UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)
x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2006
	OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER 000-19319

VERTEX PHARMACEUTICALS INCORPORATED

(Exact name of registrant as specified in its charter)

MASSACHUSETTS		04-3039129
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)
130 WAVERLY STREET
CAMBRIDGE,
MASSACHUSETTS		02139-4242
(Address of principal executive offices)		(zip code)

(617) 444-6100

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer x

Accelerated Filer o

Non-Accelerated Filer o

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Common Stock, par value $0.01 per share		111,801,481
Class		Outstanding at August 7, 2006

Vertex Pharmaceuticals Incorporated

Form 10-Q

For the Quarter Ended June 30, 2006

Table of Contents

Part I. Financial Information
Item 1.	Condensed Consolidated Financial Statements (unaudited)	2
	Condensed Consolidated Balance Sheets—June 30, 2006 and December 31, 2005	2
	Condensed Consolidated Statements of Operations—Three and Six Months Ended June 30, 2006 and 2005	3
	Condensed Consolidated Statements of Cash Flows—Six Months Ended June 30, 2006 and 2005	4
	Notes to Condensed Consolidated Financial Statements	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36
Item 4.	Controls and Procedures	36
Part II. Other Information
Item 1A.	Risk Factors	38
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	39
Item 4.	Submission of Matters to a Vote of Security Holders	39
Item 6.	Exhibits	40
Signatures		41

Part I. Financial Information

Item 1. Condensed Consolidated Financial Statements

Vertex Pharmaceuticals Incorporated
Condensed Consolidated Balance Sheets
(Unaudited)
(In thousands, except share data)

	June 30, 2006			December 31, 2005
Assets
Current assets:
Cash and cash equivalents	$	41,430			$	78,045
Marketable securities, available for sale	220,911				283,112
Accounts receivable	183,668				20,595
Prepaid expenses	6,580				3,303
Total current assets	452,589				385,055
Marketable securities, available for sale	53,523				46,353
Restricted cash	41,482				41,482
Property and equipment, net	59,971				54,533
Investments	14,849				18,863
Other assets	3,064				2,712
Total assets	$	625,478			$	548,998
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	8,277			$	6,210
Accrued expenses and other current liabilities	46,480				42,061
Accrued interest	3,185				3,184
Deferred revenue	42,931				31,449
Accrued restructuring expense	7,862				14,351
Other obligations	—				2,988
Total current liabilities	108,735				100,243
Accrued restructuring expense, excluding current portion	28,416				28,631
Collaborator development loan	19,997				19,997
Deferred revenue, excluding current portion	133,239				851
Convertible subordinated notes (due September 2007)	42,102				42,102
Convertible senior subordinated notes (due February 2011)	117,993				117,998
Total liabilities	450,482				309,822
Commitments and contingencies:
Stockholders’ equity:
Preferred stock, $0.01 par value; 1,000,000 shares authorized; none issued and outstanding at June 30, 2006 and December 31, 2005, respectively	—				—
Common stock, $0.01 par value; 200,000,000 shares authorized; 110,600,314 and 108,153,149 shares issued and outstanding at June 30, 2006 and December 31, 2005, respectively	1,089				1,081
Additional paid-in capital	1,282,984				1,243,960
Deferred compensation, net	—				(13,408		)
Accumulated other comprehensive income (loss)	8,252				(2,873		)
Accumulated deficit	(1,117,329		)		(989,584		)
Total stockholders’ equity	174,996				239,176
Total liabilities and stockholders’ equity	$	625,478			$	548,998

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

Vertex Pharmaceuticals Incorporated
Condensed Consolidated Statements of Operations
(Unaudited)
(In thousands, except per share data)

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
Revenues:
Royalties	$	9,005		$	7,467		$	18,184		$	13,620
Collaborative and other research and development revenues	20,721			24,854			50,629			47,307
Total revenues	29,726			32,321			68,813			60,927
Costs and expenses:
Royalty payments	2,885			2,489			5,880			4,519
Research and development(1)	91,250			59,357			166,452			116,792
Sales, general and administrative(1)	14,370			10,814			27,249			20,441
Restructuring expense/(credit)	443			(1,743		)	1,210			171
Total costs and expenses	108,948			70,917			200,791			141,923
Loss from operations	(79,222		)	(38,596		)	(131,978		)	(80,996		)
Interest income	3,921			2,247			7,901			4,566
Interest expense	(2,357		)	(4,639		)	(4,714		)	(9,278		)
Loss from continuing operations before cumulative effect of a change in accounting principle	(77,658		)	(40,988		)	(128,791		)	(85,708		)
Cumulative effect of a change in accounting principle—FAS 123(R)*	—			—			1,046			—
Net loss	(77,658		)	$	(40,988	)	(127,745		)	$	(85,708	)
Basic and diluted net loss from continuing operations per common share	$	(0.72	)	$	(0.50	)	$	(1.19	)	$	(1.06	)
Basic and diluted cumulative effect of a change in accounting principle per common share	—			—			0.01			—
Basic and diluted net loss per common share	$	(0.72	)	$	(0.50	)	$	(1.18	)	$	(1.06	)
Basic and diluted weighted average number of common shares outstanding	108,523			82,274			107,985			80,859

(1) Includes the following stock-based compensation expense:

	Three Months Ended June 30,				Six Months Ended June 30,
	2006		2005		2006		2005
Research and development	$	9,755	$	927	$	16,161	$	1,764
Sales, general and administrative	1,892		202		3,611		396
Total	$	11,647	$	1,129	$	19,772	$	2,160

* The Company adopted Financial Accounting Standards Board Statement No. 123 (R), “Share-Based Payments”, using a modified prospective method. See Note 3 to the Condensed Consolidated Financial Statements, “Stock-based Compensation”, for further detail.

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

Vertex Pharmaceuticals Incorporated
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)

	Six Months Ended June 30,
	2006			2005
Cash flows from operating activities:
Net loss	$	(127,745	)	$	(85,708	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization	13,059			13,371
Non-cash stock-based compensation expense under FAS 123(R)	19,772			—
Other non-cash based compensation expense	1,793			3,651
Cumulative effect of a change in accounting principle	(1,046		)	—
Realized loss on marketable securities	—			53
Loss on disposal of property and equipment	2			272
Changes in operating assets and liabilities:
Accounts receivable	1,927			(2,050		)
Prepaid expenses	(3,277		)	(2,262		)
Accounts payable	2,067			2,769
Accrued expenses and other liabilities	1,591			(6,571		)
Accrued restructuring expense	(6,704		)	(12,030		)
Accrued interest	1			406
Deferred revenue	(21,130		)	(20,641		)
Net cash used in operating activities	(119,690		)	(108,740		)
Cash flows from investing activities:
Purchase of marketable securities	(93,370		)	(48,685		)
Sales and maturities of marketable securities	163,292			133,897
Expenditures for property and equipment	(18,232		)	(7,383		)
Restricted cash	—			840
Investments and other assets	(572		)	48
Net cash provided by investing activities	51,118			78,717
Cash flows from financing activities:
Issuances of common stock from employee benefit plans, net	31,927			4,715
Issuances of common stock from stock offering, net	—			165,331
Debt exchange costs	(218		)	—
Net cash provided by financing activities	31,709			170,046
Effect of changes in exchange rates on cash	248			(334		)
Net increase (decrease) in cash and cash equivalents	(36,615		)	139,689
Cash and cash equivalents—beginning of period	78,045			55,006
Cash and cash equivalents—end of period	41,430			$	194,695
Supplemental disclosure of cash flow information:
Cash paid for interest	$	4,445		$	8,341

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

Vertex Pharmaceuticals Incorporated

Notes to Condensed Consolidated Financial Statements

1. Basis of Presentation

The accompanying condensed consolidated financial statements are unaudited and have been prepared by Vertex Pharmaceuticals Incorporated (“Vertex” or the “Company”) in accordance with accounting principles generally accepted in the United States of America.

The condensed consolidated financial statements reflect the operations of the Company and its wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

Certain information and footnote disclosures normally included in the Company’s annual financial statements have been condensed or omitted. The interim financial statements, in the opinion of management, reflect all normal recurring adjustments (including accruals) necessary for a fair presentation of the financial position and results of operations for the interim periods ended June 30, 2006 and 2005.

The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the fiscal year, although the Company expects to incur a substantial loss for the year ending December 31, 2006. These interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2005, which are contained in the Company’s 2005 Annual Report on Form 10-K that was filed with the Securities and Exchange Commission on March 16, 2006.

2. Accounting Policies

Basic and Diluted Net Loss per Common Share

Basic net loss per share 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 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 of adding such shares is dilutive. Common equivalent 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), the assumed conversion of convertible notes and the vesting of unvested restricted shares of common stock. Common equivalent shares have not been included in the net loss per share calculations because the effect of including them would have been anti-dilutive. Total potential gross common equivalent shares consisted of the following (in thousands, except per share amounts):

	At June 30,
	2006		2005
Stock options	14,617		16,133
Weighted-average exercise price, per share	$	25.30	$	22.02
Convertible notes	8,354		16,454
Weighted-average conversion price, per share	$	19.16	$	19.15
Unvested restricted shares	1,739		1,598

Stock-based Compensation Expense

The Company adopted Financial Accounting Standards Board Statement No. 123(R), “Share-Based Payments” (“FAS 123(R)”), as of January 1, 2006. FAS 123(R) revises FAS Statement No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”), supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and amends FAS Statement No. 95, “Statement of Cash Flows.” FAS 123(R) requires companies to expense the fair value of employee stock options and other

forms of stock-based employee compensation over the employees’ service periods. Compensation cost is measured at the fair value of the award at the grant date and is adjusted to reflect actual forfeitures and the outcomes of certain conditions. See Note 3, below, for additional information regarding the Company’s stock-based compensation.

Research and Development

All research and development costs, including amounts funded by research collaborators, are expensed as incurred. Research and development expenses are comprised of costs incurred in performing research and development activities, including salaries and benefits; laboratory supplies; contract services, including clinical trial costs; and infrastructure costs, including facilities costs and depreciation. The Company’s collaborators have funded portions of the Company’s research and development programs related to specific drug candidates and research targets, including, in 2006, VX-950 (telaprevir), VX-702, VX-770, kinases, and certain cystic fibrosis research targets, and, in 2005, VX-950 (telaprevir), VX-702, kinases, and certain cystic fibrosis research targets.

The following table details the research and development expenses for collaborator-sponsored and Company-sponsored programs for the three months ended June 30, 2006 and 2005 (in thousands):

	For the Three Months Ended June 30, 2006							For the Three Months Ended June 30, 2005
	Research		Development			Total		Research		Development			Total
Collaborator-sponsored Programs	$	9,612		$	41,652	$	51,264	$	16,976		$	14,814	$	31,790
Company-sponsored Programs	26,809			13,177		39,986		12,836			14,731		27,567
Total	$	36,421		$	54,829	$	91,250	$	29,812		$	29,545	$	59,357

The total research and development expense for the three months ended June 30, 2006 and 2005 includes $9.8 million and $0.9 million, respectively, of stock-based compensation expense. The following table details the research and development expenses for collaborator-sponsored and Company-sponsored programs for the six months ended June 30, 2006 and 2005 (in thousands):

	For the Six Months Ended June 30, 2006							For the Six Months Ended June 30, 2005
	Research		Development			Total		Research		Development			Total
Collaborator-sponsored Programs	$	29,153		$	70,830	$	99,983	$	33,428		$	26,431	$	59,859
Company-sponsored Programs	43,540			22,929		66,469		26,386			30,547		56,933
Total	$	72,693		$	93,759	$	166,452	$	59,814		$	56,978	$	116,792

The total research and development expense for the six months ended June 30, 2006 and 2005 includes $16.2 million and $1.8 million, respectively, of stock-based compensation expense.

Restructuring Expense

The Company records costs and liabilities associated with exit and disposal activities, as defined in Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“FAS 146”), at fair value in the period the liability is incurred. In periods subsequent to initial measurement, changes to the liability are measured using the credit-adjusted risk-free discount rate applied in the initial period.

Revenue Recognition

The Company recognizes revenue in accordance with the Securities and Exchange Commission’s (“SEC”) Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”), as amended by SEC Staff Accounting Bulletin No. 104, “Revenue Recognition” (“SAB 104”), and for revenue arrangements entered into after June 30, 2003, Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”).

