<PAGE>   1
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                    FORM 10-K

                        FOR ANNUAL AND TRANSITION REPORTS
                     PURSUANT TO SECTIONS 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

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

      For the fiscal year ended December 31, 1999

                                       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 0-22332

                           INSITE VISION INCORPORATED
             (Exact name of registrant as specified in its charter)

          Delaware                                      94-3015807
(State or other jurisdiction of                      (I.R.S. Employer
incorporation or organization)                       Identification No.)

                               965 Atlantic Avenue
                                Alameda, CA 94501
          (Address of Principal Executive Offices, including Zip Code)

       Registrant's telephone number, including area code: (510) 865-8800

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

                                                   Name of each exchange
       Title of each class                          on which registered
  ----------------------------                    -----------------------
  Common Stock, $.01 Par Value                    American Stock Exchange

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


      Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. 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 the 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. [X]

      The aggregate market value of registrant's Common Stock, $.01 par value,
held by non-affiliates as of March 27, 2000: 84,041,115 (based upon the closing
sale price of the Common Stock on March 27, 2000). Number of shares of Common
Stock, $.01 par value, outstanding as of March 27, 2000: 15,819,504. Shares of
Common Stock held by each officer and director and by each person who owns 5% or
more of the Common Stock have been excluded from such calculation as such
persons may be deemed affiliates. This determination of affiliate status is not
necessarily a conclusive determination for other purposes.

                       DOCUMENTS INCORPORATED BY REFERENCE

      Designated portions of the following document are incorporated by
reference into this Report on Form 10-K where indicated: portions of the Proxy
Statement for the registrant's 2000 Annual Meeting of Stockholders which is
estimated to be held on or about June 12, 2000 are incorporated by reference
into Part III.


<PAGE>   2

                           ANNUAL REPORT ON FORM 10-K
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999

                                TABLE OF CONTENTS

<TABLE>
<CAPTION>
                                                                                               Page
                                                                                               ----
<S>          <C>                                                                               <C>
PART I
        Item 1.  Business                                                                        1
        Item 2.  Properties                                                                     21
        Item 3.  Legal Proceedings                                                              21
        Item 4.  Submission of Matters to a Vote of Security Holders                            21

PART II
        Item 5.  Market for Registrant's Common Equity and Related Stockholder Matters          22
        Item 6.  Selected Financial Data                                                        23
        Item 7.  Management's Discussion and Analysis of Financial Condition and Results
                 of Operations                                                                  24
        Item 7a. Qualitative and Quantitative Disclosures About Market Risk                     28
        Item 8.  Financial Statements and Supplementary Data                                    28
        Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial
                 Disclosure                                                                     43

PART III
        Item 10  Directors and Executive Officers of the Registrant                             43
        Item 11. Executive Compensation                                                         43
        Item 12. Security Ownership of Certain Beneficial Owners and Management                 43
        Item 13. Certain Relationships and Related Transactions                                 43

PART IV
        Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K               43
</TABLE>



<PAGE>   3

                                     PART I

ITEM 1. BUSINESS

      Except for the historical information contained herein, the discussion in
this Annual Report on Form 10-K may contain certain forward-looking statements
that involve risks and uncertainties, such as statements of the Company's plans,
objectives, expectations and intentions. The cautionary statements made in this
document should be read as applicable to all related forward-looking statements
wherever they appear in this document. The Company's actual results could differ
materially from those discussed herein. Factors that could cause or contribute
to such differences include those discussed below in "Risk Factors," as well as
those discussed elsewhere herein.


                                   THE COMPANY

      InSite Vision Incorporated ("InSite," "InSite Vision" or the "Company") is
an ophthalmic product development company focused on genetic research for
diagnosis and prognosis of glaucoma and the development of treatment products
for ophthalmic diseases using its proprietary DuraSite(R) technology.

      Glaucoma Genetics. The Company's glaucoma genetics program, which is being
carried out in collaboration with academic researchers, is focused on
discovering genes that are associated with glaucoma, and the mutations on these
genes that cause the disease. This genetic information then may be applied to
develop new glaucoma diagnostic, prognostic and management tools. To date, the
Company's academic collaborators have identified genes associated with primary
open-angle glaucoma (the most prevalent form of the disease in adults), juvenile
glaucoma and primary congenital glaucoma. A diagnostic/prognostic technology,
ISV-900, which is capable of identifying multiple glaucoma genetic markers from
a single sample, has been developed by the Company, and was licensed to
Pharmacia & Upjohn ("P&U") in November 1999. (See "--Collaborative and Licensing
Agreements" for additional information on this transaction.) The Company's
academic collaborators for its glaucoma genetics program are at the University
of California, San Francisco ("UCSF"), the University of Connecticut Health
Center ("UCHC"), INSERM, the French equivalent of US National Institutes of
Health and other institutions in North America and Europe.

      DuraSite-Based Product and Candidates. The DuraSite delivery system is a
patented eyedrop formulation comprising a cross-linked carboxyl-containing
polymer which incorporates the drug to be delivered to the eye. The formulation
is instilled in the cul-de-sac of the eye as a small volume eyedrop and remains
in the eye for up to several hours during which time the active drug ingredient
is gradually released. This increased residence time is designed to permit lower
concentrations of a drug to be administered over a longer period of time,
thereby minimizing the inconvenience of frequent dosing and reducing potential
related adverse side effects. Eyedrops delivered in the DuraSite system contrast
to conventional eyedrops which typically only last a few minutes in the eye,
thus requiring delivery of a highly concentrated burst of drug and frequent
administration to sustain therapeutic levels. DuraSite can be customized to
deliver a variety of compounds with a broad range of molecular weights and other
properties.

      Recently, the Company received an additional patent allowance extending
the viscosity and pH ranges of the DuraSite system. This will allow a broader
range of compounds to be delivered by the system and extends the patent coverage
to 2016.

      The first product utilizing the DuraSite technology, AquaSite(R) dry eye
treatment, was launched as an over-the-counter ("OTC") medication in 1992 by
CIBA Vision Ophthalmics ("CIBA Vision"), to which the Company has licensed
certain co-exclusive rights. In 1999, the Company licensed AquaSite to Global
Damon Pharm ("Global Damon") for sale in Korea and SSP Co., Ltd. ("SSP") for
sale in Japan. (See "--Collaborative and Licensing Agreements" for additional
information on the agreements.) In connection with its DuraSite development
efforts, the Company has established collaborations with P&U and British
Biotechnology Pharmaceuticals, Inc. ("British Biotech"), among others, and has
licensed



                                       3
<PAGE>   4

marketing rights to certain DuraSite-based product candidates to P&U, CIBA
Vision and Bausch & Lomb Incorporated ("B&L").

      In January 1999, the Company entered into a license agreement and stock
purchase agreement with P&U for the exclusive worldwide rights to ISV-205 for
glaucoma. (See "--Collaborative and Licensing Agreements" for additional
information on the agreements.) During 1999, the Company successfully completed
Phase II trials of ISV-205 and has transitioned the lead on the further
development of the program to P&U.

      Business Strategy. The Company's business strategy is to license promising
product candidates and technologies from academic institutions and other
companies, to conduct preclinical and limited clinical testing, if necessary,
and to partner with pharmaceutical companies to complete clinical development
and regulatory filings as needed and to market its products. The Company also
has internally developed DuraSite-based product candidates using either
non-proprietary drugs or compounds developed by others for non-ophthalmic
indications. As with in-licensed product candidates, the Company either has or
plans to partner with pharmaceutical companies to complete clinical development
and commercialization of its own product candidates.

OPHTHALMIC PHARMACEUTICAL MARKET

      In 1999, the market for ophthalmic prescription pharmaceuticals in the
U.S. was approximately $1.5 billion. The principal categories of ophthalmic
drugs are glaucoma treatments ($568 million), antibiotics ($254 million),
anti-allergic ($218 million), and anti-viral ($213 million) products. However
many eye conditions, including those that involve damage to the retina, are
untreated at present.

      For example, age-related macular degeneration, which affects 10 million or
more people in the U.S., is the leading cause of severe blindness in Americans
aged 60 and above. Laser treatment is the only known therapy, but is only
effective in about 15% of affected patients. Even with treatment, the disease
usually progresses and eventually leads to vision loss.

      Also, approximately 10 to 14 million Americans are diabetic and many of
them will develop diabetic retinopathy later in their life. Laser therapy, which
is the only approved treatment, is effective only in a certain segment of the
diabetic population, and has potential side effects such as loss of peripheral
vision, retinal detachment, and loss of vision.

      Glaucoma is the leading cause of preventable blindness in the U.S.,
affecting two to three million people. It is estimated that 67 million people
worldwide will have glaucoma by the year 2000. The prevalence of the disease in
first-degree relatives of affected patients has been documented to be as high as
seven to ten times that of the general population. Glaucoma also may occur as a
complication of conditions such as diabetes, or as a result of extended steroid
use.

      The prevalence of eye disease is ten times greater in persons over the age
of 65 than under age 65, and the U.S. Census Bureau projects that the U.S.
population over age 65 will increase from 34 million in 1997 to approximately 69
million by the year 2030. This aging of the population in the U.S. and other
developed countries is a significant factor that the Company believes will
contribute to increased demand for new ophthalmic products.

      In addition to changing demographics, the Company believes that recent
improvements in medical technology, such as increasingly sophisticated
diagnostic techniques, will allow identification of ocular diseases at an
earlier stage, enabling more effective treatments and expanding the range of
treatment regimens available to the ophthalmologist. Further, the Company
believes that the emergence of new laser-based procedures to correct certain
vision problems has begun to increase the need for comfortable, extended-release
drug therapy during the post-surgical ocular healing process.



                                       4
<PAGE>   5

PRODUCTS AND PRODUCT CANDIDATES

      The following table summarizes the current status of the Company's
principal products and product candidates. A more detailed description of each
product and product candidate follows the table. There can be no assurance that
any of the listed products or product candidates will progress beyond its
current state of development, receive necessary regulatory approval or be
successfully marketed.

                         PRODUCTS AND PRODUCT CANDIDATES
<TABLE>
<CAPTION>

                                                      ANTICIPATED
        PRODUCT               INDICATIONS               BENEFITS               STATUS(1)
        -------               -----------             -----------              ---------

    GLAUCOMA GENETICS

<S>                       <C>                    <C>                      <C>
       ISV - 900          Glaucoma prognostic/       Detect disease       Pre-commercialization
                               diagnostic          susceptibility and             (2)
                                                   Determine disease
                                                        severity

    GLAUCOMA PRODUCT
       CANDIDATES

       ISV - 205          Steroid-induced IOP    Treat/prevent disease         Phase II
                          elevation, glaucoma         progression

 OTHER TOPICAL PRODUCT
 CANDIDATES AND PRODUCT

       ISV - 401               Antibiotic          Gram-negative and          Preclinical
                                                     gram-positive
                                                    antibiotic with
                                                     reduced dosing
                                                       frequency

       ISV - 615                Diabetic            No satisfactory         Preclinical(3)
                            retinopathy and         existing therapy
                          macular degeneration

       ISV - 205            Inflammation and    Reduced dosing frequency      Preclinical
                               analgesia

        AquaSite                Dry eye              Reduced dosing         Marketed (OTC)
                                                 frequency and extended
                                                   duration of action

     RETINAL DEVICE

       ISV - 014              Retinal drug       Non-surgical delivery         Research
                            delivery device      of drugs to the retina

</TABLE>


1)    All products except ISV-900, AquaSite and ISV-014 are expected to be
      prescription pharmaceuticals. As denoted in the table, "Preclinical"
      indicates that a specific compound is being tested in preclinical studies
      in preparation for filing an investigational new drug application ("IND").
      For a description of preclinical trials, IND, Phase I, Phase II and Phase
      III clinical trials and New Drug Application ("NDA"), see "---Government
      Regulation."

2)    A diagnostic/prognostic technology has been developed and licensed to P&U
      and a commercialization plan is being developed by P&U.

3)    The active ingredient in this product candidate is the same as in the
      ISV-120 candidate for pterygium recurrence prevention. Further development
      on ISV-120 has been deferred as resources are focused on other programs.



                                       5
<PAGE>   6

GLAUCOMA GENETICS

      Glaucoma is the leading cause of preventable blindness in the U.S.,
affecting an estimated two to three million people. Glaucoma-related
pharmaceutical sales were approximately $568 million in the U.S. in 1999. The
most prevalent form of glaucoma in adults is primary open-angle glaucoma. Other
forms of the disease include primary congenital glaucoma, a leading cause of
blindness in infants, and juvenile glaucoma that effects children and young
adults.

      Often called the "sneak thief of sight" because of its lack of symptoms,
glaucoma is believed to result when the flow of fluid through the eye is
impaired. This may lead to elevated intraocular pressure ("IOP"), which
increases pressure on the optic nerve and can cause irreversible vision loss if
left untreated. One form of glaucoma, normal or low tension glaucoma, is
associated with individuals who have normal eye pressure. It is estimated that
one-third of the U.S. glaucoma patients and three-quarters of the glaucoma
patients in Japan have this form of the disease. These patients cannot be
identified with standard glaucoma screening tests that only measure a patient's
eye pressure and usually incur visual field loss before they are diagnosed.

      ISV-900. There is accumulating evidence that genetic predisposition is a
major factor in the development of several forms of glaucoma. (Data has
indicated the prevalence of primary open-angle glaucoma ("POAG") in first-degree
relatives of affected patients to be as high as 7 to 10 times that of the
general population.) InSite Vision has formed research collaborations with
scientists at institutions located in North America, Europe and Japan both to
identify the genes associated with different forms of glaucoma and to build a
database of information on how these genes affect the progression of the disease
in different populations.

      The Company's researchers have identified several genes related to POAG
including TIGR, GLC1B, GLC1D, GLC1E, OCLM and a novel TIGR modifier gene.
Additionally, the CYP1B1 gene has been identified which is related to primary
congenital glaucoma ("PCG"). The Company has obtained exclusive worldwide
licenses for the rights to commercialize research related to the TIGR gene and
associated mutations from the Regents of the University of California ("UC
Regents"), the CYP1B1 gene and associated mutations from UCHC, the OCLM gene
from Dr. Toshihiko Matsuo of Okayama University and a novel TIGR modifier gene
from INSERM. The Company also holds an option to an exclusive worldwide license
for other glaucoma genes.

      InSite Vision currently holds patents issued on the TIGR cDNA, the TIGR
antibody, methods for the diagnosis of glaucoma using the TIGR technology and
methods for the diagnosis of glaucoma using the CYP1B1 technology. Additional
patents related to ISV-900 are currently pending.

      Current glaucoma tests are often unable to detect the disease before
substantial damage to the optic nerve has occurred. Gene-based tests may make it
possible to identify patients at risk and initiate treatment before permanent
optic nerve damage and vision loss occurs. The Company's ISV-900 program is
intended to discover the appropriate genetic markers for certain forms of
glaucoma and to incorporate those markers into prognostic, diagnostic and
management tools. The first version of these tests has been developed by the
Company and, in November 1999, was licensed to P&U. A commercialization plan is
being developed. The Company anticipates that as further research identifies
additional mutations to these genes, and new genes are located, the marketed
test will be modified to incorporate these findings.



                                       6
<PAGE>   7

GLAUCOMA CANDIDATES

      ISV-205. InSite Vision's ISV-205 product candidate contains the drug
diclofenac formulated in the DuraSite sustained-release delivery vehicle.
Diclofenac is a non-steroidal anti-inflammatory drug ("NSAID") currently used to
treat ocular inflammation. NSAIDs can block steroid-induced IOP elevation by
inhibiting the production of the TIGR protein that appears to affect the fluid
balance in the eye. The ISV-205 product candidate contains concentrations of
diclofenac which have been shown in cell culture systems to inhibit the
production of the TIGR protein.

      A Phase II clinical study was successfully completed in 1999 to evaluate
the efficacy of two concentrations of diclofenac. Analysis of the data from this
study showed that ISV-205 was safe and effective in reducing, by 75%, the number
of subjects with clinically significant IOP elevation following steroid use. A
second Phase II study is being conducted by P&U on a larger patient population.
Other potential indications may include glaucoma prevention, analgesia and
anti-inflammatory indications. Co-exclusive rights, in the U.S., to develop,
manufacture, use and sell ISV-205 to treat inflammation or analgesia, were
licensed to CIBA Vision in May 1996.

      In January 1999, the Company entered into an exclusive worldwide
royalty-bearing license agreement with P&U for ISV-205 for glaucoma. The license
provides for research and development payments to be made to the Company by P&U
and for P&U to assume responsibility for the on-going development of the product
since the completion of the Phase II study conducted by the Company. The Company
will continue to provide P&U with technical assistance on the product. P&U also
made equity investments in the Company and may make additional future equity
investments if certain project milestones are achieved. See "--Collaborative and
Licensing Agreements" for additional information on the agreement.

OTHER TOPICAL PRODUCT CANDIDATES AND PRODUCT

      ISV-401 is a formulation of an antibiotic that has not previously been
used in ophthalmology. The antibiotic, which is effective both for gram-negative
and gram-positive bacteria, may also provide reduced dosing frequency. Current
ophthalmic antibiotics must be dosed every two hours during the first day and
four times a day for the remainder of the treatment period, which may be up to
fourteen days. This may result in patient compliance issues that could be
minimized with an improved product. Also, a broad-spectrum antibiotic could be
used by physicians to treat a variety of ophthalmic diseases instead of
targeting each disease specifically.

      ISV-615 is a DuraSite-based ophthalmic formulation of batimastat that the
Company is evaluating for its potential in preventing neovascularization in the
retina related to diabetic retinopathy and macular degeneration. The Company
obtains batimastat, the active ingredient of ISV-615, through a 1992 agreement
with British Biotech, which in December 1996 advised the Company that it had
discontinued development and manufacturing of batimastat. The Company and
British Biotech are in negotiations on a new licensing agreement related to
batimastat that provides for continued supply of the drug. See "Risk Factors -
Dependence on Third Parties."

