___________________________________________________________________________ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ___________________________ FORM 10-Q [x] Quarterly report pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934 For the quarterly period ended September 30, 1998 OR [ ] Transition report pursuant to Section 13 or 15(d) of the Securities and 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, including zip code) (617) 577-6000 ---------------------------- (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 --- --- 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 $.01 per share 25,341,169 - --------------------------------------- --------------------- Class Outstanding at November 10, 1998
VERTEX PHARMACEUTICALS INCORPORATED INDEX <TABLE> <CAPTION> Page -------- <S> <C> Part I. - Financial Information Item 1. Condensed Consolidated Financial Statements Report of Independent Accountants 3 Condensed Consolidated Balance Sheets - September 30, 1998 and December 31, 1997 4 Condensed Consolidated Statements of Operations - Three Months Ended September 30, 1998 and 1997 5 Condensed Consolidated Statements of Operations - Nine Months Ended September 30, 1998 and 1997 6 Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 1998 and 1997 7 Notes to Condensed Financial Statements 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Part II. - Other Information 15 Signatures 16 </TABLE> 2
Report of Independent Accountants To the Board of Directors and Stockholders of Vertex Pharmaceuticals Incorporated: We have reviewed the condensed consolidated balance sheet of Vertex Pharmaceuticals Incorporated as of September 30, 1998, and the related condensed consolidated statements of operations and cash flows for the three month and nine month periods ended September 30, 1998 and 1997. These financial statements are the responsibility of the company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet as of December 31, 1997, and the related consolidated statements of operations, stockholders' equity, and cash flows for the year then ended (not presented herein); and in our report dated February 23, 1998, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 1997, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. PricewaterhouseCoopers LLP Boston, Massachusetts October 21, 1998 3
VERTEX PHARMACEUTICALS INCORPORATED CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands) (Unaudited) <TABLE> <CAPTION> September 30, December 31, 1998 1997 -------------- -------------- <S> <C> <C> ASSETS Current assets: Cash and cash equivalents $ 49,652 $ 71,454 Short-term investments 209,261 208,217 Prepaid expenses and other current assets 1,972 1,952 ----------- --------- Total current assets 260,885 281,623 Restricted cash 2,316 2,316 Property and equipment, net 13,709 11,095 Other assets 961 570 ----------- --------- Total assets $ 277,871 $ 295,604 ----------- --------- ----------- --------- LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Obligations under capital lease and debt $ 2,840 $ 2,510 Accounts payable and accrued expenses 8,320 10,632 Deferred revenue -- 556 ----------- --------- Total current liabilities 11,160 13,698 ----------- --------- Obligations under capital leases and debt, excluding current portion 7,629 5,905 ----------- --------- Total liabilities 18,789 19,603 ----------- --------- Stockholders' equity: Common stock 253 252 Additional paid-in capital 394,373 392,372 Accumulated other comprehensive income 1,720 152 Accumulated deficit (137,264) (116,775) ----------- --------- Total stockholders' equity 259,082 276,001 ----------- --------- Total liabilities and stockholders' equity $ 277,871 $ 295,604 ----------- --------- ----------- --------- </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. 4
VERTEX PHARMACEUTICALS INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share data) <TABLE> <CAPTION> Three Months Ended September 30, -------------------------------- 1998 1997 -------- ------- <S> <C> <C> Revenues: Collaborative and other research and development $ 14,633 $ 9,739 Investment income 3,784 3,808 --------- -------- Total revenues 18,417 13,547 --------- -------- Costs and expenses: Research and development 15,741 16,449 General and administrative 4,772 2,813 Interest 177 141 --------- -------- Total costs and expenses 20,690 19,403 --------- -------- Net loss $ (2,273) $ (5,856) --------- -------- --------- -------- Basic and diluted net loss per common share $ (0.09) $ (0.23) --------- -------- --------- -------- Basic and diluted weighted average number of common shares outstanding 25,308 25,119 --------- -------- --------- -------- </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. 5
VERTEX PHARMACEUTICALS INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share amounts) <TABLE> <CAPTION> Nine Months Ended September 30, -------------------------------- 1998 1997 --------- -------- <S> <C> <C> Revenues: Collaborative and other research and development $ 21,053 $ 22,719 Investment income 11,685 9,901 --------- --------- Total revenues 32,738 32,620 --------- --------- Costs and expenses: Research and development 40,554 37,561 General and administrative 12,189 7,654 Interest 484 438 --------- --------- Total costs and expenses 53,227 45,653 --------- --------- Net loss $(20,489) $ (13,033) --------- --------- --------- --------- Basic and diluted net loss per common share $ (0.81) $ (0.54) --------- --------- --------- --------- Basic and diluted weighted average number of common shares outstanding 25,282 23,950 --------- --------- --------- --------- </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. 6
