Reason for Report: Flash Update: 4Q17 Earnings Results

Feb 02, 2018

Vertex Pharmaceuticals Inc. (VRTX – NASDAQ) $165.96

Note: FLASH REPORT; more details to come; changes are highlighted. Except where noted, and highlighted, no other sections of this report have been updated.

Previous Edition: 3Q17 Earnings Update

Vertex (VRTX) Q4 Earnings Beat on Strong CF Products Sales

Vertex Pharmaceuticals Incorporated (VRTX) reported fourth-quarter 2017 earnings per share of 61 cents, which beat the Zacks Consensus Estimate of 58 cents and came ahead of the year-ago earnings of 35 cents. Strong product revenues led to higher profits in the quarter and lower operating expense ratio year over year.

Vertex reported revenues of $651.6 million in the fourth quarter, up almost 42% year over year driven by strong product revenues. Revenues also beat the Zacks Consensus Estimate of $596.13 million.

Fourth Quarter Sales Strong

Vertex’s fourth-quarter revenues consisted of sales from cystic fibrosis (“CF”) products — Kalydeco and Orkambi, collaborative ($29.1 million) and royalty revenues ($1.3 million). CF product revenues were $621.2 million in the fourth quarter, up 37% year over year.

Kalydeco sales surged 44% to $256 million following approvals to treat an expanded population.

In May 2017, Kalydeco was approved for use in CF patients 2 years and older who have one of 23 residual function mutations in the CFTR gene. In August 2017, Kalydeco was approved in CF patients (2 years and older) who have one of five residual function mutations that result in a splicing defect in the CFTR gene. These line-extensions increased the eligible patient population for Kalydeco.

Orkambi (lumacaftor/ivacaftor) delivered sales of $365 million, up 32% year over year. The growth was supported by continued uptake globally, especially in pediatric patients in the United States.

Costs Rise

Adjusted research and development (R&D) expenses increased 20.3% to $249.2 million in the fourth quarter due to higher costs related to development of triple combination CF regimens. Adjusted selling, general and administrative (SG&A) expenses increased 20% to $105.5 million.

2017 Results

Vertex’s full-year revenues increased 46.2% year over year to $2.49 billion mainly driven by upfront payment of $315.2 million earned from Germany-based Merck KGaA (MKGAF) and strong CF portfolio sales. The upfront payment was part of a collaboration agreement per which Vertex out-licensed four oncology programs to Merck KGaA. Adjusted earnings for 2017 were up 129% year over year to $1.95 per share.

© Copyright 2018, Zacks Investment Research. All Rights Reserved Adjusted R&D expenses increased 10.8% year over year to $1.33 billion. However, it excluded an upfront payment of $160 million related to acquisition of a CFTR potentiator, VX-561, from Concert Pharmaceuticals, Inc. (CNCE). Adjusted SG&A expenses increased 9% year over year to $375.3 million, which included costs related to the potential launch of tezacaftor/ivacaftor combination in the United States. The increase was also due to increased investment to support the global commercialization of Orkambi and Kalydeco.

Stock Repurchase Program

Concurrent with the earnings release, Vertex announced that the board has authorized a share repurchase program to buy back its common stock to the tune of $500 million in 2018 and 2019.

2018 Guidance

Vertex provided 2018 guidance for combined operating costs.

Combined adjusted research and development (R&D) and selling, general and administrative (SG&A) expenses in 2018 are anticipated in the range of $1.50 to $1.55 billion.

The increase in operating expense reflects anticipated costs related to development and commercialization of triple combinations for treating CF and planned launch of tezacaftor/ivacaftor combination.

Pipeline & Regulatory Updates

In December 2017, Vertex announced data from phase III study – ARRIVAL – evaluating Kalydeco in children (age 1-2 years) who have one of 10 mutations in the CFTR gene. It showed improvement across multiple endpoints, including measures of pancreatic function. Based on this data, Vertex plans to file regulatory applications for approval of Kalydeco in children aged one to two years in the first quarter of 2018.

