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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-Q
(MARK ONE)
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES AND EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER 000-19319
------------------------
VERTEX PHARMACEUTICALS INCORPORATED
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-3039129
(State or other jurisdiction (I.R.S. Employer
of Identification No.)
incorporation or organization)
130 WAVERLY STREET, CAMBRIDGE, 02139-4242
MASSACHUSETTS (zip code)
(Address of principal
executive offices, including
zip code)
(617) 444-6100
(Registrant's telephone number, including area code)
------------------------
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES /X/ NO / /
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock, par value $.01 per 75,738,966
share ------------------------------------
------------------------------------ Outstanding at May 10, 2002
Class
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VERTEX PHARMACEUTICALS INCORPORATED
INDEX
Part I. Financial Information
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets--
March 31, 2002 and December 31, 2001...................... 3
Condensed Consolidated Statements of Operations--
Three Months Ended March 31, 2002 and 2001................ 4
Condensed Consolidated Statements of Cash Flows--
Three Months Ended March 31, 2002 and 2001................ 5
Notes to Condensed Consolidated Financial Statements........ 6
Item 2. Management's Discussion and Analysis of Financial Condition
and
Results of Operations..................................... 11
Item 3. Quantitative and Qualitative Disclosures about Market
Risk...................................................... 17
Part II. Other Information
Item 5. Other Information........................................... 17
Item 6. Exhibits and Reports on Form 8-K............................ 17
Signature........................................................................ 18
2
VERTEX PHARMACEUTICALS INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
2002 2001
----------- ------------
(UNAUDITED)
(IN THOUSANDS EXCEPT SHARE
AND PER SHARE AMOUNTS)
ASSETS
Current assets:
Cash and cash equivalents................................. $176,229 $189,205
Marketable securities, available for sale................. 522,801 553,997
Accounts receivable....................................... 14,342 20,265
Prepaid expenses.......................................... 5,178 6,636
Other current assets...................................... 5,233 5,989
-------- --------
Total current assets.................................... 723,783 776,092
Restricted cash........................................... 26,134 26,190
Property and equipment, net............................... 84,628 80,377
Investments............................................... 26,433 26,433
Other assets.............................................. 14,532 16,039
-------- --------
Total assets............................................ $875,510 $925,131
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 10,913 $ 11,628
Accrued expenses and other current liabilities............ 22,298 31,381
Accrued interest.......................................... 529 4,467
Deferred revenue.......................................... 27,879 39,498
Obligations under capital leases and other obligations.... 3,928 4,579
-------- --------
Total current liabilities............................... 65,547 91,553
Obligations under capital leases and other obligations,
excluding current portion............................... 7,331 8,026
Deferred revenue, excluding current portion............... 37,523 35,201
Convertible subordinated notes............................ 315,000 315,000
-------- --------
Total liabilities....................................... 425,401 449,780
-------- --------
Stockholders' equity:
Preferred stock, $0.01 par value; 1,000,000 shares
authorized; none issued and outstanding................. -- --
Common stock, $0.01 par value; 200,000,000 shares
authorized; 75,289,635 and 75,055,160 shares issued and
outstanding at March 31, 2002 and December 31, 2001,
respectively............................................ 753 751
Additional paid-in capital................................ 781,023 778,018
Deferred compensation, net................................ (10) (20)
Accumulated other comprehensive income.................... 4,942 11,134
Accumulated deficit....................................... (336,599) (314,532)
-------- --------
Total stockholders' equity................................ 450,109 475,351
-------- --------
Total liabilities and stockholders' equity................ $875,510 $925,131
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
VERTEX PHARMACEUTICALS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
THREE MONTHS ENDED
MARCH 31,
---------------------
2002 2001*
--------- ---------
(UNAUDITED)
(IN THOUSANDS EXCEPT
PER SHARE DATA)
Pharmaceutical revenues:
Royalties................................................. $ 2,474 $ 2,596
Collaborative and other research and development
revenues................................................ 18,077 15,573
Discovery tools and service revenues:
Product sales............................................. 15,210 11,529
Service revenues.......................................... 4,934 5,258
-------- --------
Total revenues.............................................. 40,695 34,956
-------- --------
Costs and expenses:
Royalty payments.......................................... 817 881
Cost of product sales..................................... 4,590 6,869
Cost of service revenues.................................. 3,234 2,790
Research and development.................................. 47,022 32,540
Sales, general and administrative......................... 11,095 10,948
Merger related costs...................................... -- 1,179
-------- --------
Total costs and expenses.................................... 66,758 55,207
-------- --------
Loss from operations........................................ (26,063) (20,251)
Interest income........................................... 8,458 13,070
Interest and other expense, net........................... (4,462) (5,033)
-------- --------
Loss before cumulative effect of change in accounting
principle................................................. (22,067) (12,214)
Cumulative effect of change in accounting principle......... -- (25,901)
