargebacks
and Discounts
 
Product
Returns
 
Other
Incentives
 
Total
 
(in thousands)
Balance at December 31, 2015
$
2,089

 
$
44,669

 
$
1,228

 
$
1,310

 
$
49,296

Provision related to current period sales
14,680

 
98,242

 
1,631

 
5,547

 
120,100

Adjustments related to prior period sales
(82
)
 
(1,081
)
 
(205
)
 
(80
)
 
(1,448
)
Credits/payments made
(14,505
)
 
(70,718
)
 
(345
)
 
(5,607
)
 
(91,175
)
Balance at September 30, 2016
$
2,182

 
$
71,112

 
$
2,309

 
$
1,170

 
$
76,773

In the three and nine months ended September 30, 2016 , the Company sold ORKAMBI in France pursuant to early access programs. The Company has not recognized any product revenues based on these sales because the price is not fixed or determinable due to the ongoing negotiations regarding the reimbursement rate for ORKAMBI in France. If the negotiated reimbursement rate in France is lower than the price currently being paid by Customers in France under these programs, the Company would reimburse the difference between such prices to the Customers. The cash received from sales in France is included as a liability on the Company's condensed consolidated balance sheet, and the increase in "other liabilities, current portion" from December 31, 2015 to September 30, 2016 is primarily due to this liability.
C.
Collaborative Arrangements
Cystic Fibrosis Foundation Therapeutics Incorporated
The Company has a research, development and commercialization agreement with Cystic Fibrosis Foundation Therapeutics Incorporated (“CFFT”) that was originally entered into in May 2004, and was most recently amended on October 13, 2016 (the “2016 Amendment”). Pursuant to the agreement, as amended, the Company has agreed to pay royalties ranging from low single digits to mid-single digits on potential sales of certain compounds first synthesized and/or tested between March 1, 2014 and August 31, 2016 and tiered royalties ranging from single digits to sub-teens on any approved drugs first synthesized and/or tested during a research term on or before February 28, 2014, including KALYDECO (ivacaftor), ORKAMBI (lumacaftor in combination with ivacaftor), lumacaftor and VX-661 (tezacaftor). For combination products, such as ORKAMBI, sales will be allocated equally to each of the active pharmaceutical ingredients in the combination product consistent with the allocation of net sales for ORKAMBI since the Company began marketing ORKAMBI in mid-2015.
In each of the fourth quarter of 2015 and first quarter of 2016, CFFT earned a commercial milestone payment of $13.9 million from the Company upon achievement of certain sales levels of lumacaftor. There are no additional commercial milestone payments payable by the Company to CFFT pursuant to the agreement. Pursuant to the 2016 Amendment, the CFFT provided the Company an upfront program award of $75.0 million and agreed to provide development funding to the Company of up to $6.0 million annually.
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 2015. The Company received approval for ORKAMBI In the European Union in 2015 and in Canada and Australia in 2016. The Company has royalty obligations to CFFT for ivacaftor, lumacaftor and VX-661 until the expiration of patents covering those compounds. 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 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 extension. The Company has patents in the United States and European Union covering the composition-of-matter of VX-661 (tezacaftor) that expire in 2027 and 2028, respectively, subject to potential extension.


8

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

CRISPR Therapeutics AG
In October 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 a $30.0 million investment in CRISPR pursuant to a convertible loan agreement that converted into preferred stock in January 2016. The Company expensed $75.0 million to research and development, and the $30.0 million investment was recorded at cost and is classified as a long-term asset on the Company’s condensed consolidated balance sheet. In the second quarter of 2016, the Company made an additional preferred stock investment in CRISPR of approximately $3.1 million . In connection with CRISPR's initial public offering in October 2016, the Company made an additional $10 million common share investment in CRISPR and the Company's preferred stock investment in CRISPR converted into common shares.
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 product 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 a product has received marketing approval. 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.
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 timing of achieving the milestones, 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 reflected in the Company's financial statements as consolidated VIEs:

Parion Sciences, Inc.

