##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549





FORM 10-Q





Mark One

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

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2011

Or



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

FOR THE TRANSITION PERIOD FROM              TO

Commission File Number: 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) |  | IRS Employer Identification No.)

50 Technology Drive, Irvine,
California 92618

(Address of principal executive offices)

(949) 788-6000

(Registrants telephone number, including area code)





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.    x  Yes     ̈  No

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

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



|                        |  |                                                  |  |                           |  |  
|----------------------- |  | ------------------------------------------------ |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈                                                |  | Accelerated filer         |  |  ̈
|                        |  |                                                  | 
|Non-accelerated filer   |  |  ̈  (Do not check if a smaller reporting company) |  | Smaller reporting company |  | x

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

The number of shares of the registrants common stock, $0.001 par value, outstanding as of March 31, 2011 was 33,849,136.









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##### Table of Contents

TABLE OF CONTENTS



|                                         |  |                                                                                       |    |         |    | 
|---------------------------------------- |  | ------------------------------------------------------------------------------------- | -- | ------- | -- | 
|                                         |  |                                                                                       |    | Page No |   
|PART I FINANCIAL INFORMATION (unaudited) |  |                                                                                       | 3  |        
|                                         |  |                                                                                      
|Item 1                                   |  | Condensed Financial Statements                                                        |    |         | 3  | 
|                                         |  |                                                                                      
|                                         |  | Condensed Balance SheetsMarch 31, 2011 and December 31, 2010                         |    |         | 3  | 
|                                         |  |                                                                                      
|                                         |  | Condensed Statements of OperationsThree Months Ended March 31, 2011 and 2010         |    |         | 4  | 
|                                         |  |                                                                                      
|                                         |  | Condensed Statements of Cash FlowsThree Months Ended March 31, 2011 and 2010         |    |         | 5  | 
|                                         |  |                                                                                      
|                                         |  | Notes to Condensed Financial Statements                                               |    |         | 6  | 
|                                         |  |                                                                                      
|Item 2                                   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |    |         | 15 | 
|                                         |  |                                                                                      
|Item 3                                   |  | Quantitative and Qualitative Disclosure About Market Risk                             |    |         | 23 | 
|                                         |  |                                                                                      
|Item 4                                   |  | Controls and Procedures                                                               |    |         | 23 | 
|                                         | 
|PART II OTHER INFORMATION                |  |                                                                                       | 23 |        
|                                         |  |                                                                                      
|Item 1                                   |  | Legal Proceedings                                                                     |    |         | 23 | 
|                                         |  |                                                                                      
|Item 6                                   |  | Exhibits                                                                              |    |         | 24 | 
|                                         |  |                                                                                      
|                                         |  | Signatures                                                                            |    |         | 25 | 
|                                         |  |                                                                                      
|                                         |  | Index to Exhibits                                                                     |    |         | 26 | 



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##### Table of Contents

PART I FINANCIAL INFORMATION



|Item 1 | Condensed Financial Statements
|------ | ------------------------------

ISTA PHARMACEUTICALS INC.

Condensed Balance
Sheets

(In thousands, except per share data)

(unaudited)



|                                                                                                                                                                                                                                        |  |           |          |   |              |   |          |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------- | -------- | - | ------------ | - | -------- | -
|                                                                                                                                                                                                                                        |  | March 31, |          |   | December 31, |  
|                                                                                                                                                                                                                                        |  | 2011      |          |   | 2010         |  
|ASSETS                                                                                                                                                                                                                                  |  |           |          |   |              |   |          |  
|Current assets:                                                                                                                                                                                                                         |  |           |          |   |              |   |          |  
|Cash and cash equivalents                                                                                                                                                                                                               |  | $         | 75,763   |   |              | $ | 78,777   |  
|Accounts receivable, net of allowances of $2 and $1 at March 31, 2011 and December 31, 2010,
respectively                                                                                                                               |  |           | 34,220   |   |              |   | 33,497   |  
|Inventory, net of allowances of $836 and $1,275 at March 31, 2011 and December 31, 2010, respectively                                                                                                                                   |  |           | 6,999    |   |              |   | 6,130    |  
|Other current assets                                                                                                                                                                                                                    |  |           | 2,860    |   |              |   | 3,454    |  
|                                                                                                                                                                                                                                        |  |           |          |   |              |   |          |  
|Total current assets                                                                                                                                                                                                                    |  |           | 119,842  |   |              |   | 121,858  |  
|Property and equipment, net                                                                                                                                                                                                             |  |           | 10,115   |   |              |   | 10,352   |  
|Deferred financing costs, net                                                                                                                                                                                                           |  |           | 1,618    |   |              |   | 1,885    |  
|Deposits and other assets                                                                                                                                                                                                               |  |           | 150      |   |              |   | 145      |  
|                                                                                                                                                                                                                                        |  |           |          |   |              |   |          |  
|Total assets                                                                                                                                                                                                                            |  | $         | 131,725  |   |              | $ | 134,240  |  
|                                                                                                                                                                                                                                        |  |           |          |   |              |   |          |  
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                                                                                                                                   |  |           |          |   |              |   |          |  
|Current liabilities:                                                                                                                                                                                                                    |  |           |          |   |              |   |          |  
|Accounts payable                                                                                                                                                                                                                        |  | $         | 9,216    |   |              | $ | 4,158    |  
|Accrued compensation and related expenses                                                                                                                                                                                               |  |           | 4,175    |   |              |   | 6,428    |  
|Revolving Credit Facility                                                                                                                                                                                                               |  |           | 13,000   |   |              |   | 13,000   |  
|Current portion of Facility Agreement                                                                                                                                                                                                   |  |           | 21,450   |   |              |   | 21,450   |  
|Current portion of obligations under capital leases                                                                                                                                                                                     |  |           | 119      |   |              |   | 143      |  
|Allowance for rebates and chargebacks                                                                                                                                                                                                   |  |           | 10,054   |   |              |   | 9,273    |  
|Allowance for product returns                                                                                                                                                                                                           |  |           | 8,371    |   |              |   | 8,623    |  
|Royalties payable                                                                                                                                                                                                                       |  |           | 31,661   |   |              |   | 25,567   |  
|Other accrued expenses                                                                                                                                                                                                                  |  |           | 15,170   |   |              |   | 17,394   |  
|                                                                                                                                                                                                                                        |  |           |          |   |              |   |          |  
|Total current liabilities                                                                                                                                                                                                               |  |           | 113,216  |   |              |   | 106,036  |  
|Deferred rent and other long term liabilities                                                                                                                                                                                           |  |           | 2,221    |   |              |   | 2,287    |  
|Obligations under capital leases                                                                                                                                                                                                        |  |           | 101      |   |              |   | 123      |  
|Facility Agreement, net of current portion and unamortized discounts and derivatives                                                                                                                                                    |  |           | 39,418   |   |              |   | 38,706   |  
|Warrant liability                                                                                                                                                                                                                       |  |           | 138,419  |   |              |   | 66,185   |  
|                                                                                                                                                                                                                                        |  |           |          |   |              |   |          |  
|Total liabilities                                                                                                                                                                                                                       |  |           | 293,375  |   |              |   | 213,337  |  
|                                                                                                                                                                                                                                        |  |           |          |   |              |   |          |  
|Commitments and contingencies                                                                                                                                                                                                           |  |           |          |   |              |   |          |  
|Stockholders deficit:                                                                                                                                                                                                                  |  |           |          |   |              |   |          |  
|Preferred stock, $0.001 par value; 5,000 shares authorized of which 1,000 shares have been designated as Series A Participating
Preferred Stock at March 31, 2011 and December 31, 2010, respectively; no shares issued and outstanding |  |           |         |   |              |   |         |  
|Common stock, $0.001 par value; 100,000 shares authorized at March 31, 2011 and December 31, 2010; 33,849 and 33,589
shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively                                |  |           | 33       |   |              |   | 33       |  
|Additional paid-in capital                                                                                                                                                                                                              |  |           | 324,962  |   |              |   | 323,442  |  
|Accumulated deficit                                                                                                                                                                                                                     |  |           | (486,645 | ) |              |   | (402,572 | )
|                                                                                                                                                                                                                                        |  |           |          |   |              |   |          |  
|Total stockholders deficit                                                                                                                                                                                                             |  |           | (161,650 | ) |              |   | (79,097  | )
|                                                                                                                                                                                                                                        |  |           |          |   |              |   |          |  
|Total liabilities and stockholders deficit                                                                                                                                                                                             |  | $         | 131,725  |   |              | $ | 134,240  |  
|                                                                                                                                                                                                                                        |  |           |          |   |              |   |          |  

See accompanying notes



3



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##### Table of Contents

ISTA PHARMACEUTICALS INC.

Condensed Statements of Operations

(In thousands, except per share data)

(unaudited)



|                                                                     |  |                             |         |   |      |   |        |  
|-------------------------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------ | -
|                                                                     |  | Three Months
EndedMarch 31, |        
|                                                                     |  | 2011                        |         |   | 2010 |  
|Revenues:                                                            |  |                             |         |   |      |   |        |  
|Product sales, net                                                   |  | $                           | 36,720  |   |      | $ | 28,304 |  
|                                                                     |  |                             |         |   |      |   |        |  
|Total revenues                                                       |  |                             | 36,720  |   |      |   | 28,304 |  
|Cost of products sold                                                |  |                             | 9,216   |   |      |   | 7,284  |  
|                                                                     |  |                             |         |   |      |   |        |  
|Gross profit                                                         |  |                             | 27,504  |   |      |   | 21,020 |  
|                                                                     |  |                             |         |   |      |   |        |  
|Costs and expenses:                                                  |  |                             |         |   |      |   |        |  
|Research and development                                             |  |                             | 10,344  |   |      |   | 4,803  |  
|Selling, general and administrative                                  |  |                             | 26,931  |   |      |   | 20,868 |  
|                                                                     |  |                             |         |   |      |   |        |  
|Total costs and expenses                                             |  |                             | 37,275  |   |      |   | 25,671 |  
|                                                                     |  |                             |         |   |      |   |        |  
|Loss from operations                                                 |  |                             | (9,771  | ) |      |   | (4,651 | )
|Other (expense) income:                                              |  |                             |         |   |      |   |        |  
|Interest expense                                                     |  |                             | (2,072  | ) |      |   | (2,071 | )
|Gain on derivative valuation                                         |  |                             |        |   |      |   | 7      |  
|(Loss) gain on warrant valuation                                     |  |                             | (72,234 | ) |      |   | 7,191  |  
|Other, net                                                           |  |                             | 4       |   |      |   |       |  
|                                                                     |  |                             |         |   |      |   |        |  
|Total other (expense) income                                         |  |                             | (74,302 | ) |      |   | 5,127  |  
|                                                                     |  |                             |         |   |      |   |        |  
|Net (loss) income                                                    |  | $                           | (84,073 | ) |      | $ | 476    |  
|                                                                     |  |                             |         |   |      |   |        |  
|Net (loss) income per common share, basic and diluted                |  | $                           | (2.49   | ) |      | $ | 0.01   |  
|                                                                     |  |                             |         |   |      |   |        |  
|Shares used in computing net (loss) income per common share, basic   |  |                             | 33,715  |   |      |   | 33,364 |  
|                                                                     |  |                             |         |   |      |   |        |  
|Shares used in computing net (loss) income per common share, diluted |  |                             | 33,715  |   |      |   | 43,895 |  
|                                                                     |  |                             |         |   |      |   |        |  

See accompanying notes



4



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ISTA PHARMACEUTICALS INC.

