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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

  For Fiscal Year Ended December 31, 2003

or

  From the transition period from                     to                     

Commission file number 000-31255

ISTA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

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 30, 2003, the aggregate market value of the Registrant’s voting stock held by non-affiliates was approximately $22,053,000.

As of March 17, 2004 there were 17,456,678 shares of Common Stock outstanding.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes  ¨  No  x

DOCUMENTS INCORPORATED BY REFERENCE

None.

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ISTA PHARMACEUTICALS, INC.

PART I

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

Item 1: Business

Overview

ISTA was founded to discover, develop and market new remedies for diseases and conditions of the eye. Vitrase^® (ovine hyaluronidase), is a proprietary drug we are developing for the treatment of vitreous hemorrhage, for use as a spreading agent to facilitate the dispersion and absorption of other drugs, and for the treatment of diabetic retinopathy. We are also developing other late-stage products, including Istalol^™ (timolol) for the treatment of glaucoma, Xibrom^™ (bromfenac) for the treatment of ocular inflammation, and Caprogel^® (aminocaproic acid) for the treatment of hyphema.

In December 2001, we announced our strategic plan to transition from a development-stage organization to a specialty pharmaceutical company, with a primary focus on ophthalmology. 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.

We continue to take significant steps to scale up our marketing and manufacturing capabilities, in order to further enhance our ability to execute our strategic plan. We entered into two key manufacturing agreements for the supply of commercial quantities of Vitrase^® from Cardinal Health and Istalol^™ and Xibrom^™ from Bausch & Lomb Incorporated. We also added two senior management executives to bolster our financial, business and human resource capabilities: Lauren P. Silvernail, our Chief Financial Officer and Vice President, Corporate Development, and Kathleen McGinley, our Vice President, Human Resources and Corporate Services.

Vitrase^® for the treatment of vitreous hemorrhage

In October 2002, we submitted to the U.S. Food and Drug Administration (“FDA”) a New Drug Application (“NDA”) for Vitrase^® (ovine hyaluronidase) for the treatment of vitreous hemorrhage. On April 3, 2003, the FDA issued an approvable letter citing issues primarily related to the sufficiency of the efficacy data submitted with the NDA for Vitrase^® for the treatment of vitreous hemorrhage. The FDA requested additional analysis of the existing data and an additional confirmatory clinical study based upon that analysis. We have submitted information to the FDA in response to its non-clinical comments contained in the approvable letter and are continuing to assess and discuss with the agency the clinical issues raised in the approvable letter. Based upon these discussions, we will determine the next appropriate steps in the approval process of Vitrase^® for the treatment of vitreous hemorrhage.

Vitrase^® for use as a spreading agent

In August 2003, we submitted to the FDA a second NDA for Vitrase^® for use as a spreading agent to facilitate the dispersion and absorption of other drugs. The FDA granted “priority review” status for this NDA in August 2003 and accepted the NDA for filing and review in October 2003. In February 2004, the FDA notified us that it was extending the Prescription Drug User Fee Act (“PDUFA”) action date 90 days to May 5, 2004. Based upon current discussions with the FDA, we believe that any remaining issues, and the FDA review, can be addressed within the revised time frame. The product submitted in the second NDA is the same formulation as the product submitted in the original NDA. The dose used as a spreading agent is different than the dose used for injection into the back of the eye. With respect to the second Vitrase^® NDA, we are pursuing the development of additional package configurations for different doses of the product to facilitate product utilization, improve profit margins and

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aid in third-party reimbursement. Upon approval of the second Vitrase^® NDA, we intend to submit supplemental filings with the FDA with respect to such additional package and dosage configurations.

Other Product Candidates

In May 2002, we acquired substantially all of the assets of AcSentient, Inc., which included United States marketing rights for two ophthalmic products and worldwide rights for a third. The products with United States rights included Istalol^™, a new once-a-day formulation of timolol for the treatment of glaucoma, and Xibrom^™, a topical non-steroidal anti-inflammatory compound for the treatment of ocular inflammation. We also received worldwide marketing rights for Caprogel^®, a novel compound for the treatment of hyphema. Our rights to Istalol^™ and Xibrom^™ are licensed from Senju Pharmaceuticals Co., Ltd., a Japanese pharmaceutical company, and our rights to Caprogel^® are licensed from the Eastern Virginia Medical School.

The NDA for Istalol^™ was submitted to the FDA in September 2002 and was accepted for review in November 2002. We received an approvable letter from the FDA for Istalol^™ in July 2003, and we expect FDA approval of Istalol^™ in the first half of 2004. We completed our Phase III studies of Xibrom^™ and announced initial results of our clinical studies in March 2004. Based on the initial results of our Phase III studies, we anticipate submitting a NDA for Xibrom^™ in the second quarter of 2004. We are currently conducting feasibility studies for the reformulation and commercialization of Caprogel^®. We anticipate incurring additional research and development expenses in connection with the final development of Xibrom^™ 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 Senju in connection with the marketing approval in the United States for these compounds.

Our Strategy

Our objective is to build a specialty pharmaceutical company focused on serious diseases and conditions of the eye. We intend to capitalize on our management’s collective experience developing and commercializing ophthalmic products with goals to:

Follow-On Public Offering

On November 12, 2003, we completed a follow-on public offering of 4,000,000 shares of common stock at an offering price of $9.50 per share with gross proceeds of $38,000,000. Net proceeds, after a 6% underwriters discount and other offering expenses, were $35,169,000. Additional expenses relating to the follow-on public offering, other than the underwriters discount, were approximately $551,000. The managing underwriters for the offering were Thomas Weisel Partners LLC, Jefferies & Company, Inc., RBC Capital Markets and Roth Capital Partners. The shares of common stock sold in this offering were registered on Form S-2, as amended (File No. 333-109576).

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

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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.

Product Development Programs

We have four product candidates covering six indications in clinical development. The following is a summary of our clinical product candidates:

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Vitrase^®

We are developing Vitrase^®, a proprietary formulation of ovine hyaluronidase, for the treatment of vitreous hemorrhage, for use as a spreading agent, and for diabetic retinopathy. The term hyaluronidase describes a group of naturally occurring enzymes that can digest certain forms of carbohydrate molecules called proteoglycans. When injected into the vitreous humor, Vitrase^® breaks down the proteoglycan matrix, causing the vitreous humor to liquefy. We believe that this also results in the separation of the vitreous humor from the retina and that, together, these effects are beneficial for the treatment of vitreous hemorrhage and diabetic retinopathy. Vitrase^® may be administered directly into the vitreous humor 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. Vitrase^® can also be injected into connective tissue, where it modifies the permeability of such tissue through the hydrolysis of hyaluronic acid, thereby decreasing the viscosity of the cellular cement and promoting diffusion of injected fluids or localized transudates or exudates, thus facilitating their absorption.

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.

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.

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

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:

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

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.

