Vertex Pharmaceuticals Incorporated (“Vertex” or the “Company”) invests in scientific innovation to create transformative medicines for serious diseases. The Company’s business is focused on developing and commercializing therapies for the treatment of cystic fibrosis (“CF”) and advancing research and development programs in other indications. The Company’s marketed products are TRIKAFTA (elexacaftor/tezacaftor/ivacaftor and ivacaftor), SYMDEKO/SYMKEVI (tezacaftor in combination with ivacaftor), ORKAMBI (lumacaftor in combination with ivacaftor) and KALYDECO (ivacaftor), which are approved to treat patients with CF who have specific mutations in their cystic fibrosis transmembrane conductance regulator (“CFTR”) gene.

The Company is subject to risks common to companies in its industry including, but not limited to, the dependence on revenues from its CF products, competition, uncertainty about clinical trial outcomes and regulatory approvals, uncertainties relating to pharmaceutical pricing and reimbursement, uncertainty related to international expansion, uncertain protection of proprietary technology, the need to comply with government regulations, share price volatility, dependence on collaborative relationships and potential product liability.

The accompanying consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”), reflect the operations of (i) the Company, (ii) its wholly-owned subsidiaries and (iii) consolidated variable interest entities (“VIEs”). In 2017, the Company deconsolidated Parion Sciences, Inc. (“Parion”), a VIE the Company had consolidated since 2015. In 2018, the Company deconsolidated BioAxone Biosciences, Inc. (“BioAxone”), a VIE the Company had consolidated since 2014. As of December 31, 2019 and 2018, the Company did not have any consolidated VIEs. All material intercompany balances and transactions have been eliminated. The Company operates in one segment, pharmaceuticals. Please refer to Note R, “Segment Information,” for enterprise-wide disclosures regarding the Company’s revenues, major customers and long-lived assets by geographic area. The Company has reclassified certain items from the prior year’s consolidated financial statements to conform to the current year’s presentation.

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

Pursuant to Accounting Standards Codification (“ASC”) 606, Revenue from Contracts with Customers (“ASC 606”), the Company recognizes revenue when a customer obtains control of promised goods or services. The Company records the amount of revenue that reflects the consideration that it expects to receive in exchange for those goods or services. The Company applies the following five-step model in order to determine this amount: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations, including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation.

The Company only applies the five-step model to contracts when it is probable that it will collect the consideration to which it is entitled in exchange for the goods or services that it transfers to the customer. Once a contract is determined to be within the scope of ASC 606 at contract inception, the Company reviews the contract to determine which performance obligations it must deliver and which of these performance obligations are distinct. The Company recognizes as revenue the amount of the transaction price that is allocated to each performance obligation when that performance obligation is satisfied or as it is satisfied. Generally, the Company’s performance obligations are transferred to customers at a point in time, typically upon delivery.

The Company sells its products principally to a limited number of specialty pharmacy and specialty distributors in the United States, which account for the largest portion of its total revenues, and makes international sales primarily to specialty distributors and retail chains, as well as hospitals and clinics, many of which are government-owned or supported (collectively, its “Customers”). The Company’s Customers in the United States subsequently resell the products to patients and health care providers. In accordance with ASC 606, the Company recognizes net product revenues from sales when the Customers obtain control of the Company’s products, which typically occurs upon delivery to the Customer. The Company’s payment terms are approximately 30 days in the United States and consistent with prevailing practice in international markets.

Revenues from product sales are recorded at the net sales price, or “transaction price,” which includes estimates of variable consideration that result from (a) invoice discounts for prompt payment and distribution fees, (b) government and private payor rebates, chargebacks, discounts and fees and (c) costs of co-pay assistance programs for patients, as well as other incentives for certain indirect customers. Reserves are established for the estimates of variable consideration based on the amounts earned or to be claimed on the related sales. The reserves are classified as reductions to “Accounts receivable, net” if payable to a Customer or “Accrued expenses” if payable to a third-party. Where appropriate, the Company utilizes the expected value method to determine the appropriate amount for estimates of variable consideration based on factors such as the Company’s historical experience, current contractual and statutory requirements, specific known market events and trends, industry data and forecasted customer buying and payment patterns. The amount of variable consideration that is included in the transaction price may be constrained and is included in net product revenues only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period. Actual amounts of consideration ultimately received may differ from the Company’s estimates. If actual results vary from the Company’s estimates, the Company adjusts these estimates, which would affect net product revenue and earnings in the period such variances become known.

Invoice Discounts and Distribution Fees: The Company generally provides invoice discounts on product sales to its Customers for prompt payment and pays fees for distribution services, such as fees for certain data that Customers provide to the Company. The Company estimates that, based on its experience, its Customers will earn these discounts and fees, and deducts the full amount of these discounts and fees from its gross product revenues and accounts receivable at the time such revenues are recognized.

these estimated amounts from its gross product revenues at the time the revenues are recognized. For each product, the Company estimates the aggregate rebates, chargebacks and discounts that it will provide to Third-party Payors based upon (i) the Company’s contracts with these Third-party Payors, (ii) the government-mandated discounts and fees applicable to government-funded programs, (iii) information obtained from the Company’s Customers and other third-party data regarding the payor mix for such product and (iv) historical experience.

