Edgar Filing: VERTEX PHARMACEUTICALS INC / MA

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

________________________________________________________

FORM 10-Q



x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2019
or
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES 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 of incorporation or organization)	(I.R.S. Employer Identification No.)
50 Northern Avenue, Boston, Massachusetts	02210
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code (617) 341-6100

____________________________________________

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 o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer x	Accelerated filer o	Non-accelerated filer o	Smaller reporting company o

Emerging growth company o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

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 $0.01 per share	256,121,360
Class	Outstanding at April 24, 2019

Table of Contents

VERTEX PHARMACEUTICALS INCORPORATED

FORM 10-Q

FOR THE QUARTER ENDED MARCH 31, 2019

TABLE OF CONTENTS



		Page
Part I. Financial Information
Item 1.	Financial Statements	2
	Condensed Consolidated Financial Statements (unaudited)	2
	Condensed Consolidated Statements of Operations - Three Months Ended March 31, 2019 and 2018	2
	Condensed Consolidated Statements of Comprehensive Income - Three Months Ended March 31, 2019 and 2018	3
	Condensed Consolidated Balance Sheets - March 31, 2019 and December 31, 2018	4
	Condensed Consolidated Statements of Shareholders' Equity and Noncontrolling Interest - Three Months Ended March 31, 2019 and 2018	5
	Condensed Consolidated Statements of Cash Flows - Three Months Ended March 31, 2019 and 2018	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	32
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	42
Item 4.	Controls and Procedures	43
Part II. Other Information
Item 1.	Legal Proceedings	44
Item 1A.	Risk Factors	44
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	45
Item 6.	Exhibits	46
Signatures		47

“We,” “us,” “Vertex” and the “Company” as used in this Quarterly Report on Form 10-Q refer to Vertex Pharmaceuticals Incorporated, a Massachusetts corporation, and its subsidiaries.

“Vertex,” “KALYDECO^®,” “ORKAMBI^®,” “SYMDEKO^®” and “SYMKEVI^®” are registered trademarks of Vertex. Other brands, names and trademarks contained in this Quarterly Report on Form 10-Q are the property of their respective owners.

We use the brand name for our products when we refer to the product that has been approved and with respect to the indications on the approved label. Otherwise, including in discussions of our cystic fibrosis development programs, we refer to our compounds by their scientific (or generic) name or VX developmental designation.

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Part I. Financial Information

Item 1. Financial Statements

VERTEX PHARMACEUTICALS INCORPORATED

Condensed Consolidated Statements of Operations

(unaudited)

(in thousands, except per share amounts)



	Three Months Ended March 31,
	2019			2018
Revenues:
Product revenues, net	$	857,253		$	637,729
Collaborative and royalty revenues	1,182			3,070
Total revenues	858,435			640,799
Costs and expenses:
Cost of sales	95,092			71,613
Research and development expenses	339,490			310,553
Sales, general and administrative expenses	147,045			129,808
Restructuring income	—			(76		)
Total costs and expenses	581,627			511,898
Income from operations	276,808			128,901
Interest income	15,615			5,789
Interest expense	(14,868		)	(16,886		)
Other income, net	42,610			96,838
Income before provision for (benefit from) income taxes	320,165			214,642
Provision for (benefit from) income taxes	51,534			(12,659		)
Net income	268,631			227,301
Income attributable to noncontrolling interest	—			(17,038		)
Net income attributable to Vertex	$	268,631		$	210,263

Amounts per share attributable to Vertex common shareholders:
Net income:
Basic	$	1.05		$	0.83
Diluted	$	1.03		$	0.81
Shares used in per share calculations:
Basic	255,695			253,231
Diluted	260,175			258,526

The accompanying notes are an integral part of these condensed consolidated financial statements.

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VERTEX PHARMACEUTICALS INCORPORATED

Condensed Consolidated Statements of Comprehensive Income

(unaudited)

(in thousands)



	Three Months Ended March 31,
	2019			2018
Net income	$	268,631		$	227,301
Changes in other comprehensive income (loss):
Unrealized holding gains (losses) on marketable securities, net	596			(460		)
Unrealized losses on foreign currency forward contracts, net of tax of $1.5 million and $0.3 million, respectively	(222		)	(862		)
Foreign currency translation adjustment	4,967			(2,729		)
Total changes in other comprehensive income (loss)	5,341			(4,051		)
Comprehensive income	273,972			223,250
Comprehensive income attributable to noncontrolling interest	—			(17,038		)
Comprehensive income attributable to Vertex	$	273,972		$	206,212

The accompanying notes are an integral part of these condensed consolidated financial statements.

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VERTEX PHARMACEUTICALS INCORPORATED

Condensed Consolidated Balance Sheets

(unaudited)

(in thousands, except per share amounts)



	March 31,			December 31,
	2019			2018
Assets
Current assets:
Cash and cash equivalents	$	2,893,885		$	2,650,134
Marketable securities	584,150			518,108
Accounts receivable, net	438,297			409,688
Inventories	136,698			124,360
Prepaid expenses and other current assets	130,009			140,819
Total current assets	4,183,039			3,843,109
Property and equipment, net	742,559			812,005
Goodwill	50,384			50,384
Deferred tax assets	1,467,518			1,499,672
Operating lease assets	60,573			—
Other assets	39,041			40,728
Total assets	$	6,543,114		$	6,245,898
Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	82,262		$	110,987
Accrued expenses	532,745			604,495
Early access sales accrual	382,703			354,404
Other current liabilities	108,758			50,406
Total current liabilities	1,106,468			1,120,292
Long-term finance lease liabilities	560,381			581,550
Long-term operating lease liabilities	63,484			—
Long-term advance from collaborator	83,471			82,573
Other long-term liabilities	5,997			26,280
Total liabilities	1,819,801			1,810,695
Commitments and contingencies	—			—
Shareholders’ equity:
Preferred stock, $0.01 par value; 1,000 shares authorized; none issued and outstanding	—			—
Common stock, $0.01 par value; 500,000 shares authorized, 256,351 and 255,172 shares issued and outstanding, respectively	2,561			2,546
Additional paid-in capital	7,475,909			7,421,476
Accumulated other comprehensive income	6,000			659
Accumulated deficit	(2,761,157		)	(2,989,478		)
Total shareholders’ equity	4,723,313			4,435,203
Total liabilities and shareholders’ equity	$	6,543,114		$	6,245,898

The accompanying notes are an integral part of these condensed consolidated financial statements.

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VERTEX PHARMACEUTICALS INCORPORATED

Condensed Consolidated Statements of Shareholders’ Equity and Noncontrolling Interest

(unaudited)

(in thousands)



	Common Stock					Additional Paid-in Capital			Accumulated Other Comprehensive (Loss) Income			Accumulated Deficit			Total Vertex Shareholders’ Equity			Noncontrolling Interest			Total Shareholders’ Equity
	Shares		Amount			Additional Paid-in Capital			Accumulated Other Comprehensive (Loss) Income			Accumulated Deficit			Total Vertex Shareholders’ Equity			Noncontrolling Interest			Total Shareholders’ Equity
Balance at December 31, 2017	253,253		$	2,512		$	7,157,362		$	(11,572	)	$	(5,119,723	)	$	2,028,579		$	13,727		$	2,042,306
Cumulative effect adjustment for adoption of new accounting guidance	—		—			—			(24,120		)	33,349			9,229			—			9,229
Other comprehensive loss, net of tax	—		—			—			(4,051		)	—			(4,051		)	—			(4,051		)
Net income	—		—			—			—			210,263			210,263			17,038			227,301
Repurchase of common stock	(67	)	(1		)	(11,250		)	—			—			(11,251		)	—			(11,251		)
Issuance of common stock under benefit plans	1,682		30			89,656			—			—			89,686			—			89,686
Stock-based compensation expense	—		—			78,601			—			—			78,601			—			78,601
Other VIE activity	—		—			—			—			—			—			(1,000		)	(1,000		)
Balance at March 31, 2018	254,868		$	2,541		$	7,314,369		$	(39,743	)	$	(4,876,111	)	$	2,401,056		$	29,765		$	2,430,821

Balance at December 31, 2018	255,172		$	2,546		$	7,421,476		$	659		$	(2,989,478	)	$	4,435,203		$	—		$	4,435,203
Cumulative effect adjustment for adoption of new accounting guidance	—		—			—			—			(40,310		)	(40,310		)	—			(40,310		)
Other comprehensive income, net of tax	—		—			—			5,341			—			5,341			—			5,341
Net income	—		—			—			—			268,631			268,631			—			268,631
Repurchases of common stock	(564	)	(6		)	(103,833		)	—			—			(103,839		)	—			(103,839		)
Issuance of common stock under benefit plans	1,743		21			64,023			—			—			64,044			—			64,044
Stock-based compensation expense	—		—			94,243			—			—			94,243			—			94,243
Balance at March 31, 2019	256,351		$	2,561		$	7,475,909		$	6,000		$	(2,761,157	)	$	4,723,313		$	—		$	4,723,313

The accompanying notes are an integral part of these condensed consolidated financial statements.

