EX-13.5 6 ex-13_5.txt EXHIBIT 13.5 EXHIBIT 13.5 FINANCIAL STATEMENTS
PAGE NO. -------- GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION Combined Selected Financial Data.......................... GTR-2 Management's Discussion and Analysis of Genzyme Tissue Repair's Financial Condition and Results of Operations.............................................. GTR-4 Combined Statements of Operations--For the Years Ended December 31, 1999, 1998 and 1997........................ GTR-13 Combined Balance Sheets--December 31, 1999 and 1998....... GTR-14 Combined Statements of Cash Flows--For the Years Ended December 31, 1999, 1998 and 1997........................ GTR-15 Notes to Combined Financial Statements.................... GTR-16 Report of Independent Accountants......................... GTR-29
GTR-1 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION COMBINED SELECTED FINANCIAL DATA Genzyme Tissue Repair is our operating division that develops and markets biological products for orthopedic injuries, such as cartilage damage, and severe burns. A series of our common stock, Genzyme Tissue Repair Division Common Stock (which we refer to as "Tissue Repair Stock") is designed to reflect the value and track the performance of this division. Tissue Repair Stock is common stock of Genzyme Corporation, not of Genzyme Tissue Repair; Genzyme Tissue Repair is a division, not a company or legal entity, and therefore does not and cannot issue stock. The chief mechanisms intended to cause Tissue Repair Stock to "track" the financial performance of Genzyme Tissue Repair are provisions in our charter governing dividends and distributions. Under these provisions, our charter: - factors the assets and liabilities and income or losses attributable to Genzyme Tissue Repair into the determination of the amount available to pay dividends on Tissue Repair Stock; and - requires us to exchange, redeem or distribute a dividend to the holders of Tissue Repair Stock if all or substantially all of the assets allocated to Genzyme Tissue Repair are sold to a third party To determine earnings per share, we allocate Genzyme's earnings to each series of our common stock based on the earnings attributable to that series of stock. The earnings attributable to Tissue Repair Stock is defined in our charter as the net income or loss of Genzyme Tissue Repair determined in accordance with generally accepted accounting principles and as adjusted for tax benefits allocated to or from Genzyme Tissue Repair in accordance with our management and accounting policies. Our charter also requires that all income and expenses of Genzyme be allocated among the divisions in a reasonable and consistent manner. Our board of directors, however retains considerable discretion in determining the types, magnitudes and extent of allocations to each series of common stock without shareholder approval. Because the earnings allocated to Tissue Repair Stock are based on the income or losses attributable to Genzyme Tissue Repair, we include financial statements and management's discussion and analysis of Genzyme Tissue Repair to aid investors in evaluating its performance. The following combined selected financial data reflect the results of operations and financial position of the operations and assets we have allocated to Genzyme Tissue Repair and should be read in conjunction with the financial statements of Genzyme Tissue Repair and accompanying notes. GTR-2 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION COMBINED SELECTED FINANCIAL DATA COMBINED STATEMENT OF OPERATIONS DATA
FOR THE YEARS ENDED DECEMBER 31, -------------------------------------------------------- 1999 1998 1997 1996 1995 --------- --------- --------- --------- -------- (AMOUNTS IN THOUSANDS) Net service sales........................ $ 20,402 $ 17,117 $ 10,856 $ 7,312 $ 5,220 Operating costs and expenses: Cost of services sold................ 13,237 13,438 11,788 11,193 4,731 Selling, general and administrative..................... 24,604 24,579 25,571 27,111 12,927 Research and development............. 8,019 10,432 10,845 10,880 10,938 --------- --------- --------- --------- -------- Total operating costs and expenses......................... 45,860 48,449 48,204 49,184 28,596 --------- --------- --------- --------- -------- Operating loss........................... (25,458) (31,332) (37,348) (41,872) (23,376) Other income (expenses): Equity in net loss of joint venture(1)......................... (3,368) (7,674) (6,719) (1,727) -- Interest income...................... 609 1,176 979 1,432 1,386 Interest expense..................... (1,823) (2,556) (2,896) (148) (40) --------- --------- --------- --------- -------- Total other income (expenses)...... (4,582) (9,054) (8,636) (443) 1,346 --------- --------- --------- --------- -------- Division net loss........................ $ (30,040) $ (40,386) $ (45,984) $ (42,315) $(22,030) ========= ========= ========= ========= ========
COMBINED BALANCE SHEET DATA
DECEMBER 31, ---------------------------------------------------- 1999 1998 1997 1996 1995 -------- -------- -------- -------- -------- (AMOUNTS IN THOUSANDS) Cash and investments........................... $ 9,373 $ 7,732 $31,915 $16,230 $47,573 Working capital................................ 12,112 (6,461) 31,623 14,232 44,374 Total assets................................... 19,648 18,954 57,226 42,593 52,649 Long-term debt................................. 18,000 12,579 31,089 18,000 -- Division equity................................ (3,455) (16,396) 20,203 18,084 45,926
------------------------ (1) Operations of Diacrin/Genzyme LLC, our joint venture with Diacrin, Inc., commenced in October 1996. In May 1999, we reallocated our ownership interest in the joint venture from Genzyme Tissue Repair to Genzyme General. GTR-3 MANAGEMENT'S DISCUSSION AND ANALYSIS OF GENZYME TISSUE REPAIR'S FINANCIAL CONDITION AND RESULTS OF OPERATIONS INTRODUCTION This discussion contains forward-looking statements. These forward-looking statements represent the expectations of our management as of the filing date of this annual report. Actual results could differ materially from those anticipated by the forward-looking statements due to the risks and uncertainties described under the caption "Factors Affecting Future Operating Results" for Genzyme Tissue Repair and Genzyme Corporation included in this annual report. You should consider carefully each of these risks and uncertainties in evaluating the financial condition and results of operations of Genzyme Tissue Repair and Genzyme. We prepare the financial statements of Genzyme Tissue Repair in accordance with generally accepted accounting principles. We present financial information and accounting policies specific to Genzyme Tissue Repair in the accompanying combined financial statements. We present financial information and accounting policies relevant to the corporation and its operating divisions taken as a whole in our consolidated financial statements. You should read the consolidated financial statements in conjunction with the financial statements of Genzyme Tissue Repair. Note A., "Summary of Significant Accounting Policies," to our accompanying consolidated financial statements contains our accounting policies. Genzyme Tissue Repair Division Common Stock, which we refer to as "Tissue Repair Stock," is a series of our common stock that is designed to reflect the value and track the performance of Genzyme Tissue Repair. The chief mechanisms intended to cause Tissue Repair Stock to "track" the financial performance of Genzyme Tissue Repair are provisions in our charter governing dividends and distributions. Under these provisions, our charter: - factors the assets and liabilities and income or losses attributable to Genzyme Tissue Repair into the determination of the amount available to pay dividends on Tissue Repair Stock; and - requires us to exchange, redeem or distribute a dividend to the holders of Tissue Repair Stock if all or substantially all of the assets allocated to Genzyme Tissue Repair are sold to a third party (a dividend or redemption payment must equal in value the net after-tax proceeds from the sale; an exchange must be for Genzyme General Stock at a 10% premium to the exchanged stock's average market price following the announcement of the sale.) To determine earnings per share, we allocate Genzyme's earnings to each series of our common stock based on the earnings attributable to that series of stock. The earnings attributable to Tissue Repair Stock is defined in our charter as the net income or loss of Genzyme Tissue Repair determined in accordance with generally accepted accounting principles and as adjusted for tax benefits allocated to or from Genzyme Tissue Repair in accordance with our management and accounting policies. Our charter also requires that all income and expenses of Genzyme be allocated among the divisions in a reasonable and consistent manner. However, subject to its fiduciary duties, our board of directors can, at its discretion, change the methods of allocating earnings to each series of common stock. We intend to allocate earnings using our current methods for the foreseeable future. Because the earnings allocated to Tissue Repair Stock are based on the income or losses attributable to Genzyme Tissue Repair, we include financial statements and management's discussion and analysis of Genzyme Tissue Repair to aid investors in evaluating its performance. While Tissue Repair Stock is designed to reflect Genzyme Tissue Repair's performance, it is common stock of Genzyme Corporation and not Genzyme Tissue Repair; Genzyme Tissue Repair is a division, not a company or legal entity, and therefore does not and cannot issue stock. Consequently, holders of Tissue Repair Stock have no specific rights to assets allocated to Genzyme Tissue Repair. Genzyme Corporation continues to hold title to all of the assets allocated to Genzyme Tissue Repair and is responsible