In January 2018, the European Commission approved a line extension for Orkambi to include use in children with CF aged between six and 11 years and have two copies of the F508del mutation. The approval increases the targeted patient population by about 3,400 patients. The company has plans to file regulatory applications for approval of Orkambi in children aged two to five with CF who have two copies of the F508del mutation in the first quarter of 2018.

Vertex is also seeking approval for a combination of tezacaftor and Kalydeco (ivacaftor) in CF patients aged 12 and older who have two copies of the F508del mutation or who have at least one residual function mutation. Regulatory applications are under review in the United States and Europe. A decision is expected in the United States on Feb 28, 2018 and in Europe in the second half of 2018.

The company is also developing triple combination regimens for treating CF, which are capable of treating almost 90% of patients. Vertex has selected two out of four next-generation correctors – VX-659 and VX- 445 – for advancing into two separate phase III triple combination studies. The candidates will evaluated in combination with tezacaftor and Kalydeco. Apart from CF, Vertex is also developing treatments for sickle cell disease, thalassemia, influenza and pain management. During the fourth quarter, the company initiated a phase III study on pimodivir in combination with standard-of-care treatment in patients with influenza. This study is being conducted in collaboration with Janssen Pharmaceuticals, a subsidiary of Johnson & Johnson (JNJ).

Details, other news update and broker comments will be provided in the next edition.

Zacks Investment Research Page 2 www.zackspro.com Executive Summary

Vertex focuses on the discovery, development, manufacture and commercialization of small molecule drugs for patients suffering from serious diseases. The company's main area of focus is cystic fibrosis (CF). Vertex’s portfolio includes two marketed drugs - Kalydeco and Orkambi –- for the treatment of CF. Meanwhile, Vertex’s CF pipeline is quite strong with a broad portfolio of next-generation CF correctors

Of the 21 firms providing ratings on Vertex, two (9.5%) conferred a neutral rating while the remaining 19 (90.5%) gave a positive rating on the stock. Notably, none of the firms gave a negative rating on the stock.

Positive outlook (19/21 firms): The positive firms are encouraged by the strong results of the triple combo regimens and their prospects upon launch. Further the firms are also positive on label expansion of Kalydeco in residual function mutations in the CFTR gene. The firms believe that the triple combination regimens have the potential to boost growth upon approval.

Neutral outlook (2/21 firms): The neutral firms believe that the triple combinations will replace Kalydeco and Orkambi going forward. However, they are of the opinion that increasing competition will bring down the prices of the drug, hurting the top line.

Overview

Vertex Pharmaceuticals Inc., headquartered in Boston, MA, focuses on the discovery and commercialization of small molecule drugs for the treatment of serious diseases. The company’s portfolio includes Kalydeco and Orkambi. Kalydeco (ivacaftor) is approved for the treatment of patients (two years and above) with CF who have one of the 33 mutations in their cystic fibrosis transmembrane conductance regulator (CFTR) gene.

In 2015, Vertex gained approval for another CF treatment, Orkambi (lumacaftor-ivacaftor combination), for the treatment of the underlying cause of CF in people (aged 12 and above) with two copies of the F508del mutation. In September 2016, Orkambi was approved for use in children (6–11 years old) in the United States

Pipeline candidates include tezacaftor for CF among others mainly in double and triple combination regimens with ivacaftor. The company is also developing many new combination regimens with CFTR modulators. While CF remains the main area of focus, Vertex has other early-stage development programs in its pipeline targeting pain (VX-150), ciliary dyskinesia (VX-371) and cervical injury (VX-210). The company has out- licensed its oncology and influenza pipeline candidates. The company’s website is www.vrtx.com.

