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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 SEPTEMBER 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
252,902,848
Class
Outstanding at October 20, 2017
 


Table of Contents

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

TABLE OF CONTENTS
 
 
Page
 
 
 
Condensed Consolidated Statements of Operations - Three and Nine Months Ended September 30, 2017 and 2016
 
Condensed Consolidated Statements of Comprehensive Income (Loss) - Three and Nine Months Ended September 30, 2017 and 2016
 
Condensed Consolidated Balance Sheets - September 30, 2017 and December 31, 2016
 
Condensed Consolidated Statements of Shareholders' Equity and Noncontrolling Interest - Nine Months Ended September 30, 2017 and 2016
 
Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 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 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Revenues:
 
 
 
 
 
 
 
Product revenues, net
$
549,642

 
$
409,689

 
$
1,544,252

 
$
1,229,750

Royalty revenues
2,231

 
3,835

 
6,643

 
12,713

Collaborative revenues
26,292

 
259

 
286,123

 
1,008

Total revenues
578,165

 
413,783

 
1,837,018

 
1,243,471

Costs and expenses:
 
 
 
 
 
 
 
Cost of product revenues
72,186

 
53,222

 
188,963

 
147,165

Royalty expenses
688

 
855

 
2,104

 
2,813

Research and development expenses
454,947

 
272,370

 
1,017,961

 
799,238

Sales, general and administrative expenses
120,710

 
106,055

 
361,285

 
322,921

Restructuring expenses, net
337

 
8

 
13,859

 
1,038

Intangible asset impairment charge
255,340

 
—

 
255,340

 
—

Total costs and expenses
904,208

 
432,510

 
1,839,512

 
1,273,175

Loss from operations
(326,043
)
 
(18,727
)
 
(2,494
)
 
(29,704
)
Interest expense, net
(13,574
)
 
(20,140
)
 
(45,003
)
 
(60,993
)
Other (expenses) income, net
(77,553
)
 
(167
)
 
(80,634
)
 
3,025

Loss before (benefit from) provision for income taxes
(417,170
)
 
(39,034
)
 
(128,131
)
 
(87,672
)
(Benefit from) provision for income taxes
(125,903
)
 
503

 
(117,581
)
 
24,118

Net loss
(291,267
)
 
(39,537
)
 
(10,550
)
 
(111,790
)
Loss (income) attributable to noncontrolling interest
188,315

 
696

 
173,350

 
(33,207
)
Net (loss) income attributable to Vertex
$
(102,952
)
 
$
(38,841
)
 
$
162,800

 
$
(144,997
)
 
 
 
 
 
 
 
 
Amounts per share attributable to Vertex common shareholders:
 
 
 
 
 
 
 
Net (loss) income:
 
 
 
 
 
 
 
Basic
$
(0.41
)
 
$
(0.16
)
 
$
0.66

 
$
(0.59
)
Diluted
$
(0.41
)
 
$
(0.16
)
 
$
0.64

 
$
(0.59
)
Shares used in per share calculations:
 
 
 
 
 
 
 
Basic
250,268

 
244,920

 
247,963

 
244,529

Diluted
250,268

 
244,920

 
252,095

 
244,529

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 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Net loss
$
(291,267
)
 
$
(39,537
)
 
$
(10,550
)
 
$
(111,790
)
Changes in other comprehensive loss:
 
 
 
 
 
 
 
Unrealized holding gains (losses) on marketable securities, net of tax of zero, respectively
5,961

 
(96
)
 
(7,786
)
 
104

Unrealized (losses) gains on foreign currency forward contracts, net of tax of $0.9 million, $0.2 million, $2.9 million and $(0.4) million, respectively
(5,453
)
 
2,149

 
(27,379
)
 
1,936

Foreign currency translation adjustment
(3,884
)
 
(2,508
)
 
(11,137
)
 
(7,709
)
Total changes in other comprehensive loss
(3,376
)
 
(455
)
 
(46,302
)
 
(5,669
)
Comprehensive loss
(294,643
)
 
(39,992
)
 
(56,852
)
 
(117,459
)
Comprehensive loss (income) attributable to noncontrolling interest
188,315

 
696

 
173,350

 
(33,207
)
Comprehensive (loss) income attributable to Vertex
$
(106,328
)
 
$
(39,296
)
 
$
116,498

 
$
(150,666
)
The accompanying notes are an integral part of these condensed consolidated financial statements.