Other Incentives: Other incentives that the Company offers include co-pay mitigation rebates provided by the Company to commercially insured patients who have coverage and who reside in states that permit co-pay mitigation programs. Based upon the terms of the Company’s co-pay mitigation programs, the Company estimates average co-pay mitigation amounts for each of its products in order to establish appropriate accruals.

The Company makes significant estimates and judgments that materially affect its recognition of net product revenues. The Company adjusts its estimated rebates, chargebacks and discounts based on new information, including information regarding actual rebates, chargebacks and discounts for its products, as it becomes available. Claims by third-party payors for rebates, chargebacks and discounts frequently are submitted to the Company significantly after the related sales, potentially resulting in adjustments in the period in which the new information becomes known. The Company’s credits to product revenue related to prior period sales have not been significant and primarily related to rebates and discounts.

The Company recorded contract liabilities of $62.3 million and $24.9 million as of December 31, 2019 and 2018, respectively, related to annual contracts with government-owned and supported customers in international markets that limit the amount of annual reimbursement the Company can receive. Upon exceeding the annual reimbursement amount, products are provided free of charge, which is a material right. These contracts include upfront payments and fees. The Company defers a portion of the consideration received for shipments made up to the annual reimbursement limit as a portion of “Other current liabilities.” The deferred amount is recognized as revenue when the free products are shipped. The Company’s product revenue contracts include performance obligations that are one year or less.

The Company’s contract liabilities at the end of each fiscal year relate to contracts with annual reimbursement limits in international markets in which the annual period associated with the contract is not the same as the Company’s fiscal year. In these markets the Company recognizes revenues related to performance obligations satisfied in previous years; however, these revenues do not relate to any performance obligations that were satisfied more than 12 months prior to the beginning of the current year. During the year ended December 31, 2019, the Company recorded $24.9 million of revenues that were recorded as contract liabilities at the beginning of the year.

Pursuant to ASC 605, Revenue Recognition (“ASC 605”), which was applicable until December 31, 2017, the Company only recognized revenues from product sales if it determined that the price was fixed or determinable at the time of delivery. If the Company determined that the price was not fixed or determinable, it deferred the recognition of revenues. If the Company was able to determine that the price was fixed or determinable, it recognized the net product revenues associated with the units.

In 2015, the Company began distributing ORKAMBI through early access programs in France and remained engaged in reimbursement discussions with the French government until November 2019, when the Company reached an agreement with the French government for ORKAMBI, including ORKAMBI distributed through early access programs. From the time the Company began distributing ORKAMBI through early access programs in France, it expected the difference between the amounts collected based on the invoiced amount and the final amount for ORKAMBI distributed through early access programs would be returned to the French government. As a result, the Company has classified a refund liability related to the early access programs in France within “Accrued expenses” on its consolidated balance sheets.

Pursuant to the revenue recognition accounting guidance that was applicable until December 31, 2017, the Company’s ORKAMBI net product revenues for 2015, 2016 and 2017 did not include any net product revenues from sales of ORKAMBI in France because the price was not fixed or determinable at the time of delivery. Upon adopting ASC 606 in 2018, the Company recorded an $8.3 million cumulative effect adjustment to “Accumulated deficit” primarily related to shipments of ORKAMBI under the early access programs in France. The Company determined the amount of the adjustment based upon (i) the status of reimbursement discussions in France upon adoption, (ii) its estimate of the amount of consideration it expected to retain related to ORKAMBI sales in France that occurred on or prior to December 31, 2017 that would not be subject to a significant reversal in amounts recognized and (iii) recognition of costs previously deferred related to the ORKAMBI sales in France. Please refer to Recent Accounting Pronouncements included in this Note A, “Nature of Business and Accounting Policies,” below for more information regarding the revenue recognition guidance adopted as of January 1, 2018.

For ORKAMBI sales in France that occurred after December 31, 2017 under the early access programs, the Company recognized net product revenues based on a transaction price that reflected the Company’s estimate of consideration it expected to retain that would not be subject to a significant reversal in amounts recognized. When determining if variable consideration should be constrained, the Company considers whether there are factors outside its control that could result in a significant reversal of revenue. In making these assessments, the Company considers the likelihood and magnitude of a potential reversal of revenue. The Company recognized ORKAMBI net product revenues from sales in France based on this estimate from the first quarter of 2018 through the third quarter of 2019. Upon reaching an agreement with the French government for ORKAMBI, including ORKAMBI distributed through early access programs in November 2019, the Company updated the transaction price to reflect the final amount for ORKAMBI distributed through early access programs. As a result, the Company recognized net product revenues of $155.8 million related to prior period ORKAMBI early access program sales in the fourth quarter of 2019 because the updated transaction price for ORKAMBI distributed through these programs exceeded the Company’s previous estimate of the consideration it expected to retain that would not be subject to a significant reversal in amounts recognized. Additionally, the Company’s refund liability no longer requires estimation as of December 31, 2019 and will be paid to the French government in 2020.