The firms have identified the following issues for evaluating the investment merits of Vertex:

Key Positive Arguments Key Negative Arguments The triple combo regimens (next generation CFTR The firms are concerned about the company’s correctors) are crucial for Vertex’s long-term growth. increasing operating expenses. The acquisition of CTP-656 from Concert Orkambi sales are dependent on reimbursement Pharmaceuticals eliminates potential future competition programs, especially in ex-United States markets for Kalydeco. The approval for label expansion of Kalydeco gives The company is dependent on its CF franchise as access to the majority of residual function market, which candidates in other indications are at a nascent represents significant opportunity. stage. Moreover, several companies are developing treatments for CF, which will increase competition.

Note: The company’s financial year coincides with the calendar year. 12, 2017

Zacks Investment Research Page 3 www.zackspro.com Long-Term Growth

Vertex holds a strong position in the cystic fibrosis (CF) market. The CF franchise, consisting of approved products Kalydeco and Orkambi and other pipeline candidates, especially the triple combo regimens, are expected to drive long-term growth.

If the triple-combo regimes are successful, Vertex can address a significantly larger CF patient population – almost 90% of patients with CF - in the future.

The CF market represents huge commercial potential. It is a rare, life-threatening disease estimated to affect about 75,000 people in North America, Europe and Australia. Vertex enjoys a strong position in this market, being the first company to successfully develop a drug (Kalydeco) that treats the underlying cause of CF.

Target Price/Valuation

Rating Distribution Positive 90.48%↑ Neutral 9.52%↓ Negative 0.0% Avg. Target Price $177.30↑ High $205.00↑ Low $85.00 No. of firms with TP/Total 20/21

Recent Events

Vertex Beats on Q3 Earnings & Sales, Raises 2017 View – Oct 25

Vertex reported 3Q17 earnings per share of 53 cents which beat the Zacks Consensus Estimate of 37 cents and came ahead of the year-ago earnings of 17 cents. Strong product revenues led to higher profits in the quarter.

Vertex reported revenues of $578.2 million in the third quarter, up 40% year over year driven by strong product revenues. Revenues also beat the Zacks Consensus Estimate of $518.45 million by 11.5%.

Revenue

Vertex revenues rose almost 40% y/y to $578.2 million in 3Q17 due to strong product revenues.

Vertex’s 3Q17 revenues consisted of sales from CF products, Kalydeco and Orkambi; collaborative ($26.3 million) and royalty revenues ($2.2 million). CF product revenues were $549.6 million in 3Q17, up 34% y/y.

Revenue ($ in million) 3Q16A 2016A 1Q17A 2Q17A 3Q17A 4Q17E 2017E 2018E 2019E Digest Average $413.8 $1,702.2 $714.8 $544.1 $578.2 $590.3 $2,427.3 $2,677.3 $2,835.8 Digest High $413.8 $1,702.3 $715.7 $544.1 $578.2 $590.3 $2,427.3 $2,677.3 $2,835.8 Digest Low $413.5 $1,701.8 $714.7 $544.1 $578.2 $590.3 $2,427.3 $2,677.3 $2,835.8

Zacks Investment Research Page 4 www.zackspro.com Specific Products

Kalydeco (ivacaftor/VX-770)

Indication: Treatment of CF in patients age 2 years and above who have one of the 33 mutations in their CF gene including G551D, G1244E, G1349D, G178R, G551S, S1251N, S1255P, S549N, S549R or R117H. In Europe, Kalydeco is approved for R117H mutation only for patients of eighteen years of age and older.

Product Life Cycle Status: Marketed

Importance: Kalydeco has orphan drug designation in the United States and Europe.

Regulatory Status: On Aug 25, 2017, the FDA and the European Medicines Agency accepted regulatory applications for tezacaftor/ivacaftor (Kalydeco) combination for review. The applications are seeking approval of Kalydeco in combination with tezacaftor (VX-661) for the treatment of cystic fibrosis (CF) patients (12 and older) with two copies of the F508del mutation. The application in the United States has been granted a priority review with the FDA expected to give its decision on Feb 28, 2018.

In August 2017, the FDA approved label expansion of Kalydeco to be used in more than 600 CF patients (2 years and older) who have one of five residual function mutations that result in a splicing defect in the CFTR gene.

