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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

Mark One

     
[X]   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003

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: 000-31255

ISTA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)
     
DELAWARE
(State or other jurisdiction of
incorporation or organization)
  33-0511729
(IRS Employer
Identification No.)

15279 ALTON PARKWAY #100, IRVINE, CA 92618
(Address of principal executive offices)
(949) 788-6000
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(D) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [X] Yes    [  ] No

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2) [  ] Yes    [X] No

     The number of shares of the registrant’s common stock, $.001 par value, outstanding as of May 1, 2003 was 13,291,017.


Table of Contents

TABLE OF CONTENTS

PART I FINANCIAL INFORMATION
Item 1 Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets
Condensed Consolidated Statements of Operations
Condensed Consolidated Statements of Cash Flows
Notes to Unaudited Condensed Consolidated Financial Statements
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3 Quantitative and Qualitative Disclosures about Market Risk
Item 4 Controls and Procedures
PART II OTHER INFORMATION
Item 1 Legal Proceedings
Item 6 Exhibits and Reports on Form 8-K
Signatures
INDEX TO EXHIBITS
EXHIBIT 10.1
EXHIBIT 99.1
EXHIBIT 99.2


Table of Contents

         
        Page
        No
       
PART I   FINANCIAL INFORMATION    
Item 1   Condensed Consolidated Financial Statements   3
   
Condensed Consolidated Balance Sheets — March 31, 2003 (unaudited) and December 31, 2002
  3
   
Condensed Consolidated Statements of Operations (unaudited) — Three Month Periods Ended March 31, 2003 and 2002 and for the Period from February 13, 1992 (inception) through March 31, 2003
  4
   
Condensed Consolidated Statements of Cash Flows (unaudited) — Three Month Periods Ended March 31, 2003 and 2002 and for the Period from February 13, 1992 (inception) through March 31, 2003
  5
    Notes to Unaudited Condensed Consolidated Financial Statements   6
Item 2  
Management’s Discussion and Analysis of Financial Condition and Results of Operations
  10
Item 3   Quantitative and Qualitative Disclosure about Market Risk   20
Item 4   Controls and Procedures   21
PART II   OTHER INFORMATION    
Item 1   Legal Proceedings   21
Item 6   Exhibits and Reports on Form 8-K   21
    Signatures   22
    Index to Exhibits   25

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PART I FINANCIAL INFORMATION

Item 1 Condensed Consolidated Financial Statements

ISTA Pharmaceuticals, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share data)

                         
            March 31,   December 31,
            2003   2002
           
 
            (Unaudited)        
ASSETS
Current assets:
               
 
Cash and cash equivalents
  $ 25,205     $ 32,257  
 
Short-term investments
    4,967       3,455  
 
Other current assets
    606       509  
 
 
   
     
 
     
Total current assets
    30,778       36,221  
Property and equipment, net
    830       879  
Deposits and other assets
    35       35  
 
 
   
     
 
     
Total Assets
  $ 31,643     $ 37,135  
 
 
   
     
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
               
 
Accounts payable
  $ 1,233     $ 910  
 
Accrued compensation and related expenses
    145       687  
 
Accrued expenses — clinical trials
    814       721  
 
Other accrued expenses
    572       857  
 
 
   
     
 
     
Total current liabilities
    2,764       3,175  
Deferred rent
    10       10  
Deferred income
    4,653       4,722  
Stockholders’ equity:
               
 
Common stock, $.001 par value; 100,000,000 shares authorized at March 31, 2003 and December 31, 2002; 13,291,017 and 13,288,120 shares issued and outstanding at March 31, 2003 and December 31, 2002, respectively
    13       13  
 
Additional paid in capital
    153,014       153,022  
 
Deferred compensation
    (1,084 )     (1,390 )
 
Accumulated other comprehensive income
    (22 )     (23 )
 
Deficit accumulated during the development stage
    (127,705 )     (122,394 )
 
 
   
     
 
   
Total stockholders’ equity
    24,216       29,228  
 
 
   
     
 
   
Total Liabilities and Stockholders’ Equity
  $ 31,643     $ 37,135  
 
 
   
     
 

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ISTA Pharmaceuticals, Inc.
Condensed Consolidated Statements of Operations
(In thousands, except per share amounts)
(Unaudited)

                           
                      For the Period
                      From
                      February 13,
                      1992
      Three Months Ended   (Inception)
      March 31,   Through
     
  March 31,
      2003   2002   2003
     
 
 
Revenue
  $ 69     $ 70     $ 347  
Operating expenses:
                       
 
Research and development
    3,426       2,922       76,889  
 
Selling, general and administrative
    2,064       1,918       33,817  
 
   
     
     
 
Total operating expenses
    5,490       4,840       110,706  
 
   
     
     
 
Loss from operations
    (5,421 )     (4,770 )     (110,359 )
Interest income
    115       87       2,742  
Interest expense
    (5 )           (798 )
 
   
     
     
 
Net loss
    (5,311 )     (4,683 )     (108,415 )
Deemed dividend for preferred stockholders
                (19,245 )
 
   
     
     
 
Net loss attributable to common stockholders
  $ (5,311 )   $ (4,683 )   $ (127,660 )
 
   
     
     
 
Net loss per common share, basic and diluted
  $ (0.40 )   $ (2.82 )        
 
   
     
         
Shares used in computing net loss per common share, basic and diluted
    13,290       1,662          

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ISTA Pharmaceuticals, Inc.
Condensed Consolidated Statements of Cash Flows

(In thousands, unaudited)

                                 
                            For the Period
                            From
                            February 13,
            Three Months Ended   1992 (Inception)
            March 31,   Through
           
  March 31,
            2003   2002   2002
           
 
 
Operating Activities
                       
Net loss attributable to common stockholders
  $ (5,311 )   $ (4,683 )   $ (127,660 )
Deemed dividend for preferred stockholders
                19,245  
Adjustments to reconcile net loss attributable to common stockholders to net cash
                       
 
used in operating activities:
                       
     
Amortization of deferred compensation
    306       728       8,878  
     
Amortization of fair value of warrant discount and related accrued interest
    (16 )           451  
     
Common stock issued for services
                310  
     
Forgiveness of note receivable
                162  
     
Depreciation and amortization
    88       83       1,753  
     
Deferred rent
          3       10  
     
Deferred income
    (69 )     (70 )     4,653  
Changes in operating assets and liabilities:
                       
   
Advanced payments — clinical trials and other current assets
    (97 )     (66 )     (606 )
   
Note receivable from officer
                (162 )
   
Accounts payable
    323       407       1,234  
   
Accrued compensation and related expenses
    (542 )     (403 )     145  
   
Accrued expenses — clinical trials and other accrued expenses
    (192 )     (820 )     1,510  
   
License fee received from Visionex
                5,000  
 
   
     
     
 
       
Net cash used in operating activities
    (5,510 )     (4,821 )     (85,077 )
 
   
     
     
 
Investing Activities
                       
Purchase of marketable investment securities
    (1,523 )     (11,026 )     (48,194 )
Sale of marketable investment securities
    11       7,014       43,201  
Purchase of equipment
    (39 )     (134 )     (2,581 )
Deposits and other assets
                (53 )
Proceeds from refinancing under capital leases
                827  
Cash acquired from Visionex transaction
                4,403  
 
   
     
     
 
       
Net cash used in investing activities
    (1,551 )     (4,146 )     (2,397 )
 
   
     
     
 
Financing Activities
                       
Payments on obligation under capital lease
                (827 )
Proceeds from exercise of stock options
          116       681  
Proceeds from exercise of warrants
                41  
Proceeds from bridge loans with related parties
                5,047  
Payments on bridge loans with related parties
                (3,755 )
Proceeds from issuance of preferred stock
                34,215  
Repurchase of preferred stock
                (56 )
Proceeds from issuance of common stock
    8             77,358  
 
   
     
     
 
       
Net cash provided by financing activities
    8       116       112,704  
Effect of exchange rate changes on cash
    1       1       (25 )
 
   
     
     
 
(Decrease) Increase in Cash and Cash Equivalents
    (7,052 )     (8,850 )     25,205  
Cash and cash equivalents at beginning of period
    32,257       12,348        
 
   
     
     
 
Cash and Cash Equivalents At End of Period
  $ 25,205     $ 3,498     $ 25,205  
 
   
     
     
 

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ISTA Pharmaceuticals, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements
March 31, 2003

1. The Company

     ISTA Pharmaceuticals, Inc. (“ISTA” or the “Company”) was incorporated in the state of California on February 13, 1992 to discover, develop and market new remedies for diseases and conditions of the eye. The Company reincorporated in Delaware on August 4, 2000.

