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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13
OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934.
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998.
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934.
FOR THE TRANSITION PERIOD FROM TO .
Commission File Number: 0-23247
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FOCAL, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 94-3142791
(State or other jurisdiction of (I.R.S. employer identification
incorporation or organization) no.)
4 MAGUIRE ROAD, LEXINGTON, MA 02421
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (781) 280-7800
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
Preferred Share Purchase Rights
(Title of class)
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Indicate by check mark whether the Registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. / / Yes /X/ No
Indicate by check mark if disclosures of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in part III of this Form 10-K or any amendment to this
Form 10-K. /X/
The aggregate value of voting stock held by non-affiliates of the Registrant
was approximately $86,833,000 as of March 15, 1999, based upon the average of
the high and low prices of the Registrant's Common Stock reported for such date
on the Nasdaq National Market. Shares of Common Stock held by each executive
officer and director and by each person who owns 10% or more of the outstanding
Common Stock have been excluded in that such persons may be deemed to be
affiliates. The determination of affiliate status is not necessarily a
conclusive determination for other purposes. As of March 15, 1999, the
Registrant had outstanding 13,397,637 shares of Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Certain information is incorporated into Part III of this report by
reference to the Proxy Statement for the Registrant's 1999 Annual Meeting of
Stockholders to be filed with the Securities and Exchange Commission pursuant to
Regulation 14A not later than 120 days after the end of the fiscal year covered
by this Form 10-K. Certain information is incorporated into Parts II and IV of
this report by reference to the Registrant's Annual Report to Stockholders for
the year ended December 31, 1998.
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PART I
ITEM 1. BUSINESS
THE COMPANY
Focal, Inc. ("Focal" or the "Company") develops, manufactures and
commercializes synthetic, absorbable, liquid surgical sealants based on the
Company's proprietary polymer technology. The Company's family of
FOCALSEAL-REGISTERED TRADEMARK- surgical sealant products is currently being
developed for use inside the body to seal leaks resulting from lung,
neurological, cardiovascular and gastrointestinal surgery. FOCALSEAL-L, the
Company's first surgical sealant product, is initially being used to seal air
leaks following lung surgery. The Company has entered into an exclusive
marketing and distribution agreement for its surgical sealant products outside
North America with Ethicon, Inc., a division of Johnson & Johnson ("Ethicon"), a
worldwide leader in surgical wound closure products. The Company has received CE
mark approval for FOCALSEAL-L surgical sealant and Ethicon is marketing this
product for lung surgery indications in Europe.
There are more than 4 million open and minimally invasive lung,
neurological, cardiovascular and gastrointestinal surgical procedures performed
each year worldwide in which air or fluid leaks may arise. These leaks occur in
an unpredictable and unexpected manner, and the Company's products, if approved,
may be effective in reducing such post-surgical leaks. Because of the
unpredictable nature of these leaks, it may be difficult at the completion of
surgery for the surgeon to determine whether a particular surgical site will
leak. Accordingly, the Company believes that its FOCALSEAL surgical sealants may
be used prophylactically in many of these procedures. The Company has
successfully completed clinical trials of FOCALSEAL-L surgical sealant for lung
surgery and FOCALSEAL-S surgical sealant for neurosurgery. These clinical trials
demonstrated that FOCALSEAL surgical sealant is effective in sealing air and
fluid leaks following lung and neurological surgery and that the product is safe
in humans. Focal intends to develop products and conduct clinical trials for
cardiovascular and gastrointestinal surgery indications.
Patients with persistent air or fluid leaks may require prolonged
hospitalization, have more complications, higher levels of post-operative pain,
and a higher risk of mortality. Sutures and staples represent the principal
products comprising the over $2.5 billion worldwide wound closure market.
Sutures and staples work very effectively in bringing dissected tissues back
together after surgery. However, sutures and staples do not have inherent
sealing capabilities, and therefore cannot consistently eliminate air and fluid
leakage at the wound site.
Focal's liquid surgical sealants have the following features which the
Company believes allow the product to effectively reduce the incidence of air
and fluid leaks following surgery:
- adhere rapidly to underlying tissue;
- expand and contract with tissue;
- withstand air and fluid pressure.
FOCALSEAL surgical sealants, which are biocompatible, are designed to remain
intact through the critical wound healing period and are then absorbed and
eliminated by the body. Focal has developed two primary formulations of its
products, FOCALSEAL-L surgical sealant and FOCALSEAL-S surgical sealant, which
are designed to have absorption times that parallel long-term and short-term
synthetic, absorbable polymer sutures, respectively.
Focal believes the use of its FOCALSEAL liquid surgical sealants could
potentially shorten patient recovery times and hospital stays and reduce
post-surgical complications. Focal's pivotal U.S. clinical trial of FOCALSEAL-L
surgical sealant for lung surgery demonstrated a trend toward earlier patient
discharge from the hospital.
FOCALSEAL-L surgical sealant was launched in Europe in the first half of
1998 by Ethicon. Focal recorded over $3 million of product revenues in 1998
based on its shipments of product to Ethicon. The
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Company has completed a 180 patient, multicenter clinical trial in the United
States involving the use of FOCALSEAL-L surgical sealant in sealing air leaks
following lung surgery. This clinical trial was randomized and controlled.
FOCALSEAL-L surgical sealant was shown to be 92% effective in sealing
intraoperative air leaks in those receiving FOCALSEAL-L surgical sealant. For
those patients in the control group, who received sutures and staples alone,
only 29% were free of intraoperative air leaks. Focal is in the process of
submitting a modular Premarket Approval ("PMA") application to the FDA for lung
surgery indications and, pending FDA approval, expects to launch FOCALSEAL-L
surgical sealant in the United States through a direct sales force or through a
marketing and distribution agreement.
FOCALSEAL-S surgical sealant, the Company's second surgical sealant
formulation, will initially be used to seal cerebral spinal fluid ("CSF") leaks
following neurosurgery. Focal has completed a 44 patient multicenter clinical
trial of FOCALSEAL-S surgical sealant for this neurosurgery indication. All of
the patients enrolled in this clinical trial received FOCALSEAL-S surgical
sealant and 100% of these patients were sealed at the end of surgery. Over 90%
of these patients had CSF leaks prior to the application of FOCALSEAL-S surgical
sealant.
The Company believes, based upon preclinical evaluation of its polymers,
that its FOCALSEAL-L and FOCALSEAL-S surgical sealant formulations will also be
applicable to cardiovascular surgery, gastrointestinal surgery and other
surgical applications. Focal and a collaborator at Massachusetts General
Hospital have successfully demonstrated in preclinical models that FOCALSEAL-L
surgical sealant is effective in sealing blood leaks in coronary artery bypass
graft ("CABG") surgery. Focal's product was applied at the site of a vessel
attachment, known as an anastomosis. Focal is currently conducting further
preclinical trials. If Focal successfully completes preclinical trials of
FOCALSEAL-L surgical sealant for cardiovascular surgery and receives all
necessary approvals, Focal and Ethicon will launch this product in Europe.
Focal is also developing other applications for the liquid formulations of
its polymer technology, including local drug delivery systems, synthetic
coatings for vascular grafts and tissue coatings to prevent post-surgical
adhesions.
In local drug delivery applications, the Company believes that its polymers
can deliver high concentrations of drugs at local disease sites, thereby
potentially enhancing efficacy and reducing toxicity associated with systemic
delivery of drugs. Focal has demonstrated in preclinical models the ability to
obtain sustained release of drugs at a local disease site.
Textile vascular grafts are commonly used for cardiovascular surgery. These
grafts are typically coated with a collagen-based material to prevent blood
leakage. Such coatings do not always work effectively in sealing the graft and
have the risks associated with animal derived products. Focal polymer coatings
have been shown in preclinical testing to be effective in sealing a variety of
vascular grafts.
Focal is developing tissue coatings to prevent the formation of
post-surgical adhesions, excessive scar tissue which attaches to surrounding
tissue and can cause serious complications, such as in neurosurgery. Focal
intends to seek to enter into collaborations with medical device or
pharmaceutical companies for these additional applications of its technology.
During 1998, Focal received a grant from the National Institutes of Health to
study the effect of adhesions in nerve repair.
Focal's family of surgical sealants and its other products under development
are based on the Company's proprietary synthetic, absorbable, liquid formulation
polymer technology. The Company's polymers are comprised primarily of water,
polyethylene glycol ("PEG") and other synthetic components. These components are
widely used in other medical products approved for use inside the body,
including synthetic absorbable sutures. The Company combines PEG and other
synthetic compounds in various proprietary polymer formulations in order to
control characteristics such as absorption, viscosity, setting time, strength,
flexibility and elasticity. This enables the Company to tailor formulations for
particular surgical applications. A key distinguishing characteristic of the
Company's polymer formulations is that they are applied as liquids and then
converted by light into solid gels inside the body. The solid gel formed
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after the light has been applied, is highly flexible, elastic and transparent
and strongly adheres to moist or dry tissue. The resulting solid gel is then
absorbed and eliminated from the body over periods of time varying from weeks to
months to several years.
The Company believes it has built a strong patent portfolio related to its
polymerizable polymer technology. The Company has received, licensed or believes
it has the option or right to license 36 issued United States patents and 18
foreign patents corresponding to certain of the issued United States patents,
has eight additional United States patent applications that have been allowed
and has 26 patent applications pending in the United States, as well as foreign
counterparts of certain of these applications.
The Company's objective is to become a leader in the market for surgical
sealants and in other markets where the Company's novel polymer technology could
address large unmet clinical needs. The Company intends to achieve its goals by:
(i) commercializing FOCALSEAL surgical sealants in the areas of lung,
cardiovascular, neurological, and gastrointestinal surgery;
(ii) marketing its FOCALSEAL surgical sealant products through Ethicon
internationally and by building a direct sales force or entering into a
marketing and distribution agreement in North America;
(iii) leveraging its proprietary polymer technology to develop new products;
(iv) funding new research and development initiatives through corporate
collaborations; and
(v) retaining proprietary manufacturing processes and outsourcing
non-proprietary manufacturing processes.
Focal was incorporated in Delaware in June 1991. The Company's principal
executive offices are located at 4 Maguire Road, Lexington, Massachusetts 02421.
Its telephone number is (781) 280-7800.
This Report on Form 10-K contains certain forward looking statements
regarding future events with respect to the Company. Actual events and/or future
results of operations may differ materially as a result of the factors described
herein and in the documents incorporated herein by reference, including, in
particular, those factors described under "Business--Product and Product
Development Programs," "--Strategic Alliances," "--Patents and Proprietary
Rights," "--Government Regulation," "--Sales and Marketing," "--Manufacturing,"
"--Competition and Technological Change," "--Third Party Reimbursement" and
"Factors Affecting Operating Results."
SURGICAL SEALANT MARKET
Effective closure of internal wounds following surgical procedures is
critical to the restoration of the function of injured and diseased tissue and
the ultimate success of the surgical procedure. Failure to effectively seal
surgical wounds can result in leakage of air in lung surgeries, cerebral spinal
fluid in neurosurgeries, blood in cardiovascular surgeries, and gastrointestinal
contents in gastrointestinal surgeries. Air and fluid leaks resulting from
surgical procedures can lead to significant post-surgical morbidity resulting in
prolonged hospitalization, higher levels of post-operative pain and
complications and a higher mortality rate.
The current annual worldwide market for wound closure products, consisting
primarily of surgical sutures and staples, is estimated at over $2.5 billion.
Sutures and staples facilitate healing by joining wound edges and allowing the
body to heal naturally. However, because sutures and staples do not have
inherent sealing capabilities, they cannot consistently eliminate air and fluid
leakage at the wound site. This is particularly the case when sutures and
staples are used to close tissues containing air or fluids under pressure, such
as the lobes of the lung, the dural membrane surrounding the brain and spinal
cord, blood vessels and the gastrointestinal tract. In addition, in minimally
invasive surgical procedures, where the physician must operate through small
access devices, it can be more difficult and time-consuming for the
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physician to place sutures and staples as compared to open surgical procedures.
The Company believes that the use of surgical sealants in minimally invasive
procedures could enhance the efficacy of these procedures through more effective
and rapid wound closure.
The limitations of sutures and staples in sealing certain air and fluid
leaks have led to the adaptation of other technologies for wound closure. These
alternatives include the use of liquid fibrin glues and nonliquid collagen patch
products. Fibrin glues were originally developed as hemostatic agents to stop
diffuse bleeding. They have limited effectiveness in many surgical sealant
applications because they do not adhere strongly to, or move and expand with,
underlying tissue, particularly moist tissue. They are also not capable of
withstanding high pressure leaks. In spite of these limitations, annual
international sales of fibrin glue sealants are estimated at $250 million.
Collagen patches have similar limitations, in that they are not highly
adherent, strong or elastic. In addition, both collagen patches and fibrin glues
are absorbed by enzymatic reaction. Enzymatic reaction can result in variable
absorption time from patient to patient, depending upon metabolic rates, and can
potentially result in absorption prior to healing of the surgical site. Collagen
patches and fibrin glues are derived from animal by-products, including bovine
collagen and bovine and/or human plasma. These derivatives have resulted in
significant safety concerns such as disease transmission. Furthermore, the wound
closure industry has undergone a significant shift away from animal derived
materials to synthetic materials due to the more predictable absorption,
superior performance characteristics and more favorable safety profile of
synthetic sutures. Currently, the Company estimates that over 65% of suture
material is synthetic, as compared to only approximately 25% in 1975.
Due to the limitations of sutures and staples in achieving rapid, leakproof
wound closure and the inadequacy of animal by-product sourced glues and patches,
Focal believes that a significant market opportunity exists for its synthetic,
absorbable, liquid, surgical sealants.
FOCAL'S SYNTHETIC POLYMER TECHNOLOGY
Focal's family of surgical sealants and its other products under development
are based on the Company's proprietary synthetic, absorbable, liquid formulation
polymer technology. The Company's polymers are designed to incorporate several
beneficial characteristics, which are critical to their use as surgical sealants
and in other medical applications, including:
- adherence to tissue;
- strength, flexibility and elasticity;
- consistent absorption; and
- safety and biocompatibility
The Company's proprietary polymer formulations are primarily comprised of
water, polyethylene glycol ("PEG") and other synthetic components. Water makes
up approximately 80-90% of Focal's formulations and PEG and other synthetic
components comprise the remaining 10-20% of the formulation. The components of
Focal's sealants are widely used in other medical products approved for use
inside the body, such as synthetic absorbable sutures,
intravenously-administered pharmaceuticals, bone and dental cements, pain
medications and eye drops. The Company combines PEG and other synthetic
components in various proprietary polymer formulations in order to control
characteristics such as absorption, viscosity, setting time, strength,
flexibility and elasticity. This enables the Company to tailor polymers for
particular applications. A key distinguishing characteristic of the Company's
polymer formulations is that they are applied as liquids and are converted by
light into solid gels inside the body, a process known as photopolymerization.
The solid gel formed after the light has been applied is highly flexible,
elastic and transparent and strongly adheres to moist or dry tissue. The design
and macromer
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composition of the Company's polymers enable them to convert quickly to solid
gels without generating heat, which is a significant clinical advantage over
other IN VIVO polymerizable materials.
The key technological hurdle which the Company overcame in the development
of its synthetic, liquid surgical sealants was the crucial need to adhere
strongly to moist tissue surfaces. The Company's sealants adhere to tissue as a
result of a proprietary two-step priming and sealing process. To use FOCALSEAL
surgical sealant, the physician first applies a liquid primer which penetrates
the uneven surfaces of the tissue. Once the primer is brushed on, the sealant is
applied over the primer and both are exposed to a standard wavelength of visible
light. The primer and sealant contain a photoinitiator which enables them to
convert rapidly to a solid gel upon exposure to light. The viscosity and rapid
conversion characteristics of the Company's surgical sealants enable the
physician to apply the sealant where desired and avoid significant run off of
the material prior to polymerization. Surgeons can perform the entire surgical
sealant application process quickly and efficiently after limited training.
The key properties of the Company's synthetic liquid polymers are:
- ADHERENCE TO TISSUE. The Company's FOCALSEAL surgical sealants adhere
strongly to both moist and dry tissue, a requirement for effective
sealants which, to the Company's knowledge, has not been adequately
demonstrated by alternative technologies in clinical applications. The
combination of a viscous liquid formulation polymer incorporating a
photoinitiator enables the Company's polymers to adhere to tissue when
applied as a liquid and to polymerize rapidly when exposed to light.
- STRENGTH, FLEXIBILITY AND ELASTICITY. The composition of the Company's
polymers provides a high degree of strength, flexibility and elasticity,
enabling them to stretch with the tissue to which they are applied. These
qualities are especially significant when the polymers are used in areas
where resistance to air and fluid pressure is critical, including the
lungs, the dural membrane surrounding the brain, the vascular system and
the gastrointestinal tract.
- CUSTOMIZABLE POLYMER CHARACTERISTICS. By modifying the chemical
composition of its polymers, the Company is able to control
characteristics such as absorption, viscosity, setting time, strength,
flexibility and elasticity. The customizable nature of the Company's
polymer technology enables Focal to design and develop products with
characteristics and properties that are tailored for specific clinical
indications.
- HYDROLYTIC ABSORPTION. The Company's synthetic polymers are designed to be
predictably broken down by water, a process known as hydrolysis, and are
absorbed by the body over a specified period of time depending upon their
chemical composition. As a result, the Company's polymers should have a
relatively consistent absorption profile from patient to patient. Collagen
patches and fibrin glues are absorbed by enzymatic reaction, which can
vary significantly from patient to patient depending upon an individual's
metabolism, and can potentially result in these products being absorbed
before the wound site is completely healed.
- SAFETY AND BIOCOMPATIBILITY. Focal's synthetic polymers are comprised of
materials which are commonly found in other medical products approved for
use in humans. The PEG backbone allows the resulting formulations to be
water-soluble and biocompatible, resulting in minimal reaction with the
tissue to which the polymer is applied. In addition, the absence of animal
or human derived by-products eliminates safety concerns related to
transmission of blood borne diseases such as HIV and hepatitis.
Preclinical toxicology testing of FOCALSEAL-L and FOCALSEAL-S surgical
sealants, and initial clinical trials of FOCALSEAL-L and FOCALSEAL-S
surgical sealants, indicate that these biomaterial formulations are
nontoxic.