In May 2017, the FDA approved label expansion of Kalydeco in patients (2 years and older) with one of 23 residual function mutations in CFTR gene. The label expansion into this indication provides the company access to more than 900 patients in the United States

Partners: Vertex has a collaboration agreement with Cystic Fibrosis Foundation Therapeutics, Inc. (CFFT) for Kalydeco. Under the agreement, CFFT is entitled to receive royalties on net sales of Kalydeco.

Sales: In 3Q17, Kalydeco sales came in at $213 million, up 22% y/y. Kalydeco sales gained following approvals to treat an expanded population. The Zacks Digest average total revenues in 3Q17 were in line with the company’s report.

2017 Outlook: The company raised its sales expectations for the drug to a range of $810–$830 million in 2017 from the prior expectation of $740–$770 million.

Ongoing Studies: Vertex is evaluating Kalydeco’s efficacy on CF disease markers in young children (less than two years old) and children of ages three through five years in two separate phase III studies.

On Dec 7, 2017, Vertex announced that a phase III study evaluating Kalydeco in children (age 1-2 years) met its primary safety endpoint.

The ARRIVAL study was conducted in young children less than two years of age who have one of 10 mutations in the CFTR gene. Not only did it reveal that Kalydeco was well tolerated in children as young as one year, the study also showed improvement across multiple endpoints, including measures of pancreatic function. Based on this data, Vertex plans to file regulatory applications for approval of Kalydeco in children aged 1 to 2 years in the first quarter of 2018. The study, however, continues in infants less than one year of age.

$ in million 2015A 2016A 2017E 2018E 2019E Est. Growth (‘16-’19) Kalydeco Revenue $631.8 $703.5 $821.1↑ $832.4↑ $838.5↓ -

Zacks Investment Research Page 5 www.zackspro.com Orkambi (lumacaftor-Kalydeco combination)

Indication: Treatment of the underlying cause of CF in people aged 6 and older (in the United States), and 12 and older (in Europe) with two copies of the F508del mutation as well as those aged six to 11 years, who are homozygous for the F508del mutation in their CFTR gene (only in the U.S).

Partners: Vertex has a research agreement with CFFT for lumacaftor. According to the agreement, CFFT is entitled to receive royalties on future net sales of lumacaftor.

Regulatory Status: On Nov 10, 2017, the CHMP recommended the approval of label expansion in Europe to include children with CF ages 6 through 11 who have two copies of the F508del mutation. A potential approval is expected to increase the patient population by 3,400.

A pricing and reimbursement agreement was signed with the Health Service Executive (HSE) in the Republic of Ireland in June 2017, which will give the drug access to estimated 500 patients in Ireland. In July 2017, the company signed a reimbursement agreement in Italy for Orkambi as the first drug to treat underlying causes of CF in 12 years and older patients with two copies of the f508del mutation.

Sales: Orkambi (lumacaftor/ivacaftor) delivered sales of $336.2 million in 3Q17, up 43.7% y/y. The growth was supported by continued uptake in pediatric patients in the United States and additional revenues from European countries where Vertex has signed reimbursement agreements. The Zacks Digest average 3Q17 Orkambi revenues were in line with the company’s report.

Outlook: Orkambi revenues are expected in the range of $1.29–$1.32 billion (previously $1.1–$1.3 billion) in 2017.

Ongoing Studies: A two part phase III efficacy study in children with CF (age 2-5) who have two copies of the F508del mutation - to support the expansion of Orkambi’s label in the United States – is ongoing.

A two part phase III efficacy study in children with CF (age 6-11) who have two copies of the F508del mutation - to support the expansion of Orkambi’s label in Europe – is ongoing. About 3,400 children fall in this category in the EU.

