OVERVIEW
We are in the business of discovering, developing, manufacturing and commercializing small molecule drugs for patients with serious diseases. Over the last two years, we have obtained approval for, and initiated commercial sales of, our first two products: INCIVEK (telaprevir), which we market in the United States and Canada for the treatment of adults with genotype 1 hepatitis C virus, or HCV, infection; and KALYDECO (ivacaftor), which we market in the United States, Canada and Europe for the treatment of patients six years of age and older with cystic fibrosis, or CF, who have a specific genetic mutation that is referred to as the G551D mutation. We receive royalties from sales in Europe and other countries of telaprevir, which is marketed as INCIVO, by our collaborator, Janssen Pharmaceutica, N.V.
We invest in scientific innovation to create transformative medicines for patients with serious diseases, with a focus on specialty markets. Our strategy is to make focused investments to invent and develop innovative drugs, while we continue to market INCIVEK and KALYDECO to eligible patients to generate revenues and maintain a strong financial position.
Each of our products has achieved rapid acceptance for the treatment of patients in the United States, and our total revenues have increased from $143.4 million in 2010 to $1.5 billion in 2012. Our 2012 total revenues included INCIVEK net product revenues of $1.2 billion and KALYDECO net product revenues of $171.6 million. As of December 31, 2012, we had cash, cash equivalents and marketable securities of $1.3 billion. We expect that our total net product revenues will decline in 2013. Our net product revenues from sales of INCIVEK declined over the course of 2012, and we expect this trend to continue due to reduced demand for current therapies for HCV infection, as it appears that new competitive therapies will reach the market over the next several years. We expect that KALYDECO product revenues will increase in 2013 as compared to 2012, as we secure reimbursement for KALYDECO in additional international markets. In the future, we expect that our ability to increase net product revenues will be dependent upon increasing KALYDECO sales and introducing one or more of our late-stage development products to the market.
In the near term, we plan to focus most of our drug development investment on the following key programs:
Cystic Fibrosis - Our goal is to develop treatment regimens that will provide benefits to as many patients with CF as possible and to maximize those benefits. We are conducting three Phase 3 label-expansion clinical trials and a proof-of-concept clinical trial of ivacaftor monotherapy in people with certain mutations in their cystic fibrosis transmembrane conductance regulator, or CFTR, gene that were not studied in prior Phase 3 clinical trials. In February 2013, we initiated an international pivotal Phase 3 development program to evaluate combinations of ivacaftor and our investigational CF corrector VX-809 for patients with the most prevalent genetic mutation that causes CF.
HCV - We are investigating all-oral, interferon-free treatment regimens that are 12 weeks or less in duration with a goal of providing a high viral cure rate and improved tolerability, in order to be commercially competitive in the HCV market of the future. We plan to conduct multiple Phase 2 clinical trials to evaluate all-oral combination treatment regimens that include our HCV nucleotide analogue VX-135 together with molecules that have potentially complimentary mechanisms, such as ribavirin, or RBV, HCV protease inhibitors, HCV NS5A inhibitors and non-nucleoside HCV polymerase inhibitors.
Autoimmune Diseases - We are evaluating our JAK3 inhibitor, VX-509, in a Phase 2 clinical trial that is expected to enroll approximately 350 patients with rheumatoid arthritis.
We may seek collaborators for some of our drug candidates in order to diversify risk, broaden or accelerate or otherwise benefit a development program in an effort to fully-realize the value of a drug candidate.
We plan to continue investing in our research programs and supporting scientific innovation in order to identify and develop transformative medicines. We believe that pursuing research in diverse areas allows us to balance the risks inherent in drug development and may provide the drug candidates that will form our pipeline in future years. We have later-stage research programs in the areas of cystic fibrosis, Huntington's disease, multiple sclerosis and cancer. Discovery and development of a new pharmaceutical product is a difficult and lengthy process that requires significant financial resources along with extensive technical and regulatory expertise and can take 10 to 15 years or more. Potential drug candidates are subjected to rigorous evaluations, driven in part by stringent regulatory considerations, designed to

