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Genzyme 10-Q 2010 Documents found in this filing:
UNITED STATES
FORM 10-Q
Commission File No. 0-14680 GENZYME CORPORATION
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 ý No o Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No o Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes o No ý Number of shares of Genzyme Stock outstanding as of July 31, 2010: 254,839,847
NOTE TO UPDATE SECOND QUARTER EARNINGS RELEASE On July 21, 2010, we issued a press release containing our financial results for the three month period ended June 30, 2010, which we furnished as an exhibit to a Current Report on Form 8-K prior to hosting a conference call. Subsequent to July 21, 2010, we identified additional inventories that did not meet our quality specifications. Our decision to discard these inventories has resulted in a second quarter write off of $6.5 million in addition to the $21.9 million write off previously reported. As a result, our second quarter net loss is $(3.8) million or $(0.01) per diluted share, compared with net income of $23.0 thousand or $0.00 per diluted share reported on July 21, 2010. NOTE REGARDING REFERENCES TO GENZYME Throughout this Form 10-Q, the words "we," "us," "our" and "Genzyme" refer to Genzyme Corporation as a whole, and "our board of directors" refers to the board of directors of Genzyme Corporation. NOTE REGARDING FORWARD-LOOKING STATEMENTS This Form 10-Q contains forward-looking statements. These forward-looking statements include, among others, statements regarding:
2 Table of Contents
These statements are subject to risks and uncertainties, and our actual results may differ materially from those that are described in this report. These risks and uncertainties include:
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We refer to more detailed descriptions of these and other risks and uncertainties under the heading "Risk Factors" in Management's Discussion and Analysis of Genzyme Corporation and Subsidiaries' Financial Condition and Results of Operations in Part I., Item 2. of this Form 10-Q. We encourage you to read those descriptions carefully. We caution investors not to place substantial reliance on the forward-looking statements contained in this Form 10-Q. These statements, like all statements in this Form 10-Q, speak only as of the date of this report (unless another date is indicated), and we undertake no obligation to update or revise the statements in light of future developments. 4 NOTE REGARDING INCORPORATION BY REFERENCE The United States Securities and Exchange Commission, commonly referred to as the SEC, allows us to disclose important information to you by referring you to other documents we have filed with them. The information that we refer you to is "incorporated by reference" into this Form 10-Q. Please read that information. NOTE REGARDING TRADEMARKS Genzyme®, Cerezyme®, Fabrazyme®, Thyrogen®, Myozyme®, Renagel®, Renvela®, Campath®, Clolar®, Evoltra®, Mozobil®, Thymoglobulin®, Cholestagel®, Synvisc®, Synvisc-One®, Sepra®, Seprafilm®, Carticel®, Epicel®, MACI®, Hectorol® and Jonexa® are registered trademarks, and Lumizyme™ is a trademark, of Genzyme or its subsidiaries. Welchol® is a registered trademark of Sankyo Pharma, Inc. Aldurazyme® is a registered trademark of BioMarin/Genzyme LLC. Elaprase® is a registered trademark of Shire Human Genetic Therapies, Inc. Prochymal® and Chondrogen® are registered trademarks of Osiris Therapeutics, Inc. Fludara® and Leukine® are registered trademarks licensed to Genzyme. All other trademarks referred to in this Form 10-Q are the property of their respective owners. All rights reserved. 5
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ITEM 1. FINANCIAL STATEMENTS
Consolidated Statements of Operations (Unaudited, amounts in thousands, except per share amounts)
The accompanying notes are an integral part of these unaudited, consolidated financial statements. 7
Consolidated Balance Sheets (Unaudited, amounts in thousands, except par value amounts)
The accompanying notes are an integral part of these unaudited, consolidated financial statements. 8
The accompanying notes are an integral part of these unaudited, consolidated financial statements. 9
1. Description of Business We are a global biotechnology company dedicated to making a major impact on the lives of people with serious diseases. Our products and services are focused on rare inherited disorders, kidney disease, orthopaedics, cancer, transplant and immune disease, and diagnostic testing. Our commitment to innovation continues today with a substantial development program focused on these fields, as well as multiple sclerosis, or MS, cardiovascular disease, neurodegenerative diseases, and other areas of unmet medical need. We are organized into five financial reporting units, which we also consider to be our reporting segments:
Effective January 1, 2010, based on changes in how we review our business, we re-allocated certain of our business units among our segments and adopted new names for certain of our reporting segments. Specifically:
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Notes to Unaudited, Consolidated Financial Statements (Continued) 1. Description of Business (Continued) "Other," but no longer includes our MS business unit, which is now reported as a separate reporting segment called "Multiple Sclerosis." We report the activities of the following business units under the caption "Other": our genetic testing business unit, which provides testing services for the oncology, prenatal and reproductive markets; and our diagnostic products and pharmaceutical intermediates business units. These operating segments did not meet the quantitative threshold for separate segment reporting. We report our corporate, general and administrative operations and corporate science activities under the caption "Corporate." We have revised our 2009 segment disclosures to conform to our 2010 presentation. In May 2010, we announced that we plan to pursue strategic alternatives for our genetic testing, diagnostic products and pharmaceutical intermediates business units. Possible alternatives include divestiture, spin-out or management buy-out. Our genetic testing business unit had revenue of approximately $371 million for the year ended December 31, 2009 and approximately $183 million for the six months ended June 30, 2010. Our diagnostic products business unit had revenue of approximately $167 million for the year ended December 31, 2009 and approximately $76 million for the six months ended June 30, 2010. Revenue from our pharmaceutical intermediates business unit for the same periods was significantly less in comparison. 2. Basis of Presentation and Significant Accounting Policies Basis of Presentation Our unaudited, consolidated financial statements for each period include the statements of operations, balance sheets and statements of cash flows for our operations taken as a whole. We have eliminated all intercompany items and transactions in consolidation. We have reclassified certain 2009 data to conform to our 2010 presentation. We prepare our unaudited, consolidated financial statements following the requirements of the SEC for interim reporting. As permitted under these rules, we condense or omit certain footnotes and other financial information that are normally required by accounting principles generally accepted in the United States, or U.S. GAAP. These financial statements include all normal and recurring adjustments that we consider necessary for the fair presentation of our financial position and results of operations. Since these are interim financial statements, you should also read our audited, consolidated financial statements and notes included in Exhibit 99 to our Form 8-K filed with the SEC on June 14, 2010. Revenues, expenses, assets and liabilities can vary from quarter to quarter. Therefore, the results and trends in these interim financial statements may not be indicative of results for future periods. The balance sheet data as of December 31, 2009 that is included in this Form 10-Q was derived from our audited financial statements but does not include all disclosures required by U.S. GAAP. Our unaudited, consolidated financial statements for each period include the accounts of our wholly owned and majority owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. We account for our investments in entities not subject to consolidation using the equity method of accounting if we have a substantial ownership interest (20% to 50%) in or exercise significant influence over the entity. Our consolidated net income (loss) includes our share of the earnings or losses of these entities. From January 1, 2008 to December 31, 2009 we consolidated the results of BioMarin/Genzyme LLC, an entity we formed with BioMarin Pharmaceutical Inc., or BioMarin, in 1998, because we determined that we were the primary beneficiary of BioMarin/Genzyme LLC. Upon consolidation of the entity, we recorded the assets and liabilities of BioMarin/ 11
Notes to Unaudited, Consolidated Financial Statements (Continued) 2. Basis of Presentation and Significant Accounting Policies (Continued) Genzyme LLC in our consolidated balance sheets at fair value. Effective January 1, 2010, in accordance with new guidance we adopted for consolidating variable interest entities, we no longer consolidate the results of BioMarin/Genzyme LLC because we determined that the entity does not have a primary beneficiary under the new guidance. As a result, we deconsolidated BioMarin/Genzyme LLC and no longer record the assets and liabilities in our consolidated balance sheets. Instead, effective January 1, 2010, we began to record our portion of BioMarin/Genzyme LLC's results in equity in loss of equity method investments in our consolidated statements of operations. Revenue Recognition—Recent Healthcare Reform Legislation In March 2010, healthcare reform legislation was enacted in the United States, which contains several provisions that impact our business. Although many provisions of the new legislation do not take effect immediately, several provisions became effective in the first quarter of 2010. These include:
These provisions did not have a significant impact on our results of operations or financial position for the six months ended June 30, 2010. Effective October 1, 2010, the new legislation re-defines the Medicaid average manufacturer price, or AMP, such that the AMP and, consequently, the Medicaid rebate are expected to increase for some of our drugs, in particular those that offer discounted pricing to customers. Beginning in 2011, the new law requires that drug manufacturers provide a 50% discount to Medicare beneficiaries whose prescription drug costs cause them to be subject to the Medicare Part D coverage gap, which is known as the "donut hole." Also beginning in 2011, clinical laboratory fee schedule payments will be reduced by 1.75% over a period of five years and we will be required to pay our share of a new fee assessed on all branded prescription drug manufacturers and importers. This fee will be calculated based upon each organization's percentage share of total branded prescription drug sales to U.S. government programs (such as Medicare and Medicaid, the Department of Veterans Affairs, or VA, the Department of Defense, or DOD, and the TriCare retail pharmacy discount programs) made during the previous year. Sales of orphan drugs, however, are not included in the fee calculation. Final guidance relating to how we will be required to account for this fee is still pending, however, it is expected that the fee will be classified as either a reduction to net sales or an operating expense. 12
