##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549





FORM 10-Q





Mark One

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

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2010

Or



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

FOR THE TRANSITION PERIOD FROM             
TO

Commission File
Number: 000-31255





ISTA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)







|                                                               |  |                                 
|-------------------------------------------------------------- |  | --------------------------------
|DELAWARE                                                       |  | 33-0511729                      
|(State or other jurisdiction of
incorporation or organization) |  | IRS Employer Identification No.)

15295 Alton Parkway, Irvine,
California 92618

(Address of principal executive offices)

(949) 788-6000

(Registrants telephone number, including area code)





Indicate by
check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past 90
days.    x  Yes     ̈  No

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

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



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

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

The number of shares of the registrants common stock, $0.001 par value, outstanding as of October 22, 2010 was 33,501,592.









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##### Table of Contents

TABLE OF CONTENTS



|                                         |  |                                                                                            |    |         |    | 
|---------------------------------------- |  | ------------------------------------------------------------------------------------------ | -- | ------- | -- | 
|                                         |  |                                                                                            |    | Page No |   
|PART I FINANCIAL INFORMATION (unaudited) |  |                                                                                            | 3  |        
|                                         |  |                                                                                           
|Item 1                                   |  | Condensed Financial Statements                                                             |    |         | 3  | 
|                                         |  |                                                                                           
|                                         |  | Condensed Balance SheetsSeptember 30, 2010 and December 31, 2009                          |    |         | 3  | 
|                                         |  |                                                                                           
|                                         |  | Condensed Statements of OperationsThree and Nine Months Ended September 30, 2010 and 2009 |    |         | 4  | 
|                                         |  |                                                                                           
|                                         |  | Condensed Statements of Cash FlowsNine Months Ended September 30, 2010 and 2009           |    |         | 5  | 
|                                         |  |                                                                                           
|                                         |  | Notes to Condensed Financial Statements                                                    |    |         | 6  | 
|                                         |  |                                                                                           
|Item 2                                   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations      |    |         | 16 | 
|                                         |  |                                                                                           
|Item 3                                   |  | Quantitative and Qualitative Disclosure About Market Risk                                  |    |         | 24 | 
|                                         |  |                                                                                           
|Item 4                                   |  | Controls and Procedures                                                                    |    |         | 25 | 
|                                         | 
|PART II OTHER INFORMATION                |  |                                                                                            | 26 |        
|                                         |  |                                                                                           
|Item 1                                   |  | Legal Proceedings                                                                          |    |         | 26 | 
|                                         |  |                                                                                           
|Item 1A                                  |  | Risk Factors                                                                               |    |         | 26 | 
|                                         |  |                                                                                           
|Item 6                                   |  | Exhibits                                                                                   |    |         | 27 | 
|                                         |  |                                                                                           
|                                         |  | Signatures                                                                                 |    |         | 28 | 
|                                         |  |                                                                                           
|                                         |  | Index to Exhibits                                                                          |    |         | 29 | 



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##### Table of Contents



PART I FINANCIAL INFORMATION



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

ISTA Pharmaceuticals, Inc.

Condensed Balance
Sheets

(In thousands, except per share data)

(unaudited)



|                                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                                                                                                             |  | September 30,2010 |          |   | December 31,2009 |  
|ASSETS                                                                                                                                                                                                                       |  |                   |          |   |                  |   |          |  
|Current assets:                                                                                                                                                                                                              |  |                   |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                                                                                                                    |  | $                 | 67,213   |   |                  | $ | 53,702   |  
|Accounts receivable, net of allowances of $1 in 2010 and $94 in 2009                                                                                                                                                         |  |                   | 26,551   |   |                  |   | 17,434   |  
|Inventory, net of allowances of $748 in 2010 and $896 in 2009                                                                                                                                                                |  |                   | 5,640    |   |                  |   | 5,548    |  
|Other current assets                                                                                                                                                                                                         |  |                   | 3,746    |   |                  |   | 3,175    |  
|                                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total current assets                                                                                                                                                                                                         |  |                   | 103,150  |   |                  |   | 79,859   |  
|Property and equipment, net                                                                                                                                                                                                  |  |                   | 6,666    |   |                  |   | 6,116    |  
|Deferred financing costs, net                                                                                                                                                                                                |  |                   | 2,153    |   |                  |   | 2,957    |  
|Deposits and other assets                                                                                                                                                                                                    |  |                   | 206      |   |                  |   | 212      |  
|                                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total assets                                                                                                                                                                                                                 |  | $                 | 112,175  |   |                  | $ | 89,144   |  
|                                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|LIABILITIES AND STOCKHOLDERS DEFICIT                                                                                                                                                                                        |  |                   |          |   |                  |   |          |  
|Current liabilities:                                                                                                                                                                                                         |  |                   |          |   |                  |   |          |  
|Accounts payable                                                                                                                                                                                                             |  | $                 | 7,500    |   |                  | $ | 5,852    |  
|Accrued compensation and related expenses                                                                                                                                                                                    |  |                   | 5,676    |   |                  |   | 7,731    |  
|Revolving Credit Facility                                                                                                                                                                                                    |  |                   | 13,000   |   |                  |   | 13,000   |  
|Current portion of obligations under capital leases                                                                                                                                                                          |  |                   | 119      |   |                  |   | 154      |  
|Allowance for rebates and chargebacks                                                                                                                                                                                        |  |                   | 7,917    |   |                  |   | 4,779    |  
|Allowance for product returns                                                                                                                                                                                                |  |                   | 7,212    |   |                  |   | 5,509    |  
|Royalties payable                                                                                                                                                                                                            |  |                   | 20,665   |   |                  |   | 7,348    |  
|Other current liabilities                                                                                                                                                                                                    |  |                   | 10,803   |   |                  |   | 6,373    |  
|Current portion of Facility Agreement                                                                                                                                                                                        |  |                   | 21,450   |   |                  |   |         |  
|                                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total current liabilities                                                                                                                                                                                                    |  |                   | 94,342   |   |                  |   | 50,746   |  
|Other long-term liabilities                                                                                                                                                                                                  |  |                   | 132      |   |                  |   | 196      |  
|Obligations under capital leases                                                                                                                                                                                             |  |                   | 41       |   |                  |   | 129      |  
|Facility Agreement, net of current portion and unamortized discounts and derivatives                                                                                                                                         |  |                   | 37,994   |   |                  |   | 57,438   |  
|Warrant liability                                                                                                                                                                                                            |  |                   | 51,504   |   |                  |   | 58,663   |  
|                                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total liabilities                                                                                                                                                                                                            |  |                   | 184,013  |   |                  |   | 167,172  |  
|                                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Commitments and contingencies                                                                                                                                                                                                |  |                   |          |   |                  |   |          |  
|Stockholders deficit:                                                                                                                                                                                                       |  |                   |          |   |                  |   |          |  
|Preferred stock, $0.001 par value; 5,000 shares authorized of which 1,000 shares have been designated as Series A Participating
Preferred Stock at September 30, 2010 and December 31, 2009; no shares issued or outstanding |  |                   |         |   |                  |   |         |  
|Common stock, $0.001 par value; 100,000 shares authorized at September 30, 2010 and December 31, 2009; 33,486 and
33,291 shares issued and outstanding at September 30, 2010 and December 31, 2009, respectively             |  |                   | 33       |   |                  |   | 33       |  
|Additional paid-in capital                                                                                                                                                                                                   |  |                   | 322,274  |   |                  |   | 319,211  |  
|Accumulated deficit                                                                                                                                                                                                          |  |                   | (394,145 | ) |                  |   | (397,272 | )
|                                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total stockholders deficit                                                                                                                                                                                                  |  |                   | (71,838  | ) |                  |   | (78,028  | )
|                                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total liabilities and stockholders deficit                                                                                                                                                                                  |  | $                 | 112,175  |   |                  | $ | 89,144   |  
|                                                                                                                                                                                                                             |  |                   |          |   |                  |   |          |  

See accompanying notes



3



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ISTA
Pharmaceuticals, Inc.

Condensed Statements of Operations

(In thousands, except per share data)

(unaudited)



|                                                                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|-------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                     |  | Three Months EndedSeptember 30, |         |   | Nine Months EndedSeptember 30, |  
|                                                                     |  | 2010                            |         |   | 2009                           |   |        | 2010 |  |   | 2009    |  
|Revenues:                                                            |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Product sales, net                                                   |  | $                               | 42,020  |   |                                | $ | 29,080 |      |  | $ | 105,393 |   |  | $ | 73,309  |  
|License revenue                                                      |  |                                 |        |   |                                |   | 2,917  |      |  |   |        |   |  |   | 3,055   |  
|                                                                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total revenues                                                       |  |                                 | 42,020  |   |                                |   | 31,997 |      |  |   | 105,393 |   |  |   | 76,364  |  
|Cost of products sold                                                |  |                                 | 9,678   |   |                                |   | 7,304  |      |  |   | 25,171  |   |  |   | 18,647  |  
|                                                                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Gross profit margin                                                  |  |                                 | 32,342  |   |                                |   | 24,693 |      |  |   | 80,222  |   |  |   | 57,717  |  
|Costs and expenses:                                                  |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Research and development                                             |  |                                 | 7,945   |   |                                |   | 6,257  |      |  |   | 17,779  |   |  |   | 19,643  |  
|Selling, general and administrative                                  |  |                                 | 19,614  |   |                                |   | 13,187 |      |  |   | 60,383  |   |  |   | 38,874  |  
|                                                                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total costs and expenses                                             |  |                                 | 27,559  |   |                                |   | 19,444 |      |  |   | 78,162  |   |  |   | 58,517  |  
|                                                                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Income (loss) from operations                                        |  |                                 | 4,783   |   |                                |   | 5,249  |      |  |   | 2,060   |   |  |   | (800    | )
|Other (expense) income:                                              |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Interest expense                                                     |  |                                 | (2,081  | ) |                                |   | (2,779 | )    |  |   | (6,225  | ) |  |   | (6,494  | )
|Gain on derivative valuation                                         |  |                                 | 117     |   |                                |   | 319    |      |  |   | 130     |   |  |   | 1,158   |  
|Gain (loss) on warrant valuation                                     |  |                                 | (26,338 | ) |                                |   | (3,396 | )    |  |   | 7,159   |   |  |   | (50,703 | )
|Other, net                                                           |  |                                 | 3       |   |                                |   | (310   | )    |  |   | 3       |   |  |   | (336    | )
|                                                                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total other (expense) income, net                                    |  |                                 | (28,299 | ) |                                |   | (6,166 | )    |  |   | 1,067   |   |  |   | (56,375 | )
|                                                                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net (loss) income                                                    |  | $                               | (23,516 | ) |                                | $ | (917   | )    |  | $ | 3,127   |   |  | $ | (57,175 | )
|                                                                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net (loss) income per common share, basic                            |  | $                               | (0.70   | ) |                                | $ | (0.03  | )    |  | $ | 0.09    |   |  | $ | (1.72   | )
|                                                                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Shares used in computing net (loss) income per common share, basic   |  |                                 | 33,483  |   |                                |   | 33,251 |      |  |   | 33,418  |   |  |   | 33,210  |  
|                                                                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net (loss) income per common share, diluted                          |  | $                               | (0.70   | ) |                                | $ | (0.03  | )    |  | $ | 0.07    |   |  | $ | (1.72   | )
|                                                                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Shares used in computing net (loss) income per common share, diluted |  |                                 | 33,483  |   |                                |   | 33,251 |      |  |   | 42,939  |   |  |   | 33,210  |  
|                                                                     |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |         |  

See accompanying notes



4



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ISTA
Pharmaceuticals, Inc.