In November 2016, Vertex announced that the study met the primary endpoint with a statistically significant improvement in absolute change in lung clearance index – a measure of lung function in early CF disease – compared with placebo through 24 weeks of treatment. Moreover, Orkambi was well tolerated in the study. The study data was largely consistent with the prior open-label study used to support the U.S. label expansion filing. The data, which demonstrated that Orkambi can improve lung function even in younger patients, will support the expansion of Orkambi’s label in Europe to include the pediatric patient population. Vertex filed a Marketing Authorization Application (MAA) variation in the EU for label expansion in March 2017.

$ in million 2015E 2016A 2017E 2018E 2019E Est. Growth (‘16-’19) Orkambi Revenue $350.8 $979.5 $1,307.0↑ $1,688.8↑ $2,083.8↑ -

Zacks Investment Research Page 6 www.zackspro.com Pipeline Candidates

CF Pipeline

Tezacaftor (Formerly VX-661)

Indication: CF

Partners: Vertex has a collaboration agreement with CFFT for the discovery and development of new medicines aimed at treating CF.

Stage of Development: Phase III

Ongoing Studies: Tezacaftor is being evaluated in two phase III programs in combination with Kalydeco in CF patients. One study is evaluating the combination in patients of age 12 years and older who have one copy of the F508del mutation and a second mutation that results in a gating mutation in the CFTR gene and who are responsive to Kalydeco alone.

Another study is evaluating the combination therapy in patients of six to eleven years of age in the United States who are homozygous for the F508del mutation or who have one copy of the F508del mutation and a gating or residual function mutation.

Two earlier phase III studies evaluating tezacaftor in combination with Kalydeco – EVOLVE and EXPAND – met their primary endpoints and demonstrated statistically significant improvements in lung function in patients with CF. The first study, EVOLVE (n=500), evaluated the combination therapy in patients with two copies of the F508del mutation and showed a mean absolute improvement of 4% points in ppFEV1 (percent predicted forced expiratory volume in one second) through 24 weeks versus placebo. The second study, EXPAND (n=250), evaluated the combination therapy in patients with one Copy of the F508del Mutation and a second mutation that results in residual CFTR function which showed an absolute change of 6.8% points in ppFEV1 from baseline to the average of Week 4 and Week 8 measurements versus placebo. The combination treatment was found to be well tolerated in both the studies.

A NDA and a MAA is under review in the United states and Europe, respectively, for the tezacaftor/ivacaftor combination for treatment of CF in patients aged 12 and older who have two copies of the F508del mutation and in people who have one mutation that results in residual CFTR function and F508del mutation. The FDA has granted priority review to the NDA and a decision is expected by the end of February, 2018. A decision in EU is expected in 2H18.

Tezacaftor in combination with Kalydeco has Breakthrough Therapy designation. VX-661 also enjoys orphan drug status in the United States

VX-371: VX-371, an ENaC inhibitor being developed under a collaboration agreement with Parion Sciences, is being evaluated in a placebo-controlled phase II study as a monotherapy and in combination with Kalydeco to treat patients with primary ciliary dyskinesia.

In October 2017, Vertex announced data from the phase II, 28-day study on VX-371 in CF patients, which showed that the primary endpoint (safety compared to placebo) was not met. The company has discontinued the study following the failure.

Next-Generation CFTR correctors (VX-152, VX-440, VX-659 and VX-445): VX-152 and VX-440 are two next-generation correctors that are being evaluated as part of a triple combination with VX-661 and Kalydeco in phase II studies in healthy volunteers. Vertex initiated phase II studies in 4Q16. Based on these data, it will initiate a phase III program for the development of VX-440 and phase IIa program for VX-152, in combination with VX-661 and Kalydeco. Phase I studies on the third and fourth next-generation corrector, VX-659 and VX-445 (triple combination with tezacaftor and ivacaftor) have been initiated.

Zacks Investment Research Page 7 www.zackspro.com Data were announced from two phase II studies on VX-152 (200mg q12h), VX-440 (600mg q12h) and a phase I study on VX-659 in July 2017 in CF patients with one F508del mutation and one minimal function mutation.

