EXHIBIT 99.1
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, 1999 and 2000, and the related statements of operations,
stockholders' equity (deficit) and cash flows for each of the three years in the
period ended December 31, 2000. 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 auditing standards generally
accepted in the United States. 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,
1999 and 2000, and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 2000 in conformity with
accounting principles generally accepted in the United States.
As discussed in Note 1 to the financial statements, in 2000 the Company
changed its method of accounting for revenue recognition.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As more fully described in Note 1, the
Company has incurred recurring losses and has a net capital deficiency. These
conditions raise substantial doubt about the Company's ability to continue as a
going concern. The financial statements do not include any adjustments to
reflect the possible future effects on the recoverability and classification of
assets or the amounts and classification of liabilities that may result from the
outcome of this uncertainty.
/S/ ERNST & YOUNG LLP
Boston, Massachusetts
January 31, 2001
1
FOCAL, INC.
BALANCE SHEETS
DECEMBER 31,
---------------------------
1999 2000
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents................................. $ 8,746,897 $ 3,672,672
Marketable securities..................................... 4,715,842 201,318
Accrued interest receivable............................... 76,770 10,111
Accounts receivable....................................... 52,579 395,407
Inventories, net.......................................... 1,573,934 1,982,020
Prepaid expenses and other assets......................... 428,112 408,780
------------ ------------
Total current assets........................................ 15,594,134 6,670,308
Notes receivable from related parties....................... 271,753 247,736
Property, plant & equipment................................. 8,241,952 8,378,465
Less: accumulated depreciation and amortization............. 5,370,919 6,259,839
------------ ------------
Property, plant & equipment, net............................ 2,871,034 2,118,626
Other assets................................................ 14,025 --
------------ ------------
Total assets................................................ $ 18,750,946 $ 9,036,670
============ ============
LIABILITIES & STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 729,534 $ 738,278
Accrued liabilities....................................... 2,613,875 2,201,257
Current portion of capital lease obligations.............. 926,041 688,828
Current portion of deferred revenue....................... -- 933,877
------------ ------------
Total current liabilities................................... 4,269,450 4,562,240
Capital lease obligations................................. 1,333,090 650,528
Deferred revenue.......................................... -- 4,000,000
------------ ------------
Total long term liabilities................................. 1,333,090 4,650,528
Stockholders' equity:
Preferred stock, $0.01 par value; 5,000,000 shares
authorized; none issued and outstanding................. -- --
Common stock, $.01 par value; 50,000,000 shares
authorized; 14,234,208 and 14,935,735 shares issued and
outstanding at December 31, 1999 and 2000,
respectively............................................ 142,342 149,357
Additional paid-in capital................................ 90,178,169 95,366,165
Notes receivable from related parties..................... (828,131) (447,743)
Deferred compensation..................................... (183,713) --
Accumulated other comprehensive income.................... 8,337 1,319
Accumulated deficit....................................... (76,168,598) (95,245,196)
------------ ------------
Total stockholders' equity.................................. 13,148,406 (176,098)
------------ ------------
Total liabilities and stockholders' equity.................. $ 18,750,946 $ 9,036,670
============ ============
See accompanying notes.
2
FOCAL, INC.
STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
------------------------------------------
1998 1999 2000
------------ ------------ ------------
STATEMENTS OF OPERATIONS:
Revenues:
Collaborative research revenues................... $ 5,113,953 $ 1,772,617 $ 874,375
Product revenues.................................. 3,071,490 1,422,919 1,720,568
------------ ------------ ------------
Total revenues.................................. 8,185,443 3,195,536 2,594,943
Costs and Expenses:
Cost of product revenues.......................... 3,739,807 2,373,383 2,842,023
Research and development.......................... 15,590,647 14,453,371 8,112,363
Sales, general and administrative................. 3,815,432 3,918,917 5,999,650
------------ ------------ ------------
Total costs and expenses........................ 23,145,886 20,745,671 16,954,036
Insurance recovery.................................. -- -- 475,408
Interest income and other income.................... 1,765,420 908,460 704,689
Interest expense.................................... (212,323) (199,563) (297,602)
Loss before cumulative effect of change in
accounting principle.............................. (13,407,346) (16,841,238) (13,476,598)
------------ ------------ ------------
Cumulative effect of change in accounting
principle......................................... -- -- (5,600,000)
------------ ------------ ------------
Net loss............................................ $(13,407,346) $(16,841,238) $(19,076,598)
============ ============ ============
AMOUNTS PER COMMON SHARE:
Loss before cumulative effect of change in
accounting principle.............................. $ (1.01) $ (1.24) $ (0.92)
Cumulative effect of change in accounting principle
regarding revenue recognition..................... -- -- (0.38)
------------ ------------ ------------
Net loss per share, basic and diluted............... $ (1.01) $ (1.24) $ (1.30)
============ ============ ============
Weighted average shares, basic and diluted.......... 13,291,182 13,551,856 14,707,345
============ ============ ============
PRO FORMA AMOUNTS ASSUMING THE CHANGE IN ACCOUNTING
PRINCIPLE IS APPLIED RETROACTIVELY:
Net loss............................................ $(13,626,013) $(13,355,904) $(13,476,598)
Net loss per share, basic and diluted............... $ (1.03) $ (0.99) $ (0.92)
See accompanying notes
3
FOCAL, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
NOTES
CONVERTIBLE RECEIVABLE
PREFERRED STOCK COMMON STOCK ADDITIONAL FROM
------------------- --------------------- PAID-IN ACCUMULATED RELATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT PARTIES
-------- -------- ---------- -------- ----------- ------------ -----------
Balances at December 31, 1997.... -- -- 12,868,570 $128,686 $80,777,780 $(45,920,014) $(1,688,057)
Net proceeds from over-allotment
option......................... -- -- 375,000 3,750 3,545,750 -- --
Exercise of stock options and
warrants....................... -- -- 92,578 926 118,539 -- --
Adjustment for repurchase and
retirement of stock............ -- -- (24,884) (249) (29,675) -- 29,923
Principle loan repayments........ -- -- -- -- -- -- 215,001
Shares issued under employee
stock purchase plan............ -- -- 56,503 565 472,392 -- --
Amortization of deferred
compensation................... -- -- -- -- -- -- --
Comprehensive income:
Unrealized gain on marketable
securities................. -- -- -- -- -- -- --
Net loss..................... -- -- -- -- -- (13,407,346) --
Total comprehensive income... -- -- -- -- -- -- --
--- ---- ---------- -------- ----------- ------------ -----------
Balances at December 31, 1998.... -- $ -- 13,367,767 $133,678 $84,884,786 $(59,327,360) $(1,443,133)
--- ---- ---------- -------- ----------- ------------ -----------
Net proceeds from equity
financing...................... -- -- 810,372 8,104 4,934,566 -- --
Exercise of stock options and
warrants....................... -- -- 68,586 685 188,828 -- --
Adjustment for repurchase and
retirement of stock............ -- -- (54,515) (545) (65,009) -- 65,554
Principle loan repayments........ -- -- -- -- -- -- 549,448
Shares issued under employee
stock purchase plan............ -- -- 41,998 420 198,748 -- --
Deferred compensation............ -- -- -- -- 36,250 -- --
Amortization of deferred
compensation................... -- -- -- -- -- -- --
Comprehensive income:
Unrealized gain on marketable
securities................. -- -- -- -- -- -- --
Net loss..................... -- -- -- -- -- (16,841,238) --
Total comprehensive income...
Balances at December 31, 1999.... -- $ -- 14,234,208 $142,342 $90,178,169 $(76,168,598) $ (828,131)
--- ---- ---------- -------- ----------- ------------ -----------
Net proceeds from equity
financing...................... -- -- 614,250 6,142 4,993,853 -- --
Exercise of stock options and
warrants....................... -- -- 39,276 393 111,904 -- --
Adjustment for repurchase and
retirement of stock............ -- -- (3,526) (35) (4,205) -- --
Principle loan repayments........ -- -- -- -- -- -- 380,388
Shares issued under employee
stock purchase plan............ -- -- 51,527 515 86,444 -- --
Deferred compensation............ -- -- -- -- -- -- --
Amortization of deferred
compensation................... -- -- -- -- -- -- --
Comprehensive income:............ -- -- -- -- -- -- --
Unrealized gain on marketable
securities................. -- -- -- -- -- -- --
Net loss..................... -- -- -- -- -- (19,076,598) --
Total comprehensive income... -- -- -- -- -- -- --
--- ---- ---------- -------- ----------- ------------ -----------
Balances at December 31, 2000.... -- $ -- 14,935,735 $149,357 $95,366,165 $(95,245,196) $ (447,743)
=== ==== ========== ======== =========== ============ ===========
ACCUMULATED
OTHER TOTAL
DEFERRED COMPREHENSIVE STOCKHOLDERS'
COMPENSATION INCOME EQUITY