Condensed Statements of Cash Flows

(In thousands)

(unaudited)



|                                                                                         |  |                                |         |   |      |   |         |  
|---------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                         |  | Nine Months EndedSeptember 30, |        
|                                                                                         |  | 2010                           |         |   | 2009 |  
|Operating Activities                                                                     |  |                                |         |   |      |   |         |  
|Net income (loss)                                                                        |  | $                              | 3,127   |   |      | $ | (57,175 | )
|Adjustments to reconcile net income (loss) to net cash provided by operating activities: |  |                                |         |   |      |   |         |  
|Stock-based compensation costs                                                           |  |                                | 2,899   |   |      |   | 2,783   |  
|Amortization of deferred financing costs                                                 |  |                                | 804     |   |      |   | 846     |  
|Amortization of discount on Facility Agreement                                           |  |                                | 2,136   |   |      |   | 2,328   |  
|Change in value of warrants related to Facility Agreement                                |  |                                | (7,159  | ) |      |   | 50,703  |  
|Change in value of derivatives related to Facility Agreement                             |  |                                | (130    | ) |      |   | (1,158  | )
|Depreciation and amortization                                                            |  |                                | 906     |   |      |   | 796     |  
|Changes in operating assets and liabilities:                                             |  |                                |         |   |      |   |         |  
|Accounts receivable, net                                                                 |  |                                | (9,117  | ) |      |   | 2,584   |  
|Inventory, net                                                                           |  |                                | (92     | ) |      |   | (2,233  | )
|Other current assets                                                                     |  |                                | (571    | ) |      |   | (1,273  | )
|Accounts payable                                                                         |  |                                | 1,648   |   |      |   | (349    | )
|Accrued compensation and related expenses                                                |  |                                | (2,055  | ) |      |   | 828     |  
|Allowance for rebates and chargebacks                                                    |  |                                | 3,138   |   |      |   | (257    | )
|Allowance for product returns                                                            |  |                                | 1,703   |   |      |   | 4,567   |  
|Royalties payable                                                                        |  |                                | 13,317  |   |      |   | 10,556  |  
|Other liabilities                                                                        |  |                                | 4,366   |   |      |   | (8,679  | )
|                                                                                         |  |                                |         |   |      |   |         |  
|Net cash provided by operating activities                                                |  |                                | 14,920  |   |      |   | 4,867   |  
|                                                                                         |  |                                |         |   |      |   |         |  
|Investing Activities                                                                     |  |                                |         |   |      |   |         |  
|Maturities of marketable securities                                                      |  |                                |        |   |      |   | 4,700   |  
|Purchases of property and equipment                                                      |  |                                | (1,456  | ) |      |   | (893    | )
|Deposits and other assets                                                                |  |                                | 6       |   |      |   | (5      | )
|                                                                                         |  |                                |         |   |      |   |         |  
|Net cash (used in) provided by investing activities                                      |  |                                | (1,450  | ) |      |   | 3,802   |  
|                                                                                         |  |                                |         |   |      |   |         |  
|Financing Activities                                                                     |  |                                |         |   |      |   |         |  
|Proceeds from exercise of stock options                                                  |  |                                | 11      |   |      |   | 159     |  
|Payments under capital leases                                                            |  |                                | (123    | ) |      |   | (101    | )
|Proceeds from Revolving Credit Facility                                                  |  |                                | 39,000  |   |      |   | 39,000  |  
|Repayment on Revolving Credit Facility                                                   |  |                                | (39,000 | ) |      |   | (41,000 | )
|Proceeds from issuance of common stock                                                   |  |                                | 153     |   |      |   | 12      |  
|Financing costs on issuance of Facility Agreement                                        |  |                                |        |   |      |   | (43     | )
|                                                                                         |  |                                |         |   |      |   |         |  
|Net cash provided by (used in) financing activities                                      |  |                                | 41      |   |      |   | (1,973  | )
|                                                                                         |  |                                |         |   |      |   |         |  
|Effect of exchange rate changes on cash                                                  |  |                                |        |   |      |   | 25      |  
|Increase in Cash and Cash Equivalents                                                    |  |                                | 13,511  |   |      |   | 6,721   |  
|Cash and cash equivalents at beginning of period                                         |  |                                | 53,702  |   |      |   | 48,316  |  
|                                                                                         |  |                                |         |   |      |   |         |  
|Cash and Cash Equivalents At End of Period                                               |  | $                              | 67,213  |   |      | $ | 55,037  |  
|                                                                                         |  |                                |         |   |      |   |         |  
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                        |  |                                |         |   |      |   |         |  
|Cash paid during the period for interest                                                 |  | $                              | 3,293   |   |      | $ | 3,214   |  
|                                                                                         |  |                                |         |   |      |   |         |  
|Equipment additions under capital leases                                                 |  | $                              |        |   |      | $ | 68      |  
|                                                                                         |  |                                |         |   |      |   |         |  

See accompanying notes



5



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ISTA
Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(unaudited)

1. The
Company

We incorporated in California in February 1992 as Advanced Corneal Systems, Inc. In March
2000, we changed our name to ISTA Pharmaceuticals, Inc. and we reincorporated in Delaware in August 2000. XIBROM (bromfenac ophthalmic solution)®, XIBROM, ISTALOL®, VITRASE®, BEPREVE®, T-PRED,
BROMDAY, REMURA, ISTA®, ISTA Pharmaceuticals,
Inc.® and the ISTA logo are our trademarks, either owned or under license.

We are a rapidly growing commercial-stage, multi-specialty pharmaceutical company developing, marketing and selling our own products in
the U.S. and Puerto Rico. We are the fourth largest branded prescription eye care business in the U.S. and have an emerging allergy drug franchise. We manufacture our finished good products through third-party contracts and we in-license or acquire
new technology to add to our internal development efforts from time to time. Our products and product candidates seek to treat allergy and serious diseases of the eye and include therapies for ocular inflammation and pain, glaucoma, dry eye and
ocular and nasal allergies. The U.S. prescription markets our therapies seek to address include key segments of the $5.5 billion ophthalmic pharmaceutical market and the $2.2 billion nasal allergy market.

We currently have five products available for sale in the U.S. and Puerto Rico: XIBROM (bromfenac sodium ophthalmic solution) for the
treatment of inflammation and pain following cataract surgery, BROMDAY (bromfenac ophthalmic solution) for the treatment of postoperative inflammation and reduction of ocular pain in patients who have undergone cataract extractions, BEPREVE
(bepotastine besilate ophthalmic solution) for the treatment of ocular itching associated with allergic conjunctivitis, ISTALOL (timolol maleate ophthalmic solution) for the treatment of glaucoma and VITRASE (hyaluronidase for injection) for use as
a spreading agent. On October 16, 2010, the U.S. Food and Drug Administration, or FDA, approved BROMDAY, formerly referred to as XiDay. In addition, we have several eye and allergy product candidates in various stages of development, including
treatments for dry eye, ocular inflammation and pain and nasal allergies.

2. Summary of Significant Accounting Policies

Basis of Presentation

Our unaudited condensed financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. The accompanying unaudited condensed financial
statements do not include certain footnotes and financial presentations normally required under generally accepted accounting principles, or GAAP, and, therefore should be read in conjunction with the consolidated financial statements and the notes
thereto included in our Annual Report on Form 10-K for the year ended December 31, 2009.

In the opinion of management,
all adjustments (consisting of normal recurring adjustments) necessary for the fair presentation of the unaudited condensed balance sheets and statements of operations and cash flows for the three and nine months ended September 30, 2010 and
2009 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 Revenues. We recognize revenues
from product sales when there is persuasive evidence that an arrangement exists, when title has passed, the price is fixed or determinable, and we are reasonably assured of collecting the resulting receivable. We recognize product revenues net of
estimated allowances for rebates, chargebacks, product returns and other discounts, such as wholesaler fees. If actual future payments for allowances for discounts, product returns, wholesaler fees, rebates and chargebacks exceed the estimates we
made at the time of sale, our financial position, results of operations and cash flows may be negatively impacted.

We
establish 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;
| | - |  | -------------------------------------------------------------



6



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



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



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



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



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

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

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

In general, we are obligated to accept from our customers the return of products that have reached their expiration date. We authorize returns for damaged products and, on a limited basis, exchanges for
expiring and expired products in accordance with our return goods policy and procedures, and have established reserves for such amounts at the time of sale. We typically refund the agreed proportion of the sales price by the issuance of a credit,
rather than cash refund or exchanges for inventory, and the returned product is destroyed. With the launch of each of our products, we recorded a sales return allowance, which is larger for stocking orders than subsequent re-orders. To date, actual
product returns have not exceeded our estimated allowances for returns. Although we believe that our estimates and assumptions are reasonable as of the date when made, actual results may differ significantly from these estimates. Our financial
position, results of operations and cash flows may be materially and negatively impacted if actual returns exceed our estimated allowances for returns.

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

Allowances for product returns were $7.2 million and $5.5 million as of September 30, 2010 and December 31, 2009, respectively. These allowances reflect an estimate of our liability for products
that may be returned by the original purchaser in accordance with our stated return policy, which allows customers to return products within six months of their respective expiration dates and for a period up to twelve months after such products
have reached their respective expiration dates. We estimate our liability for product returns at each reporting period based on the estimated units in the channel and the other factors discussed above.

As a percentage of gross product revenues, the reserve for product returns was 2.7% and 3.3% for the three months ended
September 30, 2010 and 2009, respectively, and 2.5% and 3.7% for the nine months ended September 30, 2010 and 2009, respectively. The decreases were primarily due to the improvement in historical trending of actual return data, the
lengthening of product shelf life, and continued acceptance and sale of our products.

