Form 10-K for year ended December 31, 2005

10-K 1 d10k.htm FORM 10-K FOR YEAR ENDED DECEMBER 31, 2005 Form 10-K for year ended December 31, 2005

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

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

For Fiscal Year Ended December 31, 2005

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

From the transition period from to

Commission File Number 000-31255

ISTA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)


Delaware		33-0511729
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

15295 Alton Parkway, 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, $0.001 par value

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x

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 ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer ¨		Accelerated filer x		Non-accelerated filer ¨

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

As of June 30, 2005, the aggregate market value of the Registrant’s voting stock held by non-affiliates was approximately $89,395,521.

As of January 31, 2006 there were 25,917,332 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

None.

TABLE OF CONTENTS

PART I


Item 1:	Business	1
Item 1A:	Risk Factors	14
Item 1B:	Unresolved Staff Comments	23
Item 2:	Properties	23
Item 3:	Legal Proceedings	23
Item 4:	Submission of Matters to a Vote of Security Holders	23

PART II

Item 5:	Market for Registrant’s Common Equity and Related Stockholder Matters	25
Item 6:	Selected Financial Data	26
Item 7:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 7A:	Quantitative and Qualitative Disclosures about Market Risk	33
Item 8:	Financial Statements and Supplementary Data	33
Item 9:	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	34
Item 9A:	Disclosure Controls and Procedures	34

PART III

Item 10:	Directors and Executive Officers of the Registrant	36
Item 11:	Executive Compensation	39
Item 12:	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	46
Item 13:	Certain Relationships and Related Transactions	48
Item 14.	Principal Accountant Fees and Services	48

PART IV

Item 15:	Exhibits and Financial Statement Schedules	50

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 Annual Report on Form 10-K contains forward-looking statements based on expectations, estimates and projections as of the date of this filing. Actual results may differ materially from those expressed in forward-looking statements. See Item 7 of Part II – “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Forward-Looking Statements.” Vitrase^®, Istalol^®, Xibrom™, Caprogel^®, Vitragan™, ISTA^®, ISTA Pharmaceuticals^® and the ISTA logo are our trademarks, either owned or under license.

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

Item 1:

Business.

Overview

We are a specialty pharmaceutical company focused on the commercialization and development of unique and uniquely improved products for serious conditions of the eye. We currently have three products available for sale in the United States: (i) Istalol for the treatment of glaucoma, (ii)) Vitrase for use as a spreading agent, and (iii) Xibrom for the treatment of ocular inflammation and pain following cataract surgery. We also have several product candidates in various stages of development. We have incurred losses since inception and had an accumulated deficit of $226.5 million through December 31, 2005.

Our Products and Pipeline

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


Product	Indication	Development Status
Xibrom	Ocular inflammation and pain following cataract surgery	Marketed in the United States

Istalol	Glaucoma	Marketed in the United States

Vitrase	Spreading agent	Marketed in the United States

	Vitreous hemorrhage	FDA Approvable Letter received

		European market application accepted for review by EMEA

	Diabetic retinopathy	Phase II

Ecabet sodium	Dry eye syndrome	Phase IIb study completed and preliminary results announced; confirmatory study ongoing

Tobramycin and Prednisolone Acetate Combination Product	Steroid-responsive inflammatory ocular conditions	Phase III completed

Caprogel	Hyphema	Reformulation ongoing/Phase II completed

Strong Steroid Product	Ocular inflammation and allergy	Reformulation ongoing

Xibrom (bromfenac)

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

Based upon 2005 data from IMS Health, we estimate that 2005 sales in the U.S. topical ophthalmic anti-inflammatory market were approximately $400 million, with total prescriptions of 8.8 million. Currently available non-steroid treatments must be dosed three or four times a day as compared to Xibrom’s twice-daily dosing.

We received approval from the U.S. Food and Drug Administration, or FDA, for Xibrom for the treatment of ocular inflammation following cataract surgery in March 2005. We launched Xibrom in the United States in the second quarter of 2005. In January 2006, we received FDA approval of expanded indication of Xibrom to include the treatment of pain following cataract surgery. We are currently promoting Xibrom through our specialty sales force.

We are also developing Xibrom line extensions and exploring other expanded uses of Xibrom in ophthalmology, including prevention and treatment of cystoid macular edema and treatment of pain in non-cataract surgery.

Istalol (timolol)

Istalol is our once-a-day, eye drop solution of timolol, a beta-blocking agent for the treatment of glaucoma.

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

According to the Glaucoma Research Foundation, three million people in the United States suffer from the disease, with 120,000 new cases documented annually. According to prescription data compiled by IMS Health for 2005, we estimate that the U.S. pharmaceutical market for the treatment of glaucoma exceeds $1.4 billion per year. Of this, the ophthalmic beta-blocker market exceeds $170 million per year, primarily at generic prices, with over 5.2 million prescriptions written annually. Timolol maleate, which is currently available from several manufacturers in either a twice-a-day eye drop solution or once-a-day gel formulation, is the leading beta-blocker to treat glaucoma in the United States. Istalol, given once-a-day, has shown efficacy and safety comparable to timolol maleate solution, given twice-a-day. Other than Istalol, the only available formulations of timolol maleate that have demonstrated efficacy with once-a-day dosing are gels, which have been known to cause blurring of patients’ vision.

Istalol was developed by Senju in Japan. In May 2002, we acquired marketing rights for Istalol in the United States under a license agreement with Senju. We received FDA approval of Istalol in June 2004 and launched Istalol in the United States in the third quarter of 2004. In October 2004, the FDA granted Istalol a “BT” rating, which means that prescriptions of Istalol cannot be legally substituted at pharmacies with generic timolol maleate solutions.

We promote Istalol through our specialty sales force, which focuses on the 10,000 ophthalmologists whom we believe account for more than 70% of all glaucoma prescriptions.

Vitrase (ovine hyaluronidase)

We launched Vitrase, our proprietary formulation of ovine hyaluronidase, for use as a spreading agent, in the first quarter of 2005. We are also developing Vitrase for the treatment of vitreous hemorrhage and diabetic retinopathy. We are also exploring other uses of Vitrase, including use as a spreading agent in oncology radiation therapy to enhance the penetration of contrast agents in solid tumors. The term hyaluronidase describes a group of naturally occurring enzymes that can digest certain forms of carbohydrate molecules called proteoglycans. Vitrase, when used as a spreading agent, is injected into connective tissue, where it modifies the permeability of such tissues and promotes diffusion of injected drugs, thus accelerating their absorption. When injected into the vitreous humor, Vitrase breaks down the proteoglycan matrix, causing the vitreous humor to liquefy. We believe that this also results in the separation of the vitreous humor from the retina and that, together, these effects are beneficial for the treatment of vitreous hemorrhage and diabetic retinopathy. Vitrase may be administered directly into the vitreous humor through a single-dose injection. The procedure will be performed in several minutes in an ophthalmologist’s office and is virtually painless due to the application of a topical anesthetic.

Spreading Agent

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

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

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

In May 2004, the FDA approved our NDA for Vitrase, in a lyophilized 6,200 USP units multi-purpose vial, for use as a spreading agent to facilitate the absorption and dispersion of other injected drugs. In October 2004, the FDA informed us that Vitrase for use as a spreading agent was entitled to five-year new chemical market exclusivity under the federal Food, Drug and Cosmetic Act. In December 2004, the FDA approved our supplemental NDA for Vitrase for use as a spreading agent at a concentration of 200 USP units/mL in sterile solution.

We launched Vitrase in the United States for use as a spreading agent in the first quarter of 2005.

Vitrase is promoted through our specialty sales force. We target the top ophthalmic surgeons, most of whom are also high prescribers of anti-inflammatory medications that we currently target for Xibrom. In November 2005, the Center for Medicare and Medicaid Services, or CMS, established two new national Healthcare Common Procedure Coding Systems, or HCPCS, J-Codes covering the injection of preservative free ovine hyaluronidase. Physicians have been able to use these new J-Codes since January 2006. HCPCS Codes are used by healthcare insurers to process reimbursement claims. We believe that these two new J-Codes will help facilitate third-party reimbursement for Vitrase.

Vitreous Hemorrhage

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

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

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

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

Based on data compiled by Business Genetics, Inc., we believe that approximately 450,000 cases of vitreous hemorrhage occur each year in the United States, a total of 400,000 cases occur each year in the five largest European markets and 190,000 cases occur each year in Japan. Approximately 60% of all of these cases are due to diabetic retinopathy,

15% are due to trauma and 25% are due to other factors. As a result of the typical progression of the condition, we believe Vitrase, if approved, is unlikely to be used in all cases of vitreous hemorrhage. Based on data compiled for us by The Wilkerson Group, we believe that the potential annual market opportunity in the United States for Vitrase for the treatment of vitreous hemorrhage is approximately 225,000 cases.

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

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

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

During the third quarter of 2005, we filed an application for the approval in Europe of Vitragan for the treatment of vitreous hemorrhage. Vitragan is our proprietary formulation of highly purified ovine hyaluronidase which is commonly known in the United States as Vitrase. During January 2006, the European Medicines Evaluation Agency, or EMEA, accepted our Vitragan application for review. We expect that the EMEA review process will most likely result in a decision on our Vitragan application by the first half of 2007.

Diabetic Retinopathy

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

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

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

We have completed a 60 patient pilot Phase II clinical trial in Mexico City to evaluate the safety and efficacy of a single-dose injection of Vitrase to cause a detachment of the vitreous humor from the retina and the impact on slowing the progression of diabetic retinopathy over a one-year period. The continued development of Vitrase for the treatment of

diabetic retinopathy will be dependent upon the FDA’s evaluation of the Vitrase NDA for the treatment of vitreous hemorrhage, among other factors.

Ecabet Sodium

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

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

Based on data compiled from various publicly available sources, we estimate that annual sales in the United States prescription dry eye market were almost $200 million in 2005 and are anticipated to grow to approximately $350 to $700 million within three to five years.

In February 2006, we announced positive preliminary results from our U.S. randomized, three-arm (placebo/3.0%/3.9%) Phase IIb clinical study of ecabet sodium for the treatment of dry eye syndrome. The preliminary results of our Phase IIb study demonstrated a strong trend in efficacy for the lower (3%) dose with respect to ecabet sodium’s ability to address two objective signs of dry eye syndrome, corneal staining and blink rate. In addition, patients treated with the lower dose of ecabet sodium reported positive trends for reductions in symptomatology as measured by ocular surface disease index and most bothersome symptom. In the preliminary results, no efficacy trends versus placebo were observed with respect to the higher (3.9%) dose. Further analyses of our ecabet sodium Phase IIb results are ongoing.

Our Phase IIb study of ecabet sodium was designed to identify the appropriate sign and symptom and time course for future studies of this drug. Generally, improvement in one sign and one symptom in Phase III studies is considered acceptable by the FDA for approval of a prescription dry eye product. Therefore, a total of 162 patients were enrolled in our Phase IIb study and were randomly assigned to receive placebo, 3.0% or 3.9% ecabet sodium in the study eye four times a day for 90 days. Patients were evaluated for signs and symptoms four times during the trial both prior to and following exposure to a controlled adverse environment (“dry eye chamber”). The trial evaluated ocular signs, including corneal and conjunctival staining, tear film breakup time and blink rate, and ocular symptoms, including burning or stinging, itchiness or scratchiness, grittiness or sandiness, foreign body sensation, haziness and blurriness. In addition, preliminary findings from our Phase IIb study suggested a favorable safety profile for ecabet sodium for the treatment of dry eye syndrome.

We plan to complete our analyses of our Phase IIb study results to confirm our preliminary findings and, in parallel, conduct a smaller, short-term confirmatory study designed to further define the subpopulation of patients to enroll and other elements of any future Phase III studies of ecabet sodium. Assuming confirmation of Phase IIb preliminary results and timely and successful completion of the confirmatory study, our plan is to initiate a Phase III study of ecabet sodium for the treatment of dry eye syndrome during 2007.

Tobramycin and Prednisolone Acetate Combination Product

We have developed a proprietary formulation of a fixed combination product of tobramycin 0.3% and prednisolone acetate 1.0%. Our combination product is being developed for the treatment of steroid-responsive inflammatory ocular conditions where risk of bacterial infection exists.

Our combination product, if approved by the FDA, will compete in the antibiotic steroid segment of the United States topical ophthalmic anti-inflammatory market. Based upon management estimates and 2004 prescription data compiled by IMS Health, we estimate that 2005 sales in the U.S. topical ophthalmic anti-inflammatory market were approximately $400 million, with total prescriptions of 8.8 million. The combination antibiotic and steroid segment of the ophthalmic anti-inflammatory market has approximately a 45% share of the prescriptions, or about 3.8 million prescriptions according to data compiled by IMS Health.

In February 2006, we announced positive results from our Phase III bioequivalence study of our combination product for the treatment of steroid-responsive inflammatory ocular conditions where risk of bacterial infection exists. Our Phase III study was a multi-center, randomized, double-masked trial with a total enrollment of 132 patients undergoing bilateral cataract surgery. Patients were randomly assigned to receive either our combination product or prednisolone acetate 1.0% in each eye. Of these 132 patients, 124 had a viable aqueous humor sample taken from each eye at the time of surgery at either 30, 60, 90, 120, 180 or 240 minutes following administration of the test agent. Our Phase III study successfully achieved its primary endpoint, demonstrating bioequivalence of prednisolone between our combination product (tobramycin 0.3% / prednisolone acetate 1.0%) and prednisolone acetate 1.0%. Our Phase III study also successfully achieved its secondary endpoints, demonstrating that our proprietary combination product and prednisolone acetate 1.0% have similar maximum concentration of prednisolone and time to reach maximum concentration. No treatment-related adverse events were reported for our combination product in our Phase III study.

Based on our Phase III study results, we plan to submit to the FDA an NDA for our combination product in the first half of 2006.

Strong Steroid Product

We are developing a proprietary formulation of a strong steroid for the treatment of ocular inflammation and allergy. No new strong steroid products have been launched in the United States for ophthalmic applications in more than a decade. We believe our strong steroid product will be considered a new chemical entity and entitled to receive five-year new chemical entity market exclusivity pursuant to the federal Food, Drug and Cosmetic Act. During the second half of 2006, we plan to begin Phase II studies of our strong steroid product. Assuming timely and successful completion of the Phase II studies, we anticipate Phase III studies will begin during the first half of 2007.

Caprogel (aminocaproic acid)

Caprogel is a new topical gel formulation of aminocaproic acid for treating hyphema. Hyphema is a term used to describe bleeding in the anterior chamber, the space between the cornea and the iris, of the eye and usually results from trauma to the eye. In May 2002, we acquired worldwide marketing rights for Caprogel, and we are currently conducting feasibility studies for its reformulation and commercialization. Once completed, and if these studies yield promising results, we intend to pursue further clinical development consistent with these studies’ results.

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. Caprogel has received an orphan drug designation for the treatment of hyphema from the FDA, which may result in a seven year market exclusivity privilege with respect to Caprogel, if approved.

Other Product Candidates and Development Activities

We continually evaluate opportunities for late-stage or currently marketed complementary product and for expansion of our existing product franchises and, if and when appropriate, intend to pursue such opportunities through further product acquisitions and related development activities. Our ability to execute on such opportunities in some circumstances may be dependent upon our ability to raise additional capital on commercially reasonable terms.

Product Licensing Collaborations

Istalol, Xibrom and Ecabet Sodium Collaborations With Senju

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

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

Vitrase Commercialization Outside of the United States

Europe- Allergan

In September 2004, we entered into a new agreement with Allergan, Inc. replacing our previous Vitrase collaboration, and reacquired all rights to market and sell Vitrase for all uses in the United States and other specified markets. Under our new agreement, we paid Allergan approximately $10 million, which was paid in full in January 2005. We have also agreed to make royalty payments to Allergan on our U.S. sales of Vitrase for use in the posterior region of the eye. Allergan has an

option to commercialize Vitrase in Europe after European Union, or EU, product approval. If Allergan does not exercise its option, then these European rights will revert to us, and Allergan will be paid a royalty on our European sales of Vitrase for use in the posterior region of the eye.

Under our agreement with Allergan, we have responsibility to file for regulatory approval for Vitrase for vitreous hemorrhage in Europe. During the third quarter of 2005, we filed with the European Medicines Evaluations Agency, or EMEA, our centralized Marketing Authorisation Application, or MAA, seeking European market approval of Vitragan (ovine hyaluronidase) for the treatment of vitreous hemorrhage. Vitragan is our proprietary formulation of highly purified ovine hyaluronidase which is commonly known in the United States as Vitrase. In January 2006, the EMEA accepted for review our Vitragan MAA. The Vitragan MAA is based primarily upon our existing clinical trial data, including results from our two Phase III Vitrase studies for the treatment of vitreous hemorrhage. We expect that the EMEA review process will most likely result in a decision on our Vitragan MAA by the first half of 2007.

Japan- Otsuka

In December 2001, we entered into certain agreements with Otsuka Pharmaceutical Co., Ltd. with respect to the commercialization of Vitrase in Japan for ophthalmic uses in the posterior region of the eye. Under the terms of our agreements with Otsuka, Otsuka is responsible for preclinical studies, clinical trials, applying for and obtaining regulatory approvals and other development activities for Vitrase for ophthalmic uses in the posterior region of the eye in Japan. We are responsible for supplying Otsuka its requirements of Vitrase for clinical trials and, if approved, for commercial sale in Japan. Otsuka is responsible for the marketing, sale and distribution of Vitrase, if approved, in Japan. In connection with its license of Vitrase, Otsuka paid us a non-refundable license fee of $5 million as part of the license agreement. Otsuka has also agreed to pay us a milestone payment of $10 million upon regulatory approval of Vitrase for the treatment of vitreous hemorrhage in Japan. To date, we have not earned this milestone payment from Otsuka and we cannot guarantee that we will earn or receive this milestone payment in the future. Otsuka is required to purchase Vitrase from us at a percentage of the annual National Health Insurance price as established for Vitrase in Japan during the term of the license agreement, unless we are unable to supply Vitrase to Otsuka. If we are unable to supply Vitrase to Otsuka and Otsuka, or a third party, is required to manufacture Vitrase to meet Otsuka’s supply requirements, we will only receive a royalty on sales of Vitrase by Otsuka. Our agreements with Otsuka will terminate upon the later of 15 full calendar years following the date of the first commercial sale of Vitrase for licensed uses in Japan and the expiration date of the last-to-expire licensed patent relating to Vitrase for licensed uses in Japan. Otsuka may terminate the agreements at any time with six months notice to us. We may terminate the agreements if Otsuka fails to submit an application for regulatory approval of Vitrase in Japan within 12 months of completing all necessary clinical trials and the initial meeting with the Japanese Ministry of Health to review the clinical trial results.

Caprogel Collaboration With the Eastern Virginia Medical School

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

Under the terms of our agreement with the Eastern Virginia Medical School, we are responsible for development activities, including clinical trials and the preparation and submission of regulatory approvals, for Caprogel. We will also be responsible for the manufacturing, marketing and sale of Caprogel, if approved. The Eastern Virginia Medical School will receive royalty payments on all sales of Caprogel by us worldwide. The license agreement with the Eastern Virginia Medical School will terminate upon the last-to-expire licensed patent in the United States relating to Caprogel. We may terminate the license agreement with the Eastern Virginia Medical School upon three months prior written notice.

Marketing and Sales

We continue to expand our commercial infrastructure in connection with the marketing, sale and distribution of our approved products in the United States. We have hired eight regional sales managers and have expanded our specialty sales force to 72 sales representatives as of December 31, 2005 to support our commercial launch of Xibrom. Ventiv Pharma Services LLC continues to provide us with administrative and other services, including training, analytics, and operational support. We continue to target our commercialization efforts towards approximately 10,000 ophthalmologists, who comprise the most prolific prescribers of ophthalmic beta-blockers, non-steroidal anti-inflammatories and the highest volume cataract surgeons.

Customers and Distribution

We sell both Istalol and Xibrom primarily to drug wholesalers, retailers and distributors, including large chain drug stores, hospitals, clinics, government agencies and managed healthcare providers such as health maintenance organizations and other institutions. These customers comprise a significant part of the distribution network for pharmaceutical products in the United States. This distribution network is continuing to undergo significant consolidation marked by mergers and acquisitions among wholesale distributors and the growth of large retail drug store chains. As a result, a small number of large, wholesale distributors control a significant share of the market, and the number of independent drug stores and small drug store chains has decreased. We expect that consolidation of drug wholesalers and retailers will impact pricing and create other competitive pressures on drug manufacturers. In general, we are obligated to accept from customers the return of pharmaceuticals that have reached their expiration date. We authorize returns for damaged products and exchanges for expired products in accordance with our return goods policy and procedures, and have established reserves for such amounts at the time of sale.

In addition to selling Vitrase through the above distribution channels, we sell Vitrase for use as a spreading agent to specialty distributors and directly to physicians, hospitals, and clinics.

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

Sales to AmeriSource Bergen Corp, McKesson HBOC and Cardinal Health, Inc. accounted for 17%, 38% and 25%, respectively, of our annual net revenues during 2005. The loss of any of these customers could materially and adversely affect our business, results of operations, financial condition and cash flows. Due to the relatively short lead-time required to fill orders for our products, backlog of orders is not material to our business.

Competition

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

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

Amphadase five year new chemical exclusivity. The FDA has stated that the hyaluronidase in these products and other previously approved products is not fully characterized and therefore insufficient information exists to determine whether the active moiety in any of these products was previously approved. In October 2005, the FDA approved Hydase (hyaluronidase injection, USP) 150 UI mL, a bovine hyaluronidase, for use as a spreading agent. Hydase is manufactured by PrimaPharm, Inc. and is sold and competes against Vitrase. In December 2005, the FDA approved Hylenex recombinant (hyaluronidase human injection) for use as a spreading agent. Hylenex is manufactured by Halozyme Therapeutics and will be marketed and sold by Baxter Healthcare and would compete against Vitrase. Our ability to secure the benefit of the Vitrase market exclusivity depends on a variety of factors, some of which are beyond our control, including, among others, the timing, content and outcome of actions and decisions by the FDA and other regulatory authorities regarding third party products and the impact and scope of the Vitrase market exclusivity and its affect on third party products.