License and Collaboration Agreement

In June 2015, the Company entered into a strategic collaboration and license agreement (the "Parion Agreement") with Parion Sciences, Inc. (“Parion”).  Pursuant to the Parion Agreement, the Company is collaborating with Parion to develop investigational epithelial sodium channel (“ENaC”) inhibitors, including VX-371 (formerly P-1037) and VX-551 (formerly 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 VX-551 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 VX-551, for the potential treatment of CF and all other pulmonary diseases and


9

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

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 VX-551 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 a licensed product has received marketing approval. 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 Parion 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 affect 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.
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

Allocation of Assets and Liabilities

The Company allocated the total consideration to the assets and liabilities of Parion. The following table summarizes the final fair values of the assets and liabilities recorded on the effective date of the agreement:
 
June 4, 2015
 
(in thousands)
Intangible assets
$
255,340

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



10

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


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 VX-551, that are licensed by Parion to the Company. The Company recorded Parion’s assets and liabilities including (i) the fair value of the intangible assets, (ii) the fair value of the net assets attributable to noncontrolling interest, and (iii) a deferred tax liability resulting from a basis difference in the intangible assets and certain other net liabilities held by Parion.  The difference between the fair value of the consideration paid and the fair value of Parion’s net assets was recorded as goodwill.
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 recorded an in-process research and development intangible asset of $29.0 million for VX-210 and a corresponding deferred tax liability of $11.3 million attributable to BioAxone. 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.
Aggregate VIE Financial Information

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, 2016 and 2015 is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Loss attributable to noncontrolling interest before provision for income taxes
$
2,406

 
$
1,743

 
$
6,080

 
$
3,322

(Benefit from) provision for income taxes
(510
)
 
777

 
20,063

 
30,367

(Increase) decrease in fair value of contingent milestone and royalty payments
(1,200
)
 
(3,853
)
 
(59,350
)
 
(2,780
)
Net (income) loss attributable to noncontrolling interest
$
696

 
$
(1,333
)
 
$
(33,207
)
 
$
30,909


The increases in the fair value of the contingent milestone and royalty payments in the nine months ended September 30, 2016 were primarily due to a Phase 2 clinical trial of VX-371, a compound being developed pursuant to the Parion Agreement, achieving its primary safety endpoint in the second quarter of 2016. The fair value of the contingent milestone and royalty payments also reflects changes in market interest rates and the time value of money. During the three and nine months ended September 30, 2016 and 2015 , the increase (decrease) in the fair value of the contingent milestone and royalty payments related to the Company's VIEs was as follows:


11

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

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Parion
$
1,100

 
$
4,481

 
$
58,500

 
$
2,860

BioAxone
100

 
(628
)
 
850

 
(80
)

As of September 30, 2016 , the fair value of the contingent milestone and royalty payments related to the Parion Agreement and the BioAxone Agreement was $232.5 million and $28.8 million , respectively. As of December 31, 2015 , the fair value of the contingent milestone and royalty payments related to the Parion collaboration and the BioAxone collaboration was $179.0 million and $28.0 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, 2016
 
December 31, 2015
 
(in thousands)
Restricted cash and cash equivalents (VIE)
$
58,420

 
$
78,910

Prepaid expenses and other current assets
2,360

 
3,138

Intangible assets
284,340

 
284,340

Goodwill
19,391

 
19,391

Other assets
382

 
455

Accounts payable
1,122

 
676

Taxes payable
6,263

 
24,554

Other current liabilities
1,121

 
7,100

Deferred tax liability, net
133,270

 
110,438

Other liabilities
300

 
300

Noncontrolling interest
186,795

 
153,661


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 that the Company licensed from the applicable VIE. Assets recorded as a result of consolidating the Company's 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.
Other Collaborations
The Company has entered into various agreements pursuant to which it collaborates with third parties, including inlicensing and outlicensing arrangements. Although the Company does not consider any of these arrangements to be material, the most notable of these arrangements are described below.



12

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

Moderna Therapeutics, Inc.
In July 2016, the Company entered into a strategic collaboration and licensing agreement (the "Moderna Agreement") with Moderna Therapeutics, Inc. ("Moderna") pursuant to which the parties are seeking to identify and develop messenger Ribonucleic Acid ("mRNA") Therapeutics for the treatment of CF. In connection with the Moderna Agreement in the third quarter of 2016, the Company made an upfront payment to Moderna of $20.0 million and a $20.0 million cost-method investment in Moderna pursuant to a convertible promissory note that converted into preferred stock in August 2016. Moderna has the potential to receive future development and regulatory milestones of up to  $275.0 million , including $220.0 million  in approval and reimbursement milestones, as well as tiered royalty payments on future sales.
Under the terms of the Moderna Agreement, Moderna will lead discovery efforts and the Company will lead all preclinical, development and commercialization activities associated with the advancement of mRNA Therapeutics that result from this collaboration and will fund all expenses related to the collaboration.
The Company may terminate the Moderna Agreement by providing advanced notice to Moderna, with the required length of notice dependent on whether any product developed under the Moderna Agreement has received marketing approval. The Moderna 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 Moderna Agreement will continue in effect until the expiration of the Company's payment obligations under the Moderna Agreement.
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. may terminate the Janssen Influenza Agreement, subject to certain exceptions, upon six months' notice.
Janssen Inc. is responsible for costs related to the development and commercialization of the compounds. During the three and nine months ended September 30, 2016 , the Company recorded reimbursement for these development activities of $2.8 million and $10.6 million , respectively. 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. 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.
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 in the following table in the computation of the net loss per share attributable to Vertex common shareholders calculations because the effect would have been anti-dilutive during each period:


13

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

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Stock options
12,947

 
12,025

 
12,947

 
12,025

Unvested restricted stock and restricted stock units
3,624

 
3,367

 
3,624

 
3,367

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, 2016 , the Company’s investments were primarily in money market funds, short-term government-sponsored enterprise securities, corporate debt securities and commercial paper.
As of September 30, 2016 , 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 and short-term government-sponsored enterprise securities. The Company’s financial assets valued based on Level 2 inputs consisted of corporate debt securities and commercial paper, which consisted of investments in highly-rated investment-grade corporations.


14

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

The following table sets forth the Company’s financial assets (excluding VIE cash and cash equivalents) and liabilities subject to fair value measurements:
 
Fair Value Measurements as
of September 30, 2016
 
 
 
Fair Value Hierarchy
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(in thousands)
Financial assets carried at fair value:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
101,844

 
$
101,844

 
$

 
$

Marketable securities:
 
 
 
 
 
 
 
Government-sponsored enterprise securities
130,431

 
130,431

 

 

Corporate debt securities
146,942

 

 
146,942

 

Commercial paper
131,376

 

 
131,376

 

Prepaid and other current assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
7,644

 

 
7,644

 

Other assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
217

 

 
217

 

Total financial assets
$
518,454


$
232,275

 
$
286,179

 
$

Financial liabilities carried at fair value:
 
 
 
 
 
 
 
Other liabilities, current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
$
(1,459
)
 
$

 
$
(1,459
)
 
$

Other liabilities, excluding current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
(315
)
 

 
(315
)
 

Total financial liabilities
$
(1,774
)
 
$

 
$
(1,774
)
 
$



15

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

 
Fair Value Measurements as
of December 31, 2015
 
 
 
Fair Value Hierarchy
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(in thousands)
Financial instruments carried at fair value (asset position):
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
199,507

 
$
199,507

 
$

 
$

Government-sponsored enterprise securities
85,994

 
85,994

 

 

Commercial paper
34,889

 

 
34,889

 

Corporate debt securities
11,533

 

 
11,533

 

Marketable securities:
 
 
 
 
 
 
 
Government-sponsored enterprise securities
87,162

 
87,162

 

 

Commercial paper
99,123

 

 
99,123

 

Corporate debt securities
141,409

 

 
141,409

 

Prepaid and other current assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
5,161

 

 
5,161

 

Other assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
605

 
$

 
605

 
$

Total financial assets
$
665,383

 
$
372,663

 
$
292,720

 
$

Financial instruments carried at fair value (liability position):
 
 
 
 
 
 
 
Other liabilities, current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
$
(769
)
 
$

 
$
(769
)
 
$

Other liabilities, excluding current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
(132
)
 

 
(132
)
 

Total financial liabilities
$
(901
)
 
$

 
$
(901
)
 
$

The Company's VIEs invested in cash equivalents consisting of money market funds of $57.9 million as of September 30, 2016 , 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, 2016 , the fair value and carrying value of the Company's Term Loan was $297.8 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 market rates. Please refer to Note K, "Long-term Obligations" for further information regarding the Company's Term Loan.


16

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, 2016
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash and money market funds
$
719,692

 
$

 
$

 
$
719,692

Total cash and cash equivalents
$
719,692

 
$

 
$

 
$
719,692

Marketable securities:
 
 
 
 
 
 
 
Government-sponsored enterprise securities (due within 1 year)
130,404

 
29

 
(2
)
 
130,431

Commercial paper (due within 1 year)
131,099

 
277

 

 
131,376

Corporate debt securities (due within 1 year)
147,016

 
6

 
(80
)
 
146,942

Total marketable securities
$
408,519

 
$
312

 
$
(82
)
 
$
408,749

Total cash, cash equivalents and marketable securities
$
1,128,211

 
$
312

 
$
(82
)
 