The Company’s revenues are generated primarily through collaborative research, development and commercialization agreements. The terms of the agreements typically include payment to Vertex of non-refundable up-front license fees, funding of research and development efforts, milestone payments and/or royalties on product sales.

Agreements containing multiple elements are divided into separate units of accounting if certain criteria are met, including whether the delivered element has stand-alone value to the collaborator and whether there is objective and reliable evidence of fair value of the undelivered obligation(s). The consideration received is allocated among the separate units based on each unit’s fair value or using the residual method, and the applicable revenue recognition criteria are applied to each of the separate units.

The Company recognizes revenues from non-refundable, up-front license fees on a straight-line basis over the contracted or estimated period of performance, which is typically the research or development term. Research and development funding is recognized as earned, ratably over the period of effort.

Substantive milestones realized in collaboration arrangements are recognized as earned when the corresponding payment is reasonably assured, subject to the following policies in those circumstances where the Company has obligations remaining after achievement of the milestone:

· In those circumstances where collection of a substantive milestone is reasonably assured, the Company has remaining obligations to perform under the collaboration arrangement and the Company does not have sufficient evidence of fair value for its remaining obligations, management considers the milestone payment and the remaining obligations on the contract as a single unit of accounting. In those circumstances where the collaboration does not require specific deliverables at specific times or at the end of the contract term, but rather the Company’s obligations are satisfied over a period of time, substantive milestones are recognized over the period of performance. This typically results in a portion of the milestone payment being recognized as revenue on the date the milestone is achieved equal to the applicable percentage of the performance period that has elapsed as of the date the milestone is achieved, with the balance being deferred and recognized over the remaining period of performance.

The Company evaluates whether milestones are substantive at the inception of the agreement based on the contingent nature of the milestone, specifically reviewing factors such as the technological risk that must be overcome as well as the level of effort and investment required to achieve the milestone. Milestones that are not considered substantive and do not meet the separation criteria are accounted for as license payments and recognized on a straight-line basis over the remaining period of performance.

Payments received after performance obligations are met completely are recognized when earned.

Royalty revenue is recognized based upon actual and estimated net sales of licensed products in licensed territories as provided by the licensee, and is recognized in the period the sales occur. Differences between actual royalty revenues and estimated royalty revenues, which have not historically been significant, are reconciled and adjusted for in the quarter they become known.

3. Stock-based Compensation

At June 30, 2006, the Company had four stock-based employee compensation plans: the 1991 Stock Option Plan (the “1991 Plan”), the 1994 Stock and Option Plan (the “1994 Plan”), the 1996 Stock and Option Plan (the “1996 Plan”) and the 2006 Stock and Option Plan (the “2006 Plan”, and together with the 1991 Plan, the 1994 Plan, and the 1996 Plan, collectively, the “Stock and Option Plans”), and one Employee Stock Purchase Plan (the “ESPP”). Pursuant to the Stock and Option Plans, the Company may issue restricted stock and options to its directors, employees and consultants for services. Each option granted under the Stock and Option Plans has an exercise price equal to the market value of the underlying common stock on the date of grant. The price per share of restricted stock granted to employees is equal to $0.01, the par value of the Company’s common stock. Vesting of options and restricted stock is ratable over specified periods, generally four or five years, and is determined by the Management Development and Compensation Committee of the Company’s Board of Directors. All options awarded under the Stock and Option Plans expire not more than ten years from the grant date. Pursuant to the ESPP, participating employees may periodically purchase shares of the Company’s common stock at a discount to the fair value of the stock on specified measurement dates, using funds withheld from their compensation over specified offering terms.

The Company reserved an aggregate of 8,000,000 shares under the 1991 Plan and 1994 Plan. The Company reserved 22,000,000 shares under the 1996 Plan and 7,302,380 shares under the 2006 Plan. At June 30, 2006, the Company had approximately 7,105,000 shares of common stock available for grants under the 2006 Plan, and no shares were available for grants under the 1991 Plan, the 1994 Plan or the 1996 Plan. As of June 30, 2006, approximately 621,000 shares remained available for future purchases under the ESPP.

On January 1, 2006, Vertex adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payments” (“FAS 123(R)”), using the modified prospective method, pursuant to which the Company applies the provisions of FAS 123(R) to its consolidated financial statements on a going-forward basis. The modified prospective transition method requires the application of the accounting standard as of January 1, 2006, the first day of Vertex’s fiscal year 2006. Prior periods have not been restated. FAS 123(R) requires companies to recognize share-based payments to employees as compensation expense using the “fair value” method. Under the fair value recognition provisions of FAS 123(R), stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the service period, which generally is the vesting period of the award. The fair value of stock options and shares purchased pursuant to the ESPP is calculated using the Black-Scholes valuation model. The fair value of restricted stock is based on intrinsic value. The expense recognized over the service period includes an estimate of awards that will be forfeited. Prior to adoption of FAS 123(R), Vertex recorded the impact of forfeitures as they occurred. In connection with the adoption of FAS 123(R) during the first half of fiscal year 2006, Vertex recorded a $1.0 million benefit from the cumulative effect of changing from recording forfeitures related to restricted stock awards as they occurred to estimating forfeitures during the service period.

Stock-based compensation expense recognized during the first half of 2006 includes: (a) ESPP awards with offering periods commencing May 15, 2005 and November 15, 2005, based on the grant-date fair value estimated in accordance with the provisions of FAS 123, (b) stock options and restricted awards granted prior to, but not yet vested as of December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of FAS 123, and (c) stock options and restricted stock awards granted after

December 31, 2005, based on the grant-date fair value and ESPP awards with the offering period commencing May 15, 2006, in accordance with the provisions of FAS 123(R). These amounts reflect estimated forfeitures of those awards.

The estimated fair value of Vertex’s stock-based awards, less estimated forfeitures, is amortized over the awards’ service periods on a ratable basis. No equity compensation cost was capitalized during the first half of 2006.

The effect of recording stock-based compensation for the three and six months ended June 30, 2006 was as follows (in thousands):

	Three Months Ended June 30, 2006			Six Months Ended June 30, 2006
Stock-based compensation expense by type of award:
Stock options		$	9,804		$	15,402
Restricted shares		1,412			3,139
ESPP		431			1,231
Total stock-based compensation		$	11,647		$	19,772
Effect of stock-based compensation on income by line item:
Research and development		$	9,755		$	16,161
Sales, general and administrative		1,892			3,611
Total stock-based compensation		$	11,647		$	19,772
Cumulative effect of a change in accounting principle—FAS 123(R)		—			$	(1,046	)
Net stock-based compensation expense included in net loss		$	11,647		$	18,726

As a result of the adoption of FAS 123(R):

· the Company’s net loss from continuing operations for the three and six months ended June 30, 2006 is greater by $10.3 million and $16.1 million, respectively;

· the Company’s net loss for the three and six months ended June 30, 2006 is greater by $10.3 million and $15.1 million, respectively; and

· basic and diluted loss per share for the three and six months ended June 30, 2006 is greater by $0.10 and $0.14, respectively.

Options

The Company uses the Black-Scholes valuation model to estimate the fair value of stock options at the grant date. The Black-Scholes valuation model requires the Company to make certain estimates and assumptions, including assumptions related to the expected price volatility of the Company’s stock, the period during which the options are outstanding, the rate of return of risk free investments, and the expected dividend yield for the Company’s stock. The Company validates its estimates and assumptions through consultations with independent third parties having relevant expertise.

The fair values of options granted during the three and six months ended June 30, 2006 were calculated using the following weighted-average assumptions:

	For the Three Months Ended June 30, 2006			For the Six Months Ended June 30, 2006
Expected stock price volatility		57.92	%		57.26	%
Expected term of options		5.64	years		5.64	years
Risk free interest rate		5.04	%		4.61	%
Expected annual dividends		—			—

The weighted-average valuation assumptions were determined as follows:

· Expected stock price volatility: In 2006, the Company changed its method of estimating expected volatility from relying exclusively on historical volatility to relying exclusively on implied volatility. Options to purchase the Company’s stock with remaining terms of greater than a year are regularly traded in the market. Expected stock price volatility is calculated using the trailing one month average of daily implied volatilities prior to grant date.

· Expected term of options: The expected term of options represents the period of time options are expected to be outstanding. The Company used historical data to estimate employee exercise and post-vest termination behavior. The Company believes that all groups of employees exhibit similar exercise and post-vest termination behavior and therefore does not stratify employees into multiple groups.

· Risk-free interest rate: The Company bases the risk-free interest rate on U.S. Treasury securities in effect at the time of grant for a period that is commensurate with the expected term assumption.

· Expected annual dividends: The estimate for annual dividends is $0.00, because the Company has not historically and does not intend for the foreseeable future to pay a dividend.

The following table summarizes information related to the outstanding and vested options during the six months ended June 30, 2006:

	Stock Options (in thousands)			Weighted-average exercise price			Weighted-average remaining contractual life (in years)		Aggregate intrinsic value (in thousands)
Outstanding at December 31, 2005		14,669			$	22.84
Granted		2,060			$	35.36
Exercised		(1,801	)		$	16.11
Forfeited		(221	)		$	16.64
Expired		(90	)		$	61.19
Outstanding at June 30, 2006		14,617			$	25.30		6.09		$	210,492
Exercisable at June 30, 2006		9,669			$	27.08		4.92		$	142,620
Exercisable and expected to vest		13,972			$	25.36		5.97		$	203,022

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value, based on the average of the high and low price of the Company’s common stock of $35.44 on June 30, 2006, which would have been received by option holders if all option holders had exercised their options on that date.

All options granted during the three and six months ended June 30, 2006 and 2005 were granted with exercise prices equal to the fair market value of the Company’s common stock on the date of grant and had weighted-average grant date fair values of $19.83 and $6.35 for the three months, respectively and $20.01 and $5.38 for the six months, respectively.

The total intrinsic value of options exercised during the three months ended June 30, 2006 and 2005 was $9.8 million and $0.9 million, respectively. The total cash received from employees as a result of employee stock option exercises during the three months ended June 30, 2006 and 2005 was approximately $6.7 million and $2.2 million, respectively. The total intrinsic value of options exercised during the six months ended June 30, 2006 and 2005 was $36.3 million and $1.0 million, respectively. The total cash received from employees as a result of employee stock option exercises during the six months ended June 30, 2006 and 2005 was approximately $29.0 million and $2.8 million, respectively.

The Company settles employee stock option exercises with newly issued common shares.

As of June 30, 2006, there was $47.1 million of total unrecognized compensation cost, net of estimated forfeitures, related to unvested options granted under the Stock and Option Plans. That cost is expected to be recognized over a weighted-average period of 2.64 years.

Restricted Stock

The following table summarizes the restricted stock activity of the Company during the six months ended June 30, 2006:

	Restricted Stock			Weighted Average Grant Date Fair Value
	(Shares in thousands)			(per Share)
Outstanding at December 31, 2005		1,521			$	11.02
Granted		414			$	35.38
Vested		(155	)		$	10.09
Cancelled		(41	)		$	17.68
Outstanding at June 30, 2006		1,739			$	16.75

The total fair value of the shares vesting during the three months ended June 30, 2006 and 2005 (measured on the date of vesting) was $0.5 million and $0.9 million, respectively. The total fair value of the shares vesting during the six months ended June 30, 2006 and 2005 (measured on the date of vesting) was $5.8 million and $1.3 million, respectively.

As of June 30, 2006, there was $17.2 million of total unrecognized compensation expense, net of estimated forfeitures, related to unvested restricted stock granted under the Stock and Option Plans. That cost is expected to be recognized over a weighted-average period of 2.94 years.

ESPP

Vertex adopted the ESPP on July 1, 1992. The ESPP permits eligible employees to enroll in a twelve-month offering period comprising two six-month purchase periods. Participants may purchase shares of the Company’s common stock, through payroll deductions, at a price equal to 85% of the fair market value of the common stock on the first day of the applicable twelve-month offering period, or the last day of the applicable six-month purchase period, whichever is lower. Purchase dates under the ESPP occur on May 14 and November 14 of each year.