     Some of the products that the Company is developing involve the use of highly purified formulations of hyaluronidase. The Company’s lead ovine hyaluronidase-based product candidate, Vitrase®, is a proprietary drug for the treatment of vitreous hemorrhage and diabetic retinopathy. The Company is also developing products to treat hyphema, glaucoma and ocular inflammation. The Company’s goal is to become a fully integrated specialty pharmaceutical company by acquiring complementary products, either already marketed or in late-stage development. The Company has not commenced commercial operations and is considered to be in the development stage.

     As of March 31, 2003, the Company had approximately $30.2 million in cash and short-term investments. The Company incurred a net loss of $5.3 million for the three months ended March 31, 2003 and had an accumulated deficit of $127.7 million at March 31, 2003. The ability of the Company to continue as a going concern is dependent upon its ability to obtain additional capital and achieve profitable operations. The Company’s ability to transition from the development stage and ultimately, to attain profitable operations, is dependent upon obtaining sufficient working capital to complete the successful development of its products, approval by the U.S. Food and Drug Administration (“FDA”) of its products, achieving market acceptance of such products and achievement of sufficient levels of revenue to support the Company’s cost structure. Management believes that the Company’s existing capital resources will enable the Company to fund operations for at least the next 12 months. The condensed consolidated financial statements contained in this Form 10-Q do not include any adjustments to the specific amounts and classifications of assets and liabilities that might be necessary should the Company be unable to continue as a going concern.

2. Basis of Presentation

General

     The unaudited condensed consolidated financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations. In management’s opinion, the accompanying financial statements have been prepared on a basis consistent with the audited financial statements and contain adjustments, consisting of only normal, recurring accruals, necessary to present fairly the Company’s financial position and results of operations. Interim financial results are not necessarily indicative of results anticipated for the full year.

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States 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.

     On November 11, 2002, the stockholders approved a 1-for-10 reverse stock split. The reverse stock split reduced the outstanding number of shares but not the par value of the Company’s common stock. The stated capital on the Company’s balance sheet attributable to the outstanding shares of common stock (which is determined by multiplying the par value by the number of shares outstanding) was reduced proportionately based on the reverse stock split ratio of 1-for-10. However, the additional paid-in capital account on the Company’s balance sheet was increased by the amount by which the stated capital was reduced, so that the aggregate amount of the Company’s stockholders’ equity is unchanged by the reverse stock split. The per share net loss and the per share net book value of the Company’s common stock is also increased because there are fewer shares of common stock outstanding. All historical common stock shares and per share data have been adjusted for the reverse stock split throughout these financial statements for all periods presented.

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     For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K/A for the year ended December 31, 2002.

3. Revenue Recognition

     The Company recognizes revenue consistent with the provisions of the SEC Staff Accounting Bulletin No. 101 (“SAB 101”), “Revenue Recognition”, which sets forth guidelines in the timing of revenue recognition based upon factors such as passage of title, installation, payments and customer acceptance. Amounts received for upfront product and technology license fees under multiple-element arrangements are deferred and recognized ratably over the period of such services or performance if such arrangements require on-going services or performance. Non-refundable amounts received for milestone payments are recognized upon (i) the achievement of specified milestones when the Company has earned the milestone payment or, (ii) the milestone payment is substantive in nature and the achievement of the milestone was not reasonably assured at the inception of the agreement. The Company defers payments for milestone events which are reasonably assured and recognizes them ratably over the minimum remaining period of the Company’s performance obligations. Payments for milestones which are not reasonably assured are treated as the culmination of a separate earnings process and are recognized as revenue when the milestones are achieved. Royalty revenue will be recognized upon sale of the related products, provided the royalty amounts are fixed and determinable and collection of the related receivable is probable. Any amounts received prior to satisfying our revenue recognition criteria will be recorded as deferred revenue in the accompanying balance sheets.

     In December 2001, the Company began a collaboration with Otsuka Pharmaceutical Co., Ltd. under which Otsuka will be responsible for all clinical development, regulatory approvals, sales and marketing activities for Vitrase® in Japan. The Company’s principal sources of revenue from this collaboration and the commercialization of Vitrase® will be the license fee received in December 2001, which is being amortized over the Company’s continuing involvement with Otsuka, milestone payments and product sales received from Otsuka. To date, the Company has not earned this milestone payment from Otsuka and it cannot guarantee that it will receive this milestone payment in the future. Under the terms of the collaboration, the Company is responsible for the manufacture of Vitrase® and supplying all of Otsuka’s requirements for Vitrase®.

4. Comprehensive Income (Loss)

     Statement of Financial Accounting Standard (“SFAS”) No. 130, “Reporting Comprehensive Income”, requires reporting and displaying comprehensive income (loss) and its components, which, for ISTA, includes net loss and unrealized gains and losses on investments and foreign currency translation gains and losses. Total comprehensive loss for the three-month period ended March 31, 2003 and 2002 was $5,333,000 and $4,706,000, respectively. In accordance with SFAS No. 130, the accumulated balance of unrealized gains (losses) on investments and the accumulated balance of foreign currency translation adjustments are disclosed as separate components of stockholders’ equity.

5. Stock-Based Compensation

     In December 2002 the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”, which (i) amends SFAS No. 125, “Accounting for Stock-Based Compensation” to add two new transitional approaches when changing from the Accounting Principals Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” intrinsic value method of accounting for stock-based employee compensation to the SFAS No. 125 fair value method and (ii) amends APB Opinion No. 28, “Interim Financial Reporting” to call for disclosure of SFAS No. 128 pro forma information on a quarterly basis. The Company has elected to adopt the disclosure only provisions of SFAS No. 148 and will continue to follow APB Opinion No. 25 and related interpretations in accounting for stock options granted to its employees and directors. Accordingly, employee and director compensation expense is recognized only for those options whose price is less than the market value at the measurement date.

     When the exercise price of the employee or director stock options is less then the estimated fair value of the underlying stock on the grant date, the Company records deferred compensation for the difference and amortizes this amount to expense in accordance with FASB Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Options or Award Plans”, over the vesting period of the options.

     Options or stock awards issued to non-employees are recorded at their fair value as determined in accordance with SFAS No. 123 and Emerging Issues Task Force (“EITF”) No. 96-18, “Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring or in Conjunction

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With Selling Goods or Services”, and recognized over the related service period. Deferred charges for options granted to non-employees are periodically re-measured as the options vest.

     As required under SFAS No. 123 and SFAS No. 148, the pro forma effects of stock-based compensation on net income and net earnings per common share have been estimated at the date of grant using the Black-Scholes option pricing model based on the following weighted-average assumptions: risk-free interest rate of 3%, dividend yields of 0%, expected volatility of 73%, and a weighted-average expected life of the option of 4 years.