VERTEX PHARMACEUTICALS INCORPORATED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands) <TABLE> <CAPTION> Nine months ended September 30, ------------------------------- 1998 1997 --------- --------- <S> <C> <C> Cash flows from operating activities: Net loss $ (20,489) $ (13,033) Adjustment to reconcile net loss to net cash used by operating activities: Depreciation and amortization 3,116 2,565 Changes in assets and liabilities: Prepaid expenses and other current assets (20) (392) Accounts payable and accrued expenses (2,312) 4,379 Deferred revenue (556) 556 --------- --------- Net cash provided (used) by operating activities (20,261) (5,925) --------- --------- Cash flows from investing activities: Short-term investments 514 (10,468) Expenditures for property and equipment (5,730) (4,084) Other assets (391) (393) --------- --------- Net cash provided (used) by investing activities (5,607) (14,945) --------- --------- Cash flows from financing activities: Proceeds from public offering of common stock -- 148,810 Proceeds from private placement of common stock -- 10,000 Other issuances of common stock 2,002 4,776 Proceeds from equipment sale/leaseback 4,084 1,855 Repayment of capital lease obligations (2,030) (2,217) --------- --------- Net cash provided (used) by financing activities 4,056 163,224 --------- --------- Effect of exchange rate changes on cash 10 (14) --------- --------- Increase (decrease) in cash and cash equivalents (21,802) 142,340 Cash and cash equivalents at beginning of period 71,454 34,851 --------- --------- Cash and cash equivalents at end of period $ 49,652 $ 177,191 --------- --------- --------- --------- </TABLE> The accompanying notes are an integral part of these condensed consolidated financial statements. 7
VERTEX PHARMACEUTICALS INCORPORATED NOTES TO CONDENSED FINANCIAL STATEMENTS 1. Basis of Presentation The accompanying condensed consolidated financial statements are unaudited and have been prepared by the Company in accordance with generally accepted accounting principles. 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 adjustments (including normal recurring accruals) necessary for a fair statement of the results for the interim periods ended September 30, 1998 and 1997. 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 ended December 31, 1998. These interim financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 1997, which are contained in the Company's 1997 Annual Report to its shareholders and in its Form 10-K filed with the Securities and Exchange Commission. 2. Cash and Cash Equivalents For purposes of the statement of cash flows, the Company considers all highly liquid investments with maturities of three months or less at the date of purchase to be cash equivalents. Changes in cash and cash equivalents may be affected by shifts in investment portfolio maturities as well as by actual net cash receipts or disbursements. 3. Basic and Diluted Loss per Common Share Basic earnings per share is based upon the weighted average number of common shares outstanding during the period. Diluted earnings 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 is not anti-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. Common equivalent shares have not been included in the per share calculations as the effect would be anti-dilutive. Potential common equivalent shares consist of 5,311,300 stock options outstanding with a weighted average exercise price of $22.15 as of September 30, 1998. 8
VERTEX PHARMACEUTICALS INCORPORATED NOTES TO CONDENSED FINANCIAL STATEMENTS 4. Comprehensive Income The Company has adopted SFAS No. 130, "Reporting Comprehensive Income," which requires that all components of comprehensive income and total comprehensive income be reported and that changes be shown in a financial statement displayed with the same prominence as other financial statements. The Company has elected to disclose this information in its statement of stockholders' equity. For the nine months ended September 30, 1998 and 1997 total comprehensive loss was as follows (in thousands): <TABLE> <CAPTION> September 30, 1998 September 30, 1997 ------------------- ------------------ <S> <C> <C> Net loss $ (20,489) $ (13,033) Other comprehensive income (loss): Unrealized holding gains (losses) on investments 1,559 116 Foreign currency translation adjustment 10 (14) --------- --------- Total other comprehensive income (loss) 1,569 102 --------- --------- Total comprehensive loss $ (18,920) $ (12,931) --------- --------- --------- --------- </TABLE> 5. Subsequent Event In October 1998, the Company earned a $3,000,000 milestone payment from Glaxo Wellcome on the submission of a New Drug Application (NDA) for the new HIV protease inhibitor Agenerase-TM- (amprenavir). 