We have completed two Phase III clinical trials of Vitrase^® for the treatment of vitreous hemorrhage. These trials were prospective, randomized, parallel, placebo-controlled and double-masked studies. We conducted one of the trials, our North America trial, in the United States, Mexico and Canada with an enrollment of 750 patients. We conducted the other trial in Europe, Brazil, Australia and South Africa with an enrollment of 556 patients. Patients enrolled in the studies were monitored through 2003. We contracted with CroMedica Global, Inc. in connection with the North America trial and Covance Clinical Periapproval Services, Inc. in connection with the Europe, Brazil, Australia and South Africa trial to provide certain management and support services, including initiation visits with prospective candidates, site management, data accumulation, drug supply management and site audits.

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. The primary (surrogate) endpoint 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^®:

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.

In March 2002, we announced the preliminary results for our Phase III clinical studies of Vitrase^® for the treatment of vitreous hemorrhage. The data from the two Phase III studies did not show a statistically significant improvement in the primary (surrogate) endpoint. However, further analysis has shown that for the 55 IU dose of Vitrase^®, in both studies, there was a clinically meaningful and statistically significant decrease in the density of vitreous hemorrhage and a statistically significant difference in the proportion of patients with an improvement in best-corrected visual acuity at one and two months, which extended to the three-month post-treatment visit in the study conducted outside North America. Based on these improvements in visual function, and our review and discussions with the FDA regarding the data from the two studies, we submitted the clinical section and the chemistry, manufacturing and controls (“CMC”) section of the NDA for Vitrase^® for the treatment of vitreous hemorrhage in October 2002. The FDA accepted those sections of the Vitrase^® NDA for review in December

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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 have submitted information to the FDA in response to its non-clinical comments contained in the approvable letter and are continuing to assess and discuss with the agency the clinical issues raised in the approvable letter. Based upon these discussions, we will determine the next appropriate steps in the approval process of Vitrase^® for the treatment of vitreous hemorrhage.

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

When no spreading factor is present, material injected subcutaneously spreads very slowly, but hyaluronidase causes rapid spreading, provided local interstitial pressure is adequate to furnish the necessary mechanical impulse. Such an impulse is normally initiated by injected solutions. The rate of diffusion is proportionate to the amount of enzyme, and the extent is proportionate to the volume of solution.

Market Opportunity. Based on data compiled in reports published by the American Academy of Ophthalmology, we estimate that a previously marketed hyaluronidase product was used in approximately 750,000 ophthalmic surgery cases annually, when it was commercially available.

Clinical/Regulatory Status. In August 2003, we submitted to the FDA a second NDA for Vitrase^® for use as a spreading agent to facilitate the dispersion and absorption of other drugs. The FDA granted “priority review” status for this NDA in August 2003 and accepted the NDA for filing and review in October 2003. In February 2004, the FDA notified ISTA that it was extending the PDUFA action date 90 days to May 5, 2004. The product submitted in the second NDA is the same formulation as the product submitted in the original Vitrase^® NDA for the treatment of vitreous hemorrhage. The dose used as a spreading agent is different than the dose used for injection into the posterior region of the eye. With respect to the second Vitrase^® NDA, we are pursuing the development of additional package configurations for different doses of the product to facilitate product utilization, improve profit margins and aid in obtaining appropriate third-party reimbursement. Upon approval of the second Vitrase^® NDA, we intend to submit supplemental filings with the FDA with respect to such additional package configurations.

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.

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 we project it to continue growing rapidly in many regions outside the United States. Eye disease is commonly associated with diabetes. Based on our market research, we believe that nearly eight million individuals in the United States have been diagnosed with diabetes, four to six million have some form of diabetic retinopathy, and that the majority of individuals with diabetic retinopathy are in the nonproliferative stage of the disease. We believe that these people are potential candidates for treatment using Vitrase^®.

Clinical/Regulatory Status. We have completed a 60 patient pilot Phase II clinical trial in Mexico City to evaluate the safety and efficacy of a single-dose injection of Vitrase^® to cause a detachment of the vitreous humor from the retina and the impact on slowing the progression of diabetic retinopathy over a one-year period.

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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 and for use as a spreading agent, 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^™ (timolol)

Istalol^™ is our 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, we 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. Glaucoma is a chronic disease that must be treated for life. Currently, its causes are not well understood and there is no cure.

Market Opportunity. According to prescription data compiled by NDC Health, we estimate that the United States pharmaceutical market for the treatment of glaucoma exceeds $1.1 billion per year. According to data compiled by NDC Health, we estimate the U.S. ophthalmic beta-blocker market exceeds $170 million per year, with over 4.4 million prescriptions written annually.

Clinical/Regulatory Status. Senju submitted a NDA for Istalol^™ to the FDA in September 2002 that 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 completed in the United States. In July 2003, the FDA issued an approvable letter with respect to the Istalol^™ NDA citing issues related to manufacturing methods and controls. No additional clinical studies were requested. We believe the issues cited by the FDA are addressable, and we are currently seeking qualification of an additional manufacturing site. In December 2003, we submitted documents to the FDA seeking to qualify Bausch & Lomb as an alternate manufacturer of Istalol^™. We expect FDA approval of Istalol^™ in the first half of 2004.

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.

Xibrom^™ (bromfenac)

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

Market Opportunity. According to prescription data compiled for us by IMS Health, we estimate that the current global ophthalmic anti-inflammatory and allergies markets to be approximately $500 million and $630 million per year, respectively. Currently in the U.S., we estimate that there are over 5.4 million prescriptions written annually for topical ophthalmic anti-inflammatory agents.

Clinical/Regulatory Status. Phase I, Phase II and Phase III clinical studies of Xibrom^™ have been completed in Japan and the product has been approved and was launched in 2000 in Japan. In December 2003, we completed enrollment of our Phase III clinical studies in the United States and announced initial results of our clinical studies in March 2004. In two double-masked, placebo-controlled U.S. Phase III studies conducted under a single protocol, a statistically significant proportion of patients treated with Xibrom^™ achieved treatment success as compared to placebo. Treatment success was defined as the complete absence of ocular inflammation. In one study involving 296 patients at 20 study sites, more Xibrom^™ -treated patients cleared their ocular inflammation at 15 days when

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compared to patients receiving placebo at a rate of 62.6% versus 39.8%, respectively. In a second U.S. study, which involved 231 patients at 19 study sites, the rates of ocular inflammation clearance at the primary endpoint of 15 days were 65.8% for Xibrom^™ -treated patients and 47.9% for patients receiving placebo. Statistical significance in each trial reached a p value of less than 0.01. Our analyses showed that the Xibrom^™ treatment effect was evident as early as day three in both trials. The primary endpoint for both studies was the proportion of patients with complete absence of ocular inflammation, as measured by an assessment of immune cells in the anterior chamber of the eye and cellular debris. For each trial, the secondary efficacy analysis of inflammation clearance in patients only on assigned treatment (with no other medications administered) also showed a statistically significant benefit for Xibrom^™ treatment at 15 days versus placebo. In the 20-site study, the rates of clearance were 57.6% for Xibrom^™ and 23.5% for placebo. In the 19-site study, the rates of clearance were 62.0 % for Xibrom^™ and 31.5 % for placebo. Both studies, when analyzed separately, also showed that Xibrom^™ was well tolerated with a very low incidence of ocular adverse events. The efficacy and safety findings were consistent with results of previous studies conducted in Japan by Senju.

