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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549



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FORM 10-Q



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Mark One

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2007

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



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ISTA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                  
|-------------------------------------------------------------- |  | ---------------------------------
|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)



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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, or a
non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ̈Accelerated filer   x    Non-accelerated filer ̈

Indicate by check mark whether the registrant is a shell company (as defined 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 September 30, 2007 was 32,862,476.



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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  September 30, 2007 and December 31, 2006                                 |  | 1      
|                                         |  |                                                                                                                 
|                                         |  | Condensed Consolidated Statements of Operations  Three and Nine Month Periods Ended September 30, 2007 and 2006 |  | 2      
|                                         |  |                                                                                                                 
|                                         |  | Condensed Consolidated Statements of Cash Flows  Nine Month Periods Ended September 30, 2007 and 2006           |  | 3      
|                                         |  |                                                                                                                 
|                                         |  | Notes to Condensed Consolidated Financial Statements                                                             |  | 4      
|                                         |  |                                                                                                                 
|Item 2                                   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                            |  | 8      
|                                         |  |                                                                                                                 
|Item 3                                   |  | Quantitative and Qualitative Disclosure About Market Risk                                                        |  | 14     
|                                         |  |                                                                                                                 
|Item 4                                   |  | Controls and Procedures                                                                                          |  | 15     
|                                         | 
|PART II OTHER INFORMATION                |  | 15                                                                                                              
|                                         |  |                                                                                                                 
|Item 1A                                  |  | Risk Factors                                                                                                     |  | 15     
|                                         |  |                                                                                                                 
|Item 6                                   |  | Exhibits                                                                                                         |  | 16     
|                                         |  |                                                                                                                 
|                                         |  | Signatures                                                                                                       |  | 17     
|                                         |  |                                                                                                                 
|                                         |  | Index to Exhibits                                                                                                |  | 18     





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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)



|                                                                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | -------- | - | ----------------- | - | -------- | -
|                                                                                                                                                                                                                                      |  | September 30, 2007 |          |   | December 31, 2006 |  
|ASSETS                                                                                                                                                                                                                                |  |                    |          |   |                   |   |          |  
|Current assets:                                                                                                                                                                                                                       |  |                    |          |   |                   |   |          |  
|Cash and cash equivalents                                                                                                                                                                                                             |  | $                  | 34,905   |   |                   | $ | 17,236   |  
|Short-term investments                                                                                                                                                                                                                |  |                    | 20,881   |   |                   |   | 21,698   |  
|Accounts receivable, net of allowances of $88 in 2007 and $121 in 2006                                                                                                                                                                |  |                    | 7,439    |   |                   |   | 6,339    |  
|Inventory, net of allowances of $77 in 2007 and $829 in 2006                                                                                                                                                                          |  |                    | 2,122    |   |                   |   | 1,474    |  
|Other current assets                                                                                                                                                                                                                  |  |                    | 2,175    |   |                   |   | 1,672    |  
|                                                                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Total current assets                                                                                                                                                                                                                  |  |                    | 67,522   |   |                   |   | 48,419   |  
|Property and equipment, net                                                                                                                                                                                                           |  |                    | 4,285    |   |                   |   | 3,116    |  
|Deferred financing costs                                                                                                                                                                                                              |  |                    | 2,103    |   |                   |   | 2,481    |  
|Restricted cash                                                                                                                                                                                                                       |  |                    | 3,200    |   |                   |   | 5,600    |  
|Deposits and other assets                                                                                                                                                                                                             |  |                    | 243      |   |                   |   | 127      |  
|                                                                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Total assets                                                                                                                                                                                                                          |  | $                  | 77,353   |   |                   | $ | 59,743   |  
|                                                                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY / (DEFICIT)                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Current liabilities:                                                                                                                                                                                                                  |  |                    |          |   |                   |   |          |  
|Accounts payable                                                                                                                                                                                                                      |  | $                  | 1,979    |   |                   | $ | 2,218    |  
|Accrued compensation and related expenses                                                                                                                                                                                             |  |                    | 3,560    |   |                   |   | 2,311    |  
|Accrued expenses  clinical trials                                                                                                                                                                                                    |  |                    | 358      |   |                   |   | 179      |  
|Line of credit                                                                                                                                                                                                                        |  |                    | 7,500    |   |                   |   | 6,500    |  
|Current portion of long-term liabilities                                                                                                                                                                                              |  |                    | 677      |   |                   |   | 886      |  
|Current portion of obligation under capital lease                                                                                                                                                                                     |  |                    | 43       |   |                   |   | 43       |  
|Other accrued expenses                                                                                                                                                                                                                |  |                    | 11,948   |   |                   |   | 8,284    |  
|                                                                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Total current liabilities                                                                                                                                                                                                             |  |                    | 26,065   |   |                   |   | 20,421   |  
|Deferred rent                                                                                                                                                                                                                         |  |                    | 262      |   |                   |   | 216      |  
|Deferred income                                                                                                                                                                                                                       |  |                    | 3,403    |   |                   |   | 3,611    |  
|Obligation under capital leases                                                                                                                                                                                                       |  |                    | 50       |   |                   |   | 54       |  
|Convertible notes                                                                                                                                                                                                                     |  |                    | 40,167   |   |                   |   | 40,000   |  
|                                                                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Total liabilities                                                                                                                                                                                                                     |  |                    | 69,947   |   |                   |   | 64,302   |  
|Commitments and contingencies                                                                                                                                                                                                         |  |                    |          |   |                   |   |          |  
|Stockholders equity / (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 September 30, 2007 and December 31, 2006; no shares issued and outstanding |  |                    |         |   |                   |   |         |  
|Common stock, $0.001 par value; 100,000,000 shares authorized at September 30, 2007 and December 31, 2006; 32,862,476 and 26,193,745
shares issued and outstanding at September 30, 2007 and December 31, 2006, respectively          |  |                    | 33       |   |                   |   | 26       |  
|Additional paid-in-capital                                                                                                                                                                                                            |  |                    | 300,725  |   |                   |   | 260,401  |  
|Accumulated other comprehensive loss                                                                                                                                                                                                  |  |                    | (25      | ) |                   |   | (24      | )
|Accumulated deficit                                                                                                                                                                                                                   |  |                    | (293,327 | ) |                   |   | (264,962 | )
|                                                                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Total stockholders equity / (deficit)                                                                                                                                                                                                |  |                    | 7,406    |   |                   |   | (4,559   | )
|                                                                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  
|Total liabilities and stockholders equity                                                                                                                                                                                            |  | $                  | 77,353   |   |                   | $ | 59,743   |  
|                                                                                                                                                                                                                                      |  |                    |          |   |                   |   |          |  

