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  As Of               Filer                 Filing     As/For/On Docs:Pgs              Issuer               Agent

 4/30/03  Ista Pharmaceuticals Inc          10-K/A     12/31/02   11:198                                    Bowne of Irvine/FA

Document/Exhibit                   Description                      Pages   Size 

 1: 10-K/A      Amendment to Annual Report                          HTML  1,049K 
 2: EX-10.39    Material Contract                                     17     79K 
 3: EX-10.40    Material Contract                                      2     13K 
 4: EX-10.41    Material Contract                                      1      9K 
 5: EX-10.42    Material Contract                                     18     82K 
 6: EX-10.43    Material Contract                                     17     76K 
 7: EX-10.45    Material Contract                                      2     13K 
 8: EX-10.46    Material Contract                                      2     12K 
 9: EX-23.1     Consent of Experts or Counsel                          1      8K 
10: EX-99.1     Miscellaneous Exhibit                                  1      7K 
11: EX-99.2     Miscellaneous Exhibit                                  1      7K 

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

For Fiscal Year Ended December 31, 2002

or

From the transition period from          to

Commission file number 000-31255

ISTA PHARMACEUTICALS, INC.

15279 Alton Parkway, Suite 100, Irvine, California 92618
(Address of principal executive offices)

(949) 788-6000
(Registrant’s telephone number)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.001 par value
(Title of Class)

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

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ ]

     As of June 28, 2002, the aggregate market value of the Registrant’s voting and non-voting common equities held by non-affiliates was approximately $11,525,000.

DOCUMENTS INCORPORATED BY REFERENCE

Table of Contents

TABLE OF CONTENTS

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PART I

     This Annual Report on Form 10-K and the documents incorporated herein by reference contain forward-looking statements based on expectations, estimates and projections as of the date of this filing. Actual results may differ materially from those expressed in forward-looking statements. See Item 7 of Part II – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Forward-Looking Statements.”

Item 1: Business

Overview

     ISTA Pharmaceuticals, Inc. (the “Company” or “ISTA”) was founded to discover, develop and market new remedies for diseases and conditions of the eye. Some of the products that we are developing involve the use of highly purified formulations of hyaluronidase. Our lead ovine hyaluronidase-based product candidate, Vitrase®, is a proprietary drug we are developing for the treatment of vitreous hemorrhage and diabetic retinopathy. We are also developing products that are designed to treat glaucoma, hyphema, and ocular inflammation.

     In December 2001, we announced our strategic plan to transition from a development organization to a fully-integrated, specialty pharmaceutical company, with a primary focus on ophthalmology. We intend to execute this plan by continuing to advance products currently under development, and by acquiring complementary products, either already marketed or in late-stage development.

     In May 2002, we acquired substantially all of the assets of AcSentient, Inc. The assets include United States marketing rights for a new formulation of timolol, which we have named ISTALOL™, a beta-blocking agent for treating glaucoma. AcSentient previously acquired rights to this compound from Senju Pharmaceutical Co., Ltd. Senju is headquartered in Osaka, Japan and has a diverse portfolio including ophthalmic, central nervous system, cardiovascular, circulatory, gastro-intestinal, respiratory, oncology and dermatological products. Senju submitted the NDA for ISTALOL™ to the FDA in September 2002. That NDA included data from pre-clinical studies conducted in Japan, combined with data from a Phase I clinical study conducted in the United States and a multi-center Phase III clinical study recently completed in the United States. The assets acquired from AcSentient also included United States product rights to bromfenac, a topical non-steroidal anti-inflammatory compound for the treatment of ocular inflammation, and worldwide marketing rights for Caprogel®, a novel compound for the treatment of hyphema, or bleeding into the front of the eye. AcSentient previously acquired the rights to these two compounds from Senju and the Eastern Virginia School of Medicine, respectively. Under the terms of the transaction, we have assumed payment and other obligations and responsibility for final development of bromfenac and Caprogel®.

     We are currently initiating a Phase III study of bromfenac in the United States. Assuming successful completion of our clinical studies, we anticipate submitting an NDA for bromfenac in early 2004. We are currently conducting feasibility studies for the commercialization of Caprogel®. Once completed, and if these studies yield promising results, we intend to pursue further clinical development of Caprogel® consistent with such studies’ results. However, the timing and scope for our development of Caprogel® may change based on our assessment, from time to time, of this product candidate's market potential, other product opportunities and our corporate priorities.

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     We anticipate incurring additional research and development expenses in connection with the final development of bromfenac and Caprogel®, and if these compounds are approved for sale in the United States, we expect to incur significant marketing and sales expenses. In addition, we will also be responsible for certain milestone payments to a third party in connection with the marketing approval in the United States for these compounds.

     We also took significant steps in 2002 to scale up ISTA’s manufacturing and marketing capabilities, in order to further enhance our ability to execute our strategic plan. We entered into two key manufacturing agreements for the supply of finished product from Cardinal Health and Bausch & Lomb Incorporated. We also added two senior management executives to bolster our operations and marketing capabilities: Thomas A. Mitro, Vice President, Sales and Marketing, and Kirk McMullin, Vice President, Operations. In March 2003 we added Lauren P. Silvernail as our Chief Financial Officer and Vice President, Corporate Development.

Anatomy of the Eye

     The human eye is approximately one inch in diameter and functions much like a camera. The eye incorporates a lens system (the cornea and the lens) that focuses light, a variable aperture system (the iris) that controls the amount of light passing through the eye and a film (the retina) that records the image. The cornea, lens and iris operate to focus light rays on the retina, which contains the receptors that transmit images through the optic nerve to the brain.

     The cavity between the lens and the retina is filled with the vitreous humor, a clear, gel-like substance. The vitreous humor is nearly solid in children and undergoes a natural transition to liquid as one ages.

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Hyaluronidase

     The term hyaluronidase describes a group of naturally occurring enzymes that can digest certain forms of carbohydrate molecules called proteoglycans. The primary role of hyaluronidase is to digest proteoglycans such as hyaluronan, hyaluronic acid and chondroitin sulphate, substances that are part of various connective tissues in the body, including connective tissues in the eye. Physicians have used bovine-derived hyaluronidase safely and extensively for over 50 years to enhance the absorption of drugs.

     In the eye, pharmacological applications of hyaluronidase exploit the properties of this enzyme to modify the structure of the eye for therapeutic purposes. In our development work, we have focused on applications of ovine-derived hyaluronidase to take advantage of its ability to digest proteoglycans to treat a variety of eye diseases and conditions, including vitreous hemorrhage, diabetic retinopathy and corneal opacification. For treatment of serious conditions of the eye, or ophthalmic indications, only highly purified and specially formulated ovine hyaluronidase can be used. Hyaluronidase that is less pure or formulated with preservatives has been shown to be dangerous to the eye and may cause blindness.

Product Development Programs

     We have five product candidates in clinical development. The following is a summary of our clinical product candidates:

Vitrase®

     We are developing Vitrase®, a proprietary formulation of ovine hyaluronidase, for the treatment of vitreous hemorrhage and diabetic retinopathy. When injected into the vitreous humor, Vitrase® breaks down the proteoglycan matrix, causing the vitreous humor to liquefy. We believe that this also results in the separation of the vitreous humor from the retina and that, together, these effects are beneficial for the treatment of vitreous hemorrhage and diabetic retinopathy. Vitrase® is administered directly into the vitreous humor through a single-dose injection. The procedure is performed in several minutes in an ophthalmologist’s office and is virtually painless due to the application of a topical anesthetic.

Vitreous Hemorrhage

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

     Patients who seek medical care for a vitreous hemorrhage often visit a physician, who then refers them to a retinal specialist. Treatment options for patients with a vitreous hemorrhage are limited. Currently, there is no drug treatment for vitreous hemorrhage and most retinal specialists initially recommend a “watchful waiting” period, during which the attending physician provides no medical treatment in the hope that the hemorrhage will clear on its own. The risks related to watchful waiting may include continued bleeding and, if caused by diabetic retinopathy, disease progression during the time it takes for the blood to clear on its own, if at all.

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

     We believe that a substantial opportunity exists to establish Vitrase® as the initial therapy for a vitreous hemorrhage. Vitrase®, when injected into a blood-filled vitreous humor, promotes clearance by causing the vitreous humor to liquefy and the blood to settle to the bottom of the eye. Vitrase® also stimulates the cells responsible for engulfing and breaking down the blood, accelerating the reabsorption of the blood. This clears the path for light to reach the retina enabling the patient to regain vision. In addition, clearing the hemorrhage permits the retinal specialist to visualize, diagnose and treat the underlying cause of the vitreous hemorrhage.

     Hemorrhage density can vary significantly between patients who experience vitreous hemorrhage, but even a mild hemorrhage indicates the existence of a serious problem. Because of the absence of a validated and generally accepted medical definition of the various densities of vitreous hemorrhage, we classify a vitreous hemorrhage as either mild, moderate or severe depending on the density of the vitreous hemorrhage as observed by the physician:

	•		mild vitreous hemorrhage is characterized by trace blurring of retinal blood vessels
	•		moderate vitreous hemorrhage is characterized by partial obscuration of retinal blood vessels and/or the optic nerve
	•		severe vitreous hemorrhage is characterized by complete obscuration of retinal blood vessels and/or the optic nerve

     Clinical/Regulatory Status. In October 1998, the FDA granted fast-track designation for Vitrase® for the treatment of vitreous hemorrhage. The FDA’s provision for “fast-track” designated drugs, such as Vitrase®, provides for early submission of completed sections of the NDA. In January 2002, as a part of our rolling NDA for Vitrase® for the treatment of vitreous hemorrhage, we submitted the pre-clinical pharmacology and toxicology section.