Caprogel^® (aminocaproic acid)

Caprogel^® is a new topical gel formulation of amniocaproic acid for treating hyphema. In May 2002, as part of our AcSentient asset acquisition, we acquired AcSentient’s worldwide marketing rights for Caprogel^®. The product is licensed from the Eastern Virginia Medical School.

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

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

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

Other Product Candidates

We continually evaluate new opportunities for complementary product candidates and, if and when appropriate, intend to pursue such opportunities through further product acquisitions and related development activities. Our

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ability to execute on such opportunities in some circumstances will be dependent, in part, upon our ability to raise additional capital on commercially reasonable terms.

Collaborations

Collaboration With Allergan

In March 2000, we began a collaboration with Allergan, Inc. with respect to the development and commercialization of Vitrase^® worldwide (other than in Mexico until April 2004 and Japan) for ophthalmic uses for the posterior region of the eye, a supply agreement for Vitrase^® and a stock purchase agreement for $10.0 million of our Series D preferred stock. These shares of Series D preferred stock were subsequently converted into 102,407 shares of our common stock. Allergan is a leading provider of eye care and specialty pharmaceutical products throughout the world. A joint operating committee has been constituted and consists of an equal number of members from each company who will oversee development, regulatory and marketing activities with respect to Vitrase^® for ophthalmic uses in the posterior region of the eye, as more fully described below.

Under the terms of our agreements with Allergan:

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Collaboration With Otsuka

In December 2001, we began a collaboration with Otsuka Pharmaceutical Co., Ltd. with respect to the commercialization of Vitrase^® in Japan for ophthalmic uses in the posterior region of the eye, including a license agreement for the clinical development, regulatory approval, marketing, sale and distribution of Vitrase^®, a supply agreement for Vitrase^® and a securities purchase agreement for 84,567 shares of our common stock for the aggregate purchase price of $4.0 million. Otsuka is part of the Otsuka Group, headquartered in Tokyo, Japan and has a diverse portfolio including ophthalmic, central nervous system, cardiovascular, circulatory, gastro-intestinal, respiratory, oncological and dermatological products.

Under the terms of our agreements with Otsuka:

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approval of Vitrase^® for the treatment of vitreous hemorrhage in Japan. To date, we have not earned this milestone payment from Otsuka and we cannot guarantee that we will earn or receive this milestone payment in the future.

Collaboration With Senju

In May 2002, we expanded our late-stage product portfolio, acquiring three promising therapeutic products with ophthalmic applications from AcSentient. The costs associated with this acquisition were approximately $1.7 million. Two of the three products, Istalol^™ and Xibrom^™, were products developed by Senju. As a result of this acquisition, we began a collaboration with Senju including individual license agreements for the commercialization of Istalol^™ and Xibrom^™ in the United States. These license agreements were originally executed between Senju and AcSentient. The full rights and obligations of AcSentient under both license agreements were transferred to us as a part of the acquisition agreement between us and AcSentient, with such transfer approved by Senju.

Under the terms of our agreements with Senju:

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Collaboration With the Eastern Virginia Medical School

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

Under the terms of our agreements with the Eastern Virginia Medical School:

Marketing and Sales

Assuming receipt of applicable regulatory approvals, we plan to market and distribute Vitrase^® (spreading agent indication), Istalol^™, Xibrom^™ and Caprogel^® in the United States ourselves. We will therefore need to establish our own sales, marketing and distribution capabilities, through our own internal resources and/or through contract arrangements with third parties We will need to devote significant financial and management resources to develop such sales, marketing and distribution capabilities. We plan to target our commercialization efforts to the most prolific prescribers of ophthalmic beta-blockers, non-steroidal anti-inflammatories and the highest volume cataract surgeons. This focused activity is intended to maximize our reach into the market opportunity for each product, if and when they are approved. We also may commercialize a hyaluronidase product under a trade name other than Vitrase^® for use as a spreading agent directly to physicians via our new targeted sales force. Such plans are dependent upon FDA approval of our second Vitrase^® NDA, FDA approval of a dosage configuration for use only as a spreading agent, obtaining appropriate third-party reimbursement, Allergan’s rights under our collaboration with respect to Vitrase^® for uses in the posterior region of the eye and the market potential of Vitrase^® for use as a spreading agent and our corporate priorities.

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In addition, assuming receipt of applicable regulatory approvals, we plan to market and distribute Vitrase^® for use in the posterior region of the eye through our collaboration with Allergan in the United States and all international markets, except Mexico (until April 2004) and Japan. We have a distribution agreement with Laboratorios Sophia S.A. de C.V. providing for the marketing, sales and distribution of Vitrase^® in Mexico until April 2004. Pursuant to our agreement with Laboratorios Sophia, we are entitled to 75% of the final retail price for all sales of Vitrase^® by Laboratorios Sophia. The agreement with Laboratorios Sophia may not be terminated by either party without cause. We have an agreement with Otsuka providing for the development and commercialization of Vitrase^® for ophthalmic uses in the posterior region of the eye in Japan. In the United States, the primary target market for Vitrase^® for the treatment of vitreous hemorrhage is expected initially to be retinal specialists to whom most patients with vitreous hemorrhage are referred. For the use of Vitrase^® as a spreading agent, the primary market will be cataract surgeons.

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, 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. Currently, a Current Procedural Terminology (“CPT”) code has been established for the intravitreal injection of a pharmaceutical agent, which, we believe, will be appropriate for physician billing for a Vitrase^® injection. This code may result in reimbursement for the physician’s services in administering the drug, but will not result in reimbursement for the drug itself. Drug specific coverage policies are primarily developed by Medicare carriers following Medicare’s criteria for drug coverage, which include, among other requirements, that the drug be FDA-approved, be used in connection with a physician service and be medically reasonable for the treatment of an illness or injury. While reimbursement may be available under existing payment codes for miscellaneous injectable drugs, each Medicare carrier reviews such reimbursement requests separately. Uniform national Medicare reimbursement for our injectable drug products will require a favorable National Coverage Determination for our injectable drug, which would be issued by CMS following review of an application by the manufacturer. Although they are not required to do so, private health insurers often follow the Medicare program’s lead when determining whether or not to reimburse for a drug. To support our applications for reimbursement coverage with Medicare and other major third-party payers, we intend to use data from clinical trials. The lack of satisfactory reimbursement for our drug products would limit their widespread use and lower potential product revenues.