The Company recognizes collaborative revenues generated through collaborative research, development and/or commercialization agreements. The terms of these agreements typically include payment to the Company related to one or more of the following: nonrefundable, upfront license fees; development and commercial milestones; funding of research and/or development activities; and royalties on net sales of licensed products. Revenue is recognized upon satisfaction of a performance obligation by transferring control of a good or service to the collaborator.

For each collaborative research, development and/or commercialization agreement that results in revenue, the Company identifies all material performance obligations, which may include a license to intellectual property and know-how, research and development activities and/or transition activities. In order to determine the transaction price, in addition to any upfront payment, the Company estimates the amount of variable consideration at the outset of the contract either utilizing the expected value or most likely amount method, depending on the facts and circumstances relative to the contract. The Company constrains (reduces) the estimate of variable consideration such that it is probable that a significant reversal of previously recognized revenue will not occur throughout the life of the contract. When determining if variable consideration should be constrained, management considers whether there are factors outside the Company’s control that could result in a significant reversal of revenue. In making these assessments, the Company considers the likelihood and magnitude of a potential reversal of revenue. These estimates are re-assessed each reporting period as required.

Once the estimated transaction price is established, amounts are allocated to the performance obligations that have been identified. The transaction price is generally allocated to each separate performance obligation on a relative standalone selling price basis. In order to account for these agreements, the Company must develop assumptions that require judgment to determine the standalone selling price, which may include (i) the probability of obtaining marketing approval for the drug candidate, (ii) estimates regarding the timing of and the expected costs to develop and commercialize the drug candidate, (iii) estimates of future cash flows from potential product sales with respect to the drug candidate and (iv) appropriate discount and tax rates. Standalone selling prices used to perform the initial allocation are not updated after contract

Upfront License Fees: If a license to the Company’s intellectual property is determined to be distinct from the other performance obligations identified in an arrangement, the Company recognizes revenue from the related nonrefundable, upfront license fees based on the relative standalone selling price prescribed to the license compared to the total selling price of the arrangement. The revenue is recognized when the license is transferred to the collaborator and the collaborator is able to use and benefit from the license. For licenses that are not distinct from other obligations identified in the arrangement, the Company utilizes judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time. If the combined performance obligation is satisfied over time, the Company applies an appropriate method of measuring progress for purposes of recognizing revenue from nonrefundable, upfront license fees. The Company evaluates the measure of progress each reporting period and, if necessary, adjusts the measure of performance and related revenue recognition.

Development and Regulatory Milestone Payments: Depending on facts and circumstances, the Company may conclude that it is appropriate to include certain milestones in the estimated transaction price or that it is appropriate to fully constrain the milestones. A milestone payment is included in the transaction price in the reporting period that the Company concludes that it is probable that recording revenue in the period will not result in a significant reversal in amounts recognized in future periods. This may result in revenues from certain milestones and a corresponding contract asset being recorded in a reporting period before the milestone is achieved. Milestone payments that have not been included in the transaction price to date are fully constrained until the Company concludes that their achievement is probable and that recognition of the related revenue will not result in a significant reversal in amounts recognized in future periods. The Company re-evaluates the probability of achievement of such development milestones and any related constraint each reporting period and adjusts its estimate of the overall transaction price, including the amount of collaborative revenue that it has recorded, if necessary. The Company has not recorded any significant development or regulatory milestone revenues the three years ended December 31, 2019.

Research and Development Activities/Transition Services: If the Company is entitled to reimbursement from its collaborators for specified research and development expenses, it accounts for the related services that it provides as separate performance obligations if it determines that these services represent a material right. The Company also determines whether the reimbursement of research and development expenses should be accounted for as collaborative revenues or an offset to research and development expenses in accordance with the provisions of gross or net revenue presentation. The Company recognizes the corresponding revenues or records the corresponding offset to research and development expenses as it satisfies the related performance obligations.

Sales-based Milestone and Royalty Payments: The Company’s collaborators may be required to pay the Company sales-based milestones or royalties on future sales of commercial products. The Company recognizes revenues related to sales-based milestone and royalties upon the later to occur of (i) achievement of the collaborator’s underlying sales or (ii) satisfaction of any performance obligation(s) related to these sales, in each case assuming the license to the Company’s intellectual property is deemed to be the predominant item to which the sales-based milestones and/or royalties relate. The Company has not recorded any sales-based milestones or royalties revenues during the three years ended December 31, 2019.

Financial instruments that potentially subject the Company to concentration of credit risk consist principally of money market funds and marketable securities. The Company places these investments with highly rated financial institutions, and, by policy, limits the amounts of credit exposure to any one financial institution. These amounts at times may exceed federally insured limits. The Company also maintains a foreign currency hedging program that includes foreign currency forward contracts with several counterparties. The Company has not experienced any credit losses related to these financial instruments and does not believe it is exposed to any significant credit risk related to these instruments.