      AquaSite. The first product utilizing InSite's DuraSite technology was
introduced to the OTC market in the U.S. in October 1992 by CIBA Vision. The
Company receives a royalty on sales of AquaSite by CIBA Vision. The product
contains the DuraSite formulation and demulcents for the symptomatic treatment
of dry eye. In March 1999, the Company licensed the product to Global Damon
Pharm, a Korean company. The license is royalty-bearing and is exclusive in the
Republic of Korea for up to a 10 year period. In August 1999, the Company
licensed the product to SSP for sales and distribution in Japan.

RETINAL DEVICE

      Ophthalmic conditions that involve retinal damage include macular
degeneration, which affects 10 million or more people in the U.S., and diabetic
retinopathy, a common side effect of diabetes. Approximately ten to fourteen
million people in the U.S. are diabetics. Both macular degeneration and diabetic
retinopathy can lead to irreversible vision loss and blindness. Current
treatment of retinal diseases generally involves surgery and laser treatments
that can lead to loss of vision, retinal detachment and infection. There is no
effective drug therapy for these conditions.

      Retinal Delivery Device. Another technology platform is comprised of a
device, ISV-014, for the



                                       7
<PAGE>   8
controlled, non-surgical delivery of ophthalmic drugs to the retina and
surrounding tissues. In 1999, the Company continued to enhance the device and
performed invivo experiments delivering products with a variety of molecular
sizes to retinal tissues.  The combination of this device technology with
polymer-based drug platforms may permit long term delivery of therapeutic
agents to treat several retinal diseases, most of which cannot be effectively
treated at the present time.

      ISV-014 is a device for the controlled, non-surgical delivery of
ophthalmic drugs to the back of the globe. The device consists of a handle with
a distal platform that is placed against the surface of the eye. A small needle
connected to a drug reservoir is extended from the platform into the tissues of
the eye. Once in place, a metering mechanism controls the amount and rate that
the drug is injected into the tissue. This produces a highly localized depot of
drug inside the ocular tissues. By controlling both the distance and direction
that the needle protrudes, the device greatly reduces the chance that the needle
will penetrate through the sclera of the eye into the underlying tissues, which
are easily damaged. The Company has filed for two patents related to the device
and its use and specific claims to the device have been allowed. The Company is
currently investigating licensing this technology to a third party.

COLLABORATIVE AND LICENSING AGREEMENTS

      As a key element of its business strategy, the Company has entered into,
and will continue to pursue additional research collaborations, licensing
agreements and corporate collaborations. However, there can be no assurance that
the Company will be able to negotiate acceptable collaborative or licensing
agreements, or that its existing collaborations will be successful or will be
renewed when they expire.

      Pharmacia & Upjohn. On November 11, 1999, the Company entered into a
license agreement, stock purchase agreement and credit agreement pursuant to
which InSite granted P&U an exclusive worldwide royalty-bearing license to its
ISV-900 technology for diagnostic, prognostic and therapeutic applications in
the area of glaucoma. The license calls for (i) P&U to pay the Company a
licensing fee, (ii) P&U to make research and development payments to the Company
over three years starting in 2000, (iii) P&U to pay the Company royalties on
product sales should any products be successfully commercialized from this
technology, and (iv) payments by P&U to the Company if certain milestones are
achieved.

      In addition, P&U invested $2,000,000 in the Company's common stock. The
stock purchase agreement also provides for a standstill period of thirty (30)
months during which P&U and its subsidiaries will not purchase additional shares
of the Company, other than those provided for under any existing agreements
between the companies, without the prior written consent of the Company. This
standstill period will terminate earlier if certain actions are taken by other
parties to acquire more than a 9.99% interest in the stock of the Company or if
any other party announces their intention to assume control of the Company,
whether by tender offer, merger, proxy contest or otherwise. Additionally, the
transaction provides for a revolving line of credit to be made available to the
Company beginning November 11, 2001 for a period of three (3) years.

      On January 28, 1999, the Company entered into a license agreement and
stock purchase



                                       8
<PAGE>   9
agreement pursuant to which InSite granted P&U an exclusive worldwide license to
ISV-205 for the treatment of glaucoma. The license calls for (i) P&U to assume
responsibility for the development of the product upon completion by InSite of,
among other activities, Phase II studies conducted by the Company, (ii) P&U to
reimburse InSite for research and development expenses and to make payments to
InSite for on-going technical support, and (iii) the payment by P&U to InSite of
royalties on product sales should ISV-205 be successfully commercialized. InSite
will continue to bear responsibility for the prosecution and maintenance of the
patents subject to the license, among other things. The transaction also called
for an equity investment from P&U, which was made in February 1999, with the
potential for future equity investments at an average of prevailing market
prices if the Company achieves certain milestones.

      CIBA Vision Ophthalmics (CIBA Vision). The Company has entered into
license agreements with CIBA Vision (the "CIBA Vision Agreements"), pursuant to
which the Company granted CIBA Vision a co-exclusive license to manufacture,
have manufactured, use and sell fluorometholone and tear replenishment products
utilizing the DuraSite technology in the U.S. and Canada, ToPreSite, a product
candidate for ocular inflammation/infection, and ISV-205 for non-glaucoma
indications.

      Bausch and Lomb. In July 1996, the Company entered into a license
agreement ("the B&L Agreement") with B&L whereby the Company granted B&L an
exclusive worldwide royalty bearing license to make, use and sell PilaSite and
ISV-208. B&L paid the Company an up-front license fee of $500,000 and is
obligated to pay royalties on net sales of the licensed products. In addition,
B&L made a $2.0 million investment in the Company, is sharing the cost of
developing ISV-208 and agreed to manufacture other products on behalf of the
Company.

      In July 1999, the Company and B&L entered into a termination, release and
purchase agreement whereby the PilaSite license agreement and the manufacturing
agreement were terminated and the Company's equipment located at B&L's facility
was purchased by B&L. The ISV-208 license and development collaboration remains
in effect.

      British Biotech. In November 1992, the Company entered into a
collaboration agreement with British Biotech (the "ISV-120 Agreement"), pursuant
to which British Biotech had granted the Company the right to conduct, at
InSite's own expense, preclinical and clinical trials on British Biotech's
batimastat compound and the exclusive option to initiate negotiations with
British Biotech to pursue further development of ISV-120. In December 1996,
British Biotech advised the Company that it had discontinued its development and
manufacturing of batimastat. The term of the ISV-120 Agreement has expired but
British Biotech is continuing to supply batimastat to the Company while extended
access to the compound for use in its ISV-615 product candidate is being
negotiated.

      INSTITUTE NATIONAL DE LA SANTE ET DE LA RECHERCHE MEDICALE (INSERM). In
December 1999, the Company entered into an exclusive worldwide license agreement
with INSERM for the diagnostic, prognostic and therapeutic uses of a gene for
chronic open angle glaucoma. The Company has paid a licensing fee and will make
royalty payments on future product sales, if any.

      UC Regents. In March 1993, the Company entered into an exclusive license
agreement with the UC Regents for the development of ISV-205 and, in August
1994, the parties entered into another exclusive license agreement for the use
of a nucleic acid sequence that codes for a protein associated with glaucoma.
Under both agreements, the Company paid initial licensing fees and will make
royalty payments to the UC Regents on future product sales, if any.

      University of Connecticut Health Center. In August 1997, the Company
exercised its option to obtain an exclusive worldwide license from UCHC for
diagnostic uses of the newly discovered gene for primary congenital glaucoma.
The Company also has an option for a worldwide exclusive license to



                                       9
<PAGE>   10

commercialize technologies related to certain research UCHC is conducting in the
area of adult-onset glaucoma. Under the agreements, the Company will pay a
licensing fee and will make royalty payments on future product sales, if any.

      Columbia Laboratories, Inc. In February 1992, InSite entered into a
cross-license agreement (the "Columbia Agreement") with Columbia Laboratories,
Inc. ("Columbia"), pursuant to which Columbia granted InSite a perpetual,
exclusive, irrevocable, royalty-free license to a polymer technology upon which
DuraSite is based. This license permits InSite to make, use and sell products
using such polymer technology for non-veterinary ophthalmic indications in the
over-the-counter and prescription markets in North America and East Asia (the
"Columbia Territory"), and in the prescription market in countries outside the
Columbia Territory. In exchange, InSite granted Columbia a perpetual, exclusive,
irrevocable, royalty-free license, with the right to sublicense and use certain
DuraSite technology in the over-the-counter market outside the Columbia
Territory. In addition, InSite also granted Columbia a perpetual, exclusive,
irrevocable, worldwide license to certain DuraSite technology in the veterinary
field. Under certain circumstances, certain of the licenses in the Columbia
Agreement become non-exclusive. Subject to certain rights of early termination,
the Columbia Agreement continues in effect until the later of January 2002 or
expiration of all patents covered by the DuraSite technology to which Columbia
has certain rights.

      Global Damon Pharm and Kukje Pharma Ind. Co., Ltd. In March 1999, the
Company entered into a royalty-bearing license agreement with Global Damon, a
Korean company, to be the exclusive distributor of AquaSite in the Republic of
Korea. Concurrently, the Company entered into a manufacturing agreement with
Kukje Pharma Ind. Co., Ltd ("Kukje"), a Korean company, to produce the AquaSite
to be sold by Global Damon.

      SSP Co., Ltd. In August 1999, the Company entered into an exclusive
license agreement with SSP to be the exclusive manufacturer and distributor of
AquaSite in Japan. The Company will be the sole supplier to SSP for some of the
key ingredients necessary for the manufacture of AquaSite.

      Other. As part of InSite's basic strategy, InSite continually discusses
entering into agreements with other companies, universities and research
institutions concerning the licensing of additional therapeutic agents and drug
delivery technologies to complement and expand InSite's family of proprietary
ophthalmic products. InSite intends to continue exploring licensing and
collaborative opportunities.

PATENTS AND PROPRIETARY RIGHTS

      Patents and other proprietary rights are important to the Company's
business. The Company's policy is to file patent applications seeking to protect
technology, inventions and improvements to its inventions that are considered
important to the development of its business. Additionally, the Company's policy
is to assist the UC Regents, UCHC and INSERM in filing patent applications
seeking to protect inventions which are the subject of the Company's agreements
with those institutions. The Company also relies upon trade secrets, know-how,
continuing technological innovations and licensing opportunities to develop and
maintain its competitive position. InSite's DuraSite drug delivery products are
made under patents and applications, including four U.S. patents, owned by
Columbia and exclusively licensed to InSite in the field of human ophthalmic
applications. See "--Collaborative and Licensing Agreements." In addition, the
Company has filed a number of patent applications in the U.S. relating to the
Company's DuraSite technology, as well as foreign versions of certain of these
applications in many countries. Of these applications, seven U.S. patents have
been issued. In addition, the Company has obtained two U.S. patents on its unit
dose dispenser. The Company has received six additional U.S. patents directed
toward certain uses of lazaroids in ophthalmic applications. Of the patent
applications licensed from the UC Regents, eight patents have issued. Two
patents have been issued of the patent applications licensed from UCHC covering
the diagnosis of primary congenital glaucoma. Two patent applications have been
filed by the Company on its retinal delivery device and its use for delivery of
drugs to the retina. Several other patent applications by the Company and by the
UC Regents, UCHC and INSERM relating to the foregoing and other aspects of the
Company's business and potential business are also pending.



                                       10
<PAGE>   11

      The patent positions of pharmaceutical companies, including InSite, are
uncertain and involve complex legal and factual questions. In addition, the
coverage claimed in a patent application can be significantly reduced before a
patent is issued. Consequently, the Company does not know whether any of its
pending patent applications will result in the issuance of patents or if any of
its patents will provide significant proprietary protection. Since patent
applications are maintained in secrecy until patents issue in the U.S., or such
patents are published by foreign regulatory authorities, the Company cannot be
certain that it or any licensor was the first to file patent applications for
such inventions. Moreover, the Company might have to participate in interference
proceedings declared by the U.S. Patent and Trademark Office to determine
priority of invention, which could result in substantial cost to the Company,
even if the eventual outcome were favorable. There can be no assurance that the
Company's patents will be held valid or enforceable by a court or that a
competitor's technology or product would be found to infringe such patents.

      A number of pharmaceutical companies and research and academic
institutions have developed technologies, filed patent applications or received
patents on various technologies that may be related to the Company's business.
Some of these technologies, applications or patents may conflict with the
Company's technologies or patent applications. Such conflict could limit the
scope of the patents, if any, that the Company may be able to obtain or result
in the denial of the Company's patent applications. In addition, if patents that
cover the Company's activities have been or are issued to other companies, there
can be no assurance that the Company would be able to obtain licenses to these
patents, at all, or at a reasonable cost, or be able to develop or obtain
alternative technology.

      In addition to patent protection, the Company also relies upon trade
secret protection for its confidential and proprietary information. There can be
no assurance that others will not independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to the Company's
trade secrets, that such trade secrets will not be disclosed or that the Company
can effectively protect its rights to unpatented trade secrets.

ACCESS TO PROPRIETARY COMPOUNDS

      The Company believes its drug delivery technology may expand the
ophthalmic pharmaceutical market by permitting the novel use of drugs for
ophthalmic indications that are currently used or being developed for
non-ophthalmic indications. However, the Company may be required to obtain
licenses from third parties that have rights to these compounds in order to
conduct certain research, to develop or to market products that contain such
compounds. There can be no assurance that such licenses will be available on
commercially reasonable terms, if at all. See "Business - Collaborative and
Licensing Agreements."

RESEARCH AND DEVELOPMENT

      The Company's research and development staff at December 31, 1999 numbered
24 people, of whom 8 have Ph.D's. Research and development expenses sponsored by
the Company during 1999 were $1.4 million, which is net of $4.2 million funded
by P&U as part of the ISV-205 license. During 1998 and 1997, research and
development expenses were $6.2 million and $7.2 million, which is net of
$361,000 and $534,000, respectively, funded by (i) P&U and (ii) B&L, as part of
the 1996 ISV-208 joint development agreement. See "Collaborative and Licensing
Agreements" and "Management's Discussion and Analysis of Financial Condition and
Results of Operations."

MANUFACTURING

      The Company has no experience or facilities for the manufacture of
products for commercial processes. Moreover, the Company currently has no
intention of developing such experience or



                                       11
<PAGE>   12

implementing such facilities. The Company has a pilot facility, licensed by the
State of California, to produce potential products for Phase I and some of its
Phase II clinical trials. However, as stated above, the Company has no
large-scale manufacturing capacity and relies on third parties, such as P&U, for
supplies and materials necessary for all of its Phase III clinical trials. If
the Company should encounter delays or difficulties in establishing and
maintaining its relationship with qualified manufacturers to produce, package
and distribute its finished products, then clinical trials, regulatory filings,
market introduction and subsequent sales of such products would be adversely
affected. See "Risk Factors - No Commercial Manufacturing Experience."

MARKETING AND SALES

      In connection with its November 1995 restructuring, the Company elected
not to proceed with plans to establish its own sales and marketing organization.
Instead, the Company has entered into arrangements and plans to enter into
arrangements with one or more additional pharmaceutical companies to market its
products. There can be no assurance that the Company will be able to conclude or
maintain such arrangements on acceptable terms, if at all.

      Bausch and Lomb. In July 1996, the Company entered into an exclusive
worldwide royalty-bearing license agreement whereby B&L has agreed to market
and sell ISV-208. Under the terms of the agreement, the Company is entitled to
royalties based on net sales of the products, if any. See "Risk Factors -
Marketing and Sales."

      CIBA Vision. In 1991, the Company entered into a co-exclusive rights
agreement to market the AquaSite product in the U.S. and Canada. Additionally,
in May 1996, the Company granted CIBA Vision a co-exclusive U.S. license for
ISV-205 for non-glaucoma indications, and co-exclusive marketing rights within
the U.S. to sell and use ToPreSite. InSite Vision's trademark is being used,
under license, by CIBA Vision for AquaSite dry eye treatment and the Company's
patents are identified on the AquaSite packaging. The Company received a
one-time licensing fee and is entitled to royalties based on net sales of the
products, if any.

      Global Damon Pharm ("Global Damon") and Kukje Pharma Ind. Co., Ltd.
("Kukje"). In March 1999, the Company entered into a royalty-bearing licensing
agreement with Global Damon, a Korean company, to be the exclusive distributor
of AquaSite in the Republic of Korea. Concurrently, the Company entered into a
manufacturing agreement with Kukje, a Korean company, to produce the AquaSite to
be sold by Global Damon.

      Pharmacia & Upjohn. In November 1999, the Company entered into an
exclusive worldwide royalty-bearing license agreement whereby P&U has agreed to
market and sell ISV-900 for prognosis, diagnosis and treatment of glaucoma.
Under the terms of the agreement, the Company is entitled to royalties based on
net sales of the products, if any.

      In January 1999, the Company entered into an exclusive worldwide
royalty-bearing license agreement whereby P&U has agreed to market and sell
ISV-205 for glaucoma related indications. Under the terms of the agreement, the
Company is entitled to royalties based on net sales of the product, if any.

      SSP Co., Ltd. In August 1999, the Company entered into an exclusive
licensing agreement with SSP to be the exclusive manufacturer and distributor of
AquaSite in Japan. The Company will be the sole supplier to SSP for certain key
ingredients necessary for the manufacture of AquaSite.