generate information concerning efficacy, side-effects, proper dosage levels and a variety of other physical and chemical characteristics that are important in determining whether a drug candidate should be approved for marketing as a pharmaceutical product. Most chemical compounds that are investigated as potential drug candidates never progress into development, and most drug candidates that do advance into development never receive marketing approval. Because our investments in drug candidates are subject to considerable risks, we closely monitor the results of our discovery research, clinical trials and nonclinical studies, and frequently evaluate our drug development programs in light of new data and scientific, business and commercial insights, with the objective of balancing risk and potential. This process can result in relatively abrupt changes in focus and priority as new information becomes available and we gain additional understanding of our ongoing programs and potential new programs as well as those of our competitors.
If we believe the data from a completed registration program support approval of a drug candidate, we submit a New Drug Application, or NDA, to the United States Food and Drug Administration, or FDA, requesting approval to market the drug candidate in the United States and seek analogous approvals from comparable regulatory authorities in foreign jurisdictions. To obtain approval, we must, among other things, demonstrate with evidence gathered in nonclinical studies and well-controlled clinical trials that the drug candidate is safe and effective for the disease it is intended to treat and that the manufacturing facilities, processes and controls for the manufacture of the drug candidate are adequate. The FDA and foreign regulatory authorities have substantial discretion in deciding whether or not a drug candidate should be granted approval based on the benefits and risks of the drug candidate in the treatment of a particular disease, and could delay, limit or deny regulatory approval. If regulatory delays are significant or regulatory approval is limited or denied altogether, our financial results and the commercial prospects for the drug candidate involved will be harmed.
CF
KALYDECO (ivacaftor) is approved in the United States, Canada and the European Union for the treatment of patients with CF six years of age and older who have the G551D mutation on at least one allele of the CFTR gene. We are continuing our work in CF to identify and develop treatment regimens that will provide benefits to as many patients with CF as possible and to maximize those benefits. We have multiple ongoing clinical development programs to evaluate our CF treatment regimens, and our research group is working to identify additional corrector compounds that could be included in future dual- and/or triple-combination treatment regimens that have the potential to provide additional benefits to patients with CF. Ivacaftor (monotherapy)
We are conducting three Phase 3 label-expansion clinical trials and a Phase 2 clinical trial of ivacaftor monotherapy:
• We have completed enrollment in a Phase 3 clinical trial evaluating ivacaftor in patients six years of age and older with CF with gating mutations other than the G551D mutation.

• We are continuing enrollment in a Phase 3 clinical trial evaluating ivacaftor in patients six years of age and older with CF with the R117H mutation in the CFTR gene on at least one allele.

• We have begun dosing patients in a Phase 3 clinical trial in which we are evaluating a pediatric formulation of ivacaftor as a treatment for children two to five years of age with gating mutations in the CFTR gene, including the G551D mutation.

• We are enrolling patients in a Phase 2 clinical trial in which we are evaluating ivacaftor in patients with CF who have clinical evidence of residual CFTR function.

If we are able to establish that these additional patient groups will benefit from ivacaftor monotherapy, there is the potential to increase the number of patients eligible for treatment with ivacaftor monotherapy to more than 10% of patients with CF. We expect to obtain data from the Phase 3 clinical trials evaluating patients six years of age and older in 2013.