     For purposes of adjusted pro forma disclosures, the estimated fair value of the options is amortized to expense over the option’s vesting period. The effect of applying SFAS No. 123 for purposes of providing pro forma disclosures is not likely to be representative of the effects on the Company’s operating results for future years because changes in the subjective input assumptions can materially affect future value estimates. Pro forma information is as follows:

                 
    Three Months Ended
   
    March 31, 2003   March 31, 2002
   
 
Net loss attributed to common stockholders, as reported
    ($5,311 )     ($4,683 )
 
   
     
 
Pro forma net loss
    ($6,964 )     ($5,365 )
 
   
     
 
Net loss per share, basic and diluted, as reported
    ($.40 )   ($2.82 )
 
   
     
 
Pro forma net loss per share, basic and diluted
  ($.52 )   ($3.23 )
 
   
     
 

6. Net Loss Per Share

     In accordance with SFAS No. 128, “Earnings Per Share”, and SEC Staff Accounting Bulletin (“SAB”) No. 98, basic net loss per common share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period. Under SFAS No. 128, diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and common equivalent shares, such as stock options, outstanding during the period. Such common equivalent shares have not been included in the Company’s computation of net loss per share as their effect would be anti-dilutive.

     Under the provisions of SAB No. 98, common shares issued for nominal consideration, if any, would be included in the per share calculations as if they were outstanding for all periods presented. No common shares have been issued for nominal consideration.

7. Private Placement in Public Equity

     On November 19, 2002, the Company consummated a private investment in public equity (or “PIPE”) transaction, involving a private placement of 10,526,306 shares of its common stock for the aggregate purchase price of approximately $40.0 million, or $3.80 per share, and warrants to purchase up to 1,578,946 shares of its common stock for an exercise price of $3.80 per share. Investors in the PIPE transaction included persons and entities affiliated with The Sprout Group, Sanderling Venture Partners, Investor Growth Capital Limited, Gund Investment Corporation, KBL Healthcare, MDS Capital, and Ontario Teachers’ Pension Plan Board. In addition, $4.0 million of promissory notes previously issued to several of the same investors in ISTA’s September 2002 bridge financing were converted into 1,052,620 shares of the Company’s common stock, based upon the conversion price of $3.80 per share, concurrently with the consummation of the PIPE transaction. The Company believes this funding will enable it to execute on its plans to complete development work on the Company’s late-stage product candidates and introduce these products to the ophthalmic marketplace if they are approved by the FDA.

8. Commitments and Contingencies

     The Company is subject to routine claims and litigation incidental to its business. In the opinion of management, the resolution of such claims is not expected to have a material adverse effect on the operating results or financial position of the Company.

Visionex

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     Visionex was established in 1997, under the laws of Singapore, to engage in clinical, regulatory and marketing activities. During 1997, Visionex obtained from us the exclusive rights to register, import, market, sell and distribute Vitrase® and a product called Keraform® in East Asian markets, excluding Japan and Korea, for which Visionex paid us $5.0 million. Prior to the Company’s acquisition of Visionex (discussed below), investors who owned 66% of ISTA shares controlled 100% of Visionex shares.

     On March 8, 2000, the Company acquired Visionex by entering into an agreement with Visionex shareholders whereby we issued 3,319,363 shares of the Company’s Series C preferred stock, convertible into 245,879 shares of its common stock, to acquire all of the outstanding capital stock of Visionex. The Company assigned a fair value of $11.70 per share to the 3,319,363 shares of Series C preferred stock issued to effect the acquisition, at which time the Company recorded a deemed dividend of $19.2 million to recognize the excess of the value of the shares issued over the net assets acquired.

     Under Singapore tax law, Visionex was subject to a 15% withholding tax on a $5.0 million license that it paid to the Company in connection with a license to market, sell and distribute Vitrase® and its other corneaplasty products in certain countries in Southeast Asia. This withholding tax was waived by the Economic Development Board, or EDB, of Singapore subject to various conditions, including a commitment that Visionex would implement a proposed project to expand its business activities in Singapore to the benefit of the local economy. The Company substantially wound down Visionex operations in July 2002, and the proposed project was never implemented. Based upon a letter the Company recently received from the EDB and the Company’s assessment of its obligations with the EDB, management does not believe that the Company will be required to pay any withholding tax or related obligations in connection with the license fee. However, if the Company is required to pay this withholding tax, the Company does not believe such payment would have a material adverse effect on the Company’s business.

9. Recent Accounting Pronouncements

     In November 2002, the Emerging Issues Task Force (“EITF”) reached consensus on EITF 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables”, which addresses how to account for arrangements that may involve the delivery or performance of multiple products, services, and/or rights to use assets. The final consensus of EITF 00-21 will be applicable to agreements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. Additionally, companies will be permitted to apply the consensus guidance to all existing arrangements as the cumulative effect of a change in accounting principle in accordance with APB Opinion No. 20, “Accounting Changes.” Management is currently evaluating the effect that the adoption of EITF 00-21 will have on its results of operations and financial position.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 is an amendment to SFAS No. 123 providing alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and also provides additional disclosures about the method of accounting for stock-based employee compensation. Amendments are effective for financial statements for the Company beginning January 1, 2003. The Company has currently chosen to not adopt the voluntary change to the fair value based method of accounting for stock-based employee compensation. If the Company should choose to adopt such a method, its implementation pursuant to SFAS No. 148 could have a material effect on the Company’s consolidated financial position and results of operations.

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     In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51”. FIN 46 provides guidance on 1) the identification of entities for which control is achieved through means other than through voting rights, known as “variable interest entities” (“VIEs”); and 2) which business enterprise is the primary beneficiary and when it should consolidate the VIE. This new model for consolidation applies to entities: 1) where the equity investors (if any) do not have a controlling financial interest, or 2) whose equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. FIN 46 is effective for all new VIEs created or acquired after January 31, 2003. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. Certain disclosures are effective immediately. The Company does not expect the implementation of FIN 46 to have a material effect on its financial condition or results of operations.

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This Interim Report on Form 10-Q contains forward-looking statements that have been made pursuant to the provisions of the Securities Litigation Act of 1995 and concern matters that involve risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Discussions containing forward-looking statements may be found in the material set forth under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other sections of this Form 10-Q. Words such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue” or similar words are intended to identify forward-looking statements, although not all forward-looking statements contain these words. Although we believe that our opinions and expectations reflected in the forward-looking statements are reasonable as of the date of this Report, we cannot guarantee future results, levels of activity, performance or achievements, and our actual results may differ substantially from the views and expectations set forth in this Report. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations.

     Readers are urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation “Factors That May Affect Results of Operations and Financial Condition” set forth in this Form 10-Q, and the audited financial statements and the notes thereto and disclosures made under the captions, “Management Discussion and Analysis of Financial Condition and Results of Operations”, “Risk Factors”, “Consolidated Financial Statements” and “Notes to Consolidated Financial Statements”, included in the Company’s annual report on Form 10-K/A Amendment No. 1 for the year ended December 31, 2002.

Overview

     ISTA Pharmaceuticals, Inc. (the “Company” or “ISTA”) is a development-stage specialty pharmaceutical company focused on the development and commercialization of new remedies for diseases and conditions of the eye. Since the Company’s inception, we have devoted our resources primarily to fund research and development programs and late-stage product acquisitions. In December 2001, we announced our strategic plan to transition from a development organization to a fully-integrated, specialty pharmaceutical company with a primary focus on ophthalmology by acquiring complementary products, either already marketed or in late stage development.

     In order to advance our strategic plan, we are pursuing the development of several products, including, Vitrase® and ISTALOL™, which are in the later stages of review by the FDA. There can be no assurances that either Vitrase® or ISTALOL™ will receive final FDA approval. However, we are currently undertaking significant preparations for expansion of our manufacturing and marketing capabilities in the event such approvals are obtained. If approved by the FDA, Vitrase® will be manufactured for us through our contract manufacturer and marketed by Allergan in the United States, while ISTALOL™ will be manufactured for us through our contract manufacturer and marketed by us in the United States.

