Insite Vision (INSV) 10-Q 2005 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

OR

o  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 0-22332

INSITE VISION INCORPORATED

(Exact name of registrant as specified in its charter)

Delaware	94-3015807
(State or other jurisdiction	(IRS Employer
of incorporation or organization)	Identification No.)
965 Atlantic Avenue, Alameda, California	94501
(Address of principal executive offices)	(Zip Code)

Registrant's telephone number, including area code (510) 865-8800

Former name, former address and former fiscal year, if changed since last report.

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

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

APPLICABLE ONLY TO CORPORATE ISSUERS:

The number of shares of Registrant’s common stock, $0.01 par value, outstanding as of October 31, 2005: 78,918,239.

QUARTERLY REPORT ON FORM 10-Q

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005

TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets at
	September 30, 2005 and December 31, 2004	1
	Condensed Consolidated Statements of Operations
	for the three and nine months ended September 30, 2005 and 2004	2
	Condensed Consolidated Statements of Cash Flows
	for the nine months ended September 30, 2005 and 2004	3
	Notes to Condensed Consolidated Financial Statements	4
Item 2.	Management’s Discussion and Analysis of
	Financial Condition and Results of Operations	8
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25
Item 4.	Controls and Procedures	25
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	25
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	25
Item 3.	Defaults Upon Senior Securities	25
Item 4.	Submission of Matters to a Vote of Security Holders	26
Item 5.	Other Information	26
Item 6.	Exhibits	26
Signatures		26

PART I FINANCIAL INFORMATION

Item 1.Financial Statements

InSite Vision Incorporated

Condensed Consolidated Balance Sheets

(Unaudited)

	September 30,		December 31,
(in thousands, except share and per share amounts)		2005		2004

Assets
Current assets:
Cash and cash equivalents	$	3,258		$	5,351
Restricted cash		-			170
Inventories, net		17			18
Prepaid expenses and other current assets		51			71
Total current assets		3,326			5,610
Property and equipment, at cost:
Laboratory and other equipment		179			288
Leasehold improvements		73			73
		252			361
Accumulated depreciation		126			275
		126			86
Total assets	$	3,452		$	5,696
Liabilities and stockholders' equity
Current liabilities:
Short-term notes payable to related parties, unsecured	$	92		$	91
Short-term notes payable to related parties, secured		235			251
Accounts payable		857			574
Accrued liabilities		1,324			787
Accrued compensation and related expense		403			317
Deferred rent		56			75
Total current liabilities		2,967			2,095
Commitments
Stockholders’ equity
Common stock, $0.01 par value, 120,000,000 shares authorized;
78,918,239 issued and outstanding at September 30, 2005;
62,381,808 issued and outstanding at December 31, 2004		789			624
Additional paid-in capital		132,243			124,400
Notes receivable from stockholder		(168	)		(187	)
Accumulated deficit		(132,379	)		(121,236	)
Stockholders’ equity		485			3,601
Total liabilities and stockholders' equity	$	3,452		$	5,696

__________________________________________________________

See accompanying notes to condensed consolidated financial statement.

1

InSite Vision Incorporated

Condensed Consolidated Statements of Operations

(Unaudited)

	Three months ended September 30,						Nine months ended September 30,
(in thousands, except per share amounts)	2005			2004			2005			2004
Contract and product revenues	$	1		$	49		$	3		$	541
Cost of goods		3			3			11			11
Operating expenses:
Research and development		2,663			2,605			8,222			4,956
Selling, general and administrative		823			781			2,909			2,586
Total		3,486			3,386			11,131			7,542
Loss from operations		(3,488	)		(3,340	)		(11,139	)		(7,012	)
Gain on sale of assets		--			--			--			4,616
Interest (expense) and other income, net		--			--			(4	)		(43	)
Net loss applicable to common stockholders	$	(3,488	)	$	(3,340	)	$	(11,143	)	$	(2,439	)
Net loss per share applicable to common stockholders,
basic and diluted	$	(0.04	)	$	(0.05	)	$	(0.16	)	$	(0.06	)
Shares used to calculate net loss per share applicable
to common shareholders, basic and diluted		78,903			62,371			70,698			43,667

No cash dividends were declared or paid during the periods presented.

__________________________________________________________

See accompanying notes to condensed consolidated financial statements.

2

InSite Vision Incorporated

Condensed Consolidated Statements of Cash Flows

(Unaudited)

	Nine months ended Sept 30,
(in thousands)	2005			2004
Operating activities
Net income (loss)	$	(11,143	)	$	(2,439	)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization		52			150
Stock based compensation		11			66
Non-cash interest expense		4			20
Gain on sale of assets		-			(4,616	)
Changes in:
Inventories, prepaid expenses and other current assets		21			29
Accounts payable, accrued liabilities, accrued compensation and related expense, and deferred rent		637			(870	)
Net cash used in operating activities		(10,418	)		(7,660	)
Investing activities
Reduction in restricted cash		170			-
Purchases of property and equipment		(92	)		(9	)
Net cash provided by investing activities		78			(9	)
Financing activities
Issuance of common stock, net		8,247			15,120
Note payment received from stockholder		-			21
Payment of notes payable		-			(647	)
Payment on capital lease obligations		-			(10	)
Net cash provided by financing activities		8,247			14,484
Net decrease in cash and cash equivalents		(2,093	)		6,815
Cash and cash equivalents, beginning of period		5,351			1,045
Cash and cash equivalents, end of period	$	3,258		$	7,860

__________________________________________________________

See accompanying notes to condensed consolidated financial statements.

3

InSite Vision Incorporated

Notes to Condensed Consolidated Financial Statements

September 30, 2005

(Unaudited)

Note 1 -Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2005 are not necessarily indicative of the results that may be expected for any future period.  

The Company operates in one segment, using one measure of profitability to manage its business.  Revenues are primarily from one customer located in the United States and all of the Company's long-lived assets are located in the United States.

These condensed consolidated financial statements and notes should be read in conjunction with our audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2004.

Critical Accounting Policies and Use of Estimates

Stock-Based Compensation. The Company has elected to continue to follow the intrinsic value method of accounting as prescribed by Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees,” to account for employee and director stock options. Accordingly, the Company does not recognize compensation expense for options granted to employees and directors at an exercise price equal to the fair value of the underlying common stock.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting requirements and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee and director stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in the Company’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of such stock options.

Pro forma information regarding net income (loss) and net income (loss) per share is required by Statement of Financial Standards (SFAS) No. 123, “Accounting for Stock Based Compensation,” as amended by SFAS No. 148, and has been determined as if we had accounted for our employee and director stock options under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the quarters ended September 30, 2005 and 2004, risk-free interest rates ranging from 1.63% to 4.34%; volatility factors for the expected market price of our common stock of 1.04 and 1.06; and a weighted-average expected life for the options of 4 years. The following weighted-average assumptions were used to estimate the fair value for these options for the nine months ended September 30, 2005 and 2004, risk-free interest rates ranging from 0.91% to 4.93%; volatility factors for the expected market price of our common stock of 1.04 and 1.07; and a weighted-average expected life for the options of 4 years.

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The following table illustrates the effect on net income (loss) and net income (loss) per share as if we had applied the fair value recognition provisions of SFAS 123 to stock based employee and director compensation (in thousands, except per share amounts):

	Quarter Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004
Net income (loss) applicable to common stockholders-as reported	$	(3,488	)	$	(3,340	)	$	(11,143	)	$	(2,439	)
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards		(196	)		(110	)		(377	)		(260	)
Net income (loss) applicable to common stockholders-pro forma	$	(3,684	)	$	(3,450	)	$	(11,520	)	$	(2,699	)
Loss applicable to common stockholders per share:
Basic - as reported	$	(0.04	)	$	(0.05	)	$	(0.16	)	$	(0.06	)
Diluted-as reported	$	(0.04	)	$	(0.05	)	$	(0.16	)	$	(0.06	)
Basic - pro forma	$	(0.05	)	$	(0.06	)	$	(0.16	)	$	(0.06	)
Diluted-pro forma	$	(0.05	)	$	(0.06	)	$	(0.16	)	$	(0.06	)

The weighted average grant date fair value of options granted during the quarters ended September 30, 2005 and 2004 were $0.63 and $0.56 respectively. The weighted average grant date fair value of options granted during the nine months ended September 30, 2005 and 2004 were $0.63 and $0.78, respectively.

For purposes of pro forma disclosures pursuant to SFAS 123 as amended by SFAS 148, the estimated fair value of options is amortized as an expense over the options’ vesting period.

The pro forma impact of options on the net income (loss) for the quarters ended September 30, 2005 and 2004 is not representative of the effects on net income (loss) for future quarters, as future quarters will include the effects of additional stock grants.

Income (Loss) per Share. Basic and diluted net income (loss) per share information for all periods is presented pursuant to the requirements of SFAS No. 128, “Earnings per Share.” Basic income (loss) per share has been computed using the weighted-average number of common shares outstanding during the period. Dilutive income (loss) per share is computed using the sum of the weighted-average number of common shares outstanding and the potential number of dilutive common shares outstanding during the period. Potential common shares consist of the shares issuable upon exercise of stock options, warrants and convertible securities.