-------- --------
Net loss.................................................... $(22,067) $(38,115)
======== ========
Basic and diluted loss per common share before cumulative
effect of change in accounting principle--revenue
recognition............................................... $ (0.29) $ (0.17)
Basic and diluted cumulative effect of change in accounting
principle--revenue recognition............................ -- (0.35)
-------- --------
Basic and diluted net loss per common share................. $ (0.29) ($ 0.52)
======== ========
Basic and diluted weighted average number of common shares
outstanding............................................... 75,161 73,922
* Results have been adjusted to reflect the adoption of the Substantive
Milestone method of revenue recognition in the third quarter of 2001,
retroactive to January 1, 2001. See Note 3, "Change in Accounting
Principle--Revenue Recognition," for more information.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
VERTEX PHARMACEUTICALS INCORPORATED
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
THREE MONTHS ENDED
MARCH 31,
-------------------
2002 2001
-------- --------
(UNAUDITED)
(IN THOUSANDS)
Cash flows from operating activities:
Net loss.................................................. $(22,067) $(38,115)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 5,282 3,438
Other non-cash items, net................................. 410 180
Realized (gains)/losses on marketable securities.......... (835) 98
Cumulative effect of change in accounting principle....... -- 25,901
Changes in operating assets and liabilities:
Accounts receivable....................................... 5,923 5,625
Prepaid expenses.......................................... 1,458 68
Other current assets...................................... 1,081 (1,001)
Accounts payable.......................................... (715) 1,474
Accrued expenses and other current liabilities............ (7,583) (93)
Accrued interest.......................................... (3,938) (4,328)
Deferred revenue.......................................... (9,297) (3,334)
-------- --------
Net cash used in operating activities................. (30,281) (10,087)
-------- --------
Cash flows from investing activities:
Purchase of marketable securities......................... (244,679) (292,722)
Sales and maturities of marketable securities............. 270,669 211,452
Expenditures for property and equipment................... (9,812) (16,055)
Restricted cash and other assets.......................... (305) (13,570)
-------- --------
Net cash provided by (used in) investing activities... 15,873 (110,895)
-------- --------
Cash flows from financing activities:
Issuances of common stock, net............................ 2,929 8,940
Principal payments on notes payable, capital leases and
other obligations....................................... (1,346) (1,191)
-------- --------
Net cash provided by financing activities............. 1,583 7,749
-------- --------
Effect of changes in exchange rates on cash............... (151) (397)
-------- --------
Net decrease in cash and cash equivalents............. (12,976) (113,630)
Cash and cash equivalents--beginning of period.............. 189,205 346,659
-------- --------
Cash and cash equivalents--end of period.................... $176,229 $233,029
======== ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
VERTEX PHARMACEUTICALS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The accompanying condensed consolidated financial statements are unaudited
and have been prepared by Vertex Pharmaceuticals Incorporated ("Vertex" or the
"Company") in accordance with generally accepted accounting principles.
The condensed consolidated financial statements reflect the operations of
the Company and its wholly owned subsidiaries. All significant intercompany
balances and transactions have been eliminated.
Certain information and footnote disclosures normally included in the
Company's annual financial statements have been condensed or omitted. Certain
prior year amounts have been reclassified to conform with current year
presentation. The interim financial statements, in the opinion of management,
reflect all adjustments (including normal recurring accruals) necessary for a
fair statement of the results for the interim periods ended March 31, 2002 and
2001.
The results of operations for the interim periods are not necessarily
indicative of the results of operations to be expected for the fiscal year,
although the Company expects to incur a substantial loss for the year ended
December 31, 2002. These interim financial statements should be read in
conjunction with the audited financial statements for the year ended
December 31, 2001, which are contained in the Company's 2001 Annual Report to
its stockholders and in its Form 10-K filed with the Securities and Exchange
Commission.
2. ACCOUNTING POLICIES
BASIC AND DILUTED LOSS PER COMMON SHARE
Basic earnings per share is based upon the weighted average number of common
shares outstanding during the period. Diluted earnings per share is based upon
the weighted average number of common shares outstanding during the period plus
additional weighted average common equivalent shares outstanding during the
period when the effect is not anti-dilutive. Common equivalent shares result
from the assumed exercise of outstanding stock options, the proceeds of which
are then assumed to have been used to repurchase outstanding stock using the
treasury stock method, and the assumed conversion of convertible notes. Common
equivalent shares have not been included in the net loss per share calculations
as their effect would be anti-dilutive.
The following table sets forth potential common equivalent shares
outstanding at March 31 (shares in thousands):
FOR THE THREE MONTHS
ENDED MARCH 31,
---------------------
2002 2001
--------- ---------
Stock options outstanding................................. 16,429 14,419
Weighted average exercise price........................... $ 27.21 $ 27.26
Convertible notes......................................... 3,414 3,739
Weighted average conversion price......................... $ 92.26 $ 92.26
SEGMENT INFORMATION
On July 18, 2001, the Company completed a merger with Aurora Biosciences
Corporation ("Aurora"). Aurora specializes in assay development, screening and
cell biology services and systems.