COMPETITION



                                       12
<PAGE>   13

      There are many competitors of the Company in the U.S. and abroad. These
companies include ophthalmic-oriented companies that market a broad portfolio of
products, as well as large integrated pharmaceutical companies that market a
limited number of ophthalmic pharmaceuticals in addition to many other
pharmaceuticals. Many of these companies have substantially greater financial,
technical, marketing and human resources than those of the Company and may
succeed in developing technologies and products that are more effective, safer
or more commercially acceptable than any which have been or are being developed
by the Company. These competitors may also succeed in obtaining cost advantages,
patent protection or other intellectual property rights that would block the
Company's ability to develop its potential products, or in obtaining regulatory
approval for the commercialization of their products more rapidly or effectively
than the Company. The ophthalmic prescription pharmaceutical market in the U.S.
is dominated by six companies: Allergan Pharmaceuticals, a division of Allergan,
Inc.; Alcon Laboratories, Inc., a division of Nestle Company; Bausch and Lomb;
CIBA Vision, a division of Novartis Ltd.; Merck, Sharp & Dohme, a division of
Merck & Co., Inc.; and Pharmacia & Upjohn, Inc.

      The Company believes that there will be increasing competition from new
products entering the market that are covered by exclusive marketing rights and,
to a lesser degree, from pharmaceuticals that become generic. The Company is
aware of certain products manufactured or under development by competitors that
are used for the treatment of certain ophthalmic indications which the Company
has targeted for product development. The Company's competitive position will
depend on its ability to develop enhanced or innovative pharmaceuticals,
maintain a proprietary position in its technology and products, obtain required
governmental approvals on a timely basis, attract and retain key personnel and
develop effective products that can be manufactured on a cost-effective basis
and marketed successfully.

      Over the longer term, the Company's (and its partners') ability to
successfully market the current products, expand its usage and bring new
products to the marketplace, will depend on many factors, including the
effectiveness and safety of the products, and competing products, approved by
the FDA and foreign regulatory agencies, the degree of patent protection
afforded to particular products, and the effect of the advent of managed care as
an important purchaser of pharmaceutical products. See "Risk Factors -
Competition."

GOVERNMENT REGULATION

      The manufacturing and marketing of the Company's products and its research
and development activities are subject to regulation by numerous governmental
authorities in the U.S. and other countries. In the U.S., drugs are subject to
rigorous FDA regulation. The Federal Food, Drug and Cosmetic Act and regulations
promulgated thereunder govern the testing, manufacture, labeling, storage,
record keeping, approval, advertising and promotion in the U.S. of the Company's
products. In addition to FDA regulations, the Company is also subject to other
federal and state regulations such as the Occupational Safety and Health Act and
the Environmental Protection Act. Product development and approval within this
regulatory framework take a number of years and involve the expenditure of
substantial resources.

      While the FDA currently does not regulate genetic tests, it has stated
that it has the right to do so, and there can be no assurance that the FDA will
not seek to regulate such tests in the future. If the FDA should require that
genetic tests receive FDA approval prior to their use, there can be no assurance
such approval would be received on a timely basis, if at all. The failure to
receive such approval could require the Company to develop alternative testing
methods, which could result in the delay of such tests reaching the market, if
at all. Such a delay could have a materially adverse effect on the Company.

      The steps required before a pharmaceutical agent may be marketed in the
U.S. include (i) preclinical laboratory and animal tests, (ii) the submission to
the FDA of an IND, (iii) adequate and well-controlled human clinical trials to
establish the safety and efficacy of the drug, (iv) the submission of an NDA or
Product License Application ("PLA") to the FDA and (v) the FDA approval of the
NDA or PLA, prior to any commercial sale or shipment of the drug. In addition to
obtaining FDA approval for each



                                       13
<PAGE>   14

product, each domestic drug manufacturing establishment must be registered with,
and approved by, the FDA. Drug product manufacturing establishments located in
California also must be licensed by the State of California in compliance with
separate regulatory requirements.

      Preclinical tests include laboratory evaluation of product chemistry and
animal studies to assess the potential safety and efficacy of the product and
its formulation. The results of the preclinical tests are submitted to the FDA
as part of an IND and, unless the FDA objects, the IND will become effective 30
days following its receipt by the FDA.

      Clinical trials involve the administration of the drug to healthy
volunteers or to patients under the supervision of a qualified principal
investigator. Clinical trials are conducted in accordance with protocols that
detail the objectives of the study, the parameters to be used to monitor safety,
and the efficacy criteria to be evaluated. Each protocol is submitted to the FDA
as part of the IND. Each clinical study is conducted under the auspices of an
independent Institutional Review Board which considers, among other things,
ethical factors and the rights, welfare and safety of human subjects.

      Clinical trials are typically conducted in three sequential phases, but
the phases may overlap. In Phase I, the initial introduction of the drug into
human subjects, the drug is tested for safety (adverse effects), dosage
tolerance, metabolism, distribution, excretion and clinical pharmacology. Phase
II involves studies in a limited patient population to (i) determine the
efficacy of the drug for specific targeted indications, (ii) determine dosage
tolerance and optimal dosage and (iii) identify possible adverse effects and
safety risks. When a compound is found to be effective and to have an acceptable
safety profile in Phase II evaluations, Phase III trials are undertaken to
further evaluate clinical efficacy and to further test for safety within an
expanded patient population at multiple clinical study sites. The FDA reviews
both the clinical plans and the results of the trials and may discontinue the
trials at any time if there are significant safety issues.

      The results of the preclinical studies and clinical studies are submitted
to the FDA in the form of an NDA or PLA for marketing approval. The testing and
approval process is likely to require substantial time and effort and there can
be no assurance that any approval will be granted on a timely basis, if at all.
Additional animal studies or clinical trials may be requested during the FDA
review period and may delay marketing approval. After FDA approval for the
initial indications, further clinical trials are necessary to gain approval for
the use of the product for additional indications. The FDA may also require
post-marketing testing to monitor for adverse effects, which can involve
significant expense.

      Among the conditions for manufacture of clinical drug supplies and for NDA
or PLA approval is the requirement that the prospective manufacturer's quality
control and manufacturing procedures conform to GMP. Prior to approval,
manufacturing facilities are subject to FDA and/or other regulatory agency
inspection to ensure compliance with GMP. Manufacturing facilities are subject
to periodic regulatory inspection to ensure ongoing compliance.

      For marketing outside the U.S., the Company also is subject to foreign
regulatory requirements governing human clinical trials and marketing approval
for drugs. The requirements governing the conduct of clinical trials, product
licensing, pricing and reimbursement vary widely from country to country.

SCIENTIFIC AND BUSINESS ADVISORS

      The Company has access to a number of academic and industry advisors with
expertise in clinical ophthalmology and pharmaceutical development, marketing
and sales. The Company's advisors meet with management and key scientific
employees of the Company on an ad hoc basis to provide advice in their
respective areas of expertise and further assist the Company by periodically
reviewing with management the Company's preclinical, clinical and marketing
activities. The Company plans to make arrangements with other individuals to
join as advisors as appropriate. Although the Company expects to receive
guidance from the advisors, all of the advisors are employed on a full-time
basis by other entities, or are



                                       14
<PAGE>   15

primarily engaged in business activities outside the Company, and may have other
commitments to, or consulting or advisory contracts with, other entities that
may conflict or compete with their obligations to the Company.

      The Company's advisors are as follows:

<TABLE>
<CAPTION>
             Name                                   Position
             ----                                   --------
<S>                               <C>
  Chandler R. Dawson, M.D.        Emeritus Professor, Department of Ophthalmology,
                                  University of California, San Francisco
  Barbara L. Handelin, Ph.D.      Advisor and Consultant on Genetics
  Roy Karnovsky                   Advisor and Consultant in Business Development and
                                  Marketing
  Steven G. Kramer, M. D., Ph.D.  Chairman, Department of Ophthalmology, Director of Beckman
                                  Vision Center and Professor, University of California, San
                                  Francisco
  Michael Marmor, M. D.           Professor, Department of Ophthalmology, Stanford
                                  University School of Medicine
  Thai D. Nguyen, Ph.D.           Assistant Professor, University of California, San
                                  Francisco
  Gary D. Novack, Ph.D.           Founder and President, PharmaLogic Development, Inc.;
                                  former Associate Director for Glaucoma Research at
                                  Allergan, Inc.
  Jon R. Polansky, M. D.          Associate Professor of Ophthalmology, University of
                                  California, San Francisco
  Mansoor Sarfarazi, Ph.D.        Professor, Department of Surgery, University of
                                  Connecticut Health Center
  Roger Vogel, M. D.              Medical Director
</TABLE>

EMPLOYEES

      As of December 31, 1999, the Company employed 34 persons, including 30
full time employees. None of the Company's employees are covered by a collective
bargaining agreement. The Company considers its employee relations to be good.
The Company also utilizes independent consultants to provide services to the
Company in certain areas of its scientific and business operations.


                                  RISK FACTORS

IT IS DIFFICULT TO EVALUATE OUR BUSINESS BECAUSE WE ARE IN AN EARLY STAGE OF
DEVELOPMENT AND OUR TECHNOLOGY IS UNTESTED

      We are in an early stage of developing our business. We are currently only
receiving a small amount of royalties from the sale of one of our products, an
over-the-counter, or OTC, dry eye treatment. Before regulatory authorities will
grant us marketing approval, we will need to conduct significant additional
research and development and preclinical and clinical testing. All of our
products are subject to risks that are inherent to products based upon new
technologies. These risks include the risks that our products:

-     will be found to be unsafe or ineffective;

-     will fail to receive necessary marketing clearance from regulatory
      authorities;

-     even if safe and effective, will be too difficult to manufacture or
      market;

-     will be unmarketable due to the proprietary rights of third parties; or



                                       15
<PAGE>   16

-     will not be able to compete with superior, equivalent or more
      cost-effective products offered by third parties.

Therefore, we cannot guarantee that our research and development activities will
result in any commercially viable products.

WE WILL REQUIRE SIGNIFICANT ADDITIONAL FUNDING FOR OUR CAPITAL REQUIREMENTS

      We will require substantial additional funding to develop and conduct
testing on our potential products. We will also require additional funding to
manufacture and market any products which we do develop. Our future capital
requirements will depend upon many factors, including:

-     the progress of our research and development programs;

-     the progress of preclinical and clinical testing;

-     our ability to establish additional corporate partnerships to develop,
      manufacture and market our potential products;

-     the time and cost involved in obtaining regulatory approvals;

-     the cost of filing, prosecuting, defending and enforcing patent claims and
      other intellectual property rights;

-     competing technological and market developments;

-     changes in our existing collaborative and licensing relationships; and

-     the purchase of additional capital equipment.

      In addition, as part of the ISV-900 licensing activities, we received a $5
million up front licensing fee from P&U. The UC Regents have alleged that they
are entitled to receive up to $2.5 million of this payment under the terms of
the August 1994 license agreement between us and the UC Regents. We dispute this
allegation and the parties are currently discussing a resolution to this
conflict. We cannot assure you that we will be able to settle this dispute on
acceptable terms or at all and our failure to prevail in this negotiation could
significantly increase our future capital requirements and could significantly
harm our business and financial condition. In addition, any litigation that
results from this dispute, even if successful, could result in substantial cost
to, and diversion of effort by, us and could harm our business and financial
condition.

      We are currently seeking additional funding through public or private
equity or debt financing, collaborative or other arrangements, and from other
sources. We cannot be certain that we will be able to secure additional funding
from these sources, or that such funding will be on terms acceptable to us. If
we fail to secure additional funding upon acceptable terms, our business will be
harmed.

      If we raise additional funds by issuing equity securities, our
stockholders will suffer substantial dilution. However, if we cannot raise
additional funding, we may be required to delay, scale back or eliminate one or
more of our research, discovery or development programs, or scale back or cease
operations altogether. In addition, the failure to raise additional funding may
force us to enter into agreements with third parties on terms which are
disadvantageous to us, which may, among other things, require us to relinquish
rights to our technologies, products or potential products.

      We believe our cash and cash equivalents are sufficient to finance our
working capital and capital expenditure requirements through December 31, 2000.

WE EXPECT TO CONTINUE TO SUFFER LOSSES

      We have incurred significant operating losses since our inception in 1986.
As of December 31, 1999, our accumulated deficit was approximately $84.8
million. Although we achieved profitability in 1999, we expect to incur net
losses for the foreseeable future or until we are able to achieve significant
royalties from sale of our licensed products.



                                       16
<PAGE>   17

      Our ability to achieve significant revenue or profitability depends upon
our ability, alone or with third parties, to successfully develop our potential
products, conduct clinical trials, obtain required regulatory approvals and
successfully manufacture and market our products. We cannot be certain that we
will ever achieve or be able to maintain significant revenue or profitability.

WE RELY ON THIRD PARTIES TO DEVELOP, MARKET AND SELL OUR PRODUCTS

      We have not established a dedicated sales and marketing organization.
Therefore, if we are to successfully commercialize our product candidates, we
will be required to enter into arrangements with one or more third parties that
will:

-     provide for Phase III clinical testing;

-     provide for commercial scale up and manufacture of our potential products;

-     obtain or assist us in other activities associated with obtaining
      regulatory approvals for our product candidates; and

-     market and sell our products, if they are approved.

      There can be no assurance that we will be able to enter into such
arrangements on acceptable terms, if at all. If we are not successful in
concluding such arrangements, we may be required to establish our own sales and
marketing organization, although we have no experience in sales, marketing or
distribution. We cannot be certain we would be able to build such a marketing
staff or sales force, or that our sales and marketing efforts will be
cost-effective or successful.

      Our strategy for research, development and commercialization of certain of
our products requires us to enter into various arrangements with corporate and
academic collaborators, licensors, licensees and others. Furthermore, we are
dependent on the diligent efforts and subsequent success of these outside
parties in performing their responsibilities. See "Business - Collaborative and
Licensing Agreements".

      We are dependent upon British Biotechnology Pharmaceuticals, Inc., or
British Biotech, for the supply of batimastat, the active drugs incorporated
into the Company's ISV-615 product candidate. British Biotech has discontinued
clinical testing of batimastat and informed us that it will no longer
manufacture the product. We may have no source of ongoing raw materials for
ISV-615. If this turns out to be true, our business may be harmed.

      We cannot be certain that, even if regulatory approvals are obtained, our
products will be marketed diligently or successfully by our partners, or that we
will be able to conclude arrangements with other companies to support the
commercialization of other products on acceptable terms, if at all.

      In addition, we cannot be certain our collaborators will not take the
position that they are free to compete using our technology without compensating
or entering into agreements with us. Furthermore, we cannot be certain our
collaborators will not pursue alternative technologies or develop alternative
products either on their own or in collaboration with others, including our
competitors, as a means for developing treatments for the diseases or disorders
targeted by these collaborative programs.

      We plan to market and sell products through arrangements with third
parties with expertise in the ophthalmic drug or diagnostic industries. There
can be no assurance that we will be able to enter into such arrangements on
acceptable terms, if at all. If we are not successful in concluding such
arrangements, we may be required to establish our own sales and marketing
organization, although we have no experience in sales, marketing or
distribution. We cannot be certain we would be able to build such a marketing
staff or sales force, or that our sales and marketing efforts will be
cost-effective or successful. To the extent we have entered into or will enter
into co-marketing, co-promotion or other licensing arrangements for the
marketing and sale of our products, any revenues received by us will be
dependent on the efforts of third parties, such as CIBA Vision, P&U and B&L. We
cannot be certain that these partners will diligently or successfully market our
products or that such efforts will be successful.



                                       17
<PAGE>   18

OUR BUSINESS DEPENDS UPON OUR PROPRIETARY RIGHTS, AND THERE IS A RISK OF
INFRINGEMENT

      Our success will depend in large part on our ability to obtain patents,
protect trade secrets, obtain and maintain rights to technology developed by
others, and operate without infringing upon the proprietary rights of others. A
substantial number of patents in the field of ophthalmology and genetics have
been issued to pharmaceutical, biotechnology and biopharmaceutical companies.
Moreover, competitors may have filed patent applications, may have been issued
patents or may obtain additional patents and proprietary rights relating to
products or processes competitive with ours. We cannot be certain that our
patent applications will be approved, that we will develop additional
proprietary products that are patentable, that any issued patents will provide
us with adequate protection for our inventions or will not be challenged by
others, or that the patents of others will not impair our ability to
commercialize our products. The patent positions of firms in the pharmaceutical
and genetic industries generally are highly uncertain, involve complex legal and
factual questions, and have recently been the subject of much litigation. No
consistent policy has emerged from the U.S. Patent and Trademark Office or the
courts regarding the breadth of claims allowed or the degree of protection
afforded under pharmaceutical and genetic patents. Despite our efforts to
protect our proprietary rights, we cannot be certain others will not
independently develop similar products, duplicate any of our products or design
around any of our patents or that third parties from which we have licensed or
otherwise obtained technology will not attempt to terminate or scale back our
rights.

      A number of pharmaceutical and biotechnology companies and research and
academic institutions have developed technologies, filed patent applications or
received patents on various technologies that may be related to our business.
Some of these technologies, applications or patents may conflict with our
technologies or patent applications. Such conflicts could limit the scope of the
patents, if any, we may be



                                       18
<PAGE>   19

able to obtain or result in the denial of our patent applications. In addition,
if patents that cover our activities have been or are issued to other companies,
there can be no assurance that we will be able to obtain licenses to these
patents, at all, or at a reasonable cost, or be able to develop or obtain
alternative technology. If we do not obtain such licenses, we could encounter
delays or be precluded from introducing products to the market.

      Litigation may be necessary to defend against or assert claims of
infringement, to enforce patents issued to us or to protect trade secrets or
know-how owned or licensed by us. Such litigation could result in substantial
cost to and diversion of effort by the Company, all of which may harm our
business. We have also agreed to indemnify our licensees, including P&U, against
infringement claims by third parties related to our technology, which could
result in additional litigation costs and liability, which could harm our
business. In addition, we cannot be certain our efforts to protect or defend our
proprietary rights will be successful or, even if successful, will not result in
substantial cost to us.

