Document
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
________________________________________________________
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2016
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM              TO             
Commission file number 000-19319
____________________________________________
Vertex Pharmaceuticals Incorporated
(Exact name of registrant as specified in its charter)
Massachusetts
04-3039129
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
50 Northern Avenue, Boston, Massachusetts
02210
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code (617) 341-6100
____________________________________________

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o 
Smaller reporting company o
 
                                       (Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Common Stock, par value $0.01 per share
247,778,698
Class
Outstanding at July 22, 2016

 

Table of Contents

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

TABLE OF CONTENTS
 
 
Page
 
 
 
Condensed Consolidated Statements of Operations - Three and Six Months Ended June 30, 2016 and 2015
 
Condensed Consolidated Statements of Comprehensive Loss - Three and Six Months Ended June 30, 2016 and 2015
 
Condensed Consolidated Balance Sheets - June 30, 2016 and December 31, 2015
 
Condensed Consolidated Statements of Shareholders' Equity and Noncontrolling Interest - Six Months Ended June 30, 2016 and 2015
 
Condensed Consolidated Statements of Cash Flows - Six Months Ended June 30, 2016 and 2015
 
 
 
“We,” “us,” “Vertex” and the “Company” as used in this Quarterly Report on Form 10-Q refer to Vertex Pharmaceuticals Incorporated, a Massachusetts corporation, and its subsidiaries.
“Vertex,” “KALYDECO®” and “ORKAMBI®” are registered trademarks of Vertex. Other brands, names and trademarks contained in this Quarterly Report on Form 10-Q are the property of their respective owners.


Table of Contents

Part I. Financial Information
Item 1.    Financial Statements
VERTEX PHARMACEUTICALS INCORPORATED
Condensed Consolidated Statements of Operations
(unaudited)
(in thousands, except per share amounts)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Revenues:
 
 
 
 
 
 
 
Product revenues, net
$
425,651

 
$
160,388

 
$
820,061

 
$
291,263

Royalty revenues
5,282

 
5,077

 
8,878

 
11,869

Collaborative revenues
675

 
611

 
749

 
1,453

Total revenues
431,608

 
166,076

 
829,688

 
304,585

Costs and expenses:
 
 
 
 
 
 
 
Cost of product revenues
44,154

 
15,409

 
93,943

 
24,790

Royalty expenses
1,098

 
1,451

 
1,958

 
4,377

Research and development expenses
271,008

 
223,858

 
526,868

 
439,457

Sales, general and administrative expenses
111,652

 
94,394

 
216,866

 
180,254

Restructuring expenses (income), net
343

 
2,128

 
1,030

 
(1,144
)
Total costs and expenses
428,255

 
337,240

 
840,665

 
647,734

Income (loss) from operations
3,353

 
(171,164
)
 
(10,977
)
 
(343,149
)
Interest expense, net
(20,155
)
 
(21,111
)
 
(40,853
)
 
(42,418
)
Other (expenses) income, net
(1,219
)
 
1,414

 
3,192

 
(3,699
)
Loss before provision for income taxes
(18,021
)
 
(190,861
)
 
(48,638
)
 
(389,266
)
Provision for income taxes
18,130

 
30,131

 
23,615

 
30,430

Net loss
(36,151
)
 
(220,992
)
 
(72,253
)
 
(419,696
)
(Income) loss attributable to noncontrolling interest
(28,374
)
 
32,144

 
(33,903
)
 
32,242

Net loss attributable to Vertex
$
(64,525
)
 
$
(188,848
)
 
$
(106,156
)
 
$
(387,454
)
 
 
 
 
 
 
 
 
Amounts per share attributable to Vertex common shareholders:
 
 
 
 
 
 
 
Net loss:
 
 
 
 
 
 
 
Basic
$
(0.26
)
 
$
(0.78
)
 
$
(0.43
)
 
$
(1.61
)
Diluted
$
(0.26
)
 
$
(0.78
)
 
$
(0.43
)
 
$
(1.61
)
Shares used in per share calculations:
 
 
 
 
 
 
 
Basic
244,482

 
240,757

 
244,124

 
240,129

Diluted
244,482

 
240,757

 
244,124

 
240,129

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


2
Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
Condensed Consolidated Statements of Comprehensive Loss
(unaudited)
(in thousands)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
Net loss
$
(36,151
)
 
$
(220,992
)
 
$
(72,253
)
 
$
(419,696
)
Changes in other comprehensive loss:
 
 
 
 
 
 
 
Unrealized holding gains (losses) on marketable securities
(29
)
 
(46
)
 
200

 
130

Unrealized gains (losses) on foreign currency forward contracts, net of tax
4,999

 
(4,280
)
 
(213
)
 
(3,974
)
Foreign currency translation adjustment
(3,461
)
 
1,828

 
(5,201
)
 
1,220

Total changes in other comprehensive loss
1,509

 
(2,498
)
 
(5,214
)
 
(2,624
)
Comprehensive loss
(34,642
)
 
(223,490
)
 
(77,467
)
 
(422,320
)
Comprehensive (income) loss attributable to noncontrolling interest
(28,374
)
 
32,144

 
(33,903
)
 
32,242

Comprehensive loss attributable to Vertex
$
(63,016
)
 
$
(191,346
)
 
$
(111,370
)
 
$
(390,078
)
The accompanying notes are an integral part of these condensed consolidated financial statements.


3
Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
Condensed Consolidated Balance Sheets
(unaudited)
(in thousands, except share and per share amounts)
 
June 30,
 
December 31,
 
2016
 
2015
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
605,866

 
$
714,768

Marketable securities, available for sale
465,570

 
327,694

Restricted cash and cash equivalents (VIE)
70,513

 
78,910

Accounts receivable, net
189,356

 
177,639

Inventories
66,589

 
57,207

Prepaid expenses and other current assets
56,256

 
50,935

Total current assets
1,454,150

 
1,407,153

Property and equipment, net
690,607

 
697,715

Intangible assets
284,340

 
284,340

Goodwill
50,384

 
50,384

Cost method investment in CRISPR
33,213

 
—

Notes receivable
—

 
30,000

Restricted cash
22,085

 
22,083

Other assets
14,203

 
6,912

Total assets
$
2,548,982

 
$
2,498,587

Liabilities and Shareholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
51,302

 
$
74,942

Accrued expenses
275,165

 
305,820

Deferred revenues, current portion
11,468

 
16,296

Accrued restructuring expenses, current portion
7,683

 
7,894

Capital lease obligations, current portion
17,446

 
15,545

Senior secured term loan, current portion
221,576

 
71,296

Other liabilities, current portion
38,215

 
14,374

Total current liabilities
622,855

 
506,167

Deferred revenues, excluding current portion
7,411

 
9,714

Accrued restructuring expenses, excluding current portion
4,801

 
7,464

Capital lease obligations, excluding current portion
34,317

 
42,923

Deferred tax liability
132,810

 
110,439

Construction financing lease obligation, excluding current portion
472,374

 
472,611

Senior secured term loan, net of current portion and discount
74,921

 
223,863

Other liabilities, excluding current portion
30,648

 
31,778

Total liabilities
1,380,137

 
1,404,959

Commitments and contingencies


 


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

 
—

Common stock, $0.01 par value; 500,000,000 and 500,000,000 shares authorized at June 30, 2016 and December 31, 2015, respectively; 247,703,932 and 246,306,818 shares issued and outstanding at June 30, 2016 and December 31, 2015, respectively
2,440

 
2,427

Additional paid-in capital
6,350,244

 
6,197,500

Accumulated other comprehensive (loss) income
(3,390
)
 
1,824

Accumulated deficit
(5,367,940
)
 
(5,261,784
)
Total Vertex shareholders' equity
981,354

 
939,967

Noncontrolling interest
187,491

 
153,661

Total shareholders’ equity
1,168,845

 
1,093,628

Total liabilities and shareholders’ equity
$
2,548,982

 
$
2,498,587

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


4
Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
Condensed Consolidated Statements of Shareholders’ Equity and Noncontrolling Interest
(unaudited)
(in thousands)
 