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

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, Novartis Ophthalmics (a unit of Novartis AG), Pfizer, Inc. 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 obtaining licenses for currently marketed ophthalmic products, we will be subject to intense competition from major pharmaceutical companies who have extensive marketing and distribution organizations and substantially greater financial resources than ours.

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We are not aware of any other drug candidates in clinical trials for the treatment of vitreous hemorrhage or hyphema. 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:

Manufacturing

Ovine hyaluronidase, the active pharmaceutical ingredient used in Vitrase^®, is sourced from ovine testes and processed in several stages to produce a highly purified raw material for formulation. We have a supply agreement with Biozyme Laboratories Ltd. for current Good Manufacturing Practices (“cGMP”)-grade ovine hyaluronidase for use in ophthalmic applications. The ovine hyaluronidase is lyophilized, or freeze dried, by Biozyme and delivered to our contract manufacturer for formulation and filling of dose specific vials. Vitrase^® is currently required to be stored under refrigerated conditions prior to its use. We have entered into an agreement with R.P. Scherer West, Inc. to manufacture commercial quantities of Vitrase^®. R.P. Scherer West is a wholly owned subsidiary of Cardinal Health. Under the terms of the agreement, Cardinal Health will manufacture, package and perform certain manufacturing quality assurance and quality control tests on the product in accordance with specifications provided by us. Currently, Biozyme and Cardinal Health are our sole sources for ovine hyaluronidase and the finished product, respectively. We are seeking additional manufacturing sources for these products.

We have supply agreements with Bausch & Lomb to manufacture commercial quantities of Istalol^™ and Xibrom^™. 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 us. Currently, Bausch & Lomb is our sole source for Istalol^™ and Xibrom^™.

Research and Development

Since our inception, we have made substantial investments in research and development. During the years ended December 31, 2003, 2002 and 2001, we spent $17.3 million, $14.8 million and $15.8 million, respectively, on research and development activities.

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

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Patents and Proprietary Rights

Our success will depend in part on our ability to obtain patent protection for our inventions, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties. Our strategy is to actively pursue patent protection in the United States and foreign jurisdictions for technology that we believe to be proprietary and that offers a potential competitive advantage for our inventions. We currently own or license 49 United States and foreign patent applications and 25 United States and foreign issued patents.

In addition to patents, we rely on trade secrets and proprietary know-how. We seek protection of these trade secrets and proprietary know-how, in part, through confidentiality and proprietary information agreements. We make efforts to require our employees, directors, consultants and advisors, outside scientific collaborators and sponsored researchers, other advisors and other individuals and entities to execute confidentiality agreements upon the start of employment, consulting or other contractual relationships with us. These agreements provide that all confidential information developed or made known to the individual or entity during the course of the relationship is to be kept confidential and not 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. We are pursuing trademark protection for Vitrase^® in a number of different countries around the world. We have exclusively licensed the trademark Vitrase^® to Allergan under our collaboration agreement.

Government Regulation

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

The FDA approval process for drugs includes:

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. A NDA must be submitted by us, and filed and approved by the FDA before any of our drugs can be marketed commercially in the United States.

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

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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:

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 cGMP, licensing specifications, and other FDA regulations before and after a NDA has been

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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.

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

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

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:

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

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

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with the agency the clinical issues raised in the approvable letter. Based upon these discussions, we will determine the next appropriate steps in the approval process of Vitrase^® for the treatment of vitreous hemorrhage.

In August 2003, we submitted to the FDA a second NDA for Vitrase^® for use as a spreading agent to facilitate the dispersion and absorption of other drugs. The FDA granted “priority review” status for this NDA in August 2003 and accepted the NDA for filing and review in October 2003. In February 2004, the FDA notified ISTA that it was extending the PDUFA action date 90 days to May 5, 2004. The product submitted in the second NDA is the same formulation as the product submitted in the original Vitrase^® NDA for the treatment of vitreous hemorrhage. The dose used as a spreading agent is different than the dose used for injection into the posterior region of the eye. With respect to the second Vitrase^® NDA, we are pursuing the development of additional package configurations for different doses of the product to facilitate product utilization, improve profit margins and aid in obtaining appropriate third-party reimbursement. Upon approval of the second Vitrase^® NDA, we intend to submit supplemental filings with the FDA with respect to such additional package configurations.

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:

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.

Human Resources

As of March 17, 2004, we had 47 full-time employees. Approximately 33 of our employees are involved in research and clinical development activities. Five of our employees hold Ph.D. degrees and ten 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, Suite 100, Irvine, CA 92618, and our telephone number is (949) 788-6000. Vitrase^®, Istalol^™, Xibrom^™, Caprogel^®, ISTA, ISTA Pharmaceuticals and the ISTA logo are our trademarks.

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

RISK FACTORS

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

Risks Related to Our Business

If we do not receive and maintain regulatory approvals for our product candidates, we, 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 major European countries and Japan have similar requirements.

The NDA process is extensive, time-consuming and costly, and there is no guarantee that the FDA will approve NDAs of any of our product candidates, or that the timing of any such approval will be appropriate for our product launch schedule and other business priorities, which are subject to change. We have submitted NDAs which are currently pending before the FDA, two for Vitrase^®, for the treatment of vitreous hemorrhage and for use as a spreading agent, respectively, and one for Istalol^™. Moreover, we depend on the assistance of Senju for obtaining regulatory approval for Istalol^™.

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

Although we have received “priority review” status on our second NDA for Vitrase^® for its use as a spreading agent, there can be no assurances that the FDA will approve this NDA. Even if the FDA ultimately does approve this NDA, the timing of, or conditions imposed by the FDA on any such approval might not be appropriate for our marketing, product development and business priorities or those of Allergan, our marketing partner for uses in the posterior region of the eye.

The FDA has also issued an approvable letter with respect to the Istalol^™ NDA, citing issues related to manufacturing methods and controls. While we believe these issues are addressable, there can be no assurance that the FDA will approve the NDA for Istalol^™, or that the timing of any such approval would be appropriate in view of our changing business objectives and priorities.

Clinical testing of pharmaceutical products is also a long, expensive and uncertain process. Even if initial results of preclinical studies or clinical trial results are positive, we may obtain different results in later stages of drug development, including failure to show desired safety and efficacy. We completed our Phase III studies of Xibrom^™, a topical non-steroidal anti-inflammatory compound for the treatment of ocular inflammation, and announced initial results of our clinical studies in March 2004. Based on the initial results of our Phase III studies, we anticipate submitting a NDA for Xibrom^™ in the second quarter of 2004.

The clinical trials of any of our product candidates could be unsuccessful, which would prevent us from obtaining regulatory approval and commercializing the product.

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

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

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

Even if we obtain FDA approval of the Vitrase^® NDA for use as a spreading agent, our ability to commercialize Vitrase^® for such use is dependent upon the terms of our collaboration with Allergan.