As of December 31, 2019, the Company’s marketable securities consisted of investments in available-for-sale debt securities, including government-sponsored enterprise securities, corporate debt securities and commercial paper, and corporate equity securities with readily determinable fair values. The Company classifies marketable securities available to fund current operations as current assets on its consolidated balance sheets. Marketable securities are classified as long-term assets on the consolidated balance sheets if (i) they have been in an unrealized loss position for longer than one year and (ii) the Company has the ability and intent to hold them (a) until the carrying value is recovered and (b) such holding period may be longer than one year. The Company’s marketable securities are stated at fair value. The fair value of these securities is based on quoted prices for identical or similar assets.

Pursuant to the adoption of Accounting Standards Update (“ASU”) 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”) on January 1, 2018, the Company began recording changes in the fair value of its investments in corporate equity securities to “Other income (expense), net” in the Company’s consolidated statements of operations. Prior to its adoption of ASU 2016-01 in 2018, the Company recorded changes in the fair value of its investments in corporate equity securities to “Accumulated other comprehensive (loss) income.”

The Company reviews investments in marketable debt securities for other-than-temporary impairment whenever the fair value of an investment is less than the amortized cost and evidence indicates that an investment’s carrying amount is not recoverable within a reasonable period of time. To determine whether an impairment is other-than-temporary, the Company considers whether it has an intent to sell, or whether it is more likely than not that the Company will be required to sell, the investment before recovery of the investment’s amortized cost basis. Evidence considered in this assessment includes reasons for the impairment, compliance with the Company’s investment policy, the severity and the duration of the impairment and changes in value subsequent to year-end. If a decline in the fair value is considered other-than-temporary, based on available evidence, the unrealized loss is transferred from other comprehensive income (loss) to the consolidated statements of operations.

The Company deducts invoice discounts for prompt payment and fees for distribution services from its accounts receivable based on its experience that the Company’s Customers will earn these discounts and fees. The Company’s estimates for its allowance for doubtful accounts, which have not been significant to date, are determined based on existing contractual payment terms and historical payment patterns.

The Company expenses the fair value of employee stock options and other forms of stock-based employee compensation over the associated employee service period on a straight-line basis. Stock-based compensation expense is determined based on the fair value of the award at the grant date and is adjusted each period to reflect actual forfeitures and the outcomes of certain performance conditions.

For awards with performance conditions in which the award does not vest unless the performance condition is met, the Company recognizes expense if, and to the extent that, the Company estimates that achievement of the performance condition is probable. If the Company concludes that vesting is probable, it recognizes expense from the date it reaches this conclusion through the estimated vesting date.

The Company provides to employees who have rendered a certain number of years’ to the Company and meet certain age requirements, partial or full acceleration of vesting of these equity awards, subject to certain conditions including a notification period, upon a termination of employment other than for cause. Approximately 5% of the Company’s employees were eligible for partial or full acceleration of any of their equity awards as of December 31, 2019. The Company recognizes stock-based compensation expense related to these awards over a service period reflecting qualified employees’ eligibility for partial or full acceleration of vesting.

Research and development expenses are comprised of costs incurred by the Company in performing research and development activities, including salary and benefits; stock-based compensation expense; outsourced services and other direct expenses, including clinical trial and pharmaceutical development costs; collaboration and asset acquisition payments; expenses associated with drug supplies that are not being capitalized; and infrastructure costs, including facilities costs and depreciation expense.

The Company values its inventories at the lower-of-cost or net realizable value. The Company determines the cost of its inventories, which includes amounts related to materials and manufacturing overhead, on a first-in, first-out basis. The Company performs an assessment of the recoverability of capitalized inventory during each reporting period, and writes down any excess and obsolete inventories to their net realizable value in the period in which the impairment is first identified. Shipping and handling costs incurred for inventory purchases are capitalized and recorded upon sale in “Cost of sales” in the consolidated statements of operations. Shipping and handling costs incurred for product shipments are recorded as incurred in “Cost of sales” in the consolidated statements of operations.

The Company capitalizes inventories produced in preparation for initiating sales of a drug candidate when the related drug candidate is considered to have a high likelihood of regulatory approval and the related costs are expected to be recoverable through sales of the inventories. In determining whether or not to capitalize such inventories, the Company evaluates, among other factors, information regarding the drug candidate’s safety and efficacy, the status of regulatory submissions and communications with regulatory authorities and the outlook for commercial sales, including the existence of current or anticipated competitive drugs and the availability of reimbursement. In addition, the Company evaluates risks associated with manufacturing the drug candidate and the remaining shelf-life of the inventories.

Property and equipment are recorded at cost. Depreciation expense is recorded using the straight-line method over the estimated useful life of the related asset, generally seven to ten years for furniture and equipment, three to five years for computers and software and for leasehold improvements, the shorter of the useful life of the improvements or the estimated remaining life of the associated lease. Maintenance and repairs to an asset that do not improve or extend its life are charged to operations. When assets are retired or otherwise disposed of, the assets and related accumulated depreciation are eliminated from the accounts and any resulting gain or loss is reflected in the Company’s consolidated statements of operations. The Company performs an assessment of the fair value of the assets if indicators of impairment are identified during a reporting period and records the assets at the lower of the net book value or the fair value of the assets.

