Ista Pharmaceuticals (ISTA) 10-Q 2007 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

Mark One

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

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2007

Or

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

FOR THE TRANSITION PERIOD FROM            TO            

Commission File Number: 000-31255

ISTA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

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

15295 Alton Parkway, Irvine, California 92618

(Address of principal executive offices)

(949) 788-6000

(Registrant’s telephone number, including area code)

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

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

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

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

The number of shares of the registrant’s common stock, $0.001 par value, outstanding as of June 30, 2007 was 31,904,694.

TABLE OF CONTENTS

		Page No
PART I FINANCIAL INFORMATION (unaudited)		1
Item 1	Condensed Consolidated Financial Statements	1
	Condensed Consolidated Balance Sheets — June 30, 2007 and December 31, 2006	1
	Condensed Consolidated Statements of Operations — Three and Six Month Periods Ended June 30, 2007 and 2006	2
	Condensed Consolidated Statements of Cash Flows — Three and Six Month Periods Ended June 30, 2007 and 2006	3
	Notes to Condensed Consolidated Financial Statements	4
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	9
Item 3	Quantitative and Qualitative Disclosure About Market Risk	16
Item 4	Controls and Procedures	16
PART II OTHER INFORMATION		17
Item 1A	Risk Factors	17
Item 6	Exhibits	25
	Signatures	26
	Index to Exhibits	27

PART I FINANCIAL INFORMATION

Item 1 Condensed Consolidated Financial Statements

ISTA Pharmaceuticals, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except share and per share data)

(unaudited)

	June 30, 2007			December 31, 2006
ASSETS
Current assets:
Cash and cash equivalents	$	50,129		$	17,236
Short-term investments		6,099			21,698
Accounts receivable, net of allowances of $78 in 2007 and $121 in 2006		6,302			6,339
Inventory, net of allowances of $743 in 2007 and $829 in 2006		1,647			1,474
Other current assets		2,311			1,672
Total current assets		66,488			48,419
Property and equipment, net		3,935			3,116
Deferred financing costs		2,204			2,481
Restricted cash		4,000			5,600
Deposits and other assets		210			127
Total assets	$	76,837		$	59,743
LIABILITIES AND STOCKHOLDERS’ EQUITY / (DEFICIT)
Current liabilities:
Accounts payable	$	2,226		$	2,218
Accrued compensation and related expenses		2,513			2,311
Accrued expenses — clinical trials		120			179
Line of credit		6,000			6,500
Current portion of long-term liabilities		752			886
Current portion of obligation under capital lease		39			43
Other accrued expenses		10,291			8,284
Total current liabilities		21,941			20,421
Deferred rent		207			216
Deferred income		3,472			3,611
Obligation under capital leases		35			54
Convertible notes		40,000			40,000
Total liabilities		65,655			64,302
Commitments and contingencies
Stockholders’ equity / (deficit):
Preferred stock, $0.001 par value; 5,000,000 shares authorized of which 1,000,000 shares have been designated as Series A Participating Preferred Stock at June 30, 2007 and December 31, 2006; no shares issued and outstanding		—			—
Common stock, $0.001 par value; 100,000,000 shares authorized at June 30, 2007 and December 31, 2006; 31,904,694 and 26,193,745 shares issued and outstanding at June 30, 2007 and December 31, 2006, respectively		32			26
Additional paid-in-capital		296,330			260,401
Accumulated other comprehensive loss		(24	)		(24	)
Accumulated deficit		(285,156	)		(264,962	)
Total stockholders’ equity / (deficit)		11,182			(4,559	)
Total liabilities and stockholders’ equity / (deficit)	$	76,837		$	59,743

See accompanying notes

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ISTA Pharmaceuticals, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(unaudited)

	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
Revenue:
Product sales, net	$	13,518		$	6,994		$	23,701		$	12,349
License revenue		70			70			139			139
Total revenue		13,588			7,064			23,840			12,488
Cost of products sold		3,687			2,286			6,220			4,179
Gross profit margin		9,901			4,778			17,620			8,309
Costs and expenses:
Research and development		5,774			4,753			12,076			9,239
Selling, general and administrative		12,205			9,622			24,546			19,660
Total costs and expenses		17,979			14,375			36,622			28,899
Loss from operations		(8,078	)		(9,597	)		(19,002	)		(20,590	)
Interest income		319			245			773			578
Interest expense		(984	)		(157	)		(1,965	)		(197	)
Net loss	$	(8,743	)	$	(9,509	)	$	(20,194	)	$	(20,209	)
Net loss per common share, basic and diluted	$	(0.32	)	$	(0.37	)	$	(0.76	)	$	(0.78	)
Shares used in computing net loss per common share, basic and diluted		26,935			25,918			26,608			25,915

See accompanying notes

2

ISTA Pharmaceuticals, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

	Six Months Ended June 30,
	2007			2006
Operating Activities
Net loss	$	(20,194	)	$	(20,209	)
Adjustments to reconcile net loss to net cash used in operating activities:
Stock based compensation		1,639			1,231
Amortization of deferred financing costs		277			12
Depreciation and amortization		312			252
Changes in operating assets and liabilities:
Accounts receivable, net		37			(2,372	)
Inventory, net		(173	)		(51	)
Other current assets		(639	)		317
Accounts payable		8			(270	)
Accrued compensation and related expenses		202			125
Accrued expenses — clinical trials and other accrued expenses		1,948			1,292
Other liabilities		(134	)		249
Deferred rent		(9	)		4
Deferred income		(139	)		(244	)
Net cash used in operating activities		(16,865	)		(19,664	)
Investing Activities
Purchases of marketable securities		—			(6,513	)
Maturities of marketable securities		15,599			19,313
Purchases of equipment		(1,131	)		(941	)
Restricted cash		1,600			(6,400	)
Deposits and other assets		(83	)		(174	)
Net cash provided by investing activities		15,985			5,285
Financing Activities
Proceeds from exercise of stock options		186			7
Obligation under capital lease		(23	)		30
Proceeds from issuance of convertible notes, net		—			40,000
Financing costs		—			(2,700	)
Proceeds from line of credit		12,500			2,000
Repayment on line of credit		(13,000	)		—
Proceeds from issuance of common stock, net of issuance costs		34,110			94
Net cash provided by financing activities		33,773			39,431
Increase in Cash and Cash Equivalents		32,893			25,052
Cash and cash equivalents at beginning of period		17,236			6,510
Cash and Cash Equivalents At End of Period	$	50,129		$	31,562

See accompanying notes

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ISTA Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

1. The Company

ISTA Pharmaceuticals, Inc. (“ISTA” or the “Company”) was incorporated in the state of California on February 13, 1992 to discover, develop and market new remedies for diseases and conditions of the eye. The Company reincorporated in Delaware on August 4, 2000. Xibrom™, Xibrom QD™, Istalol^®, Vitrase^®, Vitragan™, T-Pred™, ISTA^®, ISTA Pharmaceuticals, Inc.^® and the ISTA logo are the Company’s trademarks, either owned or under license.