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 Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                                                      |  | 2007                             |        |   | 2006                            |   |         | 2007 |  |   | 2006    |  
|Revenue:                                                              |  |                                  |        |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Product sales, net                                                    |  | $                                | 15,796 |   |                                 | $ | 8,190   |      |  | $ | 39,497  |   |  | $ | 20,539  |  
|License revenue                                                       |  |                                  | 69     |   |                                 |   | 69      |      |  |   | 208     |   |  |   | 208     |  
|                                                                      |  |                                  |        |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Total revenue                                                         |  |                                  | 15,865 |   |                                 |   | 8,259   |      |  |   | 39,705  |   |  |   | 20,747  |  
|Cost of products sold                                                 |  |                                  | 4,197  |   |                                 |   | 2,511   |      |  |   | 10,417  |   |  |   | 6,690   |  
|                                                                      |  |                                  |        |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Gross profit margin                                                   |  |                                  | 11,668 |   |                                 |   | 5,748   |      |  |   | 29,288  |   |  |   | 14,057  |  
|Costs and expenses:                                                   |  |                                  |        |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Research and development                                              |  |                                  | 8,146  |   |                                 |   | 7,982   |      |  |   | 20,222  |   |  |   | 17,221  |  
|Selling, general and administrative                                   |  |                                  | 11,252 |   |                                 |   | 9,239   |      |  |   | 35,798  |   |  |   | 28,899  |  
|                                                                      |  |                                  |        |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Total costs and expenses                                              |  |                                  | 19,398 |   |                                 |   | 17,221  |      |  |   | 56,020  |   |  |   | 46,120  |  
|                                                                      |  |                                  |        |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Loss from operations                                                  |  |                                  | (7,730 | ) |                                 |   | (11,473 | )    |  |   | (26,732 | ) |  |   | (32,063 | )
|Interest income                                                       |  |                                  | 713    |   |                                 |   | 686     |      |  |   | 1,486   |   |  |   | 1,264   |  
|Interest expense                                                      |  |                                  | (1,154 | ) |                                 |   | (990    | )    |  |   | (3,119  | ) |  |   | (1,187  | )
|                                                                      |  |                                  |        |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Net loss                                                              |  | $                                | (8,171 | ) |                                 | $ | (11,777 | )    |  | $ | (28,365 | ) |  | $ | (31,986 | )
|                                                                      |  |                                  |        |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Net loss per common share, basic and diluted                          |  | $                                | (0.25  | ) |                                 | $ | (0.45   | )    |  | $ | (1.00   | ) |  | $ | (1.23   | )
|                                                                      |  |                                  |        |   |                                 |   |         |      |  |   |         |   |  |   |         |  
|Shares used in computing net loss per common share, basic and diluted |  |                                  | 32,284 |   |                                 |   | 25,918  |      |  |   | 28,521  |   |  |   | 25,915  |  
|                                                                      |  |                                  |        |   |                                 |   |         |      |  |   |         |   |  |   |         |  

See accompanying notes



2



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##### Table of Contents

ISTA Pharmaceuticals, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)



|                                                                            |  |                                 |         |   |      |   |         |  
|--------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | -
|                                                                            |  | Nine Months Ended September 30, |        
|                                                                            |  | 2007                            |         |   | 2006 |  
|Operating Activities                                                        |  |                                 |         |   |      |   |         |  
|Net loss                                                                    |  | $                               | (28,365 | ) |      | $ | (31,986 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                 |         |   |      |   |         |  
|Stock based compensation                                                    |  |                                 | 2,358   |   |      |   | 1,960   |  
|Amortization of deferred financing costs                                    |  |                                 | 418     |   |      |   | 148     |  
|Amortization of discount on convertible notes                               |  |                                 | 245     |   |      |   |        |  
|Change in value of derivatives                                              |  |                                 | (78     | ) |      |   |        |  
|Depreciation and amortization                                               |  |                                 | 505     |   |      |   | 390     |  
|Changes in operating assets and liabilities:                                |  |                                 |         |   |      |   |         |  
|Accounts receivable, net                                                    |  |                                 | (1,100  | ) |      |   | (2,546  | )
|Inventory, net                                                              |  |                                 | (648    | ) |      |   | 182     |  
|Other current assets                                                        |  |                                 | (503    | ) |      |   | (924    | )
|Accounts payable                                                            |  |                                 | (239    | ) |      |   | 3,519   |  
|Accrued compensation and related expenses                                   |  |                                 | 1,249   |   |      |   | 428     |  
|Accrued expenses  clinical trials and other accrued expenses               |  |                                 | 3,843   |   |      |   | 2,595   |  
|Other liabilities                                                           |  |                                 | (209    | ) |      |   | 210     |  
|Deferred rent                                                               |  |                                 | 46      |   |      |   | 2       |  
|Deferred income                                                             |  |                                 | (208    | ) |      |   | 50      |  
|                                                                            |  |                                 |         |   |      |   |         |  
|Net cash used in operating activities                                       |  |                                 | (22,686 | ) |      |   | (25,972 | )
|                                                                            |  |                                 |         |   |      |   |         |  
|Investing Activities                                                        |  |                                 |         |   |      |   |         |  
|Purchases of marketable securities                                          |  |                                 | (14,783 | ) |      |   | (10,700 | )
|Maturities of marketable securities                                         |  |                                 | 15,599  |   |      |   | 21,513  |  
|Purchases of equipment                                                      |  |                                 | (1,674  | ) |      |   | (1,067  | )
|Restricted cash                                                             |  |                                 | 2,400   |   |      |   | (6,400  | )
|Deposits and other assets                                                   |  |                                 | (116    | ) |      |   | (645    | )
|                                                                            |  |                                 |         |   |      |   |         |  
|Net cash provided by investing activities                                   |  |                                 | 1,426   |   |      |   | 2,701   |  
|                                                                            |  |                                 |         |   |      |   |         |  
|Financing Activities                                                        |  |                                 |         |   |      |   |         |  
|Proceeds from exercise of stock options                                     |  |                                 | 193     |   |      |   | 147     |  
|Obligation under capital lease                                              |  |                                 | (4      | ) |      |   | 70      |  
|Proceeds from issuance of convertible notes, net                            |  |                                 |        |   |      |   | 40,000  |  
|Financing costs                                                             |  |                                 | (40     | ) |      |   | (2,756  | )
|Proceeds from line of credit                                                |  |                                 | 20,000  |   |      |   | 7,000   |  
|Repayment on line of credit                                                 |  |                                 | (19,000 | ) |      |   | (3,500  | )
|Proceeds from issuance of common stock, net of issuance costs               |  |                                 | 37,780  |   |      |   | 142     |  
|                                                                            |  |                                 |         |   |      |   |         |  
|Net cash provided by financing activities                                   |  |                                 | 38,929  |   |      |   | 41,103  |  
|                                                                            |  |                                 |         |   |      |   |         |  
|Increase in Cash and Cash Equivalents                                       |  |                                 | 17,669  |   |      |   | 17,832  |  
|Cash and cash equivalents at beginning of period                            |  |                                 | 17,236  |   |      |   | 6,510   |  
|                                                                            |  |                                 |         |   |      |   |         |  
|Cash and Cash Equivalents At End of Period                                  |  | $                               | 34,905  |   |      | $ | 24,342  |  
|                                                                            |  |                                 |         |   |      |   |         |  

See accompanying notes



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##### Table of Contents

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®,
T-Pred, Bepreve, 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. In December 2001, ISTA
announced its strategic plan to transition to a pharmaceutical company with a primary focus on ophthalmology. In July 2004, the Company transitioned from a development-stage organization to a commercial entity. 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 general 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, 2006.

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 nine
month periods ended September 30, 2007, and 2006 have been made. The interim results of operations are not necessarily indicative of the results to be expected for the full fiscal year.

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;
| | - |  | --------------------------------------------------------------------



| |  |  | 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.
| | - |  | -------------------------------------------



4



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##### Table of Contents

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 may offer 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 $0.4 million as of
September 30, 2007 and 2006, 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 the Companys 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 $0.9 million and $0.5 million as of September 30, 2007 and 2006, 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 expiry dating 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.

For the three months
ended September 30, 2007 compared to the three months ended September 30, 2006, the Companys exposure for rebates, chargebacks and product returns has grown primarily as a result of increased sales of its existing products.
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 September 30, 2007
and 2006 was 7.0% and 6.7%, respectively, for the allowance for rebates, chargebacks and other discounts, and was 3.8% and 2.6%, respectively, for the allowance for product returns. ISTA typically applies a higher allowance for product returns on
stocking orders in connection with an initial launch, where applicable.

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 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 September 30, 2007 consisted of $0.6 million of raw materials
and $1.6 million of finished goods, net of $77,000 in inventory reserves. Inventory at December 31, 2006 consisted of $0.7 million in raw materials and $1.6 million of finished goods, net of $0.8 million 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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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 $3.2 million of restricted cash at September 30, 2007, which supports a letter of credit issued as security for interest payments on the outstanding senior subordinated convertible notes.

Comprehensive Income (Loss)

SFAS No. 130, Reporting Comprehensive Income, or SFAS No. 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 nine months ended September 30, 2007 and 2006 was $28.4 million and $32.0 million, respectively. In accordance with SFAS No. 130, the
accumulated balance of unrealized gains (losses) on investments and the accumulated balance of foreign currency translation adjustments are disclosed as separate components of stockholders equity.

As of September 30, 2007 and December 31, 2006, accumulated foreign currency translation adjustments were ($25,000) at each date and
accumulated unrealized gains (losses) on investments were $0 and $1,000 at September 30, 2007 and December 31, 2006, respectively.

Stock-Based Compensation

On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
Share-Based Payment, or SFAS No. 123(R), which requires measurement and recognition of compensation expense for all share-based awards made to employees and directors. Under SFAS No. 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 No. 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 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.

At
September 30, 2007, there was $6.0 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 2 years.

Restricted Stock Awards

During the three and
nine months ended September 30, 2007 the Company granted a total of 2,000 and 105,291 shares of restricted common stock, respectively, 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.



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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 $83,000 and $221,000 for the three and nine months ended September 30, 2007, respectively, $36,000 and $83,000 for the
three and nine months ended September 30, 2006. As of September 30, 2007, there was approximately $1.0 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 No. 128, and SAB No. 98, Earnings Per Share, or SAB No. 98, basic net loss per common share is computed by
dividing the net loss for the period by the weighted average number of common shares outstanding during the period. Under SFAS No. 128, diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the
weighted-average number of common and common equivalent shares, such as stock options, outstanding during the period. Such common equivalent shares have not been included in the Companys computation of diluted net loss per share as their
effect would be anti-dilutive. The total number of shares excluded from the calculation of diluted net loss per share, prior to application of the treasury stock method for options, warrants, and as-converted shares was 10,139,532 and 10,815,777 for
the nine months ended September 30, 2007 and 2006, respectively.

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

Executive
Employment Agreements

The Company has entered into 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

During 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 provides, among other things, that if there is a change in control of the Company,
as defined, 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 value of the derivative as of September 30, 2007 and 2006 is $0.9 million and $1.0 million, respectively. The embedded derivative
will be marked-to-market through earnings on a quarterly basis. The net effect of the changes in the value of the derivative and the amortization of the related debt discount was not significant.

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 or financial position of the Company.



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Segment Reporting

The Company currently operates in only one segment.

Recent Accounting Pronouncements

In July 2006, the Financial Accounting Standards Board, or FASB, issued FASB Interpretation No. 48 Accounting for Uncertainty in Income
Taxes, or FIN 48, which prescribes a recognition threshold and measurement process for recording in the financial statements uncertain tax positions taken or expected to be taken in a tax return. Additionally, FIN 48 provides guidance on the
derecognition, classification, accounting in interim periods and disclosure requirements for uncertain tax positions. The accounting provisions of FIN 48 became effective for the Company beginning January 1, 2007.

At December 31, 2006, the Company had federal and state tax net operating loss, or NOL, carryforwards of approximately $160.4 million and $90.4
million, respectively, which will 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 $6.3 million and $3.8 million,
respectively. The federal R&D tax credits will begin to expire in 2010, 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, 2006 and September 30, 2007. Utilization of the NOL and R&D credit carryforwards may be subject to a substantial
annual limitation due to ownership change limitations that have occurred previously or that could occur in the future provided by Sections 382 and 383 of the Internal Revenue Code of 1986, as well as similar state and foreign provisions. These
ownership changes may limit the amount of NOL and R&D credit carryforwards than can be utilized annually to offset future taxable income and tax, respectively. In general, an ownership change, as defined by Section 382, results from
transactions increasing the ownership of certain shareholders or public groups in the stock of a corporation by more than 50 percentage points over a three-year period. Since the Companys formation, the Company has raised capital through the
issuance of capital stock on several occasions which, combined with the purchasing stockholders subsequent disposition of those shares, may have resulted in a change of control, as defined by Section 382, or could result in a change of
control in the future upon subsequent disposition. The Company has not currently 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 due to
the significant complexity and cost associated with such study and that there could be additional changes in the future. If the Company has experienced a change of control at any time since Company formation, utilization of the Companys NOL or
R&D credit carryforwards would be subject to an annual limitation under Sections 382 and 383 which is determined by first multiplying the value of the Companys stock at the time of the ownership change by the applicable long-term
tax-exempt rate, and then could be subject to additional adjustments, as required. Any limitation may result in expiration of a portion of the NOL or R&D credit carryforwards before utilization. Further, until a study is completed and any
limitation known, no amounts are being presented as an uncertain tax position under FIN 48. Interest and penalties related to uncertain tax positions will be reflected in income tax expense. Tax years 1992 to 2006 remain subject to future
examination by the major tax jurisdictions in which the Company is subject to tax.