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



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Allowances for
estimated rebates, chargebacks and other discounts, such as wholesaler fees, were $11.9 million and $6.4 million as of September 30, 2010 and December 31, 2009, respectively. These allowances reflect an estimate of our liability for items
such as rebates due to various governmental organizations under the Medicare/Medicaid regulations, rebates due to managed care organizations under specific contracts, chargebacks due to various organizations purchasing certain of our products
through federal contracts and/or group purchasing agreements and fees charged by certain wholesalers under distribution agreements. We estimate our liability for rebates, chargebacks and other discounts, such as wholesaler fees, at each reporting
period based on a combination of quantitative and qualitative assumptions listed above.

As a percentage of gross product
revenues, the reserve for rebates, chargebacks and other discounts such as wholesaler fees was 17.4% and 18.4% for the three months ended September 30, 2010 and 2009, respectively; and 17.5% and 14.9% for the nine months ended
September 30, 2010 and 2009, respectively. The decrease in the three-month period is primarily due to changes in utilization of certain managed care and federal contracts. The increase in the nine-month period is due primarily to growth in the
number and utilization of managed care and federal contracts, wholesaler distribution agreements, and the impact of higher Medicaid rebates required under the recently enacted healthcare legislation ($0.3 million and $0.7 million for the three and
nine months ended September 30, 2010, respectively).

License Revenue. Amounts received for product and technology
license fees under multiple-element arrangements are deferred and recognized over the period of such services or performance if such arrangements require on-going services or performance. Amounts received for milestones are recognized upon
achievement of the milestone, unless we have ongoing performance obligations. Any amounts received prior to satisfying our revenue recognition criteria will be recorded as deferred income in the condensed balance sheets. During the nine months ended
September 30, 2009, we recognized the remaining deferred income as a result of the termination of our supply agreement with Otsuka Pharmaceutical Co., Ltd. We did not have license revenue in the nine months ended September 30, 2010.

Concentration of Credit Risk

Financial instruments that potentially subject us to a significant concentration of credit risk principally consist of cash and cash equivalents, and trade receivables. Wholesale distributors account for
a substantial portion of trade receivables. For the nine months ended September 30, 2010, net revenues from Cardinal Health, Inc., McKesson HBOC and AmeriSource Bergen Corp. and accounted for 41%, 33% and 16%, respectively, of our net revenues.
We maintain reserves for bad debt and such losses, in the aggregate, have not exceeded our estimates.

Inventory

Inventory at September 30, 2010 consisted of $2.2 million of raw materials, $0.4 million of work-in-process and
$3.7 million of finished goods, which excludes $0.7 million in inventory reserves. The work-in-process inventory consisted of hyaluronidase to be used in manufacturing VITRASE. Inventory at December 31, 2009 consisted of $2.6 million in
raw materials and $3.8 million of finished goods, which excludes $0.9 million in inventory reserves. Inventory, net of allowances, is stated at the lower of cost or market. Cost is determined by the first-in, first-to-expire method.

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

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



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Supply
Concentration Risks

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

Biozyme Laboratories, Ltd., or Biozyme, had been our sole source for highly purified ovine hyaluronidase, which is the active ingredient
in VITRASE. Our supply agreement with Biozyme ended in August 2007. In June 2010, we received approval from the FDA to manufacture hyaluronidase at our Irvine, California manufacturing facility and began production of highly purified ovine
hyaluronidase in July 2010. We have a supply agreement with Alliance Medical Products to manufacture commercial quantities of VITRASE. Currently, Alliance Medical Products is our sole source for VITRASE.

Fair Value of Financial Instruments

Our financial instruments include cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, current and long-term debt, certain derivatives related to our debt obligations and
common stock warrants issued to lenders. The carrying amount of cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities are considered to be representative of their respective fair values because of the short-term
nature of those instruments. The carrying amount of our revolving credit facility with Silicon Valley Bank, or the Revolving Credit Facility, approximates fair value since the interest rate approximates the market rate for debt securities with
similar terms and risk characteristics. Although our facility agreement, or the Facility Agreement, is considered a financial instrument, we are unable to reasonably determine fair value.

Fair Value Measurements

We account for fair value measurements under the Financial Accounting Standards Board, or FASB, Accounting Standard Codification 820 Fair Value Measurements and Disclosures, or ASC 820, which
defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market
participants at the measurement date. ASC 820 establishes a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the use of
unobservable inputs. The three levels of inputs used to measure fair value are as follows:



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



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



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

We have segregated all assets and liabilities measured at fair value on a recurring basis (at least annually) into the most appropriate
level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date in the table below. As of September 30, 2010, all of our assets and liabilities are valued using Level 1 inputs except for the
derivatives and warrants related to our Facility Agreement. We have valued both the derivatives and the warrants using a Black-Scholes model based on assumptions and data available as of September 30, 2010, including but not limited to our
stock price, risk-free interest rates and stock price volatility.



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



|                          |  |                                                      |        |  |                                     |   |        |         |  |   |      |   |  |   |        |  
|------------------------- |  | ---------------------------------------------------- | ------ |  | ----------------------------------- | - | ------ | ------- |  | - | ---- | - |  | - | ------ | -
|                          |  | Fair Value Measurements at September 30, 2010 Using: |        |  | Total CarryingValue atSeptember 30, |  
|                          |  | Level 1                                              |        |  | Level 2                             |   |        | Level 3 |  |   | 2010 |  
|Cash and cash equivalents |  | $                                                    | 67,213 |  |                                     | $ |       |         |  | $ |     |   |  | $ | 67,213 |  
|Derivatives               |  |                                                      |       |  |                                     |   |       |         |  |   | (169 | ) |  |   | (169   | )
|Warrants                  |  |                                                      |       |  |                                     |   | 51,504 |         |  |   |     |   |  |   | 51,504 |  



|                                                |  |                                                                               |         |   |                                                                                  |   |      |  
|----------------------------------------------- |  | ----------------------------------------------------------------------------- | ------- | - | -------------------------------------------------------------------------------- | - | ---- | -
|                                                |  | Fair Value MeasurementsUsing SignificantUnobservable Inputs(Level 2)
Warrants |         |   | Fair Value MeasurementsUsing SignificantUnobservable Inputs(Level 3)
Derivatives |  
|Beginning balance at December 31, 2009          |  | $                                                                             | (58,663 | ) |                                                                                  | $ | (299 | )
|Total gains or losses (realized or unrealized): |  |                                                                               |         |   |                                                                                  |   |      |  
|Included in earnings                            |  |                                                                               | 7,159   |   |                                                                                  |   | 130  |  
|                                                |  |                                                                               |         |   |                                                                                  |   |      |  
|Ending balance at September 30, 2010            |  | $                                                                             | (51,504 | ) |                                                                                  | $ | (169 | )
|                                                |  |                                                                               |         |   |                                                                                  |   |      |  

Comprehensive Income (Loss)

Accounting Standards Codification 220 Comprehensive Income, or ASC 220, requires reporting and displaying comprehensive income
(loss) and its components, which includes net income (loss) and unrealized gains and losses on investments and foreign currency translation gains and losses. For the nine months ended September 30, 2010 and 2009, we had neither unrealized gains
and losses on investments nor foreign currency translation gains and losses. Total comprehensive income (loss) for the nine months ended September 30, 2010 and 2009 was $3.1 million and ($57.2) million, respectively.

Stock-Based Compensation

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

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

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

At September 30, 2010, there was $4.6 million of total unrecognized compensation cost related to non-vested stock options, which is
expected to be recognized over a remaining weighted average vesting period of approximately 2.5 years.

Restricted Stock
Awards

The amount of unearned compensation recorded is based on the market value of the shares on the date of
issuance. Expenses related to the vesting of restricted stock were $0.1 million and $0.2 million for the three months ended September 30, 2010 and 2009, respectively, and $0.3 million and $0.4 million for the nine months ended
September 30, 2010 and 2009, respectively. As of September 30, 2010, there was approximately $0.9 million of unamortized compensation cost related to restricted stock awards, which is expected to be recognized ratably over the vesting
period of four years.



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Net Income
(Loss) Per Share

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

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



|                                                                            |  |                                      |        | 
|--------------------------------------------------------------------------- |  | ------------------------------------ | ------ | 
|                                                                            |  | Nine Months 
EndedSeptember 30, 2010 |       
|Numerator for basic and diluted income per share                            |  | $                                    | 3,127  | 
|                                                                            |  |                                      |        | 
|Denominator for basic income per share  weighted-average shares            |  |                                      | 33,418 | 
|Effect of dilutive securities                                               |  |                                      | 9,521  | 
|                                                                            |  |                                      |        | 
|Denominator for diluted income per share  adjusted weighted-average shares |  |                                      | 42,939 | 
|                                                                            |  |                                      |        | 

Diluted net income per share of common stock includes the dilutive effect of stock options, unvested
restricted stock and warrants. For the nine months ended September 30, 2010, approximately 12.9 million stock options, unvested restricted stock and warrants were excluded from the calculation of diluted income per share because their
exercise prices rendered them anti-dilutive.

Common shares issued for nominal consideration, if any, would be included in the
per share calculations as if they were outstanding for all periods presented. We have further determined that the warrants to purchase an aggregate of 15 million shares of our common stock issued in conjunction with our Facility Agreement
represent participating securities, requiring the use of the two-class method for the calculation of basic and diluted earnings per share. The two-class method for the nine months ended September 30, 2010 reflects the amount of unallocated
undistributed earnings calculated using the participation percentage. Because net losses are not allocated to the warrant holders, the two-class method does not affect our calculation of earnings per share for the three months ended
September 30, 2010 and the three and nine months ended September 30, 2009, respectively.



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



|                                        |  |                                      |       | 
|--------------------------------------- |  | ------------------------------------ | ----- | 
|                                        |  | Nine Months 
EndedSeptember 30, 2010 |      
|Net income attributable to shareholders |  | $                                    | 3,127 | 
|                                        |  |                                      |       | 
|Common stock unallocated earnings       |  | $                                    | 2,158 | 
|Warrant unallocated earnings            |  |                                      | 969   | 
|                                        |  |                                      |       | 
|Total unallocated earnings              |  | $                                    | 3,127 | 
|                                        |  |                                      |       | 

Executive Employment Agreements

We have agreements with each of our officers, each of which generally 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.