3
Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
Condensed Consolidated Balance Sheets
(unaudited)
(in thousands, except share and per share amounts)
 
September 30,
 
December 31,
 
2017
 
2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
1,384,966

 
$
1,183,945

Marketable securities, available for sale
427,282

 
250,612

Restricted cash and cash equivalents (VIE)
1,803

 
47,762

Accounts receivable, net
263,493

 
201,083

Inventories
98,192

 
77,604

Prepaid expenses and other current assets
152,238

 
70,534

Total current assets
2,327,974

 
1,831,540

Property and equipment, net
759,978

 
698,362

Intangible assets
29,000

 
284,340

Goodwill
50,384

 
50,384

Cost method investments
20,447

 
20,276

Other assets
10,542

 
11,885

Total assets
$
3,198,325

 
$
2,896,787

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
77,138

 
$
61,451

Accrued expenses
378,554

 
315,249

Deferred revenues, current portion
13,003

 
6,005

Accrued restructuring expenses, current portion
4,205

 
6,047

Capital lease obligations, current portion
19,881

 
19,426

Customer deposits
190,272

 
73,416

Credit facility
—

 
300,000

Other liabilities, current portion
27,686

 
10,943

Total current liabilities
710,739

 
792,537

Deferred revenues, excluding current portion
2,917

 
6,632

Accrued restructuring expenses, excluding current portion
146

 
1,907

Capital lease obligations, excluding current portion
20,259

 
34,976

Deferred tax liability
10,682

 
134,063

Construction financing lease obligation, excluding current portion
547,051

 
486,359

Advance from collaborator
77,258

 
73,423

Other liabilities, excluding current portion
26,029

 
28,699

Total liabilities
1,395,081

 
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; 252,683,346 and 248,300,517 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively
2,500

 
2,450

Additional paid-in capital
7,034,113

 
6,506,795

Accumulated other comprehensive (loss) income
(25,129
)
 
21,173

Accumulated deficit
(5,220,407
)
 
(5,373,836
)
Total Vertex shareholders’ equity
1,791,077

 
1,156,582

Noncontrolling interest
12,167

 
181,609

Total shareholders’ equity
1,803,244

 
1,338,191

Total liabilities and shareholders’ equity
$
3,198,325

 
$
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
—

 
—

 
—

 
(5,669
)
 
—

 
(5,669
)
 
—

 
(5,669
)
Net (loss) income
—

 
—

 
—

 
—

 
(144,997
)
 
(144,997
)
 
33,207

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

 
19

 
50,875

 
—

 
—

 
50,894

 
—

 
50,894

Stock-based compensation expense
—

 
—

 
181,351

 
—

 
—

 
181,351

 
(73
)
 
181,278

Balance at September 30, 2016
248,029

 
$
2,446

 
$
6,429,726

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

 
$
186,795

 
$
1,208,341

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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
—

 
—

 
—

 
(46,302
)
 
—

 
(46,302
)
 
—

 
(46,302
)
Net income (loss)
—

 
—

 
—

 
—

 
162,800

 
162,800

 
(173,350
)
 
(10,550
)
Issuance of common stock under benefit plans
4,382

 
50

 
298,956

 
—

 
—

 
299,006

 
33

 
299,039

Stock-based compensation expense
—

 
—

 
218,991

 
—

 
—

 
218,991

 
—

 
218,991

VIE noncontrolling interest upon deconsolidation
—

 
—

 
—

 
—

 
—

 
—

 
3,910

 
3,910

Other
—

 
—

 
—

 
—

 
—

 
—

 
(35
)
 
(35
)
Balance at September 30, 2017
252,683

 
$
2,500

 
$
7,034,113

 
$
(25,129
)
 
$
(5,220,407
)
 
$
1,791,077

 
$
12,167

 
$
1,803,244

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


5
Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
Condensed Consolidated Statements of Cash Flows
(unaudited)
(in thousands)
 
Nine Months Ended September 30,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net loss
$
(10,550
)
 
$
(111,790
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Stock-based compensation expense
215,334

 
178,623

Depreciation and amortization expense
44,965

 
45,947

Write-downs of inventories to net realizable value
11,138

 
—

Deferred income taxes
(113,969
)
 
23,544

Impairment of property and equipment
1,946

 
—

Intangible asset impairment charge
255,340

 
—

Acquired in-process research & development
160,000

 
—

Deconsolidation of VIE
76,644

 
—

Other non-cash items, net
(4,787
)
 
(904
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(54,455
)
 
(9,760
)
Inventories
(28,570
)
 
(11,536
)
Prepaid expenses and other assets
(90,006
)
 
(8,979
)
Accounts payable
6,925

 
(21,532
)
Accrued expenses and other liabilities
148,102

 
26,121

Accrued restructuring expense
(3,863
)
 
(8,151
)
Deferred revenues
3,237

 
(10,204
)
Net cash provided by operating activities
617,431

 
91,379

Cash flows from investing activities:
 
 
 
Purchases of marketable securities
(431,653
)
 
(616,625
)
Maturities of marketable securities
247,149

 
535,379

Expenditures for property and equipment
(56,817
)
 
(41,775
)
Purchase of in-process research & development
(160,000
)
 
—

(Decrease) increase in restricted cash and cash equivalents (VIE)
(15,643
)
 