Manufacturing

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

Research and Development

Since our inception, we have made substantial investments in research and development. During the years ended December 31, 2005, 2004 and 2003, we spent $16.6 million, $15.6 million and $17.3 million, respectively, on research and development activities.

We plan to focus our near-term research and development efforts on the continued development of our marketed products and the products in our current development pipeline. Building on these development efforts, 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.

Patents and Proprietary Rights

Our success will depend in part on our ability to obtain patent protection for our inventions, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties. Our strategy is to actively pursue patent protection in the United States and foreign jurisdictions for technology that we believe to be proprietary and that offers a potential competitive advantage for our inventions. We currently own or license 43 United States and foreign patent applications and 78 United States and foreign issued patents.

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

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

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

Government Regulation

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

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

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preclinical studies;

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

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

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submission of a NDA to obtain marketing approval;

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review of the NDA; and

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

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

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

Preclinical studies include laboratory evaluation of the product, as well as animal studies to assess the potential safety and effectiveness of the product. These studies must be performed according to good laboratory practices. The results of the preclinical studies, together with manufacturing information and analytical data, are submitted to the FDA as part of the 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. Each clinical trial must be reviewed and approved by an independent institutional review board at each institution at which the study will be conducted. The institutional review board will consider, among other things, ethical factors, safety of human subjects and the possible liability of the institution. Also, clinical trials must be performed according to good clinical practices. Good clinical practices are enumerated in FDA regulations and guidance documents.

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

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safety;

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any adverse effects;

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proper dosage;

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absorption;

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metabolism;

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distribution;

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excretion; and

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other drug effects.

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

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

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

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

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.

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:

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seven years of exclusive marketing upon FDA approval;

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tax credit for clinical research expense;

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grant support for investigation of rare disease treatments; and

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user fee waiver.

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

In the United States, physicians, hospitals and other healthcare providers that purchase pharmaceutical products generally rely on third-party payers, principally private health insurance plans, Medicare and, to a lesser extent, Medicaid, to reimburse all or part of the cost of the product and procedure for which the product is being used. Even if a product is approved for marketing by the FDA, there is no assurance that third-party payers will cover the cost of the product and related medical procedures. Currently, a Current Procedural Terminology (“CPT”) code has been established for the intravitreal injection of a pharmaceutical agent, which, we believe, will be appropriate for physician billing for a Vitrase injection. This code may result in reimbursement for the physician’s services in administering the drug, but will not result in reimbursement for the drug itself. Drug specific coverage policies are primarily developed by Medicare carriers following Medicare’s criteria for drug coverage, which include, among other requirements, that the drug be FDA-approved, be used in connection with a physician service and be medically reasonable for the treatment of an illness or injury. In November 2005, the Center for Medicare and Medicaid Services, or CMS, established two new national Healthcare Common Procedure Coding Systems, or HCPCS, J-Codes covering the injection of preservative free ovine hyaluronidase, Vitrase. Physicians have been able to use these new J-Codes since January 2006. HCPCS Codes are used by healthcare insurers to process reimbursement claims. We believe that these two new J-Codes will help facilitate third-party reimbursement for Vitrase. However, Vitrase sales in the future maybe negatively impacted by reimbursement levels established by third-party payers.

While reimbursement for Vitrase may be available under existing payment codes, such reimbursement cannot be guaranteed. Each Medicare carrier reviews such reimbursement requests separately. Uniform national Medicare reimbursement for our injectable drug products will require a favorable National Coverage Determination for our injectable drug, which would be issued by CMS following review of an application by the manufacturer. Although they are not required to do so, private health insurers often follow the Medicare program’s lead when determining whether or not to reimburse for a drug. To support our applications for reimbursement coverage with Medicare and other major third-party payers, we intend to use data from clinical trials. The lack of satisfactory reimbursement for our drug products would limit their widespread use and lower potential product revenues.

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

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

Human Resources

As of January 31, 2006, we had 161 full-time employees. Of our employees, 31 are engaged in research and development, 8 in manufacturing, 14 in quality assurance and quality control, 88 in sales and marketing, and 20 in

administration. Our employees do not have a collective bargaining agreement. We consider our relations with our employees to be good.

General Information

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

We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to these reports available on our website, at http://www.istavision.com, free of charge as soon as practicable after filing with the SEC. All such reports are also available free of charge via EDGAR through the SEC website at www.sec.gov. In addition, the public may read and copy materials filed by ISTA with the SEC at the SEC’s public reference room located at 100 F St., NE, 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.

Item 1A:

Risk Factors.

In addition to other information included in this report, the following factors, among others, could cause actual results to differ materially from those contained in forward-looking statements contained in this Annual Report on Form 10-K, and thus should be considered carefully in evaluating our business and future prospects.

Risks Related to Our Business

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

Approval from the FDA is necessary to manufacture and market pharmaceutical products in the United States. Three of our product candidates, Vitrase for use as a spreading agent, Istalol and Xibrom, have received regulatory approval from the FDA.

The regulatory approval process is extensive, time-consuming and costly, and there is no guarantee that the FDA will approve additional NDAs for our product candidates, or that the timing of any such approval will be appropriate for our product launch schedule and other business priorities, which are subject to change.

We filed and the FDA accepted an NDA for Vitrase for the treatment of vitreous hemorrhage. 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. We are continuing our discussions with the FDA on this NDA and other potential uses of Vitrase, such as diabetic retinopathy. In February 2006, we announced positive results from our Phase III study of our combination product (tobramycin 0.3% / prednisolone acetate 1.0%) for the treatment of steroid-responsive inflammatory ocular conditions where risk of bacterial infection exists. Based on our Phase III study results, we plan to submit to the FDA an NDA for our combination product in the first half of 2006. We cannot guarantee that we will in fact submit an NDA within the timeframe mentioned above. In addition, we cannot guarantee that if we do submit our NDA to the FDA, the FDA will accept our NDA for review or, if accepted for review, will approve our NDA for our combination product in a timely fashion on commercially viable terms, or at all.

Clinical testing of pharmaceutical products is also a long, expensive and uncertain process. Even if initial results of preclinical studies or clinical trial results are positive, we may obtain different results in later stages of drug development, including failure to show desired safety and efficacy. The clinical trials of any of our product candidates could be unsuccessful, which would prevent us from obtaining regulatory approval and commercializing the product. In February 2006, we announced positive preliminary results from our U.S. randomized, three-arm (placebo/3.0%/3.9%) Phase IIb clinical study of ecabet sodium for the treatment of dry eye syndrome. The preliminary results of our Phase IIb study demonstrated a strong trend in efficacy for the lower (3%) dose with respect to ecabet sodium’s ability to address two objective signs of dry eye syndrome, corneal staining and blink rate. In addition, patients treated with the lower dose of ecabet sodium reported positive trends for reductions in symptomatology as measured by ocular surface disease index and most bothersome symptom. In the preliminary results, no efficacy trends versus placebo were observed with respect to the higher (3.9%) dose. Further analyses of our ecabet sodium Phase IIb results are ongoing. We plan to complete our analyses of our Phase IIb study results to confirm our preliminary findings and, in parallel, conduct a smaller, short-term confirmatory study designed to further define the subpopulation of patients to enroll and other elements of any future Phase III studies of ecabet sodium. Assuming confirmation of our Phase IIb preliminary results and timely and successful completion of the confirmatory study, our plan is to initiate a Phase III study of ecabet sodium for the treatment of dry eye syndrome during 2007. However, we can provide no guarantee that a complete analysis of our Phase IIb study results, or further testing of ecabet sodium, will support our preliminary Phase IIb findings or further development or regulatory approval of this drug.

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

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

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

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

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

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

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

In addition, we intend to market, pursuant to our collaborations, certain of our products, and perhaps have certain of our products or raw materials manufactured, in foreign countries. For example, in accordance with our agreement with Allergan, we have filed a centralized filing with the European Medicines Evaluations Agency seeking European market approval of Vitragan for the treatment of vitreous hemorrhage. Vitragan is our proprietary formulation of highly purified ovine hyaluronidase which is commonly known in the United States as Vitrase. Many other countries, including major European countries and Japan, have similar requirements as the United States for the manufacture, marketing and sale of pharmaceutical products. In addition, the process of obtaining approvals in foreign countries is subject to delay and failure for similar reasons.

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

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

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

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

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our ability to fund our sales and marketing efforts; and

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the effectiveness of our sales and marketing efforts.

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

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

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

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

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

Rapid growth of our business is likely to place a significant strain on our managerial, operational and financial resources and systems. We have increased our full-time employee count from 63 as of December 31, 2004 to 165 as of December 31, 2005. We expanded our sales force from 50 sales representatives as of the first quarter of 2005 to 72 sales representatives as of December 31, 2005. To manage our anticipated growth successfully, we must attract and retain qualified

personnel and manage and train them effectively. We will be dependent on our personnel and third parties to effectively manufacture, market, sell and distribute our products. We will also depend on our personnel and third parties to successfully develop and acquire new products. Further, our anticipated growth will place additional strain on our suppliers and manufacturers, resulting in increased need for us to carefully manage these relationships and monitor for quality assurance. Although we may not in fact grow as we expect, if we fail to manage our growth effectively or to develop and expand a successful commercial infrastructure to support marketing and sales of our products, our business and financial results will be materially harmed.

We have a history of net losses and negative cash flow, and we may need to raise additional working capital.

We have never been profitable, and we might never become profitable. In this regard, we anticipate that our operating expenses will continue to increase from historical levels as we continue to expand our commercial infrastructure in connection with our commercialization of our approved products. As of December 31, 2005, our accumulated deficit was $226.5 million, including a net loss of approximately $38.5 million for the twelve months ended December 31, 2005. As of December 31, 2005, we had approximately $38.6 million in cash and cash equivalents and short-term investments and working capital of $32.9 million. We believe our current cash and cash equivalents and short-term investments on hand will be sufficient to finance anticipated capital and operating requirements for at least the next twelve months. Additionally, during December 2005, we secured a revolving line of credit with Silicon Valley Bank in the amount of $10.0 million.

If we are unable to generate sufficient product revenues, we may be required to raise additional capital in the future through collaborative agreements or public or private equity or debt financings. If we are required to raise additional capital in the future such additional financing may not be available on favorable terms, or at all, or may be dilutive to our existing stockholders. If we fail to obtain additional capital as and when required such failure could have a material adverse impact on our operating plan and business.

If we default under our credit facility, we could be required to immediately repay all outstanding borrowings, which could negatively impact our financial position.

We have a $10.0 million revolving line of credit under a loan and security agreement, pursuant to which we may borrow money at variable rates of interest, which may expose us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase and our net income and cash flows would decrease. The loan and security agreement also contains certain covenants based on our financial performance. If we violate any of these financial performance covenants, or are otherwise in default, our lender has the option to declare all outstanding borrowings immediately due and payable, which could have a material adverse impact on our financial position and business.

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

We recognize product revenue net of estimated allowances for discounts, returns, rebates and chargebacks. Such estimates require our most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. Based on industry practice, pharmaceutical companies, including us, have liberal return policies. Generally, we are obligated to accept from customers the return of pharmaceuticals that have reached their expiration date. We authorize returns for damaged products and exchanges for expired products in accordance with our return goods policy and procedures. In addition, like our competitors, we also give credits for chargebacks to wholesale customers that have contracts with us for their sales to hospitals, group purchasing organizations, pharmacies or other retail customers. A chargeback is the difference between the price the wholesale customer pays and the price that the wholesale customer’s end-customer pays for a product. Actual results may differ significantly from our estimated allowances for discounts, returns, rebates and chargebacks. Changes in estimates and assumptions based upon actual results may have a material impact on our results of operations and/or financial condition. In addition, our financial position, results of operations and cash flows may be materially and negatively impacted if actual future payments for allowances, discounts, returns, rebates and chargebacks exceed the estimates we made at the time of the sale of our products.

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

We have entered into a master services agreement with R.P. Scherer West, Inc., which was subsequently acquired by and remains a wholly owned subsidiary of Cardinal Health, Inc., for the manufacture of commercial quantities of our Vitrase product in a lyophilized 6,200 USP units multi-purpose vial and a supply agreement with Alliance Medical Products, Inc. for the manufacture of commercial quantities of our Vitrase product in 200 USP units/mL in sterile solution. We also have

entered into a manufacturing services agreement with Bausch & Lomb Incorporated for the manufacture of commercial quantities of Istalol and Xibrom. Before any contract manufacturer can produce commercial quantities of a product, we must demonstrate to the FDA’s satisfaction that the product source for commercial quantities is substantially equivalent to the supply of the product used in our clinical trials. Such demonstration may include the requirement to conduct additional clinical trials. In addition, the manufacturing facilities of all of our contract manufacturers must comply with current Good Manufacturing Practice, or 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 and, once approved, such facilities must maintain their compliance and good standing with regulatory authorities. R.P. Scherer West, Alliance Medical Products, Bausch & Lomb, or any other manufacturer we may contract with in the future may not be able, as applicable, to develop processes necessary to produce substantially equivalent product to those products used in our clinical trials so that regulatory authorities will approve them as a manufacturer, or such facilities, once approved, may not produce on a timely basis enough product to meet our sales demands, or they may not maintain their compliance and good standing with regulatory authorities. Any such failures could delay or stop our efforts to develop our product candidates and commercialize our products.

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

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

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

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

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

Our dependence upon key personnel to operate our business puts us at risk of a loss of expertise if key personnel were to leave us.

We depend upon the experience and expertise of our executive management team. The competition for executives, as well as for skilled product development and technical personnel, in the pharmaceutical industry is intense and we may not be able to retain or recruit the personnel we need. If we are not able to attract and retain existing and additional highly qualified management, sales, clinical and technical personnel, we may not be able to successfully execute our business strategy.

Risks Related to Our Industry

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

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

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

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

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

Regulatory requirements applicable to pharmaceutical products make the substitution of suppliers and manufacturers costly and time consuming. We have no internal manufacturing capabilities and are, and expect to be in the future, entirely dependent on contract manufacturers and suppliers for the manufacture of our products and for their active and other ingredients. The disqualification of these suppliers through their failure to comply with regulatory requirements could negatively impact our business because the delays and costs of obtaining and qualifying alternate suppliers (if any) could delay clinical trials or otherwise inhibit our ability to bring approved products to market or could result in a delay or disruption in the manufacture, marketing or sales of our products, which would have a material adverse affect on our business and financial condition.

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

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

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our patents and pending patent applications cover products and/or technology that we invented first;

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

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

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any of our pending patent applications will result in issued patents; and

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

We currently own or license 43 U.S. and foreign patents and 78 U.S. and foreign pending patent applications. Our existing patents, or any patents issued to us as a result of such applications, may not provide us a basis for commercially viable products, may not provide us with any competitive advantages, or may 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 patent rights from the Eastern Virginia Medical School for Caprogel and from Senju for Istalol, Xibrom and ecabet sodium. Some of these license agreements do not permit us to control the prosecution, maintenance, protection and defense of such patents. If the licensor chooses not to protect its own patent rights, we may not be able to take actions to secure our related product marketing rights. In addition, if such patent licenses are terminated before the expiration of the licensed patents, we may no longer be able to continue to manufacture and sell such products as may be covered by the patents.

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

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

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

We have not conducted an extensive search of patents issued to other parties and such patents which contain claims relating to our technology and products may exist, may have been filed, or could be issued. If such patents do exist, the owners may bring claims against us for infringement, which might have an adverse effect on our business.

If third-party reimbursement is not available at satisfactory levels or at all, our products may not be accepted in the market.

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

Both governmental and private third-party payers are increasingly attempting to limit both the coverage and the level of reimbursement of new drug products to contain costs. Consequently, significant uncertainty exists as to the reimbursement status of newly approved healthcare products. Third-party payers may not establish adequate levels of reimbursement for any

of our approved products or products we develop or acquire in the future, which could limit their market acceptance and result in a material adverse effect on our financial condition. In November 2005, the Center for Medicare and Medicaid Services, or CMS, established two new national Healthcare Common Procedure Coding Systems, or HCPCS, J-Codes covering the injection of preservative free ovine hyaluronidase. Physicians have been able to use these new J-Codes since January 2006. HCPCS Codes are used by healthcare insurers to process reimbursement claims. We believe that these two new J-Codes will help facilitate third-party reimbursement for Vitrase. However, Vitrase sales in the future could be negatively impacted by reimbursement levels established by third-party payers.

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

Our principal customers are wholesale drug distributors and major retail drug store chains. These customers comprise a significant part of the distribution network for pharmaceutical products in the U.S. This distribution network is continuing to undergo significant consolidation marked by mergers and acquisitions among wholesale distributors and the growth of large retail drug store chains. As a result, a small number of large wholesale distributors control a significant share of the market, and the number of independent drug stores and small drug store chains has decreased. We expect that consolidation of drug wholesalers and retailers will increase pricing and other competitive pressures on drug manufacturers. For the year ended December 31, 2005, our three largest customers accounted for 17%, 38% and 25%, respectively, of our net revenues. The loss of any of our customers could materially adversely affect our business, results of operations and financial condition and our cash flows. In addition, none of our customers are party to any long-term supply agreements with us which would enable them to change suppliers freely should they wish to do so.

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

Any of our products that have been or in the future are approved by the FDA may be purchased or reimbursed by state and federal government authorities, private health insurers and other organizations, such as health maintenance organizations and managed care organizations. Such third party payors increasingly challenge pharmaceutical product pricing. The trend toward managed healthcare in the United States, the growth of such organizations, and various legislative proposals and enactments to reform healthcare and government insurance programs, including the Medicare Prescription Drug Modernization Act of 2003, could significantly influence the manner in which pharmaceutical products are prescribed and purchased, resulting in lower prices and/or a reduction in demand. Such cost containment measures and healthcare reforms could adversely affect our ability to sell our products. Furthermore, individual states have become increasingly aggressive in passing legislation and implementing regulations designed to control pharmaceutical product pricing, including price or patient reimbursement constraints, discounts, restrictions on certain product access, importation from other countries and bulk purchasing. Legally mandated price controls on payment amounts by third party payors or other restrictions could negatively and materially impact our revenues and financial condition. We anticipate that we will encounter similar regulatory and legislative issues in most other countries outside the United States.

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

We have numerous competitors in the United States and abroad, including major pharmaceutical and specialized biotechnology firms, universities and other research institutions that may be developing competing products. Such competitors may include, among others, Allergan, Alcon Laboratories, Inc., Amphastar Pharmaceuticals, Inc., Bausch & Lomb, Halozyme Therapeutics, Inc., Johnson & Johnson, Novartis AG, Pfizer, Inc., Eli Lilly and Company, PrimaPharm, Inc. and Inspire Pharmaceuticals, Inc. These competitors may develop technologies and products that are more effective or less costly than our current or future products or product candidates or that could render our technologies, products and product candidates obsolete or noncompetitive. Many of these competitors have substantially more resources and product development, manufacturing and marketing experience and capabilities than we do. Many of our competitors also have more resources committed to and expertise in effectively commercializing, marketing, and promoting products approved by the FDA, including communicating the effectiveness, safety and value of the products to actual and prospective customers and medical professionals. In addition, many of our competitors have significantly greater experience than we do in undertaking preclinical testing and clinical trials of pharmaceutical product candidates and obtaining FDA and other regulatory approvals of products and therapies for use in healthcare. In August 2005, the FDA approved Nevanac™ (nepafenac ophthalmic suspension) 0.1% for the treatment of pain and inflammation associated with cataract surgery. Nevanac, sold by Alcon, is marketed as an alternative to and competes against Xibrom.

In addition, competition from generic drugs is a major challenge in the United States to branded drug companies, like us, and may have a material adverse effect on our product revenues. In October 2004, the FDA granted Istalol a “BT” rating, which means that prescriptions for Istalol cannot be substituted legally at pharmacies with generic timolol maleate products. Nonetheless, we believe that certain pharmacies may have substituted, and may be continuing to substitute, Istalol prescriptions with generic timolol maleate solutions. We have completed an educational campaign to make our customers and pharmacies aware of Istalol’s BT rating and that Istalol cannot be substituted legally at pharmacies with generic timolol maleate products. In October 2004, the FDA informed us that Vitrase (hyaluronidase for injection; lyophilized, ovine) for use as a spreading agent to facilitate the dispersion and absorption of other drugs was entitled to five-year new chemical entity market exclusivity pursuant to the federal Food, Drug and Cosmetic Act. The FDA indicated that Vitrase’s new chemical entity exclusivity would bar submission to FDA of certain third party 505(b)(2) NDAs and Abbreviated New Drug Applications, or ANDAs, for drugs containing the same active moiety as Vitrase. The submission bar would be for five years from Vitrase’s approval date (i.e., May 5, 2004) or for four years in the case of patent challenges. The FDA also said that Vitrase’s new chemical entity exclusivity is not a prohibition on FDA’s review and approval of any 505(b)(2) NDA or ANDA that was submitted to the agency before Vitrase was granted five-year exclusivity. In October 2004, the FDA approved Amphadase (hyaluronidase injection, USP) 150 IU mL, a bovine-sourced hyaluronidase, for use as a spreading agent. Amphadase is sold by Amphastar Pharmaceuticals, Inc. and competes against Vitrase. The FDA has stated that Vitrase’s five year new chemical exclusivity did not bar approval of Amphadase since Amphadase did not contain the same active moiety has Vitrase. For the purposes of market exclusivity, the FDA presumes that a product does not contain a previously approved active moiety if the agency has insufficient information to determine whether, in fact, it contains one. Like Vitrase, FDA has also granted Amphadase five year new chemical exclusivity. The FDA has stated that the hyaluronidase in these products and other previously approved products is not fully characterized and therefore insufficient information exists to determine whether the active moiety in any of these products was previously approved. In October 2005, the FDA approved Hydase (hyaluronidase injection, USP) 150 UI mL, a bovine hyaluronidase, for use as a spreading agent. Hydase is manufactured by PrimaPharm, Inc. and is sold and competes against Vitrase. In December 2005, the FDA approved Hylenex recombinant (hyaluronidase human injection) for use as a spreading agent. Hylenex is manufactured by Halozyme Therapeutics and will be marketed and sold by Baxter Healthcare and would compete against Vitrase. Our ability to secure the benefit of the Vitrase market exclusivity depends on a variety of factors, some of which are beyond our control, including, among others, the timing, content and outcome of actions and decisions by the FDA and other regulatory authorities regarding third party products and the impact and scope of the Vitrase market exclusivity and its affect on third party products.