The Company adopted ASU 2016-02, Leases (Topic 842) (“ASC 842”) as of January 1, 2019. Under ASC 842, the Company determines whether the arrangement contains a lease at the inception of an arrangement. If a lease is identified in an arrangement, the Company recognizes a right-of-use asset and liability on its consolidated balance sheet and determines whether the lease should be classified as a finance or operating lease. The Company does not recognize assets or liabilities for leases with lease terms of less than 12 months.

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

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

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

Prior to the adoption of ASC 842 on January 1, 2019, the Company applied build-to-suit accounting and was the deemed owner of its leased corporate headquarters in Boston and research site in San Diego, for which it was recognizing depreciation expense over the buildings’ useful lives and imputed interest on the corresponding construction financing lease obligations. The Company also recorded leases for equipment as capital leases pursuant to the accounting guidance that was effective until December 31, 2018.

The assets and liabilities associated with the Company’s capital lease agreements were recorded at the present value of the minimum lease payments at the inception of the lease agreement. The assets were depreciated using the straight-line method over the shorter of the useful life of the related asset or the remaining life of the associated lease. Amortization of capital lease assets was included in depreciation expense.

Deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial statement carrying amounts and the income tax bases of assets and liabilities. A valuation allowance is applied against any net deferred tax asset if, based on the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. On a periodic basis, the Company reassesses the valuation allowance on its deferred income tax assets weighing positive and negative evidence to assess the recoverability of its deferred tax assets. The Company includes, among other things, its recent financial performance and its future projections in this periodic assessment.

The Company records liabilities related to uncertain tax positions by prescribing a minimum recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company does not believe any such uncertain tax positions currently pending will have a material adverse effect on its consolidated financial statements.

The Company reviews each collaboration agreement pursuant to which it licenses assets owned by a collaborator in order to determine whether or not it has a variable interest via the license agreement with the collaborator and if the variable interest is a variable interest in the collaborator as a whole. In assessing whether the Company has a variable interest in the collaborator as a whole, the Company considers and makes judgments regarding the purpose and design of the entity, the value of the licensed assets to the collaborator, the value of the collaborator’s total assets and the significant activities of the collaborator. If the Company has a variable interest in the collaborator as a whole, the Company assesses whether or not the Company is the primary beneficiary of that VIE based on a number of factors, including (i) which party has the power to direct the activities that most significantly affect the VIE’s economic performance, (ii) the parties’ contractual rights and responsibilities pursuant to the collaboration agreement and (iii) which party has the obligation to absorb losses of or the right to receive benefits from the VIE that could be significant to the VIE. If the Company determines it is the primary beneficiary of a VIE at the onset of the collaboration agreement, the collaboration is treated as a business combination and the Company consolidates the financial statements of the VIE into the Company’s consolidated financial statements. On a quarterly basis, the Company evaluates whether it continues to be the primary beneficiary of any consolidated VIEs. If the Company determines that it is no longer the primary beneficiary of a consolidated VIE, or no longer has a variable interest in the VIE, it deconsolidates the VIE in the period that the determination is made.

The Company’s discounted cash flow models pertaining to in-process research and development assets include: (i) assumptions regarding the probability of obtaining marketing approval for a drug candidate; (ii) the timing of and the expected costs to develop and commercialize a drug candidate; (iii) estimates of future cash flows from potential product sales with respect to a drug candidate; and (iv) appropriate discount and tax rates.

The Company bases its estimates of the probability of achieving the milestones relevant to the fair value of contingent payments, which could include milestone, royalty and option payments, on industry data. Estimates included in the discounted cash flow models pertaining to contingent payments also include: (i) estimate regarding the timing of the relevant development and commercial milestones and royalties, (ii) and appropriate discount rates. Please refer to Note E, “Fair Value Measurements,” for further information.

The Company records the fair value of in-process research and development assets as of the transaction date of a business combination. Each of these assets is accounted for as an indefinite-lived intangible asset and is maintained on the Company’s consolidated balance sheet until either the project underlying it is completed or the asset becomes impaired. If the asset becomes impaired or is abandoned, the carrying value of the related intangible asset is written down to its fair value, and an impairment charge is recorded in the period in which the impairment occurs. If a project is completed, the carrying

value of the related intangible asset is amortized as a part of “Cost of sales” over the remaining estimated life of the asset beginning in the period in which the project is completed. In-process research and development assets are tested for impairment on an annual basis as of October 1, and more frequently if indicators are present or changes in circumstances suggest that impairment may exist.

Upon the occurrence of certain events and on a regular basis, the Company evaluates whether it no longer has a controlling interest in its subsidiaries, including consolidated VIEs. If the Company determines it no longer has a controlling interest, the subsidiary is deconsolidated. The Company records a gain or loss on deconsolidation based on the difference on the deconsolidation date between (i) the aggregate of (a) the fair value of any consideration received, (b) the fair value of any retained noncontrolling investment in the former subsidiary and (c) the carrying amount of any noncontrolling interest in the subsidiary being deconsolidated, less (ii) the carrying amount of the former subsidiary’s assets and liabilities.