     We currently have no approved products. Vitrase® (ovine hyaluronidase) is our proprietary drug that we are developing for the treatment of vitreous hemorrhage and diabetic retinopathy. On April 3, 2003, the FDA issued an “approvable” letter in which the FDA cited issues primarily related to the sufficiency of the efficacy data submitted with the New Drug Application (“NDA”) Vitrase®. The FDA requested additional analysis of the existing data and an additional confirmatory clinical study based upon that analysis. We intend to discuss with the FDA the comments contained in the “approvable” letter and, based upon those discussions, determine the next appropriate steps in the review and approval process of Vitrase®. We are also pursuing market approval in the United States of ISTALOL™, our new formulation of timolol, to treat glaucoma and developing other products designed to treat hyphema and ocular

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inflammation. We believe that if Vitrase®, ISTALOL™, and our other ophthalmic product candidates are successful, we will advance our strategic plan to become a fully-integrated specialty pharmaceutical company.

     We currently have no products available for sale. We have incurred losses since inception and had an accumulated deficit through March 31, 2003 of $127.7 million. Our losses have resulted primarily from research and development activities, including clinical trials, related general and administrative expenses and a deemed dividend to our preferred shareholders. We expect to continue to incur operating losses for the foreseeable future as we continue to conduct research, development and clinical testing activities, and to seek regulatory approval for our product candidates.

Vitrase®

     Our current lead product candidate is Vitrase®, which is derived from highly purified formulations of ovine hyaluronidase.

     In March 2002, we announced the preliminary results for our Phase III clinical studies of Vitrase®. Although the data from the two Phase III studies did not show a statistically significant improvement in the primary (surrogate) endpoint, further analysis has shown that for a 55 IU dose of Vitrase®, in both studies, there was a clinically meaningful and statistically significant decrease in the density of vitreous hemorrhage. A statistically significant difference in the proportion of patients with an improvement in best-corrected visual acuity at one and two months was also shown, which extended to three-month post-treatment visits in a clinical study conducted outside North America.

     Based on these improvements in visual function, and our review and discussions with the FDA regarding the data from the two studies, we submitted the clinical section and the chemistry, manufacturing and controls (“CMC”) section of the NDA for Vitrase® to the FDA in October 2002. The FDA accepted those sections of the Vitrase® NDA for review in December 2002, along with the pre-clinical pharmacology and toxicology section that was submitted in January 2002. On April 3, 2003, the FDA issued an “approvable” letter in which the FDA cited issues primarily related to the sufficiency of the efficacy data submitted with the NDA for Vitrase®. The FDA requested additional analysis of the existing data and an additional confirmatory clinical study based upon that analysis. We intend to discuss with the FDA the comments contained in the “approvable” letter and, based upon those discussions, determine the next appropriate steps in the review and approval process of Vitrase®.

     In March 2000, we entered into a collaboration with Allergan, Inc., under which Allergan will be responsible for the marketing, sale and distribution of Vitrase® in the United States and all international markets except Mexico (until April 2004) and Japan. Accordingly, we depend on the success of Allergan in commercializing Vitrase® in these markets. Our principal sources of revenue from this collaboration will be milestone, royalty and profit-sharing payments received from Allergan. Under the terms of the collaboration, we are responsible for the manufacture of Vitrase® and for supplying all of Allergan’s requirements for Vitrase®. If we are successful in obtaining regulatory approval for Vitrase® and providing adequate supplies to Allergan, and Allergan subsequently achieves significant sales of the product, we may receive substantial royalties and other payments from Allergan; however, our aggregate manufacturing costs may also increase.

     In December 2001, we entered into a collaboration with Otsuka Pharmaceuticals Co. Ltd., a leading Japan-based international health care and pharmaceuticals company. Under the terms of the collaboration, Otsuka will be responsible for all clinical development, regulatory approvals, sales and marketing activities for Vitrase® in Japan, and we will be responsible for supplying all of Otsuka’s requirements for Vitrase®. Our principal sources of revenue from this collaboration will be license fees and milestone payments from Otsuka.

     Currently, we rely upon Biozyme Laboratories Limited to supply us with ovine hyaluronidase, the active pharmaceutical ingredient in Vitrase®, and we rely on R.P. Scherer West, Inc. (a wholly owned subsidiary of Cardinal Health) to supply us with the finished Vitrase® product. Each of these parties is the sole source. Since Vitrase® has not received FDA approval, neither party has past experience in supplying us with commercial quantities of Vitrase®.

Acquisition of Other Product Candidates

     In May 2002, the Company acquired substantially all the assets of AcSentient, Inc. The assets include United States marketing rights for a new formulation of timolol, which we have named ISTALOL™, a beta-blocking agent for treating glaucoma.

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AcSentient previously acquired rights to this compound from Senju. The assets acquired from AcSentient also included United States product rights to bromfenac, a topical non-steroidal anti-inflammatory compound for the treatment ocular inflammation, and worldwide marketing rights for Caprogel®, a novel compound for the treatment of hyphema. AcSentient previously acquired the rights to these two compounds from Senju and the Eastern Virginia School of Medicine, respectively.

     We acquired the rights to these three compounds in exchange for $290,000 and 10,000 shares of our common stock valued at $99,000 ($9.90 per share). Additionally, we assumed the liabilities of two milestone payments to Senju ($750,000 and $500,000), a milestone payment to the Eastern Virginia School of Medicine ($65,000), legal expenses associated with the acquisition ($20,000) and a patent application fee for Caprogel® ($4,500). As of the date these compounds were acquired, they had not achieved feasibility and there is no significant alternative future use should our development efforts prove unsuccessful. Accordingly, we recorded an acquired in-process research and development charge of $1,728,500 in May 2002 related to the purchase of these compounds.

     The NDA for ISTALOL was submitted by Senju to the FDA in September 2002. The NDA included data from pre-clinical studies conducted in Japan, combined with data from a Phase I clinical study conducted in the United States and a multi-center Phase III clinical study recently completed in the United States. We are currently initiating a Phase III study of bromfenac in the United States. Assuming successful completion of our clinical studies, we anticipate submitting an NDA for bromfenac in early 2004. We are currently conducting feasibility studies for the commercialization of Caprogel®. Once completed, and if these studies yield promising results, we intend to pursue further clinical development of Caprogel® consistent with such studies’ results. However, the timing and scope for our development of Caprogel® may change based on our assessment, from time to time, of this product candidate’s market potential, other product opportunities and our corporate priorities.

ISTALOL

     In May 2002, we acquired substantially all of the assets of AcSentient, Inc. The assets include United States marketing rights for a new formulation of timolol, which we have named ISTALOL, a beta-blocking agent for treating glaucoma. AcSentient previously acquired rights to this compound from Senju Pharmaceutical Co., Ltd., headquartered in Osaka, Japan. Senju has a diverse product portfolio including ophthalmic, central nervous system, cardiovascular, circulatory, gastro-intestinal, respiratory, oncology and dermatological products.

     Our acquisition of ISTALOL was consistent with our strategic objective of acquiring complementary late-stage product candidates. Senju submitted the NDA for ISTALOL to the FDA in September 2002. That NDA included data from pre-clinical studies conducted in Japan, combined with data from a Phase I clinical study conducted in the United States and a multi-center Phase III clinical study recently completed in the United States.

     If the FDA approves all components of the ISTALOL NDA, we believe that we will be positioned to commercialize ISTALOL in the United States, and to thereby further broaden our specialty ophthalmic pharmaceutical product offerings.

     We have supply agreements with Bausch & Lomb Incorporated to manufacture commercial quantities of ISTALOL™ and bromfenac. Under the terms of these agreements we are required to pay approximately $825,000 in development fees to Baush & Lomb. The initial term of the supply agreement for the manufacturing of bromfenac expires on the fourth anniversary of our receipt of written FDA approval of the NDA for bromfenac and the initial term of the supply agreement for the manufacturing of ISTALOL™ expires on the third anniversary of our receipt of written FDA approval of the NDA for ISTALOL™. Each of these agreements will be automatically renewed for additional two year periods unless terminated by either party pursuant to the terms of the agreement.