Revolving Credit Facility

Under our Revolving Credit Facility with Silicon Valley Bank, we may borrow up to the lesser of $25.0 million or 80% of eligible accounts receivable, plus the lesser of 25% of net cash or $10.0 million.
As of September 30, 2010, we had $19.2 million available under the Revolving Credit Facility, of which we borrowed $13 million. All amounts borrowed under the Revolving Credit Facility were repaid in October 2010. We also had letters of credit
of $0.5 million outstanding. All outstanding amounts under the Revolving Credit Facility bear interest at a variable rate equal to the lenders prime rate plus a margin of 0.25%. In no event shall the interest rate on outstanding borrowings be
less than 4.25%, which is payable on a monthly basis. The Revolving Credit Facility also contains customary covenants regarding the operation of our business and financial covenants relating to ratios of current assets to current liabilities, and is
collateralized by all of our assets. An event of default under the Revolving Credit Facility will occur if, among other things, (i) we are delinquent in making payments of principal or interest on the Revolving Credit Facility; (ii) we
fail to cure a breach of a covenant or term of the Revolving Credit Facility; (iii) we make a representation or warranty under the Revolving Credit Facility that is materially inaccurate; (iv) we are unable to pay our debts as they become
due, certain bankruptcy proceedings are commenced or certain orders are granted against us, or we otherwise become insolvent; or (v) an acceleration event occurs under certain types of other indebtedness outstanding from time to time. If an
event of default occurs, the indebtedness to Silicon Valley Bank could be accelerated, such that it becomes immediately due and payable. As of September 30, 2010, we were in compliance with all of the covenants under the Revolving Credit
Facility. Unless repaid earlier, all amounts owing under the Revolving Credit Facility will become due and payable on December 30, 2010.

Facility Agreement

We have a Facility Agreement with certain
institutional accredited investors, collectively known as the Lenders. On September 30, 2010, we had total indebtedness under the Facility Agreement of $65 million, which excludes unamortized discounts of ($5.7) million and the value of the
derivatives of $0.2 million. Outstanding amounts under the Facility Agreement accrue interest at a rate of 6.5% per annum, payable quarterly in arrears. We are required to repay the Lenders 33% of the original principal amount (or $21.5
million) on each of September 26, 2011 and 2012, and 34% of the original principal amount (or $22.0 million) on September 26, 2013. Since the September 2011 payment is due within 12 months, $21.5 million of this Facility Agreement has been
classified as a current liability as of September 30, 2010.

Any amounts drawn under the Facility Agreement may become
immediately due and payable upon (i) an event of default, as defined in the Facility Agreement, in which case the Lenders would have the right to require us to repay 100% of the principal amount of the loan, plus any accrued and
unpaid interest thereon, or (ii) the consummation of certain change of control transactions, in which case the Lenders would have the right to require us to repay 110% of the outstanding principal amount of the loan, plus any accrued and unpaid
interest thereon. An event of default under the Facility Agreement will occur if, among other things, (i) we fail to make payment when due; (ii) we fail to comply in any material respect with any covenant of the Facility Agreement, and
such failure is not cured; (iii) any representation or warranty made by us in any



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transaction document was incorrect, false, or misleading in any material respect as of the date it was made; (iv) we are generally unable to pay our debts as they become due or a bankruptcy
or similar proceeding is commenced by or against us; and (v) cash and cash equivalents on the last day of each calendar quarter are less than $10 million. As of September 30, 2010, we are in compliance with all the covenants under this
Facility Agreement.

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

Because the consummation of certain change in control transactions results in a premium of the outstanding principal, the premium put feature is a derivative that is required to be bifurcated from the
host debt instrument and recorded at fair value at each quarter end. The value of the derivative at September 30, 2010 was $0.2 million and is marked-to-market and adjusted quarterly through interest expense.

In connection with the Facility Agreement, we issued to the Lenders warrants to purchase an aggregate of 15 million shares of our
common stock at an exercise price of $1.41 per share. If we issue or sell shares of our common stock (other than certain excluded shares, as such term is defined in the Facility Agreement), we will issue concurrently therewith additional
warrants to purchase such number of shares of common stock as will entitle the Lenders to maintain the same beneficial ownership in the Company after the issuance as they had prior to such issuance, as adjusted on a pro rata basis for repayments of
the outstanding principal amount under the loan, with such warrants being issued at an exercise price equal to the greater of $1.41 per share and the closing price of the common stock on the date immediately prior to the issuance.

Because of the anti-dilutive provisions in the warrant agreement, where additional warrants might be issued should we issue additional
equity, with such additional warrants being issued at a price equal to the fair value of the common stock being issued, but not less than $1.41, we have recorded the warrants as a liability. The warrants will be marked-to-market and adjusted
quarterly. We recorded a non-cash valuation loss of ($26.3) million, or ($0.79) per diluted share, and a non-cash valuation loss ($3.4 million), or ($0.10) per diluted share, for the three months ended September 30, 2010 and 2009, respectively;
we recorded a non-cash valuation gain of $7.2 million, or $0.17 per diluted share and a non-cash valuation loss of ($50.7) million, or ($1.53) per diluted share, for the nine months ended September 30, 2010 and 2009, respectively. The change in
the valuation of the warrants was primarily driven by changes in both our stock price and related volatility.

Commitments and Contingencies

Legal

In June 2010, we initiated a legal action by filing a Complaint
against AcSentient, Inc. and AcSentient II, LLC, which we collectively refer to as AcSentient, seeking a declaratory judgment with regard to ISTAs XIBROM royalty obligations under the Asset Purchase Agreement dated May 3, 2002 between
ISTA and AcSentient, Inc. The only U.S. patent applicable to XIBROM expired in January 2009 and, according to U.S. case law and the terms of our agreement with AcSentient, we believe no XIBROM royalties are due after patent expiration. A declaratory
judgment that we are seeking from the court in regard to royalty obligations to AcSentient may apply not only to XIBROM, but also to BROMDAY, approved by the FDA in October 2010. We initiated a similar legal action in April 2010, against Senju, also
seeking a declaratory judgment with regard to the relevant XIBROM royalty obligations to Senju and a recovery of overpaid royalties and other damages from Senju. In August 2010, a Federal judge in Los Angeles stayed our action against Senju, and in
September 2010, Senju initiated an arbitration proceeding regarding the same dispute with the International Chamber of Commerce. There can be no assurance about when these two disputes will be resolved, and we cannot predict the final financial
outcome of either. Until these two disputes are resolved, for accounting purposes, the company has been and intends to continue to reserve for XIBROM and BROMDAY royalties. As of September 30, 2010, we had $16.7 million reserved for unpaid
XIBROM royalties.

Subpoenas From the U.S. Attorney, Western District of New York.In April 2008, we received subpoenas
from the office of the U.S. Attorney for the Western District of New York requesting information regarding the marketing activities related to XIBROM. From April 2008 through September 30, 2010, we incurred approximately $3.7 million in legal
fees associated with this matter and expect to incur significant expenses in the future. In addition, if the government chooses to engage in civil litigation or initiate a criminal prosecution against us as a result of its review of the requested
documents and other evidence, we may have to incur significant amounts to defend such action or pay or incur substantial fines or penalties, either of which could significantly deplete our cash resources. The case is in its preliminary stages and
thus the likelihood of an unfavorable outcome and/or the amount/range of loss, if any, cannot be reasonably estimated.

TRICARE Retail Pharmacy Program. Section 703 of the National Defense Authorization Act of 2008, enacted on January 28, 2009,
requires that pharmaceutical products purchased through the Department of Defense, or DoD, TRICARE Retail Pharmacy program be subject to the Federal Ceiling Price discount under the Veterans Health Care Act of 1992. DoD issued a rule pursuant to
Section 703 that requires manufacturers to provide DoD with a quarterly refund on pharmaceutical products utilized through the TRICARE Retail Pharmacy program, and to pay rebates to DoD on TRICARE Retain Pharmacy purchases retroactive to January 28,
2008. We have requested a waiver of the retroactive rebate for TRICARE Retail Pharmacy utilization for the period from January 28, 2008 to May 26, 2009 (the effective date of the DoD rule). In addition, the regulation is currently the subject of
litigation, and it is our position that the retroactive application of the regulation is contrary to established case law. We have determined that payment of the retroactive rebate (from January 28, 2008 to May 26, 2009) created by the regulation is
neither reasonably estimable nor probable as of September 30, 2010.



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

Segment Reporting

The Company currently operates in only one
segment.

Income Taxes

We account for income taxes under the Income Tax Topic of the FASB Accounting Standards Codification. As of September 30, 2010 and December 31, 2009, there are no unrecognized tax benefits
included in the balance sheet that would, if recognized, affect the effective tax rate.

Our practice is to recognize interest
and/or penalties related to income tax matters in income tax expense. We had no accrual for interest or penalties on our condensed balance sheets at September 30, 2010 and December 31, 2009, respectively, and have not recognized interest
and/or penalties in the condensed statement of operations for the three and nine months ended September 30, 2010.

We are
subject to taxation in the U.S. and various state jurisdictions. Our tax years for 1994 and forward are subject to examination by the U.S. and state tax authorities.

At December 31, 2009, we had net deferred tax assets of $46.3 million. Due to uncertainties surrounding our ability to generate future taxable income to realize these assets, a full valuation has
been established to offset the net deferred tax asset. Additionally, the future utilization of our net operating loss and research and development credit carry forwards to offset future taxable income may be subject to an annual limitation, pursuant
to Internal Revenue Code Sections 382 and 383, as a result of ownership changes that may have occurred previously or that could occur in the future. We have not completed a Section 382 and 383 analysis to determine the limitation of the net
operating loss and research and development credit carry forwards.

At December 31, 2009, we had Federal and state income
tax net operating loss carry forwards of approximately $194.7 million and $113.1 million, respectively. Federal tax loss carry forwards continue to expire in 2010 unless previously utilized. California tax loss carry forwards begin to expire in
2012, unless previously utilized. In addition, we have Federal and California research and development tax credit carry forwards of $9.4 million and $6.2 million, respectively. The Federal research and development credit carry forwards will
begin to expire in 2010 unless previously utilized. The California research and development credit carry forwards can be used indefinitely.

Recent Accounting Pronouncements

In
February 2010, the FASB issued amended guidance on subsequent events. Under this amended guidance, U.S. Securities and Exchange Commission, or SEC, filers are no longer required to disclose the date through which subsequent events have been
evaluated in originally issued and revised financial statements. This guidance was effective immediately and we adopted these new requirements upon issuance of this guidance.

In January 2010, the FASB issued updated standards related to additional requirements and guidance regarding disclosures of fair value measurements. The guidance requires the gross presentation of
activity within the Level 3 fair value measurement roll forward and details of transfers in and out of Level 1 and 2 fair value measurements. In addition, companies will be required to disclose quantitative information about the inputs used in
determining fair values. We adopted these standards in the first quarter of 2010 (see Fair Value Measurements above). The adoption did not have a material impact on our condensed financial statements.

Subsequent Event

On October 16, 2010, we announced the FDA approved our supplemental New Drug Application (sNDA) for BROMDAY (bromfenac ophthalmic solution) 0.09% as a once-daily prescription eye drop for the
treatment of postoperative inflammation and reduction of ocular pain in patients who have undergone cataract extraction.