The Company assesses whether a deconsolidation is required to be presented as discontinued operations in its consolidated financial statements on the deconsolidation date. This assessment is based on whether or not the deconsolidation represents a strategic shift that has or will have a major effect on the Company’s operations or financial results. If the Company determines that a deconsolidation requires presentation as a discontinued operation on the deconsolidation date, or at any point during the one year period following such date, it will present the former subsidiary as a discontinued operation in current and comparative period financial statements.

Embedded derivatives are required to be bifurcated from the host instruments and recorded at fair value if the derivatives are not clearly and closely related to the host instruments on the date of issuance. The Company did not have any material embedded derivatives that required bifurcation recorded on its consolidated balance sheets as of December 31, 2019 and 2018, respectively.

The Company recognizes the fair value of hedging instruments that are designated and qualify as hedging instruments pursuant to GAAP, foreign currency forward contracts, as either assets or liabilities on the consolidated balance sheets. Changes in the fair value of these instruments are recorded each period in “Accumulated other comprehensive (loss) income” as unrealized gains and losses until the forecasted underlying transaction occurs. Unrealized gains and losses on these foreign currency forward contracts are included in “Prepaid expenses and other current assets” or “Other assets,” and “Other current liabilities” or “Other long-term liabilities,” respectively, on the Company’s consolidated balance sheets depending on the remaining period until their contractual maturity. Realized gains and losses for the effective portion of such contracts are recognized in “Product revenues, net” in the consolidated statement of operations in the same period that it recognizes the product revenues that were impacted by the hedged foreign exchange rate changes. The Company classifies the cash flows from hedging instruments in the same category as the cash flows from the hedged items.

The Company also enters into foreign currency forward contracts with contractual maturities of less than one month designed to mitigate the effect of changes in foreign exchange rates on monetary assets and liabilities including intercompany balances. These contracts are not designated as hedging instruments pursuant to GAAP. Realized gains and losses for such contracts are recognized in “Other income (expense), net” in the consolidated statement of operations each period.

The Company records costs and liabilities associated with exit and disposal activities based on estimates of fair value in the period the liabilities are incurred. The Company’s exit and disposal activities have primarily been associated with the Company’s facilities, but also have included the termination of employees in some cases. The Company’s initial estimate of its liabilities for net ongoing costs associated with its facility obligations are recorded at fair value on the cease use date. On a quarterly basis, the Company evaluates and adjusts these liabilities as appropriate for changes in circumstances. Changes to the Company’s estimate of these liabilities are recorded as additional restructuring expenses (credits). These costs are included in “Restructuring (income) expenses” on the Company’s consolidated statements of operations.

The Company has adopted several plans to restructure its facilities and operations for which it has incurred restructuring expenses. The only significant restructuring event during the three years ended December 31, 2019 commenced in February 2017 upon the Company’s decision to consolidate its research activities into its Boston, Milton Park and San Diego locations. The Company closed its research site in Canada as a result of this decision affecting approximately 70 positions. The Company’s lease for its research site in Canada expired in October 2018. As of December 31, 2019 and 2018, the Company has no restructuring liabilities recorded on its consolidated balance sheet and does not anticipate any additional charges related to this restructuring event in the future.

Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss), which includes foreign currency translation adjustments and unrealized gains and losses on foreign currency forward contracts and certain marketable securities. For purposes of comprehensive income (loss) disclosures, the Company records provisions for or benefits from income taxes related to the unrealized gains and losses on foreign currency forward contracts and certain marketable securities. The Company does not record provisions for or benefits from income taxes related to the cumulative translation adjustment, as the Company intends to permanently reinvest undistributed earnings in its foreign subsidiaries.

The majority of the Company’s operations occur in entities that have the U.S. dollar denominated as their functional currency. The assets and liabilities of the Company’s entities with functional currencies other than the U.S. dollar are translated into U.S. dollars at rates of exchange in effect at the end of the year. Revenue and expense amounts for these entities are translated using the average exchange rates for the period. Net unrealized gains and losses resulting from foreign currency translation are included in “Accumulated other comprehensive (loss) income.” Net foreign currency exchange transaction losses, which are included in “Other income (expense), net” on the Company’s consolidated statement of operations, were $5.2 million, $1.1 million and $5.5 million for 2019, 2018 and 2017, respectively. These net foreign currency exchange losses are presented net of the impact of the foreign currency forward contracts designed to mitigate their effect on the Company’s consolidated statement of operations.

Basic and diluted net loss per share attributable to Vertex common shareholders are presented in conformity with the two-class method required for participating securities. Under the two-class method, earnings are allocated to (i) Vertex common shares, excluding unvested restricted stock, and (ii) participating securities, based on their respective weighted-average shares outstanding for the period. Shares of unvested restricted stock granted under the Company’s Amended and Restated 2006 Stock and Option Plan have the non-forfeitable right to receive dividends on an equal basis with other outstanding common stock. As a result, these unvested shares of restricted stock are considered participating securities under the two-class method. Potentially dilutive shares result from the assumed exercise of outstanding stock options (the proceeds of which are then assumed to have been used to repurchase outstanding stock using the treasury stock method).