20,490

Investment in equity securities
—

 
(23,075
)
Decrease (increase) in other assets
380

 
(93
)
Net cash used in investing activities
(416,584
)
 
(125,699
)
Cash flows from financing activities:
 
 
 
Issuances of common stock under benefit plans
298,205

 
51,165

Payments on revolving credit facility
(300,000
)
 
—

Advance from collaborator
10,000

 
—

Payments on capital lease obligations
(14,188
)
 
(13,330
)
Proceeds from capital lease financing
—

 
2,030

Payments on construction financing lease obligation
(412
)
 
(356
)
Proceeds related to construction financing lease obligation
4,700


—

Repayments of advanced funding
(3,132
)
 
—

Net cash (used in) provided by financing activities
(4,827
)
 
39,509

Effect of changes in exchange rates on cash
5,001

 
(265
)
Net increase in cash and cash equivalents
201,021

 
4,924

Cash and cash equivalents—beginning of period
1,183,945

 
714,768

Cash and cash equivalents—end of period
$
1,384,966

 
$
719,692

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
51,990

 
$
64,662

Cash paid for income taxes
$
4,154

 
$
1,617

Capitalization of costs related to construction financing lease obligation
$
33,827

 
$
824

Issuances of common stock from employee benefit plans receivable
$
868

 
$
19


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. As of September 30, 2017, the Company deconsolidated Parion Sciences, Inc. (“Parion”), a VIE the Company has consolidated since 2015. The Company's consolidated balance sheet as of September 30, 2017 excludes Parion. Please refer to Note C, “Collaborative Arrangements and Acquisitions” for further information regarding the deconsolidation of Parion.

Certain information and footnote disclosures normally included in the Company’s annual financial statements have been condensed or omitted. These interim financial statements, in the opinion of management, reflect all normal recurring adjustments necessary for a fair presentation of the financial position and results of operations for the interim periods ended September 30, 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 and deconsolidation 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 continues to evaluate the new guidance and the effect the adoption will have on the condensed consolidated financial


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

statements.  The Company’s project team is finalizing 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 revenue recognition guidance could impact the Company’s accounting for product shipments to certain countries through early access programs, including the French early access programs, whereby the associated product has received regulatory approval but the price is not fixed or determinable based on the status of ongoing pricing discussions, and could impact the Company’s accounting for certain reimbursement agreements that the Company plans to negotiate in the fourth quarter of 2017. As the Company completes its assessment, it is 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 September 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.



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

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.

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.

In 2017, the FASB issued amended guidance applicable to hedge accounting. The new accounting guidance is effective for annual periods beginning after December 15, 2018, including interim periods within those periods. Early adoption is permitted. The amended guidance helps simplify certain aspects of hedge accounting and enables entities to more accurately present their risk management activities in their financial statements.  The Company is in the process of evaluating this guidance and determining the expected effect on its condensed consolidated financial statements.

For a discussion of other recent accounting pronouncements please refer to Note A, “Nature of Business and Accounting Policies—Recent Accounting Pronouncements,” in the 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 net product revenues associated with the units in which revenue recognition was deferred.
Revenue recognition related to the Company’s French early access programs could be impacted by the new revenue recognition guidance that is effective January 1, 2018 and described in Note A, “Basis of Presentation and Accounting


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

Policies”. The Company’s ORKAMBI net product revenues to date do not include any revenues from product sales in France because the price is not fixed or determinable. The Company began distributing ORKAMBI through early access programs in France during the fourth quarter of 2015. As of September 30, 2017, the Company’s condensed consolidated balance sheet includes $190.3 million collected in France related to shipments of ORKAMBI under the early access programs that is classified as Customer deposits. The Company expects that the difference between the amounts collected based on the invoiced price and the final price for ORKAMBI in France will be returned to the French government.
If the Company concludes as of December 31, 2017 that the price of the ORKAMBI supplied under the early access programs is fixed or determinable based on, among other factors, the status of negotiations in France, it would record net product revenues for all sales since the inception of the early access programs for ORKAMBI based on the fixed or determinable price in the fourth quarter of 2017.
If the Company concludes that the price is not fixed or determinable as of December 31, 2017, these amounts would be subject to the new guidance applicable to revenue recognition effective January 1, 2018 using the modified retrospective adoption approach.  Pursuant to the new guidance, the Company would record a cumulative effect adjustment to the Company’s accumulated deficit in the first quarter of 2018. The amount of the adjustment to accumulated deficit would be determined based upon (i) the status of pricing discussions in France upon adoption and (ii) the Company’s estimate of the amount of consideration the Company expects to retain related to the French ORKAMBI sales that occurred on or prior to December 31, 2017 that would not be subject to a significant reversal in amounts recognized. For French ORKAMBI sales after December 31, 2017 under the early access programs, the Company would recognize product revenues based on the Company’s estimate of consideration the Company expects to retain for which it is probable that a significant reversal in amounts recognized will not occur. In future periods, if the Company’s estimates regarding the amounts it will receive for ORKAMBI supplied pursuant to these programs change, the effect of the change in estimates would be reflected in net product revenues in the period in which the change in estimate occurred.
The following table summarizes activity in each of the product revenue allowance and reserve categories for the nine months ended September 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
18,776