Condensed Statements of Cash Flows

(In thousands)

(unaudited)



|                                                                                     |  |                             |         |   |      |   |         |  
|------------------------------------------------------------------------------------ |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                     |  | Three Months
EndedMarch 31, |        
|                                                                                     |  | 2011                        |         |   | 2010 |  
|OPERATING ACTIVITIES                                                                 |  |                             |         |   |      |   |         |  
|Net (loss) income                                                                    |  | $                           | (84,073 | ) |      | $ | 476     |  
|Adjustments to reconcile net (loss) income to net cash used in operating activities: |  |                             |         |   |      |   |         |  
|Stock-based compensation costs                                                       |  |                             | 769     |   |      |   | 868     |  
|Amortization of deferred financing costs                                             |  |                             | 267     |   |      |   | 270     |  
|Amortization of discounts on Facility Agreement                                      |  |                             | 712     |   |      |   | 711     |  
|Change in value of warrants related to Facility Agreement                            |  |                             | 72,234  |   |      |   | (7,191  | )
|Change in value of derivatives related to Facility Agreement                         |  |                             |        |   |      |   | (7      | )
|Depreciation and amortization                                                        |  |                             | 566     |   |      |   | 247     |  
|Changes in operating assets and liabilities:                                         |  |                             |         |   |      |   |         |  
|Accounts receivable, net                                                             |  |                             | (723    | ) |      |   | (7,284  | )
|Inventory, net                                                                       |  |                             | (869    | ) |      |   | 665     |  
|Other current assets                                                                 |  |                             | 594     |   |      |   | (589    | )
|Accounts payable                                                                     |  |                             | 5,058   |   |      |   | 1,546   |  
|Accrued compensation and related expenses                                            |  |                             | (2,253  | ) |      |   | (3,906  | )
|Allowance for rebates and chargebacks                                                |  |                             | 781     |   |      |   | (80     | )
|Allowance for product returns                                                        |  |                             | (252    | ) |      |   | 5       |  
|Royalties payable                                                                    |  |                             | 6,094   |   |      |   | 3,840   |  
|Other accrued expenses                                                               |  |                             | (2,225  | ) |      |   | 157     |  
|Deferred rent and other long term liabilities                                        |  |                             | (66     | ) |      |   |        |  
|                                                                                     |  |                             |         |   |      |   |         |  
|Net cash used in operating activities                                                |  |                             | (3,384  | ) |      |   | (10,272 | )
|                                                                                     |  |                             |         |   |      |   |         |  
|INVESTING ACTIVITIES                                                                 |  |                             |         |   |      |   |         |  
|Purchases of equipment                                                               |  |                             | (330    | ) |      |   | (226    | )
|Deposits and other assets                                                            |  |                             | (5      | ) |      |   | 1       |  
|                                                                                     |  |                             |         |   |      |   |         |  
|Net cash used in investing activities                                                |  |                             | (335    | ) |      |   | (225    | )
|                                                                                     |  |                             |         |   |      |   |         |  
|FINANCING ACTIVITIES                                                                 |  |                             |         |   |      |   |         |  
|Proceeds from exercise of stock options                                              |  |                             | 751     |   |      |   | 6       |  
|Payments under capital leases                                                        |  |                             | (46     | ) |      |   | (43     | )
|Proceeds from Revolving Credit Facility                                              |  |                             | 13,000  |   |      |   | 13,000  |  
|Repayments on Revolving Credit Facility                                              |  |                             | (13,000 | ) |      |   | (13,000 | )
|Proceeds from issuance of common stock                                               |  |                             |        |   |      |   | 36      |  
|                                                                                     |  |                             |         |   |      |   |         |  
|Net cash provided by (used in) financing activities                                  |  |                             | 705     |   |      |   | (1      | )
|                                                                                     |  |                             |         |   |      |   |         |  
|Decrease in cash and cash equivalents                                                |  |                             | (3,014  | ) |      |   | (10,498 | )
|Cash and cash equivalents at beginning of period                                     |  |                             | 78,777  |   |      |   | 53,702  |  
|                                                                                     |  |                             |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                           |  | $                           | 75,763  |   |      | $ | 43,204  |  
|                                                                                     |  |                             |         |   |      |   |         |  
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                    |  |                             |         |   |      |   |         |  
|Cash paid during the period for interest                                             |  | $                           | 1,080   |   |      | $ | 1,126   |  
|                                                                                     |  |                             |         |   |      |   |         |  

See accompanying notes



5



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ISTA PHARMACEUTICALS INC.

Notes to Condensed Financial Statements

(unaudited)

1. The Company

ISTA Pharmaceuticals, Inc. (ISTA, the Company, or we) was incorporated as Advanced
Corneal Systems, Inc. in California in February 1992 to discover, develop and market new remedies for diseases and conditions of the eye. In March 2000, we changed our name to ISTA Pharmaceuticals, Inc., and we reincorporated in Delaware in August
2000. BROMDAY, BEPREVE®, ISTALOL®, VITRASE®, XIBROM (bromfenac
ophthalmic solution)®, XIBROM, REMURA, T-PRED, ISTA®, ISTA Pharmaceuticals, Inc.® and the ISTA logo are our trademarks, either owned or under license.

We are a rapidly growing commercial-stage, multi-specialty pharmaceutical company developing, marketing and selling our own products in the United States, or the U.S., and Puerto Rico. We are the fourth
largest branded prescription eye care business in the U.S. and have an emerging allergy drug franchise. We manufacture our finished good products through third-party contracts, and we in-license or acquire new products and technologies to add to our
internal development efforts from time to time. Our products and product candidates seek to treat allergy and serious diseases of the eye and include therapies for ocular inflammation and pain, glaucoma, dry eye and ocular and nasal allergies. The
U.S. prescription markets for 2010 which our therapies seek to address include key segments of the $6.5 billion ophthalmic pharmaceutical market and the $2.5 billion nasal allergy market.

We currently have four products available for sale in the U.S. and Puerto Rico: BROMDAY (bromfenac ophthalmic solution) 0.09% for the
treatment of postoperative inflammation and reduction of ocular pain in patients who have undergone cataract extractions, BEPREVE (bepotastine besilate ophthalmic solution) 1.5% for the treatment of ocular itching associated with allergic
conjunctivitis, ISTALOL (timolol maleate ophthalmic solution) 0.05% for the treatment of glaucoma and VITRASE (hyaluronidase injection) ovine, 200 USP units/ml for use as a spreading agent. Until February 28, 2011, we sold XIBROM (bromfenac
ophthalmic solution) 0.09%, which was prescribed for the treatment of inflammation and pain following cataract surgery. Effective February 28, 2011, we stopped shipping XIBROM and focused on the conversion of XIBROM to BROMDAY. In addition, we
have several eye and allergy product candidates in various stages of development, including treatments for dry eye, ocular inflammation and pain and nasal allergies.

2. Summary of Significant Accounting Policies

Basis of Presentation

Our unaudited condensed financial statements have been prepared in accordance with the instructions to Form 10-Q and
Article 10 of Regulation S-X. The accompanying unaudited condensed financial statements do not include certain footnotes and financial presentations normally required under generally accepted accounting principles in the United States, or GAAP, and,
therefore should be read in conjunction with the consolidated financial statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2010.

In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for the fair presentation of the
unaudited condensed balance sheets as of March 31, 2011 and December 31, 2010, and statements of operations and cash flows for the three months ended March 31, 2011 and 2010 have been made. The interim results of operations are not
necessarily indicative of the results to be expected for the full fiscal year.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts
reported in the condensed financial statements and accompanying notes. Actual results could differ significantly from those estimates.

Revenue Recognition

Product Revenues. We recognize revenues
from product sales 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 revenues net of
estimated allowances for rebates, chargebacks, product returns and other discounts, such as wholesaler fees. If actual future payments for allowances for discounts, product returns, wholesaler fees, rebates and chargebacks materially exceed the
estimates we made at the time of sale, our financial position, results of operations and cash flows may be negatively impacted.



6



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We establish allowances for estimated rebates, chargebacks and product returns based on
numerous qualitative and quantitative factors, including:



| |  |  | the number of agreements with customers and specific contractual terms;
| | - |  | -----------------------------------------------------------------------



| |  |  | estimated level of units in the distribution channel;
| | - |  | -----------------------------------------------------



| |  |  | historical rebates, chargebacks and returns of products;
| | - |  | --------------------------------------------------------



| |  |  | direct communication with customers;
| | - |  | ------------------------------------



| |  |  | anticipated introduction of competitive products or generics;
| | - |  | -------------------------------------------------------------



| |  |  | anticipated pricing strategy changes by us and/or our competitors;
| | - |  | ------------------------------------------------------------------



| |  |  | analysis of prescription data gathered by a third-party prescription data provider;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | the impact of wholesaler distribution agreements;
| | - |  | -------------------------------------------------



| |  |  | the impact of changes in state and federal regulations; and
| | - |  | -----------------------------------------------------------



| |  |  | the estimated remaining shelf life of products.
| | - |  | -----------------------------------------------

In our analyses, we utilize on-hand unit data purchased from the major wholesalers, as well as prescription data purchased from a third-party data provider, to develop estimates of historical unit channel
pull-through. We utilize an internal analysis to compare, on a historical basis, net product shipments versus both estimated prescriptions written and product returns. Based on such analysis, we develop an estimate of the quantity of product which
may be subject to various discounts, product returns, rebates, chargebacks and wholesaler fees.

We record estimated
allowances for rebates, chargebacks, product returns and other discounts, such as wholesaler fees, in the same period when revenue is recognized. The objective of recording the allowances for such deductions at the time of sale is to provide a
reasonable estimate of the aggregate amount of credit to our direct customers or payments to our indirect customers. Customers typically process their claims for allowances such as early pay discounts promptly, usually within the established payment
terms. We monitor actual credit memos issued to our customers and compare such actual amounts to the estimated provisions, in the aggregate, for each allowance category to assess the reasonableness of the various reserves at each balance sheet date.
Differences between our estimated allowances and actual credits issued have not been significant, and are accounted for in the current period as a change in estimate.

In general, we are obligated to accept from our customers the return of products that have reached their expiration date. We authorize returns for damaged products, expiring and expired products in
accordance with our return goods policy and procedures, and have established reserves for such amounts at the time of sale. We typically refund the agreed proportion of the sales price by the issuance of a credit, rather than a cash refund or
exchange for inventory, and the returned product is destroyed. With the launch of each of our products, we recorded a sales return allowance, which is 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 materially exceed our estimated allowances for returns.

We identify product returns by their manufacturing lot number. Because we manufacture in bulk, lot sizes can be large and, as a result, sales of any individual lot may occur over several periods. As a
result, we are unable to specify if actual returns or credits relate to a sale that occurred in the current period or a prior period, and therefore, we cannot specify how much of the allowance recorded relates to sales made in prior periods. Since
there have been no material differences between estimates recorded and actual credits issued, we believe our systems and procedures are adequate for managing our business.

