What is the Janssen deal worth to Vertex?

Janssen paid a non-refundable $165 million up-front in July 2006 and may pay contingent milestones totaling up to $380 million on successful development, approval and launch of telaprevir. Janssen covers 50% of development costs in North America and its territories, and Vertex receives tiered royalties averaging the mid-20% range on Janssen-territory sales. Janssen can terminate on six months' notice, in which case rights revert to Vertex.

When could telaprevir reach the market, and what are the main risks?

The company plans to start Phase 3 in the second half of 2007 and believes Phase 2b data could support an NDA in late 2008, though an NDA may slip past 2008 if Phase 3 efficacy data are required. Risks include unfavorable trial results, FDA requirements, the company's limited late-stage and manufacturing experience, reliance on third-party manufacturers with capacity constraints, and competition from other HCV protease and polymerase inhibitors such as Schering-Plough's SCH 503034. Investment in commercial supply is at risk if the drug is not approved.

Is Vertex close to profitability?

No. The company has no profitable product of its own; Lexiva/Telzir royalties were $41.2 million in 2006, which is small relative to $371.7 million of R&D and $57.9 million of SG&A. Management says it cannot predict when, if ever, it will become profitable, and it expects R&D and SG&A to rise significantly in 2007. Its accumulated deficit exceeds $1.19 billion, and it has over $1.25 billion of federal net operating loss carryforwards.

What are the Kendall Square lease obligations and how could they change?

Vertex leases a 290,000 sq ft Kendall Square facility through 2018 and occupies about 120,000 sq ft. The remaining space is subleased to two tenants, and the company carries a $33.1 million accrued restructuring liability (discounted at about 10%) for the unused portion. Management says sublease rates, durations and timing assumptions could change, which could materially adjust the liability; undiscounted future lease payments total about $308 million, partly offset by $38.8 million of committed sublease income.

VRTX 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 1, 2007. Cited figures are marked; the original filing is the authoritative source.

Vertex Pharmaceuticals' FY2006 10-K (filed March 1, 2007) describes a company transitioning from a collaboration-funded discovery model toward a fully integrated pharmaceutical company, with its lead asset telaprevir (VX-950, hepatitis C protease inhibitor) at the center of that shift.

Vertex retained North American commercial rights to telaprevir under a June 2006 Janssen collaboration that provided a $165 million up-front payment and up to $380 million^a in contingent milestones, with Janssen covering 50% of development costs in its territories. The company is running three Phase 2b PROVE trials, expects to begin Phase 3 in the second half of 2007, and targets an NDA filing in late 2008 at the earliest. Management expects to invest heavily in 2007 (including $110-130 million in commercial supply investment for telaprevir), which will raise operating expenses materially.

Financially, 2006 revenue rose 35% to $216.4 million, but the net loss widened to $206.9 million^b ($1.83 per share) as R&D expense climbed 50% to $371.7 million, partly driven by $32.0 million of stock-based compensation under FAS 123(R). Cash, cash equivalents and marketable securities increased to $761.8 million, supported by a $313.7 million September 2006 equity offering and the Janssen payment. Management states this is enough to fund operations for at least the next eighteen months.

The company also redeemed its 5.75% 2011 convertible notes in March 2007, which should largely eliminate its convertible debt apart from $42.1 million^c of 2007 notes. Royalties from Lexiva/Telzir are growing but remain small relative to spending, and the company has no profitable product or visible path to profitability in the filing.

Key risks for investors are concentrated: dependence on a single late-stage asset, Phase 2b data and regulatory timing, reliance on collaborators and third-party manufacturers, and a large Kendall Square lease liability with sublease-dependent estimates. The company explicitly warns that it expects operating losses to continue beyond 2007.

02—Key points

Key Highlights

Net loss of $206.9 million ($1.83/share) in 2006 versus $203.4 million in 2005; management expects a significant operating loss in 2007 and beyond.
Total revenue rose 35% to $216.4 million, led by $175.1 million in collaborative revenue, with Janssen contributing $68.0 million including an amortized portion of its $165 million up-front payment.
Telaprevir (VX-950) is the lead candidate: three Phase 2b PROVE trials (~1,000 patients total), Phase 3 start targeted for 2H 2007, and NDA filing targeted for late 2008 at the earliest, with Fast Track designation.
R&D expense increased 50% to $371.7 million, including $27.3 million of telaprevir commercial supply investment and $32.0 million of stock-based compensation; 2007 commercial supply spending is guided to $110-130 million.
Cash, cash equivalents and marketable securities of $761.8 million at year-end 2006, up from $407.5 million, funded by a $313.7 million September 2006 equity offering and the Janssen payment; management expects this to fund operations for at least 18 months.
Debt reduction: 5.75% 2011 convertible notes ($59.6 million) were called for redemption in March 2007, with holders expected to convert about 4.0 million shares; only $42.1 million of 2007 notes remain.
Kendall Square lease carries a $33.1 million restructuring accrual for the roughly 145,000 sq ft portion it does not occupy, dependent on sublease assumptions that the company says could change materially.

03—Questions

Frequently Asked Questions

How much cash does Vertex have, and how long will it last?
Vertex had $761.8 million in cash, cash equivalents and marketable securities at December 31, 2006, and management states that this together with expected collaborator funding and Lexiva/Telzir royalties should fund operations for at least the next eighteen months. Spending is set to rise sharply in 2007 as telaprevir moves toward Phase 3 and commercial supply, so the runway could shorten if trials or launch preparations expand, and the company notes it may raise additional capital.
What is the Janssen deal worth to Vertex?
Janssen paid a non-refundable $165 million up-front in July 2006 and may pay contingent milestones totaling up to $380 million on successful development, approval and launch of telaprevir. Janssen covers 50% of development costs in North America and its territories, and Vertex receives tiered royalties averaging the mid-20% range on Janssen-territory sales. Janssen can terminate on six months' notice, in which case rights revert to Vertex.
When could telaprevir reach the market, and what are the main risks?
The company plans to start Phase 3 in the second half of 2007 and believes Phase 2b data could support an NDA in late 2008, though an NDA may slip past 2008 if Phase 3 efficacy data are required. Risks include unfavorable trial results, FDA requirements, the company's limited late-stage and manufacturing experience, reliance on third-party manufacturers with capacity constraints, and competition from other HCV protease and polymerase inhibitors such as Schering-Plough's SCH 503034. Investment in commercial supply is at risk if the drug is not approved.
Is Vertex close to profitability?
No. The company has no profitable product of its own; Lexiva/Telzir royalties were $41.2 million in 2006, which is small relative to $371.7 million of R&D and $57.9 million of SG&A. Management says it cannot predict when, if ever, it will become profitable, and it expects R&D and SG&A to rise significantly in 2007. Its accumulated deficit exceeds $1.19 billion, and it has over $1.25 billion of federal net operating loss carryforwards.
What are the Kendall Square lease obligations and how could they change?
Vertex leases a 290,000 sq ft Kendall Square facility through 2018 and occupies about 120,000 sq ft. The remaining space is subleased to two tenants, and the company carries a $33.1 million accrued restructuring liability (discounted at about 10%) for the unused portion. Management says sublease rates, durations and timing assumptions could change, which could materially adjust the liability; undiscounted future lease payments total about $308 million, partly offset by $38.8 million of committed sublease income.

04—Continue

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