for all of GTR-4 its liabilities, regardless of what we deem for financial statement presentation purposes as allocated to any division. Holders of Tissue Repair Stock, as common stockholders, are therefore subject to the risks of investing in the businesses, assets and liabilities of Genzyme as a whole. For instance, the assets allocated to each division are subject to company-wide claims of creditors, product liability plaintiffs and stockholder litigation. Also, in the event of a Genzyme liquidation, insolvency or similar event, holders of Tissue Repair Stock and other tracking stockholders would only have the rights of common stockholders in the combined assets of Genzyme. Our charter sets forth what programs and businesses are initially allocated to Genzyme Tissue Repair and states that going forward the division will also include all businesses, products or programs, developed by or acquired for the division, as determined by our board of directors. We then manage and account for transactions between Genzyme Tissue Repair and our other divisions and with third parties, and any resulting re-allocations of assets and liabilities, by applying consistently across divisions a detailed set of policies established by our board of directors. We publicly disclose our divisional management and accounting policies, which appear in Exhibit 99.1 to this Annual Report on Form 10-K. Our charter requires that all assets and liabilities of Genzyme be allocated among the divisions. Our board of directors, however, retains considerable discretion in determining the types, magnitudes and extent of allocations to each series of common stock without shareholder approval. We present earnings per share data for Tissue Repair Stock in our consolidated financial statements. We present financial information and accounting policies specific to Genzyme Tissue Repair in the accompanying combined financial statements. We present financial information and accounting policies relevant to the corporation and its operating divisions taken as a whole in our consolidated financial statements. You should, therefore, read this discussion and analysis of Genzyme Tissue Repair's financial position and results of operations in conjunction with the financial statements and related notes of Genzyme Tissue Repair, the discussion and analysis of Genzyme's financial position and results of operations, and the consolidated financial statements and related notes of Genzyme, all of which are included in this annual report. In March 2000, we entered into an agreement to acquire Biomatrix, Inc. Upon completion of the acquisition, we will form a new operating division, and the assets and liabilities allocated to Genzyme Surgical Products and Genzyme Tissue Repair will be re-allocated to that new division. For more information you should read the section entitled "Subsequent Event" below. RESULTS OF OPERATIONS The following discussion summarizes the key factors management believes are necessary for an understanding of Genzyme Tissue Repair's financial statements. GTR-5 The components of Genzyme Tissue Repair's combined statements of operations are described in the following table:
99/98 98/97 INCREASE/ INCREASE/ (DECREASE) (DECREASE) 1999 1998 1997 % CHANGE % CHANGE -------- -------- -------- ---------- ---------- (AMOUNTS IN THOUSANDS, EXCEPT PERCENTAGE DATA) Total revenues......................... $ 20,402 $ 17,117 $ 10,856 19% 58% Cost of revenues....................... 13,237 13,438 11,788 (1)% 14% Selling, general and administrative.... 24,604 24,579 25,571 0% (4)% Research and development............... 8,019 10,432 10,845 (23)% (4)% -------- -------- -------- Total operating costs and expenses....................... 45,860 48,449 48,204 (5)% 1% -------- -------- -------- Operating loss......................... (25,458) (31,332) (37,348) (19)% (16)% Other expenses, net.................... (4,582) (9,054) (8,636) (49)% 5% -------- -------- -------- Division net loss...................... $(30,040) $(40,386) $(45,984) (26)% (12)% ======== ======== ========
REVENUES
99/98 98/97 INCREASE/ INCREASE/ (DECREASE) (DECREASE) 1999 1998 1997 % CHANGE % CHANGE -------- -------- -------- ---------- ---------- (AMOUNTS IN THOUSANDS, EXCEPT PERCENTAGE DATA) Carticel-Registered Trademark- chondrocytes........................... $15,213 $10,978 $ 6,598 39% 66% Epicel-TM- skin grafts................... 5,092 6,030 4,258 (16)% 42% Other.................................... 97 109 -- (11)% N/A ------- ------- ------- Total revenues....................... $20,402 $17,117 $10,856 19% 58% ======= ======= =======
The increase in sales of Carticel-Registered Trademark- chondrocytes during both periods was a result of continued increases in the numbers of patients treated and surgeons trained as well as increases in the number of insurance reimbursement approvals. Revenue from Epicel-TM- skin grafts varies from year to year depending on the number of patients requiring severe burn care. MARGINS
99/98 99/97 INCREASE/ INCREASE/ (DECREASE) (DECREASE) 1999 1998 1997 % CHANGE % CHANGE -------- -------- ----- ---------- ---------- (AMOUNTS IN THOUSANDS, EXCEPT PERCENTAGE DATA) Gross margins.................................. $7,165 $3,679 $(932) 95% 495% % of total revenues........................ 35% 21% (9)%
Genzyme Tissue Repair's gross margins improved in both periods as a result of: - Increased sales of Carticel-Registered Trademark- chondrocytes; - Reductions in labor and manufacturing expenses; and - Decreased material expenses. GTR-6 SG&A AND R&D EXPENSES Genzyme Tissue Repair's selling, general and administrative expenses remained flat, while revenues increased, in 1999 compared to 1998 as a result of its efforts to streamline operations. Its selling, general and administrative expense decreased in 1998 compared to 1997 also as a result of its efforts to streamline operations. Genzyme Tissue Repair's research and development expense decreased in 1999 compared to 1998 due to the termination of its TGF-beta and other research and development programs. Its research and development expense decreased slightly in 1998 compared to 1997. OTHER INCOME AND EXPENSES
99/98 98/97 INCREASE/ INCREASE/ (DECREASE) (DECREASE) 1999 1998 1997 % CHANGE % CHANGE -------- -------- ------- ---------- ---------- (AMOUNTS IN THOUSANDS, EXCEPT PERCENTAGE DATA) Equity in net loss of joint venture....... $(3,368) $(7,674) $(6,719) (56)% 14% Interest income........................... 609 1,176 979 (48)% 20% Interest expense.......................... (1,823) (2,556) (2,896) (29)% (12)% ------- ------- ------- Total other income (expense), net... $(4,582) $(9,054) $(8,636) (49)% 5% ======= ======= =======
1999 AS COMPARED TO 1998 Equity in net loss of joint venture decreased in 1999 compared to 1998 as a result of the reallocation of Genzyme's ownership interest in Diacrin/Genzyme LLC from Genzyme Tissue Repair to Genzyme General in May 1999. As a result, Genzyme Tissue Repair will not recognize losses related to the joint venture going forward. In the period of 1999 prior to the transfer, Genzyme Tissue Repair provided $3.6 million in funding to the joint venture and realized a net loss of $3.4 million from the joint venture. During 1998, Genzyme Tissue Repair realized 12 months of losses from the joint venture. Interest income decreased in 1999 compared to 1998 as a result of lower average cash balances. In the second quarter of 1998, Genzyme Tissue Repair completed the accretion of the conversion feature of the 6% convertible subordinated note. Interest expense decreased in 1999 as a result. During 1999, the holder of this note converted the remaining principal amount of $12.4 million into shares of Tissue Repair Stock. 1998 AS COMPARED TO 1997 Equity in net loss of joint venture increased in 1998 compared to 1997 as a result of increased clinical trial activity during 1998. During 1998, Genzyme Tissue Repair provided $7.2 million of funding to Diacrin/Genzyme LLC and realized a net loss of $7.7 million from the joint venture. Interest income increased in 1998 compared to 1997 as a result of higher average cash balances. In the second quarter of 1998, Genzyme Tissue Repair completed the accretion of the conversion feature of the 6% convertible subordinated note. Interest expense decreased in 1997 as a result. During 1998, the holder of this note converted $0.6 million of principal into shares of Tissue Repair Stock. LIQUIDITY AND CAPITAL RESOURCES At December 31, 1999, Genzyme Tissue Repair had cash and cash equivalents of $9.4 million, a decrease of $1.6 million from December 31, 1998. GTR-7 Genzyme Tissue Repair used $25.1 million in cash for operations during 1999. This is primarily due to Genzyme Tissue Repair's net loss of $30.0 million for the year. During 1999, Genzyme Tissue Repair used $4.4 million in cash as a result of its investing activities. This amount included $3.6 million contributed to Diacrin/Genzyme LLC and $0.9 million used to purchase equipment. Genzyme Tissue Repair's financing activities generated $31.1 million in cash during 1999. This included $25.0 million in cash allocated from Genzyme General in connection with the transfer of our interest in Diacrin/Genzyme LLC to Genzyme General, and $5.0 million allocated to Genzyme Tissue Repair under its interdivisional financing arrangement from Genzyme General. At December 31, 1999, $18.0 million of funds outstanding under our revolving credit facility was allocated to Genzyme Tissue Repair. Genzyme Tissue Repair, together with our other operating divisions, has access to our revolving credit facilities. At December 31, 1999, $50.0 million was available under a facility that matures in November 2000 and $77.0 million was available under a facility that matures in November 2002. In October 1996, our board of directors made $20.0 million of Genzyme General's cash available to Genzyme Tissue Repair in order for Genzyme Tissue Repair to fund its obligations under its joint