      We also depend upon unpatented trade secrets to maintain our competitive
position. We cannot be certain others will not independently develop
substantially equivalent proprietary information and techniques or otherwise
gain access to our trade secrets, that such trade secrets will not be disclosed
or that we can effectively protect our rights to unpatented trade secrets. To
the extent that we or our consultants or research collaborators use intellectual
property owned by others in their work for us, disputes also may arise as to the
rights in related or resulting know-how and inventions.

ACQUISITIONS MAY PRESENT RISKS TO OUR BUSINESS

      At some point in the future, we may pursue acquisitions of companies,
product lines, technologies or businesses that our management believes are
complementary or otherwise beneficial to our Company. In the event that such an
acquisition does occur, we cannot be certain how such acquisitions will affect
our business. Future acquisitions may result in substantial dilution to our
stockholders, the incurrence of additional debt and amortization expenses
related to goodwill, research and development and other intangible assets, all
of which could harm our business. In addition, acquisitions would involve
several risks for us, including:

      -     assimilating employees, operations, technologies and products from
            the acquired companies with our existing employees, operation,
            technologies and products;

      -     diverting our management's attention from day-to-day operation of
            our business;

      -     entering markets in which we have no or limited direct experience;
            and

      -     potentially losing key employees from the acquired companies.

WE HAVE NO EXPERIENCE IN COMMERCIAL MANUFACTURING AND WE RELY ON A SOLE SOURCE
FOR CERTAIN RAW MATERIALS

      We have no experience manufacturing products for commercial purposes. We
have a pilot facility licensed by the State of California to manufacture certain
of our products for Phase I and Phase II clinical trials. In July 1999, we
terminated our alliance under which B&L agreed to manufacture our products.
Should we encounter delays or difficulties in establishing and maintaining a
relationship with other qualified manufacturers to produce, package and
distribute our finished products, then clinical trials, regulatory filings,
market introduction and subsequent sales of our products will be harmed.

      Contract manufacturers must adhere to Good Manufacturing Practices, or
GMP, regulations which are strictly enforced by the FDA on an ongoing basis
through its facilities inspection program. Contract manufacturing facilities
must pass a pre-approval plant inspection before the FDA will approve an New
Drug Application (NDA). Certain material manufacturing changes that occur after
approval are also subject to FDA review and clearance or approval. We cannot be
certain the FDA or other regulatory agencies will approve the process or the
facilities by which any of our products may be manufactured. Our dependence on
third parties for manufacture of products may harm our ability to develop and
deliver products on a timely and competitive basis. Should we be required to
manufacture products ourselves, we:



                                       19
<PAGE>   20

-     will be required to expend significant amounts of capital to install a
      manufacturing capability;

-     will be subject to the regulatory requirements described above;

-     will be subject to similar risks regarding delays or difficulties
      encountered in manufacturing any such products; and

-     will require substantial additional capital.

      We cannot be certain we will be able to manufacture any products
successfully or in a cost-effective manner. In addition, certain of the raw
materials we use in formulating our DuraSite drug delivery system are available
from only one source. Any significant interruption in the supply of these raw
materials could delay our clinical trials, product development or product sales
and could harm our business.

OUR PRODUCTS ARE SUBJECT TO GOVERNMENT REGULATIONS AND APPROVAL

      FDA and comparable agencies in state and local jurisdictions and in
foreign countries impose substantial requirements upon preclinical and clinical
testing, manufacturing and marketing of pharmaceutical products. Lengthy and
detailed preclinical and clinical testing, validation of manufacturing and
quality control processes, and other costly and time-consuming procedures are
required. Satisfaction of these requirements typically takes several years and
the time needed to satisfy them may vary substantially, based on the type,
complexity and novelty of the pharmaceutical product. The effect of government
regulation may be to delay or to prevent marketing of potential products for a
considerable period of time and to impose costly procedures upon our activities.
We cannot be certain the FDA or any other regulatory agency will grant approval
for any products we develop on a timely basis, or at all. Success in preclinical
or early stage clinical trials does not assure success in later stage clinical
trials. Data obtained from preclinical and clinical activities are susceptible
to varying interpretations that could delay, limit or prevent regulatory
approval. If regulatory approval of a product is granted, such approval may
impose limitations on the indicated uses for which a product may be marketed.
Further, even after we have obtained regulatory approval, later discovery of
previously unknown problems with a product may result in restrictions on the
product, including withdrawal of the product from the market. Moreover, the FDA
has recently reduced previous restrictions on the marketing, sale and
prescription of products for indications other than those specifically approved
by the FDA. Accordingly, even if we receive FDA approval of a product for
certain indicated uses, our competitors, including our collaborators, could
market products for such indications even if such products have not been
specifically approved for such indications. Delay in obtaining or failure to
obtain regulatory approvals would harm our business.

      The FDA's policies may change and additional government regulations may be
promulgated which could prevent or delay regulatory approval of our potential
products. Moreover, increased attention to the containment of health care costs
in the U.S. could result in new government regulations that could harm our
business. We cannot predict the likelihood of adverse governmental regulation
that might arise from future legislative or administrative action, either in the
U.S. or abroad. See "Risk Factors -- We face risks from the uncertainties of
pricing and other regulation".

WE COMPETE IN HIGHLY COMPETITIVE MARKETS



                                       20
<PAGE>   21

      Our success depends upon developing and maintaining a competitive position
in the development of products and technologies in our areas of focus. We have
many competitors in the U.S. and abroad, including pharmaceutical, biotechnology
and other companies with varying resources and degrees of concentration in the
ophthalmic market. Our competitors may have existing products or products under
development which may be technically superior to ours or which may be less
costly or more acceptable to the market. Competition from such companies is
intense and expected to increase as new products enter the market and new
technologies become available. Many of our competitors have substantially
greater financial, technical, marketing, manufacturing and human resources. In
addition, they may also succeed in developing technologies and products that are
more effective, safer, less expensive or otherwise more commercially acceptable
than any which we have or will develop. Our competitors may obtain cost
advantages, patent protection or other intellectual property rights that would
block or limit our ability to develop our potential products, or may obtain
regulatory approval for commercialization of their products more effectively or
rapidly than we will. To the extent we decide to manufacture and market our
products by ourselves, we will also compete with respect to manufacturing
efficiency and marketing capabilities, areas in which we have limited or no
experience.

WE ARE DEPENDENT UPON KEY EMPLOYEES

      We are highly dependent on Dr. Chandrasekaran and other principal members
of our scientific and management staff, the loss of whose services might
significantly delay the achievement of planned development objectives.
Furthermore, recruiting and retaining qualified personnel will be critical to
our success. Competition for skilled individuals in the biotechnology business
is highly intense, and we cannot be certain we will be able to continue to
attract and retain personnel necessary for the development of our business. The
loss of key personnel or the failure to recruit additional personnel or to
develop needed expertise could harm our business.

OUR INSURANCE COVERAGE MAY NOT ADEQUATELY COVER OUR POTENTIAL PRODUCT LIABILITY
EXPOSURE

      We are exposed to potential product liability risks which are inherent in
the development, testing, manufacturing, marketing and sale of human therapeutic
products. Product liability insurance for the pharmaceutical industry is
generally expensive. We cannot be certain that our present product liability
insurance coverage is adequate. Such existing coverage will not be adequate as
we further develop our products, and we cannot be certain that adequate
insurance coverage against potential claims will be available in sufficient
amounts or at a reasonable cost.

WE FACE RISKS FROM THE UNCERTAINTIES OF PRICING AND OTHER REGULATION

      Our business may be harmed by the continuing efforts of governmental and
third party payers to contain or reduce the costs of health care through various
means. For example, in certain foreign markets the pricing or profitability of
health care products is subject to government control. In the U.S., there have
been, and we expect there will continue to be, a number of federal and state
proposals to implement similar government control. While we cannot predict
whether any such legislative or regulatory proposals or reforms will be adopted,
the announcement of such proposals or reforms could harm our business, including
our ability to raise capital or form collaborations. The adoption of such
proposals or reforms could further harm our business.

      In addition, in the U.S. and elsewhere, sales of health care products are
dependent in part on the availability of reimbursement from third party payers,
such as government and private insurance plans. Significant uncertainty exists
as to the reimbursement status of newly approved health care products, and third
party payers are increasingly challenging the prices charged for medical
products and services. If we succeed in bringing one or more products to the
market, we cannot be certain that reimbursement from third party payers will be
available or will be sufficient to allow us to sell our products on a
competitive or



                                       21
<PAGE>   22

profitable basis.

WE USE HAZARDOUS MATERIALS WHICH MAY POSE ENVIRONMENTAL RISKS

      Our research, development and manufacturing processes involve the
controlled use of small amounts of radioactive and other hazardous materials. We
are subject to federal, state and local laws, regulations and policies governing
the use, manufacture, storage, handling and disposal of such materials and
certain waste products. Although we believe that our safety procedures for
handling and disposing of such materials comply with the standards prescribed by
laws and regulations, we cannot completely eliminate the risk of accidental
contamination or injury from these materials. In the event of such an accident,
we could be held liable for any damages that result, and any such liability
could exceed our resources. Moreover, we may be required to incur significant
costs to comply with environmental laws and regulations, especially to the
extent that we manufacture our own products.

OUR OFFICERS AND DIRECTORS WILL BE ABLE TO EXERT SIGNIFICANT CONTROL ON INSITE

      As of December 31, 1999, our management and principal stockholders
together beneficially owned approximately 25% of our outstanding shares of
common stock. As a result, these stockholders, acting together, may be able to
effectively control all matters requiring approval by our stockholders,
including the election of a majority of our directors and the approval of
business combinations.

THE PRICE OF OUR COMMON STOCK IS VOLATILE

      The market prices for securities of biopharmaceutical and biotechnology
companies, including ours, have been highly volatile, and the market has from
time to time experienced significant price and volume fluctuations that are
unrelated to the operating performance of particular companies. In addition,
future announcements concerning InSite, our competitors or other
biopharmaceutical companies, including the results of testing and clinical
trials, technological innovations or new therapeutic products, governmental
regulation, developments in patent or other proprietary rights, litigation or
public concern as to the safety of products developed by us or others and
general market conditions, may have a significant effect on the market price of
our common stock. We have not paid any cash dividends on our common stock, and
we do not anticipate paying any dividends in the foreseeable future.

WE HAVE ADOPTED CERTAIN ANTI-TAKEOVER PROVISIONS

      Certain provisions of our certificate of incorporation and bylaws may have
the effect of making it more difficult for a third party to acquire, or
discouraging a third party from attempting to acquire, control of InSite. Such
provisions could limit the price that certain investors might be willing to pay
in the future for shares of our common stock. The board of directors has the
authority to issue up to 5,000,000 shares of preferred stock, 7,070 of which
have been designated as Series A Convertible Redeemable Preferred Stock.
Furthermore, the board of directors has the authority to determine the price,
rights, preferences, privileges and restrictions of the remaining unissued
shares of preferred stock without any further vote or action by the
stockholders. The rights of the holders of common stock will be subject to, and
may be adversely affected by, the rights of the holders of any preferred shares
and of preferred stock that may be issued in the future. The issuance of
preferred stock, while providing desirable flexibility in connection with
possible acquisitions and other corporate purposes, could have the effect of
making it more difficult for a third party to acquire a majority of our
outstanding voting stock. Certain provisions of Delaware law applicable to us
could also delay or make more difficult a merger, tender offer or proxy contest
involving us, including Section 203 of the Delaware General Corporation Law,
which prohibits a Delaware corporation from engaging in any business combination
with any interested stockholder for a period of three years unless certain
conditions are met.

WE HAVE CONVERTIBLE, REDEEMABLE SECURITIES THAT MAY RESULT IN DILUTION FOR
COMMON STOCKHOLDERS

      Sales of a substantial number of shares of common stock issuable upon
conversion of our Series A Convertible Redeemable Preferred Stock could
adversely affect the market value of the common stock,



                                       22
<PAGE>   23

depending upon the timing of such sales, and may effect a substantial dilution
of the book value per share of our common stock.

      As of December 31, 1999, warrants for 70 shares of Series A Convertible
Redeemable Preferred Stock were issued and outstanding. The actual number of
shares of common stock issuable upon exercise and conversion of the warrants for
outstanding Series A Convertible Redeemable Preferred Stock will equal:

            (i)   the aggregate stated value of the Series A Convertible
      Redeemable Preferred Stock then being converted ($1,000 per share) plus a
      premium in the amount of 6% per annum accruing from September 12, 1997
      through the date of conversion, divided by

            (ii)  a conversion price equal to the lower of $2.127 or the product
      of the average of the lowest closing bid prices for our common stock for
      any 5 trading days during the 22 consecutive trading day period
      immediately preceding the date of conversion, subject to adjustment in
      accordance with the terms of the Certificate of Designations, Preferences
      and Rights for the Series A Convertible Redeemable Preferred Stock,
      multiplied by a conversion percentage equal to 82.5%.

      For a complete description of the relative rights, preferences,
privileges, powers and restrictions of the Series A Convertible Redeemable
Preferred Stock, see the Certificate of Designations, Preferences and Rights
attached as Exhibit 4.1 to the Registration Statement on Form S-3 filed with the
Securities and Exchange Commission on September 29, 1997. Depending on market
conditions at the time of conversion, the number of shares of common stock
issuable could increase significantly in the event of a decrease in the trading
price of the common stock. Investors in common stock could therefore experience
a dilution upon conversion of the Series A Convertible Redeemable Preferred
Stock. In addition, in the event that the holder of the warrant for Series A
Convertible Redeemable Preferred Stock is unable to convert any such securities
into common stock, the holder may cause us to redeem in cash any such Series A
Convertible Redeemable Preferred Stock that cannot be so converted. In the event
that we fail to so redeem such shares, the holder of the Series A Convertible
Redeemable Preferred Stock are entitled to additional remedies as set forth in
the Certificate of Designations, Preferences and Rights.



                                       23
<PAGE>   24

        EXECUTIVE OFFICERS AND OTHER SENIOR MANAGEMENT OF THE REGISTRANT

      As of March 27, 2000, the executive officers and other senior management
of the Company were as follows:

<TABLE>
<CAPTION>
            NAME                     AGE                    TITLE
            ----                     ---                    -----
<S>                                  <C>    <C>
S. Kumar Chandrasekaran, Ph.D.        56    Chairman of the Board, President, Chief
                                            Executive Officer and Chief Financial Officer

Lyle M. Bowman, Ph.D.                 51    Vice President, Development and Operations

Cheryl E. Chen                        40    Senior Director, Clinical Operations

T. Raymond Chen, Ph.D.                49    Senior Director, Regulatory, Quality Assurance
                                            and Quality Control

Sandra C. Heine                       38    Senior Director, Finance and Administration

Samir D. Roy, Ph.D.                   41    Senior Director, Formulation Development and
                                            Operations

Erwin C. Si, Ph.D.                    46    Senior Director, Preclinical Research
</TABLE>

      S. Kumar Chandrasekaran joined the Company in September 1987 as Vice
President, Development. From 1988 to 1989, Dr. Chandrasekaran served as Vice
President, Research and Development. From 1989 to 1993, he served as President
and Chief Operating Officer. Since August 1993, Dr. Chandrasekaran has served as
Chairman of the Board of Directors, President, Chief Executive Officer and,
since January 1999, as Chief Financial Officer, a position he also held from
December 1995 to December 1997. Dr. Chandrasekaran holds a Ph.D. in Chemical
Engineering from the University of California, Berkeley.

      Lyle M. Bowman joined the Company in October 1988 as Director of Drug
Delivery Systems. From 1989 to 1991, Dr. Bowman served as Vice President,
Science and Technology. From 1991 to 1995, he served as Vice President,
Development, and since 1995 has served as Vice President Development and
Operations. Dr. Bowman holds a Ph.D. in Physical Chemistry from the University
of Utah.

      Cheryl E. Chen joined the Company in January 1990 as the Manager of
Clinical Research. From 1994 to 1998, Ms. Chen served as Director of Clinical
Operations. In 1999, Ms. Chen became the Senior Director of Clinical Operations.
Ms. Chen holds a B.S. in Biological Science from University of California at
Irvine and an M.B.A. in Business from Pepperdine University.

      T. Raymond Chen joined the Company in August 1990 as a Senior Staff
Researcher. From 1994 to August 1997, he served as the Director of Analytical
Research. Since September 1997, Dr. Chen has served as Senior Director of
Regulatory, Quality Assurance and Quality Control. Dr. Chen holds a Ph.D. in
Analytical Research from Indiana University.

      Sandra C. Heine joined the Company in March 1997 as Controller. Since
October 1999, Ms. Heine has served as Senior Director of Finance and
Administration. Before joining the Company, Ms. Heine served as General
Accounting Manager of Software Logistics Corporation from 1995 to 1997; Systems
Engineer for Platinum Software Corporation from 1994 to 1995; General Audit
Manager for Genentech, Inc. from 1991 to 1994 and was an Audit Manager at
Deloitte & Touche from 1989 to 1991.



                                       26
<PAGE>   25

Ms. Heine holds a B.S. in Business Administration from Colorado State
University.

      Samir D. Roy joined the Company in May 1997 as Director of Formulation
Development. Since 1998, Dr. Roy has served as Senior Director of Formulation
Development and Operations involving clinical supply and scale-up activities.
Dr. Roy holds a Ph.D. in Pharmaceutical Sciences from the University of
Saskatchewan, Canada, and has post-doctoral training in drug transport at the
University of Michigan.

      Erwin C. Si joined the Company in April 1989 as Manager of Pharmacology
and Toxicology. From 1992 to 1996, he served as Manager of Drug Discovery. From
1996 to 1999, he served as Principal Scientist. Since October 1999, he has
served as Senior Director of Pre-clinical Research. Dr. Si holds a Ph.D. in
Pharmacology and Toxicology from Purdue University.

      Officers are appointed to serve, at the discretion of the Board of
Directors, until their successors are appointed. There are no family
relationships between any members of the Board of Directors or executive
officers of the Company.



                                       27
<PAGE>   26

ITEM 2. PROPERTIES

      InSite currently leases approximately 29,402 square feet of research
laboratory and office space located in Alameda, California. The facility
includes laboratories for formulation, analytical, microbiology, pharmacology,
quality control and development as well as a pilot manufacturing plant. The
lease expires on December 31, 2001, but may be renewed by the Company for an
additional 5-year term. The Company believes its existing facilities will be
suitable and adequate to meet its needs for the immediate future.

ITEM 3. LEGAL PROCEEDINGS.

      (a)   The Company is not a party to any legal proceedings.

      (b)   No legal proceedings were terminated in the fourth quarter.


ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

      No matters were submitted to a vote of the Company's stockholders during
the quarter ended December 31, 1999.



                                       28
<PAGE>   27

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

      (a)   Market Information

      Since June 10, 1998, the Company's common stock has traded on The American
Stock Exchange under the symbol "ISV." From its initial public offering on
October 18, 1993 to June 9, 1998, the Company's common stock traded on The
Nasdaq National Market under the symbol "INSV." Prior to its initial public
offering, there was no public market for the Company's common stock. The
following table sets forth the high and low sales prices for the common stock as
reported by The American Stock Exchange and The Nasdaq National Market for the
periods indicated. These prices do not include retail mark-ups, mark-downs or
commissions.

<TABLE>

      1999                                   HIGH              LOW
      ----                                   ----              ---
<S>                                          <C>              <C>
      First Quarter                          $1.56            $1.00
      Second Quarter                         $2.00            $0.88
      Third Quarter                          $2.81            $1.81
      Fourth Quarter                         $2.75            $1.69

      1998                                   HIGH              LOW
      ----                                   ----              ---

      First Quarter                          $3.56            $2.44
      Second Quarter                         $4.00            $3.13
      Third Quarter                          $4.44            $1.63
      Fourth Quarter                         $2.44            $0.94
</TABLE>

      (b)   Holders

      As of December 31, 1999, the Company had approximately 7,000 stockholders.
On March 27, 2000, the last sale price reported on The American Stock Exchange
for the Company's common stock was $5.31 per share.

      (c)   Dividends

      The Company has never paid dividends and does not anticipate paying any
dividends in the foreseeable future. It is the present policy of the Board of
Directors to retain the Company's earnings, if any, for the development of the
Company's business.

      (d)   Recent Sales of Unregistered Securities

      As part of a November 11, 1999 transaction to license the exclusive
worldwide rights to the ISV-900 diagnostic/prognostic test for glaucoma to P&U,
on January 18, 2000, the Company sold a total of



                                       29
<PAGE>   28

723,195 shares of Common Stock to P&U for $2,000,000.

     The Common Stock in this transaction was issued to a single, sophisticated
foreign investor in reliance on the private placement exemption under Section
4(2) of the Securities Act of 1933, as amended.

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected consolidated financial data for the
Company for the five years ended December 31, 1999 (in thousands except per
share amounts):

<TABLE>
<CAPTION>
                                                                     YEAR ENDED DECEMBER 31,
                                                 ------------------------------------------------------------
                                                     1999         1998         1997         1996         1995
                                                 --------     --------     --------     --------     --------
<S>                                              <C>          <C>          <C>          <C>          <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA

Revenues                                         $  4,760     $     16     $     50     $    544     $     65

Operating expenses:
     Research and development                       1,397        6,227        7,224        5,458        8,079
     General and administrative                     2,293        2,656        3,034        2,902        3,801
     Loss on vacated facility                          --           --           --        1,412           --
     Restructuring                                     --           --           --           --        1,031
                                                 --------     --------     --------     --------     --------
         Total expenses                             3,690        8,883       10,258        9,772       12,911

Interest and other income (expense), net               85          299          390          466          224
                                                 --------     --------     --------     --------     --------
Net income (loss) before taxes                      1,155       (8,568)      (9,818)      (8,762)     (12,622)

Income tax provision                                    5           --           --           --           --
                                                 --------     --------     --------     --------     --------
Net income (loss)                                   1,150       (8,568)      (9,818)      (8,762)     (12,622)

Non cash preferred dividend                            22          514        1,326           --           --
                                                 --------     --------     --------     --------     --------
Net income (loss) applicable to
common stockholders                              $  1,128     $ (9,082)    $(11,144)    $ (8,762)    $(12,622)
                                                 ========     ========     ========     ========     ========
Net income (loss) per share
applicable to common stockholders
basic and diluted                                $   0.06     $  (0.60)    $  (0.85)    $  (0.72)    $  (1.38)
                                                 ========     ========     ========     ========     ========
Shares used to calculate net income
(loss) per share basic                             19,285       15,079       13,053       12,131        9,160
                                                 ========     ========     ========     ========     ========
Shares used to calculate net income
(loss) per share diluted                           19,856       15,079       13,053       12,131        9,160
                                                 ========     ========     ========     ========     ========

                                                                      DECEMBER 31,
                                                     1999         1998         1997         1996         1995
                                                 --------     --------     --------     --------     --------
CONSOLIDATED BALANCE SHEET DATA

Cash and cash equivalents                        $  6,746     $  1,037     $  8,660     $ 10,518     $  3,867

Working capital                                     6,167          544        7,983        9,512        2,376
</TABLE>


                                       30
<PAGE>   29

<TABLE>
<CAPTION>
                                                                     YEAR ENDED DECEMBER 31,
                                                 ------------------------------------------------------------
                                                     1999         1998         1997         1996         1995
                                                 --------     --------     --------     --------     --------
<S>                                              <C>          <C>          <C>          <C>          <C>
Total assets                                        7,463        2,086       10,546       12,820        7,643

Long term notes payable                                --           --           --           --           92

Redeemable preferred stock                             30        1,511        7,533           --           --

Accumulated deficit                               (84,754)     (85,882)     (76,800)     (65,656)     (56,894)

Total stockholders' equity (deficit)                6,256         (108)       2,031       11,619        5,847
</TABLE>

No cash dividends were declared or have been paid by the Company since its
inception.



                                       31
<PAGE>   30

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

      The following discussion should be read in conjunction with the financial
statements and notes thereto included in Item 8 of this Form 10-K.

      Except for the historical information contained herein, the discussion in
this Annual Report on Form 10-K may contain certain forward-looking statements
that involve risks and uncertainties, such as statements of the Company's plans,
objectives, expectations and intentions. The cautionary statements made in this
document should be read as being applicable to all related forward-looking
statements wherever they appear in this document. The Company's actual results
could differ materially from those discussed herein. Factors that could cause or
contribute to such differences include those discussed below and under "Risk
Factors" in Item 1 of this Form 10-K, as well as those discussed elsewhere
herein.

OVERVIEW

      InSite Vision is developing genetically-based tools for the diagnosis,
prognosis and management of glaucoma and ophthalmic pharmaceutical products
based on its proprietary DuraSite eyedrop-based drug delivery technology.

      The Company is collaborating with academic researchers to develop new
diagnostic, prognostic and management tools for primary congenital, juvenile and
primary open angle glaucomas. Primary congenital glaucoma is an inherited eye
disorder and is one of the leading causes of blindness and visual impairment
affecting infants. A gene-based diagnostic kit may allow early detection of the
disease before considerable irreversible damage has occurred and may improve the
ability to treat it successfully. Primary open angle glaucoma usually affects
people over the age of forty. Current glaucoma tests are generally unable to
detect the disease before substantial damage to the optic nerve has occurred.
Gene-based tests may make it possible to identify patients at risk and initiate
treatment before permanent optic nerve damage and vision loss occurs.

      The Company has international and national collaborations with academic
institutions for the identification and clinical evaluation of genetic markers
for glaucoma. To date, the Company's academic collaborators at UCSF and UCHC
have identified genes associated with primary open-angle glaucoma (the most
prevalent form of the disease in adults), juvenile glaucoma and primary
congenital glaucoma. A diagnostic/prognostic technology, ISV-900, which is
capable of identifying multiple glaucoma genetic markers from a single sample,
has been developed and, in November 1999, the Company licensed the technology to
P&U. See "--Collaborative and Licensing Agreements" for additional information
on the agreement.

      Another result of the glaucoma genetics research has been the development
of the ISV-205 product candidate. This DuraSite formulation contains a drug that
has been shown in cell and organ culture systems to inhibit the production of a
protein that appears to cause glaucoma. In January 1999, the Company entered
into a transaction that granted P&U an exclusive worldwide license for ISV-205
for the treatment of glaucoma. See "Collaborative and Licensing Agreements" for
additional discussion of the transaction. In June 1999, the Company announced
positive results from its Phase II trial of ISV-205. P&U has assumed the
continued development of the product with the continued technical support of the
Company.

      The DuraSite delivery system is a patented eyedrop formulation comprising
a cross-linked carboxyl-containing polymer which incorporates the drug to be
delivered to the eye. The formulation is instilled in the cul-de-sac of the eye
as a small volume eyedrop. DuraSite can be customized to deliver a wide variety
of potential drug candidates with a broad range of molecular weights and other
properties. The DuraSite formulation remains in the eye for up to several hours
during which time the active drug ingredient is gradually released. DuraSite
extends the residence time of the drug due to a combination of mucoadhesion,
surface tension and viscosity. Eyedrops delivered in the DuraSite system
contrast to conventional eyedrops which typically only last in the eye a few
minutes, thus requiring delivery of a



                                       32
<PAGE>   31

highly concentrated burst of drug and frequent administration to sustain
therapeutic levels. The increased residence time for DuraSite is designed to
permit lower concentrations of a drug to be administered over a longer period of
time, thereby minimizing the inconvenience of frequent dosing and reducing the
potential related adverse side effects.

      The Company is focusing its research and development on (i) expansion of
the ISV-900 technology for the prognosis, diagnosis and management of glaucoma,
(ii) providing on-going technical support to P&U for ISV-205 for the treatment
of inflammation and the prevention and treatment of glaucoma, (iii) ISV-615 for
the treatment of diabetic retinopathy and macular degeneration, (iv) ISV-014 a
retinal drug delivery device, and (v) evaluation and development of several
antibiotics not currently used in ophthalmics.

      To date, InSite Vision has not received any revenues from the sale of
products, although it has received a small amount of royalties from the sale of
products using the Company's licensed technology. Until 1999, the Company had
been unprofitable since its inception due to continuing research and development
efforts, including preclinical studies, clinical trials and manufacturing of its
product candidates. The Company has financed its research and development
activities and operations primarily through private and public placement of its
equity securities and, to a lesser extent, from collaborative agreements.

      On January 28, 1999, the Company entered into a license agreement and
stock purchase agreement pursuant to which InSite granted P&U an exclusive
worldwide license to ISV-205 for the treatment of glaucoma. The license called
for (i) P&U to assume responsibility for the development of the product upon
completion by InSite of, among other activities, Phase II studies completed by
the Company, (ii) P&U to reimburse InSite for research and development expenses
and to make payments to InSite for on-going technical support, and (iii) the
payment by P&U to InSite of royalties on product sales should ISV-205 be
successfully commercialized. InSite will continue to bear responsibility for the
prosecution and maintenance of the patents subject to the license, among other
things. The transaction also called for equity investments from P&U of
$3,500,000 for which they received 1,942,419 shares of common stock, with the
potential for future equity investments at an average of prevailing market
prices if the Company achieves certain milestones.

      On November 11, 1999, the Company entered into a license agreement, stock
purchase agreement and credit agreement pursuant to which InSite granted P&U an
exclusive worldwide royalty-bearing license to its ISV-900 technology for
diagnostic, prognostic and therapeutic applications in the area of glaucoma. The
license calls for (i) P&U to pay the Company a $5 million licensing fee, (ii)
P&U to make up to $5 million in research and development payments to the Company
over three years starting in 2000, (iii) P&U to pay the Company royalties on
product sales should any products be successfully commercialized from this
technology, and (iv) the potential for payments of up to $3 million by P&U to
the Company based on achievement of certain milestones.

      The stock purchase agreement provided for a $2.0 million equity investment
by P&U in the Company. A total of 723,195 shares were purchased in January 2000,
45 days after the execution of the agreement. The stock purchase agreement also
provides for a standstill period of thirty (30) months during which P&U and its
subsidiaries will not purchase additional shares of the Company, other than
those provided for under any existing agreements between the companies, without
the prior written consent of



                                       33
<PAGE>   32

the Company. This standstill period will terminate earlier if certain actions
are taken by other parties to acquire more than a 9.99% interest in the stock of
the Company or if any other party announces their intention to assume control of
the Company, whether by tender offer, merger, proxy contest or otherwise.

      The credit agreement provides for a $4.0 million revolving line of credit
to be made available to the Company on November 11, 2001 for a period of three
(3) years. Any amounts drawn on the line will bear interest at a rate of three
percent (3%) over the prime rate announced at the time of borrowing by Chase
Manhattan Bank in New York City. At the Company's discretion, repayments on the
line may be made in cash at any point, or the total amount due at the end of the
loan period may be paid by issuance of the Company's stock at a twenty-five
percent (25%) premium to the average market price of the Company's stock for a
period prior to the end of the loan. The loan provides for certain affirmative
and negative covenants as well as other terms and conditions.

      In August 1999, the Company entered into a license agreement with SSP Co.,
Inc., a Japanese company, to be the exclusive manufacturer and distributor of
AquaSite in Japan. AquaSite is an over-the-counter product which uses the
Company's DuraSite technology and demulcents for the symptomatic treatment of
dry eye. Under this agreement, the Company received a net amount of $3,000 for
materials provided to SSP during 1999.

      In March 1999, the Company entered into a royalty-bearing license
agreement with Global Damon, a Korean company, to be the exclusive distributor
of AquaSite in the Republic of Korea. Concurrently, the Company entered into a
manufacturing agreement with Kukje, a Korean company, to produce the AquaSite to
be sold by Global Damon.

      As of December 31, 1999, the Company's accumulated deficit was
approximately $84.8 million. There can be no assurance that InSite Vision will
ever achieve or be able to maintain either significant revenues from product
sales or profitable operations.


RESULTS OF OPERATIONS

      The Company had total net revenues of $4.8 million, $16,000 and $50,000
for the years ended December 31, 1999, 1998 and 1997, respectively. The increase
from 1998 to 1999 was attributable to the license fee received from P&U in 1999.
The Company earned royalty income of $10,000, $16,000 and $50,000 for the years
ended December 31, 1999, 1998 and 1997, respectively, from sales of AquaSite by
CIBA Vision. To date, the Company has not relied on royalty revenues to fund its
activities, nor has it received revenues from the sale of products.

      Research and development expenses, net, decreased 77% to $1.4 million in
1999 from $6.2 million in 1998 and decreased 14% in 1998 from $7.2 million in
1997. The decrease in 1999 was primarily due to expense recovery from P&U of
$4.2 million related to the ISV-205 project. Additionally, compensation and
related costs decreased due to a reduction in R&D headcount which occurred in
November 1998. The decrease in 1998 was primarily due to lower expenditures for
outside services, consultants and compensation-related costs due to a reduction
in R&D headcount. The reduction in outside service costs mainly reflects the
completion of development activities for ISV-208 and transfer of the project to
B&L, the Company's joint development partner on that project.

      General and administrative expenses decreased 15% in 1999 to $2.3 million
from $2.7 million in 1998 and decreased 10% during 1998 from $3.0 million in
1997. The decrease in 1999 as compared to 1998 was primarily due to lower
personnel related and facility costs. The lower facility cost reflected the
sublease of a portion of unused office space beginning in January 1999. The
sublease term is consistent with the base lease which is through 2001. The
decrease in 1998 as compared to 1997 was primarily related to the reduced cost
of directors and officers' insurance, lower consulting expenses and lower costs
related to the hiring of full time personnel in the area of accounting and
finance.



                                       34
<PAGE>   33

      Net interest and other income was $85,000, $299,000 and $390,000 in 1999,
1998 and 1997, respectively. These fluctuations are due principally to changes
in average cash balances. Interest earned in the future will be dependent on the
Company's funding cycles and prevailing interest rates. Interest expense in 1997
related to notes payable which were paid off during the first quarter of 1997.

      The Company had net income for the year ended December 31, 1999 of $1.1
million and incurred net losses of $8.6 million and $9.8 million for the years
ended December 31, 1998 and 1997, respectively. The net income in 1999 is mainly
the result of licensing revenue of $4.8 million and cost reimbursement of $4.2
million received from P&U for the ISV-900 and ISV-205 projects, respectively.

LIQUIDITY AND CAPITAL RESOURCES

      Through 1995, InSite Vision financed its operations primarily through
private placements of preferred stock totaling approximately $32 million and an
October 1993 initial public offering of Common Stock, which resulted in net
proceeds of approximately $30 million. After 1995, the Company financed its
operations primarily through a January 1996 private placement of Common Stock
and warrants resulting in net proceeds of approximately $4.7 million and an
April 1996 public offering which raised net proceeds of approximately $8.1
million. In accordance with a July 1996 agreement between the Company and B&L,
the Company received a total of $2.0 million from the sale of Common Stock in
August 1996 and 1997. In September 1997, the Company completed a $7.0 million
private placement of 7,000 shares of redeemable convertible Series A Preferred
Stock resulting in net proceeds of approximately $6.5 million. In January 1999,
the Company entered into a transaction with P&U from which the Company received
a total of $3.5 million from the sale of Common Stock in January and September.
In November 1999, the Company entered into another transaction with P&U from
which the Company received a $5.0 million licensing fee and, in January 2000,
received $2.0 million from the sale of 723,195 shares of Common Stock. At
December 31, 1999, the Company had cash and cash equivalents totaling $6.7
million. It is the Company's policy to invest these funds in highly liquid
securities, such as interest bearing money market funds, Treasury and federal
agency notes and corporate debt.

      For the year ended December 31, 1999, cash provided by operating
activities, less cash used to acquire capital equipment, was $1.8 million and
for the years ended December 31, 1998 and 1997, cash used for operating
activities and additions to capital equipment was $7.8 million and $9.4 million,
respectively. Of those amounts, $88,000, $25,000 and $709,000 were for additions
to laboratory and other property and equipment in 1999, 1998 and 1997,
respectively. In 1997, $645,000 of the additional expenditures related to the
Company's portion of improvements at B&L's facilities in Tampa, Florida. In
1999, the Company sold the equipment and improvements at the Tampa facility to
B&L for $410,000, which resulted in a loss on the sale of $107,000. In 1998, the
Company had recognized an impairment in the value of this equipment of $87,000.
This also resulted in a decrease in 1998, in both laboratory and other equipment
and accumulated depreciation of $764,000.

      The Company's future capital expenditures and requirements will depend on
numerous factors, including the progress of its research and development
programs and preclinical and clinical testing, the time and costs involved in
obtaining regulatory approvals, the cost of filing, prosecuting, defending and
enforcing patent claims and other intellectual property rights, competing
technological and market developments, changes in the Company's existing
collaborative and licensing relationships, the ability of the Company to
establish additional collaborative arrangements, acquisition of new businesses,
products and technologies, the completion of commercialization activities and
arrangements, the timing of additional product development and the purchase of
additional property and equipment. Starting in 1997, the Company wrote-off its
fully depreciated assets. This resulted in a decrease in both property and
equipment and accumulated depreciation of $0.3 million, $1.3 million and $3.4
million in 1999, 1998 and 1997, respectively, with no change in net property and
equipment.

      The Company anticipates no material capital expenditures to be incurred
for environmental



                                       35
<PAGE>   34

compliance in fiscal year 2000. Based on the Company's good environmental
compliance record to date, and its current compliance with applicable
environmental laws and regulations, environmental compliance is not expected to
have a material adverse effect on the Company's operations.

      The Company believes that its cash and cash equivalents, in combination
with the cash the Company has received and will receive during 2000 as part of
the ISV-900 and ISV-205 licensing transactions with P&U, will be sufficient to
meet its operating expenses and cash requirements through 2000. InSite Vision
may require substantial additional funds prior to reaching sustained
profitability, and the Company may seek private or public equity investments,
future collaborative agreements, and possibly research funding to meet such
needs. Even if the Company does not have an immediate need for additional cash,
it may seek access to the private or public equity markets if and when it
believes conditions are favorable. There is no assurance that such additional
funds will be available for the Company to finance its operations on acceptable
terms, or at all.

YEAR 2000

      The Year 2000 ("Y2K") issue was the result of computer programs using a
two-digit format, as opposed to four digits, to indicate the year. It was
anticipated that such computer systems would be unable to interpret dates beyond
the year 1999, which could cause a system failure or other computer errors,
leading to disruptions in operations.

      The Company implemented a program to assess its exposure from Y2K related
failures in its internal systems. Prior to December 31, 1999, the Company had
determined that the majority of the Company's significant operating and
accounting systems were Y2K compliant.

      The Company did not encounter any system failures or other computer errors
related to a Y2K issue and did not suffer any interruption in service from its
suppliers or vendors. The Company has incurred less than $25,000 in expense to
upgrade or replace non-compliant computer programs or hardware. However, there
can be no assurance that the Company's eventual Y2K related costs will not
exceed this amount. While the Company does not have a comprehensive program for
monitoring whether its suppliers' and vendors' systems were or are Y2K
compliant, it does not believe that non-compliance by and single source provider
would have a material impact on its operations. The Company does not expect its
financial condition or results of operations to be materially adversely affected
by Y2K issues.

ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

      The following discusses the Company's exposure to market risk related to
changes in interest rates.

      The Company invests its excess cash in investment grade, interest-bearing
securities. At December 31, 1999, the Company had $6.7 million invested in money
market mutual funds. While a hypothetical decrease in market interest rates by
10 percent from the December 31, 1999 levels would cause a decrease in interest
income, it would not result in a loss of the principal. Additionally, the
decrease in interest income would not be material.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

      The following Consolidated Financial Statements and Report of Independent
Auditors are included on the pages that follow:



                                       36
<PAGE>   35

<TABLE>
                                                                      Page
                                                                      -----
<S>                                                                   <C>
Report of Independent Auditors                                           29

Consolidated Statements of Operations                                    30
Years Ended December 31, 1999, 1998 and 1997

Consolidated Balance Sheets - December 31, 1999 and 1998                 31

Consolidated Statements of Stockholders' Equity (Deficit)                32
Years ended December 31, 1999, 1998 and 1997

Consolidated Statements of Cash Flows                                    33
Years Ended December 31, 1999, 1998 and 1997

Notes to Consolidated Financial Statements                            34-42
</TABLE>



                                       37
<PAGE>   36

REPORT OF INDEPENDENT AUDITORS


The Board of Directors and Stockholders
InSite Vision Incorporated

We have audited the accompanying consolidated balance sheets of InSite Vision
Incorporated as of December 31, 1999 and 1998, and the related consolidated
statements of operations, stockholders' equity (deficit) and cash flows for each
of the three years in the period ended December 31, 1999. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted
in the United States. 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 InSite
Vision Incorporated at December 31, 1999 and 1998, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States.


                                          /s/  Ernst & Young LLP

Walnut Creek, California
February 9, 2000



                                       38
<PAGE>   37

                           INSITE VISION INCORPORATED

                      CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
                                                                                  Year Ended December 31,
                                                                           -------------------------------------
(in thousands, except per share amounts)                                     1999          1998           1997
                                                                           --------      --------       --------
<S>                                                                        <C>           <C>            <C>
Revenues:
     License fee                                                           $  4,750      $     --       $     --
     Royalties                                                                   10            16             50
                                                                           --------      --------       --------
         Total                                                                4,760            16             50
Operating expenses:
     Research and development, net                                            1,397         6,227          7,224
     General and administrative                                               2,293         2,656          3,034
                                                                           --------      --------       --------
         Total                                                                3,690         8,883         10,258
                                                                           --------      --------       --------
Income (loss) from operations                                                 1,070        (8,867)       (10,208)
Interest and other income (expense), net                                         85           299            390
                                                                           --------      --------       --------
Net income (loss) before taxes                                                1,155        (8,568)        (9,818)
Income tax provision                                                              5            --             --
                                                                           --------      --------       --------
Net income (loss)                                                             1,150        (8,568)        (9,818)
Non-cash preferred dividend                                                      22           514          1,326
                                                                           --------      --------       --------
Net income (loss) applicable to common stockholders                        $  1,128      $ (9,082)      $(11,144)
                                                                           ========      ========       ========
Basic net income (loss) per share applicable to common stockholders        $   0.06      $  (0.60)      $  (0.85)
                                                                           ========      ========       ========
Diluted net income (loss) per share applicable to common stockholders      $   0.06      $  (0.60)      $  (0.85)
                                                                           ========      ========       ========
Shares used to calculate basic net income (loss) per share                   19,285        15,079         13,053
                                                                           ========      ========       ========
Shares used to calculate diluted net income (loss) per share                 19,856        15,079         13,053
                                                                           ========      ========       ========
</TABLE>


See accompanying notes to consolidated financial statements.


<PAGE>   38

                           INSITE VISION INCORPORATED

                           CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
                                                                                          December 31,
(in thousands, except share and per share amounts)                                    1999           1998
--------------------------------------------------                                  --------       --------
<S>                                                                                 <C>            <C>
ASSETS
Current assets:
    Cash and cash equivalents                                                       $  6,746       $  1,037
    Prepaid expenses and other current assets                                            598            190
                                                                                    --------       --------
Total current assets                                                                   7,344          1,227

Property and equipment, at cost:
     Laboratory and other equipment                                                      204          1,062
     Leasehold improvements                                                               10             49
     Furniture and fixtures                                                               --             28
                                                                                    --------       --------
                                                                                         214          1,139
Accumulated depreciation                                                                  95            280
                                                                                    --------       --------
                                                                                         119            859
                                                                                    --------       --------
Total assets                                                                        $  7,463       $  2,086
                                                                                    ========       ========

LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
     Accounts payable                                                               $    119       $     86
     Accrued liabilities                                                                 534            341
     Accrued compensation and related expense                                            524            256
                                                                                    --------       --------
Total current liabilities                                                              1,177            683

Commitments (Note 3)

Redeemable preferred stock, $0.01 par value, 5,000,000 shares authorized; no
   shares issued and outstanding at December 31, 1999; 1,170 shares issued and
   outstanding at December 31, 1998; redemption value $1,986,000 at
   December 31, 1998                                                                      30          1,511

Common stockholders' equity (deficit):
     Common stock, $0.01 par value, 30,000,000 shares authorized;
        20,298,923 issued and outstanding at December 31, 1999;
        16,852,015 issued and outstanding at December 31, 1998;                          203            169
     Additional paid-in capital                                                       90,807         85,605
     Accumulated deficit                                                             (84,754)       (85,882)
                                                                                    --------       --------
Common stockholders' equity (deficit)                                                  6,256           (108)
                                                                                    --------       --------
Total liabilities, redeemable preferred stock and stockholders'
   equity (deficit)                                                                 $  7,463       $  2,086
                                                                                    ========       ========
</TABLE>



                                       44
<PAGE>   39

See accompanying notes to consolidated financial statements.



                                       45
<PAGE>   40

                           INSITE VISION INCORPORATED

            CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (DEFICIT)

<TABLE>
<CAPTION>
                                                                                                       TOTAL
                                                                   ADDITIONAL                       STOCKHOLDERS'
                                                     COMMON         PAID IN        ACCUMULATED         EQUITY
(dollars in thousands)                               STOCK          CAPITAL          DEFICIT         (DEFICIT)
----------------------                              --------       ----------      -----------      -------------
<S>                                                 <C>             <C>             <C>              <C>
BALANCES, JANUARY 1, 1997                           $    129        $ 77,146        $(65,656)        $ 11,619

Issuance of 205,128 shares of common stock
   to Bausch & Lomb in private placement                   2             998              --            1,000
Issuance of 43,968 shares of common stock
   from exercise of options and employee
   stock purchase plan                                     1             128              --              129
Issuance of 94,130 shares of common stock
   from conversion of preferred shares                     1             308              --              309
Non-employee stock option expense                         --             118              --              118
Net loss and comprehensive loss                           --              --          (9,818)          (9,818)
Non-cash preferred dividend                               --              --          (1,326)          (1,326)
                                                    --------        --------        --------         --------
Net loss applicable to common stockholders                --              --         (11,144)         (11,144)
                                                    --------        --------        --------         --------
BALANCES, DECEMBER 31, 1997                              133          78,698         (76,800)           2,031

Issuance of 50,000 shares of common stock
   from exercise of warrants                               1             162              --              163
Issuance of 27,195 shares of common stock
   under employee stock purchase plan                     --              50              --               50
Issuance of 3,495,667 shares of common
   stock from conversion of preferred shares              35           6,540              --            6,575
Non-employee stock option expense                         --             155              --              155
Net loss and comprehensive loss                           --              --          (8,568)          (8,568)
Non-cash preferred dividend                               --              --            (514)            (514)
                                                    --------        --------        --------         --------
Net loss applicable to common stockholders                --              --          (9,082)          (9,082)
                                                    --------        --------        --------         --------
BALANCES, DECEMBER 31, 1998                              169          85,605         (85,882)            (108)

Issuance of 1,942,419 shares of common stock
   to Pharmacia & Upjohn in private placements            19           3,480              --            3,499
Issuance of 33,073 shares of common stock
   from exercise of options and employee
   stock purchase plan                                    --              40              --               40
</TABLE>



                                       46
<PAGE>   41

<TABLE>
<CAPTION>
                                                                                                       TOTAL
                                                                   ADDITIONAL                       STOCKHOLDERS'
                                                     COMMON         PAID IN        ACCUMULATED         EQUITY
(dollars in thousands)                               STOCK          CAPITAL          DEFICIT         (DEFICIT)
----------------------                              --------       ----------      -----------      -------------
<S>                                                 <C>             <C>             <C>              <C>
Issuance of 1,471,416 shares of common
   stock from conversion of preferred shares              15           1,488              --            1,503
Non-employee stock option expense                         --             194              --              194
Net income and comprehensive income                       --              --           1,150            1,150
Non-cash preferred dividend                               --              --             (22)             (22)
                                                    --------        --------        --------         --------
Net income applicable to common stockholders              --              --           1,128            1,128
                                                    --------        --------        --------         --------
BALANCES, DECEMBER 31, 1999                         $    203        $ 90,807        $(84,754)        $  6,256
                                                    ========        ========        ========         ========
</TABLE>

See accompanying notes to consolidated financial statements.



                                       47
<PAGE>   42

                           INSITE VISION INCORPORATED

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
                                                                   Year Ended December 31,
(in thousands)                                                1999           1998           1997
                                                            --------       --------       --------
<S>                                                         <C>            <C>            <C>
OPERATING ACTIVITIES:
Net income (loss)                                           $  1,150       $ (8,568)      $ (9,818)
Adjustments to reconcile net income (loss) to net
   cash provided (used) by operating activities:
      Depreciation and amortization                              505            904            851
      Loss on sale of property and equipment                     107             --             --
      Changes in:
          Prepaid expenses and other current assets             (408)           113           (108)
          Accounts payable and accrued liabilities               494           (260)           373
                                                            --------       --------       --------
Net cash provided (used) by operating activities               1,848         (7,811)        (8,702)

INVESTING ACTIVITIES:
Sale of property and equipment                                   410             --             --
Purchases of property and equipment                              (88)           (25)          (709)
                                                            --------       --------       --------
Net cash provided (used) by investing activities                 322            (25)          (709)

FINANCING ACTIVITIES:
Principal payments of notes payable and capital lease
   obligations                                                    --             --            (92)
Issuance of redeemable preferred stock, net                       --             --          6,516
Issuance of common stock, net                                  3,539            213          1,129
                                                            --------       --------       --------
Net cash provided by financing activities                      3,539            213          7,553

Net increase (decrease) in cash and cash equivalents           5,709         (7,623)        (1,858)
Cash and cash equivalents, beginning of period                 1,037          8,660         10,518
                                                            --------       --------       --------
Cash and cash equivalents, end of period                    $  6,746       $  1,037       $  8,660
                                                            ========       ========       ========
Supplemental disclosures:
     Non-cash preferred dividends                           $     22       $    514       $  1,326
                                                            ========       ========       ========
     Non-cash conversion of redeemable preferred stock
        to common stock                                     $  1,503       $  6,575       $    309
                                                            ========       ========       ========
     Interest paid in cash                                  $     --       $     --       $      9
                                                            ========       ========       ========
</TABLE>



                                       48
<PAGE>   43

See accompanying notes to consolidated financial
statements.



                                       49
<PAGE>   44

                           INSITE VISION INCORPORATED

                   Notes to Consolidated Financial Statements
                                December 31, 1999


1.    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

      Basis of Presentation. The accompanying consolidated financial statements
include the accounts of InSite Vision and its wholly-owned United Kingdom
subsidiary, InSite Vision Limited. InSite Vision Incorporated (the "Company" or
"InSite Vision") operated in one segment and is focused on ophthalmic genetics
and developing ophthalmic drugs and ophthalmic drug delivery systems. InSite
Vision Limited was formed for the purpose of holding and licensing intellectual
property rights. All intercompany accounts and transactions have been
eliminated.

      Until 1999, the Company had incurred losses since its inception. The
Company expects to incur substantial additional development costs prior to
reaching sustained profitability, including costs related to clinical trials and
manufacturing expenses. As a result, the Company will require substantial
additional funds, and until sufficient royalties are generated from sales of the
Company's licensed products, the Company may seek collaborative agreements,
research funding, and private or public equity or debt investments to meet such
needs. If such funds are not available, management may need to reassess its
plans. Even if the Company does not have an immediate need for additional cash,
it may seek access to the private or public equity markets if and when
conditions are favorable. There is no assurance that such additional funds will
be available for the Company to finance its operations on acceptable terms, if
at all.

      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 those
estimates.

      Cash and Cash Equivalents. The Company invests its excess cash in
investment grade, interest-bearing securities. As of December 31, 1999 and 1998,
cash equivalents consisted of money market and mutual funds. All cash and cash
equivalents are stated at fair market value. The Company considers highly liquid
investments with original maturities of three months or less as cash
equivalents.

      Property and Equipment. Property and equipment is stated at cost, less
accumulated depreciation. Depreciation of property and equipment is provided
over the estimated useful lives of the respective assets, which range from three
to five years, using the straight-line method. Leasehold improvements are
amortized over the lives of the related leases or their estimated useful lives,
whichever is shorter, using the straight-line method. It is the Company's policy
to write-off its fully depreciated assets. This resulted in a decrease in both
property and equipment and accumulated depreciation in 1999 and 1998 of $0.3
million and $1.3 million, respectively, with no change in net property and
equipment.

      In accordance with FASB Statement No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," the Company
records impairment losses on long-lived assets used in operations when events
and circumstances indicate that the assets might be impaired and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amounts of those assets. During 1998, the Company evaluated certain
assets and determined that assets with a carrying value of $946,000 were
impaired and reduced their carrying value by $87,000. This loss is included in
the 1998 research and development expense in the Consolidated Statements of
Operations. In July 1999, the Company sold this equipment and recorded a loss of



                                       50
<PAGE>   45

$107,000 which is included in the 1999 research and development expense in the
Consolidated Statements of Operations.

      Earnings (Loss) per Share. Basic and diluted net income (loss) per share
information for all periods is presented under the requirement of SFAS No. 128,
"Earnings per Share." Basic earnings per share has been computed using the
weighted-average number of common shares outstanding during the period, and
excludes any dilutive effects of stock options and convertible securities.
Potentially dilutive securities have been excluded from the computation of
diluted net loss per share in 1998 and 1997, as their inclusion would be
antidilutive.