- TRANSPARENCY. The Company's polymers are transparent, enabling the
physician to observe the underlying tissue to which the polymers have
adhered to confirm sufficient coverage of the wound site. Other products
used as surgical sealants, including fibrin glues and collagen patches,
are not transparent.
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The Company has also developed proprietary systems to deliver its surgical
sealants and other products to the wound site. Easy to use brush applicators
have been designed by the Company to apply its FOCALSEAL surgical sealants and
primer over tissue surfaces. These application devices have been tailored to
each specific indication, such as lung surgery and neurosurgery. The Company
also employs a light source and light wand to generate and deliver consistent
amounts of light necessary for conversion of its liquid formulations to solid
gels. These light sources and light wands are manufactured by third parties on
behalf of Focal.
PRODUCTS AND PRODUCT DEVELOPMENT PROGRAMS
The following table summarizes the status of the Company's products and
research and product development programs:
<TABLE>
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MARKETING RIGHTS
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PRODUCT
DEVELOPMENT PROGRAM INDICATION STATUS NORTH AMERICA INTERNATIONAL
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Surgical Sealants
FocalSeal-L Lung Surgery CE Mark approval received Focal Ethicon
Product; marketed throughout
Europe; U.S. pivotal clinical
trial completed; modular PMA
submission to FDA is in
process
FocalSeal-S Neurosurgery European clinical trial Focal Ethicon
completed
FocalSeal-L Cardiovascular Preclinical(1) Focal Ethicon
surgery
FocalSeal Gastrointestinal Preclinical(1) Focal Ethicon
surgery
Vascular Graft Coatings Cardiac and Preclinical(1) Focal Focal
peripheral
vascular surgery
Tissue Coatings for post- Neurological Preclinical(1) Focal Ethicon (2)
surgical adhesions adhesions NIH Grant
Local Drug Delivery Various Preclinical Focal Focal
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(1) "Preclinical" refers to formulation development and laboratory
experimentation in animal models, including animal efficacy, safety and
toxicology testing.
(2) Ethicon received certain rights to Focal's post-surgical adhesions
technology in connection with the licensing agreement signed between the
companies in January 1997.
FOCALSEAL SURGICAL SEALANT PRODUCTS.
Focal is developing its FOCALSEAL-L and FOCALSEAL-S liquid surgical sealants
for use inside the body with or without sutures and staples to seal leaks
resulting from lung, neurological, cardiovascular and gastrointestinal surgery.
FOCALSEALsurgical sealant is expected to be used as an adjunct to sutures and
staples in most indications. The FOCALSEAL surgical sealant system consists of a
procedure kit containing primer and sealant solutions and disposable
applicators, a light source used for converting the liquid polymer to a solid
gel, and a reusable light wand. The Company's FOCALSEAL-L surgical sealant
product for lung surgery is being marketed outside North America by Ethicon, a
world leader in surgical wound closure products.
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Ethicon has marketing rights to Focal's additional surgical sealant products
outside North America. The Company has retained North American marketing rights
to all of its FOCALSEAL surgical sealants.
FOCALSEAL-L FOR LUNG SURGERY. The Company has developed FOCALSEAL-L
surgical sealant to seal air leaks resulting from lung surgery. During lung
surgery, air leaks can develop in the lung tissue that has been traumatized
during surgery and can unpredictably occur along staple and suture lines.
Approximately 300,000 lung surgery procedures, primarily for the treatment of
lung cancer, are performed worldwide each year including 150,000 such procedures
in the United States. According to the Company's clinical trial data in the U.S.
and Europe, the vast majority of patients undergoing lung surgery experience
intraoperative air leaks that are not resolved with sutures or staples.
Approximately 15% of lung surgery patients have air leaks that persist longer
than seven days and approximately 5% of patients have air leaks that are severe
enough to warrant additional surgery.
As air leaks from the lung it accumulates in the thoracic cavity, making
breathing difficult as the lung cannot expand and contract normally. As a
result, patients require insertion of chest drainage tubes to vent accumulated
air. These chest tubes prolong pain and limit patient mobility. In addition to
remaining in the hospital until the air leaks are resolved, patients with
persistent air leaks must receive more intense nursing observation and care
while in the hospital than patients who do not experience air leaks. This
additional hospitalization and more intensive care, as well as the additional
surgery required for patients whose air leaks are severely prolonged, result in
substantial additional healthcare costs. Because it is often not possible to
determine at the conclusion of surgery which air leaks are likely to be
prolonged or sustained, the Company believes that FOCALSEAL-L surgical sealant
may be used prophylactically in major lung surgery procedures.
The Company has completed a 180 patient, multicenter clinical trial in the
United States involving the use of FOCALSEAL-L surgical sealant in sealing air
leaks following lung surgery. The four hospitals involved in the clinical trial
were Massachusetts General Hospital, University of Pennsylvania Medical Center,
The Johns Hopkins University Medical Center and Strong Memorial Hospital. Of the
180 patients in the study, the initial four were pilot patients and the
remaining 176 were randomized into the treated (received FOCALSEAL-L surgical
sealant) or nontreated (control) group. In the study, prior to randomization, it
was determined that the vast majority of the patients had air leaks following
the use of standard sutures and staples. FOCALSEAL-L surgical sealant was 92%
effective in sealing intraoperative air leaks in the 117 patients who were
randomized into the treated group. By contrast, of the 59 patients in the
untreated group who received sutures and staples alone, only 29% were free of
intraoperative air leaks. Through the date of discharge from the hospital, a
statistically significant percentage of those patients treated with FOCALSEAL-L
surgical sealant remained leak-free compared with the control group. In
addition, the mean time to air leak cessation was 29 hours in the treated group
of patients, compared with 48 hours in the control group. To summarize, the end
points required by the FDA, comparing the treated group with the control group,
were as follows:
- % of patients leak-free intraoperatively;
- % of patients leak-free through hospital discharge;
- mean time to air leak cessation.
All three of these end points were met with statistical significance and
demonstrated clinical significance as well. In addition to these formal end
points, a trend toward earlier chest tube pull and earlier hospital discharge
were demonstrated. On average, chest tubes were removed 0.7 days earlier in the
treated group versus the control group and patients were discharged 2.7 days
earlier in the treated group versus the control group. There were no unexpected
safety results noted when comparing the treated group and the control group,
including the six month follow-up period required for all patients.
Focal is in the process of submitting a modular PreMarket Approval ("PMA")
application to the FDA for its FOCALSEAL-L surgical sealant for lung surgery
applications. The average review time for a PMA
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application is approximately 12 months, but the review process may be longer.
Focal currently plans to launch FOCALSEAL-L surgical sealant in the United
States either with a direct sales force or through a marketing and distribution
agreement, pending FDA approval.
Focal and its marketing partner outside North America, Ethicon, are
currently selling FOCALSEAL-L surgical sealant for lung surgeries in thirteen
countries in Europe. During 1998, Focal recorded approximately $3 million in
product revenues based on shipment of product to Ethicon. See "--Strategic
Alliances--Ethicon--a division of Johnson & Johnson.
FOCALSEAL-S FOR NEUROSURGERY. The Company is developing FOCALSEAL-S
surgical sealant to seal the dura, a membrane that encapsulates the brain and
spinal cord and contains cerebral spinal fluid ("CSF") for cushioning and
support. In cranial surgeries, the neurosurgeon must open the cranium and
penetrate through the dural membrane. Following surgery, the neurosurgeon must
meticulously suture the dura in an attempt to achieve leakproof closure, a
process that may require the use of up to hundreds of small sutures. These
attempts are not always successful, resulting in potentially serious CSF leaks.
Approximately 185,000 cranial surgeries are performed annually in the United
States, and the Company estimates that 370,000 of such procedures are performed
each year worldwide. Leakage of CSF has been reported to occur in approximately
15% of these procedures. Because these leaks occur in an unpredictable manner,
an effective surgical sealant may be used prophylactically in cranial surgery
procedures. CSF leakage can result in infections, including meningitis, caused
by the passage of infectious agents through the dural leak, as well as
debilitating headaches.
A 44 patient clinical trial was conducted during 1998 at three hospitals in
Europe, including one hospital in The Netherlands and two hospitals in
Switzerland. All patients enrolled in the trial received FOCALSEAL-S surgical
sealant on the dural membrane following their cranial surgery. There was no
control arm of the study. The two end points required by the regulatory body
(T.U.V.) in Europe were sealing of intraoperative CSF leaks and safety. These
end points were successfully attained. Following the use of FOCALSEAL-S surgical
sealant, 100% of the patients were leak-free at the end of their surgery. There
were no unexpected safety issues noted during the clinical trial, including the
three month follow-up period required for all patients.
Focal plans to submit a dossier on the clinical trial results to the
regulatory body in Europe and assuming approval, expects to launch this product
through Ethicon. The Company expects to file an investigational device exemption
("IDE") application with the FDA. If the FDA approves the IDE application, the
Company expects to initiate a several hundred patient multicenter clinical
trial.
In 1996, neurosurgeons at two major universities demonstrated the safety and
efficacy of FOCALSEAL-S surgical sealant in sealing CSF leaks in cranial
surgeries in a randomized, controlled large animal study. The results of the
study were published in the February 1998 issue of the Journal of Neurosurgery.
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In spinal surgeries, the surgeon seeks to avoid penetration of the dura.
According to published literature, inadvertent penetration of the dura occurs in
up to approximately 13% of the approximately 800,000 spinal surgeries that are
performed annually worldwide. Penetration of the dura can result in leakage of
CSF with potential complications similar to those that can arise in cranial
surgeries. When inadvertent penetration of the dura occurs in spinal surgeries,
the surgeon generally does not elect to use sutures to close the dural leak due
to the risk of injuring the spinal cord with the suturing needle. Therefore,
there is a real need for a surgical sealant product that can effectively seal
CSF leaks in this spinal indication.
CARDIOVASCULAR SURGICAL SEALANT. Focal is evaluating use of its FOCALSEAL-L
surgical sealant for use in sealing anastomoses (the attachment of vessels in
surgical procedures) and arteriotomies (the surgical opening in a vein or
artery) in cardiovascular surgeries. There are approximately 1.3 million cardiac
and vascular procedures performed annually worldwide, including over 500,000
coronary artery bypass graft surgeries. These procedures include both open and
minimally invasive coronary artery bypass graft ("CABG") surgeries and other
vascular surgical procedures. In most cardiovascular surgical procedures,
vascular anastomoses are closed with sutures. These anastomoses use both blood
vessel grafts from the patient's own veins or arteries, which occasionally leak,
and synthetic grafts, which regularly leak. In minimally invasive CABG
surgeries, achievement of a leakproof vascular anastomosis can be particularly
difficult and time consuming because the small access ports through which the
surgeon must operate can make placement of sutures difficult. Failure to achieve
a leakproof vascular graft anastomosis can result in sudden blood leaks that may
potentially be life-threatening and may occur unpredictably after the surgery
has been completed. These complications can add significant costs to
cardiovascular procedures by increasing the level of care required and
prolonging hospitalization. The Company's sealants have been shown to be
effective in sealing vascular leaks in several preclinical large animal models.
A recent study was completed by a collaborator from Massachusetts General
Hospital using a coronary artery bypass graft surgery model. This study
demonstrated that FOCALSEAL-L surgical sealant was effective in sealing blood
leaks following a CABG procedure. The results were presented at the New Era
Cardiac Conference in Phoenix, Arizona in January 1999.
In August 1998, Focal expanded its January 1997 agreement with Ethicon with
the funding of approximately $2.6 million for cardiovascular sealant development
efforts. The Company and Ethicon are currently preparing commercial plans for
this indication and will seek to obtain regulatory approval to launch this
product in Europe on the basis of preclinical data.
GASTROINTESTINAL SURGICAL SEALANT. Focal is evaluating use of its FOCALSEAL
surgical sealants to prevent leakage of gastrointestinal contents following
gastrointestinal surgery. Leakage can occur as a result of incomplete
reattachment of the portions of the digestive tract being operated upon and may
result in infections, delayed healing or fibrosis. Clinically significant
gastrointestinal tract leakage is most prevalent and unpredictable in esophageal
and large bowel surgeries. Approximately 1.3 million gastrointestinal surgeries
are performed annually worldwide, including esophageal and large bowel
surgeries. Postoperative leaks are reported to occur in up to 5-10% of large
bowel surgeries and in up to 25% of esophageal surgeries. The Company believes
that, due to the unpredictable nature of leaks in these procedures, FOCALSEAL
surgical sealant may be used prophylactically. The Company's sealants have been
shown to be effective in sealing gastrointestinal leaks in several preclinical
large animal models. Focal expects to pursue additional preclinical development
efforts for this indication in collaboration with Ethicon.
SYNTHETIC COATINGS FOR VASCULAR GRAFTS
Textile vascular grafts are commonly used for cardiovascular surgery. These
grafts are typically coated with a collagen-based material. Such coatings do not
always work effectively in sealing the graft and have the risks associated with
animal derived products. The market for artificial grafts in CABG and peripheral
vascular surgery is estimated to be approximately $200 million in 1998. This
market is dominated by several large medical device companies. An effective
synthetic coating has the potential to eventually replace
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collagen based coatings and provide a strong competitive advantage to one of the
dominant companies in this market.
FOCALSEAL surgical sealant has been shown in preclinical testing to be
effective in sealing a variety of vascular grafts.
LOCAL DRUG DELIVERY
Focal's polymers have properties that enable them to incorporate and deliver
drugs over a sustained period of time at local disease sites. Local drug
delivery can enable the administration of drugs in much higher concentrations
than if the drugs were delivered systemically. This can potentially increase the
efficacy of the drugs without a corresponding increase in side effects. Focal
has explored the delivery of drugs, including cancer drugs, growth factors,
proteins and cardiovascular drugs, with its polymers.
The focus of current research efforts is on the local delivery of cancer
drugs for the treatment of prostate cancer, breast cancer and pancreatic cancer.
These projects are at an early stage of development and while the Company has
demonstrated proof of principle that its drug delivery technology may work,
there is substantial research and development yet to be performed before these
products enter human clinical trials.
TISSUE COATINGS FOR NEUROLOGICAL AND ORTHOPEDIC ADHESION PREVENTION
The Company is exploring the development of its synthetic, liquid
formulation polymers as coatings that could be applied to surgical sites with
the objective of preventing the growth of post-surgical adhesions. Post-surgical
adhesions develop as a result of wound healing and scar formation triggered by
surgical trauma to tissue. The growth of this scar tissue following surgical
procedures is part of the body's normal healing process. During the healing
process, this growth can become excessive and result in the formation of fibrous
structures that connect tissues or organs that are not normally joined. These
fibrous structures are known as adhesions. Although the majority of surgery
patients develop post-surgical adhesions, these adhesions are generally the most
serious and clinically significant in neurological, abdominal and gynecological
surgeries. There are approximately 1.0 million neurological and orthopedic
procedures performed annually worldwide in which post-surgical adhesion
formation may occur.
In carpel tunnel syndrome, adhesions may be a frequent occurrence following
surgery. Inflamed tendons may form adhesions to surrounding tissues, causing
pain and impeding proper healing. An effective sealant applied during surgery
could improve the clinical results of carpel tunnel surgery and other types of
surgery.
Treatment alternatives for post-surgical adhesions are limited. The
principal current treatment is to undertake additional surgical procedures to
remove these adhesions. These procedures can, however, result in the regrowth of
existing adhesions and the development of new adhesions.
OTHER RESEARCH AND DEVELOPMENT INITIATIVES
The Company has identified several additional potential applications for its
proprietary synthetic, liquid formulation polymer technology. These include
tissue and membrane reinforcement and nonvascular stenting. All of these
projects are at an early research stage, and the Company is not currently
devoting a significant amount of resources to any of these projects.
Accordingly, there can be no assurance that the Company will continue any of
these research initiatives, that any of such research initiatives will result in
the identification of product formulations that demonstrate sufficient promise
in animal models to enable them to become candidates to enter human clinical
trials, or that any products for which the Company is able to seek and obtain
regulatory approvals and introduce commercially either in the United States or
internationally will result from these efforts.
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RESEARCH AND DEVELOPMENT EXPENDITURES
During the years ended December 31, 1996, 1997 and 1998, the Company
incurred expenses of $11.7, $15.7 and $15.6 million, respectively, on research
and development activities, including amounts funded by the Company's strategic
partners.
STRATEGIC ALLIANCES
Focal's commercial strategy is to develop its products both independently
and in collaboration with strategic corporate partners, including pharmaceutical
companies and medical device companies. The Company's strategic corporate
relationship with Ethicon is described below.
ETHICON (A JOHNSON & JOHNSON COMPANY)
In January 1997, the Company entered into an exclusive Distribution, License
and Supply Agreement with Ethicon, Inc., a Johnson & Johnson company, for the
research, development and commercialization of the Company's surgical sealant
and adhesion prevention products (the "Ethicon Agreement"). Ethicon received
marketing rights for all surgical sealant indications in all territories outside
North America, while the Company retained manufacturing rights worldwide and
marketing rights for North America and receives a combined royalty/transfer
price on all Ethicon sales. The Ethicon Agreement outlines the basis and
timetable for the development, supply, marketing, packaging and distribution of
FOCALSEAL-L and FOCALSEAL-S surgical sealants for use intraoperatively as
surgical sealants for lung surgery and neurosurgery indications and other
indications. In August 1998, the Ethicon Agreement was expanded with a funding
agreement for development of a cardiovascular surgical sealant. The Ethicon
Agreement also establishes a framework for additional funding for the
development of a gastrointestinal surgical sealant and other surgical sealant
indications. Ethicon will continue to receive marketing rights outside North
America to new surgical sealants as they are developed.
The Ethicon Agreement provided the Company with a one-time, non-refundable
payment of $7.0 million for research and development. During 1997 and 1998,
Ethicon provided Focal with development funding of $5 million and $3 million,
respectively, and paid a $2 million milestone payment upon receipt of a CE Mark
for FOCALSEAL-Lsurgical sealant for lung surgery. An additional milestone
payment of $1 million will be due upon approval of FOCALSEAL-L surgical sealant
in Japan, if such approval is received. Through December 31, 1998, the Company
had received $19.1 million from Ethicon under the Ethicon Agreement. The initial
payment, research and development funding and milestone payments for the
FOCALSEAL-L and FOCALSEAL-Ssurgical sealants will aggregate $20.6 million over
the term of the agreement, including the cardiovascular sealant funding,
assuming the Ethicon Agreement continues for its full term and all milestones
are achieved.
