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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 JUNE 30, 2017
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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o 
Smaller reporting company o
 
 
 
 
Emerging growth company o
                                       (Do not check if a smaller reporting company)
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  o
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
252,118,869
Class
Outstanding at July 21, 2017
 


Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2017

TABLE OF CONTENTS
 
 
Page
 
 
 
Condensed Consolidated Statements of Operations - Three and Six Months Ended June 30, 2017 and 2016
 
Condensed Consolidated Statements of Comprehensive Loss - Three and Six Months Ended June 30, 2017 and 2016
 
Condensed Consolidated Balance Sheets - June 30, 2017 and December 31, 2016
 
Condensed Consolidated Statements of Shareholders' Equity and Noncontrolling Interest - Six Months Ended June 30, 2017 and 2016
 
Condensed Consolidated Statements of Cash Flows - Six Months Ended June 30, 2017 and 2016
 
 
 
“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 June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
Product revenues, net
$
513,988

 
$
425,651

 
$
994,610

 
$
820,061

Royalty revenues
2,861

 
5,282

 
4,412

 
8,878

Collaborative revenues
27,286

 
675

 
259,831

 
749

Total revenues
544,135

 
431,608

 
1,258,853

 
829,688

Costs and expenses:
 
 
 
 
 
 
 
Cost of product revenues
70,535

 
44,154

 
116,777

 
93,943

Royalty expenses
670

 
1,098

 
1,416

 
1,958

Research and development expenses
289,451

 
271,008

 
563,014

 
526,868

Sales, general and administrative expenses
127,249

 
111,652

 
240,575

 
216,866

Restructuring expenses, net
3,523

 
343

 
13,522

 
1,030

Total costs and expenses
491,428

 
428,255

 
935,304

 
840,665

Income (loss) from operations
52,707

 
3,353

 
323,549

 
(10,977
)
Interest expense, net
(14,664
)
 
(20,155
)
 
(31,429
)
 
(40,853
)
Other (expenses) income, net
(2,537
)
 
(1,219
)
 
(3,081
)
 
3,192

Income (loss) before provision for income taxes
35,506

 
(18,021
)
 
289,039

 
(48,638
)
Provision for income taxes
4,337

 
18,130

 
8,322

 
23,615

Net income (loss)
31,169

 
(36,151
)
 
280,717

 
(72,253
)
Income attributable to noncontrolling interest
(13,173
)
 
(28,374
)
 
(14,965
)
 
(33,903
)
Net income (loss) attributable to Vertex
$
17,996

 
$
(64,525
)
 
$
265,752

 
$
(106,156
)
 
 
 
 
 
 
 
 
Amounts per share attributable to Vertex common shareholders:
 
 
 
 
 
 
 
Net income (loss):
 
 
 
 
 
 
 
Basic
$
0.07

 
$
(0.26
)
 
$
1.08

 
$
(0.43
)
Diluted
$
0.07

 
$
(0.26
)
 
$
1.06

 
$
(0.43
)
Shares used in per share calculations:
 
 
 
 
 
 
 
Basic
247,521

 
244,482

 
246,782

 
244,124

Diluted
251,635

 
244,482

 
250,199

 
244,124

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 Income (Loss)
(unaudited)
(in thousands)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
Net income (loss)
$
31,169

 
$
(36,151
)
 
$
280,717

 
$
(72,253
)
Changes in other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized holding (losses) gains on marketable securities, net of tax of $1.0 million, zero, zero and zero, respectively
(17,281
)
 
(29
)
 
(13,747
)
 
200

Unrealized (losses) gains on foreign currency forward contracts, net of tax of $1.1 million, $0.2 million, $2.0 million and $(0.6) million, respectively
(15,245
)
 
4,999

 
(21,926
)
 
(213
)
Foreign currency translation adjustment
(5,252
)
 
(3,461
)
 
(7,253
)
 
(5,201
)
Total changes in other comprehensive (loss) income
(37,778
)
 
1,509

 
(42,926
)
 
(5,214
)
Comprehensive (loss) income
(6,609
)
 
(34,642
)
 
237,791

 
(77,467
)
Comprehensive income attributable to noncontrolling interest
(13,173
)
 
(28,374
)
 
(14,965
)
 
(33,903
)
Comprehensive (loss) income attributable to Vertex
$
(19,782
)
 
$
(63,016
)
 
$
222,826

 
$
(111,370
)
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)
 
June 30,
 
December 31,
 
2017
 
2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,223,130

 
$
1,183,945

Marketable securities, available for sale
445,520

 
250,612

Restricted cash and cash equivalents (VIE)
64,628

 
47,762

Accounts receivable, net
247,949

 
201,083

Inventories
92,263

 
77,604

Prepaid expenses and other current assets
107,082

 
70,534

Total current assets
2,180,572

 
1,831,540

Property and equipment, net
740,103

 
698,362

Intangible assets
284,340

 
284,340

Goodwill
50,384

 
50,384

Cost method investments
20,252

 
20,276

Other assets
9,943

 
11,885

Total assets
$
3,285,594

 
$
2,896,787

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
75,941

 
$
61,451

Accrued expenses
345,062

 
315,249

Deferred revenues, current portion
7,277

 
6,005

Accrued restructuring expenses, current portion
6,491

 
6,047

Capital lease obligations, current portion
18,179

 
19,426

Customer deposits
147,686

 
73,416

Credit facility
—

 
300,000

Other liabilities, current portion
24,770

 
10,943

Total current liabilities
625,406

 
792,537

Deferred revenues, excluding current portion
4,161

 
6,632

Accrued restructuring expenses, excluding current portion
527

 
1,907

Capital lease obligations, excluding current portion
25,346

 
34,976

Deferred tax liability
136,649

 
134,063

Construction financing lease obligation, excluding current portion
525,019

 
486,359

Advance from collaborator
76,034

 
73,423

Other liabilities, excluding current portion
25,221

 
28,699

Total liabilities
1,418,363

 
1,558,596

Commitments and contingencies


 


Shareholders’ equity:
 
 
 
Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued and outstanding
—

 
—

Common stock, $0.01 par value; 500,000,000 shares authorized; 250,769,906 and 248,300,517 shares issued and outstanding at June 30, 2017 and December 31, 2016, respectively
2,479