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The following table sets forth the computation of basic and diluted net income (loss) per share:

	Three months ended September 30,						Nine months ended September 30,
(in thousands, except per share amounts)	2005			2004			2005			2004
Numerator:
Net income (loss)	$	(3,488	)	$	(3,340	)	$	(11,143	)	$	(2,439	)
Non-cash preferred stock dividend		-			-			-			-
Net income (loss) applicable to common stockholders	$	(3,488	)	$	(3,340	)	$	(11,143	)	$	(2,439	)
Denominator:
Weighted-average shares outstanding for basic income (loss) per share		78,903			62,371			70,698			43,667
Effect of dilutive securities:
Stock options and warrants		-			-			-			-
Weighted-average shares outstanding for diluted income (loss) per share		78,903			62,371			70,698			43,667
Basic net income (loss) per share	$	(0.04	)	$	(0.05	)	$	(0.16	)	$	(0.06	)
Diluted net income (loss) per share	$	(0.04	)	$	(0.05	)	$	(0.16	)	$	(0.06	)

Due to the net loss applicable to common stockholders, loss per share for the three and nine months ended September 30, 2005 is based on the weighted average number of common shares only, as the effect of including equivalent shares from stock options would be anti-dilutive. If the Company had recorded net income, the calculation of earnings per share would have been impacted by the dilutive effect of the outstanding stock options priced below the market price of the common shares at September 30, 2005 but would not have been affected by the outstanding stock options and warrants priced above the market price of the common shares at September 30, 2005. The following securities have not been included in the calculation of diluted net income (loss) per share as their inclusion would have been anti-dilutive:

	Three months ended			Nine months ended
	September 30,			September 30,
		2005	2004		2005	2004
Stock options		5,382,614	3,753,493		5,382,614	3,753,493
Warrants		23,383,046	17,830,546		23,383,046	17,830,546
		28,765,660	21,584,039		28,765,660	21,584,039

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Note 2 - Common Stock

On May 26, 2005, the Company received, net of placement fees, approximately $8.2 million from a private placement. The Company issued 16,363,626 shares of Common Stock and warrants to purchase 4,909,077 shares of Common Stock at an exercise price of $0.6325 per share. The Company also issued warrants to purchase 818,181 shares of Common Stock at an exercise price of $0.6325 per share to the placement agent. These warrants were valued using a Black-Scholes option pricing model, assuming no dividend yield, with the following assumptions: risk-free interest rate of 2.32%, volatility of 1.0435 and an expected life of 5 years, resulting in the recording of a stock issue cost of approximately $2.4 million for the warrants issued to the investors in the private placement and $0.4 million for the warrants issued to the placement agent.

In January 2005, the Company received approximately $9,000 from the exercise of warrants to purchase 11,758 shares of Common Stock issued as part of the March 2004 private placement. Additionally, in January 2005, the Company received approximately $50,000 from the exercise of warrants to purchase 125,000 shares of Common Stock issued in November 2003. In August 2005, the Company received approximately $10,000 from the exercise of an employee stock option to purchase 25,000 shares of Common Stock.

Note 3 - Legal Settlement

On July 8, 2004, Bristol Investment Group, or Bristol, filed with the American Arbitration Association (“AAA”) a demand for arbitration against us seeking cash compensation and warrants based on a letter agreement dated January 28, 2003 pursuant to which Bristol was engaged as a non-exclusive placement agent of investment capital for us.  On October 6, 2005 the arbitrator issued the final award in favor of Bristol, ruling that Bristol is entitled to recover $249,925, plus interest, attorneys’ and other fees, plus Bristol has the right to purchase for $922.80 a five-year, net-exerciseable warrant to purchase 922,800 shares of our common stock at an exercise price of $0.50 per share. As of September 30, 2005, we have recorded an accrued liability with respect to this arbitration award, of which the attorneys’ and other fees have been reflected in selling, general and administrative expenses and the remainder of which was recorded as a stock issuance cost in additional paid-in-capital. The warrants were valued using a Black-Scholes option pricing model, assuming no dividend yield, with the following assumptions: risk-free interest rate of 4.18%, volatility of 1.04 and an expected life of 5 years, resulting in the recording of a stock issue cost of approximately $467,000. Following the issuance of the final arbitration award, the cash arbitration award was paid to Bristol and the right to purchase the warrant for 922,800 shares was exercised. We have agreed to register the shares of common stock underlying the warrant by filing a registration statement on Form S-3 with the SEC by December 10, 2005.

Note 4 - Recent Accounting Pronouncements

In April 2005, the Securities and Exchange Commission approved a new rule that delays the effective date of SFAS 123R “Share-Based Payment” to the first annual reporting period beginning after June 15, 2005. SFAS 123R requires the measurement of all share-based payments to employees, including grants of stock options, using a fair-value-based method and the recording of such expense in the consolidated statements of operations. The Company is currently planning to implement SFAS 123R effective with the first quarter of the fiscal year ending December 31, 2006.

In May 2005, SFAS No. 154, “Accounting Changes and Error Corrections,” was issued. This statement applies to all voluntary changes in accounting principle and requires retrospective application to prior periods’ financial statements of changes in accounting principle, unless this would be impracticable. This statement also makes a distinction between “retrospective application” of an accounting principle and the “restatement” of financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company is evaluating the effect the adoption of this interpretation will have on its financial position, cash flows and results of operations.

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

Except for the historical information contained herein, all statements in the following discussion in this Quarterly Report on Form 10-Q are forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this document should be read as applicable to all related forward-looking statements wherever they appear in this document. Our actual results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include those discussed below in "Risk Factors," as well as those discussed elsewhere herein. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence or identification of previously unanticipated or unidentified events.

The following discussion should be read in conjunction with the financial statements and notes thereto included in this Quarterly Report and in our Annual Report on Form 10-K for the year ended December 31, 2004.

Overview

We are an ophthalmic product development company focused on ophthalmic pharmaceutical products based on our proprietary DuraSite® eyedrop-based drug delivery technology, as well as developing genetically-based technologies for the diagnosis, prognosis and management of glaucoma.

·   We face significant challenges related to our lack of financial resources. We only expect our current cash to enable us to continue our operations as currently planned until approximately the middle of December 2005.

On May 26, 2005, we sold 16,363,626 shares of Common Stock at $0.55 per share and warrants to purchase 4,909,077 shares of Common Stock in a private placement. The warrants have a term of 5 years and have an exercise price of $0.6325 per share. The proceeds, net of placement fees, were approximately $8.2 million. We also issued warrants to purchase 818,181 shares of Common Stock at an exercise price of $0.6325 per share to the placement agent.

With our existing resources we are focusing our research and development and commercial efforts on the following:

·   AzaSite (ISV-401), a DuraSite formulation of azithromycin, a broad spectrum antibiotic;

·   AzaSite Plus (ISV-502), a DuraSite formulation of azithromycin and a steroid for inflammation; and

·   targeted activities to support the scientific/clinical foundation of our OcuGene glaucoma genetic test based on our ISV-900 technology.

AzaSite (ISV-401). We have developed a topical formulation of the antibiotic azithromycin, an antibiotic with a broad spectrum of activity that is widely used to treat respiratory and other infections in its oral and parenteral forms, to treat bacterial conjunctivitis and other infections of the outer eye. We believe that the key advantages of AzaSite may include a significantly reduced dosing regimen (9 doses vs. 21 - 36 doses for comparable products), enabled by the high and persistent levels of azithromycin achieved in the tissues of the eye and its wide spectrum of activity. Product safety and efficacy have been shown, respectively, in Phase 1 and Phase 2 clinical trials. The Phase 2 study compared an AzaSite formulation containing 1% azithromycin to a placebo. The results of this study showed that the AzaSite formulation was more effective than the placebo in bacterial eradication and clinical cure, which includes reduction in inflammation and redness.

8

In July 2004, we initiated two pivotal Phase 3 clinical trials for AzaSite. One of the Phase 3 clinical trials is a multi-center study in which patients in one arm are being dosed with a 1% AzaSite formulation and the patients in the second arm are being dosed with a placebo. This study was designed to include approximately 550 patients, of which 224 must be confirmed positive for acute bacterial conjunctivitis in at least one eye. The other Phase 3 clinical trial is a multi-center study in which patients in one arm were dosed with a 1% AzaSite formulation and the patients in the second arm were dosed with a 0.3% formulation of the antibiotic tobramycin. This study was designed to include approximately 775 patients, of which 310 must be confirmed positive for acute bacterial conjunctivitis in at least one eye. The Phase 3 trials are being conducted in the United States and Latin America and we include both children and adults to permit aggressive enrollment of the subjects necessary to complete the studies. In October 2004, we announced that over 100 of the centers at which the clinical trials are being conducted have been activated and are enrolling patients in the two clinical trials. The primary endpoint of both trials will be clinical cure with a second endpoint of bacterial eradication. In September 2005, we announced the completion of enrollment for the clinical trial of AzaSite and tobramycin. Clinical data from that trial is anticipated to be announced before the end of November 2005.

In 2003, we secured a new source for the active ingredient used in AzaSite and in March 2005 we signed a commercial supply agreement with this source that provides for supply of the active ingredient for an initial nine year period, which may be extended. In September 2005 we signed a contract-manufacturing agreement with Cardinal Health for production of commercial units. Cardinal Health manufactured our clinical trial supplies and registration batches under the supervision of our personnel. The registration batches needed to support the filing of the New Drug Application, or NDA, for AzaSite with the United States Food and Drug Administration, or FDA, were manufactured under this arrangement in the fourth quarter of 2004. We anticipate that our contract manufacturing facility at Cardinal Heath will be ready for inspection by the FDA at the time of our NDA submission.

OcuGene. Our OcuGene glaucoma genetic test is focused on discovering genes that are associated with glaucoma, and the mutations on these genes that cause and regulate the severity of the disease and has been pursued in collaboration with academic researchers. In June 2003, a peer-reviewed study was published in Clinical Genetics titled "Association of the Myocilin mt.1 Promoter Variant with the Worsening of Glaucomatous Disease Over Time," (2003: 64: 18-27). "The results of this study indicate substantial evidence that the TIGR/MYOC mt.1(+) variant provides a strong marker for accelerated worsening of both optic disc and visual field measures of glaucoma progression above and beyond other baseline risk factors," stated one of the authors of the study, Jon Polansky, M.D., University of California, San Francisco, who also served on our Scientific Advisory Board.

In 2003, the information from this article and previous publications was used to target specific thought leaders and ophthalmic centers in an effort to support the focused introduction of the OcuGene glaucoma genetic test. In June 2003, expanded marketing efforts were curtailed as we limited our cash use and we have not resumed the marketing efforts as we focus on our AzaSite clinical trials. We have continued our interactions with key European glaucoma specialists on additional studies on the relationship of mt. 1(+) variant and ocular hypertensives and their conversion to glaucoma and other related topics.

ISV-403. In February 2003, we filed an Investigational New Drug Application, or IND with the FDA for our ophthalmic antibiotic product candidate ISV-403, which was the first milestone under the August 2002 license agreement with Bausch & Lomb and resulted in the receipt of $2.0 million from the sale of Series A-1 Preferred Stock. In April 2003, we began a Phase 1 clinical trial of ISV-403 and in June 2003 the dosing for the study was completed. In December 2003, we sold the ISV-403 product candidate to Bausch & Lomb, which resulted in the receipt of $1.5 million in cash, the return of the $4.0 million of Series A-1 Preferred Stock, and the related dividends, to us for cancellation, and provides for royalties on future product sales, if any. During the first nine months of 2004, we provided contract research services to Bausch & Lomb. These activities have been completed and due to the sale, Bausch & Lomb is now responsible for the further clinical development of the product and we are focusing our development efforts on our AzaSite anti-infective product franchise.

From our inception through the end of 2001, we did not receive any revenues from the sale of our products, other than a small amount of royalties from the sale of our AquaSite product, an over-the-counter dry eye treatment, by CIBA Vision and Global Damon. In the fourth quarter of 2001, we commercially launched our OcuGene glaucoma genetic test and early in 2002 we began to receive a small amount of revenues from the sale of this test. With the exception of 1999 and the six month period ended June 30, 2004, we have been unprofitable since our inception due to continuing research and development efforts, including preclinical studies, clinical trials and manufacturing of our product candidates. We have financed our research and development activities and operations primarily through private and public placements of our equity securities, issuance of convertible debentures and, to a lesser extent, from collaborative agreements and bridge loans.

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Results of Operations

Revenues.

We had total net revenues in the third quarter of 2005 and 2004 of $1,000 and $49,000, respectively, and $3,000 and $541,000 for the nine months ended September 30, 2005 and 2004, respectively. In the first nine months of 2005 and 2004, sales of OcuGene represented 100% and 1% of our net revenues, respectively. In the first nine months of 2004, 99% of our net revenues were derived from contract research activities. The decrease in revenue from the first nine months of 2004 to the same period in 2005 is due to contract research activities conducted for Bausch & Lomb in 2004 under the ISV-403 Asset Purchase Agreement in the first six months of 2004. We completed these services in the third quarter of 2004 and no such revenue was earned during 2005. We recognize revenue when all services have been performed and collectibility is reasonably assured. Accordingly, revenue for the sales of OcuGene may be recognized in a later period than the associated recognition of costs of the services provided, especially during the initial launch of the product.

Cost of goods.

Cost of goods of $3,000 and $3,000 for the third quarter of 2005 and 2004 respectively, and $11,000 and $11,000 for the nine months ended September 30, 2005 and 2004, respectively, reflect the cost of OcuGene tests performed as well as the cost of sample collection kits distributed for use.

Research and development.

Research and development expenses increased to $2.7 million during the third quarter of 2005 from $2.6 million during the third quarter of 2004, and increased to $8.2 million from $5.0 million for the first nine months of 2005 compared to the first nine months of 2004. These increases reflect costs related to the AzaSite program including the Phase 3 clinical trials, with payments to clinical research organizations and the testing laboratory used to conduct the trials, as well as consultants to assist with the preparation of the related New Drug Application (NDA).

Selling, general and administrative.

Selling, general and administrative expenses increased to $823,000 in the third quarter of 2005 from $781,000 in the third quarter of 2004. This increase mainly reflects the additional legal fees and related expenses incurred regarding the final settlement of the Bristol arbitration.

Selling, general and administrative expenses increased to $2.9 million during the first nine months of 2005 from $2.6 million during the first nine months of 2004. The increase mainly reflects legal fees incurred in the defense of the Bristol arbitration including the legal fees and other expense reimbursements to be paid to Bristol as part of the arbitration award. Costs incurred for marketing studies related to the AzaSite and AzaSite Plus product candidates were offset by a decrease in the costs incurred related to the 2005 annual meeting of stockholders compared to the prior year including preparation and mailing of the proxy statement and other related materials for the meetings.

Our expenses for the remainder of the year ended December 31, 2005 will be dependent upon the progress of our AzaSite Phase 3 clinical trials and we currently anticipate that our research and development expenses will increase significantly from levels incurred in the year ended December 31, 2004 as we proceed with our AzaSite program. We may also make selective additions to our headcount to further support preparation of our anticipated AzaSite NDA. We anticipate that we will continue to limit activity on our other product candidates absent additional funding as we focus on our AzaSite clinical program. Also, we anticipate that the increase in our selling, general and administrative costs we have incurred in the first three quarters of 2005 will continue at a similar level for the remainder of 2005. We anticipate that the expense reductions related to the scale-back of marketing activities related to OcuGene will continue through the remainder of 2005.

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Interest, other income and expenses.

No net interest, other income and expense was incurred in the third quarter of 2005 or in the third quarter of 2004. Net interest, other income and expense was an expense of $4,000 in the nine months ending September 30, 2005 compared to an expense of $43,000 in 2004. This change principally reflects the interest expense related to the debt discount of convertible debentures incurred before the notes were repaid in 2004 and decreased interest expense due to the lower amount of short-term notes payable in 2005 due to note repayments in 2004.

Liquidity and Capital Resources

We have financed our operations since inception primarily through private placements and public offerings of debt and equity securities, equipment and leasehold improvement financing, other debt financing and payments under corporate collaborations. At September 30, 2005, our cash and cash equivalents balance was $3.3 million. It is our policy to invest our cash and cash equivalents in highly liquid securities, such as interest bearing money market funds, Treasury and federal agency notes and corporate debt. In May 2005, we completed a private placement for approximately $8.2 million, net of placement fees. We only expect our current cash to enable us to continue our operations as currently planned until approximately the middle of December 2005.

Our auditors have included an explanatory paragraph in their audit report relating to our financial statements for our fiscal year ended December 31, 2004 referring to our recurring operating losses and substantial doubt about our ability to continue as a going concern. We will require and are seeking additional funding through collaborative or other partnering arrangements, public or private equity or debt financings, asset sales and from other sources. However, there can be no assurance that we will obtain interim or longer-term financing or that such funding, if obtained, will be sufficient to continue our operations as currently conducted or in a manner necessary for the long-term success of our company. If we raise funds through the issuance of equity securities, our stockholders may suffer substantial dilution. If we raise funds through debt securities, such debt will likely be secured by a security interest or pledge of all or substantially all of our assets, may require us to make principal and interest payments in cash, securities or a combination thereof, would likely include the issuance of warrants and may subject us to restrictive covenants. Dr. Chandrasekaran, our chief executive officer, chief financial officer and a member of our board of directors, has a senior secured note payable from us. This security interest enables Dr. Chandrasekaran to control the disposition of these assets in the event of our liquidation.

Net cash used in operating activities was $10.4 million and $7.7 million for the nine months ended September 30, 2005 and 2004, respectively. The increase in net cash used in operating activities reflected the conduct of the AzaSite Phase 3 clinical trials, which commenced in July 2004. Operating activities in the first nine months of 2004 related primarily to research and development expenditures for our antibiotic program AzaSite and under the research contract with Bausch & Lomb on ISV-403.

Net cash provided by investing activities included the reduction in restricted cash of $170,000 less $92,000 used in the first nine months 2005 for the acquisition of laboratory and other equipment. There were no material investing activities in the first nine months of 2004.

Net cash provided by financing activities was $8.2 million in the first nine months of 2005 compared to $14.5 million in the first nine months of 2004. We received net proceeds of $8.2 million from the issuance of an aggregate of approximately 16.6 million shares of common stock in a May 2005 private placement. In 2004, we received net proceeds of $15.1 million from the issuance of an aggregate of 33.0 million shares of common stock in the initial and final closing of a private placement in March and June, respectively, of 2004. We received $16,000 and $6,000 in the first nine months of 2005 and 2004, respectively from the issuance of our common stock under our employee stock purchase plan and from the exercise of stock options by employees. In the first nine months of 2004, we made $647,000 of payments on our short-term borrowings, including redemption of $17,000 of convertible notes payable, and $10,000 of payments on capital leases for certain laboratory equipment. Additionally, we received $21,000 in the first six months of 2004, respectively, as payment on notes receivable from a stockholder.

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Assuming we are able to obtain additional financing when required to continue our operations, our future capital expenditures and requirements will depend on numerous factors, including the progress and results of our clinical testing, research and development programs (particularly AzaSite) and preclinical testing, the time and costs involved in obtaining regulatory approvals, our ability tosuccessfully commercialize AzaSite and OcuGene and any other products that we may launch in the future, our ability to establish collaborative arrangements, the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights, competing technological and market developments, changes in our existing collaborative and licensing relationships, acquisition of new businesses, products and technologies, the completion of commercialization activities and arrangements, and the purchase of additional property and equipment.

RISK FACTORS

Our current cash will only fund our business until approximately the middle of December 2005. We will need additional funding, either through equity or debt financings or partnering arrangements, that could be further dilutive to our stockholders and could negatively affect us and our stock price

Our independent auditors included an explanatory paragraph in their audit report related to our consolidated financial statements for the fiscal year ended December 31, 2004 referring to our recurring operating losses and a substantial doubt about our ability to continue as a going concern.

We only expect our current cash to enable us to continue our operations as currently planned until approximately the middle of December 2005. At that point, or earlier if circumstances change from our current expectations, we will require additional funding. We cannot assure you that additional funding will be available on a timely basis, or on reasonable terms, or at all. The terms of any securities issued to future investors may be superior to the rights of our then current stockholders and could result in substantial dilution and could adversely affect the market price for our Common Stock. If we raise funds through the issuance of debt securities, such debt will likely be secured by a security interest or pledge of all of our assets, will require us to make principal and interest payments in cash, securities or a combination thereof, would likely include the issuance of warrants, and may subject us to restrictive covenants. If we do not obtain such additional financing when required, we would likely have to cease operations and liquidate our assets. In addition, the existence of the explanatory paragraph in the audit report may in and of itself harm our stock price as certain investors may be restricted or precluded from investing in companies that have received this notice in an audit report. Further, the factors leading to the explanatory paragraph in the audit report may harm our ability to obtain additional funding and could make the terms of any such funding, if available, less favorable than might otherwise be the case.

In addition, we expect to enter into partnering and collaborative arrangements in the future as part of our business plan, regardless of whether we require additional funding to continue our operations. Such arrangements could include the licensing or sale of certain assets or the issuance of securities, which may adversely affect our future financial performance and the market price of our Common Stock and we cannot assure you that such arrangements will be beneficial to us. It is difficult to know our future capital requirements precisely as such requirements depend upon many factors, including:

·   the progress and results of our preclinical and clinical testing, especially results of our ongoing Phase 3 clinical trials for our AzaSite product candidate;

·   the progress of our research and development programs;

·   our ability to establish additional corporate partnerships to develop, manufacture and market our potential products;

·   the outcome of existing or possible future legal actions;

·   the cost of maintaining or expanding a marketing organization for OcuGene and the related promotional activities;

·   changes in, or termination of, our existing collaboration or licensing arrangements;

·   whether we manufacture and market any of our other products ourselves;

·   the time and cost involved in obtaining regulatory approvals;

·   the cost of filing, prosecuting, defending and enforcing patent claims and other intellectual property rights;

·   competing technological and market developments; and

·   the purchase of additional capital equipment.

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If we do not receive additional funding when needed to continue our operations we will likely cease operations and liquidate our assets, which are secured by notes payable to our chief executive officer

In the event that we are unable to secure additional funding when required to continue our operations, we will likely be forced to wind down our operations, either through liquidation, voluntary or involuntary bankruptcy or a sale of our assets. As of September 30, 2005, our chief executive officer had outstanding notes payable from us in an aggregate principal amount of $231,000, which are secured by a lien on substantially all of our assets including our intellectual property. The notes issued by us in connection with these loans are due on the earlier to occur of March 31, 2007 or 10 business days subsequent to the successful completion of a pivotal Phase 3 clinical trial with AzaSite. In the event that we wind down operations, whether voluntarily or involuntarily, while these secured loans are outstanding, this security interest enables our chief executive officer to control the disposition of these assets. If we are unable to repay the amounts due under the secured notes when due, our chief executive officer could cause us to enter into involuntary liquidation proceedings in the event we default on our obligations and could take possession of our assets. If we wind down our operations for any reason, it is likely that our stockholders will lose their entire investment in us.

Clinical trials are very expensive, time-consuming and difficult to design and implement

We commenced two Phase 3 trials of our AzaSite product candidate in the third quarter of 2004. In October 2005 we announced the completion of enrollment in one of the two Phase 3 trials. The AzaSite Phase 3 trials will be expensive and may be difficult to implement due to the number of patients and testing sites and could be subject to delay or failure at any stage of the trials. We expect our current funding will only be sufficient to enable us to continue our operations as currently planned until approximately the middle of December 2005. Accordingly, we will require additional funds to prepare the related clinical reports, obtain the necessary FDA approvals and market the product. Any delay or failure of, or adverse results from, the AzaSite trials will likely require us to obtain even further funding in order to address such delays or failures or to refocus our efforts on other product candidates and such delay, failure or adverse results could make it much more difficult or expensive for us to obtain funding. Human clinical trials for our product candidates are very expensive and difficult to design and implement, in part because they are subject to rigorous regulatory requirements. The clinical trial process is also time-consuming. We estimate that clinical trials of our other product candidates will take at least several years to complete once initiated. Furthermore, we could encounter problems that cause us to abandon or repeat clinical trials, further delaying or preventing the completion of such trials. The commencement and completion of clinical trials may be delayed by several factors, including:

·   unforeseen safety issues;

·   determination of dosing issues;

·   lack of effectiveness during clinical trials;

·   slower than expected rates of patient recruitment;

·   inability to monitor patients adequately during or after treatment; and

·   inability or unwillingness of medical investigators to follow our clinical protocols.

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In addition, we or the FDA may suspend our clinical trials at any time if it appears that we are exposing participants to unacceptable health risks or if the FDA finds deficiencies in our submissions or the conduct of these trials.

The results of our clinical trials may not support our product candidate claims

Even if our clinical trials are completed as planned, we cannot be certain that their results will support our product candidate claims, including with respect to AzaSite. Even if pre-clinical testing and early clinical trials for a product candidate, including AzaSite, are successful, this does not ensure that later clinical trials will be successful, and we cannot be sure that the results of later clinical trials will replicate the results of prior clinical trials and pre-clinical testing or meet our expectations. The clinical trial process may fail to demonstrate that our product candidates, including AzaSite, are safe for humans or effective for indicated uses. Any such failure would likely cause us to abandon the product candidate and may delay development of other product candidates. Any delay in, or termination of, our clinical trials will delay or preclude the filing of our NDAs with the FDA and, ultimately, our ability to commercialize our product candidates and generate product revenues. For example, if our current AzaSite Phase 3 trials do not produce positive results or we are otherwise unable to obtain FDA approval for the commercialization of AzaSite, our business would be significantly harmed as we have devoted a significant portion of our resources to this product candidate, at the expense of our other product candidates. In addition, our clinical trials involve relatively small patient populations. Because of the small sample size, the results of these clinical trials may not be indicative of future results.

We may require additional licenses or be subject to expensive and uncertain patent litigation in order to sell AzaSite in the U.S. and/or Europe; We are aware that Pfizer has recently received patents in the U.S. and Europe which cover the use of azithromycin in a topical formulation to treat bacterial infections in the eye

A number of pharmaceutical and biotechnology companies and research and academic institutions have developed technologies, filed patent applications or received patents on various technologies that may be related to our business. Some of these technologies, applications or patents may conflict with our technologies or patent applications. Such conflicts could limit the scope of the patents, if any, we may be able to obtain or result in the denial of our patent applications or block our rights to exploit our technology. In addition, if the USPTO or foreign patent agencies have issued or issue patents that cover our activities to other companies, we may not be able to obtain licenses to these patents at all, or at a reasonable cost, or be able to develop or obtain alternative technology. If we do not obtain such licenses, we could encounter delays in or be precluded altogether from introducing products to the market.

We are aware that Pfizer has been recently issued U.S. Patent No. 6,681,411 by the USPTO and the European Patent Office has granted its European counter part EP 0925789, both of which cover the use of azithromycin in a topical formulation to treat ophthalmic infections. We may require a license under these patents to develop or sell AzaSite for ophthalmic indications in the U.S. and/or Europe, which may not be available on reasonable commercial terms, if at all. If we are unable to obtain a license to these patents, Pfizer brings suit to enforce them, these patents are held valid and enforceable and our technology is deemed to infringe these patents, Pfizer would be entitled to damages and we could be prevented from selling AzaSite in Europe and/or the U.S.

We may need to litigate in order to defend against claims of infringement by Pfizer or others, to enforce patents issued to us or to protect trade secrets or know-how owned or licensed by us. Litigation could result in substantial cost to and diversion of effort by us, which may harm our business. Such costs can be particularly harmful to emerging companies such as ours without significant existing revenue streams or other cash resources. We have also agreed to indemnify our licensees against infringement claims by third parties related to our technology, which could result in additional litigation costs and liability for us. In addition, our efforts to protect or defend our proprietary rights may not be successful or, even if successful, may result in substantial cost to us.

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If our products, methods, processes and other technologies infringe the proprietary rights of other parties, we could incur substantial costs and we may have to:

·   obtain licenses, which may not be available on commercially reasonable terms, if at all;

·   redesign our products or processes to avoid infringement;

·   stop using the subject matter claimed in the patents held by others, which could preclude us from commercializing our products;

·   pay damages; or

·   defend litigation or administrative proceedings which may be costly whether we win or lose, and which could result in a substantial diversion of our valuable management resources.

Our business depends upon our proprietary rights, and we may not be able to protect, enforce or secure our intellectual property rights adequately

Our future success will depend in large part on our ability to obtain patents, protect trade secrets, obtain and maintain rights to technology developed by others, and operate without infringing upon the proprietary rights of others. A substantial number of patents in the field of ophthalmology and genetics have been issued to pharmaceutical, biotechnology and biopharmaceutical companies. Moreover, competitors may have filed patent applications, may have been issued patents or may obtain additional patents and proprietary rights relating to products or processes competitive with ours. Our patent applications may not be approved. We may not be able to develop additional proprietary products that are patentable. Even if we receive patent issuances, those issued patents may not be able to provide us with adequate protection for our inventions or may be challenged by others.

Furthermore, the patents of others may impair our ability to commercialize our products. The patent positions of firms in the pharmaceutical and genetic industries generally are highly uncertain, involve complex legal and factual questions, and have recently been the subject of much litigation. The USPTO and the courts have not developed, formulated, or presented a consistent policy regarding the breadth of claims allowed or the degree of protection afforded under pharmaceutical and genetic patents. Despite our efforts to protect our proprietary rights, others may independently develop similar products, duplicate any of our products or design around any of our patents. In addition, third parties from which we have licensed or otherwise obtained technology may attempt to terminate or scale back our rights.

We also depend upon unpatented trade secrets to maintain our competitive position. Others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets. Our trade secrets may also be disclosed, and we may not be able to protect our rights to unpatented trade secrets effectively. To the extent that we or our consultants or research collaborators use intellectual property owned by others, disputes also may arise as to the rights in related or resulting know-how and inventions.

Our current financial situation may impede our ability to protect or enforce adequately our legal rights under agreements and to our intellectual property

We only expect our current cash to enable us to continue our operations as currently planned until approximately the middle of December 2005. Our limited financial resources make it more difficult for us to enforce our intellectual property rights, through the filing or maintenance of patents, taking legal action against those that may infringe on our proprietary rights, defending infringement claims against us, or otherwise. Our current financial situation may impede our ability to enforce our legal rights under various agreements we are currently a party to or may become a party to due to our inability to incur the costs associated with such enforcement. Our inability to protect our legal and intellectual property rights adequately may make us more vulnerable to infringement and could harm our business.

Physicians and patients may not accept and use our products

Even if the FDA approves our product candidates, physicians and patients may not accept and use them. Acceptance and use of our product will depend upon a number of factors including:

·   perceptions by members of the health care community, including physicians, about the safety and effectiveness of our drugs;

·   cost-effectiveness of our product relative to competing products;

·   the perceived benefits of competing products or treatments;

·   availability of reimbursement for our products from government or other healthcare payers; and

·   effectiveness of marketing and distribution efforts by us and our licensees and distributors, if any.

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Because we expect sales of our current product candidates, if approved, to generate substantially all of our product revenues for the foreseeable future, the failure of any of these drugs, particularly AzaSite, to find market acceptance would harm our business and could require us to seek additional financing.

Questions concerning our financial condition may cause customers and current and potential partners to reduce or not conduct business with us

Our recent and on-going financial difficulties, and concerns regarding our ability to continue operations even if we are able to raise additional funding, may cause current and potential customers and partners to decide not to conduct business with us, to reduce or terminate the business they currently conduct with us, or to conduct business with us on terms that are less favorable than those customarily offered by them. In such event, our sales would likely decrease, our costs could increase, our product development and commercialization efforts would suffer and our business will be significantly harmed.

It is difficult to evaluate our business because we are in an early stage of development and our technology is untested

We are in an early stage of developing our business. We have only received an insignificant amount of royalties from the sale of one of our products, an over-the-counter dry eye treatment, and in 2002 we began to receive a small amount of revenues from the sale of our OcuGene glaucoma genetic test. Before regulatory authorities grant us marketing approval for additional products, we need to conduct significant additional research and development and preclinical and clinical testing, including with respect to our leading product candidate AzaSite. All of our products, including AzaSite, are subject to risks that are inherent to products based upon new technologies. These risks include the risks that our products:

·   are found to be unsafe or ineffective;

·   fail to receive necessary marketing clearance from regulatory authorities;

·   even if safe and effective, are too difficult or expensive to manufacture or market;

·   are unmarketable due to the proprietary rights of third parties; or

·   are not able to compete with superior, equivalent, more cost-effective or more effectively promoted products offered by competitors.

Therefore, our research and development activities including with respect to AzaSite may not result in any commercially viable products.

We have a history of operating losses and we expect to continue to have losses in the future

We have incurred significant operating losses since our inception in 1986 and have pursued numerous drug development candidates that did not prove to have commercial potential. As of September 30, 2005, our accumulated deficit was approximately $132.4 million. We expect to incur net losses for the foreseeable future or until we are able to achieve significant royalties or other revenues from sales of our products. In addition, we recognize revenue when all services have been performed and collectibility is reasonably assured. Accordingly, revenue for the sales of OcuGene may be recognized in a later period than the associated recognition of costs of the services provided, especially during the initial launch of the product. In addition, due to this delay in revenue recognition, our revenues recognized in any given period may not be indicative of our then current viability and market acceptance of our OcuGene product.

Attaining significant revenue or profitability depends upon our ability, alone or with third parties, to develop our potential products successfully, conduct clinical trials, obtain required regulatory approvals and manufacture and market our products successfully. We may not ever achieve or be able to maintain significant revenue or profitability, including with respect to our leading product candidate AzaSite.

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We may not successfully manage our growth

If we are able to raise additional funding and gain FDA approval for additional products, including AzaSite, our success will depend upon the expansion of our operations and the effective management of our growth, which will place a significant strain on our management and on our administrative, operational and financial resources. To manage this growth, we will have to expand our facilities, augment our operational, financial and management systems and hire and train additional qualified personnel. If we are unable to manage our growth effectively, our business would be harmed.

We are dependent upon key employees and we may not be able to retain or attract key employees, and our ability to attract and retain key employees is likely to be harmed by our current financial situation

We are highly dependent on Dr. Chandrasekaran, who is our chief executive officer, president and chief financial officer, and Dr. Lyle Bowman, our vice president, development and operations. The loss of services from either of these key personnel might significantly delay or prevent the achievement of planned development objectives. We carry a $1.0 million life insurance policy on Dr. Chandrasekaran under which we are the sole beneficiary, however in the event of the death of Dr. Chandrasekaran such policy would be unlikely to fully compensate us for the hardship such a loss would cause us. We do not carry a life insurance policy on Dr. Bowman. Furthermore, a critical factor to our success will be recruiting and retaining qualified personnel. Competition for skilled individuals in the biotechnology business is highly intense, and we may not be able to continue to attract and retain personnel necessary for the development of our business. Our ability to attract and retain such individuals may be reduced by our recent and current financial situation and our past reductions in force. For example, during 2003 we laid off approximately 42% of our employees and salaries of our senior management were reduced. Although we have recently increased salaries to their pre-reduction levels and paid performance bonuses, and we are not aware of any plans of our management or scientific personnel to leave us, the voluntary salary reductions and other cost reduction measures we have undertaken in the past or may undertake in the future and our ongoing financial difficulties make it more likely that such individuals will seek other employment opportunities and may leave our Company permanently. The loss of key personnel or the failure to recruit additional personnel or to develop needed expertise could harm our business.

Our strategy for research, development and commercialization of our products requires us to enter into various arrangements with corporate and academic collaborators, licensors, licensees and others; Furthermore, we are dependent on the diligent efforts and subsequent success of these outside parties in performing their responsibilities

Because of our reliance on third parties for the development, marketing and sale of our products, any revenues that we receive will be dependent on the efforts of these third parties, such as our corporate collaborators. These partners may terminate their relationships with us and may not diligently or successfully market our products. In addition, marketing consultants and contract sales organizations, such as those deployed by us currently for OcuGene, or in the future for OcuGene and potential future products such as AzaSite, may market products that compete with our products and we must rely on their efforts and ability to market and sell our products effectively. We may not be able to conclude arrangements with other companies to support the commercialization of our products on acceptable terms, or at all. Moreover, our current financial condition may make us a less attractive partner to potential collaborators. In addition, our collaborators may take the position that they are free to compete using our technology without compensating or entering into agreements with us. Furthermore, our collaborators may pursue alternative technologies or develop alternative products either on their own or in collaboration with others, including our competitors, as a means for developing treatments for the diseases or disorders targeted by these collaborative programs.

Our products are subject to government regulations and approval which may delay or prevent the marketing of potential products and impose costly procedures upon our activities

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The FDA and comparable agencies in state and local jurisdictions and in foreign countries impose substantial requirements upon preclinical and clinical testing, manufacturing and marketing of pharmaceutical products. Lengthy and detailed preclinical and clinical testing, validation of manufacturing and quality control processes, and other costly and time-consuming procedures are required. Satisfaction of these requirements typically takes several years and the time needed to satisfy them may vary substantially, based on the type, complexity and novelty of the pharmaceutical product. The effect of government regulation may be to delay or to prevent marketing of potential products for a considerable period of time and to impose costly procedures upon our activities. The FDA or any other regulatory agency may not grant approval on a timely basis, or at all, for any products we develop. Success in preclinical or early stage clinical trials does not assure success in later stage clinical trials. Data obtained from preclinical and clinical activities are susceptible to varying interpretations that could delay, limit or prevent regulatory approval. If regulatory approval of a product is granted, such approval may impose limitations on the indicated uses for which a product may be marketed. Further, even after we have obtained regulatory approval, later discovery of previously unknown problems with a product may result in restrictions on the product, including withdrawal of the product from the market. Moreover, the FDA has recently reduced previous restrictions on the marketing, sale and prescription of products for indications other than those specifically approved by the FDA. Accordingly, even if we receive FDA approval of a product for certain indicated uses, our competitors, including our collaborators, could market products for such indications even if such products have not been specifically approved for such indications. Additionally, the FDA recently issued an advisory that microarrays used for diagnostic and prognostic testing may need regulatory approval. The need for regulatory approval of multiple gene analysis is uncertain at this time. Delay in obtaining or failure to obtain regulatory approvals would make it difficult or impossible to market our products and would harm our business.

The FDA's policies may change and additional government regulations may be promulgated which could prevent or delay regulatory approval of our potential products. Moreover, increased attention to the containment of health care costs in the United States could result in new government regulations that could harm our business. Adverse governmental regulation might arise from future legislative or administrative action, either in the United States or abroad. See "-Uncertainties regarding healthcare reform and third-party reimbursement may impair our ability to raise capital, form collaborations and sell our products"

We rely on third parties to develop, market and sell our products; we may not be able to continue or enter into third party arrangements, and these third parties' efforts may not be successful

We do not plan on establishing an internal dedicated sales force or a marketing organization for our product candidates. We also rely on third parties for clinical testing or certain other product development activities especially in the area of our glaucoma programs. We are currently pursuing a licensing or collaborative agreement for the sales and marketing of our AzaSite product candidate. There can be no assurances that we will be successful in entering into such an agreement or that a partner would be successful in their efforts, either of which could significantly harm our business.

In order to pursue one of our glaucoma programs ISV-205, which is currently inactive, we must enter into a third party collaboration agreement for the development, marketing and sale or develop, market and sell the product ourselves. There can be no assurance that we will be successful in finding a corporate partner for our ISV-205 program or that any collaboration will be successful, either of which could significantly harm our business. In addition, we have no experience in marketing and selling products and we cannot assure you that we would be successful in marketing ISV-205 ourselves. If we are to develop and commercialize our product candidates successfully, including ISV-205, we will be required to enter into arrangements with one or more third parties that will:

·   provide for Phase 2 and/or Phase 3 clinical testing;

·   obtain or assist us in other activities associated with obtaining regulatory approvals for our product candidates; and

·   market and sell our products, if they are approved.

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In December 2003, we completed the sale of our drug candidate ISV-403 for the treatment of ocular infections to Bausch & Lomb Incorporated. Bausch & Lomb has assumed all future ISV-403 development and commercialization expenses and is responsible for all development activities, with our assistance, as appropriate. The Bausch & Lomb Purchase Agreement and License Agreement grants Bausch & Lomb rights to develop and market ISV-403, subject to payment of royalties, in all geographies except Japan (which were retained by SSP, in connection with a separate license agreement between us and SSP), with such rights being shared with SSP in Asia (except Japan) and exclusive elsewhere. This sale resulted in the termination of the August 2002 license agreement we entered into with Bausch & Lomb related to ISV-403. Our ability to generate royalties from this agreement will be dependent upon Bausch & Lomb's ability to complete the development of ISV-403, obtain regulatory approval for the product and successfully market it. In addition, under the Bausch & Lomb Purchase Agreement, we also have certain potential indemnification obligations to Bausch & Lomb in connection with the asset sale which, if triggered, could significantly harm our business and our financial position.

Our marketing and sales efforts related to our OcuGene glaucoma genetic test have been significantly curtailed. Our activities have been mainly using external resources that included:

·   a network of key ophthalmic clinicians; and

·   other resources with ophthalmic expertise.

We may not be able to enter into or maintain arrangements with third parties with ophthalmic or diagnostic industry experience on acceptable terms or at all. If we are not successful in concluding such arrangements on acceptable terms, or at all, we may be required to establish our own sales force and expand our marketing organization significantly, despite the fact that we have no experience in sales, marketing or distribution. Even if we do enter into collaborative relationships, as we have experienced with Pharmacia, these relationships can be terminated forcing us to seek alternatives. We may not be able to build a marketing staff or sales force and our sales and marketing efforts may not be cost-effective or successful.

In addition, we currently contract with a third party to assemble the sample collection kits used in our OcuGene glaucoma genetic test. If our assembler should encounter significant delays or we have difficulty maintaining our existing relationship, or in establishing a new one, our sales of this product could be adversely affected.

We have no experience in performing the analytical procedures related to genetic testing and have established an exclusive commercial agreement with a third party to perform these procedures for our OcuGene glaucoma genetic test; If we are unable to maintain this arrangement, and are unable to establish new arrangements with third parties, we will have to establish our own regulatory compliant analytical process for genetic testing and may not have the financial resources to do so

We have no experience in the analytical procedures related to genetic testing. We have entered into an agreement with Quest Diagnostics Incorporated under which Quest exclusively performs OcuGene genetic analytical procedures at a commercial scale in the United States. Accordingly, we are reliant on Quest for all of our OcuGene analytical procedures. If we are unable to maintain this arrangement, we would have to contract with another clinical laboratory or would have to establish our own facilities. We cannot assure you that we will be able to contract with another laboratory to perform these services on a commercially reasonable basis, or at all.

Clinical laboratories must adhere to Good Laboratory Practice regulations that are strictly enforced by the FDA on an ongoing basis through the FDA's facilities inspection program. Should we be required to perform the analytical procedures for genetic testing ourselves, we:

·   will be required to expend significant amounts of capital to install an analytical capability;

·   will be subject to the regulatory requirements described above; and

·   will require substantially more additional capital than we otherwise may require.

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We cannot assure you we will be able successfully to enter into another genetic testing arrangement or perform these analytical procedures ourselves on a cost-efficient basis, or at all.

We rely on a sole source for some of the raw materials in our products, including AzaSite, and the raw materials we need may not be available to us

We currently have a single supplier for azithromycin, the active drug incorporated into our AzaSite product candidate. The supplier has submitted a Drug Master File on the compound with the FDA and is subject to the FDA's review and oversight. If the FDA were to identify issues in the production of the drug that the supplier was unable to resolve quickly, or other issues were to arise that impact production, our ability to continue with the development of AzaSite, and potentially the commercial sale if the product is approved, could be interrupted, which would harm our business. Additional suppliers for this drug exist, but qualification of an alternative source could be time consuming, expensive and could result in a delay that could harm our business and there is no guarantee that these additional suppliers can supply sufficient quantities at a reasonable price, or at all.

SSP is the sole source for the active drug incorporated into the ISV-403 product candidate we sold to Bausch & Lomb for further development and commercialization. SSP has submitted a Drug Master File on the compound with the FDA and is subject to the FDA's review and oversight. If SSP is unable to obtain and maintain FDA approval for their production of the drug or is otherwise unable to supply Bausch & Lomb with sufficient quantities of the drug, Bausch & Lomb's ability to continue with the development, and potentially the commercial sale if the product is approved, of ISV-403 would be interrupted or impeded, and our royalties from commercial sales of the ISV-403 product could be delayed or reduced and our business could be harmed.

In addition, certain of the raw materials we use in formulating our DuraSite drug delivery system are available only from Noveon Corporation. Although we do not have a current supply agreement with the Noveon Corporation, to date we have not encountered any difficulties obtaining necessary materials from them. Any significant interruption in the supply of these raw materials could delay our clinical trials, product development or product sales and could harm our business.

We have no experience in commercial manufacturing and if contract manufacturing is not available to us or does not satisfy regulatory requirements, we will have to establish our own regulatory compliant manufacturing capability and may not have the financial resources to do so

We have no experience manufacturing products for Phase 3 and commercial purposes. We have a pilot facility licensed by the State of California to manufacture a number of our products for Phase 1 and Phase 2 clinical trials but not for late stage clinical trials or commercial purposes. Any delays or difficulties that we may encounter in establishing and maintaining a relationship with qualified manufacturers to produce, package and distribute our finished products may harm our clinical trials, regulatory filings, market introduction and subsequent sales of our products.

We have a contract with Cardinal Health, the manufacturer of our AzaSite Phase 3 clinical trial supplies and registration batches, to validate their production line for commercial scale batches and to manufacture the required validation batches for FDA review. Additionally, we have entered into a commercial manufacturing agreement with Cardinal Health for an initial nine year period. Other commercial manufacturers exist and we currently believe that we could obtain alternative commercial manufacturing services if required. However, qualification of another manufacturer, transfer of the manufacturing process and regulatory approval of such a site would be costly and time consuming and would adversely impact our potential market introduction and subsequent sales of AzaSite.

We currently contract with a third party to assemble the sample collection kits used in our OcuGene glaucoma genetic test. If our assembler should encounter significant delays or we have difficulty maintaining our existing relationship, or in establishing a new one, our sales of this product could be adversely affected.

Contract manufacturers must adhere to Good Manufacturing Practices regulations that are strictly enforced by the FDA on an ongoing basis through the FDA's facilities inspection program. Contract manufacturing facilities must pass a pre-approval plant inspection before the FDA will approve a new drug application. Some of the material manufacturing changes that occur after approval are also subject to FDA review and clearance or approval. The FDA or other regulatory agencies may not approve the process or the facilities by which any of our products may be manufactured. Our dependence on third parties to manufacture our products may harm our ability to develop and deliver products on a timely and competitive basis. Should we be required to manufacture products ourselves, we:

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·   will be required to expend significant amounts of capital to install a manufacturing capability;

·   will be subject to the regulatory requirements described above;

·   will be subject to similar risks regarding delays or difficulties encountered in manufacturing any such products; and

·   will require substantially more additional capital than we otherwise may require.

Therefore, we may not be able to manufacture any products successfully or in a cost-effective manner.

We compete in highly competitive markets and our competitors' financial, technical, marketing, manufacturing and human resources may surpass ours and limit our ability to develop and/or market our products and technologies

Our success depends upon developing and maintaining a competitive advantage in the development of products and technologies in our areas of focus. We have many competitors in the United States and abroad, including pharmaceutical, biotechnology and other companies with varying resources and degrees of concentration in the ophthalmic market. Our competitors may have existing products or products under development which may be technically superior to ours or which may be less costly or more acceptable to the market. Competition from these companies is intense and is expected to increase as new products enter the market and new technologies become available. Many of our competitors have substantially greater financial, technical, marketing, manufacturing and human resources than we do, particularly in light of our current financial condition. In addition, they may succeed in developing technologies and products that are more effective, safer, less expensive or otherwise more commercially acceptable than any that we have or will develop. Our competitors may obtain cost advantages, patent protection or other intellectual property rights that would block or limit our ability to develop our potential products. Our competitors may also obtain regulatory approval for commercialization of their products more effectively or rapidly than we will. If we decide to manufacture and market our products by ourselves, we will be competing in areas in which we have limited or no experience such as manufacturing efficiency and marketing capabilities. See "- We have no experience in commercial manufacturing and need to establish manufacturing relationships with third parties, and if contract manufacturing is not available to us or does not satisfy regulatory requirements, we will have to establish our own regulatory compliant manufacturing capability and may not have the financial resources to do so"

If we cannot compete successfully for market share against other drug companies, we may not achieve sufficient product revenues and our business will suffer

The market for our product candidates is characterized by intense competition and rapid technological advances. If our product candidates receive FDA approval, they will compete with a number of existing and future drugs and therapies developed, manufactured and marketed by others. Existing or future competing products may provide greater therapeutic convenience or clinical or other benefits for a specific indication than our products, or may offer comparable performance at a lower cost. If our products fail to capture and maintain market share, we may not achieve sufficient product revenues and our business will suffer.

We will compete against fully integrated pharmaceutical companies and smaller companies that are collaborating with larger pharmaceutical companies, academic institutions, government agencies and other public and private research organizations. Many of these competitors have products competitive with AzaSite already approved or in development including Zymar and Ocuflox by Allergan, Vigamox and Ciloxan by Alcon, and Quixin by Johnson & Johnson. In addition, many of these competitors, either alone or together with their collaborative partners, operate larger research and development programs and have substantially greater financial resources than we do, as well as significantly greater experience in:

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·   developing drugs;

·   undertaking pre-clinical testing and human clinical trials;

·   obtaining FDA and other regulatory approvals of drugs;

·   formulating and manufacturing drugs;

·   launching, marketing and selling drugs; and

·   attracting qualified personnel, parties for acquisitions, joint ventures or other collaborations.

Uncertainties regarding healthcare reform and third-party reimbursement may impair our ability to raise capital, form collaborations and sell our products

The continuing efforts of governmental and third-party payers to contain or reduce the costs of healthcare through various means may harm our business. For example, in some foreign markets the pricing or profitability of health care products is subject to government control. In the United States, there have been, and we expect there will continue to be, a number of federal and state proposals to implement similar government control. The implementation or even the announcement of any of these legislative or regulatory proposals or reforms could harm our business by impeding our ability to achieve profitability, raise capital or form collaborations.

In addition, the availability of reimbursement from third-party payers determines, in large part, the demand for healthcare products in the United States and elsewhere. Examples of such third-party payers are government and private insurance plans. Significant uncertainty exists as to the reimbursement status of newly approved healthcare products, and third-party payers are increasingly challenging the prices charged for medical products and services. If we succeed in bringing one or more products to the market, reimbursement from third-party payers may not be available or may not be sufficient to allow us to sell our products on a competitive or profitable basis.

Our insurance coverage may not adequately cover our potential product liability exposure

We are exposed to potential product liability risks inherent in the development, testing, manufacturing, marketing and sale of human therapeutic products. Product liability insurance for the pharmaceutical industry is extremely expensive. Although we believe our current insurance coverage is adequate to cover likely claims we may encounter given our current stage of development and activities, our present product liability insurance coverage may not be adequate to cover all potential claims we may encounter. In addition, our existing coverage will not be adequate as we further develop, manufacture and market our products, and we may not be able to obtain or afford adequate insurance coverage against potential claims in sufficient amounts or at a reasonable cost.

Our use of hazardous materials may pose environmental risks and liabilities which may cause us to incur significant costs

Our research, development and manufacturing processes involve the controlled use of small amounts of hazardous solvents used in pharmaceutical development and manufacturing, including acetic acid, acetone, acrylic acid, calcium chloride, chloroform, dimethyl sulfoxide, ethyl alcohol, hydrogen chloride, nitric acid, phosphoric acid and other similar solvents. We retain a licensed outside contractor that specializes in the disposal of hazardous materials used in the biotechnology industry to properly dispose of these materials, but we cannot completely eliminate the risk of accidental contamination or injury from these materials. Our cost for the disposal services rendered by our outside contractor was approximately $10,400 and $6,000 for the years ended 2004 and 2003, respectively. In the event of an accident involving these materials, we could be held liable for any damages that result, and any such liability could exceed our resources. Moreover, as our business develops we may be required to incur significant costs to comply with federal, state and local environmental laws, regulations and policies, especially to the extent that we manufacture our own products.

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If we engage in acquisitions, we will incur a variety of costs, and the anticipated benefits of the acquisition may never be realized

We may pursue acquisitions of companies, product lines, technologies or businesses that our management believes are complementary or otherwise beneficial to us. Any of these acquisitions could have negative effects on our business. Future acquisitions may result in substantial dilution to our stockholders, the incurrence of additional debt and amortization expenses related to goodwill, research and development and other intangible assets. Any of these results could harm our financial condition. In addition, acquisitions would involve several risks for us, including:

·   assimilating employees, operations, technologies and products from the acquired companies with our existing employees, operations, technologies and products;

·   diverting our management's attention from day-to-day operation of our business;

·   entering markets in which we have no or limited direct experience; and

·   potentially losing key employees from the acquired companies.

Management and principal stockholders may be able to exert significant control on matters requiring approval by our stockholders and security interests in our assets held by management may enable them to control the disposition of such assets

As of September 30, 2005, our management and principal stockholders together beneficially owned approximately 20% of our outstanding shares of Common Stock. In addition, investors in our March 2004 and May 2005 private placements, as a group, owned approximately 49% of our outstanding shares of Common Stock as of September 30, 2005. If such investors were to exercise the warrants they currently hold, assuming no additional acquisitions or distributions, such investors would own approximately 60% of our outstanding shares of Common Stock based on their ownership percentages as of September 30, 2005. As a result, these two groups of stockholders, acting together or as indivitual groups, may be able to exert significant control on matters requiring approval by our stockholders, including the election of a majority of our Board of Directors and the approval of business combinations.

In July 2003, we issued a $400,000 short-term senior secured note payable to Dr. Chandrasekaran, our chief executive officer, chief financial officer and a member of our board of directors, for cash. As of September 30, 2005, $231,000 of this note remained outstanding. This note bears an annual interest rate of five and one-half percent (5.5%) and is due on the earlier to occur of March 31, 2007 or 10 business days subsequent to the successful completion of a pivotal Phase 3 clinical trial with AzaSite and is secured by a lien on substantially all of our assets including our intellectual property and certain other equipment secured by the lessor of such equipment.

This security interest enables Dr. Chandrasekaran to control the disposition of these assets in the event of our liquidation. If we are unable to repay the amounts due under this note, he could, or cause us to, enter into involuntary liquidation proceedings in the event we default on our obligation.

The market prices for securities of biopharmaceutical and biotechnology companies such as ours have been and are likely to continue to be highly volatile due to reasons that are related and unrelated to our operating performance and progress

The market prices for securities of biopharmaceutical and biotechnology companies, including ours, have been highly volatile. The market has from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. In addition, future announcements and circumstances, such as our current financial condition, the audit report included in our annual report on Form 10-K for the year ended December 31, 2004 that includes an explanatory paragraph referring to our recurring operating losses and a substantial doubt about our ability to continue as a going concern, our ability to obtain new financing, the terms of any financing we are able to raise, the results of testing and clinical trials, developments in patent or other proprietary rights of us or our competitors, litigation regarding the same, the status of our relationships with third-party collaborators, technological innovations or new therapeutic products, governmental regulation, or public concern as to the safety of products developed by us or others and general market conditions, concerning us, our competitors or other biopharmaceutical companies, may have a significant effect on the market price of our Common Stock.

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Further, the exercise of outstanding warrants and the sale of the shares of our Common Stock issuable upon exercise of those outstanding warrants could result in dilution to our current holders of Common Stock and cause a significant decline in the market price for our Common Stock. We have not paid any cash dividends on our Common Stock, and we do not anticipate paying any dividends on our Common Stock in the foreseeable future.

In addition, terrorist attacks in the U.S. and abroad, U.S. retaliation for these attacks, the war in Iraq and continued worldwide economic weakness and the related decline in consumer confidence have had, and may continue to have, an adverse impact on the U.S. and world economy. These and similar events, as well as fluctuations in our operating results and market conditions for biopharmaceutical and biotechnology stocks in general, could have a significant effect on the volatility of the market price for our Common Stock and on the future price of our Common Stock.

We have adopted and are subject to anti-takeover provisions that could delay or prevent an acquisition of our Company and could prevent or make it more difficult to replace or remove current management

Provisions of our certificate of incorporation and bylaws may constrain or discourage a third party from acquiring or attempting to acquire control of us. Such provisions could limit the price that investors might be willing to pay in the future for shares of our Common Stock. In addition, such provisions could also prevent or make it more difficult for our stockholders to replace or remove current management and could adversely affect the price of our Common Stock if they are viewed as discouraging takeover attempts, business combinations or management changes that stockholders consider in their best interest. Our Board of Directors has the authority to issue up to 5,000,000 shares of preferred stock (“Preferred Stock”), 15,000 of which have been designated as Series A-1 Preferred Stock. Our Board of Directors has the authority to determine the price, rights, preferences, privileges and restrictions, including voting rights, of the remaining unissued shares of Preferred Stock without any further vote or action by the stockholders. The rights of the holders of Common Stock will be subject to, and may be adversely affected by, the rights of the holders of any Preferred Stock that may be issued in the future. The issuance of Preferred Stock, while providing desirable flexibility in connection with possible financings, acquisitions and other corporate purposes, could have the effect of making it more difficult for a third party to acquire a majority of our outstanding voting stock, even if the transaction might be desired by our stockholders. Provisions of Delaware law applicable to us could also delay or make more difficult a merger, tender offer or proxy contest involving us, including Section 203 of the Delaware General Corporation Law, which prohibits a Delaware corporation from engaging in any business combination with any interested stockholder for a period of three years unless conditions set forth in the Delaware General Corporation Law are met. The issuance of Preferred Stock or Section 203 of the Delaware General Corporation Law could also be deemed to benefit incumbent management to the extent these provisions deter offers by persons who would wish to make changes in management or exercise control over management. Other provisions of our certificate of incorporation and bylaws may also have the effect of delaying, deterring or preventing a takeover attempt or management changes that our stockholders might consider in their best interest. For example, our bylaws limit the ability of stockholders to remove directors and fill vacancies on our board of directors. Our bylaws also impose advance notice requirements for stockholder proposals and nominations of directors and prohibit stockholders from calling special meetings or acting by written consent.

Legislative actions, higher insurance costs and potential new accounting pronouncements are likely to impact our future financial position and results of operations

There have been regulatory changes, including the Sarbanes-Oxley Act of 2002, and there may be potential new accounting pronouncements or regulatory rulings, which will have an impact on our future financial position and results of operations. The Sarbanes-Oxley Act of 2002 and other rule changes and proposed legislative initiatives are likely to increase general and administrative costs. In addition, insurance costs, including health, workers' compensation and directors and officers' insurance costs, have been dramatically increasing and insurers are likely to increase rates as a result of high claims rates over the past year and our rates are likely to increase further in the future. Further, proposed initiatives could result in changes in accounting rules, including legislative and other proposals to account for employee stock options as an expense. These and other potential changes could materially increase the expenses we report under generally accepted accounting principles, and adversely affect our operating results.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

The following discusses our exposure to market risk related to changes in interest rates.

We invest our excess cash in investment grade, interest-bearing securities. At September 30, 2005, we had approximately $3.3 million invested in money market mutual funds. A hypothetical decrease in market interest rates by 10 percent from September 30, 2005 levels would not result in a loss of principal and would not materially reduce interest income.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures. Our principal executive and financial officer, Dr. Chandrasekaran, reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Form 10-Q (the “Evaluation Date”). Based on that evaluation, Dr. Chandrasekaran concluded as of the Evaluation Date that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms.

Changes in internal control over financial reporting. There was no change in our internal control over financial reporting that occurred during the quarter ended September 30, 2005 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Part II OTHER INFORMATION

Item 1.Legal Proceedings.

On July 8, 2004, Bristol Investment Group, or Bristol, filed with the American Arbitration Association (“AAA”) a demand for arbitration against us seeking cash compensation and warrants based on a letter agreement dated January 28, 2003 pursuant to which Bristol was engaged as a non-exclusive placement agent of investment capital for us.  On October 6, 2005 the arbitrator issued the final award in favor of Bristol, ruling that Bristol is entitled to recover $249,925, plus interest, attorneys’ and other fees, plus Bristol has the right to purchase for $922.80 a five-year, net-exerciseable warrant to purchase 922,800 shares of our common stock at an exercise price of $0.50 per share. As of September 30, 2005, we have recorded an accrued liability with respect to this arbitration award, of which the attorneys’ and other fees have been reflected in selling, general and administrative expenses and the remainder of which was recorded as a stock issuance cost in additional paid-in-capital. Following the issuance of the final arbitration award, the cash arbitration award was paid to Bristol and the right to purchase the warrant for 922,800 shares was exercised. We have agreed to register the shares of common stock underlying the warrant by filing a registration statement on Form S-3 with the SEC by December 10, 2005.

Item 2.Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3.Defaults Upon Senior Securities.

None.

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Item 4.Submission of Matters to a Vote of Security Holders.

None.

Item 5.Other Information.

None.

Item 6. Exhibits.

The exhibits listed on the Exhibit Index (following the signature page of this Quarterly Report) are included or incorporated by reference, in this Quarterly Report.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

	INSITE VISION INCORPORATED
Dated: November 14, 2005	By:	/s/ S. Kumar Chandrasekaran, Ph.D.
		S. Kumar Chandrasekaran, Ph.D.
		Chairman of the Board, Chief Executive
		Officer and Chief Financial Officer
		(on behalf of the registrant and as principal
		executive, financial and accounting officer)

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EXHIBIT INDEX

Number	Exhibit Table
31.1	Rules 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
31.2	Rules 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
32.1	Section 1350 Certifications of Chief Executive Officer and Chief Financial Officer.

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