Basic net loss per share attributable to Vertex common shareholders is based upon the weighted-average number of common shares outstanding during the period, excluding restricted stock that has been issued but is not yet vested. Diluted net loss per share attributable to Vertex common shareholders is based upon the weighted-average number of common shares outstanding during the period plus additional weighted-average common equivalent shares outstanding during the period when the effect is dilutive.

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

In July 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements (“ASU 2018-11”), which offered a transition option to entities adopting ASC 842. Under ASU 2018-11, entities could elect to apply ASC 842 using a modified-retrospective adoption approach resulting in a cumulative effect adjustment to accumulated deficit at the beginning of the year in which the new lease standard is adopted, rather than adjustments to the earliest comparative period presented in their financial statements. The Company adopted ASC 842 using the modified-retrospective method. As of January 1, 2019, the Company recorded a cumulative effect adjustment to increase its “Accumulated deficit” by $40.3 million related to the adjustments to its build-to-suit leases described in the previous paragraph.

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



	Balance as of						Balance as of
	December 31, 2018 ^			Adjustments			January 1, 2019
Assets	(in thousands)
Prepaid expenses and other current assets	$	140,819		$	(2,930	)	$	137,889
Property and equipment, net	812,005			(53,920		)	758,085
Deferred tax assets	1,499,672			11,236			1,510,908
Other assets	—			61,674			61,674
Total assets	$	6,245,898		$	16,060		$	6,261,958
Liabilities and Shareholders’ Equity
Capital lease obligations, current portion	$	9,817		$	(9,817	)	$	—
Other current liabilities	40,589			34,304			74,893
Capital lease obligations, excluding current portion	19,658			(19,658		)	—
Construction financing lease obligation, excluding current portion	561,892			(561,892		)	—
Long-term finance lease liabilities	—			569,487			569,487
Other long-term liabilities	26,280			43,946			70,226
Accumulated deficit	(2,989,478		)	(40,310		)	(3,029,788		)
Total liabilities and shareholders’ equity	$	6,245,898		$	16,060		$	6,261,958
^ As reported in the Company’s 2018 Annual Report on Form 10-K.

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

In 2014, the FASB issued ASC 606. The new guidance became effective January 1, 2018. ASC 606 applies a more principles-based approach to recognizing revenue. Under ASC 606, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration that an entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The Company adopted ASC 606 on January 1, 2018 using the modified-retrospective adoption method for all contracts that were not completed as of the date of adoption. Under the modified-retrospective method, the Company recognized the cumulative effect of applying the standard within “Accumulated deficit” on its consolidated balance sheet as of January 1, 2018.

Based on the Company’s review of existing customer contracts as of January 1, 2018, it concluded that the only significant impact that the adoption of ASC 606 had on its financial statements related to shipments of ORKAMBI under early access programs in France. Prior to the adoption of ASC 606, the Company did not recognize revenue on the proceeds received from sales of ORKAMBI under early access programs in France because the price was not fixed or determinable based on the status of ongoing pricing discussions. As of January 1, 2018, the Company recorded a cumulative effect

adjustment to its accumulated deficit of $8.3 million related to the adoption of ASC 606, which primarily represented the Company’s estimated amount of consideration it expected to retain related to these shipments that would not be subject to a significant reversal in amounts recognized, net of costs previously deferred related to these shipments. Please refer to “Product Revenues, Net” above for further information related to the impact of the new revenue recognition on these sales.



	Year Ended December 31, 2018
	As Reported under ASC 606		Balances without Adoption of ASC 606		Effect of Change Higher/(Lower)
	(in thousands)
Product revenues, net	$	3,038,325	$	3,019,484	$	18,841
Cost of sales	409,539		402,925		6,614
Income from operations	635,150		622,923		12,227
Net income attributable to Vertex	$	2,096,896	$	2,084,669	$	12,227

Amounts per share attributable to Vertex common shareholders:
Net income:
Basic	$	8.24	$	8.20	$	0.04
Diluted	$	8.09	$	8.04	$	0.05

In 2016, the FASB issued ASU 2016-01, which amended guidance related to the recording of financial assets and financial liabilities. Under ASU 2016-01, equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of an investee) are measured at fair value with changes in fair value recognized in net income (loss). However, an entity has the option to measure equity investments without readily determinable fair values at (i) fair value or (ii) cost adjusted for changes in observable prices minus impairment. Changes in measurement under either alternative are recognized in net income (loss). ASU 2016-01 became effective January 1, 2018 and required the modified-retrospective adoption method. As of January 1, 2018, the Company held publicly traded equity investments and equity investments accounted for under the cost method. As a result, in 2018, the Company recorded a $25.1 million cumulative effect adjustment to “Accumulated deficit” related to its publicly traded equity investments equal to the unrealized gain, net of tax, that was recorded in “Accumulated other comprehensive (loss) income” as of December 31, 2017. The adoption of ASU 2016-01 had no effect on the Company’s equity investments accounted for under the cost method because the original cost basis of these investments was recorded on the Company’s consolidated balance sheet as of December 31, 2017. In 2019 and 2018, the Company recorded net unrealized gains of $132.5 million and $2.6 million, respectively, to “Other income (expense), net” in its consolidated statement of operations related to the change in fair value of its equity investments.