------------- -------------- -------------
Balances at December 31, 1997.... $(768,865) $(17,358) $ 32,512,172
Net proceeds from over-allotment
option......................... -- -- 3,549,500
Exercise of stock options and
warrants....................... -- -- 119,464
Adjustment for repurchase and
retirement of stock............ -- -- --
Principle loan repayments........ -- -- 215,001
Shares issued under employee
stock purchase plan............ -- -- 472,957
Amortization of deferred
compensation................... 304,659 -- 304,659
Comprehensive income:
Unrealized gain on marketable
securities................. -- 9,140 9,140
Net loss..................... -- -- (13,407,346)
Total comprehensive income... -- -- (13,398,206)
--------- -------- ------------
Balances at December 31, 1998.... $(464,206) $ (8,218) $ 23,775,547
--------- -------- ------------
Net proceeds from equity
financing...................... -- -- 4,942,670
Exercise of stock options and
warrants....................... -- -- 189,513
Adjustment for repurchase and
retirement of stock............ -- -- --
Principle loan repayments........ -- -- 549,448
Shares issued under employee
stock purchase plan............ -- -- 199,168
Deferred compensation............ (36,250) -- --
Amortization of deferred
compensation................... 316,743 -- 316,743
Comprehensive income:
Unrealized gain on marketable
securities................. -- 16,555 16,555
Net loss..................... -- -- (16,841,238)
Total comprehensive income... (16,824,683)
------------
Balances at December 31, 1999.... $(183,713) $ 8,337 $ 13,148,406
--------- -------- ------------
Net proceeds from equity
financing...................... -- -- 4,999,995
Exercise of stock options and
warrants....................... -- -- 112,297
Adjustment for repurchase and
retirement of stock............ -- -- (4,240)
Principle loan repayments........ -- -- 380,388
Shares issued under employee
stock purchase plan............ -- -- 86,959
Deferred compensation............ -- -- --
Amortization of deferred
compensation................... 183,713 -- 183,713
Comprehensive income:............ -- -- --
Unrealized gain on marketable
securities................. -- (7,018) (7,018)
Net loss..................... -- -- (19,076,598)
Total comprehensive income... -- -- (19,083,616)
--------- -------- ------------
Balances at December 31, 2000.... $ -- $ 1,319 $ (176,098)
========= ======== ============
See accompanying notes.
4
FOCAL, INC.
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
------------------------------------------
1998 1999 2000
------------ ------------ ------------
OPERATING ACTIVITIES
Net loss.................................................... $(13,407,346) $(16,841,238) $(19,076,598)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization............................. 1,158,452 954,490 1,050,771
Amortization of deferred compensation..................... 304,659 316,743 183,713
Cumulative effect of change in accounting principle....... 4,800,000
Write-down of notes receivable............................ 160,414
Interest income accrued on notes receivable from related
parties................................................. (103,280) (64,111) --
(Gain)/loss on disposal of equipment, furniture and
fixtures................................................ -- 828 (43,251)
Increase (decrease) in operating assets and liabilities:
Accounts receivable, accrued interest receivable and prepaid
expenses and other assets................................. 1,430,927 577,805 (256,837)
Inventories............................................. (370,028) (636,917) (408,086)
Accounts payable, accrued liabilities................... (373,863) (1,064,535) (403,874)
Deferred revenue........................................ 133,877
Other assets............................................ (672) (657) 14,025
Notes receivable from related parties................... 164,318 74,800 24,018
------------ ------------ ------------
Net cash used in operating activities....................... (11,093,553) (16,618,681) (13,821,828)
------------ ------------ ------------
INVESTING ACTIVITIES
Sale and maturity of marketable securities.................. 17,370,386 19,904,941 5,224,995
Purchase of marketable securities........................... (27,762,163) (7,774,937) (710,471)
Purchase of property and equipment.......................... (1,130,337) (1,143,954) (262,129)
------------ ------------ ------------
Net cash provided by (used in) investing activities......... (11,522,114) 10,986,050 4,252,395
------------ ------------ ------------
FINANCING ACTIVITIES
Proceeds from equity financings, net of issuance costs...... 3,549,500 4,942,670 4,999,995
Proceeds from exercise of stock options..................... 119,464 189,512 108,057
Proceeds from issuance of common stock under the employee
stock purchase plan....................................... 472,957 199,168 86,959
Principal payments on notes receivable...................... 215,001 549,449 219,972
Proceeds from lease financing............................... 1,077,336 1,066,426 31,085
Principal payments on capital lease obligations............. (1,112,432) (1,084,633) (950,860)
------------ ------------ ------------
Net cash provided by financing activities................... 4,321,826 5,862,592 4,495,208
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents........ (18,293,841) 229,961 (5,074,225)
Cash and cash equivalents at beginning of year.............. 26,810,777 8,516,936 8,746,897
------------ ------------ ------------
Cash and cash equivalents at end of year.................... $ 8,516,936 $ 8,746,897 $ 3,672,672
============ ============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid........................................... $ 212,323 $ 199,563 $ 297,602
See accompanying notes.