Focal is responsible for obtaining the CE mark for its FOCALSEAL-L and
FOCALSEAL-S surgical sealants for lung surgery and neurosurgery indications,
respectively. Ethicon is responsible for obtaining regulatory clearances and
approvals in Japan and countries outside of the European Union. Focal is
responsible for manufacturing products covered by the collaboration. Ethicon
will pay Focal a specified percentage of net sales of surgical sealant products
manufactured by Focal and shipped to Ethicon. In addition, in the event Focal is
unable to achieve specified supply targets or is in non-compliance with the
manufacturing standards established for the CE mark and by Ethicon, Ethicon has
the right to manufacture surgical sealants for sale in all territories outside
North America. Such manufacturing rights, if they are exercised by Ethicon, will
be royalty-bearing and non-exclusive.
The agreement is terminable upon specified events including material breach
by either party or bankruptcy or insolvency of either party. In addition,
Ethicon may terminate the agreement at any time after January 2000 upon 12
months' prior written notice with or without cause.
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In addition, in connection with the Ethicon Agreement, Ethicon was granted
the right to undertake the development and commercialization of anti-adhesion
products using the FOCALSEAL-L and FOCALSEAL-S surgical sealant formulations,
subject to the payment of the royalties or a specified percentage of net sales
if Focal manufactures the product. Focal has agreed not to compete in the
anti-adhesions field unless Ethicon ceases active development of anti-adhesion
products using Focal's technology.
PATENTS AND PROPRIETARY RIGHTS
The Company believes that patents and other proprietary rights are important
to its business. The Company's policy is to file patent applications to protect
technology, inventions and improvements to its inventions that are considered
important to its business and that provide a competitive advantage. Focal also
relies on trade secrets, general know-how, in-licensing opportunities and
continuing technological innovation.
The Company has received, licensed or believes it has the option or right to
license 36 issued United States patents and 18 foreign patents corresponding to
certain of the issued United States patents, has eight additional United States
patent applications that have been allowed and has 26 patent applications
pending in the United States, as well as foreign counterparts of certain of
these applications. The issued United States patents have expiration dates
ranging from 2010 to 2016. These patents and patent applications cover certain
aspects of the Company's photopolymerizable polymer formulations, surgical
sealant compositions and methods, and designs for delivery devices.
The Company has licensed from the University of Texas and Endoluminal
Therapeutics, Inc. (a company controlled by one of the Company's founding
scientists) worldwide rights to certain technologies which are the subject of
issued patents and pending patent applications based upon technologies developed
by two of the Company's founders. These licenses are terminable in the event of
failure by the Company to pay scheduled royalties, failure to commercialize
products in the fields covered by these licenses and under certain other
conditions.
Because of the substantial length of time and expense associated with
bringing new products through the development and regulatory approval processes
in order to reach the marketplace, the medical products industry places
considerable importance on obtaining patent and trade secret protection for new
technologies, products and processes. Accordingly, the Company intends to seek
patent protection for its proprietary technology, products and processes.
The Company's success will depend in part on its ability to obtain patent
protection for its products, preserve its trade secrets, prevent third parties
from infringing upon its proprietary rights, and operate without infringing upon
the proprietary rights of others, both in the United States and internationally.
There can be no assurance that the Company's pending or future patent
applications will issue, or that the claims of the Company's issued patents, or
any patents that may issue in the future will provide any competitive advantages
for the Company's products or that they will not be successfully challenged,
narrowed, invalidated or circumvented in the future. Moreover, litigation and
interference or opposition proceedings associated with enforcing or defending
patents or trade secrets is expensive and can divert the efforts of technical
and management personnel.
The Company has filed patent applications in certain foreign countries
corresponding to certain patent applications that it filed in the United States
and may file additional patent applications inside and outside the United
States. The Company believes that the protection afforded by foreign patents or
any other foreign intellectual property protection, if obtained, may be more
limited than that provided domestically. In addition, there can be no assurance
that competitors will not seek to apply for and obtain patents that will
prevent, limit or interfere with the Company's ability to make, use, import and
sell its products.
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The Company is aware that certain medical device, pharmaceutical and other
companies, universities and research institutions have filed patent applications
or have issued patents relating to the compositions and methods for wound
closure and adhesion prevention. In addition, the medical device and
pharmaceutical industry has been characterized by extensive litigation regarding
patents and other intellectual property rights, and many companies in the
medical device industry have employed intellectual property litigation to gain a
competitive advantage. There can be no assurance that litigation will not be
brought against the Company by third parties in the future challenging the
Company's patent rights or claiming infringement by the Company of patents held
by the third parties. Because patent applications in the United States are
confidential until the patents issue, and publication of discoveries in the
scientific and patent literature tends to lag behind actual discoveries by
several months, the Company cannot be certain that Company inventors or
licensors were the first to conceive of inventions covered by pending patent
applications or that Company was the first to file patent applications for such
inventions.
The Company may be required or find it desirable to obtain licenses to
patents or proprietary rights of others. No assurance can be given that any
licenses required under any patents or proprietary rights of third parties would
be made available on terms acceptable to the Company, or at all. If the Company
does not obtain such licenses, it could encounter delays in product
introductions while it attempts to design around such patents, or could find
that the development, manufacture or sale of products requiring such licenses is
foreclosed. Litigation may be necessary to defend against or assert claims of
patent infringement or invalidity, to enforce or defend patents issued to the
Company, to protect trade secrets or know-how owned by the Company, or to
determine the scope and validity of the proprietary rights of others. In
addition, interference proceedings declared by the United States Patent and
Trademark Office, or opposition proceedings in a foreign patent office, may be
necessary to determine the priority of inventions with respect to patent
applications of the Company or its licensors. Litigation, interference or
opposition proceedings could result in substantial costs to and diversion of
effort by the Company, and adverse determinations in any such proceedings could
have a material adverse effect on the business, financial condition or results
of operations of the Company.
The Company also relies upon unpatented trade secrets and improvements,
unpatented know-how and continuing technological innovation to develop and
maintain its competitive position, which it seeks to protect, in part, by
confidentiality agreements with its commercial partners, collaborators,
employees and consultants. The Company also has invention or patent assignment
agreements with its employees and certain, but not all, commercial partners and
consultants. There can be no assurance that relevant inventions will not be
developed by a person not bound by an invention assignment agreement. There can
be no assurance that binding agreements will not be breached, that the Company
would have adequate remedies for any breach, or that the Company's trade secrets
will not otherwise become known or be independently discovered by competitors.
GOVERNMENT REGULATION
UNITED STATES
The Company's proposed products and its research and development activities
are subject to regulation by numerous governmental authorities, principally, the
FDA and corresponding state and foreign regulatory agencies. The Federal Food,
Drug, and Cosmetic Act (the "FDC Act"), as amended, the regulations promulgated
thereunder, and other federal and state statutes and regulations, govern, among
other things, the preclinical and clinical testing, manufacture, safety,
efficacy, labeling, storage, record keeping, advertising and promotion of
medical devices and drugs, including the products currently under development by
the Company. Product development and approval within this regulatory framework
take a number of years and involves the expenditure of substantial resources.
In the United States, medical devices are classified into three different
classes, class I, II and III, on the basis of controls deemed necessary to
reasonably ensure the safety and effectiveness of the device.
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Class I devices are subject to general controls (e.g., labeling and adherence to
FDA's good manufacturing practice requirements ("GMPs")) and class II devices
are subject to general and special controls (e.g., performance standards,
postmarket surveillance, patient registries, and FDA guidelines). Generally,
class III devices are those which must receive premarket approval by the FDA to
ensure their safety and effectiveness (e.g., life-sustaining, life-supporting
and implantable devices, or new devices which have been found not to be
substantially equivalent to legally marketed Class I or II devices).
Unless it is exempt, a new medical device can be marketed only with
marketing clearance obtained through a premarket notification under Section
510(k) of the FDC Act or a premarket approval ("PMA") application under Section
515 of the FDC Act. A 510(k) clearance will typically be granted by the FDA if
it can be established that the device is substantially equivalent to a
"predicate device," which is a legally marketed class I or II device or a
preamendment class III device (i.e. one that has been marketed since a date
prior to May 28, 1976) for which the FDA has not called for PMAs. The FDA has
been requiring an increasingly rigorous demonstration of substantial equivalence
and this may include a requirement to submit human clinical trial data. It
generally takes four to twelve months from the date of a 510(k) submission to
obtain clearance, but it may take longer.
The FDA may determine that a medical device is not substantially equivalent
to a predicate device, or that additional information is needed before a
substantial equivalence determination can be made. A "not substantially
equivalent" determination, or a request for additional information, could
prevent or delay the market introduction of new products that fall into this
category. For any devices that are cleared through the 510(k) process,
modifications or enhancements that could significantly affect the safety or
effectiveness, or that constitute a major change in the intended use of the
device, will require new 510(k) submissions.
A PMA application must be filed if a proposed device is not substantially
equivalent to a legally marketed class I or class II device, or if it is a
preamendment class III device for which the FDA has called for PMAs. A PMA
application must be supported by valid scientific evidence to demonstrate the
safety and effectiveness of the device, typically including the results of
clinical trials, bench tests, and laboratory and animal studies. The PMA must
also contain a complete description of the device and its components, and a
detailed description of the methods, facilities and controls used to manufacture
the device. In addition, the submission must include the proposed labeling,
advertising literature, and any training materials. The PMA process can be
expensive, uncertain and lengthy, and a number of devices for which FDA approval
has been sought by other companies have never been approved for marketing.
Upon receipt of a PMA application, the FDA makes a threshold determination
as to whether the application is sufficiently complete to permit a substantive
review. If the FDA determines that the PMA application is sufficiently complete
to permit a substantive review, the FDA will accept the application for filing.
Once the submission is accepted for filing, the FDA begins an in-depth review of
the PMA. The FDA review of a PMA application generally takes one to three years
from the date the PMA is accepted for filing, but may take significantly longer.
The review time is often significantly extended by the FDA asking for more
information or clarification of information already provided in the submission.
During the review period, an advisory committee, typically a panel of
clinicians, may be convened to review and evaluate the application and provide a
recommendation to the FDA as to whether the device should be approved. The FDA
accords substantial weight to the recommendation but is not bound by it. Toward
the end of the PMA review process, the FDA generally will conduct an inspection
of the manufacturer's facilities to ensure compliance with applicable GMP
requirements, which include elaborate testing, control documentation and other
quality assurance procedures. The Company has not yet undergone an FDA GMP
inspection but anticipates that it will undergo such an inspection in connection
with the modular PMA application that it is currently in the process of
submitting for FOCALSEAL-L surgical sealant for lung surgery.
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If FDA's evaluations of both the PMA application and the manufacturing
facilities are favorable, the FDA may issue either an approval letter or an
approvable letter, which usually contains a number of conditions that must be
met in order to secure final approval of the PMA. When and if those conditions
have been fulfilled to the satisfaction of the FDA, the agency will issue a PMA
approval letter, authorizing marketing of the device for certain indications. If
the FDA's evaluation of the PMA application or manufacturing facilities is not
favorable, the FDA will deny approval of the PMA application or issue a
"non-approvable" letter. The FDA may determine that additional clinical trials
are necessary, in which case the PMA may be delayed for one or more years while
additional clinical trials are conducted and submitted in an amendment to the
PMA. Modifications to a device that is the subject of an approved PMA, its
labeling or manufacturing process may require approval by the FDA of PMA
supplements or new PMAs. Supplements to a PMA often require the submission of
the same type of information required for an initial PMA, except that the
supplement is generally limited to that information needed to support the
proposed change from the product covered by the original PMA.
If human clinical trials of a device are required, either for a 510(k)
submission or a PMA application, and the device presents a "significant risk,"
the sponsor of the trial (usually the manufacturer or the distributor of the
device) must file an investigational device exemption ("IDE") application prior
to commencing human clinical trials. The IDE application must be supported by
data, typically including the results of animal and laboratory testing. If the
IDE application is approved by the FDA and one or more appropriate Institutional
Review Boards ("IRBs"), human clinical trials may begin at a specific number of
investigational sites with a specific number of patients, as approved by the
FDA. If the device presents a "nonsignificant risk" to the patient, a sponsor
may begin the clinical trial after obtaining approval for the study by one or
more appropriate IRBs without the need for FDA approval. Submission of an IDE
does not give assurance that FDA will approve the IDE and, if it is approved,
there can be no assurance that FDA will determine that the data derived from the
studies support the safety and efficacy of the device or warrant the
continuation of clinical studies. Sponsors of clinical trials are permitted to
sell investigational devices distributed in the course of the study provided
such compensation does not exceed recovery of the costs of manufacture,
research, development and handling. An IDE supplement must be submitted to and
approved by the FDA before a sponsor or investigator may make a change to the
investigational plan that may affect its scientific soundness or the rights,
safety or welfare of human subjects.
The Company's FOCALSEAL surgical sealant products will be regulated as a
class III medical device and will require a separate PMA approval for each
indication to be marketed in the United States. Although the Company is
submitting a modular PMA application for FOCALSEAL-L surgical sealant for lung
surgery in the United States, there can be no assurance that the Company will
receive FDA approval of this product. In addition, the Company will be required
to obtain IDEs for additional applications of FOCALSEAL surgical sealant and for
other products that the Company develops that are regulated by the FDA as
medical devices. There is no assurance that data, typically the results of
animal and laboratory testing, that may be provided by the Company in support of
future IDE applications will be deemed adequate for the purpose of obtaining IDE
approval, that the Company will obtain approval to conduct clinical studies of
any such future product, or that such clinical studies, if completed, will
generate data adequate to support PMA approval. There can be no assurance that
PMA approval can be obtained for any product in a timely fashion, or at all.
If clearance or approval is obtained, any device manufactured or distributed
by the Company will be subject to pervasive and continuing regulation by the
FDA. The Company will be subject to inspection by the FDA and will have to
comply with the host of regulatory requirements that usually apply to medical
devices marketed in the United States, including labeling regulations, GMP
requirements, the Medical Device Reporting ("MDR") regulation (which requires a
manufacturer to report to the FDA certain types of adverse events involving its
products), and the FDA's prohibitions against promoting products for unapproved
or "off-label" uses. The Company's failure to comply with applicable regulatory
requirements
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could result in enforcement action by the FDA, which could have a material
adverse effect on the Company's business, financial condition and results of
operations.
Other products that may be developed by the Company, including products for
local drug delivery, may be regulated as drugs requiring FDA approval of a new
drug application ("NDA") prior to commercialization in the United States. The
NDA approval process is generally considered more onerous, costly and lengthy
than the PMA process, often requiring more extensive preclinical and clinical
testing, and many products for which NDAs have been submitted by other companies
have never been approved for marketing.
If the FDA believes that a company is not in compliance with law, it can
institute proceedings to detain or seize products, issue a recall, enjoin future
violations and assess civil and criminal penalties against the Company, its
officers and its employees. Failure to comply with the regulatory requirements
could have material adverse effect on the Company's business, financial
condition and results of operations. In addition, regulations regarding the
manufacture and sale of the Company's products are subject to change. The
Company cannot predict the effect, if any, that such changes might have on its
business, financial condition or results of operations.
INTERNATIONAL
In order for the Company and its strategic partners to market its products
in Europe and other foreign countries, the Company and/or its partners must
obtain required regulatory approvals and comply with extensive regulations
governing safety, quality and manufacturing processes. These regulations vary
significantly from country to country. The time required to obtain approval to
market the Company's products may be longer or shorter than that required in the
United States. In order to market FOCALSEAL surgical sealants and other products
being developed by the Company in the member countries of the European Union,
the Company will be required to obtain CE mark certification. CE mark
certification is an international symbol of adherence to quality assurance
standards and compliance with applicable European medical device directives. In
December 1997, the Company received a CE mark for its FOCALSEAL-L surgical
sealant for lung surgery and obtained ISO 9001 status. In September 1998, Focal
successfully completed the annual CE Mark and ISO 9001 audit. Although the CE
mark and ISO 9001 standards audit have been successfully completed, there can be
no assurance that the Company will be successful in maintaining its CE mark
certification and ISO 9001 status or that additional CE Mark approvals will be
received for other clinical indications.
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SALES AND MARKETING
Focal intends to market and sell its surgical sealants internationally
through Ethicon and to develop its own direct sales and marketing force or enter
into a marketing and distribution arrangement for these products in North
America. Ethicon is one of the leading manufacturers of sutures and staples
worldwide and has a significant sales and marketing presence in Europe, Latin
America and the Pacific Rim.
If and when the Company receives marketing approval in the United States,
the Company intends to build a direct sales force or enter into a marketing and
distribution arrangement for marketing its surgical sealant products in North
America. Focal anticipates that, if it markets and sells FOCALSEAL-L surgical
sealant for lung surgeries in the U.S., it will be required to hire up to
approximately 40 sales representatives to focus on the 250 key thoracic surgery
centers that account for 75-80% of the lung surgeries in the U.S.
The Company's sales and marketing strategy for other products may include
using a combination of the Company's own direct sales force, strategic marketing
partners and distributors. The sales and marketing plans for these products will
be dependent on the Company's success in entering into strategic marketing
relationships, its ability to leverage its own internal sales force to market
additional products beyond the surgical sealant products and its ability to hire
and retain additional specialized sales personnel. There can be no assurance
that the Company will be able to secure any additional strategic marketing
partners or international distributors on terms that are acceptable to the
Company, or at all, or that the Company will be successful in building a direct
sales force in the United States.
MANUFACTURING
The Company has only limited experience in manufacturing its FOCALSEAL
surgical sealants. The Company has recently added manufacturing capacity at its
Lexington, Massachusetts facility in order to meet anticipated supply
requirements for European sales of its FOCALSEAL-L surgical sealant and for the
anticipated launch of FOCALSEAL-L surgical sealant in the United States.
The Company performs certain steps in the FOCALSEAL surgical sealant
manufacturing process internally and relies on outside contractors for others.
Certain proprietary processes, including polymer synthesis, are performed by
Focal. The Company uses outside contractors for nonproprietary, high volume
processes including sterilization and fill and finish. The Company also
contracts with third parties for the manufacture of syringes, applicators, light
sources and light wands.
