<PAGE>

                       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, 2001
                                       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, $0.01 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, $0.01 par
value, held by non-affiliates of the Registrant as of March 25, 2002: was
approximately $48,549,934 (based upon the closing sale price of the Common Stock
on March 25, 2002). Number of shares of Common Stock, $0.01 par value,
outstanding as of March 25, 2002: 21,968,296. 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 2002 Annual Meeting of Stockholders which will be
held on June 3, 2002 are incorporated by reference into Part III.


<PAGE>



                           ANNUAL REPORT ON FORM 10-K
                   FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001


                                TABLE OF CONTENTS

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<S>       <C>                                                                                                <C>
PART I

          Item 1.   Business..................................................................................  1
          Item 2.   Properties................................................................................ 23
          Item 3.   Legal Proceedings......................................................................... 24
          Item 4.   Submission of Matters to a Vote of Security Holders....................................... 24

PART II

          Item 5.   Market for Registrant's Common Equity and Related Stockholder Matters..................... 25
          Item 6.   Selected Financial Data................................................................... 26
          Item 7.   Management's Discussion and Analysis of Financial Condition and Results
                    of Operations............................................................................. 27
          Item 7A.  Qualitative and Quantitative Disclosures About Market Risk................................ 32
          Item 8.   Financial Statements and Supplementary Data............................................... 32
          Item 9.   Changes in and Disagreements with Accountants on Accounting and Financial
                    Disclosure................................................................................ 48

PART III

          Item 10   Directors and Executive Officers of the Registrant........................................ 48
          Item 11.  Executive Compensation.................................................................... 48
          Item 12.  Security Ownership of Certain Beneficial Owners and Management............................ 49
          Item 13.  Certain Relationships and Related Transactions............................................ 49

PART IV

          Item 14.  Exhibits, Financial Statement Schedules, and Reports on Form 8-K.......................... 49
</TABLE>



<PAGE>



                                     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 our
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. Our 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. Readers are cautioned not to place
undue reliance on these forward-looking statements, which speak as of the date
hereof. We undertake no obligation to update any forward- looking statements to
reflect events or circumstances after the date hereof or to reflect the
occurrence of unanticipated events.

                                   THE COMPANY

         We are an ophthalmic product development company focused on developing
genetically based tools, for the diagnosis, prognosis and management of
glaucoma, as well as other ophthalmic pharmaceutical products based on our
proprietary DuraSite(R) eyedrop-based drug delivery technology. In addition, we
have retinal programs which include both a therapeutic agent and a retinal drug
delivery technology.

         We are focusing our commercial efforts and research and development on
the following:

          . launching our OcuGene(TM) glaucoma genetic test based on our ISV-900
            technology;
          . expanding our ISV-900 technology for the diagnosis, prognosis and
            management of glaucoma;
          . ISV-205, a DuraSite formulation for the treatment of glaucoma;
          . ISV-401, a DuraSite formulation of a novel antibiotic not currently
            used in ophthalmology;
          . ISV-403, a DuraSite formulation of a fourth generation
            fluoroquinolone;
          . ISV-014, a retinal drug delivery device; and treatments for
            diabetic retinopathy and macular degeneration.

         Glaucoma Genetics. Our 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. The first of
these new tools, OcuGene, is still in the launch phase and was first introduced
to the medical community at the end of 2001.

         A clinical study published in the September 2001 issue of Clinical
Genetics, showed a correlation between the presence of the TIGR promoter region
mutation in individuals with primary open-angle glaucoma, or POAG, and the
likelihood of an individual developing a more aggressive form of glaucoma
including more visual field damage. Published studies have also shown the
correlation of the coding region mutations detected by our OcuGene test and a
high probability of developing glaucoma.

         To date, our academic collaborators have identified genes associated
with POAG (the most prevalent form of the disease in adults), normal tension
glaucoma, juvenile glaucoma and primary congenital glaucoma, or PCG. Our
academic collaborators for our glaucoma genetics program are with: the
University of California, San Francisco, or UCSF; the University of Connecticut
Health Center, or UCHC; Institute National de la Sante et de la Recherche
Medicale, or INSERM, the French equivalent of US National Institutes of Health;
Okayama University in Japan; and other institutions in North America and Europe.
This research, other than what has been incorporated into our OcuGene test,
still must be converted into commercial products.

         DuraSite-Based Product and Candidates. Our DuraSite delivery system is
a patented eyedrop formulation comprising a cross-linked carboxyl-containing
polymer that 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



                                       1
<PAGE>


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 and, thus, require 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.

         We have received patent allowances covering extended viscosity and pH
ranges of the DuraSite system. These extended ranges will allow a broader range
of compounds to be delivered by the system and the additional patent allowances
have patent coverage until 2016.

         The first product utilizing our DuraSite technology, AquaSite(R) dry
eye treatment, was launched as an over-the-counter, or OTC, medication in 1992
by CIBA Vision Ophthalmics, or CIBA Vision, to which we have licensed certain
co-exclusive rights. In 2000, Global Damon Pharm launched AquaSite in Korea,
based on a licensing agreement signed in 1999. In 1999, we also licensed
AquaSite to SSP Co., Ltd., or SSP, for sale in Japan. (See "--Collaborative and
Licensing Agreements" for additional information on the agreements.) In
connection with our DuraSite development efforts, we have licensed marketing
rights to certain DuraSite-based product candidates to CIBA Vision and Bausch &
Lomb Incorporated, or B&L.

         In January 1999, we entered into a license agreement and stock purchase
agreement with Pharmacia for certain exclusive worldwide rights to ISV-205 for
glaucoma. (See "--Collaborative and Licensing Agreements" for additional
information on the agreements.) During 1999, we successfully completed a Phase
II trial of ISV-205 and transitioned the lead on the further development of the
program to Pharmacia. In May 2001, Pharmacia terminated this license agreement.
All global development and commercialization rights that had been granted to
Pharmacia were returned to us at the end of a ninety-day termination period.

         Business Strategy. Our business strategy is to license promising
product candidates and technologies from academic institutions and other
companies, to conduct preclinical and clinical testing, if necessary, and to
partner with pharmaceutical companies to complete clinical development and
regulatory filings as needed and to produce and market our products. We also
have 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, we either have or plan to
partner with pharmaceutical companies to complete clinical development and
commercialization of our own product candidates.

OPHTHALMIC PHARMACEUTICAL MARKET

         The prevalence of eye disease is ten times greater in persons over the
age of 65 than under the age of 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 we believe will
contribute to increased demand for new ophthalmic products.

         In addition to changing demographics, we believe 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, we believe 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.

         Glaucoma is the leading cause of preventable blindness affecting two to
three million people in the U.S., and 67 million people worldwide, according to
the Glaucoma Research Foundation. 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 world wide opthalmic antibiotic market was anticipated to reach
approximately $650.0 million in 2001, according to a study by Frost and
Sullivan. The study also anticipated sales of fluroquinolone products to reach
$240.0 million in 2001. The market has been, and will continue to be, impacted
by the use of antibiotics in connection with laser-based vision correction
procedures.

         Age-related macular degeneration, which affects 15 million or more
people in the U.S., is the leading cause of severe blindness in Americans age 60
and above, according to the Macular Degeneration Partnership. Laser treatment
and the photo-dynamic therapy introduced in 2000, are the only known therapies,
but are effective in only a certain portion of affected patients. Even with
treatment, the disease usually progresses and eventually leads to vision loss.


                                       2
<PAGE>


         Also, approximately 10 to 14 million Americans are diabetic and many of
them will develop diabetic retinopathy later in their life. According to the
American Diabetes Association, diabetic retinopathy is responsible for 8 percent
of the legal blindness in the U.S. and is the leading cause of new cases of
blindness in adults 20 to 74 years of age. Laser therapy 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.

PRODUCTS AND PRODUCT CANDIDATES

         The following table summarizes the current status of our 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)
           -------                    -----------                   --------                     ---------
<S>                             <C>                       <C>                                 <C>
       GLAUCOMA GENETICS
           OcuGene               Glaucoma genetic test           Detect disease                  Marketed
                                                               susceptibility and
                                                           determine disease severity



          ISV - 900              Glaucoma prognostic/         Identify new genetic               Research
                                      diagnostic                   markers to
                                                                 detect disease
                                                               susceptibility and
                                                           determine disease severity

 GLAUCOMA PRODUCT CANDIDATES

          ISV - 205                 Steroid-induced           Treat/prevent disease             Phase II(b)
                                 intraocular pressure              progression                   completed
                                  elevation, glaucoma

    OTHER TOPICAL PRODUCT
   CANDIDATES AND PRODUCT

          ISV - 401               Bacterial infection       Broad spectrum antibiotic            Phase II
                                 including ophthalmia     with reduced dosing frequency
                                      neonatorum

          ISV - 403               Bacterial infection           Fourth generation               Preclinical
                                                           fluoroquinolone antibiotic
                                                          with reduced dosing frequency

          ISV - 205                Inflammation and         Reduced dosing frequency            Preclinical
                                       analgesia

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

       RETINAL DEVICE
------------------------------------------------------------------------------------------------------------
</TABLE>



                                       3
<PAGE>



<TABLE>
<S>                             <C>                         <C>                                <C>
------------------------------------------------------------------------------------------------------------
          ISV - 014              Retinal drug delivery      Non-surgical delivery of             Research
                                 device for potential          drugs to the retina
                                 treatment of diabetic
                                retinopathy and macular
                                     degeneration
------------------------------------------------------------------------------------------------------------
</TABLE>

1)       All products except OcuGene, 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, or IND. For a description of preclinical trials, IND,
         Phase I, Phase II and Phase III clinical trials and New Drug
         Application, or NDA, see "--Government Regulation."



                                       4
<PAGE>


GLAUCOMA GENETICS

         Glaucoma is the leading cause of preventable blindness in the U.S.,
affecting an estimated two to three million people. The most prevalent form of
glaucoma in adults is POAG. Other forms of the disease include PCG, a leading
cause of blindness in infants, and juvenile glaucoma that affects 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 or 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 U.S. glaucoma patients and three-quarters of glaucoma patients in
Japan have this form of the disease, based on recent study conducted by Dr.
Kitazawa in Japan. These patients cannot be identified with standard glaucoma
screening tests that only measure a patient's eye pressure and usually they
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 or POAG in first-degree
relatives of affected patients to be as high as 7 to 10 times that of the
general population.) We have 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.

         Researchers with whom we collaborate have identified several genes
related to POAG including TIGR/MYOC, OPTN, OCLM and APOE, a gene that interacts
with TIGR. Additionally, the CYP1B1 gene is related to PCG. We have obtained
certain 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, the CYP1B1 gene and associated mutations from UCHC,
the OCLM gene from Dr. Toshihiko Matsuo of Okayama University and APOE, as it
interacts with TIGR, from INSERM.

         In December 2002, we entered into an agreement pursuant to which we
obtained certain exclusive rights for the Optineuron, or OPTN, gene and
associated mutations from UCHC. In early tests, this gene has been linked to
POAG, and the normal-tension glaucoma subset. We are in the process of
conducting additional research on the Optineuron gene and mutations and we
believe we may be able to introduce a test incorporating this gene early in
2003.

         We currently hold licenses to patents issued on the TIGR cDNA, TIGR
antibodies, 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 the ISV-900 program are currently pending and if issued will
be included in the licenses we hold.

         OcuGene. 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. Our 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, OcuGene, has been developed
and the product was commercially launched at the end of 2001. We anticipate that
as further research identifies new genes, such as Optineuron, and additional
mutations, we will bring these to market as additional tests.

GLAUCOMA PRODUCT CANDIDATES

         ISV-205. Our ISV-205 product candidate contains the drug diclofenac
formulated in the DuraSite sustained-release delivery vehicle. Diclofenac is a
non-steroidal anti-inflammatory drug or 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



                                       5
<PAGE>


candidate delivers to the eye concentrations of diclofenac that 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 indicates that ISV-205 was safe and associated with a 75%
reduction in the number of subjects with clinically significant IOP elevation
following steroid use.

         A second Phase II clinical study was conducted in 233 subjects with
ocular hypertension. Genetic information was collected on the subjects using our
ISV-900 technology and the subjects were dosed twice daily for six months with
ISV-205. Our ISV-900 technology detected the TIGR mt-1 or mt-11 mutations in
approximately 70% of the ocular hypertensives participating in the study. In
patients with the TIGR mutations, 0.1% formulation of ISV-205 was
statistically significantly more effective than placebo in lowering intraocular
pressure (IOP) (p=0.008). These effects were not seen to the same extent in
patients without the TIGR mutations. ISV-205 was similar to placebo in
ocular safety and comfort in all patients. We are planning further clinical
studies before filing for product approval with the U.S. Food and Drug
Administration, or FDA and there is no guarantee that similar clinical results
will be achieved.

         Other potential indications for ISV-205 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 non-glaucoma
indications of inflammation and analgesia, were licensed to CIBA Vision in May
1996.

OTHER TOPICAL PRODUCT CANDIDATES AND MARKETED PRODUCT

         ISV-401 is an ophthalmic formulation of a broad-spectrum antibiotic
that has not previously been used in ophthalmology. The antibiotic has a proven
safety and efficacy record in both adult and pediatric populations when used
orally. Depending on the indication, current ophthalmic antibiotics must be
dosed as often as every 15 to 30 minutes on the first day and then tapered off
to a maintenance dose of 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. The clinical dosing
regimen for this product is significantly lower than the current treatments
available.

         In September 2001, we conducted a Phase I clinical trial that indicated
the formulation was safe and well tolerated. In December 2001, we initiated a
Phase II clinical trial using a 1.0% formulation of ISV-401, compared to a
placebo, to treat bacterial conjunctivitis. We are planning further clinical
studies that we anticipate beginning in late 2002 after the Phase II trial is
completed and the data has been presented to the FDA.

         ISV-403 is a formulation of a fluoroquinolone in the DuraSite system.
Fluoroquinolones are effective against gram-positive and gram-negative bacteria
including Pseudomonas, and are often used as prophylaxis during ophthalmic
surgery. Based on recently conducted preclinical testing, we have determined
this is a fourth-generation fluoroquinolone, which has expanded bacterial
sensitivities and may be effective against the bacteria that have developed
resistance to prior generation fluoroquinolones and other antibiotics. In
addition, based on preclinical studies we believe the ISV-403 formulation may
provide for reduced dosing frequency compared to other formulations currently on
the market.

