VERTEX PHARMACEUTICALS INC quarterly report, Q1 FY2011

Vertex Pharmaceuticals Inc. — Q1 2011 Form 10-Q

Reporting period: Three months ended March 31, 2011. Unaudited consolidated results; amounts below are in U.S. dollars. Vertex was preparing to commercialize telaprevir (later marketed as INCIVEK, if approved) while advancing its cystic fibrosis and other drug programs.

Financial performance and position

Metric	Q1 2011	Q1 2010 / prior balance
Total revenue	$73.7 million	$22.4 million
Operating costs and expenses	$233.6 million	$182.7 million
Operating loss	$159.9 million	$160.3 million
Net loss	$176.1 million	$165.3 million
Net loss per share, diluted	$0.87	$0.83
Net cash used in operating activities	$186.6 million	$196.5 million
Cash, cash equivalents and marketable securities	$823.5 million	$1,031.4 million at Dec. 31, 2010

• Revenue growth was driven chiefly by $50.0 million of Janssen milestone revenue following European Medicines Agency acceptance of the telaprevir marketing application. Collaborative revenue rose to $67.6 million from $16.0 million; royalty revenue was $6.1 million versus $6.4 million.
• Research and development expense increased 11% to $158.6 million. Sales, general and administrative expense doubled to $71.5 million as Vertex expanded its commercial organization ahead of a potential launch.
• Operating loss was nearly unchanged despite higher revenue and expense. Net loss increased 7%, reflecting higher interest expense and charges related to derivatives from the September 2009 financing transactions. Those transaction-related expenses were $13.5 million versus $5.1 million.
• Operating cash use improved year over year, but remained substantial. Investing activities provided $406.0 million, mainly because marketable securities sales and maturities exceeded purchases; this is not operating cash generation. Capital expenditures were $4.9 million.
• At March 31, current assets were $873.0 million and current liabilities were $416.2 million. Total assets were $1.54 billion; total liabilities were $1.15 billion.
• Debt included $400 million principal of 3.35% convertible notes due 2015 and $105 million principal of secured notes due 2012. The balance sheet carried the secured notes at $92.1 million. Vertex had an unused $100 million revolving credit facility.

Material changes and unusual items

• Vertex began capitalizing telaprevir inventory on January 1, 2011, based on its assessment that approval was highly likely and costs were expected to be recoverable. Inventory was $17.8 million at quarter-end, compared with none at year-end. Negative regulatory or commercial developments could require an impairment.
• The $50 million Janssen milestone was applied to redeem $50 million of secured notes. Of the remaining potential $200 million of Janssen milestones, the next $105 million is committed to redeeming the remaining secured notes; the final $95 million had been sold to a third party and would not provide Vertex with liquidity.
• Cash and marketable securities declined by $208.0 million from year-end, principally due to operating expenditures, partially offset by $33.6 million of proceeds from employee share issuances.
• In May 2011, after quarter-end, Vertex entered leases for approximately 1.1 million square feet of Boston office and laboratory space. The 15-year leases provide for average aggregate rent of about $72.5 million annually, excluding operating expenses, and automatically terminate if U.S. telaprevir approval is not obtained by December 31, 2011.

Outlook, management commentary and risks

• As of the filing, the FDA target date for completing its priority review of the telaprevir NDA was May 23, 2011. On April 28, after quarter-end, the FDA advisory committee voted 18–0 to recommend approval; the recommendation was non-binding. Vertex expected a U.S. launch in mid-2011 if approved. Janssen was pursuing EU approval and launch in the second half of 2011.
• Vertex expected to submit U.S. and EU applications for VX-770 in the second half of 2011. Reported Phase 3 results showed placebo-adjusted FEV1 improvements of 10.5% at week 48 in STRIVE and 12.5% at week 24 in ENVISION; later ENVISION data were still pending.
• Management said existing cash, cash equivalents and marketable securities should fund operations for at least 12 months. If telaprevir approval and sales met expectations, it anticipated becoming cash-flow positive during 2012. These were forward-looking expectations, not guarantees.
• Key risks include regulatory delay or denial, uncertain launch uptake and pricing, competition from boceprevir, high continuing R&D and launch costs, reliance on third-party manufacturing and supply chains, and possible need for additional financing. The credit facility includes a requirement to maintain at least $400 million in cash, cash equivalents and marketable securities in domestic accounts, as well as a quarterly net-loss covenant.
• Vertex reported no material changes to the risk factors in its 2010 Form 10-K and no material contingent liabilities accrued at March 31, 2011. Disclosure controls were assessed as effective; inventory accounting controls were expanded following the start of capitalization.

Investor verification priorities

1. Confirm the FDA’s final telaprevir decision, timing of launch, commercial uptake, pricing and subsequent product revenue.
2. Track cash burn, available liquidity, credit-facility covenant compliance and the funding impact of the Boston leases.
3. Verify redemption of the remaining 2012 secured notes and the timing and allocation of further Janssen milestone payments.
4. Assess whether capitalized telaprevir inventory remains recoverable and whether launch supply is adequate.
5. Review subsequent VX-770 trial results and regulatory submissions, alongside safety, competition and commercialization risks.