There can be no assurance that the Company will be able to attract, train
and retain the required personnel or will be able to increase its manufacturing
capability to manufacture commercial quantities of surgical sealants in a timely
manner, or at all. Manufacturers often encounter difficulties in scaling up
production of their products, including problems involving production yields,
quality control and assurance, component supply and shortages of qualified
personnel. The Company anticipates that it will need to increase significantly
its current manufacturing capacity to meet commercial needs over the next
several years and that it may need to establish off-site manufacturing capacity
to meet these anticipated needs. In addition, the Company expects that it will
need to identify and qualify additional sources for materials and outsourced
manufacturing processes. There can be no assurance that the Company's
manufacturing scale-up efforts will be successful or that reliable, high-volume
manufacturing can be established or maintained at commercially reasonable costs
on a timely basis, or at all. Furthermore, the Company may be required to
establish an off-site manufacturing facility and qualify such facility under
GMP, ISO 9001 and other applicable regulatory and quality standards.
The Company would experience supply interruptions in the event it is unable
to establish or maintain commercial levels of polymer synthesis, as the
Company's polymer formulations are proprietary and are not available from third
parties. In addition, there can be no assurance that the Company will not
encounter unanticipated problems and delays in connection with its contract
manufacturers and suppliers.
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For example, in August 1998, the Company undertook a voluntary recall relating
to the packaging of its FOCALSEAL-L surgical sealant product in Europe after the
Company discovered that a small percentage of the packages containing the primer
component of the sealant may have had compromised package seals. The Company
determined that one of its vendors supplied an incorrect packaging material.
Delays associated with or difficulties encountered in establishing commercial
manufacturing, the establishment of new manufacturing facilities, or problems
encountered with contract manufacturers and suppliers, would result in
disruptions of product supply to the Company's marketing partners and for use in
clinical trials. In such event Ethicon could, under its agreement with the
Company, commence manufacturing of surgical sealants for sales in all
territories outside North America. Any of the foregoing would have a material
adverse affect on the Company's business, financial condition and results of
operations.
The Company purchases raw materials used in its products from various
suppliers. Certain materials and components are currently purchased by the
Company from single sources. These materials have generally been readily
available in the marketplace and have not been the subject of shortages. There
can, however, be no assurance that the Company or its suppliers or contract
manufacturers will not experience material shortages in the future. Any such
future shortages of materials or components could have a material adverse effect
on the Company's business, financial condition and results of operations.
The Company is also required to register as a medical device manufacturer
with the FDA and to list its products with the FDA. As such, the Company is
subject to inspections by the FDA for compliance with applicable GMP
requirements, which include elaborate testing, control documentation and other
quality assurance procedures. Further, the Company and the third party
manufacturers of its products are required to comply with various FDA
requirements for design, safety, advertising and labeling. The Company has not
yet undergone an FDA GMP inspection and anticipates that it will undergo such an
inspection in connection with the submission of its PMA for FOCALSEAL-L surgical
sealant for lung surgery.
Complex medical devices, such as the Company's products, can experience
performance problems in the field that require review and possible corrective
action by the manufacturer. There can be no assurance that component failures,
manufacturing errors or design defects that could result in an unsafe condition
or injury to the patient will not occur. If any such failures or defects were
deemed serious, the Company could be required to withdraw or recall products,
which could result in significant costs to the Company. There can be no
assurance that market withdrawals or product recalls will not occur in the
future. Any future product problems could result in market withdrawals or
recalls of products, which could have a material adverse affect on the Company's
business, financial condition or results of operations.
COMPETITION AND TECHNOLOGICAL CHANGE
The Company competes with many domestic and foreign medical device,
pharmaceutical and biopharmaceutical companies. In the surgical sealant area,
the Company will compete with existing methodologies for sealing air and fluid
leaks resulting from surgery, including some traditional wound closure products
such as sutures and staples, marketed by companies such as Johnson & Johnson,
and United States Surgical Corporation (Tyco). Other products currently being
marketed include fibrin glue, sold in Europe and the Pacific Rim countries by
Immuno AG, Cention and Fujisawa and in the U.S. by Baxter Healthcare Corporation
and others. Additional products are under development at Bristol-Myers Squibb
Company and Vitex. Other potential competitors in the surgical sealant market
include Closure Medical Corporation, B. Braun GmBH, Cryolife and Cohesion and
others. Competitive products may also be under development by other large
medical device, pharmaceutical and biopharmaceutical companies. The other areas
in which Focal is developing products, such as synthetic coatings for vascular
grafts, local drug delivery and neurological adhesion prevention, are intensely
competitive markets and the Company will encounter competition from major
medical device, pharmaceutical and biopharmaceutical companies in such markets.
Many of the Company's current and potential competitors have substantially
greater financial, technological, research and development, regulatory and
clinical, marketing and sales, and personnel resources than the Company.
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Certain of these competitors may also have greater experience in developing
products, conducting clinical trials, obtaining regulatory approvals, and
manufacturing and marketing such products. Certain of these competitors may
obtain patent protection, approval or clearance by the FDA or foreign countries
or product commercialization earlier than the Company, any of which could
materially adversely affect the Company. Furthermore, if the Company attains
significant commercial sales of its products, it will also be competing with
respect to manufacturing efficiency and marketing capabilities, areas in which
it currently has limited experience. Finally, there can be no assurance that the
Company's marketing partners will not pursue parallel development of other
technologies or products, which may result in a marketing partner developing
additional products that would compete with the Company's products.
Other recently developed technologies or procedures are, or may in the
future be, the basis of competitive products. There can be no assurance that the
Company's current competitors or other parties will not succeed in developing
alternative technologies and products that are more effective, easier to use or
more economical than those which have or are being developed by the Company or
that would render the Company's technology and products obsolete and
non-competitive in these fields. In such event, the Company's business,
financial condition and results of operations could be materially adversely
affected.
THIRD PARTY REIMBURSEMENT
Reimbursement and health care payment systems in international markets vary
significantly by country. In connection with international product
introductions, the Company and its strategic marketing partners may be required
to seek international reimbursement approvals. If required, there can be no
assurance that any such approvals will be obtained in a timely manner, or at
all, and failure to receive such international reimbursement approvals could
have an adverse effect on market acceptance of the Company's products in the
international markets in which such approvals are sought.
In the United States, health care providers, such as hospitals and
physicians, that purchase medical devices such as the Company's products,
generally rely on third-party payors, principally federal Medicare, state
Medicaid and private health insurance plans, to reimburse all or part of the
cost of surgical procedures. The Company anticipates that in a prospective
payment system, such as the DRG system utilized by Medicare, and in many managed
care systems used by private health care payors, there will be no separate,
additional reimbursement for the Company's products. Accordingly, the Company
believes that there will be no procedure-specific reimbursement codes for the
Company's products. The Company anticipates that hospital administrators and
physicians will justify the additional cost of surgical sealants by the
attendant cost savings and clinical benefits that the Company believes will be
derived from the use of its products.
There can be no assurance that reimbursement for the Company's products will
be available in the United States or in international markets under either
governmental or private reimbursement systems. Furthermore, the Company could be
adversely affected by changes in reimbursement policies of governmental or
private health care payors. Failure by physicians, hospitals and other users of
the Company's products to obtain sufficient reimbursement from health care
payors for procedures in which the Company's products are used or adverse
changes in governmental and private third party payors' policies toward
reimbursement for such procedures would have a material adverse effect on the
Company's business, financial condition and results of operations.
The Company's business may be also materially adversely affected by the
continuing efforts of government and third-party payors to contain or reduce the
costs of health care through various means. For example, in certain foreign
markets, pricing or profitability of certain medical products and prescription
pharmaceuticals is subject to government control. In the United States, an
increasing emphasis on managed care has put, and will continue to put, pressure
on pharmaceutical and medical product pricing. Such initiatives and proposals,
if adopted, could decrease the price that the Company receives for any products
it may develop and sell in the future, and thereby have a material adverse
effect on the
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Company's business, financial condition and results of operations. Further, to
the extent that such proposals or initiatives have a material adverse effect on
other companies that are corporate partners or prospective corporate partners
for certain of the Company's products, the Company's ability to commercialize
its products may be materially adversely affected.
EMPLOYEES
As of December 31, 1998, the Company employed 101 persons of whom 76 were in
research, development and manufacturing, 8 were in clinical, regulatory affairs
and quality assurance, and 17 were in management, finance and administration.
None of the Company's current employees is represented by a labor union or is
the subject of a collective bargaining agreement. The Company believes that
relations with its employees are good.
SCIENTIFIC ADVISORS AND CLINICAL INVESTIGATORS
Focal has recruited several physician specialists and experienced
practitioners in various fields pertaining to its products to serve as
scientific advisors and clinical investigators.
There is no fixed term of service for the scientific advisors. Current
members may resign or be removed at any time, and additional members may be
appointed. In general, members do not serve on an exclusive basis with the
Company and are not obligated to assign inventions to the Company. Drs. Langer,
Brem, and Slepian are scientific founders of the Company and certain inventions
of Dr. Slepian have been licensed to the Company under the Company's license
agreements with Endoluminal Therapeutics, Inc., a company controlled by Dr.
Slepian. Drs. Langer and Brem also serve as members of the Company's board of
directors. Scientific advisors have from time to time received option grants to
purchase Common Stock of the Company. Scientific Advisors have also received
cash compensation, with the amount of such compensation dependent on the time
commitment and level of involvement of each advisor. All scientific advisors
receive reimbursement for expenses incurred in traveling to and attending
meetings on behalf of the Company.
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The following individuals are currently either scientific advisors to Focal
or surgeons involved in Focal's clinical trials. Their respective areas of
specialization are identified below.
<TABLE>
<CAPTION>
<S> <C>
BIOMATERIALS/POLYMER SCIENCE
John Eaton, Ph.D. Baylor University College of Medicine
Joachim Kohn, Ph.D. Rutgers University
Joseph Vacanti, M.D. Boston Children's Hospital
Allan Hoffman, Ph.D. University of Washington
DRUG DELIVERY AND TISSUE ENGINEERING
Robert Langer, Ph.D. Massachusetts Institute of Technology
Marvin Slepian, M.D. University of Arizona Medical Center
Henry Brem, M.D. Johns Hopkins Medical Center
Jane Shaw, Ph.D. President of Stable Network; Former President
of Alza Corporation
PROCEDURE DEVELOPMENT
Joseph LoCicero III, M.D. Harvard Medical School
Peter Johnson, M.D. University of Pittsburgh Medical School
David Torchiana, M.D. Massachusetts General Hospital
LUNG SURGERY
John Wain, M.D. Massachusetts General Hospital
Larry Kaiser, M.D. University of Pennsylvania Medical Center
Stephen Yang, M.D. Johns Hopkins Medical Center
Richard Feins, M.D. Strong Memorial Hospital
Cameron Wright, M.D. Massachusetts General Hospital
David Johnstone, M.D. Strong Memorial Hospital
Paolo Maccharini, M.D. Centre Chiurgical Marie Lannelongue, France
Albert Linder, M.D. Klinik Schillerhohe, Germany
NEUROSURGERY
Andre Grotenhuis, M.D. University Hospital Nijmegen, The Netherlands
Prof. Nicholas de Tribolet, M.D. Centre Hospitalier Universitaire Vaudriis,
Prof. Bernard George Switzerland
Rees Cosgrove, M.D. Hospital Lasiboisiere, France
Henry Van Loveren, M.D. Massachusetts General Hospital
Mayfield Neurological Institute, University of
Cincinnati
</TABLE>
FACTORS AFFECTING OPERATING RESULTS
HISTORY OF OPERATING LOSSES; ACCUMULATED DEFICIT; UNCERTAINTY OF FUTURE
PROFITABILITY. The Company has incurred net losses in each year since its
inception, including a net loss of approximately $13.4 million during 1998. At
December 31, 1998, the Company had an accumulated deficit of $59.3 million. The
Company's operating losses have resulted primarily from expenses incurred in
connection with the Company's research and development activities, including
preclinical and clinical trials, development of manufacturing processes and
general and administrative expenses. The Company expects to incur net losses
through at least the first half of 2000 and may incur net losses in subsequent
periods, although the amount of future net losses and time required by the
Company to reach profitability are highly uncertain. The Company is dependent
upon corporate partners for funding of a significant portion of its research and
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development expenses. If the Company does not continue to receive funding from
its current corporate partners, or is unable to otherwise obtain third-party
funding, operating losses will increase. The Company's ability to achieve and
sustain profitability will be dependent upon obtaining regulatory approval for
and successfully commercializing its FOCALSEAL surgical sealants, and developing
the manufacturing capacity and sales and marketing capability for its products.
There can be no assurance that Focal will obtain required regulatory approvals,
or successfully develop, manufacture, commercialize and market products or that
the Company will ever record product revenues or achieve profitability.
Profitability, if achieved, may not be sustained.
UNCERTAINTIES RELATED TO EARLY STAGE OF COMMERCIALIZATION AND
DEVELOPMENT. Except for the FOCALSEAL-L and FOCALSEAL-S surgical sealants for
lung surgery and neurosurgery indications, all of the Company's products are in
early stages of development or research. To date the Company has received only
one product approval, a CE Mark approval for FOCALSEAL-L surgical sealant for
lung surgery. Focal has not received marketing approval for any products from
the FDA. In addition, FOCALSEAL-L and FOCALSEAL-S surgical sealants will
potentially require significant additional research and development efforts
before either is suitable for any indications beyond lung surgery and
neurosurgery, The development and commercialization of new bioabsorbable
synthetic polymer products are highly uncertain and subject to a number of
significant risks. Potential products that appear to be promising at early
stages of development may not reach the market for a number of reasons. Such
reasons include the possibilities that the potential products will be found
ineffective or cause harmful side effects during preclinical testing or clinical
trials, fail to receive necessary regulatory approvals, be difficult to
manufacture on a commercial scale, be uneconomical, fail to achieve market
acceptance or be precluded from commercialization by proprietary rights of third
parties. No assurance can be given that any of the Company's development
programs will be successfully completed, that clinical trials will generate
anticipated results or will commence or be completed as planned, that any PMA
application will be accepted or ultimately approved by the FDA, that required
regulatory approvals will be obtained on a timely basis, if at all, or that any
products for which approval is obtained will be commercially successful. If any
of the Company's development programs are not successfully completed, required
regulatory approvals are not obtained, or products for which approvals are
obtained are not commercially successful, the Company's business, financial
condition and results of operations would be materially adversely affected.
EARLY STAGE OF CLINICAL TESTING AND LACK OF EXTENSIVE CLINICAL DATA. A 180
patient clinical trial of the Company's FOCALSEAL-L surgical sealant product for
lung surgery was recently completed in the United States, and the company is
submitting a modular PMA application to the FDA. Although the Company believes
that the results of this trial are sufficient to obtain marketing approval in
the U.S., there are no assurances that the FDA will not require additional
clinical testing of FOCALSEAL-L surgical sealant to obtain U.S. marketing
approval. Although Focal has completed a 44 patient clinical trial of
FOCALSEAL-S surgical sealant for neurosurgery indications in Europe, Focal has
not yet commenced United States clinical trials of FOCALSEAL-S surgical sealant.
The FDA may require the Company to pursue certain clinical endpoints that were
not the subject of the European clinical trial. In the event that the Company is
required to pursue these endpoints, it may be more difficult for the Company to
demonstrate the efficacy of FOCALSEAL-S surgical sealant in the United States
trial than in the European trial, which could result in delays or adversely
affect the success of the clinical trial.
There can be no assurance that FOCALSEAL-L or FOCALSEAL-S surgical sealants
will receive marketing approval from the FDA or that any of the Company's other
products will prove to be safe and effective in United States or international
clinical trials under applicable regulatory guidelines. In addition, clinical
trials may identify significant technical or other obstacles to be overcome
prior to obtaining necessary regulatory or international approvals. If the
FOCALSEAL-L and FOCALSEAL-S surgical sealant products and the Company's other
products under development do not prove to be safe and effective in clinical
trials or if the Company is otherwise unable to commercialize these products
successfully, the Company's business, financial condition and results of
operations will be materially and adversely affected.
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DEPENDENCE UPON FOCALSEAL SURGICAL SEALANTS. The Company introduced its
first commercial product, FOCALSEAL-L surgical sealant for lung surgery
indications, in Europe in the first half of 1998 through its strategic marketing
alliance with Ethicon. The Company anticipates that revenues derived from
European sales of FOCALSEAL-L surgical sealant will account for a substantial
majority of the Company's near term product revenues. Before the Company's
second product, FOCALSEAL-S surgical sealant for neurosurgery indications, can
be sold in Europe, the Company must first obtain a CE mark for marketing in the
member countries of the European Union. Any delays or other difficulties
encountered by the Company in obtaining such CE mark for FOCALSEAL-S surgical
sealant would have a material adverse effect on the Company's business,
financial condition and results of operations. In addition, the Company's future
success will depend, in significant part, on its ability to successfully
complete additional clinical trials and to obtain regulatory approval and market
acceptance of FOCALSEAL-L and FOCALSEAL-S surgical sealant in the United States.
Although the Company recently completed a 180-patient, pivotal, multicenter
clinical trial of FOCALSEAL-L surgical sealant for lung surgery indications in
the United States and is in the process of submitting a modular PMA application
to the FDA based on the results of the trial, there can be no assurance that the
FDA will accept the PMA for filing, that the Company will be able to demonstrate
to the FDA's satisfaction that FOCALSEAL-L surgical sealant is safe and
effective, or, if marketing approval were granted by the FDA, that the Company
will successfully commercialize FOCALSEAL-L surgical sealant in the United
States. Failure by the Company to gain marketing approval from the FDA for
FOCALSEAL-L surgical sealant or to be able to successfully commercialize
FOCALSEAL-L surgical sealant in the United States would have a material adverse
effect on the Company's business, financial condition and results of operations.
DEPENDENCE ON STRATEGIC ALLIANCE PARTNERS. The Company has established a
strategic alliance with Ethicon in the field of surgical sealants for all
territories outside of North America. Under the agreement with Ethicon, the
Company is dependent upon Ethicon for marketing and sale of surgical sealants
outside North America and for obtaining international regulatory approvals other
than the CE mark, which is the responsibility of the Company to obtain. The
failure of Ethicon to continue to collaborate with the Company for subsequent
development of products, seek required regulatory approvals or commercialize
products would have a material adverse affect on the Company's business,
financial condition and results of operations.
The Company's strategy for development and commercialization of certain of
its future products may depend upon the Company entering into additional
arrangements with research collaborators, corporate partners and others, and
upon the subsequent success of these third parties in performing their
obligations. There can be no assurance that the Company will be able to enter
into additional strategic alliances on terms favorable to the Company, or at
all. The Company's inability to enter into additional strategic alliances could
have an adverse affect on the Company's business, financial condition and
results of operations.