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VERTEX PHARMACEUTICALS INCORPORATED

Condensed Consolidated Statements of Cash Flows

(unaudited)

(in thousands)



	Three Months Ended March 31,
	2019			2018
Cash flows from operating activities:
Net income	$	268,631		$	227,301
Adjustments to reconcile net income to net cash provided by operating activities:
Stock-based compensation expense	93,791			78,136
Depreciation expense	27,140			16,343
Write-downs of inventories to net realizable value	1,270			3,619
Deferred income taxes	43,425			3,587
Unrealized gain on equity securities	(43,551		)	(95,458		)
Other non-cash items, net	(3,701		)	5,827
Changes in operating assets and liabilities:
Accounts receivable, net	(30,136		)	(13,473		)
Inventories	(13,139		)	(8,208		)
Prepaid expenses and other assets	7,941			25,482
Accounts payable	(24,145		)	2,154
Accrued expenses and other liabilities	(38,425		)	(31,469		)
Early access sales accrual	35,683			38,816
Net cash provided by operating activities	324,784			252,657
Cash flows from investing activities:
Purchases of available-for-sale debt securities	(128,215		)	(38,653		)
Maturities of available-for-sale debt securities	107,118			94,365
Expenditures for property and equipment	(18,041		)	(29,279		)
Investment in equity securities	—			(21,500		)
Net cash (used in) provided by investing activities	(39,138		)	4,933
Cash flows from financing activities:
Issuances of common stock under benefit plans	63,620			88,403
Repurchase of common stock	(99,839		)	(10,000		)
Advance from collaborator	5,000			2,500
Payments on capital lease and construction financing lease obligations	—			(9,331		)
Payments on finance leases	(9,385		)	—
Proceeds related to construction financing lease obligation	—			9,566
Repayments of advanced funding	(1,385		)	(1,182		)
Other financing activities	—			(1,000		)
Net cash (used in) provided by financing activities	(41,989		)	78,956
Effect of changes in exchange rates on cash	(378		)	1,656
Net increase in cash and cash equivalents	243,279			338,202
Cash, cash equivalents and restricted cash—beginning of period	2,658,253			1,667,526
Cash, cash equivalents and restricted cash—end of period	$	2,901,532		$	2,005,728

Supplemental disclosure of cash flow information:
Cash paid for interest	$	13,148		$	16,825
Cash paid for income taxes	$	1,835		$	1,897
Capitalization of costs related to construction financing lease obligation	$	—		$	3,716
Issuances of common stock from employee benefit plans receivable	$	510		$	2,124
Accrued share repurchase liability	$	4,000		$	—

The accompanying notes are an integral part of these condensed consolidated financial statements.

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

A. Basis of Presentation and Accounting Policies

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 accounting principles generally accepted in the United States of America (“GAAP”).

The condensed consolidated financial statements reflect the operations of the Company and its wholly-owned subsidiaries. The Company's condensed consolidated financial statements for the interim period ended March 31, 2018 also include the financial results of BioAxone Biosciences, Inc. (“BioAxone”), a variable interest entity (“VIE”) that the Company consolidated from 2014 through December 31, 2018. All material intercompany balances and transactions have been eliminated. The Company operates in one segment, pharmaceuticals. The Company has reclassified certain items from the prior year’s condensed consolidated financial statements to conform to the current year’s presentation.

Certain information and footnote disclosures normally included in the Company’s 2018 Annual Report on Form 10-K have been condensed or omitted. These interim financial statements, in the opinion of management, reflect all normal recurring adjustments necessary for a fair presentation of the financial position and results of operations for the interim periods ended March 31, 2019 and 2018.

The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full fiscal year. These interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2018, which are contained in the 2018 Annual Report on Form 10-K.

Use of Estimates

The preparation of condensed consolidated financial statements in accordance with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the amounts of revenues and expenses during the reported periods. Significant estimates in these condensed consolidated financial statements have been made in connection with the calculation of revenues, research and development expenses, goodwill, deferred tax asset valuation allowances and the provision for or benefit from income taxes. The Company bases its estimates on historical experience and various other assumptions, including in certain circumstances future projections that management believes to be reasonable under the circumstances. Actual results could differ from those estimates. Changes in estimates are reflected in reported results in the period in which they become known.

Recently Adopted Accounting Standards

Leases

In 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASC 842”), which amends a number of aspects of lease accounting and requires entities to recognize right-of-use assets and liabilities on the balance sheet. ASC 842 became effective on January 1, 2019. The Company has finalized its review of its portfolio of existing leases and current accounting policies and has concluded that the amended guidance results in the recognition of additional assets and corresponding liabilities on its balance sheets. The Company also has finalized changes to its controls to address the adoption and ongoing lease accounting and related disclosure requirements of the new standard.

Until December 31, 2018, the Company applied build-to-suit accounting and was the deemed owner of its leased corporate headquarters in Boston and research site in San Diego, for which it was recognizing depreciation expense over the buildings’ useful lives and imputed interest on the corresponding construction financing lease obligations. Under the amended guidance that became effective January 1, 2019, the Company accounts for these buildings as finance leases, resulting in increased depreciation expense over the respective lease terms of 15-16 years, which are significantly shorter than the buildings’ useful lives of 40 years. The Company also expects a reduction in its imputed interest expense in the initial years of each finance lease term. In 2019, the Company expects an increase in operating expenses of approximately $26 million and a decrease in interest expense of approximately $13 million due to this change.

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”), which offered a transition option to entities adopting ASC 842. Under ASU 2018-11, entities could elect to apply ASC 842 using a modified-retrospective adoption approach resulting in a cumulative effect adjustment to accumulated deficit at the beginning of the year in which the new lease standard is adopted, rather than adjustments to the earliest comparative period presented in their financial statements. The Company adopted ASC 842 using the modified-retrospective method. As of January 1, 2019, the Company recorded a cumulative effect adjustment to increase its “Accumulated deficit” by $40.3 million related to the adjustments to its build-to-suit leases described in the previous paragraph.

The Company elected the package of transition practical expedients for leases that commenced prior to January 1, 2019, allowing it not to reassess (i) whether any expired or existing contracts contain leases, (ii) the lease classification for any expired or existing leases and (iii) the initial indirect costs for any existing leases.

Additionally, the Company recorded, upon adoption of ASC 842 on January 1, 2019, operating lease assets of $61.7 million and corresponding liabilities of $71.9 million related to its real estate leases that are not treated as finance leases under ASC 842. The difference between these assets and liabilities is primarily attributable to prepaid or accrued lease payments. The Company also reclassified amounts that were recorded as “Capital lease obligations, current portion” and “Capital lease obligations, excluding current portion” as of December 31, 2018 to “Other current liabilities” and “Long-term finance lease liabilities,” respectively, on January 1, 2019. These adjustments had no impact on the Company’s condensed consolidated statement of operations and had no impact on the Company’s accumulated deficit.

The cumulative effect of applying ASC 842 on the Company’s condensed consolidated balance sheet as of January 1, 2019 was as follows:



	Balance as of						Balance as of
	December 31, 2018 ^			Adjustments			January 1, 2019
Assets	(in thousands)
Prepaid expenses and other current assets	$	140,819		$	(2,930	)	$	137,889
Property and equipment, net	812,005			(53,920		)	758,085
Deferred tax assets	1,499,672			11,236			1,510,908
Operating lease assets	—			61,674			61,674
Total assets	$	6,245,898		$	16,060		$	6,261,958
Liabilities and Shareholders’ Equity
Capital lease obligations, current portion	$	9,817		$	(9,817	)	$	—
Other current liabilities	40,589			34,304			74,893
Capital lease obligations, excluding current portion	19,658			(19,658		)	—
Construction financing lease obligation, excluding current portion	561,892			(561,892		)	—
Long-term finance lease liabilities	—			569,487			569,487
Long-term operating lease liabilities	—			64,849			64,849
Other long-term liabilities	26,280			(20,903		)	5,377
Accumulated deficit	(2,989,478		)	(40,310		)	(3,029,788		)
Total liabilities and shareholders’ equity	$	6,245,898		$	16,060		$	6,261,958
^ As reported in the Company’s 2018 Annual Report on Form 10-K.