We have entered into a collaboration with Allergan, Inc. relating to Vitrase^® for ophthalmic uses for the posterior region of the eye. If we obtain regulatory approval for Vitrase^® for any such uses in the United States and Europe, we will be dependent on Allergan for the commercialization of Vitrase^® for such uses in these markets. We are currently in discussions with Allergan regarding marketing and other strategies in the event the FDA approves our NDA for Vitrase^® for use as a spreading agent. Allergan has informed us of its position that we need its authorization pursuant to our collaboration to market Vitrase^® on our own as a spreading agent, which Allergan asserts has not been provided. In addition, Allergan may be unwilling to pursue the marketing and commercialization of Vitrase^® with any final approved labeling that does not meet its satisfaction. Any dispute regarding our rights or Allergan’s rights under our collaboration or otherwise would be costly, time-consuming and potentially delay or possibly prevent the launch of any approved Vitrase^® product.

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^™, Xibrom^™, Caprogel^® or any other products we develop or acquire in the future, including, among others:

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

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

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

We currently are in the process of developing our sales, marketing and distribution capabilities. However, our current capabilities in these areas are limited. In order to commercialize any products successfully, we must internally develop substantial sales, marketing and distribution capabilities, and/or establish collaborations or other arrangements with third parties to perform these services. We do not have extensive experience in these areas, and we may not be able to establish adequate in-house sales, marketing and distribution capabilities or engage and effectively manage relationships with third parties to perform any or all of such services. For example, although we intend to develop our own sales and marketing capabilities (either in-house and/or through contractual arrangements with third parties) with respect to our other product candidates, we intend to rely on the sales and marketing capabilities of Allergan in the United States and Europe and Otsuka Pharmaceuticals, Co. Ltd. in Japan, respectively, to market Vitrase^® for ophthalmic uses for the posterior region of the eye. To the extent that we enter into co-promotion, licensing or other third party arrangements, our product revenues and returns are likely to be lower than if we directly marketed and sold our products, and any revenues we receive will depend upon the efforts of third parties, whose efforts may not be successful.

We have not generated any revenue from product sales to date, we have a history of net losses and negative cash flow, and we may never achieve or maintain profitability.

We have not generated any revenue from product sales to date, and we may never generate revenues from product sales in the future. Even if we do achieve significant revenues from product sales, we expect to incur significant operating losses over the next several years. We have never been profitable, and we might never become profitable. As of December 31, 2003, our accumulated deficit was $147.6 million, including a net loss of approximately $25.2 million for the year ended December 31, 2003. As of December 31, 2003, we had approximately $48.5 million in cash and short-term investments and working capital of $44.2 million. We believe our current cash and cash equivalents on hand will be sufficient to finance anticipated capital and operating requirements for at least the next twelve months. If we engage in acquisitions of companies, products, or technology in order to execute our business strategy, we may need to raise additional capital. We may be required to raise additional capital in the future through collaborative agreements, private investment in public equity financings, and various other public or private equity or debt financings. If we are required to raise additional capital in the future there can be no assurance that the additional financing will be available on favorable terms, or at all.

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

Our strategy to transition to a specialty pharmaceutical company will be dependent upon our ability to gain regulatory approval and market acceptance for our existing late-stage ophthalmic product candidates, build a commercial infrastructure to support multiple ophthalmic product launches, conduct business development efforts to further expand our late-stage product pipeline, and pursue opportunistic acquisitions of marketed products.

We have limited sales, marketing and distribution capabilities to support the marketing of any products, and we do not have experience in managing third-party manufacturers of any products in commercial quantities. In addition, if we acquire or obtain licenses for late-stage development products, our ability to successfully commercialize such products will also be dependent on our ability to successfully complete development of such products, including obtaining the necessary regulatory approvals. For example, we have obtained licenses for U.S.

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marketing rights to Istalol^™ and Xibrom^™ from Senju, and we have obtained a license for worldwide rights to Caprogel^® from the Eastern Virginia Medical School. Senju is responsible for the development of Istalol^™, including obtaining the necessary regulatory approvals in the United States. We are responsible for the development of Xibrom^™ and Caprogel^®.

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

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

We have entered into a master services agreement with R.P. Scherer West, Inc. (which has been subsequently acquired by Cardinal Health, Inc.), for the manufacture of commercial quantities, if approved, of Vitrase^®. We also intend to use a contract manufacturer to assist us in the development and manufacture of the new package configurations of Vitrase^®, if approved. We have also entered into a manufacturing services agreement with Bausch & Lomb Incorporated for the manufacture of commercial quantities, if approved, of Istalol^™ and Xibrom^™. To date, we have needed these products only in amounts sufficient for clinical trials. Before any contract manufacturer can produce commercial quantities of a product, we must demonstrate to the FDA’s satisfaction that the product source for commercial quantities is substantially equivalent to the supply of the product used in our clinical trials. Such demonstration may include the requirement to conduct additional clinical trials. In December 2003, we submitted documents to the FDA seeking to qualify Bausch & Lomb as an alternate manufacturer of Istalol^™. In addition, the manufacturing facilities of all of our contract manufacturers must comply with current Good Manufacturing Practice (“cGMP”) regulations, which the FDA strictly enforces. Moreover, the facilities of the contract manufacturer must undergo and pass pre-approval inspections by the FDA before any of our products can be approved for commercial manufacture. We cannot assure you that Cardinal Health, Bausch & Lomb, or any other manufacturer we may contract with in the future will be able, as applicable, to develop processes necessary to produce substantially equivalent product or that regulatory authorities will approve them as a manufacturer. Failure to develop necessary production processes or receive regulatory approval of our manufacturers could delay or stop our efforts to develop and commercialize our product candidates.

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

We have entered into collaborations with Allergan and Otsuka Pharmaceuticals relating to Vitrase^® for ophthalmic uses for the posterior region of the eye, and with Senju relating to Istalol^™ and Xibrom^™. If we obtain regulatory approval for Vitrase^® for any such uses in the United States and Europe, we will be dependent on Allergan for the commercialization of Vitrase^® for any such uses in these markets. We depend on Otsuka for obtaining regulatory approval of Vitrase^® for any such uses in Japan, and if such approval is obtained, we will be dependent upon Otsuka for the commercialization of Vitrase^® for such approved uses in Japan. We will also be dependent on Senju for obtaining regulatory approval for Istalol^™ in the United States. The amount and timing of resources that Allergan, Otsuka, and Senju dedicate to our collaborations is not within our control. Accordingly, any breach or termination of our agreements by, or disagreements with, these collaborators could delay or stop the development and/or commercialization of our product candidates, or adversely impact our receipt of milestone payments, profit splits, royalties, and other consideration from these collaborations. Our collaborative partners may change their strategic focus, terminate our agreements on relatively short notice, or pursue alternative technologies. Although our agreements with Allergan, Otsuka and Senju contain reciprocal terms providing that neither we nor they may develop products that directly compete in the same form with the products involved in the collaboration, there can be no assurances that our collaborators will not develop competing products in different forms or products that compete indirectly with our products. Accordingly, unfavorable developments relating to our strategic partners could have a significant adverse effect on us and our financial condition.

