# Vertex Pharmaceuticals Inc / Ma: Form 10-Q for the period ended Jun 30, 2011

- Company: [Vertex Pharmaceuticals Inc / Ma](/companies/vrtx.md) (CIK 875320)
- Form: 10-Q
- Filed: 2011-08-09
- Accepted by EDGAR: Aug 9, 2011, 20:13 ET
- Period: 2011-06-30
- Accession: 0001047469-11-007153
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/875320/000104746911007153/a2205008z10-q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/875320/000104746911007153/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2011-06-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2011-04-01 to 2011-06-30 | $114.4m | us-gaap:Revenues |
| Revenue | 6 months, 2011-01-01 to 2011-06-30 | $188.1m | us-gaap:Revenues |
| Cost of revenue | 3 months, 2011-04-01 to 2011-06-30 | $5.4m | us-gaap:CostOfGoodsSold |
| Cost of revenue | 6 months, 2011-01-01 to 2011-06-30 | $5.4m | us-gaap:CostOfGoodsSold |
| Research and development | 3 months, 2011-04-01 to 2011-06-30 | $173.6m | us-gaap:ResearchAndDevelopmentExpense |
| Research and development | 6 months, 2011-01-01 to 2011-06-30 | $332.2m | us-gaap:ResearchAndDevelopmentExpense |
| Selling, general and administrative | 3 months, 2011-04-01 to 2011-06-30 | $96.7m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Selling, general and administrative | 6 months, 2011-01-01 to 2011-06-30 | $168.2m | us-gaap:SellingGeneralAndAdministrativeExpense |
| Operating income | 3 months, 2011-04-01 to 2011-06-30 | −$165.9m | us-gaap:OperatingIncomeLoss |
| Operating income | 6 months, 2011-01-01 to 2011-06-30 | −$325.8m | us-gaap:OperatingIncomeLoss |
| Interest expense | 3 months, 2011-04-01 to 2011-06-30 | $7.0m | us-gaap:InterestExpense |
| Interest expense | 6 months, 2011-01-01 to 2011-06-30 | $19.0m | us-gaap:InterestExpense |
| Income tax | 3 months, 2011-04-01 to 2011-06-30 | $24.4m | us-gaap:IncomeTaxExpenseBenefit |
| Income tax | 6 months, 2011-01-01 to 2011-06-30 | $24.4m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2011-04-01 to 2011-06-30 | −$174.1m | us-gaap:NetIncomeLoss |
| Net income | 6 months, 2011-01-01 to 2011-06-30 | −$350.2m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2011-04-01 to 2011-06-30 | −$0.85 | us-gaap:EarningsPerShareDiluted |
| Diluted EPS | 6 months, 2011-01-01 to 2011-06-30 | −$1.72 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2011-04-01 to 2011-06-30 | −$0.85 | us-gaap:EarningsPerShareBasic |
| Basic EPS | 6 months, 2011-01-01 to 2011-06-30 | −$1.72 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2011-04-01 to 2011-06-30 | 204,413,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Diluted shares (weighted) | 6 months, 2011-01-01 to 2011-06-30 | 203,377,000 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 6 months, 2011-01-01 to 2011-06-30 | −$402.8m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 6 months, 2011-01-01 to 2011-06-30 | $15.3m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2011-06-30 | $458.2m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2011-06-30 | $827.1m | us-gaap:AssetsCurrent |
| Total assets | at 2011-06-30 | $1.76bn | us-gaap:Assets |
| Current liabilities | at 2011-06-30 | $479.0m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2011-06-30 | $1.31bn | us-gaap:Liabilities |
| Long-term debt | at 2011-06-30 | $105.0m | us-gaap:LongTermDebt |
| Shareholders' equity | at 2011-06-30 | $307.5m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 70,823 characters.

### Overview

We are in the business of discovering, developing and commercializing small molecule drugs for the treatment of serious diseases. In May 2011, we began marketing INCIVEK™ (telaprevir) in the United States for the treatment of patients with chronic hepatitis C virus, or HCV, infection. We recognized $74.5 million in net product revenues in the second quarter of 2011 and expect to generate cash flows from sales of INCIVEK beginning in the third quarter of 2011. In the first half of 2011, we successfully completed the registration program for VX-770, the lead drug candidate in our cystic fibrosis, or CF, program. We expect to submit a New Drug Application, or NDA, in the United States and a marketing authorization application, or MAA, in the European Union for VX-770 in October 2011. We plan to continue investing in our research and development programs and to develop and commercialize selected drug candidates that emerge from those programs, alone or with third-party collaborators.

#### Business Focus

In order to execute our business plan and achieve profitability, we need to successfully commercialize INCIVEK in the United States. Successful commercialization of INCIVEK requires effective marketing, distribution and pricing strategies; infrastructure to support commercial sales; appropriate and sustained levels of INCIVEK inventory; company-wide processes and systems to support compliance with applicable laws and regulations and post-marketing safety evaluations; and an effective sales force and managed markets organization to promote INCIVEK to healthcare providers and payors. For longer-term success we also need to ensure that a significant portion of the HCV-infected population that currently is undiagnosed is diagnosed and treated. The market for the treatment of patients with HCV infection is highly competitive. We are competing with Merck & Co., Inc's Victrelis™ (boceprevir), another HCV protease inhibitor that was approved for sale in the United States in the second quarter of 2011, and will have to compete in the future with any new therapies that are approved for the treatment of genotype 1 HCV infection.

We are seeking Canadian regulatory approval for INCIVEK in the second half of 2011 and are building the commercial infrastructure that will be required to market INCIVEK in Canada. Our collaborator, Janssen Pharmaceutica, N.V., or Janssen, is responsible for the commercialization of telaprevir in its territories, including the European Union, and is obligated to pay us royalties on its net sales of telaprevir. In July 2011, Tibotec Virco-Virology BVBA, an affiliate of Janssen, announced that the Committee for Medicinal Products for Human Use of the European Medicines Agency, or EMA, adopted a positive opinion to recommend the approval of telaprevir. The positive opinion will be considered by the European Commission, which has authority to approve new drugs in the European Union. We expect Janssen will receive a response from the European Commission in the third quarter of 2011. Janssen plans to market telaprevir using the brand name INCIVO™ in the European Union.

We have ongoing Phase 2 clinical programs involving drug candidates intended for the treatment of HCV infection, CF, rheumatoid arthritis and epilepsy, and plan to begin Phase 1 clinical development of VX-787, which is our first drug candidate intended for the treatment of influenza. We believe that our longer-term success will depend on our ability to continue to generate and develop innovative compounds. To that end, we expect to continue to focus on research programs directed toward the identification of new drug candidates for the treatment of serious diseases.

We are incurring substantial expenses to commercialize INCIVEK, while at the same time continuing diversified research and development efforts for our drug candidates and expanding our organization. We may seek to borrow working capital if such financing is available to us. Although we have no plans to do so in the near term, we may raise additional capital from public offerings or private placements of our securities, from new collaborative agreements or through other methods of financing. We cannot be sure that financing opportunities will be available on acceptable terms, if at all. If our cash flows from telaprevir, together with cash flows from VX-770, if approved, are not sufficient, we may be required to seek additional capital, significantly curtail or discontinue one or more of our research or development programs, including clinical trials, which could involve significant cash exit costs, or attempt to obtain funds through arrangements with collaborators or others that may require us to relinquish rights to certain of our drug candidates.

#### Drug Development and Commercialization

Discovery and development of a new pharmaceutical product is a difficult and lengthy process that requires significant financial resources along with extensive technical and regulatory expertise and can take 10 to 15 years or more. Throughout this entire process, potential drug candidates are subjected to rigorous evaluation, driven in part by stringent regulatory considerations, designed to generate information concerning efficacy, side-effects, proper dosage levels and a variety of other physical and chemical characteristics that are important in determining whether a drug candidate should be approved for marketing as a pharmaceutical product. Most chemical compounds that are investigated as potential drug candidates never progress into formal development, and most drug candidates that do advance into formal development never receive marketing approval. Because our investments are subject to considerable risks, we closely monitor the results of our discovery research, clinical trials and nonclinical studies, and frequently evaluate our drug development programs in light of new data and scientific, business and commercial insights, with the objective of balancing risk and potential. This process can result in relatively abrupt changes in focus and priority as new information becomes available and we gain additional understanding of our ongoing programs and potential new programs.