venture with Diacrin. Under this arrangement, Genzyme Tissue Repair may draw down funds as needed each quarter in exchange for Genzyme Tissue Repair designated shares based on the fair market value of Tissue Repair Stock (as defined in our charter) at the time of the draw. Genzyme Tissue Repair made a $7.0 million draw under this arrangement in 1997. In May 1998, our board of directors increased the amount committed under this arrangement from $20.0 million to $50.0 million. Genzyme Tissue Repair made a $5.0 million draw in February 1999. In May 1999, the amount available under this arrangement was reduced to $25.0 million in connection with the reallocation of our ownership interest in Diacrin/Genzyme LLC from Genzyme Tissue Repair to Genzyme General. We anticipate that Genzyme Tissue Repair's current cash resources, together with the $20.0 million that remains available under an interdivisional financing arrangement of credit from Genzyme General, will be sufficient to fund its operations through the end of 2000. If Diacrin/Genzyme LLC does not initiate a Phase III clinical trial of NeuroCell-TM- PD by June 30, 2000, Genzyme Tissue Repair will be required to pay Genzyme General $20 million plus accrued interest at 13.5% per annum. Genzyme Tissue Repair may pay Genzyme General in cash, Genzyme Tissue Repair designated shares, or a combination of both, at its option. If this milestone is not achieved and Genzyme Tissue Repair elects to repay Genzyme General in cash, its cash reserves will be substantially diminished or depleted in their entirety. Genzyme Tissue Repair's cash needs may differ from those planned as a result of many factors, including the: - ability to satisfy regulatory requirements of the FDA and other government agencies; - results of research and development and clinical testing; - enforcement of patent and other intellectual property rights; and - development of competitive products and services. Genzyme Tissue Repair will require substantial additional funds in order to continue operations at current levels beyond 2000. We cannot guarantee that we will be able to obtain any additional financing for Genzyme Tissue Repair or find it on favorable terms. If Genzyme Tissue Repair has insufficient funds or we are unable to raise additional funds for Genzyme Tissue Repair, it may be required to delay, scale back GTR-8 or eliminate certain of its programs. Genzyme Tissue Repair may also have to give third parties rights to commercialize technologies or products that it would otherwise have sought to commercialize itself. NEW ACCOUNTING PRONOUNCEMENTS, EURO, YEAR 2000 AND MARKET RISK See "Management's Discussion and Analysis of Genzyme Corporation and Subsidiaries' Financial Condition and Results of Operations" included in this annual report. FACTORS AFFECTING FUTURE OPERATING RESULTS The future operating results of Genzyme Tissue Repair could differ materially from the results described above due to the risks and uncertainties described below and under the heading "Management's Discussion and Analysis of Genzyme Corporation and Subsidiaries' Financial Condition and Results of Operations--Factors Affecting Future Operating Results" included in this annual report. THE COMMERCIAL SUCCESS OF GENZYME TISSUE REPAIR'S LEAD PRODUCT, CARTICEL-REGISTERED TRADEMARK- CHONDROCYTES, IS UNCERTAIN. Carticel-Registered Trademark- chondrocytes are used to treat knee cartilage damage. This service involves a proprietary process for growing autologous (a patient's own) cartilage cells to replace those that are damaged or lost. Revenues from Carticel-Registered Trademark- chondrocytes accounted for approximately 75% of Genzyme Tissue Repair's 1999 revenue. The commercial success of Carticel-Registered Trademark- chondrocytes will depend on many factors including: POSITIVE RESULTS FROM POST-MARKETING STUDIES. - We have agreed with the FDA to conduct two post-marketing studies to confirm the effectiveness of Carticel-Registered Trademark- chondrocytes. The first study compares clinical outcomes of patients in Genzyme Tissue Repair's registry who did not respond to treatment before being implanted with Carticel-Registered Trademark-chondrocytes. This study will measure outcomes before and after implantation with Carticel-Registered Trademark- chondrocytes. The second study compares the long-term clinical effects of treatment with Carticel-Registered Trademark-chondrocytes to other available treatments. If these studies demonstrate that treatment with Carticel-Registered Trademark- chondrocytes is not superior to the alternatives studied, the FDA may suspend or withdraw its approval of Carticel-Registered Trademark- chondrocytes. If Genzyme Tissue Repair cannot market Carticel-Registered Trademark- chondrocytes in the U.S., its financial results will be negatively impacted. FDA APPROVAL OF RELATED DEVICE. - Genzyme Tissue Repair has developed a device to improve the procedure for implanting Carticel-Registered Trademark-chondrocytes and plans to file for marketing approval with the FDA. Genzyme Tissue Repair believes it will begin marketing this device in 2000. We cannot guarantee that the FDA will approve this device, that this device will improve the procedure for implanting Carticel-Registered Trademark- chondrocytes, or that this device will gain commercial acceptance. THE AVAILABILITY OF THIRD PARTY REIMBURSEMENT. - Since the FDA approved Carticel-Registered Trademark- chondrocytes, we have seen a substantial increase in the number of third party payers who cover it. Some third party payers, however, do not cover Carticel-Registered Trademark-chondrocytes. We cannot guarantee that any third party payers will continue to cover it or that additional third party payers will begin to provide reimbursement. - Although FDA approval is a crucial factor in insurance plans deciding to cover new treatments, a number of major insurance plans also base such decisions on their own or third party evaluations of such treatments. One independent association that conducts such evaluations is the Blue Cross Blue Shield Association. The Blue Cross Blue Shield Association has determined that its Technology Assessment Committee does not believe that Carticel-Registered Trademark- chondrocytes meets all of its published GTR-9 criteria for new treatments. We believe that Carticel-Registered Trademark- chondrocytes does in fact meet all of such criteria and are discussing the evaluation with the Blue Cross Blue Shield Association. While individual Blue Cross Blue Shield plans representing more than 50% of Blue Cross Blue Shield policyholders have provided policy coverage for Carticel-Registered Trademark- chondrocytes without a favorable evaluation by the Blue Cross Blue Shield Association, many Blue Cross Blue Shield plans have delayed approving Carticel-Registered Trademark- chondrocytes from coverage under their policies as a direct result of this unfavorable ruling. Since these remaining plans represent a significant percentage of insured lives in the U.S., this ruling has delayed our access to a substantial portion of the market for Carticel-Registered Trademark- chondrocytes. THE SUCCESS OF COMPETITIVE PRODUCTS. - The process we use to grow a patient's cartilage cells is not patentable, and we do not yet have significant patent protection covering the other processes used in providing Carticel-Registered Trademark- chondrocytes. Consequently, we cannot prevent a competitor from developing the ability to grow cartilage cells and from offering a product or service that is similar or superior to Carticel-Registered Trademark- chondrocytes. If a competitor were to develop such ability and obtain FDA approval for a competitive product or service, Genzyme Tissue Repair's financial results of operations would be negatively impacted. We are aware of at least two other companies that are growing autologous cartilage cells for cartilage repair in the European market. Also, several pharmaceutical and biotechnology companies are developing alternative treatments for knee cartilage damage. One or more of these companies may develop products or services superior to the Carticel-Registered Trademark- chondrocytes. MARKET ACCEPTANCE BY ORTHOPEDIC SURGEONS. - We are marketing Carticel-Registered Trademark- chondrocytes to orthopedic surgeons. We cannot guarantee that we will train enough surgeons who incorporate it into their practice to make it commercially successful. GENZYME TISSUE REPAIR ANTICIPATES FUTURE LOSSES AND MAY NEVER BECOME PROFITABLE. We expect Genzyme Tissue Repair to have significant operating losses at least through 2000 as it continues to commercialize Carticel-Registered Trademark- chondrocytes and to conduct research and development and clinical programs. We cannot guarantee that Genzyme Tissue Repair's operations will ever be profitable. IF GENZYME TISSUE REPAIR FAILS TO OBTAIN CAPITAL NECESSARY TO FUND ITS OPERATIONS, IT WILL BE UNABLE TO FUND DEVELOPMENT PROGRAMS AND COMPLETE CLINICAL TRIALS. We anticipate that Genzyme Tissue Repair's current cash resources, together with amounts available under an interdivisional financing arrangement from Genzyme General, will be sufficient to fund Genzyme Tissue Repair's operations through the end of 2000. In 1999, Genzyme Tissue Repair received $25 million in cash from Genzyme General in connection with the transfer to Genzyme General of our interest in our joint venture with Diacrin, Inc. If the joint venture does not initiate a Phase III clinical trial of NeuroCell-TM--PD by June 30, 2000, Genzyme Tissue Repair will be required to pay Genzyme General $20 million plus accrued interest at 13.5%. Genzyme Tissue Repair may repay this amount in cash, Genzyme Tissue Repair designated shares, or combination of both, at its option. Genzyme Tissue Repair designated shares are shares of Tissue Repair Stock that are not issued and outstanding, but which our board of directors may issue, sell or distribute without allocating the proceeds