New Accounting Standard Not Yet Adopted

The FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements, in September 2006. The new standard
provides guidance on the use of fair value in such measurements. It also prescribes expanded disclosures about fair value measurements contained in the financial statements. The Company is in the process of evaluating the new standard which is not
expected to have any effect on the Companys consolidated financial position or results of operations, although financial statement disclosures will be revised to conform to the new guidance. The pronouncement, including the new disclosures, is
effective for us as of the first quarter of 2008.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option
for Financial Assets and Financial Liabilities, or SFAS No. 159. SFAS No. 159 expands opportunities to use fair value measurement in financial reporting and permits entities to choose to measure many financial instruments
and certain other items at fair value. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company has not decided if it will early adopt SFAS No. 159 or if it will choose to measure any
eligible financial assets and liabilities at fair value.



|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. Words such as may,
will, should, could, expect, plan, anticipate, believe, estimate, predict, potential,



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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, 2006. 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 $3.2 billion U.S. prescription ophthalmic market and include therapies for inflammation, ocular pain, glaucoma, allergy and
dry eye. 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 $293.3 million through September 30, 2007.

Third Quarter Developments

We increased our net revenue by 92% in the third quarter of 2007, as compared to the third
quarter of 2006.

During September 2007, we licensed exclusive North American rights to nasal dosage forms of bepotastine, an
investigational product for the treatment of allergy symptoms, from Tanabe Seiyaku Co., Ltd. Under the terms of our license agreement with Tanabe, we have paid an upfront payment to Tanabe of $2.0 million, and will make additional payments based on
achievement of development and approval milestones, and royalties on future product sales. We are responsible for all costs associated with developing nasal bepotastine for North America, including clinical trials, FDA filings, manufacturing, and,
if the product is approved, marketing and sales activities. We also obtained the right to develop other nasal bepotastine products, including a fixed combination with a steroid, and a future right to negotiate for a North American license to oral
dosage forms of bepotastine for allergy treatment.

Results of Operations

Three Months Ended September 30, 2007 and 2006

Net Revenue. Net revenue was
approximately $15.9 million for the three months ended September 30, 2007, as compared to $8.3 million for the three months ended September 30, 2006. The increase in net 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 September 30, 2007 and 2006, we recorded
license revenue of $69,000 in each of the three months ended September 30, 2007 and 2006, 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 September 30, 2007 and 2006 and the corresponding percentage change.



|           |  |                                  |      |                                  |   |          |  |     |   
|---------- |  | -------------------------------- | ---- | -------------------------------- | - | -------- |  | --- | --
|$ millions |  | Quarter Ended September 30, 2007 |      | Quarter Ended September 30, 2006 |   | % Change | 
|Xibrom     |  | $                                | 11.3 |                                  | $ | 5.2      |  | 117 | %%
|Istalol    |  |                                  | 3.0  |                                  |   | 2.1      |  | 43  | %%
|Vitrase    |  |                                  | 1.5  |                                  |   | 0.9      |  | 67  | %%



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|                  |  |                                  |      |                                  |   |          |  |    |   
|----------------- |  | -------------------------------- | ---- | -------------------------------- | - | -------- |  | -- | --
|$ millions        |  | Quarter Ended September 30, 2007 |      | Quarter Ended September 30, 2006 |   | % Change | 
|Other             |  |                                  | 0.1  |                                  |   | 0.1      |  | 0  | %%
|                  |  |                                  |      |                                  |   |          |  |    |   
|Total Net Revenue |  | $                                | 15.9 |                                  | $ | 8.3      |  | 92 | %%
|                  |  |                                  |      |                                  |   |          |  |    |   

Gross margin and cost of products sold. Gross margin for the three months ended
September 30, 2007 was 74%, or $11.7 million, as compared to 70%, or $5.7 million, for the three months ended September 30, 2006. The increase in gross margin as a percentage of net revenue is primarily due to the change in revenue mix,
primarily driven by increased Xibrom sales. Historically, as an early stage commercial entity, we were not party to any wholesaler inventory management arrangements, but we anticipate going forward that we may enter into to such arrangements. We
believe these arrangements, if entered into, could negatively impact our future net sales and gross margin.

Cost of products sold was $4.2
million for the three months ended September 30, 2007, as compared to $2.5 million for the three months ended September 30, 2006. Cost of products sold for the three months ended September 30, 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.

We expect our gross margin for 2007 will be approximately 71% to 74%, subject to quarterly fluctuations based on revenue mix, and are currently tracking
to the upper end of the range.

Research and development expenses. Research and development expenses were $8.1 million for the three
months ended September 30, 2007, as compared to $8.0 million for the three months ended September 30, 2006. Included in research and development expenses for the third quarter ended September 30, 2007 was $3.0 million in milestone
expense, including an upfront payment expense in the amount of $2.0 million associated with the licensing of the nasal dosage form of bepotastine from Tanabe. 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
September 30, 2007, approximately 24% of our research and development expenditures were for clinical development costs, 12% were for regulatory costs, 4% were for pharmaceutical development costs, 16% were for manufacturing development costs,
7% were for medical affairs costs and approximately 37% were for research and development related milestones, part of which was for an up front payment to in-license the nasal dosage form bepotastine.