 
118,592

 
3,603

 
12,238

 
153,209

Adjustments related to prior period sales
(188
)
 
(4,327
)
 
(13
)
 
(355
)
 
(4,883
)
Credits/payments made
(18,409
)
 
(97,393
)
 
(1,809
)
 
(10,021
)
 
(127,632
)
Balance at September 30, 2017
$
2,747

 
$
98,799

 
$
5,273

 
$
3,076

 
$
109,895



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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 $10.0 million of common shares at the public offering price and the Company’s preferred stock investments in CRISPR converted into common shares. As of September 30, 2017, the Company recorded the fair value of its investment in CRISPR common shares of $56.9 million in marketable securities and a $13.7 million unrealized 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 development costs and worldwide revenues. For other targets that the Company elects to license, the Company would lead all development and global commercialization activities. For each of up to six targets that the Company elects to license, other than hemoglobinapathy targets, CRISPR has the potential to receive up to $420.0 million in development, regulatory and commercial milestones and royalties on net product sales.


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

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 upfront 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 upfront 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 fourth quarter of 2017. The income tax receivable is included in Prepaid expenses and other current assets at September 30, 2017. In addition to the upfront 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 upfront 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 nine months ended September 30, 2017, the Company recorded the reimbursement for the research and development and transition activities of $5.2 million and $12.8 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.



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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, resulting 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 for portions or all of the periods presented:

Parion Sciences, Inc.

In June 2015, the Company entered into a strategic collaboration and license agreement (the “Parion Agreement”) with 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 had a variable interest in Parion via the Parion Agreement, and that the variable interest represented a variable interest in Parion as a whole because the fair value of the ENaC inhibitors represented more than half of the total fair value of Parion’s assets. The Company also concluded that it was the primary beneficiary as it had the power to direct the activities that most significantly affect the economic performance of Parion and it had 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 from June 4, 2015 through September 30, 2017. The Company deconsolidated Parion effective September 30, 2017. Notwithstanding the applicable accounting treatment, the Company's interests in Parion have been and continue to be limited to those accorded to the Company in the Parion Agreement.



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

As of June 4, 2015, the Company consolidated Parion’s financial statements, which included $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 primarily 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. When determining the valuation of goodwill, the fair value of consideration for the license was zero since there was no consideration transferred outside the condensed consolidated financial statements. While there was a transfer of $80.0 million for the upfront payment to Parion, the cash remained within the Company’s condensed consolidated balance sheet since Parion was part of the consolidated entity. The cash received, net of any cash spent by Parion, was classified as restricted cash and cash equivalents (VIE) within the condensed consolidated balance sheet as it was attributed to the noncontrolling interest holders of Parion.

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 was appropriate to continue to consolidate the financial results of Parion because it continued 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, during the three and nine months ended September 30, 2017, the Company has recognized (i) $20.0 million and $40.0 million, respectively, of collaborative revenues and (ii) a tax provision of $7.4 million and $14.8 million, respectively, both of which were attributable to noncontrolling interest related to payments that Parion received from Shire in the three and nine months ended September 30, 2017. The Company has no interest in Parion’s license agreement with Shire, including the economic benefits and/or obligations derived therefrom.
As of September 30, 2017, the Company determined that the fair value of Parion’s pulmonary ENaC platform had declined significantly based on data received in September 2017 from a Phase 2 clinical trial of VX-371 that did not meet its primary efficacy endpoint. The Company recorded an impairment charge of $255.3 million, which represented the entire value of the intangible asset in the third quarter of 2017. After evaluating the results of the clinical trial, the Company determined that it was no longer the primary beneficiary of Parion as it no longer had the power to direct the significant activities of Parion. The most important factor in this determination was the decrease in the fair value of Parion’s pulmonary ENaC platform relative to Parion’s other activities. Accordingly, the Company deconsolidated Parion as of September 30, 2017. The impairment charge of $255.3 million, decrease in the fair value of the contingent payments payable by the Company to Parion of $69.6 million and benefit from income taxes of $126.2 million resulting from these charges were recorded in the third quarter of 2017 attributable to noncontrolling interest. The benefit from income taxes consisted of benefits of $97.7 million and $28.5 million attributable to the impairment charge and decrease in the fair value of contingent payments, respectively. The net effect of these charges and impact of the deconsolidation was a loss of $7.1 million recorded in other income (expense), net attributable to Vertex in the consolidated statement of operations for the three and nine months ended September 30, 2017. The loss of $7.1 million was approximately the difference between (i) the aggregate of $85.0 million in upfront and milestone payments that the Company has made to Parion to date pursuant to the Parion Agreement and (ii) losses the Company recorded in 2015, 2016, and the first half of 2017 based on increases in the fair value of contingent payments payable by the Company to Parion.
Please refer to Note J, "Intangible Assets and Goodwill," for further information regarding the impairment of Parion’s pulmonary ENaC platform.
In connection with the deconsolidation of Parion, the Company evaluated whether the results of Parion should be presented as discontinued operations for the three and nine month period ending September 30, 2017. The Company concluded that the deconsolidation of Parion based on data from the Phase 2 clinical trial of VX-371 is not a development that significantly impacts the Company’s overall operations and financial results or plans to treat patients with CF. Research


