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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

Commission file number 000-19319

Vertex Pharmaceuticals Incorporated
(Exact name of registrant as specified in its charter)

(617) 444-6100

(Registrant's telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Exchange Act:    None

Securities registered pursuant to Section 12(g) of the Exchange Act:

Common Stock, $0.01 Par Value Per Share
(Title of class)

        Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes [X]   No [   ]

        Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   [X]

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).   Yes [X]   No [   ]

        The aggregate market value of the registrant's common stock held by non-affiliates of the registrant (without admitting that any person whose shares are not included in such calculation is an affiliate) based on the last reported sale price of the Common Stock on The Nasdaq Stock Market on June 30, 2003, was $826,746,640.

        As of March 12, 2004, the registrant had 78,183,920 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

        Portions of the definitive Proxy Statement for the 2004 Annual Meeting of Stockholders to be held on May 6, 2004 are incorporated by reference into Part III.

FORM 10-K INDEX

        The "Company," "Vertex," "we" and "us," as used in this Annual Report on Form 10-K, refer to Vertex Pharmaceuticals Incorporated, a Massachusetts corporation, and its subsidiaries.

        "Vertex" is a registered trademark of Vertex, and "E-VIPR" and "GenomeScreen," are trademarks of Vertex. "Agenerase" is a registered trademark, and "Lexiva" and "Telzir" are trademarks, of GlaxoSmithKline. "Prozei" is a trademark of Kissei Pharmaceutical Co., Ltd. Other brands, names and trademarks contained in this Annual Report are the property of their respective owners.

Forward-Looking Statements

        Our disclosure in this Annual Report on Form 10-K contains some forward-looking statements. Forward-looking statements give our current expectations or forecasts of future events. You can identify these statements by the fact that they do not relate strictly to historical or current facts. Such statements may include words such as "anticipate," "estimate," "expect," "project," "intend," "plan," "believe" and other words and terms of similar meaning in connection with any discussion of future operating or financial performance. In particular, these statements include, among other things, statements relating to:

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our business strategy;



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our predicted development and commercial timelines;



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the selection, development and approval of our products;



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the establishment, development and maintenance of collaborative partnerships;



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our ability to identify and develop new potential products;

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our ability to achieve commercial acceptance of our products;



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our ability to scale up our manufacturing capabilities and facilities;



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our estimates regarding liabilities associated with our Kendall Square lease;



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the potential for the acquisition of new and complementary technologies, resources and products;



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our projected capital expenditures; and



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our liquidity.

        Any or all of our forward-looking statements in this Annual Report may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Many factors mentioned in our discussion in this Annual Report will be important in determining future results. Consequently, no forward-looking statement can be guaranteed. Actual future results may vary materially. A more detailed reference to our forward-looking statements can be found under "Forward-looking Statements" in Item 7 of this Annual Report.

        We also provide a cautionary discussion of risks and uncertainties under "Risk Factors" in Item 1 of this Annual Report. These are factors that we think could cause our actual results to differ materially from expected results. Other factors besides those listed there could also adversely affect us.

PART I

ITEM 1. BUSINESS

Overview

        We are a biotechnology company in the business of discovering, developing and commercializing small molecule drugs for serious diseases including HIV infection, chronic hepatitis C virus infection, inflammatory and autoimmune disorders and cancer, independently and with collaborators. Our principal focus is on the development and commercialization of new treatments for viral and inflammatory diseases. There are two Vertex-discovered products on the market now for the treatment of HIV and AIDS. Our pipeline of potential products includes several drug candidates targeting chronic hepatitis C virus infection, drug candidates targeting inflammatory diseases such as rheumatoid arthritis, osteoarthritis, acute coronary syndromes and psoriasis, and compounds directed at cancer therapy.

        Our goal is to mature into a profitable pharmaceutical company with industry-leading capabilities in research, development and commercialization of products. Our strategy is to continue building these capabilities as we advance our own product candidates to market. Our two marketed products to date were developed and commercialized in collaboration with GlaxoSmithKline, who provided us with development capacity, financial support, commercial capabilities, and other valuable resources. We plan to continue to collaborate with existing and new partners to develop and market other Vertex-discovered products for selected major therapeutic areas. We also have begun developing certain potential products independently, for markets in which we believe we can commercialize products effectively and reach large patient populations, but expend comparatively fewer resources by using a sales force focused on specialists. We believe this dual approach will help us diversify risk and create the greatest number of product development and commercialization opportunities for Vertex.

        Partnerships are a key component of our corporate strategy. We have collaborations with Aventis, GlaxoSmithKline, Novartis, Serono and other companies. These collaborations provide us with financial support and other valuable resources for our research programs, development resources for our clinical drug candidates, and marketing and sales support for our products. We have had a long and fruitful collaboration with GlaxoSmithKline, resulting in our two marketed drugs, Agenerase and Lexiva, and the advancement of a third HIV protease inhibitor, VX-385, into clinical development. We expect that GlaxoSmithKline will commence a Phase II trial of VX-385 in 2004. We currently are collaborating with Aventis in the development of pralnacasan, an ICE inhibitor for the treatment of rheumatoid arthritis, osteoarthritis and other inflammatory diseases. Our collaboration with Eli Lilly, now ended, produced one of our HCV drug candidates, VX-950.

        We plan to continue adding promising potential products to our development pipeline through the conduct of our state-of-the-art research programs. Our drug design approach integrates biology, chemistry, biophysics, automation and information technologies to make the drug discovery process more efficient and productive. We believe that our drug discovery expertise is a distinguishing feature of the Company. We currently are conducting a productive research program in the area of ion channel modulation, and have been engaged in a broad scale kinase inhibitor collaboration with Novartis since 2000. We expect that future development candidates from these programs will be focused on the treatment of wide variety of diseases and conditions including cancer and neuropathic pain.

        We also seek to opportunistically license and acquire technologies, resources and products that have the potential to strengthen our drug discovery platform, product pipeline and commercial capabilities.

        In two independent transactions closed in March and December 2003, we sold the assets of our Discovery Tools and Services business for an aggregate of $101 million in cash and the assumption of certain liabilities. As a result of the disposition of these assets, we now operate in a single operating segment: Pharmaceuticals.

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        The Company's internet address is www.vrtx.com. The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available to you free of charge through the "Investors" section of our website as soon as reasonably practicable after those materials have been electronically filed with, or furnished to, the Securities and Exchange Commission.

        We were incorporated in Massachusetts in 1989, and our principal executive offices are located at 130 Waverly Street, Cambridge, Massachusetts, 02139.

Commercial Products and Clinical Development Programs

        Our product pipeline is principally focused on viral diseases, inflammatory and autoimmune diseases, and cancer.

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Vertex has co-promotion rights in the U.S. and the E.U. Kissei has marketing rights to amprenavir (Prozei™) in Japan.

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GlaxoSmithKline is seeking marketing approval in the E.U. under the name "Telzir™".

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Vertex may elect by June 30, 2004 to continue the development of VX-680 under the original terms of the Novartis agreement, in which event Novartis will hold an option on worldwide commercial rights.

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Antiviral Programs

HIV/AIDS

Background: Treatment of HIV/AIDS

        Infection with human immunosufficiency virus (HIV) leads to AIDS, a severe, life-threatening impairment of the immune system. The World Health Organization estimates that approximately 36.1 million individuals worldwide are infected with HIV. The U.S. Centers for Disease Control and Prevention (CDC) estimates that there are 980,000 patients in the United States infected with HIV.

        There are four classes of antiviral drugs approved for the treatment of HIV infection and AIDS: nucleoside reverse transcriptase inhibitors (NRTIs), such as AZT and 3TC; non-nucleoside reverse transcriptase inhibitors (NNRTIs), such as efavirenz; the fusion inhibitor enfuvirtide; and HIV protease inhibitors (PIs). PIs such as Agenerase and Lexiva are used as part of combination regimens for the treatment of HIV. PIs block the cleavage of HIV polyproteins into active proteins, and result in the production of non-infectious viral particles. The PI ritonavir has been shown to significantly boost the levels of certain other PIs in the bloodstream and therefore co-administration of PIs with ritonavir has become progressively more frequent in clinical practice as a strategy for achieving maximum antiviral activity, reducing the likelihood of treatment failure (viral breakthrough), and lowering the overall pill count for patients. We estimate that approximately 75% of Lexiva patients are treated concomitantly with ritonavir.