During the first half of 2006, the following shares were issued to employees under ESPP (shares in thousands):

The total stock-based compensation expense related to the ESPP for the three and six months ended June 30, 2006 is $0.4 million and $1.2 million, respectively. The following table reflects the weighted average assumptions used in the Black-Scholes valuation model for the ESPP at June 30, 2006:

Expected stock price volatility		57.99%
Expected term		0.87 years
Risk-free interest rate		4.07%
Expected annual dividends		—

The weighted-average fair value of each purchase right granted during the first half of 2006 and 2005 was $11.85 and $4.60, respectively.

The expected stock price volatility for ESPP offerings beginning before the fourth quarter of 2005 is based on historical volatility, while the volatility for offerings beginning in the fourth quarter of 2005 and the second quarter of 2006 is based on implied volatility. The expected term represents purchases and purchase periods that take place within the offering period. The Company bases the risk free interest rate on U.S. Treasury securities in effect at the time of grant for a period that is commensurate with the expected term assumption. The Company has not historically and does not intend for the foreseeable future to pay a dividend and therefore the estimate is zero.

Prior to the adoption of FAS 123(R)

In accordance with Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation, Transition and Disclosure,” for periods prior to January 1, 2006, the Company adopted the disclosure-only provisions of FAS 123 and also applied APB 25 and related interpretations in accounting for all stock awards granted to employees. Under APB 25, provided that other criteria were met, when the exercise price of stock options granted to employees equaled the market price of the common stock on the date of the grant, no compensation expense was recognized. Additionally, under APB 25, the Company was not required to record compensation expense for the cost of options or shares issued under the ESPP. Accordingly, no expense related to options or ESPP shares was recorded prior to January 1, 2006.

Prior to January 1, 2006, the Company recorded stock-based compensation expense related to restricted stock awards over the related vesting period for an amount equal to the difference between the price per share of restricted stock issued and the fair value of the Company’s common stock at the date of grant or issuance. Prior to January 1, 2006, the Company recorded forfeitures as they occurred.

The following table illustrates the effect on net loss and net loss per share for the three and six months ended June 30, 2005 if the fair value recognition provisions of FAS 123 had been applied to the Company’s stock-based employee compensation. Employee stock-based compensation expense was amortized on a straight-line basis, because the Company’s valuation of options subject to FAS 123 assumed a single weighted-average expected life for each award. Included in employee stock-based compensation expense for the three and six months ended June 30, 2005 is expense related to the modification of certain stock awards in accordance with an officer’s severance agreement.

	For the Three Months Ended June 30, 2005				For the Six Months Ended June 30, 2005
	(in thousands, except per share data)
Net loss attributable to common stockholders, as reported		$	(40,988	)		$	(85,708	)
Add: Employee stock-based compensation expense included in net loss, net of tax		1,129				2,160
Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of tax		(10,554		)		(21,284		)
Pro forma net loss		$	(50,413	)		$	(104,832	)
Basic and diluted net loss per common share, as reported		$	(0.50	)		$	(1.06	)
Basic and diluted net loss per common share, pro forma		$	(0.61	)		$	(1.30	)

The fair value of each option granted during the three and six months ended June 30, 2005 was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

	For the Three Months ended June 30, 2005			For the Six Months ended June 30, 2005
Expected stock price volatility		60.00	%		60.00	%
Risk free interest rate		3.77	%		3.60	%
Expected term of options		4.00	years		4.13	years
Expected annual dividends		—			—

The fair value of each ESPP purchase right outstanding during the three and six months ended June 30, 2005 was estimated on the date of subscription using the Black-Scholes option pricing model with the following weighted-average assumptions:

Expected stock price volatility	60.00	%
Risk free interest rate	2.63	%
Expected term of options	0.82	years
Expected annual dividends	—

4. Comprehensive Loss

For the three and six months ended June 30, 2006 and 2005, comprehensive loss was as follows (in thousands):

	Three Months Ended June 30,						Six Months Ended June 30,
	2006			2005			2006			2005
Net loss	$	(77,658	)	$	(40,988	)	$	(127,745	)	$	(85,708	)
Changes in other comprehensive loss:
Unrealized holding gains (losses) on marketable securities	(2,849		)	999			10,877			(138		)
Foreign currency translation adjustment	206			(252		)	248			(334		)
Total change in other comprehensive loss	(2,643		)	747			11,125			(472		)
Total comprehensive loss	$	(80,301	)	$	(40,241	)	$	(116,620	)	$	(86,180	)

5. Restructuring Expense

On June 10, 2003, Vertex adopted a plan to restructure its operations to coincide with its increasing internal emphasis on advancing drug candidates through clinical development to commercialization. The restructuring was designed to re-balance the Company’s relative investments in research and development. The restructuring plan included a workforce reduction, write-offs of certain assets and a decision not to occupy approximately 290,000 square feet of specialized laboratory and office space in Cambridge, Massachusetts under lease to Vertex (the “Kendall Square lease”). The Kendall Square lease commenced in January 2003 and has a 15-year term. In the second quarter of 2005, the Company revised its assessment of its real estate requirements. The Company now plans to occupy approximately 120,000 square feet of the facility subject to the Kendall Square lease (the “Kendall Square Facility”) beginning in 2006. As of June 30, 2006, the Company had begun occupying a portion of the building. The remaining rentable square footage of the Kendall Square Facility currently is subleased to third parties.

For the three months ended June 30, 2006, the Company recorded approximately $0.4 million of restructuring expense, which was attributable to the imputed interest cost relating to the restructuring accrual. The activity related to the restructuring accrual and related expense for the three months ended June 30, 2006 is as follows (in thousands):

Cash

payments,

Cash received

Charge,

Accrual as of

second

from subleases,

second

Accrual as of

March 31,

quarter

second quarter

quarter

June 30,

2006

Lease restructuring expense

41,719

(7,904

)

2,020

443

36,278

For the six months ended June 30, 2006, the Company recorded approximately $1.2 million of restructuring expense, which was primarily attributable to the imputed interest cost relating to the restructuring accrual. The activity related to the restructuring accrual and related expense for the six months ended June 30, 2006 is as follows (in thousands):

Cash

Cash received

Charge,

payments,

from subleases,

six months

Accrual as

Accrual as of

six months

ended

December 31,

ended June 30,

June 30,

2005

2006

Lease restructuring expense

42,982

(11,884

)

3,970

1,210

36,278

During the three months ended June 30, 2005, the Company recorded a restructuring net credit of approximately $1.7 million. This net credit resulted from adjusting the portion of the restructuring accrual for the portion of the Kendall Square Facility that Vertex expects to occupy, which is partially offset by (i) a charge in the amount of the estimated incremental ongoing lease obligations associated with the portion of the Kendall Square Facility that the Company does not intend to occupy and (ii) imputed interest costs relating to the restructuring liability. The activity related to the restructuring accrual for the three months ended June 30, 2005 is as follows (in thousands):

Portion of

Cash

facility

Payments,

Cash received

Vertex expects

Charge,

Accrual as of

second

from sublease,

to occupy,

second

March 31,

quarter

second quarter

second

quarter

Accrual as of

2005

quarter 2005

2005

June 30, 2005

Lease restructuring expense

52,305

(7,242

)

493

(10,018

)

8,275

43,813

The activity related to the restructuring accrual for the six months ended June 30, 2005 is as follows (in thousands):

Cash

Portion of

Payments,

Cash received

facility

Charge,

six months

from sublease,

Vertex expects

Six months

Accrual as of

ended

six months ended

to occupy,

ended

December 31,

June 30,

six months ended

June 30,

Accrual as of

2004

2005

June 30, 2005

2005

June 30, 2005

Lease restructuring expense

55,843

(13,017

)

816

(10,018

)

10,189

43,813

In accordance with FAS 146, the Company’s initial estimate of its liability for its net ongoing costs associated with the Kendall Square lease obligation was recorded in the second quarter of 2003 at fair value. The restructuring expense incurred from the second quarter of 2003 through the end of the first quarter of 2005 (i.e., immediately prior to the Company’s decision to utilize a portion of the Kendall Square Facility for its operations) relates to the estimated incremental net ongoing lease obligations associated with the entire Kendall Square Facility, together with imputed interest costs relating to the restructuring liability. The restructuring expense incurred in the period beginning in the second quarter of 2005 continues to be estimated in accordance with FAS 146, but relates only to the portion of the building that the Company does not intend to occupy for its operations. The remaining lease obligations, which are associated with the portion of the Kendall Square Facility that the Company expects to occupy and use for its operations, are recorded as rental expense in the period incurred. The Company reviews its assumptions and estimates quarterly and updates its estimates of this liability as changes in circumstances require. As required by FAS 146, the expense and liability recorded is calculated using probability-weighted discounted cash-flows of the Company’s estimated ongoing lease obligations, including contractual rental and build-out commitments, net of estimated sublease rentals, offset by related sublease costs.

In estimating the expense and liability under its Kendall Square lease obligation, the Company estimated (i) the costs to be incurred to satisfy its rental and build-out commitments under the lease (including operating costs), (ii) the time necessary to sublease the space, (iii) the projected sublease rental rates, and (iv) the anticipated durations of subleases. The Company validates its estimates and assumptions through consultations with independent third parties having relevant expertise. The Company used a credit-adjusted risk-free rate of approximately 10% to discount the estimated cash flows. The Company will review its estimates and assumptions on at least a quarterly basis, until the termination of the Kendall Square lease, and will make whatever modifications management believes necessary, based on the Company’s best judgment, to reflect any changed circumstances. The Company’s estimates have changed in the past, and may change in the future, resulting in additional adjustments to the estimate of liability,

and the effect of any such adjustments could be material. Because the Company’s estimate of the liability includes the application of a discount rate to reflect the time-value of money, the estimate of the liability will increase each quarter simply as a result of the passage of time. Changes to the Company’s estimate of the liability are recorded as additional restructuring expense/(credit).

6. Altus Investment

Altus Pharmaceuticals, Inc. completed the initial public offering of its common stock in January 2006. At June 30, 2006 the Company owned 817,749 shares of Altus common stock and warrants to purchase 1,962,494 shares of Altus common stock. In addition, Vertex holds 450,000 shares of Altus redeemable preferred stock, which are not convertible into common stock and which are redeemable at the Company’s option on or after December 31, 2010, or by Altus at any time. The Company was restricted from trading Altus securities for a period of six months following the initial public offering.

As a result of the public offering, at June 30, 2006, Altus common stock was classified as an available-for-sale investment and recorded at fair value, based on quoted market prices. Unrealized gains and losses on the Altus common stock are included as a component of accumulated other comprehensive income, which is a separate component of stockholders’ equity, until such gains and losses are realized. At June 30, 2006, the fair market value of the Altus common stock investment was $15.1 million, with a cost basis of $4.0 million. In July 2006, the Company sold the 817,749 shares of Altus common stock for approximately $11.7 million, resulting in a realized gain of approximately $7.7 million to be recognized in the third quarter of 2006.

The Company will continue to account for the Altus warrants under the cost method of accounting until the end of the lock-up period, at which time the warrants will be classified as derivatives. Gains or losses on the fair market value of the warrants, as derivatives, will be included in the consolidated statements of operations. Vertex will continue to account for the redeemable preferred stock under the cost method of accounting.

The Company continues to assess the Altus warrants and redeemable preferred stock on a quarterly basis to determine if there has been any estimated decrease in the fair value of that investment below the carrying value that might require Vertex to write down its cost basis of the investment. If any adjustment to the fair value of an investment reflects a decline in the value of that investment below its cost, the Company will consider the available evidence, including the duration and extent to which the decline is other-than-temporary. If the decline is considered other-than-temporary, the cost basis of the investment will be written down to fair value as a new cost basis, and the amount of the write-down will be included in the consolidated statements of operations. Vertex has not identified facts or circumstances which would cause the Company to determine that the investment basis of its interest in Altus should be changed.