Please refer to Note K, “Leases,” for further information regarding the Company’s leases as well as certain disclosures required by ASC 842.

Derivatives and Hedging

In 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815) (“ASU 2017-12”), which helps simplify certain aspects of hedge accounting and enables entities to more accurately present their risk management activities in their financial statements. ASU 2017-12 became effective January 1, 2019. The adoption of ASU 2017-12 did not have a significant effect on the Company’s condensed consolidated financial statements.

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

Recently Issued Accounting Standards

Internal-Use Software

In 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”), which clarifies the accounting for implementation costs in cloud computing arrangements. ASU 2018-15 is effective on January 1, 2020. Early adoption is permitted. The Company currently is evaluating the impact the adoption of ASU 2018-15 may have on its condensed consolidated financial statements.

Fair Value Measurement

In 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”), which modifies the disclosure requirements for fair value measurements. ASU 2018-13 is effective on January 1, 2020. Early adoption is permitted. The Company currently is evaluating the impact the adoption of ASU 2018-13 may have on its disclosures.

For a discussion of other recent accounting pronouncements please refer to Note A, “Nature of Business and Accounting Policies—Recent Accounting Pronouncements,” in the 2018 Annual Report on Form 10-K.

Summary of Significant Accounting Policies

The Company’s significant accounting policies are described in Note A, “Nature of Business and Accounting Policies,” in its 2018 Annual Report on Form 10-K. The Company is disclosing changes in its accounting policies related to guidance that became effective January 1, 2019 in this Quarterly Report on Form 10-Q. Specifically, the Company has included its policy pursuant to its adoption of ASC 842 below.

Leases

At the inception of an arrangement, the Company determines whether the arrangement contains a lease. If a lease is identified in an arrangement, the Company recognizes a right-of-use asset and liability on its balance sheet and determines whether the lease should be classified as a finance or operating lease. The Company does not recognize assets or liabilities for leases with lease terms of less than 12 months.

A lease qualifies as a finance lease if any of the following criteria are met at the inception of the lease: (i) there is a transfer of ownership of the leased asset to the Company by the end of the lease term, (ii) the Company holds an option to purchase the leased asset that it is reasonably certain to exercise, (iii) the lease term is for a major part of the remaining economic life of the leased asset, (iv) the present value of the sum of lease payments equals or exceeds substantially all of the fair value of the leased asset, or (v) the nature of the leased asset is specialized to the point that it is expected to provide the lessor no alternative use at the end of the lease term. All other leases are recorded as operating leases.

Finance and operating lease assets and liabilities are recognized at the lease commencement date based on the present value of the lease payments over the lease term using the discount rate implicit in the lease. If the rate implicit is not readily determinable, the Company utilizes its incremental borrowing rate at the lease commencement date. Operating lease assets are further adjusted for prepaid or accrued lease payments. Operating lease payments are expensed using the straight-line method as an operating expense over the lease term. Finance lease assets are amortized to depreciation expense using the straight-line method over the shorter of the useful life of the related asset or the lease term. Finance lease payments are bifurcated into (i) a portion that is recorded as imputed interest expense and (ii) a portion that reduces the finance liability associated with the lease.

The Company does not separate lease and non-lease components when determining which lease payments to include in the calculation of its lease assets and liabilities. Variable lease payments are expensed as incurred. If a lease includes an option to extend or terminate the lease, the Company reflects the option in the lease term if it is reasonably certain it will exercise the option.

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

Finance leases are recorded in “Property and equipment, net,” “Other current liabilities” and “Long-term finance lease liabilities” on the Company’s condensed consolidated balance sheet. Operating leases are recorded in “Operating lease assets,” “Other current liabilities” and “Long-term operating lease liabilities” on the Company’s condensed consolidated balance sheet.


B.	Revenue Recognition

Disaggregation of Revenue

Revenues by Product

Product revenues, net consisted of the following:



	Three Months Ended March 31,
	2019		2018
	(in thousands)
SYMDEKO/SYMKEVI	$	320,275	$	34,124
ORKAMBI	293,007		354,066
KALYDECO	243,971		249,539
Total product revenues, net	$	857,253	$	637,729

Revenues by Geographic Location

Net product revenues are attributed to countries based on the location of the customer. Collaborative and royalty revenues are attributed to countries based on the location of the Company’s subsidiary associated with the collaborative arrangement related to such revenues. Total revenues from external customers and collaborators by geographic region consisted of the following:



	Three Months Ended March 31,
	2019		2018
	(in thousands)
United States	$	641,104	$	482,667
Outside of the United States
Europe	167,751		131,895
Other	49,580		26,237
Total revenues outside of the United States	217,331		158,132
Total revenues	$	858,435	$	640,799

In the three months ended March 31, 2019 and 2018, revenues attributable to Germany contributed the largest amount to the Company’s European revenues.

French Early Access Programs

In 2015, the Company began distributing ORKAMBI through early access programs in France and continues to be engaged in ongoing pricing discussions regarding the final price for ORKAMBI in France. The Company expects that the difference between the amounts it has collected to date based on the invoiced price and the final negotiated price for ORKAMBI in France will be returned to the French government.

Pursuant to the revenue recognition accounting guidance that was applicable until December 31, 2017, the Company’s ORKAMBI net product revenues for 2015, 2016 and 2017 did not include any net product revenues from sales of ORKAMBI in France because the price was not fixed and determinable at the time of delivery. Upon adopting ASU 2014-09, Revenues from Contracts with Customers (Topic 606), in the first quarter of 2018, the Company began recognizing net product revenues on a portion of its current period sales based on its estimate of consideration it expects to retain that will not be subject to a significant reversal in amounts recognized. If the Company’s estimate regarding the amounts it will receive for

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

ORKAMBI supplied pursuant to these early access programs changes, the Company will reflect the effect of the change in estimate in “Product revenues, net” in the period in which the change in estimate occurs.

As of March 31, 2019 and December 31, 2018, the Company’s condensed consolidated balance sheets included an “Early access sales accrual” of $382.7 million and $354.4 million, respectively, which was primarily related to the amount it may be required to return to the French government related to ORKAMBI early access programs, which is considered to be a refund liability.

Contract Liabilities

The Company recorded contract liabilities of $51.4 million and $24.9 million as of March 31, 2019 and December 31, 2018, respectively, related to annual contracts with government-owned and supported customers in international markets that limit the amount of annual reimbursement the Company can receive. Upon exceeding the annual reimbursement amount, products are provided free of charge, which is a material right. These contracts, which are classified as “Other current liabilities,” include upfront payments and fees. The Company defers a portion of the consideration received for shipments made up to the annual reimbursement limit, and the deferred amount is recognized as revenue when the free products are shipped. The Company’s product revenue contracts include performance obligations that are one year or less.

Several of the Company’s contract liabilities relate to contracts with annual reimbursement limits in international markets in which the annual period associated with the contract is not the same as the Company’s fiscal year. In the majority of international markets in which the Company has a contract with an annual reimbursement limit, the annual period associated with the contract is the same as the Company’s fiscal year, resulting in no contract liability balance at the end of the year and no revenues recognized in the current year related to performance obligations satisfied in previous years. For the international markets in which the periods associated with these annual contracts are not the same as the Company’s fiscal year, the Company recognizes revenues related to performance obligations satisfied in previous years; however, these amounts are not material to the Company’s financial statements and do not relate to any performance obligations that were satisfied more than 12 months prior to the beginning of the current year.


C.	Collaborative Arrangements and Acquisitions

The Company has entered into numerous agreements pursuant to which it collaborates with third parties on research, development and commercialization programs, including in-license and out-license agreements and asset acquisitions.

In-license Agreements

The Company has entered into a number of license agreements in order to advance and obtain access to technologies and services related to its research and early-development activities. The Company is generally required to make an upfront payment upon execution of the license agreement; development, regulatory and commercialization milestones payments upon the achievement of certain product research, development and commercialization objectives; and royalty payments on future sales, if any, of commercial products resulting from the collaboration.