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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.

Some materials used in our products are currently obtained from a single source. Biozyme Laboratories, Ltd. is currently our only source for highly purified ovine hyaluronidase, which is the active ingredient in Vitrase^®. We are currently renegotiating our agreement with Biozyme. If we are unable to renegotiate our agreement on terms acceptable to us, we may be required to obtain ovine hyaluronidase from a third party supplier, if available. If approved, commercial quantities of Vitrase^® will be supplied by Cardinal Health as the sole source. Istalol^™, if approved, will be supplied by Akorn Laboratories and/or Bausch & Lomb. Xibrom^™, if approved, will be supplied by a single source, Bausch & Lomb.

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

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

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

Risks Related to Our Industry

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

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

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

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

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

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

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

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

We currently own or license 25 U.S. and foreign patents and 49 U.S. and foreign pending patent applications. There can be no assurance that our existing patents, or any patents issued to us as a result of such applications, will provide a basis for commercially viable products, will provide us with any competitive advantages, or will not face third-party challenges or be the subject of further proceedings limiting their scope or enforceability. We may become involved in interference proceedings in the U.S. Patent and Trademark Office to determine the priority of our inventions. In addition, costly litigation could be necessary to protect our patent position. We license patents held by the Eastern Virginia Medical School (for Caprogel^®) and Senju (for Istalol^™ and Xibrom^™). Some of these license agreements do not permit us to control the prosecution, maintenance, protection and defense of such patents. If the licensor chooses not to protect its own patent rights, we may not be able to take actions to secure our related product marketing rights. In addition, if such patent licenses are terminated before the expiration of the licensed patents, we may no longer be able to continue to manufacture and sell such products as may be covered by the patents.

We also rely on 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 have exclusively licensed the trademark Vitrase^® to Allergan under our collaboration agreement. Some of our other trademarks, including Caprogel^™ and Xibrom^™, are owned by or assignable to our licensors Eastern Virginia

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Medical School and Senju, and upon expiration or termination of the license agreements, we may no longer be able to use these trademarks.

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

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

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 and result in a material adverse effect on our financial condition.

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

We have numerous competitors in the United States and abroad, including, among others, major pharmaceutical and specialized biotechnology firms, universities and other research institutions that may be developing competing products. Such competitors may include Allergan, Alcon Laboratories, Inc., Bausch & Lomb, Novartis Ophthalmics (a unit of Novartis AG), 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 or at all.

We currently maintain clinical trial liability insurance with per occurrence and aggregate coverage limits of $5 million. The coverage limits of our insurance policies may be inadequate to protect us from any liabilities we might incur in connection with clinical trials or the sale of our products. Product liability insurance is expensive and in the future may not be available on commercially acceptable terms, or at all. A successful claim or claims brought against us in excess of our insurance coverage could materially harm our business and financial condition.

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Risks Related to Our Stock

Our stock price is subject to significant volatility.

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

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 March 17, 2004 was approximately 20,778 shares, and the average daily number of transactions was approximately 82 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 may negatively affect our stock price.

As a result of our bridge financing in September 2002, our PIPE financing transaction in November 2002, and our follow-on public offering in November 2003, we issued approximately 15.6 million shares of our common stock. The shares of common stock issued in connection with these transactions represents approximately 89% of

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our common stock as of March 17, 2004. In connection with our bridge financing and our PIPE financing transaction, we also issued warrants exercisable for the purchase of up to an aggregate of 1,842,104 shares of our common stock based upon a purchase price of $3.80 per share. We filed a registration statement on Form S-3 (Registration No. 333-103820), which was declared effective on June 6, 2003, to cover sales of the shares issued to the PIPE investors and issuable to the PIPE and bridge investors upon conversion of the warrants. The exercise of these warrants could result in significant dilution to our shareholders at the time of exercise. We also filed a registration statement on Form S-2 (Registration No. 333-109576) in connection with our follow-on public offering, which was declared effective on November 12, 2003, to cover sales of the shares issued the investors.

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

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

Our directors, officers, and principal stockholders together control approximately 64.3% 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 3.9% of our voting securities and our 5% or greater stockholders beneficially own approximately 60.4% 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.

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

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

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

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

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

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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

No matters were voted upon during the fourth quarter of 2003.

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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 closing 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 March 17, 2004, there were approximately 208 stockholders 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.

Item 6:    Selected Financial Data

The following selected financial data are derived from our consolidated financial statements. The data should be read in conjunction with our 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,” “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.”

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The following discussion and analysis should be read in conjunction with our consolidated financial statements and the notes to those statements filed as part of this Form 10-K.

Overview

We are an emerging specialty pharmaceutical company focused on the development and commercialization of unique and uniquely improved products for serious diseases and conditions of the eye. Since our 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-stage organization to a specialty pharmaceutical company with a primary focus on ophthalmology.

In order to advance our strategic plan, we are pursuing the development of several products, including Vitrase^® (ovine hyaluronidase) and Istalol^™ (timolol), 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. Even if we receive FDA approval of the Vitrase^® NDA for use as a spreading agent, the launch of the product may require FDA approval of supplemental filings related to product packaging and labeling and, in certain circumstances, the approval of Allergan. Nevertheless, we are currently undertaking significant preparations for expansion of our manufacturing and marketing capabilities in the event such approvals are obtained. If approved by the FDA, Vitrase^® and Istalol^™ will be manufactured for us through our contract manufacturers. In the United States the marketing of Istalol^™ will be done by us and marketing for Vitrase^®, for uses in the posterior region of the eye, will be done by Allergan, Inc.

We currently have no approved products. We are seeking FDA approval for Vitrase^®, a proprietary drug that we are developing for the treatment of vitreous hemorrhage, for use as a spreading agent to facilitate the absorption and dispersion of other injected drugs, and for the treatment of diabetic retinopathy. We are also pursuing market approval in the United States of Istalol^™, our new formulation of timolol, to treat glaucoma. In December 2003, we completed enrollment of our Phase III clinical studies in the United States for Xibrom^™ (bromfenac), a topical non-steroidal anti-inflammatory compound for the treatment of ocular inflammation and announced the initial results of our clinical studies in March 2004. Finally, we are currently conducting feasibility studies for the reformulation and commercialization of Caprogel^® (aminocaproic acid), a topical formulation aminocaproic acid for the treatment of hyphema. We believe that if Vitrase^®, Istalol^™, and our other ophthalmic product candidates obtain regulatory approval and are commercially successful, we will advance our strategic plan to build a specialty pharmaceutical company focused on serious diseases and conditions of the eye.

We currently have no products available for sale and have not generated any revenues from sales of our products. We have incurred losses since inception and had an accumulated deficit of $147.6 million through December 31, 2003. 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 and to develop our marketing, sales, distribution and other commercial and management capacities in anticipation of the approval of one or more of our product candidates.

Results of Operations

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

Years Ended December 31, 2003, 2002 and 2001

Revenue. Revenue of $278,000 for 2003 and 2002 reflects the amortization for the period of deferred revenue recorded in December 2001 for the license fee payment made by Otsuka Pharmaceuticals for commercialization rights to Vitrase^® in Japan for ophthalmic uses in the posterior regions of the eye.

Research and development expenses. Research and development expenses were $ 17.3 million in 2003, $14.8 million in 2002 and $15.8 million in 2001. Our research and development expenses to date have consisted primarily

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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^®, Istalol^™ and Xibrom^™.

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. Instead, we track costs by the type of cost incurred.

In 2003, approximately 22% of our research and development expenditures were for preclinical research, approximately 52% was spent on clinical development and approximately 26% was spent on manufacturing development. Changes in our research and development expenses are primarily due to the following:

We anticipate that our research and development expenses for 2004 will be approximately the same as our research and development expenses for 2003, and will be focused primarily on further research and development of our product candidates. Our primary product candidates are Vitrase^®, Istalol^™, Xibrom^™ and Caprogel^®.

Vitrase^® for the treatment of vitreous hemorrhage – 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 on that analysis. We have submitted information to the FDA in response to its non-clinical comments contained in the approvable letter and are continuing to assess and discuss with the agency the clinical issues raised in the approvable letter. Based upon these discussions, we will determine the next appropriate steps in the approval process of Vitrase^® for the treatment of vitreous hemorrhage.

Vitrase^® for use as a spreading agent to facilitate the diffusion and absorption of injected drugs – In August 2003, we submitted to the FDA a second NDA for Vitrase^® for use as a spreading agent to facilitate the dispersion and absorption of other drugs. The FDA granted “priority review” status for this NDA in August 2003 and accepted the NDA for filing and review in October 2003. In February 2004, the FDA notified us that it was extending the PDUFA action date 90 days to May 5, 2004. Based upon current discussions with the FDA, we believe that any remaining issues, and the FDA review, can be addressed within the revised time frame. The product we submitted in the second NDA is the same formulation as the product we submitted in the original NDA for the treatment of vitreous hemorrhage. The dose as a spreading agent is different than the dose used for injection into the posterior region of the eye. With respect to the second Vitrase^® NDA, we are pursuing the development of additional package configurations for different dosages of the product to facilitate product utilization, improve profit margins and aid in obtaining appropriate third-party reimbursement. Upon approval of the second Vitrase^® NDA, we intend to submit supplemental filings with the FDA with respect to such additional package configurations.

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Vitrase^® for the treatment of diabetic retinopathy – We have completed a patient pilot Phase II clinical study in Mexico City to evaluate the safety and efficacy of Vitrase^® for the treatment diabetic retinopathy. The continued development of Vitrase^® for the treatment of diabetic retinopathy is dependent upon a number of factors including among others, the FDA’s evaluation of the Vitrase^® NDAs for the treatment of vitreous hemorrhage and for use as a spreading agent, 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^™ – Senju submitted a NDA for Istalol^™ to the FDA in September 2002, which 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. In July 2003, the FDA issued an approvable letter with respect to the Istalol^™ NDA citing issues related to manufacturing methods and controls. No additional clinical studies were requested. We believe the issues cited by the FDA are addressable, and we are currently seeking qualification of an additional manufacturing site. In December 2003, we submitted to the FDA information seeking to qualify Bausch & Lomb Incorporated as an alternate manufacturer for Istalol. We expect a response from the FDA in the first half of 2004.

Xibrom^™ – Phase I, Phase II and Phase III clinical studies have been completed in Japan and the product has been approved and was launched in 2000 in Japan. We completed our Phase III studies of Xibrom^™ and announced initial results of our clinical studies in March 2004. Based on the initial results of our Phase III studies, we anticipate submitting a NDA for Xibrom^™ in the second quarter of 2004.

Caprogel^® – We are currently conducting feasibility studies for the reformulation and commercialization of Caprogel^®. Once completed, and if these studies yield promising results, we intend to pursue 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.

Our research and development activities reflect our efforts to advance our product candidates through the various stages of pre-clinical, clinical and regulatory product development. The expenditures that will be necessary to execute our development plans are subject to numerous uncertainties, which may affect our research and development expenditures and capital resources. For instance, the duration and the cost of clinical trials may vary significantly depending on a variety of factors including a trial’s protocol, the number of patients in the trial, the duration of patient follow-up, the number of clinical sites in the trial, and the length of time required to enroll suitable patient subjects. Even if earlier results are positive, we may obtain different results in later stages of development, including failure to show the desired safety or efficacy, which could impact our development expenditures for a particular product candidate. Although we spend a considerable amount of time planning our development activities, we may be required to alter from our plan based on new circumstances or events or our assessment from time to time of a product candidate’s market potential, other product opportunities and our corporate priorities. Any deviation from our plan may require us to incur additional expenditures or accelerate or delay the timing of our development spending. Furthermore, as we obtain results from trials and review the path toward regulatory approval, we may elect to discontinue development of certain product candidates in certain indications, in order to focus our resources on more promising candidates or indications.

Selling, general and administrative expenses. Selling, general and administrative expenses were $8.6 million in 2003, $8.2 million in 2002 and $7.5 million in 2001. The $400,000 increase in selling, general and administrative expenses in 2003 was a result of approximately $438,000 in directors’ and officers’ liability insurance premiums, $480,000 consultant related costs associated with increased activity with our product pipeline, $631,000 in marketing activities, offset by a $1.2 million decrease in deferred compensation related to stock-based compensation. The increase in general and administrative expenses in 2002 was primarily attributable to approximately $315,000 in directors and officers liability insurance premiums, $220,000 in the level of consultant related costs associated with our product acquisitions, with the remainder attributable to personnel expenses related to new management.

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

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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 Financial Accounting Standards Board Interpretation No. 28 (FIN 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, 2003, we granted stock options to employees to purchase 536,150 shares of common stock at a weighted average exercise price of $5.84 per share, equal to the fair market value of our common stock at the time of grant. 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 $423,000, $124,000 and $11,000 for the years ended December 31, 2004, 2005 and 2006 respectively, related to these option grants.

In connection with the grant of stock options to employees and directors, we recorded deferred compensation of approximately $110,000, $93,000 and $2,960,000 during the years ended December 31, 2003, 2002 and 2001, respectively, and recorded amortization of $956,000, $2,160,000 and $1,902,000 during the years ended December 31, 2003, 2002 and 2001, respectively.

Interest income. Interest income was $372,000 in 2003, $213,000 in 2002 and $826,000 in 2001. The increase in interest income in 2003 is primarily attributable to higher average cash balances on hand as compared to 2002. The decrease in interest income in 2002 over the prior year was primarily attributable to lower average cash balances on hand. We anticipate interest income to be lower in 2004 as compared to 2003 due to lower average cash balances in our short-term investment portfolio.