7. Convertible Subordinated Notes

At June 30, 2006, the Company had approximately $42.1 million in aggregate principal amount of 5% Convertible Subordinated Notes due in September 2007 (“2007 Notes”) and approximately $118.0 million in aggregate principal amount of 5.75% Convertible Senior Subordinated Notes due in February 2011 (the “2011 Notes”) outstanding. The 2007 Notes are convertible, at the option of the holder, into common stock at a price equal to $92.26 per share, subject to adjustment under certain circumstances. The 2007 Notes bear interest at the rate of 5% per annum, and the Company is required to make semi-annual interest payments on the outstanding principal balance of the 2007 Notes on March 19 and September 19 of each year. The 2007 Notes are redeemable by the Company at any time at specific redemption prices if the closing price of the Company’s common stock exceeds 120% of the conversion price for at least 20 trading days within a period of 30 consecutive trading days. The 2011 Notes are convertible, at the option of the holder, into common stock at a price equal to $14.94 per share, subject to adjustment under certain

circumstances. The 2011 Notes bear interest at the rate of 5.75% per annum, and the Company is required to make semi-annual interest payments on the outstanding principal balance of the 2011 Notes on February 15 and August 15 of each year. On or after February 15, 2007, the Company may redeem the 2011 Notes at a redemption price equal to the principal amount plus accrued and unpaid interest, if any.

In August 2006, the Company agreed to exchange approximately 4.1 million shares of newly issued common stock for $58.3 million in aggregate principal amount of outstanding 2011 Notes plus all accrued and unpaid interest thereon. As a result of these exchanges, the Company expects to incur a non-cash charge of approximately $5.0 million in the third quarter of 2006. This charge is related to the incremental shares issued in the transaction over the number that would have been issued upon the conversion of the notes under the original conversion terms.

8. Significant Revenue Arrangements

Janssen Pharmaceutica, N.V.

In June 2006, the Company entered into a collaboration agreement with Janssen Pharmaceutica, N.V. for the development, manufacture and commercialization of VX-950 (telaprevir), the Company’s HCV protease inhibitor currently in Phase IIb clinical trials. Under the agreement, Janssen will fund 50% of the costs incurred in developing VX-950 (telaprevir) in the parties’ territories (North America for the Company, and the rest of the world, other than the Far East, for Janssen) and has exclusive rights to commercialize VX-950 (telaprevir) in Europe, South America, the Middle East, Africa and Australia. The agreement provides for Janssen to make a $165 million up-front license payment to the Company, which was included in accounts receivable and deferred revenue at June 30, 2006 and subsequently paid to the Company in July 2006. Janssen has further agreed to make additional contingent milestone payments totaling up to $380 million based on the successful development, approval and launch of VX-950 (telaprevir). The agreement also provides the Company with royalties on any sales of VX-950 (telaprevir) in the Janssen territory, with a tiered royalty structure having a royalty rate averaging in the mid-20% range and provides that Janssen will contribute to the manufacture of VX-950 (telaprevir). Janssen may terminate the agreement without cause at any time upon six months’ notice to the Company. There has been no revenue recognized related to the agreement in the first half of 2006.

Merck & Co.

On June 26, 2006, the Company agreed with Merck & Co., Inc. to extend the research program term and corresponding research funding for the parties’ ongoing research collaboration for three months beyond the original termination date of June 21, 2006. The research program term will now extend until September 21, 2006. For the three and six months ended June 30, 2006, the Company recognized $9.1 million and $28.2 million, respectively, in revenue related to its agreement with Merck, which amounts include both research funding and upfront and product candidate development milestone payments.

Cystic Fibrosis Foundation

In January 2006, Vertex amended its research collaboration agreement with Cystic Fibrosis Foundation Therapeutics Incorporated (“CFFT”) to extend the term during which CFFT is providing funding for research of cystic fibrosis transmembrane regulator (“CFTR”) protein “corrector” compounds through the first quarter of 2008. In March 2006, Vertex and CFFT further amended the agreement to include development stage funding from CFFT for the purpose of accelerating the clinical development of VX-770, a CFTR “potentiator” compound. The agreement, as amended, provides that CFFT will pay up to $13.3 million to Vertex for specified VX-770 development activities through the end of 2007. Under the amended agreements, Vertex retains the right to develop and commercialize VX-770 and any other compounds discovered in the research collaboration, and will pay royalties to CFFT upon the approval and

commercialization of any compounds discovered under the collaboration. For the three and six months ended June 30, 2006, Vertex recognized $2.8 million and $5.2 million, respectively, in revenue related to its agreement with CFFT.

9. Guarantees

As permitted under Massachusetts law, Vertex’s Articles of Organization and Bylaws provide that the Company will indemnify certain of its officers and directors for certain claims asserted against them in connection with their service as an officer or director. The maximum potential amount of future payments that the Company could be required to make under these indemnification provisions is unlimited. However, the Company has purchased certain directors’ and officers’ liability insurance policies that reduce its monetary exposure and enable it to recover a portion of any future amounts paid. The Company believes the estimated fair value of these indemnification arrangements is minimal.

Vertex customarily agrees in the ordinary course of its business to indemnification provisions in agreements with clinical trials investigators and sites in its drug development programs, in sponsored research agreements with academic and not-for-profit institutions, in various comparable agreements involving parties performing services for the Company in the ordinary course of business, and in its real estate leases. The Company also customarily agrees to certain indemnification provisions in its drug discovery and development and/or commercialization collaboration agreements. With respect to the Company’s clinical trials and sponsored research agreements, these indemnification provisions typically apply to any claim asserted against the investigator or the investigator’s institution relating to personal injury or property damage, violations of law or certain breaches of the Company’s contractual obligations arising out of the research or clinical testing of the Company’s compounds or drug candidates. With respect to lease agreements, the indemnification provisions typically apply to claims asserted against the landlord relating to personal injury or property damage caused by the Company, to violations of law by the Company or to certain breaches of the Company’s contractual obligations. The indemnification provisions appearing in the Company’s collaboration agreements are similar, but in addition provide some limited indemnification for its collaborator in the event of third party claims alleging infringement of intellectual property rights. In each of the cases above, the indemnification obligation generally survives the termination of the agreement for some extended period, although the obligation typically has the most relevance during the contract term and for a short period of time thereafter. The maximum potential amount of future payments that the Company could be required to make under these provisions is generally unlimited. The Company has purchased insurance policies covering personal injury, property damage and general liability that reduce its exposure for indemnification and would enable it in many cases to recover a portion of any future amounts paid. The Company has never paid any material amounts to defend lawsuits or settle claims related to these indemnification provisions. Accordingly, the Company believes the estimated fair value of these indemnification arrangements is minimal.

Effective on March 28, 2003, the Company sold certain assets of PanVera LLC to Invitrogen Corporation for approximately $97 million. The agreement with Invitrogen requires the Company to indemnify Invitrogen against any loss it may suffer by reason of Vertex’s breach of certain representations and warranties, or failure to perform certain covenants, contained in the agreement. The representations, warranties and covenants are of a type customary in agreements of this sort. The Company’s aggregate obligations under the indemnity are, with a few exceptions that the Company believes are not material, capped at one-half of the purchase price, and apply to claims under representations and warranties made within fifteen months after closing (which period has ended), although there is no corresponding time limit for claims made based on breaches of covenants. Invitrogen has made no claims to date under this indemnity, and the Company believes that the estimated fair value of the remaining indemnification obligation is minimal.

Effective on December 3, 2003, the Company sold certain instrumentation assets to Aurora Discovery, Inc. for approximately $4.3 million. The agreement with Aurora requires the Company to indemnify Aurora against any loss it may suffer by reason of the Company’s breach of certain representations and warranties, or failure to perform certain covenants, contained in the agreement. The representations, warranties and covenants are of a type customary in agreements of this sort. The Company’s aggregate obligations under the indemnity are capped at one-half of the purchase price, and apply to claims under representations and warranties made within fifteen months after closing (which period has ended), although there is no corresponding time limit for claims made based on breaches of covenants. Aurora has made no claims to date under this indemnity, and the Company believes that the estimated fair value of the remaining indemnification obligation is minimal.

On February 10, 2004, Vertex entered into a Dealer Manager Agreement with UBS Securities LLC in connection with the exchange of approximately $153.1 million of 2011 Notes for approximately $153.1 million of 2007 Notes. On September 13, 2004, the Company entered into a second Dealer Manager Agreement with UBS Securities in connection with the exchange of approximately $79.3 million of 2011 Notes for approximately $79.3 million of 2007 Notes. Each of the Dealer Manager Agreements requires the Company to indemnify UBS Securities against any loss UBS Securities may suffer by reason of the Company’s breach of representations and warranties relating to the exchanges of the convertible notes, the Company’s failure to perform certain covenants in those agreements, the inclusion of any untrue statement of material fact in the materials provided to potential investors in the 2011 Notes, the omission of any material fact needed to make those materials not misleading, and any actions taken by the Company or its representatives in connection with the exchanges. The representations, warranties and covenants in the Dealer Manager Agreements are of a type customary in agreements of this sort. The Company believes the estimated fair value of these indemnification obligations is minimal.

On June 7, 2005, the Company entered into a Purchase Agreement with Merrill Lynch, Pierce, Fenner & Smith Incorporated, as the representative of the several underwriters named therein, relating to the Company’s 2005 public offering of common stock. The Purchase Agreement requires the Company to indemnify the underwriters against any loss they may suffer by reason of the Company’s breach of representations and warranties relating to that public offering, the Company’s failure to perform certain covenants in those agreements, the inclusion of any untrue statement of material fact in the prospectus used in connection with that offering, the omission of any material fact needed to make those materials not misleading, and any actions taken by the Company or its representatives in connection with the offering. The representations, warranties and covenants in the Purchase Agreement are of a type customary in agreements of this sort. The Company believes the estimated fair value of these indemnification obligations is minimal.

10. Contingencies

The Company has certain contingent liabilities that arise in the ordinary course of its business activities. The Company accrues contingent liabilities when it is probable that future expenditures will be made and such expenditures can be reasonably estimated.

On December 17, 2003, a purported class action, Marguerite Sacchetti v. James C. Blair et al., was filed in the Superior Court of the State of California, County of San Diego, naming as defendants all of the directors of Aurora who approved the merger of Aurora and Vertex, which closed in July 2001. The plaintiffs claim that Aurora’s directors breached their fiduciary duty to Aurora by, among other things, negligently conducting a due diligence examination of Vertex by failing to discover alleged problems with VX-745, a Vertex drug candidate that was the subject of a development program which was terminated by Vertex in September 2001. Vertex has certain indemnity obligations to Aurora’s directors under the terms of the merger agreement between Vertex and Aurora. This case was dismissed with prejudice in the first

quarter of 2006 in connection with a settlement that resulted in payment to the plaintiff by the defendants’ directors’ and officers’ liability insurer of under $200,000.

11. New Accounting Pronouncements

In May 2005, the FASB issued FAS No. 154, “Accounting Changes and Error Corrections” (“FAS 154”). FAS No. 154 replaced APB Opinion No. 20, “Accounting Changes”, and FAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” FAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impractible to determine either the period-specific effects or the cumulative effect of the change. The Company adopted FAS 154 beginning on January 1, 2006; its adoption did not have a material impact on the Company’s consolidated financial statements.

In November 2005, FASB issued FSP FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP FAS 115-1”), which provides guidance for determining when investments in certain debt and equity securities are considered impaired, whether an impairment is other-than-temporary, and on measuring such impairment loss. FSP FAS 115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP FAS 115-1 is required to be applied to reporting periods beginning after December 15, 2005. The Company adopted FSP FAS 115-1 in the first quarter of 2006. Adoption of FSP FAS 115-1 did not have a material impact on the Company’s consolidated results of operations or financial condition.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are a biotechnology company in the business of discovering, developing and commercializing small molecule drugs for the treatment of serious diseases. We have built a drug discovery capability that integrates biology, chemistry, biophysics, automation and information technologies, with a goal of making the drug discovery process more efficient and productive. Currently, a Vertex-discovered compound for the treatment of HIV infection, fosamprenavir calcium (marketed as Lexiva in the United States and Telzir in Europe), is being marketed by our collaborator GlaxoSmithKline. We have a number of drug candidates in development and a broad-based discovery effort.

We are concentrating most of our drug development resources at the present time on three compounds in specific markets: VX-950 (telaprevir) for the treatment of hepatitis C virus (HCV) infection in North America, VX-702 for the treatment of rheumatoid arthritis (RA) in North America and Europe and VX-770 for the treatment of cystic fibrosis (CF) worldwide. We rely on collaborators for (i) financial support for certain drug development programs and (ii) to conduct all or a portion of the development, manufacturing and commercialization activities for certain of our other drug candidates, either worldwide or in the markets upon which we are not currently focused.