         AquaSite. The first product utilizing our DuraSite technology was
introduced to the OTC market in the U.S. in October 1992 by CIBA Vision. We
receive 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, we licensed the product to Global Damon Pharm, a Korean company. The
license is royalty-bearing, has a term of 10 years and is exclusive in the
Republic of Korea. In August 1999, we entered into a ten year license with SSP
for sales and distribution in Japan.

RETINAL DEVICE




                                       6
<PAGE>


         Ophthalmic conditions that involve retinal damage include macular
degeneration, which affects 15 million or more people in the U.S., and diabetic
retinopathy, a common side effect of diabetes. Approximately 10 million to 14
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, including diabetic retinopathy and macular
degeneration, generally involves surgery, laser treatments and photo-dynamic
therapy, each of which can lead to loss of vision, retinal detachment, infection
and may not slow the progression of the disease. Currently, there is no
effective drug therapy for these conditions.

         Retinal Delivery Device. ISV-014 is one of our technology platforms and
consists of a device for the controlled, non-surgical delivery of ophthalmic
drugs to the retina and surrounding tissues. During 2001, we continued to
enhance the device and performed in vivo 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, including diabetic
retinopathy and macular degeneration, most of which cannot be effectively
treated at the present time.

         The ISV-014 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. We have filed for two patents related to the device and one
patent has been allowed. We are currently investigating licensing this
technology to a third party.

COLLABORATIVE, LICENSING AND SERVICE AGREEMENTS

         As part of our business strategy, we have entered into, and will
continue to pursue additional research collaborations, licensing agreements and
corporate collaborations. However, there can be no assurance that we will be
able to negotiate acceptable collaborative or licensing agreements, or that our
existing collaborations will be successful, will be renewed or will not be
terminated.

         University of Connecticut Health Center (UCHC). In July 1997, we
exercised our option granted pursuant to a research agreement with UCHC to
obtain certain exclusive rights from UCHC for diagnostic uses of the newly
discovered gene for PCG. Under the agreement, we will pay a licensing fee and
will make royalty payments on future product sales, if any.

         In December 2001, we entered into an agreement whereby we exercised our
option granted pursuant to a research agreement with UCHC to obtain certain
exclusive rights from UCHC for diagnostic uses of the Optineuron gene and
associated mutations. Under this agreement, we will pay a licensing fee and will
make royalty payments on future product sales, if any.

         Quest Diagnostics Incorporated. In November 2001, we entered into an
exclusive laboratory service agreement with Quest Diagnostics Incorporated, or
Quest, for our OcuGene test in the U.S. We will pay Quest for each OcuGene test
that they perform. The initial agreement term is for one year and may be
extended.

         Pharmacia Corporation. In December 2000, our November 1999 ISV-900
licensing and credit agreements with Pharmacia were terminated by Pharmacia.
All rights to the ISV-900 program granted to Pharmacia were returned to us, and
Pharmacia was released from any obligation to fund future research and
development, marketing efforts and any corresponding royalties for the program.
Additionally, the credit line, which would have become available to us in
November 2001, was terminated.

         As part of the November 1999 ISV-900 transaction, Pharmacia invested
$2,000,000 in our common stock. The stock purchase agreement also provides for a
standstill period of thirty (30) months during which Pharmacia and its
subsidiaries will not purchase additional shares of us, other than those
provided for under any existing agreements between the companies, without our
prior written consent.



                                       7
<PAGE>


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

         On January 28, 1999, we entered into a license agreement and stock
purchase agreement that granted Pharmacia certain exclusive rights to ISV-205
for the treatment of glaucoma. The equity investment from Pharmacia described in
the stock purchase agreement was made in February 1999. In the license,
Pharmacia assumed responsibility for the development of the product upon our
completion of, among other activities, Phase II studies we conducted in 1999. In
May 2001, Pharmacia terminated the ISV-205 license agreement, and all global
development and commercialization rights that had been granted to Pharmacia were
returned to us at the end of a ninety-day termination period.

         CIBA Vision Ophthalmics. In October 1991, we entered into license
agreements with CIBA Vision (the "CIBA Vision Agreements"), which granted CIBA
Vision certain co-exclusive rights to manufacture, have manufactured, use and
sell fluorometholone and tear replenishment products utilizing the DuraSite
technology in the U.S. and Canada, ToPreSite(R), a product candidate for ocular
inflammation/infection, and ISV-205 for non-glaucoma indications.

         Bausch and Lomb. In July 1996, we entered into a license agreement (the
"B&L Agreement") with B&L granting B&L certain exclusive rights to make, use and
sell PilaSite(R) and ISV-208. B&L paid us 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 us, is sharing the cost of
developing ISV-208 and agreed to manufacture other products on our behalf.

         In July 1999, we entered into a termination, release and purchase
agreement with B&L and the PilaSite license agreement and the manufacturing
agreement were terminated and our equipment located at B&L's facility was
purchased by B&L. The ISV-208 license and development collaboration remains in
effect but no further development activities are being pursued on the program by
B&L or us.

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

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

         Columbia Laboratories, Inc. In February 1992, we entered into a
cross-license agreement (the "Columbia Agreement") with Columbia Laboratories,
Inc., or Columbia, in which Columbia licensed to us certain exclusive rights to
a polymer technology upon which DuraSite is based. This license permits us 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, we granted Columbia a
license with certain exclusive rights to sublicense and use certain DuraSite
technology in the over-the-counter market outside the Columbia Territory. In
addition, we also granted Columbia a license with certain exclusive rights to
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 expiration of all patents covered by the DuraSite technology to
which Columbia has certain rights.



                                       8
<PAGE>


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

         SSP Co., Ltd. In April 2001, we entered into a royalty-bearing license
agreement with SSP Co., Ltd, or SSP, for two fourth-generation fluoroquinolones,
one of which is the active ingredient in ISV-403. We have world-wide development
and marketing rights except for Japan, which was retained by SSP, and will share
the rights with SSP in Asia.

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

         Other. As part of our basic strategy, we continually discuss 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 our family of proprietary ophthalmic
products and to develop and market our current products. We intend to continue
exploring licensing and collaborative opportunities, though there is no
certainty that we can successfully enter into any such agreements.

PATENTS AND PROPRIETARY RIGHTS

         Patents and other proprietary rights are important to our business. Our
policy is to file patent applications seeking to protect technology, inventions
and improvements to our inventions that we consider important to the development
of our business. Additionally, we assist UC Regents, UCHC and INSERM in filing
patent applications seeking to protect inventions that are the subject of our
agreements with those institutions. We also rely upon trade secrets, know-how,
continuing technological innovations and licensing opportunities to develop and
maintain our competitive position. Our DuraSite drug delivery products are made
under patents and applications, including four U.S. patents, owned by Columbia
and exclusively licensed to us in the field of human ophthalmic applications. In
addition, we have filed a number of patent applications in the U.S. relating to
our DuraSite technology, as well as foreign counterparts of certain of these
applications in many countries. Of these applications, ten U.S. patents have
been issued. In addition, we have obtained two U.S. patents on our unit dose
dispenser. We have received six additional U.S. patents directed toward certain
uses of lazaroids in ophthalmic applications. Of the patent applications
licensed from the UC Regents, eleven patents have issued. Five patents have been
issued of the patent applications licensed from UCHC covering the diagnosis of
PCG. We have three patent applications on file for our retinal programs and one
patent on the device used for delivery of drugs to the retina has been issued.
Three patent applications have been filed related to our antibiotic programs
with one patent issued. Several other patent applications by us and by the UC
Regents, UCHC and INSERM relating to the foregoing and other aspects of our
business and potential business are also pending.

         The patent positions of pharmaceutical companies, including ours, 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, we do not know whether any of our pending patent
applications will result in the issuance of patents or if any of our 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, we cannot be certain that we or any
licensor was the first to file patent applications for such inventions.
Moreover, we 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 us, even if the eventual outcome were
favorable. There can be no assurance that our 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.




                                       9
<PAGE>
         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 our business. Some of
these technologies, applications or patents may conflict with our technologies
or patent applications. This conflict could limit the scope of the patents, if
any, that we may be 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 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, we also rely upon trade secret
protection for our 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 our trade
secrets, that such trade secrets will not be disclosed or that we can
effectively protect our rights to unpatented trade secrets.

         We believe our 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, we may be required to obtain licenses from third parties
that have rights to these compounds in order to conduct 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.

RESEARCH AND DEVELOPMENT

         On December 31, 2001, our research and development staff numbered 27
people, of whom 8 have Ph.D.'s. In 2001, our research and development expenses,
including third party research we sponsored, were $7.3 million, of which $0.7
million was funded by Pharmacia as part of the ISV-205 license. During 2000 and
1999, our research and development expenses were $6.5 million and $5.6 million,
which included $4.8 million and $4.2 million, respectively, funded by Pharmacia
as part of the ISV-900 and ISV-205 license agreements.

MANUFACTURING

         We have no experience or facilities for the manufacture of products for
commercial processes and we currently have no intention of developing such
experience or implementing such facilities. We have a pilot facility, licensed
by the State of California, to produce potential products for Phase I and some
of our Phase II clinical trials. However, as stated above, we have no
large-scale manufacturing capacity and we rely on third parties for supplies and
materials necessary for all of our Phase III clinical trials. If we should
encounter delays or difficulties in establishing and maintaining our
relationship with qualified manufacturers to produce, package and distribute our
finished products, then clinical trials, regulatory filings, market introduction
and subsequent sales of such products would be adversely affected.

         We contract with a third party to assemble the sample collection kits
used in our OcuGene glaucoma genetic test. If our assembler should encounter
significant delays or we have difficulty maintaining our existing relationship,
or in establishing a new one, our sales could be adversely affected.

MARKETING AND SALES

         We have developed a limited marketing and sales organization focused on
the launch of OcuGene and we are primarily using external marketing and sales
resources that include:

o        marketing consultants;
o        a network of key ophthalmic clinicians; and
o        other resources with ophthalmic expertise.

         We are evaluating expansion of the external marketing and sales
resources to support the on-going OcuGene efforts. Potential resources being
evaluated included:

o        contract sales forces;
o        co-marketing arrangements in the U.S.; and



                                       10
<PAGE>


o        licensing arrangements with companies outside of the U.S.

         We do not plan on establishing a dedicated sales force or a marketing
organization for our other product candidates.

         We have also entered into arrangements, and we plan to enter into
arrangements with one or more additional pharmaceutical companies, to market our
other products. We may not be able to conclude or maintain such arrangements on
acceptable terms, if at all.

         CIBA Vision. In 1991, we entered into a co-exclusive rights agreement
to market the AquaSite product in the U.S. and Canada. Additionally, in May
1996, we 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, a product candidate that currently is not being pursued.
CIBA Vision is using our trademark, under license, for AquaSite dry eye
treatment and our patents are identified on the AquaSite packaging. We received
a one-time licensing fee and are entitled to royalties based on net sales of the
products, if any.

         Global Damon and Kukje. In March 1999, we 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, we
entered into a manufacturing agreement with Kukje, a Korean company, to produce
the AquaSite to be sold by Global Damon.

         SSP Co., Ltd. In April 2001, we entered into an exclusive licensing
agreement with SSP for two fluoroquinolone compounds, one of which is
incorporated into our ISV-403 formulation. We have exclusive marketing rights
for the world except for Japan, which SSP retained, and shared rights in the
rest of Asia. In August 1999, we entered into an exclusive licensing agreement
with SSP to be the exclusive manufacturer and distributor of AquaSite in Japan.
We will be the sole supplier to SSP for certain key ingredients necessary for
the manufacture of AquaSite.

COMPETITION

         We have many competitors 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 we do and may succeed in developing
technologies and products that are more effective, safer or more commercially
accepted than any which we have developed or are developing. These competitors
may also succeed in obtaining cost advantages, patent protection or other
intellectual property rights that would block our ability to develop our
potential products, or in obtaining regulatory approval for the
commercialization of their products more rapidly or effectively than us. 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 Corporation. It is very difficult for smaller companies,
such as ours, that do not have well-developed sales and marketing staffs to
successfully develop and market products.

         We believe 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. We are aware of certain
products manufactured or under development by competitors that are used for the
treatment of certain ophthalmic indications we have targeted for product
development. Our competitive position will depend on our ability to develop
enhanced or innovative pharmaceuticals, maintain a proprietary position in our
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.



                                       11
<PAGE>


         Over the longer term, our, and our partners', ability to successfully
market our current products, and product candidates, expand their 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 obtaining approval from managed care and
governmental organizations to purchase or reimburse for the purchase of our
products.

GOVERNMENT REGULATION

         The manufacturing and marketing of our products and our 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 our products.
In addition to FDA regulations, we are 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 us to develop alternative testing methods,
which could result in the delay of such tests reaching the market, if at all.
Such a delay could materially harm our business.

         The steps required before a pharmaceutical agent may be marketed in the
U.S. include:

o        preclinical laboratory and animal tests;
o        submission to the FDA of an IND;
o        adequate and well-controlled human clinical trials to establish the
         safety and efficacy of the drug;
o        the submission of an NDA or Product License Application ("PLA") to the
         FDA;
o        and 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 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 that considers, among other things,
ethical factors and the rights, welfare and safety of human subjects.




                                       12
<PAGE>


         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., we are also 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 and in
some cases are even more rigorous than in the U.S.




                                       13
<PAGE>



SCIENTIFIC AND BUSINESS ADVISORS

         We have access to a number of academic and industry advisors with
expertise in clinical ophthalmology and pharmaceutical development, marketing
and sales. Our advisors meet with our management and key scientific employees on
an ad hoc basis to provide advice in their respective areas of expertise and
further assist us by periodically reviewing with management our preclinical,
clinical and marketing activities. We plan to make arrangements with other
individuals to join as advisors as appropriate. Although we expect to receive
guidance from the advisors, all of the advisors are employed on a full-time
basis by other entities, or are primarily engaged in outside business
activities, and may have other commitments to, or consulting or advisory
contracts with, other entities that may conflict or compete with their
obligations to us.