6. Recent Collaborative Agreements In August 1998, the Company and Schering AG, Germany entered into an agreement to collaborate on the research, development and commercialization of novel, orally active neurophilin compounds to promote nerve regeneration for the treatment of a number of neurological diseases. Under the terms of the agreement, Schering AG will pay the Company up to $88,000,000 composed of a $6,000,000 upfront license payment paid in September 1998, $22,000,000 of product research funding over five years and $60,000,000 of development and commercialization milestone payments. Under terms of the agreement, Vertex and Schering AG will have an equal role in management of neurophilin research and product development. In North America, Vertex will have manufacturing rights, and Vertex and Schering AG will share equally in the marketing expenses and profits from commercialized compounds. In addition to having manufacturing rights in North America, the Company retains the option to manufacture bulk drug substance for sales and marketing in territories outside Europe, the Middle East and Africa. Schering AG will have the right to manufacture and market any commercialized compounds in Europe, the Middle East and Africa, and pay Vertex a royalty on product sales. Schering AG has the right to terminate the research agreement without cause upon three months' notice after December 1998, but will be obligated to make the payments for the period January to December 1999. After December 2000, Schering AG has the right to terminate without cause upon a six months' written notice. 9
7. Recently Issued Accounting Standards In July 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," which is effective for fiscal years beginning after December 15, 1997. The interim reporting disclosures are not required in the first year of adoption. SFAS 131 specifies revised guidelines for determining an entity's operating segments and the type and level of financial information to be disclosed. SFAS 131 changes current practice under SFAS No. 14 by establishing a new framework on which to base segment reporting. The "management" approach expands the required disclosures for each segment. The Company will adopt SFAS 131 in the fourth quarter ending December 31, 1998 and has not yet determined the impact of such adoption on its segment reporting. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999. SFAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and if it is, the type of hedge transaction. The Company is currently assessing the impact of this SFAS 133 does not believe that it will have a material impact on the financial statements. 8. Legal Proceedings Chiron Corporation ("Chiron") filed suit on July 30, 1998 against the Company and Eli Lilly and Company in the United States District Court for the Northern District of California, alleging infringement by the defendants of various U.S. patents issued to Chiron. The infringement action relates to research activities by the defendants in the hepatitis C viral protease field and the alleged use of inventions claimed by Chiron in connection with that research and development. Chiron has requested damages in an unspecified amount, as well as an order permanently enjoining the defendants from unlicensed use of Chiron inventions. The Company intends to vigorously contest the action. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion contains forward-looking statements which are subject to certain risks and uncertainties that can cause actual results to differ materially from those described. Factors that may cause such differences include but are not limited to those described in the section of the Company's annual report on Form 10-K entitled "Risk Factors." Readers are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Company undertakes no obligation to publicly update or revise these forward-looking statements to reflect events or circumstances after the date hereof. Since its inception in 1989, the Company has been engaged in the discovery, development and commercialization of novel, small molecule pharmaceuticals for the treatment of major diseases for which there are currently limited or no effective treatments. The Company is a leader in the use of structure-based drug design, an approach to drug discovery that integrates advanced biology, biophysics and chemistry. The company is conducting research and development programs to develop pharmaceuticals for the treatment of viral diseases, multidrug resistance in cancer, autoimmune and inflammatory diseases and neurodegenerative disorders. 10