The following table sets forth the computation of basic and diluted earnings
(loss) per share:

<TABLE>
<CAPTION>

=====================================================================================================
(in thousands, except per share amounts)                         1999          1998           1997
----------------------------------------                       --------      --------       --------
<S>                                                            <C>           <C>            <C>
Numerator:
      Net income (loss)                                        $  1,150      $ (8,568)      $ (9,818)
      Non-cash preferred dividend                                    22           514          1,326
                                                               --------      --------       --------
      Net earnings (loss) applicable to common
         stockholders                                             1,128        (9,082)       (11,144)
                                                               ========      ========       ========

Denominator:
      Denominator for basic earnings (loss) per share -
         weighted-average shares outstanding                     19,285        15,079         13,053

Effect of dilutive securities:
      Employee & director stock options and preferred
         stock warrant (determined using the treasure
         stock method)                                              260            --             --

      Convertible preferred stock (using the if-converted
         method)                                                    311            --             --
                                                               --------      --------       --------
      Denominator for diluted earnings per share -
         weighted-average shares outstanding                     19,856        15,079         13,053
                                                               ========      ========       ========
Basic earnings (loss) per share                                $   0.06      $  (0.60)      $  (0.85)
                                                               ========      ========       ========
Diluted earnings (loss) per share                              $   0.06      $  (0.60)      $  (0.85)
                                                               ========      ========       ========
=====================================================================================================
</TABLE>

      Due to the loss from operations, earnings (loss) per share for 1998 and
1997 is based on the weighted average number of common shares only, as the
effect of including equivalent shares from stock options would be anti-dilutive.
If the Company had recorded net income, the calculation of earnings per share
would have included approximately an additional 2,186,000 and 1,193,000 common
equivalent shares related to the outstanding stock options and warrants
(determined using the treasury stock method) and convertible preferred stock
(using the if-converted method) for 1998 and 1997, respectively.

      Accounting for Employee Stock Options. The Company accounts for stock
options granted to employees and directors in accordance with Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to
Employees" and, accordingly, does not recognize compensation expense for options
granted to employees and directors at an exercise price equal to the fair value
of the underlying common stock.

      Accounting for Stock Options Exchanged for Services. The Company issues
stock options to consultants of the Company in exchange for services. The
Company has valued these options using the Black-Scholes option valuation model
at each reporting period and has recorded charges to operations over the vesting
periods of the individual stock options. Such charges amounted to approximately
$194,000, $155,000 and $118,000 in 1999, 1998 and 1997, respectively.

      Accounting for Materials Purchased for Research and Development. The
Company expenses materials for research and development activities when the
items are purchased.



                                       51
<PAGE>   46

      Accounting for Cost Sharing Agreements. The Company directly reduces
expenses for amounts reimbursed pursuant to cost sharing agreements. During 1999
and 1998, research and development expenses were reduced by $4,248,000 and
$361,000, respectively, for costs reimbursed by Pharmacia & Upjohn (P&U) and
Bausch and Lomb Pharmaceuticals, Inc. (B&L) under the terms of the
collaborations described in Note 2.

      Key Suppliers. The Company is dependent on single or limited source
suppliers for certain materials used in its research and development activities.
The Company has generally been able to obtain adequate supplies of these
components. However, an extended interruption in the supply of these components
currently obtained from single or limited source suppliers could adversely
affect the Company's research and development efforts.

      The Company obtains batimastat, the active ingredient for its ISV-615
product candidate, from British Biotech. In December 1996, British Biotech
advised the Company that it had discontinued its own development and
manufacturing of batimastat. The Company is currently negotiating with British
Biotech to license the compound and obtain access to on-going drug supply.
Inability to obtain a license would adversely affect the Company's ability to
continue the ISV-615 development program.

      Revenue Recognition. Non-refundable technology license fees are recognized
as revenues when received and when all contractual obligations of the Company
relating to the fees have been fulfilled, evidence of an arrangement exists, the
fee is fixed and determinable and collectibility is reasonably assured.

2.    LICENSES

      In December 1999, the Company entered into an exclusive worldwide license
agreement with INSERM for the diagnostic, prognostic and therapeutic uses of a
gene for chronic open angle glaucoma. The Company has paid a licensing fee and
will make royalty payments on future product sales, if any.

      On November 11, 1999, the Company entered into a license agreement, stock
purchase agreement and credit agreement pursuant to which InSite granted P&U an
exclusive worldwide royalty-bearing license to its ISV-900 technology for
diagnostic, prognostic and therapeutic applications in the area of glaucoma. The
license calls for (i) P&U to pay the Company a $5 million licensing fee, (ii)
P&U to make up to $5 million in research and development payments to the Company
over three years starting in 2000, (iii) P&U to pay the Company royalties on
product sales should any products be successfully commercialized from this
technology, and (iv) payments of up to $3 million by P&U to the Company if
certain milestones are achieved.

      P&U is receiving rights to sub-license all development work on ISV-900
completed as of November 11, 1999, which includes rights to certain genes, a
diagnostic test, a database and access to other data relating to these genes.
The Company expects that these rights will translate into 3 products - one for
indications of more severe forms of glaucoma, one for detecting the possibility
of developing glaucoma and one for diagnosing glaucoma in infants. These
products are ready for commercialization by P&U.



                                       52
<PAGE>   47

      The additional research and development payments of $5 million are to be
used for further development of the ISV-900 technology. This R&D work will
include searching for additional gene mutations as well as gathering information
for the development of possible therapeutic products based on the genetic data.
The result of this work could be further enhancements to the products currently
ready for commercialization as discussed above, which would be released
separately, or additional products altogether. This work is not essential to the
products currently ready for commercialization by P&U.

      The Company recognized $4.8 million as license revenue during the fourth
quarter of 1999, due to the persuasive evidence of the existence of an
arrangement, delivery had occurred, the fee was fixed and determinable and
collectibility was reasonably assured. The technology represented a separate
element of the arrangement that was recognized when the technology was delivered
to P&U for commercialization.

      The stock purchase agreement provided for a $2.0 million equity investment
by P&U in the Company. A total of 723,195 shares were purchased in January 2000,
45 days after the execution of the agreement. The stock purchase agreement also
provides for a standstill period of thirty (30) months during which P&U and its
subsidiaries will not purchase additional shares of the Company, other than
those provided for under any existing agreements between the companies, without
the prior written consent of the Company. This standstill period will terminate
earlier if certain actions are taken by other parties to acquire more than a
9.99% interest in the stock of the Company or if any other party announces their
intention to assume control of the Company, whether by tender offer, merger,
proxy contest or otherwise.

      The credit agreement provides for a $4 million revolving line of credit to
be made available to the Company on November 11, 2001 for a period of three (3)
years. Any amounts drawn on the line will bear interest at a rate of three
percent (3%) over the prime rate announced by Chase Manhattan Bank in New York
City. At the Company's discretion, repayments on the line may be made in cash at
any point, or the total amount due at the end of the loan period may be paid by
issuance of the Company's stock at a twenty-five percent (25%) premium to the
average market price of the Company's stock for a period prior to the end of the
loan. The loan provides for certain affirmative and negative covenants as well
as other terms and conditions.

      In August 1999, the Company entered into a license agreement with SSP Co.,
Inc., a Japanese company, to be the exclusive manufacturer and distributor of
AquaSite in Japan. AquaSite is an over-the-counter product which uses the
Company's DuraSite technology and demulcents for the symptomatic treatment of
dry eye. Under this agreement, the Company received a net amount of $3,000 for
materials provided to SSP during 1999.

      In March 1999, the Company entered into a royalty-bearing license
agreement with Global Damon, a Korean company, to be the exclusive distributor
of AquaSite in the Republic of Korea. Concurrently, the Company entered into a
manufacturing agreement with Kukje, a Korean company, to produce the AquaSite to
be sold by Global Damon.

      On January 28, 1999, the Company entered into a license agreement and
stock purchase agreement pursuant to which InSite granted P&U an exclusive
worldwide license to ISV-205 for the treatment of glaucoma. The license calls
for (i) P&U to assume responsibility for the development of the product upon
completion by the Company of, among other activities, Phase II studies currently
being conducted by the Company, (ii) P&U to reimburse InSite for certain
research and development expenses and make payments to InSite for on-going
technical support, and (iii) the payment by P&U to InSite of royalties on
product sales should ISV-205 be successfully commercialized. InSite will
continue to bear responsibility for the prosecution and maintenance of the
patents subject to the license, among other things. The transaction also called
for equity investments from P&U of $3,500,000 for which they received 1,942,419
shares of common stock in February and September 1999, with the potential for
future equity investments based on achievement of certain milestones.

      The Company has a license agreement with CIBA Vision, an ophthalmic
company which is an affiliate of



                                       53
<PAGE>   48

CIBA-GEIGY Limited. Under the terms of the agreement, CIBA Vision has
co-exclusive rights to manufacture and market AquaSite and ToPreSite in the U.S.
and AquaSite in Canada. The license agreement requires CIBA Vision to pay
royalties on net sales of the licensed products. The Company recognized $10,000,
$16,000 and $50,000 of royalty revenue for sales of AquaSite in 1999, 1998 and
1997, respectively.

3.    LEASE COMMITMENTS

      The Company leases its facilities under noncancelable operating lease
agreements that expire in 2001. Rent expense was $431,000, $514,000 and $497,000
for 1999, 1998 and 1997, respectively. The 1999 rent expense reflects $63,000
received by the Company related to the January 1999 sublease of a portion of the
Company's facility. The sublease continues through the term of the Company's
operating lease and provides for annual payments of $64,000 in 2000 and 2001. As
of December 31, 1999, the aggregate future minimum payments under noncancelable
leases, not considering amounts to be received under subleasing agreements, are:

<TABLE>
                         <S>                                  <C>
                         2000                                 $  500,000
                         2001                                    514,000
                                                              ----------
                         Total                                $1,014,000
                                                              ==========
</TABLE>

4.    INCOME TAXES

      Significant components of the Company's deferred tax assets for federal
and state income taxes as of December 31, 1999 and 1998 are as follows (in
thousands):

<TABLE>
<CAPTION>
                                                            1999             1998
                                                          --------         --------
<S>                                                       <C>              <C>
Deferred tax assets:
     Net operating loss carryforwards                     $ 24,508         $ 26,226
     Research and development credit carryforwards           3,392            2,916
     Capitalized research and development                    7,404            5,824
     Depreciation                                              579              572
     Other                                                     217               90
                                                          --------         --------
     Total                                                  36,100           35,629
Valuation allowance                                        (36,100)         (35,629)
                                                          --------         --------
Net deferred tax assets                                   $     --         $     --
                                                          ========         ========
</TABLE>

      The valuation allowance decreased by $54,000 and increased $3.3 million
during the years ended December 31, 1999 and 1998, respectively.

      At December 31, 1999, the Company has net operating loss carryforwards for
federal income tax purposes of approximately $66.0 million, which expire in the
years 2001 through 2018 and net operating loss carryforwards for state income
tax purposes of approximately $29.0 million which expire in the years 1999
through 2003. The Company also has federal and state research and development
credit carryforwards of approximately $2.0 million



                                       54
<PAGE>   49

and $1.0 million, respectively, which expire in the years 2001 through 2013.

      Utilization of the Company's federal and state net operating loss
carryforwards and research and development tax credits are subject to an annual
limitation against taxable income in future periods due to the ownership change
limitations provided by the Internal Revenue Code of 1986. As a result of this
annual limitation, a significant portion of these carryforwards will expire
before ultimately becoming available for offset against taxable income.
Additional losses and credits will be subject to limitation if the Company
incurs another change in ownership in the future.

5.    REDEEMABLE PREFERRED STOCK

      In September 1997, the Company received net proceeds of approximately $6.5
million from a private placement of 7,000 shares of Series A Convertible
Preferred Stock with a $0.01 par value ("Series A Preferred"). The number of
shares of Common Stock issuable upon conversion of the Series A Preferred is
equal to the face value of each share of Series A Preferred divided by the lower
of the fixed conversion price of $2.127 or a variable conversion price. The
variable conversion price is determined by applying a discount, which ranged
from 10% for shares converted prior to June 10, 1998, to 17.5% for shares
converted after December 7, 1998, to an average of closing bid prices of the
Company's common stock at the time of conversion. Such conversion prices are
subject to adjustment in accordance with the terms of the Certificate of
Designations, Preferences and Rights of the Series A Preferred. The value of the
Series A Preferred shares to be converted will also include a 6% per annum
premium which accrues from the date of issuance until the date of conversion.
Three years after issuance, any remaining unconverted preferred shares will
automatically be converted into common stock. As of December 31, 1999, all of
the outstanding shares of Series A Preferred have been converted into 5,061,213
shares of common stock. The Company also issued a warrant to purchase 70 shares
of Series A Preferred that is subject to the same conversion terms and premium
as described above, which is still outstanding as of December 31, 1999. Holders
of the Series A Preferred have no voting rights, except as required by
applicable Delaware law. The Company has authorized 5,000,000 shares of
Preferred Stock, 7,070 of which have been designated Series A Preferred.
Pursuant to the agreement, 6,000,000 shares of common stock have been reserved
for issuance to the holders of the Series A Preferred of which 938,787 shares
remain reserved at December 31, 1999.

      For the years ended December 31, 1999, 1998 and 1997, in accordance with
SEC Rules and Regulations, the Company reported non-cash preferred dividends of
$22,000, $514,000 and $1,326,000, respectively. The dividends are related to the
discount at which Series A Preferred could be converted to common stock and the
6% per annum premium, payable in additional common stock, earned on the
outstanding Series A Preferred Stock. The dividends are used to determine the
net loss per share applicable to common stockholders.

      The following table summarizes information concerning the issuance and
conversion of the Series A Preferred Stock (in thousands):

<TABLE>
                                                               Amount
                                                               ------
<S>                                                            <C>
Issuance of 7,000 shares of Series A Preferred Stock and
  a warrant for 70 shares of Series A Preferred Stock          $ 6,516
Conversion of 300 shares of Series A Preferred Stock
  into common stock                                               (309)
Non-cash preferred dividend                                      1,326
                                                               -------
Balance at December 31, 1997                                     7,533
Reduction in accrued stock issuance costs                           39
Conversion of 5,530 shares of Series A Preferred Stock
  into common stock                                             (6,575)
Non-cash preferred dividend                                        514
                                                               -------
Balance at December 31, 1998                                     1,511
</TABLE>



                                       55
<PAGE>   50

<TABLE>
                                                               Amount
                                                               ------
<S>                                                            <C>
Conversion of 1,170 shares of Series A Preferred Stock
  into common stock                                             (1,503)
Non-cash preferred dividend                                         22
                                                               -------
Balance at December 31, 1999                                   $    30
                                                               =======
</TABLE>

6.    COMMON STOCKHOLDERS' EQUITY

      In January 2000, the Company received $2,000,000 from P&U for the purchase
of 723,195 shares of Common Stock in connection with the November 1999 license
for the Company's ISV-900 glaucoma genetics program.

      In September 1999, the Company received $1,500,000 from P&U for the
purchase of 846,913 shares of Common Stock for a milestone reached in connection
with the January 1999 license of the Company's ISV-205 glaucoma product.

      In February 1999, the Company received $2,000,000 from P&U for the
purchase of 1,095,506 shares of Common Stock in connection with the January 1999
license for the Company's ISV-205 glaucoma product. The agreement also provides
for additional equity purchases by P&U at an average of prevailing market prices
if the Company achieves certain milestones, the first of which was reached in
September of 1999.

      In April 1998, the Company received $163,000 from the exercise of warrants
issued as part of a January 1996 private placement. Each warrant entitles its
holder to purchase shares of the Company's Common Stock for $3.25 per share
until January 2001. As of December 31, 1999, warrants to purchase 317,308 shares
of Common Stock were outstanding.

      In August 1997, the Company received $1.0 million from B&L for the
purchase of 205,128 shares of Common Stock in connection with a July 1996
agreement between the Company and B&L. B&L made an initial $1.0 million purchase
for 210,527 shares of Common Stock in August 1996.

      In January 1996, the Company received net proceeds of approximately $4.7
million from a private placement of 1,469,232 shares of its Common Stock and
367,308 warrants. Each warrant entitles its holder to purchase one share of the
Company's Common Stock for $3.25 per share until January 2001.

Stock Option Plan.