5
FOCAL, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BUSINESS
Focal, Inc. (the "Company") develops, manufactures and commercializes
synthetic, absorbable 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, neurological, cardiovascular and gastrointestinal surgery.
LIQUIDITY AND MANAGEMENT'S PLANS
The Company has incurred recurring losses and has a net capital deficiency
at December 31, 2000. These conditions raise substantial doubt about the
Company's ability to continue as a going concern.
Focal will require substantial additional capital resources to fund
continuing operations through the end of 2001 and beyond. The Company believes
there may be a number of alternatives available to meet the continuing capital
requirements of its operations, such as collaborative agreements and public or
private financings. There can be no assurance that any of these alternatives
will be available on terms acceptable to the Company, or at all. If adequate
funds are not available, the Company will be required to significantly curtail
its operations and may have to sell or license out significant portions of the
Company's technology or potential products or discontinue operations.
The 2000 financial statements do not include any adjustments to reflect the
possible future effects on the recoverability and classification of assets or
the amounts and classification of liabilities that may result from the outcome
of this uncertainty.
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 cash accounts and 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 has classified all cash equivalents and
marketable securities as available-for-sale securities, which are carried at
fair value, with unrealized gains and losses reported as a separate component of
stockholders' equity.
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, substantially all collaborative research revenues and
substantially all accounts receivable are derived from two customers.
6
FOCAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
Carrying amounts of financial instruments held by the Company, which include
cash, cash equivalents, marketable securities, 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) or market
using estimated standard costs.
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 over the
contract life. Revenue from non-refundable, up-front, license and milestone
payments not specifically tied to a separate earnings process, are recognized
ratably over the term of the research contract. When payments are specifically
tied to a separate earnings process and when considered appropriate, revenue is
recognized when earned. In addition, when appropriate, the Company recognizes
revenue from certain research payments based on the level of research services
performed during the contract or over the term of the agreement. 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 only when the contract is signed, the
product has been shipped and all obligations have been delivered to the
customer, the fee is fixed and determinable, and collection is probable (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" and
related interpretations. The Company has adopted the disclosure provisions only
of Statement of Financial Accounting Standards No. 123, "ACCOUNTING FOR
STOCK-BASED COMPENSATION" (FAS 123).
7
FOCAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 reverse. Deferred tax assets
are 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 all periods presented.
RECLASSIFICATIONS
Certain reclassifications have been made in the accompanying financial
statements in order to conform to the 2000 presentation.
IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In 1998, the Financial Accounting Standards Board issued Statement No. 133,
"ACCOUNTING FOR DERIVATIVE INVESTMENTS AND HEDGING ACTIVITIES", which was
amended by FAS 137 and FAS 138, which requires the adoption of FAS 133 by Focal
in the first quarter of 2001. Focal does not expect the implementation of this
statement to have a significant impact on its results of operations or financial
position.
Effective in the fourth quarter of 2000, Focal changed its method of
accounting for revenue recognition in accordance with Staff Accounting Bulletin
(SAB) No. 101, "REVENUE RECOGNITION IN FINANCIAL STATEMENTS." Previously, Focal
had recognized revenue relating to non-refundable, up-front, license and
milestone payments and certain research funding payments from its strategic
partners in accordance with the contract. Under the new accounting method
adopted retroactively to January 1, 2000, Focal now recognizes revenue from
non-refundable, up-front, license and milestone payments not specifically tied
to a separate earnings process, ratably over the term of the research contract
or the distribution arrangement. When payments are specifically tied to a
separate earnings process and when considered appropriate, revenue is recognized
when earned. In addition, when appropriate, Focal recognized revenue from
certain research payments based upon the level of research services performed
during the research contract or over the term of the agreement. The cumulative
effect of the change in accounting principle resulted in a charge to income of
$5.6 million, which is included in the loss for the year ended December 31,
2000. The pro forma amounts presented in the consolidated statements of
operations were calculated assuming the accounting change was made retroactively
to the prior periods presented. Included in revenue for the year ended
December 31, 2000 is $800,000 of revenue relating to the adoption of SAB 101.