 
2,450

Additional paid-in capital
6,808,002

 
6,506,795

Accumulated other comprehensive (loss) income
(21,753
)
 
21,173

Accumulated deficit
(5,117,455
)
 
(5,373,836
)
Total Vertex shareholders’ equity
1,671,273

 
1,156,582

Noncontrolling interest
195,958

 
181,609

Total shareholders’ equity
1,867,231

 
1,338,191

Total liabilities and shareholders’ equity
$
3,285,594

 
$
2,896,787

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, 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
—

 
—

 
—

 
(5,214
)
 
—

 
(5,214
)
 
—

 
(5,214
)
Net loss
—

 
—

 
—

 
—

 
(106,156
)
 
(106,156
)
 
33,903

 
(72,253
)
Issuance of common stock under benefit plans
1,397

 
13

 
33,557

 
—

 
—

 
33,570

 
—

 
33,570

Stock-based compensation expense
—

 
—

 
119,187

 
—

 
—

 
119,187

 
(73
)
 
119,114

Balance at June 30, 2016
247,704

 
$
2,440

 
$
6,350,244

 
$
(3,390
)
 
$
(5,367,940
)
 
$
981,354

 
$
187,491

 
$
1,168,845

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
248,301

 
$
2,450

 
$
6,506,795

 
$
21,173

 
$
(5,373,836
)
 
$
1,156,582

 
$
181,609

 
$
1,338,191

Cumulative effect adjustment for adoption of new accounting guidance
—

 
—

 
9,371

 
 
 
(9,371
)
 
—

 
—

 
—

Other comprehensive loss, net of tax
—

 
—

 
—

 
(42,926
)
 
—

 
(42,926
)
 
—

 
(42,926
)
Net income
—

 
—

 
—

 
—

 
265,752

 
265,752

 
14,965

 
280,717

Issuance of common stock under benefit plans
2,469

 
29

 
147,979

 
—

 
—

 
148,008

 
—

 
148,008

Stock-based compensation expense
—

 
—

 
143,857

 
—

 
—

 
143,857

 
—

 
143,857

Other
—

 
—

 
—

 
—

 
—

 
—

 
(616
)
 
(616
)
Balance at June 30, 2017
250,770

 
$
2,479

 
$
6,808,002

 
$
(21,753
)
 
$
(5,117,455
)
 
$
1,671,273

 
$
195,958

 
$
1,867,231

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)
 
Six Months Ended June 30,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income (loss)
$
280,717

 
$
(72,253
)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
 
 
 
Stock-based compensation expense
141,564

 
117,414

Depreciation and amortization expense
29,740

 
31,378

Write-downs of inventories to net realizable value
9,479

 
—

Deferred income taxes
4,626

 
22,858

Impairment of property and equipment
1,946

 
—

Other non-cash items, net
(4,834
)
 
3,436

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(41,450
)
 
(12,954
)
Inventories
(22,028
)
 
(7,779
)
Prepaid expenses and other assets
(47,848
)
 
(7,971
)
Accounts payable
14,047

 
(23,821
)
Accrued expenses and other liabilities
83,643

 
(14,562
)
Accrued restructuring expense
(1,058
)
 
(2,892
)
Deferred revenues
(1,199
)
 
(7,131
)
Net cash provided by operating activities
447,345

 
25,723

Cash flows from investing activities:
 
 
 
Purchases of marketable securities
(377,667
)
 
(470,077
)
Maturities of marketable securities
168,882

 
332,316

Expenditures for property and equipment
(28,866
)
 
(27,892
)
(Increase) decrease in restricted cash and cash equivalents (VIE)
(16,865
)
 
8,397

Investment in CRISPR Series B preferred stock
—

 
(3,075
)
Decrease (increase) in other assets
388

 
(159
)
Net cash used in investing activities
(254,128
)
 
(160,490
)
Cash flows from financing activities:
 
 
 
Issuances of common stock under benefit plans
147,887

 
33,702

Payments on revolving credit facility
(300,000
)
 
—

Advance from collaborator
7,500

 
—

Payments on capital lease obligations
(10,637
)
 
(7,538
)
Payments on construction financing lease obligation
(238
)
 
(209
)
Repayments of advanced funding
(2,044
)
 
—

Net cash (used in) provided by financing activities
(157,532
)
 
25,955

Effect of changes in exchange rates on cash
3,500

 
(90
)
Net increase (decrease) in cash and cash equivalents
39,185

 
(108,902
)
Cash and cash equivalents—beginning of period
1,183,945

 
714,768

Cash and cash equivalents—end of period
$
1,223,130

 
$
605,866

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
35,003

 
$
41,325

Cash paid for income taxes
$
2,218

 
$
1,237

Capitalization of costs related to construction financing lease obligation
$
38,930

 
$
—

Issuances of common stock from employee benefit plans receivable
$
188

 
$
161


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

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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 June 30, 2017 and 2016.
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, 2016, which are contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 that was filed with the Securities and Exchange Commission (the “SEC”) on February 23, 2017 (the “2016 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, 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 2016 Annual Report on Form 10-K.
Recent Accounting Pronouncements
In 2014, the Financial Accounting Standards Board (“FASB”) issued new guidance applicable to revenue recognition that will be effective January 1, 2018. Early adoption was permitted for the year-ending December 31, 2017. The new guidance applies a more principles based approach to recognizing revenue. Under the new guidance, revenue is recognized when a customer obtains control of promised goods or services and is recognized in an amount that reflects the consideration that an entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new guidance must be adopted using either a modified retrospective approach or a full retrospective approach for all periods presented. Under the modified retrospective method, the cumulative effect of applying the standard would be recognized at the date of initial application within retained earnings. Under the full retrospective approach, the standard would be applied to each prior reporting period presented. Upon adoption, the Company will use the modified retrospective method. The Company continued its evaluation of the new guidance and the effect of adoption on the condensed consolidated financial statements.  The Company’s project team progressed its review of existing customer contracts and current accounting policies to identify and assess the potential differences that would result from applying the requirements of the new standard. Based on the Company’s assessment performed to date, the new guidance could impact the Company’s accounting for product shipments