If we complete a registration program for a drug candidate and believe the data support approval of the drug candidate, we generally would submit an NDA to the United States Food and Drug Administration, or FDA, requesting approval to market the drug candidate in the United States. We or our collaborators also generally would seek analogous approvals from comparable regulatory authorities in foreign jurisdictions. To obtain approval, we must, among other things, demonstrate with evidence gathered in nonclinical studies and well-controlled clinical trials that the drug candidate is safe and effective for the disease it is intended to treat and that the manufacturing facilities, processes and controls for the manufacture of the drug candidate are adequate. The FDA and foreign regulatory authorities have substantial discretion in deciding whether or not a drug candidate should be granted approval based on the benefits and risks of the drug candidate in the treatment of a particular disease, and could delay, limit or deny regulatory approval. If regulatory delays are significant or regulatory approval is limited or denied altogether, our financial results and the commercial prospects for the drug candidate involved will be harmed.

We believe that by focusing on serious diseases and innovative drugs that have the potential to provide significant advantages over existing therapies, we can increase the likelihood that our drug candidates, if approved, will be commercially successful. We believe that INCIVEK has a commercially competitive profile and that a significant group of patients with genotype 1 HCV infection will be willing to seek treatment with an INCIVEK-based treatment regimen. VX-770, if approved, would be the first drug to treat the underlying cause of CF in any patient population. However, we cannot accurately predict the revenues that will be generated by INCIVEK or by VX-770, if it receives regulatory approvals, and we may need to adjust our business plan as we obtain additional information regarding our actual product revenues. Even drugs that achieve initial market acceptance may then be rendered obsolete or noncompetitive by the introduction of additional therapies, expiration of intellectual property protections or introduction of generic competition. Approved drugs continue to be subject, among other things, to numerous regulatory risks, post-approval safety monitoring and risks related to supply chain disruptions.

We require a supply of INCIVEK for sale in North America and will require a supply of VX-770 for sale worldwide if we are successful in obtaining marketing approval for VX-770. We rely on an international network of third parties to manufacture and distribute our drug candidates for clinical trials, and we expect that we will continue to rely on third parties for the foreseeable future to meet our commercial supply needs for INCIVEK and any of our drug candidates that are approved for sale. Third-party contract manufacturers, including some in China, supply us with raw materials, and contract manufacturers in the European Union and the United States convert these raw materials into drug substance and convert the drug substance into final dosage form. Establishing and managing this global supply chain requires a significant financial commitment and the creation and maintenance of numerous third-party relationships. Although we attempt to effectively manage the business relationships with companies in our supply chain, we do not have complete control over their activities. Also, because of the significant lead times required to manufacture our commercial supply of INCIVEK, we may have less flexibility to adjust our supply in response to increased demand than if we had shorter lead times.

We had not marketed pharmaceutical products before we obtained approval for INCIVEK, and prior to 2010 we had a relatively small commercial organization. As a result, in the past many of the regulations related to the marketing of pharmaceutical products have had limited applicability to our business. As we expanded our commercial organization, we focused on implementing a comprehensive compliance program to actively identify, prevent and mitigate risk through the implementation of compliance policies and systems and by promoting a culture of compliance. Among other laws, regulations and standards, we are subject to various federal and state laws pertaining to healthcare fraud and abuse, including anti-kickback and false claims statutes. Anti-kickback laws make it illegal for a prescription drug manufacturer to solicit, offer, receive, or pay any remuneration in exchange for, or to induce, the referral of business, including the purchase or prescription of a particular drug. False claims laws prohibit anyone from presenting for payment to third-party payors, including Medicare and Medicaid, claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed, or claims for medically unnecessary items or services. We expect to continue to devote substantial resources to maintain and administer these compliance programs.

#### Recent Developments

### Cystic Fibrosis Foundation Therapeutics Incorporated

In April 2011, we expanded our collaboration with Cystic Fibrosis Foundation Therapeutics Incorporated, or CFFT. Under the expanded collaboration, CFFT agreed to provide up to $75.0 million in financial support over approximately five years for development activities for VX-661, a corrector compound discovered under the collaboration, and additional research and development activities directed at discovering new corrector compounds. We retain the rights to develop and commercialize VX-770, VX-809, VX-661 and any other compounds discovered during the course of the research collaboration with CFFT. We will pay royalties to CFFT on the net sales of any approved drugs discovered in the collaboration.

### Fan Pier Leases

In May 2011, we entered into two leases, pursuant to which we agreed to lease approximately 1.1 million square feet of office and laboratory space in two buildings to be built at Fan Pier in Boston, Massachusetts. These leases will commence upon completion of the buildings, scheduled for late 2013, and will extend for 15 years from the commencement date. Pursuant to the leases, we will pay an average of approximately $72.5 million per year in aggregate rent, exclusive of operating expenses, for both buildings during the initial 15-year term of the leases.

### Alios BioPharma, Inc.

In June 2011, we entered into a license and collaboration agreement with Alios BioPharma, Inc., or Alios. Under the agreement, we agreed to collaborate with Alios on the research, development and commercialization of two nucleotide analogues discovered by Alios, ALS-2200 and ALS-2158, which act on the hepatitis C polymerase. Alios plans to initiate Phase 1 clinical trials of ALS-2200 and ALS-2158 in the fourth quarter of 2011. We are responsible for costs related to development and commercialization of the compounds, including manufacturing costs, and will provide research funding to Alios to conduct a program directed to the discovery of additional HCV nucleotide analogues. Under the terms of the collaboration agreement, we received exclusive worldwide rights to ALS-2200 and ALS-2158 and have the option to select additional compounds discovered in the research program. We paid Alios a $60.0 million up-front payment, and Alios is eligible to receive research and development milestone payments of up to $715.0 million if both compounds are approved and commercialized. Alios also is eligible to receive commercial milestone payments of up to $750.0 million, as well as tiered royalties, on net sales of any approved drugs.

### Clinical Developments

#### Cystic Fibrosis Combination Clinical Trials

In June 2011, we announced interim data from Part 1 of a Phase 2 clinical trial designed to evaluate multiple combination regimens of VX-770 and VX-809, which enrolled 62 patients with CF with the F508del mutation on both alleles. Part 1 of the clinical trial evaluated a 200 mg dose of VX-809, or placebo, alone for 14 days and then in combination with two doses of VX-770, or placebo, for 7 days.

In Part 1 of this clinical trial no serious adverse events were reported, and the adverse event profile observed during the 14-day portion of the clinical trial in which VX-809 was dosed as monotherapy was similar to the profile observed during the subsequent 7-day portion in which VX-809 and VX-770 were dosed in combination. Safety is a primary endpoint of the clinical trial, and we believe the interim safety data support further clinical evaluations of combination regimens involving a cystic fibrosis transmembrane conductance regulator, or CFTR, potentiator and a CFTR corrector.

Another primary endpoint of this clinical trial is the effect on CFTR function as measured by sweat chloride levels during the combination-dosing portion of the clinical trial. Elevated sweat chloride levels—high levels of salt in sweat—occur in CF patients and result directly from defective CFTR activity in epithelial cells in the sweat ducts. Patients with CF typically have elevated sweat chloride levels that are in excess of 60 mmol/L, compared to normal values of less than 40 mmol/L. In Part 1 of this clinical trial, the mean baseline sweat chloride level across the three arms was approximately 100 mmol/L. In the first 14 days, patients receiving VX-809 had a mean decrease in sweat chloride from baseline of -4.21 mmol/L (p=0.008), while patients receiving placebo had a decrease in sweat chloride levels from baseline of -2.86 mmol/L (p=0.179). During the seven-day period in which patients received a combination of VX-809 and VX-770, (i) patients in the treatment arm receiving the higher dose of VX-770 (250 mg) had a -9.10 mmol/L (p\<0.001) decrease in sweat chloride levels compared to the values at the end of the 14-day period in which the patients received VX-809 alone and (ii) patients in the treatment arm receiving the lower dose of VX-770 (150 mg) had a -2.24 mmol/L (p\<0.163) decrease in sweat chloride levels compared to the values at the end of the 14-day period in which the patients received VX-809 alone.

