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 March 31, 2006
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) of incorporation or organization) | (IRS Employer 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
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 a large accelerated filer, an accelerated filer, or a non-accelerated filer.
Large accelerated filer o Accelerated filer o Non-accelerated filer 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
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class | | Outstanding as of April 28, 2006 |
Common Stock, $0.001 par value per share | | 86,406,535 shares |
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED MARCH 31, 2006
TABLE OF CONTENTS
| Page |
PART I. FINANCIAL INFORMATION | |
| | |
Item 1. | Financial Statements | |
| | |
| Condensed Consolidated Balance Sheets at March 31, 2006 (unaudited) and December 31, 2005 | 3 |
| | |
| Unaudited Condensed Consolidated Statements of Operations For the three months ended March 31, 2006 and 2005 | 4 |
| | |
| Unaudited Condensed Consolidated Statements of Cash Flows For the three months ended March 31, 2006 and 2005 | 5 |
| | |
| Notes to Condensed Consolidated Financial Statements | 6 |
| | |
Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 11 |
| | |
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 15 |
| | |
Item 4. | Controls and Procedures | 15 |
| | |
PART II. OTHER INFORMATION | |
| | |
Item 1. | Legal Proceedings | 15 |
| | |
Item 1A. | Risk Factors | 15 |
| | |
Item 6. | Exhibits | 29 |
| | |
Signatures | | 29 |
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
InSite Vision Incorporated
Condensed Consolidated Balance Sheets
| | March 31 | | December 31, | |
(in thousands, except share and per share amounts) | | 2006 | | 2005 | |
| | (unaudited) | | (1) | |
Assets | | | | | |
Current assets: | | | | | |
Cash and cash equivalents | | $ | 3,827 | | $ | 4,027 | |
Restricted cash and cash equivalents | | | 75 | | | 75 | |
Inventory | | | 17 | | | 17 | |
Prepaid expenses and other current assets | | | 65 | | | 81 | |
Total current assets | | | 3,984 | | | 4,200 | |
| | | | | | | |
Property and equipment, at cost: | | | | | | | |
Laboratory and other equipment | | | 347 | | | 313 | |
Leasehold improvements | | | 73 | | | 73 | |
Furniture and fixtures | | | 10 | | | 10 | |
| | | 430 | | | 396 | |
Accumulated depreciation | | | 120 | | | 131 | |
| | | 310 | | | 265 | |
Deferred debt issuance cost | | | 404 | | | 614 | |
Total assets | | $ | 4,698 | | $ | 5,079 | |
| | | | | | | |
Liabilities and stockholders’ deficit | | | | | | | |
Current liabilities: | | | | | | | |
Short-term notes payable to related parties, unsecured | | $ | 35 | | $ | 35 | |
Short-term notes payable to related parties, secured | | | 231 | | | 231 | |
Short-term notes payable, secured, (net of debt discount of $444 at March 31, 2006 and $491 at December 31, 2005) | | | 5,856 | | | 3,809 | |
Accrued interest | | | 155 | | | 3 | |
Accounts payable | | | 873 | | | 1,941 | |
Accrued liabilities | | | 373 | | | 1,167 | |
Accrued compensation and related expense | | | 304 | | | 388 | |
Deferred rent | | | 38 | | | 50 | |
Total current liabilities | | | 7,865 | | | 7,624 | |
| | | | | | | |
Stockholders deficit | | | | | | | |
Preferred stock, $0.01 par value, 5,000,000 shares authorized, none issued and outstanding at March 31, 2005 and December 31, 2005 | | | - | | | - | |
Common stock, $0.01 par value, 120,000,000 shares authorized; | | | | | | | |
86,085,307 issued and outstanding at March 31, 2006; | | | | | | | |
79,614,806 issued and outstanding at December 31, 2005 | | | 861 | | | 796 | |
Additional paid-in capital | | | 137,744 | | | 133,278 | |
Notes receivable from stockholder | | | - | | | (168 | ) |
Accumulated deficit | | | (141,772 | ) | | (136,451 | ) |
Stockholders’ deficit | | | (3,167 | ) | | (2,545 | ) |
Total liabilities and stockholders’ deficit | | $ | 4,698 | | $ | 5,079 | |
(1) Derived from the Company’s audited consolidated financial statements as of December 31, 2005.
See accompanying notes to condensed consolidated financial statements.
InSite Vision Incorporated
Condensed Consolidated Statements of Operations
(Unaudited)
| | Three months ended March 31, | |
(in thousands, except per share amounts) | | 2006 | | 2005 | |
| | | | | |
Revenues | | $ | 1 | | $ | 1 | |
| | | | | | | |
Cost of revenue | | | 3 | | | 5 | |
Gross margin | | | (2 | ) | | (4 | ) |
| | | | | | | |
| | | | | | | |
Operating expenses: | | | | | | | |
Research and development (a) | | | 3,471 | | | 2,428 | |
Selling, general and administrative (a) | | | 1,338 | | | 1,003 | |
Total | | | 4,809 | | | 3,431 | |
| | | | | | | |
Loss from operations | | | (4,811 | ) | | (3,435 | ) |
| | | | | | | |
Interest (expense) and other income, net | | | (510 | ) | | (3 | ) |
| | | | | | | |
Net loss | | $ | (5,321 | ) | $ | (3,438 | ) |
| | | | | | | |
| | | | | | | |
Net loss per share - basic and diluted | | $ | (0.06 | ) | $ | (0.06 | ) |
| | | | | | | |
Shares used to calculate basic and diluted net loss per share | | | 83,756 | | | 62,493 | |
| | | | | | | |
(a) Includes the following amounts related to stock based compensation: | | | |
Research and development | | $ | 96 | | $ | - | |
Selling, general and administrative | | | 33 | | | - | |
| | $ | 129 | | $ | - | |
__________________________________________________________
See accompanying notes to condensed consolidated financial statements.
InSite Vision Incorporated
Condensed Consolidated Statements of Cash Flows
(Unaudited)
| | Three months ended March 31, | |
(in thousands) | | 2006 | | 2005 | |
| | | | | |
Operating activities | | | | | |
Net loss | | $ | (5,321 | ) | $ | (3,438 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: | | | | | | | |
Depreciation and amortization | | | 12 | | | 21 | |
Stock based compensation | | | 129 | | | 5 | |
Amortization of deferred debt issuance costs | | | 405 | | | - | |
Accretion of debt discount | | | 354 | | | - | |
Changes in: | | | | | | | |
Inventories, prepaid expenses and other current assets | | | 16 | | | (31 | ) |
Accrued interest | | | 152 | | | 4 | |
Accounts payable | | | (1,068 | ) | | 370 | |
Accrued liabilities | | | (794 | ) | | 127 | |
Accrued compensation and related expense, and deferred rent | | | (96 | ) | | (33 | ) |
Net cash used in operating activities | | | (6,211 | ) | | (2,975 | ) |
| | | | | | | |
Investing activities | | | | | | | |
Reduction in restricted cash | | | - | | | 59 | |
Purchases of property and equipment | | | (57 | ) | | (7 | ) |
Net cash (used in) provided by investing activities | | | (57 | ) | | 52 | |
| | | | | | | |
Financing activities | | | | | | | |
Issuance of common stock from exercise of options and warrants, net | | | 4,095 | | | 59 | |
Note payment received from stockholder | | | 168 | | | - | |
Issuance of short-term notes payable, net of issuance costs | | | 1,805 | | | - | |
Net cash provided by financing activities | | | 6,068 | | | 59 | |
Net decrease in cash and cash equivalents | | | (200 | ) | | (2,864 | ) |
Cash and cash equivalents, beginning of period | | | 4,027 | | | 5,351 | |
| | | | | | | |
Cash and cash equivalents, end of period | | $ | 3,827 | | $ | 2,487 | |
__________________________________________________________
See accompanying notes to condensed consolidated financial statements.
InSite Vision Incorporated
Notes to Condensed Consolidated Financial Statements
March 31, 2006
(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 month period ended March 31, 2006 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 the Company’s audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005.
Reclassifications
Certain prior year balance sheet and cash flow amounts have been reclassified to conform to the current financial statement presentation. These reclassifications had no impact of previously reported results of operations or stockholders’ equity.
Note 2 - Employee Stock-Based Compensation
Effective January 1, 2006, the Company adopted the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004) “Share-Based Payment” (“SFAS No. 123 (R)”). SFAS No. 123 (R) establishes accounting for stock-based awards exchanged for employee services. Accordingly, stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period. All of the Company’s stock compensation is accounted for as an equity instrument. The Company previously applied Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations and provided the required pro forma disclosures of SFAS No. 123, “Accounting for Stock-Based Compensation”.
Impact of the Adoption of SFAS 123 (R)
The Company elected to adopt the modified prospective application method as provided by SFAS No. 123 (R). The effect of recording stock-based compensation for the three months ended March 31, 2006 was as follows (in thousands, except per share data):
| | Three months ended | |
Stock-based compensation expense by type of award: | | March 31, 2006 | |
Employee stock options | | $ | 128 | |
Non-employee stock options | | | 1 | |
Total stock-based compensation | | | 129 | |
Tax effect on stock-based compensation | | | -- | |
Total stock-based compensation expense | | $ | 129 | |
Impact on net loss per share | | $ | (0.00 | ) |
As of January 1, 2006, the Company had an unrecorded deferred stock-based compensation balance related to stock options of approximately $1.4 million before estimated forfeitures. In the Company’s pro forma disclosures prior to the adoption of SFAS No. 123 (R), the Company accounted for forfeitures upon occurrence. SFAS No. 123 (R) requires forfeitures to be estimated at the time of grant and revised if necessary in subsequent periods if actual forfeitures differ from those estimates. Based on the Company’s historical experience of option pre-vesting cancellations and estimates of future forfeiture rates, the Company has assumed an annualized forfeiture rate of 10% for its options.
During the three months ended March 31, 2006, the Company granted 1,420,000 stock options with an estimated total grant-date fair value of $1.4 million. Of this amount, the Company estimated that the stock-based compensation for the awards not expected to vest was $0.5 million. During the three months ended March 31, 2006, the Company recorded stock-based compensation related to all stock options of $128,000.
As of March 31, 2006, the unrecorded deferred stock-based compensation balance related to stock options was $1.6 million and will be recognized over an estimate weighted average amortization period of 3.1 years.
Valuation assumptions
The Company estimates the fair value of stock options using a Black-Scholes valuation model, consistent with the provisions of SFAS No. 123 (R), Securities and Exchange Commission Staff Accounting Bulletin No. 107 and the Company’s prior period pro forma disclosures of net loss, including stock-based compensation (determined under a fair value method as prescribed by SFAS No. 123). The fair value of each option grant is estimated on the date of grant using the Black-Scholes option valuation model and the graded-vesting method with the following weighted-average assumptions:
| | Three months ended March 31, 2006 | |
Risk-free interest rate | | | 4.2 | % |
Expected term (years) | | | 5 | |
Expected dividends | | | 0.0 | % |
Volatility | | | 78.2 | % |
The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Expected volatility is based on the combination of historical volatility of the Company’s common stock and the common stock the Company’s competitors, the expected moderation in future volatility over the period commensurate with the expected life of the options and other factors. The risk-free interest rates are taken from the Daily Federal Yield Curve Rates as of the grant dates as published by the Federal Reserve and represent the yields on actively traded Treasury securities for terms equal to the expected term of the options. The expected term calculation is based on the terms utilized by the Company’s competitors, observed historical option exercise behavior and post-vesting forfeitures of options by the Company’s employees.
Employee Stock Purchase Plans
The Company currently has an employee stock purchase plan, adopted in 1994 and amended thereafter (or “the Purchase Plan”). The Purchase Plan allows eligible employees to purchase Common Stock at 85% of the lower of the fair market value of the Common Stock on the grant date or the fair market value on the purchase date. The offering period under the Purchase Plan is currently 24 months, and the purchase price is established during each new offering period. Purchases are limited to 15% of each employee’s eligible compensation and subject to certain Internal Revenue Service restrictions. All of the Company’s employees are eligible to participate in the Purchase Plan after certain service periods are met. As of March 31, 2006, 548,622 shares were reserved for issuance under this Purchase Plan.
Equity Incentive Program
The Company currently grants options under a stock option plan adopted in 1994 and amended thereafter (“the 1994 Plan”), that allows for the granting of non-qualified stock options, incentive stock options and stock purchase rights to the Company’s employees, directors, and consultants. Options granted under the plan expire 10 years from the date of grant and become exercisable at such times and under such conditions as determined by the Company’s Board of Directors (generally ratably over four years, with the first 25% vesting after one year). Upon termination, unexercised options will expire at the end of 60 days. No stock purchase rights or incentive stock options have been granted under the 1994 Plan to date. A summary of activity under the 1994 Plan during the quarter ended March 31, 2006 is as follows:
| | Number of shares | | Weighted Average Exercise Price | | Weighted Average Remaining Contractual Term (Years) | | Aggregate Intrinsic Value (In thousands) | |
Outstanding at December 31, 2005 | | | 5,554,990 | | $ | 1.15 | | | | | | | |
Granted | | | 1,420,000 | | | 1.51 | | | | | | | |
Exercised | | | (26,353 | ) | | 0.66 | | | | | $ | 23 | |
Canceled | | | (12,857 | ) | | 0.81 | | | | | | | |
Outstanding at March 31, 2006 | | | 6,935,780 | | $ | 1.23 | | | 7.57 | | $ | 7,677 | |
Options vested and expected to vest at March 31, 2006 | | | 6,384,696 | | $ | 1.25 | | | 6.96 | | $ | 7,027 | |
Options vested at March 31, 2006 | | | 3,214,752 | | $ | 1.51 | | | 5.40 | | $ | 3,286 | |
At March 31, 2006 the Company had 403,546 options available for grant under its stock option plans. The weighted average grant date fair value of options granted during the quarter ended March 31, 2006 and 2005 were $1.00 and $0.81 respectively. The total fair value of shares vested during the three months ended March 31, 2006 was $42,000.
The following table summarizes information concerning currently outstanding and exercisable options:
| | | | |
| | Options Outstanding at March 31, 2006 | | Options Vested and Exercisable at March 31, 2006 |
| | Weighted Average | | | Weighted |
| Number | | | Number | Average |
Range of Exercise Prices | Outstanding | | Exercise Price | Exercisable | Exercise Price |
$0.41 - $0.60 | 282,500 | 7.73 | $0.41 | 236,878 | $0.41 |
$0.63 - $0.63 | 2,129,826 | 9.03 | 0.63 | 464,685 | 0.63 |
$0.64 - $1.13 | 2,079,104 | 6.77 | 0.87 | 1,488,891 | 0.90 |
$1.20 - $6.38 | 2,444,350 | 6.95 | 2.15 | 1,024,298 | 3.03 |
| 6,935,780 | 7.57 | $1.23 | 3,214,752 | $1.51 |
| | | | | |
Prior to the Adoption of SFAS No. 123 (R)
Prior to the adoption of SFAS No. 123 (R), the Company provided the disclosures required under SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosures.”
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:
| | Three months ended March 31, 2005 | |
Risk-free interest rate | | | 4.64 | % |
Expected term (years) | | | 4 | |
Expected dividends | | | 0.0 | % |
Volatility | | | 105 | % |
The following table illustrates the effect on net loss and net 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 March 31, | |
| | 2005 | |
| | | |
Net income (loss) applicable to common stockholders-as reported | | $ | (3,438 | ) |
Deduct: Total stock-based employee compensation expense determined under fair value method for all awards | | | (80 | ) |
Net income (loss) applicable to common stockholders-pro forma | | $ | (3,518 | ) |
| | | | |
Net income (loss) applicable to common stockholders per share: | | | | |
Basic - as reported | | $ | (0.06 | ) |
Basic - pro forma | | $ | (0.06 | ) |
Diluted - as reported | | $ | (0.06 | ) |
Diluted - pro forma | | $ | (0.06 | ) |
| | | | |
Note 3 - Income (Loss) per Share
Basic and diluted net income (loss) per share information for all periods is presented under the requirement 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.
The following table sets forth the computation of basic and diluted net loss per share:
| | | |
| | Three months ended March 31, | |
(in thousands, except per share amounts) | | 2006 | | 2005 | |
| | | | | |
Numerator: | | | | | |
Net loss | | $ | (5,321 | ) | $ | (3,438 | ) |
| | | | | | | |
Denominator: | | | | | | | |
Weighted-average shares outstanding | | | 83,756 | | | 62,493 | |
Effect of dilutive securities: | | | | | | | |
Stock options, warrants and convertible notes payable | | | - | | | - | |
Weighted-average shares outstanding for diluted loss per share | | | 83,756 | | | 62,493 | |
| | | | | | | |
Basic and diluted net loss per share | | $ | (0.06 | ) | $ | (0.06 | ) |
| | | | | | | |
Due to the net loss, net loss per share for the quarter ended March 31, 2006 is based on the weighted average number of common shares only, as the effect of including equivalent shares from stock options and warrants 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 and warrants priced below the market price of the common shares at March 31, 2006 and 2005 but would not have been effected by the outstanding stock options and warrants priced above the market price of the common shares at March 31, 2006 and 2005. The following securities have not been included in the calculation of diluted net loss per share as their inclusion would have been anti-dilutive:
| | March 31, | |
| | 2006 | | 2005 | |
Stock options | | | 6,943,963 | | | 3,834,249 | |
Warrants | | | 18,161,548 | | | 17,655,788 | |
| | | 25,105,511 | | | 21,490,037 | |
Note 4 - Short-term Notes Payable - Secured
In January 2006, the Company issued an additional $2,000,000 short-term Senior Secured Notes payable and warrants to purchase 400,000 shares of Common Stock at an exercise price of $0.82 per share. These warrants were valued using a Black-Scholes option pricing model, assuming no dividend yield, with the following assumptions: risk-free interest rate of 4.30%, volatility of 1.0285 and an expected life of 5 years. The relative fair value model was then applied to the Black-Scholes valuation of the warrants issued to the note holders resulting in the recording of a debt discount of $307,000 which will be amortized over the term of the notes. The Company also incurred approximately $140,000 of additional deferred debt issuance costs related to the issuance of the Senior Secured Notes.
This note and the $4.3 million Senior Secured Notes issued in December 2005, are secured by a lien on all of the assets of the Company, including the Company’s intellectual property. The Senior Secured Note issued in January 2006 bears interest at a rate of ten percent (10%) and has an original maturity date of July 11, 2006, but may be extended for an additional six months at an interest rate of twelve percent (12%). Payments of principal and interest under the Notes are due in one lump sum upon the earlier of the applicable maturity date and an “Event of Acceleration” under the Notes.
Note 5 - Common Stock
In the first quarter of 2006 the Company received approximately $3,711,000, net of approximately $115,000 of fees, from the exercise of warrants to purchase 5,100,994 shares of Common Stock issued as part of the March 2004 private placement. The Company also issued 10,088 shares of Common Stock from the cashless exercise of 18,088 warrants issued to the placement agent as part of the March 2004 private placement. Additionally, the Company received approximately $345,000 from the exercise of warrants to purchase 545,451 shares of Common Stock issued as part of the May 2005 private placement. The Company also issued 172,490 shares of Common Stock from the cashless exercise of 299,998 warrants issued as part of the May 2005 private placement. The Company also received $25,000 from the exercise of warrants to purchase 50,000 shares of Common Stock issued in 2003. The Company also received approximately $17,000 from the exercise of 26,353 options issued to employees.
Note 6 - Note Receivable From Stockholder
In May 2000, the Company issued loans to Dr. Chandrasekaran, the Company’s President, Chief Executive Officer, Chief Financial Officer and Chairman of the Board, related to his exercise of 126,667 options to acquire common stock. The loans were full recourse and had an interest rate of 7% per annum. While the 126,667 shares of common stock issued secured the loans, the Company was not limited to these shares to satisfy the loan. In January 2006, these notes which had a balance of $168,000 at December 31, 2005 were repaid in full.
Note 7 - Recent Accounting Pronouncements
In November 2005, the FASB issued FASB Staff Position (FSP) No. 123R-3 "Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards" (FSP No. 123(R)-3). FSP 123(R)-3 provides an alternative transition method of accounting for the tax effects of adopting SFAS No. 123(R). This FSP grants one year from the later of the date of the FSP or the adoption of SFAS No. 123R by the Company for determination of the one-time election for purposes of transition. The Company is evaluating the alternative methods.
Note 8 - Subsequent Event
From April 1, 2006 through May 10, 2006, the Company received approximately $210,000, net of approximately $6,000 of fees, from the exercise of warrants to purchase 288,818 shares of Common Stock issued as part of the March 2004 private placement. The Company also issued 101,584 shares of Common Stock from the cashless exercise of 136,363 warrants issued as part of the May 2005 private placement. The Company also received approximately $17,000 from the exercise of options to purchase 25,826 shares of Common Stock issued under its 1994 Stock Option Plan.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Except for the historical information contained herein, the discussion in this Quarterly Report on Form 10-Q contains certain forward-looking statements under the safe harbor provided by Section 27(a) of the Securities Act of 1933 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 unanticipated events or previously unidentified events.
The following discussion should be read in conjunction with the condensed consolidated 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, 2005.
Overview
We are an ophthalmic product development company focused on ophthalmic pharmaceutical products based on our proprietary DuraSite(R) 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 July 2006. Our independent auditors included an explanatory paragraph in their audit report related to our consolidated financial statements for the fiscal year ended December 31, 2005 referring to our recurring operating losses and a substantial doubt about our ability to continue as a going concern.
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; and
· AzaSite Plus™ (ISV-502), a DuraSite formulation of azithromycin and a steroid for inflammation and pain.
AzaSite (ISV-401). To treat bacterial conjunctivitis and other infections of the outer eye we have developed a topical formulation (AzaSite) 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. 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 by our formulation 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 significantly more effective than the placebo in clinical resolution (p < 0.03), which includes reduction in inflammation and redness, and bacterial eradication (p < 0.001).
In July 2004, we initiated two pivotal Phase 3 clinical trials for AzaSite which were conducted both in the United States and in select Latin American countries. One of the Phase 3 clinical trials was 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. In November 2005, we announced that upon completion of enrollment this study included a total of 746 patients 1 year or older, of which 316 were confirmed positive for acute bacterial conjunctivitis in at least one eye. The results of this Phase 3 study indicated that AzaSite demonstrated a clinical resolution rate of 80% as compared to 78% for tobramycin. This result shows that the clinical resolution rate of AzaSite is equivalent to tobramycin, the primary efficacy endpoint of the study, according to statistical criteria which were previously agreed to by the FDA. The bacterial eradication rate was also equivalent for both groups.
The other Phase 3 clinical trial was a multi-center study in which patients in one arm were dosed with a 1% AzaSite formulation and patients in the second arm were dosed with a placebo. In January 2006, we completed enrollment in this study of approximately 685 patients, of which approximately 277 were confirmed positive for acute bacterial conjunctivitis in at least one eye. In March 2006, we announced that the results of this study showed that the AzaSite formulation was more effective than the placebo in clinical resolution, which includes reduction in inflammation and redness, while also being superior in bacterial eradication over placebo.
In September 2005, we signed a manufacturing supply agreement with Cardinal Health for the manufacture of AzaSite commercial units. Cardinal Health has manufactured the clinical trial supplies used in our two Phase 3 bacterial conjunctivitis clinical trials, and also the registration batches to be used for the AzaSite New Drug Application. We anticipate that this contract manufacturing facility will be ready for inspection by the FDA soon after our NDA submission.
AzaSite Plus (ISV-502). Our first effort toward the expansion of our product candidate AzaSite into a larger franchise is the development of a combination of AzaSite with an anti-inflammatory steroid for the treatment of blepharitis, an infection of the eyelid, one of the most common eye problems in older adults. This combination product candidate is currently in preclinical development and will be more actively pursued as personnel and financial resources become available and as activities to support the AzaSite NDA are completed. We anticipate initiating Phase 1 clinical trials in 2006.
Revenue. 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 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.
Results of Operations
Revenues.
We had total revenues in the first quarters of 2006 and 2005 of $1,000 and $1,000, respectively. In the first three months of 2006 and 2005, sales of OcuGene represented 100% of the revenues.
Cost of goods.
Cost of goods was $3,000 and $5,000 for each of the first quarters of 2006 and 2005, respectively, reflecting in each case 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 $3.5 million during the first quarter of 2006 from $2.4 million during the first quarter of 2005. Approximately 37% of this increase represents increased costs of the clinical research organizations due to the final milestones reached at the completion of our AzaSite Phase 3 clinical trials. The remainder of the increase mainly reflects costs related to additional headcount, consultants and temporary labor to assist with the preparation of the AzaSite New Drug Application, or NDA, and approximately $96,000 of non-cash expense related to the adoption of FAS 123R and the related expensing of options granted to directors and employees.
Selling, general and administrative.
Selling, general and administrative expenses increased to $1.3 million in the first quarter of 2006 from $1.0 million in the first quarter of 2005. The increase mainly reflects the amortization of deferred debt issuance costs related to our short-term Senior Secured Notes issued in December 2005 and January 2006 and approximately $32,000 of non-cash expense related to the adoption of FAS 123R and the related expensing of options granted to directors and employees.
Our expenses for the year ended December 31, 2006 will be dependent upon the progress of the AzaSite NDA and the development activities related to the AzaSite Plus ophthalmic product candidate (ISV-502). We currently anticipate that our research and development expenses will be consistent with the levels incurred in the year ended December 31, 2005 as we submit the AzaSite NDA and proceed with our AzaSite Plus program. We may also continue to make selective additions to our headcount. We anticipate that we will continue the suspension of activity on our other product candidates absent additional funding as we focus on our AzaSite NDA and AzaSite Plus clinical program. Also, we anticipate that our selling, general and administrative costs will increase from the 2005 levels.
Interest, other income and expenses.
Net interest, other income and expense was an expense of $510,000 in the first quarter of 2006 compared to an expense of $3,000 in 2005. The increase reflects accrued interest payable on short-term Senior Secured Notes issued in December 2005 and January 2006 and the accretion of the value of the debt discount.
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 March 31, 2006, our cash and cash equivalents balance was $3.8 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.
Our auditors have included an explanatory paragraph in their audit report referring to our recurring operating losses and a substantial doubt about our ability to continue as a going concern. Absent additional funding from exercise of outstanding warrants, private or public equity or debt financings, collaborative or other partnering arrangements, asset sales, or other sources, we expect that our cash on hand, anticipated cash flow from operations and current cash commitments to us will only be adequate to fund our operations until approximately the middle of July 2006. If we are unable to secure sufficient additional funding prior to that time, we will need to cease operations and liquidate our assets, which are secured by the 2005 Senior Secured Notes. Our consolidated financial statements were prepared on the assumption that we will continue as a going concern and do not include any adjustments that might result should we be unable to continue as a going concern.
Even if we are able to obtain additional financing in order to continue long-term operations beyond approximately the middle of July 2006, we will require and will seek 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 continued development of our products or the long-term success of our company. If we raise funds through the issuance of debt securities, such debt will be secured by a security interest or pledge of all of our assets, will require us to make principal and interest payments, would likely include the issuance of warrants and may subject us to restrictive covenants. In addition, our stockholders may suffer substantial dilution if we raise additional funds by issuing equity securities.
Net cash used in operating activities was $6.2 million and $3.0 million for the three months ended March 31, 2006 and 2005, respectively. The increase in net cash used in operating activities reflected the completion of the AzaSite Phase 3 clinical trials, which commenced in July 2004, activities in preparation for the filing of the related AzaSite NDA and payment of approximately $1.9 million of accounts payable and accrued liabilities. Operating activities in the first three months of 2005 related primarily to research and development expenditures, including conduct of our Phase 3 clinical trials, for our AzaSite antibiotic program.
In the first quarter of 2006 the net cash used in investing activities of $57,000 reflected the acquisition of laboratory and other equipment. Net cash provided by investing activities in the first quarter of 2005 included the reduction in restricted cash of $59,000 less $7,000 used for the acquisition of laboratory and other equipment.
Net cash provided by financing activities was $6.1 million in the first quarter of 2006 compared to $59,000 in the first quarter of 2005. In the first quarter of 2006 and 2005 we received $4.1 million and $59,000, respectively, from the exercise of warrants and options. In the first quarter of 2006, we received $168,000 from a stockholder as a payment of a note. We also received net proceeds of $1.8 million from the final closing of senior secured notes. The notes bear an interest rate of 10% and are due on July 11, 2006, but the maturity date may be extended at our option to January 11, 2007, and would bear an interest rate of 12% during that period.
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 and preclinical testing, the time and costs involved in obtaining regulatory approvals, our ability to successfully 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.
Contractual Obligations
As of March 31, 2006 our contractual obligations under notes payable increased to $6.6 million from $4.6 million at December 31, 2005, and our purchase obligations decreased to $0.7 million from $2.2 million at December 31, 2005. We believe there have been no other significant changes in our payments due under contractual obligations as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2005.
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 March 31, 2006, we had approximately $3.8 million invested in money market mutual funds. While a hypothetical decrease in market interest rates by 10 percent from the March 31, 2006 levels would cause a decrease in interest income, it would not result in a loss of the principal. Additionally, the decrease in interest income would not be material.
Item 4. Controls and Procedures
(a) 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 Rule 13a-15(e) and 15(d)-15(e)) as of the end of the period covered by this Form 10-Q. Based on that evaluation, Dr. Chandrasekaran concluded that our disclosure controls and procedures are effective in providing him with material information relating to us in a timely manner, as required to be disclosed in the reports we file under the Exchange Act.
(b) Changes in internal control over financial reporting. There was no change in the Company's internal control over financial reporting that occurred during the period covered by this Form 10-Q that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
Part II OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 1A. Risk Factors.
The following description of the risk factors includes any material changes to and supersedes the description of the risk factors previously disclosed in Item 1A of our annual report on Form 10-K for the fiscal year ended December 31, 2005.
Our current cash will only fund our business until approximately the middle of July 2006. 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 to our consolidated financial statements for the fiscal year ended December 31, 2005 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 July 2006. 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 exclusive 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 precisely predict our future capital requirements 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; |
| · | our ability to establish additional corporate partnerships to develop, manufacture and market our potential products; |
| · | the progress of our research and development programs; |
| · | 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. |
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 the holders of our December 2005/January 2006 Senior Secured Notes and 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 March 31, 2006, we had outstanding secured indebtedness under our December 2005/January 2006 Senior Secured Notes (the “Senior Secured Notes”) and a note issued to our chief executive officer in an aggregate principal amount of $6,531,000, which is secured by a lien on all of our assets including our intellectual property. In the event that we wind down operations, whether voluntarily or involuntarily, while these secured notes are outstanding, this security interest enables the holders of our Senior Secured Notes to control the disposition of these assets. If we are unable to repay the amounts due under the secured notes when due, the holders of such notes 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 and it is unclear whether the results of such clinical trials will be favorable
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 and in December 2005 announced preliminary results of that first trial. In January 2006 we announced the completion of enrollment in the second Phase 3 trial and in March 2006 announced the results of that trial. We expect our current cash will only be sufficient to enable us to continue our operations as currently planned until approximately the middle of July 2006. Accordingly, we may require additional funds to prepare the related clinical reports, obtain the necessary FDA approvals and market the product. Any delay or failure in the filing of our NDA for AzaSite or in the FDA approval process will likely require us to obtain even further funding and such delay or failure 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. |
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. Even if pre-clinical testing and early clinical trials for a product candidate 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 are safe for humans or effective for indicated uses. 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. 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 the FDA determines that our current AzaSite Phase 3 trials did not produce sufficient evidence to obtain approval for the commercialization of AzaSite or the FDA refuses to approve our AzaSite NDA for any other reason, 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.
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 invalidate our issued patents, limit the scope of the patents, if any, we may be able to obtain, 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 issued U.S. Patent No. 6,681,411 by the USPTO and the European Patent Office has granted its European counterpart 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, prospects, financial condition, and results of operations. 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, thereby utilizing our limited resources for purposes other than product development and commercialization.
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; |
| · | 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.
We may not be able to make principal or interest payments on our Senior Secured Notes
The Senior Secured Notes are secured by a lien on all of our assets, including our intellectual property. $4.3 million in aggregate principal amount under the Senior Secured Notes has an initial maturity date of June 30, 2006, which may be extended, at our option, until December 30, 2006. In addition, $2.0 million in aggregate principal amount under the Senior Secured Notes has an initial maturity date of July 11, 2006, which may be extended, at our option, until January 11, 2007. If we are unable to enter into additional corporate collaborations, close equity or debt financings or generate sufficient cash flow from our operations and are otherwise unable to obtain funds necessary to meet required payments of principal and interest on our Senior Secured Notes by December 30, 2006 and January 11, 2007, we would be in default under the terms of such notes. In the event of such a payment or other event of default, the holders of the Senior Secured Notes (as well as the holders of our other secured indebtedness) could elect to declare all the funds borrowed thereunder to be due and payable, together with accrued and unpaid interest, and institute foreclosure proceedings against our assets, and we could be forced into bankruptcy or insolvency proceedings. Because the holders of the Senior Secured Notes have a senior security interest in all of our assets, they will have the ability to control the liquidation of our assets and will have first priority on any funds generated therefrom. Our common stockholders will likely not receive any proceeds from such a liquidation. Even if we are successful in raising additional funds, we may be forced to curtail our operating activities in order to meet our obligations under the Senior Secured Notes which could harm our business and prospects.
In addition, the Senior Secured Notes contain various negative covenants, including covenants that prevent us from incurring indebtedness in excess of $100,000, granting liens on our assets or repurchasing or declaring dividends on our equity securities, any of which could harm our business. In addition to limiting our ability to operate our business, a failure to comply with these covenants would lead to a default under the notes and an acceleration of the outstanding amounts due under the notes. If this were to occur we can make no assurance that we would have sufficient funds to repay the notes, which could result in foreclosure proceedings against our assets or bankruptcy or insolvency proceedings.
Our current financial situation may impede our ability to protect or enforce adequately our legal rights under agreements and to our intellectual property
We expect our current cash to enable us to continue our operations as currently planned only until approximately the middle of July 2006. 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 adequately protect our legal and intellectual property rights may make us more vulnerable to infringement and could materially harm our business.
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 and expense in finding a successor 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 difficult financial situation and our past reductions in force. The loss of key personnel or the failure to recruit additional personnel or to develop needed expertise would harm our business.
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 and certain other product development activities especially in the area of our glaucoma programs. We are currently pursuing a licensing or collaborative agreement for the sale 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 our anti-inflammatory and glaucoma programs, ISV-205, we must enter into a third party collaboration agreement for the development, marketing and sale thereof 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 programs 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. |
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. Any future activities would mainly pursued 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 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.
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, we may use 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.
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. |
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 March 31, 2006, our accumulated deficit was approximately $141.8 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.
We may not successfully manage any 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.
Our products are subject to government regulations and approvals which may delay or prevent the marketing of potential products and impose costly procedures upon our activities
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, prospects, financial condition, and results of operations.
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 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. |
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 this supplier failed or refused to continue to supply us, 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 the development of AzaSite, and potentially the commercial sale if the product is approved, could be interrupted, which would harm our business prospects. Additional suppliers for this drug exist, but qualification of an alternative source could be time consuming, expensive and 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 or unwilling 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 four 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. Cardinal Health’s facility and the line that will be used to produce the AzaSite units will be subject to inspection by the FDA prior to the approval of the related NDA that we anticipate filing in 2006. While we believe Cardinal Health will be prepared for the inspections, they could encounter delays or difficulties in preparing for, or during, the inspection which 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:
| · | 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. 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. 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 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 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,” and “- 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 financia1 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 be harmed.
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:
| · | 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 $7,100 and $10,400 for the years ended 2005 and 2004, 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.
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 a negative effect 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. 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 March 31, 2006, our management and principal stockholders together beneficially owned approximately 18% of our outstanding shares of Common Stock. In addition, investors in our March/June 2004 and May 2005 private placements, as a group, owned approximately 39% of our outstanding shares of Common Stock as of March 31, 2006. If such investors were to exercise the warrants they currently hold, assuming no additional acquisitions or distributions, such investors would own approximately 51% of our outstanding shares of Common Stock based on their ownership percentages as of March 31, 2006. As a result, these two groups of stockholders, acting together or as individual groups, may be able to exert significant control on matters requiring approval by our stockholders, including the election of all or at least a majority of our Board of Directors, amendments to our charter, and the approval of business combinations and certain financing transactions.
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 March 31, 2006, $231,000 in principal amount 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 and upon an event that triggers a Mandatory Redemption of the notes issued in the offering of our Senior Secured Notes, and is secured by a lien on all of our assets including our intellectual property. In addition, the Senior Secured Notes are secured by a lien on all of our assets and are on parity with the note issued to our chief executive officer.
These security interests will enable the holders of the Senior Secured Notes to control the disposition of all of our assets in the event of our liquidation. If we are unable to repay the amounts due under this indebtedness, such secured lenders could cause us to enter into involuntary liquidation proceedings in the event we default on our obligations and take possession of our assets.
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, 2005 that included 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.
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.
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 connection with our December 2005/January 2006 Private Placement of Notes and Warrants, we issued Warrants to purchase 1,460,000 shares of our Common Stock. The issuance of these shares of Common Stock will be dilutive to our current stockholders and could adversely affect the market price for 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. These and other potential changes could materially increase the expenses we report under generally accepted accounting principles, and adversely affect our operating results.
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.
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| INSITE VISION INCORPORATED |
| | |
Date: May 15, 2006 | 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) |
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. |