The Company cannot control the amount and timing of resources which its
current or any future corporate partners devote to the Company's programs or
potential products. If any of the Company's current or future corporate partners
breach their agreements with the Company or otherwise fail to conduct their
collaborative activities in a timely manner, the clinical development and/or
commercialization of products may be delayed, and the Company may be required to
devote additional resources to product development and commercialization, or
terminate certain development programs. The termination of any current or future
strategic alliances could have a material adverse affect on the Company's
business, financial condition and results of operations.
In addition, Focal's current and any future strategic partners may develop,
either alone or with others, products that compete directly with the development
and marketing of the Company's products. Competing products, either developed by
the corporate partners or to which the corporate partners have rights, may
result in their withdrawal of support with respect to all or a portion of the
Company's technology, marketing and development efforts, which would have a
material adverse affect on the Company's business, financial condition and
results of operations. There can be no assurance that disputes will not
25
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arise in the future with respect to the ownership of rights to any products or
technology developed with corporate partners. These and other possible
disagreements between corporate partners in the Company could lead to delays in
or termination of the collaborative research, development or commercialization
of certain products and could require or result in litigation or arbitration,
which would be time-consuming and expensive, and would have a material adverse
affect on the Company's business, financial condition and results of operations.
UNCERTAINTY OF MARKET ACCEPTANCE. The Company's FOCALSEALsurgical sealants
represent a new method of sealing air and fluid leaks that arise in connection
with surgery, and there can be no assurance that these products will gain
commercial acceptance among physicians, patients and health care payors, even if
necessary international and United States marketing approvals can be obtained.
The Company believes that recommendations and endorsements by physicians will be
essential for market acceptance of FOCALSEAL, and there can be no assurance that
any such recommendations or endorsements will be obtained. Physicians will not
use the FOCALSEAL surgical sealants unless they determine, based on clinical
data and other factors, that these systems are an effective means of sealing air
and fluid leaks and that the clinical benefits to the patient and cost savings
achieved through use of these systems outweigh their cost. Such determinations
will depend, in part, on the ability of the Company's FOCALSEAL-L surgical
sealant to reduce the time a lung surgery patient must be connected to a chest
tube and the length of hospital stays associated with lung surgery. Acceptance
among physicians may also depend upon the Company's ability to train thoracic
surgeons and other potential users of the Company's products in the application
of liquid surgical sealants, which such physicians typically have not performed,
and the willingness of such users to learn these new techniques. Failure of the
Company's products to achieve significant market acceptance would have a
material adverse effect on the Company's business, financial condition and
results of operations.
NEED FOR ADDITIONAL FUNDING; UNCERTAINTY OF ACCESS TO CAPITAL. Focal will
require substantial additional funding in order to continue its research and
product development programs, including for preclinical testing and clinical
trials of its product candidates, for operating expenses, for the pursuit of
regulatory approvals for its product candidates, and may require additional
funding for establishing manufacturing and marketing capabilities in the future.
The Company believes that its existing capital resources, interest income and
future payments due under strategic alliances, will be sufficient to satisfy its
current and projected funding requirements for at least 15 months. However, no
assurance can be given that the Company's resources will be sufficient to
conduct its research and development programs as planned.
The Company's future capital requirements will depend on many factors,
including continued scientific progress in its research and development
programs, the magnitude of these programs, progress with preclinical testing and
clinical trials, the time and costs involved in obtaining regulatory approvals,
if any, the costs involved in filing and prosecuting patent applications and
enforcing patent claims, competing technological and market developments, the
establishment of additional strategic alliances, the cost of manufacturing
facilities and of commercialization activities, and the cost of product
in-licensing and any possible acquisitions. There can be no assurance that the
Company's cash, cash equivalents and marketable securities, and interest income
earned thereon, together with funding that may be received under the Company's
strategic alliances, will be adequate to satisfy its capital and operating
requirements.
Focal intends to seek additional funding through strategic alliances, and
may seek additional funding through public or private sales of the Company's
securities, including equity securities. In addition, the Company has obtained
equipment lease financing and other forms of debt financing and may continue to
pursue opportunities to obtain additional lease or debt financing in the future.
There can be no assurance, however, that additional equity or debt financing
will be available on reasonable terms, if at all. Any additional equity
financings would be dilutive to the Company's stockholders. If adequate funds
are not available, Focal may be required to curtail significantly one or more of
its research and development programs and/or obtain funds through arrangements
with corporate partners or others that may require Focal to relinquish rights to
certain of its technologies or product candidates.
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UNCERTAINTY OF ABILITY TO ATTRACT AND RETAIN KEY MANAGEMENT, EMPLOYEES AND
CONSULTANTS. The Company is highly dependent on the principal members of its
management and scientific staff. The loss of services of any of these personnel
could impede the achievement of the Company's development objectives.
Furthermore, recruiting and retaining qualified scientific personnel to perform
research and development work in the future will also be critical to the
Company's success. There can be no assurance that the Company will be able to
attract and retain personnel on acceptable terms given the competition among
biotechnology, pharmaceutical and healthcare companies, universities and
non-profit research institutions for experienced scientists. In addition, the
Company relies on members of its Scientific Advisory Board and a significant
number of consultants to assist the Company in formulating its research and
development strategy. All of Focal's consultants and the members of the
Company's Scientific Advisory Board are employed by employers other than the
Company, and may have commitments to, or advisory or consulting agreements with,
other entities that may limit their availability to the Company.
POTENTIAL PRODUCT LIABILITY OR PRODUCT RECALL EXPOSURE; LIMITED INSURANCE
COVERAGE. The use of any of the Company's potential products in clinical trials,
and the sale of any approved products, may expose the Company to liability
claims resulting from the use of its products or to product recalls. Product
liability claims might be made directly by consumers, health care providers or
by pharmaceutical companies or others selling such products. Focal has obtained
product liability insurance coverage, subject to certain policy limits, for its
clinical trials. The Company intends to expand its insurance coverage to include
the sale of commercial products if marketing approval is obtained for products
in development. However, insurance coverage is becoming increasingly expensive,
and no assurance can be given that the Company will be able to maintain
insurance coverage at a reasonable cost or in sufficient amounts to protect the
Company against losses due to liability. There can also be no assurance that the
Company will be able to obtain commercially reasonable product liability
insurance for any products approved for marketing. A successful product
liability claim or series of claims brought against the Company or a product
recall could have a material adverse effect on its business, financial condition
and results of operations.
HAZARDOUS MATERIALS; ENVIRONMENTAL MATTERS. The Company's research and
development processes involve the controlled use of hazardous materials. The
Company is subject to federal, state and local laws and regulations governing
the use, manufacture, storage, handling and disposal of such materials and
certain waste products. Although the Company believes that its safety procedures
for handling and disposing of such materials comply with the standards
prescribed by such laws and regulations, the risk of accidental contamination or
injury from these materials cannot be completely eliminated. In the event of
such an accident, the Company could be held liable for any damages that result
and any such liability could exceed the resources of the Company. The Company
believes that it is in compliance in all material respects with applicable
environmental laws and regulations.
ITEM 2.
PROPERTIES
Focal currently occupies approximately 54,000 square feet of manufacturing,
laboratory and administrative space in Lexington, Massachusetts under a lease
which expires in September 2004. Focal has an option to extend this lease for
several additional five year periods. The Company believes that this facility is
sufficient to meet the Company's requirements through at least 1999. The Company
is currently evaluating the possibility of obtaining additional facility space
in the Lexington, Massachusetts area and believes such space can be obtained on
commercially reasonable terms.
ITEM 3.
LEGAL PROCEEDINGS
The Company is not currently a party to any material legal proceedings.
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ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
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PART II
ITEM 5.
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
The Company's Common Stock is traded on the Nasdaq National Market under the
symbol "FOCL." The following table sets forth the range of the high and low sale
prices by quarter as reported on the Nasdaq National Market since December 11,
1997, the date the Common Stock commenced trading.
<TABLE>
<S> <C> <C>
Dec 11-31, 1997............................................. $ 10.75 $ 10.00
First Quarter 1998.......................................... $ 19.00 $ 10.63
Second Quarter 1998......................................... $ 20.50 $ 8.75
Third Quarter 1998.......................................... $ 12.50 $ 5.50
Fourth Quarter 1998......................................... $ 10.50 $ 6.50
</TABLE>
As of January 31, 1999, the number of common stockholders of record was 303.
The Company has never paid any dividends on its Common Stock. The Company
currently intends to retain any earnings for use in its business and does not
anticipate paying any cash dividends in the foreseeable future.
On December 11, 1997, the Company commenced and completed its initial public
offering (the "IPO") of 2,500,000 shares of its Common Stock, $0.01 par value
per share, at a public offering price of $10.00 per share pursuant to a
registration statement on Form S-1 (file no. 333-38379) filed with the
Securities and Exchange Commission. All of the shares registered were sold,
including an additional 375,000 shares which were sold upon exercise of the
underwriters' over-allotment option. Lehman Brothers, Piper Jaffray, Inc., and
Pacific Growth Equities, Inc. were the managing underwriters of the IPO. All of
the net proceeds of the IPO, less funds expended to date, were held in cash,
cash equivalents and marketable securities at December 31, 1998.
ITEM 6. SELECTED FINANCIAL DATA
The information required by this item is incorporated by reference from the
Company's 1998 Annual Report to Stockholders under the caption "Selected
Financial Data," which appears in Exhibit 13 to this Annual Report on Form 10-K.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The information required by this item is incorporated by reference from the
Company's 1998 Annual Report to Stockholders under the caption "Management's
Discussion and Analysis of Financial Condition and Results of Operations," which
appears in Exhibit 13 to this Annual Report on Form 10-K.
ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
The Company maintains an investment portfolio in accordance with its
Investment Policy. The primary objectives of the Company's Investment Policy are
to preserve principal, maintain proper liquidity to meet operating needs and
maximize yields. The Company's Investment Policy specifies credit quality
standards for the Company's investment and limits the amount of credit exposure
to any single issue, issuer or type of investment.
The Company's investments consist of securities of various types and
maturities of one year or less, with an average maturity of 3 months. The
Company accounts for its investments in accordance with Statement of Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" (SFAS 115). All of the Company's cash equivalents and marketable
securities are treated as available-for-sale under SFAS 115.
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The securities held in the company's investment portfolio are subject to
interest rate risk. Changes in interest rates affect the fair market value of
the available-for-sale securities. After a review of the Company's marketable
securities as of December 31, 1998, the Company has determined that in the event
of a hypothetical ten percent increase in interest rates, the resulting decrease
in fair market value of the Company's marketable investment securities would be
insignificant to the financial statements as a whole.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTAL DATA
The information required by this item is listed below under Item 14 and is
incorporated by reference from the Company's 1998 Annual Report to Stockholders
under the caption "Financial Statements and Notes Thereto," which appears in
Exhibit 13 to this Annual Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
During the Company's two most recently completed fiscal years there have
been no disagreements with its independent accountants on accounting and
financial disclosure matters.
PART III
ITEM 10.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item relating to directors is incorporated
by reference to the information under the caption "Proposal No. 1--Election of
Directors" in the definitive proxy statement with respect to the 1999 Annual
Meeting of Stockholders (the "Proxy Statement") to be held May 26, 1999.
The executive officers and other key officers of the Registrant, who are
elected by the board of directors, are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------------------------------- --- -----------------------------------------------------
<S> <C> <C>
David M. Clapper..................................... 47 President, Chief Executive Officer and Director
Arthur J. Coury, Ph.D................................ 57 Chief Scientific Officer
David J. Enscore, Ph.D............................... 47 Vice President, Research and Development & Drug
Delivery
Stephen J. Herman.................................... 50 Vice President, Operations
Mary Lou Mooney...................................... 42 Vice President, Clinical and Regulatory Affairs &
Quality
Ronald S. Rudowsky................................... 49 Vice President, Marketing and Procedure Development
W. Bradford Smith.................................... 43 Vice President, Finance and Administration and Chief
Financial Officer
James McEvoy......................................... 49 Vice President, Human Resources
</TABLE>
DAVID M. CLAPPER has been President, Chief Executive Officer and a Director
since joining Focal in July 1993. Before joining Focal, Mr. Clapper was employed
at Johnson & Johnson from 1977 until 1993. He served as Vice President and a
Board member at the Critikon, Inc. division of Johnson & Johnson from July 1992
to July 1993. From 1977 to June 1992, Mr. Clapper held a variety of positions,
including Vice President of Sales & Marketing and a Board Member of Ethicon
Endo-Surgery, and Vice President of Product Management and a Board Member at
Ethicon Inc.. Mr. Clapper holds a B.S. in Marketing from Bowling Green State
University.
ARTHUR J. COURY, PH.D. has been Chief Scientific Officer since 1998.
Previously, Mr. Coury was Vice President, Materials Research of the Company
since joining Focal in July 1993. From 1976 to June 1993, Dr. Coury held various
positions with Medtronic, Inc., serving most recently as Director, Polymer
29
<PAGE>
Technology and Corporate Research Fellow. He has over 20 years of biomaterials
research and development experience and has been issued 30 patents. Dr. Coury
holds a Ph.D. in Organic Chemistry and an M.B.A. from the University of
Minnesota.
DAVID J. ENSCORE, PH.D. has been Vice President, Research, Development and
Drug Delivery since 1998. Previously, he was Vice President, Development and
Drug Delivery of the Company since joining Focal in September 1995. From 1979
until joining the Company, Dr. Enscore held several positions with ALZA
Corporation, a biopharmaceutical company, most recently as Executive Director,
Transdermal Product Development. Dr. Enscore has been issued 15 patents. He
holds a Ph.D. in Chemical Engineering from North Carolina State University.
STEPHEN J. HERMAN has been Vice President, Operations of the Company since
August 1992. From March 1990 to May 1992, Mr. Herman served as President and
Chief Executive Officer of Cardiopulmonary Corporation, a medical equipment
development company. From 1982 to 1990, he held various positions with C. R.
Bard, Inc., a medical device company, most recently as President of its critical
care division. Mr. Herman previously held product development management
positions with Cobe Laboratories. Mr. Herman holds an M.B.A. from the University
of Colorado and a B.S. in Mechanical Engineering from the University of
Missouri.
MARY LOU MOONEY, Vice President, Clinical Affairs, Regulatory Affairs and
Quality, joined the Company in June 1993 as Director, Regulatory Affairs. In
January 1997, Ms. Mooney was promoted to her current position. From March 1991
to June 1993, she held various positions with C.R. Bard Inc., a medical device
company, most recently as Director, Regulatory Affairs and Quality Assurance for
its ventures division. Ms. Mooney has also held regulatory positions with
Cardiac Pacemakers, Inc., Biometric Research Institute, Inc. and Cordis
Corporation. Ms. Mooney holds an M.S. in Biomedical Science from Drexel
University.
RONALD S. RUDOWSKY, Vice President, Marketing and Procedure Development,
joined the Company in January 1994 as Director, Procedure Development. In
January 1997, Mr. Rudowsky was promoted to his current position. From June 1991
to December 1993, he was the Director of Marketing of Ethicon Endo-Surgery, a
medical device company and a division of Johnson & Johnson. Previously, he spent
14 years in various sales and marketing positions at Ethicon, Inc. Mr. Rudowsky
holds a B.B.A. in Marketing from Marshall University.
W. BRADFORD SMITH, Vice President, Finance and Administration and Chief
Financial Officer, joined the Company as Director of Finance in May 1993. In
March 1994, Mr. Smith was appointed to his current position. From June 1990 to
May 1993, he served as Director of Finance for CytoTherapeutics, Inc., a
biotechnology company. Prior to that, he was Director of Finance at ImmuCell
Corporation, a biotechnology company, a Financial Analyst for a division of
Lockheed Corporation and a Senior Accountant with Coopers & Lybrand. Mr. Smith
holds an M.B.A. from the University of New Hampshire and a B.S. from Tufts
University.
JAMES MCEVOY, Vice President, Human Resources, joined Focal in June 1998.
From 1995 to 1998, Mr. McEvoy was a Human Resources consultant to several
biotechnology and medical device companies, including Focal, Biopure
Corporation, Phytera, Inc. and AutoImmune, Inc. Previously, he served as Vice
President of Human Resources at The Ares-Serono Group and as Vice President of
Human Resources at Wang Laboratories.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference from the
information under the caption "Executive Compensation" in the Proxy Statement.
30
<PAGE>
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item is incorporated by reference from the
information under the caption "Record Date and Stock Ownership" in the Proxy
Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference from the
information under the caption "Certain Transactions" in the Proxy Statement.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. Financial Statements
The following Financial Statements of Focal, Inc. and Report of Independent
Auditors are incorporated by reference from the Company's 1998 Annual Report to
Stockholders:
<TABLE>
<CAPTION>
PAGE NO. IN
1998 ANNUAL
REPORT TO
STOCKHOLDERS
-----------------
<S> <C>
Balance Sheets, As of December 31, 1998 and 1997.................................................... 15
Statements of Operations, Years Ended December 31, 1996, 1997 and 1998.............................. 16
Statements of Cash Flows, Years Ended December 31, 1996, 1997 and 1998.............................. 17
Statements of Stockholders' Equity, Years Ended December 31, 1996, 1997 and 1998.................... 18
Notes to Financial Statements....................................................................... 20
Report of Independent Auditors...................................................................... 28
</TABLE>
2. Financial Statement Schedules
All financial statement schedules are omitted because they are not
applicable or the required information is shown in the Financial Statements or
the notes thereto.
3. Exhibits
The exhibits listed in the Exhibit Index immediately preceding the Exhibits
are filed as a part of this Annual Report on Form 10-K.
(b) Reports on Form 8-K
None.
31
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
FOCAL, INC
By: /s/ DAVID M. CLAPPER
----------------------------------------
David M. Clapper,
President and
Chief Executive Officer
KNOW ALL MEN AND WOMEN BY THESE PRESENTS, that each person whose signature
appears below constitutes and appoints David M. Clapper and W. Bradford Smith,
jointly and severally, his or her attorneys-in-fact, and each with the power of
substitution, for him or her in any and all capacities, to sign any amendments
to this Report on Form 10-K, and to file the same, with exhibits thereto and
other documents in connection therewith, with the Securities and Exchange
Commission, hereby ratifying and confirming all that each of said
attorneys-in-fact, or his or her substitute or substitutes, may do or cause to
be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the date indicated.