     In both studies, we enrolled patients who had both a vitreous hemorrhage that had been present for at least one month and a Best Corrected Visual Acuity (“BCVA”) of less than 20/200 at initial screening. After enrollment, patients were randomly assigned to either a test group or a control group. Patients in the test group received either a 7.5 (North America only), 55 or 75 international unit, or IU, injection of Vitrase®. Patients in the control group received a saline injection. Treatment success in both studies was defined by the clearance of the vitreous hemorrhage sufficient to allow for the occurrence of any one of the following, which must have occurred within three months following treatment with Vitrase®:

	•		panretinal laser photocoagulation surgery to slow or stop the cause of the vitreous hemorrhage
	•		other surgical treatment not specifically indicated for the clearance of the vitreous hemorrhage (for example, vitrectomy to enable treatment of retinal detachment)
	•		documented medical evidence that the clinical cause of the vitreous hemorrhage has been resolved without the need for further therapy

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     Additionally, at each study visit and specifically at months one, two and three following treatment, BCVA was assessed using an eye chart in both studies.

Diabetic Retinopathy

     Abnormal changes and/or damage to the blood vessels in the eye due to diabetes are known as diabetic retinopathy. Diabetic retinopathy is a progressive disease consisting of two stages, nonproliferative and proliferative. Nonproliferative diabetic retinopathy is the first stage of diabetic retinopathy and occurs when the retinal blood vessels swell and leak fluid and small amounts of blood into the eye. Under current practice, physicians do not generally treat patients at the nonproliferative stage of the disease because there is no effective treatment available. If untreated, nonproliferative diabetic retinopathy will likely progress into the more dangerous, proliferative stage of diabetic retinopathy. Proliferative diabetic retinopathy occurs when normal retinal blood vessels become obstructed and new, abnormal blood vessels begin to grow, or proliferate, on the surface of the retina or into the vitreous humor. The growth of these new, abnormal blood vessels creates a dangerous condition because they are weak and grow beyond the supporting structure of the retina. These blood vessels are prone to bleed and hemorrhage, and can lead to serious problems, including retinal tears and retinal detachment, both of which can severely impair vision and cause blindness. There is no cure for diabetic retinopathy.

     The most common treatment for patients with proliferative diabetic retinopathy is panretinal laser photocoagulation. In this treatment, a laser makes hundreds of tiny burns to the retina to reduce the growth of the abnormal blood vessels into the vitreous humor. Panretinal laser photocoagulation surgery has been shown to be effective in slowing the progression of proliferative diabetic retinopathy. Panretinal laser photocoagulation surgery frequently leads to increased loss of night vision and can make night driving more difficult. Also, after panretinal laser photocoagulation surgery, peripheral, or side vision, is often not as good as before the surgery.

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

     Market Opportunity. Diabetes continues to be a major healthcare problem in the United States and is projected to continue growing rapidly in many regions outside the United States. Eye disease is commonly associated with diabetes, and the risk of blindness to individuals with diabetes is 25 times greater than in the general population. Of the nearly eight million individuals in the United States diagnosed with diabetes, four to six million have some form of diabetic retinopathy. The majority of individuals with diabetic retinopathy are in the nonproliferative stage of the disease. We believe that these people are potential candidates for treatment using Vitrase®.

     Clinical/Regulatory Status. We have completed a 60 patient pilot Phase IIa clinical trial in Mexico City to evaluate the safety and efficacy of a single-dose injection of Vitrase® to cause a detachment of the vitreous humor from the retina and the impact on slowing the progression of diabetic retinopathy over a one-year period. This trial was a prospective, randomized, placebo controlled, double masked study. Patients with nonproliferative diabetic retinopathy were randomly assigned to one of four groups; a control group who

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received a saline injection, a test group who received a 75 IU injection of Vitrase®, a test group who received a 0.3 ml injection of a gas called sulphur-hexafluroride or SF6, and a test group who received a 75 IU injection of Vitrase® and a 0.3 ml injection of SF6 at 4 weeks following Vitrase® injection if a complete detachment of the vitreous humor from the retina had not occurred.

     Interim study results at 16 weeks post-treatment demonstrated that complete detachment of the vitreous humor from the retina was documented in 60% of eyes treated with a single dose of Vitrase®. This is compared with only 6% of patients in the saline control group. In the study’s two additional treatment groups, detachment of the vitreous humor from the retina was documented in 53% of eyes treated with SF6 gas and in 50% of eyes treated with a combination of Vitrase® and SF6 gas.

     To assess and measure the progression of diabetic retinopathy for study patients, seven-field fundus photographs (photographs of the retina) were taken at approximately 16 weeks following study entry and again 12 months later. The fundus photographs were reviewed in a masked fashion by an independent reading center to determine an Early Treatment for Diabetic Retinopathy Study (ETDRS) retinopathy severity scale score assigned for each patient’s study eye. These ETDRS retinopathy severity scores were then evaluated to identify any changes in the patients’ diabetic retinopathy over the one-year evaluation period. Of the study’s 60 patients, complete sets of fundus photographs were available, analyzed and scored for 46 patients.

     Although the study was not designed to demonstrate statistical significance for progression of diabetic retinopathy among study groups, evaluation of ETDRS retinopathy severity scores did highlight trends for slowing the progress of diabetic retinopathy. Of the 46 patients with fundus photographs that were analyzed and scored, 67% of patients treated with Vitrase® (10 of 15) had stable ETDRS scores, indicating no measurable progression of diabetic retinopathy over the one-year evaluation period. This compares to stable ETDRS scores for the one-year evaluation period of 38% of patients treated with saline (6 of 16); 40% of patients treated with SF6 gas (6 of 15) and 43% of patients treated with Vitrase® plus SF6 gas (6 of 14). Worsening of ETDRS scores, indicating a progression of diabetic retinopathy over the one-year evaluation period was seen in 13% of patients treated with Vitrase® (2 of 15); 38% of patients treated with saline (6 of 16); 20% of patients treated with SF6 gas (3 of 15) and 21% of patients treated with Vitrase® plus SF6 gas (3 of 14).

     The continued development of Vitrase® for the treatment of diabetic retinopathy will be dependent upon a number of factors including, among others, the FDA’s evaluation of the Vitrase® NDA for the treatment of vitreous hemorrhage, the successful completion of any additional clinical trials for the diabetic retinopathy indication and the continuing assessment of the market opportunity for this indication as compared to other product opportunities we may be pursuing at the time.

ISTALOL™

     ISTALOL™ is the Company’s once daily, topical solution of timolol, a beta-blocking agent for the treatment of glaucoma. The product was developed by Senju in Japan. In May 2002, as part of the AcSentient asset acquisition, ISTA acquired marketing rights for ISTALOL™ in the United States.

     Glaucoma is a disease that gradually reduces eyesight without warning and often without symptoms. Vision loss is caused by damage to the optic nerve. It was once thought that high intraocular pressure (“IOP”) was the main cause of this damage. It is now believed that other factors must also be involved since people with “normal” IOP can experience vision loss from glaucoma. Glaucoma is a chronic disease that must be treated for life. Currently, its causes are not well understood and there is no cure.

     The most common form of glaucoma, Primary Open Angle Glaucoma, affects about three million Americans. It happens when the eye’s drainage canals become clogged over time. The IOP rises because the correct amount of fluid cannot drain out of the eye. With open angle glaucoma, the entrances to the drainage canals are clear and should be working correctly. The clogging problem occurs inside the drainage canals. ISTALOL™ is a beta-blocker that improves drainage of aqueous humor from the eyeball.

     Clinical/Regulatory Status. Senju submitted an NDA for ISTALOL™ to the FDA in September 2002 and was accepted for review in November 2002. The NDA is based on data from a Phase I clinical study and a multi-center Phase III clinical trial conducted in the United States, as well as results from preclinical studies and Phase I and Phase II studies conducted in Japan.

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     In the clinical trials, ISTALOL™ has shown efficacy and safety comparable to timolol maleate, which is the leading beta-blocker to treat glaucoma in the United States. Advantages of ISTALOL™ include enhanced corneal penetration and once-daily administration. Third party formulations of timolol currently on the market are twice-daily solutions or gel formulations, which are known to cause blurring of patients’ vision.

Bromfenac

     Bromfenac is a topical non-steroidal anti-inflammatory compound for the treatment of ocular inflammation. The product was developed by Senju in Japan. Senju launched bromfenac in Japan in 2000 and its rapid sales growth is principally due to its superior potency and twice-daily dosing regimen as compared to the requirement of four doses-per-day for most other anti-inflammatory products on the Japanese market. In May 2002, as part of our AcSentient asset acquisition, ISTA acquired marketing rights for bromfenac in the United States.