Bromfenac and Caprogel®

     The assets acquired from AcSentient also include United States product rights to bromfenac, a topical non-steroidal anti-inflammatory compound for the treatment of ocular inflammation, and worldwide marketing rights for Caprogel®, a novel compound for the treatment of hyphema, or bleeding into the front of the eye. AcSentient had previously acquired the rights to these two compounds from Senju and the Eastern Virginia School of Medicine, respectively. Under the terms of the AcSentient asset acquisition, we are responsible for payments and other obligations connected with further development of bromfenac and Caprogel®.

     We are currently initiating a Phase III study of bromfenac in the United States. Assuming successful completion of our clinical studies, we anticipate submitting an NDA for bromfenac in early 2004.

     We are currently conducting feasibility studies for the commercialization of Caprogel®. Once completed, and if these studies yield promising results, we intend to pursue further clinical development of Caprogel® consistent with such studies’ results. However, the timing and scope for our development of Caprogel® may change based on our assessment, from time to time, of this product candidate’s market potential, other product opportunities and our corporate priorities.

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     We anticipate incurring additional research and development expenses in connection with the further development of bromfenac and Caprogel®. If these compounds are approved for sale in the United States, we expect to incur significant additional marketing and sales expenses in establishing and supporting the necessary infrastructure to market and distribute these products in the United States.

Results of Operations

Three Months Ended March 31, 2003 and 2002

     Revenue. Revenue of $69,000 and $70,000 for the three months ended March 31, 2003 and 2002 reflects the amortization for the period of deferred revenue recorded in December 2001 for the license fee payment made by Otsuka in connection with the license for Vitrase® in Japan.

     Research and development expenses. Research and development expenses for the three months ended March 31, 2003 were $3.4 million compared to $2.9 million for the three months ended March 31, 2002. The increase of $500,000 is principally the result of development and manufacturing activities related to Vitrase®, ISTALOL™ and bromfenac.

     Selling, general and administrative expenses. Selling, general and administrative expenses were $2.1 million for the three months ended March 31, 2003 compared to $1.9 million for the three months ended March 31, 2002. The increase is primarily due to additional personnel and facilities expenses in 2003 compared to 2002 and an increase in the cost of directors’ and officers’ insurance that went into effect during the last half of 2002.

     Interest income. Interest income was $115,000 for the three months ended March 31, 2003 compared to $87,000 for the three months ended March 31, 2002. The increase in interest income was primarily attributable to higher cash balances for the first quarter of 2003 compared to the first quarter of 2002 due to the PIPE transaction that occurred in November 2002.

     Interest expense. Interest expense was $5,000 for the three months ended March 31, 2003 and there was no interest expense for the three months ended March 31, 2002. The interest expense was primarily attributable to the financing of our directors’ and officers’ insurance premiums during the three months ended March 31, 2003.

Liquidity and Capital Resources

     As of March 31, 2003, we had approximately $30.2 million in cash and short-term investments.

     We have financed our operations since inception primarily through private sales of our preferred stock and sale of our common stock in our initial public offering. We received net proceeds of $10.0 million from the private sale of preferred stock in March 2000, $31.5 million from our initial public offering in August 2000, $4.0 million from the private sale of common stock in December 2001, $5.0 million from a license fee payment in December 2001, $4.0 million from the issuance of promissory notes in September 2002 and $40.0 million from our PIPE transaction in November 2002. This PIPE transaction involved a private placement of 10,526,306 shares of our common stock for the aggregate purchase price of approximately $40.0 million, or $3.80 per share, and warrants to purchase up to 1,578,946 shares of our common stock for an exercise price of $3.80 per share.

     For the three months ended March 31, 2003, we used $5.5 million of cash for operations principally as a result of the net loss of $5.3 million partially offset by non-cash compensation expense of $306,000. We used approximately $4.8 million of cash for operations in the three months ended March 31, 2002.

     For the three months ended March 31, 2003, we used $1.6 million of cash for investing activities, primarily to purchase marketable securities. For the three months ended March 31, 2002, we used $4.1 million for investing activities, primarily to purchase marketable securities.

     For the three months ended March 31, 2003, we received $8,000 from financing activities, primarily from the issuance of common stock relative to our Employee Stock Purchase Plan. For the three months ended March 31, 2002, we received $116,000 from financing activities, primarily from the exercise of stock options.

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     We may be required to raise additional capital in the future through collaborative agreements, PIPE related financing, and various other equity or debt financings. If we are required to raise additional capital in the future, there can be no assurance that the additional financing will be available on favorable terms.

     We continually evaluate new opportunities for late-stage or currently marketed complementary product candidates and, if and when appropriate, intend to pursue such opportunities through further product acquisitions and related development activities. Our ability to execute on such opportunities in some circumstances will be dependant upon our ability to raise additional capital on commercially reasonable terms. There can be no assurance that funds from these sources will be available when needed or, if available, will be on terms favorable to us or to our stockholders. If additional funds are raised by issuing equity securities, the percentage ownership of our stockholders will be reduced, stockholders may experience additional dilution or such equity securities may provide for rights, preferences or privileges senior to those of the holders of our common stock.

     Our actual future capital requirements will depend on many factors, including the following:

    receiving milestone payments from Allergan and Otsuka
 
    the rate of progress of our research and development programs
 
    the results of our clinical trials and requirements to conduct additional clinical trials
 
    the time and expense necessary to obtain regulatory approvals
 
    activities and payments in connection with the in-license or acquisition of products
 
    our ability to establish and maintain collaborative relationships
 
    sales and marketing activities related to each of ISTALOL™, bromfenac and Caprogel®
 
    competitive, technological, market and other developments

Factors that May Affect Results of Operations and Financial Condition.

Risks Related to Our Company

If we do not receive and maintain regulatory approvals for our product candidates, we or our marketing partners will not be able to commercialize our products, which would substantially impair our ability to generate revenues and materially harm our business and financial condition.

     None of our product candidates has received regulatory approval from the FDA. Approval from the FDA is necessary to manufacture and market pharmaceutical products in the United States. Many other countries including the major European countries and Japan have similar requirements.

     The NDA process is extensive, time-consuming and costly, and there is no guarantee that regulatory authorities will approve NDAs of any of our product candidates. We have submitted NDAs, which are currently pending before the FDA, for both Vitrase® and for ISTALOL™. Moreover, we depend on the assistance of Senju Pharmaceuticals for obtaining regulatory approval for ISTALOL™.

     Although we recently received an “approvable” letter from the FDA with respect to ISTA’s NDA for Vitrase® for the treatment of vitreous hemorrhage, the FDA has requested additional analysis of the existing data and an additional confirmatory clinical study based upon that analysis. There can be no assurances that the FDA will approve our NDA for Vitrase®, even if we decide to and are successfully able to undertake the further analysis and clinical testing requested by the FDA.

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     Clinical testing of pharmaceutical products is also a long, expensive and uncertain process. Even if initial results of preclinical studies or clinical trial results are positive, we may obtain different results in later stages of drug development, including failure to show desired safety and efficacy. Our bromfenac product, a topical non-steroidal anti-inflammatory compound for the treatment of ocular inflammation is currently undergoing clinical trials. The clinical trials of any of our product candidates could be unsuccessful, which would prevent us from obtaining regulatory approval and commercializing the product.