Notes to Unaudited, Consolidated Financial Statements (Continued) 2. Basis of Presentation and Significant Accounting Policies (Continued) Presently, uncertainty exists as many of the specific determinations necessary to implement this new legislation have yet to be decided and communicated to industry participants. We are still assessing the full extent that the U.S. healthcare reform legislation may have on our business. Accounts Receivable Related to Sales in Greece Total accounts receivable in our consolidated balance sheets includes approximately $57 million, net of reserves, as of both June 30, 2010 and December 31, 2009 of accounts receivable held by our subsidiary in Greece related to sales to government-owned or supported healthcare facilities in Greece. These sales are subject to significant payment delays due to government funding and reimbursement practices. We believe that this is an industry-wide issue for suppliers to these facilities. In May 2010, the government of Greece announced a plan for repayment of its debt to international pharmaceutical companies, which calls for immediate payment of accounts receivable balances that were established in 2005 and 2006. For accounts receivable established between 2007 and 2009, the government of Greece will issue non-interest bearing bonds, expected to be exchange tradable, with maturities ranging from 2 to 4 years. We recorded a charge of $7.2 million to bad debt expense, a component of selling, general and administrative expenses, or SG&A, in our consolidated statements of operations for the three and six months ended June 30, 2010 to write down the accounts receivable balances held by our subsidiary in Greece to present value using a 10% discount rate. In conjunction with this plan, the government of Greece also instituted price decreases of between 20% and 27% for all future pharmaceutical product sales. Because our customers in Greece are government owned or supported, we may also be impacted by declines in sovereign credit ratings or sovereign debt defaults. The government of Greece has recently required financial support from both the European Union and the International Monetary Fund, or IMF, to avoid defaulting on its sovereign debt. If significant additional changes occur in the availability of government funding in Greece, we may not be able to collect on amounts due from these customers. We do not expect this concentration of credit risk to have a material adverse impact on our financial position or liquidity. Stock-Based Compensation All stock-based awards to non-employees are accounted for at their fair value. We periodically grant awards, including time vesting stock options, time vesting restricted stock units, or RSUs, and performance vesting restricted stock units, or PSUs, under our employee and director equity plans. Beginning in 2010, our long-term incentive program for senior executives includes a combination of:
Approximately half of each senior executive's grant consists of time vesting stock options with the remainder in PSUs. Grants under our former long-term incentive program were comprised of time vesting stock options and time vesting RSUs. We record the estimated fair value of awards granted as stock-based compensation expense in our consolidated statements of operations over the requisite service period, which is generally the vesting period. Where awards are made with non-substantive vesting periods, such as where a portion of the award vests upon retirement eligibility, we estimate and recognize expense based on the period from the grant date to the date on which the employee is retirement eligible. 13
Notes to Unaudited, Consolidated Financial Statements (Continued) 2. Basis of Presentation and Significant Accounting Policies (Continued) The fair values of our:
Recent Accounting Pronouncements Periodically, accounting pronouncements and related information on the adoption, interpretation and application of U.S. GAAP are issued or amended by the Financial Accounting Standards Board, or FASB, or other standard setting bodies. Changes to the FASB Accounting Standards Codification™, or ASC, are communicated through Accounting Standards Updates, or ASUs. The following table shows FASB ASUs recently issued that could affect our disclosures and our position for adoption:
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Notes to Unaudited, Consolidated Financial Statements (Continued) 2. Basis of Presentation and Significant Accounting Policies (Continued)
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Notes to Unaudited, Consolidated Financial Statements (Continued) 3. Fair Value Measurements A significant number of our assets and liabilities are carried at fair value. These include:
Fair Value Measurement—Definition and Hierarchy Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (i.e., the "exit price") in an orderly transaction between market participants at the measurement date. In determining fair value, we are permitted to use various valuation approaches, including market, income and cost approaches. We are required to follow an established fair value hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the observable inputs be used when available. The fair value hierarchy is broken down into three levels based on the reliability of inputs. We have categorized our fixed income, equity securities, derivatives and contingent consideration obligations within the hierarchy as follows:
Valuation Techniques Fair value is a market-based measure considered from the perspective of a market participant who would buy the asset or assume the liability rather than our own specific measure. All of our fixed income securities are priced using a variety of daily data sources, largely readily-available market data and broker quotes. To validate these prices, we compare the fair market values of our fixed income investments using market data from observable and corroborated sources. We also perform the fair value calculations for our derivatives and equity securities using market data from observable and corroborated sources. We determine the fair value of the contingent consideration obligations based on 16
Notes to Unaudited, Consolidated Financial Statements (Continued) 3. Fair Value Measurements (Continued) a probability-weighted income approach. The measurement is based on significant inputs not observable in the market. In periods of market inactivity, the observability of prices and inputs may be reduced for certain instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or from Level 2 to Level 3. During the six months ended June 30, 2010, none of our instruments were reclassified between Level 1, Level 2 or Level 3. The following tables set forth our assets and liabilities that were accounted for at fair value on a recurring basis as of June 30, 2010 and December 31, 2009 (amounts in thousands):
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Notes to Unaudited, Consolidated Financial Statements (Continued) 3. Fair Value Measurements (Continued)
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Notes to Unaudited, Consolidated Financial Statements (Continued) 3. Fair Value Measurements (Continued) Changes in the fair value of our Level 3 contingent consideration obligations during the six months ended June 30, 2010 were as follows (amounts in thousands):
In June 2010, we issued $500.0 million aggregate principal amount of our 3.625% senior notes due in June 2015, which we refer to as our 2015 Notes, and $500.0 million aggregate principal amount of our 5.000% senior notes due in June 2020, which we refer to as our 2020 Notes, and, together with our 2015 Notes, as the Notes, as described in Note 11., "Long-Term Debt," to these consolidated financial statements. As of June 30, 2010 our:
The fair values of our 2015 Notes and 2010 Notes were determined through a market-based approach using observable and corroborated sources; within the hierarchy of fair value measurements, these are classified as Level 2 fair values. The carrying amounts reflected in our consolidated balance sheets for cash, accounts receivable, other current assets, accounts payable, accrued expenses, current portion of contingent consideration obligations and current portion of long-term debt and capital lease obligations approximate fair value due to their short-term maturities. Derivative Instruments As a result of our worldwide operations, we face exposure to adverse movements in foreign currency exchange rates. Exposures to currency fluctuations that result from sales of our products in foreign markets are partially offset by the impact of currency fluctuations on our international expenses. We may also use derivatives, primarily foreign exchange forward contracts for which we do not apply hedge accounting treatment, to further reduce our exposure to changes in exchange rates, primarily to offset the earnings effect from short-term foreign currency assets and liabilities. We account for such derivatives at market value with the resulting gains and losses reflected within SG&A in our consolidated statements of operations. We do not have any derivatives designated as hedging instruments and we do not use derivative instruments for trading or speculative purposes. 19
Notes to Unaudited, Consolidated Financial Statements (Continued) 3. Fair Value Measurements (Continued) Foreign Exchange Forward Contracts Generally, we enter into foreign exchange forward contracts with maturities of not more than 15 months. All foreign exchange forward contracts in effect as of June 30, 2010 and December 31, 2009 had maturities of 1 to 2 months. We report these contracts on a net basis. Net asset derivatives are included in other current assets and net liability derivatives are included in accrued expenses in our consolidated balance sheets. The following table summarizes the balance sheet classification of the fair value of these derivatives on both a gross and net basis as of June 30, 2010 and December 31, 2009 (amounts in thousands):
Total foreign exchange (gains) and losses included in SG&A in our consolidated statements of operations includes unrealized and realized (gains) and losses related to both our foreign exchange forward contracts and our foreign currency assets and liabilities. The net impact of our overall unrealized and realized foreign exchange (gains) and losses for both the three and six months ended June 30, 2010 and 2009 was not significant. The following table summarizes the effect of the unrealized and realized net (gains)/losses related to our foreign exchange forward contracts on our consolidated statements of operations for the three and six months ended June 30, 2010 and 2009 (amounts in thousands):
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Notes to Unaudited, Consolidated Financial Statements (Continued) 4. Net Income (Loss) Per Share The following table sets forth our computation of basic and diluted net income (loss) per common share (amounts in thousands, except per share amounts):
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Notes to Unaudited, Consolidated Financial Statements (Continued) 5. Comprehensive Income (Loss) The components of comprehensive income (loss) for the periods presented are as follows (amounts in thousands):
6. Strategic Transactions Purchase of In-Process Research and Development The following table sets forth the significant in-process research and development, or IPR&D, projects for the companies and assets we acquired between January 1, 2006 and June 30, 2010 (amounts in millions):
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Notes to Unaudited, Consolidated Financial Statements (Continued) 6. Strategic Transactions (Continued)
Pro Forma Financial Summary The following pro forma financial summary is presented as if the acquisition from Bayer was completed as of January 1, 2009. The pro forma combined results are not necessarily indicative of the actual results that would have occurred had the acquisition been consummated on that date, or of the future operations of the combined entities. Material nonrecurring charges related to this acquisition, such as a gain on acquisition of business of $24.2 million, are included in the pro forma financial summaries for the period presented (amounts in thousands, except per share amounts):
7. Inventories
Manufacturing-Related Charges Cerezyme and Fabrazyme In order to build a small inventory buffer to help us more consistently manage the resupply of Cerezyme to patients and reduce interruptions in shipping that occur in the absence of inventory, we began shipping Cerezyme to meet 50% of estimated product demand at the end of February 2010. Although we achieved our goal of building a small inventory buffer during the first quarter of 2010, we continued shipping at 50% of demand level due to an interruption in operations at our Allston facility 23