     Clinical/Regulatory Status. Phase I, Phase II and Phase III clinical studies of bromfenac have been completed in Japan and the product has been approved and was launched in 2000 in Japan. We are currently initiating a Phase III study of bromfenac in the United States. Assuming successful completion of our clinical studies, we anticipate submitting an NDA for bromfenac in early 2004.

Caprogel®

     Caprogel®, a topical gel form of amniocaproic acid, is a new compound for treating hyphema, which typically results from trauma to the eye. The product was initially licensed from the Eastern Virginia School of Medicine. In May 2002, as part of our AcSentient asset acquisition, ISTA acquired worldwide marketing rights for Caprogel®.

     Hyphema is a term used to describe bleeding in the anterior chamber, the space between the cornea and the iris, of the eye. It occurs when blood vessels in the iris bleed and leak into the clear aqueous fluid. Hyphemas are usually characterized by pooling of blood in the anterior chamber that may be visible to the naked eye. The red blood cells of very small hyphemas are visible only with magnification. Even the slightest amount of blood in the anterior chamber will cause decreased vision when mixed in the clear aqueous fluid.

     Some of the symptoms of hyphema are decreased vision, depending on the amount of blood in the eye, pool of blood in the anterior chamber and elevated intraocular pressure. A doctor will assess visual acuity, measure intraocular pressure and examine the eye with a split lamp microscope and ophthalmoscope.

     The treatment is dependent on the cause and severity of the hyphema. Frequently, the blood is reabsorbed over a period of days to weeks. During this time, the doctor will carefully monitor the intraocular pressure for signs of the blood preventing normal flow of the aqueous through the eye’s angle structures. If the eye pressure becomes elevated, eye drops may be prescribed to control it. The pupils are also evaluated to rule out damage to the iris.

     In some cases, a procedure is performed to irrigate the blood from the anterior chamber to prevent secondary complications such as glaucoma and bloodstains on the cornea.

     Clinical/Regulatory Status. We are currently conducting feasibility studies for the commercialization of Caprogel®. Once completed, and if these studies yield promising results, we intend to pursue further clinical development of Caprogel® consistent with such studies’ results. However, the timing and scope for our development of Caprogel® may change based on our assessment, from time to time, of this product candidate’s market potential, other product opportunities and our corporate priorities. Caprogel® has received an orphan drug designation for the treatment of hypherma from the FDA, which may result in ISTA receiving a seven year market exclusivity privilege

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     We continually evaluate new opportunities for late-stage or currently marketed complementary product candidates and, if and when appropriate, intend to pursue such opportunities through further product acquisitions and related development activities. ISTA’s ability to execute on such opportunities in some circumstances will be dependant upon our ability to raise additional capital on commercially reasonable terms.

Collaboration With Allergan

     Under the terms of our agreements with Allergan:

	•		Development. We are responsible for all product development, preclinical studies and clinical trials in support of marketing approvals of Vitrase® for the treatment of vitreous hemorrhage in the United States and Europe. We are also responsible for all preclinical studies and clinical trials to demonstrate the safety and efficacy of Vitrase® for the treatment of diabetic retinopathy.
	•		Regulatory Approvals. We are responsible for applying for and obtaining regulatory approval of Vitrase® in the United States and in the European Union. Allergan will be responsible for applying for and obtaining regulatory approvals of Vitrase® in markets outside the United States and the European Union where it deems appropriate, other than Mexico (until April 2004) and Japan.
	•		Manufacturing. We are responsible for the manufacture of Vitrase® and, if approved, for supplying all of Allergan’s requirements for Vitrase® during the term of the license agreement.
	•		Marketing. In the United States, Allergan will be responsible for the overall management of marketing, sale and distribution activities for Vitrase® through its established sales and marketing organization. Under the terms of the license agreement, we will employ medical specialists in the United States to assist in physician training and usage development. In all markets outside the United States, except Mexico and Japan, Allergan will be solely responsible for the marketing, sale and distribution of Vitrase®.
	•		Milestone Payments. Allergan has agreed to pay us up to $35.0 million in milestone payments based on our achievement of specified regulatory and development objectives with respect to Vitrase® for the treatment of vitreous hemorrhage and diabetic retinopathy. To date, we have not earned any milestone payments from Allergan and we cannot guarantee that we will receive any future milestone payments.
	•		Profit Sharing and Royalties. In the United States, we will share profits on the sale of Vitrase® with Allergan on a 50/50 basis during the term of the license agreement. In all markets outside the United States, except Mexico (until April 2004) and Japan, we will receive a royalty on all sales of Vitrase® by Allergan.
	•		Term and Termination. Allergan’s license to market, sell and distribute Vitrase® in the United States will expire ten full calendar years following the date of its first commercial sale, at which time all commercial rights for Vitrase® in the United States will revert to us. Allergan’s obligation to pay royalties will terminate on a country-by-country basis upon the latest of 10 full calendar years following the date of the first commercial sale in each particular country and the expiration date of the last-to-expire licensed patent relating to Vitrase® in that country. Allergan may terminate the license agreement at any time with three months notice to us. We may terminate the license agreement on a country-by-country basis in certain countries if Allergan fails to commercialize Vitrase® within 12 months of regulatory approval in that country.
	•		Board of Director Representation and Visitation Rights. Allergan has the right to request that we nominate an Allergan representative to our Board of Directors. In the event that the Allergan nominee is not elected to the Board of Directors,

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Allergan has certain visitation rights, which include the designation of an Allergan representative to attend and observe all of our Board of Director meetings.

Collaboration With Otsuka

     Under the terms of our agreements with Otsuka:

	•		Clinical Development. Otsuka is responsible for all preclinical studies and clinical trials in support of marketing approval of Vitrase® for the treatment of vitreous hemorrhage in Japan. Otsuka is also responsible for all preclinical studies and clinical trials for regulatory approvals for additional indications including the treatment of diabetic retinopathy.
	•		Regulatory Approvals. Otsuka is responsible for applying for and obtaining regulatory approval of Vitrase® in Japan. Otsuka will also be responsible for obtaining National Health Insurance pricing approval for Vitrase® from the Japanese Ministry of Health. We will be responsible for providing Otsuka with copies of preclinical and clinical data and study reports and other documents in connection with our regulatory filings for Vitrase® in the United States.
	•		Manufacturing. We are responsible for the manufacture of Vitrase® and for the supply of all of Otsuka’s requirements for clinical trials in Japan. If approved, we will also be responsible for supplying all of Otsuka’s commercial product requirements for Vitrase® during the term of the license agreement.
	•		Marketing. Otsuka will be responsible for the overall management of marketing, sales and distribution activities for Vitrase® in Japan through its established sales and marketing organization.
	•		Milestone Payments. Otsuka paid us a non-refundable license fee as part of the license agreement. Otsuka has also agreed to pay us a milestone payment upon regulatory approval of Vitrase® for the treatment of vitreous hemorrhage in Japan. To date, we have not earned this milestone payment from Otsuka and we cannot guarantee that we will receive this milestone payment in the future.
	•		Commercial Purchase of Vitrase®. Otsuka is required to purchase Vitrase® from us at a percentage of the annual National Health Insurance price as established for Vitrase® in Japan during the term of the license agreement, unless we are unable to supply Vitrase® to Otsuka. If we are unable to supply Vitrase® to Otsuka and Otsuka, or a third party, is required to manufacture Vitrase® to meet Otsuka’s supply requirements, we will only receive a royalty on sales of Vitrase® by Otsuka.
	•		Term and Termination. Our agreements with Otsuka will terminate upon the latest of 15 full calendar years following the date of the first commercial sale of Vitrase® in Japan and the expiration date of the last-to-expire licensed patent relating to Vitrase® in Japan. Otsuka may terminate the agreements at any time with six months notice to us. We may terminate the agreements if Otsuka fails to submit an application for regulatory approval of Vitrase® in Japan within 12 months of completing all necessary clinical trials and the initial meeting with the Japanese Ministry of Health to review the clinical trial results.

Collaboration With Senju

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     Under the terms of our agreements with Senju:

	•		Clinical Development. ISTA is responsible for completing development activities for Caprogel®. We are currently conducting feasibility studies for the commercialization of Caprogel®. Once completed, and if these studies yield promising results, we intend to pursue further clinical development of Caprogel® consistent with such studies results. However, the timing and scope for our development of Caprogel® may change based on our assessment, from time to time, of this product candidate's market potential, other product opportunities and our corporate priorities.
	•		Regulatory Approvals. ISTA is responsible for the preparation and submission of an NDA to the FDA for Caprogel® assuming the successful conclusion of our clinical study efforts. All follow-up activities with the FDA for Caprogel® will be handled by ISTA.
	•		Manufacturing. ISTA will be responsible for the manufacture of Caprogel®.
	•		Marketing. ISTA will be responsible for the overall management of marketing, sales and distribution activities for Caprogel® on a worldwide basis.
	•		Royalties. The Eastern Virginia School of Medicine will receive royalty payments on all sales of Caprogel® by ISTA worldwide.
	•		Term and Termination. The license agreement with the Eastern Virginia School of Medicine will terminate upon the last-to-expire licensed patent in the United States relating to Caprogel®. ISTA may terminate the license agreement with the Eastern Virginia School of Medicine upon three months prior written notice.

Research and Development

     Since our inception, we have made substantial investments in research and development. During the years ended December 31, 2002, 2001 and 2000, we spent $14.8 million, $15.8 million and $16.2 million, respectively, on research and development activities.

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We plan to focus our near-term research and development efforts on the continued development of the products in our current development pipeline, which include Vitrase®, ISTALOL™, bromfenac and Caprogel®. Building on this pipeline, ISTA’s goal is to become a fully-integrated specialty pharmaceutical company by developing or acquiring complementary products, either already marketed or in late stage development. Some acquired products may require additional research and development activities prior to regulatory approval and commercialization.

Patents and Proprietary Rights

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

     We also file trademark applications to protect the names of our products. These applications may not mature to registration and may be challenged by third parties.

Competition

     The markets for therapies that treat diseases and conditions of the eye are subject to intense competition and technological change. Many companies, including major pharmaceutical companies and specialized biotechnology companies, are engaged in activities similar to ours. Such companies include Allergan, Inc., Alcon Laboratories, Inc., Bausch & Lomb Incorporated, CIBA Vision (a unit of Novartis AG), Pharmacia/Pfizer and Eli Lilly and Company. Many of these companies have substantially greater financial and other resources, larger research and development staffs and more extensive marketing and manufacturing organizations than ours. Many of these companies have significant experience in preclinical testing, clinical trials and other parts of the regulatory approval process.

     Should we be successful in acquiring or in-licensing currently marketed ophthalmic products, we will be subject to intense competition from major pharmaceutical companies who have extensive marketing and distribution organization and substantially greater financial resources than ours.

     We are not aware of any other drug candidates in clinical trials for the treatment of vitreous hemorrhage or hyphema. Eli Lilly and Company is currently conducting clinical trials for the use of a systemic drug to treat diabetic retinopathy, and several companies are working on drugs and systems to help control diabetes and the consequences of diabetes, including diabetic retinopathy. In addition, numerous companies are working on alternate therapies for ocular inflammation and glaucoma.

     Our success will depend, in part, on our ability to:

	•		demonstrate the safety and efficacy of our products
	•		obtain regulatory approval in a timely manner
	•		demonstrate potential advantages over alternative treatment methods

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	•		effectively market and distribute our products, either through our collaborators or by establishing and enhancing our own resources in these areas
	•		obtain reimbursement coverage from insurance companies and other third-party payers
	•		demonstrate cost-effectiveness
	•		obtain patent protection and effectively enforce our patent rights

Marketing and Sales

     We plan to market and distribute ISTALOL™, bromfenac and Caprogel® in the United States through our own resources. We will therefore need to establish our own sales, marketing and distribution capabilities. We will need to devote significant financial and management resources to develop such sales, marketing and distribution capabilities.

Third-party Reimbursement

     In the United States, physicians, hospitals and other healthcare providers that purchase pharmaceutical products generally rely on third-party payers, principally private health insurance plans and Medicare and, to a lesser extent, Medicaid, to reimburse all or part of the cost of the product and procedure for which the product is being used. We expect that patients with a vitreous hemorrhage who are candidates for Vitrase® treatment will include, primarily due to demographic factors, patients with health insurance coverage provided by Medicare and private insurers, including Medicare health maintenance organizations. Currently, a Medicare reimbursement code has been established for the intravitreal injection of a pharmaceutical agent, which, we believe, will be appropriate for physician billing for a Vitrase® injection. Hospitals and physicians are reimbursed separately for drugs. Typically, the Health Care Financing Administration, or HCFA, the governmental agency responsible for Medicare reimbursement policy, does not issue national coverage guidelines for individual drugs. Drug specific coverage policies are primarily developed by individual health insurance companies following Medicare’s criteria for drug coverage, which include, among other requirements, that the drug be FDA approved, be used in connection with a physician service and be medically reasonable for the treatment of an illness or injury. While reimbursement may be available under existing payment codes for miscellaneous injectable drugs, each Medicare health insurance provider reviews such reimbursement requests separately. Widespread and uniform reimbursement for our injectable drug products will require the establishment of a specific reimbursement code for the injectable drug, which is issued by HCFA following review of an application by the manufacturer. To support our applications for reimbursement coverage with Medicare and other major third-party payers, we intend to use data from clinical trials, including Phase III and Phase IV clinical trials, to demonstrate the clinical utility and potential economic benefits of using Vitrase® for the treatment of vitreous hemorrhage. The lack of satisfactory reimbursement for our drug products will limit their widespread use and lower potential product revenues.

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

Government Regulation

     Our pharmaceutical products are subject to extensive government regulation in the United States. If we distribute our products abroad, these products will also be subject to extensive foreign government regulation. In the United States, the FDA regulates

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pharmaceutical products. FDA regulations govern the testing, manufacturing, advertising, promotion, labeling, sale and distribution of our products.

     The FDA approval process for drugs includes:

	•		preclinical studies
	•		submission of an Investigational NDA for clinical trials
	•		adequate and well-controlled human clinical trials to establish the safety and efficacy of the product
	•		submission of a NDA
	•		review of the NDA
	•		inspection of the facilities used in the manufacturing of the drug to assess compliance with the current Good Manufacturing Practices regulations

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

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

     Preclinical studies include laboratory evaluation of the product, as well as animal studies to assess the potential safety and effectiveness of the product. These studies must be performed according to good laboratory practices. The results of the preclinical studies, together with manufacturing information and analytical data, are submitted to the FDA as part of the Investigational New Drug Application (“IND”). Clinical trials may begin 30 days after the IND is received, unless the FDA raises concerns or questions about the conduct of the clinical trials. If concerns or questions are raised, the IND sponsor and the FDA must resolve any outstanding concerns before clinical trials can proceed. We cannot assure you that submission of an IND will result in authorization to commence clinical trials. Nor can we assure you that if clinical trials are approved, that data will result in marketing approval.

     Clinical trials involve the administration of the product that is the subject of the trial to volunteers or patients under the supervision of a qualified principal investigator. Furthermore, each clinical trial must be reviewed and approved by an independent institutional review board at each institution at which the study will be conducted. The institutional review board will consider, among other things, ethical factors, the safety of human subjects and the possible liability of the institution. Also, clinical trials must be performed according to good clinical practices. Good clinical practices are enumerated in FDA regulations and guidance documents.

     Clinical trials typically are conducted in three sequential phases: Phases I, II and III, with Phase IV studies conducted after approval and generally required for drugs subject to accelerated approval regulations. These phases may overlap. In Phase I clinical trials, the drug is usually tested on healthy volunteers to determine:

	•		safety
	•		any adverse effects
	•		dosage tolerance
	•		absorption
	•		metabolism
	•		distribution
	•		excretion

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•

other drug effects

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

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

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

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

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

Food and Drug Administration Modernization Act of 1997

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

	•		post-approval studies and follow-up to validate the surrogate endpoint or confirm the effect on the clinical endpoint
	•		prior review of all promotional materials

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

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

	•		seven years of exclusive marketing upon FDA approval
	•		tax credit for clinical research expense
	•		grant support for investigation of rare disease treatments
	•		user fee waiver

International

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

Manufacturing

     We have supply agreements with Bausch & Lomb Incorporated to manufacture commercial quantities of ISTALOL™ and bromfenac. Under the terms of the agreements, Bausch & Lomb will manufacture, package and perform certain manufacturing quality assurance and quality control tests on the two products in accordance with specifications provided by the Company. Currently, Bausch & Lomb is our sole source for ISTALOL™ and bromfenac. We are seeking additional manufacturing sources for these products.

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Human Resources

     As of February 18, 2003, we had 39 full-time employees. Approximately 32 of our employees are involved in research and clinical development activities. Six of our employees hold Ph.D. or M.D. degrees and eight other employees hold other advanced degrees. Our employees do not have a collective bargaining agreement. We consider our relations with our employees to be good.

General Information

     We incorporated in California in February 1992 as Advanced Corneal Systems, Inc. In March 2000, we changed our name to ISTA Pharmaceuticals, Inc. and we reincorporated in Delaware in August 2000. Our corporate headquarters and principal research laboratories are located at 15279 Alton Parkway, Building 100, Irvine, California 92618, and our telephone number is (949) 788-6000. Vitrase®, ISTALOL™, Caprogel®, ISTA, ISTA Pharmaceuticals and the ISTA logo are our trademarks.

     We maintain an Internet website at www.istavision.com where our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports are available without charge, as reasonably practicable following the time they are filed with or furnished to the SEC.

RISK FACTORS

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

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

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

     The NDA process is extensive, time-consuming and costly, and there is no guarantee that regulatory authorities will approve NDAs of any of our product candidates. We have submitted NDAs which are currently pending before the FDA for both Vitrase® and for ISTALOL™. Moreover, we depend on the assistance of Senju Pharmaceuticals for obtaining regulatory approval for ISTALOL™.

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

	•		FDA officials may not find a product candidate safe or effective to merit an approval
	•		FDA officials may not find that the data from preclinical testing and clinical trials justifies approval, or they may require additional studies that would make it commercially unattractive to continue pursuit of approval

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	•		the FDA might not approve our manufacturing processes or facilities, or the processes or facilities of our contract manufacturers or raw material suppliers
	•		the FDA may change its approval policies or adopt new regulations
	•		the FDA may approve a product candidate for indications that are narrow or under conditions that place our product at a competitive disadvantage, which may limit our sales and marketing activities or otherwise adversely impact the commercial potential of a product

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

If our product candidates are approved by the FDA but do not gain market acceptance, our business will suffer because we might not be able to fund future operations.

     A number of factors may affect the market acceptance of Vitrase®, ISTALOL™, bromfenac, Caprogel® or any other products we develop or acquire in the future, including, among others:

	•		the price of our products relative to other therapies for the same or similar treatments
	•		the perception by patients, physicians and other members of the health care community of the effectiveness and safety of our products for their prescribed treatments
	•		our ability to fund sales and marketing departments
	•		the effectiveness of our sales and marketing efforts

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

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

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We may be unable to execute our strategic plan to transition to a fully-integrated specialty pharmaceutical company, which could have a material adverse impact on our business and financial condition.

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

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

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

	•		our patents and pending patent applications use technology that we invented first
	•		we were the first to file patent applications for these inventions
	•		others will not independently develop similar or alternative technologies or duplicate our technologies
	•		any of our pending patent applications will result in issued patents

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     We may become involved in interference proceedings in the U.S. Patent and Trademark Office to determine the priority of our inventions. In addition, costly litigation could be necessary to protect our patent position. We also rely on trademarks to protect the names of our products. These trademarks may be challenged by others. If we enforce our trademarks against third parties, such enforcement proceedings may be expensive. We also rely on trade secrets, unpatented proprietary know-how and continuing technological innovation that we seek to protect with confidentiality agreements with employees, consultants and others with whom we discuss our business. Disputes may arise concerning the ownership of intellectual property or the applicability or enforceability of these agreements, and we might not be able to resolve these disputes in our favor.

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

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

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

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

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

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

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

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Our stock price is subject to significant volatility.

	•		the scope, outcome and timeliness of any governmental, court or other regulatory action that may involve us (including, without limitation, the scope, outcome or timeliness of any inspection or other action of the FDA)
	•		the availability to us, on commercially reasonable terms, of third party sourced products and materials
	•		developments concerning proprietary rights, including the ability of third parties to assert patents or other intellectual property rights against us which, among other things, could cause a delay or disruption in the development, manufacture, marketing or sale of our products
	•		competitors announcing products under development or new commercial products
	•		competitors publicity regarding actual or potential products under development
	•		period-to-period fluctuations in our financial results
	•		economic and other external factors, including disasters and other crises

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

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

     The average daily trading volume in our common stock for the twelve-month period ending December 31, 2002 was approximately 1,872 shares, and the average daily number of transactions was approximately 65 for the same period. If limited trading in our stock continues, it may be difficult for investors to sell their shares in the public market at any given time at prevailing prices.

Future sales of shares of our common stock, including sales of shares following the expiration of “lock-up” arrangements, may negatively affect our stock price.

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     Sales of substantial amounts of shares of our common stock, or even the potential for such sales, could lower the market price of our common stock and impair our ability to raise capital through the sale of equity securities.

Concentration of ownership could delay or prevent change in control or otherwise influence or control most matters submitted to our stockholders.

     Our directors, officers, and principal stockholders together control approximately 89.0% of our voting securities, a concentration of ownership that could delay or prevent a change in control. Our executive officers and directors beneficially own approximately 2.5% of our voting securities and our 5% or greater stockholders beneficially own approximately 86.5% of our voting securities. These stockholders, if acting together, would be able to influence and possibly control most matters submitted for approval by our stockholders, including the election of directors, delaying or preventing a change of control, and the consideration of transactions in which stockholders might otherwise receive a premium for their shares over then-current market prices.

	•		a classified board of directors,
	•		the ability of the board of directors to designate the terms of and issue new series of preferred stock,
	•		advance notice requirements for nominations for election to the board of directors, and
	•		special voting requirements for the amendment of our charter and bylaws.

Item 2: Properties

     We currently lease two facilities, which approximate 19,000 square feet of laboratory and office space in Irvine, California. The current term of the first lease expires September 2004. The current term of our second lease expires June 2005. We believe that these two facilities are adequate for our immediate needs. Additional space will be required, however, as we expand our research and clinical development, manufacturing and selling and marketing activities. We do not foresee any significant difficulties in obtaining any required additional facilities close to our current facility.

Item 3: Legal Proceedings

     From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. We currently are not a party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on our results of operations or financial position.

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

     Set forth below is information concerning each matter submitted to a vote at a Special Meeting of Stockholders on November 11, 2002.

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     Proposal No. 1: The stockholders approved the terms of the Company’s private placement of $40.0 million of its common stock at a price of $0.38 per share and warrants exercisable for $6.0 million of common stock to investors at a price of $0.38 per share (with 8,782,645 affirmative votes, 478,164 votes against, 49,163 votes abstaining, and no broker non-votes).

     Proposal No. 2: The stockholders approved the full conversion of promissory notes issued in the Company’s bridge financing to investors for shares of the Company’s common stock (with 8,797,880 affirmative votes, 465,434 votes against, 46,658 votes abstaining, and no broker non-votes).

     Proposal No. 3: The stockholders approved an amendment to the Company’s current amended and restated certificate of incorporation to effect a reverse split of the Company’s common stock of not less than 1-for-7 and not more than 1-for-10, with the Company’s board of directors having the authority to determine which, if any, of those reverse stock splits to effect within those parameters (with 8,741,923 affirmative votes, 528,811 votes against, 39,238 votes abstaining, and no broker non-votes).

     Proposal No. 4: The stockholders did not approve an amendment to the Company’s current amended and restated certificate of incorporation to permit stockholders to act by written consent in lieu of a meeting. This proposition required affirmative votes equaling half of the total shares outstanding, or 9,309,972 affirmative votes (with 8,802,212 affirmative votes, 476,856 votes against, 30,904 votes abstaining, and no broker non-votes).

     Proposal No. 5: The stockholders approved an increase in the number of shares reserved for issuance pursuant to the Company’s 2000 Stock Plan by a total of 25.0 million shares (with 6,937,089 affirmative votes, 2,324,429 votes against, 48,454 votes abstaining, and no broker non-votes).

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PART II

Item 5: Market for Registrant’s Common Equity and Related Stockholder Matters

Price Range of Common Stock

     Our common stock began trading on the Nasdaq National Market under the symbol “ISTA” on August 21, 2000. Prior to this date, there was no public market for our common stock. Our common stock was affected by a 1-for-10 reverse stock split, which became effective at the close of trading on November 13, 2002. The following table presents high and low sales prices of our common stock, on a post split basis, as reported on the Nasdaq National Market, for the periods indicated since our initial public offering:

Holders of Common Stock

     As of February 18, 2003, there were approximately 140 shareholders of record of our common stock based upon the records of our transfer agent which do not include beneficial owners of common stock whose shares are held in the names of various securities brokers, dealers and registered clearing agencies.

Dividend Policy

     We have never declared or paid any cash dividends on our common stock and do not intend to pay any cash dividends on our common stock in the foreseeable future.

Use of Proceeds of Our Initial Public Offering

     On August 25, 2000 we completed our initial public offering of 300,000 shares of common stock at an initial public offering price of $105.00 per share with gross proceeds of $31,500,000. Net proceeds, after a 7% underwriters discount, were $29,295,000. Additional expenses relating to the initial public offering, other than the underwriters discount, amounted to $1,918,000. The managing underwriters for the offering were CIBC World Markets, Prudential Vector Healthcare and Thomas Weisel Partners LLC. The shares of common stock sold in the offering were registered on Form S-1, as amended (File No. 333-34120).

     In September 2000, the underwriters exercised their over-allotment option for an additional 45,000 shares of common stock at the initial public offering price of $105.00, less a 7% discount, resulting in net proceeds of $4,394,000.

     To date, the net proceeds from our initial public offering were used to fund our clinical trials and preclinical research, with a particular focus on Vitrase® for the treatment of vitreous hemorrhage, and for general corporate purposes, including working capital. None of the net offering proceeds of our initial public offering have been or will be paid directly or indirectly to any director, officer,

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general partner of ISTA or their associates, persons owning more than 10% or more of any class of ISTA’s equity securities or an affiliate of ISTA.

Recent Sales of Unregistered Securities

     In December 2001, we completed the private placement of 84,567 shares of common stock at a price of $47.30 per share as part of our collaboration with Otsuka Pharmaceuticals, Co. Ltd. for the rights for Vitrase® in Japan.

Item 6: Selected Financial Data

     The following selected financial data are derived from the consolidated financial statements of the Company. The data should be read in conjunction with the consolidated financial statements, related notes, and other financial information included herein.

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Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This Annual Report on Form 10-K contains forward-looking statements that have been made pursuant to the provisions of the Securities Litigation Act of 1995 and concern matters that involve risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Discussions containing forward-looking statements may be found in the material set forth under “Business,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in other sections of this Form 10-K. Words such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue” or similar words are intended to identify forward-looking statements, although not all forward-looking statements contain these words. Although we believe that our opinions and expectations reflected in the forward-looking statements are reasonable as of the date of this Report, we cannot guarantee future results, levels of activity, performance or achievements, and our actual results may differ substantially from the views and expectations set forth in this Report. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations. Readers are urged to carefully review and consider the various disclosures made by us, which attempt to advise interested parties of the risks, uncertainties, and other factors that affect our business, set forth in detail in Item 1 of Part I, “Business-Risk Factors.”

     The following discussion and analysis should be read in conjunction with the consolidated financial statements and the notes to those statements filed as part of this report.

Overview

     ISTA Pharmaceuticals, Inc. (the “Company” or “ISTA”) is a development-stage specialty pharmaceutical company focused on the development and commercialization of new remedies for diseases and conditions of the eye. Since the Company’s inception, we have devoted our resources primarily to fund research and development programs and late-stage product acquisitions. In December 2001, we announced our strategic plan to transition from a development organization to a fully-integrated, specialty pharmaceutical company with a primary focus on ophthalmology by acquiring complementary products, either already marketed or in late stage development.

     In order to advance our strategic plan, we are pursuing the development of several products, including, Vitrase® and ISTALOL™, which are in the later stages of review by the FDA. There can be no assurances that either Vitrase® or ISTALOL™ will receive final FDA approval. However, we are currently undertaking significant preparations for expansion of its manufacturing and marketing capabilities in the event such approvals are obtained. If approved by the FDA, Vitrase® will be manufactured for us through our contract manufacturer and marketed by Allergan in the United States, while ISTALOL™ will be manufactured for us through our contract manufacturer and marketed by us in the United States.

     We have incurred losses since inception and had an accumulated deficit through December 31, 2002 of $122.4 million. Our losses have resulted primarily from research and development activities, including clinical trials, related general and administrative expenses and a deemed dividend to our preferred shareholders. We expect to continue to incur operating losses for the foreseeable future as we continue to conduct research, development and clinical testing activities, and to seek regulatory approval for our product candidates.

Vitrase®

     Our current lead product candidate is Vitrase®, which is derived from highly purified formulations of ovine hyaluronidase.

     In March 2002, we announced the preliminary results for our Phase III clinical studies of Vitrase®. Although the data from the two Phase III studies did not show a statistically significant improvement in the primary (surrogate) endpoint, further analysis has shown

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that for a 55 IU dose of Vitrase®, in both studies, there was a clinically meaningful and statistically significant decrease in the density of vitreous hemorrhage. A statistically significant difference in the proportion of patients with an improvement in best-corrected visual acuity at one and two months was also shown, which extended to three-month post-treatment visits in a clinical study conducted outside North America.

     Based on these improvements in visual function, and our review and discussions with the Food and Drug Administration (“FDA”) regarding the data from the two studies, we submitted the clinical section and the chemistry, manufacturing and controls (“CMC”) section of the New Drug Application (“NDA”) for Vitrase® to the FDA in October 2002. The FDA accepted those sections of the Vitrase® NDA for review in December 2002, along with the pre-clinical pharmacology and toxicology section that was submitted in January 2002. On April 3, 2003, the FDA issued an “approvable” letter in which the FDA cited issues primarily related to the sufficiency of the efficacy data submitted with the NDA for Vitrase®. The FDA requested additional analysis of the existing data and an additional confirmatory clinical study based upon that analysis. We intend to discuss with the FDA the comments contained in the “approvable” letter and, based upon those discussions, determine the next appropriate steps in the review and approval process of Vitrase®.

     Thus, significant research and development efforts and expenses with respect to Vitrase® have been incurred over the last three years, and we have now completed Phase III clinical trials for Vitrase® for the treatment of vitreous hemorrhage. We are currently in the process of scaling up our manufacturing operations to support commercialization of Vitrase® in the event the FDA approves all components of our Vitrase® NDA.

     In March 2000, we entered into a collaboration with Allergan, Inc., under which Allergan will be responsible for the marketing, sale and distribution of Vitrase® in the United States and all international markets except Mexico (until April 2004) and Japan. Accordingly, we depend on the success of Allergan in commercializing Vitrase® in these markets. Our principal sources of revenue from this collaboration will be milestone, royalty and profit-sharing payments received from Allergan. Under the terms of the collaboration, we are responsible for the manufacture of Vitrase® and for supplying all of Allergan’s requirements for Vitrase®. If we are successful in obtaining regulatory approval for Vitrase® and providing adequate supplies to Allergan, and Allergan subsequently achieves significant sales of the product, we may receive substantial royalties and other payments from Allergan; however, our aggregate manufacturing costs may also increase.

     In December 2001, we entered into a collaboration with Otsuka Pharmaceuticals Co. Ltd., a leading Japan-based international health care and pharmaceuticals company. Under the terms of the collaboration, Otsuka will be responsible for all clinical development, regulatory approvals, sales and marketing activities for Vitrase® in Japan, and we will be responsible for supplying all of Otsuka’s requirements for Vitrase®. Our principal sources of revenue from this collaboration will be license fees and milestone payments from Otsuka.

     Currently, we rely upon a third party to supply us with ovine hyaluronidase, the active pharmaceutical ingredient in Vitrase®, and we rely on a contract manufacturer to supply us with the finished Vitrase® product. Each of these parties is the sole source. Since Vitrase® has not received FDA approval, neither party has past experience in supplying us with commercial quantities of Vitrase®.

     The Company acquired the rights to these three compounds in exchange for $290,000 and 10,000 shares of the Company’s common stock valued at $99,000 ($9.90 per share). Additionally, the Company assumed the liabilities of two milestone payments to Senju ($750,000 and $500,000), a milestone payment to the Eastern Virginia School of Medicine ($65,000), legal expenses associated with the acquisition ($20,000) and a patent application fee for Caprogel® ($4,500). As of the date these compounds were acquired, they had not achieved feasibility and there is no significant alternative future use should the Company’s development efforts prove unsuccessful. Accordingly, the Company recorded an acquired in-process research and development charge of $1,728,500 in May 2002 related to the purchase of these compounds.

     The NDA for ISTALOL™ was submitted by Senju to the FDA in September 2002. The NDA included data from pre-clinical studies conducted in Japan, combined with data from a Phase I clinical study conducted in the United States and a multi-center Phase III clinical study recently completed in the United States. We are currently initiating a Phase III study of bromfenac in the United States. Assuming successful completion of our clinical studies, we anticipate submitting an NDA for bromfenac in early 2004. We are currently conducting feasibility studies for the commercialization of Caprogel®. Once completed, and if these studies yield promising results, we intend to pursue further clinical development of Caprogel® consistent with such studies’ results. However, the timing and scope for our development of Caprogel® may change based on our assessment, from time to time, of this product candidate’s market potential, other product opportunities and our corporate priorities.

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ISTALOL™

     In May 2002, we acquired substantially all of the assets of AcSentient, Inc. The assets include United States marketing rights for a new formulation of timolol, which we have named ISTALOL™, a beta-blocking agent for treating glaucoma. AcSentient previously acquired rights to this compound from Senju Pharmaceutical Co., Ltd., headquartered in Osaka, Japan. Senju has a diverse product portfolio including ophthalmic, central nervous system, cardiovascular, circulatory, gastro-intestinal, respiratory, oncology and dermatological products.

     Our acquisition of ISTALOL™ was consistent with our strategic objective of acquiring complementary late-stage product candidates. Senju submitted the NDA for ISTALOL™ to the FDA in September 2002. That NDA included data from pre-clinical studies conducted in Japan, combined with data from a Phase I clinical study conducted in the United States and a multi-center Phase III clinical study recently completed in the United States.

     If the FDA approves all components of the ISTALOL™ NDA, we believe that we will be positioned to commercialize ISTALOL™ in the United States, and to thereby further broaden our specialty ophthalmic pharmaceutical product offerings.

Emerging Product Candidates

     The assets acquired from AcSentient also include United States product rights to bromfenac, a topical non-steroidal anti-inflammatory compound for the treatment of ocular inflammation, and worldwide marketing rights for Caprogel®, a novel compound for the treatment of hyphema, or bleeding into the front of the eye. AcSentient had previously acquired the rights to these two compounds from Senju and the Eastern Virginia School of Medicine, respectively. Under the terms of the AcSentient asset acquisition, we are responsible for payments and other obligations connected with further development of bromfenac and Caprogel®.

     We are currently initiating a Phase III study of bromfenac in the United States. Assuming successful completion of our clinical studies, we anticipate submitting an NDA for bromfenac in early 2004.

     We are currently conducting feasibility studies for the commercialization of Caprogel®. Once completed, and if these studies yield promising results, we intend to pursue further clinical development of Caprogel® consistent with such studies’ results. However, the timing and scope for our development of Caprogel® may change based on our assessment, from time to time, of this product candidate’s market potential, other product opportunities and our corporate priorities.

     We anticipate incurring additional research and development expenses in connection with the further development of bromfenac and Caprogel®. If these compounds are approved for sale in the United States, we expect to incur significant additional marketing and sales expenses in establishing and supporting the necessary infrastructure to market and distribute these products in the United States.

Critical Accounting Policies & Estimates

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

     We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the

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valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.

     Our discussion and analysis of our financial condition and results of operations are based upon the Company’s consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from these estimates.

Results of Operations

Years Ended December 31, 2002, 2001 and 2000

     The following discussion of our results of operations generally reflects our continuing transition from a development-stage company to a fully-integrated specialty pharmaceuticals company with a primary focus on ophthalmology.

     Revenue. Revenue of $278,000 for 2002 reflects the amortization for the period of deferred revenue recorded in December 2001 for the $5.0 million license fee payment made by Otsuka Pharmaceuticals, Co. Ltd. in connection with the license for Vitrase® in Japan.

     Research and development expenses. Research and development expenses were $14.8 million in 2002, $15.8 million in 2001 and $16.2 million in 2000. Our research and development expenses to date have consisted primarily of costs associated with the clinical trials of our product candidates, compensation and other expenses for research and development personnel, costs for consultants and contract research organizations and costs related to the development of commercial scale manufacturing capabilities for Vitrase®.

     We generally classify and separate research and development expenditures into amounts related to preclinical research, clinical development and manufacturing development. We have not tracked our historical research and development costs by specific project; rather, we track costs by the type of cost incurred.

     In 2002, approximately 34% of our research and development expenditures were for preclinical research, approximately 55% was spent on clinical development and approximately 11% was spent on manufacturing development. Research and development expenses decreased to $14.8 million in 2002 from $15.8 million in 2001. Changes in our research and development expenses are primarily due to the following:

	•		Clinical Development Costs — Overall clinical costs for 2002 decreased by $4.9 million from 2001. The decrease in clinical costs in 2002 was due to the completion of our Phase III clinical trials for Vitrase® for the treatment of vitreous hemorrhage. As a result, our overall clinical costs, which include clinical investigator fees, study monitoring costs and data management, decreased in 2002 as compared to 2001.
	•		Personnel Costs — Personnel costs, including outside consultant expenses, for 2002 increased by $2.0 million from 2001. The increase is primarily attributable to expenses for consultants to assist us with clinical data compilation, review and analysis in preparation of the filing of the NDA for Vitrase® for the treatment of vitreous hemorrhage.
	•		Direct Research Costs — Research costs for 2002 increased by $1.5 million from 2001. This increase is principally attributable to the acquisition of three late-stage development compounds. The costs associated with the purchase ($1.7 million) were immediately expensed as in-process research and development costs because there were no alternative future uses and did not otherwise quality for capitalization.
	•		Manufacturing Development Costs — Contract manufacturing costs for 2002 increased by $400,000 from 2001. The increase in manufacturing development costs was due to increased activities in connection with the preparations for commercial scale manufacture of the active pharmaceutical ingredient in Vitrase® at Biozyme and pre-production activities by Cardinal Health.

     We anticipate that our research and development expenses for 2003 will be substantially the same that we incurred in 2002, and will be focused primarily on further research and development of Vitrase®, ISTALOL™, bromfenac and Caprogel®.

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     In the event that Vitrase® and/or ISTALOL™ are approved by the FDA in 2003, our selling, general and administrative expenses will likely increase substantially as compared to 2002 to support the commercialization of these product candidates.

     Stock-based compensation. Deferred compensation for stock options granted to employees and directors is the difference between the exercise price and the estimated fair value of the underlying common stock for financial reporting purposes on the date the options were granted. Deferred compensation is included as a component of stockholders’ equity and is being amortized in accordance with

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Statement of Financial Accounting Standard, (SFAS), Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans”, over the vesting period of the related options, which is generally four years.

     Compensation for stock options granted to non-employees has been determined in accordance with SFAS No. 123, “Accounting for Stock-Based Compensation”, and Emerging Issues Task Force (“EITF”) Consensus No. 96-18, “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services”, as the fair value of the equity instrument issued and is periodically re-measured as the underlying options vest. Stock option compensation for non-employees is recorded as the related services are rendered and the value of compensation is periodically re-measured as the underlying options vest.

     For the year ended December 31, 2002, we granted stock options to employees to purchase 1,773,670 shares of common stock at a weighted average exercise price of $3.80 per share, equal to fair market value at the time of issuance. However, in previous years, we had granted stock options to employees with a grant price less than the fair market value at the date of grant. Therefore, we anticipate recording deferred compensation expense of approximately $920,000, $374,000 and $96,000 for the years ended December 31, 2003, 2004 and 2005 respectively, related to these option grants.

     In connection with the grant of stock options to employees and directors, we recorded deferred compensation of approximately $93,000, $2,960,000 and $3,535,000 during the years ended December 31, 2002, 2001 and 2000, respectively, and recorded amortization of $2,160,000, $1,902,000 and $3,165,000 during the years ended December 31, 2002, 2001 and 2000, respectively.

     Interest income. Interest income was $213,000 in 2002, $826,000 in 2001 and $848,000 in 2000. The decrease in interest income in 2002 is primarily attributable to lower average cash balances on hand as compared to 2001. The decrease in interest income in 2001 over the prior year was primarily attributable to forgiveness of $46,000 in accrued interest relating to a loan made to a former Company officer, who resigned in 2001. We anticipate interest income to be higher in 2003 as compared to 2002 due to higher average cash balances in our short-term investment portfolio.

     Deemed dividend. During the year ended December 31, 2000, we acquired Visionex and accounted for the acquisition under the purchase method of accounting. At the time of the acquisition, we recorded $4.4 million of tangible assets acquired and recognized a deemed dividend of $19.2 million for the excess of the extended value of the shares issued over the net tangible assets acquired.

     Income taxes. We incurred net operating losses in 2002, 2001 and 2000 and consequently did not pay any federal, state or foreign income taxes. At December 31, 2002, we had federal and California net operating loss carryforwards of approximately $75.6 million and $67.9 million, respectively, which we have fully reserved due to the uncertainty of realization. Our federal tax loss carryforwards will begin to expire in 2008, unless previously utilized. Our California tax loss carryforwards will begin to expire in 2005. We also have federal and California research tax credit carryforwards of $3.7 million and $2.2 million, respectively. The federal research tax credits will begin to expire in 2010, unless previously utilized.

     During 2002, a change in ownership, as described in the Internal Revenue Code Section 382, did occur and will limit the ability of the Company to utilize the net operating losses and tax credit carryforwards in the future.

Quarterly Results of Operations

     The following table sets forth a summary of our unaudited quarterly operating results for each of the last eight quarters in the period ended December 31, 2002. This data has been derived from our unaudited consolidated interim financial statements which, in our opinion, have been prepared on substantially the same basis as the audited financial statements contained elsewhere in this report and include all normal recurring adjustments necessary for a fair presentation of the financial information for the periods presented. These unaudited quarterly results should be read in conjunction with our financial statements and notes thereto included elsewhere in this report. The operating results in any quarter are not necessarily indicative of the results that may be expected for any future period (in 000’s except earnings per share).

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     Research & development expenses. During 2002, our quarterly research and development expenses decreased primarily as a result of the completion of our Phase III clinical trials for Vitrase® for the treatment of vitreous hemorrhage and the deferral of other development activities relating to our other product candidates. The decrease in activity during 2002 was offset by the acquisition costs related to the three late-stage development compounds from AcSentient during May 2002. The acquisition costs were expensed immediately as in-process research and development costs. Vitrase® development activities included the collection and review of clinical data from study sites around the world, improvements in the manufacturing process of our contract manufacturers and preparations for the submission of an NDA to the FDA.

     Selling, general & administrative expenses. During 2002, our selling, general and administrative expenses increased primarily as a result of increases in personnel and operating expenses consisting of non-cash compensation associated with stock option grants, legal and accounting expenses relating to due diligence efforts for a potential acquisition, and personnel costs associated with the hiring of two additional executive employees.

     Interest income/expense (net). During the fourth quarter of 2002, our interest expense increased significantly as a result of the amortization of the fair value attributable to the warrants issued in connection with the $4.0 million bridge loan in September 2002.

Liquidity and Capital Resources

     As of December 31, 2002, we had approximately $35.7 million in cash and short-term investments and working capital of $33.0 million. We anticipate that our existing capital resources will enable us to fund operations for at least the next 12 months.

     We have financed our operations since inception primarily through private sales of our common and preferred stock and the sale of our common stock in our initial public offering. We received net proceeds of $10.0 million from the private sale of preferred stock in March 2000, $31.7 million from our initial public offering in August 2000, $4.0 million from the private sale of common stock in December 2001, $5.0 million from a license fee payment in December 2001, $4.0 million from a bridge loan in September 2002 and $37.3 million from the private sale of common stock in November 2002.

     During 2002 we used $20.9 million of cash for operations principally as a result of the net loss of $23.0 million partially offset by non-cash compensation expense of $2.2 million. In 2001, we used $13.9 million of cash for operations principally as a result of the net loss of $22.5 million partially offset by the non-cash compensation expense of approximately $1.9 million and $5.0 million in deferred income. In 2000, we used $20.8 million of cash for operations principally as a result of the net loss of $21.9 million offset by non-cash compensation expense of approximately $3.2 million.

     Net cash invested totaled $648,000 during 2002 compared to $13.4 million provided by investing activities in 2001. During 2000, $12.5 million of cash was invested. Cash used for investing activities in 2002 is primarily attributable to the purchase of short-term investments. During 2001, the cash provided by investing activities was from the sale of short-term investments to fund our research and development efforts and general operating expenses.

     Net cash provided by financing activities totaled $41.5 million during 2002 compared to $4.1 million in 2001 and $41.4 million in 2000. The increase in net cash provided by financing activities in 2002 is primarily attributable to the $4.0 million net proceeds from the issuance of a bridge loan in September 2002 and the $37.3 million net proceeds from the private sale of common stock to certain investors during November 2002, while the cash provided by financing activities in 2001 is primarily attributable to the $4.0 million net proceeds from the private sale of common stock to Otsuka during December 2001.

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     We continually evaluate new opportunities for late-stage or currently marketed complementary product candidates and, if and when appropriate, intend to pursue such opportunities through further product acquisitions and related development activities. Our ability to execute on such opportunities in some circumstances will be dependant upon our ability to raise additional capital on commercially reasonable terms. There can be no assurance that funds from these sources will be available when needed or, if available, will be on terms favorable to us or to our stockholders. If additional funds are raised by issuing equity securities, the percentage ownership of our stockholders will be reduced, stockholders may experience additional dilution or such equity securities may provide for rights, preferences or privileges senior to those of the holders of our common stock.

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

	•		receiving milestone payments from Allergan and Otsuka
	•		the rate of progress of our research and development programs
	•		the results of our clinical trials and requirements to conduct additional clinical trials
	•		the time and expense necessary to obtain regulatory approvals
	•		activities and payments in connection with the in-license or acquisition of products
	•		our ability to establish and maintain collaborative relationships
	•		sales and marketing activities related to each of ISTALOL™, bromfenac and Caprogel®
	•		competitive, technological, market and other developments

Visionex

     Visionex was established in 1997, under the laws of Singapore, to engage in clinical, regulatory and marketing activities. During 1997, Visionex obtained from us the exclusive rights to register, import, market, sell and distribute Vitrase® and a product called Keraform® in East Asian markets, excluding Japan and Korea, for which Visionex paid us $5.0 million. Prior to our acquisition of Visionex (discussed below), investors who owned 66% of ISTA shares controlled 100% of Visionex shares.

     On March 8, 2000, we acquired Visionex by entering into an agreement with Visionex shareholders whereby we issued 3,319,363 shares of our Series C preferred stock, convertible into 245,879 shares of our common stock, to acquire all of the outstanding capital stock of Visionex. We assigned a fair value of $11.70 per share to the 3,319,363 shares of Series C preferred stock issued to effect the acquisition, at which time we recorded a deemed dividend of $19.2 million to recognize the excess of the value of the shares issued over the net assets acquired.

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Recently Issued Accounting Standards

     In June 2001, the FASB issued SFAS No. 141, “Business Combinations”, and SFAS No. 142, “Goodwill and Other Intangible Assets”. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Use of the pooling-of-interest method is no longer permitted. SFAS No. 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets acquired in a business combination that is completed after June 30, 2001. SFAS No. 142 no longer permits the amortization of goodwill and indefinite-lived intangible assets. Instead, these assets must be reviewed annually (or more frequently under certain conditions) for impairment in accordance with this statement. This impairment test uses a fair value approach rather than the undiscounted cash flows approach previously required by SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of”. The amortization of goodwill included in investments in equity will also no longer be recorded upon adoption of the new rules. Intangible assets that do not have indefinite lives will continue to be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 121. Upon adoption on January 1, 2002, SFAS No. 142 did not have a material effect on our financial position or results of operations.

     In October 2001, the FASB issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, which establishes one accounting model to be used for long-lived assets to be disposed of by sale and broadens the presentation of discontinued operations to include more disposal transactions. SFAS No. 144 supercedes SFAS No. 121 and the accounting and reporting provisions of Accounting Principles Board (“APB”) Opinion No. 30, “Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions”. Upon adoption in January 2002, SFAS No. 144 did not have a material effect on our financial position or results of operations.

     In July 2002, FASB issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities”. The statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies EITF Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS 146 requires that a liability for costs associated with an exit or disposal activity be recognized when a liability is incurred. Under EITF 94-3, a liability for an exit cost as generally defined in EITF 94-3 was recognized at the date of an entity’s commitment to an exit plan. The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002; however, earlier adoption is permissible. We do not intend to early adopt SFAS 146 and we do not believe adoption will have a material impact on our operations or financial position.

     In November 2002, the EITF reached consensus on EITF 00-21, “Accounting for Revenue Arrangements with Multiple Deliverables,” which addresses how to account for arrangements that may involve the delivery or performance of multiple products, services, and/or rights to use assets. The final consensus of EITF 00-21 will be applicable to agreements entered into in fiscal periods beginning after June 15, 2003, with early adoption permitted. Additionally, companies will be permitted to apply the consensus guidance to all existing arrangements as the cumulative effect of a change in accounting principle in accordance with APB Opinion No. 20, “Accounting Changes”. Management is currently evaluating the effect that the adoption of EITF 00-21 will have on its results of operations and financial position.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 is an amendment to SFAS No. 123 providing alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and also provides additional disclosures about the method of accounting for stock-based employee compensation. Amendments are effective for financial statements for the Company beginning January 1, 2003. The Company has currently chosen to not adopt the voluntary change to the fair value based method of accounting for stock-based employee compensation. If the Company should choose to adopt such a method, its implementation pursuant to SFAS No. 148 could have a material effect on the Company’s consolidated financial position and results of operations.

Item 7A: Quantitative and Qualitative Disclosures about Market Risk

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

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increases in interest rates over time will increase our interest expense. Historically, and as of December 31, 2002, we have not used derivative instruments or engaged in hedging activities.

     We have operated primarily in the United States and have had no sales to date. Accordingly, we have not had any significant exposure to foreign currency rate fluctuations. Visionex’s functional currency is the Singapore dollar and a portion of Visionex’s business was conducted in currencies other than the Singapore dollar prior to the successful wind down of operations in July 2002. As a result, currency fluctuations between the Singapore dollar and the currencies in which Visionex had done business will cause foreign currency translation gains and losses. We do not expect our foreign currency translation gains or losses to be material. We do not currently engage in foreign exchange hedging transactions to manage our foreign currency exposure.

Item 8: Financial Statements and Supplemental Data

     The consolidated financial statements and supplementary data required by this item are set forth on the pages indicated in Item 15 (a).

Item 9: Changes and Disagreements with Accountants and Financial Disclosure

     None.

PART III

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     The following table sets forth the names, ages and positions of our executive officers:

     Vicente Anido, Jr., Ph.D. has served as our as President and Chief Executive Officer since December 2001. From June 2000 to September 2001, Dr. Anido was general partner for Windamere Venture Partners. From 1996 to 1999, Dr. Anido served as President and Chief Executive Officer of CombiChem, Inc., a biotechnology company. From 1993 to 1996, he served as President of the Americas Region of Allergan, Inc. Dr. Anido received a Ph.D. in Pharmacy Administration from the University of Missouri.

     William S. Craig, Ph.D. has served as our Vice President, Research and Product Development since March 2001. From 1996 to December 1999, Dr. Craig was Vice President, Research and Development for Alpha Therapeutics Corporation, a biotechnology company. From 1988 to 1996 he was Senior Director Research and Development for Telios Pharmaceuticals, Inc., a biotechnology company. Dr. Craig received a Ph.D. in Chemistry from the University of California, San Diego.

     Marvin J. Garrett has served as our Vice President, Regulatory Affairs, Quality & Compliance since February 1999. From May 1994 to May 1999, Mr. Garrett was Vice President, Regulatory Affairs and Clinical Research for Xoma. From 1990 to 1994, he was President and General Manager of Coopervision Pharmaceutical; a division of the Cooper Companies, Inc. Mr. Garrett received a B.S. in Microbiology from California State University Long Beach.

     Lisa R. Grillone, Ph.D. has served as our Vice President, Clinical Research and Medical Affairs since August 2000. From 1990 to July 2000, Dr. Grillone served in various drug development positions with ISIS Pharmaceuticals, Inc., last serving as Executive Director, Intellectual Property Licensing. Dr. Grillone received a Ph.D. in Cell Biology and Anatomy from New York University.

     Kirk McMullin has served as Vice President, Operations since August 2002. From 1995 to 2002, Mr. McMullin was Vice President, Worldwide Manufacturing Support for Allergan, Inc., a specialty pharmaceutical company focusing on ophthalmology, dermatology and neuromuscular indications. Mr. McMullin received a B.A. from Humboldt State University.

     Thomas A. Mitro has served as our Vice President, Sales & Marketing since July 2002. From 1980 to 2002, Mr. Mitro held several positions at Allergan, Inc. including Vice President, Skin Care, Vice President, Business Development and Vice President, e-Business. Allergan, Inc. is a specialty pharmaceutical company focusing on ophthalmology, dermatology and neuromuscular indications. Mr. Mitro received a B.S. degree from Miami University.

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