Drug Discovery and Development

Discovery and development of a new pharmaceutical product is a lengthy and resource-intensive process, which may take 10 to 15 years or more. Throughout this entire process, potential drug candidates are subjected to rigorous evaluation, driven in part by stringent regulatory considerations, designed to generate information concerning efficacy, proper dosage levels and a variety of other physical and chemical characteristics that are important in determining whether a proposed drug candidate should be approved for marketing. The toxicity characteristics and profile of drug candidates at varying dose levels administered for varying periods of time also are monitored continually and evaluated during the nonclinical and clinical development process. Most chemical compounds that are investigated as potential drug candidates never progress into formal development, and most drug candidates that do advance into formal development never become commercial products. A drug candidate’s failure to progress or advance may be the result of any one or more of a wide range of adverse experimental outcomes including, for example, the lack of acceptable absorption characteristics or other physical properties, the lack of sufficient efficacy against the disease target, difficulties in developing a cost-effective manufacturing or formulation method or the discovery of toxicities or side effects that are unacceptable for the disease indication being treated.

Given the uncertainties of the research and development process, it is not possible to predict with confidence which, if any, of our current research and development efforts will result in a marketable pharmaceutical product. We monitor the results of our discovery research and our nonclinical and clinical trials and frequently evaluate our portfolio investments with the objective of balancing risk and potential return in light of new data and scientific, business and commercial insights. This process can result in relatively abrupt changes in focus and priority as new information becomes available and we gain additional insights into ongoing programs and potential new programs.

Business Strategy

We have elected to diversify our research and development activities across a relatively broad array of investment opportunities, due in part to the high risks associated with the biotechnology and pharmaceutical business. We plan to expend significant resources on development and commercialization of some of our drug product candidates in certain markets, and rely on collaborators to develop and commercialize certain of our other drug candidates either worldwide or in markets upon which we are not

currently focused. This diversification strategy requires more significant financial resources than would be required if we pursued a more limited approach.

Because we have incurred losses from our inception and expect to incur losses for the foreseeable future, we are dependent in large part on our continued ability to raise significant funding to finance our discovery and development operations and our overhead and to meet our long-term contractual commitments and obligations. In the past, we have secured funds principally through capital market transactions, strategic collaborative agreements, proceeds from the disposition of assets, investment income and the issuance of stock under our employee benefit programs. At June 30, 2006, we had $315.9 million of cash, cash equivalents and available-for-sale securities, $42.1 million in principal amount of 5% Convertible Subordinated Notes due 2007 (the “2007 Notes”) and $118.0 million in principal amount of 5.75% Convertible Senior Subordinated Notes due 2011 (the “2011 Notes”). In early July 2006, we received $165.0 million as an upfront payment under our June 30, 2006 VX-950 (telaprevir) collaboration agreement with Janssen. In early August 2006, we agreed to exchange approximately 4.1 million newly issued shares of our common stock for approximately $58.3 million in aggregate principal amount of outstanding 2011 Notes, including accrued and unpaid interest, reducing our outstanding aggregate principal amount of outstanding 2011 Notes to approximately $59.6 million. In order to fund our research, development and manufacturing activities, particularly for later stage compounds including VX-950 (telaprevir), we expect to continue to pursue a general financing strategy that may lead us to undertake one or more additional capital transactions, which may or may not be similar to transactions in which we have engaged in the past. We cannot be sure that any such financing opportunities will be available on acceptable terms.

Collaborations have been and will continue to be an important component of our business strategy.

On June 30, 2006, we entered into a License, Development, Manufacturing and Commercialization Agreement with Janssen Pharmaceutica, N.V., an affiliate of the Johnson & Johnson Company, for the development, manufacture and commercialization of VX-950 (telaprevir), which is currently being investigated in Phase II clinical trials for the treatment of HCV infection. Under our agreement with Janssen, we will collaborate with Janssen to develop VX-950 (telaprevir) worldwide except for the Far East, and Janssen will be responsible for commercializing the compound worldwide except for North America and the Far East. We have retained exclusive commercial rights to VX-950 (telaprevir) in North America and will lead the global development program. Under the agreement, we received an upfront payment of $165 million in July 2006. In addition, the agreement provides for up to $380 million in milestone payments, contingent upon the successful development and commercialization of VX-950 (telaprevir). Janssen will fund 50% of costs for the VX-950 (telaprevir) development program for North America and the Janssen territories beginning on the date of the agreement. Janssen is responsible for commercialization of VX-950 (telaprevir) in Janssen’s territory and will pay us tiered royalties on any product sales, averaging in the mid -20% range, and will be responsible for paying certain third party royalties. In connection with the development and commercialization of VX-950 (telaprevir), we will work with Tibotec Pharmaceuticals, also a Johnson & Johnson company, to establish a global health initiative to increase the prevention, diagnosis, treatment and cure of HCV infection, to be principally directed toward developing countries.

Also in June 2006, we extended the two-year research program term under our Exclusive Research Collaboration, License and Commercialization Agreement with Merck & Co, Inc. by an additional three months, until September 2006. Our research collaboration with Novartis Pharma AG, together with the corresponding research funding, expired during the second quarter of 2006. We expect that the revenue and funding from collaborations that support our development stage compounds, such as the Janssen agreement, will in the future provide a proportionately higher level of financial support for the Company’s R&D activities than revenue from research collaboration agreements.

Our pipeline also includes other potential drug candidates that we may choose to develop with or through a collaborator, as we maintain focus on our core product candidates. We may also seek collaborators for our research programs.

Clinical Development Programs

We are focusing our 2006 preclinical and clinical development investment on VX-950 (telaprevir), VX-702 and VX-770. As a result of our progress in the first half of 2006 in the VX-950 (telaprevir) development program, we currently plan to further increase our investment in that compound to support the global Phase IIb clinical development program. We also currently are incurring and expect to continue to incur significant costs to manufacture VX-950 (telaprevir) drug product, in advance of obtaining regulatory marketing approval, in sufficient quantities to support a timely commercial product launch if we are successful in obtaining such approval. Investment in these activities at the current stage of clinical development is subject to considerable risk that VX-950 (telaprevir) will not advance to product registration, placing our full investment in the compound at risk.

We currently are conducting two major Phase II clinical trials of VX-950 (telaprevir)—PROVE I in the United States and PROVE 2 in Europe, as part of a global Phase II development program for VX-950 (telaprevir). We expect that together, the two clinical trials will evaluate sustained viral response (“SVR”) rates in 580 treatment-naïve patients infected with genotype 1 HCV. Our global Phase II development program in treatment-naïve patients has three objectives: (i) to evaluate the optimal SVR rate that can be achieved with VX-950 (telaprevir) therapy in combination with the current standard of care; (ii) to evaluate the optimal treatment duration for VX-950 (telaprevir) combination therapy; and (iii) to evaluate the role of ribavirin in VX-950 (telaprevir)-based therapy. We have enrolled over 100 patients in PROVE 1 to date. In addition to these two clinical trials, we expect to begin additional clinical trials of VX-950 (telaprevir) in the second half of the year, including a Phase II clinical trial in patients who have failed prior standard of care treatment. We anticipate those additional clinical trials to enroll approximately 400 patients. By the end of the first quarter of 2007, we expect to have enrolled approximately 1,000 patients in clinical trials of VX-950 (telaprevir). We collaborate in the Far East clinical development of VX-950 (telaprevir) with Mitsubishi Pharma Corporation, which began the first Phase I clinical trial of VX-950 (telaprevir) in the Far East.

We recently revised our clinical development plans for VX-702, and now expect to initiate a Phase II clinical trial of VX-702 on a background of methotrexate in patients with RA in 2007.

We have completed dosing in the first two cohorts of healthy volunteers in the single dose Phase I clinical trial of VX-770, which targets a key mechanism underlying the progression of cystic fibrosis. In the second half of 2006, we plan to evaluate multiple doses of VX-770 in healthy volunteers and assess single doses of VX-770 in patients with CF.

We believe that each of these programs requires that we make a comprehensive investment to realize its full clinical and commercial value. We also recognize that development investment at this stage is subject to the considerable risk that any one or more of these compounds will not advance to product registration. Each compound could fail to progress or advance due to a wide range of adverse experimental outcomes, placing our full investment in the compound at risk. While we attempt to stage our investments to mitigate these financial risks, drug discovery and development by its nature is a very risky undertaking. We expect to continue to evaluate and prioritize investment in our clinical development programs based on the emergence of new clinical and nonclinical data in each program throughout 2006 and in subsequent years.

In the clinical development program being conducted by our collaborator Merck for VX-680, an investigational drug candidate targeting Aurora kinase, Merck began patient enrollment in a Phase II clinical trial of VX-680 in patients with advanced lung cancer. A Phase II clinical trial of VX-680 in

patients with advanced colorectal cancer and an extended Phase I clinical trial of patients with hematologic cancers are ongoing. We now expect that our collaborator GSK will initiate Phase III development of brecanavir, a novel HIV protease inhibitor currently being evaluated in a Phase II clinical trial, in 2007.

Financial Guidance

The key financial measures for which we have provided guidance are as follows:

Net Loss: In July 2006, we revised our expected net loss on a GAAP basis upward from our previous guidance of a range of $205 to $225 million, including an estimated $34 million in stock-based compensation expense and an estimated $6 million of restructuring expense, to incorporate additional research and development investment related to our expanded global Phase IIb program for VX-950 (telaprevir). We now expect that the net loss on a GAAP basis for 2006 will be in the range of $222 million to $237 million. This net loss estimate includes an estimated $38 million in stock-based compensation expense and an estimated $4 million of restructuring expense as a result of imputed interest charges relating to the restructuring accrual.

Revenues: We expect that the Company’s revenue will be in the range of $210 to $235 million in 2006.

Research and Development (“R&D”) Expense: We expect that R&D expense will be in the range of $375 to $395 million for 2006, including approximately $31 million of stock-based compensation expense. In July 2006, we increased our estimate for R&D expense by $25 million from a range of $350 to $370 million, including $28 million of stock-based compensation expense. The increase is a result of the anticipated increased investment in our global Phase IIb program for VX-950 (telaprevir).

Sales, General and Administrative (“SG&A”) Expense: We expect our SG&A expense will be in the range of $55 to $60 million for 2006, including approximately $6 million of stock-based compensation expense.

Cash, Cash Equivalents and Available-for-Sale Securities: As a result of the $165 million upfront payment that we received in early July 2006 as part of the VX-950 (telaprevir) collaboration with Janssen, we expect cash, cash equivalents and available-for-sale securities at the end of 2006 to be in excess of $400 million.

The financial measures set forth above are forward-looking and are subject to risks and uncertainties that could cause our actual results to vary materially, including the risks and uncertainties that we describe in “Risk Factors” in Item 1A of our 2005 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 16, 2006, and in the section below entitled “Forward-Looking Statements.”

Liquidity and Capital Resources

We have incurred operating losses since our inception and historically have financed our operations principally through public and private offerings of our equity and debt securities, strategic collaborative agreements that include research and development funding, development milestones and royalties on the sales of products, proceeds from the disposition of assets, investment income and proceeds from the issuance of stock under our employee benefit programs.

At June 30, 2006, we had cash, cash equivalents and available-for-sale securities of $315.9 million, a decrease of $91.6 million from $407.5 million at December 31, 2005. This decrease is primarily the result of investment in our clinical development activities, offset by approximately $31.9 million received from the issuance of common stock under our employee benefit plans. Expenditures for property and equipment during the six months ended June 30, 2006 were $18.2 million.

In July 2006, we received a $165.0 million upfront payment under our collaboration with Janssen for the development, manufacture and commercialization of VX-950 (telaprevir). Under the terms of the Agreement, Janssen will fund 50% of drug development costs incurred on or after June 30, 2006 in the global development program for VX-950 (telaprevir).

At June 30, 2006, we had approximately $42.1 million in aggregate principal amount of 2007 Notes and approximately $118.0 million in aggregate principal amount of 2011 Notes outstanding. The 2011 Notes are convertible into common stock at the option of the holder at a price equal to $14.94 per share, subject to adjustment under certain circumstances. The 2007 Notes are convertible into common stock at the option of the holder at a price equal to $92.26 per share, subject to adjustment under certain circumstances. In August 2006, we exchanged approximately 4.1 million shares of newly issued common stock for approximately $58.3 million in aggregate principal amount of outstanding 2011 Notes, plus accrued interest. As a result of these exchanges we expect to incur a non-cash charge of approximately $5.0 million in the third quarter of 2006. This charge is related to the incremental shares issued in the transaction over the number that would have been issued upon the conversion of the notes under the original conversion terms.