        Currently, approximately 175,000 of the HIV patients receiving drug treatment in the U.S. take at least one PI. The market for HIV PIs is highly competitive, with seven different PIs vying for a share. Worldwide sales of HIV PIs were estimated at more than $1.8 billion in 2003, and U.S. sales alone during the same period were estimated at more than $1 billion.

Vertex HIV/AIDS Products

Agenerase

        Our first marketed product is the HIV protease inhibitor Agenerase (amprenavir), an orally administered drug for the treatment of HIV infection and AIDS. Agenerase received regulatory approval in the U.S. in April 1999. We created and developed Agenerase in collaboration with GlaxoSmithKline. GlaxoSmithKline markets, and we co-promote, Agenerase in the U.S. and Europe. We collaborated with Kissei Pharmaceutical Co., Ltd. to develop amprenavir in Japan, where it is sold by Kissei under the trade name Prozei™.

        Regulatory authorities have approved once-daily use of Agenerase on the basis of data demonstrating that ritonavir (a PI) significantly boosts levels of Agenerase in the bloodstream in both once-daily and twice-daily dosing regimens.

        We receive royalties on sales of amprenavir by GlaxoSmithKline and Kissei. We also supply bulk amprenavir drug substance to Kissei.

Lexiva

        Our second HIV protease inhibitor, Lexiva (fosamprenavir calcium), was co-discovered by Vertex and GlaxoSmithKline and has been developed by GlaxoSmithKline under our collaboration. GlaxoSmithKline has worldwide marketing rights for Lexiva, and we have the right to co-promote Lexiva in the United States and the European Union. We also have the right to supply bulk drug substance to GlaxoSmithKline. We receive royalties on GlaxoSmithKline's sales of Lexiva.

        GlaxoSmithKline conducted an extensive Phase III clinical program for Lexiva, including trials in both treatment-naïve and treatment-experienced patients. The first study (NEAT) compared Lexiva to nelfinavir in treatment-naïve patients. The second study (SOLO) compared Lexiva in combination with ritonavir, administered once-daily, to nelfinavir in treatment-naïve patients. The third study

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(CONTEXT) evaluated both once-daily and twice-daily dosing of Lexiva in combination with ritonavir, compared to lopinavir/ritonavir, in treatment-experienced patients. In all of these studies, patients received reverse transcriptase inhibitors as part of the combination regimen.

        Data from the Phase III clinical program was presented at various medical conferences in 2002 and 2003. In the NEAT trial, 66% of 166 HIV-positive patients achieved an undetectable viral load with Lexiva (<400 copies/ml vRNA), compared to 52% of 83 patients taking nelfinavir. In the SOLO study, 69% of 322 HIV-positive patients achieved undetectable viral load with Lexiva/ritonavir compared to 68% of 327 patients taking nelfinavir. Forty-eight-week data from the CONTEXT study has shown similar efficacy responses in BID regimens of both Lexiva/ritonavir and lopinavir/ritonavir. The incidence of adverse events was low in the Lexiva treatment groups.

        In December 2002, GlaxoSmithKline filed a New Drug Application (NDA) with the U.S. Food and Drug Administration (FDA) and a Marketing Authorization Application (MAA) in the European Union (E.U.) for marketing approval of Lexiva in the U.S. and E.U. The submissions for registration included data from more than 1,100 treatment-naïve and treatment-experienced patients who participated in the Phase III trials. The FDA approved Lexiva on October 20, 2003. GlaxoSmithKline and Vertex launched Lexiva in the United States shortly thereafter. GlaxoSmithKline currently is seeking marketing approval for Lexiva (under the name Telzir) in the E.U. We anticipate that E.U. marketing approval will be granted in 2004.

        Lexiva is a prodrug of amprenavir. A prodrug is an inactive compound that is metabolized by the body to become the active drug. Administration of a prodrug can result in a smaller pill burden for patients, due to the need to use fewer fillers, with a resulting higher ultimate drug load per pill. HIV-infected patients typically require a large number of pills daily as part of combination drug regimens. We believe that Lexiva will offer important new benefits to HIV patients, including a low pill count and the ability to be dosed once or twice a day. This dosing benefit could lead to a material increase in physician acceptance of Lexiva, and patient compliance with Lexiva dosing regimens, as compared to other Agenerase and certain other currently marketed PIs. We also believe that trends in HIV patient demographics and emerging themes in HIV treatment strategy in Western countries may result in increased use of protease inhibitors generally, including Lexiva.

        We believe that Lexiva retains many of the favorable properties associated with amprenavir, including:

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a half-life which allows for convenient twice-daily dosing and provides high levels of the drug in the bloodstream;



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ability to be dosed once daily when co-administered with ritonavir;



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ability to be dosed effectively with or without food, providing convenience for patients;



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well tolerated;



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relatively low levels of cross-resistance to other protease inhibitors; and



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a favorable lipid profile.

VX-385

        We have a third novel, orally available HIV protease inhibitor in clinical development, VX-385 (GW640385), which was co-discovered by Vertex and GlaxoSmithKline. VX-385 is chemically distinct from Agenerase, Lexiva, and other currently marketed protease inhibitors. Preclinical results presented at medical meetings in 2003 demonstrate that VX-385 is a highly potent inhibitor and demonstrates anti-HIV activity against HIV strains resistant to a number of currently marketed protease inhibitors. Clinical results to date indicate that VX-385 is well-tolerated in single doses in healthy volunteers and achieves blood levels consistent with those believed to have an antiviral effect.

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        Our collaborator GlaxoSmithKline controls development of VX-385 and plans to initiate a Phase II clinical trial of the compound in the second half of 2004.

HEPATITIS C VIRUS INFECTION

Background: Treatment of Hepatitis C

        Hepatitis C virus (HCV) causes chronic inflammation in the liver. In a majority of patients, HCV infection can persist for decades and eventually lead to cirrhosis, liver failure and liver cancer. HCV infection represents a significant medical problem worldwide. Sources at the CDC have estimated that approximately 2.7 million Americans, or approximately 1% of the population, are chronically infected with HCV, and the World Health Organization estimates that there are as many as 185 million chronic carriers of the virus worldwide.

        Currently, there is no vaccine available to prevent hepatitis C infection. The current standard treatment for hepatitis C viral infection is a combination of pegylated interferon and ribavirin. At present, however, approximately 50% of patients still fail to show long-term sustained response to pegylated interferon/ribavirin combination therapy. As a result, new safe and effective treatment options for HCV infection are needed.

Vertex HCV Drug Candidates

        Vertex is developing two drug candidates targeting hepatitis C virus infection by different mechanisms. The most advanced compound is merimepodib, which targets HCV indirectly and is currently in Phase II development. Vertex's second HCV drug candidate, VX-950, targets the hepatitis C virus directly, by inhibiting hepatitis C NS3-4A protease, an enzyme necessary for HCV replication. We expect to begin Phase I clinical trials of VX-950 in 2004. Vertex holds all marketing rights to both merimepodib and VX-950.

Merimepodib

        Merimepodib is Vertex's most advanced orally available drug candidate for the treatment of HCV infection. Merimepodib targets HCV infection indirectly through inhibition of the human enzyme inosine 5'-monophosphate dehydrogenase (IMPDH). Vertex has conducted in vitro experiments that demonstrate that merimepodib has an additive antiviral effect, in vitro, in combination with pegylated interferon and ribavirin.