6
VERTEX PHARMACEUTICALS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACCOUNTING POLICIES (CONTINUED)
On March 1, 2001, Aurora completed a merger with PanVera Corporation
("PanVera"). PanVera is a biotechnology company engaged in the development,
manufacture and worldwide supply of proteins and reagents for evaluation as
targets and drug screening assays for high-throughput screening.
In the first quarter of 2002, following the acquisitions, the Company has
aligned its business into two operating segments: (i) Pharmaceuticals and
(ii) Discovery Tools and Services.
The Company's Pharmaceuticals business seeks to discover, develop and
commercialize major pharmaceutical products independently and with partners. The
Company's Discovery Tools and Services business specializes in assay
development, screening services and the manufacture and sale of proteins and
reagents.
3. CHANGE IN ACCOUNTING PRINCIPLE--REVENUE RECOGNITION
In the third quarter of 2001, in connection with an overall review of
accounting policies concurrent with the merger with Aurora, Vertex elected to
change its revenue recognition policy for collaborative and other research and
development revenues from the EITF 91-6 method to the substantive milestone
method. Vertex believes this method is preferable because it is more reflective
of the Company's on going business operations and because it is consistent with
industry practices following the prior year implementation of SAB 101, "Revenue
Recognition in Financial Statements," throughout the biotechnology industry.
Under the new accounting method, adopted retroactively to January 1, 2001, the
Company recognizes revenue from non-refundable, up-front, license and milestone
payments, not specifically tied to a separate earnings process, ratably over the
period of performance. Research funding is recognized as earned ratably over the
period of effort. Milestones, based on designated achievement points that are
considered at risk and substantive at the inception of the contract, are
recognized as earned when the corresponding payment is reasonably assured. The
Company evaluates whether milestones are at risk and substantive based on the
contingent nature of the milestone, specifically reviewing factors such as the
technological and commercial risk that needs to be overcome and the level of
investment required.
Previously, the Company had recognized revenue from collaborative research
and development arrangements in a manner similar to that prescribed by EITF
91-6. Under that model, revenue was recognized for non-refundable license fees,
milestones, and collaborative research and development funding using the lesser
of the non-refundable cash received or the result achieved using percentage of
completion accounting. Where the Company had no continuing involvement,
non-refundable license fees were recorded as revenue upon receipt and milestones
were recorded as revenue upon achievement of the milestone by the collaborative
partner.
Pursuant to this change in accounting principle, Vertex recorded a one-time
non-cash charge of $25,901,000 in the first quarter of 2001. The impact of the
adoption of this new accounting policy for revenue recognition for collaborative
and other research and development revenues was to defer revenue recognition for
certain portions of revenue previously recognized in prior accounting periods
under our collaborative agreements into future accounting periods. The results
for the quarter ended March 31, 2001 have been restated in accordance with the
new revenue recognition policy.
7
VERTEX PHARMACEUTICALS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. SEGMENT INFORMATION
The Company has aligned its business into two operating segments:
(i) Pharmaceuticals and (ii) Discovery Tools and Services. The Company's
Pharmaceuticals business seeks to discover, develop and commercialize major
pharmaceutical products independently and with partners. The Company's Discovery
Tools and Services business specializes in assay development, screening services
and the manufacture and sale of proteins and reagents. The Company evaluates
segment performance based on the loss before merger related charges and the
cumulative effect of the change in accounting principle. The Company does not
evaluate segment performance based on the segment's total assets and therefore
the Company's assets are not reported by segment. The following table presents,
by segment, the results of operations for the periods ending March 31, 2002. For
the period ending March 31, 2001, the Company was unable to restate the results
of operations into the new operating segments: Pharmaceuticals and Discovery
Tools and Services. Thus, for comparative purposes, the table also presents
results of operations information for the three month periods ended March 31,
2002 and 2001 by the former segments: Vertex and Aurora.
DISCOVERY
TOOLS AND
(IN THOUSANDS) PHARMACEUTICALS SERVICES TOTAL
-------------- --------------- --------- --------
Three Months Ended March 31, 2002:
Revenues................................................... $ 20,551 $20,144 $ 40,695
Reportable segment income (loss)........................... $(31,030) $ 8,963 $(22,067)
-------- ------- --------
VERTEX AURORA TOTAL
------ -------- --------
Three Months Ended 31, 2002:
Revenues.................................................... $ 20,193 $20,502 $ 40,695
Reportable segment income (loss)............................ $(23,148) $ 1,081 $(22,067)
-------- ------- --------
Three Months Ended 31, 2001:
Revenues.................................................... $ 17,435 $17,521 $ 34,956
Reportable segment loss..................................... $(10,492) $ (543) $(11,035)
-------- ------- --------
MARCH 31, MARCH 31,
2002 2001
--------- ---------
Total loss for reportable segments...................... $(22,067) $(11,035)
Merger related charges.................................. -- (1,179)
Cumulative effect of change in accounting
principle--revenue recognition........................ -- (25,901)
-------- --------
Total net loss.......................................... $(22,067) $(38,115)
======== ========
8
VERTEX PHARMACEUTICALS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. COMPREHENSIVE LOSS
For the three months ended March 31, 2002 and 2001, respectively,
comprehensive loss was as follows (in thousands):
FOR THE THREE MONTHS
ENDED
MARCH 31,
---------------------
2002 2001
--------- ---------
Net loss................................................ $(22,067) $(38,115)
Changes in other comprehensive income:
Unrealized holding gains (losses) on marketable
securities............................................ (6,041) 5,281
Foreign currency translation adjustment................. (151) (397)
Total change in other comprehensive income.............. (6,192) 4,884
-------- --------
Total comprehensive loss................................ $(28,259) $(33,231)
======== ========
6. LEGAL PROCEEDINGS
Chiron Corporation (Chiron) filed suit on July 30, 1998 against Vertex and
Eli Lilly and Company in the United States District Court for the Northern
District of California, alleging infringement by the defendants of three U.S.