SIGNATURE TITLE DATE
- ------------------------------ --------------------------- -------------------
President, Chief Executive
/s/ DAVID M. CLAPPER Officer and Director
- ------------------------------ (Principal Executive March 30, 1999
(David M. Clapper) Officer)
Vice President, Finance and
/s/ W. BRADFORD SMITH Chief Financial Officer
- ------------------------------ (Principal Financial and March 30, 1999
(W. Bradford Smith) Accounting Officer)
/s/ HENRY BREM, M.D.
- ------------------------------ Director March 30, 1999
(Henry Brem, M.D.)
/s/ JANET EFFLAND
- ------------------------------ Director March 30, 1999
(Janet Effland)
/s/ ROBERT LANGER, PH.D.
- ------------------------------ Director March 30, 1999
(Robert Langer, Ph.D.)
/s/ MARK J. LEVIN
- ------------------------------ Director March 30, 1999
(Mark J. Levin)
/s/ MICHAEL J. LEVINTHAL
- ------------------------------ Director March 30, 1999
(Michael J. Levinthal)
/s/ JESSE I. TREU, PH.D
- ------------------------------ Director March 30, 1999
(Jesse I. Treu, Ph.D.)
32
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
- --------- -------------------------------------------------------------------------------------------------------
<C> <S>
3.2(1) Restated Certificate of Incorporation of the Registrant.
3.3(1) Bylaws of the Registrant as amended.
4.2(1) Specimen Common Stock Certificate.
10.1(1) Form of Indemnification Agreement between the Registrant and each of its directors and officers.
10.2(1) 1992 Incentive Stock Plan, as amended, and form of Stock Option Agreement.
10.3(1) 1997 Employee Stock Purchase Plan and forms of agreements thereunder.
10.4(1) 1997 Directors' Option Plan and forms of agreements thereunder.
10.5(1) Restated Investors Rights Agreement dated April 12, 1996 among the Registrant and certain stockholders
of the Registrant.
10.6(1) Lease Agreement dated April 4, 1994 between Registrant and The Mutual Life Insurance Company of New
York relating to lease of facility located at 4 Maguire Road, Lexington, MA, as amended to date.
10.7(1) Master Lease Agreement dated October 30, 1992 between Registrant and Comdisco, Inc.
10.8(1) Master Lease Agreement dated February 28, 1994 between Registrant and MMC/GATX Limited Partnership I.
10.9(1) Master Loan and Security Agreement dated April 18, 1997 between Registrant and Transamerica Leasing.
10.10(1) Patent and Technology License Agreement dated June 11, 1992 between Registrant and University of Texas.
10.11(1) Exclusive License Agreement dated August 7, 1992 among Registrant, Marvin Slepian, M.D. and Endoluminal
Therapeutics, Inc.
10.12(1) Collaboration and License Agreement dated April 25, 1996 between Registrant, Ciba Corporation and
Chiron Corporation.
10.13(1) Distribution, License and Supply Agreement dated January 2, 1997 between Registrant and Ethicon, Inc.
10.14(1) Agreement for Consulting Services dated November 15, 1991 between Registrant and Robert Langer, Ph.D.
10.15(1) Agreement for Consulting Services dated August 7, 1992 between Registrant and Marvin Slepian, M.D.
10.16(1) Agreement for Consulting Services and Sabbatical Employment dated June 1, 1992 between Registrant and
Jeffrey Hubbell.
10.17(1) Form of Restricted Stock Purchase Agreement.
10.18(1) Loan Agreement dated March 29, 1995 between Registrant and Ronald Rudowsky.
10.19(1) Loan Agreement dated February 28, 1997 between Registrant and Arthur Coury, Ph.D.
10.20(1) Form of Preferred Shares Rights Agreement between Registrant and Norwest Bank Minnesota N.A.
13 1998 Annual Report to Stockholders (which shall be deemed filed only with respect to those portions
specifically incorporated by reference herein).
23.1 Consent of Ernst & Young LLP, independent auditors.
27.1 Financial Data Schedule.
</TABLE>
- ------------------------
(1) Incorporated by reference to the like-numbered exhibits previously filed
with Registrant's Registration Statement on Form S-1, File No. 333-38379,
originally filed with the Securities and Exchange Commission on October 21,
1997.
<PAGE>
Exhibit 13
Contents
9 -- Contents
10 -- Selected Financial Data
11 -- Management's Discussion & Analysis
15 -- Balance Sheets
16 -- Statements of Stockholders' Equity
18 -- Statements of Operations
19 -- Statements of Cash Flows
20 -- Notes to Financial Statements
28 -- Report of Independent Auditors
IBC -- Corporate Directory
Focal, Inc. 1998 Annual Report
9
<PAGE>
Selected Financial Data
(In thousands, except per share data)
<TABLE>
<CAPTION>
Year ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
1994 1995 1996 1997 1998
- ------------------------------------------------------------------------------------------------------------------------------------
Statement of Operations Data:
Revenues:
<S> <C> <C> <C> <C> <C>
Collaborative research revenues $ 50 $ 968 $ 3,098 $ 17,489 $ 5,114
Product revenues -- -- -- -- 3,071
--------- --------- ------------ --------- ----------
Total revenues 50 968 3,098 17,489 8,185
Costs and expenses:
Cost of product revenues -- -- -- -- 3,740
Research and development 11,890 9,665 11,680 15,712 15,590
General and administrative 2,034 2,098 2,175 3,058 3,815
--------- --------- ------------ --------- ----------
Total costs and expenses 13,924 11,763 13,855 18,770 23,145
Interest income 668 443 691 968 1,765
Interest expense (79) (107) (92) (129) (212)
--------- --------- ------------ --------- ----------
Net loss $ (13,285) $ (10,459) $ (10,158) $ (442) $(13,407)
--------- --------- ------------ --------- ----------
Basic and diluted
net loss per share (1) $ (1.26) $ (0.04) $ (1.01)
------------ --------- ----------
Shares used in computing basic and
diluted net loss per share 8,088,898 10,410,091 13,291,182
------------ --------- ----------
</TABLE>
<TABLE>
<CAPTION>
Year ended December 31,
- -------------------------------------------------------------------------------------------------------------------
1994 1995 1996 1997 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash, cash equivalents and
marketable securities $ 12,240 $ 6,948 $ 12,208 $ 33,239 $ 25,346
Working capital 10,159 4,401 9,003 30,867 22,188
Total assets 15,331 9,306 14,089 39,606 30,461
Capital lease obligations, long-term portion 934 462 315 1,422 1,391
Total stockholders' equity 11,626 5,995 10,099 32,512 23,776
</TABLE>
(1) PRO FORMA IN 1997 AND 1996.
SEE NOTE 1 TO THE FINANCIAL STATEMENTS.
Management's Discussion
10
<PAGE>
The following discussion should be read in conjunction with the financial
statements, including the notes thereto, appearing elsewhere in this Annual
Report on Form 10-K.
This Management's Discussion and Analysis contains certain forward looking
statements regarding future events with respect to Focal. Actual events and/or
future results of operations may differ materially as a result of the factors
described herein and in Focal's Report on Form 10-K for the year ended December
31, 1998, into which this Management's Discussion and Analysis is incorporated
by reference. Those factors described under "Business--Product and Product
Development Programs," "--Strategic Alliances," "--Patents and Proprietary
Rights," "--Government Regulation," "--Competition and Technological Change,"
"--Sales and Marketing," "--Manufacturing," "--Competition and Technological
Change," "--Third Party Reimbursement" and "Factors Affecting Operating Results"
in the Report on Form 10-K should be read in conjunction with this Management's
Discussion and Analysis.
OVERVIEW
Focal was founded in 1991, and is focused on the development, manufacture and
commercialization of synthetic, absorbable, liquid surgical sealants based on
Focal's proprietary polymer technology. Since inception, Focal has funded its
operations primarily through the private placement of equity securities and most
recently, in December 1997, through an initial public offering of common stock.
In addition, Focal has entered into strategic alliances with corporate partners
and has recorded revenues totalling $27 million through December 31, 1998, in
connection with these alliances.
Focal has incurred net losses in each year since its inception, including
net losses of approximately $13.4 million during 1998. At December 31, 1998,
Focal had an accumulated deficit of $59.3 million. Focal's operating losses have
resulted primarily from expenses incurred in connection with its research and
development activities, including preclinical and clinical trials, development
of manufacturing processes and general and administrative expenses. Focal
expects to incur net losses at least through 1999 and may incur net losses in
subsequent periods although the amount of future net losses and the time
required by Focal to reach profitability are highly uncertain. Focal is
dependent upon corporate partners for funding of a significant portion of
research and development expenses. If Focal does not continue to receive funding
from its current corporate partner, or is unable to otherwise obtain third-party
funding, net losses will continue to increase. The Company's ability to achieve
and sustain profitability will be dependent upon obtaining regulatory approval
for and successfully commercializing its FocalSeal surgical sealants, and
developing the manufacturing capacity and sales and marketing capability for its
products. There can be no assurance that Focal will obtain required regulatory
approvals, or successfully develop, manufacture, commercialize and market
products or that Focal will ever achieve profitability.
Focal introduced its first commercial product, FocalSeal-L surgical sealant
for lung surgery indications, in Europe in March 1998 through its strategic
marketing alliance with Ethicon Inc., a division of Johnson & Johnson. Focal
recorded its initial revenues from the sale of products in the first quarter of
1998. Focal anticipates that revenues derived from European sales of FocalSeal
surgical sealants will account for a substantial majority of the Company's
near-term product revenues.
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998, COMPARED TO YEAR ENDED
DECEMBER 31, 1997
Revenues for the year ended December 31, 1998 were $8.2 million compared with
$17.5 million for the year ended December 31, 1997. Revenues in 1998 included
$3.1 million in product revenues and $5.1 million in collaborative research
revenues. Revenues in 1997 of $17.5 million consisted exclusively of
collaborative research revenues.
Higher collaborative revenues were realized in 1997 than in 1998 in
connection with Focal's strategic alliance with Ethicon, including a one-time,
non-refundable payment of $7.0 million, as well as funding of $5.0 million for
research and development activities and a milestone payment of $2.0 million for
obtaining a CE mark for FocalSeal-L sealant for lung surgery. In addition,
during 1997, Focal recorded $3.4 million in revenues from its local drug
delivery partnership with Novartis. This alliance was terminated in early 1998.
During 1998, Focal recorded $3.0 million in collaborative research revenues
from Ethicon for the development of its lung surgery and neurosurgery sealant
products and $1.5 million for the development of its cardiovascular sealant
product. In addition, $0.6 million in collaborative research revenues were
realized from other sources, including a grant from the National Institutes of
Health.
Product revenues of $3.1 million realized in 1998 represented Focal's
shipments of AdvaSeal surgical sealant products to Ethicon for its distribution
in Europe and other markets outside North America. Focal realizes a combined
royalty and transfer price as a percentage of Ethicon
Cost of product revenues for the year ended December 31, 1998 totalled $3.7
million. These costs were recorded in connection with commercial sales of
AdvaSeal surgical sealant product to Ethicon. Gross margins were negative due to
the startup phase of Focal's manufacturing operations and the resulting lack of
economies of scale and certain fixed overhead costs being amortized over the
limited volume
11
<PAGE>
MANAGEMENT'S DISCUSSION (CONT'D) SALES.
experienced in the year of launch. Additionally, costs of
approximately $150,000 were incurred relating to a voluntary product recall
announced in August 1998.
Research and development expenses were $15.6 million for the year ended
December 31, 1998, compared with $15.7 million for the year ended December 31,
1997. Staffing levels in the research and development group were at
approximately the same levels in 1997 and 1998. Clinical and regulatory expenses
increased in 1998 due to clinical trials ongoing in both Europe and the United
States. Manufacturing scale-up costs decreased in 1998 from 1997 levels. During
1997, manufacturing scale-up costs were charged to research and development,
since the lung sealant product CE mark approval had not yet been received.
During 1998, the majority of manufacturing scale-up costs were capitalized as
inventory, and charged to cost of sales upon product shipment.
General and administrative expenses increased to $3.8 million for the year
ended December 31, 1998 from $3.1 million for the year ended December 31, 1997.
General and administrative expenses during these years consisted primarily of
personnel costs, which increased due to the hiring of additional administrative
and finance personnel. In addition, in 1998, certain general and administrative
expenses, including public and investor relations, insurance and legal expenses,
increased as a result of Focal's transition to a publicly traded company.
Interest income increased to $1.8 million for the year ended December 31,
1998, from $1.0 million for the year ended December 31, 1997, as a result of
higher average cash balances, including the proceeds from the initial public
offering.
The Company recorded a net loss of approximately $13.4 million for the year
ended December 31, 1998, compared with a net loss of $0.4 million for the same
period in 1997. This increased net loss was primarily the result of receipt of a
one-time payment of $7.0 million in 1997 and higher collaborative research and
development funding in 1997. The Company anticipates that it will incur net
operating losses at least through 1999.
YEAR ENDED DECEMBER 31, 1997, COMPARED TO YEAR ENDED DECEMBER 31, 1996
Revenues for the year ended December 31, 1997 increased to $17.5 million, from
$3.1 million for the year ended December 31, 1996, due to higher collaborative
research and development funding, which comprised all of the Company's revenues
during both years. The increase in 1997 was due primarily to a strategic
alliance for surgical sealants entered into with Ethicon in January 1997.
Revenues recorded in connection with this strategic alliance for the year ended
December 31, 1997 included a one-time, non-refundable payment of $7.0 million,
as well as funding of $5 million during 1998 for research and development
activities and a milestone payment of $2.0 million for obtaining a CE mark for
FocalSeal-L for lung surgery.
Research and development expenses increased to $15.7 million for the year
ended December 31, 1997, from $11.7 million for the year ended December 31,
1996. This increase resulted from the hiring of additional research and
development personnel in 1997, as well as increased clinical trials and
manufacturing start-up costs.
General and administrative expenses increased to $3.1 million for the year
ended December 31, 1997 from $2.2 million for the year ended December 31, 1996.
General and administrative expenses during these years consisted primarily of
personnel costs, which increased due to the hiring of additional administrative
personnel.
Interest income increased to $1.0 million for the year ended December 31,
1997, from $.7 million for the year ended December 31, 1996, as a result of
higher average cash balances.
The Company recorded a net loss of approximately $442,000 for the year
ended December 31, 1997. The Company's modest net loss was primarily the result
of receipt of a one-time payment of $7.0 million and collaborative research and
development funding by Ethicon.
YEAR 2000 DISCLOSURE
The Company is preparing for the impact of the arrival of the Year 2000 on its
business, as well as on the businesses of its customers, suppliers and business
partner. The "Year 2000 Issue" is a term used to describe the problems created
by systems that are unable to accurately interpret dates after December 31,
1999. These problems are derived predominantly from the fact that many software
programs have historically categorized the "year" in a two-digit format. The
Year 2000 Issue creates potential risks for the Company, including potential
problems in the Company's products as well as in the Information Technology
("IT") and non-IT systems that the Company uses in its business operations. The
Company may also be exposed to risks from third parties with whom the Company
interacts who fail to adequately address their own Year 2000 Issues.
The Company's plan for IT systems consists of four phases: (1)
inventory-identifying all IT systems; (2) assessment --identifying IT systems
that use date functions and assessing them for Year 2000 functionality; (3)
remediation--reprogramming, or replacing where necessary, inventoried items to
ensure they are Year 2000 ready; and (4) testing and certification--testing the
code modifications and new inventory with other associated systems, including
extensive date testing and performing quality assurance testing to ensure
successful operation in the post-1999 environment.
12
<PAGE>
The Company completed the inventory and assessment phases for substantially
all of its IT systems by year-end 1998. The Company's IT systems are currently
in the remediation and testing and certification phases. The Company plans to
complete the remediation of substantially all of its IT systems by June 30,
1999, and the testing and certification of all of its IT systems by September
30, 1999.
The Company also faces the risk that one or more of its critical suppliers
or customers ("external relationships") will not be able to interact with the
Company due to the third party's inability to resolve its own Year 2000 issues,
including those associated with its own external relationships.
The Company has initiated a formal process designed to determine the
overall Year 2000 readiness of its external relationships. In the case of
important suppliers, the Company is engaged in discussions with those suppliers
and is attempting to obtain detailed information as to those parties' Year 2000
plans and state of readiness. Although the Company is not aware of any problems
that would materially impact results of operations, liquidity or capital
resources, the Company does not have sufficient means to determine whether its
external relationships will be Year 2000 ready. The inability of those parties
to complete their Year 2000 remediation could have a material adverse effect on
Focal.
Total Year 2000 project costs are currently estimated to be $300,000 to
$400,000 in 1999. A large majority of these costs are expected to be incremental
expenses that will not recur in the Year 2000 or thereafter. The Company's
current estimates primarily reflect increased remediation and testing efforts,
increased use of outside resources, and certain software and hardware
expenditures related to remediation. Focal is currently evaluating fully
integrated enterprise resource planning systems ("ERP system") and expects to
install such an ERP system during 1999. A key requirement of an ERP system will
be Year 2000 compliance. Also, affecting the cost estimates are expenses related
to upgrading much of the Company's Analytical Chemistry equipment to full Year
2000 compliance. During 1998, the Company upgraded many of the personal
computers and software used by employees, and the Company now believes that the
majority of the computers currently in use are Year 2000 ready. The costs
incurred in 1998 relating to this upgrade of personal computers and software was
approximately $200,000.
Focal believes that the potential risks associated with unresolved Year
2000-related issues are limited in that the Company has relatively few
sophisticated systems that drive the Company's business at this time. Focal is
prepared to develop contingency plans to address any unresolved Year 2000 issues
or to address key suppliers' failures to respond to the Company's request for
state of readiness disclosure from those suppliers.
Any critical unresolved Year 2000 issues at the Company or its external
relationships could have a material adverse effect on the Company's results of
operations, liquidity or financial condition. In addition, the Company's
expectations about the future costs and timely and successful completion of its
Year 2000 program are subject to uncertainties that could cause actual results
to differ materially from what has been discussed above under "Year 2000."
Factors that could influence the amount of future costs and the completion dates
and effectiveness of remediation, testing and certification and contingency
planning efforts include the Company's success in identifying IT systems and
embedded systems that contain two-digit year codes, the nature and amount of
required reprogramming, testing and certification, the rate and magnitude of
related labor and consulting costs, the availability of qualified personnel and
the success of the Company's external relationships in addressing their own Year
2000 issues.