We intend to initiate Part 2 of this Phase 2 clinical trial in the fourth quarter of 2011. In Part 2, we expect to evaluate longer periods of combination dosing of multiple doses of VX-770 and VX-809, including higher doses of VX-809. In addition, we plan to initiate a Phase 2a clinical trial of VX-770 and VX-661 by the end of 2011 that will evaluate patients with the F508del mutation on both alleles.

#### VX-222

In July 2011, we provided interim results from an ongoing Phase 2a clinical trial in patients with genotype 1 HCV designed to evaluate response-guided combination treatment regimens of telaprevir and VX-222. The primary endpoint of this trial is safety and tolerability, and secondary endpoints are on-treatment antiviral activity and the proportion of people in each treatment arm who achieve a sustained viral response.

The interim analysis included an analysis of end-of-treatment and post-treatment antiviral activity data from the two four-drug treatment arms consisting of telaprevir, VX-222, pegylated-interferon, or peg-IFN, and ribavirin, or RBV. In the treatment arm in which patients received the higher dose of VX-222, 15 of 30 patients, or 50%, had undetectable HCV RNA levels at both week 2 and week 8 and were eligible to stop all treatment after 12 weeks, and one of these patients relapsed during the twelve weeks following treatment. Of the 15 patients in this arm who were not eligible to stop all treatment after 12 weeks, 13 completed 24 weeks of treatment. In the treatment arm in which patients received the lower dose of VX-222, 11 of 29 patients, or 38%, had undetectable RNA levels at both week 2 and week 8 and were eligible to stop all treatment after 12 weeks, and two of these patients relapsed during the twelve weeks following treatment. Of the 18 patients in this arm who were not eligible to stop all treatment after 12 weeks, 14 completed 24 weeks of treatment. The following table summarizes the interim antiviral activity data from the two four-drug treatment arms of this clinical trial:

| Treatment Arm | Total Number of Patients | Patients with undetectable HCV RNA levels 12 weeks after end-of-treatment Patients with undetectable HCV RNA levels at end of treatment (Patients who were eligible for and completed 12 total weeks of treatment) (Patients who were ineligible for 12 weeks of treatment and completed 24 total weeks of treatment) | (All patients, including patients who discontinued treatment) | Patients with undetectable HCV RNA levels 24 weeks after beginning treatment |
| --- | ---: | --- | --- | --- |
| VX-222 (400 mg), telaprevir, peg-IFN and RBV | 30 | 93% (14/15) | 100% (13/13) | 90% (27/30) |
| VX-222 (100 mg), telaprevir, peg-IFN and RBV | 29 | 82% (9/11) | 93% (13/14) | 83% (24/29) |

Two patients in the treatment arm receiving the higher dose of VX-222 discontinued treatment before week 12 and did not have undetectable HCV RNA levels 12 weeks after end-of-treatment. Four people in the VX-222 (100 mg) treatment arm discontinued treatment before week 12 and two of these patients had undetectable HCV RNA levels 12 weeks after end-of-treatment. We did not have end-of-treatment data for one of the patients in the treatment arm receiving the lower dose of VX-222 who received 24 total weeks of treatment, and that patient is reflected as having detectable HCV RNA levels in the third and fourth column of the above table.

The most frequent adverse events observed in the four-drug treatment arms were fatigue, nausea, diarrhea, anemia, pruritis (itchiness) and rash. The majority of events were mild or moderate. Mild diarrhea occurred more frequently in the treatment arm in which patients received the higher dose of VX-222. Six patients discontinued treatment due to adverse events; three from each treatment arm. Two patients from each treatment arm discontinued treatment before week 12 and one patient in each treatment arm discontinued treatment between weeks 12 and 24 while they were receiving peg-IFN and RBV alone.

Additional treatment arms in the clinical trial are evaluating an all-oral, three-drug regimen consisting of VX-222, telaprevir and RBV, and we expect these treatment arms to complete enrollment in the third quarter of 2011. We are evaluating patients with genotype 1a HCV infection in one of these treatment arms, and patients with genotype 1b HCV infection in the second treatment arm.

#### VX-770

In addition to our plan to file applications for regulatory approval of VX-770 in the United States and European Union in October 2011, we plan to subsequently seek approval in certain other countries including Canada. These submissions will seek approval for VX-770 as a treatment for patients six years of age and older who have the G551D mutation on at least one allele.

In the first half of 2012, we are planning to initiate a clinical trial of a pediatric formulation of VX-770 that will enroll children younger than six years of age who have the G551D mutation on at least one allele. We also are planning to initiate two clinical trials of VX-770 that will enroll patients who have other CFTR mutations where, based on *in vitro* data, we believe VX-770 may help improve the function of the CFTR protein on the cell surface.

#### VX-787

VX-787 is our first drug candidate intended for the treatment of influenza. VX-787 aims to treat influenza in a way that is distinct from neuraminidase inhibitors, which are the current standard of care for the treatment of influenza. We have completed our pre-Investigational New Drug meeting with the FDA and intend to begin Phase 1 development of VX-787 in September 2011. If the clinical trials in healthy volunteers are successful, we could begin evaluating VX-787 in patients with influenza in the first half of 2012.

### Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our condensed consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States. The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenues and expenses during the reported periods. These items are monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are reflected in reported results for the period in which the change occurs. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate. During the six months ended June 30, 2011, there were no material changes to our critical accounting policies as reported in our Annual Report on Form 10-K for the year ended December 31, 2010 except:

#### Product Revenues, Net

In the second quarter of 2011, we began generating revenues in the United States from sales of INCIVEK. We sell INCIVEK principally to a limited number of major wholesalers, as well as selected regional wholesalers and specialty pharmacy providers, collectively our distributors, who subsequently resell INCIVEK to patients and healthcare providers. Separately, we have arrangements with numerous third-party payors that provide for government-mandated and privately-negotiated rebates, chargebacks and discounts.

We recognize net product revenues from sales of INCIVEK upon delivery to our distributors as long as:

there is persuasive evidence that an arrangement exists between us and our distributor;

collectibility is reasonably assured; and

the price is fixed or determinable.

We have written contracts with our distributors and delivery occurs when a distributor receives INCIVEK (freight on board destination). We evaluate the creditworthiness of each of our distributors and have determined that all of our material distributors are creditworthy. In order to conclude that the price is fixed or determinable, we must be able to calculate our gross product revenues from our distributors and reasonably estimate our net product revenues. Our gross product revenues are based on the fixed wholesale acquisition cost for INCIVEK that we charge our distributors. We estimate our net product revenues by deducting from our gross product revenues (i) trade allowances, such as invoice discounts for prompt payment and distributor fees, (ii) estimated government and private payor rebates, chargebacks and discounts, such as Medicaid reimbursements, (iii) reserves for expected product returns and (iv) estimated costs of incentives offered to certain indirect customers including patients. These estimates, and in particular the estimates for rebates, chargebacks and discounts and expected product returns, require us to make significant judgments that materially affect our recognition of net product revenues on sales of INCIVEK.

The value of the rebates, chargebacks and discounts provided to third-party payors per course of treatment vary significantly and are based on government-mandated discounts and our arrangements with other third-party payors. Typically, government-mandated discounts are significantly larger than discounts provided to other third-party payors. In order to estimate our total rebates, chargebacks and discounts, we estimate the percentage of prescriptions that will be covered by each third-party payor, which is referred to as the payor mix. In order to estimate the payor mix for INCIVEK in the second quarter of 2011, we used both (i) information obtained from our distributors and third parties regarding the payor mix for INCIVEK that has been prescribed since we began marketing INCIVEK in May 2011 and (ii) historical industry information regarding the payor mix for peg-IFN and RBV. Based on this information, we have estimated that approximately 30% of the initial patients receiving INCIVEK will be covered by a third-party payor entitled to a government-mandated discount. We will track available information regarding changes, if any, to the payor mix for INCIVEK, to our contractual terms with third-party payors and to applicable governmental programs and regulations. If necessary, we will adjust our estimated rebates, chargebacks and discounts based on new information, including information regarding actual rebates, chargebacks and discounts for INCIVEK, as it becomes available. If we increased our estimate of the percentage of patients receiving INCIVEK covered by third-party payors entitled to government-mandated discounts by five percentage points, our net product revenues would decrease by less than 1% for the three months ended June 30, 2011.