To date, the Company has not received any revenues from the sale of pharmaceutical products. The Company's lead product candidate, Agenerase-TM-(amprenavir) for the treatment of HIV infection, is presently undergoing Phase III clinical trials. A New Drug Application ("NDA") was submitted to the U.S. Food and Drug Administration in October 1998, and equivalent applications were subsequently submitted to Canadian and European regulatory agencies. If the clinical trials are concluded successfully and if the NDA is approved by the FDA, and product sales commence, the Company will receive a royalty on sales of Agenerase-TM- by its partner Glaxo Wellcome plc ("Glaxo Wellcome"). However, there can be no assurance that Phase III clinical trials will be successfully completed, or that marketing approval will be granted by the FDA. The Company has incurred operating losses since its inception and expects to incur a loss in 1998. The Company believes that operating losses may continue for the next several years even if significant royalties are realized on Agenerase-TM- sales because the Company is planning to make significant investments in research and development for its other potential products. The Company expects that losses will fluctuate from quarter to quarter and that such fluctuations may be substantial. Results of Operations Three Months Ended September 30, 1998 Compared with Three Months Ended September 30, 1997. The Company's total revenues increased to $18,417,000 in the third quarter of 1998 from $13,547,000 in the third quarter of 1997. In the third quarter of 1998, revenues consisted of $14,407,000 under the Company's collaborative agreements, $3,784,000 in investment income and $226,000 in government grants and other revenue. In the third quarter of 1997, the Company received $9,380,000 in revenue from its collaborative agreements, $3,808,000 in investment income and $359,000 from government grants and other revenue. Revenues for the third quarter in 1998 included $9,000,000 of payments from Schering AG, under a new collaboration (the "Schering Agreement") signed in August 1998 to research, develop and commercialize novel, orally active neurophilin compounds that promote nerve growth and repair. The payment included $3,000,000 in research funding for the period from January 1, 1998 to September 30, 1998, and a $6,000,000 license fee. Also in the third quarter 1998, Vertex received a $2,000,000 milestone payment from Kissei Pharmaceutical Co., Ltd. ("Kissei") relating to the selection of Vertex's compound VX-745 as a lead drug development candidate targeting the p38 MAP kinase enzyme. Revenues for the third quarter of 1998 increased even though 1997 third quarter revenues included a $4,000,000 up-front payment and $750,000 in research funding received from Kissei under the collaborative agreement for the Company's p38 MAP kinase program, signed in September 1997, and the reimbursement by Hoechst Marion Roussel ("HMR") of certain costs associated with the Company's ICE program. The Company's total costs and expenses increased to $20,690,000 in the third quarter of 1998 from $19,403,000 in the third quarter of 1997. Research and development expenses decreased to $15,741,000 in the third quarter of 1998 from $16,449,000 in the third quarter of 1997. In the third quarter of 1998, the Company experienced lower clinical and preclinical development expenses for its MDR program for cancer, the ICE program for inflammatory diseases and the IMPDH program for autoimmune diseases. These decreases were offset in part by headcount growth of the scientific organization and by commencement of research activities at the Company's new U.K. research facility. General and administrative expenses increased to $4,772,000 in the third quarter of 1998 from $2,813,000 in the third quarter of 1997. The increase in general and administrative expenses principally reflects the impact of personnel additions and an increase in marketing activities in preparation for the anticipated launch of Agenerase-TM-. Interest expense increased to $177,000 in the third quarter of 1998 from $141,000 in the third quarter of 1997 due to higher levels of equipment lease financing during the year. The Company expects that research and development as well as general and administrative expenses will continue to increase as the Company starts new research projects, advances current clinical and preclinical candidates, and expands its marketing and business development activities. The Company recorded a net loss of $2,273,000 or $0.09 per share in the third quarter of 1998 compared to a net loss of $5,856,000 or $0.23 per share in the third quarter of 1997. 11
Nine Months Ended September 30, 1998 Compared with Nine Months Ended September 30, 1997. The Company's total revenues were $32,738,000 for the nine months ended September 30, 1998 as compared to $32,620,000 for the nine months ended September 30, 1997. In 1998, the Company's revenues consisted of $20,368,000 in collaborative revenues, $11,685,000 in investment income, and $685,000 in government grants and other income. In 1997, the Company's revenues consisted of $21,439,000 earned under the Company's collaborative agreements, $9,901,000 in investment income and $1,280,000 in government grants and other income. While the 1998 first three quarters revenue included $9,000,000 of payments from Schering AG, there was a moderate decline relative to the 1997 period due to the Company's receipt in 1997 of $4,000,000 in development reimbursements from Kissei for a clinical trial of Agenerase-TM-, $3,000,000 of upfront payments from Lilly for the Company's Hepatitis C program and $4,000,000 from Kissei for the p38 MAP Kinase program. The Company's total costs increased to $53,227,000 for the nine months ended September 30, 1998 