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

This Quarterly Report on Form 10-Q contains forward-looking statements that have been made pursuant to the provisions of the Private
Securities Litigation Reform Act of 1995 and concern matters that involve risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Discussions containing forward-looking
statements may be found in the material set forth under Managements Discussion and Analysis of Financial Condition and Results of Operations, and in other sections of this Quarterly Report on Form 10-Q. Words such as
may, will, should, could, expect, plan, anticipate, believe, estimate, predict, potential, continue or
similar words are intended to identify forward-looking statements, although not all forward-looking statements contain these words. Although we believe that our opinions and expectations reflected in the forward-looking statements are reasonable as
of the date of this Quarterly Report on Form 10-Q, we cannot guarantee future results, levels of activity, performance or achievements, and our actual results may differ substantially from the views and expectations set forth in this Quarterly
Report on Form 10-Q. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations. Readers are urged to
carefully review and consider the various disclosures made by us, which attempt to advise interested parties of the risks, uncertainties, and other factors that affect our business, including without limitation the disclosures made under the caption
Managements Discussion and Analysis of Financial Condition and Results of Operations in this Quarterly Report on Form 10-Q and the audited financial statements and the notes thereto and disclosures made under the captions
Management Discussion and Analysis of Financial Condition and Results of Operations, Risk Factors,  Consolidated Financial Statements and Notes to Consolidated Financial Statements included in our
Annual Report on Form 10-K for the year ended December 31, 2009. We obtained the market data and industry information contained in this Quarterly Report on Form 10-Q from internal surveys, estimates, reports and studies, as appropriate, as well
as from market research, publicly available information and industry publications. Although we believe our internal surveys, estimates, reports, studies and market research, as well as industry publications, are reliable, we have not independently
verified such information, and, as such, we do not make any representation as to its accuracy.

The following
discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended
December 31, 2009 and the unaudited condensed financial statements and related notes included in this Quarterly Report on Form 10-Q. References in this Quarterly Report on Form 10-Q to ISTA, we, our,
us or the Company refer to ISTA Pharmaceuticals, Inc.

Overview

We are a rapidly growing commercial-stage, multi-specialty pharmaceutical company developing, marketing and selling our own products in
the United States and Puerto Rico. We are the fourth largest branded prescription eye care business and have an emerging allergy drug franchise. We manufacture our finished good products through third party contracts and we in-license or acquire new
technology to add to our internal development efforts from time to time. Our products and product candidates seek to treat allergy and serious diseases of the eye and include therapies for ocular inflammation and pain, glaucoma, dry eye and ocular
and nasal allergies. The U.S. prescription markets our therapies seek to address include key segments of the $5.5 billion ophthalmic pharmaceutical market and the $2.2 billion nasal allergy market.

We currently have five products available for sale in the United States and Puerto Rico: XIBROM (bromfenac sodium ophthalmic solution)
for the treatment of inflammation and pain following cataract surgery, BROMDAY (bromfenac ophthalmic solution) for the treatment of postoperative inflammation and reduction of ocular pain in patients who have undergone cataract extractions, BEPREVE
(bepotastine besilate ophthalmic solution) for the treatment of ocular itching associated with allergic conjunctivitis, ISTALOL (timolol maleate ophthalmic solution) for the treatment of glaucoma and VITRASE (hyaluronidase for injection) for use as
a spreading agent. On October 16, 2010, the FDA approved BROMDAY, formerly referred to as XiDay. In addition, we have several eye and allergy product candidates in various stages of development, including treatments for dry eye, ocular
inflammation and pain and nasal allergies.

We have incurred losses, excluding the nine months ended September 30, 2010,
since inception and had an accumulated deficit of $394.1 million (including a cumulative non-cash warrant valuation loss of $44.9 million) through September 30, 2010.



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During the quarter
ended September 30, 2010 and through the date of this filing, the following events occurred:



| |  |  | During July 2010, we announced the initiation of a Phase 1/2 clinical study of bepotastine nasal spray conducted in Canada for the treatment of
symptoms associated with seasonal allergic rhinitis, the inflammation of the nasal passages caused by allergies. In October 2010, we announced positive, preliminary results form this study and our intention to complete the analysis of the data, file
an Investigational New Drug (IND) application and initiate Phase 2 clinical studies before the end of 2010;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | During September 2010, we announced the initiation of a Phase 3 clinical program of ISTAs proprietary formulation of REMURA (bromfenac
ophthalmic solution for dry eye) for alleviating the signs and symptoms of dry eye disease. The Phase 3 efficacy and safety studies are being conducted under a Special Protocol Assessment (SPA) agreed upon with the FDA. Assuming timely completion of
the study, we plan to announce preliminary results in the middle of 2011; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | On October 16, 2010, we announced the FDA approved our supplemental New Drug Application (sNDA) for BROMDAY (bromfenac ophthalmic solution) 0.09%
as a once-daily prescription eye drop for the treatment of postoperative inflammation and reduction of ocular pain in patients who have undergone cataract extraction. We expect to launch BROMDAY prior to the end of 2010.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Results of Operations

Three Months Ended September 30, 2010 and 2009

Revenues.Net revenues were approximately $42.0 million for the three months ended September 30, 2010, as compared to $32.0 million for the three months ended September 30,
2009. Net revenue growth was primarily driven by strong demand for XIBROM and BEPREVE, supported by revenue increases in VITRASE. In the three months ended September 30, 2009, we terminated our Supply Agreement with Otsuka, ending our
obligation to supply Otsuka with hyaluronidase for injection. As a result, we recognized the remaining $2.9 million of previously deferred license revenue resulting from the up-front payment we received from Otsuka in 2001.

The following table sets forth our net revenues for each of our products for the three months ended September 30, 2010 and 2009,
respectively (dollars in millions), and the corresponding percentage change.



|                   |  |                                  |      |  |      |   |      |          |  |  |     |  
|------------------ |  | -------------------------------- | ---- |  | ---- | - | ---- | -------- |  |  | --- | -
|                   |  | Three Months Ended September 30, |     
|                   |  | 2010                             |      |  | 2009 |   |      | % change | 
|XIBROM             |  | $                                | 29.6 |  |      | $ | 21.4 |          |  |  | 38  | %
|BEPREVE            |  |                                  | 3.9  |  |      |   | 1.2  |          |  |  | 225 | %
|ISTALOL            |  |                                  | 5.3  |  |      |   | 5.1  |          |  |  | 4   | %
|VITRASE            |  |                                  | 3.2  |  |      |   | 1.4  |          |  |  | 129 | %
|                   |  |                                  |      |  |      |   |      |          |  |  |     |  
|Product sales, net |  |                                  | 42.0 |  |      |   | 29.1 |          |  |  | 44  | %
|License revenue    |  |                                  |     |  |      |   | 2.9  |          |  |  |    |  
|                   |  |                                  |      |  |      |   |      |          |  |  |     |  
|Total revenues     |  | $                                | 42.0 |  |      | $ | 32.0 |          |  |  | 31  | %
|                   |  |                                  |      |  |      |   |      |          |  |  |     |  

Gross margin and cost of products sold. Gross margin for the three months ended
September 30, 2010 was 77% of net revenues, or $32.3 million, as compared to 77% of net revenues, or $24.7 million, for the three months ended September 30, 2009. Product gross margin was 77% and 75% for the three months ended
September 30, 2010 and 2009, respectively, excluding the $2.9 million in previously deferred revenue. The increase in product gross margin percentage for the three months ended September 30, 2010, as compared to the three months ended
September 30, 2009 is primarily the result of increased sales of our higher gross margin products, XIBROM and BEPREVE.

Cost of products sold was $9.7 million for the three months ended September 30, 2010, as compared to $7.3 million for the three
months ended September 30, 2009. Cost of products sold for the three months ended September 30, 2010 and 2009 consisted primarily of standard costs for each of our commercial products, distribution costs, royalties, inventory reserves and
other costs of products sold. The increase in cost of products sold is primarily the result of increased net revenues.



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Research and
development expenses. Research and development expenses were $7.9 million for the three months ended September 30, 2010, as compared to $6.3 million for the three months ended September 30, 2009. The increase in research and
development expenses is due primarily to timing associated with the initiation and completion of clinical trials. 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 to third parties
prior to regulatory approval of a product candidate under our licensing agreements unless there is an alternative future use. In the three months ended September 30, 2009, research and development expenses included a $2.0 million milestone
payment upon the FDA approval of our BEPREVE New Drug Application, or NDA. We did not make milestone payments in the three months ended September 30, 2010. For the three months ended September 30, 2010, approximately 48% of our research
and development expenditures were for clinical development costs, 12% were for regulatory costs, 4% were for pharmaceutical development costs, 9% were for manufacturing development costs, 24% were for medical affairs costs, and 3% were for
stock-based compensation costs ($0.3 million).

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



| |  |  | Clinical Development Costs  Overall clinical development costs, which include clinical investigator fees, clinical trial monitoring costs and
data management, for the three months ended September 30, 2010 were $3.8 million as compared to $1.6 million for the three months ended September 30, 2009. The increase in costs resulted from the initiation of the REMURA dry eye trials and
the initiation and completion of bepotastine nasal clinical trials. The three months ended September 30, 2009 included costs associated with our BROMDAY trials, costs associated with our T-PRED trials and costs incurred to support our BEPREVE
NDA. We expect clinical development costs to increase in the fourth quarter of 2010 as we plan to complete the analysis of the data from the bepotastine nasal trial, file an IND application to initiate the bepotastine nasal Phase 2 study and conduct
the REMURA dry eye trials.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Regulatory Costs  Regulatory costs, which include compliance expenses for existing products and other activity for pipeline projects, for both
the three months ended September 30, 2010 and 2009 were $0.9 million, respectively.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pharmaceutical Development Costs  Pharmaceutical development costs, which include costs related to the testing and development of our pipeline
products, for both the three months ended September 30, 2010 and 2009 were $0.3 million, respectively.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Manufacturing Development Costs  Manufacturing development costs, which include costs related to production scale-up and validation, raw material
qualification, and stability studies, for the three months ended September 30, 2010 were $0.7 million, compared with $0.5 million for the three months ended September 30, 2009.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Medical Affairs Costs  Medical affairs costs, which include activities that relate to medical information in support of our products, for the
three months ended September 30, 2010 were $1.9 million as compared to $0.7 million for the three months ended September 30, 2009, or an increase of $1.2 million. The increase is primarily attributable to personnel costs and continuing
medical education costs, primarily associated with the launch of BEPREVE.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our research and development
activities reflect our efforts to advance our product candidates through the various stages of product development. The expenditures that will be necessary to execute our development plans are subject to numerous uncertainties, which may affect our
research and development expenditures and capital resources. For instance, the duration and the cost of clinical trials may vary significantly depending on a variety of factors including a trials protocol, the number of patients in the trial,
the duration of patient follow-up, the number of clinical sites in the trial, and the length of time required to enroll suitable patient subjects in the trial. Even if earlier results are positive, we may obtain different results in later stages of
development, including failure to show the desired safety or efficacy, which could impact our development expenditures for a particular product candidate. Although we spend a considerable amount of time planning our development activities, we may be
required to deviate from our plan based on new circumstances or events or our assessment from time to time of a product candidates market potential, other product opportunities or 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 clinical 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 cost and timing to complete our product development programs and each future
product development program is not estimable.



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Selling, general
and administrative expenses. Selling, general and administrative expenses were $19.6 million for the three months ended September 30, 2010, as compared to $13.2 million for the three months ended September 30, 2009. The $6.4 million
increase reflects the addition of approximately 65 new sales representatives, additional corporate support staff, and promotional activities associated with the launch of BEPREVE. Selling expenses are expected to increase in the fourth quarter of
2010 due to our sales force expansion and promotional activities associated with the marketing of BEPREVE and the launch of BROMDAY.

Stock-based compensation costs. Total stock-based compensation costs for the three months ended September 30, 2010 and 2009 were $1.0 million and $1.2 million, respectively. For the three
months ended September 30, 2010 and 2009, we granted stock options to employees to purchase 60,000 shares of common stock (at a weighted average exercise price of $3.11 per share) and 63,000 shares of common stock (at a weighted average
exercise price of $5.13 per share), respectively, equal to the fair market value of our common stock at the time of grant. We also issued 3,333 and 3,066 restricted stock awards for the three months ended September 30, 2010 and 2009,
respectively. Included in stock-based compensation costs were $0.1 million and $0.2 million for the three months ended September 30, 2010 and 2009, respectively, related to restricted stock awards.

Interest expense. Interest expense was $2.1 million for the three months ended September 30, 2010, as compared to $2.8
million for the three months ended September 30, 2009. Interest expense for the three months ended September 30, 2010 included interest payments on our Facility Agreement ($1.1 million), amortization of the discount on the Facility
Agreement ($0.6 million), amortization of the deferred financing costs ($0.3 million), and amortization of the derivative on the Facility Agreement ($0.1 million). Interest expense for the three months ended September 30, 2009 included interest
payments on our Facility Agreement ($1.1 million), amortization of the discount on the Facility Agreement ($1.2 million), amortization of the deferred financing costs ($0.4 million), and interest on our borrowings under our Revolving Credit Facility
($0.1 million).

Gain on derivative valuation.Derivative valuation for the three months ended September 30, 2010
was a gain of $0.1 million as compared to a gain of $0.3 million for the three months ended September 30, 2009. For both the three months ended September 30, 2010 and 2009, the change in the value of the derivative was due to changes in
our stock price, risk-free interest rates and related stock price volatility.

Loss on warrant valuation.For the three
months ended September 30, 2010, we recorded a non-cash valuation loss of ($26.3) million, or ($0.79) per diluted share, as compared to a non-cash valuation loss of ($3.4) million, or ($0.10) per diluted share, for the three months ended
September 30, 2009. The change in the valuation of the warrants for the three months ended September 30, 2010 was primarily driven by an increase in our stock price, with a slight contribution from an increase in related volatility.

Nine Months Ended September 30, 2010 and 2009

Revenues. Net revenues were approximately $105.4 million for the nine months ended September 30, 2010, as compared to $76.4
million for the nine months ended September 30, 2009. Net revenue growth was primarily driven by strong demand for XIBROM and BEPREVE, supported by revenue increases in ISTALOL and VITRASE. In the nine months ended September 30, 2009, we
recognized the remaining $3.1 million of previously deferred license revenue resulting from the up-front payment we received from Otsuka in 2001.



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The following table
sets forth our net revenues for each of our products for the nine months ended September 30, 2010 and 2009, respectively (dollars in millions), and the corresponding percentage change.



|                   |  |                                 |       |  |      |   |      |          |  |  |     |  
|------------------ |  | ------------------------------- | ----- |  | ---- | - | ---- | -------- |  |  | --- | -
|                   |  | Nine Months Ended September 30, |      
|                   |  | 2010                            |       |  | 2009 |   |      | % change | 
|XIBROM             |  | $                               | 71.0  |  |      | $ | 55.1 |          |  |  | 29  | %
|BEPREVE            |  |                                 | 10.6  |  |      |   | 1.2  |          |  |  | 783 | %
|ISTALOL            |  |                                 | 15.0  |  |      |   | 13.0 |          |  |  | 15  | %
|VITRASE            |  |                                 | 8.8   |  |      |   | 4.0  |          |  |  | 120 | %
|                   |  |                                 |       |  |      |   |      |          |  |  |     |  
|Product sales, net |  |                                 | 105.4 |  |      |   | 73.3 |          |  |  | 44  | %
|License revenue    |  |                                 |      |  |      |   | 3.1  |          |  |  |    |  
|                   |  |                                 |       |  |      |   |      |          |  |  |     |  
|Total revenues     |  | $                               | 105.4 |  |      | $ | 76.4 |          |  |  | 38  | %
|                   |  |                                 |       |  |      |   |      |          |  |  |     |  

Gross margin and cost of products sold. Gross margin for the nine months ended
September 30, 2010 was 76% of net revenues, or $80.2 million, as compared to 76% of net revenues, or $57.7 million, for the nine months ended September 30, 2009. Product gross margin was 76% and 75% for the nine months ended
September 30, 2010 and 2009, respectively, excluding $3.1 million in previously deferred revenue. The increase in the product gross margin percentage for the nine months ended September 30, 2010, as compared to the nine months ended
September 30, 2009 is primarily the result of increased sales of our higher gross margin products, XIBROM and BEPREVE.

Cost of products sold was $25.2 million for the nine months ended September 30, 2010, as compared to $18.6 million for the nine
months ended September 30, 2009. Cost of products sold for the nine months ended September 30, 2010 and 2009 consisted primarily of standard costs for each of our commercial products, distribution costs, royalties, inventory reserves and
other costs of products sold. The increase in cost of products sold is primarily the result of increased net revenues.

Research and development expenses. Research and development expenses were $17.8 million for the nine months ended
September 30, 2010, as compared to $19.6 million for the nine months ended September 30, 2009. Research and development expenses in the nine months ended September 30, 2009 included total milestone payments of $3.0 million to
Senju for the FDAs acceptance and approval of the BEPREVE NDA. Excluding these milestone payments, recurring research and development expenses increased $1.2 million. The increase in research and development expenses is due primarily to the
timing associated with the initiation and completion of clinical trials.

For the nine months ended September 30, 2010,
approximately 34% of our research and development expenditures were for clinical development costs, 16% were for regulatory costs, 6% were for pharmaceutical development costs, 16% were for manufacturing development costs, 24% were for medical
affairs costs, and 4% were for stock-based compensation costs ($0.8 million).

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



| |  |  | Clinical Development Costs  Overall clinical development costs for the nine months ended September 30, 2010 were $6.1 million as
compared to $6.9 million for the nine months ended September 30, 2009. Due to the variation in the initiation, timing and completion of clinical trials, we realized a decrease in our clinical development costs of $0.8 million. The nine months
ended September 30, 2009 included costs associated with our BROMDAY trials and T-PRED trials and costs incurred to support our BEPREVE NDA. The nine months ended September 30, 2010 showed a reduction in our clinical development costs
because the BROMDAY and the T-PRED trials were completed in 2009, offset by costs associated with our bepotastine nasal and the REMURA dry eye trials. We expect clinical development costs to increase in the fourth quarter of 2010 as we plan to
complete the analysis of the data from the bepotastine nasal trial, file an IND application to initiate the bepotastine nasal Phase 2 study and conduct the REMURA dry eye trials.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Regulatory Costs  Regulatory costs for the nine months ended September 30, 2010 were $2.9 million as compared to $3.0 million for the nine
months ended September 30, 2009. The decrease of $0.1 million was due primarily to a reduction in outside consulting costs.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Pharmaceutical Development Costs  Pharmaceutical development costs were $1.0 million for the nine months ended September 30, 2010 and
September 30, 2009.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Manufacturing Development Costs  Manufacturing development costs for the nine months ended September 30, 2010 were $2.6 million as
compared to $2.4 million for the nine months ended September 30, 2009. The increase was due primarily to consulting and outside service costs.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Medical Affairs Costs  Medical affairs costs for the nine months ended September 30, 2010 were $4.4 million as compared to $2.4 million for
the nine months ended September 30, 2009, or an increase of $2.0 million. The increase is primarily attributable to personnel costs and continuing medical education costs, primarily associated with the launch of BEPREVE.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Selling, general and administrative expenses. Selling, general and administrative expenses were
$60.4 million for the nine months ended September 30, 2010, as compared to $38.9 million for the nine months ended September 30, 2009. The $21.5 million increase reflects the addition of approximately 65 new sales representatives,
additional corporate support staff, and promotional activities associated with the launch of BEPREVE. Selling expenses are expected to increase in the fourth quarter of 2010 due to our sales force expansion and promotional activities associated with
the marketing of BEPREVE and the launch of BROMDAY.

Stock-based compensation costs. Total stock-based compensation
costs for the nine months ended September 30, 2010 were $2.9 million, compared with $2.8 million for the nine months ended September 30, 2009. For the nine months ended September 30, 2010 and 2009, we granted stock options to
employees to purchase 929,302 shares of common stock (at a weighted average exercise price of $3.57 per share) and 812,288 shares of common stock (at a weighted average exercise price of $1.64 per share), respectively, equal to the fair market value
of our common stock at the time of grant. We also issued 155,152 and 148,101 restricted stock awards for the nine months ended September 30, 2010 and 2009, respectively. Included in stock-based compensation costs were $0.3 million and $0.4
million for the nine months ended September 30, 2010 and 2009, respectively, related to restricted stock awards.

Interest expense. Interest expense was $6.2 million for the nine months ended September 30, 2010, as compared to $6.5 million
for the nine months ended September 30, 2009. Interest expense for the nine months ended September 30, 2010 included interest payments on our Facility Agreement ($3.2 million), amortization of the discount on the Facility Agreement ($1.9
million), amortization of the deferred financing costs ($0.8 million), amortization of the derivative on the Facility Agreement ($0.2 million) and interest on our borrowings under our Revolving Credit Facility ($0.1 million). Interest expense for
the nine months ended September 30, 2009 included interest payments on our Facility Agreement ($3.2 million), amortization of the discount on the Facility Agreement ($2.3 million), amortization of the deferred financing costs ($0.8 million) and
interest on our borrowings under our Revolving Credit Facility ($0.2 million).

Gain on derivative valuation.Derivative valuation for the nine months ended September 30, 2010 was a gain of $0.1 million, as compared to a gain of $1.2 million for the nine months ended September 30, 2009. For both the nine months ended September 30, 2010
and 2009, the change in the value of the derivative was due to change in our stock price, risk-free interest rates and related stock price volatility.