Pursuant to the terms of its in-license agreements, the Company’s collaborators lead the discovery efforts and the Company leads all preclinical, development and commercialization activities associated with the advancement of any drug candidates and funds all expenses unless otherwise described below.

The Company typically can terminate its in-license agreements by providing advance notice to its collaborators; the required length of notice is dependent on whether any product developed under the license agreement has received marketing approval. The Company’s license agreements may be terminated by either party for a material breach by the other, subject to notice and cure provisions. Unless earlier terminated, these license agreements generally remain in effect until the date on which the royalty term and all payment obligations with respect to all products in all countries have expired.

CRISPR Therapeutics AG

In 2015, the Company entered into a strategic collaboration, option and license agreement (the “CRISPR Agreement”) with CRISPR Therapeutics AG and its affiliates (“CRISPR”) to collaborate on the discovery and development of potential new treatments aimed at the underlying genetic causes of human diseases using CRISPR-Cas9 gene-editing technology. The

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

Company has the exclusive right to license up to six CRISPR-Cas9-based targets, including targets for the potential treatment of sickle cell disease. In connection with the CRISPR Agreement, the Company made an upfront payment to CRISPR of $75.0 million and an investment in CRISPR’s stock. The Company has also made several subsequent investments in CRISPR’s common stock, which has resulted in CRISPR becoming a related party of the Company. Please refer to Note F, “Marketable Securities and Equity Investments,” for further information regarding the Company’s investment in CRISPR’s common stock.

The Company funds all the discovery activities conducted pursuant to the CRISPR Agreement. For targets that the Company elects to license, other than hemoglobinopathy treatments, the Company would lead all development and global commercialization activities. For each target that the Company elects to license, other than hemoglobinopathy targets, CRISPR has the potential to receive up to $420.0 million in development, regulatory and commercial milestones as well as royalties on net product sales. As part of the collaboration, the Company and CRISPR share equally all development costs and potential worldwide revenues related to potential hemoglobinopathy treatments, including treatments for beta thalassemia and sickle cell disease.

In 2017, the Company entered into a co-development and co-commercialization agreement with CRISPR pursuant to the terms of the CRISPR Agreement, under which the Company and CRISPR are co-developing and will co-commercialize CTX001 (the “CTX001 Co-Co Agreement”) for the treatment of hemoglobinopathy, including treatments for sickle cell disease and beta thalassemia. The Company concluded that the CTX001 Co-Co Agreement is a cost-sharing arrangement, which results in the net impact of the arrangement being recorded in “Research and development expenses” in its condensed consolidated statements of operations. During the three months ended March 31, 2019 and 2018, the net expense related to the CTX001 Co-Co Agreement was $7.0 million and $3.6 million, respectively.

Other In-license Agreements

In 2016, the Company entered into a strategic collaboration and licensing agreement with Moderna Therapeutics, Inc. (“Moderna”), pursuant to which the parties are seeking to identify and develop messenger ribonucleic acid, or mRNA, therapeutics for the treatment of CF. The Company made an upfront payment to Moderna of $20.0 million and an investment in Moderna’s preferred stock, which converted to common stock when Moderna became a publicly traded company in December 2018. Moderna has the potential to receive future development and regulatory milestones of up to $275.0 million, as well as royalties on net product sales. Please refer to Note F, “Marketable Securities and Equity Investments,” for further information regarding the Company’s investment in Moderna’s common stock.

In December 2018, the Company entered into a strategic collaboration and licensing agreement (the “Arbor Agreement”) with Arbor Biotechnologies, Inc. (“Arbor”) focused on the discovery of novel proteins, including DNA endonucleases, to advance the development of new gene-editing therapies. Pursuant to the Arbor Agreement, Arbor’s platform technology is being applied in the collaboration activities for up to five Vertex disease areas in exchange for an upfront payment of $30.0 million. In addition, the Company received a convertible promissory note that matures in 2023 for an additional $15.0 million payment. For each product identified by the collaboration, Arbor has the potential to receive up to $337.5 million in development, regulatory and commercial milestones as well as royalties on net product sales.

The Company determined that the fair value of the convertible promissory note approximated its contractual value upon agreement execution and classifies the convertible note in “Other assets” at amortized cost. The Company determined that substantially all of the fair value of the Arbor Agreement was attributable to an in-process research and development asset and no substantive processes were acquired that would constitute a business. The Company concluded that it did not have any alternative future use for the acquired in-process research and development asset and recorded the $30.0 million upfront payment to “Research and development expenses.”

In 2015, the Company entered into a strategic collaboration and license agreement with Parion Sciences, Inc. (“Parion”) focused on the development of investigational epithelial sodium channel (“ENaC”) inhibitors for the potential treatment of CF and all other pulmonary diseases. Parion received a $5.0 million milestone that was recorded as “Research and development expenses” in the three months ended March 31, 2019 and has the potential to receive additional development and regulatory milestones related to the ENaC inhibitors.

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

Variable Interest Entities (VIEs)

The Company has licensed rights to certain drug candidates from these third-party collaborators, which has resulted in the consolidation of certain third-parties’ financial statements into the Company’s condensed consolidated financial statements as VIEs for certain periods of time. As of December 31, 2018, and continuing through the first quarter of 2019, the Company had no consolidated VIEs reflected in its financial statements.

BioAxone Biosciences, Inc.

In 2014, the Company entered into a license and collaboration agreement (the “BioAxone Agreement”) with BioAxone, which resulted in the consolidation of BioAxone as a VIE beginning in October 2014. The Company made an initial payment to BioAxone of $10.0 million in 2014.

In the three months ended March 31, 2018, the Company recorded net income attributable to noncontrolling interest of $17.0 million, which was primarily related to a $24.0 million increase in the fair value of the contingent payments payable by Vertex to BioAxone due to (i) the expiration of an option held by the Company to purchase BioAxone in the first quarter of 2018 that increased the probability of a $10.0 million license continuation fee for VX-210 (which was ultimately paid in the first quarter of 2018) and (ii) the probability that additional milestone and royalty payments related to the BioAxone Agreement would be paid. Net income attributable to noncontrolling interest also included a $6.4 million benefit from income taxes during the three months ended March 31, 2018 that was primarily related to the increase in the fair value of the contingent payments.

In October 2018, the Company announced it would stop clinical development of VX-210 and terminate the Phase 2b clinical trial of VX-210 based on the recommendation of the clinical trial’s Data Safety Monitoring Board and the Company’s review of interim data from the clinical trial. In December 2018, the Company notified BioAxone of its intent to terminate the BioAxone Agreement and executed a release that immediately allowed BioAxone to control development of its neurological programs other than VX-210 without the Company’s consent. As a result, the Company deconsolidated BioAxone as of December 31, 2018 because it determined that it no longer was the primary beneficiary of BioAxone as it no longer had the power to direct the significant activities of BioAxone. The net impact of the deconsolidation was not material to the Company’s condensed consolidated statement of operations.

Asset Acquisition

Concert Pharmaceuticals

In 2017, the Company acquired certain CF assets including VX-561 (the “Concert Assets”) from Concert Pharmaceuticals Inc. (“Concert”) pursuant to an asset purchase agreement (the “Concert Agreement”). VX-561 is an investigational CFTR potentiator that has the potential to be used as part of combination regimens of CFTR modulators to treat CF. Pursuant to the Concert Agreement, Vertex paid Concert $160.0 million in cash for the Concert Assets, which was recorded to “Research and development expenses” in 2017. If VX-561 is approved as part of a combination regimen to treat CF, Concert could receive up to an additional $90.0 million in milestones based on regulatory approval in the United States and reimbursement in the United Kingdom, Germany or France.

Out-license agreements

The Company has entered into licensing agreements pursuant to which it has out-licensed rights to certain drug candidates to third-party collaborators. Pursuant to these out-license agreements, the Company’s collaborators become responsible for all costs related to the continued development of such drug candidates and obtain development and commercialization rights to these drug candidates. Depending on the terms of the agreements, the Company’s collaborators may be required to make upfront payments, milestone payments upon the achievement of certain product research and development objectives and may also be required to pay royalties on future sales, if any, of commercial products resulting from the collaboration. The termination provisions associated with these collaborations are generally the same as those described above related to the Company’s in-license agreements.

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

Merck KGaA, Darmstadt, Germany

In January 2017, the Company entered into a strategic collaboration and license agreement (the “Oncology Agreement”) with Merck KGaA, Darmstadt, Germany (the “Licensee”). Pursuant to the Oncology Agreement, the Company granted the Licensee an exclusive worldwide license to research, develop and commercialize four oncology research and development programs including two clinical-stage programs targeting DNA damage repair: its ataxia telangiectasia and Rad3-related protein kinase inhibitor program, or ATR program, including VX-970 and VX-803, and its DNA-dependent protein kinase inhibitor program, or DNA-PK program, including VX-984. In addition, the Company granted the Licensee exclusive, worldwide rights to two pre-clinical programs. The Company recorded the $230.0 million upfront payment related to the Oncology Agreement as “Collaborative and royalty revenues” upon delivery of the license in 2017. The Company’s activities related to the Oncology Agreement were substantially complete in 2017.

In December 2018, the Company entered into an agreement with Merck KGaA, Darmstadt, Germany (the “DNA-PK Agreement”) whereby the Company licensed the two lead Vertex DNA-PK compounds from its DNA-PK program for use in the field of gene integration for six specific indications. In exchange for this exclusive worldwide license to research, develop and commercialize the DNA-PK program for the specified indications within the field of gene integration, the Company made an upfront payment of $65.0 million. Merck KGaA, Darmstadt, Germany has the potential to receive additional milestones, primarily related to approval and reimbursement in various markets, as well as royalties on net product sales.

The Company evaluated the DNA-PK Agreement and concluded it represents a modification of the Oncology Agreement pursuant to ASC 606. As of December 2018, when the Company entered into the DNA-PK Agreement, the Company had completed its obligations under the Oncology Agreement, but the Oncology Agreement was an open contract pursuant to ASC 606 since the Company could receive future royalty payments from the commercialization of the licensed programs under the Oncology Agreement.

In applying ASC 606, the Company determined that the license granted under the DNA-PK Agreement is distinct from the license granted by the Company under the Oncology Agreement since the license to the two lead Vertex DNA-PK compounds is capable of being distinct as the Company is able to benefit from the license via its ability to internally develop and commercialize the two lead Vertex DNA-PK compounds in the six named indications in the field of gene-editing, and the license is not dependent on Merck KGaA, Darmstadt, Germany providing any specialized services to the Company. In addition, the license to the two lead Vertex DNA-PK compounds granted to the Company under the DNA-PK Agreement is distinct from the license granted by the Company under the Oncology Agreement as the rights conveyed in the licenses differ and both parties have the ability to commercially benefit from the licenses on their own. Furthermore, the consideration attributable to the license of the two lead Vertex DNA-PK compounds represents fair value. Therefore, the Company determined it should account for the DNA-PK Agreement as a separate agreement.

The Company determined that substantially all of the fair value of the DNA-PK Agreement was attributable to a single in-process research and development asset that did not constitute a business. The Company concluded that it did not have any alternative future use for the acquired in-process research and development asset and recorded the $65.0 million payment to “Research and development expenses” accordingly.

Janssen Pharmaceuticals, Inc.

In 2014, the Company entered into an agreement with Janssen Pharmaceuticals, Inc. (“Janssen”). Pursuant to the agreement, Janssen has an exclusive worldwide license to develop and commercialize certain drug candidates for the treatment of influenza, including pimodivir. The Company has received upfront and milestone payments of $60.0 million from Janssen to date. The most recent milestone was earned based on Janssen’s initiation of a Phase 3 clinical trial in 2017.

Cystic Fibrosis Foundation

The Company has a research, development and commercialization agreement that was originally entered into in 2004 with Cystic Fibrosis Foundation (“CFF”), as successor in interest to the Cystic Fibrosis Foundation Therapeutics, Inc. This agreement was most recently amended in 2016 (the “2016 Amendment”). Pursuant to the agreement, as amended, the Company agreed to pay royalties ranging from low-single digits to mid-single digits on potential sales of certain compounds

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

first synthesized and/or tested between March 1, 2014 and August 31, 2016, including VX-659 and VX-445, and tiered royalties ranging from single digits to sub-teens on any approved drugs first synthesized and/or tested during a research term on or before February 28, 2014, including KALYDECO (ivacaftor), ORKAMBI (lumacaftor in combination with ivacaftor) and SYMDEKO/SYMKEVI (tezacaftor in combination with ivacaftor). For combination products, such as ORKAMBI and SYMDEKO, sales are allocated equally to each of the active pharmaceutical ingredients in the combination product. There are no remaining commercial milestone payments payable by the Company to CFF pursuant to the agreement.

Pursuant to the 2016 Amendment, the Company received an upfront payment of $75.0 million and is receiving development funding from CFF of up to $6.0 million annually. The Company concluded that the upfront payment plus any future development funding represent a form of financing pursuant to ASC 730 and thus records the amounts as a liability on the condensed consolidated balance sheet, primarily reflected in “Long-term advance from collaborator.” The Company reduces this liability over the estimated royalty term of the agreement and reflects the reductions as an offset to “Cost of sales” and as “Interest expense.”

The Company has royalty obligations to CFF for ivacaftor, lumacaftor and tezacaftor until the expiration of patents covering those compounds. The Company has patents in the United States and European Union covering the composition-of-matter of ivacaftor that expire in 2027 and 2025, respectively, subject to potential patent extension. The Company has patents in the United States and European Union covering the composition-of-matter of lumacaftor that expire in 2030 and 2026, respectively, subject to potential extension. The Company has patents in the United States and European Union covering the composition-of-matter of tezacaftor that expire in 2027 and 2028, respectively, subject to potential extension.


D.	Earnings Per Share

Basic net income per share attributable to Vertex common shareholders is based upon the weighted-average number of common shares outstanding during the period, excluding restricted stock, restricted stock units and performance-based restricted stock units, or “PSUs,” that have been issued but are not yet vested. Diluted net income per share attributable to Vertex common shareholders 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 dilutive.

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

The following table sets forth the computation of basic and diluted net income per share for the periods ended:



	Three Months Ended March 31,
	2019		2018
	(in thousands, except per share amounts)
Basic net income attributable to Vertex per common share calculation:
Net income attributable to Vertex common shareholders	$	268,631	$	210,263
Less: Undistributed earnings allocated to participating securities	—		(99		)
Net income attributable to Vertex common shareholders—basic	$	268,631	$	210,164

Basic weighted-average common shares outstanding	255,695		253,231
Basic net income attributable to Vertex per common share	$	1.05	$	0.83

Diluted net income attributable to Vertex per common share calculation:
Net income attributable to Vertex common shareholders	$	268,631	$	210,263
Less: Undistributed earnings allocated to participating securities	—		(97		)
Net income attributable to Vertex common shareholders—diluted	$	268,631	$	210,166

Weighted-average shares used to compute basic net income per common share	255,695		253,231
Effect of potentially dilutive securities:
Stock options	2,585		3,248
Restricted stock and restricted stock units (including PSUs)	1,870		2,013
Employee stock purchase program	25		34
Weighted-average shares used to compute diluted net income per common share	260,175		258,526
Diluted net income attributable to Vertex per common share	$	1.03	$	0.81

The Company did not include the securities in the following table in the computation of the net income per share attributable to Vertex common shareholders calculations because the effect would have been anti-dilutive during each period:



	Three Months Ended March 31,
	2019	2018
	(in thousands)
Stock options	2,837	1,633
Unvested restricted stock and restricted stock units (including PSUs)	6	4


E.	Fair Value Measurements

The fair value of the Company’s financial assets and liabilities reflects the Company’s estimate of amounts that it would have received in connection with the sale of the assets or paid in connection with the transfer of the liabilities in an orderly transaction between market participants at the measurement date. In connection with measuring the fair value of its assets and liabilities, the Company seeks to maximize the use of observable inputs (market data obtained from sources independent from the Company) and to minimize the use of unobservable inputs (the Company’s assumptions about how market participants would price assets and liabilities). The following fair value hierarchy is used to classify assets and liabilities based on the observable inputs and unobservable inputs used in order to value the assets and liabilities:

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Notes to Condensed Consolidated Financial Statements

(unaudited)



Level 1:	Quoted prices in active markets for identical assets or liabilities. An active market for an asset or liability is a market in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2:	Observable inputs other than Level 1 inputs. Examples of Level 2 inputs include quoted prices in active markets for similar assets or liabilities and quoted prices for identical assets or liabilities in markets that are not active.
Level 3:	Unobservable inputs based on the Company’s assessment of the assumptions that market participants would use in pricing the asset or liability.

The Company’s investment strategy is focused on capital preservation. The Company invests in instruments that meet the credit quality standards outlined in the Company’s investment policy. This policy also limits the amount of credit exposure to any one issue or type of instrument. The Company maintains strategic investments separately from the investment policy that governs its other cash, cash equivalents and marketable securities as described in “Note F, “Marketable Securities and Equity Investments.” As of March 31, 2019, the Company’s investments were in money market funds, U.S. Treasury securities, government-sponsored enterprise securities, corporate debt securities, commercial paper and corporate equity securities. Additionally, the Company utilizes foreign currency forward contracts intended to mitigate the effect of changes in foreign exchange rates on its condensed consolidated statement of operations.

As of March 31, 2019, all of the Company’s financial assets and liabilities that were subject to fair value measurements were valued using observable inputs. The Company’s financial assets valued based on Level 1 inputs consisted of money market funds, U.S. Treasury securities, government-sponsored enterprise securities and corporate equity securities. The Company’s financial assets and liabilities valued based on Level 2 inputs consisted of certain corporate equity securities as described below, corporate debt securities, commercial paper, which consisted of investments in highly-rated investment-grade corporations, and foreign currency forward contracts with reputable and creditworthy counterparties. In 2018, Moderna became a publicly traded company. The Company has valued its investment in Moderna based on Level 2 inputs due to transfer restrictions subsequent to Moderna’s initial public offering lasting until December 2019. The reduction in fair value recorded on the Company’s condensed consolidated balance sheet related to this transfer restriction is not material to its financial statements. During the three months ended March 31, 2019 and 2018, the Company did not record any other-than-temporary impairment charges related to its financial assets.

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

The following table sets forth the Company’s financial assets and liabilities subject to fair value measurements (and does not include $1.5 billion and $1.4 billion of cash as of March 31, 2019 and December 31, 2018, respectively):



	Fair Value Measurements as of March 31, 2019
				Fair Value Hierarchy
	Total			Level 1		Level 2			Level 3
	(in thousands)
Financial instruments carried at fair value (asset positions):
Cash equivalents:
Money market funds	$	1,354,656		$	1,354,656	$	—		$	—
U.S. Treasury securities	5,996			5,996		—			—
Government-sponsored enterprise securities	11,786			11,786		—			—
Corporate debt securities	4,519			—		4,519			—
Commercial paper	35,955			—		35,955			—
Marketable securities:
Corporate equity securities	210,874			192,207		18,667			—
Government-sponsored enterprise securities	15,181			15,181		—			—
Corporate debt securities	231,572			—		231,572			—
Commercial paper	126,523			—		126,523			—
Prepaid expenses and other current assets:
Foreign currency forward contracts	19,210			—		19,210			—
Other assets:
Foreign currency forward contracts	973			—		973			—
Total financial assets	$	2,017,245		$	1,579,826	$	437,419		$	—
Financial instruments carried at fair value (liability positions):
Other current liabilities:
Foreign currency forward contracts	$	(310	)	$	—	$	(310	)	$	—
Other long-term liabilities:
Foreign currency forward contracts	(68		)	—		(68		)	—
Total financial liabilities	$	(378	)	$	—	$	(378	)	$	—

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)



	Fair Value Measurements as of December 31, 2018
				Fair Value Hierarchy
	Total			Level 1		Level 2			Level 3
	(in thousands)
Financial instruments carried at fair value (asset positions):
Cash equivalents:
Money market funds	$	1,226,603		$	1,226,603	$	—		$	—
U.S. Treasury securities	5,966			5,966		—			—
Government-sponsored enterprise securities	7,123			7,123		—			—
Commercial paper	58,268			—		58,268			—
Marketable securities:
Corporate equity securities	167,323			153,733		13,590			—
U.S. Treasury securities	6,026			6,026		—			—
Government-sponsored enterprise securities	10,704			10,704		—			—
Corporate debt securities	233,665			—		233,665			—
Commercial paper	100,390			—		100,390			—
Prepaid expenses and other current assets:
Foreign currency forward contracts	19,023			—		19,023			—
Other assets:
Foreign currency forward contracts	1,514			—		1,514			—
Total financial assets	$	1,836,605		$	1,410,155	$	426,450		$	—
Financial instruments carried at fair value (liability positions):
Other current liabilities:
Foreign currency forward contracts	$	(340	)	$	—	$	(340	)	$	—
Other long-term liabilities:
Foreign currency forward contracts	(108		)	—		(108		)	—
Total financial liabilities	$	(448	)	$	—	$	(448	)	$	—

Please refer to Note F, “Marketable Securities and Equity Investments,” for the carrying amount and related unrealized gains (losses) by type of investment.

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Notes to Condensed Consolidated Financial Statements

(unaudited)


F.	Marketable Securities and Equity Investments

A summary of the Company’s cash equivalents and marketable securities, which are recorded at fair value (and do not include $1.5 billion and $1.4 billion of cash as of March 31, 2019 and December 31, 2018, respectively), is shown below:



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(in thousands)
As of March 31, 2019
Cash equivalents:
Money market funds	$	1,354,656	$	—	$	—		$	1,354,656
U.S. Treasury securities	5,996		—		—			5,996
Government-sponsored enterprise securities	11,787		—		(1		)	11,786
Corporate debt securities	4,519		—		—			4,519
Commercial paper	35,959		—		(4		)	35,955
Total cash equivalents	1,412,917		—		(5		)	1,412,912
Marketable securities:
Government-sponsored enterprise securities	15,180		2		(1		)	15,181
Corporate debt securities	231,516		88		(32		)	231,572
Commercial paper	126,515		34		(26		)	126,523
Total marketable debt securities	373,211		124		(59		)	373,276
Corporate equity securities	133,157		79,093		(1,376		)	210,874
Total marketable securities	$	506,368	$	79,217	$	(1,435	)	$	584,150

As of December 31, 2018
Cash equivalents:
Money market funds	$	1,226,603	$	—	$	—		$	1,226,603
U.S. Treasury securities	5,967		—		(1		)	5,966
Government-sponsored enterprise securities	7,124		—		(1		)	7,123
Commercial paper	58,271		—		(3		)	58,268
Total cash equivalents	1,297,965		—		(5		)	1,297,960
Marketable securities:
U.S. Treasury securities	6,026		—		—			6,026
Government-sponsored enterprise securities	10,704		—		—			10,704
Corporate debt securities	234,088		27		(450		)	233,665
Commercial paper	100,498		—		(108		)	100,390
Total marketable debt securities	351,316		27		(558		)	350,785
Corporate equity securities	133,157		40,619		(6,453		)	167,323
Total marketable securities	$	484,473	$	40,646	$	(7,011	)	$	518,108

Available-for-sale debt securities were recorded in the Company's condensed consolidated balance sheets at fair value as follows:



	As of March 31, 2019		As of December 31, 2018
	(in thousands)
Cash and cash equivalents	$	1,412,912	$	1,297,960
Marketable securities	373,276		350,785
Total	$	1,786,188	$	1,648,745

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

Available-for-sale debt securities by contractual maturity were as follows:



	As of March 31, 2019		As of December 31, 2018
	(in thousands)
Matures within one year	$	1,775,571	$	1,647,500
Matures after one year through five years	10,617		1,245
Total	$	1,786,188	$	1,648,745

The Company has a limited number of available-for-sale debt securities in insignificant loss positions as of March 31, 2019, which it does not intend to sell and has concluded it will not be required to sell before recovery of the amortized costs for the investments at maturity. The Company did not record any charges for other-than-temporary declines in the fair value of available-for-sale debt securities or gross realized gains or losses in the three months ended March 31, 2019 and 2018.

The Company maintains strategic investments separately from the investment policy that governs its other cash, cash equivalents and marketable securities. The Company’s investments in the common stock of publicly traded companies, CRISPR and Moderna as of March 31, 2019 and December 31, 2018, respectively, have readily determinable fair values and are recorded in “Marketable securities” on its condensed consolidated balance sheets. As of March 31, 2019 and December 31, 2018, the total fair value of the Company’s strategic investments in the common stock of publicly traded companies, was $210.9 million and $167.3 million, respectively. During the three months ended March 31, 2019 and 2018, the Company recorded unrealized gains of $43.6 million and $95.5 million, respectively, primarily related to increases in the fair value of its investment in CRISPR.

As of March 31, 2019, the carrying value of the Company’s equity investments without readily determinable fair values, which are recorded in “Other assets” on its condensed consolidated balance sheets, was $13.6 million.


G.	Accumulated Other Comprehensive Income (Loss)

The following table summarizes the changes in accumulated other comprehensive (loss) income by component:



				Unrealized Holding Gains (Losses), Net of Tax
	Foreign Currency Translation Adjustment			On Available-For-Sale Debt Securities			On Foreign Currency Forward Contracts			Total
	(in thousands)
Balance at December 31, 2018	$	(11,227	)	$	(536	)	$	12,422		$	659
Other comprehensive income before reclassifications	4,967			596			5,126			10,689
Amounts reclassified from accumulated other comprehensive income	—			—			(5,348		)	(5,348		)
Net current period other comprehensive income (loss)	4,967			596			(222		)	5,341
Balance at March 31, 2019	$	(6,260	)	$	60		$	12,200		$	6,000

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)



				Unrealized Holding Gains (Losses), Net of Tax
	Foreign Currency Translation Adjustment			On Available-For-Sale Debt Securities			On Equity Securities			On Foreign Currency Forward Contracts			Total
	(in thousands)
Balance at December 31, 2017	$	(21,031	)	$	(594	)	$	25,069		$	(15,016	)	$	(11,572	)
Other comprehensive loss before reclassifications	(2,729		)	(460		)	—			(7,639		)	(10,828		)
Amounts reclassified from accumulated other comprehensive income (loss)	—			—			—			6,777			6,777
Net current period other comprehensive loss	(2,729		)	(460		)	—			(862		)	(4,051		)
Amounts reclassified to accumulated deficit pursuant to adoption of new accounting standard	949			—			(25,069		)	—			(24,120		)
Balance at March 31, 2018	$	(22,811	)	$	(1,054	)	$	—		$	(15,878	)	$	(39,743	)


H.	Hedging

Foreign currency forward contracts - Designated as hedging instruments

The Company maintains a hedging program intended to mitigate the effect of changes in foreign exchange rates for a portion of the Company’s forecasted product revenues denominated in certain foreign currencies. The program includes foreign currency forward contracts that are designated as cash flow hedges under GAAP having contractual durations from one to eighteen months. The Company recognizes realized gains and losses for the effective portion of such contracts in “Product revenues, net” in its condensed consolidated statements of operations in the same period that it recognizes the product revenues that were impacted by the hedged foreign exchange rate changes.

The Company formally documents the relationship between foreign currency forward contracts (hedging instruments) and forecasted product revenues (hedged items), as well as the Company’s risk management objective and strategy for undertaking various hedging activities, which includes matching all foreign currency forward contracts that are designated as cash flow hedges to forecasted transactions. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the foreign currency forward contracts are highly effective in offsetting changes in cash flows of hedged items. If the Company were to determine that a (i) foreign currency forward contract is not highly effective as a cash flow hedge, (ii) foreign currency forward contract has ceased to be a highly effective hedge or (iii) forecasted transaction is no longer probable of occurring, the Company would discontinue hedge accounting treatment prospectively. The Company measures effectiveness based on the change in fair value of the forward contracts and the fair value of the hypothetical foreign currency forward contracts with terms that match the critical terms of the risk being hedged. As of March 31, 2019, all hedges were determined to be highly effective.

The Company considers the impact of its counterparties’ credit risk on the fair value of the foreign currency forward contracts. As of March 31, 2019 and December 31, 2018, credit risk did not change the fair value of the Company’s foreign currency forward contracts.

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

The following table summarizes the notional amount of the Company’s outstanding foreign currency forward contracts designated as cash flow hedges under GAAP:



	As of March 31, 2019		As of December 31, 2018
Foreign Currency	(in thousands)
Euro	$	373,264	$	335,179
British pound sterling	76,685		73,460
Australian dollar	70,889		52,820
Canadian dollar	40,089		43,759
Total foreign currency forward contracts	$	560,927	$	505,218

Foreign currency forward contracts - Not designated as hedging instruments

The Company also enters into foreign currency forward contracts with contractual maturities of less than one month, which are designed to mitigate the effect of changes in foreign exchange rates on monetary assets and liabilities, including intercompany balances. These contracts are not designated as hedging instruments under GAAP. The Company recognizes realized gains and losses for such contracts in “Other income, net” in its condensed consolidated statements of operations each period. As of March 31, 2019, the notional amount of the Company’s outstanding foreign currency forward contracts where hedge accounting under GAAP is not applied was $220.9 million.

During the three months ended March 31, 2019 and 2018, the Company recognized the following related to foreign currency forward contacts in its condensed consolidated statements of operations:



	Three Months Ended March 31,
	2019		2018
	(in thousands)
Designated as hedging instruments - Reclassified from AOCI
Product revenues, net	$	6,839	$	(6,485	)
Not designated as hedging instruments
Other income, net	$	3,151	$	1,539

The following table summarizes the fair value of the Company’s outstanding foreign currency forward contracts designated as cash flow hedges under GAAP included on its condensed consolidated balance sheets:



As of March 31, 2019
Assets			Liabilities
Classification	Fair Value		Classification	Fair Value
(in thousands)
Prepaid expenses and other current assets	$	19,210	Other current liabilities	$	(310	)
Other assets	973		Other long-term liabilities	(68		)
Total assets	$	20,183	Total liabilities	$	(378	)



As of December 31, 2018
Assets			Liabilities
Classification	Fair Value		Classification	Fair Value
(in thousands)
Prepaid expenses and other current assets	$	19,023	Other current liabilities	$	(340	)
Other assets	1,514		Other long-term liabilities	(108		)
Total assets	$	20,537	Total liabilities	$	(448	)

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

As of March 31, 2019, the Company expects amounts that are related to foreign exchange forward contracts designated as cash flow hedges under GAAP recorded in “Prepaid expenses and other current assets” and “Other current liabilities” to be reclassified to earnings within twelve months.

The following table summarizes the potential effect of offsetting derivatives by type of financial instrument designated as cash flow hedges under GAAP on the Company’s condensed consolidated balance sheets:



	As of March 31, 2019
	Gross Amounts Recognized			Gross Amounts Offset		Gross Amounts Presented			Gross Amounts Not Offset			Legal Offset
Foreign currency forward contracts	(in thousands)
Total assets	$	20,183		$	—	$	20,183		$	(378	)	$	19,805
Total liabilities	$	(378	)	$	—	$	(378	)	$	378		$	—



	As of December 31, 2018
	Gross Amounts Recognized			Gross Amounts Offset		Gross Amounts Presented			Gross Amounts Not Offset			Legal Offset
Foreign currency forward contracts	(in thousands)
Total assets	$	20,537		$	—	$	20,537		$	(448	)	$	20,089
Total liabilities	$	(448	)	$	—	$	(448	)	$	448		$	—

I. Inventories

Inventories consisted of the following:



	As of March 31, 2019		As of December 31, 2018
	(in thousands)
Raw materials	$	11,649	$	9,677
Work-in-process	80,529		87,944
Finished goods	44,520		26,739
Total	$	136,698	$	124,360

J. Revolving Credit Facility

In October 2016, the Company entered into a Credit Agreement (the “Credit Agreement”) with Bank of America, N.A., as administrative agent and the lenders referred to therein. The Credit Agreement provides for a $500.0 million revolving facility, $300.0 million of which was drawn at closing (the “Loans”) and was repaid in February 2017. The Credit Agreement also provides that, subject to satisfaction of certain conditions, the Company may request that the borrowing capacity under the Credit Agreement be increased by an additional $300.0 million. The Credit Agreement matures on October 13, 2021.

The Loans will bear interest, at the Company’s option, at either a base rate or a Eurodollar rate, in each case plus an applicable margin. Under the Credit Agreement, the applicable margins on base rate loans range from 0.75% to 1.50% and the applicable margins on Eurodollar loans range from 1.75% to 2.50%, in each case based on the Company’s consolidated leverage ratio (the ratio of the Company’s total consolidated debt to the Company’s trailing twelve-month EBITDA).

The Loans are guaranteed by certain of the Company’s domestic subsidiaries and secured by substantially all of the Company’s assets and the assets of the Company’s domestic subsidiaries (excluding intellectual property, owned and leased real property and certain other excluded property) and by the equity interests of the Company’s subsidiaries, subject to certain exceptions. Under the terms of the Credit Agreement, the Company must maintain, subject to certain limited exceptions, a consolidated leverage ratio of 3.00 to 1.00 and consolidated EBITDA of at least $200.0 million, in each case measured on a quarterly basis.

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

The Credit Agreement contains customary representations and warranties and usual and customary affirmative and negative covenants. The Credit Agreement also contains customary events of default. In the case of a continuing event of default, the administrative agent would be entitled to exercise various remedies, including the acceleration of amounts due under outstanding loans.

K. Leases

Finance Leases

The Company’s finance lease assets and liabilities primarily relate to its corporate headquarters in Boston and research site in San Diego (the “Buildings”). These Buildings are classified as finance leases because the present value of the sum of the lease payments associated with the Buildings exceeds substantially all of the fair value of the Buildings. The Company also has outstanding finance leases for equipment.

Prior to the adoption of ASC 842 on January 1, 2019, the Company was deemed for accounting purposes to be the owner of the Buildings during their construction periods and recorded project construction costs incurred by its landlords. Upon completion of the Buildings, the Company determined that the underlying leases did not meet the criteria for “sale-leaseback” treatment. Accordingly, the Company depreciated the Buildings over 40 years and recorded interest expense associated with the financing obligations for the Buildings. The Company bifurcated the lease payments pursuant to the Buildings into (i) a portion that was allocated to the buildings and (ii) a portion that is allocated to the land on which the buildings were constructed. The portion of the lease obligations allocated to the land was treated as an operating lease.

Pursuant to ASC 842, the Company adjusted the amounts recorded on its condensed consolidated balance sheet as of January 1, 2019 for the Buildings to reflect the present value of the lease payments over the remaining lease term related to the Buildings. The finance lease assets associated with the Buildings are amortized to depreciation expense using the straight-line method over the remaining lease term, which is significantly shorter than the Buildings’ useful lives. The Company continues to record interest expense associated with the finance lease liabilities for the Buildings.

Corporate Headquarters

In 2011, the Company entered into two lease agreements, pursuant to which the Company leases approximately 1.1 million square feet of office and laboratory space in two buildings in Boston, Massachusetts for a term of 15 years. Base rent payments commenced in December 2013, and will continue through December 2028. The Company utilizes this initial period as its lease term. The Company has an option to extend the lease terms for an additional ten years.

San Diego Lease

In 2015, the Company entered into a lease agreement pursuant to which the Company leases approximately 170,000 square feet of office and laboratory space in San Diego, California for a term of 16 years. Base rent payments will commence in the second quarter of 2019, and will continue through May 2034. The Company utilizes this initial period as its lease term. The Company has an option to extend the lease term for up to two additional five-year terms. The Company placed this building in service in the second quarter of 2018.

Operating Leases

The Company’s operating leases relate to its real estate leases that are not classified as finance leases.

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

Aggregate Lease Information Related to the Application of ASC 842

The following information is disclosed in accordance with ASC 842, which became effective January 1, 2019. The components of lease cost recorded in the Company’s condensed consolidated statement of operations were as follows:



	Three Months Ended March 31, 2019
	(in thousands)
Operating lease cost	$	2,639
Finance lease cost
Amortization of leased assets	12,365
Interest on lease liabilities	13,449
Variable lease cost	6,762
Sublease income	(1,484		)
Net lease cost	$	33,731

The Company’s variable lease cost during the three months ended March 31, 2019 primarily related to operating expenses, taxes and insurance associated with its finance leases. The Company’s sublease income during the three months ended March 31, 2019 primarily related to subleases for an insignificant portion of the Company’s corporate headquarters.

The Company’s leases are included on its condensed consolidated balance sheets as follows:



	As of March 31, 2019		As of December 31, 2018 ^
	(in thousands)
Finance leases
Property and equipment, net	$	473,129	$	640,952
Total finance lease assets	$	473,129	$	640,952

Capital lease obligations, current portion	$	—	$	9,817
Other current liabilities	35,725		5,271
Capital lease obligations, excluding current portion	—		19,658
Construction financing lease obligation, excluding current portion	—		561,892
Long-term finance lease liabilities	560,381		—
Total finance lease liabilities	$	596,106	$	596,638

Operating leases
Operating lease assets	$	60,573	$	—
Total operating lease assets	$	60,573	$	—

Other current liabilities	$	7,520	$	—
Long-term operating lease liabilities	63,484		—
Total operating lease liabilities	$	71,004	$	—
^ As reported in the Company’s 2018 Annual Report on Form 10-K.

Maturities of the Company’s finance and operating lease liabilities in accordance with ASC 842 as of March 31, 2019 were as follows:

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)



Year	Finance Leases			Operating Leases			Total
	(in thousands)
Remainder of 2019	$	61,339		$	7,331		$	68,670
2020	88,998			10,366			99,364
2021	87,365			8,658			96,023
2022	85,016			8,233			93,249
2023	84,092			8,151			92,243
Thereafter	512,804			46,212			559,016
Total lease payments	919,614			88,951			1,008,565
Less: amount representing interest	(323,508		)	(17,947		)	(341,455		)
Present value of lease liabilities	$	596,106		$	71,004		$	667,110

The weighted-average remaining lease terms and discount rates related to the Company’s leases were as follows:



	Three Months Ended March 31, 2019
Weighted-average remaining lease term (in years)
Finance leases	10.45
Operating leases	10.91

Weighted-average discount rate
Finance leases	9.11	%
Operating leases	4.05	%

Please refer to Note O, “Additional Cash Flow Information,” for cash flow impact of the Company’s leases.

Additional Lease Information Related to the Application of ASC 840

The following information is disclosed in accordance with ASC 840, Leases (Topic 840) (“ASC 840”), which was applicable until December 31, 2018. As of December 31, 2018, future minimum commitments under the Company’s real estate leases with initial terms of more than one year were as follows:



Year	Fan Pier Leases		San Diego Lease		Other Leases		Total Lease Commitments
	(in thousands)
2019	$	66,540	$	5,324	$	13,207	$	85,071
2020	72,589		9,127		14,270		95,986
2021	72,589		9,127		12,529		94,245
2022	72,589		9,127		12,045		93,761
2023	72,589		9,530		11,952		94,071
Thereafter	389,855		119,864		65,472		575,191
Total minimum lease payments	$	746,751	$	162,099	$	129,475	$	1,038,325

As of December 31, 2018, the Company’s total sublease income to be received related to its facility leases was $6.2 million. During the three months ended March 31, 2018, rental expense was $4.6 million.

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)

As of December 31, 2018, the Company had outstanding capital leases totaling gross property and equipment of $94.8 million and accumulated depreciation of $34.0 million. The capital leases, which were related to equipment and leasehold improvements, bore interest at rates ranging from less than 1% to 6% per year. The Company’s capital lease amortization was included in depreciation expense during the three months ended March 31, 2018. The following table set forth the Company’s future minimum payments due under capital leases as of December 31, 2018:



Year	(in thousands)
2019	$	10,770
2020	7,282
2021	5,649
2022	3,300
2023	1,974
Thereafter	3,085
Total payments	32,060
Less: amount representing interest	(2,585		)
Present value of payments	$	29,475

L. Stock-based Compensation Expense and Share Repurchase

Stock-based compensation expense

During the three months ended March 31, 2019 and 2018, the Company recognized the following stock-based compensation expense:



	Three Months Ended March 31,
	2019			2018
	(in thousands)
Stock-based compensation expense by type of award:
Restricted stock and restricted stock units (including PSUs)	$	63,510		$	50,418
Stock options	28,156			26,055
ESPP share issuances	2,577			2,128
Stock-based compensation expense related to inventories	(452		)	(465		)
Total stock-based compensation included in costs and expenses	$	93,791		$	78,136

Stock-based compensation expense by line item:
Cost of sales	$	1,338		$	813
Research and development expenses	59,715			48,488
Sales, general and administrative expenses	32,738			28,835
Total stock-based compensation included in costs and expenses	93,791			78,136
Income tax effect	(39,524		)	(21,859		)
Total stock-based compensation included in costs and expenses, net of tax	$	54,267		$	56,277

The following table sets forth the Company’s unrecognized stock-based compensation expense as of March 31, 2019, by type of award and the weighted-average period over which that expense is expected to be recognized:

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VERTEX PHARMACEUTICALS INCORPORATED

Notes to Condensed Consolidated Financial Statements

(unaudited)