The primary endpoint of these studies was improvement in lung function measured by percent predicted forced expiratory volume in one second (ppFEV1). All the studies met their primary endpoints. The study evaluating VX-152 showed a mean absolute improvement of 9.7% points in ppFEV1 from baseline through two weeks versus placebo. The study on VX-440 showed an absolute change of 12% points in ppFEV1 from baseline to the average of the week 4 measurements versus placebo. The VX-659 regimen achieved a mean improvement of 9.6% points from baseline compared to placebo. The data demonstrated the potential of the regimens to treat the underlying cause of CF in patients with severe and difficult-to-treat type of the disease rather than treating the symptoms. Also, the three different regimens were well tolerated in patients and most of the adverse events were mild to moderate in severity.

The company is also evaluating VX-152 or VX-440 in patients with two copies of the F508del mutation who are already receiving tezacaftor and Kalydeco combination. The initial data showed improvements in mean absolute ppFEV1 of 7.3% and 9.5% points. Vertex fourth next-generation corrector under development is VX-445. A phase II triple combination study on VX-445 is ongoing whereas the company expects to initiate phase II study on VX-659 early next month. Data from these studies are expected in early 2018. Thereafter, upon discussion with regulatory agencies, Vertex will initiate pivotal studies on one or more of these triple combination regimens in the first half of 2018.

Non-CF Pipeline

VX-210: VX-210 is in a randomized, double-blind, placebo controlled phase IIb/III study in patients with certain acute cervical spinal cord injuries.

VX-150: VX-150 is being developed for the treatment of pain. A six-week crossover phase II proof-of-concept study is currently ongoing in people with symptomatic osteoarthritis of the knee.

Alliances, Agreements, Collaborations, and Acquisitions

On Jul 25, 2017, Vertex announced the closing of a previously announced agreement to buy worldwide development and commercialization rights to Concert Pharma’s CF pipeline candidate, CTP-656. Vertex plans to develop CTP-656 for potential use in future once-daily regimens in combination with its other pipeline drugs to treat the underlying cause of CF. Per the terms of the agreement, Vertex paid $160 million to Concert Pharma in cash upon closing and is liable to pay up to $90 million in additional milestones based on regulatory approval in the United States and reimbursement in the UK, Germany or France.

Please refer to the Zacks Research Digest spreadsheet on VRTX for further details on revenue.

Zacks Investment Research Page 8 www.zackspro.com Margins

Adjusted research and development expenses increased 15.3% to $243.2 million in 3Q17 due to higher costs related to development of triple combination CF regimens. Adjusted selling, general and administrative (SG&A) expenses increased 7.9% to $90.6 million due to increased investment to support the global launch of Orkambi.

Outlook for 2017

Combined adjusted research and development (R&D) and SG&A expenses in 2017 are anticipated in the range of $1.33 to $1.36 billion.

Note: According to the Zacks Digest model, COGS is expected to increase 25.9% y/y in 2017 and 26.4% y/y in 2018; SG&A expense is expected to increase 29.0% y/y in 2017 and 27.2% y/y in 2018; and R&D expense is expected to increase 12.3% y/y in 2017 and 12.9% y/y in 2018. Revenue is expected to increase 42.6% y/y in 2017 and 10.3% in 2018.

Please refer to the Zacks Research Digest spreadsheet on VRTX for further details on margins.

Earnings per Share

Vertex reported 3Q17 earnings of 53 cents per share, up 211.8% y/y. Strong product revenues led to higher profits in the quarter.

Please refer to the Zacks Research Digest spreadsheet on VRTX for further details on EPS.

Analyst Indrajit Bandyopadhyay Copy Editor Debasmita Banerjee

Content Editor Kinjel Shah

Lead Analyst & QCA Kinjel Shah

Last Updated By Kinjel Shah Reason for Update 3Q17 Earnings Update DISCLOSURE

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

DISCLOSURE

Zacks Investment Research Page 9 www.zackspro.com