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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Mark One

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2003

Or

FOR THE TRANSITION PERIOD FROM                      TO

Commission File Number: 000-31255

ISTA PHARMACEUTICALS, INC.

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 August 1, 2003 was 13,319,604.

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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)

Note: The balance sheet at December 31, 2002 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

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

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ISTA Pharmaceuticals, Inc.
Condensed Consolidated Statements of Cash Flows
(In thousands, unaudited)

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ISTA Pharmaceuticals, Inc.
Notes to Unaudited Condensed Consolidated Financial Statements
June 30, 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. In addition, ISTA is developing Vitrase® for use as a spreading agent to facilitate the dispersion and absorption of other drugs. 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 June 30, 2003, the Company had approximately $25.1 million in cash and short-term investments. The Company incurred a net loss of $11.4 million for the six months ended June 30, 2003 and had an accumulated deficit of $133.8 million at June 30, 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 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®, for ophthalmic uses in the posterior segment of the eye, 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 six-month period ended June 30, 2003 and 2002 was $11,358,000 and $11,303,000, 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 Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure”, which (i) amends SFAS No. 123, “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. 123 fair value method and (ii) amends APB Opinion No. 28, “Interim Financial Reporting” to call for disclosure of SFAS No. 148 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 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.

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     As required under SFAS No. 123 and SFAS No. 148, the pro forma effects of stock-based compensation on net loss and net loss 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:

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 Investment in Public Equity

     On November 19, 2002, the Company consummated a private investment in public equity (“PIPE”) transaction, involving a private placement of 10,526,306 shares of its common stock for the aggregate gross 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

     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.

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     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 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.

     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

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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®, for the treatment of vitreous hemorrhage, will be manufactured for us through our contract manufacturer and marketed by Allergan, Inc. 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. In addition, we are pursuing market approval in the United States for Vitrase® for use as a spreading agent to facilitate the dispersion and absorption of other drugs. 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 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 June 30, 2003 of $133.8 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 October 2002, we submitted to the FDA a New Drug Application (“NDA”) for Vitrase® for the treatment of vitreous hemorrhage.

     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® for the treatment of vitreous hemorrhage. The FDA requested additional analysis of the existing data and an additional confirmatory clinical study based upon that analysis. We are discussing with the FDA the comments contained in the “approvable” letter and, based upon those discussions, will determine the next appropriate steps in the review and approval process of Vitrase® for the treatment of vitreous hemorrhage.

     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®, for ophthalmic uses in the posterior region of the eye, 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

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of Allergan’s requirements for Vitrase® for these markets. If we are successful in obtaining regulatory approval for Vitrase® in these markets 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® for ophthalmic uses in the posterior segment of the eye in Japan, and we will be responsible for supplying all of Otsuka’s requirements for Vitrase® for this market. 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®.

     In July 2003, we announced that we had been granted United States patent number 6,551,590 B2 covering the use of certain preparations of hyaluronidase derived from any source (including bovine and ovine sources) for ophthalmic administration and enzymatic methods for accelerating the clearance of hemorrhagic blood from the vitreous body of the eye. Previously, we were granted United States patent number 5,866,120 in July 1999 and United States patent number 6,039,943 in March 2000, both covering methods for clearing blood from the vitreous humor using hyaluronidase.

     In August 2003, we submitted to the FDA a second NDA for Vitrase® for use as a spreading agent to facilitate the dispersion and absorption of other drugs. In addition, in the Dosage and Administration section of this second Vitrase® NDA, we are seeking approval from the FDA to provide directions for reconstitution of Vitrase® for potential treatment applications in the back of the eye. The product submitted in the second NDA is the same package configuration as the original NDA. The dose used as a spreading agent is different than the dose used for injection to the back of the eye. With respect to the second Vitrase® NDA, we may pursue different package configurations of the product over time to facilitate product utilization, improve profit margins and aid in third party reimbursement.