Our distributors have the right to return unopened unprescibed INCIVEK beginning six months prior to the labeled expiration date and ending twelve months after the labeled expiration date. The expiration date for INCIVEK is two years after it has been converted into tablet form, which is the last step in the manufacturing process for INCIVEK and generally occurs within a few months before INCIVEK is delivered to distributors. As of June 30, 2011, we have not received any product returns. As of mid-July 2011, we believe that a high percentage of the INCIVEK sold to our distributors in the second quarter of 2011 has been prescribed to patients. In the second quarter of 2011, based on our specialty distribution model with sales to a limited number of distributors, data provided to us by our distributors, including weekly reporting of distributor sales and inventory levels, and by other third parties, historical industry information regarding return rates for similar specialty pharmaceutical products, the estimated remaining shelf life of INCIVEK previously shipped and currently being shipped, and contractual agreements with our distributors intended to limit the amount of inventory they maintain, we have estimated that product returns for INCIVEK sold to distributors in the second quarter of 2011 will be less than 1%. We will track actual returns by individual production lots and will continue to monitor inventory levels. If necessary, we will adjust our estimated product returns based on new information as it becomes available.

#### Variable Interest Entity and Collaborative Arrangements—Alios BioPharma, Inc.

In June 2011, we entered into an agreement with Alios pursuant to which we agreed to collaborate on the research, development and commercialization of ALS-2200 and ALS-2158, two HCV nucleotide analogues discovered by Alios. We are responsible for all expenses related to the development and commercialization of the Alios compounds incurred after the effective date of the agreement, including manufacturing costs for the supply of ALS-2200 and ALS-2158 after the effective date, and will provide research funding to Alios. We paid Alios a $60.0 million up-front payment, and Alios is eligible to receive research and development milestone payments, commercial milestone payments and tiered royalties on net sales of any approved drugs licensed by us under the collaboration agreement. Our interests in Alios are limited to those accorded to us pursuant to our collaboration agreement with Alios, and we have no equity interest, or right to acquire any equity interest, in Alios. In addition to Alios' activities related to HCV nucleotide analogues, Alios is engaged in separate programs directed at developing novel drugs.

Our collaboration with Alios requires us to apply accounting policies that involve significant judgments and that have a material effect on our condensed consolidated financial statements. Under applicable accounting guidance, as a result of the relationship established through the collaboration agreement, Alios is deemed to be a variable interest entity, or VIE. Because we acquired an exclusive license to certain intellectual property belonging to the VIE, and based on the significance of the two licensed compounds to Alios taken as a whole, the collaboration is treated for accounting purposes as if we have acquired an interest in the entire VIE. In the Alios collaboration, where (a) through the joint steering committee, we have the power to direct the development and commercialization of the two licensed compounds, which are the activities that most significantly impact the economic performance of Alios, (b) we are required to fund research and development activities related to the licensed assets and (c) we are entitled to receive a majority of the potential revenues from sales of drugs developed pursuant to the collaboration, we are deemed under accounting guidance to be the primary beneficiary of a VIE that is a business, and as a consequence, are required to consolidate the VIE's financial statements into our financial statements.

We believe that the following effects of the consolidation on our condensed consolidated financial statements are the most significant:

We reflect all of Alios' cash and cash equivalents as restricted cash and cash equivalents (Alios) when we consolidate Alios' balance sheet. We do not have any rights to Alios' cash or cash equivalents; these resources are not available to fund research and development programs pursuant to the collaboration and these amounts do not provide us with any additional liquidity. As a result of the $60.0 million up-front payment that we made to Alios in June 2011, Alios had significant liquid assets as of June 30, 2011. Alios has control over the restricted cash and cash equivalents (Alios), including the ability to distribute the restricted cash and cash equivalents to Alios' equityholders, and as a result this asset, although carried on our balance sheet, is not included in the discussion of our liquidity and should be disregarded when evaluating our financial condition.

We recorded $250.6 million of intangible assets based on our preliminary estimate of the fair value of Alios' in-process research and development assets as of the transaction date. We determined the preliminary fair value of these in-process research and development assets using probability-weighted present-value models and made significant estimates regarding: the probability of obtaining regulatory approval of an HCV nucleotide analogue; the timing and expected costs of clinical trials and other development activities; future potential cash flows from sales of drugs and the appropriate discount rates. If we are successful in developing one or more HCV nucleotide analogues, we will amortize the carrying value of the intangible asset as part of cost of product revenues. We will test these in-process research and development assets for impairment on an annual basis as of October 1, and more frequently if indicators are present or changes in circumstances suggest that impairment may exist. If these in-process research and development assets become impaired, we could record significant charges in the period in which the impairment occurs.

In each period, we will consolidate all of Alios' expenses and revenues, if any, into our condensed consolidated statements of operations, eliminating all intercompany balances and transactions. As of June 2011, Alios had approximately 30 employees and is responsible, subject to our oversight, for most of the research and development activities that will occur in the early phase of the collaboration. In the second quarter of 2011, Alios' operating expenses were immaterial to our condensed consolidated statements of operations. In future periods, if Alios increases its headcount and/or expands its activities related to its other programs, its operating expenses could increase substantially. To the extent that Alios pursues other programs, we expect that expenses of Alios related to those activities would be reflected in our research and development expenses and our sales, general and administrative expenses as a result of the financial statement consolidation. We would not be entitled to any benefits from those activities.

In each period, we will record a net loss (gain) attributable to the Alios noncontrolling interest. This net loss (gain) reflects Alios' net (loss) gain for the period as adjusted for gains and losses in the fair value of the contingent milestone and royalty payments payable by us to Alios. Determining the fair value of the contingent milestone and royalty payments payable by us to Alios requires us to make significant estimates regarding the probability and potential timing of achieving each of the milestones pursuant to the agreement; future potential net sales of HCV nucleotide analogues licensed from Alios and appropriate discount rates. In future periods, we expect that the net loss (gain) attributed to noncontrolling interest (Alios) could be significantly adjusted on account of changes in the fair value of the contingent milestone and royalty payments. For example, if we successfully advance one or more of Alios' HCV nucleotide analogues into later-stage clinical development, the fair value of the contingent milestone and royalty payments could increase significantly due to increases in the likelihood of achieving milestones and obtaining regulatory approvals, together with decreases in the time period over which we are discounting potential milestone and royalty payments. Increases in the fair value of the contingent milestone and royalty payments could result in significant net gains attributable to the noncontrolling interest (Alios) on our condensed consolidated statements of operations.

### Results of Operations—Three and Six Months Ended June 30, 2011 Compared with Three and Six Months Ended June 30, 2010

*(in thousands)*

*(in thousands)*

|  | Three Months Ended June 30, Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Six Months Ended June 30, |  |  |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Revenues | $114,424 | $31,622 | $82,802 | 262% | $188,086 | $54,051 | $134,035 | 248% |
| Operating costs and expenses | 280,314 | 201,195 | 79,119 | 39% | 513,875 | 383,906 | 129,969 | 34% |
| Non-operating expenses | 8,980 | 30,433 | (21,453) | (70)% | 25,177 | 35,422 | (10,245) | (29)% |
| Net loss attributable to Vertex | $174,069 | $200,006 | $(25,937) | (13)% | $350,165 | $365,277 | $(15,112) | (4)% |

#### Net Loss Attributable to Vertex

Our net losses (excluding those attributable to the Alios noncontrolling interests) in the second quarter and first half of 2011 decreased as compared to our net losses in the second quarter and first half of 2010, due to significant increases in our revenues and decreases in our non-operating expenses, partially offset by significant increases in our operating costs and expenses. Our increased revenues were the result of INCIVEK net product revenues recognized in the second quarter of 2011 and $50.0 million in milestone revenues from Janssen recognized in the first quarter of 2011, for which there were no comparable revenues in the first half of 2010. The significant increases in our operating costs and expenses in the second quarter and first half of 2011 as compared to the second quarter and first half of 2010 were primarily the result of the expansion of our commercial organization and costs related to initiating sales of INCIVEK in the United States.