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

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

We currently maintain sold products and clinical trial liability insurance with per occurrence and aggregate coverage limits of $10.0 million. The coverage limits of our insurance policies may be inadequate to protect us from any liabilities we might incur in connection with clinical trials or the sale of our products. Product liability insurance is expensive and in the future may not be available on commercially acceptable terms, or at all. A successful claim or claims brought against us in excess of our insurance coverage could materially harm our business and financial condition.

Risks Related to Our Stock

Our stock price is subject to significant volatility.

Since 2001 until the present, the daily closing price per share of our common stock has ranged from a high of $133.75 per share to a low of $2.60 per share, as adjusted for the 1-for-10 reverse stock split effected November 2002. Our stock price has been and may continue to be subject to significant volatility. Among others, the following factors may cause the market price of our common stock to fall:

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

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market acceptance and demand for our approved products;

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

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

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

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

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period-to-period fluctuations in our financial results;

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public concern as to the safety of new technologies;

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future sales of debt or equity securities by us;

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

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comments made by securities analysts; and

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

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

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

The average daily trading volume in our common stock for the twelve-month period ended December 31, 2005 was approximately 151,768 shares and the average daily number of transactions was approximately 480 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.

Substantial future sales of our common stock in the public market may depress our stock price and make it difficult for you to recover the full value of your investment in our shares.

We have approximately 25.9 million shares of common stock outstanding, most of which are freely tradable. In addition, we also issued warrants exercisable for the purchase of up to an aggregate of 1,842,104 shares of our common stock for a purchase price of $3.80 per share (as of December 31, 2005, 300,163 warrants have been exercised). The market price of our common stock could drop due to sales of a large number of shares or the perception that such sales could occur. These factors also could make it more difficult to raise funds through future offerings of common stock.

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

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

As of January 31, 2006, our directors and officers, as a group, control approximately 30% of our voting securities, a concentration of ownership that could delay or prevent a change in control. We are contractually obligated to include a representative of Investor Growth Capital as a nominee for election to our board of directors and Sprout has the right to designate two such nominees. Our principal stockholders, if acting together, would be able to influence and possibly control most matters submitted for approval by our stockholders, including the election of directors, delaying or preventing a change of control, and the consideration of transactions in which stockholders might otherwise receive a premium for their shares over then-current market prices.

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

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

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a classified board of directors;

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

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

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

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

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

We have never declared or paid cash dividends on our common stock and do not plan to pay any cash dividends in the near future. Our current policy is to retain all funds and any earnings for use in the operation and expansion of our business. The payment of cash dividends by us is restricted by our credit facility, which contain restrictions prohibiting us from paying any cash dividends without the lender’s prior approval.

Item 1B:

Unresolved Staff Comments.

None.

Item 2:

Properties.

We currently lease facilities, which approximate 44,739 square feet of laboratory and office space, in Irvine, California. The term of our Irvine, California leaseholds expire October 31, 2009 and September 30, 2015, but may be renewed by us for an additional five year term. We believe that these three facilities are adequate for our immediate needs. Additional space may be required, however, as we expand our research and clinical development, manufacturing and selling and marketing activities. We do not foresee any significant difficulties in obtaining any required additional facilities close to our current facility.

Item 3:

Legal Proceedings.

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

Item 4:

Submission of Matters to a Vote of Security Holders.

Set forth below is information concerning each matter submitted to a vote at the Annual Meeting of Stockholders on October 13, 2005.

Proposal No. 1: The stockholders elected three Class II directors to serve for a term of three years expiring upon the 2008 Annual Meeting of Stockholders or until his or her successor has been duly elected and qualified.


Nominee	Votes For	Votes Withheld
Vicente Anido, Jr.	22,855,950	467,607
Kathleen D. LaPorte	22,488,038	835,519
Richard C. Williams	22,856,150	467,407

The names and biographies of each continuing director, including those elected at the Annual Meeting of Stockholders on October 13, 2005, are set forth in Part III, Item 10 below.

Proposal No. 2: The stockholders ratified the appointment of Ernst & Young LLP as our independent auditors for the fiscal year ended December 31, 2005 (with 23,317,649 votes for, 4,790 votes against, and 1,118 votes abstaining).

Proposal No. 3: The stockholders approved and adopted our Second Amendment and Restatement of the 2004 Performance Incentive Plan (with 15,774,239 votes for, 1,975,976 votes against, and 6,480 votes abstaining).

PART II

Item 5:

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Price Range of Common Stock

Our common stock is listed on the Nasdaq National Market under the symbol “ISTA.” The following table shows the high and low sale prices for our common stock as reported by the Nasdaq National Market during the calendar quarters indicated:


	High		Low
Year Ended December 31, 2004
First Quarter	$	13.26	$	8.61
Second Quarter		15.60		9.35
Third Quarter		12.86		8.40
Fourth Quarter		12.19		8.86
Year Ended December 31, 2005
First Quarter	$	11.24	$	8.60
Second Quarter		9.80		6.91
Third Quarter		10.47		5.91
Fourth Quarter		7.24		5.56
Year Ending December 31, 2006
First Quarter (through January 31, 2006)	$	7.20	$	6.28

Holders of Common Stock

As of January 31, 2006, there were approximately 249 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. The payment of cash dividends by us is restricted by our credit facility, which contains restrictions prohibiting us from paying any cash dividends without the lender’s prior approval.

Equity Compensation Plans

The information specified by Item 201(d) of Regulation S-K of the Securities Act of 1933, as amended, regarding our equity compensation plans is set forth in Part III, Item 12 below.

Item 6:

Selected Financial Data.

The table below presents selected consolidated financial data of ISTA and our subsidiaries as of and for the years ended December 31, 2005, 2004, 2003, 2002 and 2001. The following selected consolidated financial data has been derived from our audited consolidated financial statements and should be read in conjunction with our consolidated financial statements contained herein, and related notes thereto, as well as our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K.


	Year Ended December 31, (in thousands, except per share data)
	2005			2004			2003			2002			2001
Consolidated Statement of Operations Data:
Revenues:
Product sales, net	$	10,382		$	1,619		$	—		$	—		$	—
License revenue		278			278			278			278			—

Total revenue		10,660			1,897			278			278			—

Cost of products sold		3,542			1,427			—			—			—

Gross profit margin		7,118			470			278			278			—
Costs and expenses:
Research and development		16,611			15,583			17,250			14,751			15,770
Selling, general and administrative		30,599			25,841			8,635			8,224			7,538

Total costs and expenses		47,210			41,424			25,885			22,975			23,308

Loss from operations		(40,092	)		(40,954	)		(25,607	)		(22,697	)		(23,308	)
Interest income		1,642			584			372			213			826
Interest expense		(30	)		(54	)		(10	)		(473	)		(25	)

Net loss attributable to common stockholders	$	(38,480	)	$	(40,424	)	$	(25,245	)	$	(22,957	)	$	(22,507	)

Net loss per common share, basic and diluted⁽¹⁾	$	(1.51	)	$	(2.22	)	$	(1.83	)	$	(7.53	)	$	(14.43	)

Shares used in computing net loss per share, basic and diluted⁽¹⁾		25,490			18,190			13,803			3,049			1,559

⁽¹⁾	In November 2002 we completed a 1-for-10 reverse stock split to the then outstanding common stock. All historical common shares and per share data have been adjusted for the reverse stock split.


	As of December 31, (in thousands)
	2005			2004			2003			2002			2001
Consolidated Balance Sheet Data:
Cash and cash equivalents and short-term investments	$	38,626		$	27,748		$	48,463		$	35,712		$	15,602
Working capital		32,990			18,872			44,193			33,046			12,079
Total assets		45,339			30,373			50,182			37,135			16,956
Deferred revenue		3,994			4,166			4,444			4,722			5,000
Other long-term obligations		255			455			9			10			2
Accumulated deficit		(226,543	)		(188,063	)		(147,639	)		(122,394	)		(99,437	)
Total stockholders’ equity		30,335			15,318			40,424			29,228			7,940

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 Annual Report on Form 10-K. 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 1A of Part I, under the heading “Risk Factors.”

The following discussion and analysis should be read in conjunction with our consolidated financial statements and the related notes to those statements contained elsewhere in this Annual Report on Form 10-K.

Overview

We are a specialty pharmaceutical company focused on the commercialization and development of unique and uniquely improved products for serious conditions of the eye. We currently have three products available for sale in the United States: (i) Istalol for the treatment of glaucoma, (ii) Vitrase for use as a spreading agent, and (iii) Xibrom for the treatment of ocular inflammation and pain following cataract surgery. We also have several product candidates in various stages of development. We have incurred losses since inception and had an accumulated deficit of $226.5 million through December 31, 2005.

Results of Operations

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

Years Ended December 31, 2005, 2004 and 2003

Revenue. Revenue was approximately $10.7 million in 2005, as compared to $1.9 million in 2004 and $278,000 in 2003. The increase in revenue in 2005 as compared to 2004 was primarily attributable to the launch of Vitrase and Xibrom in the first and second quarters of 2005, respectively. The increase in revenue in 2004 as compared to 2003 was primarily attributable to the launch of Istalol in the third quarter of 2004.

Of our total revenue for 2005, $10.4 million was derived from sales of our products, which included Xibrom’s initial stocking order. Net product sales for 2004 were $1.6 million, which was Istalol’s initial stocking order. There were no product sales during 2003.

In addition to product revenues in 2005 and 2004, we recorded license revenue of $278,000 in 2005, 2004 and 2003, which reflects the amortization for the period of deferred revenue recorded in December 2001 for the license fee payment made by Otsuka Pharmaceuticals Co., Ltd. in connection with the license of Vitrase in Japan for ophthalmic uses in the posterior region of the eye.

Cost of products sold. Cost of products sold was $3.5 million in 2005 as compared to $1.4 million in 2004. There were no product sales during 2003. Cost of products sold for 2005 consisted primarily of standard costs for each of our commercial products, distribution costs, royalties, inventory reserves for short dating of certain Istalol lots and other costs of products sold. The increase in cost of products sold in 2005 from 2004 was primarily the result of increased net product sales after the launch of our new products in 2005. Product gross margin for the twelve month period ended December 31, 2005 was $6.8 million, or 66% of net product sales, as compared to $192,000, or 12% of net product sales, for the twelve month period ended December 31, 2004 which included net product sales only from the launch of our first commercial product, Istalol, in the third quarter of 2004. The percentage increase in product gross margin for the twelve month period ended December 31, 2005

as compared to the prior 2004 period is primarily due to changes in our product mix resulting from launching two new products in 2005.

Research and development expenses. Research and development expenses were $16.6 million in 2005, $15.6 million in 2004 and $17.3 million in 2003. Our research and development expenses to date have consisted primarily of costs associated with the clinical trials of our product candidates, compensation and other expenses for research and development personnel, costs for consultants and contract research organizations and costs related to the development of commercial scale manufacturing capabilities for Vitrase, Istalol and Xibrom. Research and development expenses for 2005 included $1.3 million in milestone payments under various licensing agreements.

We generally classify and separate research and development expenditures into amounts related to clinical development costs, regulatory costs, pharmaceutical development costs, manufacturing development costs and medical affairs costs. In 2005, approximately 34% of our research and development expenditures were for clinical development costs, 22% was spent on regulatory costs, 10% was spent on pharmaceutical development costs, 18% was spent on manufacturing development costs and approximately 16% was spent on medical affairs costs.

Changes in our research and development expenses are primarily due to the following:

•

Clinical Development Costs — Overall clinical costs, which include clinical investigator fees, study monitoring costs and data management, for 2005 increased by $800,000 from 2004. The increase in clinical costs in 2005 was primarily due to the commencement and completion of enrollment during the second half of 2005 of the tobra/pred product Phase III clinical study and the ecabet sodium Phase IIb clinical study.

•

Regulatory Costs — Regulatory costs for 2005 increased by $200,000 from 2004. The increase is primarily attributable to the EMEA filing fees for Vitragan in Europe.

•

Pharmaceutical Development Costs — Research costs for 2005 decreased by $200,000 from 2004. The decrease is primarily due to the loss recorded on the transfer of assets to our raw material third party manufacturer during 2004.

•

Manufacturing Development Costs — Contract manufacturing costs for 2005 increased by $400,000 from 2004. The increase is primarily attributable to the scale up of activities associated with the increase in the number of commercial products during 2005 as compared to 2004 and the continued improvement of our product pipeline.

•

Medical Affairs Costs — Medical Affairs costs for 2005 increased by $2.1 million from 2004. The increase is due to the scale up of the department, increasing the headcount of the department and the related activities of the department. Medical Affairs department was created during 2004 to provide additional expertise to the Company. The costs in 2004 primarily relate to personnel costs.

Our research and development activities reflect our efforts to advance our product candidates through the various stages of 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 enrolling 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.

Depending upon the progress of our clinical and pre-clinical programs we expect our research and development expenses in 2006 to be approximately 10 - 15% higher than the same prior year period.

Selling, general and administrative expenses. Selling, general and administrative expenses were $30.6 million in 2005, $25.8 million in 2004 and $8.6 million in 2003. The $4.8 million increase in selling, general and administrative expenses in 2005 as compared to 2004 is primarily attributable to an increase of $13.9 million in sales and marketing expenses associated with the commercial launch of our approved products (including an increase in sales personnel from 28 to 72 representatives

as of December 31, 2005) offset by a decrease of $9.1 million in general corporate expenses. The decrease of $9.1 million in general corporate expenses is the result of a $900,000 increase in general corporate expense in 2005 principally related to facility and personnel costs, offset by a one-time payment during the third quarter of 2004 of $10.0 million which was recorded upon entering an agreement with Allergan pursuant to which we reacquired all rights to market and sell Vitrase for all uses in the United States and other specified markets.

The $17.2 million increase in selling, general and administrative expenses in 2004 as compared to 2003 was primarily attributable to (i) increases in selling and marketing expenses of $6.0 million to support the commercial launch of our approved products; (ii) increases in general and administrative expenses of $1.2 million due to increased administrative costs related to expanding our commercial operations and other general corporate expenses principally related to accounting and auditing fees associated with the Sarbanes Oxley Act of 2002; and (iii) one-time payment of $10.0 million to Allergan, Inc. in connection with our reacquisition of all rights to market and sell Vitrase for all uses in the United States and other specified markets.

We expect our selling, general and administrative expenses in 2006 to be approximately 10 - 15% higher than the same prior year period.

Stock-based compensation. Deferred compensation for stock options granted to employees and directors is the difference between the exercise price and the estimated fair value of the underlying common stock for financial reporting purposes on the date the options were granted. Deferred compensation is included as a component of stockholders’ equity and is being amortized in accordance with 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”, 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”, and SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure”, 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, 2005, we granted stock options to employees to purchase 959,000 shares of common stock at a weighted average exercise price of $9.08 per share, equal to the fair market value of our common stock at the time of grant. In previous years, we granted stock options to employees with a grant price less than the fair market value at the date of grant.

In connection with the grant of stock options to employees and directors, we recorded deferred compensation of approximately $53,000, $54,000 and $110,000 during the years ended December 31, 2005, 2004 and 2003, respectively, and recorded amortization of $196,000, $434,000 and $956,000 during the years ended December 31, 2005, 2004 and 2003, respectively.

Interest income. Interest income was $1.6 million in 2005, $584,000 in 2004 and $372,000 in 2003. The increase in interest income in 2005 was primarily attributable to higher cash balances as a result of our receipt of $53.0 million of net proceeds from our January 2005 financing and other stock issuances and higher rates of return as compared to 2004. The increase in interest income in 2004 is attributable to higher average cash balances on hand as compared to 2003, primarily as a result of our receipt of $35.7 million of net proceeds in connection with our November 2003 equity financing and $14.5 million of net proceeds in connection with our August 2004 equity financings.

Interest expense. Interest expense was approximately $30,000 in 2005, $54,000 in 2004 and $10,000 in 2003. Interest expense incurred during 2005 was primarily attributable to the interest accrued on the $3.5 million liability due (and fully paid during the first quarter of 2005) to Allergan as a result of our reacquisition of all rights to market and sell Vitrase in the United States and other specified markets. Interest expense incurred during 2004 was also primarily attributable to the interest accrued on the $3.5 million liability due to Allergan, which was entered into during the fourth quarter of 2004. The interest expense incurred during 2003 was primarily attributable to the interest paid on the financing of our directors’ and officers’ insurance premiums.

Income taxes. We incurred net operating losses in 2005, 2004 and 2003 and consequently did not pay any federal, state or foreign income taxes. At December 31, 2005, we had federal and California net operating loss carryforwards of

approximately $172.4 million and $132.5 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 2006, unless previously utilized. We also have federal and California research tax credit carryforwards of approximately $5.1 million and $2.8 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 manufacturer’s investment credit of approximately $34,000 that will begin to expire in 2008, 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.

Investments. We review investments in corporate bonds and government agency securities for other-than-temporary impairment whenever the fair value of an investment is less than amortized cost and evidence indicates that an investment’s carrying amount is not recoverable within a reasonable period of time. Investments in an unrealized loss position for greater than a year were comprised of corporate bonds and U.S. government agency securities. The unrealized losses were due to fluctuations in interest rates. To determine whether impairment is other-than-temporary, we consider whether we have the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable and outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, compliance with our investment policy, the severity and the duration of the impairment and changes in value subsequent to year end. We have reviewed those securities with unrealized losses as of December 31, 2005 and 2004 and have concluded that no other-than-temporary impairment existed as of December 31, 2005 and 2004.

Liquidity and Capital Resources

As of December 31, 2005, we had approximately $38.6 million in cash, cash equivalents and short-term investments and working capital of $33.0 million. Historically, we have financed our operations primarily through sales of our debt and equity securities. Since March 2000, we have received gross proceeds of approximately $201.3 million from sales of our common stock and the issuance of promissory notes. In addition, we received $5.0 million from a licensing arrangement entered into in 2001.

In December 2005, we entered into a revolving credit facility, whereby we may borrow up to $10.0 million. As of December 31, 2005, we had $8.5 million available for borrowing under the credit facility. All outstanding amounts under the credit facility bear interest at a variable rate equal to the lender’s prime rate or, at our option, LIBOR plus 2.5%, which is payable on a monthly basis. The credit facility also contains customary covenants regarding operations of our business and financial covenants relating to ratios of current assets to current liabilities and maximum losses during any calendar quarter and is collateralized by all of our assets with the exception of our intellectual property. As of December 31, 2005, we were in compliance with all of the covenants under the credit facility. All amounts owing under the credit facility will become due and payable on January 31, 2007.

During 2005, we used $43.1 million of cash for operations primarily as a result of the net loss of $38.5 million and a change in working capital of $5.2 million, which primarily includes a $3.5 million payment (including interest) incurred as a result our reacquisition of all rights to market and sell Vitrase in the United States and other specified markets from Allergan, and a combined increase in accounts receivable, net, and inventory, net, of $3.0 million. During 2004, we used $34.5 million of cash for operations principally as a result of the net loss of $40.4 million partially offset by non-cash compensation expense of $698,000, the transfer of equipment for technology of $214,000 and the change in other liabilities of $4.2 million, relative to the $10.0 million liability incurred in connection with our reacquisition of all rights to market and sell Vitrase for all uses in the United States and other specified markets ($6.5 million was paid prior to December 31, 2004). 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.

Net cash used in investing activities totaled $14.8 million during 2005 compared to $12.3 million of cash provided by investing activities during 2004. During 2003, $28.1 million of cash was used in investing activities. Cash used in investing activities for 2005 is primarily attributable to the purchase of our short-term investment securities. Cash provided for investing activities in 2004 is primarily attributable to the sale of an aggregate of 1,820,000 shares of common stock in two registered direct offerings in August 2004 at an aggregate purchase price of $15.5 million (before offering expenses and fees), which was subsequently invested in short-term investments. Cash used for investing activities in 2003 is primarily attributable to the follow-on public offering of 4,000,000 shares of common stock in November 2003 at an aggregate purchase price of $38.0 million (before offering expenses, fees and discounts), which was subsequently invested in short-term investments.

Net cash provided by financing activities totaled $54.9 million during 2005 compared to $14.7 million in 2004 and $35.5 million in 2003. The net cash provided by financing activities in 2005 is primarily the result of the sale of an aggregate of 6,325,000 shares of common stock under our universal shelf registration statement in an underwritten public offering for an aggregate purchase price of $56.2 million, before offering expenses and underwriting discounts. The net cash provided by financing activities in 2004 is primarily attributable to $14.3 million net cash from the sale of an aggregate of 1,820,000 shares of common stock in two registered direct offerings in August 2004 at an aggregate purchase price of $15.5 million. The net cash provided by financing activities in 2003 is primarily attributable to $35.2 million net proceeds from the public sale of 4,000,000 shares of common stock in November 2003.

We believe that our existing cash balances, together with amounts available for borrowing under our credit facility, will be sufficient to fund our operations at least through the end of 2006. However, our actual future capital requirements will depend on many factors, including the following:

•

the success of the commercialization of our products;

•

sales and marketing activities, and expansion of our commercial infrastructure, related to our approved products and product candidates;

•

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

•

the rate of progress of our research and development programs;

•

the time and expense necessary to obtain regulatory approvals;

•

activities and payments in connection with potential acquisitions of companies, products or technology;

•

competitive, technological, market and other developments;

•

our ability to establish and maintain collaborative relationships; and

•

opportunities for the acquisition of late-stage or currently marketed complementary product candidates.

These factors may cause us to seek to raise additional funds through additional sales of our debt or equity securities. 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.

Contractual Obligations

The following table summarizes our contractual obligations as of December 31, 2005:


	Payments due by period
Contractual Obligations	Total		Less than 1 year		1-3 years		3-5 years		More than 5 years
Operating Lease Obligations	$	2,661	$	809	$	1,428	$	424	$	—
Obligation Under Capital Leases		58		13		26		19		—
Long-term Liability Obligations		366		366		—		—		—

Total:	$	3,085	$	1,188	$	1,454	$	443	$	—

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 Annual Report on Form 10-K, are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. Our significant accounting policies are described in the notes to the audited consolidated financial statements contained elsewhere in this Annual Report on Form 10-K. Included within these policies are our “critical accounting policies.” Critical accounting policies are those policies that are most important to the preparation of our consolidated financial statements and require management’s most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. Although we believe that our estimates and assumptions are reasonable, actual results may differ significantly from these estimates. Changes in estimates and assumptions based upon actual results may have a material impact on our results of operations and/or financial condition.

We believe that the critical accounting policies that most impact the consolidated financial statements are as described below.

Revenue Recognition

Product Revenue. We recognize revenue from product sales, in accordance with Statement of Financial Accounting Standard No. 48 “Revenue Recognition When Right of Return Exists”, when there is persuasive evidence that an arrangement exists, when title has passed, the price is fixed or determinable, and we are reasonably assured of collecting the resulting receivable. We recognize product revenue net of estimated allowances for discounts, returns, rebates and chargebacks. If actual future payments for allowances for discounts, returns, rebates and chargebacks exceed the estimates we made at the time of sale, our financial position, results of operations and cash flows would be negatively impacted. In general, we are obligated to accept from our customers the return of pharmaceuticals that have reached their expiration date. We authorize returns for damaged products and exchanges for expired products in accordance with our return goods policy and procedures, and have established reserves for such amounts at the time of sale. With the launch of each of our products, we recorded a sales return allowance, which was larger for stocking orders than subsequent re-orders. To date, actual product returns have not exceeded our estimated allowances for returns. Although we believe that our estimates and assumptions are reasonable as of the date when made, actual results may differ significantly from these estimates. Our financial position, results of operations and cash flows may be materially and negatively impacted if actual returns exceed our estimated allowances for returns.

License Revenue. We recognize revenue consistent with the provisions of the Securities and Exchange Commission’s Staff Accounting Bulletin No. 104, “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.

Inventories

Inventory consists of currently marketed products. Inventory primarily represents raw materials used in production and finished goods inventory on hand, valued at standard cost. Inventories are reviewed periodically for slow-moving or obsolete status. If a launch of a new product is delayed, inventory may not be fully utilized and could be subject to impairment, at which point we would record a reserve to adjust inventory to its net realizable value. Inventories, net of allowances, are stated at the lower of cost or market. Cost is determined by the first-in, first-to-expire method.

Income Taxes

We record a full 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.

New Accounting Pronouncement

In December 2004, the FASB issued Statement No. 123R (Revised 2004), “Share-Based Payment”. The revisions to SFAS No. 123 require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards will be re-measured each reporting period. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. SFAS No. 123R replaces SFAS No. 123 and supersedes APB Opinion No. 25. For public entities, the provisions of the statement are effective as of the beginning of the first annual reporting period that begins after December 15, 2005. We will adopt the provisions of the new statement in the first fiscal quarter of 2006. Although we will continue to evaluate the application of SFAS No. 123R, we expect the adoption to have a material impact on our results of operations in amounts not yet determinable.

recognized as current-period charges. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. SFAS No. 151 is not expected to have a material impact on our financial statements.

In May 2005, the FASB issue SFAS No. 154, “Accounting Changes and Error Corrections”, which replaced APB Opinion No. 20, “Accounting Changes”, and SFAS No. 3, “Reporting Changes in Interim Financial Statements”. SFAS No. 154 requires retrospective application to prior periods’ financial statements of voluntary changes in accounting principles and changes required by a new accounting standard when the standard does not include specific transition provisions. Previous guidance required most voluntary change in accounting principle to be recognized by including in net income of the period in which the change was made the cumulative effect of changing to the new accounting principle. SFAS No. 154 carries forward existing guidance regarding the reporting of the correction of an error and a change in accounting estimate. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. Adoption of SFAS No. 154 as of January 1, 2006 is not expected to have a material effect on our consolidated financial position or 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. Seeking to minimize this risk, we 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 2005 was less than one year. Due to the short-term nature of these investments, we believe we have no material exposure to interest rate risk arising from our investments. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair market value of our interest sensitive financial investments. Declines in interest rates over time will, however, reduce our investment income, while increases in interest rates over time will increase our interest expense. Historically, and as of December 31, 2005, we have not used derivative instruments or engaged in hedging activities.

All outstanding amounts under our revolving credit facility bear interest at a variable rate equal to the lender’s prime rate or, at our option, LIBOR plus 2.5%, which is payable on a monthly basis and which may expose us to market risk due to changes in interest rates. As of December 31, 2005, we had $1.5 million outstanding under our credit facility. We estimate that a 10% change in interest rates on our credit facility would not have had a material effect on our net loss for 2005.

We have operated primarily in the United States. Accordingly, we have not had any significant exposure to foreign currency rate fluctuations.

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.

Our management, with the participation and under the supervision of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this Annual Report. The Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective based on their evaluation of these controls and procedures required by paragraph (b) of Exchange Act Rules 13a-15 and 15d-15. A controls system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the controls are met, and no evaluation of controls can provide absolute assurance that all controls and instances of fraud, if any, within a company have been detected.

Management Report On Internal Control Over Financial Reporting

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:

•

Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Company;

•

Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and

•

Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. In making this assessment, the Company’s management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.

Based on our assessment, management believes that, as of December 31, 2005, the Company’s internal control over financial reporting is effective based on those criteria.

The Company’s independent auditors have issued an audit report on our assessment of the Company’s internal control over financial reporting. This report appears below.

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s most recently completed fiscal quarter that materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

The Board of Directors and Stockholders of ISTA Pharmaceuticals, Inc.

We have audited management’s assessment, included in the accompanying Management Report on Internal Control Over Financial Reporting, that ISTA Pharmaceuticals, Inc. maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). ISTA Pharmaceuticals, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that ISTA Pharmaceuticals, Inc. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, ISTA Pharmaceuticals, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of ISTA Pharmaceuticals, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005 and our report dated March 1, 2006 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

San Diego, California

March 1, 2006

Item 9B:

Other Information.

None.

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 eight persons and one vacancy. Our Board of Directors is divided into three classes serving staggered terms of three years. The Class I directors, Peter Barton Hutt and Benjamin F. McGraw III, Pharm.D., are scheduled to serve until the annual meeting of stockholders in 2007. 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 2008. The Class III directors, Rolf Classon, Dean J. Mitchell, and Wayne I. Roe, are scheduled to serve until the annual meeting of stockholders in 2006.

The following table sets forth the names, ages as of January 31, 2006, principal occupations and year of appointment of our directors:


Name	Age	Principal Occupation	Director Since
Class I Directors
Peter Barton Hutt	71	Partner, Covington & Burling	2002
Benjamin F. McGraw III, Pharm.D.	56	Chairman, President and Chief Executive Officer, Valentis, Inc.	2000	*

Class II Directors
Vicente Anido, Jr., Ph.D.	53	President and Chief Executive Officer	2001
Kathleen D. LaPorte	44	Managing Director, New Leaf Venture Partners, L.L.C.	2002
Richard C. Williams	62	President, Conner-Thoele Limited	2002

Class III Directors
Dean J. Mitchell	50	President and Chief Executive Officer, Guilford Pharmaceuticals, Inc.	2004
Rolf Classon	60	Interim President and Chief Executive Officer, Hillenbrand Industries, Inc.	2004
Wayne I. Roe	55	Retired	1998	*

*	Dr. McGraw and Mr. Roe resigned as directors on November 19, 2002 in connection with the closing of a private placement financing and were reappointed as directors in December 2002.

Class I Directors

Peter Barton Hutt has served on our Board of Directors since November 2002. Mr. Hutt is a senior counsel specializing in food and drug law in the Washington, D.C. law firm of Covington & Burling. From time to time, Covington & Burling provides legal services to us. Mr. Hutt joined Covington & Burling in 1960 and was named partner in 1968, leaving from 1971 to 1975 to serve as Chief Counsel for the Food and Drug Administration and returning to Covington & Burling in September 1975. Mr. Hutt is the co-author of the casebook used to teach Food and Drug Law throughout the country and teaches a full course on the subject annually at Harvard Law School. Mr. Hutt is a member of the Board of Directors of Introgen Therapeutics, Inc., CV Therapeutics, Inc., Momenta Pharmaceuticals, Inc., Favrille, Inc. and Xoma Ltd. Mr. Hutt received a B.A. from Yale University and a LL.B. from Harvard University. In addition, Mr. Hutt received a Master of Laws degree in Food and Drug Law from New York University Law School.

Benjamin F. McGraw, III, Pharm.D. has served on our Board of Directors since April 2000, except for the period from November 2002 to December 2002. Dr. McGraw has been President and Chief Executive Officer since 1994, and Chairman of the Board since 1996, of Valentis, Inc., a biotechnology company. Prior to this, Dr. McGraw was Corporate Vice President for Corporate Development of Allergan. Before that, he was an equity analyst and a fund manager at Carerra Capital Management. Prior to this, he was Vice-President, Development for Marion Laboratories and Marion, Merrell Dow. Dr. McGraw received B.S. and Doctor of Pharmacy degrees from the University of Tennessee Center for the Health Sciences where he also completed a clinical practice residency.

Class II Directors

Vicente Anido, Jr., Ph.D. has served as our President and Chief Executive Officer and on our Board of Directors since December 2001. From June 2000 to September 2001, Dr. Anido was general partner for Windamere Venture Partners. From 1996 to 1999, Dr. Anido served as President and Chief Executive Officer of CombiChem, Inc., a biotechnology company. From 1993 to 1996, he served as President of the Americas Region of Allergan, a specialty pharmaceutical company focusing on ophthalmology, dermatology and neuromuscular indications. Dr. Anido is also a director of Apria Healthcare, Inc. Dr. Anido received a Ph.D. in Pharmacy Administration from the University of Missouri.

Kathleen D. LaPorte has served on our Board of Directors since November 2002. Ms. LaPorte is a Managing Director of New Leaf Venture Partners, LLC located in Menlo Park, California. Previously, Ms. LaPorte was a General Partner in the Healthcare Technology Group of the Sprout Group located in Menlo Park, California, which she joined in 1993 and became a General Partner in 1994. Between 1987 and 1993, Ms. LaPorte was a principal at Asset Management Company, a venture capital firm focused on early-stage investments. Previously, Ms. LaPorte was a financial analyst with The First Boston Corporation. Ms. LaPorte is a member of the Board of Directors of Adeza Biomedical Corporation and VNUS Medical Technologies, Inc. Ms. LaPorte received a B.S. from Yale University and a M.B.A. from Stanford University Graduate School of Business. Sprout Group has a contractual right to designate two representatives to be nominated to our Board of Directors. Ms. LaPorte is the designated representative of Sprout Group.

Richard C. Williams has served on our Board of Directors since December 2002 and as Chairman of our Board of Directors since July 2004. Since 1989, Mr. Williams has served as the founder and President of Conner-Thoele Limited, a consulting and financial advisory firm specializing in the healthcare industry and pharmaceutical segment. From 2000 to April 2001, Mr. Williams also served as Vice Chairman-Strategic Planning and director of King Pharmaceuticals, Inc. From 1992 to 2000, Mr. Williams served as Chairman and director of Medco Research, a cardiovascular pharmaceutical development company, prior to its acquisition by King Pharmaceuticals in 2000. From 1997 to 1999, Mr. Williams was Co-Chairman and a director of Vysis, a genetic biopharmaceutical company. Prior to founding Conner-Thoele Limited, Mr. Williams held various operational and financial management officer positions with Erbamont, N.V., Field Enterprises, Inc., Abbott Laboratories and American Hospital Supply Corporation. Mr. Williams is also a director of EP Med Systems and a director, Chairman and interim Chief Executive Officer of Cellegy Pharmaceuticals, Inc., a specialty biopharmaceutical company. Mr. Williams received a B.A. degree from DePauw University and an M.B.A. from the Wharton School of Finance.

Class III Directors

Dean J. Mitchell was appointed to our Board of Directors in July 2004. Mr. Mitchell previously assumed the roles of President and Chief Executive Officer at Guilford Pharmaceuticals, Inc. and following the merger with MGI Pharma Inc., has joined the Board of Directors of Guilford. Prior to joining Guilford, Mr. Mitchell had been the Vice President, Strategy at Bristol-Myers Squibb (BMS) from February 2004 to November 2004. From March 2002 to January 2004, he was the President, U.S. Primary Care, Worldwide Medicines Pharmaceuticals Group, a division of BMS. From September 2001 to February 2002, he was the President, International, Worldwide Medicines Pharmaceuticals Group, a division of BMS. From September 1999 to August 2001, he was the Senior Vice President, Clinical Development and Product Strategy of GlaxoSmithKline plc. From June 1995 to September 1999, he was the Vice President and General Manager, Specialty Divisions, Strategic Planning and Business Development of GlaxoSmithKline. Mr. Mitchell is on the Board of the National Pharmaceutical Council and serves as its Vice Chairman. He received his MBA degree from City University Business School (London, UK) and his B.Sc. degree in Biology from Coventry University, UK.

Rolf Classon was appointed to our Board of Directors in July 2004. In May 2005, Mr. Classon assumed the roles of interim President and Chief Executive Officer of Hillenbrand Industries. From October 2002 to July 2004, Mr. Classon was the President of Bayer HealthCare LLC, a subsidiary of Bayer AG. From October 2002 to July 2004, Mr. Classon served as the Chief Executive Officer of Bayer HealthCare LLC. From December 1995 to October 2002, Mr. Classon served as President of Bayer Diagnostics. From September 1991 to December 1995, Mr. Classon was an Executive Vice President in charge of Bayer Diagnostics’ Worldwide Marketing, Sales and Service operations. From May 1990 to September 1991, Mr. Classon was the President and Chief Operating Officer of Pharmacia Biosystems A.B. Prior to 1991, Mr. Classon served as President of Pharmacia Development Company Inc. and Pharmacia A.B.’s Hospital Products Division. Mr. Classon is a member of the Board of Directors of Enzon Pharmaceuticals, Inc., Hillenbrand Industries and Auxilium Pharmaceuticals. He received his Chemical Engineering Certificate from the Gothenburg School of Engineering, and he has a Business Degree from the University of Gothenburg.

Wayne I. Roe has served on our Board of Directors since June 1998, except for the period from November 2002 to December 2002. Mr. Roe was Senior Vice President for United Therapeutics, Inc., a biotechnology company, from November 1999 to November 2000. From November 1988 to March 1999, Mr. Roe founded and served in various management positions at Covance Health Economics and Outcome Services, a consulting firm for life sciences companies, last serving as Chairman of the Board of Directors. Mr. Roe is also currently a director of Aradigm Corporation, a developer of drug delivery systems, and is also currently a director of Favrille Inc., a biopharmaceutical company focused on the treatment of cancer and other diseases of the immune system. Mr. Roe received a M.A. in Political Economy from the State University of New York and an M.A. in Economics from the University of Maryland.

Other Executive Officers

Marvin J. Garrett (55) has served as our Vice President, Regulatory Affairs, Quality & Compliance since June 1999. From May 1994 to June 1999, Mr. Garrett was Vice President, Regulatory Affairs and Clinical Research for Xoma, Ltd., a biotechnology company. From 1990 to 1994, he was President and General Manager of Coopervision Pharmaceutical, a division of the Cooper Companies, Inc. Mr. Garrett received a B.S. in Microbiology from California State University, Long Beach.

Lisa R. Grillone, Ph.D. (56) has served as our Vice President, Clinical Research and Medical Affairs since August 2000. From 1990 to July 2000, Dr. Grillone served in various drug development positions with ISIS Pharmaceuticals, Inc., a biotechnology company, last serving as Executive Director, Intellectual Property Licensing. Dr. Grillone received a Ph.D. in Cell Biology and Anatomy from New York University.

Kathleen McGinley (56) has served as our Vice President, Human Resources and Corporate Services, since November 2003. From January 2003 to November 2003, Ms. McGinley served as a consultant to ISTA. From May 2000 to January 2003, Ms. McGinley served as Director and Vice President, Human Resources for Littlefeet, Inc. From December 1999 to May 2000 she served as Director of Human Resources for Combi-Chem/Dupont Pharmaceuticals in San Diego, CA. Ms. McGinley received a M.S. from the University of Tennessee, Knoxville.

Kirk McMullin (52) has served as Vice President, Operations since August 2002. From 1995 to 2002, Mr. McMullin was Vice President, Worldwide Manufacturing Support for Allergan. Mr. McMullin received a B.A. from Humboldt State University.

Thomas A. Mitro (48) has served as our Vice President, Sales & Marketing since July 2002. From 1980 to 2002, Mr. Mitro held several positions at Allergan, including Vice President, Skin Care, Vice President, Business Development and Vice President, e-Business. Mr. Mitro received a B.S. degree from Miami University.

Lauren P. Silvernail (47) has served as our Chief Financial Officer, Chief Accounting Officer and Vice President, Corporate Development, since March 2003. From 1995 to March 2003, Mrs. Silvernail served in various operating and corporate development positions for Allergan, most recently serving as Vice President, Business Development. From 1989 to 1994, she was a general partner at Glenwood Ventures and served as a director and operating manager for several portfolio companies. Mrs. Silvernail received a M.B.A. from the University of California, Los Angeles.

Family Relationships

There are no family relationships between any of our directors or executive officers.

Audit Committee and Audit Committee Financial Expert

The members of the Audit Committee of the Board of Directors are Richard C. Williams (Chairman), Benjamin F. McGraw, III, Pharm.D. and Wayne I. Roe, all of whom meet the definition of “independent” set forth in the NASDAQ corporate governance listing standards. The Board of Directors has also designated Mr. Williams and Dr. McGraw as our “audit committee financial experts,” as defined by the rules of the SEC. The Audit Committee’s responsibilities include: (i) reviewing the independence, qualifications, services, fees, and performance of the independent auditors, (ii) appointing, replacing and discharging the independent auditors, (iii) pre-approving the professional services provided by the independent auditors, (iv) reviewing the scope of the annual audit and reports and recommendations submitted by the independent auditors, and (v) reviewing our financial reporting and accounting policies, including any significant changes, with management and the independent auditors.

Code of Ethics and Conduct

We have adopted a Code of Ethics and Conduct that is applicable to all of our directors, officers and employees and have posted this Code of Ethics and Conduct on our website at www.istavision.com.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our directors, officers and beneficial owners of more than 10% of our Common Stock to file reports of ownership and reports of changes in the ownership with the Securities and Exchange Commission. Such persons are required by Securities and Exchange Commission regulations to furnish us with copies of all Section 16(a) forms they file.

Based solely on our review of the copies of such forms submitted to us during the year ended December 31, 2005, we believe that all Section 16(a) filing requirements applicable to our officers and directors were complied with.

Item 11:

Executive Compensation

The following table sets forth information for the years ended December 31, 2003, 2004 and 2005 regarding the compensation of our Chief Executive Officer and each of our four other most highly compensated executive officers whose total annual salary and bonus for such fiscal years were in excess of $100,000 (collectively, the “Named Executive Officers”).


	Annual Compensation				Long-Term Compensation Awards Securities Underlying Options	All Other Compensation ($)*
Name and Principal Position	Year	Salary ($)		Bonus ($)	Long-Term Compensation Awards Securities Underlying Options	All Other Compensation ($)*
Vicente Anido, Jr., Ph.D President and Chief Executive Officer	2005 2004 2003	409,019 392,533 381,100		184,490 114,330 138,750	95,601 88,000 —	3,539 3,000 5,000
Marvin J. Garrett Vice President, Regulatory Affairs, Quality and Compliance	2005 2004 2003	265,000 255,543 252,871		75,000 43,500 60,000	20,000 21,000 —	5,000 4,475 5,000
Lisa R. Grillone, Ph.D. Vice President, Clinical Research and Medical Affairs	2005 2004 2003	262,000 254,800 245,000		70,000 43,500 58,000	17,000 25,000 —	4,726 3,545 5,000
Thomas A. Mitro Vice President, Sales and Marketing	2005 2004 2003	255,000 246,891 239,700		80,000 48,000 60,000	18,000 25,000 —	5,000 4,000 5,000
Lauren P. Silvernail Chief Financial Officer and Vice President, Corporate Development	2005 2004 2003	230,000 215,672 157,692	⁽¹⁾	75,000 43,050 —	20,000 28,000 165,000	5,000 4,500 5,000

*	Life insurance or medical benefits.

⁽¹⁾	Ms. Silvernail joined ISTA in May 2003. Her annualized salary for 2003 was $205,000.

Option Grants

Option Grants During Last Fiscal Year. The following table sets forth each grant of stock options made during the fiscal year ended December 31, 2005 to each of the Named Executive Officers:

Option Grants in Fiscal 2005


	Individual Grants
	Number of Securities Underlying Options Granted (#)⁽¹⁾	% of Total Options Granted to Employees in Fiscal Year⁽²⁾		Exercise Price ($/Sh)		Expiration Date	Potential Realizable at Assumed Annual Rates of Stock Price Appreciation for Option Term ($)⁽³⁾
Name	Number of Securities Underlying Options Granted (#)⁽¹⁾	% of Total Options Granted to Employees in Fiscal Year⁽²⁾		Exercise Price ($/Sh)		Expiration Date	5%		10%
Vicente Anido, Jr., Ph.D	95,601	10.0	%	$	10.27	02/17/15	$	617,463	$	1,564,772
Marvin J. Garrett	20,000	2.1	%	$	10.27	02/17/15	$	129,175	$	327,355
Lisa R. Grillone, Ph.D	17,000	1.8	%	$	10.27	02/17/15	$	109,799	$	278,252
Thomas A. Mitro	18,000	1.9	%	$	10.27	02/17/15	$	116,257	$	294,619
Lauren P. Silvernail	20,000	2.1	%	$	10.27	02/17/15	$	129,175	$	327,355

⁽¹⁾	These options vest in equal monthly installments over four years from the date of grant.

⁽²⁾	Options to purchase an aggregate of 958,651 shares of common stock were granted to employees, including the Named Executive Officers, during the fiscal year ended December 31, 2005.

⁽³⁾

In accordance with rules and regulations of the Securities and Exchange Commission, these columns show gains that could accrue for the respective options, assuming that the market price of our common stock appreciates from the date of grant over a period of 10 years at an annualized rate of 5% and 10%, respectively. The potential realizable value at 5% and 10% annual rates of stock price appreciation for each person is based on the market price of the underlying shares of Common Stock on the date each option was granted. Unless the market price of the common stock appreciates over the option term, no value will be realized from the option grants made to the executive officers.