      At December 31, 1999, a total of 2,541,300 shares of Common Stock were
reserved under the 1994 Stock Plan for issuance upon the exercise of options or
by direct sale to employees, including officers, directors and consultants.
Options granted under the plan expire 10 years from the date of grant and become
exercisable at such times and under such conditions as determined by the
Company's Board of Directors (generally ratably over four years). Activity under
the 1994 Stock Plan is as follows:

<TABLE>
<CAPTION>
                                                 Shares
                                       ----------------------------
                                        Options                                             Weighted Average
                                       Available          Options                           Exercise Price of
                                       for Grant        Outstanding       Option Price      Shares Under Plan
                                       ---------        -----------       ------------      -----------------
<S>                                    <C>              <C>               <C>               <C>
Balances at January 1, 1997             210,026          1,272,866        $0.60 - 9.25          $  2.79
</TABLE>



                                       56
<PAGE>   51

<TABLE>
<CAPTION>
                                                 Shares
                                       ----------------------------
                                        Options                                             Weighted Average
                                       Available          Options                           Exercise Price of
                                       for Grant        Outstanding       Option Price      Shares Under Plan
                                       ---------        -----------       ------------      -----------------
<S>                                     <C>              <C>              <C>     <C>           <C>
Additional shares reserved              500,000                 --                  --               --
Granted                                (628,500)           628,500         2.81 - 6.25             4.07
Exercised                                    --            (30,598)        0.60 - 4.38             2.86
Forfeited                               204,927           (204,927)        0.60 - 6.75             4.07
                                       --------          ---------
Balances at December 31, 1997           286,453          1,665,841         0.60 - 9.25             3.12
Additional shares reserved              265,521                 --                  --               --
Granted                                 (70,000)            70,000         1.31 - 3.53             2.26
Forfeited                               102,709           (102,709)        2.75 - 6.38             3.93
                                       --------          ---------
Balances at December 31, 1998           584,683          1,633,132         0.60 - 9.25             3.03
Additional shares reserved              336,981                 --                  --               --
Granted                                (715,932)           715,932         1.06 - 2.44             1.28
Exercised                                    --            (13,496)        2.00 - 2.63             1.25
Forfeited                               158,749           (158,749)        0.60 - 6.38             4.69
                                       --------          ---------
Balances at December 31, 1999           364,481          2,176,819        $0.60 - 9.25          $  2.34
                                       ========          =========
</TABLE>

The following table summarizes information concerning currently outstanding and
exercisable options:

<TABLE>
<CAPTION>
                                          Options Outstanding                       Options Exercisable
                               -------------------------------------------   ------------------------------
                                                    Weighted Average
                                              ----------------------------                      Weighted
                                 Number       Contractual                      Number           Average
 Range of Exercise Prices      Outstanding        Life      Exercise Price   Exercisable     Exercise Price
 ------------------------      -----------    -----------   --------------   -----------     --------------
<S>                            <C>              <C>         <C>               <C>            <C>
      $0.60 - $1.13               905,435         6.01        $   0.90          390,761        $   0.61
      $1.25 - $2.75               595,500         6.86            2.38          193,791            2.53
      $2.81 - $5.00               549,170         7.57            3.81          349,999            3.83
      $5.63 - $9.25               126,714         6.97            6.13          103,193            6.15
                                ---------         ----        --------        ---------        --------
                                2,176,819         6.69        $   2.34        1,037,744        $   2.60
                                =========         ====        ========        =========        ========
</TABLE>

      The weighted average grant date fair values of options granted during
1999, 1998 and 1997 was $1.28, $2.26 and $3.58, respectively.

      Pursuant to the terms of the 1994 Stock Plan, generally each non-employee
director who is newly elected or appointed after October 25, 1993, is granted an
option to purchase 10,000 shares of common stock at a price per share equal to
the fair market value of the common stock on the grant date. Each continuing
non-employee director also receives an annual grant of an option to purchase
10,000 shares. Such options vest one year after the grant date.

      The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25), and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation," requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.



                                       57
<PAGE>   52

      The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting requirements
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

      Pro forma information regarding net loss and loss per share is required by
Statement 123, and has been determined as if the Company had accounted for its
employee stock options under the fair value method of that Statement. The fair
value for these options was estimated at the date of grant using a Black-Scholes
option pricing model with the following weighted-average assumptions for 1999,
1998 and 1997, respectively: risk-free interest rates ranging from 4.64% to
6.87%; volatility factors for the expected market price of the Company's common
stock of 1.15, 1.08 and 0.89; and a weighted-average expected life for the
options of 4 years.

      For purposes of pro forma disclosure, the estimated fair value of the
options is amortized to expense over the vesting period of the related options.
The Company's pro forma information follows (in thousands except for loss per
share information):

<TABLE>
                                                                 1999              1998              1997
                                                              ---------         ---------         ----------
<S>                                                           <C>               <C>               <C>
Net income (loss) applicable to common stockholders
   - as presented                                             $   1,128         $  (9,082)        $  (11,144)
Net loss applicable to common stockholders - pro forma              (35)           (9,681)           (11,652)
Net income (loss) per share applicable to common
stockholders                                                       0.06             (0.60)             (0.85)
   - as presented
   basic and diluted
Net loss per share applicable to common stockholders -
   pro forma basic and diluted                                    (0.00)            (0.64)             (0.89)
</TABLE>

      The pro forma impact of options on the net income (loss) for 1999, 1998
and 1997 is not representative of the effects on net income (loss) for future
years, as future years will include the effects of additional stock option
grants.


Employee Stock Purchase Plan.

      On April 1, 1994, employees of the Company began participating in an
Employee Stock Purchase Plan which provides the opportunity to purchase Common
Stock at prices not more than 85% of market value at the time of purchase.
During the years ended December 31, 1999, 1998 and 1997, respectively, 19,577,
27,195 and 13,370 shares of Common Stock were issued pursuant to this plan. At
December 31, 1999, an additional 19,577 shares are reserved for issuance under
this plan. The effects of this plan on the pro forma disclosures above are not
material.

7.    LEGAL PROCEEDINGS

      From time to time, the Company is subject to legal proceedings and claims
in the ordinary course of business, including claims of alleged infringement of
trademarks and other intellectual property rights. The



                                       58
<PAGE>   53

Company currently is not aware of any such legal proceedings or claims that it
believes will have, individually or in the aggregate, a material adverse effect
on its business, prospects, financial condition and operating results.




                                       59
<PAGE>   54

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

      None.

                                    PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

      The information required by this item with respect to the identification
of Directors is hereby incorporated by reference from the information under the
caption "Proposal One-Election of Directors" in the Company's Proxy Statement
for its Annual Meeting of Stockholders which is estimated to be held on or about
June 12, 2000 (the "Proxy Statement").

      The information required by this item with respect to the identification
of Executive Officers is contained in Item 1 of Part I of this report under the
caption "Executive Officers."

      The information required by Item 405 of Regulation S-K regarding
compliance with Section 16(a) of the Securities Exchange Act of 1934 is hereby
incorporated by reference from the information under the caption "Compliance
with Section 16(a) of the Securities Exchange Act of 1934" in the Proxy
Statement.

ITEM 11. EXECUTIVE COMPENSATION

      The information required by this item is hereby incorporated by reference
from the information under the caption "Executive Compensation and Related
Information" in the Proxy Statement.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

      The information required by this item is hereby incorporated by reference
from the information under the caption "Principal Stockholders" in the Proxy
Statement.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

      The information required by this item is hereby incorporated by reference
from the information under the captions "Executive Compensation and Related
Information" and "Certain Relationships and Related Transactions" in the Proxy
Statement.

                                     PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K



                                       61
<PAGE>   55

(a)(1) Financial Statements

       The Financial Statements and Report of Independent Auditors are included
in a separate section of this Annual Report on Form 10-K.

   (2) Financial Statement Schedules

       All financial statement schedules have been omitted because they are not
applicable or are not required or the required information to be set forth
therein is included in the Financial Statements or notes thereto included in a
separate section of this Annual Report on Form 10-K.

   (3) Exhibits

       The following exhibits are referenced or included in this report.

<TABLE>
<CAPTION>
         Number          Exhibit Table
         ------          -------------
<S>                      <C>
           3.1(1)        Restated Certificate of Incorporation.
           3.2(7)        Amended  and Restated Bylaws.
           4.1(4)        Registration Rights Agreement, dated January 24, 1996 (the
                         "Registration Rights Agreement"), between the Registrant
                         and the investors listed on Schedule 1 thereto.
           4.2(4)        Form of Warrant to Purchase Shares of Common Stock between
                         the Registrant and each of the investors listed on
                         Schedule 1 to the Registration Rights Agreement.
           4.3(10)       Certificate of Designations, Preferences and Rights of
                         Series A Convertible Preferred Stock as filed with the
                         Delaware Secretary of State on September 11, 1997.
           4.4(10)       Certificate of Correction of the Certificate of
                         Designations, Preferences and Rights of Series A
                         Convertible Preferred Stock as filed with the Delaware
                         Secretary of State on September 26, 1997.
          10.5(2)        InSite Vision Incorporated Employee Stock Purchase Plan.
          10.6(2)        Form of Indemnity Agreement Between the Registrant and its
                         directors and officers.
          10.7(2)        Form of Employee's Proprietary Information and Inventions
                         Agreement.
          10.13(3)(H)    License Agreement dated as of October 9, 1991 by and
                         between the Company and CIBA Vision Corporation, as
                         amended October 9, 1991.
          10.14(3)(H)    Letter Agreement dated February 27, 1992 by and among the
                         Company, Columbia Laboratories, Inc. and Joseph R.
                         Robinson, as amended October 23, 1992.
          10.15(2)(H)    Collaboration Agreement dated as of November 24, 1992 by
                         and between the Company and British Bio-technology
                         Limited.
          10.16(2)(H)    Collaboration Agreement dated as of April 30, 1993 by and
                         between the Company and British Bio-technology Limited.
          10.17(8)       Facilities Lease, dated September 1, 1996, between the
                         Registrant and Alameda Real Estate Investments.
          10.18(1)(H)    Agreement dated as of February 15, 1994 by and between the
                         Company and Timm A. Carpenter.
          10.19(9)(HH)   InSite Vision Incorporated 1994 Stock Option Plan (Amended
                         and Restated as of June 8, 1998).
          10.20(1)(HH)   Form of InSite Vision Incorporated Notice of Grant of
                         Stock Option and Stock Option Agreement, with Addenda.
          10.21(9)(HH)   Form of InSite Vision Incorporated Notice of Automatic
                         Option Grant and Non-Employee Director Option Agreement.
          10.22(1)       InSite Vision Incorporated 1994 Employee Stock Purchase
                         Plan.
          10.23(1)       Form of InSite Vision Incorporated Stock Purchase Agreement.
          10.24(1)       Form of InSite Vision Incorporated Employee Stock Purchase
                         Plan Enrollment/Change Form.
</TABLE>



                                       62
<PAGE>   56

<TABLE>
<CAPTION>
         Number          Exhibit Table
         ------          -------------
<S>                      <C>
          10.25(4)       Letter Agreement dated February 3, 1995 between the
                         Company and David G. Harper.
          10.26(4)       Settlement Agreement and General Release dated March 3,
                         1995 between the Company and Clifford Orent.
          10.27(5)       Common Stock Purchase Agreement dated January 19, 1996
                         between the Registrant and the Investors listed on
                         Schedule 1 thereto.
          10.28(6)(H)    ISV-205 License Agreement dated May 28, 1996 by and
                         between the Company and CIBA Vision Ophthalmics.
          10.29(6)(H)    ToPreSite License Agreement dated May 28, 1996 by and
                         between the Company and CIBA Vision Ophthalmics.
          10.30(6)(H)    BetaSite Contract Manufacturing Agreement dated July 18,
                         1996 by and between the Company and Bausch & Lomb
                         Pharmaceuticals, Inc.
          10.31(6)(H)    PilaSite License Agreement dated July 18, 1996 by and
                         between the Company and Bausch & Lomb Pharmaceuticals,
                         Inc.
          10.32(6)(H)    Timolol Development Agreement dated July 18, 1996 by and
                         between the Company and Bausch & Lomb Pharmaceuticals,
                         Inc.
          10.33(6)(H)    Stock Purchase Agreement dated July 18, 1996 by and
                         between the Company and Bausch & Lomb Pharmaceuticals,
                         Inc.
          10.34(10)      Engagement Agreement, dated April 1, 1997, by and between
                         the Company and William Blair & Company LLC.
          10.35(10)(H)   License Agreement, dated July 1, 1997, by and between the
                         University of Connecticut Health Center and the Company.
          10.36(10)(H)   License Agreement, dated August 19, 1997, by and between
                         the University of Rochester and the Company.
          10.37(10)      Form of Securities Purchase Agreement, dated September 12,
                         1997, by and among the Company and the Selling
                         Stockholders thereunder.
          10.38(10)      Form of Registration Rights Agreement, dated September 12,
                         1997, by and among the Company and the Selling
                         Stockholders thereunder.
          10.39(10)      Form of Warrant, dated September 12, 1997, to William
                         Blair & Company LLC.
          10.40(11)(H)   License Agreement, dated January 28, 1999, by and between
                         the Company and Pharmacia & Upjohn AB.
          10.41(11)(H)   Stock Purchase Agreement, dated January 28, 1999, by and
                         between the Company and Pharmacia & Upjohn AB and
                         Pharmacia & Upjohn, SA.
          10.42(12)      Project Agreement, dated November 11, 1999, by and between
                         the Company and Pharmacia & Upjohn AB.
          10.43(12)      Stock Purchase Agreement, dated November 11, 1999, by and
                         between the Company and Pharmacia & Upjohn AB.
          10.44(12)      Credit Agreement, dated November 11, 1999, by and between
                         the Company and Pharmacia & Upjohn Company.
          23.1           Consent of Ernst & Young LLP, Independent Auditors.
          24.1           Power of Attorney (included in Part IV of this Annual
                         Report on Form 10-K under the caption "Signatures").
          27             Financial Data Schedule.
</TABLE>

(1)   Incorporated by reference to exhibit of the same number in the Company's
      Annual Report on Form 10-K for the year ended December 31, 1993.

(2)   Incorporated by reference to exhibit of the same number in the Company's
      Registration Statement on Form S-1 (Registration No. 33-68024) as filed
      with the Securities and Exchange Commission on August 27, 1993.

(3)   Incorporated by reference to exhibit of the same number in Amendment No. 1
      the Company's Registration Statement on Form S-1 (Registration No.
      33-68024) as filed with the Securities and Exchange Commission on
      September 16, 1993.



                                       63
<PAGE>   57

(4)   Incorporated by reference to exhibit of the same number in the Company's
      Quarterly Report on Form 10-Q for the quarter ended June 30, 1995.

(5)   Incorporated by reference to Exhibit 10.25 in the Company's Annual Report
      on Form 10-K for the year ended December 31, 1995.

(6)   Incorporated by reference to exhibit of the same number in the Company's
      Quarterly Report on Form 10-Q for the quarter ended June 30, 1996.

(7)   Incorporated by reference to exhibit of the same number in the Company's
      Quarterly Report on Form 10-Q for the quarter ended March 31, 1997.

(8)   Incorporated by reference to exhibit of the same number in the Company's
      Annual Report on Form 10-K for the year ended December 31, 1996.

(9)   Incorporated by reference to Exhibits 99.1, 99.3, 99.4 and 99.8,
      respectively, in the Company's Registration Statement on Form S-8
      (Registration No. 333-60057) as filed with the Securities and Exchange
      Commission on July 28, 1998.

(10)  Incorporated by reference to Exhibits 4.1, 4.2, 10.1, 10.2, 10.3, 10.4,
      10.5 and 10.6, respectively, in the Company's Registration Statement on
      Form S-3 (Registration No. 333-36673) as filed with the Securities and
      Exchange Commission on September 29, 1997.

(11)  Incorporated by reference to exhibit of the same number in the Company's
      Annual Report on Form 10-K for the year ended December 31, 1998.

(12)  Confidential treatment has been requested as to certain portions of this
      agreement. Such omitted confidential information has been designated by an
      asterisk and has been filed separately with the Securities and Exchange
      Commission pursuant to Rule 24b-2 under the Securities Exchange Act of
      1934, as amended, pursuant to an application for confidential treatment.

(H)   Confidential treatment has been granted with respect to certain portions
      of this agreement.

(HH)  Management contract or compensatory plan.

(b)   Reports on Form 8-K

      A Report on Form 8-K was filed by the Company on November 30, 1999.

(c)   Exhibits

      See list of exhibits under (a)(3) above.

(d)   Financial Statement Schedules

      See (a)(2) above.

                                   SIGNATURES



                                       64
<PAGE>   58

      Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

Dated: March 28, 2000
                                              INSITE VISION INCORPORATED


                                          By: /s/ S. Kumar Chandrasekaran
                                            ---------------------------
                                              S. Kumar Chandrasekaran, Ph.D.
                                              Chairman of the Board, President,
                                              Chief Executive Officer and
                                              Chief Financial Officer



                                       65
<PAGE>   59

                                POWER OF ATTORNEY

      KNOW ALL PERSONS BY THESE PRESENTS:

      That the undersigned officers and directors of InSite Vision Incorporated,
a Delaware corporation, do hereby constitute and appoint S. Kumar Chandrasekaran
as his true and lawful attorney-in-fact and agent, with the power and authority
to do any and all acts and things and to execute any and all instruments which
said attorney and agent determines may be necessary or advisable or required to
enable said corporation to comply with the Securities Exchange Act of 1934, as
amended, and any rules or regulations or requirements of the Securities and
Exchange Commission in connection with this Annual Report on Form 10-K. Without
limiting the generality of the foregoing power and authority, the powers granted
include the power and authority to sign the names of the undersigned officers
and directors in the capacities indicated below to this Annual Report on Form
10-K, to any and all amendments, and to any and all instruments or documents
filed as part of or in conjunction with this Annual Report on Form 10-K or
amendments or supplements thereof, and each of the undersigned hereby ratifies
and confirms all that said attorney and agent shall do or cause to be done by
virtue hereof. This Power of Attorney may be signed in several counterparts.

      IN WITNESS WHEREOF, each of the undersigned has executed this Power of
Attorney as of the date indicated.

      Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.

<TABLE>
<CAPTION>
           Name                                       Capacity                             Date
           ----                                       --------                             ----
<S>                                             <C>                                     <C>
/s/ S. Kumar Chandrasekaran                     Chairman of the Board, President,       March 28, 2000
--------------------------------------          Chief Executive Officer and
    S. Kumar Chandrasekaran, Ph.D.              Chief Financial Officer

/s/ Mitchell H. Friedlaender                    Director                                March 28, 2000
--------------------------------------
    Mitchell H. Friedlaender, M. D.

/s/ John E. Lucas                               Director                                March 28, 2000
--------------------------------------
    John E. Lucas


/s/ John L. Mattana                             Director                                March 28, 2000
--------------------------------------
    John L. Mattana


/s/ Jon S. Saxe                                 Director                                March 28, 2000
--------------------------------------
    Jon S. Saxe
</TABLE>



                                       67
<PAGE>   60

<TABLE>
<CAPTION>
           Name                                       Capacity                             Date
           ----                                       --------                             ----
<S>                                             <C>                                     <C>

/s/ Anders P. Wiklund                           Director                                March 28, 2000
--------------------------------------
    Anders P. Wiklund
</TABLE>



                                       68