In July 2006, we sold 817,749 shares of Altus Pharmaceuticals common stock for approximately $11.7 million, resulting in a realized gain of approximately $7.7 million, to be recognized in the third quarter of 2006.

We expect to continue to make significant investments in our pipeline, particularly in clinical trials for certain of our product candidates, in our ion channel and kinase discovery efforts and in our effort to prepare for potential registration, regulatory approval and commercial launch of our existing and future product candidates. We also expect to continue incurring significant costs to manufacture VX-950 (telaprevir) drug products in advance of obtaining regulatory marketing approval, in sufficient quantities to support a timely commercial product launch if we are successful in obtaining such approval. Consequently, we expect to incur losses on a quarterly and annual basis for the foreseeable future.

As part of our strategy for managing our capital structure, we have from time to time adjusted the amount and maturity of our debt obligations through new issues, privately negotiated transactions and market purchases, depending on market conditions and our perceived needs at the time. During the remainder of 2006, we expect to continue pursuing a general financial strategy that may lead us to undertake one or more additional capital transactions. Any such capital transactions may or may not be similar to transactions in which we have engaged in the past.

To the extent that our current cash and marketable securities, in addition to the above-mentioned sources, are not sufficient to fund our activities, it will be necessary to raise additional funds through public offerings or private placements of our securities or other methods of financing. We also will continue to manage our capital structure and consider all financing opportunities, whenever they may occur, that could strengthen our long-term liquidity profile. There can be no assurance that any such financing opportunities will be available on acceptable terms, if at all.

There have been no significant changes to our commitments and obligations as reported in our 2005 Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 16, 2006.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements prepared in accordance with GAAP. The preparation of these financial statements requires us to make certain estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated

financial statements and the reported amounts of revenue and expense during the reported periods. These items are constantly monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates if past experience or other assumptions do not turn out to be substantially accurate.

We believe that the application of the accounting policies for restructuring and other expense, revenue recognition, research and development expenses, investments and stock-based compensation, all of which are important to our financial condition and results of operations, require significant judgments and estimates on the part of management. Our accounting polices, including the ones discussed below, are more fully described in Note B, “Accounting Policies,” to our consolidated financial statements included in our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 16, 2006.

Restructuring Expense

We record liabilities associated with restructuring activities based on estimates of fair value in the period the liabilities are incurred, in accordance with FAS 146. As prescribed by FAS 146, we use a probability-weighted discounted cash-flow analysis to calculate the amount of the liability. The probability-weighted discounted cash-flow analysis is based on management’s assumptions and estimates of our ongoing lease obligations, including contractual rental commitments, build-out commitments and building operating costs, and estimates of income from subleases, based on the term and timing of such subleases. We discount the estimated cash flows using a discount rate of approximately 10%. These cash flow estimates are reviewed and may be adjusted in subsequent periods. Adjustments are based, among other things, on management’s assessment of changes in factors underlying the estimates. Because our estimate of the liability includes the application of a discount rate to reflect the time-value of money, the estimate will increase simply as a result of the passage of time, even if all other factors remain unchanged.

Our estimates of our restructuring liability have changed in the past, and it is possible that our assumptions and estimates will change in the future, resulting in additional adjustments to the amount of the estimated liability. The effect of any such adjustments could be material. For example, we currently have two subleases for portions of the Kendall Square Facility with terms of six and seven years, respectively, and we have made certain estimates and assumptions relating to future sublease terms following the expiration of the current subleases. Market variability may require adjustments to those assumptions in the future. We will review our assumptions and judgments related to the lease restructuring on at least a quarterly basis until the Kendall Square lease is terminated or expires, and make whatever modifications we believe are necessary, based on our best judgment, to reflect any changed circumstances.

The accrual for restructuring expense of $36.3 million at June 30, 2006 is related to the portion of the Kendall Square Facility that we do not intend to occupy. This estimate represents our best judgment of the assumptions and estimates most appropriate in measuring the ongoing obligation.

Revenue Recognition

We recognize revenue in accordance with the Securities and Exchange Commission’s (“SEC”) Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”), as amended by SEC Staff Accounting Bulletin No. 104, “Revenue Recognition,” (“SAB 104”) and for revenue arrangements entered into after June 30, 2003, Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”).

Our revenues are generated primarily through collaborative research, development and commercialization agreements. The terms of the agreements typically include payment to us of non-

refundable up-front license fees, funding of research and development efforts, milestone payments and/or royalties on product sales.

Agreements containing multiple elements are divided into separate units of accounting if certain criteria are met, including whether the delivered element has stand-alone value to the collaborator and whether there is objective and reliable evidence of fair value of the undelivered obligation(s). The consideration received is allocated among the separate units based on each unit’s fair value or the residual method, and the applicable revenue recognition criteria are applied to each of the separate units.

We recognize revenues from non-refundable, up-front license fees on a straight-line basis over the contracted or estimated period of performance, which is typically the research or development term. Research and development funding is recognized as earned, ratably over the period of effort.

Substantive milestones realized in collaboration arrangements are recognized as earned when the corresponding payment is reasonably assured, subject to the following policies in those circumstances where we have obligations remaining after achievement of the milestone:

· In those circumstances where collection of a substantive milestone is reasonably assured, we have remaining obligations to perform under the collaboration arrangements and we have evidence of fair value for our remaining obligations, we consider the milestone payment and the remaining obligations to be separate units of accounting. In these circumstances, we use the residual method under EITF 00-21, Revenue Arrangements with Multiple Deliverables to allocate revenue among the milestones and the remaining obligations.

· In those circumstances where collection of a substantive milestone is reasonably assured, we have remaining obligations to perform under the collaboration arrangement, and we do not have sufficient evidence of fair value for our remaining obligations, we consider the milestone payment and the remaining obligations on the contract as a single unit of accounting. In those circumstances where the collaboration does not require specific deliverables at specific times or at the end of the contract term, but rather our obligations are satisfied over a period of time, substantive milestones are recognized over the period of performance. This typically results in a portion of the milestone payment being recognized as revenue at the date the milestone is achieved equal to the applicable percentage of the performance period that has elapsed as of the date the milestone is achieved, with the balance being deferred and recognized over the remaining period of performance.

We evaluate whether milestones are substantive at the inception of the agreement based on the contingent nature of the milestone, specifically reviewing factors such as the technological risk that must be overcome as well as the level of effort and investment required to achieve the milestone. Milestones that are not considered substantive and do not meet the separation criteria are accounted for as license payments and recognized on a straight-line basis over the remaining period of performance.

Payments received after performance obligations are met completely are recognized when earned.

Royalty revenue is recognized based upon actual and estimated net sales of licensed products in licensed territories as provided by the licensee and is recognized in the period the sales occur. Differences between actual royalty revenues and estimated royalty revenues, which have not historically been significant, are reconciled and adjusted for in the quarter they become known.

Research and Development Costs

All research and development costs, including amounts funded by research and development collaborations, are expensed as incurred. Research and development expenses are comprised of costs incurred in performing research and development activities including salaries and benefits; laboratory supplies; contract services, including clinical trial costs; and infrastructure costs, including facilities costs

and depreciation. To record clinical trial, contract services and other outside costs, we are required to make estimates of the costs incurred in a given accounting period and record accruals at period-end, because the third party service periods and billing terms do not always coincide with our period-end. We base our estimates on our knowledge of the research and development programs, services performed for the period, past history for related activities and the expected duration of the third party service contract, where applicable.

Altus Investment

Altus Pharmaceuticals, Inc. completed an initial public offering in January 2006. At June 30, 2006, we owned 817,749 shares of Altus common stock and warrants to purchase 1,962,494 shares of Altus common stock. In addition, we hold 450,000 shares of Altus redeemable preferred stock, which are not convertible into common stock and which are redeemable at our option on or after December 31, 2010, or by Altus at any time. We were restricted from trading Altus securities for a period of six months following the initial public offering. The period ended in July 2006.

As a result of the public offering, the common stock is classified as an available-for-sale investment and is recorded at fair value, based on quoted market prices, with unrealized gains and losses included as a component of accumulated other comprehensive income, which is a separate component of stockholders’ equity, until such gains and losses are realized. At June 30, 2006, the fair market value of the Altus common stock investment was $15.1 million, with a cost value of $4.0 million. In July 2006, we sold the 817,749 shares of common stock for approximately $11.7 million. We expect to record a gain of approximately $7.7 million on this sale in the third quarter of 2006.

We continued to account for the warrants under the cost method of accounting until the end of the restricted trading period in July 2006, after which time the warrants have been classified as derivatives. Gains or losses on the fair market value of the warrants, as derivatives, will be included in the consolidated statements of operations beginning in the third quarter of 2006. We continue to account for the redeemable preferred stock under the cost method of accounting.

We continue to assess the Altus warrants and redeemable preferred stock on a quarterly basis to determine if there has been any estimated decrease in the fair value of that investment below the carrying value that might require us to write down the cost basis of the investment. If any adjustment to the fair value of an investment reflects a decline in the value of that investment below its cost, we consider the evidence available to us, including the duration and extent to which the decline is other-than-temporary. If the decline is considered other-than-temporary, the cost basis of the investment is written down to fair value as a new cost basis and the amount of the write-down is included in the consolidated statements of operations. We have not identified facts or circumstances which would cause us to determine that the investment basis of our interest in Altus should be changed.

Stock-based compensation

We adopted the provisions of Statement of Financial Accounting Standards Board No. 123(R), “Share-Based Payments” (“FAS 123(R)”), on January 1, 2006. FAS 123(R) requires us to measure compensation cost of stock-based compensation at the grant date, based on the fair value of the award, and to recognize that cost as an expense over the employee’s requisite service period (generally the vesting period of the equity award). Prior to January 1, 2006, we accounted for stock-based compensation to employees in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), and related interpretations. We also followed the disclosure requirements of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”). We elected to adopt the modified prospective transition method as provided by FAS 123(R) and accordingly, financial statement amounts for the periods prior to January 1, 2006 that are presented in this Form 10-Q have not been restated to reflect the fair value method.

Under FAS 123(R), we determine the fair value of awarded stock options and ESPP shares using the Black-Scholes valuation model. The Black-Scholes valuation model requires us to make certain assumptions and estimates concerning our stock price volatility, the rate of return of risk-free investments, the anticipated term of the awards, and our anticipated dividends. In determining the amount of expense to be recorded, judgment is also required to estimate forfeiture rates for awards based on the probability that employees will complete the required service period. If actual forfeitures differ significantly from our estimates, our results could be materially impacted.

Results of Operations

Three Months Ended June 30, 2006 Compared with Three Months Ended June 30, 2005

Our net loss for the three months ended June 30, 2006 was $77,658,000, or $0.72 per basic and diluted common share, compared to net loss of $40,988,000, or $0.50 per basic and diluted common share for the three months ended June 30, 2005. Included in the net loss for the quarter ended June 30, 2006 is stock-based compensation expense of $11,647,000 and restructuring expense of $443,000. Included in the net loss for the quarter ended June 30, 2005 is stock-based compensation expense of $1,129,000 and a credit to restructuring expense of $1,743,000. The increase in the net loss is primarily the result of increased development investment related to VX-950 (telaprevir) as well as increased charges for stock-based compensation due to the adoption of FAS 123(R) on January 1, 2006.

Revenues

Total revenues decreased $2,595,000 to $29,726,000 for the three months ended June 30, 2006, compared to $32,321,000 for the three months ended June 30, 2005. In the second quarter of 2006, revenue was comprised of $9,005,000 in royalties and $20,721,000 in collaborative research and development revenue. In the second quarter of 2005, revenue was comprised of $7,467,000 in royalties and $24,854,000 in collaborative research and development revenue.

Royalties consist principally of Lexiva/Telzir royalty revenue, based on actual and estimated worldwide net sales. We began earning royalties on sales of Lexiva in the United States in the fourth quarter of 2003 and on Telzir in the European Union in third quarter of 2004. The increase in royalty revenue is due to an increase in Lexiva/Telzir sales. We pay a royalty to a third party on sales of Lexiva/Telzir.

