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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 JUNE 30, 2008

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.)

15295 Alton Parkway, 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 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  x        
|Non-accelerated filer   ̈ (Do not check if a smaller reporting company) |  | Smaller reporting company   ̈

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 June 30, 2008 was 33,028,578.









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##### Table of Contents

TABLE OF CONTENTS



|                                         |  |                                                                                                            |  |        
|---------------------------------------- |  | ---------------------------------------------------------------------------------------------------------- |  | -------
|                                         |  |                                                                                                            |  | Page No
|PART I FINANCIAL INFORMATION (unaudited) |  | 1                                                                                                         
|                                         |  |                                                                                                           
|Item 1                                   |  | Condensed Consolidated Financial Statements                                                                |  | 1      
|                                         |  |                                                                                                           
|                                         |  | Condensed Consolidated Balance Sheets  June 30, 2008 and December 31, 2007                                |  | 1      
|                                         |  |                                                                                                           
|                                         |  | Condensed Consolidated Statements of Operations  Three and Six Month Periods Ended June 30, 2008 and 2007 |  | 2      
|                                         |  |                                                                                                           
|                                         |  | Condensed Consolidated Statements of Cash Flows  Three and Six Month Periods Ended June 30, 2008 and 2007 |  | 3      
|                                         |  |                                                                                                           
|                                         |  | Notes to Condensed Consolidated Financial Statements                                                       |  | 4      
|                                         |  |                                                                                                           
|Item 2                                   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                      |  | 11     
|                                         |  |                                                                                                           
|Item 3                                   |  | Quantitative and Qualitative Disclosure About Market Risk                                                  |  | 19     
|                                         |  |                                                                                                           
|Item 4                                   |  | Controls and Procedures                                                                                    |  | 19     
|                                         | 
|PART II OTHER INFORMATION                |  | 19                                                                                                        
|                                         |  |                                                                                                           
|Item 1A                                  |  | Risk Factors                                                                                               |  | 19     
|                                         |  |                                                                                                           
|Item 6                                   |  | Exhibits                                                                                                   |  | 21     
|                                         |  |                                                                                                           
|                                         |  | Signatures                                                                                                 |  | 22     
|                                         |  |                                                                                                           
|                                         |  | Index to Exhibits                                                                                          |  | 23     



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##### Table of Contents

PART I FINANCIAL INFORMATION



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

ISTA Pharmaceuticals, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except share and per share data)

(unaudited)



|                                                                                                                                                                                                                                 |  |              |          |   |                  |   |          |  
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                                                                                                                 |  | June 30,2008 |          |   | December 31,2007 |  
|ASSETS                                                                                                                                                                                                                           |  |              |          |   |                  |   |          |  
|Current assets:                                                                                                                                                                                                                  |  |              |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                                                                                                                        |  | $            | 19,386   |   |                  | $ | 25,500   |  
|Short-term investments  available for sale securities                                                                                                                                                                           |  |              | 2,396    |   |                  |   | 20,640   |  
|Accounts receivable, net of allowances of $323 in 2008 and $187 in 2007                                                                                                                                                          |  |              | 9,446    |   |                  |   | 11,161   |  
|Inventory, net of allowances of $641 in 2008 and $396 in 2007                                                                                                                                                                    |  |              | 2,805    |   |                  |   | 2,294    |  
|Other current assets                                                                                                                                                                                                             |  |              | 1,893    |   |                  |   | 2,122    |  
|                                                                                                                                                                                                                                 |  |              |          |   |                  |   |          |  
|Total current assets                                                                                                                                                                                                             |  |              | 35,926   |   |                  |   | 61,717   |  
|Property and equipment, net                                                                                                                                                                                                      |  |              | 5,804    |   |                  |   | 5,389    |  
|Available for sale securities                                                                                                                                                                                                    |  |              | 4,441    |   |                  |   |         |  
|Deferred financing costs                                                                                                                                                                                                         |  |              | 1,683    |   |                  |   | 1,963    |  
|Restricted cash                                                                                                                                                                                                                  |  |              | 800      |   |                  |   | 2,400    |  
|Deposits and other assets                                                                                                                                                                                                        |  |              | 261      |   |                  |   | 247      |  
|                                                                                                                                                                                                                                 |  |              |          |   |                  |   |          |  
|Total assets                                                                                                                                                                                                                     |  | $            | 48,915   |   |                  | $ | 71,716   |  
|                                                                                                                                                                                                                                 |  |              |          |   |                  |   |          |  
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                                                                                                                            |  |              |          |   |                  |   |          |  
|Current liabilities:                                                                                                                                                                                                             |  |              |          |   |                  |   |          |  
|Accounts payable                                                                                                                                                                                                                 |  | $            | 1,723    |   |                  | $ | 3,661    |  
|Accrued compensation and related expenses                                                                                                                                                                                        |  |              | 2,616    |   |                  |   | 3,696    |  
|Accrued expenses  clinical trials                                                                                                                                                                                               |  |              | 934      |   |                  |   | 960      |  
|Line of credit                                                                                                                                                                                                                   |  |              | 10,000   |   |                  |   | 7,500    |  
|Current portion of long-term liabilities                                                                                                                                                                                         |  |              | 440      |   |                  |   | 601      |  
|Current portion of convertible notes                                                                                                                                                                                             |  |              | 40,312   |   |                  |   |         |  
|Current portion of obligation under capital lease                                                                                                                                                                                |  |              | 71       |   |                  |   | 98       |  
|Other accrued expenses                                                                                                                                                                                                           |  |              | 10,239   |   |                  |   | 12,515   |  
|                                                                                                                                                                                                                                 |  |              |          |   |                  |   |          |  
|Total current liabilities                                                                                                                                                                                                        |  |              | 66,335   |   |                  |   | 29,031   |  
|Deferred rent                                                                                                                                                                                                                    |  |              | 225      |   |                  |   | 230      |  
|Deferred income                                                                                                                                                                                                                  |  |              | 3,194    |   |                  |   | 3,333    |  
|Obligation under capital leases                                                                                                                                                                                                  |  |              | 141      |   |                  |   | 177      |  
|Convertible notes                                                                                                                                                                                                                |  |              |         |   |                  |   | 40,253   |  
|                                                                                                                                                                                                                                 |  |              |          |   |                  |   |          |  
|Total liabilities                                                                                                                                                                                                                |  |              | 69,895   |   |                  |   | 73,024   |  
|Commitments and contingencies                                                                                                                                                                                                    |  |              |          |   |                  |   |          |  
|Stockholders deficit:                                                                                                                                                                                                           |  |              |          |   |                  |   |          |  
|Preferred stock, $0.001 par value; 5,000,000 shares authorized of which 1,000,000 shares have been designated as Series A Participating
Preferred Stock at June 30, 2008 and December 31, 2007; no shares issued and outstanding |  |              |         |   |                  |   |         |  
|Common stock, $0.001 par value; 100,000,000 shares authorized at June 30, 2008 and December 31, 2007; 33,028,578 and 32,911,887
shares issued and outstanding at June 30, 2008 and December 31, 2007, respectively               |  |              | 33       |   |                  |   | 33       |  
|Additional paid-in-capital                                                                                                                                                                                                       |  |              | 303,868  |   |                  |   | 301,857  |  
|Accumulated other comprehensive loss                                                                                                                                                                                             |  |              | (284     | ) |                  |   | (15      | )
|Accumulated deficit                                                                                                                                                                                                              |  |              | (324,597 | ) |                  |   | (303,183 | )
|                                                                                                                                                                                                                                 |  |              |          |   |                  |   |          |  
|Total stockholders deficit                                                                                                                                                                                                      |  |              | (20,980  | ) |                  |   | (1,308   | )
|                                                                                                                                                                                                                                 |  |              |          |   |                  |   |          |  
|Total liabilities and stockholders deficit                                                                                                                                                                                      |  | $            | 48,915   |   |                  | $ | 71,716   |  
|                                                                                                                                                                                                                                 |  |              |          |   |                  |   |          |  