     FDA approval can be delayed, limited or not granted for many reasons, including, among others:

    FDA officials may not find a product candidate safe or effective to merit an approval
 
    FDA officials may not find that the data from preclinical testing and clinical trials justifies approval, or they may require additional studies that would make it commercially unattractive to continue pursuit of approval
 
    the FDA might not approve our manufacturing processes or facilities, or the processes or facilities of our contract manufacturers or raw material suppliers
 
    the FDA may change its approval policies or adopt new regulations
 
    the FDA may approve a product candidate for indications that are narrow or under conditions that place our product at a competitive disadvantage, which may limit our sales and marketing activities or otherwise adversely impact the commercial potential of a product

     If the FDA does not approve our products on commercially viable terms or we terminate development of any of our products due to difficulties encountered in the regulatory approval process, it will have a material adverse impact on our business and we will be dependent on the development of our other product candidates and/or our ability to successfully acquire other products and technologies.

     In addition, we intend to market our products, and perhaps have certain of our products manufactured, in foreign countries. The process of obtaining approvals in foreign countries is subject to delay and failure for similar reasons.

If our product candidates are approved by the FDA but do not gain market acceptance, our business will suffer because we might not be able to fund future operations.

     A number of factors may affect the market acceptance of Vitrase®, ISTALOL™, bromfenac, Caprogel® or any other products we develop or acquire in the future, including, among others:

    the price of our products relative to other therapies for the same or similar treatments
 
    the perception by patients, physicians and other members of the health care community of the effectiveness and safety of our products for their prescribed treatments
 
    our ability to fund sales and marketing departments
 
    the effectiveness of our sales and marketing efforts

     If our products do not gain market acceptance we may not be able to fund future operations, including the development or acquisition of new product candidates and/or our sales and marketing efforts for our approved products.

If we are unable to sufficiently develop our sales, marketing and distribution capabilities or enter into agreements with third parties to perform these functions, we will not be able to commercialize products.

     We currently are in the process of developing our sales, marketing and distribution capabilities. However, our current capabilities in these areas are limited. In order to commercialize any products, we must internally develop substantial sales, marketing and distribution capabilities, or establish collaborations or other arrangements with third parties to perform these services. We do not have extensive experience in these areas, and we may not be able to establish adequate in-house sales, marketing and distribution capabilities or engage and effectively manage relationships with third parties to perform any or all of such services. For example, we

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intend to rely on Allergan to commercialize Vitrase® in the United States, and Otsuka Pharmaceuticals, Co. Ltd. to market Vitrase® in Japan. To the extent that we enter into co-promotion or other licensing arrangements, our product revenues are likely to be lower than if we directly marketed and sold our products, and any revenues we receive will depend upon the efforts of third parties, whose efforts may not be successful.

We have a history of net losses and negative cash flow, and we may never achieve or maintain profitability.

     We have only a limited operating history upon which you can evaluate our business. We have never been profitable, and we might never become profitable. As of March 31, 2003, our accumulated deficit was $127.7 million, including a net loss of approximately $23.0 million for the year ended December 31, 2002 and a net loss of $5.3 million for the three months ended March 31, 2003. We have not generated any revenue from product sales to date, and we may never generate revenues from product sales in the future. Even if we do achieve significant revenues from product sales, we expect to incur significant operating losses over the next several years. As of March 31, 2003, we had approximately $30.2 million in cash and short-term investments and working capital of $28.0 million. We anticipate that our existing capital resources will enable us to fund operations for at least the next twelve months. We may be required to raise additional capital in the future. If we are required to raise additional capital in the future there can be no assurance that the additional financing will be available on favorable terms.

We may be unable to execute our strategic plan to transition to a fully-integrated specialty pharmaceutical company, which could have a material adverse impact on our business and financial condition.

     Our strategy to acquire or in-license ophthalmic pharmaceutical products, either currently marketed or in late-stage development, will be dependent upon a number of factors including identifying such acquisition opportunities, successfully negotiating favorable terms with third parties for the acquisition or licensing of such products and our ability to raise additional capital to facilitate the acquisition or licensing of such products. Furthermore, we have limited sales, marketing and distribution capabilities to support the marketing of any products, and we do not have experience in managing third-party manufacturers of any products in commercial quantities. In addition, if we acquire or in-license late-stage development products, our ability to successfully commercialize such products will also be dependent on our ability to successfully complete development of such products, including obtaining the necessary regulatory approvals. For example, we have in-licensed U.S. marketing rights to ISTALOL™ and bromfenac from Senju Pharmaceutical, and we have in-licensed worldwide rights to Caprogel® from the Eastern Virginia School of Medicine. Senju is responsible for the development of ISTALOL™, including obtaining the necessary regulatory approvals in the United States. The Company is responsible for the further development of bromfenac and Caprogel®.

     We may not be able to identify any product acquisition opportunities or be successful in negotiating favorable terms for any such product acquisitions. Should we be successful in acquiring or licensing any products, we will need to establish and enhance our sales, marketing, distribution and manufacturing capabilities, each of which will require substantial financial and management resources. Our failure to establish effective sales, marketing, distribution and manufacturing capabilities on a timely basis would adversely affect our ability to commercialize any acquired products. If we are unable to execute our strategic plan to transition to a fully-integrated specialty pharmaceutical company on a timely basis, our ability to generate revenues would be substantially impaired which would materially harm our business and financial condition.

If we have problems with our contract manufacturers, our product development and commercialization efforts could be delayed or stopped.

     We have entered into a master services agreement with R.P Scherer West, Inc. (which was subsequently acquired by Cardinal Health), for the manufacture of commercial quantities, if approved, of our Vitrase® finished product. We have also entered into a manufacturing services agreement with Bausch and Lomb for the manufacture of commercial quantities, if approved, of our ISTALOL™ and bromfenac products. To date, we have needed these products only in amounts sufficient for clinical trials. Before any contract manufacturer can produce commercial quantities of a product, we must demonstrate to the FDA’s satisfaction that the product source for commercial quantities is substantially equivalent to the supply of the product used in our clinical trials. Such demonstration may include the requirement to conduct additional clinical trials. In addition, the manufacturing facilities of all of our contract manufacturers must comply with current Good Manufacturing Practice regulations, which the FDA strictly enforces. Moreover, the facilities of the contract manufacturer must undergo and pass pre-approval inspection by the FDA before any of our products can be approved for manufacture. We cannot assure you that Cardinal Health or Bausch and Lomb will be able, as applicable, to develop processes necessary to produce substantially equivalent product or that regulatory authorities will approve them as a manufacturer. Failure to develop necessary production processes or receive regulatory approval could delay or stop our efforts to develop and commercialize our product candidates.

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Our strategic partners may not perform their duties under our agreements, in which case our ability to commercialize our products may be significantly impaired.

     We have entered into collaborations with Allergan, Inc. and Otsuka Pharmaceuticals, Co. Ltd. relating to Vitrase®, and with Senju Pharmaceuticals relating to ISTALOL™ and bromfenac. If we obtain regulatory approval for Vitrase® in the United States and Europe, we will be dependent on Allergan for the commercialization of Vitrase® in the United States and Europe. We will depend on Otsuka for obtaining regulatory approval of Vitrase® in Japan, and if such approval is obtained, we will be dependent upon Otsuka for the commercialization of Vitrase® in Japan. We will also be dependent on Senju Pharmaceuticals for obtaining regulatory approval for ISTALOL™ in the United States. The amount and timing of resources that Allergan, Otsuka, and Senju dedicate to our collaborations are not within our control. Accordingly, any breach or termination of our agreements by these collaborators could delay or stop the development and/or commercialization of our product candidates. Our collaborative partners may change their strategic focus, terminate our agreements, or pursue alternative technologies. Although our agreements with Allergan, Otsuka and Senju contain reciprocal terms providing that neither we nor they may develop products that directly compete in the same form with the products involved in the collaboration, there can be no assurances that our collaborators will not develop competing products in different forms or products that compete indirectly with our products. Accordingly, unfavorable developments in our relationship with our strategic partners could have a significant adverse effect on us and our financial condition.

If we have problems with our sole source suppliers, our product development and commercialization efforts for our product candidates could be delayed or stopped.