Allowances for product returns were $8.4 million and $8.6 million as of March 31, 2011 and December 31, 2010, respectively. These allowances reflect an estimate of our liability for products
that may be returned by the original purchaser in accordance with our stated return policy, which allows customers to return products within six months of their respective expiration dates and for a period up to twelve months after such products
have reached their respective expiration dates. We estimate our liability for product returns at each reporting period based on the estimated units in the channel and the other factors discussed above. We believe we are adequately reserved for
product returns for any remaining XIBROM inventory in the distribution channel.



7



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##### Table of Contents

As a percentage of gross product revenues, the allowance for product returns was 1.1% and
1.6% for the three months ended March 31, 2011 and 2010, respectively. The decrease is primarily due to the improvement in historical trending of actual return data, the lengthening of product shelf life, and continued acceptance and pull
through of our products.

We also periodically offer promotional discounts to our existing customer base. These discounts are
usually calculated as a percentage of the current published list price. Accordingly, the discounts are recorded as a reduction of revenue in the period that the program is offered. In addition to promotional discounts, at the time we implement a
price increase, we generally offer our existing customer base an opportunity to purchase a limited quantity of products at the previous list price. Shipments resulting from these programs generally are not in excess of ordinary levels and therefore,
we recognize the related revenue upon receipt by the customer and include the sale in estimating our various product-related allowances. In the event we determine that these sales represent purchases of inventory in excess of ordinary levels for a
given wholesaler, the potential impact on product returns exposure would be specifically evaluated and reflected as a reduction to revenue at the time of such sale.

Allowances for estimated rebates and chargebacks were $10.1 million and $9.3 million as of March 31, 2011 and December 31, 2010, respectively. Other discounts, such as wholesaler fees and prompt
pay discounts, were $4.2 million and $5.0 million as of March 31, 2011 and December 31, 2010, respectively. These allowances reflect an estimate of our liability for items such as rebates due to various governmental organizations under the
Medicare/Medicaid regulations, rebates due to managed care organizations under specific contracts, chargebacks due to various organizations purchasing certain of our products through federal contracts and/or group purchasing agreements and fees
charged by certain wholesalers under distribution agreements. We estimate our liability for rebates, chargebacks and other discounts, such as wholesaler fees, at each reporting period based on the assumptions described above.

As a percentage of gross product revenues, the allowance for rebates, chargebacks and other discounts such as wholesaler fees was 21.8%
and 17.6% for the three months ended March 31, 2011 and 2010, respectively. The increase is primarily due to growth in the number and utilization of managed care contracts, federal contracts, and wholesaler distribution agreements and the
impact of higher Medicaid rebates required under the recently enacted healthcare legislation. We record estimated Medicare rebates required under the recently enacted healthcare legislation, commonly known as the donut-hole, that became
effective beginning January 1, 2011. We believe these rebates will impact us commencing the second quarter of 2011, with most of the rebates being incurred during the second and third quarters.

License Revenue. 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 we have ongoing performance
obligations. Any amounts received prior to satisfying our revenue recognition criteria will be recorded as deferred income in the accompanying condensed balance sheets.

Cash and Cash Equivalents

Cash and cash equivalents consist of cash
in banks and short-term U.S. Treasury investments with maturities of three months or less when purchased. Cash and cash equivalents are carried at cost, which we believe approximates fair value because of the short-term maturity of these
instruments. Cash and cash equivalents are maintained at financial institutions and, at times, balances may exceed federally insured limits. We have never experienced any losses related to these balances. All of our non-interest bearing cash
balances were fully insured at March 31, 2011 and December 31, 2010, due to a temporary federal program in effect through December 31, 2012. Under the program, there is no limit to the amount of insurance for eligible accounts.
Beginning in 2013, insurance coverage will revert to $250,000 per depositor at each financial institution, and our non-interest bearing cash balances may exceed federally insured limits. We had total cash and cash equivalents of approximately $75.8
million and $78.8 million as of March 31, 2011 and December 31, 2010, respectively, of which, $55 million and $60 million, respectively, were invested in low interest bearing U.S. Treasury Funds.

Concentration of Credit Risk and Customer Risk

Financial instruments that potentially subject us to a significant concentration of credit risk principally consist of trade receivables. Wholesale distributors account for a substantial portion of trade
receivables. Accounts receivables from McKesson HBOC, Cardinal Health, Inc., and AmeriSource Bergen Corp. accounted for 40%, 34% and 19%, respectively, of our total accounts receivables as of March 31, 2011. Accounts receivables from McKesson
HBOC, Cardinal Health, Inc., and AmeriSource Bergen Corp. accounted for 37%, 43% and 14%, respectively, of our total accounts receivables as of December 31, 2010. We maintain reserves for bad debt and such losses, in the aggregate, have not
exceeded our estimates.



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Sales to McKesson HBOC, Cardinal Health, Inc., and AmeriSource Bergen Corp. accounted for
34%, 34% and 23% of our net revenues for the three months ended March 31, 2011. Sales to Cardinal Health, Inc., McKesson HBOC and AmeriSource Bergen Corp. accounted for 42%, 28% and 20% of our net revenues for the three months ended
March 31, 2010.

Inventory

Inventory at March 31, 2011 was $7.0 million, which was comprised of $3.4 million of raw materials, $0.7 million of work-in-progress and $3.7 million of finished goods and excluded $0.8 million in
inventory reserves. Inventory at December 31, 2010 was $6.1 million, which was comprised of $3.5 million of raw materials, $0.1 million of work-in-progress and $3.8 million of finished goods and excluded $1.3 million in inventory reserves.
Inventory, net of allowances, is stated at the lower of cost or market. Cost is determined by the first-in, first-to-expire method.

Inventory is reviewed periodically for slow-moving or obsolete status. We adjust our inventory to reflect situations in which the cost of inventory is not expected to be recovered. We would record a
reserve to adjust inventory to its net realizable value if: (i) a launch of a new product is delayed, inventory may not be fully utilized and could be subject to impairment, (ii) when a product is close to expiration and not expected to be
sold, (iii) when a product has reached its expiration date or (iv) when a product is not expected to be saleable. In determining the reserves for these products, we consider factors such as the amount of inventory on hand and its remaining
shelf life, and current and expected market conditions, including management forecasts and levels of competition. We have evaluated the current level of inventory considering historical trends and other factors, and based on our evaluation, have
recorded adjustments to reflect inventory at its net realizable value. These adjustments are estimates, which could vary significantly from actual results if future economic conditions, customer demand, competition or other relevant factors differ
from expectations. These estimates require us to make assessments about the future demand for our products in order to categorize the status of such inventory items as slow-moving, obsolete or in excess-of-need. These future estimates are subject to
the ongoing accuracy of our forecasts of market conditions, industry trends, competition and other factors. Differences between our estimated reserves and actual inventory adjustments have not been significant, and are accounted for in the current
period as a change in estimate.

Costs incurred for the manufacture of validation batches for pre-approval products are
recorded as research and development expenses in the period in which those costs are incurred.

Supply Concentration
Risks

Some materials used in our products are currently obtained from a single source. We have a supply agreement with
Senju Pharmaceuticals, Co. Ltd., or Senju, for bepotastine besilate, which is the active pharmaceutical ingredient in BEPREVE. Currently, Senju is our sole source for bepotastine besilate for BEPREVE. We have a supply agreement with Regis
Technologies, Inc., or Regis, for bromfenac, which is the active pharmaceutical ingredient in BROMDAY and was also used for XIBROM. Currently, Regis is our sole source for bromfenac. We also have supply agreements with Bausch & Lomb,
Incorporated to manufacture finished product of BROMDAY, BEPREVE and ISTALOL. Currently, Bausch & Lomb Incorporated is our sole source for finished product of BROMDAY, BEPREVE and ISTALOL.

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 2010, we received approval from the U.S. Food and Drug Administration, or the FDA, to manufacture hyaluronidase at our Irvine, California manufacturing facility and began production in July 2010. We have a
supply agreement with Alliance Medical Products to manufacture commercial quantities of VITRASE. Currently, Alliance Medical Products is our sole source for VITRASE.

Fair Value of Financial Instruments

Our financial instruments
include cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, current and long-term debt, certain derivatives related to our debt obligations and common stock warrants issued to lenders. The carrying amount of cash
and cash equivalents, 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. The carrying amount of our Revolving
Credit Facility approximates fair value since the interest rate approximates the market rate for debt securities with similar terms and risk characteristics. Although our Facility Agreement is considered a financial instrument, we are unable to
reasonably determine fair value.

Fair Value Measurements

We account for fair value measurements under the Financial Standards Accounting Board, or the FASB, Accounting Standard Codification 820
Fair Value Measurements and Disclosures, or ASC 820, which defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most



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advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a three-level fair value hierarchy that
prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:



| |  |  | Level 1  Quoted prices in active markets for identical assets or liabilities.
| | - |  | ------------------------------------------------------------------------------



| |  |  | Level 2  Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities
in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Level 3  Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the
assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We have segregated all assets and liabilities measured at fair value on a recurring basis into the most appropriate level within the fair
value hierarchy based on the inputs used to determine the fair value at the measurement date in the table below. As of March 31, 2011 and December 31, 2010, all of our assets and liabilities are valued using Level 1 inputs except for the
derivatives and warrants related to our Facility Agreement. We have valued the warrants using a Black-Scholes model, which we believe is the appropriate valuation model based on the terms of the warrants and based on assumptions and data available
as of March 31, 2011 and December 31, 2010, including but not limited to our stock price, risk-free interest rates and stock price volatility.

Assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands) (unaudited):



|                                                         |  |                               |        |  |                        |   |   |         |  |   |          |   |  |   |          |  
|-------------------------------------------------------- |  | ----------------------------- | ------ |  | ---------------------- | - | - | ------- |  | - | -------- | - |  | - | -------- | -
|                                                         |  | Fair Value Measurements using |        |  | Total CarryingValue
at |  
|                                                         |  | Level 1                       |        |  | Level 2                |   |   | Level 3 |  |  
|March 31, 2011                                           |  |                               |        |  |                        |   |   |         |  |   |          |   |  |   |          |  
|Cash and cash equivalents, including U.S. Treasury Funds |  | $                             | 75,763 |  |                        | $ |  |         |  | $ |         |   |  | $ | 75,763   |  
|Derivatives (Facility Agreement)                         |  |                               |       |  |                        |   |  |         |  |   | (169     | ) |  |   | (169     | )
|Warrants                                                 |  |                               |       |  |                        |   |  |         |  |   | (138,419 | ) |  |   | (138,419 | )
|                                                         |  |                               |        | 
|December 31, 2010                                        |  |                               |        |  |                        |   |   |         |  |   |          |   |  |   |          |  
|Cash and cash equivalents, including U.S. Treasury Funds |  |                               | 78,777 |  |                        |   |  |         |  |   |         |   |  |   | 78,777   |  
|Derivatives (Facility Agreement)                         |  |                               |       |  |                        |   |  |         |  |   | (169     | ) |  |   | (169     | )
|Warrants                                                 |  |                               |       |  |                        |   |  |         |  |   | (66,185  | ) |  |   | (66,185  | )



|                                               |  |                                                                                 |      |   |                                                                               |   |          |  
|---------------------------------------------- |  | ------------------------------------------------------------------------------- | ---- | - | ----------------------------------------------------------------------------- | - | -------- | -
|                                               |  | Fair Value MeasurementsUsing SignificantUnobservable Inputs(Level 3)
Derivative |      |   | Fair Value MeasurementsUsing SignificantUnobservable Inputs(Level 3)
Warrants |  
|Balance at December 31, 2010                   |  | $                                                                               | (169 | ) |                                                                               | $ | (66,185  | )
|Total gains or losses (realized or unrealized) |  |                                                                                 |     |   |                                                                               |   | (72,234  | )
|                                               |  |                                                                                 |      |   |                                                                               |   |          |  
|Balance at March 31, 2011                      |  | $                                                                               | (169 | ) |                                                                               | $ | (138,419 | )
|                                               |  |                                                                                 |      |   |                                                                               |   |          |  

Comprehensive (Loss) Income

Accounting Standards Codification 220 Comprehensive Income, or ASC 220, requires reporting and displaying comprehensive income
(loss) and its components, which includes net income (loss) and unrealized gains and losses on investments and foreign currency translation gains and losses. Total comprehensive (loss) income for the three months ended March 31, 2011 and 2010
was $(84.1) million and $0.5 million, respectively.