Collaborative research and development revenue decreased $4,133,000, or 17%, for the three months ended June 30, 2006, as compared with the same period in 2005. This decrease is primarily related to the expiration of our research collaboration with Novartis in April 2006.

With the signing of the VX-950 (telaprevir) collaboration with Janssen, we expect that for the foreseeable future the revenue and funding from collaborations that support our development-stage compounds, including development cost reimbursements and milestones, will provide a proportionately higher level of financial support for the Company’s research and development activities than revenue from research collaboration agreements.

Costs and Expenses

Research and development expenses increased $31,893,000, or 54%, to $91,250,000, including $9.8 million of stock-based compensation, for the three months ended June 30, 2006, from $59,357,000, including $0.9 million of stock-based compensation, for the same period in 2005. The increase in research and development expenses was driven primarily by investment in our clinical development programs for VX-950 (telaprevir) and VX-702 as well as an increase in stock-based compensation expense of $8,828,000

due to the adoption of FAS 123(R). Development expenses accounted for 79%, or $25,284,000, of the aggregate increase in research and development expenses.

Research and development expenses consist primarily of salary and benefits, laboratory supplies, contractual services and infrastructure costs, including facilities costs and depreciation. Set forth below is a summary that reconciles our total research and development expenses for the three months ended June 30, 2006 and 2005 (in thousands):

	Three Months Ended June 30,
	2006		2005		$ Change			% Change
Research Expenses:
Salary and benefits	$	16,136	$	10,066	$	6,070			60	%
Laboratory supplies and other direct expenses	5,965		5,419		546				10	%
Contractual services	1,772		1,750		22				1	%
Infrastructure costs	12,548		12,577		(29		)		—	%
Total research expenses	$	36,421	$	29,812	$	6,609
Development Expenses:
Salary and benefits	$	14,292	$	6,330	$	7,962			126	%
Laboratory supplies and other direct expenses	4,610		2,763		1,847				67	%
Contractual services	25,376		13,844		11,532				83	%
Infrastructure costs	10,551		6,608		3,943				60	%
Total development expenses	$	54,829	$	29,545	$	25,284
Total Research and Development Expenses:
Salary and benefits	$	30,428	$	16,396	$	14,032			86	%
Laboratory supplies and other direct expenses	10,575		8,182		2,393				29	%
Contractual services	27,148		15,594		11,554				74	%
Infrastructure costs	23,099		19,185		3,914				20	%
Total research and development expenses	$	91,250	$	59,357	$	31,893

Sales, general and administrative expenses increased to $14,370,000, including $1,892,000 of stock-based compensation, for the three months ended June 30, 2006, compared to $10,814,000, including $202,000 of stock-based compensation, for the same period in 2005. The change is due to an increase in infrastructure costs to support increases in research and development.

Restructuring expense for the three months ended June 30, 2006 was $443,000, compared to a restructuring credit for the three months ended June 30, 2005 of $1,743,000. The charge in the three months ended June 30, 2006 resulted primarily from an imputed interest cost related to the restructuring accrual. The restructuring credit for the three months ended June 30, 2005 resulted from an adjustment of the portion of restructuring accrual relating to the portion of the Kendall Square Facility that we are occupying, offset by (i) a charge in the amount of the estimated incremental net ongoing lease obligation associated with the portion of the Kendall Square Facility that we still do not intend to occupy and (ii) imputed interest costs relating to the restructuring liability.

The activity related to the restructuring accrual and related expense for the three months ended June 30, 2006 is as follows (in thousands):

Cash

payments,

Cash received

Charge,

Accrual as of

second

from subleases,

second

Accrual as of

March 31,

quarter

second quarter

quarter

June 30,

2006

Lease restructuring expense

41,719

(7,904

)

2,020

443

36,278

The activity related to the restructuring accrual and related expense for the three months ended June 30, 2005 is as follows (in thousands):

Portion of

Cash

facility

payments,

Cash received

Vertex expects

Charge,

Accrual as of

second

from sublease,

to occupy,

second

March 31,

quarter

second quarter

second

quarter

Accrual as of

2005

quarter 2005

2005

June 30, 2005

Lease restructuring expense

52,305

(7,242

)

493

(10,018

)

8,275

43,813

Interest income increased $1,674,000, or 74%, to $3,921,000 for the three months ended June 30, 2006 from $2,247,000 for the three months ended June 30, 2005. The increase is a result of higher portfolio yields.

Interest expense decreased $2,282,000, or 49%, to $2,357,000 for the three months ended June 30, 2006 from $4,639,000 for the three months ended June 30, 2005. The decrease resulted from reduction of outstanding debt in 2005.

As of June 30, 2006, there was approximately $64,353,000 of unrecognized compensation cost, net of forfeitures, related to stock-based awards granted under the Stock and Option Plans. We expect to recognize that cost over a weighted-average period of 2.72 years.

Six Months Ended June 30, 2006 Compared with Six Months Ended June 30, 2005

Our net loss for the six months ended June 30, 2006 was $127,745,000, or $1.18 per basic and diluted common share, compared to net loss of $85,708,000, or $1.06 per basic and diluted common share for the six months ended June 30, 2005. Included in the net loss for the six months ended June 30, 2006 is stock-based compensation expense of $19,772,000, restructuring expense of $1,210,000 and the effect of a cumulative benefit of accounting change of $1,046,000, related to the adoption of FAS 123(R). Included in the net loss for the six months ended June 30, 2005 is stock-based compensation expense of $2,160,000 and restructuring expense of $171,000.

Revenues

Total revenues increased $7,886,000 to $68,813,000 for the six months ended June 30, 2006, compared to $60,927,000 for the six months ended June 30, 2005. In the first half of 2006, revenue was comprised of $18,184,000 in royalties and $50,629,000 in collaborative research and development revenue. In the first half of 2005, revenue was comprised of $13,620,000 in royalties and $47,307,000 in collaborative research and development revenue.

Collaborative research and development revenue increased $3,322,000, or 7%, in the first half of 2006, as compared with the same period in 2005. This increase primarily relates to milestone payments from Merck upon the initiation of Phase II clinical trials of VX-680, partially offset by reduced research funding under our Novartis collaboration, which expired in April 2006.

Costs and Expenses

Research and development expenses increased $49,660,000, or 43%, to $166,452,000, including $16.2 million of stock-based compensation, for the six months ended June 30, 2006 from $116,792,000, including $1.8 million of stock-based compensation, for the same period in 2005. The increase in research and development expenses was driven primarily by investment in our clinical development programs for VX-950 (telaprevir) and VX-702 as well as an increase in stock-based compensation expense of $14,397,000 due to the adoption of FAS 123(R). Development expenses accounted for 74%, or $36,781,000, of the aggregate increase in research and development expenses.

Research and development expenses consist primarily of salary and benefits, laboratory supplies, contractual services and infrastructure costs, including facilities costs and depreciation. Set forth below is a summary that reconciles our total research and development expenses for the six months ended June 30, 2006 and 2005 (in thousands):

	Six Months Ended June 30,
	2006		2005		$ Change		% Change
Research Expenses:
Salary and benefits	$	30,843	$	20,143	$	10,700		53	%
Laboratory supplies and other direct expenses	11,866		11,012		854			8	%
Contractual services	3,581		3,511		70			2	%
Infrastructure costs	26,403		25,148		1,255			5	%
Total research expenses	$	72,693	$	59,814	$	12,879
Development Expenses:
Salary and benefits	$	26,080	$	12,589	$	13,491		107	%
Laboratory supplies and other direct expenses	8,445		4,829		3,616			75	%
Contractual services	41,035		26,743		14,292			53	%
Infrastructure costs	18,199		12,817		5,382			42	%
Total development expenses	$	93,759	$	56,978	$	36,781
Total Research and Development Expenses:
Salary and benefits	$	56,923	$	32,732	$	24,191		74	%
Laboratory supplies and other direct expenses	20,311		15,841		4,470			28	%
Contractual services	44,616		30,254		14,362			47	%
Infrastructure costs	44,602		37,965		6,637			17	%
Total research and development expenses	$	166,452	$	116,792	$	49,660

Sales, general and administrative expenses increased to $27,249,000, including $3,611,000 of stock-based compensation, for the six months ended June 30, 2006, compared to $20,441,000, including $396,000 of stock-based compensation, for the same period in 2005. The change is due to an increase in infrastructure costs to support the growing research and development effort.

Restructuring expense for the six months ended June 30, 2006 was $1,210,000, compared to a restructuring expense for the six months ended June 30, 2005 of $171,000. The charge in the six months ended June 30, 2006 resulted primarily from an imputed interest cost related to the restructuring accrual. The expense for the six months ended June 30, 2005 includes an adjustment of the portion of restructuring relating to the portion of the Kendall Square Facility that we expect to occupy, offset by (i) a charge in the amount of the estimated incremental net ongoing lease obligation associated with the portion of the Kendall Square Facility that we still do not intend to occupy and (ii) imputed interest costs relating to the restructuring liability.

The activity related to the restructuring accrual and related expense for the six months ended June 30, 2006 is as follows (in thousands):

Cash,

Cash received

Charge

payments

from subleases,

six months

Accrual as of

six months

ended

Accrual as of

Dec. 31,

ended June 30,

June 30,

2005

2006

Lease restructuring expense

42,982

(11,884

)

3,970

1,210

36,278

The activity related to the restructuring accrual and related expense for the six months ended June 30, 2005 is as follows (in thousands):

Cash

Cash received

Portion of
facility

payments,

from sublease,

Vertex

Charge,

six months

expects

Six months

Accrual as of

ended

to occupy,

ended

Accrual as of

December 31,

June 30,

six months ended

June 30,

2004

2005

June 30, 2005

2005

Lease restructuring
expense

55,843

(13,017

)

816

(10,018

)

10,189

43,813

Interest income increased $3,335,000, or 73%, to $7,901,000 for the six months ended June 30, 2006 from $4,566,000 for the six months ended June 30, 2005. The increase is a result of higher portfolio yields.

Interest expense decreased $4,564,000, or 49%, to $4,714,000 for the six months ended June 30, 2006 from $9,278,000 for the six months ended June 30, 2005. The decrease resulted from our reduction of outstanding debt in 2005.

Pursuant to the adoption of FAS 123(R), stock-based compensation expense is recognized over the service period, including an estimate of awards that will be forfeited. Previously, we recorded the impact of forfeitures as they occurred. In connection with the adoption of FAS 123(R) during the first half of fiscal year 2006, we recorded a $1,046,000 benefit from the cumulative effect of changing from recording forfeitures related to restricted stock awards as they occurred to estimating forfeitures during the service period.

New Accounting Pronouncements

In May 2005, the FASB issued FAS No. 154, “Accounting Changes and Error Corrections” (“FAS 154”). FAS No. 154 replaces APB Opinion No. 20, “Accounting Changes” and FAS No. 3, “Reporting Accounting Changes in Interim Financial Statements.” FAS No. 154 requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. We adopted FAS 154 beginning on January 1, 2006; its adoption did not have a material impact on our consolidated financial statements.

In November 2005, FASB issued FSP FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“FSP FAS 115-1”), which provides guidance on determining when investments in certain debt and equity securities are considered impaired, whether an impairment is other-than-temporary, and on measuring such impairment loss. FSP FAS 115-1 also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. FSP FAS 115-1 is required to be applied to reporting periods beginning after December 15, 2005. We adopted FSP FAS 115-1 in the first quarter of 2006. Adoption of

FSP FAS 115-1 did not have a material impact on our consolidated results of operations or financial condition.