See accompanying notes



1



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##### Table of Contents

ISTA Pharmaceuticals, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(unaudited)



|                                                                      |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|--------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                      |  | Three Months EndedJune 30, |        |   | Six Months EndedJune 30, |  
|                                                                      |  | 2008                       |        |   | 2007                     |   |        | 2008 |  |   | 2007    |  
|Revenue:                                                              |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Product sales, net                                                    |  | $                          | 17,691 |   |                          | $ | 13,518 |      |  | $ | 33,145  |   |  | $ | 23,701  |  
|License revenue                                                       |  |                            | 70     |   |                          |   | 70     |      |  |   | 139     |   |  |   | 139     |  
|                                                                      |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Total revenue                                                         |  |                            | 17,761 |   |                          |   | 13,588 |      |  |   | 33,284  |   |  |   | 23,840  |  
|Cost of products sold                                                 |  |                            | 4,766  |   |                          |   | 3,687  |      |  |   | 8,955   |   |  |   | 6,220   |  
|                                                                      |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Gross profit margin                                                   |  |                            | 12,995 |   |                          |   | 9,901  |      |  |   | 24,329  |   |  |   | 17,620  |  
|Costs and expenses:                                                   |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Research and development                                              |  |                            | 7,472  |   |                          |   | 6,012  |      |  |   | 17,287  |   |  |   | 12,565  |  
|Selling, general and administrative                                   |  |                            | 13,302 |   |                          |   | 11,967 |      |  |   | 26,952  |   |  |   | 24,057  |  
|                                                                      |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Total costs and expenses                                              |  |                            | 20,774 |   |                          |   | 17,979 |      |  |   | 44,239  |   |  |   | 36,622  |  
|                                                                      |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Loss from operations                                                  |  |                            | (7,779 | ) |                          |   | (8,078 | )    |  |   | (19,910 | ) |  |   | (19,002 | )
|Interest income                                                       |  |                            | 163    |   |                          |   | 319    |      |  |   | 551     |   |  |   | 773     |  
|Interest expense                                                      |  |                            | (843   | ) |                          |   | (984   | )    |  |   | (2,055  | ) |  |   | (1,965  | )
|                                                                      |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net loss                                                              |  | $                          | (8,459 | ) |                          | $ | (8,743 | )    |  | $ | (21,414 | ) |  | $ | (20,194 | )
|                                                                      |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Net loss per common share, basic and diluted                          |  | $                          | (0.26  | ) |                          | $ | (0.32  | )    |  | $ | (0.65   | ) |  | $ | (0.76   | )
|                                                                      |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  
|Shares used in computing net loss per common share, basic and diluted |  |                            | 33,029 |   |                          |   | 26,935 |      |  |   | 33,008  |   |  |   | 26,608  |  
|                                                                      |  |                            |        |   |                          |   |        |      |  |   |         |   |  |   |         |  

See accompanying notes



2



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##### Table of Contents

ISTA Pharmaceuticals, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)



|                                                                            |  |                          |         |   |      |   |         |  
|--------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | -
|                                                                            |  | Six Months EndedJune 30, |        
|                                                                            |  | 2008                     |         |   | 2007 |  
|Operating Activities                                                        |  |                          |         |   |      |   |         |  
|Net loss                                                                    |  | $                        | (21,414 | ) |      | $ | (20,194 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                          |         |   |      |   |         |  
|Stock-based compensation                                                    |  |                          | 1,957   |   |      |   | 1,639   |  
|Amortization of deferred financing costs                                    |  |                          | 283     |   |      |   | 277     |  
|Amortization of discount on convertible notes                               |  |                          | 17      |   |      |   |        |  
|Change in value of derivatives related to convertible notes                 |  |                          | 42      |   |      |   |        |  
|Depreciation and amortization                                               |  |                          | 508     |   |      |   | 312     |  
|Changes in operating assets and liabilities:                                |  |                          |         |   |      |   |         |  
|Accounts receivable, net                                                    |  |                          | 1,715   |   |      |   | 37      |  
|Inventory, net                                                              |  |                          | (511    | ) |      |   | (173    | )
|Other current assets                                                        |  |                          | 229     |   |      |   | (639    | )
|Accounts payable                                                            |  |                          | (1,938  | ) |      |   | 8       |  
|Accrued compensation and related expenses                                   |  |                          | (1,080  | ) |      |   | 202     |  
|Accrued expenses  clinical trials and other accrued expenses               |  |                          | (2,302  | ) |      |   | 1,948   |  
|Other liabilities                                                           |  |                          | (161    | ) |      |   | (134    | )
|Deferred rent                                                               |  |                          | (5      | ) |      |   | (9      | )
|Deferred income                                                             |  |                          | (139    | ) |      |   | (139    | )
|                                                                            |  |                          |         |   |      |   |         |  
|Net cash used in operating activities                                       |  |                          | (22,799 | ) |      |   | (16,865 | )
|                                                                            |  |                          |         |   |      |   |         |  
|Investing Activities                                                        |  |                          |         |   |      |   |         |  
|Maturities of marketable securities                                         |  |                          | 13,534  |   |      |   | 15,599  |  
|Purchases of equipment                                                      |  |                          | (923    | ) |      |   | (1,131  | )
|Restricted cash                                                             |  |                          | 1,600   |   |      |   | 1,600   |  
|Deposits and other assets                                                   |  |                          | (14     | ) |      |   | (83     | )
|                                                                            |  |                          |         |   |      |   |         |  
|Net cash provided by investing activities                                   |  |                          | 14,197  |   |      |   | 15,985  |  
|                                                                            |  |                          |         |   |      |   |         |  
|Financing Activities                                                        |  |                          |         |   |      |   |         |  
|Proceeds from exercise of stock options                                     |  |                          | 6       |   |      |   | 186     |  
|Obligation under capital lease                                              |  |                          | (63     | ) |      |   | (23     | )
|Proceeds from line of credit                                                |  |                          | 20,000  |   |      |   | 12,500  |  
|Repayment on line of credit                                                 |  |                          | (17,500 | ) |      |   | (13,000 | )
|Financing costs                                                             |  |                          | (3      | ) |      |   |        |  
|Proceeds from issuance of common stock, net of issuance costs               |  |                          | 48      |   |      |   | 34,110  |  
|                                                                            |  |                          |         |   |      |   |         |  
|Net cash provided by financing activities                                   |  |                          | 2,488   |   |      |   | 33,773  |  
|                                                                            |  |                          |         |   |      |   |         |  
|(Decrease)/Increase in Cash and Cash Equivalents                            |  |                          | (6,114  | ) |      |   | 32,893  |  
|Cash and cash equivalents at beginning of period                            |  |                          | 25,500  |   |      |   | 17,236  |  
|                                                                            |  |                          |         |   |      |   |         |  
|Cash and Cash Equivalents At End of Period                                  |  | $                        | 19,386  |   |      | $ | 50,129  |  
|                                                                            |  |                          |         |   |      |   |         |  

See accompanying notes



3



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ISTA Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

1. The Company

ISTA Pharmaceuticals, Inc. (ISTA or the Company) was incorporated in the
state of California on February 13, 1992 to discover, develop and market new remedies for diseases and conditions of the eye. The Company reincorporated in Delaware on August 4, 2000. Xibrom, Xibrom QD, Istalol®, Vitrase®, Bepreve, T-Pred, ISTA®, ISTA Pharmaceuticals,
Inc.® and the ISTA logo are the Companys trademarks, either owned or under license.

ISTA is an ophthalmic pharmaceutical company focused on the development and commercialization of products for serious diseases and conditions of the eye. Since the Companys inception, it has devoted its
resources primarily to fund research and development programs, late-stage product acquisitions and product commercial launches.

The Company
currently has three products available for sale in the U.S.: Xibrom (bromfenac sodium ophthalmic solution) for the treatment of inflammation and pain following cataract surgery, Istalol (timolol maleate ophthalmic solution) for the treatment of
glaucoma, and Vitrase (hyaluronidase for injection) for use as a spreading agent. The Company also has several product candidates in various stages of development.

2. Summary of Significant Accounting Policies

Basis of Presentation

The unaudited condensed consolidated financial statements of ISTA have been prepared in accordance with the instructions to Form 10-Q and Article 10 of
Regulation S-X. The accompanying consolidated financial statements do not include certain footnotes and financial presentations normally required under generally accepted accounting principles (GAAP) and, therefore should be read in conjunction with
the consolidated financial statements and the notes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31, 2007.

In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for the fair presentation of the statement of financial condition and results of operations for the three and six
month periods ended June 30, 2008, and 2007 have been made. The interim results of operations are not necessarily indicative of the results to be expected for the full fiscal year.

Beginning June 22, 2009, the holders of ISTAs convertible notes have the right to seek repayment of the notes. The Company does not have
sufficient cash available to repay the note holders should they seek repayment in June 2009 or there after. The Company has initiated discussions with certain of the note holders regarding alternatives for the repayment of the notes prior to
June 2009. The discussions with the note holders are not concluded at this time. Should the note holders require repayment, ISTA would need to raise additional capital before June 2009. Excluding any repayment of principal to its note holders in
June 2009 or there after, the Company believes that its existing cash balances will be sufficient to fund our operations for at least the next twelve months.

Revenue Recognition

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

The Company establishes allowances for estimated rebates,
chargebacks and product returns based on numerous qualitative and quantitative factors, including:



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



| |  |  | 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 ISTA and/or its competitors;
| | - |  | --------------------------------------------------------------------



4



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##### Table of Contents

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

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

| |  |  | Estimated remaining shelf life of products.
| | - |  | -------------------------------------------

In its analyses, the Company utilizes 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. The Company
utilizes an internal analysis to compare historical net product shipments to estimated historical prescriptions written. Based on that analysis, it develops an estimate of the quantity of product in the channel which may be subject to various
rebate, chargeback and product return exposures.