Notes to Unaudited, Consolidated Financial Statements (Continued) 7. Inventories (Continued) at the end of March 2010. The interruption resulted from an unexpected city electrical power failure that compounded issues with the plant's water system. Once production resumed, we continued shipping at the 50% demand level through the end of the second quarter of 2010. We supplied approximately the same amount of Cerezyme in July 2010 as we supplied in each of May 2010 and June 2010, and expect that supply will then increase in the following months. However, there will be regional variations when Cerezyme will be available, and in some countries, patients' infusion schedules may need to shift due to short-term shipping delays. Since the fourth quarter of 2009, we have been shipping Fabrazyme to meet approximately 30% of estimated product demand. We have been working to increase the productivity of the Fabrazyme manufacturing process, which has performed at the low end of the historical range since the re-start of production. We have developed a new working cell bank for Fabrazyme that has been approved by the FDA and the European Medicines Agency, or EMA. The new working cell bank has completed three runs and has had 30% greater productivity than the old working cell bank. We expect to continue shipping Fabrazyme at the 30% of demand level through the third quarter and increase shipments of Fabrazyme in the fourth quarter. We recorded $14.9 million of charges for the three months ended and $16.4 million of charges for the six months ended June 30, 2010 to cost of products sold in our consolidated statements of operations to write off Cerezyme and Fabrazyme work-in-process material that was unfinished when the interruption occurred, based on our determination that such material could not be finished, and other inventory for these products that did not meet the necessary quality specifications. We also recorded charges of $6.0 million for the three months and $7.1 million for the six months ended June 30, 2010 to cost of products sold in our consolidated statements of operations to write off certain lots of Thyrogen that did not meet the necessary quality specifications. We capitalize inventory produced for commercial sale, which may result in the capitalization of inventory prior to regulatory approval of a product. If a product is not approved for sale, it would result in the write off of the inventory and a charge to earnings. As of June 30, 2010, the amount of inventory for Fabrazyme related to the new working cell bank that has not yet been approved for sale was not significant. Inventory Subject to Additional Evaluation and Release At any particular period, we may have certain inventory that requires further evaluation or testing to ensure that it meets appropriate quality specifications. As of June 30, 2010, we have approximately $16 million of inventory that is being evaluated or tested, including $6.3 million of Fabrazyme, $3.9 million of Myozyme and $3.6 million of Thymoglobulin. If we determine that this inventory, or any portion thereof, does not meet the necessary quality standards, it would result in a write off of the inventory and a charge to earnings. Sevelamer Hydrochloride and Sevelamer Carbonate We manufacture the majority of our supply requirements for sevelamer hydrochloride (the active ingredient in Renagel) and sevelamer carbonate (the active ingredient in Renvela) at our manufacturing facility in Haverhill, England. In December 2009, equipment failure caused an explosion and fire at this facility, which damaged some of the equipment used to produce these active ingredients 24
Notes to Unaudited, Consolidated Financial Statements (Continued) 7. Inventories (Continued) as well as the building in which the equipment was located. As a result, we temporarily suspended production of sevelamer hydrochloride and sevelamer carbonate at this facility so the damaged equipment could be repaired. We resumed production of sevelamer hydrochloride in May 2010. We anticipate that the facility will resume production of sevelamer carbonate in the fourth quarter of 2010. We believe that we have adequate supply levels to meet the current demand for both Renagel and Renvela and do not anticipate there will be any supply constraints for either product while the facility undergoes repairs. We recorded $6.1 million of expenses, net of $2.4 million of insurance reimbursements, for the three months ended and $13.7 million, net of $5.4 million of insurance reimbursements, for the six months ended June 30, 2010, to cost of products sold in our consolidated statements of operations for Renagel and Renvela related to the remediation cost of our Haverhill, England manufacturing facility, including repairs and idle capacity expenses. We expect to incur approximately $10 million of additional costs related to the remediation of this facility in the third quarter of 2010. 8. Goodwill and Other Intangible Assets The following table contains the change in our goodwill during the six months ended June 30, 2010 (amounts in thousands):
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Notes to Unaudited, Consolidated Financial Statements (Continued) 8. Goodwill and Other Intangible Assets (Continued)
Other Intangible Assets The following table contains information about our other intangible assets for the periods presented (amounts in thousands):
All of our finite-lived other intangible assets are amortized over their estimated useful lives. 26
Notes to Unaudited, Consolidated Financial Statements (Continued) 8. Goodwill and Other Intangible Assets (Continued) As of June 30, 2010, the estimated future amortization expense for our finite-lived other intangible assets for the remainder of fiscal year 2010, the four succeeding fiscal years and thereafter is as follows (amounts in thousands):
9. Investment in BioMarin/Genzyme LLC We and BioMarin have entered into agreements to develop and commercialize Aldurazyme, a recombinant form of the human enzyme alpha-L-iduronidase, used to treat an LSD known as mucopolysaccharidosis, or MPS, I. Under the relationship, an entity we formed with BioMarin in 1998 called BioMarin/Genzyme LLC has licensed all intellectual property related to Aldurazyme and other collaboration products on a royalty-free basis to BioMarin and us. BioMarin holds the manufacturing rights and we hold the global marketing rights. We are required to pay BioMarin a tiered royalty payment ranging from 39.5% to 50% of worldwide net product sales of Aldurazyme. Prior to January 1, 2010, we determined that we were the primary beneficiary of BioMarin/Genzyme LLC and, as a result, we:
Effective January 1, 2010, in accordance with new guidance we adopted for consolidating variable interest entities, we were required to reassess our designation as primary beneficiary of 27
Notes to Unaudited, Consolidated Financial Statements (Continued) 9. Investment in BioMarin/Genzyme LLC (Continued) BioMarin/Genzyme LLC. Under the new guidance, the entity with the power to direct the activities that most significantly impact a variable interest entity's economic performance is the primary beneficiary. We have concluded that BioMarin/Genzyme LLC is a variable interest entity, but does not have a primary beneficiary because the power to direct the activities of BioMarin/Genzyme LLC that most significantly impact its performance, is, in fact, shared equally between us and BioMarin through our commercialization rights and BioMarin's manufacturing rights. Effective January 1, 2010, we no longer consolidate the results of BioMarin/Genzyme LLC and instead record our portion of the results of BioMarin/Genzyme LLC in equity in loss of equity method investments in our consolidated statements of operations. For the three and six months ended June 30, 2010, the results of BioMarin/Genzyme LLC and our portion of the results of BioMarin/Genzyme LLC were not significant. 10. Investment in Isis Pharmaceuticals, Inc. Common Stock We review for potential impairment the carrying value of each of our strategic investments in equity securities on a quarterly basis. The closing price per share of Isis Pharmaceuticals, Inc, or Isis, common stock exhibited volatility during 2009 and the six months ended June 30, 2010 and has remained below our historical cost since September 1, 2009, with closing prices since that date ranging from a high of $15.69 per share to a low of $8.66 per share. We considered all available evidence in assessing the decline in value of our investment in Isis common stock, including investment analyst reports and Isis's expected results and future outlook. However, despite such evidence if the fair value of any of our investments remain below our historical cost for a consecutive nine months, we will generally conclude that it is unclear over what period the stock price of our investment would recover and that any evidence suggesting that the investment would recover to at least our historical cost is not sufficient to overcome the presumption that the current market price is the best indicator of the value of this investment. Accordingly, given the significance and duration of the decline in value of our investment in Isis common stock as of June 30, 2010, we considered the decline in value of this investment to be other than temporary and we recorded a $32.3 million impairment charge to losses on investment in equity securities, net in our consolidated statements of operations for the three and six months ended June 30, 2010. 11. Long-Term Debt 2015 and 2020 Senior Notes In June 2010, we sold $500.0 million aggregate principal amount of our 2015 Notes and $500.0 million aggregate principal amount of our 2020 Notes through institutional private placements to fund the $1.0 billion payment under our accelerated share repurchase agreement, as discussed in Note 12., "Stockholders' Equity," to these consolidated financial statements. We received net proceeds from the sale of the Notes of approximately $986.6 million, after deducting commissions and other expenses related to the offerings. We recorded the net proceeds in our consolidated balance sheets as of June 30, 2010 as:
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Notes to Unaudited, Consolidated Financial Statements (Continued) 11. Long-Term Debt (Continued) Both the debt offering costs and debt discount will be amortized to interest expense in our consolidated statements of operations. The debt offering costs have been allocated proportionately to our 2015 Notes and our 2020 Notes and are being amortized based on the term of each such group of the Notes. The debt discount for each group of the Notes will be amortized using the effective interest method. The 2015 Notes mature in June 2015 and the 2020 Notes mature in June 2020. Interest accrues on the Notes from June 17, 2010 and is payable semi-annually in arrears on June 15 and December 15 of each year starting on December 15, 2010. The Notes are our senior unsecured obligations and rank equally in right of payment with all of our other senior unsecured indebtedness from time to time outstanding. The Notes are fully and unconditionally guaranteed by one of our subsidiaries that also guarantees our indebtedness under our 2006 revolving credit facility. We may redeem the Notes in whole or in part at any time at a redemption price equal to the greater of:
We may be required to offer to repurchase the Notes at a purchase price equal to 101% of their principal amount if we are subject to certain changes of control. Revolving Credit Facility In July 2006, we entered into a five-year $350.0 million senior unsecured revolving credit facility with JPMorgan Chase Bank, N.A., as administrative agent, Bank of America, N.A., as syndication agent, ABN AMRO Bank N.V., Citizens Bank of Massachusetts and Wachovia Bank, National Association, as co-documentation agents, and a syndicate of lenders, which we refer to as our 2006 revolving credit facility. The proceeds of loans under our 2006 revolving credit facility can be used to finance working capital needs and for general corporate purposes. We may request that our 2006 revolving credit facility be increased at any time by up to an additional $350.0 million in the aggregate, subject to the agreement of the lending banks, as long as no default or event of default has occurred or is continuing and certain other customary conditions are satisfied. Borrowings under our 2006 revolving credit facility will bear interest at various rates depending on the nature of the loan. As of June 30, 2010, we had approximately $9 million of outstanding standby letters of credit and no borrowings, resulting in approximately $341 million of available credit under our 2006 revolving credit facility, which matures July 14, 2011. The terms of this credit facility include various covenants, including financial covenants that require us to meet minimum interest coverage ratios and maximum leverage ratios. As of June 30, 2010, we were in compliance with these covenants. 12. Stockholders' Equity Share Repurchase Plan In April 2010, our board of directors authorized a $2.0 billion share repurchase plan consisting of the near-term purchase of $1.0 billion of our common stock to be financed with proceeds of newly issued debt, and the purchase of an additional $1.0 billion of our common stock by June 2011. On 29
Notes to Unaudited, Consolidated Financial Statements (Continued) 12. Stockholders' Equity (Continued) June 17, 2010, we entered into an accelerated share repurchase agreement with Goldman Sachs & Co., or Goldman Sachs, under which we will repurchase $1.0 billion worth of shares of our common stock. Our effective per share purchase price will be based generally on the average of the daily volume weighted average prices per share of our common stock, less a discount, calculated during a period of up to four months. In connection with this agreement, we paid $1.0 billion to Goldman Sachs and received 15.6 million shares, of which:
We recorded the $1.0 billion payment to the bank as a decrease to stockholders' equity in our consolidated balance sheet as of June 30, 2010, consisting of decreases of $0.2 million in common stock and $799.8 million in additional paid-in capital as well as a $200.0 million share purchase contract receivable for the advance payment described above. The total number of shares ultimately repurchased will not be known until the calculation period ends and a final settlement occurs. Upon final settlement, we will either receive a settlement amount of additional shares of our common stock or be required to remit a settlement amount, payable, at our option, in cash or common stock. Shares repurchased under this agreement will be deemed authorized shares that are no longer outstanding. Modification of Certain Stock Options and RSUs On May 26, 2010, in connection with our plan to approve strategic alternatives for our genetic testing, diagnostic products and pharmaceutical intermediates business units, the compensation committee of our board of directors approved certain modifications to the stock options and RSUs previously granted to the employees of those business units, to be effective as of the date of divestiture of each business unit. The post-termination exercise period for these stock options was modified to extend the post-termination exercise period from three months to one year. We used Black-Scholes valuation models, based on the following assumptions, to determine the valuation adjustment required for the extension of the post-termination exercise period, and recorded stock-based compensation expense using an expected term of seven months:
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Notes to Unaudited, Consolidated Financial Statements (Continued) 12. Stockholders' Equity (Continued) Based on our analysis, we recorded an additional $9.1 million of stock-based compensation expense in our consolidated statements of operations for the three months ended June 30, 2010 for the valuation adjustment related to the modification of these stock options. On May 26, 2010, the compensation committee of our board of directors also approved the following modifications to certain RSUs granted to the employees of these three business units, to be effective as of the date of divestiture for each business unit, including:
Prior to these modifications, the RSUs granted in May 2008 had a grant date fair value of $68.48 per share and the RSUs granted in May 2009 had a grant date fair value of $58.66 per share based on the closing price of our common stock at the date of each grant. The modifications triggered a new measurement date for these RSUs and, as a result, we revalued these RSUs based on a new grant date fair value of $50.00 per share, the closing price of our common stock on the date of modification. We recorded a net reduction in stock-based compensation for these RSUs of $(2.9) million in our consolidated statements of operations for the three months ended June 30, 2010 to adjust the cumulative stock-based compensation expense recorded for these RSUs for the modifications, including:
We expect to record approximately $13 million of additional stock-based compensation expense for these RSUs during the second half of 2010 as a result of these modifications. Long-Term Incentive Program for Senior Executives From 2007 through 2009, our long-term incentive program for senior executives was comprised of equity awards in the form of time vesting stock options and time vesting RSUs. Beginning with 2010, the equity vehicles for our long-term incentive program for senior executives includes a combination of:
Approximately half of each senior executive's grant consists of time vesting stock options with the remainder in PSUs. For the 2010 through 2012 performance period, the performance metrics are:
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Notes to Unaudited, Consolidated Financial Statements (Continued) 12. Stockholders' Equity (Continued) Each metric is weighted equally. For both metrics, performance between the threshold level and the target level will be awarded in PSUs. The PSUs will be paid out in shares of our stock at the end of the three-year period if performance between the threshold level and target level is achieved. If performance above the target level is achieved, the portion of the award above the target level will be paid out in cash up to a predetermined maximum cash award. Since it is possible that the PSUs may not pay out at all, it is completely "at risk" compensation. In January 2010, the compensation committee of our board of directors approved a range for the three-year cash flow return on invested capital metric of 85% to 115%. For performance between 85% and 100% of the cash flow return on invested capital target, the payout range is 50% to 100% of the senior executive's target PSU award associated with this performance measure. Performance between 101% and 115% of the cash flow return on invested capital target will result in a cash payment that will be awarded based on performance achieved between target and maximum levels, up to a predetermined maximum. The committee also approved the following performance levels for R-TSR:
For performance between the R-TSR threshold and target levels, the payout range is 35% to 100% of the senior executive's target PSU award associated with this performance measure. R-TSR performance between the target and maximum levels will result in a cash payment that will be awarded based on performance achieved between target and maximum levels, up to a predetermined maximum. If a participating senior executive's employment is terminated before the end of the performance period because of death, disability or retirement, payment of the PSU will be pro-rated to the date of termination based upon the company's actual achievement of performance levels at the end of the performance period. Upon a change in control, payment of a PSU will be paid out at the target performance level and pro-rated to the date of the change of control. PSUs During the six months ended June 30, 2010, we granted a total of 223,066 PSUs with a weighted average grant date fair value of $49.86 per share to senior executives under our 2004 Equity Plan. The PSUs are subject to the attainment of certain performance criteria established at the beginning of the performance period, as described above, and cliff vest at the end of the performance period, which ends December 31, 2012. Compensation expense associated with our PSUs is initially based upon the number of shares expected to vest after assessing the probability that certain performance criteria will be met and the associated targeted payout level that is forecasted will be achieved, net of estimated forfeitures. Compensation expense for our PSUs is recognized over the applicable performance period, adjusted for the effect of estimated forfeitures. The fair value of PSUs subject to the cash flow return on investment performance metric, which includes both performance and service conditions, is estimated based on the market value of our stock on the date of grant. We use a lattice model with a Monte Carlo simulation to determine the fair value 32
Notes to Unaudited, Consolidated Financial Statements (Continued) 12. Stockholders' Equity (Continued) of PSUs subject to the R-TSR performance metric, which includes both market and service conditions. The lattice model requires various highly judgmental assumptions to determine the fair value of the awards. This model samples paths of our stock price and the stock prices of a group of peer companies in the S&P 500 Health Care Index, which we refer to as the Peer Group, and calculates the resulting change in cash flow multiple at the end of the forecasted performance period. This model iterates these randomly forecasted results until the distribution of results converge on a mean or estimated fair value. We used the following assumptions to determine the fair value of these awards:
Stock-Based Compensation Expense, Net of Estimated Forfeitures We allocated pre-tax stock-based compensation expense, net of estimated forfeitures, based on the functional cost center of each employee as follows (amounts in thousands):
We amortize stock-based compensation expense capitalized to inventory based on inventory turns. At June 30, 2010, there was $275.6 million of pre-tax stock-based compensation expense, net of estimated forfeitures, related to unvested awards not yet recognized which is expected to be recognized over a weighted average period of 2.2 years. 33
Notes to Unaudited, Consolidated Financial Statements (Continued) 13. Commitments and Contingencies FDA Consent Decree On May 24, 2010, we entered into a consent decree with the FDA relating to our Allston facility. Under the terms of the consent decree, we will pay an upfront disgorgement of past profits of $175.0 million. Conditioned upon our compliance with the terms of the consent decree, we may continue to ship Cerezyme and Fabrazyme, which are manufactured, filled and finished at the facility, as well as Thyrogen, which is filled and finished at the facility. In the United States, Thyrogen that is filled and finished at the facility will only be distributed based on medical necessity, in accordance with FDA criteria. The consent decree requires us to move our fill-finish operations out of the Allston facility for Thyrogen sold within the United States by November 22, 2010 and for Fabrazyme sold within the United States by November 24, 2010. We must move our fill-finish operations for all products sold outside of the United States by August 31, 2011. If we are not able to meet these deadlines, the FDA can require us to disgorge 18.5% of the revenue from the sale of any products that are filled and finished at the Allston facility after the applicable deadlines. The consent decree also requires us to implement a plan to bring the Allston facility operations into compliance with applicable laws and regulations. The plan must address any deficiencies previously reported to us or identified as part of a comprehensive inspection conducted by a third-party expert, who we are required to retain, and who will monitor and oversee our implementation of the plan. In 2009, we began implementing a comprehensive remediation plan, prepared with assistance from our compliance consultant, The Quantic Group, Ltd., or Quantic, to improve quality and compliance at the Allston facility. We intend to revise that plan to include any additional remediation efforts required in connection with the consent decree as identified by Quantic, who we are retaining as the third-party expert under the consent decree. The plan, as revised, which will be subject to FDA approval, is expected to take approximately 3-4 years to complete and will include a timetable of specified compliance milestones. If the milestones are not met in accordance with the timetable, the FDA can require us to pay $15,000 per day, per affected drug, until these compliance milestones are met. Upon satisfying the compliance requirements in accordance with the terms of the consent decree, we will be required to retain an auditor to monitor and oversee ongoing compliance at the Allston facility for an additional five years. The consent decree is subject to, and effective upon, approval by the U.S. District Court for the District of Massachusetts. The consent decree was filed with the U.S. District Court on May 24, 2010 and we are awaiting the court's approval. Legal Proceedings Federal Securities Litigation In July 2009 and August 2009, two purported securities class action lawsuits were filed in the U.S. District Court for the District of Massachusetts against us and our President and Chief Executive Officer. The lawsuits were filed on behalf of those who purchased our common stock during the period from June 26, 2008 through July 21, 2009 and allege violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. Each of the lawsuits is premised upon allegations that we made materially false and misleading statements and omissions by failing to disclose instances of viral contamination at two of our manufacturing facilities and our receipt of a list of inspection observations from the FDA related to one of the facilities, which detailed observations of practices that the FDA considered to be deviations from good manufacturing practice, or GMP. The plaintiffs seek unspecified damages and reimbursement of costs, including attorneys' and 34
Notes to Unaudited, Consolidated Financial Statements (Continued) 13. Commitments and Contingencies (Continued) experts' fees. In November 2009, the lawsuits were consolidated in In Re Genzyme Corp. Securities Litigation and a lead plaintiff was appointed. In March 2010, the plaintiffs filed a consolidated amended complaint that extended the class period from October 24, 2007 through November 13, 2009. In June 2010, we filed a motion to dismiss the class action. If the action is not dismissed, we intend to defend this lawsuit vigorously. Shareholder Demand Letters Since August 2009, we have received ten letters from shareholders demanding that our board of directors take action on behalf of Genzyme Corporation to remedy alleged breaches of fiduciary duty by our directors and certain executive officers. The demand letters are primarily premised on allegations regarding our disclosures to shareholders with respect to manufacturing issues and compliance with GMP and our processes and decisions related to manufacturing at our Allston facility. Several of the letters also assert that certain of our executive officers and directors took advantage of their knowledge of material non-public information about Genzyme to illegally sell stock they personally held in Genzyme. Our board of directors has designated a special committee of three independent directors to oversee the investigation of the allegations made in the demand letters and to recommend to the independent directors of the board whether any action should be instituted on behalf of Genzyme Corporation against any officer or director. The committee has retained independent legal counsel. If the independent members of our board of directors were to make a determination that it was in our best interest to institute an action against any officers or directors, any monetary recovery would be to the benefit of Genzyme Corporation. The special committee's investigation is ongoing. Shareholder Derivative Actions In December 2009, two actions were filed by shareholders derivatively for Genzyme's benefit in the U.S. District Court for the District of Massachusetts against our board of directors and certain of our executive officers after a ninety day period following their respective demand letters had elapsed (the "District Court Actions"). In January 2010, a derivative action was filed in Massachusetts Superior Court (Middlesex County) by a shareholder who has not issued a demand letter and in February and March 2010, two additional derivative actions were filed in Massachusetts Superior Court (Suffolk County and Middlesex County, respectively) by two separate shareholders after the lapse of a ninety day period following the shareholders' respective demand letters (collectively, the "State Court Actions"). The derivative actions in general are based on allegations that our board of directors and certain executive officers breached their fiduciary duties by causing Genzyme to make purportedly false and misleading or inadequate disclosures of information regarding manufacturing issues, compliance with GMP, ability to meet product demand, expected revenue growth, and approval of Lumizyme. The actions also allege that certain of our directors and executive officers took advantage of their knowledge of material non-public information about Genzyme to illegally sell stock they personally held in Genzyme. The plaintiffs generally seek, among other things, judgment in favor of Genzyme for the amount of damages sustained by Genzyme as a result of the alleged breaches of fiduciary duty, disgorgement to Genzyme of proceeds that certain of our directors and executive officers received from sales of Genzyme stock and all proceeds derived from their service as directors or executives of Genzyme, and reimbursement of plaintiffs' costs, including attorneys' and experts' fees. The District 35
Notes to Unaudited, Consolidated Financial Statements (Continued) 13. Commitments and Contingencies (Continued) Court Actions have been consolidated in In Re Genzyme Derivative Litigation and the plaintiffs have agreed to a joint stipulation staying these cases until our board of directors has had sufficient time to exercise its duties and complete an appropriate investigation, which is ongoing. On July 9, 2010, one of the State Court Actions was dismissed without prejudice for plaintiffs' failure to serve process on the defendants. The Middlesex Court also ordered transfer and consolidation of the remaining two State Court Actions in the Suffolk Superior Court Business Litigation Session. The court has indicated that discovery in that action also will be stayed for some period pending the board of director's completion of its ongoing investigation in response to the shareholders demand. Fabrazyme Patent Litigation In October 2009, Shelbyzyme LLC filed a complaint against us in the U.S. District Court for the District of Delaware alleging infringement of U.S. patent 7,011,831 by "making, using, selling and promoting a method for the treatment of" Fabry disease. The '831 patent, which is directed to a method for treating Fabry disease, was issued in March 2006 and expired in March 2009. The plaintiffs seek damages for past infringement, including treble damages for alleged willful infringement and reimbursement of costs, including attorney's fees. We intend to defend this lawsuit vigorously. Other Matters We are party to a legal action brought by Kayat pending before the District Court in Nicosia, Cyprus. Kayat alleges that we breached a 1996 distribution agreement under which we granted Kayat the right to distribute melatonin tablets in the Ukraine, primarily by not providing products or by providing non-conforming products. Kayat further claims that due to the alleged breach, it suffered lost profits that Kayat claims it would have received under agreements it alleges it had entered into with subdistributors. Kayat also alleges common law fraud and violations of Mass. Gen. L. c. 93A and the Racketeer Influenced and Corrupt Organizations Act. Kayat filed its suit on August 8, 2002 and a trial began in Cyprus in December 2009. Kayat seeks damages for its legal claims and for expenses it claims it has incurred, including legal fees and advertising, promotion and other out-of-pocket expenses. We believe we acted appropriately in all regards, including properly terminating the agreement when we decided to exit the melatonin business, and we intend to defend this lawsuit vigorously. We are not able to predict the outcome of the lawsuits and matters described above or estimate the amount or range of any possible loss we might incur if we do not prevail in final, non-appealable determination of these matters. Therefore, we have not accrued any amounts in connection with the lawsuits and matters described above. We also are subject to other legal proceedings and claims arising in connection with our business. Although we cannot predict the outcome of these proceedings and claims, we do not believe the ultimate resolution of any of these existing matters would have a material adverse effect on our consolidated financial position or results of operations. 36
Notes to Unaudited, Consolidated Financial Statements (Continued) 14. Benefit from (Provision for) Income Taxes
Our effective tax rate for all periods presented varies from the U.S. statutory tax rate as a result of:
In addition, our tax benefit for both the three and six months ended June 30, 2010 includes:
Our benefits from tax provisions for the six months ended June 30, 2010 also includes tax benefits in the amount of $15.2 million as a result of the resolution of tax examinations in major tax jurisdictions. We are currently under audit by various states and foreign jurisdictions for various years. We believe that we have provided sufficiently for all audit exposures. Settlement of these audits or the expiration of the statute of limitations on the assessment of income taxes for any tax year will likely result in a reduction of future tax provisions. Any such benefit would be recorded upon final resolution of the audit or expiration of the applicable statute of limitations. 15. Segment Information We present segment information in a manner consistent with the method we use to report this information to our management. Effective January 1, 2010, based on changes in how we review our business, we re-allocated certain of our business units amongst our segments and adopted new names for certain of our reporting segments. Under the new reporting structure, we are organized into five reporting segments as described above in Note 1., "Description of Business," to these consolidated financial statements. We have revised our 2009 segment disclosures to conform to our 2010 presentation. 37
Notes to Unaudited, Consolidated Financial Statements (Continued) 15. Segment Information (Continued) We have provided information concerning the operations of these reportable segments in the following tables (amounts in thousands):
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Notes to Unaudited, Consolidated Financial Statements (Continued) 15. Segment Information (Continued) Income (loss) before income taxes for our Hematology and Oncology and Multiple Sclerosis reporting segments includes the following contingent consideration expenses (amounts in thousands):
In addition, income (loss) before income taxes for our Multiple Sclerosis reporting segment includes a gain on acquisition of business of $24.2 million for the three and six months ended June 30, 2009 for which there were no comparable amounts in 2010. The fair value of the identifiable assets acquired of $1.03 billion exceeded the fair value of the purchase price for the transaction of $1.01 billion.