$
1,128,441

 
 
 
 
 
 
 
 
As of December 31, 2015
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash and money market funds
$
582,352

 
$

 
$

 
$
582,352

Government-sponsored enterprise securities
85,994

 

 

 
85,994

Commercial paper
34,889

 

 

 
34,889

Corporate debt securities
11,533

 

 

 
11,533

Total cash and cash equivalents
$
714,768

 
$

 
$

 
$
714,768

Marketable securities:
 
 
 
 
 
 
 
Government-sponsored enterprise securities (due within 1 year)
$
87,176

 
$

 
$
(14
)
 
$
87,162

Commercial paper (due within 1 year)
98,877

 
246

 

 
99,123

Corporate debt securities (due within 1 year)
141,515

 

 
(106
)
 
141,409

Total marketable securities
$
327,568

 
$
246

 
$
(120
)
 
$
327,694

Total cash, cash equivalents and marketable securities
$
1,042,336

 
$
246

 
$
(120
)
 
$
1,042,462

The Company has a limited number of marketable securities in insignificant loss positions as of September 30, 2016 , 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, 2016 and 2015 .


17

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 on Marketable Securities
 
Unrealized Gains (Losses) on Foreign Currency Forward Contracts, net of tax
 
Total
 
(in thousands)
Balance at December 31, 2015
$
(2,080
)
 
$
126

 
$
3,778

 
$
1,824

Other comprehensive (loss) income before reclassifications
(7,709
)
 
104

 
6,715

 
(890
)
Amounts reclassified from accumulated other comprehensive loss

 

 
(4,779
)
 
(4,779
)
Net current period other comprehensive (loss) income
$
(7,709
)
 
$
104

 
$
1,936

 
$
(5,669
)
Balance at September 30, 2016
$
(9,789
)
 
$
230

 
$
5,714

 
$
(3,845
)
 
Foreign Currency Translation Adjustment
 
Unrealized Holding (Losses) Gains 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

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.
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, 2016 , all hedges were determined to be highly effective and the Company had 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:


18

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

 
As of September 30, 2016
 
As of December 31, 2015
Foreign Currency
(in thousands)
Euro
$
156,245

 
$
103,362

British pound sterling
73,684

 
78,756

Australian dollar
26,550

 
27,167

Total foreign currency forward contracts
$
256,479

 
$
209,285

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, 2016
Assets
 
Liabilities
Classification
 
Fair Value
 
Classification
 
Fair Value
(in thousands)
Prepaid and other current assets
 
$
7,644

 
Other liabilities, current portion
 
$
(1,459
)
Other assets
 
217

 
Other liabilities, excluding current portion
 
(315
)
Total assets
 
$
7,861

 
Total liabilities
 
$
(1,774
)
As of December 31, 2015
Assets
 
Liabilities
Classification
 
Fair Value
 
Classification
 
Fair Value
(in thousands)
Prepaid and other current assets
 
$
5,161

 
Other liabilities, current portion
 
$
(769
)
Other assets
 
605

 
Other liabilities, excluding current portion
 
(132
)
Total assets
 
$
5,766

 
Total liabilities
 
$
(901
)
The following table summarizes the potential effect of offsetting derivatives by type of financial instrument on the Company's condensed consolidated balance sheets:
 
As of September 30, 2016
 
Gross Amounts Recognized
 
Gross Amounts Offset
 
Gross Amounts Presented
 
Gross Amounts Not Offset
 
Legal Offset
Foreign currency forward contracts
(in thousands)
Total assets
$
7,861

 
$

 
$
7,861

 
$
(1,774
)
 
$
6,087

Total liabilities
$
(1,774
)
 
$

 
$
(1,774
)
 
$
1,774

 
$

 
As of December 31, 2015
 
Gross Amounts Recognized
 
Gross Amounts Offset
 
Gross Amounts Presented
 
Gross Amounts Not Offset
 
Legal Offset
Foreign currency forward contracts
(in thousands)
Total assets
$
5,766

 
$

 
$
5,766

 
$
(901
)
 
$
4,865

Total liabilities
$
(901
)
 
$

 
$
(901
)
 