LIQUIDITY AND CAPITAL RESOURCES
Since its inception, the Company has financed operations primarily from the sale
of preferred stock in private place Management's Discussion (cont'd) ments as
well as the Company's 1997 initial public offering. Through December 31, 1998,
the Company has raised approximately $83.5 million from equity financings and
has received $7.0 million in equipment lease financing. In addition, the Company
has received funding from Ethicon and other corporate partners totaling
approximately $26.7 million through December 31, 1998.
Cash used in operations totalled $11.1 million in the year ended December
31, 1998, as compared to the use of $0.1 million for the same period of 1997.
The change in cash from operations was due to significantly higher net losses
incurred in 1998, compared to 1997. Cash used in operations is equal to the net
loss incurred for each period, plus non-cash charges such as depreciation and
amortization of property and equipment plus any changes in working capital.
Capital expenditures from inception through December 31, 1998 totalled $7.6
million, representing laboratory equipment, office furniture and equipment,
computers and certain leasehold improvements. The majority of these purchases
13
<PAGE>
MANAGEMENT'S DISCUSSION (CONT'D) SALES.
have been financed through either direct financing leases or sale and leaseback
arrangements. As of December 31, 1998, the Company did not have any material
commitments for future capital expenditures. In the next 12 to 24 months, the
Company anticipates capital expenditures of approximately $2.5 million for
manufacturing facilities and related equipment. The Company has commitments from
lenders in the form of lease lines totalling $1.5 million to provide for its
expected capital needs during 1999 and the first half of 2000.
Under certain agreements with universities and consultants, the Company is
obligated to make payments for sponsored research and consulting services. The
Company's research funding commitments under these agreements totalled
approximately $118,000 at December 31, 1998. Payments under these agreements are
typically made on a quarterly or monthly basis.
Under the Company's surgical sealant collaborative agreement with Ethicon,
a total of $21.6 million has been committed to Focal and $20.1 million had been
received as of December 31, 1998. Additional payments may be made under this
agreement for research and development activities and upon achievement of
specified development milestones. However, there can be no assurance as to the
receipt or timing of any such payments. The Company believes that its existing
capital resources, interest income and future payments due under strategic
alliances, will be sufficient to satisfy its current and projected funding
requirements for at least 15 months.
There can be no assurance that the Company's capital resources will be
sufficient to enable the Company to conduct its research and development
programs as planned. The Company's future capital requirements will depend on
many factors, including continued progress in its research and development
programs, progress with preclinical testing and clinical trials, the time and
costs involved in obtaining regulatory approvals, if any, the costs involved in
filing and prosecuting patent applications and enforcing patent claims,
competing technological and market developments, the establishment of additional
strategic alliances, the cost of manufacturing facilities and of
commercialization activities and arrangements, and the cost of product
in-licensing and any possible acquisitions. There can be no assurance that the
Company's cash, cash equivalents and marketable securities and interest income
earned thereon, together with funding that may be received under the Company's
strategic alliances, will be adequate to satisfy its capital and operating
requirements.
The Company intends to seek additional funding through strategic alliances,
and may seek additional funding through public or private sales of the Company's
securities, including equity securities. In addition, the Company has obtained
equipment lease financing and other forms of debt financing and may continue to
pursue opportunities to obtain additional lease or debt financing in the future.
There can be no assurance, however, that additional equity or debt financing
will be available on reasonable terms, if at all. Any additional equity
financing would be dilutive to the Company's stockholders. If adequate funds are
not available, the Company may be required to curtail significantly one or more
of its research and development programs and/or obtain funds through
arrangements with corporate partners or others that may require the Company to
relinquish rights to certain of its technologies or product candidates.
14
<PAGE>
BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
- -------------------------------------------------------------------------------------------------------------------
1997 1998
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents $ 26,810,777 $ 8,516,936
Marketable securities 6,428,374 16,829,291
Accrued interest receivable 201,225 359,911
Contract revenues receivable 2,046,641 --
Accounts receivable -- 587,380
Inventories, net 566,989 937,017
Prepaid expenses and other assets 485,718 252,086
------------ ---------------
Total current assets 36,539,724 27,482,621
Notes receivable from related parties 343,480 282,442
Property and equipment 6,438,098 7,568,435
Less accumulated depreciation and amortization 3,727,585 4,886,037
------------ ---------------
Net property and equipment 2,710,513 2,682,398
Other assets 12,696 13,368
------------ ---------------
Total assets $ 39,606,413 $ 30,460,829
Liabilities and stockholders' equity Current liabilities:
Accounts payable $ 1,577,105 $ 1,105,585
Accrued liabilities 2,454,702 2,752,359
Deferred revenue 750,000 550,000
Current portion of capital lease obligations 890,451 886,517
------------ ---------------
Total current liabilities 5,672,258 5,294,461
Capital lease obligations 1,421,983 1,390,821
Commitments and contingent liabilities
Stockholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized;
none issued and outstanding -- --
Common stock, $.01 par value; 50,000,000 shares authorized;
12,868,570, and 13,367,767 shares issued and outstanding at
December 31, 1997 and 1998, respectively 128,686 133,678
Additional paid-in capital 80,777,780 84,884,786
Accumulated deficit (45,920,014) (59,327,360)
Notes receivable from related parties (1,688,057) (1,443,133)
Deferred compensation (768,865) (464,206)
Accumulated other comprehensive income (17,358) (8,218)
------------ ---------------
Total stockholders' equity 32,512,172 23,775,547
Total liabilities and stockholders' equity $ 39,606,413 $ 30,460,829
------------ ---------------
------------ ---------------
</TABLE>
SEE ACCOMPANYING NOTES.
15
<PAGE>
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Convertible
Preferred Stock Common Stock
- -------------------------------------------------------------------------------------------------------------------
Shares Amount Shares Amount
- -------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balances at December 31, 1995 14,561,046 $ 145,610 664,504 $ 6,645
Net issuance of Series E convertible
preferred stock at $1.74 per share 9,784,201 97,842
Exercise of stock options 58,840 588
Deferred compensation
Amortization of deferred compensation
Comprehensive income
Unrealized gain on marketable securities
Net loss
Total comprehensive income
------------ ---------- --------- -----------
Balances at December 31, 1996 24,345,247 243,452 723,344 7,233
------------ ---------- --------- -----------
Exercise of stock options for notes receivable 1,494,775 14,948
Net proceeds from initial public offering 2,500,000 25,000
Conversion of preferred stock upon IPO (24,345,247) (243,452) 8,117,803 81,178
Exercise of stock options and warrants 32,648 327
Deferred compensation
Amortization of deferred compensation
Comprehensive income
Unrealized gain on marketable securities
Net loss
Total comprehensive income
------------ ---------- --------- -----------
Balances at December 31, 1997 12,868,570 128,686
Net proceeds from exercise of over-allotment option 375,000 3,750
Exercise of stock options 92,578 926
Shares repurchased and retired (24,884) (249)
Principal payments on notes receivable
Shares issued under ESPP 56,503 565
Amortization of deferred compensation
Comprehensive income:
Unrealized gain on marketable securities
Net loss
Total comprehensive income
------------ ---------- --------- -----------
Balances at December 31, 1998 $-- 13,367,767 $133,678
</TABLE>
16
<PAGE>
SEE ACCOMPANYING NOTES.
<TABLE>
<CAPTION>
Notes Accumulated
Additional Receivable Other Total
Paid-in Accumulated From Related Deferred Comprehensive Stockholders'
Capital Deficit Parties Compensation Income Equity
-------------- -------------- ------------- ------------- --------------- ----------------
<S> <C> <C> <C> <C> <C>
$ 41,215,682 $ (35,320,380) $(52,400) $ 5,995,157
13,959,510 14,057,352
54,129 54,717
1,074,637 (1,074,637)
140,533 140,533
9,357 9,357
(10,158,089) (10,158,089)
(10,148,732)
-------------- -------------- ------------- ------------- --------------- ----------------
56,303,958 (45,478,469) (934,104) (43,043) 10,099,027
1,673,109 (1,688,057)
22,471,550 22,496,550
162,274
13,849 14,176
153,040 (153,040)
318,279 318,279
25,685 25,685
(441,545) (441,545)
(415,860)
-------------- -------------- ------------- ------------- --------------- ----------------
80,777,780 (45,920,014) (1,688,057) (768,865) (17,358) 32,512,172
3,545,750 3,549,500
118,539 119,464
(29,675) 29,923
215,001 215,001
472,392 472,957
304,659 304,659
9,140 9,140
(13,407,346) (13,407,346)
(13,398,206)
-------------- -------------- ------------- ------------- --------------- ----------------
$84,884,786 $(59,327,360) $(1,443,133) $ (464,206) $ (8,218) $ 23,775,547
</TABLE>
17
<PAGE>
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
Year ended December 31,
- -----------------------------------------------------------------------------------------------------------------------------------
1996 1997 1998
- -----------------------------------------------------------------------------------------------------------------------------------
Revenues:
<S> <C> <C> <C>
Collaborative research revenues $ 3,098,289 $ 17,489,264 $ 5,113,953
Product revenues -- -- 3,071,490
---------------- --------------- ----------------
Total revenues 3,098,289 17,489,264 8,185,443
Costs and expenses:
Cost of product revenues -- -- 3,739,807
Research and development 11,679,942 15,711,504 15,590,647
General and administrative 2,174,911 3,058,424 3,815,432
---------------- --------------- ----------------
Total costs and expenses 13,854,853 18,769,928 23,145,886
Other income (expense):
Interest income 690,745 968,141 1,765,420
Interest expense (92,270) (129,022) (212,323)
---------------- --------------- ----------------
598,475 839,119 1,553,097
Net loss $(10,158,089) $ (441,545) $(13,407,346)
Basic and diluted net loss per share (pro forma
in 1996 and 1997) $ (1.26) $ (0.04) $ (1.01)
Shares used in computing basic and diluted
net loss per share 8,088,898 10,410,091 13,291,182
</TABLE>
SEE ACCOMPANYING NOTES.
18
<PAGE>
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31,
- -------------------------------------------------------------------------------------------------------------------
1996 1997 1998
- -------------------------------------------------------------------------------------------------------------------
Operating activities
<S> <C> <C> <C>
Net loss $(10,158,089) $ (441,545) $(13,407,346)
Adjustments to reconcile net loss to net cash
used in operating activities:
Depreciation and amortization 969,868 1,128,923 1,158,452
Amortization of deferred compensation 140,533 318,279 304,659
Interest accrued on notes receivable (10,604) (112,238) (103,280)
Loss on sale of property and equipment 3,647 -- --
Changes of operating assets and liabilities:
Accrued interest receivable (110,006) (42,790) (158,686)
Contract revenues receivable -- (2,046,641) 2,046,641
Accounts receivable -- -- (587,380)
Inventories -- (566,989) (370,028)
Prepaid expenses and other assets (58,146) (173,837) 233,632
Accounts payable (112,894) 1,075,501 (471,520)
Accrued liabilities 315,969 589,712 297,657
Deferred revenue 655,333 94,667 (200,000)
Other assets 565,666 (647) (672)
Notes receivable (88,000) 33,908 164,318
------------- ------------- ----------------
Net cash used in operating activities (7,886,723) (143,697) (11,093,553)
Investing activities
Purchase of marketable securities (12,760,761) (9,589,782) (27,762,163)
Maturities of marketable securities 7,975,000 9,929,811 17,370,386
Purchase of property and equipment (388,683) (2,326,008) (1,130,337)
Proceeds from sale of property and equipment 2,150 -- --
------------- ------------- ----------------
Net cash used in investing activities (5,172,294) (1,985,979) (11,522,114)
Financing activities
Proceeds from issuance of common stock, net 54,717 22,510,726 3,549,500
Proceeds from lease financing 372,356 2,029,382 1,077,336
Principal payments on capital lease obligations (960,243) (1,065,126) (1,112,432)
Proceeds from the issuance of convertible preferred
stock, net of issuance costs 14,057,352 -- --
Proceeds from exercise of stock options -- -- 119,464
Proceeds from issuance of common stock under
the employee stock purchase plan -- -- 472,957
Principal payments on notes receivable -- -- 215,001
------------- ------------- ----------------
Net cash provided by financing activities 13,524,182 23,474,982 4,321,826
Net increase in cash and cash equivalents 465,165 21,345,306 (18,293,841)
Cash and cash equivalents at beginning of the year 5,000,306 5,465,471 26,810,777
------------- ------------- ----------------
Cash and cash equivalents at end of the year $ 5,465,471 $26,810,777 $ 8,516,936
Supplemental disclosure of cash flow information:
Property acquired under capital lease obligations $ 408,943 $ 379,639 $ 0
------------- ------------- ----------------
Interest paid $ 92,270 $ 129,022 $ 212,323
</TABLE>
SEE ACCOMPANYING NOTES.
19
<PAGE>
NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998
NOTE 1: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
Focal, Inc. (the Company) develops, manufactures and commercializes synthetic,
absorbable, liquid surgical sealants based on the Company's proprietary polymer
technology. The Company's family of FocalSeal surgical sealant products is
currently being developed for use inside the body to seal air and fluid leaks
resulting from lung surgery, neurosurgery, cardiovascular surgery and
gastrointestinal surgery.
REVERSE STOCK SPLIT
On October 16, 1997, the Board of Directors approved a 1 for 3.25 reverse stock
split of common shares, effected in the form of a reverse stock dividend which
became effective on December 11, 1997. All common share and per common share
amounts included in the accompanying financial statements and notes thereto have
been retroactively restated to give effect to a 1 for 3.25 reverse stock split.
USE OF ESTIMATES
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES
Cash and cash equivalents include funds held in investments with original
maturities of three months or less. Marketable securities consist of investments
in agencies of the U.S. government, investment grade corporate notes and other
investments with original maturities of greater than three months.
The Company determines the appropriate classification of cash equivalents
and marketable securities at the time of purchase and reevaluates such
designation as of each balance sheet date. The Company has classified such
holdings as available-for-sale securities, which are carried at fair value, with
unrealized gains and losses reported as a separate component of stockholders'
equity.
CONCENTRATION OF CREDIT RISK
The Company invests its cash equivalents and marketable securities with
institutions that have strong credit ratings. The Company has developed
guidelines relative to investment risk and liquidity.
All product revenues and accounts receivable are derived from one customer.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Carrying amounts of financial instruments held by the Company, which include
cash equivalents, accounts receivable, accounts payable and accrued expenses,
approximate fair value due to their short duration.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out method) or
market.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and are depreciated using the
straight-line method over estimated useful lives of 3-5 years. Property and
equipment under capital leases are amortized using the straight-line method over
the lease term, typically 4 years.
REVENUE RECOGNITION
Revenues from collaborative research agreements are
recognized as earned upon the incurrence of reimbursable expenses or the
achievement of certain milestones. Payments received in advance of research
performed are designated as deferred revenue. Reimbursable expenses incurred or
milestones achieved but not yet reimbursed are designated as contract revenues
receivable.
Product revenues are recognized upon shipment to the customer (see Note 8).
RESEARCH AND DEVELOPMENT COSTS AND PATENT COSTS
All research and development costs, including the cost of acquiring patents and
licensing fees paid in connection with university technology licensing
agreements, are expensed as incurred.
STOCK BASED COMPENSATION
The Company accounts for its stock based compensation arrangements under the
provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees. The
Company has adopted the disclosure provisions only of Statement of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation (FAS 123).
20
<PAGE>
NOTES TO FINANCIAL STATEMENTS DECEMBER 31, 1998
INCOME TAXES
The liability method is used to account for income taxes. Deferred tax assets
and liabilities are determined based on differences between the financial
reporting and income tax basis of assets and liabilities as well as net
operating loss carryforwards, and are measured using the enacted tax rates and
laws that will be in effect when the differences are expected to reverse.
Deferred tax assets may be reduced by a valuation allowance to reflect the
uncertainty associated with their ultimate realization.
BASIC AND DILUTED NET LOSS PER SHARE
Basic and diluted net loss per share is presented in accordance with the
provisions of Statement of Financial Accounting Standards No. 128, Earnings Per
Share. Basic net loss per share is computed based on the weighted average number
of shares of common stock outstanding. Diluted net loss per share does not
differ from basic net loss per share since potential common shares to be issued
upon exercise of stock options are anti-dilutive for the periods presented. Pro
forma net loss per share for 1996 and 1997 is computed using the weighted
average number of outstanding common shares and convertible preferred shares,
assuming conversion at date of issuance. Historical earnings per share for 1996
and 1997 have not been presented since such amounts are not deemed meaningful
due to the significant change in the Company's capital structure that occurred
in connection with the initial public offering in 1997.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In 1998, the Company adopted Statement of Financial Accounting Standards No.
130, Reporting Comprehensive Income (FAS 130). FAS 130 establishes standards for
the reporting and display of comprehensive income and its components. FAS 130
did not have a material impact on the Company's financial statements.
In 1998, the Financial Accounting Standards Board issued Statement No. 133
Accounting for Derivative Instruments and Hedging Activities (FAS 133). FAS 133
requires companies to record derivatives on the balance sheet as assets or
liabilities, measured at fair value. Gains or losses resulting from changes in
values of those derivatives would be accounted for depending on the use of the
derivative and whether it qualifies for hedge accounting. FAS 133 is effective
for the Company in fiscal 2000. The Company does not believe that the adoption
of FAS 133 will have a material effect on the Company's financial statements.
RECLASSIFICATIONS
Certain amounts in 1996 and 1997 have been reclassified to permit comparison
with 1998 amounts.
NOTE 2: MARKETABLE SECURITIES
Available-for-sale marketable securities consisted of the following at December
31:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1997
- --------------------------------------------------------------------------------
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. government
securities due
within one year $2,000,000 $ 4,200 $ (19,300) $1,984,900
Corporate notes
due within
one year 4,445,732 -- (2,258) 4,443,474
---------- ------- ---------- -----------
Total debt
securities
included in
marketable
securities $6,445,732 $ 4,200 $ (21,558) $6,428,374
---------- ------- ---------- -----------
</TABLE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1998
- --------------------------------------------------------------------------------
Gross Gross
Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
U.S. government
securities due
within one year $ 1,000,000 $ 490 $ 0 $ 1,000,490
Corporate notes
due within
one year 15,837,508 5,384 (14,091) 15,828,801
----------- ------ --------- -----------
Total debt
securities
included in
marketable
securities $16,837,508 $5,874 $(14,091) $16,829,291
----------- ------ --------- -----------
</TABLE>
Amortized cost basis was used in computing the cost of marketable
securities sold.