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

and development expenses incurred related to this program accounted for a minor portion of the Company’s overall annual research and development expenses and the Company remains focused on developing medicines to treat CF. Therefore, the Company has not presented the results related to Parion as discontinued operations in its condensed consolidated statements of operations for the three and nine month ending September 30, 2017.
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.
Aggregate VIE Financial Information
An aggregate summary of net income attributable to noncontrolling interest related to the Company’s VIEs for the three and nine months ended September 30, 2017 and 2016 is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Loss attributable to noncontrolling interest before (benefit from) provision for income taxes and changes in fair value of contingent payments
$
238,946

 
$
2,406

 
$
222,448

 
$
6,080

(Benefit from) provision for income taxes
(120,181
)
 
(510
)
 
(111,658
)
 
20,063

Decrease (increase) in fair value of contingent payments
69,550

 
(1,200
)
 
62,560

 
(59,350
)
Net loss (income) attributable to noncontrolling interest
$
188,315

 
$
696

 
$
173,350

 
$
(33,207
)

The decreases in the noncontrolling interest holders’ claim to net assets with respect to the fair value of the contingent payments in the three and nine months ended September 30, 2017 were primarily due to the decrease in the fair value of Parion’s pulmonary ENaC platform described above. The increases in the fair value of the contingent payments in the three and nine months ended September 30, 2016 were primarily due to a separate Phase 2 clinical trial of VX-371 achieving its primary safety endpoint in the second quarter of 2016. During the three and nine months ended September 30, 2017 and 2016, the (increases) decreases in the fair value of the contingent payments related to the Company’s VIEs were as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Parion
$
69,550

 
$
(1,100
)
 
$
63,460

 
$
(58,500
)
BioAxone
—

 
(100
)
 
(900
)
 
(850
)

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:



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

 
September 30, 2017
 
December 31, 2016
 
(in thousands)
Parion
$
—

 
$
238,800

BioAxone
18,900

 
18,000


The table below 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. Amounts as of September 30, 2017 related to BioAxone while amounts as of December 31, 2016 related to Parion and BioAxone.
 
September 30, 2017
 
December 31, 2016
 
(in thousands)
Restricted cash and cash equivalents (VIE)
$
1,803

 
$
47,762

Prepaid expenses and other current assets
42

 
6,812

Intangible assets
29,000

 
284,340

Other assets
280

 
399

Accounts payable
455

 
415

Accrued expenses
1,021

 
1,330

Other liabilities, current portion
119

 
2,137

Deferred tax liability
8,338

 
131,446

Other liabilities, excluding current portion
—

 
300

Noncontrolling interest
12,167

 
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 sheets 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 advance 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


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

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.
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 nine months ended September 30, 2017 the Company recorded reimbursement for these development activities of zero and $1.8 million, respectively. During the three and nine months ended September 30, 2016 the Company recorded reimbursement for these development activities of $2.8 million and $10.6 million, respectively. 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.
Asset Acquisition
Concert Pharmaceuticals
In July 2017, the Company completed the acquisition of certain CF assets including VX-561 (formerly CTP-656) from Concert Pharmaceuticals Inc. (“Concert”) pursuant to an asset purchase agreement that was entered into in March 2017 (the “Concert Agreement”). VX-561 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 $160.0 million in cash for all worldwide development and commercialization rights to VX-561. If VX-561 is approved as part of a combination regimen to treat CF, Concert could receive up to an additional $90.0 million in milestones based on regulatory approval in the U.S. and reimbursement in the UK, Germany or France. The Company determined that substantially all of the fair value of the Concert Agreement was attributable to a single in-process research and development asset, VX-561, which did not constitute a business. The Company cannot conclude that there is any alternative future use for the acquired in-process research and development asset. Thus, the Company recorded the $160.0 million upfront payment as a research and development expense in the three and nine months ended September 30, 2017. The total purchase price for the transaction was $165.1 million including $5.1 million of transaction costs that were recorded as sales, general and administrative expenses. If the Company achieves one or more of the $90.0 million of regulatory approval and reimbursement milestones, the Company will record the value of the milestone as an intangible asset and will begin amortizing the asset in cost of product revenues in the period that the relevant milestone is achieved.
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.


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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 September 30,
 
Nine Months Ended September 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
$
(102,952
)
 
$
(38,841
)
 
$
162,800

 
$
(144,997
)
Less: Undistributed earnings allocated to participating securities
—

 
—

 
(203
)
 
—

Net income (loss) attributable to Vertex common shareholders—basic
$
(102,952
)
 
$
(38,841
)
 
$
162,597

 
$
(144,997
)
 
 
 
 
 
 
 
 
Basic weighted-average common shares outstanding
250,268

 
244,920

 
247,963

 
244,529

Basic net income (loss) attributable to Vertex per common share
$
(0.41
)
 
$
(0.16
)
 
$
0.66

 
$
(0.59
)
 
 
 
 
 
 
 
 
Diluted net income (loss) attributable to Vertex per common share calculation:
 
 
 
 
 
 
 
Net income (loss) attributable to Vertex common shareholders
$
(102,952
)
 
$
(38,841
)
 
$
162,800

 
$
(144,997
)
Less: Undistributed earnings allocated to participating securities
—

 
—

 
(200
)
 
—

Net income (loss) attributable to Vertex common shareholders—diluted
$
(102,952
)
 
$
(38,841
)
 
$
162,600

 
$
(144,997
)
 
 
 
 
 
 
 
 
Weighted-average shares used to compute basic net income (loss) per common share
250,268

 
244,920

 
247,963

 
244,529

Effect of potentially dilutive securities:
 
 
 
 
 
 
 
Stock options
—

 
—

 
2,700

 
—

Restricted stock and restricted stock units
—

 
—

 
1,204

 
—

Other
—

 
—

 
228

 
—

Weighted-average shares used to compute diluted net income (loss) per common share
250,268

 
244,920

 
252,095

 
244,529

Diluted net income (loss) attributable to Vertex per common share
$
(0.41
)
 
$
(0.16
)
 
$
0.64

 
$
(0.59
)
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 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Stock options
10,278

 
12,947

 
3,904

 
12,947

Unvested restricted stock and restricted stock units
4,241

 
3,624

 
281

 
3,624

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


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

participants would price assets and liabilities). The following fair value hierarchy is used to classify assets and liabilities based on the observable inputs and unobservable inputs used in order to value the assets and liabilities:
Level 1:
Quoted prices in active markets for identical assets or liabilities. An active market for an asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2:
Observable inputs other than Level 1 inputs. Examples of Level 2 inputs include quoted prices in active markets for similar assets or liabilities and quoted prices for identical assets or liabilities in markets that are not active.
Level 3:
Unobservable inputs based on the Company’s assessment of the assumptions that market participants would use in pricing the asset or liability.
The Company’s investment strategy is focused on capital preservation. The Company invests in instruments that meet the credit quality standards outlined in the Company’s investment policy. This policy also limits the amount of credit exposure to any one issue or type of instrument. As of September 30, 2017, the Company’s investments were primarily in money market funds, government-sponsored enterprise securities, corporate equity securities, corporate debt securities and commercial paper. Additionally, the Company utilizes foreign currency forward contracts intended to mitigate the effect of changes in foreign exchange rates on its condensed consolidated statement of operations.
As of September 30, 2017, all of the Company’s financial assets and liabilities 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, government-sponsored enterprise securities and corporate equity securities. The Company’s financial assets and liabilities valued based on Level 2 inputs consisted of corporate debt securities and commercial paper, which consisted of investments in highly-rated investment-grade corporations and foreign currency forward contracts with highly reputable and creditworthy counterparties.
.


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 September 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
$
466,702

 
$
466,702

 
$
—

 
$
—

Government-sponsored enterprise securities
14,979

 
14,979

 
—

 
—

Corporate debt securities
4,488

 
—

 
4,488

 
—

Commercial paper
14,608

 
—

 
14,608

 
—

Marketable securities:
 
 
 
 
 
 
 
Corporate equity securities
56,944

 
56,944

 
—

 
—

Corporate debt securities
295,171

 
—

 
295,171

 
—

Commercial paper
75,167

 
—

 
75,167

 
—

Prepaid and other current assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
42

 
—

 
42

 
—

Other assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
8

 
—

 
8

 
—

Total financial assets
$
928,109


$
538,625

 
$
389,484

 
$
—

Financial instruments carried at fair value (liability position):
 
 
 
 
 
 
 
Other liabilities, current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
$
(13,897
)
 
$
—

 
$
(13,897
)
 
$
—

Other liabilities, excluding current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
(977
)
 
—

 
(977
)
 
—

Total financial liabilities
$
(14,874
)
 
$
—

 
$
(14,874
)
 
$
—

 
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
)
 