$
901

 
$

I. Inventories
Inventories consisted of the following:
 
As of September 30, 2016
 
As of December 31, 2015
 
(in thousands)
Raw materials
$
9,824

 
$
8,696

Work-in-process
46,057

 
40,695

Finished goods
15,918

 
7,816

Total
$
71,799

 
$
57,207

J. Intangible Assets and Goodwill
Intangible Assets
As of September 30, 2016 and December 31, 2015 , in-process research and development intangible assets of $284.3 million were recorded on the Company's condensed consolidated balance sheet.
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 VX-551, 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.
Goodwill
As of September 30, 2016 and December 31, 2015 , goodwill of $50.4 million was recorded on the Company's condensed 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, the Company was deemed for accounting purposes to be the owner of the Buildings during the construction period and recorded project construction costs incurred by the landlord. Upon completion of the Buildings, the Company evaluated the Fan Pier Leases and determined that the Fan Pier Leases did not meet the criteria for “sale-leaseback” treatment. Accordingly, the Company 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 $492.3 million and $502.3 million as of September 30, 2016 and December 31, 2015 , respectively, related to construction costs for the Buildings. The carrying value of the Company's lease agreement liability for the Buildings was $472.7 million and $473.0 million as of September 30, 2016 and December 31, 2015 , respectively.
San Diego Lease
On December 2, 2015, the Company entered into a lease agreement for 3215 Merryfield Row, San Diego, California with ARE-SD Region No. 23, LLC. Pursuant to this agreement, the Company agreed to lease approximately 170,000 square feet of office and laboratory space in a building to be built in San Diego, California. The lease will commence upon completion of the building, scheduled for the first half of 2018, and will extend for 16 years from the commencement date. Pursuant to the lease agreement, during the initial 16 -year term, the Company will pay an average of approximately $10.2 million per year in aggregate rent, exclusive of operating expenses. The Company has the option to extend the lease term for up to two additional five -year terms.



19

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

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 provided for a $300.0 million senior secured term loan ("Macquarie Loan"). On October 13, 2016, the Company terminated and repaid all outstanding obligations under the Macquarie Loan.
The Macquarie Loan initially bore interest at a rate of 7.2% per annum, which was reduced to 6.2% per annum based on the FDA's approval of ORKAMBI. The Term Loan bore interest at a rate of LIBOR plus 5.0% per annum during the third year of the term. If the Company had not terminated and repaid all outstanding obligations, the maturity date of all loans under the facilities was July 9, 2017.
Based on the Company's evaluation of the Macquarie Loan, the Company determined that the Macquarie Loan contained several embedded derivatives. These embedded derivatives were clearly and closely related to the host instrument because they related to the Company's credit risk; therefore, they did not require bifurcation from the host instrument, the Macquarie Loan.
The Company incurred $5.3 million in fees paid to Macquarie that were recorded as a discount on the Macquarie Loan and were 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, 2016 and December 31, 2015 , the unamortized discount associated with the Macquarie Loan that was included in the senior secured term loan caption on the Company’s condensed consolidated balance sheet was $2.1 million and $4.6 million , respectively.
Subsequent Event
On October 13, 2016, the Company entered into a Credit Agreement (the “Credit Agreement”) with Bank of America, N.A., as administrative agent and the lenders referred to therein. The Credit Agreement provides for a $500.0 million revolving facility, $300.0 million of which was drawn at closing (the “Loans”). The Credit Agreement also provides that, subject to satisfaction of certain conditions, the Company may request that the borrowing capacity under the Credit Agreement be increased by an additional $300.0 million . The Credit Agreement matures on October 13, 2021.
The proceeds of the borrowing under the Credit Agreement were used primarily to repay the Company's existing indebtedness under the Macquarie Loan. The Company will incur a charge of $2.2 million in the fourth quarter of 2016 related to a loss on extinguishment attributable to the Macquarie Loan. The Loans will bear interest, at the Company's option, at either a base rate or a Eurodollar rate, in each case plus an applicable margin. Under the Credit Agreement, the applicable margins on base rate loans range from 0.75% to 1.50% and the applicable margins on Eurodollar loans range from 1.75% to 2.5% , in each case based on the Company's consolidated leverage ratio (the ratio of the Company's total consolidated debt to the Company's trailing twelve-month EBITDA).
The Loans are guaranteed by certain of the Company's domestic subsidiaries and secured by substantially all of the Company's assets and the assets of the Company's domestic subsidiaries (excluding intellectual property, owned and leased real property and certain other excluded property) and by the equity interests of the Company's subsidiaries, subject to certain exceptions. Under the terms of the Credit Agreement, the Company must maintain, subject to certain limited exceptions, a consolidated leverage ratio of 3.00 to 1.00 and consolidated EBITDA of at least $200.0 million , in each case to be measured on a quarterly basis.
The Credit Agreement contains customary representations and warranties and usual and customary affirmative and negative covenants. The Credit Agreement also contains customary events of default. In the case of a continuing event of default, the administrative agent would be entitled to exercise various remedies, including the acceleration of amounts due under outstanding loans.
L. Stock-based Compensation Expense
During the three and nine months ended September 30, 2016 and 2015 , the Company recognized the following stock-based compensation expense:


20

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

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Stock-based compensation expense by type of award:
 
 
 
 
 
 
 
Stock options
$
28,773

 
$
39,074

 
$
86,859

 
$
105,720

Restricted stock and restricted stock units
30,966

 
26,203

 
88,107

 
78,274

ESPP share issuances
2,425

 
1,738

 
6,385

 
5,703

Less stock-based compensation expense capitalized to inventories
(955
)
 
(1,281
)
 
(2,728
)
 
(3,318
)
Total stock-based compensation included in costs and expenses
$
61,209

 
$
65,734

 
$
178,623

 
$
186,379

 
 
 
 
 
 
 


Stock-based compensation expense by line item:
 
 
 
 
 
 
 
Research and development expenses
$
39,980

 
$
44,701

 
$
115,068

 
$
124,550

Sales, general and administrative expenses
21,229

 
21,033

 
63,555

 
61,829

Total stock-based compensation included in costs and expenses
$
61,209

 
$
65,734

 
$
178,623

 
$
186,379

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, 2016
 
Unrecognized Expense,
Net of
Estimated Forfeitures
 
Weighted-average
Recognition
Period
 
(in thousands)
 
(in years)
Type of award:
 
 
 
Stock options
$
185,148

 
2.66
Restricted stock and restricted stock units
$
206,336

 
2.57
ESPP share issuances
$
2,886

 
0.47
The following table summarizes information about stock options outstanding and exercisable at September 30, 2016 :
 
 
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
 
137

 
1.35
 
$
18.93

 
137

 
$
18.93

$20.01–$40.00
 
1,816

 
3.32
 
$
34.08

 
1,815

 
$
34.07

$40.01–$60.00
 
1,937

 
5.89
 
$
48.19

 
1,719

 
$
48.57

$60.01–$80.00
 
1,348

 
7.38
 
$
75.90

 
809

 
$
75.51

$80.01–$100.00
 
4,598

 
8.74
 
$
90.62

 
1,271

 
$
89.38

$100.01–$120.00
 
1,627

 
8.33
 
$
109.33

 
606

 
$
109.29

$120.01–$134.69
 
1,484

 
8.80
 
$
130.60

 
510

 
$
130.06

Total
 
12,947

 
7.29
 
$
80.99

 
6,867

 
$
66.29

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, 2016 , the Company had $15.8 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.
N. Income Taxes
The Company is subject to United States federal, state, and foreign income taxes. For the three and nine months ended September 30, 2016 , the Company recorded a provision for income taxes of $0.5 million and $24.1 million , respectively. The provision for income taxes recorded in the three and nine months ended September 30, 2016 included a benefit of $0.5 million and a provision of $20.1 million , respectively, related to the Company's VIEs' income tax provision. The Company has no liability for taxes payable by the Company's VIEs and the income tax provision and related liability have been allocated to noncontrolling interest (VIE). 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, primarily related to the Company's VIEs' income tax provision.
As of September 30, 2016 and December 31, 2015 , the Company had unrecognized tax benefits of zero and $0.4 million , respectively. The Company recognizes interest and penalties related to income taxes as a component of income tax expense. As of September 30, 2016 , 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, 2016 and December 31, 2015 . For the three months ended September 30, 2016 , the Company reduced the balance of its unrecognized tax benefits by approximately $0.4 million due to the expiration of statute of limitations, which reduced 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 United States 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 Delaware, Canada and Quebec for varying periods including the years ended December 31, 2011 through 2014. No adjustments have been reported. The Company is not under examination by any other jurisdictions for any tax year. The Company concluded audits with Pennsylvania and Texas during 2016 and Massachusetts and New York during 2015 with no material adjustments.
The Company currently intends to reinvest the total amount of its unremitted earnings. At September 30, 2016 , 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 United States 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, 2016 and 2015 were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Liability, beginning of the period
$
6,388

 
$
9,924

 
$
7,944

 
$
11,596

Cash payments
(5,340
)
 
(3,975
)
 
(13,104
)
 
(10,544
)
Cash received from subleases
2,866

 
2,919

 
8,882

 
8,194

Restructuring expense (income)
30

 
146

 
222

 
(232
)
Liability, end of the period