ISTA is an ophthalmic pharmaceutical company focused on the development and commercialization of products for serious diseases and conditions of the eye. Since the Company’s inception, it has devoted its resources primarily to fund research and development programs, late-stage product acquisitions and product commercial launches. In December 2001, ISTA announced its strategic plan to transition from a development-stage organization to a pharmaceutical company with a primary focus on ophthalmology. In July 2004, the Company transitioned from a development-stage organization to a commercial entity. The Company currently has three products available for sale in the U.S.: Xibrom (bromfenac sodium ophthalmic solution) for the treatment of inflammation and pain following cataract surgery, Istalol (timolol maleate ophthalmic solution) for the treatment of glaucoma, and Vitrase (hyaluronidase for injection) for use as a spreading agent. The Company also has several product candidates in various stages of development.

2. Summary of Significant Accounting Policies

Basis of Presentation

The unaudited condensed consolidated financial statements of ISTA have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. These statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.

In the opinion of management, all adjustments (consisting of normal recurring adjustments) necessary for the fair presentation of the statement of financial condition and results of operations for the three and six month periods ended June 30, 2007, and 2006 have been made. The interim results of operations are not necessarily indicative of the results to be expected for the full fiscal year.

Revenue Recognition

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

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

• The number of and specific contractual terms of agreements with customers;

• Estimated level of units in the distribution channel;

• Historical rebates, chargebacks and returns of products;

• Direct communication with customers;

• Anticipated introduction of competitive products or generics;

• Anticipated pricing strategy changes by ISTA and/or its competitors;

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

• The impact of changes in state and federal regulations; and

• Estimated remaining shelf life of products.

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In its analyses, the Company utilizes on hand unit data purchased from the major wholesalers, as well as prescription data purchased from a third-party data provider to develop estimates of historical unit channel pull-through. The Company utilizes an internal analysis to compare historical net product shipments to estimated historical prescriptions written. Based on that analysis, it develops an estimate of the quantity of product in the channel which may be subject to various rebate, chargeback and product return exposures.

Consistent with industry practice, the Company periodically offers promotional discounts to its existing customer base. These discounts are calculated as a percentage of the current published list price and the net price (i.e., the current published list price less the applicable discount is invoiced to the customer). Accordingly, the discounts are recorded as a reduction of revenue in the period that the program is offered. In addition to promotional discounts, at the time that the Company implements a price increase, the Company may offer its existing customer base an opportunity to purchase a limited quantity of product at the previous list price. Shipments resulting from these programs generally are not in excess of ordinary levels; therefore, the Company recognizes the related revenue upon receipt by the customer and includes the sale in estimating its various product-related allowances. In the event the Company determines that these sales represent purchases of inventory in excess of ordinary levels for a given wholesaler, the potential impact on product returns exposure would be specifically evaluated and reflected as a reduction in revenue at the time of such sale.

Allowances for estimated rebates and chargebacks were $0.8 million and $0.4 million as of June 30, 2007 and 2006, respectively. These allowances reflect an estimate of the Company’s liability for items such as rebates due to various governmental organizations under the Medicare/Medicaid regulations, rebates due to managed care organizations under specific contracts and chargebacks due to various organizations purchasing certain of our products through federal contracts and/or group purchasing agreements. The Company estimates its liability for rebates and chargebacks at each reporting period based on a combination of quantitative and qualitative assumptions listed above.

Allowances for product returns were $0.6 million and $0.5 million as of June 30, 2007 and 2006, respectively. These allowances reflect an estimate of the Company’s liability for product that may be returned by the original purchaser in accordance with the Company’s stated return policy, which allows customers to return product within six months of it expiry dating and for a period up to 12 months after it has reached the expiration date. The Company estimates its liability for product returns at each reporting period based on the estimated units in the channel and the other factors discussed above.

For the three months ended June 30, 2007 and 2006, the Company’s exposure for rebates, chargebacks and product returns has grown primarily as a result of increased sales of its existing products and the approval of new products. Accordingly, reductions to revenue and corresponding increases to allowance accounts have likewise increased. The exposure to these revenue-reducing items as a percentage of gross product revenue for the three months ended June 30, 2007 and 2006 was 6.8% and 8.5%, respectively, for the allowance for rebates, chargebacks and other discounts, and was 2.2% and 3.3%, respectively, for the allowance for product returns. ISTA typically applies a higher allowance for product returns on stocking orders in connection with an initial launch.

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

Inventories

Inventory at June 30, 2007 consisted of $0.4 million of raw materials and $1.9 million of finished goods, net of $0.7 million in inventory reserves. Inventory at December 31, 2006 consisted of $0.7 million in raw materials and $1.6 million of finished goods, net of $0.8 million in inventory reserves.

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

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Inventories are reviewed periodically for slow-moving or obsolete status. The Company adjusts its inventory to reflect situations in which the cost of inventory is not expected to be recovered. The Company would record a reserve to adjust inventory to its net realizable value: (1) if a launch of a new product is delayed, inventory may not be fully utilized and could be subject to impairment; (2) when a product is close to expiration and not expected to be sold; (3) when a product has reached its expiration date; or (4) when a product is not expected to be saleable. In determining the reserves for these products, the Company considers factors such as the amount of inventory on hand and its remaining shelf life, and current and expected market conditions, including management forecasts and levels of competition. ISTA has evaluated the current level of inventory considering historical trends and other factors, and based on its evaluation, has recorded adjustments to reflect inventory at its net realizable value. These adjustments are estimates, which could vary significantly from actual results if future economic conditions, customer demand, competition or other relevant factors differ from expectations. These estimates require ISTA to make assessments about the future demand for its products in order to categorize the status of such inventory items as slow-moving, obsolete or in excess-of-need. These future estimates are subject to the ongoing accuracy of management’s forecasts of market conditions, industry trends, competition and other factors. If the Company over or under estimates the amount of inventory that will not be sold prior to expiration, there may be a material impact on its consolidated financial condition and results of operations.

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

Restricted Cash

The Company has $4.0 million of restricted cash at June 30, 2007, which supports a letter of credit issued as security for interest payments on the outstanding senior subordinated convertible notes.

Comprehensive Income (Loss)

SFAS No. 130, “Reporting Comprehensive Income”, or SFAS No. 130, requires reporting and displaying comprehensive income (loss) and its components, which, for ISTA, includes net loss and unrealized gains and losses on investments and foreign currency translation gains and losses. Total comprehensive loss for the six months ended June 30, 2007 and 2006 was $20.2 million for each period. In accordance with SFAS No. 130, the accumulated balance of unrealized gains (losses) on investments and the accumulated balance of foreign currency translation adjustments are disclosed as separate components of stockholders’ equity.

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

Stock-Based Compensation

On January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment”, or SFAS No. 123(R), which requires measurement and recognition of compensation expense for all share-based awards made to employees and directors. Under SFAS No. 123R, the fair value of share-based awards is estimated at grant date using an option pricing model, and the portion that is ultimately expected to vest is recognized as compensation cost over the requisite service period.

Since share-based compensation under SFAS No. 123R is recognized only for those awards that are ultimately expected to vest, the Company has applied an estimated forfeiture rate to unvested awards for the purpose of calculating compensation cost. These estimates will be revised, if necessary, in future periods if actual forfeitures differ from estimates. Changes in forfeiture estimates impact compensation cost in the period in which the change in estimate occurs.

The Company uses Black-Scholes option-pricing model to estimate the fair value of share-based awards. The determination fair value using the Black-Scholes option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables, including expected stock price volatility, risk-free interest rate, expected dividends and projected employee stock option exercise behaviors.