21
<PAGE>
NOTES TO FINANCIAL STATEMENTS(CONT'D) DECEMBER 31, 1998
NOTE 3: INVENTORIES
Inventories consist of the following at December 31:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1997 1998
- --------------------------------------------------------------------------------
<S> <C> <C>
Purchased parts and sub assemblies $566,989 $219,298
Work in process -- 672,928
Finished goods -- 44,791
-------- --------
$566,989 $937,017
-------- --------
-------- --------
</TABLE>
NOTE 4: PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1997 1998
- --------------------------------------------------------------------------------
<S> <C> <C>
Leasehold improvements $1,094,980 $1,118,916
Laboratory equipment 3,905,092 4,678,566
Office equipment, computers
and software 867,667 1,157,125
Furniture and fixtures 570,359 613,828
----------- -----------
$6,438,098 $7,568,435
----------- -----------
</TABLE>
NOTE 5: ACCRUED LIABILITIES
Accrued liabilities consist of the following at December 31:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1997 1998
- --------------------------------------------------------------------------------
<S> <C> <C>
Accrued university research funding
and outside scientific services $ 950,107 $1,022,264
Accrued payroll-related expenses 453,481 669,140
Accrued professional fees 349,988 217,900
Accrued other 701,126 843,055
---------- -----------
$2,454,702 $2,752,359
---------- -----------
---------- -----------
</TABLE>
NOTE 6: STOCKHOLDERS' EQUITY
PREFERRED STOCK
The Company is authorized to issue up to 5,000,000 shares of preferred stock,
$.01 par value, in one or more series, each of such series to have such rights
and preferences, including voting rights, dividend rights, conversion rights,
redemption privileges and liquidation preferences, as shall be determined by the
Board of Directors.
In 1997, the Company adopted a Shareholder Rights Plan (the Rights Plan)
designed to protect shareholders from unsolicited attempts to acquire the
Company on terms that do not maximize stockholder value. In connection with the
Rights Plan, the Board of Directors will designate a certain number of shares of
the Company's preferred stock as Series A Participating Preferred Stock. Under
the Rights Plan, a right to purchase one one-thousandth of one share of the
Series A Preferred Stock (the Rights) will be distributed as a dividend for each
share of common stock. The terms of the Rights Plan provide that the Rights will
become exercisable upon the earlier of the tenth day after any person or group
acquires 15% or more of the Company's outstanding common stock or the tenth
business day after any person or group commences a tender or exchange offer
which would, if completed, result in the offer or owning 15% or more of the
Company's outstanding common stock. The Rights may generally be redeemed by
action of the Board of Directors at $.001 per Right at any time prior to the
tenth day following the public announcement that any person or group has
acquired 15% or more of the outstanding common stock of the Company. The Rights
expire on January 28, 2007. The Rights have certain anti-takeover effects in
that they would cause substantial dilution to the party attempting to acquire
the Company.
In certain circumstances, the Rights allow the Company's stockholders to
purchase the number of shares of the Company's common stock having a market
value at the time of the transaction equal to twice the exercise price of the
Rights, or in certain circumstances, the stockholders would
be able to acquire that number of shares of the acquirer's common stock having a
market value, at the time of the transaction, equal to twice the exercise price
of the Rights. The Company will continue to issue Rights with future issuances
of common stock.
22
<PAGE>
WARRANTS
Prior to the initial public offering, the Company granted warrants to secure
lease financing, to raise capital, to obtain letters of credit and as a form of
compensation to various consultants. At December 31, 1998, the Company has
common stock warrants outstanding covering 51,878 shares at exercise prices
ranging from $5.66 to $13.83 per share expiring at various dates through
February 2006.
STOCK OPTIONS
The 1992 Incentive Stock Plan (the 1992 Plan) authorizes the grant of incentive
stock options and nonqualified stock options to employees and nonqualified stock
options to consultants. A total of 2,600,000 shares have been reserved for
issuance under the 1992 Plan. The exercise price of incentive stock options
granted under the 1992 Plan may not be less than 100% of the fair market value
of the common stock as of the grant date, as determined by the Board of
Directors. The exercise price of nonqualified stock options may not be less than
85% of the fair market value of the common stock as of the grant date. Options
issued under the 1992 Plan generally have a four year vesting period, unless
otherwise determined by the Board of Directors. The term of stock options
granted under the 1992 Plan may not exceed ten years. Subject to the approval of
the Board of Directors, the Plan allows option holders the right to immediately
exercise outstanding options (both vested and unvested), with the subsequent
share issuances being subject to a repurchase option by the Company under
certain conditions according to the original vesting schedule and exercise
price.
For certain options granted, the Company recognizes
as compensation expense the excess of the deemed fair value for accounting
purposes of the common stock issuable upon exercise of such options over the
aggregate exercise price of such options. In connection with these grants,
$1,074,637 and $153,040 of deferred compensation was recorded in the years ended
December 31, 1996 and 1997, respectively. No deferred compensation was incurred
during 1998. This compensation expense is being amortized over the vesting
period of each option.
In January 1997, the Board of Directors approved a program under which
directors, executive officers and certain other key employees were permitted to
exercise options to purchase 1,494,775 common shares in exchange for four-year
notes with an interest rate of 6% per annum as permitted by the 1992 Plan. The
notes are full recourse and principal and accrued interest are payable upon the
maturity of the note. Under certain conditions, the shares are subject to a
repurchase option by the Company according to the original vesting schedule. At
December 31, 1998, a total of 388,236 shares issued under the 1992 Plan are
subject to the Company's repurchase option and $1,443,133 of notes receivable
are outstanding and included in the stockholders' equity section of the
accompanying financial statements.
The 1997 Employee Stock Purchase Plan (the Purchase Plan) has 200,000
shares of common stock reserved for issuance thereunder. Under the Purchase Plan
eligible employees may purchase common shares at a price per share equal to 85%
of the lower of the fair market value of the common stock at the beginning of a
two year offering period or the end of each six month purchase period included
in such offering period. Participation in the offering period is limited to 15%
of the employee's compensation or $25,000 in any calendar year. The first
offering period commenced in January 1998 and the Purchase Plan will terminate
in 2007.
The 1997 Non-Employee Director Option Plan (the Director Plan) has 150,000
shares of common stock reserved for issuance thereunder. Effective with the 1998
annual meeting of stockholders and annually thereafter, each non-employee
director is automatically granted a nonstatutory option to purchase 5,000 shares
of common stock. The exercise price of each of these options will be equal to
the fair market value of the common stock on the date of grant. Each option
granted under the Director Plan will vest on a cumulative monthly basis over a
four-year period. The Director Plan will terminate in September 2007, unless
terminated earlier in accordance with the provisions of the Director Plan.
23
<PAGE>
NOTES TO FINANCIAL STATEMENTS(CONT'D) DECEMBER 31, 1998
The following table presents the activity of all of the stock option plans
for the years ended December 31, 1996, 1997 and 1998:
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------------------------------
1996 1997 1998
- -----------------------------------------------------------------------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Options Exercise Price Options Exercise Price Options Exercise Price
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of year 557,894 $ .94 1,712,650 $1.14 497,267 $4.42
Granted 1,275,691 1.20 313,058 6.40 394,778 9.87
Exercised (58,840) .85 (1,510,287) 1.13 (92,578) 1.26
Canceled (62,095) 1.17 (18,154) 2.01 (19,105) 4.66
---------- --------- ----------- ---------- ------- -----------
Outstanding at end of year 1,712,650 $1.14 497,267 $4.42 780,362 $7.55
---------- --------- ----------- ---------- ------- -----------
Options exercisable at end of year 537,121 $1.01 184,052 $2.74 189,439 $5.07
V
Weighted average fair value per share
of options granted during the year $ .46 $3.69 $5.84
--------- ---------- -----------
</TABLE>
The following table presents weighted average price and life information
about significant option groups outstanding at December 31, 1998:
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
- -----------------------------------------------------------------------------------------------------------------------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Range of Number Contractual Exercise Number Exercise
Exercise Prices Outstanding Life (Yrs.) Price Exercisable Price
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$0.72 6,528 4.4 $0.72 6,528 $0.72
1.20 106,938 7.0 1.20 73,614 1.20
4.06-5.69 74,488 8.5 4.68 27,312 4.59
7.64 197,230 8.8 7.64 54,625 7.64
8.13-10.88 315,573 9.8 8.67 21,482 10.63
11.00-13.13 44,000 9.4 12.71 1,066 12.95
15.00-18.00 35,605 9.3 17.13 4,812 17.32
------- ----------
780,362 189,439
------- ----------
</TABLE>
24
<PAGE>
If the compensation cost for the option plans had been determined based on
the fair value at the grant date for grants in 1996, 1997 and 1998, consistent
with the provisions of FAS 123, the pro forma net loss and net loss per share
for 1996, 1997 and 1998, would be as follows (in thousands except per share):
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1996 1997 1998
- --------------------------------------------------------------------------------
As Pro As Pro As Pro
Reported Forma Reported Forma Reported Forma
- --------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Net loss $(10,158) $(10,287) $(442) $(792) $(13,407) $(14,121)
Basic and
diluted
net loss
per share $ (1.26) $ (1.27) $(.04) $(.08) $ (1.01) $ (1.06)
</TABLE>
The fair value of options and warrants issued at the date of grant were
estimated using the Black-Scholes model with the following weighted average
assumptions:
<TABLE>
<CAPTION>
Options Granted
- --------------------------------------------------------------------------------
1996 1997 1998
- --------------------------------------------------------------------------------
<S> <C> <C> <C>
Expected life (years) 5.0 5.0 5.0
Interest rate 6.6 6.0 4.5
Volatility 30% 60% 66%
</TABLE>
The Company has never declared nor paid dividends on any of its capital
stock and does not expect to do so in the foreseeable future.
The effects on 1996, 1997 and 1998 pro forma net loss and net loss per
share of expensing the estimated fair value of stock options are not necessarily
representative of the effects on reporting the results of operations for future
years as the periods presented include only one, two and three years,
respectively, of option grants under the Company's plans.
COMMON STOCK RESERVED FOR ISSUANCE
At December 31, 1998, the Company has reserved 1,257,168 shares of common stock
for issuance upon the exercise of all outstanding warrants and options
authorized under the 1992 Plan, Purchase Plan and the Director Plan.
NOTE 7: COMMITMENTS
The Company has a ten-year lease agreement expiring in 2004 for its principal
facility. In connection with this lease, the lessor funded approximately
$4,367,000 of leasehold improvements which are reimbursed as part of the minimum
lease payments. The Company has certain options to purchase the building and the
leasehold improvements.
The Company leases the majority of its equipment, furniture and fixtures
under capital leases. Included in property and equipment at December 31, 1997
and 1998, respectively, were assets with a cost basis of $6,057,532 and
$7,253,337 acquired under capital leases. Accumulated amortization as of
December 31, 1997 and 1998, respectively, related to these assets was $3,599,571
and $4,742,226.
As of December 31, 1998, the future minimum lease payments under capital
and operating leases are as follows:
<TABLE>
<CAPTION>
Capital Building
Leases Operating Lease
- --------------------------------------------------------------------------------
<S> <C> <C>
Year ended December 31,1999 1,037,914 1,109,337
2000 864,445 1,147,974
2001 497,711 1,147,974
2002 152,711 1,147,974
2003 -- 1,147,974
Thereafter -- 860,980
---------- -----------
Total minimum lease payments 2,552,781 $6,562,213
Less interest 275,443
Present value of minimum
lease payments 2,277,338
Less capital lease obligations
due within one year 886,517
----------
Capital lease obligations--
long-term portion $1,390,821
----------
</TABLE>
25
<PAGE>
Total rent expense was $1,078,803, $1,090,332 and $1,114,389 in 1996, 1997,
and 1998, respectively.
The Company has a lease commitment totaling $1.5 million from a leasing
company for the financing of equipment and leasehold improvements. Under this
agreement, the term for financing equipment purchases and leasehold improvements
is 48 months and 36 months, respectively. The interest rate is established as of
the commencement date for each new drawdown, based on a treasury security index,
and is fixed for the term of the financing. There is a fixed percentage buy-out
provision at the end of the lease period. The lease financings are
collateralized by the equipment and leasehold improvements being financed. As of
December 31, 1998, there were $762,456 in outstanding borrowings under this
financing arrangement. There are no financial covenants in connection with this
lease financing.
NOTE 8: RESEARCH AND DEVELOPMENT AND
LICENSING AGREEMENTS
In January 1997, the Company entered into a distribution and licensing agreement
with Ethicon, Inc., a Johnson & Johnson company ("Ethicon") for the research,
development and commercialization of the Company's surgical sealant products.
Ethicon received marketing rights to all territories outside North America in
exchange for (a) a one-time, nonrefundable payment to the Company for past
research and development expenditures; (b) fixed quarterly funding for two years
to be applied toward research and development costs for lung surgery and
neurosurgery surgical sealant products; (c) funding of certain additional
research and development expenses; (d) payments upon achievement of specific
milestones; and (e) specified percentages of product sales representing a
combined royalty and product cost payment. The Company retained worldwide
manufacturing rights and North American marketing rights. The term of the
Ethicon Agreement extends until January 2007, subject to one year extensions at
Ethicon's discretion. In addition, Ethicon may terminate the agreement at any
time after January 2000 upon 12 months' prior written notice with or without
cause. The Company began shipping its surgical sealant product to Ethicon in
1998. In August 1998, the Ethicon agreement was expanded to include research and
development funding for a cardiovascular surgical sealant.
The Company has collaborative research agreements and technology licensing
agreements with certain universities. The Company has worldwide exclusive
licenses to the technologies developed under these agreements in exchange for
funding certain research and payment of licensing fees and royalties on
applicable product sales. Research and development expense and licensing fees
incurred under these agreements during the years ended December 31, 1996, 1997,
and 1998, totaled $156,000, $144,000, and $150,000, respectively. In connection
with these agreements, the Company has research funding commitments totaling
approximately $118,000 at December 31, 1998.
NOTE 9: INCOME TAXES
Due to net losses incurred by the Company in each year since its inception, no
provision for income taxes has been recorded. At December 31, 1998, the Company
had tax net operating loss carryforwards of approximately $56 million and
federal and state research and development tax credit carryforwards of
approximately $3.3 million, which expire at various times through 2018.
Significant components of the Company's deferred tax assets as of December
31 are as follows:
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
1997 1998
- --------------------------------------------------------------------------------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards$ 17,327,000 $ 22,468,000
Research and development
tax credits 2,363,000 3,290,000
Other 735,000 885,000
------------ -------------
20,425,000 26,643,000
Valuation allowance (20,425,000) (26,643,000)
------------ -------------
Net deferred tax assets $ -- $ --
------------ -------------
</TABLE>
For financial reporting purposes, a valuation allowance has been provided
since realization of such deferred tax assets is uncertain at this time. The
valuation allowance increased by $6,218,000 during 1998, due primarily to the
increase in tax credits and net operating loss carryforwards. The future
utilization of the net operating loss carryforwards may be subject to
limitations under the change in stock ownership provisions of the Internal
Revenue Code.
26
<PAGE>
NOTE 10: RELATED PARTY TRANSACTIONS
In connection with an employment agreement, interest-bearing loans aggregating
$120,000 were made to an officer of the Company. Principal and accrued interest
on this loan were paid in full by December 31, 1998. Other officer and
non-officer employee notes receivable, certain of which notes contain similar
repayment terms as those described above, are outstanding and included in notes
receivable from related parties in the accompanying financial statements.
Certain participants in the Company's preferred stock financing
transactions include venture capital funds affiliated with members of the
Company's board of directors.
NOTE 11: SUBSEQUENT EVENTS
On February 24, 1999, the Board of Directors adopted the 1999 Stock Incentive
Plan (the 1999 Plan) and reserved 875,000 shares of common stock for issuance
thereunder subject to the approval of the Company's shareholders. The exercise
price of incentive stock options may not be less than 100% of the fair market
value of the common stock on the date of grant. The exercise price of the
non-qualified options may not be less than 85% of the fair market value of the
common stock on the date of grant. Options granted under the 1999 Plan will
generally vest over a four year period and will expire no later than 10 years
from the date of grant.
27
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Focal, Inc.
We have audited the accompanying balance sheets of Focal, Inc. as of December
31, 1997 and 1998, and the related statements of operations, stockholders'
equity, and cash flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards 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. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Focal, Inc. at December 31,
1997 and 1998, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Boston, Massachusetts
January 26, 1999, except for Note 11,
as to which the date is February 24, 1999
28
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in this Annual Report (Form 10-K)
of Focal, Inc. of our report dated January 26, 1999, except for Note 11, as to
which the date is February 24, 1999, included in the 1998 Annual Report to
Stockholders of Focal, Inc.
We also consent to the incorporation by reference in the Registration Statement
(Form S-8) pertaining to the Focal, Inc. 1992 Incentive Stock Option Plan, 1997
Employee Stock Purchase Plan, and the 1997 Directors' Option Plan of our report
dated January 26, 1999, except for Note 11, as to which the date is February 24,
1999, with respect to the financial statements incorporated herein by reference.
/s/ Ernst & Young LLP
Boston, Massachusetts
March 24, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 8,516,936
<SECURITIES> 16,829,291
<RECEIVABLES> 947,291
<ALLOWANCES> 0
<INVENTORY> 937,017
<CURRENT-ASSETS> 27,482,621
<PP&E> 7,568,435
<DEPRECIATION> 4,886,037
<TOTAL-ASSETS> 30,460,829
<CURRENT-LIABILITIES> 5,294,461
<BONDS> 0
0
0
<COMMON> 133,678
<OTHER-SE> 23,641,869
<TOTAL-LIABILITY-AND-EQUITY> 30,460,829
<SALES> 0
<TOTAL-REVENUES> 8,185,443
<CGS> 0
<TOTAL-COSTS> 3,739,807
<OTHER-EXPENSES> 19,406,079
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 212,323
<INCOME-PRETAX> (13,407,346)
<INCOME-TAX> 0
<INCOME-CONTINUING> (13,407,346)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (13,407,346)
<EPS-PRIMARY> (1.01)
<EPS-DILUTED> (1.01)
</TABLE>