     Some materials used in the Company’s products are currently sourced from a single source. Biozyme Laboratories, Ltd. is currently our only source for highly purified ovine hyaluronidase, which is the active ingredient in Vitrase®. If approved, commercial quantities of Vitrase® will be supplied by Cardinal Health as the sole source. ISTALOL™ and bromfenac, if approved, will be supplied by a single source, Bausch and Lomb. The Company has not established and may not be able to establish arrangements with additional suppliers for these ingredients or products. Difficulties in our relationship with our sole source suppliers or delays or interruptions in such suppliers’ supply of our requirements could limit our ability to provide sufficient quantities of our products, on a timely basis, for clinical trials and, if our products are approved, could limit commercial sales, which would have a material adverse effect on our business and financial condition. While we are currently pursuing additional sources for these products and materials, our success in establishing such additional supply arrangements cannot be assured.

We depend on our Chief Executive Officer, Vicente Anido, Jr., Ph.D., to execute our strategic plan to transition to a fully-integrated specialty pharmaceutical company.

     Our success largely depends on the skills, experience and efforts of our Chief Executive Officer, Vicente Anido, Jr., Ph.D. We have entered into a written employment agreement with Dr. Anido that can be terminated at any time by the Company or by Dr. Anido. In the event Dr. Anido’s employment is terminated, other than voluntarily or for cause, Dr. Anido will receive nine months of salary as severance compensation. In the event Dr. Anido’s employment is terminated after a change of control of the Company (such as a merger where the Company is bought by another entity, or a sale of substantially all of the assets of the Company), other than voluntarily or for cause, then Dr. Anido’s stock options will immediately vest and become exercisable in full, and Dr. Anido will receive twenty-four months of salary as severance compensation. In addition, we do not maintain “key person” life insurance policies covering Dr. Anido. The loss of Dr. Anido would jeopardize our ability to execute our strategic plan and materially harm our business.

Risks Related to Our Industry

Our suppliers and manufacturers are subject to regulation by the FDA and other agencies, and if they do not meet their commitments, we would have to find substitute suppliers or manufacturers, which could delay the supply of our products to market.

     Regulatory requirements applicable to pharmaceutical products make the substitution of suppliers and manufacturers costly and time consuming. We have no internal manufacturing capabilities and are, and expect to be in the future, entirely dependent on contract manufacturers and suppliers for the manufacture of our products and for their active ingredients. The disqualification of these suppliers through their failure to comply with regulatory requirements could negatively impact our business because the delays and costs in obtaining and qualifying alternate suppliers (if such alternative suppliers are available, which we cannot assure) could delay clinical trials or otherwise inhibit our ability to bring approved products to market, which would have a material adverse affect on our business and financial condition.

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We may be required to initiate or defend against legal proceedings related to intellectual property rights, which may result in substantial expense, delay and/or cessation of our development and commercialization of our products.

     We rely on patents to protect our intellectual property rights. The strength of this protection, however, is uncertain. In particular, it is not certain that:

    our patents and pending patent applications use technology that we invented first
 
    we were the first to file patent applications for these inventions
 
    others will not independently develop similar or alternative technologies or duplicate our technologies
 
    any of our pending patent applications will result in issued patents

     We currently have 56 patent applications pending. In the event any patents are issued to us as a result of such applications, there can be no assurance that such patents will provide a basis for commercially viable products, will provide us with any competitive advantages, or will not face third party challenges or be the subject of further proceedings limiting their scope or enforceability.

     We may become involved in interference proceedings in the U.S. Patent and Trademark Office to determine the priority of our inventions. In addition, costly litigation could be necessary to protect our patent position. We also rely on trademarks to protect the names of our products. These trademarks may be challenged by others. If we enforce our trademarks against third parties, such enforcement proceedings may be expensive. We also rely on trade secrets, unpatented proprietary know-how and continuing technological innovation that we seek to protect with confidentiality agreements with employees, consultants and others with whom we discuss our business. Disputes may arise concerning the ownership of intellectual property or the applicability or enforceability of these agreements, and we might not be able to resolve these disputes in our favor.

     The Company licenses patents held by the Eastern Virginia School of Medicine (for Caprogel®) and Senju Pharmaceutical (for ISTALOL™ and bromfenac). The license agreements with these licensors provide that the licensor is responsible for prosecution, maintenance, protection and defense of such patents, at the licensor’s cost with respect to the agreements with Senju, and at our cost with respect to the agreement with the Eastern Virginia School of Medicine. If the licensor chooses not to protect its own patent rights, we may not be able to take actions to secure our related product marketing rights.

     In addition to protecting our own intellectual property rights, third parties may assert patent, trademark or copyright infringement or other intellectual property claims against us based on what they believe are their own intellectual property rights. We may be required to pay substantial damages, including but not limited to treble damages, for past infringement if it is ultimately determined that our products infringe a third party’s intellectual property rights. Even if infringement claims against us are without merit, defending a lawsuit takes significant time, may be expensive and may divert management’s attention from other business concerns. Further, we may be stopped from developing, manufacturing or selling our products until we obtain a license from the owner of the relevant technology or other intellectual property rights. If such a license is available at all, it may require us to pay substantial royalties or other fees.

If we do not receive third-party reimbursement, our products may not be accepted in the market.

     Our ability to earn sufficient returns on our products will depend in part on the extent to which reimbursement for our products and related treatments will be available from government health administration authorities, private health insurers, managed care organizations and other healthcare providers.

     Third-party payers are increasingly attempting to limit both the coverage and the level of reimbursement of new drug products to contain costs. Consequently, significant uncertainty exists as to the reimbursement status of newly approved healthcare products. If we succeed in bringing one or more of our product candidates to market, third-party payers may not establish adequate levels of reimbursement for our products, which could limit their market acceptance.

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We face intense competition and rapid technological change that could result in products that are superior to the products we are developing.

     We have numerous competitors in the United States and abroad, including, among others, major pharmaceutical and specialized biotechnology firms, universities and other research institutions that may be developing competing products. Such competitors may include Allergan, Inc., Alcon Laboratories, Inc., Bausch & Lomb Incorporated, CIBA Vision (a unit of Novartis AG), Pharmacia/Pfizer and Eli Lilly and Company. These competitors may develop technologies and products that are more effective or less costly than our current or future product candidates or that could render our technologies and product candidates obsolete or noncompetitive. Many of these competitors have substantially more resources and product development, manufacturing and marketing experience and capabilities than we do. In addition, many of our competitors have significantly greater experience than we do in undertaking preclinical testing and clinical trials of pharmaceutical product candidates and obtaining FDA and other regulatory approvals of products and therapies for use in healthcare.

We are exposed to product liability claims, and insurance against these claims may not be available to us on reasonable terms.

     We currently maintain clinical trial liability insurance with per occurrence and aggregate coverage limits of $5 million. The coverage limits of our insurance policies may be inadequate to protect us from any liabilities we might incur in connection with clinical trials or the sale of our products. Product liability insurance is expensive and in the future may not be available on commercially acceptable terms, or at all. A successful claim or claims brought against us in excess of our insurance coverage could materially harm our business and financial condition.

Risks Relating to Our Stock

Our stock price is subject to significant volatility.

     During the two most recent fiscal years and up until the present, the daily closing price per share of our common stock has ranged from a high of $133.75 per share to a low of $2.60 per share. Our stock price has been and may continue to be subject to significant volatility. The following factors, in addition to other risks and uncertainties described in this section and elsewhere in this report, may cause the market price of our common stock to fall:

    the scope, outcome and timeliness of any governmental, court or other regulatory action that may involve us (including, without limitation, the scope, outcome or timeliness of any inspection or other action of the FDA)
 
    the availability to us, on commercially reasonable terms, of third party sourced products and materials
 
    developments concerning proprietary rights, including the ability of third parties to assert patents or other intellectual property rights against us which, among other things, could cause a delay or disruption in the development, manufacture, marketing or sale of our products
 
    competitors announcing products under development or new commercial products
 
    competitors publicity regarding actual or potential products under development
 
    period-to-period fluctuations in our financial results
 
    economic and other external factors, including disasters and other crises

     We participate in a highly dynamic industry, which often results in significant volatility in the market price of our common stock irrespective of company performance. Fluctuations in the price of our common stock may be exacerbated by conditions in the healthcare and technology industry segments or conditions in the financial markets generally.