to Genzyme Tissue Repair. If these milestones are not achieved, and Genzyme Tissue Repair elects to repay Genzyme General in cash, its cash reserves will be substantially diminished or depleted in their entirety. If Genzyme Tissue Repair elects to repay Genzyme General in Genzyme Tissue Repair designated shares, this would substantially dilute the rights of the holders of Tissue Repair Stock and could significantly affect the market price of Tissue Repair Stock. GTR-10 Genzyme Tissue Repair's cash needs may differ from those planned as a result of various factors, including the: - ability to satisfy regulatory requirements of the FDA and other government agencies; - results of research and development and clinical testing; - enforcement of patent and other intellectual property rights; and - development of competitive products and services. Genzyme Tissue Repair will require substantial additional funds in order to continue operations at current levels beyond 2000. We cannot guarantee that we will be able to obtain any additional financing for Genzyme Tissue Repair or find it on favorable terms. If Genzyme Tissue Repair has insufficient funds or we are unable to raise additional funds for Genzyme Tissue Repair, it may be required to delay, scale back or eliminate certain of its programs. Genzyme Tissue Repair may also have to give rights to third parties to commercialize technologies or products that it would otherwise commercialize itself. GENZYME TISSUE REPAIR'S RESULTS FLUCTUATE QUARTERLY AND THIS COULD HAVE AN ADVERSE EFFECT ON ITS OPERATIONS. We expect that the revenues from the sale of the Carticel-Registered Trademark- chondrocytes will fluctuate based on Genzyme Tissue Repair's success in penetrating the market, the availability of competitive procedures and the availability of third party reimbursement. We cannot predict the timing or magnitude of these fluctuations. Furthermore, we expect that revenues from Carticel-Registered Trademark- chondrocytes will be lower in the summer months because fewer operations are typically performed during those months. We also expect that revenues from the sale of Epicel-TM- skin grafts will continue to fluctuate from quarter to quarter. This fluctuation is a result of several unpredictable factors, including the number and survival rate of severe burn patients who are treated with Epicel-TM- skin grafts. Since Genzyme Tissue Repair must maintain extensive tissue culture facilities and a trained staff for both Carticel-Registered Trademark- chondrocytes and Epicel-TM- skin grafts, a significant portion of its costs are fixed and, therefore, fluctuations in demand can have an adverse effect on its results of operations. GENZYME TISSUE REPAIR RELIES ON KEY COLLABORATORS TO SUPPORT FURTHER RESEARCH AND DEVELOPMENT OF CARTICEL-REGISTERED TRADEMARK-CHONDROCYTES AND THESE EFFORTS COULD SUFFER IF IT EXPERIENCES PROBLEMS WITH THESE COLLABORATORS. Carticel-Registered Trademark- chondrocytes were developed based on the work of a group of Swedish physicians. Genzyme Tissue Repair had consulting agreements with the two leaders of that group. These agreements, however, expired in 1998 and Genzyme Tissue Repair is currently negotiating renewals of these agreements. Pending these negotiations, these physicians are continuing to advise Genzyme Tissue Repair on the commercialization and further development Carticel-Registered Trademark- chondrocytes. We cannot guarantee that the two physicians will sign a new consulting agreement or continue to advise Genzyme Tissue Repair. In addition, individuals who are familiar with the know-how underlying Carticel-Registered Trademark- chondrocytes through their association with these physicians may disclose such information to our competitors. Either event could have an adverse effect on Genzyme Tissue Repair's results of operations. We have entered into a sponsored research agreement with the University of Gothenburg in Sweden and certain physicians, including the two physicians discussed above. The purpose of the agreement is to conduct additional research on Carticel-Registered Trademark- chondrocytes. The agreement prohibits each member of the research team from disclosing any information relating to Genzyme Tissue Repair or its business that they acquire in connection with their work under the agreement. The agreement also states that all inventions that the members conceive or reduce to practice during the course of the research program will be GTR-11 Genzyme Tissue Repair's property, with royalties payable to the inventing member. We cannot guarantee that these members will honor their obligations under the sponsored research agreement. SUBSEQUENT EVENT In March 2000, we entered into an agreement to acquire Biomatrix, Inc. Upon the effectiveness of our Registration Statement on Form S-4 and completion of the merger, we will form a new operating division called Genzyme Biosurgery and create a new series of common stock designed to reflect its value and track its performance. We refer to this stock as "Biosurgery Stock". In connection with the merger, and upon Genzyme shareholder approval, the assets and liabilities allocated to Genzyme Surgical Products and Genzyme Tissue Repair will be reallocated to Genzyme Biosurgery and shares of Surgical Products Stock and Tissue Repair Stock will be exchanged for Biosurgery Stock. We will account for the acquisition of Biomatrix as a purchase. Biomatrix stockholders will receive $37 in cash, one share of Biosurgery Stock, or a combination of cash and stock for each share of Biomatrix Stock they hold. The merger agreement provides that we will pay cash for up to 28.38% of the outstanding shares of Biomatrix common stock that receive merger consideration, or up to approximately $245.0 million. Holders of Surgical Products Stock will receive 0.6060 share of Biosurgery Stock in exchange for each share of Surgical Products Stock they hold and holders of Tissue Repair Stock will receive 0.3352 share of Biosurgery Stock in exchange for each share of Tissue Repair Stock they hold. For more information about the merger and the merger consideration, we encourage you to carefully read our Registration Statement on Form S-4 (File No. 333-34972) filed with the SEC on April 18, 2000 and as amended from time to time. The acquisition is subject to: - approval by Biomatrix shareholders; - approval by our shareholders, including separate approvals by the holders of shares of Surgical Products Stock and Tissue Repair Stock; and - other customary closing conditions. GTR-12 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION COMBINED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, --------------------------------------- 1999 1998 1997 --------- --------- --------- (AMOUNTS IN THOUSANDS) Total revenues........................................... $ 20,402 $ 17,117 $ 10,856 Operating costs and expenses: Cost of services sold.................................. 13,237 13,438 11,788 Selling, general and administrative.................... 24,604 24,579 25,571 Research and development............................... 8,019 10,432 10,845 --------- --------- --------- Total operating costs and expenses................. 45,860 48,449 48,204 --------- --------- --------- Operating loss........................................... (25,458) (31,332) (37,348) Other income (expenses): Equity in net loss of joint venture.................... (3,368) (7,674) (6,719) Interest income........................................ 609 1,176 979 Interest expense....................................... (1,823) (2,556) (2,896) --------- --------- --------- Total other income (expenses)...................... (4,582) (9,054) (8,636) --------- --------- --------- Division net loss........................................ $ (30,040) $ (40,386) $ (45,984) ========= ========= ========= Comprehensive loss, net of tax: Division net loss........................................ $ (30,040) $ (40,386) $ (45,984) Other comprehensive income (loss), net of tax: Unrealized gains on securities arising during the period............................................... -- 9 (9) --------- --------- --------- Comprehensive loss....................................... $ (30,040) $ (40,377) $ (45,993) ========= ========= =========
The accompanying notes are an integral part of these combined financial statements. GTR-13 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION COMBINED BALANCE SHEETS
DECEMBER 31, ----------------------- 1999 1998 -------- -------- (AMOUNTS IN THOUSANDS) ASSETS Current assets: Cash and cash equivalents................................. $ 9,373 $ 7,732 Accounts receivable, net.................................. 4,968 3,833 Inventories............................................... 2,394 2,645 Other current assets...................................... 253 1,723 ------- -------- Total current assets.................................... 16,988 15,933 Plant and equipment, net.................................... 2,545 2,836 Other....................................................... 115 185 ------- -------- Total assets............................................ $19,648 $ 18,954 ======= ======== LIABILITIES AND DIVISION EQUITY Current liabilities: Accounts payable.......................................... $ 1,062 $ 1,355 Accrued expenses.......................................... 3,131 2,491 Due to Genzyme General.................................... 683 548 Current portion of long-term debt......................... -- 18,000 ------- -------- Total current liabilities............................... 4,876 22,394 Convertible note, net....................................... -- 12,579 Long-term debt.............................................. 18,000 -- Other....................................................... 227 377 ------- -------- Total liabilities....................................... 23,103 35,350 Commitments and Contingencies (See Notes) Division equity (Note I).................................... (3,455) (16,396) ------- -------- Total liabilities and division equity................... $19,648 $ 18,954 ======= ========