VX-809 in Combination with Ivacaftor
In February 2013, we initiated an international pivotal Phase 3 clinical program to evaluate combinations of VX-809 and ivacaftor in patients with CF who have two copies of the F508del mutation in their CFTR gene (homozygous). We plan to conduct two 24-week Phase 3 clinical trials that are designed to support approval of the combination of VX-809 and ivacaftor for patients 12 years of age and older. Each Phase 3 clinical trial will enroll approximately 500 patients with CF who are homozygous for the F508del mutation, for a total of approximately 1,000 patients. The two clinical trials have the same design and together will be conducted at approximately 200 clinical trial sites in North America, Europe and Australia. We expect to obtain final safety and efficacy data from both Phase 3 clinical trials in 2014. If these trials are successful, we plan to submit an NDA to the FDA in 2014 and a Marketing Authorization Application, or MAA, to the European Medicines Agency, or EMA.
We also plan to conduct an 8-week exploratory Phase 2 clinical trial of VX-809 in combination with ivacaftor in patients with CF who are 12 years of age and older and who have one copy of the F508del mutation in the CFTR gene and a pharmacokinetics and safety clinical trial to evaluate VX-809 in combination with ivacaftor in children with CF six to eleven years of age who have two copies of the F508del mutation. If successful, we plan to use the data from the pharmacokinetics and safety clinical trial, along with data from the two Phase 3 clinical trials, for registration in the United States in patients six to eleven years of age, following registration in patients 12 years of age and older, and are continuing discussions with European regulatory agencies for patients in this age group.
HCV
Janssen and we market INCIVEK/INCIVO in direct competition with Merck & Co., Inc.'s VICTRELIS™ (boceprevir), another HCV protease inhibitor that was approved for sale in the United States and Europe in 2011. We expect that a number of new therapies for HCV infection will become available to patients over the next several years. The most advanced drug candidates, Gilead's GS-7977 and Janssen's TMC435, may be approved for administration in combination with pegylated-interferon, or peg-IFN, and RBV, as soon as late 2013 or 2014. The top-line results reported by Gilead and Janssen from recently completed Phase 3 clinical trials suggest that the safety and efficacy profiles of GS-7977 and TMC435 will position them, if approved, to potentially take a significant portion of the market for HCV therapies.
We plan to compete in the HCV infection market as it shifts away from current treatment regimens, including our INCIVEK triple-combination therapy, to regimens that incorporate new drugs with improved safety, efficacy and/or tolerability, by pursuing development of all-oral regimens incorporating one or more of our drug candidates, particularly our HCV nucleotide analogue VX-135. A number of pharmaceutical companies are investigating combination regimens that incorporate one or more of an HCV protease inhibitor, an HCV nucleotide analogue, an HCV non-nucleotide polymerase inhibitor or an NS5A inhibitor. Clinical trials of these investigational combination regimens are being conducted in a wide variety of patient populations, including treatment-naïve and treatment-failure patients, and across all HCV genotypes, which respond differently to different combinations of molecules employing different mechanisms. In the future, we expect that the market for any specific HCV treatment regimen, including INCIVEK triple-combination therapy, could be affected by the introduction of new competitive drugs or drug combinations, sales from currently approved drugs, adverse information regarding the safety characteristics or efficacy of the regimen, significant new information regarding potential treatment regimens being evaluated in clinical trials, and enrollment by patients in clinical trials being conducted by us or our competitors. While it is possible that a portion of patients with HCV infection would continue to benefit from treatment regimens that include peg-IFN, we expect that treatment regimens that include the administration of peg-IFN by injection will command a relatively small portion of the overall market. We are evaluating potential all-oral treatment regimens in planned and ongoing Phase 2 clinical trials in order to determine which regimen or regimens appear likely to provide benefits to patients and to take forward into Phase 3 clinical development. Some of our competitors' potential all-oral treatment regimens are more advanced, including all-oral treatment regimens that are being evaluated in Phase 3 clinical trials by Gilead and Abbvie, Inc. While the development and regulatory timelines for drug candidates for the treatment of HCV infection are subject to risk and uncertainty, and the development of a number of HCV infection drug candidates, including Bristol-Myers Squibb's BMS-986094 and one of our two HCV nucleotide analogues, ALS-2158, ended in 2012, we believe that
(i) substantial additional clinical data regarding potential all-oral treatment regimens will become available in 2013 and (ii) it is possible that one or more all-oral treatment regimens for genotype 1 HCV infection could be commercially available as soon as late 2014. As a result, if we are successful in developing all-oral treatment regimens that include VX-135 and/or VX-222, independently or with a collaborator, it is likely

that our all-oral treatment regimens would compete directly with one or more previously approved all-oral treatment regimens. Drug Supply
In order to generate revenues from our approved products, we must manufacture, or have manufactured, our products in accordance with our specifications and regulatory requirements and in sufficient quantities to satisfy demand. We rely on an international network of third parties to manufacture and distribute our products and for supplies of compounds for clinical trials, and we expect that we will continue to rely on third parties to provide these manufacturing services for the foreseeable future. Third-party contract manufacturers, including some in China, supply us with raw materials, and contract manufacturers in the European Union and the United States convert these raw materials into drug substance and convert the drug substance into final dosage form. Establishing and managing this global supply chain requires a significant financial commitment and the creation and maintenance of numerous third-party relationships. Although we believe we effectively manage the business relationships with companies in our supply chain, we do not have complete control over their activities.
We require a supply of INCIVEK for commercial sale in the United States and Canada. We attempt to manage our INCIVEK inventory levels based on forecasted demand, which has had variable results due to the rapidly evolving nature of the HCV market, which resulted in decreased demand for INCIVEK. We currently believe that we have sufficient supply to meet forecasted demand for INCIVEK. In addition, we have significant quantities of materials that we do not expect to utilize.
We require a supply of ivacaftor for commercial sale (as KALYDECO) and for use in our clinical trials. We obtain ivacaftor to meet our commercial and clinical supply needs through a third-party manufacturing network. Our supply chain includes sole source suppliers. A disruption in the commercial supply of KALYDECO for patients would have a significant impact on patients, our business and our product revenues. A disruption in the clinical supply of ivacaftor could delay the completion of clinical trials and impact timelines for filing an sNDA or NDA. Accordingly, we are in the process of establishing secondary sources for our KALYDECO supply needs to reduce the risk of a supply disruption. In 2013, we plan to obtain an alternative source for the active ingredient of ivacaftor, which is a sole-sourced material that is critical to the supply of ivacaftor, and to obtain second source suppliers in 2014 for other components of the ivacaftor supply chain. There can be no assurance that we will be able to establish secondary sources for all of our KALYDECO supply needs on a timely basis or at all.
Regulatory Compliance
Our marketing of pharmaceutical products, which began in 2011, is subject to extensive and complex laws and regulations. We have a corporate compliance program designed to actively identify, prevent and mitigate risk through the implementation of compliance policies and systems and the promotion of a culture of compliance. Among other laws, regulations and standards, we are subject to various federal and state laws pertaining to health care fraud and abuse, including anti-kickback and false claims statutes, and laws prohibiting the promotion of drugs for unapproved, or off-label, uses. Anti-kickback laws make it illegal for a prescription drug manufacturer to solicit, offer, receive or pay any remuneration in exchange for, or to induce, the referral of business, including the purchase or prescription of a particular drug. False claims laws prohibit anyone from presenting for payment to third-party payors, including Medicare and Medicaid, claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed or claims for medically unnecessary items or services. We expect to continue to devote substantial resources to maintain, administer and expand these compliance programs globally.
Operations
Over the last several years we experienced significant growth and expanded our operations globally to support the launch of our first two products and our continued investment in key development and research programs. We are planning to move our corporate headquarters and a majority of our employees from a number of buildings in Cambridge, Massachusetts into a new facility in Boston, Massachusetts in the first half of 2014. This move is intended to allow us to consolidate our headquarters into one campus and to update our physical infrastructure, including our laboratories and other research facilities. In order to manage the global expansion of our business and our move to these new headquarters, we will need to enhance our cross-functional operational, financial and management processes while continuing to attract and maintain highly skilled employees. We expect that managing our growing operations will be challenging and will require significant financial and management resources.

RESULTS OF OPERATIONS

                                                                                     2012/2011                            2011/2010
                                                                                    Comparison                           Comparison
                                                                         Increase                                 Increase        Increase/
                            2012            2011            2010        (Decrease)      Increase (Decrease)      (Decrease)       (Decrease)
                                       (in thousands)                                    (in thousands, except percentages)
Revenues                $ 1,527,042     $ 1,410,626     $  143,370     $   116,416                8  %         $  1,267,256          884 %
Operating costs and
expenses                  1,524,710       1,296,806        839,447         227,904               18  %              457,359           54 %
Other loss, net             (53,467 )       (72,641 )      (58,549 )       (19,174 )            (26 )%               14,092           24 %
Net loss (income)
attributable to
noncontrolling interest
(Alios)                     (55,897 )       (11,605 )            -          44,292              382  %               11,605          n/a
Net income (loss)
attributable to Vertex  $  (107,032 )   $    29,574     $ (754,626 )           n/a              n/a                     n/a          n/a

Net Income (Loss) Attributable to Vertex Net loss attributable to Vertex was $(107.0) million in 2012 compared to net income attributable to Vertex of $29.6 million in 2011. The net loss attributable to Vertex in 2012 as compared to the net income attributable to Vertex in 2011 was due to increased operating expenses partially offset by increased revenues. Our increased revenues in 2012 as compared to 2011 were due to increased INCIVEK net product revenues, increased INCIVO royalty revenues and KALYDECO net product revenues for which there were no comparable revenues in 2011, partially offset by decreased collaborative revenues. Our operating costs and expenses increased in 2012 as compared to 2011, principally due to increased research and development expenses, increased sales, general and administrative expenses and increased cost of product revenues.
In 2012, net income (loss) attributable to Vertex was negatively affected by an aggregate of $133.2 million in lower of cost or market charges for excess and obsolete INCIVEK inventories and an increase in the fair value of contingent milestone payments and royalties payable by us to Alios of $115.0 million. In 2011, net income attributable to Vertex was negatively affected by an impairment charge that had a net effect of $73.1 million and an increase in the fair value of contingent milestone payments and royalties payable by us to Alios of $70.0 million.
In 2010, prior to the obtaining marketing approval for our first product in 2011, we had net loss attributable to Vertex of $(754.6) million. Our increased revenues in 2011 as compared to 2010 were the result of INCIVEK net product revenues and collaborative milestone revenues in 2011 for which there were no comparable revenues in 2010. Our increased revenues were partially offset by increased operating costs and expenses in 2011 as compared to 2010.
Our operating costs and expenses in 2012, 2011 and 2010 included $114.3 million, $118.2 million and $91.1 million, respectively, of stock-based compensation expense.
Net Income (Loss) Attributable to Vertex per Diluted Share Net loss attributable to Vertex was $(0.50) per diluted share in 2012 as compared to net income attributable to Vertex of $0.14 per diluted share in 2011 and net loss attributable to Vertex of $(3.77) per diluted share in 2010.

Revenues
                                                                                               2012/2011                                        2011/2010
                                                                                              Comparison                                       Comparison
                            2012              2011              2010          Increase/(Decrease)     Increase/(Decrease)      Increase/(Decrease)      Increase/(Decrease)
                                         (in thousands)                                                    (in thousands, except percentages)
Product revenues, net  $   1,333,458     $     950,889     $           -     $           382,569               40  %         $             950,889                 n/a
Royalty revenues             141,498            50,015            30,244                  91,483              183  %                        19,771                  65 %
Collaborative revenues        52,086           409,722           113,126                (357,636 )            (87 )%                       296,596                 262 %
Total revenues         $   1,527,042     $   1,410,626     $     143,370     $           116,416                8  %         $           1,267,256                 884 %


Product Revenues, Net
                                   2012          2011       2010
                                         (in thousands)
  INCIVEK                      $ 1,161,813    $ 950,889    $   -
  KALYDECO                         171,645            -        -
   Total product revenues, net $ 1,333,458    $ 950,889    $   -

Our total net product revenues increased by 40% in 2012 as compared to 2011 due to increased INCIVEK net product revenues in 2012 as compared to 2011 and KALYDECO net product revenues in 2012 for which there were no comparable revenues in 2011. In 2013, we expect that total product revenues will decline due to an expected decrease in INCIVEK net product revenues partially offset by an expected increase in KALYDECO net product revenues.
We began recognizing net product revenues from sales of INCIVEK in the second quarter of 2011. Our INCIVEK net product revenues increased by $210.9 million in 2012 as compared to 2011 due to our recognition of INCIVEK net product revenues over a full fiscal year in 2012 as compared to for a partial fiscal year in 2011. INCIVEK net product revenues have been declining on a quarterly basis since reaching a peak in the fourth quarter of 2011 and were $222.8 million in the fourth quarter of 2012. The declines in INCIVEK net product revenues in 2012 were principally due to decreasing numbers of patients with genotype 1 HCV infection who chose to start treatment with available treatment options. We believe these decreases are the result of a combination of factors, including new safety and efficacy data that have been reported by our competitors regarding treatment regimens for HCV infection that may become commercially available over the next several years.
We began recognizing net product revenues from sales of KALYDECO in the first quarter of 2012, and KALYDECO net product revenues increased on a quarterly basis during 2012. Since its approval, most eligible patients in the United States have initiated and are receiving treatment with KALYDECO. KALYDECO net product revenues were $58.5 million in the fourth quarter of 2012, including $8.6 million of net product revenues from countries in Europe. Further increases in KALYDECO net product revenues in 2013 are dependent on ongoing reimbursement decisions in international markets. We currently receive funding for KALYDECO from France and Germany, while we are continuing to discuss the reimbursement rate we will receive in those countries in future periods. Funding for KALYDECO has been recommended in England and Ireland, and we anticipate that reimbursement in these countries will begin in the second quarter of 2013. Royalty Revenues
Janssen obtained approval to market INCIVO in the European Union in the third quarter of 2011. Our royalty revenues increased by $91.5 million in 2012 as compared to 2011 due to a $97.3 million increase in royalty revenues from sales . . .