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Table of Contents

 

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended September 30, 2010

OR

 

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

For the transition period from             to             

Commission file number 0-22332

 

 

INSITE VISION INCORPORATED

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   94-3015807

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

965 Atlantic Avenue, Alameda, California   94501
(Address of principal executive offices)   (Zip Code)

(510) 865-8800

Registrant’s telephone number, including area code

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding as of November 2, 2010

Common Stock, $0.01 par value per share   94,812,468 shares

 

 

 


Table of Contents

 

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2010

TABLE OF CONTENTS

 

           Page  
PART I. FINANCIAL INFORMATION   
Item 1.    Financial Statements   
   Condensed Consolidated Balance Sheets at September 30, 2010 (unaudited) and December 31, 2009      1   
   Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2010 and 2009 (unaudited)      2   
   Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2010 and 2009 (unaudited)      3   
   Notes to Condensed Consolidated Financial Statements (unaudited)      4   
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      11   
Item 3.    Quantitative and Qualitative Disclosures About Market Risk      15   
Item 4.    Controls and Procedures      15   
PART II. OTHER INFORMATION   
Item 1.    Legal Proceedings      16   

Item 1A.

   Risk Factors      16   

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      31   
Item 3.    Defaults Upon Senior Securities      31   
Item 4.    (Removed and Reserved)      31   
Item 5.    Other Information      31   
Item 6.    Exhibits      31   
Signatures      32   


Table of Contents

 

PART I FINANCIAL INFORMATION

Item 1. Financial Statements

InSite Vision Incorporated

Condensed Consolidated Balance Sheets

 

(in thousands, except share data)

   September 30,
2010
    December 31,
2009
 
ASSETS      (UNAUDITED)        (1)   

Current assets:

    

Cash and cash equivalents

   $ 14,570      $ 7,222   

Short-term investments

     3,000        17,499   

Accounts receivable, net of allowance of $50 at September 30, 2010

     2,835        3,137   

Prepaid expenses and other current assets

     439        157   
                

Total current assets

     20,844        28,015   
                

Property and equipment, at cost:

    

Laboratory and other equipment

     1,093        955   

Leasehold improvements

     29        29   

Furniture and fixtures

     36        33   
                
     1,158        1,017   

Accumulated depreciation

     (905     (708
                
     253        309   
                

Debt issuance costs, net

     3,609        3,922   
                

Total assets

   $ 24,706      $ 32,246   
                
LIABILITIES AND STOCKHOLDERS’ DEFICIT     

Current liabilities:

    

Accounts payable

   $ 183      $ 286   

Accrued liabilities

     421        360   

Accrued compensation and related expense

     471        968   

Accrued royalties

     763        647   

Accrued interest

     3,297        2,938   

Deferred revenues

     75        75   
                

Total current liabilities

     5,210        5,274   

Capital lease obligation, less current portion

     —          5   

Non-recourse secured notes payable

     60,000        60,000   
                

Total liabilities

     65,210        65,279   
                

Commitments and contingencies

    

Stockholders’ deficit:

    

Preferred stock, $0.01 par value, 5,000,000 shares authorized, none issued and outstanding

     —          —     

Common stock, $0.01 par value, 240,000,000 shares authorized; 94,769,330 and 94,738,400 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively

     948        947   

Additional paid-in capital

     149,274        149,012   

Accumulated deficit

     (190,726     (182,992
                

Total stockholders’ deficit

     (40,504     (33,033
                

Total liabilities and stockholders’ deficit

   $ 24,706      $ 32,246   
                

 

 

(1) Derived from the Company’s audited consolidated financial statements as of December 31, 2009.

See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

 

InSite Vision Incorporated

Condensed Consolidated Statements of Operations

(Unaudited)

 

     Three months ended September 30,     Nine months ended September 30,  

(in thousands, except per share data)

   2010     2009     2010     2009  

Revenues:

        

Royalties

   $ 3,000      $ 2,209      $ 7,729      $ 4,963   

Licensing fee and milestone amortization

     —          —          —          1,373   

Other product and service revenues

     235        —          258        —     
                                

Total revenues

     3,235        2,209        7,987        6,336   
                                

Expenses:

        

Research and development (a)

     1,398        1,007        3,581        4,550   

General and administrative (a)

     992        1,425        3,195        4,626   

Cost of revenues, principally royalties to third parties

     625        316        1,264        798   

Severance

     —          —          —          369   

Impairment of property and equipment

     —          —          —          615   
                                

Total expenses

     3,015        2,748        8,040        10,958   
                                

Income (loss) from operations

     220        (539     (53     (4,622

Interest expense and other, net

     (2,565     (2,513     (7,681     (7,485
                                

Net loss

   $ (2,345   $ (3,052   $ (7,734   $ (12,107
                                

Net loss per share:

        

Loss per share - basic

   $ (0.02   $ (0.03   $ (0.08   $ (0.13
                                

Loss per share - diluted

   $ (0.02   $ (0.03   $ (0.08   $ (0.13
                                

Weighted average shares used in per-share calculation:

        

- Basic

     94,769        94,738        94,762        94,701   
                                

- Diluted

     94,769        94,738        94,762        94,701   
                                

 

(a)     Stock-based compensation included in expense line items:

        

Research and development

   $ 24      $ 13      $ 51      $ 305   

General and administrative

   $ 74      $ 35      $ 203      $ 275   

See accompanying notes to condensed consolidated financial statements.

 

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InSite Vision Incorporated

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

     Nine months ended September 30,  

(in thousands)

   2010     2009  

OPERATING ACTIVITIES:

    

Net loss

   $ (7,734   $ (12,107

Adjustment to reconcile net loss to net cash used in operating activities:

    

Depreciation and amortization

     197        511   

Impairment of assets

     —          615   

Loss on sale of assets

     —          1   

Amortization of debt issuance costs

     313        313   

Stock-based compensation

     254        580   

Changes in operating assets and liabilities:

    

Accounts receivable, net of allowance

     302        (754

Prepaid expenses and other current assets

     (282     158   

Accounts payable

     (103     (920

Accrued liabilities

     61        (126

Accrued compensation and related expense

     (497     8   

Accrued royalties

     116        167   

Accrued interest

     359        1,177   

Deferred revenues

     —          (298
                

Net cash used in operating activities

     (7,014     (10,675
                

INVESTING ACTIVITIES:

    

Purchase of property and equipment

     (141     (34

Proceeds from sale of asset

     —          5   

Decrease (increase) in short-term investments

     14,499        (25,997
                

Net cash provided by (used in) investing activities

     14,358        (26,026
                

FINANCING ACTIVITIES:

    

Issuance of common stock from exercise of options and employee purchase plan, net of issuance costs

     9        9   

Payment of capital lease obligation

     (5     (12
                

Net cash provided by (used in) financing activities

     4        (3
                

Net increase (decrease) in cash and cash equivalents

     7,348        (36,704

Cash and cash equivalents at beginning of period

     7,222        37,456   
                

Cash and cash equivalents at end of period

   $ 14,570      $ 752   
                

Supplemental disclosure of cash flow information:

    

Interest received

   $ 15      $ 60   
                

Interest paid

   $ 7,023      $ 6,049   
                

Income taxes

   $ —        $ 2   
                

See accompanying notes to condensed consolidated financial statements.

 

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InSite Vision Incorporated

Notes to Condensed Consolidated Financial Statements

September 30, 2010

(Unaudited)

Note 1. Significant Accounting Policies and Use of Estimates

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include the accounts of InSite Vision, Inc. (“InSite” or the “Company”) and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in the preparation of the condensed consolidated financial statements.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. Accordingly, they do not include all of the information and footnotes required for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 2010 are not necessarily indicative of the results that may be expected for any future period.

The Company operates in one segment, using one measure of profitability to manage its business. Revenues are primarily royalties from the license (the “Inspire License Agreement”) of AzaSite to Inspire Pharmaceuticals, Inc. (“Inspire”), located in the United States. All of the Company’s long-lived assets are located in the United States.

These unaudited condensed consolidated financial statements and notes should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009.

Use of Estimates

The preparation of financial statements requires the Company to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Fair Value Measurements

The Company measures assets and liabilities at fair value. The levels of fair value measurements are:

 

Level 1:   Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.
Level 2:   Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. The Company had no Level 2 assets at September 30, 2010.
Level 3:   Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. The Company had no Level 3 assets or liabilities at September 30, 2010.

At September 30, 2010, $17.3 million of our cash and cash equivalents and short-term investments consisted of Level 1 United States Treasury backed money market funds.

The Company’s financial instruments consist mainly of cash equivalents, short-term investments, short-term accounts receivable, accounts payable and debt obligations. Short-term accounts receivable and accounts payable are reflected in the accompanying unaudited condensed consolidated financial statements at cost, which approximates fair

 

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value due to the short-term nature of these instruments. While the Company believes its valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

The Company has long-term debt in the form of non-recourse, secured notes payable with fixed interest rates. The Company had $60 million in Level 2 borrowings outstanding at September 30, 2010, with an interest rate of 16%. At September 30, 2010, the face value of our long-term debt was estimated to be approximately the fair value based on current market rates.

Short-Term Investments

The Company’s investment policy is to limit the risk of principal loss of invested funds by generally attempting to limit market risk. Accordingly, the Company’s short-term investments of $3.0 million are currently invested in United States Treasury securities with original maturities of twelve months or less. They are classified as trading securities principally bought and held for the purpose of selling them in the near term, with unrealized gains and losses included in earnings. For the three and nine months ended September 30, 2010, the unrealized gains were under $1,000.

Recent Accounting Pronouncements

In October 2009, the FASB issued an amendment to accounting standards related to multiple-deliverable revenue arrangements. The amendment requires entities to allocate revenue in multiple-deliverable revenue arrangements using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. The standard is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning after June 15, 2010. The Company is currently evaluating the impact to the Company’s financial position and results of operations.

In January 2010, the FASB issued an amendment to accounting standards related to fair value disclosures. The amendment requires entities to provide enhanced disclosures about transfers into and out of the Level 1 (fair value determined based on quoted prices in active markets for identical assets and liabilities) and Level 2 (fair value determined based on significant other observable inputs) classifications, provide separate disclosure about purchases, sales, issuances and settlements relating to the tabular reconciliation of beginning and ending balances of the Level 3 (fair value determined based on significant unobservable inputs) classification and provide greater disaggregation for each class of assets and liabilities that use fair value measurements. The standard is effective for interim and annual reporting periods beginning after December 31, 2009, except for the Level 3 disclosure. The Company adopted this standard during the period ended March 31, 2010. The adoption did not impact the Company’s consolidated financial position or results of operations. The Level 3 disclosure is effective for interim and annual reporting periods beginning after December 31, 2010. The Company expects that the adoption of the Level 3 disclosure will not materially impact the Company’s consolidated financial position or results of operations, other than additional disclosure requirements.

Note 2. Stock-Based Compensation

Equity Incentive Program

In October 2007, the Company’s stockholders approved the Company’s 2007 Performance Incentive Plan (the “2007 Plan”), that provides for grants of options and other equity-based awards to the Company’s employees, directors and consultants. Options granted under this plan, and its predecessor plan, expire 10 years after the date of grant and become exercisable at such times and under such conditions as determined by the Company’s Board of Directors (generally with 25% vesting after one year and the balance vesting on a daily basis over the next three years of service). Upon termination of the optionee’s service, unvested options terminate and vested options generally expire at the end of three months. Only nonqualified stock options have been granted under these plans to date. On January 1 of each calendar year during the term of the 2007 Plan, the shares of common stock available for issuance under the 2007 Plan will be increased by the lesser of (i) 2% of the total outstanding shares of common stock on December 31 of the preceding calendar year and (ii) 3,000,000 shares.

 

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Employee Stock Purchase Plans

The Company maintained an employee stock purchase plan (the “Purchase Plan”) until August 2009. In August 2009, the Purchase Plan was suspended. 515,183 shares remain reserved for issuance under the Purchase Plan. No new offering period will commence and no additional shares will be added to the Purchase Plan under its evergreen provision unless and until approved by the Company’s Board of Directors. During the nine months ended September 30, 2009, 56,782 shares were issued under the Purchase Plan. As of September 30, 2010, there was no remaining unrecorded deferred stock-based compensation related to the Purchase Plan.

Employee Stock-based Compensation

Our stock-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as expense over the requisite service period.

The effect of recording stock-based compensation for the three and nine months ended September 30, 2010 and 2009 was as follows (in thousands):

 

     Three months ended
September 30,
     Nine months ended
September 30,
 
     2010      2009      2010      2009  

Stock-based compensation expense by type of award:

           

Employee stock options

   $ 98       $ 48       $ 254       $ 549   

Employee stock purchase plan

     —           —           —           28   

Non-employee stock options

     —           —           —           3   
                                   

Total stock-based compensation

   $ 98       $ 48       $ 254       $ 580   
                                   

During the nine months ended September 30, 2010 and 2009, the Company granted options to purchase 1,680,000 and 2,285,000 shares, respectively, of common stock with an estimated total grant date fair value of $477,000 and $310,000, respectively. Based on the Company’s historical experience of option pre-vesting cancellations and estimates of future forfeiture rates, the Company has assumed an annualized forfeiture rate of 10% for its options for all periods disclosed. Accordingly, of the $477,000 and $310,000, the Company estimated that the stock-based compensation for the awards not expected to vest was $82,000 and $51,000, respectively.

As of September 30, 2010, unrecorded deferred stock-based compensation balance related to stock options was $0.6 million and will be recognized over an estimated weighted-average amortization period of 2.2 years.

 

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Valuation assumptions

The Company estimates the fair value of stock options and employee stock purchase plans using a Black-Scholes valuation model using the graded-vesting method with the following weighted-average assumptions:

 

     Three months ended
September 30,
    Nine months ended
September 30,
 

Stock Options

   2010     2009     2010     2009  

Risk-free interest rate

     1.3     1.8     2.6     1.8

Expected term (years)

     5        5        5        5   

Expected dividends

     0.0     0.0     0.0     0.0

Volatility

     88.7     80.5     85.7     80.5

Employee Stock Purchase Plan

   Three months ended
September 30, 2009
    Nine months ended
September 30, 2009
 

Risk-free interest rate

     1.7%        1.7%   

Expected term (years)

     1.5        1.5   

Expected dividends

     0.0%        0.0%   

Volatility

     80.5%        80.5%   

The dividend yield of zero is based on the fact that the Company has never paid cash dividends and has no present intention to pay cash dividends. Expected volatility is based on the historical volatility of the Company’s common stock and the expected moderation in future volatility over the period commensurate with the expected life of the options and other factors. The risk-free interest rates are taken from the Daily Federal Yield Curve Rates as of the grant dates as published by the Federal Reserve and represent the yields on actively traded Treasury securities for terms equal to the expected term of the options. The expected term calculation is based on the terms utilized by the Company’s peers, observed historical option exercise behavior and post-vesting forfeitures of options by the Company’s employees.

The following is a summary of activity under these plans for the indicated periods:

 

     Number of
shares
    Weighted-Average
Exercise Price
     Weighted-Average
Remaining Contractual
Term (Years)
   Aggregate
Intrinsic Value

(in thousands)
 

Outstanding at December 31, 2009

     7,406,285      $ 0.74       4.93    $ 296   

Granted

     1,680,000      $ 0.42         

Exercised

     (30,930   $ 0.28         

Forfeited

     (325,804   $ 0.34         

Expired

     (420,196   $ 1.24         
                

Outstanding at September 30, 2010

     8,309,355      $ 0.67       5.17    $ 113   
                

Options vested and expected to vest at September 30, 2010

     7,998,967      $ 0.68       5.01    $ 108   

Options exercisable at September 30, 2010

     4,856,620      $ 0.90       2.40    $ 48   

At September 30, 2010, the Company had 2,550,353 shares of common stock available for grant or issuance under its 2007 Plan. The weighted average grant date fair value of options granted during the nine months ended September 30, 2010 and 2009 was $0.28 and $0.14, respectively. The intrinsic value of options exercised during the nine months ended September 30, 2010 was $7,000. No options were exercised during the nine months ended September 30, 2009.

 

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The following table summarizes information concerning outstanding and exercisable options as of September 30, 2010:

 

     Options Outstanding at September 30, 2010      Options Vested and Exercisable at
September 30, 2010
 
            Weighted-Average                

Range of Exercise Prices

   Number
Outstanding
     Contractual
Life
   Exercise Price      Number
Exercisable
     Weighted-
Average
Exercise Price
 

$0.20 - $0.20

     1,050,000       8.38    $ 0.20         424,165       $ 0.20   

$0.22 - $0.36

     833,266       7.83    $ 0.27         378,148       $ 0.28   

$0.38 - $0.38

     900,000       9.21    $ 0.38         —         $ 0.00   

$0.41 - $0.41

     145,000       0.62    $ 0.41         145,000       $ 0.41   

$0.42 - $0.42

     1,430,000       9.50    $ 0.42         —         $ 0.00   

$0.52 - $0.60

     220,000       7.89    $ 0.53         206,328       $ 0.53   

$0.63 - $0.63

     1,358,266       0.76    $ 0.63         1,358,266       $ 0.63   

$0.64 - $1.46

     822,823       1.97    $ 0.94         794,713       $ 0.94   

$1.50 - $1.50

     950,000       0.72    $ 1.50         950,000       $ 1.50   

$1.59 - $2.20

     600,000       0.96    $ 1.61         600,000       $ 1.61   
                                        
     8,309,355       5.17    $ 0.67         4,856,620       $ 0.90   
                          

The following table details the Company’s nonvested options activity for the period ended September 30, 2010:

 

     Number of
shares
    Weighted-Average
Grant-Date Fair Value
 

Outstanding at December 31, 2009

     2,796,083      $ 0.19   

Granted

     1,680,000        0.28   

Vested

     (823,348     0.20   

Forfeited

     (200,000     0.29   
          

Outstanding at September 30, 2010

     3,452,735      $ 0.23   
          

Note 3. Net Loss per Share

Basic net loss per share has been computed using the weighted-average number of common shares outstanding during the period. Dilutive net loss per share is computed using the sum of the weighted average number of common shares outstanding and the potential number of dilutive common shares outstanding during the period. Potential common shares consist of the shares issuable upon exercise of stock options and warrants. Potentially dilutive securities have been excluded from the computation of diluted net loss per share in 2010 and 2009 as their inclusion would be antidilutive. At September 30, 2010 and 2009, 10,627,370 and 13,194,219 options and warrants were excluded from the calculation of diluted earnings per share because the effect was anti-dilutive.

 

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

 

     Three months ended
September 30,
    Nine months ended
September 30,
 

(in thousands, except per share data)

   2010     2009     2010     2009  

Numerator:

        

Net loss

   $ (2,345   $ (3,052   $ (7,734   $ (12,107
                                

Denominator:

        

Weighted-average shares outstanding

     94,769        94,738        94,762        94,701   

Effect of dilutive securities:

        

Stock options and warrants

     —          —          —          —     
                                

Weighted-average shares outstanding for diluted loss per share

     94,769        94,738        94,762        94,701   
                                

Net loss per share:

        

Basic

   $ (0.02   $ (0.03   $ (0.08   $ (0.13
                                

Diluted

   $ (0.02   $ (0.03   $ (0.08   $ (0.13
                                

Note 4. Common Stock Warrants

The following table shows outstanding warrants as of September 30, 2010. All of the outstanding warrants have cashless exercise provisions. All warrants are exercisable for common stock.

 

                          Potential Total  
Date Issued    Warrant Shares      Exercise Price      Expiration Date      Cash if Exercised  

December 30, 2005

     860,000       $ 0.82         December 29, 2010         705,200   

December 30, 2005

     100,000       $ 0.82         December 29, 2010         82,000   

January 11, 2006

     400,000       $ 0.82         January 10, 2011         328,000   

August 16, 2006

     958,015       $ 1.51         August 15, 2011         1,446,603   
                       

Total

     2,318,015               2,561,803   
                       

Average exercise price per share

            $ 1.11   
                 

 

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Note 5. Restructuring Charge

In December 2008 and March 2009, the Company announced corporate restructuring plans to focus on the Company’s growth opportunities and conserve resources. As of September 30, 2010, the restructuring plan had reduced the Company’s personnel by 39 employees. The Company recorded the severance-related costs upon notice of termination. As of September 30, 2010, aggregate severance expense totaled approximately $2.4 million of which $0.2 million was a non-cash transaction. In 2008, $1.9 million was recorded as severance expense in the Consolidated Statements of Operations. The remaining $0.5 million was recorded as severance expense in the Condensed Consolidated Statements of Operations in 2009. The Company has not incurred severance related costs in 2010.

The following table summarizes the activity for the accrued severance included in accrued compensation and related expense in the Consolidated Balance Sheets (in thousands):

 

Accrual at December 31, 2009

   $ 157   

Payments made

     (157
        

Accrual at September 30, 2010

   $ —     
        

There is no remaining liability for severance related costs as of September 30, 2010.

Note 6. Subsequent Events

On October 29, 2010, the Company was notified it will receive grants for the development of ISV-502 and ISV-303 from the Department of the Treasury under the Therapeutic Discovery Project under Section 48D of the Internal Revenue Code. The Company will receive amounts equaling 50% of qualified investments, up to $489,000, under this project.

 

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

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

The following discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto included in this Quarterly Report and in our Annual Report on Form 10-K for the year ended December 31, 2009.

Overview

We are an ophthalmic product development company advancing ophthalmic pharmaceutical products to address unmet eye care needs. Our current portfolio of products is based on our proprietary DuraSite® drug delivery technology.

Our DuraSite® sustained drug delivery technology is a proven synthetic polymer-based formulation designed to extend the residence time of a drug relative to conventional topical therapies. It enables topical delivery of a drug as a solution, gel or suspension and can be customized for delivering a wide variety of drug candidates. We have focused our research and development and commercial support efforts on the following topical products formulated with our DuraSite® drug delivery technology. We may also utilize our DuraSite technology platform for the formulation of new ocular product candidates using either non-proprietary drugs or compounds originally developed by others for non-ophthalmic indications.

 

   

AzaSite® (azithromycin ophthalmic solution) 1% is a DuraSite formulation of azithromycin, a broad spectrum ocular antibiotic approved by the FDA in April 2007 to treat bacterial conjunctivitis (pink eye). It was launched in the United States by Inspire Pharmaceuticals in August 2007. Additional indications are being pursued by Inspire Pharmaceuticals for this product. The key advantages are a significantly reduced dosing regimen leading to better compliance and outcome, with a broad spectrum antibiotic, and a lowered probability of bacterial resistance based on high tissue concentration.

 

   

BesivanceTM (besifloxacin ophthalmic suspension) 0.6% is a DuraSite formulation of besifloxacin, a broad spectrum ocular antibiotic approved by the FDA in May 2009 to treat bacterial conjunctivitis (pink eye). An advantage of Besivance is a faster rate of resolution of the infection that may reduce the duration of the illness and reduce the chances of infecting others. Besivance was developed by Bausch & Lomb and launched in the United States in the second half of 2009.

 

   

ISV-502 is a fixed combination of azithromycin and dexamethasone in DuraSite for the treatment of ocular inflammation and infection (blepharitis and/or blepharoconjunctivitis) for which there is no FDA- approved indicated treatment; we completed the first Phase 3 trial in November 2008. ISV-502 was very well tolerated. However, the trial did not achieve its primary endpoint as defined by the protocol. We discussed the results of this trial with the FDA and determined a development plan for this product candidate. We are pursuing a Special Protocol Assessment (“SPA”) for the next Phase 3 clinical trial for this product candidate.

 

   

ISV-305 is a DuraSite formulation of dexamethasone in development for the treatment of ocular inflammation. We have met with the FDA to discuss the development pathway for this product candidate. We are pursuing a SPA for the next Phase 3 clinical trial for this product candidate.

 

   

ISV-303 is a DuraSite formulation of bromfenac in development for the treatment of post operative inflammation and eye pain. We initiated a Phase 1/2 clinical trial for this product candidate in August 2010.

 

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ISV-405, a DuraSite formulation with a higher percentage of azithromycin, is in preclinical development for the treatment of ocular infection for markets outside the United States.

Business Strategy.

Our business strategy consists of the following:

1. Support and expand sales of AzaSite. Working with our North American commercial partner, Inspire Pharmaceuticals, we seek to increase AzaSite sales through a variety of approaches, including the evaluation of AzaSite for additional indications such as blepharitis (inflammation of the eyelid). We are also seeking additional commercial partners outside the United States to market AzaSite, particularly in Asia and Europe.

2. Develop and monetize our pipeline of ocular product candidates. We plan to conduct preclinical and clinical testing of product candidates in our portfolio, and then partner with pharmaceutical companies to complete clinical development, manufacture and market these products.

Major Developments

In the first nine months of 2010, our major developments and events included:

 

   

meeting with the FDA to discuss the development pathway for ISV-502, ISV-305 and ISV-303;

 

   

initiated a Phase 1/2 clinical trial for ISV-303, and

 

   

increased sales of AzaSite by Inspire in the United States.

Results of Operations

Revenues.

The Company had total revenues for the three months ended September 30, 2010 and 2009 of $3.2 million and $2.2 million, respectively. Revenues in the third quarter of 2010 primarily consisted of $2.8 million of royalties from net sales of AzaSite by Inspire, compared to $2.2 million in the third quarter of 2009. This increase was driven by a 23% increase in AzaSite revenues and an increase in the royalty rate from 20% to 25% beginning in July 2009. Revenues in the third quarter of 2010 also included $0.2 million of royalties from net sales of Besivance by Bausch & Lomb and $0.2 million from the sale of azithromycin to Inspire under a supply agreement (the “Supply Agreement”).

The Company had total revenues for the nine months ended September 30, 2010 and 2009 of $8.0 million and $6.3 million, respectively. Revenues in the nine months ended September 30, 2010 primarily consisted of $7.3 million of royalties from net sales of AzaSite by Inspire, compared to $5.0 million in the comparable period of 2009. This increase was driven by a 29% increase in AzaSite revenues and an increase in the royalty rate from 20% to 25% beginning in July 2009. Revenues in the nine months ended September 30, 2010 also included $0.4 million of royalties from net sales of Besivance by Bausch & Lomb and $0.2 million from the sale of materials to Inspire under the Supply Agreement. Revenues in the nine months ended September 30, 2009 also included $1.4 million from the amortization and recognition of international license fee payments for AzaSite.

 

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Research and development expenses.

Our research and development (R&D) expenses for the three and nine months ended September 30, 2010 and 2009 were:

R&D Cost by Program

(in millions)

 

     Three months ended
September 30,
     Nine months ended
September 30,
 

Program

   2010      2009      2010      2009  

ISV-303

   $ 0.5       $ —         $ 0.8       $ —     

AzaSite ex-US

     0.1         —           0.4         —     

ISV-502

     —           —           —           0.4   

AzaSite

     0.1         —           0.1         0.2   

New products and other

     —           0.1         —           0.4   

Programs - non-specific

     0.7         0.9         2.3         3.6   
                                   

Total

   $ 1.4       $ 1.0       $ 3.6       $ 4.6   
                                   

For the three and nine months ended September 30, 2010, program expenses primarily consisted of non-specific program costs which comprised facility, internal personnel and stock-based compensation costs that are not allocated to a specific development program. The non-specific costs decrease in 2010, as compared to 2009, was primarily due to savings resulting from the Company’s corporate restructuring in March 2009. Our ISV-303 program expenses primarily related to preclinical experiments and the Phase 1/2 clinical trial that was initiated in August 2010. Our AzaSite ex-US program expenses represented costs incurred to prepare for the distribution and manufacture of AzaSite internationally.

For the three and nine months ended September 30, 2009, program expenses consisted primarily of non-specific program costs which comprised facility, internal personnel and stock-based compensation costs. In addition, our ISV-502 program expenses consisted of ongoing consulting and data analysis pertaining to our Phase 3 trials.

General and administrative expenses.

General and administrative expenses for the three months ended September 30, 2010 and 2009 were $1.0 million and $1.4 million, respectively. General and administrative expenses for the nine months ended September 30, 2010 and 2009 were $3.2 million and $4.6 million, respectively. In 2010, we incurred lower personnel-related expenses as a result of our 2009 corporate restructuring.

Cost of revenues.

Cost of revenues for the three months ended September 30, 2010 and 2009 were $0.6 million and $0.3 million, respectively. Cost of revenues for the nine months ended September 30, 2010 and 2009 were $1.3 million and $0.8 million, respectively. Cost of revenues were primarily comprised of royalties accrued for third parties, including Pfizer. For the three and nine months ended September 30, 2010, cost of revenues also included the cost of the azithromycin supplied to Inspire under the Supply Agreement.

Severance.

Severance expenses were $0.4 million in the nine months ended September 30, 2009 and were associated with our corporate restructuring which was announced in March 2009. No severance expense has been incurred in 2010.

 

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Impairment.

Impairment expenses were $0.6 million in the nine months ended September 30, 2009 and were associated with our corporate restructuring announced in March 2009. The Company impaired laboratory and other equipment, leasehold improvements and furniture and fixtures located at our corporate headquarters.

Interest expense and other, net.

Interest expense and other, net, for the three months ended September 30, 2010 and 2009 was an expense of $2.6 million and $2.5 million, respectively. Interest expense and other, net, for the nine months ended September 30, 2010 and 2009 was an expense of $7.7 million and $7.5 million, respectively. The expense is primarily related to interest on the secured notes payable.

Liquidity and Capital Resources

In recent years, we have financed our operations primarily through private placements, debt financings and payments from corporate collaborations. At September 30, 2010, our cash and cash equivalents and short-term investments were $14.6 million and $3.0 million, respectively. It is our policy to invest our cash and cash equivalents and short-term investments in highly liquid securities, such as interest-bearing money market funds, treasury and federal agency notes. The current uncertain credit markets may affect the liquidity of such money market funds or other cash investments.

Net cash used in operating activities was $7.0 million and $10.7 million for the nine months ended September 30, 2010 and 2009, respectively. The decrease primarily resulted from lower costs as a result of our corporate restructuring in 2009 and an increase in royalty revenue.

Net cash provided by investing activities was $14.4 million for the nine months ended September 30, 2010. Net cash used in investing activities was $26.0 million for the nine months ended September 30, 2009. In 2009, the Company invested an additional $26.0 million in short-term investments compared to converting $14.5 million to cash and cash equivalents in 2010.

Net cash provided by financing activities was $4,000 for the nine months ended September 30, 2010. Net cash used in financing activities was $3,000 for the nine months ended September 30, 2009.

Recent Accounting Pronouncements

In October 2009, the FASB issued an amendment to the accounting standards related to multiple-deliverable revenue arrangements. The amendment requires entities to allocate revenue in multiple-deliverable revenue arrangements using estimated selling prices of the delivered goods and services based on a selling price hierarchy. The amendments eliminate the residual method of revenue allocation and require revenue to be allocated using the relative selling price method. The standard is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning after June 15, 2010. The Company is currently evaluating the impact to the Company’s financial position and results of operations.

In January 2010, the FASB issued an amendment to accounting standards related to fair value disclosures. The amendment requires entities to provide enhanced disclosures about transfers into and out of the Level 1 (fair value determined based on quoted prices in active markets for identical assets and liabilities) and Level 2 (fair value determined based on significant other observable inputs) classifications, provide separate disclosure about purchases, sales, issuances and settlements relating to the tabular reconciliation of beginning and ending balances of the Level 3 (fair value determined based on significant unobservable inputs) classification and provide greater disaggregation for each class of assets and liabilities that use fair value measurements. The standard is effective for interim and annual reporting periods beginning after December 31, 2009, except for the Level 3 disclosure. The Company adopted this standard during the period ended March 31, 2010. The adoption did not impact the Company’s consolidated financial

 

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position or results of operations. The Level 3 disclosure is effective for interim and annual reporting periods beginning after December 31, 2010. The Company expects that the adoption of the Level 3 disclosure will not materially impact the Company’s consolidated financial position or results of operations, other than additional disclosure requirements.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

The Company has long-term debt in the form of non-recourse, secured notes payable with fixed interest rates. As a result, our exposure to market risk caused by fluctuations in interest rates is minimal. We had $60 million in borrowings outstanding as of September 30, 2010, with a fixed interest rate of 16%. If the market interest rates increase by 10% from the September 30, 2010 levels, it would not result in an increase in interest expense. As of September 30, 2010, the face value of our long-term debt was estimated to be approximately the fair value based on current market rates.

The securities in our investment portfolio are not leveraged and are subject to minimal interest rate risk. Due to their original maturities of twelve months or less, the securities are classified as cash and cash equivalents or short-term investments. They are classified as trading securities principally bought and held for the purpose of selling them in the near term, with unrealized gains and losses included in earnings. Because of the short-term maturities of our investments, we do not believe that a change in market rates would have a significant negative impact on the value of our investment portfolio. While a hypothetical decrease in market interest rates by 10 percent from the September 30, 2010 levels would cause a decrease in interest income, it would not likely result in loss of principal.

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. To achieve this objective in the current economic environment, we maintain our portfolio in cash equivalents or short-term investments, including obligations of United States government-sponsored enterprises and money market funds. These securities are classified as cash and cash equivalents or short-term investments and consequently are recorded on the balance sheet at fair value. We do not utilize derivative financial instruments to manage our interest rate risks.

 

Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures. Our principal executive officer and principal financial officer, Louis Drapeau, reviewed and evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) and 15(d)-15(e)) as of the end of the period covered by this Form 10-Q (the “Evaluation Date”). Based on that evaluation, Mr. Drapeau concluded that our disclosure controls and procedures were effective as of the Evaluation Date in providing him with material information relating to us in a timely manner, as required to be disclosed in the reports we file under the Exchange Act.

(b) Changes in internal control over financial reporting. There was no change in the Company’s internal control over financial reporting that occurred during the third quarter of 2010 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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Part II OTHER INFORMATION

 

Item 1. Legal Proceedings.

The Company is subject to various claims and legal actions during the ordinary course of our business. On November 30, 2009, a patent interference was declared before the Board of Patent Appeals and Interferences on certain U.S. patents covering AzaSite. Regents of the University of California (the “University”) assert that the inventions contained in these patents were made by a former employee of the University alone, and without collaboration with InSite Vision. They are asserting that they own those inventions, and that they are entitled to an award of priority of invention and a judgment that the inventions are not patentable to InSite Vision. InSite Vision believes the University’s assertions are without merit and intends to vigorously contest those assertions.

We believe that there are currently no other claims or legal actions that would have a material adverse impact on our financial position, operations or potential performance.

 

Item 1A. Risk Factors

The following description of the risk factors associated with our business includes any material changes to and supersedes the description of the risk factors associated with our business previously disclosed in Part II, Item 1A of our quarterly report on Form 10-Q for the quarter ended September 30, 2010.

Risks Relating to Our Business

It is difficult to evaluate our business because we are in an early stage of commercializing our products, our technology is untested and successful development of pharmaceutical products is highly uncertain and requires significant expenditures and time

We are in the early stages of commercializing our products. AzaSite received regulatory approval in April 2007 and commercial sales of AzaSite began in the third quarter of 2007. Besivance received regulatory approval in May 2009 and commercial sales of Besivance began in the second half of 2009. We must receive approval in other countries prior to marketing AzaSite in such countries. Before regulatory authorities grant us marketing approval for additional products, we need to conduct significant additional research and development and preclinical and clinical testing and submit a New Drug Application (“NDA”). Successful development of pharmaceutical products is highly uncertain. Products that appear promising in research or development, may be delayed or fail to reach later stages of development or the market for several reasons, including:

 

   

preclinical tests may show the product to be toxic or lack efficacy in animal models;

 

   

failure to receive the necessary United States and international regulatory approvals or a delay in receiving such approvals. Among other things, such delays may be caused by slow enrollment in clinical studies; extended length of time or failure to achieve study endpoints; additional time requirements for data analysis or Biologic License Application or NDA preparation; discussions with the FDA; FDA requests for additional preclinical or clinical data; analyses or changes to study design; or unexpected safety, efficacy, or manufacturing issues;

 

   

enrollment in clinical studies; extended length of time or failure to achieve study endpoints; additional time requirements for data analysis or Biologic License Application or NDA preparation; discussions with the FDA; FDA requests for additional preclinical or clinical data; analyses or changes to study design; or unexpected safety, efficacy, or manufacturing issues;

 

   

clinical trial results may show the product to be less effective than desired or to have harmful or problematic side effects;

 

   

difficulties in formulating the product, scaling the manufacturing process, or getting approval for manufacturing;

 

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even if safe and effective, manufacturing costs, pricing, reimbursement issues, or other factors may make the product uneconomical;

 

   

proprietary rights of others and their competing products and technologies may prevent the product from being developed or commercialized; or

 

   

inability to compete with superior, equivalent, more cost-effective or more effectively promoted products offered by competitors.

Therefore, our research and development activities may not result in any commercially viable products.

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

We have incurred significant operating losses since our inception in 1986 and have pursued numerous drug development candidates that did not prove to have commercial potential. We expect to incur net losses for the foreseeable future or until we are able to achieve significant royalties or other revenues from sales of our products. Attaining significant revenue or profitability depends upon our ability, alone or with third parties, to develop our potential products successfully, conduct clinical trials, obtain required regulatory approvals and manufacture and market our products successfully. We may not ever achieve or be able to maintain significant revenue or profitability, including with respect to AzaSite, our lead product which has not yet been commercially launched outside the United States.

Clinical trials, such as the recently announced ISV-303 clinical trial, are expensive, time-consuming and difficult to design and implement and there can never be any assurance that the results of such clinical trials will be favorable

Human clinical trials for our product candidates are very expensive and difficult to design and implement, in part because they are subject to rigorous regulatory requirements. The clinical trial process is also time-consuming. We estimate that any particular clinical trial may take over a year to complete. Furthermore, we could encounter problems that might cause us to abandon or repeat clinical trials resulting in additional expense, further delays and potentially preventing the completion of such trials. The commencement and completion of clinical trials may be delayed or terminated due to several factors, including:

 

   

unforeseen safety issues;

 

   

lack of effectiveness during clinical trials;

 

   

difficulty in determining dosing and trial protocols;

 

   

slower than expected rates of patient recruitment;

 

   

inability to monitor patients adequately during or after treatment; and

 

   

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

In addition, we or the FDA may suspend our clinical trials at any time if it appears that we are exposing participants to unacceptable health risks or if the FDA finds deficiencies in our submissions or the conduct of these trials. In any such case, including with respect to the ISV-303 clinical trial, we may not be able to obtain regulatory approval for our product candidates, in which case we would not obtain any benefit from our substantial investment in developing the product and conducting clinical trials for such products.

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

Even if our clinical trials, such as the recently announced ISV-303 clinical trial, are completed as planned, we cannot be certain that the results will support our product candidate claims. Even if pre-clinical testing and early clinical trials for a product candidate are successful, this does not ensure that later clinical trials will be successful and we cannot

 

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be sure that the results of later clinical trials will replicate the results of prior clinical trials and pre-clinical testing or meet our expectations. The clinical trial process may fail to demonstrate that our product candidates are safe for humans or effective for indicated uses. In addition, our clinical trials involve relatively small patient populations. Because of the small sample size, the results of these clinical trials may not be indicative of future results. Any such failure would likely cause us to abandon the product candidate and may delay development of other product candidates. Any delay in, or termination of, our clinical trials will delay or preclude the filing of our NDAs with the FDA and, ultimately, our ability to commercialize our product candidates and generate product revenues.

For example, results from the Phase 3(a) clinical trial of ISV-502 for the treatment of blepharoconjunctivitis showed improved clinical outcomes as compared to treatment with a corticosteroid alone or antibiotic alone in the reduction of inflammatory signs and symptoms and bacterial eradication, respectively. In addition, ISV-502 was very well tolerated. However, the trial did not achieve its primary endpoint as defined by the protocol. We discussed the results of this trial with the FDA and determined a development plan for ISV-502. The initiation of any further clinical studies of ISV-502 is currently on hold pending the outcome of our evaluation of our strategic opportunities. We cannot assure you that any additional clinical trials for ISV-502 will be conducted or, if conducted, that they will meet the prescribed clinical endpoint as defined in the protocol for that study or that we will ultimately achieve FDA approval for the commercialization of ISV-502.

Our strategy for commercialization of our products requires us to enter into successful arrangements with corporate collaborators

We generally intend to enter into partnering and collaborative arrangements with respect to the commercialization of our product candidates, such as ISV-502 and ISV-303. However, we cannot assure you that we will be able to enter into such arrangements or that they will be beneficial to us. The success of our partnering and collaboration arrangements will depend upon many factors, including:

 

   

the progress and results of our preclinical and clinical testing and research and development programs;

 

   

the time and cost involved in obtaining regulatory approvals;

 

   

our ability to negotiate favorable terms with potential collaborators;

 

   

the efforts and success of our collaborators in further developing or marketing the product;

 

   

our ability to prosecute, defend and enforce patent claims and other intellectual property rights;

 

   

the outcome of possible future legal actions; and

 

   

competing technological and market developments.

We may not be able to conclude arrangements with third parties to support the commercialization of our products on acceptable terms, or at all, and may not be able to maintain any arrangement that we do enter into. If we pursue a partnership for ISV-502 prior to completing the Phase 3 trials, we will likely receive less favorable economic terms than if we completed successful Phase 3 trials.

The commercial success of our products is dependent on the diligent efforts of our corporate collaborators

Because we generally rely on third parties for the marketing and sale of our products, revenues that we receive will be highly dependent on the efforts and success of these third parties, particularly our partner Inspire. These partners may terminate their relationships with us and/or may not diligently or successfully market or sell our products. These partners may also pursue alternative or competing technologies or develop alternative products either on their own or in collaboration with others, including our competitors. In addition, marketing consultants and contract sales organizations that we may use in the future for our products may market products that compete with our products and we must rely on their efforts and ability to market and sell our products effectively.

 

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If we fail to enter into future collaborations or our current collaborations are terminated, we will need to enter into new collaborations or establish our own sales and marketing organization

We may not be able to enter into or maintain collaborative arrangements with third parties. If we are not successful in entering into future collaborations or maintaining our existing collaborations, particularly with Inspire, we may be required to find new corporate collaborators or establish our own sales and marketing organization. Under the terms of the Inspire License Agreement, Inspire may terminate the agreement at any time. We have no experience in sales, marketing or distribution and establishing such an organization would be costly. Moreover, there is no guarantee that a sales and marketing organization would be successful once established. If we are unable to maintain existing collaborations, enter into additional collaborations or successfully market our products ourselves, our revenues and financial results would be significantly harmed.

Our future success depends on our ability to engage third parties to assist us with the development of new products, new indications for existing products and in the conduct of our clinical trials to achieve regulatory approval for commercialization and any failure or delay by those parties to fulfill their obligations could adversely affect our development and commercialization plans

For our business model to succeed, we must continually develop new products or discover new indications for our existing products. As part of that process, we rely on third parties such as clinical research organizations, clinical investigators and outside testing labs for development activities, such as Phase 2 and/or Phase 3 clinical testing, and to assist us in obtaining regulatory approvals for our product candidates. We rely heavily on these parties for successful execution of their responsibilities but have no control over how these parties manage their businesses and cannot assure you that such parties will diligently or effectively perform their activities. For example, the clinical investigators conducting our clinical trials, including our first Phase 3(a) trial for ISV-502 and Phase 1/2 trial for ISV-303, were not our employees and we anticipate that any future Phase 3 trials of ISV-502 or ISV-303 will also be conducted by a third party. However, we are responsible for ensuring that each of our clinical trials is conducted in accordance with applicable protocols, rules and regulations or in accordance with the general investigational plan and protocols for the trial as well as the various rules and regulations governing clinical trials in the United States and abroad. Any failure by those parties to perform their duties effectively and on a timely basis could harm our ability to develop and commercialize new products, harm our business and subject us to potential liabilities.

Physicians and patients may not accept or use our products

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

 

   

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

 

   

cost-effectiveness of our products relative to competing products or treatments;

 

   

actual or perceived benefits of competing products or treatments;

 

   

physicians’ comfort level and prior experience with and use of competing products or treatments;

 

   

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

 

   

effectiveness of marketing and distribution efforts by us and our licensees and distributors.

 

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We may require additional licenses or be subject to expensive and uncertain patent litigation in order to sell our products

A number of pharmaceutical and biotechnology companies and research and academic institutions have developed technologies, filed patent applications or received patents on various technologies that may be related to our business. Some of these technologies, applications or patents may conflict with our technologies or patent applications. As is common in the pharmaceutical and biotech industry, from time to time we receive notices from third parties alleging various challenges to our patent rights. Such conflicts, if proven, could invalidate our issued patents, limit the scope of the patents, if any, that we may be able to obtain, result in the denial of our patent applications or block our rights to exploit our technology. If the United States Patent and Trademark Office (“USPTO”), or foreign patent agencies have issued or in the future issue patents to other companies that cover our activities, we may not be able to obtain licenses to these patents at a reasonable cost, or at all, or be able to develop or obtain alternative technology. If we do not obtain such licenses, we could encounter delays in or be precluded altogether from introducing products to the market. If we are required to obtain additional licenses from third parties for the sale by Inspire of AzaSite in the United States and Canada, we will be required to pay for such additional licenses from our existing cash under the terms of the $60 million in aggregate principal amount of non-convertible, non-recourse promissory notes due in 2019 (the “AzaSite Notes”).

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

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

 

   

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

 

   

redesign our products or processes to avoid infringement;

 

   

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

 

   

pay damages; or

 

   

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

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

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

A patent interference was declared before the Board of Patent Appeals and Interferences on certain U.S. patents covering AzaSite. Regents of the University of California assert that the inventions contained in these patents were made by a former employee of the university alone, and without collaboration with InSite Vision. They

 

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are asserting that they own those inventions, and that they are entitled to an award of priority of invention and a judgment that the inventions are not patentable to InSite Vision. InSite Vision believes the University’s assertions are without merit and intends to vigorously contest those assertions. A declaration and adverse outcome of this interference would impact our royalty stream from Inspire for AzaSite.

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

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

In certain circumstances, we may lose the potential to receive future royalty payments after the AzaSite Notes are repaid in full or we may be required to pay damages for breaches of representations, warranties or covenants under certain of the AzaSite Note Financing Agreements.

In February 2008, through a wholly-owned subsidiary, we issued $60 million in aggregate principal amount of AzaSite Notes, which are secured principally by royalty payments from future sales of AzaSite in North America, but not the right to receive such payments and by a pledge by us of all the outstanding equity interest in our subsidiary. If the AzaSite royalty payments are insufficient to repay the AzaSite Notes or if an event of default occurs under the indenture governing the AzaSite Notes, in certain circumstances, we would have to make payments on the AzaSite Notes out of our own cash resources, the royalty payments and our equity interest in our subsidiary may be foreclosed upon and we would lose the potential to receive future royalty payments after the AzaSite Notes are repaid in full and our intellectual property and other rights related to AzaSite. In addition, in connection with the issuance of the AzaSite Notes, we have made certain representations, warranties and covenants to our subsidiary and the holders of the AzaSite Notes (the “Noteholders”). If we breach these representations, warranties or covenants, such breach could trigger an event of default under the indenture and we could also be liable to our subsidiary or the Noteholders for substantial damages in respect of any such breach, which could harm our financial condition and ability to conduct our business as currently planned. See Note 5 of the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended December 31, 2009 for a more complete description of the terms of the AzaSite Notes.

Inspire’s failure to successfully market and commercialize AzaSite would harm sales of AzaSite and, therefore, would delay or prevent repayment of the AzaSite Notes, which would delay or prevent us from receiving future revenue from sales of AzaSite.

The AzaSite Notes issued by our subsidiary will be repaid solely from royalties on net sales of AzaSite in the United States and Canada by Inspire under the Inspire License Agreement. Inspire has assumed full control of all promotional, sales and marketing activities for AzaSite in these territories, and has sole control over the pricing of AzaSite. Accordingly, royalty payments in respect of net sales of AzaSite in the United States and Canada, if Inspire markets AzaSite in Canada, will be entirely dependent on the actions, efforts and success of Inspire, over whom neither we nor our subsidiary have control. The success of Inspire’s commercialization of AzaSite and the timely repayment of the AzaSite Notes will depend on a number of factors, including:

 

   

the scope of Inspire’s launch of AzaSite in the United States and Canada;

 

   

the effectiveness and extent of Inspire’s promotional, sales and marketing efforts;

 

   

Inspire’s ability to build, train and retain an effective sales force;

 

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Inspire’s marketing efforts outside of the eye care professionals;

 

   

Inspire’s ability to successfully sell AzaSite to physicians and patients;

 

   

Inspire’s pricing decisions regarding AzaSite;

 

   

Inspire’s marketing and selling of any current or future competing products;

 

   

Inspire’s ability to compete against larger and more experienced competitors;

 

   

the discovery of any side effects or negative efficacy findings for AzaSite;

 

   

product recalls or product liability claims relating to AzaSite;

 

   

the introduction of generic competition;

 

   

competing products for the treatment of bacterial conjunctivitis obtain more favorable formulary status than AzaSite; and

 

   

the relevant parties’ ability to adequately maintain or enforce the intellectual property rights relevant to AzaSite.

Inspire has reported that it has incurred substantial expenses in establishing and maintaining its sales force for AzaSite, including substantial additional expenses for the training and management of personnel and the acquisition of infrastructure to enable its sales force to be effective and compliant with the multiple laws and regulations affecting sales and promotion of pharmaceutical products. Although individual members of the sales force have experience in sales with other companies, Inspire did not have a sales force prior to 2004 and may experience difficulties building and maintaining its sales force, which could harm sales of AzaSite.

Inspire is currently promoting AzaSite solely to eye care professionals. Pediatricians and primary care physicians write more than 67% of prescriptions for ophthalmic antibiotics. However, Inspire has no experience calling on pediatricians and primary care physicians. Inspire’s focus on eye care professionals rather than pediatricians and primary care providers could result in lower royalties paid to us. A large number of pharmaceutical companies, including those with competing products, much larger sales forces and much greater financial resources, and those with products for indications that are completely unrelated to AzaSite, compete for the time and attention of eye care professionals, pediatricians and primary care physicians. Neither we nor our subsidiary have any control over how Inspire manages and operates its sales force, how effective Inspire’s sales efforts will be or Inspire’s pricing decisions regarding AzaSite.

In addition, Inspire depends on three pharmaceutical wholesalers for the vast majority of its AzaSite sales in the United States. These companies are Cardinal Health, McKesson Corporation and AmerisourceBergen. The loss of any of these wholesalers could harm sales of AzaSite. It is also possible that these wholesalers, or others, could decide to change their policies or fees, or both, in the future. This could cause Inspire to incur higher product distribution costs, which would result in lower net sales of AzaSite.

Inspire could experience financial or other difficulties unrelated to AzaSite that could adversely affect the marketing or sale of AzaSite. Moreover, Inspire could change its commercial strategy and deemphasize or sell or sublicense its rights to AzaSite. Neither we nor our subsidiary can prevent Inspire from developing or licensing a product that competes with AzaSite or limiting or withdrawing its support of AzaSite. Our subsidiary’s ability to pay amounts due on the AzaSite Notes may be materially harmed to the extent Inspire fails or is unable to successfully market and sell AzaSite. To the extent that our subsidiary fails to meet its payment obligations, we will have to make such payments out of our own cash resources in order to avoid a default under the AzaSite Notes, which we have done in the past. Our subsidiary again received insufficient royalties to make the interest payment in full that is due on November 15, 2010. We have the ability to make-up this shortfall with our own cash resources. This shortfall in interest payments constitutes a default under the indenture but not an event of default. To the extent that we pay in full

 

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the November 15th shortfall (plus interest thereon) by February 15, 2010, we will avoid triggering an event of default under the indenture. To the extent that an event of default occurs, the bondholders could seek available remedies, including foreclosure on our subsidiary. Our ability to receive future revenue from sales of AzaSite is dependent on our subsidiary repaying the AzaSite Notes in a timely fashion. If our subsidiary takes longer than anticipated to repay the AzaSite Notes, or if it defaults on the AzaSite Notes, we may not receive future revenue from AzaSite as currently planned, or at all.

Royalties under the Inspire License Agreement may not be sufficient for our subsidiary to meet its payment obligations under the AzaSite Notes.

Inspire’s obligation to pay royalties on net sales of AzaSite under the Inspire License Agreement expires on a country-by-country basis upon the later of 11 years from the first commercial sale of AzaSite or when the last valid claim under one of our licensed patents covering a subject product under the Inspire License Agreement in the United States and Canada expires. In the United States, first commercial sales occurred in August 2007, therefore, the obligation to pay royalties expires in August 2018. While our subsidiary will be entitled to minimum royalties under the Inspire License Agreement from Inspire for five years after the first year of a commercial sale, such minimum royalties will not be sufficient for our subsidiary to meet its payment obligations under the AzaSite Notes and, therefore, it will be dependent on Inspire’s successful sales and marketing efforts for AzaSite in order for it to receive royalties in excess of these minimum amounts. To the extent that royalties, including minimum royalties, are insufficient for our subsidiary to meet its payment obligations, we will have to make such payments out of our own cash resources in order to avoid a default under the notes, which we have done in the past. In addition, Inspire’s obligation to pay minimum royalties is suspended during any period in which (i) the FDA or any other applicable regulatory authority has required any Inspire licensed product to be withdrawn from the market or the marketing thereof otherwise to be suspended in the United States or (ii) Inspire is unable, despite use of commercially reasonable efforts, to obtain supply of any Inspire licensed product in finished form in commercially reasonable amounts necessary to launch or market such Inspire licensed product in the United States.

Royalties under the Inspire License Agreement are subject to a cumulative reduction or offset in the event of patent invalidity, generic competition, uncured material breaches by us or in the event that Inspire is required to pay royalties, milestone payments or license fees to third parties for the continued use of AzaSite. The applicable royalty rate is also subject to reduction by up to 50% in any country during any period in which AzaSite does not have patent protection. These cumulative reductions or offsets could result in our subsidiary receiving significantly reduced or no royalties under the Inspire License Agreement, which would delay repayment of the AzaSite Notes, or result in a default under the AzaSite Notes. In such circumstances we may not receive future revenue from AzaSite as currently planned, or at all.

If the Inspire License Agreement is terminated in whole or in part while the AzaSite Notes remain outstanding, we will be forced to find a new third party collaborator for AzaSite, pursue commercialization efforts ourselves or else we will lose our right to certain intellectual property rights related to AzaSite to our subsidiary.

In February 2008, in connection with our subsidiary’s issuance of the AzaSite Notes, we entered into the residual license agreement with our subsidiary (the “Residual License Agreement”). Under the terms of the Residual License Agreement, if the Inspire License Agreement is terminated in the United States or Canada while the AzaSite Notes are outstanding, all of our rights to AzaSite in such country or countries will be licensed to our subsidiary and we have three months under the terms of the Interim Sublicense, which is a part of the Residual License Agreement, to find a new third party collaborator to undertake commercialization efforts with respect to AzaSite or pursue commercialization efforts ourselves in such country or countries. Inspire can terminate the Inspire License Agreement unilaterally in a variety of circumstances, including at any time in its discretion. If the Inspire License Agreement is terminated, our efforts to find a new third-party collaborator or pursue direct commercialization efforts ourselves will divert the attention of senior management from our current business operations, which could delay the development or licensing of our other product candidates. If we elect to commercialize AzaSite ourselves, we may expend significant resources as we currently have no sales, marketing or distribution capabilities or experience, and have no current plans to establish any such resources, which may not be successful and could harm our financial condition and results of operation.

 

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If we are unsuccessful in finding a new third party collaborator for AzaSite or elect not to pursue commercialization efforts ourselves, the Interim Sublicense will terminate and our subsidiary will retain all rights to the intellectual property with respect to AzaSite in the related country or countries in which the Inspire License Agreement was terminated. If the Interim Sublicense terminates in accordance with the Residual License Agreement, our subsidiary may grant a sublicense under the license granted under the Residual License Agreement or pursue commercialization efforts itself. In any such circumstances, our subsidiary will remit for payment on the AzaSite Notes any royalties and other payments arising from the exercise of the license under the Residual License Agreement. As all economic value arising from the intellectual property subject to the Inspire License Agreement shall remain with our subsidiary (whether or not the Inspire License Agreement remains in effect and whether or not our subsidiary continues to be owned by us or our equity in the subsidiary is foreclosed upon by the Noteholders), while the AzaSite Notes are outstanding and following repayment thereof, we may never receive any future royalties or economic benefit from AzaSite and may lose rights to the intellectual property relating thereto.

We rely on a sole source for the supply of the active pharmaceutical ingredient for AzaSite.

We currently have a single supplier for azithromycin, the active drug incorporated into AzaSite. Under the Inspire License Agreement and the Supply Agreement, we have agreed to provide a supply of azithromycin to Inspire for the manufacture of AzaSite in the Territory, which we currently arrange through one supplier. The supplier of azithromycin has a drug master file on the compound with the FDA and is subject to the FDA’s review and oversight. The supplier’s manufacturing facility is subject to potential natural disasters, including earthquakes, hurricanes, tornadoes, floods, fires or explosions, and other interruptions in operation due to factors including labor unrest or strikes, failures of utility services or microbial or other contamination. If the supplier failed or refused to continue to supply us, if the FDA were to identify issues in the production of azithromycin that the supplier was unable to resolve quickly and cost-effectively, or if other issues were to arise that impact production, Inspire’s ability to manufacture and commercialize AzaSite could be interrupted, and our subsidiary’s ability to pay amounts due on the AzaSite Notes may be materially harmed, which could force us to make such payments out of our own cash resources in order to avoid a default under the AzaSite Notes and prevent or delay our ability to receive future revenue from AzaSite. Additional suppliers for azithromycin exist, but qualification of an alternative source could be time consuming and expensive and, during such qualification process, could negatively impact the sales of AzaSite. There is also no guarantee that these additional suppliers can supply sufficient quantities or quality product at a reasonable price, or at all. While we are required to maintain a certain level of inventory of azithromycin to support Inspire’s manufacturing needs, that inventory may not be sufficient to prevent an interruption in the availability of AzaSite.

In addition, certain of the raw materials that we use in formulating DuraSite, the drug delivery system used in AzaSite, are available only from Lubrizol Advanced Materials, Inc. (“Lubrizol”). Although we do not have a current supply agreement with Lubrizol, we have not encountered any difficulties obtaining necessary materials from Lubrizol. Any significant interruption in the supply of these raw materials could delay sales of AzaSite, which could then harm our subsidiary’s ability to pay amounts due on the AzaSite Notes and affect our ability to receive future revenue from AzaSite.

We have experienced senior management departures, which could harm our ability to attract and retain key employees.

Louis Drapeau, our vice president and chief financial officer, was appointed to the position of interim chief executive officer in October 2008. Our Board of Directors continues to search for a new chief executive officer. There is no guarantee this search will be successful. There is no guarantee that Mr. Drapeau will remain at our company until a new chief executive officer can be recruited or for an extended period of time thereafter. We are currently dependent on Mr. Drapeau and the loss of Mr. Drapeau’s services could significantly delay or prevent the achievement of planned development objectives. Furthermore, if we hire a new chief executive officer, we may lose employees and it may take time for our management team to coalesce and address the challenges we face. We are also dependent on Dr. Lyle Bowman, our vice president, development. We do not carry a life insurance policy on Mr. Drapeau or on Dr. Bowman.

A critical factor to our success will be retaining our personnel or recruiting replacement personnel. Competition for skilled individuals in the biotechnology business, particularly in the San Francisco Bay Area is highly competitive, and we may not be able to continue to attract and retain personnel necessary for the development of our business. Our ability to attract and retain such individuals may be reduced by our current financial situation and the

 

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challenges we face. Moreover, a significant portion of our outstanding stock options have exercise prices that are higher than our current trading price, which may reduce the retention benefit of such stock options. The loss of key personnel, the failure to recruit replacement personnel or to develop needed expertise would harm our business.

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

We are in the process of pursuing acquisitions of companies, product lines, technologies or businesses that our management believes may be complementary or otherwise beneficial to us. Any of these acquisitions, if completed, could have a negative effect on our business. Future acquisitions may result in substantial dilution to our stockholders, the expenditure of our current cash resources, the incurrence of additional debt and amortization expenses related to goodwill, research and development and other intangible assets. In addition, acquisitions would involve many risks for us, including:

 

   

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

 

   

the potential need for additional funding to support our combined business;

 

   

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

 

   

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

 

   

potentially losing key employees from the acquired companies.

If we fail to adequately manage these risks we may not achieve the intended benefits from our acquisitions.

The pursuit of a sale of our company may cause us to incur significant costs and the market price of our securities may suffer increased volatility.

We are in the process of evaluating potential business combinations, including the potential sale of our company. There can be no assurance that we will be successful in identifying an appropriate business combination or negotiating agreement terms that are favorable to our company and our stockholders. Even if a business combination is announced publicly, there can be no assurance that we will be successful in concluding the business combination. Moreover, while we are conducting this process, our management’s attention may be diverted from the daily operation of our business and the market price of our securities may be subject to increased volatility due to additional press coverage, news and rumors.

A sale of our company would involve a majority of our stockholders agreeing to sell or transfer all or a portion of our assets or common stock, resulting in stockholders of an acquiring company obtaining a controlling interest in our company or business. The sale of our company, or any change in control of our company, will likely result in the removal or departure of our present officers and directors and may result in key employee departures, a loss of employee motivation and a loss of company expertise. In addition, a sale of our company would trigger certain change in control benefits to certain of our officers, which could reduce the price that a potential acquirer would be willing to pay for us or make it more difficult for us to attract a buyer.

Federal and state tax consequences will, in all likelihood, be a major consideration in any business combination we undertake. We intend to structure any business combination so as to minimize the federal and state tax consequences to our company; however, there can be no assurance that such business combination will meet the statutory requirements of a tax-free reorganization or that the parties will obtain the intended tax-free treatment upon a transfer of stock or assets.

 

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

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

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

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

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

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

 

   

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

 

   

will be subject to the regulatory requirements described above;

 

   

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

 

   

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

 

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

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

Our success depends upon developing and maintaining a competitive advantage in the development of products and technologies in our areas of focus. We have many competitors in the United States and abroad, including pharmaceutical, biotechnology and other companies with varying resources and degrees of concentration in the ophthalmic market. Our competitors may have existing products or products under development which may be technically superior to ours or which may be less costly or more acceptable to the market. Our competitors may obtain cost advantages, patent protection or other intellectual property rights that would block or limit our ability to develop our potential products. Competition from these companies is intense and is expected to increase as new products enter the market and new technologies become available. Many of our competitors have substantially greater financial, technical, marketing, manufacturing and human resources than we do, particularly in light of our current financial condition. In addition, they may succeed in developing technologies and products that are more effective, safer, less expensive or otherwise more commercially acceptable than any that we have or will develop. Our competitors may also obtain regulatory approval for commercialization of their products more effectively or rapidly than we will. If we decide to manufacture and market our products by ourselves, we will be competing in areas in which we have limited or no experience such as manufacturing efficiency and marketing capabilities.

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

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

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

 

   

developing drugs;

 

   

undertaking pre-clinical testing and human clinical trials;

 

   

obtaining FDA and other regulatory approvals of drugs;

 

   

formulating and manufacturing drugs;

 

   

launching, marketing and selling drugs; and

 

   

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

 

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

The continuing efforts of governmental and third-party payers to contain or reduce the costs of healthcare through various means may harm our business. For example, in some foreign markets, the pricing or profitability of healthcare products is subject to government control. In the United States, there have been, and we expect there will continue to be, a number of federal and state proposals to implement similar government control. The implementation or even the announcement of any of these legislative or regulatory proposals or reforms could harm our business by reducing the prices we or our partners are able to charge for our products, impeding our ability to achieve profitability, raise capital or form collaborations. In addition, the availability of reimbursement from third-party payers determines, in large part, the demand for healthcare products in the United States and elsewhere. Examples of such third-party payers are government and private insurance plans. Significant uncertainty exists as to the reimbursement status of newly approved healthcare products and third-party payers are increasingly challenging the prices charged for medical products and services. If we or our partners succeed in bringing one or more products to the market, reimbursement from third-party payers may not be available or may not be sufficient to allow the sale of these products on a competitive or profitable basis.

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

We are exposed to potential product liability risks inherent in the development, testing, manufacturing, marketing and sale of human therapeutic products. Product liability insurance for the pharmaceutical industry is expensive. Although we believe our current insurance coverage is adequate to cover likely claims we may encounter given our current stage of development and activities, our present product liability insurance coverage will not be adequate to cover all potential claims we may encounter, particularly as AzaSite is commercialized outside the United States and Canada. Once AzaSite is commercialized in other countries, we may have to increase our coverage, which will be expensive, and we may not be able to obtain or afford adequate insurance coverage against potential claims in sufficient amounts or at a reasonable cost.

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

Our research, development and manufacturing processes involve the controlled use of small amounts of hazardous solvents used in pharmaceutical development and manufacturing, including acetic acid, acetone, acrylic acid, calcium chloride, chloroform, dimethyl sulfoxide, ethyl alcohol, hydrogen chloride, nitric acid, phosphoric acid and other similar solvents. We retain a licensed outside contractor that specializes in the disposal of hazardous materials used in the biotechnology industry to properly dispose of these materials, but we cannot completely eliminate the risk of accidental contamination or injury from these materials. Our cost for the disposal services rendered by our outside contractor was not material for the years ended 2009, 2008, or 2007, respectively. In the event of an accident involving these materials, we could be held liable for any damages that result and any such liability could exceed our resources. Moreover, as our business develops we may be required to incur significant costs to comply with federal, state and local environmental laws, regulations and policies, especially to the extent that we manufacture our own products.

Management and principal stockholders may be able to exert significant control on matters requiring approval by our stockholders

As of September 30, 2010, our management and principal stockholders (those owning more than 5% of our outstanding shares) together beneficially owned approximately 26% of our shares of common stock. As a result, our management and principal stockholders, acting together or individually, may be able to exert significant control on matters requiring approval by our stockholders, including the election of all or at least a majority of our Board of Directors, the approval of amendments to our charter, and the approval of business combinations and certain financing transactions. In September 2008, a group of our stockholders prevailed in a proxy contest that resulted in the replacement of all members of our Board of Directors.

 

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The market prices for securities of biopharmaceutical and biotechnology companies such as ours have been and are likely to continue to be highly volatile due to reasons that are related and unrelated to our operating performance and progress; we have not paid dividends in the past and do not anticipate doing so in the future

The market prices for securities of biopharmaceutical and biotechnology companies, including ours, have been highly volatile. The market has from time to time experienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. In addition, future announcements and circumstances, the status of our relationships or proposed relationships with third-party collaborators, the results of testing and clinical trials, the exercise of outstanding options and warrants that could result in dilution to our current holders of common stock, developments in our patents or other proprietary rights or those of our competitors, our own or Inspire’s failure to meet analyst expectations, any litigation regarding the same, technological innovations or new therapeutic products, governmental regulation, or public concern as to the safety of products developed by us or others and general market conditions concerning us, our competitors or other biopharmaceutical companies may have a significant effect on the market price of our common stock. For example, in the twelve months ended September 30, 2010, our closing stock price fluctuated from a high of $0.57 to a low of $0.25. Such fluctuations can lead to securities class action litigation. Securities litigation against us could result in substantial costs and a diversion of our management’s attention and resources, which could have an adverse effect on our business.

We have not paid any cash dividends on our common stock and we do not anticipate paying any dividends on our common stock in the foreseeable future.

Our common stock was delisted from the New York Stock Exchange Alternext US

On April 21, 2009, our common stock was delisted from the NYSE Alternext US LLC (the “Exchange”) for our failure to comply with the Exchange’s stockholders equity requirements. Our common stock currently trades on the over-the-counter bulletin board (“OTCBB”) market, although there are no assurances that it will continue to trade on this market. OTC transactions involve risks in addition to those associated with transactions on a stock exchange. The delisting and OTC status could harm the trading volume and liquidity of our common stock and, as a result, the market price for our common stock might become more volatile. The delisting and OTC status could also cause a reduction in the number of investors willing or able to hold or acquire our common stock, transactions in our common stock could be delayed and securities analysts’ and news media coverage of us may be reduced. These factors could result in lower prices and larger spreads in the bid and ask prices for shares of common stock. Delisting and OTC status could also make our common stock substantially less attractive as collateral for loans, for investment by potential financing sources under their internal policies or state legal investment laws or as consideration in future capital raising transactions. Furthermore, the delisting and OTC status may have other negative implications, including the potential loss of confidence by suppliers, partners and employees. Our OTC status may also make it more difficult and expensive for us to comply with state and federal securities laws in connection with future financings, acquisitions or equity issuances to employees and other service providers, thereby making it more difficult and expensive for us to raise capital, acquire other businesses using our stock and compensate our employees using equity.

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

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

 

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of our certificate of incorporation and bylaws may also have the effect of delaying, deterring or preventing a takeover attempt or management changes that our stockholders might consider in their best interest. For example, our bylaws limit the ability of stockholders to remove directors and fill vacancies on our Board of Directors. Our bylaws also impose advance notice requirements for stockholder proposals and nominations of directors and prohibit stockholders from calling special meetings or acting by written consent.

If earthquakes and other catastrophic events strike, our business may be negatively affected

Our corporate headquarters, including our research and development and pilot plant operations, are located in the San Francisco Bay area, a region known for seismic activity. A significant natural disaster such as an earthquake would have a material adverse impact on our business, results of operations, and financial condition. If we were able to use the equipment at our contract manufacturing site we could conduct our pilot plant operations although we would incur significant additional costs and delays in our product development timelines.

We face the risk of a decrease in our cash balances and losses in our investment portfolio

Our investment policy is structured to limit credit risk and manage interest rate risk. By policy, we only invest in what we view as very high quality debt securities, such as United States Government securities. However, the recent uncertainties in the credit markets could prevent us from liquidating our positions in securities that we currently believe constitute high quality investments and could also result in the loss of some or all of our principal if the issuer of such securities defaults on its credit obligations. Following completion of our $60.0 million financing on February 21, 2008, investment income has become a more substantial component of our income. The ability to achieve our investment objectives is affected by many factors, some of which are beyond our control. Our interest income will be affected by changes in interest rates, which are highly sensitive to many factors, including governmental monetary policies and domestic and international economic and political conditions. The outlook for our investment income is dependent on the future direction of interest rates and the amount of cash flows from operations, if any, that are available for investment. Any significant decline in our investment income or the value of our investments as a result of falling interest rates, deterioration in the credit of the securities in which we have invested or general market conditions, could harm our ability to liquidate our investments, our cash position and our income.

 

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

None.

 

Item 3. Defaults Upon Senior Securities.

None.

 

Item 4. (Removed and Reserved).

 

Item 5. Other Information.

None.

 

Item 6. Exhibits.

The information required under this Item appears under the heading “Exhibit Index” of this Quarterly Report on Form 10-Q.

 

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SIGNATURES

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

 

     INSITE VISION INCORPORATED
Dated: November 5, 2010    by:  

/s/ Louis Drapeau

     Louis Drapeau
     Interim Chief Executive Officer
     (Principal Executive Officer)
     Chief Financial Officer
     (Principal Financial Officer)

 

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EXHIBIT INDEX

 

Number

  

Exhibit Table

31.1    Certificate of Principal Executive Officer and Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Certification of Principal Executive Officer and Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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