The accompanying notes are an integral part of these combined financial statements. GTR-14 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION COMBINED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, --------------------------------- 1999 1998 1997 --------- --------- --------- (AMOUNTS IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES: Division net loss......................................... $ (30,040) $ (40,386) $ (45,984) Reconciliation of division net loss to net cash used in operating activities: Depreciation and amortization............................. 1,186 1,757 2,482 Loss on disposal of property, plant and equipment......... -- -- 24 Non-cash compensation expense............................. -- 108 221 Accrued interest/amortization on bonds.................... -- 188 (188) Provision for bad debts and inventory..................... 2,718 2,985 4,400 Accretion of debt discount................................ 220 453 1,071 Equity in net loss of joint venture....................... 3,368 7,674 6,719 Amortization of deferred rent............................. (150) (150) (150) Increase (decrease) in cash from working capital: Accounts receivable..................................... (1,319) (1,869) (1,024) Inventories............................................. (2,283) (3,400) (4,070) Other current assets.................................... 1,248 (719) (587) Accounts payable and accrued expenses................... (151) (574) (39) Due to Genzyme General.................................. 135 (665) (391) --------- --------- --------- Net cash used in operating activities................. (25,068) (34,598) (37,516) CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of investments.................................. -- -- (10,614) Sales and maturities of investments....................... -- 10,614 318 Investment in joint venture............................... (3,594) (7,163) (6,820) Purchases of property, plant and equipment................ (894) (670) (496) Sale of property, plant and equipment to Genzyme General................................................. -- 16,500 852 Other..................................................... 70 15 (428) --------- --------- --------- Net cash provided by (used in) investing activities... (4,418) 19,296 (17,188) CASH FLOWS FROM FINANCING ACTIVITIES: Allocated proceeds from issuance of Tissue Repair Stock, net..................................................... 462 2,204 31,475 Allocated proceeds from issuance of debt, net............. -- -- 13,542 Payments of debt and capital lease obligations............ (96) (445) 3 Cash allocated from Genzyme General....................... 30,037 155 14,892 Bank overdraft............................................ 724 -- -- --------- --------- --------- Net cash provided by financing activities............. 31,127 1,914 59,912 Increase (decrease) in cash and cash equivalents............ 1,641 (13,388) 5,208 Cash and cash equivalents at beginning of period............ 7,732 21,120 15,912 --------- --------- --------- Cash and cash equivalents at end of period.................. $ 9,373 $ 7,732 $ 21,120 ========= ========= ========= Supplemental cash flow information: Cash paid during the year for interest.................... $ 1,594 $ 2,265 $ 1,127 Supplemental disclosures of non-cash transactions: Transfer of plant and equipment--Note E. Conversion of 5% convertible subordinated note--Note H.
The accompanying notes are an integral part of these combined financial statements. GTR-15 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS NOTE A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS Genzyme Tissue Repair is our operating division that develops and markets biological products for orthopedic injuries, such as cartilage damage, and severe burns. BASIS OF PRESENTATION The combined financial statements of Genzyme Tissue Repair for each period include the balance sheets, results of operations and cash flows of the businesses we allocate to Genzyme Tissue Repair. We also allocate a portion of our corporate operations to Genzyme Tissue Repair using methods described in our allocation policy below. These combined financial statements are prepared using amounts included in our consolidated financial statements included in this annual report. We have reclassified certain 1998 and 1997 data to conform with the 1999 presentation. We prepare the financial statements of Genzyme Tissue Repair in accordance with generally accepted accounting principles. We present financial information and accounting policies specific to Genzyme Tissue Repair in the accompanying combined financial statements. We present financial information and accounting policies relevant to the corporation and its operating divisions taken as a whole in our consolidated financial statements. You should read the consolidated financial statements in conjunction with the financial statements of Genzyme Tissue Repair. Note A., "Summary of Significant Accounting Policies," to our consolidated financial statements contains our accounting policies. We incorporate that information into this note by reference. TRACKING STOCK Genzyme Tissue Repair Division Common Stock, which we refer to as "Tissue Repair Stock," is a series of our common stock that is designed to reflect the value and track the performance of Genzyme Tissue Repair. The chief mechanisms intended to cause Tissue Repair Stock to "track" the financial performance of Genzyme Tissue Repair are provisions in our charter governing dividends and distributions. Under these provisions, our charter: - factors the assets and liabilities and income or losses attributable to Genzyme Tissue Repair into the determination of the amount available to pay dividends on Tissue Repair Stock; and - requires us to exchange, redeem or distribute a dividend to the holders of Tissue Repair Stock if all or substantially all of the assets allocated to Genzyme Tissue Repair are sold to a third party (a dividend or redemption payment must equal in value the net after-tax proceeds from the sale; an exchange must be for Genzyme General Stock at a 10% premium to the exchanged stock's average market price following the announcement of the sale). To determine earnings per share, we allocate Genzyme's earnings to each series of our common stock based on the earnings attributable to that series of stock. The earnings attributable to Tissue Repair Stock, is defined in our charter as the net income or loss of Genzyme Tissue Repair determined in accordance with generally accepted accounting principles and as adjusted for tax benefits allocated to or from Genzyme Tissue Repair in accordance with our management and accounting policies. Our charter also requires that all income and expenses of Genzyme be allocated among the divisions in a reasonable and consistent manner. However, subject to its fiduciary duties, our board of directors can, at its discretion, GTR-16 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) change the methods of allocating earnings to each series of common stock. We intend to allocate earnings using our current methods for the foreseeable future. Because the earnings allocated to Tissue Repair Stock are based on the income or losses attributable to Genzyme Tissue Repair, we include financial statements and management's discussion and analysis of Genzyme Tissue Repair to aid investors in evaluating its performance. While Tissue Repair Stock is designed to reflect Genzyme Tissue Repair's performance, it is common stock of Genzyme Corporation and not Genzyme Tissue Repair; Genzyme Tissue Repair is a division, not a company or legal entity, and therefore does not and cannot issue stock. Consequently, holders of Tissue Repair Stock have no specific rights to assets allocated to Genzyme Tissue Repair. Genzyme Corporation continues to hold title to all of the assets allocated to Genzyme Tissue Repair and is responsible for all of its liabilities, regardless of what we deem for financial statement presentation purposes as allocated to any division. Holders of Tissue Repair Stock, as common stockholders, are therefore subject to the risks of investing in the businesses, assets and liabilities of Genzyme as a whole. For instance, the assets allocated to each division are subject to company-wide claims of creditors, product liability plaintiffs and stockholder litigation. Also, in the event of a Genzyme liquidation, insolvency or similar event, holders of Tissue Repair Stock and other tracking stockholders would only have the rights of common stockholders in the combined assets of Genzyme. ALLOCATION POLICY Our charter sets forth what operations and assets are initially allocated to Genzyme Tissue Repair and states that going forward the division will also include all business, products or programs, developed by or acquired for the division, as determined by our board of directors. We then manage and account for transactions between Genzyme Tissue Repair and our other divisions and with third parties, and any resulting re-allocations of assets and liabilities, by applying consistently across divisions a detailed set of policies established by our board of directors. We publicly disclose our divisional management and accounting policies, which appear in Exhibit 99.1 to this Annual Report on Form 10-K. Our charter requires that all assets and liabilities of Genzyme be allocated among the divisions. Our board of directors, however, retains considerable discretion in determining the types, magnitudes and extent of allocations to each series of common stock without shareholder approval. Our allocations to our divisions are based on one of the following methodologies: - Specific identification--assets that are dedicated to the production of goods of a division or which solely benefit a division are allocated