7
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

to certain countries through early access programs, including the French early access programs, whereby the associated product has received regulatory approval but the reimbursement rate has not been finalized, and could impact the Company’s accounting for certain reimbursement agreements that the Company plans to negotiate in the second half of 2017. The Company is also in the process of implementing appropriate changes to its controls to support revenue recognition and additional revenue-related disclosures under the new standard.
In 2016, the FASB issued amended guidance applicable to share-based compensation to employees that 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 amended guidance became effective for the Company during the first quarter of 2017. The amended guidance eliminates the requirement that excess tax benefits be realized as a reduction in current taxes payable before the associated tax benefit can be recognized as an increase in additional paid-in capital. This created approximately $410.8 million of deferred tax asset (“DTA”) relating to federal and state net operating losses (“NOLs”) that are fully reserved by an equal increase in valuation allowance. The Company recorded DTAs of approximately $404.7 million relating to Federal NOLs and approximately $6.1 million relating to State NOLs, both of which are offset by a full valuation allowance. Upon adoption, the Company also elected to change its accounting policy to account for forfeitures of options and awards as they occur. The change was applied on a modified retrospective basis with a cumulative effect adjustment to the Company’s accumulated deficit of $9.4 million, which increased the accumulated deficit as of January 1, 2017. This change also resulted in an increase to the DTA of $3.4 million, which is offset by a full valuation allowance. As a result, there was no cumulative-effect adjustment to accumulated deficit. The provisions related to the recognition of excess tax benefits in the income statement and classification in the statement of cash flows were adopted prospectively, and as such, the prior periods were not retrospectively adjusted.
In 2016, the FASB issued amended guidance related to the recording of financial assets and financial liabilities. Under the amended guidance, equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) are to be measured at fair value with changes in fair value recognized in net income. However, an entity has the option to either measure equity investments without readily determinable fair values at fair value or at cost adjusted for changes in observable prices minus impairment. Changes in measurement under either alternative will be recognized in net income. The amended guidance is effective for the year-ending December 31, 2018. Early adoption is permitted. The Company expects the implementation of this standard to have an impact on its consolidated financial statements and related disclosures, as the Company held publicly traded equity investments as of June 30, 2017 as well as equity investments accounted for under the cost method. A cumulative-effect adjustment to the balance sheet will be recorded as of the beginning of the fiscal year of adoption. The implementation of this amended guidance is expected to increase volatility in net income as the volatility currently recorded in other comprehensive income related to changes in the fair market value of available-for-sale equity investments will be reflected in net income after adoption.

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 guidance requires entities 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 this guidance and determining the expected effect on its condensed consolidated financial statements.

In 2016, the FASB issued amended guidance related to intra-entity transfers other than inventory. This guidance removes the current exception in GAAP prohibiting entities from recognizing current and deferred income tax expenses or benefits related to transfer of assets, other than inventory, within the consolidated entity. The current exception to defer the recognition of any tax impact on the transfer of inventory within the consolidated entity until it is sold to a third party remains unaffected. The amended guidance is effective for the year ending December 31, 2018. Early adoption is permitted. The Company is in the process of evaluating this guidance and determining the expected effect on its condensed consolidated financial statements.

In 2017, the FASB issued amended guidance related to business combinations. The amended guidance clarifies the definition of a business with the objective of adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The new accounting guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. Early adoption is permitted. The Company early adopted this new guidance as of January 1, 2017 and will apply this new guidance to future acquisitions.


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


In 2017, the FASB issued amended guidance related to measurements of goodwill. The amended guidance eliminates a step from the goodwill impairment test. Under the amended guidance, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity would recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. The amended guidance is effective for the year-ending December 31, 2020. Early adoption is permitted. The Company does not expect a significant effect on its condensed consolidated financial statements upon adoption of this new guidance.

In 2017, the FASB issued amended guidance related to the scope of stock option modification accounting, to reduce diversity in practice and provide clarity regarding existing guidance. The new accounting guidance is effective for annual periods beginning after December 15, 2017, including interim periods within those periods. Early adoption is permitted. The Company does not expect the adoption of this guidance to have a material effect on its condensed consolidated financial statements and related disclosures.

For a discussion of other recent accounting pronouncements please refer to Note A, “Nature of Business and Accounting Policies—Recent Accounting Pronouncements,” in the 2016 Annual Report on Form 10-K.

B.
Product Revenues, Net
The Company sells its products principally to a limited number of specialty pharmacy providers 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. ORKAMBI net product revenues do not include any revenues from product sales in France. The Company began distributing ORKAMBI through early access programs in France during the fourth quarter of 2015. The Company’s condensed consolidated balance sheet includes $147.7 million collected as of June 30, 2017 in France related to ORKAMBI that is classified as Customer deposits. The Company currently expects that revenues from these early access programs and deferred expenses associated with these revenues will be recognized in the period that a formal reimbursement agreement in France is reached based on the terms of such agreement.


9
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VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

The following table summarizes activity in each of the product revenue allowance and reserve categories for the six months ended June 30, 2017:
 
Trade
Allowances
 
Rebates,
Chargebacks
and Discounts
 
Product
Returns
 
Other
Incentives
 
Total
 
(in thousands)
Balance at December 31, 2016
$
2,568

 
$
81,927

 
$
3,492

 
$
1,214

 
$
89,201

Provision related to current period sales
11,941

 
69,669

 
1,777

 
9,224

 
92,611

Adjustments related to prior period sales
(194
)
 
(3,268
)
 
(48
)
 
(145
)
 
(3,655
)
Credits/payments made
(11,683
)
 
(58,121
)
 
(631
)
 
(6,966
)
 