$
—



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

The Company’s VIE invested in cash equivalents consisting of money market funds of $1.5 million as of September 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 the Company’s VIE includes the fair value of the contingent payments, which consist of milestone, royalty and option payments, which are valued based on Level 3 inputs. Please refer to Note C, “Collaborative Arrangements and Acquisitions,” 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 September 30, 2017
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash and money market funds
$
1,350,891

 
$
—

 
$
—

 
$
1,350,891

Government-sponsored enterprise securities
14,979

 
—

 
—

 
14,979

Commercial paper
14,610

 
—

 
(2
)
 
14,608

Corporate debt securities
4,488

 
—

 
—

 
4,488

Total cash and cash equivalents
$
1,384,968

 
$
—

 
$
(2
)
 
$
1,384,966

Marketable securities:
 
 
 
 
 
 
 
Corporate equity securities
43,213

 
13,731

 
—

 
56,944

Commercial paper (matures within 1 year)
75,186

 
1

 
(20
)
 
75,167

Corporate debt securities (matures within 1 year)
235,679

 
8

 
(106
)
 
235,581

Corporate debt securities (matures after 1 year)
59,651

 
—

 
(61
)
 
59,590

Total marketable securities
$
413,729

 
$
13,740

 
$
(187
)
 
$
427,282

Total cash, cash equivalents and marketable securities
$
1,798,697

 
$
13,740

 
$
(189
)
 
$
1,812,248

 
 
 
 
 
 
 
 
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 September 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 nine months ended September 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
(11,137
)
 
(7,786
)
 
(25,981
)
 
(44,904
)
Amounts reclassified from accumulated other comprehensive income (loss)
—

 
—

 
(1,398
)
 
(1,398
)
Net current period other comprehensive (loss) income
$
(11,137
)
 
$
(7,786
)
 
$
(27,379
)
 
$
(46,302
)
Balance at September 30, 2017
$
(18,999
)
 
$
9,735

 
$
(15,865
)
 
$
(25,129
)
 
Foreign Currency Translation Adjustment
 
Unrealized Holding Gains on Marketable Securities
 
Unrealized Gains (Losses) on Foreign Currency Forward Contracts, Net of Tax
 
Total
 
(in thousands)
Balance at December 31, 2015
$
(2,080
)
 
$
126

 
$
3,778

 
$
1,824

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

 
6,715

 
(890
)
Amounts reclassified from accumulated other comprehensive income (loss)
—

 
—

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

 
$
1,936

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

 
$
5,714

 
$
(3,845
)
H.
Hedging
The Company maintains a hedging program intended to mitigate the effect of changes in foreign exchange rates for a portion of the Company’s forecasted product revenues denominated in certain foreign currencies. The program includes foreign currency forward contracts that are designated as cash flow hedges under GAAP having contractual durations from one to eighteen months.
The Company formally documents the relationship between foreign currency forward contracts (hedging instruments) and forecasted product revenues (hedged items), as well as the Company’s risk management objective and strategy for undertaking various hedging activities, which includes matching all foreign currency forward contracts that are designated as cash flow hedges to forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the foreign currency forward contracts are highly effective in offsetting changes in cash flows of hedged items on a prospective and retrospective basis. If the Company determines that a (i) foreign currency forward contract is not highly effective as a cash flow hedge, (ii) foreign currency forward contract has ceased to be a highly effective hedge or (iii) forecasted transaction is no longer probable of occurring, the Company would discontinue hedge accounting treatment prospectively. The Company measures effectiveness based on the change in fair value of the forward contracts and the fair value of the hypothetical foreign currency forward contracts with terms that match the critical terms of the risk being hedged. As of September 30, 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 under GAAP:


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

 
As of September 30, 2017
 
As of December 31, 2016
Foreign Currency
(in thousands)
Euro
$
234,477

 
$
164,368

British pound sterling
77,387

 
65,237

Australian dollar
31,283

 
23,776

Total foreign currency forward contracts
$
343,147

 
$
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 September 30, 2017
Assets
 
Liabilities
Classification
 
Fair Value
 
Classification
 
Fair Value
(in thousands)
Prepaid and other current assets
 
$
42

 
Other liabilities, current portion
 
$
(13,897
)
Other assets
 
8

 
Other liabilities, excluding current portion
 
(977
)
Total assets
 
$
50

 
Total liabilities
 
$
(14,874
)
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
)
As of September 30, 2017, the Company expects amounts recorded in prepaid and other currents assets and other liabilities, current portion to be reclassed to earnings within twelve months.
The following table summarizes the potential effect of offsetting derivatives by type of financial instrument designated as cash flow hedges under GAAP on the Company’s condensed consolidated balance sheets:
 
As of September 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
$
50

 
$
—

 
$
50

 
$
(50
)
 
$
—

Total liabilities
$
(14,874
)
 
$
—

 
$
(14,874
)
 
$
50

 
$
(14,824
)
 
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)

The Company also enters into foreign exchange forward contracts with contractual maturities of less than one month designed to mitigate the effect of changes in foreign exchange rates on monetary assets and liabilities including intercompany balances. The Company recognized losses of $4.1 million and $13.0 million, recorded in other income (expense), net, for the three and nine months ended September 30, 2017, respectively, related to foreign exchange contracts, which are not designated as hedging instruments under GAAP. The Company recognized a loss of  $1.2 million and a gain of $0.5 million, for the three and nine months ended September 30, 2016, respectively, related to foreign exchange contracts not designated as hedging instruments.

As of September 30, 2017, the notional amount of foreign exchange contracts where hedge accounting under GAAP is not applied was $113.8 million. The following table summarizes the fair value of the Company’s outstanding foreign currency forward contracts not designated for hedge accounting included on the Company’s condensed consolidated balance sheets:
 
As of September 30, 2017
 
As of December 31, 2016
 
(in thousands)
Prepaid expenses and other current assets
$
1,709

 
$
660


I. Inventories
Inventories consisted of the following:
 
As of September 30, 2017
 
As of December 31, 2016
 
(in thousands)
Raw materials
$
12,678

 
$
6,348

Work-in-process
67,826

 
56,672

Finished goods
17,688

 
14,584

Total
$
98,192

 
$
77,604

Based on its evaluation of, among other factors, information regarding tezacaftor's safety and efficacy, the Company has capitalized $9.6 million of inventory costs for tezacaftor manufactured in preparation for its potential product launch as of September 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 September 30, 2017 and December 31, 2016, in-process research and development intangible assets of $29.0 million and $284.3 million, respectively, 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.
In connection with its preparation of its financial statements for the three and nine months ended September 30, 2017, the Company determined that there were indicators that the value of the pulmonary ENaC platform intangible asset had become impaired. The Company determined that the fair value of the intangible asset had decreased significantly based on data received in September 2017 from a Phase 2 clinical trial of VX-371 that did not meet its primary efficacy endpoint. Based on this data, the Company evaluated the fair value of Parion’s pulmonary ENaC platform using the discounted cash


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

flow approach from the perspective of a market participant and determined that the fair value of the intangible asset was zero as of September 30, 2017. The discounted cash flow model pertaining to the impairment of the pulmonary ENaC platform includes (i) assumptions regarding the probability of obtaining marketing approval for the drug candidate, (ii) estimates regarding the timing of and the expected costs to develop and commercialize the drug candidate, (iii) estimates of future cash flows from potential product sales with respect to the drug candidate and (iv) appropriate discount and tax rates. The Company recorded a $255.3 million impairment charge and a benefit from income taxes of $97.7 million in the three and nine months ended September 30, 2017 attributable to noncontrolling interest.
Goodwill
As of September 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.
Property and equipment, net, included $479.0 million and $489.0 million as of September 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 $472.2 million and $472.6 million as of September 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


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

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 $73.9 million and $15.0 million as of September 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 $71.8 million and $12.6 million as of September 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 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


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

During the three and nine months ended September 30, 2017 and 2016, the Company recognized the following stock-based compensation expense:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
 
(in thousands)
Stock-based compensation expense by type of award:
 
 
 
 
 
 
 
Stock options
$
25,969

 
$
28,773

 
$
80,865

 
$
86,859

Restricted stock and restricted stock units
46,737

 
30,966

 
131,388

 
88,107

ESPP share issuances
2,428

 
2,425

 
6,738

 
6,385

Less stock-based compensation expense capitalized to inventories
(1,364
)
 
(955
)
 
(3,657
)
 
(2,728
)
Total stock-based compensation included in costs and expenses
$
73,770

 
$
61,209

 
$
215,334

 
$
178,623

 
 
 
 
 
 
 


Stock-based compensation expense by line item:
 
 
 
 
 
 
 
Research and development expenses
$
46,186

 
$
39,980

 
$
134,855

 
$
115,068

Sales, general and administrative expenses
27,584

 
21,229

 
80,479

 
63,555

Total stock-based compensation included in costs and expenses
$
73,770

 
$
61,209

 
$
215,334

 
$
178,623

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:
 
As of September 30, 2017
 
Unrecognized Expense
 
Weighted-average
Recognition Period
 
(in thousands)
 
(in years)
Type of award:
 
 
 
Stock options
$
175,298

 
2.60
Restricted stock and restricted stock units
$
289,008

 
2.64
ESPP share issuances
$
2,636

 
0.46


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

The following table summarizes information about stock options outstanding and exercisable at September 30, 2017:
 
 
Options Outstanding
 
Options Exercisable
Range of Exercise Prices
 
Number
Outstanding
 
Weighted-average
Remaining
Contractual Life
 
Weighted-average
Exercise Price
 
Number
Exercisable