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 one-a-day liquid 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. 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. In July 2003, the FDA issued an “approvable” letter with respect to the ISTALOL™ NDA citing issues related to manufacturing methods and controls. No additional clinical studies were requested. We believe the issues cited by the FDA are addressable and we are also seeking qualification of an alternative manufacturing site. We are currently conducting 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 once-a-day liquid 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.

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     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. In July 2003, the FDA issued an “approvable” letter with respect to the ISTALOL™ NDA citing issues related to manufacturing methods and controls. No additional clinical studies were requested. We believe the issues cited by the FDA are addressable and we are also seeking qualification of Bausch & Lomb as an alternative manufacturing site.

     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 Bausch & 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’s market potential, other product opportunities and our corporate priorities.

     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 June 30, 2003 and 2002

     Revenue. Revenue of $70,000 for both the three months ended June 30, 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 June 30, 2003 were $3.9 million compared to $4.5 million for the three months ended June 30, 2002. The decrease of $600,000 is principally due to the immediate write off in the second quarter of 2002 of acquisition costs associated with the asset purchase of three late stage development compounds (ISTALOL™, bromfenac, and Caprogel®) from AcSentient, Inc. As of the date these compounds were acquired, they had not achieved feasibility and there was no significant alternative future use should our development efforts prove unsuccessful. Accordingly, we recorded an acquired in-process research and development charge of $1.7 million in the second quarter of 2002. Exclusive of this one-time expense, the $1.1 million increase in research and development costs in the second quarter of 2003 as compared to the same period last year is primarily attributable to increased development and/or manufacturing spending related to Vitrase®, ISTALOL™, and bromfenac.

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     Selling, general and administrative expenses. Selling, general and administrative expenses were $2.3 million for the three months ended June 30, 2003 compared to $2.2 million for the three months ended June 30, 2002. The increase in selling, general and administrative expenses is primarily due to additional personnel and facilities expenses in 2003 compared to 2002.

     Interest income. Interest income was $94,000 for the three months ended June 30, 2003 compared to $43,000 for the three months ended June 30, 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 $1,000 for the three months ended June 30, 2003 and there was no interest expense for the three months ended June 30, 2002. The interest expense was primarily attributable to the financing of our directors’ and officers’ insurance premiums during the three months ended June 30, 2003.

Six Months Ended June 30, 2003 and 2002

     Revenue. Revenue of $139,000 and $140,000 for the six months ended June 30, 2003 and the six months ended June 30, 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 were $7.4 million for the six months ended June 30, 2003 and remained flat at $7.4 million for the six months ended June 30, 2002. During the six months ended June 30, 2002, we incurred an immediate write off of acquisition costs associated with the asset purchase of three late stage development compounds (ISTALOL™, bromfenac, and Caprogel®) from AcSentient, Inc. As of the date these compounds were acquired, they had not achieved feasibility and there was no significant alternative future use should our development efforts prove unsuccessful. Accordingly, we recorded an acquired in-process research and development charge of $1.7 million during the six months ended June 30, 2002. Exclusive of this one-time expense, the $1.7 million increase in research and development costs during the six months ended June 30, 2003 as compared to the same period last year is primarily attributable to increased development and/or manufacturing spending related to Vitrase®, ISTALOL™, and bromfenac.

     Selling, general and administrative expenses. General and administrative expenses were $4.4 million for the six months ended June 30, 2003 compared to $4.2 million for the six months ended June 30, 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 & officers insurance that went into effect during the last half of 2002.

     Interest income. Interest income was $209,000 for the six months ended June 30, 2003 compared to $130,000 for the six months ended June 30, 2002. The increase in interest income was attributable to higher cash balances during the first six months of 2003 compared to the first six months of 2002.

     Interest expense. Interest expense was $6,000 for the six months ended June 30, 2003 and there was no interest expense for the six months ended June 30, 2002. The interest expense was primarily attributable to the financing of our directors’ and officers’ insurance premiums during the six months ended June 30, 2003.