         Our advisors are as follows:

      Name                                      Position
      ----                                      --------

Mark Abelson, M.D.                  Associate Clinical Professor of
                                    Ophthalmology, Department of Ophthalmology,
                                    Harvard Medical School

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

David G. Hwang, M.D.                Professor of Clinical Ophthalmology,
                                    Co-Director, Cornea and Refractive Surgery
                                    Service, University of California, San
                                    Francisco School of Medicine

Chris A. Johnson, Ph.D.             Director of Diagnostic Research, Discoveries
                                    Insight Research Lab, Devers Eye Institute

Steven G. Kramer, M. D., Ph.D.      Chairman, Department of Ophthalmology,
                                    Director of Beckman Vision Center and
                                    Professor, University of California, San
                                    Francisco

Eliot Lazar, M.D.                   President, El Con Medical Consulting,
                                    Buffalo, New York

Michael Marmor, M. D.               Professor, Department of Ophthalmology,
                                    Stanford University School of Medicine


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


EMPLOYEES

         As of December 31, 2001, we employed 39 persons, including 37 full time
employees. None of our employees are covered by a collective bargaining
agreement. We believe we have good employee relations. We also utilize
independent consultants to provide services in certain areas of our scientific
and business operations.



                                       14
<PAGE>


                                  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 have only
received an insignificant amount of royalties from the sale of one of our
products, an over-the-counter dry eye treatment. Before regulatory authorities
grant us marketing approval, we 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:

         o        are found to be unsafe or ineffective;
         o        fail to receive necessary marketing clearance from regulatory
                  authorities;
         o        even if safe and effective, are too difficult or expensive to
                  manufacture or market;
         o        are unmarketable due to the proprietary rights of third
                  parties; or
         o        are not able to compete with superior, equivalent or more
                  cost-effective products offered by competitors.

Therefore, our research and development activities may not result in any
commercially viable products.

WE WILL REQUIRE SIGNIFICANT ADDITIONAL FUNDING AND WE MAY HAVE DIFFICULTY
RAISING ADDITIONAL FUNDING

         We will require substantial additional funding to develop and conduct
testing on our potential products. We will also require additional funding to
support our sales and marketing efforts for our OcuGene glaucoma genetic test
and if we decide to independently manufacture or market any of our other
products. Our future capital requirements depend upon many factors, including:

         o        the cost of maintaining or expanding a marketing organization
                  for OcuGene and the related promotional activities;
         o        the progress of our research and development programs;
         o        our ability to establish additional corporate partnerships to
                  develop, manufacture and market our potential products;
         o        the progress of preclinical and clinical testing;
         o        changes in, or termination of, our existing collaboration or
                  licensing arrangements;
         o        whether we manufacture and market any of our other products
                  ourselves;
         o        the time and cost involved in obtaining regulatory approvals;
         o        the cost of filing, prosecuting, defending and enforcing
                  patent claims and other intellectual property rights;
         o        competing technological and market developments; and
         o        the purchase of additional capital equipment.

         We may seek additional funding through public or private equity or debt
financing, collaborative or other arrangements, and from other sources. We may
not be able to secure additional funding from these sources, and any funding may
not be on terms acceptable to us. In addition, our board of directors has the
authority to determine the price and terms of any sale of common stock and the
rights, preferences and privileges of any preferred stock or debt or other
security that is convertible into or exercisable for the common stock. The terms
of any securities issued to future investors may be superior to the rights of
our common stockholders, could result in substantial dilution and could
adversely affect the market price for our common stock.

         Our stockholders will suffer substantial dilution if we raise
additional funds by issuing equity securities. However, if we cannot raise
additional funding, we may be required to delay, scale back or eliminate one or
more of our research, discovery, development or marketing programs, or scale
back or cease operations altogether. In addition, the failure to raise
additional funding may force us to enter into



                                       15
<PAGE>


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 HAVE A HISTORY OF OPERATING LOSSES AND WE EXPECT TO CONTINUE TO HAVE LOSSES
IN THE FUTURE

         We have incurred significant operating losses since our inception in
1986 and have pursued numerous drug development candidates that did not prove to
have commercial potential. As of December 31, 2001, our accumulated deficit was
approximately $97.8 million. We expect to incur net losses for the foreseeable
future or until we are able to achieve significant royalties or other revenues
from sales of our products.

         Attaining 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 may not ever achieve or be
able to maintain significant revenue or profitability.

WE RELY ON THIRD PARTIES TO DEVELOP, MARKET AND SELL OUR PRODUCTS, WE MAY NOT BE
ABLE TO CONTINUE OR ENTER INTO THIRD PARTY ARRANGEMENTS, AND THESE THIRD
PARTIES' EFFORTS MAY NOT BE SUCCESSFUL

         Following the termination of our ISV-900 agreement with Pharmacia in
December 2000, we began to develop a marketing organization focused on the
launch of our OcuGene glaucoma genetic test. We do not plan on establishing a
dedicated sales force or a marketing organization for our other product
candidates and primarily use external marketing and sales resources even for
OcuGene. We also rely on third parties for clinical testing or product
development. In addition, in May 2001, Pharmacia terminated the January 1999
licensing agreement we had entered into that granted Pharmacia an exclusive
worldwide license for ISV-205 for the treatment of glaucoma. We now must enter
into another third party collaboration agreement for the development, marketing
and sale of our ISV-205 product or develop, market and sell the product
ourselves. There can be no assurance that we will be successful in finding a new
corporate partner for our ISV-205 program or that any collaboration will be
successful, either of which could significantly harm our business. In addition,
we have no experience in marketing and selling products and we cannot assure you
that we would be successful in marketing ISV-205 ourselves. If we are to
successfully develop and commercialize our product candidates, including
ISV-205, we will be required to enter into arrangements with one or more third
parties that will:

         o        provide for Phase II and/or Phase III clinical testing;
         o        obtain or assist us in other activities associated with
                  obtaining regulatory approvals for our product candidates; and
         o        market and sell our products, if they are approved.

         We are marketing and selling our OcuGene glaucoma genetic test mainly
using external marketing and sales resources that include:

         o        marketing consultants;
         o        a network of key ophthalmic clinicians; and
         o        other resources with ophthalmic expertise.

         We may not be able to enter into arrangements with third parties with
ophthalmic or diagnostic industry experience on acceptable terms or at all. If
we are not successful in concluding such arrangements on acceptable terms, we
may be required to establish our own sales force and significantly expand our
marketing organization, despite the fact that we have no experience in sales,
marketing or distribution. Even if we do enter into collaborative relationships,
as we have recently experienced with Pharmacia, these relationships can be
terminated forcing us to seek alternatives. We may not be able to build a
marketing staff or sales force and our sales and marketing efforts may not be
cost-effective or successful.

         In addition, we currently contract with a third party to assemble the
sample collection kits used in our OcuGene glaucoma genetic test. If our
assembler should encounter significant delays or we have



                                       16
<PAGE>


difficulty maintaining our existing relationship, or in establishing a new one,
our sales of this product could be adversely affected.

         Our strategy for research, development and commercialization 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.

         Because of our reliance on third parties for the development, marketing
and sale of our products, any revenues that we receive will be dependent on the
efforts of these third parties, such as our corporate collaborators. These
partners may terminate their relationships with us and may not diligently or
successfully market our products. In addition, marketing consultants and
contract sales organizations, such as those deployed by us currently or in the
future for OcuGene, may market products that compete with our products and we
must rely on their efforts and ability to effectively market and sell our
products. We may not be able to conclude arrangements with other companies to
support the commercialization of our products on acceptable terms. In addition,
our collaborators may take the position that they are free to compete using our
technology without compensating or entering into agreements with us.
Furthermore, our collaborators may 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.

OUR BUSINESS DEPENDS UPON OUR PROPRIETARY RIGHTS, AND WE MAY NOT BE ABLE TO
ADEQUATELY PROTECT, ENFORCE OR SECURE OUR INTELLECTUAL PROPERTY RIGHTS

         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. Our patent applications may not be
approved. We may not be able to develop additional proprietary products that are
patentable. Even if we receive patent issuances, those issued patents may not be
able to provide us with adequate protection for our inventions or may be
challenged by others. Furthermore, the patents of others may 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. Neither the United States Patent and Trademark Office nor the courts
has developed, formulated, or presented a consistent policy 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, others may independently develop similar products, duplicate
any of our products or design around any of our patents. In addition, third
parties from which we have licensed or otherwise obtained technology may 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 able to obtain or result in the denial of our patent
applications. In addition, if the United States Patent and Trademark Office or
foreign patent agencies have issued or issue patents that cover our activities
to other companies, we may not 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 in or
be precluded altogether from introducing products to the market.

         We may need to litigate in order 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. Litigation could result in substantial cost to
and diversion of effort by us, which may harm our business. We have also agreed
to indemnify our licensees against infringement claims by third parties related
to our technology, which could




                                       17
<PAGE>

result in additional litigation costs and liability for us. In addition, our
efforts to protect or defend our proprietary rights may not be successful or,
even if successful, may result in substantial cost to us.

         We also depend upon unpatented trade secrets to maintain our
competitive position. Others may independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to our trade
secrets. Our trade secrets may also be disclosed, and we may not be able to
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, disputes also may arise as to the rights in related or resulting
know-how and inventions.

IF WE ENGAGE IN ACQUISITIONS, WE WILL INCUR A VARIETY OF COSTS, AND THE
ANTICIPATED BENEFITS OF THE ACQUISITION MAY NEVER BE REALIZED

         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 us. Any of these acquisitions could
have negative effects on 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. Any of these results could harm our financial condition. In
addition, acquisitions would involve several risks for us, including:

         o        assimilating employees, operations, technologies and products
                  from the acquired companies with our existing employees,
                  operation, technologies and products;
         o        diverting our management's attention from day-to-day operation
                  of our business;
         o        entering markets in which we have no or limited direct
                  experience; and
         o        potentially losing key employees from the acquired companies.

WE HAVE NO EXPERIENCE IN COMMERCIAL MANUFACTURING AND NEED TO ESTABLISH
MANUFACTURING RELATIONSHIPS WITH THIRD PARTIES, AND IF CONTRACT MANUFACTURING IS
NOT AVAILABLE TO US OR DOES NOT SATISFY REGULATORY REQUIREMENTS, WE WILL HAVE TO
ESTABLISH OUR OWN REGULATORY COMPLIANT MANUFACTURING CAPABILITY

         We have no experience manufacturing products for commercial purposes.
We have a pilot facility licensed by the State of California to manufacture a
number of our products for Phase I and Phase II clinical trials but not for late
stage clinical trials or commercial purposes. Any delays or difficulties that we
may encounter in establishing and maintaining a relationship with qualified
manufacturers to produce, package and distribute our finished products may harm
our clinical trials, regulatory filings, market introduction and subsequent
sales of our products.

         We currently contract with a third party to assemble the sample
collection kits used in our OcuGene glaucoma genetic test. If our assembler
should encounter significant delays or we have difficulty maintaining our
existing relationship, or in establishing a new one, our sales of this product
could be adversely affected.

         Contract manufacturers must adhere to Good Manufacturing Practices
regulations that 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 a new drug
application. Some of the material manufacturing changes that occur after
approval are also subject to FDA review and clearance or approval. The FDA or
other regulatory agencies may not approve the process or the facilities by which
any of our products may be manufactured. Our dependence on third parties to
manufacture our 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:

         o        will be required to expend significant amounts of capital to
                  install a manufacturing capability;
         o        will be subject to the regulatory requirements described
                  above;
         o        will be subject to similar risks regarding delays or
                  difficulties encountered in manufacturing any such products;
                  and
         o        will require substantial additional capital.



                                       18
<PAGE>



         Therefore, we may not be able to manufacture any products successfully
or in a cost-effective manner.

WE HAVE NO EXPERIENCE IN PERFORMING THE ANALYTICAL PROCEDURES RELATED TO GENETIC
TESTING AND HAVE ESTABLISHED AN EXCLUSIVE COMMERCIAL AGREEMENT WITH A THIRD
PARTY TO PERFORM THESE PROCEDURES FOR OUR OCUGENE GLAUCOMA GENETIC TEST. IF WE
ARE UNABLE TO MAINTAIN THIS ARRANGEMENT, AND ARE UNABLE TO ESTABLISH NEW
ARRANGEMENTS WITH THIRD PARTIES, WE WILL HAVE TO ESTABLISH OUR OWN REGULATORY
COMPLIANT ANALYTICAL PROCESS FOR GENETIC TESTING.

         We have no experience in the analytical procedures related to genetic
testing. We have entered into an agreement with Quest under which Quest will
exclusively perform OcuGene genetic analytical procedures at a commercial scale
in the United States. Accordingly, we are reliant on Quest for all of our
OcuGene analytical procedures. If we are unable to maintain this arrangement, we
would have to contract with another clinical laboratory or would have to
establish our own facilities. We cannot assure you that we will be able to
contract with another laboratory to perform these services on a commercially
reasonable basis, or at all.

         Clinical laboratories must adhere to Good Laboratory Practice
regulations that are strictly enforced by the FDA on an ongoing basis through
its facilities inspection program. Should we be required to perform the
analytical procedures for genetic testing ourselves, we:

         o        will be required to expend significant amounts of capital to
                  install an analytical capability;
         o        will be subject to the regulatory requirements described
                  above; and
         o        will require substantial additional capital.

         We cannot assure you we will be able to successfully enter into another
genetic testing arrangement or perform these analytical procedures ourselves on
a cost-efficient basis, or at all.

WE RELY ON A SOLE SOURCE FOR SOME OF THE RAW MATERIALS IN OUR PRODUCTS, AND THE
RAW MATERIALS WE NEED MAY NOT BE AVAILABLE TO US

            We are dependent upon our development partner for the active drug
incorporated into our ISV-616 product candidate. ISV-616 is a DuraSite-based
formulation of a compound that may inhibit the growth of new blood vessels. This
compound may be a treatment for such retinal diseases as diabetic retinopathy or
macular degeneration. We are performing limited formulation and pre-clinical
testing of ISV-616 in collaboration with the pharmaceutical company that
developed the compound. The further development of this product will be
dependent upon reaching appropriate agreement with our development partner on
future supply of the compound and other development terms.

         In addition, certain of the raw materials we use in formulating our
DuraSite drug delivery system, and other components of our product candidates,
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 WHICH MAY DELAY
OR PREVENT THE MARKETING OF POTENTIAL PRODUCTS AND IMPOSE COSTLY PROCEDURES UPON
OUR ACTIVITIES

         The 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.
The FDA or any other regulatory agency may not 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



                                       19
<PAGE>



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 make it difficult or impossible to market our products and 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 United States could result in new government regulations that could harm
our business. Adverse governmental regulation might arise from future
legislative or administrative action, either in the United States or abroad. See
"--Uncertainties regarding healthcare reform and third-party reimbursement may
impair our ability to raise capital, form collaborations and sell our products."