        In 2003, we completed the treatment arms of a triple combination Phase II study of merimepodib with pegylated interferon and ribavirin, to evaluate the safety of the triple combination, in 31 patients with genotype I HCV infection who did not respond to a previous course of alpha interferon in combination with ribavirin. The study provided for six months of treatment, with an optional 6-month extension phase for patients who responded to therapy. In 2003, we reported six-month results from this study, indicating that merimepodib was well-tolerated and, in addition, that merimepodib treatment was associated with a statistically significant, dose-dependent increase in the percentage of patients who had undetectable HCV viral RNA after six months of treatment.

        Merimepodib was discovered through Vertex's program to discover and develop novel orally administered IMPDH inhibitors. IMPDH inhibition selectively inhibits cell proliferation and/or the cycle of viral infection by interrupting the biosynthesis of guanine nucleotides and, indirectly, the synthesis of RNA and DNA in the cell, through one of two pathways available to cells for guanine synthesis. Accordingly, IMPDH is believed to be an attractive target for inhibition of rapid cell proliferation and/or viral replication. Some viruses, including HCV, may be more sensitive to disruptions in the pathway catalyzed by IMPDH. In addition, IMPDH inhibitors appear to work additively or synergistically with other treatments for HCV, including ribavirin. The specific mechanism by which merimepodib enhances ribavirin activity is not known, but it has been proposed that merimepodib may increase the likelihood of ribavirin incorporation into viral RNA during replication,

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resulting either in decreased replication or in the production of immature or non-infective viral particles.

        In preclinical and early clinical studies, merimepodib demonstrated potent biological activity and oral bioavailability. Data from a Phase I trial in healthy volunteers showed that merimepodib was well-tolerated in single escalating doses and achieved blood levels well above those we believe, to be necessary, based on in vitro studies, to achieve potent inhibition of IMPDH. Data from a Phase II clinical trial indicated that merimepodib, when given for 28 days as monotherapy to HCV patients who were unresponsive to prior treatment with alpha interferon, was well tolerated and appeared to reduce levels of serum alanine aminotransferase, a marker of liver inflammation.

        We have also assessed the safety, tolerability and clinical activity of merimepodib combined with alpha interferon in another Phase II trial involving treatment-naïve patients with HCV infection. The viral load data from this study showed a trend toward enhanced antiviral activity in patients given one of two doses of merimepodib combined with interferon, as compared to patients receiving interferon alone. Patients receiving a 100 mg dose of merimepodib three times daily showed a greater reduction in HCV-RNA after 28 days. Merimepodib treatment was associated with statistically significant viral RNA decreases in this study when treatment-non-compliant patients were excluded from the analysis. These results are consistent with an additive antiviral effect mediated by merimepodib, when given in combination with alpha interferon.

        We expect to initiate expanded clinical studies of merimepodib in 2004. If our clinical activities progress as planned, we believe we may be able to file a new drug application (NDA) for merimepodib as early as 2007.

VX-950

        In 2001, we selected VX-950, a potent orally-administered HCV protease inhibitor, for preclinical development. We believe that VX-950 is among the most advanced drug development candidates in a new class of antiviral drugs being studied to inhibit hepatitis C NS3-4A protease, an enzyme thought to be necessary for HCV replication. We believe that therapeutics such as VX-950 which directly target viral replication may significantly increase the number of patients that achieve a complete viral response, clearing HCV from the body permanently. VX-950 has the potential to become one of the first compounds targeting HCV directly and could provide an important treatment advance for individuals with chronic HCV infection. Promising preclinical results for VX-950 were presented in multiple medical and research forums in 2003. Based on progress in preclinical development in 2003, we expect to begin Phase I clinical development of VX-950 in 2004, and we may initiate a first study in HCV patients in the second half of 2004. We hold worldwide marketing rights to VX-950 and all other second-generation HCV protease inhibitors discovered by Vertex in collaboration with Eli Lilly, and would pay Lilly royalties on certain future product sales.

Inflammatory and Autoimmune Disease

Background: ICE Inhibitors for Inflammatory Disease

        Interleukin-1b converting enzyme (ICE; caspase-1) is an enzyme that controls the release of active interleukin-1b (IL-1b, one of two forms of IL-1) and interleukin-18 (IL-18) from white blood cells into the bloodstream and within tissues. IL-1b and IL-18 are cytokines that mediate a wide range of immune and inflammatory responses in many cell types. Early in the inflammatory process, IL-1b is released from white blood cells, initiating a complex cascade of events that results in inflammation and tissue damage. IL-18 is an important factor in the activation of lymphocytes, a type of white blood cell. Elevated IL-1b and IL-18 levels have been correlated with disease states in a number of acute and chronic inflammatory diseases.

        Rheumatoid arthritis (RA) is a potential indication for small molecule ICE inhibitors. In patients with RA, increased activity of IL-1b and IL-18 is observed in joint tissues during disease flare-ups, and

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IL-1b is known to activate osteoclasts, a cell type important in bone erosion characteristic of rheumatoid arthritis. IL-18 may have a similar effect.

        There are more than 6 million patients with RA worldwide, including approximately 2.1 million in the United States. The main drugs currently used to treat RA are non-steroidal anti-inflammatory drugs (NSAIDs) such as Motrin (ibuprofen) and Celebrex (celecoxib). These drugs are palliative—they relieve pain and swelling but do not reverse or prevent the progression of the disease. Methotrexate is a disease-modifying drug that is widely used, but its use is associated with side effects that include liver toxicity. Even when they tolerate it well, many patients become unresponsive to methotrexate over the long term. Newer therapies including Enbrel® (etanercept) and Remicade® (infliximab) provide a strong rationale for a new kind of disease-modifying therapy that involves inhibition of the cytokine tumor necrosis factor (TNF) alpha. In 2001 Kineret® (anakinra) became the first therapy approved for RA targeting the cytokine IL-1. All of these newer agents are administered by injection, which can be inconvenient and painful for patients. We believe that a well tolerated oral ICE inhibitor may have significant commercial advantages over currently available treatments. In addition, we believe that anakinra's activity is different than that of Vertex's ICE inhibitors and is not predictive of the degree of efficacy our drug candidates could have.

        Osteoarthritis (OA) is also a potential indication for treatment with small molecule ICE inhibitors. OA, a degenerative joint disease, is the most common form of arthritis, afflicting more than 240 million patients worldwide, including more than 21 million in the United States alone. Onset generally occurs after middle age, and as the disease progresses, it causes the loss of cartilage, damage to bone, formation of bone spurs, and inflammation of the soft tissues. OA may also occur in joints that have suffered previous injury, have been subjected to repetitive stress, or have been damaged by prior infection or inflammatory arthritis. Patients with OA experience pain, tenderness, swelling and progressive loss of mobility. Patients with OA currently are treated with over-the-counter drugs as well as palliative treatments such as NSAIDS and COX-2 inhibitors. These drugs do not address the underlying progressive joint destruction. Patients with more severe cases may become candidates for partial or total joint replacement surgery.

        The inflammatory response plays a significant role in the joint damage characteristic of OA, and increased cytokine activity has been observed in patients with OA. IL-1b is a key driver of pathology in OA, and results of tests conducted in animal models provide a strong rationale for pursuing IL-1b modulation for the treatment of OA.

Vertex ICE Inhibitors for Inflammatory Disease

        Vertex is developing ICE inhibitors for the treatment of acute and chronic inflammatory conditions. We have collaborated with Aventis S.A. in the development of our most advanced ICE inhibitor, pralnacasan, and we are independently developing a second generation ICE inhibitor, VX-765. We hold worldwide rights to VX-765.