Liquidity and Capital Resources

     As of June 30, 2003, we had approximately $25.1 million in cash and short-term investments.

     We have financed our operations since inception primarily through private equity sales and the 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.

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     For the six months ended June 30, 2003, we used $10.6 million of cash for operations principally as a result of the net loss of $11.4 million partially offset by non-cash compensation expense of $556,000 related to the amortization of our deferred stock-based compensation. We used approximately $10.1 million of cash for operations in the six months ended June 30, 2002.

     For the six months ended June 30, 2003, we used $6.6 million of cash for investing activities, primarily to purchase marketable securities. For the six months ended June 30, 2002, we used $1.1 million for investing activities, primarily to purchase marketable securities.

     For the six months ended June 30, 2003, we received $84,000 from financing activities, primarily from the exercise of stock options. For the six months ended June 30, 2002, we received $107,000 from financing activities, primarily from the exercise of stock options.

     We may be required to raise additional capital in the future through collaborative agreements, PIPE related financing, and various other public or private 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 our product candidates, including 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 Pharmaceutical Co., Ltd. for obtaining regulatory approval for ISTALOL™.

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     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. The FDA has also issued an “approvable” letter with respect to the ISTALOL™ NDA citing issues related to manufacturing methods and controls. While we believe these issues are addressable, there can be no assurance that the FDA will accept our responses to these issues or will otherwise approve the NDA for ISTALOL™.

     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

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     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 intend to rely on Allergan, Inc. in the United States and Otsuka Pharmaceuticals, Co. Ltd. in Japan, to respectively market Vitrase® for ophthalmic uses for the posterior region of the eye. 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 June 30, 2003, our accumulated deficit was $133.8 million, including a net loss of approximately $23.0 million for the year ended December 31, 2002 and a net loss of $11.4 million for the six months ended June 30, 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 June 30, 2003, we had approximately $25.1 million in cash and short-term investments and working capital of $22.3 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 Co., Ltd., 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

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manufacturing services agreement with Bausch & 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 & 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.

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® for ophthalmic uses for the posterior region of the eye, and with Senju Pharmaceutical Co., Ltd. relating to ISTALOL™ and bromfenac. If we obtain regulatory approval for Vitrase® for any such uses in the United States and Europe, we will be dependent on Allergan for the commercialization of Vitrase® for such approved uses in the United States and Europe. We will depend on Otsuka for obtaining regulatory approval of Vitrase® for any such uses in Japan, and if such approval is obtained, we will be dependent upon Otsuka for the commercialization of Vitrase® for such approved uses in Japan. We will also be dependent on Senju 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 our 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 & Lomb. We have 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.

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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.

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 Co. Ltd. (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.

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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.

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

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     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 June 30, 2003 was approximately 17,530 shares, and the average daily number of transactions was approximately 62 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.

Future sales of shares of our common stock 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 expired 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 common stock or other equity securities, including but not limited to 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.

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     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 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 six 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

     Evaluation of Disclosure Controls and Procedures. As of the end of the fiscal quarter ended June 30, 2003, 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.

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 April 9, 2003 we filed a Form 8-K attaching a press release announcing that the U.S. Food and Drug Administration had issued an approvable letter regarding the Registrant’s New Drug Application for Vitrase® (ovine hyaluronidase) for the treatment of vitreous hemorrhage.

     On April 9, 2003 we filed a Form 8-K attaching a Certificate of Correction of Restated Certificate of Incorporation, filed with the Delaware Secretary of State March 31, 2003.

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     On April 23, 2003 we filed a Form 8-K attaching a press release relating to the Registrant’s financial results for the quarter ended March 31, 2003.

     On April 25, 2003 we filed a Form 8-K/A attaching a press release revising certain information contained in the press release attached a part of the Form 8-K filed on April 23, 2003.

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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 14th day of August 2003.

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INDEX TO EXHIBITS

[ADD 2000 STOCK PLAN]

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