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Notes to Unaudited, Consolidated Financial Statements (Continued) 15. Segment Information (Continued) Segment Assets We provide information concerning the assets of our reportable segments in the following table (amounts in thousands):
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF GENZYME CORPORATION AND SUBSIDIARIES' FINANCIAL CONDITION AND RESULTS OF OPERATIONS When reviewing the discussion below, you should keep in mind the substantial risks and uncertainties that characterize our business. In particular, we encourage you to review the risks and uncertainties described under the heading "Risk Factors" below. These risks and uncertainties could cause actual results to differ materially from those forecasted in forward-looking statements or implied by past results and trends. Forward-looking statements are statements that attempt to project or anticipate future developments in our business; we encourage you to review the examples of forward looking statements under "Note Regarding Forward-Looking Statements" at the beginning of this report. These statements, like all statements in this report, speak only as of the date of this report (unless another date is indicated), and we undertake no obligation to update or revise the statements in light of future developments. Note: All references to increases or decreases for the three months ended June 30, 2010 are as compared to the three months ended June 30, 2009. All references to increases or decreases for the six months ended June 30, 2010 are as compared to the six months ended June 30, 2009, unless otherwise noted. INTRODUCTION We are a global biotechnology company dedicated to making a major impact on the lives of people with serious diseases. Our products and services are focused on rare inherited disorders, kidney disease, orthopaedics, cancer, transplant and immune disease, and diagnostic testing. Our commitment to innovation continues today with a substantial development program focused on these fields, as well as MS, cardiovascular disease, neurodegenerative diseases, and other areas of unmet medical need. We are organized into five financial reporting units, which we also consider to be our reporting segments:
41 Effective January 1, 2010, based on changes in how we review our business, we re-allocated certain of our business units among our segments and adopted new names for certain of our reporting segments. Specifically:
We report the activities of the following business units under the caption "Other": our genetic testing business unit, which provides testing services for the oncology, prenatal and reproductive markets; and our diagnostic products and pharmaceutical intermediates business units. These operating segments did not meet the quantitative threshold for separate segment reporting. We report our corporate, general and administrative operations and corporate science activities under the caption "Corporate." We have revised our 2009 segment disclosures to conform to our 2010 presentation. In May 2010, we announced a plan to pursue strategic alternatives for our genetic testing, diagnostic products and pharmaceutical intermediates business units. Possible alternatives include divestiture, spin-out or management buy-out. Our genetic testing business unit had revenue of approximately $371 million for the year ended December 31, 2009 and approximately $183 million for the six months ended June 30, 2010. Our diagnostic products business unit had revenue of approximately $167 million for the year ended December 31, 2009 and approximately $76 million for the six months ended June 30, 2010. Revenue from our pharmaceutical intermediates business unit for the same periods was significantly less in comparison. Transactions for these business units are targeted for the end of 2010. Update to Second Quarter Earnings Release On July 21, 2010, we issued a press release containing our financial results for the three month period ended June 30, 2010, which we furnished as an exhibit to a Current Report on Form 8-K prior to hosting a conference call. Subsequent to July 21, 2010, we identified additional inventories that did not meet our quality specifications. Our decision to discard these inventories has resulted in a second quarter write off of $6.5 million in addition to the $21.9 million write off previously reported. As a result, our second quarter net loss is $(3.8) million or $(0.01) per diluted share, compared with net income of $23.0 thousand or $0.00 per diluted share reported on July 21, 2010. CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES Our critical accounting policies and significant judgments and estimates are set forth under the heading "Management's Discussion and Analysis of Genzyme Corporation and Subsidiaries' Financial Condition and Results of Operations—Critical Accounting Policies and Significant Judgments and 42 Estimates" in Part II., Item 7. to our 2009 Form 10-K. Excluding the addition of our policy for PSUs to our stock-based compensation policy, there have been no significant changes to our critical accounting policies or significant judgments and estimates since December 31, 2009. Additional information regarding our provisions and estimates for our product sales allowances, sales allowance reserves and accruals, and distributor fees and our revised stock-based compensation policy are included below. Revenue Recognition Product Sales Allowances Sales of many biotechnology products in the United States are subject to increased pricing pressure from managed care groups, institutions, government agencies and other groups seeking discounts. We and other biotechnology companies in the U.S. market are also required to provide statutorily defined rebates and discounts to various U.S. government agencies in order to participate in the Medicaid program and other government-funded programs. In most international markets, we operate in an environment where governments may and have mandated cost-containment programs, placed restrictions on physician prescription levels and patient reimbursements, emphasized greater use of generic drugs and enacted across-the-board price cuts as methods to control costs. In some cases, we have estimated the potential impact of these allowances. The sensitivity of our estimates can vary by program, type of customer and geographic location. Estimates associated with Medicaid and other government allowances may become subject to adjustment in a subsequent period. We record product sales net of the following significant categories of product sales allowances:
43 Our provisions for product sales allowances reduced gross product sales as follows (amounts in thousands):
Total product sales allowances increased for both the three and six months ended June 30, 2010, primarily due to:
These increases were offset, in part, by decreases of $6.3 million for the three months and $16.2 million for the six months in the aggregate product sales allowances for Cerezyme and Fabrazyme as a result of supply constraints. Total estimated product sales allowance reserves and accruals in our consolidated balance sheets increased approximately 11% to approximately $263 million as of June 30, 2010, as compared to approximately $236 million as of December 31, 2009, primarily due to increased contractual adjustments for our Renal and Endocrinology reporting segment and changes in the timing of certain payments. Our actual results have not differed materially from amounts recorded. The annual variation has been less than 0.5% of total product sales for the last three years. Accounts Receivable Related to Sales in Greece Total accounts receivable in our consolidated balance sheets includes approximately $57 million, net of reserves, as of both June 30, 2010 and December 31, 2009 of accounts receivable held by our subsidiary in Greece related to sales to government-owned or supported healthcare facilities in Greece. These sales are subject to significant payment delays due to government funding and reimbursement practices. We believe that this is an industry-wide issue for suppliers to these facilities. In May 2010, the government of Greece announced a plan for repayment of its debt to international pharmaceutical companies, which calls for immediate payment of accounts receivable balances that were established in 2005 and 2006. For accounts receivable established between 2007 and 2009, the government of Greece will issue non-interest bearing bonds, expected to be exchange tradable, with maturities ranging from 2 44 to 4 years. We recorded a charge of $7.2 million to bad debt expense, a component of SG&A, in our consolidated statements of operations for the three and six months ended June 30, 2010 to write down the accounts receivable balances held by our subsidiary in Greece to present value using a 10% discount rate. In conjunction with this plan, the government of Greece also instituted price decreases of between 20% and 27% for all future pharmaceutical product sales. Because our customers in Greece are government owned or supported, we may also be impacted by declines in sovereign credit ratings or sovereign debt defaults. The government of Greece has recently required financial support from both the European Union and the IMF to avoid defaulting on its sovereign debt. If significant additional changes occur in the availability of government funding in Greece, we may not be able to collect on amounts due from these customers. We do not expect this concentration of credit risk to have a material adverse impact on our financial position or liquidity. Healthcare Reform Legislation In March 2010, healthcare reform legislation was enacted in the United States. Although many provisions of the new legislation do not take effect immediately, several provisions became effective in the first quarter of 2010. These include:
These provisions did not have a significant impact on our results of operations or financial position for the six months ended June 30, 2010. Effective October 1, 2010, the new legislation re-defines the Medicaid AMP such that the AMP and, consequently, the Medicaid rebate are expected to increase for some of our drugs, in particular those that offer discounted pricing to customers. Beginning in 2011, the new law requires drug manufacturers to provide a 50% discount to Medicare beneficiaries whose prescription drug costs cause them to be subject to the Medicare Part D coverage gap, which is known as the "donut hole". Also beginning in 2011, clinical laboratory fee schedule payments will be reduced 1.75% over a period of five years and we will be required to pay our share of a new fee assessed on all branded prescription drug manufacturers and importers. This fee will be calculated based upon each organization's percentage share of total branded prescription drug sales to U.S. government programs (such as Medicare and Medicaid and VA, DOD and TriCare retail pharmacy discount programs) made during the previous year. Sales of orphan drugs, however, are not included in the fee calculation. Final guidance relating to how we will be required to account for this fee is still pending; however, it is expected that the fee will be classified as either a reduction of net sales or an operating expense. The aggregated industry wide fee is expected to total approximately 45 $28 billion through 2019, ranging from $2.5 billion to $4.1 billion annually. Beginning in 2013, a 2.3% excise tax will be imposed on sales of all medical devices except retail purchases by the public intended for individual use. Presently, uncertainty exists as many of the specific determinations necessary to implement this new legislation have yet to be decided and communicated to industry participants. We have made several estimates with regard to important assumptions relevant to determining the financial impact of this legislation on our business due to the lack of availability of both certain information and complete understanding of how the process of applying the legislation will be implemented. Although we are still assessing the full extent that the U.S. healthcare reform legislation may have on our business, we currently estimate that our revenues in the United States will be adversely impacted by less than approximately $20 million in 2010, with most of the impact occurring in the third and fourth quarters, and by approximately $30 million to $40 million in 2011. We expect that the U.S. Congress and state legislatures will continue to review and assess healthcare proposals, and public debate of these issues will likely continue. We cannot predict which, if any, of such reform proposals will be adopted and when they might be adopted. In addition, we anticipate seeing continued efforts to reduce healthcare costs in many other countries outside the United States. For example, in May 2010, the Greek health ministry imposed a flat mandatory discount of 27% on medicinal products above a certain price level. This discount, however, does not apply to our orphan drugs or Thymoglobulin. The Greek health ministry has stated that this newly imposed pricing will apply up through August 31, 2010, at which time the ministry will issue new pricing for most medicinal products based on the average of the three lowest prices in the European Union, and at that time, also determine the pricing for orphan products. As another example, the German government has enacted legislation, effective August 2010, that among other things, increases mandatory discounts from 6% to 16% and imposes August 2009 pricing levels on pharmaceuticals through the end of 2013. We expect that our revenues would be negatively impacted if these or similar measures are implemented or maintained. Distributor Fees Cash consideration (including a sales incentive) given by a vendor to a customer is presumed to be a reduction of the selling prices of the vendor's products or services and, therefore, is appropriately characterized as a reduction in revenue. We include such fees in contractual adjustments, which are recorded as a reduction to product sales. That presumption is overcome and the consideration should be characterized as a cost incurred if, and to the extent that, both of the following conditions are met:
46 We record service fees paid to our distributors as a charge to SG&A, a component of operating expenses, only if the criteria set forth above are met. The following table sets forth the distributor fees recorded as a reduction to product sales and charged to SG&A (amounts in thousands):
Stock-Based Compensation We use the Black-Scholes model to value both service condition and performance condition option awards. For awards with only service conditions and graded-vesting features, we recognize compensation cost on a straight-line basis over the requisite service period. For awards with performance conditions, we recognize stock-based compensation expense based on the graded-vesting method. Determining the appropriate fair value model and related assumptions requires judgment, including estimating stock price volatility, forfeiture rates, and expected terms. The expected volatility rates are estimated based on historical and implied volatilities of our common stock. The expected term represents the average time that options that vest are expected to be outstanding based on the vesting provisions and our historical exercise, cancellation and expiration patterns. We estimate pre-vesting forfeitures when recognizing stock-based compensation expense based on historical rates and forward-looking factors. We update these assumptions at least on an annual basis and on an interim basis if significant changes to the assumptions are warranted. We issue PSUs to our senior executives, which vest upon the achievement of certain financial performance goals, including cash flow return on investment and R-TSR. The fair value of PSUs subject to the cash flow return on investment performance metric, which includes both performance and service conditions, is based on the market value of our stock on the date of grant. We use a lattice model with a Monte Carlo simulation to value PSUs subject to the R-TSR performance metric, which is a market condition. We recognize compensation cost for our PSUs on a straight-lined basis over the requisite performance period. Determining the appropriate amount to expense based on the anticipated achievement of the stated goals requires judgment, including forecasting future financial results. The estimate of expense is revised periodically based on the probability of achieving the required performance targets and adjustments are made as appropriate. The cumulative impact of any revision is reflected in the period of change. In the case of PSUs subject to the R-TSR performance metric, if the financial performance goals are not met, the award does not vest, no compensation cost is recognized and any previously recognized stock-based compensation expense is reversed. We review our valuation assumptions periodically and, as a result, we may change our valuation assumptions used to value share-based awards granted in future periods. Such changes may lead to a significant change in the expense we recognize in connection with share-based payments. 47 RESULTS OF OPERATIONS The following discussion summarizes the key factors our management believes are necessary for an understanding of our consolidated financial statements. REVENUES The components of our total revenues are described in the following table (amounts in thousands):
Product Revenue The following table sets forth our products and their related indications:
48
49 The following table sets forth our product revenue on a reporting segment basis (amounts in thousands):
Personalized Genetic Health Regulatory and Manufacturing FDA Consent Decree On May 24, 2010, we entered into a consent decree with the FDA relating to our Allston facility. Under the terms of the consent decree, we will pay an upfront disgorgement of past profits of $175.0 million. Conditioned upon our compliance with the terms of the consent decree, we may continue to ship Cerezyme and Fabrazyme, which are manufactured, filled and finished at the facility, as well as Thyrogen, which is filled and finished at the facility. In the United States, Thyrogen that is filled and finished at our Allston facility will only be distributed based on medical necessity, in accordance with FDA criteria. The consent decree requires us to move our fill-finish operations out of our Allston facility for Thyrogen sold within the United States by November 22, 2010 and for Fabrazyme sold within the United States by November 24, 2010. We must move our fill-finish operations for all products sold outside of the United States by August 31, 2011. If we are not able to meet these deadlines, the FDA can require us to disgorge 18.5 percent of the revenue from the sale of any products that are filled and finished at our Allston facility after the applicable deadlines. The consent decree also requires us to implement a plan to bring our Allston facility operations into compliance with applicable laws and regulations. The plan must address any deficiencies previously reported to us or identified as part of a comprehensive inspection conducted by a third-party expert, who we are required to retain, and who will monitor and oversee our implementation of the plan. In 2009, we began implementing a comprehensive remediation plan, prepared with assistance from our compliance consultant, Quantic, to improve quality and compliance at our Allston facility. We intend to revise that plan to include any additional remediation efforts required in connection with the consent decree as identified by Quantic, who we are retaining as the third-party expert under the consent decree. The plan, as revised, which will be subject to FDA approval, is expected to take approximately 3-4 years to complete and will include a timetable of specified compliance milestones. If the milestones are not met in accordance with the timetable, the FDA can require us to pay $15,000 per day, per affected drug, until these compliance milestones are met. Upon satisfying the compliance requirements in accordance with the terms of the consent decree, we will be required to retain an auditor to monitor and oversee ongoing compliance at our Allston facility for an additional five years. The consent decree is subject to, and effective upon, approval by the U.S. District Court for the District of Massachusetts. The consent decree was filed with the U.S. District Court on May 24, 2010 and we are awaiting the court's approval. Manufacturing and Supply of Cerezyme and Fabrazyme In June 2009, we interrupted production of Cerezyme and Fabrazyme at our Allston facility after identifying a virus, Vesivirus 2117, in a bioreactor used for Cerezyme production. The virus we 50 identified impairs the viability of cells used in the manufacturing process and is not known to cause infection in humans. We completed sanitization of the facility and resumed production there in the third quarter of 2009. Cerezyme and Fabrazyme inventories were not sufficient to avoid shortages. We resumed Cerezyme shipments in the fourth quarter of 2009. In order to build a small inventory buffer to help us more consistently manage the resupply of Cerezyme to patients and reduce interruptions in shipping that occur in the absence of inventory, we began shipping Cerezyme to meet 50% of estimated product demand at the end of February 2010. Although we achieved our goal of building a small inventory buffer during the first quarter of 2010, we continued shipping at the 50% of demand level due to an interruption in operations at our Allston facility at the end of March 2010. The interruption resulted from an unexpected city electrical power failure that compounded issues with the facility's water system. Once production resumed, we continued shipping at the 50% of demand level through the end of the second quarter of 2010. We supplied approximately the same amount of Cerezyme in July 2010 as we supplied in each of May 2010 and June 2010, and expect that supply will then increase in the following months. However, there will be regional variations when Cerezyme will be available, and in some countries, patients' infusion schedules may need to shift due to short-term shipping delays. Since the fourth quarter of 2009, we have been shipping Fabrazyme to meet approximately 30% of estimated product demand. We have been working to increase the productivity of the Fabrazyme manufacturing process, which has performed at the low end of the historical range since the re-start of production. We have developed a new working cell bank for Fabrazyme that has been approved by the FDA and EMA. The new working cell bank has completed three runs and has had 30% greater productivity than the old working cell bank. We expect to continue shipping Fabrazyme at the 30% of demand level through the third quarter and increase shipments of Fabrazyme in the fourth quarter of 2010. We will continue to work with minimal levels of inventory for Cerezyme and Fabrazyme until our new Framingham manufacturing facility is approved, which is anticipated to take place in late 2011. Any additional manufacturing interruptions or delays will likely impact supply of these products. We are also working to transition fill-finish operations out of our Allston facility to our Waterford, Ireland plant and to Hospira, a third-party contract manufacturer. The fill-finish area of the Waterford facility is being expanded to accommodate the long-term growth of our PGH products, and we currently anticipate receiving approval of this new capacity in 2011. Lumizyme Approval In May 2010, we received FDA approval to market Lumizyme, alglucosidase alfa produced at the 4000L scale in the United States. Lumizyme is the first treatment approved in the U.S. specifically to treat patents with late-onset Pompe disease. We produce Lumizyme at our Geel facility, where we have produced Myozyme at the 4000L scale since February 2009 when we received approval for the 4000L scale process in Europe. As of the first quarter of 2010, the majority of markets outside of the United States have transitioned to the 4000L scale product. At our Geel facility, we are adding a third bioreactor for the production of Myozyme/Lumizyme produced at the 4000L scale, for which we expect to receive FDA approval in mid-2011. We have implemented a Risk Evaluation and Mitigation Strategy, or REMS, which we call the Lumizyme ACE Program, to ensure that the appropriate patients receive Lumizyme commercially. We have initiated this program with the health care professionals involved in the Alglucosidase Alfa Temporary Access Program, or ATAP, the program created in 2007 through which we have provided therapy free of charge to nearly 200 patients prior to commercial approval of Lumizyme. We will keep ATAP open until August 20, 2010 to ensure that patients have uninterrupted therapy while working to enroll participants in the Lumizyme ACE Program. We have also begun working with U.S. health care 51 professionals to enable those adult patients who have been waiting to access treatment to begin Lumizyme therapy. Personalized Genetic Health Product Revenue
PGH product revenue decreased for the three and six months ended June 30, 2010, primarily due to the temporary suspension of production at our Allston facility in June 2009 during a time of already low levels of inventory for Cerezyme and Fabrazyme, resulting in supply constraints for Cerezyme and Fabrazyme since that time offset, in part, by:
Cerezyme and Fabrazyme The supply constraint for Cerezyme adversely impacted Cerezyme revenue by $154.9 million for the three months ended June 30, 2010 and by $280.5 million for the six months ended June 30, 2010. The weakening of foreign currencies, primarily the Euro, against the U.S. dollar, adversely impacted Cerezyme revenue by $1.5 million for the three months ended June 30, 2010. Exchange rate fluctuations, primarily the Euro against the U.S. dollar, positively impacted Cerezyme revenue by $5.9 million for the six months ended June 30, 2010. Our results of operations are dependent on sales of Cerezyme and any reduction in revenue from sales of this product adversely affects our results of operations. Sales of Cerezyme were approximately 13% of our total revenue for the three months ended June 30, 2010, and 15% of our total revenue for the six months ended June 30, 2010 which reflect periods of supply constraint, as compared to approximately 24% and 25% for the same periods in 2009. The supply constraint for Fabrazyme adversely impacted Fabrazyme revenue by $94.2 million for the three months ended June 30, 2010 and by $166.6 million for the six month ended June 30, 2010. The weakening of foreign currencies against the U.S. dollar had no significant impact on Fabrazyme revenue for the three months ended June 30, 2010. Exchange rate fluctuations positively impacted Fabrazyme revenue by $2.3 million for the six months ended June 30, 2010. Under the FDA consent decree, we are required to move our fill-finish operations for Cerezyme and Fabrazyme out of our Allston facility. We are in the process of transferring these operations to Hospira. The Cerezyme and Fabrazyme supply constraints resulting from the suspension of production at our Allston facility have created opportunities for our competitors and our future sales may be 52 negatively affected by competitive products by Shire Human Genetic Therapies Inc., a business unit of Shire plc, or Shire, and Protalix Biotherapeutics Ltd., or Protalix. After our products experienced supply constraints, Shire and Protalix were able to offer their developmental therapies for the treatment of Gaucher disease to patients in the United States through an FDA-approved treatment investigational new drug application, or T-IND, protocol and to patients in the European Union and other countries through pre-approval access programs. Shire received marketing approval for VPRIV™ from the FDA in late February 2010 and announced that it will price this therapy lower than Cerezyme. Shire also received a positive opinion from the EMA Committee for Human Medicinal Product in June 2010. Shire has announced that it expects its manufacturing plant to be approved for commercial product in late 2011 or early 2012. Protalix submitted its new drug application, or NDA, for UPLYSO™ to the FDA in December 2009 and has been granted "fast track" designation with a Prescription Drug User Fee Act, or PDUFA, date of February 25, 2011. In December 2009, Protalix and Pfizer entered into an agreement to develop and commercialize UPLYSO. The FDA has granted orphan drug status to both Shire's and Protalix's therapies for the treatment of Gaucher disease. Outside of the United States, Fabrazyme currently competes with Replagal, a product marketed by Shire. In the United States, the FDA has approved a T-IND for Replagal. In August 2010, Shire reported that it had withdrawn its biologics license application, or BLA, for Replagal that it had submitted in December 2009 to the FDA, and for which it had been granted "fast track" designation, to consider updating it with additional clinical data. In June 2010, Shire closed enrollment in its T-IND in the United States for Replagal and announced plans to actively manage emergency requests for the drug from new patients. We are aware that some Gaucher and Fabry patients have switched to one of our competitors' therapies during the period of supply constraint and there is a risk that they may not switch back to our products, which would result in the loss of additional revenue for us. In April 2010, the EMA advised physicians to consider switching Fabry disease patients from Fabrazyme to Replagal based on its concerns that certain patients were not tolerating reduced dosages of Fabrazyme. We also have encouraged patients to switch to competitors products during the period of supply constraint. These actions may result in additional patients switching to our competitors' therapies. In July 2010, the EMA issued a temporary recommendation to physicians that new Fabry disease patients be treated with Replagal as an alternative to Fabrazyme because of continued supply shortages of Fabrazyme. In addition, the institution of treatment guidelines and dose conservation measures during the supply constraint present the risk that physicians and patients will not resume prior treatment or dosage levels after the supply constraint has ended, potentially resulting in further loss of revenue for us. Our estimates of the demand for Cerezyme and Fabrazyme and, as a result, estimates of our shipping allocations based on such demand, are impacted by patients switching to our competitors' therapies and by long-term adoption by patients of lower treatment or dosage levels. Myozyme/Lumizyme Myozyme/Lumizyme revenue increased for the three and six months ended June 30, 2010 due to increased patient identification outside of the United States following the European approval in February 2009 and the U.S. approval in May 2010 of the product produced at our Geel facility using the 4000L scale process. We implemented a price increase for Myozyme/Lumizyme as of June 1, 2010 which had no significant impact on Myozyme/Lumizyme revenue for the three and six months ended June 30, 2010. The weakening of foreign currencies, primarily the Euro, against the U.S. dollar, adversely impacted Myozyme/Lumizyme revenue by $3.7 million for the three months ended June 30, 2010. Exchange rate fluctuations had no significant impact on Myozyme/Lumizyme revenue for the six months ended June 30, 2010. 53 Aldurazyme Aldurazyme revenue increased for the three and six months ended June 30, 2010 due to increased patient identification worldwide as Aldurazyme was introduced into new markets. Exchange rate fluctuations had no significant impact on Aldurazyme revenue for the three and six months ended June 30, 2010. Other Personalized Genetic Health Other PGH product revenue increased for the three and six months ended June 30, 2010, primarily due to increased sales of Elaprase attributable to the continued identificat | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||