2006 Cash Bonus Plan

In February 2006, our Board of Directors, upon recommendation of the Board’s Compensation Committee (“Compensation Committee”), adopted a cash bonus plan (“Bonus Plan”) pursuant to which our participating executive officers and employees will be eligible to earn cash bonus compensation based on 2006 company and individual performance. The terms of the Bonus Plan are not contained in a formal written document.

A summary of the material terms of the Bonus Plan are as follows:

•

Under the Bonus Plan, participating employees may be eligible to receive all or a portion of a target bonus expressed as a percentage of their respective base salaries. The target bonus of our Chief Executive Officer is 50% of his base salary and the other participating executive officers’ target bonuses are between 30% and 35% of their respective annual base salaries.

•

Upon recommendation of the Compensation Committee, the Board of Directors, at its discretion, will approve the amount of the total funding of the Bonus Plan based on 2006 company performance which will take into account our accomplishment of the following goals: achieving certain 2006 financial targets approved by the Board, advancing the development and commercialization of certain of our product candidates as determined by the Board, and acquiring, licensing or developing a new product candidate for our pipeline. Achievement of each goal is given a certain percentage weight toward funding of the Bonus Plan with the potential of decreased funding for underachievement and increased funding for overachievement of our 2006 financial goal.

•

The Compensation Committee will evaluate the Chief Executive Officer’s individual performance for 2006 and will submit to the Board the Compensation Committee’s recommendation regarding the amount of the cash bonus payable to the Chief Executive Officer under the Bonus Plan. The Compensation Committee’s recommendation will be based upon 2006 company performance and such other relevant factors considered in the discretion of the Compensation Committee. The Board shall have the final authority to approve the Compensation Committee’s recommendation regarding the amount of the cash bonus payable to the Chief Executive Officer under the Bonus Plan.

•

The Chief Executive Officer will evaluate each participating executive officer’s 2006 performance and will submit to the Compensation Committee his recommendations regarding the amount of the cash bonus payable to each such executive officer. The Chief Executive Officer’s recommendations will be based upon the Chief Executive Officer’s assessment of each executive officer’s individual performance for

2006 and other relevant factors considered in the discretion of the Chief Executive Officer. The Compensation Committee shall have the final authority to approve the Chief Executive Officer’s recommendations regarding the amount of the cash bonus payable to each executive officer under the Bonus Plan.

Option Exercises in Last Fiscal Year and Fiscal Year End Option Values. The following table sets forth the information with respect to stock option exercises during the year ended December 31, 2005, by the Named Executive Officers, and the number and value of securities underlying unexercised options held by the Named Executive Officers at December 31, 2005.

Aggregate Option Exercises in Fiscal 2005 and Year-End Option Values


	Shares Acquired Upon Exercise (#)	Value Realized ($)	Number of Securities Underlying Unexercised Options At December 31, 2005 (#)		Value of Unexercised In-the-Money Options at December 31, 2005 ⁽¹⁾
Name	Shares Acquired Upon Exercise (#)	Value Realized ($)	Exercisable	Unexercisable	Exercisable		Unexercisable
Vicente Anido, Jr., Ph.D.	—	—	446,249	148,751	$	1,280,735	$	426,915
Marvin J. Garrett	—	—	138,000	0	$	396,060	$	0
Lisa R. Grillone, Ph.D.	—	—	140,000	0	$	401,800	$	0
Thomas A. Mitro	—	—	122,999	41,001	$	353,007	$	117,673
Lauren P. Silvernail	—	—	113,437	51,563	$	108,900	$	49,500

⁽¹⁾	Closing price of our Common Stock at fiscal year-end minus the exercise price. The fair market value of our Common Stock at the close of business on December 31, 2005 was $6.36.

Compensation of Directors

Our non-employee directors receive an annual retainer of $20,000 and $1,500 in cash compensation from us for their service as members of the Board of Directors for each Board meeting attended, $1,000 for each committee meeting attended and $1,000 for telephonic attendance at any Board or committee meeting. In addition, the Chairperson of the Board and the Chairperson of the Audit each received an additional $10,000 annual retainer. The Chairperson of each of the Compensation and Nominating and Governance Committees each receive an additional $5,000 annual retainer. All non-employee directors are reimbursed for travel and miscellaneous expenses in connection with attendance at Board and committee meetings.

Under our 2004 Performance Incentive Plan, our Board of Directors, upon the recommendation of our Board’s Compensation Committee, has approved that each non-employee director is granted options to purchase 20,000 shares of our common stock upon their initial election or appointment to the Board and subsequent annual grants of options to purchase 16,000 shares of our common stock. The shares subject to the initial option grants vest in three equal annual installments while the shares subject to the subsequent annual grants will be fully vested upon the first anniversary of the date of grant. During the fiscal year ending December 31, 2005, we granted our non-employee directors options to purchase an aggregate of 128,000 shares of common stock each at an exercise price of $5.82 per share under our 2004 Performance Incentive Plan.

Employment and Change in Control Agreements

We have entered into an employment agreement with Dr. Anido. Dr. Anido’s employment agreement sets forth his compensation arrangements, including his initial annual base salary and initial option grant. Dr. Anido is also entitled to a performance bonus of up to 50% of his salary. In the event of termination of employment other than voluntarily or for cause, Dr. Anido will receive nine months of base salary as severance; provided that, in the event such termination occurs after a “change of control” of ISTA, Dr. Anido will receive twenty-four months of base salary as severance and his initial option grant to purchase our common stock will become fully vested and exercisable.

We have entered into an employment agreement with Mrs. Silvernail. Mrs. Silvernail’s employment agreement sets forth her compensation arrangements, including her initial annual base salary and initial option grant. Mrs. Silvernail is also entitled to a performance bonus of up to 35% of her salary. In the event of termination of employment other than voluntarily or for cause, Mrs. Silvernail will receive six months of base salary as severance; provided that, in the event such termination occurs after a “change of control” of ISTA, Mrs. Silvernail will receive the benefits discussed in the paragraph below.

We have entered into change of control severance agreements with the following Named Executive Officers: Mr. Garrett, Dr. Grillone, Mr. Mitro and Mrs. Silvernail. Each of these agreements provides that if the executive’s employment is terminated as a result of an “involuntary termination” within 24 months after a “change of control,” the executive will be entitled to nine months of base salary and healthcare related benefits and a pro rata portion of his or her performance bonus based upon the number of months that such employee was employed during the year of termination. In addition, all options to purchase our Common Stock held by the executive at the time of such termination shall vest in full; provided that in the case of Mrs. Silvernail, such options shall vest in full upon a “change in control” regardless of whether she is terminated.

Compensation Committee Interlocks and Insider Participation

During 2005, no member of the Compensation Committee was an officer or employee of ISTA. During 2005, no member of the Compensation Committee or executive officer of ISTA served as a member of the Board of Directors or Compensation Committee of any entity that has an executive officer serving as a member of our Board of Directors or Compensation Committee.

Compensation Committee Report on Executive Compensation

Notwithstanding anything to the contrary in any of our previous or future filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, that might incorporate this Annual Report on Form 10-K or future filings with the Securities and Exchange Commission, in whole or in part, the foregoing Compensation Committee Report shall not be “soliciting material” or “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any such filing.

The Compensation Committee of the Board of Directors, comprising three non-employee directors, oversees our executive compensation programs. These programs include base salary for executive officers and both annual and long-term incentive compensation programs. Our compensation programs are designed to provide a competitive level of total compensation and include incentive and equity ownership opportunities linked to our performance and stockholder return.

Compensation Philosophy. Our overall executive compensation philosophy is based on a series of guiding principles derived from our values, business strategy, and management requirements. These principles are summarized as follows:

•

Provide competitive levels of total compensation which will enable us to attract and retain the best possible executive talent;

•

Motivate executives to achieve optimum performance for us;

•

Align the financial interest of executives and stockholders through equity-based plans; and

•

Provide a total compensation program that recognizes individual contributions as well as overall business results.

Compensation Program. The Compensation Committee is responsible for reviewing and recommending to the Board of Directors the compensation and benefits of our Chief Executive Officer and for approving the compensation and benefits of our other executive officers. In addition, the Compensation Committee sets our executive compensation guidelines and reviews, approves and evaluates our executive compensation plans, policies and programs. The Compensation Committee is also responsible for the administration of our 2004 Performance Incentive Plan, which provides for the grant of stock options, restricted stock awards and performance shares to qualified employees, officers, directors, consultants and other service providers. There are two major components to our executive compensation: base salary and potential cash bonus, as well as potential long-term compensation in the form of equity awards, which may include stock options and shares of restricted stock. The Compensation Committee considers the total current and potential long-term compensation of each executive officer in recommending and approving each element of compensation.

1. Base Salary. In recommending compensation levels for our Chief Executive Officer or setting compensation levels for our other executive officers, the Compensation Committee reviews competitive information relating to compensation levels for comparable positions at pharmaceutical and other life sciences companies. In addition, the Compensation Committee may, from time to time, hire compensation and benefit consultants to assist in developing and reviewing overall salary strategies. Individual executive officer base and potential bonus compensation may vary based on time in position, assessment of individual performance, salary relative to internal and external equity and critical nature of the position relative to our success.

2. Long-Term Incentives. Our 2004 Performance Incentive Plan provides for the grant of stock options, restricted stock awards and performance shares to qualified employees, and officers. Equity awards, which may include stock options and restricted stock grants, are provided to our executive officers and other employees both as a reward for past individual and corporate performance and as an incentive for future performance. The Compensation Committee believes that stock-based performance compensation arrangements are essential in aligning the interests of management and the stockholders in enhancing the value of our equity.

2005 Compensation for the Chief Executive Officer. In recommending Dr. Anido’s salary for 2005 for Board approval, the Compensation Committee considered competitive compensation data for chief executive officers and presidents of similar

companies within the life sciences industry, taking into account Dr. Anido’s experience and knowledge. Based upon this review, the Compensation Committee found that Dr. Anido’s total compensation (and, in the case of severance and change-in-control scenarios, the potential payouts) in the aggregate to be reasonable and not excessive. Dr. Anido’s annual salary was $407,000 for 2005.

Section 162(m) of the Internal Revenue Code Limitations on Executive Compensation. Section 162(m) of the United States Internal Revenue Code of 1986, as amended, (the “Code”) may limit our ability to deduct for United States federal income tax purposes compensation in excess of $1,000,000 paid to the our Chief Executive Officer and our four other highest paid executive officers in any one fiscal year. None of our executive officers received any such compensation in excess of this limit during fiscal 2005.

Section 162(m) of the Code places limits on the deductibility for United States federal income tax purposes of compensation paid to certain of our executive officers. In order to preserve our ability to deduct the compensation income associated with equity awards granted to such person, for the purposes of Section 162(m) of the Code, the 2004 Performance Incentive Plan provides that no employee may be granted, in any of one calendar year, options relating to more than 400,000 shares of common stock and restricted shares and performance shares relating to more than 100,000 shares of common stock. In addition, the 2004 Performance Incentive Plan provides that in connection with an employee’s initial employment, the employee may be granted options relating to up to 800,000 shares of common stock and restricted shares and performance shares relating to up to 200,000 shares of common stock. To the extent grants under the 2004 Performance Incentive Plan are in excess of these limitations, such excess shall not be exempt from the deductibility limits of Section 162(m) of the Code.

Respectfully submitted,

Benjamin F. McGraw III, Pharm.D., Chairman

Kathleen D. LaPorte

Dean J. Mitchell

Stock Performance Graph

The following graph compares our total cumulative stockholder return as compared to the Nasdaq National Market and U.S. index (“Nasdaq U.S. Index”) and the Nasdaq Pharmaceutical Index for the period beginning on August 22, 2000, our first day of trading after our initial public offering, and ending on December 31, 2005. Total stockholder return assumes $100.00 invested at the beginning of the period in our Common Stock, the stocks represented by the Nasdaq U.S. Index and the Nasdaq Pharmaceutical Index, respectively. Total return assumes reinvestment of dividends; we have paid no dividends on our Common Stock.

LOGO

Item 12:

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.

The following table sets forth the beneficial ownership of our Common Stock as of January 31 2006, by (i) each person or entity who is known by us to own beneficially more than 5% of the outstanding shares of Common Stock, (ii) each of our directors, (iii) each of the Named Executive Officers, and (iv) all of our directors and executive officers as a group.


Name And Address of Beneficial Owner⁽¹⁾	Amount And Nature of Beneficial Ownership⁽²⁾	Approximate Percent Owned⁽²⁾
DIRECTORS AND NAMED EXECUTIVE OFFICERS
Vicente Anido, Jr., Ph.D. ⁽³⁾	668,920	2.5	%
Rolf Classon ⁽⁴⁾	10,834	*
Marvin J. Garrett ⁽⁵⁾	175,090	*
Lisa R. Grillone, Ph.D. ⁽⁶⁾	173,823	*
Peter Barton Hutt ⁽⁷⁾	57,750	*
Kathleen D. LaPorte ⁽⁸⁾	6,068,031	22.8	%
Benjamin F. McGraw III, Pharm.D. ⁽⁹⁾	65,083	*
Dean J. Mitchell ⁽¹⁰⁾	10,834	*
Thomas A. Mitro ⁽¹¹⁾	179,269	*
Wayne I. Roe ⁽¹²⁾	67,672	*
Lauren P. Silvernail ⁽¹³⁾	150,869	*
Richard C. Williams ⁽¹⁴⁾	84,250	*
All executive officers and directors as a group (14 persons) ⁽¹⁵⁾	7,886,492	29.7	%
5% STOCKHOLDERS
Investor AB ⁽¹⁶⁾	3,286,429	12.4	%
Credit Suisse First Boston ⁽¹⁷⁾	6,009,155	22.6	%
Sanderling Investment Entities ⁽¹⁸⁾	1,578,070	6.0	%
Elizabeth R. Foster, Michael P. Walsh and Kilkenny Capital Management, L.L.C. ⁽¹⁹⁾	1,479,214	5.7	%
AXA Financial, Inc. and related entities ⁽²⁰⁾	1,375,975	5.3	%
Arnold H. Snider and Deerfield Investment Entities ⁽²¹⁾	2,507,708	9.7	%
A. Alex Porter ⁽²²⁾ Paul Orlin Geoffrey Hulme Jonathan W. Friedland	1,609,134	6.2	%
Mazama Capital Management, Inc. ⁽²³⁾	1,349,500	5.2	%

*	Less than 1%

⁽¹⁾	Unless otherwise indicated, the business address of each stockholder is c/o ISTA Pharmaceuticals, Inc., 15295 Alton Parkway, Irvine, California 92618.

⁽²⁾

This table is based upon information supplied by officers, directors, principal stockholders, and Schedules 13D and 13G filed with the SEC. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission. Applicable percentage ownership is based on 25,917,332 shares of common stock outstanding as of January 31, 2006. Shares of common stock subject to options and warrants currently exercisable or exercisable within 60 days of the January 31, 2006, are deemed outstanding for computing the ownership percentage of the person holding such options or warrants, but are not deemed outstanding for computing the ownership percentage of any other person. Except as otherwise noted, we believe that each of the stockholders named in the table have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them, subject to applicable community property laws.

⁽³⁾	Includes 655,620 shares subject to options exercisable within 60 days after January 31, 2006.

⁽⁴⁾	Consists of shares subject to options exercisable within 60 days after January 31, 2006.

⁽⁵⁾	Consists of shares subject to options exercisable within 60 days after January 31, 2006.

⁽⁶⁾	Consists of shares subject to options exercisable within 60 days after January 31, 2006.

⁽⁷⁾	Consists of shares subject to options exercisable within 60 days after January 31, 2006.

⁽⁸⁾

Represents 5,702,787 shares (including 653,978 shares issuable upon exercise of warrants) of Sprout Capital IX, L.P. (“Spout IX”), 22,678 shares (including 2,577 shares issuable upon exercise of warrants) of Sprout Entrepreneurs’ Fund, L.P. (“SEF”) and 283,690 shares (including 32,919 shares issuable upon exercise of warrants) of Sprout IX Plan Investors, L.P. (“SIPI”). Ms. LaPorte is a Managing Director of New Leaf Venture Partners, LLC, which has entered into a management agreement with DLJ Capital Corporation whereby New Leaf Venture Partners, LLC will act as a sub-manager to DLJ Capital Corporation with respect to the shares held by Sprout Group. Ms. LaPorte is designated to our Board of Directors by Sprout Group pursuant to its contractual right. Ms. LaPorte disclaims beneficial ownership except the extent of her pecuniary interest therein. Ms. LaPorte’s beneficial ownership also includes 57,750 shares subject to options exercisable within 60 days after January 31, 2006. Ms. LaPorte’s business address is c/o New Leaf Venture Partners, LLC, 3000 Sand Hill Road, 3-170, Menlo Park, CA 94025.

⁽⁹⁾	Consists of shares subject to options exercisable within 60 days after January 31, 2006.

⁽¹⁰⁾	Consists of shares subject to options exercisable within 60 days after January 31, 2006.

⁽¹¹⁾	Consists of shares subject to options exercisable within 60 days after January 31, 2006.

⁽¹²⁾	Includes 66,546 shares subject to options exercisable within 60 days after January 31, 2006.

⁽¹³⁾	Includes 143,748 shares subject to options exercisable within 60 days after January 31, 2006.

⁽¹⁴⁾	Includes 57,750 shares subject to options exercisable within 60 days after January 31, 2006.

⁽¹⁵⁾	Includes 2,342,071 shares subject to options and warrants exercisable within 60 days after January 31, 2006.

⁽¹⁶⁾

Represents 2,300,501 shares (including 372,105 shares issuable upon exercise of warrants) held by Investor Growth Capital Limited and 985,928 shares (including 159,474 shares issuable upon exercise of warrants) held by Investor Group, L.P., of which Investor AB serves as the ultimate general partner. Investor Growth Capital Limited is a Guernsey company, with its principal place of business at National Westminster House, Le Truchot, St. Peter Port, Guernsey, Channel Islands GYI, 4PW. Investor Growth Capital Limited is ultimately a wholly owned subsidiary of Investor AB, a publicly held Swedish company with its principal place of business at Arsenalsgatan 8c, S-103 32, Stockholm, Sweden.

⁽¹⁷⁾

Credit Suisse First Boston (the “Bank”) may be deemed the “beneficial owner” of 6,009,155 shares, consisting of 5,702,787 shares (including 653,978 shares issuable upon exercise of warrants) of Sprout Capital IX, L.P. (“Sprout IX”), 22,678 shares (including 2,577 shares issuable upon exercise of warrants) of Sprout Entrepreneurs’ Fund, L.P. (“SEF”) and 283,690 shares (including 32,919 shares issuable upon exercise of warrants) of Sprout IX Plan Investors, L.P. (“SIPI”). The address of the Bank’s principal business and office is Uetlibergstrasse 231, P.O. Box 900, CH 8070 Zurich, Switzerland and the Bank’s principal business and office in the United States is 11 Madison Avenue, New York, New York 10010. The Bank owns directly a majority of the voting stock, and all of the non-voting stock, of Credit Suisse First Boston, Inc. (“CSFBI”), a Delaware corporation. CSFBI owns all of the voting stock of Credit Suisse First Boston (USA), Inc., a Delaware corporation and holding company (“CSFB-USA”). Sprout IX, SEF and SIPI are Delaware limited partnerships which make investments for long term appreciation. DLJ Capital Corporation (“DLJCC”), a wholly owned subsidiary of CSFB-USA, acts as a venture capital partnership management company. DLJCC is also the general partner of SEF and the managing general partner of Sprout IX, and, as such, is responsible for their day-to-day management. DLJCC makes all of the investment decisions on behalf of Sprout IX and SEF. DLJ Associates IX, L.P. (“Associates IX”), a Delaware limited partnership, is a general partner of Sprout IX and in accordance with the terms of the relevant partnership agreement, does not participate in investment decisions made on behalf of Sprout IX. DLJ Capital Associates IX, Inc., a Delaware corporation and wholly owned subsidiary of DLJCC, is a managing partner of Associates IX. DLJ LBO Plans Management Corporation II (“DLJLBO”) is the general partner of SIPI and, as such, is responsible for its day-to-day management. DLJLBO makes all of the investment decisions on behalf of SIPI. DLJLBO is a wholly owned subsidiary of Credit Suisse First Boston Private Equity, Inc. (“CSFBPE”), a Delaware corporation, which, in turn, is a wholly owned subsidiary of CSFB-USA.

⁽¹⁸⁾

Consists of 966 shares owned by Sanderling IV Biomedical, 1,595 shares owned by Sanderling IV Limited Partnership, 118,900 shares (including 17,664 shares issuable upon exercise of warrants) owned by Sanderling V Beteiligungs GmbH & Co. KG, 495,973 shares (including 74,153 shares issuable upon exercise of warrants) owned by Sanderling V Biomedical Co-Investment Fund, 133,775 shares (including 20,001 shares issuable upon exercise of warrants) owned by Sanderling V Limited Partnership, 3,604 shares owned by Sanderling Venture Partners IV, 4,098 shares owned by Sanderling Venture Partners IV LP, 776 shares owned by Sanderling Venture, 818,081 shares (including 122,312 shares issuable upon exercise of warrants) owned by Sanderling Venture Partners V Co-Investment Fund and 302 shares owned by Sanderling IV Biomedical Limited LP. Sanderling Venture Partners is located at 2730 Sand Hill Road, Suite 200, Menlo Park, California 94024.

⁽¹⁹⁾

Represents 1,479,214 shares beneficially owned by Kilkenny Capital Management, L.L.C., 1,479,214 shares beneficially owned by Michael P. Walsh and 1,479,214 shares beneficially owned by Elizabeth R. Foster based on information set forth in a Schedule 13G filed with the SEC on February 14, 2005. Kilkenny Capital Management, L.L.C. is a registered investment advisor. Michael P. Walsh is the executive manager of Kilkenny Capital Management and Michael P. Walsh and Elizabeth R. Foster are the controlling members of Kilkenny Capital Management, L.L.C. Kilkenny Capital Management, L.L.C., Michael P. Walsh and Elizabeth R. Foster constitute a group as defined in Rule 13d-5(b)(1) and have shared voting power and shared dispositive power over the 1,479,214 shares. The business address of the foregoing is 311 South Wacker Drive, Suite 6350, Chicago, Illinois 60606.

⁽²⁰⁾

Represents 1,362,375 shares beneficially owned by AXA Framlington, a subsidiary of AXA, and 13,600 shares beneficially owned by Alliance Capital Management, L.P., a subsidiary of AXA Financial, Inc., based on information set forth in a Schedule 13G filed with the SEC on February 14, 2006. The address for AXA Financial, Inc. is 1290 Avenue of the Americas, New York, New York 10104 and the address for AXA is 25, avenue Matignon, 75008 Paris, France.

⁽²¹⁾

Represents 1,083,058 shares beneficially owned by Deerfield Capital, L.P. and Deerfield Partners, L.P., and 1,424,040 shares beneficially owned by Deerfield Management Company, L.P. and Deerfield International Limited based on information set forth in a Schedule 13G/A filed with the SEC on February 14, 2006. Arnold H. Snider, as president of each of the general partners of the record holder of the shares, has shared voting power over the shares. Arnold H. Snider, Deerfield Capital, L.P., Deerfield Partners, L.P., Deerfield Management Company, L.P. and Deerfield International Limited constitute a group as defined in Rule 13d-5(b)(1). The business address of Arnold H. Snider, Deerfield Capital, L.P., Deerfield Partners, L.P. and Deerfield Management Company, L.P. is 780 Third Avenue, 37th Floor, New York, New York 10017. The business address of Deerfield International Limited is c/o Hemisphere Management (B.V.I.) Limited, Bison Court, Columbus Centre, P.O. Box 3460, Road Town, Tortola, British Virgin Islands.

⁽²²⁾	Based on information set forth in a Schedule 13G filed with the SEC on February 10, 2006. The business address for Messrs. Porter, Orlin, Hulme and Friedland is 666 5th Avenue, 34th Floor, New York, New York 10103.

⁽²³⁾	Based on information set forth in a Schedule 13G filed with the SEC on February 8, 2006. The business address of Mazama Capital Management, Inc. is One Southwest Columbia Street, Suite 1500 Portland, Oregon 97258.

Equity Compensation Plan Information


Plan category	(a) Number of securities to be issued upon exercise of outstanding options, warrants and rights	(b) Weighted- average exercise price of outstanding options, warrants and rights		(c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)
Equity compensation plans approved by security holders ⁽¹⁾	3,427,083	$	6.74	2,098,430
Equity compensation plans not approved by security holders ⁽²⁾	145,461	$	16.28	0

Total	3,572,544	$	7.13	2,098,430

⁽¹⁾

Our Employee Stock Purchase Plan provides for annual increases in the number of shares available for issuance under the plan on the first day of each year equal to the lesser of 20,000 shares, 1.5% of the outstanding shares of common stock on the first day of the year, or a lesser amount as the Board of Directors may determine.

⁽²⁾

In December 2001, the Board of Directors granted our new Chief Executive Officer and President, as an inducement to his employment, a stand-alone option agreement to purchase 100,461 shares of our common stock for a purchase price of $20.00 per share. In June 2002, the Board of Directors granted our new Vice President, Sales & Marketing, as an inducement to his employment, a stand-alone option agreement to purchase 30,000 shares of our common stock of for a purchase price of $8.50. In August 2002, the Board of Directors granted our new Vice President, Operations, as an inducement to his employment, a stand-alone option agreement to purchase 15,000 shares of our common stock for a purchase price of $6.90. Each option holder may purchase up to 25% of the shares under each option on the first anniversary of the option grant date and the right to purchase the remaining shares vests in equal monthly installments so that each option is fully vested four years after the date of grant.

Item 13:

Certain Relationships and Related Transactions.

Peter Barton Hutt, a member of our Board of Directors since November 2002, is a partner in the Washington, D.C. law firm of Covington & Burling. From time to time, Covington & Burling provides legal services to us.

Item 14:

Principal Accountant Fees and Services.

The following is a summary of the fees billed to ISTA by Ernst & Young LLP for professional services rendered for the fiscal years ended December 31, 2005 and December 31, 2004:


Fee Category	Fiscal 2005 Fees		Fiscal 2004 Fees
Audit Fees	$	367,449	$	383,068
Audit Related Fees		—		3,575
Tax Fees		24,059		12,000
All Other Fees		—		—

Total Fees	$	391,508	$	398,643

Audit Fees We paid Ernst & Young, LLP fees in the aggregate of (i) $157,161 and $114,211 for the fiscal years ended December 31, 2005 and December 31, 2004, respectively, for professional services rendered for the audits of our annual financial statements, (ii) $146,409 and $143,259 for the fiscal years ended December 31, 2005 and December 31, 2004, respectively, for the audits of management’s assessment and effectiveness of internal control over financial reporting, and (iii) $56,579 and $37,903 for the fiscal years ended December 31, 2005 and December 31, 2004, respectively for the review of the financial statements included in our quarterly reports on Form 10-Q during the last two fiscal years.

Audit-Related Fees In addition to fees disclosed under “Audit Fees” above, the aggregate fees for professional services rendered by Ernst & Young, LLP for assurance and related services that are reasonably related to the performance of the audit and reviews of our financial statements were $0 and $3,575 for the fiscal years ended December 31, 2005 and December 31, 2004, respectively. These services include consultations concerning financial accounting and reporting standards.

Tax Fees The aggregate fees for professional services rendered by Ernst & Young, LLP for tax compliance, tax planning and tax advice were $24,059 and $12,000 for the fiscal years ended December 31, 2005 and December 31, 2004, respectively. These services include assistance related to state tax incentives.

The Audit Committee’s policy is to pre-approve all audit and permissible non-audit services performed by the independent auditors. These services may include audit services, audit-related services, tax services and other services. For audit services, the independent auditor provides audit service detail in advance of the meeting of the Audit Committee held during the first calendar quarter of each year, outlining the scope of the audit and related audit fees. If agreed to by the Audit Committee, an engagement letter is formally accepted by the Audit Committee.

For non-audit services, our senior management will submit from time to time to the Audit Committee for approval non-audit services that it recommends the Audit Committee engage the independent auditor to provide for the fiscal year. Our senior management and the independent auditor will each confirm to the Audit Committee that each non-audit service is permissible under all applicable legal requirements. A budget, estimating non-audit service spending for the fiscal year, will be provided to the Audit Committee along with the request. The Audit Committee must approve both permissible non-audit services and the budget for such services. The Audit Committee will be informed routinely as to the non-audit services actually provided by the independent auditor pursuant to this pre-approval process.

PART IV

Item 15:

Exhibits and Financial Statement Schedules.

(a)

Financial Statements

(1) Index to Consolidated Financial Statements

The financial statements required by this item are submitted in a separate section beginning on page F-1 of this report.

CONSOLIDATED FINANCIAL STATEMENTS OF ISTA PHARMACEUTICALS, INC.


Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets as of December 31, 2005 and 2004		F-3
Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and 2003		F-4
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2005, 2004 and 2003		F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003		F-7
Notes to Consolidated Financial Statements		F-8

(2) Financial Statement Schedules

None

(3) Exhibits

See Exhibit Index

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form 10-K and has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Irvine, State of California, on March 6, 2006.



By:		/s/ VICENTE ANIDO, JR., PH.D.
		Vicente Anido, Jr., Ph.D. President and Chief
		Executive Officer

POWER OF ATTORNEY

Each person whose signature appears below constitutes and appoints each of Vicente Anido, Jr., Ph.D. and Lauren P. Silvernail as his or her attorney-in-fact, with full power of substitution, for him or her in any and all capacities, to sign any amendments to this Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each attorney-in-fact, or his substitute, may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this Form 10-K has been signed by the following persons in the capacities and on the dates indicated.


Signature	Title	Date

/s/ VICENTE ANIDO, JR., PH.D.	President, Chief Executive Officer and Director	March 6, 2006
Vicente Anido, Jr., Ph.D.	President, Chief Executive Officer and Director	March 6, 2006

/s/ LAUREN P. SILVERNAIL	Chief Financial Officer, Chief Accounting Officer and Vice President, Corporate Development	March 6, 2006
Lauren P. Silvernail		March 6, 2006

/s/ RICHARD C. WILLIAMS	Director (Chairman of the Board of Directors)	March 6, 2006
Richard C. Williams

/s/ ROLF CLASSON	Director	March 6, 2006
Rolf Classon	Director	March 6, 2006

/s/ PETER BARTON HUTT	Director	March 6, 2006
Peter Barton Hutt	Director	March 6, 2006

/s/ KATHLEEN D. LAPORTE	Director	March 6, 2006
Kathleen D. LaPorte	Director

/s/ BENJAMIN F. MCGRAW III	Director	March 6, 2006
Benjamin F. McGraw III	Director

/s/ DEAN J. MITCHELL	Director	March 6, 2006
Dean J. Mitchell	Director

/s/ WAYNE I. ROE	Director	March 6, 2006
Wayne I. Roe	Director

ISTA PHARMACEUTICALS, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


		Page
Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets as of December 31, 2005 and 2004		F-3
Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and 2003		F-4
Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2005, 2004 and 2003		F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003		F-7
Notes to Consolidated Financial Statements		F-8

F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders of ISTA Pharmaceuticals, Inc.

We have audited the accompanying consolidated balance sheets of ISTA Pharmaceuticals, Inc. as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of ISTA Pharmaceuticals, Inc. at December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the Public Company Accounting Oversight Board (United States), the effectiveness of ISTA Pharmaceuticals, Inc.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2006 expressed an unqualified opinion thereon.

San Diego, California

March 1, 2006

F-2

ISTA PHARMACEUTICALS, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)


	December 31,
	2005			2004
ASSETS
Current assets:
Cash and cash equivalents	$	6,510		$	9,506
Short-term investments		32,116			18,242
Accounts receivable, net of allowances of $130 in 2005 and $4 in 2004		1,804			18
Inventory, net of allowance of $1,298 in 2005 and $785 in 2004		1,991			756
Other current assets		1,324			784

Total current assets		43,745			29,306
Property and equipment, net		1,330			911
Deposits and other assets		264			156

Total assets	$	45,339		$	30,373

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,599		$	1,707
Accrued compensation and related expenses		1,420			1,379
Accrued expenses — clinical trials		152			28
Line of credit		1,500			—
Current portion of long-term liabilities		375			3,866
Other accrued expenses		4,709			3,454

Total current liabilities		10,755			10,434
Deferred rent		217			89
Deferred income		3,994			4,166
Obligation under capital leases		38			—
Long-term liabilities		—			366
Commitments and Contingencies
Stockholders’ equity:
Preferred stock, $0.001 par value; 5,000,000 shares authorized of which 1,000,000 shares have been designated as Series A Participating Preferred Stock at December 31, 2005 and 2004; no shares issued and outstanding at December 31, 2005 and 2004, respectively		—			—
Common stock, $0.001 par value; 100,000,000 shares authorized at December 31, 2005 and 2004; 25,899,887 and 19,350,715 shares issued and outstanding at December 31, 2005 and 2004, respectively		26			19
Additional paid-in capital		256,960			203,611
Deferred compensation		(24	)		(167	)
Accumulated other comprehensive loss		(84	)		(82	)
Accumulated deficit		(226,543	)		(188,063	)

Total stockholders’ equity		30,335			15,318

Total liabilities and stockholders’ equity	$	45,339		$	30,373

See accompanying notes.

F-3

ISTA PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except share and per share data)


	Years Ended December 31,
	2005			2004			2003
Revenue
Product sales, net	$	10,382		$	1,619		$	—
License revenue		278			278			278

Total revenue		10,660			1,897			278

Cost of products sold		3,542			1,427			—

Gross profit margin		7,118			470			278
Costs and expenses:
Research and development		16,611			15,583			17,250
Selling, general and administrative		30,599			25,841			8,635

Total costs and expenses		47,210			41,424			25,885

Loss from operations		(40,092	)		(40,954	)		(25,607	)
Interest income		1,642			584			372
Interest expense		(30	)		(54	)		(10	)

Net loss	$	(38,480	)	$	(40,424	)	$	(25,245	)

Net loss per common share, basic and diluted	$	(1.51	)	$	(2.22	)	$	(1.83	)

Shares used in computing net loss per common share, basic and diluted		25,489,756			18,190,490			13,802,540

See accompanying notes.

F-4

ISTA PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(in thousands, except share and per share data)


	Common Stock				Additional Paid-in Capital
	Shares		Amount		Additional Paid-in Capital
Balance at December 31, 2002	13,288,120		$	13	$	153,022
Issuance of common stock for options	79,857			—		301
Common stock issued under ESPP	7,462			—		20
Issuance of common stock in conjunction with the follow-on public offering, net of issuance costs of $2,831	4,000,000			4		35,165
Deferred compensation related to stock options	—			—		110
Amortization of deferred compensation	—			—		3
Net loss	—			—		—
Foreign currency translation adjustment	—			—		—
Unrealized loss on investments	—			—		—
Comprehensive loss	—			—		—

Balance at December 31, 2003	17,375,439			17		188,621
Issuance of common stock for options	72,468			—		337
Common stock issued under ESPP	10,353			—		66
Issuance of common stock in conjunction with the registered direct public offerings, net of issuance costs of $1,199	1,820,000			2		14,269
Deferred compensation related to stock options	—			—		54
Amortization of deferred compensation	—			—		—
Stock-based compensation related to consultants						264
Warrant exercise	72,455			—		—
Net loss	—			—		—
Foreign currency translation adjustment	—			—		—
Unrealized loss on investments	—			—		—
Comprehensive loss	—			—		—

Balance at December 31, 2004	19,350,715			19		203,611
Issuance of common stock for options	67,589			—		305
Restricted stock issuances	7,500			—		—
Common stock repurchase	(748	)		—		(5	)
Common stock issued under ESPP	19,413			—		150
Issuance of common stock in conjunction with the registered direct public offerings, net of issuance costs of $3,683	6,325,000			7		52,476
Deferred compensation related to stock options	—			—		53
Amortization of deferred compensation	—			—		—
Warrant exercise	130,418			—		370
Net loss	—			—		—
Foreign currency translation adjustment	—			—		—
Unrealized gain on investments	—			—		—
Comprehensive loss	—			—		—

Balance at December 31, 2005	25,899,887		$	26	$	256,960

[Additional columns below]

F-5

[Continued from above table, first column(s) repeated]


	Deferred Compensation			Accumulated Other Comprehensive Loss			Accumulated Deficit			Total Stockholders’ Equity
Balance at December 31, 2002	$	(1,390	)	$	(23	)	$	(122,394	)	$	29,228
Issuance of common stock for options		—			—			—			301
Common stock issued under ESPP		—			—			—			20
Issuance of common stock in conjunction with the follow-on public offering, net of issuance costs of $2,831		—			—			—			35,169
Deferred compensation related to stock options		(110	)		—			—			—
Amortization of deferred compensation		953			—			—			956
Net loss		—			—			(25,245	)		(25,245	)
Foreign currency translation adjustment		—			(2	)		—			(2	)
Unrealized loss on investments		—			(3	)		—			(3	)
Comprehensive loss		—			—			—			(25,250	)

Balance at December 31, 2003		(547	)		(28	)		(147,639	)		40,424
Issuance of common stock for options		—			—			—			337
Common stock issued under ESPP		—			—			—			66
Issuance of common stock in conjunction with the registered direct public offerings, net of issuance costs of $1,199		—			—			—			14,271
Deferred compensation related to stock options		(54	)		—			—			—
Amortization of deferred compensation		434			—			—			434
Stock based compensation related to consultants											264
Warrant exercise		—			—			—			—
Net loss		—			—			(40,424	)		(40,424	)
Foreign currency translation adjustment		—			(16	)		—			(16	)
Unrealized loss on investments		—			(38	)		—			(38	)
Comprehensive loss		—			—			—			(40,478	)

Balance at December 31, 2004		(167	)		(82	)		(188,063	)		15,318
Issuance of common stock for options		—			—			—			305
Restricted stock issuances		—			—			—			—
Common stock repurchase		—			—			—			(5	)
Common stock issued under ESPP		—			—			—			150
Issuance of common stock in conjunction with the registered direct public offerings, net of issuance costs of $3,683		—			—			—			52,483
Deferred compensation related to stock options		(53	)		—			—			—
Amortization of deferred compensation		196			—			—			196
Warrant exercise		—			—			—			370
Net loss		—			—			(38,480	)		(38,480	)
Foreign currency translation adjustment		—			(13	)		—			(13	)
Unrealized gain on investments		—			11			—			11
Comprehensive loss		—			—			—			(38,482	)

Balance at December 31, 2005	$	(24	)	$	(84	)	$	(226,543	)	$	30,335

See accompanying notes.

F-6

ISTA PHARMACEUTICALS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)


	Years Ended December 31,
	2005			2004			2003
OPERATING ACTIVITIES
Net loss	$	(38,480	)	$	(40,424	)	$	(25,245	)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock based compensation		196			698			956
Transfer of equipment for technology		—			214			—
Depreciation and amortization		369			251			343
Changes in operating assets and liabilities:
Accounts receivable, net		(1,786	)		(18	)		—
Advanced payments — clinical trials and other current assets		(540	)		251			(526	)
Inventory, net		(1,235	)		(756	)		—
Accounts payable		892			(365	)		1,162
Accrued compensation and related expenses		41			680			12
Accrued expenses — clinical trials and other accrued expenses		1,379			948			956
Other liabilities		(3,866	)		4,232			—
Deferred rent		128			80			(1	)
Deferred income		(172	)		(278	)		(278	)

Net cash used in operating activities		(43,074	)		(34,487	)		(22,621	)
INVESTING ACTIVITIES
Purchases of marketable securities		(56,363	)		(10,378	)		(37,036	)
Maturities of marketable securities		42,487			23,559			9,009
Purchase of equipment		(788	)		(727	)		(113	)
Deposits and other assets		(108	)		(121	)		—

Net cash (used in) provided by investing activities		(14,772	)		12,333			(28,140	)
FINANCING ACTIVITIES
Proceeds from exercise of stock options		305			337			301
Obligation under capital lease		47			—			—
Proceeds from line of credit		1,500			—			—
Proceeds from issuance of common stock, net of issuance costs		52,998			14,334			35,189

Net cash provided by financing activities		54,850			14,671			35,490
Effect of exchange rate changes on cash		—			1			2

Decrease in cash and cash equivalents		(2,996	)		(7,482	)		(15,269	)
Cash and cash equivalents at beginning of year		9,506			16,988			32,257

Cash and cash equivalents at end of year	$	6,510		$	9,506		$	16,988

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the year for interest	$	27		$	7		$	10

See accompanying notes.

F-7

ISTA PHARMACEUTICALS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 2005

1. Organization and Summary of Significant Accounting Policies

The Company

ISTA Pharmaceuticals, Inc. (“ISTA” or the “Company”) was incorporated in the state of California on February 13, 1992 to discover, develop and market new remedies for diseases and conditions of the eye. The Company reincorporated in Delaware on August 4, 2000. Vitrase^®, Istalol^®, Xibrom™, Caprogel^®, Vitragan™, ISTA^®, ISTA Pharmaceuticals^® and the ISTA logo are our trademarks, either owned or under license.

ISTA is a specialty pharmaceutical company focused on the development and commercialization of unique and uniquely improved ophthalmic products for serious diseases and conditions of the eye. Since the Company’s inception, it has devoted its resources primarily to fund research and development programs, late-stage product acquisitions and product commercial launches. In July 2004, the Company transitioned from a development-stage organization to a commercial entity.

Basis of Presentation

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. This basis of accounting contemplates the recovery of the Company’s assets and the satisfaction of its liabilities in the normal course of business. Through December 31, 2005, the Company has incurred accumulated losses of $226.5 million. The Company’s ability to attain profitable operations is dependent upon obtaining sufficient working capital to complete the successful development of its products, FDA approval of its products, achieving market acceptance of such products and achievement of sufficient levels of revenue to support the Company’s cost structure. Management believes that the Company’s existing capital resources will enable the Company to fund operations for at least the next 12 months.

The consolidated financial statements include the accounts of the Company and its controlled subsidiaries. All significant intercompany amounts have been eliminated in consolidation.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash in banks, certificates of deposit and short-term investments with original maturities of three months or less when purchased. Cash and cash equivalents are carried at cost, which management believes approximates fair value because of the short-term maturity of these instruments.

Short-term Investments

Investments with an original maturity of more than three months from the date of purchase are considered short-term investments and have been classified by management as available-for-sale. Such investments are carried at fair value, with unrealized gains and losses included as a separate component of stockholders’ equity. The basis for computing realized gain or losses is by specific identification.

Inventory

Inventory consists of currently marketed products. Inventory primarily represents raw materials used in production and finished goods inventory on hand, valued at standard cost. Inventories are reviewed periodically for slow-moving or obsolete status. If a launch of a new product is delayed, inventory may not be fully utilized and could be subject to impairment, at which point the Company would record a reserve to adjust inventory to its net realizable value.

Inventory relates to Istalol, for the treatment of glaucoma; Vitrase, lyophilized 6,200 USP units multi-purpose vial and Vitrase 200 USP units/mL for use as a spreading agent to facilitate the absorption and dispersion of other injected drugs; and Xibrom, a topical non-steroidal anti-inflammatory formulation of bromfenac for the treatment of ocular inflammation and pain following cataract surgery. Inventories, net of allowances, are stated at the lower of cost or market. Cost is determined by the first-in, first-to-expire method.

F-8

Fair Value of Financial Instruments

The carrying amount of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued liabilities are considered to be representative of their respective fair values because of the short-term nature of those instruments.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash and cash equivalents and short-term investments.

Property and Equipment

Property and equipment are recorded at cost. Equipment and furniture are depreciated using the straight-line method over their estimated useful lives (generally three to seven years) and leasehold improvements are amortized using the straight-line method over the estimated useful life of the asset or the lease term, whichever is shorter. Equipment acquired under capital leases is amortized over the estimated useful life of the assets.

Impairment of Long-lived Assets

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, if indicators of impairment exist, the Company assesses the recoverability of the affected long-lived assets by determining whether the carrying value of such assets can be recovered through undiscounted future operating cash flows. If impairment is indicated, the Company measures the amount of such impairment by comparing the fair value to the carrying value. While the Company’s current and historical operating and cash flow losses are indicators of impairment, the Company believes the future cash flows to be received from the long-lived assets will exceed the assets’ carrying value, and accordingly, the Company has not recognized any impairment losses through December 31, 2005.

Research and Development Costs

Expenditures relating to research and development are expensed in the period incurred. The Company also expenses costs incurred to obtain and prosecute patents, as recoverability of such expenditures is not assured. Approximately $457,000, $374,000 and $251,000 of patent-related costs were included in research and development expense in 2005, 2004 and 2003, respectively.

Research and development expenses to date have consisted primarily of costs associated with the clinical trials of the Company’s product candidates, compensation and other expenses for research and development personnel, costs for consultants and contract research, costs related to development of commercial scale manufacturing capabilities for the Company’s product candidates Vitrase, Istalol, Xibrom and in process research and development costs related to the acquisition of three late-stage development compounds.

The Company generally classifies and separates research and development expenditures into amounts related to clinical development costs, regulatory costs, pharmaceutical development costs, manufacturing development costs and medical affairs costs.

Stock-based Compensation

As permitted by SFAS No. 123, “Accounting for Stock-Based Compensation”, the Company has elected to follow Accounting Principals Board, or APB, Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations in accounting for stock-based employee compensation. Under APB 25, if the exercise price of the Company’s employee and director stock options equals or exceeds the estimated fair value of the underlying stock on the date of grant, no compensation expense is recognized.

When the exercise price of the employee or director stock options is less than the estimated fair value of the underlying stock on the grant date, the Company records deferred compensation for the difference and amortizes this amount to expense in accordance with Financial Accounting Standards Board, or FASB, Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans”, over the vesting period of the options.

Options or stock awards issued to non-employees are recorded at their fair value as determined in accordance with SFAS No. 123 and Emerging Issues Task Force, or EITF, No. 96-18, “Accounting for Equity Instruments That Are Issued to

F-9

Other Than Employees for Acquiring or in Conjunction With Selling Goods or Services”, and recognized over the related service period. Deferred charges for options granted to non-employees are periodically re-measured as the options vest.

As required under SFAS No. 123 and SFAS No. 148, “Accounting for Stock-Based Compensation - Transition and Disclosure”, the pro forma effects of stock-based compensation on net loss have been estimated at the date of grant using the Black-Scholes option-pricing model. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

SFAS No. 148 was issued in December 2002 as 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 providing additional disclosures about the method of accounting for stock-based employee compensation. Amendments are effective for financial statements for the Company beginning January 1, 2003. The Company has currently chosen to not adopt the voluntary change to the fair value based method of accounting for stock-based employee compensation. If the Company should choose to adopt such a method, its implementation pursuant to SFAS No. 148 could have a material effect on the Company’s consolidated financial position and results of operations.

The fair value of the employee stock options was estimated at the date of grant using the minimum value pricing model for grants prior to the initial public offering and the Black Scholes method for grants after the initial public offering with the following weighted average assumptions for 2005, 2004 and 2003: risk-free interest rate of 3.0%, zero dividend yield, volatility of 73%, and a weighted-average life of the option of four years. The estimated weighted average fair value of stock options granted during 2005, 2004 and 2003 was $9.08, $10.10 and $2.99, respectively. The Company expects to adopt the provisions of SFAS No. 123R (Revised 2004), “Share-Based Payments” in the first Quarter of 2006. Although the Company will continue to evaluate the application of SFAS No. 123R, management expects the adoption to have a material impact on its results of operations in amounts not yet determinable.

For purposes of adjusted pro forma disclosures, the estimated fair value of the options is amortized to expense over the option’s vesting period. The effect of applying SFAS No. 123 for purposes of providing pro forma disclosures is not likely to be representative of the effects on the Company’s operating results for future years because changes in the subjective input assumptions can materially affect future value estimates. Pro forma information is as follows (in thousands, except per share data):


	Years Ended December 31,
	2005			2004			2003
Net loss, as reported	$	(38,480	)	$	(40,424	)	$	(25,245	)
Add: Stock-based employee compensation expense included in net loss determined under intrinsic-value method for all awards		196			434			956
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards		(4,615	)		(2,229	)		(1,604	)

Pro forma net loss	$	(42,899	)	$	(42,219	)	$	(25,893	)
Net loss per share, basic and diluted, as reported	$	(1.51	)	$	(2.22	)	$	(1.83	)
Pro forma net loss per share, basic and diluted	$	(1.68	)	$	(2.32	)	$	(1.88	)

F-10

Use of Estimates

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

Revenue Recognition

Product revenue. The Company recognizes revenue from product sales, in accordance with Statement of Financial Accounting Standard, or SFAS, No. 48 “Revenue Recognition When Right of Return Exists”, when there is persuasive evidence that an arrangement exists, when title has passed, the price is fixed or determinable, and the Company is reasonably assured of collecting the resulting receivable. The Company recognizes product revenue net of estimated allowances for discounts, returns, rebates and chargebacks. Such estimates require the most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. Actual results may differ significantly from the Company’s estimates. Changes in estimates and assumptions based upon actual results may have a material impact on the Company’s results of operations and/or financial condition.

In general, the Company is obligated to accept from its customers the return of pharmaceuticals that have reached their expiration date. The Company authorizes returns for damaged products and exchanges for expired products in accordance with its return goods policy and procedures, and has established reserves for such amounts at the time of sale. The Company launched its first marketed product, Istalol in the third quarter of 2004, its second product, Vitrase in the first quarter of 2005 and its third product, Xibrom in the second quarter of 2005. Actual Istalol, Vitrase and Xibrom returns have not exceeded the Company’s estimated allowances for returns.

License revenue. The Company recognizes revenue consistent with the provisions of the SEC’s Staff Accounting Bulletin, or SAB, No. 104, “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 the Company has 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 the Company’s revenue recognition criteria will be recorded as deferred revenue in the accompanying balance sheets.

Net Loss Per Share

In accordance with SFAS No. 128, “Earnings Per Share”, and SEC SAB No. 98, basic net loss per common share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period. Under SFAS No. 128, diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common and common equivalent shares, such as stock options, outstanding during the period. Such common equivalent shares have not been included in the Company’s computation of diluted net loss per share as their effect would be anti-dilutive. The total number of shares excluded from the calculation of diluted net loss per share, prior to application of the treasury stock method for options and warrants, was 1,758,059, 1,297,817 and 823,988 for the years ended December 31, 2005, 2004 and 2003, respectively.

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

Segment Reporting

The Company currently operates in only one segment.

Comprehensive Income

Statement of Financial Accounting Standard, or SFAS, No. 130, “Reporting Comprehensive Income”, requires reporting and displaying comprehensive income (loss) and its components, which, for ISTA, includes net loss and unrealized gains and losses on investments and foreign currency translation gains and losses. Total comprehensive loss for the year ended December 31, 2005 and 2004 was $38,482,000 and $40,478,000, respectively. In accordance with SFAS No. 130, the

F-11

accumulated balance of unrealized gains (losses) on investments and the accumulated balance of foreign currency translation adjustments are disclosed as separate components of stockholders’ equity.

As of December 31, 2005 and 2004, accumulated foreign currency translation adjustments were ($37,000) and ($24,000), respectively, and accumulated unrealized gains (losses) on investments were ($47,000) and ($58,000), respectively. Comprehensive loss is reflected in the consolidated statements of stockholders’ equity.

New Accounting Pronouncements

In December 2004, the FASB issued Statement No. 123R (Revised 2004), “Share-Based Payment”. The revisions to SFAS No. 123 require compensation costs related to share-based payment transactions to be recognized in the financial statements. With limited exceptions, the amount of compensation cost will be measured based on the grant-date fair value of the equity or liability instruments issued. In addition, liability awards will be re-measured each reporting period. Compensation cost will be recognized over the period that an employee provides service in exchange for the award. SFAS No. 123R replaces SFAS No. 123 and supersedes APB Opinion No. 25. For public entities, the provisions of the statement are effective as of the beginning of the first annual reporting period that begins after December 15, 2005, however early adoption is allowed. The Company expects to adopt the provisions of the new statement in the first fiscal quarter of 2006. Although the Company will continue to evaluate the application of SFAS No. 123R, management expects the adoption to have a material impact on its results of operations in amounts not yet determinable.

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs—an amendment of ARB No. 43, Chapter 4”. SFAS No. 151 amends the guidance in Accounting Research Bulletin, or ARB, No. 43, Chapter 4, “Inventory Pricing”, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) are to be recognized as current-period charges. SFAS No. 151 is effective for fiscal years beginning after June 15, 2005. SFAS No. 151 is not expected to have a material impact on the Company’s financial statements.

Supply Concentration Risks

Some materials used in the Company’s products are currently obtained from a single source. Biozyme Laboratories, Ltd. is currently the Company’s only source for highly purified ovine hyaluronidase, which is the active ingredient in Vitrase. The Company’s supply agreement with Biozyme ends in August 2007, after which any further supply of hyaluronidase by Biozyme to the Company would be subject to Biozyme’s agreement. The Company has also entered into supply agreements with R.P. Scherer West and Alliance Medical Products to manufacture commercial quantities of Vitrase in a lyophilized 6,200 USP units multi-purpose vial and 200 USP units/mL in sterile solution, respectively. Currently, R.P. Scherer West and Alliance Medical Products each is the Company’s sole source for Vitrase in these respective configurations. The Company also has supply agreements with Bausch & Lomb to manufacture commercial quantities of Istalol and Xibrom. Currently, Bausch & Lomb is the Company’s sole source for Istalol and Xibrom.

F-12

2. Balance Sheet Details

Inventory

Inventories are stated at the lower of cost (first in, first to expire) or market. Inventory at December 31, 2005 consisted of $575,000 of raw materials and $2.7 million of finished goods. Additionally, the Company recorded $1.3 million in inventory reserves. Inventory at December 31, 2004 consisted of $337,000 in raw materials and $1.1 million of finished goods and $79,000 of in-transit inventory. Additionally, the Company recorded $785,000 in inventory reserves.

Property and Equipment

Equipment and leasehold improvements and related accumulated depreciation and amortization are as follows (in thousands):


	December 31,
	2005			2004
Property and equipment:
Equipment	$	1,388		$	1,244
Furniture and fixtures		933			903
Capital leases		53			—
Leasehold improvements		711			379

		3,085			2,526
Less accumulated depreciation and amortization		(1,755	)		(1,615	)

	$	1,330		$	911

Total depreciation and amortization expense amounted to $369,000, $251,000 and $343,000 for the years ended December 31, 2005, 2004 and 2003, respectively.

Accrued Expenses

Other accrued expenses consist of the following (in thousands):


	December 31,
	2005		2004
Accrued general expenses	$	1,433	$	1,106
Accrued royalties		534		419
Accrued sales return allowance		837		345
Accrued sales and marketing expenses		1,315		1,239
Accrued contract manufacturing expenses		582		330
Accrued state tax payable		8		15

	$	4,709	$	3,454

3. Short-Term Investments

The Company classifies its short-term investments as “available-for-sale” and records such assets at the estimated fair value with unrealized gains and losses excluded from earnings and reported in comprehensive income (loss). The basis for computing realized gains or losses is by specific identification.

The following is a summary of available-for-sale securities (in thousands):


	Gross Amortized Cost		Net Unrealized Gains/(Losses)			Estimated Fair Value
At December 31, 2005:
U.S. Treasury securities and agency bonds	$	8,661	$	(23	)	$	8,638
Corporate Bonds		8,765		(37	)		8,728
Auction Rate securities		14,750		—			14,750

	$	32,176	$	(60	)	$	32,116


	Gross Amortized Cost		Net Unrealized Gains/(Losses)			Estimated Fair Value
At December 31, 2004:
U.S. Treasury securities and agency bonds	$	12,543	$	(35	)	$	12,508
Corporate Bonds		3,507		(23	)		3,484
Auction Rate Securities		2,250		—			2,250

	$	18,300	$	(58	)	$	18,242

F-13

Available-for-sale securities by contractual maturity are as follows (in thousands):


Due in one year or less	$	18,542
Due after one year through two years		13,574

	$	32,116

Realized gains and losses were immaterial to the Company’s financial results for the years ended December 31, 2005, 2004 and 2003. Gross unrealized gains were $65,000, $57,000 and $37,000 for December 31, 2005, 2004 and 2003, respectively. Gross unrealized losses were $67,000, $116,000 and $44,000 for the years ended December 31, 2005, 2004 and 2003, respectively.

The Company reviews investments in corporate bonds and government agency securities for other-than-temporary impairment whenever the fair value of an investment is less than amortized cost and evidence indicates that an investment’s carrying amount is not recoverable within a reasonable period of time. Investments in an unrealized loss position for greater than a year were comprised of corporate bonds and U.S. government agency securities. The unrealized losses were due to fluctuations in interest rates. To determine whether impairment is other-than-temporary, the Company considers whether it has the ability and intent to hold the investment until a market price recovery and considers whether evidence indicating the cost of the investment is recoverable and outweighs evidence to the contrary. Evidence considered in this assessment includes the reasons for the impairment, compliance with the Company’s investment policy, the severity and the duration of the impairment and changes in value subsequent to year end. The Company has reviewed those securities with unrealized losses as of December 31, 2005 and 2004 and has concluded that no other-than-temporary impairment existed as of December 31, 2005 and 2004.

4. Stockholders’ Equity

Common and Preferred Stock

In November 2003, the Company sold, in a follow-on public offering, 4,000,000 shares of common stock to certain investors for $38.0 million.

In August 2004, the Company sold, in two registered direct offerings, 1,820,000 shares of common stock to certain investors for $15.5 million.

In January 2005, the Company sold, under a universal shelf registration statement in an underwritten public offering, 6,325,000 shares of common stock to certain investors for $56.2 million.

At December 31, 2005 and 2004, the Company had 5,000,000 shares of preferred stock authorized at a $.001 par value and no shares were issued and outstanding.

Common Stock Warrants

In November 2002, the Company consummated a private placement of $40.0 million of its common stock and warrants exercisable for an additional $6.0 million of common stock to certain investors with a purchase price of $3.80 per share. In addition, $4.0 million of promissory notes previously issued to several of the same investors in the Company’s September 2002 bridge financing were converted into 1,052,620 shares of the Company’s common stock, based upon the conversion price of $3.80 per share, concurrently with the consummation of the private placement.

The warrants were accounted for under EITF 98-5 “Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios”, and APB 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants”, which require the warrants to be recorded at their fair value as a discount on the underlying note. The fair value of the warrants was determined to be $412,000 under SFAS No. 123, “Accounting for Stock-Based Compensation”, using the Black-Scholes Valuation Model. The warrants were valued using the following assumptions: risk-free interest rate of 3%; dividend yield of 0%; expected volatility of 73%; and a term of five years. The value of the warrants was amortized as interest expense over the period of time the promissory notes were outstanding in 2002.

F-14

Employee Stock Purchase Plan

In April 2000, the Company’s Board of Directors adopted the Employee Stock Purchase Plan (the “Stock Purchase Plan”), which initially provided for the issuance of a maximum of 20,000 shares of common stock.

Eligible employees can have up to 15% of their earnings withheld, subject to certain maximums, to be used to purchase shares of the Company’s common stock every January and July. The price of the common stock purchased under the Stock Purchase Plan will be equal to 85% of the lower of the fair value of the common stock on the commencement date of the offering period or the specified purchase date. During fiscal year ended December 31, 2005, 19,413 shares had been issued to participants, with an additional 17,329 shares issuable at year end.

The Stock Purchase Plan provides for annual increases in the number of shares available for issuance under the plan on the first day of each year, beginning in 2001, equal to the lesser of 20,000 shares, 1.5% of the outstanding shares of common stock on the first day of the year, or a lesser amount as the Board of Directors may determine.

Stock Compensation Plan

The Company had reserved 53,618 shares of common stock under the 1993 Stock Plan (the “1993 Plan”) for issuance to eligible employees, officers, directors and consultants. The 1993 Plan provided for the grant of incentive and nonstatutory stock options. Terms of the stock option agreements, including vesting requirements, were determined by the Board of Directors, subject to the provisions of the 1993 Plan. Options granted by the Company vest ratably over four years and are exercisable from the date of grant for a period of ten years. The option price equaled the estimated fair value of the common stock as determined by the Board of Directors on the date of the grant. Upon completion of the Company’s initial public offering in August 2000, the 1993 Plan was terminated. Upon adoption of the 2000 Stock Plan, as discussed in the paragraph below, no further grants were made under the 1993 Plan, and any shares reserved but not issued and cancellations under the Plan were made available for grant under the 2000 Stock Plan.

In 2000, the Company’s stockholders approved the 2000 Stock Plan (the “2000 Stock Plan”) that became effective upon the completion of the Company’s initial public offering in August 2000. The 2000 Stock Plan provided for the grant of incentive stock options to employees and for the grant of nonstatutory stock options and stock purchase rights to employees, directors and consultants. A total of 20,000 shares of common stock were initially reserved for issuance under the 2000 Stock Plan. The 2000 Stock Plan provided for annual increases in the number of shares available for issuance under the plan on the first day of each year, beginning in 2000, equal to the lesser of 20,000 shares, 1.5% of the outstanding shares of common stock on the first day of the year, or a lesser amount as the Board of Directors may determine. As of January 1, 2003, the number of shares available for issuance increased to 200,000 shares, 1.5% of the outstanding shares of common stock on the first day of the year, or a lesser amount as the Board of Directors determined. At the Special Shareholder Meeting on November 11, 2002, the shareholders approved an increase of 2,500,000 options available for issuance under the 2000 Stock Plan. Upon adoption of the 2004 Plan, as discussed in the paragraph below, no further grants were made under the 2000 Stock Plan, and any shares reserved but not issued and cancellations under the 2000 Stock Plan were made available for grant under the 2004 Plan.

The Company has outstanding options to purchase shares of its common stock under individual option agreements, its 1993 Stock Plan, as amended, and its 2000 Stock Plan. All of the outstanding options granted under the individual option agreements, 1993 Plan and 2000 Stock Plan will remain outstanding and subject to the provisions of the applicable agreement and plan until they are either exercised or expire in accordance with their respective terms. No options have been issued under the 1993 Plan after the adoption of the 2000 Stock Plan as shares of common stock available for future issuance under the 1993 Plan were assumed under the 2000 Plan. With the approval of the 2004 Stock Plan, no additional options have been awarded under the 2000 Plan. Any shares available for future issuance under the 2000 Plan have been included in the shares of common stock authorized for issuance under the 2004 Stock Plan.

In 2004, the Company’s stockholders approved the 2004 Performance Incentive Plan (the “2004 Plan”). The 2004 Plan provides for the grant of stock options, restricted stock awards, performance shares, performance units and stock appreciation rights to qualified employees, officers, directors, consultants and other service providers. The 2004 Plan authorized the Company to grant options and/or rights to purchase up to an aggregate of 2,053,107 shares of common stock, which included 453,107 shares of common stock available for future issuance under the 2000 Stock Plan and 1,600,000 shares of common stock available for future issuance under the 2004 Plan, of which 200,000 shares may only be issued in connection with restricted stock awards. At the Shareholder Meeting in October 2005, the stockholders approved the Second Amendment and Restatement of the 2004 Plan, which increased the number of shares available by 1,000,000 shares to 3,053,107, of which 300,000 shares may only be issued in connection with restricted stock awards or performance share awards.

F-15

As of December 31, 2005, a total of 2,098,430 shares of common stock were reserved for issuance under the 2004 Performance Incentive Plan.

In December 2001, the Board of Directors granted our new Chief Executive Officer and President a stand-alone option agreement to purchase 100,461 shares of common stock of the Company for a purchase price of $20.00 per share.

In June 2002, the Board of Directors granted our new Vice President, Sales & Marketing a stand-alone option agreement to purchase 30,000 shares of common stock of the Company for a purchase price of $8.50.

In August 2002, the Board of Directors granted our new Vice President, Operations a stand-alone option agreement to purchase 15,000 shares of common stock of the Company for a purchase price of $6.90.

A summary of the Company’s stock option activity and related information follows:


	Shares		Price Per Share	Weighted-Average Exercise Price
Outstanding at December 31, 2002	2,071,864		$2.03 – $51.25	$	5.66
Granted	536,150		$4.20 – $9.05	$	5.84
Exercised	(79,857	)	$2.03 – $7.56	$	3.78
Canceled	(219,541	)	$3.49 – $51.25	$	9.82

Outstanding at December 31, 2003	2,308,616		$3.49 – $51.25	$	5.37
Granted	736,000		$9.25 – $14.01	$	10.10
Exercised	(72,468	)	$3.49 – $9.70	$	4.68
Canceled	(148,013	)	$3.49 – $51.25	$	6.25

Outstanding at December 31, 2004	2,824,135		$3.49 – $51.25	$	6.58
Granted	958,651		$5.82 – $10.78	$	9.08
Exercised	(67,589	)	$3.49 – $9.41	$	4.54
Canceled	(142,653	)	$3.49 – $51.25	$	10.54

Outstanding at December 31, 2005	3,572,544		$3.49 – $51.25	$	7.13

The following table summarizes information about options outstanding at December 31, 2005:


Range of Exercise Price	Number Outstanding as of 12/31/2005	Options Outstanding			Options Exercisable
Range of Exercise Price	Number Outstanding as of 12/31/2005	Weighted Average Remaining Contractual Life	Weighted Average Exercise Price		Number Exercisable and Vested	Weighted Average Exercise Price
$3.49 – $3.49	1,400,502	6.96	$	3.4900	1,171,123	$	3.4900
$4.20 – $5.82	377,425	8.06	$	5.3410	188,655	$	5.1514
$6.15 – $8.42	382,006	8.11	$	7.2921	181,880	$	7.0603
$8.46 – $9.41	408,208	8.14	$	9.2463	174,138	$	9.2541
$9.57 – $10.27	458,601	8.98	$	10.1781	88,464	$	10.1905
$10.30 – $11.00	357,633	8.98	$	10.6057	103,565	$	10.6671
$11.10 – $30.00	181,719	6.59	$	17.8535	143,598	$	19.0318
$32.10 – $32.10	1,000	5.39	$	32.1000	1,000	$	32.1000
$33.75 – $33.75	850	5.26	$	33.7500	850	$	33.7500
$51.25 – $51.25	4,600	5.18	$	51.2500	4,600	$	51.2500

$3.49 – $51.25	3,572,544	7.77	$	7.1280	2,057,873	$	6.3125

F-16

Shares Reserved for Future Issuance

The following shares of common stock are reserved for future issuance at December 31, 2005:


Stock plans:
Options granted and outstanding		3,572,544
Reserved for future option grants		2,098,430

		5,670,974
Warrants:
Reserved for future issuance		1,541,941
Stock purchase plan:
Reserved for future issuance		401

		7,213,316

Deferred Compensation

During the years ended December 31, 2005, 2004 and 2003 in connection with the grant of various stock options to employees, the Company recorded deferred stock compensation totaling $53,000, $54,000 and $110,000, respectively, representing the difference between the exercise price and the estimated market value of the Company’s common stock as determined by the Company’s management on the date such stock options were granted. Deferred compensation is included as a reduction of stockholders’ equity and is being amortized to expense over the vesting period of the options in accordance with FASB Interpretation No. 28, which permits an accelerated amortization methodology. During the years ended December 31, 2005, 2004 and 2003, the Company recorded amortization of deferred compensation expense of $196,000, $434,000 and $956,000, respectively.

5. Commitments and Contingencies

Line of Credit

In December 2005, the Company entered into a revolving credit facility, whereby the Company may borrow up to $10.0 million. As of December 31, 2005, the Company had $8.5 million available for borrowing under the credit facility. All outstanding amounts under the credit facility bear interest at a variable rate equal to the lender’s prime rate or, at the Company’s option, LIBOR plus 2.5%, which is payable on a monthly basis. The credit facility also contains customary covenants regarding operations of the Company’s business and financial covenants relating to ratios of current assets to current liabilities and maximum losses during any calendar quarter and is collateralized by all of the Company’s assets with the exception of its intellectual property. As of December 31, 2005, the Company was in compliance with all of the covenants under the credit facility. All amounts owing under the credit facility will become due and payable on January 31, 2007.

Purchase Commitments

In June 2004, the Company entered into an amended and restated supply agreement with Biozyme Laboratories, Ltd. for ovine hyaluronidase for use in ophthalmic and spreading agent applications. Under its agreement with Biozyme, the Company is obligated to make product purchases totaling at least $750,000 over three years. The Company also entered into a technology license agreement with Biozyme providing it certain rights to manufacture hyaluronidase, in return for an aggregate license fee of $1.1 million payable over three years. The Company’s supply agreement with Biozyme ends in August 2007, after which any further supply of hyaluronidase by Biozyme to ISTA would be subject to Biozyme’s agreement. Currently, Biozyme is the Company’s sole source for ovine hyaluronidase.

Lease Commitments

The Company leases its corporate and laboratory facilities and certain equipment under various operating leases. As of December 31, 2005, the Company has made approximately $78,000 in cash deposits related to operating leases. Provisions of the facilities lease provide for abatement of rent during certain periods and escalating rent payments during the term. For financial reporting purposes, rent expense is recognized on a straight-line basis over the term of the lease. Accordingly, rent expense recognized in excess of rent paid is reflected as deferred rent. Additionally, the Company is required to pay taxes, insurance and maintenance expenses related to the building. Rent expense on the facilities and equipment during 2005, 2004 and 2003 was $526,000, $426,000 and $512,000, respectively.

Future annual minimum payments under operating leases and long-term obligations as of December 31, 2005, are as follows (in thousands):


Years Ending December 31:
2006	$	1,188
2007		758
2008		696
2009		437
2010		6

	$	3,085

F-17

6. Income Taxes

At December 31, 2005, the Company had federal and California income tax net operating loss carryforwards of approximately $172,360,000 and $132,538,000, respectively.

The Company’s federal tax loss carryforwards will begin to expire in 2008, unless previously utilized. The Company’s California tax loss carryforwards will begin to expire in 2006, unless previously utilized. The Company also has federal and California research tax credit carryforwards of approximately $5.1 million and $2.8 million, respectively. The federal research tax credits will begin to expire in 2010, unless previously utilized. The Company’s California research tax credit carryforwards do not expire and will carryforward indefinitely until utilized. In addition, the Company has California manufacturer’s investment credit of approximately $34,000 that will begin to expire in 2008, unless previously utilized.

Pursuant to Sections 382 and 383 of the Internal Revenue Code (“IRC”), annual use of the Company’s net operating losses and tax credit carryforwards may be limited because of cumulative changes in ownership of more than 50% that have occurred. During 2002, a change in ownership as described in IRC Section 382, did occur and will limit the ability of the Company to utilize the net operating losses and tax credit carryforwards in the future.

Significant components of the Company’s deferred tax assets are shown below. A valuation allowance of $85,789,000 has been established to offset the deferred tax assets, as realization of such assets is uncertain.


	December 31,
	2005			2004
Deferred tax asset:
Net operating loss carryforwards	$	67,966,000		$	58,630,000
Tax credits		7,884,000			7,043,000
Capitalized research and development		3,828,000			4,170,000
Deferred revenue		1,628,000			1,827,000
Non-qualified stock option expense		3,175,000			3,674,000
Other, net		1,308,000			811,000

Total deferred tax asset		85,789,000			76,155,000
Valuation allowance for deferred tax assets		(85,789,000	)		(76,155,000	)

	$	—		$	—

The increase in the valuation allowance of approximately $9.6 million is attributable to the increase in deferred tax assets, primarily due to the increase of net operating losses and tax credits.

A portion of the deferred tax assets related to net operating loss carryforwards as of December 31, 2005 include amounts related to stock option activity for which subsequent recognizable tax benefits, if any, will be credited to stockholders’ equity.

7. Employee Benefit Plan

The Company has a 401(k) Savings Plan covering substantially all employees that have been employed for at least three months and meet certain age requirements. Employees may contribute up to 92% of their compensation per year (subject to a maximum limit by federal tax law). The Company does not provide matching contributions to the 401(k) Savings Plan.

F-18

8. Allergan Agreement

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

9. Otsuka Agreement

In December 2001, the Company entered into a license agreement with Otsuka Pharmaceuticals, Co. Ltd., under which Otsuka will be responsible for the marketing, sale and distribution of Vitrase in Japan. Under a related supply agreement, the Company will supply all of Otsuka’s requirements of Vitrase at a fixed price per unit subject to certain future adjustments. The term of the license is the later of fifteen years from the date of first commercial sale of Vitrase in Japan or the expiration of the last valid claim of the licensed patents. Currently, no patents for Vitrase have been issued in Japan.

The Company is responsible for all costs related to manufacturing, while Otsuka is responsible for preclinical studies, clinical trials and regulatory approval of Vitrase in Japan. In December 2001, the Company received an initial license payment of $5.0 million and may receive an additional license payment upon regulatory approval of Vitrase in Japan. Due to the Company’s continuing involvement with Otsuka under the license agreement and related supply agreement, the $5.0 million license fee was recorded as deferred revenue as of December 31, 2001 and is being amortized over the estimated life of the license agreement of 18 years.

The Company also issued 84,567 shares of common stock to Otsuka Pharmaceuticals, Co. Ltd. at $47.30 per share in a private placement for net proceeds of approximately $4.0 million.

10. AcSentient Agreement

In May 2002, the Company acquired substantially all the assets of AcSentient, Inc. The assets include United States marketing rights for a new formulation of timolol, which the Company has named Istalol, a beta-blocking agent for treating glaucoma. AcSentient previously acquired rights to this compound from Senju. The assets acquired from AcSentient also included United States product rights to Xibrom, a topical non-steroidal anti-inflammatory compound for the treatment of ocular inflammation, and worldwide marketing rights for Caprogel, a topical formulation of amniocaproic acid for the treatment of hyphema. AcSentient previously acquired the rights to these two compounds from Senju and the Eastern Virginia Medical School, respectively.

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

F-19

11. 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, 2005. This data has been derived from our unaudited consolidated interim financial statements which, in our opinion, have been prepared on substantially the same basis as the audited financial statements contained elsewhere in this report and include all normal recurring adjustments necessary for a fair presentation of the financial information for the periods presented. These unaudited quarterly results should be read in conjunction with our financial statements and notes thereto included elsewhere in this report. The operating results in any quarter are not necessarily indicative of the results that may be expected for any future period (in thousands except earnings per share).


	Quarter Ended
	Dec. 31, 2005			Sept. 30, 2005			June 30, 2005			Mar. 31, 2005			Dec. 31, 2004			Sept. 30, 2004			June 30, 2004			Mar. 31, 2004
	(Unaudited)
Revenue:
Product sales, net	$	3,613		$	3,518		$	2,740		$	511		$	(165	)	$	1,784		$	—		$	—
License revenue		70			69			70			69			70			69			70			69

Total revenue		3,683			3,587			2,810			580			(95	)		1,853			70			69

Cost of products sold		1,231			968			977			366			788			639			—			—

Gross profit margin		2,452			2,619			1,833			214			(883	)		1,214			70			69

Costs and expenses:
Research and development		4,907			4,842			4,452			2,410			3,492			3,502			5,562			3,027
Selling, general and administrative		8,662			7,286			8,279			6,372			5,380			15,081			2,951			2,429

Total costs and expenses		13,569			12,128			12,731			8,782			8,872			18,583			8,513			5,456

Loss from operations		(11,117	)		(9,509	)		(10,898	)		(8,568	)		(9,755	)		(17,369	)		(8,443	)		(5,387	)
Interest income (expense), net		382			409			462			359			97			155			131			147

Net loss	$	(10,735	)	$	(9,100	)	$	(10,436	)	$	(8,209	)	$	(9,658	)	$	(17,214	)	$	(8,312	)	$	(5,240	)

Net loss per common share, basic and diluted	$	(0.41	)	$	(0.35	)	$	(0.40	)	$	(0.34	)	$	(0.50	)	$	(0.93	)	$	(0.48	)	$	(0.30	)

F-20

EXHIBIT INDEX


Exhibit Number		Description
3.1		Restated Certificate of Incorporation of Registrant (Incorporated by reference to Exhibit 3.1 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002, filed with the Commission on March 7, 2003).

3.2		Certificate of Correction to Restated Certificate of Incorporation of Registrant (Incorporated by reference to Exhibit 3.2 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2002, filed with the Commission on March 7, 2003).

3.3		Second Certificate of Correction to Restated Certificate of Incorporation of Registrant (Incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed with the Commission on August 31, 2005).

3.4		Amended and Restated Bylaws of Registrant (Incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed with the Commission on December 15, 2004).

4.1		Specimen common stock certificate (Incorporated by reference to Exhibit 4.1 of the Registrant’s Registration Statement on Form S-1/A (File No. 333-34120) filed with the Commission on August 7, 2000).

4.2		Preferred Stock Rights Agreement dated as of December 31, 2001, by and between the Registrant and Mellon Investor Services LLC, as rights agent (Incorporated by reference to Exhibit 4.2 of the Registrant’s Registration Statement on Form 8-A (File No. 000-31255) filed with the Commission on January 22, 2002).

4.2.1		First Amendment to the Preferred Stock Rights Agreement dated as of November 18, 2002, by and between the Registrant and Mellon Investor Services LLC, as rights agent (Incorporated by reference to Exhibit 4.2 of the Registrant’s Registration Statement on Form 8-A12G/A (File No. 000-31255) filed with the Commission on November 19, 2002).

10.1		1993 Stock Plan and forms of agreements thereunder (Incorporated by reference to Exhibit 10.2 of the Registrant’s Registration Statement on Form S-1 (File No. 333-34120) filed with the Commission on April 5, 2000). (2)

10.2		2000 Stock Plan (Amended and Restated) (Incorporated by reference to Exhibit 10.1 of the Registrant’s Quarterly Report on Form 10-Q for the period ended June 30, 2003 filed with the Commission on August 14, 2003). (2)

10.3		Forms of agreements under 2000 Stock Plan (Incorporate by reference to Exhibit 10.3 of the Registrant’s Registration Statement on Form S-1 (File No. 333-34120) filed with the Commission on April 5, 2000). (2)

10.4		2000 Employee Stock Purchase Plan (Incorporated by reference to Exhibit 10.4 of the Registrant’s Registration Statement on Form S-1 (File No. 333-34120) filed with the Commission on April 5, 2000). (2)

10.4.1		Amendment No. 1 to Employee Stock Purchase Plan (Incorporated by reference to Exhibit 10.1 of the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on July 20, 2004). (2)

10.4.2		Amendment No. 2 to Employee Stock Purchase Plan (Incorporated by reference to Exhibit 10.2 of the Registrant’s Current Report of Form 8-K filed with the Commission on December 22, 2005). (2)

10.5		Second Amendment and Restatement to the 2004 Performance Incentive Plan (Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the Commission on October 14, 2005). (2)

10.6		Form of Stock Option Agreement under 2004 Performance Incentive Plan (Incorporated by reference to Exhibit 10.2 of the Registrant’s Current Report on Form 8-K filed with the Commission on August 31, 2005). (2)

10.7		Form of Restricted Stock Purchase Agreement under 2004 Performance Incentive Plan (Incorporated by reference to Exhibit 10.3 of the Registrant’s Current Report on Form 8-K filed with the Commission on August 31, 2005). (2)


10.8		Form of Indemnification Agreement with executive officers and directors of Registrant. (2)

10.9		Lease between the Registrant and Aetna Life Insurance Company dated September 13, 1996 for leased premises located at 15279 Alton Parkway, Suite 100, Irvine, California (Incorporated by reference to Exhibit 10.9 of the Registrant’s Registration Statement on Form S-1 (File No. 333-34120) filed with the Commission on April 5, 2000).

10.9.1		First Amendment to Lease between the Registrant and Alton Plaza Property, Inc. dated June 27, 2001 for leased premises located at 15279 Alton Parkway, Suite 100, Irvine, California (Incorporated by reference to Exhibit 10.30 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001, filed with the Commission on April 1, 2002).

10.9.2		Second Amendment to Lease between the Registrant and Alton Plaza Property, Inc. dated February 13, 2002 for leased premises located at 15279 Alton Parkway, Suite 100, Irvine, California (Incorporated by reference to Exhibit 10.31 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001, filed with the Commission on April 1, 2002).

10.9.3		Third Amendment to Lease between the Registrant and Alton Plaza Property, Inc. dated August 12, 2004 for leased premises located at 15279 Alton Parkway, Suite 100, Irvine California (Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the Commission on August 13, 2004).

10.9.4		Fourth Amendment to Lease between the Registrant and Alton Plaza Property, Inc., dated for reference purposes only as of August 31, 2005, for the lease of office space located at 15273 Alton Parkway, Irvine, CA 92618 (Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the Commission on September 14, 2005).

10.10		Clinical Development Agreement dated as of November 3, 1998, by and between Covance, Inc. and the Registrant (Incorporated by reference to Exhibit 10.6 of the Registrant’s Registration Statement on Form S-1 (File No. 333-34120) filed with the Commission on April 5, 2000).

10.11		License Agreement dated as of December 13, 2001, by and between Otsuka Pharmaceutical Co., Ltd., and the Registrant (Incorporated by reference to Exhibit 10.21 of the Registrant’s Current Report on Form 8-K filed with the Commission on January 2, 2002). (1)

10.12		Supply Agreement dated as of December 13, 2001, by and between Otsuka Pharmaceutical Co., Ltd., and the Registrant (Incorporated by reference to Exhibit 10.22 of the Registrant’s Current Report on Form 8-K filed with the Commission on January 2, 2002). (1)

10.13		Executive Employment Agreement dated December 21, 2001, by and between Vicente Anido, Jr., Ph.D. and the Registrant (Incorporated by reference to Exhibit 10.27 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001, filed with the Commission on April 1, 2002). (2)

10.14		Executive Employment Agreement dated February 10, 2003, by and between Lauren P. Silvernail and the Registrant (Incorporated by reference to Exhibit 10.1 of the Registrant’s Quarterly Report on Form 10-Q for the period ended March 31, 2003 filed with the Commission on May 15, 2003). (2)

10.15		Stand-Alone Stock Option Agreement dated December 21, 2001, by and between Vicente Anido, Jr., Ph.D. and the Registrant (Incorporated by reference to Exhibit 10.28 of the Registrant’s Annual Report on Form 10-K for the year ended December 31, 2001, filed with the Commission on April 1, 2002). (2)

10.16		Asset Purchase and Sale Agreement dated May 3, 2002, by and between the Registrant and AcSentient, Inc. (Incorporated by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K filed with the Commission on May 6, 2002).


10.17		Form of Change in Control Severance Agreement with Lauren Silvernail. (2)

10.18		Common Stock and Warrant Purchase Agreement dated September 19, 2002, by and between the Registrant and investors named therein (Incorporated by reference to Exhibit 10.33 of the Registrant’s Annual Report on Form 10-K/A for the period ended December 31, 2002 filed with the Commission on May 14, 2003).

10.19		Form of Warrant to be issued under the Common Stock and Warrant Purchase Agreement (Incorporated by reference to Exhibit 99.3 of the Registrant’s Current Report on Form 8-K filed with the Commission September 25, 2002).

10.20		Individual Non-Qualified Stock Option Agreement dated July 1, 2002, by and between Thomas A. Mitro and the Registrant (Incorporated by reference to Exhibit 99.1 of the Registrant’s Registration Statement on Form S-8 (File No. 333-103279) filed with the Commission on February 18, 2003). (2)

10.21		Individual Non-Qualified Stock Option Agreement dated August 5, 2002, by and between Kirk McMullin and the Registrant (Incorporated by reference to Exhibit 99.2 of the Registrant’s Registration Statement on Form S-8 (File No. 333-103279) filed with the Commission on February 18, 2003). (2)

10.22		Bausch & Lomb Pharmaceuticals, Inc. Contract Manufacturing Supply Agreement dated November 25, 2002, by and between Bausch & Lomb Pharmaceuticals, Inc. and the Registrant (Incorporated by reference to Exhibit 10.38 of the Registrant’s Annual Report on Form 10-K/A for the period ended December 31, 2002 filed with the Commission on June 4, 2003).

10.23		Bausch & Lomb Pharmaceuticals, Inc. Contract Manufacturing Supply Agreement dated November 25, 2002, by and between Bausch & Lomb Pharmaceuticals, Inc. and the Registrant (Incorporated by reference to Exhibit 10.37 of the Registrant’s Annual Report on Form 10-K/A for the period ended December 31, 2002 filed with the Commission on June 4, 2003).

10.24		License Agreement dated January 29, 2002, by and between Eastern Virginia Medical School and AcSentient, Inc. (Incorporated by reference to Exhibit 10.39 of the Registrant’s Annual Report on Form 10-K/A for the period ended December 31, 2002 filed with the Commission on June 4, 2003). (1)

10.24.1		Addendum dated April 30, 2002, by and between Eastern Virginia Medical School and AcSentient, Inc. (Incorporated by reference to Exhibit 10.40 of the Registrant’s Annual Report on Form 10-K/A for the period ended December 31, 2002 filed with the Commission on April 30, 2003). (1)

10.24.2		Letter dated April 26, 2002 from AcSentient, Inc. to Eastern Virginia Medical School regarding consent to assignment of License Agreement (Incorporated by reference to Exhibit 10.41 of the Registrant’s Annual Report on Form 10-K/A for the period ended December 31, 2002 filed with the Commission on April 30, 2003).

10.25		Agreement dated April 17, 2002, by and between Senju Pharmaceutical Co., Ltd. and AcSentient, Inc. (Incorporated by reference to Exhibit 10.42 of the Registrant’s Annual Report on Form 10-K/A for the period ended December 31, 2002 filed with the Commission on June 4, 2003). (1)

10.25.1		Amendment to Timolol Agreement dated August 13, 2002, by and between Senju Pharmaceutical Co., Ltd. and the Registrant (Incorporated by reference to Exhibit 10.46 of the Registrant’s Annual Report on Form 10-K/A for the period ended December 31, 2002 filed with the Commission on April 30, 2003). (1)

10.26		License Agreement dated March 7, 2002, by and between Senju Pharmaceutical Co., Ltd and AcSentient, Inc. (Incorporated by reference to Exhibit 10.42 of the Registrant’s Annual Report on Form 10-K/A for the period ended December 31, 2002 filed with the Commission on June 4, 2003). (1)

10.26.1		Amendment to Bromfenac License Agreement dated August 13, 2002, by and between Senju Pharmaceutical Co., Ltd and the Registrant (Incorporated by reference to Exhibit 10.45 of the Registrant’s Annual Report on Form 10-K/A for the period ended December 31, 2002 filed with the Commission on April 30, 2003). (1)


10.27		Amended and Restated Supply Agreement dated June 16, 2004, by and between Biozyme Laboratories, Ltd. and the Registrant (Incorporated by reference to Exhibit 99.1 of the Registrant’s Current Report on Form 8-K filed with the Commission on June 21, 2004).

10.28		Technology License Agreement dated June 16, 2004, by and between Biozyme Laboratories, Ltd. and the Registrant (Incorporated by reference to Exhibit 99.2 of the Registrant’s Current Report on Form 8-K filed with the Commission on June 21, 2004).

10.29		Vitrase^® Agreement dated September 27, 2004, by and between the Registrant and Allergan Sales, LLC (Incorporated by reference to Exhibit 10.1 of the Registrant’s Quarterly Report on Form 10-Q for the period ended September 30, 2004 filed with the Commission on November 12, 2004). (1)

10.30		License Agreement dated November 17, 2004, by and between the Registrant and Senju Pharmaceuticals Co., Ltd. (Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K/A filed with the Commission on December 28, 2004). (1)

10.31		Supply Agreement dated August 30, 2004, by and between the Registrant and Alliance Medical Products, Inc. (Incorporated by reference to Exhibit 10.45 of the Registrant’s Annual Report on Form 10-K for the period ended December 31, 2004 filed with the Commission on March 15, 2005). (1)

10.32		Loan and Security Agreement dated December 22, 2005, by and between the Registrant and Silicon Valley Bank (Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the Commission on December 22, 2005).

21.1		Subsidiaries of the Registrant.

23.1		Consent of Independent Registered Public Accounting Firm.

24.1		Power of Attorney (included in the signature page)

31.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(d)/15d-14(a) of the Securities Exchange Act of 1934.

31.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(d)/15d-14(a) of the Securities Exchange Act of 1934.

32.1		Certification of Chief Executive Officer Pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.

32.2		Certification of Chief Financial Officer Pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.

(1)	Portions of this exhibit are omitted and were filed separately with the Secretary of the Commission pursuant to ISTA’s application requesting confidential treatment under Rule 406 of the Securities Act of 1933.

(2)	These exhibits are identified as management contracts or compensatory plans or arrangements of the Registrant pursuant to Item 15(a)(3) of Form 10-K.