Consistent with industry practice, the Company periodically offers promotional discounts
to its existing customer base. These discounts are calculated as a percentage of the current published list price and the net price (i.e., the current published list price less the applicable discount is invoiced to the customer). 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 that the Company implements a price increase, the Company generally offers its existing customer base an
opportunity to purchase a limited quantity of product at the previous list price. Shipments resulting from these programs generally are not in excess of ordinary levels. Therefore, the Company recognizes the related revenue upon receipt by the
customer and includes the sale in estimating its various product-related allowances. In the event the Company determines 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 in revenue at the time of such sale.

Allowances for
estimated rebates and chargebacks were $0.9 million and $0.8 million as of June 30, 2008 and 2007, respectively. These allowances reflect an estimate of the Companys 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 and chargebacks due to various organizations purchasing certain of our products through federal contracts and/or group
purchasing agreements. The Company estimates its liability for rebates and chargebacks at each reporting period based on a combination of quantitative and qualitative assumptions listed above.

Allowances for product returns were $2.2 million and $0.6 million as of June 30, 2008 and 2007, respectively. These allowances reflect an estimate of
the Companys liability for product that may be returned by the original purchaser in accordance with the Companys stated return policy, which allows customers to return product within six months of its expiration date and for a period up
to 12 months after it has reached the expiration date. The Company estimates its liability for product returns at each reporting period based on the estimated units in the channel and the other factors discussed above. The Companys absolute
exposure for product returns has increased as a result of increased sales of its existing products and the Company having additional historical sales data upon which to analyze these allowances. Accordingly, reductions to revenue and corresponding
increases to allowance accounts have likewise increased.

The exposure to these revenue-reducing items as a percentage of gross product
revenue for the three months ended June 30, 2008 and 2007 was 8.6% and 6.8%, respectively, for the allowance for rebates, chargebacks and discounts, and was 3.4% and 2.2%, respectively, for the allowance for product returns.

License revenue.The Company recognizes revenue consistent with the provisions of the Securities and Exchange Commissions, or SECs,
Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition, which sets forth guidelines in the timing of revenue recognition based upon factors such as passage of title, installation, payments and customer acceptance. Amounts
received for product and technology license fees under multiple-element arrangements are deferred and recognized over the period of such services or performance if such arrangements require on-going services or performance in accordance with
Emerging Issues Task Force, or EITF, Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. Amounts received for milestones are recognized upon achievement of the milestone, unless the Company has ongoing performance
obligations. Royalty revenue is recognized upon sale of the related products, provided the royalty amounts are fixed and determinable and collection of the related receivable is reasonably assured. Any amounts received prior to satisfying the
Companys revenue recognition criteria are recorded as deferred revenue in the accompanying balance sheets.

Inventories

Inventory at June 30, 2008 consisted of $1.5 million of raw materials and $2.0 million of finished goods, net of $641,000 in inventory reserves.
Inventory at December 31, 2007 consisted of $617,000 in raw materials and $2.1 million of finished goods, net of $396,000 in inventory reserves.

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



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##### Table of Contents

Inventories are reviewed periodically for slow-moving or obsolete status. The Company adjusts its
inventory to reflect situations in which the cost of inventory is not expected to be recovered. The Company would record a reserve to adjust inventory to its net realizable value: (1) if a launch of a new product is delayed, inventory may not
be fully utilized and could be subject to impairment; (2) when a product is close to expiration and not expected to be sold; (3) when a product has reached its expiration date; or (4) when a product is not expected to be saleable. In
determining the reserves for these products, the Company considers 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.
ISTA has evaluated the current level of inventory considering historical trends and other factors, and based on its evaluation, has 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 ISTA to make assessments about the future demand for its 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 managements forecasts of market conditions, industry trends, competition and other
factors. If the Company over or under estimates the amount of inventory that will not be sold prior to expiration, there may be a material impact on its consolidated financial condition and results of operations.

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

Restricted Cash

The Company has $800,000 of restricted cash at June 30, 2008, which supports a letter of credit issued as security for interest payments on the outstanding senior subordinated convertible notes. As of
July 29, 2008, the letter of credit was extinguished reducing restricted cash to zero.

Fair Value Measurements

Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements, or SFAS 157, 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 advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date.
SFAS 157 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.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Companys adoption of SFAS 157 did not have a material impact on its consolidated financial statements. The Company has segregated all financial assets and liabilities at fair value on a recurring basis (at
least annually) 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. FASB Staff Position (FSP FAS 157-2Effective Date of FASB Statement
No. 157), or FSP FAS 157-2, delayed the effective date for all nonfinancial assets and liabilities until January 1, 2009, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. As
of June 30, 2008, all of the Companys financial assets and liabilities are valued using Level 1 inputs except for auction rate securities and a derivative related to its convertible notes as discussed below.

Effective January 1, 2008, the Company adopted SFAS No. 159, The Fair Value Option for Financial Assets and Financial
LiabilitiesIncluding an amendment of FASB Statement No. 115, or SFAS 159, which provides entities the option to measure many financial instruments and certain other items at fair value. Entities that choose the fair value option
will recognize unrealized gains and losses on items for which the fair value option was elected in earnings at each subsequent reporting date. The Company has currently chosen not to elect the fair value option for any items that are not already
required to be measured at fair value in accordance with GAAP.



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##### Table of Contents

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



|                                                       |  |                                                 |        |                                             |                                    |                                         |  |   |       |   |  |   |        |  
|------------------------------------------------------ |  | ----------------------------------------------- | ------ | ------------------------------------------- | ---------------------------------- | --------------------------------------- |  | - | ----- | - |  | - | ------ | -
|                                                       |  | Fair Value Measurements at June 30, 2008 Using: |        |                                             | Total CarryingValue atJune 30,2008 |                                        
|                                                       |  | Quoted Prices inActive Markets(Level 1)         |        | Significant OtherObservableInputs (Level 2) |                                    | SignificantUnobservableInputs (Level 3) |  |  
|Cash and cash equivalents (including restricted cash)  |  | $                                               | 19,386 |                                             | $                                  |                                        |  | $ |      |   |  | $ | 19,386 |  
|Short-term investments  available for sale securities |  |                                                 | 2,396  |                                             |                                    |                                        |  |   |      |   |  |   | 2,396  |  
|Available for sale securities  long term              |  |                                                 |       |                                             |                                    |                                        |  |   | 4,441 |   |  |   | 4,441  |  
|Derivatives                                            |  |                                                 |       |                                             |                                    |                                        |  |   | (422  | ) |  |   | (422   | )



|                                               |  |                                                                                                    |       |  
|---------------------------------------------- |  | -------------------------------------------------------------------------------------------------- | ----- | -
|                                               |  | Fair Value MeasurementsUsing SignificantUnobservable Inputs(Level 3) Auction RateSecurities        |      
|Beginning balance at December 31, 2007         |  | $                                                                                                  |      |  
|Total gains or losses (realized or unrealized) |  |                                                                                                    |      |  
|Included in earnings                           |  |                                                                                                    |       |  
|Included in other comprehensive income         |  |                                                                                                    | (259  | )
|Purchases, issuances, and settlements          |  |                                                                                                    |      |  
|Transfers in and/or out of Level 3             |  |                                                                                                    | 4,700 |  
|                                               |  |                                                                                                    |       |  
|Ending balance at June 30, 2008                |  | $                                                                                                  | 4,441 |  
|                                               |  |                                                                                                    |       |  
|                                               | 
|                                               |  | Fair Value MeasurementsUsing SignificantUnobservable Inputs(Level 3) Derivative onConvertible Note |      
|Beginning balance at December 31, 2007         |  | $                                                                                                  | (380  | )
|Total gains or losses (realized or unrealized) |  |                                                                                                    |       |  
|Included in earnings                           |  |                                                                                                    | (42   | )
|Included in other comprehensive income         |  |                                                                                                    |      |  
|Purchases, issuances, and settlements          |  |                                                                                                    |      |  
|Transfers in and/or of Level 3                 |  |                                                                                                    |      |  
|                                               |  |                                                                                                    |       |  
|Ending balance at June 30, 2008                |  | $                                                                                                  | (422  | )
|                                               |  |                                                                                                    |       |  

Available for Sale Securities  Short and Long Term

Available for sale securities consist primarily of certificates of deposit, corporate bonds, commercial paper and auction rate securities
(ARS). ARS are long-term variable rate bonds tied to short-term interest rates that are reset through a Dutch auction process which primarily occur every 7 to 35 days.

Available for sale securities at fair value, which approximates unamortized cost, consist of the following:



|                        |  |              |       |                  |   |       
|----------------------- |  | ------------ | ----- | ---------------- | - | ------
|                        |  | June 30,2008 |       | December 31,2007
|Commercial Paper        |  | $            | 1,697 |                  | $ | 7,042 
|Corporate Bonds         |  |              |      |                  |   | 3,247 
|Certificates of Deposit |  |              | 699   |                  |   | 601   
|Auction Rate Securities |  |              | 4,441 |                  |   | 9,750 
|                        |  |              |       |                  |   |       
|Total                   |  | $            | 6,837 |                  | $ | 20,640
|                        |  |              |       |                  |   |       



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##### Table of Contents

Despite the underlying long-term contractual maturity of ARS, there was a ready liquid market for these
securities based on the interest reset mechanism. Historically, these securities were classified as current assets due to the Companys intent and ability to sell these securities as necessary to meet current liquidity needs. However,
as a result of current negative liquidity and uncertainty in financial credit markets, the Company has experienced failed auctions associated with certain of its remaining ARS since February 2008. In the case of a failed auction,
the ARS become illiquid long-term bonds (until a future auction is successful or the security is called prior to the contractual maturity date by the issuer) and the rates are reset in accordance with the terms in the prospectus/offering
circular. The Company held $9.8 million of auction rate securities at December 31, 2007, which consist primarily of fully insured, AAA rated government guaranteed student loan-backed securities under the Federal Family Education Loan
Program, or FFELP. Since December 31, 2007, the Company has sold, at par value, $5.1 million of these securities through the auction process. On February 13, 2008, the Company was informed that there was insufficient demand at auction for
the $4.7 million in remaining auction rate securities. As a result, these affected securities are currently not liquid and may not become liquid unless the Company is successfully able to re-finance them, which could take up to twelve months, or
unless a future auction on these investments is successful. If a liquid market does not ever develop for these securities, the Company may be required to hold them to maturity.

Due to the aforementioned uncertainties, all of the Companys auction rate securities were classified as long-term investments in the condensed
consolidated balance sheet as of June 30, 2008. In determining the fair value of the Companys available-for-sale auction rate securities at June 30, 2008, it has taken into consideration fair values determined by the financial
institutions, current credit rating of the securities, discounted cash flow analysis, as deemed appropriate, and its current liquidity position. Since the ARS are primarily affected by liquidity risk, rather than credit risk in the underlying
collateral or the issuer, unrealized losses are deemed to be temporary in nature. The amount of unrealized losses related to the temporary impairment of the ARS was $0.3 million for the six months ended June 30, 2008.

Comprehensive Income (Loss)

Statement of
Financial Accounting Standard No. 130, Reporting Comprehensive Income, or SFAS 130, requires reporting and displaying comprehensive income (loss) and its components, which, for ISTA, includes net loss and unrealized gains and losses
on investments and foreign currency translation gains and losses. Total comprehensive loss for the six months ended June 30, 2008 and 2007 was $21.7 million and $20.2 million, respectively. In accordance with SFAS 130, the net accumulated
balance of unrealized gains (losses) on investments and the accumulated balance of foreign currency translation adjustments are disclosed as a separate component of stockholders deficit.

As of June 30, 2008 and December 31, 2007, accumulated foreign currency translation adjustments were ($25,000) and ($25,000), respectively, and
accumulated unrealized gains (losses) on investments were ($259,000) and $10,000, at June 30, 2008 and December 31, 2007, respectively.

Stock-Based Compensation

On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
Share-Based Payment, or SFAS 123(R), which requires measurement and recognition of compensation expense for all share-based awards made to employees and directors. Under SFAS 123R, the fair value of share-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 share-based compensation under SFAS 123R is recognized only for those awards that are ultimately expected to vest, the Company has 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.

The Company uses the Black-Scholes option-pricing model to
estimate the fair value of share-based awards. The determination of fair value using the Black-Scholes option-pricing model is affected by the Companys 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. Beginning January 1, 2008, the simplified method was no longer permitted and the Company estimated
the expected term based on the contractual term of the awards and employees exercise and expected post-vesting termination behavior. The impact of this transition did not have a significant impact on the valuation of the Companys stock
options.

At June 30, 2008, there was $8.0 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 years.



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##### Table of Contents

Restricted Stock Awards

During the three and six months ended June 30, 2008 the Company granted a total of 2,000 and 123,205 shares of restricted common stock to employees under the Companys 2004 Performance Incentive Plan, as
amended. Restrictions on these shares will expire and related charges are being amortized as earned over the vesting period of four years.

The amount of compensation to be recognized is based on the market value of the shares on the date of issuance. Expenses related to the vesting of restricted stock (charged to selling, general and administrative expenses) were $156,000 and
$289,000 for the three and six months ended June 30, 2008 and $80,000 and $138,000 for the three and six months ended June 30, 2007, respectively. As of June 30, 2008, there was approximately $1.4 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
Loss Per Share

In accordance with SFAS No. 128, Earnings Per Share, or SFAS 128, and SEC SAB No. 98, or SAB
98, basic net loss per common share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period. Under SFAS 128, diluted net income (loss) per share is computed by dividing the
net income (loss) for the period by the weighted-average number of common and common equivalent shares, such as stock options, outstanding during the period. Such common equivalent shares have not been included in the Companys computation of
diluted net loss per share as their effect would be anti-dilutive. The total number of shares excluded from the calculation of diluted net loss per share, prior to application of the treasury stock method for options, warrants, and as-converted
shares was 11,129,578 and 11,087,187 for the six months ended June 30, 2008 and 2007, respectively.

Under the provisions of
SAB 98, common shares issued for nominal consideration, if any, would be included in the per share calculations as if they were outstanding for all periods presented.

Executive Employment Agreements

The Company has agreements with each of its 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 within twenty-four months following such change in control such officers employment is terminated by the Company without cause or such officer resigns for good reason within sixty days of the event forming the basis for such good
reason termination.

Equity Financing

In June 2007, the Company entered into definitive agreements with institutional accredited investors with respect to the private placement of 5.25 million shares of its common stock at a purchase price of $7.00 per share, resulting in
gross proceeds of approximately $36.75 million before payment of placement agent fees and offering expenses.

Convertible Notes

The Company issued $40 million in convertible notes in June 2006 which provide, among other things, that if there is a change in control of the
Company, as defined, during the term of the convertible notes (maturing in June 2011) the holders of the notes will be entitled to receive a cash payment equal to 115% of the principal amount of the notes, plus accrued but unpaid interest, or a
formula based on the Companys stock price on certain specified dates. Since the settlement is indexed to the Companys stock, the settlement feature is a derivative that is required to be bifurcated from the host debt instrument and
recorded at fair value at each quarter end. Changes in fair value of the derivative are recorded as interest expense and the difference between the face value of the convertible notes and the amount remaining after the bifurcation is recorded as a
discount to be amortized over the term of the notes, which is five years.

The derivative liability as of June 30, 2008 and 2007 is
$0.4 million and $0.2 million, respectively, and is classified with the host debt instrument in convertible notes in the condensed consolidated balance sheet. The embedded derivative is marked-to-market through earnings on a quarterly basis. The net
effect of the changes in the value of the derivative ($42,000 for the six months ended June 30, 2008) and the amortization of the related debt discount ($17,000 for the six months ended June 30, 2008) was not significant in 2008 and 2007.

The convertible notes provide the note holders the right any time from and after June 22, 2009 to require the Company to redeem all
or any portion of the convertible notes. Accordingly, the convertible notes were reclassified to a current liability as of June 30, 2008. Additionally, the Company has the right to redeem the convertible notes at face value on
June 22, 2009.



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##### Table of Contents

Commitments and Contingencies

The Company is subject to routine claims and litigation incidental to its business. In the opinion of management, the resolution of such claims is not
expected to have a material adverse effect on the operating results, cash flows or financial position of the Company.

Segment Reporting

The Company currently operates in only one segment.

Income Taxes

At December 31, 2007, the Company had federal and state tax net operating loss, or NOL,
carryforwards of approximately $175.1 million and $96.3 million, respectively, which begin to expire in 2008 and 2007 respectively, unless previously utilized. The Company also had federal and state research and development, or R&D, credit
carryforwards of $7.3 million and $4.5 million, respectively. The federal R&D tax credits begin to expire in 2008, unless previously utilized. The Companys California research tax credit carryforwards do not expire and will carry forward
indefinitely until utilized.

Because realization of such tax benefits is uncertain, the Company has provided a 100% valuation allowance as
of December 31, 2007 and June 30, 2008. Pursuant to Sections 382 and 383 of the Internal Revenue Code of 1986, as well as similar state and foreign provisions, utilization of the NOL and R&D credit carryforwards may be subject to a
substantial annual limitation due to ownership change limitations that might have occurred previously or that could occur in the future. Due to the significant complexity and cost, the Company has not completed a study to assess whether a change in
control has occurred or whether there have been multiple changes of control since the Companys formation. Further, until a study is completed and any limitation known, no amounts are being presented as an uncertain tax position under FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes  An Interpretation of FASB Statement No. 109, or FIN 48. There have been no significant changes during the three and six months ended June 30,
2008 for any uncertain tax positions and the Company does not expect its unrecognized tax benefits to change significantly over the next 12 months. There were no accrued interest and penalties associated with uncertain tax positions as of
December 31, 2007 or June 30, 2008. Interest and penalties related to uncertain tax positions will be reflected in income tax expense. Tax years 1992 to 2007 remain subject to future examination by the major tax jurisdictions in which the
Company is subject to tax.

New Accounting Standard Not Yet Adopted

In November 2007, the Emerging Issues Task Force, or EITF, issued EITF Issue 07-01 Accounting for Collaborative Arrangements, or EITF 07-01.
EITF 07-01 requires collaborators to present the results of activities for which they act as the principal on a gross basis and report any payments received from (made to) other collaborators based on other applicable GAAP or, in the absence of
other applicable GAAP, based on analogy to authoritative accounting literature or a reasonable, rational, and consistently applied accounting policy election. Further, EITF 07-01 clarified that the determination of whether transactions within a
collaborative arrangement are part of a vendor-customer (or analogous) relationship subject to EITF Issue 01-9, Accounting for Consideration Given by a Vendor to a Customer. EITF 07-01 is effective for fiscal years beginning after
December 15, 2008. The Company has not yet completed its evaluation of EITF 07-01, but does not currently believe that it will have a material impact on the results of operations, financial position or cash flows of the Company.

On December 4, 2007, the FASB issued SFAS No. 141 (Revised 2007), Business Combinations, or SFAS 141R. Under SFAS 141R,
an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at the acquisition date fair value with limited exceptions. SFAS 141R will change the accounting treatment for certain specific
items, including:



| |  |  | acquisition costs will be generally expensed as incurred;
| | - |  | ---------------------------------------------------------



| |  |  | noncontrolling interests will be valued at fair value at the acquisition date;
| | - |  | ------------------------------------------------------------------------------



| |  |  | acquired contingent liabilities will be recorded at fair value at the acquisition date and subsequently measured at either the higher of such amount or the amount
determined under existing guidance for non-acquired contingencies;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | in-process research and development will be recorded at fair value as an indefinite-lived intangible asset at the acquisition date until the completion or
abandonment of the associated research and development efforts;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | restructuring costs associated with a business combination will be generally expensed subsequent to the acquisition date; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in deferred tax asset valuation allowances and income tax uncertainties after the acquisition date generally will affect income tax expense.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------



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SFAS 141R also includes a substantial number of new disclosure requirements. SFAS 141R applies
prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company is currently assessing
the impact of this statement but believes it will not have a material impact on its consolidated financial position, results of operations, or cash flows upon adoption.

On December 4, 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements  An Amendment of ARB No. 51, or SFAS 160. SFAS 160
establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Specifically, this statement requires the recognition of a noncontrolling interest (minority interest) as
equity in the consolidated financial statements and separate from the parents equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement.
SFAS 160 clarifies that changes in a parents ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires
that a parent recognize a gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. SFAS 160 also includes
expanded disclosure requirements regarding the interests of the parent and its noncontrolling interest. SFAS 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier
adoption is prohibited. The Company is currently assessing the impact of this statement, but believes it will not have a material impact on its consolidated financial position, results of operations, or cash flows upon adoption.

In March 2008, the FASB issued FAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB
Statement No. 133 Accounting for Derivative Instruments and Hedging Activities. FAS No. 161 requires entities to provide greater transparency about how and why an entity uses derivative instruments, how derivative instruments
and related hedged items are accounted for under FAS No. 133, and how derivative instruments and related hedged items affect an entitys financial position, results of operations, and cash flows. The statement is effective for financial
statements issues for fiscal years and interim periods beginning after November 15, 2008. The Company is currently assessing the impact of this statement, but believes it will not have a material impact on its consolidated financial position,
results of operations, or cash flows upon adoption.

In April 2008, the FASB issued FASB Staff Position, or FSP, FAS No. 142-3,
which amends the factors that must be considered in developing renewal or extension assumptions used to determine the useful life over which to amortize the cost of a recognized intangible asset under FAS No. 142, Goodwill and Other
Intangible Assets. The FSP requires an entity to consider its own assumptions about renewal or extension of the term of the arrangement, consistent with its expected use of the asset, and is an attempt to improve consistency between the useful
life of a recognized intangible asset under FAS No. 142 and the period of expected cash flows used to measure the fair value of the asset under FAS No. 141, Business Combinations. The FSP is effective for fiscal years beginning
after December 15, 2008, and the guidance for determining the useful life of a recognized intangible asset must be applied prospectively to intangible assets acquired after the effective date. The Company is currently assessing the impact of
this statement, but believes it will not have a material impact on its consolidated financial position, results of operations, or cash flows upon adoption.

In May 2008, the FASB issued Financial Accounting Standard, or FAS, No. 162, The Hierarchy of Generally Accepted Accounting Principles. The statement is intended to improve financial
reporting by identifying a consistent hierarchy for selecting accounting principles to be used in preparing financial statements that are prepared in conformance with GAAP. Unlike SAS No. 69, The Meaning of Present in Conformity With
GAAP, FAS No. 162 is directed to the entity rather than the auditor. The statement is effective 60 days following the SECs approval of the Public Company Accounting Oversight Board amendments to AU Section 411, The
Meaning of Present Fairly in Conformity with GAAP. The Company is currently assessing the impact of this statement, but believes it will not have a material impact on its consolidated financial position, results of operations, or cash flows
upon adoption.

In May 2008, the FASB issued FSP APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement). FSP APB 14-1 requires the liability and equity components of convertible debt instruments to be separately accounted for in a manner that reflects the non-convertible debt borrowing rate for
interest expense recognition. In addition, direct issuance costs associated with the convertible debt instruments are required to be allocated to the liability and equity components in proportion to the allocation of proceeds and accounted for as
debt issuance costs and equity issuance costs, respectively. FSP APB 14-1 will be effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. FSP APB 14-1 must be applied retrospectively and early
adoption is prohibited. The Company is currently evaluating the expected impact of the provisions of FSP APB 14-1, but believes it will not have a material impact on its consolidated financial position, results of operations, or cash flows upon
adoption.

In June 2008, the FASB issued FASB Staff Position, or FSP, EITF No. 03-6-1, Determining Whether
Instruments Granted in Share-Based Payment Transactions Are Participating Securities. Under the FSP, unvested share-based payment awards that contain rights to receive nonforfeitable dividends (whether paid or unpaid) are participating
securities, and should be included in the two-class method of computing EPS. The FSP is effective for fiscal years beginning after December 15, 2008, and interim periods within those years. The Company is currently assessing the impact of this
statement, but believes it will not have a material impact on its consolidated financial position, results of operations, or cash flows upon adoption.



|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, Risk Factors and other sections of this Quarterly Report on Form 10-Q.



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##### Table of Contents

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 captions Managements Discussion and Analysis of Financial Condition and Results of Operations and Risk
Factors 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, 2007. 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.

Overview

We are an ophthalmic pharmaceutical company. Our products and product candidates address the $4.7
billion U.S. prescription ophthalmic market and include therapies for inflammation, ocular pain, glaucoma, allergy, dry eye, vitreous hemorrhage, and diabetic retinopathy. We currently have three products for sale in the U.S.: Xibrom
(bromfenac sodium ophthalmic solution) for the treatment of inflammation and pain following cataract surgery, Istalol® (timolol maleate ophthalmic solution) for the treatment of glaucoma,
and Vitrase® (hyaluronidase for injection) for use as a spreading agent. We also have several product candidates in various stages of development. We have incurred losses since inception
and had an accumulated deficit of $324.6 million through June 30, 2008.

Results of Operations

Three Months Ended June 30, 2008 and 2007

Revenue. Product sales were approximately $17.7 million for the three months ended June 30, 2008, as compared to $13.5 million for the three months ended June 30, 2007. The increase in revenue was primarily attributable to
the continued growth of Xibrom and Istalol in the marketplace.

In addition to product revenues for the three months ended June 30,
2008 and 2007, we recorded license revenue of $70,000 in each of the three month periods ended June 30, 2008 and 2007, reflecting the amortization of deferred revenue recorded in December 2001 for the license fee payment made by Otsuka
Pharmaceuticals Co., Ltd. in connection with the license of Vitrase in Japan for ophthalmic uses in the posterior region of the eye.

The
following table sets forth our net revenue for each of our products for each of the three month periods ended June 30, 2008 and 2007 and the corresponding percentage change.