(77,401
)
Balance at June 30, 2017
$
2,632

 
$
90,207

 
$
4,590

 
$
3,327

 
$
100,756



10
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

C.
Collaborative Arrangements and Acquisitions
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 in October 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 (i) KALYDECO (ivacaftor) and ORKAMBI (lumacaftor in combination with ivacaftor), which are the Company’s current products and (ii) tezacaftor in combination with ivacaftor. For combination products, such as ORKAMBI, sales will be allocated equally to each of the active pharmaceutical ingredients in the combination product.
In the 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 program award plus any future development funding represent a form of financing pursuant to Accounting Standards Codification (ASC) 730, Research and Development, and thus the amounts are recorded as a liability on the condensed consolidated balance sheet, primarily reflected in Advance from collaborator. The liability is reduced over the estimated royalty term of the agreement. Reductions in the liability are reflected as an offset to cost of product revenues and as interest expense.
The Company has royalty obligations to CFFT for ivacaftor, lumacaftor and tezacaftor 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 tezacaftor that expire in 2027 and 2028, respectively, subject to potential extension.
CRISPR Therapeutics AG
In 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, including targets for the potential treatment of sickle cell disease. 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 was classified as a long-term asset on the Company’s condensed consolidated balance sheets. 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 purchased $10 million of common shares at public offering price and the Company’s preferred stock investments in CRISPR converted into common shares. As of June 30, 2017, the Company recorded the CRISPR common shares it holds at fair value and included the $51.0 million fair value of the common shares in its marketable securities and the 7.8 million unrecognized gain related to these common shares in accumulated other comprehensive income (loss) on the condensed consolidated balance sheet.
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


11
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VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

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.
Merck KGaA

On January 10, 2017, the Company entered into a strategic collaboration and license agreement (the “Merck KGaA Agreement”) with Merck KGaA, Darmstadt, Germany (“Merck KGaA”). Pursuant to the Merck KGaA Agreement, the Company granted Merck KGaA an exclusive worldwide license to research, develop and commercialize four oncology research and development programs. Under the Merck KGaA Agreement, the Company granted Merck KGaA exclusive, worldwide rights to two clinical-stage programs targeting DNA damage repair: its ataxia telangiectasia and Rad3-related protein inhibitor program, including VX-970 and VX-803, and its DNA-dependent protein kinase inhibitor program, including VX-984. In addition, the Company granted Merck KGaA exclusive, worldwide rights to two pre-clinical programs.

The Merck KGaA Agreement provided for an up-front payment from Merck KGaA to the Company of $230.0 million. During the first quarter of 2017, the Company received $193.6 million of the up-front payment and the remaining $36.4 million was remitted to the German tax authorities. Pursuant to a tax treaty between the United States and Germany, the Company filed a refund application for the tax withholding and expects to receive the refund in the second half of 2017. The income tax receivable is included in Prepaid expenses and other current assets at June 30, 2017. In addition to the up-front payment, the Company will receive tiered royalties on potential sales of licensed products, calculated as a percentage of net sales, that range from (i) mid-single digits to mid-twenties for clinical-stage programs and (ii) mid-single digits to high single digits for the pre-clinical research programs. Merck KGaA has assumed full responsibility for development and commercialization costs for all programs.

The Company evaluated the deliverables, primarily consisting of a license to the four programs and the obligation to complete certain fully-reimbursable research and development and transition activities as directed by Merck KGaA, pursuant to the Merck KGaA Agreement, under the multiple element arrangement accounting guidance. The Company concluded that the license has stand-alone value from the research and development and transition activities based on the resources and know-how possessed by Merck KGaA, and thus concluded that there are two units of accounting in the arrangement. The Company determined the relative selling price of the units of accounting based on the Company’s best estimate of selling price. The Company utilized key assumptions to determine the best estimate of selling price for the license, which included future potential net sales of licensed products, development timelines, reimbursement rates for personnel costs, discount rates, and estimated third-party development costs. The Company utilized a discounted cash flow model to determine its best estimate of selling price for the license and determined the best estimate of selling price for the research and development and transition activities based on what it would sell the services for separately. Based on this analysis, the Company recognized approximately $231.7 million in collaborative revenues related to the up-front payment upon delivery of the license and to the research and development and transition activities provided during the first quarter of 2017. During the three and six months ended June 30, 2017, the Company recorded the reimbursement for the research and development and transition activities of $6.1 million and $7.6 million, respectively, as revenue in the Company’s consolidated statements of operations primarily due to the fact that the Company is the primary obligor in the arrangement. The Company is providing research and development and transition activities and will recognize the revenues and associated expenses as the services are provided.

Merck KGaA may terminate the Merck KGaA Agreement or any individual program by providing 90 days’ notice, or, in the case of termination of a program with a product that has received marketing approval, 180 days’ notice. The Merck KGaA Agreement also may be terminated by either party for a material breach by the other party, subject to notice and cure provisions. Unless earlier terminated, the Merck KGaA Agreement will continue in effect until the date on which the royalty term and all payment obligations with respect to all products in all countries have expired.


12
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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 payments, which consist of milestone, royalty and option 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 payments. The following collaborations are reflected in the Company’s financial statements as consolidated VIEs:

Parion Sciences, Inc.

In June 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 VX-551 (formerly P-1055), for the potential treatment of CF, and all 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 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 it has a variable interest in Parion via the Parion Agreement, and that the variable interest represents a variable interest in Parion as a whole since the fair value of the ENaC inhibitors represents more than half of the total fair value of Parion’s assets. The Company also concluded that it is the primary beneficiary as it has the power to direct the activities that most significantly affect the economic performance of Parion and it has the obligation to absorb losses and right to receive benefits that potentially could be significant to 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.



13
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VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

While there was a transfer of $80.0 million to Parion, the cash remained within the Company’s condensed consolidated balance sheet since Parion is part of the consolidated entity. The cash received, net of any cash spend by Parion, is classified as restricted cash and cash equivalents (VIE) within the condensed consolidated balance sheet as it is attributed to the noncontrolling interest holders of Parion. When determining the valuation of goodwill, the fair value of consideration for the license is zero since there was no consideration transferred outside the condensed consolidated financial statements. 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 also recorded the fair value of the net assets attributable to noncontrolling interest of $164.3 million, deferred tax liability of $91.0 million resulting from a basis difference in the intangible assets and certain other net liabilities held by Parion of $10.5 million.  The difference between the fair values of the consideration and noncontrolling interest and the fair value of Parion’s net assets was recorded as goodwill.