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 September 30, 2007 were $2.0 million as compared to $2.8 million for the three months ended September 30, 2006 or a decrease of $0.8 million. The decrease in clinical costs was primarily due to the timing of commencement and
completion of various clinical trials.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Regulatory Costs  Regulatory costs, which include compliance expense for existing products and other activity for pipeline projects, were $0.9 million for
each of the three months ended September 30, 2007 and 2006.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pharmaceutical Development Costs  Pharmaceutical development costs, which include costs related to the testing and development of our pipeline products, for
the three months ended September 30, 2007 were $0.3 million as compared to $0.4 million for the three months ended September 30, 2006 or a decrease of $0.1 million. The decrease is primarily due to the overall reduction 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, were $1.3 million for each of the three months ended September 30, 2007 and 2006.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Medical Affairs Costs  Medical affairs costs, which include activities that relate to medical information in support of our products, were $0.6 million for
each of the three months ended September 30, 2007 and 2006.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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

Depending upon the progress of our clinical and pre-clinical programs, we expect our research and development expenses in 2007 will be approximately $28
to $30 million.

Selling, general and administrative expenses. Selling, general and administrative expenses were $11.3 million for
the three months ended September 30, 2007, as compared to $9.2 million for the three months ended September 30, 2006. The $2.1 million increase in selling, general and administrative expenses in 2007 as compared to 2006 primarily results
from higher sales and marketing expenses associated with the expansion of our sales force. Selling, general, and administrative expenses during the third quarter of 2007 and 2006 each include $0.7 million, respectively, in stock-based compensation
expense.

We anticipate our selling, general and administrative expenses for 2007 will be approximately $44 to $48 million, excluding stock
compensation expense which we estimate will be approximately $3 to $4 million for 2007.

Stock-based compensation. Compensation for
stock options granted to non-employees has been determined in accordance with Statement of Financial Accounting Standards, or SFAS, No. 123(R), Share-Based Payment and Emerging Issues Task Force 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 September 30, 2007
and 2006, we granted stock options to employees to purchase 52,600 shares of common stock (at a weighted average exercise price of $7.11 per share) and 24,800 shares of common stock (at a weighted average exercise price of $6.27 per share),
respectively, equal to the fair market value of our common stock at the time of grant. We also issued 2,000 and 1,500 restricted stock awards for the three months ended September 30, 2007 and 2006, respectively, and included in stock
compensation expense was $83,000 and $36,000 for the three months ended September 30, 2007 and 2006, respectively, related to these restricted stock awards.

Interest income. Interest income was each $0.7 million for the three months ended September 30, 2007 and the three months ended September 30, 2006, respectively.

Interest expense. Interest expense was $1.2 million for the three months ended September 30, 2007 and $1.0 million for the three months ended
September 30, 2006. The increase is due in part to the amortization of the discount on the convertible notes offset by the change in the value of the derivative associated with the convertible notes.

We expect our net interest expense in 2007 will be approximately $2 to $3 million as a result of the interest on our senior subordinated convertible
notes and interest on our revolving credit facility, offset by interest earned on our higher cash balances.

Nine Months Ended September 30, 2007
and 2006

Net Revenue. Net revenue was approximately $39.7 million for the nine months ended September 30, 2007, as compared
to $20.7 million for the nine months ended September 30, 2006. The increase in net revenue was primarily attributable to the continued growth of Xibrom and Istalol in the marketplace.

Included in net revenues for the nine months ended September 30, 2007 and 2006, we recorded license revenue of $0.2 million in each of the nine
months ended September 30, 2007 and 2006, 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.



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The following table sets forth our net revenue for each of our products for each of the nine month
periods ended September 30, 2007 and 2006 and the corresponding percentage change.



|                  |  |                                      |      |                                      |   |          |  |     |  
|----------------- |  | ------------------------------------ | ---- | ------------------------------------ | - | -------- |  | --- | -
|$ millions        |  | Nine Months Ended September 30, 2007 |      | Nine Months Ended September 30, 2006 |   | % Change | 
|Xibrom            |  | $                                    | 28.1 |                                      | $ | 12.0     |  | 134 | %
|Istalol           |  |                                      | 7.7  |                                      |   | 5.7      |  | 35  | %
|Vitrase           |  |                                      | 3.7  |                                      |   | 2.8      |  | 32  | %
|Other             |  |                                      | 0.2  |                                      |   | 0.2      |  | 0   | %
|                  |  |                                      |      |                                      |   |          |  |     |  
|Total Net Revenue |  | $                                    | 39.7 |                                      | $ | 20.7     |  | 92  | %
|                  |  |                                      |      |                                      |   |          |  |     |  

Gross margin and cost of products sold. Gross margin for the nine months ended
September 30, 2007 was 74%, or $29.3 million, as compared to 68%, or $14.1 million, for the nine months ended September 30, 2006. The increase in gross margin as a percentage of net revenue is primarily due to the change in revenue mix.
Cost of products sold was $10.4 million for the nine months ended September 30, 2007, as compared to $6.7 million for the nine months ended September 30, 2006. Cost of products sold for the nine months ended September 30, 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 $20.2 million for the nine months ended
September 30, 2007, as compared to $17.2 million for the nine months ended September 30, 2006. The increase in research and development expenses for the nine months ended September 30, 2007 was primarily the result of an increase in
clinical development costs, which include FDA filing fees, clinical investigator fees, study monitoring costs and data management costs, due to the completion of the Xibrom QD once-daily Phase III studies, the completion of the Bepreve
(bepotastine ophthalmic solution) Phase II/III study, the completion of the ecabet sodium Phase IIb confirmatory study and the recording of milestone expense in the amount of $3.0 million, which included a $2.0 million upfront payment associated
with the licensing of the nasal dosage form of bepotastine from Tanabe.

For the nine months ended September 30, 2007, approximately
39% of our research and development expenditures were for clinical development costs, 14% were for regulatory costs, 4% were for pharmaceutical development costs, 19% were for manufacturing development costs, 9% were for medical affairs costs and
approximately 15% was for research and development related milestones, part of which was for an up front payment to in-license the nasal dosage form of bepotastine.

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 nine months
ended September 30, 2007 were $7.9 million as compared to $5.2 million for the nine months ended September 30, 2006 or an increase of $2.7 million. The increase in clinical costs in 2007 was primarily due to the completion of the Xibrom QD
once-daily Phase III clinical trials, completion of the ecabet sodium Phase IIb confirmatory study and completion of the Bepreve (bepotastine ophthalmic solution) Phase II/III clinical trials.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Regulatory Costs  Regulatory costs, which include compliance expense for existing products and other activity for pipeline projects, were $2.7 million for the
nine months ended September 30, 2007 as compared to $3.0 million for the nine months ended September 30, 2006 or a decrease of $0.3 million. The decrease in regulatory costs for the nine months ended September 30, 2007 was primarily
due to the allocation of FDA fees to inventory.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pharmaceutical Development Costs  Pharmaceutical development costs, which include costs related to the testing and development of our pipeline products, for
the nine months ended September 30, 2007 were $0.9 million as compared to $1.2 million for the nine months ended September 30, 2006 or a decrease of $0.3 million. The decrease is primarily due to the overall reduction 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 nine months ended September 30, 2007 were $3.8 million as compared to $3.6 million for the nine months ended September 30, 2006 or an increase of $0.2 million. The increase is primarily
attributable to the allocation of production costs to capitalized inventory as a function of the scale up of activities associated with the increase in the number of commercial products during 2007 as compared to 2006.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Medical Affairs Costs  Medical affairs costs, which include activities that relate to medical information in support of our products, were $1.9 million for
each of the nine months ended September 30, 2007 and 2006.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Selling, general and administrative expenses.
Selling, general and administrative expenses were $35.8 million for the nine months ended September 30, 2007, as compared to $28.9 million for the nine months ended September 30, 2006. The $6.9 million increase in selling, general and
administrative expenses in 2007 as compared to 2006 primarily results from higher sales and marketing expenses associated with the expansion of our sales force. Selling, general, and administrative expenses during the 2007 and 2006 periods include
$2.4 million and $2.0 million, respectively, in stock-based compensation expense.

Stock-based compensation. For the nine months
ended September 30, 2007 and 2006, we granted stock options to employees to purchase 1,004,629 shares of common stock (at a weighted average exercise price of $7.62 per share) and 793,924 shares of common stock (at a weighted average exercise
price of $6.64 per share), respectively, equal to the fair market value of our common stock at the time of grant. We also issued 105,291 restricted stock awards and 81,180 restricted stock awards for the nine months ended September 30, 2007 and
2006, respectively, and included in stock compensation expense was $221,000 and $83,000 for the nine months ended September 30, 2007 and 2006, respectively, related to these restricted stock awards.

Interest income. Interest income was $1.5 million for the nine months ended September 30, 2007, as compared to $1.3 million for the nine
months ended September 30, 2006. The increase in interest income was primarily attributable to higher cash balances as a result of our receipt of $40.0 million in net proceeds from the issuance of senior subordinated convertible notes during
2006, the interest earned on the restricted cash and higher rates of return as compared to 2006.

Interest expense. Interest expense
was $3.1 million for the nine months ended September 30, 2007, as compared to $1.2 million for the nine months ended September 30, 2006. The increase in interest expense was primarily attributable to the interest on the outstanding amounts
under our credit facility, the amortization of the deferred financing costs, the amortization of the discount and the change in the value of the derivative associated with the issuance of $40.0 million in senior subordinated convertible notes and
the interest recorded on these outstanding senior subordinated convertible notes.

Liquidity and Capital Resources

As of September 30, 2007, we had approximately $55.8 million in cash, cash equivalents and short-term investments, $3.2 million of restricted cash,
which supports a letter of credit issued as security for interest payments on our outstanding senior subordinated convertible notes, and working capital of $41.5 million. Historically, we have financed our operations primarily through sales of our
debt and equity securities. Since March 2000, we have received gross proceeds of approximately $281.7 million from sales of our common stock and the issuance of promissory notes and convertible debt.

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 September 30, 2007, we had $2.5 million available for borrowing under the credit facility. All outstanding amounts under the credit facility bear interest at a variable rate equal to the lenders prime rate 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 September 30, 2007, 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, 2008.

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 September 30, 2007, $0.7 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 any time following their issuance, into shares of our common stock at a
conversion price of $7.63 per share, subject to certain adjustments and limitations set forth therein.



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For the nine months ended September 30, 2007, we used $22.7 million of cash for operations
principally as a result of the net loss of $28.4 million, the net change in operating assets and liabilities of $2.2 million, offset by the recording of $2.4 million in stock based compensation and the recording of $0.9 million in depreciation and
amortization. For the nine months ended September 30, 2006, we used approximately $26.0 million of cash for operations principally as a result of the net loss of $32.0 million.