WE COMPETE IN HIGHLY COMPETITIVE MARKETS AND OUR COMPETITORS' FINANCIAL,
TECHNICAL, MARKETING, MANUFACTURING AND HUMAN RESOURCES MAY SURPASS OR LIMIT OUR
ABILITY TO DEVELOP AND/OR MARKET OUR PRODUCTS AND TECHNOLOGIES

         Our success depends upon developing and maintaining a competitive
advantage in the development of products and technologies in our areas of focus.
We have many competitors in the United States 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 these companies is intense and is 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 than we do. 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 that 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. Our competitors may also obtain regulatory
approval for commercialization of their products more effectively or rapidly
than we will. If we decide to manufacture and market our products by ourselves,
we will be competing in areas in which we have limited or no experience such as
manufacturing efficiency and marketing capabilities. See "-- We have no
experience in commercial manufacturing and need to establish manufacturing
relationships with third parties, and if contract manufacturing is not available
to us or does not satisfy regulatory requirements, we will have to establish our
own regulatory compliant manufacturing capability."

WE ARE DEPENDENT UPON KEY EMPLOYEES AND WE MAY NOT BE ABLE TO RETAIN OR ATTRACT
NEW KEY EMPLOYEES

         We are highly dependent on Dr. Chandrasekaran and other principal
members of our scientific and management staff. The loss of services from these
key personnel might significantly delay the achievement of planned development
objectives. Furthermore, a critical factor to our success is recruiting and
retaining qualified personnel. Competition for skilled individuals in the
biotechnology business is highly intense, and we may not 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 inherent in the
development, testing, manufacturing, marketing and sale of human therapeutic
products. Product liability insurance for the pharmaceutical industry is
extremely expensive. Our present product liability insurance coverage may not be
adequate. In addition, our existing coverage will not be adequate as we further
develop, manufacture




                                       20
<PAGE>



and market our products, and adequate insurance coverage against potential
claims may not be available in sufficient amounts or at a reasonable cost.

UNCERTAINTIES REGARDING HEALTHCARE REFORM AND THIRD-PARTY REIMBURSEMENT MAY
IMPAIR OUR ABILITY TO RAISE CAPITAL, FORM COLLABORATIONS AND SELL OUR PRODUCTS

         The continuing efforts of governmental and third party payers to
contain or reduce the costs of healthcare through various means may harm our
business. For example, in some foreign markets the pricing or profitability of
health care products is subject to government control. In the United States,
there have been, and we expect there will continue to be, a number of federal
and state proposals to implement similar government control. The implementation
or even the announcement of any of these legislative or regulatory proposals or
reforms could harm our business by impeding our ability to achieve
profitability, raise capital or form collaborations.

         In addition, the availability of reimbursement from third party payers
determines, in large part, the demand for healthcare products in the United
States and elsewhere. Examples of such third party payers are government and
private insurance plans. Significant uncertainty exists as to the reimbursement
status of newly approved healthcare 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, reimbursement from
third party payers may not be available or may not be sufficient to allow us to
sell our products on a competitive or profitable basis.

OUR USE OF HAZARDOUS MATERIALS MAY POSE ENVIRONMENTAL RISKS AND LIABILITIES
WHICH MAY CAUSE US TO INCUR SIGNIFICANT COSTS

         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 radioactive and other
hazardous materials and waste products. Although we believe that our safety
procedures for handling and disposing of these materials comply with the
standards prescribed by current 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.

MANAGEMENT AND PRINCIPAL STOCKHOLDERS MAY BE ABLE TO EXERT SIGNIFICANT CONTROL
ON MATTERS REQUIRING APPROVAL BY OUR STOCKHOLDERS

         As of December 31, 2001, 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 MARKET PRICES FOR SECURITIES OF BIOPHARMACEUTICAL AND BIOTECHNOLOGY
COMPANIES SUCH AS OURS MAY BE HIGHLY VOLATILE DUE TO REASONS THAT ARE RELATED
AND UNRELATED TO THE OPERATING PERFORMANCE AND PROGRESS OF OUR COMPANY

         The market prices for securities of biopharmaceutical and biotechnology
companies, including ours, have been highly volatile. 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, such as the results of testing and clinical trials, the status of
our relationships with third-party collaborators, 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, concerning us,
our competitors or other biopharmaceutical companies, may have a significant
effect on the market price of our common stock. Further, the standstill we have
in place with Pharmacia in connection with our November 1999 ISV-900 transaction
expires on May 11, 2002. As a result, we will no longer have any control over
Pharmacia's




                                       21
<PAGE>



future purchases or sales of our common stock, which could increase the
volatility in the market price for 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.

         In addition, on September 11, 2001, terrorist attacks destroyed the
World Trade Center in New York City and damaged the Pentagon in Washington, D.C.
The impact of these events, as well as any future events occurring in connection
with these events, including U.S. military retaliation or additional terrorist
acts, on financial markets is not yet fully known but has included, and could
continue to include, among other things, increased price and volume volatility
and/or economic recession. These events, as well as fluctuations in our
operating results and market conditions for biopharmaceutical and biotechnology
stocks in general, could have a significant effect on the volatility of the
market price for our common stock and on the future price of our common stock.

WE HAVE ADOPTED AND ARE SUBJECT TO ANTI-TAKEOVER PROVISIONS THAT COULD DELAY OR
PREVENT AN ACQUISITION OF OUR COMPANY

         Provisions of our certificate of incorporation and bylaws may constrain
or discourage a third party from acquiring or attempting to acquire control of
us. Such provisions could limit the price that investors might be willing to pay
in the future for shares of our common stock. Our board of directors has the
authority to issue up to 5,000,000 shares of preferred stock. 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 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. 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
conditions set forth in the Delaware General Corporation Law are met.

        EXECUTIVE OFFICERS AND OTHER SENIOR MANAGEMENT OF THE REGISTRANT

         As of March 30, 2002, our executive officers and other senior
management were as follows:

         NAME                      AGE                 TITLE
         ----                      ---                 -----

S. Kumar Chandrasekaran, Ph.D.      59      Chairman of the Board, President,
                                            Chief Executive Officer and Chief
                                            Financial Officer

Lyle M. Bowman, Ph.D.               53      Vice President, Development and
                                            Operations

Charles G. Chavdarian, Ph.D.        53      Senior Director, Analytical Research
                                            and Development

Cheryl E. Chen                      42      Senior Director, Clinical Operations

T. Raymond Chen, Ph.D.              51      Senior Director, Regulatory, Quality
                                            Assurance and Quality Control

Sandra C. Heine                     40      Senior Director, Finance and
                                            Administration

Samir D. Roy, Ph.D.                 43      Senior Director, Formulation
                                            Development and Operations

Erwin C. Si, Ph.D.                  48      Senior Director, Preclinical
                                            Research



                                       22
<PAGE>




           S. Kumar Chandrasekaran joined us 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 us 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.

           Charles G. Chavdarian joined us in February 2001 as Senior Director
of Analytical Research and Development. Before joining us, Dr. Chavdarian held
pharmaceutical management positions in analytical chemistry at Cellegy
Pharmaceuticals from April 1998 to February 2001, ALZA Corporation from December
1996 to April 1998, Penederm Incorporated from April 1993 to November 1996, and
Syntex Corporation from May 1987 to March 1993; and earlier was a researcher in
the chemical industry. Dr. Chavdarian holds a Ph.D. in Organic Chemistry from
the University of California, Berkeley, and has post-doctoral training in
pharmaceutical chemistry at the University of California, San Francisco.

           Cheryl E. Chen joined us 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 us 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 us in March 1997 as Controller. Since October
1999, Ms. Heine has served as Senior Director of Finance and Administration.
Before joining us, 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.
Ms. Heine holds a B.S. in Business Administration from Colorado State
University.

           Samir D. Roy joined us 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-doctorial training in drug transport at the
University of Michigan.

           Erwin C. Si joined us 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 our Board of Directors and our executive
officers.

ITEM 2. PROPERTIES

         We currently lease 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



                                       23
<PAGE>


December 31, 2006, and may be renewed by us for an additional 5-year term. We
believe our existing facilities will be suitable and adequate to meet our needs
for the immediate future.

ITEM 3.  LEGAL PROCEEDINGS.

         (a)      We are 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 our stockholders during the
quarter ended December 31, 2001.


                                       24
<PAGE>



PART II

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

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

<TABLE>
<CAPTION>
         2001                                             HIGH                 LOW
         ----                                             ----                 ---
<S>                                                       <C>                 <C>
         First Quarter                                    $3.94               $1.91
         Second Quarter                                   $2.40               $0.90
         Third Quarter                                    $1.49               $0.95
         Fourth Quarter                                   $2.00               $0.90
</TABLE>

<TABLE>
<CAPTION>
         2000                                             HIGH                 LOW
         ----                                             ----                 ---
<S>                                                       <C>                 <C>
         First Quarter                                    $7.50               $2.50
         Second Quarter                                   $5.94               $3.06
         Third Quarter                                    $7.69               $3.56
         Fourth Quarter                                   $8.50               $2.18
</TABLE>


         (b)      Holders

         As of March 25, 2002, we had approximately 300 stockholders of record.
On March 25, 2002, the last sale price reported on The American Stock Exchange
for our common stock was $2.21 per share.

         (c)      Dividends

         We have never paid dividends and do not anticipate paying any dividends
in the foreseeable future. It is the present policy of our Board of Directors to
retain our earnings, if any, for the development of our business.



                                       25
<PAGE>

ITEM 6. SELECTED FINANCIAL DATA

The comparability of the following selected financial data is affected by a
variety of factors, and this data is qualified by reference to and should be
read in conjunction with the consolidated financial statements and notes thereto
elsewhere in this Annual Report on Form 10-K and the Management's Discussion and
Analysis of Financial Condition and Results of Operations. The following table
sets forth selected consolidated financial data for us for the five years ended
December 31, 2001 (in thousands except per share amounts):

<TABLE>
<CAPTION>
                                                                       YEAR ENDED DECEMBER 31,
                                                   2001          2000          1999         1998          1997
                                                 --------      --------      --------      --------      --------
<S>                                              <C>           <C>           <C>           <C>           <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA

Revenues, net                                    $      5      $  4,513      $  4,760      $     16      $     50
Operating expenses:
 Research and development, net                      6,610         1,674         1,397         6,227         7,224
 General and administrative                         3,523         2,584         2,293         2,656         3,034
                                                 ----------------------------------------------------------------
 Total expenses                                    10,133         4,258         3,690         8,883        10,258
Interest and other income (expense), net              572           791            85           299           390
                                                 ----------------------------------------------------------------
Net income (loss) before taxes                     (9,556)        1,046         1,155        (8,568)       (9,818)
Income tax provision                                   --            --             5            --            --
                                                 ----------------------------------------------------------------
Net income (loss) before cumulative
effect of accounting change                        (9,556)        1,046         1,150        (8,568)       (9,818)
Cumulative effect of accounting change (1)             --        (4,486)           --            --            --
                                                 ----------------------------------------------------------------
Net income (loss)                                  (9,556)       (3,440)        1,150        (8,568)       (9,818)
Non cash preferred dividend                            --             3            22           514         1,326
                                                 ----------------------------------------------------------------
Net income (loss) applicable to common
stockholders                                     $ (9,556)     $ (3,443)     $  1,128      $ (9,082)     $(11,144)
                                                 ================================================================
Basic earnings (loss) per share:
Net income (loss) per share applicable to
common stockholders before cumulative effect
of accounting change                             $  (0.38)     $   0.04      $   0.06      $  (0.60)     $  (0.85)
Cumulative effect of accounting change (1)             --         (0.19)           --            --            --
                                                 ----------------------------------------------------------------
Net income (loss) per share applicable to
common stockholders                              $  (0.38)     $  (0.15)     $   0.06      $  (0.60)     $  (0.85)
                                                 ================================================================
Diluted earnings (loss) per share:
Net income (loss) per share applicable to
common stockholders before cumulative effect
of accounting change                             $  (0.38)     $   0.04      $   0.06      $  (0.60)     $  (0.85)
Cumulative effect of accounting change (1)             --         (0.18)           --            --            --
                                                 ----------------------------------------------------------------
Net income (loss) per share applicable to
common stockholders                              $  (0.38)     $  (0.14)     $   0.06      $  (0.60)     $  (0.85)
                                                 ================================================================
Pro-forma net income (loss) assuming the
accounting change is applied retroactively       $ (9,556)     $  1,043      $ (3,358)     $ (9,082)     $(10,894)
                                                 ================================================================
Pro-forma net income (loss) per share
assuming the accounting change is applied
retroactively, basic and diluted                 $  (0.38)     $   0.04      $  (0.17)     $  (0.60)     $  (0.83)
                                                 ================================================================
Shares used to calculate basic net income
(loss) per share                                   24,897        23,574        19,285        15,079        13,053
                                                 ================================================================
Shares used to calculate diluted net income
(loss) per share                                   24,897        24,483        19,856        15,079        13,053
                                                 ================================================================
Shares used to calculate pro-forma basic net
income (loss) per share                            24,897        23,574        19,285        15,079        13,053
                                                 ================================================================
Shares used to calculate pro-forma diluted
net income (loss) per share                        24,897        24,483        19,285        15,079        13,053
                                                 ================================================================
</TABLE>

(1)      Reflects the impact of the adoption of SAB 101 on revenue recognition
         effective January 1, 2000.


                                       26
<PAGE>



<TABLE>
<CAPTION>
                                                                            DECEMBER 31,
                                                      2001        2000         1999        1998         1997
                                                      ----        ----         ----        ----         ----
<S>                                               <C>          <C>           <C>         <C>          <C>
CONSOLIDATED BALANCE SHEET DATA

Cash and cash equivalents                         $ 10,095     $18,904       $6,746      $1,037       $8,660
Working capital                                      8,747      18,305        6,167         544        7,983
Total assets                                        11,051      20,000        7,463       2,086       10,546
Long term notes payable                                 45          26           --          --           --
Redeemable preferred stock                              --          --           30       1,511        7,533
Accumulated deficit                                (97,753)    (88,197)     (84,754)    (85,882)     (76,800)
Total stockholders' equity (deficit)                 9,485      18,770        6,256        (108)       2,031
</TABLE>

No cash dividends have been declared or paid by us since our inception.