Forward-Looking Statements

Our disclosure in this Quarterly Report on Form 10-Q contains forward-looking statements. Forward-looking statements give our current expectations or present 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 phrases of similar meaning in connection with any discussion of future operating or financial performance. In particular, these statements include forward-looking statements about our business, including our expectations that:

· we will incur a substantial loss for the year ending December 31, 2006;

· the estimates and assumptions used in determining the value of stock-based compensation under FAS 123(R), including assumptions relating to future stock volatility, award forfeiture rates and employee behavior, will prove accurate;

· the estimates and assumptions used in evaluating the future obligations arising from the Kendall Square lease, including assumptions relating the costs to be incurred to satisfy our buildout requirements under the lease, the time necessary to sublease the space, projected sublease rental rates and the duration of future subleases, will prove accurate;

· we will rely on collaborators to develop and commercialize certain of our drug candidates either worldwide or in markets upon which we are not currently focused;

· the timing of our drug development activities will be as set forth in this Quarterly Report;

· we may choose to develop some of our drug candidates with or through a collaborator, as we maintain focus on our core product candidates;

· we may seek collaborators for our research programs;

· our increased clinical investment will be as a result of our investment in our core programs;

· we will continue to evaluate and prioritize investment in our clinical development programs based on the emergence of new clinical and nonclinical data in each program in 2006 and in subsequent years;

· we will further increase our investment in VX-950 (telaprevir) to support the global Phase IIb development program;

· we will continue to incur significant manufacturing costs for VX-950 (telaprevir) drug product in quantities to support a timely commercial launch;

· our timelines for development and commercialization of VX-950 (telaprevir) will be as we have projected;

· PROVE 1 and PROVE 2 together will evaluate sustained viral response (“SVR”) rates in 580 treatment naïve patients infected with genotype 1 HCV;

· we will begin additional clinical trials of VX-950 (telaprevir) in approximately 400 patients in the second half of the year, including a Phase IIb study in patients who failed prior standard of care treatment;

· by the end of the first quarter of 2007, we will have enrolled approximately 1,000 patients in clinical trials of VX-950 (telaprevir);

· we will initiate a Phase II clinical trial of VX-702 on a background of methotrexate in patients with RA in 2007;

· we will evaluate multiple doses of VX-770 in healthy volunteers and assess single doses of VX-770 in patients with CF;

· GSK will initiate a Phase III clinical trial of brecanavir in 2007;

· our net loss on a GAAP basis for 2006 will be in the range of $222 million to $237 million, including an estimated $38 million in stock-based compensation expense and an estimated $4 million of restructuring expense;

· our 2006 revenue will be in the range of $210 to $235 million;

· our SG&A expense will be in the range of $55 to $60 million for 2006, including approximately $6 million of stock-based compensation expense;

· our R&D expense in 2006 will be in the range of $375 million to $395 million, including approximately $31 million of stock-based compensation expense;

· our cash, cash equivalents and available-for-sale securities at the end of 2006 will be in excess of $400 million;

· we will incur a non-cash charge of approximately $5.0 million related to the August 2006 debt exchange in the third quarter of 2006;

· we will record a gain of approximately $7.7 million on the sale of Altus common stock in the third quarter of 2006;

· we will continue to make significant investments in our pipeline, particularly in clinical trials for certain of our product candidates, in our ion channel and kinase discovery efforts and in our effort to prepare for potential registration, regulatory approval and commercial launch of our existing and future product candidates;

· we will incur losses on a quarterly and annual basis for the foreseeable future;

· for the foreseeable future, revenue and funding from collaborations that support our development-stage compounds will provide a proportionately higher level of financial support for the Company’s research and development activities than revenue and funding from research collaborations;

· we will continue pursuing a general financial strategy that may lead us to undertake one or more additional capital transactions, which may or may not be similar to transactions in which we have engaged in the past; and

· we will continue to manage our capital structure and consider all financing opportunities, whenever they may occur, that could strengthen our long-term liquidity profile.

Any or all of our forward-looking statements in this Quarterly 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 Quarterly Report will be important in determining future results. While management makes its best efforts to be accurate in making forward-looking statements, such statements are subject to risks and uncertainties that could cause our actual results to vary materially. These risks and uncertainties include, among other things, the risk that (1) any one or more of our internal drug development programs or our development programs with collaborators will not proceed as planned for technical, scientific or commercial reasons, due to U.S. Food and Drug Administration disagreement on trial designs, due to patient enrollment issues, due to manufacturing delay or due to judgments based on new information from non-clinical studies or clinical trials or from other sources, (2) one or more of our assumptions underlying our revenue expectations or our expense expectations will not be realized, (3) we will be unable to realize one or more of our financial objectives for 2006 due to unexpected and costly program delays (including delays due to regulatory action or lack of action) or any number of other financial, technical or collaboration considerations, (4) unexpected costs associated with one or more of

our programs will necessitate a reduction in our investment in other programs or a change in our financial projections, (5) future competitive or other market factors may adversely impact the commercial potential for our product candidates in HCV and inflammation and other areas, (6) due to scientific, medical or technical developments, our drug discovery efforts will not ultimately result in commercial products or assets that can generate revenue, (7) we will be unable to enter into new collaborative relationships to support our research and development programs on acceptable terms, or at all, (8) the key estimates and assumptions underlying our forward-looking statements will turn out to be incorrect or not reflective of changing scientific knowledge or business conditions in the future, as well as other risks set forth under the heading “Risk Factors” appearing in Item 1A of our Annual Report on Form 10-K, filed with the Securities and Exchange Commission on March 16, 2006 and updated on this Quarterly Report on Form 10-Q, which 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. Consequently, no forward-looking statement can be guaranteed. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

As part of our investment portfolio, we own financial instruments that are sensitive to market risks. The investment portfolio is used to preserve our capital until it is required to fund operations, including our research and development activities. None of these market risk sensitive instruments are held for trading purposes. As of June 30, 2006, there were no derivative financial instruments in our investment portfolio.

Interest Rate Risk

We invest our cash in a variety of financial instruments, principally securities issued by the U.S. government and its agencies, investment grade corporate bonds and notes and money market instruments. These investments are denominated in U.S. dollars. All of our interest-bearing securities are subject to interest rate risk, and could decline in value if interest rates fluctuate. Substantially all of our investment portfolio consists of marketable securities with active secondary or resale markets to help ensure portfolio liquidity, and we have implemented guidelines limiting the term to maturity of our investment instruments. Due to the conservative nature of these instruments, we do not believe that we have a material exposure to interest rate risk.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

The Company’s chief executive officer and chief financial officer, after evaluating the effectiveness of the Company’s disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Quarterly Report on Form 10-Q, have concluded that, based on such evaluation, at the end of the period covered by this report, our disclosure controls and procedures were effective and designed to provide reasonable assurance that the information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms. These procedures and controls include, without limitation, controls and procedures designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, our Company’s management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Changes in Internal Controls Over Financial Reporting

No change in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) occurred during the second fiscal quarter, ended June 30, 2006, that has affected, or is reasonably likely to affect, our internal control over financial reporting.

Part II. Other Information

Item 1A. Risk Factors

We depend on our collaborators to work with us to develop, manufacture and commercialize many of our drug candidates.

We are currently focusing our development activities on three drug candidates, VX-950 (telaprevir), VX-702, and VX-770. We have granted development and commercialization rights to VX-950 (telaprevir) to Mitsubishi Pharma Corp. (Far East) and to Janssen Pharmaceutica, N.V. (rest of world other than North America and Far East). The success of our collaborations depends on the efforts and activities of our collaborators. We also have granted Far East rights to VX-702 to our collaborator Kissei Pharmaceuticals. For some compounds on which we are not currently focusing our development efforts, we have granted worldwide rights to a collaborator, such as our VX-680 collaboration with Merck and Co., Inc., our Lexiva/Telzir, brecanavir and VX-409 collaborations with GlaxoSmithKline and our VX-944 collaboration with Avalon Pharmaceuticals.

We expect to receive significant financial support under our Janssen collaboration agreement, as well as meaningful technical and manufacturing contributions to the VX-950 (telaprevir) program. The success of our global collaborations depends on the efforts and activities of our collaborators. Similarly, the success of our key in-house programs, such as for VX-950 (telaprevir) and VX-702, is dependent upon the continued financial and other support that our collaborators have agreed to provide. Each of our collaborators has significant discretion in determining the efforts and resources that it will apply to the collaboration. Our existing and any future collaborations may not be scientifically or commercially successful.

The risks that we face in connection with these existing and any future collaborations include the following:

· Our collaboration agreements are subject to termination under various circumstances, including, as in the case of our agreement with Janssen, termination without cause. Any such termination could delay the development and commercial sale of our drug candidates, including VX-950 (telaprevir).

· Our collaborators may change the focus of their development and commercialization efforts. Pharmaceutical and biotechnology companies historically have re-evaluated their development and commercialization priorities following mergers and consolidations, which have been common in recent years in these industries. The ability of some of our product candidates to reach their potential could be limited if our collaborators decrease or fail to increase development or commercialization efforts related to those products.

· Our collaboration agreements may have the effect of limiting the areas of research and development that we may pursue, either alone or in collaboration with third parties.

· Our collaborators may develop and commercialize, either alone or with others, products that are similar to or competitive with the products that are the subject of the collaboration with us.

For additional risk factors relating to the Company and its business, see Item 1A of our 2005 Annual Report on Form 10-K, which was filed with the Commission on March 16, 2006.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

(c) The table set forth below shows all repurchases of securities by the Company during the three months ended June 30, 2006:

Period	Total Number of Shares Purchased(1)		Average Price Paid per Share			Total Number of Shares Purchased as part of publicly announced Plans or Programs		Maximum Number of Shares that may yet be purchased under Plans or Programs
April 1, 2006 to April 30, 2006		3,070		$	0.01		—		—
May 1, 2006 to May 31, 2006		9,863		$	0.01		—		—
June 1, 2006 to June 30, 2006		10,497		$	0.01		—		—

(1) Under the terms of the Company’s 1996 Stock and Option Plan and 2006 Stock and Option Plan, the Company may award shares of restricted stock to its employees and consultants. These shares of restricted stock typically are subject to a lapsing right of repurchase on the part of the Company. The Company may exercise this right of repurchase in the event that a restricted stock recipient’s service to the Company is terminated. If the Company exercises this right, it is required to repay the purchase price paid by or on behalf of the recipient for the repurchased restricted shares, which typically is the par value per share of $0.01. Repurchased shares are returned to the applicable Stock and Option Plan under which they were issued. Shares returned to the 2006 Stock and Option Plan are available for future awards under the terms of that plan.

Item 4. Submission of Matters to a Vote of Security Holders

The Company’s annual meeting of stockholders was held on May 11, 2006.

The stockholders elected Mr. Eric K. Brandt, Mr. Bruce I. Sachs and Dr. Eve E. Slater to serve on the Board of Directors until the annual meeting of stockholders to be held in 2009. The tabulation of votes with respect to the election of such directors is as follows:

	For	Withheld
Eric K. Brandt	88,536,811	1,731,254
Bruce I. Sachs	82,425,075	7,842,991
Eve E. Slater	89,937,730	330,336

Following the meeting, the Company’s Board of Directors consists of Charles A. Sanders (Chairman), Joshua S. Boger, Eric K. Brandt, Roger W. Brimblecombe, Stuart J.M. Collinson, Eugene Cordes, Matthew W. Emmens, Bruce I. Sachs, Eve E. Slater and Elaine S. Ullian.

In addition, the stockholders approved the adoption of the Company’s 2006 Stock and Option Plan at the annual meeting. The tabulation of votes with respect to the adoption of the 2006 Stock and Option Plan is as follows:

For		Against		Abstain
47,050,901		25,806,926		62,757

Item 6. Exhibits

Exhibit No.		Description
10.1		License, Development, Manufacturing and Commercialization Agreement, dated June 30, 2006, by and between Vertex Pharmaceuticals Incorporated and Janssen Pharmaceutica, N.V. †
10.2		Letter Agreement, dated June 26, 2006, by and between Merck & Co., Inc. and Vertex Pharmaceuticals Incorporated.
31.1		Certification of the Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of the Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

† Confidential portions of this document have been filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment.

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

August 9, 2006	VERTEX PHARMACEUTICALS INCORPORATED
	By:	/s/ IAN F. SMITH
		Ian F. Smith
		Executive Vice President and Chief Financial Officer
		(principal financial officer and duly authorized officer)

Exhibit Index

Exhibit No.		Description
10.1		License, Development, Manufacturing and Commercialization Agreement, dated June 30, 2006, by and between Vertex Pharmaceuticals Incorporated and Janssen Pharmaceutica, N.V. †
10.2		Letter Agreement, dated June 26, 2006, by and between Merck & Co., Inc. and Vertex Pharmaceuticals Incorporated.
31.1		Certification of the Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of the Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

† Confidential portions of this document have been filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment.

Six months ended
June 30, 2006

Number of shares

Average price paid