In the second quarter of 2017, Parion signed a license agreement with an affiliate of Shire plc related to the development of a drug candidate for the potential treatment of dry eye disease. The Company evaluated the license agreement entered into by Parion as a reconsideration event to determine whether it should continue to consolidate Parion as a variable interest entity into its condensed consolidated financial statements. The Company determined that there was no substantive change in the design of Parion subsequent to Parion’s agreement with Shire. Additionally, the Company concluded that it is appropriate to continue to consolidate the financial results of Parion because it continues to have (i) the power to direct the activities that most significantly affect the economic performance of Parion and (ii) the obligation to absorb losses and right to receive benefits that potentially could be significant to Parion. Based on the consolidation of Parion’s financial statements, in the three and six months ended June 30, 2017, the Company recognized (i) $20.0 million of collaborative revenues and (ii) a tax provision of $7.4 million, both of which were attributable to noncontrolling interest related to an upfront payment that Parion received from Shire in the second quarter of 2017. The Company has no interest in Parion’s license agreement with Shire, including the economic benefits and/or obligations derived therefrom.
BioAxone Biosciences, Inc.
In October 2014, the Company entered into a license and collaboration agreement (the “BioAxone Agreement”) with BioAxone Biosciences, Inc. (“BioAxone”), 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.


14
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

Aggregate VIE Financial Information

An aggregate summary of net income attributable to noncontrolling interest related to the Company’s VIEs for the three and six months ended June 30, 2017 and 2016 is as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
(Income) loss attributable to noncontrolling interest before provision for income taxes and changes in fair value of contingent payments
$
(18,045
)
 
$
2,835

 
$
(16,498
)
 
$
3,674

Provision for income taxes
8,132

 
17,511

 
8,523

 
20,573

Increase in fair value of contingent payments
(3,260
)
 
(48,720
)
 
(6,990
)
 
(58,150
)
Net income attributable to noncontrolling interest
$
(13,173
)
 
$
(28,374
)
 
$
(14,965
)
 
$
(33,903
)

The increases in the noncontrolling interest holders’ claim to net assets with respect to the fair value of the contingent payments in the three and six months ended June 30, 2017 were primarily due to changes in market interest rates and the time value of money. The increases in the fair value of the contingent milestone and royalty payments in the three and six months ended June 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. During the three and six months ended June 30, 2017 and 2016, the increases in the fair value of the contingent payments related to the Company’s VIEs was as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Parion
$
3,260

 
$
48,400

 
$
6,090

 
$
57,400

BioAxone
—

 
320

 
900

 
750


The fair value of the contingent payments related to the Parion Agreement and the BioAxone Agreement as of the dates set forth in the table:

 
June 30, 2017
 
December 31, 2016
 
(in thousands)
Parion
$
244,890

 
$
238,800

BioAxone
18,900

 
18,000




15
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

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:
 
June 30, 2017
 
December 31, 2016
 
(in thousands)
Restricted cash and cash equivalents (VIE)
$
64,628

 
$
47,762

Prepaid expenses and other current assets
1,198

 
6,812

Intangible assets
284,340

 
284,340

Goodwill
19,391

 
19,391

Other assets
752

 
399

Accounts payable
702

 
415

Accrued expenses
4,118

 
1,330

Other liabilities, current portion
1,610

 
2,137

Deferred tax liability
134,305

 
131,446

Other liabilities, excluding current portion
300

 
300

Noncontrolling interest
195,958

 
181,609


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.

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.

The Company evaluates the carrying value of its $20.0 million cost-method investment in Moderna, which is not a publicly traded company, for impairment on a quarterly basis and has not recorded any adjustments to the carrying value of its investment to date.


16
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

Janssen Pharmaceuticals, Inc.
In June 2014, the Company entered into an agreement (the “Janssen 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 Agreement, Janssen Inc. has an exclusive worldwide license to develop and commercialize certain drug candidates for the treatment of influenza, including JNJ-3872 (formerly 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 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 six months ended June 30, 2017 the Company recorded reimbursement for these development activities of $0.3 million and $1.8 million, respectively. During the three and six months ended June 30, 2016 the Company recorded reimbursement for these development activities of $4.3 million and $7.8 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.
Acquisition
Concert Pharmaceuticals
In July 2017, the Company acquired certain CF assets including CTP-656 from Concert Pharmaceuticals Inc. (“Concert”) pursuant to an asset purchase agreement that was entered into in March 2017 (the “Concert Agreement”). CTP-656 is an investigational CFTR potentiator that has the potential to be used as part of future once-daily combination regimens of CFTR modulators that treat the underlying cause of CF. As part of the Concert Agreement, Vertex paid Concert $160 million in cash for all worldwide development and commercialization rights to CTP-656. If CTP-656 is approved as part of a combination regimen to treat CF, Concert could receive up to an additional $90 million in milestones based on regulatory approval in the U.S. and reimbursement in the UK, Germany or France. There was no accounting impact relating to this agreement during the three and six months ended June 30, 2017. In the third quarter of 2017, the Company expects to record the $160 million payment as a research and development expense.
D.
Earnings Per Share
Basic net income (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 income (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.


17
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

The following table sets forth the computation of basic and diluted net income (loss) per share for the periods ended:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands, except per share amounts)
Basic net income (loss) attributable to Vertex per common share calculation:
 
 
 
 
 
 
 
Net income (loss) attributable to Vertex common shareholders
$
17,996

 
$
(64,525
)
 
$
265,752

 
$
(106,156
)
Less: Undistributed earnings allocated to participating securities
(23
)
 
—

 
(387
)
 
—

Net income (loss) attributable to Vertex common shareholders—basic
$
17,973

 
$
(64,525
)
 
$
265,365

 
$
(106,156
)
 
 
 
 
 
 
 
 
Basic weighted-average common shares outstanding
247,521

 
244,482

 
246,782

 
244,124

Basic net income (loss) attributable to Vertex per common share
$
0.07

 
$
(0.26
)
 
$
1.08

 
$
(0.43
)
 
 
 
 
 
 
 
 
Diluted net income (loss) attributable to Vertex per common share calculation:
 
 
 
 
 
 
 
Net income (loss) attributable to Vertex common shareholders
$
17,996

 
$
(64,525
)
 
$
265,752

 
$
(106,156
)
Less: Undistributed earnings allocated to participating securities
(23
)
 
—

 
(382
)
 
—

Net income (loss) attributable to Vertex common shareholders—diluted
$
17,973

 
$
(64,525
)
 
$
265,370

 
$
(106,156
)
 
 
 
 
 
 
 
 
Weighted-average shares used to compute basic net income (loss) per common share
247,521

 
244,482

 
246,782

 
244,124

Effect of potentially dilutive securities:
 
 
 
 
 
 
 
Stock options
2,787

 
—

 
2,407

 
—

Restricted stock and restricted stock units
1,264

 
—

 
958

 
—

Other
63

 
—

 
52

 
—

Weighted-average shares used to compute diluted net income (loss) per common share
251,635

 
244,482

 
250,199

 
244,124

Diluted net income (loss) attributable to Vertex per common share
$
0.07

 
$
(0.26
)
 
$
1.06

 
$
(0.43
)
The Company did not include the securities in the following table in the computation of the dilutive net income (loss) per share attributable to Vertex common shareholders calculations because the effect would have been anti-dilutive during each period:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Stock options
3,112

 
12,231

 
7,065

 
12,231

Unvested restricted stock and restricted stock units
6

 
3,506

 
32

 
3,506

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:


18
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

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 June 30, 2017, the Company’s investments were primarily in money market funds, corporate equity securities, corporate debt securities and commercial paper.
As of June 30, 2017, 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, corporate debt securities, commercial paper and corporate equity 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.


19
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, which are recorded as Restricted cash and cash equivalents (VIE)) and liabilities subject to fair value measurements:
 
Fair Value Measurements as of June 30, 2017
 
 
 
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
$
318,411

 
$
318,411

 
$
—

 
$
—

Commercial paper
5,996

 
—

 
5,996

 
—

Marketable securities:
 
 
 
 
 
 
 
Corporate equity securities
51,049

 
51,049

 
—

 
—

Corporate debt securities
291,124

 
—

 
291,124

 
—

Commercial paper
103,347

 
—

 
103,347

 
—

Prepaid and other current assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
985

 
—

 
985

 
—

Total financial assets
$
770,912


$
369,460

 
$
401,452

 
$
—

Financial instruments carried at fair value (liability position):
 
 
 
 
 
 
 
Other liabilities, current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
$
(8,067
)
 
$
—

 
$
(8,067
)
 
$
—

Other liabilities, excluding current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
(1,435
)
 
—

 
(1,435
)
 
—

Total financial liabilities
$
(9,502
)
 
$
—

 
$
(9,502
)
 
$
—

 
Fair Value Measurements as of December 31, 2016
 
 
 
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
$
280,560

 
$
280,560

 
$
—

 
$
—

Marketable securities:
 
 
 
 
 
 
 
Government-sponsored enterprise securities
15,508

 
15,508

 
—

 
—

Corporate equity securities
64,560

 
64,560

 
—

 
—

Commercial paper
59,404

 
—

 
59,404

 
—

Corporate debt securities
111,140

 
—

 
111,140

 
—

Prepaid and other current assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
14,407

 
—

 
14,407

 
—

Other assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
1,186

 
$
—

 
1,186

 
$
—

Total financial assets
$
546,765

 
$
360,628

 
$
186,137

 
$
—

Financial instruments carried at fair value (liability position):
 
 
 
 
 
 
 
Other liabilities, current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
$
(144
)
 
$
—

 
$
(144
)
 
$
—

Total financial liabilities
$
(144
)
 
$
—

 
$
(144
)
 
$
—

The Company’s VIEs invested in cash equivalents consisting of money market funds of $62.6 million as of June 30, 2017, 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 payments, which consist of milestone, royalty


20
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

and option payments, which are valued based on Level 3 inputs. Please refer to Note C, “Collaborative Arrangements,” for further information.
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 June 30, 2017
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash and money market funds
$
1,217,134

 
$
—

 
$
—

 
$
1,217,134

Commercial paper
5,996

 
—

 
—

 
5,996

Total cash and cash equivalents
$
1,223,130

 
$
—

 
$
—

 
$
1,223,130

Marketable securities:
 
 
 
 
 
 
 
Corporate equity securities
43,213

 
7,836

 
—

 
51,049

Commercial paper (matures within 1 year)
103,386

 
1

 
(40
)
 
103,347

Corporate debt securities (matures within 1 year)
218,216

 
4

 
(143
)
 
218,077

Corporate debt securities (matures after 1 year)
73,115

 
2

 
(70
)
 
73,047

Total marketable securities
$
437,930

 
$
7,843

 
$
(253
)
 
$
445,520

Total cash, cash equivalents and marketable securities
$
1,661,060

 
$
7,843

 
$
(253
)
 
$
1,668,650

 
 
 
 
 
 
 
 
As of December 31, 2016
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash and money market funds
$
1,183,945

 
$
—

 
$
—

 
$
1,183,945

Total cash and cash equivalents
$
1,183,945

 
$
—

 
$
—

 
$
1,183,945

Marketable securities:
 
 
 
 
 
 
 
Government-sponsored enterprise securities (matures within 1 year)
$
15,506

 
$
2

 
$
—

 
$
15,508

Corporate equity securities
43,213

 
21,347

 
—

 
64,560

Commercial paper (matures within 1 year)
59,331

 
73

 
—

 
59,404

Corporate debt securities (matures within 1 year)
111,225

 
—

 
(85
)
 
111,140

Total marketable securities
$
229,275

 
$
21,422

 
$
(85
)
 
$
250,612

Total cash, cash equivalents and marketable securities
$
1,413,220

 
$
21,422

 
$
(85
)
 
$
1,434,557

The Company has a limited number of marketable securities in insignificant loss positions as of June 30, 2017, which the Company does not intend to sell and has concluded it will not be required to sell before recovery of the amortized costs of 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 six months ended June 30, 2017 and 2016.