Interest expense. Interest expense was approximately $10,000 in 2003, $473,000 in 2002 and $25,000 in 2001. Interest expense incurred during 2003 was primarily attributable to the interest paid on the financing of our directors’ and officers’ insurance premiums. Interest expense incurred during 2002 was primarily attributable to approximately $412,000 related to the amortization of the fair value of the warrants issued in connection with the bridge loan in September 2002. Interest expense incurred during 2001 was primarily attributable to the interest paid on the financing of our directors’ and officers’ insurance premiums. We had no capital leases during 2001.

Income taxes. We incurred net operating losses in 2003, 2002 and 2001 and consequently did not pay any federal, state or foreign income taxes. At December 31, 2003, we had federal and California net operating loss carryforwards of approximately $95.5 million and $84.4 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 2004, unless previously utilized. We also have federal and California research tax credit carryforwards of approximately $4.6 million and $2.6 million, respectively. The federal research tax credits will begin to expire in 2010, unless previously utilized. Our California research tax credit carryforwards do not expire and will carryforward indefinitely until utilized. In addition, we have California manufacturers investment credit of approximately $30,000 that 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 our ability 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, 2003. This data has been derived from our unaudited consolidated

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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 thousands except earnings per share).

Research & development expenses. During 2003, our quarterly research and development expenses increased primarily as a result of the commencement of the Xibrom^™ Phase III clinical trial and increased development and/or manufacturing spending related to Vitrase^®, Istalol^™, and Xibrom^™. 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 a NDA to the FDA.

Selling, general & administrative expenses. During 2003, our quarterly selling, general and administrative expenses increased primarily as a result of additional personnel expenses with the hiring of two additional key management employees and two additional executive employees, and other related facilities 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 2003, our quarterly net interest income increased from 2002 due to higher cash balances as a result of the PIPE transaction in November 2002 and the follow-on public offering in November 2003. 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.

Net loss per common share, basic and diluted. Basic and diluted net loss per share computation for each quarter are independent and may not add up to the net loss per share computation for the respective year. See Note 1 of Notes to the Consolidated Financial Statements for an explanation of the determination of basic and diluted net loss per share.

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Critical Accounting Policies and Estimates

Management’s discussion and analysis of financial condition and results of operations, as well as disclosures included elsewhere in this Report are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Actual results could differ from these estimates and could affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingencies.

We believe that the critical accounting policies that most impact the consolidated financial statements are as described below. A summary of our significant accounting policies is included in Note 1 to our consolidated financial statements which begin on page F-1.

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 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.

Liquidity and Capital Resources

As of December 31, 2003, we had approximately $48.5 million in cash, cash equivalents and short-term investments and working capital of $44.2 million.

We have financed our operations since inception primarily through private equity sales and the sale of our common stock in our initial and follow-on public offerings. 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 the issuance of promissory notes in September 2002, $37.3 million from our PIPE transaction in November 2002 and $35.7 million from our follow-on public offering in November 2003. The PIPE transaction in November 2002 involved a private placement of 10,526,306 shares of our common stock for the aggregate purchase price of approximately $40.0 million, or $3.80 per share, and warrants to purchase up to 1,578,946 shares of our common stock for an exercise price of $3.80 per share. The follow-on public offering in November 2003 involved the sale of 4,000,000 shares of our common stock for the aggregate purchase price of $38.0 million, or $9.50 per share.

During 2003, we used $22.6 million of cash for operations principally as a result of the net loss of $25.2 million partially offset by non-cash compensation expense of $956,000. 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. During 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 $1.9 million and $5.0 million in deferred income.

Net cash invested totaled $28.1 million during 2003 compared to $648,000 net cash invested during 2002. During 2001, $13.4 million of cash was provided by investing activities. Cash used for investing activities in 2003

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is primarily attributable to the follow-on public offering of 4,000,000 shares of common stock at an aggregate purchase price of $38.0 million, or $9.50 per share. During 2002, the net cash invested was primarily attributable to the purchase of short-term investments.

Net cash provided by financing activities totaled $35.5 million during 2003 compared to $41.5 million in 2002 and $4.1 million in 2001. The net cash provided by financing activities in 2003 is primarily attributable to $35.7 million net proceeds from the public sale of 4,000,000 shares of common stock in November 2003, while the cash provided by financing activities in 2002 is primarily attributable to $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.

We may be required to raise additional capital in the future through collaborative agreements, PIPE related financings, and various other public or private equity or debt financings. If we are required to raise additional capital in the future, there can be no assurance that the additional financing will be available on favorable terms, or at all.

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 the acquisitions of companies, products, or technology and our own research and development activities. Our ability to execute on such opportunities in some circumstances will be dependent, in part, 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:

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Tabular Disclosure of Contractual Obligations

The following table summarizes our contractual obligations as of December 31, 2003:

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.

Under Singapore tax law, Visionex was subject to a 15% withholding tax on a $5.0 million license that it paid to us in connection with a license to market, sell and distribute our Vitrase^® and corneaplasty products in certain countries in Southeast Asia. This withholding tax was waived by the Economic Development Board, or EDB, of Singapore subject to various conditions, including a commitment that Visionex would implement a proposed project to expand its business activities in Singapore to the benefit of the local economy. We substantially wound down Visionex operations in July 2002, and the proposed project was never implemented. Based upon a letter we received from the EDB and our assessment of our obligations with the EDB, management does not believe that we will be required to pay any withholding tax or related obligations in connection with the license fee. However, if we are required to pay this withholding tax, our financial condition will suffer.

New Accounting Pronouncement

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 our financial statements beginning January 1, 2003. We have currently chosen to not adopt the voluntary change to the fair value based method of accounting for stock-based employee compensation. If we should choose to adopt such a method, its implementation pursuant to SFAS No. 148 could have a material effect on our 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 2003 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

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our investments. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair market value of our interest sensitive financial investments. Declines in interest rates over time will, however, reduce our investment income, while increases in interest rates over time will increase our interest expense. Historically, and as of December 31, 2003, 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 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 on Accounting and Financial Disclosure

None.

Item 9A: Disclosure Controls and Procedures

An evaluation as of the end of the period covered by this report was carried out, under the supervision and participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in our periodic SEC filings.

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PART III

Item 10:    Directors and Executive Officers of the Registrant

Directors

Pursuant to our Amended and Restated Certificate of Incorporation and Bylaws, our Board of Directors currently consists of nine persons, divided into three classes serving staggered terms of three years. The Class I directors, Peter Barton Hutt, Benjamin F. McGraw III, Pharm.D. and Liza Page Nelson, are scheduled to serve until the annual meeting of stockholders in 2004. The Class II directors, Vicente Anido, Jr., Ph.D., Kathleen D. LaPorte, and Richard C. Williams, are scheduled to serve until the annual meeting of stockholders in 2005. The Class III directors, Jeffrey L. Edwards, Robert G. McNeil, Ph.D., and Wayne I. Roe, are scheduled to serve until the annual meeting of stockholders in 2006.

The following table sets forth the names, ages, principal occupations and year of appointment of our directors: