<PAGE>
 
                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549

                              ___________________

                                  Form 10-K/A

                               (Amendment No. 1)

[X]  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
     ACT OF 1934

                   For the Year Ended December 31, 1998, 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:  0-26208

                               KERAVISION, INC.
            (Exact name of Registrant as specified in its charter)

                  Delaware                                     77-0328942
(State or other jurisdiction of incorporation                (I.R.S. Employer
               or organization)                              Identification No.)

                              48630 Milmont Drive
                               Fremont, CA 94538
                    (Address of principal executive offices)
      Registrant's telephone number, including area code:  (510) 353-3000

                       __________________________________

       Securities registered pursuant to Section 12(b) of the Act:  None

          Securities registered pursuant to Section 12(g) of the Act:

                    Common Stock, $0.001 par value per share
                       __________________________________

     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 than the
Registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days.  YES X   NO 
                                              ---     ---

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. (__)
            

     The aggregate market value of the voting stock held by nonaffiliates of the
Registrant based upon the closing sale price of the Registrant's Common Stock on
the Nasdaq National Market was approximately $152,467,487 as of March 31, 1999.
Shares of Common Stock held by each officer and director and by each person who
owns 5% or more of the outstanding Common Stock have been excluded in that such
persons may be deemed to be affiliates. This determination of affiliate status
is not necessarily a conclusive determination for other purposes.

     There were 12,820,919 shares of Registrant's Common Stock issued and
outstanding as of March 31, 1999.
<PAGE>
 
                      DOCUMENTS INCORPORATED BY REFERENCE

     Parts of the Proxy Statement for the Registrant's 1999 Annual Meeting of
Stockholders scheduled to be held on May 26, 1999  is incorporated by reference
in Part III of this Form 10-K Report.

                                 EXPLANATORY NOTE

     The undersigned Registrant hereby amends its Annual Report on Form 10-K for
the year ended December 31, 1998 as follows:
<PAGE>
 
                                     PART I

Item 1.  Business
-------  --------

  The Company notes that certain of the statements in this report, including
without limitation statements about the timing of FDA approval, are forward
looking.  Actual results may differ materially due to a variety of factors
including, but not limited to (i) unavailability of capital, (ii) lack of market
acceptance of KeraVision Intacs, (iii) determinations by the FDA or foreign
regulatory bodies that the clinical data collected are insufficient to support
the safety and efficacy of KeraVision Intacs (iv) changes in regulatory review
guidelines, procedures, regulations or administrative interpretations, (v)
complications relating to KeraVision Intacs or the surgical procedure, (vi)
competitive products and technology, and (vii) other risk factors described
under the heading "Risk Factors Affecting the Company, its Business and its
Stock Price" as set forth below in this Item 1.

General

  KeraVision was founded in 1986 to develop and commercialize proprietary
medical products for the treatment of common vision problems, including myopia
(nearsightedness), hyperopia (farsightedness) and astigmatism, which in the
aggregate are believed to affect one-half of the world's population.
KeraVision's initial product, KeraVision Intacs/TM/ are designed to reduce or
eliminate the need for eyeglasses or contact lenses to correct myopia by
reshaping the curvature of the cornea of the eye. KeraVision Intacs is composed
of two thin, half-circles that are inserted into the periphery of the cornea in
a simple outpatient procedure. KeraVision Intacs is made from a polymer that has
been used in intraocular lens replacements for cataract surgery since 1952.
KeraVision Intacs is designed to be permanent; however, it can be removed if
desired and the shape of the eye returns typically to its original curvature.
The currently available refractive surgery procedures typically require
irreversible cutting or tissue removal in the central cornea. Other potential
benefits of KeraVision Intacs are expected to include:

  .    long-term, convenient correction,

  .    rapid visual recovery,

  .    predictable results,

  .    a simple, minimally-invasive, out-patient procedure.


                               Recent Developments

  FDA approval.  On April 9, 1999 KeraVision obtained FDA approval to distribute
and sell KeraVision Intacs in the United States for the treatment of myopia in
the range of -1.0 to -3.0 diopters of correction in patients over 21 years old.
The FDA approval is conditioned upon post-market surveillance consisting of
monitoring a limited number of patients who participated in the Phase III
clinical trial for a period of two years. Results from the Phase III clinical
trial of KeraVision Intacs indicate that 97% of the patients achieved 20/40 or
better vision, 87% were 20/25 or better, 70% were 20/20 or better and 53% were
20/16 or better.

  Prior to granting this approval, the FDA had accepted for filing KeraVision's
application to sell KeraVision Intacs in August 1998. On January 12, 1999, the
relevant FDA advisory panel unanimously recommended that the FDA approve
KeraVision's application with conditions. These conditions related to labeling
changes and the post-market surveillance study. In February 1999, the FDA deemed
KeraVision's application "approvable."

  We have also applied for FDA clearance of our pending 510(k) pre-market
approval application for some of the surgical instruments which are used in the
KeraVision Intacs procedure. Upon receipt of this approval we plan to commence
commercialization of KeraVision Intacs in the United States. We have taken the
following steps to prepare for this commercialization:

  Surgeon training. We have established sites to train surgeons in the
KeraVision Intacs treatment. These sites are located in Atlanta, Houston, Kansas
City, San Diego, Santa Monica, and St. Louis. Each site is headed by an
ophthalmic surgeon who will lead the training. We have established relationships
with eye care services companies to provide surgical support services for
KeraVision's surgical training course in over 20 vision correction surgery
centers in the United States. To promote optimum clinical results, we will
proctor surgeons once they return home and begin performing the Intacs
treatment.

                                       3
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  Sales team. We have hired 11 direct sales representatives and four
manufacturers' representatives. Their initial focus will be on the vision
correction surgery markets where excimer laser procedures have already gained
acceptance.

  Market development. We are testing a multi-media advertising campaign in a
Canadian market and, if it is successful, may use this campaign in the United
States. As surgeons are trained in the KeraVision Intacs treatment, we intend to
help create consumer awareness through locally-oriented advertising and
publicity activities.

  Distribution and Sales. In April 1999, we entered into additional purchase and
distribution agreements with several eye care services companies that specialize
in vision correction. These companies have agreed to purchase KeraVision Intacs
and related instrumentation for use in vision correction surgery centers in the
United States.

  In Canada, KeraVision received approval in May 1998 to sell KeraVision Intacs
for the range of -1.0 to -5.0 diopters of correction, as well as the related
instrument set. KeraVision began commercialization of KeraVision Intacs in the
European Union for both mild and moderate myopia in December 1996, after
receiving the right to affix the CE Mark and the certification of KeraVision's
ISO 9001 quality system in November 1996. To date, KeraVision has primarily
concentrated its selling efforts for KeraVision Intacs and related instruments
in Canada, France and Germany.

  In Singapore, KeraVision began a clinical trial in July 1998 with the
objective of obtaining approval to sell product there after sufficient analysis
has been completed. KeraVision is also investigating other regions of Asia for
potential future commercialization opportunities.

  In April 1997, KeraVision began a feasibility study outside the United States
using KeraVision Intacs technology for the treatment of hyperopia. With
encouraging initial results obtained from 40 patients, KeraVision is seeking to
expand its feasibility study to up to three European clinical centers. Nine
patients have been enrolled in the expanded study.

 Sales and Marketing

  Vision impairment is a common worldwide healthcare problem. KeraVision
estimates that over one-half of the world's population suffers from common
vision problems such as myopia, hyperopia or astigmatism. In the United States,
approximately 140 million people currently use some form of eyewear to correct
for common vision problems, and an estimated 70 million people suffer from
myopia. Glasses and contacts are the most prevalent techniques to correct
vision. Surgical techniques to correct common vision problems, known as
refractive surgery, include laser assisted in situ keratomileusis ("LASIK"),
photo-refractive keratectomy ("PRK") and radial keratotomy ("RK"). LASIK and PRK
both require the use of a laser system to remove corneal tissue to achieve
flattening of the cornea. It is estimated more than 350,000 laser-based
treatments were performed in 1998, a substantial growth from the estimated
80,000 procedures performed in 1996, the first year after the approval of PRK in
late 1995. Each of these procedures requires irreversible cutting or tissue
removal in the central cornea.

  KeraVision believes that KeraVision Intacs may provide the following potential
benefits for the treatment of myopia:

  .    Long-term, Convenient Correction. KeraVision designed KeraVision Intacs
       to provide permanent correction of myopia in a form more convenient than
       eyeglasses or contact lenses;

  .    Removable, Replaceable Product. KeraVision Intacs can be removed in a
       simple, outpatient procedure, if desired. In cases where KeraVision
       Intacs has been removed, patients typically have returned to
       approximately the same level of vision as measured prior to insertion of
       KeraVision Intacs;

  .    Rapid Visual Recovery. Clinical trials to date have demonstrated that
       significant improvements in vision are achieved within one day after
       insertion of KeraVision Intacs;

  .    Predictable Results. KeraVision believes it has developed the ability to
       adequately predict the correction that can be achieved using KeraVision
       Intacs;

  .    Simple, Minimally-Invasive, Outpatient Procedure. The KeraVision Intacs
       procedure, which requires a single, small incision and separation of
       corneal tissue layers, can typically be performed in less than 15
       minutes. The outpatient procedure, performed using topical anesthesia,
       results in minimal trauma to the eye; and

  .    Standardized Procedure. KeraVision designed KeraVision Intacs and related
       instrumentation to standardize the procedure to promote ease of surgery
       and consistent outcomes.

                                       4
<PAGE>
 
 Strategy

  KeraVision's objective is to commercialize KeraVision Intacs technology for
the treatment of common vision problems on a worldwide basis. KeraVision's
business strategy for achieving this objective includes the following key
elements:

  .    Commercialize KeraVision Intacs for Treatment of Myopia. KeraVision
       received approval to commercialize KeraVision Intacs in the European
       Union in November 1996 with sales efforts focused in France and Germany.
       KeraVision received approval from the FDA in late 1996 to commence a
       Phase III clinical trial in the United States and had its premarket
       approval application accepted for filing by the FDA in August 1998. On
       April 9, 1999, KeraVision received FDA approval to sell and distribute
       KeraVision Intacs in the United States for the treatment of myopia. In
       Canada, KeraVision received approval to sell KeraVision Intacs and
       related instrumentation in May 1998. By focusing on the approval and
       commercialization of KeraVision Intacs for myopia, KeraVision seeks to
       establish a scientific, technical, regulatory and marketing platform to
       facilitate the approval and launch of potential products under
       development for the treatment of other vision problems.

  .    Increase Awareness of KeraVision Intacs. In developing and testing its
       technology, KeraVision works with a broad range of independent
       researchers to expand awareness of KeraVision Intacs technology.
       KeraVision also works with leading surgeons and academic centers in the
       ophthalmology field in the design, development and clinical testing of
       its technology. KeraVision believes that these researchers, practitioners
       and institutions, among others, have significant influence on the
       adoption of new technologies and the development of clinical parameters
       upon which these technologies are analyzed. In addition, KeraVision
       dedicates significant resources to the publication of research papers,
       the presentation of clinical and technical data at major ophthalmology
       conferences, and the review of KeraVision Intacs clinical data with
       leading ophthalmologists. Through these activities, KeraVision seeks to
       disseminate accurate clinical information and foster awareness of
       KeraVision Intacs technology.

  .    Focus Initial Marketing on Surgeons. KeraVision is focusing its initial
       marketing efforts on opinion leaders and surgeons with active practices
       in the ophthalmic community. As part of this strategy, KeraVision has
       developed surgeon training programs utilizing its proprietary instruments
       to promote standardized procedures for insertion of KeraVision Intacs.
       KeraVision believes that an emphasis on surgeon training will aid in
       achieving successful procedural outcomes and thereby increase market
       acceptance of KeraVision Intacs by both ophthalmic surgeons and patients.

  .    Expand Applications of Core Technology. KeraVision has products under
       development utilizing its core KeraVision Intacs technology for the
       treatment of other common vision problems, including hyperopia and
       astigmatism. In each target application, KeraVision seeks to preserve the
       potential advantages of its technology as a refractive procedure that
       does not interfere with the central cornea. KeraVision is currently
       working to expand the potential applications of its core KeraVision
       Intacs technology, including the development of new designs, the use of
       new materials and the development of new surgical techniques and
       instruments.

  .    Utilize Advanced Development Methods. KeraVision seeks to use advanced
       scientific and engineering methods in developing KeraVision Intacs
       technology or other potential products for different types of vision
       impairment. These include the use of sophisticated modeling techniques to
       understand the optical, mechanical and biological effects of inserting
       KeraVision Intacs or other potential products into the cornea to correct
       for myopia, hyperopia, astigmatism or combinations of each. KeraVision
       believes that this approach allows it to improve the design of its
       potential products and increase its understanding of potential product
       performance prior to commencing clinical trials.

  .    Strengthen Proprietary Position. KeraVision intends to continue to
       develop and protect its proprietary KeraVision Intacs technology. To
       date, KeraVision has 18 United States and 24 foreign patents issued and
       has filed applications for over 180 United States and foreign patents.

 Background

  Vision and Vision Impairment. The eye functions much like a camera,
incorporating a lens system consisting of a cornea and a lens that focuses
light, the iris which functions as an aperture system that regulates the amount
of light that passes through the central zone of the cornea, and the retina, a
light-sensitive surface that, like film, records the image. The cornea, lens and
iris operate to focus light rays on the retina, which contains the light-
sensitive receptors that transmit the image through the optic nerve to the
brain. Nearly all light that reaches the retina passes through the central
portion of the 

                                       5
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cornea, called the optical zone. Approximately 75% of the refractive, or
focusing, power of the eye is provided by the curvature of the cornea.

  Most common refractive problems result from an inability of the optical system
to focus images on the retina properly. This inability to focus is known as a
refractive error. For instance, in the myopic (nearsighted) eye, light rays
focus in front of the retina when the curvature of the cornea is too steep.
People with myopia see nearby objects clearly, but distant objects appear
blurry. Conversely, in the hyperopic (farsighted) eye, light rays focus behind
the retina when the curvature of the cornea is too flat. People with hyperopia
see distant objects clearly, but may need correction so that nearby objects do
not appear blurry. In the astigmatic eye, the curvature of the cornea is not
uniform. This lack of uniform curvature makes it difficult for a person to focus
clearly on an object. Refractive surgery changes the cornea's refractive power
by altering the curvature of the cornea, so that light passing through the eye
can be properly focused on the retina, thereby improving vision.

  Vision Correction Market. KeraVision estimates that over one-half of the
world's population suffers from common vision problems such as myopia, hyperopia
or astigmatism. In the United States alone, approximately 140 million people
currently use eyeglasses or contact lenses to correct these common vision
problems, with over $12 billion spent for corrective eyewear products annually.
It is estimated that over 70 million people are affected by myopia. Of the 70
million people with myopia, an estimated 26 million people have low to moderate
myopia without significant astigmatism and are age 21 or older. As many as an
estimated 22 million of these 26 million people have mild myopia and require -
1.0 to -3.5 diopters of correction, the range covered by KeraVision Intacs
application. In addition to age and degree of myopia, KeraVision believes that
the potential market for KeraVision Intacs may be further limited by the
inability of some patients to afford the procedure, the psychological aversion
of some patients to refractive surgery, the acceptance of other refractive
surgery techniques or other factors.

  Market research in the United States has shown that people using corrective
eyewear would like to achieve long-term, more convenient vision correction. In
response, ophthalmic surgeons and medical researchers have sought to develop
alternatives to eyeglasses and contact lenses to correct refractive errors.
Their efforts have resulted in the emergence of the field of refractive surgery.

  The most prevalent surgical techniques that have emerged are LASIK, PRK and
RK. Generally these procedures have been used to treat myopia; however, laser-
based technologies to treat hyperopia have recently been approved by the FDA,
and other procedures are under development.

  Although the target market is potentially large, it is estimated that over 50%
of that group have completed another refractive surgery or are currently outside
the range of correction provided by KeraVision Intacs.

  Current Refractive Surgery Techniques. Current refractive surgery procedures
include PRK, LASIK and RK, among others. PRK is a refractive surgery technique
in which a laser is used to irreversibly remove tissue within the optical zone
to reshape the cornea, with the amount of tissue to be removed based upon the
level of intended change sought. Typically, the top layer of the central cornea,
known as the epithelium, is manually removed. The patient is then asked to
fixate on a light to minimize eye movement while the laser removes or ablates
tissue from the central cornea. The procedure, the results of which can be
dependent on the variability of the laser beam and individual patient wound
healing response, is conducted in an outpatient setting using topical
anesthetic, although postoperative pain may require the prescription of
narcotics for the first few days following the procedure. While vision
improvement is achieved, PRK depends in part on a healing response to reach the
desired level of flattening of the cornea, which generally occurs over a three-
month period, although the cornea may continue to reshape itself over a 12- to
15-month period. The equipment required to conduct this procedure is
significantly more expensive than the equipment required for use in RK. Because
PRK, like RK, surgically alters tissue in the optical zone, haze, haloes,
reduced night vision and other vision problems have been observed in patients
who have undergone the PRK procedure.

  LASIK, estimated to be the most common refractive surgery technique used in
the United States, involves using an automated cutting device called a
microkeratome to cut a large corneal flap, which is then pulled back to expose
the underlying tissue called the stroma. A laser is used to remove stromal
tissue from the central cornea. The corneal flap is then placed back on the
stromal tissue where it adheres back onto the eye. With the removal of the
corneal tissue, the cornea is flattened, thereby achieving correction for
myopia. Primary complications with this procedure arise from cutting of the
corneal flap, including incorrect flap thickness.

  In RK, a diamond knife is used to make from four to eight radial incisions
that penetrate beyond 90% of the depth of the cornea. The procedure is generally
conducted using topical anesthesia in an outpatient setting. As the incisions
heal, the curvature of the cornea is altered and vision may be improved.
Although additional operations may be performed to attempt to improve the vision
for those whose vision is undercorrected, the RK procedure is considered to be
refractively 

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irreversible. RK results can vary with the skill and experience of the surgeon
and can be relatively unpredictable for patients requiring greater degrees of
correction. Because RK entails making cuts in or near the optical zone of the
eye, unwanted side effects, such as haloes, reduced night vision and other
visual distortions may occur. In addition, data from the Prospective Evaluation
of Radial Keratotomy ("PERK") 10-year study, funded by the National Eye
Institute and completed in 1994, indicate that a significant percentage of those
undergoing RK did not achieve a stable result as measured over a ten-year
period, with a shift towards hyperopia occurring over time. The PERK data,
however, did indicate that 85% of patients undergoing the procedure achieved
visual acuity of 20/40 or better vision. In addition, it is believed the RK
technique has improved since the PERK study commenced.

  Another treatment for myopia currently being investigated in a phase III
clinical trial in the United States is the Intraocular Contact Lens or ICL. The
ICL seeks to correct refractive errors by placing a lens inside the eye between
the natural lens and the iris. The ICL is currently available for sale in
Europe.

  Another potential treatment for vision correction is Radio Frequency
Keratoplasmy (RFK), which uses radio-frequency energy to change the shape of the
cornea. Currently, this treatment has been approved for use in Canada but has
not been approved for use in the United States.

  Quality of Vision. The most common measurement of vision utilizes an eye
chart. One of the recent developments in ophthalmology involves the concept of
quality of vision. It has been observed that a patient can attain 20/20 vision,
as measured with an eye chart, and still be dissatisfied with the quality of his
vision. This issue may play a role in the future in modifying current refractive
surgery techniques, which are known to affect the smooth shape of the cornea and
to create corneal scarring in ways that may induce unwanted visual aberrations.
Typical vision complaints include haze, haloes, reduced night vision and other
visual distortions. At the current time, most assessments attribute undesirable
visual side-effects of refractive procedures either to a disturbance of corneal
tissue within the optical zone or to the interruption or distortion of the
smooth shape of the cornea. New measurement techniques, including corneal
topography, contrast sensitivity and night-vision testing, are emerging to
analyze more fully the quality of vision beyond the assessment available using
standardized eye charts.

 KeraVision Intacs and Instruments

  In response to the perceived market need for a predictable, refractively
reversible procedure, KeraVision has developed KeraVision Intacs for the long-
term treatment of myopia. KeraVision Intacs is a proprietary product designed to
reduce or eliminate the need for corrective eyewear by reshaping the curvature
of the patient's cornea. KeraVision Intacs is inserted between the layers of the
corneal stroma through a small incision made in the periphery of the cornea. The
presence of KeraVision Intacs in the periphery of the cornea creates a
flattening of the central cornea, thereby increasing the number of light rays
properly focused on the retina. The KeraVision Intacs procedure does not cut or
remove tissue from the optical zone of the cornea and therefore may reduce the
risk of unwanted visual side-effects such as haze, haloes and reduced night
vision.

  The initial design of KeraVision Intacs consisted of an optically clear split
ring made of polymethylmethacrylate ("PMMA"), a clear acrylic that has been
widely used in implantable intraocular lenses since 1952. In order to simplify
the surgical procedure, KeraVision modified the design of KeraVision Intacs in
1995 into two, thin half-circles of PMMA, each with an arc length of 150
degrees. The two half-circles are placed in the periphery of the cornea at a
diameter of approximately eight millimeters. KeraVision has extensively studied
the relationship between physical parameters of KeraVision Intacs and corneal
curvature change. As a result of these studies, KeraVision believes that a small
number of KeraVision Intacs sizes, with minor variations in their dimensions,
can produce a wide range of corneal curvature change and, therefore, could
provide treatment for a substantial segment of those people with myopia.
KeraVision has developed KeraVision Intacs in six different thicknesses ranging
from 0.21 mm to 0.45 mm.

  KeraVision has developed proprietary surgical instruments to be used for the
insertion of KeraVision Intacs. These stainless steel and titanium instruments
include a marking instrument, a centering guide and a stromal separator.
KeraVision's instruments have been designed to standardize the KeraVision Intacs
procedure and reduce the variability associated with differing levels of
surgical skill by, among other things, showing the surgeon where to make the
corneal incision and aiding the surgeon in placing KeraVision Intacs at the
right depth. It is believed that the purchase of KeraVision's instruments will
represent a small capital investment for ophthalmic surgeons, similar to that
required for surgeons performing RK procedures and substantially less than that
required for surgeons performing LASIK or PRK procedures.

                                       7
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 The KeraVision Intacs Insertion Procedure

  KeraVision believes that insertion of KeraVision Intacs is a relatively
simple, minimally invasive procedure that can be performed on an outpatient
basis in typically 15 minutes or less. The procedure is usually performed using
topical anesthetic eyedrops. In addition to the KeraVision instruments, the
KeraVision Intacs procedure in part employs surgical techniques and ophthalmic
surgical instruments that are widely used by ophthalmic surgeons. The KeraVision
Intacs procedure requires a single incision of less than two millimeters outside
of the optical zone of the cornea. The incision is located at the top of the eye
under the eyelid. The amount of postoperative discomfort experienced by patients
participating in KeraVision Intacs clinical studies has been relatively modest
and is typically treated with nonprescription pain relievers.

  The KeraVision Intacs insertion procedure consists of the following steps.
First, the ophthalmic surgeon uses a guide to mark the geometric center of the
cornea. Using the reference mark, a marking instrument is used to mark the line
of incision on the cornea outside the optical zone and the location where the
ring segments are to be placed. A small entry incision is then made to
approximately two-thirds of the depth of the cornea and the layers of the stroma
at the bottom of the incision are separated. The stroma, which comprises 90% of
the cornea, consists of 500 to 700 overlapping layers of tissue that can be
easily separated. Next, the surgeon places the centering guide over the eye,
introduces the stromal separator through the small entry incision and rotates
the stromal separator, spreading the layers of the stroma to create a circular
subsurface channel in the periphery of the cornea. The surgeon removes the
stromal separator and the centering guide. KeraVision Intacs is introduced into
the channel and rotated into place. Finally, the entry incision is typically
closed with one to two sutures which are generally removed within two weeks.

  Clinical Trials Results

  Since 1991, ophthalmic surgeons have utilized KeraVision Intacs technology for
the treatment of myopia in 1,700 patient eyes in clinical trials conducted in
the United States and throughout the world. KeraVision initiated clinical trials
using the initial design of KeraVision Intacs in 1991 in both the United States
and Brazil. In September 1994, KeraVision completed enrollment of a 90-patient
United States Phase II myopia trial using the initial design of KeraVision
Intacs. In September 1996, KeraVision completed enrollment of the group of 150
United States Phase II patients with a modified KeraVision Intacs.  In October
1996, KeraVision received approval to commence a ten-center Phase III clinical
trial in the United States and began that trial in December 1996. KeraVision
completed the enrollment for the trial in May 1997. KeraVision expanded the
Phase III trial to cover a greater range of myopia and has begun limited
enrollment for the expanded ranges. In addition, KeraVision has conducted
clinical trials in Europe for myopia and has begun a trial for myopia in
Singapore.

  KeraVision's clinical trials have been designed to demonstrate the safety and
efficacy of KeraVision Intacs and the safety of the surgical procedure used to
insert KeraVision Intacs. Safety of KeraVision Intacs is evaluated using
standard ophthalmic techniques.

  Myopia. In May 1995, KeraVision commenced a United States Phase II trial for
the current KeraVision Intacs design. This trial included six clinical sites and
involved 150 patients requiring a myopic correction in the range of -1.0 to -6.0
diopters. KeraVision completed enrollment in September 1996 for this Phase II
trial. KeraVision performed an interim analysis on the initial 75 patients who
had three months of available follow-up. KeraVision submitted this data to the
FDA for review prior to initiating the Phase III trial for KeraVision Intacs.
Based upon the analysis of the Phase II data, KeraVision proceeded to slightly
modify the range of correction achieved with the current KeraVision Intacs
design and to separate the myopia indication into mild myopia (-1.0 to -3.5
diopters) and moderate myopia (-3.5 to -5.0 diopters).

  KeraVision implanted a total of 195 patient eyes as part of this Phase II
trial. The data from the first 139 Phase II patients (-1.0 to -6.0 diopters)
with twelve months of follow-up indicated that 91% were 20/40 or better, 76%
were 20/25 or better and 60% were 20/20 or better. Additionally, 79% of the
patients were within 1.0 diopter of their intended correction. Five surgically-
related events resulted in the removal of one or both Intacs segments as of the
twelve month point: two cases of infection and three cases related to surgical
technique. All of these patients are stable with no clinically significant
consequences. In total, 31 of the 195 patient eyes underwent removal of
KeraVision Intacs by the twelve month point due to patient dissatisfaction
related to undercorrection (eleven), visual symptoms including glare, halos, and
other symptoms related to low light conditions (nine), induced astigmatism (ten)
and cosmetic reasons (one).

  KeraVision initiated an expanded Phase II trial in November 1996 to evaluate
moderate myopia (-3.5 to -5.0 diopters) using the revised performance criteria
for two thicker Intacs sizes. Enrollment of the 59 patients was completed in
February 1997. The three month follow-up data for 58 Phase II patients with the
two higher ring sizes indicated that 98% were 20/40 or better, 83% were 20/25 or
better and 57% were 20/20 or better. The predictability of the refractive effect
within 1.0 diopter increased from 46% to 70% for this trial as compared to the
results from initial Phase II trial for the same thicknesses. Two surgically
related events resulted in the removal of one or both Intacs segments: one case
of infection and 

                                       8
<PAGE>
 
one case related to surgical technique. Both patients are stable with no
clinically significant consequences. Seven patient eyes underwent removal of
KeraVision Intacs due to patient dissatisfaction: one removal related to under-
correction, three removals related to visual symptoms, two removals related to
induced astigmatism and one removal related to cosmetic reasons. KeraVision
submitted the three month follow-up data from this trial to the FDA and received
approval in November 1997 to expand the existing Phase III trial to include
these sizes of KeraVision Intacs.

  In December 1996, KeraVision initiated a Phase III trial at ten clinical sites
involving 360 patients, for a total of 595 patient eyes, requiring correction
for mild myopia (-1.0 to -3.5 diopters). Enrollment was completed for this trial
in early May 1997. The recently presented data from the first 410 Phase III
patient eyes with twelve months of follow-up indicate that 97% were 20/40 or
better, 87% were 20/25 or better, 74% were 20/20 or better and 53% were 20/16 or
better. The predictability data indicated that 89% of the patients were within
1.0 diopter of their intended correction. There have been 26 removals of
KeraVision Intacs from the 595 patient eyes, included in this Phase III trial.
There was one postoperative adverse event reported in which a subject had a best
spectacle corrected visual acuity loss of ten or more letters at two consecutive
exams. The investigator is currently monitoring this subject. Three removals
were for personal reasons. Twenty-three KeraVision Intacs were removed due to
patient dissatisfaction with the correction achieved although some of these
patients achieved 20/40 vision or better.

  In anticipation of the launch of KeraVision Intacs in the European Union,
KeraVision conducted two European clinical trials. The results from these trials
are comparable with KeraVision's clinical studies in the United States.

  Complications, Visual Side Effects and Observations. Although KeraVision has
developed seven-year clinical data on the safety and efficacy of KeraVision
Intacs in correcting myopia, it has only limited long-term safety or efficacy
data. KeraVision performed the first procedure for the treatment of myopia using
KeraVision Intacs in 1991, and to date KeraVision has conducted more than 1,700
procedures using KeraVision Intacs technology in clinical trials. We cannot
assure you that long-term safety and efficacy data when collected will be
consistent with these clinical trial results and will demonstrate that
KeraVision Intacs can be used safely and successfully to treat myopia in a broad
segment of the population or on a long-term basis.

  All surgical procedures, including the KeraVision Intacs procedure, involve
some inherent risk of complications. KeraVision has observed complications in a
small number of patients who have received KeraVision Intacs, but no patient has
suffered any serious or lasting injury to the eye or any material loss of either
uncorrected or best corrected visual acuity. The complications include, among
other things: induced astigmatism, infection, decentered placement and a
reduction in central corneal sensation. In addition, patients undergoing
KeraVision Intacs procedure have reported visual side effects. These include
glare, haloes and reduced night vision. All of these complications and visual
side effects have also been observed in connection with other refractive
surgeries. Although KeraVision believes these complications and side effects may
be mitigated, KeraVision cannot assure you that these or other complications or
side effects will not be serious or lasting or will not impair or preclude
KeraVision from obtaining regulatory approval for its potential products or the
acceptance of these products by patients or ophthalmologists. In many patients,
KeraVision has observed deposits in the stromal channel next to KeraVision
Intacs. Although KeraVision believes that these deposits are not complications
and do not cause side effects, we cannot assure you that this will be the case.

  Hyperopia. Data obtained from laboratory work on eye bank eyes and from finite
element analysis has indicated that a design based on KeraVision Intacs
technology may correct hyperopia. Based on these data and analysis, KeraVision
is testing the feasibility of a potential product for hyperopia in a small
clinical study, with 40 patients to date having undergone a procedure to correct
hyperopia. Made from the same material as KeraVision Intacs for myopia and using
a simple insertion technique, the early results from this study are promising,
but require more long-term follow-up. In addition, because only a limited number
of patients to date have received the treatment for hyperopia. KeraVision will
need to treat additional patients in order to characterize the range and
predictability of correction prior to moving to a large scale study. Work has
begun in one clinical center, with nine patients having been enrolled.
KeraVision intends to do further characterization in up to three European
clinical centers in the near future.

  Astigmatism. KeraVision has studied a potential product that uses arc segments
of KeraVision Intacs to treat astigmatism. This device utilizes the core
technology for the treatment of myopia and the segments are manufactured from
the same material as KeraVision Intacs. A similar surgical technique is employed
to implant the segments in the eye. In August 1994 and March 1995, KeraVision
implanted arc segments in eight astigmatic patients. Clinical results showed
that the patients exhibited improvement in their vision after the implantation
of arc segments. KeraVision is pursuing broader experimentation and analysis,
but has not enrolled further patients due to the perceived smaller size of the
potential market.

                                       9
<PAGE>
 
Marketing and Sales

  Europe. Upon obtaining the right in November 1996 to market KeraVision Intacs
in European Union countries, KeraVision commenced a sales and marketing program
concentrated in parts of France, Germany and Austria. As part of this program,
KeraVision established a European headquarters in Paris, France. A small sales
office in France handles sales of KeraVision Intacs in the French market. A
distributor sells KeraVision's products in Germany and Austria.

  From information obtained in the course of conducting the training sessions
and from consumer marketing studies, KeraVision determined that the overall
refractive surgery market in France and Germany was significantly less than that
of the United States on a per capita basis, and that the refractive surgery
markets in those countries do not appear to be growing at a substantial rate, if
at all. This lack of growth may be related in part to the lack of a delivery or
referral channel whereby potential patients can easily reach the ophthalmic
surgeon, rather than the non-surgical ophthalmologists and opticians who may
tend to recommend that a patient not consider refractive surgery. Further,
restrictions on direct broad scale advertising hinders the expansion of consumer
awareness of refractive surgery. It is expected that because of these and other
factors the refractive surgery market and the market for KeraVision Intacs will
be slow to develop in Europe. KeraVision, however, is seeking to expand its
reach to other countries by adding additional distributors.

  Canada. KeraVision received approval in Canada to sell KeraVision Intacs for
the treatment of myopia in the range of -1.0 to -5.0 diopters of correction,
along with related instruments, in May 1998. KeraVision focused its initial
marketing efforts on developing seven sites to become proficient in KeraVision
Intacs procedure, to be able to discuss the Canadian experience with KeraVision
Intacs and to potentially serve as training centers. KeraVision then formally
announced the product launch in October 1998. KeraVision's next goal is to
target a specific region of Canada for the purpose of training a high percentage
of the refractive surgeons in the region and then to test the effect of consumer
advertising on patient flow to those centers. KeraVision has hired a direct
sales force to facilitate the Canadian sales process.

  United States. The primary market for KeraVision Intacs is the ophthalmic
surgery market. There are approximately 8,000 ophthalmic surgeons in the United
States. Cataract surgery, with an intraocular lens replacement, is the most
prevalent form of ophthalmic surgery, with an estimated more than 1.5 million
procedures being performed annually in the United States. KeraVision believes
that increased consumer interest in corneal refractive surgery, improved visual
results of emerging refractive surgery techniques and reduced reimbursement
rates for cataract surgery are providing incentives for ophthalmic surgeons to
enter the refractive surgery market. It is estimated that there are over 2,000
ophthalmic surgeons performing refractive surgery in the United States.

  KeraVision estimates that existing refractive procedure costs in the United
States average $2,100 per eye for a LASIK procedure, $800 per eye for a RK
procedure and $1,800 per eye for a PRK procedure, with a fairly wide range for
each procedure. KeraVision anticipates that the KeraVision Intacs procedure, if
approved for marketing in the United States, will be competitively priced with
existing laser-based procedures. It is estimated that over 350,000 laser-based
procedures were performed in 1998.

  KeraVision currently has limited sales or marketing organization or
experience. Because the ophthalmic surgery market is highly concentrated,
KeraVision expects to market its products through a direct sales force, or a
combination of a direct sales force and distributors, in the United States and
Europe. In other selected foreign markets, including parts of the Pacific Rim,
KeraVision may seek a strategic partner to assist in regulatory approval and
marketing activities. Medical investigators have presented KeraVision Intacs
technology as an investigational device at various professional meetings and
symposia in the United States, Europe and Asia. KeraVision expects continued
demonstrations of its technology at scientific and ophthalmic conferences
worldwide.

 No Reimbursement

  Consumers receiving treatment generally pay directly for currently available
refractive surgery procedures and are generally not reimbursed by third-party
payers. We anticipate that consumers will also pay directly for KeraVision
Intacs procedures. KeraVision believes that the successful development and
commercialization of KeraVision Intacs will not depend upon the availability of
third-party reimbursement.

 Patents and Proprietary Rights

  One of KeraVision's primary strategies has been to develop a strong
proprietary patent position with respect to KeraVision Intacs technology.
KeraVision has over 180 pending patent applications worldwide and has been
awarded 24 United States patents and 38 foreign patents. These issued and
pending patents cover various aspects of KeraVision Intacs technology, including
KeraVision Intacs, methods of use, instruments and related materials and other
vision correction technology. The expiration dates of the United States issued
patents range from 2002 to 2015. KeraVision's policy is to 

                                       10
<PAGE>
 
protect its technology by, among other things, filing patent applications
relating to important aspects of its KeraVision Intacs technology and other
vision correction technology.

 Manufacturing and Supply

  KeraVision manufactures KeraVision Intacs in its facility in Fremont
California using a computer-controlled machining process. This process will
require continued regulatory review and approval from both foreign and United
States government agencies, which could result in significant manufacturing and
shipping delays. Third-party suppliers manufacture critical components of
KeraVision's instruments to KeraVision's specifications. In many cases,
instruments and other purchased materials critical for production are sole-
sourced. KeraVision has entered into confidentiality agreements with its
contract manufacturers in order to protect the proprietary nature of its
technology. We cannot assure you that KeraVision will be able to develop
clinical or commercial-scale manufacturing capabilities at acceptable costs or
enter into agreements with third parties with respect to these activities.

  KeraVision Intacs is made from PMMA, a clear acrylic widely used in
implantable intraocular lenses since 1952. PMMA cast sheet is purchased from a
sole supplier and is stored at KeraVision prior to release to production.
KeraVision believes it could develop the capability over a significant time
period to manufacture PMMA cast sheet internally if this sole source were to
become unavailable. As a result of the notification that its supplier has
discontinued its manufacture of the particular material used by KeraVision,
KeraVision has agreed to purchase a significant supply of the PMMA cast sheet
stock which is expected to be delivered over the next 12 months. Any change in
materials used for KeraVision Intacs would require additional testing,
regulatory review and approval, which could result in significant manufacturing
and shipping delays. KeraVision sterilizes KeraVision Intacs at a sole-sourced
independent contract sterilization facility.

  KeraVision has several sole-sources for sterilization, tools and equipment,
PMMA and other elements necessary to manufacture KeraVision Intacs and the
related instrumentation. Since KeraVision is dependent upon third parties for
the manufacture of its products, KeraVision's profit margins and its ability to
develop and deliver such products on a timely basis may be adversely affected by
the lack of alternative sources of supply. Moreover, we cannot assure you that
our sole suppliers will adequately perform and any failures by third parties may
delay the submission of products for regulatory approval, impair KeraVision's
ability to deliver products on a timely basis, or otherwise impair KeraVision's
competitive position.

  KeraVision has limited volume manufacturing capacity and is building
experience in manufacturing medical devices and other products. To be
successful, KeraVision's proposed products must be manufactured in commercial
quantities in compliance with regulatory requirements at acceptable costs.
Production in clinical or commercial-scale quantities may involve technical
challenges for KeraVision. Establishing its own manufacturing capabilities may
require significant scale-up expenses and additions to facilities and personnel.
KeraVision may consider seeking collaborative arrangements with other companies
to manufacture some of its potential products, including KeraVision Intacs. The
manufacturer of KeraVision's potential products will be subject to periodic
inspection by regulatory authorities. Any such operations must undergo
compliance inspections conducted by the FDA and equivalent inspections conducted
by state and foreign officials. We cannot assure you that KeraVision will be
able to successfully pass these inspections on a timely basis or at all.

 Research and Development

  KeraVision has been engaged in the research and development of KeraVision
Intacs technology since its inception in 1986. The development effort has
incorporated both extensive clinical testing as well as laboratory testing to
determine the effect of various configurations and insertion techniques for
KeraVision Intacs technology. Some of the analytical techniques employed include
computer modeling using finite element analysis, optical ray tracing and various
corneal topography measurement instruments. These approaches aid in determining
the expected change in the shape of the cornea, the pattern of light
distribution through the cornea and curvature of the cornea achieved with
various designs. The analytical approaches are used in conjunction with
information determined from both feasibility studies and expanded clinical
trials to determine the best design to move forward in the testing cycle.

  KeraVision has also used these approaches to begin work on potential products
for astigmatism and hyperopia. KeraVision has begun investigations into
refinements for the existing product for myopia, including myopia concurrent
with high level of astigmatism and potential treatments for slightly higher
levels of myopic correction.

 Competition

  KeraVision Intacs competes with other treatments for refractive problems,
including eyeglasses, contact lenses, other refractive surgery procedures such
as PRK, LASIK, RK, the ICL, RFK and "refractive" intraocular lenses. Refractive
intraocular lenses involve the placement of an intraocular lens for the
correction of vision problems. Significant competitive factors in the industry
include efficacy of vision correction, safety, reliability, convenience and
price. The healthcare field is 

                                       11
<PAGE>
 
characterized by extensive research and rapid technological change. At any time,
competitors may develop and bring to market new products or surgical techniques
with vision correction capabilities superior to those of KeraVision Intacs or
which would otherwise render KeraVision Intacs technology obsolete.

  Other companies, most of which are larger and better financed than KeraVision,
are engaged in the refractive surgery market. Four companies, Summit Technology,
VISX, Autonomous Technologies and Nidek, Inc. have received approval to market
their products in the United States. Summit Technology recently purchased
Autonomous Technologies. In addition to Summit Technology and VISX, there are a
number of other large entities that currently market and sell laser systems
overseas for use in refractive surgery, including Bausch and Lomb, Aesculap-
Meditec, GmbH and Schwind, several of whom are seeking to obtain approval with
the FDA to sell their products in the United States.

  KeraVision's competition will be determined in part by those refractive
surgery products that are ultimately approved for sale by regulatory
authorities. The relative speed at which KeraVision is able to develop its
potential products, complete the necessary governmental and regulatory approval
processes for those products and manufacture and market commercial quantities of
the products will be important competitive factors.

 United States Government Regulation and Product Testing

  KeraVision's potential products are subject to regulation by numerous
governmental authorities in the United States and other countries. In the United
States, medical devices are subject to rigorous FDA review. Pursuant to the
Federal Food, Drug, and Cosmetic Act and other federal statutes and regulations,
the FDA regulates the

  .    testing;

  .    manufacture;

  .    safety;

  .    labeling;

  .    storage;

  .    record keeping;

  .    reporting;

  .    approval;

  .    sale;

  .    distribution;

  .    advertising; and

  .    promotion of medical devices.

  Noncompliance with applicable requirements can result in:

  .    fines;

  .    recall;

  .    injunction or seizure of products;

  .    total or partial suspension of production;

  .    withdrawal of approval or refusal to approve product approval
       applications or allow KeraVision to enter into supply contracts; and

  .    criminal prosecution.

                                       12
<PAGE>
 
  The FDA also has the authority to request repair, replacement or refund of the
cost of any device manufactured and distributed by KeraVision. Changes in
existing requirements or adoption of new requirements could have a material
adverse effect on KeraVision's business, financial condition and results of
operation.

  Medical devices are classified into one of three classes, Class I, II or III,
on the basis of the controls necessary to reasonably assure their safety and
effectiveness. Safety and effectiveness can reasonably be assured for Class I
devices through general controls including labeling, premarket notification and
adherence to the Quality System Regulation and for Class II devices through the
use of additional special controls including performance standards, postmarket
surveillance, patient registries, and FDA guidelines. Generally, Class III
devices are those which must receive premarket approval by the FDA to ensure
their safety and effectiveness. Class III devices include life-sustaining, life-
supporting and implantable devices, or new devices which have been found not to
be substantially equivalent to legally marketed devices.

  510(k) Pre-Market Notification Process. Before a new device can be introduced
to the market, the manufacturer generally must obtain FDA clearance through
either a 510(k) premarket notification or a premarket approval application.
KeraVision's surgical instruments are the only products for which it will be
seeking 510(k) clearance; however, KeraVision may submit 510(k)s with respect to
future potential products. The FDA will grant a 510(k) clearance to a product if
the submitted information establishes that the proposed device is "substantially
equivalent" (a) to a legally marketed Class I or Class II medical device, or (b)
to a preamendment Class III medical device. A pre-amendment device is one that
has been on the market since a date prior to May 28, 1976 for which the FDA has
not called for premarket approval applications. The FDA has recently been
requiring a more rigorous demonstration of substantial equivalence. It generally
takes four to 12 months from submission to obtain 510(k) premarket clearance,
but may take longer. The FDA may determine that the proposed device is not
substantially equivalent, or that additional data is needed before a substantial
equivalence determination can be made. A "not substantially equivalent"
determination, or a request for additional information, could delay the market
introduction of new products, if any, that fall into this category and could
have a materially adverse effect on KeraVision's business, financial condition
and results of operations. We cannot assure you that KeraVision will obtain
510(k) premarket clearance within the above time frames, if at all, for any of
the devices for which it may file a 510(k). If KeraVision modifies or enhances
any product that has been cleared through the 510(k) process in a manner that
could significantly affect safety or effectiveness it must submit new 510(k)
submissions.

  Pre-Market Approval Process. A manufacturer must file a premarket approval
application if the proposed device is not substantially equivalent to a legally
marketed Class I or II device or to a preamendment Class III device for which
the FDA has not called for premarket approval applications. A premarket approval
application must be supported by valid scientific evidence, which typically
includes extensive data, including preclinical and clinical trial data, to
demonstrate the safety and efficacy of the device. KeraVision Intacs is
considered a Class III device and required a premarket approval application, as
will other KeraVision products under development for the treatment of myopia,
hyperopia and astigmatism.

  Upon receipt of a premarket approval application, the FDA makes a threshold
determination as to whether the application is sufficiently complete to permit a
substantive review. If the FDA determines that the premarket approval
application is sufficiently complete to permit a substantive review, the FDA
will accept the application for filing. Once the submission is filed, the FDA
begins review of the premarket approval application. An FDA review of a
premarket approval application historically has taken between one to two years
from the date that the premarket approval application is accepted for filing,
but may take significantly longer. The FDA often significantly extends the
review time to ask for more information or clarification of information already
provided in the submission. During the review period, an advisory committee,
typically a panel of clinicians, is convened to review and evaluate the
application and provide recommendations to the FDA as to whether the device
should be approved. In addition, the FDA will inspect the manufacturing facility
to ensure compliance with the FDA's Quality System Regulation requirements prior
to approval of a premarket approval application.

  Even after approval of a premarket approval application, the FDA may require a
new premarket approval application or premarket approval application supplement
for modifications to a device, its labeling or its manufacturing process.
Supplements to a premarket approval application often require submission of the
same type of information as a premarket approval application, except that the
supplement is limited to information needed to support any changes from the
product covered by the original premarket approval application, and may not
require the submission of clinical data or the convening of any advisory
committees and corresponding review.

  The premarket approval application process can be expensive, uncertain and
lengthy, frequently requiring from one to several years, and some devices for
which premarket approval application approval has been sought by other companies
have never been approved for marketing.

                                       13
<PAGE>
 
  In addition, the FDA may require extensive post-marketing testing and
surveillance to monitor the effects of approved products or place conditions on
any approvals that could restrict the commercial applications of such products.
The FDA may withdraw product approvals if compliance with regulatory standards
is not maintained or if problems occur following initial marketing. In addition,
delays imposed by the governmental approval process may materially reduce the
period during which KeraVision may have the exclusive right to exploit patented
products or technologies.

  Clinical Trials. Before future KeraVision products can be commercialized in
the United States, KeraVision may be required to undergo a series of approval
processes that are sequential in nature. If these approval processes are
applicable, KeraVision generally must:

  .    generate biocompatibility and long-term preclinical safety data;

  .    conduct under an investigational device exemption a clinical study
       involving nonfunctional human eyes; and

  .    conduct under an investigational device exemption a phased series of
       clinical studies using sighted human eyes.

KeraVision must submit the data from these studies to the FDA in a premarket
approval application for review.

  If human clinical trials of a device are required, and the device presents a
"significant risk," the manufacturer or the distributor of the device will have
to obtain FDA approval of an investigational device exemption application with
the FDA prior to commencing human clinical trials. An application must be
supported by data, typically including the results of animal and laboratory
testing. If the FDA approves an investigational device exemption application,
human clinical trials may begin at a specified number of investigational sites
with a maximum number of patients, as approved by the FDA. FDA regulations
govern many important aspects of the clinical investigation of medical products,
and require, among other things, obtaining informed consent from clinical
subjects, and securing the approval for the clinical protocol from an
institutional review board. A review board will consider, among other things,
ethical facts, the safety of patients and the possible liability of the
institution at which the study will be conducted. Sponsors of clinical trials
are permitted to sell investigational devices distributed in the course of the
study provided such compensation does not exceed the recovery of the costs of
manufacture, research, development and handling. KeraVision received FDA
approval of an investigational device exemption application for its phase I, II
and III trials for the treatment of myopia with KeraVision Intacs.

  Having received FDA approval for KeraVision Intacs, KeraVision must maintain
compliance with all FDA requirements and conditions in its approved application,
including post-market surveillance requirements, product specification,
manufacturing process, labeling and promotional material and record keeping and
reporting requirements. Failure to comply, or the occurrence of unanticipated
adverse effects during commercial marketing, could lead to the need for product
recall or other FDA initiated action, which could delay further marketing until
the products are brought into compliance.

  Other Regulatory Requirements. Any products manufactured or distributed by
KeraVision pursuant to a pre-market clearance notification or an approved
premarket approval application are subject to pervasive and continuing
regulation by the FDA, including recordkeeping requirements and reporting of
adverse experiences associated with the use of the devices. Labeling and
promotional activities are subject to scrutiny by the FDA and by the Federal
Trade Commission. The FDA actively enforces regulations prohibiting marketing of
products for unapproved uses.

  The FDC Act requires KeraVision and its contract manufacturers to manufacture
its products in registered establishments and in accordance with the Quality
System Regulation requirements for devices. The Quality System Regulation (21
CFR Part 820, Medical Devices, Current Good Manufacturing Practice) as
promulgated by the FDA establishes the current good manufacturing requirements
necessary in the design, manufacture and distribution of medical devices to
assure product safety and efficacy. As the developer of KeraVision Intacs,
KeraVision must meet the applicable Quality System Regulation requirements.
KeraVision is also required to adhere to additional Quality System Regulation
requirements for the distribution of KeraVision Intacs. KeraVision will be
required to engage in extensive recordkeeping and reporting and to conduct
extensive post-market surveillance or other device follow-up. To supply products
for use in the United States, foreign manufacturing establishments must also
comply with Quality System Regulation and are subject to periodic inspection by
the FDA. KeraVision's manufacturing facilities will be subject to periodic
inspections by the FDA and the Food and Drug Branch of the California Department
of Health Services. KeraVision's products are also subject to regulation by
state and foreign government agencies.

  KeraVision is also subject to regulation by the Occupational Safety and Health
Administration and the Environmental Protection Agency and to regulation under
the Toxic Substances Control Act, the Resource Conservation and Recovery Act,
the National Environmental Policy Act and other regulatory statutes, and may in
the future be subject to other federal, state or local regulations. In addition,
new or modified regulations may be promulgated governing KeraVision's Intacs or

                                       14
<PAGE>
 
KeraVision's potential products that may be more restrictive or that may
otherwise alter or affect KeraVision's research and development programs. We
cannot assure you that KeraVision will not be required to incur significant
costs to comply with these laws and regulations in the future or that such laws
and regulations will not have a materially adverse effect upon KeraVision's
ability to do business. KeraVision is unable to predict whether any agency will
adopt any regulation that would have a material adverse effect on KeraVision's
operations.

  All of the above described government regulation and product approval risks
apply to KeraVision Intacs and will apply to any future potential product of
KeraVision. Government regulation may become more restrictive in the future. We
cannot assure you that KeraVision will not be required to incur significant
costs to comply with such laws and regulations in the future or that such laws
and regulations will not have a material adverse effect upon KeraVision's
ability to conduct business.

 European Government Regulation and Product Testing

  Sales of medical devices outside the United States are subject to foreign
regulatory requirements that vary widely from country to country. The time
required to obtain approvals required by foreign countries may be longer or
shorter than that required for FDA approval, and requirements for licensing may
differ from FDA requirements. Export sales of investigational devices that have
not received FDA marketing approval may be subject to FDA export permit
requirements. As KeraVision begins to sell products in additional foreign
markets it will be required to obtain an FDA export permit and comply with
foreign regulations for each of these markets. A delay in obtaining the
necessary approvals or failing to comply with regulatory requirements could have
a material adverse effect on KeraVision's business, financial condition and
results of operations.

  The regulatory environment in Europe for medical devices differs significantly
from that in the United States. A total of 15 European countries are grouped in
a union with the objective of establishing a single market without internal
borders among the member countries and eliminating divergent national
requirements. The members of the European Union include Austria, Belgium,
Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, The
Netherlands, Portugal, Spain, Sweden and the United Kingdom.

  Products that comply with the requirements of a specified medical directive
will be entitled to bear CE marking. Since July 14, 1998, all commercial medical
device products have been required to bear CE marking. It is illegal to market
these products in the European Union without a CE marking.

  To obtain a CE marking, the product must be assessed and found to conform to
the applicable directive. The method of assessing conformity depends on the
class of the product, but normally involves some combination of a manufacturer's
self-assessment and a third party assessment conducted by a "notified body." The
notified body assessment may consist of an audit of the manufacturer's quality
system or specific testing of the product. A manufacturer can sell a product
throughout the European Union once it secures an assessment by a notified body
in one of the European Union countries.

  The European Union has adopted two directives dealing with medical devices,
including the "Active Implantable Medical Devices Directive" and the "Medical
Devices Directive," and has proposed a third directive, the "In Vitro Diagnostic
Medical Devices Directive," to harmonize the regulatory requirements for medical
devices.

  Medical devices such as KeraVision Intacs are regulated under the Medical
Devices Directive. A manufacturer may affix CE marking after a determination
that the product complies with the essential requirements of this directive and
completion of the appropriate conformity assessment procedure as specified by
the directive. The conformity assessment requirements are based upon a given
product's classification within the directive. Products within the scope of the
directive are grouped within four classes: Class I, IIA, IIB and III. A product
with a higher classification is considered to have higher risk, and will
therefore be subject to more controls in order to obtain CE marking. KeraVision
Intacs has been designated as a Class IIB device. Essential requirements under
the directive include substantiating that the device meets the manufacturer's
performance claims and that any undesirable side effects of the device
constitute an acceptable medical risk when weighed against the intended benefits
of the device.

  There are two basic options for assessing conformity of devices designated as
Class IIB. The first option allows a manufacturer to seek a decision from the
notified body that the processes employed in the design and manufacture of a
device qualify as a full quality system. Alternatively, manufacturers can seek
product certification based on various control schemes. KeraVision obtained
qualification of its processes as a full quality system. Approval of
KeraVision's full quality system has been achieved through ISO 9001
certification by an approved notified body. The full quality system encompasses
the organizational structure, responsibilities, procedures, processes and
resources necessary to assure quality assurance in design, development,
production, installation and servicing of its medical devices.

                                       15
<PAGE>
 
  The Medical Devices Directive also covers the instrumentation supplied by
KeraVision for the purpose of implanting KeraVision Intacs. These instruments
are classified as Class I and therefore are subject to fewer requirements than
KeraVision Intacs.

  Once a manufacturer has satisfactorily completed the regulatory compliance
tasks required by the Directive and received a favorable decision from the
notified body, it may affix CE marking to its product. Based on the current
regulatory laws, no additional premarket approvals in the individual European
Union countries, Iceland, Liechtenstein or Norway are required. Custom-made
devices and devices intended for clinical investigation do not bear CE marking
and are subject to particular requirements under the Directive. Manufacturers
are required to report serious adverse incidents concerning CE marked devices to
the authorities of the countries where the incidents take place. If such
incidents occur, the manufacturer may have to take remedial action, perhaps
including withdrawal of the product from the European market.

  The directive must be transposed into national law in order to be applied. One
member state of the European Union, Belgium, has not yet completed this
transposition. This fact does not in itself create an obstacle to placing a CE-
marked medical device on the Belgian market, but it may result in practical
complications and delays in this country with respect to product introduction,
marketing and sales. This transposition process has not created significant
differences among the member states of the European Union with respect to
compliance with the essential requirements and the conformity assessment
process. However, meaningful differences have emerged in at least the following
areas: authorities' evaluation of proposed clinical investigation, notification
of products and activities, handling of adverse event reporting and language
requirements for labels and instructions for use. As the directive does not
cover distribution practices, healthcare financing and purchasing, it is
expected that there will be significant regulatory variances from country to
country in these areas. We cannot assure you that the transposition of the
directive into national law will be completed by member countries in a timely
fashion, or at all, or that the failure to complete such transposition or
variations in national law will not materially and adversely affect KeraVision.

  KeraVision obtained conformity certification under Annex II of the directive
in October 1996 from a notified body and thus achieved the right to affix the CE
marking to KeraVision Intacs in November 1996. The right to affix the CE mark
can be withdrawn by the notified body and no assurance can be given that it will
be obtained again in a timely fashion or at all. Furthermore, there can be no
assurance that KeraVision's notified body will retain its status as a "notified
body."

 Data and Safety Monitoring Board

  KeraVision has established an independent Data and Safety Monitoring Board to
serve in a medical monitoring capacity and to review the collective safety and
efficacy data generated from KeraVision's various clinical trials. In addition,
the members of the Monitoring Board examine representative patients from the
United States investigational sites, provide medical advice to the clinical
investigators, review any complications and provide suggested guidelines for
patient management to the investigators. The Monitoring Board currently consists
of three prominent ophthalmologists. Additional individuals will be added to the
Monitoring Board, as required. The members of the Monitoring Board are not
allowed to be clinical investigators for KeraVision Intacs.

Employees

  As of April 22, 1999, KeraVision had 135 full-time employees, of whom 42 are
engaged in, or directly support, KeraVision's research and development
activities. KeraVision also has contracts with outside consultants. KeraVision
considers relations with its employees to be good. None of KeraVision's
employees is covered by a collective bargaining agreement.

  KeraVision and its business strategy depends in large part on the ability of
KeraVision to attract and retain key management, scientific and operating
personnel. KeraVision will need to develop expertise and add skilled personnel
or retain consultants in such areas as research and development, clinical
testing, government approvals, sales, marketing and manufacturing in the future.
KeraVision currently has a small research and management group with limited
operating experience. The loss of the services of one or more members of the
research or management group or the inability to hire additional personnel and
develop expertise as needed could have a material adverse effect on KeraVision.
KeraVision has an employment agreement with one of its employees.

                                       16
<PAGE>
 
Executive Officers of the KeraVision

     The executive officers of KeraVision and their ages as of December 31,
1998, are as follows:

<TABLE>
<CAPTION>
Name                                         Age                                     Position
--------------------------------          -------        ---------------------------------------------------------------
<S>                                       <C>            <C>
Thomas M. Loarie                             52          Chairman of the Board of Directors, Chief Executive Officer
                                                           and President,
Darlene E. Crockett-Billig                   46          Vice President, Regulatory Affairs and Clinical Research
Mark D. Fischer-Colbrie                      42          Vice President, Finance and Administration, Chief Financial
                                                           Officer
David Heniges                                55          Vice President, Europe
Richard Meader                               53          Vice President, Quality Assurance
Edward R. Newill                             45          Vice President, North American Marketing and Sales
Thomas A. Silvestrini                        46          Vice President, Research and Development
Robert P. Wood                               40          Vice President, Manufacturing
</TABLE>

  Thomas M. Loarie has served as President, Chief Executive Officer and Chairman
of the Board of Directors of the Company since September 1987.  From 1985 until
joining KeraVision, Mr. Loarie served as President of ABA BioManagement, a
management service firm specializing in medical technology start-ups, and from
1984 to 1985 he served as President of Novacor Medical Corporation, a
manufacturer of cardiovascular implants.  Prior to 1984, Mr. Loarie held
management positions in four divisions of American Hospital Supply Corporation,
now Baxter International, a manufacturer of healthcare products, serving most
recently as President of the American Heyer-Schulte Division, where he was
responsible for bringing several new implantable devices to the markets of
neurosurgery, oncology, urology, plastic surgery and wound management as well as
rebuilding the company's international business.  Mr. Loarie holds a B.S. degree
in engineering from the University of Notre Dame and has completed graduate work
in business administration at the Universities of Chicago and Minnesota.  Mr.
Loarie also serves as a member of the Executive Committee of the Company, a
director of the Health Industry Manufacturers Association and serves on the
Board of the California Healthcare Institute.

  Darlene E. Crockett-Billig has served as Vice President, Regulatory Affairs
and Clinical Research of the Company since February 1988.  From 1986 to 1988,
she served as Regulatory Affairs Manager for CooperVision Ophthalmic Products,
an ophthalmic device manufacturer, where she was responsible for all FDA
submissions, product approval strategies and regulatory compliance.  Prior to
that time, Ms. Crockett-Billig spent ten years in management and laboratory
supervision positions with Miles Laboratories and Medtronic, Inc., two
healthcare products manufacturers.  Ms. Crockett-Billig received her B.A. in
Biology from Augustana College and her M.B.A. from the College of St. Thomas,
Minnesota.

  Mark D. Fischer-Colbrie has served as Vice President, Finance and
Administration and Chief Financial Officer of the Company since March 1992.
From 1983 to 1992, Mr. Fischer-Colbrie held several senior financial positions,
most recently as Vice President, Controller, at Maxtor Corporation, a
manufacturer of computer disk drives.  Prior to 1983, he worked for four years
with a subsidiary of Xerox Corp. in accounting and finance.  Mr. Fischer-Colbrie
holds a B.A. from Stanford University and an M.B.A. in Finance and Marketing
from the University of California at Berkeley.

  David Heniges has served as Vice-President Europe since July, 1998. Mr.
Heniges was most recently VP Global Marketing for Baxter International's
Cardiovascular Surgery Division. Prior to that position, Mr. Heniges was VP
Worldwide Business Development for IOLAB, a division of Johnson & Johnson. Mr.
Heniges worked for Johnson & Johnson for 23 years.

  Richard Meader has served as Vice-President, Quality Assurance since
September, 1998.  Mr. Meader was most recently VP Regulatory and Quality Affairs
for B. Braun/McGaw Inc., a $350 million-a-year maker of medical device systems
for drug delivery and a provider of pharmacy out-source services.

  Edward R. Newill has served as Vice President, Marketing and Sales since May
1996.  Mr. Newill has 21 years of international experience in a broad range of
surgical specialties including plastic surgery, which like vision correction
surgery is consumer-based and non-reimbursed by insurers.  Mr. Newill held
management positions with Mentor from 1990 to 1996.  Mr. Newill holds a B.S. in
General Business from Miami University and a Masters International Management
from American Graduate School of International Management.

  Thomas A. Silvestrini has served as Vice President, Research and Development
of the Company since July 1990.  Prior to joining the Company, Mr. Silvestrini
spent 12 years in senior management and project positions including Manager of
Research and Development, Project Leader, and Senior Research Scientist with the
Corporate Research Center of the 

                                       17
<PAGE>
 
Hospital Products Group for the Pfizer Corporation, a manufacturer of healthcare
products. He has received 11 patents for medical devices and has an additional
12 patents pending. Mr. Silvestrini received his B.S. in Chemical Engineering
and his M.S. in Organic Chemistry from the University of Minnesota.

  Robert P. Wood has served as Vice President, Manufacturing since April 1996.
From 1994 to 1996, Mr. Wood was operations manager of Allergan, Inc.'s medical
device and pharmaceutical facility.  From 1987 to 1994 Mr. Wood held management
positions with Abbott Laboratories.  Mr. Wood holds a B.S., in mechanical
engineering from Texas A&M University.

 Each executive officer serves at the sole discretion of the Board of
Directors.

Risk Factors Affecting the Company, its Business and its Stock Price

KeraVision may not be able to execute its business plan if a significant amount
of capital is not available to it in the near future.

  KeraVision will be required to commit substantial resources to establish
production, marketing and sales capabilities in order to bring KeraVision Intacs
to market. KeraVision will be required to commit additional resources to
conducting the research and development, clinical studies and regulatory
activities necessary to bring any other medical device products to market. We do
not anticipate that KeraVision's current cash, cash equivalents and short-term
investments or financing plans will be sufficient to fund KeraVision's
operations to profitability. KeraVision will need to raise substantial
additional funds for this purpose. KeraVision may seek such additional funding
through collaborative arrangements and through public or private debt or equity
financings. Any additional equity financing will be dilutive to you as a
stockholder to the extent you do not participate in the financing, and any debt
financing, if available, may restrict KeraVision's future ability to pay
dividends on its capital stock or the manner in which KeraVision conducts its
business. KeraVision currently has no commitments for any additional financings,
and we cannot assure you that any such financings will be available. Nor can we
assure you that funds from these financings will be available when needed or
available on terms favorable to KeraVision. If KeraVision fails to obtain
sufficient funds, it may need to delay, scale back or eliminate some or all of
its research and product development programs, clinical studies or regulatory
activities or license third parties to commercialize products or technologies
that it would otherwise seek to develop itself. Such actions would adversely
affect KeraVision's business and financial condition.

KeraVision needs market acceptance of KeraVision Intacs and other products to be
successful.

  KeraVision's future performance depends, to a substantial extent, upon the
degree of market acceptance of KeraVision Intacs for correction of myopia, and
on KeraVision's ability to successfully manufacture, market, deliver and support
KeraVision Intacs. We cannot assure you that KeraVision Intacs or any future
product that KeraVision develops will achieve or maintain acceptance in their
target markets. To be successful KeraVision Intacs will have to be accepted by
ophthalmic surgeons as well as by patients. To date, KeraVision has sold its
product primarily in Canada, France and Germany, and has so far received only
limited acceptance and generated only limited revenues. KeraVision has only
recently begun the sale of KeraVision Intacs in the United States. Many surgeons
in these countries and elsewhere have already invested significant time and
resources in developing expertise in other corrective ophthalmic surgical
techniques. KeraVision intends to market its proposed products to people whose
vision can be corrected with eyeglasses or contact lenses. We cannot assure you
that these persons will elect to undergo surgical insertion of KeraVision Intacs
when such nonsurgical vision-correction alternatives are available. The extent
of, and rate at which, KeraVision Intacs and future products achieve market
acceptance and penetration is a function of many variables including price,
safety, efficacy, reliability and marketing and sales efforts. Similar risks may
confront other products KeraVision develops in the future.

                                       18
<PAGE>
 
The development of KeraVision's products and KeraVision's future revenue are
uncertain and may not be successful.

  KeraVision Intacs will require a significant investment of capital before
commercialization in the United States. To obtain revenues KeraVision must,
alone or with others, successfully manufacture and market KeraVision Intacs and
successfully develop, obtain regulatory approval for, manufacture and market
other products. The time frame for any products and potential products,
including KeraVision Intacs, to succeed in the market is long and uncertain.
Although KeraVision has received approval to market KeraVision Intacs in the
United States, the European Union and Canada, we cannot assure you that
KeraVision will successfully complete its research and development efforts for
this or other products to be marketed elsewhere. Nor can we assure you that
KeraVision Intacs will perform in the manner anticipated, or that we will
experience the results observed in animal, eye-bank or human nonfunctional and
sighted-eye testing in long-term use of KeraVision Intacs. We also cannot assure
you that KeraVision Intacs will prove to be safe or effective over the long term
in correcting vision. If KeraVision Intacs fails to perform as anticipated our
business and financial condition will be jeopardized.

Compliance with governmental standards applicable to KeraVision and its products
may prove too burdensome and costly for KeraVision to operate profitably.

  Having received approval from the FDA for the correction of myopia, KeraVision
Intacs is subject to additional post-market testing and surveillance programs
required by regulatory agencies. KeraVision is also required to engage in
extensive record keeping and reporting, and to conduct extensive post-market
surveillance or other device follow-up. In addition, KeraVision expects to
manufacture KeraVision Intacs internally and will accordingly be required to
adhere to additional FDA requirements for the manufacture and distribution of
KeraVision Intacs. KeraVision's ongoing compliance with the government's quality
system regulation, labeling and other applicable regulatory requirements is
monitored through periodic inspections by state and federal agencies, including
the FDA, and comparable agencies in other countries. Failure to comply with the
applicable regulatory requirements can, among other things, result in fines,
injunctions, civil penalties, suspensions or withdrawal of regulatory approvals,
product recalls, product seizures, including cessation of manufacturing and
sales, operating restrictions and criminal prosecution, and the occurrence of
any of these events could have a material adverse effect on KeraVision's
business, financial condition and results of operations.

KeraVision may not be able to obtain necessary regulatory approvals in a timely
manner, which would delay the sale and distribution of KeraVision Intacs or
future products and adversely affect our revenues.

  As the manufacturer of KeraVision Intacs and potential products, KeraVision's
operations must undergo quality service regulation compliance inspections
conducted by the FDA and equivalent inspections conducted by state and foreign
officials. Third parties manufacturing KeraVision instrumentation may similarly
be affected. We cannot assure you that KeraVision or these third parties will be
able to obtain necessary regulatory approvals of their manufacturing operations
in a timely manner or at all. Delays in receipt of, failure to receive or loss
of previously received approvals would have a material adverse effect on
KeraVision's business, financial condition and results of operations.

KeraVision may not obtain the approvals necessary for the sale of its products
in foreign markets which would prevent the sale of products in these markets.

  KeraVision's success depends in part on its ability to develop and market its
products in markets outside the United States. Although we have received
approvals for the sale of our products in some of these markets, we cannot
assure you that we will obtain the requisite approvals of foreign countries for
the sale of our products in new foreign markets. Even if we ultimately obtain
these approvals, doing so may take longer, and the licensing requirements may be
more restrictive, than we anticipate. As a result, the sale of our products in
additional foreign markets may be delayed or prevented and our financial
condition and results of operations may be adversely affected.

The cost of KeraVision Intacs and the availability of other established vision
correction products may limit the potential market for KeraVision Intacs which
may impact KeraVision's ability to realize revenues.

  KeraVision's target market for KeraVision Intacs currently is limited to
healthy patients who have mild to moderate myopia without significant
astigmatism and are generally over the age of 21. We cannot assure you that even
this target population will prefer refractive surgery to current and future
alternatives for visual correction. KeraVision believes that the inability of
some patients to afford the procedure and the psychological aversion of some
patients to refractive surgery may further limit the potential market for
KeraVision Intacs. KeraVision also expects that the relative attractiveness and
affordability of other refractive surgical techniques will affect the market.

                                       19
<PAGE>
 
Long-term follow-up data may not demonstrate that KeraVision Intacs is safe.

  The KeraVision Intacs technology is a relatively new technology. KeraVision
has developed only limited clinical data to date on the safety and efficacy of
KeraVision Intacs in correcting myopia, and KeraVision has not yet developed any
long-term safety or efficacy data. KeraVision cannot yet determine if KeraVision
Intacs will prove to be effective for the predictable treatment of myopia. We
cannot assure you that the clinical trial results of KeraVision Intacs are
necessarily indicative of the degree of safety or efficacy that KeraVision
Intacs will achieve in the long term.

Complications and visual side effects associated with KeraVision Intacs may
affect KeraVision's ability to obtain regulatory approval or gain market
acceptance for KeraVision Intacs.

  Although no patient has suffered any serious or lasting injury to the eye or
any material loss of vision, some patients who have received KeraVision Intacs
have experienced various complications. These complications include induced
astigmatism, infection, decentered placement and a reduction in central
corneal sensation. In addition, patients undergoing the KeraVision Intacs
procedure have reported various visual side effects. These include glare,
haloes and other visual symptoms associated with low-light conditions. We
cannot assure you that these complications or side effects will not be serious
or lasting or will not impair or preclude acceptance of the product by
patients or ophthalmologists or preclude KeraVision from obtaining regulatory
approval for its potential products.

KeraVision's ability to operate its business may be adversely affected if is
unable to retain its key personnel or to hire additional key personnel.

  KeraVision's success depends in large part on its ability to attract and
retain key management, scientific and operating personnel. We cannot assure you
that KeraVision will be able to attract and retain the qualified personnel or
develop the expertise needed for its business. KeraVision currently has a small
research and management group. The loss of the services of one or more members
of the research or management group or the inability to hire additional
personnel and develop expertise as needed could limit KeraVision's ability to
maximize the potential of KeraVision Intacs and develop new products. Such
persons are in high demand and often receive competing employment offers.
KeraVision also will need to develop expertise and add skilled personnel or
retain consultants in such areas as clinical testing, government approvals,
sales, and marketing and manufacturing.

KeraVision has limited manufacturing experience and may be unable to develop
commercial-scale manufacturing capabilities.

  KeraVision has limited ability to manufacture a large volume of products and
limited experience in manufacturing medical devices or other products. We cannot
assure you that KeraVision will be able to develop commercial-scale
manufacturing capabilities at acceptable costs or enter into agreements with
third parties with respect to these activities. To be successful, KeraVision
must manufacture its products and potential products in commercial quantities in
compliance with regulatory requirements at acceptable costs. Production of
commercial-scale quantities will involve technical challenges for KeraVision. In
addition, if KeraVision established its own commercial-scale manufacturing
capability, it would incur significant scale-up expenses including the need to
expand its facilities and hire additional personnel. KeraVision may seek
collaborative arrangements with other companies to manufacture products and
potential products, including KeraVision Intacs. If we are dependent upon third
parties for the manufacture of our products and proposed products, then our
profit margins and ability to develop and deliver such products on a timely
basis may be adversely affected. Moreover, we cannot assure you that such
parties will adequately perform, and any failures by third parties may impair
our ability to deliver products on a timely basis or otherwise impair our
competitive position.

KeraVision has limited sales and marketing experience and may not be able to
successfully sell or market its products.

  KeraVision has only sold products in the United States since April 1999, in
Canada since mid-1998 and Europe since late-1996. KeraVision has recently
entered into additional distribution agreements and also plans to market and
sell its products through a direct sales force. We cannot assure you that
KeraVision's sales effort will be successful. To successfully market and sell
its products, KeraVision will need to hire a sales force that has established
relationships with physicians. KeraVision also needs to hire personnel with
consumer marketing skills. KeraVision will need significant resources to recruit
and retain skilled sales management, direct sales persons or distributors. To
the extent that KeraVision has established or enters into distribution
arrangements for the sale of its products, KeraVision is and will be dependent
on the efforts of third parties. We cannot assure you that such efforts will be
successful.

                                       20
<PAGE>
 
KeraVision may not be able to successfully compete in the highly competitive
field of research and development of vision correction alternatives.

  KeraVision is engaged in a rapidly evolving field. Many public and private
companies, universities and research laboratories engage in activities relating
to research on vision correction alternatives. We cannot assure you that
KeraVision's competitors will not succeed in developing technologies, procedures
or products that are more effective or economical than those KeraVision is
developing or that would render its technology and proposed products obsolete or
noncompetitive.

  Other companies, most of which are larger and better financed than KeraVision,
are engaged in the refractive surgery market. Four companies have received
approval to market their products in the United States. In addition, a number of
other large entities currently market and sell laser systems overseas for use in
refractive surgery, including Bausch and Lomb, Aesculap-Meditec, GmbH and
Schwind, several of whom are seeking to obtain FDA approval to sell their
products in the United States. See "KeraVision, Inc.--Business[_]7Competition."
Moreover, several companies are developing other non-laser approaches to vision
correction, including the use of radio-frequency energy to reshape the cornea.

  These companies and institutions represent significant long-term competition
for KeraVision. In comparison to KeraVision, they have:

  .    substantially greater resources;

  .    larger research and development staffs;

  .    better facilities;

  .    more experience in research and development;

  .    more experience in preclinical and human clinical studies

  .    more experience obtaining regulatory approval; and

  .    more experience manufacturing and marketing medical device products.

KeraVision is subject to the risk that product liability litigation and
insurance may be unavailable.

  KeraVision faces a risk of exposure to product liability claims or product
recalls if the use of KeraVision Intacs or other future potential product is
alleged to have resulted in serious adverse effects. We cannot assure you that
the precautions we take with respect to these risks will prevent KeraVision from
incurring significant liability. We cannot assure you that our current product
liability insurance policies will cover all material liabilities or that the
coverage we have obtained will continue to be available at an acceptable cost,
if at all, before or after commercialization of any of KeraVision's products. A
product liability claim, product recall or other claims with respect to
uninsured liabilities or in excess of insured liabilities could have a material
adverse effect on KeraVision's business or financial condition. See "KeraVision,
Inc.--Business--Product Liability."

KeraVision depends on one supplier who will discontinue manufacturing raw
material needed by KeraVision and additional supplies may not be available.

  KeraVision currently purchases the raw material used in manufacturing
KeraVision Intacs from a single source. This sole-source supplier has given
KeraVision notice that it will discontinue its manufacture of the particular
material KeraVision uses. KeraVision has agreed to purchase a significant amount
of this material, which we anticipate will provide us with a three year supply
and will be delivered over the next twelve months. We cannot assure you that:

  .    the supplier will timely deliver the raw material;

  .    interruptions in supplies will not occur in the future;

  .    KeraVision will not have to obtain substitute vendors, which would
       require additional regulatory submissions; or

  .    this supply will last as long as we anticipate.

                                       21
<PAGE>
 
We have been informed that our supplier will be able to make available an
additional five year supply of material beyond the supplies we have agreed to
purchase. As a result, we have not made arrangements to obtain an alternate
supply of material. In the event we are unable to obtain alternative supplies of
materials upon the depletion of our current supply we will experience delays in
the production of KeraVision Intacs and will need to obtain alternate materials.
If we are required to manufacture KeraVision Intacs using alternate materials we
will also be required to obtain FDA approval of this material, a process that
could take several years and cause us to incur substantial costs. Furthermore,
we cannot assure you that we will be able to obtain FDA approval of a new
material at all. Any interruption of supply would have a material adverse effect
on KeraVision's ability to manufacture KeraVision Intacs or future products
which could have a material adverse effect on its business, financial condition
or results of operations.

Year 2000 computer problems may affect KeraVision's computer systems and its
ability to operate.

  The Year 2000 computer problem is caused by the inability of some software and
hardware to handle dates after December 31, 1999. KeraVision is actively working
with critical suppliers of products and services to determine that the
suppliers' operations and the products and services they provide are year 2000
compliant and to monitor their progress toward year 2000 compliance. However,
some of KeraVision's or its suppliers' computer systems could fail or
miscalculation could occur, causing disruptions in our operations, including a
temporary inability to process transactions, send invoices or engage in similar
normal business activities.

  We cannot assure you that any system of other companies on which KeraVision's
systems rely and which are not Year 2000 compliant, will be year 2000 compliant
in a timely fashion and would not have an adverse effect on KeraVision's
systems.

KeraVision may not have the ability to obtain and maintain patents on KeraVision
Intacs and its technology which could permit others to develop similar products
or more easily compete with our business.

  KeraVision's commercial success depends in part on acquiring and maintaining
patent and trade secret protection of KeraVision Intacs technology, KeraVision
Intacs and any other potential products it seeks to develop. We cannot assure
you that KeraVision will be successful in obtaining additional necessary patents
or license rights; KeraVision's processes or products will not infringe patents
or proprietary rights of others; or that any issued patents will provide
KeraVision with any competitive advantages or will withstand challenges by third
parties.

  KeraVision is aware of ongoing academic research on both solid and injectable
forms of corneal inserts. We cannot assure you that others will not
independently develop similar products or duplicate KeraVision Intacs or design
products that circumvent any patents used by KeraVision.

  In addition, KeraVision could incur substantial costs in defending against
patent litigation or in bringing suits to protect its patents against
infringement. If the outcome of any such litigation is adverse to KeraVision,
its business could be adversely affected.

  KeraVision also relies on trade secrets and proprietary know-how which it
seeks to protect by confidentiality agreements with its employees, consultants,
investigators and advisors. We cannot assure you that these agreements will not
be breached, that KeraVision will have adequate remedies for any breach, or that
competitors will not otherwise discover KeraVision's trade secrets and
proprietary know-how.


Item 2.  Properties
-------  ----------

     KeraVision's primary manufacturing, R&D and administrative facilities
occupy approximately a total of approximately 40,000 square feet of space in two
locations in Fremont, California.  The facilities is subject to leases which
expire  in 1999.  The current monthly rent is approximately $29,000.  The
Company's European sales facilities occupy approximately 3,300 square feet of
space in Chatenay-Malabry, France.  The facility is subject to a lease which
expires in 1999.  The current monthly rent is approximately $4,500.  The Company
believes that this space is adequate for its immediate needs, and that it will
be able to renew its lease or obtain additional space as necessary.

                                       22
<PAGE>
 
Item 3.  Legal Proceedings update from last 10-Q
------   ----------------------------------------

Not applicable.

Item 4.  Submission of Matters to a Vote of Security Holders update
------   ----------------------------------------------------------

  No matters were submitted to a vote of security holders during the fourth
quarter for the fiscal year ended December 31, 1998.

PART II

Item 5.  Market for the Registrant's Common Stock and Related Stockholder
------   ----------------------------------------------------------------
Matters
-------

         The following table sets forth, for the periods indicated, the high and
low trading prices for the Company's common stock as reported on the Nasdaq
National Market.

<TABLE>
<CAPTION>
Calendar Year                                              High                       Low
----------------------------------------------    ---------------------     ---------------------
1998
<S>                                                 <C>                       <C>
First quarter                                                   $  8.25                    $ 5.25
Second quarter                                                    10.625                     7.25
Third quarter                                                      8.063                     4.25
Fourth quarter                                                    13.50                      8.625
 
1997
First quarter                                                   $ 15.00                    $10.00
Second quarter                                                    10.50                      6.75
Third quarter                                                     10.188                     7.00
Fourth quarter                                                     8.50                      5.125
</TABLE>

     The closing stock price on February 24, 1999 was $12.063.  The Company
reported 274 stockholders of record and 8,794 beneficial holders of the
Company's common stock on February 24, 1999.

     The Company has not historically paid cash dividends.  The Company does not
anticipate paying cash dividends in the foreseeable future.

Item 6.  Selected Financial Data
------   -----------------------

<TABLE>
<CAPTION>
                                                                                      Year Ended December 31,                    
(in thousands, except per share data)                1998               1997              1996             1995                1994
Statement of Operations Data                                                                                                  
<S>                                              <C>          <C>                <C>               <C>               <C>      
Net sales.......................................     $835               $355              $137               $--                $--
                                                                                                                                   
Costs and expenses:                                                                                                               
 Cost of sales and manufacturing expenses.......    4,386              3,701               319                --                 -- 

 Research and development.......................   11,356             10,774            10,888             6,527              5,146 

 Selling, general and administrative............    9,693              6,405             3,930             1,725              1,262
                                                 --------          ---------         ---------         ---------           -------- 

Total costs and expenses........................   25,435             20,880            15,137             8,252              6,408 
                                                 --------          ---------         ---------         ---------           -------- 
Operating loss..................................  (24,600)           (20,525)          (15,000)           (8,252)            (6,408)

Interest income, net............................      563              1,129             2,121             1,203                425
Other expense...................................       --                 --                --               (57)              (114)
                                                  --------          ---------         ---------         ---------           --------
                                                 
Net loss........................................ $(24,037)          $(19,396)         $(12,879)         $ (7,106)           $(6,097)

                                                 ========           =========         =========         =========           ========

                                                                                                                          
Net loss applicable to common stockholders...... $(27,414)          $(19,396)         $(12,879)         $ (7,106)           $(6,097)

                                                 ========           =========         =========         =========           ========

Basic and diluted net loss per share applicable                                                                          
    to common stockholders......................   $(2.16)           $(1.55)            $(1.04)           $(1.05)            $(4.52)

Shares used in calculation of net loss per                                                                                    
    share.......................................   12,686            12,528             12,342             6,757              1.348
</TABLE> 
                                       23
<PAGE>
<TABLE> 
<CAPTION> 
 
                                                                            December 31,                                   
                                            ----------------------------------------------------------------------------------      

(in thousands)                                  1998               1997              1996              1995               1994   
-----------------------------------------   --------     --------------     -------------     -------------     --------------     
<S>                                         <C>          <C>                <C>               <C>               <C> 
Balance Sheet Data                                                                                                                
Cash, cash equivalents and                                                                                                      
 available-for-sale investments..........   $  7,728           $ 14,113          $ 32,065          $ 44,703           $  5,909    
                                                                                                                               
Working capital..........................      4,915             11,820            30,435            43,205              4,935   
Total assets.............................     11,184             17,345            35,485            45,919              6,934   
Capital lease obligations, noncurrent....        821                850               793               114                210    
Redeemable convertible preferred stock...     17,489                 --                --                --             27,844     
Accumulated deficit......................    (90,092)           (62,678)          (43,282)          (30,403)           (23,440) 
Total stockholders' equity (net capital                                                                                          
 deficiency).............................    (11,447)            12,937            31,765            44,035            (22,144)  
 
</TABLE>

Item 7.  KeraVision Management's Discussion and Analysis
------              -------------------------------------

    The following discussion should be read in conjunction with the financial
statements and notes thereto included elsewhere in this Annual Report on Form
10-K.

Overview

    Since its founding in November 1986, the Company has been engaged in the
research and development of the KeraVision Intacs and related technology.
Although the Company recorded its first revenue in the quarter ended December
31, 1996, the Company expects to continue to incur substantial losses at least
through the year ending December 31, 1999 and until sufficient revenue and
margin can be generated to offset expenses.  Given the uncertainties in
developing a new market, revenues may not significantly accelerate in the
foreseeable future.  Furthermore, the Company expects its overall expenses to
increase as its sales and marketing activities grow.

    On April 9, 1999, KeraVision obtained FDA approval to distribute and sell
KeraVision Intacs in the United States for the treatment of myopia in the range
of 1.0 to 3.0 diopters of correction for patients over 21 years old.  Prior to
receiving this approval, KeraVision's Pre-Market Approval application to sell
Intacs, was deemed "approvable" by the FDA on February 16, 1999.  On January 12,
1999, the Ophthalmic Devices Panel of the FDA unanimously recommended approval
with conditions for KeraVision to sell its initial product, Intacs, in the range
of -1.0 to -3.5 diopters. The Company has enrolled a limited number of patients
in the range of -0.5 and -1.0 diopters and -3.5 to -5.0 diopters in a Phase III
trial.  In May 1998, the Company received regulatory approval in Canada to sell
KeraVision Intacs in the range of -1.0 to -5.0 diopters; the Company has
subsequently begun limited commercial sales in Canada.  In late 1996, the
Company was granted the right to affix the CE mark on KeraVision Intacs for
myopia which allows the Company to sell product in the range of -1.0 to -5.0
diopters in European Union countries.

    The research, manufacture, sale and distribution of medical devices such as
KeraVision Intacs are subject to numerous regulations, imposed by governmental
authorities, principally the FDA and corresponding state and foreign agencies.
The regulatory process is lengthy, expensive and uncertain. Prior to commercial
sale in the United States, most medical devices, including KeraVision Intacs,
must be cleared or approved by the FDA. Securing FDA approvals and clearances
required the submission to the FDA of extensive clinical data and supporting
information. Current FDA enforcement policy strictly prohibits the marketing of
medical devices for uses other than those for which the product has been
approved or cleared.  Product approvals have been given, product approvals and
clearances can be withdrawn for failure to comply with regulatory standards or
for the occurrence of unforeseen problems following initial marketing. Foreign
governments or agencies also have review processes for medical devices which
present many of the same risks.  The right to affix the CE mark can be
withdrawn, resulting in an inability to sell products in European countries.

    Until the development and testing processes for KeraVision Intacs are fully
complete, we cannot be sure that KeraVision Intacs will perform in the manner we
anticipate.  Although the Company does have approval to sell products in the
United States, the European Union and Canada, we cannot be sure that KeraVision
Intacs will prove to be safe or effective over the long term in correcting
vision or that KeravVision Intacs or any other product developed by the Company
will be commercially successful, will be successfully marketed or achieve market
acceptance. There can be no assurance that the Company will ever achieve either
significant revenues from sales of KeraVision Intacs or any other potential
products or ever achieve profitable operations.

                                       24
<PAGE>
 
Years ended December 31, 1998 and 1997

    Net revenues for 1998 increased to $835,000 from $355,000 in 1997, primarily
as a result of increased unit shipments associated with the Company's limited
product launch into the Canadian market.  Sales to customers in Canada
represented 51% of net sales in 1998.

    Cost of sales exceeded revenues reflecting currently low production volumes
and fixed costs associated with the Company's higher volume manufacturing
capabilities.

    Research and development expenses for the year ended December 31, 1998 were
$11.4 million compared to $10.8 million incurred in the prior year.  Research
and development expenses in 1998  represented 46% of the $24.6 million loss from
operations, and in 1997 represented 53% of the $20.5 million loss from
operations.  The Company expects research and development expenses to remain
relatively stable as studies are completed and replaced with new indications.

    Selling, general and administrative expenses in 1998 were $9.7 million, an
increase of $3.3 million from 1997.  The increase in spending reflects increased
staffing and associated expenses, in addition to increased marketing efforts
related to our limited launch in Canada and a pending U.S. launch dependent on
FDA regulatory approval.

    The Company recorded $563,000 of net interest income for the year ended
December 31, 1998, as compared to $1.1 million for the previous year.  Interest
income decreased due to lower average cash and investment balances from period
to period.  The net loss in 1998 was $24.0 million, an increase of $4.6 million
from the net loss of $19.4 million in 1997.  The net loss per share applicable
to common stockholders was $2.16.  This per share calculation includes the
effect of a deemed dividend of $2.5 million, in addition the effect of a
dividend of $846,000 to preferred stockholders as part of the series B
redeemable convertible preferred stock financing. The Company believes that its
net loss could significantly increase in future periods.

Years ended December 31, 1997 and 1996

    Net revenues for 1997 increased to $355,000 from $137,000 in 1996 as a
result of increased unit shipments. 1997 results include a full year of
commercial shipments to the European Market.

    Cost of sales exceeded revenues reflecting currently low production volumes
and fixed costs associated with the Company's higher volume manufacturing
capabilities.

    Research and development expenses for the year ended December 31, 1997 were
$10.8 million compared to $10.9 million incurred in the prior year.  Research
and development expenses for the most recent year represented 53% of the $20.5
million loss from operations, and in 1996 represented 73% of the $15.0 million
loss from operations.

    Selling, general and administrative expenses in 1997 were $6.4 million, an
increase of $2.5 million from 1996.  The increase in spending reflects increased
staffing and associated expenses, in addition to increased marketing efforts
related to European commercialization.

    The Company recorded $1.1 million of net interest income for the year ended
December 31, 1997, as compared to $2.1 million for the previous year.  Interest
income decreased due to lower average cash and investment balances from period
to period.  The net loss in 1997 was $19.4 million, an increase of $6.5 million
from the net loss of $12.9 million in 1996.

Tax Matters

    As of December 31, 1998, the Company had federal, state and French net
operating loss carryforwards of approximately $66.3 million, $16.9 million and
$3.7 million, respectively.  The Company also had federal and state research and
experimentation credit carryforwards of approximately $1.3 million and $1.0
million, respectively.  The net operating loss and credit carryforwards will
expire at various dates beginning in 1999 through 2018, if not utilized.
Utilization of the net operating loss and credit carryforwards may be subject to
a substantial annual limitation due to the "change of ownership" rules provided
by the Internal Revenue Code and similar state tax provisions.  KeraVision has
not yet evaluated the potential impact of these provisions on its ability to
currently utilize the net operating loss and credit carryforwards.

    Under Statement of Financial Accounting Standards No. 109 ("FAS 109"),
deferred tax assets and liabilities are based on differences between financial
reporting and tax bases of assets and liabilities, and are measured using the
enacted tax rates and laws that will be in effect when the differences are
expected to reverse.  The Company has provided a full 

                                       25
<PAGE>
 
valuation allowance against its net deferred tax assets due to uncertainties
surrounding their realization, primarily due to the Company's lack of an
earnings history.

Liquidity and Capital Resources

     The Company has financed its operations since incorporation primarily
through its initial public offering, private sales of preferred stock, interest
income and equipment financing arrangements. On June 12, 1998, the Company
completed the sale of Series B Convertible Preferred Stock with net proceeds to
the Company of $16.6 million. Cash used in operating activities for 1998 has
increased to $23.0 million from $18.0 million in the prior year, reflecting
increased selling, general and administrative, research and development and
increased negative gross margins. Cash, cash equivalents and available-for-sale
investments were $7.7 million at December 31, 1998.  Capital expenditures for
1998 and 1997 were $0.7 million and $0.5 million, respectively.

     On December 23, 1998 the Company announced that it had entered into a
definitive merger agreement to acquire Transcend Therapeutics, Inc. (Nasdaq:
TSND) and its anticipated net cash balance of about $8 million.  This
transaction will be accounted for as an acquisition of assets.  Under the
agreement, Transcend will wind down its operations as a drug development company
and no Transcend employees will be retained after the closing of the
transaction.  According to the terms of the agreement, Transcend will become a
wholly owned subsidiary of the Company.  Transcend stockholders will receive
shares of KeraVision common stock with a value equal to the amount of net cash
of Transcend as of the closing date plus a premium of 30 percent.  Stockholders
holding 51% of Transcend outstanding common stock have agreed to vote in favor
of the merger.  In addition, KeraVision will be entitled to a breakup fee of
$500,000 if the agreement is terminated for certain reasons.

     In March 1999, the Company entered into a senior term loan agreement
providing for borrowings of $5,000,000.  The full amount was advanced on March
25, 1999.  The loan bears interest at 11.75% per year until the Company repays
the loan on September 30, 2001.  The Company has the right to prepay the loan
subject to a prepayment penalty of 6% of the current outstanding principal.
Repayment of the loan is secured by the Company's assets except for intellectual
property.  In connection with the loan, KeraVision granted to the lender
warrants to purchase 55,492 shares of the common stock at an exercise price of
$10.8125, the closing price as of March 5, 1999, the date of the loan
commitment.  The respective warrants are exercisable for 7 years from the date
of issuance.

     KeraVision expects to continue to incur substantial expenses in support of
additional research and development and sales and marketing activities,
including cost of clinical studies, manufacturing costs, the expansion of its
sales and marketing organization and the support for ongoing administrative
activities. Management's planned expenditures for 1999 exceed current cash, cash
equivalents and available-for-sale investments, and the funds to be received
from the Transcend acquisition and the Senior Term Loan. Management believes
that sufficient funds will be available from additional investors to support
planned operations through December 1999.  The Company intends to raise
additional funds through the sale of its equity securities and/or debt
financings. The Company may also enter into collaborative arrangements with
corporate partners that could provide the Company with additional funding in the
form of equity, debt or license fees in exchange for the Company's rights with
respect to markets or technology.  There can be no assurance that the Company
will be able to raise any additional funds or enter into any such collaborative
arrangements on terms favorable to the Company, or at all.  If the Company is
unable to obtain the necessary additional capital, significant reductions in
spending and the delay or cancellation of planned activities or more substantial
restructuring options may be necessary.  In such event, the Company intends to
implement expense reduction plans in a timely manner to enable the Company to
meet its operating cash requirements through December 31, 1999.  These actions
would have material adverse effects on the Company's business, results of
operations and prospects.

    The Company's cash requirements may vary materially from those now planned
because of results of research, development and clinical testing, establishment
of relationships with strategic partners, changes in focus and direction of the
Company's research and development programs, changes in the scale, timing, or
cost of the Company's commercial manufacturing facility, competitive and
technological advances, the FDA or other regulatory processes, changes in the
Company's marketing and distribution strategy, and other factors.

Year 2000

     The Year 2000 Issue is the result of computer programs being written using
two digits rather than four to define the applicable year.  Any of the Company's
computer programs or hardware that have date-sensitive software or embedded
chips may recognize a date using "00" as the year 1900 rather than the year
2000.  This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, send invoices, or engage in similar normal business
activities.

                                       26
<PAGE>
 
     Based on recent assessments, the Company determined that it would be
required to replace a small portion of its software so that those systems will
properly utilize dates beyond December 31, 1999. The Company has determined that
all of its critical business systems are already year 2000 compliant.
Assessment, testing and remediation are proceeding in tandem, and the Company
currently plans to have all modifications to systems completed and tested by
mid-1999.  These activities are intended to encompass all major categories of
systems in use by the Company, including manufacturing, sales, finance and human
resources.  KeraVision is also actively working with critical suppliers of
products and services to determine that the suppliers' operations and the
products and services they provide are year 2000 compliant or to monitor their
progress toward year 2000 compliance.  The Company reviewed its product line and
determined that all of the products it has sold and will continue to sell do not
require remediation to be year 2000 compliant.  There can be no guarantee that
any system of other companies, on which the Company's systems rely and which are
not year 2000 compliant, will be year 2000 compliant in a timely fashion and
would not have an adverse effect on the Company's systems.

     The costs incurred to date related to these programs are less than $5,000.
The Company currently expects that the total cost of these programs, including
both incremental spending and redeployed resources, will not exceed $60,000.
The total cost estimated does not include potential costs related to any
customer or other claims or the cost of internal software and hardware replaced
in the normal course of business.  The total cost estimate is based on the
current assessment of the projects and is subject to change as the projects
progress.

     Due to the Company's reliance on widely used software packages that have
been certified as year 2000 compliant, the Company has not developed a formal
contingency plan for software. Should unforeseen problems surface during its
testing of those packages, the Company will evaluate its alternatives, such as
utilizing different software packages.  The Company is currently working on
developing contingency plans to increase inventories and raw materials in
preparation for the year 2000.  This plan is currently in the development stages
and should be finalized by mid 1999.

     Based on currently available information, management does not believe that
the year 2000 matters discussed above related to internal systems, will have a
material adverse impact on the Company's financial condition or overall results
of operations; however, it is uncertain to what extent the Company may be
affected by such matters.  In addition, there can be no guarantee that the
failure to ensure year 2000 compliance by a supplier or another third party
would not have a material adverse effect on the Company.

Euro

     The Company does not presently expect that the introduction and use of the
Euro will materially affect the Company's foreign exchange or will result in any
material increase in costs to the Company.  While KeraVision will continue to
evaluate the impact of the Euro introduction over time, based on currently
available information, management does not believe that the introduction of the
Euro currency will have a material adverse impact on the Company's financial
condition or overall trends in results of operations.

Market Risk Disclosure

     Interest Rate Risk

    The Company's exposure to market risk for changes in interest rates relates
primarily to the Company's investment portfolio and long-term debt obligations.
The Company does not use derivative financial instruments in its investment
portfolio.  The Company places its investments with high credit quality issuers
and, by policy, limits the amount of credit exposure to any one issuer.  As
stated in its policy, the Company is averse to principal loss and seeks to
ensure the safety and preservation of its invested funds by limiting default
risk, market risk, and reinvestment risk.

    The Company mitigates default risk by investing in only the safest and
highest credit quality securities.  The portfolio includes only marketable
securities with active secondary or resale markets to ensure portfolio
liquidity.

    The Company has no cash flow exposure due to rate changes for long-term debt
obligations.  The Company primarily enters into debt obligations to support
general corporate purposes including capital expenditures and working capital
needs.

    The table below presents principal amounts and related weighted average
interest rates by year of maturity for the Company's investment portfolio and
debt obligations.  All investments mature, by policy, in one year or less.

                                       27
<PAGE>
 
<TABLE>
<S>                              <C>          <C>           <C>           <C>           <C>           <C>        <C>
                                                                                                                      Fair Value
(in thousands)                         1999          2000          2001          2002           2003    Total           12/31/98
--------------------------------------------------------------------------------------------------------------------------------
Assets:
Cash equivalents
   Fixed rate                        $1,449           $--           $--           $--            $--     $1,449           $1,449
   Average interest rate               2.87%
Available-for-sale investments
   Fixed rate                         6,279            --            --            --             --      6,279            6,279
   Average interest rate                5.3%
 
Total investments
   Securities                         7,728            --            --            --             --      7,728            7,728
   Average interest rate               4.85%
 
Long-Term Debt:
   Fixed rate                           646           563           233           150             --      1,592            1,592
   Average interest rate              13.93%        13.94%        16.47%        17.77%
</TABLE>

     Foreign Currency Risk

     The Company transacts business in French Francs, German Deutsch Marks and
Canadian dollars. Transactions in foreign currency are minimal and do not have a
material impact on the Company's financial statements.

Item 8.  Financial Statements and Supplementary Data
------   -------------------------------------------

     See Item 14(a) for an index to financial statements and supplementary
information.

Item 9.  Changes in and Disagreements with Accountants on Accounting and
------   ---------------------------------------------------------------
       Financial Disclosure
       --------------------

          Not applicable.

                                    PART III

     Certain information required by Part III is omitted from this report
because the Registrant will file a definitive proxy statement within 120 days
after the end of its fiscal year pursuant to Regulation 14A (the "Proxy
Statement") for its annual meeting of stockholders scheduled to be held May 26,
1999, and the information included therein is incorporated herein by reference
to the extent detailed below.

Item 10.  Directors and Executive Officers of the Registrant
-------   --------------------------------------------------

          Information with respect to the Registrant's directors required by
this Item is incorporated by reference from the information under the caption
"Election of Directors--Board of Directors" in the Registrant's Proxy Statement.

          Information as to the Registrant's executive officers is set forth in
"Item 1 -- Business -- Executive Officers of the Company" of this Form 10-K.

Item 11.  Executive Compensation
-------   ----------------------

          Information required by this Item is incorporated by reference from
the information under the caption "Executive Compensation" in the Registrant's
Proxy Statement.

Item 12.  Security Ownership of Certain Beneficial Owners and Management
-------   --------------------------------------------------------------

          Information required by this Item is incorporated by reference from
the information under the caption "Common Stock Ownership of Certain Beneficial
Owners and Management" in the Registrant's Proxy Statement.

                                       28
<PAGE>
 
Item 13.  Certain Relationships and Related Transactions
-------   ----------------------------------------------

          Information required by this Item is incorporated by reference from
the information under the caption "Certain Relationships and Related
Transactions" in the Registrant's Proxy Statement.

                                    PART IV

Item 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K
-------   ---------------------------------------------------------------

(a)(1)The following financial statements and Report of Ernst & Young LLP,
   Independent Auditors, are filed as part of this report:

                                                                     Page
                                                                     ----
        Report of Ernst & Young, Independent Auditors                 34
  
        Consolidated Balance Sheets at December 31, 1998 and 1997     35

        Consolidated Statements of Operations Years Ended             36
            December 31, 1998, 1997 and 1996

        Consolidated Statements of Redeemable Convertible
            Preferred Stock and Stockholders' Equity (net capital 
            deficiency) Years Ended December 31, 1998, 1997 and 1996  37

        Consolidated Statements of Cash Flows Years Ended             38
            December 31, 1998, 1997, and 1996

        Notes to Consolidated Financial Statements                    39      
 
   (2)  Financial Statement Schedule
                                                                  
        Schedules have been omitted because the information required
        to be set forth therein is not applicable or is shown in the 
        financial statements or notes thereto.

   (3)  The following exhibits are filed as part of this report:


<TABLE>
<CAPTION>
Exhibit       Description
Number        -----------
------
<C>           <S>
   2.1        Agreement and Plan of  reorganization by and among KeraVision, Inc. KVTT acquisition
              corporation and Transcend Theraputics, Inc. dated as of December 22, 1998.(13)
   3.1        Amended and Restated Certificate of Incorporation of Registrant.(1)
   3.2        Amended and Restated Bylaws of Registrant, as amended.
   4.1        Preferred Shares Rights Agreement, dated as of August 18, 1997, between Registrant and Bank
              Boston, N.A. (7)
   4.2        KeraVision, Inc. Investors' Rights Agreement.(13)
   4.3        Certificate of Designation of Rights, Preferences and Privileges of Series B Convertible
              Preferred Stock of KeraVision, Inc.(14)
  10.1        Form of Indemnification Agreements for directors and officers. (1)
  10.2        1997 Employee Stock Option Plan.(1)(2)
  10.3        1987 Stock Option Plan and forms of agreements thereunder.(1)(2)
  10.4        Form of Change of Control Agreement entered into between Registrant and Chief Executive Officer
              in May 1997.(2)(8)
  10.5        Form of Change of Control Agreement entered into between Registrant and Executive Officers in May
              1997.(2)(8)
  10.6        1995 Stock Plan, as amended.(2)(9)
  10.7        1995 Directors' Option Plan and form of subscription agreement.(4)(2)
  10.8        401(k) Plan.(1)(2)
</TABLE> 
                                       29
<PAGE>
<TABLE> 
<CAPTION> 

<S>           <C>  
 10.9         Fremont Office Lease dated August 20, 1993 and all amendments thereto.(1)
 10.10        Kilmer License Agreement, dated December 31, 1992.(1)
 10.11        Manufacturing Agreement dated October 1, 1992.(1)(3)
 10.12        Form of Warrant for Series D Preferred Stock between Registrant and certain holders of Common
              Stock of Registrant.(1)
 10.13        Promissory Notes, dated January 29, 1988, March 8, 1988, March 8, 1989, October 30, 1991, April
              12, 1993 and November 7, 1993, executed by Thomas Loarie in favor of Registrant and all
              amendments thereto. (9)
 10.14        Promissory Notes, dated September 17, 1990, October 30, 1991, October 30, 1991, and November 7,
              1993, executed by Thomas Silvestrini in favor of Registrant and all amendments thereto. (9)
 10.15        Promissory Note, dated November 7, 1993, executed by Mark Fischer-Colbrie in favor of Registrant
              and all amendments thereto.(10)
 10.16        Promissory Notes, dated March 8, 1988, March 8, 1988, March 8, 1989, October 30, 1991, and
              November 7, 1993, executed by Darlene Crockett-Billig in favor of Registrant and all amendments
              thereto.(9)
 10.17        Consulting Agreement dated January 19, 1994 between Registrant and John R. Gilbert, and all
              amendments thereto.(1)
 10.18        Information and Registration Rights Agreement between Registrant and holders of the Preferred
              Stock of the Registrant, dated as of November 19, 1992.(1)
 10.19        Consulting Agreement dated January 1, 1996 between Registrant and John R. Gilbert.(4)
 10.20        Employment Agreement dated January 1997 between Registrant and Thomas M. Loarie.(2)(6)
 10.21        Distribution Agreement dated as of October 31, 1996 by and between Registrant and AM Peschke, a
              German corporation.(5)(6)
 10.22        Promissory notes, dated April 1, 1998, executed by Thomas Loarie in favor of Registrant.(11)
 10.23        Promissory note, dated April 1, 1998, executed by Mark Fischer-Colbrie in favor of Registrant.(11)
 10.24        Promissory note, dated April 1, 1998, executed by Thomas Silvestrini in favor of Registrant.(11)
 10.25        Promissory notes, dated September 1, 1998 executed by Thomas Loarie in favor of Registrant.(12)
 10.26        Promissory notes, dated September 1, 1998 executed by Darlene Crockett-Billig in favor of
              Registrant.(12)
 10.27        Promissory notes, dated September 1, 1998 executed by Thomas Silvestrini in favor of
              Registrant.(12)
 10.28        Promissory notes, dated September 1, 1998 executed by Mark Fischer-Colbrie in favor of
              Registrant.(12)
 10.29        Master loan and security agreement dated March 25, 1999 between Registrant in favor of
              Transamerica Business Credit Corporation.(13)
 10.30        Agreement with A.M. Pappas & Associates dated January 20, 1998.
  23.1        Consent of Ernst & Young LLP, Independent Auditors.
  24.1        Power of Attorney (See Signature Page).(13)
    27        Financial Data Schedule.(13)
</TABLE>
________________


(1)  Incorporated by reference to identically numbered exhibits filed in
     Registrant's Registration Statement on Form S-1 and Amendment No. 1,
     Amendment No. 2 and Amendment No. 3 thereto (File No. 33-92880), which
     became effective on July 27, 1995.

(2)  Management contract or compensatory plan or arrangement.

(3)  Confidential treatment has been granted with respect to certain portions of
     this Exhibit by the Securities and Exchange Commission by order dated July
     27, 1995.

(4)  Incorporated by reference to identically numbered exhibits filed in
     Registrant's Form 10-K for the year ended December 31, 1995.

(5)  Confidential treatment has been sought with respect to certain portions of
     this Exhibit.

(6)  Incorporated by reference to identically numbered exhibits filed in
     Registrant's Form 10-K for the year ended December 31, 1996.

(7)  Incorporated by reference to identically numbered exhibit filed in
     Registrant's Registration on Form 8-A which became effective on August 25,
     1997.

                                       30
<PAGE>
 
(8)  Incorporated by reference to exhibits 10.23 and 10.24 filed in Registrant's
     Form 10-K for the year ended December 31, 1997.

(9)  Incorporated by reference to identically numbered exhibits filed in
     Registrant's Registration Statement on Form S-1 (File No. 33-92880), which
     became effective on July 27, 1995, and Form 10-K for the year ended
     December 31, 1996.

(10) Incorporated by reference to identically numbered exhibits filed in
     Registrant's Registration Statement on Form S-1 (File No. 33-92880), which
     became effective on July 27, 1995, and Form 10-K for the year ended
     December 31, 1997.

(11) Incorporated by reference to Exhibits 10.25 through 10.27 filed in
     Registrant's Form 10-Q for the quarterly period ended March 31, 1998.

(12) Incorporated by reference to Exhibits 10.28 through 10.31 filed in
     Registrant's Form 10-Q for the quarterly period ended September 30, 1998.

(13) Incorporated by reference to identically numbered Exhibits filed in
     Registrant's Form 10-K for the year ended December 31, 1998.

(14) Incorporated by reference to Exhibit 3.3 filed in Registrant's Form 10-K
     for the year ended December 31, 1998.

(15) (b)  The Company filed the following reports on Form 8-K during the year
          ended December 31, 1998:

     Report Date:  August 26, 1998                     
     Item 5.  Other Events

     Pioneering Ring technology for nearsighted people to receive full PMA
     review by FDA.

     Report Date:  August 3, 1998                     
     Item 5.  Other Events

     KeraVision Appoints to Board Peter L. Wilson, Former President of
     Richardson Vicks USA.

     Report Date:  July 23, 1998                     
     Item 5.  Other Events

     KeraVision Appoints 23-Year J&J Veteran as VP-EuropeMenlo Park, California
     on this 27th day of March 1999.

     Report Date:  July 23, 1998                     
     Item 5.  Other Events

     KeraVision reports second quarter results.


 

                                       31
<PAGE>
 
                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Amendment No. 1 to the
Report on Form 10-K to be signed on its behalf by the undersigned, thereunto
duly authorized in the City of Menlo Park, California on this 3rd day of May
1999.

                             KERAVISION, INC.

                             By:  /s/Mark Fischer-Colbrie
                                  ---------------------------------------
                                    Mark Fischer-Colbrie 
                                 Vice President, Finance and
                    Administration, Chief Financial Officer and Assistant
                   Secretary (Principal Financial and Accounting Officer)


     Pursuant to the requirements of the Securities Exchange Act of 1934, this
Amendment No. 1 to the Report on Form 10-K has been signed below by the
following persons in the capacities and on May 3, 1999.

           Signature                                 Title
           ---------                                 -----
 
              *                  Chairman of the Board of Directors,      
-------------------------------  President and Chief Executive Officer    
      (Thomas M. Loarie)         (Principal Executive Officer)             

  /s/Mark Fischer-Colbrie        Vice President, Finance and Administration,
-------------------------------  Chief Financial Officer, and Assistant
  (Mark Fischer-Colbrie)         Secretary (Principal Financial and
                                 Accounting Officer)
 
 
               *                 Director
-------------------------------
      (Charles Crocker)
 
               *                 Director
-------------------------------
      (John R. Gilbert)
 
               *                 Director
-------------------------------
      (Kathleen D. La Porte)
 
               *                 Director
-------------------------------
      (Lawrence Lehmkuhl)
 
               *                 Director
-------------------------------
      (Kshitij Mohan)
 
               *                 Director
-------------------------------
      (Arthur M. Pappas)
 
               *                 Director
-------------------------------
      (Peter L. Wilson)
 
 
*By: /s/Mark Fischer-Colbrie     Vice President, Finance and Administration,
    ------------------------
       (Mark Fischer-Colbrie)    Chief
           Attorney-in-Fact      Financial Officer, and Assistant Secretary
                                 (Principal Financial and Accounting Officer)
 

                                       32
<PAGE>
 
                                KERAVISION, INC.

                               Index to Exhibits
<TABLE> 
<CAPTION> 
     Exhibit
     Number                                 Description                            Page Number
----------------------------------------------------------------------------------------------
 
<S>                <C>                                                             <C>
       3.2         Amended and Restated Bylaws of Registrant
 
      10.30        Agreement with A.M. Pappas & Associates dated January 20, 1998
 
      23.1         Consent of Ernst & Young LLP, Independent Auditors
 
 
</TABLE>

                                       33
<PAGE>
 
Report of Ernst & Young LLP, Independent Auditors



The Board of Directors and Stockholders
KeraVision, Inc.

          We have audited the accompanying consolidated balance sheets of
KeraVision, Inc. as of December 31, 1998 and 1997, and the related consolidated
statements of operations, and redeemable convertible preferred stock and
stockholders' equity (net capital deficiency), and cash flows for each of the
three years in the period ended December 31, 1998.  These financial statements
are the responsibility of the Company's management.  Our responsibility is to
express an opinion on these financial statements based on our audits.

          We conducted our audits in accordance with generally accepted auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

          In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the consolidated financial
position of KeraVision, Inc. at December 31, 1998 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1998, in conformity with generally accepted accounting
principles.


                                                               Ernst & Young LLP



February 3, 1999,
except for Note 9, as to which the date is
March 25, 1999
San Jose, California

                                       34
<PAGE>
 
                                KERAVISION, INC.
                          Consolidated Balance Sheets
               (in thousands, except share and per share amounts)
                                        
<TABLE>
<CAPTION>
                                                                                                       December 31,
                                                                                                -----------------------
                                                                                                    1998         1997
                                                                                                -----------------------
<S>                                                                                               <C>          <C>
Assets
Current assets:
  Cash and cash equivalents.....................................................................    $1,449       $2,574
  Available-for-sale investments................................................................     6,279       11,539
  Prepaid expenses and other current assets.....................................................     1,508        1,265
                                                                                                  --------     --------
 
Total current assets............................................................................     9,236       15,378
 
Property and equipment, at cost:
  Manufacturing and laboratory equipment........................................................     3,709        3,298
  Office furniture and fixtures.................................................................       597          586
  Leasehold improvements........................................................................       636          383
                                                                                                  --------     --------
                                                                                                     4,942        4,267
Accumulated depreciation and amortization.......................................................    (3,102)      (2,398)
                                                                                                  --------     --------
  Net property and equipment....................................................................     1,840        1,869
Other assets....................................................................................       108           98
                                                                                                  --------     --------
 
Total assets....................................................................................   $11,184      $17,345
                                                                                                  ========     ========
 
Liabilities and stockholders' equity (net capital deficiency)
Current liabilities:
  Accounts payable..............................................................................    $1,742       $1,089
  Accrued payroll and related expenses..........................................................       581          489
  Accrued clinical trial costs..................................................................     1,282        1,211
  Other accrued liabilities.....................................................................       204          414
  Current portion of capital lease obligations..................................................       512          355
                                                                                                  --------     --------
 
Total current liabilities.......................................................................     4,321        3,558
 
Capital lease obligations.......................................................................       821          850
Redeemable convertible series B preferred stock, no par value:
 Authorized shares--662,500;
 Issued and outstanding shares--562,500 at December 31, 1998, aggregate liquidation
   preference of $20,520,000....................................................................    17,489           --
Commitments and contingencies
Stockholders' equity (net capital deficiency):
  Preferred stock, par value $.001, 2,000,000 shares authorized, none issued and outstanding....        --           --
  Common stock, par value $.001, 30,000,000 shares authorized, 12,776,920 and 12,593,646 shares
   issued and outstanding in 1998 and 1997, respectively........................................        13           13
 
  Additional paid-in capital....................................................................    80,162       76,540
  Deferred compensation.........................................................................       (30)        (179)
  Accumulated other comprehensive income........................................................       109           44
  Accumulated deficit...........................................................................   (90,092)     (62,678)
  Notes receivable from stockholders............................................................    (1,609)        (803)
                                                                                                  --------     --------
 
Total stockholders' equity (net capital deficiency).............................................   (11,447)      12,937
                                                                                                  --------     --------
 
Total liabilities and stockholders' equity (net capital deficiency).............................   $11,184      $17,345
                                                                                                  ========     ========
</TABLE>

                            See accompanying notes.

                                       35
<PAGE>
 
                                KERAVISION, INC.
                     Consolidated Statements of Operations
                     (in thousands, except per share data)
                                        
<TABLE>
<CAPTION>
                                                                                           Year Ended
                                                                                          December 31,
                                                                     ---------------------------------------------------
                                                                                1998             1997             1996
                                                                     ---------------------------------------------------
<S>                                                                    <C>               <C>              <C>
 
 
   Net sales.........................................................             $835             $355             $137
 
   Costs and expenses:
       Cost of sales and manufacturing expenses......................            4,386            3,701              319
       Research and development......................................           11,356           10,774           10,888
       Selling, general and administrative...........................            9,693            6,405            3,930
                                                                     --------------------------------------------------- 
 
   Total costs and expenses..........................................           25,435           20,880           15,137
                                                                     --------------------------------------------------- 

   Operating loss....................................................          (24,600)         (20,525)         (15,000)
   Interest income, net..............................................              563            1,129            2,121
                                                                     --------------------------------------------------- 
 
   Net loss..........................................................         $(24,037)        $(19,396)        $(12,879)
                                                                     ---------------------------------------------------
 
   Preferred stock dividend requirements:
     Redeemable convertible series B.................................             (846)              --               --
     Deemed dividend (Note 5)........................................           (2,531)              --               --
                                                                     ---------------------------------------------------
 
   Net loss applicable to common stockholders........................         $(27,414)        $(19,396)        $(12,879)
                                                                     ===================================================
   Basic and diluted net loss per share applicable to common
    stockholders.....................................................           $(2.16)          $(1.55)          $(1.04)
 
   Shares used in calculation of net loss per share..................           12,686           12,528           12,342
</TABLE>

                            See accompanying notes.

                                       36
<PAGE>
<TABLE>  
<CAPTION> 
                                                         KeraVision, Inc.
        Consolidated Statements of Redeemable Convertible Preferred Stock and Stockholders' Equity (Net Capital Deficiency)
                                        (In thousands, except share and per share amounts)

                                                   Redeemable Convertible                                        
                                                     Preferred Stock           Common Stock        Additional           
                                                  ---------------------------------------------      Paid-In       Deferred
(in thousands, except share and per share amounts) Shares      Amount       Shares       Amount      Capital      Compensation  
------------------------------------------------------------------------------------------------------------------------------
<S>                                                <C>        <C>           <C>          <C>        <C>           <C> 
Balance at December 31, 1995                         --          --         12,262,845   $ 12         $ 75,710         $ (477)
Issuance of common stock upon exercise of options    --          --            181,957     --              404       --       
Amortization of deferred compensation                --          --           --           --          --                 149 
Forgiveness of notes receivable from stockholders,                                                                           
  net of accrued interest                            --          --           --           --          --            --       
Comprehensive income:                                                                                                        
Net loss                                             --          --           --           --          --            --       
Other comprehensive income, net of tax:                                                                                      
  Unrealized gain on available-for-sale securities,                                                                          
      net of reclassification adjustments            --          --           --           --          --            --       
  Foreign currency translation adjustments           --          --           --           --          --            --       
  Other comprehensive income                         --          --           --           --          --            --       
Comprehensive income (loss)                          --          --           --           --          --            --       
                                                  ----------------------------------------------------------------------------

Balance at December 31, 1996                         --          --         12,444,802          12      76,114           (328)
Issuance of common stock upon exercise of options    --          --            148,844           1         426       --       
Amortization of deferred compensation                --          --           --           --          --                 149 
Accrued interest on notes receivable from            
  stockholder                                        --          --           --           --          --            --    
Comprehensive income:                                                                                                        
Net loss                                             --          --           --           --          --            --       
Other comprehensive income, net of tax:                                                                                      
  Unrealized gain on available-for-sale securities,                                                                          
      net of reclassification adjustments            --          --           --           --          --            --       
  Foreign currency translation adjustments           --          --           --           --          --            --       
  Other comprehensive income                         --          --           --           --          --            --       
Comprehensive income (loss)                          --          --           --           --          --            --       
                                                  ----------------------------------------------------------------------------

Balance at December 31, 1997                         --          --         12,593,646          13      76,540           (179)
Issuance of common stock upon exercise of options    --          --            183,274     --              598       --       
Issuance of redeemable convertible series B                                                                                  
  preferred stock, net of issuance costs             562,500    $ 14,112      --           --            2,531       --       
Accretion of dividends on preferred stock            --              150      --           --          --            --       
Dividends on preferred stock to be distributed       --              696      --           --          --            --       
Dividends on series B preferred stock issuance                                                                               
  related to deemed dividend (Note 5)                --            2,531      --           --          --            --       
Amortization of deferred compensation                --          --           --           --          --                 149 
Issuance of stockholder notes                        --          --           --           --          --            --       
Forgiveness of notes receivable from stockholders,                                                                           
  net of accrued interest                            --          --           --           --          --            --       
Accrued interest on notes receivable from                  
  stockholders                                       --          --           --           --          --            --  
Compensation expense related to employee stock       
  activity                                           --          --           --           --              493       --    
Comprehensive income:                                                                                                         
Net loss                                             --          --           --           --          --            --       
Other comprehensive income, net of tax:                                                                                      
  Unrealized gain on available-for-sale securities,                                                                          
      net of reclassification adjustments            --          --           --           --          --            --       
  Foreign currency translation adjustments           --          --           --           --          --            --       
  Other comprehensive income                         --          --           --           --          --            --       
Comprehensive income (loss)                          --          --           --           --          --            --       
                                                  ----------------------------------------------------------------------------
Balance at December 31, 1998                         562,500    $ 17,489    12,776,920        $ 13    $ 80,162          $ (30)
                                                  ============================================================================
</TABLE> 
See accompanying notes.                           
<TABLE> 
<CAPTION> 

                                                                                                                  Total     
                                                                   Accumulated                    Notes      Stockholders'
                                                                     Other                     Receivable    Equity (Net
                                                   Comprehensive  Comprehensive  Accumulated      From        Capital    
(in thousands, except share and per share amounts) Income/(loss)     Income       Deficit     Stockholders    Deficiency)  
------------------------------------------------------------------------------------------------------------------------
<S>                                                <C>            <C>            <C>           <C>            <C>  
Balance at December 31, 1995                            $--           $--          $ (30,403)      $ (807)     $ 44,035 
Issuance of common stock upon exercise of options        --            --            --           --                404 
Amortization of deferred compensation                    --            --            --           --                149 
Forgiveness of notes receivable from stockholders,                                                                      
  net of accrued interest                                --            --            --                39            39 
Comprehensive income:                                                                                                   
Net loss                                                  (12,879)     --            (12,879)     --            (12,879)
                                                   --------------  
Other comprehensive income, net of tax:                                                                                 
  Unrealized gain on available-for-sale securities,                                                                     
      net of reclassification adjustments                      18      --            --           --                 18 
  Foreign currency translation adjustments                     (1)     --            --           --                 (1)
                                                   --------------
  Other comprehensive income                                   17            17      --           --           --       
                                                   --------------
Comprehensive income (loss)                             $ (12,862)                   --           --           --       
                                                   ===============------------------------------------------------------

Balance at December 31, 1996                                                 17      (43,282)        (768)       31,765 
Issuance of common stock upon exercise of options        --            --            --           --                427 
Amortization of deferred compensation                    --            --            --           --                149 
Accrued interest on notes receivable from                --            --            --               (35)          (35)
  stockholders                                                                                                             
Comprehensive income:                                                                                                   
Net loss                                                  (19,396)     --            (19,396)     --            (19,396)
                                                   --------------
Other comprehensive income, net of tax:                                                                                 
  Unrealized gain on available-for-sale securities,                                                                     
      net of reclassification adjustments                      26      --            --           --                 26 
  Foreign currency translation adjustments                      1      --            --           --                  1 
                                                   --------------
  Other comprehensive income                                   27            27      --           --           --       
                                                   --------------
Comprehensive income (loss)                             $ (19,369)     --            --           --           --       
                                                   ===============------------------------------------------------------

Balance at December 31, 1997                                                 44      (62,678)        (803)       12,937 
Issuance of common stock upon exercise of options        --            --            --           --                598 
Issuance of redeemable convertible series B                                                                             
  preferred stock, net of issuance costs                 --            --            --           --              2,531 
Accretion of dividends on preferred stock                --            --               (150)     --               (150)
Dividends on preferred stock to be distributed           --            --               (696)     --               (696)
Dividends on series B preferred stock issuance                                                                          
  related to deemed dividend (Note 5)                    --            --             (2,531)     --             (2,531)
Amortization of deferred compensation                    --            --            --           --                149 
Issuance of stockholder notes                            --            --            --              (776)         (776)
Forgiveness of notes receivable from stockholders,                                                                      
  net of accrued interest                                --            --            --                46            46 
Accrued interest on notes receivable from                
  stockholders                                           --            --            --               (76)          (76)         
Compensation expense related to employee stock           
  activity                                               --            --            --           --                493   
Comprehensive income:                                                                                                 0 
Net loss                                                  (24,037)     --            (24,037)     --            (24,037)
                                                   --------------
Other comprehensive income, net of tax:                                                                                 
  Unrealized gain on available-for-sale securities,                                                                     
      net of reclassification adjustments                     (42)     --            --           --                (42)
  Foreign currency translation adjustments                    107      --            --           --                107 
                                                   --------------
  Other comprehensive income                                   65            65      --           --           --       
                                                   --------------
Comprehensive income (loss)                             $ (23,972)     --            --           --           --       
                                                   ===============------------------------------------------------------
Balance at December 31, 1998                                              $ 109    $ (90,092)    $ (1,609)    $ (11,447)
                                                                  ====================================================== 
</TABLE> 
See accompanying notes.                            
 

                                       37
<PAGE>
 
                                KERAVISION, INC.
                     Consolidated Statements Of Cash Flows
                     Decrease in cash and cash equivalents
                                 (in thousands)
 
<TABLE> 
<CAPTION> 

                                                                                          Year Ended
                                                                                         December 31,
                                                                           ----------------------------------------
                                                                              1998            1997            1996
                                                                           ----------------------------------------
 
Cash flows from operating activities:
<S>                                                                   <C>             <C>             <C>
 Net loss...........................................................       $(24,037)       $(19,396)       $(12,879)
 Adjustments to reconcile net loss to net cash used in operating
  activities:
    Depreciation and amortization...................................            704             652             448
    Issuance of stockholders' notes receivable......................           (776)             --              --
    Interest receivable on stockholders' notes......................            (76)            (35)            (41)
    Expenses related to employee stock activity, including
     amortization of deferred compensation..........................            688             149             229
 
    Changes in operating assets and liabilities:
      Prepaid expenses and other current assets.....................           (115)             32          (1,025)
       Accounts payable.............................................            653             116             528
       Other accrued liabilities....................................            (47)            504             391
                                                                           --------        --------        --------
     Net cash used in operating activities..........................        (23,006)        (17,978)        (12,349)
                                                                           --------        --------        --------
 
Cash flows from investing activities:
 Purchases of available-for-sale investments........................        (22,214)        (20,620)        (40,402)
 Sales of available-for-sale investments............................         25,210          11,408          10,790
 Maturities of available-for-sale investments.......................          2,201          21,474           5,855
 Capital expenditures...............................................           (675)           (545)         (1,550)
 Other assets.......................................................            (10)             49             (77)
                                                                           --------        --------        --------
 
     Net cash provided by (used in) investing activities............          4,512          11,766         (25,384)
                                                                           --------        --------        --------
 
Cash flows from financing activities:
 Principal payments under capital lease obligations.................           (480)           (427)           (156)
 Proceeds from sales-leaseback of capital equipment.................            608             495           1,073
 Proceeds from issuance of equity securities, net of
   repurchases......................................................            598             427             404
 Proceeds from issuance of redeemable convertible Series B
   preferred stock, net of issuance costs...........................         16,643              --              --
                                                                           --------        --------        --------
     Net cash provided by financing activities......................         17,369             495           1,321
                                                                           --------        --------        --------
Net decrease in cash and cash equivalents...........................         (1,125)         (5,717)        (36,412)
Cash and cash equivalents at the beginning of the year..............          2,574           8,291          44,703
                                                                           --------        --------        --------
Cash and cash equivalents at the end of the year....................       $  1,449        $  2,574        $  8,291
                                                                           ========        ========        ========
Supplemental disclosure of non-cash financing activities:
Accrued and deemed dividends related to preferred stock.............       $  3,227             $--             $--
Accretion related to preferred stock................................       $    150             $--             $--
Supplemental disclosures of cash flow information
Cash paid for interest..............................................       $    123        $    140        $     25
                                                                           ========        ========        ========
</TABLE>
                            See accompanying notes.

                                       38
<PAGE>
 
                                KeraVision, Inc.
                   Notes to Consolidated Financial Statements
                                        


1.   Organization and Summary of Significant Accounting Policies

Organization and Basis of Presentation

       KeraVision, Inc. (''KeraVision'' or the ''Company'') was incorporated on
November 6, 1986 in the State of California and reincorporated in the State of
Delaware on July 25, 1995. On August 2, 1995, the Company completed its initial
public offering ("IPO") by issuing 3,600,000 shares of common stock in exchange
for net proceeds of $44.4 million.

       The Company was founded to develop and commercialize proprietary medical
products for the treatment of common vision problems. On December 23, 1986, the
Company acquired certain equipment and patent rights from Kera Associates, a
partnership, in exchange for 425,000 shares of the Company's common stock issued
to the former partners of Kera Associates. The assets were recorded at the
predecessor's cost basis. As part of the transaction with Kera Associates, the
Company acquired the exclusive license, existing between Kera Associates and an
outside third party, to develop and market the licensor's ''proprietary
rights,'' as defined, relating to the development of certain instruments used in
the insertion of the KeraVision Intacs, the Company's initial potential product.
The term of the license agreement will continue until the expiration of the last
expiring patent then existing or developed thereafter by the licensor relating
to the proprietary rights. Royalties are payable based upon sales of KeraVision
Intacs or the instruments.

Management's Plans and Financing

       The Company's financial statements are prepared and presented on a basis
assuming it continues as a going concern.  At December 31, 1998, the Company had
an accumulated deficit of $90.0 million and incurred a net loss of $24.0 million
as of and for the year ended December 31, 1998, respectively.

     On December 23, 1998 the Company announced that it had entered into a
definitive merger agreement to acquire Transcend Therapeutics, Inc. (Nasdaq:
TSND) and its anticipated net cash balance of about $8 million (see Note 8 -
Acquisitions).  In March 1999, the Company entered into a senior term loan
agreement providing for borrowings of $5,000,000, which was advanced on March
25, 1999 (see Note 9 - Subsequent Events).

     Management's planned expenditures for 1999 exceed current cash, cash
equivalents and available-for-sale investments and the funds to be received from
the Transcend acquisition and the senior term loan.  The Company will need to
obtain additional funds to continue its research and development activities,
fund operating expenses and pursue regulatory approvals for its products under
development.  Management believes that sufficient funds will be available from
additional investors to support planned operations through December 1999.  The
Company intends to raise additional funds through the sale of its equity
securities and/or debt financings. The Company may also enter into collaborative
arrangements with corporate partners that could provide the Company with
additional funding in the form of equity, debt or license fees in exchange for
the Company's rights with respect to certain markets or technology.  There can
be no assurance that the Company will be able to raise any additional funds or
enter into any such collaborative arrangements on terms favorable to the
Company, or at all.  If the Company is unable to obtain the necessary additional
capital, significant reductions in spending and the delay or cancellation of
planned activities or more substantial restructuring options may be necessary.
In such event, the Company intends to implement expense reduction plans in a
timely manner to enable the Company to meet its operating cash requirements
through December 31, 1999.  These actions would have material adverse effects on
the Company's business, results of operations and prospects.

Comprehensive Income

       In June 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (FAS
130).  FAS 130 establishes standards for the reporting and display of
comprehensive income and its components in a full set of general purpose
financial statements and is effective for fiscal years beginning after December
15, 1997.  The Company adopted FAS 130 in 1998.  The impact to the Company as a
result of the adoption of FAS 130 was immaterial as there was no significant
difference between the Company's net loss reported and the comprehensive net
loss under FAS 130 for the periods presented.

                                       39
<PAGE>
 
Segment Information
 
       The Company operates in one business segment, which is the development,
production and marketing of medical products for the treatment of common vision
problems.  The Chief Executive Officer has been identified as the Chief
Operating Decision Maker (CODM) because he has final authority over resource
allocation decisions and performance assessment.  The CODM does not receive
discrete financial information about individual components or geographical
information.

Principles of Consolidation

       The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary.  Significant intercompany transactions and
balances have been eliminated in consolidation.

Concentration of Credit Risk and Other Risks

       Financial instruments that potentially subject the Company to
concentrations of credit risk consist primarily of cash equivalents, short-term
investments and accounts receivables. The Company was founded to develop and
commercialize proprietary medical products for the treatment of common vision
problems.  The Company generally does not require collateral.  The Company
maintains allowances for credit losses, and such losses have been within
management's expectations.

Use of Estimates

       The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes.  Actual results could differ from these estimates.

Long-Lived Assets

       In accordance with Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of," the Company continually reviews long-lived assets to assess
recoverability based upon undiscounted cash flow analysis.  Impairments, if any,
are recognized in operating results in the period in which a permanent
diminuation in value is determined.

Depreciation and Amortization

       Depreciation is provided on a straight-line basis over assets' estimated
useful lives of three to five years. Assets acquired under capital leases are
amortized on a straight-line basis over the lesser of the assets' useful life or
the term of the lease.

Cash, Cash Equivalents, and Available-for-Sale Investments

       The Company considers all highly liquid investments with a maturity of
three months or less from the date of purchase to be cash equivalents. All other
liquid investments are classified as available-for-sale and consist primarily of
short-term investment grade securities, all of which mature within the next
twelve months.  The Company is exposed to credit risk in the event of default by
the financial institutions or issuers of investments only to the extent recorded
on the balance sheet.  At December 31, 1998 and 1997, the Company's liquid
assets were composed of deposits with banks and investments in U.S. Government
securities, corporate debt securities, certificates of deposits, auction market
preferred stocks and money market funds.  Investments include reverse repurchase
agreements with major financial institutions.  Due to the short-term nature of
the reverse repurchase agreements, the Company generally does not take
possession of the underlying securities.

       Management determines the appropriate classification of investments at
the time of purchase and reevaluates such designation as of each balance sheet
date. At December 31, 1998 and 1997, all debt and equity securities are
designated as available-for-sale. Available-for-sale securities are carried at
fair value as determined by reference to quoted market prices, with the
unrealized gains and losses reported in stockholders' equity (deficit). The
amortized cost of debt securities in this category is adjusted for the
amortization of premiums and accretion of discounts to maturity. Such
amortization is included in interest income. Realized gains and losses and
declines in value judged to be other-than-temporary, if any, on available-for-
sale securities are included in other expense. The cost of securities sold is
based on the specific identification method. Interest and dividends on
securities classified as available-for-sale are included in interest income.

                                       40
<PAGE>
 
Revenue Recognition

       The Company recognizes revenues from product sales upon shipment. The
Company provides allowances for estimated bad debts and sales returns, which
have not been material to date.  Customers do not have significant return
privileges.  Product sales in 1997 were composed principally of sales to the
European market through the Company's French sales office and German
Distributor.  In 1998, approximately 51% of the Company's sales were generated
from its limited product launch into the Canadian market, and the balance of the
sales were in Europe.

Net Loss Per Share

       In 1997, the Financial Accounting Standards Board issued Statement No.
128, "Earnings Per Share" (FAS 128).  FAS 128 replaced the calculation of
primary and fully diluted earnings per share with basic and diluted earnings per
share.  Unlike primary earnings per share, basic earnings per share excludes any
dilutive effects of options, warrants and convertible securities.  Due to the
Company's net loss in all periods presented, net loss per share includes only
weighted average shares outstanding.  All earnings per share amounts for all
periods have been presented, and where appropriate, restated to conform to the
FAS 128 requirements.

Advertising Expenses

       The cost of advertising is recorded as an expense when incurred.
Advertising costs for the years ended December 31, 1998 were $1.7 million.
Advertising expenses for the years ended December 31, 1997, and 1996 were
immaterial.

Accounting for Employee Stock Options

       The Company accounts for stock-based compensation issued to employees
and directors, including outside directors, using the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" (APB Opinion No. 25).  No grants were made to outside
directors subsequent to December 15, 1998.  The Company's policy is to grant
options with an exercise price equal to the fair market value of the Company's
common stock on the date of the grant.  Accordingly, no compensation cost, other
than the compensation discussed in Note 6, has been recognized in the Company's
statements of operations.  The Company provides additional pro forma disclosures
as required under Statement of Financial Accounting Standards No. 123
"Accounting for Stock-Based Compensation" (FAS 123) (see Note 6).