to that division. Liabilities incurred as a result of the performance of services for the benefit of a division or in connection with the expenses incurred which directly benefit a division are allocated to the division. Such specifically identified assets and liabilities include cash, investments, accounts receivable, inventories, property and equipment, intangible assets, accounts payable, accrued expenses and deferred revenue. Revenues from the licensing of a division's products or services to third parties and the related costs are allocated to a division; - Actual usage--expenses are charged to the division for whose benefit such expenses are incurred. Research and development, sales and marketing and direct general and administrative services are GTR-17 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) charged to the divisions for which the service is performed on a cost basis. Such charges are generally based on direct labor hours; - Proportionate usage--costs incurred which benefit more than one division are allocated based on management's estimate of the proportionate benefit each division receives. Such costs include facilities, legal, finance, human resources, executive and investor relations; or - Board directed--programs and products, both internally developed and acquired, are allocated to divisions by the board of directors. The board of directors also allocates long-term debt and strategic investments. Note B., "Policies Governing the Relationship Between Genzyme's Operating Divisions," further describes our policies concerning interdivisional transactions and income tax allocations. We believe that the divisional allocations are reasonable and have been consistently applied. However, the division's results of operations may not be indicative of what would have been realized if the division was a stand-alone entity. TRANSLATION OF FOREIGN CURRENCIES We translate the financial statements of foreign subsidiaries allocated to Genzyme Tissue Repair from local currency into U.S. dollars and include translation adjustments for these subsidiaries in division equity. Genzyme Tissue Repair records gains and losses in foreign currency transactions in income. We include exchange gains and losses on intercompany balances which are long-term in nature in our division equity. Our gains and losses on all other transactions are included in our results of operations. REVENUE RECOGNITION Genzyme Tissue Repair recognizes revenue from sales of Carticel-Registered Trademark- chondrocytes and Epicel-TM- skin grafts when the cartilage or skin cells, as applicable, are shipped and title has passed. Cancellation charges apply to cancelled shipments of Epicel-TM- skin grafts. NET INCOME (LOSS) PER SHARE Earnings per share is calculated for each series of Genzyme stock using the two-class method, as further described in the notes to the consolidated financial statements. We present earnings per share data only in the consolidated financial statements of Genzyme because Genzyme Corporation is the issuer of the securities. Genzyme's divisions do not and cannot issue securities because they are not companies or legal entities. NOTE B. POLICIES GOVERNING THE RELATIONSHIP OF GENZYME'S OPERATING DIVISIONS Because each of our operating divisions is a part of a single company, our board of directors has adopted policies to address issues that may arise among divisions and to govern the management of and the relationships between each division. With some exceptions that are mentioned specifically in this note, our board of directors may modify or rescind these policies, or adopt additional policies, in its sole GTR-18 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE B. POLICIES GOVERNING THE RELATIONSHIP OF GENZYME'S OPERATING DIVISIONS (CONTINUED) discretion without stockholder approval, subject only to our board of directors' fiduciary duty to stockholders. Generally accepted accounting principles require that any change in policy be preferable (in accordance with these principles) to the previous policy. INTERDIVISION ASSET TRANSFERS Our board of directors may at any time reallocate any program, product or other asset from one division to any other division. We account for interdivision asset transfers at book value. The consideration paid for an asset transfer generally must be fair value as determined by our board of directors. The difference between the consideration paid and the book value of the assets transferred is recorded in division equity. Our board of directors determines fair value using the following methodologies: a risk-adjusted discounted cash flow model or a comparable transaction model. The risk-adjusted discounted cash flow model estimates fair value by taking the discounted value of all the cash inflows and outflows related to a program or product over a specified period of time, generally the economic life of the project, adjusted for the probabilities of certain outcomes occurring or not occurring. In performing this analysis, we consider various factors that could affect the success or failure of the program including: - the duration, cost and probability of success of each phase of development; - the current and potential size of the market and barriers to entry into the market; - the maximum number of patients likely to be treated with the product and the speed with which that maximum number will be reached; - reimbursement policies and pricing limitations; - current and potential competitors; - the net proceeds received by us upon the sale of the program or product; and - the costs of manufacturing and marketing the product or program. The comparable transaction model estimates fair value through comparison to valuations established for other transactions within the biotechnology and biosurgical areas involving similar programs and products having similar terms and structure. In identifying comparable transactions, we consider, among other factors, the following: - the similarity of market opportunity; - the comparability of the medical needs addressed; - the similarity of the regulatory, reimbursement and competitive environment; - the stage of product or program development; and - the risk profile of successfully commercializing the product or program. GTR-19 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE B. POLICIES GOVERNING THE RELATIONSHIP OF GENZYME'S OPERATING DIVISIONS (CONTINUED) We customarily use the comparable transaction model to corroborate valuations derived under the risk-adjusted discounted cash flow model. When determining the fair value of a program under development using either model, our board of directors also takes into account the following criteria in the case of a program under development: - the commercial potential of the program; - the phase of clinical development of the program; - the expenses associated with realizing any income from the program and the likelihood and time of the realization; and - other matters that our board of directors and its financial advisors, if any, deem relevant. One division may compensate another division for a reallocation with cash or other consideration having a value equal to the fair market value of the reallocated assets. In the case of a reallocation of assets from Genzyme General to Genzyme Tissue Repair, our board of directors may elect instead to account for the reallocation as an increase in Genzyme Tissue Repair designated shares in accordance with the provisions of our charter. No gain or loss is recognized as a result of these transfers. Our policy regarding transfers of assets between divisions may not be changed by our board of directors without the approval of the holders of Tissue Repair Stock voting as a separate class unless the policy change does not affect Genzyme Tissue Repair. OTHER INTERDIVISION TRANSACTIONS Our divisions may engage in transactions directly with one or more other divisions or jointly with one or more other divisions and one or more third parties. These transactions may include agreements by one division to provide products and services for use by another division, license agreements and joint ventures or other collaborative arrangements involving more than one division to develop new products and services jointly and with third parties. These transactions are subject to the following conditions: - We charge research and development (including clinical and regulatory support), distribution, sales, marketing, and general and administrative services (including allocated space) performed by one division for another division to the division for which the services are performed on a cost basis. We charge direct costs to the division for which we incur them. We allocate direct labor and indirect costs in reasonable and consistent manners based on the use by a division of relevant services. Divisions performing services for other divisions do not recognize revenue for the services they perform. - We charge the manufacturing of goods and performance of services by one division exclusively for another division to the division for which it is performed on a cost basis. We include in manufacturing costs an interest charge (based on our short-term borrowing rate at the beginning of the fiscal year) on the gross fixed assets used in the manufacturing process. To perform this calculation, we determine gross fixed assets for the facility used at the beginning of each fiscal year and apply our short-term borrowing rate. We allocate direct labor and indirect costs in reasonable and consistent GTR-20 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE B. POLICIES GOVERNING THE RELATIONSHIP OF GENZYME'S OPERATING DIVISIONS (CONTINUED) manners based on the benefit received by a division of related goods and services. Divisions performing services for other divisions do not recognize revenue for the services they perform. - Other than transactions involving research and development, manufacturing, distribution, sales, marketing, general