Trading in our stock over the last 12 months has been limited, so investors may not be able to sell as much stock as they want at prevailing prices.

     The average daily trading volume in our common stock for the twelve-month period ending March 31, 2002 was approximately 14,770 shares, and the average daily number of transactions was approximately 75 for the same period. If limited trading in our stock continues, it may be difficult for investors to sell their shares in the public market at any given time at prevailing prices.

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Future sales of shares of our common stock, including sales of shares following the expiration of “lock-up” arrangements, may negatively affect our stock price.

     As a result of our recent PIPE financing transaction, the PIPE investors received approximately 11.6 million shares of our common stock. The shares of common stock issued in connection with the PIPE transaction represented approximately 87% of our common stock. In connection with our PIPE financing transaction, we also issued warrants to the PIPE investors that are exercisable for the purchase of up to an aggregate of 1,578,946 shares of our common stock based upon a purchase price of $3.80 per share. The exercise of these warrants could result in significant dilution to shareholders at the time of exercise.

     The PIPE investors also entered into “lock-up” agreements with the Company that impose restrictions on the ability of the PIPE investors to sell or otherwise dispose of the shares of our common stock that they received in the PIPE transaction. These “lock-up” restrictions expire on May 19, 2003. We filed a registration statement on Form S-3 to cover the shares issued to the PIPE investors and issuable upon conversion of the warrants. In the future, we may issue additional options, warrants or other derivative securities convertible into our Common Stock.

     Sales of substantial amounts of shares of our common stock, or even the potential for such sales, could lower the market price of our common stock and impair our ability to raise capital through the sale of equity securities.

Concentration of ownership could delay or prevent change in control or otherwise influence or control most matters submitted to our stockholders.

     Our directors, officers, and principal stockholders together control approximately 89.0% of our voting securities, a concentration of ownership that could delay or prevent a change in control. Our executive officers and directors beneficially own approximately 2.5% of our voting securities and our 5% or greater stockholders beneficially own approximately 86.5% of our voting securities. These stockholders, if acting together, would be able to influence and possibly control most matters submitted for approval by our stockholders, including the election of directors, delaying or preventing a change of control, and the consideration of transactions in which stockholders might otherwise receive a premium for their shares over then-current market prices.

Our stockholder rights plan, provisions in our charter documents, and Delaware law may inhibit a takeover of the Company, which could limit the price investors might be willing to pay in the future for our common stock, and could entrench management.

     We have a stockholder rights plan that may have the effect of discouraging unsolicited takeover proposals, thereby entrenching current management and possibly depressing the market price of our common stock. The rights issued under the stockholder rights plan would cause substantial dilution to a person or group that attempts to acquire us on terms not approved in advance by our board of directors. In addition, our charter and bylaws contain provisions that may discourage unsolicited takeover proposals that stockholders may consider to be in their best interests. These provisions include:

    a classified board of directors,
 
    the ability of the board of directors to designate the terms of and issue new series of preferred stock,
 
    advance notice requirements for nominations for election to the board of directors, and
 
    special voting requirements for the amendment of our charter and bylaws.

     We are also subject to anti-takeover provisions under Delaware law, each of which could delay or prevent a change of control. Together these provisions and the rights plan may make more difficult the removal of management and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for common stock.

Item 3 Quantitative and Qualitative Disclosures about Market Risk

     The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold

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a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities. The average duration of all of our investments in 2002 and for the first three months of 2003 was less than one year. Due to the short-term nature of these investments, we believe we have no material exposure to interest rate risk arising from our investments. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair market value of our interest sensitive financial investments. Declines in interest rates over time will, however, reduce our investment income, while increases in interest rates over time will increase our interest expense.

     We have operated primarily in the United States and have had no sales to date. Accordingly, we have not had any significant exposure to foreign currency rate fluctuations. Visionex’s functional currency is the Singapore dollar and a portion of Visionex’s business is conducted in currencies other than the Singapore dollar. However, Visionex’s operations were wound down during the third quarter of 2002 and we currently have no plans to substantially increase Visionex’s activity. As a result, we do not expect our foreign currency translation gains or losses to be material. We do not currently engage in foreign exchange hedging transactions to manage our foreign currency exposure.

Item 4 Controls and Procedures

  a)   Evaluation of Disclosure Controls and Procedures. Within the 90 days prior to the date of this quarterly report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 240.13a-14. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our current disclosure controls and procedures are effective in timely alerting them to material information relating to us and our subsidiaries required to be included in our periodic SEC filings.
 
  b)   Changes in Internal Controls. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out this evaluation.

PART II OTHER INFORMATION

Item 1 Legal Proceedings

     From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. We currently are not a party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on our results of operations or financial position.

Item 6 Exhibits and Reports on Form 8-K

  (a)   Exhibits

      See Exhibit Index

  (b)   Reports on Form 8-K

          On March 18, 2003 we filed a Form 8-K attaching a press release announcing that the U.S. Food and Drug Administration’s Dermatologic and Ophthalmic Drug Advisory Committee reviewed the Registrant’s Vitrase® product (ovine hyaluronidase) for the treatment of vitreous hemorrhage

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Signatures

     Pursuant to the requirements of the Securities Exchange Act of 1934, ISTA Pharmaceuticals, Inc. has duly caused this 10-Q report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, County of Orange, State of California, on this 15th day of May 2003.

     
    ISTA PHARMACEUTICALS, INC.
   
    (Registrant)
     
    /s/ Vicente Anido, Jr., Ph.D.

Vicente Anido, Jr., Ph.D.
    President and Chief Executive Officer
     
    /s/ Lauren P. Silvernail

Lauren P. Silvernail
    Chief Financial Officer and
    Vice President, Corporate Development

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CERTIFICATION OF CHIEF EXECUTIVE OFFICER

I, Vicente Anido, Jr., Ph.D., certify that:

1.   I have reviewed this quarterly report on Form 10-Q of ISTA Pharmaceuticals, Inc.;
 
2.   Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3.   Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

  a.   Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
  b.   Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
  c.   Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the evaluation functions):

  a.   All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
  b.   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and
 

6.   The registrant’s other certifying officer and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 15, 2003

/s/ Vicente Anido, Jr., Ph.D.


Vicente Anido, Jr., Ph.D.
President and Chief Executive Officer

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CERTIFICATION OF CHIEF FINANCIAL OFFICER

I, Lauren P. Silvernail, certify that:

1.   I have reviewed this quarterly report on Form 10-Q of ISTA Pharmaceuticals, Inc.;
 
2.   Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
 
3.   Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
 
4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

  a.   Designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
 
  b.   Evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
 
  c.   Presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the evaluation functions):

  a.   All significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
 
  b.   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.   The registrant’s other certifying officer and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 15, 2003

/s/ Lauren P. Silvernail


Lauren P. Silvernail
Chief Financial Officer &
Vice President, Corporate Development

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INDEX TO EXHIBITS

     
Exhibit    
Number   Description

 
10.1   Executive Employment Agreement between Lauren P. Silvernail and the Registrant, dated February 10, 2003
     
99.1   President and Chief Executive Officer’s Certification Pursuant to Section 1350, Chapter 63 of Title 18 of the United States Code, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
     
99.2   Chief Financial Officer and Vice President, Corporate Development’s Certification Pursuant to Section 1350, Chapter 63 of Title 18 of the United States Code, as adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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