Stock-Based Compensation

We recognize compensation costs for all stock-based awards made to employees and directors. The fair value of stock-based awards is
estimated at grant date using an option pricing model and the portion that is ultimately expected to vest is recognized as compensation cost over the requisite service period.

Since stock-based compensation is recognized only for those awards that are ultimately expected to vest, we have applied an estimated forfeiture rate to unvested awards for the purpose of calculating
compensation cost. These estimates will be revised, if necessary, in future periods if actual forfeitures differ from estimates. Changes in forfeiture estimates impact compensation cost in the period in which the change in estimate occurs.



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We use the Black-Scholes option-pricing model to estimate the fair value of stock-based
awards. The determination of fair value using the Black-Scholes option-pricing model is affected by our stock price as well as assumptions regarding a number of complex and subjective variables, including expected stock price volatility, risk-free
interest rate, expected dividends and projected employee stock option exercise behaviors. We estimate the expected term based on the contractual term of the awards and employees exercise and expected post-vesting termination behavior.

At March 31, 2011, there was $6.8 million of total unrecognized compensation cost related to non-vested stock options,
which is expected to be recognized over a remaining weighted average vesting period of approximately 2.6 years.

Restricted Stock Awards

The amount of unearned compensation recorded is based on the market value of the shares on the date of issuance. Expenses related to the vesting of restricted stock were $0.1 million for both of the three
months ended March 31, 2011 and 2010, respectively. As of March 31, 2011, there was approximately $1.5 million of unamortized compensation cost related to restricted stock awards, which is expected to be recognized ratably over the
vesting period of four years.

Net Income (Loss) Per Share

Basic net income (loss) per common share is computed by dividing the net income (loss) for the period by the weighted average number of
common shares outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted-average number of common and common equivalent shares, such as stock options, unvested restricted shares
and warrants, outstanding during the period. Diluted earnings for common stockholders per common share consider the impact of potentially dilutive securities except in periods in which there is a loss because the inclusion of the potential common
shares would have an anti-dilutive effect. Diluted EPS excludes the impact of potential common shares related to our stock options, unvested restricted shares and warrants, in periods in which the exercise or conversion price is greater than the
average market price of our common stock during the period.

Basic and diluted net income per share was calculated as follows
(in thousands, unaudited):



|                                                                            |  |                                  |        | 
|--------------------------------------------------------------------------- |  | -------------------------------- | ------ | 
|                                                                            |  | Three Months EndedMarch 31, 2010 |       
|Numerator for basic and diluted income per share                            |  | $                                | 476    | 
|                                                                            |  |                                  |        | 
|Denominator for basic income per share  weighted-average shares            |  |                                  | 33,364 | 
|Effect of dilutive securities                                               |  |                                  | 10,531 | 
|                                                                            |  |                                  |        | 
|Denominator for diluted income per share  adjusted weighted-average shares |  |                                  | 43,895 | 
|                                                                            |  |                                  |        | 

Diluted net income per share of common stock includes the dilutive effect of stock options, unvested
restricted stock and warrants. As we incurred a net loss for the three months ended March 31, 2011, we have not computed the diluted earnings per share, as the potentially dilutive securities would have an anti-dilutive effect on earnings. For the
three months ended March 31, 2011 and 2010, respectively, approximately 9.4 million and 12.5 million stock options and shares of unvested restricted stock were excluded from the calculation of diluted income per share because their
exercise prices rendered them anti-dilutive.

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. We have further determined that the 15 million warrants issued in conjunction with our Facility Agreement represent participating securities, requiring the use of the
two-class method for the calculation of basic and diluted earnings per share. Because net losses are not allocated to the warrant holders, the two-class method does not effect our calculation of earnings per share for the three months ended
March 31, 2011. The two-class method for the three months ended March 31, 2010 reflects the amount of unallocated undistributed earnings calculated using the participation percentage.

The following table sets forth the calculation of unallocated undistributed earnings using the two-class method for amounts attributable
to our common stock and our warrants (in thousands) (unaudited):



|                                        |  |                                  |     | 
|--------------------------------------- |  | -------------------------------- | --- | 
|                                        |  | Three Months EndedMarch 31, 2010 |    
|Net income attributable to shareholders |  | $                                | 476 | 
|                                        |  |                                  |     | 
|Common stock unallocated earnings       |  | $                                | 328 | 
|Warrant unallocated earnings            |  |                                  | 148 | 
|                                        |  |                                  |     | 
|Total unallocated earnings              |  | $                                | 476 | 
|                                        |  |                                  |     | 



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Executive Employment Agreements

We have agreements with each of our officers which provides that any unvested stock options and restricted shares then held by such
officer will become fully vested and, with respect to stock options, immediately exercisable, in the event of a change in control of the Company and, in certain instances, if such officers employment is terminated by the Company without cause
within twenty-four months following such change in control or such officer resigns for good reason within sixty days of the event forming the basis for such good reason termination.

Revolving Credit Facility

Under our revolving credit facility with Silicon Valley Bank, or the Revolving Credit Facility, we may borrow up to the lesser of $25.0 million or 80% of eligible accounts receivable, plus the lesser of
25% of net cash and cash equivalents or $10.0 million. As of March 31, 2011, we had $25.0 million available under the Revolving Credit Facility, of which we borrowed $13.0 million. All outstanding amounts under the Revolving Credit Facility
bear interest at a variable rate equal to the lenders prime rate plus a margin of 0.50%. In no event shall the interest rate on outstanding borrowings be less than 4.50%, which is payable on a monthly basis. The Revolving Credit Facility also
contains customary covenants regarding the operation of our business and financial covenants relating to ratios of current assets to current liabilities and is collateralized by all of our assets. An event of default under the Revolving Credit
Facility will occur if, among other things, (i) we are delinquent in making payments of principal or interest on the Revolving Credit Facility; (ii) we fail to cure a breach of a covenant or term of the Revolving Credit Facility;
(iii) we make a representation or warranty under the Revolving Credit Facility that is materially inaccurate; (iv) we are unable to pay our debts as they become due, certain bankruptcy proceedings are commenced or certain orders are
granted against us, or we otherwise become insolvent; or (v) an acceleration event occurs under certain types of other indebtedness outstanding from time to time. If an event of default occurs, the indebtedness to Silicon Valley Bank could be
accelerated, such that it becomes immediately due and payable. We also had letters of credit of $0.6 million outstanding. As of March 31, 2011, we were in compliance with all of the covenants under the Revolving Credit Facility. All amounts
borrowed under the Revolving Credit Facility were repaid in April 2011. The Revolving Credit Facility expires on March 31, 2012.

Facility Agreement

We have a facility agreement, or the Facility
Agreement, with certain institutional accredited investors, collectively known as Lenders, pursuant to which the Lenders loaned us $65 million. On March 31, 2011, we had total indebtedness under the Facility Agreement of $65 million, which
excludes unamortized discounts of $4.3 million and the value of the derivative of $0.2 million. Outstanding amounts under the Facility Agreement accrue interest at a rate of 6.5% per annum, payable quarterly in arrears. We are required to repay
the Lenders 33% of the original principal amount (or $21.5 million) on each of September 26, 2011 and 2012, and 34% of the original principal amount (or $22.0 million) on September 26, 2013.

Any amounts drawn under the Facility Agreement may become immediately due and payable upon (i) an event of default, as
defined in the Facility Agreement, in which case the Lenders would have the right to require us to repay 100% of the principal amount of the loan, plus any accrued and unpaid interest thereon, or (ii) the consummation of certain change of
control transactions, in which case the Lenders would have the right to require us to repay 110% of the outstanding principal amount of the loan, plus any accrued and unpaid interest thereon. An event of default under the Facility Agreement will
occur if, among other things, (i) we fail to make payment when due; (ii) we fail to comply in any material respect with any covenant of the Facility Agreement, and such failure is not cured; (iii) any representation or warranty made
by us in any transaction document was incorrect, false, or misleading in any material respect as of the date it was made; (iv) we are generally unable to pay our debts as they become due or a bankruptcy or similar proceeding is commenced by or
against us; or (v) cash and cash equivalents on the last day of each calendar quarter are less than $10 million. The Facility Agreement also contains customary covenants regarding operations of our business. As of March 31, 2011, we were
in compliance with all the covenants under the Facility Agreement.

In connection with the Facility Agreement, we entered into
a security agreement with the Lenders, pursuant to which, as security for our repayment obligations under the Facility Agreement, we granted to the Lenders a security interest in certain of our intellectual property, including intellectual property
relating to BROMDAY, BEPREVE, ISTALOL, VITRASE, REMURA and XIBROM and each other product marketed by or under license from us, and certain personal property relating thereto.

Because the consummation of certain change in control transactions results in a premium of the outstanding principal, the premium put feature is a derivative that is required to be bifurcated from the
host debt instrument and recorded at fair value at each quarter end. The value of the derivative at March 31, 2011 was $0.2 million and is marked-to-market and adjusted quarterly through other expense.



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In connection with the Facility Agreement, we issued to the Lenders warrants to purchase an
aggregate of 15 million shares of our common stock at an exercise price of $1.41 per share. If we issue or sell shares of our common stock (other than certain excluded shares, as such term is defined in the Facility Agreement), we
will issue concurrently therewith additional warrants to purchase such number of shares of common stock as will entitle the Lenders to maintain the same beneficial ownership in the Company after the issuance as they had prior to such issuance, as
adjusted on a pro rata basis for repayments of the outstanding principal amount under the loan, with such warrants being issued at an exercise price equal to the greater of $1.41 per share and the closing price of the common stock on the date
immediately prior to the issuance. The anti-dilutive element in the warrant agreement requires us to follow the Derivatives and Hedging Topic of the FASB Accounting Standards Codification. The Codification requires us to classify our warrants as a
liability, which are marked to market and adjusted quarterly. We recorded a non-cash valuation loss of $72.2 million, or $2.14 per basic and diluted share for the three month period ended March 31, 2011. We recorded a valuation gain of $7.2
million, or $0.16 per basic and diluted share for the three month period ended March 31, 2010. The change in the valuation of the warrants was primarily driven by changes in both our stock price and related volatility. In April 2011, one of the
Lenders exercised 1,615,385 warrants on a cashless basis. We issued 1,398,859 shares of our common stock, net of shares in lieu of payment for the exercise value.

Commitments and Contingencies

We are subject to routine claims and
litigation incidental to our business. In the opinion of management, the resolution of such claims is not expected to have a material adverse effect on our operating results or financial position.

Legal

Bromfenac Royalty Litigation: We initiated legal action in April 2010 against Senju seeking a declaratory judgment with regard to
our XIBROM royalty obligations to Senju and a recovery of overpaid royalties and other damages from Senju. The only U.S. patent applicable to XIBROM expired in January 2009 and, according to U.S. case law and the terms of our agreement with Senju,
we believe no XIBROM royalties are due after patent expiration. In August 2010, the U.S. District Court for the Central District of California stayed our action against Senju, and, in September 2010, Senju initiated an arbitration proceeding
regarding the same dispute with the International Chamber of Commerce, or the ICC. The order staying our action against Senju will not become appealable until after the arbitration is concluded and a judgment is entered in the court case. A
declaratory judgment that we were seeking from the court in regard to royalty obligations to Senju may apply not only to XIBROM, but also to BROMDAY, which was approved by the FDA in October 2010. The arbitration proceeding, the outcome of
which may also affect our BROMDAY royalty obligations, is in its early stages.

In June 2010, we initiated a legal action
by filing a Complaint against AcSentient, Inc. and AcSentient II, LLC, which we collectively refer to as AcSentient, seeking a declaratory judgment with regard to our XIBROM royalty obligations under the Asset Purchase Agreement dated May 3,
2002 between us and AcSentient, Inc. The only U.S. patent applicable to XIBROM expired in January 2009 and, according to U.S. case law and the terms of our agreement with AcSentient, Inc., we believe no XIBROM royalties are due after patent
expiration. A declaratory judgment that we are seeking from the court in regard to royalty obligations to AcSentient may apply not only to XIBROM, but also to BROMDAY, which was approved by the FDA in October 2010. In November 2010, the Superior
Court of the State of California, County of Orange stayed our case against AcSentient and ruled that the dispute had to be arbitrated. We will have an opportunity to appeal that court ruling after the final judgment is entered by the court. On
January 24, 2011, AcSentient filed a request for arbitration with the ICC.

There can be no assurance about when these two
disputes will be resolved, and we cannot predict the final outcome and financial impact of either. Until these two disputes are resolved, for accounting purposes, we have been and intend to continue to reserve for BROMDAY and XIBROM royalties, which
would have been payable to Senju and AcSentient if the relevant contractual royalty obligations were existing and enforceable. As of March 31, 2011, we had approximately $27 million reserved for such contingent XIBROM and BROMDAY royalties.

Subpoenas From the U.S. Attorney, Western District of New York.In April 2008, we received subpoenas from the office
of the U.S. Attorney for the Western District of New York requesting information regarding the marketing activities related to XIBROM. From April 2008 through March 31, 2011, we have incurred approximately $3.9 million in legal fees associated
with this matter and expect to incur significant expenses in the future. In addition, if the government chooses to engage in civil litigation or initiate a criminal prosecution against us as a result of its review of the requested documents and
other evidence, we may have to incur significant amounts to defend such action or pay or incur substantial fines or penalties, either of which could significantly deplete our cash resources. The case is ongoing and the likelihood of an unfavorable
outcome and/or the amount/range of loss, if any, cannot be reasonably estimated.



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TRICARE Retail Pharmacy Program. Section 703 of the National Defense
Authorization Act of 2008, enacted on January 28, 2009, requires that pharmaceutical products purchased through the Department of Defense, or DoD, TRICARE Retail Pharmacy program be subject to the Federal Ceiling Price discount under the
Veterans Health Care Act of 1992. DoD issued a rule pursuant to Section 703 that requires manufacturers to provide DoD with a quarterly refund on pharmaceutical products utilized through the TRICARE Retail Pharmacy program, and to pay rebates
to DoD on TRICARE Retail Pharmacy purchases retroactive to January 28, 2008. We have requested a waiver of the retroactive rebate for TRICARE Retail Pharmacy utilization for the period from January 28, 2008 to May 26, 2009 (the
effective date of the DoD rule). In addition, the regulation is currently the subject of litigation, and it is our position that the retroactive application of the regulation is contrary to established case law. We have determined that payment of
the retroactive rebate (from January 28, 2008 to May 26, 2009) created by the regulation is neither reasonably estimable nor probable as of March 31, 2011.

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

Segment Reporting

The Company currently operates in only one segment.

Income Taxes

We account for income taxes under the Income Tax Topic of the FASB Accounting Standards Codification. As of
March 31, 2011 and December 31, 2010, there are no unrecognized tax benefits included in the balance sheet that would, if recognized, affect the effective tax rate.

Our practice is to recognize interest and/or penalties related to income tax matters in income tax expense. We had no accrual for interest or penalties on our condensed balance sheets at March 31,
2011 and December 31, 2010, respectively, and have not recognized interest and/or penalties in the condensed statement of operations for the three months ended March 31, 2011.

We are subject to taxation in the United States and various state jurisdictions. Our tax years for 2007 and forward are subject to
examination by federal tax authorities, as are the years 2006 and forward by state tax authorities. Net operating loss carryforwards from the years 1995 forward are also subject to adjustment.

At December 31, 2010, we had net deferred tax assets of $42.9 million. Due to uncertainties surrounding our ability to generate
future taxable income to realize these assets, a full valuation has been established to offset the net deferred tax asset. Additionally, the future utilization of our net operating loss and research and development credit carryforwards to offset
future taxable income may be subject to an annual limitation, pursuant to Internal Revenue Code Sections 382 and 383, as a result of ownership changes that may have occurred previously or that could occur in the future due to the exercise of
warrants or other transactions. Due to the existence of the valuation allowance, future changes in our unrecognized tax benefits will not impact our effective tax rate.

At December 31, 2010, we had federal and state net operating loss carryforwards of approximately $117.5 million and $72.3 million, respectively, after utilizing $17.8 million to offset taxable income
in 2010 and limiting our net operating loss carryforwards due to previous ownership changes under Internal Revenue Code Section 382. Federal tax loss carryforwards continue to expire in 2011 unless previously utilized. California tax loss
carryforwards begin to expire in 2012, unless previously utilized. In addition, we have federal and California research and development tax credit carryforwards of $10.1 million and $6.2 million, respectively. The federal research and
development credit carryforwards will begin to expire in 2011 unless previously utilized. The California research and development credit carryforwards carry forward indefinitely.

New Accounting Pronouncements

In December 2010, the FASB updated the accounting guidance relating to the annual goodwill impairment test. The updated guidance requires companies to perform the second step of the impairment test to
measure the amount of impairment loss, if any, when it is more likely than not that a goodwill impairment exists when the carrying amount of a reporting unit is zero or negative. In considering whether it is more likely than not that a goodwill
impairment exists, an entity must evaluate whether there are adverse qualitative factors. The updated guidance is effective beginning in our fiscal 2012 year. The adoption of this guidance is not expected to have a material impact on our financial
position or results of operations.

In December 2010, the FASB updated the accounting guidance relating to the disclosure of
supplementary pro forma information for business combinations. The updated guidance requires companies to provide additional comparative pro forma financial information along with the nature and amount of any material nonrecurring pro forma
adjustments related to the business combination. The updated guidance is effective for business combinations which have an acquisition date in fiscal years beginning on or after December 15, 2010, or our 2011 fiscal year. The adoption of this
guidance is not expected to have a material impact on our financial position or results of operations.



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##### Table of Contents

In December 2010, the FASB issued an Accounting Standards Update, or ASU, 2010-27, Other
Expenses (Topic 720): Fees Paid to the Federal Government by Pharmaceutical Manufacturers (A consensus of the FASB Emerging Issues Task Force).ASU 2010-27 addresses questions concerning how pharmaceutical companies should recognize and classify
in their income statements fees mandated by the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act, or the Healthcare Reform Act, and collectively referred to as the Acts. The
Acts impose an annual fee on the pharmaceutical manufacturing industry for each year beginning on or after January 1, 2011. For reporting entities that are subject to the pharmaceutical fee mandated by the Acts, the amendments in ASU 2010-27
specify the liability for the fee should be estimated and recorded in full upon the first qualifying sale with a corresponding deferred cost that is amortized to expense using a straightline method of allocation unless another better method
better allocates the fee over the calendar year that it is payable. ASU 2010-27 is effective for calendar years beginning after December 31, 2010, or our 2011 fiscal year, when the fee initially becomes payable. We adopted the provisions of ASU
2010-27 on January 1, 2011 and the adoption did not have a material effect to our financial position or results of operations.

In April 2010, the FASB issued ASU 2010-17, Revenue Recognition  Milestone Method (Topic 605): Milestone Method of Revenue Recognition,or ASU 2010-17.ASU 2010-17 provides guidance on
applying the milestone method to milestone payments for achieving specified performance measures when those payments are related to uncertain future events. Under ASU 2010-17, entities can make an accounting policy to recognize arrangement
consideration received for achieving specified performance measures during the period in which the milestones are achieved, provided certain criteria are met for the milestones to be considered substantive. ASU 2010-17 is effective on a prospective
basis for research and development milestones achieved in fiscal years, beginning on or after June 15, 2010, which for us means 2011. We adopted the provisions of ASU 2010-17 on January 1, 2011 and the adoption did not have a material
effect to our financial position or results of operations.

Subsequent Events

In April 2011, one of the Lenders exercised 1,615,385 warrants on a cashless basis. We issued 1,398,859 shares of our common stock, net of
shares in lieu of payment for the exercise value. Additionally, in May 2011, an assignee of one of the Lenders exercised 500,000 warrants for cash and we issued the shares to the assignee.



|Item 2 | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------ | -------------------------------------------------------------------------------------

This Quarterly Report on Form 10-Q contains forward-looking statements that have been made pursuant to the provisions of the Private
Securities Litigation Reform 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 Managements Discussion and Analysis of Financial Condition and Results of Operations, and in other sections of this Quarterly Report on Form 10-Q. 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 Quarterly Report on Form 10-Q, 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 Quarterly
Report on Form 10-Q. 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, including without limitation the disclosures made under the caption
Managements Discussion and Analysis of Financial Condition and Results of Operations in this Quarterly Report on Form 10-Q and the audited financial statements and the notes thereto and disclosures made under the captions
Management Discussion and Analysis of Financial Condition and Results of Operations, Risk Factors,  Consolidated Financial Statements and Notes to Consolidated Financial Statements included in our
Annual Report on Form 10-K for the year ended December 31, 2010. We obtained the market data and industry information contained in this Quarterly Report on Form 10-Q 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.

The following discussion and
analysis of our financial condition and results of operations should be read in conjunction with our audited condensed financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2010 and
the unaudited condensed financial statements and related notes included in this Quarterly Report on Form 10-Q. References in this Quarterly Report on Form 10-Q to ISTA, we, our, us, or the
Company refer to ISTA Pharmaceuticals, Inc.



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##### Table of Contents

Overview

We are a rapidly growing commercial-stage, multi-specialty pharmaceutical company developing, marketing and selling our own products in
the U.S. and Puerto Rico. We are the fourth largest branded prescription eye care business in the U.S. and have an emerging allergy drug franchise. We manufacture our finished good products through third-party contracts, and we in-license or acquire
new products and technologies to add to our internal development efforts from time to time. Our products and product candidates seek to treat allergy and serious diseases of the eye and include therapies for ocular inflammation and pain, glaucoma,
dry eye and ocular and nasal allergies. The United States, or U.S., prescription markets for 2010 which our therapies seek to address include key segments of the $6.5 billion ophthalmic pharmaceutical market and the $2.5 billion nasal allergy
market.

We currently have four products available for sale in the U.S. and Puerto Rico: BROMDAY (bromfenac ophthalmic
solution) 0.09% for the treatment of postoperative inflammation and reduction of ocular pain in patients who have undergone cataract extractions, BEPREVE (bepotastine besilate ophthalmic solution) 1.5% for the treatment of ocular itching associated
with allergic conjunctivitis, ISTALOL (timolol maleate ophthalmic solution) 0.05% for the treatment of glaucoma and VITRASE (hyaluronidase injection) ovine, 200 USP units/ml for use as a spreading agent. Until February 28, 2011, we sold XIBROM
(bromfenac ophthalmic solution) 0.09%, which was prescribed for the treatment of inflammation and pain following cataract surgery. Effective February 28, 2011, we stopped shipping XIBROM and focused on the conversion of XIBROM to BROMDAY. As of
the week ended April 15, 2011, 81% of the new prescriptions for the bromfenac franchise were converted to BROMDAY. In addition, we have several eye and allergy product candidates in various stages of development, including treatments for dry
eye, ocular inflammation and pain and nasal allergies.

We have, in general, incurred losses since inception and have a
stockholders deficit of $161.7 million (including a cumulative non-cash valuation warrant loss of $131.8 million) through March 31, 2011.

During the quarter ended March 31, 2011 and through the date of this filing, the following events occurred:



| |  |  | We filed a Citizen Petition, or CP, with the FDA on March 1, 2011. The CP requests the FDA refrain from granting tentative or final approval of
any abbreviated new drug application, or ANDA, for bromfenac sodium ophthalmic solution 0.09% that utilizes the labeling for discontinued XIBROM (bromfenac ophthalmic solution)® 0.09% or omits any portion of the BROMDAY label relating to the once-per-day dosing. The FDA has acknowledged publicly there are potential safety concerns related to
the use of the entire class of ophthalmic nonsteroidal anti-inflammatory drugs and patients receiving these compounds post cataract surgery should receive only the lowest effective dose. We filed the CP based upon its head-to-head study between
BROMDAY (bromfenac sodium ophthalmic solution) 0.09% and bromfenac sodium 0.18%, both dosed once-daily, which showed BROMDAY is the lowest-effective dose of this formulation of bromfenac ophthalmic solution for treating postoperative
inflammation and reduction in ocular pain post cataract surgery. The FDA is expected to respond within 180 days of the filing;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Due to the rapid adoption of BROMDAY (bromfenac ophthalmic solution) 0.09%, the first and only once-daily non-steroidal anti-inflammatory
prescription eye drop for the treatment of postoperative inflammation and reduction of ocular pain in patients who have undergone cataract extractions, we stopped shipping twice-daily XIBROM (bromfenac ophthalmic solution)® 0.09% on February 28, 2011. We anticipated wholesalers would continue to sell XIBROM to pharmacies until their
inventories were depleted. As of March 31, 2011, most of the wholesalers inventories were depleted. The conversion of XIBROM to BROMDAY has been well accepted by the markets;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In April 2011, one of the Lenders exercised 1,615,385 warrants on a cashless basis. We issued 1,398,859 shares of our common stock, net of shares in
lieu of payment for the exercise value. Additionally, in May 2011, an assignee of one of the Lenders exercised 500,000 warrants for cash and we issued the shares to the assignee. After such issuances, we have approximately 12.9 million warrants
and approximately 35.8 million shares outstanding;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In April 2011, we announced positive, topline results from our Phase 2 dose-ranging, environmental clinical trial of bepotastine besilate nasal spray
for the treatment of symptoms associated with seasonal allergic rhinitis, the inflammation of the nasal passages caused by allergies. According to the trial findings, each of three concentrations of bepotastine besilate nasal spray showed
statistically significant improvements compared to placebo in patients nasal symptoms following exposure to Mountain Cedar pollen during the peak season for this allergen. These improvements were seen on day one of therapy and were sustained
through the two-week treatment period. Further, safety data demonstrated bepotastine besilate was well-tolerated as a nasal spray, with an adverse event profile similar to placebo and consistent with those observed with bepotastine besilate dosed as
a nasal spray in prior clinical trials and with other antihistamine nasal sprays;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In May 2011, we initiated Phase 3 studies for the low-concentration BROMDAY, which is a new, patent-pending formulation containing a lower
concentration of bromfenac than the currently marketed BROMDAY. We plan to enroll about 400 patients in the low-concentration BROMDAY Phase 3 studies which follow a similar design to those performed to gain approval of BROMDAY. Because of
the similarity of the design to prior studies, the Phase 3 studies we initiated this week are not covered by an FDA Special Protocol Assessment. Assuming timely completion, results from these studies are expected in the fourth quarter of 2011; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In May 2011, we filed a universal shelf registration statement on Form S-3 with the SEC. When the registration statement is declared effective by the
SEC, we will be able to offer and sell up to $150 million of any form of securities including, but not limited to, equity, debt and other securities as described in the registration statement. Our intent with respect to the registration statement is
to provide us with flexibility for financing future growth through acquisitions and strategic transactions, and does not reflect a change in our financing strategy. At present, we have no specific plans to issue any form of securities under the
registration.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

Results of Operations

Three Months Ended March 31, 2011 and 2010

Revenues. Net revenues were approximately $36.7 million for the three months ended March 31, 2011, as compared to $28.3 million for the three months ended March 31, 2010.

The increase in revenues for the three months ended March 31, 2011 as compared to the three months ended March 31, 2010 is the
primarily the result of the following:



| |  |  | increased growth in prescription levels and market share for all of our products, particularly BROMDAY/XIBROM and BEPREVE;
| | - |  | --------------------------------------------------------------------------------------------------------------------------



| |  |  | continued growth of ISTALOL; and
| | - |  | --------------------------------



| |  |  | increased revenues due to VITRASE gaining 100% market share;
| | - |  | ------------------------------------------------------------

The following table sets forth our net revenues for each of our products for the three months ended March 31, 2011 and 2010, respectively (dollars in millions), and the corresponding percentage
change.



|                   |  |                              |      |  |      |   |      |          |  |  |     |  
|------------------ |  | ---------------------------- | ---- |  | ---- | - | ---- | -------- |  |  | --- | -
|                   |  | Three Months Ended March 31, |     
|                   |  | 2011                         |      |  | 2010 |   |      | % Change | 
|BROMDAY and XIBROM |  | $                            | 23.0 |  |      | $ | 20.3 |          |  |  | 13  | %
|BEPREVE            |  |                              | 4.2  |  |      |   | 0.5  |          |  |  | 740 | %
|ISTALOL            |  |                              | 6.2  |  |      |   | 5.4  |          |  |  | 15  | %
|VITRASE            |  |                              | 3.3  |  |      |   | 2.1  |          |  |  | 57  | %
|                   |  |                              |      |  |      |   |      |          |  |  |     |  
|Total Revenues     |  | $                            | 36.7 |  |      | $ | 28.3 |          |  |  | 30  | %
|                   |  |                              |      |  |      |   |      |          |  |  |     |  

Gross margin and cost of products sold. Gross margin for the three months ended
March 31, 2011 was 75% of net revenues, or $27.5 million, as compared to 74% of net revenues, or $21.0 million, for the three months ended March 31, 2010. The increase in the gross margin percentage for the three months ended
March 31, 2011, as compared to the three months ended March 31, 2010 is primarily the result of growth in revenues and market share from BROMDAY/XIBROM and BEPREVE, our highest gross margin products. Cost of products sold was $9.2 million
for the three months ended March 31, 2011, as compared to $7.3 million for the three months ended March 31, 2010. Cost of products sold for the three months ended March 31, 2011 and 2010 consisted primarily of standard costs for each
of our commercial products, distribution costs, royalties, inventory reserves and other costs of products sold. The increase in cost of products sold is primarily the result of increased net product sales.

Research and development expenses. Research and development expenses were $10.3 million for the three months ended March 31,
2011, as compared to $4.8 million for the three months ended March 31, 2010. The increase in research and development expenses of $5.5 million is due primarily to timing associated with the initiation and completion of clinical trials and
increased medical affairs costs, as described below.

Generally, our research and development resources are not dedicated to a
single project but are applied to multiple product candidates in our portfolio. As a result, we manage and evaluate our research and development expenditures generally by the type of costs incurred. 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 addition, we also record as research and development
expenses any upfront and milestone payments to third parties prior to regulatory approval of a product candidate under our licensing agreements unless there is an alternative future use. For the three months ended March 31, 2011, approximately
58% of our research and development expenditures were for clinical development costs, 11% were for regulatory costs, 3% were for pharmaceutical development costs, 6% were for manufacturing development costs, 19% were for medical affairs costs, and
3% were for stock-based compensation costs ($0.3 million).

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



| |  |  | Clinical Development Costs  Overall clinical development costs, which include clinical investigator fees, clinical trial monitoring costs, data
management and statistical analysis, for the three months ended March 31, 2011 were $5.9 million as compared to $1.0 million for the three months ended March 31, 2010. The increase in costs resulted from the ongoing Phase 3 efficacy and
safety dry eye trials for REMURA, the ongoing Phase 2 bepotastine besilate nasal spray clinical trials and preliminary costs related to a future lower concentration BROMDAY study.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| |  |  | Regulatory Costs  Regulatory costs, which include compliance expenses for existing products and other activity for pipeline projects, were $
1.1 million and $1.0 million for the three months ended March 31, 2011 and 2010, respectively.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pharmaceutical Development Costs  Pharmaceutical development costs, which include costs related to the testing and development of our pipeline
products, were $0.3 million for the three months ended March 31, 2011 and 2010, respectively.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Manufacturing Development Costs  Manufacturing development costs, which include costs related to production scale-up and validation, raw material
qualification, and stability studies, were $0.7 million and $0.9 million for the three months ended March 31, 2011 and 2010, respectively.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Medical Affairs Costs  Medical affairs costs, which include activities that relate to medical information and communication in support of our
products, for the three months ended March 31, 2011 were $2.0 million as compared to $1.3 million for the three months ended March 31, 2010, or an increase of $0.7 million. The increase is primarily attributable to increased personnel
costs, an increase in continuing medical education costs, primarily associated with the launch of BROMDAY and increased post-marketing clinical studies.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 to enroll suitable patient subjects. Even if earlier
results are positive, we may obtain different results in later stages of development, including failure to show the desired safety or efficacy, which could impact our development expenditures for a particular product candidate. Although we spend a
considerable amount of time planning our development activities, we may be required to deviate 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. As a result, the amount or ranges of costs and
timing to complete our product development programs and each future product development program is not estimable.

Selling,
general and administrative expenses. Selling, general and administrative expenses were $26.9 million for the three months ended March 31, 2011, as compared to $20.9 million for the three months ended March 31, 2010. The $6.0 million
increase primarily reflect expenses of $4.5 million in legal, professional and other fees incurred in connection with financing and due diligence activities to pursue a potential acquisition of a company with marketed products, for which we were
successful in securing a financing commitment but were unsuccessful in concluding the acquisition, and additional promotional costs associated with our products of $1.1 million, primarily BROMDAY.

Stock-based compensation costs. Total stock-based compensation costs for the three months ended March 31, 2011 and 2010 were
$0.8 million and $0.9 million, respectively. For the three months ended March 31, 2011 and 2010, we granted stock options to employees to purchase 635,940 shares of common stock (at a weighted average exercise price of $6.60 per share) and
708,540 shares of common stock (at a weighted average exercise price of $3.74 per share), respectively, equal to the fair market value of our common stock at the time of grant. We also issued 139,543 and 129,470 restricted stock awards for the three
months ended March 31, 2011 and 2010, respectively. Included in stock-based compensation costs were $0.1 million for each of the three months ended March 31, 2011 and 2010, related to restricted stock awards.

Interest expense. Interest expense was $2.1 million for both of the three months ended March 31, 2011 and 2010, respectively.
The components of interest expense are as follows (in millions):



|                                                       |  |                              |     |  |      |   |     | 
|------------------------------------------------------ |  | ---------------------------- | --- |  | ---- | - | --- | 
|                                                       |  | Three MonthsEnded March 
31, |    
|                                                       |  | 2011                         |     |  | 2010 |  
|Interest related to the Facility Agreement             |  | $                            | 1.0 |  |      | $ | 1.0 | 
|Amortization of the discount on the Facility Agreement |  |                              | 0.6 |  |      |   | 0.6 | 
|Amortization of deferred financing costs               |  |                              | 0.3 |  |      |   | 0.3 | 
|Amortization of derivative on the Facility Agreement   |  |                              | 0.1 |  |      |   | 0.1 | 
|Interest related to the Revolving Credit Facility      |  |                              | 0.1 |  |      |   | 0.1 | 
|                                                       |  |                              |     |  |      |   |     | 
|Interest expense                                       |  | $                            | 2.1 |  |      | $ | 2.1 | 
|                                                       |  |                              |     |  |      |   |     | 



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##### Table of Contents

Gain on derivative valuation.There was no change in the derivative value for the
three months ended March 31, 2011, as compared to a gain of $7,000 for the three months ended March 31, 2010.

Gain (loss) on warrant valuation. For the three months ended March 31, 2011, we recorded a non-cash valuation loss of $72.2
million, or $2.14 per basic and diluted share, as compared to a non-cash valuation gain of $7.2 million, or $0.21 per basic and diluted share, for the three months ended March 31, 2010. The change in the valuation of the warrants for the three
months ended March 31, 2011 was primarily driven by a significant increase in our stock price. The change in the valuation of the warrants for the three months ended March 31, 2010 was primarily driven by a decrease in our stock price,
offset by an increase in related volatility.

Reaffirming our 2011 Financial Outlook and adding adjusted net cash net
income and fully diluted earnings per share



| |  |  | We expect our net revenues for 2011 will be approximately $175 to $190 million. As in previous years, our net revenues are seasonal, with first quarter
net revenues typically being the lowest of the year and less than the prior quarter.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We expect our gross margin in 2011 will be in the range of 75% to 77% of net revenues.
| | - |  | --------------------------------------------------------------------------------------



| |  |  | We expect research and development expenses for 2011 to be approximately 18% to 22% of net revenues, depending upon the progress of our clinical
programs.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We expect selling, general and administrative expenses for 2011 to be approximately 44% to 48% of net revenues.
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | We expect our operating income for 2011 will be $13 to $16 million.
| | - |  | -------------------------------------------------------------------



| |  |  | We expect our 2011 non-GAAP adjusted cash earnings per diluted share of $0.26 to $0.32, using 50 million fully diluted shares on a treasury basis
calculated at a stock price of $10. We define adjusted cash net income as our net income adjusted for the non-cash mark-to-market adjustments relating to warrants, plus non-cash interest expense and non-cash stock-based compensation
costs of approximately $7.5 million to $8.5 million annually. For the three months ended March 31, 2011, we define adjusted cash loss as the Companys net loss adjusted for the expenses associated with the unconcluded
acquisition and non-cash mark-to-market adjustments relating to warrants, plus non-cash interest expense and non-cash stock-based compensation costs. The non-GAAP measure of adjusted cash net income or loss is important as the presentation of these
non-GAAP financial measures provides useful information to investors regarding ISTAs results of operations as these non-GAAP financial measures allow investors to better evaluate ongoing business performance.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We expect our business to have at least $90 million in cash by the end of 2011, which includes a scheduled repayment of debt of $21 million and
reserves for royalties on XIBROM and BROMDAY.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Excluding the warrant valuation expense, we expect 2011 to be
our second year of profitability. However, as anticipated, we incurred a loss in the first quarter of 2011, due to timing of revenues and expenses.

Liquidity and Capital Resources

As of March 31, 2011, we had
$75.8 million in cash and working capital of $6.6 million. One-third of our $65 million Facility Agreement (or $21.5 million) is due in September 2011 and we anticipate making the $21.5 million principal repayment out of cash on hand. Historically,
we have financed our operations primarily through sales of our debt and equity securities and cash receipts from product sales. Since March 2000, we have received gross proceeds of approximately $347.2 million from sales of our common stock and the
issuance of promissory notes and convertible debt.

Under our Revolving Credit Facility with Silicon Valley Bank, we may
borrow up to the lesser of $25.0 million or 80% of eligible accounts receivable, plus the lesser of 25% of net cash and cash equivalents or $10.0 million. As of March 31, 2011, we had $25.0 million available under the Revolving Credit Facility,
of which we borrowed $13.0 million. All outstanding amounts under the Revolving Credit Facility bear interest at a variable rate equal to the lenders prime rate plus a margin of 0.50%. In no event shall the interest rate on outstanding
borrowings be less than 4.50%, which is payable on a monthly basis. The Revolving Credit Facility also contains customary covenants regarding the operation of our business and financial



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covenants relating to ratios of current assets to current liabilities and is collateralized by all of our assets. An event of default under the Revolving Credit Facility will occur if, among
other things, (i) we are delinquent in making payments of principal or interest on the Revolving Credit Facility; (ii) we fail to cure a breach of a covenant or term of the Revolving Credit Facility; (iii) we make a representation or
warranty under the Revolving Credit Facility that is materially inaccurate; (iv) we are unable to pay our debts as they become due, certain bankruptcy proceedings are commenced or certain orders are granted against us, or we otherwise become
insolvent; or (v) an acceleration event occurs under certain types of other indebtedness outstanding from time to time. If an event of default occurs, the indebtedness to Silicon Valley Bank could be accelerated, such that it becomes
immediately due and payable. We also had letters of credit of $0.6 million outstanding. As of March 31, 2011, we were in compliance with all of the covenants under the Revolving Credit Facility. All amounts borrowed under the Revolving Credit
Facility were repaid in April 2011. The Revolving Credit Facility expires on March 31, 2012.

We have a Facility
Agreement with certain institutional accredited investors, collectively known as the Lenders. On March 31, 2011, we had total indebtedness under the Facility Agreement of $65 million, which excludes unamortized discounts of $4.3 million and the
value of the derivative of $0.2 million. Outstanding amounts under the Facility Agreement accrue interest at a rate of 6.5% per annum, payable quarterly in arrears. We are required to repay the Lenders 33% of the original principal amount (or
$21.5 million) on each of September 26, 2011 and 2012, and 34% of the original principal amount (or $22.0 million) on September 26, 2013.

Any amounts drawn under the Facility Agreement may become immediately due and payable upon (i) an event of default, as defined in the Facility Agreement, in which case the Lenders would
have the right to require us to repay 100% of the principal amount of the loan, plus any accrued and unpaid interest thereon, or (ii) the consummation of certain change of control transactions, in which case the Lenders would have the right to
require us to repay 110% of the outstanding principal amount of the loan, plus any accrued and unpaid interest thereon. An event of default under the Facility Agreement will occur if, among other things, (i) we fail to make payment when due;
(ii) we fail to comply in any material respect with any covenant of the Facility Agreement, and such failure is not cured; (iii) any representation or warranty made by us in any transaction document was incorrect, false, or misleading in
any material respect as of the date it was made; (iv) we are generally unable to pay our debts as they become due or a bankruptcy or similar proceeding is commenced by or against us; or (v) cash and cash equivalents on the last day of each
calendar quarter are less than $10 million. The Facility Agreement also contains customary covenants regarding the operation of our business. As of March 31, 2011, we were in compliance with all the covenants under the Facility Agreement.

In connection with the Facility Agreement, we entered into a security agreement with the Lenders, pursuant to which, as
security for our repayment obligations under the Facility Agreement, we granted to the Lenders a security interest in certain of our intellectual property, including intellectual property relating to BROMDAY, BEPREVE, ISTALOL, VITRASE, REMURA and
XIBROM and each other product marketed by or under license from us, and certain personal property relating thereto.

For the
three months ended March 31, 2011, we used $3.4 million of cash from operations, primarily the result of the decrease of accrued compensation costs and other accrued expenses. We incurred a net loss of $84.1 million, which included a loss on
warrant valuation ($72.2 million) and other non-cash charges of $2.3 million. Non-cash charges consisted primarily of stock-based compensation costs ($0.8 million), amortization of discounts on the Facility Agreement ($0.7 million), depreciation and
amortization ($0.5 million) and amortization of deferred financing costs ($0.3 million). For the three months ended March 31, 2010, we used $10.3 million of cash from operations, primarily the result of the increase in accounts receivable of
$7.3 million and other changes in operating assets and liabilities. We had net income of $0.5 million, which included a gain on warrant valuation ($7.2 million) and other non-cash charges of $2.1 million. Non-cash charges consisted primarily of
stock-based compensation costs ($0.9 million), amortization of discounts on the Facility Agreement ($0.7 million), depreciation and amortization ($0.2 million) and amortization of deferred financing costs ($0.3 million).

For the three months ended March 31, 2011 and 2010, we used $0.3 million and $0.2 million of cash from investing activities,
respectively, primarily due to the purchases of equipment.

For the three months ended March 31, 2011, we generated cash
from financing activities of $0.7 million, primarily from exercises of stock options granted to our employees. For the three months ended March 31, 2010, we neither used nor generated cash from financing activities.

We believe that current cash and cash equivalents, together with amounts available for borrowing under our Revolving Credit Facility and
cash generated from operations, will be sufficient to meet anticipated cash needs for operating and capital expenditures for at least the next twelve months.



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



| |  |  | the success of the commercialization of our products;
| | - |  | -----------------------------------------------------



| |  |  | our sales and marketing activities;
| | - |  | -----------------------------------



| |  |  | the 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 introduction of potential generic products;
| | - |  | -----------------------------------------------



| |  |  | 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 technologies;
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | scheduled principal payments under our Facility Agreement;
| | - |  | ----------------------------------------------------------



| |  |  | the outcome of pending litigation;
| | - |  | ----------------------------------



| |  |  | competitive, technological, market and other developments; and
| | - |  | --------------------------------------------------------------



| |  |  | our ability to establish and maintain partnering relationships.
| | - |  | ---------------------------------------------------------------

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

We have incurred losses since inception and have never been profitable. Excluding the non-cash warrant valuation adjustment, in 2010 we
generated net income of $2.2 million. While we anticipate continuing to be profitable in 2011 and beyond (excluding any non-cash warrant valuation adjustments), we might not be able to achieve profitability or continue to remain profitable. We have
a stockholders deficit of approximately $161.7 million (including non-cash valuation warrant adjustments of $131.8 million) through March 31, 2011.

We initiated legal action in April 2010 against Senju seeking a declaratory judgment with regard to our XIBROM royalty obligations to Senju and a recovery of overpaid royalties and other damages from
Senju. The only U.S. patent applicable to XIBROM expired in January 2009 and, according to U.S. case law and the terms of our agreement with Senju, we believe no XIBROM royalties are due after patent expiration. In August 2010, the U.S. District
Court for the Central District of California stayed our action against Senju, and, in September 2010, Senju initiated an arbitration proceeding regarding the same dispute with the International Chamber of Commerce, or the ICC. The order staying
our action against Senju will not become appealable until after the arbitration is concluded and a judgment is entered in the court case. A declaratory judgment that we were seeking from the court in regard to royalty obligations to Senju may apply
not only to XIBROM, but also to BROMDAY, which was approved by the FDA in October 2010. The arbitration proceeding, the outcome of which may also affect our BROMDAY royalty obligations, is in its early stages.

In June 2010, we initiated a legal action by filing a Complaint against AcSentient, Inc. and AcSentient II, LLC, which we
collectively refer to as AcSentient, seeking a declaratory judgment with regard to our XIBROM royalty obligations under the Asset Purchase Agreement dated May 3, 2002 between us and AcSentient, Inc. The only U.S. patent applicable to XIBROM
expired in January 2009 and, according to U.S. case law and the terms of our agreement with AcSentient, Inc., we believe no XIBROM royalties are due after patent expiration. A declaratory judgment that we are seeking from the court in regard to
royalty obligations to AcSentient may apply not only to XIBROM, but also to BROMDAY, which was approved by the FDA in October 2010. In November 2010, the Superior Court of the State of California, County of Orange stayed our case against AcSentient
and ruled that the dispute had to be arbitrated. We will have an opportunity to appeal that court ruling after the final judgment is entered by the court. On January 24, 2011, AcSentient filed a request for arbitration with the
ICC.

There can be no assurance about when these two disputes will be resolved, and we cannot predict the final outcome and
financial impact of either. Until these two disputes are resolved, for accounting purposes, we have been and intend to continue to reserve for XIBROM and BROMDAY royalties, which would have been payable to Senju and AcSentient if the relevant
contractual royalty obligations were existing and enforceable. As of March 31, 2011, we had approximately $27 million reserved for such contingent XIBROM and BROMDAY royalties.



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In April 2008, we received subpoenas from the office of the U.S. Attorney for the Western
District of New York requesting information regarding the marketing activities related to XIBROM. From April 2008 through March 31, 2011, we have incurred approximately $3.9 million in legal fees associated with this matter and expect to incur
significant expenses in the future. In addition, if the government chooses to engage in civil litigation or initiate a criminal prosecution against us as a result of its review of the requested documents and other evidence, we may have to incur
significant amounts to defend such action or pay or incur substantial fines or penalties, either of which could significantly deplete our cash resources. The case is ongoing and the likelihood of an unfavorable outcome and/or the amount/range of
loss, if any, cannot be reasonably estimated.

Section 703 of the National Defense Authorization Act of 2008, enacted on
January 28, 2009, requires that pharmaceutical products purchased through the Department of Defense, or DoD, TRICARE Retail Pharmacy program be subject to the Federal Ceiling Price discount under the Veterans Health Care Act of 1992. DoD issued
a rule pursuant to Section 703 that requires manufacturers to provide DoD with a quarterly refund on pharmaceutical products utilized through the TRICARE Retail Pharmacy program, and to pay rebates to DoD on TRICARE Retail Pharmacy purchases
retroactive to January 28, 2008. We have requested a waiver of the retroactive rebate for TRICARE Retail Pharmacy utilization for the period from January 28, 2008 to May 26, 2009 (the effective date of the DoD rule). In addition, the
regulation is currently the subject of litigation, and it is our position that the retroactive application of the regulation is contrary to established case law. We have determined that payment of the retroactive rebate (from January 28, 2008
to May 26, 2009) created by the regulation is neither reasonably estimable nor probable as of March 31, 2011.

We
incurred legal expenses in the amount of $0.1 million and $0.2 million with the law firm, Covington & Burling, for the three months ended March 31, 2011 and 2010, respectively. A member of our Board of Directors is senior counsel in
this law firm.

New Accounting Pronouncements

In December 2010, the FASB updated the accounting guidance relating to the annual goodwill impairment test. The updated guidance requires
companies to perform the second step of the impairment test to measure the amount of impairment loss, if any, when it is more likely than not that a goodwill impairment exists when the carrying amount of a reporting unit is zero or negative. In
considering whether it is more likely than not that a goodwill impairment exists, an entity must evaluate whether there are adverse qualitative factors. The updated guidance is effective beginning in our fiscal 2012 year. The adoption of this
guidance is not expected to have a material impact on our financial position or results of operations.

In December 2010, the
FASB updated the accounting guidance relating to the disclosure of supplementary pro forma information for business combinations. The updated guidance requires companies to provide additional comparative pro forma financial information along with
the nature and amount of any material nonrecurring pro forma adjustments related to the business combination. The updated guidance is effective for business combinations which have an acquisition date in fiscal years beginning on or after
December 15, 2010, or our 2011 fiscal year. The adoption of this guidance is not expected to have a material impact on our financial position or results of operations.

In December 2010, the FASB issued an Accounting Standards Update, or ASU, 2010-27, Other Expenses (Topic 720): Fees Paid to the Federal Government by Pharmaceutical Manufacturers (A consensus of the
FASB Emerging Issues Task Force).ASU 2010-27 addresses questions concerning how pharmaceutical companies should recognize and classify in their income statements fees mandated by the Patient Protection and Affordable Care Act, as amended by the
Health Care and Education Affordability Reconciliation Act, or the Healthcare Reform Act, and collectively referred to as the Acts. The Acts impose an annual fee on the pharmaceutical manufacturing industry for each year beginning on or after
January 1, 2011. For reporting entities that are subject to the pharmaceutical fee mandated by the Acts, the amendments in ASU 2010-27 specify the liability for the fee should be estimated and recorded in full upon the first qualifying sale
with a corresponding deferred cost that is amortized to expense using a straight-line method of allocation unless another better method better allocates the fee over the calendar year that it is payable. ASU 2010-27 is effective for calendar years
beginning after December 31, 2010, or our 2011 fiscal year, when the fee initially becomes payable. We adopted the provisions of ASU 2010-27 on January 1, 2011 and the adoption did not have a material effect to our financial position or
results of operations.

In April 2010, the FASB issued ASU 2010-17, Revenue Recognition  Milestone Method (Topic
605): Milestone Method of Revenue Recognition, or ASU 2010-17. ASU 2010-17 provides guidance on applying the milestone method to milestone payments for achieving specified performance measures when those payments are related to uncertain future
events. Under ASU 2010-17, entities can make an accounting policy to recognize arrangement consideration received for achieving specified performance measures during the period in which the milestones are achieved, provided certain criteria are met
for the milestones to be considered substantive. ASU 2010-17 is effective on a prospective basis for research and development milestones achieved in fiscal years, beginning on or after June 15, 2010, which for us means 2011. We adopted the
provisions of ASU 2010-17 on January 1, 2011 and the adoption did not have a material effect to our financial position or results of operations.



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##### Table of Contents

|Item 3 | Quantitative and Qualitative Disclosures About Market Risk
|------ | ----------------------------------------------------------

The primary objective of our investment policy is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk.

Interest Rate Risk

Some
of the securities that we have invested in were subject to 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 interest rate and the prevailing interest rate later increases, the principal amount of our investment will probably decline. Seeking to minimize this risk, historically we maintained 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 and auction rate securities. All of our cash is held in non-interest bearing accounts,
which is fully insured by the Federal Deposit Insurance Corporation. When our cash is invested in short-term investments, the average duration is usually less than one year.

All outstanding amounts under our Revolving Credit Facility bear interest at a variable rate equal to the lenders prime rate plus a margin of 0.50%. In no event shall the interest rate on
outstanding borrowings be less than 4.50%. Interest is payable on a monthly basis and may expose us to market risk due to changes in interest rates. As of March 31, 2011, we had $13.0 million in borrowings under our Revolving Credit Facility.
The interest rate at March 31, 2011 was 4.50%. A 10% change in interest rates on our Revolving Credit Facility would not have had a material effect on our net income for the three months ended March 31, 2011.

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



|Item 4 | Controls and Procedures
|------ | -----------------------

Evaluation of 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 Rule 13a-15(e)) under the Securities Exchange Act of 1934, as amended, which we refer to as the Exchange Act, as of the end of the period covered by this Quarterly Report on Form 10-Q. The Chief Executive Officer and Chief Financial
Officer have concluded, based on their evaluation of these controls and procedures required by paragraph (b) of Rules 13a-15 and 15d under the Exchange Act, that our disclosure controls and procedures were effective as of the end of the period
covered by this Quarterly Report on Form 10-Q to provide reasonable assurance that information required to be disclosed by us in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the
applicable rules and forms promulgated by the Securities and Exchange Commission. 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.

Changes in internal control over financial reporting

We have not made any significant changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) during the quarter ended March 31, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION



|Item 1 | Legal Proceedings
|------ | -----------------

In
June 2010, we initiated a legal action by filing a Complaint against AcSentient seeking a declaratory judgment with regard to our XIBROM royalty obligations under the Asset Purchase Agreement dated May 3, 2002 between us and AcSentient, Inc. The
only U.S. patent applicable to XIBROM expired in January 2009 and, according to U.S. case law and the terms of our agreement with AcSentient, Inc., we believe no XIBROM royalties are due after patent expiration. A declaratory judgment that we are
seeking from the court in regard to royalty obligations to AcSentient may apply not only to XIBROM, but also to BROMDAY, which was approved by the FDA in October 2010. In November 2010, the Superior Court of the State of California, County of Orange
stayed our case against AcSentient and ruled that the dispute had to be arbitrated. We will have an opportunity to appeal that court ruling after the final judgment is entered by the court. On January 24, 2011, AcSentient filed a request for
arbitration with the ICC. There can be no assurance about when this dispute will be resolved, and we cannot predict the final outcome and financial impact of such dispute.



|Items | 2  5. Not applicable.
|----- | ----------------------



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##### Table of Contents

|Item 6 | Exhibits
|------ | --------



|               |  |                                                                                                                                                 
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
Number |  | Description                                                                                                                                     
|               | 
|31.1           |  | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.                           
|               | 
|31.2           |  | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/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.



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##### Table of Contents

Signatures

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

|                   |  |  |  |  |  |                                                                                       
|------------------ |  |  |  |  |  | --------------------------------------------------------------------------------------
|                   |  |  |  |  |  | ISTA PHARMACEUTICALS, INC.
(Registrant)                                               
|                   |  |  | 
|Dated: May 5, 2011 |  |  |  |  |  | /S/    VICENTE ANIDO,
JR., PH.D.                                                      
|                   |  |  |  |  |  | Vicente Anido, Jr., Ph.D. President and Chief Executive Officer                       
|                   |  |  | 
|Dated: May 5, 2011 |  |  |  |  |  | /S/    LAUREN P.
SILVERNAIL                                                           
|                   |  |  |  |  |  | Lauren P. Silvernail Chief Financial Officer and Vice President, Corporate
Development



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##### Table of Contents

INDEX TO EXHIBITS



|               |  |                                                                                                                                                   
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
Number |  | Description                                                                                                                                       
|               | 
|31.1           |  | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a) / 15d-14(a) of the Securities Exchange Act of 1934.                           
|               | 
|31.2           |  | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a) / 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.



26