Pralnacasan

        We are collaborating with Aventis S.A. in the clinical development of pralnacasan (VX-740). Aventis has invested in parallel clinical trials of pralnacasan in both RA and OA, in addition to ongoing nonclinical toxicology studies. In 2003, Aventis and Vertex voluntarily suspended the clinical development of pralnacasan, including an ongoing Phase II RA study, so that Aventis and Vertex could analyze findings that emerged from a 9-month nonclinical toxicology study. In the nonclinical study, high doses of pralnacasan were associated with the development of fibrosis in circumscribed areas of the liver of one species of animal. Aventis and Vertex are committed to exploring the toxicology issue with the goal of re-initiating clinical development as soon as prudently possible. The companies' best estimate is that, if the toxicology issue is satisfactorily addressed, development of pralnacasan will be delayed at least 12-24 months from the original timeline. If the toxicology findings cannot be satisfactorily addressed, development of pralnacasan may be discontinued.

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        In 2002, Aventis completed a 284 patient Phase IIa study in RA to evaluate clinical activity using standard measures of response to treatment, including the American College of Rheumatology (ACR) response criteria, which measure improvement in patient-reported and physician-assessed disease severity and activity. Data from the Phase IIa clinical trial demonstrated that treatment with pralnacasan was well tolerated and led to positive anti-inflammatory effects in patients with RA. Aventis previously had completed a Phase IIa 28-day clinical trial of pralnacasan in patients with RA to evaluate the safety and pharmacokinetics of multiple doses of pralnacasan. Results showed dose-dependent suppression of the production of interleukin-1b, a cytokine that plays a role in inflammation and tissue damage.

        In 2003, prior to the adverse nonclinical toxicology finding, Aventis completed a Phase II study of pralnacasan in OA. The purpose of this study was to enable Vertex and Aventis to evaluate the safety and efficacy of pralnacasan in OA patients. More than 500 patients were enrolled in the OA study, and received one of three doses of pralnacasan or placebo for 12 weeks. Pralnacasan was well-tolerated across all three dosage groups. There was improvement (29-35%) in all four treatment groups in the primary endpoint, total WOMAC scores, during the 12 weeks of study. The WOMAC is the "Western Ontario and McMasters Universities" scale for measuring signs and symptoms in OA studies. However, there were no statistically significant differences in the change in total WOMAC score between placebo treatment and any of the pralnacasan treatment groups. However, statistically significant changes in some urine and serum markers of bone and cartilage turnover were observed. Interpretation of these results in the context of modifying the progression of OA requires additional scientific understanding, which will require further clinical validation.

        Under our 1999 agreement, Aventis holds an exclusive worldwide license to develop, manufacture and market pralnacasan in any indication, as well as an exclusive option for certain other compounds discovered under our previous research collaboration with Aventis. We will receive milestone payments for successful development of pralnacasan in RA, as well as for each additional indication, if any, for which it is developed. In addition, we will receive royalties on any sales of pralnacasan, and Aventis will partially fund a Vertex co-promotion effort in the U.S.

VX-765

        VX-765 is the first clinical candidate to be selected for clinical development from our second generation ICE inhibitor research program. VX-765 is chemically distinct from pralnacasan. In 2003, we completed Phase I clinical studies of VX-765 in healthy volunteers. These studies demonstrated a dose-dependent decrease in levels of the cytokine interleukin-18, the first time this has been demonstrated for any therapeutic agent. Preclinical data show that VX-765 reduces inflammation and cytokine levels in animal dermatitis and arthritis models. We plan to initiate additional clinical studies of VX-765 in an inflammatory or autoimmune disease in 2004. We hold worldwide development and commercial rights to VX-765.

Background: p38 MAP Kinase Inhibitors for Acute Coronary Syndromes and other Inflammatory Diseases

        The mitogen-activated protein (MAP) kinases are a family of structurally-related human enzymes involved in intracellular signaling pathways that enable cells to respond to their environment. The p38 MAP kinase is a human enzyme involved in the onset and progression of inflammation and apoptosis (cell death). When activated, the p38 MAP kinase triggers production of the cytokines IL-1, tumor necrosis factor-alpha (TNF-alpha), and interleukin-6 (IL-6). Excess levels of IL-1 and TNF-alpha are associated with a broad range of acute and chronic inflammatory diseases.

        We have extensive pre-clinical and clinical experience with p38 MAP kinase inhibitors, which have the potential to be a powerful and broadly useful new class of oral anti-inflammatory drugs. The initial objective of our p38 program was to identify and extensively evaluate compounds that target p38 MAP kinase to develop novel, orally active drugs for the treatment of inflammatory diseases, such as

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rheumatoid arthritis, asthma, Crohn's disease, certain hematologic disorders, congestive heart failure, and neurological diseases such as stroke.

        The central role of inflammation in many cardiovascular diseases has been well established. Specifically, inflammation is increasingly recognized as a key component of the overall process in the development of coronary artery disease and particularly acute coronary syndromes (ACS). ACS is a broad term that includes unstable angina and certain types of myocardial infarctions. P38 MAP kinase regulates the production of key proinflammatory cytokines implicated in the pathogenesis of ACS, including TNF-alpha, IL-lb and IL-6. As a potential once-daily therapy addressing a novel target for ACS, a potent p38 MAP kinase inhibitor could provide an approach to complement current therapies for this disease, which affects nearly 1.9 million individuals in the U.S. each year.

VX-702—Vertex's p38 MAP kinase inhibitor for inflammatory diseases

        We have collaborated with Kissei on the discovery and development of novel p38 MAP kinase inhibitors since 1997. The research portion of our collaboration with Kissei was completed in 2000. Kissei holds rights to our p38 MAP kinase inhibitor, VX-702, in Japan and certain other Asian countries, and we hold all development and commercial rights elsewhere.

        We initiated a Phase I clinical study of VX-702 in June 2002. The double-blind, placebo-controlled, randomized clinical trial was designed to test the safety, tolerability, pharmacokinetics and pharmacodynamics of VX-702 in single and multiple doses in healthy volunteers. Results from this Phase I study supported further clinical development of VX-702.

        We began Phase II development of VX-702 in 2003. We intend to explore the potential of VX-702 in a variety of disease settings in which inflammation plays an important role. We have decided to advance the clinical development of VX-702 initially in acute disease indications. The initial focus of the Phase II program is aimed at the use of VX-702 as an ACS therapy. We expect our pilot Phase II clinical trial of VX-702 in ACS to be completed in 2004. A third compound discovered by Vertex, VX-850, is in preclinical development and serves as a backup to VX-702.

Other Clinical Development Candidates

VX-680

        VX-680 is the first kinase inhibitor to be advanced by Vertex with potential for the treatment of cancer. VX-680 is a potent inhibitor of Aurora kinases and of Flt-3 kinase. Aurora kinases are enzymes thought to play multiple roles in the development and progression of cancer, acting as regulators of cell proliferation, transforming normal cells into cancer cells and downregulating p53, one of the body's natural tumor suppressors. Flt-3 is a receptor tyrosine kinase that is known to be inappropriately activated in several different types of leukemia. Inhibitors of Aurora kinases and Flt-3 have the potential to be useful as highly targeted treatments for a range of oncology indications.

        Vertex researchers published the three-dimensional atomic structure of Aurora-A kinase in 2002, and published the structure of Flt-3 kinase in January 2004. We also presented preclinical data in a number of research and medical venues in 2003 that indicate the potential of VX-680 to treat several different cancer types for which there are currently few or no available treatments. In a paper published in February 2004, researchers at Vertex reported demonstrating for the first time that a selective small molecule inhibitor of the Aurora kinase (VX-680) profoundly inhibits tumor growth and induces tumor regression in in vivo cancer models.

        Vertex has filed an IND for the clinical study of VX-680 in the United States, and we expect that Phase I clinical studies of VX-680 will be initiated in 2004. We discovered VX-680 in collaboration with Novartis. Under our amended agreement with Novartis, we may elect either to continue development of VX-680 under the terms of the original agreement with Novartis, using loan proceeds from the Novartis loan facility, or to develop VX-680 independently or with a third party. If we choose to

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continue development under the original agreement, Novartis will have an option on worldwide commercial rights to VX-680.