#### Net Loss Attributable to Vertex per Common Share

Our net loss attributable to Vertex for the three months ended June 30, 2011 was $0.85 per basic and diluted common share compared to $1.00 for the three months ended June 30, 2010. Our net loss attributable to Vertex for the six months ended June 30, 2011 was $1.72 per basic and diluted common share compared to $1.83 for the six months ended June 30, 2010. These decreases in net loss attributable to Vertex per common share for the three and six months ended June 30, 2011 compared to the comparable periods in 2010 were the result of the decreases in our net loss together with small increases in the basic and diluted weighted-average number of common shares outstanding.

#### Stock-based Compensation and Certain Other Expenses

The comparisons of our costs and expenses during the three and six months ended June 30, 2011 and 2010 reflects changes in our levels of stock-based compensation expense and expense related to our September 2009 financial transactions. Our stock-based compensation expense has increased due to the expansion of our workforce and increased expenses related to equity awards that include performance-based accelerated vesting provisions. The stock-based compensation expense related to the equity awards with performance-based accelerators increased as we progressed INCIVEK through the final stages of development in 2010, obtained approval for INCIVEK in the second quarter of 2011 and received positive results from our VX-770 registration program in the first half of 2011. Non-cash expenses related to our September 2009 financial transactions were significantly lower in the three and six months ended June 30, 2011 as compared to the three and six months ended June 30, 2010.

Our costs and expenses in the three and six months ended June 30, 2011 and 2010 included the following:

*(in thousands)*

|  | Three Months Ended June 30, 2011 | 2010 | Six Months Ended June 30, 2011 | 2010 |
| --- | ---: | ---: | ---: | ---: |
| Stock-based compensation expense | $31,879 | $24,449 | $59,758 | $43,782 |
| Restructuring expense | 741 | 2,112 | 1,501 | 2,892 |
| September 2009 financial transaction expenses | 5,083 | 30,936 | 18,615 | 36,008 |

### Revenues

*(in thousands)*

*(in thousands)*

|  | Three Months Ended June 30, Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Six Months Ended June 30, |  |  |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Product revenues, net | $74,535 | $— | $74,535 | n/a | $74,535 | $— | $74,535 | n/a |
| Royalty revenues | 10,010 | 7,262 | 2,748 | 38% | 16,071 | 13,669 | 2,402 | 18% |
| Collaborative revenues | 29,879 | 24,360 | 5,519 | 23% | 97,480 | 40,382 | 57,098 | 141% |
| Total revenues | $114,424 | $31,622 | $82,802 | 262% | $188,086 | $54,051 | $134,035 | 248% |

In the second quarter of 2011, we began recognizing net product revenues from sales in the United States of INCIVEK, which was approved by the FDA on May 23, 2011. Prior to the second quarter of 2011, our total revenues consisted primarily of collaborative revenues, which have fluctuated significantly on a quarterly basis. This variability has been due to, among other things: the timing of recognition of up-front payments and significant milestone revenues, the variable level of net reimbursement we have received for the telaprevir development program from Janssen, and revenues from services we provided to our telaprevir collaborators through our third-party manufacturing network.

### Product Revenues, Net

We began recognizing net product revenues on sales of INCIVEK in the United States in the second quarter of 2011. Our net product revenues in the second quarter of 2011 were $74.5 million, representing INCIVEK that was delivered to our distributors between May 23, 2011 and June 30, 2011. We expect these revenues on a quarterly basis to increase during the remainder of 2011 as compared to the second quarter of 2011.

### Royalty Revenues

Janssen has agreed to pay us royalties on sales of telaprevir in Janssen's territories, including sales pursuant to early access programs that are authorized by certain European countries. In the second quarter of 2011, our royalty revenues reflect $2.5 million of royalty revenues due to sales of INCIVO by Janssen to the French government pursuant to an early access program. Janssen has obtained a positive opinion from the EMA recommending approval of INCIVO and expects a response from the European Commission in the third quarter of 2011. We expect that our royalty revenues related to INCIVO will increase significantly once Janssen obtains marketing approval and begins marketing INCIVO in the European Union.

The rest of our royalty revenues in the second quarter of 2011 and all of our royalty revenues in periods prior to the second quarter of 2011 relate to sales by GlaxoSmithKline plc of HIV protease inhibitors that were discovered and developed pursuant to our collaboration with GlaxoSmithKline. In 2008, we sold our right to receive future royalties from GlaxoSmithKline with respect to these HIV protease inhibitors, excluding the portion allocated to pay a subroyalty on these net sales to a third party, in return for a one-time cash payment. We deferred the recognition of revenues from this sale and are recognizing these deferred revenues over the term of our agreement with GlaxoSmithKline under the units-of-revenue method. We recognize additional royalty revenues equal to the amount of a third-party subroyalty and an offsetting royalty expense for the third-party subroyalty payment.

### Collaborative Revenues

The table presented below is a summary of revenues from our collaborative arrangements for the three and six months ended June 30, 2011 and 2010:

*(in thousands)*

|  | Three Months Ended June 30, 2011 | 2010 | Six Months Ended June 30, 2011 | 2010 |
| --- | ---: | ---: | ---: | ---: |
| Janssen | $9,058 | $11,882 | $65,174 | $18,346 |
| Mitsubishi Tanabe | 14,873 | 12,036 | 26,358 | 21,594 |
| CFFT | 5,948 | — | 5,948 | — |
| Other | — | 442 | — | 442 |
| Total collaborative revenues | $29,879 | $24,360 | $97,480 | $40,382 |

We recognized $50.0 million in milestone revenues under our collaboration agreement with Janssen in the first half of 2011 related to the acceptance of the filing of the MAA for INCIVO. The $50.0 million milestone payment was applied to the redemption of $50.0 million of 2012 Notes, as required pursuant to the terms of the 2012 Notes. In the second half of 2011, we believe we will achieve one or more of the additional $200.0 million in potential Janssen milestone payments related to the approval and launch of INCIVO in the European Union. We are obligated to apply the proceeds from the next $105.0 million of these milestone payments toward the redemption of the remaining $105.0 million of 2012 Notes. The final $95.0 million in milestone payments related to the potential launch of INCIVO in the European Union are to be paid by Janssen directly to the purchaser of these milestone payments.

In each of the three and six months ended June 30, 2011 and 2010, we recognized $9.6 million and $19.1 million of deferred revenues from Mitsubishi Tanabe related to a one-time payment of $105.0 million that we received in 2009. We expect to continue recognizing $9.6 million of deferred revenues each quarter from the one-time payment of $105.0 million through the first quarter of 2012.

In the second quarter of 2011, we began recognizing collaborative revenues pursuant to the April 2011 amendment to our collaboration agreement with CFFT.

### Costs and Expenses

*(in thousands)*

*(in thousands)*

|  | Three Months Ended June 30, Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Six Months Ended June 30, |  |  |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Cost of product revenues | $5,404 | $— | $5,404 | n/a | $5,404 | $— | $5,404 | n/a |
| Research and development expenses | 173,604 | 155,082 | 18,522 | 12% | 332,216 | 298,094 | 34,122 | 11% |
| Sales, general and administrative expenses | 96,663 | 40,915 | 55,748 | 136% | 168,186 | 76,467 | 91,719 | 120% |
| Royalty expenses | 3,902 | 3,086 | 816 | 26% | 6,568 | 6,453 | 115 | 2% |
| Restructuring expense | 741 | 2,112 | (1,371) | (65)% | 1,501 | 2,892 | (1,391) | (48%) |
| Total costs and expenses | $280,314 | $201,195 | $79,119 | 39% | $513,875 | $383,906 | $129,969 | 34% |

Our operating costs and expenses primarily relate to our research and development expenses and our sales, general and administrative expenses. Our research and development expenses have been increasing due to the expanding scope of activities related to the development of and regulatory submissions for our clinical drug candidates. Our sales, general and administrative expenses have increased substantially as we increased our headcount, expanded our capabilities in preparation for the commercial launch of INCIVEK and began incurring marketing expenses.