Income Taxes

       Income taxes are calculated under the provisions of Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" (FAS 109).
Under FAS 109, the liability method is used in accounting for income taxes,
which includes the effects of temporary differences between financial and
taxable amounts of assets and liabilities.

2.   Investments

       At December 31, 1998, the Company's investments were composed of the
following (in thousands):
<TABLE>
<CAPTION>
                                                                                                 Gross              Estimated
                                                                                             Unrealized                 Fair
                                                                         Cost                    Gains                 Value
                                                                 ------------------    ------------------    ----------------
<S>                                                                <C>                   <C>                   <C>
Money market instrument..................................                      $215                   $--                $215
Certificate of deposit...................................                       165                    --                 165
Auction rate preferred...................................                     1,875                    --               1,875
Corporate debt securities................................                     4,859                     2               4,861
                                                                 ------------------    ------------------    ----------------
 
Available-for-sale investment                                                 7,114                     2               7,116
Included in cash & cash equivalents......................                       837                    --                 837
Included in available for sale  investments..............                    $6,277                    $2              $6,279
                                                                 ==================    ==================    ================
</TABLE>

       The $7,116,000 included in available-for-sale investments matures in less
than one year.  During 1998, 1997 and 1996 there were no gross realized gains or
losses.

                                       41
<PAGE>
 
       At December 31, 1997, the Company's investments were composed of the
following (in thousands):

<TABLE>
<CAPTION>
                                                                                                    Gross               Estimated
                                                                                                 Unrealized                 Fair
                                                                             Cost                   Gains                  Value
                                                                     ------------------     ------------------    ----------------
<S>                                                                    <C>                    <C>                   <C>
Money market instrument......................................                    $2,574                    $--              $2,574
Certificate of deposit.......................................                       659                     --                 659
U.S. Treasury Bills & other governmental agency obligations..                     3,003                     --               3,003
Corporate debt securities....................................                     7,835                     42               7,877
                                                                     ------------------     ------------------    ----------------
                                                                                 14,071                     42              14,113
Included in cash & cash equivalents..........................                    (2,574)                    --              (2,574)
Included in available for sale  investments..................                   $11,497                    $42             $11,539
                                                                     ==================     ==================    ================
</TABLE>

       The $11,539,000 included in available-for-sale investments matures in
less than one year.

3.   Capital Lease Obligations

       The Company leases certain office and manufacturing equipment under
capitalized leases which expire in 2002. The total future minimum lease payments
under capital leases as of December 31, 1998 are as follows (in thousands):

Years ended December 31:
<TABLE>
<S>              <C>       <C>                                    <C>
                           1999.............................         $646                
                           2000.............................          563                
                           2001.............................          233                
                           2002.............................          150                
                                                                  -------
                 Total minimum lease payments...............        1,592
                 Amounts representing interest..............         (259)
                                                                 --------
                 Present value of minimum lease payments....        1,333
                 Less current portion.......................         (512)
                                                                 --------
                 Noncurrent portion.........................       $  821 
                                                                 ========
</TABLE>

   The cost of assets under capital leases at December 31, 1998 and 1997 were
$2,552,000 and $1,987,000 with related accumulated amortization  amounting to
$1,293,000 and $851,000, respectively.

4.   Commitments and Contingencies

Leases

       The Company rents office facilities under operating lease agreements
which expire at various dates through 1999. The facility lease agreement
provides for an option for the Company to extend the lease for an additional
five years. Aggregate annual rental commitments under noncancelable operating
leases as of December 31, 1998 are as follows (in thousands):

1999........................................................    $261
2000........................................................--------
Total minimum lease payments................................    $261
                                                            ========

Legal Matters

      The Company is involved in a claim arising in the ordinary course of
business.  The Company believes this matter will be resolved without material
adverse effect on the Company's financial position, results of operations or
cash flows.

5.   Redeemable Convertible Preferred Stock

      On June 12, 1998, the Company issued 562,500 shares of the Company's
Series B Redeemable Convertible Preferred Stock (the "Series B Shares") at
$32.00 per share.  The Series B Shares are entitled to receive quarterly
dividends at the rate of seven percent (7%) per annum, payable, at the election
of the Company, in either cash or additional Series B Shares, as described in
the Certificate of Designation of Rights, Preferences and Privileges of Series B
Convertible Preferred Stock (the "Certificate of Designation").  Each Series B
Share is immediately convertible, at the option of the holders, into four shares
of common stock at $8.00 per share.  The Series B Shares are convertible at the
Company's option, at the applicable conversion rate which is currently $8.00 per
share, after two years if the price of the Company's common 

                                       42
<PAGE>
 
stock exceeds $16.00 per share. The conversion rate is subject to adjustment in
the event of certain circumstances described in the Certificate of Designation,
including if the then-current value of the common stock is below $8.00 per share
on June 12, 2000. The Series B Shares are redeemable, at $32 per share, at the
option of the holders after five (5) years. The cumulative quarterly dividends
as of December 31, 1998 were approximately $696,000. For the year ended December
31, 1998, preferred dividends of $696,000, accretion of $150,000 and the deemed
dividends, representing the difference, at the date of issuance, between the
market value of the Company's common stock of $9.125 at June 12, 1998 and the
conversion price of the Company's series B convertible preferred stock of $2.5
million are added to the net loss to arrive at net loss applicable to common
stockholders. The difference between the carrying value of the preferred stock
and the aggregate redemption value is being accreted as preferred stock
dividends over the five year redemption period.

Upon any liquidation, dissolution or winding up of the Corporation, no
distribution shall be made to the holders of shares of stock ranking junior to
the series B convertible preferred stock unless, prior thereto, the holders of
shares of series B convertible preferred stock have received an amount equal to
accrued and unpaid dividends and distributions thereon, whether or not declared,
to the date of such payment, plus an amount equal to $32 per share and in the
event such payment is made on or before June 12, 2000, an amount equal to $4.48
per share, less (i) the accrued dividends and (ii) dividends previously paid.
Preferred stockholders are additionally entitled to any dividends distributed to
common stockholders.

6.   Stockholders' Equity

Stock Options

      In June 1995, the Company adopted the 1995 Stock Plan (the "1995 Plan")
and the 1995 Directors' Option Plan (the "Directors' Plan").  A total of 800,000
and 150,000 shares were reserved for issuance under the 1995 Plan and the
Directors' Plan, respectively.  Options outstanding under the Company's 1987
Stock Plan continue to be governed by such Plan. Common stock options may be
granted to employees, consultants and directors.  Options granted under the 1995
Plan may be either incentive stock options or nonstatutory stock options,
determined at the compensation committees' discretion. Options granted under the
Directors' Plan must be nonstatutory options. In August 1997, the Company
adopted the 1997 Stock Plan (the "1997 Plan").  A total of 300,000 shares were
reserved for issuance under the 1997 Plan.  Options granted under the 1997 Plan
must be nonstatutory stock options.  Options are generally granted at an
exercise price (as determined by the compensation committee) equal to an amount
of not less than the fair value per share on the date of and become exercisable
pursuant to the applicable terms of the grant. The term of any option shall not
be greater than ten years from the date of grant.

      In October 1998, the Board of Directors authorized the Company to offer
all employees the opportunity to cancel certain previously granted options in
exchange for new options with four year vesting and fair market value prices of
$5.938.  The repriced options may not be exercised prior to October 28, 1999.
In connection with this offer, options to purchase 410,977 shares of common
stock with a weighted-average price of $11.72 were exchanged for 328,781 new
options.

Information relative to stock option activity under all plans is as follows:

<TABLE>
<CAPTION>
                                                                                   Outstanding Options
                                                           -----------------------------------------------------------------
                                                                                  Weighted-Average                Aggregate
                                             Available              Number            Exercise                    exercise 
                                             for Grant            of Shares            Price                        Price   
                                    -------------------    -----------------    -------------------     -------------------- 
<S>                                   <C>                    <C>                  <C>                     <C>
Balance at December 31, 1995                    876,500              806,770                   4.76                3,844,095
 Granted............................           (463,500)             463,500                  13.85                6,421,700
 Canceled...........................             38,376              (72,996)                  9.93                 (724,720)
 Exercised..........................                 --             (166,045)                  1.43                 (237,553)
                                    -------------------    -----------------                            -------------------- 
Balance at December 31, 1996                    451,376            1,031,229                   9.02                9,303,522
 Authorized.........................            300,000                   --                     --                       --
 Granted............................           (515,342)             515,342                   7.86                4,049,417
 Canceled...........................             56,116              (59,411)                 12.45                 (739,954)
 Exercised..........................                 --             (123,555)                  2.13                 (263,559)
                                    -------------------    -----------------                            --------------------
Balance at December 31, 1997                    292,150            1,363,605                   9.06               12,349,426
 Authorized.........................            590,000                   --                     --                       --
 Granted, including 328,781
  repriced options..................           (892,131)             949,731                   6.14                5,859,373
 Canceled...........................            601,164             (679,204)                 11.36               (7,712,820)
 Exercised..........................                 --             (152,556)                  2.72                 (415,491)
                                    -------------------    -----------------                            --------------------
Balance at December 31, 1998                    591,183            1,481,576                 $ 6.80              $10,080,488
                                    ===================    =================                            ====================
</TABLE>
 

                                       43
<PAGE>
 
       Options generally vest over a period of four years, up to a maximum of
5.5 years. Certain options granted in 1995 and 1997 have accelerated vesting
positions.  At December 31, 1998 and 1997, approximately 284,926 and 514,656,
respectively, of the outstanding options were exercisable.

The following table summarizes information about options outstanding at December
31, 1998:
<TABLE>
<CAPTION>
                                 Options Outstanding                                                  Options Exercisable
-------------------------------------------------------------------------------------     -----------------------------------------
                                                Weighted Average                     
                                                     Remaining       Weighted Average                            Weighted Average
  Range of                Number Outstanding      Contractual           Exercise             Number Exercisable    Exercise Price
Exercise  Prices             at 12/31/98             Life                 Price                at 12/31/98
-------------------------------------------------------------------------------------     -----------------------------------------
<S>                    <C>                    <C>                   <C>                     <C>                   <C>
 $1.875-5.438                        492,089           8.19               $ 4.77                         107,070        $ 3.82     
   5.75-6.25                         374,981           8.49                 5.97                           3,411          5.96     
  7.125-8.75                         440,169           7.05                 7.74                         131,645          8.25     
 9.125-15.50                         174,337           8.78                11.97                          42,800         13.01     
                     =======================                                              ======================                   
$1.875-15.50                       1,481,576           8.00               $ 6.80                         284,926        $ 7.27     
                     =======================                                              ====================== 
</TABLE>

       The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" ("FAS 123"). Accordingly, no compensation cost has been recognized
for stock options granted in 1998, 1997 and 1996 with exercise prices equal to
the fair value of the Company's common stock on the date of grant.  Had
compensation cost for the Company's stock option plans and employee stock
purchase plan described below been determined based on the fair value at the
grant date for awards in 1998, 1997 and 1996 consistent with the provisions of
FAS No. 123, the Company's net loss and net loss per share would have increased
to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                                       1998                     1997                    1996
                                                              --------------------     -------------------     -------------------
<S>                                                             <C>                      <C>                     <C>
Net loss applicable to common stockholders - as reported
 (in thousands)...........................................                $(27,414)               $(19,396)               $(12,879)
Net loss applicable to common stockholders - pro forma
 (in thousands)...........................................                $(28,947)               $(21,414)               $(14,227)
Basic and diluted net loss per share - as reported........                $  (2.16)               $  (1.55)               $  (1.04)
Basic and diluted net loss per share - pro forma..........                $  (2.28)               $  (1.71)               $  (1.15)
</TABLE>
                                                                                
          Due to FAS No. 123 being applicable only to options granted subsequent
to December 31, 1994, its pro forma effect was not fully reflected until 1998.

          The weighted average fair value of each option granted in 1998, 1997
and 1996 is $2.87, $6.31 and $8.27 respectively, estimated using the Black-
Scholes Multiple option-pricing model with the following weighted-average
assumptions:
<TABLE>
<CAPTION>
                                                       1998                   1997                1996                   
                                               -----------------       ---------------     ----------------             
<S>                                            <C>                     <C>                 <C>
 Expected volatility..................               .8669                 .8068                .5318
 Risk-free interest rate..............                5.02%                 6.06%                6.04%
 Weighted-average expected life.......                4.60                  4.53                 4.46
 Dividend yield.......................                  --                    --                   --
</TABLE>

Deferred and Other Compensation

       For certain options granted prior to December 31, 1995, the Company
recognized as deferred compensation the excess of the deemed value for financial
reporting purposes of the common stock issuable upon the exercise of such
options over the aggregate exercise price of such options.  Deferred
compensation of $597,000 recorded in 1995 is being amortized ratably over the
vesting period of such options.  In connection with the modification of certain
employee stock arrangements and the forgiveness of employee notes receivable,
the Company recorded compensation expense of $539,000 in 1998.

Stock Purchase Plan

       In June 1995, the Company adopted the 1995 Employee Stock Purchase
Plan (the "Purchase Plan") and reserved 200,000 shares for issuance.  The
Purchase Plan permits eligible employees to purchase common stock through
payroll deductions at a price equal to the lower of 85% of the fair market value
of the Company's common stock at the beginning or end of the applicable offering
period.  Employees purchased 30,718 and 25,289 shares in 1998 and 1997,
respectively.

                                       44
<PAGE>
 
       Under the Company's predecessor plan (the "1987 Purchase Plan"), the
Company sold 217,193, 105,533, and 346,302 shares of common stock at $1.875,
$0.375, and $0.625 per share, respectively, to employees in exchange for notes
that bear interest at 3.7% to 7.4% and are payable at various dates in 1999,
2000 and 2001. The Company has the option to repurchase unvested shares, upon
termination of employment, at the original issuance price per share. Shares vest
over a period of four years. At December 31, 1998, there were no shares of
common stock subject to repurchase.

Common Stock Reserved for Issuance

       The Company has reserved shares of common stock for the following at 
       December 31, 1998:

<TABLE>
<S>                                                                                     <C>
             Exercises under the 1987 Stock Option Plan..........................                     242,558
             Purchases under the 1995 Employee Stock Purchase Plan...............                     128,080
             Exercises under the 1995 Stock Option Plan..........................                   1,283,720
             Exercises under the 1995 Directors Option Plan......................                     150,000
             Exercises under the 1997 Stock Option Plan..........................                     396,461
             Conversion of Redeemable Convertible Series B preferred stock.......                   2,650,000
             Conversion of undesignated preferred stock..........................                   2,000,000
                                                                                      -----------------------
                                                                                                    6,850,819
                                                                                      =======================
</TABLE>

Stockholder Rights Plan

       On August 18, 1997, the Company's Board of Directors adopted a
Stockholders' Rights Plan (the "Rights Plan").  In conjunction with the Rights
Plan, the Board of Directors declared a dividend of one right ("Right") to
purchase one one-hundredth of a share of preferred stock on each share of common
stock.  Under the terms of the Rights Plan, the Rights become exercisable only
if a person or group acquires 20% or more of the Company's common stock or
announces a tender offer that would result in ownership by a person or group of
20% or more of the Company's common stock, subject to certain exceptions.  Each
Right has an exercise price of $60.00 and, in certain circumstances, may become
exercisable or exchangeable for consideration.  Each Right, following the time
the Rights become exercisable, may be redeemed for $0.01 at the option of the
Board of Directors.

7.   Income Taxes

       Due to the Company's loss position, there was no provision for income
taxes for the years ended December 31, 1998, 1997 and 1996.

       A reconciliation of the income tax provision at the U.S. federal
statutory rate (34%) to the provision for income
tax at the effective tax rate is as follows:

<TABLE>
<CAPTION>
                                                                             Years Ended December 31,
                                                             1998                      1997                      1996
                                                   ----------------------    ----------------------    ----------------------
<S>                                                  <C>                       <C>                       <C>
                                                                                    (In Thousands)
Income tax benefit computed at the federal
 statutory rate....................................            $(8,173)               $(6,595)                  $(4,379)
Operating losses not utilized......................              8,173                  6,595                     4,379
                                                   ----------------------    ----------------------    ----------------------
                                                     $        --               $        --               $        --
                                                   ======================    ======================    ======================
</TABLE>

       As of December 31, 1998, the Company has federal, state and French net
operating loss carryforwards of approximately $66.3 million, $16.9 million and
$3.7 million, respectively, that will expire in fiscal years 1999 through 2018,
if not utilized. The Company also has federal and state research and
experimentation credit carryforwards of approximately $1.3 million and $1.0
million, respectively, that will expire in fiscal years 2002 through 2018, if
not utilized.

       Utilization of the net operating loss and credit carryforwards may be
subject to an annual limitation due to ownership change limitations provided by
the Internal Revenue Code and similar state tax provisions.

       Deferred income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and the amounts used for income tax purposes. Significant
components of the Company's deferred tax assets are as follows:

                                       45
<PAGE>
 
<TABLE>
<CAPTION>
                                                                                   December 31,
                                                                     ------------------------------------
                                                                              1998                  1997
                                                                     ------------------------------------
<S>                                                             <C>                     <C>
                                                                                 (In Thousands)
Deferred tax assets:
Net operating loss carryforwards..............................               $ 25,109            $ 15,186
Capitalized research costs....................................                  7,556               8,772
Research credit carryforwards.................................                  1,901               1,535
Other.........................................................                    368                 506
                                                                     ------------------------------------
Total deferred tax assets.....................................                 34,934              25,999
Valuation allowance...........................................                (34,934)            (25,999)
                                                                     ------------------------------------
Net deferred tax assets.......................................                  $  --               $  --
                                                                     ====================================
</TABLE>
 
      The deferred tax asset valuation allowance increased $8,935,000,
$8,048,000 and $5,108,000 in 1998, 1997 and 1996, respectively.

8.  Pending Acquisition

     On December 23, 1998 the Company announced that it had entered into a
definitive merger agreement to acquire Transcend Therapeutics, Inc. (Nasdaq:
TSND) and its anticipated net cash balance of about $8 million.  This
transaction would be accounted for as a purchase of assets.  Under the
agreement, Transcend will wind down its operations as a drug development company
and no Transcend employees will be retained after the closing of the
transaction.  According to the terms of the agreement, Transcend will become a
wholly owned subsidiary of the Company.  Transcend stockholders will receive
shares of KeraVision common stock with a  value equal to the amount of net cash
of Transcend as of the closing date plus a premium expected to be 30 percent.
KeraVision's board members approved the transaction with Transcend because the
merger, including the premium being paid over the net cash book value of the
Trascend shares, provides KeraVision a source of cash on terms that are
favorable to current financing options available to KeraVision.  Stockholders,
representing a majority of the voting interests of Transcend have agreed to vote
in favor of the merger.  In addition, KeraVision will be entitled to a breakup
fee of $500,000 if the agreement is terminated for certain reasons.

9.  Subsequent Events

     In March 1999, the Company entered into a senior term loan agreement
providing for borrowings of $5,000,000, which were advanced on March 25, 1999.
Borrowings under the loan are secured by substantially all of the company's
assets except for intellectual property.  In conjunction with the loan, the
Company granted to the lender warrants to purchase 55,492 shares of the common
stock at an exercise price of $10.8125, the closing price as of March 5, 1999,
the date of the loan commitment.  The respective warrants are exercisable for 7
years from the date of issuance.  The Company will record the fair value of the
warrants as additional interest expense to be amortized over the term of the
related debt.  The value of the immediately exercisable warrants will be
determined using a Black Scholes valuation model, based on the contractual term
of the warrants.

                                       46