VX-944

        VX-944 is an oral IMPDH inhibitor with potential for the treatment of cancer. Results from certain preclinical studies of VX-944 have suggested that VX-944 has potent anti-tumor activity. Phase I clinical studies of VX-944 in healthy volunteers demonstrated that VX-944 is orally bioavailable and well-tolerated. Vertex is now evaluating the possibility of entering into a collaborative relationship for more advanced clinical development of VX-944.

RESEARCH and EARLY DEVELOPMENT PROGRAMS

Vertex Drug Design Platform and Drug Discovery Strategy

        We believe that our integrated drug design approach has significantly enhanced our ability to discover and develop small molecule drug candidates directed at biologically complex targets, including novel targets identified in genomic research. We believe that our approach has been validated through our collaborations and success in moving drug candidates into clinical trials.

        Integrated Drug Design Approach.    Our drug design platform integrates advanced biology, biophysics, chemistry, automation and information technologies in a coordinated and simultaneous fashion throughout the discovery process. The goal of our integrated, interdisciplinary approach is to increase the speed and predictability of drug discovery and development.

        Focused Drug Discovery in Target-Rich Gene Families.    Vertex has pioneered a novel approach to drug discovery in target-rich gene families. Our approach organizes and prioritizes targets within gene families, which are groups of genes with similar sequences that code for structurally similar proteins. This approach essentially clusters targets according to how they interact with chemical inhibitors, and allows us to use high-throughput screening technologies, informatics and medicinal chemistry to rapidly identify drug-like classes of compounds in parallel for multiple targets. In concert with this approach, we use a variety of biological and chemical methodologies that interrogate the function of newly discovered proteins in order to focus our drug discovery and development efforts on the most promising targets within the most promising gene families. We believe that our systematic application of this drug discovery approach is increasing the speed and efficiency of drug design efforts directed at novel biological targets, and is securing valuable intellectual property for us in gene families of interest.

Technology Platform

        Our integrated technology platform employs a variety of technologies and uses information from a number of different scientific disciplines. The most significant of them are as follows.

        Functional Genomics.    We use functional genomics techniques, such as gene knock-out mice, to help guide target selection and test the potential of chemical compounds in disease models. Our patented GenomeScreen™ technology allows us to identify and validate targets by scanning the genome of living human cells and identifying those genes activated or repressed in various disease states. We have used GenomeScreen to assist us in mapping gene activation and cell signaling pathways and in characterizing poorly understood cellular processes. We also use antisense, siRNA, dominant negative cell lines, and other biological approaches to better characterize the role played by specific targets in cellular processes.

        Biophysics.    We generate atomic structural information on molecular targets using X-ray crystallography and nuclear magnetic resonance (NMR) spectroscopy to guide design and optimization of lead classes of drugs.

        Computer-based Modeling.    We apply advanced proprietary computational modeling tools to guide the evaluation and selection of compounds for synthesis. During our virtual ("in silico")

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screening process, candidate compounds are selected for synthesis and screening. We use proprietary algorithms to sort and filter compounds for specific properties in order to seek compounds that are more likely to become development candidates.

        Pharmacology.    We employ a number of approaches to obtain predictive information on the bioavailability and pharmacokinetic profile of potential drug candidates. These approaches include in vitro metabolism and toxicological studies and in vivo assessment of leads in predictive animal models.

        Assay Development.    We use assay development and screening techniques, built upon a number of gene reporter technologies such as green fluorescent protein (GFP) and beta lactamase, to rapidly generate large numbers of lead compounds and drug candidates across certain gene families. We are also utilizing our assay development capabilities to develop novel proprietary assays to establish ADME/toxicology profiles for compounds in our screening library.

        High-Throughput Screening.    We conduct assays for most enzyme and receptor targets using the ultra high-throughput screening (UHTSS) system, which integrates compound management, plate replication with miniaturized screening, hit (potential lead) identification and follow-up. The ultra high-throughput capability is achieved through the use of a 3,456 well assay microplate.

        Instrumentation.    Some of our ion channel research is conducted using E-VIPR, our proprietary screening technology which uses fluorescent probes and waves of electrical stimulation to study ion channels. E-VIPR provides an automated, high-throughput platform which enables us to collect high quality data at speeds up to a thousand times faster than patch clamping. We can use E-VIPR to study both fast and slow channel activity and state dependence, a phenomenon in which compounds bind preferentially to certain conformations of channels. With respect to voltage-gated channels, electrical stimulation eliminates the need for the addition of liquids and pharmacological modifiers which often distort the native conformation and activity of ion channels.

Current Research Programs

        Our past drug discovery efforts have produced a variety of drug candidates for development by Vertex or its partners. We believe our ongoing research programs, particularly those directed at the kinase and ion channel gene families, continue to create potential value for Vertex by generating new product candidates in areas of significant unmet medical need.

Kinase Program

        We have a broad-based drug discovery effort targeting the human protein kinase family, of which there are approximately 500 members. Protein kinases are enzymes that play a key role in transmitting signals between and within cells. Kinases exert their effect by phosphorylating other proteins, which then become activated and perform a specific function. Kinase activity has been implicated in most major diseases, including cancer and autoimmune, inflammatory, cardiovascular, metabolic, and neurological diseases. As a result, kinases can be ideal targets for therapeutic intervention. The clinical success of the oncology drugs Gleevec (Novartis) and Iressa (AstraZeneca) offer examples of how small molecule kinase inhibitors can be tailored to address specific diseases.

        In May 2000 we entered into an agreement with Novartis Pharma AG to collaborate on the discovery, development and commercialization of small molecule drugs directed at protein kinases. We expect the research effort under this agreement, which was amended in early 2004, to continue through April 2006. The support provided by Novartis is enabling us to conduct extensive parallel drug design efforts within the kinase target family.

        In 2003, we filed an Investigational New Drug Application (IND) with the FDA covering VX-680, a potent small molecule inhibitor of Aurora kinases and Flt-3 kinase. Aurora kinases are three closely-related proteins required in rapidly dividing cells. Inhibition of Aurora kinase activity with a small

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molecule may provide a means of slowing or reversing the uncontrolled cell growth observed in cancer. In addition it is thought that more than 30% of patients with acute myelogenous leukemia (AML) have activating mutations of Flt-3. Thus VX-680 could provide therapeutic benefits for patients with solid tumors and hematological malignancies including AML. Under our restructured agreement with Novartis, we may either continue development of VX-680 under the terms of our original agreement with Novartis, or elect to develop and commercialize VX-680 independent of Novartis.

        Vertex has drug discovery efforts underway targeting several other kinases, including those that play a role in the development and progression of cancer, inflammation and autoimmune disease.

        The infrastructure created over the first three years of the Novartis/Vertex collaboration has enabled a parallel approach to drug discovery in the kinase gene family. Our researchers have determined the atomic structure of more than 20 kinase drug targets and more than 300 kinase/inhibitor co-complexes, providing information to help accelerate drug design and further our understanding of the role kinases play in disease. Most recently, Vertex researchers published structural interpretations of the process by which mutations in kinases like Flt-3 can lead to uncontrolled cellular proliferation and cancer. Using proprietary in silico and in vitro methodologies, Vertex has designed a diverse library of proprietary kinase inhibitors, leading to the filing of more than 90 patents covering many hundreds of distinct chemical scaffolds. Over the next several years, we expect to advance a number of kinase inhibitors as development candidates targeting multiple therapeutic areas.

Ion Channel Program

        We are conducting a broad-based drug discovery program targeting the ion channel family. Ion channels are a gene family of more than 500 proteins that act as cellular gatekeepers, controlling the flow of ions across cell membranes. The ion channel target family contains numerous druggable targets representing potential therapeutic intervention points for indications including cystic fibrosis, neuropathic pain and inflammatory, cardio-vascular, and metabolic diseases. Existing therapies such as amlodipine and nifedipine, which are calcium channel blockers for the treatment of hypertension, and lamotrigine and carbamezepine, which are sodium channel inhibitors for the treatment of epilepsy, provide a strong rationale for developing drugs targeting ion channels.

