Ista Pharmaceuticals (ISTA) 10-Q 2002 Q1 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-Q

Mark One

[X]  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002

or

[   ]  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES EXCHANGE ACT OR 1934 FOR THE TRANSITION PERIOD FROM      TO      

Commission File Number: 333-34120

ISTA PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)

DELAWARE
(State or other jurisdiction of
incorporation or organization) 33-0511729
(IRS Employer Identification No.)

15279 ALTON PARKWAY #100, IRVINE, CA 92618
(Address of principal executive offices)

(949) 788-6000
(Registrant’s telephone number, including area code)

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

     The number of shares of the registrant’s common stock, $.001 par value, outstanding as of April 30, 2002 was 16,753,312.

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TABLE OF CONTENTS

PART I FINANCIAL INFORMATION
	Item 1 Financial Statements
		Consolidated Balance Sheets
		Consolidated Statements of Operations
		Consolidated Statements of Cash Flows
		Notes to Unaudited Consolidated Financial Statements
	Item 2 Management’s Discussion And Analysis Of Financial Condition And Results Of Operations
	Item 3 Quantitative and Qualitative Disclosures about Market Risk
PART II OTHER INFORMATION
	Item 1 Legal Proceedings
	Item 2 Change in Securities and Use of Proceeds
	Item 3 Defaults upon Senior Securities
	Item 4 Submission of Matters to a Vote of Security Holders
	Item 5 Other Information
	Item 6 Exhibits and Reports on Form 8-K
Signatures

Table of Contents

			Page No
PART I	FINANCIAL INFORMATION
Item 1	Financial Statements			3
		Condensed Consolidated Balance Sheets — December 31, 2001 and March 31, 2002 (unaudited)		3
		Condensed Consolidated Statements of Operations (unaudited) — Three Month Periods Ended March 31, 2002 and 2001 and for the Period from February 13, 1992 (inception) to March 31, 2002		4
		Condensed Consolidated Statements of Cash Flows (unaudited) — Three Month Periods Ended March 31, 2002 and 2001 and for the Period from February 13, 1992 (inception) to March 31, 2002		5
		Notes to Unaudited Condensed Consolidated Financial Statements		6
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations			7
Item 3	Quantitative and Qualitative Disclosure about Market Risk			15
PART II	OTHER INFORMATION
Item 1	Legal Proceedings			15
Item 2	Change in Securities and Use of Proceeds			15
Item 3	Defaults upon Senior Securities			15
Item 4	Submission of Matters to a Vote of Security Holders			16
Item 5	Other Information			16
Item 6	Exhibits and Reports on Form 8-K			16
	Signatures			17

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PART I FINANCIAL INFORMATION

Item 1 Financial Statements

ISTA Pharmaceuticals, Inc.
Condensed Consolidated Balance Sheets
(In thousands, except share and per share data)

			March 31,			December 31,
			2002			2001
			(Unaudited)
ASSETS
Current assets:
	Cash and cash equivalents		$	3,498		$	12,348
	Short-term investments			7,233			3,254
	Advance payments — clinical trials			40			40
	Other current assets			517			451
		Total current assets		11,288			16,093
Property and equipment, net				870			819
Deposits and other assets				44			44
		Total Assets	$	12,202		$	16,956
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
	Accounts payable		$	1,298		$	891
	Accrued compensation and related expenses			396			799
	Accrued expenses — clinical trials			457			770
	Other accrued expenses			1,047			1,554
		Total current liabilities		3,198			4,014
Deferred rent				5			2
Deferred income				4,930			5,000
Stockholders’ equity:
	Common stock, $.001 par value; 100,000,000 shares authorized at March 31, 2002 and 2001; 16,753,312 and 15,504,983 shares issued and outstanding at March 31, 2002 and 2001, respectively			17			16
	Additional paid in capital			111,019			111,026
	Deferred compensation			(2,804	)		(3,643	)
	Accumulated other comprehensive loss			(43	)		(22	)
	Deficit accumulated during the development stage			(104,120	)		(99,437	)
		Total stockholders’ equity		4,069			7,940
		Total Liabilities and Stockholders’ Equity	$	12,202		$	16,956

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

								For the Period
								From
								February 13,
								1992
		Three Months Ended						(Inception)
		March 31,						Through
								March 31,
		2002			2001			2002
Revenue		$	70		$	0		$	70
Operating expenses:
	Research and development		2,922			3,929			61,634
	General and administrative		1,918			1,495			25,447
Total operating expenses			4,840			5,424			87,081
Loss from operations			(4,770	)		(5,424	)		(87,011	)
Interest income			87			264			2,501
Interest expense			—			—			(320	)
Net loss			(4,683	)		(5,160	)		(84,830	)
Deemed dividend for preferred stockholders			—			—			(19,245	)
Net loss attributable to common stockholders		$	(4,683	)	$	(5,160	)	$	(104,075	)
Net loss per common share, basic and diluted		$	(0.28	)	$	(0.33	)
Shares used in computing net loss per common share, basic and diluted			16,624			15,444

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

										For the Period
										From
										February 13,
				Three Months Ended						1992 (Inception)
				March 31,						Through
										March 31,
				2002			2001			2002
Operating Activities
Net loss attributable to common stockholders				$	(4,683	)	$	(5,160	)	$	(104,075	)
Deemed dividend for preferred stockholders					—			—			19,245
Adjustments to reconcile net loss attributable to common stockholders to net cash used in operating activities:
		Amortization of deferred compensation			728			410			7,139
		Common stock issued for services			—			—			113
		Forgiveness of note receivable			—			—			162
		Depreciation and amortization			83			84			1,412
Changes in operating assets and liabilities:
	Advanced payments — clinical trials and other current assets				(66	)		396			(557	)
	Note receivable from officer				—			(3	)		(162	)
	Accounts payable				407			82			1,298
	Accrued compensation and related expenses				(403	)		(239	)		396
	Accrued expenses — clinical trials and other accrued expenses				(820	)		531			1,628
	Deferred rent				3			(4	)		5
	Deferred income				(70	)		—			4,930
	License fee received from Visionex				—			—			5,000
			Net cash used in operating activities		(4,821	)		(3,903	)		(63,466	)
Investing Activities
Purchase of marketable securities					(11,026	)		(4,219	)		(43,180	)
Sale of marketable securities					7,014			9,219			35,924
Purchase of equipment					(134	)		(94	)		(2,274	)
Deposits and other assets					—			72			(44	)
Proceeds from refinancing under capital leases					—			—			827
Cash acquired from Visionex transaction					—			—			4,403
			Net cash (used in) provided by investing activities		(4,146	)		4,978			(4,344	)
Financing Activities
Payments on obligation under capital lease					—			(15	)		(827	)
Proceeds from exercise of stock options					116			22			676
Proceeds from exercise of warrants					—			—			41
Proceeds from bridge loans with related parties					—			—			5,047
Payments on bridge loans with related parties					—			—			(3,755	)
Proceeds from issuance of preferred stock					—			—			34,215
Repurchase of preferred stock					—			—			(56	)
Proceeds from issuance of common stock					—			—			36,007
			Net cash provided by financing activities		116			7			71,348
Effect of exchange rate changes on cash					1			(11	)		(40	)
(Decrease) increase in cash and cash equivalents					(8,850	)		1,071			3,498
Cash and cash equivalents at beginning of period					12,348			8,772			—
Cash and cash equivalents at end of period				$	3,498		$	9,843		$	3,498

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ISTA Pharmaceuticals, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

March 31, 2002

1. The Company

     ISTA Pharmaceuticals, Inc. (“ISTA” or the “Company”) was incorporated in the state of California on February 13, 1992 to discover, develop and market novel therapeutics for diseases and conditions of the eye. ISTA’s initial product development efforts are focused on using highly purified formulations of the enzyme hyaluronidase to treat diseases and conditions such as vitreous hemorrhage, diabetic retinopathy and corneal opacification. The Company’s lead product candidate, Vitrase®, which has completed two Phase III clinical trials, is a proprietary drug for the treatment of vitreous hemorrhage. The Company has not commenced commercial operations and is considered to be in the development stage. The Company reincorporated in Delaware on August 4, 2000.

The financial statements included herein have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business for the foreseeable future.

As of March 31, 2002, we had approximately $10.7 million in cash and short-term investments. The Company incurred a net loss of $4.7 million for the three months ended March 31, 2002 and had an accumulated deficit of $104.1 million at March 31, 2002. The ability of the Company to continue as a going concern is dependent upon its ability to obtain additional capital and achieve profitable operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The Company will continue to rely on outside sources of financing to meet its capital needs beyond the next year. The outcome of these matters cannot be predicted at this time. Further, there can be no assurance, assuming the Company raises additional funds, that the Company will achieve positive cash flow. If the Company is not able to secure additional funding, we will be required to scale back our research and development programs and general and administrative activities and we may not be able to continue in business. These condensed consolidated financial statements do not include any adjustments to the specific amounts and classifications of assets and liabilities that might be necessary should the Company be unable to continue as a going concern.

2. Basis of Presentation

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

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

     For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2001.

3. Revenue Recognition

     We recognize revenue consistent with the provisions of the Securities and Exchange Commission’s (“SEC”) Staff Accounting Bulletin No. 101 (“SAB 101”), “Revenue Recognition”, which sets forth guidelines in the timing of revenue recognition based upon factors such as passage of title, installation, payments and customer acceptance. Amounts received for upfront product and technology license fees under multiple-element arrangements are deferred and recognized over the period of such services or performance if such arrangements require on-going services or performance. Amounts received for milestones are recognized upon achievement of the milestone, unless the amounts received are creditable against royalties or we have ongoing performance obligations. Royalty revenue will be recognized upon sale of the related products, provided the royalty amounts are fixed and determinable and collection of the related receivable is probable. Any amounts received prior to satisfying our revenue recognition criteria will be recorded as deferred revenue in the accompanying balance sheets.

     In December 2001, we began a collaboration with Otsuka under which Otsuka will be responsible for all clinical development, regulatory approvals, sales and marketing activities for Vitrase in Japan. Our principal sources of revenue from this collaboration and the commercialization of Vitrase will be the license fee received in December 2001 and amortized over the Company’s continuing involvement with Otsuka, milestone payments and product sales received from Otsuka. Under the terms of the collaboration, we are responsible for the manufacture of Vitrase and supplying all of Otsuka’s requirements for Vitrase.

4. Comprehensive Income (Loss)

     Statement of Financial Accounting Standard (SFAS) No. 130,Reporting Comprehensive Income,requires reporting and displaying comprehensive income (loss) and its components, which, for ISTA, includes net loss and unrealized gains and losses on investments and foreign currency translation gains and losses. Total comprehensive loss for the three month periods ended March 31, 2002 and 2001 was $4,726,000 and $5,166,000, respectively. In accordance with SFAS No. 130, the accumulated balance of unrealized gains (losses) on investments and the accumulated balance of foreign currency translation adjustments are disclosed as separate components of stockholders’ equity.

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5. Net Loss Per Share

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

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

6. New Accounting Pronouncements

     In June 2001, the Financial Accounting Standards Board issued SFAS No. 141,Business Combinations, and No. 142,Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Use of the pooling-of-interest method is no longer permitted. SFAS No. 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination that is completed after June 30, 2001.

     SFAS No. 142 no longer permits the amortization of goodwill and indefinite-lived intangible assets. Instead, these assets must be reviewed annually (or more frequently under certain conditions) for impairment in accordance with this statement. This impairment test uses a fair value approach rather than the undiscounted cash flows approach previously required by SFAS No. 121,Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. The amortization of goodwill included in our investments in equity investees will also no longer be recorded upon adoption of the new rules. Intangible assets that do not have indefinite lives will continue to be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 121. We adopted SFAS No. 142 on January 1, 2002. Because we have no goodwill or other indefinite-lived intangible assets recorded in our financial statements, SFAS No. 142 did not have an impact on our results of operations or financial condition.

Item 2 Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

     This report contains forward-looking statements that involve risks and uncertainties. The statements contained in this report that are not purely historical are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. These forward-looking statements concern matters that involve risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Words such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue” or similar words are intended to identify forward looking statements, although not all forward looking statements contain these words.

     Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Moreover, neither we nor any other person assumes responsibility for the accuracy and completeness of the forward-looking statements. We are under no duty to update any of the forward-looking statements after the date hereof to conform such statements to actual results or to changes in our expectations.

     Readers are urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation “Factors That May Affect Results of Operations and Financial Condition” set forth in this Form 10-Q, and the audited financial statements and

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the notes thereto and disclosures made under the captions, “Management Discussion and Analysis of Financial Condition and Results of Operations”, “Risk Factors”, “Consolidated Financial Statements” and “Notes to Consolidated Financial Statements”, included in the Company’s annual report on Form 10-K for the year ended December 31, 2001.

Overview

     ISTA was founded to discover, develop and market new remedies for diseases and conditions of the eye. Our product development efforts involve using highly purified formulations of the enzyme hyaluronidase to treat diseases and conditions such as vitreous hemorrhage, diabetic retinopathy and corneal opacification. Our lead hyaluronidase based product candidate, Vitrase, is a proprietary drug for the treatment of vitreous hemorrhage and diabetic retinopathy.

     In March 2000, we completed the acquisition of Visionex, a Singapore corporation, which had been conducting a Phase II clinical trial of Vitrase in Singapore. Visionex was a related party through common ownership by some of our stockholders. We are planning to significantly wind down the operations of Visionex in 2002 upon completion of the Phase II clinical trials of Vitrase in Singapore.

     In March 2000, we began a collaboration with Allergan, Inc., under which Allergan will be responsible for the marketing, sale and distribution of Vitrase in the United States and all international markets, except Mexico until April 2004, and Japan. We will be dependent on the success of Allergan in commercializing Vitrase in these markets. Our principal sources of revenue from this collaboration and the commercialization of Vitrase will be milestone, royalty and profit sharing payments received from Allergan. Under the terms of the collaboration, we are responsible for the manufacture of Vitrase and for supplying all of Allergan’s requirements for Vitrase. If we are successful in obtaining regulatory approval for Vitrase and Allergan achieves significant sales of the product, our aggregate manufacturing costs will increase.

     In December 2001, we began a collaboration with Otsuka Pharmaceutical Co., Ltd., under which Otsuka will be responsible for all clinical development, regulatory approval, sales and marketing activities for Vitrase in Japan. We received a license fee in December 2001 that will be amortized over the Company’s continuing involvement with Otsuka. Principal sources of future revenue from this collaboration will be milestone payments and product sales received from Otsuka. Under the terms of the collaboration, we are responsible for the manufacture of Vitrase and supplying all of Otsuka’s requirements for Vitrase.

     In December 2001, we announced our strategic plan to transition from a development organization to a fully-integrated, specialty pharmaceutical company with a primary focus on ophthalmology by acquiring complimentary products, either already marketed or in development.

     In March 2002, we announced the preliminary results for our Phase III clinical studies of Vitrase for the treatment of severe vitreous hemorrhage. Data from the two Phase III studies did not show a statistically significant improvement in the primary (surrogate) endpoint. In April 2002, following discussions and a review of preliminary safety and efficacy data from the two Phase III studies with the FDA, we announced our plans to proceed with the preparation and filing of the clinical and other required sections of the New Drug Application (NDA) for Vitrase based on improvement in visual function for Vitrase treated patients in both studies. The FDA’s review of the NDA for Vitrase may result in a requirement that we conduct additional Phase III clinical studies to support regulatory approval or a decision by us to terminate further development of Vitrase for the treatment of severe vitreous hemorrhage. We cannot assure you that we will conduct additional clinical trials to support regulatory approval of Vitrase for the treatment of severe vitreous hemorrhage, or, if we conduct additional studies, that the results will support the filing or approval of a NDA.

     On May 9, 2002 we acquired substantially all of the assets of AcSentient, Inc. The assets include United States product rights to bromfenac, a topical non-steroidal anti-inflammatory compound for the treatment of ocular inflammations and United States marketing rights for a new formulation of timolol, a beta-blocking agent for treating glaucoma. The assets also include worldwide marketing rights for Caprogel®, a novel compound for the treatment of hyphema, or bleeding into the front of the eye. AcSentient previously acquired rights to these compounds from Senju Pharmaceutical Co., Ltd (Japan) and the Eastern Virginal School of Medicine. Under the terms of the transaction, we have assumed payment and other obligations and responsibility for final development of bromfenac and Caprogel®. We will incur additional research and development expenses in connection with the final development of bromfenac and Caprogel®, and if these compounds are approved for sale in the United States, we expect to incur significant marketing and sales expenses. In addition, we will also be responsible for certain milestone payments to a third party in connection with the marketing approval in the United States for these compounds.

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     We currently have no products available for sale. We have incurred losses since our inception and had an accumulated deficit through March 31, 2002 of $104.1 million. Our losses have resulted primarily from research and development activities, including clinical trials, related general and administrative expenses and a deemed dividend for preferred stockholders. We expect to continue to incur operating losses for the foreseeable future as we continue our research and development and clinical testing activities, and seek regulatory approval for our product candidates.

Results of Operations

Three Months Ended March 31, 2002 and 2001

     Revenue.Revenue of $70,000 for the quarter ended March 31, 2002 reflects the amortization of deferred revenue recorded in December 2001 for the license fee payment made by Otsuka Pharmaceutical Co., Ltd. in connection with the license for Vitrase in Japan.

     Research and development expenses.Research and development expenses were $2.9 million for the three months ended March 31, 2002 compared to $3.9 million for the three months ended March 31, 2001. The decrease in research and development expenses was primarily attributable to decreases in expenses associated with two Phase III clinical trials of Vitrase for the treatment of severe vitreous hemorrhage. We expect that our research and development expenses will increase in future periods primarily due to activities in connection with the development of bromfenac and Caprogel®.

     General and administrative expenses.General and administrative expenses were $1.9 million for the three months ended March 31, 2002 compared to $1.5 million for the three months ended March 31, 2001. The increase in general and administrative expenses was primarily attributable to an increase in the amortization of non-cash, stock based compensation expense.

     Interest income.Interest income was $87,000 for the three months ended March 31, 2002 compared to $264,000 for the three months ended March 31, 2001. The decrease in interest income was attributable to higher cash balances for the first quarter of 2001 compared to 2002.

Liquidity and Capital Resources

     As of March 31, 2002, we had approximately $10.7 million in cash and short-term investments.

     We have financed our operations since inception primarily through private sales of our preferred stock and sale of our common stock in our initial public offering. We received net proceeds of $10.0 million from the private sale of preferred stock in March 2000, $31.7 million from our initial public offering in August 2000, $4.0 million from the private sale of common stock in December 2001 and $5.0 million from a license fee payment in December 2001.

     For the three months ended March 31, 2002, we used $4.8 million of cash for operations principally as a result of the net loss of $4.7 million partially offset by non-cash compensation expense of approximately $728,000. We used approximately $3.9 million of cash for operations in the three months ended March 31, 2001.

     For the three months ended March 31, 2002, we used $4.1 million of cash for investing activities, primarily for the purchase of marketable securities. For the three months ended March 31, 2001, $5.0 million of cash was provided by investing activities, primarily from the sale of marketable securities.

     Net cash provided by financing activities totaled $116,000 for the three months ended March 31, 2002 compared to $7,000 for the three ended March 31, 2001.

     As of March 31, 2002 the Company had an accumulated deficit of $104.1 million. The Company has operated at a loss since inception and expects this to continue for some time. The amount of the accumulated deficit will continue to grow as we continue our clinical, research and development efforts for our product candidates. If these activities are successful and we receive FDA approval to market these products, additional funding will be required to market and sell these products. As of this filing, the Company’s ability to continue as a going concern will be dependent on our ability to raise additional capital to meet our projected operating needs for at least the next twelve months.

     Due to expenses associated with the acquisition of products rights from AcSentient and currently anticipated increase in research and development expenses in 2002 over levels previously planned, we now anticipate that our cash on hand will be sufficient to fund our operations and capital expenditure needs for approximately the next six months. We will need to raise additional funds to continue the development and commercialization of Vitrase for the treatment of vitreous hemorrhage and diabetic retinopathy, fund further development of our other product candidates, including bromfenac and Caprogel®, and to acquire or in-license additional products and technology beyond this period. Alternatives to raise additional funds include borrowings, collaborative research and development arrangements with technology companies, the licensing of product rights to third parties or additional public and private financing. There can be no assurance that funds from these sources will be available when needed or, if available, will be on terms favorable to us or to our stockholders. Insufficient funds may require us to further delay, scale back or

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eliminate some or all of our product development efforts or may limit our ability to operate as a going concern. If additional funds are raised by issuing equity securities, the percentage ownership of our stockholders will be reduced, stockholders may experience additional dilution or such equity securities may provide for rights, preferences or privileges senior to those of the holders of our common stock.

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

• the rate of progress of our research and development programs

• the results of our clinical trials and requirements to conduct additional clinical trials

• the time and expense necessary to obtain regulatory approvals

• activities in connection with the in-license or acquisition of products and technologies

• our ability to establish and maintain collaborative relationships

• receiving milestone payments from Allergan and Otsuka

• competitive, technological, market and other developments

Factors that May Effect Results of Operations and Financial Condition.

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

     We have only a limited operating history upon which you can evaluate our business. We have incurred losses every year since we began operations. As of March 31, 2002, our accumulated deficit was $104.1 million, including a net loss of $22.5 million for the year ended December 31, 2001 and a net loss of approximately $4.7 million for the three months ended March 31, 2002. We have not generated any revenue from product sales to date, and we may never generate revenues from product sales in the future. Even if we do achieve significant revenues from product sales, we expect to incur significant operating losses over the next several years. We may never achieve profitable operations.

If we cannot raise additional capital on acceptable terms, we will need to significantly curtail our operations.

     We believe that our cash on hand will be sufficient to fund our operations and capital expenditure needs for approximately the next six months. During this period, we plan to allocate our capital resources primarily to the development of our lead product candidate, Vitrase, for the treatment of severe vitreous hemorrhage and bromfenac and Caprogel®. We will need to raise additional funds to continue the development and commercialization of all our product candidates, including Vitrase, beyond this period. These funds may not be available on favorable terms, or at all. If we do not succeed in raising additional funds, we will need to curtail our operations significantly.

Due to the preliminary results of our Phase III clinical trials for Vitrase, we may terminate the development of Vitrase for severe vitreous hemorrhage.

     In March 2002, we announced preliminary efficacy and safety results for our two Phase III clinical trials of Vitrase for the treatment of severe vitreous hemorrhage. Data from both Phase III studies did not show a statistically significant improvement in the primary (surrogate) endpoint. In April 2002, following discussions and a review of preliminary safety and efficacy data from the two Phase III studies with the FDA, we announced our plans to proceed with the preparation and filing of the clinical and other required sections of the New Drug Application (NDA) for Vitrase based on improvement in visual function for Vitrase treated patients in both studies. The FDA’s review of the NDA for Vitrase may result in a requirement that we conduct additional Phase III clinical studies to support regulatory approval. Additional Phase III clinical studies will require us to raise additional capital, which we may not be able to raise on favorable terms, or at all. Even if we raise additional funds, we may decide to terminate further development of Vitrase for the treatment of severe vitreous hemorrhage. If we terminate development of

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Vitrase, we will not have a lead product candidate, and we will be dependent on the development of our other product candidates and our ability to successfully acquire other products and technologies. Even if we conduct additional studies for Vitrase, we cannot assure you that the results will support the filing or regulatory approval of a NDA.

If we are not able to complete clinical trials for bromfenac or Caprogel successfully or our clinical trials are delayed, we may not be able to market these products.

In connection with our acquisition of substantially all of the assets of AcSentient, we acquired United States product rights to bromfenac and worldwide marketing rights for Caprogel®. Phase I, Phase II and Phase III clinical trials of bromfenac have already been completed in Japan and we anticipate submitting an NDA for bromfenac following successful completion of a single Phase III study in the United States. Phase II and Phase III clinical trials of Caprogel® have been completed and we believe that we need to complete one additional Phase III study prior to a submission of an NDA. However, the FDA may required us to conduct additional clinical trials with respect to bromfenac or Caprogel® prior to filing an NDA. We may not be able to raise additional capital in order to conduct necessary clinical trials and there is a possibility that the results of any clinical trials conduct by us for bromfenac or Caprogel® may not support regulatory approval.

If we do not receive and maintain regulatory approvals for our products, we will not be able to manufacture or market our products.

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

     The process that pharmaceuticals must undergo to receive necessary approval is extensive, time-consuming and costly, and there is no guarantee that regulatory authorities will approve any of our product candidates. FDA approval can be delayed, limited or not granted for many reasons, including:

• a product candidate may not be safe or effective

• FDA officials may not find that the data from preclinical testing and clinical trials justifies approval

• the FDA might not approve our manufacturing processes or facilities or the processes or facilities of our contract manufacturers or raw material suppliers

• the FDA may change its approval policies or adopt new regulations

• the FDA may approve a product candidate for indications that are narrow, which may limit our sales and marketing activities

     The process of obtaining approvals in foreign countries is subject to delay and failure for the same reasons.

If we are not able to complete our clinical trials successfully, we may not be able to obtain regulatory approvals to market our products.

     Many of our research and development programs are at an early stage and clinical testing is a long, expensive and uncertain process. Even if initial results of preclinical studies or clinical trial results are positive, we may obtain different results in later stages of drug development, including failure to show desired safety and efficacy. For example, our preliminary efficacy and safety results for our two Phase III clinical trials of Vitrase for the treatment of severe vitreous hemorrhage did not show a statistically significant improvement in the primary (surrogate) endpoint. We cannot assure you that any additional clinical trials we may decide to conduct of Vitrase for the treatment of severe vitreous hemorrhage will support the filing or regulatory approval of a NDA.

     The clinical trials of any of our product candidates could be unsuccessful, which would prevent us from obtaining regulatory approval and commercializing the product. Our failure to develop safe and effective products would substantially impair our ability to generate revenues and materially harm our business and financial condition.

If regulatory approval for the new formulation of timolol is unsuccessful or delayed, we may not be able to market the product.

In connection with our acquisition of substantially all of the assets of AcSentient, we also acquired the United States marketing rights for a new formulation of timolol. We depend on Senju Pharmaceutical Co., Ltd for obtaining regulatory approval for the new formulation of timolol. We believe that an NDA submission by Senju for this new formulation will be based on pre-clinical trials and other clinical trials, combined with data from a multi-center Phase III clinical trial recently completed in the United States. However, the FDA may require Senju to conduct additional clinical trials prior to filing an NDA. The amount of time and resources Senju dedicates to obtaining regulatory approval of the new formulation of timolol is not within our control.

We may be unable to execute our strategic plan to transition to a fully-integrated, specialty pharmaceutical company.

     Our strategy to acquire or in-license currently marketed ophthalmic products will be dependent upon a number of factors including identifying such acquisition opportunities, successfully negotiating favorable terms with third parties for the acquisition of such products and our ability to raise additional capital to enable the acquisition of such products. Furthermore, we have not established sales, marketing or distribution capabilities to support the marketing of any products and we do not have experience in the manufacturing of any products in commercial quantities.

     We may not be able to identify any product acquisition opportunities or be successful in negotiating favorable terms for such product acquisitions, or at all. Should we be successful in acquiring any products, we will need to establish our own sales, marketing, distribution and manufacturing capabilities, each of which will require substantial financial and management resources. Our failure to establish an effective sales, marketing, distribution

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and manufacturing capabilities on a timely basis would adversely affect our ability to commercialize any acquired products.

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

     Our success largely depends on the skills, experience and efforts of our new Chief Executive Officer, Vicente Anido, Jr., Ph.D. Dr. Anido may terminate his employment at any time. In addition, we do not maintain “key person” life insurance policies covering Dr. Anido. The loss of Dr. Anido would jeopardize our ability to execute our strategic plan.

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

     We have relied on Prima Pharm, Inc. (Prima Pharm) for formulation and filling of dose specific vials of hyaluronidase used in our clinical trials. The manufacturing facilities of all of our contract manufacturers must comply with current Good Manufacturing Practice regulations, which the FDA strictly enforces. Furthermore, the facilities of the contract manufacturer must undergo and pass pre-approval inspection by the FDA before any of our products can be approved for manufacture. If we fail to reach an agreement with a new contract manufacturer, we will have to negotiate with Prima Pharm to improve Prima Pharm’s manufacturing facilities in order to manufacture our products in commercial volume in compliance with current Good Manufacturing Practice regulations. Such improvements will require a substantial capital commitment on our part. Difficulties in our relationship with Prima Pharm could limit our ability to insure that the required improvements are made.

     We have entered into a letter of intent with a new contract manufacturer, SP, to scale up production and are in the process of negotiating a definitive agreement for the manufacture of commercial quantities of Vitrase. To date, we needed Vitrase only for clinical trials. We may not be able to complete an agreement with this new contract manufacturer on favorable terms, or at all. Additionally, before any new contract manufacturer can produce commercial quantities of Vitrase, if applied, we must demonstrate to the FDA’s satisfaction that the new source of Vitrase is substantially equivalent to the supply of the drug used in our clinical trials. Such demonstration may include the requirement to conduct additional clinical trials. A new manufacturer will also be subject to new testing and compliance inspections by regulatory authorities. We cannot assure you that any new contract manufacturer will be able to develop processes necessary to produce substantially equivalent product or that regulatory authorities would approve any new manufacturer. Failure to complete an agreement with a new contract manufacturer on a timely basis, or alternatively, successfully implement improvements to the manufacturing facilities of Prima Pharm, will adversely affect our ability to provide sufficient quantities of our products for commercial sale.

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

     We have entered into collaborations with both Allergan and Otsuka for Vitrase. If we obtain regulatory approval for Vitrase in the United States and Europe, we will be dependent on Allergan for the commercialization of Vitrase in the United States and Europe. We will depend on Otsuka for obtaining regulatory approval of Vitrase in Japan, and if such approval is obtained, we will be dependent upon Otsuka for the commercialization of Vitrase in Japan. The amount and timing of resources Allergan and Otsuka dedicate to our collaborations is not within our control. Accordingly, any breach or termination of our agreements by Allergan or Otsuka could delay or stop the commercialization of Vitrase. For various reasons, including our preliminary results of our two Phase III clinical trials of Vitrase for the treatment of severe vitreous hemorrhage, our strategic partners may change their strategic focus, terminate our agreements, pursue alternative technologies or develop competing products. Unfavorable developments in our relationship with our strategic partners could have a significant adverse effect on us and our stock price.

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

     We have a supply agreement with Biozyme pursuant to which Biozyme supplies our contract manufacturer with all of our ovine hyaluronidase requirements for use in our clinical trials. Biozyme is currently our only source for highly purified hyaluronidase, which is extracted from sheep in New Zealand. Difficulties in our relationship with

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Biozyme could limit our ability to provide sufficient quantities of our products for clinical trials and commercial sales.

The outbreak of foot-and-mouth disease in Europe and elsewhere may significantly interrupt the supply of the active pharmaceutical ingredient for our products.

     The active pharmaceutical ingredient in our product candidates is hyaluronidase, which is extracted from sheep in New Zealand. Biozyme, the company that processes hyaluronidase for us, is located in Wales and ships hyaluronidase to our manufacturer, Prima Pharm, in San Diego, approximately twice per month for formulation and filling of dose specific vials. The export of each shipment of hyaluronidase from the United Kingdom (UK) requires that the Ministry of Agriculture, Fisheries and Food (MAFF) issue an export permit. The MAFF has never denied the issuance of an export permit for any shipment of hyaluronidase to ISTA. To permit the importation of hyaluronidase in to the United States, we are required to secure an annual import permit from the United States Department of Agriculture (USDA). The USDA has never denied the issuance of an annual import permit to ISTA.

     In February 2001, an outbreak of foot-and-mouth disease in the UK led to governmental actions around the world to prevent the highly contagious disease from spreading to animals in other countries. Such actions have included temporarily prohibiting the importation and exportation of cattle, sheep and other animals subject to the disease, and products derived from these animals, to and from the UK and to and from other countries. As a result, the MAFF temporarily placed exportation of processed hyaluronidase and other biological materials on hold because of the foot-and-mouth disease outbreak. Before it will issue export permits for these materials, including hyaluronidase, MAFF is requiring that the USDA make a written request that permits be issued. The USDA issued a permit request for our hyaluronidase. The MAFF then issued the export permit and the shipment of hyaluronidase was delivered to ISTA. Subsequent shipments of hyaluronidase have been delivered without delay consistent with the procedure in place prior to the outbreak of foot-and-mouth disease. If future events lead to lengthy delays in the shipment of our active pharmaceutical ingredient to our manufacturer, our on-going clinical studies and our business and financial condition may be materially impaired.

We may be required to bring litigation to enforce our intellectual property rights, which may result in substantial expense.

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

• our patents and pending patent applications use technology that we invented first

• we were the first to file patent applications for these inventions

• others will not independently develop similar or alternative technologies or duplicate our technologies

• any of our pending patent applications will result in issued patents

• any patents issued to us will provide a basis for commercially viable products, will provide us with any competitive advantages or will not face third party challenges or be the subject of further proceedings limiting their scope

     We may become involved in interference proceedings in the U.S. Patent and Trademark Office to determine the priority of our inventions. We could also become involved in opposition proceedings in foreign countries challenging the validity of our patents. In addition, costly litigation could be necessary to protect our patent position. Patent law relating to the scope of claims in the technology fields in which we operate is still evolving and, consequently, patent positions in our industry are generally uncertain. We may not prevail in any lawsuit or, if we do prevail, we may not receive commercially valuable remedies. Failure to protect our patent rights could harm us.

     We also rely on trade secrets, unpatented proprietary know-how and continuing technological innovation that we seek to protect with confidentiality agreements with employees, consultants and others with whom we discuss our business. These individuals may breach our confidentiality agreements and our remedies may not be adequate to enforce these agreements. Disputes may arise concerning the ownership of intellectual property or the applicability or enforceability of these agreements, and we may not resolve these disputes in our favor. Furthermore, our

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competitors may independently develop trade secrets and proprietary technology similar to ours. We may not be able to maintain the confidentiality of information relating to such products.

Our products could infringe the intellectual property rights of others, which may cause us to engage in costly litigation and, if we are not successful, could cause us to pay substantial damages and prohibit us from selling our products.

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

     We have ceased negotiations with a third party for our acquisition of rights to patent applications owned by such party related to our Keraform product in development. As a result, we may be required to license these patent rights in order to commercialize our Keraform product as currently planned. Such a license may not be available to us on favorable terms, if at all. If such license is not available and we commercialize our Keraform product in its current configuration, there is a possibility that we could be sued for patent infringement should any patents containing claims related to our Keraform product issue from these patent applications.

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

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

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

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

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

We are exposed to product liability claims, and insurance against these claims may not be available to us at a reasonable rate.

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

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We deal with hazardous materials and generate hazardous wastes and must comply with environmental laws and regulations, which can be expensive and restrict how we do business. We could also be liable for damages or penalties if we are involved in a hazardous material or waste spill or other accident.

     Our research and development work and manufacturing processes involve the use of hazardous materials and waste, including chemical, radioactive and biological materials. Our operations also produce hazardous wastes. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of these materials and waste. In the event of a hazardous material or waste spill or other accident, we could also be liable for damages or penalties. In addition, we may be liable or potentially liable for injury or contamination that results from our, or a third party’s, use of these materials, and our liability could exceed our total assets.

Item 3 Quantitative and Qualitative Disclosures about Market Risk

     The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities. The average duration of all of our investments in 2001 and for the first three months of 2002 was less than one year. Due to the short-term nature of these investments, we believe we have no material exposure to interest rate risk arising from our investments. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair market value of our interest sensitive financial investments. Declines in interest rates over time will, however, reduce our investment income, while increases in interest rates over time will increase our interest expense.

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

PART II OTHER INFORMATION

Item 1 Legal Proceedings

     None

Item 2 Change in Securities and Use of Proceeds

Initial Public Offering

     On August 25, 2000 the Company completed an initial public offering of 3,000,000 shares of common stock at an initial public offering price of $10.50 per share with gross proceeds of $31,500,000. Net proceeds, after a 7% underwriters’ discount, were $29,295,000. Additional expenses relating to the initial public offering, other than the underwriters’ discount, amounted to $1,918,000. The managing underwriters for the offering were CIBC World Markets, Prudential Vector Healthcare and Thomas Weisel Partners LLC. The shares of common stock sold in the offering were registered under the Act in a Registration Statement on Form S-1, as amended (File No. 333-34120). The Securities and Exchange Commission initially declared the Registration Statement effective on August 9, 2000. We subsequently filed two post-effective amendments to the Registration Statement, the last of which was declared effective on August 21, 2000.

     In September 2000, the underwriters exercised their over-allotment option for an additional 450,000 shares of common stock at the initial public offering price of $10.50, less a 7% discount, resulting in net proceeds of $4,394,000.

     The net proceeds from our initial public offering are primarily being used to fund our clinical trials and preclinical research, with a particular focus on Vitrase for the treatment of severe vitreous hemorrhage, and for general corporate purposes, including working capital. We may use a portion of the net proceeds to acquire or invest in technologies, products or businesses complementary to our business. None of the net offering proceeds of ISTA have been or will be paid directly or indirectly to any director, officer, general partner of ISTA or their associates, persons owning more than 10% or more of any class of ISTA’s equity securities, or an affiliate of ISTA.

Otsuka Collaboration

     In December 2001, we completed the private placement of 845,665 shares of common stock at a price of $4.73 per share as part of our collaboration with Otsuka for the rights for Vitrase in Japan.

     The sale and issuance of these securities were deemed to be exempt from registration under the Securities Act of 1933, as amended in reliance upon Section 4(2) of the Securities Act of 1933, as amended. The recipient of securities represented their intention to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof and appropriate legends were affixed to the securities issued in such transactions. All recipients had adequate access, through their relationship with ISTA, to information about us.

Item 3 Defaults upon Senior Securities

     None

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Item 4 Submission of Matters to a Vote of Security Holders

     None

Item 5 Other Information

     None

Item 6 Exhibits and Reports on Form 8-K

1.	January 2, 2002 a Form 8-K was filed with regard to the Company’s adoption of a Preferred Stockholder’s Rights Agreement.
2.	January 2, 2002 a Form 8-K was filed with regard to the Company’s entering into a (i) License Agreement, (ii) Supply Agreement, (iii) Securities Purchase Agreement and (iv) Registration Rights Agreement with Otsuka Pharmaceutical Co., Ltd.

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Signatures

     Pursuant to the requirements of the Securities Exchange Act of 1934, ISTA Pharmaceuticals, Inc. has duly caused this 10-Q report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, County of Orange, State of California, on this 15th day of May 2002.

ISTA Pharmaceuticals, Inc.(Registrant)
 
 
/s/   J. C. MacRaeJ. C. MacRae
Executive Vice President,
Chief Operating Officer and
Chief Financial Officer

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