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.

OVERVIEW

         In addition to 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 our 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. Our
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 in this 10-K.

         We are an ophthalmic product development company focused on developing
genetically based tools, for the diagnosis, prognosis and management of
glaucoma, as well as ophthalmic pharmaceutical products based on our proprietary
DuraSite(R) eyedrop-based drug delivery technology. Our retinal programs include
both a therapeutic agent and a retinal drug delivery technology.

         We are focusing our commercial efforts and research and development on
the following:

         o        launching our OcuGene(TM)glaucoma genetic test based on our
                  ISV-900 technology;
         o        expanding our ISV-900 technology for the diagnosis,
                  prognosis and management of glaucoma;
         o        ISV-205, a DuraSite formulation for the treatment of glaucoma;
         o        ISV-401, a DuraSite formulation of a novel antibiotic not
                  currently used in ophthalmology;
         o        ISV-403, a DuraSite formulation of a fourth generation
                  fluoroquinolone;
         o        ISV-014, a retinal drug delivery device; and
         o        treatments for diabetic retinopathy and macular degeneration.

            Since our inception through the end of 2001, we had not received any
revenues from the sale of our products, although we have received a small amount
of royalties from the sale of products using our licensed technology. However,
at the end of 2001, we commercially launched our OcuGene glaucoma genetic test
and in the beginning of 2002 we began to receive a small amount of revenues from
the sale of this test. With the exception of 1999, we have been unprofitable
since our inception due to continuing research and development efforts,
including preclinical studies, clinical trials and manufacturing of our product
candidates. We have financed our research and development activities and
operations primarily through private and public placement of our equity
securities and, to a lesser extent, from collaborative agreements.



                                       27
<PAGE>


CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES

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

         The following are items in our financial statements that require
significant estimates and judgments:

            Inventory. Our inventories are stated at the lower of cost or
market. The cost of the inventory is based on the first-in first-out method. If
the cost of the inventory exceeds the expected market value a provision is
recorded for the difference between cost and market. At December 31, 2001, our
inventories solely consisted of OcuGene kits.

            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 our policy to
write-off our fully depreciated assets.

         Additionally, we record 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.

         Revenue Recognition. We recognize up-front fees over the expected term
of the research and development services using the straight-line method. When
changes in the expected term of ongoing services are identified, the
amortization period for the remaining fees is appropriately modified.

         Revenue related to performance milestones is recognized when the
milestone is achieved based on the terms set forth in the related agreements.

         We directly reduce expenses for amounts reimbursed due to cost sharing
agreements. We recognize the received cost sharing payments when persuasive
evidence of an arrangement exists, the services have been rendered, the fee is
fixed or determinable and collectibility is reasonably assured.

         We receive royalties from licensees based on third-party sales and the
royalties are recorded as earned in accordance with contract terms, when third
party results are reliably measured and collectibility is reasonably assured.

         Research and Development (R&D) Expenses. R&D expenses include salaries,
benefits, facility costs, services provided by outside consultants and
contractors, administrative costs and materials for research and development
activities. We also fund research at a variety of academic institutions based on
agreements that are generally cancelable. We recognize such costs as they are
incurred.

         General and Administrative (G&A) Expenses. G&A expenses include
salaries, benefits, facility costs, services provided by outside consultants and
contractors, investor relations, financial reporting, materials and other
expenses related to general corporate activities.




                                       28
<PAGE>


RESULTS OF OPERATIONS

            We had total net revenues of $5,000, $4,513,000, and $4,760,000 for
the years ended December 31, 2001, 2000 and 1999, respectively. Our net revenues
in 2001 only represented royalties while the net revenues in 2000 included
licensing revenue. Our net revenues in 1999 were attributable to the ISV-900
license fee received from Pharmacia. The net revenues in 2000 included the
impact of the implementation of Staff Accounting Bulletin 101 (SAB 101). SAB 101
included new guidelines from the Securities and Exchange Commission regarding
revenue recognition of non-refundable up-front license fees, such as the
$4,750,000 net licensing fee we received from Pharmacia in 1999. To implement
SAB 101, the net licensing fee from Pharmacia, previously recognized as revenue
in 1999, was deferred in our cumulative effect of accounting change and was
amortized over the term of the ongoing research and development activities. As a
result, we recorded a charge for the cumulative effect of the change in
accounting principle of $4,486,000 as of January 1, 2000. Upon the termination
of the related licensing agreement in December 2000, the remaining unamortized
deferred revenue was recognized. Amortization of revenue deferred in the
cumulative effect was $4,486,000 of the total net revenues for 2000.

            We earned royalty income of $5,000, $27,000 and $10,000 for the
years ended December 31, 2001, 2000 and 1999, respectively, from sales of
AquaSite by CIBA Vision and Global Damon who began selling AquaSite in Korea in
2000. We have not relied on royalty revenues to fund our activities, and through
December 31, 2001 we have received revenues from the sale of products.

            Our R&D expenses in 2001 increased 13% to $7.3 million from $6.5
million in 2000. R&D expenses in 2000 increased 14% to $6.5 million from $5.6
million in 1999. The increase in 2001 related primarily to the cost of preparing
for, and filing, an IND and the subsequent initiation of clinical studies for
the ISV-401 antibiotic program. Additionally, the cost of filing and maintaining
our owned and licensed patents increased as our patent portfolio grew. The
increase in 2000 primarily related to outside laboratory services supporting the
ISV-401, 402 and 403 antibiotic programs and a 13% increase in R&D headcount.

            In 2001, our R&D cost reimbursements decreased 85% to $0.7 million
from $4.8 million in 2000. This reflected the termination of both the ISV-900
and the ISV-205 licenses by Pharmacia in 2000 and 2001, respectively. In 2000,
cost reimbursement increased 13% to $4.8 million from $4.2 million in 1999. This
increase reflects cost reimbursement by Pharmacia for the ISV-900 and ISV-402
programs in 2000, in addition to the ISV-205 program.

            Our R&D activities can be separated into two major segments,
research and clinical development. Research includes activities involved in
evaluating a potential product and the related pre-clinical testing. Clinical
development includes activities related to filings with the FDA and the related
human clinical testing required to obtain marketing approval for a potential
product. We estimate that the following represents the approximate cost of these
activities for 2001, 2000 and 1999 (in thousands):

<TABLE>
<CAPTION>
                                              2001             2000            1999
                                             ------           ------          ------
<S>                                          <C>              <C>             <C>
Research                                     $5,050           $4,670          $4,005
Clinical development                          2,273            1,783           1,640
                                             ------           ------          ------
Total research and development               $7,323           $6,453          $5,645
                                             ======           ======          ======
</TABLE>

         Due to our limited personnel and number of projects that we are
developing, our personnel are involved in a number of projects at the same
time. Accordingly, the majority of our R&D expenses are not linked to a specific
project but are allocated across projects, based on personnel time expended on
each project. Accordingly, the allocated costs may not reflect the actual costs
of each project.

         The increase in our research activities from 1999 through 2001 reflects
the addition of antibiotic programs to our portfolio and the expansion of our
glaucoma genetics research projects. A portion of these activities is conducted
through research agreements with academic centers in the U.S., Canada, Europe
and Japan. Expenses for such activities are expensed when incurred as these
research agreements may be terminated when the appropriate notice is provided as
required in each agreement.



                                       29
<PAGE>


         The increase in our clinical development expenses from 1999 through
2001 reflects the initiation of clinical studies on our ISV-401 antibiotic
project, the conduct of clinical studies to support our glaucoma genetics
projects and the increased number of projects we have filed with the FDA.

            Most of our projects are in the early stages of the product
development cycle and may not result in commercial products. Please see
"Products and Product Candidates" in the business section for further
information as to what stage in the development cycle each project is in as of
December 31, 2001. Projects in development may not proceed into clinical trials
due to a number of reasons even though the project looks promising early in the
process. Once a project reaches clinical studies it may be found to be
ineffective or there may be harmful side effects. Additionally, during the
development cycle, other companies may develop new treatments that decrease the
market potential for our project and we may decide not to proceed. Other factors
including the cost of manufacturing at a commercial scale and the availability
of quality manufacturing capabilities could negatively impact our ability to
bring the project to the market. Also, our business strategy is to license
projects to third parties to complete the development cycle and to market and
sell the product. These collaborative arrangements may either speed the
development or they may extend the anticipated time to market. For a more
detailed review of these uncertainties, please see the risks discussed under
"Risk Factors" in Item 1 of this Report, as well as those discussed elsewhere in
the Report. Because of these factors, as well as others, we cannot be certain
if, or when, our projects in development will complete the development cycle and
be commercialized.

         General and administrative expenses increased 36% in 2001 to $3.5
million from $2.6 million in 2000, and increased 13% in 2000 to $2.6 million
from $2.3 million in 1999. The increase in 2001 is primarily related to $0.9
million we expended on preparing for, and executing, the commercial launch of
the OcuGene glaucoma genetic test. The increase in 2000 from 1999 mainly
reflected the increase in finance, investor relations and public relations
consulting and activities.

            Net interest and other income was $572,000, $791,000, and $85,000 in
2001, 2000, and 1999, respectively. These fluctuations are due principally to
changes in average cash balances and decreased interest rates. Interest earned
in the future will be dependent on our funding cycles and prevailing interest
rates.

         We had a net loss for the years ended December 31, 2001 and 2000 of
$9.6 million and $3.4 million, respectively, and net income of $1.1 million in
1999. The increase in the net loss in 2001 mainly reflects the 85% decrease in
cost reimbursement from Pharmacia, the higher cost of our development projects
and the launch of the OcuGene glaucoma genetic test. 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 Pharmacia.

LIQUIDITY AND CAPITAL RESOURCES

            Through 1995, we financed our operations primarily through private
placements of preferred stock totaling approximately $32.0 million and an
October 1993 initial public offering of Common Stock, which resulted in net
proceeds of approximately $30.0 million. After 1995, we financed our operations
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 with B&L, we received a total of $2.0 million from the sale
of Common Stock in August 1996 and 1997. In September 1997, we 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, we entered into a transaction with Pharmacia from which we
received a total of $3.5 million from the sale of Common Stock in January and
September. In November 1999, we entered into another transaction with Pharmacia
from which we received a $5.0 million licensing fee and, in January 2000,
received $2.0 million from the sale of Common Stock. In April 2000, we received
$0.6 million from the exercise of warrants issued as part of the 1995 private
placement. In May 2000, we completed a private placement of Common Stock and
warrants from which we raised net proceeds of approximately $13.0 million.
During 2000 and 2001, we also received $243,000 and $71,000, respectively, from
the issuance of Common Stock related to the exercise of stock options and sales
of Common Stock through our Employee Stock Purchase Plan. At December 31, 2001,
we had cash and cash



                                       30
<PAGE>


equivalents totaling $10.1 million. It is our 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 years ended December 31, 2001 and 2000, cash used for operating
activities and to acquire capital equipment, was $8.9 million and $3.6 million,
respectively. For the year ended December 31, 1999, cash provided by operating
activities, less cash used to acquire capital equipment, was $1.8 million. Of
those amounts, $474,000, $450,000, and $88,000 were for additions to laboratory
and other property and equipment in 2001, 2000, and 1999, respectively. In 1999,
we sold the equipment and improvements we had installed at B&L's Tampa facility,
to B&L for $410,000, which resulted in a loss on the sale of $107,000.

         Our future capital expenditures and requirements will depend on
numerous factors, including the progress of our research and development
programs and preclinical and clinical testing, the time and costs involved in
obtaining regulatory approvals, our ability to establish additional
collaborative arrangements, changes in our existing collaborative and licensing
relationships, the cost of filing, prosecuting, defending and enforcing patent
claims and other intellectual property rights, competing technological and
market developments, 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, we wrote-off our fully depreciated assets. This
resulted in a decrease in both property and equipment and accumulated
depreciation of $57,000, $44,000 and $300,000 in 2001, 2000 and 1999,
respectively, with no change in net property and equipment.

         As of December 31, 2001, our accumulated deficit was approximately
$97.8 million. There can be no assurance that we will ever achieve or be able to
maintain either significant revenues from product sales or profitable
operations.

            We do not anticipate any material capital expenditures to be
incurred for environmental compliance in fiscal year 2002. Based on our good
environmental compliance record to date, and our current compliance with
applicable environmental laws and regulations, environmental compliance is not
expected to have a material adverse effect on our operations.

         Our commitments as of December 31, 2001 were as follows (in thousands):

<TABLE>
<CAPTION>
                                                   Due in     Due in      Due in    Due in      Due in
                                         Total       2002       2003       2004      2005        2006
                                         ------     ------     ------     ------     ------     ------
<S>                                      <C>        <C>        <C>        <C>        <C>        <C>
       Capital lease obligations (1)     $   86     $   38     $   38     $   10     $   --     $    -
       Operating leases (2)               3,582        658        694        718        743        769
       Research and development
        agreements (3)                      343        343          -          -          -          -
       Licensing agreements (4)             160         15         15         30         50         50
                                         ------     ------     ------     ------     ------     ------
       Total commitments                 $4,171     $1,054     $  747     $  758     $  793     $  819
                                         ======     ======     ======     ======     ======     ======
</TABLE>

(1)      We lease certain laboratory equipment under capital lease agreements,
         which expire through 2005.

(2)      We lease our facilities under a non-cancelable operating lease that
         expires in 2006.

(3)      We have research and development agreements with academic centers in
         the U.S., Canada, Europe and Japan. The terms of most of these
         agreements is one year with the option to extend the term with the
         consent of both the academic center and us.

(4)      We have certain licensing agreements that require minimum royalty
         payments for the life of the licensed patents. The life of the patents
         which may be issued and covered by the licensing agreements cannot be
         determined at this time, but the minimum royalties due under such
         agreements is approximately $60,000 per year after 2006 until the
         expiration of the related patents.

            We believe our cash and cash equivalents will be sufficient to meet
our operating expenses and cash requirements through 2002. We will require
substantial additional funds prior to reaching sustained profitability, and we
may seek private or public equity investments, future collaborative agreements,
and possibly research funding to meet such needs. Even if we do not have an
immediate need for additional cash, we may seek access to the private or public
equity markets if and when we believe conditions are favorable. However, there
is no assurance that additional funds will be available to us to finance our
operations, on acceptable terms, or at all.


                                       31
<PAGE>


RECENT ACCOUNTING PRONOUNCEMENTS

         In June 2001, the Financial Accounting Standards Board or FASB, issued
Statements of Financial Accounting Standards No. 141, Business Combinations, and
No. 142, Goodwill and other Intangible Assets, effective for fiscal years
beginning after December 15, 2001. Under the new rules, goodwill and intangible
assets deemed to have indefinite lives will no longer be amortized but will be
subject to an annual impairment test in accordance with the Statements. Other
intangible assets will continue to be amortized over their useful lives. We do
not expect that the adoption of Statement 142 will have a material effect on our
consolidated financial position or results of operations.

            In October 2001, FASB issued Statements of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, effective for fiscal years beginning after December 15, 2001, with
transition provisions for certain matters. The FASB's new rules on asset
impairment supersedes FASB Statement No. 121, Accounting for Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and provide a
single accounting model for long-lived assets to be disposed of. We do not
expect that the adoption of Statement 144 will have a material effect on our
consolidated financial position or results of operations.

ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK

         The following discusses our exposure to market risk related to changes
in interest rates.

         We invest our excess cash in investment grade, interest-bearing
securities. At December 31, 2001, we had $10.1 million invested in money market
mutual funds. While a hypothetical decrease in market interest rates by 10
percent from the December 31, 2001 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:

<TABLE>
<CAPTION>
                                                                              Page
                                                                              ----

<S>                                                                         <C>
Report of Independent Auditors                                                 33

Consolidated Statements of Operations                                          34
Years Ended December 31, 2001, 2000 and 1999

Consolidated Balance Sheets - December 31, 2001 and 2000                       35

Consolidated Statements of Stockholders' Equity                                36
Years ended December 31, 2001, 2000 and 1999

Consolidated Statements of Cash Flows                                          37
Years Ended December 31, 2001, 2000 and 1999

Notes to Consolidated Financial Statements                                  38-48
</TABLE>




                                       32
<PAGE>


                REPORT OF ERNST & YOUNG LLP, 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, 2001 and 2000, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 2001. 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, 2001 and 2000, and the consolidated results
of its operations and its cash flows for each of the three years in the period
ended December 31, 2001, in conformity with accounting principles generally
accepted in the United States.


                                                       /s/Ernst & Young LLP

Palo Alto, California
February 1, 2002




                                       33
<PAGE>








                           INSITE VISION INCORPORATED

                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                                                                      Year Ended December 31,
(in thousands, except per share amounts)                                        2001           2000          1999
-------------------------------------------------------------------------------------------------------------------
<S>                                                                        <C>               <C>           <C>
Revenues:
 License fee                                                                   $      -      $  4,486      $  4,750
 Royalties                                                                            5            27            10
                                                                               --------      --------      --------
 Total                                                                                5         4,513         4,760
Operating expenses:
 Research and development                                                         7,323         6,453         5,645
 Cost reimbursement                                                                 713         4,779         4,248
                                                                               --------      --------      --------
 Research and development, net                                                    6,610         1,674         1,397
 Selling, general and administrative                                              3,523         2,584         2,293
                                                                               --------      --------      --------
 Total                                                                           10,133         4,258         3,690
                                                                               --------      --------      --------
Income (loss) from operations                                                   (10,128)          255         1,070
Interest and other income (expense), net                                            572           791            85
                                                                               --------      --------      --------
Net income (loss) before taxes                                                   (9,556)        1,046         1,155
Income tax provision                                                                  -             -             5
                                                                               --------      --------      --------
Net income (loss) before cumulative effect of accounting change                  (9,556)        1,046         1,150
Cumulative effect of accounting change                                                -        (4,486)            -
                                                                               --------      --------      --------
Net income (loss)                                                                (9,556)       (3,440)        1,150
Non-cash preferred dividend                                                           -             3            22
                                                                               --------      --------      --------
Net income (loss) applicable to common stockholders                            $ (9,556)     $ (3,443)     $  1,128
                                                                               ========      ========      ========

Basic income (loss) per share:

Net income (loss) per share applicable to common stockholders
before cumulative effect of accounting change                                  $  (0.38)     $   0.04      $   0.06
Cumulative effect of accounting change                                                -         (0.19)            -
                                                                               --------      --------      --------
Net income (loss) per share applicable to common stockholders                  $  (0.38)     $  (0.15)     $   0.06
                                                                               ========      ========      ========

Diluted income (loss) per share:

Net income (loss) per share applicable to common stockholders
before cumulative effect of accounting change                                  $  (0.38)     $   0.04      $   0.06
Cumulative effect of accounting change                                                -         (0.18)            -
                                                                               --------      --------      --------
Net income (loss) per share applicable to common stockholders                  $  (0.38)     $  (0.14)     $   0.06
                                                                               ========      ========      ========

Pro-forma amounts assuming the accounting change is applied retroactively:

Net income (loss) applicable to common stockholders                            $ (9,556)     $  1,043      $ (3,358)
                                                                               ========      ========      ========
Net income (loss) per share applicable to common stockholders, basic
 and diluted                                                                   $  (0.38)     $   0.04      $  (0.17)
                                                                               ========      ========      ========

Shares used to calculate basic net income (loss) per share                       24,897        23,574        19,285
                                                                               ========      ========      ========
Shares used to calculate diluted net income (loss) per share                     24,897        24,483        19,856
                                                                               ========      ========      ========

Shares used to calculate pro-forma basic net income (loss) per share             24,897        23,574        19,285
                                                                               ========      ========      ========
Shares used to calculated pro-forma diluted net income (loss) per share          24,897        24,483        19,285
                                                                               ========      ========      ========
</TABLE>


See accompanying notes to consolidated financial statements.



                                       34
<PAGE>



                         INSITE VISION INCORPORATED

                         CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>

                                                                                          December 31,
(in thousands, except share and per share amounts)                                    2001           2000
------------------------------------------------------------------------------------------------------------
<S>                                                                                 <C>            <C>
ASSETS
Current assets:

Cash and cash equivalents                                                           $  10,095      $  18,904
Inventory                                                                                  70              -
Prepaid expenses and other current assets                                                 103            605
                                                                                    ---------      ---------
Total current assets                                                                   10,268         19,509

Property and equipment, at cost:
 Laboratory and other equipment                                                         1,056            647
 Leasehold improvements                                                                    68              9
 Furniture and fixtures                                                                     3              3
                                                                                    ---------      ---------
                                                                                        1,127            659
Accumulated depreciation                                                                  344            168
                                                                                    ---------      ---------
                                                                                          783            491
                                                                                    ---------      ---------
Total assets                                                                        $  11,051      $  20,000
                                                                                    =========      =========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
 Accounts payable                                                                   $     344      $     181
 Accrued liabilities                                                                      356            376
 Accrued compensation and related expense                                                 821            647
                                                                                    ---------      ---------
Total current liabilities                                                               1,521          1,204

Long-term notes payable                                                                    45             26

Commitments (Note 3)

Redeemable preferred stock, $0.01 par value
  5,000,000 shares authorized; no shares
  issued and outstanding at December 31, 2001 and 2000                                      -             -

Common stockholders' equity:
 Common stock, $0.01 par value, 60,000,000 shares authorized; 24,930,350 issued
  and outstanding at December 31, 2001;
  24,853,767 issued and outstanding at December 31, 2000;                                 249            248
 Additional paid-in capital                                                           107,246        106,976
 Notes receivable from stockholder                                                       (257)          (257)
 Accumulated deficit                                                                  (97,753)       (88,197)
                                                                                    ---------      ---------
Common stockholders' equity                                                             9,485         18,770
                                                                                    ---------      ---------
Total liabilities, redeemable preferred stock and stockholders' equity              $  11,051      $  20,000
                                                                                    =========      =========
</TABLE>


See accompanying notes to consolidated financial statements.




                                       35
<PAGE>


                           INSITE VISION INCORPORATED

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                              NOTE
                                                             ADDITIONAL     RECEIVABLE                  TOTAL
                                                  COMMON      PAID IN         FROM      ACCUMULATED  STOCKHOLDERS'
 (dollars in thousands)                           STOCK       CAPITAL      STOCKHOLDER    DEFICIT       EQUITY
------------------------------------------------------------------------------------------------------------------
<S>                                              <C>          <C>          <C>           <C>           <C>
BALANCES, JANUARY 1, 1999                        $    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
Issuance of 1,471,416 shares of common
 stock from conversion of preferred shares             15        1,488            -             -           1,503
Non-employee stock option compensation                  -          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
Issuance of 723,195 shares of common stock              -
 to Pharmacia & Upjohn in private placements            7        1,993            -             -           2,000
Issuance of 192,308 shares of common stock
 from exercise of warrants                              2          623            -             -             625
Issuance of 3,349,722 shares of common stock
 in a private placement                                33       13,007            -             -          13,040
Issuance of 261,582 shares of common stock
 from exercise of options and employee stock
 purchase plan                                          3          316         (257)            -              62
Issuance of 28,037 shares of common
 stock from conversion of preferred stock               -           33            -             -              33
Non-employee stock option compensation                  -          197            -             -             197
Net loss and comprehensive loss                         -            -            -        (3,440)         (3,440)
Non-cash preferred dividend                             -            -            -            (3)             (3)
                                                 -----------------------------------------------------------------
Net loss applicable to common stockholders              -            -            -        (3,443)         (3,443)
                                                 -----------------------------------------------------------------
BALANCES, DECEMBER 31, 2000                      $    248     $106,976     $   (257)     $(88,197)     $   18,770
Issuance of 76,583 shares of common stock
 from exercise of options and employee stock
 purchase plan                                          1           70            -             -              71
Non-employee stock option compensation                  -          200            -             -             200
Net loss and comprehensive loss                         -            -            -        (9,556)         (9,556)
                                                 -----------------------------------------------------------------
BALANCES, DECEMBER 31, 2001                      $    249     $107,246     $   (257)     $(97,753)     $    9,485
                                                 =================================================================
</TABLE>

See accompanying notes to consolidated financial statements.




                                       36
<PAGE>



                           INSITE VISION INCORPORATED

                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                                            Year Ended December 31,
(in thousands)                                                      2001            2000             1999
-------------------------------------------------------------------------------------------------------------
<S>                                                             <C>            <C>               <C>
OPERATING ACTIVITIES:

Net income (loss)                                               $     (9,556)  $      (3,440)    $      1,150
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
 Depreciation and amortization                                           233             117              311
 Stock based compensation                                                200             197              194
 Loss on sale of property and equipment                                    -               -              107
 Changes in:
  Prepaid expenses and other current assets                              432              (7)            (408)
  Accounts payable and accrued liabilities                               292              20              494
                                                                ------------   -------------     ------------
Net cash provided by (used in) operating activities                   (8,399)         (3,113)           1,848

INVESTING ACTIVITIES:

Sale of property and equipment                                             -               -              410
Purchases of property and equipment                                     (474)           (450)             (88)
                                                                ------------   -------------     ------------
Net cash provided by (used in) investing activities                     (474)           (450)             322

FINANCING ACTIVITIES:

Payment of capital lease obligation                                       (7)             (6)               -
Issuance of common stock, net                                             71          15,727            3,539
                                                                ------------   -------------     ------------
Net cash provided by financing activities                                 64          15,721            3,539

Net increase (decrease) in cash and cash equivalents                  (8,809)         12,158            5,709
Cash and cash equivalents, beginning of period                        18,904           6,746            1,037
                                                                ------------   -------------     ------------
Cash and cash equivalents, end of period                        $     10,095   $      18,904     $      6,746
                                                                ============   =============     ============
Supplemental disclosures:
 Non-cash preferred dividends                                   $          -   $           3     $         22
                                                                ============   =============     ============
 Non-cash conversion of redeemable preferred stock
  to common stock                                               $          -   $          33     $      1,503
                                                                ============   =============     ============
 Capital lease obligation incurred                              $         51   $          39     $          -
                                                                ============   =============     ============
</TABLE>


See accompanying notes to consolidated financial statements.



                                       37
<PAGE>


                           InSite VISION INCORPORATED

                   Notes to Consolidated Financial Statements
                                December 31, 2001

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.

         The Company's consolidated financial statements have been presented on
a basis that contemplates the realization of assets and the satisfaction of
liabilities in the normal course of business. Except for 1999, the Company has
incurred losses since its inception and the Company expects to incur
substantial additional developement costs prior to reaching sustained
profitability, including costs related to clinical trials and manufacturing
expenses. The Company is actively pursuing various sources of additional funds,
including new license and collaboration agreements and securing additional
equity financing, and believes that sufficient funding will be available to
meet its projected operating and capital requirements through December 31, 2002.
There is no assurance that such additional funds will be available for the
Company to finance its operations on acceptable terms, if at all.  If such
funds are not available, management will be required to delay, scale back or
eliminate one or more of its research, discovery or developement programs.
Such actions may include significantly reducing its anticipated level of
expenditures and/or the sale of rights to certain of its technologies, product
candidates or products. The financial statements do not include any adjustments
to reflect the possible future effects on the recoverability and classification
of assets or the amounts and classification of liabilities that may result from
the outcome of this uncertainty.


         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, 2001 and 2000,
cash equivalents consisted of money market funds. All cash and cash equivalents
are available for sale and stated at fair market value. The Company considers
highly liquid investments with original maturities of three months or less as
cash equivalents.

         Inventory. The Company states its inventories at the lower of cost or
market. The cost of the inventory is based on the first-in first-out method. If
the cost of the inventory exceeds the expected market value a provision is
recorded for the difference between cost and market. The Company's inventories
consisted of OcuGene glaucoma genetic test kits at December 31, 2001.

            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 2001 and 2000 of
$57,000 and $44,000, respectively, with no change in net property and equipment.
The amortization of the cost of capital lease assets is included in depreciation
expense.

         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 was included in
the 1998 research and development expense. In July 1999, the Company sold this
equipment and recorded a loss of $107,000 which is included in the 1999 research
and development expense in the Consolidated Statements of Operations.




                                       38
<PAGE>


         Revenue Recognition. Effective January 1, 2000, in accordance with
Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements"
("SAB 101"), the Company changed its method of accounting for up-front
technology license fees when ongoing research and development services will be
performed. Previously, on the only such arrangement it had executed, the Company
had recognized the up-front fee as revenue upon the effective date of the
arrangement. Under the new accounting method adopted retroactive to January 1,
2000, (a) the Company recognized the up-front fee over the expected term of the
research and development services, which was 36 months, using the straight-line
method. As a result of the termination of this arrangement in December 2000, the
Company recognized the then remaining deferred revenue in the fourth quarter of
2000. The cumulative effect of the change on prior years resulted in a charge to
operations of $4,486,000, which is included in net loss for the year ended
December 31, 2000. The effect of the change on the year ended December 31, 2000
was to increase income before the cumulative effect of the accounting change by
$4,486,000 ($.19 per share). The pro forma amounts presented in the statement of
operations were calculated assuming the accounting change was made retroactively
to prior periods.

         Accounting for Royalties. Royalties from licensees are based on
third-party sales and are recorded as earned in accordance with contract terms,
when third party results are reliably measured and collectibility is reasonably
assured.

            Accounting for Cost Sharing Agreements. The Company directly reduces
expenses for amounts reimbursed pursuant to cost sharing agreements. During
2001, 2000 and 1999, research and development expenses were reduced by $713,000,
$4,779,000 and $4,248,000, respectively, for costs reimbursed primarily by
Pharmacia Corporation (Pharmacia) and another research collaboration partner
under the terms of the collaborations described in Note 2.

         In accordance with SAB 101, the Company recognizes the received cost
sharing payments when persuasive evidence of an arrangement exists, the services
have been rendered, the fee is fixed or determinable and collectibility is
reasonably assured.

         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.

            In April 2000, the Financial Accounting Standards Board issued
Interpretation No. 44 (FIN 44), "Accounting for Certain Transactions Involving
Stock Compensation: An Interpretation of APB No. 25." The Company has adopted
the provisions of FIN no. 44. The adoption of these provisions did not
materially impact the Company's results of operations. Note 6 provides the
pro-forma effects on reported net income and earnings per share for 2001, 2000
and 1999 based on the fair value of options and shares granted as prescribed by
Statement 123.

            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
$200,000, $197,000 and $194,000 in 2001, 2000 and 1999, respectively.




                                       39
<PAGE>

            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 2001 and 2000, 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)                               2001         2000           1999
--------------------------------------------------------------------------------------------------------
<S>                                                                 <C>           <C>           <C>
Numerator:
Net income (loss) before cumulative effect of accounting change     $ (9,556)     $  1,046      $  1,150
Cumulative effect of accounting change                                    --        (4,486)           --
                                                                    ------------------------------------
Net income (loss)                                                     (9,556)       (3,440)        1,150
Non-cash preferred dividend                                               --            (3)          (22)
                                                                    ------------------------------------
Net earnings (loss) applicable to common stockholders               $ (9,556)  $    (3,443)     $  1,128
                                                                    ====================================

Denominator:
Denominator for basic earnings (loss) per share -
weighted-average shares outstanding                                   24,897        23,574        19,285

Effect of diluted securities:
Employee & director stock options, warrants and preferred
stock warrant (determined using the treasury stock method)                --           909           260
Convertible preferred stock (using the if-converted method)               --            --           311
                                                                    ------------------------------------
Denominator for diluted earnings per share -
weighted-average shares outstanding                                   24,897        24,483        19,856
                                                                    ------------------------------------
Basic earnings (loss) per share                                     $  (0.38)     $  (0.15)     $   0.06
                                                                    ====================================
Diluted earnings (loss) per share                                   $  (0.38)     $  (0.14)     $   0.06
                                                                    ====================================
--------------------------------------------------------------------------------------------------------
</TABLE>

         Due to the loss from operations, earnings (loss) per share for 2001 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 343,000 common equivalent shares related to the
outstanding stock options and warrants (determined using the treasury stock
method).

         Accounting for Materials Purchased for Research and Development. The
Company expenses materials for research and development activities when the
obligation for the items is incurred.

         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.

         Recent accounting pronouncements. In June 2001, the Financial
Accounting Standards Board or FASB, issued Statements of Financial Accounting
Standards No. 141, Business Combinations, and No. 142, Goodwill and other
Intangible Assets, effective for fiscal years beginning after December 15, 2001.
Under the new rules, goodwill and intangible assets deemed to have indefinite
lives will no longer be amortized but will be subject to an annual impairment
test in accordance with the Statements. Other intangible assets will continue to
be amortized over their useful lives. The



                                       40
<PAGE>


Company does not expect that the adoption of Statements 141 and 142 will have a
material effect on its consolidated financial position or results of operations.

         In October 2001, FASB issued Statements of Financial Accounting
Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, effective for fiscal years beginning after December 15, 2001, with
transition provisions for certain matters. The FASB's new rules on asset
impairment supersedes FASB Statement No. 121, Accounting for Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and provide a
single accounting model for long-lived assets to be disposed of. The Company
does not expect that the adoption of Statement 144 will have a material effect
on its consolidated financial position or results of operations.

2.       LICENSES

         In April 2001, the Company signed a licensing agreement with SSP Co.,
Ltd. of Tokyo, Japan ("SSP"), for two fourth generation fluoroquinolones, which
have indicated increased sensitivity against gram positive and negative
bacteria. The Company has exclusive rights to any products developed using
these compounds, with the exception of Japan, where SSP will retain the rights
and the rest of Asia, where the Company will share joint rights with SSP. One of
the compounds, SS734, is currently under development under the designation
ISV-403.

         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
Pharmacia an exclusive worldwide royalty-bearing license to its ISV-900
technology for diagnostic, prognostic and therapeutic applications in the area
of glaucoma. The transaction included the following payments from Pharmacia (i)
a $5.0 million licensing fee, (ii) up to $5.0 million in research and
development payments over a three year period, (iii) royalties on product sales,
and (iv) up to $3 million if certain milestones were achieved. In December 2000,
the Company and Pharmacia terminated the ISV-900 license agreement and the
related credit agreement. All rights that had been granted to Pharmacia were
returned to the Company and any future payment obligations by Pharmacia were
cancelled.

         The Company recognized $4.8 million as license revenue from Pharmacia
during the fourth quarter of 1999 ($264,000 on a pro-forma basis), 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 Pharmacia for commercialization.

         The stock purchase agreement provided for a $2.0 million equity
investment by Pharmacia 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 provided for a standstill period of thirty (30) months
during which Pharmacia 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.

         The credit agreement with Pharmacia which expired unused, provided for
a $4 million revolving line of credit that would have been available to the
Company on November 11, 2001 for a period of three (3) years.

         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 that uses the
Company's DuraSite technology and demulcents for the symptomatic treatment of
dry eye.



                                       41
<PAGE>


         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 Pharmacia an
exclusive worldwide license to ISV-205 for the treatment of glaucoma. The
transaction also called for equity investments from Pharmacia of $3,500,000
for which they received 1,942,419 shares of common stock in February 1999 and
September 1999. In May 2001, Pharmacia Corporation terminated the ISV-205
licensing agreement. All global development and commercialization rights that
had been granted to Pharmacia were returned to the Company at the end of a
ninety-day termination period and any future payment obligations by Pharmacia
were cancelled.

         The Company has a license agreement with CIBA Vision, an ophthalmic
company which is an affiliate of 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 Company also has
a license agreement with Global Damon, and a manufacturing agreement with Kukje,
to produce and sell AquaSite in Korea. Both of the license agreements require
royalty payments on net sales of the licensed products. The Company recognized
$5,000, $27,000 and $10,000 of royalty revenue for sales of AquaSite in 2001,
2000 and 1999, respectively.

3.       LEASE COMMITMENTS

            The Company leases its facilities under non-cancelable operating
lease agreements that expire in 2006. Rent expense was $445,000, $430,000, and
$431,000 for 2001, 2000 and 1999, respectively. The 2001, 2000 and 1999 rent
expense reflects $74,000, $64,000 and $63,000, respectively, received by the
Company related to the January 1999 sublease of a portion of the Company's
facility. The sublease continues through February 2002 and provides for annual
payments of $12,400 in 2002.

         Capital lease obligations represent the present value of future rental
payments under capital lease agreement for laboratory equipment. The original
cost and accumulated amortization on the equipment under capital leases is
$103,600 and $20,000, respectively, at December 31, 2001 and $39,900 and
$10,000, respectively, at December 31, 2000.

         Future minimum payments under capital and operating leases are as
follows:

<TABLE>
<CAPTION>
                ----------------------------------------------------------------------------------------------
                                                                                  Capital            Operating
                Year ending December 31,                                           Leases             Leases
                ----------------------------------------------------------------------------------------------
<S>                                                                               <C>              <C>
                2002                                                               $37,665          $  657,988
                2003                                                                38,162             693,826
                2004                                                                10,052             718,113
                2005                                                                    --             743,253
                2006                                                                    --             769,245
                                                                                   -------          ----------
                Total minimum lease payments                                        85,879          $3,582,425
                                                                                                    ==========
                Amount representing interest                                         8,619
                                                                                   -------
                Present value of net minimum lease payments                         77,260
                Current portion                                                     32,197
                                                                                   -------
                Long-term portion                                                   45,063
                                                                                   -------
                ----------------------------------------------------------------------------------------------
</TABLE>



4.       INCOME TAXES


                                       42
<PAGE>


         Significant components of the Company's deferred tax assets for federal
and state income taxes as of December 31, 2001 and 2000 are as follows (in
thousands):

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------
                                                                                         2001                  2000
-------------------------------------------------------------------------------------------------------------------
<S>                                                                                <C>                   <C>
Deferred tax assets:
 Net operating loss carryforwards                                                  $   27,106            $   25,093
 Tax credit carryforwards                                                               4,742                 3,939
 Capitalized research and development                                                   9,014                 7,723
 Depreciation                                                                             468                   502
 Other                                                                                    275                   175
                                                                                   ----------            ----------
 Total deferred tax assets                                                             41,605                37,432
Valuation allowance                                                                   (41,605)              (37,432)
                                                                                   ----------            ----------
Net deferred tax assets                                                            $       -             $        -
                                                                                   ==========            ==========
-------------------------------------------------------------------------------------------------------------------
</TABLE>

         The valuation allowance increased by $4.2 million and $1.3 million
during the years ended December 31, 2001 and 2000, respectively.

         At December 31, 2001, the Company has net operating loss carryforwards
for federal income tax purposes of approximately $74.0 million, which expire in
the years 2002 through 2021 and federal tax credits of approximately $2.8
million which expire in the years 2002 through 2021. The Company also has net
operating loss carryforwards for state income tax purposes of approximately
$28.0 million which expire in the years 2002 through 2011, and state research
and development tax credits of approximately and $1.7 million which carryforward
indefinitely.

         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 was 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 was 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 were 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 also included a 6%
per annum premium, which accrued from the date of issuance until the date of
conversion. Three years after issuance, any remaining unconverted preferred
shares would have automatically been converted into common stock. All of the
outstanding shares of Series A Preferred have been converted into 5,089,250
shares of common stock. In September 1997, the Company also issued a warrant to
purchase 70 shares of Series A Preferred that was subject to the same conversion
terms and premium as described above. The warrant was exercised in September
2000, and immediately converted by the holder, using their net exercise right,
into 28,037 shares of common stock. Holders of the Series A Preferred had 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 this private placement, 6,000,000
shares of common stock had been reserved for issuance to the holders of the
Series A Preferred of which 910,750 shares remain reserved at December 31, 2001.



                                       43
<PAGE>


         For the years ended December 31, 2000 and 1999, in accordance with SEC
Rules and Regulations, the Company reported non-cash preferred dividends of
$3,000, and $22,000, 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>
<CAPTION>
--------------------------------------------------------------------
                                                              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
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
Non-cash preferred dividend                                        3
Exercise of 70 warrants for Series A Preferred Stock and
  conversion into common stock                                   (33)
                                                             -------
Balance at December 31, 2000                                 $    --
                                                             =======
--------------------------------------------------------------------
</TABLE>

6.       COMMON STOCKHOLDERS' EQUITY

            In February 2001, the Company filed a shelf registration for the
issuance of up to $40.0 million of Common Stock or securities convertible into
or exercisable into the Company's Common Stock. The Common Stock, if issued,
will be sold through a placement agent. As of December 31, 2001 no shares had
been issued under this shelf registration.

         In May 2000, the Company received net proceeds of $13,040,000 from a
private placement of 3,349,722 shares of Common Stock and warrants. Each warrant
entitles its holder to purchase shares of the Company's Common Stock for $5.64
per share until April 2004. As of December 31, 2001, warrants to purchase
1,172,381 shares of Common Stock were outstanding. In connection with this
private placement the Company also issued the placement agent warrants to
purchase 334,972 shares of the Company's Common Stock for $5.01 per share until
April 2004, all of which were outstanding as of December 31, 2001. Also, the
Company issued warrants to a placement agent to purchase 150,000 shares of the
Company's Common Stock for $5.25 per share until March 2004, all of which were
outstanding as of December 31, 2001. These warrants were valued using a
Black-Scholes option pricing model with the following assumptions:risk-free
interest rate of 4.85%, volatility of 1.0162 and an expected life of 4 years,
resulting in a valuation of $794,000 which has been recorded as an issuance
cost.

         In April 2000, the Company received $625,000 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, 2001, the remaining warrants
issued as part of the January 1996 private placement to purchase 125,000 shares
of Common Stock, which had not been exercised, had been cancelled.



                                       44
<PAGE>

         In January 2000, the Company received $2,000,000 from Pharmacia 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 Pharmacia 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 Pharmacia 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 Pharmacia at average prevailing
market prices if the Company achieves certain milestones, the first of which was
reached in September of 1999.




                                       45
<PAGE>



Stock Option Plan.

         At December 31, 2001, a total of 3,162,705 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, with the first 25% vesting after one year). 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, 1999                              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
 Additional shares reserved                               405,916               -                -                    -
 Granted                                                  (98,750)         98,750      4.56 - 5.88                 5.05
 Exercised                                                      -        (241,117)     0.60 - 4.38                 1.21
 Forfeited                                                116,349        (116,349)     1.13 - 6.38                 3.94
                                                        ---------     -----------
 Balances at December 31, 2000                            787,996       1,918,103     $0.60 - 9.25                $2.53
 Additional shares reserved                               497,014
 Granted                                                 (444,500)        444,500     $1.02 - 2.20                $1.52
 Exercised                                                                (40,406)    $0.60 - 1.13                $0.66
 Forfeited                                                 35,443         (35,443)    $1.45 - 5.88                $3.71
                                                        ---------     -----------
 Balances at December 31, 2001                            875,953       2,286,754     $0.60 - 9.25                $2.35
                                                        =========     ===========
------------------------------------------------------------------------------------------------------------------------
</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                707,809              5.67              $0.97             640,391            $0.97
         $1.20-$2.75                926,697              6.67               2.06             551,285             2.42
         $2.81-$5.25                572,034              5.97               3.97             550,568             3.95
         $5.63-$9.25                 80,214              5.52               6.25              73,398             6.28
                                  ---------              ----              -----           ---------            -----
                                  2,286,754              6.14              $2.35           1,815,642            $2.53
                                  =========              ====              =====           =========            =====
------------------------------------------------------------------------------------------------------------------------
</TABLE>

         The weighted average grant date fair values of options granted during
2001, 2000 and 1999 was 1.52, $5.05 and $1.28, respectively



                                       46
<PAGE>



         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.

         The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options that 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 2001, 2000 and 1999, 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 1.09, 1.14 and 1.15; 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>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------
                                                                             2001            2000          1999
-----------------------------------------------------------------------------------------------------------------
<S>                                                                      <C>             <C>            <C>
Net income (loss) applicable to common stockholders
 - as presented                                                          $   (9,556)     $  (3,443)     $   1,128
Net loss applicable to common stockholders - pro forma                      (10,200)        (4,619)           (35)

Basic net income (loss) per share applicable to common
  stockholders - as presented                                                 (0.38)         (0.15)          0.06
Basic net income (loss) per share applicable to common
  stockholders - pro forma                                                    (0.41)         (0.20)         (0.00)

Diluted net income (loss) per share applicable to common
  stockholders - as presented                                                 (0.38)         (0.14)          0.06
Diluted net income (loss) per share applicable to common
  stockholders -pro forma                                                     (0.41)         (0.19)         (0.00)
-----------------------------------------------------------------------------------------------------------------
</TABLE>

         The pro forma impact of options on the net income (loss) for 2001, 2000
and 1999 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.




                                       47
<PAGE>



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. In
June 2000, the Company's shareholders approved an additional 85,000 shares of
Common Stock be reserved for issuance under the 1994 Employee Stock Purchase
Plan. During the years ended December 31, 2001, 2000 and 1999, respectively,
45,759, 20,465 and 19,577 shares of Common Stock were issued pursuant to this
plan. At December 31, 2001, an additional 37,129 shares are reserved for
issuance under this plan. The effects of this plan on the pro forma disclosures
above are not material.

7.       NOTES RECEIVABLE FROM STOCKHOLDER

            In May 2000, the Company issued loans to Dr. Chandrasekaran, the
Company's President, Chief Executive Officer (CEO), Chief Financial Officer
(CFO) and Chairman of the Board, related to his exercise of 126,667 options to
acquire common stock. In May 2001, the terms on the loans were extended from 4
years to 5 years. The loans are full recourse and bear interest at 7% per annum.
Interest payments are due semi-annually and principal payments are due annually.
While the 126,667 shares of common stock issued secure the loans, the Company is
not limited to these shares to satisfy the loan.

8.       LEGAL PROCEEDINGS

         From time to time, the Company may be 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 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.

9.      QUARTERLY RESULTS (UNAUDITED)

        The following table is a summary of the quarterly results of operations
for the years ended December 31, 2001 and 2000. The Company believes that the
following information reflects all normal recurring adjustments necessary for a
fair presentation of the information for the periods presented. The operating
results for any quarter are not necessarily indicative of results for any future
period.

<TABLE>
<CAPTION>
                                                                 (in thousands, except per share amounts)

                                                                                   2001

                                                  First           Second          Third          Fourth         Total
                                                  Quarter         Quarter         Quarter        Quarter         Year
                                                  --------------------------------------------------------------------
<S>                                              <C>             <C>             <C>            <C>            <C>

Revenues                                         $   2           $   1           $   1          $   1         $    5
Loss from operations                              (2,292)         (2,433)         (2,562)        (2,841)       (10,128)
Net loss                                          (2,059)         (2,266)         (2,457)        (2,774)        (9,556)
Basic and diluted loss per share:                $ (0.08)        $ (0.09)        $ (0.10)       $ (0.11)      $  (0.38)
Shares used to calculate basic and
  diluted net loss per share                      24,873          24,891          24,907         24,915         24,897
                                                 =======         =======         =======        =======       ========
</TABLE>


<TABLE>
<CAPTION>
                                                                                   2000

                                                  First           Second          Third          Fourth         Total
                                                 Quarter*        Quarter*        Quarter*        Quarter         Year
                                                 ---------------------------------------------------------------------
<S>                                              <C>             <C>             <C>            <C>            <C>
Revenues                                         $   402         $   398         $   410        $ 3,303        $ 4,513

Income (loss) from operations                       (418)           (422)         (1,121)         2,216            255

Net income (loss) applicable to common
  stockholders before cumulative effect
  of change in accounting principle                 (337)           (253)           (850)         2,483          1,043

Cumulative effect of accounting change            (4,486)             --              --             --         (4,486)

Net income (loss) applicable to common
  stockholders                                    (4,823)           (253)           (850)         2,483         (3,443)

Basic earnings (loss) per share:

Net income (loss) per share applicable to
  common stockholders before cumulative
  effect of accounting change                      (0.02)          (0.01)          (0.03)          0.10           0.04

Cumulative effect of accounting change             (0.21)             --              --             --          (0.19)

Net income (loss) per share applicable to
  common stockholders                              (0.23)          (0.01)          (0.03)          0.10          (0.15)

Diluted earnings (loss) per share:

Net income (loss) per share applicable to
  common stockholders before cumulative
  effect of accounting change                    $ (0.02)        $ (0.01)        $ (0.03)       $  0.10        $  0.04

Cumulative effect of accounting change             (0.21)             --              --             --          (0.18)

Net income (loss) per share applicable to
  common stockholders                              (0.23)          (0.01)          (0.03)          0.10          (0.14)

Shares used to calculate basic net
  income (loss) per share                         21,058          23,601          24,795         24,843         23,574

Shares used to calculate diluted net
  income (loss) per share                         21,058          23,601          24,795         25,965         24,483
                                                 =======         =======         =======        =======        =======
</TABLE>


* The first, second and third quarter differ from Form 10Q originally filed with
the SEC for the respective periods because of a cumulative accounting change
related to the implementation of SAB 101. In Note 1, see Revenue Recognition,
for additional information about the cumulative accounting change.

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 will be
held on June 3, 2002 (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.




                                       48
<PAGE>



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

(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

         See Exhibit Index on page 52 of this Annual Report on Form 10-K.

(b)      Reports on Form 8-K

         None.

(c)      Exhibits

         See Exhibit Index on page 52 of this Annual Report on Form 10-K.

(d)      Financial Statement Schedules

         See (a)(2) above.

                                   SIGNATURES

         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 29, 2002
                                          INSITE VISION INCORPORATED


                                    By:   /s/ S. Kumar Chandrasekaran
                                          -----------------------------------


                                       49
<PAGE>


                                          S. Kumar Chandrasekaran, Ph.D.
                                          Chairman of the Board, President,
                                          Chief Executive Officer and
                                          Chief Financial Officer



                                       50
<PAGE>



                                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 29, 2002
----------------------------------------    Chief Executive Officer and
     S. Kumar Chandrasekaran, Ph.D.         Chief Financial Officer

/s/  Mitchell H. Friedlaender               Director                                March 29, 2002
----------------------------------------
     Mitchell H. Friedlaender, M.D.


/s/  John L. Mattana                        Director                                March 29, 2002
----------------------------------------
     John L. Mattana

/s/  Jon S. Saxe                            Director                                March 29, 2002
----------------------------------------
     Jon S. Saxe

/s/  Anders P. Wiklund                      Director                                March 29, 2002
----------------------------------------
     Anders P. Wiklund
</TABLE>




                                       51
<PAGE>


                                  EXHIBIT INDEX

Number         Exhibit Table
------         -------------
3.1(1)      Restated Certificate of Incorporation.

3.2(7)      Amendedand 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.

10.1(13)    InSite Vision Incorporated 1994 Employee Stock Purchase Plan (As
            amended and restated through April 17, 2000).

10.2(2)     Form of Indemnity Agreement Between the Registrant and its directors
            and officers.

10.3(2)     Form of Employee's Proprietary Information and Inventions Agreement.

10.4(3H)    License Agreement dated as of October 9, 1991 by and between the
            Company and CIBA Vision Corporation, as amended October 9, 1991.

10.5(3H)    Letter Agreement dated February 27, 1992 by and among the Company,
            Columbia Laboratories, Inc. and Joseph R. Robinson, as amended
            October 23, 1992.

10.6(2H)    Collaboration Agreement dated as of November 24, 1992 by and between
            the Company and British Bio-technology Limited.

10.7(2H)    Collaboration Agreement dated as of April 30, 1993 by and between
            the Company and British Bio-technology Limited.

10.8(8)     Facilities Lease, dated September 1, 1996, between the Registrant
            and Alameda Real Estate Investments.

10.9(1H)    Agreement dated as of February 15, 1994 by and between the Company
            and Timm A. Carpenter.

10.10(9HH)  InSite Vision Incorporated 1994 Stock Option Plan (Amended and
            Restated as of June 8, 1998).

10.11(1HH)  Form of InSite Vision Incorporated Notice of Grant of Stock Option
            and Stock Option Agreement, with Addenda.

10.12(9HH)  Form of InSite Vision Incorporated Notice of Automatic Option Grant
            and Non-Employee Director Option Agreement.

10.13(1)    InSite Vision Incorporated 1994 Employee Stock Purchase Plan.

10.14(1)    Form of InSite Vision Incorporated Stock Purchase Agreement.

10.15(1)    Form of InSite Vision Incorporated Employee Stock Purchase Plan
            Enrollment/Change Form.

10.16(4)    Letter Agreement dated February 3, 1995 between the Company and
            David G. Harper.

10.17(4)    Settlement Agreement and General Release dated March 3, 1995 between
            the Company and Clifford Orent.

10.18(5)    Common Stock Purchase Agreement dated January 19, 1996 between the
            Registrant and the Investors listed on Schedule 1 thereto.

10.19(6H)   ISV-205 License Agreement dated May 28, 1996 by and between the
            Company and CIBA Vision Ophthalmics.

10.20(6H)   ToPreSite License Agreement dated May 28, 1996 by and between the
            Company and CIBA Vision Ophthalmics.

10.21(6H)   BetaSite Contract Manufacturing Agreement dated July 18, 1996 by and
            between the Company and Bausch & Lomb Pharmaceuticals, Inc.

10.22(6H)   PilaSite License Agreement dated July 18, 1996 by and between the
            Company and Bausch & Lomb Pharmaceuticals, Inc.


                                       52
<PAGE>


   10.23(6H)   Timolol Development Agreement dated July 18, 1996 by and between
               the Company and Bausch & Lomb Pharmaceuticals, Inc.

   10.24(6H)   Stock Purchase Agreement dated July 18, 1996 by and between the
               Company and Bausch & Lomb Pharmaceuticals, Inc.

   10.25(10)   Engagement Agreement, dated April 1, 1997, by and between the
               Company and William Blair & Company LLC.

   10.26(10H)  License Agreement, dated July 1, 1997, by and between the
               University of Connecticut Health Center and the Company.

   10.27(10H)  License Agreement, dated August 19, 1997, by and between the
               University of Rochester and the Company.

   10.28(10)   Form of Securities Purchase Agreement, dated September 12, 1997,
               by and among the Company and the Selling Stockholders thereunder.

   10.29(10)   Form of Registration Rights Agreement, dated September 12, 1997,
               by and among the Company and the Selling Stockholders thereunder.

   10.30(10)   Form of Warrant, dated September 12, 1997, to William Blair &
               Company LLC.

   10.31(11H)  License Agreement, dated January 28, 1999, by and between the
               Company and Pharmacia & Upjohn AB.

   10.32(11H)  Stock Purchase Agreement, dated January 28, 1999, by and between
               the Company and Pharmacia & Upjohn AB and Pharmacia & Upjohn, SA.

   10.33(12)   Project Agreement, dated November 11, 1999, by and between the
               Company and Pharmacia & Upjohn AB.

   10.34(12)   Stock Purchase Agreement, dated November 11, 1999, by and between
               the Company and Pharmacia & Upjohn AB.

   10.35(12)   Credit Agreement, dated November 11, 1999, by and between the
               Company and Pharmacia & Upjohn Company.

   10.36(14)   Form of Stock and Warrant Purchase Agreement, dated May 1, 2000
               by and among the Company and the purchasers thereto.

   10.37(15)   ISV-900 Project Agreement Termination and Release, dated December
               10, 2000, by and between the Company and Pharmacia & Upjohn AB.

   10.38(15)   Credit Agreement Termination and Release, dated December 10,
               2000, by and between the Company and Pharmacia & Upjohn Company.

   10.39(16)   Placement Agent Agreement with Ladenburg Thalmann & Co., Inc.
               dated January 9, 2001.

   10.40(17)   Amendment No. 1 to Marina Village Office Tech Lease, dated July
               20, 2001 and effective January 1, 2002.

   10.41(18)   License Agreement, dated December 21, 2001 by and between the
               Company and The University of Connecticut Health Center.

   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").

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

2  Incorporated by reference to an exhibit 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 an exhibit 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.

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



                                       53
<PAGE>



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

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

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

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

9           Incorporated by reference to exhibits 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 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 an exhibit in the Company's Annual
            Report on Form 10-K for the year ended December 31, 1998.

12          Incorporated by reference to an exhibit in the Company's Annual
            Report on For 10-K for the year ended December 31, 1999.

13          Incorporated by reference to an exhibit to the Company's
            Registration Statement on Form S-8 (Registration No. 333-43504) as
            filed with the Securities and Exchange Commission on August 11,
            2000.

14          Incorporated by reference to an exhibit to the Company's
            Registration Statement on Form S-3 (Registration No. 333-38266) as
            filed with the Securities and Exchange Commission on June 1, 2000.

15          Incorporated by reference to an exhibit in the Company's Annual
            Report on Form 10-K for the year ended December 31, 2000.

16          Incorporated by reference to an exhibit to the Company's
            Registration Statement on Form S-3 (Registration No. 333-54912) as
            filed with the Securities and Exchange Commission on February 2,
            2001.

17          Incorporated by reference to an exhibit to the Company's Quarterly
            Report on Form 10-Q for the quarter ended September 30, 2001.

18          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.



                                       54