from $45,653,000 for the nine months ended September 30, 1997. Research and development expenses increased to $40,554,000 in the first three quarters of 1998 from $37,561,000 in the first three quarters of 1997, primarily due to the expansion of the Company's research and development activities. General and administrative expenses increased during the first three quarters of 1998 to $12,189,000 from $7,654,000 in the first three quarters of 1997 due primarily to increases in personnel and professional expenses, particularly in preparation for the expected market launch of Agenerase-TM- and corporate advertising activities. Interest expense was $484,000 in the first three quarters of 1998, an increase from $438,000 in the first three quarters of 1997 as a result of higher levels of equipment financing during the period. For the reasons stated above, the Company incurred a net loss of $20,489,000 or $0.81 per share in the nine months ended September 30, 1998 compared to a net loss of $13,033,000 or $0.54 per share in the nine months ended September 30, 1997. Liquidity and Capital Resources The Company's operations have been funded principally through strategic collaborative agreements, public offerings and private placements of the Company's equity securities, equipment lease financing, government grants and investment income. The Company expects to incur increased research and development and related supporting expenses and, consequently, may continue to experience losses on a quarterly and annual basis as it continues to develop existing and future compounds and to conduct clinical trials of potential drugs. The Company also expects to incur substantial administrative and commercialization expenditures in the future and additional expenses related to the filing, prosecution, defense and enforcement of patent and other intellectual property rights. The Company expects to finance these substantial cash needs with its existing cash and investments of approximately $258,913,000 at September 30, 1998, together with investment income earned thereon, future payments under its existing collaborative agreements, and facilities and equipment financing. In addition, an NDA for Agenerase-TM- was submitted in October which, if approved, will lead to royalty income. To the extent that funds from these sources are not sufficient to fund the Company's activities, it will be necessary to raise additional funds through public offerings or private placements of securities or new research collaborations for new or existing projects, or other methods of financing. There can be no assurance that such financing will be available on acceptable terms, if at all. The Company believes that its existing cash and investments should be sufficient to meet its anticipated requirements for at least the next two years. The Company's aggregate cash and investments decreased by $20,758,000 during the nine months ended September 30, 1998 to $258,913,000. Cash used by operations, principally to fund research and development activities, was $20,261,000 during the same period. The Company also expended $5,730,000 during this period to acquire property and equipment, principally for research equipment and 12
facilities. During the first three quarters of 1998, the Company entered into equipment financing arrangements in the aggregate amount of $4,084,000 and repaid $2,030,000 of its lease obligations. In addition to the expansion of the research and development activities in the U.S., the Company started the expansion of its U.K. operations to include a research site during the third quarter in 1998. The Company expects that, in general, research and development as well as general and administrative expenses will continue to increase as the Company starts new research projects, advances current clinical and preclinical candidates, and expands its marketing and business development activities. Under the terms of the Schering Agreement, Schering AG will pay the Company up to $88,000,000 composed of a $6,000,000 upfront license payment paid in September 1998, $22,000,000 of product research funding over five years and $60,000,000 of development and commercialization milestone payments. The Company adopted requirements relating to comprehensive income in accordance with the Statement of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive Income". This Statement requires that total comprehensive income be reported and that changes be shown in a financial statement displayed with the same prominence as other financial statements. In July 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information", which is effective for fiscal years beginning after December 15, 1997. The interim reporting disclosures are not required in the first year of adoption. SFAS 131 specifies revised guidelines for determining an entity's operating segments and the type and level of financial information to be disclosed. SFAS 131 changes current practice under SFAS No. 14 by establishing a new framework on which to base segment reporting. The "management" approach expands the required disclosures for each segment. The Company will adopt SFAS 131 in the fourth quarter ended December 31, 1998 and has not yet determined the impact of such adoption on its segment reporting. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 is effective for all fiscal quarters of all fiscal years beginning after June 15, 1999. SFAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivatives are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and if it is, the type of hedge transaction. The Company is currently assessing the impact of this FASB and does not believe that it will have a material impact on the financial statements. Year 2000 The Company is currently assessing the potential impact of the Year 2000 on the processing of date-sensitive information by the Company's computerized information systems and products purchased by the Company. The Company's review includes its own computer systems and software ("IT Systems"), embedded systems in its non-computer equipment ("Non-IT Systems"), and relationships with certain third parties. The Company has completed its evaluation of its business critical IT Systems and has determined the actions necessary in order to ensure that such IT Systems will be able to function without disruption with respect to the application of dating systems in the Year 2000. The Company has begun to upgrade, replace and test certain of its IT Systems based on the results of that evaluation. Evaluation of Non-IT Systems for Year 2000 compliance is under way but has not been completed. In addition to risks associated with the Company's own computer systems and equipment, the Company has relationships with, and is to varying degrees dependent upon, a number of third parties that provide goods, services and information to the Company. These include contract manufacturers, suppliers, 13
licensees and licensors, vendors, research partners and financial institutions, whose systems and equipment are outside the control of the Company. If certain of these third parties experience failures in their computer systems or equipment due to Year 2000 non-compliance, it could affect the Company's ability to engage in normal business activities. The Company intends to contact its significant vendors and partners to ascertain their Year 2000 compliance and to determine the extent to which the Company is vulnerable to their non-compliance, if any. The Company expects to complete its internal evaluation and remediation efforts and its assessment of third party compliance by mid-1999. However, there can be no assurance that these evaluations and any required remedial actions will be able to be completed on a timely basis. The Company believes that its internal IT Systems and Non-IT Systems are either already Year 2000 compliant or will be so prior to the Year 2000 without incurring material costs. There can be no assurance, however, that the Company will not experience unexpected costs in achieving Year 2000 compliance for its internal systems, which could result in a material adverse effect on the Company's future results of operations. The Company believes that it will be able to locate alternate sources for any critical goods or services provided by non-compliant third parties, if any. However, the Company may not be able to timely develop or implement contingency plans to address those business critical systems and third party relationships which may not be Year 2000 compliant. 14
PART II. OTHER INFORMATION Item 1. Legal Proceedings: Chiron Corporation ("Chiron") filed suit on July 30, 1998 against the Company and Eli Lilly and Company in the United States District Court for the Northern District of California, alleging infringement by the defendants of various U.S. patents issued to Chiron. The infringement action relates to research activities by the defendants in the hepatitis C viral protease field and the alleged use of inventions claimed by Chiron in connection with that research and development. Chiron has requested damages in an unspecified amount, as well as an order permanently enjoining the defendants from unlicensed use of Chiron inventions. The Company intends to vigorously contest the action. Item 2. Changes in Securities: None Item 3. Defaults Upon Senior Securities: None Item 4. Submission of Matters to a Vote of Security Holders: None Item 5. Other Information: None Item 6. Exhibits: 10.1 Research Agreement dated August 24, 1998 between the Company and Schering AG. (Filed herewith with certain confidential information omitted. The omitted portions have been filed separately with the Securities and Exchange Commission pursuant to a request for confidential treatment.) 27 Financial Data Schedule. (Exhibit 27 is submitted as an exhibit only in the electronic format of this Quarterly Report on Form 10-Q submitted to the Securities and Exchange Commission.) 99 Letter of Independent Accountants Reports on Form 8-K: None 15
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. VERTEX PHARMACEUTICALS INCORPORATED Date: November 13, 1998 /s/ Thomas G. Auchincloss ------------------------- Thomas G. Auchincloss, Jr. Vice President of Finance and Treasurer (Principal Financial Officer) Date: November 13, 1998 /s/ Hans D. van Houte -------------------------------------- Hans D. van Houte Controller (Principal Accounting Officer) 16