Common Stock
 
Additional
Paid-in Capital
 
Accumulated
Other
Comprehensive (Loss) Income
 
Accumulated Deficit
 
Total Vertex
Shareholders’ Equity
 
Noncontrolling
Interest
 
Total
Shareholders’ Equity
 
Shares
 
Amount
 
 
 
 
 
 
Balance at December 31, 2014
241,764

 
$
2,385

 
$
5,777,154

 
$
917

 
$
(4,705,450
)
 
$
1,075,006

 
$
21,177

 
$
1,096,183

Other comprehensive loss, net of tax
—

 
—

 
—

 
(2,624
)
 
—

 
(2,624
)
 
—

 
(2,624
)
Net loss
—

 
—

 
—

 
—

 
(387,454
)
 
(387,454
)
 
(32,242
)
 
(419,696
)
Issuance of common stock under benefit plans
2,578

 
21

 
87,333

 
—

 
—

 
87,354

 
—

 
87,354

Stock-based compensation expense
—

 
—

 
122,682

 
—

 
—

 
122,682

 
—

 
122,682

Noncontrolling interest upon consolidation
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
164,317

 
$
164,317

Balance at June 30, 2015
244,342

 
$
2,406

 
$
5,987,169

 
$
(1,707
)
 
$
(5,092,904
)
 
$
894,964

 
$
153,252

 
$
1,048,216

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
246,307

 
$
2,427

 
$
6,197,500

 
$
1,824

 
$
(5,261,784
)
 
$
939,967

 
$
153,661

 
$
1,093,628

Other comprehensive loss, net of tax
—

 
—

 
—

 
(5,214
)
 
—

 
(5,214
)
 
—

 
(5,214
)
Net (loss) income
—

 
—

 
—

 
—

 
(106,156
)
 
(106,156
)
 
33,903

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

 
13

 
33,557

 
—

 
—

 
33,570

 
—

 
33,570

Stock-based compensation expense
—

 
—

 
119,187

 
—

 
—

 
119,187

 
(73
)
 
119,114

Balance at June 30, 2016
247,704

 
$
2,440

 
$
6,350,244

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

 
$
187,491

 
$
1,168,845

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


5
Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED
Condensed Consolidated Statements of Cash Flows
(unaudited)
(in thousands)
 
Six Months Ended June 30,
 
2016
 
2015
Cash flows from operating activities:
 
 
 
Net loss
$
(72,253
)
 
$
(419,696
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Stock-based compensation expense
117,414

 
120,645

Depreciation and amortization expense
31,378

 
30,428

Deferred income taxes
22,858

 
6,346

Other non-cash items, net
3,436

 
6,045

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(12,954
)
 
(21,197
)
Inventories
(7,779
)
 
(9,426
)
Prepaid expenses and other assets
(7,971
)
 
(15,397
)
Accounts payable
(23,821
)
 
(3,033
)
Accrued expenses and other liabilities
(14,562
)
 
8,098

Accrued restructuring expense
(2,892
)
 
(26,012
)
Deferred revenues
(7,131
)
 
(9,303
)
Net cash provided by (used in) operating activities
25,723

 
(332,502
)
Cash flows from investing activities:
 
 
 
Purchases of marketable securities
(470,077
)
 
(125,655
)
Maturities of marketable securities
332,316

 
741,725

Payment for acquisition of variable interest entity
—

 
(80,000
)
Expenditures for property and equipment
(27,892
)
 
(23,978
)
Increase in restricted cash and cash equivalents
—

 
(21,975
)
Investment in CRISPR Series B preferred stock
(3,075
)
 
—

Decrease in restricted cash and cash equivalents (VIE)
8,397

 
2,277

(Increase) decrease in other assets
(159
)
 
87

Net cash (used in) provided by investing activities
(160,490
)
 
492,481

Cash flows from financing activities:
 
 
 
Issuances of common stock under benefit plans
33,702

 
87,850

Payments on capital lease obligations
(7,538
)
 
(14,441
)
Proceeds from capital lease financing
—

 
13,386

Payments on construction financing lease obligation
(209
)
 
(184
)
Net cash provided by financing activities
25,955

 
86,611

Effect of changes in exchange rates on cash
(90
)
 
(1,306
)
Net (decrease) increase in cash and cash equivalents
(108,902
)
 
245,284

Cash and cash equivalents—beginning of period
714,768

 
625,259

Cash and cash equivalents—end of period
$
605,866

 
$
870,543

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
41,325

 
$
42,885

Cash paid for income taxes
$
1,237

 
$
1,022

Issuances of common stock exercises from employee benefit plans receivable
$
161

 
$
166

The Company has reclassified certain amounts in the period ending June 30, 2015 between operating, investing, and financing to correct improper classifications. 

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

6
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)


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

Certain information and footnote disclosures normally included in the Company's annual financial statements have been condensed or omitted. These interim financial statements, in the opinion of management, reflect all normal recurring adjustments necessary for a fair presentation of the financial position and results of operations for the interim periods ended June 30, 2016 and 2015.
The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full fiscal year. These interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2015, which are contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2015 that was filed with the Securities and Exchange Commission (the “SEC”) on February 16, 2016 (the "2015 Annual Report on Form 10-K").
Use of Estimates and Summary of Significant Accounting Policies
The preparation of condensed consolidated financial statements in accordance with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the amounts of revenues and expenses during the reported periods. Significant estimates in these condensed consolidated financial statements have been made in connection with the calculation of revenues, inventories, research and development expenses, stock-based compensation expense, restructuring expense, the fair value of intangible assets, goodwill, contingent consideration, noncontrolling interest, the consolidation of VIEs, leases, the fair value of cash flow hedges and the provision for or benefit from income taxes. The Company bases its estimates on historical experience and various other assumptions, including in certain circumstances future projections that management believes to be reasonable under the circumstances. Actual results could differ from those estimates. Changes in estimates are reflected in reported results in the period in which they become known.
The Company's significant accounting policies are described in Note A, "Nature of Business and Accounting Policies," in the 2015 Annual Report on Form 10-K.
Recent Accounting Pronouncements
In 2016, the Financial Accounting Standards Board (“FASB”) issued amended guidance applicable to leases that will be effective for the year ending December 31, 2019. Early adoption is permitted. This update requires an entity to recognize assets and liabilities for leases with lease terms of more than 12 months on the balance sheet. The Company is in the process of evaluating the new guidance and determining the expected effect on its consolidated financial statements.

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

For a discussion of other recent accounting pronouncements please refer to Note A, “Nature of Business and Accounting Policies—Recent Accounting Pronouncements,” in the 2015 Annual Report on Form 10-K. The Company did not adopt any


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

new accounting pronouncements during the six months ended June 30, 2016 that had a material effect on its condensed consolidated financial statements.
B.
Product Revenues, Net
The Company sells its products principally to a limited number of specialty pharmacy providers and selected regional wholesalers in North America as well as government-owned and supported customers in international markets (collectively, its “Customers”). The Company's Customers in North America subsequently resell the products to patients and health care providers. The Company recognizes net revenues from product sales upon delivery to the Customer as long as (i) there is persuasive evidence that an arrangement exists between the Company and the Customer, (ii) collectibility is reasonably assured and (iii) the price is fixed or determinable.
In order to conclude that the price is fixed or determinable, the Company must be able to (i) calculate its gross product revenues from sales to Customers and (ii) reasonably estimate its net product revenues upon delivery to its Customers' locations. The Company calculates gross product revenues based on the price that the Company charges its Customers. The Company estimates its net product revenues by deducting from its gross product revenues (a) trade allowances, such as invoice discounts for prompt payment and Customer fees, (b) estimated government and private payor rebates, chargebacks and discounts, (c) estimated reserves for expected product returns and (d) estimated costs of co-pay assistance programs for patients, as well as other incentives for certain indirect customers.
The Company makes significant estimates and judgments that materially affect the Company's recognition of net product revenues. In certain instances, the Company may be unable to reasonably conclude that the price is fixed or determinable at the time of delivery, in which case it defers the recognition of revenues. Once the Company is able to determine that the price is fixed or determinable, it recognizes the revenues associated with the units in which revenue recognition was deferred.
The following table summarizes activity in each of the product revenue allowance and reserve categories for the six months ended June 30, 2016:
 