### Cost of Product Revenues

Our cost of product revenues consists of the costs of producing INCIVEK inventories that correspond to product revenues for the reporting period plus the third-party royalties payable on net sales of INCIVEK. We began capitalizing INCIVEK inventory on January 1, 2011. As a result, we expensed most of the manufacturing costs of INCIVEK sold in the second quarter of 2011 as research and development expenses in periods prior to January 1, 2011. We expect our cost of product revenues to increase as a percentage of net sales in future periods.

### Research and Development Expenses

*(in thousands)*

*(in thousands)*

|  | Three Months Ended June 30, Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Six Months Ended June 30, |  |  |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Research expenses | $51,733 | $45,776 | $5,957 | 13% | $103,104 | $91,730 | $11,374 | 12% |
| Development expenses | 121,871 | 109,306 | 12,565 | 11% | 229,112 | 206,364 | 22,748 | 11% |
| Total research and development expenses | $173,604 | $155,082 | $18,522 | 12% | $332,216 | $298,094 | $34,122 | 11% |

Our research and development expenses include internal and external costs incurred for our drug candidates, including VX-770. We do not assign our internal costs, such as salary and benefits, stock-based compensation expense, laboratory supplies and infrastructure costs, to individual drug candidates, because the employees within our research and development groups typically are deployed across multiple research and development programs. These internal costs are significantly greater than our external costs, such as the costs of services provided to us by clinical research organizations and other outsourced research, which we do allocate by individual drug development program. All research and development costs for our drug candidates are expensed as incurred.

To date, we have incurred in excess of $4.3 billion in research and development expenses associated with drug discovery and development. The successful development of our drug candidates is highly uncertain and subject to a number of risks. In addition, the duration of clinical trials may vary substantially according to the type, complexity and novelty of the drug candidate and the disease indication being targeted. The FDA and comparable agencies in foreign countries impose substantial requirements on the introduction of therapeutic pharmaceutical products, typically requiring lengthy and detailed laboratory and clinical testing procedures, sampling activities and other costly and time-consuming procedures. Data obtained from nonclinical and clinical activities at any step in the testing process may be adverse and lead to discontinuation or redirection of development activity. Data obtained from these activities also are susceptible to varying interpretations, which could delay, limit or prevent regulatory approval. The duration and cost of discovery, nonclinical studies and clinical trials may vary significantly over the life of a project and are difficult to predict. Therefore, accurate and meaningful estimates of the ultimate costs to bring our drug candidates to market are not available.

Over the last several years costs related to INCIVEK have represented the largest portion of the development costs for our clinical drug candidates. We have obtained approval for INCIVEK, but expect to continue to incur telaprevir development costs related to the conduct of additional clinical trials to support potential supplemental applications. We are planning to submit an NDA and an MAA for VX-770 in October 2011 and could begin receiving product revenues from VX-770, if approved, in 2012. Our other drug candidates are less advanced and, as a result, any estimates regarding development and regulatory timelines for these drug candidates are highly subjective and subject to change. We cannot make a meaningful estimate when, if ever, these drug candidates, including the drug candidates we acquired in our ViroChem acquisition and those we in-licensed from Alios, will generate revenues and cash flows.

#### Research Expenses

*(in thousands)*

*(in thousands)*

| Research Expenses: | Three Months Ended June 30, Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Six Months Ended June 30, |  |  |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Salary and benefits | $17,798 | $16,129 | $1,669 | 10% | $35,750 | $32,614 | $3,136 | 10% |
| Stock-based compensation expense | 6,634 | 6,277 | 357 | 6% | 12,889 | 11,925 | 964 | 8% |
| Laboratory supplies and other direct expenses | 8,258 | 7,460 | 798 | 11% | 16,047 | 15,160 | 887 | 6% |
| Contractual services | 2,730 | 1,321 | 1,409 | 107% | 5,744 | 4,259 | 1,485 | 35% |
| Infrastructure costs | 16,313 | 14,589 | 1,724 | 12% | 32,674 | 27,772 | 4,902 | 18% |
| Total research expenses | $51,733 | $45,776 | $5,957 | 13% | $103,104 | $91,730 | $11,374 | 12% |

We have maintained a substantial investment in research activities with changes in various categories of expense resulting in increases of 13% and 12% in research expenses in the three and six months ended June 30, 2011, respectively, as compared to the comparable periods in 2010. We expect to continue to invest in our research programs in an effort to identify additional drug candidates.

#### Development Expenses

*(in thousands)*

*(in thousands)*

| Development Expenses: | Three Months Ended June 30, Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Six Months Ended June 30, |  |  |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Salary and benefits | $31,504 | $25,208 | $6,296 | 25% | $61,288 | $50,195 | $11,093 | 22% |
| Stock-based compensation expense | 13,819 | 11,458 | 2,361 | 21% | 26,113 | 20,130 | 5,983 | 30% |
| Laboratory supplies and other direct expenses | 8,391 | 8,214 | 177 | 2% | 15,740 | 14,447 | 1,293 | 9% |
| Contractual services | 35,316 | 24,677 | 10,639 | 43% | 63,807 | 46,898 | 16,909 | 36% |
| Commercial supply costs | 9,680 | 18,549 | (8,869) | (48)% | 15,394 | 35,024 | (19,630) | (56)% |
| Infrastructure costs | 23,161 | 21,200 | 1,961 | 9% | 46,770 | 39,670 | 7,100 | 18% |
| Total development expenses | $121,871 | $109,306 | $12,565 | 11% | $229,112 | $206,364 | $22,748 | 11% |

In the first half of 2010, our commercial supply costs included both costs of raw materials and work in process that we were producing for the commercial launch of INCIVEK and costs of manufacturing services that we provided our collaborators through our third-party manufacturing network. On January 1, 2011, we began to capitalize our INCIVEK inventory, which resulted in decreases of $8.9 million and $19.6 million, respectively, in the commercial supply costs in the three and six months ended June 30, 2011 as compared to the three and six months ended June 30, 2010.

Our development expenses, excluding our commercial supply costs, increased by $21.4 million, or 24%, in the three months ended June 30, 2011 as compared to the three months ended June 30, 2010, and by $42.4 million, or 25%, in the six months ended June 30, 2011 as compared to the six months ended June 30, 2010. These increases were primarily due to increased workforce expenses and contractual services expenses. The increased workforce expenses were largely attributable to hiring additional employees in our medical affairs and safety groups in preparation for the commercial launch of INCIVEK.

### Sales, General and Administrative Expenses

*(in thousands)*

*(in thousands)*

|  | Three Months Ended June 30, Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Increase/ (Decrease) $ 2011 | Increase/ (Decrease) % 2010 | Six Months Ended June 30, |  |  |  |
| --- | ---: | ---: | ---: | ---: | ---: | ---: | ---: | ---: |
| Sales, general and administrative expenses | $96,663 | $40,915 | 55,748 | 136% | $168,186 | $76,467 | $91,719 | 120% |

Sales, general and administrative expenses increased substantially in the three and six months ended June 30, 2011 as compared to the comparable periods in 2010, primarily as a result of substantial increases in expenses incurred by our commercial organization, which are classified as sales expenses. The sales expenses increased from $14.4 million in the second quarter of 2010 to $62.4 million in the second quarter of 2011 and from $24.8 million in the first half of 2010 to $103.4 million in the first half of 2011. These sales expenses include salary and benefits for our sales force and managed market organization, the majority of whom were hired in the second half of 2010, and market research and other third-party expenses incurred in connection with the launch of INCIVEK. We expect that these sales expenses will continue to increase during the remainder of 2011.

### Royalty Expenses

Royalty expenses increased by $0.8 million, or 26%, in the second quarter of 2011 as compared to the second quarter of 2010, and increased by $0.1 million or 2%, in the first half of 2011 as compared to the first half of 2010. Royalty expenses primarily relate to a subroyalty payable to a third party on net sales of the HIV protease inhibitors that were discovered and developed under our collaboration with GlaxoSmithKline plc. The subroyalty expense offsets a corresponding amount of royalty revenues. We expect to continue to recognize this subroyalty as an expense in future periods.

### Restructuring Expense

As of June 30, 2011, our lease restructuring liability was $28.2 million. Our restructuring expense was $0.7 million in the second quarter of 2011 compared to the $2.1 million in the second quarter of 2010. Our restructuring expense was $1.5 million in the first half of 2011 compared to the $2.9 million in the first half of 2010. During the second half of 2011, we expect to make additional cash payments of $7.4 million against the accrued expense and to receive $4.7 million in sublease rental payments.

### Non-operating Items

### Interest Income

Interest income decreased by $0.3 million to $0.2 million for the three months ended June 30, 2011 from $0.5 million for the three months ended June 30, 2010. Interest income increased by $0.7 million to $1.6 million for the six months ended June 30, 2011 from $0.9 million for the six months ended June 30, 2010. Our cash, cash equivalents and marketable securities yielded less than 1% on an annual basis in the second quarter of 2011.

### Interest Expense

Interest expense increased by $3.3 million, or 89%, to $7.0 million in the second quarter of 2011 from $3.7 million in the second quarter of 2010. Interest expense increased by $11.3 million, or 148%, to $19.0 million in the first half of 2011 from $7.6 million in the first half of 2010. These increases were primarily the result of the 3.35% convertible senior subordinated notes due 2015, or 2015 Notes, we issued in September 2010. In the second half of 2011, we expect to incur approximately $6.7 million in interest expense related to the 2015 Notes and that we will continue to incur imputed interest expense related to our 2012 Notes.

### Change in Fair Value of Derivative Instruments

In the second quarter of 2011 and 2010, we recorded charges of $2.2 million and $27.2 million, respectively, in connection with the embedded and free-standing derivatives associated with our September 2009 financial transactions. In the first half of 2011 and 2010, we recorded charges of $7.8 million and $28.7 million, respectively, in connection with the embedded and free-standing derivatives associated with our September 2009 financial transactions. If Janssen obtains approval for and launches INCIVO in the European Union, we expect that we will incur $18.2 million in additional non-cash charges related to the September 2009 financial transactions. We expect a portion of these charges to be reflected as a change in the fair value of derivative instruments and a portion of these charges to be reflected as interest expense.

### Noncontrolling Interest (Alios)

The net loss (gain) attributable to noncontrolling interest (Alios) recorded on our condensed consolidated statements of operations reflects Alios' net (loss) income for the reporting period, excluding revenues related to the up-front payment we made to Alios and adjusted for any changes during the reporting period in the fair value of the contingent milestone and royalty payments potentially payable by us to Alios. A summary of net loss attributable to noncontrolling interest (Alios) for the second quarter of 2011 is as follows:

*(in thousands)*

|  | Three Months Ended June 30, 2011 |
| --- | ---: |
| Loss of noncontrolling interest (Alios) before provision for income taxes | $(801) |
| Income tax provision (Alios) | (24,448) |
| Change in fair value of contingent milestone and royalty payments | — |
| Net loss attributable to noncontrolling interest (Alios) | $(25,249) |

We reduced our net loss by this $25.2 million net loss attributable to noncontrolling interest (Alios) in order to determine the net loss attributable to Vertex. For the three and six months ended June 30, 2011, the $25.2 million net loss represents expenses incurred by Alios between June 13, 2011 and June 30, 2011 that are not reimbursed by us pursuant to our collaboration agreement with Alios and an income tax provision (Alios). In future periods, the net loss (gain) attributable to noncontrolling interest (Alios) could have a material effect on the net loss attributable to Vertex, particularly if there is a significant change in the fair value of the contingent milestone and royalty payments payable by us to Alios.

### Liquidity and Capital Resources

At June 30, 2011, we had cash, cash equivalents and marketable securities, excluding Alios' cash and cash equivalents, of $593.5 million, which was a decrease of $437.9 million from $1.0 billion at December 31, 2010. This decrease was the result of cash expenditures we made in the first half of 2011 related to, among other things, research and development expenses, sales, general and administrative expenses, the $60.0 million up-front payment we made to Alios and capital expenditures for property and equipment of $15.3 million. These cash expenditures were partially offset by $88.7 million in cash received from issuances of common stock from employee benefit plans in the first half of 2011. We expect to begin receiving cash flows from INCIVEK in the third quarter of 2011.

We believe that our current cash, cash equivalents and marketable securities, together with our expected cash flows from telaprevir, will be sufficient to fund our operations for at least the next twelve months. If we meet our expectations for sales of INCIVEK, we believe we will begin generating earnings as a cash flow positive company during 2012. If our cash flows from telaprevir, together with cash flows from VX-770, if approved, are not sufficient, we may be required to seek additional capital, significantly curtail or discontinue one or more of our research or development programs, including clinical trials, which could involve significant cash exit costs, or attempt to obtain funds through arrangements with collaborators or others that may require us to relinquish rights to certain of our drug candidates.

#### Sources of Liquidity

We have financed our operations principally through public and private offerings of our equity and debt securities, strategic collaborative agreements that include research and/or development funding, development milestones and royalties on the sales of products, strategic sales of assets or businesses, financial transactions, investment income and proceeds from the issuance of common stock under our employee benefit plans.

Beginning in the third quarter of 2011, we plan to rely on cash flows from product sales as our primary source of liquidity. As of June 30, 2011, we had $79.0 million in accounts receivable, net related to sales of INCIVEK in the United States. Because our contracts with our distributors provide for customary prompt payment discounts, we expect that in the third quarter of 2011 our distributors will pay the accounts receivable that were outstanding on June 30, 2011 and we will receive additional payments for a portion of the INCIVEK that is sold to our distributors in the third quarter of 2011. We are seeking approval to market INCIVEK in Canada and plan to submit applications for regulatory approval of VX-770 in the United States and the European Union in October 2011, which could begin providing additional cash flows over the next twelve months. In addition to cash flows from product sales, we expect to begin receiving cash flows from royalties payable by Janssen on INCIVO beginning in early 2012.

We may seek to borrow funds to finance our working capital needs if such financing is available to us. Our existing $100.0 million credit facility is initially unsecured, but is subject to a number of affirmative and negative covenants, including a liquidity covenant that requires us to maintain cash, cash equivalents and marketable securities of more than $400.0 million in domestic accounts. If we breach any of these covenants and it results in an event of default, upon the event of default the lender would obtain a security interest in cash, cash equivalents and marketable securities having a margined value of $100.0 million, which would be transferred to an account controlled by the lender. The credit agreement terminates on July 6, 2012.

#### Future Capital Requirements

We are incurring substantial expenses to commercialize INCIVEK, while at the same time continuing diversified research and development efforts for our drug candidates and expanding our organization. Our operating expenses have increased in recent periods as we expanded our organization and launched commercial sales of INCIVEK, with our total operating expenses excluding stock-based compensation expense equaling $248.4 million in the second quarter of 2011 as compared to $176.7 million in the second quarter of 2010. The adequacy of our available funds to meet our future operating and capital requirements will depend on many factors, including the timing and amounts of revenues generated by telaprevir, the timing of regulatory approvals for VX-770, the number, breadth, cost and prospects of our discovery and development programs, and our decisions regarding manufacturing and commercial investments.

In addition to funding our operating expenses, we have entered into the following transactions that affect our liquidity:

We had $105.0 million in 2012 Notes outstanding on June 30, 2011, which was a decrease of $50.0 million from $155.0 million on December 31, 2010. The 2012 Notes mature on October 31, 2012, but, pursuant to mandatory redemption provisions set forth in the 2012 Notes, we expect to redeem these 2012 Notes prior to maturity with the proceeds of milestone payments from Janssen. In September 2009, we also sold our rights to receive an additional $95.0 million of potential future milestone payments that we expect to receive from Janssen for the launch of INCIVO in the European Union. As a result of these transactions, the $200.0 million of remaining potential milestone payments from Janssen related to the approval and launch of INCIVO in the European Union, if and when earned, will not provide us with liquidity except to the extent that they fund the redemption of the remaining $105.0 million of our 2012 Notes.

At June 30, 2011, we had outstanding $400.0 million in aggregate principal amount of 2015 Notes. The 2015 Notes bear interest at the rate of 3.35% per annum, and we are required to make semi-annual interest payments on the outstanding principal balance of the 2015 Notes on April 1 and October 1 of each year. The 2015 Notes will mature on October 1, 2015. The 2015 Notes are convertible, at the option of the holder, into our common stock at a price equal to approximately $48.83 per share, subject to adjustment.

#### Financing Strategy

Although we do not have any plans to do so in the near term, we may raise additional capital through public offerings or private placements of our securities, securing new collaborative agreements or other methods of financing. Any such capital transactions may or may not be similar to transactions in which we have engaged in the past. As part of our strategy for managing our capital structure, we have from time to time adjusted the amount and maturity of our debt obligations through new issues, privately negotiated transactions and market purchases, depending on market conditions and our perceived needs at the time. We expect to continue pursuing a general financial strategy that may lead us to undertake one or more additional transactions with respect to our outstanding debt obligations, and the amounts involved in any such transactions, individually or in the aggregate, may be material. Any such transaction related to our outstanding debt obligations may or may not be similar to transactions in which we have engaged in the past. We will continue to manage our capital structure and to consider all financing opportunities, whenever they may occur, that could strengthen our long-term liquidity profile. There can be no assurance that any such financing opportunities will be available on acceptable terms, if at all.

### Contractual Commitments and Obligations

Our commitments and obligations were reported in our Annual Report on Form 10-K for the year ended December 31, 2010, which was filed with the Securities and Exchange Commission, or SEC, on February 17, 2011. There have been no material changes from the contractual commitments and obligations previously disclosed in that Annual Report on Form 10-K, as updated by the Form 10-Q for the quarter ended March 31, 2011, which was filed with the SEC on May 6, 2011, except:

In the second quarter of 2011, we agreed to lease approximately 1.1 million square feet of office and laboratory space in two buildings to be built in Boston, Massachusetts. These leases will commence upon completion of the buildings, scheduled for late 2013, and will extend for 15 years from the lease commencement date. Pursuant to the leases, we will pay an average of approximately $72.5 million per year in aggregate rent, exclusive of operating expenses, for both buildings during the initial 15-year term of the leases.

In the second quarter of 2011, we entered into a license and collaboration agreement with Alios. Under the terms of the agreement, Alios is eligible to receive research and development milestone payments of up to $715.0 million if both compounds are approved and commercialized. We expect to pay up to $35.0 million in development milestones to Alios in the second half of 2011. Alios also is eligible to receive commercial milestone payments of up to $750.0 million under the agreement.

### Recent Accounting Pronouncements

Refer to Note B, "Accounting Policies—Recent Accounting Pronouncements," in the accompanying notes to the condensed consolidated financial statements. There were no new accounting pronouncements adopted during the six months ended June 30, 2011 that had a material impact on our financial statements.

## Market risk

As filed, 1,202 characters.

As part of our investment portfolio, we own financial instruments that are sensitive to market risk. The investment portfolio is used to preserve our capital until it is required to fund operations, including our research and development activities. None of these market risk-sensitive instruments are held for trading purposes. We do not have derivative financial instruments in our investment portfolio.

### Interest Rate Risk

We invest our cash in a variety of financial instruments, principally securities issued by the United States government and its agencies, investment grade corporate bonds and notes and money market instruments. These investments are denominated in United States dollars. All of our interest-bearing securities are subject to interest rate risk and could decline in value if interest rates fluctuate. Substantially all of our investment portfolio consists of marketable securities with active secondary or resale markets to help ensure portfolio liquidity, and we have implemented guidelines limiting the term-to-maturity of our investment instruments. Due to the short maturities of these instruments, we do not believe that we have material exposure to interest rate risk.

## Controls and procedures

As filed, 2,584 characters.

### Evaluation of Disclosure Controls and Procedures

Our chief executive officer and chief financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that, based on such evaluation, as of June 30, 2011 our disclosure controls and procedures were effective and designed to provide reasonable assurance that the information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. In designing and evaluating our disclosure controls and procedures, our management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

### Changes in Internal Controls Over Financial Reporting

In the second quarter of 2011, we began generating revenues from sales of INCIVEK in the United States and entered into a collaboration agreement with Alios. The accounting for our net product revenues and the collaboration with Alios is material to our financial position as of June 30, 2011 and results of operations for the three months ended June 30, 2011, and we believe the internal controls and procedures relating to the accounting for net product revenues and the Alios collaboration have a material effect on our internal control over financial reporting. See Note B, "Accounting Policies" and Note K, "Collaborative Arrangements," to our unaudited condensed consolidated financial statements contained in this Quarterly Report on Form 10-Q for further details.

We have expanded our Section 404 compliance program under the Sarbanes-Oxley Act of 2002 and the applicable rules and regulations under this act to include controls with respect to our net product revenues and our collaboration with Alios. Except for the controls related to our accounting for net product revenues and our Alios collaboration, no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, as amended) occurred during the second quarter of 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 5,215 characters.

Information regarding risk factors appears in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010, which was filed with the SEC on February 17, 2011. There have been no material changes from the risk factors previously disclosed in that Annual Report on Form 10-K.

### SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q and, in particular, our Management's Discussion and Analysis of Financial Condition and Results of Operations set forth in Part I—Item 2, contain or incorporate a number of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, including statements regarding:

our expectations regarding clinical trials, development timelines and regulatory authority filings and submissions for INCIVEK, VX-770, VX-222, VX-809, VX-509, VX-765, VX-661, VX-787, ALS-2158 and ALS-2200, including our expectations regarding regulatory authorities' timelines for review of our New Drug Submission for INCIVEK in Canada, and Janssen's MAA for INCIVO in the European Union, and the possibility that we could submit an NDA and an MAA for VX-770 in October 2011;

our statement regarding the possibility that we could begin generating earnings as a cash flow positive company in 2012;

our ability to successfully market INCIVEK;

preliminary valuations and allocations related to the Alios collaboration;

our expectations regarding the timing and structure of clinical trials of our drug and drug candidates, including telaprevir, VX-770, VX-222, VX-509, VX-765, VX-661, VX-787, ALS-2158 and ALS-2200 and combinations of telaprevir with VX-222 and VX-770 with VX-809 or VX-661, and the timing of our receipt of data from our clinical trials;

expectations regarding the amount of, timing of and trends with respect to our revenues, costs and expenses and other gains and losses, including those related to future product revenues and potential royalty revenues from sales of telaprevir, to potential milestone payments from Janssen, to the intangible assets associated with the ViroChem acquisition and the Alios collaboration, to gain (losses) with respect to the noncontrolling interest (Alios) and to the liabilities we recorded in connection with the September 2009 financial transactions;

the data that will be generated by ongoing and planned clinical trials and the ability to use that data to support regulatory filings, including potential applications for marketing approval for VX-770;

our beliefs regarding the support provided by clinical trials and preclinical and nonclinical studies of our drug candidates for further investigation, clinical trials or potential use as a treatment;

the focus of our drug development efforts and our financial and management resources and our plan to continue investing in our research and development programs and to develop and commercialize selected drug candidates that emerge from those programs, alone or with third-party collaborators;

the establishment, development and maintenance of collaborative relationships;

our ability to use our research programs to identify and develop new drug candidates to address serious diseases and significant unmet medical needs;

statements regarding our leases of buildings to be built in Boston, Massachusetts;

our estimates regarding obligations associated with a lease of a facility in Kendall Square, Cambridge, Massachusetts; and

our liquidity and our expectations regarding the possibility of raising additional capital.

Without limiting the foregoing, the words "believes," "anticipates," "plans," "intends," "expects" and similar expressions are intended to identify forward-looking statements. Any or all of our forward-looking statements in this Quarterly Report on Form 10-Q may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors mentioned in our discussion in this Quarterly Report on Form 10-Q will be important in determining future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially from expected results. We also provide a cautionary discussion of risks and uncertainties under "Risk Factors" in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010, which was filed with the SEC on February 17, 2011, and updated and supplemented by "Part II—Item 1A—Risk Factors" of this Quarterly Report on Form 10-Q. These are factors that we think could cause our actual results to differ materially from expected results. Other factors besides those listed could also adversely affect us. In addition, the forward-looking statements contained herein represent our estimate only as of the date of this filing and should not be relied upon as representing our estimate as of any subsequent date. While we may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so to reflect actual results, changes in assumptions or changes in other factors affecting such forward-looking statements.

Filed Aug 9, 2011.
Source: SEC EDGAR, the filing index for accession 0001047469-11-007153. Last ingested by Listed: Nov 6, 2026, 12:56 ET. No prices; not investment advice.