21
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

G.
Accumulated Other Comprehensive Income (Loss)
A summary of the Company’s changes in accumulated other comprehensive income (loss) by component is shown below:
 
Foreign Currency Translation Adjustment
 
Unrealized Holding Gains (Losses) on Marketable Securities, Net of Tax
 
Unrealized Gains (Losses) on Foreign Currency Forward Contracts, Net of Tax
 
Total
 
(in thousands)
Balance at December 31, 2016
$
(7,862
)
 
$
17,521

 
$
11,514

 
$
21,173

Other comprehensive loss before reclassifications
(7,253
)
 
(13,747
)
 
(17,215
)
 
(38,215
)
Amounts reclassified from accumulated other comprehensive loss
—

 
—

 
(4,711
)
 
(4,711
)
Net current period other comprehensive (loss) income
$
(7,253
)
 
$
(13,747
)
 
$
(21,926
)
 
$
(42,926
)
Balance at June 30, 2017
$
(15,115
)
 
$
3,774

 
$
(10,412
)
 
$
(21,753
)
 
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
(5,201
)
 
200

 
1,847

 
(3,154
)
Amounts reclassified from accumulated other comprehensive loss
—

 
—

 
(2,060
)
 
(2,060
)
Net current period other comprehensive (loss) income
$
(5,201
)
 
$
200

 
$
(213
)
 
$
(5,214
)
Balance at June 30, 2016
$
(7,281
)
 
$
326

 
$
3,565

 
$
(3,390
)
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 U.S. 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 June 30, 2017, 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:


22
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

 
As of June 30, 2017
 
As of December 31, 2016
Foreign Currency
(in thousands)
Euro
$
209,800

 
$
164,368

British pound sterling
71,917

 
65,237

Australian dollar
28,680

 
23,776

Total foreign currency forward contracts
$
310,397

 
$
253,381

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 June 30, 2017
Assets
 
Liabilities
Classification
 
Fair Value
 
Classification
 
Fair Value
(in thousands)
Prepaid and other current assets
 
$
985

 
Other liabilities, current portion
 
$
(8,067
)
Other assets
 
—

 
Other liabilities, excluding current portion
 
(1,435
)
Total assets
 
$
985

 
Total liabilities
 
$
(9,502
)
As of December 31, 2016
Assets
 
Liabilities
Classification
 
Fair Value
 
Classification
 
Fair Value
(in thousands)
Prepaid and other current assets
 
$
14,407

 
Other liabilities, current portion
 
$
(144
)
Other assets
 
1,186

 
Other liabilities, excluding current portion
 
—

Total assets
 
$
15,593

 
Total liabilities
 
$
(144
)
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 June 30, 2017
 
Gross Amounts Recognized
 
Gross Amounts Offset
 
Gross Amounts Presented
 
Gross Amounts Not Offset
 
Legal Offset
Foreign currency forward contracts
(in thousands)
Total assets
$
985

 
$
—

 
$
985

 
$
(985
)
 
$
—

Total liabilities
$
(9,502
)
 
$
—

 
$
(9,502
)
 
$
985

 
$
(8,517
)
 
As of December 31, 2016
 
Gross Amounts Recognized
 
Gross Amounts Offset
 
Gross Amounts Presented
 
Gross Amounts Not Offset
 
Legal Offset
Foreign currency forward contracts
(in thousands)
Total assets
$
15,593

 
$
—

 
$
15,593

 
$
(144
)
 
$
15,449

Total liabilities
$
(144
)
 
$
—

 
$
(144
)
 
$
144

 
$
—



23
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

I. Inventories
Inventories consisted of the following:
 
As of June 30, 2017
 
As of December 31, 2016
 
(in thousands)
Raw materials
$
13,876

 
$
6,348

Work-in-process
63,116

 
56,672

Finished goods
15,271

 
14,584

Total
$
92,263

 
$
77,604

Based on its evaluation of, among other factors, information regarding tezacaftor's safety and efficacy, the Company has capitalized $4.9 million of inventory costs for tezacaftor manufactured in preparation for its potential product launch as of June 30, 2017. In periods prior, the Company expensed costs associated with tezacaftor’s raw materials and work-in-process as a development expense. The Company submitted a New Drug Application to the United States Food and Drug Administration and a Marketing Authorization Application to the European Medicines Agency for tezacaftor in combination with ivacaftor. The Company plans to continue to monitor the status of the tezacaftor regulatory process and the other factors used to determine whether or not to capitalize the tezacaftor inventory and, if there are significant negative developments regarding tezacaftor, the Company could be required to impair previously capitalized costs.
J. Intangible Assets and Goodwill
Intangible Assets
As of June 30, 2017 and December 31, 2016, in-process research and development intangible assets of $284.3 million were recorded on the Company’s condensed consolidated balance sheet. In 2015, the Company recorded an in-process research development intangible asset of $255.3 million related 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. In 2014, the Company recorded an in-process research development intangible asset of $29.0 million related to VX-210 that is licensed by BioAxone to the Company.
Goodwill
As of June 30, 2017 and December 31, 2016, 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 “Fan Pier 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 Fan Pier Buildings during the construction period and recorded project construction costs incurred by the landlord. Upon completion of the Fan Pier 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 Fan Pier Buildings were constructed. The portion of the lease obligations allocated to the land is treated as an operating lease that commenced in 2011.


24
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

Property and equipment, net, included $482.4 million and $489.0 million as of June 30, 2017 and December 31, 2016, respectively, related to construction costs for the Fan Pier Buildings. The carrying value of the Company’s lease agreement liability for the Fan Pier Buildings was $472.4 million and $472.6 million as of June 30, 2017 and December 31, 2016, 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 (the “San Diego Building”). 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.

Because the Company is involved in the construction project, the Company is deemed for accounting purposes to be the owner of the San Diego Building during the construction period and recorded project construction costs incurred by the landlord. The Company bifurcates its lease payments pursuant to the San Diego Lease into (i) a portion that is allocated to the San Diego Building and (ii) a portion that is allocated to the land on which the San Diego Building was constructed. Although the Company will not begin making lease payments pursuant to the San Diego Lease until the commencement date, the portion of the lease obligation allocated to the land is treated for accounting purposes as an operating lease that commenced in the fourth quarter of 2016. Upon completion of the San Diego Building, the Company will evaluate the San Diego Lease and determine if the San Diego Lease meets the criteria for “sale-leaseback” treatment. If the San Diego Lease meets the “sale-leaseback” criteria, the Company will remove the asset and the related liability from its consolidated balance sheet and treat the San Diego Lease as either an operating or a capital lease based on the Company’s assessment of the accounting guidance. The Company expects that upon completion of construction of the San Diego Building the San Diego Lease will not meet the “sale-leaseback” criteria. If the San Diego Lease does not meet “sale-leaseback” criteria, the Company will treat the San Diego Lease as a financing obligation and will depreciate the asset over its estimated useful life.