        Our ion channel research extends across several ion channel subfamilies, including sodium channels and calcium channels, and is principally focused on the design and development of small molecule drugs for the treatment of neuropathic pain and cystic fibrosis. Specific sodium channels have been shown to increase in expression and function in peripheral nerve cells at the site of injury, making them novel and attractive targets for the treatment of neuropathic pain. Ion channel modulators also could be important therapeutic agents for cystic fibrosis, a chronic, progressive genetic disorder. We have an ongoing research collaboration with the Cystic Fibrosis Foundation targeting the cystic fibrosis regulator protein (CFTR). The symptoms of cystic fibrosis, particularly the development of thick mucous that causes lung tissue inflammation and damage, are caused by a defect in CFTR. A CFTR channel modulator potentially may slow or halt the progression of cystic fibrosis.

        We are utilizing our expertise in assay development and screening to advance discovery efforts within the ion channel family. Our capabilities are augmented by the use of E-VIPR, our proprietary ion channel screening technology. E-VIPR uses fluorescent probes and waves of electrical stimulation to study ion channels in an automated high-throughput platform enabling the collection of high quality data at speeds up to a thousand times faster than patch-clamping.

Caspase Program

        The human caspase family is a subfamily of proteases which presently include 11 structurally related enzymes that play specific roles in inflammation and apoptosis (programmed cell death). We are conducting research focused on the design of small molecules which can potentially exert a protective effect on cells in specific tissues by inhibiting caspase-mediated apoptotic and inflammatory processes.

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        Through gene knockout studies, our scientists have gained important insight into the biological role of different caspases in the activation of apoptosis in specific cells and tissues. Vertex research teams have solved the three-dimensional atomic structures of four caspases, including one caspase from each of the three caspase subfamilies, and more than 50 enzyme/inhibitor complexes.

        Potential indications for caspase inhibitor compounds include tissue damage related to acute conditions such as stroke, myocardial ischemia and sepsis, and neurodegenerative disorders such as Alzheimer's disease and Parkinson's disease. We are collaborating in a portion of our caspase program with Serono S.A. under an agreement signed in 2000, covering the development and commercialization of certain caspase inhibitors in the U.S. and the European Union.

Bacterial Gyrase

        We are engaged in the discovery of novel antibiotics that target DNA gyrase B, an essential enzyme found in many bacteria. DNA gyrase is utilized during the bacterial replication process. DNA gyrase inhibitors already on the market have proven to be potent, broad-spectrum antibiotics and are used to treat a variety of common gram-positive and gram-negative infections in various treatment settings. Existing gyrase inhibitors work by interacting with the gyrase A subunit. In contrast, we are targeting the gyrase B subunit, and specifically the ATP-binding site that is common to multiple species of bacteria. We have discovered a class of molecules that also shows activity against the highly similar par E subunit of topoisomerase IV, another essential bacterial enzyme. These dual gyrB/parE inhibitors not only appear to be potent in preclinical testing, but may also be less susceptible to the development of drug resistance, a major and growing problem with marketed antibiotics. We are currently optimizing this dual inhibitor class and may select a clinical candidate in 2004.

Additional Discovery Efforts

        We plan to utilize our proprietary gene family-based platform and experience in structure-based drug design to pursue targets in other medically important gene families. We have exploratory efforts underway targeting g-protein coupled receptors (GPCRs) and nuclear receptors, among other things, as well as a program directed toward second generation HCV inhibitors.

Corporate Collaborations

        We have entered into corporate collaborations with pharmaceutical companies that provide financial and other resources, including capabilities in research, development, manufacturing, and sales and marketing, to support our research and development programs. At present, we have the following major corporate collaborations:

Novartis Pharma AG

        In May 2000, we entered into an agreement with Novartis Pharma AG to collaborate on the discovery, development and commercialization of small molecule drugs directed at protein kinases. We amended this collaboration agreement in February 2004. Under the original agreement, we were responsible for drug discovery and clinical proof-of-concept testing of all drug candidates. Novartis agreed, among other things, to pay us up to $200,000,000 in product research funding through April 2006, and to loan us up to $200,000,000 on a non-interest-bearing basis to support our clinical studies. We continue to be responsible for drug discovery under the amended agreement, and Novartis will continue to provide research funding through the end of the six-year research term. However, under the agreement as modified, Novartis will be responsible for all clinical and nonclinical development of drug candidates which it accepts for development, and consequently the loan facility has been eliminated. We may either continue development of VX-680 under the terms of the original agreement, using loan proceeds we have received under the Novartis loan facility, or elect to develop and commercialize VX-680 independent of Novartis. If we elect to develop and commercialize VX-680 independent of Novartis, loan amounts with respect to that drug candidate which are unspent and

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uncommitted at the time of our election will be repayable immediately. At December 31, 2003, approximately $14 million in development loans previously advanced to us on account of VX-680 were unspent and uncommitted. The agreement also provides up to $35 million in license fees and milestones for each preclinical drug candidate nominated by us and accepted by Novartis. Novartis will have exclusive worldwide development, manufacturing and marketing rights to drug candidates that it accepts from us for development. We will receive royalties on any products that are marketed as part of the collaboration.

GlaxoSmithKline

        In December 1993, we entered into a collaboration with GlaxoSmithKline covering the research, development and commercialization of HIV protease inhibitors, including Agenerase (amprenavir), Lexiva (fosamprenavir calcium) and VX-385. Under the original agreement, GlaxoSmithKline had exclusive rights to develop and commercialize our HIV protease inhibitors in all parts of the world except the Far East. In 2003, we amended the agreement to add the Far East to GlaxoSmithKline's territory for development and commercialization of Lexiva. GlaxoSmithKline pays us a royalty on all sales of the HIV protease inhibitors covered by the agreement. We have retained certain bulk drug manufacturing rights and certain co-promotion rights in the territories licensed to GlaxoSmithKline. Under the collaborative agreement, GlaxoSmithKline agreed to pay us up to $42 million, comprised of a $15 million up-front license payment made in 1993, $14 million of product research funding over five years and $13 million of development and commercialization milestone payments for an initial drug candidate. We have received the entire $42 million. We began receiving royalties on sales of Agenerase in 1999 and on Lexiva in 2003. GlaxoSmithKline is also obligated to pay us additional development and commercialization milestone payments for subsequent drug candidates, including Lexiva and VX-385. In addition, GlaxoSmithKline is required to bear the costs of development in its territory under the collaboration.

        GlaxoSmithKline has the right to terminate its agreement with us without cause upon 12 months' notice. Termination of the agreement by GlaxoSmithKline will relieve it of its obligation to make further commercialization and development milestone and royalty payments, and will end any license granted by us to GlaxoSmithKline under the agreement.

        In June 1996, we and GlaxoSmithKline obtained a worldwide, non-exclusive license under certain G.D. Searle & Co. (now owned by Pharmacia/Pfizer) patents in the area of HIV protease inhibition. We pay Searle a royalty based on sales of Agenerase and Lexiva.

Aventis S.A.

        In September 1999, we entered into an expanded agreement with Aventis S.A., formerly Hoechst Marion Roussel Deutschland GmbH (HMR), covering the development of pralnacasan. Aventis has an exclusive worldwide license to develop, manufacture and market pralnacasan, as well as an exclusive option for certain other compounds discovered as part of the research collaboration between HMR and us that ended in 1997. Aventis will fund the development of pralnacasan. We may co-promote the product in the United States and Europe and will receive royalties on global sales, if any. Under the agreement, Aventis has paid us a $20 million up-front payment for prior research costs, and has agreed to pay us up to $62 million in milestone payments for successful development by Aventis of pralnacasan for rheumatoid arthritis, the first targeted indication. Milestone payments are also due for each additional indication. The agreement also provides that Aventis will partially fund a Vertex co-promotion effort in the U.S. under certain conditions. Aventis has the right to terminate this agreement without cause upon six months' written notice. Termination by Aventis will end any license we have granted Aventis under the agreement.

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Serono S.A.

        In December 2000, we entered into a collaboration with Serono S.A. to discover, develop, and market certain types of caspase inhibitors. Under the terms of the agreement, we could receive up to $95 million of pre-commercial payments, based on the successful development and commercialization of more than one drug candidate, to support and expand our drug discovery activities in the caspase protein family. That amount would include milestone payments as drug candidates move through development. Of that total, we have received $5 million in up-front payments for prior research, and could also receive up to $20 million in research funding, some of which has been paid, over the five year agreement term. The two companies will share development costs. We have the option to establish a joint venture with Serono for the commercialization of products in North America, where we will share marketing rights and profits from the sale of drug products, if any. Serono will have exclusive rights to market caspase inhibitors in other territories, excluding Japan and certain other countries in the Far East, and will pay us for supplies of drug substance. Serono has the right to terminate the agreement without cause effective at the end of 2004 upon written notice delivered on or before the end of June 2004.

Other Collaborations

        Schering AG (Germany).    In August 1998, we entered into a collaboration with Schering AG covering the research, development and commercialization of novel, orally active neurophilin ligand compounds to promote nerve regeneration for the treatment of a number of neurological diseases. Vertex and Schering AG have an equal role in management of neurophilin ligand research and product development. Research funding under this agreement has concluded. We have amended the original agreement to extend Schering's option to designate a compound or compounds for development under the agreement until September 2004. In North America, we will have manufacturing rights to, and we will share equally with Schering AG in the marketing expenses and profits from, any compounds which may be selected for development and commercialization. Schering AG will have the right to manufacture and market any commercialized compounds in Europe, the Middle East and Africa, and will pay us a royalty on any product sales. Schering AG has the right to terminate the agreement without cause upon six months' written notice.

        Kissei Pharmaceutical Co., Ltd.    Kissei launched our HIV protease inhibitor amprenavir (Agenerase) in Japan under the name Prozei in 1999 and pays us a royalty on all sales of Prozei. In September 1997, we entered into a collaboration with Kissei to identify and develop compounds that target p38 MAP kinase. We are collaborating with Kissei in the development and commercialization of VX-702, a novel, orally active p38 MAP kinase inhibitor for the treatment of ACS and inflammatory diseases. Kissei has exclusive rights to develop and commercialize VX-702 in Japan and certain Southeast Asian countries, and semi-exclusive rights in China, Taiwan and South Korea. We retain exclusive marketing rights in the United States, Canada, Europe, and the rest of the world. In addition, we will have the right to supply bulk drug material to Kissei for sale in its territory, and will receive royalties and drug supply payments on any product sales. The research program ended on June 30, 2000, and we have received the full amount of research funding specified under the agreement. Kissei has the right to terminate the agreement without cause upon six months' notice.

        Eli Lilly & Company.    In June 1997, we entered into a collaboration with Eli Lilly covering the development of novel small molecule compounds to treat hepatitis C infection, including VX-950. In December 2001, together with Eli Lilly, we selected VX-950 for development. In December 2002, we restructured our agreement with Eli Lilly, ending the research collaboration approximately six months early and providing us with worldwide rights to compounds identified during the collaboration. We will pay Eli Lilly a royalty on any future sales of drug products developed from VX-950 and other certain other HCV protease inhibitor compounds.

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Intellectual Property

        We actively seek, when appropriate, protection for our products and proprietary information by means of United States and foreign patents, trademarks and contractual arrangements. In addition, we rely upon trade secrets and contractual arrangements to protect certain of our proprietary information and products. In addition to patents and pending patent applications that relate to potential drug targets, compounds we are developing to modulate those targets, and methods of making or using those compounds, we have several patents and pending patent applications directed to proprietary elements of our drug discovery platform. These include patent applications claiming our E-VIPR platform which enables optical membrane potential assays for detecting activity of rapidly gating ion channels, and methods of using our E-VIPR platform for high-throughput screening of voltage-gated ion channels.

        Much of our technology and many of our processes depend upon the knowledge, experience and skills of key scientific and technical personnel. To protect our rights to our proprietary know-how and technology, we require all employees, consultants and advisors to enter into confidentiality agreements that prohibit the disclosure of Vertex confidential information to anyone outside Vertex. These agreements typically require disclosure and assignment to Vertex of ideas, developments, discoveries and inventions made by employees, consultants and advisors.

Patents and Pending Applications

        We have issued patents and pending applications in the United States, and in foreign countries we deem appropriate, covering intellectual property developed as part of each of our most advanced research, development and commercial programs. These include:

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issued United States patents that cover classes of chemical compounds, pharmaceutical formulations and/or uses of the same for treating HIV infection and AIDS. The patents include specific coverage for amprenavir and its pharmaceutical formulations, methods of manufacture and methods to treat HIV infection or AIDS-related central nervous system disorders. We have a non-exclusive, worldwide license under certain Searle patent applications claiming HIV protease inhibitors. We have an issued patent in the United States and patents and pending applications in other countries claiming fosamprenavir and related compounds, as well as VX-385.



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issued United States patents that cover classes of chemical compounds, pharmaceutical compositions containing such compounds, and methods of using those compounds to treat or prevent IMPDH-mediated diseases, including HCV. These patents claim merimepodib, its combination with certain other therapeutic agents and the use thereof for treating HCV.



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issued United States patents covering pralnacasan, the active metabolite of pralnacasan, and several different classes of compounds useful as inhibitors of ICE, as well as pharmaceutical compositions containing those compounds and methods of using those compounds to treat ICE-related diseases. These patents and applications include a series of patents and applications purchased from Sanofi S.A., in July 1997, including a United States patent that covers DNA sequences encoding ICE. We also have applications pending in the United States and other countries claiming VX-765 and related compounds.



•

an issued United States patent that covers a class of chemical compounds that includes VX-702 and VX-850, as well as compositions comprising those compounds and the use of those compounds to treat p38 MAP kinase related disorders.



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issued United States patents and pending applications covering assays useful to evaluate potential inhibitors of hepatitis C protease and covering the X-ray crystal structures of hepatitis C protease and hepatitis C helicase, including the use of those structures to develop hepatitis C protease inhibitors and hepatitis C helicase inhibitors, respectively. Other United States and

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worldwide pending applications cover VX-950, additional hepatitis C protease inhibitors and hepatitis C helicase inhibitors.

•

issued United States patents and filed applications worldwide claiming inhibitors of multiple kinase proteins.



•

pending applications and an issued United States patent for methods of designing novel chemical inhibitors of protein kinases. The method involves using mutagenesis techniques to create hybrid kinases that act as surrogate targets for drug design and compound screening.



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pending applications claiming modulators of sodium ion channels, and uses thereof.

Manufacturing

        We rely on third party manufacturers and collaborative partners to produce our compounds for clinical purposes and may do so for commercial production of any drug candidates that are approved for marketing. Commercial manufacturing of Agenerase and Lexiva is being done by GlaxoSmithKline. We retain the option to manufacture a portion of GlaxoSmithKline's requirements for bulk drug substance for Agenerase and Lexiva. If we were to exercise that option, we believe we would need to rely upon one or more contract manufacturers to manufacture the bulk drug substance on our behalf.

        We have established a quality assurance program intended to ensure that third party manufacturers under contract produce our compounds in accordance with the FDA's current Good Manufacturing Practices, or cGMP, and other applicable regulations.

        We believe that all of our clinical drug candidates can be produced using established manufacturing methods, primarily through standard techniques of pharmaceutical synthesis. We believe that we will be able to continue to negotiate third party manufacturing arrangements on commercially reasonable terms and that it will not be necessary for us to develop an internal manufacturing capability in order to successfully commercialize our products. Our objective is to maintain flexibility in deciding whether to develop internal manufacturing capabilities for certain of our potential products. However, if we are unable to obtain contract manufacturing, or obtain such manufacturing on commercially reasonable terms, we may not be able to commercialize our products as planned. We have limited experience in manufacturing pharmaceutical or other products or in conducting manufacturing testing programs required to obtain FDA and other regulatory approvals, and there can be no assurance that we will further develop those capabilities successfully.

        Since most of our potential products are at an early stage of development, we will need to improve or modify our existing manufacturing processes and capabilities to produce commercial quantities of any drug product economically. We cannot quantify the time or expense that may ultimately be required to improve or modify our existing process technologies, but it is possible that such time or expense could be substantial.

        The production of our drug candidates is based in part on technology that we believe to be proprietary. We may license this technology to contract manufacturers to enable them to manufacture drug candidates for us. In addition, a contract manufacturer may develop process technology related to the manufacture of our drug candidates that the manufacturer owns either independently or jointly with us. This would increase our reliance on that manufacturer or require us to obtain a license from that manufacturer in order to have our products manufactured.

Competition

        We are engaged in biopharmaceutical fields characterized by extensive research efforts, rapid technological progress and intense competition. There are many public and private companies, including pharmaceutical companies, chemical companies and biotechnology companies, engaged in developing products for the same human therapeutic applications as those we are targeting. In order for us to compete successfully, we must demonstrate improved safety, efficacy, ease of manufacturing

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and market acceptance of our products over those of our competitors who have received regulatory approval and currently are marketing their drugs. In the field of HIV protease inhibition, Abbott Laboratories, Inc., Bristol Myers Squibb, Gilead, Hoffmann-La Roche, Merck & Co., Inc. and Pfizer Inc., among others, have other HIV protease inhibitor drugs in development or on the market. Similarly, a variety of companies are attempting to develop new treatments for hepatitis C virus infection. Many of our competitors have substantially greater financial, technical and human resources than ours and are more experienced in the development of new drugs.

Government Regulation

        Our development, manufacture and potential sale of therapeutics are subject to extensive regulation by United States and foreign governmental authorities. In particular, pharmaceutical products are subject to rigorous preclinical and clinical testing and to other approval requirements by the FDA in the United States under the Food, Drug and Cosmetic Act, and by comparable agencies in most foreign countries.

Approval Process.

        As an initial step in the FDA regulatory approval process, preclinical studies typically are conducted in animals to identify potential safety problems. For certain diseases, animal models exist that are believed to be predictive of human efficacy. For such diseases, a drug candidate is tested in an animal model. The results of the studies are submitted to the FDA as a part of the Investigational New Drug application (IND) which is filed to comply with FDA regulations prior to commencement of human clinical testing in the U.S. For diseases for which no appropriately predictive animal model exists, no such results can be filed. For several of our drug candidates, no appropriately predictive model exists. As a result, no in vivo evidence of efficacy will be available until those compounds progress to human clinical trials. A variety of nonclinical trials in a number of animal species, and other nonclinical studies, are ordinarily conducted while human clinical trials are underway, to provide supplemental toxicology and other information and to help provide a foundation for the design of broader and more lengthy human clinical trials as human clinical studies progress through the approval process.

        Clinical trials typically are conducted in three sequential phases, although the phases may overlap. In Phase I, which frequently begins with the initial introduction of the drug into healthy human subjects prior to introduction into patients, the drug candidate is tested for safety, dosage tolerance, absorption, bioavailability, biodistribution, metabolism, excretion, clinical pharmacology and, if possible, for early information on effectiveness. Phase II typically involves studies in a small sample of the intended patient population to assess the efficacy and duration of the drug for a specific indication, to determine dose tolerance and the optimal dose range and to gather additional information relating to safety and potential adverse effects. Phase III trials are undertaken to further evaluate clinical safety and efficacy in an expanded patient population at geographically dispersed study sites, to determine the overall risk-benefit ratio of the drug and to provide an adequate basis for physician labeling. Each trial is conducted in accordance with certain standards under protocols that detail the objectives of the study, the parameters to be used to monitor safety and the efficacy criteria to be evaluated. Each protocol must be submitted to the FDA as part of the IND. Further, each clinical study must be evaluated by an independent Institutional Review Board at the institution at which the study will be conducted. The Institutional Review Board will consider, among other things, ethical factors, the safety of human subjects and the possible liability of the institution.

        Data from nonclinical testing and clinical trials are submitted to the FDA in a New Drug Application (NDA) for marketing approval. The process of completing nonclinical and clinical testing and obtaining FDA approval for a new drug is likely to take a number of years and require the expenditure of substantial resources. Preparing an NDA involves considerable data collection, verification, analysis and expense, and there can be no assurance that approval will be granted on a timely basis, if at all. The approval process is affected by a number of factors, including the severity of the disease, the availability of alternative treatments and the risks and benefits demonstrated in clinical

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trials. The FDA may deny an NDA if applicable regulatory criteria are not satisfied or may require additional testing or information. Among the conditions for marketing approval is the requirement that the prospective manufacturer's quality control and manufacturing procedures conform to the FDA's cGMP regulations, which must be followed at all times. In complying with standards set forth in these regulations, manufacturers must continue to expend time, money and effort in the area of production and quality control to ensure full technical compliance. Manufacturing establishments, both foreign and domestic, also are subject to inspections by or under the authority of the FDA and by or under the authority of other federal, state or local agencies.

Timing to Approval.

        We estimate that it takes 10 to 15 years (the industry average is 12 years) to discover, develop and bring to market a new pharmaceutical product in the U.S. as outlined below:

        Animal and other nonclinical studies are typically conducted during each phase of human clinical studies.

Post-approval Studies.

        Even after initial FDA approval has been obtained, further studies, including post-approval studies, may be required to provide additional data on safety and will be required to gain approval for the use of a product as a treatment for clinical indications other than those for which the product was initially tested. Also, the FDA will require post-approval reporting to monitor the side effects of the drug. Results of post-approval programs may limit or expand further marketing of the drug product. Further, if there are any modifications to the drug, including changes in indication, manufacturing process, labeling or manufacturing facilities, an NDA supplement may be required to be submitted to the FDA.

Other Regulations.

        Under the Drug Price Competition and Patent Term Restoration Act of 1984, a sponsor may be granted marketing exclusivity for a period of time following FDA approval of certain drug applications, if FDA approval is received before the expiration of the patent's original term. This marketing exclusivity would prevent a third party from obtaining FDA approval for a similar or identical drug through an Abbreviated New Drug Application, which is the application form typically used by manufacturers seeking approval of a generic drug. The statute also allows a patent owner to extend the term of the patent for a period equal to one-half the period of time elapsed between the filing of an IND and the filing of the corresponding NDA plus the period of time between the filing of the NDA and FDA approval. We intend to seek the benefits of this statute, but there can be no assurance that we will be able to obtain any such benefits.

        Whether or not FDA approval has been obtained, approval of a drug product by regulatory authorities in foreign countries must be obtained prior to the commencement of commercial sales of

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the product in such countries. Historically, the requirements governing the conduct of clinical trials and product approvals, and the time required for approval, have varied widely from country to country.

        In addition to the statutes and regulations described above, we are also subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Resource Conservation and Recovery Act and other present and potential future federal, state and local regulations.

Employees

        As of December 31, 2003, we had more than 720 employees (approximately 714 full time, 10 part time), including approximately 486 in research and development and 238 in general and administrative functions. Approximately 80 of these employees were located at our U.K. research and development facility and 157 were located at our facility in San Diego. Our scientific staff members (278 of whom hold Ph.D. and/or M.D. degrees) have diversified experience and expertise in molecular and cell biology, biochemistry, animal pharmacology, synthetic organic chemistry, protein X-ray crystallography, protein nuclear magnetic resonance spectroscopy, computational chemistry, biophysical chemistry, medicinal chemistry, clinical pharmacology and clinical medicine. Our employees are not covered by a collective bargaining agreement, and we consider our relations with our employees to be good.

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EXECUTIVE OFFICERS AND DIRECTORS

        The names, ages and positions held by our executive officers and directors are as follows: