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The following is an excerpt from a 10-K SEC Filing, filed by ISTA PHARMACEUTICALS INC on 3/15/2005.
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ISTA PHARMACEUTICALS INC - 10-K - 20050315 - PART_I

PART I

 

References in this Annual Report on Form 10-K to “ISTA”, “we”, “our”, “us” or the “Company” refer to ISTA Pharmaceuticals, Inc. This Form 10-K and the documents incorporated herein by reference contain forward-looking statements based on expectations, estimates and projections as of the date of this filing. Actual results may differ materially from those expressed in forward-looking statements. See Item 7 of Part II – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Forward-Looking Statements.” Vitrase ® , Istalol , Xibrom , Caprogel ® , ISTA , ISTA Pharmaceuticals and the ISTA logo are our trademarks, either owned or under license.

 

We obtained the market data and industry information contained or incorporated by reference in this Annual Report on Form 10-K from internal surveys, estimates, reports and studies, as appropriate, as well as from market research, publicly available information and industry publications. Although we believe our internal surveys, estimates, reports, studies and market research, as well as industry publications are reliable, we have not independently verified such information, and as such, we do not make any representation as to its accuracy.

 

Item 1:    Business.

 

Overview

 

We are a specialty pharmaceutical company focused on the commercialization and development of unique and uniquely improved products for serious conditions of the eye. We recently launched in the United States our first product, Istalol for the treatment of glaucoma and our second product, Vitrase for use as a spreading agent. In addition, we have two New Drug Applications, or NDAs, on file with the U.S. Food and Drug Administration, or FDA, one for Vitrase for the treatment of vitreous hemorrhage and one for Xibrom for the treatment of ocular inflammation, eye pain and photophobia following cataract surgery. We continue to expand our commercial infrastructure in connection with the marketing, sale and distribution of our approved products in the United States.

 

Additionally, in January 2005, we sold 6,325,000 shares of our common stock under our universal shelf registration statement in an underwritten public offering for an aggregate purchase price of $56.2 million, or $8.88 per share, before offering expenses and underwriting discounts. We intend to use the proceeds to finance potential acquisitions and licensing of complementary businesses, assets, technologies and products that we may consider from time to time and fund the continued development of our product candidates, the expansion of our commercial infrastructure to commercialize our approved products and other general corporate purposes, including working capital.

 

Since our inception, we have devoted our resources primarily to fund research and development programs, late stage product acquisitions and product commercial launches. In December 2001, we announced our strategic plan to transition from a development-stage organization to a specialty pharmaceutical company, with a primary focus on ophthalmology. Over the last several years, we have taken significant steps to enhance and expand our marketing, sales, manufacturing and administrative capabilities by adding senior management and other key employees, enhancing and augmenting our in-house resources and entering into arrangements with third parties to perform these services. We intend to continue our efforts to expand and enhance our commercial infrastructure to support the commercialization of our approved products and our future products. We plan to execute our growth strategy by pursuing opportunistic acquisitions or licenses of complementary products, either already marketed or in late-stage development, and leveraging our development capabilities to identify and advance our own late stage product opportunities.

 

We believe that the prescription market in the United States for ophthalmic pharmaceutical products represents a significant and growing market. According to industry sources, this market had annual sales in 2003 of approximately $2.8 billion and a historic growth rate of over 12% per year over the past five years.


Table of Contents

Our Products and Pipeline

 

The following is a summary of our products and product candidates:

 

    Product    Indication    Development Status
   

Istalol

  

Glaucoma

  

Marketed

   

Vitrase

  

Spreading agent

  

Marketed

        

Vitreous hemorrhage

  

Approvable Letter received

        

Diabetic retinopathy

  

Phase II

   

Xibrom

  

Ocular inflammation

  

NDA under review; PDUFA action date March 26, 2005

   

Ecabet sodium

  

Dry eye syndrome

  

Phase II

   

Caprogel

  

Hyphema

  

Reformulation ongoing/Phase II completed

 

Istalol

 

Overview

 

Istalol is our once-a-day, eye drop solution of timolol, a beta-blocking agent for the treatment of glaucoma. The product was developed by Senju Pharmaceuticals Co., Ltd. in Japan. In May 2002, we acquired marketing rights for Istalol in the United States under a license agreement with Senju. We received FDA approval of Istalol in June 2004 and launched Istalol in the United States in the third quarter of 2004.

 

Glaucoma

 

Glaucoma is a chronic disease that gradually reduces eyesight without warning and often without symptoms. If undetected and untreated, glaucoma can lead to irreversible eye damage and eventual blindness. According to the Glaucoma Research Foundation, in the United States glaucoma is the cause of an estimated 9-12% of all blindness cases and is the second leading cause of blindness. Currently, its causes are not well understood and there is no cure.

 

Market opportunity. According to the Glaucoma Research Foundation, three million people in the United States suffer from the disease, with 120,000 new cases documented annually. According to prescription data compiled by IMS Health for 2003, we estimate that the U.S. pharmaceutical market for the treatment of glaucoma exceeds $1.3 billion per year. Of this, the ophthalmic beta-blocker market exceeds $170 million per year, primarily at generic prices, with over 4.4 million prescriptions written annually. Timolol maleate, which is currently available from several manufacturers in either a twice-a-day eye drop solution or once-a-day gel formulation, is the leading beta-blocker to treat glaucoma in the United States. In clinical trials, Istalol, given once-a-day, has shown efficacy and safety comparable to timolol maleate solution, given twice-a-day. Other than Istalol, the only available formulations of timolol maleate which have demonstrated efficacy with once a day dosing are gels, which have been known to cause blurring of patients’ vision.

 

We launched Istalol in July 2004, and currently promote it through our specialty sales force. Istalol promotion is now focused on the 5,000 ophthalmologists whom we believe account for more than 70% of all glaucoma prescriptions.

 

Clinical/regulatory status. Senju submitted an NDA for Istalol for the treatment of glaucoma to the FDA in September 2002 that was accepted for review in November 2002. In June 2004, the FDA approved the NDA for Istalol. In October 2004, the FDA granted Istalol a “BT” rating, which means that prescriptions of Istalol cannot be legally substituted at pharmacies with generic timolol maleate solutions.

 

Vitrase

 

Overview

 

We recently received approval of, and have launched, Vitrase, our proprietary formulation of ovine hyaluronidase, for use as a spreading agent. We also are developing Vitrase for the treatment of vitreous hemorrhage and diabetic retinopathy. The term hyaluronidase describes a group of naturally occurring enzymes that can digest certain forms of carbohydrate molecules called proteoglycans. Vitrase, when used as a spreading agent, is injected into connective tissue, where it modifies the permeability of such tissues and promotes diffusion of injected drugs, thus accelerating their absorption. When injected into the vitreous humor, Vitrase breaks down the proteoglycan matrix, causing the vitreous humor to liquefy. We believe that this also results in the separation of the vitreous humor from the retina and that, together, these effects are beneficial for the treatment of vitreous hemorrhage and diabetic retinopathy. Vitrase may be administered directly into the vitreous humor

 

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through a single-dose injection. The procedure will be performed in several minutes in an ophthalmologist’s office and is virtually painless due to the application of a topical anesthetic.

 

Spreading Agent

 

Hyaluronidase has been found to be a spreading or diffusing substance, which modifies the permeability of connective tissue through the hydrolysis of hyaluronic acid, a polysaccharide found in the intercellular ground substance of connective tissue, and of certain specialized tissues, such as the umbilical cord and vitreous humor. Hyaluronidase temporarily decreases the viscosity of the cellular cement and promotes diffusion of injected drugs, thus facilitating their absorption.

 

When no spreading agent is present, material injected subcutaneously spreads very slowly, but hyaluronidase causes rapid spreading, provided local interstitial pressure is adequate to furnish the necessary mechanical impulse. Such an impulse is normally initiated by injected solutions. The rate of diffusion is proportionate to the amount of enzyme, and the extent is proportionate to the volume of solution. When a spreading agent is administered with anesthesia, it speeds the onset of the anesthetic effect thereby reducing the time required for ocular surgery.

 

Market opportunity. Based on published reports, we believe the potential annual market opportunity for Vitrase as a spreading agent consists of the 3,000,000 ophthalmic surgeries in the United States each year, of which 2,600,000 are cataract surgeries. In addition to uses in ophthalmology, potential uses for spreading agents include oncology, plastic surgery, pain management and pediatrics.

 

We have launched Vitrase in the United States for use as a spreading agent and are currently promoting it through our specialty sales force. We plan to target the top cataract surgeons, many of whom are also high prescribers of glaucoma medications that we currently target for Istalol. In order to support the launch of Vitrase, we plan to expand our sales force to approximately 50 people by the end of the first quarter of 2005.

 

Clinical/regulatory status. In May 2004, the FDA approved our NDA for Vitrase, in a lyophilized 6,200 USP units multi-purpose vial, for use as a spreading agent to facilitate the absorption and dispersion of other injected drugs. In October 2004, the FDA informed us that Vitrase (hyaluronidase for injection; lyophilized, ovine) for use as a spreading agent was entitled to five-year new chemical market exclusivity under the federal Food, Drug and Cosmetic Act. In December 2004, the FDA approved our supplemental NDA for Vitrase for use as a spreading agent at a concentration of 200 USP units/mL in sterile solution. We believe the 200 USP units/mL product will help facilitate utilization and enhance market acceptance.

 

Vitreous Hemorrhage

 

A vitreous hemorrhage occurs when retinal blood vessels rupture and bleed into the vitreous humor. These hemorrhages result from leakage from abnormal, weak blood vessels and are associated with diabetic retinopathy, trauma and other factors. The immediate consequence of a vitreous hemorrhage is a reduction in the amount of light that can pass through the normally clear vitreous humor to the retina. The effects of a hemorrhage can be limited to a few dark spots in vision or can result in completely obscured vision. Depending on the severity of the vitreous hemorrhage, it may take several months or significantly longer for the body to reabsorb the blood and for the patient to regain vision. In addition to obstructing the patient’s vision, a vitreous hemorrhage often prevents physicians from seeing into the back of the eye to diagnose or treat the cause of the hemorrhage. If extensive or repeated bleeding occurs, fibrous tissue or scarring can form on the retina, which can lead to a detachment of the retina and permanent vision loss or blindness.

 

Vitrase is being developed to promote clearance when injected into a blood-filled vitreous humor by causing the vitreous humor to liquefy and the blood to settle to the bottom of the eye. Vitrase may also stimulate the cells responsible for engulfing and breaking down the blood, accelerating the reabsorption of the blood. This would clear the path for light to reach the retina and may enable the patient to regain vision. In addition, clearing the hemorrhage permits the retinal specialist to visualize, diagnose and treat the underlying cause of the vitreous hemorrhage.

 

Market opportunity. Retinal specialists have limited options for treating vitreous hemorrhage. Currently, there is no drug treatment available and most retinal specialists initially recommend a “watchful waiting” period, during which the attending physician provides no medical treatment in the hope that the hemorrhage will clear on its own. The risks related to watchful waiting may include continued bleeding and, if caused by diabetic retinopathy, disease progression during the time it takes for the blood to clear on its own, if at all.

 

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An alternative to watchful waiting is a surgical procedure called a vitrectomy, in which the vitreous humor and hemorrhage are surgically removed and replaced with a balanced salt solution. There are serious risks associated with a vitrectomy, including both cataract formation and possible loss of vision associated with retinal detachment. These risks contribute to the limited use of vitrectomy as an initial treatment option for vitreous hemorrhage patients.

 

Based on data compiled by Business Genetics, Inc., we believe that approximately 450,000 cases of vitreous hemorrhage occur each year in the United States, a total of 400,000 cases occur each year in the five largest European markets and 190,000 cases occur each year in Japan. Approximately 60% of all of these cases are due to diabetic retinopathy, 15% are due to trauma and 25% are due to other factors. As a result of the typical progression of the condition, we believe Vitrase, if approved, is unlikely to be used in all cases of vitreous hemorrhage. Based on data compiled for us by The Wilkerson Group, we believe that the potential annual market opportunity in the United States for Vitrase for the treatment of vitreous hemorrhage is approximately 225,000 cases.

 

Clinical/regulatory status. We have an NDA on file with the FDA for Vitrase for treatment of vitreous hemorrhage. Our NDA submission was supported by two Phase III clinical trials. These trials were prospective, randomized, parallel, placebo-controlled and double-masked studies. We conducted one trial in the United States, Mexico and Canada with an enrollment of 750 patients. We conducted the other trial in Europe, Brazil, Australia and South Africa with an enrollment of 556 patients. Patients enrolled in the studies were monitored through 2003.

 

The data from the two Phase III studies did not show a statistically significant improvement in the primary endpoint. The primary endpoint was composed of three elements: clearing the vitreous hemorrhage, permitting the physician to diagnose the underlying cause of the bleeding and allowing the physician to complete any required treatment. Further analysis conducted prior to submission of the NDA showed that in both studies for the 55 IU dose of Vitrase there were clinically meaningful and statistically significant results with respect to two of the three elements compromising the primary endpoint: clearing the vitreous hemorrhage and permitting the physician to diagnose the underlying cause of the bleeding. In addition, a statistically significant difference in the proportion of patients with an improvement in best-corrected visual acuity was seen at one and two months, which extended to the three-month post-treatment visit in the study conducted outside North America.

 

In April 2003, the FDA issued an approvable letter in which it cited issues primarily related to the sufficiency of the efficacy data submitted with the NDA for Vitrase for the treatment of vitreous hemorrhage. The FDA requested additional analysis of the existing data and an additional confirmatory clinical study based upon that analysis. We have submitted information to the FDA in response to its comments contained in the approvable letter. We believe that all non-clinical issues have been resolved with the FDA, and we are continuing to assess and discuss with the agency the clinical issues raised in the approvable letter. Based upon these discussions, we will determine the next appropriate steps in the approval process of Vitrase for the treatment of vitreous hemorrhage.

 

Diabetic Retinopathy

 

Abnormal changes and/or damage to the blood vessels in the eye due to diabetes are known as diabetic retinopathy. Diabetic retinopathy is a progressive disease consisting of two stages, nonproliferative and proliferative. Nonproliferative diabetic retinopathy is the first stage of the condition and occurs when the retinal blood vessels swell and leak fluid and small amounts of blood into the eye.

 

We believe that Vitrase can treat diabetic retinopathy at the nonproliferative stage. Following injection into the vitreous humor, Vitrase acts to separate the vitreous humor from the retina, thereby limiting growth of retinal blood vessels into the vitreous humor. We believe that Vitrase achieves this by breaking down the proteoglycan component of the substance that binds the vitreous humor to the retina and by liquefying the vitreous humor. This process allows the vitreous humor to detach from the retina. Retinal specialists consider this detachment to be beneficial to diabetic retinopathy patients because it may delay the progression of the disease.

 

Market opportunity. Diabetes continues to be a major healthcare problem throughout the world and is commonly associated with eye disease. Based on our market research, we believe that nearly eight million individuals in the United States have been diagnosed with diabetes, four to six million have some form of diabetic retinopathy, and that the majority of individuals with diabetic retinopathy are in the nonproliferative stage of the disease. We believe that these people are potential candidates for treatment using Vitrase.

 

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Clinical/regulatory status. We have completed a 60 patient pilot Phase II clinical trial in Mexico City to evaluate the safety and efficacy of a single-dose injection of Vitrase to cause a detachment of the vitreous humor from the retina and the impact on slowing the progression of diabetic retinopathy over a one-year period. The continued development of Vitrase for the treatment of diabetic retinopathy will be dependent upon the FDA’s evaluation of the Vitrase NDA for the treatment of vitreous hemorrhage, among other factors.

 

Xibrom

 

Overview

 

Xibrom is a topical non-steroidal anti-inflammatory formulation of bromfenac for the treatment of ocular inflammation, eye pain and photophobia. The product was developed by Senju and launched in the Japanese market in 2000. We believe its sales growth in Japan is principally due to its superior potency and twice-daily dosing regimen, as compared to the requirement of four doses-per-day for most other anti-inflammatory products. In May 2002, we acquired marketing rights for Xibrom in the United States under a license agreement with Senju.

 

Ocular Inflammation, Eye Pain and Photophobia

 

Market opportunity. Currently in the U.S., we estimate that over 5.4 million prescriptions are written annually for topical ophthalmic anti-inflammatory agents. Currently available non-steroid treatments must be dosed four times a day as compared to Xibrom’s twice daily dosing.

 

Clinical/regulatory status. Senju completed clinical development of bromfenac in Japan and launched the product in Japan in 2000. We submitted an NDA in May 2004 for Xibrom for the treatment of postoperative inflammation and for the reduction of eye pain and photophobia in patients who have undergone cataract extraction. In July 2004, the FDA accepted our Xibrom NDA for filing and review. Based on the Prescription Drug User Fee Act, or PDUFA, action date, we anticipate receiving a response from the FDA on our Xibrom NDA by the end of March 2005.

 

We completed two pivotal Phase III clinical studies in the United States of Xibrom. The trials were randomized, double-masked, placebo-controlled and were conducted under a single protocol. Patients who had cataract surgery were given either Xibrom or placebo and were asked to instill drops two times per day for 14 days. On day 15, the investigator evaluated the inflammation in the eye. As illustrated below, a statistically significant proportion of patients treated with Xibrom achieved treatment success as compared to placebo. The primary endpoint for both studies was the proportion of patients with complete absence of ocular inflammation, as measured by an assessment of immune cells in the anterior chamber of the eye and cellular debris.

 

     East Study

    West Study

 

Number of subjects

   296     231  

Number of sites

   20     19  

Xibrom response

   62.6 %   65.8 %

Placebo response

   39.8 %   47.9 %

p-value

   p<0.01     p<0.01  

 

A secondary endpoint in the two trials was the change from the mean baseline Inflammation Score prior to the administration of a different anti-inflammatory medication. The last summed Inflammation Score prior to treatment with a different anti-inflammatory medication was used for those patients who were given a second medication. As depicted in the chart below, a treatment effect was evident in the Xibrom group as early as Day 3 and by the end of the evaluation period the average Inflammation Score of Xibrom subjects in the study was near zero, compared to 1.5 for the placebo arm.

 

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LOGO

 

Investigators were allowed to remove subjects from treatment at their discretion if the effect was not adequate and place the subject on another anti-inflammatory medication. Both studies, when analyzed separately, also showed that Xibrom was well tolerated with a lower overall incidence of ocular adverse events than the placebo group, as depicted in the chart below.

 

     Xibrom

    Placebo

 

Number of Patients

   356     171  

Ocular Adverse Events

            

Iritis

   25 (7.0 %)   30 (17.5 %)

Abnormal sensation in eye

   23 (6.5 %)   13 (7.6 %)

Photophobia

   6 (1.7 %)   19 (11.1 %)

Hyperemia

   8 (2.2 %)   19 (11.1 %)

Conjunctival edema

   5 (1.4 %)   9 (5.3 %)

Pruritis

   14 (3.9 %)   5 (2.9 %)

Redness

   8 (2.2 %)   13 (7.6 %)

Irritation (includes burning and stinging)

   9 (2.5 %)   8 (4.7 %)

Pain

   15 (4.2 %)   20 (11.7 %)

 

The efficacy and safety findings were consistent with results of previous studies conducted in Japan by Senju.

 

Ecabet Sodium

 

Overview

 

We are developing ecabet sodium as a prescription eye drop for the treatment of dry eye syndrome. Ecabet sodium represents a new class of molecules that increases the quantity and quality of mucin produced by conjunctival goblet cells and corneal epithelia. Mucin is a glycoprotein component of tear film that lubricates while retarding moisture loss from tear evaporation. Ecabet sodium is currently marketed in Japan as an oral agent for treatment of gastric ulcers and gastritis. In November 2004, we acquired U.S. marketing rights to ecabet sodium for the treatment of dry eye syndrome in the United States under a license agreement with Senju.

 

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Dry Eye Syndrome

 

According to the National Eye Institute, dry eye syndrome (keratoconjunctivities sicca or KCS) is defined as a disorder of the tear film due to the tear deficiency or excessive tear evaporation which causes damage to the interpalpebral (the exposed area between the upper and lower eye lids) ocular surface and is associated with symptoms of ocular discomfort. Dry eye syndrome has been linked with a number of factors, including age, hormonal changes, ocular disease, medications that disrupt tear secretion or blinking, and autoimmune diseases such as lupus and rheumatoid arthritis. In severe cases of dry eye syndrome, scarring develops that may lead to blindness.

 

Market opportunity. Based on data compiled from various publicly available sources, we estimate that annual sales in the U.S. prescription dry eye market are expected to be approximately $80 to $100 million in 2004 and are anticipated to grow to approximately $350 to $700 million within three to five years.

 

Clinical/regulatory status. Senju has commenced Phase II testing of the product in Japan for the treatment of dry eye syndrome. We anticipate completing an additional Phase IIb study in the second half of 2005. Depending upon the results of our Phase IIb study, we expect to design and initiate two Phase III studies.

 

Caprogel

 

Overview

 

Caprogel is a topical gel formulation of amniocaproic acid for the treatment of hyphema. In May 2002, we acquired worldwide marketing rights for Caprogel under a license agreement with Eastern Virginia Medical School.

 

Hyphema

 

Hyphema is a term used to describe bleeding in the anterior chamber, the space between the cornea and the iris, of the eye. It occurs when blood vessels in the iris bleed and leak into the clear aqueous fluid and typically results from trauma to the eye. Hyphemas are usually characterized by pooling of blood in the anterior chamber that may be visible to the naked eye. Some of the symptoms of hyphema are decreased vision, depending on the amount of blood in the eye, pooling of blood in the anterior chamber and elevated intraocular pressure.

 

The treatment is dependent on the cause and severity of the hyphema. Frequently, the blood is reabsorbed over a period of days to weeks. During this time, the doctor will carefully monitor the intraocular pressure for signs of the blood preventing normal flow of the aqueous fluid through the eye’s angle structures. If the eye pressure becomes elevated, eye drops may be prescribed to control it. In some cases, a procedure is performed to irrigate the blood from the anterior chamber to prevent secondary complications such as glaucoma and bloodstains on the cornea.

 

Market opportunity. Based on data compiled for us by Milliman U.S.A., we believe that hyphema affects an estimated 50,000 patients per year in the United States, and currently there is no available pharmaceutical agent approved for its treatment.

 

Clinical/Regulatory status. We are currently conducting feasibility studies for the reformulation and commercialization of Caprogel. Once completed, and if these studies yield promising results, we intend to pursue the remaining Phase III clinical development of Caprogel consistent with such studies’ results. However, the timing and scope for our development of Caprogel may change based on a number of factors, including, among others, our assessment, from time to time, of this product’s clinical results, market potential, other product opportunities and our corporate priorities. Caprogel has received an orphan drug designation for the treatment of hyphema from the FDA, which may result in us receiving a seven year market exclusivity privilege with respect to Caprogel, if approved.

 

Product Licensing Collaborations

 

Istalol, Xibrom and Ecabet Sodium Collaborations With Senju

 

In May 2002, we acquired substantially all of the assets of AcSentient, Inc., which included U.S. marketing rights for Istalol and Xibrom. Istalol and Xibrom were originally licensed by AcSentient from Senju. The full rights and obligations of AcSentient under the Senju license agreements were assigned to us as a part of the acquisition agreement between us and AcSentient, with such transfer approved by Senju. In November 2004, we entered into another license agreement with Senju under which Senju has granted us U.S. marketing rights to Senju’s ecabet sodium product for the treatment of dry eye syndrome.

 

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Under the terms of our agreements with Senju, we are responsible for U.S. development activities, including clinical trials and the preparation and submission of regulatory approvals, for Xibrom and ecabet sodium and post-approval activities with FDA for Istalol. We are also responsible for the manufacturing, marketing and sale of the products, if approved, in the United States. We will be required to pay to Senju non-refundable milestone payments of up to $4,000,000, most of which has been paid, if all such milestones, relating to the development process and regulatory approval of both Istalol and Xibrom, are accomplished; and royalties on product sales. We will also be required to pay to Senju non-refundable milestone payments of up to $3,000,000, some of which has been paid, if all such milestones, relating to the development process and regulatory approval of ecabet sodium are accomplished; and royalties on product sales. The license agreements with Senju for Istalol and Xibrom will terminate upon the last-to-expire licensed patent in the United States with respect to Istalol and ten years after the first commercial sale of Xibrom in the United States, respectively. The license agreement with Senju for ecabet sodium will terminate ten years after the earlier of the last-to-expire licensed patent in the United States relating to ecabet sodium or ten years after the first commercial sale of ecabet sodium in the United States. Neither party may terminate the license agreements without cause or good reason.

 

Vitrase Commercialization Outside of the United States

 

Europe- Allergan

 

In September 2004, we entered into a new agreement with Allergan, Inc. replacing our previous Vitrase collaboration, and reacquired all rights to market and sell Vitrase for all uses in the United States and other specified markets. Under our new agreement, we agreed to pay Allergan approximately $10.0 million, which was paid in full in January 2005. We have also agreed to make royalty payments to Allergan on our U.S. sales of Vitrase for use in the posterior region of the eye. Allergan has an option to commercialize Vitrase in Europe subsequent to European Union, or EU, product approval. If Allergan does not exercise its option, then such European rights will revert to us, and Allergan will be paid a royalty on our European sales of Vitrase for use in the posterior region of the eye. Under our agreement with Allergan, we have responsibility to file for regulatory approval for Vitrase for vitreous hemorrhage in the EU.

 

Japan- Otsuka

 

In December 2001, we entered into certain agreements with Otsuka Pharmaceutical Co., Ltd. with respect to the commercialization of Vitrase in Japan for ophthalmic uses in the posterior region of the eye. Under the terms of our agreements with Otsuka, Otsuka is responsible for preclinical studies, clinical trials, applying for and obtaining regulatory approvals and other development activities for Vitrase for ophthalmic uses in the posterior region of the eye in Japan. We are responsible for supplying Otsuka its requirements of Vitrase for clinical trials and, if approved, for commercial sale in Japan. Otsuka is responsible for the marketing, sale and distribution of Vitrase, if approved, in Japan. In connection with its license of Vitrase, Otsuka paid us a non-refundable license fee of $5.0 million as part of the license agreement. Otsuka has also agreed to pay us a milestone payment of $10.0 million upon regulatory approval of Vitrase for the treatment of vitreous hemorrhage in Japan. To date, we have not earned this milestone payment from Otsuka and we cannot guarantee that we will earn or receive this milestone payment in the future. Otsuka is required to purchase Vitrase from us at a percentage of the annual National Health Insurance price as established for Vitrase in Japan during the term of the license agreement, unless we are unable to supply Vitrase to Otsuka. If we are unable to supply Vitrase to Otsuka and Otsuka, or a third party, is required to manufacture Vitrase to meet Otsuka’s supply requirements, we will only receive a royalty on sales of Vitrase by Otsuka. Our agreements with Otsuka will terminate upon the latest of 15 full calendar years following the date of the first commercial sale of Vitrase for licensed uses in Japan and the expiration date of the last-to-expire licensed patent relating to Vitrase for licensed uses in Japan. Otsuka may terminate the agreements at any time with six months notice to us. We may terminate the agreements if Otsuka fails to submit an application for regulatory approval of Vitrase in Japan within 12 months of completing all necessary clinical trials and the initial meeting with the Japanese Ministry of Health to review the clinical trial results.

 

Caprogel Collaboration With the Eastern Virginia Medical School

 

In May 2002, as part of our AcSentient asset acquisition, we acquired worldwide marketing rights for Caprogel. Caprogel was initially licensed by AcSentient from the Eastern Virginia Medical School. The full rights and obligations of AcSentient under the Eastern Virginia Medical School license agreement were assigned to us as a part of the acquisition agreement between us and AcSentient, with such transfer approved by the Eastern Virginia Medical School.

 

Under the terms of our agreement with the Eastern Virginia Medical School, we are responsible for development activities, including clinical trials and the preparation and submission of regulatory approvals, for Caprogel. We will also be responsible for the manufacturing, marketing and sale of Caprogel, if approved . The Eastern Virginia Medical School will

 

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receive royalty payments on all sales of Caprogel by us worldwide. The license agreement with the Eastern Virginia Medical School will terminate upon the last-to-expire licensed patent in the United States relating to Caprogel. We may terminate the license agreement with the Eastern Virginia Medical School upon three months prior written notice.

 

Marketing and Sales

 

We continue to expand our commercial infrastructure in connection with the marketing, sale and distribution of our approved products in the United States. In July 2004, we launched our first product, Istalol and launched our second product, Vitrase for use as a spreading agent in January 2005. We have hired five regional sales managers, and plan to expand our sales force to approximately 50 sales representatives by the end of the first quarter of 2005 to support our commercial launch of Vitrase for use as a spreading agent. We further intend to expand our sales force to approximately 70 persons in conjunction with our expected U.S. launch of Xibrom, if approved by the FDA. Our sales representatives are now our employees and, as a result, Ventiv Pharma Services LLC no longer provides us with a contract sales force. We have recently exercised our contract right with Ventiv to hire certain Ventiv sales representatives for a nominal fee. We intend to have Ventiv continue to provide us with administrative and other services, including recruitment, training, analytics, and full operational support. We plan to target our commercialization efforts towards approximately 10,000 ophthalmologists, who comprise the most prolific prescribers of ophthalmic beta-blockers, non-steroidal anti-inflammatories and the highest volume cataract surgeons.

 

Customers and Distribution

 

We launched our first product, Istalol, in the third quarter of 2004. During 2004, we generated net product sales of Istalol of $1.6 million, which was the initial stocking order. We sell Istalol primarily to drug wholesalers, retailers and distributors, including large chain drug stores, hospitals, clinics, government agencies and managed healthcare providers such as health maintenance organizations and other institutions. If approved, we believe that we will sell Xibrom to the same customer base as Istalol. These customers comprise a significant part of the distribution network for pharmaceutical products in the U.S. This distribution network is continuing to undergo significant consolidation marked by mergers and acquisitions among wholesale distributors and the growth of large retail drug store chains. As a result, a small number of large, wholesale distributors control a significant share of the market, and the number of independent drug stores and small drug store chains has decreased. We expect that consolidation of drug wholesalers and retailers will impact pricing and create other competitive pressures on drug manufacturers. In general, we are obligated to accept from customers the return of pharmaceuticals that have reached their expiration date. We authorize returns for damaged products and exchanges for expired products in accordance with our return goods policy and procedures, and have established reserves for such amounts at the time of sale.

 

We initiated the commercial launch of our second product, Vitrase for use as a spreading agent, in January 2005. In addition to the distribution channels above, we sell Vitrase for use as a spreading agent to specialty distributors and directly to physicians, hospitals, and clinics.

 

We have engaged Cardinal Health PTS, LLC, by and through its Specialty Pharmaceutical Services group, to act as our exclusive distributor for commercial shipment and distribution of Istalol and Vitrase for use as a spreading agent to our customers in the United States. In addition to distribution services, Cardinal Health provides us with other related services, including product storage, returns, customer support, and administrative support.

 

Sales to AmeriSource Bergen Corp, McKesson HBOC and Cardinal Health, Inc. accounted for 15%, 40% and 25%, respectively, of our annual net revenues during 2004. The loss of any of these customers could materially and adversely affect our business, results of operations, financial condition and cash flows. Due to the relatively short lead-time required to fill orders for our products, backlog of orders is not material to our business.

 

Competition

 

The markets for therapies that treat diseases and conditions of the eye are subject to intense competition and technological change. Many companies, including major pharmaceutical companies, specialty pharmaceutical companies and specialized biotechnology companies, are engaged in activities similar to ours. Such companies include Allergan, Alcon Laboratories, Inc., Amphastar Pharmaceuticals, Inc., Bausch & Lomb Incorporated, Halozyme Therapeutics, Inc., Johnson & Johnson, Novartis AG, Pfizer, Inc., Eli Lilly and Company and Inspire Pharmaceuticals, Inc. Many of these companies have substantially greater financial and other resources, larger research and development staffs and more extensive marketing and manufacturing organizations than ours.

 

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We are not aware of any other drug candidates in clinical trials for the treatment of vitreous hemorrhage or hyphema. Numerous companies are working on alternate therapies for ocular inflammation, dry eye syndrome, glaucoma, use as a spreading agent and treatment to help control diabetes and the consequences of diabetes, including diabetic retinopathy.

 

In addition, competition from generic drugs is a major challenge in the United States to branded drug companies, like us, and may have a material adverse effect on our product revenues. In October 2004, the FDA granted Istalol a “BT” rating, which means that prescriptions for Istalol cannot be substituted legally at pharmacies with generic timolol maleate products. Nonetheless, we believe that certain pharmacies may have substituted, and may be continuing to substitute, Istalol prescriptions with generic timolol maleate solutions. We have commenced an educational campaign to make our customers and pharmacies aware of Istalol’s BT rating and that Istalol cannot be substituted legally at pharmacies with generic timolol maleate products. In October 2004, the FDA informed us that Vitrase (hyaluronidase for injection; lyophilized, ovine) for use as a spreading agent to facilitate the dispersion and absorption of other drugs was entitled to five-year new chemical entity market exclusivity pursuant to the U.S. Food, Drug and Cosmetic Act. The FDA indicated that Vitrase’s new chemical entity exclusivity would bar submission to FDA of certain third party NDAs filed under Section 505(b)(2) of the Federal Food Drug and Cosmetic Act, or FEDCA, and Abbreviated New Drug Applications, or ANDAs, for drugs containing the same active moiety as Vitrase. The submission bar would be for five years from Vitrase’s approval date (i.e., May 5, 2004) or for four years in the case of patent challenges. The FDA also said that Vitrase’s new chemical entity exclusivity is not a prohibition on FDA’s review and approval of any 505(b)(2) NDA or ANDA that was submitted to the agency before Vitrase was granted five-year exclusivity. In October 2004, the FDA approved Amphadase (hyaluronidase) injection, USP, 150 IU mL, a bovine-sourced hyaluronidase, for use as a spreading agent. Amphadase, manufactured by Amphastar Pharmaceuticals, Inc., is the generic equivalent of a branded bovine-sourced hyaluronidase which is no longer commercially available. Our ability to secure the benefit of the Vitrase market exclusivity depends on a variety of factors, some of which are beyond our control, including, among others, the timing, content and outcome of actions and decisions by the FDA and other regulatory authorities regarding third party products and the impact and scope of the Vitrase market exclusivity and its affect on third party products.

 

Manufacturing

 

We have supply agreements with Bausch & Lomb to manufacture commercial quantities of Istalol and, if approved, Xibrom. Currently, Bausch & Lomb is our sole source for Istalol and Xibrom. Ovine hyaluronidase, the active pharmaceutical ingredient used in Vitrase, is processed in several stages to produce a highly purified raw material for formulation. In June 2004, we entered into an amended and restated supply agreement with Biozyme Laboratories, Ltd. for ovine hyaluronidase for use in ophthalmic and spreading agent applications. Under our agreement with Biozyme, we are obligated to make product purchases totaling at least $750,000 over three years. We also entered into a technology license agreement with Biozyme providing us certain rights to manufacture hyaluronidase, in return for an aggregate license fee of $1.1 million payable over three years. Our supply agreement with Biozyme ends in August 2007, after which any further supply of hyaluronidase by Biozyme to us would be subject to Biozyme’s agreement. Currently, Biozyme is our sole source for ovine hyaluronidase. We have entered into supply agreements with R.P. Scherer West, Inc. and Alliance Medical Products, Inc. to manufacture commercial quantities of Vitrase in a lyophilized 6,200 USP units multi-purpose vial and 200 USP units/mL in sterile solution, respectively. Currently, each of R.P. Scherer West and Alliance Medical Products is our sole source for Vitrase in these respective configurations. While we are currently pursuing additional sources for these products and materials, our success in establishing such additional supply arrangements can not be assured.

 

Research and Development

 

Since our inception, we have made substantial investments in research and development. During the years ended December 31, 2004, 2003 and 2002, we spent $15.6 million, $17.3 million and $14.8 million, respectively, on research and development activities.

 

We plan to focus our near-term research and development efforts on the continued development of the products in our current development pipeline, which include Vitrase, Xibrom, ecabet sodium and Caprogel. We are also pursuing development of a reformulated ophthalmic product. Building on this pipeline, our goal is to continue our growth as a specialty pharmaceutical company by developing or acquiring complementary products, either already marketed or in late-stage development. Some acquired products may require additional research and development activities prior to regulatory approval and commercialization.

 

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Patents and Proprietary Rights

 

Our success will depend in part on our ability to obtain patent protection for our inventions, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties. Our strategy is to actively pursue patent protection in the United States and foreign jurisdictions for technology that we believe to be proprietary and that offers a potential competitive advantage for our inventions. We currently own or license 43 United States and foreign patent applications and 53 United States and foreign issued patents.

 

In addition to patents, we rely on trade secrets and proprietary know-how. We seek protection of these trade secrets and proprietary know-how, in part, through confidentiality and proprietary information agreements. We make efforts to require our employees, directors, consultants and advisors, outside scientific collaborators and sponsored researchers, other advisors and other individuals and entities to execute confidentiality agreements upon the start of employment, consulting or other contractual relationships with us. These agreements provide that all confidential information developed or made known to the individual or entity during the course of the relationship is to be kept confidential and not be disclosed to third parties except in specific circumstances. In the case of employees and some other parties, the agreements provide that all inventions conceived by the individual will be our exclusive property. These agreements may not provide meaningful protection for or adequate remedies to protect our technology in the event of unauthorized use or disclosure of information. Furthermore, our trade secrets may otherwise become known to, or be independently developed by, our competitors.

 

We have not conducted an extensive search of patents issued to other parties and no assurance can be given that such patents do not exist, have not been filed, or could not be issued which contain claims relating to our technology and products. If such patents do exist, the owners may bring claims against us for infringement, which might have an adverse effect on our business.

 

We also file trademark applications to protect the names of our products. These applications may not mature to registration and may be challenged by third parties. In addition, some of our trademarks, including Caprogel and Xibrom, are owned by or assignable to our licensors Eastern Virginia Medical School and Senju, and upon expiration or termination of the license agreements, we may no longer be able to use these trademarks.

 

Government Regulation

 

Our pharmaceutical products are subject to extensive government regulation in the United States. If we distribute our products abroad, these products will also be subject to extensive foreign government regulation. In the United States, the FDA regulates pharmaceutical products. FDA regulations govern the testing, manufacturing, advertising, promotion, labeling, sale and distribution of our products.

 

In general, the FDA approval process for drugs includes, without limitation:

 

    preclinical studies;

 

    submission of an Investigational New Drug Application, or INDA, for clinical trials;

 

    adequate and well-controlled human clinical trials to establish the safety and efficacy of the product;

 

    submission of a NDA to obtain marketing approval;

 

    review of the NDA; and

 

    inspection of the facilities used in the manufacturing of the drug to assess compliance with the FDA’s current Good Manufacturing Practice, or cGMP, regulations.

 

The NDA must include comprehensive and complete descriptions of the preclinical testing, clinical trials, and the chemical, manufacturing and control requirements of a drug that enable the FDA to determine the drug’s safety and efficacy. A NDA must be submitted by us, and filed and approved by the FDA before any of our drugs can be marketed commercially in the United States.

 

The FDA testing and approval process requires substantial time, effort and money. We cannot assure you that any approval will ever be granted.

 

Preclinical studies include laboratory evaluation of the product, as well as animal studies to assess the potential safety and effectiveness of the product. These studies must be performed according to good laboratory practices. The results of the preclinical studies, together with manufacturing information and analytical data, are submitted to the FDA as part of the

 

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INDA. Clinical trials may begin 30 days after the INDA is received, unless the FDA raises concerns or questions about the conduct of the clinical trials. If concerns or questions are raised, the INDA sponsor and the FDA must resolve any outstanding concerns before clinical trials can proceed.

 

We cannot assure you that submission of an INDA will result in authorization to commence clinical trials. Nor can we assure you that if clinical trials are approved, that data will result in marketing approval. Clinical trials involve the administration of the product that is the subject of the trial to volunteers or patients under the supervision of a qualified principal investigator. Each clinical trial must be reviewed and approved by an independent institutional review board at each institution at which the study will be conducted. The institutional review board will consider, among other things, ethical factors, safety of human subjects and the possible liability of the institution. Also, clinical trials must be performed according to good clinical practices. Good clinical practices are enumerated in FDA regulations and guidance documents.

 

Clinical trials typically are conducted in three sequential phases: Phases I, II and III, with Phase IV studies conducted after approval. Drugs for which Phase IV studies are required include those approved under accelerated approval regulations. The four phases may overlap. In Phase I clinical trials, the drug is usually tested on a small number of healthy volunteers to determine:

 

    safety;

 

    any adverse effects;

 

    proper dosage;

 

    absorption;

 

    metabolism;

 

    distribution;

 

    excretion; and

 

    other drug effects.

 

In Phase II clinical trials, the drug is usually tested on a limited number of subjects (generally up to several hundred subjects) to preliminarily evaluate the efficacy of the drug for specific, targeted indications, determine dosage tolerance and optimal dosage, and identify possible adverse effects and safety risks. In Phase III clinical trials, the drug is usually tested on a larger number of subjects (up to several thousand), in an expanded patient population and at multiple clinical sites. The FDA may require that we suspend clinical trials at any time on various grounds, including if the FDA makes a finding that the subjects are being exposed to an unacceptable health risk.

 

In Phase IV clinical trials or other post-approval commitments, additional studies and patient follow-up are conducted to gain experience from the treatment of patients in the intended therapeutic indication. Additional studies and follow-up are also conducted to document a clinical benefit where drugs are approved under accelerated approval regulations and based on surrogate endpoints. In clinical trials, surrogate endpoints are alternative measurements of the symptoms of a disease or condition that are substituted for measurements of observable clinical symptoms. Failure to promptly conduct Phase IV clinical trials and follow-up could result in expedited withdrawal of products approved under accelerated approval regulations.

 

The facilities, procedures, and operations of our contract manufacturers must be determined to be adequate by the FDA before product approval. Manufacturing facilities are subject to inspections by the FDA for compliance with cGMP, licensing specifications, and other FDA regulations before and after a NDA has been approved. Foreign manufacturing facilities are also subject to periodic FDA inspections or inspections by foreign regulatory authorities. Among other things, the FDA may withhold approval of NDAs or other product applications of a facility if deficiencies are found at the facility. Vendors that supply us finished products or components used to manufacture, package and label products are subject to similar regulation and periodic inspections.

 

Following such inspections, the FDA may issue notices on Form 483 and Warning Letters that could cause us to modify certain activities identified during the inspection. A Form 483 notice is generally issued at the conclusion of a FDA inspection and lists conditions the FDA investigators believe may violate cGMP or other FDA regulations. FDA guidelines specify that a Warning Letter be issued only for violations of “regulatory significance” for which the failure to adequately and promptly achieve correction maybe expected to result in an enforcement action.

 

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In addition, the FDA imposes a number of complex regulatory requirements on entities that advertise and promote pharmaceuticals, including, but not limited to, standards and regulations for direct-to-consumer advertising, off-label promotion, industry sponsored scientific and educational activities, and promotional activities involving the Internet.

 

Failure to comply with FDA and other governmental regulations can result in fines, unanticipated compliance expenditures, recall or seizure of products, total or partial suspension of production and/or distribution, suspension of the FDA’s review of NDAs, injunctions and criminal prosecution. Any of these actions could have a material adverse effect on us.

 

The Food and Drug Administration Modernization Act of 1997 was enacted, in part, to ensure the availability of safe and effective drugs, biologics and medical devices by expediting the FDA review process for new products. The Modernization Act establishes a statutory program for the approval of fast-track products. The fast-track provisions essentially codify the FDA’s accelerated approval regulations for drugs and biologics. A fast-track product is defined as a new drug or biologic intended for the treatment of a serious or life-threatening condition that demonstrates the potential to address unmet medical needs for this condition. Under the new fast-track program, the sponsor of a new drug or biologic may ask the FDA to designate the drug or biologic as a fast-track product at any time during the clinical development of the product. The Modernization Act specifies that the FDA must determine if the product qualifies for fast-track designation within 60 days of receipt of the sponsor’s request. Fast- track designated products may qualify for accelerated approval and priority review, or review within six months. Accelerated approval will be subject to:

 

    post-approval studies and follow-up to validate the surrogate endpoint or confirm the effect on the clinical endpoint; and

 

    prior review of all promotional materials.

 

If a preliminary review of the clinical data suggests that the product is effective, the FDA may initiate review of sections of an application for fast-track designation for a product before the application is complete. This rolling review is available if the applicant provides a schedule for submission of remaining information and pays applicable user fees. However, the time period specified in the Prescription Drug User Fees Act of 1992, which governs the time period goals to which the FDA has committed for reviewing an application, does not begin until the complete application is submitted.

 

In October 1998, the FDA granted our application for fast-track designation for Vitrase for the treatment of vitreous hemorrhage. During 2002 we submitted three sections of the Vitrase NDA as they were completed. The pre-clinical pharmacology and toxicology section was submitted in January 2002. The clinical section and the CMC section were submitted in October 2002. The FDA accepted those sections of the Vitrase NDA for review in December 2002, along with the pre-clinical pharmacology and toxicology section that was submitted in January 2002. On April 3, 2003, the FDA issued an approvable letter in which the FDA cited issues primarily related to the sufficiency of the efficacy data submitted with the NDA for Vitrase. We have submitted information to the FDA in response to its non-clinical comments contained in the approvable letter and are continuing to assess and discuss with the agency the clinical issues raised in the approvable letter. Based upon these discussions, we will determine the next appropriate steps in the approval process of Vitrase for the treatment of vitreous hemorrhage.

 

One of our product candidates, Caprogel, for the treatment of hyphema, has been designated by the FDA as an orphan drug. An orphan drug is defined in the 1984 amendments of the Orphan Drug Act as a drug intended to treat a condition affecting fewer than 200,000 persons in the United States. The Orphan Drug Act has numerous incentives including:

 

    seven years of exclusive marketing upon FDA approval;

 

    tax credit for clinical research expense;

 

    grant support for investigation of rare disease treatments; and

 

    user fee waiver.

 

For marketing outside the United States, we also are subject to foreign regulatory requirements governing human clinical trials and marketing approval for pharmaceutical products. The requirements governing the conduct of clinical trials, product approval, pricing and reimbursement vary widely from country to country. Whether or not FDA approval has been obtained, approval of a product by the comparable regulatory authorities of foreign countries must be obtained before manufacturing or marketing the product in those countries. The approval process varies from country to country and the time required for such approvals may differ substantially from that required for FDA approval. We cannot assure you that clinical trials conducted in one country will be accepted by other countries or that approval in one country will result in approval in any other country. For clinical trials conducted outside the United States, the clinical stages are generally comparable to the phases of clinical development established by the FDA.

 

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In the United States, physicians, hospitals and other healthcare providers that purchase pharmaceutical products generally rely on third-party payers, principally private health insurance plans, Medicare and, to a lesser extent, Medicaid, to reimburse all or part of the cost of the product and procedure for which the product is being used. Even if a product is approved for marketing by the FDA, there is no assurance that third-party payers will cover the cost of the product and related medical procedures. Currently, a Current Procedural Terminology (“CPT”) code has been established for the intravitreal injection of a pharmaceutical agent, which, we believe, will be appropriate for physician billing for a Vitrase injection. This code may result in reimbursement for the physician’s services in administering the drug, but will not result in reimbursement for the drug itself. Drug specific coverage policies are primarily developed by Medicare carriers following Medicare’s criteria for drug coverage, which include, among other requirements, that the drug be FDA-approved, be used in connection with a physician service and be medically reasonable for the treatment of an illness or injury. While reimbursement for Vitrase may be available under existing payment codes for miscellaneous injectable drugs, such reimbursement cannot be guaranteed. Each Medicare carrier reviews such reimbursement requests separately. Uniform national Medicare reimbursement for our injectable drug products will require a favorable National Coverage Determination for our injectable drug, which would be issued by CMS following review of an application by the manufacturer. Although they are not required to do so, private health insurers often follow the Medicare program’s lead when determining whether or not to reimburse for a drug. To support our applications for reimbursement coverage with Medicare and other major third-party payers, we intend to use data from clinical trials. The lack of satisfactory reimbursement for our drug products would limit their widespread use and lower potential product revenues.

 

Reimbursement systems in international markets vary significantly by country and, within some countries, by region. Reimbursement approvals must be obtained on a country-by-country basis. In many foreign markets, including markets in which we anticipate selling our products, the pricing of prescription pharmaceuticals is subject to government pricing control. In these markets, once marketing approval is received, pricing negotiations could take another six to twelve months or longer. As in the United States, the lack of satisfactory reimbursement or inadequate government pricing of our products would limit their widespread use and lower potential product revenues.

 

Federal, state and local laws of general applicability, such as laws regulating working conditions, also govern us. In addition, we are subject to various federal, state and local environmental protection laws and regulations, including those governing the discharge of material into the environment. We do not expect the costs of complying with such environmental provisions to have a material effect on our earnings, cash requirements or competitive position in the foreseeable future.

 

Seasonality

 

Our business is not materially affected by seasonal factors.

 

Human Resources

 

As of February 28, 2005, we had 114 full-time employees. Of our employees, 28 are engaged in research and development, five in manufacturing, 13 in quality assurance and quality control, 52 in sales and marketing, and 16 in administration. Our employees do not have a collective bargaining agreement. We consider our relations with our employees to be good.

 

General Information

 

We incorporated in California in February 1992 as Advanced Corneal Systems, Inc. In March 2000, we changed our name to ISTA Pharmaceuticals, Inc., and we reincorporated in Delaware in August 2000. Our corporate headquarters and principal research laboratories are located at 15295 Alton Parkway, Irvine, CA 92618, and our telephone number is (949) 788-6000.

 

We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports available on our website, at http://www.istavision.com, free of charge as soon as practicable after filing with the SEC. All such reports are also available free of charge via EDGAR through the SEC website at www.sec.gov. In addition, the public may read and copy materials filed by ISTA with the SEC at the SEC’s public reference room located at 450 Fifth St., N.W., Washington, D.C., 20549. Information regarding operation of the SEC’s public reference room can be obtained by calling the SEC at 1-800-SEC-0330.

 

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RISK FACTORS

 

In addition to other information included in this report, the following factors should be considered in evaluating our business and future prospects:

 

Risks Related to Our Business

 

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

 

Only two of our product candidates have received regulatory approval from the FDA. In May 2004, the FDA approved our NDA for Vitrase, in a lyophilized 6,200 USP units multi-purpose vial, for use as a spreading agent. In December 2004, the FDA approved our supplemental NDA for Vitrase for use as a spreading agent at a concentration of 200 USP units/mL in sterile solution. In June 2004, we received FDA approval of the NDA for Istalol for the treatment of glaucoma. Approval from the FDA is necessary to manufacture and market pharmaceutical products in the United States. Many other countries including major European countries and Japan have similar requirements.

 

The regulatory approval process is extensive, time-consuming and costly, and there is no guarantee that the FDA will approve additional NDAs for our product candidates, or that the timing of any such approval will be appropriate for our product launch schedule and other business priorities, which are subject to change. We have submitted two NDAs which are currently pending before the FDA, one for Vitrase for the treatment of vitreous hemorrhage and one for Xibrom for the treatment of ocular inflammation, eye pain and photophobia following cataract surgery.

 

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

 

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

 

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

 

    FDA officials may not find a product candidate safe or effective to merit an approval;

 

    FDA officials may not find that the data from preclinical testing and clinical trials justifies approval, or they may require additional studies that would make it commercially unattractive to continue pursuit of approval;

 

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

 

    the FDA may change its approval policies or adopt new regulations; and

 

    the FDA may approve a product candidate for indications that are narrow or under conditions that place our product at a competitive disadvantage, which may limit our sales and marketing activities or otherwise adversely impact the commercial potential of a product.

 

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

 

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

 

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If our products do not gain market acceptance, our business will suffer because we might not be able to fund future operations.

 

A number of factors may affect the market acceptance of our products or any other products we develop or acquire, including, among others:

 

    the price of our products relative to other therapies for the same or similar treatments;

 

    the perception by patients, physicians and other members of the health care community of the effectiveness and safety of our products for their prescribed treatments;

 

    our ability to fund our sales and marketing efforts; and

 

    the effectiveness of our sales and marketing efforts.

 

In addition, our ability to market and promote our products is restricted to the labels approved by the FDA. If the approved labels are restrictive, our sales and marketing efforts and market acceptance and the commercial potential of our products may be negatively affected. For example, should the market not widely accept Vitrase for usage based on the label of the approved NDA, we may have to await approval of additional indications in order to reach the full market potential for this drug.

 

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

 

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

 

We are continuing to develop and enhance our sales, marketing and distribution capabilities. Although we have recently expanded our capabilities, our current resources in these areas are limited. In order to commercialize any products successfully, we must continue to develop and expand substantial sales, marketing and distribution capabilities, and/or maintain our arrangements with Ventiv and Cardinal Health or establish other collaborations or other arrangements with third parties to perform these services. We do not have extensive experience in these areas, and we may not be able to establish adequate in-house sales, marketing and distribution capabilities or engage and effectively manage relationships with third parties to perform any or all of such services. To the extent that we enter into co-promotion, licensing or other third party arrangements, our product revenues and returns are likely to be lower than if we directly marketed and sold our products, and any revenues we receive will depend upon the efforts of third parties, whose efforts may not be successful.

 

If we fail to properly manage our anticipated growth, our business could suffer.

 

Rapid growth of our business is likely to place a significant strain on our managerial, operational and financial resources and systems. We have increased our full-time employee count from 42 as of December 31, 2003 to 114 as of February 28, 2005. We plan to expand our sales force from 41 sales representatives currently to approximately 50 sales representatives by the end of the first quarter of 2005 to support our commercial launch of Vitrase for use as a spreading agent. We further intend to expand our sales force to approximately 70 persons in conjunction with our expected U.S. launch of Xibrom, if approved by the FDA. To execute our anticipated growth successfully, we must attract and retain qualified personnel and manage and train them effectively. We will be dependent on our personnel and third parties to effectively manufacture, market, sell and distribute our products. We will also depend on our personnel and third parties to successfully develop and acquire new products. Further, our anticipated growth will place additional strain on our suppliers and manufacturers, resulting in increased need for us to carefully manage these relationships and monitor for quality assurance. Although we cannot assure you that we will, in fact, grow as we expect, if we fail to manage our growth effectively or to develop and expand a successful commercial infrastructure to support marketing and sales of our products, our business and financial results will be materially harmed.

 

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We have generated minimal revenue from product sales to date, we have a history of net losses and negative cash flow, and we may need to raise additional working capital.

 

We have generated minimal revenue from product sales to date, and we may never generate significant revenues from product sales in the future. For example, during 2004, we generated net product sales of Istalol of $1.6 million, which was the initial stocking order. We believe generic substitution limited Istalol prescription activity in 2004. In October 2004, the FDA granted Istalol a “BT” rating, which means that prescriptions of Istalol cannot be legally substituted at pharmacies with generic timolol maleate solutions. As pharmacies comply with Istalol’s “BT” rating and cease further generic substitutions, we expect Istalol prescription activity to increase in 2005. Although we expect our sales of Istalol to increase in future periods assuming Istalol prescription activity increases and wholesalers replenish their Istalol inventories, we cannot guarantee that Istalol sales will increase or that our product sales will be significant in the future.

 

In addition, we have never been profitable, and we might never become profitable. As of December 31, 2004, our accumulated deficit was $188.1 million, including a net loss of approximately $40.4 million. As of December 31, 2004, we had approximately $27.7 million in cash and cash equivalents and short-term investments and working capital of $18.9 million. In January 2005, we sold 6,325,000 shares of common stock under our shelf registration statement in our underwritten public offering for net proceeds to us of $52.8 million. We believe our current cash and cash equivalents and short-term investments on hand will be sufficient to finance anticipated capital and operating requirements for at least the next twelve months. We anticipate, however, that our operating expenses will substantially increase from historical levels as we continue to expand our commercial infrastructure in connection with our commercialization of our approved products.

 

If we are unable to generate sufficient product revenues, we may be required to raise additional capital in the future through collaborative agreements, private investment in public equity financings, and various other public or private equity or debt financings. If we are required to raise additional capital in the future there can be no assurance that the additional financing will be available on favorable terms, or at all. If we fail to obtain additional capital as and when required such failure could have a material adverse impact on our operating plan and business.

 

If actual future payments for allowances, discounts, returns, rebates and chargebacks exceed the estimates we made at the time of the sale of our products, our financial position, results of operations and cash flows may be materially and negatively impacted.

 

We recognize product revenue net of estimated allowances for discounts, returns, rebates and chargebacks. Such estimates require our most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. Based on industry practice, pharmaceutical companies, including us, have liberal return policies. Generally, we are obligated to accept from customers the return of pharmaceuticals that have reached their expiration date. We authorize returns for damaged products and exchanges for expired products in accordance with our return goods policy and procedures. In addition, like our competitors, we also give credits for chargebacks to wholesale customers that have contracts with us for their sales to hospitals, group purchasing organizations, pharmacies or other retail customers. A chargeback is the difference between the price the wholesale customer pays and the price that the wholesale customer’s end-customer pays for a product. Actual results may differ significantly from our estimated allowances for discounts, returns, rebates and chargebacks. For instance, because of generic substitution, Istalol prescription activity during the fourth quarter of 2004 was not in line with our expectations. As a result, we did not record any Istalol product sales during the fourth quarter of 2004. In addition, we increased our reserves for sales returns and also for discounts related to managed care and government contracts entered into during the fourth quarter of 2004. The increase in reserves in the fourth quarter of 2004 resulted in negative net product sales during the fourth quarter of ($165,000). Changes in estimates and assumptions based upon actual results may have a material impact on our results of operations and/or financial condition. In addition, our financial position, results of operations and cash flows may be materially and negatively impacted if actual future payments for allowances, discounts, returns, rebates and chargebacks exceed the estimates we made at the time of the sale of our products.

 

We may be unable to execute our strategic plan, which could have a material adverse impact on our business and financial condition.

 

Our ability to execute our strategic plan is dependent upon our ability to gain additional regulatory approvals for our product candidates and market acceptance for our approved products, expand our commercial infrastructure to support multiple product launches, conduct business development efforts to further expand our late-stage product pipeline, and pursue opportunistic acquisitions of or licenses for marketed products.

 

We have limited sales, marketing and distribution capabilities to support the marketing of any products, and we do not have significant experience in managing third-party manufacturers of any products in commercial quantities. In addition, if

 

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we acquire or obtain licenses for late-stage development products, our ability to successfully commercialize such products will also be dependent on our ability to successfully complete development of such products, including obtaining the necessary regulatory approvals. For example, we have obtained a license for U.S. marketing rights to Xibrom and ecabet sodium from Senju, and we have obtained a license for worldwide rights to Caprogel from the Eastern Virginia Medical School. We are responsible for the development of Xibrom, ecabet sodium and Caprogel.

 

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

 

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

 

We have entered into a master services agreement with R.P. Scherer West, Inc., which was subsequently acquired by and remains a wholly owned subsidiary of Cardinal Health, Inc., for the manufacture of commercial quantities of our Vitrase product in a lyophilized 6,200 USP units multi-purpose vial and a supply agreement with Alliance Medical Products, Inc. for the manufacture of commercial quantities of our Vitrase product in 200 USP units/mL in sterile solution. We also have entered into a manufacturing services agreement with Bausch & Lomb Incorporated for the manufacture of commercial quantities of Istalol and, if approved, Xibrom. Other than Istalol and Vitrase, to date, we have needed these products only in amounts sufficient for clinical trials. Before any contract manufacturer can produce commercial quantities of a product, we must demonstrate to the FDA’s satisfaction that the product source for commercial quantities is substantially equivalent to the supply of the product used in our clinical trials. Such demonstration may include the requirement to conduct additional clinical trials. In addition, the manufacturing facilities of all of our contract manufacturers must comply with current Good Manufacturing Practice, or GMP, regulations, which the FDA strictly enforces. Moreover, the facilities of the contract manufacturer must undergo and pass pre-approval inspections by the FDA before any of our products can be approved for commercial manufacture and, once approved, such facilities must maintain their compliance and good standing with regulatory authorities. We cannot assure you that R.P. Scherer West, Alliance Medical Products, Bausch & Lomb, or any other manufacturer we may contract with in the future will be able, as applicable, to develop processes necessary to produce substantially equivalent product to those products used in our clinical trials so that regulatory authorities will approve them as a manufacturer, or that such facilities, once approved, will produce on a timely basis enough product to meet our sales demands, or that they will maintain their compliance and good standing with regulatory authorities. Any such failures could delay or stop our efforts to develop our product candidates and commercialize our products.

 

Our collaborative partners may terminate, or fail to perform their duties under, our collaboration agreements, in which case our ability to commercialize our products may be significantly impaired.

 

We have entered into collaborations with Senju relating to Istalol, Xibrom and ecabet sodium. We have also entered into collaborations with Allergan and Otsuka relating to the commercialization of Vitrase in specified markets outside the United States for ophthalmic uses for the posterior region of the eye. In September 2004, we entered into a new agreement with Allergan, replacing our previous Vitrase collaboration, under which we reacquired all rights to market and sell Vitrase for all uses in the United States and other specified markets. Allergan retains an option to commercialize Vitrase for the posterior segment of the eye in Europe upon approval. If Allergan exercises its option, we will be dependent upon Allergan for the commercialization of Vitrase for such approved uses in Europe. If Allergan does not exercise its option, then such European rights will revert to ISTA, and we will pay Allergan a royalty on our European sales of Vitrase for use in the posterior segment of the eye. We depend on Otsuka for obtaining regulatory approval of Vitrase for ophthalmic uses for the posterior region of the eye in Japan, and if such approval is obtained, we will be dependent upon Otsuka for the commercialization of Vitrase for such approved uses in Japan. The amount and timing of resources that our partners dedicate to our collaborations is not within our control. Accordingly, any breach or termination of our agreements by, or disagreements with, these collaborators could delay or stop the development and/or commercialization of our product candidates within the scope of these collaborations, or, in the case of Allergan and Otsuka, adversely impact our receipt of milestone payments, profit splits, royalties, and other consideration from these collaborations. Our collaborative partners may change their strategic focus, terminate our agreements or choose not to exercise their options, on relatively short notice, or pursue alternative technologies. Our agreements with Otsuka and Senju contain reciprocal terms providing that neither we nor they may develop products that directly compete in the same form with the products involved in the collaboration.

 

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Nonetheless, there can be no assurances that our collaborators will not develop competing products in different forms or products that compete indirectly with our products.

 

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

 

Some materials used in our products are currently obtained from a single source. Biozyme Laboratories, Ltd. is currently our only source for highly purified ovine hyaluronidase, which is the active ingredient in Vitrase. Our supply agreement with Biozyme ends in August 2007, after which any further supply of hyaluronidase by Biozyme to us would be subject to Biozyme’s agreement. While we are currently pursuing additional sources for this material, our success in establishing such additional supply agreements cannot be assured. We have also entered into supply agreements with R.P. Scherer West and Alliance Medical Products to manufacture commercial quantities of Vitrase in a lyophilized 6,200 USP units multi-purpose vial and 200 USP units/mL in sterile solution, respectively. Currently, R.P. Scherer West and Alliance Medical Products each is our sole source for Vitrase in these respective configurations. We also have supply agreements with Bausch & Lomb to manufacture commercial quantities of Istalol and, if approved, Xibrom. Currently, Bausch & Lomb is our sole source for Istalol and Xibrom.

 

We have not established and may not be able to establish arrangements with additional suppliers for these ingredients or products. Difficulties in our relationship with our suppliers or delays or interruptions in such suppliers’ supply of our requirements could limit or stop our ability to provide sufficient quantities of our products, on a timely basis, for clinical trials and, for our approved products, could limit or stop commercial sales, which would have a material adverse effect on our business and financial condition.

 

We depend on our Chief Executive Officer, Vicente Anido, Jr., Ph.D., and other key personnel, to execute our strategic plan.

 

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

 

Risks Related to Our Industry

 

Compliance with extensive government regulations to which we are subject is expensive and time consuming, and may result in the delay, cessation or cancellation of product sales, introductions or modifications.

 

Extensive industry regulation has had, and will continue to have, a significant impact on our business. All pharmaceutical companies, including us, are subject to extensive, complex, costly and evolving regulation by the federal government, principally the FDA and to a lesser extent by the U.S. Drug Enforcement Administration, or DEA, and foreign and state government agencies. The Federal Food, Drug and Cosmetic Act, the Controlled Substances Act and other domestic and foreign statutes and regulations govern or influence the testing, manufacturing, packing, labeling, storing, record keeping, safety, approval, advertising, promotion, sale and distribution of our products. Under certain of these regulations, we and our contract suppliers and manufacturers are subject to periodic inspection of our or their respective facilities, procedures and operations and/or the testing of our products by the FDA, the DEA and other authorities, which conduct periodic inspections to confirm that we and our contract suppliers and manufacturers are in compliance with all applicable regulations. The FDA also conducts pre-approval and post-approval reviews and plant inspections to determine whether our systems, or our contract suppliers’ and manufacturers’ processes, are in compliance with cGMP and other FDA regulations.

 

In addition, the FDA imposes a number of complex regulatory requirements on entities that advertise and promote pharmaceuticals, including, but not limited to, standards and regulations for direct-to-consumer advertising, off-label promotion, industry sponsored scientific and educational activities, and promotional activities involving the Internet.

 

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We are dependent on receiving and maintaining FDA and other governmental approvals in order to manufacture, market, sell and ship our products. Consequently, there is always a risk that the FDA or other applicable governmental authorities will not approve our products, or will take post-approval action limiting, modifying or revoking our ability to manufacture or sell our products, or that the rate, timing and cost of such approvals will adversely affect our product introduction plans or results of operations.

 

To the extent that our products are reimbursed by the Medicare, Medicaid and other federal programs, our marketing and sales activities will be subject to regulation. Federal agencies in recent years have initiated investigations against and entered into multi-million dollar settlements with a number of pharmaceutical companies alleging violations of fraud and abuse provisions. We will need to ensure that our sales force is properly trained to comply with these laws. Even with such training, there is a risk that some of our marketing practices could come under scrutiny, or that we will not be able to institute or continue certain marketing practices.

 

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

 

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

 

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

 

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

 

    our patents and pending patent applications cover products and/or 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; and

 

    any of our issued patents, or pending patent applications that result in issued patents, will be held valid and infringed in the event the patents are asserted against others.

 

We currently own or license 53 U.S. and foreign patents and 43 U.S. and foreign pending patent applications. There can be no assurance that our existing patents, or any patents issued to us as a result of such applications, will provide a basis for commercially viable products, will provide us with any competitive advantages, or will not face third-party challenges or be the subject of further proceedings limiting their scope or enforceability. We may become involved in interference proceedings in the U.S. Patent and Trademark Office to determine the priority of our inventions. In addition, costly litigation could be necessary to protect our patent position. We license patents from the Eastern Virginia Medical School for Caprogel and from Senju for Istalol, Xibrom and ecabet sodium. Some of these license agreements do not permit us to control the prosecution, maintenance, protection and defense of such patents. If the licensor chooses not to protect its own patent rights, we may not be able to take actions to secure our related product marketing rights. In addition, if such patent licenses are terminated before the expiration of the licensed patents, we may no longer be able to continue to manufacture and sell such products as may be covered by the patents.

 

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.

 

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Disputes may arise concerning the ownership of intellectual property or the applicability or enforceability of these agreements, and we might not be able to resolve these disputes in our favor.

 

We also rely on trademarks to protect the names of our products. These trademarks may be challenged by others. If we enforce our trademarks against third parties, such enforcement proceedings may be expensive. Some of our trademarks, including Caprogel and Xibrom, are owned by or assignable to our licensors Eastern Virginia Medical School and Senju, and upon expiration or termination of the license agreements, we may no longer be able to use these trademarks.

 

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

 

We have not conducted an extensive search of patents issued to other parties and no assurance can be given that such patents do not exist, haven not been filed, or could not be issued which contain claims relating to our technology and products. If such patents do exist, the owners may bring claims against us for infringement, which might have an adverse effect on our business.

 

If third-party reimbursement is not available, our products may not be accepted in the market.

 

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

 

Both governmental and private 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. Third-party payers may not establish adequate levels of reimbursement for any of our approved products or products we develop or acquire in the future, which could limit their market acceptance and result in a material adverse effect on our financial condition.

 

Sales of our products may continue to be adversely affected by the continuing consolidation of our distribution network and the concentration of our customer base.

 

Our principal customers are wholesale drug distributors and major retail drug store chains. These customers comprise a significant part of the distribution network for pharmaceutical products in the U.S. This distribution network is continuing to undergo significant consolidation marked by mergers and acquisitions among wholesale distributors and the growth of large retail drug store chains. As a result, a small number of large wholesale distributors control a significant share of the market, and the number of independent drug stores and small drug store chains has decreased. We expect that consolidation of drug wholesalers and retailers will increase pricing and other competitive pressures on drug manufacturers. We launched our first product, Istalol, in the third quarter of 2004. For the year ended December 31, 2004, our three largest customers accounted for 15%, 40% and 25%, respectively, of our net revenues. The loss of any of these customers could materially adversely affect our business, results of operations and financial condition and our cash flows. In addition, none of our customers are party to any long-term supply agreements with us which would enable them to change suppliers freely should they wish to do so.

 

The rising cost of healthcare and related pharmaceutical product pricing has lead to cost-containment pressures that could cause us to sell our products at lower prices, resulting in less revenue to us.

 

Any of our products that have been or in the future are approved by the FDA may be purchased or reimbursed by state and federal government authorities, private health insurers and other organizations, such as health maintenance organizations and managed care organizations. Such third party payors increasingly challenge pharmaceutical product pricing. The trend toward managed healthcare in the United States, the growth of such organizations, and various legislative proposals and enactments to reform healthcare and government insurance programs, including the Medicare Prescription Drug Modernization Act of 2003, could significantly influence the manner in which pharmaceutical products are prescribed and

 

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purchased, resulting in lower prices and/or a reduction in demand. Such cost containment measures and healthcare reforms could adversely affect our ability to sell our products. Furthermore, individual states have become increasingly aggressive in passing legislation and implementing regulations designed to control pharmaceutical product pricing, including price or patient reimbursement constraints, discounts, restrictions on certain product access, importation from other countries and bulk purchasing. Legally mandated price controls on payment amounts by third party payors or other restrictions could negatively and materially impact our revenues and financial condition. We anticipate that we will encounter similar regulatory and legislative issues in most other countries outside the United States.

 

We face intense competition and rapid technological change that could result in the development of products by others that are superior to the products we are developing. In addition, we face competition from manufacturers of generic drugs which may have an adverse impact on our product revenues.

 

We have numerous competitors in the United States and abroad, including, among others, major pharmaceutical and specialized biotechnology firms, universities and other research institutions that may be developing competing products. Such competitors may include Allergan, Alcon Laboratories, Inc., Amphastar Pharmaceuticals, Inc., Bausch & Lomb, Halozyme Therapeutics, Inc., Johnson & Johnson, Novartis AG, Pfizer, Inc., Eli Lilly and Company and Inspire Pharmaceuticals, Inc. These competitors may develop technologies and products that are more effective or less costly than our current or future products or product candidates or that could render our technologies, products 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. Many of our competitors also have more resources committed to and expertise in effectively commercializing, marketing, and promoting products approved by the FDA, including communicating the effectiveness, safety and value of the products to actual and prospective customers and medical professionals. 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.

 

In addition, competition from generic drugs is a major challenge in the United States to branded drug companies, like us, and may have a material adverse effect on our product revenues. In October 2004, the FDA granted Istalol a “BT” rating, which means that prescriptions for Istalol cannot be substituted legally at pharmacies with generic timolol maleate products. Nonetheless, we believe that certain pharmacies may have substituted, and may be continuing to substitute, Istalol prescriptions with generic timolol maleate solutions. We have commenced an educational campaign to make our customers and pharmacies aware of Istalol’s BT rating and that Istalol cannot be substituted legally at pharmacies with generic timolol maleate products. In October 2004, the FDA informed us that Vitrase (hyaluronidase for injection; lyophilized, ovine) for use as a spreading agent to facilitate the dispersion and absorption of other drugs was entitled to five-year new chemical entity market exclusivity pursuant to the federal Food, Drug and Cosmetic Act. The FDA indicated that Vitrase’s new chemical entity exclusivity would bar submission to FDA of certain third party 505(b)(2) NDAs and Abbreviated New Drug Applications, or ANDAs, for drugs containing the same active moiety as Vitrase. The submission bar would be for five years from Vitrase’s approval date (i.e., May 5, 2004) or for four years in the case of patent challenges. The FDA also said that Vitrase’s new chemical entity exclusivity is not a prohibition on FDA’s review and approval of any 505(b)(2) NDA or ANDA that was submitted to the agency before Vitrase was granted five-year exclusivity. In October 2004, the FDA approved Amphadase (hyaluronidase) injection, USP, 150 IU mL, a bovine-sourced hyaluronidase, for use as a spreading agent. Amphadase, manufactured by Amphastar Pharmaceuticals, Inc., is the generic equivalent of a branded bovine-sourced hyaluronidase which is no longer commercially available. Our ability to secure the benefit of the Vitrase market exclusivity depends on a variety of factors, some of which are beyond our control, including, among others, the timing, content and outcome of actions and decisions by the FDA and other regulatory authorities regarding third party products and the impact and scope of the Vitrase market exclusivity and its affect on third party products.

 

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

 

The design, development, manufacture and sale of our products involve an inherent risk of product liability claims by consumers and other third parties. As a commercial company, we have begun to market and promote our approved products, like Istalol and Vitrase, and we may be subject to various product liability claims. In addition, we may in the future recall or issue field corrections related to our products due to manufacturing deficiencies, labeling errors or other safety or regulatory reasons. We cannot assure you that we will not experience material losses due to product liability claims, product recalls or corrections. These events, among others, could result in additional regulatory controls, such as the performance of costly post-approval clinical studies or revisions to our approved labeling that could limit the indications or patient population for our products or could even lead to the withdrawal of a product from the market. Furthermore, any adverse publicity associated with such an event could cause consumers to seek alternatives to our products, which may cause our sales to decline, even if our products are ultimately determined not to have been the primary cause of the event.

 

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We currently maintain sold products and clinical trial liability insurance with per occurrence and aggregate coverage limits of $10 million. The coverage limits of our insurance policies may be inadequate to protect us from any liabilities we might incur in connection with clinical trials or the sale of our products. Product liability insurance is expensive and in the future may not be available on commercially acceptable terms, or at all. A successful claim or claims brought against us in excess of our insurance coverage could materially harm our business and financial condition.

 

Risks Related to Our Stock

 

Our stock price is subject to significant volatility.

 

Since 2001 until the present, the daily closing price per share of our common stock has ranged from a high of $133.75 per share to a low of $2.60 per share, as adjusted for the 1-for-10 reverse stock split affected November 2002. Our stock price has been and may continue to be subject to significant volatility. The following factors, in addition to other risks and uncertainties described in this prospectus supplement and the accompanying prospectus, may cause the market price of our common stock to fall:

 

    the scope, outcome and timeliness of any governmental, court or other regulatory action that may involve us, including, without limitation, the scope, outcome or timeliness of any inspection or other action of the FDA;

 

    market acceptance and demand for our approved products;

 

    the availability to us, on commercially reasonable terms or at all, of third-party sourced products and materials;

 

    timely and successful implementation of our strategic initiatives, including the expansion of our commercial infrastructure to support the marketing, sale, and distribution of our approved products;

 

    developments concerning proprietary rights, including the ability of third parties to assert patents or other intellectual property rights against us which, among other things, could cause a delay or disruption in the development, manufacture, marketing or sale of our products;

 

    competitors’ publicity regarding actual or potential products under development or new commercial products, and the impact of competitive products and pricing;

 

    period-to-period fluctuations in our financial results;

 

    public concern as to the safety of new technologies;

 

    future sales of debt or equity securities by us;

 

    sales of our securities by our directors, officers or significant shareholders;

 

    comments made by securities analysts; or

 

    economic and other external factors, including disasters and other crises.

 

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

 

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

 

The average daily trading volume in our common stock for the twelve-month period ended December 31, 2004 was approximately 66,642 shares and the average daily number of transactions was approximately 208 for the same period. If limited trading in our stock continues, it may be difficult for investors to sell their shares in the public market at any given time at prevailing prices.

 

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Future sales of shares of our common stock may negatively affect our stock price.

 

As a result of our bridge financing in September 2002, our PIPE financing transaction in November 2002, our follow-on public offering in November 2003, our registered direct offerings in August 2004 and our follow-on public offering in January 2005, we issued approximately 23.7 million shares of our common stock. The shares of common stock issued in connection with these transactions represent approximately 92% of our common stock outstanding as of March 8, 2005. In connection with our bridge financing and our PIPE financing transaction, we also issued warrants exercisable for the purchase of up to an aggregate of 1,842,104 shares of our common stock based upon a purchase price of $3.80 per share. We filed a registration statement on Form S-3 (Registration No. 333-103820), which was declared effective on June 6, 2003, to cover sales of the shares issued to the PIPE investors and issuable to the PIPE and bridge investors upon conversion of the warrants. The exercise of these warrants could result in significant dilution to our shareholders at the time of exercise. We also filed a registration statement on Form S-2 (Registration No. 333-109576) in connection with our November 2003 follow-on public offering, which was declared effective on November 12, 2003, in which we issued and sold 4,000,000 shares of our common stock. In April 2004, we filed a universal shelf registration statement on Form S-3 with the SEC, which was declared effective in May 2004, providing for the offering from time to time of up to $75 million of our securities, which may consist of common stock, preferred stock, warrants, or debt securities. On August 6, 2004 we sold 1,570,000 shares of common stock under our shelf registration statement for an aggregate purchase price of $13.3 million, or $8.50 per share, before placement agency fees and other offering expenses. On August 10, 2004, we sold 250,000 shares of common stock under our shelf registration statement for an aggregate purchase price of $2.1 million, or $8.50 per share, before offering expenses. In January 2005, we sold 6,325,000 shares of our common stock under our universal shelf registration statement in an underwritten public offering for an aggregate purchase price of $56.2 million, or $8.88 per share, before offering expenses and underwriting discounts.

 

In the future, we may issue additional shares of common stock or other equity securities, including but not limited to options, warrants or other derivative securities convertible into our common stock, which could result in significant dilution to our stockholders.

 

Concentration of ownership and contractual board rights could delay or prevent a change in control or otherwise influence or control most matters submitted to our stockholders and could enable certain shareholders to exert control over us and our significant corporate decisions.

 

As of March 8, 2005, our directors, officers, and principal stockholders together control approximately 55% of our voting securities, a concentration of ownership that could delay or prevent a change in control. We are obligated to include a representative of Investor Growth Capital as a nominee for election to our board of directors and Sprout Capital has the right to designate two such nominees. Our principal stockholders, if acting together, would be able to influence and possibly control most matters submitted for approval by our stockholders, including the election of directors, delaying or preventing a change of control, and the consideration of transactions in which stockholders might otherwise receive a premium for their shares over then-current market prices.

 

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

 

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

 

    a classified board of directors;

 

    the ability of the board of directors to designate the terms of and issue new series of preferred stock;

 

    advance notice requirements for nominations for election to the board of directors; and

 

    special voting requirements for the amendment of our charter and bylaws.

 

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

 

We do not anticipate declaring any cash dividends on our common stock.

 

We have never declared or paid cash dividends on our common stock and do not plan to pay any cash dividends in the near future. Our current policy is to retain all funds and any earnings for use in the operation and expansion of our business.

 

Item 2:    Properties.

 

We currently lease facilities, which approximate 34,877 square feet of laboratory and office space, in Irvine, California. The term of our Irvine, California leasehold expires October 31, 2009. We believe that these two facilities are adequate for our immediate needs. Additional space will be required, however, as we expand our research and clinical development, manufacturing and selling and marketing activities. We do not foresee any significant difficulties in obtaining any required additional facilities close to our current facility.

 

Item 3:    Legal Proceedings.

 

We are involved in legal proceedings incidental to our business from time to time. We believe that pending actions, individually and in the aggregate, will not have a material adverse effect on our financial condition, results of operations or cash flows, and that adequate provision has been made for the resolution of such actions and proceedings.

 

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

 

Set forth below is information concerning each matter submitted to a vote at the Annual Meeting of Stockholders on October 20, 2004.

 

Proposal No. 1: The stockholders elected three Class I directors to serve for a term of three years expiring upon the 2007 Annual Meeting of Stockholders or until his successor has been duly elected and qualified.

 

Nominee


   Votes For

   Votes Withheld

Peter Barton Hutt

   17,300,230    597,654

Benjamin F. McGraw III, Pharm.D.

   17,198,391    699,493

Liza Page Nelson

   15,986,482    1,911,402

 

The names and biographies of each continuing director, including those elected at the Annual Meeting of Stockholders on October 20, 2004, are set forth in Part III, Item 10 below.

 

Proposal No. 2: The stockholders ratified the appointment of Ernst & Young LLP as the Company’s independent auditors for the fiscal year ended December 31, 2004 (with 17,888,839 votes for, 9,030 votes against, and 15 votes abstaining).

 

Proposal No. 3: The stockholders approved and adopted the Company’s 2004 Performance Incentive Plan (with 14,891,247 votes for, 1,136,647 votes against, and 1,361 votes abstaining).

 

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