patents issued to Chiron. The infringement action relates to research activities
by Vertex and Eli Lilly in the hepatitis C viral protease field and the alleged
use of inventions claimed by Chiron in connection with that research. Chiron has
requested damages in an unspecified amount, as well as an order permanently
enjoining the defendants from unlicensed use of the claimed Chiron inventions.
During 1999, Chiron requested and was granted a reexamination by the U.S. Patent
and Trademark Office of all three of the patents involved in the suit. Chiron
also requested and, over the opposition of Vertex and Eli Lilly, was granted a
stay in the infringement lawsuit, pending the outcome of the patent
re-examination. That reexamination proceeding is still on going for one of the
three patents and the stay is still in effect. However, a Reexamination
Certificate has been issued in the other two Chiron patents in suit. While the
length of the stay and the final outcome of the lawsuit cannot be determined,
Vertex maintains that Chiron's claims are without merit and intends to defend
the lawsuit, if and when it resumes, vigorously.
On December 7, 2001 Oregon Health Sciences University filed suit against
Vertex in the District Court of Oregon. The complaint in the suit seeks to name
Dr. Bruce Gold, an employee of Oregon Health Sciences University, as an inventor
and Oregon Health Sciences University as part owner of five of Vertex's
neurophilin patents. The suit stems from assays run on Vertex compounds by
Dr. Gold under a sponsored research agreement in 1996. Vertex has investigated
the inventorship on these patents and believes that Dr. Gold is not an inventor,
Oregon Health Sciences has no ownership interest in any of these patents, and
that the claims made in this complaint are without merit. The suit is ongoing
and Vertex intends to contest this claim vigorously.
7. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which requires that ratable amortization of goodwill be replaced with
periodic tests of the goodwill's impairment and that intangible assets other
than goodwill be amortized over their useful lives. The provisions of SFAS
No. 142 are effective for fiscal years beginning after December 15, 2001. The
9
VERTEX PHARMACEUTICALS INCORPORATED
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. RECENT ACCOUNTING PRONOUNCEMENTS (CONTINUED)
Company adopted the provisions of SFAS 142 on January 1, 2002 as required; the
adoption did not have a material effect on the Company's financial position and
results of operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment of Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" and provides a single accounting model for long-lived assets to
be disposed of. The provisions of SFAS No. 144 are effective for fiscal years
beginning after December 15, 2001. The Company adopted the provisions of
SFAS 144 on January 1, 2002 as required; the adoption did not have a material
effect on the Company's financial position and results of operations.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
We are a global biotechnology company with more than 1,000 employees located
in Cambridge, MA, Madison, WI, San Diego, CA and Abingdon, UK. We have two
operating businesses: Pharmaceuticals, and Discovery Tools and Services.
Our Pharmaceuticals business seeks to discover, develop, and commercialize
major pharmaceutical products independently and with collaborators.
Chemogenomics, our proprietary, systematic, genomics-based platform, is designed
to accelerate the discovery of new drugs and to expand intellectual property
coverage of drug candidate compounds and classes of related compounds. We
believe this approach, which targets gene families, has formed the basis for
successful drug discovery and for the advancement of drug candidates by Vertex
and its collaborators. We are developing several drug candidates in commercial
collaborations in which we retain rights to downstream product revenue.
Our first approved product is Agenerase-Registered Trademark- (amprenavir),
an HIV protease inhibitor, which we co-promote with GlaxoSmithKline. We earn a
royalty from GlaxoSmithKline on sales of Agenerase. Agenerase has received
approval in 34 countries worldwide, including the United States, the 15 member
states of the European Union (E.U.), and Japan, where the drug is sold under the
trade name Prozei-TM-. We have more than twelve drug candidates in development
to treat viral diseases, cancer, autoimmune and inflammatory diseases and
neurological disorders. We have significant collaborations with large
pharmaceutical companies including Aventis, Eli Lilly, GlaxoSmithKline,
Novartis, and Serono.
Our Discovery Tools and Services business specializes in assay development,
screening services and products, and the manufacture and sale of proteins and
reagents. This business has collaborations with large pharmaceutical companies
for assay development, screening services and the development of specialized
screening platforms, as well as the sale of proteins and reagents to the
Pharmaceuticals industry.