At June 30, 2007, there was $7.5 million of total unrecognized compensation cost, related to non-vested stock options, which is expected to be recognized over a remaining weighted average vesting period of 2 years.

Restricted Stock Awards

During the three and six months ended June 30, 2007 the Company granted a total of 2,000 and 103,291 shares of restricted common stock to employees under the Company’s 2004 Performance Incentive Plan, as amended, respectively. Restrictions on these shares will expire and related charges are being amortized as earned over the vesting period of four years.

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The amount of compensation to be recognized is based on the market value of the shares on the date of issuance. Expenses related to the vesting of restricted stock (charged to selling, general and administrative expenses) were $80,000 and $138,000 for the three and six months ended June 30, 2007 and $32,000 and $47,000 for the three and six months ended June 30, 2006, respectively. As of June 30, 2007, there was approximately $1.0 million of unamortized compensation cost related to restricted stock awards, which is expected to be recognized ratably over the vesting period of four years.

Net Loss Per Share

In accordance with SFAS No. 128, “Earnings Per Share”, or SFAS No. 128, and SAB No. 98, “Earnings Per Share”, or SAB No. 98, basic net loss per common share is computed by dividing the net loss for the period by the weighted average number of common shares outstanding during the period. Under SFAS No. 128, diluted net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted-average number of common and common equivalent shares, such as stock options, outstanding during the period. Such common equivalent shares have not been included in the Company’s computation of diluted net loss per share as their effect would be anti-dilutive. The total number of shares excluded from the calculation of diluted net loss per share, prior to application of the treasury stock method for options, warrants, and as-converted shares was 11,087,187 and 10,881,396 for the six months ended June 30, 2007 and 2006, respectively.

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

Executive Employment Agreements

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

Equity Financing

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

Commitments and Contingencies

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

Segment Reporting

The Company currently operates in only one segment.

Recent Accounting Pronouncements

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

At December 31, 2006, the Company had federal and state tax net operating loss, or NOL, carryforwards of approximately $160.4 million and $90.4 million, respectively, which will begin to expire in 2008 and 2007 respectively, unless previously utilized. The Company also had federal and state research and development, or R&D, credit carryforwards of $6.3 million and $3.8 million, respectively. The federal R&D tax credits will begin to expire in 2010, unless previously utilized. The Company’s California research tax credit carryforwards do not expire and will carry forward indefinitely until utilized. Because realization of such tax benefits is uncertain, the Company has provided a 100% valuation allowance as of December 31, 2006 and June 30, 2007. Utilization of the NOL and R&D credit carryforwards may be subject to a substantial annual limitation due to ownership change limitations that have occurred previously or that could occur in the future provided by Sections 382 and 383 of the Internal Revenue Code of 1986, as well as similar state and foreign provisions. These ownership changes may limit the amount of NOL and R&D credit carryforwards than can be utilized annually to offset future taxable income and tax, respectively. In general, an ownership change, as defined by Section 382, results from transactions increasing the ownership of certain shareholders or public groups in the stock of a corporation by more than 50 percentage points over a three-year period. Since the Company’s formation, the Company has raised capital through the issuance of capital stock on several occasions which, combined with the purchasing stockholders’ subsequent disposition of those shares, may have resulted in a change of control, as defined by Section 382, or could result in a change of control in the future upon

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subsequent disposition. The Company has not currently completed a study to assess whether a change in control has occurred or whether there have been multiple changes of control since the Company’s formation due to the significant complexity and cost associated with such study and that there could be additional changes in the future. If we have experienced a change of control at any time since Company formation, utilization of our NOL or R&D credit carryforwards would be subject to an annual limitation under Sections 382 and 383 which is determined by first multiplying the value of our stock at the time of the ownership change by the applicable long-term tax-exempt rate, and then could be subject to additional adjustments, as required. Any limitation may result in expiration of a portion of the NOL or R&D credit carryforwards before utilization. Further, until a study is completed and any limitation known, no amounts are being presented as an uncertain tax position under FIN 48. Interest and penalties related to uncertain tax positions will be reflected in income tax expense. Tax years 1992 to 2006 remain subject to future examination by the major tax jurisdictions in which we are subject to tax.

New Accounting Standard Not Yet Adopted

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

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

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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,” “Risk Factors” and other sections of this Quarterly Report on Form 10-Q. Words such as “may,” “will,” “should,” “could,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue” or similar words are intended to identify forward-looking statements, although not all forward-looking statements contain these words. Although we believe that our opinions and expectations reflected in the forward-looking statements are reasonable as of the date of this Quarterly Report on Form 10-Q, we cannot guarantee future results, levels of activity, performance or achievements, and our actual results may differ substantially from the views and expectations set forth in this Quarterly Report on Form 10-Q. We expressly disclaim any intent or obligation to update any forward-looking statements after the date hereof to conform such statements to actual results or to changes in our opinions or expectations. Readers are urged to carefully review and consider the various disclosures made by us, which attempt to advise interested parties of the risks, uncertainties, and other factors that affect our business, including without limitation the disclosures made under the captions “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” in this Quarterly Report on Form 10-Q and the audited financial statements and the notes thereto and disclosures made under the captions “Management Discussion and Analysis of Financial Condition and Results of Operations”, “Risk Factors”, “Consolidated Financial Statements” and “Notes to Consolidated Financial Statements” included in our Annual Report on Form 10-K for the year ended December 31, 2006. We obtained the market data and industry information contained in this Quarterly Report on Form 10-Q from internal surveys, estimates, reports and studies, as appropriate, as well as from market research, publicly available information and industry publications. Although we believe our internal surveys, estimates, reports, studies and market research, as well as industry publications, are reliable, we have not independently verified such information, and, as such, we do not make any representation as to its accuracy.

Overview

We are an ophthalmic pharmaceutical company. Our products and product candidates address the $3.2 billion U.S. prescription ophthalmic market and include therapies for inflammation, ocular pain, glaucoma, allergy and dry eye. We currently have three products for sale in the U.S.: Xibrom™ (bromfenac sodium ophthalmic solution) for the treatment of inflammation and pain following cataract surgery, Istalol^® (timolol maleate ophthalmic solution) for the treatment of glaucoma, and Vitrase^® (hyaluronidase for injection) for use as a spreading agent. We also have several product candidates in various stages of development. We have incurred losses since inception and had an accumulated deficit of $285.2 million through June 30, 2007.

Second Quarter Developments

We increased our net revenue by 92% in the second quarter of 2007, as compared to the second quarter of 2006. Dollarized total prescriptions as measured by IMS Health, or IMS, in the second quarter of 2007 for both Xibrom and Istalol grew by 87% to $14.2 million as compared to the second quarter of 2006. In particular, dollarized total prescriptions, as measured by IMS, were (i) $11.6 million for Xibrom in the second quarter of 2007, as compared to $8.6 million in the first quarter of 2007 and $5.7 million in the second quarter of 2006, and (ii) $2.6 million for Istalol in the second quarter of 2007, as compared to $2.5 million in the first quarter of 2007 and $1.9 million in the second quarter of 2006.

During May 2007, we completed and announced statistically significant results from the preliminary analysis of our U.S. Phase II/III clinical study of bepotastine for the treatment of allergic conjunctivitis. The study evaluated two concentrations of bepotastine, each dosed once daily and twice daily. The primary endpoints of the study were the assessment of efficacy for bepotastine in treating ocular itching and redness. The preliminary results of the study demonstrate both concentrations were highly statistically significant in the reduction of the first primary endpoint, ocular itching, when dosed twice a day, and in one concentration when dosed once a day. We plan to discuss the results with the U.S. Food and Drug Administration, or FDA, to determine the remaining clinical studies required to confirm ocular safety and efficacy for the submission of a New Drug Application, or NDA, for bepotastine for the treatment of allergic conjunctivitis.

During May 2007, we completed and announced positive results from our preliminary analysis of our Phase IIb confirmatory study of ecabet sodium, which is being developed as a treatment for dry eye syndrome. Patients in the ecabet sodium group achieved a strong trend in the objective sign of blink rate. In addition, patients in the ecabet sodium group reported a strong trend in the Ocular Symptom Disease Index, or OSDI, and a positive trend in the subjective assessment of patients’ most bothersome symptom. Strong and positive trends are used to confirm observations from previous clinical ecabet sodium studies and to serve as indicators of potential efficacy endpoints in Phase III studies.

In May 2007, we received a not approvable letter from the FDA relating to our NDA for T-Pred™ (prednisolone acetate 1.0% and tobramycin 0.3% ophthalmic suspension). The FDA assessed our clinical data as not showing sufficient equivalence between the prednisolone component in T-Pred and PredForte at least at one of the time points measured nor equivalence in the kill time between the tobramycin components in T-Pred and Tobrex^®, although it showed equivalence versus Zylet^® and Tobradex^®. We have filed for dispute resolution with the FDA, as we do not agree with this assessment. We plan to work closely with the FDA to efficiently resolve the issues.

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

During the second quarter of 2007, we initiated a pilot study for our strong steroid product candidate and, if the study results are timely and positive, we will advance the product candidate into Phase II clinical studies during the second half of 2007.

Results of Operations

Three Months Ended June 30, 2007 and 2006

Net Revenue. Net revenue was approximately $13.6 million for the three months ended June 30, 2007, as compared to $7.1 million for the three months ended June 30, 2006. The increase in net revenue was primarily attributable to the continued growth of Xibrom and Istalol in the marketplace.

In addition to product revenues for the three months ended June 30, 2007 and 2006, we recorded license revenue of $70,000 in each of the three months ended June 30, 2007 and 2006, reflecting the amortization of deferred revenue recorded in December 2001 for the license fee payment made by Otsuka Pharmaceuticals Co., Ltd. in connection with the license of Vitrase in Japan for ophthalmic uses in the posterior region of the eye.

Net Revenue

$ millions	Quarter Ended June 30, 2007		Quarter Ended June 30, 2006		% Change
Xibrom	$	9.7	$	4.0	143	%
Istalol		2.5		1.9	32	%
Vitrase		1.3		1.1	18	%
Other		0.1		0.1	0	%
Total Net Revenue	$	13.6	$	7.1	92	%

Gross margin and cost of products sold. Gross margin for the three months ended June 30, 2007 was 73%, or $9.9 million, as compared to 68%, or $4.8 million, for the three months ended June 30, 2006. The increase in gross margin is primarily due to the change in revenue mix, primarily driven by increased Xibrom sales. Cost of products sold was $3.7 million for the three months ended June 30, 2007, as compared to $2.3 million for the three months ended June 30, 2006. Cost of products sold for the three months ended June 30, 2007 consisted primarily of standard costs for each of our commercial products, distribution costs, royalties, and other costs of products sold. The increase in cost of products sold is primarily the result of increased net product sales year over year.

We expect our gross margin for 2007 will be approximately 71% to 74%, subject to quarterly fluctuations based on revenue mix.

Research and development expenses. Research and development expenses were $5.8 million for the three months ended June 30, 2007, as compared to $4.8 million for the three months ended June 30, 2006. The increase in research and development expenses for the second quarter of 2007 was primarily the result of an increase in clinical development costs, which include clinical investigator fees, study monitoring costs and data management costs, due to the completion of the bepotastine Phase II/III study and the completion of the ecabet sodium Phase IIb confirmatory study. Our research and development expenses to date have consisted primarily of costs associated with the clinical trials of our product candidates, compensation and other expenses for research and development personnel, costs for consultants and contract research organizations and costs related to the development of commercial scale manufacturing capabilities for Vitrase, Istalol and Xibrom.

Generally, our research and development resources are not dedicated to a single project but are applied to multiple product candidates in our portfolio. As a result, we manage and evaluate our research and development expenditures generally by the type of costs incurred. We generally classify and separate research and development expenditures into amounts related to clinical development costs, regulatory costs, pharmaceutical development costs, manufacturing development costs, and medical affairs costs. In addition, we also record as research and development expenses any up front and milestone payments that have accrued to third parties prior to regulatory approval of a product candidate under our licensing agreements unless there is an alternative future use. For the three months ended June 30, 2007, approximately 41%

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of our research and development expenditures were for clinical development costs, 17% were for regulatory costs, 6% were for pharmaceutical development costs, 25% were for manufacturing development costs, and 11% were for medical affairs costs.

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

• Clinical Development Costs — Overall clinical costs, which include clinical investigator fees, study monitoring costs and data management, for the three months ended June 30, 2007 were $2.4 million as compared to $1.0 million for the three months ended June 30, 2006 or an increase of $1.4 million. The increase in clinical costs in 2007 was primarily due to the completion of the ecabet sodium Phase IIb confirmatory study and the completion of the bepotastine Phase II/III clinical trials.

• Regulatory Costs — Regulatory costs, which include compliance expense for existing products and other activity for pipeline projects, were $1.0 million for the three months ended June 30, 2007 as compared to $1.3 million for the three months ended June 30, 2006 or a decrease of $0.3 million. The decrease in regulatory costs for the three months ended June 30, 2007 was primarily due to the allocation of annual FDA facility fees to inventory.

• Pharmaceutical Development Costs — Pharmaceutical development costs, which include costs related to the testing and development of our pipeline products, for the three months ended June 30, 2007 were $0.3 million as compared to $0.5 million for the three months ended June 30, 2007 or a decrease of $0.2 million. The decrease is primarily due to the overall reduction in outside research expenses.

• Manufacturing Development Costs — Manufacturing development costs, which include costs related to production scale-up and validation, raw material qualification, and stability studies, for the three months ended June 30, 2007 were $1.4 million as compared to $1.1 million for the three months ended June 30, 2006 or an increase of $0.3 million. The increase is primarily attributable to the increase in research costs associated with manufacturing scale-up activities, offset by the allocation of production costs to capitalized inventory as a function of the scale-up of activities associated with the increase in the number of commercial products during 2007 as compared to 2006.

• Medical Affairs Costs — Medical affairs costs, which include activities that relate to medical information in support of our products, were $0.7 million for the three months ended June 30, 2007 as compared to $0.6 million for the three months ended June 30, 2006, or an increase of $0.1 million due to increased product support activity.

Our research and development activities reflect our efforts to advance our product candidates through the various stages of product development. The expenditures that will be necessary to execute our development plans are subject to numerous uncertainties, which may affect our research and development expenditures and capital resources. For instance, the duration and the cost of clinical trials may vary significantly depending on a variety of factors including a trial’s protocol, the number of patients in the trial, the duration of patient follow-up, the number of clinical sites in the trial, and the length of time required enrolling suitable patient subjects. Even if earlier results are positive, we may obtain different results in later stages of development, including failure to show the desired safety or efficacy, which could impact our development expenditures for a particular product candidate. Although we spend a considerable amount of time planning our development activities, we may be required to alter from our plan based on new circumstances or events or our assessment from time to time of a product candidate’s market potential, other product opportunities and our corporate priorities. Any deviation from our plan may require us to incur additional expenditures or accelerate or delay the timing of our development spending. Furthermore, as we obtain results from trials and review the path toward regulatory approval, we may elect to discontinue development of certain product candidates in certain indications, in order to focus our resources on more promising candidates or indications. As a result, the amount or ranges of estimable cost and timing to complete our product development programs and each future product development program is not estimable.

Depending upon the progress of our clinical and pre-clinical programs, we expect our research and development expenses in 2007 will be approximately $24 to $28 million.

Selling, general and administrative expenses. Selling, general and administrative expenses were $12.2 million for the three months ended June 30, 2007, as compared to $9.6 million for the three months ended June 30, 2006. The $2.6 million increase in selling, general and administrative expenses in 2007 as compared to 2006 primarily results from higher sales and marketing expenses associated with the expansion of our sales force ($2.2 million), increased compensation expense ($0.1 million) and an overall increase in administrative costs related to expanding our operations and other general corporate expenses, such as facility and personnel costs ($0.3 million). Selling, general, and administrative expenses during the second quarter of 2007 and 2006 includes $0.8 million and $0.7 million, respectively, in stock-based compensation expense.

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

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

For the three months ended June 30, 2007 and 2006, we granted stock options to employees to purchase 42,200 shares of common stock (at a weighted average exercise price of $8.77 per share) and 76,800 shares of common stock (at a weighted average exercise price of $5.92 per share), respectively, equal to the fair market value of our common stock at the time of grant. We also issued 2,000 and 10,000 restricted stock awards for the three months ended June 30, 2007 and 2006, respectively, and included in stock compensation expense was $80,000 and $32,000 for the three months ended June 30, 2007 and 2006, respectively, related to these restricted stock awards.

Interest income. Interest income was $0.3 million for the three months ended June 30, 2007, as compared to $0.2 million for the three months ended June 30, 2006. The increase in interest income was primarily attributable to higher cash balances as a result of our receipt of $40.0 million in net proceeds from the issuance of senior subordinated convertible notes during 2006, the interest earned on the $4.0 million in restricted cash and higher rates of return as compared to 2006.

Interest expense. Interest expense was $1.0 million for the three months ended June 30, 2007, as compared to $0.2 million for the three months ended June 30, 2006. The increase in interest expense was primarily attributable to the interest on the outstanding amounts under our credit facility, the amortization of the deferred financing costs associated with the issuance of $40.0 million in senior subordinated convertible notes and the interest recorded on these outstanding senior subordinated convertible notes.

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

Six Months Ended June 30, 2007 and 2006

Net Revenue. Net revenue was approximately $23.8 million for the six months ended June 30, 2007, as compared to $12.5 million for the six months ended June 30, 2006. The increase in net revenue was primarily attributable to the continued growth of Xibrom and Istalol in the marketplace.

In addition to product revenues for the six months ended June 30, 2007 and 2006, we recorded license revenue of $0.1 million in each of the six months ended June 30, 2007 and 2006, reflecting the amortization of deferred revenue recorded in December 2001 for the license fee payment made by Otsuka Pharmaceuticals Co., Ltd. in connection with the license of Vitrase in Japan for ophthalmic uses in the posterior region of the eye.

Net Revenue

$ millions	Six Months Ended June 30, 2007		Six Months Ended June 30, 2006		% Change
Xibrom	$	16.7	$	6.8	146	%
Istalol		4.7		3.7	27	%
Vitrase		2.3		1.9	21	%
Other		0.1		0.1	0	%
Total Net Revenue	$	23.8	$	12.5	90	%

Gross margin and cost of products sold. Gross margin for the six months ended June 30, 2007 was 74%, or $17.6 million, as compared to 67%, or $8.3 million, for the six months ended June 30, 2006. The increase in gross margin is primarily due to the change in revenue mix. Cost of products sold was $6.2 million for the six months ended June 30, 2007, as compared to $4.2 million for the six months ended June 30, 2006. Cost of products sold for the six months ended June 30, 2007 consisted primarily of standard costs for each of our commercial products, distribution costs, royalties, and other costs of products sold. The increase in cost of products sold is primarily the result of increased net product sales year over year.

Research and development expenses. Research and development expenses were $12.1 million for the six months ended June 30, 2007, as compared to $9.2 million for the six months ended June 30, 2006. The increase in research and development expenses for the six months ended June 30, 2007 was primarily the result of an increase in clinical development costs, which include FDA filing fees, clinical investigator fees, study monitoring costs and data management costs, due to completion of the Xibrom QD once-daily Phase III studies, completion of the bepotastine Phase II/III study and the completion of the ecabet sodium Phase IIb confirmatory study.

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For the six months ended June 30, 2007, approximately 49% of our research and development expenditures were for clinical development costs, 15% were for regulatory costs, 5% were for pharmaceutical development costs, 21% were for manufacturing development costs, and 10% were for medical affairs costs.

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

• Clinical Development Costs — Overall clinical costs, which include clinical investigator fees, study monitoring costs and data management, for the six months ended June 30, 2007 were $5.9 million as compared to $2.4 million for the six months ended June 30, 2006 or an increase of $3.5 million. The increase in clinical costs in 2007 was primarily due to the completion of the Xibrom QD once-daily Phase III clinical trials, completion of the ecabet sodium Phase IIb confirmatory study and completion of the bepotastine Phase II/III clinical trials.

• Regulatory Costs — Regulatory costs, which include compliance expense for existing products and other activity for pipeline projects, were $1.8 million for the six months ended June 30, 2007 as compared to $2.1 million for the six months ended June 30, 2006 or a decrease of $0.3 million. The decrease in regulatory costs for the six months ended June 30, 2007 was primarily due to the allocation of FDA fees to inventory.

• Pharmaceutical Development Costs — Pharmaceutical development costs, which include costs related to the testing and development of our pipeline products, for the six months ended June 30, 2007 were $0.6 million as compared to $0.8 million for the six months ended June 30, 2007 or a decrease of $0.2 million. The decrease is primarily due to the overall reduction in outside research expenses.

• Manufacturing Development Costs — Manufacturing development costs, which include costs related to production scale-up and validation, raw material qualification, and stability studies, for the six months ended June 30, 2007 were $2.5 million as compared to $2.3 million for the six months ended June 30, 2006 or an increase of $0.2 million. The increase is primarily attributable to the allocation of production costs to capitalized inventory as a function of the scale up of activities associated with the increase in the number of commercial products during 2007 as compared to 2006.

• Medical Affairs Costs — Medical affairs costs, which include activities that relate to medical information in support of our products, were $1.3 million for each of the six months ended June 30, 2007 and June 30, 2006.

Selling, general and administrative expenses. Selling, general and administrative expenses were $24.5 million for the six months ended June 30, 2007, as compared to $19.7 million for the six months ended June 30, 2006. The $4.8 million increase in selling, general and administrative expenses in 2007 as compared to 2006 primarily results from higher sales and marketing expenses associated with the expansion of our sales force ($4.0 million), increased compensation expense ($0.4 million) and an overall increase in administrative costs related to expanding our operations and other general corporate expenses, such as facility and personnel costs ($0.4 million). Selling, general, and administrative expenses during the 2007 and 2006 periods include $1.6 million and $1.2 million, respectively, in stock-based compensation expense.

Stock-based compensation. For the six months ended June 30, 2007 and 2006, we granted stock options to employees to purchase 952,029 shares of common stock (at a weighted average exercise price of $7.65 per share) and 769,124 shares of common stock (at a weighted average exercise price of $6.65 per share), respectively, equal to the fair market value of our common stock at the time of grant. We also issued 103,291 restricted stock awards and 79,680 restricted stock awards for the six months ended June 30, 2007 and 2006, respectively, and included in stock compensation expense was $138,000 and $47,000 for the six months ended June 30, 2007 and 2006, respectively, related to these restricted stock awards.

Interest income. Interest income was $0.8 million for the six months ended June 30, 2007, as compared to $0.6 million for the six months ended June 30, 2006. The increase in interest income was primarily attributable to higher cash balances as a result of our receipt of $40.0 million in net proceeds from the issuance of senior subordinated convertible notes during 2006, the interest earned on the $4.0 million in restricted cash and higher rates of return as compared to 2006.

Interest expense. Interest expense was $2.0 million for the six months ended June 30, 2007, as compared to $0.2 million for the six months ended June 30, 2006. The increase in interest expense was primarily attributable to the interest on the outstanding amounts under our credit facility, the amortization of the deferred financing costs associated with the issuance of $40.0 million in senior subordinated convertible notes and the interest recorded on these outstanding senior subordinated convertible notes.

Liquidity and Capital Resources

As of June 30, 2007, we had approximately $56.2 million in cash, cash equivalents and short-term investments, $4.0 million of restricted cash, which supports a letter of credit issued as security for interest payments on the outstanding senior

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subordinated convertible notes and working capital of $44.5 million. Historically, we have financed our operations primarily through sales of our debt and equity securities. Since March 2000, we have received gross proceeds of approximately $278.1 million from sales of our common stock and the issuance of promissory notes and convertible debt.

Under our revolving credit facility, we may borrow up to the lesser of $10.0 million or 66.67% of our unrestricted cash, cash equivalents and net receivables. As of June 30, 2007, we had $4.0 million available for borrowing under the credit facility. All outstanding amounts under the credit facility bear interest at a variable rate equal to the lender’s prime rate plus 0.5%, which is payable on a monthly basis. The credit facility also contains customary covenants regarding operations of our business and financial covenants relating to ratios of current assets to current liabilities and is collateralized by all of our assets with the exception of our intellectual property. As of June 30, 2007, we were in compliance with all of the covenants under the credit facility. All amounts owing under the credit facility will become due and payable on March 31, 2008.

In April 2006, we entered into a credit arrangement whereby we may borrow up to $1.2 million to finance the purchase of certain capital equipment. The outstanding amounts under this arrangement will become due and payable ratably over three years from the purchase date of the equipment. As of June 30, 2007, $0.8 million was outstanding under this arrangement.

Additionally, in June 2006, we issued an aggregate of $40.0 million in principal amount of our senior subordinated convertible notes, bearing 8% interest per annum payable quarterly in cash in arrears which began October 1, 2006. The notes mature in June 2011 and are convertible, at any time following their issuance, into shares of our common stock at a conversion price of $7.63 per share, subject to certain adjustments and limitations set forth therein.

For the six months ended June 30, 2007, we used $16.9 million of cash for operations principally as a result of the net loss of $20.2 million, the net change in operating assets and liabilities of $1.1 million, offset by the recording of $1.6 million in stock based compensation and the recording of $0.6 million in depreciation and amortization. For the six months ended June 30, 2006, we used approximately $19.7 million of cash for operations principally as a result of the net loss of $20.2 million.

For the six months ended June 30, 2007, we received $16.0 million of cash from investing activities, primarily due to the maturities of our short-term investment securities. For the six months ended June 30, 2006, we received $5.3 million of cash from investing activities, primarily due to the maturities of our short-term investment securities, offset by restricted cash deposit requirements under our letter of credit.

For the six months ended June 30, 2007, we received $33.8 million from financing activities, primarily as a result of the sale of an aggregate of 5.25 million shares of our common stock at a purchase price of $7.00 per share, resulting in gross proceeds to us of $36.75 million before payment of offering expenses and placement agent fees of $2.6 million. For the six months ended June 30, 2006, we received $39.4 million from financing activities, primarily as a result of $2.0 million of borrowing under the credit facility and the issuance of senior subordinated convertible notes in the principal amount of $40.0 million less $2.7 million of financing costs.

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

• the success of the commercialization of our products;

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

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

• the rate of progress of our research and development programs;

• the time and expense necessary to obtain regulatory approvals;

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

• competitive, technological, market and other developments; and

• our ability to establish and maintain collaborative relationships.

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

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We have never been profitable, and we might never become profitable. In this regard, we anticipate that our operating expenses will continue to increase from historical levels as we continue to expand our commercial infrastructure in connection with our commercialization of our approved products. As of June 30, 2007, our accumulated deficit was $285.2 million, including a net loss of approximately $20.2 million for the six months ended June 30, 2007 and a stockholders’ equity of $11.2 million.

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Item 3 Quantitative and Qualitative Disclosures about Market Risk

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline. Seeking to minimize this risk, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities. The average duration of all of our investments in 2006 was less than one year. Due to the short-term nature of these investments, we believe we have no material exposure to interest rate risk arising from our investments. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair market value of our interest sensitive financial investments. Declines in interest rates over time will, however, reduce our investment income, while increases in interest rates over time will increase our interest expense. Historically, and as of June 30, 2007, we have not used derivative instruments or engaged in hedging activities.

All outstanding amounts under our revolving credit facility bear interest at a variable rate equal to the lender’s prime rate plus 0.5%, which is payable on a monthly basis and which may expose us to market risk due to changes in interest rates. As of June 30, 2007, we had $6.0 million outstanding under our credit facility. We estimate that a 10% change in interest rates on our credit facility would not have had a material effect on our net loss for the six months ended June 30, 2007.

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

Item 4 Controls and Procedures

Evaluation of disclosure controls and procedures

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

Changes in internal control over financial reporting

We have not made any significant changes to our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the fiscal quarter ended June 30, 2007 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 1A Risk Factors

In addition to other information included in this Quarterly Report on Form 10-Q, the following factors, among others, could cause actual results to differ materially from those contained in forward-looking statements contained in this Quarterly Report on Form 10-Q, and thus should be considered carefully in evaluating our business and future prospects. The following risk factors are not an exhaustive list of the risks associated with our business. New factors may emerge or changes to these risks could occur that could materially affect our business.

Risks Related to Our Business

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

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

The regulatory approval process is extensive, time-consuming and costly, and the FDA may not approve additional product candidates, or the timing of any such approval may not be appropriate for our product launch schedule and other business priorities, which are subject to change. For example, in May 2007, we announced that the FDA did not approve our NDA for T-Pred, our fixed combination product (tobramycin/prednisolone acetate) for the treatment of inflammatory ocular conditions for which a corticosteroid is indicated where bacterial infections or a risk of bacterial infection exists.

Clinical testing of pharmaceutical products is also a long, expensive and uncertain process. Even if initial results of preclinical studies or clinical trial results are positive, we may obtain different results in later stages of drug development, including failure to show desired safety and efficacy. The clinical trials of any of our product candidates could be unsuccessful, which would prevent us from obtaining regulatory approval and commercializing the product.

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

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

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

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

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

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

If the FDA does not approve our product candidates in a timely fashion on commercially viable terms or we terminate development of any of our product candidates due to difficulties or delays encountered in clinical testing and the regulatory approval process, it will have a material adverse impact on our business.

In addition, we have certain raw materials manufactured in foreign countries. We may also elect in the future to market certain of our products, and perhaps have certain of our products or certain additional raw materials manufactured, in foreign countries. Many other countries, including major European countries and Japan, have similar requirements as the United States for the manufacture, marketing and sale of pharmaceutical products.

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

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

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

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

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• the availability of satisfactory levels, or at all, of third party reimbursement for our products and related treatments;

• our ability to fund our sales and marketing efforts; and

• the effectiveness of our sales and marketing efforts.

In addition, our ability to market and promote our products is restricted to the labels approved by the FDA. If the approved labels are restrictive, our sales and marketing efforts and market acceptance and the commercial potential of our products may be negatively affected.

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

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

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

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

We have never been profitable, and we might never become profitable. In this regard, we anticipate that our operating expenses will continue to increase from historical levels as we continue to expand our commercial infrastructure in connection with our commercialization of our approved products. As of December 31, 2006, our accumulated deficit was $265.0 million, including a net loss of approximately $38.4 million for the year ended December 31, 2006. As of December 31, 2006, we had approximately $38.9 million in cash and cash equivalents and short-term investments and working capital of $28.0 million. We believe our current cash and cash equivalents and short-term investments on hand, together with borrowings available under our credit facility and other borrowing arrangements, will be sufficient to finance anticipated capital and operating requirements for at least the next twelve months.

If we are unable to generate sufficient product revenues, we may be required to raise additional capital in the future through collaborative agreements or public or private equity or debt financings. If we are required to raise additional capital in the future such additional financing may not be available on favorable terms, or at all, or may be dilutive to our existing stockholders. In addition, our credit facility and our senior subordinated convertible notes contain restrictions on our ability to incur certain indebtedness without the consent of our lender or the holders of the notes, as the case may be. If we fail to obtain additional capital as and when required such failure could have a material adverse impact on our operating plan and business.

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

Outstanding amounts under our revolving credit facility bear interest at variable rates, which may expose us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase and our net income and cash flows would decrease. The loan and security agreement also contains certain covenants based on our financial performance. If we violate any of these financial performance covenants, or are otherwise in default, our lender has the option to declare all outstanding borrowings immediately due and payable, which could also cause a default under our senior subordinated convertible notes. If we would be required to immediately repay all, or a portion of this indebtedness, it could have a material adverse impact on our financial position and business.

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

We recognize product revenue net of estimated allowances for discounts, returns, rebates and chargebacks. Such estimates require our most subjective and complex judgment due to the need to make estimates about matters that are

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

Our quarterly results may fluctuate significantly and could fall below the expectations of securities analysts and investors, resulting in a decline in our stock price.

Our quarterly operating results may fluctuate significantly because of several factors, including:

• the level of our expenses, revenues and gross margins;

• the timing of our regulatory submissions or approvals;

• the initiation and progress of our clinical trials and other product development activities;

• the introduction of competitive products and announcements from competitors regarding actual or potential products under development or new commercial products, and the impact of competitive products and pricing;

• the level of orders within a given quarter and preceding quarters;

• the levels of inventory for our products maintained by our customers including wholesalers;

• the timing of our product shipments and our customer’s receipt of such shipments within a given quarter;

• the timing of introducing new products;

• the changes in our pricing policies or in the pricing policies of our competitors or suppliers; and

• our product mix and dependence on a small number of products for most of our revenue.

In addition, sales of Xibrom, which accounted for 62% of our net revenues in 2006, tend to be lower in the first quarter as compared to other quarters. Due to these and other factors, we believe that quarter-to-quarter comparisons of results from operations, or any other similar period-to-period comparisons, should not be construed as reliable indicators of our future performance. In any quarterly period, our results may be below the expectations of market analysts and investors, which would likely cause the trading price of our common stock to decrease.

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

We have entered into licensing collaborations with Senju Pharmaceutical, Co. Ltd. relating to Istalol, Xibrom, ecabet sodium, bepotastine, iganidipine, and certain prostaglandins compounds, including latanoprost. With respect to Xibrom, ecabet sodium, bepotastine and iganidipine, certain patent and other intellectual property rights we have received from Senju have been licensed to Senju from third parties. As a result, Senju’s license of such rights to us is subject to Senju maintaining and performing its obligations under these third party license agreements. We have also entered into collaborations with Allergan, Inc. and Otsuka Pharmaceutical Co. Ltd. relating to the commercialization of Vitrase and Vitragan in specified markets outside the United States for ophthalmic uses for the posterior region of the eye. Allergan retains an option to commercialize Vitragan for the posterior segment of the eye in Europe upon approval. During 2007, we have had discussions with the European authorities regarding Vitragan. Based on the additional data that the European Medicines Agency, or EMEA, has requested and the associated costs of complying with their request, we withdrew the Vitragan application in April 2007 and have notified Allergan that we will not be pursuing approval in Europe. We depend on Otsuka for obtaining regulatory approval of Vitrase for ophthalmic uses for the posterior region of the eye in Japan, and if such approval is obtained, we will be dependent upon Otsuka for the commercialization of Vitrase for such approved uses in Japan. The amount or timing of resources that our partners dedicate to our collaborations is not totally within our control. For example, in October 2005, Otsuka requested, and we agreed, that, in light of the U.S. development status of Vitrase for the treatment of vitreous hemorrhage, Otsuka’s development work for Vitrase for the treatment of vitreous hemorrhage in Japan be postponed until October 2008 or until such earlier time as Otsuka considers it is proper to resume such clinical development work. If Otsuka has not resumed development work before October 2008, we have agreed to meet with Otsuka to discuss the future development plans for Vitrase in Japan. As such, we do not know when Otsuka will continue its development work on Vitrase, if ever.

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Any breach or termination of our agreements by, or disagreements with, our collaborative partners could delay or stop the development and/or commercialization of our product candidates within the scope of these collaborations, or, in the case of Allergan and Otsuka, adversely impact our receipt of milestone payments, profit splits, royalties, and other consideration from these collaborations. In addition, any failure by Senju to perform its obligations under its license agreements with third parties or any adverse modification or termination of these third party license agreements could significantly impair our ability to continue or stop our development and/or commercialization of any product candidates or products for which Senju has licensed us rights subject to these third party agreements. Our collaborative partners may change their strategic focus, terminate our agreements or choose not to exercise their options, on relatively short notice, or pursue alternative technologies. Our agreements with Otsuka and Senju generally contain reciprocal terms providing that neither we nor they may develop products that directly compete in the same form with the products involved in the collaboration. Nonetheless, our collaborators may develop competing products in different forms or products that compete indirectly with our products.

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

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

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

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

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

Risks Related to Our Industry

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

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

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In addition, the FDA imposes a number of complex regulatory requirements on entities that advertise and promote pharmaceuticals, including, but not limited to, standards and regulations for direct-to-consumer advertising, off-label promotion, industry sponsored scientific and educational activities, and promotional activities involving the Internet.