The amount of revenue to be recognized in future years that is included in the
cumulative effect of the change in accounting principle is $800,000 for each of
8
FOCAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
the next six years. After giving effect to the implementation of SAB 101, Focal
had a net loss of $19,076,598 or $1.30 per share for the year 2000.
2. MARKETABLE SECURITIES
Available-for-sale marketable securities consisted of the following:
DECEMBER 31, 1999
-------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ----------
Corporate notes due within one year.............. $4,707,503 $8,339 -- $4,715,842
---------- ------ ------ ----------
Total debt securities included in marketable
securities..................................... $4,707,503 $8,339 -- $4,715,842
========== ====== ====== ==========
DECEMBER 31, 2000
-------------------------------------------------
GROSS GROSS
UNREALIZED UNREALIZED ESTIMATED
COST GAINS LOSSES FAIR VALUE
---------- ---------- ---------- ----------
Corporate notes (maturing in 2025)............... $ 199,999 $1,319 -- $ 201,318
---------- ------ ------ ----------
Total debt securities included in marketable
securities..................................... $ 199,999 $1,319 -- $ 201,318
========== ====== ====== ==========
Amortized cost basis was used in computing the cost of marketable securities
sold.
3. INVENTORIES
Inventories consist of the following at December 31:
1999 2000
---------- ----------
Purchased parts and subassemblies.................... $ 146,906 $1,443,572
Work in process...................................... 1,265,623 321,006
Finished goods....................................... 161,405 217,442
---------- ----------
$1,573,934 $1,982,020
========== ==========
9
FOCAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
4. PROPERTY AND EQUIPMENT
Property and equipment consist of the following at December 31:
1999 2000
---------- ----------
Leasehold improvements............................... $1,187,801 $1,216,569
Laboratory equipment................................. 5,530,008 5,511,712
Office equipment, computers and software............. 897,351 1,009,382
Furniture and fixtures............................... 626,793 640,803
---------- ----------
$8,241,953 $8,378,465
Less accumulated depreciation and amortization....... 5,370,919 6,259,839
---------- ----------
$2,871,034 $2,118,626
========== ==========
5. ACCRUED LIABILITIES
Accrued liabilities consist of the following at December 31:
1999 2000
---------- ----------
Accrued university research funding and outside
services........................................... $ 687,167 $ 6,883
Accrued payroll and related expenses................. 620,145 460,358
Accrued professional fees............................ 250,492 347,140
Accrued other........................................ 1,056,071 1,386,876
---------- ----------
$2,613,875 $2,201,257
========== ==========
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 Board of Directors of the Company adopted a Preferred Shares
Rights Agreement (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
10
FOCAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
6. STOCKHOLDERS' EQUITY (CONTINUED)
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 October 1999, the Board of Directors approved an amendment to
the Rights Plan, which provides that certain purchases of voting stock by
Genzyme Biosurgery Corporation will not trigger the exercisability of the Rights
under the Rights Plan.
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.
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, 2000, the Company has
common stock warrants outstanding covering 43,782 shares at exercise prices
ranging from $5.66 to $12.03 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.
In May 1999, the Company adopted the 1999 Stock Incentive Plan (the "1999
Plan"). A total of 875,000 shares have been reserved for issuance under the 1999
Plan. The 1999 Plan authorizes the grant of incentive and nonqualified stock
options to officers, directors, consultants and advisors of the Company. The
Board establishes the exercise price at the time an option is granted and
specifies such price in the applicable option agreement. Options issued under
the 1999 Plan generally have a four-year vesting period, unless otherwise
determined by the Board of Directors. The term of stock options granted under
the 1999 Plan may not exceed ten years.
In February 2000, the Board of Directors approved an increase in the number
of shares reserved for issuance under the 1999 Plan from 875,000 shares to
1,525,000 shares. The increase was approved by the Company's shareholders at the
May 2000 annual meeting.
11
FOCAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
6. STOCKHOLDERS' EQUITY (CONTINUED)
For certain options granted under the 1992 Plan, the Company recognizes as
compensation expense the excess of the deemed 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, $316,743 and
$183,713 of deferred compensation amortization was recorded in the year ended
December 31, 1999 and 2000, respectively. There was no compensation expense to
be amortized in future periods as of December 31, 2000.
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. In October 2000, the Board of Directors approved an
extension to the maturity of the notes in the program for an additional 12
months or forgiveness due to change in control. Under certain conditions, the
shares are subject to a repurchase option by the Company according to the
original vesting schedule. At December 31, 2000, a total of 54,572 shares issued
under the 1992 Plan were subject to the Company's repurchase option and $447,745
of notes receivable were 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 nonemployee
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.
12
FOCAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
6. STOCKHOLDERS' EQUITY (CONTINUED)
The following table presents the activity of all of the Company's stock
plans for the years ended December 31, 1998, 1999 and 2000:
1998 1999 2000
------------------------- -------------------------- --------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE
-------- -------------- --------- -------------- --------- --------------
Outstanding at beginning of
year....................... 497,267 $4.42 780,362 $7.55 1,723,274 $5.53
Granted...................... 394,778 9.87 1,171,392 4.40 1,017,816 2.83
Exercised.................... (92,578) 1.26 (53,675) 1.66 (39,264) 2.62
Canceled..................... (19,105) 4.66 (174,805) 8.18 (423,938) 5.93
------- ----- --------- ----- --------- -----
Outstanding at end of year... 780,362 $7.55 1,723,274 $5.53 2,277,888 $4.30
======= ===== ========= ===== ========= =====
Options exercisable at end of
year....................... 189,439 $5.07 310,721 $6.27 912,622 $5.07
======= ===== ========= ===== ========= =====
Weighted average fair value
per share of options
granted during the year.... $5.84 $2.55 $2.47
===== ===== =====
The following table presents weighted average price and life information
about significant option groups outstanding at December 31, 2000:
OPTIONS OUTSTANDING
------------------------------------ OPTIONS EXERCISABLE
WEIGHTED ----------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
NUMBER CONTRACTUAL EXERCISE NUMBER EXERCISE
RANGE OF EXERCISE PRICES OUTSTANDING LIFE (YRS.) PRICE EXERCISABLE PRICE
- ------------------------ ----------- ----------- -------- ----------- --------
$0.0000 - $1.7500......... 54,560 5.91 $1.19 47,469 $1.17
$2.5000 - $2.5000......... 846,500 9.71 $2.50 161,965 $2.50
$2.5940 - $4.0625......... 307,154 8.55 $3.81 148,275 $3.87
$4.3750 - $4.3750......... 660,000 8.97 $4.38 291,874 $4.38
$4.6875 - $18.0000........ 409,674 7.77 $8.67 263,039 $8.80
--------- -------
2,277,888 912,622
========= =======
FAS 123 DISCLOSURES
If the compensation cost for the option plans had been determined based on
the fair value at the grant date for grants in 1998, 1999 and 2000, consistent
with the provisions of FAS 123, the pro forma
13
FOCAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
6. STOCKHOLDERS' EQUITY (CONTINUED)
net loss and net loss per share for 1998, 1999 and 2000, would be as follows (in
thousands except per share amounts):
1998 1999 2000
----------------------- ----------------------- -----------------------
AS REPORTED PRO FORMA AS REPORTED PRO FORMA AS REPORTED PRO FORMA
----------- --------- ----------- --------- ----------- ---------
Net loss........................ $(13,407) $(14,121) $(16,841) $(17,914) $(19,077) $(20,568)
Basic and diluted net loss per
share......................... $ (1.01) $ (1.06) $ (1.24) $ (1.32) $ (1.30) $ (1.40)
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:
OPTIONS GRANTED
------------------------------
1998 1999 2000
-------- -------- --------
Expected life (years)...................................... 5.0 5.0 5.0
Interest rate.............................................. 4.5 6.4 6.5
Volatility................................................. 66% 60% 130%
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 1998, 1999 and 2000 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 two, three and four years,
respectively, of option grants under the Company's plans.
COMMON STOCK RESERVED FOR ISSUANCE
At December 31, 2000, the Company has reserved 2,321,670 shares of common
stock for issuance upon the exercise of all outstanding warrants and options
authorized under the Company's various stock plans.
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, 1999
and 2000, respectively, were assets with a cost basis of $7,994,045 and
$8,111,464 acquired under capital leases. Accumulated amortization as of
December 31, 1999 and 2000, respectively, related to these assets was $5,229,830
and $5,400,476. Amortization of assets under capital leases are included with
depreciation and amortization in the accompanying financial statements.
14
FOCAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
7. COMMITMENTS (CONTINUED)
As of December 31, 2000, the Company's minimum lease payments under capital
and operating leases are as follows:
BUILDING
CAPITAL OPERATING
LEASES LEASE
---------- ----------
2001................................................. $ 762,782 $1,147,974
2002................................................. 500,780 1,147,974
2003................................................. 204,580 1,147,974
2004................................................. 8,317 860,980
Thereafter........................................... -- --
---------- ----------
Total minimum lease payments......................... 1,476,459 $4,304,902
==========
Less interest........................................ 137,103
----------
Present value of minimum lease payments.............. 1,339,356
Less capital lease obligations due within one year... 688,828
----------
Capital lease obligations--long-term portion......... $ 650,528
==========
Total rent expense was $1,114,389, $1,126,917 and $1,046,811 in 1998, 1999,
and 2000, 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, 2000, there were $1,339,000 in outstanding borrowings under this
financing arrangement. There are no financial covenants in connection with this
lease financing.
In September 2000, the Company entered into a sublease agreement with
TruExchange, Inc. to sublease 8,000 square feet of space for $24,027 per month.
In October 2000, the Company entered into a sublease agreement with Lexigen
Pharmaceuticals Corp. to sublease 3,360 square feet of space for $9,800 per
month.
8. RESEARCH AND DEVELOPMENT, LICENSING AND MARKETING AND DISTRIBUTION
AGREEMENTS
In October 1999, the Company entered into a Marketing and Distribution
Agreement with Genzyme Biosurgery (formerly Genzyme Surgical Products), a
division of Genzyme Corporation. Genzyme Biosurgery was granted exclusive
marketing and distribution rights to Focal's surgical sealant products for lung
surgery, cardiovascular surgery and gastrointestinal surgery in North America.
The Company retained manufacturing rights to these products. Under the terms of
the agreement, the Company will be reimbursed for its cost of manufacturing
product plus 50% of the gross margin generated from Genzyme Biosurgery's sales
of the Company's sealant products to customers. The term of the agreement is for
ten years, with two five-year renewal options which are automatic if Genzyme
15
FOCAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
8. RESEARCH AND DEVELOPMENT, LICENSING AND MARKETING AND DISTRIBUTION
AGREEMENTS (CONTINUED)
Biosurgery meets certain minimum performance standards. In addition to the
Marketing and Distribution Agreement, in October 1999 Focal and Genzyme
Biosurgery also entered into a Stock Purchase Agreement, with up to
$20.0 million in purchases of the Company's common stock committed by Genzyme
Biosurgery over a twenty month period, subject to certain specified conditions.
The first $5.0 million purchase was made by Genzyme Biosurgery in November 1999,
with Genzyme Biosurgery purchasing approximately 810,000 shares at a 25% premium
to the ten day average trading price of the Company's common stock prior to the
investment. The second $5.0 million purchase was made by Genzyme Biosurgery in
April 2000, with Genzyme Biosurgery purchasing approximately 614,000 shares at
the twenty day average trading price of the Company's common stock prior to the
investment. The third $5.0 million investment was made by Genzyme Biosurgery in
January 2001, with Genzyme Biosurgery purchasing approximately 2.4 million
shares at the twenty day average trading price of the Company's common stock
prior to the investment. At Focal's option, one additional $5.0 million
investment will be made by Genzyme Biosurgery. The final investment of
$5.0 million may be called by Focal in the second quarter of 2001, subject to
the satisfaction of closing conditions. The final investment will be priced
based upon the twenty day trading average of the Company's stock.
In January 1997, the Company entered into a distribution and licensing
agreement with the Ethicon, Inc. division of Johnson & Johnson ("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 future research and development
costs; (c) funding of certain additional research and development expenses;
(d) payments upon achievement of specific milestones; and (e) specified
percentages of product sales, if any, 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 upon 12 months' prior
written notice with or without cause. In August 1998, the Ethicon Agreement was
expanded to include research and development funding for a cardiovascular
sealant which Ethicon subsequently elected not to fund.
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, 1998, 1999,
and 2000, totaled $150,000, $134,000 and $355,000, respectively. In connection
with these agreements, the Company has no research funding commitments at
December 31, 2000.
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, 2000, the
Company had federal and state tax net operating loss carryforwards of
approximately $86.1 and $51.0 million, respectively, and federal and
16
FOCAL, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
DECEMBER 31, 2000
9. INCOME TAXES (CONTINUED)
state research and development tax credit carryforwards of approximately $4.4
million which expire at various times through 2020.
Significant components of the Company's deferred tax assets as of
December 31 are as follows:
1999 2000
------------ ------------
Deferred tax assets:
Net operating losses........................... $ 27,418,000 $ 32,341,000
Research and development tax credits........... 4,067,000 4,390,000
Other.......................................... 709,000 2,652,000
------------ ------------
32,194,000 39,383,000
Valuation allowance............................ (32,194,000) (39,383,000)
------------ ------------
Net deferred tax assets.......................... $ -- $ --
============ ============
For financial reporting purposes, a valuation allowance has been provided
since realization of such deferred tax assets is uncertain. The valuation
allowance increased by $7,189,000 during 2000, 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.
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 during 1998. Other officer and
nonofficer 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.
11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
The quarterly information for the first three quarters of 2000 reflect the
quarters as previously reported prior to the adoption of SAB 101. In 2000, the
"as restated" quarterly amounts represent the quarterly information restated for
the retroactive adoption of SAB 101 to January 1, 2000, as noted in the column
headings. Focal increased the inventory reserve due to high levels of
inventory--resulting in a charge to cost of product revenues of $737,000 in the
fourth quarter of 2000. The 1999 quarterly information is as previously
reported.
17
FOCAL, INC.
STATEMENT OF OPERATIONS
FOURTH QUARTER
ENDED
FIRST QUARTER ENDED SECOND QUARTER ENDED THIRD QUARTER ENDED DECEMBER 31,
MARCH 31, 2000 JUNE 30, 2000 SEPTEMBER 30, 2000 2000
---------------------------- ---------------------------- ---------------------------- --------------
AS PREVIOUSLY AS AS PREVIOUSLY AS AS PREVIOUSLY AS AS
REPORTED RESTATED REPORTED RESTATED REPORTED RESTATED REPORTED
------------- ------------ ------------- ------------ ------------- ------------ --------------
STATEMENT OF
OPERATIONS:
REVENUES:
Collaborative
Revenues.......... -- 200,000 17,212 217,212 33,083 233,083 224,080
Product Revenues.... 237,366 237,366 397,072 397,072 486,872 486,872 598,258
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total Revenues.... 237,366 437,366 414,284 614,284 519,955 719,955 822,338
------------ ------------ ------------ ------------ ------------ ------------ ------------
Total costs and
expenses........ 4,486,111 4,486,111 3,805,955 3,805,955 3,684,951 3,684,951 4,977,019
Total other
(income)
expense......... (606,906) (606,906) (129,379) (129,379) (112,394) (112,394) (33,816)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Net loss before
cumulative effect of
change in accounting
principle........... (3,641,839) (3,441,839) (3,262,292) (3,062,292) (3,052,602) (2,852,602) (4,119,865)
------------ ------------ ------------ ------------ ------------ ------------ ------------
Cumulative effect of
change in accounting
principle........... -- (5,600,000) -- -- -- -- --
------------ ------------ ------------ ------------ ------------ ------------ ------------
Net Loss.............. (3,641,839) $ (9,041,839) $ (3,262,292) $ (3,062,292) $ (3,052,602) $ (2,852,602) $ (4,119,865)
============ ============ ============ ============ ============ ============ ============
Basic and diluted per
share............... $ (0.26) $ (0.64) $ (0.22) $ (0.21) $ (0.20) $ (0.19) $ (0.28)
Weighted average
shares, basic and
diluted............. 14,235,994 14,235,994 14,777,506 14,777,506 14,900,436 14,900,436 14,707,345
FIRST QUARTER SECOND QUARTER THIRD QUARTER FOURTH QUARTER
ENDED ENDED ENDED ENDED
MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31,
1999 1999 1999 1999
------------- -------------- -------------- --------------
STATEMENT OF
OPERATIONS:
REVENUES:
Collaborative
Revenues.......... 608,160 94,238 18,236 1,051,983
Product Revenues.... 717,832 679,268 12,986 12,833
------------ ------------ ------------ ------------
Total Revenues.... 1,325,992 773,506 31,222 1,064,816
------------ ------------ ------------ ------------
Total costs and
expenses........ 5,659,696 5,968,223 4,536,854 4,580,898
Total other
(income)
expense......... (250,970) (195,162) (138,859) (123,906)
------------ ------------ ------------ ------------
Net loss before
cumulative effect of
change in accounting
principle........... (4,082,734) (4,999,555) (4,366,773) (3,392,176)
------------ ------------ ------------ ------------
Cumulative effect of
change in accounting
principle........... -- -- -- --
------------ ------------ ------------ ------------
Net Loss.............. $ (4,082,734) $ (4,999,555) $ (4,366,773) $ (3,392,176)
============ ============ ============ ============
Basic and diluted per
share............... $ (0.30) $ (0.37) $ (0.32) $ (0.24)
Weighted average
shares, basic and
diluted............. 13,391,484 13,407,029 13,441,931 13,961,920
18