Our Discovery Tools and Services business has contracts in place that
require the delivery of products, licenses and services throughout 2002. These
contracts account for over $70 million of potential 2002 revenue of which
approximately $12 million relates to one specific contract.
Our collaborations and contracts in the Pharmaceuticals and Discovery Tools
and Services businesses provide us with financial support and other valuable
resources for our research programs, development of our clinical drug
candidates, and marketing and sales of our products. We believe that we are
positioned to commercialize multiple products in the coming years, which we
expect will generate increased milestone payments, product revenues and royalty
payments.
We have incurred operating losses since our inception and expect to incur
losses for the foreseeable future. We plan to make significant investments in
research and development for our other potential products. We expect that losses
will fluctuate from year to year and that such fluctuations may be substantial.
In the third quarter of 2001, in connection with our overall review of
accounting policies concurrent with our merger with Aurora, we elected to change
our revenue recognition policy for collaborative and other research and
development revenues from the Emerging Issues Task Force No. 91-6 (EITF 91-6)
method to the Substantive Milestone Method. We believe this method is preferable
because it is reflective of the Company's on going business operations and is
more consistent with the industry practices following the prior year
implementation of SAB 101 throughout the biotechnology industry.
The cumulative effect of the 2001 change in accounting principle related to
revenue recognition recorded in the third quarter of 2001, retroactive to
January 1, 2001, resulted in a non-cash charge to income of $25,901,000 in the
first quarter of 2001. Included in the charge to income was $1,591,000 of
11
revenue recognized in the three months ended March 31, 2002 and $1,825,000 of
revenue recognized in the three months ended March 31, 2001.
THREE MONTHS ENDED MARCH 31, 2002 COMPARED WITH THREE MONTHS ENDED MARCH 31,
2001
Our net loss for the three months ended March 31, 2002 was $22,067,000 or
$0.29 per basic and diluted common share compared to a net loss, before our
change in accounting principle and merger related costs, of $11,035,000 or $0.15
per basic and diluted common share for the three months ended March 31, 2001.
The net loss, for the three months ended March 31, 2001 including a $25,901,000
non-cash charge for the cumulative effect of our change in accounting principle
relating to revenue recognition and merger related costs of $1,179,000, was
$38,115,000 or $0.52 per basic and diluted common share.
Total revenues increased to $40,695,000 for the three months ending
March 31, 2002 compared to $34,956,000 for the three months ending March 31,
2001. In the first quarter of 2002 Pharmaceuticals revenue was comprised of
$2,474,000 in royalty revenue and $18,077,000 in collaborative and other
research and development revenue, as compared with $2,596,000 in royalty revenue
and $15,573,000 in collaborative and other research and development revenue in
the first quarter of 2001. In the first quarter of 2002 Discovery Tools and
Services revenue was comprised of $15,210,000 in product sales revenue and
$4,934,000 in service revenue, as compared with $11,529,000 in product sales
revenue and $5,258,000 in service revenue in the first quarter of 2001.
Royalties consist primarily of Agenerase royalty revenue. Agenerase royalty
revenue is based on estimated and actual worldwide net sales of Agenerase.
Collaborative and other research and development revenue consists of
research support payments, development reimbursements, milestones and
amortization of previously received up-front or license payments.
Collaborative and other research and development revenue increased in the
first quarter of 2002 by 16% or $2,504,000 as compared with the first quarter of
2001 due primarily to additional revenue earned under the Novartis
collaboration. In the first quarter of 2002, we recognized $10,032,000 of
revenue under the Novartis collaboration compared with $7,111,000 in the first
quarter of 2001. Effort related to our kinase research program increased
significantly in the first quarter of 2002.
Product sales include instrumentation sales, technology licensing and
biotechnology product sales.
Product sales increased $3,681,000, or 32%, to $15,210,000 in the first
quarter of 2002 from $11,529,000 in the first quarter of 2001. The increase in
product sales is due primarily to technology licensing revenue earned under the
Pfizer contract.
Service revenue includes assay development, screening services and
contracted product development.
Service revenue decreased $324,000 or 6% to $4,934,000 in the first quarter
of 2002 from $5,258,000 in the first quarter of 2001. The decrease is a result
of the completion of several significant screening agreements in late 2001.
Royalty costs of $817,000 and $881,000 in the first quarter of 2002 and
2001, respectively, consist primarily of royalty payments on the sales of
Agenerase.
Product costs decreased $2,279,000 or 33% to $4,590,000 in the first quarter
of 2002 from $6,869,000 in the first quarter of 2001. The decrease in product
costs is attributable to a strategic shift in focus of the Discovery Tools and
Services business towards technology licensing and discovery tools which have
higher gross margins. Product gross margins will fluctuate from period to period
based upon the product mix.
12
Cost of service revenue increased from $2,790,000 in the first quarter of
2001 to $3,234,000 in the first quarter of 2002. The increase is primarily due
to increased overhead to service such agreements.