and administrative services, which are addressed above, all interdivisional transactions are performed on terms and conditions obtainable in arm's length transactions with third parties. Divisions performing services for other divisions do not recognize revenue for the services they perform. - Our board of directors must approve interdivisional transactions that are performed on terms and conditions other than as described above and are material to one or more of the participating divisions. In giving its approval, our board of directors must determine that the transaction is fair and reasonable to each participating division and to holders of the common stock representing each participating division. - Divisions may make loans to other divisions. Any loan of $1 million or less matures within 18 months and accrues interest at the best borrowing rate available to the corporation for a loan of like type and duration. Our board of directors must approve any loan in excess of $1 million. In giving its approval, our board of directors must determine that the material terms of the loan, including the interest rate and maturity date, are fair and reasonable to each participating division and to holders of the common stock representing each such division. - All material interdivisional transactions are set forth in a written agreement that is signed by an authorized member of the management team of each division involved in the transaction. TAX ALLOCATIONS We file a consolidated tax return and allocate income taxes to Genzyme Tissue Repair based upon the financial statement income, taxable income, credits and other amounts properly allocable to each division under generally accepted accounting principles as if it were a separate taxpayer. We assess the realizability of our deferred tax assets at the division level. As a result, our consolidated tax provision may not equal the sum of the divisions' tax provision. As of the end of any fiscal quarter, however, if Genzyme Tissue Repair cannot use any projected annual tax benefit attributable to it to offset or reduce its current or deferred income tax expense, we may allocate the tax benefit to the other divisions in proportion to their taxable income without any compensating payment or allocation. ACCESS TO TECHNOLOGY AND KNOW-HOW Genzyme Tissue Repair has unrestricted access to all technology and know-how owned or controlled by Genzyme Corporation that may be useful in its business, subject to any obligations or limitations that apply to the corporation generally. NOTE C. ACCOUNTS RECEIVABLE Genzyme Tissue Repair performs credit evaluations of its customers on an ongoing basis and generally does not require collateral. Genzyme Tissue Repair states accounts receivable at fair value after GTR-21 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE C. ACCOUNTS RECEIVABLE (CONTINUED) reflecting an allowance for doubtful accounts. This allowance was $1.0 million at December 31, 1999 and 1998. NOTE D. INVENTORIES
DECEMBER 31, ------------------- 1999 1998 ------ ------ (AMOUNTS IN THOUSANDS) Raw materials............................................ $ 428 $ 264 Work-in-process.......................................... 1,938 2,381 Finished products........................................ 28 -- ------ ------ Total inventory.................................... $2,394 $2,645 ====== ======
NOTE E. PLANT AND EQUIPMENT
DECEMBER 31, ----------------------- 1999 1998 ------- ------- (AMOUNTS IN THOUSANDS) Plant and equipment.................................... $ 4,675 $ 3,845 Leasehold improvements................................. 2,597 2,577 Furniture and fixtures................................. 191 146 ------- ------- 7,463 6,568 Less accumulated depreciation.......................... (4,918) (3,732) ------- ------- Plant and equipment, net............................... $ 2,545 $ 2,836 ======= =======
Genzyme Tissue Repair's depreciation and amortization expense was $1.2 million in 1999, $1.6 million in 1998, and $2.3 million in 1997. In June 1998, our board of directors reallocated a manufacturing facility (including land, building and equipment) from Genzyme Tissue Repair to Genzyme General in exchange for $16.5 million in cash. Genzyme Tissue Repair recorded a gain in division equity of approximately $0.7 million in connection with this reallocation. NOTE F. DIACRIN JOINT VENTURE In May 1999, we reallocated our ownership interest in Diacrin/Genzyme LLC, our joint venture with Diacrin, Inc. for the development and commercialization of NeuroCell-TM--PD for the treatment of Parkinson's disease and NeuroCell-TM--HD for the treatment of Huntington's disease, from Genzyme Tissue Repair to Genzyme General in exchange for $25.0 million in cash. For the period October 1996 through May 1999, Genzyme Tissue Repair provided a total of $19.5 million of funding to the joint venture, $5.1 million of which was provided by Genzyme General in exchange for 489,810 Genzyme Tissue Repair designated shares. Genzyme Tissue Repair realized net losses from the joint venture of $3.4 million in 1999, $7.7 million in 1998 and $6.8 million in 1997. GTR-22 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE F. DIACRIN JOINT VENTURE (CONTINUED) If Diacrin/Genzyme LLC does not initiate a Phase III clinical trial of NeuroCell-TM--PD by June 30, 2000, Genzyme Tissue Repair is required to pay Genzyme General $20 million plus accrued interest at 13.5% per annum. Genzyme Tissue Repair may pay Genzyme General in cash, Genzyme Tissue Repair designated shares, or a combination of both, at its option. Condensed financial information and allocation of the losses of the Diacrin/Genzyme LLC are summarized below:
FOR THE YEAR ENDED DECEMBER 31, ------------------------------- 1999 1998 1997 --------- -------- -------- (AMOUNTS IN THOUSANDS) Operating expenses............................ $ (10,718) $ (9,595) $ (6,809) Net loss...................................... (10,713) (9,595) (6,809)
DECEMBER 31, --------------- 1999 1998 ---- ---- (AMOUNTS IN THOUSANDS) Current assets.............................................. $443 $364 Noncurrent assets........................................... 192 220 Current liabilities......................................... 972 885 Noncurrent liabilities...................................... -- --
NOTE G. ACCRUED EXPENSES
DECEMBER 31, ------------------- 1999 1998 ------ ------ (AMOUNTS IN THOUSANDS) Compensation............................................. $1,569 $1,271 Professional fees........................................ 334 505 Royalties................................................ 97 88 Other.................................................... 1,131 627 ------ ------ Total accrued expenses............................. $3,131 $2,491 ====== ======
NOTE H. DEBT INSTRUMENTS AND OPERATING LEASES REVOLVING CREDIT FACILITY During 1999, we refinanced our revolving credit facility allocated to Genzyme Tissue Repair, which matured in October 1999. At December 31, 1999, $18.0 million of the amount outstanding under our new revolving credit facility was allocated to Genzyme Tissue Repair. On that date, the interest rate on this borrowing was approximately 6.635%. Genzyme Tissue Repair incurred interest expense of $0.2 million on amounts borrowed under this revolving credit facility. GTR-23 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE H. DEBT INSTRUMENTS AND OPERATING LEASES (CONTINUED) Genzyme Tissue Repair incurred interest expense of $0.8 million in 1999, $1.1 million in 1998 and $1.1 million in 1997 on amounts borrowed under our credit facility that matured in 1999. 5% CONVERTIBLE SUBORDINATED NOTE In February 1997, we issued a 5% convertible subordinated note in a principal amount of $13.0 million. This note was convertible into shares of Tissue Repair Stock at a discount to the market value of Tissue Repair Stock. Genzyme Tissue Repair recorded a $0.2 million charge to interest expense in 1999, $0.5 million in 1998 and $1.1 million in 1997, to reflect the accretion to fair value of the conversion feature of this note. In 1998, the holder of this note converted $0.6 million in principal amount into 223,405 shares of Tissue Repair Stock. Genzyme Tissue Repair paid $1.1 million in accrued interest in connection with these conversions. In 1999, the holder converted the remaining $12.4 million in principal amount into 7,257,573 shares of Tissue Repair Stock. Genzyme Tissue Repair paid $0.5 million in accrued interest in connection with these conversions. As of December 31, 1999, there was no principal or interest remaining on this convertible note. OPERATING LEASES Genzyme Tissue Repair leases facilities and personal property under operating leases with terms in excess of one year. Genzyme Tissue Repair's total expense under operating leases was:
1999 1998 1997 ---- ---- ---- $1.7 million $2.2 million $1.8 million
Over the next five years, Genzyme Tissue Repair will be required to repay the following amounts under operating leases:
2000 2001 2002 2003 2004 AFTER 2004 ---- ---- ---- ---- ---- ---------- $1.9 million $1.8 million $1.5 million $1.5 million $1.5 million $1.5 million
GTR-24 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE I. DIVISION EQUITY The following table contains the components of division equity for Genzyme Tissue Repair for the periods presented:
DECEMBER 31, ------------------------------ 1999 1998 1997 -------- -------- -------- (AMOUNTS IN THOUSANDS) Balance at beginning of period.............................. $(16,396) $ 20,203 $ 18,084 Division net loss........................................... (30,040) (40,386) (45,984) Allocated proceeds from issuance of Tissue Repair Stock under stock plans......................................... 397 2,109 2,438 Allocation of cash to Genzyme Tissue Repair for designated shares(1)................................................. 5,001 -- 14,892 Tissue Repair Stock issued in public offering............... -- -- 29,037 Payment from Genzyme General for research program........... 100 250 -- Payment from Genzyme General for transfer of interest in joint venture............................................. 25,000 -- -- Allocated stock compensation expense........................ -- 108 221 Allocated value of debt conversion feature.................. -- -- 1,524 Allocated value of Tissue Repair Stock issued upon conversion of convertible debt............................ 12,483 600 -- Allocated gain on transfer of facility...................... -- 711 -- Allocated equity adjustments................................ -- 9 (9) -------- -------- -------- Balance at end of period.................................... $ (3,455) $(16,396) $(20,203) ======== ======== ========
------------------------ (1) Genzyme Tissue Repair designated shares are shares of Tissue Repair Stock that are not issued and outstanding, but which our board of directors may issue, sell or distribute without allocating the proceeds to Genzyme Tissue Repair. As of December 31, 1999, there were 2,238,053 Genzyme Tissue Repair designated shares. STOCK COMPENSATION PLANS We apply APB Opinion 25 and related interpretations in accounting for our five stock-based compensation plans: the 1990 Equity Incentive Plan, the 1997 Equity Plan (both of which are stock option plans), the 1990 Employee Stock Purchase Plan, the 1999 Employee Stock Purchase Plan, and the 1998 Director Stock Option Plan. We do not recognize compensation expense for options granted and shares purchased under the provisions of these plans for options granted to employees with an exercise price greater than or equal to fair market value. The following table sets forth division net loss data for Genzyme Tissue Repair as if compensation expense for our stock-based compensation plans was determined in accordance with SFAS 123 based on GTR-25 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE I. DIVISION EQUITY (CONTINUED) the fair value at the grant dates of the awards, and the compensation expense related to Tissue Repair Stock awards would be allocated to Genzyme Tissue Repair in accordance with our allocation policies:
DECEMBER 31, --------------------------------------- 1999 1998 1997 --------- --------- --------- (AMOUNTS IN THOUSANDS) Division net loss: As reported......................... $ (30,040) $ (40,386) $ (45,984) Pro forma........................... $ (33,292) $ (44,481) $ (49,547)
Note L, "Stockholders' Equity," to our consolidated financial statements contains information regarding the assumptions we made in calculating pro forma compensation expense in accordance with SFAS 123. INTERDIVISIONAL FINANCING ARRANGEMENT In October 1996, our board of directors made $20.0 million of Genzyme General's cash available to Genzyme Tissue Repair in order for Genzyme Tissue Repair to fund its obligations under its joint venture with Diacrin. Under this arrangement, Genzyme Tissue Repair may draw down funds as needed each quarter in exchange for Genzyme Tissue Repair designated shares based on the fair market value of Tissue Repair Stock (as defined in our charter) at the time of the draw. Genzyme Tissue Repair made a $7.0 million draw under this line in 1997. In May 1998, our board of directors increased the amount committed under this arrangement from $13.0 million to $50.0 million. Genzyme Tissue Repair made a $5.0 million draw in February 1999. In May 1999, the amount available under this arrangement was reduced to $25.0 million in connection with the reallocation of our ownership interest in Diacrin/Genzyme LLC from Genzyme Tissue Repair to Genzyme General. NOTE J. COMMITMENTS AND CONTINGENCIES We periodically become subject to legal proceedings and claims arising in connection with our business. We do not believe that there were any asserted claims against us as of December 31, 1999 which, if adversely decided, would have a material adverse effect on Genzyme Tissue Repair's results of operations, financial condition, or liquidity. GTR-26 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE K. INCOME TAXES Genzyme Tissue Repair's provisions for income taxes were at rates other than the U.S. federal statutory tax rate for the following reasons:
1999 1998 1997 ------- ------- ------- Tax at U.S. statutory rate...................... (35.0)% (35.0)% (35.0)% State taxes, net................................ (1.3) (2.8) (3.0) Benefit of tax credits.......................... (0.1) (3.4) (1.4) Other, net...................................... 0.2 0.6 1.0 Deductions subject to deferred tax valuation allowance..................................... 36.2 40.6 38.4 ----- ----- ----- Effective tax rate.............................. 0.0 % 0.0 % 0.0 % ===== ===== =====
The components of net deferred tax assets are described in the following table:
DECEMBER 31, ------------------- 1999 1998 -------- -------- (AMOUNTS IN THOUSANDS) Deferred tax assets: Net operating loss carryforwards..................... $ 66,011 $ 55,582 Tax credits.......................................... 2,360 2,331 Intangible amortization.............................. 9,651 10,586 Reserves and other................................... 5,830 5,035 -------- -------- Gross deferred tax assets................................ $ 83,852 $ 73,534 Valuation allowance...................................... (83,852) (73,534) -------- -------- Net deferred tax asset................................... $ -- $ -- ======== ========
As a result of uncertainty surrounding our ability to realize certain tax benefits that primarily relate to operating loss carryforwards, we placed valuation allowances of $83.9 million in 1999 and $73.5 million in 1998 against otherwise recognizable deferred tax assets. As Genzyme Tissue Repair recognizes these deferred tax assets in accordance with generally accepted accounting principles, the benefits of those assets are reflected in its tax provision. However, the benefit of these deferred tax assets has previously been allocated to Genzyme General in accordance with our management and accounting policies. NOTE L. BENEFIT PLANS Note P. "Benefit Plans," to our consolidated financial statements contains information regarding our 401(k) plan. We incorporate that information into this note by reference. NOTE M. SUBSEQUENT EVENT In March 2000, we entered into an agreement to acquire Biomatrix, Inc. Upon the effectiveness of our Registration Statement on Form S-4 and completion of the merger, we will form a new operating division GTR-27 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION NOTES TO COMBINED FINANCIAL STATEMENTS (CONTINUED) NOTE M. SUBSEQUENT EVENT (CONTINUED) called Genzyme Biosurgery and create a new series of common stock designed to reflect its value and track its performance. We refer to this stock as "Biosurgery Stock." In connection with the merger, and upon Genzyme shareholder approval, the assets and liabilities allocated to Genzyme Surgical Products and Genzyme Tissue Repair will be reallocated to Genzyme Biosurgery and shares of Surgical Products Stock and Tissue Repair Stock will be exchanged for Biosurgery Stock. We will account for the acquisition of Biomatrix as a purchase. Biomatrix stockholders will receive $37 in cash, one share of Biosurgery Stock, or a combination of cash and stock for each share of Biomatrix Stock they hold. The merger agreement provides that we will pay cash for up to 28.38% of the outstanding shares of Biomatrix common stock that receive merger consideration, or up to approximately $245.0 million. Holders of Surgical Products Stock will receive 0.6060 share of Biosurgery Stock in exchange for each share of Surgical Products Stock they hold and holders of Tissue Repair Stock will receive 0.3352 share of Biosurgery Stock in exchange for each share of Tissue Repair Stock they hold. GTR-28 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Genzyme Corporation: In our opinion, the accompanying combined balance sheets and the related combined statements of operations and cash flows present fairly, in all material respects, the financial position of Genzyme Tissue Repair (as described in Note A) at December 31, 1999 and 1998, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, the financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related combined financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significantly estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As more fully described in Note A to these financial statements, Genzyme Tissue Repair is a division of Genzyme Corporation; accordingly, the combined financial statements of Genzyme Tissue Repair should be read in conjunction with the audited consolidated financial statements of Genzyme Corporation and Subsidiaries. /s/ PricewaterhouseCoopers LLP Boston, Massachusetts February 23, 2000 GTR-29 GENZYME TISSUE REPAIR A DIVISION OF GENZYME CORPORATION SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E ------------------------- ------------------- --------------------------------- ---------- ------------- ADDITIONS --------------------------------- BALANCE AT CHARGED TO COSTS CHARGED TO BALANCE AT DESCRIPTION BEGINNING OF PERIOD AND EXPENSES OTHER ACCOUNTS DEDUCTIONS END OF PERIOD ------------------------- ------------------- ---------------- -------------- ---------- ------------- Year ended December 31, 1999: Allowance for doubtful accounts............... $ 1,021,000 $ 184,000 $ -- $ 215,000(1) $ 990,000 Inventory reserve........ $10,652,000 $ 2,534,000 $ -- $ -- $13,186,000 Year ended December 31, 1998: Allowance for doubtful accounts............... $ 839,000 $ 257,000 $ -- $ 75,000(1) $ 1,021,000 Inventory reserve........ $ 8,347,000 $ 2,728,000 $ -- $ 423,000 $10,652,000 Year ended December 31, 1997: Allowance for doubtful accounts............... $ 408,000 $ 480,000 $ -- $ 49,000(1) $ 839,000 Inventory reserve........ $ 4,427,000 $ 3,920,000 $ -- $ -- $ 8,347,000
------------------------ (1) Uncollectible accounts written off, net of recoveries. GTR-30