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

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

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

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

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

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

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

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

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

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

As of June 30, 2007, we owned or licensed 74 U.S. and foreign patents and 24 U.S. and foreign pending patent applications. Our existing patents, or any patents issued to us as a result of such applications, may not provide us a basis for commercially viable products, may not provide us with any competitive advantages, or may face third-party challenges or be the subject of further proceedings limiting their scope or enforceability. We may become involved in interference proceedings in the U.S. Patent and Trademark Office to determine the priority of our inventions. In addition, costly litigation could be necessary to protect our patent position. We license patent rights from Senju for Istalol, Xibrom, ecabet sodium, bepotastine, iganidipine and certain prostaglandin compounds, including latanoprost. Some of these license agreements do not permit us to control the prosecution, maintenance, protection and/or defense of such patents. If the licensor chooses not to protect and enforce its own patent rights, we may not be able to take actions to secure our related product marketing rights. In addition, if such patent licenses are terminated before the expiration of the licensed patents, we may no longer be able to continue to manufacture and sell these products covered by the patents. In this regard, certain patent rights licensed from Senju have been licensed by Senju from third parties. As a result, any failure by Senju to perform its obligations under its license agreements with third parties or any adverse modification or termination of these third party license agreements could significantly impair our ability to continue or stop our development and/or commercialization of any product candidates or products for which Senju has licensed us rights subject to these third party license agreements.

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

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

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

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

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

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

Both governmental and private third-party payers are increasingly attempting to limit both the coverage and the level of reimbursement of new drug products to contain costs. Consequently, significant uncertainty exists as to the reimbursement status of newly approved healthcare products. Third-party payers may not establish adequate levels of reimbursement for any of our approved products or products we develop or acquire in the future, which could limit their market acceptance and result in a material adverse effect on our financial condition.

Continuing consolidation of our distribution network and the concentration of our customer base could adversely affect our results of operations.

Our principal customers are wholesale drug distributors and major retail drug store chains. These customers comprise a significant part of the distribution network for pharmaceutical products in the United States. This distribution network is continuing to undergo significant consolidation marked by mergers and acquisitions among wholesale distributors and the growth of large retail drug store chains. As a result, a small number of large wholesale distributors control a significant share of the market, and the number of independent drug stores and small drug store chains has decreased. We expect that consolidation of drug wholesalers and retailers will increase pricing and other competitive pressures on drug manufacturers. For the year ended December 31, 2006, our three largest customers accounted for 18%, 35% and 34%, respectively, of our net revenues. The loss of any of our customers could materially adversely affect our business, results of operations and financial condition and our cash flows. In addition, none of our customers are party to any long-term supply agreements with us which would enable them to change suppliers freely should they wish to do so.

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

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

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

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

In addition, competition from generic drugs is a major challenge in the United States to branded drug companies, like us, and may have a material adverse effect on our product revenues. The FDA granted Istalol a “BT” rating, which means that prescriptions for Istalol cannot be substituted legally at pharmacies with generic timolol maleate products. Nonetheless, we believe that certain pharmacies may have substituted, and may be continuing to substitute, Istalol prescriptions with generic timolol maleate solutions. We have completed an educational campaign to make our customers and pharmacies aware of Istalol’s BT rating and that Istalol cannot be legally substituted at pharmacies with generic timolol maleate products. However, our efforts may not be successful and pharmacies may continue to substitute Istalol subscriptions with generic timolol maleate solutions, which would negatively impact our results of operations.

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

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

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

Risks Related to Our Stock

Our stock price is subject to significant volatility.

Since 2002, the daily closing price per share of our common stock has ranged from a high of $74.40 per share to a low of $2.20 per share, as adjusted for the 1-for-10 reverse stock split effected November 2002. Our stock price has been and may continue to be subject to significant volatility. Among others, the following factors may cause the market price of our common stock to fall:

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

• market acceptance and demand for our approved products;

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

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

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

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

• period-to-period fluctuations in our financial results;

• public concern as to the safety of new technologies;

• future sales of debt or equity securities by us;

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

• comments made by securities analysts; and

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

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

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

The average daily trading volume in our common stock for the year ended December 31, 2006 was approximately 84,631 shares and the average daily number of transactions was approximately 336 for the same period. If limited trading in our stock continues, it may be difficult for investors to sell their shares in the public market at any given time at prevailing prices. Moreover, the market price for shares of our common stock is made more volatile because of the relatively low volume of trading in our common stock. When trading volume is low, significant price movement can be caused by the trading in a relatively small number of shares. Volatility in our common stock could cause stockholders to incur substantial losses.

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

We have approximately 31.9 million shares of common stock outstanding, most of which are freely tradable. In addition, as of June 30, 2007, an aggregate of 4,893,565 shares of common stock were issuable upon exercise of outstanding options, 951,152 shares of common stock were issuable upon exercise of outstanding warrants and 5,242,570 shares of common stock were issuable upon conversion of our senior subordinated convertible notes and 3,487,861 shares remain available for issuance under our equity incentive plans. The market price of our common stock could drop due to sales of a large number of shares or the perception that such sales could occur. These factors also could make it more difficult to raise funds through future offerings of common stock.

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

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

As of June 30, 2007, our directors and officers, as a group, control approximately 30% of our voting securities, a concentration of ownership that could delay or prevent a change in control. We are contractually obligated to include a representative of Investor Growth Capital as a nominee for election to our board of directors and the Sprout Group has the right to designate two such nominees. Our principal stockholders, if acting together, would be able to influence and possibly control most matters submitted for approval by our stockholders, including the election of directors, delaying or preventing a change of control, and the consideration of transactions in which stockholders might otherwise receive a premium for their shares over then-current market prices.

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

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

• a classified board of directors;

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

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

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

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

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

We have never declared or paid cash dividends on our common stock and do not plan to pay any cash dividends in the near future. Our current policy is to retain all funds and any earnings for use in the operation and expansion of our business. The payment of cash dividends by us is restricted by our credit facility and our senior subordinated convertible notes, which contain restrictions prohibiting us from paying any cash dividends without the lender’s or note holders, as the case may be, prior approval. If we do not pay dividends, our stock may be less valuable to you because a return on your investment will only occur if our stock price appreciates.

Item 6 Exhibits

Exhibit Number	Description
10.1	Purchase Agreement, dated as of June 26, 2007, by and between the Registrant and the investors named therein (Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the Commission on June 27, 2006).
31.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
31.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
32.1	Certification of Chief Executive Officer Pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.
32.2	Certification of Chief Financial Officer Pursuant to Rule 13a-14(b)/15d-14(b) of the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350.

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Signatures

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

	ISTA PHARMACEUTICALS, INC.
	(Registrant)
Dated: August 2, 2007	/s/ Vicente Anido, Jr., Ph.D.
	Vicente Anido, Jr., Ph.D.
	President and Chief Executive Officer
Dated: August 2, 2007	/s/ Lauren P. Silvernail
	Lauren P. Silvernail
	Chief Financial Officer, Chief Accounting Officer and Vice President, Corporate Development

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INDEX TO EXHIBITS

Exhibit Number	Description
10.1	Purchase Agreement, dated as of June 26, 2007, by and between the Registrant and the investors named therein (Incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K filed with the Commission on June 27, 2006).
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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