Research and development expenses increased to $47,022,000 in the first
quarter of 2002 from $32,540,000 in the first quarter 2001 primarily due to our
continued investment in advancing our broad clinical pipeline and fueling our
drug discovery engine. We focused our clinical investment into the advancement
of our p38 MAP kinase, IMPDH and caspase inhibitor programs. These oral drugs
are currently focused on large market opportunities such as rheumatoid
arthritis, hepatitis C and psoriasis. We continued to expand our multi-target
gene family research programs, of which kinases is our most advanced. Also
related to our expansion, were increases in personnel and facilities expenses.
We have more than 12 drug candidates in development targeting a range of
major diseases. Our collaborative partners have agreed to fund portions of our
research and development programs and/or to conduct certain research and
development related to specified drug candidates. The following table details
our Collaborator and Company-sponsored research and development expenses for the
three months ended March 31 (in thousands):
2002
---------------------------------
RESEARCH DEVELOPMENT TOTAL
-------- ----------- --------
Collaborator-Sponsored......................... $14,663 $ 7,424 $22,087
Company-Sponsored.............................. 15,241 9,694 24,935
------- ------- -------
Total.......................................... $29,904 $17,118 $47,022
======= ======= =======
2001
---------------------------------
RESEARCH DEVELOPMENT TOTAL
-------- ----------- --------
Collaborator-Sponsored......................... $10,952 $ 5,188 $16,140
Company-Sponsored.............................. 11,387 5,013 16,400
------- ------- -------
Total.......................................... $22,339 $10,201 $32,540
======= ======= =======
To date we have incurred in excess of $677,000,000 in research and
development costs associated with drug discovery and development. We anticipate
research and development expenses will continue to increase as we add personnel
and expand research and development activities to accommodate our existing
collaborations and additional commitments we may undertake.
We estimate that it takes from 10 to 15 years (industry average is
12 years) to discover, develop and bring to market a pharmaceutical product.
Drug development in the United States is a process that includes several steps
defined by the FDA as outlined below:
ESTIMATED
PHASE: OBJECTIVE: DURATION:
------ ------------------------------------------------ -----------------
Discovery Lead identification and target validation 2 to 4 years
Pre-Clinical Toxicology to identify risks for humans; gather
early pharmacokentic data 1 to 2 years
Phase I Establish safety in humans, study how the drug
works, metabolizes and interacts with other
drugs 1 to 2 years
Phase II Establish effectiveness of the drug and its
optimal dosage 2 to 4 years
Phase III Confirm efficacy, dose regime and safety profile
of the drug 2 to 4 years
FDA approval Approval by the FDA to sell and market the drug
under certain prescribed labelling 6 mths to 2 years
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The successful development of our products is highly uncertain and subject
to a number of risk factors. The duration of clinical trials may vary
substantially according to the type, complexity and novelty of the
pharmaceutical product. The FDA and comparable agencies in foreign countries
impose substantial requirements on the introduction of therapeutic
pharmaceutical products through lengthy and detailed laboratory and clinical
testing procedures, sampling activities and other costly and time-consuming
procedures. Data obtained from pre-clinical and clinical activities are
susceptible to varying interpretations, which could delay, limit or prevent
regulatory approval. The duration and the cost related to discovery,
pre-clinical and clinical trials may vary significantly over the life of a
project and are difficult to predict. The most significant costs associated with
drug discovery and development are those costs associated with Phase II and
Phase III clinical trials.
Below is a summary of our drug candidates currently in clinical development:
DRUG CLINICAL INDICATIONS PHASE PROGRAM COLLABORATOR
---- ------------------------------- -------- --------------- ---------------
INFECTIOUS DISEASE
VX-175 HIV III HIV GlaxoSmithKline
Merimepodib Chronic hepatitis C II IMPDH --
(VX-497)
VX-950 Chronic hepatitis C Preclin Hepatitis C Eli Lilly
protease
VX-799 Sepsis Preclin Caspases Serono; Taisho
VX-385 HIV Preclin HIV GlaxoSmithKline
INFLAMMATION AND AUTOIMMUNE DISEASE
Pralnacasan Rheumatoid arthritis (RA); II ICE Aventis
(VX-740) inflammatory diseases
VX-148 Psoriasis; autoimmune diseases I IMPDH --
VX-944 Autoimmune diseases Preclin IMPDH --
VX-850 Inflammatory diseases Preclin p38 MAP Kinase Kissei
VX-702 Inflammatory diseases Preclin p38 MAP Kinase Kissei
VX-765 Inflammatory diseases Preclin ICE --
CANCER
Incel-TM- Multidrug resistant solid tumor II MDR --
cancers
VX-853 Multidrug resistant solid tumor I/II MDR --
cancers
GENETIC DISORDERS
VX-563 Multiple indications Preclin Histone --
Deacetylase
We organize our research and development efforts based on the target gene
families and target program. The programs detailed above identify the targets
for therapeutic intervention.
Sales, general and administrative expenses remained consistent with the
prior period. We have established an infrastructure to support our growth and we
are committed to managing such investment prudently.