Property and equipment, net, included $57.1 million and $15.0 million as of June 30, 2017 and December 31, 2016, respectively, related to construction costs for the San Diego Building. The carrying value of the Company’s lease agreement liability for the San Diego Building was $50.2 million and $12.6 million as of June 30, 2017 and December 31, 2016, respectively.

Revolving Credit Facility
In October 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”) and was repaid in February 2017. 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 then outstanding indebtedness under the Macquarie Loan (as defined below). 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 2.50%, 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


25
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

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.
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 (the “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.
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.
L. Stock-based Compensation Expense
During the three and six months ended June 30, 2017 and 2016, the Company recognized the following stock-based compensation expense:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Stock-based compensation expense by type of award:
 
 
 
 
 
 
 
Stock options
$
27,915

 
$
31,826

 
$
54,896

 
$
58,086

Restricted stock and restricted stock units
43,906

 
29,608

 
84,651

 
57,141

ESPP share issuances
2,246

 
1,436

 
4,310

 
3,960

Less stock-based compensation expense capitalized to inventories
(1,485
)
 
(928
)
 
(2,293
)
 
(1,773
)
Total stock-based compensation included in costs and expenses
$
72,582

 
$
61,942

 
$
141,564

 
$
117,414

 
 
 
 
 
 
 


Stock-based compensation expense by line item:
 
 
 
 
 
 
 
Research and development expenses
$
43,832

 
$
40,640

 
$
88,669

 
$
75,088

Sales, general and administrative expenses
28,750

 
21,302

 
52,895

 
42,326

Total stock-based compensation included in costs and expenses
$
72,582

 
$
61,942

 
$
141,564

 
$
117,414

The following table sets forth the Company’s unrecognized stock-based compensation expense by type of award and the weighted-average period over which that expense is expected to be recognized:


26
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

 
As of June 30, 2017
 
Unrecognized Expense
 
Weighted-average
Recognition Period
 
(in thousands)
 
(in years)
Type of award:
 
 
 
Stock options
$
165,047

 
2.51
Restricted stock and restricted stock units
$
249,474

 
2.41
ESPP share issuances
$
5,064

 
0.62
The following table summarizes information about stock options outstanding and exercisable at June 30, 2017:
 
 
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
 
129

 
0.61
 
$
18.93

 
129

 
$
18.93

$20.01–$40.00
 
943

 
2.57
 
$
34.74

 
943

 
$
34.74

$40.01–$60.00
 
1,233

 
5.15
 
$
48.58

 
1,233

 
$
48.58

$60.01–$80.00
 
1,042

 
6.69
 
$
75.83

 
784

 
$
75.63

$80.01–$100.00
 
5,336

 
8.45
 
$
89.52

 
1,733

 
$
89.89

$100.01–$120.00
 
1,437

 
7.56
 
$
109.35

 
786

 
$
109.27

$120.01–$131.89
 
1,416

 
8.03
 
$
130.34

 
763

 
$
130.00

Total
 
11,536

 
7.21
 
$
86.12

 
6,371

 
$
77.74

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 June 30, 2017, the Company had $9.6 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 six months ended June 30, 2017, the Company recorded a provision for income taxes of $4.3 million and $8.3 million, respectively, which included a provision of $8.1 million and $8.5 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 six months ended June 30, 2016, the Company recorded a provision for income taxes of $18.1 million and $23.6 million, respectively, which included a provision of $17.5 million and $20.6 million, respectively, related to the Company’s VIEs’ income tax provision.
As of June 30, 2017 and December 31, 2016, the Company did not have unrecognized tax benefits. The Company recognizes interest and penalties related to income taxes as a component of income tax expense. As of June 30, 2017, no interest and penalties have been accrued. The Company does not expect that its unrecognized tax benefits will materially


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

increase within the next twelve months. The Company did not recognize any material interest or penalties related to uncertain tax positions as of June 30, 2017 and December 31, 2016.
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.
As described in Footnote A, the Company adopted Accounting Standards Update (ASU) 2016-09, during the six month period ended June 30, 2017. The ASU eliminates additional paid in capital (“APIC”) pools and requires excess tax benefits and tax deficiencies to be recorded in the condensed consolidated statement of operations when the awards vest or are settled. Amendments related to accounting for excess tax benefits have been adopted prospectively resulting in a tax benefit of $30.4 million and $30.8 million for the three and six months ended June 30, 2017, respectively. In connection with the adoption of this new standard, the Company recorded a cumulative-effect adjustment of $410.8 million as of January 1, 2017 to accumulated deficit and deferred tax assets, with an equal offsetting adjustment to the Company’s valuation allowance. In addition, the Company has recorded $9.4 million related to the impact from adoption of the provisions related to forfeiture rates to accumulated deficit. This change also increased the Company’s deferred tax assets by $3.4 million that is offset by an increase to the valuation allowance in the same amount.

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 or any other major taxing jurisdiction for years before 2011, except where the Company has net operating losses or tax credit carryforwards that originate before 2011. The Company currently is under examination by Canada Revenue Agency for the years ending December 31, 2011 through December 31, 2013. No adjustments have been reported.
At June 30, 2017, 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
Research and Development Restructuring
In February 2017, the Company decided to consolidate its research activities into its Boston, Milton Park and San Diego locations and to close the research site in Canada.  As a result, the Company is in the process of closing one of its research sites.  In connection with this decision, approximately 70 positions were affected. The Company estimates that it will incur aggregate restructuring charges of approximately $12.4 million, including $6.9 million for employee salary, severance and benefit costs, $2.2 million in assets associated with the restructuring that have become impaired and $3.3 million for other costs primarily related to the Company’s exit from the facility.


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

The restructuring charge and other activities recorded during the the three and six months ended June 30, 2017 and the related liability balance as of June 30, 2017 were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2017
 
2017
 
(in thousands)
Liability, beginning of the period
$
3,727

 
$
—