Net Revenue



|                  |  |                            |      |                            |   |          |  |    |  
|----------------- |  | -------------------------- | ---- | -------------------------- | - | -------- |  | -- | -
|$ millions        |  | Quarter EndedJune 30, 2008 |      | Quarter EndedJune 30, 2007 |   | % Change | 
|Xibrom            |  | $                          | 13.6 |                            | $ | 9.7      |  | 40 | %
|Istalol           |  |                            | 2.8  |                            |   | 2.5      |  | 12 | %
|Vitrase           |  |                            | 1.3  |                            |   | 1.3      |  | 0  | %
|Other             |  |                            | 0.1  |                            |   | 0.1      |  | 0  | %
|                  |  |                            |      |                            |   |          |  |    |  
|Total Net Revenue |  | $                          | 17.8 |                            | $ | 13.6     |  | 31 | %
|                  |  |                            |      |                            |   |          |  |    |  

Gross margin and cost of products sold. Gross margin for the three months ended
June 30, 2008 was 73% of net revenue, or $13.0 million, as compared to 73% of net revenue, or $9.9 million, for the three months ended June 30, 2007.

Cost of products sold was $4.8 million for the three months ended June 30, 2008, as compared to $3.7 million for the three months ended June 30, 2007. Cost of products sold for the three months ended
June 30, 2008 and 2007 consisted primarily of standard costs for each of our commercial products, distribution costs, royalties, and other costs of products sold. The increase in cost of products sold is primarily the result of increased net
product sales year over year.



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Research and development expenses. Research and development expenses were $7.5 million for the
three months ended June 30, 2008, as compared to $6.0 million for the three months ended June 30, 2007. The increase in research and development expenses for the second quarter of 2008 was primarily the result of an increase in clinical
development costs, which include clinical investigator fees, study monitoring costs and data management costs, due to the work performed on our key product candidates: Xibrom, Bepreve Phase III efficacy, Bepreve safety and T-Pred studies. Our
research and development expenses to date have consisted primarily of costs associated with the clinical trials of our product candidates, compensation and other expenses for research and development personnel, costs for consultants and contract
research organizations and costs related to the development of commercial scale manufacturing capabilities for Vitrase, Istalol and Xibrom.

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 up front and milestone payments that have accrued 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 June 30, 2008, approximately 52% of our research and development expenditures were for clinical development costs, 15% were for regulatory costs, 4% were for pharmaceutical
development costs, 18% were for manufacturing development costs, 9% were for medical affairs costs and 2% for stock-based compensation expense.

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



| |  |  | Clinical Development Costs  Overall clinical costs, which include clinical investigator fees, study monitoring costs and data management, for the three months
ended June 30, 2008 were $3.9 million as compared to $2.4 million for the three months ended June 30, 2007 or an increase of $1.5 million. The increase in clinical costs in 2008 was primarily due to costs associated with the Xibrom
(bromfenac sodium 0.18%) clinical trial, the Bepreve Phase III clinical trials and other study costs.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Regulatory Costs  Regulatory costs, which include compliance expense for existing products and other activity for pipeline projects, were $1.1 million for the
three months ended June 30, 2008 as compared to $1.0 million for the three months ended June 30, 2007. The increase of $100,000 was due primarily to an overall increase in outside consulting costs.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pharmaceutical Development Costs  Pharmaceutical development costs, which include costs related to the testing and development of our pipeline products, for
both the three months ended June 30, 2008 and the three months ended June 30, 2007 were $0.3 million
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Manufacturing Development Costs  Manufacturing development costs, which include costs related to production scale-up and validation, raw material
qualification, and stability studies, for the three months ended June 30, 2008 were $1.3 million as compared to $1.4 million for the three months ended June 30, 2007 or a decrease of $100,000. The decrease is primarily attributable to the
timing of costs incurred quarter over quarter related to costs such as clinical supplies and stability studies associated with our growing pipeline of products.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Medical Affairs Costs  Medical affairs costs, which include activities that relate to medical information in support of our products, for both the three
months ended June 30, 2008 and the three months ended June 30, 2007 were $0.7 million.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Stock-based compensation expense  Stock-based compensation expense for both the three months ended June 30, 2008 and the three months ended June 30,
2007 was $0.2 million.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 alter from our plan based on new circumstances or events or our
assessment from time to time of a product candidates market potential, other product opportunities and our corporate priorities. Any deviation from our plan may require us to incur additional expenditures or accelerate or delay the timing of
our development spending. Furthermore, as we obtain results from trials and review the path toward regulatory approval, we may elect to discontinue development of certain product candidates in certain indications, in order to focus our resources on
more promising candidates or indications. As a result, the amount or ranges of estimable cost and timing to complete our product development programs and each future product development program is not estimable.



13



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Selling, general and administrative expenses. Selling, general and administrative expenses were
$13.3 million for the three months ended June 30, 2008, as compared to $12.0 million for the three months ended June 30, 2007. The $1.3 million increase in selling, general and administrative expenses in 2008 as compared to 2007 primarily
results from higher sales and marketing expenses associated with the expansion of our sales force, which occurred in the first quarter of 2008 ($0.5 million) and an overall increase in administrative costs, primarily related to legal expenses ($0.8
million). Selling, general, and administrative expenses during the second quarter of 2008 includes $0.8 million in stock-based compensation expense.

Stock-based compensation. Compensation for stock options granted to non-employees has been determined in accordance with SFAS No. 123(R), Share-Based Payment, or SFAS 123R, and EITF Consensus
No. 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring or in Conjunction with Selling Goods or Services. Stock option compensation for non-employees is recorded as the related services are
rendered and the value of compensation is periodically re-measured as the underlying options vest.

For the three months ended
June 30, 2008 and 2007, we granted stock options to employees to purchase 45,400 shares of common stock (at a weighted average exercise price of $2.15 per share) and 42,200 shares of common stock (at a weighted average exercise price of $8.77
per share), respectively, equal to the fair market value of our common stock at the time of grant. We also issued 2,000 restricted stock awards for both the three months ended June 30, 2008 and 2007, respectively, and included in stock
compensation expense was $156,000 and $80,000 for the three months ended June 30, 2008 and 2007, respectively, related to these restricted stock awards.

Interest income. Interest income was $0.2 million for the three months ended June 30, 2008, as compared to $0.3 million for the three months ended June 30, 2007. The decrease in interest income was
primarily attributable to lower rates of return on cash balances for the quarter ended June 30, 2008 as compared to the quarter ended June 30, 2007.

Interest expense. Interest expense was $0.8 million for the three months ended June 30, 2008, as compared to $1.0 million for the three months ended June 30, 2007. Interest expense consists of the
interest on the outstanding amounts under our credit facility, the amortization of the deferred financing costs associated with the issuance of $40.0 million in senior subordinated convertible notes, the interest recorded on these outstanding senior
subordinated convertible notes and the mark-to-market adjustment on the derivative associated with the subordinated convertible notes. The decrease of $0.2 million is primarily attributable to the decrease in the value of the derivative associated
with the subordinated convertible notes.

Guidance



| |  |  | We expect our net revenue for 2008 will be approximately $75 to $82 million.
| | - |  | ----------------------------------------------------------------------------



| |  |  | We expect our gross margin for 2008 will be approximately 70% to 73%, subject to quarterly fluctuations based on revenue mix.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



| |  |  | Depending upon the progress of our clinical and pre-clinical programs, we expect our research and development expenses in 2008 will be approximately $34 to $38
million, including stock-based compensation expense which we estimate will be approximately $0.5 to $1 million.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We anticipate our selling, general and administrative expenses for 2008 will be approximately $50 to $54 million, including stock-based compensation expense which
we estimate will be approximately $3.5 to $4.5 million.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Six Months Ended June 30, 2008 and 2007

Revenue. Product sales were approximately $33.1 million for the six months ended June 30, 2008, as compared to $23.7 million for the six
months ended June 30, 2007. The increase in revenue was primarily attributable to the continued growth of Xibrom and Istalol in the marketplace.

In addition to product revenues for the six months ended June 30, 2008 and 2007, we recorded license revenue of $0.1 million in each of the six months ended June 30, 2008 and 2007, reflecting the
amortization of deferred revenue recorded in December 2001 for the license fee payment made by Otsuka Pharmaceuticals Co., Ltd. in connection with the license of Vitrase in Japan for ophthalmic uses in the posterior region of the eye.

The following table sets forth our net revenue for each of our products for each of the six month periods ended June 30, 2008 and 2007 and the
corresponding percentage change.