Interest income decreased approximately $4,612,000 to $8,458,000 in the
first quarter of 2002 from $13,070,000 in the first quarter of 2001. This is a
reflection of lower funds invested and lower portfolio yields.
Interest expense decreased $553,000 to approximately $4,450,000 in the first
quarter of 2002 from $5,003,000 in the first quarter of 2001. The decrease in
interest expense is a result of the reduction in principal amount of our
convertible notes from $345,000,000 at March 31, 2001 to $315,000,000 at
March 31, 2002. In October 2001, we repurchased $30,000,000 in principal amount
of our 5% convertible subordinated notes due September 2002.
14
LIQUIDITY AND CAPITAL RESOURCES
Our operations have been funded principally through strategic collaborative
agreements, strategic technology alliances, revenues from assay development and
screening services, product sales, royalties, public offerings and private
placements of our equity and debt securities, equipment lease financing, and
investment income. With the approval and launch of Agenerase in April 1999, we
began receiving product royalty revenues. In 2000, we completed private
placements of $175,000,000 of 5% Convertible Subordinated Notes due March 2007
and $345,000,000 of 5% Convertible Subordinated Notes due September 2007.
We have continued to increase and advance products in our research and
development pipeline. Consequently, we expect to incur losses on a quarterly and
annual basis as we continue to develop existing and future compounds and to
conduct clinical trials of potential drugs. We also expect to incur substantial
administrative and commercialization expenditures in the future and additional
expenses related to filing, prosecution, defense and enforcement of patent and
other intellectual property rights.
We expect to finance these substantial cash needs with future payments under
our existing and future collaborative agreements, strategic technology
alliances, royalties from the sales of Agenerase, revenues from assay
development and screening services, product sales, existing cash and marketable
securities of $699,030,000 at March 31, 2002, together with investment income
earned thereon, and facilities and equipment financing. To the extent that funds
from these sources are not sufficient to fund our activities, it will be
necessary to raise additional funds through public offerings or private
placements of securities or other methods of financing. There can be no
assurance that such financing will be available on acceptable terms, if at all.
Our aggregate cash and marketable securities decreased $44,172,000 to
$699,030,000, including cash and cash equivalents of $176,229,000, at March 31,
2002 from $743,202,000, including cash and cash equivalents of $189,205,000, at
December 31, 2001. Net cash used in operations was $30,281,000 for the three
months ended March 31, 2002. Included in the cash used in operations was the net
loss of $22,067,000 and a decrease in deferred revenue of $9,297,000, partially
offset by $4,857,000 of non-cash charges and gains. Deferred revenue decreased
due to cash received for research funding and the receipt of a milestone payment
in late 2001, the majority of which will be recognized in 2002. Net cash
provided by investing activities for the three months ended March 31, 2002 was
$15,873,000, including net sales of marketable securities of $25,990,000
partially offset by property and equipment expenditures of $9,812,000. Cash
provided by financing activities during the three months ended March 31, 2002
was $1,583,000 including $2,929,000 from the issuance of common stock under
employee stock option and benefit plans offset by $1,346,000 in principal
payments on capital leases and other obligations. The decrease in cash and
marketable securities from December 31, 2001 is not indicative of the expected
quarterly cash spend for the remainder of 2002.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements about our business,
including our expectation that (i) we are positioned to commercialize multiple
products in the coming years that we expect will generate increased revenues,
(ii) our losses will continue, (iii) our research and development expenses, our
administrative and commercialization expenses and our expenses related to
filing, prosecuting and defending our patents and intellectual property rights
will increase, and sales, general and administrative expenses will remain
consistent with current levels, and (iv) the Chiron Corporation and Oregon
Health Sciences University litigation will not have a material adverse effect on
us. While management makes its best efforts to be accurate in making
forward-looking statements, such statements are subject to risks and
uncertainties that could cause our actual results to vary materially. These
risks and uncertainties include, among other things, our inability to
successfully integrate Aurora into our existing business, our inability to
further identify, develop and achieve commercial success for new products and
technologies, the possibility of delays in the research and development
necessary to
15
select drug development candidates and delays in clinical trials, the risk that
clinical trials may not result in marketable products, the risk that we may be
unable to successfully finance and secure regulatory approval of and market our
drug candidates, our dependence upon pharmaceutical and biotechnology
collaborations, the levels and timing of payments under our collaborative
agreements, uncertainties about our ability to obtain new corporate
collaborations and acquire new technologies on satisfactory terms, if at all,
the development of competing systems, our ability to protect our proprietary
technologies, patent-infringement claims, risks of new, changing and competitive
technologies and regulations in the U.S. and internationally. Please see the
"Risk Factors" appearing in our 2001 Annual Report to Stockholders and in our
Form 10-K filed with the Securities and Exchange Commission for more details
regarding these and other risks. We disclaim any intention or obligation to
update or revise any forward-looking statements, whether as a result of new
information, future events or otherwise.
LEGAL PROCEEDINGS
Chiron filed suit on July 30, 1998 against Vertex and Eli Lilly and Company
in the United States District Court for the Northern District of California,
alleging infringement by the defendants of three U.S. patents issued to Chiron.
The infringement action relates to research activities by Vertex and Eli Lilly
in the hepatitis C viral protease field and the alleged use of inventions
claimed by Chiron in connection with that research. Chiron has requested damages
in an unspecified amount, as well as an order permanently enjoining the
defendants from unlicensed use of the claimed Chiron inventions. During 1999,
Chiron requested and was granted a reexamination by the U.S. Patent and
Trademark Office of all three of the patents involved in the suit. Chiron also
requested and, over the opposition of Vertex and Eli Lilly, was granted a stay
in the infringement lawsuit, pending the outcome of the patent re-examination.
That reexamination proceeding is still on going for one of the three patents and
the stay is still in effect. However, a Reexamination Certificate has been
issued in the other two Chiron patents in suit. While the length of the stay and
the final outcome of the lawsuit cannot be determined, we maintain that Chiron's
claims are without merit and we intend to defend the lawsuit, if and when it
resumes, vigorously.
On December 7, 2001 Oregon Health Sciences University filed suit against
Vertex in the District Court of Oregon. The complaint in the suit seeks to name
Dr. Bruce Gold, an employee of Oregon Health Sciences University, as an inventor
and Oregon Health Sciences University as part owner of five of Vertex's
neurophilin patents. The suit stems from assays run on Vertex compounds by
Dr. Gold under a sponsored research agreement in 1996. We have investigated the
inventorship on these patents and believe that Dr. Gold is not an inventor,
Oregon Health Sciences has no ownership interest in any of these patents, and
that the claims made in this complaint are without merit. The suit is ongoing
and we intend to contest this claim vigorously.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets," which requires that ratable amortization of goodwill be replaced with
periodic tests of the goodwill's impairment and that intangible assets other
than goodwill be amortized over their useful lives. The provisions of SFAS
No. 142 are effective for fiscal years beginning after December 15, 2001. We
adopted the provisions of SFAS 142 on January 1, 2002 as required. That adoption
did not have a material effect on our financial position and results of
operations.
In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment of Long-Lived Assets." SFAS No. 144 supercedes SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" and provides a single accounting model for long-lived assets to
be disposed of. The provisions of SFAS No. 144 are effective for fiscal years
beginning after December 15, 2001. We adopted the provisions of SFAS 144 on
January 1, 2002 as required. That adoption did not have a material effect on our
financial position and results of operations.
16
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As part of its investment portfolio, Vertex owns financial instruments that
are sensitive to market risks. The investment portfolio is used to preserve
Vertex's capital until it is required to fund operations, including Vertex's
research and development activities. None of these market risk sensitive
instruments are held for trading purposes. Vertex does not have derivative
financial instruments in its investment portfolio.
INTEREST RATE RISK
Vertex invests its cash in a variety of financial instruments, principally
securities issued by the U.S. government and its agencies, investment grade
corporate bonds and notes and money market instruments. These investments are
denominated in U.S. dollars. All of its interest-bearing securities are subject
to interest rate risk, and could decline in value if interest rates fluctuate.
Substantially all of Vertex's investment portfolio consists of marketable
securities with active secondary or resale markets to help ensure portfolio
liquidity, and Vertex has implemented guidelines limiting the term to maturity
of its investment instruments. Due to the conservative nature of these
instruments, Vertex does not believe that it has a material exposure to interest
rate risk.
PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
On December 27, 2001, Vicki L. Sato, the Company's President, entered into a
plan with Goldman, Sachs & Co., pursuant to which Goldman will undertake to
sell, subject to a limit order, an aggregate of 100,000 shares of the Company's
stock issuable upon exercise of options held by Dr. Sato. Sales under the plan
are to begin no earlier than 90 days after adoption of the plan, and will take
place at specified intervals between April 3, 2002 and March 19, 2003.
On March 22, 2002, Roger W. Brimblecombe, a non-employee director of the
Company, entered into a plan with Goldman, Sachs & Co., pursuant to which
Goldman will undertake to sell, subject to a limit order, an aggregate of 15,000
shares of the Company's stock issuable upon exercise of options held by
Dr. Brimblecombe. Sales under the plan are to begin no earlier than 90 days
after adoption of the plan, and will take place at specified intervals between
July 3, 2002 and June 4, 2003.
On April 26, 2002, Joshua S. Boger, the Company's Chairman and CEO, entered
into a plan with Goldman, Sachs & Co., pursuant to which Goldman will undertake
to sell, subject to a limit order, an aggregate of 520,000 shares of the
Company's stock issuable upon exercise of options held by Dr. Boger. Sales under
the plan are to begin no earlier than 90 days after adoption of the plan, and
will take place at specified intervals between July 30, 2002 and July 22, 2003.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
None
(b) Reports on Form 8-K:
None
17
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
VERTEX PHARMACEUTICALS INCORPORATED
May 15, 2002 By: /s/ IAN F. SMITH
-----------------------------------------
Ian F. Smith
VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
18