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, 2007. We obtained the market data and industry information contained in this Quarterly Report on Form 10-Q from internal surveys, estimates, reports and studies, as appropriate, as well as from market research, publicly available information and industry publications. Although we believe our internal surveys, estimates, reports, studies and market research, as well as industry publications, are reliable, we have not independently verified such information, and, as such, we do not make any representation as to its accuracy.

Overview

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

Results of Operations

Three Months Ended June 30, 2008 and 2007

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

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

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

                                  Net Revenue



                                Quarter Ended     Quarter Ended
           $ millions           June 30, 2008     June 30, 2007    % Change
           Xibrom              $          13.6   $           9.7         40 %
           Istalol                         2.8               2.5         12 %
           Vitrase                         1.3               1.3          0 %
           Other                           0.1               0.1          0 %

           Total Net Revenue   $          17.8   $          13.6         31 %

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

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

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

Generally, our research and development resources are not dedicated to a single project but are applied to multiple product candidates in our portfolio. As a result, we manage and evaluate our research and development expenditures generally by the type of costs incurred. We generally classify and separate research and development expenditures into amounts related to clinical development costs, regulatory costs, pharmaceutical development costs, manufacturing development costs, and medical affairs costs. In addition, we also record as research and development expenses any up front and milestone payments that have accrued to third parties prior to regulatory approval of a product candidate under our licensing agreements unless there is an alternative future use. For the three months ended June 30, 2008, approximately 52% of our research and development expenditures were for clinical development costs, 15% were for regulatory costs, 4% were for pharmaceutical development costs, 18% were for manufacturing development costs, 9% were for medical affairs costs and 2% for stock-based compensation expense.

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

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

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

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

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

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

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

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

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

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

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

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

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

Guidance

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

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

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

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

Six Months Ended June 30, 2008 and 2007

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

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

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

                                  Net Revenue



                             Six Months Ended     Six Months Ended
        $ millions            June 30, 2008        June 30, 2007      % Change
        Xibrom              $             25.5   $             16.7         53 %
        Istalol                            5.5                  4.7         17 %
        Vitrase                            2.2                  2.3         -4 %
        Other                              0.1                  0.1          0 %

        Total Net Revenue   $             33.3   $             23.8         40 %

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Liquidity and Capital Resources

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

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

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

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

For the six months ended June 30, 2008, we used $22.8 million of cash for operations principally as a result of the net loss of $21.4 million, the net . . .