For the nine months ended September 30, 2007, we received $1.4 million of cash from investing activities, primarily due to the maturities of our
short-term investment securities. For the nine months ended September 30, 2006, we received $2.7 million of cash from investing activities, primarily due to the maturities of our short-term investment securities, offset by restricted cash
deposit requirements under our letter of credit.

For the nine months ended September 30, 2007, we received $38.9 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. Additionally, we received $3.6 million from the exercise of 951,151 warrants. For the nine months ended September 30, 2006, we received $41.1 million from financing activities, primarily as a result of
$3.5 million of net borrowing under the credit facility and the issuance of senior subordinated convertible notes in the principal amount of $40.0 million less $2.8 million of financing costs.

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



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



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



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



| |  |  | the rate of progress of our research and development programs;
| | - |  | --------------------------------------------------------------



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



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



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



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

These factors, among others, may cause us to seek to raise additional funds through additional sales of our debt or equity securities. There can be no assurance that funds from these sources will be available when
needed or, if available, will be on terms favorable to us or to our stockholders. If additional funds are raised by issuing equity securities, the percentage ownership of our stockholders will be reduced, stockholders may experience additional
dilution or such equity securities may provide for rights, preferences or privileges senior to those of the holders of our common stock.

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 September 30, 2007, our accumulated deficit was $293.3 million, including a net loss of approximately $28.4 million for the nine months ended September 30, 2007 and a
stockholders equity of $7.4 million.



|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. The average duration of all of our investments in 2006 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 September 30, 2007, we have not
used derivative instruments or engaged in hedging activities.



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##### Table of Contents

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 September 30, 2007, we had $7.5 million outstanding under our credit facility. We estimate
that a 10% change in interest rates on our credit facility would not have had a material effect on our net loss for the nine months ended September 30, 2007.

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. Our 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 fiscal quarter ended September 30, 2007 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
|------- | ------------

There have been no material changes
to the Risk Factors contained in our Annual Report for Form 10-K for the period ended December 31, 2006, except as follows:

If we are unable to
obtain materials from our sole source suppliers in a timely manner, our product development and commercialization efforts for our product candidates could be delayed or stopped.

Some materials used in our products are currently obtained from a single source. For example, Biozyme Laboratories, Ltd. is currently our only source for
highly purified ovine hyaluronidase, which is the active ingredient in Vitrase. We currently purchase hyaluronidase on a purchase order basis and do not have a long term agreement with Biozyme for the supply of hyaluronidase. However, we have
entered into a supply arrangement with and are currently validating another third party as an alternate supplier of ovine hyaluronidase but, we may not be able to successfully establish and validate the supply arrangement with this third party.
While we are currently pursuing additional sources for this material, we may not be successful in establishing such additional sources. The active ingredient for Xibrom is also supplied to us from a sole supplier. We have also entered into supply
agreements with R.P. Scherer West, Inc. and Alliance Medical Products, Inc. to manufacture commercial quantities of Vitrase in a lyophilized 6,200 USP units multi-purpose vial and 200 USP units/mL in sterile solution, respectively. Currently, R.P.
Scherer West and Alliance Medical Products each is our sole source for Vitrase in these respective configurations. We also have supply agreements with Bausch & Lomb, Incorporated to manufacture commercial quantities of Istalol and Xibrom,
and, currently, Bausch & Lomb is our sole source for such products.

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



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##### Table of Contents

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



|               |  |                                                                                                                                                 
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                     
|               | 
|10.47          |  | Exclusive License Agreement dated September 25, 2007, by and between the Registrant and Tanabe Seiyaku Co., Ltd. (1)                            
|               | 
|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.



|(1) | Portions of this exhibit have been omitted pursuant to a request for confidential treatment under Rule 24b-2 of the Exchange Act. The omitted material has been separately filed with
the Securities and Exchange Commission.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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##### Table of Contents

Signatures

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



|                        |  |  |  |                            |  |                                      
|----------------------- |  |  |  | -------------------------- |  | -------------------------------------
|                        |  |  |  | ISTA PHARMACEUTICALS, INC.
|                        |  |  |  | (Registrant)              
|                        |  |  | 
|Dated: November 6, 2007 |  |  |  |                            |  | /s/ Vicente Anido, Jr., Ph.D.        
|                        |  |  |  |                            |  | Vicente Anido, Jr., Ph.D.            
|                        |  |  |  |                            |  | President and Chief Executive Officer



|                        |  |  |  |  |  |                                      
|----------------------- |  |  |  |  |  | -------------------------------------
|                        |  |  | 
|Dated: November 6, 2007 |  |  |  |  |  | /s/ Lauren P. Silvernail             
|                        |  |  |  |  |  | Lauren P. Silvernail                 
|                        |  |  |  |  |  | Chief Financial Officer,             
|                        |  |  |  |  |  | Chief Accounting Officer and         
|                        |  |  |  |  |  | Vice President, Corporate Development



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##### Table of Contents

INDEX TO EXHIBITS



|               |  |                                                                                                                                                   
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                       
|               | 
|10.47          |  | Exclusive License Agreement dated September 25, 2007, by and between the Registrant and Tanabe Seiyaku Co., Ltd. (1)                              
|               | 
|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.



|(1) | Portions of this exhibit have been omitted pursuant to a request for confidential treatment under Rule 24b-2 of the Exchange Act. The omitted material has been separately filed with
the Securities and Exchange Commission.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



18