Gain (loss) on warrant valuation. For the nine months ended September 30, 2010, we recorded a non-cash valuation gain of $7.2 million, or $0.17 per diluted share, as compared to a
non-cash valuation loss of $50.7 million, or $1.53 per diluted share, for the nine months ended September 30, 2009. The change in the valuation of the warrants for the nine months ended September 30, 2010 and September 30, 2009 was
primarily driven by changes in our stock price and the related volatility.

Reaffirming our 2010 Financial Outlook and
Providing 2011 Net Revenues Outlook



| |  |  | We expect our net revenues will be approximately in the middle of the $147 million to $165 million range. We expect net revenues from XIBROM and
BROMDAY combined will be at the higher end of the $95 million to $105 million range and anticipate net revenues from BEPREVE will be approximately $16 to $20 million.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We expect our gross margin will be at the higher end of the range of 74% to 76% of net revenues.
| | - |  | ------------------------------------------------------------------------------------------------



| |  |  | We expect research and development expenses will be at the lower end of the range of 18% to 22% of net revenues, depending upon the progress of our
clinical programs.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We expect selling, general and administrative expenses will be at the higher end of the range of 48% to 52% of net revenues, including launch expenses
for BROMDAY. We expect selling expenses in the fourth quarter of 2010 to increase due to BROMDAY launch costs.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our expectations for operating income are unchanged, at approximately $8 to $10 million.
| | - |  | ----------------------------------------------------------------------------------------



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| |  |  | We expect our net income will be at least $1 million, or earnings per share of $0.02, excluding any mark-to-market adjustments relating to our
outstanding warrants. As of September 30, 2010, our fully diluted common shares, including our outstanding shares of common stock plus warrants and stock options on a treasury stock basis, were approximately 43 million shares.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We expect our year-end cash balance to be at least $70 million including amounts borrowed under our revolving credit facility with Silicon Valley Bank.
Included in our year-end cash estimates is $20 to $25 million in reserved bromfenac royalties.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | We expect our 2011 net revenues to be in the range of $175 million to $190 million and will provide further guidance on 2011 when we report our 2010
full year results.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

Liquidity and Capital Resources

As of September 30, 2010, we had $67.2 million in cash and working capital of $30.3 million, excluding the $21.5 million portion of
the Facility Agreement with is classified as a current liability. Historically, we have financed our operations primarily through sales of our debt and equity securities and cash receipts from product sales. Since March 2000, we have received gross
proceeds of approximately $346.7 million from sales of our common stock and the issuance of promissory notes and convertible debt.

Under our Revolving Credit Facility with Silicon Valley Bank, we may borrow up to the lesser of $25.0 million or 80% of eligible accounts receivable, plus the lesser of 25% of net cash or $10.0 million.
As of September 30, 2010, we had $19.2 million available under the Revolving Credit Facility of which we borrowed $13 million. All amounts borrowed under the Revolving Credit Facility were repaid in October 2010. We also had letters of credit
of $0.5 million outstanding. All outstanding amounts under the Revolving Credit Facility bear interest at a variable rate equal to the lenders prime rate plus a margin of 0.25%. In no event shall the interest rate on outstanding borrowings be
less than 4.25%, which is payable on a monthly basis. The Revolving 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. An event of default under the Revolving Credit Facility will occur if, among other things, (i) we are delinquent in making payments of principal or interest on the Revolving Credit Facility; (ii) we
fail to cure a breach of a covenant or term of the Revolving Credit Facility; (iii) we make a representation or warranty under the Revolving Credit Facility that is materially inaccurate; (iv) we are unable to pay our debts as they become
due, certain bankruptcy proceedings are commenced or certain orders are granted against us, or we otherwise become insolvent; or (v) an acceleration event occurs under certain types of other indebtedness outstanding from time to time. If an
event of default occurs, the indebtedness to Silicon Valley Bank could be accelerated, such that it becomes immediately due and payable. As of September 30, 2010, we were in compliance with all of the covenants under the Revolving Credit
Facility. Unless repaid earlier, all amounts owing under the Revolving Credit Facility will become due and payable on December 30, 2010. While we believe we will be able extend the maturity date of our Revolving Credit Facility, or refinance
outstanding amounts with another lender, we may be unable to do so. If we are unable to renew our Revolving Credit Facility or obtain suitable alternative debt financing, our ability to execute on our business plan may be adversely affected.

We have a Facility Agreement with certain institutional accredited investors, collectively known as the Lenders. On
September 30, 2010, we had total indebtedness under the Facility Agreement of $65 million, which excludes unamortized discounts of ($5.7) million and the value of the derivatives of $0.2 million. Outstanding amounts under the Facility Agreement
accrue interest at a rate of 6.5% per annum, payable quarterly in arrears. We are required to repay the Lenders 33% of the original principal amount (or $21.5 million) on each of September 26, 2011 and 2012, and 34% of the original
principal amount (or $22.0 million) on September 26, 2013. Since the September 2011 payment is due within 12 months, $21.5 million of this Facility Agreement has been classified as a current liability as of September 30, 2010.

Any amounts drawn under the Facility Agreement may become immediately due and payable upon (i) an event of default, as
defined in the Facility Agreement, in which case the Lenders would have the right to require us to repay 100% of the principal amount of the loan, plus any accrued and unpaid interest thereon, or (ii) the consummation of certain change of
control transactions, in which case the Lenders would have the right to require us to repay 110% of the outstanding principal amount of the loan, plus any accrued and unpaid interest thereon. An event of default under the Facility Agreement will
occur if, among other things, (i) we fail to make payment when due; (ii) we fail to comply in any material respect with any covenant of the Facility Agreement, and such failure is not cured; (iii) any representation or warranty made
by us in any transaction document was incorrect, false, or misleading in any material respect as of the date it was made; (iv) we are generally unable to pay our debts as they become due or a bankruptcy or similar proceeding is commenced by or
against us; or (v) cash and cash equivalents on the last day of each calendar quarter are less than $10 million. The Facility Agreement also contains customary covenants regarding operations of our business. As of September 30, 2010, we
are in compliance with all the covenants under the Facility Agreement.



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

For the nine months ended September 30, 2010, we generated $14.9 million of cash from operations, primarily the result of the
increase in royalties payable of $13.3 million and other changes in operating assets and liabilities, offset by the increase in accounts receivable of $9.1 million. We had net income of $3.1 million, which included the warrant valuation gain of $7.2
million and non-cash charges of $6.6 million. Non-cash charges consisted primarily of stock-based compensation costs ($2.9 million), amortization of discount on the Facility Agreement ($2.1 million), depreciation and amortization ($0.9 million) and
amortization of deferred financing costs ($0.8 million), partially offset by the gain on derivative valuation ($0.1 million). For the nine months ended September 30, 2009, we generated $4.9 million of cash from operations. The cash received
from operations was primarily the result of a net increase in non-cash charges, a change in operating assets and liabilities of $5.7 million, offset by a net loss of $57.2 million. Non-cash charges primarily consisted of the warrant valuation loss
($50.7 million), stock-based compensation costs ($2.8 million), amortization of discount on the Facility Agreement ($2.3 million), depreciation and amortization ($0.8 million) and amortization of deferred financing costs ($0.8 million), partially
offset by the gain on derivative valuation ($1.2 million).

For the nine months ended September 30, 2010, we used $1.5
million of cash from investing activities, primarily due to purchases of equipment. For the nine months ended September 30, 2009, we received $3.8 million of cash from investing activities, primarily due to the maturities of our short-term
investment securities.

For the nine months ended September 30, 2010, we generated negligible cash from financing
activities. For the nine months ended September 30, 2009, we used $2.0 million of cash from financing activities, primarily as a result of net repayments on our Revolving Credit Facility.

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

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



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



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



| |  |  | the expansion of our commercial infrastructure related to our approved products and product candidates;
| | - |  | -------------------------------------------------------------------------------------------------------



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



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



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



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



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



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



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



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



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

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



Our net income in the nine months ended September 30, 2009
of $3.1 million included a gain on our warrant valuation of $7.2 million. Excluding this gain, we have never been profitable, and, while we currently anticipate becoming profitable excluding warrant valuation adjustments in 2010, we might never
become profitable. As of September 30, 2010, our accumulated deficit was $394.1 million (including a cumulative non-cash warrant valuation loss of $44.9 million), including net income of approximately $3.1 million for the nine months ended
September 30, 2010 and a stockholders deficit of $71.8 million.



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In June 2010, we
initiated a legal action by filing a Complaint against AcSentient, Inc. and AcSentient II, LLC, which we collectively refer to as AcSentient, seeking a declaratory judgment with regard to ISTAs XIBROM royalty obligations under the Asset
Purchase Agreement dated May 3, 2002 between ISTA and AcSentient, Inc. The only U.S. patent applicable to XIBROM expired in January 2009 and, according to U.S. case law and the terms of our agreement with AcSentient, we believe no XIBROM
royalties are due after patent expiration. A declaratory judgment that we are seeking from the court in regard to royalty obligations to AcSentient may apply not only to XIBROM, but also to BROMDAY, approved by the FDA in October 2010. We initiated
a similar legal action in April 2010, against Senju, also seeking a declaratory judgment with regard to the relevant XIBROM royalty obligations to Senju and a recovery of overpaid royalties and other damages from Senju. In August 2010, a
Federal judge in Los Angeles stayed our action against Senju, and in September 2010, Senju initiated an arbitration proceeding regarding the same dispute with the International Chamber of Commerce. There can be no assurance about when these two
disputes will be resolved, and we cannot predict the final financial outcome of either. Until these two disputes are resolved, for accounting purposes, the company has been and intends to continue to reserve for XIBROM and BROMDAY royalties. As of
September 30, 2010, we had $16.7 million reserved for unpaid XIBROM royalties.

In April 2008, we received subpoenas from
the office of the U.S. Attorney for the Western District of New York requesting information regarding the marketing activities related to XIBROM. From April 2008 through September 30, 2010, we incurred approximately $3.7 million in legal fees
associated with this matter and expect to incur significant expenses in the future. In addition, if the government chooses to engage in civil litigation or initiate a criminal prosecution against us as a result of its review of the requested
documents and other evidence, we may have to incur significant amounts to defend such action or pay or incur substantial fines or penalties, either of which could significantly deplete our cash resources. This matter is in its preliminary stages and
thus the likelihood of an unfavorable outcome and/or the amount/range of loss, if any, cannot be reasonably estimated. As of September 30, 2010, such legal costs are neither reasonably estimable nor probable.