Trade
Allowances
 
Rebates,
Chargebacks
and Discounts
 
Product
Returns
 
Other
Incentives
 
Total
 
(in thousands)
Balance at December 31, 2015
$
2,089

 
$
44,669

 
$
1,228

 
$
1,310

 
$
49,296

Provision related to current period sales
9,935

 
65,066

 
1,288

 
4,220

 
80,509

Adjustments related to prior period sales
(77
)
 
(1,712
)
 
(205
)
 
5

 
(1,989
)
Credits/payments made
(9,762
)
 
(44,113
)
 
(260
)
 
(4,638
)
 
(58,773
)
Balance at June 30, 2016
$
2,185

 
$
63,910

 
$
2,051

 
$
897

 
$
69,043

In the three and six months ended June 30, 2016, the Company sold ORKAMBI in France pursuant to early access programs. The Company has not recognized any product revenues based on these sales because the price is not fixed or determinable due to the ongoing negotiations regarding the reimbursement rate for ORKAMBI in France. If the negotiated reimbursement rate in France is lower than the price currently being paid by Customers in France under these programs, the Company would reimburse the difference between such prices to the Customers. The cash received from sales in France is included as a liability on the Company's condensed consolidated balance sheet, and the increase in "other liabilities, current portion" from December 31, 2015 to June 30, 2016 is primarily due to this liability.
C.
Collaborative Arrangements
Cystic Fibrosis Foundation Therapeutics Incorporated
In April 2011, the Company entered into an amendment (the “April 2011 Amendment”) to its existing collaboration agreement with Cystic Fibrosis Foundation Therapeutics Incorporated (“CFFT”) pursuant to which CFFT agreed to provide financial support for (i) development activities for VX-661, a compound that targets the processing and trafficking defect of the F508del CFTR proteins discovered under the collaboration, and (ii) additional research and development activities directed at discovering new compounds targeting the processing and trafficking defect of the F508del protein.


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

Under the April 2011 Amendment, CFFT agreed to provide the Company with up to $75.0 million in funding over approximately five years for corrector compound research and development activities. The Company retains the right to develop and commercialize KALYDECO (ivacaftor), ORKAMBI (lumacaftor in combination with ivacaftor), lumacaftor and VX-661. The Company recognized no collaborative revenues from this collaboration during the three and six months ended June 30, 2016 and 2015.
In the original agreement, as amended prior to the April 2011 Amendment, the Company agreed to pay CFFT tiered royalties calculated as a percentage, ranging from single digits to sub-teens, of annual net sales of any approved drugs first synthesized or tested during the research term that ended in 2008, including ivacaftor, lumacaftor and VX-661. The April 2011 Amendment provides for a tiered royalty in the same range on net sales of corrector compounds first synthesized or tested during the research term that ended in February 2014. In each of 2012 and 2013, CFFT earned a commercial milestone payment of $9.3 million from the Company upon achievement of certain sales levels for KALYDECO. In each of the fourth quarter of 2015 and first quarter of 2016, CFFT earned a commercial milestone payment of $13.9 million from the Company upon achievement of certain sales levels of lumacaftor. There are no additional commercial milestone payments payable by the Company to CFFT related to sales levels for KALYDECO or ORKAMBI.
The Company began marketing KALYDECO in the United States and certain countries in the European Union in 2012 and began marketing ORKAMBI in the United States in 2015. The Company received approval for ORKAMBI in the European Union in 2015 and in Canada and Australia in 2016. The Company has royalty obligations to CFFT for ivacaftor, lumacaftor and VX-661 until the expiration of patents covering that compound. The Company has patents in the United States and European Union covering the composition-of-matter of ivacaftor that expire in 2027 and 2025, respectively, subject to potential patent extensions. The Company has patents in the United States and European Union covering the composition-of-matter of lumacaftor that expire in 2030 and 2026, respectively, subject to potential extension. The Company has patents in the United States and European Union covering the composition-of-matter of VX-661 that expire in 2027 and 2028, respectively, subject to potential extension.
CRISPR Therapeutics AG
On October 26, 2015, the Company entered into a strategic collaboration, option and license agreement (the "CRISPR Agreement") with CRISPR Therapeutics AG and its affiliates ("CRISPR") to collaborate on the discovery and development of potential new treatments aimed at the underlying genetic causes of human diseases using CRISPR-Cas9 gene editing technology. The Company has the exclusive right to license up to six CRISPR-Cas9-based targets. In connection with the CRISPR Agreement, the Company made an upfront payment to CRISPR of $75.0 million and a $30.0 million investment in CRISPR pursuant to a convertible loan agreement that converted into preferred stock in January 2016. The Company expensed $75.0 million to research and development, and the $30.0 million investment was recorded at cost and is classified as a long-term asset on the Company’s condensed consolidated balance sheet. In the second quarter of 2016, the Company made an additional preferred stock investment in CRISPR of approximately $3.1 million.
The Company will fund all of the discovery activities conducted pursuant to the CRISPR Agreement. For potential hemoglobinapathy treatments, including treatments for sickle cell disease, the Company and CRISPR will share equally all research and development costs and worldwide revenues. For other targets that the Company elects to license, the Company would lead all development and global commercialization activities. For each of up to six targets that the Company elects to license, other than hemoglobinapathy targets, CRISPR has the potential to receive up to $420.0 million in development, regulatory and commercial milestones and royalties on net product sales.
The Company may terminate the CRISPR Agreement upon 90 days’ notice to CRISPR prior to any product receiving marketing approval or upon 270 days’ notice after a product has received marketing approval. The CRISPR Agreement also may be terminated by either party for a material breach by the other, subject to notice and cure provisions. Unless earlier terminated, the CRISPR Agreement will continue in effect until the expiration of the Company's payment obligations under the CRISPR Agreement.
Variable Interest Entities
The Company has entered into several agreements pursuant to which it has licensed rights to certain drug candidates from third-party collaborators, which has resulted in the consolidation of the third parties' financial statements into the


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

Company's condensed consolidated financial statements as VIEs. In order to account for the fair value of the contingent milestone and royalty payments related to these collaborations under GAAP, the Company uses present-value models based on assumptions regarding the probability of achieving the relevant milestones, estimates regarding the timing of achieving the milestones, estimates of future product sales and the appropriate discount rates. The Company bases its estimate of the probability of achieving the relevant milestones on industry data for similar assets and its own experience. The discount rates used in the valuation model represent a measure of credit risk and market risk associated with settling the liabilities. Significant judgment is used in determining the appropriateness of these assumptions at each reporting period. Changes in these assumptions could have a material effect on the fair value of the contingent milestone and royalty payments. The following collaborations are reflected in the Company's financial statements as consolidated VIEs:
Parion Sciences, Inc.
License and Collaboration Agreement

On June 4, 2015, the Company entered into a strategic collaboration and license agreement (the "Parion Agreement") with Parion Sciences, Inc. (“Parion”).  Pursuant to the agreement, the Company is collaborating with Parion to develop investigational epithelial sodium channel (“ENaC”) inhibitors, including VX-371 (formerly P-1037) and VX-551 (formerly P-1055), for the potential treatment of cystic fibrosis, or CF, and other pulmonary diseases.  The Company is leading development activities for VX-371 and VX-551 and is responsible for all costs, subject to certain exceptions, related to development and commercialization of the compounds.

Pursuant to the Parion Agreement, the Company has worldwide development and commercial rights to Parion’s lead investigational ENaC inhibitors, VX-371 and VX-551, for the potential treatment of CF and all other pulmonary diseases and has the option to select additional compounds discovered in Parion’s research program.  Parion received an $80.0 million up-front payment and has the potential to receive up to an additional (i) $490.0 million in development and regulatory milestone payments for development of ENaC inhibitors in CF, including $360.0 million related to global filing and approval milestones, (ii) $370.0 million in development and regulatory milestones for VX-371 and VX-551 in non-CF pulmonary indications and (iii) $230.0 million in development and regulatory milestones should the Company elect to develop an additional ENaC inhibitor from Parion’s research program. The Company has agreed to pay Parion tiered royalties that range from the low double digits to mid-teens as a percentage of potential sales of licensed products.

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

The Company determined that Parion is a VIE based on, among other factors, the significance to Parion of the ENaC inhibitors licensed to the Company pursuant to the Parion Agreement and on the Company's power to direct the activities that most significantly affect the economic performance of Parion.  Accordingly, the Company consolidated Parion's financial statements beginning on June 4, 2015. However, the Company's interests in Parion are limited to those accorded to the Company in the Parion Agreement.

The Company recorded $255.3 million of intangible assets on the Company's condensed consolidated balance sheet for Parion's in-process research and development assets. These in-process research and development assets relate to Parion's pulmonary ENaC platform, including the intellectual property related to VX-371 and VX-551, that are licensed by Parion to the Company. The difference between the fair value of the consideration and the fair value of Parion's assets (including the fair value of intangible assets) and liabilities was allocated to goodwill. The measurement period for purchase accounting was closed during the quarter. There were no purchase accounting adjustments recorded during the measurement period.


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

BioAxone Biosciences, Inc.
In October 2014, the Company entered into a license and collaboration agreement (the “BioAxone Agreement”) with BioAxone Biosciences, Inc. (“BioAxone”), a privately-held biotechnology company, which resulted in the consolidation of BioAxone as a VIE beginning on October 1, 2014. The Company paid BioAxone initial payments of $10.0 million in the fourth quarter of 2014.
BioAxone has the potential to receive up to $90.0 million in milestones and fees, including development, regulatory and milestone payments and a license continuation fee. In addition, BioAxone would receive royalties and commercial milestones on future net product sales of VX-210, if any. The Company recorded an in-process research and development intangible asset of $29.0 million for VX-210 and a corresponding deferred tax liability of $11.3 million attributable to BioAxone. The Company holds an option to purchase BioAxone at a predetermined price. The option expires on the earliest of (a) the day the FDA accepts the Biologics License Application submission for VX-210, (b) the day the Company elects to continue the license instead of exercising the option to purchase BioAxone and (c) March 15, 2018, subject to the Company’s option to extend this date by one year.
Aggregate VIE Financial Information

An aggregate summary of net loss attributable to noncontrolling interest related to the Company's VIEs for the three and six months ended June 30, 2016 and 2015 is as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Loss attributable to noncontrolling interest before provision for income taxes
$
2,835

 
$
1,293

 
$
3,674

 
$
1,579

Provision for income taxes
17,511

 
29,653

 
20,573

 
29,590

(Increase) decrease in fair value of contingent milestone and royalty payments
(48,720
)
 
1,198

 
(58,150
)
 
1,073

Net (income) loss attributable to noncontrolling interest
$
(28,374
)
 
$
32,144

 
$
(33,903
)
 
$
32,242


The increases in the fair value of the contingent milestone and royalty payments in the three and six months ended June 30, 2016 were primarily due to a Phase 2 clinical trial of VX-371, a compound being developed pursuant to the Parion Agreement, achieving its primary safety endpoint in the second quarter of 2016. The fair value of the contingent milestone and royalty payments also reflects changes in market interest rates and the time value of money. During the three and six months ended June 30, 2016 and 2015, the increase (decrease) in the fair value of the contingent milestone and royalty payments related to the Company's VIEs was as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Parion
$
48,400

 
$
(1,621
)
 
$
57,400

 
$
(1,621
)
BioAxone
320

 
423

 
750

 
548


As of June 30, 2016, the fair value of the contingent milestone and royalty payments related to the Parion Agreement and the BioAxone Agreement was $231.4 million and $28.7 million, respectively. As of December 31, 2015, the fair value of the contingent milestone and royalty payments related to the Parion collaboration and the BioAxone collaboration was $179.0 million and $28.0 million, respectively.

The following table summarizes items related to the Company's VIEs included in the Company's condensed consolidated balance sheets as of the dates set forth in the table:


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

 
June 30, 2016
 
December 31, 2015
 
(in thousands)
Restricted cash and cash equivalents (VIE)
$
70,513

 
$
78,910

Prepaid expenses and other current assets
3,001

 
3,138

Intangible assets
284,340

 
284,340

Goodwill
19,391

 
19,391

Other assets
383

 
455

Accounts payable
1,129

 
676

Taxes payable
11,723

 
24,554

Other current liabilities
7,059

 
7,100

Deferred tax liability, net
132,810

 
110,438

Other liabilities
310

 
300

Noncontrolling interest
187,491

 
153,661


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

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

Pursuant to the Janssen Influenza Agreement, Janssen Inc. has an exclusive worldwide license to develop and commercialize certain drug candidates for the treatment of influenza, including VX-787. The Company received non-refundable payments of $35.0 million from Janssen Inc. in 2014, which were recorded as collaborative revenue. The Company has the potential to receive development, regulatory and commercial milestone payments as well as royalties on future product sales, if any. Janssen Inc. may terminate the Janssen Influenza Agreement, subject to certain exceptions, upon six months' notice.
Janssen Inc. is responsible for costs related to the development and commercialization of the compounds. During the three and six months ended June 30, 2016, the Company recorded reimbursement for these development activities of $4.3 million and $7.8 million, respectively. During the three and six months ended June 30, 2015, the Company recorded reimbursement for these development activities of $7.1 million and $14.7 million, respectively. The reimbursements are recorded as a reduction to development expense in the Company's condensed consolidated statements of operations primarily due to the fact that Janssen Inc. directs the activities and selects the suppliers associated with these activities.


12
Table of Contents
VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

Subsequent Event
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 made a $20.0 million investment in Moderna pursuant to a convertible promissory note. 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 collaboration, Moderna will lead discovery efforts and the Company will lead all preclinical, development and commercialization activities associated with the advancement of mRNA Therapeutics that result from this collaboration and will fund all expenses related to the collaboration.
The Company may terminate the Moderna Agreement by providing advanced notice to Moderna, with the required length of notice dependent on whether any product developed under the Moderna Agreement has received marketing approval. The Moderna Agreement also may be terminated by either party for a material breach by the other, subject to notice and cure provisions. Unless earlier terminated, the Moderna Agreement will continue in effect until the expiration of the Company's payment obligations under the Moderna Agreement.
D.
Earnings Per Share
Basic net loss per share attributable to Vertex common shareholders is based upon the weighted-average number of common shares outstanding during the period, excluding restricted stock and restricted stock units that have been issued but are not yet vested. Diluted net loss per share attributable to Vertex common shareholders is based upon the weighted-average number of common shares outstanding during the period plus additional weighted-average common equivalent shares outstanding during the period when the effect is dilutive.
The Company did not include the securities in the following table in the computation of the net loss per share attributable to Vertex common shareholders calculations because the effect would have been anti-dilutive during each period:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Stock options
12,231

 
11,933

 
12,231

 
11,933

Unvested restricted stock and restricted stock units
3,506

 
3,355

 
3,506

 
3,355

E.
Fair Value Measurements
The fair value of the Company’s financial assets and liabilities reflects the Company’s estimate of amounts that it would have received in connection with the sale of the assets or paid in connection with the transfer of the liabilities in an orderly transaction between market participants at the measurement date. In connection with measuring the fair value of its assets and liabilities, the Company seeks to maximize the use of observable inputs (market data obtained from sources independent from the Company) and to minimize the use of unobservable inputs (the Company’s assumptions about how market participants would price assets and liabilities). The following fair value hierarchy is used to classify assets and liabilities based on the observable inputs and unobservable inputs used in order to value the assets and liabilities:


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

Level 1:
Quoted prices in active markets for identical assets or liabilities. An active market for an asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2:
Observable inputs other than Level 1 inputs. Examples of Level 2 inputs include quoted prices in active markets for similar assets or liabilities and quoted prices for identical assets or liabilities in markets that are not active.
Level 3:
Unobservable inputs based on the Company’s assessment of the assumptions that market participants would use in pricing the asset or liability.
The Company’s investment strategy is focused on capital preservation. The Company invests in instruments that meet the credit quality standards outlined in the Company’s investment policy. This policy also limits the amount of credit exposure to any one issue or type of instrument. As of June 30, 2016, the Company’s investments were in money market funds, short-term government-sponsored enterprise securities, U.S. Treasury securities, corporate debt securities and commercial paper.
As of June 30, 2016, all of the Company’s financial assets that were subject to fair value measurements were valued using observable inputs. The Company’s financial assets valued based on Level 1 inputs consisted of money market funds, short-term government-sponsored enterprise securities and U.S. Treasury securities. The Company’s financial assets valued based on Level 2 inputs consisted of corporate debt securities and commercial paper, which consisted of investments in highly-rated investment-grade corporations.
The following table sets forth the Company’s financial assets (excluding VIE cash and cash equivalents) and liabilities subject to fair value measurements:
 
Fair Value Measurements as
of June 30, 2016
 
 
 
Fair Value Hierarchy
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(in thousands)
Financial assets carried at fair value:
 
 
 
 
 
 
 
Cash equivalents:
 
 
 
 
 
 
 
Money market funds
$
110,696

 
$
110,696

 
$
—

 
$
—

Marketable securities:
 
 
 
 
 
 
 
U.S. Treasury securities
33,142

 
33,142

 
—

 
—

Government-sponsored enterprise securities
131,900

 
131,900

 
—

 
—

Corporate debt securities
135,675

 
—

 
135,675

 
—

Commercial paper
164,853

 
—

 
164,853

 
—

Prepaid and other current assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
9,966

 
—

 
9,966

 
—

Other assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
1,604

 
—

 
1,604

 
—

Total financial assets
$
587,836


$
275,738

 
$
312,098

 
$
—

Financial liabilities carried at fair value:
 
 
 
 
 
 
 
Other liabilities, current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
$
(7,317
)
 
$
—

 
$
(7,317
)
 
$
—

Other liabilities, excluding current portion:
 
 
 
 
 
 
 
Foreign currency forward contracts
(88
)
 
—

 
(88
)
 
—

Total financial liabilities
$
(7,405
)
 
$
—

 
$
(7,405
)
 
$
—



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

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

 
$
199,507

 
$
—

 
$
—

Government-sponsored enterprise securities
85,994

 
85,994

 
—

 
—

Commercial paper
34,889

 
—

 
34,889

 
—

Corporate debt securities
11,533

 
—

 
11,533

 
—

Marketable securities:
 
 
 
 
 
 
 
Government-sponsored enterprise securities
87,162

 
87,162

 
—

 
—

Commercial paper
99,123

 
—

 
99,123

 
—

Corporate debt securities
141,409

 
—

 
141,409

 
—

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

 
—

 
5,161

 
—

Other assets:
 
 
 
 
 
 
 
Foreign currency forward contracts
605

 
$
—

 
605

 
$
—

Total financial assets
$
665,383

 
$
372,663

 
$
292,720

 
$
—

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

 
$
(769
)
 
$
—

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

 
(132
)
 
—

Total financial liabilities
$
(901
)
 
$
—

 
$
(901
)
 
$
—

The Company's VIEs invested in cash equivalents consisting of money market funds of $70.2 million as of June 30, 2016, which are valued based on Level 1 inputs. These cash equivalents are not included in the table above. The Company’s noncontrolling interest related to VIEs includes the fair value of the contingent milestone and royalty payments, which are valued based on Level 3 inputs. Please refer to Note C, “Collaborative Arrangements,” for further information.
As of June 30, 2016, the fair value and carrying value of the Company's Term Loan was $296.5 million. The fair value of the Company's Term Loan was estimated based on Level 3 inputs computed using the effective interest rate of the Term Loan. The effective interest rate considers the timing and amount of estimated future interest payments as well as current market rates. Please refer to Note K, "Long-term Obligations" for further information regarding the Company's Term Loan.


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

F.
Marketable Securities
A summary of the Company’s cash, cash equivalents and marketable securities is shown below:
 
Amortized Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
 
(in thousands)
As of June 30, 2016
 
 
 
 
 
 
 
Cash and cash equivalents:
 
 
 
 
 
 
 
Cash and money market funds
$
605,866

 
$
—

 
$
—

 
$
605,866

Total cash and cash equivalents
$
605,866

 
$
—

 
$
—

 
$
605,866

Marketable securities:
 
 
 
 
 
 
 
U.S. Treasury securities (due within 1 year)
$
33,138

 
$
4

 
$
—

 
$
33,142

Government-sponsored enterprise securities (due within 1 year)
131,868

 
35

 
(3
)
 
131,900

Commercial paper (due within 1 year)
164,575

 
278

 
—

 
164,853

Corporate debt securities (due within 1 year)
135,663

 
34

 
(22
)
 
135,675

Total marketable securities
$
465,244

 
$
351

 
$
(25
)
 
$
465,570

Total cash, cash equivalents and marketable securities
$
1,071,110

 
$
351

 
$
(25
)
 
$
1,071,436

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

 
$
—

 
$
—

 
$
582,352

Government-sponsored enterprise securities
85,994

 
—

 
—

 
85,994

Commercial paper
34,889

 
—

 
—

 
34,889

Corporate debt securities
11,533

 
—

 
—

 
11,533

Total cash and cash equivalents
$
714,768

 
$
—

 
$
—

 
$
714,768

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

 
$
—

 
$
(14
)
 
$
87,162

Commercial paper (due within 1 year)
98,877

 
246

 
—

 
99,123

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

 
—

 
(106
)
 
141,409

Total marketable securities
$
327,568

 
$
246

 
$
(120
)
 
$
327,694

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

 
$
246

 
$
(120
)
 
$
1,042,462

The Company has a limited number of marketable securities in insignificant loss positions as of June 30, 2016, which the Company does not intend to sell and has concluded it will not be required to sell before recovery of the amortized costs for the investment at maturity. There were no charges recorded for other-than-temporary declines in fair value of marketable securities nor gross realized gains or losses recognized in the three and six months ended June 30, 2016 and 2015.


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

G.
Accumulated Other Comprehensive (Loss) Income
A summary of the Company's changes in accumulated other comprehensive (loss) income by component is shown below:
 
Foreign Currency Translation Adjustment
 
Unrealized Holding Gains (Losses) on Marketable Securities
 
Unrealized Gains on Foreign Currency Forward Contracts, net of tax
 
Total
 
(in thousands)
Balance at December 31, 2015
$
(2,080
)
 
$
126

 
$
3,778

 
$
1,824

Other comprehensive (loss) income before reclassifications
(5,201
)
 
200

 
1,847

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

 
—

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

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

 
$
3,565

 
$
(3,390
)
 
Foreign Currency Translation Adjustment
 
Unrealized Holding (Losses) Gains on Marketable Securities
 
Unrealized Gains (Losses) on Foreign Currency Forward Contracts
 
Total
 
(in thousands)
Balance at December 31, 2014
$
(971
)
 
$
(123
)
 
$
2,011

 
$
917

Other comprehensive (loss) income before reclassifications
1,220

 
130

 
(1,370
)
 
(20
)
Amounts reclassified from accumulated other comprehensive loss
—

 
—

 
(2,604
)
 
(2,604
)
Net current period other comprehensive (loss) income
$
1,220

 
$
130

 
$
(3,974
)
 
$
(2,624
)
Balance at June 30, 2015
$
249

 
$
7

 
$
(1,963
)
 
$
(1,707
)
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 June 30, 2016, all hedges were determined to be highly effective and the Company had not recorded any ineffectiveness related to the hedging program.
The following table summarizes the notional amount of the Company’s outstanding foreign currency forward contracts designated as cash flow hedges:


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

 
As of June 30, 2016
 
As of December 31, 2015
Foreign Currency
(in thousands)
Euro
$
193,542

 
$
103,362

British pound sterling
79,845

 
78,756

Australian dollar
28,318

 
27,167

Total foreign currency forward contracts
$
301,705

 
$
209,285

The following table summarizes the fair value of the Company's outstanding foreign currency forward contracts designated as cash flow hedges under GAAP included on the Company's condensed consolidated balance sheets:
As of June 30, 2016
Assets
 
Liabilities
Classification
 
Fair Value
 
Classification
 
Fair Value
(in thousands)
Prepaid and other current assets
 
$
9,966

 
Other liabilities, current portion
 
$
(7,317
)
Other assets
 
1,604

 
Other liabilities, excluding current portion
 
(88
)
Total assets
 
$
11,570

 
Total liabilities
 
$
(7,405
)
As of December 31, 2015
Assets
 
Liabilities
Classification
 
Fair Value
 
Classification
 
Fair Value
(in thousands)
Prepaid and other current assets
 
$
5,161

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

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

 
Total liabilities
 
$
(901
)
The following table summarizes the potential effect of offsetting derivatives by type of financial instrument on the Company's condensed consolidated balance sheets:
 
As of June 30, 2016
 
Gross Amounts Recognized
 
Gross Amounts Offset
 
Gross Amounts Presented
 
Gross Amounts Not Offset
 
Legal Offset
Foreign currency forward contracts
(in thousands)
Total assets
$
11,570

 
$
—

 
$
11,570

 
$
(7,405
)
 
$
4,165

Total liabilities
$
(7,405
)
 
$
—

 
$
(7,405
)
 
$
7,405

 
$
—

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

 
$
—

 
$
5,766

 
$
(901
)
 
$
4,865

Total liabilities
$
(901
)
 
$
—

 
$
(901
)
 
$
901

 
$
—



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

I. Inventories
Inventories consisted of the following:
 
As of June 30, 2016
 
As of December 31, 2015
 
(in thousands)
Raw materials
$
5,408

 
$
8,696

Work-in-process
45,807

 
40,695

Finished goods
15,374

 
7,816

Total
$
66,589

 
$
57,207

J. Intangible Assets and Goodwill
Intangible Assets
As of June 30, 2016 and December 31, 2015, in-process research and development intangible assets of $284.3 million were recorded on the Company's condensed consolidated balance sheet.
In June 2015, in connection with entering into the Parion Agreement, the Company recorded an in-process research and development intangible asset of $255.3 million based on the Company’s estimate of the fair value of Parion’s lead investigational ENaC inhibitors, including VX-371 and VX-551, that were licensed by the Company from Parion. The Company aggregated the fair value of the ENaC inhibitors into a single intangible asset because the phase, nature and risks of development as well as the amount and timing of benefits associated with the assets were similar. In October 2014, the Company recorded an in-process research and development intangible asset of $29.0 million based on the Company’s estimate of the fair value of VX-210, a drug candidate for patients with spinal cord injuries that was licensed by the Company from BioAxone. The Company used discount rates of 7.1% and 7.5% in the present-value models to estimate the fair values of the ENaC inhibitors and VX-210 intangible assets, respectively.
Goodwill
As of June 30, 2016 and December 31, 2015, goodwill of $50.4 million was recorded on the Company's condensed consolidated balance sheet.
K. Long-term Obligations
Fan Pier Leases
In 2011, the Company entered into two lease agreements, pursuant to which the Company leases approximately 1.1 million square feet of office and laboratory space in two buildings (the “Buildings”) at Fan Pier in Boston, Massachusetts (the “Fan Pier Leases”). The Company commenced lease payments in December 2013, and will make lease payments pursuant to the Fan Pier Leases through December 2028. The Company has an option to extend the term of the Fan Pier Leases for an additional ten years.
Because the Company was involved in the construction project, the Company was deemed for accounting purposes to be the owner of the Buildings during the construction period and recorded project construction costs incurred by the landlord. Upon completion of the Buildings, the Company evaluated the Fan Pier Leases and determined that the Fan Pier Leases did not meet the criteria for “sale-leaseback” treatment. Accordingly, the Company began depreciating the asset and incurring interest expense related to the financing obligation in 2013. The Company bifurcates its lease payments pursuant to the Fan Pier Leases into (i) a portion that is allocated to the Buildings and (ii) a portion that is allocated to the land on which the Buildings were constructed. The portion of the lease obligations allocated to the land is treated as an operating lease that commenced in 2011.
Property and equipment, net, included $495.7 million and $502.3 million as of June 30, 2016 and December 31, 2015, respectively, related to construction costs for the Buildings. The carrying value of the Company's lease agreement liability for the Buildings was $472.8 million and $473.0 million as of June 30, 2016 and December 31, 2015, respectively.


19
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VERTEX PHARMACEUTICALS INCORPORATED
Notes to Condensed Consolidated Financial Statements
(unaudited)

San Diego Lease
On December 2, 2015, the Company entered into a lease agreement for 3215 Merryfield Row, San Diego, California with ARE-SD Region No. 23, LLC. Pursuant to this agreement, the Company agreed to lease approximately 170,000 square feet of office and laboratory space in a building to be built in San Diego, California. The lease will commence upon completion of the building, scheduled for the second half of 2017, 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.

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


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

with the Term Loan that was included in the senior secured term loan caption on the Company’s condensed consolidated balance sheet was $3.4 million and $4.6 million, respectively.
L. Stock-based Compensation Expense
During the three and six months ended June 30, 2016 and 2015, the Company recognized the following stock-based compensation expense:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
Stock-based compensation expense by type of award:
 
 
 
 
 
 
 
Stock options
$
31,826

 
$
37,687

 
$
58,086

 
$
66,646

Restricted stock and restricted stock units
29,608

 
24,902

 
57,141

 
52,071

ESPP share issuances
1,436

 
1,825

 
3,960

 
3,965

Less stock-based compensation expense capitalized to inventories
(928
)
 
(1,153
)
 
(1,773
)
 
(2,037
)
Total stock-based compensation included in costs and expenses
$
61,942

 
$
63,261

 
$
117,414

 
$
120,645

 
 
 
 
 
 
 


Stock-based compensation expense by line item:
 
 
 
 
 
 
 
Research and development expenses
$
40,640

 
$
41,632

 
$
75,088

 
$
79,849

Sales, general and administrative expenses
21,302

 
21,629

 
42,326

 
40,796

Total stock-based compensation included in costs and expenses
$
61,942

 
$
63,261

 
$
117,414

 
$
120,645

The following table sets forth the Company's unrecognized stock-based compensation expense, net of estimated forfeitures, by type of award and the weighted-average period over which that expense is expected to be recognized:
 
As of June 30, 2016
 
Unrecognized Expense,
Net of
Estimated Forfeitures
 
Weighted-average
Recognition
Period
 
(in thousands)
 
(in years)
Type of award:
 
 
 
Stock options
$
176,251

 
2.66
Restricted stock and restricted stock units
$
201,858

 
2.57
ESPP share issuances
$
5,546

 
0.64


21
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 June 30, 2016:
 
 
Options Outstanding
 
Options Exercisable
Range of Exercise Prices
 
Number
Outstanding
 
Weighted-average
Remaining
Contractual Life
 
Weighted-average
Exercise Price
 
Number
Exercisable
 
Weighted-average
Exercise Price
 
 
(in thousands)
 
(in years)
 
(per share)
 
(in thousands)
 
(per share)
$18.93–$20.00
 
137

 
1.61
 
$
18.93

 
137

 
$
18.93

$20.01–$40.00
 
1,964

 
3.45
 
$
34.24

 
1,962

 
$
34.23

$40.01–$60.00
 
2,066

 
6.07
 
$
48.14

 
1,657

 
$
48.66

$60.01–$80.00
 
1,368

 
7.62
 
$
75.90

 
734

 
$
75.39

$80.01–$100.00
 
3,555

 
8.60
 
$
90.68

 
1,080

 
$
88.91

$100.01–$120.00
 
1,644

 
8.57
 
$
109.32

 
500

 
$
109.27

$120.01–$134.69
 
1,497

 
9.05
 
$
130.61

 
420

 
$
129.84

Total
 
12,231

 
7.21
 
$
79.37

 
6,490

 
$
63.32

M. Other Arrangements
Sale of HIV Protease Inhibitor Royalty Stream
In 2008, the Company sold to a third party its rights to receive royalty payments from GlaxoSmithKline plc, net of royalty amounts to be earned by and due to a third party, for a one-time cash payment of $160.0 million. These royalty payments relate to net sales of HIV protease inhibitors, which had been developed pursuant to a collaboration agreement between the Company and GlaxoSmithKline plc. As of June 30, 2016, the Company had $18.9 million in deferred revenues related to the one-time cash payment, which it is recognizing over the life of the collaboration agreement with GlaxoSmithKline plc based on the units-of-revenue method. In addition, the Company continues to recognize royalty revenues equal to the amount of the third-party subroyalty and an offsetting royalty expense for the third-party subroyalty payment.
N. Income Taxes
The Company is subject to United States federal, state, and foreign income taxes. For the three and six months ended June 30, 2016, the Company recorded a provision for income taxes of $18.1 million and $23.6 million, respectively. The provision for income taxes recorded in the three and six months ended June 30, 2016 included $17.5 million and $20.6 million, respectively, related to the Company's VIEs' income tax provision. The Company has no liability for taxes payable by the Company's VIEs and the income tax provision and related liability have been allocated to noncontrolling interest (VIE). For the three and six months ended June 30, 2015, the Company recorded a provision for income taxes of $30.1 million and $30.4 million, respectively, primarily related to the Company's VIEs' income tax provision.
As of June 30, 2016 and December 31, 2015, the Company had unrecognized tax benefits of $0.4 million. The Company recognizes interest and penalties related to income taxes as a component of income tax expense. As of June 30, 2016, no interest and penalties have been accrued. The Company does not expect that its unrecognized tax benefits will materially increase within the next twelve months. The Company did not recognize any material interest or penalties related to uncertain tax positions as of June 30, 2016 and December 31, 2015. In 2016, it is reasonably possible that the Company will reduce the balance of its unrecognized tax benefits by approximately $0.4 million due to the application of statute of limitations and settlements with taxing authorities, all of which would reduce the Company’s effective tax rate.
The Company continues to maintain a valuation allowance against certain deferred tax assets where it is more likely than not that the deferred tax asset will not be realized because of its extended history of annual losses.
The Company files United States federal income tax returns and income tax returns in various state, local and foreign jurisdictions. The Company is no longer subject to any tax assessment from an income tax examination in the United States


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

before 2011 or any other major taxing jurisdiction for years before 2009, except where the Company has net operating losses or tax credit carryforwards that originated before 2009. The Company currently is under examination by the Internal Revenue Service for the year ended December 31, 2011 and in Delaware, Canada and Quebec for varying periods including the years ended December 31, 2011 through 2014. No adjustments have been reported. The Company is not under examination by any other jurisdictions for any tax year. The Company concluded audits with Pennsylvania and Texas during 2016 and Massachusetts and New York during 2015 with no material adjustments.
The Company currently intends to reinvest the total amount of its unremitted earnings. At June 30, 2016, foreign earnings, which were not significant, have been retained indefinitely by foreign subsidiary companies for reinvestment; therefore, no provision has been made for income taxes that would be payable upon the distribution of such earnings, and it would not be practicable to determine the amount of the related unrecognized deferred income tax liability. Upon repatriation of those earnings, in the form of dividends or otherwise, the Company would be subject to United States federal income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries.
O. Restructuring Liabilities
2003 Kendall Restructuring
In 2003, the Company adopted a plan to restructure its operations to coincide with its increasing internal emphasis on advancing drug candidates through clinical development to commercialization. The restructuring liability relates to specialized laboratory and office space that is leased to the Company pursuant to a 15-year lease that terminates in 2018. The Company has not used more than 50% of this space since it adopted the plan to restructure its operations in 2003. This unused laboratory and office space currently is subleased to third parties.
The activities related to the restructuring liability for the three and six months ended June 30, 2016 and 2015 were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
 
 
 
 
Liability, beginning of the period
$
7,224

 
$
9,506

 
$
7,944

 
$
11,596

Cash payments
(3,833
)
 
(2,584
)
 
(7,764
)
 
(6,569
)
Cash received from subleases
3,008

 
2,799

 
6,016

 
5,275

Restructuring expense (income)
(11
)
 
203

 
192

 
(378
)
Liability, end of the period
$
6,388

 
$
9,924

 
$
6,388

 
$
9,924


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


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

The activities related to the restructuring liability for the three and six months ended June 30, 2016 and 2015 were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
 
 
 
 
Liability, beginning of the period
$
5,449

 
$
11,137

 
$
5,964

 
$
33,390

Cash payments
(3,096
)
 
(3,095
)
 
(6,252
)
 
(22,351
)
Cash received from subleases
2,361

 
—

 
4,769

 
—

Restructuring expense (income)
149

 
975

 
382

 
(2,022
)
Liability, end of the period
$
4,863

 
$
9,017

 
$
4,863

 
$
9,017

Other Restructuring Activities
The Company has engaged in several other restructuring activities that are unrelated to its 2003 Kendall Restructuring and the Fan Pier Move Restructuring. The most significant activity commenced in October 2013 when the Company adopted a restructuring plan that included (i) a workforce reduction primarily related to the commercial support of INCIVEK following the continued and rapid decline in the number of patients being treated with INCIVEK as new medicines for the treatment of HCV infection neared approval and (ii) the write-off of certain assets. This action resulted from the Company's decision to focus its investment on future opportunities in CF and other research and development programs.
The activities related to the Company's other restructuring liabilities for the three and six months ended June 30, 2016 and 2015 were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2016
 
2015
 
2016
 
2015
 
(in thousands)
 
 
 
 
Liability, beginning of the period
$
1,262

 
$
845

 
$
1,450

 
$
869

Cash payments
(234
)
 
(893
)
 
(673
)
 
(1,223
)
Restructuring expense
205

 
950

 
456

 
1,256

Liability, end of the period
$
1,233

 
$
902

 
$
1,233

 
$
902

P. Commitments and Contingencies
Financing Arrangements
As of June 30, 2016, the Company had irrevocable stand-by letters of credit outstanding that were issued in connection with property leases and other similar agreements totaling $21.9 million that are cash collateralized. The cash used to support these letters of credit is included in restricted cash, as of June 30, 2016, on the Company's condensed consolidated balance sheet.
Litigation
On May 28, 2014, a purported shareholder class action Local No. 8 IBEW Retirement Plan & Trust v. Vertex Pharmaceuticals Incorporated, et al. was filed in the United States District Court for the District of Massachusetts, naming the Company and certain of the Company's current and former officers and directors as defendants. The lawsuit alleged that the Company made material misrepresentations and/or omissions of material fact in the Company's disclosures during the period from May 7, 2012 through May 29, 2012, all in violation of Section 10(b) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder. The purported class consists of all persons (excluding defendants) who purchased the Company’s common stock between May 7, 2012 and May 29, 2012. The plaintiffs seek unspecified monetary damages, costs and attorneys’ fees as well as disgorgement of the proceeds from certain individual defendants’ sales of the Company’s stock. On October 8, 2014, the Court approved Local No. 8 IBEW Retirement Fund as lead plaintiff, and Scott


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

and Scott LLP as lead counsel for the plaintiff and the putative class. On February 23, 2015, the Company filed a reply to the plaintiffs’ opposition to its motion to dismiss.  The court heard oral argument on the motion to dismiss on March 6, 2015 and took the motion under advisement. On September 30, 2015, the court granted the Company's motion to dismiss. On October 15, 2015, the plaintiff filed a notice of appeal. The First Circuit Court of Appeals issued a scheduling order on December 24, 2015. On February 2, 2016, the Plaintiff filed their opening brief and the Company filed its opposition brief on March 7, 2016. On March 24, 2016, the plaintiff filed their reply brief. Oral argument on the appeal took place on July 26, 2016. The Company believes the claims to be without merit and intend to vigorously defend the litigation. As of June 30, 2016, the Company has not recorded any reserves for this purported class action.
Guaranties and Indemnifications
As permitted under Massachusetts law, the Company’s Articles of Organization and By-laws provide that the Company will indemnify certain of its officers and directors for certain claims asserted against them in connection with their service as an officer or director. The maximum potential amount of future payments that the Company could be required to make under these indemnification provisions is unlimited. However, the Company has purchased directors’ and officers’ liability insurance policies that could reduce its monetary exposure and enable it to recover a portion of any future amounts paid. No indemnification claims currently are outstanding, and the Company believes the estimated fair value of these indemnification arrangements is minimal.
The Company customarily agrees in the ordinary course of its business to indemnification provisions in agreements with clinical trial investigators and sites in its drug development programs, sponsored research agreements with academic and not-for-profit institutions, various comparable agreements involving parties performing services for the Company and its real estate leases. The Company also customarily agrees to certain indemnification provisions in its drug discovery, development and commercialization collaboration agreements. With respect to the Company’s clinical trials and sponsored research agreements, these indemnification provisions typically apply to any claim asserted against the investigator or the investigator’s institution relating to personal injury or property damage, violations of law or certain breaches of the Company’s contractual obligations arising out of the research or clinical testing of the Company’s compounds or drug candidates. With respect to lease agreements, the indemnification provisions typically apply to claims asserted against the landlord relating to personal injury or property damage caused by the Company, to violations of law by the Company or to certain breaches of the Company’s contractual obligations. The indemnification provisions appearing in the Company’s collaboration agreements are similar to those for the other agreements discussed above, but in addition provide some limited indemnification for its collaborator in the event of third-party claims alleging infringement of intellectual property rights. In each of the cases above, the indemnification obligation generally survives the termination of the agreement for some extended period, although the Company believes the obligation typically has the most relevance during the contract term and for a short period of time thereafter. The maximum potential amount of future payments that the Company could be required to make under these provisions is generally unlimited. The Company has purchased insurance policies covering personal injury, property damage and general liability that reduce its exposure for indemnification and would enable it in many cases to recover all or a portion of any future amounts paid. The Company has never paid any material amounts to defend lawsuits or settle claims related to these indemnification provisions. Accordingly, the Company believes the estimated fair value of these indemnification arrangements is minimal.
Other Contingencies
The Company has certain contingent liabilities that arise in the ordinary course of its business activities. The Company accrues a reserve for contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. There were no material contingent liabilities accrued as of June 30, 2016 or December 31, 2015.


25
Table of Contents

Item 2.     Management's Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
We are in the business of discovering, developing, manufacturing and commercializing medicines for serious diseases. We use precision medicine approaches with the goal of creating transformative medicines for patients in specialty markets. Our business is focused on developing and commercializing therapies for the treatment of cystic fibrosis, or CF, and advancing our research and development programs in other indications, while maintaining our financial strength. Our two marketed products are ORKAMBI and KALYDECO.
Cystic Fibrosis
ORKAMBI
ORKAMBI (lumacaftor in combination with ivacaftor) was approved by the United States Food and Drug Administration, or FDA, in July 2015 and by the European Commission in November 2015, for the treatment of patients with CF twelve years of age and older who are homozygous for the F508del mutation in their cystic fibrosis transmembrane conductance regulator, or CFTR, gene. ORKAMBI was approved for this patient population in Canada and Australia in the first quarter of 2016. Our future ORKAMBI net product revenues in the United States will reflect the number of patients for whom treatment with ORKAMBI is initiated, the proportion of initiated patients who remain on treatment, patient compliance with the recommended treatment regimen and the level of rebates, chargebacks, discounts and other adjustments to our ORKAMBI gross product revenues. We believe that there currently are approximately 8,500 patients in the United States who are eligible for treatment with ORKAMBI. We have begun the country-by-country reimbursement approval process in ex-U.S. markets. We believe that there are approximately 12,000 patients with CF twelve years of age and older who are homozygous for the F508del mutation in Europe and approximately an aggregate of 2,500 patients with CF twelve years of age and older who are homozygous for the F508del mutation in Canada and Australia.
In May 2016, the FDA accepted our supplemental New Drug Application, or sNDA, for ORKAMBI for the treatment of patients with CF six to eleven years of age who are homozygous for the F508del mutation in their CFTR gene. The FDA granted our request for priority review and set the target review date of September 30, 2016. The sNDA was based upon the results of a Phase 3 clinical trial evaluating lumacaftor in combination with ivacaftor in 58 patients with CF six to eleven years of age who are homozygous for the F508del mutation in their CFTR gene. We have completed enrollment in a second Phase 3 clinical trial evaluating lumacaftor in combination with ivacaftor in approximately 200 patients in this same patient population. If this clinical trial is successful, we expect to submit a Marketing Authorization Application to the European Medicines Agency seeking approval of ORKAMBI in this patient population in the European Union in the first half of 2017.
We recently initiated a Phase 3 clinical trial for lumacaftor in combination with ivacaftor in patients with CF two to five years of age who are homozygous for the F508del mutation in their CFTR gene. The first part of the two-part clinical trial is evaluating safety and pharmacokinetics to inform dose selection for the second part of the clinical trial. The primary endpoint of the second part of the clinical trial is safety and tolerability, with multiple efficacy measurements as secondary endpoints.
KALYDECO
KALYDECO (ivacaftor) was approved in 2012 in the United States and European Union as a treatment for patients with CF six years of age and older who have the G551D mutation in their CFTR gene. Since 2012, we have increased the number of patients who are being treated with KALYDECO in the United States and ex-U.S. markets by expanding the label for KALYDECO to include patients with CF who have additional mutations in their CFTR gene and to include patients in additional age demographics. We believe that there are approximately 4,000 patients in North America, Europe and Australia who are currently eligible for treatment with KALYDECO.
We have initiated a Phase 3 clinical trial for ivacaftor in patients with CF less than two years of age to evaluate the effect of ivacaftor on markers of CF disease in young children. The clinical trial utilizes a weight-based dose of ivacaftor granules that can be mixed in soft foods or liquids. The clinical trial is enrolling patients with one of the ten CFTR gene mutations for which KALYDECO is currently approved.
VX-661
VX-661 is an orally-administered CFTR corrector drug candidate that we are evaluating in a Phase 3 development program in combination with ivacaftor in multiple CF patient populations who have at least one copy of the F508del mutation in their CFTR gene. Details of the patient population and status of each of these clinical trials is as follows:



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Two copies of the F508del in their CFTR gene: We plan to complete enrollment in this clinical trial in August 2016 and expect data from this clinical trial to be available in the first half of 2017.
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One copy of the F508del mutation in their CFTR gene and a second mutation in their CFTR gene that results in a gating defect in the CFTR protein: We plan to complete enrollment in this clinical trial in late 2016 or early 2017.
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One copy of the F508del mutation in their CFTR gene and a second mutation in their CFTR gene that results in residual CFTR function: We expect to complete enrollment in this clinical trial in the second half of 2016.
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One copy of the F508del mutation in their CFTR gene and a second mutation that results in minimal CFTR function: Enrollment is complete in the first part of this clinical trial and we expect an interim futility analysis of efficacy data to be completed in the third quarter of 2016.
If supported by data from the Phase 3 clinical program, Vertex plans to submit an NDA to the FDA for VX-661 in combination with ivacaftor in the second half of 2017.

In addition to evaluating the efficacy of the combination regimen, these Phase 3 clinical trials will provide safety data on the combination of VX-661 and ivacaftor to support the planned development of a triple combination regimen that includes a next-generation corrector in combination with VX-661 and ivacaftor.

ENaC Inhibition
VX-371 is an investigational epithelial sodium channel, or ENaC, inhibitor, we are evaluating in a Phase 2 development program in collaboration with Parion Sciences, Inc., or Parion. Parion completed a Phase 2 clinical trial in approximately 142 patients with CF with no restriction on the mutations in their CFTR gene. The primary endpoint of the clinical trial was safety as compared to patients on placebo. Secondary endpoints evaluated the effect on mean absolute forced expiratory volume in one second, or FEV1 and patient-reported respiratory symptoms as reported in the CF questionnaire-revised, or CFQ-R. The clinical trial met its primary safety endpoint and data from the clinical trial showed that VX-371 was generally well tolerated. There were no statistically significant changes in FEV1 or CFQ-R for patients who received VX-371.

In the first quarter of 2016, we initiated a Phase 2a clinical trial evaluating VX-371 in approximately 150 patients on ORKAMBI, both with and without the addition of hypertonic saline, who have two copies of the F508del mutat