In 2016, the FASB issued ASU 2016-16, Intra-Entity Transfers of Assets Other Than Inventory (“ASU 2016-16”), which removes the previous exception in GAAP prohibiting an entity from recognizing current and deferred income tax expenses or benefits related to the transfer of assets, other than inventory, within the consolidated entity. The exception to defer the recognition of any tax impact on the transfer of inventory within the consolidated entity until it is sold to a third party remains unaffected. ASU 2016-16 became effective January 1, 2018. In 2018, upon adoption of ASU 2016-16, the Company recorded a deferred tax asset and corresponding full valuation allowance of $204.7 million equal to the unamortized cost of

In 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350) (“ASU 2017-04”) related to measurements of goodwill. ASU 2017-04 modifies the concept of impairment from the condition that exists when the carrying amount of goodwill exceeds its implied fair value to the condition that exists when the carrying amount of a reporting unit exceeds its fair value, which eliminates Step 2 from the goodwill impairment test. An entity would recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to the related reporting unit. The Company early adopted ASU 2017-04 and utilized this approach for annual and interim goodwill impairment tests conducted after January 1, 2018. The adoption of ASU 2017-04 did not have a significant effect on the Company’s consolidated financial statements.

In 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) Restricted Cash (“ASU 2016-18”), which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and restricted cash. Therefore, amounts described as restricted cash should be included with cash and cash equivalents when reconciling the beginning of period and end of period amounts shown on the statement of cash flows. ASU 2016-18 became effective January 1, 2018 and was effective on a retrospective basis. The cash, cash equivalents and restricted cash balances for the years ended December 31, 2019 through 2016, which are presented in the Company’s consolidated statements of cash flows subsequent to the adoption of ASU 2016-18, consisted of the following:



	As of December 31,
	2019		2018		2017		2016
	(in thousands)
Cash and cash equivalents	$	3,109,322	$	2,650,134	$	1,665,412	$	1,183,945
Prepaid expenses and other current assets	8,004		4,910		2,114		47,762
Other assets	3,355		3,209		—		—
Cash, cash equivalents and restricted cash per statement of cash flows	$	3,120,681	$	2,658,253	$	1,667,526	$	1,231,707

The Company’s restricted cash, if any, is included in “Prepaid expenses and other current assets” and “Other assets” in its consolidated balance sheets. As of December 31, 2017 and 2016, the Company recorded BioAxone’s cash and cash equivalents as “Prepaid expenses and other current assets” because the Company did not have any interest in or control over BioAxone’s cash and cash equivalents.

In 2016, the FASB issued ASU 2016-09, Compensation—Stock Compensation (Topic 718) Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”), which simplifies the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. ASU 2016-09 became effective January 1, 2017. ASU 2016-09 eliminated the requirement that excess tax benefits were realized as a reduction in current taxes payable before the associated tax benefit could be recognized as an increase in additional paid-in capital. This created a deferred tax asset of $410.8 million relating to federal and state net operating losses (“NOLs”) that were fully reserved by an equal increase in the Company’s valuation allowance as of January 1, 2017. The Company recorded deferred tax assets of $404.7 million relating to federal NOLs and $6.1 million relating to state NOLs, both of which were offset by a full valuation allowance. Upon adoption, the Company also elected to change its accounting policy to account for forfeitures of options and awards as they occur. The change was applied on a modified-retrospective basis with a cumulative effect adjustment to increase “Accumulated deficit” by $9.4 million as of January 1, 2017. This change also resulted in an increase to the deferred tax asset of $3.4 million, which was offset by a full valuation allowance. As a result, there was no cumulative effect adjustment to accumulated deficit related to income taxes. The provisions related to the recognition of excess tax benefits in the Company’s consolidated statement of

In 2018, the FASB issued ASU 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”), which clarifies the accounting for implementation costs in cloud computing arrangements. ASU 2018-15 was effective on January 1, 2020. The Company expects the adoption of ASU 2018-15 will result in an insignificant amount of additional assets recorded on its consolidated balance sheet.

In 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”), which modifies the disclosure requirements for fair value measurements. ASU 2018-13 was effective on January 1, 2020. The Company expects the adoption of ASU 2018-13 will result in additional disclosures related to its assets and liabilities that are valued based on Level 3 inputs.

In 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”), which requires entities to record expected credit losses for certain financial instruments, including trade receivables, as an allowance that reflects the entity's current estimate of credit losses expected to be incurred. For available-for-sale debt securities in unrealized loss positions, ASU 2016-13 requires allowances to be recorded instead of reducing the amortized cost of the investment. ASU 2016-13 was effective on January 1, 2020. The Company does not expect the adoption of ASU 2016-13 to have a significant impact on its consolidated financial statements.