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##### Table of Contents

Net Revenue



|                  |  |                               |      |                               |   |          |  |    |  
|----------------- |  | ----------------------------- | ---- | ----------------------------- | - | -------- |  | -- | -
|$ millions        |  | Six Months EndedJune 30, 2008 |      | Six Months EndedJune 30, 2007 |   | % Change | 
|Xibrom            |  | $                             | 25.5 |                               | $ | 16.7     |  | 53 | %
|Istalol           |  |                               | 5.5  |                               |   | 4.7      |  | 17 | %
|Vitrase           |  |                               | 2.2  |                               |   | 2.3      |  | -4 | %
|Other             |  |                               | 0.1  |                               |   | 0.1      |  | 0  | %
|                  |  |                               |      |                               |   |          |  |    |  
|Total Net Revenue |  | $                             | 33.3 |                               | $ | 23.8     |  | 40 | %
|                  |  |                               |      |                               |   |          |  |    |  

Gross margin and cost of products sold. Gross margin for the six months ended June 30,
2008 was 73% of net revenue, or $24.3 million, as compared to 74% of net revenue, or $17.6 million, for the six months ended June 30, 2007. The change in gross margin as a percentage of net revenue is primarily due to an increase in royalty
rate for Xibrom and other costs.

Cost of products sold was $9.0 million for the six months ended June 30, 2008, as compared to $6.2
million for the six months ended June 30, 2007. Cost of products sold for the six months ended June 30, 2008 and 2007 consisted primarily of standard costs for each of our commercial products, distribution costs, royalties, and other costs
of products sold. The increase in cost of products sold is primarily the result of increased net product sales year over year.

Research
and development expenses. Research and development expenses were $17.3 million for the six months ended June 30, 2008, as compared to $12.6 million for the six months ended June 30, 2007. The increase in research and development
expenses for the six months ended June 30, 2008 was primarily the result of an increase in clinical development costs, which include clinical investigator fees, study monitoring costs and data management costs, due to the work performed on our
key product candidates: Xibrom, Bepreve Phase III efficacy, Bepreve safety and T-Pred studies. Our research and development expenses to date have consisted primarily of costs associated with the clinical trials of our product candidates,
compensation and other expenses for research and development personnel, costs for consultants and contract research organizations and costs related to the development of commercial scale manufacturing capabilities for Vitrase, Istalol and Xibrom.

For the six months ended June 30, 2008, approximately 62% of our research and development expenditures were for clinical development
costs, 8% were for regulatory costs, 4% were for pharmaceutical development costs, 16% were for manufacturing development costs, 8% were for medical affairs costs and 2% for stock-based compensation expense.

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



| |  |  | Clinical Development Costs  Overall clinical costs, which include clinical investigator fees, study monitoring costs and data management, for the six months
ended June 30, 2008 were $10.8 million as compared to $5.9 million for the six months ended June 30, 2007 or an increase of $4.9 million. The increase in clinical costs in 2008 was primarily due to costs associated with the Xibrom
(bromfenac sodium 0.18%) clinical trial, the Bepreve Phase III clinical trials and other study costs.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Regulatory Costs  Regulatory costs, which include compliance expense for existing products and other activity for pipeline projects, were $1.3 million for the
six months ended June 30, 2008 as compared to $1.8 million for the six months ended June 30, 2007. The decrease of $500,000 was due primarily to an overall increase in outside consulting costs offset by a receivable recorded in the first
quarter of 2008 in the amount of $0.9 million representing a partial refund of our NDA filing fee paid in December 2007 for Xibrom (bromfenac sodium 0.18%). The receivable was subsequently collected.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pharmaceutical Development Costs  Pharmaceutical development costs, which include costs related to the testing and development of our pipeline products, for
the six months ended June 30, 2008 were $0.7 million as compared to $0.6 million for the six months ended June 30, 2007 or an increase of $100,000. The increase is primarily due to an overall increase in outside research expenses.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Manufacturing Development Costs  Manufacturing development costs, which include costs related to production scale-up and validation, raw material
qualification, and stability studies, for the six months ended
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

| | June 30, 2008 were $2.8 million as compared to $2.5 million for the six months ended June 30, 2007 or an increase of $300,000. The increase is
primarily attributable to an overall increase in research related costs such as clinical supplies and stability studies associated with our growing pipeline of products.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Medical Affairs Costs  Medical affairs costs, which include activities that relate to medical information in support of our products, for the six months ended
June 30, 2008 were $1.4 million as compared to $1.3 million for the six months ended June 30, 2007, or an increase of $100,000. The increase is primarily attributable to an overall increase in outside consulting and investigator costs.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Stock-based compensation expense  Stock-based compensation expense for the six months ended June 30, 2008 was $0.3 million as compared to $.05 million
for the six months ended June 30, 2007.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Selling, general and administrative expenses. Selling, general and
administrative expenses were $27.0 million for the six months ended June 30, 2008, as compared to $24.1 million for the six months ended June 30, 2007. The $2.9 million increase in selling, general and administrative expenses in 2008 as
compared to 2007 primarily results from higher sales and marketing expenses associated with the expansion of our sales force, which occurred in the first quarter of 2008 ($1.4 million), an overall increase in administrative costs primarily legal
expenses ($1.2 million), and an increase in compensation expense ($0.3 million). Selling, general, and administrative expenses during the six months ended June 30, 2008 includes $1.5 million in stock-based compensation expense.

Stock-based compensation. For the six months ended June 30, 2008 and 2007, we granted stock options to employees to purchase 868,847 shares
of common stock (at a weighted average exercise price of $4.49 per share) and 952,029 shares of common stock (at a weighted average exercise price of $7.65 per share), respectively, equal to the fair market value of our common stock at the time of
grant. We also issued 123,205 and 103,291 restricted stock awards for the six months ended June 30, 2008 and 2007, respectively, and included in stock compensation expense was $289,000 and $138,000 for the six months ended June 30, 2008
and 2007, respectively, related to these restricted stock awards.

Interest income. Interest income was $0.6 million for the six
months ended June 30, 2008, as compared to $0.8 million for the six months ended June 30, 2007. The decrease in interest income was primarily attributable to lower rates of return on cash balances for the quarter ended June 30, 2008
as compared to the quarter ended June 30, 2007.

Interest expense. Interest expense was $2.1 million for the six months ended
June 30, 2008, as compared to $2.0 million for the six months ended June 30, 2007. Interest expense consists of interest on the outstanding amounts under our credit facility, the amortization of the deferred financing costs associated with
the issuance of $40.0 million in senior subordinated convertible notes, the interest recorded on these outstanding senior subordinated convertible notes and the mark-to-market adjustment on the derivative associated with the subordinated convertible
notes. The increase year over year is due to the increase in the value of the derivative associated with the subordinated convertible notes.

Liquidity
and Capital Resources

As of June 30, 2008, we had approximately $21.8 million in cash, cash equivalents and short-term
investments, $800,000 of restricted cash, which supports a letter of credit issued as security for interest payments on the outstanding senior subordinated convertible notes, $4.4 million in long term investments and working capital of ($30.4)
million due to the reclassification of the current portion of the subordinated convertible notes from long term liabilities to current liabilities during the second quarter of 2008. Historically, we have financed our operations primarily through
sales of our debt and equity securities. Since March 2000, we have received gross proceeds of approximately $281.7 million from sales of our common stock and the issuance of promissory notes and convertible debt.



16



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##### Table of Contents

Under our revolving credit facility, we may borrow up to the lesser of $10.0 million or 66.67% of our
unrestricted cash, cash equivalents and net receivables. As of June 30, 2008, we had no available borrowings under the credit facility. All outstanding amounts under the credit facility bear interest at a variable rate equal to the
lenders prime rate plus 0.5%, which is payable on a monthly basis. The credit facility also contains customary covenants regarding operations of our business and financial covenants relating to ratios of current assets to current liabilities
and is collateralized by all of our assets with the exception of our intellectual property. As of June 30, 2008, we were in compliance with all of the covenants under the credit facility. All amounts owing under the credit facility will become
due and payable on March 31, 2009.

In April 2006, we entered into a credit arrangement whereby we may borrow up to $1.2 million to
finance the purchase of certain capital equipment. The outstanding amounts under this arrangement will become due and payable ratably over three years from the purchase date of the equipment. As of June 30, 2008, $0.4 million was outstanding
under this arrangement.

Additionally, in June 2006 we issued an aggregate of $40.0 million in principal amount of our senior
subordinated convertible notes, bearing 8% interest per annum payable quarterly in cash in arrears which began October 1, 2006. The notes mature in June 2011 and are convertible, at the option of the holders of the notes, into shares of our
common stock at a conversion price of $7.63, subject to certain adjustments set forth therein. The convertible notes provide the note holders the right any time from and after June 22, 2009 to require us to redeem all or any portion of the
convertible notes. Accordingly, the convertible notes were reclassified as a current liability as of June 30, 2008.

For the
six months ended June 30, 2008, we used $22.8 million of cash for operations principally as a result of the net loss of $21.4 million, the net change in operating assets and liabilities of ($4.2) million, offset by the recording of $2.0 million
in stock-based compensation, the recording of $0.5 million in depreciation and amortization and the recording of $0.3 million in amortization of deferred financing costs associated with the subordinated convertible notes. For the six months ended
June 30, 2007, we used approximately $16.9 million of cash for operations principally as a result of the net loss of $20.2 million, the net change in operating assets and liabilities of $1.1 million, offset by the recording of $1.6 million in
stock based compensation and the recording of $0.6 million in depreciation and amortization.

For the six months ended June 30, 2008,
we received $14.2 million of cash from investing activities, primarily due to the maturities of our short-term investment securities. For the six months ended June 30, 2007, we received $16.0 million of cash from investing activities, primarily
due to the maturities of our short-term investment securities.

For the six months ended June 30, 2008, we received $2.5 million from
financing activities, primarily as a result of net proceeds from our revolving line of credit. For the six months ended June 30, 2007, we received $33.8 million from financing activities, primarily as a result of the sale of an aggregate of
5.25 million shares of our common stock at a purchase price of $7.00 per share, resulting in gross proceeds to us of $36.75 million before payment of offering expenses and placement agent fees of $2.6 million.

Beginning June 22, 2009, the holders of our convertible notes have the right to seek repayment of the notes. We do not have sufficient cash available to
repay the note holders should they seek repayment in June 2009 or there after. We have initiated discussions with certain of the note holders regarding alternatives for repayment of the notes prior to June 2009. The discussions with the note holders
are not concluded at this time. Should the note holders require repayment, we would need to raise additional capital before June 2009.

Excluding any repayment of principal to our note holders on or before June 2009, we believe that our existing cash balances will be sufficient to fund our operations for at least the next twelve months. However, our actual future capital
requirements will depend on many factors, including the following:



| |  |  | whether or not our note holders require repayment in June 2009 or thereafter;
| | - |  | -----------------------------------------------------------------------------



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



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



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



| |  |  | our research and development programs;
| | - |  | --------------------------------------



| |  |  | the time and expense necessary to obtain regulatory approvals;
| | - |  | --------------------------------------------------------------



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



| |  |  | the results of inquiries from the subpoena received in April 2008 from the United States District Attorneys office;
| | - |  | --------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

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



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

These factors may cause us to seek to raise additional funds through additional sales of our debt, 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, 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 never been
profitable, and we might never become profitable. In this regard, we anticipate that our operating expenses will continue to increase from historical levels as we continue to expand our commercial infrastructure in connection with our
commercialization of our approved products. As of June 30, 2008, our accumulated deficit was $324.6 million, including a net loss of approximately $21.4 million for the six months ended June 30, 2008 resulting in a stockholders
deficit of $21.0 million.



18



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##### Table of Contents

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

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may
have market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the
prevailing interest rate later rises, the principal amount of our investment will probably decline. Seeking to minimize this risk, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including
commercial paper, money market funds, government and non-government debt securities and auction rate securities. The average duration of all of our investments in 2008 was less than one year. Due to the short-term nature of these investments, we
believe we have no material exposure to interest rate risk arising from our investments. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair market value of
our interest sensitive financial investments. Declines in interest rates over time will, however, reduce our investment income, while increases in interest rates over time will increase our interest expense. Historically, and as of June 30,
2008, we have not used derivative instruments or engaged in hedging activities.

At June 30, 2008, we held approximately $4.4 million
in auction rate securities with a AAA credit rating upon purchase. In February 2008, we were informed that there was insufficient demand at auction for these securities. As a result, this amount is currently not liquid and may not become liquid
unless the issuer is able to refinance it. We have classified our investment in auction rate securities as a long-term investment and included the investment in other assets on our balance sheet.

All outstanding amounts under our revolving credit facility bear interest at a variable rate equal to the lenders prime rate plus 0.5%, which is
payable on a monthly basis and which may expose us to market risk due to changes in interest rates. As of June 30, 2008, we had $10.0 million outstanding under our credit facility. We estimate that a 10% change in interest rates on our credit
facility would not have had a material effect on our net loss for the six months ended June 30, 2008.

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

Changes in internal control over financial reporting

We have not made any significant changes to our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the quarter ended June 30, 2008 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION



|Item 1A | Risk Factors
|------- | ------------

Our Annual Report on Form 10-K for
the year ended December 31, 2007 contains a full discussion of our risk factors. There have been no material changes to the risk factors disclosed in our Form 10-K except for the risk factors set forth below.

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

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



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

To the extent that our products are reimbursed by Medicare, Medicaid or other federal programs, our marketing and sales activities will be subject to
regulation. Federal agencies in recent years have initiated investigations against and entered into multi-million dollar settlements with a number of pharmaceutical companies alleging violations of fraud and abuse provisions. We will need to ensure
that our sales force is properly trained to comply with these laws. Even with such training, there is a risk that some of our marketing practices could come under scrutiny, or that we will not be able to institute or continue certain marketing
practices. The majority of states also have statutes or regulations similar to these federal laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. In
addition, some states have laws that require pharmaceutical companies to adopt comprehensive compliance programs. Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a manufacturers products from
reimbursement under government programs, criminal fines and imprisonment. Because of the breadth of these laws and the narrowness of the safe harbors, it is possible that some of our business activities could be subject to challenge under one or
more of such laws.

In addition, the FDA imposes a number of complex regulatory requirements on entities that advertise and promote
pharmaceuticals, including, but not limited to, standards and regulations for direct-to-consumer advertising, off-label promotion, industry sponsored scientific and educational activities, and promotional activities involving the Internet. In April
2008, we received a subpoena from the United States District Attorneys office requesting the production of documents regarding promotional, educational and other activities relating to Xibrom.

If our past or present operations are found to be in violation of any of the laws described above or other similar governmental regulations to which we
are subject, we may be subject to the applicable penalty associated with the violation which could adversely affect our ability to operate our business and our financial results.

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

We have numerous competitors in the United
States and abroad, including major pharmaceutical and specialized biotechnology firms, universities and other research institutions that may be developing competing products. Our competitors include, among others, Allergan, Alcon Laboratories, Inc.,
Amphastar Pharmaceuticals, Inc., Bausch & Lomb, Halozyme Therapeutics, Inc., Johnson & Johnson, Novartis AG, Pfizer, Inc., and Inspire Pharmaceuticals, Inc. These competitors may develop technologies and products that are more effective or
less costly than our current or future products or product candidates or that could render our technologies, products and product candidates obsolete or noncompetitive. Many of these competitors have substantially more resources and product
development, manufacturing and marketing experience and capabilities than we do. Many of our competitors also have more resources committed to and expertise in effectively commercializing, marketing, and promoting products approved by the FDA,
including communicating the effectiveness, safety and value of the products to actual and prospective customers and medical professionals. In addition, many of our competitors have significantly greater experience than we do in undertaking
preclinical testing and clinical trials of pharmaceutical product candidates and obtaining FDA and other regulatory approvals of products and therapies for use in healthcare.

We also face competition from manufacturers of generic drugs. The patent for our main product, Xibrom, expires in January 2009, at which point we may no
longer be able to prevent generic drug manufacturers, or other third parties, from manufacturing and selling a product containing bromfenac. If a third party were to develop and market such a product, our revenues may be adversely impacted.

Additionally, the FDA granted our Istalol product a BT rating, which means that prescriptions for Istalol cannot be
substituted legally at pharmacies with generic timolol maleate products. Nonetheless, we believe that certain pharmacies may have substituted, and may be continuing to substitute, Istalol prescriptions with generic timolol maleate solutions. We have
completed an educational campaign to make our customers and pharmacies aware of Istalols BT rating and that Istalol cannot be legally substituted at pharmacies with generic timolol maleate products. However, our efforts may not be successful
and pharmacies may continue to substitute Istalol subscriptions with generic timolol maleate solutions, which would negatively impact our results of operations.



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##### Table of Contents

Items 2  5. Not applicable.

Item 6 Exhibits



|               |  |                                                                                                                                                                                                                                                       
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                                                                                           
|               | 
|10.1           |  | Loan Modification Agreement, dated June 30, 2008, by and between ISTA Pharmaceuticals, Inc. and Silicon Valley Bank (Incorporated by reference to Exhibit 10.1 of the Companys Current
Report on Form 8-K filed with the Commission on July 3, 2008).
|               | 
|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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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: August 8, 2008 |  |  |  | /s/ Vicente Anido, Jr., Ph.D.                                    
|                      |  |  |  | Vicente Anido, Jr., Ph.D.                                        
|                      |  |  |  | President and Chief Executive Officer                            
|                      |  | 
|Dated: August 8, 2008 |  |  |  | /s/ Lauren P. Silvernail                                         
|                      |  |  |  | Lauren P. Silvernail                                             
|                      |  |  |  | Chief Financial Officer and Vice President, Corporate Development



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INDEX TO EXHIBITS



|               |  |                                                                                                                                                                                                                                                       
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                                                                                           
|               | 
|10.1           |  | Loan Modification Agreement, dated June 30, 2008, by and between ISTA Pharmaceuticals, Inc. and Silicon Valley Bank (Incorporated by reference to Exhibit 10.1 of the Companys Current
Report on Form 8-K filed with the Commission on July 3, 2008).
|               | 
|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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