Section 703 of the National Defense Authorization Act of 2008, enacted on January 28, 2009, requires that pharmaceutical products
purchased through the Department of Defense, or DoD, TRICARE Retail Pharmacy program be subject to the Federal Ceiling Price discount under the Veterans Health Care Act of 1992. DoD issued a rule pursuant to Section 703 that requires manufacturers
to provide DoD with a quarterly refund on pharmaceutical products utilized through the TRICARE Retail Pharmacy program, and to pay rebates to DoD on TRICARE Retain Pharmacy purchases retroactive to January 28, 2008. We have requested a waiver of the
retroactive rebate for TRICARE Retail Pharmacy utilization for the period from January 28, 2008 to May 26, 2009 (the effective date of the DoD rule). In addition, the regulation is currently the subject of litigation, and it is our position that the
retroactive application of the regulation is contrary to established case law. We have determined that payment of the retroactive rebate (from January 28, 2008 to May 26, 2009) created by the regulation is neither reasonably estimable nor probable
as of September 30, 2010.

We incurred legal expenses in the amount of $0.2 million and $1.0 million with the law firm,
Covington & Burling, for the nine months ended September 30, 2010 and 2009, respectively. A member of our Board of Directors is senior counsel in this law firm.

Recent Accounting Pronouncements

In February 2010, the FASB
issued amended guidance on subsequent events. Under this amended guidance, SEC filers are no longer required to disclose the date through which subsequent events have been evaluated in originally issued and revised financial statements. This
guidance was effective immediately and we adopted these new requirements upon issuance of this guidance.

In
January 2010, the FASB issued updated standards related to additional requirements and guidance regarding disclosures of fair value measurements. The guidance require the gross presentation of activity within the Level 3 fair value measurement
roll forward and details of transfers in and out of Level 1 and 2 fair value measurements. In addition, companies will be required to disclose quantitative information about the inputs used in determining fair values. These standards were adopted in
the first quarter of 2010. The adoption did not have a material impact on our condensed financial statements.



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

The primary objective of our investment policy is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the
securities that we have invested in were subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed
interest rate at the then-prevailing interest rate and the prevailing interest rate later increases, the principal amount of our investment will probably decline. Seeking to minimize this



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risk, historically we maintained our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and
non-government debt securities and auction rate securities. All of our cash is held in non-interest bearing accounts, which are no longer insured by the Federal Deposit Insurance Corporation. When our cash is invested in short-term investments, the
average duration is usually less than one year.

All outstanding amounts under our Revolving Credit Facility bear interest at
a variable rate equal to the lenders prime rate plus a margin of 0.25%. In no event shall the interest rate on outstanding borrowings be less than 4.25%. Interest is payable on a monthly basis and may expose us to market risk due to changes in
interest rates. As of September 30, 2010, we had $13.0 million in borrowings under our Revolving Credit Facility. The interest rate at September 30, 2010 was 4.25%. A 10% change in interest rates on our Revolving Credit Facility would not
have had a material effect on our net income for the nine months ended September 30, 2010.

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 Securities Exchange Act of 1934 Rule 13a-15(e)) as of the end of the period covered by this Quarterly Report. The Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation of these controls and
procedures required by paragraph (b) of Securities Exchange Act of 1934 Rules 13a-15 and 15d-15, that our disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report to provide reasonable
assurance that information required to be disclosed by us in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in applicable SEC rules and forms. 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 Securities Exchange Act of 1934
Rules 13a-15(f) and 15d-15(f)) during the quarter ended September 30, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



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PART II. OTHER INFORMATION



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

In
June 2010, we initiated a legal action by filing a Complaint against AcSentient, Inc. and AcSentient II, LLC, which we collectively refer to as AcSentient, seeking a declaratory judgment with regard to ISTAs XIBROM royalty obligations
under the Asset Purchase Agreement dated May 3, 2002 between ISTA and AcSentient, Inc. The only U.S. patent applicable to XIBROM expired in January 2009 and, according to U.S. case law and the terms of our agreement with AcSentient, we believe
no XIBROM royalties are due after patent expiration. A declaratory judgment that we are seeking from the court in regard to royalty obligations to AcSentient may apply not only to XIBROM, but also to BROMDAY, approved by the FDA in October 2010. We
initiated a similar legal action in April 2010, against Senju, also seeking a declaratory judgment with regard to the relevant XIBROM royalty obligations to Senju and a recovery of overpaid royalties and other damages from Senju. In
August 2010, a Federal judge in Los Angeles stayed our action against Senju, and in September 2010, Senju initiated an arbitration proceeding regarding the same dispute with the International Chamber of Commerce. There can be no assurance
about when these two disputes will be resolved, and we cannot predict the final financial outcome of either. Until these two disputes are resolved, for accounting purposes, the company has been and intends to continue to reserve for XIBROM and
BROMDAY royalties. As of September 30, 2010, we had $16.7 million reserved for unpaid XIBROM royalties.



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

Our Annual
Report on Form 10-K for the year ended December 31, 2009 contains a full discussion of our risk factors. There have been no material changes to the risk factors disclosed in our Form 10-K, except for the risk factors set forth below.

If generic manufacturers obtain approval for generic versions of our products, our business, results of operations and financial condition
may suffer.

Under the Federal Food, Drug and Cosmetics Act, or the FDCA, the FDA can approve an abbreviated NDA, or an
ANDA, for a generic version of a branded drug, and under what is referred to as a Section 505(b)(2) NDA for a modified version of an existing branded drug, without the ANDA applicant undertaking the clinical testing necessary to obtain approval
to market a new drug. In place of such clinical studies, an ANDA applicant usually needs only to submit data demonstrating that its product has the same active ingredient(s) and is bioequivalent to the branded product, in addition to any data
necessary to establish that any difference in strength, dosage form, inactive ingredients, or delivery mechanism does not result in different safety and efficacy profiles, as compared to the branded drug.

The FDCA requires an applicant for a drug that relies, at least in part, on the existing approval of one of our branded drugs to notify
us of their application and potential infringement of our patent rights. Upon receipt of this notice, we have 45 days to bring a patent infringement suit in federal district court against the company seeking approval of a product covered by one of
our patents. The discovery, trial and appeals process in such suits can take several years. If such a suit is commenced, the FDCA provides a 30-month stay on the FDAs approval of the competitors application. Such litigation is often
time-consuming and quite costly and may result in generic competition if such patent(s) are not upheld or if the generic competitor is found not to infringe such patent(s). If the litigation is resolved in favor of the applicant or the challenged
patent expires during the 30-month stay period, the stay is lifted and the FDA may thereafter approve the application based on the standards for approval of ANDAs and Section 505(b)(2) NDAs.

In January 2009, the patent on XIBROM expired, and we lost regulatory exclusivity for XIBROM. Because of the patent expiration,
competitors became eligible to receive approval for ANDAs for ophthalmic formulations of bromfenac with indications identical to XIBROM. During the second quarter of 2008, we submitted a citizen petition, or the First Citizen Petition, to the FDA
requesting that the FDA refrain from approving any applications that contain bromfenac manufactured outside the United States until the FDA conducts full inspections and determines that manufacturers are in compliance with applicable regulations.
The FDA denied the First Citizen Petition in the fourth quarter of 2008. During the second quarter of 2008, we submitted a second citizen petition, or the Second Citizen Petition, to the FDA requesting that the FDA refrain from approving any
application for generic bromfenac ophthalmic formulations unless specific standards are satisfied, including but not limited to, corneal safety standards. On December 15, 2008, the FDA notified us that it had not yet reached a decision on the
Second Citizen Petition and that further review and analysis was required. The FDA published a guidance document in the Federal Register in January 2009 outlining its interpretation of responding to citizens petitions as



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required under the Food and Drug Administration Amendments Act. In the guidance document, the FDA noted that it would not be required to respond to citizens petitions within the 180-day period
from when the citizen petition was filed in the event that an ANDA had not been filed as of the petition filing date. During the fourth quarter of 2008, we submitted a third citizen petition, or the Third Citizen Petition, to the FDA requesting that
the FDA refrain from approving any applications for ophthalmic pharmaceutical products that do not contain standards for endotoxin levels and water for injection. On June 2, 2009, the FDA denied our Third Citizen Petition. On June 30, 2009, we filed
a petition for reconsideration of the denial of our Third Citizen Petition, or the Reconsideration Petition. On December 28, 2009, we received a letter from FDA informing us that the FDA has not reached a determination on our Reconsideration
Petition.

Since the XIBROM patent expiration in January 2009, three Drug Master Files, or DMFs have been filed for bromfenac.
In addition, we believe a bromfenac ANDA was filed on May 10, 2010. Based upon publicly available information on the two year or longer average FDA review times for ANDAs, we do not anticipate that a generic form of bromfenac will receive FDA
approval by a competitor until late 2011, or beyond. We cannot predict whether the FDA will grant or deny our Second Citizen Petition or our Reconsideration Petition, or when it may take action with respect to our Second Citizen Petition or our
Reconsideration Petition.

The approval of any ANDA or Section 505(b)(2) NDAs with respect to XIBROM, or any of our other
branded drugs, leading to generic competition could have an adverse impact on our net revenues and results of operations. For the nine months ended September 30, 2010, XIBROM accounted for approximately 67% of our net revenues and 71% of our
gross profit. Moreover, if the patents covering our branded drugs (other than XIBROM) were not upheld in litigation or if a competitor is found not to infringe these patents, the resulting competition would have a material adverse effect on our
business, results of operations and financial condition.

On October 16, 2010, the FDA approved BROMDAY for the treatment
of postoperative inflammation and reduction of ocular pain in patients who have undergone cataract extraction. We applied for three years of exclusivity under the Drug Price Competition and Patent Term Restoration Act, commonly known as the
Hatch-Waxman Act. We plan to launch BROMDAY in the fourth quarter of 2010 and switch physicians from prescribing twice-daily XIBROM to prescribing once-daily BROMDAY. We plan to discontinue selling XIBROM in 2011.



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



|               |  |                                                                                                                                                 
|-------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
Number |  | Description                                                                                                                                     
|               | 
|31.1           |  | Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.                           
|               | 
|31.2           |  | Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.                           
|               | 
|32.1           |  | Certification of Chief Executive Officer Pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
|               | 
|32.2           |  | Certification of Chief Financial Officer Pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.



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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 3, 2010 |  |  |  |  |  | /S/    VICENTE ANIDO,
JR., PH.D.                                                      
|                        |  |  |  |  |  | Vicente Anido, Jr., Ph.D. President and Chief Executive Officer                       
|                        |  |  | 
|Dated: November 3, 2010 |  |  |  |  |  | /S/    LAUREN P.
SILVERNAIL                                                           
|                        |  |  |  |  |  | Lauren P. Silvernail Chief Financial Officer and Vice President, Corporate
Development



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INDEX TO EXHIBITS



|               |  |                                                                                                                                                   
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
Number |  | Description                                                                                                                                       
|               | 
|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.



28